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Section 1: 10-Q (10-Q)

Document


 
 
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-Q 
(Mark one)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended
June 30, 2018
or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from
 
to
 
           
Commission file number 1-14023 (Corporate Office Properties Trust)
Commission file number 333-189188 (Corporate Office Properties, L.P.)
Corporate Office Properties Trust
Corporate Office Properties, L.P.
(Exact name of registrant as specified in its charter)
Corporate Office Properties Trust
 
Maryland
 
23-2947217
 
 
(State or other jurisdiction of
 
(IRS Employer
 
 
incorporation or organization)
 
Identification No.)
 
 
 
 
 
Corporate Office Properties, L.P.
 
Delaware
 
23-2930022
 
 
(State or other jurisdiction of
 
(IRS Employer
 
 
incorporation or organization)
 
Identification No.)
6711 Columbia Gateway Drive, Suite 300, Columbia, MD
21046
(Address of principal executive offices)
 
(Zip Code)
 
Registrant’s telephone number, including area code:  (443) 285-5400
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Corporate Office Properties Trust ý Yes   o No
Corporate Office Properties, L.P. ý Yes   o No
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Corporate Office Properties Trust ý Yes   o No
Corporate Office Properties, L.P. ý Yes   o No





Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Corporate Office Properties Trust
Large accelerated filer ý
 
Accelerated filer o
 
Non-accelerated filer o
 
Smaller reporting company o
Emerging growth company o
 
 
 
 
(Do not check if a smaller reporting company)
 
 
 

Corporate Office Properties, L.P.
Large accelerated filer ý
 
Accelerated filer o
 
Non-accelerated filer o
 
Smaller reporting company o
Emerging growth company o
 
 
 
 
(Do not check if a smaller reporting company)
 
 
 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 

Corporate Office Properties Trust o
Corporate Office Properties, L.P. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)

Corporate Office Properties Trust o Yes   ý No
Corporate Office Properties, L.P. o Yes   ý No

As of July 20, 2018, 103,263,449 of Corporate Office Properties Trust’s Common Shares of Beneficial Interest, $0.01 par value, were issued and outstanding.
 
 
 
 
 

EXPLANATORY NOTE

This report combines the quarterly reports on Form 10-Q for the period ended June 30, 2018 of Corporate Office Properties Trust (“COPT”) and subsidiaries (collectively, the “Company”) and Corporate Office Properties, L.P. (“COPLP”) and subsidiaries (collectively, the “Operating Partnership”). Unless stated otherwise or the context otherwise requires, “we,” “our,” and “us” refer collectively to COPT, COPLP and their subsidiaries.

COPT is a real estate investment trust, or REIT, and the sole general partner of COPLP. As of June 30, 2018, COPT owned approximately 97.0% of the outstanding common units in COPLP; the remaining common units and all of the outstanding COPLP preferred units were owned by third parties. As the sole general partner of COPLP, COPT controls COPLP and can cause it to enter into major transactions including acquisitions, dispositions and refinancings and cause changes in its line of business, capital structure and distribution policies.

There are a few differences between the Company and the Operating Partnership which are reflected in this Form 10-Q. We believe it is important to understand the differences between the Company and the Operating Partnership in the context of how the two operate as an interrelated, consolidated company. COPT is a REIT whose only material asset is its ownership of partnership interests of COPLP. As a result, COPT does not conduct business itself, other than acting as the sole general partner of COPLP, issuing public equity and guaranteeing certain debt of COPLP. COPT itself is not directly obligated under any indebtedness but guarantees some of the debt of COPLP. COPLP owns substantially all of the assets of COPT either directly or through its subsidiaries, conducts almost all of the operations of the business and is structured as a limited partnership with no publicly traded equity. Except for net proceeds from public equity issuances by COPT, which are contributed to COPLP in exchange for partnership units, COPLP generates the capital required by COPT’s business through COPLP’s operations, by COPLP’s direct or indirect incurrence of indebtedness or through the issuance of partnership units.

Noncontrolling interests, shareholders’ equity and partners’ capital are the main areas of difference between the consolidated financial statements of COPT and those of COPLP. The common limited partnership interests in COPLP not owned by COPT are accounted for as partners’ capital in COPLP’s consolidated financial statements and as noncontrolling




interests in COPT’s consolidated financial statements. COPLP’s consolidated financial statements also reflect COPT’s noncontrolling interests in certain real estate partnerships and limited liability companies (“LLCs”); the differences between shareholders’ equity, partners’ capital and noncontrolling interests result from the differences in the equity issued at the COPT and COPLP levels and in COPT’s noncontrolling interests in these real estate partnerships and LLCs. The only other significant differences between the consolidated financial statements of COPT and those of COPLP are assets in connection with a non-qualified elective deferred compensation plan (comprised primarily of mutual funds and equity securities) and the corresponding liability to the plan’s participants that are held directly by COPT.

We believe combining the quarterly reports on Form 10-Q of the Company and the Operating Partnership into this single report results in the following benefits:
combined reports better reflect how management, investors and the analyst community view the business as a single operating unit;
combined reports enhance investors’ understanding of the Company and the Operating Partnership by enabling them to view the business as a whole and in the same manner as management;
combined reports are more efficient for the Company and the Operating Partnership and result in savings in time, effort and expense; and
combined reports are more efficient for investors by reducing duplicative disclosure and providing a single document for their review.

To help investors understand the significant differences between the Company and the Operating Partnership, this report presents the following separate sections for each of the Company and the Operating Partnership:
consolidated financial statements;
the following notes to the consolidated financial statements:
Note 4, Fair Value Measurements of COPT and subsidiaries and COPLP and subsidiaries; and
Note 15, Earnings per Share of COPT and subsidiaries and Earnings per Unit of COPLP and subsidiaries;
“Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources of COPT”; and
“Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources of COPLP.”

