COPT Defense Properties (CDP) 2006 Q1 法說會逐字稿

Welcome to the Corporate Office Properties Trust first-quarter 2006 earnings conference call.

As a reminder, today's call is being recorded.

At this time, I will turn the call over to Ms. Mary Ellen Fowler, the Company's Vice President of Finance and Investor Relations.

Ms. Fowler, please go ahead.

Thank you, and good afternoon, everyone.

Yesterday, our earnings press release was faxed or e-mailed to each of you.

If there's anyone on the call who needs a copy of the release or would like to get our quarterly supplemental package, please contact me after the call at 410-992-7324, or you can access both documents from the Investor Relations section of our Web site 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 Web site, you will find a reconciliation of our annual 2006 guidance.

With me today is Rand Griffin, our President and CEO, and Roger Waesche, our CFO.

In just a minute, they will review the results of the first quarter, and 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 and future events are forward-looking statements within 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 projects, 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 Rand.

Thanks, Mary Ellen, and good afternoon, everyone.

We're pleased to report a solid first quarter for the Company, reaching consensus FFO of $0.49 a share.

Total FFO for this quarter grew by 8.9% on a diluted per-share basis over the first quarter of last year.

Our results for the quarter reflect the positive impact of last year's acquisitions and development placed into service, offset somewhat by substantially lower term fees as well as slightly higher G&A and interest expense.

During the first quarter of 2006, we saw improvements in our core markets with strong rental rates on renewed and retenanted space, lower capital expenditures on renewals, and positive same-property NOI growth.

We made good progress on development leasing, signing leases at both NBP and Washington Tech Park II.

Turning to our external growth strategy, we have made good progress on a number of fronts.

First, we continue to dispose of assets in noncore markets, and selectively, properties in core markets that are not located in office parks.

Second, in addition to pursuing our acquisition and development programs, we have been focused on several other drivers, namely continuing our tenant-centric expansion in Colorado Springs and continuing to evaluate other potential expansion cities for next year.

Third, we announced the first transaction in what we view as another avenue of growth for us, working with several universities to build office space on university-owned land.

The first transaction is a small, fully-leased building located in the University of Maryland Baltimore County's Research and Technology Park, BTECH at UMBC.

We expect to start development of the second building for 110,000 square feet in the same location later this year.

We're very pleased to be chosen to partner with UMBC to develop these buildings.

Fourth, we are pursuing opportunities to partner with our tenants in an effort to help the tenant win contracts where we would provide the real estate solution.

The tenants are using our brand value, which means our track record, our development in construction and management expertise, specialized credentials and our financial strength.

Our brand value, coupled with the tenants' expertise in product, brings a highly competitive team to the table.

The location of these projects will be tenant-driven, not location driven.

We hope to announce the first of these projects in the second quarter.

Lastly, we continue to evaluate and position the Company to successfully bid on opportunities that will arise from BRAC over the next several years.

With that, I will turn the call over to Mary Ellen.

Thanks, Rand.

FFO for the quarter totaled $25.4 million, or $0.49 per share, as compared to FFO for the first quarter of last year of $21.1 million or $0.45 per share, representing an 8.9% per share increase.

Several factors impacted first-quarter results.

On the positive side, we're seeing the effects of the $124 million acquisition that took place in fourth quarter 2005.

As expected, we didn't lose a 98,000 square foot tenant in northern Virginia but were able to offset this vacancy somewhat with strong leasing elsewhere in the portfolio.

In addition, we also experienced a slight increase in G&A and higher interest expense.

Turn fees for the quarter were light at $350,000, versus the $750,000 we had previously projected in our guidance and significantly below the $1.2 million average per quarter in 2005.

Turning to AFFO, after adjusting FFO for capital expenditures, straight-lining of rents and FAS 141 income, our adjusted funds from operations for the first quarter totaled $18.9 million compared to $14.8 million during the first quarter of 2005, representing a strong increase of 27.8%.

For the quarter, we had a 56% FFO payout ratio, up slightly from 55% for first quarter 2005.

Our AFFO payout ratio was 72%, down from the 78% in first quarter 2005.

