COPT Defense Properties (Corporate Office Properties Trust) — Q1 2018 Form 10-Q
Business context and reporting period
For the three months ended March 31, 2018. COPT is a REIT that conducts substantially all operations through Corporate Office Properties, L.P. (COPLP), which it owned approximately 97.0% of at quarter-end. The company owns, operates, leases and develops office and data-center properties, primarily in U.S. government, defense and IT markets. Its portfolio included 159 properties totaling 17.6 million square feet, plus a 19.25-megawatt wholesale data center.
Financial and operating performance
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Total revenue | $155.5 million | $139.8 million |
| Operating income | $35.9 million | $35.4 million |
| Net income | $18.8 million | $22.7 million |
| Net income attributable to COPT common shareholders | $17.2 million; $0.17 per diluted share | $17.8 million; $0.18 per diluted share |
| Diluted FFO per share | $0.49; $0.50 adjusted for comparability | $0.51; $0.47 adjusted for comparability |
| Operating cash flow | $26.2 million | $60.1 million |
| NOI from real estate operations | $78.5 million | $79.5 million |
Revenue increased 11.2%, principally because construction and other service revenue rose to $27.2 million from $13.0 million; related expenses also rose, and service NOI was $1.0 million versus $0.5 million. GAAP net income declined mainly because Q1 2017 included a $4.2 million real-estate sale gain; Q1 2018 had no material sale gain. Same-property NOI was $70.2 million versus $72.0 million, with management citing higher snow, utility and property-tax costs. Portfolio occupancy was 91.0%, down from 93.6% at year-end 2017, primarily reflecting newly completed, largely unoccupied space. The common dividend declared was $0.275 per share, unchanged year over year.
Balance sheet, cash flow and liquidity
At March 31, 2018, total assets were $3.60 billion and debt, net, was $1.85 billion, up from $1.83 billion at December 31, 2017. Cash and cash equivalents were $8.9 million; cash plus restricted cash was $12.5 million. Operating cash flow fell by $33.9 million year over year, primarily due to lower net cash flows from construction services and a larger cash outflow from accounts payable, accrued expenses and other liabilities. Investing activities used $34.8 million, versus $2.0 million provided in the prior-year quarter, largely reflecting the absence of prior-year property-sale proceeds. Financing activities provided $6.3 million, including $25.9 million of net debt borrowings and $20.0 million of equity proceeds, partly offset by distributions.
The $800 million revolving credit facility had $647 million available at quarter-end and matures in May 2019, with two conditional six-month extension options. The company reported compliance with debt covenants and investment-grade ratings for COPLP’s senior unsecured debt. COPT itself has no direct debt, but guarantees specified COPLP debt. Management stated that liquidity was adequate for near- and longer-term needs without requiring property sales.
Outlook, risks and unusual items
- Management expected to spend approximately $240 million on construction and development and $50 million on operating-property improvements during the remainder of 2018. It expected to fund development initially primarily through revolver borrowings and forward equity proceeds, and property improvements primarily through operating cash flow.
- Development and redevelopment commitments were $64.8 million; operating-property capital expenditure commitments were $45.9 million. The company also reported $90.5 million of future operating-lease payments, mostly under ground leases, with expirations extending to 2100.
- Interest-rate sensitivity was material: a 1% increase in applicable LIBOR would have increased quarterly interest expense by an estimated $434,000, taking account of swaps. Variable-rate debt and refinancing maturities expose the company to rate and funding risk.
- Key stated risks include government budget cuts or shutdowns affecting tenants and demand, real-estate market competition, development delays or cost overruns, tenant occupancy and rent risks, access to financing, joint-venture partner performance, REIT tax rules and environmental requirements. Management reported no material change to the risk factors in the 2017 Form 10-K.
- A property sale remained accounted for as a financing arrangement because of a guaranty covering up to $20 million of defined potential losses through June 30, 2019; management did not expect a loss. The filing also disclosed routine legal claims that could result in losses, but management did not expect them to materially affect financial position, liquidity or results.
- The company adopted several accounting standards in 2018. It expected the new lease standard, effective January 1, 2019, to require recognition of right-of-use assets and lease liabilities for ground leases, while its assessment was ongoing.
Important facts for investors to verify
- Whether occupancy and leasing improve as newly completed space is absorbed, particularly in the Fort Meade/Baltimore-Washington Corridor and Northern Virginia.
- Whether the 2018 development and improvement spending plan is delivered on schedule and within budget, and how it is financed.
- The refinancing or extension plan for the $153 million revolving-facility balance due in 2019 and other upcoming debt maturities.
- Whether operating cash flow recovers after the quarter’s construction-related and working-capital cash-flow pressures.
- Updates on the $20 million property guaranty, development commitments, and adoption of the 2019 lease-accounting standard.