This report also includes separate sections under Part I, Item 4. Controls and Procedures and separate Exhibit 31 and Exhibit 32 certifications for each of COPT and COPLP to establish that the Chief Executive Officer and the Chief Financial Officer of each entity have made the requisite certifications and that COPT and COPLP are compliant with Rule 13a-15 and Rule 15d-14 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and 18 U.S.C. §1350.





TABLE OF CONTENTS
 
FORM 10-Q
 
 
PAGE
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2



PART I: FINANCIAL INFORMATION
ITEM 1. Financial Statements


Corporate Office Properties Trust and Subsidiaries
Consolidated Balance Sheets
(in thousands, except share data)
(unaudited)
 
June 30,
2018
 
December 31,
2017
Assets
 

 
 

Properties, net:
 

 
 

Operating properties, net
$
2,760,632

 
$
2,737,611

Projects in development or held for future development
422,905

 
403,494

Total properties, net
3,183,537

 
3,141,105

Assets held for sale, net
42,226

 
42,226

Cash and cash equivalents
8,472

 
12,261

Investment in unconsolidated real estate joint venture
40,806

 
41,787

Accounts receivable (net of allowance for doubtful accounts of $811 and $607, respectively)
23,656

 
31,802

Deferred rent receivable (net of allowance of $423 and $364, respectively)
89,606

 
86,710

Intangible assets on real estate acquisitions, net
50,586

 
59,092

Deferred leasing costs (net of accumulated amortization of $29,546 and $29,560, respectively)
48,183

 
48,322

Investing receivables
54,427

 
57,493

Prepaid expenses and other assets, net
70,863

 
74,407

Total assets
$
3,612,362

 
$
3,595,205

Liabilities and equity
 

 
 

Liabilities:
 

 
 

Debt, net
$
1,871,445

 
$
1,828,333

Accounts payable and accrued expenses
88,885

 
108,137

Rents received in advance and security deposits
24,905

 
25,648

Dividends and distributions payable
29,449

 
28,921

Deferred revenue associated with operating leases
10,783

 
11,682

Deferred property sale
43,377

 
43,377

Capital lease obligation
640

 
15,853

Other liabilities
9,849

 
41,822

Total liabilities
2,079,333

 
2,103,773

Commitments and contingencies (Note 16)


 


Redeemable noncontrolling interests
24,544

 
23,125

Equity:
 

 
 

Corporate Office Properties Trust’s shareholders’ equity:
 

 
 

Common Shares of beneficial interest ($0.01 par value; 150,000,000 shares authorized; shares issued and outstanding of 103,260,495 at June 30, 2018 and 101,292,299 at December 31, 2017)
1,033

 
1,013

Additional paid-in capital
2,254,430

 
2,201,047

Cumulative distributions in excess of net income
(822,270
)
 
(802,085
)
Accumulated other comprehensive income
9,012

 
2,167

Total Corporate Office Properties Trust’s shareholders’ equity
1,442,205

 
1,402,142

Noncontrolling interests in subsidiaries:
 

 
 

Common units in COPLP
44,651

 
45,097

Preferred units in COPLP
8,800

 
8,800

Other consolidated entities
12,829

 
12,268

Noncontrolling interests in subsidiaries
66,280

 
66,165

Total equity
1,508,485

 
1,468,307

Total liabilities, redeemable noncontrolling interests and equity
$
3,612,362

 
$
3,595,205


See accompanying notes to consolidated financial statements.

3



Corporate Office Properties Trust and Subsidiaries
Consolidated Statements of Operations
(in thousands, except per share data)
(unaudited)
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
Revenues
 

 
 

 
 
 
 
Rental revenue
$
101,121

 
$
101,347

 
$
201,955

 
$
201,962

Tenant recoveries and other real estate operations revenue
28,041

 
26,950

 
55,485

 
53,102

Construction contract and other service revenues
17,581

 
23,138

 
44,779

 
36,172

Total revenues
146,743

 
151,435

 
302,219

 
291,236

Expenses
 

 
 

 
 

 
 

Property operating expenses
49,446

 
48,628

 
100,397

 
97,147

Depreciation and amortization associated with real estate operations
33,190

 
32,793

 
66,702

 
65,852

Construction contract and other service expenses
16,941

 
22,315

 
43,157

 
34,801

Impairment losses

 
1,625

 

 
1,625

General, administrative and leasing expenses
7,628

 
7,859

 
14,920

 
16,470

Business development expenses and land carry costs
1,234

 
1,597

 
2,848

 
3,290

Total operating expenses
108,439

 
114,817

 
228,024

 
219,185

Operating income
38,304

 
36,618

 
74,195

 
72,051

Interest expense
(18,945
)
 
(19,163
)
 
(37,729
)
 
(38,157
)
Interest and other income
1,439

 
1,583

 
2,798

 
3,309

Loss on early extinguishment of debt

 
(513
)
 

 
(513
)
Income before equity in income of unconsolidated entities and income taxes
20,798

 
18,525

 
39,264

 
36,690

Equity in income of unconsolidated entities
373

 
370

 
746

 
747

Income tax expense
(63
)
 
(48
)
 
(118
)
 
(88
)
Income before gain on sales of real estate
21,108

 
18,847

 
39,892

 
37,349

Gain on sales of real estate
(23
)
 
12

 
(27
)
 
4,250

Net income
21,085

 
18,859

 
39,865

 
41,599

Net income attributable to noncontrolling interests:
 

 
 

 
 

 
 

Common units in COPLP
(608
)
 
(261
)
 
(1,152
)
 
(883
)
Preferred units in COPLP
(165
)
 
(165
)
 
(330
)
 
(330
)
Other consolidated entities
(878
)
 
(907
)
 
(1,799
)
 
(1,841
)
Net income attributable to COPT
19,434

 
17,526

 
36,584

 
38,545

Preferred share dividends

 
(3,039
)
 

 
(6,219
)
Issuance costs associated with redeemed preferred shares

 
(6,847
)
 

 
(6,847
)
Net income attributable to COPT common shareholders
$
19,434

 
$
7,640

 
$
36,584

 
$
25,479

 
 
 
 
 
 
 
 
Earnings per common share:
 

 
 

 
 

 
 

Net income attributable to COPT common shareholders - basic
$
0.19

 
$
0.08

 
$
0.36

 
$
0.26

Net income attributable to COPT common shareholders - diluted
$
0.19

 
$
0.08

 
$
0.36

 
$
0.26

Dividends declared per common share
$
0.275

 
$
0.275

 
$
0.550

 
$
0.550


See accompanying notes to consolidated financial statements.

