UNITED STATES

SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-Q

(Mark one)

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

For the quarterly period ended                                    March 31, 2003                                                                       

or

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

For the transition period from                                                               to                                                                      

Commission file number 1-14023

Corporate Office Properties Trust

(Exact name of registrant as specified in its charter)

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

ý Yes   oNo

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).
ýYes  o No

On May 9, 2003, 24,001,234 shares of the Company’s Common Shares of Beneficial Interest, $0.01 par value, were issued.

TABLE OF CONTENTS

FORM 10-Q

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PART I: FINANCIAL INFORMATION

ITEM 1. Financial Statements

Corporate Office Properties Trust and Subsidiaries

Consolidated Balance Sheets

(Dollars in thousands)

See accompanying notes to consolidated financial statements.

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Corporate Office Properties Trust and Subsidiaries

Consolidated Statements of Operations

(Dollars in thousands, except per share data)

(unaudited)

See accompanying notes to consolidated financial statements.

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Corporate Office Properties Trust and Subsidiaries

Consolidated Statements of Cash Flows

(Dollars in thousands)

(unaudited)

See accompanying notes to consolidated financial statements.

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Corporate Office Properties Trust and Subsidiaries

Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)

1.         Organization

Corporate Office Properties Trust (“COPT”) and subsidiaries (collectively, the “Company”) is a fully- integrated and self-managed real estate investment trust (“REIT”).  We focus principally on the ownership, management, leasing, acquisition and development of suburban office properties located in select submarkets in the Mid-Atlantic region of the United States.  COPT is qualified as a REIT as defined in the Internal Revenue Code and is the successor to a corporation organized in 1988.  As of March 31, 2003, our portfolio included 112 operating properties, including three owned through joint ventures.

We conduct almost all of our operations through our operating partnership, Corporate Office Properties, L.P. (the “Operating Partnership”), for which we are the managing general partner.  The Operating Partnership owns real estate both directly and through subsidiary partnerships and limited liability companies (“LLCs”).  A summary of our Operating Partnership’s forms of ownership and the percentage of those ownership forms owned by COPT as of March 31, 2003 follows:

The Operating Partnership also owns 100% of Corporate Office Management, Inc. (“COMI”) (together with its subsidiaries defined as the “Service Companies”).  COMI’s consolidated subsidiaries are set forth below:

2.                                    Basis of Presentation

The accompanying unaudited interim Consolidated Financial Statements have been prepared in accordance with the rules and regulations for reporting on Form 10-Q.  Accordingly, certain information and disclosures required by accounting principles generally accepted in the United States for complete Consolidated Financial Statements are not included herein.  These interim financial statements should be read together with the financial statements and notes thereto included in our 2002 Annual Report on Form 10-K.  The interim financial statements on the previous pages reflect all adjustments which we believe are necessary for the fair presentation of our financial position and results of operations for the interim periods presented.  These adjustments are of a normal recurring nature.  The results of operations for such interim periods are not necessarily indicative of the results for a full year.

                We use four different accounting methods to report our investments in entities: the consolidation method, the equity method, the cost method and the financing method.

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Consolidation Method

We use the consolidation method when we own most of the outstanding voting interests in an entity and can control its operations.  This means the accounts of the entity are combined with our accounts.  We eliminate balances and transactions between companies when we consolidate these accounts.  Our Consolidated Financial Statements include the accounts of:

•                  COPT;

•                  the Operating Partnership and its subsidiary partnerships and LLCs;

•                  the Service Companies; and

•                  Corporate Office Properties Holdings, Inc. (of which we own 100%).

See the section in Note 3 entitled “Recent Accounting Pronouncements” for a description of Financial Accounting Standards Board (“FASB”) Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”).  FIN 46 affects our determination of when to use the consolidation method of accounting.

Equity Method

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.  Under the equity method, we report:

•                  our ownership interest in the entity’s capital as an investment on our Consolidated Balance Sheets; and

•                  our percentage share of the earnings or losses from the entity in our Consolidated Statements of Operations.

See the section in Note 3 entitled “Recent Accounting Pronouncements” for a description of FIN 46.  FIN 46 affects our determination of when to use the equity method of accounting.

