=============================================================================== UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark one) /x/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 For the quarterly period ended SEPTEMBER 30, 1999 ------------------------------------------------ or / / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 For the transition period from to ------------------------- ----------------- Commission file number 0-20047 CORPORATE OFFICE PROPERTIES TRUST (Exact name of registrant as specified in its charter) MARYLAND 23-2947217 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 401 CITY AVENUE, SUITE 615, BALA CYNWYD, PA 19004 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (610) 538-1800 ---------------------------------------- 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. /x/ Yes / / No On November 8, 1999, 17,174,171 shares of the Company's Common Shares of Beneficial Interest, $0.01 par value, were outstanding. =============================================================================== 1 TABLE OF CONTENTS FORM 10-Q
PAGE ----- PART I: FINANCIAL INFORMATION Item 1: Financial Statements: Consolidated Balance Sheets as of September 30, 1999 (unaudited) and December 31, 1998 3 Consolidated Statements of Operations for the three and nine months ended September 30, 4 1999 and 1998 (unaudited) Consolidated Statements of Cash Flows for the nine months ended September 30, 1999 and 5 1998 (unaudited) Notes to Consolidated Financial Statements 6 Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations 20 Item 3: Quantitative and Qualitative Disclosures About Market Risk 29 PART II: OTHER INFORMATION Item 1: Legal Proceedings 30 Item 2: Changes in Securities 30 Item 3: Defaults Upon Senior Securities 30 Item 4: Submission of Matters to a Vote of Security Holders 31 Item 5: Other Information 31 Item 6: Exhibits and Reports on Form 8-K 31 SIGNATURES 38
2 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS CORPORATE OFFICE PROPERTIES TRUST CONSOLIDATED BALANCE SHEETS (DOLLARS IN THOUSANDS)
September 30, December 31, 1999 1998 ------------- ------------- (unaudited) ASSETS Commercial real estate properties: Operating properties, net $ 550,995 $ 536,228 Projects under construction 26,353 10,659 - ------------------------------------------------------------------------------------------------------------------ Total commercial real estate properties, net 577,348 546,887 Investment in and advance to unconsolidated real estate joint venture 37,199 -- - ------------------------------------------------------------------------------------------------------------------ Investment in real estate 614,547 546,887 Cash and cash equivalents 957 2,349 Restricted cash 1,064 293 Accounts receivable, net 1,887 2,986 Investment in and advances to Service Companies 1,697 2,351 Deferred rent receivable 4,000 2,263 Deferred charges, net 5,592 3,542 Prepaid and other assets 3,377 3,006 - ------------------------------------------------------------------------------------------------------------------ TOTAL ASSETS $ 633,121 $ 563,677 - ------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------ LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Mortgage and other loans payable $ 336,643 $ 306,824 Accounts payable and accrued expenses 5,303 3,395 Rents received in advance and security deposits 2,996 2,789 Dividends/distributions payable 5,732 4,692 Other liabilities 1,393 -- - ------------------------------------------------------------------------------------------------------------------ Total liabilities 352,067 317,700 - ------------------------------------------------------------------------------------------------------------------ Minority interests: Preferred Units in the Operating Partnership 52,500 52,500 Common Units in the Operating Partnership 26,643 24,696 Other consolidated partnerships 90 -- - ------------------------------------------------------------------------------------------------------------------ Total minority interests 79,233 77,196 - ------------------------------------------------------------------------------------------------------------------ Commitments and contingencies (Note 15) Shareholders' equity: Preferred Shares ($0.01 par value; 5,000,000 authorized); 1,025,000 designated as Series A Cumulative Convertible Preferred Shares of beneficial interest (984,308 shares issued and outstanding) 10 10 1,725,000 designated as Series B Cumulative Redeemable Preferred Shares of beneficial interest (1,250,000 issued and outstanding at September 30, 1999) 12 -- Common Shares of beneficial interest ($0.01 par value; 45,000,000 authorized, shares issued and outstanding of 17,174,171 at September 30, 1999 and 16,801,876 at December 31, 1998) 172 168 Additional paid-in capital 208,725 175,802 Accumulated deficit (7,098) (7,199) - ------------------------------------------------------------------------------------------------------------------ Total shareholders' equity 201,821 168,781 - ------------------------------------------------------------------------------------------------------------------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 633,121 $ 563,677 - ------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------
See accompanying notes to financial statements. 3 CORPORATE OFFICE PROPERTIES TRUST CONSOLIDATED STATEMENTS OF OPERATIONS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
For the three months ended For the nine months ended September 30, September 30, ------------------------------- ---------------------------- 1999 1998 1999 1998 -------------- ---------------- ------------- -------------- REVENUES Rental income $ 17,471 $ 8,562 $ 50,879 $ 20,539 Tenant recoveries and other income 2,989 1,250 7,646 2,640 - ------------------------------------------------------------------------------------------------------------------------- Total revenues 20,460 9,812 58,525 23,179 - ------------------------------------------------------------------------------------------------------------------------- EXPENSES Property operating 6,051 2,457 16,439 5,001 General and administrative 631 397 2,316 1,055 Interest 4,990 2,849 15,409 7,424 Amortization of deferred financing costs 168 119 715 266 Depreciation and other amortization 3,087 1,514 8,766 3,772 Reformation costs -- -- -- 637 - ------------------------------------------------------------------------------------------------------------------------- Total expenses 14,927 7,336 43,645 18,155 - ------------------------------------------------------------------------------------------------------------------------- Income before equity in (loss) income of unconsolidated entities, gain on sales of rental properties, minority interests and extraordinary item 5,533 2,476 14,880 5,024 Equity in (loss) income of unconsolidated entities (43) 17 283 17 - ------------------------------------------------------------------------------------------------------------------------- Income before gain on sales of rental properties, minority interests and extraordinary item 5,490 2,493 15,163 5,041 Gain on sales of rental properties -- -- 1,140 -- - ------------------------------------------------------------------------------------------------------------------------- Income before minority interests and extraordinary item 5,490 2,493 16,303 5,041 Minority interests Preferred Units (853) (853) (2,559) (2,559) Common Units (591) (301) (1,757) (713) - ------------------------------------------------------------------------------------------------------------------------- Income before extraordinary item 4,046 1,339 11,987 1,769 Extraordinary item - loss on early retirement of debt -- -- (838) -- - ------------------------------------------------------------------------------------------------------------------------- NET INCOME 4,046 1,339 11,149 1,769 Preferred Share dividends (1,060) (10) (1,736) (10) - ------------------------------------------------------------------------------------------------------------------------- NET INCOME AVAILABLE TO COMMON SHAREHOLDERS $ 2,986 $ 1,329 $ 9,413 $ 1,759 - ------------------------------------------------------------------------------------------------------------------------- BASIC EARNINGS PER COMMON SHARE Income before extraordinary item $ 0.18 $ 0.13 $ 0.61 $ 0.26 Extraordinary item -- -- (0.05) -- - ------------------------------------------------------------------------------------------------------------------------- Net income $ 0.18 $ 0.13 $ 0.56 $ 0.26 - ------------------------------------------------------------------------------------------------------------------------- DILUTED EARNINGS PER COMMON SHARE Income before extraordinary item $ 0.16 $ 0.12 $ 0.53 $ 0.26 Extraordinary item -- -- (0.04) -- - ------------------------------------------------------------------------------------------------------------------------- Net income $ 0.16 $ 0.12 $ 0.49 $ 0.26 - -------------------------------------------------------------------------------------------------------------------------
See accompanying notes to financial statements. 4 CORPORATE OFFICE PROPERTIES TRUST CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS) (UNAUDITED)
For the nine months ended September 30, --------------------------------------- 1999 1998 ---------------- --------------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 11,149 $ 1,769 Adjustments to reconcile net income to net cash provided by operating activities: Minority interests 4,316 3,272 Depreciation and other amortization 8,766 3,772 Amortization of deferred financing costs 715 266 Equity in income of unconsolidated entities (283) (17) Gain on sales of rental properties (1,140) -- Increase in deferred rent receivable (2,135) (1,083) Increase in accounts receivable, restricted cash and prepaid and other assets (1,331) (2,678) Increase in accounts payable, accrued expenses, rents received in advance and security deposits 1,204 2,173 - --------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 21,261 7,474 - --------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES Purchases of and additions to commercial real estate properties (70,618) (96,897) Proceeds from sales of rental properties 29,970 -- Investment in and advance to unconsolidated real estate joint venture (37,199) -- Investment in and advances to Service Companies 937 204 Leasing commissions paid (1,859) (151) Increase in prepaid and other assets (201) (1,465) - --------------------------------------------------------------------------------------------------------------- Net cash used in investing activities (78,970) (98,309) - --------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from mortgage and other loans payable 170,991 26,700 Repayments of mortgage and other loans payable (130,145) (1,762) Increase in other liabilities 1,393 -- Deferred financing costs paid (1,145) (565) Net proceeds from issuance of Preferred Shares 29,450 -- Net proceeds from issuance of Common Shares -- 72,237 Dividends paid (10,078) (2,089) Distributions paid (4,149) (3,475) Increase in prepaid and other assets -- (1,700) - --------------------------------------------------------------------------------------------------------------- Net cash provided by financing activities 56,317 89,346 - --------------------------------------------------------------------------------------------------------------- Net decrease in cash and cash equivalents (1,392) (1,489) CASH AND CASH EQUIVALENTS Beginning of period 2,349 3,395 - --------------------------------------------------------------------------------------------------------------- End of period $ 957 $ 1,906 - --------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------
See accompanying notes to financial statements. 5 CORPORATE OFFICE PROPERTIES TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED) NOTE 1 ORGANIZATION Corporate Office Properties Trust ("COPT") and subsidiaries is a fully integrated and self-managed real estate investment trust ("REIT"). We focus on the ownership, management, leasing, acquisition and development of suburban office properties in select Mid-Atlantic submarkets. COPT is qualified as a REIT as defined in the Internal Revenue Code and is the successor to a corporation organized in 1988. As of September 30, 1999, our portfolio included 74 commercial real estate properties leased principally for office purposes, including nine properties owned through an unconsolidated joint venture (see Note 5). We conduct our operations principally through our operating partnership, Corporate Office Properties, L.P. (the "Operating Partnership"), for which we are the managing general partner. The Operating Partnership owns real estate both directly and through subsidiary partnerships and limited liability companies ("LLCs"). The Operating Partnership also owns the principal economic interest and, collectively with our Chief Executive Officer and Chief Operating Officer, 49.5% of the voting stock of Corporate Office Management, Inc. ("COMI") (together with its subsidiaries defined as the "Service Companies"). A summary of our Operating Partnership's forms of ownership and the percentage of those ownership forms owned by COPT as of September 30, 1999 follows:
% Owned by COPT --------------- Common Units (see Notes 3 and 17) 84% Series A Preferred Units 100% Series B Preferred Units 100% Initial Preferred Units (see Notes 3 and 17) 0%