4



Corporate Office Properties Trust and Subsidiaries
Consolidated Statements of Comprehensive Income
(in thousands)
(unaudited)
 
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
Net income
$
21,085

 
$
18,859

 
$
39,865

 
$
41,599

Other comprehensive income
 

 
 

 
 

 
 

Unrealized gain (loss) on interest rate derivatives
1,912

 
(1,800
)
 
6,588

 
(1,576
)
(Gain) loss on interest rate derivatives recognized in interest expense
(47
)
 
941

 
198

 
2,125

Equity in other comprehensive income of equity method investee

 
39

 

 
39

Other comprehensive income (loss)
1,865

 
(820
)
 
6,786

 
588

Comprehensive income
22,950

 
18,039

 
46,651

 
42,187

Comprehensive income attributable to noncontrolling interests
(1,708
)
 
(1,306
)
 
(3,498
)
 
(3,074
)
Comprehensive income attributable to COPT
$
21,242

 
$
16,733

 
$
43,153

 
$
39,113

 
See accompanying notes to consolidated financial statements.



5



Corporate Office Properties Trust and Subsidiaries
Consolidated Statements of Equity
(Dollars in thousands)
(unaudited)
 
Preferred
Shares
 
Common
Shares
 
Additional
Paid-in
Capital
 
Cumulative
Distributions in
Excess of Net
Income
 
Accumulated
Other
Comprehensive Income (Loss)
 
Noncontrolling
Interests
 
Total
Balance at December 31, 2016 (98,498,651 common shares outstanding)
$
172,500

 
$
985

 
$
2,116,581

 
$
(747,825
)
 
$
(1,731
)
 
$
72,267

 
$
1,612,777

Redemption of preferred shares (6,900,000 shares)
(172,500
)
 

 
6,847

 
(6,847
)
 

 

 
(172,500
)
Conversion of common units to common shares (187,000 shares)

 
2

 
2,562

 

 

 
(2,564
)
 

Common shares issued under at-the-market program (591,042 shares)

 
6

 
19,662

 

 

 

 
19,668

Exercise of share options (5,000 shares)

 

 
150

 

 

 

 
150

Share-based compensation (189,948 shares issued, net of redemptions)

 
2

 
3,045

 

 

 

 
3,047

Redemption of vested equity awards

 

 
(1,813
)
 

 

 

 
(1,813
)
Adjustments to noncontrolling interests resulting from changes in ownership of COPLP

 

 
(514
)
 

 

 
514

 

Comprehensive income

 

 

 
38,545

 
568

 
1,934

 
41,047

Dividends

 

 

 
(60,922
)
 

 

 
(60,922
)
Distributions to owners of common and preferred units in COPLP

 

 

 

 

 
(2,202
)
 
(2,202
)
Distributions to noncontrolling interests in other consolidated entities

 

 

 

 

 
(2,610
)
 
(2,610
)
Adjustment to arrive at fair value of redeemable noncontrolling interests

 

 
(401
)
 

 

 

 
(401
)
Balance at June 30, 2017 (99,471,641 common shares outstanding)
$

 
$
995

 
$
2,146,119

 
$
(777,049
)
 
$
(1,163
)
 
$
67,339

 
$
1,436,241

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2017 (101,292,299 common shares outstanding)
$

 
$
1,013

 
$
2,201,047

 
$
(802,085
)
 
$
2,167

 
$
66,165

 
$
1,468,307

Cumulative effect of accounting change for adoption of hedge accounting guidance

 

 

 
(276
)
 
276

 

 

Balance at December 31, 2017, as adjusted

 
1,013

 
2,201,047

 
(802,361
)
 
2,443

 
66,165

 
1,468,307

Conversion of common units to common shares (53,817 shares)

 
1

 
760

 

 

 
(761
)
 

Common shares issued under forward equity sale agreements (1,777,000 shares)

 
18

 
52,209

 

 

 

 
52,227

Share-based compensation (137,379 shares issued, net of redemptions)

 
1

 
3,399

 

 

 

 
3,400

Redemption of vested equity awards

 

 
(1,525
)
 

 

 

 
(1,525
)
Adjustments to noncontrolling interests resulting from changes in ownership of COPLP

 

 
(702
)
 

 

 
702

 

Comprehensive income

 

 

 
36,584

 
6,569

 
2,269

 
45,422

Dividends

 

 

 
(56,493
)
 

 

 
(56,493
)
Distributions to owners of common and preferred units in COPLP

 

 

 

 

 
(2,088
)
 
(2,088
)
Distributions to noncontrolling interests in other consolidated entities

 

 

 

 

 
(7
)
 
(7
)
Adjustment to arrive at fair value of redeemable noncontrolling interests

 

 
(758
)
 

 

 

 
(758
)
Balance at June 30, 2018 (103,260,495 common shares outstanding)
$

 
$
1,033

 
$
2,254,430

 
$
(822,270
)
 
$
9,012

 
$
66,280

 
$
1,508,485


See accompanying notes to consolidated financial statements.

