Welcome to the Corporate Office Properties Trust Third Quarter 2017 Earnings Conference Call. As a reminder, today's call is being recorded. At this time, I will turn the call over to Stephanie Krewson-Kelly, COPT's Vice President of Investor Relations. Ms. Krewson-Kelly, please go ahead.

Thank you, Liz. Good afternoon, and welcome to COPT's conference call to discuss our third quarter 2017 results. With me today are, Steve Budorick, President and CEO; Paul Adkins, EVP and COO; and Anthony Mifsud, EVP and CFO. In addition to the supplemental package and press release related to our results, we have posted slides on the Investors section of our website to accompany management's remarks. As management discusses GAAP and non-GAAP measures, you will find a reconciliation of such financial measures in the press release and on our website. At the conclusion of management's remarks, we will open the call for your questions. Statements made during this call may be forward-looking within the meaning of the safe harbor of the Private Securities Litigation Reform Act of 1995, and actual results may differ materially due to a variety of risks, uncertainties and other factors. Please refer to today's press release and our SEC filings for a detailed discussion of forward-looking statements. I will now turn the call over to Steve.

Thank you, Stephanie, and good afternoon. Our third quarter results were excellent, exceeding our expectations. As we indicated on our second quarter call, demand in our operating portfolio is building nicely. Development leasing has also begun to accelerate and we expect to end the year with strong leasing momentum that should carry into 2018 and beyond. As highlighted on Slide 4, FFO per share of $0.53 in the third quarter was at the high end of our guidance range. Same office cash NOI grew by 5.2% in the quarter, which exceeded our expectations. Our balance sheet remains strong at 6.2x total leverage to EBITDA. Renewals are stronger than forecasted at 81% for the first 9 months of the year, and the government is undeniably open for business, particularly as related to national security. In the first 9 months, we renewed all of the 451,000 square feet of government leases at roll, for an average term of 6.5 years. Additionally, as Paul will detail, we are pleased with the progress towards completing the lease up at both secured developments held for government use. Development leasing in the quarter was solid and is accelerating as we anticipated. We said on our first and second quarter calls that the protracted Continuing Resolution, under which the government operated for most of the fiscal 2017 would push some leasing into the second half of the year and into 2018. Recall that we also expected demand would accelerate within 2 to 3 quarters after the federal budget passed into law. That's exactly what we are seeing. For the first 9 months, we completed 482,000 square feet of development leasing. And so far in the fourth quarter, we've completed another 185,000 square feet, bringing our total through October to 667,000 square feet. We're in active negotiations on…

Thank you, Steve. During the quarter, we completed 1.1 million square feet of leases, bringing our 9-month total to 2 million square feet. Tenant retention rates continued to strengthen. In the quarter, we renewed 903,000 square feet equating to an 89% renewal rate. For the 3 quarters ended September 30, we renewed 1.3 million square feet and achieved an 81% retention rate. Our initial 2017 renewal guidance was 70% to 75%, which we increased to 75% to 80% on our last call. Given our outperformance and based on tenant discussions, we are raising our full year renewal rate again to a range of 80% to 82%. Cash rents on renewals increased 30 basis points in the quarter and were flat for the 9 months ended September 30. For the full year, we now expect cash rents on renewals to average flat to minus 1%, a slightly stronger result than we expected in our initial guidance. Our longer-term renewal forecast of -- for large leases, and the composition of those tenants supports our expectation that leasing economics should continue improving in the next few years. We define large leases as 100,000 square feet or more in size, and Slide 7 summarizes our 14 large leases scheduled to expire between the fourth quarter of this year and the end of 2019. Approximately 2/3 of this space is in leases located in the B/W Corridor and 1.3 million square feet are leased to the U.S. government. Based on discussions and negotiations already underway, we forecast a renewal rate of at least 80% on these 2 million square feet. In the quarter, we leased 88,000 square feet of vacancy and 232,000 square feet of vacancy for the 9 months. Combined with placing 839,000 square feet of development projects in the service that, on average,…

