COPT DEFENSE PROPERTIES annual report, FY2013

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COPT 2013 Form 10-K Summary

Business context and reporting period

Corporate Office Properties Trust (COPT), a REIT, conducts nearly all operations through Corporate Office Properties, L.P. (COPLP). The fiscal year ended December 31, 2013; this is an annual filing, not a standalone fourth-quarter report. COPT focuses on office and data-center properties serving U.S. government agencies and defense contractors, primarily in the Greater Washington, D.C./Baltimore region.

  • At year-end, the portfolio included 183 operating office properties totaling 17.4 million square feet, 89.1% occupied, plus a partially operational wholesale data center.
  • About 87% of office square footage was in the Greater Washington, D.C./Baltimore region. Strategic Tenant Properties generated 69.7% of office annualized rental revenue.

Financial performance and condition

  • Revenue: $523.4 million, up 3.0% from $508.1 million in 2012. Real estate operations revenue rose to $461.0 million from $434.3 million; construction and service revenue fell to $62.4 million from $73.8 million.
  • Operating results: Operating income was $141.9 million versus $89.1 million. Net income was $101.5 million versus $20.3 million; income attributable to COPT common shareholders was $70.8 million, or $0.83 per share, compared with a $1.7 million loss, or $0.03 loss per share, in 2012.
  • NOI and FFO: Real estate NOI increased to $317.9 million from $312.4 million. Diluted FFO rose to $2.40 per share from $2.13; diluted FFO adjusted for comparability declined to $1.97 from $2.11.
  • Cash flow: Operating cash flow was $159.0 million, down from $191.8 million. Investing activities used $119.8 million, compared with $13.7 million provided in 2012. Financing activities provided $4.6 million versus $200.5 million used.
  • Debt and liquidity: Debt was $1.928 billion at year-end, down from $2.019 billion. Cash and cash equivalents were $54.4 million; $784.6 million was available under the $800 million revolving facility. Management reported covenant compliance.
  • Distributions: Common dividends were $1.10 per share for 2013, paid at $0.275 quarterly. The filing reports the same annual common dividend in 2012.

Material changes versus 2012

  • Occupancy improved to 89.1% from 87.8%, although much of the increase reflected sales of lower-occupancy properties. Same-office occupancy edged up to 89.8% from 89.5%.
  • Real estate NOI growth reflected same-office NOI of $256.1 million, up $3.6 million, and increased contributions from newly placed-in-service properties. Same-office average occupancy rose 1.3 percentage points to 90.2% on an annual average basis.
  • Reported net income included significant disposition-related items: a $67.8 million gain from transferring properties to extinguish a $146.5 million nonrecourse loan, partly offset by a $27.0 million loss on early debt extinguishment. Discontinued operations contributed $55.7 million of income.
  • COPT sold or conveyed 31 operating properties totaling 2.3 million square feet for aggregate transaction values of $293.3 million, completing its exit from the Colorado Springs operating segment. It also placed 812,000 square feet of new properties into service.
  • Financing actions included issuing $600 million of senior notes, raising $157.4 million net from common equity offerings, repaying nearly all $239.4 million principal of its 4.25% exchangeable notes, and redeeming $84.8 million of Series J preferred shares. Fixed-rate debt rose to 89% from 80%, unsecured debt to 63% from 50%, and weighted average debt maturity to 5.0 years from 3.2 years.

Outlook, commentary, risks and unusual items

  • Management said the January 2014 federal appropriations act supported expectations for generally flat defense spending over the next three years and a more normalized government contract-award process. Management viewed this as potentially supportive of leasing near defense installations; this is an outlook, not quantified company guidance.
  • Management expected more than $280 million of construction and development spending and approximately $40 million of operating-property improvements in 2014. It expected to fund 2014 debt maturities primarily through credit facilities and debt markets. Scheduled 2014 debt maturities were $89.5 million; 2015 maturities were $396.0 million.
  • Tenant and government exposure is material: the U.S. government represented 24.8% of office annualized rental revenue, the four largest tenants 41.0%, and the top 20 tenants 65.1%. Many government leases have one-year terms or early termination rights and may depend on congressional funding.
  • The wholesale data center had 9 MW operational and 6.3 MW leased against an expected stabilized 18 MW critical load. Management cautioned that leasing could remain slow and new 2014 leases were expected to contribute minimally to that year’s income; a change in strategy could lead to impairment.
  • Other key risks include regional and property concentration, lease renewals and vacancies, refinancing and interest-rate exposure, development costs and lease-up, potential real estate impairments, REIT qualification, environmental liabilities, and dependence on external capital. A 1% increase in short-term rates was estimated to increase 2013 interest expense by $3.6 million.
  • The filing reports no material litigation and no material off-balance-sheet arrangements in 2013. It discloses a $2.5 million estimated tax-increment financing shortfall obligation and certain environmental indemnities. Management identified a nonmaterial $3.7 million prior-year balance-sheet classification error, corrected as a 2013 out-of-period adjustment without impact to net income.

Important facts for investors to verify

  • How much of 2013 earnings and per-share results depended on the debt-extinguishment gain and other disposition activity, versus recurring property operations.
  • Whether occupancy and leasing improve after property sales, and how 2014 lease expirations—14.5% of office annualized rental revenue—are renewed or backfilled.
  • Whether government funding, contract awards, and defense-sector demand support renewals and leasing, given the concentration and termination provisions of government leases.
  • Progress on refinancing near-term maturities, maintaining credit-facility availability and meeting development commitments; the filing does not provide quantified 2014 earnings or FFO guidance.
  • Data-center leasing, development spending, and impairment assumptions, as well as the ongoing costs and contingencies related to joint ventures and environmental matters.