COPT Defense Properties (Corporate Office Properties Trust) — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016. COPT is a REIT whose operating partnership owns and operates office and data-center properties, predominantly serving U.S. government, defense and IT tenants. At quarter-end, the portfolio included 181 operating office properties totaling 18.4 million square feet and a 19.25-megawatt wholesale data center.
Financial performance and position
| Metric | Q2 2016 | Six months 2016 |
|---|---|---|
| Total revenue | $145.9 million | $290.2 million |
| Operating income (loss) | $(27.0) million | $3.4 million |
| Net income (loss) | $(48.3) million | $(40.2) million |
| Net income (loss) attributable to COPT common shareholders | $(51.0) million; $(0.54) per share | $(47.7) million; $(0.51) per share |
| Real estate NOI | $85.8 million | $167.0 million |
| FFO per diluted share | $0.36 | $0.75 |
| Adjusted FFO per diluted share | $0.52 | $0.99 |
| Operating cash flow | Not separately reported for the quarter | $124.4 million |
Six-month operating cash flow was $122.8 million in the prior-year period. Cash and cash equivalents were $13.3 million at June 30, 2016, versus $60.3 million at December 31, 2015. Net debt was $2.094 billion, compared with $2.078 billion at year-end. The company declared common dividends of $0.275 per share for the quarter ($0.55 for the first half).
Material changes and notable items
- Q2 revenue declined 14% year over year, mainly because construction and other service revenue fell to $12.0 million from $42.2 million as tenant-related construction activity slowed. First-half revenue fell 12% to $290.2 million; real-estate operating revenue increased $16.1 million, but service revenue declined $57.3 million.
- Impairment charges were $69.7 million in Q2 and $72.1 million for the first half, compared with $1.2 million in the first half of 2015. The charges reflected a revised strategy to sell or not develop selected properties and land, including Aberdeen, Maryland assets and properties in Northern Virginia, the Fort Meade/BW Corridor, Frederick and Greater Philadelphia.
- Real-estate NOI rose to $85.8 million in Q2 from $81.8 million and to $167.0 million for the first half from $153.8 million. Same-office occupancy was 90.8% at June 30, down from 91.1% at year-end; overall operating-office occupancy was 91.2%, versus 91.6% at year-end.
- Executive transition costs were $4.4 million for the first half. Stephen E. Budorick became CEO on May 12, 2016; former CEO Roger A. Waesche and development executive Wayne H. Lingafelter departed.
- Accumulated derivative losses and the liability for interest-rate swaps increased; swap liabilities were $20.2 million at quarter-end. The company estimated $5.6 million of accumulated losses would be reclassified to interest expense over the next 12 months.
Liquidity, outlook and risks
Operating cash flow was $124.4 million for the first half; investing activities used $104.2 million and financing activities used $67.2 million. The $800 million revolving credit facility had $727.2 million available at June 30, and a further $150 million was available under an unsecured term loan. On July 1, the company repaid $162.5 million of 2016 debt maturities using the revolver. Management said liquidity was adequate for near- and longer-term needs without requiring property sales, but expected approximately $440 million of property-interest sales in 2016 to repay borrowings and fund development. It also expected to spend about $95 million on construction and development and $35 million on operating-property improvements during the remainder of 2016.
On July 21, 2016, COPT contributed six single-tenant data-center properties to a joint venture, sold a 50% interest for $44 million, and obtained $60 million of nonrecourse mortgage financing through the venture. It expects to account for its retained 50% interest using the equity method and recognized an approximately $18 million partial gain.
Key risks include federal budget reductions, shutdowns or delays affecting tenant demand and lease renewals; occupancy and leasing conditions; execution and financing of development projects; asset-sale pricing and further impairments; joint-venture partner obligations; interest-rate exposure; and REIT qualification. Management reported compliance with debt covenants at June 30. No material off-balance-sheet arrangements or material litigation were reported. Management stated disclosure controls were effective and there were no material changes to internal control over financial reporting.
Most important facts for investors to verify
- Whether planned 2016 property-interest sales materialize at expected values and proceeds, and how they affect debt and development funding.
- Whether the impairment-driven portfolio strategy leads to additional write-downs or changes in operating results.
- Occupancy, lease renewals and tenant demand, particularly in government- and defense-oriented markets and the wholesale data center.
- Debt maturities, revolving-credit usage, covenant headroom and derivative exposure, including the expected $5.6 million interest-expense reclassification.
- Underlying operating performance alongside GAAP losses: adjusted FFO excludes specified impairments, derivative losses and transition costs and is not a substitute for cash flow.