UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

(Mark one)

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

For the quarterly period ended March 31, 2007

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.)

 

 

 

6711 Columbia Gateway Drive, Suite 300, Columbia MD

 

21046

(Address of principal executive offices)

 

(Zip Code)

 

Registrant’s telephone number, including area code:  (443) 285-5400


 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes 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 x

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 x No

On April 27, 2007, 47,069,523 shares of the Company’s Common Shares of Beneficial Interest, $0.01 par value, were issued.

 




 

TABLE OF CONTENTS

FORM 10-Q

 

PAGE

PART I: FINANCIAL INFORMATION

 

 

 

 

Item 1:

Financial Statements:

 

 

Consolidated Balance Sheets as of March 31, 2007 and December 31, 2006 (unaudited)

3

 

Consolidated Statements of Operations for the three months ended March 31, 2007 and 2006 (unaudited)

4

 

Consolidated Statements of Cash Flows for the three months ended March 31, 2007 and 2006 (unaudited)

5

 

Notes to Consolidated Financial Statements

6

Item 2:

Management’s Discussion and Analysis of Financial Condition and Results of Operations

23

Item 3:

Quantitative and Qualitative Disclosures About Market Risk

38

Item 4:

Controls and Procedures

39

 

 

 

PART II: OTHER INFORMATION

 

 

 

Item 1:

Legal Proceedings

39

Item 1A:

Risk Factors

39

Item 2:

Unregistered Sales of Equity Securities and Use of Proceeds

40

Item 3:

Defaults Upon Senior Securities

40

Item 4:

Submission of Matters to a Vote of Security Holders

40

Item 5:

Other Information

40

Item 6:

Exhibits

40

 

 

 

 

 

SIGNATURES

 

42

 

2




 

PART I: FINANCIAL INFORMATION

ITEM 1. Financial Statements

Corporate Office Properties Trust and Subsidiaries
Consolidated Balance Sheets
(Dollars in thousands)
(unaudited)

 

 

March 31,

 

December 31,

 

 

 

2007

 

2006

 

Assets

 

 

 

 

 

Investment in real estate:

 

 

 

 

 

Operating properties, net

 

$

2,080,310

 

$

1,812,883

 

Property held for sale, net

 

14,573

 

 

Projects under construction or development

 

379,294

 

298,427

 

Total commercial real estate properties, net

 

2,474,177

 

2,111,310

 

Cash and cash equivalents

 

22,003

 

7,923

 

Restricted cash

 

19,030

 

52,856

 

Accounts receivable, net

 

24,478

 

26,367

 

Deferred rent receivable

 

44,294

 

41,643

 

Intangible assets on real estate acquisitions, net

 

131,934

 

87,325

 

Deferred charges, net

 

45,496

 

43,710

 

Prepaid and other assets

 

53,311

 

48,467

 

Total assets

 

$

2,814,723

 

$

2,419,601

 

 

 

 

 

 

 

Liabilities and shareholders’ equity

 

 

 

 

 

Liabilities:

 

 

 

 

 

Mortgage and other loans payable

 

$

1,515,183

 

$

1,298,537

 

3.5% Exchangeable Senior Notes

 

200,000

 

200,000

 

Accounts payable and accrued expenses

 

61,131

 

68,190

 

Rents received in advance and security deposits

 

25,127

 

20,237

 

Dividends and distributions payable

 

20,687

 

19,164

 

Deferred revenue associated with acquired operating leases

 

14,607

 

11,120

 

Distributions in excess of investment in unconsolidated real estate joint venture

 

3,797

 

3,614

 

Fair value of derivatives

 

556

 

308

 

Other liabilities

 

8,395

 

7,941

 

Total liabilities

 

1,849,483

 

1,629,111

 

Minority interests:

 

 

 

 

 

Common units in the Operating Partnership

 

118,614

 

104,934

 

Preferred units in the Operating Partnership

 

8,800

 

8,800

 

Other consolidated real estate joint ventures

 

2,408

 

2,453

 

Total minority interests

 

129,822

 

116,187

 

Commitments and contingencies (Note 20)

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

Preferred Shares of beneficial interest ($0.01 par value; shares authorized of

 

 

 

 

 

15,000,000, issued and outstanding of 8,121,667 at March 31, 2007

 

 

 

 

 

and 7,590,000 at December 31, 2006 (Note 13)

 

81

 

76

 

Common Shares of beneficial interest ($0.01 par value;

 

 

 

 

 

75,000,000 shares authorized, shares issued and outstanding of

 

 

 

 

 

46,879,852 at March 31, 2007 and 42,897,639 at December 31, 2006

 

469

 

429

 

Additional paid-in capital

 

932,287

 

758,032

 

Cumulative distributions in excess of net income

 

(96,516

)

(83,541

)

Accumulated other comprehensive loss

 

(903

)

(693

)

Total shareholders’ equity

 

835,418

 

674,303

 

Total liabilities and shareholders’ equity

 

$

2,814,723

 

$

2,419,601

 

 

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,

 

 

 

2007

 

2006

 

Revenues

 

 

 

 

 

Rental revenue

 

$

75,882

 

$

60,562

 

Tenant recoveries and other

 

 

 

 

 

real estate operations revenue

 

13,793

 

8,660

 

Construction contract revenues

 

8,691

 

14,544

 

Other service operations revenues

 

1,386

 

1,765

 

Total revenues

 

99,752

 

85,531

 

Expenses

 

 

 

 

 

Property operating expenses

 

31,748

 

21,061

 

Depreciation and other amortization

 

 

 

 

 

associated with real estate operations

 

26,569

 

18,672

 

