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, 2011
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, 2011, 67,104,034 of the Company’s Common Shares of Beneficial Interest, $0.01 par value, were issued and outstanding.
TABLE OF CONTENTS
PAGE
PART I: FINANCIAL INFORMATION
Item 1:
Financial Statements:
Consolidated Balance Sheets as of March 31, 2011 and December 31, 2010 (unaudited)
3
Consolidated Statements of Operations for the Three Months Ended March 31, 2011 and 2010 (unaudited)
4
Consolidated Statements of Equity for the Three Months Ended March 31, 2011 and 2010 (unaudited)
5
Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2011 and 2010 (unaudited)
6
Notes to Consolidated Financial Statements (unaudited)
8
Item 2:
Management’s Discussion and Analysis of Financial Condition and Results of Operations
26
Item 3:
Quantitative and Qualitative Disclosures About Market Risk
36
Item 4:
Controls and Procedures
37
PART II: OTHER INFORMATION
Legal Proceedings
Item 1A:
Risk Factors
38
Unregistered Sales of Equity Securities and Use of Proceeds
Defaults Upon Senior Securities
Removed and Reserved
Item 5:
Other Information
Item 6:
Exhibits
39
SIGNATURES
40
2
ITEM 1. Financial Statements
Corporate Office Properties Trust and Subsidiaries
Consolidated Balance Sheets
(Dollars in thousands)
(unaudited)
March 31,
December 31,
2011
2010
Assets
Properties, net:
Operating properties, net
$
2,819,096
2,802,773
Properties under construction or development
649,675
642,682
Total properties, net
3,468,771
3,445,455
Cash and cash equivalents
12,606
10,102
Restricted cash and marketable securities
24,094
22,582
Accounts receivable (net of allowance for doubtful accounts of $2,752 and $2,796, respectively)
19,765
18,938
Deferred rent receivable
82,901
79,160
Intangible assets on real estate acquisitions, net
106,444
113,735
Deferred leasing and financing costs, net
60,479
60,649
Prepaid expenses and other assets
90,749
93,896
Total assets
3,865,809
3,844,517
Liabilities and equity
Liabilities:
Debt, net
2,396,795
2,323,681
Accounts payable and accrued expenses
103,043
99,699
Rents received in advance and security deposits
29,427
31,603
Dividends and distributions payable
33,048
32,986
Deferred revenue associated with operating leases
13,897
14,802
Distributions received in excess of investment in unconsolidated real estate joint venture
5,686
5,545
Other liabilities
12,255
13,063
Total liabilities
2,594,151
2,521,379
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, 2011 and December 31, 2010)
81
Common Shares of beneficial interest ($0.01 par value; 125,000,000 shares authorized, shares issued and outstanding of 67,103,918 at March 31, 2011 and 66,931,582 at December 31, 2010)
671
669
Additional paid-in capital
1,511,638
1,511,844
Cumulative distributions in excess of net income
(331,313
)
(281,794
Accumulated other comprehensive loss
(3,197
(4,163
Total Corporate Office Properties Trust’s shareholders’ equity
1,177,880
1,226,637
Noncontrolling interests in subsidiaries:
Common units in the Operating Partnership
66,016
69,337
Preferred units in the Operating Partnership
8,800
Other consolidated entities
18,962
18,364
Noncontrolling interests in subsidiaries
93,778
96,501
Total equity
1,271,658
1,323,138
Total liabilities and equity
See accompanying notes to consolidated financial statements.