Cost Method

We use the cost method of accounting when we own an interest in an entity and cannot exert significant influence over the entity’s operations.  Under the cost method, we report:

•                  the cost of our investment in the entity as an investment on our Consolidated Balance Sheets; and

•                  distributions to us of the entity’s earnings in our Consolidated Statements of Operations.

Financing Method

We use the financing method of accounting for certain real estate joint ventures. We use this method when we contribute a parcel of land into a real estate joint venture and have an option to acquire our  partner’s joint venture interest for a pre-determined purchase price.  Details of the financing method of accounting are described below:

•                  the costs associated with a land parcel at the time of its contribution into a joint venture are reported as commercial real estate properties on our Consolidated Balance Sheets;

•                  the cash received from a joint venture in connection with our land contribution is reported as other liabilities on our Consolidated Balance Sheets.  The liability is accreted towards the pre-determined purchase price over the life of our option to acquire our partner’s interest in the joint venture.  We also report interest expense in connection with the accretion of the liability;

•                  as construction of a building on the land parcel is completed and operations of the building commence, we report 100% of the revenues and expenses associated with the property on our Consolidated Statements of Operations; and

•                  construction costs and debt activity for the real estate project relating to periods after the land contribution are not reported by us.

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At the time we exercise the option to acquire our partner’s joint venture interest, we begin consolidating the accounts of the entity with our accounts.  See the section in Note 3 entitled “Recent Accounting Pronouncements” for a description of FIN 46.  FIN 46 affects our determination of when to use the financing method of accounting.

Reclassification

        We reclassified certain amounts from the prior period to conform to the current period presentation of our Consolidated Financial Statements.  These reclassifications did not affect consolidated net income or shareholders’ equity.  See the section in Note 3 entitled “Recent Accounting Pronouncements” for a description of (1) our reclassification in connection with our accounting under Statement of Financial Accounting Standards No. 141, “Business Combinations” (“SFAS 141”) and (2) our reclassification of 2002 losses on early retirement of debt in connection with our adoption of Statement of Financial Accounting Standards No. 145, “Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical Corrections” (“SFAS No. 145”) on January 1, 2003.

3.         Summary of Significant Accounting Policies

Use of Estimates in the Preparation of Financial Statements

We make estimates and assumptions when preparing financial statements under generally accepted accounting principles (“GAAP”).  These estimates and assumptions affect various matters, including:

•                  the reported amounts of assets and liabilities in our Consolidated Balance Sheets at the dates of the financial statements;

•                  the disclosure of contingent assets and liabilities at the dates of the financial statements; and

•                  the reported amounts of revenues and expenses in our Consolidated Statements of Operations during the reporting periods.

These estimates involve judgments with respect to, among other things, future economic factors that are difficult to predict and are often beyond management’s control.  As a result, actual amounts could differ from these estimates.

Minority Interests

As discussed previously, we consolidate the accounts of our Operating Partnership and its subsidiaries into our financial statements.  However, we do not own 100% of the Operating Partnership.  Our Operating Partnership also did not own 11% of one of its subsidiary partnerships until September 11, 2002, when it acquired that remaining interest.  In addition, COMI did not own 20% of one of its subsidiaries, CC&C, until May 31, 2002, when it acquired that remaining interest.  The amounts reported for minority interests on our Consolidated Balance Sheets represent the portion of these consolidated entities’ equity that we do not own.  The amounts reported for minority interests on our Consolidated Statements of Operations represent the portion of these consolidated entities’ net income not allocated to us.

Common units of the Operating Partnership (“common units”) are substantially similar to our common shares of beneficial interest (“common shares”).  Common units are also exchangeable into our common shares, subject to certain conditions.

The only preferred units in the Operating Partnership not owned by us during the reporting periods were 1,016,662 Series C Preferred Units.

Earnings Per Share (“EPS”)

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

•                  the denominator is increased to include 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

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•                  the numerator is adjusted to add back any convertible preferred dividends and any other changes in income or loss that would result from the assumed conversion into common shares.