Construction contract expenses

 

8,483

 

14,026

 

Other service operations expenses

 

1,405

 

1,678

 

General and administrative expenses

 

4,614

 

3,963

 

Total operating expenses

 

72,819

 

59,400

 

Operating income

 

26,933

 

26,131

 

Interest expense

 

(19,876

)

(17,029

)

Amortization of deferred financing costs

 

(884

)

(556

)

Income from continuing operations before equity in loss of unconsolidated entities, income taxes and minority interests

 

6,173

 

8,546

 

Equity in loss of unconsolidated entities

 

(94

)

(23

)

Income tax expense

 

(105

)

(215

)

Income from continuing operations before minority interests

 

5,974

 

8,308

 

Minority interests in income from continuing operations

 

 

 

 

 

Common units in the Operating Partnership

 

(308

)

(826

)

Preferred units in the Operating Partnership

 

(165

)

(165

)

Other consolidated entities

 

47

 

33

 

Income from continuing operations

 

5,548

 

7,350

 

(Loss) income from discontinued operations, net of minority interests

 

(1

)

2,477

 

Income before gain on sales of real estate

 

5,547

 

9,827

 

Gain on sales of real estate, net

 

 

110

 

Net income

 

5,547

 

9,937

 

Preferred share dividends

 

(3,993

)

(3,654

)

Net income available to common shareholders

 

$

1,554

 

$

6,283

 

Basic earnings per common share

 

 

 

 

 

Income from continuing operations

 

$

0.03

 

$

0.10

 

Discontinued operations

 

 

0.06

 

Net income available to common shareholders

 

$

0.03

 

$

0.16

 

Diluted earnings per common share

 

 

 

 

 

Income from continuing operations

 

$

0.03

 

$

0.09

 

Discontinued operations

 

 

0.06

 

Net income available to common shareholders

 

$

0.03

 

$

0.15

 

 

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,

 

 

 

2007

 

2006

 

Cash flows from operating activities

 

 

 

 

 

Net income

 

$

5,547

 

$

9,937

 

Adjustments to reconcile net income to net cash

 

 

 

 

 

provided by operating activities:

 

 

 

 

 

Minority interests

 

426

 

1,538

 

Depreciation and other amortization

 

26,626

 

19,337

 

Amortization of deferred financing costs

 

884

 

559

 

Amortization of deferred market rental revenue

 

(511

)

(556

)

Equity in loss of unconsolidated entities

 

94

 

23

 

Gain on sales of real estate

 

 

(2,571

)

Share-based compensation

 

1,340

 

642

 

Excess income tax benefits from share-based compensation

 

(865

)

(258

)

Changes in operating assets and liabilities:

 

 

 

 

 

Increase in deferred rent receivable

 

(2,651

)

(2,198

)

Decrease (increase) in accounts receivable

 

1,889

 

(1,123

)

Decrease in restricted cash and prepaid and other assets

 

1,349

 

5,152

 

Decrease in accounts payable, accrued expenses and other liabilities

 

(4,005

)

(2,637

)

Increase in rents received in advance and security deposits

 

4,890

 

1,620

 

Other

 

(25

)

(79

)

Net cash provided by operating activities

 

34,988

 

29,386

 

Cash flows from investing activities

 

 

 

 

 

Purchases of and additions to commercial real estate properties

 

(187,966

)

(38,267

)

Proceeds from sales of properties

 

 

28,217

 

Investments in and advances to unconsolidated entities

 

 

(190

)

Acquisition of partner interests in consolidated joint ventures

 

 

(3,016

)

Distributions from unconsolidated entities

 

89

 

113

 

Leasing costs paid

 

(4,059

)

(1,984

)

Decrease in restricted cash associated with investing activities

 

13,858

 

218

 

Other

 

(5,951

)

(175

)

Net cash used in investing activities

 

(184,029

)

(15,084

)

Cash flows from financing activities

 

 

 

 

 

Proceeds from mortgage and other loans payable

 

188,090

 

47,905

 

Repayments of mortgage and other loans payable

 

(10,380

)

(36,559

)

Deferred financing costs paid

 

(507

)

(49

)

Distributions paid to partners in consolidated joint ventures

 

 

(787

)

Net proceeds from issuance of common shares

 

5,120

 

1,581

 

Dividends paid

 

(16,931

)

(14,721

)

Distributions paid

 

(2,787

)

(2,553

)

Excess income tax benefits from share-based compensation

 

865

 

258

 

Other

 

(349

)

8

 

Net cash provided by (used in) financing activities

 

163,121

 

(4,917

)

Net increase in cash and cash equivalents

 

14,080

 

9,385

 

Cash and cash equivalents

 

 

 

 

 

Beginning of period

 

7,923

 

10,784

 

End of period

 

$

22,003

 

$

20,169

 

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 also have 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, 2007, our investments in real estate included the following:

·                  226 wholly owned operating properties in our portfolio totaling 17.4 million square feet;

·                  17 wholly owned properties under construction or development that we estimate will total approximately 1.9 million square feet upon completion and two wholly owned office properties totaling approximately 129,000 square feet that were under redevelopment;

·                  wholly owned land parcels totaling 1,254 acres that we believe are potentially developable into approximately 10.3 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, 2007 follows:

Common Units

84%

 

 

Series G Preferred Units

100%

 

 

Series H Preferred Units

100%

 

 

Series I Preferred Units

0%

 

 

Series J Preferred Units

100%

 

 

Series K Preferred Units

100%

 

(issued on January 9, 2007)

Two of our trustees also controlled, either directly or through ownership by other entities or family members, 13% 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

COPT Environmental Systems, LLC (“CES”)

 

Heating and Air Conditioning

Most of the services that CPM provides are for us.  CDC, CDS and CES 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 required by accounting principles generally accepted in the United States for complete Consolidated Financial

6




Statements are not included herein.  These interim financial statements should be read together with the financial statements and notes thereto included in our 2006 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 of beneficial interest (“common shares”) outstanding during the period.  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 changes in income or loss that would result from the assumed conversion of securities into common shares that were added to the denominator.