The Series A Preferred Units and Initial Preferred Units are convertible into Common Units in the Operating Partnership. NOTE 2 BASIS OF PRESENTATION These notes to our interim financial statements highlight significant changes to the notes to the financial statements included in our 1998 Form 10-K. As a result, these notes to our interim financial statements should be read together with the financial statements and notes thereto included in our 1998 Form 10-K. The interim financial statements on the previous pages reflect all adjustments which we believe are necessary for the fair presentation of our financial position and results of operations for the interim periods presented. These adjustments are of a normal recurring nature. The results of operations for such interim periods are not necessarily indicative of the results for a full year. We use two different accounting methods to report our investments in entities: the consolidation method and the equity method. CONSOLIDATION METHOD We use the consolidation method when we own most of the outstanding voting interests in an entity and can control its operations. This means the accounts of the entity are combined with our accounts. We eliminate balances and transactions between companies when we consolidate these accounts. Our consolidated financial statements include the accounts of: - - COPT, 6 - - the Operating Partnership and its subsidiary partnerships and LLCs, and - - Corporate Office Properties Holdings, Inc. (we own 100%). EQUITY METHOD We use the equity method of accounting to report our investments in an unconsolidated real estate joint venture (see Note 5) and the Service Companies. Under the equity method, we report: - - our ownership interest in the capital of these entities as an investment on our Consolidated Balance Sheets and - - our percentage share of the earnings or losses from these entities in our Consolidated Statements of Operations. NOTE 3 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS We make estimates and assumptions when preparing financial statements under generally accepted accounting principles. These estimates and assumptions affect various matters, including: - - our reported amounts of assets and liabilities in our Consolidated Balance Sheets at the dates of the financial statements, - - our disclosure of contingent assets and liabilities at the dates of the financial statements, and - - our reported amounts of revenues and expenses in our Consolidated Statements of Operations during the reporting periods. These estimates involve judgements with respect to, among other things, future economic factors that are difficult to predict and are often beyond management's control. As a result, actual amounts could differ from these estimates. MINORITY INTERESTS As discussed previously, we consolidate the accounts of our Operating Partnership into our financial statements. However, we do not own 100% of the Operating Partnership. We also consolidate the accounts of a real estate joint venture of which we own 89%. The amounts reported for minority interests on our Consolidated Balance Sheets represent the portion of these entities' equity that we do not own. The amounts reported for minority interests on our Consolidated Statements of Operations represent the portion of these entities' net income not allocated to us. Common Units of the Operating Partnership are substantially similar economically to our Common Shares of beneficial interest ("Common Shares"). The Common Units are also exchangeable into our Common Shares, subject to certain conditions. We have accrued distributions related to Common Units owned by minority interests of $557 at September 30, 1999 and $488 at December 31, 1998. The owners of our Operating Partnership's Initial Preferred Units are entitled to a 6.5% priority annual return. Income of our Operating Partnership is also allocated to holders of Initial Preferred Units using the 6.5% priority annual return. These units are convertible by unitholders at their option on or after October 1, 1999, into Common Units on the basis of 3.5714 Common Units for each Initial Preferred Unit, plus any accrued return (see Note 17). We have accrued distributions related to Initial Preferred Units owned by minority interests of $853 at September 30, 1999 and December 31, 1998. INTEREST RATE SWAP ARRANGEMENTS We recognize the interest rate differential to be paid or received on interest rate swap agreements as an adjustment to interest expense (see Note 17). 7 EARNINGS PER SHARE ("EPS") We present both basic and diluted EPS. We compute basic EPS by dividing income available to common shareholders by the weighted-average number of Common Shares outstanding during the period. Our computation of diluted EPS is similar except that: - - the denominator is increased to include the weighted average number of potential additional Common Shares that would have been outstanding if securities that are convertible now or in the future into our Common Shares were converted and - - the numerator is adjusted to add back any convertible preferred dividends and any other changes in income or loss that would result from the assumed conversion into Common Shares. Our computation of diluted EPS does not assume conversion of securities into our Common Shares if conversion of those securities would increase our diluted EPS in a given period. A summary of the numerator and denominator for purposes of our basic and diluted EPS calculations for income before extraordinary item is as follows (dollars and shares in thousands):
Three Months Ended Nine Months Ended September 30, September 30, ---------------------------- ---------------------------- 1999 1998 1999 1998 -------- -------- --------- --------- Numerator: Net income available to Common Shareholders $ 2,986 $ 1,329 $ 9,413 $ 1,759 Extraordinary loss -- -- 838 -- ------------ ---------- ---------- ---------- Numerator for basic earnings per share before extraordinary item 2,986 1,329 10,251 1,759 Minority interests - Initial Preferred Units 853 853 2,559 -- Dividends on Series A Preferred Shares -- -- -- -- Minority interests - Common Units -- 301 -- -- ------------ ---------- ---------- ---------- Numerator for diluted earnings per share before extraordinary item $ 3,839 $ 2,483 $12,810 $ 1,759 ------------ ---------- ---------- ---------- ------------ ---------- ---------- ---------- Denominator: Weighted average Common Shares - basic 17,037 9,973 16,881 6,652 Assumed conversion of share options 18 10 9 86 Conversion of Initial Preferred Units 7,500 7,500 7,500 -- Conversion of weighted average Series A Preferred Shares -- -- -- -- Conversion of weighted average Common Units -- 2,582 -- -- ------------ ---------- ---------- ---------- Weighted average Common Shares - diluted 24,555 20,065 24,390 6,738 ------------ ---------- ---------- ---------- ------------ ---------- ---------- ----------
Our diluted EPS computation for the three months ended September 30, 1999 only assumes conversion of Initial Preferred Units because conversions of Preferred Shares and Common Units would increase diluted EPS in that period. Our diluted EPS computation for the three months ended September 30, 1998 only assumes conversion of Initial Preferred Units and Common Units because conversions of Preferred Shares would increase diluted EPS in that period. Our diluted EPS computation for the nine months ended September 30, 1999 only assumes conversion of Initial Preferred Units because conversions of Preferred Shares and Common Units would increase diluted EPS in that period. Our diluted EPS computation for the nine months ended September 30, 1998 does not assume conversion of Initial Preferred Units, Preferred Shares or Common Units since these conversions would increase diluted EPS in that period. 8 NOTE 4 COMMERCIAL REAL ESTATE PROPERTIES Operating properties consisted of the following:
September 30, December 31, 1999 1998 ------------- ------------ Land $ 112,810 $ 108,433 Buildings and improvements 452,810 436,932 Furniture, fixtures and equipment 335 332 ---------- ---------- 565,955 545,697 Less: accumulated depreciation (14,960) (9,469) ---------- ---------- $ 550,995 $ 536,228 ---------- ---------- ---------- ----------
Projects we had under development consisted of the following:
September 30, December 31, 1999 1998 ------------- ------------ Land $ 10,150 $ 8,941 Construction in progress 16,203 1,718 --------- --------- $ 26,353 $ 10,659 --------- --------- --------- ---------
1999 ACQUISITIONS We acquired the following office properties during the nine months ended September 30, 1999:
Number Date of of Total Rentable Initial Project Name Location Acquisition Buildings Square Feet Cost - ------------------------------- ----------------------- ----------- --------- -------------- ----------- Airport Square XXI Linthicum, MD 2/23/99 1 67,913 $ 6,751 Parkway Crossing Properties Hanover, MD 4/16/99 2 99,026 9,524 Commons Corporate Portfolio (1) Hanover, MD 4/28/99 8 250,413 25,442 Princeton Executive Center Monmouth Junction, NJ 6/24/99 1 61,300 6,020 Gateway Central (2) Harrisburg, PA 8/12/99 3 55,726 5,960
- ----------------------- (1) Does not include $400 allocated to projects under development and $50 relating to land under a ground lease. (2) Acquired 89% ownership interest. We also acquired the following: - - a parcel of land located in Annapolis Junction, Maryland that is contiguous to certain of our existing operating properties acquired for $2,908 on May 28, 1999, - - a 57,000 square foot warehouse facility for redevelopment into office space located on 8.5 acres of land contiguous to properties we own in South Brunswick, New Jersey acquired for $2,172 on July 9, 1999, and - - a parcel of land located in Linthicum, Maryland that is contiguous to certain of our existing operating properties acquired for $1,970 on August 1, 1999. 9 1999 DISPOSITIONS We sold the following properties during the nine months ended September 30, 1999:
Property Date Total Rentable Sales Project Name Location Type (1) of Sale Square Feet Price - ------------------- ----------------- --------- ----------- -------------- ------------ Cranberry Square Westminster, MD R 1/22/99 139,988 $ 18,900 Delafield Retail Delafield, WI R 2/26/99 52,800 3,303 Indianapolis Retail Indianapolis, IN R 3/09/99 67,541 5,735 Plymouth Retail Plymouth, MN R 3/09/99 67,510 5,465 Glendale Retail Glendale, WI R 5/04/99 36,248 1,900 Peru Retail Peru, IL R 6/16/99 60,232 3,750 Browns Wharf Baltimore, MD O 6/24/99 103,670 10,575 Oconomowoc Retail Oconomowoc, WI R 6/25/99 39,272 2,575
- ----------------------- (1) "R" indicates retail property; "O" indicates office property. 1999 CONSTRUCTION IN PROGRESS We completed the construction of a 93,482 square foot office building located in Annapolis Junction, Maryland in August 1999. Costs incurred on this property through September 30, 1999 totaled $9,163. We also completed an expansion project that increased the rentable square footage of one of our properties by 6,350 square feet. At September 30, 1999, we had development underway on three new buildings and redevelopment underway on an existing building. NOTE 5 INVESTMENT IN AND ADVANCE TO REAL ESTATE JOINT VENTURE On September 15, 1999, we acquired a 49% interest in Corporate Gateway General Partnership, a newly organized joint venture, for $2,952. On the same day, the joint venture acquired nine office buildings located in Greater Harrisburg, Pennsylvania for $39,925 using cash and proceeds from a $34,247 loan payable to our Operating Partnership. This loan payable is evidenced by notes that carry an interest rate of 10% through their maturity date of September 14, 2000. We account for our investment in Corporate Gateway General Partnership using the equity method of accounting. Our investment in and advance to this joint venture at September 30, 1999 included the following: Notes receivable $ 34,247 Investment in joint venture 2,952 --------- Total $ 37,199 --------- ---------
NOTE 6 ACCOUNTS RECEIVABLE Our accounts receivable are reported net of an allowance for bad debts of $0 at September 30, 1999 and $50 at December 31, 1998. NOTE 7 INVESTMENT IN AND ADVANCES TO SERVICE COMPANIES On August 31, 1999, COMI acquired an 80% interest in Martin G. Knott and Associates, LLC ("MGK"), a limited liability company that provides heating and air conditioning maintenance and repair services. COMI acquired its interest in MGK for $160,000. 10 We account for our investment in COMI and its subsidiaries, Corporate Realty Management, LLC ("CRM"), Corporate Development Services, LLC ("CDS") and MGK using the equity method of accounting. Our investment in and advances to these Service Companies included the following:
September 30, December 31, 1999 1998 ------------- -------------- Notes receivable $ 2,005 $ 3,205 Equity investment in Service Companies 892 609 Advances payable (1,200) (1,463) -------- ----------- Total $ 1,697 $ 2,351 -------- ----------- -------- -----------
NOTE 8 DEFERRED CHARGES Deferred charges consisted of the following:
September 30 December 31, 1999 1998 ------------- ------------ Deferred financing costs $ 3,693 $ 2,611 Deferred leasing costs 3,242 1,468 Deferred other 24 24 -------- --------- 6,959 4,103 Accumulated amortization (1,367) (561) -------- --------- Deferred charges, net $ 5,592 $ 3,542 -------- --------- -------- ---------