Thanks, Paul. FFO per share of $0.53 in the third quarter met the high-end of our guidance range, due in part to better-than-expected operating efficiencies. We continue to forecast same-office cash NOI will increase between 3.3% and 3.6% for the year and are narrowing our forecast for same office occupancy to end the year between 92.5% and 93%. During the year, we sold the last of our holdings in White Marsh for $47.5 million. That sale completed 6 years of programmatic asset sales that positively transformed our portfolio and balance sheet. In the future, we will select assets for sale based on the opportunity to recycle capital into higher value creation opportunities. Our balance sheet metrics remain strong, and we expect our year-end debt plus preferred to EBITDA ratio to be consistent with the third quarter's ratio of 6.2x. Additionally, as shown on Slide 12, assuming we exercise the extension options of our line of credit, we have no debt maturing until 2020, at which time our $100 million term loan and line of credit mature. Slide 13 of our presentation summarizes the major assumptions behind our guidance for the fourth quarter and full year FFO per share as adjusted for comparability. In the third quarter, we are adjusting our guidance to $0.53 to $0.55. NOI gains from placing DC21 into service and recent occupancy gains in our operating portfolio, partially offset by higher-than-expected property level expenses scheduled for the fourth quarter, account for a more modest increase versus third quarter results. For the full year, we are narrowing our range from $2.02 to $2.06 to a new range of $2.03 to $2.05. With that, I'll turn the call back to Steve.

Thank you, Anthony. The defense industry is at the beginning of a multiyear recovery and expansion and the demand for cloud computing facilities in our region is explosive. We are excited about the rapid increase in demand, evidenced by the doubling of our shadow development pipeline from 1.4 million square feet last quarter to as much as 3 million square feet today. We're equally excited about our strong competitive advantages and contending to win the majority of these transactions. Our Maryland, Northern Virginia, Alabama and Texas properties and land are located advantageously to serve mission growth, and we differentiate ourselves from the data center shell business with our speed-to-market and quality control. Our track record of success is supported by credentialed personnel, strategic land positions and the balance sheet flexibility to capitalize on these opportunities to the benefit of our shareholders. We intend to aggressively pursue every Defense/IT deal in our markets and to maintain a disciplined balance sheet. We believe we are at the forefront of a boom period in demand for our locations, and we intend to translate that opportunity into attractive risk-adjusted returns for investors. With that, operator, please open the call up for questions.

[Operator Instructions]. Our first question comes from the line of Manny Korchman with Citi.

Steve, maybe we think about the, that increased development pipeline. Two things. One or maybe three, if everything came through in that pipeline, which markets could they be in? And my other 2, related to the same pipeline, just, if we think about historically, the number of successes or realizations to that pipeline versus the size of the pipeline, what would that be, and then the timing to sort of realize that.

Okay, so first question, what markets would that affect? Seven different markets with what's on our pipeline today. So the data center market, Redstone Gateway, U.S. Government campuses, University of Maryland campus, Washington, D.C. and Columbia Gateway. And then with regard to our hit rate, we've been realizing -- I haven't done the calculation, but I would say 75% or better of what we put on that, even though we handicap it at 50%. The question is, over time how much do we -- at what rate do we realize the magnitude of it. With regard to what we have on the low end, the 2 million square feet, pretty confident we're going to generate almost all of it, if not all of it.

And then a quick one on the development--

So and then, with regard to timing, think of it as '18 and '19. There's a little bit that's in 2020, but it's heavily concentrated in '18 and '19.

Perfect. And then, just on the press release developments last night, you mentioned a Fortune 500 user. Was that a government contract user or sort of just a more normal, for lack of a better word, Fortune 500 Company?

Our connection's a little fuzzy, could you repeat the question?

The question was, the Fortune 500 customer that you announced last night, is that a government contractor or just sort of a normal office user?

It's a data center shell user.