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,

 

 

 

2007

 

2006

 

Numerator:

 

 

 

 

 

Income from continuing operations

 

$

5,548

 

$

7,350

 

Add: Gain on sales of real estate, net

 

 

110

 

Less: Preferred share dividends

 

(3,993

)

(3,654

)

Numerator for basic and diluted EPS from continuing operations

 

1,555

 

3,806

 

(Loss) income from discontinued operations, net

 

(1

)

2,477

 

Numerator for basic and diluted EPS on net income available

 

 

 

 

 

to common shareholders

 

$

1,554

 

$

6,283

 

Denominator (all weighted averages):

 

 

 

 

 

Denominator for basic EPS (common shares)

 

45,678

 

39,668

 

Dilutive effect of share-based compensation awards

 

1,465

 

1,842

 

Denominator for diluted EPS

 

47,143

 

41,510

 

 

 

 

 

 

 

Basic EPS:

 

 

 

 

 

Income from continuing operations

 

$

0.03

 

$

0.10

 

Income from discontinued operations

 

 

0.06

 

Net income available to common shareholders

 

$

0.03

 

$

0.16

 

Diluted EPS:

 

 

 

 

 

Income from continuing operations

 

$

0.03

 

$

0.09

 

Income from discontinued operations

 

 

0.06

 

Net income available to common shareholders

 

$

0.03

 

$

0.15

 

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,

 

 

 

2007

 

2006

 

Conversion of weighted average common units

 

8,411

 

8,520

 

Conversion of weighted average convertible preferred units

 

176

 

176

 

Conversion of weighted average convertible preferred shares

 

395

 

 

The 3.5% Exchangeable Senior Notes did not affect our diluted EPS reported above since the weighted average closing price of our common shares during the period over which the notes were outstanding was less than $54.30.

4.             Recent Accounting Pronouncements

In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - - an interpretation of FASB Statement No. 109” (“FIN 48”).  FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes.”  FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.  FIN 48 also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.  FIN 48 is effective for fiscal years beginning after December 15, 2006.  Our adoption of FIN 48 did not have a material effect on our financial position, results of operations or cash flows.

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (“SFAS 157”).   SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements.  The Statement does not require any new fair value measurements but does apply under other accounting pronouncements that require or permit fair value measurements.  The changes to current practice resulting from the Statement relate to the definition of fair value, the methods used to measure fair value and the expanded disclosures about fair value measurements.  SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years, with earlier application encouraged.  We do not expect that the adoption of this Statement will have a material effect on our financial position, results of operations or cash flows.

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”).  SFAS 159 permits entities to choose to measure many financial assets and financial liabilities at fair value.  Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings.  SFAS 159 is effective for fiscal years beginning after November 15, 2007.  We are currently assessing the impact of SFAS 159 on our consolidated financial position and results of operations.

5.             Commercial Real Estate Properties

Operating properties consisted of the following:

 

 

March 31,

 

December 31,

 

 

 

2007

 

2006

 

Land

 

$

409,859

 

$

343,098

 

Buildings and improvements

 

1,904,154

 

1,689,359

 

 

 

2,314,013

 

2,032,457

 

Less: accumulated depreciation

 

(233,703

)

(219,574

)

 

 

$

2,080,310

 

$

1,812,883

 

At March 31, 2007, 429 Ridge Road, an office property located in Dayton, New Jersey that we were under contract to sell for $17,000, was classified as held for sale (Dayton, New Jersey is located in the Northern/Central New Jersey Region).  We expect to complete the sale of this property by January 2008.  The components associated with 429 Ridge Road as of March 31, 2007 included the following:

8




 

 

 

March 31,

 

 

 

2007

 

Land

 

$

2,932

 

Buildings and improvements

 

14,588

 

 

 

17,520

 

Less: accumulated depreciation

 

(2,947

)

 

 

$

14,573

 

Projects we had under construction or development consisted of the following:

 

 

March 31,

 

December 31,

 

 

 

2007

 

2006

 

Land

 

$

193,715

 

$

153,436

 

Construction in progress

 

185,579

 

144,991

 

 

 

$

379,294

 

$

298,427

 

2007 Acquisitions

On January 9 and 10, 2007, we completed a series of transactions that resulted in the acquisition of 56 operating properties totaling approximately 2.4 million square feet and land parcels totaling 187 acres.  We refer to these transactions collectively as the Nottingham Acquisition.  All of the acquired properties are located in Maryland, with 36 of the operating properties, totaling 1.6 million square feet, and land parcels totaling 175 acres, located in White Marsh, Maryland (located in the Suburban Baltimore region) and the remaining properties and land parcels located in other regions in Northern Baltimore County and the Baltimore/Washington Corridor.  We believe that the land parcels can support at least 2.0 million developable square feet.  We completed the Nottingham Acquisition for an aggregate cost of $366,830.  The table below sets forth the allocation of the acquisition costs of the Nottingham Acquisition:

Land, operating properties

 

$

69,322

 

Land, construction or development

 

37,789

 

Building and improvements

 

211,194

 

Intangible assets on real estate acquisitions

 

53,214

 

Total assets

 

371,519

 

Deferred revenue associated with acquired operating leases

 

(4,689

)

Total acquisition cost

 

$

366,830

 

Intangible assets recorded in connection with the Nottingham Acquisition include the following:

 

 

 

 

Weighted

 

 

 

 

 

Average

 

 

 

 

 

Amortization

 

 

 

Cost

 

Period (in
Years)

 

Tenant relationship value

 

$

25,778

 

8

 

Lease-up value

 

19,425

 

4

 

Lease cost portion of deemed cost avoidance

 

4,206

 

5

 

Lease to market value

 

3,805

 

4

 

 

 

$

53,214

 

6

 

 

2007 Construction and Development Activities

As of March 31, 2007, we had construction underway on four new buildings in the Baltimore/Washington Corridor (including one partially operational property owned through a 50% joint venture), two in Colorado Springs, Colorado and one each in Suburban Baltimore, Southwest Virginia and Chesterfield, Virginia.  We also had development activities underway on five new buildings located in the Baltimore/Washington Corridor (including one owned through a joint venture), two in Suburban Baltimore, two in Suburban Maryland and one each

9




in King George County, Virginia and Colorado Springs, Colorado (we owned a 50% undivided interest in the Colorado Springs property until April 6, 2007, when we purchased the remaining 50%).  In addition, we had redevelopment underway on two wholly owned existing buildings (one is located in the Baltimore/Washington Corridor and the other in Colorado Springs, Colorado) and two buildings owned by a joint venture (one is located in Northern Virginia and the other in the Baltimore/Washington Corridor).

6.                                      Real Estate Joint Ventures

During the three months ended March 31, 2007, we had an investment in one unconsolidated real estate joint venture accounted for using the equity method of accounting.  Information pertaining to this joint venture investment is set forth below.

 

 

Investment Balance at

 

 

 

 

 

 

 

Total

 

Maximum

 

 

 

March 31,

 

December 31,

 

Date

 

Owner-

 

Nature of

 

Assets at

 

Exposure

 

 

 

2007

 

2006

 

Acquired

 

ship

 

Activity

 

3/31/2007

 

to Loss (1)

 

Harrisburg Corporate

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gateway Partners, L.P.

 

$(3,797)(2

)

$(3,614)(2

)

9/29/2005

 

20%

 

Operates 16 buildings(3

)

$75,190

 

 


(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, which we would be required to make if certain contingent events occur.

(2)             The carrying amount of our investment in this joint venture was lower than our share of the equity in the joint venture by $4,860 at March 31, 2007 and $5,072 at December 31, 2006 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 remains the same.

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

The following table sets forth condensed balance sheets for Harrisburg Corporate Gateway Partners, L.P.:

 

 

March 31,

 

December 31,

 

 

 

2007

 

2006

 

Commercial real estate property

 

$

72,199

 

$

72,688

 

Other assets

 

2,991

 

3,207

 

Total assets

 

$

75,190

 

$

75,895

 

 

 

 

 

 

 

Liabilities

 

$

68,149

 

$

67,350

 

Owners’ equity

 

7,041

 

8,545

 

Total liabilities and owners’ equity

 

$

75,190

 

$

75,895

 

The following table sets forth a combined condensed statement of operations for Harrisburg Corporate Gateway Partners, L.P. for the three months ended March 31, 2007:

Revenues

 

$

2,444

 

Property operating expenses

 

(960

)

Interest expense

 

(1,138

)

Depreciation and amortization expense

 

(867

)

Net loss

 

$

(521

)

 

10




 

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

 

 

 

 

Ownership

 

 

 

Total

 

Collateralized

 

 

Date

 

% at

 

Nature of

 

Assets at

 

Assets at

 

 

Acquired

 

3/31/2007

 

Activity

 

3/31/2007

 

3/31/2007

COPT Opportunity Invest I, LLC

 

12/20/2005

 

92.5%

 

Redeveloping two properties (1)

 

$

44,919

 

$

Commons Office 6-B, LLC

 

2/10/2006

 

50.0%

 

Developing land parcel (2)

 

7,466

 

7,430

MOR Forbes 2 LLC

 

12/24/2002

 

50.0%

 

Operates one building (3)

 

4,074

 

3,697

COPT-FD Indian Head, LLC

 

10/23/2006

 

75.0%

 

Developing land parcel (4)

 

3,003

 

 

 

 

 

 

 

 

 

$

59,462

 

$

11,127


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

(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).

(4)             This joint venture’s property is located in Charles County, Maryland (located in our “other” business segment).

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

7.             Intangible Assets on Real Estate Acquisitions

Intangible assets on real estate acquisitions consisted of the following:

 

 

March 31, 2007

 

December 31, 2006

 

 

 

Gross Carrying

 

Accumulated

 

Net Carrying

 

Gross Carrying

 

Accumulated

 

Net Carrying

 

 

 

Amount

 

Amortization

 

Amount

 

Amount

 

Amortization

 

Amount

 

Lease-up value

 

$

125,144

 

$

43,900

 

$

81,244

 

$

105,719

 

$

38,279

 

$

67,440

 

Tenant relationship value

 

35,149

 

2,691

 

32,458

 

9,371

 

1,178

 

8,193

 

Lease cost portion of deemed

 

 

 

 

 

 

 

 

 

 

 

 

 

 cost avoidance

 

17,086

 

6,591

 

10,495

 

12,880

 

5,819

 

7,061

 

Lease to market value

 

14,428

 

7,869

 

6,559

 

10,623

 

7,178

 

3,445

 

Market concentration premium

 

1,333

 

155

 

1,178

 

1,333

 

147

 

1,186

 

 

 

$

193,140

 

$

61,206

 

$

131,934

 

$

139,926

 

$

52,601

 

$

87,325

 

Amortization of the intangible asset categories set forth above totaled $8,628 in the three months ended March 31, 2007 and $5,017 in the three months ended March 31, 2006.  The approximate weighted average amortization periods of the categories set forth below follow: lease-up value: nine years; tenant relationship value: eight years; lease cost portion of deemed cost avoidance: six years; lease to market value: five years; and market concentration premium: 35 years.  The approximate weighted average amortization period for all of the categories combined is nine years.  Estimated amortization expense associated with the intangible asset categories set forth above for the nine months ended December 31, 2007 is $20.1 million, for 2008 is $21.8 million, for 2009 is $19.1 million, for 2010 is $14.8 million, for 2011 is $11.9 million and for 2012 is $9.6 million.

8.             Deferred Charges

Deferred charges consisted of the following:

 

 

March 31,

 

December 31,

 

 

 

2007

 

2006

 

Deferred leasing costs

 

$

55,716

 

$

52,263

 

Deferred financing costs

 

28,837

 

28,275

 

Goodwill

 

1,853

 

1,853

 

Deferred other

 

155

 

155

 

 

 

86,561

 

82,546

 

Accumulated amortization

 

(41,065

)

(38,836

)

Deferred charges, net

 

$

45,496

 

$

43,710

 

 

11




 

9.             Accounts Receivable

Our accounts receivable are reported net of an allowance for bad debts of $286 at March 31, 2007 and $252 at December 31, 2006.

10.          Prepaid and Other Assets

Prepaid and other assets consisted of the following:

 

 

March 31,

 

December 31,

 

 

 

2007

 

2006

 

Construction contract costs incurred in excess of billings

 

$

19,194

 

$

18,324

 

Furniture, fixtures and equipment

 

10,587

 

10,495

 

Prepaid expenses

 

7,714

 

9,059

 

Other assets

 

15,816

 

10,589

 

Prepaid and other assets

 

$

53,311

 

$

48,467

 

11.          Debt

Our debt consisted of the following:

 

 

Maximum

 

 

 

 

 

 

 

 

Principal Amount

 

Carrying Value at

 

 

 

Scheduled
Maturity

 

 

Under Debt at

 

March 31,

 

December 31,

 

Stated Interest Rates at

 

Dates at

 

 

March 31, 2007

 

2007

 

2006

 

March 31, 2007

 

March 31, 2007

Mortgage and other loans payable:

 

 

 

 

 

 

 

 

 

 

Revolving Credit Facility

 

 

 

 

 

 

 

 

 

 

Wachovia Bank, N.A. Revolving Credit Facility

 

$

500,000

 

$

264,000

 

$

185,000

 

LIBOR + 1.15% to 1.55%

 

March 2008 (1)

 

 

 

 

 

 

 

 

 

 

 

Mortgage Loans

 

 

 

 

 

 

 

 

 

 

Fixed rate mortgage loans (2)

 

N/A

 

1,048,913

 

1,020,619

 

5.20% — 9.48% (3)

 

2007 — 2034 (4)

Variable rate construction loan facilities

 

122,447

 

76,324

 

56,079

 

LIBOR + 1.40% to 2.20%

 

2007 — 2008 (5)

Other variable rate mortgage loans

 

N/A

 

123,615

 

34,500

 

LIBOR + 1.20% to 1.50%

 

2007 (6)

Total mortgage loans

 

 

 

1,248,852

 

1,111,198

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Note payable

 

 

 

 

 

 

 

 

 

 

Unsecured seller notes

 

N/A

 

2,331

 

2,339

 

0% — 5.95%

 

2007-2008

Total mortgage and other loans payable

 

 

 

1,515,183

 

1,298,537

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

3.5% Exchangeable Senior Notes

 

N/A

 

200,000

 

200,000

 

3.50%

 

September 2026(7)

Total debt

 

 

 

$

1,715,183

 

$

1,498,537

 

 

 

 


(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 $839 at March 31, 2007 and $210 at December 31, 2006.

(3)             The weighted average interest rate on these loans was 6.05% at March 31, 2007.

(4)             A loan with a balance of $4,874 at March 31, 2007 that matures in 2034 may be repaid in March 2014, subject to certain conditions.

(5)             At March 31, 2007, $53,505 in loans scheduled to mature in 2008 may be extended for a one-year period, subject to certain conditions.

(6)             At March 31, 2007, a $34,500 loan scheduled to mature in 2007 may be extended for a one-year period, subject to certain conditions.

(7)             Refer to our 2006 Annual Report on Form 10-K for descriptions of provisions for early redemption and repurchase of these notes.

 

We capitalized interest costs of $4,132 in the three months ended March 31, 2007 and $3,130 in three months ended March 31, 2006.

12




 

12.          Derivatives

The following table sets forth our derivative contracts at March 31, 2007 and their respective fair values:

 

 

 

 

 

 

 

 

 

 

Fair Value at

 

 

 

Notional

 

One-Month

 

Effective

 

Expiration

 

March 31,

 

December 31,

 

Nature of Derivative

 

Amount

 

LIBOR base

 

Date

 

Date

 

2007

 

2006

 

Interest rate swap

 

$

50,000

 

5.0360

%

3/28/2006

 

3/30/2009

 

$

(174

)

$

(42

)

Interest rate swap

 

25,000

 

5.2320

%

5/1/2006

 

5/1/2009

 

(191

)

(133

)

Interest rate swap

 

25,000

 

5.2320

%

5/1/2006

 

5/1/2009

 

(191

)

(133

)

 

 

 

 

 

 

 

 

 

 

$

(556

)

$

(308

)

We designated these derivatives as cash flow hedges.  These contracts hedge the risk of changes in interest rates on certain of our one-month LIBOR-based variable rate borrowings until their respective maturities.

