COPT Defense Properties (CDP) 2012 Q2 法說會逐字稿

Welcome to the Corporate Office Properties Trust second-quarter 2012 earnings conference call.

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

At this time, I will turn the call over to Stephanie Krewson, COPT's Vice President of Investor Relations.

Ms. Krewson, please go ahead.

Thank you, Janita.

Good morning and welcome to COPT's conference call to discuss the Company's second-quarter 2012 results.

With me today are Roger Waesche, President and CEO, Steve Riffee, Executive Vice President and CFO, Steve Budorick, Executive VP and COO, and Wayne Lingafelter, EVP of Development and Construction.

As Management discusses GAAP and non-GAAP measures, you will find a reconciliation of such financial measures in the press release issued earlier this morning, and under the Investor Relations section of our website.

At the conclusion of Management's remarks, the call will be opened up for your questions.

Before turning the call over to Management, let me remind all of you 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.

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 dispositions, acquisitions, and development projects, changes in interest rates, and other risks associated with the commercial real estate business as detailed in our filings with the SEC.

I would now like to turn the call over to Roger for his formal remarks.

Thank you, Stephanie and good morning everyone.

I'm happy to report that we continue to successfully execute our strategic initiatives, and as yesterday's press release indicates, we have now exceeded our 2012 goal in terms of selling assets in our strategic reallocation plan, and reinvested part of the proceeds into a highly strategic new property.

Before we get into specifics about the second quarter, I want to take a moment to frame up where we are with our broader strategic initiatives.

In 2011, management and the Board decided to upgrade the overall quality of COPT's portfolio, focusing on the Company's historical core competency with strategic tenets in the government and defense IT industries, and strengthening our balance sheet.

We have made significant progress on these initiatives.

Since that time and through the close of business yesterday, we have sold 58 buildings that contain 3.2 million square feet and adjacent land for $394 million.

Equally important, we reduced the number of leases we have to manage by approximately 30%, and removed from our portfolio smaller, older buildings that required disproportionately more capital.

We have completely exited Montgomery County in Maryland and Fort Richie, we have reduced our percentage of annualized revenues derived from assets located in suburban Maryland and greater Baltimore from a combined 19% at March 31, 2011 to 11% today.

Because our strategic initiative is a reallocation plan and not simply a disposition plan, we have recycled proceeds into properties that we will believe will strengthen our long-term competitive position in our markets and within our strategic tenant niche.

Specifically, although we have prudently scaled back our development program, we continue to recycle proceeds into strategic projects with visible demand and where we believe we will see long-term demand once the federal budget issues are resolved.

These key locations are our [Parks] serving 48 in Annapolis Junction, Maryland, our Patriot Ridge Project that supports Fort Belvoir in Northern Virginia, and our Redstone Gateway Project, which will support the 15 agencies and commands located at Redstone Arsenal in Huntsville, Alabama.

Responding to this ongoing market-driven demand, we started construction on two new buildings in the second quarter, NBP 420 and the Flex Building at Redstone Gateway.

We also recycled sale proceeds into one highly strategic acquisition.

In July, we acquired McLaren Center, a Class A office building that contains approximately 200,000 square feet and is located in the Herndon submarket of Northern Virginia.

We paid $49.5 million or about $245 a square foot.

The building is well located in a strategic market, in close proximity to government demand drivers and is 100% leased.

The property deepens our alignment with knowledge-based programs that are priorities for the US Government, and strengthens our relationship with an existing strategic tenant.

As we execute our portfolio objectives, we are also strengthening our balance sheet by reducing total debt, increasing liquidity, solidifying coverage, and extending our debt maturities.

Executing the strategic reallocation plan is at the heart of these portfolio and balance sheet improvements.

We will continue to pursue the sale of nonstrategic buildings and land in Colorado Springs and one-off buildings in greater suburban Baltimore.

We will remain disciplined as to how we reinvest sale proceeds into new properties and selective developments.

A quick word on development leasing.

Leasing to strategic tenants remains on pace with our expectations.

Recall that we began the year tracking 400,000 square feet of demand per new construction in three of our strategic markets, namely the Fort Meade area, Patriot Ridge, and Redstone Gateway.

In the first half of the year, we leased 180,000 square feet.