Our next question comes from the line of Steve Sakwa with Evercore ISI.

I guess, I was just hoping to get a little more color on the shorter term that took place on the renewals in the quarter. Were there some unusual events going on? And do you expect that to persist into the future?

Hey Steve, this is Paul Adkins. The shorter term on the renewals that we had was driven by an automatic 1 year renewal for 242,000 square feet at Redstone Gateway, which is the 2 of the 3 buildings that Boeing has. So it's the first of 5 1-year automatic renewals. And then the second was a renewal add for 155,000 square feet at the data center that we have in Annapolis, Maryland. So those are both being 1-year extensions, that both -- so on a weighted average basis, brought down our overall renewal terms.

So that Boeing deal was structured as a firm 5 with 5 automatic, or prenegotiated 1-year extensions, to provide comfort of priority contract for the country. So we're going to see those every year for 4 years now.

And is there any discussion with them about potentially turning that into a longer-term renewal? Or you think it just goes to 4 years and you'll sort of deal with it at the end of that term?

Yes, we talked to them about it a couple months ago, their attention really turned to other matters. But they're very happy in the buildings and it's likely we could do that in the coming year.

Our next question comes from the line of Craig Mailman with KeyBanc Capital Markets.

Circling back to the shadow pipeline. Steve, that was helpful, kind of given the market [indiscernible]. Just curious of that 2 million to 3 million square feet, how that breaks out between kind of data center shells and office?

So currently, it's about 2/3 data center shell and 1/3 office. If you really broke it down on the capital allocation, it's 60:40, data to office. But I think it's an important point to make that both data and office grew. But the data growth exceeded the office growth.

That's helpful. And then, could you just -- data center returns have been coming down and your primary tenant, they're obviously probably pushing for lower yields on the deals you're doing. Can you kind of give us a sense of where yields of that 2 million to 3 million square feet could come in relative to kind of the 8 to 10 you talked about historically?

So if you just handicapped 2/3 to 1/3 ratio, the 2/3 would be 7 to 7 in the quarter, depending on location. And then the 1/3 would be north of 8 at a minimum.

And then, as this relates, maybe this is for Anthony. You guys are kind of there on your leverage targets. But clearly, if this comes to fruition in the next 2 years, this is a lot of development to bring on. Kind of what's your preferred method for financing this to stay within that leverage target?

Well, we've talked for quite some time out about our plan to match fund the new development using new equity, generally through the ATM, as those opportunities materialize.

So we shouldn't expect a ramp in asset sales to maybe take advantage of the environment right now?

Well we don't have much left to sell, Craig. We're happy with our portfolio.

Well I guess, would you JV anymore the data centers with GI or sell -- I remember there had been talk about maybe selling some of the other data centers that you guys own that aren't a shell?

So I'm going to duck the second half of that question. And the first half, we consider that an option in the future to do further JVs if we need the liquidity. But it's more of a fallback than a priority strategy.

Our next question comes from the line of Tom Catherwood with BTIG.

I maybe walking into something that you just ducked, but it looks like now that we know that the programmatic sales are now complete, but if we look at what is held for sale now, it's about $23 million higher than it was last quarter, even given the White Marsh disposition. So what's the thought process about recycling in the portfolio right now? And is there kind of any change in your thoughts on selling assets?

Right. So you pinned me down. We were approached by a private investor to negotiate to sell two partial data center office buildings that are single tenant leased. In other parts of northern Virginia, we've been pursuing a negotiation. I don't have any better than 50% confidence that we can actually complete something. But if we do complete it, it's with the intention of recycling that capital into the value creative data center shell program we have. Besides that, we have a one-off building that's no longer a defense-oriented building in the B/W Corridor that we're negotiating the transfer to a private investor that we have a great relationship in the market. Fully stabilized.

And Tom, I would just add to that, that you're probably aware, which 2 of those, sort of office/data buildings are. One's in -- outside of Richmond and one's in southwestern Virginia. Both of -- if those were to sell within the quarter, we've -- that the range of our FFO guidance would accommodate that dilution from that sale within our current range.

