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OFC > SEC Filings for OFC > Form 10-Q on 30-Jul-2014All Recent SEC Filings

Show all filings for CORPORATE OFFICE PROPERTIES TRUST

Form 10-Q for CORPORATE OFFICE PROPERTIES TRUST


30-Jul-2014

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations

Overview

COPT is a REIT that focuses primarily on serving the specialized requirements of United States Government agencies and defense contractors, most of whom are engaged in defense information technology and national security related activities. COPLP and its subsidiaries are the entities through which COPT, the sole general partner of COPLP, conducts almost all of its operations and owns almost all of its assets. We generally acquire, develop, manage and lease office and data center properties concentrated in large office parks located near knowledge-based government demand drivers and/or in targeted markets or submarkets in the Greater Washington, DC/Baltimore region. COPLP owns real estate both directly and through subsidiary partnerships and LLCs. COPLP also owns subsidiaries that provide real estate services such as property management and construction and development services primarily for our properties but also for third parties.

During the six months ended June 30, 2014:

we issued a $300.0 million aggregate principal amount of 3.700% Senior Notes on May 14, 2014 at an initial offering price of 99.739% of their face value. The proceeds from the offering, after deducting underwriting discounts, but before other offering expenses, were approximately $297.3 million. We used the net proceeds of the offering to repay borrowings under our Revolving Credit Facility, repay $50.0 million under an existing term loan facility, fund the expected redemption of our Series H Preferred Shares and for general corporate purposes;

COPT redeemed all of its outstanding Series H Preferred Shares on June 16, 2014 at a price of $25.00 per share, or $50.0 million in the aggregate, plus accrued and unpaid dividends thereon through the date of redemption, using proceeds from the 3.700% Senior Notes issuance. These shares accrued dividends equal to 7.5% of the liquidation preference. In connection with this redemption, COPLP redeemed the Series H Preferred Units previously owned by COPT that carried terms substantially the same as the Series H Preferred Shares. At the time of the redemption, we recognized a $1.8 million decrease to net income available to common shareholders/unitholders pertaining to the original issuance costs incurred on the securities;

a wholly owned subsidiary of ours defaulted on the payment terms of a $150.0 million nonrecourse mortgage loan secured by two operating properties in Northern Virginia with an aggregate estimated fair value that was less than the loan balance. This loan has an interest rate of 5.65% (excluding the effect of default interest) and was originally scheduled to mature in 2017. In July 2014, the lender accelerated the loan's maturity date to July 2014. We expect that we will convey the properties to the lender to extinguish the loan;

we placed into service an aggregate of 457,000 square feet in three newly constructed properties that were 91% leased as of June 30, 2014; and

we finished the period with occupancy of our portfolio of operating office properties at 89.3%.

We discuss significant factors contributing to changes in our net income in the section below entitled "Results of Operations." The results of operations discussion is combined for COPT and COPLP because there are no material differences in the results of operations between the two reporting entities.

In addition, the section below entitled "Liquidity and Capital Resources" includes discussions of, among other things:

how we expect to generate cash for short and long-term capital needs; and

our commitments and contingencies.

You should refer to our consolidated financial statements as you read this section.

This section contains "forward-looking" statements, as defined in the Private Securities Litigation Reform Act of 1995, that are based on our current expectations, estimates and projections about future events and financial trends affecting the financial condition and operations of our business.
Forward-looking statements can be identified by the use of words such as "may," "will," "should," "could," "believe," "anticipate," "expect," "estimate," "plan" or other comparable terminology. Forward-looking statements are inherently subject to risks and uncertainties, many of which we cannot predict with accuracy and some of which we might not even anticipate. Although we believe that the expectations, estimates and projections reflected in such forward-looking statements are based on reasonable assumptions at the time made, we can give no assurance that these expectations, estimates and projections will be achieved. Future events and actual results may differ materially from


those discussed in the forward-looking statements. Important factors that may affect these expectations, estimates and projections include, but are not limited to:

general economic and business conditions, which will, among other things, affect office property and data center demand and rents, tenant creditworthiness, interest rates, financing availability and property values;

adverse changes in the real estate markets, including, among other things, increased competition with other companies;

governmental actions and initiatives, including risks associated with the impact of a prolonged government shutdown or budgetary reductions or impasses, such as a reduction in rental revenues, non-renewal of leases and/or a curtailment of demand for additional space by our strategic customers;

our ability to borrow on favorable terms;

risks of real estate acquisition and development activities, including, among other things, risks that development projects may not be completed on schedule, that tenants may not take occupancy or pay rent or that development or operating costs may be greater than anticipated;

risks of investing through joint venture structures, including risks that our joint venture partners may not fulfill their financial obligations as investors or may take actions that are inconsistent with our objectives;

changes in our plans for properties or views of market economic conditions or failure to obtain development rights, either of which could result in recognition of significant impairment losses;

our ability to satisfy and operate effectively under Federal income tax rules relating to real estate investment trusts and partnerships;

the dilutive effects of issuing additional common shares;

our ability to achieve projected results; and

environmental requirements.

