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, 2006

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 a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer ý

Accelerated filer o

Non-accelerated filer o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) o  Yes    ý  No

 

On May 2, 2006, 42,265,475 shares of the Company’s Common Shares of Beneficial Interest, $0.01 par value, were issued.

 

 

TABLE OF CONTENTS

 

FORM 10-Q

 

 

PART I: FINANCIAL INFORMATION
Item 1:	Financial Statements:
	Consolidated Balance Sheets as of March 31, 2006 and December 31, 2005 (unaudited)
	Consolidated Statements of Operations for the three months ended March 31, 2006 and 2005 (unaudited)
	Consolidated Statements of Cash Flows for the three months ended March 31, 2006 and 2005 (unaudited)
	Notes to Consolidated Financial Statements
Item 2:	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3:	Quantitative and Qualitative Disclosures About Market Risk
Item 4:	Controls and Procedures
PART II: OTHER INFORMATION
Item 1:	Legal Proceedings
Item 1A:	Risk Factors
Item 2:	Unregistered Sales of Equity Securities and Use of Proceeds
Item 3:	Defaults Upon Senior Securities
Item 4:	Submission of Matters to a Vote of Security Holders
Item 5:	Other Information
Item 6:	Exhibits
SIGNATURES

 

2

 

PART I: FINANCIAL INFORMATION

ITEM 1. Financial Statements

 

Corporate Office Properties Trust and Subsidiaries

Consolidated Balance Sheets

(Dollars in thousands)

(unaudited)

 

		March 31, 2006			December 31, 2005
Assets
Investment in real estate:
Operating properties, net		$	1,632,056		$	1,631,038
Projects under construction or development		267,345			255,617
Total commercial real estate properties, net		1,899,401			1,886,655
Investments in and advances to unconsolidated real estate joint ventures		1,439			1,451
Investment in real estate, net		1,900,840			1,888,106
Cash and cash equivalents		20,169			10,784
Restricted cash		23,793			21,476
Accounts receivable, net		16,729			15,606
Investment in other unconsolidated entity		1,621			1,621
Deferred rent receivable		34,247			32,579
Intangible assets on real estate acquisitions, net		85,699			90,984
Deferred charges, net		33,731			35,046
Prepaid and other assets		21,722			29,255
Furniture, fixtures and equipment, net		4,214			4,302
Fair value of derivatives		110			—
Total assets		$	2,142,875		$	2,129,759
Liabilities and shareholders’ equity
Liabilities:
Mortgage and other loans payable		$	1,360,638		$	1,348,351
Accounts payable and accrued expenses		42,792			41,693
Rents received in advance and security deposits		16,394			14,774
Dividends and distributions payable		16,878			16,703
Deferred revenue associated with acquired operating leases		11,721			12,707
Distributions in excess of investment in unconsolidated real estate joint venture		3,010			3,081
Other liabilities		5,314			4,727
Total liabilities		1,456,747			1,442,036
Minority interests:
Common units in the Operating Partnership		92,903			95,014
Preferred units in the Operating Partnership		8,800			8,800
Other consolidated real estate joint ventures		1,190			1,396
Total minority interests		102,893			105,210
Commitments and contingencies (Note 20)
Shareholders’ equity:
Preferred Shares of beneficial interest ($0.01 par value; shares authorized of 15,000,000, issued of 8,569,000 and outstanding of 6,775,000) (Note 14)		67			67
Common Shares of beneficial interest ($0.01 par value; 75,000,000 shares authorized, shares issued and outstanding of 40,243,729 at March 31, 2006 and 39,927,316 at December 31, 2005)		400			399
Additional paid-in capital		655,818			657,339
Cumulative distributions in excess of net income		(72,670		)	(67,697		)
Value of unearned restricted common share grants		—			(7,113		)
Accumulated other comprehensive loss		(380		)	(482		)
Total shareholders’ equity		583,235			582,513
Total liabilities and shareholders’ equity		$	2,142,875		$	2,129,759

 

