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:

 

7



 

 

 

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:

 

10



 

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.

 

12



 

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:

 

13



 

 

 

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:

 

14



 

 

 

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.

 

15



 

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.

 

16



 

14.          Shareholders’ Equity

 

Preferred Shares

 

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

 

 

 

March 31,
2006

 

December 31,
2005

 

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, 2006, we converted 43,425 common units in our Operating Partnership into common shares on the basis of one common share for each common unit.

 

See Note 5 for disclosure of common share activity pertaining to our share-based compensation plans.

 

Accumulated Other Comprehensive Loss

 

The table below sets forth activity in the AOCL component of shareholders’ equity:

 

 

 

For the Three Months
Ended March 31,

 

 

 

2006

 

2005

 

Beginning balance

 

$

(482

)

$

 

Unrealized gain on derivatives, net of minority interests

 

90

 

 

Realized loss on derivatives, net of minority interests

 

12

 

 

Ending balance

 

$

(380

)

$

 

 

The table below sets forth our comprehensive income:

 

 

 

For the Three Months

Ended March 31,

 

 

 

2006

 

2005

 

Net income

 

$

9,937

 

$

9,040

 

Unrealized gain on derivatives, net of minority interests

 

90

 

 

Realized loss on derivatives, net of minority interests

 

12

 

 

Total comprehensive income

 

$

10,039

 

$

9,040

 

 

17



 

15.          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, 2006:

 

 

 

Record Date

 

Payable Date

 

Dividend/
Distribution Per
Share/Unit

 

Total Dividend/
Distribution

 

Series E Preferred Shares:

 

 

 

 

 

 

 

 

 

Fourth Quarter 2005

 

December 31, 2005

 

January 13, 2006

 

$

0.6406

 

$

737

 

First Quarter 2006

 

March 31, 2006

 

April 14, 2006

 

$

0.6406

 

$

737

 

 

 

 

 

 

 

 

 

 

 

Series F Preferred Shares:

 

 

 

 

 

 

 

 

 

Fourth Quarter 2005

 

December 31, 2005

 

January 13, 2006

 

$

0.6172

 

$

880

 

First Quarter 2006

 

March 31, 2006

 

April 14, 2006

 

$

0.6172

 

$

880

 

 

 

 

 

 

 

 

 

 

 

Series G Preferred Shares:

 

 

 

 

 

 

 

 

 

Fourth Quarter 2005

 

December 31, 2005

 

January 13, 2006

 

$

0.5000

 

$

1,100

 

First Quarter 2006

 

March 31, 2006

 

April 14, 2006

 

$

0.5000

 

$

1,100

 

 

 

 

 

 

 

 

 

 

 

Series H Preferred Shares:

 

 

 

 

 

 

 

 

 

Fourth Quarter 2005

 

December 31, 2005

 

January 13, 2006

 

$

0.4688

 

$

938

 

First Quarter 2006

 

March 31, 2006

 

April 14, 2006

 

$

0.4688

 

$

938

 

 

 

 

 

 

 

 

 

 

 

Common Shares:

 

 

 

 

 

 

 

 

 

Fourth Quarter 2005

 

December 31, 2005

 

January 13, 2006

 

$

0.2800

 

$

11,180

 

First Quarter 2006

 

March 31, 2006

 

April 14, 2006

 

$

0.2800

 

$

11,268

 

 

 

 

 

 

 

 

 

 

 

Series I Preferred Units:

 

 

 

 

 

 

 

 

 

Fourth Quarter 2005

 

December 31, 2005

 

January 13, 2006

 

$

0.4688

 

$

165

 

First Quarter 2006

 

March 31, 2006

 

April 14, 2006

 

$

0.4688

 

$

165

 

 

 

 

 

 

 

 

 

 

 

Common Units:

 

 

 

 

 

 

 

 

 

Fourth Quarter 2005

 

December 31, 2005

 

January 13, 2006

 

$

0.2800

 

$

2,387

 

First Quarter 2006

 

March 31, 2006

 

April 14, 2006

 

$

0.2800

 

$

2,374

 

 

16.      Supplemental Information to Statements of Cash Flows

 

 

 

For the Three Months Ended
March 31,

 

 

 

2006

 

2005

 

Supplemental schedule of non-cash investing and financing activities:

 

 

 

 

 

 

 

 

 

 

 

Increase (decrease) in accrued capital improvements and leasing costs

 

$

6,307

 

$

(1,091

)

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

 

$

45

 

$

68

 

Increase (decrease) in fair value of derivatives applied to AOCL and minority interests

 

$

110

 

$

 

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

 

$

778

 

$

55

 

Dividends/distribution payable

 

$

16,878

 

$

14,766

 

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

 

$

1,945

 

$

 

Issuance of restricted shares

 

$

 

$

3,481

 

 

18



 

17.          Information by Business Segment

 

As of March 31, 2006, we had nine primary office property segments: Baltimore/Washington Corridor; Northern Virginia; Suburban Baltimore, Maryland, Suburban Maryland; Greater Philadelphia; St. Mary’s and King George Counties; Northern/Central New Jersey; Colorado Springs, Colorado; and San Antonio, Texas. During 2005, we also had an office property segment in Greater Harrisburg, Pennsylvania prior to the contribution of our properties in that region into a real estate joint venture in exchange for cash and a 20% interest in such joint venture on September 29, 2005.

