COPT Defense Properties (CDP) 2006 Q2 法說會逐字稿

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

And as a reminder, today's conference is being recorded.

At this time, I would like to turn the conference over to Mary Ellen Fowler, Vice President of Finance and Investor Relations.

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 443-285-5450, or you can access both documents from the investor relations section of our website at www.COPT.com.

Within the supplemental package, you'll find a reconciliation of non-GAAP financial measures to GAAP measures referenced about this call.

Also under the investor relations section of our website, you'll find a reconciliation of our annual 2006 guidance.

With me today is Rand Griffin, our President and CEO, and Roger Waesche, our CFO and soon-to-be COO.

In just a minute they will review the results of the second 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 on 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 re-lease 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 our filings from time to time with the Securities and Exchange Commission.

Now, I'd like to call over to Rand.

Thanks, good afternoon everyone.

Thank you for being on the call despite today's distraction with the SL Green and Reckson merger announcement.

We have a number of positive events to share with you today.

First, we're reporting good quarterly results.

We generated $0.49 per share in FFO for the quarter, meeting our consensus estimate equating to a 4.3% increase in FFO per-share year-over-year.

Second, in spite of the challenging acquisition environment, we have acquired $129 million of accretive office property so far this year, on track towards our goal of $300 million.

Roger will provide more details in a minute.

Third, we continue to pursue our disposition strategy, selling two office buildings in our New Jersey portfolio subsequent to quarter end and selling a total of $47.9 million of property so far this year.

And fourth, as we announced recently, we have made several changes in regard to the management team.

In doing so, we're beginning to address succession planning in a thoughtful, well-planned manner while at the same time reducing my span of management, increasing our tenant relationship focus, and adding depth to the Company for our continued growth.

The first change is promoting Roger from CFO to the COO position.

Roger as CFO also had asset management reporting to him, and as a result was heavily involved in every transaction on the leasing, acquisition, and disposition side of our business.

Our Company has grown substantially over the last five years.

We now need to split Roger's role so we can devote more time towards creating value through executing on our strategic initiatives, pursuing acquisitions, cultivating tenant relationships, and integrating the leasing and property management side of our business.

In his new role, Roger will be responsible for investments, asset management, property management, and government services.

Roger is a very -- is very strong on the transaction side of the business, and we believe this shifting of responsibilities will help accelerate our growth.

Secondly, we have hired Steve Riffee, former CFO at CarrAmerica, as our CFO to manage accounting and tax reporting, finance, treasury, investor relations, and the IT areas.

He is an experienced financial executive who brings years of public company and REIT experience.

Steve adds immediate and impactful depth to our Company.

We initiated a search over eight months ago and feel fortunate to find a local candidate of Steve's experience and character.

This change will be effective as of August 14th.

Congratulations to both Roger and Steve.

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

Thanks, Rand.

To [enter] our performance, FFO for the second quarter totaled $25.2 million or $0.49 per share as compared to FFO over the second quarter last year of $21.8 million or $0.47 per-share, representing a 4.3% increase in FFO on a per share basis.

Turning to AFFO after adjusting for capital expenditures and straightlining of rents, our adjusted funds from operations increased 11.6% to $18.9 million for the second quarter compared to second quarter of 2005.

Payout ratios were strong at 56.4% for FFO and 75% for AFFO for the quarter ending June, 2006.

The Company's EBITDA to interest expense was 2.7 to 1 and our EBITDA to fixed charge coverage was 2.2 to 1.

Looking at GAAP earnings for the second quarter, we reported earnings of $0.13 per share versus $0.14 per share for the second quarter of 2005.

In terms of same property net operating income for the 120 comparative properties representing 72% of our portfolio, same property cash NOI increased 1.1% from the second quarter of 2005.

On a year-over-year basis, even though we experienced increased occupancy in rental rates in our same-store portfolio, this increase was offset to a great extent by lower term fees of $1.1 million.

Adjusting for this event, our same-store would have increased by about 4%.

Turning to our balance sheet at June 30th, our total market capitalization was approximately $3.8 billion with $1.4 billion of debt outstanding, equating to 38% debt to total market cap ratio.

At June 30th, 27% of our debt was floating and 73% was fixed.

We have lowered the floating-rate debt from 32% one year ago.

As we mentioned on previous calls, the level of floating-rate debt reflects the volume of construction underway, all financed with short-term debt.

We continue to pursue lowering the level of our floating-rate debt and are currently in the market with $125 million to $140 million package that will be financed on a long-term non-recourse fixed-rate basis.

We expect to close this transaction by the end of October.

