COPT Defense Properties (CDP) 2007 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the first-quarter 2007 Corporate Office Properties Trust earnings conference call.

My name is Shaquanna and I will be your coordinator for today.

At this time, all participants are in a listen-only mode.

We will facilitate a question-and-answer session towards the end of this conference.

(OPERATOR INSTRUCTIONS).

As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today's call, Ms.

Mary Ellen Fowler, the Company's Vice President and Treasurer.

Please proceed, ma'am.

Thank you and good afternoon, everyone.

Yesterday, our earnings press release was faxed or emailed 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 throughout this call.

Also under the Investor Relations section of our website, you will find a reconciliation of our annual 2007 guidance.

With me today is Rand Griffin, our President and CEO; Roger Waesche, our COO; and Steve Riffee, our CFO.

In just a minute, they will review the results of the first quarter.

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 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 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.

Good afternoon, everyone.

We're pleased to report a solid first quarter for the Company, achieving FFO of $0.51 per diluted share.

Total FFO for this quarter grew by 4.1% on a diluted per share basis over the first quarter of last year.

As Steve will discuss in more detail in a minute, our FFO growth this year is primarily in the second half of the year.

We still expect to produce a strong 10% to 13% growth rate, which is the second-highest of all office REITs.

You should not extrapolate the first-quarter run rate to the entire year, since this quarter was adversely impacted by unrecovered expenses relating to snow and utility costs.

Turning to our external growth strategy, as you know, we closed on the $362 million Nottingham portfolio in mid-January.

Some investors have commented that this portfolio was off core, but we saw it as an opportunity to buy a franchise location and own 100% of a growing submarket at very accretive pricing.

Our vision is to densify the product as we develop on ground we have acquired as part of the acquisition, sell off some of the land for retail and multi-family uses, and eventually tear down the single-story product along Interstate 95 to develop midrise buildings.

In the future, this will be a 5 million square foot submarket and we will have created significant value for our shareholders.

As a reminder, we have about half of our revenues coming from the government and defense sector.

We continue to build to meet this demand and have seen our strategy create expansion opportunities in San Antonio, Colorado Springs, the BWI Corridor and in Southern Maryland.

We now also control additional land at both Aberdeen Proving Ground north of Baltimore and Fort Dietrich in Frederick, Maryland, which will need to have significant product in place by 2009 to meet the anticipated BRAC demand.

We are also well positioned with ground control around Fort Meade and can accommodate there the bulk of the 4 to 5 million square feet of demand coming from that BRAC.

We have the best sites at the lowest cost basis, have significant long-term relationships and expect to capture the majority of the office demand.

As part of our recent land acquisitions at Fort Ritchie, Nottingham and InterQuest in Colorado Springs, we have ground that can be developed and sold for non-office use.

We believe this activity is a natural component of our large office parks and further accentuates the overall value.

Beginning in the second half of this year and gradually increasing over a number of years, you will start to see land sales be a component of our FFO results.

We have worked very hard to position the Company for a strong growth now and into the future.

Sometimes this growth is lumpy, but we take the long-term view that our government and defense focus, our strong relationships, our significant land and development capacity, and our deep team will produce above-market FFO growth on a continued basis.

And with that, I will turn the call over to Roger.

Thanks, Rand.

Turning to our portfolio at March 31, our wholly owned portfolio ended the quarter at 93% occupied and 93.7% leased.

Overall occupancy remained flat since last quarter, even with absorbing the 2.4 million square foot Nottingham portfolio at 85% occupied.

We did terminate AT&T in 112,000 square feet at 429 Ridge Road in New Jersey last quarter.

This resulted in a decrease in occupancy from 97% to about 69% in our 417,000 square foot New Jersey portfolio.

As you may recall, we agreed to terminate the AT&T lease on this building so that we can sell this building to an existing tenant.

We expect this building will sell late this year or early next year, and you will see this property recorded in our discontinued operations for the balance of the year.

Along with 429 Ridge Road, the tenant will purchase the other two buildings that they now occupy, along with the adjacent land, all located on Ridge Road, which will result in our exiting the New Jersey market within the next two years.

With regard to the balance of the portfolio, since last quarter, we have improved occupancy in suburban Maryland from 83.2% to 94.8% as the remaining space in our Rockville property was leased to AARP.

Looking at our suburban Baltimore portfolio, occupancy increased to 85.2% from 81.1% at the end of the last quarter.

This portfolio includes the former GGP assets, which we purchased in 2005.

The Rutherford properties acquired from GGP are 93% leased and the market is fairly strong due to the government agencies located in the area.