NOTE 9 MORTGAGE AND OTHER LOANS PAYABLE This section highlights new borrowing arrangements entered into during the nine months ended September 30, 1999. On January 5, 1999, we entered into an interest rate swap agreement with Deutsche Banc Alex. Brown. This swap agreement fixes our one-month LIBOR base at 5.085% per annum on a notional amount of $30,000 through May 2001 (see Note 17). On January 13, 1999, we entered into a $9,825 construction loan with Allfirst Bank to finance the construction of a building at our 134 National Business Parkway property. This loan has an interest rate of LIBOR plus 1.6%. This loan matures on February 1, 2001 and may be extended for a one-year period, subject to certain conditions. Borrowings under this loan totaled $6,179 at September 30, 1999. On February 8, 1999, we entered into a $10,875 construction loan with Provident Bank of Maryland to finance the construction of a building at our Woodlands II property. This loan has an interest rate of LIBOR plus 1.75%. This loan matures on February 8, 2001 and may be extended for a one-year period, subject to certain conditions. Borrowings under this loan totaled $7,233 at September 30, 1999. On April 8, 1999, we obtained a $12,500 mortgage loan payable from Allfirst Bank, $9,000 of which is nonrecourse. The loan provides for monthly payments of interest, at a rate of LIBOR plus 1.75%, and principal of $23 in the loan's first year, $25 in the second year and $27 in the third year. The loan matures on May 1, 2002. We pledged three of our operating properties and one parcel of land as collateral to the lender. We use the term collateralize to describe all such arrangements. On April 16, 1999, we assumed three nonrecourse loans in connection with the acquisition of the Parkway Crossing Properties. We assumed a $3,200 mortgage loan payable from IDS Life Insurance Company. The loan provides for monthly payments of principal and interest at a fixed rate of 8.375%. The loan matures on June 1, 2007. We also assumed two loans with the seller totaling $1,897 that carry identical terms. These 11 loans provide for monthly payments of interest at a rate equal to the lesser of prime plus 0.5% or 9.38% plus fixed principal payments of $4. These loans mature on May 25, 2007. On May 5, 1999, we obtained a $10,000 loan from Deutsche Banc Alex. Brown. The loan bears interest at a rate of LIBOR plus 1.75% and provides for monthly payments of interest only. The loan matures on November 5, 1999 and is collateralized by the Commons Corporate Portfolio. On August 12, 1999, we assumed a $4,549 construction loan with Mellon Bank in connection with the Gateway Central acquisition. The loan bears interest at a rate equal to the yield on 5-year Treasury Securities plus 2.0%. The loan provides for monthly payments of interest only through August 2000 and equal monthly payments of principal and interest based on a 30-year amortization period commencing September 2000. The loan matures on August 1, 2005. Borrowings under this loan totaled $4,304 as of September 30, 1999. On September 9, 1999, we entered into a $7,400 construction loan with Bank of Maryland to finance the construction of a building at our Airport Square XV property. This loan has an interest rate of LIBOR plus 1.75%. This loan matures on October 1, 2001 and may be extended for a one-year period, subject to certain conditions. Borrowings under this loan totaled $27 at September 30, 1999. On September 30, 1999, we obtained a $60,000 mortgage loan payable from Teachers Insurance and Annuity Association of America. This loan carries a fixed interest rate of 7.72% and provides for monthly payments of principal and interest of $452. The loan matures on October 1, 2006 and may not be prepaid prior to April 1, 2003. The loan is collaterized by 13 of our properties. NOTE 10 SHAREHOLDERS' EQUITY In July 1999, we completed the sale of 1,250,000 Series B Cumulative Redeemable Preferred Shares of beneficial interest ("Series B Preferred Shares") to the public at a price of $25.00 per share. These shares are nonvoting and are redeemable for cash at $25.00 per share at our option on or after July 15, 2004. Holders of these shares are entitled to cumulative dividends, payable quarterly (as and if declared by the Board of Trustees). Dividends accrue from the date of issue at the annual rate of $2.50 per share, which is equal to 10% of the $25.00 per share redemption price. We contributed the net proceeds to our Operating Partnership in exchange for 1,250,000 Series B Preferred Units. The Series B Preferred Units carry terms that are substantially the same as the Series B Preferred Shares. On August 4, 1999, 372,295 of our Common Units were converted to Common Shares. 12 NOTE 11 DIVIDENDS AND DISTRIBUTIONS The following summarizes our dividends/distributions for the nine months ended September 30, 1999:
Dividend/ Total Distribution Dividend/ Record Date Payable Date Per Share Distribution ----------------- --------------- ------------ ------------- Series A Preferred Shares: Fourth Quarter 1998 December 31, 1998 January 15, 1999 $0.34375 $327 First Quarter 1999 March 31, 1999 April 15, 1999 $0.34375 $338 Second Quarter 1999 June 30, 1999 July 15, 1999 $0.34375 $338 Third Quarter 1999 September 30, 1999 October 15, 1999 $0.34375 $338 Series B Preferred Shares: Third Quarter 1999 (1) September 30, 1999 October 15, 1999 $0.68 $850 Common Shares: Fourth Quarter 1998 December 31, 1998 January 15, 1999 $0.18 $3,025 First Quarter 1999 March 31 ,1999 April 15, 1999 $0.18 $3,025 Second Quarter 1999 June 30, 1999 July 15, 1999 $0.18 $3,025 Third Quarter 1999 September 30, 1999 October 15, 1999 $0.19 $3,263 Initial Preferred Units: Fourth Quarter 1998 December 31, 1998 January 15, 1999 $0.40625 $853 First Quarter 1999 March 31, 1999 April 15, 1999 $0.40625 $853 Second Quarter 1999 June 30, 1999 July 15, 1999 $0.40625 $853 Third Quarter 1999 September 30, 1999 October 15, 1999 $0.40625 $853 Common Units: Fourth Quarter 1998 December 31, 1998 January 15, 1999 $0.18 $487 First Quarter 1999 March 31, 1999 April 15, 1999 $0.18 $527 Second Quarter 1999 June 30, 1999 July 15, 1999 $0.18 $576 Third Quarter 1999 September 30, 1999 October 15, 1999 $0.19 $557
- ----------------------- (1) Represents dividend for period commencing on date of issuance through October 15, 1999. NOTE 12 RELATED PARTY TRANSACTIONS MANAGEMENT We have a contract with COMI under which COMI provides asset management, managerial, financial and legal support. Under the terms of this contract, we reimburse COMI for personnel and other overhead-related expenses. During the nine months ended September 30, 1999, we incurred management fees and related costs of $2,248 under this contract. We have a management agreement with CRM under which CRM provides property management services to most of our properties. Under the terms of this arrangement, CRM is entitled to a fee equal to 3% of revenue from tenant billings. CRM is also entitled to reimbursement for direct labor and out-of-pocket costs. We incurred property management fees and related costs of $2,745 under this agreement during the nine months ended September 30, 1999. We had a management agreement with Glacier Realty LLC ("Glacier"), a company that was partially owned by one of our former Trustees. Under the management agreement, Glacier was responsible for the management of our retail properties for a base annual fee of $250 plus a percentage of Average Invested Assets (as defined in the management agreement). Glacier was also entitled to fees upon our acquisition or sale of any net-leased retail real estate property, a fee that increased in the event that all or substantially all of the net-leased retail real estate properties were sold. The management agreement, entered into on October 14, 1997, had a term of five years. A fee was also due in the event that the management agreement was terminated, including for non-renewal. We incurred fees under this agreement of $63 for the nine months ended September 30, 1999 and $188 for the nine months ended September 30, 1998. On March 19, 1999, our Operating Partnership issued 200,000 13 Common Units in exchange for all of the ownership interests in Glacier. For accounting purposes, we recorded the value of this transaction against the gain on the sale of our retail properties in the Midwest region of the United States. We also had a management agreement with a company for which one of our Trustees serves on the Board of Directors. We incurred management fees and related costs under this contract of $62 for the nine months ended September 30, 1999 and $60 for the nine months ended September 30, 1998. CONSTRUCTION COSTS We have entered into a contract with CDS under which CDS provides construction and development services. Under the terms of this contract, we reimburse CDS for these services based on actual time incurred at market rates. During the nine months ended September 30, 1999, we incurred $922 under this contract, a substantial portion of which was capitalized into the cost of the related activities. RENTAL INCOME During the nine months ended September 30, 1999, we recognized revenue of $313 on office space leased to COMI and CRM. During the nine months ended September 30, 1999, we recognized revenue of $700 on office space leased to Constellation Real Estate, Inc. ("Constellation"), which owns 41% of our Common Shares and 100% of our Series A Preferred Shares, and its affiliate, Baltimore Gas and Electric Company ("BGE"). INTEREST INCOME During the nine months ended September 30, 1999, we earned interest income of $202 on notes receivable from the Service Companies. During the nine months ended September 30, 1999, we also earned interest income of $152 on notes receivable from Corporate Gateway General Partnership. CONSTRUCTION FEES During the nine months ended September 30, 1999, the Service Companies earned construction management fees of $60 from an entity owned by an officer and Trustee of ours. LEASING COMMISSION During the nine months ended September 30, 1999, the Service Companies earned a leasing commission of $117 from an entity owned by an officer and Trustee of ours. FEES EARNED FROM CONSTELLATION AND BGE During the nine months ended September 30, 1999, the Service Companies earned $950 from a project consulting and management agreement with Constellation. The Service Companies also earned $340 in fees and expense reimbursements during the nine months ended September 30, 1999 under a property management agreement with BGE. FEES EARNED FROM REAL ESTATE JOINT VENTURE During the nine months ended September 30, 1999, we earned an acquisition services fee of $213 from Corporate Gateway General Partnership. UTILITIES EXPENSE During the nine months ended September 30, 1999, BGE provided utility services to most of our properties in the Baltimore/Washington Corridor. 14 ACQUISITIONS On May 28, 1999, we acquired a parcel of land located in Annapolis Junction, Maryland from Constellation for $2,908. On August 1, 1999, we acquired a parcel of land located in Linthicum, Maryland from CDS for $1,970. On August 12, 1999, we acquired an 89% interest in an entity owning three office buildings located in Harrisburg, Pennsylvania from an officer and Trustee of ours for $5,960. On September 15, 1999, we acquired a 49% interest in Corporate Gateway General Partnership for $2,952. On the same day, the joint venture acquired nine office buildings for $39,925 from First Industrial Realty Trust, Inc., a publicly held real estate investment company where Jay Shidler, the Chairman of our Board of Trustees, serves as Chairman of the Board of Directors. 15 NOTE 13 SUPPLEMENTAL INFORMATION TO STATEMENTS OF CASH FLOWS
For the Nine Months Ended September 30, -------------------------- 1999 1998 -------- --------- Supplemental schedule of non-cash investing and financing activities: Debt repaid in connection with sales of rental properties $ 20,928 $ -- -------- --------- -------- --------- Debt assumed in connection with acquisitions $ 9,901 $ 66,025 -------- --------- -------- --------- Increase in minority interests resulting from issuance of Common Units in connection with property acquisitions $ 3,942 $ 11,351 -------- --------- -------- --------- Increase in minority interests resulting from issuance of Common Units in connection with Glacier acquisition $ 1,487 $ -- -------- --------- -------- --------- Increase in shareholders' equity resulting from issuance of Common Shares and Preferred Shares in connection with acquisitions $ -- $ 75,207 -------- --------- -------- --------- Note receivable balance applied to cost of property acquisition $ 1,575 $ -- -------- --------- -------- --------- Increase in accrued capital improvements $ 911 $ 3,042 -------- --------- -------- --------- Adjustments to minority interests resulting from changes in ownership of Operating Partnership by COPT $ (348) $ 11,351 -------- --------- -------- --------- Dividends/distributions payable $ 5,732 $ 4,692 -------- --------- -------- --------- Decrease in minority interests and increase in shareholders' equity in connection with conversion of Common Units into Common Shares $ 3,141 $ -- -------- --------- -------- ---------
16 NOTE 14 INFORMATION BY BUSINESS SEGMENT We have five segments: Baltimore/Washington office, Greater Philadelphia office, Northern/Central New Jersey office, Greater Harrisburg office and retail. Our office properties represent our core-business. We manage our retail properties as a single segment since they are considered outside of our core-business. The table below reports segment financial information. Our Greater Harrisburg and retail segments are not separately reported since they do not meet the reporting thresholds. We measure the performance of our segments based on total revenues less property operating expenses. Accordingly, we do not report other expenses by segment in the table below.