Our computation of diluted EPS does not assume conversion of securities into our common shares if conversion of those securities would increase our diluted EPS in a given year.  A summary of the numerator and denominator for purposes of basic and diluted EPS calculations is set forth below (dollars and shares in thousands, except per share data):

Our diluted EPS computation for the three months ended March 31, 2003 only assumes conversion of share options and Series D Cumulative Convertible Redeemable Preferred Shares of beneficial interest (the “Series D Preferred Shares”) because conversions of preferred units, common units and vesting of restricted common shares would increase diluted EPS in that year.  Our diluted EPS computation for the three months ended March 31, 2002 only assumes conversion of share options because conversions of Series D Preferred Shares, preferred units, common units and vesting of restricted common shares would increase diluted EPS in that year.

Stock-Based Compensation

We and the Service Companies recognize expense from share options issued to employees using the intrinsic value method.  As a result, we do not record compensation expense for share option grants except as set forth below:

•                  When the exercise price of a share option grant is less than the market price of our common shares on the option grant date, we recognize compensation expense equal to the difference between the exercise price and the grant-date market price; this compensation expense is recognized over the service period to which the options relate.

•                  In 1999, we reduced the exercise price of 360,500 share options from $9.25 to $8.00.  We recognize compensation expense on the share price appreciation and future vesting associated with the re-priced share options.  As of March 31, 2003, 7,700 of these shares options were outstanding.

•                  We recognize compensation expense on share options granted to employees of CRM and CC&C prior to January 1, 2001 equal to the difference between the exercise price of such share options and the market price of our common shares on January 1, 2001, to the extent such amount relates to service periods remaining after January 1, 2001.

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We grant common shares subject to forfeiture restrictions to certain employees.  We recognize compensation expense for such grants over the service periods to which the grants relate.  We compute compensation expense for common share grants based on the value of such grants, as determined by the value of our common shares on the applicable measurement date, as defined below:

•                  When forfeiture restrictions on grants only require the recipient to remain employed by us over defined periods of time for such restrictions to lapse, the measurement date is the date the shares are granted.

•                  When forfeiture restrictions on grants require (1) that the recipient remain employed by us over defined periods of time and (2) that the Company meet certain performance criteria for such restrictions to lapse, the measurement date is the date that the performance criteria are deemed to be met.

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

•                  an increase in general and administrative expenses of $39 in the three months ended March 31, 2003 and  $115 in the three months ended March 31, 2002; and

•                  an increase in our losses from service operations of $8 in the three months ended March 31, 2003 and a decrease in our losses from service operations of $36 in the three months ended March 31, 2002.

The following table summarizes our operating results as if we elected to account for our stock-based compensation under the fair value provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation:”

The stock-based compensation expense under the fair value method, as reported in the above table, was computed using the Black-Scholes option-pricing model.

Recent Accounting Pronouncements

On July 1, 2001, we adopted SFAS 141.  SFAS 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001.  SFAS 141 also requires upon the acquisition of operating real estate that value be assigned to in-place operating leases.  The effect of SFAS 141 on the Company’s accounting for in-place operating leases is as follows:

•                  Value is assigned to in-place operating leases to the extent that the future cash flows under the contractual lease terms are above or below market at the time of acquisition.  For example, if we acquire a property and the leases in place for that property carry rents below the market rent for such leases at the time of acquisition, we classify the amount equal to the difference as deferred revenue and increase the amount of the acquisition classified as investment in real estate.  Conversely, if the leases in place for that property carry rents above the market rent, we classify the amount equal to the

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difference as a deferred asset, and decrease the amount of the acquisition classified as investment in real estate.  Deferred revenue or deferred assets recorded in connection with in-place operating leases of acquired properties are amortized into rental revenue over the lives of the leases.

•                  Value is assigned to the deemed cost avoidance of acquiring in-place operating leases.  For example, when a new lease is entered into, the lessor typically incurs a number of origination costs in connection with the leases; such costs include tenant improvements and leasing costs.  When a property is acquired with in-place leases, the origination costs for such leases were already incurred by the prior owner.  Therefore, to recognize the value of these costs in recording a property acquisition, we assign value to the tenant improvements and leasing costs associated with the remaining term of in-place operating leases.  The value assigned reduces the amount of the acquisition attributable to the base building’s acquisition cost.  The value assigned to the tenant improvements and leasing costs is depreciated or amortized over the lives of the leases.  Since the depreciation period for tenant improvements and amortization period for leasing costs is less than the depreciation period attributable to a base building’s acquisition cost, the effect of SFAS 141 is to increase depreciation and amortization expense until the tenant improvements and leasing costs have been fully depreciated or amortized, and to decrease depreciation and amortization expense afterwards.

