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COPT DEFENSE PROPERTIES - Quarter Report: 2012 March (Form 10-Q)

Table of Contents

 

 

 

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 March 31, 2012

 

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  x Yes  o No

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

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

 

As of April 18, 2012, 72,040,863 of the Company’s Common Shares of Beneficial Interest, $0.01 par value, were issued and outstanding.

 

 

 



Table of Contents

 

TABLE OF CONTENTS

 

FORM 10-Q

 

 

 

PAGE

PART I:  FINANCIAL INFORMATION

 

 

 

 

 

Item 1:

Financial Statements:

 

 

 

Consolidated Balance Sheets as of March 31, 2012 and December 31, 2011 (unaudited)

 

3

 

Consolidated Statements of Operations for the Three Months Ended March 31, 2012 and 2011 (unaudited)

 

4

 

Consolidated Statements of Comprehensive Income for the Three Months Ended March 31, 2012 and 2011 (unaudited)

 

5

 

Consolidated Statements of Equity for the Three Months Ended March 31, 2012 and 2011 (unaudited)

 

6

 

Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2012 and 2011 (unaudited)

 

7

 

Notes to Consolidated Financial Statements (unaudited)

 

9

Item 2:

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

 

28

Item 3:

Quantitative and Qualitative Disclosures About Market Risk

 

38

Item 4:

Controls and Procedures

 

39

 

 

 

PART II: OTHER INFORMATION

 

 

 

 

 

Item 1:

Legal Proceedings

 

40

Item 1A:

Risk Factors

 

40

Item 2:

Unregistered Sales of Equity Securities and Use of Proceeds

 

40

Item 3:

Defaults Upon Senior Securities

 

40

Item 4:

Mine Safety Disclosures

 

40

Item 5:

Other Information

 

40

Item 6:

Exhibits

 

40

 

 

 

SIGNATURES

 

42

 

2



Table of Contents

 

PART I: FINANCIAL INFORMATION

ITEM 1. Financial Statements

 

Corporate Office Properties Trust and Subsidiaries

Consolidated Balance Sheets

(Dollars in thousands, except share data)

(unaudited)

 

 

 

March 31,

 

December 31,

 

 

 

2012

 

2011

 

Assets

 

 

 

 

 

Properties, net:

 

 

 

 

 

Operating properties, net

 

$

2,704,323

 

$

2,714,056

 

Projects in development or held for future development

 

633,968

 

638,919

 

Total properties, net

 

3,338,291

 

3,352,975

 

Assets held for sale, net

 

81,352

 

116,616

 

Cash and cash equivalents

 

7,987

 

5,559

 

Restricted cash and marketable securities

 

21,711

 

36,232

 

Accounts receivable (net of allowance for doubtful accounts of $3,796 and $3,546, respectively)

 

11,231

 

26,032

 

Deferred rent receivable

 

89,337

 

86,856

 

Intangible assets on real estate acquisitions, net

 

83,940

 

89,120

 

Deferred leasing and financing costs, net

 

66,987

 

66,515

 

Prepaid expenses and other assets

 

96,532

 

87,619

 

Total assets

 

$

3,797,368

 

$

3,867,524

 

 

 

 

 

 

 

Liabilities and equity

 

 

 

 

 

Liabilities:

 

 

 

 

 

Debt, net

 

$

2,418,078

 

$

2,426,303

 

Accounts payable and accrued expenses

 

93,156

 

96,425

 

Rents received in advance and security deposits

 

27,647

 

29,548

 

Dividends and distributions payable

 

24,544

 

35,038

 

Deferred revenue associated with operating leases

 

15,258

 

15,554

 

Distributions received in excess of investment in unconsolidated real estate joint venture

 

6,178

 

6,071

 

Interest rate derivatives

 

2,673

 

30,863

 

Other liabilities

 

9,038

 

9,657

 

Total liabilities

 

2,596,572

 

2,649,459

 

Commitments and contingencies (Note 15)

 

 

 

Equity:

 

 

 

 

 

Corporate Office Properties Trust’s shareholders’ equity:

 

 

 

 

 

Preferred Shares of beneficial interest with an aggregate liquidation preference of $216,333 ($0.01 par value; 15,000,000 shares authorized and 8,121,667 shares issued and outstanding at March 31, 2012 and December 31, 2011)

 

81

 

81

 

Common Shares of beneficial interest ($0.01 par value; 125,000,000 shares authorized, shares issued and outstanding of 72,037,627 at March 31, 2012 and 72,011,324 at December 31, 2011)

 

720

 

720

 

Additional paid-in capital

 

1,670,451

 

1,668,645

 

Cumulative distributions in excess of net income

 

(549,456

)

(532,288

)

Accumulated other comprehensive loss

 

(2,201

)

(1,733

)

Total Corporate Office Properties Trust’s shareholders’ equity

 

1,119,595

 

1,135,425

 

Noncontrolling interests in subsidiaries:

 

 

 

 

 

Common units in the Operating Partnership

 

53,883

 

55,281

 

Preferred units in the Operating Partnership

 

8,800

 

8,800

 

Other consolidated entities

 

18,518

 

18,559

 

Noncontrolling interests in subsidiaries

 

81,201

 

82,640

 

Total equity

 

1,200,796

 

1,218,065

 

Total liabilities and equity

 

$

3,797,368

 

$

3,867,524

 

 

See accompanying notes to consolidated financial statements.

 

3



Table of Contents

 

Corporate Office Properties Trust and Subsidiaries

Consolidated Statements of Operations

(in thousands, except per share data)

(unaudited)

 

 

 

For the Three Months

 

 

 

Ended March 31,

 

 

 

2012

 

2011

 

Revenues

 

 

 

 

 

Rental revenue

 

$

99,144

 

$

94,249

 

Tenant recoveries and other real estate operations revenue

 

22,795

 

22,212

 

Construction contract and other service revenues

 

21,534

 

21,028

 

Total revenues

 

143,473

 

137,489

 

Expenses

 

 

 

 

 

Property operating expenses

 

47,202

 

47,061

 

Depreciation and amortization associated with real estate operations

 

31,066

 

30,043

 

Construction contract and other service expenses

 

20,607

 

20,618

 

Impairment losses

 

5,126

 

27,742

 

General and administrative expenses

 

7,017

 

6,777

 

Business development expenses and land carry costs

 

1,594

 

1,241

 

Total operating expenses

 

112,612

 

133,482

 

Operating income

 

30,861

 

4,007

 

Interest expense

 

(25,224

)

(26,115

)

Interest and other income

 

1,217

 

1,168

 

Income (loss) from continuing operations before equity in (loss) income of unconsolidated entities and income taxes

 

6,854

 

(20,940

)

Equity in (loss) income of unconsolidated entities

 

(89

)

30

 

Income tax (expense) benefit

 

(4,173

)

544

 

Income (loss) from continuing operations

 

2,592

 

(20,366

)

Discontinued operations

 

4,385

 

(901

)

Income (loss) before gain on sales of real estate

 

6,977

 

(21,267

)

Gain on sales of real estate, net of income taxes

 

 

2,701

 

Net income (loss)

 

6,977

 

(18,566

)

Net (income) loss attributable to noncontrolling interests:

 

 

 

 

 

Common units in the Operating Partnership

 

(159

)

1,479

 

Preferred units in the Operating Partnership

 

(165

)

(165

)

Other consolidated entities

 

24

 

(538

)

Net income (loss) attributable to Corporate Office Properties Trust

 

6,677

 

(17,790

)

Preferred share dividends

 

(4,025

)

(4,025

)

Net income (loss) attributable to Corporate Office Properties Trust common shareholders

 

$

2,652

 

$

(21,815

)

Net income (loss) attributable to Corporate Office Properties Trust:

 

 

 

 

 

Income (loss) from continuing operations

 

$

2,539

 

$

(16,946

)

Discontinued operations, net

 

4,138

 

(844

)

Net income (loss) attributable to Corporate Office Properties Trust

 

$

6,677

 

$

(17,790

)

 

 

 

 

 

 

Basic earnings per common share (1)

 

 

 

 

 

Loss from continuing operations

 

$

(0.02

)

$

(0.32

)

Discontinued operations

 

0.06

 

(0.01

)

Net income (loss) attributable to COPT common shareholders

 

$

0.04

 

$

(0.33

)

Diluted earnings per common share (1)

 

 

 

 

 

Loss from continuing operations

 

$

(0.02

)

$

(0.32

)

Discontinued operations

 

0.06

 

(0.01

)

Net income (loss) attributable to COPT common shareholders

 

$

0.04

 

$

(0.33

)

 


(1) Basic and diluted earnings per common share are calculated based on amounts attributable to common shareholders of Corporate Office Properties Trust.

 

See accompanying notes to consolidated financial statements.

 

4



Table of Contents

 

Corporate Office Properties Trust and Subsidiaries

Consolidated Statements of Comprehensive Income

(Dollars in thousands)

(unaudited)

 

 

 

For the Three Months

 

 

 

Ended March 31,

 

 

 

2012

 

2011

 

Net income (loss)

 

$

6,977

 

$

(18,566

)

Other comprehensive income

 

 

 

 

 

Unrealized losses on interest rate derivatives

 

(1,987

)

(136

)

Losses on interest rate derivatives included in net income

 

1,474

 

1,104

 

Other comprehensive (loss) income

 

(513

)

968

 

Comprehensive income (loss)

 

6,464

 

(17,598

)

Comprehensive (income) loss attributable to noncontrolling interests

 

(271

)

714

 

Comprehensive income (loss) attributable to COPT

 

$

6,193

 

$

(16,884

)

 

See accompanying notes to consolidated financial statements.

 

5



Table of Contents

 

Corporate Office Properties Trust and Subsidiaries

Consolidated Statements of Equity

(Dollars in thousands)

(unaudited)

 

 

 

Preferred 
Shares

 

Common 
Shares

 

Additional 
Paid-in 
Capital

 

Cumulative 
Distributions in 
Excess of Net 
Income (Loss)

 

Accumulated 
Other 
Comprehensive 
Loss

 

Noncontrolling 
Interests

 

Total

 

Balance at December 31, 2010 (66,931,582 common shares outstanding)

 

$

81

 

$

669

 

$

1,511,844

 

$

(281,794

)

$

(4,163

)

$

96,501

 

$

1,323,138

 

Conversion of common units to common shares (16,725 shares)

 

 

 

263

 

 

 

(263

)

 

Costs associated with common shares issued to the public

 

 

 

(117

)

 

 

 

(117

)

Exercise of share options (24,667 shares)

 

 

 

346

 

 

 

 

346

 

Share-based compensation

 

 

2

 

3,201

 

 

 

 

3,203

 

Restricted common share redemptions (104,592 shares)

 

 

 

(3,713

)

 

 

 

(3,713

)

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

 

 

 

(163

)

 

 

163

 

 

Adjustments related to derivatives designated as cash flow hedges

 

 

 

 

 

966

 

2

 

968

 

Net loss

 

 

 

 

(17,790

)

 

(776

)

(18,566

)

Dividends

 

 

 

 

(31,729

)

 

 

(31,729

)

Distributions to owners of common and preferred units in the Operating Partnership

 

 

 

 

 

 

(1,974

)

(1,974

)

Contributions from noncontrolling interests in other consolidated entities

 

 

 

(23

)

 

 

125

 

102

 

Balance at March 31, 2011 (67,103,918 common shares outstanding)

 

$

81

 

$

671

 

$

1,511,638

 

$

(331,313

)

$

(3,197

)

$

93,778

 

$

1,271,658

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2011 (72,011,324 common shares outstanding)

 

$

81

 

$

720

 

$

1,668,645

 

$

(532,288

)

$

(1,733

)

$

82,640

 

$

1,218,065

 

Conversion of common units to common shares (34,550 shares)

 

 

 

444

 

 

 

(444

)

 

Costs associated with common shares issued to the public

 

 

 

(5

)

 

 

 

(5

)

Exercise of share options (5,667 shares)

 

 

 

82

 

 

 

 

82

 

Share-based compensation

 

 

 

3,746

 

 

 

 

3,746

 

Restricted common share redemptions (97,094 shares)

 

 

 

(2,373

)

 

 

 

(2,373

)

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

 

 

 

(88

)

 

 

88

 

 

Adjustments related to derivatives designated as cash flow hedges

 

 

 

 

 

(468

)

(45

)

(513

)

Net income

 

 

 

 

6,677

 

 

300

 

6,977

 

Dividends

 

 

 

 

(23,845

)

 

 

(23,845

)

Distributions to owners of common and preferred units in the Operating Partnership

 

 

 

 

 

 

(1,338

)

(1,338

)

Balance at March 31, 2012 (72,037,627 common shares outstanding)

 

$

81

 

$

720

 

$

1,670,451

 

$

(549,456

)

$

(2,201

)

$

81,201

 

$

1,200,796

 

 

See accompanying notes to consolidated financial statements.