 

The table below reports segment financial information. Our segment entitled “Other” includes assets and operations not specifically associated with the other defined segments, including corporate assets, investments in unconsolidated entities and 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

 

Suburban
Baltimore

 

Suburban
Maryland

 

Greater
Philadelphia

 

St. Mary’s &
King George
Counties

 

Colorado
Springs

 

Northern/
Central New
Jersey

 

San
Antonio

 

Greater
Harrisburg

 

Other

 

Total

 

Three Months Ended March 31, 2006

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

34,393

 

$

15,573

 

$

7,357

 

$

3,553

 

$

2,505

 

$

2,988

 

$

1,289

 

$

2,893

 

$

1,810

 

$

 

$

(182

)

$

72,179

 

Property operating expenses

 

10,369

 

5,490

 

2,840

 

1,317

 

40

 

691

 

491

 

985

 

333

 

 

(489

)

22,067

 

NOI

 

$

24,024

 

$

10,083

 

$

4,517

 

$

2,236

 

$

2,465

 

$

2,297

 

$

798

 

$

1,908

 

$

1,477

 

$

 

$

307

 

$

50,112

 

Commercial real estate property expenditures

 

$

31,563

 

$

3,123

 

$

871

 

$

404

 

$

338

 

$

311

 

$

5,833

 

$

587

 

$

7,702

 

$

 

$

(268

)

$

50,464

 

Segment assets at March 31, 2006

 

$

925,067

 

$

462,441

 

$

187,732

 

$

114,873

 

$

99,029

 

$

98,818

 

$

69,086

 

$

58,203

 

$

51,570

 

$

 

$

76,056

 

$

2,142,875

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31, 2005

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

29,679

 

$

14,419

 

$

2,662

 

$

2,454

 

$

2,506

 

$

2,878

 

$

 

$

3,871

 

$

 

$

2,244

 

$

(86

)

$

60,627

 

Property operating expenses

 

9,409

 

5,015

 

1,173

 

1,089

 

36

 

706

 

 

1,509

 

 

744

 

(763

)

18,918

 

NOI

 

$

20,270

 

$

9,404

 

$

1,489

 

$

1,365

 

$

2,470

 

$

2,172

 

$

 

$

2,362

 

$

 

$

1,500

 

$

677

 

$

41,709

 

Commercial real estate property expenditures

 

$

23,049

 

$

22,393

 

$

1,158

 

$

343

 

$

207

 

$

2,745

 

$

 

$

141

 

$

34,092

 

$

109

 

$

(58

)

$

84,179

 

Segment assets at March 31, 2005

 

$

792,391

 

$

438,831

 

$

60,590

 

$

68,486

 

$

100,636

 

$

98,299

 

$

 

$

82,719

 

$

34,092

 

$

67,631

 

$

55,245

 

$

1,798,920

 

 

19



 

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,

 

 

 

2006

 

2005

 

Segment revenues

 

$

72,179

 

$

60,627

 

Construction contract revenues

 

14,544

 

15,728

 

Other service operations revenues

 

1,765

 

1,369

 

Less: Revenues from discontinued real estate operations (Note 19)

 

(479

)

(1,699

)

Total revenues

 

$

88,009

 

$

76,025

 

 

The following table reconciles our segment property operating expenses to property operating expenses as reported on our Consolidated Statements of Operations:

 

 

 

For the Three Months
Ended March 31,

 

 

 

2006

 

2005

 

 

 

 

 

 

 

Segment property operating expenses

 

$

22,067

 

$

18,918

 

Less: Property operating expenses from discontinued
real estate operations (Note 19)

 

(182

)

(749

)

Total property operating expenses

 

$

21,885

 

$

18,169

 

 

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,

 

 

 

2006

 

2005

 

NOI for reportable segments

 

$

50,112

 

$

41,709

 

Construction contract revenues

 

14,544

 

15,728

 

Other service operations revenues

 

1,765

 

1,369

 

Equity in loss of unconsolidated entities

 

(23

)

 

Income tax expense

 

(215

)

(457

)

Less:

 

 

 

 

 

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

)

Interest expense on continuing operations

 

(17,584

)

(12,962

)

Amortization of deferred financing costs

 

(559

)

(396

)

Minority interests in continuing operations

 

(1,041

)

(1,433

)

NOI from discontinued operations

 

(297

)

(950

)

Income from continuing operations

 

$

7,722

 

$

8,975

 

 

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 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

 

20



 

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.

