COPT DEFENSE PROPERTIES (Corporate Office Properties Trust) — Q3 2016 Form 10-Q
Business context and reporting period
Quarter ended September 30, 2016; financial statements are unaudited. COPT is a REIT that conducts nearly all operations through Corporate Office Properties, L.P. The portfolio focuses on office and data-center properties, primarily serving U.S. government, defense and IT tenants. At quarter-end, it had 168 operating office properties totaling 17.5 million square feet, plus development and land holdings.
Key financial metrics
| Metric | Q3 2016 | Nine months 2016 |
|---|---|---|
| Total revenue | $142.1 million | $432.3 million |
| Operating income | $11.5 million | $15.0 million |
| Net income (loss) | $29.3 million | ($10.9 million) |
| Net income (loss) attributable to COPT common shareholders | $23.7 million; $0.25 per share | ($24.0 million); ($0.26) per share |
| NOI from real estate operations | $82.0 million | $249.0 million |
| Operating cash flow | Not separately provided | $170.0 million |
Common dividends declared were $0.275 per share for Q3 and $0.825 per share for the first nine months, unchanged from 2015. At September 30, cash and cash equivalents were $47.6 million; debt, net, was $1.874 billion; total assets were $3.634 billion. The $800 million revolving credit facility was fully available at quarter-end, and an additional $150 million term-loan commitment was available. Debt covenants were satisfied. COPT itself had no direct debt, but guaranteed specified COPLP debt.
Material changes versus prior comparable periods
- Q3 revenue declined 5.7% from $150.7 million; nine-month revenue fell 10.3% from $482.1 million. Real-estate operations revenue increased, but construction and other service revenue dropped substantially as project activity declined.
- Q3 operating income fell from $32.0 million to $11.5 million, while nine-month operating income fell from $100.0 million to $15.0 million. Impairment losses were $27.7 million in Q3 and $99.8 million year to date, versus $2.3 million and $3.5 million, respectively, in 2015.
- Q3 net income included a $34.1 million gain on real-estate sales. Nine-month results also reflect $34.1 million of sale gains, but were weighed down by impairments. The prior-year periods benefited from an approximately $85.7 million gain on early debt extinguishment.
- Real-estate NOI was $82.0 million in Q3, down from $84.8 million; nine-month NOI rose to $249.0 million from $238.6 million. Portfolio occupancy was 91.3% at quarter-end versus 91.6% at December 2015.
- Operating cash flow increased to $170.0 million from $147.7 million for the first nine months. Investing activities provided $77.9 million, versus $371.3 million used in 2015, largely reflecting greater property-sale proceeds and no 2016 acquisitions. Financing activities used $260.6 million.
Outlook, commentary, risks and unusual items
- Management expected to raise more than $100 million from property-interest sales during the remainder of 2016, using proceeds to repay borrowings and fund development. It expected approximately $30 million of construction and development spending and $20 million of operating-property improvements for the remainder of 2016. Management stated liquidity was adequate without requiring property sales.
- During the first nine months, COPT sold 15 operating properties totaling 1.1 million square feet for $210.7 million, sold land for $5.7 million, and contributed a 50% interest in six Virginia data-center properties to a joint venture. The joint venture transaction generated $44.3 million in proceeds from the partner’s purchase of its interest and a $17.9 million partial gain.
- Impairments reflected a changing disposition strategy, weaker local market conditions, reduced sale-price indications, and uncertainty about a major tenant’s renewal of a lease expiring in 2019. Further changes in property plans or market values could produce additional impairment charges. Assets held for sale were $161.5 million at quarter-end.
- Other notable items included approximately $6.0 million of executive transition costs, a $17.3 million interest-rate-derivative liability, and an estimated $5.2 million of derivative losses expected to be reclassified to interest expense over the next 12 months. On October 12, 2016, the company repaid a $120 million term loan, primarily using cash and revolving-facility proceeds.
- Key risks include government budget reductions or shutdowns, tenant demand and lease renewals, office-market conditions, development execution and costs, financing and interest-rate exposure, joint-venture risks, and possible dilution from equity issuance. The filing provided no specific earnings or FFO guidance.
Most important facts for investors to verify
- Whether planned property sales were completed at expected prices and whether further asset impairments were recorded.
- Tenant renewal prospects, particularly the major tenant with a 2019 lease expiration, and occupancy trends in weaker submarkets.
- Debt maturities, variable-rate exposure, swap obligations and liquidity following the $120 million term-loan repayment.
- Whether development commitments, leasing and expected spending translate into occupancy and cash-flow growth.
- How much of reported earnings and adjusted FFO reflects recurring operations versus sale gains, impairments and other adjustments.