We reclassified certain items in connection with our accounting under SFAS 141 in the quarter ended March 31, 2003.  The primary effects of the reclassification to our Consolidated Financial Statements were as follows:

•                  since the in-place leases of properties acquired since July 1, 2001 were on average at below market rents, the application of SFAS 141 resulted in our recording of net deferred revenue; and

•                  we recognized additional rental revenue in 2002 associated with the amortization of the deferred revenue described above and recognized offsetting depreciation and amortization expense on tenant improvements and leasing costs associated with in-place leases.

We are changing our presentation of the effects of SFAS 141 on the results of operations by reclassifying the depreciation of tenant improvements and amortization of leasing costs associated with in-place operating leases of acquired properties from rental revenue to depreciation and amortization expense.  We believe that the revised presentation of the results of operations more closely reflects the economic substance of an acquisition transaction.  This change in classification increases rental revenues for the periods reported, with an offsetting increase to depreciation and amortization expense.  The reclassification described above changes certain financial statements line items in the Consolidated Financial Statements, as well as certain presentations of operating results and measures of performance that include rental revenue but exclude depreciation and amortization expense, that appear in our previous filings pertaining to 2002.  However, such changes do not affect net income, EPS or net cash flows.  Additional revenue recognized pursuant to these reclassifications under SFAS 141 totaled $549 for the three months ended March 31, 2003 and $226 for the three months ended March 31, 2002.

On January 1, 2003, we adopted SFAS 145.   SFAS 145 generally eliminates the requirement that gains and losses from the retirement of debt be aggregated and, if material, classified as an extraordinary item, net of the related income tax effect.  SFAS 145 also eliminates previously existing inconsistencies between the accounting for sale-leaseback transactions and certain lease modifications that have economic effects similar to those of sale-leaseback transactions.  Certain aspects of the standard were effective for certain types of transactions occurring after May 15, 2002, although we had no such types of transactions.  Upon adoption, we reclassified all prior period losses on early retirement of debt from the line on the Consolidated Statements of Operations entitled “extraordinary item” to the line entitled “amortization of deferred financing costs.”  These reclassifications did not result in changes to net income available to common shareholders or basic and diluted EPS on net income available to common shareholders.  Losses from retirement of debt reclassified for the three months ended March 31, 2002 totaled $42.

On January 1, 2003, we adopted FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (“FIN 45”) on a prospective basis for guarantees issued or modified after December 31, 2002.  FIN 45 clarifies the requirements of Statements of Financial Accounting Standards No. 5, “Accounting for Contingencies,” relating to a guarantor’s accounting for, and disclosure of, the issuance of certain types of guarantees.  It requires that a guarantor recognize a liability for the fair value of the obligation it assumes under that guarantee.   Since our adoption of FIN 45’s provisions was prospective, we were not affected for our guarantees previously in place.  However, since we expect to continue to enter into guarantee arrangements covered within the scope of FIN 45 as we have in the past, we will be affected in the future primarily by having to record liabilities associated with such arrangements.

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In January 2003, the FASB issued FIN 46.  FIN 46 provides guidance in identifying situations in which an entity is controlled by its owners without such owners owning most of the outstanding voting rights in the entity; it defines the entity in such situations as a variable interest entity (“VIE”).  Situations identified by FIN 46 include when the equity owners do not have the characteristics of controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties.  FIN 46 then provides guidance in determining when an owner of a VIE should use the consolidation method in accounting for its investment in the VIE.  It also provides for additional disclosure requirements for certain owners of VIEs.  We will adopt FIN 46 on July 1, 2003 for VIEs created before February 1, 2003 and immediately for all subsequently created VIEs, although we were required to adopt certain disclosure requirements for purposes of these Consolidated Financial Statements.  While we are currently reviewing the provisions of FIN 46 and assessing the impact upon adoption, it is likely that we will need to begin using the consolidation method of accounting for certain of our unconsolidated real estate joint venture investments.  See Note 5 for disclosures pertaining to our unconsolidated real estate joint ventures.

