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

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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

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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.

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TABLE OF CONTENTS

 

FORM 10-Q

 

		PAGE
PART I: FINANCIAL INFORMATION
Item 1:	Financial Statements:
Consolidated Financial Statements of Corporate Office Properties Trust
	Consolidated Balance Sheets as of June 30, 2018 and December 31, 2017 (unaudited)	3
	Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2018 and 2017 (unaudited)	4
	Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2018 and 2017 (unaudited)	5
	Consolidated Statements of Equity for the Six Months Ended June 30, 2018 and 2017 (unaudited)	6
	Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2018 and 2017 (unaudited)	7
Consolidated Financial Statements of Corporate Office Properties, L.P.
	Consolidated Balance Sheets as of June 30, 2018 and December 31, 2017 (unaudited)	9
	Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2018 and 2017 (unaudited)	10
	Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2018 and 2017 (unaudited)	11
	Consolidated Statements of Equity for the Six Months Ended June 30, 2018 and 2017 (unaudited)	12
	Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2018 and 2017 (unaudited)	13
Notes to Consolidated Financial Statements (unaudited)		15
Item 2:	Management’s Discussion and Analysis of Financial Condition and Results of Operations	37
Item 3:	Quantitative and Qualitative Disclosures About Market Risk	50
Item 4:	Controls and Procedures	50
PART II: OTHER INFORMATION
Item 1:	Legal Proceedings	51
Item 1A:	Risk Factors	51
Item 2:	Unregistered Sales of Equity Securities and Use of Proceeds	51
Item 3:	Defaults Upon Senior Securities	51
Item 4:	Mine Safety Disclosures	51
Item 5:	Other Information	51
Item 6:	Exhibits	52
SIGNATURES		53

2

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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.

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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.

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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.

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 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

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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.

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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				Impact of Adoption				As Adjusted
Investment in unconsolidated real estate joint venture		$	25,066			$	16,721			$	41,787			$	25,335			$	17,417			$	42,752			$	25,548			$	18,113			$	43,661
Cumulative distributions in excess of net income		$	(818,190	)		$	16,105			$