In July, we signed another 47,000 square feet of space at NBP 316, a recently developed but not yet stabilized operating property, leaving approximately 175,000 square feet of that original 400,000 square feet, much of which we hope to convert to signed leases during the second half of the year.

We are also encouraged by the emergence of new pockets of potential demand for development space in our markets.

Regarding capital markets activity, we opportunistically access attractively priced long-term capital in the form preferred shares, the proceeds of which we use to pay down debt and to redeem a more expensive series of preferred stock.

As a result of outperforming our expectations for asset sales and our balance sheet initiative, we are tightening our 2012 guidance of FFO per share.

Steve Riffee will walk you through those revisions in a moment.

So we feel good about how 2012 is shaping up.

While there is continued uncertainty related to future defense spending and federal budgets, we are prepared for the government to start a fourth consecutive year without a budget and to operate instead under a continuing resolution.

In terms of our inventory exposure, we have less than 100,000 square feet under construction that anticipates federal agency demand.

We are also encouraged by the fact that government demand drivers, with which our portfolio is aligned, are knowledge-based defense installations, not weapons or troops oriented.

Their missions are priority programs related to national defense.

So we expect these agencies' budgets to be largely maintained.

And cyber should actually see increased funding.

The leasing environment in fiscal 2013 will remain difficult, but we are confident we are in a much better position to perform in a tepid economic environment.

To sum up our strategic thinking, the faster we are able to execute our strategic initiatives, the sooner our company will be positioned for growth.

In the meantime, we continue to improve our net asset value and financial flexibility through the sale of nonstrategic assets.

With that, let me hand the call over to Steve Riffee to discuss our financial results, our guidance, and also the progress we've made related to our financing objectives.

Steve?

Thanks, Roger and good morning everyone.

FFO as adjusted for comparability and as defined by NAREIT was $0.54 per share for the second quarter.

Our second quarter 2012 FFO per share was $0.02 above the high end of our guidance range.

The up side was driven primarily by the timing of spending on discretionary repair and maintenance in our same office pool, which will self-correct in the third quarter as these maintenance dollars are spent.

Diluted earnings per share was $0.09 for the quarter as compared to a loss per share of $0.42 in the second quarter of 2011.

Including and excluding lease termination fees by both calculations, same office cash NOI grew by $3.1 million or 5% from the second quarter of 2011.

Our diluted FFO payout ratio for the second quarter as adjusted was 51% and our diluted AFFO payout ratio, excluding capital expenditures invested at properties that are part of our disposition plan, was 54%.

And we expect our AFFO payout ratio to be in the mid 60% range for the full year.

Turning to the balance sheet, although leasing vacancy and selling non-strategic assets remain our primary strategic objectives, we have also advanced our longer-term objective of deleveraging our balance sheet.

At June 30, the Company had a total market cap of $4.4 billion, with $2.2 billion in debt outstanding, for a debt-to-total-market-capitalization ratio of 50%.

One of our key metrics is debt-to-gross-asset value, a ratio that is calculated according to our bank loan covenant.

At June 30, this ratio was 45.1%, which is 4.1 percentage points lower than the 49.2% ratio at March 31 and approximately 9 percentage points lower since we launched the SRP last April.

Between the end of the first quarter in 2011 through the second quarter this year, we reduced our outstanding debt by approximately $180 million and extended our debt maturities.

Subsequent to the quarter end, the capital markets and property transactions we completed have reduced our indebtedness by an additional $70 million, which brings our total debt repayment since beginning the SRP to $250 million and leaves approximately $160 million drawn on our $1 billion revolving line of credit.

In addition, we have minimal near term debt maturities and solid coverage ratios.

We continue to monitor market conditions in order to access long-term capital opportunistically.

Late in the second quarter, we issued $172.5 million of series L preferred stock with a [7.375] dividend.

We used the proceeds to pay down our line of credit and subsequently announced our intent to redeem all $55 million of outstanding Series G preferred shares, which pay an 8% dividend.

We plan on taking advantage of the lower rate interest environment by swapping our variable rate exposure to fixed.

Now turning to guidance, we are tightening our annual 2012 guidance for FFO per-share as adjusted for comparability to a range of $2.02 to $2.08.

The high end of our range has been adjusted for the impact of accelerating and increasing asset sales netted against accretion for the McLaren purchase, and for a sense of dilution from paying down our line of credit with proceeds from the Series L preferred offering net of the accretion associated with redeeming our Series G preferred.