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,
		2006			2005
Revenues
Rental revenue		$	62,662		$	51,701
Tenant recoveries and other real estate operations revenue		9,038			7,227
Construction contract revenues		14,544			15,728
Other service operations revenues		1,765			1,369
Total revenues		88,009			76,025
Expenses
Property operating expenses		21,885			18,169
Depreciation and other amortization associated with real estate operations		19,313			14,169
Construction contract expenses		14,026			14,897
Other service operations expenses		1,678			1,291
General and administrative expenses		3,963			3,276
Total operating expenses		60,865			51,802
Operating income		27,144			24,223
Interest expense		(17,584		)	(12,962		)
Amortization of deferred financing costs		(559		)	(396		)
Income from continuing operations before equity in loss of unconsolidated entities, income taxes and minority interests		9,001			10,865
Equity in loss of unconsolidated entities		(23		)	—
Income tax expense		(215		)	(457		)
Income from continuing operations before minority interests		8,763			10,408
Minority interests in income from continuing operations
Common units in the Operating Partnership		(909		)	(1,292		)
Preferred units in the Operating Partnership		(165		)	(165		)
Other consolidated entities		33			24
Income from continuing operations		7,722			8,975
Income from discontinued operations, net of minority interests		2,105			46
Income before gain on sales of real estate		9,827			9,021
Gain on sales of real estate, net		110			19
Net income		9,937			9,040
Preferred share dividends		(3,654		)	(3,654		)
Net income available to common shareholders		$	6,283		$	5,386
Basic earnings per common share
Income from continuing operations		$	0.11		$	0.15
Discontinued operations		0.05			—
Net income		$	0.16		$	0.15
Diluted earnings per common share
Income from continuing operations		$	0.10		$	0.14
Discontinued operations		0.05			—
Net income		$	0.15		$	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,
		2006			2005
Cash flows from operating activities
Net income		$	9,937		$	9,040
Adjustments to reconcile net income to net cash provided by operating activities:
Minority interests		1,538			1,449
Depreciation and other amortization		19,337			14,666
Amortization of deferred financing costs		559			396
Amortization of deferred market rental revenue		(556		)	(70		)
Equity in loss of unconsolidated entities		23			—
Gain on sales of real estate		(2,571		)	(24		)
Excess income tax benefits from share-based compensation		(258		)	—
Changes in operating assets and liabilities:
Increase in deferred rent receivable		(2,198		)	(1,608		)
Decrease (increase) in accounts receivable, restricted cash and prepaid and other assets		4,029			(2,678		)
(Decrease) increase in accounts payable, accrued expenses, rents received in advance and security deposits		(1,017		)	1,898
Other		563			1,843
Net cash provided by operating activities		29,386			24,912
Cash flows from investing activities
Purchases of and additions to commercial real estate properties		(38,267		)	(84,955		)
Proceeds from sales of properties		28,217			—
Investments in and advances to unconsolidated entities		(190		)	(8		)
Distributions from unconsolidated entities		113			—
Leasing costs paid		(1,984		)	(1,675		)
Other		43			(49		)
Net cash used in investing activities		(12,068		)	(86,687		)
Cash flows from financing activities
Proceeds from mortgage and other loans payable		47,905			93,458
Repayments of mortgage and other loans payable		(36,559		)	(24,365		)
Deferred financing costs paid		(49		)	(235		)
Acquisition of partner interests in consolidated joint ventures		(3,016		)	—
Distributions paid to partners in consolidated joint ventures		(787		)	—
Net proceeds from issuance of common shares		1,581			593
Dividends paid		(14,721		)	(12,941		)
Distributions paid		(2,553		)	(2,344		)
Excess income tax benefits from share-based compensation		258			—
Other		8			—
Net cash (used) provided by financing activities		(7,933		)	54,166
Net increase (decrease) in cash and cash equivalents		9,385			(7,609		)
Cash and cash equivalents
Beginning of period		10,784			13,821
End of period		$	20,169		$	6,212

 

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”) that focuses on the acquisition, development, ownership, management and leasing of primarily Class A suburban office properties in the Greater Washington, D.C. region and other select submarkets. We have implemented a core customer expansion strategy that is built on meeting, through acquisitions and development, the multi-location requirements of our strategic tenants. As of March 31, 2006, our investments in real estate included the following:

 

•      163 wholly owned operating properties totaling 13.7 million square feet;

•      13 wholly owned properties under construction or development that we estimate will total approximately 1.6 million square feet upon completion and two wholly owned office properties totaling approximately 115,000 square feet that were under redevelopment;

•      wholly owned land parcels totaling 352 acres that we believe are potentially developable into approximately 5.1 million square feet; and

•      partial ownership interests in a number of other real estate projects in operations or under development or redevelopment.