 

6



Table of Contents

 

Corporate Office Properties Trust and Subsidiaries

Consolidated Statements of Cash Flows

(Dollars in thousands)

(unaudited)

 

 

 

For the Three Months Ended

 

 

 

March 31,

 

 

 

2012

 

2011

 

Cash flows from operating activities

 

 

 

 

 

Revenues from real estate operations received

 

$

129,184

 

$

114,303

 

Construction contract and other service revenues received

 

18,170

 

21,405

 

Property operating expenses paid

 

(42,608

)

(45,267

)

Construction contract and other service expenses paid

 

(12,454

)

(28,315

)

General and administrative and business development expenses paid

 

(6,156

)

(6,860

)

Interest expense paid

 

(19,896

)

(22,252

)

Cash settlement of interest rate derivatives

 

(29,738

)

 

Proceeds from sale of trading marketable securities

 

7,041

 

 

Interest and other income received

 

252

 

108

 

Income taxes paid

 

(8

)

(170

)

Net cash provided by operating activities

 

43,787

 

32,952

 

Cash flows from investing activities

 

 

 

 

 

Purchases of and additions to properties

 

 

 

 

 

Construction, development and redevelopment

 

(35,476

)

(46,676

)

Tenant improvements on operating properties

 

(7,934

)

(8,778

)

Other capital improvements on operating properties

 

(3,360

)

(4,064

)

Proceeds from sales of properties

 

61,230

 

3,149

 

Mortgage and other loan receivables funded or acquired

 

(3,506

)

(1,181

)

Leasing costs paid

 

(2,853

)

(2,894

)

Other

 

(310

)

(920

)

Net cash provided by (used in) investing activities

 

7,791

 

(61,364

)

Cash flows from financing activities

 

 

 

 

 

Proceeds from debt

 

331,097

 

97,273

 

Repayments of debt

 

 

 

 

 

Scheduled principal amortization

 

(3,207

)

(3,798

)

Other repayments

 

(337,050

)

(25,050

)

Deferred financing costs paid

 

(2,044

)

(482

)

Dividends paid

 

(33,711

)

(31,664

)

Distributions paid

 

(1,939

)

(1,981

)

Restricted share redemptions

 

(2,373

)

(3,713

)

Other

 

77

 

331

 

Net cash (used in) provided by financing activities

 

(49,150

)

30,916

 

 

 

 

 

 

 

Net increase in cash and cash equivalents

 

2,428

 

2,504

 

Cash and cash equivalents

 

 

 

 

 

Beginning of period

 

5,559

 

10,102

 

End of period

 

$

7,987

 

$

12,606

 

 

See accompanying notes to consolidated financial statements.

 

7



Table of Contents

 

Corporate Office Properties Trust and Subsidiaries

Consolidated Statements of Cash Flows

(Dollars in thousands)

(unaudited)

 

 

 

For the Three Months Ended

 

 

 

March 31,

 

 

 

2012

 

2011

 

Reconciliation of net income (loss) to net cash provided by operating activities:

 

 

 

 

 

Net income (loss)

 

$

6,977

 

$

(18,566

)

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

 

 

 

 

 

Depreciation and other amortization

 

31,705

 

33,645

 

Impairment losses

 

5,479

 

27,742

 

Amortization of deferred financing costs

 

1,572

 

1,759

 

Increase in deferred rent receivable

 

(2,559

)

(4,240

)

Amortization of net debt discounts

 

775

 

1,649

 

Gain on sales of real estate

 

(4,138

)

(2,701

)

Share-based compensation

 

3,402

 

2,917

 

Other

 

(1,423

)

(926

)

Changes in operating assets and liabilities:

 

 

 

 

 

Decrease (increase) in accounts receivable

 

14,792

 

(827

)

Decrease in restricted cash and marketable securities and prepaid expenses and other assets

 

9,448

 

4,701

 

Increase (decrease) in accounts payable, accrued expenses and other liabilities

 

7,661

 

(10,025

)

Decrease in rents received in advance and security deposits

 

(1,901

)

(2,176

)

Decrease in interest rate derivatives in connection with cash settlement

 

(28,003

)

 

Net cash provided by operating activities

 

$

43,787

 

$

32,952

 

 

 

 

 

 

 

Supplemental schedule of non-cash investing and financing activities:

 

 

 

 

 

Increase in accrued capital improvements, leasing and other investing activity costs

 

$

11,828

 

$

13,171

 

Increase in property, debt and other liabilities in connection with acquisitions

 

$

 

$

3,040

 

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

 

$

528

 

$

662

 

Dividends/distribution payable

 

$

24,544

 

$

33,048

 

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

 

$

444

 

$

263

 

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

 

$

88

 

$

163

 

 

See accompanying notes to consolidated financial statements.

 

8



Table of Contents

 

Corporate Office Properties Trust and Subsidiaries

 

Notes to Consolidated Financial Statements

(unaudited)

 

1.                                      Organization

 

Corporate Office Properties Trust (“COPT”) and subsidiaries (collectively, the “Company,” “we” or “us”) is a fully-integrated and self-managed real estate investment trust (“REIT”) that focuses primarily on serving the specialized requirements of strategic customers in the United States Government and defense information technology sectors.  We acquire, develop, manage and lease office and data center properties that are typically concentrated in large office parks primarily located adjacent to government demand drivers and/or in office markets that we believe possess growth opportunities.  As of March 31, 2012, our investments in real estate included the following:

 

·                  231 operating office properties totaling 20.2 million square feet;

·                  seven office properties under construction or redevelopment that we estimate will total approximately 903,000 square feet upon completion, including two partially operational properties included above;

·                  land held or under pre-construction totaling 2,327 acres (including 583 controlled but not owned) that we believe are potentially developable into approximately 20.5 million square feet; and

·                  a partially operational, wholesale data center which upon completion and stabilization is expected to have a critical load of 18 megawatts.

 

We conduct almost all of our operations through our operating partnership, Corporate Office Properties, L.P. (the “Operating Partnership”), of which we are the managing general partner.  The Operating Partnership owns real estate both directly and through subsidiary partnerships and limited liability companies (“LLCs”).  A summary of our Operating Partnership’s forms of ownership and the percentage of those ownership forms owned by COPT as of March 31, 2012 follows:

 

Common Units

 

94

%

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

%

 

Three of our trustees also controlled, either directly or through ownership by other entities or family members, an additional 5% of the Operating Partnership’s common units (“common units”) as of March 31, 2012.

 

In addition to owning real estate, the Operating Partnership also owns entities that provide real estate services such as property management and construction and development services primarily for our properties but also for third parties.

 

2.                                      Summary of Significant Accounting Policies

 

Basis of Presentation

 

The consolidated financial statements include the accounts of COPT, the Operating Partnership, their subsidiaries and other entities in which we have a majority voting interest and control.  We also consolidate certain entities when control of such entities can be achieved through means other than voting rights (“variable interest entities” or “VIEs”) if we are deemed to be the primary beneficiary of such entities.  We eliminate all significant intercompany balances and transactions in consolidation.

 

We use the equity method of accounting when we own an interest in an entity and can exert significant influence over the entity’s operations but cannot control the entity’s operations.

 

We use the cost method of accounting when we own an interest in an entity and cannot exert significant influence over its operations.

 

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These interim financial statements should be read together with the financial statements and notes thereto as of and for the year ended December 31, 2011 included in our 2011 Annual Report on Form 10-K.  The unaudited consolidated financial statements include all adjustments that are necessary, in the opinion of management, to fairly present our financial position and results of operations.  All adjustments are of a normal recurring nature.  The consolidated financial statements have been prepared using the accounting policies described in our 2011 Annual Report on Form 10-K.

 

Reclassifications

 

We reclassified certain amounts from prior periods to conform to the current period presentation of our consolidated financial statements with no effect on previously reported net income or equity.  Included among these reclassifications is a retrospective change in the presentation of costs expensed in connection with properties not in operations; these costs are included in the line on our consolidated statements of operations entitled “business development expenses and land carry costs,” after having been included in property operating expenses in our 2011 Annual Report on Form 10-K.

 

Recent Accounting Pronouncements

 

We adopted guidance issued by the Financial Accounting Standards Board (“FASB”) effective January 1, 2012 related to the presentation of comprehensive income that requires us to present the total of comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements.  We adopted this guidance using retrospective application.  This guidance eliminates the option to present the components of other comprehensive income as part of the statement of equity.  Our adoption of this guidance did not affect our financial position, results of operations, cash flows or measurement of comprehensive income but did change the location of our disclosure pertaining to comprehensive income in our consolidated financial statements.

 

We adopted guidance issued by the FASB effective January 1, 2012 that amends measurement and disclosure requirements related to fair value measurements to improve consistency with International Financial Reporting Standards.  In connection with our adoption of this guidance, we made an accounting policy election to use an exception provided for in the guidance with respect to measuring counterparty credit risk for derivative instruments; this election enables us to continue to measure the fair value of groups of assets and liabilities associated with derivative instruments consistently with how market participants would price the net risk exposure at the measurement date.  Our adoption of this guidance did not affect our financial position, results of operations or cash flows but did result in additional disclosure pertaining to our fair value measurements.

 

We adopted guidance issued by the FASB effective January 1, 2012 relating to the testing of goodwill for impairment that permits us to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test.  This guidance eliminates the requirement to calculate the fair value of a reporting unit unless the entity determines that it is more likely than not that its fair value is less than its carrying amount.  Our adoption of this guidance did not materially affect our consolidated financial statements or disclosures.

 

3.                                      Fair Value Measurements

 

For a description on how we estimate fair value, see Note 3 to the consolidated financial statements in our 2011 Annual Report on Form 10-K.

 

Recurring Fair Value Measurements

 

The table below sets forth our financial assets and liabilities that are accounted for at fair value on a recurring basis as of March 31, 2012 and the hierarchy level of inputs used in measuring their respective fair values under applicable accounting standards (in thousands):

 

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Quoted Prices in

 

 

 

 

 

 

 

 

 

Active Markets for

 

Significant Other

 

Significant

 

 

 

 

 

Identical Assets

 

Observable Inputs

 

Unobservable Inputs

 

 

 

Description

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Total

 

Assets:

 

 

 

 

 

 

 

 

 

Marketable securities in deferred compensation plan (1)

 

 

 

 

 

 

 

 

Mutual funds

 

$

6,121

 

$

 

$

 

$

6,121

 

Common stocks

 

414

 

 

 

414

 

Other

 

238

 

 

 

238

 

Common stock (1)

 

454

 

 

 

454

 

Warrants to purchase common shares in KEYW (2)

 

 

133

 

 

133

 

Assets

 

$

7,227

 

$

133

 

$

 

$

7,360

 

 

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

Deferred compensation plan liability (3)

 

$

6,773

 

$

 

$

 

$

6,773

 

Interest rate derivatives

 

 

2,673

 

 

2,673

 

Liabilities

 

$

6,773

 

$

2,673

 

$

 

$

9,446

 

 


(1)          Included in the line entitled “restricted cash and marketable securities” on our consolidated balance sheet.

(2)          Included in the line entitled “prepaid expenses and other assets” on our consolidated balance sheet.

(3)          Included in the line entitled “other liabilities” on our consolidated balance sheet.

 

At December 31, 2011, we owned 1.9 million shares, or approximately 7%, of the common stock of The KEYW Holding Corporation (“KEYW”).  During the three months ended March 31, 2012, we completed the sale of all of these shares for $14.0 million.  At March 31, 2012 and December 31, 2011, we owned warrants to purchase 50,000 additional shares of KEYW common stock at an exercise price of $9.25 per share.

 

The carrying values of cash and cash equivalents, restricted cash, accounts receivable, other assets (excluding mortgage loans receivable) and accounts payable and accrued expenses are reasonable estimates of their fair values because of the short maturities of these instruments.  We estimated the fair values of our mortgage loans receivable as discussed in Note 6 based on the discounted estimated future cash flows of the loans (categorized within Level 3 of the fair value hierarchy); the discount rates used approximate current market rates for loans with similar maturities and credit quality, and the estimated cash payments include scheduled principal and interest payments.  For our disclosure of debt fair values in Note 7 to the consolidated financial statements, we estimated the fair value of our exchangeable senior notes based on quoted market prices for publicly-traded debt (categorized within Level 2 of the fair value hierarchy) and estimated the fair value of our other debt based on the discounted estimated future cash payments to be made on such debt (categorized within Level 3 of the fair value hierarchy); the discount rates used approximate current market rates for loans, or groups of loans, with similar maturities and credit quality, and the estimated future payments include scheduled principal and interest payments.  Fair value estimates are made at a specific point in time, are subjective in nature and involve uncertainties and matters of significant judgment.  Settlement of such fair value amounts may not be possible and may not be a prudent management decision.

 

For additional fair value information, please refer to Note 6 for mortgage loans receivable, Note 7 for debt and Note 8 for interest rate derivatives.