The first quarter 2006, the Company's EBITDA and interest expense is 2.8-to-1, and our fixed charge EBITDA coverage continues at a solid 2.3-to=1 ratio.

Looking at GAAP earnings for the quarter, we recorded earnings of $0.15 per share, versus $0.14 for the comparable 2005 first quarter.

Looking at our same-office results for the first quarter, for the 121 properties, or 79% of the total square footage owned, same-office cash NOI increased a solid 5.5%.

On a GAAP basis, the increase was 3.9%.

Turning to our balance sheet, at March 31, our total market capitalization was approximately $3.8 billion with $1.4 billion of debt outstanding, equating to a 36% debt-to-total market cap ratio.

During the quarter, we executed an interest rate hedge to swap from a LIBOR floating-rate to a fixed rate on $50 million at 5.04% for three years.

As of March 31, 29% of our debt was floating and 71% was fixed.

Subsequent to quarter end, we executed two interest rate hedges, swapping LIBOR floating for a fixed rate of 5.2% on an additional $50 million for three years.

These hedges have reduced our floating-rate debt today to 25%.

Before the end of the year, we expect to finance up to $100 million on a long-term, nonrecourse fixed rate basis that will further reduce our floating-rate debt exposure.

Turning to the equity side, we raised about $83 million of capital through the issuance of 2 million shares of common stock, including Shoe through a bought transaction with two investment banks.

We used the proceeds initially to pay down our revolving line of credit and subsequently plan to redeem our 10.25 Series E and 9 7/8 Series F preferred shares totaling about $64 million that are callable July 15 and October 15 this year.

Redeeming the two preferred series equates to about $0.06 of annual FFO accretion.

We also had $60 million in permanent loans we plan to prepay in July that have a blended rate of 7.8%.

We can refinance the assets with long-term fixed-rate debt in the 6% range.

Now, I will turn the call over to Roger.

Thanks, Mary Ellen.

Looking first at our annual guidance, we're maintaining the $1.98 to $2.05 FFO per share range for now, given the multiple events we expect to happen this year and the uncertainty regarding the timing of those events.

Turning to our portfolio, at March 31, our wholly-owned portfolio ended the quarter at 93.3% occupied and 94.4% leased.

We experienced and expected dip due to the loss of a 98,000 square foot tenant in northern Virginia.

We were aware at the time we purchased Pinnacle Towers in 2004 that this tenant had planned to vacate the space at lease expiration.

We have good activity on the vacated space and we are seeing increasing rental rates in the market.

We do expect to be close to 95% occupied by year-end.

In terms of leasing statistics, we renewed 421,000 square feet, equating to a 65% annual rate at an average capital cost of $2.80 per square foot.

Average rental rates for the renewed and retenanted space were -- for 492,000 square feet, increased 14.1% for total rent on a straight-line basis and increased 4.8% on a cash basis.

For renewed and retenanted space for the quarter, the average capital cost was a low $4.11 per square foot.

These statistics reflect overall healthy core markets.

Turning to lease expirations for 2006, we have 5.7% of our total revenue expiring, down from 9.3% at the beginning of the year.

We anticipate renewing all leases maturing for the remainder of the year that are 50,000 square feet or more, reaching a projected renewal rate of around 70% for the year.

We believe that, overall, we are roughly 10 to 12% under market on our expiring rents with the opportunity to further increase rents in a tightening market.

With regard to leasing of the development space, we executed a 32,000 square foot lease at 302 NBP and a 78,000 square foot lease at Washington Tech Park II.

We have additional leasing activity at Washington Tech Park II and we expect to be nearly 100% leased by the second quarter of this year.

In the process of leasing this building, we were able to increase the rentable square footage from 213,000 to 234,000 square feet.

As a result, anticipated NOI for the building will be higher but will be offset to some extent by increased TI costs.

We still expect the building stabilizing at an 11% cash-on-cash yield.

With regard to our markets, we've continued to outperform each of our core markets.

With respect to specific conditions in the BWI submarket as of March 31, vacancy including sublease stood at 10.6%, up from 6.5% one year ago.