Got it. And then for Paul, given the anchor lease at 2100 L Street, is there anything else, as far as investments or development projects in your Regional Office portfolio that you've got, either looking at or active right now?

Well, with regard to 2100 L Street, we're also pleased to report that we have several other dialogues going on with regard to some of the other vacancy as part of that building. So that's good news. I think, frankly our posture right now is that we want to -- as I mentioned, we're not even beginning construction on 2100 L Street until mid-next year. And I think, we'll just make sure that we get off on the right foot with regard to this development and are not really actively pursuing the additional investment in downtown DC.

And then we have some minor activity we're pursuing in Downtown Baltimore, generally repositioning our office inventory with some retail enhancement.

Our next question comes from the line of Dick Schiller with Baird.

It's Dave here with Dick. I wanted to just ask, Paul, you made a great point that the first time you've been 95% leased since 2001, and so I guess, the first question we have to ask is, now we're going to see rent growth, right? But I really wanted your comment on kind of what your thoughts are on the rent growth going forward. It looks like you came in little better than expected on spread this year. Is the market still so challenged around you, we shouldn't have better expectations? And how do you look at that going forward?

Well, I think as you -- if you read research broadly, the market has been almost same for the last handful of years. I do think that the activity that I mentioned of 700,000 square feet of either advanced or pipeline or solid prospects against that 800,000 square feet of vacancy, certainly changes our mindset to begin the realizing that some firming pricing pressure is possible. And so we're seeing in some of our select office parks more demand than we have supply. So I think you have to be very cautious, but the short answer is, I do believe that in '18 and looking forward, we -- hopefully we'll start to push some rent growth.

Our next question comes from Jed Reagan with Green Street Advisors.

Just to follow-up on 2100 L in DC. Can you provide yield expectations for that project?

We expect to have a stabilized yield at mid 6s to upper 6s percent on that project. There's still some moving pieces. As I said, we're not starting construction for another 8 months, so some of the final GMPs will still have to be seen. But that's the target we're looking for and I think that's with conservative, fair underwriting on that -- leasing the balance of the building.

Okay, that's helpful. And then you guys talked about the strong pipeline of data center shell development demand. Is there a ceiling for how much concentration as a percent of assets you'd be comfortable with in that business, maybe just kind of remind us how you're thinking about that?

It's currently operating. The data center shell shells business is only about 4% of our revenue. And I think we're pretty comfortable getting that up to 15% because of the immensely strong credit, the -- immensely heavy co-investment with our customer and surety of the growth of that industry, we're very happy to grow it up to, let's say, 15% and reconsider at that point.

I mean, would you characterize that as a goal to get to 15%? Or just that you'd be okay getting to that level?

We'd be okay getting to that level. We're in the business of creating value and there is immense value creation in that development opportunity. And we plan to take advantage of it as it emerges.

What percent of that pipeline or concentration is with a single, the same tenant, versus diversified amongst a variety of tenants?

So the bulk of the data center shells was a single tenant. We have some preliminary discussions with other people in the industry for something similar.

Our next question comes from the line of Rob Simone with Evercore ISI.

Sorry, I was on mute. And apologies, I joined the call late, so if this has already been answered, forgive me. But it seemed like, given that 2 million to 3 million square foot pipeline and you said, I think, it was '18 and '19, it implies about, call 1 million square feet of development per year, if you kind of -- if you hit it all. Given the current size of the infrastructure, is there a kind of like a dollar or square foot number that you guys are comfortable with developing annually, over which you might have to add to the infrastructure?

Infrastructure, being our team? Our company?