 

Nonrecurring Fair Value Measurements

 

We assess each of our operating properties for impairment quarterly using cash flow projections and estimated fair values that we derive for each of the properties.  We update the leasing and other assumptions used in these projections regularly, paying particular attention to properties that have experienced chronic vacancy or face significant market challenges.  We review our plans and intentions for our development projects and land parcels quarterly.  Each quarter, we also review the reasonableness of changes in our estimated operating property fair values from amounts estimated in the prior quarter.  If events or changes in circumstances indicate that the carrying values of certain operating properties, properties in development or land held for future development may be impaired, we perform a recovery analysis for such properties.  For long-lived assets to be held and used, we analyze recoverability based on the estimated undiscounted future cash flows expected to be generated from the operations and eventual disposition of the assets over, in most cases, a ten-year holding period.  If we believe there is a significant possibility that we might dispose of the assets earlier, we analyze

 

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recoverability using a probability weighted analysis of the estimated undiscounted future cash flows expected to be generated from the operations and eventual disposition of the assets over the various possible holding periods.  If the recovery analysis indicates that the carrying value of a tested property is not recoverable from estimated future cash flows, it is written down to its estimated fair value and an impairment loss is recognized.  If and when our plans change, we revise our recoverability analyses to use the cash flows expected from the operations and eventual disposition of each asset using holding periods that are consistent with our revised plans.

 

Property fair values are determined based on contract prices, indicative bids, discounted cash flow analyses or yield analyses. The estimated cash flows used are based on our plans for the property and our views of market and economic conditions. The estimates consider items such as current and future rental rates, occupancies for the tested property and comparable properties, estimated operating and capital expenditures and recent sales data for comparable properties; most of these items are influenced by market data obtained from third party sources such as CoStar Group and real estate leasing and brokerage firms and our direct experience with the properties and their markets.

 

We recognized impairment losses on certain properties and other assets associated with such properties during the three months ended March 31, 2012.  Accordingly, certain properties and related assets were adjusted to fair value.  The table below sets forth the fair value hierarchy of the valuation techniques used by us in determining such fair values (dollars in thousands):

 

 

 

Quoted Prices in

 

 

 

 

 

 

 

 

 

 

 

Active Markets for

 

Significant Other

 

Significant

 

 

 

Impairment

 

 

 

Identical Assets

 

Observable Inputs

 

Unobservable Inputs

 

 

 

Losses

 

Description

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Total

 

Recognized

 

Assets (1):

 

 

 

 

 

 

 

 

 

 

 

Properties, net

 

$

 

$

 

$

92,176

 

$

92,176

 

$

5,479

 

 


(1) Reflects balance sheet classifications of assets at time of fair value measurement, excluding the effect of held for sale classifications.

 

The table below sets forth quantitative information about significant unobservable inputs used for the Level 3 fair value measurements reported above:

 

 

 

Fair value

 

 

 

 

 

Range

 

 

 

on measurement

 

Valuation

 

Unobservable

 

(Weighted

 

Description

 

date

 

Technique

 

Input

 

Average)

 

Properties on which impairment losses were recognized

 

$

92,176

 

Bid for properties indicative of value

 

Indicative bid (1)

 

(1)

 

 

 

 

 

Contract of sale

 

Contract price (1)

 

(1)

 

 

 

 

 

Discounted cash flow

 

Discount rate

 

11.0% (2)

 

 

 

 

 

 

 

Terminal capitalization rate

 

9.0% (2)

 

 

 

 

 

 

 

Market rent growth rate

 

3.0% (2)

 

 

 

 

 

 

 

Expense growth rate

 

3.0% (2)

 

 

 

 

 

Yield Analysis

 

Yield

 

12% (2)

 

 

 

 

 

 

 

Market rent rate

 

8.5 (2)

 

 

 

 

 

 

 

Leasing costs

 

$20.00 per square foot (2)

 

 


(1) These fair value measurements were developed from third party sources, subject to our corroboration for reasonableness.

(2) Only one level applied to this unobservable input.

 

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4.                                      Properties, net

 

Operating properties, net consisted of the following (in thousands):

 

 

 

March 31,

 

December 31,

 

 

 

2012

 

2011

 

Land

 

$

471,995

 

$

472,483

 

Buildings and improvements

 

2,802,570

 

2,801,252

 

Less: accumulated depreciation

 

(570,242

)

(559,679

)

Operating properties, net

 

$

2,704,323

 

$

2,714,056

 

 

Projects we had in development or held for future development consisted of the following (in thousands):

 

 

 

March 31,

 

December 31,

 

 

 

2012

 

2011

 

Land

 

$

225,085

 

$

229,833

 

Construction in progress, excluding land

 

408,883

 

409,086

 

Projects in development or held for future development

 

$

633,968

 

$

638,919

 

 

Dispositions and Impairments

 

We sold the following operating properties during the three months ended March 31, 2012 (dollars in thousands):

 

 

 

 

 

 

 

Number

 

Total

 

 

 

 

 

 

 

 

 

Date of

 

of

 

Rentable

 

 

 

Gain on

 

Project Name

 

Location

 

Sale

 

Buildings

 

Square Feet

 

Sale Price

 

Sale

 

White Marsh Portfolio (1)

 

White Marsh, Maryland

 

1/30/2012

 

5

 

163,000

 

$

19,100

 

$

2,445

 

1101 Sentry Gateway

 

San Antonio, Texas

 

1/31/2012

 

1

 

95,000

 

13,500

 

1,750

 

222 and 224 Schilling Circle

 

Hunt Valley, Maryland

 

2/10/2012

 

2

 

56,000

 

4,400

 

202

 

 

 

 

 

 

 

8

 

314,000

 

$

37,000

 

$

4,397

 

 


(1)         Includes three properties comprising the White Marsh Professional Center, 8615 Ridgely’s Choice and 8114 Sandpiper Circle.

 

We also sold non-operating properties during the three months ended March 31, 2012 for aggregate sale prices totaling $25.7 million; in addition to the gain on sales reflected above, we also recognized impairment losses on certain of these sales that are disclosed below.

 

As discussed in our 2011 Annual Report on Form 10-K, we implemented a plan in 2011 to dispose of office properties and land that are no longer closely aligned with our strategy (the “Strategic Reallocation Plan”).  During the three months ended March 31, 2012, we recognized aggregate net impairment losses in connection with the Strategic Reallocation Plan of $6.6 million (including $1.5 million classified as discontinued operations and $1.1 million in exit costs).  Approximately $5.1 million of these losses related to our expected disposition of an additional property. The expected cash flows from the resulting shortened holding period for this property are not sufficient to recover its carrying value.

 

2012 Construction Activities

 

As of March 31, 2012, we had construction underway on six office properties that we estimate will total 789,000 square feet upon completion, including three in the Baltimore/Washington Corridor, one in Greater Baltimore, one in Northern Virginia and one in Huntsville, Alabama, and redevelopment underway on one office property in Greater Philadelphia that we estimate will total 113,000 square feet upon completion.

 

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5.                                      Real Estate Joint Ventures

 

During the three months ended March 31, 2012, 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 (dollars in thousands):

 

 

 

 

 

 

 

 

 

 

 

Maximum

 

Investment Balance at (1)

 

Date

 

 

 

Nature of

 

Exposure

 

March 31, 2012

 

December 31, 2011

 

Acquired

 

Ownership

 

Activity

 

to Loss (2)

 

$

 (6,178

)

$

(6,071

)

9/29/2005

 

20

%

Operates 16 Buildings

 

$

 

 


(1)         The carrying amount of our investment in this joint venture was lower than our share of the equity in the joint venture by $5.2 million at March 31, 2012 and December 31, 2011 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.

 

(2)         Derived from the sum of our investment balance and maximum additional unilateral capital contributions or loans required from us.  Not reported above are additional amounts that we and our partner are required to fund when needed by this joint venture; these funding requirements are proportional to our respective ownership percentages.  Also not reported above are additional unilateral contributions or loans from us, the amounts of which are uncertain, that we would be required to make if certain contingent events occur (see Note 15).

 

The following table sets forth condensed balance sheets for this unconsolidated real estate joint venture (in thousands):

 

 

 

March 31,

 

December 31,

 

 

 

2012

 

2011

 

Properties, net

 

$

59,333

 

$

59,792

 

Other assets

 

4,403

 

3,529

 

Total assets

 

$

63,736

 

$

63,321

 

 

 

 

 

 

 

Liabilities (primarily debt)

 

$

68,663

 

$

67,710

 

Owners’ equity

 

(4,927

)

(4,389

)

Total liabilities and owners’ equity

 

$

63,736

 

$

63,321

 

 

The following table sets forth condensed statements of operations for this unconsolidated real estate joint venture (in thousands):

 

 

 

For the Three Months

 

 

 

Ended March 31,

 

 

 

2012

 

2011

 

Revenues

 

$

1,894

 

$

1,924

 

Property operating expenses

 

(737

)

(986

)

Interest expense

 

(1,125

)

(1,011

)

Depreciation and amortization expense

 

(570

)

(608

)

Net loss

 

$

(538

)

$

(681

)

 

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The table below sets forth information pertaining to our investments in consolidated real estate joint ventures at March 31, 2012 (dollars in thousands):

 

 

 

 

 

Ownership

 

 

 

March 31, 2012 (1)

 

 

 

Date

 

% at

 

Nature of

 

Total

 

Pledged

 

Total

 

 

 

Acquired

 

3/31/2012

 

Activity

 

Assets

 

Assets

 

Liabilities

 

M Square Associates, LLC

 

6/26/2007

 

50

%

Operating two buildings and developing others (2)

 

$

60,260

 

$

47,845

 

$

44,117

 

LW Redstone Company, LLC

 

3/23/2010

 

85

%

Developing business park (3)

 

55,255

 

15,858

 

11,373

 

Arundel Preserve #5, LLC

 

7/2/2007

 

50

%

Operating one building (4)

 

32,477

 

31,619

 

18,079

 

COPT-FD Indian Head, LLC

 

10/23/2006

 

75

%

Developing land parcel (5)

 

6,544

 

 

 

MOR Forbes 2 LLC

 

12/24/2002

 

50

%

Operating one building (6)

 

3,836

 

 

40

 

 

 

 

 

 

 

 

 

$

158,372

 

$

95,322

 

$

73,609

 

 


(1) Excludes amounts eliminated in consolidation.

(2) This joint venture’s properties are in College Park, Maryland (in the Suburban Maryland region).

(3) This joint venture’s property is in Huntsville, Alabama.

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

(5) This joint venture’s property is in Charles County, Maryland.

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

 

Our commitments and contingencies pertaining to our real estate joint ventures are disclosed in Note 15.

 

6.                                      Prepaid Expenses and Other Assets

 

Prepaid expenses and other assets consisted of the following (in thousands):

 

 

 

March 31,

 

December 31,

 

 

 

2012

 

2011

 

Mortgage and other investing receivables

 

$

32,739

 

$

27,998

 

Prepaid expenses

 

14,196

 

20,035

 

Proceeds from sale of KEYW stock receivable (1)

 

11,934

 

5,057

 

Construction contract costs incurred in excess of billings

 

10,592

 

2,094

 

Furniture, fixtures and equipment, net

 

9,607

 

10,177

 

Deferred tax asset

 

6,746

 

10,892

 

Lease incentives

 

5,360

 

5,233

 

Other assets

 

5,358

 

6,133

 

Prepaid expenses and other assets

 

$

96,532

 

$

87,619

 

 


(1)         Represents unsettled proceeds from sales of KEYW common stock that settled shortly following the respective reporting dates.

 

Mortgage and Other Investing Receivables

 

Mortgage and other investing receivables consisted of the following (in thousands):

 

 

 

March 31,

 

December 31,

 

 

 

2012

 

2011

 

Notes receivable from City of Huntsville

 

$

22,526

 

$

17,741

 

Mortgage loans receivable

 

10,213

 

10,257

 

 

 

$

32,739

 

$

27,998

 

 

Our notes receivable from the City of Huntsville funded infrastructure costs in connection with our LW Redstone Company, LLC joint venture (see Note 5).  Our mortgage loans receivable reflected above consists of two loans secured by properties in Greater Baltimore and the Baltimore/Washington Corridor.  We did not have an allowance for credit losses in connection with these receivables at March 31, 2012 or December 31, 2011.  The fair value of our mortgage and other investing receivables totaled $32.7 million at March 31, 2012 and $28.0 million at December 31, 2011.

 

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Operating Notes Receivable

 

We had operating notes receivable due from tenants with terms exceeding one year totaling $482,000 at March 31, 2012 and $530,000 at December 31, 2011.  We carried allowances for estimated losses for most of these balances.

