UNITED STATES

SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

 

FORM 10-Q

(Mark one)

ý QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934

 

For the quarterly period ended                                       March 31, 2005

 

or

 

o 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 1-14023

 

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.)

 

 

 

8815 Centre Park Drive, Suite 400, Columbia MD

 

21045

(Address of principal executive offices)

 

(Zip Code)

 

Registrant’s telephone number, including area code:  (410) 730-9092

 

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.

ý  Yes   o No

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).  ýYes   o No

 

On April 30, 2005, 37,066,915 shares of the Company’s Common Shares of Beneficial Interest, $0.01 par value, were issued.

 

 



 

TABLE OF CONTENTS

 

FORM 10-Q

 

 

PAGE

PART I: FINANCIAL INFORMATION

 

 

 

Item 1:

Financial Statements:

 

 

Consolidated Balance Sheets as of March 31, 2005 (unaudited) and December 31, 2004

3

 

Consolidated Statements of Operations for the three months ended March 31, 2005 and 2004 (unaudited)

4

 

Consolidated Statements of Cash Flows for the three months ended March 31, 2005 and 2004 (unaudited)

5

 

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

35

Item 4:

Controls and Procedures

35

 

 

PART II: OTHER INFORMATION

 

 

 

Item 1:

Legal Proceedings

36

Item 2:

Unregistered Sales of Equity Securities and Use of Proceeds

36

Item 3:

Defaults Upon Senior Securities

36

Item 4:

Submission of Matters to a Vote of Security Holders

36

Item 5:

Other Information

36

Item 6:

Exhibits

36

 

 

SIGNATURES

37

 

2



 

PART I: FINANCIAL INFORMATION

ITEM 1. Financial Statements

 

Corporate Office Properties Trust and Subsidiaries

Consolidated Balance Sheets

(Dollars in thousands)

 

 

 

March 31,

 

December 31,

 

 

 

2005

 

2004

 

 

 

(unaudited)

 

 

 

Assets

 

 

 

 

 

Investment in real estate:

 

 

 

 

 

Operating properties, net

 

$

1,409,637

 

$

1,407,148

 

Projects under construction or development

 

206,430

 

136,152

 

Total commercial real estate properties, net

 

1,616,067

 

1,543,300

 

Investments in and advances to unconsolidated real estate joint ventures

 

1,209

 

1,201

 

Investment in real estate, net

 

1,617,276

 

1,544,501

 

Cash and cash equivalents

 

6,212

 

13,821

 

Restricted cash

 

13,830

 

12,617

 

Accounts receivable, net

 

17,529

 

16,771

 

Investment in other unconsolidated entity

 

1,621

 

1,621

 

Deferred rent receivable

 

27,890

 

26,282

 

Intangible assets on real estate acquisitions, net

 

64,965

 

67,560

 

Deferred charges, net

 

27,168

 

27,642

 

Prepaid and other assets

 

19,658

 

18,646

 

Furniture, fixtures and equipment, net

 

2,771

 

2,565

 

Total assets

 

$

1,798,920

 

$

1,732,026

 

Liabilities and shareholders’ equity

 

 

 

 

 

Liabilities:

 

 

 

 

 

Mortgage and other loans payable

 

$

1,091,688

 

$

1,022,688

 

Accounts payable and accrued expenses

 

46,400

 

46,307

 

Rents received in advance and security deposits

 

13,298

 

12,781

 

Dividends and distributions payable

 

14,766

 

14,713

 

Deferred revenue associated with acquired operating leases

 

6,612

 

7,247

 

Other liabilities

 

7,661

 

7,488

 

Total liabilities

 

1,180,425

 

1,111,224

 

Minority interests:

 

 

 

 

 

Common units in the Operating Partnership

 

87,539

 

88,355

 

Preferred units in the Operating Partnership

 

8,800

 

8,800

 

Other consolidated real estate joint ventures

 

1,699

 

1,723

 

Total minority interests

 

98,038

 

98,878

 

Commitments and contingencies (Note 18)

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

Preferred Shares of beneficial interest ($0.01 par value; 15,000,000 shares authorized) (Note 13)

 

67

 

67

 

Common Shares of beneficial interest ($0.01 par value; 75,000,000 shares authorized, shares issued of 37,043,386 at March 31, 2005 and 36,842,108 at December 31, 2004)

 

370

 

368

 

Additional paid-in capital

 

582,805

 

578,228

 

Cumulative distributions in excess of net income

 

(55,312

)

(51,358

)

Value of unearned restricted common share grants

 

(7,473

)

(5,381

)

Total shareholders’ equity

 

520,457

 

521,924

 

Total liabilities and shareholders’ equity

 

$

1,798,920

 

$

1,732,026

 

 

See accompanying notes to consolidated financial statements.

 

3



 

Corporate Office Properties Trust and Subsidiaries

Consolidated Statements of Operations

(Dollars in thousands, except per share data)

(unaudited)

 

 

 

For the Three Months
Ended March 31,

 

 

 

2005

 

2004

 

Revenues

 

 

 

 

 

Rental revenue

 

$

53,263

 

$

43,194

 

Tenant recoveries and other real estate operations revenue

 

7,364

 

5,777

 

Construction contract revenues

 

15,728

 

6,137

 

Other service operations revenues

 

1,369

 

1,515

 

Total revenues

 

77,724

 

56,623

 

Expenses

 

 

 

 

 

Property operating

 

18,918

 

15,039

 

Depreciation and other amortization associated with real estate operations

 

14,666

 

10,359

 

Construction contract expenses

 

14,897

 

5,818

 

Other service operations expenses

 

1,291

 

1,092

 

General and administrative expenses

 

3,276

 

2,286

 

Total operating expenses

 

53,048

 

34,594

 

Operating income

 

24,676

 

22,029

 

Interest expense

 

(13,358

)

(10,262

)

Amortization of deferred financing costs

 

(396

)

(859

)

Income from continuing operations before gain (loss) on sales of real estate, equity in loss of unconsolidated entities, income taxes and minority interests

 

10,922

 

10,908

 

Gain (loss) on sales of real estate

 

24

 

(222

)

Equity in loss of unconsolidated entities

 

 

(88

)

Income tax expense

 

(457

)

(200

)

Income from continuing operations before minority interests

 

10,489

 

10,398

 

Minority interests in income from continuing operations

 

 

 

 

 

Common units in the Operating Partnership

 

(1,308

)

(1,405

)

Preferred units in the Operating Partnership

 

(165

)

 

Other consolidated entities

 

24

 

 

Net income

 

9,040

 

8,993

 

Preferred share dividends

 

(3,654

)

(4,456

)

Net income available to common shareholders

 

$

5,386

 

$

4,537

 

Basic earnings per common share

 

$

0.15

 

$

0.15

 

Diluted earnings per common share

 

$

0.14

 

$

0.14

 

 

See accompanying notes to consolidated financial statements.

 

4



 

Corporate Office Properties Trust and Subsidiaries

Consolidated Statements of Cash Flows

(Dollars in thousands)

(unaudited)

 

 

 

For the Three Months Ended
March 31,

 

 

 

2005

 

2004

 

Cash flows from operating activities

 

 

 

 

 

Net income

 

$

9,040

 

$

8,993

 

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

 

 

 

 

 

Minority interests

 

1,449

 

1,405

 

Depreciation and other amortization

 

14,666

 

10,359

 

Amortization of deferred financing costs

 

396

 

859

 

Amortization of deferred market rental revenue

 

(70

)

(309

)

Equity in loss of unconsolidated entities

 

 

88

 

(Gain) loss on sales of real estate

 

(24

)

222

 

Changes in operating assets and liabilities:

 

 

 

 

 

Increase in deferred rent receivable

 

(1,608

)

(763

)

(Increase) decrease in accounts receivable, restricted cash and prepaid and other assets

 

(2,678

)

685

 

Increase (decrease) in accounts payable, accrued expenses, rents received in advance and security deposits

 

1,898

 

(5,408

)

Other

 

1,843

 

1,317

 

Net cash provided by operating activities

 

24,912

 

17,448

 

Cash flows from investing activities

 

 

 

 

 

Purchases of and additions to commercial real estate properties

 

(84,955

)

(60,024

)

Investments in and advances to unconsolidated entities

 

(8

)

(4

)

Leasing costs paid

 

(1,675

)

(552

)

Increase in advances to certain real estate joint ventures

 

 

(515

)

Other

 

(49

)

(3,298

)

Net cash used in investing activities

 

(86,687

)

(64,393

)

Cash flows from financing activities

 

 

 

 

 

Proceeds from mortgage and other loans payable

 

93,458

 

189,125

 

Repayments of mortgage and other loans payable

 

(24,365

)

(129,549

)

Deferred financing costs paid

 

(235

)

(1,948

)

Net proceeds from issuance of common shares

 

593

 

2,189

 

Dividends paid

 

(12,941

)

(10,732

)

Distributions paid

 

(2,344

)

(2,085

)

Net cash provided by financing activities

 

54,166

 

47,000

 

Net (decrease) increase in cash and cash equivalents

 

(7,609

)

55

 

Cash and cash equivalents

 

 

 

 

 

Beginning of period

 

13,821

 

9,481

 

End of period

 

$

6,212

 

$

9,536

 

 

See accompanying notes to consolidated financial statements.

 

5



 

Corporate Office Properties Trust and Subsidiaries

Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)

(unaudited)

 

1.             Organization

 

Corporate Office Properties Trust (“COPT”) and subsidiaries (collectively, the “Company”) is a fully-integrated and self-managed real estate investment trust (“REIT”).  We focus on the ownership, management, leasing, acquisition and development of suburban office properties.  We typically focus our operations geographically in select submarkets that are attractive to our tenant base and in which we believe we can establish a critical mass of square footage.  At March 31, 2005, all of our operating properties were located in the Mid-Atlantic region of the United States, although in accordance with our strategy of focusing on submarkets that are attractive to our tenants, we may from time to time seek to expand our operations outside of this region.  COPT is qualified as a REIT as defined in the Internal Revenue Code of 1986 and is the successor to a corporation organized in 1988.  As of March 31, 2005, our portfolio included 145 office properties in operations, including two properties owned through joint ventures.

 

We conduct almost all of our operations 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”).  A summary of our Operating Partnership’s forms of ownership and the percentage of those ownership forms owned by COPT as of March 31, 2005 follows:

 

 

 

% Owned
by COPT

 

Common Units

 

80

%

Series E Preferred Units

 

100

%

Series F Preferred Units

 

100

%

Series G Preferred Units

 

100

%

Series H Preferred Units

 

100

%

Series I Preferred Units

 

0

%

 

The Operating Partnership also owns 100% of Corporate Office Management, Inc. (“COMI”) (collectively with its subsidiaries defined as the “Service Companies”).  COMI’s consolidated subsidiaries are set forth below:

 

Entity Name

 

Type of Service Business

Corporate Realty Management, LLC (“CRM”)

 

Real Estate Management

Corporate Development Services, LLC (“CDS”)

 

Construction and Development

Corporate Cooling and Controls, LLC (“CC&C”)

 

Heating and Air Conditioning

 

COMI owns 100% of these entities.  Most of the services that CRM and CDS provide are for us.

 

2.                                      Basis of Presentation

 

The accompanying unaudited interim Consolidated Financial Statements have been prepared in accordance with the rules and regulations for reporting on Form 10-Q.  Accordingly, certain information and disclosures required by accounting principles generally accepted in the United States for complete Consolidated Financial Statements are not included herein.  These interim financial statements should be read together with the financial statements and notes thereto included in our 2004 Annual Report on Form 10-K.  The interim financial statements on the previous pages reflect all adjustments that we believe are necessary for the fair statement 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.

 

6



 

3.             Earnings Per Share (“EPS”)

 

A summary of the numerator and denominator for purposes of our basic and diluted EPS calculations is set forth below (dollars and shares in thousands, except per share data):

 

 

 

For the three months ended
March 31,

 

 

 

2005

 

2004

 

Numerator:

 

 

 

 

 

Numerator for basic EPS on net income available to common shareholders

 

$

5,386

 

$

4,537

 

Add: Convertible preferred share dividends

 

 

21

 

Numerator for diluted EPS on net income available to common shareholders

 

$

5,386

 

$

4,558

 

Denominator (all weighted averages):

 

 

 

 

 

Denominator for basic EPS (common shares)

 

36,555

 

29,814

 

Assumed conversion of share options

 

1,537

 

1,749

 

Assumed conversion of convertible preferred shares

 

 

539

 

Denominator for diluted EPS

 

38,092

 

32,102

 

 

 

 

 

 

 

Basic EPS

 

$

0.15

 

$

0.15

 

Diluted EPS

 

$

0.14

 

$

0.14

 

 

Our diluted EPS computations do not include the effects of the following securities since the conversions of such securities would increase diluted EPS for the respective periods:

 

 

 

Weighted average

 

 

 

shares in denominator

 

 

 

for the three months

 

 

 

ended March 31,

 

 

 

2005

 

2004

 

Conversion of weighted average common units

 

8,544

 

8,863

 

Conversion of weighted average convertible preferred units

 

176

 

 

Restricted common shares

 

143

 

149

 

Conversion of share options

 

 

5

 

 

4.             Share-Based Compensation

 

Expenses from share-based compensation are reflected in our Consolidated Statements of Operations as follows:

 

 

 

For the three months
ended March 31,

 

 

 

2005

 

2004

 

Increase in general and administrative expenses

 

$

413

 

$

359

 

Increase in construction contract and other service operations expenses

 

46

 

139

 

 

The following table summarizes our operating results as if we elected to account for our share-based compensation under the fair value provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation:”

 

 

7



 

 

 

For the three months

 

 

 

ended March 31,

 

 

 

2005

 

2004

 

Net income, as reported

 

$

9,040

 

$

8,993

 

Add: Share-based compensation expense, net of related tax effects and minority interests, included in the determination of net income

 

354

 

337

 

Less: Share-based compensation expense determined under the fair value based method, net of related tax effects and minority interests

 

(339

)

(279

)

Net income, pro forma

 

$

9,055

 

$

9,051

 

Basic EPS on net income available to common shareholders, as reported

 

$

0.15

 

$

0.15

 

Basic EPS on net income available to common shareholders, pro forma

 

$

0.15

 

$

0.15

 

Diluted EPS on net income available to common shareholders, as reported

 

$

0.14

 

$

0.14

 

Diluted EPS on net income available to common shareholders, pro forma

 

$

0.14

 

$

0.14

 

 

The share-based compensation expense under the fair value method, as reported in the above table, was computed using the Black-Scholes option-pricing model.

 

5.             Recent Accounting Pronouncements

 

In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 153, “Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29” (“SFAS 153”).  The Accounting Principles Board’s Opinion No. 29, “Accounting for Nonmonetary Transactions” (“APB 29”) is based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged.  However, the guidance in APB 29 included certain exceptions to that principle.  SFAS 153 amends APB 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance.  Under SFAS 153, a nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange.  SFAS 153 will be effective for us for nonmonetary asset exchanges occurring after December 31, 2005.  We are reviewing the provisions of SFAS 153 and assessing the impact it will have on us upon adoption.

 

In March 2005, the FASB issued Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations-an interpretation of FASB Statement No. 143” (“FIN 47”).  FIN 47 clarifies that the term “conditional asset retirement obligation” as used in FASB Statement No. 143, “Accounting for Asset Retirement Obligations,” refers to an unconditional obligation to perform an asset retirement activity in which the timing and (or) method of settlement are conditional upon future events that may or may not be within the entity’s control.  The fair value of liabilities related to such obligations should be recognized when incurred and reasonably estimable.  Uncertainty about the timing and (or) method of settlement of a conditional asset retirement obligation should be factored into the measurement of the liability when sufficient information exists. Statement 143 acknowledges that in some cases, sufficient information may not be available to reasonably estimate the fair value of an asset retirement obligation.  This Interpretation also clarifies when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation.  FIN 47 is effective no later than December 31, 2005.  We are reviewing the provisions of FIN 47 and assessing the impact it will have on us upon adoption.

 

In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment” (“SFAS 123(R)”).  The statement establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services, focusing primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions.  The statement will require us to measure the cost of employee services received in exchange for an award of equity instruments based generally on the fair value of the award on the grant date; such cost will be recognized over the period during which the employee is required to provide service in exchange for the award (generally the vesting period).  No compensation

 

 

8



 

cost is recognized for equity instruments for which employees do not render the requisite service.  SFAS 123(R) was to be effective for us in June 2005 for applicability to all awards granted, modified, repurchased or cancelled after July 1, 2005; the statement also was to require that we recognize compensation cost on or after July 1, 2005 for the portion of outstanding awards for which the requisite service has not yet been rendered, based on the fair value of those awards on the date of grant.  In April 2005, the Securities and Exchange Commission (the “SEC”) extended the effective date of SFAS 123(R) to the beginning of our next fiscal year (January 1, 2006).  The SEC’s new rule does not change the accounting required by SFAS 123(R); it changes only the dates for compliance with the standard.  We are reviewing the provisions of SFAS 123(R) and assessing the impact it will have on us upon adoption.

 

In March 2005, the SEC issued Staff Accounting Bulletin No. 107 (“SAB 107”).  SAB 107 expresses the SEC staff’s views regarding the interaction between SFAS 123(R) and certain SEC rules and regulations and provides the SEC staff’s views regarding the valuation of share-based payment arrangements for public companies.  In particular, it provides guidance in a number of areas, including share-based payment transactions with nonemployees, valuation methods, the classification of compensation expense, non-GAAP measures, capitalization of compensation costs related to share-based payment arrangements, the accounting for income tax effects of share-based payment arrangements upon adoption of SFAS 123(R), the modification of employee share options prior to adoption of SFAS 123(R) and certain disclosure requirements.  We are reviewing the provisions of SAB 107 and assessing the impact it will have on us upon our adoption of SFAS 123(R).

 

6.             Commercial Real Estate Properties

 

Operating properties consisted of the following:

 

 

 

March 31,

 

December 31,

 

 

 

2005

 

2004

 

Land

 

$

268,307

 

$

268,327

 

Buildings and improvements

 

1,294,457

 

1,280,537

 

 

 

1,562,764

 

1,548,864

 

Less: accumulated depreciation

 

(153,127

)

(141,716

)

 

 

$

1,409,637

 

$

1,407,148

 

 

Projects we had under construction or pre-construction consisted of the following:

 

 

 

March 31,

 

December 31,

 

 

 

2005

 

2004

 

Land

 

$

97,085

 

$

74,190

 

Construction in progress

 

109,345

 

61,962

 

 

 

$

206,430

 

$

136,152

 

 

2005 Acquisitions

 

On March 30, 2005, we acquired for $30,674 two office properties containing an aggregate of 468,994 rentable square feet that are located in San Antonio, Texas.  These buildings are initially undergoing redevelopment that is expected to be completed by the fourth quarter of 2005.  The table below sets forth the allocation of the acquisition cost of these properties:

 

Land

 

$

10,945

 

Construction in progress

 

19,729

 

Total acquisition costs

 

$

30,674

(1)

 


(1)     Classified in projects under construction or development on the March 31, 2005 consolidated balance sheet due to the property undergoing redevelopment.

 

We also acquired the following during the three months ended March 31, 2005:

 

 

9



 

 

                  a 19 acre parcel of land located in Chantilly, Virginia that is adjacent to an office park we own for $7,141 on January 27, 2005 (Chantilly, Virginia is located in the Northern Virginia region).  We expect to develop this land parcel in the future;

                  a 39 acre parcel of land located in Dahlgren, Virginia that is adjacent to one of our office properties for $1,212 on March 16, 2005 (Dahlgren, Virginia is located in the St. Mary’s and King George Counties region).  We expect to develop this land parcel in the future; and

                  a 15.7 acre parcel of land adjacent to the two office properties we acquired in San Antonio, Texas for $3,418 on March 30, 2005.  We expect to operate this land parcel as part of the campus that includes the two acquired office properties.

 

2005 Construction and Pre-Construction Activities

 

As of March 31, 2005, we had construction underway on seven new buildings in the Baltimore/Washington Corridor, one in Northern Virginia and one in St. Mary’s County, Maryland.  We also had pre-construction activities underway on two new buildings located in the Baltimore/Washington Corridor and redevelopment underway on two existing buildings in San Antonio, Texas.

 

7.                                      Real Estate Joint Ventures

 

Our investments in and advances to unconsolidated real estate joint ventures accounted for using the equity method of accounting included the following:

 

 

 

Balance at

 

 

 

 

 

 

 

Total

 

Maximum

 

 

 

March 31,

 

December 31,

 

Date

 

 

 

Nature of

 

Assets at

 

Exposure

 

 

 

2005

 

2004

 

Acquired

 

Ownership

 

Activity

 

3/31/05

 

to Loss (1)

 

Route 46 Partners, LLC

 

$

1,209

 

$

1,201

 

3/14/03

 

20

%

Operating building (2)

 

$

22,911

 

$

1,623

 

 


(1)          Derived from the sum of our investment balance and maximum additional unilateral capital contributions or loans required from us.  Not reported above are additional amounts that we and our partner are required to fund when needed by this joint venture; these funding requirements are proportional to our ownership percentage.

(2)          This joint venture’s property is located in Fairfield, NJ.

The following table sets forth a condensed balance sheet for Route 46 Partners, LLC as of March 31, 2005:

 

Commercial real estate property

 

$

21,450

 

Other assets

 

1,461

 

Total assets

 

$

22,911

 

 

 

 

 

Liabilities

 

$

14,752

 

Owners’ equity

 

8,159

 

Total liabilities and owners’ equity

 

$

22,911

 

 

Our investments in consolidated real estate joint ventures included the following:

 

 

 

 

 

Ownership

 

 

 

Total

 

Collateralized

 

 

 

Date

 

% at

 

Nature of

 

Assets at

 

Assets at

 

 

 

Acquired

 

3/31/05

 

Activity

 

3/31/2005

 

3/31/2005

 

MOR Forbes 2 LLC

 

12/24/02

 

50

%

Operating building (1)

 

$

4,642

 

$

4,101

 

Gateway 70 LLC

 

4/5/01

 

80

%

Constructing/developing two buildings (2)

 

5,687

 

 

MOR Montpelier 3 LLC

 

2/21/02

 

50

%

Developing land parcel (3)

 

950

 

 

 

 

 

 

 

 

 

 

$

11,279

 

$

4,101

 

 


(1) This joint venture’s property is located in Lanham, Maryland (located in the Suburban Maryland region).

(2) This joint venture’s property is located in Columbia, Maryland (located in the Baltimore/Washington Corridor).

(3) This joint venture’s property is located in Laurel, Maryland (located in the Suburban Maryland region).

 

10



 

Our commitments and contingencies pertaining to our real estate joint ventures are disclosed in Note 18.

 

8.             Investment in Other Unconsolidated Entity

 

Our investment in an unconsolidated non-real estate entity is set forth below:

 

 

 

 

 

 

 

 

 

Ownership

 

Investment

 

 

 

March 31,

 

December 31,

 

Date

 

% at

 

Accounting

 

 

 

2005

 

2004

 

Acquired

 

3/31/05

 

Method

 

TractManager, Inc. (1)

 

$

1,621

 

$

1,621

 

Various 2000

 

5

%

Cost

 

 


(1) TractManager, Inc. has developed an Internet-based contract imaging and management system for sale to real estate owners and healthcare providers.

 

9.             Intangible Assets on Real Estate Acquisitions

 

Intangible assets on real estate acquisitions consisted of the following:

 

 

 

March 31,

 

December 31,

 

 

 

2005

 

2004

 

Lease-up value

 

$

65,638

 

$

65,638

 

Lease to market value

 

9,595

 

9,595

 

Lease cost portion of deemed cost avoidance

 

8,700

 

8,700

 

Market concentration premium

 

1,333

 

1,333

 

Subtotal

 

85,266

 

85,266

 

Accumulated amortization

 

(20,301

)

(17,706

)

Intangible assets on real estate acquisitions, net

 

$

64,965

 

$

67,560

 

 

10.          Deferred Charges

 

Deferred charges consisted of the following:

 

 

 

March 31,

 

December 31,

 

 

 

2005

 

2004

 

Deferred leasing costs

 

$

33,995

 

$

33,302

 

Deferred financing costs

 

17,270

 

16,996

 

Goodwill

 

1,853

 

1,853

 

Deferred other

 

155

 

155

 

 

 

53,273

 

52,306

 

Accumulated amortization

 

(26,105

)

(24,664

)

Deferred charges, net

 

$

27,168

 

$

27,642

 

 

11.          Accounts Receivable

 

Our accounts receivable are reported net of an allowance for bad debts of $521 at March 31, 2005 and $490 at December 31, 2004.

 

11



 

12.          Derivatives

 

The following table sets forth the one derivative contract that was in effect during part of the three months ended March 31, 2005 and its fair value:

 

Nature of Derivative

 

Notional
Amount in
(millions)

 

One-Month
LIBOR base

 

Effective
Date

 

Expiration
Date

 

Fair Value at
March 31,
2005

 

Fair Value at
December 31,
2004

 

Interest rate swap

 

$

50.0

 

2.308

%

1/2/2003

 

1/3/2005

 

$

 

$

 

 

We designated this derivative as a cash flow hedge.  This derivative hedged the risk of changes in interest rates on certain of our one-month LIBOR-based variable rate borrowings.  This derivative expired on January 3, 2005.

 

The table below sets forth our accounting application of changes in derivative fair values:

 

 

 

For the Three Months

 

 

 

Ended March 31,

 

 

 

2005

 

2004

 

(Decrease) in fair value applied to AOCL (1)  and minority interests

 

$

 

$

(39

)

Increase in fair value recognized as gain (2)

 

$

 

$

77

 

 


(1)   AOCL is defined as accumulated other comprehensive loss.

(2)   Represents hedge ineffectiveness and is included in interest expense on our Consolidated Statements of Operations.

13.          Shareholders’ Equity

 

Preferred Shares

 

Preferred shares of beneficial interest (“preferred shares”) consisted of the following:

 

 

 

March 31,
2005

 

December 31,
2004

 

1,265,000 designated as Series E Cumulative Redeemable Preferred Shares of beneficial interest (1,150,000 shares issued with an aggregate liquidation preference of $28,750)

 

11

 

11

 

1,425,000 designated as Series F Cumulative Redeemable Preferred Shares of beneficial interest (1,425,000 shares issued with an aggregate liquidation preference of $35,625)

 

14

 

14

 

2,200,000 designated as Series G Cumulative Redeemable Preferred Shares of beneficial interest (2,200,000 shares issued with an aggregate liquidation preference of $55,000)

 

22

 

22

 

2,000,000 designated as Series H Cumulative Redeemable Preferred Shares of beneficial interest (2,000,000 shares issued with an aggregate liquidation preference of $50,000)

 

20

 

20

 

Total preferred shares

 

$

67

 

$

67

 

 

Common Shares

 

During the three months ended March 31, 2005, we issued 130,975 common shares of beneficial interest (“common shares”) to certain employees.  All of these shares are subject to forfeiture restrictions that lapse annually throughout their respective terms provided that the employees remain employed by us.  During the same period, forfeiture restrictions lapsed on 131,304 common shares previously issued to employees.

 

We issued 70,303 common shares upon the exercise of share options during the three months ended March 31, 2005.

 

12



 

Comprehensive Income

 

The table below sets forth our comprehensive income:

 

 

 

For the three months
ended March 31,

 

 

 

2005

 

2004

 

Net income

 

$

9,040

 

$

8,993

 

Unrealized loss on interest rate swaps, net of minority interests

 

 

(34

)

Total comprehensive income

 

$

9,040

 

$

8,959

 

 

14.          Dividends and Distributions

 

The following table summarizes our dividends and distributions when either the payable dates or record dates occurred during the three months ended March 31, 2005:

 

 

 

Record Date

 

Payable Date

 

Dividend/
Distribution Per
Share/Unit

 

Total
Dividend/
Distribution

 

Series E Preferred Shares:

 

 

 

 

 

 

 

 

 

Fourth Quarter 2004

 

December 31, 2004

 

January 14, 2005

 

$

0.6406

 

$

737

 

First Quarter 2005

 

March 31, 2005

 

April 15, 2005

 

$

0.6406

 

$

737

 

 

 

 

 

 

 

 

 

 

 

Series F Preferred Shares:

 

 

 

 

 

 

 

 

 

Fourth Quarter 2004

 

December 31, 2004

 

January 14, 2005

 

$

0.6172

 

$

880

 

First Quarter 2005

 

March 31, 2005

 

April 15, 2005

 

$

0.6172

 

$

880

 

 

 

 

 

 

 

 

 

 

 

Series G Preferred Shares:

 

 

 

 

 

 

 

 

 

Fourth Quarter 2004

 

December 31, 2004

 

January 14, 2005

 

$

0.5000

 

$

1,100

 

First Quarter 2005

 

March 31, 2005

 

April 15, 2005

 

$

0.5000

 

$

1,100

 

 

 

 

 

 

 

 

 

 

 

Series H Preferred Shares:

 

 

 

 

 

 

 

 

 

Fourth Quarter 2004

 

December 31, 2004

 

January 14, 2005

 

$

0.4688

 

$

938

 

First Quarter 2005

 

March 31, 2005

 

April 15, 2005

 

$

0.4688

 

$

938

 

 

 

 

 

 

 

 

 

 

 

Common Shares:

 

 

 

 

 

 

 

 

 

Fourth Quarter 2004

 

December 31, 2004

 

January 14, 2005

 

$

0.2550

 

$

9,288

 

First Quarter 2005

 

March 31, 2005

 

April 15, 2005

 

$

0.2550

 

$

9,339

 

 

 

 

 

 

 

 

 

 

 

Series I Preferred Units:

 

 

 

 

 

 

 

 

 

Fourth Quarter 2004

 

December 31, 2004

 

January 14, 2005

 

$

0.4688

 

$

165

 

First Quarter 2005

 

March 31, 2005

 

April 15, 2005

 

$

0.4688

 

$

165

 

 

 

 

 

 

 

 

 

 

 

Common Units:

 

 

 

 

 

 

 

 

 

Fourth Quarter 2004

 

December 31, 2004

 

January 14, 2005

 

$

0.2550

 

$

2,179

 

First Quarter 2005

 

March 31, 2005

 

April 15, 2005

 

$

0.2550

 

$

2,179

 

 

13



 

15.          Supplemental Information to Statements of Cash Flows

 

 

 

For the Three Months
Ended March 31,

 

 

 

2005

 

2004

 

Supplemental schedule of non-cash investing and financing activities:

 

 

 

 

 

 

 

 

 

 

 

Consolidation of real estate joint ventures in connection with adoption of FASB Interpretation FIN 46(R), “Consolidation of Variable Interest Entities”:

 

 

 

 

 

Operating properties

 

$

 

$

2,176

 

Projects under construction or development

 

 

17,959

 

Investments in and advances to unconsolidated real estate joint ventures

 

 

(3,957

)

Restricted cash

 

 

10

 

Accounts receivable, net

 

 

145

 

Deferred rent receivable

 

 

7

 

Deferred charges, net

 

 

1,026

 

Prepaid and other assets

 

 

(3,263

)

Mortgage and other loans payable

 

 

(10,171

)

Accounts payable and accrued expenses

 

 

(2,737

)

Rents received in advance and security deposits

 

 

(347

)

Other liabilities

 

 

4,650

 

Minority interests-other consolidated real estate entities

 

 

(5,498

)

Net adjustment

 

$

 

$

 

Adjustment to purchase of commercial real estate properties by acquiring joint venture interests:

 

 

 

 

 

Operating properties

 

$

 

$

(83

)

Investments in and advances to unconsolidated real estate joint ventures

 

 

83

 

Net adjustment

 

$

 

$

 

Debt assumed in connection with acquisitions

 

$

 

$

21,218

 

(Decrease) increase in accrued capital improvements and leasing costs

 

$

(1,091

)

$

10,087

 

Amortization of discounts and premiums on mortgage loans to commercial real estate properties

 

$

68

 

$

92

 

Accretion of other liability to commercial real estate properties

 

$

 

$

147

 

Decrease in fair value of derivatives applied to AOCL and minority interests

 

$

 

$

(39

)

Adjustments to minority interests resulting from changes in ownership of Operating Partnership by COPT

 

$

55

 

$

1,129

 

Dividends/distribution payable

 

$

14,766

 

$

12,991

 

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

 

$

 

$

1,003

 

Conversion of preferred shares adjusted to common shares and paid in capital

 

$

 

$

12

 

Issuance of restricted shares

 

$

3,481

 

$

2,271

 

 

14



 

 

16.          Information by Business Segment

 

We have eight primary office property segments: Baltimore/Washington Corridor, Northern Virginia, Greater Philadelphia, St. Mary’s and King George Counties, Northern/Central New Jersey, Suburban Maryland, Greater Harrisburg and San Antonio, Texas.

 

The table below reports segment financial information.  Our segment entitled “Other” includes assets and operations not specifically associated with the other defined segments, including elimination entries required in consolidation.  We measure the performance of our segments based on total revenues less property operating expenses, a measure we define as net operating income (“NOI”).  We believe that NOI is an important supplemental measure of operating performance for a REIT’s operating real estate because it provides a measure of the core operations that is unaffected by depreciation, amortization, financing and general and administrative expenses; this measure is particularly useful in our opinion in evaluating the performance of geographic segments, same-office property groupings and individual properties.

 

 

 

Baltimore/
Washington
Corridor

 

Northern
Virginia

 

Greater
Philadelphia

 

St. Mary’s &
King George
Counties

 

Northern/
Central New
Jersey

 

Suburban
Maryland

 

Greater
Harrisburg

 

San Antonio

 

Other

 

Total

 

Three Months Ended March 31, 2005:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

29,679

 

$

14,419

 

$

2,506

 

$

2,878

 

$

3,871

 

$

2,454

 

$

2,244

 

$

-

 

$

2,576

 

$

60,627

 

Property operating expenses

 

9,409

 

5,015

 

36

 

706

 

1,509

 

1,089

 

744

 

-

 

410

 

$

18,918

 

NOI

 

$

20,270

 

$

9,404

 

$

2,470

 

$

2,172

 

$

2,362

 

$

1,365

 

$

1,500

 

$

-

 

$

2,166

 

$

41,709

 

Commercial real estate property expenditures

 

$

23,049

 

$

22,393

 

$

207

 

$

2,745

 

$

141

 

$

343

 

$

109

 

$

34,092

 

$

1,100

 

$

84,179

 

Segment assets at March 31, 2005

 

$

793,325

 

$

439,147

 

$

100,636

 

$

98,299

 

$

82,719

 

$

69,419

 

$

67,631

 

$

34,092

 

$

113,652

 

$

1,798,920

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31, 2004:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

25,278

 

$

10,886

 

$

2,506

 

$

124

 

$

4,679

 

$

1,555

 

$

2,243

 

$

-

 

$

1,700

 

$

48,971

 

Property operating expenses

 

8,125

 

3,312

 

40

 

33

 

1,486

 

598

 

742

 

-

 

703

 

$

15,039

 

NOI

 

$

17,153

 

$

7,574

 

$

2,466

 

$

91

 

$

3,193

 

$

957

 

$

1,501

 

$

-

 

$

997

 

$

33,932

 

Commercial real estate property expenditures

 

$

29,761

 

$

3,064

 

$

179

 

$

48,531

 

$

233

 

$

26,489

 

$

195

 

$

-

 

$

359

 

$

108,811

 

Segment assets at March 31, 2004

 

$

700,417

 

$

265,400

 

$

101,835

 

$

52,092

 

$

83,757

 

$

70,388

 

$

68,922

 

$

-

 

$

89,199

 

$

1,432,010

 

 

15



 

The following table reconciles our segment revenues to total revenues as reported on our Consolidated Statements of Operations:

 

 

 

For the Three Months Ended
March 31,

 

 

 

2005

 

2004

 

Segment revenues

 

$

60,627

 

$

48,971

 

Construction contract revenues

 

15,728

 

6,137

 

Other service operations revenues

 

1,369

 

1,515

 

Total revenues

 

$

77,724

 

$

56,623

 

 

The following table reconciles our NOI for reportable segments to income from continuing operations as reported on our Consolidated Statements of Operations:

 

 

 

For the Three Months Ended March 31,

 

 

 

2005

 

2004

 

NOI for reportable segments

 

$

41,709

 

$

33,932

 

Construction contract revenues

 

15,728

 

6,137

 

Other service operations revenues

 

1,369

 

1,515

 

Gain (loss) on sales of real estate

 

24

 

(222

)

Equity in loss of unconsolidated entities

 

 

(88

)

Income tax expense

 

(457

)

(200

)

Less:

 

 

 

 

 

Depreciation and other amortization associated with real estate operations

 

(14,666

)

(10,359

)

Construction contract expenses

 

(14,897

)

(5,818

)

Other service operations expenses

 

(1,291

)

(1,092

)

General and administrative expenses

 

(3,276

)

(2,286

)

Interest expense

 

(13,358

)

(10,262

)

Amortization of deferred financing costs

 

(396

)

(859

)

Minority interests

 

(1,449

)

(1,405

)

Income from continuing operations

 

$

9,040

 

$

8,993

 

 

The accounting policies of the segments are the same as those previously disclosed for Corporate Office Properties Trust and subsidiaries, where applicable.  We did not allocate gain (loss) on sales of real estate, 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 construction contract revenues, other service operations revenues, construction contract expenses, other service operations expenses, equity in loss of unconsolidated entities, general and administrative expense, income taxes and minority interests because these items represent general corporate items not attributable to segments.

 

17.          Income Taxes

 

COMI’s provision for income tax expense consisted of the following:

 

 

 

For the Three Months
Ended March 31,

 

 

 

2005

 

2004

 

Deferred

 

 

 

 

 

Federal

 

374

 

165

 

State

 

83

 

35

 

Total

 

$

457

 

$

200

 

 

16



 

Items contributing to temporary differences that lead to deferred taxes include net operating losses that are not deductible until future periods, depreciation and amortization, certain accrued compensation and compensation paid in the form of contributions to a deferred nonqualified compensation plan.

 

COMI’s combined Federal and state effective tax rate was 39% for the three months ended March 31, 2005 and 40% for the three months ended March 31, 2004.

 

18.          Commitments and Contingencies

 

In the normal course of business, we are involved in legal actions arising from our ownership and administration of properties.  Management does not anticipate that any liabilities that may result will 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 environmental 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.

 

Acquisition

 

As of March 31, 2005, we were under contract to acquire a land parcel in Linthicum, Maryland for $841.  We were also under contract to acquire two buildings and an adjacent land parcel in Rockville, Maryland for $43,300; we acquired these properties on April 7, 2005.

 

In addition, as of March 31, 2005, we were under contract to acquire a property in Washington County, Maryland for $9,000, subject to potential future reductions ranging from $750 to $4,000; the amount of such decrease will be determined based on defined levels of job creation resulting from the future development of the property taking place.  Upon completion of this acquisition, we will be obligated to incur $7,500 in development and construction costs for the property over approximately five years.

 

Property Sales

 

As of March 31, 2005, we were under contract to sell two properties, each owned by consolidated real estate joint ventures, for an aggregate of approximately $7,500.  These property sales will take place upon our completion of construction of new buildings on each of the properties.

 

Joint Ventures

 

We may be required to make additional unilateral capital contributions to Route 46 Partners, LLC of up to $320 to fund our partners’ preferred return.  We may also be required to fund leasing commissions associated with leasing space in this joint venture’s building to the extent such commissions exceed a defined amount; we do not expect that any such funding, if required, will be material to us.  In addition, we agreed to unilaterally loan the joint venture an additional $100 in the event that funds are needed by the entity.

 

We may need to make our pro rata share of additional investments in our real estate joint ventures (generally based on our percentage ownership) in the event that additional funds are needed.  In the event that the other members of these joint ventures do not pay their share of investments when additional funds are needed, we may then need to make even larger investments in these joint ventures.

 

In the three consolidated joint ventures that we owned as of March 31, 2005, we would be obligated to acquire the other members’ interest in each of the joint ventures (20% in the case of one and 50% each in the case of two) if defined events were to occur.  The amount we would need to pay for those membership interests is computed based on the amount that the owners of those interests would receive under the joint venture agreements in the event that office properties owned by the respective joint ventures were sold for a

 

17



 

capitalized fair value (as defined in the agreements) on a defined date.  We estimate the aggregate amount we would need to pay for our partners’ membership interests in these joint ventures to be $2,067; however, since the determination of this amount is dependent on the operations of the office properties and none of the properties are both completed and occupied, this estimate is preliminary and could be materially different from the actual obligation.

 

Operating Leases

 

We are obligated as lessee under five operating leases for office space.  Future minimum rental payments due under the terms of these leases as of March 31, 2005 follow:

 

2005

 

$

464

 

2006

 

364

 

2007

 

80

 

2008

 

70

 

2009

 

11

 

 

 

$

989

 

 

Land Leases

 

At March 31, 2005, we were obligated under leases for two parcels of land, both of which are being held for future development.  These leases provide for monthly rent through April 2079.  Future minimum rental payments due under the terms of these leases as of March 31, 2005 follow:

 

2005

 

$

18

 

2006

 

12

 

2007

 

12

 

2008

 

12

 

2009

 

12

 

Thereafter

 

832

 

 

 

$

898

 

 

The owners of these land parcels contributed them to the Operating Partnership in exchange for 142,776 common units in the Operating Partnership on April 18, 2005.  The common units were valued at $3,698.  At the time of the contribution, the leases were terminated.

 

Other Operating Leases

 

We are obligated under various leases for vehicles and office equipment.  Future minimum rental payments due under the terms of these leases as of March 31, 2005 follow:

 

2005

 

$

259

 

2006

 

282

 

2007

 

181

 

2008

 

92

 

2009

 

9

 

Thereafter

 

5

 

 

 

$

828

 

 

19.          Pro Forma Financial Information

 

We accounted for our 2004 and 2005 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 March 31, 2005.

 

18



 

We prepared our pro forma condensed consolidated financial information presented below as if all of our 2004 and 2005 acquisitions and dispositions of operating properties had occurred at the beginning of the respective periods.  The pro forma financial information is unaudited and is not necessarily indicative of the results that actually would have occurred if these acquisitions and dispositions had occurred at the beginning of the respective periods, nor does it intend to indicate our results of operations for future periods.

 

 

For the Three Months
Ended March 31,

 

 

 

2005

 

2004

 

 

 

 

 

 

 

Pro forma total revenues

 

$

77,724

 

$

63,982

 

Pro forma net income

 

$

9,040

 

$

9,457

 

Pro forma net income available to common shareholders

 

$

5,386

 

$

5,001

 

Pro forma earnings per common share on net income available to common shareholders

 

 

 

 

 

Basic

 

$

0.15

 

$

0.17

 

Diluted

 

$

0.14

 

$

0.16

 

 

20.          Subsequent Events

 

As previously discussed, on April 7, 2005, we acquired two buildings totaling 221,702 square feet and an adjacent 9.7 acre parcel of land located in Rockville, Maryland (Rockville, Maryland is part of the Suburban Maryland region).  We acquired the properties for a contract price of $43,300.

 

On April 7, 2005, we entered into a forward starting swap at a fixed rate of 5.0244% on a notional amount of $73,400.  We obtained this swap to lock in the 10-year LIBOR swap rate in contemplation of our obtaining a long-term, fixed rate financing later in 2005.  The swap goes into effect in July 2005 and expires in July 2015.  We expect to cash settle the swap at the time we lock the rate on a long-term, fixed rate financing.  If the 10-year LIBOR swap rate is below 5.0244% at the time we cash settle the swap, we would be required to make a payment to the swap counter-party; if the 10-year LIBOR swap rate is above 5.0244% at the time we cash settle the swap, we would receive a payment from the swap counter-party.  The amount that we either pay or receive would be equal to the present value of the basis point differential between 5.0244% and the 10-year LIBOR swap rate at the time we cash settle the swap.  This swap is a highly effective cash flow hedge under Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended.

 

On April 11, 2005, we executed a contribution agreement that formed a joint venture relationship with a limited partnership to develop up to 1.8 million square feet of office space on 63 acres of land located in Hanover, Maryland (located in the Baltimore/Washington Corridor).  Under the contribution agreement, we agreed to fund up to $2,200 in pre-construction costs associated with the property.  As we and the joint venture partner agree to proceed with the construction of buildings in the future, we would make additional cash capital contributions into newly-formed entities and our joint venture partner would contribute land into such entities.  We have a 50% interest in this joint venture relationship.

 

19



 

Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Overview

 

Corporate Office Properties Trust (“COPT”) and subsidiaries (collectively, the “Company”) is a real estate investment trust, or REIT, that focuses on the ownership, management, leasing, acquisition and development of suburban office properties.  We typically focus our operations geographically in select submarkets that are attractive to our tenant base and in which we believe we can establish a critical mass of square footage.  At March 31, 2005, all of our operating properties were located in the Mid-Atlantic region of the United States, although in accordance with our strategy of focusing on submarkets that are attractive to our tenants, we may from time to time seek to expand our operations outside of that region.  We conduct our real estate ownership activity through our operating partnership, Corporate Office Properties, L.P. (the “Operating Partnership”), for which we are the sole general partner.  The Operating Partnership owns real estate both directly and through subsidiary partnerships and limited liability companies.  The Operating Partnership also owns an entity through which we provide real estate-related services that include (1) property management, (2) construction and development management and (3) heating and air conditioning services and controls.  The number of operating properties in our portfolio totaled 145 as of March 31, 2005 and December 31, 2004.

 

During the three months ended March 31, 2005, we:

 

                  experienced increased revenues, operating expenses and earnings from real estate operations due primarily to the addition of properties through acquisition and construction activities since January 1, 2004;

                  experienced increased revenue from Same-Office Properties of $1.1 million, or 2%, and increased operating expenses from those properties of $1.7 million, or 11%;

                  finished the period with occupancy for our portfolio of properties at 92.4%;

                  renewed 80.3% of the square footage under leases expiring during the period; and

                  entered the San Antonio, Texas market with our acquisition for $30.7 million of two buildings.  These buildings are 100% leased but are initially undergoing redevelopment that is expected to be completed by the fourth quarter of 2005.

 

In this section, we discuss our financial condition and results of operations as of and for the three months ended March 31, 2005.  This section includes discussions on, among other things:

 

                  our results of operations and why various components of our Consolidated Statements of Operations changed for the three months ended March 31, 2005 compared to the same period in 2004;

                  how we raised cash for acquisitions and other capital expenditures during the three months ended March 31, 2005;

                  our cash flows;

                  how we expect to generate cash for short and long-term capital needs;

                  our off-balance sheet arrangements in place that are reasonably likely to affect our financial condition, results of operations and liquidity;

                  our commitments and contingencies; and

                  the computation of our Funds from Operations for the three months ended March 31, 2005 and 2004.

 

You should refer to our Consolidated Financial Statements and Selected Financial Data table as you read this section.

 

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 and operations of our business.  Forward-looking statements can be identified by the use of words such as “may,” “will,” “should,” “expect,” “estimate” or other comparable terminology.  Forward-looking statements are inherently subject to risks and uncertainties, many of which we cannot predict with accuracy and some of which we might not even

 

20



 

anticipate.  Although we believe that the expectations, estimates and projections reflected in such forward-looking statements are based on reasonable assumptions at the time made, we can give no assurance that these expectations, estimates and projections will be achieved.  Future events and actual results may differ materially from those discussed in the forward-looking statements.  Important factors that may affect these expectations, estimates and 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, interest rates and financing availability;

                  adverse changes in the real estate markets, including, among other things, increased competition with other companies;

                  risks of real estate acquisition and development activities, including, among other things, risks that development projects may not be completed on schedule, that tenants may not take occupancy or pay rent or that development and operating costs may be greater than anticipated;

                  risks of investing through joint venture structures, including risks that our joint venture partners may not fulfill their financial obligations as investors or may take actions that are inconsistent with our objectives;

                  governmental actions and initiatives; and

                  environmental requirements.

 

We undertake no obligation to update or supplement forward-looking statements.

 

21



 

Corporate Office Properties Trust and Subsidiaries

Operating Data Variance Analysis

 

(Dollars for this table are in thousands, except per share data)

 

 

 

For the Three Months Ended March 31,

 

 

 

2005

 

2004

 

Variance

 

% Change

 

Revenues

 

 

 

 

 

 

 

 

 

Rental revenue

 

$

53,263

 

$

43,194

 

$

10,069

 

23

%

Tenant recoveries and other real estate operations revenue

 

7,364

 

5,777

 

1,587

 

27

%

Construction contract revenues

 

15,728

 

6,137

 

9,591

 

156

%

Other service operations revenues

 

1,369

 

1,515

 

(146

)

(10

)%

Total revenues

 

77,724

 

56,623

 

21,101

 

37

%

Expenses

 

 

 

 

 

 

 

 

 

Property operating

 

18,918

 

15,039

 

3,879

 

26

%

Depreciation and other amortization associated with real estate operations

 

14,666

 

10,359

 

4,307

 

42

%

Construction contract expenses

 

14,897

 

5,818

 

9,079

 

156

%

Other service operations expenses

 

1,291

 

1,092

 

199

 

18

%

General and administrative expense

 

3,276

 

2,286

 

990

 

43

%

Total operating expenses

 

53,048

 

34,594

 

18,454

 

53

%

Operating income

 

24,676

 

22,029

 

2,647

 

12

%

Interest expense and amortization of deferred financing costs

 

(13,754

)

(11,121

)

(2,633

)

24

%

Gain (loss) on sales of real estate

 

24

 

(222

)

246

 

N/A

 

Equity in loss of unconsolidated entities

 

 

(88

)

88

 

(100

)%

Income tax expense

 

(457

)

(200

)

(257

)

129

%

Income from continuing operations before minority interests

 

10,489

 

10,398

 

91

 

1

%

Minority interests

 

(1,449

)

(1,405

)

(44

)

3

%

Net income

 

9,040

 

8,993

 

47

 

1

%

Preferred share dividends

 

(3,654

)

(4,456

)

802

 

(18

)%

Net income available to common shareholders

 

$

5,386

 

$

4,537

 

$

849

 

19

%

Basic earnings per common share

 

$

0.15

 

$

0.15

 

$

 

 

Diluted earnings per common share

 

$

0.14

 

$

0.14

 

$

 

 

 

22



 

Results of Operations

 

While reviewing this section, you should refer to the “Operating Data Variance Analysis” table set forth on the preceding page, as it reflects the computation of the variances described in this section.

 

Occupancy and leasing

 

The table below sets forth certain occupancy and leasing information:

 

 

 

March 31,
2005

 

December 31,
2004

 

Total rentable square feet (in thousands)

 

11,982

 

11,978

 

Occupancy for portfolio of properties

 

92.4

%

94.0

%

Average contractual rental rate per square foot (1)

 

$

20.68

 

$

20.32

 

Weighted average lease term (in years)

 

4.9

 

4.9

 

 


(1) Includes estimated expense reimbursements.

 

The decrease in occupancy from December 31, 2004 to March 31, 2005 is attributable primarily to an early lease termination involving 143,000 square feet in one of our buildings that occurred during the period.  We were able to renew 80.3% of the square footage under leases scheduled to expire in the three months ended March 31, 2005 (excluding the effect of early lease terminations).

 

23



 

Concentration of leases with certain tenants

 

The following schedule lists our 20 largest tenants based on percentage of portfolio annualized rental revenue:

 

 

 

Percentage of Portfolio
Annualized Rental Revenue
for 20 Largest Tenants as of

 

Tenant

 

March 31,
2005

 

December 31,
2004

 

 

 

 

 

 

 

United States of America

 

13.3

%

13.1

%

Booz Allen Hamilton, Inc.