6



Corporate Office Properties Trust and Subsidiaries
Consolidated Statements of Cash Flows
(in thousands)
(unaudited) 
 
For the Six Months Ended June 30,
 
2018
 
2017
Cash flows from operating activities
 

 
 

Revenues from real estate operations received
$
262,602

 
$
254,392

Construction contract and other service revenues received
18,411

 
39,917

Property operating expenses paid
(83,642
)
 
(79,683
)
Construction contract and other service expenses paid
(62,624
)
 
(31,996
)
General, administrative, leasing, business development and land carry costs paid
(15,148
)
 
(20,315
)
Interest expense paid
(36,155
)
 
(36,351
)
Lease incentives paid
(4,825
)
 
(9,375
)
Other
2,093

 
940

Net cash provided by operating activities
80,712

 
117,529

Cash flows from investing activities
 

 
 

Construction, development and redevelopment
(67,749
)
 
(85,926
)
Tenant improvements on operating properties
(18,352
)
 
(13,711
)
Other capital improvements on operating properties
(8,584
)
 
(11,780
)
Proceeds from dispositions of properties

 
54,798

Leasing costs paid
(3,838
)
 
(3,904
)
Other
1,715

 
1,746

Net cash used in investing activities
(96,808
)
 
(58,777
)
Cash flows from financing activities
 

 
 

Proceeds from debt
 
 
 
Revolving Credit Facility
153,000

 
213,000

Repayments of debt
 
 
 
Revolving Credit Facility
(109,000
)
 
(19,000
)
Scheduled principal amortization
(2,101
)
 
(2,013
)
Other debt repayments

 
(200,000
)
Payments on capital lease obligation
(15,379
)
 

Net proceeds from issuance of common shares
52,277

 
19,835

Redemption of preferred shares

 
(199,083
)
Common share dividends paid
(55,950
)
 
(54,439
)
Preferred share dividends paid

 
(9,305
)
Distributions paid to noncontrolling interests in COPLP
(2,110
)
 
(2,274
)
Redemption of vested equity awards
(1,525
)
 
(1,813
)
Other
(5,370
)
 
(2,952
)
Net cash provided by (used in) financing activities
13,842

 
(258,044
)
Net decrease in cash and cash equivalents and restricted cash
(2,254
)
 
(199,292
)
Cash and cash equivalents and restricted cash
 

 
 

Beginning of period
14,831

 
212,619

End of period
$
12,577

 
$
13,327


See accompanying notes to consolidated financial statements.
 


7



Corporate Office Properties Trust and Subsidiaries
Consolidated Statements of Cash Flows (continued)
(in thousands)
(unaudited)
 
For the Six Months Ended June 30,
 
2018
 
2017
Reconciliation of net income to net cash provided by operating activities:
 

 
 

Net income
$
39,865

 
$
41,599

Adjustments to reconcile net income to net cash provided by operating activities:
 

 
 

Depreciation and amortization
67,684

 
66,948

Impairment losses

 
1,618

Amortization of deferred financing costs and net debt discounts
1,648

 
2,613

(Increase) decrease in deferred rent receivable
(3,470
)
 
669

Gain on sales of real estate
27

 
(4,250
)
Share-based compensation
3,132

 
2,820

Other
(777
)
 
(1,861
)
Changes in operating assets and liabilities:
 

 
 
Decrease (increase) in accounts receivable
8,050

 
(8,304
)
Decrease in prepaid expenses and other assets, net
14,718

 
22,418

Decrease in accounts payable, accrued expenses and other liabilities
(49,422
)
 
(2,387
)
Decrease in rents received in advance and security deposits
(743
)
 
(4,354
)
Net cash provided by operating activities
$
80,712

 
$
117,529

Reconciliation of cash and cash equivalents and restricted cash:
 
 
 
Cash and cash equivalents at beginning of period
$
12,261

 
$
209,863

Restricted cash at beginning of period
2,570

 
2,756

Cash and cash equivalents and restricted cash at beginning of period
$
14,831

 
$
212,619

 
 
 
 
Cash and cash equivalents at end of period
$
8,472

 
$
10,606

Restricted cash at end of period
4,105

 
2,721

Cash and cash equivalents and restricted cash at end of period
$
12,577

 
$
13,327

Supplemental schedule of non-cash investing and financing activities:
 

 
 

Increase (decrease) in accrued capital improvements, leasing and other investing activity costs
$
2,909

 
$
(4,927
)
Increase in property in connection with capital lease obligation
$

 
$
16,127

Increase in fair value of derivatives applied to accumulated other comprehensive income and noncontrolling interests
$
6,719

 
$
513

Equity in other comprehensive income of an equity method investee
$

 
$
39

Dividends/distributions payable
$
29,449

 
$
28,462

Decrease in noncontrolling interests and increase in shareholders’ equity in connection with the conversion of common units into common shares
$
761

 
$
2,564

Adjustments to noncontrolling interests resulting from changes in COPLP ownership
$
702

 
$
514

Increase in redeemable noncontrolling interests and decrease in equity to carry redeemable noncontrolling interests at fair value
$
758

 
$
401

 
See accompanying notes to consolidated financial statements.


8





Corporate Office Properties, L.P. and Subsidiaries
Consolidated Balance Sheets
(in thousands, except unit data)
(unaudited)
 
June 30,
2018
 
December 31,
2017
Assets
 

 
 

Properties, net:
 

 
 

Operating properties, net
$
2,760,632

 
$
2,737,611

Projects in development or held for future development
422,905

 
403,494

Total properties, net
3,183,537

 
3,141,105

Assets held for sale, net
42,226

 
42,226

Cash and cash equivalents
8,472

 
12,261

Investment in unconsolidated real estate joint venture
40,806

 
41,787

Accounts receivable (net of allowance for doubtful accounts of $811 and $607, respectively)
23,656

 
31,802

Deferred rent receivable (net of allowance of $423 and $364, respectively)
89,606

 
86,710

Intangible assets on real estate acquisitions, net
50,586

 
59,092

Deferred leasing costs (net of accumulated amortization of $29,546 and $29,560, respectively)
48,183

 
48,322

Investing receivables
54,427

 
57,493

Prepaid expenses and other assets, net
66,669

 
69,791

Total assets
$
3,608,168

 
$
3,590,589

Liabilities and equity
 

 
 

Liabilities:
 

 
 