Considering the performance of the portfolio, the minimal revenue we have at risk, and the lack of forecasted properties' transactions, we are confident in our tighter guidance range.

Our guidance for FFO per diluted share as defined by NAREIT is $0.02 below our FFO per share guidance as adjusted for comparability.

The difference is due to two items.

First, a $0.03 write-off of original issuance costs on the Series G preferred share redemption, and second, a $0.01 net gain related to early extinguishments of debt.

For the third quarter, we are establishing guidance of FFO per share as adjusted for comparability at a range of $0.47 to $0.50.

This implies fourth quarter FFO per share of $0.48 to $0.51 and I'll briefly discuss the major assumptions that differ from those given on our prior calls, and I'll be happy to revisit any of them during the Q&A.

First, asset sales represent the most attractive source of capital for our Company and we still have roughly $170 million of buildings and land left to sell under the SRP.

Although we are actively marketing assets for sale, our revised guidance does not anticipate additional closings during 2012.

Second, we expect G&A to be between $5 million to $5.5 million in both the third and fourth quarters, which is $2 million less per quarter than the first half of the year.

This is because the first two quarters contained executive transition costs and non-recurring costs incurred to reduce overhead in anticipation of the SRP asset sales.

Third, recall we forecasted same office cash NOI growth excluding lease termination fees for the year of 0% to 2%.

Last year, a tenant prepaid some rent in the third quarter.

Because we do not expect a similar prepayment this year, we forecast our third quarter cash NOI will decline 6% versus the third quarter of 2011.

In the fourth quarter, we expect same office NOI to be flat versus the fourth quarter of 2011.

These quarterly forecasts combined with the 7.3% and 5.2% increases we achieved in same office cash NOI in the first and second quarters respectively pencil out to full year NOI growth of around 150 basis points, which is consistent with prior guidance.

Fourth is occupancy.

At the end of the second quarter, our same office pool of assets was 89.7% occupied and our consolidated operating portfolio was 87.4% occupied.

In both cases, we forecast occupancy to be essentially flat for the remainder of the year.

Fifth, we forecast quarterly capitalized interest at $3.3 million in the second half of the year.

And sixth, the accelerated dispositions affected our outlook for straight line rents for the second half of the year, which we forecast at approximately $2.7 million in the third and $2.1 million in the fourth quarter.

I'd like to conclude my remarks with an observation about our AFFO.

Although we have lowered the top end of our FFO guidance, we do not expect a commensurate decrease in our AFFO this year owing to the fact that the asset sales we closed will decrease our straight line rent adjustments and our expected CapEx obligations on the remaining portfolio.

As such, we expect our AFFO payout ratio for the year to be around 65%, which highlights the security of our dividend.

And with that, I will now turn the call over to Steve Budorick.

Thanks, Steve and good morning everyone.

I'm going to provide an update on second quarter leasing, then share updates of our major markets, including detail on some of potential leasing requirements that Roger alluded to earlier.

Our overall consolidated portfolio is 87.4% occupied and 89.3% leased at quarter end, up 40 basis points in both cases from the end of the first quarter.

Our same-office portfolio occupancy of 89.7% at the end of the second quarter was up 30 basis points sequentially.

In the second quarter, we leased a total of 726,000 square feet, of which 400,000 square feet were renewals, 100,000 square feet were retenanted, 94,000 square feet related to development or redevelopment projects, and 132,000 square feet represented other first-generation space leased.

Rents and renewals or retenanted leases in the second quarter declined 6% on a GAAP basis and 11.8% on a cash basis.

This is the first quarter since late 2009 that we experienced a decline in GAAP rents.

The reasons for the decline were threefold.

First, 20% of the GAAP roll down can be attributed to aggressive leasing we completed in SRP properties, and in particular in the portfolio of dispositions announced in yesterday's press release, in order to maximize value prior to sale.

Second, retenanting activity, which in many cases was short duration, low TI deals, represented about 50% of the GAAP roll down.

And lastly, we completed several larger renewals under terms that provided concessions and impacted straight-line rents of stabilized occupancy.

Year to date, rents on renewals or retenanted leases declined 2.5% on a GAAP basis and 10% on a cash basis.