Baltimore/ Greater Northern/ Washington Philadelphia Central New Office Office Jersey Office Other Total --------------------------------------------------------------- Three Months Ended September 30, 1999: Revenues $ 11,573 $ 2,506 $ 4,735 $ 1,646 $ 20,460 Property operating expenses 3,814 20 1,916 301 6,051 -------- -------- ------- -------- -------- Income from operations $ 7,759 $ 2,486 $ 2,819 $ 1,345 $ 14,409 -------- -------- ------- -------- -------- -------- -------- ------- -------- -------- Commercial real estate property $ 5,469 $ 17 $ 2,425 $ 12,373 $ 20,284 expenditures -------- -------- ------- -------- -------- -------- -------- ------- -------- -------- Three Months Ended September 30, 1998: Revenues $ 2,970 $ 2,506 $ 2,710 $ 1,626 $ 9,812 Property operating expenses 1,092 3 1,030 332 2,457 -------- -------- ------- -------- -------- Income from operations $ 1,878 $ 2,503 $ 1,680 $ 1,294 $ 7,355 -------- -------- ------- -------- -------- -------- -------- ------- -------- -------- Commercial real estate property expenditures $122,952 $ -- $ 915 $ 23,799 $147,666 -------- -------- ------- -------- -------- -------- -------- ------- -------- -------- Nine Months Ended September 30, 1999: Revenues $ 33,307 $ 7,519 $12,898 $ 4,801 $ 58,525 Property operating expenses 10,341 62 4,966 1,070 16,439 -------- -------- ------- -------- -------- Income from operations $22,966 $ 7,457 $ 7,932 $ 3,731 $ 42,086 -------- -------- ------- -------- -------- -------- -------- ------- -------- -------- Commercial real estate property expenditures $49,373 $ 17 $10,336 $ 27,221 $ 86,947 -------- -------- ------- -------- -------- -------- -------- ------- -------- -------- Segment assets at September 30, 1999 $312,906 $107,887 $107,844 $104,484 $633,121 -------- -------- ------- -------- -------- -------- -------- ------- -------- -------- Nine Months Ended September 30, 1998: Revenues $ 4,883 $ 7,519 $ 6,318 $ 4,459 $ 23,179 Property operating expenses 1,723 9 2,310 959 5,001 -------- -------- ------- -------- -------- Income from operations $ 3,160 $ 7,510 $ 4,008 $ 3,500 $ 18,178 -------- -------- ------- -------- -------- -------- -------- ------- -------- -------- Commercial real estate property expenditures $195,662 $ -- $30,382 $ 23,923 $249,967 -------- -------- ------- -------- -------- -------- -------- ------- -------- -------- Segment assets at September 30, 1998 $220,324 $109,221 $62,145 $ 56,294 $447,984 -------- -------- ------- -------- -------- -------- -------- ------- -------- --------
17 The following table reconciles our income from operations for reportable segments to income before extraordinary item as reported in our Consolidated Statements of Operations.
Three Months Ended Nine Months Ended September 30, September 30, ------------------------------ ------------------------ 1999 1998 1999 1998 ------------- ------------- ----------- ------------ Income from operations for reportable segments $ 14,409 $ 7,355 $ 42,086 $ 18,178 Add: Equity in (loss) income of unconsolidated entities (43) 17 283 17 Gain on sales of rental properties -- -- 1,140 -- Less: General and administrative (631) (397) (2,316) (1,055) Interest (4,990) (2,849) (15,409) (7,424) Amortization of deferred financing costs (168) (119) (715) (266) Depreciation and amortization (3,087) (1,514) (8,766) (3,772) Reformation costs -- -- -- (637) Minority interests (1,444) (1,154) (4,316) (3,272) ------- ------- ------- ------- Income before extraordinary item $ 4,046 $ 1,339 $11,987 $ 1,769 ------- ------- ------- ------- ------- ------- ------- -------
We did not allocate gain on sales of rental properties, interest expense, amortization of deferred financing costs and depreciation and other amortization to segments since they are not included in the measure of segment profit reviewed by management. We also did not allocate equity in (loss) income of unconsolidated entities, general and administrative and reformation costs and minority interests since these items represent general corporate items not attributable to segments. NOTE 15 COMMITMENTS AND CONTINGENCIES In the normal course of business, we are involved in legal actions arising from our ownership and administration of properties. In management's opinion, any liabilities that may result are not expected to have a materially adverse effect on our financial position, operations or liquidity. We are subject to various federal, state and local environmental regulations related to our property ownership and operation. We have performed environment assessments of our properties the results of which have not revealed any environmental liability that we believe would have a materially adverse effect on our financial position, operations or liquidity. In June 1999, we sold an office building and assigned our rights to purchase two office buildings to an unrelated third party. Simultaneously with these transactions, we entered into a contract with the third party under which the third party has the right to transfer these three office buildings to us on or before March 31, 2000 for total consideration of approximately $40.5 million. Under the terms of the contract, we would pay up to $25.0 million (but in no event less than $23.9 million) of the acquisition price in convertible Preferred Units (the "Convertible Preferred Units") in the Operating Partnership and the balance in cash or debt assumption. We would also issue ten-year detachable warrants exercisable for an additional number of Common Units in the Operating Partnership to be determined based upon the share price of the Common Shares over the first five years following the acquisition. However, if the price of our Common Shares used to determine the additional number of Common Units equals or exceeds $14.21, no warrants will be issuable. The Convertible Preferred Units issuable under the terms of the contract will be entitled to a 9% priority annual return for the first ten years following issuance, 10.5% for the five following years and 12% thereafter. The Convertible Preferred Units are convertible, subject to certain restrictions, commencing one year after their issuance into Common Units in the Operating Partnership on the basis of 2.381 Common Units for each Convertible Preferred Unit, plus any accrued return. The Common Units are exchangeable for Common Shares, subject to certain conditions. The Convertible Preferred Units also carry a liquidation preference of $25.00 per unit, plus any accrued return, and may be redeemed for cash by the Operating Partnership at any time after the tenth anniversary of their issuance. 18 We are under contract to purchase two office buildings totaling 198,391 square feet and a parcel of undeveloped land located in Linthicum, Maryland for $25,825. NOTE 16 PRO FORMA FINANCIAL INFORMATION (UNAUDITED) We accounted for most of our 1999 and 1998 acquisitions using the purchase method of accounting. We included the results of operations for the acquisitions in our Consolidated Statements of Operations from their respective purchase dates through September 30, 1999. We prepared the pro forma condensed consolidated financial information presented below as if all of our 1999 and 1998 acquisitions accounted for using the purchase method and dispositions had occurred on January 1, 1998. Accordingly, we were required to make pro forma adjustments where deemed necessary. The pro forma financial information is unaudited and is not necessarily indicative of the results which actually would have occurred if these acquisitions and dispositions had occurred on January 1, 1998, nor does it intend to represent our results of operations for future periods.
Nine Months Ended September 30, ------------------------------- 1999 1998 ----------- ----------- Pro forma total revenues $ 59,791 $ 49,741 -------- -------- -------- -------- Pro forma net income available to Common Shareholders $ 9,682 $ 5,027 -------- -------- -------- -------- Pro forma earnings per Common Share Basic $ 0.56 $ 0.29 -------- -------- -------- -------- Diluted $ 0.50 $ 0.29 -------- -------- -------- --------
NOTE 17 SUBSEQUENT EVENTS On October 1, 1999, the holders of all of the Initial Preferred Units in our Operating Partnership converted their units into Common Units. Upon completion of these conversions, COPT owned 60% of the Operating Partnership's Common Units. On October 20, 1999, we received $492 from Deutsche Banc Alex. Brown in exchange for the termination of our interest rate swap agreement. On October 22, 1999, we acquired a parcel of land located in Annapolis Junction, Maryland. We acquired this land for $2,945. On October 26, 1999, we entered into a $12,375 construction loan with Allfirst Bank to finance the construction of a building at our 132 National Business Parkway property. This loan has an interest rate of LIBOR plus 1.75%. This loan matures on October 1, 2001 and may be extended for a one-year period, subject to certain conditions. 19 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Over the last six quarters, we completed a significant number of acquisitions. Our portfolio consisted of seven retail properties and ten office properties at March 31, 1998. During the last three quarters of 1998, we acquired 38 office and two retail properties. During the first three quarters of 1999, we acquired 15 office properties, completed construction of a new office property and sold seven retail properties and one office property. During 1999, we also acquired nine office properties through an unconsolidated joint venture. We financed the acquisitions and construction using debt and issuing Common Shares, Preferred Shares and ownership interests in our Operating Partnership. To accommodate our growth and changing needs as an organization, we added significant management capabilities. As of September 30, 1999, our portfolio included 74 commercial real estate properties leased principally for office purposes, including the nine properties owned through the unconsolidated joint venture. Due to these significant changes, our results of operations changed dramatically. In this section, we discuss our financial condition and results of operations for the three and nine months ended September 30, 1999. This section includes discussions on: - - why various components of our Consolidated Statements of Operations changed for the three and nine months ended September 30, 1999 compared to the same periods in 1998, - - what our primary sources and uses of cash were for the nine months ended September 30, 1999, - - how we raised cash for investing and financing activities during the nine months ended September 30, 1999, - - how we intend to generate cash for future capital expenditures, and - - the computation of our funds from operations. It may be helpful as you read this section to refer to our consolidated financial statements and accompanying notes and operating data variance analysis set forth below. This section contains "forward-looking" statements, as defined in the Private Securities Litigation Reform Act of 1995 that are based on our current expectations, estimates and projections about future events and financial trends affecting the financial condition of our business. Statements that are not historical facts, including statements about our beliefs and expectations, are forward-looking statements. These statements are not guarantees of future performance, events or results and involve potential risks and uncertainties. Accordingly, actual results may differ materially. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Important facts that may affect these expectations, estimates or projections include, but are not limited to: our ability to borrow on favorable terms; general economic and business conditions, which will, among other things, affect office property demand and rents, tenant creditworthiness and financing availability; adverse changes in the real estate markets including, among other things, competition with other companies; risks of real estate acquisition and development; governmental actions and initiatives and environmental requirements. 20 CORPORATE OFFICE PROPERTIES TRUST OPERATING DATA VARIANCE ANALYSIS (DOLLARS FOR THIS TABLE ARE IN THOUSANDS, EXCEPT PER SHARE DATA)
Three Months Ended September 30, ---------------------------------------------- 1999 1998 Variance % Change ------- ------ -------- -------- Revenues Rental income $17,471 $8,562 $ 8,909 104% Tenant recoveries and other income 2,989 1,250 1,739 139% ------- ------ ------- Total revenues 20,460 9,812 10,648 109% ------- ------ ------- Expenses Property operating 6,051 2,457 3,594 146% General and administrative 631 397 234 59% Interest and amortization of financing costs 5,158 2,968 2,190 74% Depreciation and other amortization 3,087 1,514 1,573 104% Reformation costs -- -- -- -- ------- ------ ------- Total expenses 14,927 7,336 7,591 103% ------- ------ ------- Income before equity in (loss) income of unconsolidated entities, gain on sales of rental properties, minority interests and extraordinary item 5,533 2,476 3,057 123% Equity in (loss) income of unconsolidated entities (43) 17 (60) (353%) Gain on sales of rental properties -- -- -- -- ------- ------ ------- Income before minority interests and extraordinary item 5,490 2,493 2,997 120% Minority interests (1,444) (1,154) (290) 25% Extraordinary item -- -- -- -- ------- ------ ------- Net income 4,046 1,339 2,707 202% Preferred Share dividends (1,060) (10) (1,050) 10,500% ------- ------ ------- Net income available to Common Shareholders $ 2,986 $ 1,329 $1,657 125% ------- ------ ------- ------- ------ ------- Earnings per Common Share on net income Basic $ 0.18 $ 0.13 $ 0.05 38% Diluted $ 0.16 $ 0.12 $ 0.04 33%
Nine Months Ended September 30, ---------------------------------------------- 1999 1998 Variance % Change ------ ------ -------- -------- Revenues Rental income $ 50,879 $20,539 $ 30,340 148% Tenant recoveries and other income 7,646 2,640 5,006 190% -------- ------- ------- Total revenues 58,525 23,179 35,346 152% -------- ------- ------- Expenses Property operating 16,439 5,001 11,438 229% General and administrative 2,316 1,055 1,261 120% Interest and amortization of financing costs 16,124 7,690 8,434 110% Depreciation and other amortization 8,766 3,772 4,994 132% Reformation costs -- 637 (637) (100%) -------- ------- ------- Total expenses 43,645 18,155 25,490 140% -------- ------- ------- Income before equity in (loss) income of unconsolidated entities, gain on sales of rental properties, minority interests and extraordinary item 14,880 5,024 9,856 196% Equity in (loss) income of unconsolidated entities 283 17 266 1,565% Gain on sales of rental properties 1,140 -- 1,140 N/A -------- ------- ------- Income before minority interests and extraordinary item 16,303 5,041 11,262 223% Minority interests (4,316) (3,272) (1,044) 32% Extraordinary item (838) -- (838) N/A -------- ------- ------- Net income 11,149 1,769 9,380 530% Preferred Share dividends (1,736) (10) (1,726) 17,260% -------- ------- ------- Net income available to Common Shareholders $ 9,413 $ 1,759 $ 7,654 435% -------- ------- ------- -------- ------- ------- Earnings per Common Share on net income Basic $ 0.56 $ 0.26 $ 0.30 115% Diluted $ 0.49 $ 0.26 $ 0.23 88%
