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 EXCHANGE ACT OF 1934

For the quarterly period ended  June 30, 2007

or

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES 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 July 27, 2007, 47,163,665 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 June 30, 2007 and December 31, 2006 (unaudited)

 

3

 

Consolidated Statements of Operations for the three and six months ended June 30, 2007 and 2006 (unaudited)

 

4

 

Consolidated Statements of Cash Flows for the six months ended June 30, 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

 

25

Item 3:

Quantitative and Qualitative Disclosures About Market Risk

 

43

Item 4:

Controls and Procedures

 

43

 

 

 

 

PART II: OTHER INFORMATION

 

 

 

 

 

 

Item 1:

Legal Proceedings

 

44

Item 1A:

Risk Factors

 

44

Item 2:

Unregistered Sales of Equity Securities and Use of Proceeds

 

44

Item 3:

Defaults Upon Senior Securities

 

44

Item 4:

Submission of Matters to a Vote of Security Holders

 

45

Item 5:

Other Information

 

45

Item 6:

Exhibits

 

45

 

 

 

SIGNATURES

 

46

 

2




PART I: FINANCIAL INFORMATION

ITEM 1. Financial Statements

Corporate Office Properties Trust and Subsidiaries

Consolidated Balance Sheets

(Dollars in thousands)

(unaudited)

 

 

June 30,

 

December 31,

 

 

 

2007

 

2006

 

Assets

 

 

 

 

 

Investment in real estate:

 

 

 

 

 

Operating properties, net

 

$

2,140,298

 

$

1,812,883

 

Property held for sale, net

 

14,578

 

 

Projects under construction or development

 

369,697

 

298,427

 

Total commercial real estate properties, net

 

2,524,573

 

2,111,310

 

Cash and cash equivalents

 

15,123

 

7,923

 

Restricted cash

 

20,482

 

52,856

 

Accounts receivable, net

 

18,826

 

26,367

 

Deferred rent receivable

 

47,579

 

41,643

 

Intangible assets on real estate acquisitions, net

 

123,861

 

87,325

 

Deferred charges, net

 

47,292

 

43,710

 

Prepaid and other assets

 

56,993

 

48,467

 

Total assets

 

$

2,854,729

 

$

2,419,601

 

 

 

 

 

 

 

Liabilities and shareholders’ equity

 

 

 

 

 

Liabilities:

 

 

 

 

 

Mortgage and other loans payable

 

$

1,552,478

 

$

1,298,537

 

3.5% Exchangeable Senior Notes

 

200,000

 

200,000

 

Accounts payable and accrued expenses

 

61,531

 

68,190

 

Rents received in advance and security deposits

 

26,547

 

20,237

 

Dividends and distributions payable

 

20,754

 

19,164

 

Deferred revenue associated with acquired operating leases

 

13,522

 

11,120

 

Distributions in excess of investment in unconsolidated real estate joint venture

 

3,852

 

3,614

 

Other liabilities

 

7,525

 

8,249

 

Total liabilities

 

1,886,209

 

1,629,111

 

Minority interests:

 

 

 

 

 

Common units in the Operating Partnership

 

119,297

 

104,934

 

Preferred units in the Operating Partnership

 

8,800

 

8,800

 

Other consolidated real estate joint ventures

 

2,654

 

2,453

 

Total minority interests

 

130,751

 

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 June 30, 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 47,154,605 at June 30, 2007 and 42,897,639 at December 31, 2006)

 

472

 

429

 

Additional paid-in capital

 

944,818

 

758,032

 

Cumulative distributions in excess of net income

 

(107,277

)

(83,541

)

Accumulated other comprehensive loss

 

(325

)

(693

)

Total shareholders’ equity

 

837,769

 

674,303

 

Total liabilities and shareholders’ equity

 

$

2,854,729

 

$

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
June 30,

 

For the Six Months
Ended June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Revenues

 

 

 

 

 

 

 

 

 

Rental revenue

 

$

78,824

 

$

61,635

 

$

154,706

 

$

122,197

 

Tenant recoveries and other real estate operations revenue

 

12,128

 

9,134

 

25,921

 

17,794

 

Construction contract revenues

 

10,620

 

12,156

 

19,311

 

26,700

 

Other service operations revenues

 

1,073

 

1,984

 

2,459

 

3,749

 

Total revenues

 

102,645

 

84,909

 

202,397

 

170,440

 

Expenses

 

 

 

 

 

 

 

 

 

Property operating expenses

 

29,038

 

21,640

 

60,786

 

42,701

 

Depreciation and other amortization associated with real estate operations

 

27,429

 

18,095

 

53,998

 

36,767

 

Construction contract expenses

 

10,136

 

11,643

 

18,619

 

25,669

 

Other service operations expenses

 

1,126

 

1,818

 

2,531

 

3,496

 

General and administrative expenses

 

5,085

 

3,705

 

9,699

 

7,668

 

Total operating expenses

 

72,814

 

56,901

 

145,633

 

116,301

 

Operating income

 

29,831

 

28,008

 

56,764

 

54,139

 

Interest expense

 

(20,541

)

(17,132

)

(40,417

)

(34,161

)

Amortization of deferred financing costs

 

(921

)

(606

)

(1,805

)

(1,162

)

Gain on sale of non-real estate investment

 

1,033

 

 

1,033

 

 

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

 

9,402

 

10,270

 

15,575

 

18,816

 

Equity in loss of unconsolidated entities

 

(57

)

(32

)

(151

)

(55

)

Income tax expense

 

(178

)

(206

)

(283

)

(421

)

Income from continuing operations before minority interests

 

9,167

 

10,032

 

15,141

 

18,340

 

Minority interests in income from continuing operations

 

 

 

 

 

 

 

 

 

Common units in the Operating Partnership

 

(825

)

(1,095

)

(1,133

)

(1,921

)

Preferred units in the Operating Partnership

 

(165

)

(165

)

(330

)

(330

)

Other consolidated entities

 

31

 

25

 

78

 

58

 

Income from continuing operations

 

8,208

 

8,797

 

13,756

 

16,147

 

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

 

(492

)

294

 

(493

)

2,771

 

Income before gain on sales of real estate

 

7,716

 

9,091

 

13,263

 

18,918

 

Gain on sales of real estate, net

 

161

 

25

 

161

 

135

 

Net income

 

7,877

 

9,116

 

13,424

 

19,053

 

Preferred share dividends

 

(4,025

)

(3,653

)

(8,018

)

(7,307

)

Net income available to common shareholders

 

$

3,852

 

$

5,463

 

$

5,406

 

$

11,746

 

Basic earnings per common share

 

 

 

 

 

 

 

 

 

Income from continuing operations

 

$

0.09

 

$

0.12

 

$

0.13

 

$

0.22

 

Discontinued operations

 

(0.01

)

0.01

 

(0.01

)

0.07

 

Net income available to common shareholders

 

$

0.08

 

$

0.13

 

$

0.12

 

$

0.29

 

Diluted earnings per common share

 

 

 

 

 

 

 

$

 

Income from continuing operations

 

$

0.09

 

$

0.12

 

$

0.12

 

$

0.21

 

Discontinued operations

 

(0.01

)

0.01

 

(0.01

)

0.07

 

Net income available to common shareholders

 

$

0.08

 

$

0.13

 

$

0.11

 

$

0.28

 

 

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 Six Months Ended
June 30,

 

 

 

2007

 

2006

 

Cash flows from operating activities

 

 

 

 

 

Net income

 

$

13,424

 

$

19,053

 

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

 

 

 

 

 

Minority interests

 

1,325

 

2,835

 

Depreciation and other amortization

 

54,055

 

38,087

 

Amortization of deferred financing costs

 

1,805

 

1,168

 

Amortization of deferred market rental revenue

 

(985

)

(1,050

)

Equity in loss of unconsolidated entities

 

151

 

55

 

Gain on sales of real estate

 

(183

)

(2,563

)

Gain on sale of non-real estate investment

 

(1,033

)

 

Share-based compensation

 

3,141

 

1,491

 

Changes in operating assets and liabilities:

 

 

 

 

 

Increase in deferred rent receivable

 

(5,936

)

(4,586

)

Decrease in accounts receivable

 

7,541

 

160

 

(Increase) decrease in restricted cash and prepaid and other assets

 

(10,274

)

3,333

 

Decrease in accounts payable, accrued expenses and other liabilities

 

(4,037

)

(1,386

)

Increase in rents received in advance and security deposits

 

6,310

 

3,350

 

Other

 

(370

)

(156

)

Net cash provided by operating activities

 

64,934

 

59,791

 

Cash flows from investing activities

 

 

 

 

 

Purchases of and additions to commercial real estate properties

 

(243,936

)

(186,597

)

Proceeds from sales of properties

 

 

28,209

 

Proceeds from disposition of non-real estate investment

 

2,526

 

 

Investments in and advances to unconsolidated entities

 

 

(372

)

Acquisition of partner interests in consolidated joint ventures

 

(1,262

)

(3,016

)

Distributions from unconsolidated entities

 

89

 

254

 

Leasing costs paid

 

(8,164

)

(4,232

)

Decrease in restricted cash associated with investing activities

 

14,838

 

4,978

 

Other

 

(262

)

(544

)

Net cash used in investing activities

 

(236,171

)

(161,320

)

Cash flows from financing activities

 

 

 

 

 

Proceeds from mortgage and other loans payable

 

431,495

 

234,748

 

Repayments of mortgage and other loans payable

 

(216,352

)

(187,660

)

Deferred financing costs paid

 

(1,556

)

(756

)

Distributions paid to partners in consolidated joint ventures

 

 

(787

)

Net proceeds from issuance of common shares

 

6,140

 

85,054

 

Dividends paid

 

(35,523

)

(29,632

)

Distributions paid

 

(5,505

)

(5,091

)

Other

 

(262

)

617

 

Net cash provided by financing activities

 

178,437

 

96,493

 

Net increase (decrease) in cash and cash equivalents

 

7,200

 

(5,036

)

Cash and cash equivalents

 

 

 

 

 

Beginning of period

 

7,923

 

10,784

 

End of period

 

$

15,123

 

$

5,748

 

 

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 June 30, 2007, our investments in real estate included the following:

·                  229 wholly owned operating properties in our portfolio totaling 17.7 million square feet;

·                  21 wholly owned properties under construction or development that we estimate will total approximately 2.2 million square feet upon completion and one wholly owned office property totaling approximately 75,000 square feet that was under redevelopment;

·                  wholly owned land parcels totaling 1,362 acres that we believe are potentially developable into approximately 11.6 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 June 30, 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.