Debt, net
$
1,871,445

 
$
1,828,333

Accounts payable and accrued expenses
88,885

 
108,137

Rents received in advance and security deposits
24,905

 
25,648

Distributions payable
29,449

 
28,921

Deferred revenue associated with operating leases
10,783

 
11,682

Deferred property sale
43,377

 
43,377

Capital lease obligation
640


15,853

Other liabilities
5,655

 
37,206

Total liabilities
2,075,139

 
2,099,157

Commitments and contingencies (Note 16)


 


Redeemable noncontrolling interests
24,544

 
23,125

Equity:
 

 
 

Corporate Office Properties, L.P.’s equity:
 

 
 

Preferred units held by limited partner, 352,000 preferred units outstanding at June 30, 2018 and December 31, 2017
8,800

 
8,800

Common units, 103,260,495 and 101,292,299 held by the general partner and 3,197,061 and 3,250,878 held by limited partners at June 30, 2018 and December 31, 2017, respectively
1,477,575

 
1,445,022

Accumulated other comprehensive income
9,235

 
2,173

Total Corporate Office Properties, L.P.’s equity
1,495,610

 
1,455,995

Noncontrolling interests in subsidiaries
12,875

 
12,312

Total equity
1,508,485

 
1,468,307

Total liabilities, redeemable noncontrolling interests and equity
$
3,608,168

 
$
3,590,589


See accompanying notes to consolidated financial statements.


9



Corporate Office Properties, L.P. and Subsidiaries
Consolidated Statements of Operations
(in thousands, except per unit data)
(unaudited)
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
Revenues
 

 
 

 
 
 
 
Rental revenue
$
101,121

 
$
101,347

 
$
201,955

 
$
201,962

Tenant recoveries and other real estate operations revenue
28,041

 
26,950

 
55,485

 
53,102

Construction contract and other service revenues
17,581

 
23,138

 
44,779

 
36,172

Total revenues
146,743

 
151,435

 
302,219

 
291,236

Expenses
 

 
 

 
 

 
 

Property operating expenses
49,446

 
48,628

 
100,397

 
97,147

Depreciation and amortization associated with real estate operations
33,190

 
32,793

 
66,702

 
65,852

Construction contract and other service expenses
16,941

 
22,315

 
43,157

 
34,801

Impairment losses

 
1,625

 

 
1,625

General, administrative and leasing expenses
7,628

 
7,859

 
14,920

 
16,470

Business development expenses and land carry costs
1,234

 
1,597

 
2,848

 
3,290

Total operating expenses
108,439

 
114,817

 
228,024

 
219,185

Operating income
38,304

 
36,618

 
74,195

 
72,051

Interest expense
(18,945
)
 
(19,163
)
 
(37,729
)
 
(38,157
)
Interest and other income
1,439

 
1,583

 
2,798

 
3,309

Loss on early extinguishment of debt

 
(513
)
 

 
(513
)
Income before equity in income of unconsolidated entities and income taxes
20,798

 
18,525

 
39,264

 
36,690

Equity in income of unconsolidated entities
373

 
370

 
746

 
747

Income tax expense
(63
)
 
(48
)
 
(118
)
 
(88
)
Income before gain on sales of real estate
21,108

 
18,847

 
39,892

 
37,349

Gain on sales of real estate
(23
)
 
12

 
(27
)
 
4,250

Net income
21,085

 
18,859

 
39,865

 
41,599

Net income attributable to noncontrolling interests in consolidated entities
(878
)
 
(907
)
 
(1,799
)
 
(1,841
)
Net income attributable to COPLP
20,207

 
17,952

 
38,066

 
39,758

Preferred unit distributions
(165
)
 
(3,204
)
 
(330
)
 
(6,549
)
Issuance costs associated with redeemed preferred units

 
(6,847
)
 

 
(6,847
)
Net income attributable to COPLP common unitholders
$
20,042

 
$
7,901

 
$
37,736

 
$
26,362

Earnings per common unit:
 

 
 

 
 

 
 

Net income attributable to COPLP common unitholders - basic
$
0.19

 
$
0.08

 
$
0.36

 
$
0.26

Net income attributable to COPLP common unitholders - diluted
$
0.19

 
$
0.08

 
$
0.36

 
$
0.26

Distributions declared per common unit
$
0.275

 
$
0.275

 
$
0.550

 
$
0.550


See accompanying notes to consolidated financial statements.

10



Corporate Office Properties, L.P. and Subsidiaries
Consolidated Statements of Comprehensive Income
(in thousands)
(unaudited) 
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
Net income
$
21,085

 
$
18,859

 
$
39,865

 
$
41,599

Other comprehensive income
 

 
 

 
 
 
 
Unrealized gain (loss) on interest rate derivatives
1,912

 
(1,800
)
 
6,588

 
(1,576
)
(Gain) loss on interest rate derivatives recognized in interest expense
(47
)
 
941

 
198

 
2,125

Equity in other comprehensive income of equity method investee

 
39

 

 
39

Other comprehensive income (loss)
1,865

 
(820
)
 
6,786

 
588

Comprehensive income
22,950

 
18,039

 
46,651

 
42,187

Comprehensive income attributable to noncontrolling interests
(878
)
 
(907
)
 
(1,799
)
 
(1,841
)
Comprehensive income attributable to COPLP
$
22,072

 
$
17,132

 
$
44,852

 
$
40,346

 
See accompanying notes to consolidated financial statements.