We undertake no obligation to update or supplement forward-looking statements.

Occupancy and Leasing

Office Properties

The tables below set forth occupancy information pertaining to our portfolio of operating office properties. All of our operating portfolio square footage, occupancy and leasing statistics included below and elsewhere in this Quarterly Report on Form 10-Q exclude the effect of the two properties serving as collateral for debt which is in default that we expect to extinguish via conveyance of such properties (totaling 665,000 square feet that were 38.9% occupied as of June 30, 2014); effective April 1, 2014, all cash flows from such properties belong to the lender.

                                                         June 30, 2014     December 31, 2013
Occupancy rates at period end
Total                                                            89.3 %                89.1 %
Baltimore/Washington Corridor                                    91.7 %                91.7 %
Northern Virginia                                                88.9 %                88.6 %
San Antonio                                                      96.6 %                96.6 %
Huntsville                                                       81.5 %                80.7 %
Washington, DC - Capitol Riverfront                              75.7 %                76.4 %
St. Mary's and King George Counties                              93.2 %                89.8 %
Greater Baltimore                                                78.4 %                77.2 %
Greater Philadelphia                                             88.9 %                93.7 %
Other                                                           100.0 %               100.0 %
Average contractual annual rental rate per square foot
at period end (1)                                       $       29.10     $           28.99

(1) Includes estimated expense reimbursements.


                                                             Rentable       Occupied
                                                           Square Feet    Square Feet
                                                                 (in thousands)
December 31, 2013                                              17,370         15,484
Square feet vacated upon lease expiration (1)                       -           (497 )
Occupancy of previously vacated space in connection with
new leases (2)                                                      -            306
Square feet constructed or redeveloped                            528            442
Square feet removed from operations for redevelopment            (304 )            -
Square feet of properties to be conveyed                         (665 )         (623 )
Other changes                                                      (6 )           (1 )
June 30, 2014                                                  16,923         15,111

(1) Includes lease terminations and space reductions occurring in connection with lease renewals.

(2) Excludes occupancy of vacant square feet acquired or developed.

Occupancy of our Same Office Properties was 90.8% as of June 30, 2014, up from 90.6% as of December 31, 2013.

During the six months ended June 30, 2014, we completed 1.1 million square feet of leasing, including 188,000 of construction and redevelopment space, and renewed 68.8% of the square footage of our lease expirations for the period (including the effect of early renewals, and excluding the effect of a 219,000 square foot property vacated in Greater Philadelphia that was removed from service for redevelopment).

Wholesale Data Center Property

Our wholesale data center property is expected to have a critical load of 18 megawatts upon completion. As of June 30, 2014, the property had 9.0 megawatts in operations, of which 6.3 were leased to tenants with further expansion rights of up to a combined 7.2 megawatts.

Results of Operations

We evaluate the operating performance of our properties using NOI from real estate operations, our segment performance measure derived by subtracting property operating expenses from revenues from real estate operations. We view our NOI from real estate operations as comprising the following primary categories of operating properties:

office properties owned and 100% operational throughout the current and prior year reporting periods, excluding properties held for future disposition. We define these as changes from "Same Office Properties";

office properties acquired during the current and prior year reporting periods;

constructed or redeveloped office properties placed into service that were not 100% operational throughout the current and prior year reporting periods;

two properties that we expect to convey to a mortgage holder; and

property dispositions.

You may refer to Note 15 of the consolidated financial statements for a summary of operating properties that were disposed and therefore are included in discontinued operations.

In addition to owning properties, we provide construction management and other services. The primary manner in which we evaluate the operating performance of our construction management and other service activities is through a measure we define as NOI from service operations, which is based on the net of the revenues and expenses from these activities. The revenues and expenses from these activities consist primarily of subcontracted costs that are reimbursed to us by customers along with a management fee. The operating margins from these activities are small relative to the revenue. We believe NOI from service operations is a useful measure in assessing both our level of activity and our profitability in conducting such operations.