Consolidated Statements of Operations
(Dollars in thousands, except per share data)
For the Three Months
Ended March 31,
Revenues
Rental revenue
99,426
91,010
Tenant recoveries and other real estate operations revenue
22,941
21,218
Construction contract and other service revenues
21,028
37,365
Total revenues
143,395
149,593
Expenses
Property operating expenses
50,905
48,135
Depreciation and amortization associated with real estate operations
33,020
27,596
Construction contract and other service expenses
20,618
36,399
Impairment loss
27,742
General and administrative expenses
6,777
5,900
Business development expenses
488
155
Total operating expenses
139,550
118,185
Operating income
3,845
31,408
Interest expense
(26,928
(22,638
Interest and other income
1,168
1,302
(Loss) income from continuing operations before equity in income (loss) of unconsolidated entities and income taxes
(21,915
10,072
Equity in income (loss) of unconsolidated entities
30
(205
Income tax benefit (expense)
544
(41
(Loss) income from continuing operations
(21,341
9,826
Discontinued operations
74
832
(Loss) income before gain on sales of real estate
(21,267
10,658
Gain on sales of real estate, net of income taxes
2,701
17
Net (loss) income
(18,566
10,675
Less net (loss) income attributable to noncontrolling interests:
1,479
(527
(165
(538
(45
Net (loss) income attributable to Corporate Office Properties Trust
(17,790
9,938
Preferred share dividends
(4,025
Net (loss) income attributable to Corporate Office Properties Trust common shareholders
(21,815
5,913
Net (loss) income attributable to Corporate Office Properties Trust:
(17,859
9,174
Discontinued operations, net
69
764
Basic earnings per common share (1)
(0.33
0.08
0.02
Net (loss) income attributable to COPT common shareholders
0.10
Diluted earnings per common share (1)
(1) Basic and diluted earnings per common share are calculated based on amounts attributable to common shareholders of Corporate Office Properties Trust.
Consolidated Statements of Equity
Preferred Shares
Common Shares
Additional Paid-in Capital
Cumulative Distributions in Excess of Net Income
Accumulated Other Comprehensive Loss
Noncontrolling Interests
Total
Balance at December 31, 2009 (58,342,673 common shares outstanding)
583
1,238,704
(209,941
(1,907
93,112
1,120,632
Conversion of common units to common shares (309,497 shares)
4,512
(4,515
Costs associated with common shares issued to the public
(18
Exercise of share options (128,461 shares)
1
2,055
2,056
Share-based compensation
2,609
2,611
Restricted common share redemptions (96,970 shares)
(3,610
Adjustments to noncontrolling interests resulting from changes in ownership of Operating Partnership by COPT
(180
180
Adjustments related to derivatives designated as cash flow hedges
(1,371
(103
(1,474
Net income
737
Dividends
(27,186
Distributions to owners of common and preferred units in the Operating Partnership
(2,032
Contributions from noncontrolling interests in other consolidated entities
9,247
Acquisition of noncontrolling interests in other consolidated entities
(26
(336
(362
Balance at March 31, 2010 (58,927,117 common shares outstanding)
589
1,244,046
(227,189
(3,278
96,290
1,110,539
Balance at December 31, 2010 (66,931,582 common shares outstanding)
Conversion of common units to common shares (16,725 shares)
263
(263
(117
Exercise of share options (24,667 shares)
346
3,201
3,203
Restricted common share redemptions (104,592 shares)
(3,713
(163
163
966
968
Net loss
(776
(31,729
(1,974
(23
125
102
Balance at March 31, 2011 (67,103,918 common shares outstanding)
Consolidated Statements of Cash Flows
For the Three Months Ended
Cash flows from operating activities
Revenues from real estate operations received
114,303
112,328
Construction contract and other service revenues received
21,405
54,915
Property operating expenses paid
(45,267
(46,733
Construction contract and other service expenses paid
(28,315
(55,834
General and administrative and business development expenses paid
(6,860
(7,565
Interest expense paid
(22,252
(21,844
Interest and other income received
108
466
Income taxes paid
(170
Net cash provided by operating activities
32,952
35,733
Cash flows from investing activities
Purchases of and additions to properties
Construction, development and redevelopment
(46,676
(44,032
Tenant improvements on operating properties
(8,778
(2,971
Capital improvements on operating properties
(4,064
(2,735
Proceeds from sales of properties
3,149
2,952
Mortgage and other loan receivables funded or acquired
(1,181
(321
Leasing costs paid
(2,894
(3,038
Investment in unconsolidated entities
(250
(4,500
Other
(670
(707
Net cash used in investing activities
(61,364
(55,352
Cash flows from financing activities
Proceeds from debt, including issuance of exchangeable senior notes
97,273
135,892
Repayments of debt
Scheduled principal amortization
(3,798
(3,469
Other repayments
(25,050
(80,050
Net proceeds from issuance of common shares
2,038
Dividends paid
(31,664
(26,948
Distributions paid
(1,981
(2,154