During the quarter, we raised our borrowing capacity and our unsecured revolving line to from $400 million to $500 million with all other terms remaining the same.

Subsequent to quarter end, we repaid $60 million in permanent loans with a blended interest rate of 7.8% and we redeemed our 10.25% Series E preferred shares for $28.8 million.

The write-off of the issuance costs associated with the redemption will reduce our FFO and EPS by $0.4 per share for the third quarter and for the year.

We plan to redeem our 9.875% Series F preferred shares for $35.6 million on October 15th of this year.

Upon redemption of Series F, the estimated write-off of issuance costs will reduce FFO though by an additional $0.04 a share and EPS by $0.05 a share.

Subsequent to quarter end, we raised $82 million of capital through the issuance of 3.4 million shares of 7.625% Series J preferred stock.

We believe it prudent to raise additional capital to lower our floating-rate debt, given the rising interest rate environment as well as to provide funding for our development pipeline.

Now, I will turn it call over to Roger.

Thanks Mary Ellen.

Looking first at our annual guidance, we're tightening the range slightly to $1.99 to $2.05 FFO per share.

This guidance does not include the estimated $0.08 per share impact to FFO due to the write-off of issuance costs for the two preferred share redemptions.

As we look toward the second half of the year, our variables relate largely to the timing of dispositions and acquisitions.

Additionally, G&A is increasing slightly as we position the Company for continued growth.

While development leasing is going very well, the timing of our development occupancy has slipped slightly.

Based on our current knowledge, we're driving to the upper middle of the range.

Turning to our portfolio performance at June 30th, our wholly-owned portfolio totaled 14.8 million square feet and ended the second quarter at 93.6% occupied and 95% leased.

We have made good progress on leasing the former PwC space at Pinnacle Towers and now project the portfolio to be over 95% leased by year-end.

In terms of leasing statistics, we renewed 239,000 square feet, equating to a 62.5% renewal rate at an average capital cost of $2.16 per square foot.

Average rental rates for the renewed and retenanted space for 427,000 square feet increased 12.6% for total rent on a straight line basis, and increased 5.3% on a cash basis.

For renewed and retenanted space for the quarter, the average capital cost was $14.06 per square foot.

These numbers reflect a strong market with continuing landlord pricing power.

Turning to lease expirations for the balance of 2006, we have 4.1% of our total revenue or 577,000 square feet expiring by year-end.

We anticipate reaching a projected renewal rate of around 70% for the year.

We believe that overall we are still roughly 10 to 12% under market on our expiring rents.

With regard to leasing of development space, we executed a total of 358,000 square feet of new leases.

This total included two leases for Northrop Grumman, 195,000 square feet for our new building located in Richmond, and 146,000 square feet at Washington Tech Park II.

With this lease, we're 100% leased at Washington Tech Park II and 100% leased in our Westfield portfolio, consisting of 1.5 million square feet.

With regard to our markets, we continue to outperform each of our core markets.

With respect to specific conditions in the BWI submarket, as of June 30th vacancy including sublease stood at 10.9%, up from 6.1% a year ago.

It should be noted that during the past year, 1 million square feet has been added to the market.

Our BWI portfolio totaling 4.1 million square feet and representing 72% of the BWI submarket was 94.6% leased at June 30th.

With regard to the Columbia submarket in Howard County at June 30th, vacancy with sublease was 12.5%, up from 10.5% one year ago.

In Columbia, 900,000 square feet of new development has been added to the market.

Our properties in the Columbia market total 2.5 million square feet and are currently 98.6% leased.

In the Dulles South submarket in Northern Virginia, the vacancy rate including sublease ended the second quarter at 10.9%, up from 9.7% one year ago.

Our operating portfolio of eight buildings totaling just over 1.2 million square feet is 100% occupied.

Turning to dispositions, we continued to take advantage of the seller's market by exiting our noncore markets.

We sold $15.8 million wholly-owned property and a 20% interest in the joint venture property, both located in New Jersey, subsequent to quarter end.

We're now down to seven buildings in New Jersey and expect to continue making progress this year.

We sold a total of $47.9 million of property so far and would now expect to exceed our $100 million goal for the year by 20 to 30%.

We've also placed our Unisys campus on the market.

This 140 acre, 960,000 square foot property can be increased by 1.2 million square feet, and therefore is an excellent value add development opportunity with stable existing cash flow.

We expect this property to be well-received in the market, but do not expect this sale to impact 2006 earnings.

With regard to acquisitions, it was a busy quarter.

We purchased $129 million of office property located in Colorado Springs and Columbia, Maryland that added about 1 million square feet to our operating portfolio.

