COPT Defense Properties (CDP) 2003 Q3 法說會逐字稿

Good day, everyone and welcome to the Corporate Office Properties Trust third quarter 2003 earnings release conference call. Just a reminder that today's call will be recorded. At this time I will turn the call over to Mary Ellen Fowler, Vice President of Finance and Investor Relations. Please go ahead ma'am.

Thank you. Good afternoon, everyone. Yesterday our earnings press release was faxed or e-mailed to each one of you. If there is anyone on the call who needs a copy of the release or would like to get our quarterly supplemental package, please contact me after this call at 410-992-7324. Or you can access both documents from the investor relations section of our website at www.copt.com. Within the supplemental package you will find a reconciliation of non-GAAP financial measures to GAAP measures referenced throughout this call. Also under the investor relations section of our website you will find a reconciliation of our 2003 and 2004 guidance. With me today is Clay Hamlin our CEO, Rand Griffin our President and COO and Roger Waesche our CFO. In just a minute they will review the results of the third quarter and first 9 months of 2003. Then the call will be opened up for your questions. First I must remind all of you at the outset that certain statements made during this call regarding anticipated operating results of future events are forward-looking statements within the the meaning of the Private Securities Litigation Reform Act of 1995. Although such statements and projections are based upon what we believe to be reasonable assumptions, actual results may differ from those projected. These factors that could cause actual results to differ materially include without limitation the ability to renew or release space under favorable terms, regulatory changes, changes in the economy, the successful and timely completion of acquisitions and development project, changes in interest rates and other risks associated with the commercial real estate business as detailed in our filings from time to time with the Securities and Exchange Commission. Now I would like to turn the call over to Clay Hamlin.

Thank you, Mary Ellen. Good afternoon, every one. We are pleased to report another strong quarter of growth on performance for the company. We achieved a strong 13.9% increase in FFO under the diluted per share basis, exceeding the consensus estimate. Our performance continues to be driven predominantly by a combination of consistent leasing activity, strategic acquisitions, a favorable interest rate environment, and, new development opportunities. In terms of leasing, we had a very active quarter, leasing 621,000 square feet with overall increasing rents. Also, we have surpassed our acquisitions goal for the year by acquiring $165 million of acquisitions through the end of the third quarter. We continue to ramp up our development pipeline based on our solid tenant demand as well. As we've commented on prior calls over the past 12 months, we are continuing to see good leasing activity, but it is still taking longer to translate into finalized leases. The main driver of demand continues to be the government and defense sectors, which in turn is positively impacting our portfolio. The credit strength of our tenant base is becoming stronger as a result of consolidation taking place within the industry. As an example, this year alone, three non-rated government contractor companies, all among our top 25 largest tenants, merged into investment grade companies. Along with growing our portfolio, we continue to enhance our balance sheet and financial flexibility. We funded our investment activities this year predominantly with equity. During the first nine months we raised approximately 133 million of equity capital, and we generated 14 million in excess proceeds from the sale of noncore assets. As a result, we have the financial capacity to fund our growth. Our debt to market cap is now at a low level and our interest coverage has steadily improved. At the same time, we continue to actively lock in historically low long-term interest rates through long term fixed rate financing which Roger will discuss in a moment. In light of our on going strong performance and cash flow we recently increased our common dividend by 6.8% to 23.5 cents per share per quarter. This represents our 6th consecutive year of delivering increased dividends to shareholders. At the same time we have maintained very solid FFO and AFFO payout ratios. In summary, we are very pleased with our results thus far for the year. Our first call consensus estimate of $1.55 per share for the year, we remain very comfortable with that number. This represents 8% growth over 2002. Looking ahead to 2004, we are encouraged by our increasing occupancy and current development activity. The acquisition environment will continue to be challenging and we are assuming higher interest rates throughout 2004. With that in mind, and excluding any new accounting changes impacting FFO, we expect our FFO per share growth to be in the 8% range as it was this year and Roger will go into all the details in a minute. Now I would like to turn the call over to Roger and then Rand to take you through the details.