The former GGP Hunt Valley assets have been slower to lease and present our greatest leasing challenge for the portfolio overall.

Interestingly, the 3.6 million square foot Hunt Valley market absorbed almost 100,000 square feet in the first quarter of this year, indicating there is demand in the market.

We have been working diligently to reposition our buildings and bring them up to our typical standards.

As we projected, this repositioning would take up to three years from closing to achieve, and we are about one-third of the way there.

Lastly, with regard to the Nottingham portfolio, 80% of the revenues for the properties we acquired were added to our suburban Baltimore portfolio in the first quarter.

We have made progress with renewals, as well as leasing vacant space, and the total portfolio is 86.1% occupied as of March 31, up from 84.9% occupied at the closing.

We expect to take at least two years to bring the Nottingham portfolio up to our typical 94% leasing level.

For the first quarter, the Nottingham portfolio performed and contributed to earnings as we originally forecast.

In terms of overall leasing statistics, we renewed 571,000 square feet, equating to a 72% renewal rate at an average cost of $7.98 per square foot.

Average rental rates for the renewed and retenanted space for 780,000 square feet increased 7.4% for total rent on a straight-line basis and increased 1.1% on a cash basis.

For renewed and retenanted space for the quarter, the average capital cost was $10.06 per square foot.

Turning to lease expirations for 2007, we have 9.8% of our total revenue expiring, down from 12.4% at the beginning of the year, including the Nottingham portfolio expirations.

With regard to the Nottingham portfolio, we've made great progress.

At closing, we had 33% of the portfolio expiring during 2007.

Based on renewals signed or in process, this has been reduced to 13% or 300,000 square feet, with the majority of the tenants being renewed.

With regard to the BWI submarket, as of March 31, within the total market of 6.2 million square feet, vacancy, including subleased, stood at 9.7%, the same as one year ago.

Our BWI portfolio totaling 4.3 million square feet and representing 70% of the BWI submarket was 95.4% leased at March 31.

Turning next to the Columbia submarket in Howard County, at March 31, vacancy with sublease was 12.3%, down from 15.1% one year ago.

Our properties in the Columbia market total 3 million square feet and are currently 93.9% leased.

Within COPT's northern Virginia submarkets, the vacancy rate was up slightly at 10.25% versus 9.7% one year ago.

Year-to-date absorption has been 211,000 square feet.

Our portfolio of 2.5 million square feet is 99.4% leased at March 31.

Looking just at the Dulles South submarket in northern Virginia, the vacancy rate, including sublease, ended the first quarter at 13%, up from 9.2% one year ago.

Within the Dulles South market, there are currently nine buildings under construction for a total of 1.3 million square feet.

Our operating portfolio of nine buildings totaling approximately 1.5 million square feet is 99.6% leased.

With regard to acquisitions, we closed on the $362 million Nottingham portfolio in early January.

Subsequent to quarter end, we bought out our partner's interest in InterQuest Park in Colorado Springs, Colorado, for $14 million.

By owning the entire InterQuest Park development parcel, we can move quickly to get the first two buildings underway this year to meet tenant demand.

We continue to believe that 2007 will be a difficult year for acquisitions, and although we are pursuing various properties, we're still maintaining our disciplined underwriting.

With that, I will turn the call over to Steve.

Thanks, Roger.

Turning first to our FFO for the first quarter, we generated $28.3 million or $0.51 per diluted share as compared to FFO for the first quarter of last year of $24.4 million or $0.49 per diluted share, representing a 4.1% increase.

Several factors impacted our first-quarter results.

On the positive side, we closed on the Nottingham acquisition in early January.

And same-office cash NOI increased by 2.4% or $1.1 million compared to the first quarter of 2006.

This was offset to some extent by the $1.1 million in unrecoverable expenses, primarily due to increased snow removal and utility expenses.

We incurred $2.7 million of snow removal costs in the first quarter of 2007 versus $852,000 in the first quarter of 2006.

And turning to AFFO, after adjusting FFO for capital expenditures, the straight-lining of rents and the FAS 141 income, our adjusted funds from operations for the first quarter totaled $22.1 million compared to $18.9 million during the first quarter of 2006.

That represents a strong increase of 17%.

For the quarter, we had a 60.4% FFO payout ratio, which is up slightly from the 56% in the first quarter of 2006, and our AFFO payout ratio was 77.4% -- that is up slightly from the 72.3% in the first quarter of 2006.

For the first quarter of 2007, the Company's debt to market cap ratio was 38.5%.

The interest expense coverage ratio was 2.7 times and our fixed charge coverage ratio continues to be a solid 2.2 times.