We believe that operating income, as reported on our consolidated statements of operations, is the most directly comparable generally accepted accounting principles ("GAAP") measure for both NOI from real estate operations and NOI from service operations. Since both of these measures exclude certain items includable in operating income, reliance on these measures has limitations; management compensates for these limitations by using the measures simply as supplemental measures that are considered alongside other GAAP and non-GAAP measures.


The table below reconciles NOI from real estate operations and NOI from service operations to operating income reported on the consolidated statements of operations:

                                              For the Three Months Ended June   For the Six Months Ended June
                                                            30,                              30,
                                                   2014              2013           2014             2013
                                                                      (in thousands)
NOI from real estate operations               $   72,108         $   80,621     $  147,252       $  158,632
NOI from service operations                          725              1,413          3,891            2,198
NOI from discontinued operations                      79             (6,222 )           40          (12,664 )
Depreciation and amortization associated with
real estate operations                           (30,895 )          (27,673 )      (74,491 )        (54,683 )
Impairment losses                                 (1,302 )                -         (1,302 )              -
General, administrative and leasing expenses      (7,528 )           (6,583 )      (15,671 )        (14,403 )
Business development expenses and land carry
costs                                             (1,351 )           (1,327 )       (2,677 )         (2,686 )
Operating income                              $   31,836         $   40,229     $   57,042       $   76,394

Comparison of the Three Months Ended June 30, 2014 to the Three Months Ended

 June 30, 2013

                                                       For the Three Months Ended June 30,
                                                      2014               2013          Variance
                                                                  (in thousands)
Revenues
Revenues from real estate operations             $    115,959       $    115,732     $      227
Construction contract and other service revenues       23,861             20,795          3,066
Total revenues                                        139,820            136,527          3,293
Expenses
Property operating expenses                            43,772             41,333          2,439
Depreciation and amortization associated with
real estate operations                                 30,895             27,673          3,222
Construction contract and other service expenses       23,136             19,382          3,754
Impairment losses                                       1,302                  -          1,302
General, administrative and leasing expenses            7,528              6,583            945
Business development expenses and land carry
costs                                                   1,351              1,327             24
Total operating expenses                              107,984             96,298         11,686
Operating income                                       31,836             40,229         (8,393 )
Interest expense                                      (23,478 )          (21,102 )       (2,376 )
Interest and other income                               1,299              2,006           (707 )
Loss on early extinguishment of debt                     (270 )          (21,470 )       21,200
Equity in (loss) income of unconsolidated
entities                                                  (47 )              126           (173 )
Income tax expense                                        (92 )              (21 )          (71 )
Income (loss) from continuing operations                9,248               (232 )        9,480
Discontinued operations                                  (198 )           (4,502 )        4,304
Gain on sales of real estate                                -                329           (329 )
Net income (loss)                                $      9,050       $     (4,405 )   $   13,455


NOI from Real Estate Operations

                                                              For the Three Months Ended June 30,
                                                        2014                      2013              Variance
                                                      (Dollars in thousands, except per square foot data)
Revenues
Same Office Properties                          $         104,648         $         104,657       $        (9 )
Constructed office properties placed in service             6,222                     1,952             4,270
Properties held for sale                                      730                       739                (9 )
Properties to be conveyed                                   1,859                     5,287            (3,428 )
Dispositions                                                    4                     9,546            (9,542 )
Other                                                       2,501                     3,094              (593 )
                                                          115,964                   125,275            (9,311 )
Property operating expenses
Same Office Properties                                     37,592                    36,718               874
Constructed office properties placed in service             1,910                       430             1,480
Properties held for sale                                      364                       327                37
Properties to be conveyed                                   1,328                     1,895              (567 )
Dispositions                                                   83                     3,435            (3,352 )
Other                                                       2,579                     1,849               730
                                                           43,856                    44,654              (798 )
NOI from real estate operations
Same Office Properties                                     67,056                    67,939              (883 )
Constructed office properties placed in service             4,312                     1,522             2,790
Properties held for sale                                      366                       412               (46 )
Properties to be conveyed                                     531                     3,392            (2,861 )
Dispositions                                                  (79 )                   6,111            (6,190 )
Other                                                         (78 )                   1,245            (1,323 )
                                                $          72,108         $          80,621       $    (8,513 )
Same Office Properties rent statistics
Average occupancy rate                                       90.8 %                    90.4 %             0.4 %
Average straight-line rent per occupied square
foot (1)                                        $            6.16         $            6.17       $     (0.01 )

(1) Includes minimum base rents, net of abatements, and lease incentives on a straight-line basis for the three-month periods set forth above.