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

 

For the Three Months Ended
March 31,

 

 

 

2007

 

2006

 

(Decrease) increase in fair value applied to accumulated

 

 

 

 

 

other comprehensive loss and minority interests

 

$

(248

)

$

110

 

13.          Shareholders’ Equity

Preferred Shares

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

 

 

March 31,

 

December 31,

 

 

 

2007

 

2006

 

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

 

3,390,000 designated as Series J Cumulative Redeemable Preferred Shares of beneficial interest (3,390,000 shares issued with an aggregate liquidation preference of $84,750)

 

34

 

34

 

531,667 designated as Series K Cumulative Redeemable Convertible Preferred Shares of beneficial interest (531,667 shares issued with an aggregate liquidation preference of $26,583)

 

5

 

 

Total preferred shares

 

$

81

 

$

76

 

We issued the Series K Cumulative Redeemable Convertible Preferred Shares of beneficial interest (the “Series K Preferred Shares”) in the Nottingham Acquisition at a value of, and liquidation preference equal to, $50 per share.  The Series K Preferred Shares are nonvoting, redeemable for cash at $50 per share at our option on or after January 9, 2017, and are convertible, subject to certain conditions, into common shares on the basis of 0.8163 common shares for each preferred share, in accordance with the terms of the Articles Supplementary describing the Series K Preferred Shares.  Holders of the Series K Preferred Shares are entitled to cumulative dividends, payable quarterly (as and if declared by our Board of Trustees).  Dividends accrue from the date of issue at the annual rate of $2.80 per share, which is equal to 5.6% of the $50 per share liquidation preference.

13




 

Common Shares

In connection with the Nottingham Acquisition in January 2007, we issued 3,161,000 common shares at a value of $49.57 per share.

During the three months ended March 31, 2007, we converted 221,350 common units in our Operating Partnership into common shares on the basis of one common share for each common unit.

See Note 17 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,

 

 

 

2007

 

2006

 

Beginning balance

 

$

(693

)

$

(482

)

Unrealized (loss) gain on derivatives, net of minority interests

 

(223

)

90

 

Realized loss on derivatives, net of minority interests

 

13

 

12

 

Ending balance

 

$

(903

)

$

(380

)

The table below sets forth our comprehensive income:

 

 

For the Three Months
Ended March 31,

 

 

 

2007

 

2006

 

Net income

 

$

5,547

 

$

9,937

 

Unrealized (loss) gain on derivatives, net of minority interests

 

(223

)

90

 

Realized loss on derivatives, net of minority interests

 

13

 

12

 

Total comprehensive income

 

$

5,337

 

$

10,039

 

 

14




 

14.          Dividends and Distributions

The following table summarizes our dividends and distributions when either the payable dates or record dates occurred during the three months ended March 31, 2007:

 

 

 

 

 

 

Dividend/ 

 

 

 

 

 

 

 

 

 

Distribution Per 

 

Total Dividend/ 

 

 

 

Record Date

 

Payable Date

 

Share/Unit

 

Distribution

 

Series G Preferred Shares:

 

 

 

 

 

 

 

 

 

Fourth Quarter 2006

 

December 29, 2006

 

January 17, 2007

 

$

0.5000

 

$

1,100

 

First Quarter 2007

 

March 30, 2007

 

April 17, 2007

 

$

0.5000

 

$

1,100

 

 

 

 

 

 

 

 

 

 

 

Series H Preferred Shares:

 

 

 

 

 

 

 

 

 

Fourth Quarter 2006

 

December 29, 2006

 

January 17, 2007

 

$

0.4688

 

$

938

 

First Quarter 2007

 

March 30, 2007

 

April 17, 2007

 

$

0.4688

 

$

938

 

 

 

 

 

 

 

 

 

 

 

Series J Preferred Shares:

 

 

 

 

 

 

 

 

 

Fourth Quarter 2006

 

December 29, 2006

 

January 17, 2007

 

$

0.4766

 

$

1,616

 

First Quarter 2007

 

March 30, 2007

 

April 17, 2007

 

$

0.4766

 

$

1,616

 

 

 

 

 

 

 

 

 

 

 

Series K Preferred Shares:

 

 

 

 

 

 

 

 

 

First Quarter 2007

 

March 30, 2007

 

April 17, 2007

 

$

0.7466

 

$

397

 

 

 

 

 

 

 

 

 

 

 

Common Shares:

 

 

 

 

 

 

 

 

 

Fourth Quarter 2006

 

December 29, 2006

 

January 17, 2007

 

$

0.3100

 

$

13,292

 

First Quarter 2007

 

March 30, 2007

 

April 17, 2007

 

$

0.3100

 

$

14,529

 

 

 

 

 

 

 

 

 

 

 

Series I Preferred Units:

 

 

 

 

 

 

 

 

 

Fourth Quarter 2006

 

December 29, 2006

 

January 17, 2007

 

$

0.4688

 

$

165

 

First Quarter 2007

 

March 30, 2007

 

April 17, 2007

 

$

0.4688

 

$

165

 

 

 

 

 

 

 

 

 

 

 

Common Units:

 

 

 

 

 

 

 

 

 

Fourth Quarter 2006

 

December 29, 2006

 

January 17, 2007

 

$

0.3100

 

$

2,622

 

First Quarter 2007

 

March 30, 2007

 

April 17, 2007

 

$

0.3100

 

$

2,554

 

 