 

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 securities owned by COPT as of March 31, 2006 follows:

 

Common Units		82	%
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	%

 

Two of our trustees controlled, either directly or through ownership by other entities or family members, an additional 15% of the Operating Partnership’s common units.

 

In addition to owning interests in real estate, the Operating Partnership also owns 100% of Corporate Office Management, Inc. (“COMI”) and owns, either directly or through COMI, 100% of the consolidated subsidiaries that are set forth below (collectively defined as the “Service Companies”):

 

Entity Name		Type of Service Business
COPT Property Management Services, LLC (“CPM”)		Real Estate Management
COPT Development & Construction Services, LLC (“CDC”)		Construction and Development
Corporate Development Services, LLC (“CDS”)		Construction and Development
Corporate Cooling & Controls, LLC (“CC&C”)		Heating and Air Conditioning

 

Most of the services that CPM provides are for us. CDC, CDS and CC&C provide services to us and to third parties.

 

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

 

6

 

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 2005 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.

 

3.             Earnings Per Share (“EPS”)

 

We present both basic and diluted EPS. We compute basic EPS by dividing net income available to common shareholders by the weighted average number of common shares outstanding during the year. Our computation of diluted EPS is similar except that:

 

•      the denominator is increased to include: (1) the weighted average number of potential additional common shares that would have been outstanding if securities that are convertible into our common shares were converted; and (2) the effect of dilutive potential common shares outstanding during the period attributable to share-based compensation using the treasury stock method; 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 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,
		2006			2005
Numerator:
Income from continuing operations		$	7,722		$	8,975
Add: Gain on sales of real estate, net		110			19
Less: Preferred share dividends		(3,654		)	(3,654		)
Numerator for basic and diluted EPS from continuing operations available to common shareholders		4,178			5,340
Add: Income from discontinued operations, net		2,105			46
Numerator for basic and diluted EPS on net income available to common shareholders		$	6,283		$	5,386
Denominator (all weighted averages):
Denominator for basic EPS (common shares)		39,668			36,555
Dilutive effect of share-based compensation awards		1,842			1,537
Denominator for diluted EPS		41,510			38,092
Basic EPS:
Income from continuing operations		$	0.11		$	0.15
Income from discontinued operations		0.05			—
Net income available to common shareholders		$	0.16		$	0.15
Diluted EPS:
Income from continuing operations		$	0.10		$	0.14
Income from discontinued operations		0.05			—
Net income available to common shareholders		$	0.15		$	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:

 

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		Weighted Average Shares in Denominator For the Three Months Ended March 31,
		2006		2005
Conversion of weighted average common units		8,520		8,544
Conversion of weighted average convertible preferred units		176		176
Share-based compensation awards		—		143

 

4.             Recent Accounting Pronouncements

 

See Note 5 for disclosure associated with our implementation of recent accounting pronouncements relating to our accounting for share-based compensation.

 

In June 2005, the FASB ratified the consensus reached by the Emerging Issues Task Force (“EITF”) regarding EITF 04-05, “Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights.” The conclusion provided a framework for addressing the question of when a general partner, as defined in EITF 04-05, should consolidate a limited partnership. Under the consensus, a general partner is presumed to control a limited partnership (or similar entity) and should consolidate that entity unless the limited partners possess kick-out rights or other substantive participating rights as described in EITF 96-16, “Investor’s Accounting for an Investee When the Investor has a Majority of the Voting Interest but the Minority Shareholder or Shareholders Have Certain Approval or Veto Rights.” This EITF is effective for all new limited partnerships formed and for existing limited partnerships for which the partnership agreements are modified after June 29, 2005, and, as of January 1, 2006, for existing limited partnership agreements. The EITF did not impact us in 2005. The adoption of this EITF in 2006 for existing limited partnership agreements did not have a material effect on our financial position, results of operations or cash flows.