However, looking forward to the third and fourth quarter activity, we expect leasing metrics to return to recent historical pattern, producing mildly positive GAAP rent increases and mildly negative cash rent roll downs, as higher portions of the activity are with strategic tenants and the SRP related leasing diminishes.

Importantly, we continue to achieve our leasing volume goals with below average capital commitments.

In the second quarter, TIs and leasing commissions on renewing and retenanted space averaged $9.11 a square foot, and for the first half of the year these costs averaged $9.65.

These capital commitments compare favorable to our average capital cost of over $11 per square foot between 2009 and 2011.

Based on leasing to date, revenue at risk required to meet the midpoint of our guidance has been reduced from $15 million at the beginning of the year and $9 million at the end of the first quarter to just over $3.7 million.

We have pending leases that would reduce this revenue at risk to less than $1 million.

On a macro basis, the fundamentals in our major markets are not materially different than they were in the first quarter.

The commercial office markets in Maryland, Washington DC, and Northern Virginia continue to be challenged by the uncertainty around the 2013 federal budget, the upcoming federal elections in November, and the restraint in GSA leasing.

Overall vacancies hover in the 15% to 16% range and second quarter absorption was flat to negative 1%, varying by market.

Despite these challenging market conditions, demand for our properties adjacent to government demand drivers appears to be picking up marginally, which reaffirms our investment strategy to concentrate on serving the Department of Defense element that conduct intelligence and cyber activities.

In addition to the 94,000 square feet of development space released during the second quarter, we are in various stages of discussions with strategic customers for several large blocks of space at existing construction and redevelopment projects.

Let me walk you through some color on this demand beginning with our projects that support the agencies located at Fort Meade.

We recently saw the first signs that the contract detail associated with the relocation of the Defense Information Systems Agency, or DISA, to Fort Meade is beginning to move.

In June, DISA awarded a nearly $2 billion contract to a large government contractor, which recently leased two floors of space, totaling 52,000 square feet at the National Business Park.

This tenant is a prime contractor with DISA and we anticipate demand from their subcontractors will begin to appear in the coming quarters.

Subsequent to the quarter, we signed 47,000 square feet at NBP 316, which is now 100% leased to a government customer.

At Arundel Preserve, our development project is across the Baltimore-Washington Parkway to the north of NBP and Fort Meade.

We leased 61,000 square feet to a strategic tenant at 7740 Milestone Parkway, which is now 100% leased.

The tenant, who is a defense IT contractor, will take occupancy in phases in the second half of 2012.

We believe this leasing validates the Arundel Preserve project as a desirable location for serving DISA and its contractors at the northwest gate of Fort Meade in much the same way that NBP serves the other agencies and their contractors at the southwest gate.

In Huntsville, Alabama we are making good progress towards leasing our first building at Redstone Gateway, and at Patriot Ridge, which serves Fort Belvoir, we are in negotiations with a 60,000 square foot user, which would bring that building's preleasing to 70%.

At Power Loft, we reassessed our marketing efforts during the first quarter of 2012 and we launched a realigned marketing campaign in the second quarter.

Broadly speaking, we are building out multiple marketing channels to gain a broader exposure locally and nationally.

We simplified our pricing structures.

We've expanded our target market all in an effort to create more leasing opportunities.

Additionally, we have rebranded the entirety of the program under the COPT umbrella to better convey the financial strength of our sponsorship.

Although we have no signed leases to report currently, we are pleased with the increased activity generated by the new campaign and we are confident we will have progress to report in the coming months.

Overall market conditions continue to be challenging with significant leasing in recent months being dominated by organic growth at our competitor's facilities.

Nevertheless, we have active prospects for over 150% of our unleased capacity with 60% of those prospects requiring solutions in the next four quarters.

The active prospects are highly diverse in business model and sector and their capacity requirement range from less than a megawatt to high single digit megawatt capacities.

We look forward to reporting our progress more specifically on the next earnings call, and with that, I'll turn the call back to Roger.

Thanks, Steve.

In summary, although the 2012 economic and operating environment remains challenging, we have been able to execute our plan.

Management and all the employees remain focused during this year of transition on executing along four major strategic lines, leasing space, executing the sale of our remaining non-strategic properties in land, allocating capital prudently, and strengthening our balance sheet.

With that, operator, please open up the call for questions.

Thank you, Mr. Waesche.

(Operator Instructions) Your first question comes from the line of Jamie Feldman with Bank of America.