4.         Commercial Real Estate Properties

Operating properties consisted of the following:

At December 31, 2002, we were negotiating the saleof our office property and adjacent undeveloped land parcels located in Oxon Hill, Maryland.  As a result, these properties were classified as held for sale.  The components associated with these properties at December 31, 2002 included the following:

We sold these properties on March 31, 2003.

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

2003 Acquisitions

On January 24, 2003, we completed the first phase of a $29.8 million, 108-acre land parcel acquisition from an affiliate of Constellation Real Estate, Inc. (“Constellation”).  The land parcel is located in an office park that we own in Annapolis Junction, Maryland.  The first phase was acquired for $21,339, of which $18,433 was financed by a seller-provided mortgage loan bearing interest at 3%.  Since we considered the interest rate on this loan to be below the market rate for similar loans, we discounted the recorded amounts for the acquisition and mortgage loan by $1,516.  Under an agreement that terminated on March 5, 2002, Constellation nominated two members for election to our Board of Trustees; these

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members still served on our Board of Trustees as of March 31, 2003.  The terms of the land parcel acquisition were determined as a result of arms-length negotiations.  In management’s opinion, the resulting terms reflected fair value for the property based on management’s knowledge and experience in the real estate market.

On March 4, 2003, we acquired an office building located in Annapolis, Maryland totaling approximately 155,000 square feet for $18,036.

2003 Construction/Development

During the three months ended March 31, 2003, a 123,743 square foot building that was partially operational at December 31, 2002 became 100% operational.  The building is located in Columbia, Maryland.

2003 Dispositions

On January 31, 2003, we contributed a developed land parcel into a real estate joint venture called NBP 220, LLC (“NBP 220”) and subsequently received a $4,000 distribution.  Upon completion of this transaction, we owned a 20% interest in NBP 220.  We have the option to acquire our joint venture partner’s interest between September 1, 2004 and February 28, 2005 or prior to that date if certain events defined in the agreement were to occur.  The minimum purchase price would be $4,911.  We account for our interest in this joint venture using the financing method of accounting, which is discussed in Note 2 above.  Our commitments and contingencies pertaining to NBP 220 are included in Note 16.

On March 14, 2003, we contributed a 157,394 square foot office building located in Fairfield, New Jersey into a real estate joint venture called Route 46 Partners, LLC and subsequently received a $19,960 distribution.  Upon completion of this transaction, we owned a 20% interest in the joint venture.  Our joint venture partner has preference in receiving distributions of cash flows for a defined return; once our partner receives its defined return, we are entitled to receive distributions for a defined return and, once we receive that return, remaining distributions of cash flows are allocated based on percentages defined in the joint venture agreement.  Due primarily to a $3,300 loan we made to an affiliate of our joint venture partner as part of the transaction, we deferred a gain of $1,414 on this transaction.  See Notes 5 and 16 for further disclosures related to this joint venture.

On March 31, 2003, we sold an office property totaling 181,768 square feet and two adjacent land parcels located in Oxon Hill, Maryland, for a total purchase price of $21,288.  We recognized a total gain of $3,387 on this sale.

5.                                    Investments in and Advances to Unconsolidated Real Estate Joint Ventures

Our investments in and advances to unconsolidated real estate joint ventures accounted for using the equity method of accounting included the following:

(1)         This joint venture’s property is located in Columbia, Maryland.

(2)         This joint venture’s property is located in Annapolis Junction, Maryland.

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

(4)         This joint venture’s property is located in Lanham, Maryland.

(5)         Derived from the sum of our investment balance, loan guarantees (based on maximum loan balance) and maximum additional unilateral capital contributions required from us.  Not reported above are additional amounts that we and our partners are required to fund when needed by these joint ventures; these funding requirements are proportional to our ownership percentage, except in the case of NBP 140, LLC, in which we are required to fund 50% of additional fundings.

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Our commitments and contingencies pertaining to our unconsolidated real estate joint ventures are disclosed in Note 16.

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

As discussed in Note 3, we are currently reviewing the provisions of FIN 46 and assessing the impact upon our adoption, but it is likely that we will need to begin using the consolidation method of accounting for certain of our unconsolidated real estate joint venture investments.