 

5.             Share-Based Compensation

 

Share-based Compensation Plans

 

In 1993, we adopted a share option plan for our Trustees under which we have 75,000 common shares reserved for issuance. These options expire ten years after the date of grant and are all exercisable. Shares for this plan are issued under a registration statement on a Form S-8 that became effective upon filing with the Securities and Exchange Commission. As of March 31, 2006, there were no awards available for future grant under this plan.

 

In March 1998, we adopted a long-term incentive plan for our Trustees and employees. This plan provides for the award of options to acquire our common shares (“share options”), common shares subject to forfeiture restrictions (“restricted shares”) and dividend equivalents. We are authorized to issue awards under the plan amounting to no more than 13% of the total of (1) our common shares outstanding plus (2) the number of shares that would be outstanding upon redemption of all units of the Operating Partnership or other securities that are convertible into our common shares. Trustee options under this plan become exercisable beginning on the first anniversary of their grant. The vesting periods for employees’ options under this plan range from immediately to five years, although they generally, on average, are three years. Restricted shares generally vest annually in the following increments: 16% upon the first anniversary following the date of grant, 18% upon the second anniversary, 20% upon the third anniversary, 22% upon the fourth anniversary and 24% upon the fifth anniversary. Options expire ten years after the date of grant. Shares for this plan are issued under a registration statement filed on a Form S-8 that became effective upon filing with the Securities and Exchange Commission. As of March 31, 2006, we had 647,570 awards available for future grant under this plan.

 

The following table summarizes share option transactions under the plans described above for the three months ended March 31, 2006:

 

8

 

		Shares		Weighted Average Exercise Price per Share			Weighted Average Remaining Contractual Term (in Years)		Aggregate Intrinsic Value
Outstanding at December 31, 2005		2,709,927		$	14.41
Granted		188,089		$	41.15
Forfeited		(13,183	)	$	27.54
Exercised		(151,448	)	$	12.98
Outstanding at March 31, 2006		2,733,385		$	16.26		6		$	80,574
Exercisable at March 31, 2006		2,019,857		$	11.08		5		$	70,010
Options expected to vest		677,852		$	30.94		9		$	10,035

 

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the difference between the closing stock price of our common shares on March 31, 2006 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had the holders of in-the-money options exercised their options on March 31, 2006. This amount changes based on the fair market value of our common shares. The total intrinsic value of options exercised during the three months ended March 31, 2006 was $4,428.

 

We received $1,966 in proceeds from the exercise of share options during the three months ended March 31, 2006.

 

The following table summarizes restricted share transactions under the plans described above for the three months ended March 31, 2006:

 

		Shares		Weighted Average Grant Date Fair Value
Unvested at December 31, 2005		395,609		$	19.88
Granted		133,420		$	42.06
Forfeited		(7,685	)	$	20.12
Vested		(119,237	)	$	17.20
Unvested at March 31, 2006		402,107		$	28.03
Restricted shares expected to vest		382,002

 

The total fair value of restricted shares vested during the three months ended March 31, 2006 was $5,110.

 

We realized a windfall tax benefit of $258 on options exercised and restricted shares vested during the three months ended March 31, 2006.

 

Adoption of Statement of Financial Accounting Standards No. 123(R)

 

We have historically issued two forms of share-based compensation: share options and restricted shares. Prior to January 1, 2006, when we adopted Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment” (“SFAS 123(R)”), our general method for accounting for these forms of share-based compensation was as follows:

 

•      Share options: These awards were accounted for using the intrinsic value method. Under this method, we recorded compensation expense only when the exercise price of a grant was less than the market price of our common shares on the option grant date; when this occurred, we recognized compensation expense equal to the

 

9

 

difference between the exercise price and the grant-date market price over the service period to which the options related.

•      Restricted shares: We computed compensation expense for restricted share grants based on the value of such grants, as determined by the value of our common shares on the applicable measurement date (generally the date of grant). We recognized compensation expense for such grants over the service periods to which the grants related based on the vesting schedules for such grants.