Our BWI portfolio totaling 4 million square feet and representing 70% of the BWI submarket was 95% leased at March 31.

Turning next to the Columbia submarket in Howard County, at March 31, vacancy with sublease was 15.1%, up from 11.5% one year ago.

Our properties in the Columbia market total 1.9 million square feet and are currently 97% leased.

In the Dulles South submarket in northern Virginia, the vacancy rate, including sublease, continues to decrease, ending the first quarter at 90.2%, down from 10.2% one year ago.

Our operating portfolio of eight buildings totaling just over 1.2 million square feet is 99.9% leased and occupied.

Turning to dispositions, we've continued to make good progress this quarter toward our $100 million goal, selling a total of four properties with three located in the B/W corridor and one in central New Jersey, for a total of $29.2 million.

As we mentioned on previous calls, we plan to continue divesting our New Jersey portfolio as well as certain noncore B/W Corridor assets.

With regard to our Unisys campus, as some of you may be aware, we are presenting conceptual plans at several public meetings to add development square footage to the site.

We are having ongoing discussions with Unisys with regard to their future plans, and we have also had discussions with the local hospital that would potentially be built on the site and adjacent ground, along with medical office buildings.

At this point, we do not know what additional square footage would be developed or redeveloped on the site, or what the timeframe would be.

However, we do believe we will have an opportunity to reduce our lease exposure to Unisys as well as create significant value and therefore upside for the Company.

With regard to acquisitions, it was a relatively quiet quarter.

We purchased a 60,000 square foot office building and extra ground in Colorado Springs for $43 per square foot that will be redeveloped to a very attractive yield.

As noted in our prospectus for the offering, we are hard on a contract for $78 million to acquire property located in Columbia Gateway Business park that should close during the second quarter.

We continue to follow our policy of not exceeding replacement costs, and we're fortunate to have additional submarkets, like Colorado Springs, where we can continue to acquire properties at attractive yields.

We believe we are still on target to reach our acquisition goal of $300 million for the year.

Turning to our land inventory, during the quarter, we acquired a 31-acre parcel in San Antonio that can support 375,000 square feet located contiguous to our existing land and building and a 6-acre land parcel in Hanover Maryland that can support 60,000 square feet.

Subsequent to quarter end, we purchased a 20-acre parcel that can support 300,000 square feet located adjacent to our Patriot Park in Colorado Springs that will bring the total development capacity in that Park close to 1 million square feet.

We now have 8.3 million square feet of development potential, and we are adding some other key sites hopefully later this year that would bring this total close to 12 million square feet.

With that, I will turn the call back over to Rand.

Thank you, Roger.

First, I'd like to provide an update on our development and construction activities.

As I mentioned earlier, we're very excited about our partnership with UMBC, as we expect it to become a template for partnerships with other universities in our core markets, as well as other cities where we are located.

In addition to the UMBC activities, you may have read reports that we're working on a project called MSQUARE, which will be a partnership with the University of Maryland at College Park to develop office space within the research park on the university campus.

This site can support up to 2 million square feet of development.

We are just finishing up documentation and hope to start the first building later this year.

We continue to make good progress with the four buildings under construction and two under development at the National Business Park.

As Roger mentioned, we signed another lease this quarter at NBP.

Even though we do not see the same pace with leases for full building users, we still have good leasing activity with leases in the 20 to 50,000 square foot range, which we expect will be the case going forward.

Also within the B/W Corridor, we have good leasing activity at our new headquarters building Gateway Exchange II and therefore, we anticipate starting Gateway Exchange III, a 132,000 square foot building, later this year.

We also anticipate starting our first building at [Arunda] Preserve later this year.

Turning to northern Virginia, as we mentioned, we're making good progress towards leasing WTP II.

However, in light of the substantial new construction starting over the next year, we are moving forward cautiously with any other new development and expect that we would only start new buildings with some preleasing or if build-to-suit opportunities arise.

Moving onto our goal of adding depth to our team, we've added two new positions within our government services group.

As you may recall, about two years ago, we formed this government services team to address the needs of our largest tenants.