Yes, that's right. Just kind of like a -- it's a capacity question, like what's the square footage or dollar number you guys feel comfortable developing per year kind, of ahead of this anticipated ramp in demand for your Defense/IT [indiscernible]

So we have strong scale on our team. And depending on the mix of the realization of the pipeline, we may add another body to the data center program. But we have great skill in our development team, generally. With regards to spend, we've been guiding to $200 million and $250 million a year. And I think if, with this ramp-up, you could expect that to be more like $350 million, or possibly a little bit more.

Our next question comes from the line of Bill Crow with Raymond James.

Let me start by just applauding the effort you've made to kind of refocus the company back to its roots when we launched coverage back in, I guess 15 years ago. So the question then is, simply put, Steve, can you just kind of go back to why you're still in the data center business, let alone expanding that interest? I don't know if you get proper valuation within the stock for that pursuit.

Well, we demonstrated with our JV program the immense value creation that we have in that -- those 6 assets that we JV'd. And in that particular transaction with pricing, we agreed to, at that point in time, we're able to take 85% of our capital out and retain 15% of the cash flow. Since then, valuations

Fifty.

What did I say?

Fifteen.

Fifty, sorry. Since then, valuations have tightened, and the value creation is in excess of that level. To the point of the product, our customer is, in many respects, a U.S. government contractor, it's a cloud computing customer that serves government missions, as well as just general industry missions, but we've maintained the discipline to keep that development program here in Northern Virginia. And so we consider part of it, the whole Defense IT cyber world, it's a good fit with our skill set and our strategy.

Our next question comes from the line of Jamie Feldman with Bank of America Merrill Lynch.

I apologize, I missed the first couple of minutes of the call. So if you answered this, we can discuss offline. But, just bigger picture, I mean, we don't have a passed budget yet, but you've seen a material pickup in demand in leasing. What is it -- can you talk through like, who can make decisions now versus once the budget gets passed and why this pickup happened now?

So the pickup is really dispersed all over the portfolio. Much of it is defense contractors that have better clarity on contracts for a longer period of time. So I'll take one of our toughest environments, Patriot Ridge where we had new product, in an environment where contracts were short term. We couldn't marry up the tenant improvement commitment for short-term commitments from contractors. And since the fourth quarter of 2016, we've been methodically getting opportunities to attract contractors serving the defense mission adjacent to that property. In our Navy support group, what we see is growth in overall contracting and mission, but also growth from the Navy having, finally the money it needs, to put its personnel in the kind of facilities that they deserve, where they had been restricted for quite some period of time. And then, in the B/W Corridor, a big chunk of our pickup is cyber tenancy. Year-to-date, 44% of the new tenants -- new tenant leases that we've executed is in, is with cyber companies, either small to medium that are growing, in support of an industry that is in bad need of innovation or growth. So it's pretty spread across the portfolio. But to give you kind of some metrics around how demand has picked up since our last call, our prospect to advance, just the number of deals we're tracking grew by 29% in the quarter. The working to advance, the ones we're actually negotiating with grew by 100%. And our pipeline to advance, which is what we think we're 50% likely of winning or better, grew by 52%. So to reiterate what I said in my terms, or my points, the budget got passed in May. The funds have been released to the system. The activity is building, and it's basically planned out exactly as we expected.

Okay. And then, thinking about your guidance, especially for same store, it looks like you're expecting a moderation in the fourth quarter. Can you just talk about what the moving pieces are to make that happen?

Sure. In the fourth quarter of 2016, we had some sort onetime items that increased the fourth quarter of 2016 that won't be repeated in the fourth quarter of 2017. And then, the sort of $0.01 shift between the third quarter and fourth quarter for FFO relates to timing of some operating expenses that we expect to incur in the fourth quarter versus the third quarter.

Okay. And then finally, if you do get these 2 data center buildings sold, what's like the full year dilution or impact on earnings? I know you said a 30 in your range, but what's the magnitude?

Yes, those buildings were 15-year leases with tenant. They started at a relatively high yield on cost, and have grown to a pretty high yield relative to sort of their fair value today. So the annualized dilution on those buildings is about net of the timing of reinvestment, it's about $0.06.