Looking at GAAP earnings for the first quarter, we recorded earnings of $0.03 per share versus $0.15 per share for the comparable 2006 quarter.

The decrease in earnings per share resulted from a $7.9 million increase in depreciation and amortization associated with real estate operations, of which $6.4 million related to the Nottingham portfolio.

With regard to our same-office results for the first quarter, for the 157 properties comprising 75.7% of the total square footage, same-office cash NOI increased 2.4%.

There were increases in our BW Corridor and northern Virginia portfolio same-store results that were partially offset by weaknesses in our suburban Baltimore portfolio.

The former GGP assets within the suburban Baltimore portfolio had several leases rolling that were not renewed, resulting in increased vacancy.

As we previously mentioned, we experienced increased operating costs due to snow removal, and higher than usual utility use as a result of the third-coldest February on record in the greater D.C.

region.

In terms of same-office expense trends, in the third quarter of 2006, we experienced a 31% increase in electricity rates in our largest market.

The rate increases will continue to impact comparability to prior quarters until we reach the third quarter of 2007.

Turning to our balance sheet, at March 31, our total market capitalization was approximately $4.5 billion, with $1.7 billion of debt outstanding equating to a 38.5% debt to market cap ratio.

As of March 31, 21% of our debt was floating and 79% was fixed.

And subsequent to the quarter end, we executed a rate lock agreement for a fixed rate of 5.58% on a $150 million, 10-year, nonrecourse permanent loan.

We expect this loan to close within the next month.

With regard to equity, we issued approximately 3.2 million common shares and 532,000 convertible preferred shares in connection with the Nottingham purchase.

Given our leverage level and the availability under our revolver, we do not anticipate raising additional equity this year.

Turning to our FFO per diluted share guidance, please note we have placed our detailed guidance on the Investor Relations page of our website.

We are keeping the low end of our guidance at $2.18, and we're lowering the top end of our range from $2.27 to $2.25 per diluted share to reflect the higher unrecovered costs in the first quarter, as well as the increased cost of stock options, which, when valued, were at a cost higher than we had previously expected.

As we've stated previously, our earnings for the year are heavily weighted to the third and fourth quarters due to the development occupancy commencing on 550,000 square feet, as well as leasing ramping up in the second half of the year.

As a result, we expect second-quarter FFO to be slightly ahead of the first quarter of this year, with increased FFO significantly accelerating in the second half of the year.

When we view our range for guidance for 2007, we are at a 10% to 13% growth rate in an environment where external growth other than development is difficult.

Given that, we feel very good about our projected 2007 performance for our shareholders.

And on that, I will turn the call over to Rand.

Thank you, Steve.

Turning to our development and construction activities, as Steve mentioned, we have about 550,000 square feet that will come online later this year.

The first Grumman VITA building near Richmond, Virginia, will come online fully in July.

The second Northrop Grumman VITA in Southwest Virginia will come online in October.

About 50% of the space at 302 NBP and the small building at UMBC will come online in the third quarter and 320 NBP will come online late in the fourth quarter.

So as Steve mentioned, our earnings growth this year is heavily weighted to the last six months of the year.

With regard to construction starts, we have under development our first building for 125,000 square feet in White Marsh.

We are seeing significant pent-up demand from our tenants in the submarket and are moving quickly to meet this demand.

As you may know, Federal Realty acquired the Nottingham retail portion in White Marsh and we have receive very favorable feedback from some investors who value Federal Realty's expertise in finding and expanding great infill locations.

We believe that over the next 10 years, White Marsh will grow as a great mixed-use location, and we're positioned to add an additional 3 million square feet to create, over time, a total 5 million square foot submarket.

We are also considering the sale of land parcels that are better suited to retail or residential use, which could be sold at a significant increase over our basis.

At Fort Ritchie, we're working with our government and defense relationships to generate demand for office.

We are currently demolishing the nonhistoric older buildings and beginning the infrastructure work necessary to support new development.

We are completing details of the master plan and beginning the marketing process to position us to begin selling residential lots next year.

In Colorado Springs, we have two buildings under construction and have under development two buildings in the InterQuest Business Park that we hope to start later this year.

We are excited about the InterQuest location, given the retail amenity base that is being developed adjacent to our site and the demand for office space that we see ramping up.

We have turned over to Spectranetics 40,000 square feet of our 74,000 square foot building at 9965 Federal Drive in InterQuest and will see full occupancy and rent of that first phase in the second half of the year.

Lastly, with respect to San Antonio, the local press has disclosed a projected doubling of employment at our location.

While we're not in a position to discuss these plans, at the request of our tenant, the expansion at our site is very positive for our future plans in San Antonio.