 

In December 2004, the Financial Accounting Standards Board (“FASB”) issued 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 requires 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 should then 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 cost is recognized for equity instruments for which employees do not render the requisite service. In 2005, the FASB also issued several FASB Staff Positions that clarify certain aspects of SFAS 123(R). SFAS 123(R) became effective for us on January 1, 2006, applying to all awards granted after January 1, 2006 and to awards modified, repurchased or cancelled after that date. We used the modified prospective application approach to adoption provided for under SFAS 123(R); under this approach, we recognized compensation cost on or after January 1, 2006 for the portion of outstanding awards for which the requisite service was not yet rendered, based on the fair value of those awards on the date of grant.

 

The primary effect of our adoption of SFAS 123(R) on our Consolidated Financial Statements is that beginning January 1, 2006 we are: (1) incurring higher expense associated with share options issued to employees relative to what we would have recognized under the intrinsic value method; (2) recognizing expenses associated with restricted common shares over the life of the grant using a straight line basis methodology over the service period; and (3) reporting the benefits of tax deductions in excess of recognized compensation costs as cash flow from financing activities (such benefits were previously reported as operating cash flows).

 

Prior to our adoption of SFAS 123(R), we provided disclosures in our financial statements for periods prior to 2006 that summarized what our operating results would have been if we had 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” (“SFAS 123”). In computing the amounts that appeared in these disclosures, we accounted for forfeitures as they occurred. SFAS 123(R) requires that share-based compensation be computed based on awards that are ultimately expected to vest. As a result, future forfeitures of awards are to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. SFAS 123(R) also requires that companies make a one-time cumulative effect adjustment upon adoption of the standard to record the effect that estimated future forfeitures of outstanding awards would have on expenses previously recognized in the companies’ financial statements; we did not record such a cumulative effect adjustment since we determined that the effect of pre-vesting forfeitures on our recorded expense has historically been negligible. The amounts included in our Consolidated Statements of Operations for share-based compensation in the three months ended March 31, 2006 reflected an estimate of pre-vesting forfeitures of approximately 5%.

 

In the disclosures that we provided in our financial statements for periods prior to 2006 that summarized what our operating results would have been if we had elected to account for our share-based compensation under the fair value provisions of SFAS 123, we did not capitalize costs associated with share-based compensation. Effective upon our adoption of SFAS 123(R), we began capitalizing costs associated with share-based compensation.

 

On November 10, 2005, the FASB issued FASB Staff Position No. FAS 123(R)-3, “Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards.” We elected to adopt the alternative transition method provided in this FASB Staff Position for calculating the tax effects of share-based compensation pursuant to SFAS 123(R). The alternative transition method includes a simplified method to establish the beginning balance of the additional paid-in capital pool (APIC pool) related to the tax effects of employee share-based compensation, which is available to absorb tax deficiencies recognized subsequent to the adoption of SFAS 123(R).

 

We compute the fair value of share options under SFAS 123(R) using the Black-Scholes option-pricing model; the weighted average assumptions we used in that model for share options issued during the three months ended March 31, 2006 are set forth below:

 

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Weighted average fair value of grants on grant date		$	5.46
Risk-free interest rate		4.62		%(1)
Expected life-years		7.06
Expected volatility		23.88		%
Expected dividend yield		6.41		%

 

(1) Ranged from 4.35% to 4.79%.

 

The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant. The expected option life is based on our historical experience of employee exercise behavior. Expected volatility is based on historical volatility of our common shares. Expected dividend yield is based on the average historical dividend yield on our common shares over a period of time ending on the grant date of the options.

 

The table below sets forth information relating to expenses from share-based compensation included in our Consolidated Statements of Operations for the three months ended March 31, 2006:

 

Increase in general and administrative expenses		$	469
Increase in construction contract and other service operations expenses		144
Share-based compensation expense		613
Income taxes		(17			)
Minority interests		(109			)
Net share-based compensation expense		$		487
Net share-based compensation expense per share
Basic		$		0.01
Diluted		$		0.01

 

We also capitalized approximately $28 in share-based compensation costs.