Our Same Office Properties pool consisted of 161 office properties, comprising 89% of our operating office square footage as of June 30, 2014. The pool excluded operating office properties disposed or otherwise no longer held for long-term investment (currently two properties expected to be conveyed to lenders and eight properties held for sale) by, or as of, June 30, 2014. This pool of properties included the following changes from the pool used for purposes of comparing 2013 and 2012 in our 2013 Annual Report on Form 10-K: the additions of three properties placed in service and 100% operational by January 1, 2013, one property acquired and fully operational by January 1, 2013 and two properties in the Greater Philadelphia region (this region was previously excluded from the pool as it was not considered held for long-term investment); and the removals of eight properties reclassified to held for sale in 2014 and two properties newly classified as redevelopment.

Impairment Losses

We recognized impairment losses in the current and prior periods (including amounts in discontinued operations) in connection with expected dispositions of properties and land.

Interest Expense

The increase in interest expense in the current period included $1.9 million in incremental additional interest expense in connection with the default rate on the debt to be extinguished via conveyance of properties.


Loss on Early Extinguishment of Debt

The loss on early extinguishment of debt in the prior period was attributable primarily to a $20.6 million loss recognized on our repayment of a $185.7 million principal amount of our 4.25% Exchangeable Senior Notes resulting from a tender offer completed during the period.

Discontinued Operations

Discontinued operations in the prior period was due primarily to impairment
losses recognized in connection with the expected dispositions of properties and
land no longer aligned with our strategy.

Comparison of the Six Months Ended June 30, 2014 to the Six Months Ended
 June 30, 2013

                                                       For the Six Months Ended June 30,
                                                      2014              2013         Variance
                                                                 (in thousands)
Revenues
Revenues from real estate operations             $    240,836       $  227,689     $   13,147
Construction contract and other service revenues       45,651           35,057         10,594
Total revenues                                        286,487          262,746         23,741
Expenses
Property operating expenses                            93,544           81,721         11,823
Depreciation and amortization associated with
real estate operations                                 74,491           54,683         19,808
Construction contract and other service expenses       41,760           32,859          8,901
Impairment losses                                       1,302                -          1,302
General, administrative and leasing expenses           15,671           14,403          1,268
Business development expenses and land carry
costs                                                   2,677            2,686             (9 )
Total operating expenses                              229,445          186,352         43,093
Operating income                                       57,042           76,394        (19,352 )
Interest expense                                      (44,305 )        (41,392 )       (2,913 )
Interest and other income                               2,584            2,952           (368 )
Loss on early extinguishment of debt                     (270 )        (26,654 )       26,384
Equity in income of unconsolidated entities                13              167           (154 )
Income tax expense                                       (156 )            (37 )         (119 )
Income from continuing operations                      14,908           11,430          3,478
Discontinued operations                                  (187 )         (3,241 )        3,054
Gain on sales of real estate                                -            2,683         (2,683 )
Net income                                       $     14,721       $   10,872     $    3,849


NOI from Real Estate Operations

                                                            For the Six Months Ended June 30,
                                                        2014                  2013               Variance
                                                   (Dollars in thousands, except per square foot data)
Revenues
Same Office Properties                        $           214,132      $        207,058       $      7,074
Constructed office properties placed in
service                                                    12,208                 3,341              8,867
Properties held for sale                                    1,435                 1,413                 22
Properties to be conveyed                                   7,253                10,438             (3,185 )
Dispositions                                                   23                19,667            (19,644 )
Other                                                       5,809                 5,435                374
                                                          240,860               247,352             (6,492 )
Property operating expenses
Same Office Properties                                     81,415                72,789              8,626
Constructed office properties placed in
service                                                     3,460                   840              2,620
Properties held for sale                                      886                   653                233
Properties to be conveyed                                   3,148                 3,697               (549 )
Dispositions                                                   63                 7,269             (7,206 )
Other                                                       4,636                 3,472              1,164
                                                           93,608                88,720              4,888
NOI from real estate operations
Same Office Properties                                    132,717               134,269             (1,552 )
Constructed office properties placed in
service                                                     8,748                 2,501              6,247
Properties held for sale                                      549                   760               (211 )
Properties to be conveyed                                   4,105                 6,741             (2,636 )
Dispositions                                                  (40 )              12,398            (12,438 )
Other                                                       1,173                 1,963               (790 )
                                              $           147,252      $        158,632       $    (11,380 )
Same Office Properties rent statistics
Average occupancy rate                                       90.8 %                90.1 %              0.7 %
. . .
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