This quarter, we added to the depth of this team by hiring [Kathryn Baird] Manager for Government Services.

Kathryn's background and experience with the military and federal affairs office of Maryland's Department of Business and Economic Development and her contacts throughout the community will help us identify additional opportunities to further expand our government services initiative, as well as help in our analysis of BRAC.

We've also added strength to the construction group for government services by bringing Frank Ziegler on board as Vice President of Government and Construction Services.

Frank was employed by the Rouse Company for 17 years, most recently as Director of Construction.

Frank's experience will help us further expand our ability to meet the needs of our largest tenants.

Finally, looking at our recent accomplishments, we are pleased to report that we achieved, for the second year in a row, a best in industry ranking by CEL & Associates Inc. for our commitment to the highest level of quality and service to our tenants.

We won first place for the 2005 National Commercial Real Estate Customer Service Award for Excellence for Category One Properties, also referred to as the A-list award.

Category One represents companies owning over 100 properties\ and is the largest of the categories.

CEL surveys over 2 million tenants a year to derive the ratings for each landlord.

We consistently stress good service as the key to satisfying and retaining our tenants, and it is the foundation of our tenant-centric expansion strategy.

Needless to say, we're very proud for the second year in a row to receive this recognition, since it reflects our dedication to serving our tenants in an exceptional manner.

In summary, we remain on track for a strong year and are excited about our new initiatives and the opportunities to partner with our tenants, as well as our local universities.

We continue to seek ways to build on our strengths, expand our relationships with tenants and create increasing shareholder value.

With that, we will open up the call for your questions.

Yes, sir.

Thank you. (OPERATOR INSTRUCTIONS).

John Guinee, Stifel, Nicolaus.

Very nice job.

A couple of quick ones -- first, Roger, did you say Columbia Gateway you are hard on a deal there?

Yes, there is a 613,000 square foot office -- combination office/warehouse building that's on 37 acres that we are hard on.

Well, a single building?

Yes.

It was a warehouse building and part of it has been converted to office, and over time, the balance will probably be converted.

There's additional ground that we're picking up with the acquisition that will allow us to build another building, stand-alone.

Of the 78 million, how much are you attributing to the asset and how much to the land?

Approximately $3 million to the land, which is 100,000 square feet at $30 an SAR foot, and the balance to the building.

Okay.

Rand, you mentioned development and partnership with universities.

It looks to me like you have a ground sublease arrangement.

Yes.

So, who is the owner of the land?

Who is the lessor who turns out to be the lessee to you as the sub-lessor or however -- (multiple speakers)?

Well, in effect, what the universities have done trying to convert their land into a revenue source, but more importantly to them is to find people like us that have the expertise and the tenant relationships to bring tenants on board that can be complementary to the university activities.

So they on the ground under a ground lease, and then we in effect are the lessor of the buildings.

We will own the buildings, and they participate through the ground lease mechanism.

That's the same on University of Maryland as well.

How long are the ground leases?

62 years.

I got you.

Okay, thank you very much.

(OPERATOR INSTRUCTIONS).

Rich Anderson, Harris Nesbitt.

Good afternoon, everybody.

You mentioned, Roger, being 10 to 12% under market on your expiring leases.

Is that a cash number or GAAP?

It's probably a combination, but probably GAAP with cash -- actually, I mean cash with GAAP being slightly higher.

Okay, GAAP higher.

With regard to the university strategy, would that be sort of ear-marked for local schools, like the University of Maryland and Washington-area schools, or would you take that on the road as well?

Well, I think, as I said in my comments, Rich -- this is Rand -- while we have the core focus within the Washington area, other universities have actually been here and toured what we're doing here and have an interest in a similar situation in some of the other cities that we operate in.

Where do you see the value add here?

Is this just a mechanism to sort of diversify your reach as an office company, or is there like incremental returns that you can get from this business that make it attractive to you versus other investment alternatives?

Well, I think, first and foremost, it adds another element of growth to us.

A lot of the universities are reaching out to utilize their excess ground, and they are really interested in creating a partnership with our kinds of tenants.