 

As of March 31, 2006, there was $1,627 of unrecognized compensation cost related to nonvested options that is expected to be recognized over a weighted average period of approximately two years. As of March 31, 2006, there was $9,714 of unrecognized compensation cost related to nonvested restricted shares that is expected to be recognized over a weighted average period of approximately three years.

 

Disclosure for Periods Prior to 2006, Including Pro Forma Financial Information Under SFAS 123

 

Expenses from share-based compensation reflected in our Consolidated Statements of Operations for the three months ended March 31, 2005 were as follows:

 

Increase in general and administrative expenses		$	413
Increase in construction contract and other service operations expenses		46

 

The following table summarizes our operating results for the three months ended March 31, 2005 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” in that period:

 

11

 

Net income, as reported		$	9,040
Add: Share-based compensation expense, net of related tax effects and minority interests, included in the determination of net income		354
Less: Share-based compensation expense determined under the fair value based method, net of related tax effects and minority interests		(339		)
Net income, pro forma		$	9,055
Basic EPS on net income available to common shareholders, as reported		$	0.15
Basic EPS on net income available to common shareholders, pro forma		$	0.15
Diluted EPS on net income available to common shareholders, as reported		$	0.14
Diluted EPS on net income available to common shareholders, pro forma		$	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.

 

6.             Commercial Real Estate Properties

 

Operating properties consisted of the following:

 

		March 31, 2006			December 31, 2005
Land		$	314,550		$	314,719
Buildings and improvements		1,501,426			1,491,254
		1,815,976			1,805,973
Less: accumulated depreciation		(183,920		)	(174,935		)
		$	1,632,056		$	1,631,038

 

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

 

		March 31, 2006			December 31, 2005
Land		$	126,738		$	117,434
Construction in progress		140,607			138,183
		$	267,345		$	255,617

 

2006 Acquisitions

 

During the three months ended March 31, 2006, we acquired the following:

 

•      a property located in Colorado Springs, Colorado containing a 60,000 square foot building that will be redeveloped and a four acre parcel of land that we believe can support approximately 30,000 developable square feet for $2,602 on January 19, 2006;

•      a 31-acre parcel of land located in San Antonio, Texas that we believe can support up to 375,000 developable square feet for $7,430 on January 20, 2006;

•      a six-acre parcel of land located in Hanover, Maryland that we believe can support up to 60,000 developable square feet for $2,142 on February 28, 2006 (Hanover, Maryland is located in the Baltimore/Washington Corridor).

 

We also acquired a 50% interest in a joint venture called Commons Office 6-B, LLC that owns a land parcel located in Hanover, Maryland for $1,830 on February 10, 2006. The joint venture is constructing an office property totaling approximately 44,000 square feet on the land parcel.

 

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2006 Construction and Pre-Construction Activities

 

During 2006, we placed into service a 162,000 square foot building located in Annapolis Junction, Maryland (Annapolis Junction, Maryland is located in the Baltimore/Washington Corridor).

 

As of March 31, 2006, we had construction underway on six new buildings in the Baltimore/Washington Corridor (including the one 50% joint venture discussed above), one in Northern Virginia, one in St. Mary’s County, Maryland and one in Colorado Springs, Colorado. We also had pre-construction activities underway on four new buildings located in the Baltimore/Washington Corridor, one in King George County, Virginia, one in Colorado Springs, Colorado and one in Suburban Baltimore. In addition, we had redevelopment underway on (1) two wholly owned existing buildings (one is located in the Baltimore/Washington Corridor and the other in Colorado Springs, Colorado) and (2) two buildings owned by a joint venture (one is located in Northern Virginia and the other in the Baltimore/Washington Corridor).

 

2006 Dispositions

 

During the three months ended March 31, 2006, we sold the following operating properties:

 

Project Name		Location		Date of Sale		Number of Buildings		Total Rentable Square Feet		Sale Price			Gain on Sale
Lakeview at the Greens		Laurel, Maryland (1	)	2/6/2006		2		141,783		$	17,000		$	2,087
68 Culver Road		Dayton, New Jersey		3/8/2006		1		57,280		9,700			348
						3		199,063		$	26,700		$	2,435

 

(1)   Laurel, Maryland is located in the Suburban Maryland region.