 

7.                                      Debt

 

Our debt consisted of the following (dollars in thousands):

 

 

 

 

 

 

 

 

 

 

 

Scheduled

 

 

 

Maximum

 

Carrying Value at

 

 

 

Maturity

 

 

 

Availability at

 

March 31,

 

December 31,

 

Stated Interest Rates

 

Dates at

 

 

 

March 31, 2012

 

2012

 

2011

 

at March 31, 2012

 

March 31, 2012

 

 

 

 

 

 

 

 

 

 

 

 

 

Mortgage and Other Secured Loans:

 

 

 

 

 

 

 

 

 

 

 

Fixed rate mortgage loans (1)

 

N/A

 

$

1,049,204

 

$

1,052,421

 

5.20% - 7.87% (2)

 

2012-2034

 

Variable rate secured loans

 

N/A

 

39,027

 

39,213

 

LIBOR + 2.25% (3)

 

2015

 

Other construction loan facilities

 

$

123,802

 

50,594

 

40,336

 

LIBOR + 1.95% to 2.75% (4)

 

2012-2015

 

Total mortgage and other secured loans

 

 

 

1,138,825

 

1,131,970

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revolving Credit Facility

 

1,000,000

 

396,000

 

662,000

 

LIBOR + 1.75% to 2.50% (5)

 

September 1, 2014

 

Term Loan Facilities (6)

 

650,000

 

650,000

 

400,000

 

LIBOR + 1.65% to 2.40% (7)

 

2015-2017

 

Unsecured notes payable

 

N/A

 

5,078

 

5,050

 

0% (8)

 

2015-2026

 

4.25% Exchangeable Senior Notes

 

N/A

 

228,175

 

227,283

 

4.25%

 

April 2030(9)

 

Total debt

 

 

 

$

2,418,078

 

$

2,426,303

 

 

 

 

 

 


(1)         Several of the fixed rate mortgages carry interest rates that were above or below market rates upon assumption and therefore were recorded at their fair value based on applicable effective interest rates.  The carrying values of these loans reflect net unamortized premiums totaling $2.2 million at March 31, 2012 and $2.4 million at December 31, 2011.

(2)         The weighted average interest rate on these loans was 6.01% at March 31, 2012.

(3)         The interest rate on the loan outstanding was 2.49% at March 31, 2012.

(4)         The weighted average interest rate on these loans was 2.73% at March 31, 2012.

(5)         The weighted average interest rate on the Revolving Credit Facility was 2.24% at March 31, 2012.

(6)         As described further below, we entered into a new facility effective on February 14, 2012.

(7)         The weighted average interest rate on these loans was 2.15% at March 31, 2012.

(8)         These notes may carry interest rates that were below market rates upon assumption and therefore were recorded at their fair value based on applicable effective interest rates.  The carrying value of these notes reflects an unamortized discount totaling $1.7 million at March 31, 2012 and $1.8 million at December 31, 2011.

(9)         As described further in our 2011 Annual Report on Form 10-K, these notes have an exchange settlement feature that provides that the notes may, under certain circumstances, be exchangeable for cash and, at the Operating Partnership’s discretion, our common shares at an exchange rate (subject to adjustment) of 20.8513 shares per one thousand dollar principal amount of the notes (exchange rate is as of March 31, 2012 and is equivalent to an exchange price of $47.96 per common share).  The carrying value of these notes included a principal amount of $240.0 million and an unamortized discount totaling $11.8 million at March 31, 2012 and $12.7 million at December 31, 2011.  The effective interest rate under the notes, including amortization of the issuance costs, was 6.05%.  Because the closing price of our common shares at March 31, 2012 and December 31, 2011 was less than the exchange price per common share applicable to these notes, the if-converted value of the notes did not exceed the principal amount.  The table below sets forth interest expense recognized on these notes before deductions for amounts capitalized (in thousands):

 

 

 

For the Three Months

 

 

 

Ended March 31,

 

 

 

2012

 

2011

 

Interest expense at stated interest rate

 

$

2,550

 

$

2,550

 

Interest expense associated with amortization of discount

 

892

 

840

 

Total

 

$

3,442

 

$

3,390

 

 

Effective February 14, 2012, we entered into an unsecured term loan agreement (the “Term Loan Agreement”) with a group of lenders for which J.P. Morgan Securities LLC and KeyBank Capital Markets acted as joint lead arrangers and joint book runners, KeyBank National Association acted as administrative agent and JPMorgan Chase Bank, N.A. acted as syndication agent.  We borrowed $250.0 million under the Term Loan Agreement.  The term loan matures on February 14, 2017.  The variable interest rate on the loan is based on the LIBOR rate (customarily the 30-day rate) plus 1.65% to 2.40%, as determined by our leverage levels.

 

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At March 31, 2012 and December 31, 2011, we were in default on a $15 million nonrecourse mortgage loan secured by a property with an estimated fair value of approximately $11 million that is included in our Strategic Reallocation Plan.

 

We capitalized interest costs of $3.8 million in the three months ended March 31, 2012 and $4.3 million in the three months ended March 31, 2011.

 

The following table sets forth information pertaining to the fair value of our debt (in thousands):

 

 

 

March 31, 2012

 

December 31, 2011

 

 

 

Carrying

 

Estimated

 

Carrying

 

Estimated

 

 

 

Amount

 

Fair Value

 

Amount

 

Fair Value

 

Fixed-rate debt

 

 

 

 

 

 

 

 

 

4.25% Exchangeable Senior Notes

 

$

228,175

 

$

239,331

 

$

227,283

 

$

238,077

 

Other fixed-rate debt

 

1,054,282

 

1,049,110

 

1,057,471

 

1,054,424

 

Variable-rate debt

 

1,135,621

 

1,135,847

 

1,141,549

 

1,139,856

 

 

 

$

2,418,078

 

$

2,424,288

 

$

2,426,303

 

$

2,432,357

 

 

8.                                      Interest Rate Derivatives

 

The following table sets forth the key terms and fair values of our interest rate swap derivatives (dollars in thousands):

 

 

 

 

 

 

 

 

 

 

 

Fair Value at

 

Notional

 

Fixed

 

Floating Rate

 

Effective

 

Expiration

 

March 31,

 

December 31,

 

Amount

 

Rate

 

Index

 

Date

 

Date

 

2012

 

2011

 

$

 50,000

 

0.5025

%

One-Month LIBOR

 

1/3/2011

 

1/3/2012

 

$

 

$

(1

)

50,000

 

0.5025

%

One-Month LIBOR

 

1/3/2011

 

1/3/2012

 

 

(1

)

120,000

 

1.7600

%

One-Month LIBOR

 

1/2/2009

 

5/1/2012

 

(152

)

(552

)

100,000

 

1.9750

%

One-Month LIBOR

 

1/1/2010

 

5/1/2012

 

(144

)

(532

)

100,000

 

0.6123

%

One-Month LIBOR

 

1/3/2012

 

9/1/2014

 

(282

)

55

 

100,000

 

0.6100

%

One-Month LIBOR

 

1/3/2012

 

9/1/2014

 

(277

)

56

 

100,000

 

0.8320

%

One-Month LIBOR

 

1/3/2012

 

9/1/2015

 

(365

)

(66

)

100,000

 

0.8320

%

One-Month LIBOR

 

1/3/2012

 

9/1/2015

 

(363

)

(49

)

39,027

(1)

3.8300

%

One-Month LIBOR

 

11/2/2010

 

11/2/2015

 

(1,090

)

(1,054

)

100,000

(2)

3.8415

%

Three-Month LIBOR

 

9/30/2011

 

9/30/2021

 

 

(16,333

)

75,000

(2)

3.8450

%

Three-Month LIBOR

 

9/30/2011

 

9/30/2021

 

 

(12,275

)

100,000

(2)

2.0525

%

Three-Month LIBOR-Reverse

 

12/30/2011

 

9/30/2021

 

 

345

 

75,000

(2)

2.0525

%

Three-Month LIBOR-Reverse

 

12/30/2011

 

9/30/2021

 

 

260

 

 

 

 

 

 

 

 

 

 

 

$

(2,673

)

$

(30,147

)

 


(1)         The notional amount of this instrument is scheduled to amortize to $36.2 million.

(2)         As described further in our 2011 Annual Report on Form 10-K, on January 5, 2012, we cash settled these instruments, along with interest accrued thereon, for an aggregate of $29.7 million.  Our policy is to present payments to terminate interest rate swaps entered into in order to hedge forecasted interest payments as operating activities on our consolidated statement of cash flows.  Accordingly, the payments to cash settle these instruments were included in net cash provided by operating activities on our consolidated statement of cash flows.

 

Each of the one-month LIBOR interest rate swaps set forth in the table above was designated as cash flow hedges of interest rate risk.

 

The table below sets forth the fair value of our interest rate derivatives as well as their classification on our consolidated balance sheet (in thousands):

 

 

 

March 31, 2012

 

December 31, 2011

 

Derivatives

 

Balance Sheet Location

 

Fair Value

 

Balance Sheet Location

 

Fair Value

 

Interest rate swaps designated as cash flow hedges

 

Prepaid expenses and other assets

 

$

 

Prepaid expenses and other assets

 

$

111

 

Interest rate swaps not designated as hedges

 

N/A

 

 

Prepaid expenses and other assets

 

605

 

Interest rate swaps designated as cash flow hedges

 

Interest rate derivatives

 

(2,673

)

Interest rate derivatives

 

(2,255

)

Interest rate swaps not designated as hedges

 

N/A

 

 

Interest rate derivatives

 

(28,608

)

 

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Table of Contents

 

The table below presents the effect of our interest rate derivatives on our consolidated statements of operations and comprehensive income (in thousands):

 

 

 

For the Three Months

 

 

 

Ended March 31,

 

 

 

2012

 

2011

 

Amount of loss recognized in AOCL (effective portion)

 

$

(1,987

)

$

(136

)

Amount of loss reclassified from AOCL into interest expense (effective portion)

 

(1,474

)

(1,104

)

 

Over the next 12 months, we estimate that approximately $2.5 million will be reclassified from AOCL as an increase to interest expense.

 

We have agreements with each of our interest rate derivative counterparties that contain provisions under which, if we default or are capable of being declared in default on any of our indebtedness, we could also be declared in default on our derivative obligations.  These agreements also incorporate the loan covenant provisions of our indebtedness with a lender affiliate of the derivative counterparties.  Failure to comply with the loan covenant provisions could result in our being declared in default on any derivative instrument obligations covered by the agreements.  As of March 31, 2012, the fair value of interest rate derivatives in a liability position related to these agreements was $2.7 million, excluding the effects of accrued interest. As of March 31, 2012, we had not posted any collateral related to these agreements.  We are not in default with any of these provisions.  If we breached any of these provisions, we could be required to settle our obligations under the agreements at their termination value of $3.3 million.

 

9.                                      Shareholders’ Equity

 

During the three months ended March 31, 2012, holders of 34,550 common units in our Operating Partnership converted their units into common shares on the basis of one common share for each common unit.

 

We declared dividends per common share of $0.275 in the three months ended March 31, 2012 and $0.4125 in the three months ended March 31, 2011.

 

See Note 11 for disclosure of common share activity pertaining to our share-based compensation plans.

 

18


 


Table of Contents

 

10.                               Information by Business Segment

 

We have ten reportable operating office property segments (comprised of: the Baltimore/Washington Corridor; Northern Virginia; San Antonio; Washington, DC — Capitol Riverfront; St. Mary’s and King George Counties; Greater Baltimore; Suburban Maryland; Colorado Springs; Greater Philadelphia; and other). We also have an operating wholesale data center segment.  On January 1, 2012, we revised our reportable segments to include only operating properties.  Accordingly, we revised net operating income from real estate operations (“NOI from real estate operations”) to exclude operating expenses not related to operating properties, revised our definition of segment assets to include only long-lived assets associated with operating properties and revised our definition of additions to long-lived assets to include only additions to existing operating properties (excluding acquisitions and transfers from non-operating properties).  Financial information for prior periods has been presented in conformity with this revision.

 

The table below reports segment financial information for our reportable segments (in thousands).  We measure the performance of our segments through the measure we define as NOI from real estate operations, which is derived by subtracting property operating expenses from revenues from real estate operations.