Please proceed.

Great, thank you.

I was hoping to talk a little bit more about the contract detail you're starting to see from DISA in terms of how would you think about the potential magnitude of that in terms of demand?

And then when you think about other similar agencies that have moved recently, kind of what do you view as the pipeline for how we can kind of paint the picture going forward?

Well, Jamie, I think we've been obviously talking to investors for a long time about the uncertainty that the prime contractors and smaller and medium sized contractors have over their future and their unwillingness to move in close proximity to their government customer without certainty about their future contracts.

So this is the first definitive activity that we've seen around DISA where a prime contractor, or actually in this case, a contractor want a recompete from another contractor, and they have now taken a couple floors at NBP.

And there's a pretty big subcontractor following with this prime contractor.

So we're optimistic that this will be the impetus for people who now have real contracts and certainty about their future to move and be close to the government.

But it was a big contract.

It was one of the biggest that DISA has and so we're feeling good about that particular location and that particular agency, and that movement will start to happen.

So that was a big contract, what do the next couple contracts look like from both DISA and then when you think about the other agencies?

Are there any in the pipeline that could give you similar confidence?

There are.

There's a lot of contacts up for grabs up in Aberdeen, for C4ISR and with the NGA.

But at this point, things aren't signed and so until they are we probably won't see the activity level that we had hoped for.

And then what was the lag this time and how is it changing this cycle in terms of the allocation to actually see people in the market looking for space?

Well, obviously the prime contractor was confident that they were going to win because they leased space in advance of the announcement.

Then there's a handful of subcontractors behind them and we're not -- we're trying to sort out where exactly they are now and try to get in front of them in order to encourage them to get close to their prime contractor and the government.

Okay, and then secondly, can you just talk a little bit more about demand for your assets, who are the buyers these days and what are their objectives?

Well, overall demand for our buildings has been across the board.

We have sold buildings to users.

We've sold buildings to private owners and markets who can source bank financing.

We've sold them to institutions who didn't need capital.

We've sold it to private equity.

The large sale that we had in July was to private equity backed by institutional capital.

So it's really been across the board and financing has not been an issue and there's good demand given capital markets availability and low interest rates.

Okay, thank you.

Your next question comes from the line of Brendan Maiorana with Wells Fargo.

Please proceed.

Thanks, good morning and just wanted to apologize.

I had an error in our note this morning so sorry about that.

It was just a busy morning, but Roger wanted to kind of get your thoughts on the contractor increase, the increase in demand it sounds like that you're starting to see for your first generation space.

How do you think that kind of compares to the second generation space in the Baltimore-Washington Corridor in Northern Virginia where it seemed like the leasing volume this quarter was a little bit soft relative to where it had been?

Right, so what I would say is that overall I would say leasing is a little soft right now, a little slow and I think there's a couple parts to that.

Part one is that we're in the normal summer slowdown.

The second is as we talked, both Steve and I talked on the call about the overall cautiousness of our government and defense tenants around seeing frustration in the future budgets.

However, putting that aside, we have seen several large one off leasing possibilities where we have very meaningful proposal dialogue going on.

It's just hard for us to handicap that activity because both as to, A, will it happen because of still the uncertainty going on?

And then secondly, the timing of it.

But we have seen a pickup in what I'll call the trailing demand around Tricare in Northern Virginia, around our assets there, around the NGA, around DISA, and C4ISR.

I think the issue right now is just that there's an uncertain vision of the future for the contractors and so they're just being very cautious in terms of making decisions.

I would say that we feel like over the last couple years we have already felt some of the consolidation of the contractors.

There may be more to happen so we're not naive to that.

But I do feel like we've already seen a lot of that.

And in terms of our business model, we feel like we need to press on with our A locations and be willing to divest those locations that would be considered not the A locations around the government demand drivers to make sure that we're well positioned even if the budgets are tight for a number of years.

Was there something specific that happened in the quarter?

Because it looked like retention ratios were low in the quarter in Northern Virginia and the BW corridor.

And I would think if there's uncertainty in the market, it would tend to drive the retention ratios up just because tenants probably stay put for the time being.

Was there just something anomalous that happened in Q2 that maybe caused a couple of move outs?

Nothing in particular.

I mean our overall retention was 63.

It was actually slightly better first quarter.