6.         Accounts Receivable

Our accounts receivable are reported net of an allowance for bad debts of $1,207 at March 31, 2003 and $767 at December 31, 2002.

7.         Investments in and Advances to Other Unconsolidated Entities

Our investments in and advances to other unconsolidated entities include the following:

(1)   TractManager, Inc. has developed an Internet-based contract imaging and management
system for sale to real estate owners and healthcare providers.

8.         Deferred Charges

Deferred charges consisted of the following:

(1)   Includes accumulated amortization associated with other intangibles of $151 at March 31, 2003 and December 31, 2002.

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9.         Derivatives

The following table sets forth our derivative contracts and their respective fair values:

We have designated each of these derivatives as cash flow hedges.  These derivatives hedge the risk of changes in interest rates on certain of our one-month LIBOR-based variable rate borrowings.  At March 31, 2003, our outstanding interest rate swaps were considered highly effective cash flow hedges under Statement of Financial Accounting Standards 133, “Accounting for Derivative Instruments and Hedging Activities.”

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

^{(1)                   AOCL is defined below.}

^{(2)                   Represents hedge ineffectiveness and is included in tenant recoveries and other revenue}

^{on our Consolidated Statements of Operations}

Over time, the unrealized losses associated with interest rate swaps that are held in the accumulated other comprehensive loss component of shareholders’ equity (“AOCL”) and minority interests will be reclassified to earnings as interest payments occur on our LIBOR-based borrowings.

10.                            Shareholders’ Equity

Common Shares

In January 2003, we issued 86,724 common shares to certain employees; these shares are subject to forfeiture restrictions that lapse annually throughout their respective terms provided that the employees remain employed by us.

During the three months ended March 31, 2003, forfeiture restrictions lapsed on 41,407 common shares issued to officers.

We issued 72,922 common shares in connection with the exercise of share options during the three months ended March 31, 2003.

A summary of the activity in the AOCL component of shareholders’ equity for the three months ended March 31, 2003 follows:

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11.       Dividends and Distributions

The following table summarizes our dividends and distributions for the three months ended March 31, 2003:

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12.                            Supplemental Information to Statements of Cash Flows

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13.                            Information by Business Segment

We have six primary office property segments: Baltimore/Washington Corridor, Northern Virginia, Greater Philadelphia, Northern/Central New Jersey, Greater Harrisburg and Surburban Maryland.

The table below reports segment financial information.  Our segment entitled “Other” includes assets and operations not specifically associated with the other defined segments.  We measure the performance of our segments based on total revenues less property operating expenses, a measure we define as net operating income (“NOI”).  We believe that NOI is an important supplemental measure of operating performance for a REIT’s operating real estate because it provides a measure of the core operations that is unaffected by depreciation, amortization, financing and general and administrative expenses; this measure is particularly useful in our opinion in evaluating the performance of geographic segments, same-office property groupings and individual properties.

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The following table reconciles our NOI for reportable segments to income before income taxes and discontinued operations as reported in our Consolidated Statements of Operations:

We did not allocate gain on sales of real estate, interest expense, amortization of deferred financing costs and depreciation and other amortization to segments since they are not included in the measure of segment profit reviewed by management.  We also did not allocate equity in (loss) income of unconsolidated real estate joint ventures, losses from service operations, general and administrative expense and minority interests since these items represent general corporate items not attributable to segments.

14.       Income Taxes

COMI’s provision for income tax benefit consists of the following:

Items contributing to temporary differences that lead to deferred taxes include depreciation and amortization, certain accrued compensation, compensation made in the form of contributions to a deferred nonqualified compensation plan and expenses associated with stock-based compensation.

COMI’s combined Federal and state effective tax rate for the three months ended March 31, 2003 and 2002 was approximately 40%.

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15.       Discontinued Operations

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

16.       Commitments and Contingencies

In the normal course of business, we are involved in legal actions arising from our ownership and administration of properties.  Management does not anticipate that any liabilities that may result will have a materially adverse effect on our financial position, operations or liquidity. We are subject to various Federal, state and local environmental regulations related to our property ownership and operation.  We have performed environmental assessments of our properties, the results of which have not revealed any environmental liability that we believe would have a materially adverse effect on our financial position, operations or liquidity.