Thanks, Clay. As a note, all per share amounts are presented on a fully diluted basis and take into account the effects of FASB 141 and 145. And as Mary Ellen noted we provide a reconciliation of non-GAAP numbers to GAAP numbers in our press release and supplemental package. FFO for the quartet ended September 30, totaled $16.7 million or 41 cents a share as compared to FFO for the third quarter of 2002 of $13.4 million or 36 cents per share. This represents a 25.2% increase in total FFO and a 13.9% per share increase. Looking at our GAAP earnings for the third quarter, the company reported earnings of 18 cents per diluted share as compared to earnings per diluted share of 15 cents for the third quarter of 2002. After adjusting for capital expenditures, straightlining of rent and FASB 141 revenue, our adjusted funds from operation for the third quarter totaled $12 million as compared to AFFO of $10.5 million for the third quarter of 2002, representing a 14.2% increase. Our results for the third quarter were positively impacted and had a consensus in part due to generating fee income from third party construction management and tenant improvement services we provide and also from higher lease termination fees. In terms of same property net operating income, cash NOI increased by 6.5% as compared to the third quarter of 2002, in part due to lease termination fees. Excluding lease termination fees, same property cash NOI increased 3.4%. Turning to the balance sheet, at September 30, the company had a total market cap of over $1.6 billion with $759 million of debt outstanding of which 78% is fixed rate debt, including $100 million of slop agreements. The resulting weighted average cost of debt for the third quarter was a low 5.73%. We continued to take advantage of the low interest rate environment by exchanging floating rate debt for long-term fixed rate nonrecourse debt. As an example, we expect to close before year end a $52 million, seven-year loan with a fixed rate of 5.36%. In terms of coverage ratios from the third quarter, the company's EBITDA, the interest expense ratio, was three times and with our repurchase of our series C 9% convertible preferred which occurred during the second quarter and the recent issuance of our series G 8% preferred totaling $55 million, our fixed charged coverage ratio improved to 2.3 times. And lastly, with respect to FFO guidance for next year that Clay mentioned earlier, we have made the following assumptions. Over the year we are projecting an increase in occupancy of 2% to approximately 94%. In terms of external growth, we are targeting acquiring $100 million net of dispositions radically over the year. Adding to this we have four development properties totaling $65 million currently under construction with one project being completed this quarter, second to be completed and placed into service by June of '04 and the remaining two buildings to be completed and placed into service in the second half of 2004. Fourth we see a ramp up in third party construction fee income during 2004. Offsetting these increases we see higher G&A expense due to Sarbanes Oxley related costs and increased personnel expense to support our growth. In addition we assume that interest rates will increase 100 basis points over the course of the year. With these assumptions, we expect FFO per diluted share to be in the $1.66 to $1.71 per share range. Our FFO assumptions for 2004 result in the approximate following FFO per share amounts. 5 cents for occupancy, 9 cents for acquisitions, 5 cents for development placed into service, and 2 cents for third party fee income. Offsetting these increases in FFO are deductions of 4 cents in G&A and 3 cents for higher interest rates. Our guidance is based upon comparable accounting treatments year over year, plus guidance excludes any accounting charge that we would be required if we redeem our series B 10% preferred stock issue in July next year. That redemption would result in a 4 cent charge to FFO. With that, I will turn the call over to Rand.