 

 

 

Operating Office Property Segments

 

 

 

 

 

 

 

Baltimore/
Washington
Corridor

 

Northern
Virginia

 

San
Antonio

 

Washington,
DC - Capitol
Riverfront

 

St. Mary’s & 
King George
Counties

 

Greater
Baltimore

 

Suburban
Maryland

 

Colorado
Springs

 

Greater
Philadelphia

 

Other

 

Operating
Wholesale
Data Center

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31, 2012

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues from real estate operations

 

$

56,250

 

$

18,560

 

$

7,608

 

$

3,894

 

$

4,212

 

$

15,372

 

$

5,749

 

$

6,453

 

$

2,172

 

$

3,618

 

$

1,416

 

$

125,304

 

Property operating expenses

 

20,151

 

7,400

 

3,817

 

1,910

 

1,258

 

5,890

 

2,521

 

2,385

 

615

 

1,233

 

1,207

 

48,387

 

NOI from real estate operations

 

$

36,099

 

$

11,160

 

$

3,791

 

$

1,984

 

$

2,954

 

$

9,482

 

$

3,228

 

$

4,068

 

$

1,557

 

$

2,385

 

$

209

 

$

76,917

 

Additions to long-lived assets

 

$

1,864

 

$

1,661

 

$

 

$

(729

)

$

167

 

$

719

 

$

771

 

$

99

 

$

 

$

26

 

$

 

$

4,578

 

Transfers from non-operating properties

 

$

25,594

 

$

 

$

362

 

$

 

$

556

 

$

365

 

$

335

 

$

316

 

$

7,303

 

$

 

$

 

$

34,831

 

Segment assets at March 31, 2012

 

$

1,231,949

 

$

480,457

 

$

120,024

 

$

108,649

 

$

99,946

 

$

370,754

 

$

147,197

 

$

181,241

 

$

109,432

 

$

114,108

 

$

43,390

 

$

3,007,147

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31, 2011

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues from real estate operations

 

$

53,252

 

$

18,274

 

$

7,663

 

$

4,590

 

$

3,534

 

$

17,612

 

$

5,609

 

$

5,920

 

$

1,939

 

$

2,838

 

$

1,210

 

$

122,441

 

Property operating expenses

 

21,058

 

7,590

 

3,813

 

1,627

 

1,014

 

8,452

 

2,661

 

2,343

 

418

 

467

 

709

 

50,152

 

NOI from real estate operations

 

$

32,194

 

$

10,684

 

$

3,850

 

$

2,963

 

$

2,520

 

$

9,160

 

$

2,948

 

$

3,577

 

$

1,521

 

$

2,371

 

$

501

 

$

72,289

 

Additions to long-lived assets

 

$

6,405

 

$

2,033

 

$

 

$

156

 

$

380

 

$

8,088

 

$

1,052

 

$

736

 

$

(4

)

$

(646

)

$

 

$

18,200

 

Transfers from non-operating properties

 

$

19,883

 

$

(7

)

$

600

 

$

 

$

 

$

4,247

 

$

354

 

$

 

$

(2,474

)

$

 

$

6,654

 

$

29,257

 

Segment assets at March 31, 2011

 

$

1,199,244

 

$

488,599

 

$

115,221

 

$

117,758

 

$

87,690

 

$

479,474

 

$

145,913

 

$

214,111

 

$

96,372

 

$

83,247

 

$

30,714

 

$

3,058,343

 

 

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Table of Contents

 

The following table reconciles our segment revenues to total revenues as reported on our consolidated statements of operations (in thousands):

 

 

 

For the Three Months

 

 

 

Ended March 31,

 

 

 

2012

 

2011

 

Segment revenues from real estate operations

 

$

125,304

 

$

122,441

 

Construction contract and other service revenues

 

21,534

 

21,028

 

Less: Revenues from discontinued operations (Note 13)

 

(3,365

)

(5,980

)

Total revenues

 

$

143,473

 

$

137,489

 

 

The following table reconciles our segment property operating expenses to property operating expenses as reported on our consolidated statements of operations (in thousands):

 

 

 

For the Three Months

 

 

 

Ended March 31,

 

 

 

2012

 

2011

 

Segment property operating expenses

 

$

48,387

 

$

50,152

 

Less: Property operating expenses from discontinued operations (Note 13)

 

(1,185

)

(3,091

)

Total property operating expenses

 

$

47,202

 

$

47,061

 

 

As previously discussed, we provide real estate services such as property management and construction and development services primarily for our properties but also for third parties.  The primary manner in which we evaluate the operating performance of our service activities is through a measure we define as net operating income from service operations (“NOI from service operations”), which is based on the net of revenues and expenses from these activities.  Construction contract and other service revenues and expenses consist primarily of subcontracted costs that are reimbursed to us by the customer along with a management fee. The operating margins from these activities are small relative to the revenue.  We believe NOI from service operations is a useful measure in assessing both our level of activity and our profitability in conducting such operations. The table below sets forth the computation of our NOI from service operations (in thousands):

 

 

 

For the Three Months

 

 

 

Ended March 31,

 

 

 

2012

 

2011

 

Construction contract and other service revenues

 

$

21,534

 

$

21,028

 

Construction contract and other service expenses

 

(20,607

)

(20,618

)

NOI from service operations

 

$

927

 

$

410

 

 

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Table of Contents

 

The following table reconciles our NOI from real estate operations for reportable segments and NOI from service operations to income (loss) from continuing operations as reported on our consolidated statements of operations (in thousands):

 

 

 

For the Three Months

 

 

 

Ended March 31,

 

 

 

2012

 

2011

 

NOI from real estate operations

 

$

76,917

 

$

72,289

 

NOI from service operations

 

927

 

410

 

Interest and other income

 

1,217

 

1,168

 

Equity in (loss) income of unconsolidated entities

 

(89

)

30

 

Income tax (expense) benefit

 

(4,173

)

544

 

Other adjustments:

 

 

 

 

 

Depreciation and other amortization associated with real estate operations

 

(31,066

)

(30,043

)

Impairment losses

 

(5,126

)

(27,742

)

General and administrative expenses

 

(7,017

)

(6,777

)

Business development expenses and land carry costs

 

(1,594

)

(1,241

)

Interest expense on continuing operations

 

(25,224

)

(26,115

)

NOI from discontinued operations

 

(2,180

)

(2,889

)

Income (loss) from continuing operations

 

$

2,592

 

$

(20,366

)

 

The following table reconciles our segment assets to total assets (in thousands):

 

 

 

March 31,

 

March 31,

 

 

 

2012

 

2011

 

Segment assets

 

$

3,007,147

 

$

3,058,343

 

Non-operating property assets

 

638,856

 

652,223

 

Other assets

 

151,365

 

155,243

 

Total assets

 

$

3,797,368

 

$

3,865,809

 

 

The accounting policies of the segments are the same as those used to prepare our consolidated financial statements, except that discontinued operations are not presented separately for segment purposes.  In the segment reporting presented above, we did not allocate interest expense, depreciation and amortization and impairment losses to our real estate segments since they are not included in the measure of segment profit reviewed by management.  We also did not allocate general and administrative expenses, business development expenses and land carry costs, interest and other income, equity in (loss) income of unconsolidated entities, income taxes and noncontrolling interests because these items represent general corporate or non-operating property items not attributable to segments.

 

21



Table of Contents

 

11.                               Share-Based Compensation

 

Performance Share Units (“PSUs”)

 

On March 1, 2012, our Board of Trustees granted 54,070 PSUs with an aggregate grant date fair value of $1.8 million to executives.  The PSUs have a performance period beginning on January 1, 2012 and concluding on the earlier of December 31, 2014 or the date of: (1) termination by the Company without cause, death or disability of the executive or constructive discharge of the executive (collectively, “qualified termination”); or (2) a sale event.  The number of PSUs earned (“earned PSUs”) at the end of the performance period will be determined based on the percentile rank of the Company’s total shareholder return relative to a peer group of companies, as set forth in the following schedule:

 

Percentile Rank

 

Earned PSUs Payout %

75th or greater

 

200% of PSUs granted

50th

 

100% of PSUs granted

25th

 

50% of PSUs granted

Below 25th

 

0% of PSUs granted

 

If the percentile rank exceeds the 25th percentile and is between two of the percentile ranks set forth in the table above, then the percentage of the earned PSUs will be interpolated between the ranges set forth in the table above to reflect any performance between the listed percentiles.  At the end of the performance period, we, in settlement of the award, will issue a number of fully-vested common shares equal to the sum of:

 

·                  the number of earned PSUs in settlement of the award plan; plus

·                  the aggregate dividends that would have been paid with respect to the common shares issued in settlement of the earned PSUs through the date of settlement had such shares been issued on the grant date, divided by the share price on such settlement date, as defined under the terms of the agreement.

 

If a performance period ends due to a sale event or qualified termination, the number of earned PSUs is prorated based on the portion of the three-year performance period that has elapsed.  If employment is terminated by the employee or by the Company for cause, all PSUs are forfeited.  PSUs do not carry voting rights.

 

We computed a grant date fair value of $32.77 per PSU using a Monte Carlo model, which included assumptions of, among other things, the following: baseline common share value of $24.39; expected volatility for our common shares of 43.2%; and risk-free interest rate of 0.41%.  We are recognizing the grant date fair value in connection with these PSU awards over the performance period.

 

All PSUs granted on March 4, 2010 and outstanding at December 31, 2011 were held by Mr. Randall M. Griffin, our Chief Executive Officer, and were terminated upon his retirement on March 31, 2012.  Based on the Company’s total shareholder return relative its peer group of companies, there was no payout value in connection with the termination of the PSUs.

 

The PSUs granted to our executives on March 3, 2011, as described in our 2011 Annual Report on Form 10-K, were outstanding at March 31, 2012.

 

Restricted Shares

 

During the three months ended March 31, 2012, certain employees were granted a total of 87,449 restricted shares with an aggregate grant date fair value of $2.1 million (weighted average of $24.39 per share).  Restricted shares granted to employees vest based on increments and over periods of time set forth

 

22



Table of Contents

 

under the terms of the respective awards provided that the employees remain employed by us.  During the three months ended March 31, 2012, forfeiture restrictions lapsed on 251,985 previously issued common shares; these shares had a weighted average grant date fair value of $31.93 per share, and the aggregate intrinsic value of the shares on the vesting dates was $6.2 million.

 

Options

 

During the three months ended March 31, 2012, 5,667 options to purchase common shares (“options”) were exercised.  The weighted average exercise price of these options was $14.54 per share, and the aggregate intrinsic value of the options exercised was $56,000.

 

12.                               Income Taxes

 

We own a taxable REIT subsidiary (“TRS”) that is subject to Federal and state income taxes.  Our TRS’s provision for income tax (expense) benefit consisted of the following (in thousands):

 

 

 

For the Three Months 
Ended March 31,

 

 

 

2012

 

2011

 

Deferred

 

 

 

 

 

Federal

 

$

(3,417

)

$

447

 

State

 

(756

)

100

 

 

 

(4,173

)

547

 

Current

 

 

 

 

 

Federal

 

 

(2

)

State

 

 

(1

)

 

 

 

(3

)

Total income tax (expense) benefit

 

$

(4,173

)

$

544

 

 

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

 

Our TRS’s combined Federal and state effective tax rate was 38.6% for the three months ended March 31, 2012 and 2011.

 

13.                               Discontinued Operations and Assets Held for Sale

 

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

 

·                  1344 and 1348 Ashton Road and 1350 Dorsey Road in the Baltimore/Washington Corridor that were sold on May 24, 2011;

·                  216 Schilling Circle in Greater Baltimore that was sold on August 23, 2011;

·                  four properties comprising the Towson Portfolio in Greater Baltimore that were sold on September 29, 2011;

·                  11011 McCormick Road in Greater Baltimore that was sold on November 1, 2011;

·                  10001 Franklin Square Drive in Greater Baltimore that was sold on December 13, 2011;

·                  13 properties comprising the Rutherford Business Center portfolio in Greater Baltimore that were sold on December 15, 2011;

·                  three properties comprising the White Marsh Professional Center, 8615 Ridgely’s Choice and 8114 Sandpiper Circle in Greater Baltimore that were sold on January 30, 2012;

 

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Table of Contents

 

·                  1101 Sentry Gateway in San Antonio that was sold on January 31, 2012;

·                  222 and 224 Schilling Circle in the Greater Baltimore region that were sold on February 10, 2012; and

·                  four operating properties that were classified as held for sale as of March 31, 2012, including the following:

·                  226 Schilling Circle in Greater Baltimore;

·                  11800 Tech Road in Suburban Maryland; and

·                  15 and 45 West Gude Drive in Suburban Maryland.

 

The table below sets forth the components of discontinued operations reported on our consolidated statements of operations (in thousands):

 

 

 

For the Three Months

 

 

 

Ended March 31,

 

 

 

2012

 

2011

 

Revenue from real estate operations

 

$

3,365

 

$

5,980

 

Property operating expenses

 

(1,185

)

(3,091

)

Depreciation and amortization

 

(21

)

(2,977

)

Impairment losses

 

(1,461

)

 

Interest expense

 

(451

)

(813

)

Gain on sales of real estate

 

4,138

 

 

Discontinued operations

 

$

4,385

 

$

(901

)

 

The table below sets forth the components of assets held for sale on our consolidated balance sheets (in thousands):

 

 

 

March 31, 2012

 

December 31, 2011

 

Properties, net

 

$

74,758

 

$

108,356

 

Deferred rent receivable

 

2,371

 

2,800

 

Intangible assets on real estate acquisitions, net

 

930

 

1,737

 

Deferred leasing costs, net

 

3,293

 

3,723

 

Assets held for sale

 

$

81,352

 

$

116,616

 

 

14.                               Earnings Per Share (“EPS”)

 

We present both basic and diluted EPS.  We compute basic EPS by dividing net income available to common shareholders allocable to unrestricted common shares under the two-class method by the weighted average number of unrestricted 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 or if-converted methods; and

·                  the numerator is adjusted to add back any changes in income or loss that would result from the assumed conversion into common shares that we added to the denominator.