15.          Supplemental Information to Statements of Cash Flows

 

 

For the Three Months Ended

 

 

 

March 31,

 

 

 

2007

 

2006

 

Supplemental schedule of non-cash investing and financing activities:

 

 

 

 

 

 

 

 

 

 

 

Debt assumed in connection with acquisition of properties

 

$

38,848

 

$

 

(Decrease) increase in accrued capital improvements and leasing costs

 

$

(2,600

)

$

6,307

 

Amortization of discounts and premiums on mortgage loans to

 

 

 

 

 

commercial real estate properties

 

$

255

 

$

45

 

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

 

$

(248

)

$

110

 

Issuance of common shares in connection with acquisition of properties

 

$

156,691

 

$

 

Issuance of preferred shares in connection with acquisition of properties

 

$

26,583

 

$

 

Restricted cash used in connection with acquisition of properties

 

$

20,122

 

$

 

Adjustments to minority interests resulting from changes in ownership

 

 

 

 

 

of Operating Partnership by COPT

 

$

26,511

 

$

778

 

Dividends/distribution payable

 

$

20,687

 

$

16,878

 

Decrease in minority interests and increase in shareholders’ equity in

 

 

 

 

 

connection with the conversion of common units into common shares

 

$

10,563

 

$

1,945

 

 

15




 

16.          Information by Business Segment

As of March 31, 2007, we had nine primary office property segments: Baltimore/Washington Corridor; Northern Virginia; Suburban Baltimore; Colorado Springs, Suburban Maryland; Greater Philadelphia; St. Mary’s and King George Counties; San Antonio; and Northern/Central New Jersey.

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

 

Colorado
Springs

 

Suburban
Maryland

 

Greater
Philadelphia

 

St. Mary’s 
&
King 
George 
Counties

 

San 
Antonio

 

Northern/
Central 
New Jersey

 

Other

 

Total

 

Three Months Ended March 31, 2007

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

43,837

 

$

17,172

 

$

13,081

 

$

3,595

 

$

3,967

 

$

2,506

 

$

3,098

 

$

1,781

 

$

1,786

 

$

(428

)

$

90,395

 

Property operating expenses

 

14,526

 

6,328

 

5,771

 

1,280

 

1,663

 

33

 

771

 

359

 

697

 

596

 

32,024

 

NOI

 

$

29,311

 

$

10,844

 

$

7,310

 

$

2,315

 

$

2,304

 

$

2,473

 

$

2,327

 

$

1,422

 

$

1,089

 

$

(1,024

)

$

58,371

 

Additions to commercial real estate properties

 

$

77,115

 

$

10,852

 

$

261,734

 

$

3,803

 

$

496

 

$

232

 

$

69

 

$

(34

)

$

254

 

$

25,421

 

$

379,942

 

Segment assets at March 31, 2007

 

$

1,153,457

 

$

480,989

 

$

462,330

 

$

137,948

 

$

117,496

 

$

97,306

 

$

96,884

 

$

57,250

 

$

44,486

 

$

166,577

 

$

2,814,723

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31, 2006

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

34,393

 

$

15,573

 

$

7,357

 

$

1,289

 

$

3,553

 

$

2,505

 

$

2,988

 

$

1,810

 

$

2,893

 

$

(182

)

$

72,179

 

Property operating expenses

 

10,369

 

5,490

 

2,840

 

491

 

1,317

 

40

 

691

 

333

 

985

 

(489

)

22,067

 

NOI

 

$

24,024

 

$

10,083

 

$

4,517

 

$

798

 

$

2,236

 

$

2,465

 

$

2,297

 

$

1,477

 

$

1,908

 

$

307

 

$

50,112

 

Additions to commercial real estate properties

 

$

31,563

 

$

3,123

 

$

871

 

$

5,833

 

$

404

 

$

338

 

$

311

 

$

7,702

 

$

587

 

$

(268

)

$

50,464

 

Segment assets at March 31, 2006

 

$

925,067

 

$

462,441

 

$

187,732

 

$

69,086

 

$

114,873

 

$

99,029

 

$

98,818

 

$

51,570

 

$

58,203

 

$

76,056

 

$

2,142,875

 

 

16




 

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,

 

 

 

2007

 

2006

 

Segment revenues

 

$

90,395

 

$

72,179

 

Construction contract revenues

 

8,691

 

14,544

 

Other service operations revenues

 

1,386

 

1,765

 

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

 

(720

)

(2,957

)

Total revenues

 

$

99,752

 

$

85,531

 

 

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,

 

 

 

2007

 

2006

 

 

 

 

 

 

 

Segment property operating expenses

 

$

32,024

 

$

22,067

 

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

 

(276

)

(1,006

)

Total property operating expenses

 

$

31,748

 

$

21,061

 

 

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,

 

 

 

2007

 

2006

 

NOI for reportable segments

 

$

58,371

 

$

50,112

 

Construction contract revenues

 

8,691

 

14,544

 

Other service operations revenues

 

1,386

 

1,765

 

Equity in loss of unconsolidated entities

 

(94

)

(23

)

Income tax expense

 

(105

)

(215

)

Less:

 

 

 

 

 

Depreciation and other amortization associated with real estate operations

 

(26,569

)

(18,672

)

Construction contract expenses

 

(8,483

)

(14,026

)

Other service operations expenses

 

(1,405

)

(1,678

)

General and administrative expenses

 

(4,614

)

(3,963

)

Interest expense on continuing operations

 

(19,876

)

(17,029

)

Amortization of deferred financing costs

 

(884

)

(556

)

Minority interests in continuing operations

 

(426

)

(958

)

NOI from discontinued operations

 

(444

)

(1,951

)

Income from continuing operations

 

$

5,548

 

$

7,350

 

 

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

17




revenues, other service operations revenues, construction contract expenses, other service operations expenses, equity in loss of unconsolidated entities, general and administrative expense, income taxes and minority interests because these items represent general corporate items not attributable to segments.