Included in this total was a 611,000 square foot building located in the heart of Columbia Gateway Business Park where we now own 2 million square feet.

We viewed this property as the value add opportunity as we have the ability to develop an additional 120,000 square feet and to convert 292,000 square feet of warehouse to office over time.

Adding to our Colorado Springs portfolio, we purchased five buildings totaling over 400,000 square feet as well as 32 acres of land that can support 420,000 square feet of additional development.

As you may have read in the wall Street Journal article yesterday, Colorado Springs is expected to add 9,000 to 12,000 jobs that Department of Defense will relocate to Fort Carson as part of the plan to reduce the number of personnel located at overseas outposts.

Defense contractors are also growing in the area with SI international being awarded a large contract for work with the space command and North American Air Defense Command.

The office market continues to tighten, with vacancy decreasing to 8% from 9.5% one year ago.

We continue to follow our policy of not exceeding replacement costs on acquisitions and look for value creation opportunities where we have the opportunity to enhance market share or enter new submarket.

We passed on many opportunities where the IRR is less and our cost of capital.

We believe we still are on target to reach or acquisition goal of $300 million for the year, although this may be year end loaded.

Even though we're striving to achieve this goal with the right opportunities, we will not compromise our underwriting standards.

Turning to our land inventory, during the quarter, we acquired 216 acres that can support 1.8 million square feet of development.

As we mentioned earlier, 178 acres of this land is adjacent to the National Business Park and provides the opportunity to build another 1.25 million square feet in Phase III at the National Business Park.

We believe we are well positioned to absorb a major portion of the office demand that will result from the additional BRAC jobs being moved to Fort Meade over the next four to eight years.

Overall, we now control or own 9.8 million square feet of development potential, which equates to a 60% increase in the size of our portfolio today.

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

Thank you, Roger.

With regard to new opportunities with our existing tenants, as you remember from our last call, we mentioned that we were pursuing ways to partner with our key tenants on transactions where we would provide the real estate solution.

We were pleased to announce recently that we executed on the first of these transactions, a 193,000 square foot lease with Northrop Grumman for a $54 million building to be occupied by their Virginia Information Technologies Agency, or VITA as it is called, and Northrop Grumman employees.

In this particular case, Northrop Grumman won a $2 billion contract to provide a technology solution, and we're providing the real estate solution for the state of Virginia.

We believe this transaction can become a template for other similar projects around the country and exemplifies that our deep relationships with key core tenants lead to great value creation opportunities for our Company.

In addition to our project with Northrop Grumman, we have also the working with Computer Sciences Corp. to develop a facility mega center of approximately 60,000 square feet to be located in a portion of one of our buildings at NBP that would provide a plug and play environment for defense contractors.

This is another example of partnering with a key tenant to provide real estate and technology solutions for our defense contractor tenant base.

This project is a new concept for us that has been initiated by the U.S. government that will accelerate contractors relocating from Fort Meade.

We're hopeful that this concept can be expanded to other locations.

These transactions result in a continued acceleration of our construction and development activities.

We currently have a total of $545 million under way, including $263 million of property under construction which is 64% leased, $197 million under development and $85 million under redevelopment.

This volume should continue to grow based on additional opportunities we're seeing on the market.

In summary, we have good momentum on all fronts and in particular, we continue to add tenant driven projects to our development pipeline.

We will continue to cautiously pursue acquisitions in this difficult market, as well as recycle our capital through non-core dispositions.

At the same time, we continue to add depth to our management team and we're well positioned to continue strong growth for our shareholders.

And with that, we'll open up the call for your questions.

(OPERATOR INSTRUCTIONS).

John Guinee, Stifel Nicolaus.

Good day.

A few questions.

First, actually, first, Roger, congratulations.

Thank you.

It's not about me.

It's about the great team we have here at COPT and I am just pleased to be part of it.

Good.

Is Steve there?

No -- he's --

[Not until the] 14th.

We wanted to spare him the exercise of a Q and a call.

All right.

Hey Rand, which piece of the Reckson deal did you bid on?

It was news to us, so fortunately we're not in that game.

Okay.

Can you talk a little bit, seriously, about the products you're buying and building in Colorado?

It looks to me like you're buying land out there for $5 or $10 bucks per developable foot.

It -- you probably have a few dollars in infrastructure cost.

It looks like you're buying stabilized assets at about 130.

And correct if I'm wrong on those numbers, but can you give us what you think it costs to develop new product including land, core and shell, TI, soft costs, etc.?

I think all in, John, we're a little heavier on the land of the time you get done with the development rights and so on -- maybe up in the $10 to $12 [FAR] foot range.

