COPT / Corporate Office Properties Trust — Q1 2014 Form 10-Q
Business context and period: The filing covers the three months ended March 31, 2014. COPT is a REIT focused on office and data-center properties serving U.S. government agencies and defense contractors, primarily in the Greater Washington, D.C./Baltimore region. COPLP conducts nearly all operations and holds nearly all assets; COPT is its general partner. Unless noted, amounts below are consolidated and in U.S. dollars.
Key financial results
| Metric | Q1 2014 | Q1 2013 / comparison |
|---|---|---|
| Total revenue | $146.7 million | $126.2 million; up 16.2% |
| Operating income | $25.2 million | $36.2 million; down 30.3% |
| Net income | $5.7 million | $15.3 million |
| Net income attributable to COPT common shareholders | $0.3 million; reported EPS $0.00 | $8.9 million; EPS $0.11 |
| FFO available to common shareholders and unit holders | $43.7 million; diluted FFO per share $0.48 | $38.2 million; diluted FFO per share $0.45 |
| Cash from operating activities | $51.5 million | $47.3 million |
| Cash used in investing activities | $60.9 million | $60.2 million |
| Cash used in financing activities | $26.7 million | Cash provided of $25.8 million |
| Cash and cash equivalents at period end | $18.4 million | $54.4 million at December 31, 2013 |
| Debt, net | $1.932 billion | $1.928 billion at December 31, 2013 |
Operating margin was approximately 17.2%, versus 28.7% a year earlier. The filing does not provide a single standardized overall net margin measure; reported net income was $5.7 million on $146.7 million of revenue. Quarterly common dividends were $0.275 per share, unchanged year over year.
Material changes and operating performance
- Revenue growth reflected higher real-estate revenue and construction/service revenue. Construction and other service revenue rose $7.5 million, while related expenses rose $5.1 million; service NOI increased to $3.2 million, including $2.4 million from one large construction contract.
- Same-office occupancy averaged 89.7%, versus 88.9% a year earlier. Portfolio occupancy at quarter-end was 89.8%, up from 89.1% at year-end 2013. The average contractual annual rental rate was $28.90 per square foot.
- Same-office NOI declined $0.8 million to $65.8 million. Higher tenant recoveries were largely offset by higher property expenses, partly reflecting unusually severe Mid-Atlantic winter weather.
- Operating income fell principally because real-estate depreciation and amortization increased $16.6 million. This included $12.9 million of additional depreciation following a shortened useful-life estimate for a Greater Philadelphia property removed from service for redevelopment. The prior-year period also included a $5.2 million debt-extinguishment loss and a $2.4 million gain on a land sale; neither recurred.
- FFO increased despite lower GAAP net income. FFO and adjusted diluted FFO per share were $0.48 and $0.48, respectively, compared with $0.45 and $0.48 in Q1 2013.
Liquidity, debt, outlook, and risks
- At March 31, the $800 million revolving credit facility had no borrowings and $785.2 million of availability. Up to $180 million of additional term-loan borrowing was available subject to lender approval and no default; construction facilities had $6.4 million available.
- Management said operating cash flow and available credit were adequate for near- and longer-term requirements. It expected to fund development with cash and borrowings and operating-property improvements primarily with operating cash flow. The company expected to spend more than $210 million on construction and development and approximately $40 million on operating-property improvements during the remainder of 2014. No specific earnings or FFO guidance was provided.
- Material subsequent event: in April 2014, a wholly owned subsidiary defaulted on payment terms for a $150 million nonrecourse mortgage secured by two Northern Virginia properties. The loan bears 5.65% interest and was scheduled to mature in 2017. Management intended to negotiate a restructuring but expected to convey the properties to the lender to extinguish the debt; the properties’ estimated fair value was below the loan balance.
- Contractual obligations totaled $2.573 billion, including debt principal and interest, construction and redevelopment, and capital expenditures. The company expected to refinance 2014 balloon maturities. It reported compliance with financial debt covenants as of March 31; the filing does not establish the effect of the subsequent mortgage default on future covenant compliance.
- Interest-rate exposure is significant: a 1% increase in short-term rates was estimated to add $0.55 million to quarterly interest expense, after swaps. Approximately $3.0 million of derivative losses were expected to be reclassified into interest expense over the next 12 months.
- Key business risks include government budget reductions or shutdowns affecting tenant demand, leasing and renewals; property-market and financing conditions; development execution and costs; and interest-rate and refinancing risk. The filing reported no material change to the risk factors in the 2013 Form 10-K.
- Management reported no material litigation, and stated that disclosure controls were effective and there had been no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Progress and final outcome of the $150 million Northern Virginia mortgage default, including property transfer, debt extinguishment, and any related impairment or accounting effects.
- Whether planned 2014 development spending and operating-property improvements remain consistent with cash generation, facility availability, and refinancing access.
- Leasing, occupancy, and rent trends, particularly government-related demand and the 89.8% portfolio occupancy level.
- Drivers of the large year-over-year depreciation increase and its implications for future GAAP earnings versus FFO.
- Debt maturities, variable-rate exposure, derivative positions, and covenant compliance after the subsequent default.