21 COMPARISON OF THE NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998 Our total revenues increased $35.3 million or 152%, of which $30.3 million was generated by rental income and $5.0 million by tenant recoveries and other income. Tenant recovery income includes payments from tenants as reimbursement for property taxes, insurance and other property operating expenses. Our growth in revenues was due primarily to our property acquisitions in 1998 and 1999, although revenues increased $607,000 or 4% on the operations of office properties owned since the beginning of 1998 and $727,000 due to interest and real estate service income, offset by a $1.0 million decrease due to our Midwest region retail property sales. Our total expenses increased $25.5 million or 140% due mostly to the effects of the increases in property operating, interest expense and amortization of deferred financing costs, depreciation and other amortization and general and administrative expenses described below. However, our expenses for the nine months ended September 30, 1998 also included $637,000 in nonrecurring costs associated with our reformation into a Maryland REIT in March 1998. Our property operating expenses increased $11.4 million or 229% due mostly to our property acquisitions, although property operating expenses increased $339,000 or 13% at office properties owned since the beginning of 1998. Our property operating expenses increased as a percentage of total revenue from 22% to 28% due to more of our leases being written on a gross basis (meaning we incur operating expenses) versus a net basis (meaning the tenant incurs operating expenses directly). Our interest expense and amortization of deferred financing costs increased $8.4 million or 110% due mostly to our borrowings and assumptions of debt needed to finance property acquisitions, although a decrease of $474,000 is attributable to our Midwest region retail property sales. Our depreciation and other amortization expense increased $5.0 million or 132% due mostly to our property acquisitions, although a decrease of $241,000 is attributable to our Midwest region retail property sales. Our general and administrative expenses increased $1.3 million or 120%. Much of this increase is due to the addition of management and other staffing functions necessitated by our growing portfolio of properties and the desire to enhance our organizational infrastructure to more efficiently meet tenant needs and further the growth of the Company. Approximately $200,000 of this increase is due to additional professional fees for audit, legal and tax preparation required to support the increased complexity of our organization resulting from our growth and the creation of our Operating Partnership and the Service Companies. In addition, approximately $70,000 of this increase resulted from external costs we incurred for public relations and marketing. Our general and administrative expenses decreased as a percentage of total revenue from 4.6% to 4.0%. Our income before minority interests and extraordinary item for the nine months ended September 30, 1999 also includes the gain we realized on the sale of six of our retail properties, a line item that was not present for the nine months ended September 30, 1998. As a result of the above factors, income before minority interests and extraordinary item increased by $11.3 million or 223%. Our income allocation to minority interests increased $1.0 million or 32%. The amounts reported for minority interests on our Consolidated Statements of Operations represent the portion of the Operating Partnership's net income not allocated to us. Ownership of the Operating Partnership by minority interests averaged 17% during the nine months ended September 30, 1999 versus 48% during the nine months ended September 30, 1998. Accordingly, the increase in income allocated to minority interests is due to the increase in the Operating Partnership's net income, offset by the decreased percentage of income allocated to minority interests. Our net income available to Common Shareholders increased $7.7 million due to the factors discussed above partially offset by an $838,000 loss on the retirement of debt and a $1.7 million increase in Preferred Share dividends. Our diluted earnings per Common Share increased $0.23 per share due to the effect of the increase in net income being proportionately greater than the dilutive effects of our share offering in April 1998 and the issuance of our Common and Series A Preferred Shares and Common Units in our Operating Partnership in connection with acquisitions occurring during the later portion of 1998 and during 1999. 22 COMPARISON OF THE THREE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998 Our total revenues increased $10.6 million or 109%, of which $8.9 million was generated by rental income and $1.7 million by tenant recoveries and other income. Our growth in revenues was due primarily to our property acquisitions occurring during the later portion of 1998 and in 1999, although revenues increased $763,000 or 9% on the operations of office properties owned since the beginning of July 1998 and $430,000 due to interest and real estate service income, offset by a $548,000 decrease due to our Midwest region retail property sales. Our total expenses increased $7.6 million or 103% due mostly to the effects of the increases in property operating, interest expense and amortization of deferred financing costs, depreciation and other amortization and general and administrative expenses described below. Our property operating expenses increased $3.6 million or 146% due mostly to our property acquisitions, although property operating expenses increased $393,000 or 17% at office properties owned since the beginning of July 1998. Our property operating expenses increased as a percentage of total revenue from 25% to 30% due to more of our leases being written on a gross basis versus a net basis. Our interest expense and amortization of deferred financing costs increased $2.2 million or 74% due mostly to our borrowings and assumptions of debt needed to finance property acquisitions, although a decrease of $244,000 is attributable to our Midwest region retail property sales. Our depreciation and other amortization expense increased $1.6 million or 104% due mostly to our property acquisitions, although a decrease of $122,000 is attributable to our Midwest region retail property sales. Our general and administrative expenses increased $234,000 or 59%. Most of this increase is due to the addition of management and other staffing functions necessitated by our growing portfolio of properties and the desire to enhance our organizational infrastructure to more efficiently meet tenant needs and further the growth of the Company. Our general and administrative expenses decreased as a percentage of total revenue from 4.0% to 3.1%. As a result of the above factors, income before minority interests and extraordinary item increased by $3.0 million, or 120%. Our income allocation to minority interests increased $290,000 or 25%. Ownership of the Operating Partnership by minority interests averaged 17% during the three months ended September 30, 1999 versus 24% during the three months ended September 30, 1998. Accordingly, the increase in income allocated to minority interests is due to the increase in the Operating Partnership's net income, offset by the decreased percentage of income allocated to minority interests. Our net income available to Common Shareholders increased $1.7 million due to the factors discussed above partially offset by a $1.1 million increase in Preferred Share dividends. Our diluted earnings per Common Share increased $0.04 per share due to the effect of the increase in net income being proportionately greater than the dilutive effects of the issuance of our Common and Series A Preferred Shares and Common Units in our Operating Partnership in connection with acquisitions occurring during the later portion of 1998 and during 1999. LIQUIDITY AND CAPITAL RESOURCES CAPITALIZATION AND LIQUIDITY Cash provided from operations represents our primary source of liquidity to fund shareholder and unitholder distributions, pay debt service and fund working capital requirements. We expect to continue to use our property cash flow to meet our short-term cash requirements, including all property expenses, general and administrative expenses, debt service, distribution requirements and recurring capital improvements and leasing commissions. We do not anticipate borrowing to meet these requirements. 23 We have financed our property acquisitions using a combination of borrowings secured by our properties and the equity issuances of Common and Preferred Units in our Operating Partnership and Common and Preferred Shares. We use our secured revolving credit facility with Deutsche Banc Alex. Brown (the "Revolving Credit Facility") to finance much of our investing and financing activities. We pay down our Revolving Credit Facility using proceeds from long-term borrowings collateralized by our properties as attractive financing conditions arise and equity issuances as attractive equity market conditions arise. As of November 5, 1999, the maximum amount available under our Revolving Credit Facility was $78.1 million, of which $23.4 million was unused. Our debt strategy favors long-term, fixed-rate, secured debt over variable-rate debt to minimize the risk of short-term increases in interest rates. As of September 30, 1999, 85% of our mortgage loans payable balance carried fixed interest rates. Mortgage and other loans payable at September 30, 1999 consisted of the following (dollars in thousands): Term Credit Facility, 7.50%, maturing October 2000 (1) $ 100,000 TIAA Mortgage, 6.89%, maturing November 2008 83,813 TIAA Mortgage, 7.72%, maturing October 2006 60,000 Revolving Credit Facility, LIBOR + 1.75%, maturing May 2000 (2) 36,200 Allfirst Bank, LIBOR + 1.75%, maturing May 2002 12,360 Deutsche Banc Alex. Brown, LIBOR + 1.75%, maturing November 1999 (3) 10,000 Provident Bank of Maryland, LIBOR + 1.75%, maturing February 2001 (4) 7,233 Aegon USA Realty Advisors, Inc., 8.29%, maturing May 2007 6,255 Allfirst Bank, LIBOR + 1.6%, maturing February 2001 (5) 6,179 Mellon Bank, yield on 5-year Treasury Securities plus 2%, maturing August 2005 (6) 4,304 IDS Life Insurance Company, 8.375%, maturing June 2007 (3) 3,055 Provident Bank of Maryland, LIBOR + 1.75%, maturing September 2000 2,845 Northern Life Insurance Company, 8%, maturing February 2014 2,497 Seller mortgage, lesser of Prime + 0.5% or 9.38%, maturing May 2007 1,875 Bank of Maryland, LIBOR + 1.75%, maturing October 2001 (7) 27 ---------- $ 336,643 ---------- ----------
- ----------------------- (1) May be extended for two one-year periods, subject to certain conditions. (2) May be extended for a one-year period, subject to certain conditions. (3) Balance repaid on November 4, 1999 using proceeds from the Revolving Credit Facility. (4) Construction loan with a total commitment of $10,875. Loan may be extended for a one-year period, subject to certain conditions. (5) Construction loan with a total commitment of $9,825. Loan may be extended for a one-year period, subject to certain conditions. (6) Construction loan with a total commitment of $4,549. (7) Construction loan with a total commitment of $7,400. Loan may be extended for a one-year period, subject to certain conditions. In June 1999, we sold an office building and assigned our rights to purchase two office buildings to an unrelated third party. Simultaneously with these transactions, we entered into a contract with the third party under which the third party has the right to transfer these three office buildings to us on or before March 31, 2000 for total consideration of approximately $40.5 million. Under the terms of the contract, we would pay up to $25.0 million (but in no event less than $23.9 million) of the acquisition price in Convertible Preferred Units in the Operating Partnership and the balance in cash or debt assumption. We would also issue ten-year detachable warrants exercisable for an additional number of Common Units in the Operating Partnership to be determined based upon the share price of the Common Shares over the first five years following the acquisition. However, if the price of our Common Shares used to determine the additional number of Common Units equals or exceeds $14.21, no warrants will be issuable. 