Restricted share redemptions
(34
(162
Net cash provided by financing activities
30,916
21,537
Net increase in cash and cash equivalents
2,504
1,918
Beginning of period
8,262
End of period
10,180
Reconciliation of net (loss) income to net cash provided by operating activities:
Adjustments to reconcile net (loss) income to net cash provided by operating activities:
Depreciation and other amortization
33,645
28,253
Amortization of deferred financing costs
1,759
1,126
Increase in deferred rent receivable
(4,240
(2,555
Amortization of above or below market leases
(207
(607
Amortization of net debt discounts
1,649
917
Gain on sales of real estate
(2,701
(325
2,917
(719
(329
Changes in operating assets and liabilities:
(Increase) decrease in accounts receivable
(827
3,274
Decrease in restricted cash and marketable securities and prepaid expenses and other assets
4,701
16,870
Decrease in accounts payable, accrued expenses and other liabilities
(10,025
(24,575
(Decrease) increase in rents received in advance and security deposits
(2,176
398
Supplemental schedule of non-cash investing and financing activities:
Increase (decrease) in accrued capital improvements, leasing and other investing activity costs
13,171
(1,313
Increase in property and debt in connection with loan assumption
3,040
Increase in property and noncontrolling interests in connection with property contribution by a noncontrolling interest in a joint venture
9,000
Increase in fair value of derivatives applied to AOCL and noncontrolling interests
662
1,490
Dividends/distribution payable
28,556
Decrease in noncontrolling interests and increase in shareholders’ equity in connection with the conversion of common units into common shares
4,515
7
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 strategic customer relationships and specialized tenant requirements in the United States Government and defense information technology sectors and data centers serving such 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 strong markets that we believe possess growth opportunities. As of March 31, 2011, our investments in real estate included the following:
· 252 wholly owned operating office properties totaling 20.2 million square feet;
· 20 wholly owned office properties under construction, development or redevelopment that we estimate will total approximately 2.9 million square feet upon completion, including four partially operational properties included above;
· wholly owned land parcels totaling 1,496 acres that we believe are potentially developable into approximately 14.3 million square feet;
· a wholly owned, partially operational, wholesale data center which upon completion is expected to have an initial stabilization critical load of 18 megawatts; and
· partial ownership interests in a number of other real estate projects in operations, under construction or development or held for future development.
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, 2011 follows:
Common Units
94
%
Series G Preferred Units
100
Series H Preferred Units
Series I Preferred Units
0
Series J Preferred Units
Series K Preferred Units
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, 2011.
In addition to owning real estate, the Operating Partnership also owns entities that provide real estate services such as property management, construction and development and heating and air conditioning 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.
These interim financial statements should be read together with the financial statements and notes thereto as of and for the year ended December 31, 2010 included in our 2010 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 2010 Annual Report on Form 10-K.
3. Fair Value Measurements
For a description on how we estimate fair value, see Note 3 to the consolidated financial statements in our 2010 Annual Report on Form 10-K.
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, 2011 and the hierarchy level of inputs used in measuring their respective fair values under applicable accounting standards (in thousands):
Quoted Prices in Active Markets for
Significant Other
Significant
Identical Assets
Observable Inputs
Unobservable Inputs
Description
(Level 1)
(Level 2)
(Level 3)
Assets:
Marketable securities in deferred compensation plan (1)
Mutual funds
6,248
Common stocks
1,141
Preferred stocks
322
431
200
Common stock (1)
801
Interest rate derivative (2)
935
Warrants to purchase common shares in KEYW (2)
337
9,143
1,272
10,415
Deferred compensation plan liability (3)
8,342
Interest rate derivatives (3)
3,564
Liabilities
11,906
(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. We own warrants to purchase common shares in The KEYW Holding Corporation (“KEYW”), an equity method investee (see Note 6).
(3) Included in the line entitled “other liabilities” on our consolidated balance sheet.
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. 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.
9
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.