At March 31, 2003, we were under contract to acquire from Constellation the second phase of a 108-acre land purchase for a minimum purchase price of $8,881.  We expect to acquire this parcel by the middle of 2003.

Joint Ventures

In the event that costs to complete construction of buildings owned by two of our joint ventures exceed amounts funded by credit facilities and member investments previously made, we will be responsible for making additional investments in these joint ventures of up to $8,500.  We do not expect that such contributions will be necessary.

We may be required to make additional unilateral capital contributions to Route 46 Partners, LLC of up to $320 to fund our partners’ preferred return; we do not expect that such contributions will be necessary.  We may also be required to fund leasing commissions associated with leasing space in this joint venture’s building to the extent such commissions exceed a defined amount; we do not expect that any such funding, if required, will be material to us.

We may need to make our share of additional investments in our real estate joint ventures (generally based on our percentage ownership) in the event that additional funds are needed.  In the event that the other members of these joint ventures do not pay their share of investments when additional funds are needed, we may then need to make even larger investments in these joint ventures.

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As of March 31, 2003, we served as guarantor for the repayment of mortgage loans totaling $11,685 for certain of our unconsolidated real estate joint ventures in the event that the joint ventures default on the payment of such loans.  The maturity dates of these loans range from May 2003 to November 2004.

In four of our unconsolidated real estate joint ventures owned as of March 31, 2003, we would be obligated to acquire the other members’ interest in each of the joint ventures (20% in the case of three and 50% in the case of one) in the event that all of the following were to occur:

(1)          an 18-month period passes from the date of completion of the shell of the final building to be constructed by the joint venture;

(2)          at the end of the 18-month period, the aggregate leasable square footage of the joint venture’s buildings is 90% leased and occupied by tenants who are not in default under their leases; and

(3)          six months pass from the end of the 18-month period and either the buildings have not been sold or we have not acquired the other members’ interest.

The amount we would need to pay for those membership interests is computed based on the amount that the owners of those interests would receive under the joint venture agreements in the event that the buildings were sold for a capitalized fair value (as defined in the agreements) on a defined date.  As of March 31, 2003, none of the four real estate joint ventures had completed the shell construction on their final building.  We estimate the aggregate amount we would need to pay for our partners’ membership interests in these joint ventures to be $2.1 million; however, since the determination of this amount is dependent on the operations of the properties and none of these properties are both completed and occupied, this estimate is preliminary and could be materially different from the actual obligation.

We would be required to acquire the other members’ interests in NBP 140, LLC and NBP 220, LLC in the event that the joint ventures default on their obligations as landlords or do not meet established construction completion timeframes.  The minimum amount we would need to acquire these membership interests is $10,262 at March 31, 2003.

Operating Leases

We are obligated under five operating leases for office space.  Future minimum rental payments due under the terms of these leases as of March 31, 2003 were as follows:

Land Leases

We are obligated under leases for two parcels of land; we have a building located on one of these parcels and the other parcel is being developed.  These leases provide for monthly rent on one parcel through March 2098 and the other through September 2099.  Future minimum annual rental payments due under the terms of these leases as of March 31, 2003 were as follows:

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Vehicle Leases

We are obligated under various leases for vehicles.  Future minimum annual rental payments due under the terms of these leases as of March 31, 2003 were as follows:

17.                            Pro Forma Financial Information (Unaudited)

We accounted for our 2002 and 2003 acquisitions of consolidated entities using the purchase method of accounting.  We included the results of operations for the acquisitions in our Consolidated Statements of Operations from their respective purchase dates through March 31, 2003.

We prepared our pro forma condensed consolidated financial information presented below as if all of our 2002 and 2003 acquisitions and dispositions involving operating properties had occurred on January 1, 2002.  The pro forma financial information is unaudited and is not necessarily indicative of the results that actually would have occurred if these acquisitions and dispositions had occurred on January 1, 2002, nor is it intended to indicate our results of operations for future periods.