And finally, looking at our recent accomplishments, we are pleased to report that we achieved, for the third 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 were the winner of the 2006 National Commercial Real Estate Customer Service Award for Excellence for Category I properties, also referred to as the A-List Award.

Category I represents companies owning over 100 properties and is the largest of the four categories.

CEL surveys over 2.5 million tenants a year to derive their 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.

We are very proud for the third year in a row to receive this recognition since it reflects our dedication to serving our tenants in an exceptional manner.

And with that, we will now open the call up for your questions.

(OPERATOR INSTRUCTIONS).

Michael Bilerman, Citigroup.

Jon Litt is on the phone with me as well.

Rand, I just wanted to go back to a comment you made in your prepared remarks about land sales becoming a component of FFO.

Can you just elaborate on that a little bit more in terms of the magnitude -- I'm not sure if anything will hit this year -- and just how you are thinking about that?

I think the magnitude is kind of hard to talk about because it is over a fairly extended period of time.

But if you look at Fort Ritchie, we have 637 residential units.

And the present value of the residential component, present value, is somewhere between $35 and $55 million.

So that will start to occur, as I said, next year and then just gradually ramp up.

You are in a situation where you could sell it today, but you want to take advantage of the job growth that we are bringing to that site and to the increasing value over time as that site solidifies.

So we are in a very gradual ramp-up and it will be a consistent component to FFO.

We do have, as part of the Nottingham transaction, we do, as we said, some fairly significant sites that when we really dug into them, are much more valuable from a multifamily and retail component than for the office component of it.

And we're working to reposition those with the development plans necessary to then proceed.

So as I said, we are in a position for some sales in the second half of this year and then as we start to work into our guidance for next year we will try and identify that component in the future.

And how much is it going to contribute in the back half?

I don't remember that being any part of guidance before.

I don't know.

We're still -- it's not huge; it's an upside in the second half.

It helps explain some of the gap, maybe, that some of you have in our model versus our guidance.

And then just in terms of thinking sequentially to the second quarter, I guess if you take the 51, you add back the $0.02 of the extra snow removal and electricity costs, gets you to 53 -- I guess you have the Pinnacle lease that started -- I guess the run rate should be at about 54.

Am I thinking about it the right way?

We don't tend to give quarterly guidance, but you are in the right range.

Sri Nagarajan, RBC Capital Markets.

Rand, there was something in the news about -- on San Antonio NSA expansions there.

Could you elaborate on your plans there and what we should see in the coming years?

We were asked by our tenant not to comment on that.

You saw the release in the paper, and the site that was identified for that expansion is, of course, our site.

So as I said in my comment, we will see a significant increase on our site, and now on the adjacent ground that we own, but I really can't comment more than that.

One small bookkeeping question -- what was the capitalized interest during the quarter?

$4.2 million.

John Guinee, Stifel.

A couple of things.

A great time to sell, and Roger alluded to New Jersey.

Can you get into any more detail on New Jersey, Hunt Valley, Baltimore County, West -- miscellaneous Nottingham assets, miscellaneous one-off assets, and give us some idea as to what you might dispose of in '07 and '08?

John, I think we are looking at all of that.

I think when we bought the general growth portfolio, we said that a significant component of that was going to be create value and then sell.

And we're still in the process of doing that, particularly up in Hunt Valley.

And with respect to the Nottingham/White Marsh portfolio, as Rand mentioned in his remarks, we view that as long-term core.

So we will be moving New Jersey out and we will be selectively selling assets as we create value in the Baltimore suburban portfolio, but it is going to take the next 24 months to realize that.

Also, Northrop Grumman, September, I guess July and September coming on line -- clearly not core assets.

Are you going to keep those on the balance sheet or are you going to sell them this year?

We're still trying to sort that out.

We are looking at our financing options there, joint venture options and our sale options, and then we will determine.

But keep in mind that Northrop Grumman is a key core client of COPT's that are our number two tenant now, when these leases kick in.

And so we obviously have to look at the big picture strategically with our number two customer.

And for what it's worth, I think you absolutely should be running land through FFO.

Thanks a lot.

(OPERATOR INSTRUCTIONS).

Chris Haley, Wachovia.

I had a question on core growth rates.

Maybe, Steve, you could help me out, or Roger.

In terms of looking at the rest of the year, are there any particular comparatives, comps or leases that you are looking at that might impact how your remaining 2007 same-store comparisons would look?

I think in terms of leasing, Chris, we do have leasing out in Colorado that Rand mentioned with Spectranetics that will kick in.

And we have the AARP lease that doesn't really start paying rent for another couple months in suburban Maryland.