Okay. And you said it's a 50% probability?

No better than 50%, it's a fluid situation.

We would characterize it as, we've got a buyer. We've had our confidence range and the buyer's ability to execute has been wavering. And we're sort of handicapping their ability to close, and we're just being cautious about giving any expectations about them.

Okay. But these are assets you consider noncore and wouldn't be holding long term anyway?

So these -- let's just put it this way. Our current management team wouldn't have invested in these assets. They're good assets, they're in remote locations. They serve a state level contract in Virginia. It's not really the -- down in the middle of our fairway, the way we think about the company today.

Our next question comes from the line of Jon Petersen with Jefferies.

Just stick on the shadow pipeline, on the data centers, you answered most of the questions, but it sounds like 2 million to 3 million shadow pipeline, maybe 1.5 million to 2 million square feet-ish, of data center space. So I am looking at the -- your land bank right now, supports about 200,000 square feet of future data center shells on 21 acres. So just kind of curious, your thoughts on acquiring land in kind of the Latin country market, where data center stuff tends to be -- there's been quite a land grab there recently, and prices are going up. So how aggressive are you willing to be in, to build that land bank up.

So we work in harmony with our primary customers to identify land that meets their needs and will allow us to give them the appropriate cost structure that they're looking for. We're in multiple counties, in multiple locations, almost continuously evaluating land opportunities. Indeed, if we fulfill what we expect to, we'll be acquiring additional land, generally in conjunction with the pre-lease for the ultimate campus that will go on that land.

Okay, all right. And then, I mean, I think you've kind of answered this in different ways, but I'll ask it again. So on the on shadow pipeline, big increase. Stripping out the data center part and just thinking about the defense part, how much of that increase is just pent-up demand that needs space now? Or how much is that is kind of a new, sustainable level of demand?

So with regard to the defensive side, I view that in that early-stage -- stages of growth. It certainly increased in the last quarter, primarily with build-to-suit discussions with defense contractors that are moving from, kind of a short-term cautious mode to a long-term strategic mode. And I don't have a percentage off hand, but it grew as well as the data center over the last quarter.

[Operator Instructions]. We have a follow-up question from the line of Jed Reagan with Green Street Advisors.

It looks like the average escalators in the stuff you signed this past quarter the past years, call 1.5% range. Where do you sit for kind of the overall portfolio at this point in terms of average bumps and has something changed in the environment or kind of how things are getting negotiated?

This is Paul. I'd say overall, I'll expect a 2% to 2.4% escalator as being more typical in our portfolio. Certainly is, on a weighted average basis, I think, this quarter is lower than what we could expect as a normalized annualized bump.

And with respect to what's embedded in the existing portfolio, the average is about 2.5%.

I think it was watered down because of the 1-year renewals at the data center shell.

Yes, because they're 1-year deals, they have no escalation, Jed.

So 2.5% sort of across the portfolio in place, and maybe stuff you're negotiating now, more typically now, 2% to 2.5%, is that what I'm hearing?

Yes, I think on weighted average, 2% to, low 2%. So 2.5% is what we get on a lot of the deals, but on a weighted average basis, 2% to 2.5% is more, is the appropriate range.

But in terms of the current quarter and the 9 months ended, the impact of those 2 buildings, the Boeing buildings in Redstone, as well as the data center in Annapolis, impact the average because they were 1 year renewals and, therefore, there is no increase for the second year. But, for example, the Boeing increases are 2.5% increases with each annual renewal, but it's not reflected in that average, because they're a series of 1-year renewals.

It's not contractual.

I am showing no further questions in queue at this time. I will now turn the call back to Mr. Budorick from closing remarks.

Thank you all for joining our call today. We're in our offices this afternoon, so please coordinate through Stephanie if you'd like a follow-up call later today, and thanks for joining us.

Thank you for your participation today in the Corporate Office Properties Trust third quarter 2017 earnings conference call. This concludes the presentation. You may now disconnect. Good day.