And all in on development, we think we'll be in the $150 to $160 range.

A little bit depends upon if it's on the Peterson Air Force Base side, you will have a slightly higher TI, hence higher rental rate for defense contractors.

If it's on the north side, those might be non defense and a little less TI.

But as you saw from the Wall Street journal article yesterday, that market has got excellent growth and good population growth as well and we think we're well positioned.

We're now the largest owner -- office owner in Colorado Springs.

Good.

Thank you.

Nice quarter.

(OPERATOR INSTRUCTIONS).

Rich Anderson, BMO Capital Markets.

I think everyone's all SL Green/RA'd out or something, but I thought I would chime in.

You mentioned how great of a market Colorado Springs is.

However, was that requirement for you to go out there?

My understanding is you guys are moving with your tenants and it's less of a market thing and more of a tenant thing.

Is that a fair statement?

I think that's fair.

We look for any of these expansions, Rich, to be where we have government demand drivers.

We really have a number of them.

The article mention for Carson, but we really went out there as a result of the Peterson Air Force Base.

Secondly, as a result of that, our tenants, our core tenants are getting a number of defense contracts and hence they're -- they need more space and they're winning more job growth.

It doesn't hurt, though, to have continued growth in a city, and because the non defense also adds to the vitality of the area.

And I think the article mention you do see a number of call centers that are out there with Progressive Life Insurance and FedEx, and T. Rowe Price just announced another large building out there and so we like that kind growth.

We think that will bode very well for us in our continued expansion.

Okay.

And as it relates to state of Virginia project with Northrop, you talked about that becoming a reputable business.

What evidence do you have that makes you think that could become a repeatable type of business for you?

In addition to Northrop Grumman, there are other firms who are bidding on similar proposals.

We -- in going through the original RFP process and kind of studying this, we understand our 30 other states entertaining similar requirements for centralizing, upgrading their IT and putting them into secured buildings.

And so we think that we will get a share of those, certainly.

And typically, these are two locational facilities, one for the core one and one for a backup facility elsewhere in the state.

Okay.

And have you guys given the thought -- you are sort of venturing outside of D.C.

Have you given any thought, taking your sort of secured infrastructure in your secured skill sets outside of United States -- maybe to develop embassies or things of that nature that require a certain level of sophistication and security?

No.

We have our hands full keeping of our growth here.

And -- I grew up internationally and have lived there twice in different parts of the world a number of times and we're just very content for a number of years being local.

Okay.

Thanks very much.

Good quarter.

Paul Puryear, Raymond James.

Good afternoon.

Rand, did we hear you correctly -- is the development leasing slowing somewhat?

What was your comment with regard to that?

I think what we said wasn't that it was slowing, but we're -- it's taking longer to get the tenants in and paying rent.

The actual leasing is going well, but the time between leasing and occupancy has slowed a little bit for us for this year.

And that's really, Paul, the larger the leases, the longer the decision process for the buildout.

And tenant spaces are getting increasingly sophisticated, particularly kinds of tenants that we do.

The overall construction volume has extended the leadtime for some thing.

We certainly have seen that here in our new headquarters.

And so we just wanted to let people know that the leasing is going very well, in fact, but the in-place paying rent as we define occupancy is lagging slightly.

Okay.

And then, at the National Business Park, you talked about developing 60,000 feet in some sort of a special project.

We didn't quite get all that.

Could you say a little more about that?

Sure.

The -- as little as I can.

I can't say a lot, but this is a new initiative that the U.S. government has started and in an effort to accelerate defense contractors moving off of Fort Meade, and so it's a facility that we are doing in an existing National Business Park building.

And it will be, as we said, a plug and play.

And other words, it's a Turnkey fully equipped with furniture and the necessary IT requirements.

And Computer Sciences Corp. is providing that component of it.

So we're -- it's a new concept still.

Lots of work to do on it, but we think that it is transportable to other locations.

So what's the cost of something like that?

I think we're still working through that.

Certainly more than conventional buildout because -- but the rents are also more than conventional buildout.

So it's very, very profitable for us.

Okay.

Thanks.

(OPERATOR INSTRUCTIONS).

There are no further questions at this time.

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

Thank you.

Thank you again for joining us today despite all of the buzz and distractions of SL Green and Reckson.

As always, we greatly appreciate your participation and support.

Roger and Mary Ellen and I are available to answer any other questions you might have, and we do intend to hold our third quarter conference call on Thursday, October 26.

Thank you and have a great day everyone.

That does conclude today's conference.

We appreciate your participation.