We also have the development components that Rand mentioned that will kick in.

And then we've got some leasing activity on the suburban Baltimore portfolio that we hope will start to kick in in the third quarter.

And expanding on that, when you look at the marginal change in lease rates, new versus old, and then the inducements to generate those rents, which would you characterize are your strongest two markets and weakest two markets?

The strongest would be the BW Corridor, where we have a significant presence.

And then I would say in terms of weakness, it would be the suburban Baltimore portfolio.

Northern Virginia, I can't comment on that only because we're not really in the market.

We are 99.6% leased there and we have very little turnover this year, so we don't have a lot of transactions going on to know exactly what is going on there.

I think Colorado Springs has proven to be a nice, pleasant surprise for us.

We bought properties that were in the $10 and $11 range and the new product that we are in the process of bringing on and the leases that are being done there are moving up in the $14 to $18 range, so we're seeing very nice growth in that market.

In your capital expenditure figures, Roger and Steve, is the retention at the Nottingham assets during the first quarter included in your CapEx numbers?

Yes.

And are the capital expenditure numbers that you've -- in the first quarter and so far in the second quarter and what you are budgeting, consistent with where you originally were in terms of tenant improvement and building improvement dollars?

Yes.

We said with Nottingham that over a three-year period, we would probably spend $15 to $20 million on tenant improvements, leasing commissions and capital improvements.

So in your FAD deductions, AFFO, you are including that as a deduction, whereas others might view that as first-generation CapEx.

Actually, our policy is that when we buy vacant space, we do not include the first-generation cost to lease that vacant space in our FAD.

And if you look back on page 35 of our supplement, we outline what our total capital costs are and what we subtract from that in the way of first-generation leasing and then come to the balance, which is our recurring capital expenditures.

I'm trying to reconcile what you had said before in terms of those capital costs related to Nottingham, you've said were included in your TI figures.

I'm just making -- or are you referring to committed leases versus the dollars that were actually spent and therefore reconciled down the AFFO?

In terms of committed dollars, they are included in our statistics.

But not in your FFO to AFFO reconciliation if it's first-generation lease?

That is correct.

Chris Lucas, Robert W.

Baird.

Just a couple of quick questions.

First off, just a follow-up on the sales process -- any update on Unisys at this point?

As you know, Unisys is an interesting opportunity for us in that they occupy or lease 960,000 square feet.

We have in that campus the opportunity to almost double that square footage from an entitlement standpoint.

And we have been working through the process of trying to determine whether we would sell the whole property or start to break it down into the three natural campuses.

It would appear that the Campus B, which Unisys leases but does not currently occupy, has some strong interest on the outside with either some multitenant situations or full tenants interested in taking that for various requirements.

And so we are really studying pretty seriously the ability to break that campus into three components.

Unisys themselves is going through an RFP process to look at their requirements and most likely would end up consolidating down into the A campus and taking all or part of that campus.

And then we still have Merck in the C campus.

So we're working pretty diligently.

We've got some time, through into the '09 time frame, and I think we'll end up with some upside out of this whole scenario.

And then in the development and service business, there was sort of a massive decelerations in earnings out of that activity during the first quarter.

Is that a run rate for this year, or is that something phenomenal?

Because it seems like last year you were generating a little over a penny out of those businesses.

We are in a little bit of a lull in terms of the TI work that we're doing for a couple of our customers, but we expect that to ramp up towards the end of the year and significantly in '08 and '09.

Rich Anderson, BMO.

Just a quick one on your geographical expansion plans.

I am sure you won't give us any ideas about where you might go next, but are there applications for what you're doing there to go outside of the United States?

And if so, are you considering it?

There are applications for outside the United States.

We do have a fair amount of questions and interest from tenants on that.

So far, we have remained pretty focused on doing the good job that we can in our existing submarkets.

I grew up internationally.

I have worked internationally.

And office, of all of the real estate components, is probably less desirable internationally than some of the other REITs that you are seeing that are more natural for international locations, such as the warehouse and hotel and, to a degree, the retail.

So we're going to stay focused in our markets.

At this time, we have no further questions.

I would now like to turn the call over to Mr.

Rand Griffin for closing remarks.

Thank you for joining us today.

As always, we do appreciate your participation and support.

Roger, Stephen, Mary Ellen and I will be available to answer any further questions you might have.

And for those of you who are interested, we are holding our annual meeting, at our corporate headquarters this time, on May 17 at 9.30 in the morning.

Thank you, and have a good day, everyone.

Thank you for your participation in today's conference.

This concludes the presentation.

You may now disconnect, and have a good day.