Thanks, Roger and good afternoon, every one. We currently have 118 suburban office properties in operation totaling 9.9 million square feet. As Clay indicated, occupancy continues to slowly and steadily trend upwards. We ended the third quarter at 91.7% occupied and 92.2% leased. That's up from 90.8% occupied as of the first quarter and 91.6% occupied as of the end of June. Looking at the fourth quarter, we expect occupancy at the end of the year to be around 92% with leasing at 93%. As Clay indicated, we executed leases totaling 621,000 square feet, including renewing 370,000 square feet of space, representing a very strong 87.2% retention rate. In terms of rental growth during the third quarter, we achieved a solid 13.9% increase and renewed and re-tenanted base rent on a straight line basis, equating to a 3.3% increase on a cash basis. In addition, we continued to manage our re-tenanting costs very carefully. During the third quarter our renewal and re-tenancy costs, including improvements and leasing commissions, averaged $8.48 a square foot. As to the fourth quarter, we only have about 76,000 square feet scheduled to expire, which is less than 1% of our total portfolio. Looking at our lease expirations for next year, we currently have approximately 870,000 square feet rolling or about 9% of our total portfolio. The average total rent for this space is $18.62 per square foot, which remains comfortably below market as is evidenced by our strong rental rate increases in the third quarter. We are continuing to see a slow improvement generally in our core sub markets with defense and government leading the way. For example, in the BWI sub market of Anne Arundel County in the Baltimore/Washington corridor, as of September 30, Class A vacancy had dropped to 6% as compared to 7.1% last quarter. Our portfolio in the BW sub market, which totals 3.3 million square feet representing 78% of that market, was 91.7% leased as of September 30. Howard County in the BW corridor has slipped slightly during the quartet with a direct vacancy rate of 13.3% up from 12.6% as of June 30, and including sublease space totals 17.6% vacant up from 16.9% as of June 30. These numbers, however, still have improved from the 21.8% vacancy at the beginning of the year. Our Howard County portfolio consisting of 1.6 million square feet is currently 89% leased. Along with the improvement in the BW corridor we are also continuing to see positive signs with respect to the northern Virginia market. Overall, northern Virginia's vacancy rate with subleased space dropped again this quarter to 16.5%. There was net positive absorption of 126,000 square feet despite the negative impact of several large tenant consolidations. This is the second quarter in a row over the last 10 quarters that this market has had positive absorption. Our portfolio, consisting of 1.6 million square feet is currently 95.5% leased. Turning to acquisitions year-to-date, we have acquired $165 million in class A suburban office properties including acquiring $76 million during the third quarter. Taking into account the $40 million in noncore dispositions that we continued in the first quarter, on a net basis, we have acquired $125 million through the first nine months exceeding our stated objective of acquiring a net $100 million rapidly through the entire year. Our average yield on these acquisitions is approximately 10% reflecting the fact that most of these assets were not on the market. The properties are currently over 97% occupied with very little rollover during the next two years. In terms of development activity, we currently have four buildings under construction totaling 421,000 square feet. We are scheduled to place one of the four buildings into service by year end, which is 140 National Business Parkway. As we we noted on our last call, the building is committed to a major tenant and we expect to announce shortly a long-term lease for this entire building. With respect to the remaining three development projects, 4234 Boulevard is scheduled for completion by second quarter 2004 and is 50% preleased. The remaining two buildings will be completed in the second half of 2004 and include 220 NBP which is 157,000 square feet and is 100% preleased to Titan Corporation and they recently announced a merger with Lockheed Martin. In Greens 3, which is a 88,000 square foot building in Westfields in northern Virginia that we broke ground on during the third quarter, and it is 100% preleased to the Aerospace Corporation. Beyond these four projects, we are also in the design stage with a number of other projects, including one site on phase 1 and three sites on phase 2 at the National Business Park and an expansion of Washington Technology Park in Westfields in northern Virginia. We could be in a position to start construction on some of the National Business Park sites by year end. In total, we have under control additional development sites that are all strategically located adjacent to existing occupied buildings. These sites can support a total of 4.2 million square feet of additional space. As demand for space continues to ramp back up, we are very well positioned to make the most of this development pipeline. Lastly, to underscore some of Clay's and Roger's comments, while we continue to work very hard at meeting and exceeding the market's growth expectations for the company, we have also been working hard this year at capitalizing on the strong financial market conditions to strengthen our balance sheet and financial flexibility. We have completed several transactions that serve to simplify our capital structure with an eye towards keeping the company well positioned and with the capacity to take advantage of opportunities that arise across our core market. As such we continue to be very excited and confident about the growth prospects for our company going forward. And with that, we would be happy to address any questions that you may have.

Thank you, gentlemen. Ladies and gentlemen, at this time if you do have a question or comment simply press star 1 on your touchtone telephone. We will take as many questions as time permits and proceed in the order that you do signal us. Again, any questions please press star 1. And we will pause for just one moment to allow every one a chance to respond. We will go first to Ken Weinberg with Legg Mason.

Yes, thank you. Good afternoon. Real quick, actually a question for Roger on the balance sheet and it's relation to some of the comments you made about strengthening it for next year, I guess, tying that back to the guidance you alluded to the 52 million that you are going to be terming out and fixing in the fourth quarter here, and I assume you'll also be doing something with the short-term debt from the acquisition. If you could paint a picture of what the balance sheet on pro forma going to look like, what it is going to look like next year, floating versus fixed. Do you see the numbers falling out?

Sure. We have one interest rate swap that matures December 31 of this year. As we mentioned in the call so far today we have a $52 million loan that we expect to close in November of this year to replace that swap, so we will be swapping in a shorter term fixed for a longer term fixed situation there. Secondly, we are in the market for a second $50 million loan at this point that we also would hope we could finalize, circle this year, and close early next year. That would take us into next year with about $150 million of floating rate debt, of which $50 million would be swapped and $100 million would be floating. So approximately 15% of our debt would be floating somewhere around the first quarter of 2004.

Okay, thanks. That's helpful. Just getting back to some of the leasing activity in the pipeline you mentioned what is going on, and some of the projects at NBP, but the projects that were placed into service earlier this year, I guess the big ones in Columbia. Any update on any activity there? It seem like it should flow there?

We have very good activity, Ken, on the 6731 Gateway Exchange which had been sort of stuck at 67% leased and we have now a number of leases in various stages there. So we think that that will be in very good shape by year end. The other one was 13 and 4, a concourse which had been about at the same level for almost the entire year, and that one also we have now very good leasing activity and would expect to be into the 90% lease range by year end. So the other two are in a joint venture on the Robert Morris Drive, and both of those also have deals in the works, right now we are at 50% roughly, we think those will move up certainly into the 75% range or 80% range. So things have turned the corner. Deals take a little longer to get done, decision making is slow, but we think the trend is upward.

Okay. Along the lines, how much have you seen rents move in the past year, and particularly in Columbia?

Well, I think in Columbia the rents are under pressure. The single story product, particularly is probably in oversupply. That's where the bulk of the vacancy factor is, and so that has some pressure, rental rates have probably been, as we said in one of the earlier call, probably been pushed down $1 or so, a little bit of pressure on GIs there, and that was reflected in the re-tenanted portion of our leases that we did this quarter, moving up into the $8.48 range including commissions. But the multi tenant component has not been under pressure, and we have been getting our quota lease rates and doing pretty well there. So it is a bifurcation of the market but as you can see the numbers are tightening up pretty well. National Business Park, any leasing that's done there is doing very, very well, nice returns and the trick there was to keep up with the demand.

Okay, thanks. And lastly, just getting back to the ramp up in the C business, and do you expect that to continue into 2004? I mean nearly all of that is just related to tenant finish work for the government, gaining some visibility to some work that needs to be done next year?

Right now it is 100% related to work we are doing, third party work for the government. It tends to be a little lumpy. If you have work that you are doing that involves exterior construction, that's going to be impacted in the first portion of the year by the weather, potentially, the internal jobs will go fine. We think it will be, even with that lumpiness as Roger said, a little bit ahead next year of this year, and this year was sort of a second half is when it really is kicked in here. It shows no signs of slowing down whatsoever.

Okay, great, thank you. Nice quarter.

Thank you.

And we go next to Chris Haley with Wachovia Securities.

Hi, Rand, hope you are doing well, congratulations on a nice quarter.

Thank you.

Roger, also congratulations on the 9 cents and the 5 cents of acquisition and development service but I may have missed the numbers that are supporting that and the projects supporting that. Can you help me out on that?

