COPT DEFENSE PROPERTIES quarterly report, Q2 FY2017

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COPT Defense Properties (Corporate Office Properties Trust) — Q2 2017 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2017. Amounts are in U.S. dollars; financial statement amounts are generally in millions unless noted. COPT is a REIT whose operating assets and business are held primarily through Corporate Office Properties, L.P. (COPLP).

Business context

COPT owns, manages, leases and develops office and data-center properties, with most of its portfolio in locations serving U.S. government, defense and information-technology tenants. At quarter-end it reported 165 operating office properties totaling 17.3 million square feet, including 14 single-tenant data-center properties, plus development projects and land holdings. Portfolio office occupancy was 93.0%.

Financial and operating performance

  • Revenue: Q2 total revenue was $151.4 million, up from $145.9 million a year earlier. Real-estate operations revenue declined to $128.3 million from $133.9 million; construction and other service revenue rose to $23.1 million from $12.0 million. For the first half, total revenue was $291.2 million versus $290.2 million.
  • Profit: Q2 net income was $19.2 million versus a $48.3 million loss in Q2 2016. First-half net income was $42.3 million versus a $40.2 million loss. The prior-year results included substantially larger impairment charges. COPT common-share EPS was $0.08 for Q2 and $0.26 for the first half, versus losses of $0.54 and $0.51, respectively, in 2016. Q2 EPS included $6.8 million of costs associated with redeeming preferred shares.
  • Property operations: Q2 real-estate NOI was $81.0 million, down from $85.8 million; first-half NOI was $160.5 million, down from $167.0 million. Same-office occupancy improved to 92.7% at June 30 from 91.9% at December 31, 2016. Same-office NOI rose to $70.9 million in Q2 from $69.5 million. Comparable diluted FFO per share, as adjusted for comparability, was $0.49 in Q2 versus $0.52, and $0.97 for the first half versus $0.99.
  • Cash flow: First-half operating cash flow was $117.7 million, compared with $124.4 million in 2016. Investing activities used $59.0 million, versus $104.2 million, reflecting higher property-sale proceeds. Financing activities used $258.0 million, primarily including $199.1 million to redeem preferred shares or units and $66.0 million in dividends and distributions. Cash and cash equivalents fell to $10.6 million from $209.9 million at year-end.
  • Debt and liquidity: Debt, net, was $1.898 billion at June 30, compared with $1.904 billion at December 31, 2016. The company repaid $200 million on a term loan and had $194 million outstanding on its revolving facility; $606 million of the facility’s $800 million capacity was available. Management said liquidity was adequate for near- and longer-term requirements without requiring property sales. The company was compliant with debt covenants.
  • Distributions and capital: The declared common dividend was $0.275 per share each quarter ($0.55 for the first half), unchanged from 2016. COPT redeemed its Series K and Series L preferred shares during the first half and raised $19.7 million net through its at-the-market common-share program.

Material changes, outlook and risks

  • The $1.6 million Q2 impairment charge primarily related to White Marsh properties reclassified as held for sale. Q2 2016 included $69.7 million of impairment losses; the first-half 2016 total was $72.1 million.
  • On July 28, 2017, COPT sold its remaining White Marsh assets, including eight operating properties totaling 412,000 square feet and land, for $47.5 million. Net proceeds were primarily used to repay revolver borrowings.
  • Management expected to spend approximately $110 million on construction and development and $30 million on improvements to operating properties during the remainder of 2017. The filing provides no specific earnings or FFO guidance.
  • Development activity included eight office properties under construction or contractually committed, estimated at 1.3 million square feet, and two redevelopment projects estimated at 61,000 square feet. Newly constructed or redeveloped space placed in service during the first half was 79% leased at quarter-end.
  • Key disclosed risks include changes in government budgets or demand, real-estate market and tenant conditions, interest rates and refinancing, development costs and leasing, joint-venture partner performance, impairment judgments, REIT qualification and environmental requirements. A 1% increase in LIBOR would have increased first-half interest expense by an estimated $401,000, based on period-end variable-rate debt and hedges.
  • Other commitments include $53.3 million of development and redevelopment obligations, $50.7 million of operating-property capital expenditures and $65.1 million of third-party construction obligations expected to be reimbursed by clients. Ground-lease payments extend through 2100; a new 99-year ground lease generated a $16.2 million capital-lease obligation.
  • The filing reported no material off-balance-sheet arrangements, no material litigation, no material changes to previously disclosed risk factors, and effective disclosure controls.

Important facts for investors to verify

  • Whether the White Marsh sale proceeds materially reduced revolving borrowings and how disposition proceeds affect recurring rental revenue and NOI.
  • Leasing, occupancy and completion progress for development projects, especially space intended for U.S. government tenants.
  • Underlying same-property performance and the divergence between declining total real-estate NOI and improving same-office occupancy and NOI.
  • Debt maturities, refinancing conditions, variable-rate exposure and continued compliance with financial covenants.
  • The sustainability of the $0.275 quarterly common dividend relative to operating cash flow, capital needs and the REIT distribution requirement.