6




2.                                      Basis of Presentation

The accompanying unaudited interim Consolidated Financial Statements have been prepared in accordance with the rules and regulations for reporting on Form 10-Q.  Accordingly, certain information and disclosures required by accounting principles generally accepted in the United States for complete Consolidated Financial Statements are not included herein.  These interim financial statements should be read together with the financial statements and notes thereto included in our 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 June 30,

 

For the Six Months
Ended June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Numerator:

 

 

 

 

 

 

 

 

 

Income from continuing operations

 

$

8,208

 

$

8,797

 

$

13,756

 

$

16,147

 

Add: Gain on sales of real estate, net

 

161

 

25

 

161

 

135

 

Less: Preferred share dividends

 

(4,025

)

(3,653

)

(8,018

)

(7,307

)

Numerator for basic and diluted EPS from continuing operations

 

4,344

 

5,169

 

5,899

 

8,975

 

(Loss) income from discontinued operations, net

 

(492

)

294

 

(493

)

2,771

 

Numerator for basic and diluted EPS on net income available to common shareholders

 

$

3,852

 

$

5,463

 

$

5,406

 

$

11,746

 

Denominator (all weighted averages):

 

 

 

 

 

 

 

 

 

Denominator for basic EPS (common shares)

 

46,686

 

41,510

 

46,185

 

40,594

 

Dilutive effect of share-based compensation awards

 

1,105

 

1,721

 

1,305

 

1,801

 

Denominator for diluted EPS

 

47,791

 

43,231

 

47,490

 

42,395

 

 

 

 

 

 

 

 

 

 

 

Basic EPS:

 

 

 

 

 

 

 

 

 

Income from continuing operations

 

$

0.09

 

$

0.12

 

$

0.13

 

$

0.22

 

(Loss) income from discontinued operations

 

(0.01

)

0.01

 

(0.01

)

0.07

 

Net income available to common shareholders

 

$

0.08

 

$

0.13

 

$

0.12

 

$

0.29

 

Diluted EPS:

 

 

 

 

 

 

 

 

 

Income from continuing operations

 

$

0.09

 

$

0.12

 

$

0.12

 

$

0.21

 

(Loss) income from discontinued operations

 

(0.01

)

0.01

 

(0.01

)

0.07

 

Net income available to common shareholders

 

$

0.08

 

$

0.13

 

$

0.11

 

$

0.28

 

 

7




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

 

 

Weighted Average Shares in Denominator

 

 

 

For the Three Months
Ended June 30,

 

For the Six Months
Ended June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Conversion of weighted average common units

 

8,313

 

8,465

 

8,361

 

8,493

 

Conversion of weighted average convertible preferred shares

 

434

 

 

415

 

 

Conversion of weighted average convertible preferred units

 

176

 

176

 

176

 

176

 

 

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:

 

June 30,

 

December 31,

 

 

 

2007

 

2006

 

Land

 

$

411,938

 

$

343,098

 

Buildings and improvements

 

1,980,661

 

1,689,359

 

 

 

2,392,599

 

2,032,457

 

Less: accumulated depreciation

 

(252,301

)

(219,574

)

 

 

$

2,140,298

 

$

1,812,883

 

 

As of June 30, 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

8




New Jersey Region).  We expect to complete the sale of this property by January 2008.  The components associated with 429 Ridge Road as of June 30, 2007 included the following:

 

June 30,

 

 

 

2007

 

Land

 

$

2,932

 

Buildings and improvements

 

14,593

 

 

 

17,525

 

Less: accumulated depreciation

 

(2,947

)

 

 

$

14,578

 

 

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

 

June 30,

 

December 31,

 

 

 

2007

 

2006

 

Land

 

$

205,887

 

$

153,436

 

Construction in progress

 

163,810

 

144,991

 

 

 

$

369,697

 

$

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

 

$

70,250

 

Land, construction or development

 

37,813

 

Building and improvements

 

210,242

 

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

 

 

 

 

 

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

 

 

On April 6, 2007, we purchased for $13,586 the remaining 50% undivided interest in a 132-acre parcel of land located in Colorado Springs, Colorado that we believe can support approximately 1.75 million developable square feet of office space.

9




2007 Construction and Development Activities

During the six months ended June 30, 2007, we had one property totaling 193,000 square feet located in Chesterfield County, Virginia become fully operational and placed into service 21,363 square feet in a partially operational property located in the Baltimore/Washington Corridor (operational space in this property totaled 89,559 square feet at June 30, 2007).

As of June 30, 2007, we had construction underway on five new buildings in the Baltimore/Washington Corridor (including the partially operational property discussed above and one property owned through a joint venture formed in July 2007 in which we have a 50% interest), two in Colorado Springs, Colorado, two in Suburban Baltimore and one in Southwest Virginia.  We also had development activities underway on five new buildings located in the Baltimore/Washington Corridor, three in Colorado Springs, Colorado, two in Suburban Maryland and one each in Suburban Baltimore and King George County, Virginia.  In addition, we had redevelopment underway on one wholly owned existing building located in Colorado Springs, Colorado and three buildings owned by a joint venture (two are located in Northern Virginia and the other in the Baltimore/Washington Corridor).

6.                                      Real Estate Joint Ventures

During the six months ended June 30, 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

 

 

 

  June 30,  

 

December 31,

 

Date

 

 

 

Nature of

 

Assets at

 

Exposure

 

 

 

2007

 

2006

 

Acquired

 

Ownership

 

Activity

 

  6/30/2007  

 

to Loss (1)

 

Harrisburg Corporate Gateway Partners, L.P.  

 

$

(3,852

)(2)

$

(3,614

)(2)

9/29/2005  

 

20

%

Operates 16 buildings (3)  

 

$

74,249  

 

$

—  

 

 


(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 $4,718 at June 30, 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.:

 

June 30,

 

December 31,

 

 

 

2007

 

2006

 

Commercial real estate property

 

$

71,834

 

$

72,688

 

Other assets

 

2,415

 

3,207

 

Total assets

 

$

74,249

 

$

75,895

 

 

 

 

 

 

 

Liabilities

 

$

67,918

 

$

67,350

 

Owners’ equity

 

6,331

 

8,545

 

Total liabilities and owners’ equity

 

$

74,249

 

$

75,895

 

 

The following table sets forth combined condensed statements of operations for the two unconsolidated real estate joint ventures we owned from January 1, 2006 through June 30, 2007, which included Harrisburg Corporate Gateway Partners, L.P. and Route 46 Partners, a joint venture that was dissolved on July 26, 2006:

10




 

 

For the Three Months
Ended June 30,

 

For the Six Months 
Ended June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Revenues

 

$

2,426

 

$

3,254

 

$

4,870

 

$

6,458

 

Property operating expenses

 

(876

)

(1,082

)

(1,836

)

(2,187

)

Interest expense

 

(980

)

(1,189

)

(2,118

)

(2,351

)

Depreciation and amortization expense

 

(855

)

(993

)

(1,722

)

(1,905

)

Net income

 

$

(285

)

$

(10

)

$

(806

)

$

15

 

 

Activity related to consolidated joint ventures during the six months ended June 30, 2007 included the following:

·                  as of December 31, 2006, we owned a 50% interest in Commons Office 6-B, LLC, an entity developing a land parcel in Hanover, Maryland.  We acquired the remaining 50% interest in this entity for $1,262 on May 24, 2007; and

·                  on June 26, 2007, we completed the formation of Enterprise Campus Developers, LLC, an entity in which we own a 90% interest.  This entity was created to develop and construct one or more office buildings on land parcels located in College Park, Maryland as part of a separate joint venture to be formed with another party.  At June 30, 2007, development and construction activities were underway in anticipation of the entity’s membership into this future joint venture.

The table below sets forth information pertaining to our investments in consolidated joint ventures at June 30, 2007:

 

 

 

 

Ownership

 

 

 

Total

 

Collateralized

 

 

 

Date

 

% at

 

Nature of

 

Assets at

 

Assets at

 

 

 

Acquired

 

6/30/2007

 

Activity

 

6/30/2007

 

6/30/2007

 

COPT Opportunity Invest I, LLC

 

12/20/2005

 

92.5%

 

Redeveloping three properties (1)

 

$

47,910

 

$

 

Enterprise Campus Developers, LLC

 

6/26/2007

 

90.0%

 

Developing land parcels (2)

 

11,401

 

 

MOR Forbes 2 LLC

 

12/24/2002

 

50.0%

 

Operates one building (3)

 

4,264

 

 

COPT-FD Indian Head, LLC

 

10/23/2006

 

75.0%

 

Developing land parcel (4)

 

3,029

 

 

 

 

 

 

 

 

 

 

$

66,604

 

$

 

 


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

(2) This joint venture is developing land parcels located in College Park, Maryland (located in the Suburban Maryland 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:

 

 

June 30, 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

 

$

49,210

 

$

75,934

 

$

105,719

 

$

38,279

 

$

67,440

 

Tenant relationship value

 

35,149

 

4,117

 

31,032

 

9,371

 

1,178

 

8,193

 

Lease cost portion of deemed cost avoidance

 

17,086

 

7,307

 

9,779

 

12,880

 

5,819

 

7,061

 

Lease to market value

 

14,428

 

8,481

 

5,947

 

10,623

 

7,178

 

3,445

 

Market concentration premium

 

1,333

 

164

 

1,169

 

1,333

 

147

 

1,186

 

 

 

$

193,140

 

$

69,279

 

$

123,861

 

$

139,926

 

$

52,601

 

$

87,325

 

 

Amortization of the intangible asset categories set forth above totaled $16,678 in the six months ended June 30, 2007 and $7,608 in the six months ended June 30, 2006.  The approximate weighted average amortization periods

11




of the categories set forth above follow: lease-up value: nine years; tenant relationship value: eight years; lease cost portion of deemed cost avoidance: six years; lease to market value: four 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 six months ended December 31, 2007 is $12.5 million, for 2008 is $21.7 million, for 2009 is $19.1 million, for 2010 is $14.8 million, for 2011 is $11.8 million and for 2012 is $9.5 million.

8.             Deferred Charges

Deferred charges consisted of the following:

 

June 30,

 

December 31,

 

 

 

2007

 

2006

 

Deferred leasing costs

 

$

58,875

 

$

52,263

 

Deferred financing costs

 

29,915

 

28,275

 

Goodwill

 

1,853

 

1,853

 

Deferred other

 

155

 

155

 

 

 

90,798

 

82,546

 

Accumulated amortization

 

(43,506

)

(38,836

)

Deferred charges, net

 

$

47,292

 

$

43,710

 

 

9.             Accounts Receivable

Our accounts receivable are reported net of an allowance for bad debts of $326 at June 30, 2007 and $252 at December 31, 2006.

10.          Prepaid and Other Assets

Prepaid and other assets consisted of the following:

 

June 30,

 

December 31,

 

 

 

2007

 

2006

 

Construction contract costs incurred in excess of billings

 

$

31,817

 

$

18,324

 

Furniture, fixtures and equipment

 

10,448

 

10,495

 

Prepaid expenses

 

5,762

 

9,059

 

Other assets

 

8,966

 

10,589

 

Prepaid and other assets

 

$

56,993

 

$

48,467

 

 

12




11.          Debt

Our debt consisted of the following:

 

 

Maximum

 

 

 

 

 

 

 

Scheduled

 

 

 

Principal Amount

 

Carrying Value at

 

 

 

Maturity

 

 

 

Under Debt at

 

June 30,

 

December 31,

 

Stated Interest Rates at

 

Dates at

 

 

 

June 30, 2007

 

2007

 

2006

 

June 30, 2007

 

June 30, 2007

 

Mortgage and other loans payable:

 

 

 

 

 

 

 

 

 

 

 

Revolving Credit Facility

 

 

 

 

 

 

 

 

 

 

 

Wachovia Bank, N.A. Revolving Credit Facility

 

500,000

 

267,000

 

185,000

 

LIBOR + 1.15%  to 1.55%

 

March 2008 (1)

 

 

 

 

 

 

 

 

 

 

 

 

 

Mortgage Loans

 

 

 

 

 

 

 

 

 

 

 

Fixed rate mortgage loans (2)

 

N/A

 

1,159,654

 

1,020,619

 

5.20% - 8.75% (3)

 

2007 - 2034 (4)

 

Variable rate construction loan facilities

 

111,500

 

88,966

 

56,079

 

LIBOR + 1.40% to 1.50%

 

2007 - 2008 (5)

 

Other variable rate mortgage loans

 

N/A

 

34,500

 

34,500

 

LIBOR + 1.20% to 1.50%

 

2007 (6)

 

Total mortgage loans

 

 

 

1,283,120

 

1,111,198

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Note payable

 

 

 

 

 

 

 

 

 

 

 

Unsecured seller notes

 

N/A

 

2,358

 

2,339

 

0% - 5.95%

 

2007-2008

 

Total mortgage and other loans payable

 

 

 

1,552,478

 

1,298,537

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

3.5% Exchangeable Senior Notes

 

N/A

 

200,000

 

200,000

 

3.50%

 

September 2026 (7)

 

Total debt

 

 

 

$

1,752,478

 

$

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 $702 at June 30, 2007 and $210 at December 31, 2006.

(3)          The weighted average interest rate on these loans was 5.96% at June 30, 2007.

(4)          A loan with a balance of $4,857 at June 30, 2007 that matures in 2034 may be repaid in March 2014, subject to certain conditions.

(5)          At June 30, 2007, $74,099 in loans scheduled to mature in 2008 may be extended by us for a one-year period, subject to certain conditions.

(6)          At June 30, 2007, a $34,500 loan scheduled to mature in 2007 may be extended by us 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 $8,906 in the six months ended June 30, 2007 and $6,665 in the six months ended June 30, 2006.

12.          Derivatives

The following table sets forth our derivative contracts at June 30, 2007 and their respective fair values:

 

 

 

 

 

 

 

 

 

Fair Value at

 

 

 

Notional

 

One-Month

 

Effective

 

Expiration

 

June 30,

 

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

 

$

141

 

$

(42

)

Interest rate swap

 

25,000

 

5.2320

%

5/1/2006

 

5/1/2009

 

(14

)

(133

)

Interest rate swap

 

25,000

 

5.2320

%

5/1/2006

 

5/1/2009

 

(14

)

(133

)

 

 

 

 

 

 

 

 

 

 

$

113

 

$

(308

)

 

These amounts are included on the Consolidated Balance Sheets as prepaid and other assets as of June 30, 2007 and other liabilities as of December 31, 2006.

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:

13




 

 

For the Three
Months Ended

 

For the Six
Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Increase in fair value applied to accumulated other comprehensive loss and minority interests

 

669

 

723

 

421

 

833

 

 

13.          Shareholders’ Equity

Preferred Shares

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

 

 

June 30,

 

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.

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 six months ended June 30, 2007, we converted 401,621 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 accumulated other comprehensive loss or income component of shareholders’ equity:

14




 

 

For the Six Months
Ended June 30,

 

 

 

2007

 

2006

 

Beginning balance

 

$

(693

)

$

(482

)

Unrealized gain on derivatives, net of minority interests

 

342

 

683

 

Realized loss on derivatives, net of minority interests

 

26

 

25

 

Ending balance

 

$

(325

)

$

226

 

 

The table below sets forth our comprehensive income:

 

 

For the Three Months

 

For the Six Months

 

 

 

Ended June 30,

 

Ended June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Net income

 

$

7,877

 

$

9,116

 

$

13,424

 

$

19,053

 

Unrealized gain on derivatives, net of minority interests

 

565

 

593

 

342

 

683

 

Realized loss on derivatives, net of minority interests

 

13

 

13

 

26

 

25

 

Total comprehensive income

 

$

8,455

 

$

9,722

 

$

13,792

 

$

19,761

 

 

15




14.          Dividends and Distributions

The following table summarizes our dividends and distributions when either the payable dates or record dates occurred during the six months ended June 30, 2007:

 

 

Record Date

 

Payable Date

 

Dividend/
Distribution Per
Share/Unit

 

Total Dividend/
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

 

Second Quarter 2007

 

June 29, 2007

 

July 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

 

Second Quarter 2007

 

June 29, 2007

 

July 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

 

Second Quarter 2007

 

June 29, 2007

 

July 17, 2007

 

$

0.4766

 

$

1,616

 

 

 

 

 

 

 

 

 

 

 

Series K Preferred Shares:

 

 

 

 

 

 

 

 

 

First Quarter 2007

 

March 30, 2007

 

April 17, 2007

 

$

0.7466

 

$

397

 

Second Quarter 2007

 

June 29, 2007

 

July 17, 2007

 

$

0.7000

 

$

372

 

 

 

 

 

 

 

 

 

 

 

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

 

Second Quarter 2007

 

June 29, 2007

 

July 17, 2007

 

$

0.3100

 

$

14,613

 

 

 

 

 

 

 

 

 

 

 

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

 

Second Quarter 2007

 

June 29, 2007

 

July 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

 

Second Quarter 2007

 

June 29, 2007

 

July 17, 2007

 

$

0.3100

 

$

2,574

 

 

16




15.          Supplemental Information to Statements of Cash Flows

 

 

For the Six Months Ended

 

 

 

June 30,

 

 

 

2007

 

2006

 

Supplemental schedule of non-cash investing and financing activities:

 

 

 

 

 

 

 

 

 

 

 

Debt assumed in connection with acquisition of properties

 

$

38,848

 

$

37,484

 

(Decrease) increase in accrued capital improvements, leasing, and acquisition costs

 

$

(3,057

)

$

6,557

 

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

 

275

 

87

 

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

 

$

421

 

$

833

 

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

 

$

 

Issuance of common units in the Operating Partnership in connection with acqusitions of interests in properties

 

12,125

 

7,497

 

Reclassification of operating asset to investment in consolidated real estate joint venture

 

$

10,341

 

$

 

Consolidation of real estate joint venture:

 

 

 

 

 

Real estate assets

 

$

39

 

$

 

Prepaid and other assets

 

1,021

 

 

Minority interest

 

(1,060

)

 

Net adjustment

 

$

 

$

 

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

 

25,167

 

9,643

 

Dividends/distribution payable

 

$

20,754

 

$

17,450

 

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

 

18,958

 

4,691

 

Increase in accrued furniture, fixtures and equipment

 

$

19

 

$

1,584

 

 

17




16.          Information by Business Segment

As of June 30, 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 June 30, 2007

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

43,622

 

$

18,254

 

$

13,448

 

$

3,695

 

$

3,943

 

$

2,507

 

$

3,029

 

$

1,863

 

$

1,006

 

$

(197

)

$

91,170

 

 

Property operating expenses

 

13,336

 

6,483

 

4,954

 

1,192

 

1,652

 

29

 

739

 

386

 

387

 

136

 

29,294

 

 

NOI

 

$

30,286

 

$

11,771

 

$

8,494

 

$

2,503

 

$

2,291

 

$

2,478

 

$

2,290

 

$

1,477

 

$

619

 

$

(333

)

$

61,876

 

 

Additions to commercial real estate properties

 

$

18,902

 

$

6,019

 

$

4,178

 

$

20,564

 

$

1,412

 

$

300

 

$

214

 

$

40

 

$

11

 

$

17,360

 

$

69,000

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended June 30, 2006

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

34,797

 

$

15,796

 

$

7,230

 

$

1,963

 

$

3,785

 

$

2,506

 

$

3,037

 

$

1,797

 

$

2,386

 

$

(219

)

$

73,078

 

 

Property operating expenses

 

10,134

 

5,804

 

2,932

 

616

 

1,265

 

40

 

704

 

319

 

823

 

(239

)

22,398

 

 

NOI

 

$

24,663

 

$

9,992

 

$

4,298

 

$

1,347

 

$

2,520

 

$

2,466

 

$

2,333

 

$

1,478

 

$

1,563

 

$

20

 

$

50,680

 

 

Additions to commercial real estate properties

 

$

118,873

 

$

3,765

 

$

883

 

$

51,770

 

$

830

 

$

277

 

$

659

 

$

906

 

$

534

 

$

(390

)

$

178,107

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended June 30, 2007

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

87,459

 

$

35,426

 

$

26,529

 

$

7,290

 

$

7,910

 

$

5,013

 

$

6,127

 

$

3,644

 

$

2,792

 

$

(625

)

$

181,565

 

 

Property operating expenses

 

27,862

 

12,811

 

10,725

 

2,472

 

3,315

 

62

 

1,510

 

745

 

1,084

 

732

 

61,318

 

 

NOI

 

$

59,597

 

$

22,615

 

$

15,804

 

$

4,818

 

$

4,595

 

$

4,951

 

$

4,617

 

$

2,899

 

$

1,708

 

$

(1,357

)

$

120,247

 

 

Additions to commercial real estate properties

 

$

96,017

 

$

16,871

 

$

265,912

 

$

24,367

 

$

1,908

 

$

532

 

$

283

 

$

6

 

$

265

 

$

42,781

 

$

448,942

 

 

Segment assets at June 30, 2007

 

$

1,160,666

 

$

482,966

 

$

460,210

 

$

157,397

 

$

129,064

 

$

96,888

 

$

96,061

 

$

53,032

 

$

44,425

 

$

174,020

 

$

2,854,729

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended June 30, 2006

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

69,190

 

$

31,369

 

$

14,587

 

$

3,252

 

$

7,338

 

$

5,013

 

$

6,025

 

$

3,608

 

$

5,280

 

$

(405

)

$

145,257

 

 

Property operating expenses

 

20,503

 

11,294

 

5,772

 

1,107

 

2,582

 

81

 

1,395

 

652

 

1,808

 

(729

)

44,465

 

 

NOI

 

$

48,687

 

$

20,075

 

$

8,815

 

$

2,145

 

$

4,756

 

$

4,932

 

$

4,630

 

$

2,956

 

$

3,472

 

$

324

 

$

100,792

 

 

Additions to commercial real estate properties

 

$

150,436

 

$

6,888

 

$

1,754

 

$

57,603

 

$

1,234

 

$

615

 

$

970

 

$

8,608

 

$

1,121

 

$

(658

)

$

228,571

 

 

Segment assets at June 30, 2006

 

$

1,047,754

 

$

463,782

 

$

186,125

 

$

127,196

 

$

114,800

 

$

98,644

 

$

98,259

 

$

51,350

 

$

58,030

 

$

63,178

 

$

2,309,118

 

 

 

18




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

 

For the Three Months
Ended June 30,

 

For the Six Months 
Ended June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Segment revenues

 

$

91,170

 

$

73,078

 

$

181,565

 

$

145,257

 

Construction contract revenues

 

10,620

 

12,156

 

19,311

 

26,700

 

Other service operations revenues

 

1,073

 

1,984

 

2,459

 

3,749

 

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

 

(218

)

(2,309

)

(938

)

(5,266

)

Total revenues

 

$

102,645

 

$

84,909

 

$

202,397

 

$

170,440

 

 

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 June 30,

 

For the Six Months 
Ended June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

 

 

 

 

 

 

 

 

 

 

Segment property operating expenses

 

$

29,294

 

$

22,398

 

$

61,318

 

$

44,465

 

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

 

(256

)

(758

)

(532

)

(1,764

)

Total property operating expenses

 

$

29,038

 

$

21,640

 

$

60,786

 

$

42,701

 

 

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 June 30,

 

For the Six Months
Ended June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

NOI for reportable segments

 

$

61,876

 

$

50,680

 

$

120,247

 

$

100,792

 

Construction contract revenues

 

10,620

 

12,156

 

19,311

 

26,700

 

Other service operations revenues

 

1,073

 

1,984

 

2,459

 

3,749

 

Equity in loss of unconsolidated entities

 

(57

)

(32

)

(151

)

(55

)

Income tax expense

 

(178

)

(206

)

(283

)

(421

)

Other adjustments:

 

 

 

 

 

 

 

 

 

Depreciation and other amortization

 

 

 

 

 

 

 

 

 

associated with real estate operations

 

(27,429

)

(18,095

)

(53,998

)

(36,767

)

Construction contract expenses

 

(10,136

)

(11,643

)

(18,619

)

(25,669

)

Other service operations expenses

 

(1,126

)

(1,818

)

(2,531

)

(3,496

)

General and administrative expenses

 

(5,085

)

(3,705

)

(9,699

)

(7,668

)

Interest expense on continuing operations

 

(20,541

)

(17,132

)

(40,417

)

(34,161

)

Gain on sale of non-real estate investment

 

1,033

 

 

1,033

 

 

Amortization of deferred financing costs

 

(921

)

(606

)

(1,805

)

(1,162

)

Minority interests in continuing operations

 

(959

)

(1,235

)

(1,385

)

(2,193

)

Add (less) net operating loss (income) from discontinued operations

 

38

 

(1,551

)

(406

)

(3,502

)

Income from continuing operations

 

$

8,208

 

$

8,797

 

$

13,756

 

$

16,147

 

 

19




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

17.          Share-Based Compensation

During the six months ended June 30, 2007, we granted 262,066 options to purchase common shares (“options”) to employees and 40,000 options to Trustees.  The weighted average exercise price of these option grants total $47.91 per share.  The employee option grants 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.  Trustee options vest on the first anniversary of their grant provided that the Trustees remain in their positions.  All of the option grants 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

 

$

9.58

 

Risk-free interest rate

 

4.64

%(1)

Expected life (in years)

 

6.15

 

Expected volatility

 

21.46

%(2)

Expected annual dividend yield

 

3.24

%(3)

 


(1) Ranged from 4.53% to 4.91%.

(2) Ranged from 21.28% to 21.75%.

(3) Ranged from 3.12% to 3.35%.

During the six months ended June 30, 2007, 565,112 options to purchase common shares were exercised.  The weighted average exercise price of these options was $11.52 per share, and the total intrinsic value of options exercised was $22,591.

During the six months ended June 30, 2007, certain employees were granted restricted shares totaling 128,109 with a weighted average grant date fair value of $50.45 per share.  These shares are subject to forfeiture restrictions that lapse in equal increments annually over a three-year period (for most of the grants) or a five-year period beginning on the first anniversary of the grant date provided that the employees remain employed by us.  During the six months ended June 30, 2007, forfeiture restrictions lapsed on 132,427 common shares previously issued to employees.  These shares had a weighted average grant date fair value of $21.72 per share, and the total fair value of the shares on the vesting date was $6,768.

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

20




 

 

For the
Three Months Ended 
June 30,

 

For the 
Six Months Ended
June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Increase in general and administrative expenses

 

$

1,196

 

$

594

 

$

2,075

 

$

1,063

 

Increase in construction contract and other service operations expenses

 

509

 

198

 

863

 

342

 

Share-based compensation expense

 

1,705

 

792

 

2,938

 

1,405

 

Income taxes

 

(66

)

(25

)

(101

)

(42

)

Minority interests

 

(256

)

(134

)

(449

)

(243

)

Net share-based compensation expense

 

$

1,383

 

$

633

 

$

2,388

 

$

1,120

 

 

18.          Income Taxes

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

 

For the Three Months 
Ended June 30,

 

For the Six Months 
Ended June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Deferred

 

 

 

 

 

 

 

 

 

Federal

 

$

148

 

$

169

 

$

234

 

$

345

 

State

 

33

 

37

 

52

 

76

 

Total

 

$

181

 

$

206

 

$

286

 

$

421

 

 

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 and six months ended June 30, 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 June 30, 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:

21




 

 

For the Three Months
Ended June 30,

 

For the Six Months
Ended June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Revenue from real estate operations

 

$

218

 

$

2,309

 

$

938

 

$

5,266

 

Expenses from real estate operations:

 

 

 

 

 

 

 

 

 

Property operating expenses

 

256

 

758

 

532

 

1,764

 

Depreciation and amortization

 

 

655

 

57

 

1,320

 

Interest expense

 

533

 

504

 

921

 

1,190

 

Other

 

 

4

 

 

7

 

Expenses from real estate operations

 

789

 

1,921

 

1,510

 

4,281

 

(Loss) income from discontinued operations before gain on sales of real estate and minority interests

 

(571

)

388

 

(572

)

985

 

(Loss) gain on sales of real estate

 

(11

)

(32

)

(11

)

2,403

 

Minority interests in discontinued operations

 

90

 

(62

)

90

 

(617

)

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

 

$

(492

)

$

294

 

$

(493

)

$

2,771

 

 

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 June 30, 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;

·                  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; and

·                  a parcel of land in Colorado Springs, Colorado for $2,330, of which we had paid a deposit of $80 as of June 30, 2007.  We completed this acquisition on July 12, 2007.

Joint Ventures

As part of our obligations under the partnership agreement of Harrisburg Corporate Gateway Partners, LP, we 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.

22




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.  One such entity was created in July 2007.  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 one of the consolidated joint ventures that we owned as of June 30, 2007, we would be obligated to acquire the other member’s 50% interest in the joint venture if defined events were to occur.  The amount we would need to pay for that membership interest is computed based on the amount that the owner of the interest would receive under the joint venture agreement in the event that office property owned by the joint venture was 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 member’s membership interest in this joint venture to be $718; however, since the determination of this amount is dependent on the operations of the office property, which is not both completed and sufficiently occupied, this estimate is preliminary and could be materially different from the actual obligation.

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 June 30, 2007 follow:

Six months ended December 31, 2007

 

$

148

 

2008

 

261

 

2009

 

176

 

2010

 

135

 

2011

 

57

 

 

 

$

777

 

 

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 June 30, 2007 follow:

Six months ended December 31, 2007

 

$

265

 

2008

 

487

 

2009

 

331

 

2010

 

150

 

2011

 

21

 

 

 

$

1,254

 

 

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:

23




·                  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

·                  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.

We have insurance coverage in place that we believe will indemnify us, at least in part, for losses incurred as a result of this agreement.

21.          Pro Forma Financial Information (Unaudited)

We accounted for our 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 June 30, 2007.

We prepared our pro forma condensed consolidated financial information presented below as if the Nottingham Acquisition 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 this acquisition had occurred at the beginning of the respective periods, nor does it purport to indicate our results of operations for future periods.

 

For the Six Months

 

 

 

Ended June 30,

 

 

 

2007

 

2006

 

 

 

 

 

 

 

Pro forma total revenues

 

$

203,216

 

$

187,115

 

Pro forma net income

 

$

13,688

 

$

15,309

 

Pro forma net income available to common shareholders

 

$

5,636

 

$

7,258

 

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

 

 

 

 

 

Basic

 

$

0.12

 

$

0.17

 

Diluted

 

$

0.12

 

$

0.16

 

 

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.  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 June 30, 2007, our investments in real estate included the following:

·                  229 wholly owned operating properties in our portfolio totaling 17.7 million square feet;

·                  21 wholly owned properties under construction or development that we estimate will total approximately 2.2 million square feet upon completion and one wholly owned office property totaling approximately 75,000 square feet that was under redevelopment;

·                  wholly owned land parcels totaling 1,362 acres that we believe are potentially developable into approximately 11.6 million square feet; and

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

During the six months ended June 30, 2007, we:

·                  experienced increased revenues, operating expenses and operating income due primarily to the addition of properties through acquisition and construction activities since January 1, 2006;

·                  finished the period with occupancy of our wholly owned portfolio of properties at 92.7%;

·                  completed, on January 9 and 10, 2007, 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 $366.8 million.  We financed the acquisition by issuing $26.6 million in Series K Cumulative Redeemable Convertible Preferred Shares of beneficial interest (the “Series K Preferred Shares”) to the seller, issuing $156.7 million in common shares of beneficial interest (“common shares”) to the seller at a value of $49.57 per share, using $20.1 million from an escrow funded by proceeds from one of our property sales and using debt borrowings for the remainder;

·                  had one newly-constructed property in Chesterfield County, Virginia totaling 193,000 square feet become fully operational; and

·                  borrowed $150.0 million under a mortgage loan with a 10-year term at a fixed rate of 5.65%, using the proceeds to repay other debt.

In this section, we discuss our financial condition and results of operations as of and for the three and six months ended June 30, 2007.  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 and six months ended June 30, 2007 compared to the same periods in 2006;

·                  how we raised cash for acquisitions and other capital expenditures during the six months ended June 30, 2007;

·                  our cash flows;

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

·                  our commitments and contingencies; and

·                  the computation of our Funds from Operations for the three and six months ended June 30, 2007 and 2006.

25




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 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 June 30,

 

For the Six Months Ended June 30,

 

 

 

2007

 

2006

 

Variance

 

% Change

 

2007

 

2006

 

Variance

 

% Change

 

Revenues

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Rental revenue

 

$

78,824

 

$

61,635

 

$

17,189

 

27.9

%

$

154,706

 

$

122,197

 

$

32,509

 

26.6

%

Tenant recoveries and other real estate operations revenue

 

12,128

 

9,134

 

2,994

 

32.8

%

25,921

 

17,794

 

8,127

 

45.7

%

Construction contract revenues

 

10,620

 

12,156

 

(1,536

)

(12.6

)%

19,311

 

26,700

 

(7,389

)

(27.7

)%

Other service operations revenues

 

1,073

 

1,984

 

(911

)

(45.9

)%

2,459

 

3,749

 

(1,290

)

(34.4

)%

Total revenues

 

102,645

 

84,909

 

17,736

 

20.9

%

202,397

 

170,440

 

31,957

 

18.7

%

Expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Property operating expenses

 

29,038

 

21,640

 

7,398

 

34.2

%

60,786

 

42,701

 

18,085

 

42.4

%

Depreciation and other amortization associated with real estate operations

 

27,429

 

18,095

 

9,334

 

51.6

%

53,998

 

36,767

 

17,231

 

46.9

%

Construction contract expenses

 

10,136

 

11,643

 

(1,507

)

(12.9

)%

18,619

 

25,669

 

(7,050

)

(27.5

)%

Other service operations expenses

 

1,126

 

1,818

 

(692

)

(38.1

)%

2,531

 

3,496

 

(965

)

(27.6

)%

General and administrative expense

 

5,085

 

3,705

 

1,380

 

37.2

%

9,699

 

7,668

 

2,031

 

26.5

%

Total operating expenses

 

72,814

 

56,901

 

15,913

 

28.0

%

145,633

 

116,301

 

29,332

 

25.2

%

Operating income

 

29,831

 

28,008

 

1,823

 

6.5

%

56,764

 

54,139

 

2,625

 

4.8

%

Interest expense and amortization of deferred financing costs

 

(21,462

)

(17,738

)

(3,724

)

21.0

%

(42,222

)

(35,323

)

(6,899

)

19.5

%

Gain on sale of non-real estate investment

 

1,033

 

 

1,033

 

N/A

 

1,033

 

 

1,033

 

N/A

 

Equity in loss of unconsolidated entities

 

(57

)

(32

)

(25

)

78.1

%

(151

)

(55

)

(96

)

174.5

%

Income tax expense

 

(178

)

(206

)

28

 

(13.6

)%

(283

)

(421

)

138

 

(32.8

)%

Income from continuing operations before minority interests

 

9,167

 

10,032

 

(865

)

(8.6

)%

15,141

 

18,340

 

(3,199

)

(17.4

)%

Minority interests in income from continuing operations

 

(959

)

(1,235

)

276

 

(22.3

)%

(1,385

)

(2,193

)

808

 

(36.8

)%

Income from continuing operations

 

8,208

 

8,797

 

(589

)

(6.7

)%

13,756

 

16,147

 

(2,391

)

(14.8

)%

(Loss) income from discontinued operations, net

 

(492

)

294

 

(786

)

(267.3

)%

(493

)

2,771

 

(3,264

)

(117.8

)%

Gain on sales of real estate, net

 

161

 

25

 

136

 

544.0

%

161

 

135

 

26

 

19.3

%

Net income

 

7,877

 

9,116

 

(1,239

)

(13.6

)%

13,424

 

19,053

 

(5,629

)

(29.5

)%

Preferred share dividends

 

(4,025

)

(3,653

)

(372

)

10.2

%

(8,018

)

(7,307

)

(711

)

9.7

%

Net income available to common shareholders

 

$

3,852

 

$

5,463

 

$

(1,611

)

(29.5

)%

$

5,406

 

$

11,746

 

$

(6,340

)

(54.0

)%

Basic earnings per common share

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income from continuing operations

 

$

0.09

 

$

0.12

 

$

(0.03

)

(25.0

)%

$

0.13

 

$

0.22

 

$

(0.09

)

(40.9

)%

Net income available to common shareholders

 

$

0.08

 

$

0.13

 

$

(0.05

)

(38.5

)%

$

0.12

 

$

0.29

 

$

(0.17

)

(58.6

)%

Diluted earnings per common share

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income from continuing operations

 

$

0.09

 

$

0.12

 

$

(0.03

)

(25.0

)%

$

0.12

 

$

0.21

 

$

(0.09

)

(42.9

)%

Net income available to common shareholders

 

$

0.08

 

$

0.13

 

$

(0.05

)

(38.5

)%

$

0.11

 

$

0.28

 

$

(0.17

)

(60.7

)%

 

27




Results of Operations

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

Geographic Concentration of Property Operations

The table below sets forth the changes in the regional allocation of our annualized rental revenue from December 31, 2006 to June 30, 2007.  These changes occurred primarily as a result of the Nottingham Acquisition, but also due to the effect of development and leasing activity:

 

Percentage of Annualized

 

 

 

Rental Revenue of

 

 

 

Wholly Owned Properties as of

 

Region

 

June 30, 2007

 

December 31, 
2006

 

Baltimore/Washington Corridor

 

46.2

%

51.2

%

Northern Virginia

 

19.9

%

20.5

%

Suburban Baltimore

 

14.6

%

7.5

%

Suburban Maryland

 

4.2

%

4.1

%

Colorado Springs, Colorado

 

3.9

%

4.2

%

St. Mary’s and King George Counties

 

3.6

%

4.2

%

Greater Philadelphia

 

3.1

%

3.7

%

San Antonio, Texas

 

2.0

%

2.4

%

Other

 

1.5

%

N/A

 

Northern/Central New Jersey

 

1.0

%

2.2

%

 

 

100.0

%

100.0

%

 

Annualized rental revenue is a measure that we use to evaluate the source of our rental revenue as of a point in time.  It is computed by multiplying by 12 the sum of monthly contractual base rents and estimated monthly expense reimbursements under active leases as of a point in time.  We consider annualized rental revenue to be a useful measure for analyzing revenue sources because, since it is point-in-time based, it does not contain increases and decreases in revenue associated with periods in which lease terms were not in effect; historical revenue under GAAP does contain such fluctuations.  We find the measure particularly useful for leasing, tenant, segment and industry analysis.

Since most of the operating properties included in the Nottingham Acquisition were located in the Suburban Baltimore region, the percentage of annualized revenue derived from wholly owned properties in that region increased to approximately twice what it was prior to the acquisition.

Concentration of Leases With Certain Tenants

We experienced changes in our tenant base during the six months ended June 30, 2007 due primarily to the Nottingham Acquisition, but also due to development and leasing activity.  The following table lists the 20 largest tenants in our portfolio of wholly owned properties based on percentage of annualized rental revenue:

28




 

 

Percentage of Annualized Rental

 

 

 

Revenue of Wholly Owned Properties

 

 

 

for 20 Largest Tenants as of

 

Tenant

 

June 30, 2007

 

December 31, 2006

 

United States Government

 

15.0

%

16.3

%

Northrop Grumman Corporation (1)

 

6.7

%

4.2

%

Booz Allen Hamilton, Inc.

 

5.7

%

6.9

%

Computer Sciences Corporation (1)

 

3.3

%

3.8

%

L-3 Communications Holdings, Inc. (1)

 

2.6

%

3.0

%

Unisys Corporation (2)

 

2.5

%

3.0

%

General Dynamics Corporation

 

2.0

%

2.4

%

Wachovia Corporation (1)

 

1.9

%

2.1

%

The Aerospace Corporation

 

1.9

%

2.1

%

AT&T Corporation (1)

 

1.7

%

3.0

%

Comcast Corporation

 

1.5

%

N/A

 

The Boeing Company (1)

 

1.2

%

1.4

%

Ciena Corporation

 

1.1

%

1.2

%

Science Applications International Corporation

 

0.9

%

1.1

%

Lockheed Martin Corporation

 

0.9

%

1.0

%

Magellan Health Services, Inc.

 

0.9

%

1.0

%

BAE Systems PLC (1)

 

0.8

%

1.0

%

Merck & Co., Inc. (2)

 

0.8

%

0.8

%

Johns Hopkins University (1)

 

0.7

%

N/A

 

Wyle Laboratories, Inc.

 

0.7

%

0.8

%

Harris Corporation

 

N/A

 

0.8

%

EDO Corporation

 

N/A

 

0.8

%

Subtotal of 20 largest tenants

 

52.8

%

56.7

%

All remaining tenants

 

47.2

%

43.3

%

Total

 

100.0

%

100.0

%

 


(1) Includes affiliated organizations and agencies and predecessor companies.

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

Industry Concentration of Tenants

The percentage of total annualized rental revenue in our wholly owned properties derived from the United States defense industry decreased during the six months ended June 30, 2007 due primarily to the Nottingham Acquisition, since the properties included in that transaction had an insignificant number of tenants in that industry, but also due to the effect of development and leasing activity.  The table below sets forth the percentage of annualized rental revenue in our portfolio of wholly owned properties derived from that industry:

29




 

 

Percentage of Annualized

 

 

 

Rental Revenue of Wholly

 

 

 

Owned Properties from Defense

 

 

 

Industry Tenants as of

 

 

 

June 30,
2007

 

December 31,
2006

 

Total Portfolio

 

47.5

%

54.4

%

Baltimore/Washington Corridor

 

63.9

%

66.7

%

Northern Virginia

 

49.9

%

54.5

%

Suburban Baltimore

 

6.8

%

9.8

%

Suburban Maryland

 

11.2

%

13.3

%

Colorado Springs

 

35.8

%

39.4

%

St. Mary’s and King George Counties

 

89.9

%

89.8

%

San Antonio

 

100.0

%

100.0

%

Other

 

0.0

%

N/A

 

 

Occupancy and Leasing

The table below sets forth leasing information pertaining to our portfolio of wholly owned operating properties:

 

 

June 30,

 

December 31,

 

 

 

2007

 

2006

 

Occupancy rates

 

 

 

 

 

Total

 

92.7

%

92.8

%

Baltimore/Washington Corridor

 

93.5

%

95.1

%

Northern Virginia

 

99.2

%

90.9

%

Suburban Baltimore

 

84.3

%

81.1

%

Suburban Maryland

 

95.9

%

83.2

%

Colorado Springs, Colorado

 

94.5

%

92.8

%

St. Mary’s and King George Counties

 

92.1

%

92.1

%

Greater Philadelphia

 

100.0

%

100.0

%

San Antonio, Texas

 

100.0

%

100.0

%

Other

 

100.0

%

N/A

 

Northern/Central New Jersey

 

68.7

%

97.2

%

 

 

 

 

 

 

Average contractual annual rental rate per square foot at period end (1)

 

$

21.09

 

$

20.90

 

 


(1) Includes estimated expense reimbursements.

The total occupancy rate of our wholly owned properties was negatively affected by the operating properties included in the Nottingham Acquisition, which were 85.7% occupied at June 30, 2007.  We also had a decrease in occupancy in our New Jersey region that was attributable to a lease termination at our 429 Ridge Road property located in Dayton, New Jersey (we are under contract to sell our 429 Ridge Road property and expect to complete such sale by January 2008).  However, we had a net increase in occupancy in our other properties that offset most of the decreasing effects of the Nottingham Acquisition and the 429 Ridge Road property; this positive increase was largely attributable to lease commencements for space in our Northern Virginia and Suburban Maryland regions.

We renewed 70.8% of the square footage scheduled to expire in the six months ended June 30, 2007 (including the effects of early renewals and early lease terminations).

We believe that there continues to be a fair amount of uncertainty surrounding our leasing outlook.  Certain key economic indicators, including employment growth, seem to favor continued strength in our

30




regions’ real estate markets.  However, the recent and scheduled addition of new square footage in our regions along with continued strong competition from existing properties in these regions present challenges to the Company’s ability to meet our leasing objectives.  We believe that reporting by the Base Realignment and Closure Commission of the United States Congress (“BRAC”) favors continued expansion in the regions in which our properties are located.  However, while we view this reporting as favorable for the Company’s future leasing outlook, there is uncertainty over the level and timing of such expansion.

Despite this uncertainty regarding our leasing outlook, we believe that we are somewhat protected in the short run from a slow down in leasing activity since the weighted average lease term for our wholly owned properties at June 30, 2007 was five years.  In addition, only 16.5% of our annualized rental revenues at June 30, 2007 were from leases scheduled to expire by the end of 2008.  Looking longer term, 65.0% of our annualized rental revenues on leases in place as of June 30, 2007 were from leases scheduled to expire by the end of 2012, with no more than 15% scheduled to expire in any one calendar year through 2012.

The table below sets forth occupancy information pertaining to properties in which we have a partial ownership interest:

 

 

 

 

Occupancy Rate at

 

 

Ownership

 

June 30,

 

December 31,

 

Geographic Region

 

Interest

 

2007

 

2006

 

Suburban Maryland

 

50.0

%

75.0

%

47.9

%

Northern Virginia

 

92.5

%

100.0

%(1)

100.0

%(1)

Greater Harrisburg

 

20.0

%

91.0

%

91.2

%

 


(1) Excludes the effect of 62,000 unoccupied square feet undergoing redevelopment at period end.

Revenues from real estate operations and property operating expenses

We view our changes in revenues from real estate operations and property operating expenses as being comprised of the following main components:

·                  Changes attributable to the operations of properties owned and 100% operational throughout the two periods being compared.  We define these as changes from “Same-Office Properties.”  For example, when comparing the six months ended June 30, 2006 and 2007, Same-Office Properties would be properties owned and 100% operational from January 1, 2006 through June 30, 2007.

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

The tables below set forth the components of our changes in revenues from real estate operations and property operating expenses (dollars in thousands).  The tables and the discussion that follows in this section pertain to properties included in continuing operations:

31




 

 

Changes From the Three Months Ended June 30, 2006 to 2007

 

 

 

Property 
Additions

 

Same-Office Properties

 

Other

 

Total

 

 

 

Dollar

 

Dollar

 

Percentage

 

Dollar

 

Dollar

 

 

 

Change (1)

 

Change

 

Change

 

Change (2)

 

Change

 

Revenues from real estate operations

 

 

 

 

 

 

 

 

 

 

 

Rental revenue

 

$

15,728

 

$

1,660

 

2.7

%

$

(199

)

$

17,189

 

Tenant recoveries and other real estate operations revenue

 

1,923

 

473

 

5.6

%

598

 

2,994

 

Total

 

$

17,651

 

$

2,133

 

3.1

%

$

399

 

$

20,183

 

 

 

 

 

 

 

 

 

 

 

 

 

Property operating expenses

 

$

5,773

 

$

1,397

 

6.6

%

$

228

 

$

7,398

 

 

 

 

 

 

 

 

 

 

 

 

 

Straight-line rental revenue adjustments included in rental revenue

 

$

1,415

 

$

(533

)

N/A

 

$

2

 

$

884

 

Amortization of deferred market rental revenue

 

$

122

 

$

(55

)

N/A

 

$

 

$

67

 

 

 

 

 

 

 

 

 

 

 

 

 

Number of operating properties included in component category

 

73

 

157

 

N/A

 

 

230

 

 


(1) Includes 63 acquired properties, eight newly-constructed properties and two redevelopment properties placed into service.

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

 

 

Changes From the Six Months Ended June 30, 2006 to 2007

 

 

 

Property 
Additions

 

Same-Office Properties

 

Other

 

Total

 

 

 

Dollar

 

Dollar

 

Percentage

 

Dollar

 

Dollar

 

 

 

Change (1)

 

Change

 

Change

 

Change (2)

 

Change

 

Revenues from real estate operations

 

 

 

 

 

 

 

 

 

 

 

Rental revenue

 

$

29,411

 

$

3,528

 

2.9

%

$

(430

)

$

32,509

 

Tenant recoveries and other real estate operations revenue

 

4,629

 

2,901

 

17.2

%

597

 

8,127

 

Total

 

$

34,040

 

$

6,429

 

4.7

%

$

167

 

$

40,636

 

 

 

 

 

 

 

 

 

 

 

 

 

Property operating expenses

 

$

11,507

 

$

5,297

 

12.6

%

$

1,281

 

$

18,085

 

 

 

 

 

 

 

 

 

 

 

 

 

Straight-line rental revenue adjustments included in rental revenue

 

$

2,633

 

$

(1,125

)

N/A

 

$

6

 

$

1,514

 

Amortization of deferred market rental revenue

 

$

242

 

$

(131

)

N/A

 

$

 

$

111

 

 

 

 

 

 

 

 

 

 

 

 

 

Number of operating properties included in component category

 

73

 

157

 

N/A

 

 

230

 

 


(1) Includes 63 acquired properties, eight newly-constructed properties and two redevelopment properties placed into service.

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

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

32




With regard to changes in the Same-Office Properties’ revenues from real estate operations for the three month periods:

·                  the increase in revenues from real estate operations for the Same-Office Properties for the three month periods included the following:

·                  an increase of $1.8 million, or 3.0%, in rental revenue from the Same-Office Properties attributable primarily to changes in rental rates and occupancy between the two periods.  Of this increase, $787,000 was attributable to one property located in Northern Virginia; and

·                  a decrease of $108,000, or 13.6%, in net revenue from the early termination of leases.  To explain further the term net revenue from the early termination of leases, when tenants terminate their lease obligations prior to the end of the agreed lease terms, they typically pay fees to break these obligations.  We recognize such fees as revenue and write off against such revenue any (1) deferred rents receivable and (2) deferred revenue and deferred assets that are amortizable into rental revenue associated with the leases; the resulting net amount is the net revenue from the early termination of the leases.

·                  tenant recoveries and other revenue from the Same-Office Properties increased due primarily to an increase in property operating expenses, as described below.

With regard to changes in the Same-Office Properties’ revenues from real estate operations for the six month periods:

·                  the increase in revenues from real estate operations for the Same-Office Properties for the six month periods included the following:

·                  an increase of $3.1 million, or 2.6%, in rental revenue from the Same-Office Properties attributable primarily to changes in rental rates and occupancy between the two periods.  Of this increase, $1.7 million was attributable to two properties; and

·                  an increase of $384,000, or 29.9%, in net revenue from the early termination of leases.

·                  tenant recoveries and other revenue from the Same-Office Properties increased due primarily to an increase in property operating expenses, as described below.

The increase in operating expenses for the Same-Office Properties for the three month periods included the following:

·                  an increase of $728,000, or 17.0%, in utilities due primarily to (1) rate increases that we believe are the result of (a) increased oil prices and (b) energy deregulation in Maryland and (2) our assumption of responsibility for payment of utilities at certain properties due to changes in occupancy and lease structure;

·                  an increase of $475,000, or 20.0%, in repairs and maintenance labor due primarily to: (1) an increase in labor hours due primarily to the addition of new employees to address staffing needs and increased labor requirements at certain properties with increased occupancy; and (2) higher labor rates resulting from an increase in the underlying costs for labor; and

·                  an increase of $200,000, or 7.5%, in cleaning expenses due primarily to (1) our assumption of responsibility for payment of such costs at certain properties due to changes in occupancy and lease structures and (2) increased contractor costs at certain properties.

The increase in operating expenses for the Same-Office Properties for the six month periods included the following:

·                  an increase of $2.0 million, or 22.7%, in utilities due primarily to the reasons discussed above for the variance in the three month periods;

·                  an increase of $1.2 million, or 161.1%, in snow removal due to increased snow and ice in our regions in 2007;

·                  an increase of $574,000, or 12.0%, in repairs and maintenance labor due primarily to the reasons discussed above for the variance in the three month periods; and

33




·                  an increase of $404,000, or 19.6%, in heating and air conditioning repairs and maintenance due to an increase in general repair activity and the commencement of new service contracts at certain properties.

Construction contract and other service revenues and expenses

The table below sets forth changes in our construction contract and other service revenues and expenses (dollars in thousands):

 

 

Changes Between the Three Month Periods

 

Changes Between the Six Month Periods

 

 

 

Ended June 30, 2007 and 2006

 

Ended June 30, 2007 and 2006

 

 

 

Construction

 

Other 
Service

 

 

 

Construction

 

Other 
Service

 

 

 

 

 

Contract 
Dollar

 

Operations 
Dollar

 

Total Dollar

 

Contract 
Dollar

 

Operations 
Dollar

 

Total Dollar

 

 

 

Change

 

Change

 

Change

 

Change

 

Change

 

Change

 

Service operations

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

(1,536

)

$

(911

)

$

(2,447

)

$

(7,389

)

$

(1,290

)

$

(8,679

)

Expenses

 

(1,507

)

(692

)

(2,199

)

(7,050

)

(965

)

(8,015

)

Income from service operations

 

$

(29

)

$

(219

)

$

(248

)

$

(339

)

$

(325

)

$

(664

)

 

The gross revenues and costs associated with these services generally bear little relationship to the level of activity from these operations since a substantial portion of the costs are subcontracted costs that are reimbursed to us by the customer at no mark up.  As a result, the operating margins from these operations are small relative to the revenue.  We use the net of service operations revenues and expenses to evaluate performance.  We believe that the changes in net amounts reflected above were not significant.

Depreciation and amortization

Our increase in depreciation and other amortization expense for the three month and six month periods was attributable primarily to the Property Additions ($8.8 million for the three month periods and $17.8 million for the six month periods); most of the increase in the property additions was attributable to the Nottingham Acquisition ($6.2 million for the three month periods and $12.5 million for the six month periods).  Compared to other acquisitions that we have completed in recent years, a considerably larger portion of the value of the operating properties included in the Nottingham Acquisition was allocated to assets with lives that are based on the lives of the underlying leases; due to that fact and the fact that a large number of the leases in these properties have lives of four years or less, much of the depreciation and amortization associated with these properties will be front-loaded to the four years following the completion of the acquisition.  This will result in increased depreciation and amortization expense over the initial four years following the acquisition.

General and administrative expenses

The increase in general and administrative expenses for the three month periods was attributable primarily to a $1.5 million, or 44.7%, increase in compensation expense due in large part to: (1) the increased number of employees in response to the continued growth of the Company; (2) increased salaries and bonuses for existing employees; and (3) a $602,000 increase in expense associated with share-based compensation due to the effects of awards issued in 2006 and 2007 and an increase in the award values being amortized into expense.

The increase in general and administrative expenses for the six month periods included the following:

·                  a $2.4 million, or 35.9%, increase in compensation expense due to the reasons discussed above for the variance in the three month periods; this increase included an increase of $1.0 million associated with share-based compensation; and

34




·                  a $1.1 million, or 47.7%, decrease attributable to increased allocation of corporate overhead primarily to our service companies.  Although our overall general and administrative expenses have increased as discussed above, this 1.1 million decrease in general and administrative expenses is caused by the combined effect of (1) the increase in allocable general and administrative expenses and (2) a larger percentage of general and administrative expenses being allocated to the service companies due in large part to the increased number of employees in the service companies.

Interest expense and amortization of deferred financing costs

For the three month periods, the increase in interest expense and amortization of deferred financing costs included in continuing operations was due primarily to a 31.4% increase in our average outstanding debt balance, resulting primarily from our acquisition and construction activities, offset in part by the effects of: (1) a $1.2 million, or 35.0%, increase in interest capitalized to construction and development projects due to increased construction and development activity; and (2) a decrease in our weighted average interest rates from 6.4% to 5.9%.

For the six month periods, the increase in interest expense and amortization of deferred financing costs included in continuing operations was due primarily to a 27.5% increase in our average outstanding debt balance, resulting primarily from our acquisition and construction activities, offset in part by the effects of: (1) a $2.2 million, or 33.6%, increase in interest capitalized to construction and development projects due to increased construction and development activity; and (2) a decrease in our weighted average interest rates from 6.3% to 5.9%.

Gain on sale of non-real estate investment

The 2007 periods include a $1.0 million gain recognized on the disposition of most of our investment in TractManager, Inc., an investment that we account for using the cost method of accounting.  TractManager, Inc. is an entity that developed an Internet-based contract imaging system for sale to real estate owners and healthcare providers.

Minority interests

Interests in our Operating Partnership are in the form of preferred and common units.  The line entitled “minority interests in income from continuing operations” includes primarily income before continuing operations allocated to preferred and common units not owned by us; for the amount of this line attributable to preferred units versus common units, you should refer to our Consolidated Statements of Operations.  Income is allocated to minority interest preferred unitholders in an amount equal to the priority return from the Operating Partnership to which they are entitled.  Income is allocated to minority interest common unitholders based on the income earned by the Operating Partnership after allocation to preferred unitholders multiplied by the percentage of the common units in the Operating Partnership owned by those common unitholders.

As of June 30, 2007, we owned 96% of the outstanding preferred units and 84% of the outstanding common units.  The percentage of the Operating Partnership owned by minority interests decreased in the aggregate due primarily to the effect of the following transactions:

·                  the issuance of additional units to us as we issued new preferred shares and common shares due to the fact that we receive preferred units and common units in the Operating Partnership each time we issue preferred shares and common shares;

·                  the exchange of common units for our common shares by certain minority interest holders of common units;

·                  our issuance of common units to third parties totaling 262,165 in 2007 and 181,097 in 2006; and

·                  our redemption of the Series E and Series F Preferred Shares in 2006.

The decrease in income allocated to minority interest holders of common units included in income from continuing operations was attributable primarily to the following:

35




·                  a decrease in the Operating Partnership’s income from continuing operations before minority interests due in large part to the changes described above; and

·                  a decrease attributable to our increasing ownership of common units (from 82% at December 31, 2005 to 84% at June 30, 2007).

Income from discontinued operations, net of minority interests

Our income from discontinued operations decreased for the six month periods due primarily to the sale of three properties in the prior period from which we recognized a gain of $2.4 million before allocation to minority interests.

Diluted earnings per common share

Diluted earnings per common share on net income available to common shareholders decreased due to the following:

·                  decreases in net income available to common shareholders, attributable primarily to the reasons set forth above; and

·                  a larger number of common shares outstanding due to share issuances since January 1, 2006.

Liquidity and Capital Resources

Cash and cash equivalents

Our cash and cash equivalents balance totaled $15.1 million as of June 30, 2007, a 90.9% increase from the balance at December 31, 2006.  The cash and cash equivalents balances that we carry as of a point in time can vary significantly due in part to the inherent variability of the cash needs of our acquisition and development activities.  We maintain sufficient cash and cash equivalents to meet our operating cash requirements and short term investing and financing cash requirements.  When we determine that the amount of cash and cash equivalents on hand is more than we need to meet such requirements, we may pay down our Revolving Credit Facility or forgo borrowing under construction loan credit facilities to fund construction activities.

Operating Activities

We generated most of our cash from the operations of our properties.  Most of the amount by which our revenues from real estate operations exceeded property operating expenses was cash flow; we applied most of this cash flow towards interest expense, scheduled principal amortization on debt, dividends to our shareholders, distributions to minority interest holders of preferred and common units in the Operating Partnership, capital improvements and leasing costs for our operating properties and general and administrative expenses.

Our cash flow from operations determined in accordance with GAAP increased $5.1 million, or 8.6%, when comparing the six months ended June 30, 2007 and 2006; this increase is attributable primarily to the additional cash flow from operations generated by our newly-acquired and newly-constructed properties.  We expect to continue to use cash flow provided by operations to meet our short-term capital needs, including all property operating expenses, general and administrative expenses, interest expense, scheduled principal amortization on debt, dividends to our shareholders, distributions to our minority interest holders of preferred and common units in the Operating Partnership and capital improvements and leasing costs.  We do not anticipate borrowing to meet these requirements.

Investing and Financing Activities During the Six Months Ended June 30, 2007

As discussed above, we completed the Nottingham Acquisition on January 9 and 10, 2007.  The acquired properties included 56 operating properties totaling approximately 2.4 million square feet and land parcels totaling 187 acres that we believe can support at least 2.0 million developable square feet.  We

36




completed the Nottingham Acquisition for an aggregate cost of $366.8 million, which was financed using the following:

·                  the issuance of 3,161,000 common shares to the seller at a value of $156.7 million, or $49.57 per share;

·                  the issuance of 531,667 Series K Preferred Shares to the seller at a value of $26.6 million, or $50.00 per share;

·                  $89.1 million in borrowings under a variable-rate loan bearing interest at LIBOR plus 1.15 to 1.55% depending on our leverage levels;

·                  borrowings assumed under fixed-rate mortgage loans with an aggregate fair value of $38.6 million;

·                  $33.7 million in borrowings under our Revolving Credit Facility;

·                  $20.1 million in cash from a previous property sale that was released from escrow; and

·                  a $2.0 million deposit previously paid.

We issued 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.

During the six months ended June 30, 2007, we also purchased the remaining 50% undivided interest in a 132-acre parcel of land located in Colorado Springs, Colorado that we believe can support approximately 1.75 million developable square feet of office space for $13.6 million.  We financed most of this acquisition by issuing 262,165 common units in the Operating Partnership valued at $12.1 million.

Activity related to consolidated joint ventures during the six months ended June 30, 2007 included the following:

·                  as of December 31, 2006, we owned a 50% interest in Commons Office 6-B, LLC, an entity developing a land parcel in Hanover, Maryland.  We acquired the remaining 50% interest in this entity for $1.3 million on May 24, 2007; and

·                  we completed the formation of Enterprise Campus Developers, LLC, an entity in which we own a 90% interest.  This entity was created to develop and construct one or more office buildings on land parcels located in College Park, Maryland as part of a separate joint venture to be formed with another party.  At June 30, 2007, development and construction activities were underway in anticipation of the entity’s membership into this future joint venture.

We had one newly-constructed property totaling 193,000 square feet become fully operational in the six months ended June 30, 2007.  This property, which was 100.0% leased upon entry into operations, is located in Chesterfield County, Virginia.  Costs incurred on this property through June 30, 2007 totaled $53.7 million, $25.6 million of which was incurred in the six months ended June 30, 2007.  We financed the 2007 costs using primarily borrowings from a $37.6 million construction loan facility prior to the facility’s repayment using proceeds from other debt.

At June 30, 2007, we had construction activities underway on ten office properties totaling 1.0 million square feet that were 48.5% pre-leased, including 89,559 square feet already placed in service in a partially operational property.  One of these properties is owned through a consolidated joint venture formed in July 2007 in which we have a 50% interest.  Costs incurred on these properties through June 30, 2007 totaled approximately $118.1 million, of which approximately $31.6 million was incurred in the six months ended June 30, 2007.  We have construction loan facilities in place totaling $67.5 million to finance the construction of three of these properties; borrowings under these facilities totaled $51.4 million at June 30, 2007, $3.6 of which was borrowed in the six months ended June 30, 2007.  The remaining costs incurred in

37




the six months ended June 30, 2007 were funded using primarily borrowings from our Revolving Credit Facility and cash reserves.

The table below sets forth the major components of our additions to the line entitled “Total Commercial Real Estate Properties” on our Consolidated Balance Sheet for the six months ended June 30, 2007 (in thousands):

Acquisitions

 

$

335,919

 

Construction and development

 

89,701

 

Tenant improvements on operating properties

 

13,372

(1)

Capital improvements on operating properties

 

9,950

 

 

 

$

448,942

 


(1)          Tenant improvement costs incurred on newly-constructed properties are classified in this table as construction and development.

On May 17, 2007, we borrowed $150.0 million under a mortgage loan with a 10-year term at a fixed rate of 5.65%.  We used $120.5 million of the proceeds from this loan to pay down debt scheduled to mature in June 2007 and the balance to pay down borrowings under our Revolving Credit Facility.

Certain of our mortgage loans require that we comply with a number of restrictive financial covenants, including leverage ratio, minimum net worth, minimum fixed charge coverage, minimum debt service and maximum secured indebtedness.  As of June 30, 2007, we were in compliance with these financial covenants.

Analysis of Cash Flow Associated with Investing and Financing Activities

Our net cash flow used in investing activities increased $74.9 million when comparing the six months ended June 30, 2007 and 2006.  This increase was due primarily to the following:

·                  a $57.3 million, or 30.7%, increase in purchases of and additions to commercial real estate due primarily to the completion of the Nottingham Acquisition; and

·                  a $28.2 million decrease in proceeds from sales of properties.

Our cash flow provided by financing activities increased $81.9 million due primarily to the following:

·                  a $196.7 million, or 83.8%, increase in proceeds from mortgage and other loans payable driven mostly by the financing needs of the Nottingham Acquisition; offset in part by

·                  a $78.9 million, or 92.8%, decrease in proceeds from common share issuances due primarily to the issuance of 2.0 million common shares in April 2006; and

·                  a $28.7 million, or 15.3%, increase in repayments of mortgage and other loans payable due primarily to the use of proceeds under the $150.0 million mortgage loan to repay various financings in May 2007.

Off-Balance Sheet Arrangements

We had no significant changes in our off-balance sheet arrangements from those described in the section entitled “Off-Balance Sheet Arrangements” in our 2006 Annual Report on Form 10-K.

Other Future Cash Requirements for Investing and Financing Activities

As of June 30, 2007, we were under contract to acquire the following:

38




·                  a parcel of land in Aberdeen, Maryland for $10.0 million, of which we paid a deposit of $100,000 in 2006;

·                  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:  $1.3 million in 2007, $1.0 million in 2008 and $155,000 in 2009.  We could incur an additional cash obligation to the seller after that of up to $4.0 million; this $4.0 million cash obligation is subject to reduction by an amount ranging between $750,000 and $4.0 million, 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; and

·                  a parcel of land in Colorado Springs, Colorado for $2.3 million, of which we had paid a deposit of $80,000 as of June 30, 2007.  We completed this acquisition on July 12, 2007.

We expect to fund these acquisitions and development costs using borrowings under our Revolving Credit Facility.

As previously discussed, as of June 30, 2007, we had construction activities underway on ten office properties totaling 1.0 million square feet that were 48.5% pre-leased (including one property owned through a joint venture formed in July 2007 in which we have a 50% interest).  We estimate remaining costs to be incurred will total approximately $93.5 million upon completion of these properties; we expect to incur these costs through 2009.  We have $16.1 million remaining to be borrowed under construction loan facilities totaling $67.5 million for three of these properties.  We expect to fund the remaining portion of these costs using borrowings from new construction loan facilities and our Revolving Credit Facility.

As of June 30, 2007, we had development activities underway on 12 new office properties estimated to total 1.3 million square feet.  We estimate that costs for these properties will total approximately $265.8 million.  As of June 30, 2007, costs incurred on these properties totaled $36.7 million and the balance is expected to be incurred from 2007 through 2009.  We expect to fund most of these costs using borrowings from new construction loan facilities.

As of June 30, 2007, we had redevelopment activities underway on four properties totaling 741,000 square feet (three of these properties are owned through a consolidated joint venture in which we own a 92.5% interest).  We estimate that the remaining costs of the redevelopment activities will total approximately $42.4 million.  We expect to fund most of these costs using borrowings under new construction loan facilities.

During the remainder of 2007 and beyond, we could complete other acquisitions of properties and commence construction and development activities in addition to the ones previously described.  We expect to finance these activities as we have in the past, using mostly a combination of borrowings from new debt, borrowings under our Revolving Credit Facility, proceeds from sales of existing properties and additional equity issuances of common and/or preferred shares or units.

The maximum principal amount on our Revolving Credit Facility is $500.0 million, with a right to further increase the maximum principal amount in the future to $600.0 million, subject to certain conditions.  The borrowing capacity under this Revolving Credit Facility is generally computed based on 65% of the value of assets identified by us to support repayment of the loan.  As of July 27, 2007, the borrowing capacity under the Revolving Credit Facility was $500.0 million, of which $182.0 million was available.

Funds From Operations

Funds from operations (“FFO”) is defined as net income computed using GAAP, excluding gains (or losses) from sales of real estate, plus real estate-related depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures.  Gains from sales of newly-developed properties less accumulated depreciation, if any, required under GAAP are included in FFO on the basis

39




that development services are the primary revenue generating activity; we believe that inclusion of these development gains is in accordance with the National Association of Real Estate Investment Trusts (“NAREIT”) definition of FFO, although others may interpret the definition differently.

Accounting for real estate assets using historical cost accounting under GAAP assumes that the value of real estate assets diminishes predictably over time.  NAREIT stated in its April 2002 White Paper on Funds from Operations that “since real estate asset values have historically risen or fallen with market conditions, many industry investors have considered presentations of operating results for real estate companies that use historical cost accounting to be insufficient by themselves.”  As a result, the concept of FFO was created by NAREIT for the REIT industry to “address this problem.”  We agree with the concept of FFO and believe that FFO is useful to management and investors as a supplemental measure of operating performance because, by excluding gains and losses related to sales of previously depreciated operating real estate properties and excluding real estate-related depreciation and amortization, FFO can help one compare our operating performance between periods.  In addition, since most equity REITs provide FFO information to the investment community, we believe that FFO is useful to investors as a supplemental measure for comparing our results to those of other equity REITs.  We believe that net income is the most directly comparable GAAP measure to FFO.

Since FFO excludes certain items includable in net income, reliance on the measure has limitations; management compensates for these limitations by using the measure simply as a supplemental measure that is weighed in the balance with other GAAP and non GAAP measures.  FFO is not necessarily an indication of our cash flow available to fund cash needs.  Additionally, it should not be used as an alternative to net income when evaluating our financial performance or to cash flow from operating, investing and financing activities when evaluating our liquidity or ability to make cash distributions or pay debt service.  The FFO we present may not be comparable to the FFO presented by other REITs since they may interpret the current NAREIT definition of FFO differently or they may not use the current NAREIT definition of FFO.

Basic funds from operations (“Basic FFO”) is FFO adjusted to (1) subtract preferred share dividends and (2) add back GAAP net income allocated to common units in the Operating Partnership not owned by us.  With these adjustments, Basic FFO represents FFO available to common shareholders and common unitholders.  Common units in the Operating Partnership are substantially similar to our common shares and are exchangeable into common shares, subject to certain conditions.  We believe that Basic FFO is useful to investors due to the close correlation of common units to common shares.  We believe that net income is the most directly comparable GAAP measure to Basic FFO.  Basic FFO has essentially the same limitations as FFO; management compensates for these limitations in essentially the same manner as described above for FFO.

Diluted funds from operations (“Diluted FFO”) is Basic FFO adjusted to add back any changes in Basic FFO that would result from the assumed conversion of securities that are convertible or exchangeable into common shares.  However, the computation of Diluted FFO does not assume conversion of securities other than common units in the Operating Partnership that are convertible into common shares if the conversion of those securities would increase Diluted FFO per share in a given period.  We believe that Diluted FFO is useful to investors because it is the numerator used to compute Diluted FFO per share, discussed below.  In addition, since most equity REITs provide Diluted FFO information to the investment community, we believe Diluted FFO is a useful supplemental measure for comparing us to other equity REITs.  We believe that the numerator for diluted EPS is the most directly comparable GAAP measure to Diluted FFO.  Since Diluted FFO excludes certain items includable in the numerator to diluted EPS, reliance on the measure has limitations; management compensates for these limitations by using the measure simply as a supplemental measure that is weighed in the balance with other GAAP and non-GAAP measures.  Diluted FFO is not necessarily an indication of our cash flow available to fund cash needs.  Additionally, it should not be used as an alternative to net income when evaluating our financial performance or to cash flow from operating, investing and financing activities when evaluating our liquidity or ability to make cash distributions or pay debt service.  The Diluted FFO that we present may not be comparable to the Diluted FFO presented by other REITs.

40




Diluted funds from operations per share (“Diluted FFO per share”) is (1) Diluted FFO divided by (2) the sum of the (a) weighted average common shares outstanding during a period, (b) weighted average common units outstanding during a period and (c) weighted average number of potential additional common shares that would have been outstanding during a period if other securities that are convertible or exchangeable into common shares were converted or exchanged.  However, the computation of Diluted FFO per share does not assume conversion of securities other than common units in the Operating Partnership that are convertible into common shares if the conversion of those securities would increase Diluted FFO per share in a given period.  We believe that Diluted FFO per share is useful to investors because it provides investors with a further context for evaluating our FFO results in the same manner that investors use earnings per share (“EPS”) in evaluating net income available to common shareholders.  In addition, since most equity REITs provide Diluted FFO per share information to the investment community, we believe Diluted FFO per share is a useful supplemental measure for comparing us to other equity REITs.  We believe that diluted EPS is the most directly comparable GAAP measure to Diluted FFO per share.  Diluted FFO per share has most of the same limitations as Diluted FFO (described above); management compensates for these limitations in essentially the same manner as described above for Diluted FFO.

