COPT Defense Properties (Corporate Office Properties Trust) — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017; comparisons are to the corresponding 2016 periods unless noted. Amounts are in U.S. dollars; financial statement amounts are generally in millions.
Business context
COPT is a REIT that conducts nearly all operations through Corporate Office Properties, L.P. The company owns, manages, leases and develops office and data-center properties, with much of its portfolio serving U.S. government, defense and information-technology tenants. At quarter-end, it reported 159 operating office properties totaling 17.4 million square feet, including 15 single-tenant data-center properties, and a 19.25-megawatt wholesale data center.
Financial and operating performance
- Revenue: Q3 total revenue was $157.0 million, up from $142.1 million. Nine-month revenue was $448.3 million, up from $432.3 million. Growth in construction and other services more than offset lower real-estate operating revenue; service revenue largely reflects reimbursed subcontracting costs and carries a small margin.
- Profit and EPS: Q3 net income was $22.7 million versus $29.3 million; common-share EPS was $0.21 versus $0.25. Nine-month net income was $65.0 million versus a $10.9 million loss; common-share EPS was $0.47 versus a loss of $0.26 per share.
- Non-GAAP measures: Q3 real-estate NOI was $82.2 million versus $82.0 million; nine-month NOI was $242.7 million versus $249.0 million. Diluted FFO per share was $0.55 for Q3 and $1.47 for nine months, compared with $0.49 and $1.25. Adjusted diluted FFO per share was $0.53 and $1.50, respectively, versus $0.51 and $1.50.
- Cash flow: Nine-month operating cash flow was $170.7 million, approximately level with $170.0 million in 2016. Investing activities used $52.7 million, compared with providing $77.9 million in 2016, primarily reflecting lower property-sale proceeds. Financing activities used $317.0 million. Cash and cash equivalents declined to $10.9 million from $209.9 million at year-end 2016; the cash-flow statement does not provide Q3-only cash flow.
- Debt and liquidity: Debt, net, was $1.873 billion, down from $1.904 billion at year-end. The $800 million revolver had $170 million drawn and $630 million available. The company reported compliance with debt covenants and investment-grade ratings. The revolver matures in May 2019, with two optional six-month extensions subject to conditions.
- Dividends and capital: COPT redeemed its preferred shares during the period for $199.1 million in aggregate, including $172.5 million for Series L. It issued common shares through its ATM program for $19.7 million net proceeds. Common dividends declared were $0.275 per share for Q3 and $0.825 per share for nine months.
- Occupancy: Office portfolio occupancy was 93.4% at September 30, up from 92.1% at December 31, 2016. Same-office occupancy rose to 92.6% from 91.8% at year-end. The wholesale data center had 16.9 of 19.25 megawatts leased.
Material changes and unusual items
- Q3 operating income rose to $38.9 million from $11.5 million, aided by a $27.9 million year-over-year reduction in impairment expense. Nine-month impairment losses were $1.5 million versus $99.8 million in 2016, when the company recorded substantial write-downs amid a property-disposition strategy.
- Net income comparisons also reflect property-sale gains: Q3 gains were $1.2 million versus $34.1 million in 2016; nine-month gains were $5.4 million versus $34.1 million. Thus, higher nine-month net income largely reflects the prior-year impairment burden, while lower prior-year comparison-period gains affected reported profit.
- Real-estate revenue declined year over year for both Q3 and the nine-month period, partly reflecting dispositions. Same-office NOI increased, while nine-month total NOI declined, including the effect of sold properties.
- On October 27, 2017, COPT sold two data-center-shell properties for $29.2 million and $44.3 million. For the latter sale, COPT gave the buyer a guaranty of up to $20 million for specified losses tied to a potential capital event through June 30, 2019. The filing says sale accounting will be deferred and the proceeds recorded as a liability until the guaranty expires; management did not expect a loss.
Outlook, risks and commitments
No formal earnings or FFO guidance is stated in the provided filing text. Management said it expects liquidity and capital resources to meet near- and longer-term needs without requiring property sales. It expected to spend approximately $60 million on construction and development and $20 million on operating-property improvements during the remainder of 2017, funded primarily through revolver borrowings and operating cash flow, respectively.
Key risks include changes in government budgets, shutdowns or demand; tenant renewals and credit; interest rates and refinancing; development costs, schedules and leasing; real-estate market conditions and property values; joint-venture partner performance; REIT qualification; and environmental requirements. Contractual obligations totaled $2.55 billion, including debt principal and interest, development commitments, capital expenditures and lease payments. The filing reported no material off-balance-sheet arrangements, no material litigation expected to affect the company, and no material change to previously disclosed risk factors.
Important facts for investors to verify
- Whether occupancy and same-office NOI gains continue to offset rental-revenue declines and the impact of property dispositions.
- The composition and cash-generating quality of reported revenue growth, particularly construction and other service revenue with small margins.
- Liquidity after preferred-share redemptions, the low reported cash balance, revolver usage and the 2019 maturity/extension terms.
- Leasing progress and completion costs for development projects, including the 1.1 million square feet under construction or committed.
- The outcome and accounting treatment of the October property sale guaranty, and any future impairment or sale gains and losses.
- The sustainability of distributions relative to cash flow, debt service and planned capital spending; FFO and adjusted FFO are supplemental non-GAAP measures, not substitutes for cash flow.