 

18.          Income Taxes

 

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

 

 

 

For the Three Months
Ended March 31,

 

 

 

2006

 

2005

 

Deferred

 

 

 

 

 

Federal

 

$

176

 

$

374

 

State

 

39

 

83

 

Total

 

$

215

 

$

457

 

 

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, 2006 and 2005.

 

19.          Discontinued Operations

 

Income from discontinued operations includes revenues and expenses associated with the following:

 

                  three properties located in the Northern/Central New Jersey region that were sold on September 8, 2005;

                  the two Lakeview at the Greens properties that were sold on February 6, 2006; and

                  the 68 Culver Road property sold on March 8, 2006.

 

The table below sets forth the components of income from discontinued operations:

 

 

 

For the Three Months
Ended March 31,

 

 

 

2006

 

2005

 

Revenue from real estate operations

 

$

479

 

$

1,699

 

Expenses from real estate operations:

 

 

 

 

 

Property operating expenses

 

182

 

749

 

Depreciation and amortization

 

24

 

497

 

Interest expense

 

131

 

396

 

Expenses from real estate operations

 

337

 

1,642

 

Income from discontinued operations before gain on sales of real estate
and minority interests

 

142

 

57

 

Gain on sales of real estate

 

2,435

 

 

Minority interests in discontinued operations

 

(472

)

(11

)

Income from discontinued operations, net of minority interests

 

$

2,105

 

$

46

 

 

Interest expense that is specifically identifiable to properties included in discontinued operations is used in the computation of interest expense attributable to discontinued operations. When properties included in the borrowing base to support lines of credit are classified as discontinued operations, we

 

21



 

allocate a portion of such credit lines’ interest expense to discontinued operations; we compute this allocation based on the percentage that the related properties represent of all properties included in the borrowing base to support such credit lines.

 

20.          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.

 

Acquisitions

 

As of March 31, 2006, we were under contract to acquire a property in Washington County, Maryland for $9,000, subject to potential reductions ranging from $750 to $4,000; the amount of such decrease, if any, 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. We submitted a $500 deposit in connection with this acquisition.

 

On March 31, 2006, we were also under contract to acquire, for $78,000, a mixed-use facility containing 328,000 square feet of office space and 285,000 square feet of warehouse space, located in Columbia, Maryland. We submitted a $750 deposit in connection with this acquisition.

 

Joint Ventures

 

As part of our obligations under the partnership agreement of Harrisburg Corporate Gateway Partners, LP, we may be required to make unilateral payments to fund rent shortfalls on behalf of a tenant that was in bankruptcy at the time the partnership was formed. Our total unilateral commitment under this guaranty is approximately $712; the tenant’s account was current as of March 31, 2006. We also agreed to indemnify the partnership’s lender for 80% of any losses under standard nonrecourse loan guarantees (environmental indemnifications and guarantees against fraud and misrepresentation) during the period of time in which we manage the partnership’s properties; we do not expect to incur any losses under these loan guarantees.

 

For Route 46 Partners, we may 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 $181 in the event that funds are needed by the entity.

 

We are party to 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. 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 will have a 50% interest in this joint venture relationship.

 

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.

 

22



 

In two of the consolidated joint ventures that we owned as of March 31, 2006, we would be obligated to acquire the other members’ 50% interests in the joint ventures if defined events were to occur. The amounts we would need to pay for those membership interests are computed based on the amounts that the owners of the interests would receive under the joint venture agreements in the event that office properties owned by the joint ventures were sold for a capitalized fair value (as defined in the agreements) on a defined date. We estimate the aggregate amount we would need to pay for the other members’ membership interests in these joint ventures to be $1,691; however, since the determination of this amount is dependent on the operations of the office properties, which are not both completed and sufficiently occupied, this estimate is preliminary and could be materially different from the actual obligation.

 

Ground Lease

 

On March 8, 2006, we entered into a 62 year ground lease agreement on a five-acre land parcel on which we intend to construct a 24,000 square foot property. We paid $118 to the lessor upon lease execution and expect to pay an additional $399 in rent under the lease in 2006; no other rental payments are required over the life of the lease, although we are responsible for expenses associated with the property. We will recognize the total lease payments incurred under the lease evenly over the term of the lease.