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

In this section, we discuss our financial condition and results of operations for the three months ended March 31, 2003.  This section includes discussions on, among other things:

•                  why various components of our Consolidated Statements of Operations changed for the three months ended March 31, 2003 compared to the same period in 2002;

•                  what our primary sources and uses of cash were in the three months ended March 31, 2003;

•                  how we raised cash for acquisitions and other capital expenditures during the three months ended March 31, 2003;

•                  significant changes since December 31, 2002 in our off-balance sheet arrangements in place that are reasonably likely to affect our financial condition, results of operations and liquidity;

•                  how we intend to generate cash for short- and long-term capital needs; and

•                  the computation of our funds from operations.

You should refer to our Consolidated Financial Statements and “Operating Data Variance Analysis” table set forth below as you read this section.

This section contains “forward-looking” statements, as defined in the Private Securities Litigation Reform Act of 1995, that are based on our current expectations, estimates and projections about future events and financial trends affecting the financial condition and operations of our business.  Forward-looking statements can be identified by the use of words such as “may,” “will,” “should,” “expect,” “estimate” or other comparable terminology.  Forward-looking statements are inherently subject to risks and uncertainties, many of which we cannot predict with accuracy and some of which we might not even anticipate.  Although we believe that the expectations, estimates and projections reflected in such forward-looking statements are based on reasonable assumptions at the time made, we can give no assurance that these expectations, estimates and projections will be achieved.  Future events and actual results may differ materially from those discussed in the forward-looking statements.  Important factors that may affect these expectations, estimates and projections include, but are not limited to: our ability to borrow on favorable terms; general economic and business conditions, which will, among other things, affect office property demand and rents, tenant creditworthiness, interest rates and financing availability; adverse changes in the real estate markets including, among other things, increased competition with other companies; risks of real estate acquisition and development, 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 or 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; governmental actions and initiatives; and environmental requirements.  We undertake no obligation to update or supplement forward-looking statements.

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Corporate Office Properties Trust

Operating Data Variance Analysis

(Dollars for this table are in thousands, except per share data)

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Results of Operations

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

Comparison of the three months ended March 31, 2003 and 2002

We believe that the economic slowdown in the United States affected our property operations by decreasing occupancy in certain of our properties, which in turn led to decreased revenues in those properties.  Occupancy in our portfolio decreased from 93.9% at March 31, 2002, to 93.0% at December 31, 2002 to 90.8% at March 31, 2003; this decrease was felt most in our Baltimore/Washington Corridor properties, where occupancy decreased from 92.8% at March 31, 2002, to 91.3% at December 31, 2002 to 87.5% at March 31, 2003.  Lower occupancy rates and the resulting increased competition for tenants in our operating regions placed downward pressure on rental rates in most of these regions, a trend that will affect us further as we attempt to lease vacant space and renew leases scheduled to expire on occupied space.  Our rate of tenant renewals for square footage associated with expiring leases decreased from 56.7% for the three months ended March 31, 2002 to 37.4% for the three months ended March 31, 2003.  Our exposure to continued pressure on occupancy and rental rates in the short term is reduced somewhat by the fact that as of March 31, 2003, leases on only 19% of our occupied square feet were scheduled to expire by the end of 2004.

We believe that the economic slowdown adversely affected a number of our tenants during the year.  Bad debt expense increased $323,000 ($241,000 of which related to one tenant) for the three months ended March 31, 2003 compared to the three months ended March 31, 2002.  Magellan Health Services, Inc. (“Magellan”), a tenant in 150,622 square feet in two of our buildings, filed for Chapter 11 bankruptcy protection during the quarter; Magellan’s leases for these spaces expire on October 31, 2003 and August 31, 2004, although we were negotiating their renewal since Magellan was current in making payments under these leases through March 31, 2003.  We also had several other tenants who were current in fulfilling their lease obligations as of March 31, 2003 that we believe could encounter financial difficulties in the foreseeable future.  However, the economic slowdown has not had a materially adverse effect on the timing of our accounts receivable collections; while our accounts receivable balance increased from $3.5 million at December 31, 2002 to $7.6 million at March 31, 2003, most of this increase is attributable to large construction billings to tenants that took place prior to the end of the period.

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We experienced changes in our tenant base during the three months ended March 31, 2003 due to leasing activity.  The following schedule lists our twenty largest tenants based on annualized rental revenue (defined below) as of March 31, 2003: