Corporate Office Properties Trust Earnings Call Nuggets: Sequester Outlook and Vacancy

Corporate Office Properties Trust, Inc. (NYSE:OFC) recently reported its second quarter earnings and discussed the following topics in its earnings conference call.

Sequester Outlook

Jordan Sadler – KeyBanc Capital Markets: Hi, Roger. Hi, Steve. This is for you on the sequester your color was helpful. I wanted to – I’m curious about what you’re hearing and seeing from your tenants regarding expectations for next year I mean it sounds like and certainly we’re hearing from our analysts that the contractors are suggesting that they would expect next year to be tougher on the sequester. I know we’re focused on ’13 right now, but just curious on your thoughts on that.

Roger A. Waesche, Jr. – President and CEO: Well, clearly, the sequester kicked in on March 1, so we’re experiencing it, as I said $37 billion in this current fiscal year that grows to $52 billion when you have a fully phased-in year beginning in fiscal ’14; October 1 of 2013. I would say that we are experiencing what we have been experiencing for the last three or four years with budget uncertainty, with continuing resolution to nail sequestration having been put into effect. And so, people have been rationalizing their business models, adjusting their cost structures, and we feel like we are, as we’ve said before in the (fifth or sixth any) at least of that rationalization. What we are now experiencing a little bit is some people wanting to accelerate their situations, extend leases, and give back some space, and so we’ve been entertaining that to try to be proactive and try to preempt further difficulties down the road. I think, generally speaking, there’s still uncertainty out there, and so until the uncertainty goes away, people are still going to be cautious with their decision-making and space-taking and we just have to live with that, but we have been living with it for a long period of time. It’s all about how you’re positioned in the DoD budget, and fortunately we’ve been – we’re better positioned than the budget as a whole as manifested by our 1.8 million square feet of development leasing over the last six quarters.

Jordan Sadler – KeyBanc Capital Markets: It does sound that way given some of the development leasing you’ve signed. On the Data Center on DC-6, I think Steve you said, modestly below-market rent. What does that mean is that below market rent for a wholesale lease or for a co-lo lease?

Stephen E. Budorick – EVP and COO: Yeah, a little aggressive for our wholesale lease. The important point there is that we work very closely with this particular customer to achieve a mutually beneficial configuration and we’re able to move them into our data center in very high density. So all things being equal, they are stacked into about 80% of the space that you would expect a 2 megawatt user to require. And that helps us to achieve a nice yield on that and give them the pricing they needed to deploy that particular use in their business model…

Jordan Sadler – KeyBanc Capital Markets: Given sort of that you’ve got north of 6, north of two-thirds of this thing knocked down. I am curious one, what your prospects are on that for the remaining third and then propensity to commission the other half?

Stephen E. Budorick – EVP and COO: Well, as I mentioned in the prepared remarks, we are tracking about 10 megawatts of leasing currently and that’s in various stages. We are getting very excited about some of the activity around their colocation leasing which is really targeted at our government vertical, if you will government and defense. And so reasonably optimistic, we’re going to have some transactions in that vertical that are going to start consuming some additional power. So optimistic about what we can do in the next two quarters and we are planning to be ready to add additional power when we get another meg and a half or so committed.



Joshua Attie – Citi: There were three things I heard in the prepared remarks that I thought you could provide more color on, the vacancy that you see coming; the Colorado Springs sale and also the ATM issuance and maybe we could start with the vacancy. Where in the portfolio is it, and how much in terms of square footage do you see as being at-risk over the next six or 12 months?

Stephen E. Budorick – EVP and COO: Well, Josh, working with two large customers right now; and rationalizing and rightsizing their footprint for the new sequestration environment. One of those is a 150,000 square foot lease of which a 103,000 square foot will be extended, and roughly 50,000 square foot, we’re considering taking back this year whereas the contract would not obligate us to do that till next year. Then there’s another that will produce about 30,000 square feet over the next two quarters. So they are relatively modest, but there are a few. Now having said that, I do want to point out that if you look at our new leasing this year, what we’ve done in the first half — of 327,000 square feet is about 1.7% of our overall 90 million square foot portfolio. We do have good backlog of deals that we’re working on in our existing assets. So we’re not exactly sure where things are going to shakeout. We’re just giving you a heads-up that we may be taking some space back with big customers. Then lastly, when you look at occupancy, we’re about to add in the coming quarter, two buildings from our development pipeline into our stabilized portfolio, and they will add about 0.7% of additional vacancy as well that will move that stat down…

Joshua Attie – Citi: So I guess, should we interpret that as there is — it sounds like maybe a 100,000 square feet that you think may come back to you and that’s sort of the issue or that you feel less comfortable with the defense contractors in your portfolio generally and beyond that 100,000 square feet there may be more?

Stephen E. Budorick – EVP and COO: I think the former more than the latter.

Joshua Attie – Citi: And on Colorado Springs can you just explain to us, A, what happened, why is the sale being delayed and also from accounting perspective is Colorado Springs going to remain in discontinued operation and then also lastly, what the impact of the delay in sale was on guidance?

Roger A. Waesche, Jr. – President and CEO: Let me when we start with sort of the transaction itself and then Steve can talk about guidance and discontinued operations. First of all, I want to be clear that we want to exit the market. We’re not re-treating the strategy. What we want is reasonable, not optimal value. Our shareholders have already suffered. That portfolio is now stable and it’s actually improving. We do have the newest portfolio in town. No new supply because rents don’t support new construction. Right now it’s what we would call a capital markets issue and not a real estate fundamentals issues. The issue is that we are selling into fear. Our investors can’t underwrite sequestration or defense budget segmenting like a COPT can. COPT would actually be the natural buyer of this portfolio because of our ability to underwrite the market in the different nuances of the defense budget, but we’re the seller. And also unlike the balance of our SRP where we didn’t say, wood assets we were selling. We clearly communicated to the market that we wanted to sell this project and we wanted to sell it in this timeframe and so that really hurt our leverage. So what all we’re trying to do now is to take some pressure off the deal for a little bit of time so that we can have an orderly sale of the project.

Stephen E. Riffee – EVP and CFO: With regard to the held for sale accounting, the determining factor is to whether it’s classified as held for sale, as to whether we believe it will still sell within 12 months. We haven’t changed that assumption with regard to guidance. When you look at the fourth quarter range, we’re assuming now that the deal wouldn’t close until some point in mid-fourth quarter to be at the low end of the range, and if we don’t get it closed by the end of the year, we would be at the higher end of the fourth quarter range…

Joshua Attie – Citi: Obviously, keeping it that versus the third quarter, that has a positive effect on the guidance versus what it was previously?

Stephen E. Riffee – EVP and CFO: Yeah, we’ve increased the overall guidance for the year and try to give you a new set of parameters for the fourth quarter.

Joshua Attie – Citi: Roger, if I could just clarify something that you said, you said it was a capital markets issue but also kind of selling into fear in the sequester. Was it that treasury yields moved up and impacted cost to capital, or was it more fundamental that buyers are concerned about leasing?

Roger A. Waesche, Jr. – President and CEO: I think it’s both. I think, obviously, we were willing to take a discount to exit and then interest rates rose their ugly head in terms of – and so it gave a buyer a reason to come back and want a different price, and so, again, we just want to walk away for a little bit of time and let things settle down and then move forward, either in a block basis or selling it off in pieces.

Joshua Attie – Citi: Just lastly on the ATM, I know you mentioned on the call, but if you could just repeat because I didn’t catch all the numbers, how much did you issue, at what price, and also, when?

Roger A. Waesche, Jr. – President and CEO: We issued after June 30 and so we are still in the month of July so that will tell you we issued in the in the month of July 1.5 million shares, common stock through the ATM. The average price was $26.05 and our net proceeds were $38.5 million…

Joshua Attie – Citi: And I know you had the ATM since last November and you haven’t issued it at all and you’ve kind of talked about it as being just kind of an opportunistic source of capital. What was the rationale for using it now?

Stephen E. Riffee – EVP and CFO: Well, as we’ve announced a lot of success in the development leasing we’ve increased our development spending estimates by $50 million above our prior range. We feel really good about our development, leasing momentum and opportunities. And so we want to make sure that we keep up with our balance sheet metrics and capitalize our growth. So we use the ATM to get a little bit ahead of it.

Joshua Attie – Citi: Did any delay in the sale of Colorado Springs impact decision at all to raise more equity?

Stephen E. Riffee – EVP and CFO: We have a little extra equity above the increased development spend for the year so it probably somewhat hedges that if we end up slowing down to sell just a little bit or have to sell it in more than one piece.

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