24 The Convertible Preferred Units issuable under the terms of the contract will be entitled to a 9% priority annual return for the first ten years following issuance, 10.5% for the five following years and 12% thereafter. The Convertible Preferred Units are convertible, subject to certain restrictions, commencing one year after their issuance into Common Units in the Operating Partnership on the basis of 2.381 Common Units for each Convertible Preferred Unit, plus any accrued return. The Common Units are exchangeable for Common Shares, subject to certain conditions. The Convertible Preferred Units also carry a liquidation preference of $25.00 per unit, plus any accrued return, and may be redeemed for cash by the Operating Partnership at any time after the tenth anniversary of their issuance. We are also under contract to purchase two office buildings totaling 198,391 square feet and a parcel of land located in Linthicum, Maryland for $25.8 million. We have no other contractual obligations for property acquisitions or material capital costs other than the October property acquisitions discussed below, the completion of the four development projects discussed below and tenant improvements and leasing costs in the ordinary course of business. We expect to meet our long-term capital needs through a combination of cash from operations, additional borrowings and additional equity issuances of Common Shares, Preferred Shares, Common Units and/or Preferred Units. We have an effective Form S-3 shelf registration statement on file with the Securities and Exchange Commission under which we may sell up to $218.8 million in debt or equity securities depending upon our needs and market conditions. INVESTING AND FINANCING ACTIVITIES FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999: During the nine months ended September 30, 1999, we acquired 15 operating properties, four parcels of land and a warehouse facility to undergo redevelopment for an aggregate acquisition cost of $61.2 million. Of the 15 operating properties acquired, 11 are located in the Baltimore/Washington Corridor, one in New Jersey and three in Pennsylvania. The four land parcels acquired are located in the Baltimore/Washington Corridor and the warehouse facility is located in New Jersey. The operating property acquisitions increased our rentable square footage by 534,000. These acquisitions were financed by: - using $41.3 million in borrowings under our Revolving Credit Facility, - assuming $9.9 million in mortgage and other loans, - issuing 377,251 Common Units in our Operating Partnership, - applying $1.6 million outstanding receivable balance towards a purchase, and - using cash reserves for the balance. During the nine months ended September 30, 1999, we completed construction of a 93,482 square foot office building located in Annapolis Junction, Maryland. Costs incurred on this property through September 30, 1999 totaled $9.2 million. We entered into a $9.8 million construction loan for this project $6.2 million of which was borrowed through September 30, 1999. We also completed an expansion project that increased the rentable square footage of one of our properties by 6,350 square feet. As of September 30, 1999, we also had construction underway on an aggregate of 347,745 square feet of new office space that was 87% pre-leased at our Woodlands II, 132 National Business Parkway, Airport Square 15 and 68 Culver Road properties. We entered into $18.3 million in construction loans during this period to finance the construction of two of these projects. Borrowings under these loans totaled $7.3 million at September 30, 1999. During the nine months ended September 30, 1999, we sold eight properties for $52.2 million, of which $20.9 million was used to pay off the mortgage loans payable on the properties. We realized a gain of $1.1 million on the sales of these properties, including the value of the transaction involving Glacier (see Note 12 to the Consolidated Financial Statements). Net proceeds from these sales totaled $30.0 million, $24.3 million of which was used to repay a portion of our Revolving Credit Facility and the remainder was applied to working capital. 25 On March 19, 1999, our Operating Partnership issued 200,000 Common Units in exchange for all of the ownership interests in Glacier. For accounting purposes, we recorded the value of this transaction against the gain on the sale of our retail properties in the Midwest region of the United States (see Note 12 to the Consolidated Financial Statements). On April 8, 1999, we obtained a $12.5 million mortgage loan payable from Allfirst Bank, $9.0 million of which is nonrecourse. The loan provides for monthly payments of interest, at a rate of LIBOR plus 1.75%, and principal of $23,000 in the loan's first year, $25,000 in the second year and $27,000 in the third year. The loan matures on May 1, 2002. This loan is collateralized by three of our operating properties and one parcel of land. The proceeds from this loan were used to pay down our Revolving Credit Facility. On April 16, we assumed three nonrecourse mortgage loans payable in connection with the acquisition of the Parkway Crossing Properties. One of these loans is with IDS Life Insurance Company. This loan has a balance of $3.2 million, bears interest at a fixed rate of 8.375% and provides for monthly principal and interest payments of $44,000. This loan was repaid on November 4, 1999 using proceeds from the Revolving Credit Facility. We also assumed two loans with the seller totaling $1.9 million that carry identical terms. These loans provide for monthly payments of interest at a rate equal to the lesser of prime plus 0.5% (currently 8.75%) or 9.38% plus fixed principal payments of $4,000. These loans mature on May 25, 2007. On May 5, 1999, we obtained a $10.0 million loan from Deutsche Banc Alex. Brown. The loan bears interest at a rate of LIBOR plus 1.75% and provides for monthly payments of interest only. The proceeds from this loan were used to pay down our Revolving Credit Facility. This loan was repaid on November 4, 1999 using proceeds from our Revolving Credit Facility. In July 1999, we completed the sale of 1,250,000 Series B Preferred Shares to the public at a price of $25.00 per share. These shares are nonvoting (except in limited circumstances) and are redeemable for cash at $25.00 per share plus accrued and unpaid dividends at our option on or after July 15, 2004. Holders of these shares are entitled to cumulative dividends, payable quarterly (as and if declared by the Board of Trustees). Dividends accrue from the date of issue at the annual rate of $2.50 per share, which is equal to 10% of the $25.00 per share redemption price. We contributed the net proceeds to our Operating Partnership in exchange for 1,250,000 Series B Preferred Units. Our Operating Partnership used most of the proceeds to pay down our Revolving Credit Facility. The Series B Preferred Units carry terms that are substantially the same as the Series B Preferred Shares. On August 4, 1999, 372,295 of our Common Units were converted to Common Shares. On August 12, 1999, we assumed a $4.5 million construction loan with Mellon Bank in connection with the Gateway Central acquisition. The loan bears interest at a rate equal to the yield on 5-year Treasury Securities plus 2.0% (currently 7.97%). The loan provides for monthly payments of interest only through August 2000 and equal monthly payments of principal and interest based on a 30-year amortization period commencing September 2000. The loan matures on August 1, 2005. Borrowings under this loan totaled $4.3 million as of September 30, 1999. On September 9, 1999, we entered into a $7.4 million construction loan with Bank of Maryland to finance the construction of a building at our Airport Square XV property. This loan has an interest rate of LIBOR plus 1.75%. This loan matures on October 1, 2001 and may be extended for a one-year period, subject to certain conditions. Borrowings under this loan totaled $27,000 at September 30, 1999. On September 15, 1999, we acquired a 49% interest in Corporate Gateway General Partnership, a newly organized joint venture, for $3.0 million. On the same day, the joint venture acquired nine office buildings located in Greater Harrisburg, Pennsylvania for $39.9 million using cash and proceeds from a $34.2 million loan payable to our Operating Partnership. This loan payable is evidenced by notes that carry an interest rate of 10% through their maturity date of September 14, 2000. We financed the investment and the loan using $36.2 million in borrowings under our Revolving Credit Facility and cash reserves for the balance. 26 On September 30, 1999, we obtained a $60.0 million mortgage loan payable from Teachers Insurance and Annuity Association of America. This loan carries a fixed interest rate of 7.72% and provides for monthly payments of principal and interest of $452,000. The loan matures on October 1, 2006 and may not be prepaid prior to April 1, 2003. The loan is collaterized by 13 of our properties. INVESTING AND FINANCING ACTIVITIES SUBSEQUENT TO THE NINE MONTHS ENDED SEPTEMBER 30, 1999: On October 20, 1999, we received $492,000 from Deutsche Banc Alex. Brown in exchange for the termination of our interest rate swap agreement. On October 22, 1999, we acquired a parcel of land located in Annapolis Junction, Maryland. We acquired this land for $2.9 million using borrowings under our Revolving Credit Facility. On October 26, 1999, we entered into a $12.4 million construction loan with Allfirst Bank to finance the construction of a building at our 132 National Business Parkway property. This loan has an interest rate of LIBOR plus 1.75%. This loan matures on October 1, 2001 and may be extended for a one-year period, subject to certain conditions. STATEMENT OF CASH FLOWS We generated net cash flow from operating activities of $21.3 million for the nine months ended September 30, 1999, an increase of $13.8 million from the nine months ended September 30, 1998. Our increase in cash flows from operating activities is due mostly to income generated from our newly acquired properties. Our net cash flow used in investing activities for the nine months ended September 30, 1999 decreased $19.3 million from the nine months ended September 30, 1998 due mostly to the $26.3 million decrease in cash outlays associated with purchases of and improvements to real estate properties during the period and $30.0 million in proceeds generated from sales of our rental properties, offset by $37.2 million invested in an unconsolidated real estate joint venture. Our net cash flow provided by financing activities for the nine months ended September 30, 1999 decreased $33.0 million from the nine months ended September 30, 1998 due primarily to $72.2 million from the issuance of Common Shares in the prior period, $128.4 million in additional repayments of mortgage and other loans payable and $8.7 million in additional dividend and distribution payments, offset by $144.3 million in additional proceeds from mortgage and other loans payable and $29.5 million from the issuance of our Series B Preferred Shares. FUNDS FROM OPERATIONS We consider Funds from Operations ("FFO") to be meaningful to investors as a measure of the financial performance of an equity REIT when considered with the financial data presented under generally accepted accounting principles ("GAAP"). Under the National Association of Real Estate Investment Trusts' ("NAREIT") definition, FFO means net income (loss) computed using generally accepted accounting principles, excluding gains (or losses) from debt restructuring and sales of property, plus real estate-related depreciation and amortization and after adjustments for unconsolidated partnerships and joint ventures. Further, if the conversion of securities into common shares is dilutive, we exclude any GAAP income allocated to these securities in computing FFO. The FFO we present may not be comparable to the FFO of other REITs since they may interpret the current NAREIT definition of FFO differently or they may not use the current NAREIT definition of FFO. FFO is not the same as cash generated from operating activities or net income determined in accordance with GAAP. FFO is not necessarily an indication of our cash flow available to fund cash needs. Additionally, it should not be used as an alternative to net income when evaluating our financial performance or to cash flow from operating, investing and financing when evaluating our liquidity or ability to make cash distributions or pay debt service. Our FFO for the nine months ended September 30, 1999 and 1998 are summarized in the following table: 27
(Dollars and shares for this table are in thousands) ------------------------------------------------------ For the three months For the nine months ended ended September 30, September 30, --------------------- ------------------------- 1999 1998 1999 1998 -------- ------- --------- -------- Income before minority interests and extraordinary item.............................................. $5,490 $ 2,493 $ 16,303 $ 5,041 Add: Real estate related depreciation and amortization...................................... 3,073 1,502 8,719 3,743 Add: Nonrecurring charges - Reformation costs....... -- -- -- 637 Less: Preferred Unit distributions.................. (853) (853) (2,559) (2,559) Less: Preferred Share dividends..................... (1,060) (10) (1,736) (10) Less: Gain on sales of rental properties............ -- -- (1,140) -- ------ ------- -------- ------- Funds from operations............................... 6,650 3,132 19,587 6,852 Add: Preferred Unit distributions................... 853 853 2,559 2,559 Add: Preferred Share dividends..................... 339 10 1,015 10 ------ ------- -------- ------- Funds from operations assuming conversion of Preferred Units and Preferred Shares.............. 7,842 3,995 23,161 9,421 Less: Straight line rent adjustments............... (634) (341) (2,134) (1,083) Less: Recurring capital improvements............... (643) (34) (1,790) (34) ------ ------- -------- ------- Adjusted funds from operations assuming conversion of Preferred Units and Preferred Shares.............. $6,565 $ 3,620 $ 19,237 $ 8,304 ------ ------- -------- ------- ------ ------- -------- ------- Weighted average Common Shares...................... 17,037 9,973 16,881 6,651 Conversion of weighted average Common Units......... 3,068 2,582 3,012 2,582 ------ ------- -------- ------- Weighted average Common Shares/Units................ 20,105 12,555 19,893 9,233 Assumed conversion of share options................. 18 11 9 86 Conversion of weighted average Preferred Shares..... 1,845 52 1,845 18 Conversion of weighted average Preferred Units...... 7,500 7,500 7,500 7,500 ------ ------- -------- ------- Weighted average Common Shares/Units assuming conversion of Preferred Units and Preferred Shares 29,468 20,118 29,247 16,837 ------ ------- -------- ------- ------ ------- -------- -------