 

5.0

%

5.4

%

Computer Sciences Corporation (1)

 

5.0

%

5.2

%

General Dynamics Corporation

 

3.9

%

3.7

%

Titan Corporation (1)

 

3.7

%

3.9

%

Northrop Grumman Corporation

 

3.6

%

3.6

%

Unisys (2)

 

3.4

%

3.4

%

AT&T Corporation  (1)

 

3.0

%

4.2

%

The Aerospace Corporation

 

2.5

%

2.2

%

Wachovia Bank

 

2.3

%

2.3

%

VeriSign, Inc.

 

2.0

%

1.4

%

The Boeing Company (1)

 

1.8

%

1.8

%

Ciena Corporation

 

1.4

%

1.4

%

Commonwealth of Pennsylvania (1)

 

1.3

%

1.3

%

Magellan Health Services, Inc.

 

1.2

%

1.1

%

PricewaterhouseCoopers LLP

 

1.2

%

1.3

%

Johns Hopkins University (1)

 

1.1

%

1.1

%

Merck & Co., Inc. (2)

 

1.0

%

1.0

%

Carefirst, Inc. and Subsidiaries (1)

 

1.0

%

1.0

%

BAE Systems

 

1.0

%

1.0

%

Subtotal of 20 largest tenants

 

58.7

%

59.4

%

All remaining tenants

 

41.3

%

40.6

%

Total

 

100.0

%

100.0

%

 


(1) Includes affiliated organizations and agencies.

(2) Unisys subleases space to Merck and Co., Inc.; revenue from this subleased space is classified as Merck & Co., Inc. revenue.

 

Annualized rental revenue is a measure that we use to evaluate the source of our rental revenue as of a point in time.  It is computed by multiplying by 12 the sum of monthly contractual base rents and estimated monthly expense reimbursements under active leases in our portfolio of properties as of a point in time.  Portfolio annualized rental revenue is annualized rental revenue for our entire portfolio of properties as of a point in time, including both consolidated properties and properties owned through unconsolidated real estate joint ventures.  We consider annualized rental revenue to be a useful measure for analyzing revenue sources because, since it is point-in-time based, it does not contain increases and decreases in revenue associated with periods in which lease terms were not in effect; historical revenue under generally accepted accounting principles (“GAAP”) does contain such fluctuations.  We find the measure particularly useful for leasing, tenant, segment and industry analysis.

 

Most of the leases with the United States Government provide for a series of one-year terms or provide for early termination rights.  The government may terminate its leases if, among other reasons, the United States Congress fails to provide funding.

 

24



 

Revenues from real estate operations and property operating expenses

 

We view our changes in revenues from real estate operations and property operating expenses as comprising two main components:

 

                  Changes attributable to the operations of properties owned and 100% operational throughout the two periods being compared.  We define these as changes from “Same-Office Properties.”  For example, when comparing the first quarters of 2004 and 2005, Same-Office Properties would be properties owned and 100% operational from January 1, 2004 through March 31, 2005.

                  Changes attributable to operating properties acquired during or in between the two periods being compared and newly-constructed properties that were placed into service and not 100% operational throughout the two periods being compared.  We define these as changes from “Property Additions.”

 

The table below sets forth the components of our changes in revenues from real estate operations and property operating expenses (dollars in thousands):

 

 

 

Property Additions

 

Same-Office Properties

 

Other

 

Total

 

 

 

Dollar

 

Dollar

 

Percentage

 

Dollar

 

Dollar

 

 

 

Change (1)

 

Change

 

Change

 

Change (2)

 

Change

 

Revenues from real estate operations

 

 

 

 

 

 

 

 

 

 

 

Rental revenue

 

$

10,058

 

$

156

 

0

%

$

(145

)

$

10,069

 

Tenant recoveries and other real estate operations revenue

 

644

 

934

 

16

%

9

 

$

1,587

 

Total

 

$

10,702

 

$

1,090

 

2

%

$

(136

)

$

11,656

 

 

 

 

 

 

 

 

 

 

 

 

 

Property operating expenses

 

$

3,074

 

$

1,660

 

11

%

$

(855

)

$

3,879

 

 

 

 

 

 

 

 

 

 

 

 

 

Straight-line rental revenue adjustments included in rental revenue

 

$

827

 

$

(17

)

N/A

 

$

2

 

$

812

 

Amortization of deferred market rental revenue

 

$

(85

)

$

(154

)

N/A

 

$

 

$

(239

)

 

 

 

 

 

 

 

 

 

 

 

 

Number of operating properties included in component category

 

25

 

119

 

N/A

 

N/A

 

144

 

 


(1)          Includes 22 acquired properties and three newly-constructed properties.

(2)          Includes, among other things, the effects of amounts eliminated in consolidation. Certain amounts eliminated in consolidation are attributable to the Property Additions and Same-Office Properties.

 

As the table above indicates, our total increase in revenues from real estate operations and property operating expenses was attributable primarily to the Property Additions.

 

The increase in rental revenue from the Same-Office Properties includes a decrease of $1.3 million in net revenue from the early termination of leases, $1.5 million of which was attributable to one property.  To explain further, when tenants terminate their lease obligations prior to the end of the agreed lease terms, they typically pay fees to break these obligations.  We recognize such fees as revenue and write off against such revenue any (1) deferred rents receivable and (2) deferred revenue and deferred assets that are amortizable into rental revenue associated with the leases; the resulting net amount is the net revenue from the early termination of the leases.  Rental revenue excluding net revenue from the early termination of leases increased $1.5 million, or 3.7%.

 

The increase in the Same-Office Properties’ property operating expenses included the following:

 

25



 

                  an increase of $1.0 million, or 43.3%, in utilities due primarily to (1) rate increases that we believe is the result of (a) increased oil prices and (b) energy deregulation in Maryland and (2) our assumption of responsibility for payment of utilities at certain properties due to changes in occupancy; and

                  an increase of $604,000, or 48.4%, in snow removal due to greater snow and ice precipitation in the current period.

 

Income from service operations

 

The table below sets forth changes in revenues and expenses from our service operations (dollars in thousands):

 

 

 

Changes between three months periods
ended March 31, 2005 and 2004

 

 

 

Construction
contract
dollar
change

 

Other
service
operations
dollar
change

 

Total dollar
change

 

Service operations

 

 

 

 

 

 

 

Revenues

 

$

9,591

 

$

(146

)

$

9,445

 

Expenses

 

9,079

 

199

 

9,278

 

Income from service operations

 

$

512

 

$

(345

)

$

167

 

 

The increase in construction contract revenue and expenses was attributable primarily to a large volume of activity for certain existing contracts during the current period.  We earned $831,000 in income from construction contracts (defined as construction contract revenues less construction contract expenses) in the current period; $543,000 of this income was attributable to three construction contracts.

 

Depreciation and amortization

 

Of the $4.3 million increase in our depreciation and other amortization expense, $2.6 million was attributable to the Property Additions and $1.6 million was attributable to the Same-Office Properties, a 16.0% increase for such properties.  The increase attributable to the Same-Office Properties included, among other things, depreciation of additional capital improvements.

 

General and administrative expenses

 

General and administrative expenses increased $990,000, or 43%.  Approximately $900,000 of this increase was due to increased compensation expenses; the increase in compensation expenses was attributable primarily to additional employee positions, increased salaries and bonus expense for existing employees and a $250,000 bonus paid to Clay W. Hamlin, III, our former Chief Executive Officer, in connection with his retirement.

 

Interest expense and amortization of deferred financing costs