Well, in terms of development, we have four projects under construction, one of which we are hoping will have rent commencement by January 1 of '04. The second one will have rent commencement in the second quarter of '04 and the third and fourth projects, the two build to suits for what is now Lockheed Martin and the Aerospace Corporation will kick in sometime in third to fourth quarter of '04. We're hedging a little bit because it is a matter of how fast we can get the TI construction done on those two particular buildings. All of these projects have very high margins and so they are very profitable for us once they kick in. In terms of acquisitions, the number I am quoting, not only factors in the $100 million of acquisitions on a net basis but also factors in those acquisitions that we did in 2003 that will then place for only a partial year, so we will be getting the full-year benefit of those in 2004, plus the $100 million net of acquisitions.

And that's a net number, not gross, so you are not assuming any asset sales?

For my own purposes, we are showing $125 million gross and 25 million of sales.

I'm sorry, that's right. On an annualized basis these four projects will generate what in terms of a after debt cash flow?

On a first year basis.

Or gross, whatever you want to give.

Well, we have got about $65 million and the margins on those are roughly 5%. So $3 million conservatively of FFO contribution.

Okay. And 5 cents of occupancy gains? What do you expect in terms of rental rate, portfolio wide on renewal, new? I may have missed that for '04?

We are assuming flat to nominally positive on rental rate growth. The assumption for same store next year is that we will get occupancy increase and not as much rental rate growth. Although as Rand mentioned in his comments next year's renewals, we believe, are at below market rent rates but we are factoring in some comfort there, still knowing that the market is a little difficult.

Okay any large capital expenditure projects for existing assets, any changes? I am assuming a straight line rent number might change a little bit on the upward in the Cap Ex items?

Well, I think in general CapEx will continue to be under pressure because of the supply and demand factors in the marketplace, so we would expect that what you've seen this year, which is a pretty substantial increase in '03 over '02 for CapEx would continue into '04. Don't believe it will get any worse than what you have seen but we do believe that continuation of a higher trend than we had back in the's 90s.

Okay, great. Thanks.

I will go next to Dave Aubuchon of AG Edwards.

Just curious when you look at your 2004 and 2005 [inaudible], what is your largest lease expiration or are they all just the standard 5 to 10,000, 20,000 standard feet leases?

We have three leases that expire in 2004 that are greater than 50,000 square feet. One of those is for 80,000 square feet in round numbers, one is for 57,000 square feet and one is for 70,000 square feet. We are expecting all three of those leases to renew in 2004, and that the balance of our expirations would have somewhat of a 65% renewal factor to them, 60 to 65, and when you balance all that, we are assuming that we will get to about a 70% of renewal assumptions for 2004.

Okay, and when you speak about negotiations taking a little bit longer, are you being more aggressive under these larger leases than you would typically of the smaller ones or does it just depend on what lease is expiring, what building, what marketing?

These particular buildings happen to be well located with tenants that have a high probability of renewal, so I don't expect it will be under significant pressure for those. It is actually the smaller space where the tenants have the greater bargaining power in our market at this point.

Okay, thanks.

And next you have Paul Adornato with Cobblestone Research.

Hi. Kind of a general question. Was wondering if there were opportunities to serve the the Federal Government outside of the Washington region and if you've kind of considered those parts of expansion.

There are, Paul, and, yes, we have considered that and it all relates somewhat to the increase in concern on the government for putting into effect the new forced protection requirements that require secured campuses and enhanced security. So we are obviously in the forefront of that based on our experience with our government tenants. And so we have had some early discussions and we expect those to be on going for providing those services beyond our immediate core markets.

Just to perhaps give us a sense of the size of that potential market, if you will, how much does the Federal Government have in the defense areas outside of the Washington region?

I think that is hard to say in here. I think what you are seeing is a general trend on the part of the government, both GSA and Army Corps of Engineers, to adjust to the reality and the continued threat of terrorism here in the country.

Uh-huh.

So they are tending to constantly evaluate that situation and tending to go more and more to secured campuses located in key parts of the country or to buildings that don't meet those criteria to new buildings that will need to be completed by the 2008 time frame. So I think it is virtually impossible, Paul, to put any sort of specific number on it. All we know is that it's active and we are certainly at the forefront of understanding that process but it seems to change every day.