The third quarter and fourth quarter tend to be dominated by large core transactions and that's where we gain a lot of ground on the overall rate.

Okay, and I was just -- it looked like in those two markets, it looked like it was a little bit lower.

Okay, and then just lastly for me, the same store numbers, they were up nicely and Steve, you kind of highlighted how they're going to go down sequentially in the back half of the year.

But what was driving the number up so much in the quarter given that it looks like occupancy was down year-over-year, and your rents were maybe up a little bit roughly kind of flattish year-on-year over the past 12 months.

And there's some improvement that you would get from lower straight-line rent, but I'm just sort of having a little bit of trouble understanding what drove that number.

Was it an expense adjustment or something else?

I think, as I mentioned on the call, I think we had a bit of a timing issue in terms of some of the repair and maintenance expense.

There's some projects that got started that didn't get as far underway in the second quarter that we think are going to still into the -- I think drives most of that, Brendan.

All right, thank you.

Your next question comes from the line of Craig Mailman with Key.

Please proceed.

Hi, guys.

George [Saller] is on the line with me as well.

Roger, maybe could you just provide a little bit more color on the acquisition, kind of profile the defense contractor or government and maybe what the cap rate was?

Sure.

Well, I think first of all, there was maybe a little bit of surprise that we made an acquisition, but I think to be successful in this business you need to be opportunistic.

In this case, we were able to seize an opportunity for an asset that was both strategic.

It was new high quality building.

We got good economics to yield and replacement costs were all very favorable and the location is in the heart of the nexus of government demand drivers.

And for COPT, the investment has a value greater than the land, the building, and the lease because it allows us to enhance our customer relationship and open up other business with that customer, and other groups that are in the building.

In terms of the cap rate, the cap rate was right around an 8% yield.

So it sounds like maybe the tenant is more of a government agency.

Is that fair?

Contractor.

Contractor.

Okay, and can you just give us an update, you guys are well ahead of the $205 million on the sales, but where do you guys shake out on the cap rate versus the [8] that you were expecting for the year?

We're right on the 8.

Okay, and then you guys have the $170 million of strategic assets basically left to sell, but it sounds like you guys are kind of gearing up for another continuing resolution, maybe sequestration.

I'm just looking at the vacancy that you guys have left in the development pipeline.

I'm just trying to get a sense of how much of those proceeds in '13 kind of go towards more of these strategic acquisitions versus just planning back into either the development pipeline or kind of the sense there.

Well, we do have dollars that will be needed to complete the shells on the buildings that we've already started and then we'll need dollars on leasing commissions and for tenant improvements.

But I think the large amount of dollars from the strategic reallocation plan will be spent on development next year.

We're not really a natural buyer today.

We're an opportunistic buyer if something really strategic comes along, but our focus is on our development pipeline and on leasing up our unstable existing development.

Okay, so there's not a bunch more of these strategic acquisitions in the pipeline?

If they come up, you guys will pull the trigger, if not you'll just keep doing what you're doing is a fair way to look at it.

Okay, just lastly, on Power Loft, sounds like the new marketing strategy is at least attracting a little bit more interest.

But just curious, kind of the two-year anniversary is coming up of when you guys acquired this, and the occupancy is basically still flat from there.

At what point do you guys make the decision of whether to hold onto it or get rid of it?

I'm just trying to see -- the asset is yielding about 1% and you could basically redeploy that into almost any investment and it could be accretive on a number of different metrics.

So just your thoughts on that.

Well, first of all, we think -- we're very comfortable that we have a very high quality asset.

It's a superior facility.

Long-term, the market is strong.

We believe (inaudible) outstrip supply.

I do think we made some missteps in our initial marketing of the asset both in terms of not going after multiple channels and the way we price the asset.

But we're confident that we put the right resources in place today to execute successfully on that asset.

We need some time, but we're confident we're going to get a good outcome.

Great.

Thanks, guys.

Your next question comes from the line of John Guinee with Stifel.

Please proceed.

Hi.

Congratulations on a lot of success.

Question for you, Wayne, when did you guys first announce the land ground lease down in Huntsville Redstone?

We announced it in March of 2010.

Right before an investor day, as I recall.

And have you signed any leases yet?

No, we've not.

But you're starting a third building, I think?

No, it's the second building, John.

It's a flex building.

It's a small building.

It's about 62,000 square feet.