The big issue going forward for these tenants is going to be where do I find the workers?

If they can align with strong universities that have an excellent, educated workforce coming out of the universities, they are going to be ahead of the game.

So the fact that we are in the middle of those relationships, serving both parties, really in effect makes us more effective in dealing with our own tenants.

So to us, it's adding some square footage, but more importantly adding to the depth of our relationships with our tenants and also helping out the universities.

But these will big government-type tenants that are going to be located on university campuses?

Typically, they have been that, yes.

Okay.

Then on the partnerships with existing tenants who will help win projects, can you just give like a for-example of how your company would participate in a -- what would be an example of a real estate solution for a government defense contract?

Our contractors provide IT services to the government, for instance, and so those IT services need to be housed in real estate.

It makes it easier for the government to possibly accept one solution, one provider who has both the real estate and the IT solution together.

Okay.

So again, same question on that front -- is this a particularly interesting rate of return-type business, or is it just again another sort of way to diversify your platform?

Again, we are a tenant-driven company, and so to the extent we can take our customers and play with them with the bigger customer, that's what we want to do.

So everything we're doing is driving towards customer satisfaction, customer expansion, and we think this fits into that model.

Okay.

Then the last question is, on the G&A, would you call the first-quarter a run rate for the full year at a higher level?

The first quarter is generally seasonally higher because we've got annual report expenses, audit expenses; we've got tax return preparation.

So I think the first quarter was higher than what you should see going forward for the next couple of quarters.

How about -- it may be difficult to predict -- lease termination fee run-rate?

It is difficult to predict because we only do them when it's economically beneficial to the Company to do it.

We would never do it just to generate some revenue for a quarter.

So, this quarter, we didn't see any lease opportunities where we had a tenant in tow to replace another tenant, so we elected not to do any additional lease terminations.

But, I think the history of our company is that we get to, on the low side, 2.5 million and on average to about $4 million a year.

But this year, we did project 2 to $3 million, and I think we would stick with that projection on the low side.

Okay, thank you.

Dave Aubuchon, A.G. Edwards.

Roger, relative to the 10 to 12% market rents increase potential, that's on a cash basis.

So would you say the 4.8% increase in the first quarter was an anomaly or just not something that we should look to for the balance of the year?

Well, we're going to have ups and downs obviously because that increase is not level over our entire portfolio, so it really depends on what leases mature at any one time.

But on balance, we, again, think our portfolio is about 10% under market on a cash basis and a little higher than that on a GAAP basis.

Okay, so is that an in-place -- so I understand the number correctly -- is that an in-place overall in-place rent versus market, everything in the portfolio, or 2006 or both?

That's the entire portfolio.

Okay.

The university business, will there be any lab component, potentially?

Generally no, not in these.

Both in the MSQUARE and the new UMBC, these are not labs.

Okay.

Then, just looking at the under-development table in your supplemental, I noticed a few changes if I can go through those. 300 NBP -- it looks like the square footage increased by about 34,000 square feet.

I'm just curious of what's the changes that are undergoing, underway there.

That's right.

We've added a floor to that building and also we added a small retail component in sort of a half-basement area to serve as that part, the expansion part of National Business Park.

So again, we see continued strong demand and that building sits right at the heart of the NBP.

So does that suggest an eye on a particular tenant need or desire?

No, not really.

As I said in my call, you were still seeing nice 20 to 50,000 for leases, and occasionally we will see a full building kind of user coming along and it's sort of steady.

So it's really more responding to the potential to maximize density in the Park.

Okay.

Then 6721 Columbia Gateway, from fourth quarter to first quarter, the total cost estimate went from 24 million to 31 million?

That is a reflection that we had allocated 100% of the land to Gateway Exchange I and II prior.

For the third building, we're going to have to build a parking garage.

So we decided, instead of allocating any -- going back and reallocating the land, allocate the parking garage to this particular building.

Okay.

Then last question -- I didn't hear or see anywhere the capitalized interest for the quarter.

$3.1 million.

Okay, thank you.

Chris Lucas, Robert Baird.

Good afternoon.

