COPT Defense Properties (then Corporate Office Properties Trust) — Q2 2015 Form 10-Q
Reporting period: Three and six months ended June 30, 2015. COPT is a REIT that conducts substantially all operations through Corporate Office Properties, L.P. The portfolio focuses on office and data-center properties serving U.S. government agencies and contractors, particularly in the Greater Washington, D.C./Baltimore region. Unless noted, figures below are consolidated and in U.S. dollars.
Financial results and key metrics
- Q2 revenue: $170.4 million, up 21.8% from $139.8 million. Rental revenue was $105.5 million, up from $94.3 million; construction and other service revenue rose to $42.2 million from $23.9 million, with substantially offsetting service costs.
- Q2 earnings: Operating income was $37.5 million versus $31.8 million; net income was $17.2 million versus $9.1 million. Net income attributable to COPT common shareholders was $12.2 million, or $0.13 per diluted share, compared with $1.8 million, or $0.02, a year earlier. The comparison reflects, among other items, lower preferred dividends and prior-year preferred-share redemption costs.
- First-half results: Revenue was $331.4 million versus $286.5 million; operating income $68.0 million versus $57.0 million; and net income $32.0 million versus $14.7 million. Common-shareholder net income was $22.0 million versus $2.0 million. The 2015 period included a $4.0 million gain on land sales.
- Property operations: Q2 real-estate NOI was $81.8 million, up $9.7 million year over year; first-half NOI was $153.8 million, up $6.6 million. First-half same-office NOI declined $1.0 million (about 0.7%). Q2 operating margin was approximately 22.0% of total revenue; construction/service activities had $0.9 million of NOI on $42.2 million of revenue, reflecting their low-margin, largely reimbursed-cost nature.
- FFO: Diluted FFO per share was $0.48 for Q2 versus $0.37; adjusted diluted FFO per share was $0.52 versus $0.44. For the first half, the respective figures were $0.92 versus $0.85 and $0.97 versus $0.92. These are non-GAAP measures and should not be treated as operating cash flow or cash available for distributions.
- Cash flow: First-half operating cash flow was $122.8 million, up from $103.0 million. Investing used $261.0 million, including $137.1 million for acquisitions and $117.5 million for construction, development and redevelopment. Financing provided $169.2 million. Cash and equivalents were $37.1 million at June 30, versus $6.1 million at year-end.
- Debt and liquidity: Debt, net, was $2.13 billion versus $1.92 billion at December 31, 2014. The $800 million revolver had $785.2 million available at quarter-end. Total assets were $3.91 billion and total liabilities $2.37 billion. Management said liquidity was adequate for near- and longer-term requirements; the company was compliant with debt covenants.
- Distribution and equity: The common dividend was $0.275 per share per quarter, unchanged year over year. COPT issued 890,241 shares through its ATM program at a weighted-average $30.29, raising $26.6 million net.
Material changes and operating developments
- Portfolio occupancy was 92.0% at June 30, compared with 90.9% at year-end; same-office occupancy was 91.2%, up from 90.8%. The average contractual annual rental rate was $29.63 per square foot, versus $29.27.
- The company acquired two office properties for a combined $142.4 million: 250 W. Pratt Street in Baltimore and 2600 Park Tower Drive in Northern Virginia. They contributed $4.0 million of Q2 revenue and $40,000 of continuing-operations net income.
- It placed 620,000 square feet of newly constructed or redeveloped space into service during the first half; those properties were fully leased at June 30. Six properties were under construction or committed for construction, estimated at 1.0 million square feet, with six more under redevelopment.
- The wholesale data center had 12.5 megawatts in operation at quarter-end; 11.06 megawatts were leased, and a further 6.75 fully leased megawatts were under development. The completed facility is expected to have a 19.25-megawatt critical load.
- Six Greater Baltimore properties and one Northern Virginia property, with $77.0 million of net assets, were classified as held for sale. The company recorded a $1.2 million impairment on a Northern Virginia property. It sold land for $18.1 million during the first half and recognized a $4.0 million gain.
Debt, outlook, risks and contingencies
- A $150 million nonrecourse mortgage secured by two Northern Virginia properties was in default. The properties were 25.4% occupied; their cash flows had belonged to the lender since April 2014. Management expected to extinguish the obligation through conveyance of the properties. The filing includes $150 million in 2015 maturities for this loan and adds the properties’ negative FFO to its adjusted FFO measure.
- On May 6, the company extended the revolver maturity to May 2019, with two optional six-month extensions, and consolidated/amended a term loan, including a $50 million increase and extension of that loan’s maturity to May 2020. On June 29, it issued $300 million of 5.00% senior notes due 2025; proceeds were used primarily to repay revolver borrowings. Debt rose despite these financing actions, partly in connection with acquisitions and investment spending.
- Management expected to spend more than $170 million on construction and development and approximately $40 million on operating-property improvements during the remainder of 2015. It expected to finance development and an anticipated acquisition using cash and revolver borrowings, and use property-sale proceeds primarily to repay revolver debt. No formal earnings or FFO guidance is provided in the supplied filing text.
- Interest-rate exposure is material: a 1% increase in one-month LIBOR would have increased first-half interest expense by an estimated $1.5 million. Approximately $3.3 million of derivative losses were expected to be reclassified to interest expense over the next 12 months.
- Key business risks cited include government budget reductions or shutdowns affecting demand and leases, real-estate market and financing conditions, development and acquisition execution, joint-venture risks, dilution from equity issuance, REIT qualification, and environmental requirements. Management reported no material change to the prior annual report’s risk factors.
- Commitments included $32.3 million for new construction/redevelopment, $39.8 million for operating-property capital expenditures, and $21.5 million for third-party construction projects expected to be reimbursed. Contingencies include a $2.4 million estimated tax-incremental-financing obligation and environmental indemnities with stated caps and duration limits. Management did not expect routine legal matters to materially affect financial position, operations or liquidity.
- After quarter-end, the company sold 1550 Westbranch Drive for $27.8 million, approximately its carrying value; proceeds were primarily intended to repay revolver borrowings. Management reported effective disclosure controls and no material change in internal control over financial reporting.
Investor verification priorities
- Track resolution and final accounting for the $150 million defaulted mortgage, including conveyance timing, lender claims and any remaining obligations.
- Review debt maturities, revolver usage and availability, covenant headroom, and the cost and terms of any refinancing.
- Confirm occupancy, lease renewals and rental rates, especially in weaker submarkets and among government-related tenants; assess data-center lease commencements and delivery timing.
- Compare actual development, redevelopment and capital-spending requirements with management’s 2015 estimates, and monitor leasing and returns on recently acquired and completed properties.
- Assess recurring earnings and distribution coverage apart from the land-sale gain, preferred-share effects, acquisition contributions and the company’s adjusted FFO exclusions; consider dilution from ATM issuance.
- Review the full notes and subsequent filings for held-for-sale dispositions, environmental and tax-related contingencies, and the assumptions behind fair-value estimates.