 

In addition, on January 17, 2006, we sold a newly constructed property in Columbia, Maryland (located in the Baltimore/Washington Corridor) for $2,530. We recognized a gain of $111 on this sale.

 

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:

 

		Investment Balance at						Date Acquired		Ownership		Nature of Activity		Total Assets at 3/31/2006			Maximum Exposure to Loss (1)
		March 31, 2006			December 31, 2005
Route 46 Partners		$	1,439	(2)	$	1,451	(2)	3/14/2003		20	%	Operates one building	(3)	$	23,359		$	1,620
Harrisburg Corporate Gateway Partners, L.P.		(3,010)		(4)	(3,081)		(4)	9/29/2005		20	%	Operates 16 buildings	(5)	78,382			—

 

(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 respective ownership percentages. Also not reported above are additional unilateral contributions or loans from us, the amounts of which are uncertain, that would be due if certain contingent events occurred.

(2)   The carrying amount of our investment in this joint venture was lower than our share of the equity in the joint venture by $1,370 at March 31, 2006 and December 31, 2005 due to our deferral of gain on the contribution by us of real estate into the joint venture upon its formation.  A difference will continue to exist to the extent the nature of our continuing involvement in the joint venture does not change.

(3)   This joint venture’s property is located in Fairfield, New Jersey.

(4)   The carrying amount of our investment in this joint venture was lower than our share of the equity in the joint venture by $5,198 at March 31, 2006 and $5,204 at December 31, 2005 due to our deferral of gain on the contribution by us of real estate into the joint venture upon its formation.  A difference will continue to exist to the extent the nature of our continuing involvement in the joint venture does not change.

(5)   This joint venture’s properties are located in Greater Harrisburg, Pennsylvania.

 

The following table sets forth condensed balance sheets for our unconsolidated real estate joint ventures:

 

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		March 31, 2006			December 31, 2005
Commercial real estate property		$	94,701		$	94,552
Other assets		7,040			8,006
Total assets		$	101,741		$	102,558
Liabilities		$	82,275		$	82,619
Owners’ equity		19,466			19,939
Total liabilities and owners’ equity		$	101,741		$	102,558

 

The following table sets forth a combined condensed statement of operations for the three months ended March 31, 2006 for the two unconsolidated joint ventures we owned as of March 31, 2006:

 

Revenues		$	3,204
Property operating expenses		(1,105		)
Interest expense		(1,162		)
Depreciation and amortization expense		(912		)
Net income		$	25

 

Our joint venture partner in Route 46 Partners has preference in receiving distributions of cash flows for a defined return. Once our partner receives its defined return, we are entitled to receive distributions for a defined return. We did not recognize income from our investment in Route 46 Partners in the three months ended March 31, 2006 since the income earned by the entity in those periods did not exceed our partner’s defined return.

 

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

 

		Date Acquired		Ownership % at 3/31/2006		Nature of Activity		Total Assets at 3/31/2006			Collateralized Assets at 3/31/2006
COPT Opportunity Invest I, LLC		12/20/2005		92.5	%	Redeveloping two properties (1)		$	36,022		$	—
Commons Office 6-B, LLC		2/10/2006		50.0	%	Developing land parcel (2)		5,614			5,569
MOR Forbes 2 LLC		12/24/2002		50.0	%	Operating building (3)		4,298			3,892
								$	45,934		$	9,461

 

(1) This joint venture owns one property in Northern Virginia and one in the Baltimore/Washington Corridor.

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

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

 

On January 17, 2006 we acquired our partner’s remaining 50% interest in MOR Montpelier 3 LLC, an entity that recently completed the construction of an office property, for $1,186. We then sold the property to a third party for $2,530, as discussed in Note 6.

 

Our commitments and contingencies pertaining to our real estate joint ventures are disclosed in Note 20.