 

11



Corporate Office Properties, L.P. and Subsidiaries
Consolidated Statements of Equity
(Dollars in thousands)
(unaudited)
 
Limited Partner Preferred Units
 
General Partner
 Preferred Units
 
Common Units
 
Accumulated Other Comprehensive Income (Loss)
 
Noncontrolling Interests in Subsidiaries
 
 
 
Units
 
Amount
 
Units
 
Amount
 
Units
 
Amount
 
 
 
Total Equity
Balance at December 31, 2016
352,000

 
$
8,800

 
6,900,000

 
$
172,500

 
102,089,042

 
$
1,419,710

 
$
(1,854
)
 
$
13,621

 
$
1,612,777

Redemption of preferred units resulting from redemption of preferred shares

 

 
(6,900,000
)
 
(172,500
)
 

 

 

 

 
(172,500
)
Issuance of common units resulting from common shares issued under COPT at-the-market program

 

 

 

 
591,042

 
19,668

 

 

 
19,668

Issuance of common units resulting from exercise of share options

 

 

 

 
5,000

 
150

 

 

 
150

Share-based compensation (units net of redemption)

 

 

 

 
189,948

 
3,047

 

 

 
3,047

Redemptions of vested equity awards

 

 

 

 

 
(1,813
)
 

 

 
(1,813
)
Comprehensive income

 
330

 

 
6,219

 

 
33,209

 
588

 
701

 
41,047

Distributions to owners of common and preferred units

 
(330
)
 

 
(6,219
)
 

 
(56,575
)
 

 

 
(63,124
)
Distributions to noncontrolling interests in subsidiaries

 

 

 

 

 

 

 
(2,610
)
 
(2,610
)
Adjustment to arrive at fair value of redeemable noncontrolling interests

 

 

 

 

 
(401
)
 

 

 
(401
)
Balance at June 30, 2017
352,000

 
$
8,800

 

 
$

 
102,875,032

 
$
1,416,995

 
$
(1,266
)
 
$
11,712

 
$
1,436,241

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2017
352,000

 
$
8,800

 

 
$

 
104,543,177

 
$
1,445,022

 
$
2,173

 
$
12,312

 
$
1,468,307

Cumulative effect of accounting change for adoption of hedge accounting guidance

 

 

 

 

 
(276
)
 
276

 

 

Balance at December 31, 2017, as adjusted
352,000

 
8,800

 

 

 
104,543,177

 
1,444,746

 
2,449

 
12,312

 
1,468,307

Issuance of common units resulting from common shares issued under COPT forward equity sale agreements

 

 

 

 
1,777,000

 
52,227

 

 

 
52,227

Share-based compensation (units net of redemption)

 

 

 

 
137,379

 
3,400

 

 

 
3,400

Redemptions of vested equity awards

 

 

 

 

 
(1,525
)
 

 

 
(1,525
)
Comprehensive income

 
330

 

 

 

 
37,736

 
6,786

 
570

 
45,422

Distributions to owners of common and preferred units

 
(330
)
 

 

 

 
(58,251
)
 

 

 
(58,581
)
Distributions to noncontrolling interests in subsidiaries

 

 

 

 

 

 

 
(7
)
 
(7
)
Adjustment to arrive at fair value of redeemable noncontrolling interests

 

 

 

 

 
(758
)
 

 

 
(758
)
Balance at June 30, 2018
352,000

 
$
8,800

 

 
$

 
106,457,556

 
$
1,477,575

 
$
9,235

 
$
12,875

 
$
1,508,485


See accompanying notes to consolidated financial statements.

12



Corporate Office Properties, L.P. and Subsidiaries
Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
 
For the Six Months Ended June 30,
 
2018
 
2017
Cash flows from operating activities
 

 
 

Revenues from real estate operations received
$
262,602

 
$
254,392

Construction contract and other service revenues received
18,411

 
39,917

Property operating expenses paid
(83,642
)
 
(79,683
)
Construction contract and other service expenses paid
(62,624
)
 
(31,996
)
General, administrative, leasing, business development and land carry costs paid
(15,148
)
 
(20,315
)
Interest expense paid
(36,155
)
 
(36,351
)
Lease incentives paid
(4,825
)
 
(9,375
)
Other
2,093

 
940

Net cash provided by operating activities
80,712

 
117,529

Cash flows from investing activities
 

 
 

Construction, development and redevelopment
(67,749
)
 
(85,926
)
Tenant improvements on operating properties
(18,352
)
 
(13,711
)
Other capital improvements on operating properties
(8,584
)
 
(11,780
)
Proceeds from dispositions of properties

 
54,798

Leasing costs paid
(3,838
)
 
(3,904
)
Other
1,715

 
1,746

Net cash used in investing activities
(96,808
)
 
(58,777
)
Cash flows from financing activities
 

 
 

Proceeds from debt
 
 
 
Revolving Credit Facility
153,000

 
213,000

Repayments of debt
 
 
 
Revolving Credit Facility
(109,000
)
 
(19,000
)
Scheduled principal amortization
(2,101
)
 
(2,013
)
Other debt repayments

 
(200,000
)
Payments on capital lease obligation
(15,379
)
 

Net proceeds from issuance of common units
52,277

 
19,835

Redemption of preferred units

 
(199,083
)
Common unit distributions paid
(57,730
)
 
(56,383
)
Preferred unit distributions paid
(330
)
 
(9,635
)
Redemption of vested equity awards
(1,525
)
 
(1,813
)
Other
(5,370
)
 
(2,952
)
Net cash provided by (used in) financing activities
13,842

 
(258,044
)
Net decrease in cash and cash equivalents and restricted cash
(2,254
)
 
(199,292
)
Cash and cash equivalents and restricted cash
 

 
 

Beginning of period
14,831

 
212,619

End of period
$
12,577

 
$
13,327


See accompanying notes to consolidated financial statements.