Just a couple of quick questions -- Roger, just understanding the same-store -- on a sequential basis, it was negative from fourth quarter to first quarter.

Is that primarily or solely related to the PWC moveout at Pinnacle, or were there some lease termination fees in the fourth quarter that -- (multiple speakers) -- that number?

$750,000 of that relates to the lease termination fees.

Then the other piece is, at the end of the year, we do an annual [CAM] insulation, which catches up the whole year.

Generally, on a quarterly basis, we capture about 70% of our portfolio, and at the end of the year, we catch that up.

So we had about $500,000 in the fourth quarter to true-up [CAM] for the year.

So those two things, the 750 and the 500 was a million, 1.25 million, which made up the difference.

Okay.

Then just on a follow-up on the last question related to Gateway, what -- given the reallocation costs then, how would that adjust for your yield? (multiple speakers)

It didn't adjust for the yield; we just had not -- the items that are in the development page aren't yet as firm as those things that are in the construction, and so we just had not yet decided how to allocate the parking garage and -- or reallocate the land, so that was just fine-tuning that at this point.

Okay.

Then Rand, just sort of off-topic a little bit, but there was an article in the paper this weekend related to the defense security service halting their clearance process for contractors.

Any thoughts on how that may or may not impact your tenants' businesses in terms of -- and just the government contracting business, as that kind of works its way through?

Well think, as the article already said, it's already difficult to get clearances; there already are shortages, and that would just (indiscernible) that situation.

So we don't see necessarily it impacting our tenants.

It certainly makes people that have clearances more valuable, and then it continues to put pressure on the government to try and figure out how they're going to get their job done with cleared personnel.

So, you know, it's a continued difficultly that's really been going on since 9/11.

Okay, thanks.

That's all I have.

Charles Place, Ferris Baker Watts.

Thank you.

Good afternoon.

Most of the questions that I had had been addressed.

I guess the two that are remaining is do you ever provide or have an estimate kind of what your CapEx target for the year is?

It will probably be higher than what the first quarter is because, in the first quarter, we did not have a lot of retenanting; we had largely renewals. 420,000 of the 492,000 square feet were renewals, and cost for renewing is generally less than retenanting.

So if you go back historically to the last four quarters prior to that, in the $5 million range, that's probably where we will go in the next couple of quarters.

Okay, great.

Then secondly, I'm sorry.

I missed the part about the level of termination fee revenue in the first quarter.

$350,000.

Okay, thank you very much.

(OPERATOR INSTRUCTIONS). [Eduardo Avush], Millennium Partners.

Thank you.

My questions have been asked.

Thank you very much.

Thank You.

At this time, we have no further questions in the queue, but we would like to give everyone one last opportunity to signal. (OPERATOR INSTRUCTIONS).

We will take a question from [Eduardo Avush], Millennium Partners.

I could get another question in.

When looking at same-store NOI, I know, as we discussed, I think the part of the reason why it was slightly lower was (indiscernible) seasonal, so the fact that this 98,000 square foot tenant was out.

But looking forward towards the year, what kind of run rate are you expecting for your same-store NOI?

We are anticipating approximately 3% same-store NOI growth.

Is that --?

On a cash basis.

On a cash basis.

Can you break it out between revenues and expenses, gross?

For the first quarter, our expenses increased 2.5%, and our revenues increased 3.5 on a cash basis and 4.5% on a GAAP basis.

I would anticipate that expenses will increase a little higher than that, approximately 4 to 5%, and that revenues would increase around 7 to 8%.

Okay, thank you very much.

At this time, we have no further questions.

I would like to turn the conference back over to Mr. Griffin for any additional or closing remarks.

Thank you, everyone, for joining us today.

As always, we greatly appreciate your participation and support.

Roger, Mary Ellen and I are available to answer any other questions you might have.

In addition, we intend to hold our second-quarter conference call on August 3.

For those of you interested, we are also holding our annual meeting in Baltimore and 9:30 AM on May 18.

Thank you and have a great day, everyone.

That does conclude today's presentation.

We thank you for your participation, and you may disconnect at this time.