Perfect.

Okay.

Next question is, DISA moved, and the same story is true for Aberdeen Proving Grounds, but DISA relocated out of Vornado Skyline Tower Facility a year or two ago and they had great employee retention.

And the reason they had great employee retention according to their facility people is they gave their employees extensive flextime, ability to work at home, that sort of thing.

So that the end result was a typical DISA employee only had to be at Fort Meade three out of ten days in a typical two-week cycle.

And then if you look at -- go over to the Aberdeen Proving Grounds, you'll see those parking lots are full of cars with New Jersey license plates.

And so the question is, in this go around unlike 2002 to 2005, how important is it for the prime and the secondary contractors, the tail to actually be adjacent to the government contractor while the government contractor's employees tend to not have to be at that location?

Well, John, we still think by and large the business is about colocation and it's about collaboration, and to be successful you need to be working together in a common environment.

But you're right with DISA.

There are, because some of the work that they're doing allows them to work from home, but that hasn't necessarily impacted the contractor tail that would locate around Fort Meade in support of them.

But we have experienced what you have expressed, which is that the DISA employees can work from home some in an unclassified environment on some of their work.

Great.

Thank you.

Your next question comes from the line of Michael Knott with Green Street Advisors.

Please proceed.

Hey, Roger.

Can -- just wondering if you can help me put together some of the pieces to just thinking about your sort of bottom line outlook for leasing, and tenant demand, and tenant decision making.

You obviously have the elections coming up.

You have the new budget or lack of one that would take place I guess on October 1. You have the possibility of the automatic 10% defense cuts, which ostensibly wouldn't hurt you guys directly too much, but would just seem to weigh on confidence among those types of tenants.

Just, can you help -- and then obviously you talked about the positives of this contractor tail.

Can you kind of put all that in a bowl and mix it all together for me?

I think we're challenged and the challenge has to do with the concept of uncertainty.

I think if we can get past the election and get a president and congress in alignment that we'll find out where the floor is on defense spending, which will then allow decision-making.

Even if the defense budget were to be cut 5% that wouldn't be the worst outcome than the continual uncertainty that is hampering people from making decisions in their business.

So we're optimistic, but we're realistic first of all that it's probably going to be into '13 before anything gets resolved.

But we are optimistic that there won't be major cuts to the defense budget, and certainly not major cuts to the parts of the budget that we're tied to.

But I think just getting certainty will allow people to make decisions.

I think in the short run, we're going to limp along.

I did mention a few minutes ago, that we are seeing some larger one-off opportunities, which had to do with moves and if they were hit we would have a very successful conclusion to 2012 and going into 2013.

But I'm leery about putting a high percentage of realization on that simply because we have been, for the last 18 months, experiencing a slowness and a cautiousness on behalf of our customers.

So I think I would say that the core is stable, we're not looking to lose what we have.

The question is how much improvement can we make in our 87% occupancy and how much progress can we make in our development pipeline.

Okay, that's helpful.

And then for the acquisition, is that a new customer for you?

Not the tenant, but who the tenant is engaged with is potentially a new customer.

Okay, and then why do you think that you can sell some of those lower quality assets and buy a relatively new building in Northern Virginia?

Is it because Southern Virginia is still perceived as so weak or just it seems like an interesting contrast for similar yields.

Right.

We were buying a building with a defense contractor in it, and so obviously, perspective buyers were cautious about that.

And we were able to underwrite the particular building and the user, et cetera, et cetera, differently than most people were, which gave us an edge in this case.

But it also allowed us to get a much higher yield than we would have gotten a year earlier because of the nervousness around Northern Virginia currently.

Right, and how long is that lease term left?

2017.

Okay, and then just with respect to the disposition program, there's no thought to increase it beyond the stated size of [560], but you just reached -- seemingly about to reach the finish line sooner or at least gotten through a lot of it sooner than you thought.

Right, I think we're not prepared to announce anything at this point.

We are obviously studying what we want to do with capital allocation beyond the current SRP.

But I think we're probably three months away from doing anything else.

Thank you.

Your next question comes from the line of George Auerbach with ISI Group.

Great.

Thanks.

Hi, guys.

Steve, your occupancy commentary for guidance was a little bit cautious.

Is that because there's a couple of large leases rolling off the back part of the year?