 

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Table of Contents

 

Summaries of the numerator and denominator for purposes of basic and diluted EPS calculations are set forth below (in thousands, except per share data):

 

 

 

For the Three Months

 

 

 

Ended March 31,

 

 

 

2012

 

2011

 

Numerator:

 

 

 

 

 

Income (loss) from continuing operations

 

$

2,592

 

$

(20,366

)

Gain on sales of real estate, net

 

 

2,701

 

Preferred share dividends

 

(4,025

)

(4,025

)

(Income) loss from continuing operations attributable to noncontrolling interests

 

(53

)

719

 

Income from continuing operations attributable to restricted shares

 

(141

)

(282

)

Numerator for basic EPS from continuing operations attributable to COPT common shareholders

 

(1,627

)

(21,253

)

Dilutive effect of common units in the Operating Partnership on diluted EPS from continuing operations

 

 

(1,422

)

Numerator for diluted EPS from continuing operations attributable to COPT common shareholders

 

$

(1,627

)

$

(22,675

)

 

 

 

 

 

 

Numerator for basic EPS from continuing operations attributable to COPT common shareholders

 

$

(1,627

)

$

(21,253

)

Discontinued operations

 

4,385

 

(901

)

Discontinued operations attributable to noncontrolling interests

 

(247

)

57

 

Numerator for basic EPS on net income (loss) attributable to COPT common shareholders

 

2,511

 

(22,097

)

Dilutive effect of common units in the Operating Partnership

 

 

(1,479

)

Numerator for diluted EPS on net income (loss) attributable to COPT common shareholders

 

$

2,511

 

$

(23,576

)

 

 

 

 

 

 

Denominator (all weighted averages):

 

 

 

 

 

Denominator for basic EPS (common shares)

 

71,458

 

66,340

 

Dilutive effect of common units

 

 

4,396

 

Denominator for diluted EPS

 

71,458

 

70,736

 

 

 

 

 

 

 

Basic EPS:

 

 

 

 

 

Loss from continuing operations attributable to COPT common shareholders

 

$

(0.02

)

$

(0.32

)

Discontinued operations attributable to COPT common shareholders

 

0.06

 

(0.01

)

Net income (loss) attributable to COPT common shareholders

 

$

0.04

 

$

(0.33

)

Diluted EPS:

 

 

 

 

 

Loss from continuing operations attributable to COPT common shareholders

 

$

(0.02

)

$

(0.32

)

Discontinued operations attributable to COPT common shareholders

 

0.06

 

(0.01

)

Net income (loss) attributable to COPT common shareholders

 

$

0.04

 

$

(0.33

)

 

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 (in thousands):

 

 

 

Weighted Average Shares

 

 

 

Excluded from Denominator

 

 

 

For the Three Months

 

 

 

Ended March 31,

 

 

 

2012

 

2011

 

Conversion of common units

 

 

4,396

 

Conversion of convertible preferred units

 

176

 

176

 

Conversion of convertible preferred shares

 

434

 

434

 

 

The following share-based compensation securities were excluded from the computation of diluted EPS because their effect was antidilutive:

 

·                 weighted average restricted shares for the three months ended March 31, 2012 and 2011 of 572,000 and 651,000, respectively; and

 

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·                  weighted average options for the three months ended March 31, 2012 and 2011 of 819,000 and 1.2 million, respectively.

 

As discussed in Note 7, we have outstanding senior notes that have an exchange settlement feature but did not affect our diluted EPS reported above since the weighted average closing price of our common shares during each of the periods was less than the exchange prices per common share applicable for such periods.

 

15.                               Commitments and Contingencies

 

Litigation

 

In the normal course of business, we are involved in legal actions arising from our ownership and administration of properties.  We establish reserves for specific legal proceedings when we determine that the likelihood of an unfavorable outcome is probable and the amount of loss can be reasonably estimated.  Management does not anticipate that any liabilities that may result from such proceedings will have a materially adverse effect on our financial position, operations or liquidity.  Our assessment of the potential outcomes of these matters involves significant judgment and is subject to change based on future developments.

 

Environmental

 

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.

 

Joint Ventures

 

In connection with our 2005 contribution of properties to an unconsolidated partnership in which we hold a partnership interest, we entered into standard nonrecourse loan guarantees (environmental indemnifications and guarantees against fraud and misrepresentation, and springing guarantees of partnership debt in the event of a voluntary bankruptcy of the partnership).  The maximum amount we could be required to pay under the guarantees is approximately $65 million.  We are entitled to recover 20% of any amounts paid under the guarantees from an affiliate of our partner pursuant to an indemnity agreement so long as we continue to manage the properties.  In the event that we no longer manage the properties, the percentage that we are entitled to recover is increased to 80%.  Management estimates that the aggregate fair value of the guarantees is not material and would not exceed the amounts included in distributions received in excess of investment in unconsolidated real estate joint venture reported on the consolidated balance sheets.

 

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.  As we and the joint venture partner agree to proceed with the construction of buildings in the future, our joint venture partner would contribute land into newly-formed entities and we would make cash capital contributions into such entities to fund development and construction activities for which financing is not obtained.  We owned a 50% interest in one such joint venture as of March 31, 2012.

 

We may be required 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 deem it appropriate to make even larger investments in these joint ventures.

 

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Tax Incremental Financing Obligation

 

In August 2010, Anne Arundel County, Maryland issued $30 million in tax incremental financing bonds to third-party investors in order to finance public improvements needed in connection with our project known as National Business Park North.  The real estate taxes on increases in assessed value of a development district encompassing National Business Park North are to be transferred to a special fund pledged to the repayment of the bonds.  We recognized a $4.4 million liability through March 31, 2012 representing the estimated fair value of our obligation to fund through a special tax any future shortfalls between debt service on the bonds and real estate taxes available to repay the bonds.

 

Environmental Indemnity Agreement

 

We agreed to provide certain environmental indemnifications in connection with a lease and subsequent sale of three New Jersey properties. 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 environmental indemnification agreement, we agreed to the following:

 

·                  to indemnify the tenant against losses covered under the prior owner’s indemnity agreement if the prior owner fails to indemnify the tenant for such losses.  This indemnification is capped at $5.0 million 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.  This indemnification is limited to $12.5 million; 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 limited to $300,000 annually and $1.5 million in the aggregate.

 

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

 

Overview

 

We are an office real estate investment trust (“REIT”) that focuses primarily on serving the specialized requirements of strategic customers in the United States Government and defense information technology sectors.  We acquire, develop, manage and lease office and data center properties that are typically concentrated in large office parks primarily located adjacent to government demand drivers and/or in office parks that we believe possess growth opportunities.

 

During the three months ended March 31, 2012, we:

 

·                  had an increase in net income attributable to common shareholders of $24.5 million as compared to the three months ended March 31, 2011, due in large part to a decrease in impairment losses attributable primarily to a $27.7 million loss recognized on our property in Cascade, Maryland that was formerly the Army base known as Fort Ritchie (“Fort Ritchie”) in the three months ended March 31, 2011;

·                  had an increase of $3.1 million as compared to the three months ended March 31, 2011 in our net operating income (“NOI”) from real estate operations (defined below) attributable to our Same Office Properties (also defined below);

·                  finished the period with occupancy of our portfolio of operating office properties at 87.0%;

·                  sold eight operating properties totaling 314,000 square feet and non-operating properties for aggregate sale prices totaling $62.7 million.  The net proceeds from these sales were used primarily to pay down our Revolving Credit Facility; and

·                  entered into an unsecured term loan agreement, under which we borrowed $250.0 million.  The term loan agreement matures on February 14, 2017.  The net proceeds from these borrowings were used to pay down our Revolving Credit Facility.

 

We discuss significant factors contributing to changes in our net income attributable to common shareholders and diluted earnings per share over the prior year period in the section below entitled “Results of Operations.” In addition, the section below entitled “Liquidity and Capital Resources” includes discussions of, among other things:

 

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

·                  our commitments and contingencies.

 

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,” “could,” “believe,” “anticipate,” “expect,” “estimate,” “plan” 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:

 

·                  general economic and business conditions, which will, among other things, affect office property and data center demand and rents, tenant creditworthiness, interest rates, financing availability and property values;

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

 

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·                  governmental actions and initiatives, including risks associated with the impact of a government shutdown or budgetary reductions or impasses, such as a reduction in rental revenues, non-renewal of leases and/or a curtailment of demand for additional space by our strategic customers;

·                  our ability to sell properties included in our Strategic Reallocation Plan;

·                  our ability to borrow on favorable terms;

·                  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;

·                  changes in our plans for properties or views of market economic conditions or failure to obtain development rights, either of which could result in recognition of impairment losses;

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

·                  the dilutive effects of issuing additional common shares; and

·                  environmental requirements.

 

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

 

Occupancy and Leasing

 

Office Properties

 

The tables below set forth occupancy information pertaining to our portfolio of operating office properties:

 

 

 

March 31,

 

December 31,

 

 

 

2012

 

2011

 

Occupancy rates at period end

 

 

 

 

 

Total

 

87.0

%

86.2

%

Baltimore/Washington Corridor

 

87.6

%

87.9

%

Northern Virginia

 

86.4

%

84.8

%

San Antonio

 

96.5

%

90.7

%

Washington, DC - Capitol Riverfront

 

89.0

%

89.6

%

St. Mary’s and King George Counties

 

88.4

%

87.3

%

Greater Baltimore

 

86.1

%

84.5

%

Suburban Maryland

 

79.6

%

79.6

%

Colorado Springs

 

77.0

%

74.9

%

Greater Philadelphia

 

99.7

%

99.7

%

Other

 

100.0

%

100.0

%

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

 

$

26.95

 

$

26.59

 

 


(1) Includes estimated expense reimbursements.

 

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Rentable

 

Occupied

 

 

 

Square Feet

 

Square Feet

 

 

 

(in thousands)

 

December 31, 2011

 

20,514

 

17,685

 

Square feet vacated upon lease expiration (1)

 

 

(199

)

Square feet retenanted after lease expiration (2)

 

 

224

 

Square feet constructed or redeveloped

 

48

 

79

 

Dispositions

 

(314

)

(176

)

Other changes

 

(12

)

(8

)

March 31, 2012

 

20,236

 

17,605

 

 


(1) Includes lease terminations and space reductions occurring in connection with lease renewals.

(2) Excludes retenanting of vacant square feet acquired or developed.

 

Wholesale Data Center Property

 

Our shell-complete wholesale data center property, which upon completion and stabilization is expected to have a critical load of 18 megawatts, had three megawatts in operations at March 31, 2012 and December 31, 2011 that was leased to tenants with further expansion rights of up to a combined five megawatts.  We did not complete any leases on this property during the three months ended March 31, 2012.

 

Results of Operations

 

We evaluate the operating performance of our properties using NOI from real estate operations, our segment performance measure which is derived by subtracting property operating expenses from revenues from real estate operations.  We view our NOI from real estate operations as comprising the following primary categories of operating properties:

 

·                  office properties owned and 100% operational throughout the current and prior year reporting periods, excluding properties included in the Strategic Reallocation Plan.  We define these as changes from “Same Office Properties”

·                  office properties acquired during the current and prior year reporting periods;

·                  constructed office properties placed into service that were not 100% operational throughout the current and prior year reporting periods; and

·                  properties included in the Strategic Reallocation Plan that were not sold as of March 31, 2012; and

·                  property dispositions.

 

Refer to Note 13 of the consolidated financial statements for a summary of operating properties that were either disposed or classified as held for sale and therefore are included in discontinued operations.

 

The primary manner in which we evaluate the operating performance of our construction management and other service activities is through a measure we define as NOI from service operations, which is based on the net of the revenues and expenses from these activities.  The revenues and expenses from these activities consist primarily of subcontracted costs that are reimbursed to us by customers along with a management fee.  The operating margins from these activities are small relative to the revenue.  We believe NOI from service operations is a useful measure in assessing both our level of activity and our profitability in conducting such operations.

 

We believe that operating income, as reported on our consolidated statements of operations, is the most directly comparable generally accepted accounting principles (“GAAP”) measure for both NOI from real estate operations and NOI from service operations.  Since both of these measures exclude certain items includable in operating income, reliance on these measures has limitations; management compensates for these limitations by using the measures simply as supplemental measures that are considered alongside other GAAP and non-GAAP measures.