 

Operating Leases

 

We are obligated as lessee under seven operating leases for office space. Future minimum rental payments due under the terms of these leases as of March 31, 2006 follow:

 

2006

 

$

242

 

2007

 

80

 

2008

 

71

 

2009

 

11

 

 

 

$

404

 

 

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, 2006 follow:

 

2006

 

$

309

 

2007

 

316

 

2008

 

230

 

2009

 

80

 

2010

 

3

 

 

 

$

938

 

 

Environmental Indemnity Agreement

 

We agreed to provide certain environmental indemnifications in connection with a lease of three properties in our New Jersey region. The prior owner of the properties, a Fortune 100 company that is responsible for groundwater contamination at such properties, previously agreed to indemnify us for (1) direct losses incurred in connection with the contamination and (2) its failure to perform remediation activities required by the State of New Jersey, up to the point that the state declares the remediation to be complete. Under the lease agreement, we agreed to the following:

 

                  to indemnify the tenant against losses covered under the prior owner’s indemnity agreement if the prior owner fails to indemnify the tenant for such losses. This indemnification is capped at $5,000 in perpetuity after the State of New Jersey declares the remediation to be complete;

                  to indemnify the tenant for consequential damages (e.g., business interruption) at one of the buildings in perpetuity and another of the buildings for 15 years after the tenant’s acquisition of the property from us, if such acquisition occurs. This indemnification is capped at $12,500; and

 

23



 

                  to pay 50% of additional costs related to construction and environmental regulatory activities incurred by the tenant as a result of the indemnified environmental condition of the properties. This indemnification is capped at $300 annually and $1,500 in the aggregate.

 

21.          Pro Forma Financial Information (Unaudited)

 

We accounted for our 2005 and 2006 acquisitions using the purchase method of accounting. We included the results of operations on our acquisitions in our Consolidated Statements of Operations from their respective purchase dates through March 31, 2006.

 

We prepared our pro forma condensed consolidated financial information presented below as if our acquisition of the Hunt Valley/Rutherford portfolios on December 22, 2005 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 purport to indicate our results of operations for future periods.

 

 

 

For the Three
Months Ended
March 31,

 

 

 

2005

 

 

 

 

 

Pro forma total revenues

 

$

80,663

 

Pro forma net income

 

$

8,490

 

Pro forma net income available to common shareholders

 

$

4,836

 

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

 

 

 

Basic

 

$

0.13

 

Diluted

 

$

0.13

 

 

22.          Subsequent Events

 

In April 2006, we sold 2.0 million common shares to an underwriter at a net price of $41.31 per share for gross proceeds before offering costs of $82,620. We contributed the proceeds to our Operating Partnership in exchange for 2.0 million common units. The proceeds were used primarily to pay down our Revolving Credit Facility.

 

On April 4, 2006, we entered into a 62-year ground lease agreement on a six-acre land parcel on which we expect to construct a 110,000 square foot property. We paid $550 to the lessor upon lease execution and expect to pay an additional $1,870 in rent under the lease by 2007. No other rental payments are required over the life of the lease, although we are responsible for expenses associated with the property. We will recognize the total lease payments incurred under the lease evenly over the term of the lease.

 

On April 21, 2006, we acquired a 20-acre land parcel that we believe can support approximately 300,000 developable square feet for a contract price of $1,050 using cash reserves.

 

On April 27, 2006, we entered into two interest rate swap agreements that fix the one-month LIBOR base rate at 5.232% on an aggregate notional amount of $50,000. These swap agreements became effective on May 1, 2006 and carry three-year terms.

 

24



 

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

 

Overview

 

We are a REIT that focuses on the acquisition, development, ownership, management and leasing of primarily Class A suburban office properties in select, demographically strong submarkets where we can achieve critical mass, operating synergies and key competitive advantages, including attracting high quality tenants and securing acquisition and development opportunities. 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.

 

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

 

                  experienced increased revenues, operating expenses and operating income due primarily to the addition of properties through acquisition and construction activities since January 1, 2005;

                  finished the period with occupancy for our wholly owned portfolio of properties at 93.3%;

                  acquired a 60,000 square foot property to be redeveloped, and 41 acres of land that can support up to approximately 465,000 developable square feet, for $12.2 million;

                  placed into service a newly-constructed property totaling 162,000 square feet in the Baltimore/Washington Corridor; and

                  sold three operating properties and a newly constructed property for a total of $29.2 million.

 

In this section, we discuss our financial condition and results of operations as of and for the three months ended March 31, 2006. 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, 2006 compared to the same period in 2005;

                  how we raised cash for acquisitions and other capital expenditures during the three months ended March 31, 2006;

                  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, 2006 and 2005.

 

You should refer to our Consolidated Financial Statements 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 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

 

25



 

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;

                  our ability to satisfy and operate effectively under federal income tax rules relating to real estate investment trusts and partnerships;

                  governmental actions and initiatives; and

                  environmental requirements.

 

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

 

26



 

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,

 

 

 

2006

 

2005

 

Variance