INFLATION We have not been significantly impacted by inflation during the periods presented in this report. This is mostly because of the relatively low inflation rates in our markets. Most of our tenants are contractually obligated to pay their share of operating expenses, thereby reducing exposure to increases in such costs resulting from inflation. IMPACT OF THE YEAR 2000 ISSUE Many older computer software programs refer to years in terms of their final two digits only. Such programs may interpret the year 2000 to mean the year 1900 instead. If not corrected, this could result in a system failure or miscalculations causing disruption of operations, including a temporary inability to process transactions, prepare financial statements, send invoices or engage in similar normal business activity. Our accounting software system was certified as Year 2000 compliant by its manufacturer. Our information technology and accounting groups also completed an internal test of our accounting software to ensure compliance. No problems were noted during this testing process. Accordingly, we do not anticipate problems in processing the billing and collection of revenue, paying of expenditures, recording of financial transactions, preparing financial statements and maintaining and generating system driven managerial information. Our 28 accounting department has developed a plan that will enable a certain amount of manual processing to take place in the unlikely event that problems arise with our accounting software. Our property management team has been continually evaluating the impact of the Year 2000 Issue on the various facets of property operating systems since the beginning of 1998, including the telecommunication, security, energy management, sprinkler and elevator systems. This evaluation process was completed in the second quarter of 1999. Based on the results of this evaluation process, we do not anticipate any material adverse consequences on property operations. Our property management team has alternative plans in place to address unexpected problems that may arise with the property operating systems. Additional property management staff will also be on-call to respond to any such problems beginning January 1, 2000. We rely on third party suppliers for a number of key services. Interruption of supplier operations due to the Year 2000 Issue could affect our operations. After contacting our significant suppliers regarding their Year 2000 readiness, our property management team does not anticipate any material adverse consequences relating to these suppliers' abilities to support our properties. Our property management team plans to continue its efforts to obtain additional written assurance from material suppliers to support representations provided regarding their Year 2000 readiness. The team also completed the documentation of our contingency plans in the unlikely event that certain suppliers are adversely impacted by the Year 2000 Issue. We are dependent upon our tenants for revenue and cash flow. Interruptions in tenant operations due to the Year 2000 Issue could result in reduced revenue, increased receivable levels and cash flow reductions. To address this concern, our property management team solicited responses from certain of our significant tenants regarding their Year 2000 readiness. We also reviewed Year 2000 disclosures provided by certain of our significant tenants required to report to the Securities and Exchange Commission. All tenants responding to our solicitation were in the advanced stages of addressing the Year 2000 Issue; this was also the case with all of the tenants included in our review of Year 2000 disclosures reported in filings by such tenants to the Securities and Exchange Commission. The tenants included in our analysis represent 58% of our monthly contractual base rents as of September 30, 1999 multiplied by 12 plus estimated annualized expense reimbursements. Despite our efforts described above, given the nature of the Year 2000 Issue, there can be no assurance that we will be able to identify and correct all possible aspects. However, based on all information available to us, we believe that we have addressed all areas where the Year 2000 Issue could materially impact our Company's business. Based on information currently available from our internal assessment, we do not expect significant incremental costs associated with our Year 2000 activities during 1999. We will also continue to evaluate Year 2000 issues for all future property acquisitions and development. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are exposed to certain market risks associated with our financial instruments, the most predominant of which is changes in interest rates. Increases in interest rates can result in increased interest expense under our Revolving Credit Facility and our other loans payable carrying variable interest rate terms. Increases in interest rates can also result in increased interest expense when our loans payable carrying fixed interest rate terms mature and need to be refinanced. 29 The following table sets forth our long-term debt obligations, principal cash flows by scheduled maturity, weighted average interest rates and estimated fair market value ("FMV") at September 30, 1999 (dollars in thousands):
For the Year Ended December 31, ---------------------------------------------------------------- 1999 2000 (2) 2001 2002 (3) 2003 Thereafter Total FMV - ---------------------------------------------------------------------------------------------------------------------------- Long term debt: Fixed rate (1) $ 526 132,834 $ 3,048 $ 3,279 $ 3,526 $ 142,407 $ 285,620 $278,655 Average interest rate 7.46% 6.95% 7.42% 7.42% 7.42% 7.30% 7.15% Variable rate $10,075 $ 9,364 $ 389 $25,249 $ 88 $ 5,858 $ 51,023 $ 51,023 Average interest rate 7.13% 7.19% 7.39% 7.09% 8.36% 8.20% 7.25%
- ----------------------- (1) Includes $30.0 million balance governed by a swap agreement that fixes the LIBOR rate on the underlying loan to 5.085%. (2) Includes $100.0 million maturity in October that may be extended for two one-year terms, subject to certain conditions. Also includes $32.6 million maturity in May that may be extended for a one-year period, subject to certain conditions. (3) Includes $13.4 million for 3 construction loans maturing that may be extended for a one-year period, subject to certain conditions. Based on our variable rate debt balances during the nine months ended September 30, 1999, our interest expense would have increased $492,000 if interest rates were 1% higher. PART II ITEM 1. LEGAL PROCEEDINGS We are not currently involved in any material litigation nor, to the best of our knowledge, is any material litigation currently threatened against us (other than routine litigation arising in the ordinary course of business, substantially all of which is expected to be covered by liability insurance). ITEM 2. CHANGES IN SECURITIES a. None b. None c. On July 9, 1999, we issued 50,476 Common Units in our Operating Partnership in connection with the acquisition of a warehouse facility located in South Brunswick, New Jersey. The issuance of these Common Units is exempt from registration under Section 4 (2) of the Securities Act of 1933, as amended. These Common Units are exchangeable into our Common Shares, subject to certain conditions. On August 4, 1999, 372,295 of our Common Units were converted to Common Shares. The issuance of these Common Shares is exempt from registration under Section 4 (2) of the Securities Act of 1933, as amended. d. None ITEM 3. DEFAULTS UPON SENIOR SECURITIES None 30 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None ITEM 5. OTHER INFORMATION None ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits:
EXHIBIT NO. DESCRIPTION ------- ------------------------------------------------------------------------------------------- 2.1 Agreement and Plan of Merger, dated January 31, 1998, among the Registrant, the Maryland Company and the Company (filed with the Trust's Registration Statement on Form S-4 (Commission File No. 333-45649) and incorporated herein by reference). 2.2 Assignment of Partnership Interests, dated April 30, 1998, between Airport Square Limited Partnership, Airport Square Corporation, Camp Meade Corporation and COPT Airport Square One LLC and COPT Airport Square Two LLC. (filed with the Company's Current Report on Form 8-K on May 14, 1998 and incorporated herein by reference). 2.3 Assignment of Purchase and Sale Agreement, dated April 30, 1998, between Aetna Life Insurance Company and the Operating Partnership. (filed with the Company's Current Report on Form 8-K on May 14, 1998 and incorporated herein by reference). 2.4 Assignment of Loan Purchase and Sale Agreement, dated April 30, 1998, between Constellation Real Estate, Inc. and the Operating Partnership. (filed with the Company's Current Report on Form 8-K on May 14, 1998 and incorporated herein by reference). 2.5 Purchase and Sale Agreement, dated April 1, 1998, between Aetna Life Insurance Company and Airport Square Limited Partnership (filed with the Company's Current Report on Form 8-K on May 14, 1998 and incorporated herein by reference). 2.6.1 Loan Purchase and Sale Agreement, dated March 13, 1998, between Aetna Life Insurance Company and Constellation Real Estate, Inc. (filed with the Company's Current Report on Form 8-K on May 14, 1998 and incorporated herein by reference). 2.6.2 Amendment to Loan Purchase and Sale Agreement, dated April 16, 1998, between Aetna Life Insurance Company and Constellation Real Estate, Inc. (filed with the Company's Current Report on Form 8-K on May 14, 1998 and incorporated herein by reference). 2.7.1 Purchase and Sale Agreement, dated March 4, 1998, between 695 Rt. 46 Realty, LLC, 710 Rt. 46 Realty, LLC and COPT Acquisitions, Inc. (filed with the Company's Current Report on Form 8-K on June 10, 1998 and incorporated herein by reference). 2.7.2 Letter Amendment to Purchase and Sale Agreement, dated March 26, 1998, between 695 Rt. 46 Realty, LLC, 710 Rt. 46 Realty, LLC and COPT Acquisitions, Inc. (filed with the Company's Current Report on Form 8-K on June 10, 1998 and incorporated herein by reference). 2.8.1 Contribution Agreement between the Company and the Operating Partnership and certain Constellation affiliates (filed as Exhibit A of the Company's Schedule 14A Information on June 26, 1998 and incorporated herein by reference).
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EXHIBIT NO. DESCRIPTION ------- ------------------------------------------------------------------------------------------- 2.8.2 First Amendment to Contribution Agreement, dated July 16, 1998, between Constellation Properties, Inc. and certain entities controlled by Constellation Properties, Inc. (filed with the Company's Current Report on Form 8-K on October 13, 1998 and incorporated herein by reference). 2.8.3 Second Amendment to Contribution Agreement, dated September 28, 1998, between Constellation Properties, Inc. and certain entities controlled by Constellation Properties, Inc. (filed with the Company's Current Report on Form 8-K on October 13, 1998 and incorporated herein by reference). 2.9 Service Company Asset Contribution Agreement between the Company and the Operating Partnership and certain Constellation affiliates (filed as Exhibit B of the Company's Schedule 14A Information on June 26, 1998 and incorporated herein by reference). 2.10.1 Option Agreement, dated May 14, 1998, between the Operating Partnership and NBP-III, LLC (a Constellation affiliate) (filed as Exhibit C of the Company's Schedule 14A Information on June 26, 1998 and incorporated herein by reference). 2.10.2 First Amendment to Option Agreement, dated June 22, 1998, between the Operating Partnership and NBP-III, LLC (a Constellation affiliate) (filed as Exhibit E of the Company's Schedule 14A Information on June 26, 1998 and incorporated herein by reference). 2.11.1 Option Agreement, dated May 14, 1998, between the Operating Partnership and Constellation Gatespring II, LLC (a Constellation affiliate) (filed as Exhibit D of the Company's Schedule 14A Information on June 26, 1998 and incorporated herein by reference). 2.11.2 First Amendment to Option Agreement, dated June 22, 1998, between the Operating Partnership and Constellation Gatespring II, LLC (a Constellation affiliate) (filed as Exhibit F of the Company's Schedule 14A Information on June 26, 1998 and incorporated herein by reference). 2.12 Option Agreement, dated September 28, 1998, between Jolly Acres Limited Partnership, Arbitrage Land Limited Partnership and the Operating Partnership (filed with the Company's Current Report on Form 8-K on October 13, 1998 and incorporated herein by reference). 2.13 Right of First Refusal Agreement, dated September 28, 1998, between Constellation Properties, Inc. and the Operating Partnership (filed with the Company's Current Report on Form 8-K on October 13, 1998 and incorporated herein by reference). 2.14 Right of First Refusal Agreement, dated September 28, 1998, between 257 Oxon, LLC and the Operating Partnership (filed with the Company's Current Report on Form 8-K on October 13, 1998 and incorporated herein by reference). 2.15 Development Property Acquisition Agreement, dated May 14, 1998, between the Operating Partnership and CPI Piney Orchard Village Center, Inc. (a Constellation affiliate) (filed as Exhibit H of the Company's Schedule 14A Information on June 26, 1998 and incorporated herein by reference).
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EXHIBIT NO. DESCRIPTION ------- ------------------------------------------------------------------------------------------- 2.16 Contribution Agreement, dated September 30, 1998, between COPT Acquisitions, Inc. and M.O.R. XXIX Associates Limited Partnership (filed with the Company's Current Report on Form 8-K on October 28, 1998 and incorporated herein by reference). 2.17 Purchase and Sale Agreement, dated September 30, 1998, between New England Life Pension Properties II: A Real Estate Limited Partnership and COPT Acquisitions, Inc. (filed with the Company's Current Report on Form 8-K on October 28, 1998 and incorporated herein by reference). 2.18.1 Sale-Purchase Agreement, dated August 20, 1998 between South Middlesex Industrial Park Associates, L.P. and SM Monroe Associates and COPT Acquisitions, Inc. (filed with the Company's Current Report on Form 8-K on October 28, 1998 and incorporated herein by reference). 2.18.2 First Amendment to Sale-Purchase Agreement, dated October 30, 1998, between South Middlesex Industrial Park Associates, L.P. and SM Monroe Associates, L.P. and COPT Acquisitions, Inc. (filed with the Company's Current Report on Form 8-K on November 16, 1998 and incorporated herein by reference). 2.19 Contribution Agreement, dated December 31, 1998, between the Operating Partnership and M.O.R. 44 Gateway Associates L.P., RA & DM, Inc. and M.R.U. L.P. (filed with the Company's Current Report on Form 8-K on January 14, 1999 and incorporated herein by reference). 2.20.1 Purchase and Sale Agreement, dated December 31, 1998, between Metropolitan Life Insurance Company and Corporate Office Acquisitions, Inc. (filed with the Company's Current Report on Form 8-K on January 14, 1999 and incorporated herein by reference). 2.20.2 Amendment to Purchase and Sale Agreement, dated December 31, 1998, between Metropolitan Life Insurance Company, DPA/Gateway L.P., Corporate Office Acquisitions, Inc., COPT Gateway, LLC and the Operating Partnership (filed with the Company's Current Report on Form 8-K on January 14, 1999 and incorporated herein by reference). 2.21 Contribution Agreement, dated February 24, 1999, between the Operating Partnership and John Parsinen, John D. Parsinen, Jr., Enterprise Nautical, Inc. and Vernon Beck (filed with the Company's Quarterly Report on Form 10-Q on May 14, 1999 and incorporated herein by reference). 2.22 Agreement to Sell Partnership Interests, dated August 12, 1999, between Gateway Shannon Development Corporation, Clay W. Hamlin, III and COPT Acquisitions, Inc. 2.23 Agreement of Purchase and Sale, dated July 21, 1999, between First Industrial Financing Partnership, L.P. and COPT Acquisitions, Inc. 3.1 Amended and Restated Declaration of Trust of Registrant (filed with the Registrant's Registration Statement on Form S-4 (Commission File No. 333-45649) and incorporated herein by reference). 3.2 Bylaws of Registrant (filed with the Registrant's Registration Statement on Form S-4 (Commission File No. 333-45649) and incorporated herein by reference).
