COPT DEFENSE PROPERTIES quarterly report, Q2 FY2013

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Business context and reporting period

Corporate Office Properties Trust (COPT), a REIT, and its operating partnership filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2013. The business primarily owns, develops, manages and leases office and data-center properties serving U.S. government agencies and defense contractors, concentrated in the Greater Washington, D.C./Baltimore region and selected markets. At quarter-end, the portfolio included 210 operating office properties totaling 19.0 million square feet, plus development projects and a partially operational wholesale data center.

Financial performance and position

Amounts below are in millions except per-share data. COPT and the operating partnership report substantially the same operating results.

  • Second-quarter revenue: $140.5, up 10.1% from $127.7 in Q2 2012. Rental revenue was $97.3 versus $90.0.
  • Second-quarter operating income: $41.0 versus $33.5. Real-estate NOI was $80.6 versus $79.9; same-office NOI increased to $70.6 from $68.8.
  • Second-quarter earnings: consolidated net loss was $4.4 versus net income of $11.9. The loss attributable to common shareholders was $13.2, or $0.16 per share, versus income of $7.1, or $0.10 per share. A $21.5 debt-extinguishment loss was a major factor.
  • First-half revenue and earnings: revenue was $271.1 versus $259.4. Net income was $10.9 versus $22.1; common shareholders had a $4.2 loss, or $0.05 per share, versus income of $13.4, or $0.18 per share. The first-half debt-extinguishment loss was $26.7.
  • FFO: diluted FFO per share was $0.25 in Q2 versus $0.54; adjusted-for-comparability diluted FFO per share was $0.52 versus $0.54. First-half figures were $0.69 versus $1.13 and $1.00 versus $1.07, respectively. FFO is a non-GAAP measure and is not a substitute for cash flow or GAAP earnings.
  • Cash flow and liquidity: first-half operating cash flow was $61.5 versus $111.9. Investing used $115.3, compared with $24.6 provided in the prior-year period; financing provided $52.4 versus $137.3 used. Cash was $9.2 at June 30.
  • Debt: debt, net, was $2,093.1 at June 30, up from $2,019.2 at year-end 2012. The $800 million revolving facility had $650.9 million available at quarter-end. The filing reports covenant compliance.
  • Occupancy and distributions: operating-office occupancy was 88.2%, up from 87.8% at year-end; same-office occupancy was 89.4%, up from 88.8%. The quarterly common dividend was $0.275 per share, unchanged from Q2 2012.

Material changes versus the prior comparable period

  • Revenue and operating income rose in Q2, supported by same-office growth, newly placed-in-service properties and higher service revenue. First-half same-office NOI was essentially flat at $139.8 versus $135.9, while total real-estate NOI was nearly unchanged at $158.6.
  • GAAP earnings declined sharply, principally because of costs from repurchasing exchangeable notes early and impairments related to planned property dispositions. Q2 discontinued operations included $7.2 million of impairment losses; first-half impairment losses were $9.1 million.
  • Interest expense declined in the first half, which management attributed primarily to lower average debt following repayments. The company issued $350 million of 3.60% senior notes due 2023 and repaid $239.4 million principal amount of 4.25% exchangeable notes, recognizing a $25.9 million extinguishment loss.
  • COPT raised $118.1 million net of underwriting discounts through a March common-share offering and redeemed $84.8 million of 7.625% Series J preferred shares in April. The preferred redemption generated $2.9 million of issuance costs charged against income available to common holders.
  • Prior-period presentation was revised for reclassifications and corrections of previously identified accounting errors. The filing states the revisions did not change Q2 2012 net income; first-half 2012 net income was revised from $18.8 million to $22.1 million.

Outlook, management commentary and risks

  • Management gave no specific earnings or FFO guidance in the supplied filing text. It said liquidity and capital resources were considered adequate for near- and longer-term needs, while expecting property sales under its Strategic Reallocation Plan through 2013 and beyond.
  • Management expected to spend more than $100 million on construction and development and approximately $30 million on operating-property improvements during the remainder of 2013. It expected to fund development and remaining-2013 debt maturities mainly through the revolving facility and construction loans, and property improvements mainly from operating cash flow.
  • At June 30, 11 office properties were under construction or contractually committed, estimated at 1.5 million square feet, with estimated remaining costs of $126.4 million; one redevelopment project of 183,000 square feet had estimated remaining costs of $6.7 million. A July 16 credit amendment extended the revolving facility maturity from September 2014 to July 2017 and reduced its stated borrowing spread; amendments also extended options and revised spreads on certain term loans.
  • After quarter-end, COPT issued 1.5 million shares through its at-the-market program for $38.5 million net proceeds. The proceeds were contributed to the operating partnership.
  • Key risks include dependence on government and defense-related demand, potential government shutdowns or budget reductions, leasing and occupancy, development execution and cost overruns, refinancing and interest-rate exposure, property-sale execution, joint-venture partner performance, and REIT tax compliance.
  • Contingencies include guarantees associated with a troubled unconsolidated joint venture, environmental indemnities, joint-venture funding obligations and a tax-incremental-financing obligation. Management did not expect routine litigation or identified environmental matters to materially harm financial position, operations or liquidity. The company reported no material litigation and no material change to previously disclosed risk factors.

Important facts for investors to verify

  1. Review the composition and timing of the $26.7 million first-half debt-extinguishment loss and the remaining debt maturities, including the July 2013 amendments.
  2. Assess whether occupancy, same-office NOI and leasing trends can offset operating-cost increases and the expected effects of government budget or staffing changes.
  3. Check the assumptions, costs, leasing progress and funding needs for development projects, and the execution and pricing of planned property dispositions.
  4. Evaluate the $61.5 million first-half operating cash flow against distributions, capital spending, debt service and the low $9.2 million cash balance.
  5. Review impairment assumptions and exposures tied to the troubled joint venture, guarantees, environmental indemnities and other commitments; also note the stated prior-period financial-statement revisions.