Uh-huh, uh-huh uh-huh and perhaps along the same lines, have you considered additional property types within the Washington region? I am thinking probably most obviously of flex space, that might be synergistic to the office that you have.

Generally we were going to stay with our core suburban office and if there are flex properties, it's been interesting, we've had a few of what you would have called flex properties that have ended up being very profitable for us with key tenants that use that to convert to office and are looking more for adjacent ground to expand or to provide securities. So we still view those, eventually they are office projects and we think that one of the attractions we have as a company is you know that we are very focused geographically. You know that we are focused on product type and will continue to do that.

Okay, thank you.

Just a reminder today, if you do have any questions or comments simply press star 1 at this time. We will go next to Rich Anderson with Maxcor Financial.

Thank you. With regard to your '04 guidance, I think you mentioned the lack of inclusion of the one-time cost of redemption of the series B, is that correct?

That's correct.

Would the guidance, is that a net number of the 4 cents, or is that inclusive of the upside of putting that preferred to rest and maybe refinancing it with something of a lower rate?

That is just the noncash accounting charge that we would incur if we were to redeem that series B preferred. We aren't factoring in any benefit we would derive from, quote, refinancing that preferred into the lower yielding class of nonconvertible preferred.

Okay. For the third quarter leasing activity, what was the average rate that got you the 10 plus GAAP increase on the expiring leases?

Just a minute. Rich, we use a blended rate because some of them are triple net, some are gross leases and so, it's a little bit complicated here because we have to go back -.

Maybe while you are looking for that, I will ask my other question.

Sure.

Where would a combined Lockheed Titan company rank in your list of top 20 tenants?

Once that merger is completed, which we anticipate in the first part of next year they would become our number 5 tenant, and obviously are A rated company. So that's a very substantial credit enhancement for us and positions us very well with Lockheed, of course, the largest defense contractor.

I will ask another, if you haven't found the other.

$19.58.

$19.58. Okay. My last question is, the leasing expirations that you identified during the third quarter was substantially greater than what the lease expiration schedule identified during your second quarter release. I read the footnotes. And it said that there is an option for many of your government tenants to have an early term expiration option. Is that the difference completely, that issue?

We actually had two tenants, one a government tenant who wants to invest $8 million in their space who came to us and said we need to do an early renewal and extend our lease out for five-years in order to insure that we can get the benefit of the dollars that we are going to place into service. The second was another tenant, the Aerospace Corporation down in northern Virginia who had 133,000 square feet with an early termination right in 2007 where we eliminated that termination right and extended their lease out until 2014. So included in the renewal statistics for the quarter are those two early renewals, if you will.

Okay, and I'm sorry, one last question. The 848 you identified in TI, what was the term on those new leases?

The average was about 4.5 years.

Thank you.

And anything further, Mr. Anderson?

No, that's it. Thank you.

We will move to Anatole Pevnev with McDonald Investments.

Hi, this is actually Frank Greywitt. Just a quick question on the number of loans that you expect to close, the one in November, is that the same loan that was indicated in your press release?

That's correct.

So in total the 52 million and then another $50 million?

Correct.

And then just real quick, could you give the per share amount again for the third party income in your guidance as well as capitalized interest in the quarter?

For the quarter or for next year?

I'm sorry, the third party income for next year in your guidance.

Okay. We said 2 cents and that would be after tax, so that would equate to approximately $800,000, and in terms of capitalized interest for the third quarter, we had capitalized interest of $310,000.

Great, thank you.

And there appears to be no further questions today. Mr. Hamlin, I would like to turn the conference back to you for any closing or additional remarks, sir.

Sure, thanks again everybody for joining us today. We appreciate your participation and support. Rand, Roger, Mary Ellen and I are available to answer any of your other questions you might have. I wanted to note that we intend to hold our fourth quarter year end conference call on Thursday, February 5, 2004. Thanks again and have a good day.

And again that will conclude today's Corporate office Properties third quarter 2003 earnings release conference call. We thank you all for joining us and have a great day