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EXHIBIT NO. DESCRIPTION ------- ------------------------------------------------------------------------------------------- 4.1 Form of certificate for the Registrant's Common Shares of Beneficial Interest, $0.01 par value per share (filed with the Registrant's Registration Statement on Form S-4 (Commission File No. 333-45649) and incorporated herein by reference). 4.2 Amended and Restated Registration Rights Agreement, dated March 16, 1998, for the benefit of certain shareholders of the Company (filed with the Company's Quarterly Report on Form 10-Q on August 12, 1998 and incorporated herein by reference). 4.3 Articles Supplementary of Corporate Office Properties Trust Series A Convertible Preferred Shares, dated September 28, 1998 (filed with the Company's Current Report on Form 8-K on October 13, 1998 and incorporated herein by reference). 4.4.1 Amended and Restated Limited Partnership Agreement of the Operating Partnership, dated March 16, 1998 (filed with the Company's Quarterly Report on Form 10-Q on August 12, 1998 and incorporated herein by reference). 4.4.2 First Amendment to Amended and Restated Limited Partnership Agreement of the Operating Partnership, dated September 28, 1998 (filed with the Company's Current Report on Form 8-K on October 13, 1998 and incorporated herein by reference). 4.4.3 Second Amendment to Amended and Restated Limited Partnership Agreement of the Operating Partnership, dated October 13, 1998 (filed with the Company's Current Report on Form 8-K on October 28, 1998 and incorporated herein by reference). 4.4.4 Third Amendment to Amended and Restated Limited Partnership Agreement of the Operating Partnership, dated December 31, 1998 (filed with the Company's Current Report on Form 8-K on January 14, 1999 and incorporated herein by reference). 4.5 Registration Rights Agreement, dated September 28, 1998, for the benefit of certain shareholders of the Company (filed with the Company's Quarterly Report on Form 10-Q on May 14, 1999 and incorporated herein by reference). 4.6 Articles Supplementary of Corporate Office Properties Trust Series B Convertible Preferred Shares, dated July 2, 1999 (filed with the Company's Current Report on Form 8-K on July 7, 1999 and incorporated herein by reference). 10.1 Clay W. Hamlin III Employment Agreement, dated October 14, 1997, with the Operating Partnership (filed with the Company's Current Report on Form 8-K on October 29, 1997, and incorporated herein by reference). 10.2 Employment Agreement, dated October 20, 1997, between the Operating Partnership and Thomas D. Cassel (filed with the Company's Annual Report on Form 10-K on March 25, 1998 and incorporated herein by reference). 10.3 Employment Agreement, dated September 28, 1998, between Corporate Office Management, Inc. and Randall M. Griffin (filed with the Company's Current Report on Form 8-K on October 13, 1998 and incorporated herein by reference). 10.4 Employment Agreement, dated September 28, 1998, between Corporate Office Management, Inc. and Roger A. Waesche, Jr. (filed with the Company's Current Report on Form 8-K on October 13, 1998 and incorporated herein by reference).
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EXHIBIT NO. DESCRIPTION ------- ------------------------------------------------------------------------------------------- 10.5 Management Agreement between Registrant and Glacier Realty, LLC (filed with the Company's Current Report on Form 8-K on October 29, 1997, and incorporated herein by reference). 10.6 Senior Secured Credit Agreement, dated October 13, 1997, (filed with the Company's Current Report on Form 8-K on October 29, 1997, and incorporated herein by reference). 10.7.1 Corporate Office Properties Trust 1998 Long Term Incentive Plan (filed with the Registrant's Registration Statement on Form S-4 (Commission File No. 333-45649) and incorporated herein by reference). 10.7.2 Amendment No. 1 to Corporate Office Properties Trust 1998 Long Term Incentive Plan (filed with the Company's Quarterly Report on Form 10-Q on August 13, 1999 and incorporated herein by reference). 10.8 Stock Option Plan for Directors (filed with Royale Investments, Inc.'s Form 10-KSB for the year ended December 31, 1993 (Commission File No. 0-20047) and incorporated herein by reference). 10.9 Lease Agreement between Blue Bell Investment Company, L.P. and Unisys Corporation dated March 12, 1997 with respect to lot A (filed with the Registrant's Registration Statement on Form S-4 (Commission File No. 333-45649) and incorporated herein by reference). 10.10 Lease Agreement between Blue Bell Investment Company, L.P. and Unisys Corporation, dated March 12, 1997, with respect to lot B (filed with the Registrant's Registration Statement on Form S-4 (Commission File No. 333-45649) and incorporated herein by reference). 10.11 Lease Agreement between Blue Bell Investment Company, L.P. and Unisys Corporation, dated March 12, 1997, with respect to lot C (filed with the Registrant's Registration Statement on Form S-4 (Commission File No. 333-45649) and incorporated herein by reference). 10.12 Senior Secured Revolving Credit Agreement, dated May 28, 1998, between the Company, the Operating Partnership, Any Mortgaged Property Subsidiary and Bankers Trust Company (filed with the Company's Current Report on Form 8-K on June 10, 1998 and incorporated herein by reference). 10.13 Secured Promissory Note, dated April 29, 1997, between 710 Rt. 46 Realty, LLC and Life Investors Insurance Company of America (filed with the Company's Current Report on Form 8-K on June 10, 1998 and incorporated herein by reference). 10.14 Mortgage and Security Agreement, dated April 29, 1997, between 710 Rt. 46 Realty, LLC and Life Investors Insurance Company of America (filed with the Company's Current Report on Form 8-K on June 10, 1998 and incorporated herein by reference). 10.15 Amended and Restated Deed of Trust Note, dated October 6, 1995, between Cranberry-140 Limited Partnership and Security Life of Denver Insurance Company (filed with the Company's Current Report on Form 8-K on October 13, 1998 and incorporated herein by reference).
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EXHIBIT NO. DESCRIPTION ------- ------------------------------------------------------------------------------------------- 10.16.1 Promissory Note, dated September 15, 1995, between Tred Lightly Limited Liability Company and Provident Bank of Maryland (filed with the Company's Current Report on Form 8-K on October 13, 1998 and incorporated herein by reference). 10.16.2 Allonge to Promissory Note, dated September 28, 1998, between Tred Lightly Limited Liability Company and Provident Bank of Maryland (filed with the Company's Current Report on Form 8-K on October 13, 1998 and incorporated herein by reference). 10.17.1 Third Loan Modification and Extension Agreement, dated November 12, 1997, between St. Barnabus Limited Partnership, Constellation Properties, Inc. and NationsBank, N.A. (filed with the Company's Current Report on Form 8-K on October 13, 1998 and incorporated herein by reference). 10.17.2 Fourth Loan Modification Agreement, dated September 28, 1998, between St. Barnabus Limited Partnership, Constellation Properties, Inc. and NationsBank, N.A. (filed with the Company's Current Report on Form 8-K on October 13, 1998 and incorporated herein by reference). 10.18.1 Deed of Trust Note, dated September 20, 1988, between Brown's Wharf Limited Partnership and Mercantile-Safe Deposit and Trust Company (filed with the Company's Current Report on Form 8-K on October 13, 1998 and incorporated herein by reference). 10.18.2 Extension Agreement and Allonge to Deed of Trust Note, dated July 1, 1994, between Brown's Wharf Limited Partnership and Mercantile-Safe Deposit and Trust Company (filed with the Company's Current Report on Form 8-K on October 13, 1998 and incorporated herein by reference). 10.19 Consulting Services Agreement, dated April 28, 1998, between the Company and Net Lease Finance Corp., doing business as Corporate Office Services (filed with the Company's Current Report on Form 8-K on October 13, 1998 and incorporated herein by reference). 10.20 Project Consulting and Management Agreement, dated September 28, 1998, between Constellation Properties, Inc. and COMI (filed with the Company's Current Report on Form 8-K on October 13, 1998 and incorporated herein by reference). 10.21 Promissory Note, dated October 22, 1998, between Teachers Insurance and Annuity Association of America and the Operating Partnership (filed with the Company's Quarterly Report on Form 10-Q on November 13, 1998 and incorporated herein by reference). 10.22 Indemnity Deed of Trust, Assignment of Leases and Rents and Security Agreement, dated October 22, 1998, by affiliates of the Operating Partnership for the benefit of Teachers Insurance and Annuity Association of America (filed with the Company's Quarterly Report on Form 10-Q on November 13, 1998 and incorporated herein by reference). 10.23 Agreement for Services, dated September 28, 1998, between the Company and Corporate Office Management, Inc. (filed with the Company's Quarterly Report on Form 10-Q on May 14, 1999 and incorporated herein by reference). 10.24.1 Lease Agreement, dated September 28,1998, between St. Barnabus Limited Partnership and Constellation Properties, Inc. (filed with the Company's Quarterly Report on Form 10-Q on May 14, 1999 and incorporated herein by reference).
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EXHIBIT NO. DESCRIPTION ------- ------------------------------------------------------------------------------------------- 10.24.2 First Amendment to Lease, dated December 31, 1998, between St. Barnabus, LLC and Constellation Properties, Inc. (filed with the Company's Quarterly Report on Form 10-Q on May 14, 1999 and incorporated herein by reference). 10.25.1 Lease Agreement, dated August 3, 1998, between Constellation Real Estate, Inc. and Constellation Properties, Inc. (filed with the Company's Quarterly Report on Form 10-Q on May 14, 1999 and incorporated herein by reference). 10.25.2 First Amendment to Lease, dated December 30, 1998, between Three Centre Park, LLC and Constellation Properties, Inc. (filed with the Company's Quarterly Report on Form 10-Q on May 14, 1999 and incorporated herein by reference). 10.26.1 Lease Agreement, dated April 27, 1993, between Constellation Properties, Inc. and Baltimore Gas and Electric Company (filed with the Company's Quarterly Report on Form 10-Q on May 14, 1999 and incorporated herein by reference). 10.26.2 First Amendment to Lease, dated December 9, 1998, between COPT Brandon, LLC and Baltimore Gas and Electric Company (filed with the Company's Quarterly Report on Form 10-Q on May 14, 1999 and incorporated herein by reference). 10.27 Underwriting Agreement, dated June 29, 1999, between Corporate Office Properties Trust and the underwriters of the Series B Preferred Shares (filed with the Company's Current Report on Form 8-K on July 7, 1999 and incorporated herein by reference). 10.28 Contribution Rights Agreement, dated June 23, 1999, between the Operating Partnership and United Properties Group, Incorporated (filed with the Company's Quarterly Report on Form 10-Q on August 13, 1999 and incorporated herein by reference). 10.29 Promissory Note, dated September 30, 1999, between Teachers Insurance and Annuity Association of America and the Operating Partnership. 10.30 Indemnity Deed of Trust, Assignment of Leases and Rents and Security Agreement, dated September 30, 1999, by affiliates of the Operating Partnership for the benefit of Teachers Insurance and Annuity Association of America. 27 Financial Data Schedule.
37 c. Reports on Form 8-K We filed the following Current Reports on Form 8-K in the three months ended September 30, 1999: Item 5 dated July 6, 1999 in connection with our Series B Preferred Share offering. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. CORPORATE OFFICE PROPERTIES TRUST Date: November 8, 1999 By: /s/ Randall M. Griffin ------------------------- Randall M. Griffin President and Chief Operating Officer Date: November 8, 1999 By: /s/ Roger A. Waesche, Jr. ---------------------------- Roger A. Waesche, Jr. Senior Vice President and Chief Financial Officer 38