13



Corporate Office Properties, L.P. and Subsidiaries
Consolidated Statements of Cash Flows (Continued)
(in thousands)
(unaudited)

 
For the Six Months Ended June 30,
 
2018
 
2017
Reconciliation of net income to net cash provided by operating activities:
 

 
 

Net income
$
39,865

 
$
41,599

Adjustments to reconcile net income to net cash provided by operating activities:
 

 
 

Depreciation and amortization
67,684

 
66,948

Impairment losses

 
1,618

Amortization of deferred financing costs and net debt discounts
1,648

 
2,613

(Increase) decrease in deferred rent receivable
(3,470
)
 
669

Gain on sales of real estate
27

 
(4,250
)
Share-based compensation
3,132

 
2,820

Other
(777
)
 
(1,861
)
Operating changes in assets and liabilities:
 

 
 
Decrease (increase) in accounts receivable
8,050

 
(8,304
)
Decrease in prepaid expenses and other assets, net
14,296

 
21,126

Decrease in accounts payable, accrued expenses and other liabilities
(49,000
)
 
(1,095
)
Decrease in rents received in advance and security deposits
(743
)
 
(4,354
)
Net cash provided by operating activities
$
80,712

 
$
117,529

Reconciliation of cash and cash equivalents and restricted cash:
 
 
 
Cash and cash equivalents at beginning of period
$
12,261

 
$
209,863

Restricted cash at beginning of period
2,570

 
2,756

Cash and cash equivalents and restricted cash at beginning of period
$
14,831

 
$
212,619

 
 
 
 
Cash and cash equivalents at end of period
$
8,472

 
$
10,606

Restricted cash at end of period
4,105

 
2,721

Cash and cash equivalents and restricted cash at end of period
$
12,577

 
$
13,327

Supplemental schedule of non-cash investing and financing activities:
 

 
 

Increase (decrease) in accrued capital improvements, leasing and other investing activity costs
$
2,909

 
$
(4,927
)
Increase in property in connection with capital lease obligation
$

 
$
16,127

Increase in fair value of derivatives applied to accumulated other comprehensive income and noncontrolling interests
$
6,719

 
$
513

Equity in other comprehensive income of an equity method investee
$

 
$
39

Distributions payable
$
29,449

 
$
28,462

Increase in redeemable noncontrolling interests and decrease in equity to carry redeemable noncontrolling interests at fair value
$
758

 
$
401

 
See accompanying notes to consolidated financial statements.



14



Corporate Office Properties Trust and Subsidiaries and Corporate Office Properties, L.P. and Subsidiaries
Notes to Consolidated Financial Statements
(unaudited)
 
1.    Organization
 
Corporate Office Properties Trust (“COPT”) and subsidiaries (collectively, the “Company”) is a fully-integrated and self-managed real estate investment trust (“REIT”). Corporate Office Properties, L.P. (“COPLP”) and subsidiaries (collectively, the “Operating Partnership”) is the entity through which COPT, the sole general partner of COPLP, conducts almost all of its operations and owns almost all of its assets. Unless otherwise expressly stated or the context otherwise requires, “we”, “us” and “our” as used herein refer to each of the Company and the Operating Partnership. We own, manage, lease, develop and selectively acquire office and data center properties. The majority of our portfolio is in locations that support the United States Government and its contractors, most of whom are engaged in national security, defense and information technology (“IT”) related activities servicing what we believe are growing, durable, priority missions (“Defense/IT Locations”). We also own a portfolio of office properties located in select urban/urban-like submarkets in the Greater Washington, DC/Baltimore region
with durable Class-A office fundamentals and characteristics (“Regional Office”). As of June 30, 2018, our properties included the following:

159 properties totaling 17.7 million square feet comprised of 143 office properties and 16 single-tenant data center shell properties (“data center shells”). We owned six of these data center shells through an unconsolidated real estate joint venture;
a wholesale data center with a critical load of 19.25 megawatts;
nine properties under construction or redevelopment (five office properties and four data center shells) that we estimate will total approximately 1.0 million square feet upon completion, including one partially-operational property; and
approximately 1,000 acres of land controlled for future development that we believe could be developed into approximately 12.3 million square feet and 150 acres of other land.
 
COPLP owns real estate directly and through subsidiary partnerships and limited liability companies (“LLCs”).  In addition to owning real estate, COPLP also owns subsidiaries that provide real estate services such as property management and construction and development services primarily for our properties but also for third parties. Some of these services are performed by a taxable REIT subsidiary (“TRS”).

Equity interests in COPLP are in the form of common and preferred units. As of June 30, 2018, COPT owned 97.0% of the outstanding COPLP common units (“common units”); the remaining common units and all of the outstanding COPLP preferred units (“preferred units”) were owned by third parties. Common units not owned by COPT carry certain redemption rights. The number of common units owned by COPT is equivalent to the number of outstanding common shares of beneficial interest (“common shares”) of COPT, and the entitlement of all common units to quarterly distributions and payments in liquidation is substantially the same as those of COPT common shareholders. Similarly, in the case of any series of preferred units held by COPT, there is a series of preferred shares of beneficial interest (“preferred shares”) in COPT that is equivalent in number and carries substantially the same terms as such series of COPLP preferred units. COPT’s common shares are publicly traded on the New York Stock Exchange (“NYSE”) under the ticker symbol “OFC”.

Because COPLP is managed by COPT, and COPT conducts substantially all of its operations through COPLP, we refer to COPT’s executive officers as COPLP’s executive officers; similarly, although COPLP does not have a board of trustees, we refer to COPT’s Board of Trustees as COPLP’s Board of Trustees.
  
2.     Summary of Significant Accounting Policies
 
Basis of Presentation
 
The COPT consolidated financial statements include the accounts of COPT, the Operating Partnership, their subsidiaries and other entities in which COPT has a majority voting interest and control.  The COPLP consolidated financial statements include the accounts of COPLP, its subsidiaries and other entities in which COPLP has a majority voting interest and control.  We also consolidate certain entities when control of such entities can be achieved through means other than voting rights (“variable interest entities” or “VIEs”) if we are deemed to be the primary beneficiary of such entities.  We eliminate all intercompany balances and transactions in consolidation.

15




 We use the equity method of accounting when we own an interest in an entity and can exert significant influence over but cannot control the entity’s operations. We discontinue equity method accounting if our investment in an entity (and net advances) is reduced to zero unless we have guaranteed obligations of the entity or are otherwise committed to provide further financial support for the entity.
 
We use the cost method of accounting when we own an interest in an entity and cannot exert significant influence over its operations.

These interim financial statements should be read together with the consolidated financial statements and notes thereto as of and for the year ended December 31, 2017 included in our 2017 Annual Report on Form 10-K.  The unaudited consolidated financial statements include all adjustments that are necessary, in the opinion of management, to fairly state our financial position and results of operations.  All adjustments are of a normal recurring nature.  The consolidated financial statements have been prepared using the accounting policies described in our 2017 Annual Report on Form 10-K as updated for our adoption of recent accounting pronouncements discussed below.