Or is that just more in general with all the DC noise and tenants being a bit more cautious that you're just not willing to kind of bank on further occupancy this year?

I think it's just overall caution and the fact that we've handicapped what we have in our pipeline right now, and then new things that will develop you can't really underwrite that you might get that in by the end of the year.

It's kind of a slow sales cycle.

Things are cautious.

Then there could be some better results, but nothing we're going to guide too.

Okay, and then just one more on the balance sheet.

The (inaudible) debt is still around 23% of the total debt.

Any plans to take that percentage down over time, or should we expect kind of the 20% to 25% you've been running kind of be a good long-term number?

I think you'll see it go down right after quarter end as we take in some of these proceeds.

I think for the near term, we're comfortable operating 20% or below.

What we have also done, and I think we've footnoted in our supplemental, we've extended out some of our variable to floating rate fixed rate swaps for a longer period of time.

So I think we will try to operate under 20% and we put a little bit further term on our swaps.

Great.

Thanks.

(Operator Instructions) Your next question comes from the line of Michael Carroll with RBC Capital Markets.

Please proceed.

Hi, guys.

Kind of off of John's question earlier, can you give us some color on what you're seeing in NBP and Huntsville that drove you to start the two new projects?

It sounds like DISA was a driver in NBP.

What about Huntsville?

Well, in the case of Huntsville, one of the big contractors in Huntsville won two very significant contracts in 2011 and we thought that that would extend term out for quite some time where we felt that they and some of their subcontractors would be more comfortable making commitments in the near term.

So it's really based on the activity level in the one hand, and then secondly, the flex building really goes at the different market segment.

There's a lot of testing and R&D in Huntsville.

There's a pretty significant R&D building market in Huntsville and the product is older today.

So we think we can benefit from people moving in closer to the customer and into newer products.

Okay, and then can you describe on what you're seeing in Power Loft that's making you a little more confident?

Then also, it looks like you completed a few pods during the quarter.

How many pods do you have available to be leased right now?

We have six pods constructed to be -- that are available for leasing and six megawatts power that's completely available.

And then what brings rise to our optimism is really our prospect list on active negotiations and things that are a little further up that we're tracking and have good visibility on.

As we mentioned, we realigned our marketing team.

We added some new resources.

We're getting better looks nationally and locally and we continue to develop those marketing channels and we're feeling pretty strong about our success possibilities.

Do you think you'll be able to announce some leases signed by next quarter?

I sure hope so.

All right.

Thanks guys.

Your next question comes from the line of Michael Bilerman with Citi.

Please proceed.

Good morning, and it's Josh Attie.

Can you remind us what your target is for construction pipeline leasing for this year?

It was a square footage number of 400,000 square feet, which would have taken us up to about 70%.

Now, since then we've added two new buildings to the denominator, so I'm not sure if the 70% is still a good number.

I quite frankly haven't -- can't figure that out in the next minute, but we can let you know what that is.

But we are on target to achieve our 400,000 square feet of leasing in our development pipeline for the year, and with a little bit of luck could actually maybe do better than that.

And did you expect that to be backend loaded?

When I looked at the numbers, it seemed like on a same property basis, excluding what was added, those same properties were about 30% leased at the end of the first quarter and maybe 31%, 32% leased at the end of this quarter.

So it didn't seem like very much leasing was done on a same property basis.

Did you expect most of the activity to come in that third and fourth quarter?

I think the answer is yes to that.

We think it's a back end loaded.

Obviously, it is now.

Steve talked about the one lease of 47,000 square feet and then we're hopeful on some other activity that we have.

And if I could just ask one more question on the pipeline.

I thought you had mentioned on the last call that NBP 410, you had leased it up after the quarter to 100% occupancy, and when I looked at the supplemental, it looked like it was still at 48%.

That was a rental preserve.

Oh, okay.

So was there a lease that you talked about that didn't happen or did I just have that information wrong?

You just confused the two properties.

Okay.

Thank you very much.

And at this time, we have no further questions.

I will now turn the call back to Mr. Waesche for any closing remarks.

Thank you all again for joining us today.

If you have any questions that were not answered on this call, we're in our offices and available to speak with you later.

Thank you.

Good day.

Thank you for your participation today in the Corporate Office Properties Trust second-quarter 2012 earnings conference call.

This concludes the presentation.

You may now disconnect.

Have a good day.