17.          Share-Based Compensation

During the three months ended March 31, 2007, we granted to employees 226,660 options to purchase common shares with a weighted average exercise price of $49.25 per share.  All of these options vest in equal increments annually over a three-year period beginning on the first anniversary of the grant date provided that the employees remain employed by us, and they expire ten years after the grant date.  We computed share-based compensation expense for these options under the fair value method using the Black-Scholes option-pricing model; the weighted average assumptions we used in that model are set forth below:

Weighted average fair value per share option granted during the period

 

$

9.85

 

Risk-free interest rate

 

4.61

%(1)

Expected life (in years)

 

6.25

 

Expected volatility

 

21.51

%(2)

Expected annual dividend yield

 

3.27

%(3)


(1) Ranged from 4.53% to 4.91%.

(2) Ranged from 21.41% to 21.75%.

(3) Ranged from 3.21% to 3.35%.

During the three months ended March 31, 2007, 469,918 options to purchase common shares were exercised.  The weighted average exercise price of these options was $10.92 per share, and the total intrinsic value of options exercised was $19,642.

During the three months ended March 31, 2007, certain employees were granted 128,776 restricted shares with a weighted average grant date fair value of $50.57 per share.  All of these shares are subject to forfeiture restrictions that lapse in equal increments annually over a three-year period beginning on the first anniversary of the grant date provided that the employees remain employed by us.  During the three months ended March 31, 2007, forfeiture restrictions lapsed on 126,619 common shares previously issued to employees.  These shares had a weighted average grant date fair value of $21.97 per share, and the total fair value of the shares on the vesting date was $6,514.

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

 

For the

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2007

 

2006

 

Increase in general and administrative expenses

 

$

879

 

$

469

 

Increase in construction contract and other service operations expenses

 

354

 

144

 

Share-based compensation expense

 

1,233

 

613

 

Income taxes

 

(35

)

(17

)

Minority interests

 

(193

)

(109

)

Net share-based compensation expense

 

$

1,005

 

$

487

 

 

18




 

18.          Income Taxes

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

 

For the Three Months 
Ended March 31,

 

 

 

2007

 

2006

 

Deferred

 

 

 

 

 

Federal

 

$

86

 

$

176

 

State

 

19

 

39

 

Total

 

$

105

 

$

215

 

 

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, 2007 and 2006.

19.          Discontinued Operations

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

 

 

·

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

·

the 68 Culver Road property that was sold on March 8, 2006;

·

the 710 Route 46 property that was sold on July 26, 2006;

·

the 230 Schilling Circle property that was sold on August 9, 2006;

·

the 7 Centre Drive property that was sold on August 30, 2006;

·

the Brown’s Wharf property that was sold on September 28, 2006; and

·

the 429 Ridge Road property which, as of March 31, 2007, we were under contract to sell, and was classified as held for sale.

 

 

 

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

 

 

For the Three Months
Ended March 31,

 

 

 

2007

 

2006

 

Revenue from real estate operations

 

$

720

 

$

2,957

 

Expenses from real estate operations:

 

 

 

 

 

Property operating expenses

 

276

 

1,006

 

Depreciation and amortization

 

57

 

665

 

Interest expense

 

388

 

686

 

Other

 

 

3

 

Expenses from real estate operations

 

721

 

2,360

 

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

 

(1

)

597

 

Gain on sales of real estate

 

 

2,435

 

Minority interests in discontinued operations

 

 

(555

)

Income from discontinued operations, net of minority interests

 

$

(1

)

$

2,477

 

 

19




 

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, 2007, we were under contract to acquire the following properties:

·                  a parcel of land in Aberdeen, Maryland for $10,000, of which we paid a deposit of $100 in 2006; and

·                  the remaining 91 acres of land not yet acquired as part of the acquisition of the former Fort Ritchie United States Army base located in Cascade, Washington County, Maryland; we expect to make the following additional future cash payments to the seller for (1) the acquisition of the remaining 91 acres and (2) portions of the contract price on which payment was deferred by the contract:  $1,310 in 2007, $1,000 in 2008 and $155 in 2009.  We could incur an additional cash obligation to the seller after that of up to $4,000; this $4,000 cash obligation is subject to reduction by an amount ranging between $750 and $4,000, with the amount of such reduction to be determined based on defined levels of (1) job creation resulting from the future development of the property and (2) future real estate taxes generated by the property.  Following completion of this acquisition, we will be obligated to incur $7,500 in development and construction costs for the property.

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 $153; the tenant’s account was current as of March 31, 2007.  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.

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.

In two of the consolidated joint ventures that we owned as of March 31, 2007, 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

20




interests in these joint ventures to be $2,383; 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 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 amount of approximately $1,898 in rent under the lease in 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

Office Space Operating Leases

We are obligated as lessee under five operating leases for office space.  Future minimum rental payments due under the terms of these leases as of March 31, 2007 follow:

Nine months ended December 31, 2007

 

$

212

 

2008

 

261

 

2009

 

176

 

2010

 

135

 

2011

 

57

 

 

 

$

841

 

 

 

 

 

 

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, 2007 follow:

 

Nine months ended December 31, 2007

 

$

426

 

2008

 

493

 

2009

 

317

 

2010

 

142

 

2011

 

21

 

 

 

$

1,399

 

 

 

 

 

 

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

·