 

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The table below reconciles NOI from real estate operations and NOI from service operations to operating income reported on our consolidated statement of operations:

 

 

 

For the Three Months

 

 

 

Ended March 31,

 

 

 

2012

 

2011

 

 

 

(in thousands)

 

NOI from real estate operations

 

$

76,917

 

$

72,289

 

NOI from service operations

 

927

 

410

 

NOI from discontinued operations

 

(2,180

)

(2,889

)

Depreciation and amortization associated with real estate operations

 

(31,066

)

(30,043

)

Impairment losses

 

(5,126

)

(27,742

)

General and administrative expense

 

(7,017

)

(6,777

)

Business development expenses and land carry costs

 

(1,594

)

(1,241

)

Operating income

 

$

30,861

 

$

4,007

 

 

Comparison of the Three Months Ended March 31, 2012 to the Three Months Ended March 31, 2011

 

 

 

For the Three Months Ended March 31,

 

 

 

2012

 

2011

 

Variance

 

 

 

(in thousands)

 

Revenues

 

 

 

 

 

 

 

Revenues from real estate operations

 

$

121,939

 

$

116,461

 

$

5,478

 

Construction contract and other service revenues

 

21,534

 

21,028

 

506

 

Total revenues

 

143,473

 

137,489

 

5,984

 

Expenses

 

 

 

 

 

 

 

Property operating expenses

 

47,202

 

47,061

 

141

 

Depreciation and amortization associated with real estate operations

 

31,066

 

30,043

 

1,023

 

Construction contract and other service expenses

 

20,607

 

20,618

 

(11

)

Impairment losses

 

5,126

 

27,742

 

(22,616

)

General and administrative expense

 

7,017

 

6,777

 

240

 

Business development expenses and land carry costs

 

1,594

 

1,241

 

353

 

Total operating expenses

 

112,612

 

133,482

 

(20,870

)

 

 

 

 

 

 

 

 

Operating income

 

30,861

 

4,007

 

26,854

 

Interest expense

 

(25,224

)

(26,115

)

891

 

Interest and other income

 

1,217

 

1,168

 

49

 

Equity in (loss) income of unconsolidated entities

 

(89

)

30

 

(119

)

Income tax (expense) benefit

 

(4,173

)

544

 

(4,717

)

Income (loss) from continuing operations

 

2,592

 

(20,366

)

22,958

 

Discontinued operations

 

4,385

 

(901

)

5,286

 

Gain on sales of real estate, net of income taxes

 

 

2,701

 

(2,701

)

Net income (loss)

 

6,977

 

(18,566

)

25,543

 

Net (income) loss attributable to noncontrolling interests

 

(300

)

776

 

(1,076

)

Preferred share dividends

 

(4,025

)

(4,025

)

 

Net income (loss) attributable to COPT common shareholders

 

$

2,652

 

$

(21,815

)

$

24,467

 

 

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Table of Contents

 

NOI from Real Estate Operations

 

 

 

For the Three Months Ended March 31,

 

 

 

2012

 

2011

 

Variance

 

 

 

(Dollars in thousands, except per square foot data)

 

Revenues

 

 

 

 

 

 

 

Same Office Properties

 

$

104,416

 

$

102,528

 

$

1,888

 

Constructed office properties placed in service

 

4,868

 

2,679

 

2,189

 

Acquired office properties

 

916

 

 

916

 

Strategic Reallocation Plan Properties

 

13,014

 

12,133

 

881

 

Dispositions

 

374

 

3,563

 

(3,189

)

Other

 

1,716

 

1,538

 

178

 

 

 

125,304

 

122,441

 

2,863

 

Property operating expenses

 

 

 

 

 

 

 

Same Office Properties

 

39,590

 

40,753

 

(1,163

)

Constructed office properties placed in service

 

1,441

 

671

 

770

 

Acquired office properties

 

157

 

 

157

 

Strategic Reallocation Plan Properties

 

4,951

 

5,328

 

(377

)

Dispositions

 

197

 

2,442

 

(2,245

)

Other

 

2,051

 

958

 

1,093

 

 

 

48,387

 

50,152

 

(1,765

)

NOI from real estate operations

 

 

 

 

 

 

 

Same Office Properties

 

64,826

 

61,775

 

3,051

 

Constructed office properties placed in service

 

3,427

 

2,008

 

1,419

 

Acquired office properties

 

759

 

 

759

 

Strategic Reallocation Plan Properties

 

8,063

 

6,805

 

1,258

 

Dispositions

 

177

 

1,121

 

(944

)

Other

 

(335

)

580

 

(915

)

 

 

$

76,917

 

$

72,289

 

$

4,628

 

Same Office Properties rent statistics

 

 

 

 

 

 

 

Average occupancy rate

 

89.5

%

90.1

%

-0.6

%

Average straight-line rent per occupied square foot (1)

 

$

5.86

 

$

5.80

 

$

0.06

 

 


(1)         Includes minimum base rents, net of abatements, and lease incentives on a straight-line basis for the three month periods set forth above.

 

The decrease in property operating expenses of Same Office Properties was primarily due to decreases in snow removal and utility expenses resulting from a milder winter in the Mid Atlantic region in the current period.

 

Impairment Losses

 

We recognized the impairment losses described below in the current and prior periods:

 

·                  as described further in Note 4 to the consolidated financial statements, we recognized aggregate net impairment losses in the three months ended March 31, 2012 of $6.6 million (including $1.5 million classified as discontinued operations and $1.1 million in exit costs) on dispositions completed or expected to occur in connection with the Strategic Reallocation Plan; and

·                  as described further in our 2011 Annual Report on Form 10-K, we recognized an impairment loss of $27.7 million on Fort Ritchie in the three months ended March 31, 2011.

 

The table below sets forth impairment losses (recoveries) recognized by property classification:

 

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Three Months Ended

 

 

 

March 31,

 

 

 

2012

 

2011

 

 

 

(in thousands)

 

Operating properties

 

$

11,833

 

$

 

Non-operating properties

 

(5,246

)

27,242

 

Total

 

$

6,587

 

$

27,242

 

 

Income Tax (Expense) Benefit

 

The income tax expense recognized in the current period was due primarily to taxes recognized by our taxable REIT subsidiary in connection with the disposition of a non-operating property under the Strategic Reallocation Plan.

 

Discontinued Operations

 

The increase in discontinued operations was due primarily to $4.1 million in gains on sales of real estate recognized in the current period.

 

Gain on Sales of Real Estate, Net of Income Taxes

 

The decrease in gain on sales of real estate was attributable to our sale of a land parcel in Hunt Valley, Maryland in the prior period.

 

Funds from Operations

 

Funds from operations (“FFO”) is defined as net income computed using GAAP, excluding gains on sales of, and impairment losses on, previously depreciated operating properties, plus real estate-related depreciation and amortization. We believe that we use the National Association of Real Estate Investment Trusts (“NAREIT”) definition of FFO, although others may interpret the definition differently and, accordingly, our presentation of FFO may differ from those of other REITs.  We believe that FFO is useful to management and investors as a supplemental measure of operating performance because, by excluding gains related to sales of, and impairment losses on, previously depreciated operating properties, net of related tax benefit, 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.

 

Basic FFO available to common share and common unit holders (“Basic FFO”) is FFO adjusted to subtract (1) preferred share dividends, (2) income attributable to noncontrolling interests through ownership of preferred units in the Operating Partnership or interests in other consolidated entities not owned by us, (3) depreciation and amortization allocable to noncontrolling interests in other consolidated entities and (4) Basic FFO allocable to restricted shares.  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

 

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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 FFO available to common share and common unit holders (“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.  We believe that Diluted FFO is useful to investors because it is the numerator used to compute Diluted FFO per share, discussed below.  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.

 

Diluted FFO, as adjusted for comparability is defined as Diluted FFO adjusted to exclude operating property acquisition costs, gains on sales of, and impairment losses on, properties other than previously depreciated operating properties, net of associated income tax, gain or loss on early extinguishment of debt and loss on interest rate swaps.  We believe that the excluded items are not reflective of normal operations and, as a result, we believe that a measure that excludes these items is a useful supplemental measure in evaluating our operating performance.  We believe that the numerator to diluted EPS is the most directly comparable GAAP measure to this non-GAAP measure.  This measure has essentially the same limitations as Diluted FFO, as well as the further limitation of not reflecting the effects of the excluded items; we compensate for these limitations in essentially the same manner as described above for Diluted FFO.

 

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.  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 that 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.

 

Diluted FFO per share, as adjusted for comparability is (1) Diluted FFO, as adjusted for comparability 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.  We believe that this measure is useful to investors because it provides investors with a further context for evaluating our FFO results.  We believe that diluted EPS is the most directly comparable GAAP measure to this per share measure.  This measure has most of the same limitations as Diluted FFO (described above) as well as the further limitation of not reflecting the effects of the excluded items; we compensate for these limitations in essentially the same manner as described above for Diluted FFO.

 

The computations for all of the above measures on a diluted basis assume the conversion of common units in our Operating Partnership but do not assume the conversion of other securities that are convertible into common shares if the conversion of those securities would increase per share measures in a given period.

 

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Table of Contents

 

The table below sets forth the computation of the above stated measures for the three months ended March 31, 2012 and 2011 and provides reconciliations to the GAAP measures associated with such measures:

 

 

 

For the Three Months

 

 

 

Ended March 31,

 

 

 

2012

 

2011

 

 

 

(Dollars and shares in
thousands, except per
share data)

 

Net income (loss)

 

$

6,977

 

$

(18,566

)

Add: Real estate-related depreciation and amortization

 

31,087

 

33,020

 

Add: Depreciation and amortization on unconsolidated real estate entities

 

114

 

119

 

Add: Impairment losses on previously depreciated operating properties

 

11,833

 

 

Less: Gain on sales of previously depreciated operating properties, net of income taxes

 

(4,138

)

 

FFO

 

45,873

 

14,573

 

Less: Noncontrolling interests-preferred units in the Operating Partnership

 

(165

)

(165

)

Less: Noncontrolling interests-other consolidated entities

 

24

 

(538

)

Less: Preferred share dividends

 

(4,025

)

(4,025

)

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

 

(284

)

(65

)

Basic and Diluted FFO allocable to restricted shares

 

(294

)

(282

)

Basic and Diluted FFO

 

$

41,129

 

$

9,498

 

Operating property acquisition costs

 

 

23

 

Gain on sales of non-operating properties, net of income taxes

 

 

(2,701

)

Impairment (recoveries) losses on other properties

 

(5,246

)

27,742

 

Income tax expense on impairment recoveries on other properties

 

4,642

 

 

Diluted FFO, as adjusted for comparability

 

$

40,525

 

$

34,562

 

 

 

 

 

 

 

Weighted average common shares

 

71,458

 

66,340

 

Conversion of weighted average common units

 

4,281

 

4,396

 

Weighted average common shares/units - Basic FFO

 

75,739

 

70,736

 

Dilutive effect of share-based compensation awards

 

44

 

261

 

Weighted average common shares/units - Diluted FFO

 

75,783

 

70,997

 

 

 

 

 

 

 

Diluted FFO per share

 

$

0.54

 

$

0.13

 

Diluted FFO per share, as adjusted for comparability

 

$

0.53

 

$

0.49

 

 

 

 

 

 

 

Numerator for diluted EPS

 

$

2,511

 

$

(23,576

)

Add: Income allocable to noncontrolling interests-common units in the Operating Partnership

 

159

 

 

Add: Real estate-related depreciation and amortization

 

31,087

 

33,020

 

Add: Depreciation and amortization of unconsolidated real estate entities

 

114

 

119

 

Add: Impairment losses on previously depreciated operating properties

 

11,833

 

 

Add: Numerator for diluted EPS allocable to restricted shares

 

141

 

282

 

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

 

(284

)

(65

)

Less: Basic and diluted FFO allocable to restricted shares

 

(294

)

(282

)

Less: Gain on sales of previously depreciated operating properties, net of income taxes

 

(4,138

)

 

Basic and Diluted FFO

 

$

41,129

 

$

9,498

 

Operating property acquisition costs

 

 

23

 

Gain on sales of non-operating properties, net of income taxes

 

 

(2,701

)

Impairment (recoveries) losses on other properties

 

(5,246

)

27,742

 

Income tax expense on impairment recoveries on other properties

 

4,642

 

 

Diluted FFO, as adjusted for comparability

 

$

40,525

 

$

34,562

 

 

 

 

 

 

 

Denominator for diluted EPS

 

71,458

 

70,736

 

Weighted average common units

 

4,281

 

 

Anti-dilutive EPS effect of share-based compensation awards

 

44

 

261

 

Denominator for diluted FFO per share measures

 

75,783

 

70,997

 

 

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Table of Contents

 

Property Additions

 

The table below sets forth the major components of our additions to properties for the three months ended March 31, 2012 (in thousands):

 

Construction, development and redevelopment

 

$

33,546

 

Tenant improvements on operating properties

 

948

(1)

Capital improvements on operating properties

 

1,694

 

 

 

$

36,188

 

 


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

 

Cash Flows

 

Our net cash flow provided by operating activities increased $10.8 million when comparing the three months ended March 31, 2012 and 2011 due primarily to: an increase in cash flow received from real estate operations, which was affected by the timing of cash receipts; an increase in cash flow associated with the timing of cash flow from third-party construction projects; and $7.0 million in proceeds from the sale of our KEYW common stock in the current period; offset in part by $29.7 million paid to cash settle interest rate swaps in the current period.

 

Our net cash flow provided by investing activities increased $69.2 million when comparing the three months ended March 31, 2012 and 2011 due primarily to a $58.1 million increase from sales of properties.  Property sales in the current period included the disposition of properties in connection with the Strategic Reallocation Plan.  Property sales in the prior period included the disposition of a land parcel in Hunt Valley, Maryland.