Our Basic FFO, Diluted FFO and Diluted FFO per share for the three and six months ended June 30, 2007 and 2006 and reconciliations of (1) net income to FFO, (2) the numerator for diluted EPS to diluted FFO and (3) the denominator for diluted EPS to the denominator for diluted FFO per share are set forth in the following table (dollars and shares in thousands, except per share data):

41




 

 

 

For the Three Months

 

For the Six Months

 

 

 

Ended June 30,

 

Ended June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

7,877

 

$

9,116

 

$

13,424

 

$

19,053

 

Add: Real estate-related depreciation and amortization

 

27,087

 

18,490

 

53,387

 

37,558

 

Add: Depreciation and amortization on unconsolidated real estate entities

 

169

 

109

 

337

 

194

 

Less: Depreciation and amortization allocable to minority interests in other consolidated entities

 

(47

)

(44

)

(89

)

(77

)

Loss (gain) on sales of real estate, excluding development portion (1)

 

11

 

6

 

11

 

(2,453

)

Funds from operations (“FFO”)

 

35,097

 

27,677

 

67,070

 

54,275

 

Add: Minority interests-common units in the Operating Partnership

 

765

 

1,157

 

1,073

 

2,563

 

Less: Preferred share dividends

 

(4,025

)

(3,653

)

(8,018

)

(7,307

)

Funds from Operations - basic and diluted (“Basic and Diluted FFO”)

 

$

31,837

 

$

25,181

 

$

60,125

 

$

49,531

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares

 

46,686

 

41,510

 

46,185

 

40,594

 

Conversion of weighted average common units

 

8,313

 

8,465

 

8,361

 

8,493

 

Weighted average common shares/units - Basic FFO

 

54,999

 

49,975

 

54,546

 

49,087

 

Dilutive effect of share-based compensation awards

 

1,105

 

1,721

 

1,305

 

1,801

 

Weighted average common shares/units - Diluted FFO

 

56,104

 

51,696

 

55,851

 

50,888

 

 

 

 

 

 

 

 

 

 

 

Diluted FFO per common share

 

$

0.57

 

$

0.49

 

$

1.08

 

$

0.97

 

 

 

 

 

 

 

 

 

 

 

Numerator for diluted EPS

 

$

3,852

 

$

5,463

 

$

5,406

 

$

11,746

 

Add: Minority interests-common units in the Operating Partnership

 

765

 

1,157

 

1,073

 

2,563

 

Add: Real estate-related depreciation and amortization

 

27,087

 

18,490

 

53,387

 

37,558

 

Add: Depreciation and amortization on unconsolidated real estate entities

 

169

 

109

 

337

 

194

 

Less: Depreciation and amortization allocable to minority interests in other consolidated entities

 

(47

)

(44

)

(89

)

(77

)

Loss (gain) on sales of real estate, excluding development portion (1)

 

11

 

6

 

11

 

(2,453

)

Diluted FFO

 

$

31,837

 

$

25,181

 

$

60,125

 

$

49,531

 

 

 

 

 

 

 

 

 

 

 

Denominator for diluted EPS

 

47,791

 

43,231

 

47,490

 

42,395

 

Weighted average common units

 

8,313

 

8,465

 

8,361

 

8,493

 

Denominator for Diluted FFO per share

 

56,104

 

51,696

 

55,851

 

50,888

 

 


(1)          Gains from the sale of real estate that are attributable to sales of non-operating properties are included in FFO.  Gains from newly-developed or re-developed properties less accumulated depreciation, if any, required under GAAP are also included in FFO on the basis that development services are the primary revenue generating activity; we believe that inclusion of these development gains is in compliance with the NAREIT definition of FFO, although others may interpret the definition differently.

Inflation

Most of our tenants are obligated to pay their share of a building’s operating expenses to the extent such expenses exceed amounts established in their leases, based on historical expense levels.  Some of our tenants are obligated to pay their full share of a building’s operating expenses.  These arrangements somewhat reduce our exposure to increases in such costs resulting from inflation.  In addition, since our average lease life is approximately five years, we generally expect to be able to compensate for increased operating expenses through increased rental rates upon lease renewal or expiration.

Our costs associated with constructing buildings and completing renovation and tenant improvement work increased due to higher cost of materials.  We expect to recover a portion of these costs through higher tenant rents and reimbursements for tenant improvements.  The additional costs that we do not recover increase depreciation expense as projects are completed and placed into service.

42




Item 3.  Quantitative and Qualitative Disclosures about Market Risk

We are exposed to certain market risks, the most predominant of which is change in interest rates.  Increases in interest rates can result in increased interest expense under our Revolving Credit Facility and our other debt carrying variable interest rate terms.  Increases in interest rates can also result in increased interest expense when our debt carrying fixed interest rate terms mature and need to be refinanced.  Our debt strategy favors long-term, fixed-rate, secured debt over variable-rate debt to minimize the risk of short-term increases in interest rates.  As of June 30, 2007, 85.7% of our fixed-rate debt was scheduled to mature after 2008.  As of June 30, 2007, 16.6% of our total debt had variable interest rates, including the effect of interest rate swaps.  As of June 30, 2007, the percentage of variable-rate debt, including the effect of interest rate swaps, relative to total assets was 10.2%.

The following table sets forth our long-term debt obligations by scheduled maturity and weighted average interest rates at June 30, 2007 (dollars in thousands):

 

 

For the Periods Ended December 31,

 

 

 

 

2007 (2)

 

2008 (3)

 

2009

 

2010

 

2011

 

Thereafter

 

Total

 

Long term debt:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed rate (1)

 

$

36,568

 

$

157,626

 

$

62,643

 

$

74,033

 

$

109,814

 

$

920,626

 

$

1,361,310

 

Average interest rate

 

5.39

%

5.46

%

5.31

%

5.24

%

5.18

%

4.66

%

5.02

%

Variable rate

 

$

49,367

 

$

341,099

 

$

 

$

 

$

 

$

 

$

390,466

 

Average interest rate

 

6.62

%

6.65

%

 

 

 

 

6.63

%

 


(1)   Represents scheduled principal maturities only and therefore excludes a net premium of $702,000.

(2)   Our loan maturities in 2007 include $49.4 million that may be extended until 2008, subject to certain conditions, and $28.2 million under various loans that we expect to either refinance or repay using borrowings under our Revolving Credit Facility; the balance of the 2007 maturities represent primarily scheduled principal amortization payments that we expect to pay using cash flow from operations.

(3)   Our loan maturities in 2008 include $341.1 million that may be extended until 2009, subject to certain conditions.

The fair market value of our debt was $1.69 billion at June 30, 2007.  If interest rates on our fixed-rate debt had been 1% lower, the fair value of this debt would have increased by $53.7 million at June 30, 2007.

The following table sets forth information pertaining to our derivative contracts in place as of June 30, 2007, and their respective fair values (dollars in thousands):

 

 

 

 

 

 

 

 

 

Fair Value at

 

 

 

Notional

 

One-Month

 

Effective

 

Expiration

 

June 30,

 

Nature of Derivative

 

Amount

 

LIBOR base

 

Date

 

Date

 

2007

 

Interest rate swap

 

$

50,000

 

5.0360

%

3/28/2006

 

3/30/2009

 

$

141

 

Interest rate swap

 

25,000

 

5.2320

%

5/1/2006

 

5/1/2009

 

(14

)

Interest rate swap

 

25,000

 

5.2320

%

5/1/2006

 

5/1/2009

 

(14

)

 

Based on our variable-rate debt balances, our interest expense would have increased by $1.4 million in the six months ended June 30, 2007 if short-term interest rates were 1% higher.

Item 4.    Controls and Procedures

(a)           Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) as of June 30, 2007.  Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures as of June 30, 2007 were functioning effectively to provide reasonable assurance that the information required to be disclosed by us

43




in reports filed or submitted under the Securities Exchange Act of 1934 is (i) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (ii) accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

 (b)          Change in Internal Control over Financial Reporting

No change in our internal control over financial reporting occurred during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II

Item 1.  Legal Proceedings

Jim Lemon and Robin Biser, as plaintiffs, initiated a suit on May 12, 2005, in The United States District Court for the District of Columbia (Case No. 1:05CV00949), against The Secretary of the United States Army, PenMar Development Corporation (“PMDC”) and the Company, as defendants, in connection with the then pending acquisition by the Company of the former army base known as Fort Ritchie located in Cascade, Maryland.  The case was dismissed by the United States District Court on September 28, 2006, due to the plaintiffs’ lack of standing.  The plaintiffs have filed an appeal in the case in the United States Court of Appeals for the District of Columbia Circuit and that appeal is pending. The plaintiffs were unsuccessful in their request for an emergency injunction pending appeal.  The Company acquired from PMDC fee simple title to 500 acres of the 591 acres comprising Fort Ritchie on October 5, 2006.

We are not currently involved in any other material litigation nor, to our knowledge, is any material litigation currently threatened against the Company (other than routine litigation arising in the ordinary course of business, substantially all of which is expected to be covered by liability insurance).

Item 1A.  Risk Factors

Not applicable

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds

(a)          During the three months ended June 30, 2007, 180,271 of the Operating Partnership’s common units were exchanged for 180,271 common shares in accordance with the Operating Partnership’s Second Amended and Restated Limited Partnership Agreement, as amended.  The issuance of these common shares was effected in reliance upon the exemption from registration under Section 4(2) of the Securities Act of 1933, as amended.

(b)      Not applicable

(c)       Not applicable

Item 3.  Defaults Upon Senior Securities

(a)       Not applicable

(b)      Not applicable

44




Item 4.  Submission of Matters to a Vote of Security Holders

On May 17, 2007, we held our annual meeting of shareholders.  At the annual meeting, the shareholders voted on the election of four trustees, each for a three-year term, and the proposal to extend the term of the Amended and Restated 1998 Long Term Incentive Plan for a period of ten years.  The voting results at the annual meeting were as follows:

Proposal 1:

 

Votes

 

Votes

 

Name of Nominee

 

Received

 

Withheld

 

Jay H. Shidler

 

33,427,727

 

4,058,351

 

Clay W. Hamlin, III

 

33,246,041

 

4,240,037

 

Douglas M. Firstenberg

 

30,893,936

 

6,592,142

 

Kenneth S. Sweet, Jr.

 

30,727,434

 

6,758,644

 

 

The terms of Thomas F. Brady, Robert L. Denton, Randall M. Griffin, Steven D. Kesler and Kenneth D. Wethe as trustees continued after the annual meeting.

Proposal 2:

 

Votes Cast

 

 

 

Broker

 

 

 

For

 

Against

 

Abstain

 

Non-votes

 

Extension of the term of the Amended and Restated 1998 Long Term Incentive Plan

 

5,152,631

 

27,411,712

 

177,640

 

4,744,097

 

 

Item 5.  Other Information

Not applicable

Item 6.  Exhibits

(a)       Exhibits:

EXHIBIT
NO.

 

DESCRIPTION

 

 

 

31.1

 

Certification of the Chief Executive Officer of Corporate Office Properties Trust required by Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended (filed herewith).

 

 

 

31.2

 

Certification of the Chief Financial Officer of Corporate Office Properties Trust required by Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended (filed herewith).

 

 

 

32.1

 

Certification of the Chief Executive Officer of Corporate Office Properties Trust required by Rule 13a-14(b) under the Securities Exchange Act of 1934, as amended. (This exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liability of that section. Further, this exhibit shall not be deemed to be incorporated by reference into any filing under the Securities Exchange Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended.) (Furnished herewith.)

 

 

 

32.2

 

Certification of the Chief Financial Officer of Corporate Office Properties Trust required by Rule 13a-14(b) under the Securities Exchange Act of 1934, as amended. (This exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liability of that section. Further, this exhibit shall not be deemed to be incorporated by reference into any filing under the Securities

 

45




 

EXHIBIT
NO.

 

DESCRIPTION

 

 

 

 

 

Exchange Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended.) (Furnished herewith.)

 

SIGNATURES

Pursuant to the requirements of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

CORPORATE OFFICE PROPERTIES
TRUST

 

 

 

 

 

 

Date:

August 9, 2007

 

By:

/s/ Randall M. Griffin

 

 

 

 

Randall M. Griffin

 

 

 

President and Chief Executive Officer

 

 

 

 

Date:

August 9, 2007

 

By:

/s/ Stephen E. Riffee

 

 

 

 

Stephen E. Riffee

 

 

 

Executive Vice President and Chief
Financial Officer

 

46