Reclassification

We reclassified certain amounts from prior periods to conform to the current period presentation of our consolidated financial statements with no effect on previously reported net income or equity, including restricted cash and marketable securities that were reclassified to the line entitled “prepaid expenses and other assets, net” on our consolidated balance sheets after having been reported on a separate line in our Quarterly Reports on Form 10-Q filed in prior years and previous Annual Reports on Form 10-K.

Recent Accounting Pronouncements

We adopted guidance issued by the Financial Accounting Standards Board (“FASB”) effective January 1, 2018 regarding the recognition of revenue from contracts with customers (“Topic 606”). Under this guidance, an entity recognizes revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This guidance also requires improved disclosures regarding the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. We determined that Topic 606 is applicable to our construction contract and other service revenues, which includes predominantly construction and design projects performed primarily for tenants of our properties. We used the modified retrospective method for contracts that were not completed as of January 1, 2018. Under this method, the cumulative effect of initially applying the guidance is recognized as an adjustment to the opening balance of retained earnings as of the date of initial application. Our adoption of Topic 606 effective January 1, 2018 did not affect our consolidated financial statements other than additional disclosure provided in accordance with the guidance. We did not elect to use any of the practical expedients provided for under the guidance. As discussed further below, once the new guidance setting forth principles for the recognition, measurement, presentation and disclosure of leases goes into effect on January 1, 2019, Topic 606 may apply to executory costs and other components of revenue due under leases that are deemed to be non-lease components (such as common area maintenance and provision of utilities).

We adopted guidance issued by the FASB effective January 1, 2018 that requires entities to measure equity investments at fair value through net income, except for those that result in consolidation or are accounted for under the equity method of accounting. For equity investments without readily determinable fair values, the guidance permits the application of a measurement alternative using the cost of the investment, less any impairments, plus or minus changes resulting from observable price changes for an identical or similar investment of the same issuer. Our adoption of this guidance had no effect on our consolidated financial statements.
 
We adopted guidance issued by the FASB retrospectively effective January 1, 2018 that clarifies how entities should classify certain cash receipts and cash payments on the statement of cash flows with the objective of reducing the existing diversity in practice related to eight specific cash flow issues. The areas addressed in the new guidance relate to debt prepayment costs, settlement of zero-coupon debt instruments, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims, proceeds from the settlement of corporate-owned and bank-owned life insurance policies, distributions received from equity method investments, beneficial interest in securitization transactions and separately identifiable cash flows and application of the predominance principle. Our adoption of this guidance had no effect on our consolidated financial statements.


16



We adopted guidance issued by the FASB retrospectively effective January 1, 2018 that requires the statement of cash flows to explain the change during the period in the total of cash, cash equivalents and amounts described as restricted cash or restricted cash equivalents.  Under the new guidance, amounts described as restricted cash and restricted cash equivalents will be included with cash and cash equivalents when reconciling the beginning of period and end of period total amounts shown on the statement of cash flows.  As a result of our adoption of this guidance, the change in restricted cash is no longer reported as either operating or investing activities on our statements of cash flows. Our restricted cash primarily consists of cash escrowed under mortgage debt for capital improvements and real estate taxes and certain tenant security deposits. Our adoption of this guidance had the following effects on our consolidated statements of cash flows for the six months ended June 30, 2017 (in thousands):
 
 
As Previously Reported
 
Impact of Adoption
 
As
Adjusted
Net cash provided by operating activities
 
$
117,737

 
$
(208
)
 
$
117,529

Net cash used in investing activities
 
$
(58,950
)
 
$
173

 
$
(58,777
)
Net decrease in cash and cash equivalents and restricted cash
 
$
(199,257
)
 
$
(35
)
 
$
(199,292
)
Beginning of period cash and cash equivalents and restricted cash
 
$
209,863

 
$
2,756

 
$
212,619

End of period cash and cash equivalents and restricted cash
 
$
10,606

 
$
2,721

 
$
13,327


We adopted guidance issued by the FASB that clarifies the scope of provisions and accounting for nonfinancial asset derecognition, including partial sales of real estate assets, effective January 1, 2018 using the full retrospective method. The new guidance requires recognition of a sale of real estate and resulting gain or loss when control transfers and the buyer has the ability to direct use of, or obtain substantially all of the remaining benefit from, the asset (which generally will occur on the closing date); the factor of continuing involvement is no longer a specific consideration for the timing of recognition. The new guidance eliminates the need to consider adequacy of buyer investment, which was replaced by additional judgments regarding collectability and intent and/or ability to pay. The new guidance also requires an entity to derecognize nonfinancial assets and in-substance nonfinancial assets once it transfers control of such assets. When an entity transfers its controlling interest in a nonfinancial asset but retains a noncontrolling ownership interest, the entity is required to measure any non-controlling interest it receives or retains at fair value and recognize a full gain or loss on the transaction; as a result, sales and partial sales of real estate assets are now subject to the same derecognition model as all other nonfinancial assets. We had a transaction in July 2016 accounted for as a partial sale under the previous guidance that meets the criteria for immediate full gain recognition under the new guidance; as a result, we retrospectively recognized an additional $18 million in income in 2016 that was being amortized into income in subsequent periods under the previous guidance. The recognition pattern for our other sales of real estate were not changed by this new guidance. The full retrospective method requires adjustment of each reporting period presented at the time of adoption.






17



The tables below set forth the impact of the adoption of this guidance for amounts previously reported on the consolidated financial statements of COPT and subsidiaries (in thousands):
 
 
As of December 31, 2017
 
As of June 30, 2017
 
As of December 31, 2016
Consolidated Balance Sheets
 
As Previously Reported
 
Impact of Adoption
 
As
Adjusted
 
As Previously Reported
 
Impact of Adoption
 
As
Adjusted
 
As Previously Reported