 

Our net cash flow used in financing activities increased $80.1 million when comparing the three months ended March 31, 2012 and 2011 due primarily to:

 

·                  a $311.4 million increase in debt repayments.  Our debt repayments in the current period included primarily $337.0 million to pay down our Revolving Credit Facility using mostly proceeds from a new $250.0 million term loan agreement and property sales.  Our debt repayments in the prior period included primarily $25.0 million to pay down our Revolving Credit Facility using mostly proceeds from draws under construction loan facilities; offset in part by

·                  a $233.8 million increase in proceeds from debt.  Our proceeds in the current period included primarily: (1) $250.0 million upon origination of the new term loan agreement; and (2) $71.0 million in draws under our Revolving Credit Facility.  Our proceeds in the prior period included primarily $78.0 million in draws under our Revolving Credit Facility.

 

Liquidity and Capital Resources

 

Our primary cash requirements are for operating expenses, debt service, development of new properties, improvements to existing properties and acquisitions.  We expect to continue to use cash flow provided by operations as the primary source to meeting our short-term capital needs, including property operating expenses, general and administrative expenses, interest expense, scheduled principal amortization of debt, dividends to our shareholders, distributions to our noncontrolling interest holders of preferred and common units in the Operating Partnership and improvements to existing properties.  We believe that our liquidity and capital resources are adequate for our near-term and longer-term requirements without necessitating property sales.  However, we do expect to generate significant cash by selling properties during the remainder of 2012 and in 2013.

 

We have historically relied on fixed-rate, non-recourse mortgage loans from banks and institutional lenders for long-term financing and to restore availability on our Revolving Credit Facility.  In recent years, we have relied more on unsecured bank loans and publicly issued, convertible unsecured debt for long-term

 

36



Table of Contents

 

financing.  We also periodically access the public equity markets to raise capital by issuing common and/or preferred shares.

 

We often use our Revolving Credit Facility to initially finance much of our investing activities.  We then pay down the facility using proceeds from long-term borrowings, equity issuances and property sales.   The lenders’ aggregate commitment under the facility is $1.0 billion, with a right for us to increase the lenders’ aggregate commitment to $1.5 billion, provided that there is no default under the facility.  Amounts available under the facility are computed based on 60% of our unencumbered asset value, as defined in the agreement.  The Revolving Credit Facility matures on September 1, 2014, and may be extended by one year at our option, provided that there is no default under the facility and we pay an extension fee of 0.20% of the total availability of the facility.  As of March 31, 2012, the maximum borrowing capacity under this facility totaled $1.0 billion, of which $590.6 million was available.

 

We also have construction loan facilities that provide for aggregate borrowings of up to $123.8 million, $73.2 million of which was available at March 31, 2012 to fund future construction costs at specific projects.

 

The following table summarizes our contractual obligations as of March 31, 2012 (in thousands):

 

 

 

For the Periods Ending December 31,

 

 

 

 

 

2012

 

2013

 

2014

 

2015

 

2016

 

Thereafter

 

Total

 

Contractual obligations (1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Debt (2)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balloon payments due upon maturity

 

$

52,953

 

$

159,058

 

$

547,681

 

$

804,284

 

$

274,605

 

$

550,621

 

$

 

2,389,202

 

Scheduled principal payments

 

9,854

 

10,285

 

7,099

 

5,738

 

4,037

 

3,258

 

40,271

 

Interest on debt (3)

 

73,345

 

90,753

 

78,032

 

55,371

 

30,891

 

4,562

 

332,954

 

New construction and redevelopment obligations (4)(5)

 

41,582

 

6,746

 

 

 

 

 

48,328

 

Third-party construction and development obligations (5)(6)

 

30,176

 

3,353

 

 

 

 

 

33,529

 

Capital expenditures for operating properties (5)(7)

 

19,393

 

6,464

 

 

 

 

 

25,857

 

Operating leases (8)

 

832

 

1,068

 

986

 

864

 

810

 

70,478

 

75,038

 

Other purchase obligations (9)

 

3,020

 

3,591

 

2,435

 

1,491

 

968

 

233

 

11,738

 

Total contractual cash obligations

 

$

231,155

 

$

281,318

 

$

636,233

 

$

867,748

 

$

311,311

 

$

 

629,152

 

$

 

2,956,917

 

 


(1)          The contractual obligations set forth in this table generally exclude property operations contracts that had a value of less than $20,000.  Also excluded are contracts associated with the operations of our properties that may be terminated with notice of one month or less, which is the arrangement that applies to most of our property operations contracts.

(2)          Represents scheduled principal amortization payments and maturities only and therefore excludes a net discount of $11.4 million.

(3)          Represents interest costs for debt at March 31, 2012 for the terms of such debt.  For variable rate debt, the amounts reflected above used March 31, 2012 interest rates on variable rate debt in computing interest costs for the terms of such debt.

(4)          Represents contractual obligations pertaining to new construction and redevelopment activities.  Construction and redevelopment activities underway at March 31, 2012 included the following:

 

 

 

 

 

 

 

Estimated

 

Expected Year

 

 

 

Number of

 

Square Feet (in

 

Remaining Costs

 

For Costs to be

 

Activity

 

Properties

 

thousands)

 

(in millions)

 

Incurred Through

 

Construction of new office properties

 

6

 

789

 

$

61.2

 

2013

 

Redevelopment of existing office properties

 

1

 

113

 

6.4

 

2013

 

 

(5)          Due to the long-term nature of certain construction and development contracts and leases included in these lines, the amounts reported in the table represent our estimate of the timing for the related obligations being payable.

(6)          Represents contractual obligations pertaining to projects for which we are acting as construction manager on behalf of unrelated parties who are our clients.  We expect to be reimbursed in full for these costs by our clients.

(7)          Represents contractual obligations pertaining to recurring and nonrecurring capital expenditures for our operating properties.  We expect to finance these costs primarily using cash flow from operations.

(8)          We expect to pay these items using cash flow from operations.

 

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Table of Contents

 

(9)          Primarily represents contractual obligations pertaining to managed-energy service contracts in place for certain of our operating properties.  We expect to pay these items using cash flow from operations.

 

We expect to spend more than $150 million on construction and development costs and approximately $70 million on improvements to operating properties (including the commitments set forth in the table above) during the remainder of 2012.  We expect to fund these costs and our debt maturities during the remainder of 2012 using primarily a combination of borrowings under our Revolving Credit Facility and existing construction loan facilities.  We expect to sell more than $130 million of properties during the remainder of 2012 and use the proceeds primarily to pay down our Revolving Credit Facility and pay off debt secured by the properties.

 

Certain of our debt instruments require that we comply with a number of restrictive financial covenants, including maximum leverage ratio, unencumbered leverage ratio, minimum net worth, minimum fixed charge coverage, minimum unencumbered interest coverage ratio, minimum debt service and maximum secured indebtedness ratio.  As of March 31, 2012, we were well within the compliance requirements of these financial covenants.

 

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 2011 Annual Report on Form 10-K.

 

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.

 

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 other variable rate debt.  Increases in interest rates can also result in increased interest expense when our fixed rate debt matures and needs to be refinanced.

 

The following table sets forth as of March 31, 2012 our debt obligations and weighted average interest rates for fixed rate debt by expected maturity date (dollars in thousands):

 

 

 

For the Periods Ending December 31,

 

 

 

 

 

2012

 

2013

 

2014

 

2015

 

2016

 

Thereafter

 

Total

 

Long term debt: (1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed rate debt (2)

 

$

45,426

 

$

144,345

 

$

157,965

 

$

363,595

 

$

278,642

 

$

303,879

 

$

1,293,852

 

Weighted average interest rate

 

6.37

%

5.62

%

6.41

%

4.66

%

6.57

%

5.52

%

5.65

%

Variable rate debt

 

$

17,381

 

$

24,998

 

$

396,815

 

$

446,427

 

$

 

$

250,000

 

$

1,135,621

 

 


(1)          Maturities include $16.8 million during the remainder of 2012, $24.2 million in 2013, $396.0 million in 2014 and $409.6 million in 2015 that may each be extended for one year, subject to certain conditions.

(2)          Represents principal maturities only and therefore excludes net discounts of $11.4 million.

 

The fair market value of our debt was $2.4 billion at March 31, 2012.  If interest rates had been 1% lower, the fair value of our fixed-rate debt would have increased by approximately $78 million at March 31, 2012.

 

The following table sets forth information pertaining to interest rate swap contracts in place as of March 31, 2012 and December 31, 2011 and their respective fair values (dollars in thousands):

 

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Table of Contents

 

 

 

 

 

 

 

 

 

 

 

Fair Value at

 

Notional

 

Fixed

 

Floating Rate

 

Effective

 

Expiration

 

March 31,

 

December 31,

 

Amount

 

Rate

 

Index

 

Date

 

Date

 

2012

 

2011

 

$

50,000

 

0.5025

%

One-Month LIBOR

 

1/3/2011

 

1/3/2012

 

$

 

$

(1

)

50,000

 

0.5025

%

One-Month LIBOR

 

1/3/2011

 

1/3/2012

 

 

(1

)

120,000

 

1.7600

%

One-Month LIBOR

 

1/2/2009

 

5/1/2012

 

(152

)

(552

)

100,000

 

1.9750

%

One-Month LIBOR

 

1/1/2010

 

5/1/2012

 

(144

)

(532

)

100,000

 

0.6123

%

One-Month LIBOR

 

1/3/2012

 

9/1/2014

 

(282

)

55

 

100,000

 

0.6100

%

One-Month LIBOR

 

1/3/2012

 

9/1/2014

 

(277

)

56

 

100,000

 

0.8320

%

One-Month LIBOR

 

1/3/2012

 

9/1/2015

 

(365

)

(66

)

100,000

 

0.8320

%

One-Month LIBOR

 

1/3/2012

 

9/1/2015

 

(363

)

(49

)

39,027

(1)

3.8300

%

One-Month LIBOR

 

11/2/2010

 

11/2/2015

 

(1,090

)

(1,054

)

100,000

(2)

3.8415

%

Three-Month LIBOR

 

9/30/2011

 

9/30/2021

 

 

(16,333

)

75,000

(2)

3.8450

%

Three-Month LIBOR

 

9/30/2011

 

9/30/2021

 

 

(12,275

)

100,000

(2)

2.0525

%

Three-Month LIBOR-Reverse

 

12/30/2011

 

9/30/2021

 

 

345

 

75,000

(2)

2.0525

%

Three-Month LIBOR-Reverse

 

12/30/2011

 

9/30/2021

 

 

260

 

 

 

 

 

 

 

 

 

 

 

$

(2,673

)

$

(30,147

)

 


(1)          The notional amount of this instrument is scheduled to amortize to $36.2 million.

(2)          As described further in our 2011 Annual Report on Form 10-K, on January 5, 2012, we cash settled these instruments, along with interest accrued thereon, for an aggregate of $29.7 million.

 

Based on our variable-rate debt balances, including the effect of interest rate swap contracts, our interest expense would have increased by $1.3 million in the three months ended March 31, 2012 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 March 31, 2012.  Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures as of March 31, 2012 were functioning effectively to provide reasonable assurance that the information required to be disclosed by us 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.

 

39



Table of Contents

 

PART II

 

Item 1.  Legal Proceedings

 

We are not currently involved in any 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

 

There have been no material changes to the risk factors included in our 2011 Annual Report on Form 10-K.

 

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

 

(a)          During the three months ended March 31, 2012, 34,550 of the Operating Partnership’s common units were exchanged for 34,550 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

 

Item 4.  Mine Safety Disclosures

 

Not applicable

 

Item 5.  Other Information

 

None

 

Item 6.  Exhibits

 

(a)       Exhibits:

 

EXHIBIT
NO.

 

DESCRIPTION

 

 

 

10.1

 

Term Loan Agreement, dated as of February 14, 2012, by and among Corporate Office Properties, L.P.; Corporate Office Properties Trust; J.P. Morgan Securities LLC; KeyBanc Capital Markets; KeyBank National Association; JPMorgan Chase Bank, N.A.; Bank of America, N.A.; PNC Bank, National Association; Royal Bank of Canada; and Wells Fargo Bank, National Association (filed herewith).

 

 

 

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).

 

40



Table of Contents

 

EXHIBIT
NO.

 

DESCRIPTION

 

 

 

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

 

 

 

101.INS

 

XBRL Instance Document (furnished herewith).

 

 

 

101.SCH

 

XBRL Taxonomy Extension Schema Document (furnished herewith).

 

 

 

101.CAL

 

XBRL Taxonomy Extension Calculation Linkbase Document (furnished herewith).

 

 

 

101.LAB

 

XBRL Extension Labels Linkbase (furnished herewith).

 

 

 

101.PRE

 

XBRL Taxonomy Extension Presentation Linkbase Document (furnished herewith).

 

 

 

101.DEF

 

XBRL Taxonomy Extension Definition Linkbase Document (furnished herewith).

 

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Table of Contents

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange 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:  April 27, 2012

By:

/s/ Roger A. Waesche, Jr.

 

 

Roger A. Waesche, Jr.

 

 

President and Chief Executive Officer

 

 

 

Date:  April 27, 2012

By:

/s/ Stephen E. Riffee

 

 

Stephen E. Riffee

 

 

Executive Vice President and Chief Financial Officer

 

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