 

8.             Intangible Assets on Real Estate Acquisitions

 

Intangible assets on real estate acquisitions consisted of the following:

 

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		March 31, 2006									December 31, 2005
		Gross Carrying Amount			Accumulated Amortization			Net Carrying Amount			Gross Carrying Amount			Accumulated Amortization			Net Carrying Amount
Lease-up value		$	92,854		$	24,845		$	68,009		$	92,812		$	20,824		$	71,988
Lease cost portion of deemed cost avoidance		11,054			4,375			6,679			11,054			3,991			7,063
Lease to market value		9,772			5,688			4,084			9,772			5,277			4,495
Tenant relationship value		6,026			310			5,716			6,349			130			6,219
Market concentration premium		1,333			122			1,211			1,333			114			1,219
		$	121,039		$	35,340		$	85,699		$	121,320		$	30,336		$	90,984

 

9.             Deferred Charges

Deferred charges consisted of the following:

 

		March 31, 2006			December 31, 2005
Deferred leasing costs		$	43,239		$	42,752
Deferred financing costs		21,659			21,574
Goodwill		1,853			1,853
Deferred other		155			155
		66,906			66,334
Accumulated amortization		(33,175		)	(31,288		)
Deferred charges, net		$	33,731		$	35,046

 

10.          Accounts Receivable

 

Our accounts receivable are reported net of an allowance for bad debts of $388 at March 31, 2006 and $421 at December 31, 2005.

 

11.          Prepaid and Other Assets

 

Prepaid and other assets consisted of the following:

 

		March 31, 2006			December 31, 2005
Construction contract costs incurred in excess of billings		$	10,309		$	15,277
Prepaid expenses		4,733			7,007
Other assets		6,680			6,971
Prepaid and other assets		$	21,722		$	29,255

 

12.          Derivatives

 

The following table sets forth our one derivative contract at March 31, 2006 and its fair value:

 

Fair Value at

Nature of Derivative

Notional Amount

One-Month LIBOR base

Effective Date

Expiration Date

March 31, 2006

December 31, 2005

Interest rate swap

$

50,000

5.0360

%

3/28/2006

3/30/2009

$

110

N/A

 

We designated this derivative as a cash flow hedge. The contract hedges the risk of changes in interest rates on certain of our one-month LIBOR-based variable rate borrowings until its maturity.

 

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

 

		For the Three Months Ended March 31,
		2006			2005
Increase in fair value applied to AOCL (1) and minority interests		$	110		$	—

 

(1)   AOCL is accumulated other comprehensive loss.

 

13.          Mortgages and Other Loans Payable

 

Mortgage and other loans payable consisted of the following:

 

		Maximum Principal Amount Under Loans at March 31, 2006			Carrying Value at								Scheduled Maturity Dates at March 31, 2006
					March 31, 2006			December 31, 2005			Stated Interest Rates at March 31, 2006
Revolving Credit Facility
Wachovia Bank, N.A. Revolving Credit Facility		$	400,000		$	279,000		$	273,000		LIBOR + 1.15% to 1.55%		March 2008 (1)
Mortgage Loans
Fixed rate mortgage loans (2)		N/A			913,562			921,265			3.00% - 9.48% (3)		2006 - 2034 (4)
Variable rate construction loan facilities		125,701			84,228			70,238			LIBOR + 1.40 to 2.20%		2006 - 2008 (5)
Other variable rate mortgage loans		N/A			82,800			82,800			LIBOR + 1.15% to 1.55% and Prime rate + 2.50%		2006 - 2010
Total mortgage loans					1,080,590			1,074,303
Note payable
Unsecured seller note		N/A			1,048			1,048			5.95%		May 2007 (6)
Total mortgage and other loans payable, net					$	1,360,638		$	1,348,351

 

(1)   The Revolving Credit Facility may be extended for a one-year period, subject to certain conditions.

(2)   Several of the fixed rate mortgages carry interest rates that were above or below market rates upon assumption and therefore are recorded at their fair value based on applicable effective interest rates. The carrying values of these loans reflect net premiums totaling $1,247 at March 31, 2006 and $1,391 at December 31, 2005.

(3)   The weighted average interest rate on these loans was 6.9% at March 31, 2006.

(4)   A loan with a balance of $4,945 at March 31, 2006 that matures in 2034 may be repaid in March 2014, subject to certain conditions.

(5)   At March 31, 2006, $44.4 million in loans scheduled to mature in 2008 may be extended for a one-year period, subject to certain conditions.

(6)   This loan is callable within 90 days by the lender.

 

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