4. Properties, net
Operating properties, net consisted of the following (in thousands):
Land
502,048
501,210
Buildings and improvements
2,843,873
2,804,595
3,345,921
3,305,805
Less: accumulated depreciation
(526,825
(503,032
Properties under construction or development consisted of the following (in thousands):
253,505
256,487
Construction in progress, excluding land
396,170
386,195
As discussed further in Note 15, on February 15 and 17, 2011, the United States Army (the “Army”) provided us disclosures regarding the past testing and use of tactical defoliants/herbicides at our property in Cascade, Maryland that was formerly an Army base known as Fort Ritchie (“Fort Ritchie”). Upon receipt of these disclosures, we commenced a review of our development plans and prospects for the property. We believe that these disclosures by the Army are likely to cause further delays in the resolution of certain existing litigation related to the property (also discussed in Note 15), and that they also increase the level of uncertainty as to our ultimate development rights at the property and future residential and commercial demand for the property. We analyzed various possible outcomes and resulting cash flows expected from the operations and ultimate disposition of the property. After determining that the carrying amount of the property will not likely be recovered from those cash flows, we recognized a non-cash impairment loss of $27.7 million in the three months ended March 31, 2011 for the amount by which the carrying value of the property exceeded its estimated fair value.
2011 Construction, Development and Redevelopment Activities
During the three months ended March 31, 2011, we had one newly constructed office property in the Baltimore/Washington Corridor totaling 151,000 square feet become fully operational (31,000 of these square feet were placed into service in 2010) and placed into service 6,000 square feet in one partially operational office property.
As of March 31, 2011, we had construction underway on 11 office properties totaling 1.2 million square feet, including four in the Baltimore/Washington Corridor, three in Greater Baltimore, one in San Antonio, one in Northern Virginia, one in Huntsville, Alabama and one in St. Mary’s and King George Counties. We also had development activities underway on seven office properties totaling 991,000 square feet, including three in the Baltimore/Washington Corridor, two in San Antonio, one in Huntsville and one in Greater Baltimore. In addition, we had redevelopment underway on four office properties totaling 868,000 square feet, including two in Greater Philadelphia, one in the Baltimore/Washington Corridor and one in Northern Virginia.
5. Real Estate Joint Ventures
During the three months ended March 31, 2011, 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 (in thousands):
10
Investment Balance at (1)
Maximum
Date
Nature of
Exposure
Acquired
Ownership
Activity
to Loss (2)
(5,686)
(5,545)
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, 2011 and December 31, 2010 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):
Properties, net
61,101
61,521
Other assets
4,060
4,174
65,161
65,695
Liabilities (primarily debt)
67,626
67,454
Owners’ equity
(2,465
(1,759
Total liabilities and owners’ equity
The following table sets forth condensed statements of operations for this unconsolidated real estate joint venture (in thousands):
1,924
2,100
(986
(994
(1,011
(981
Depreciation and amortization expense
(608
(878
(681
(753
The table below sets forth information pertaining to our investments in consolidated real estate joint ventures at March 31, 2011 (dollars in thousands):
March 31, 2011 (1)
% at
Pledged
3/31/2011
M Square Associates, LLC
6/26/2007
50.0%
Operating two buildings and developing others (2)
60,458
49,042
44,319
Arundel Preserve #5, LLC
7/2/2007
Operating one building (3)
29,521
28,735
16,815
LW Redstone Company, LLC
3/23/2010
85.0%
Developing land parcel (4)
21,070
46
COPT-FD Indian Head, LLC
10/23/2006
75.0%
Developing land parcel (5)
7,486
MOR Forbes 2 LLC
12/24/2002
Operating one building (6)
4,003
60
122,538
77,777
61,257
(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 Hanover, Maryland (in the Baltimore/Washington Corridor).
(4) This joint venture’s property is in Huntsville, Alabama.
(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.
11
6. Prepaid Expenses and Other Assets
Prepaid expenses and other assets consisted of the following (in thousands):
Investment in KEYW
23,019
22,779
Mortgage and other investing receivables
20,573
18,870
Prepaid expenses
14,823
19,995
Furniture, fixtures and equipment, net
11,120
11,504
Construction contract costs incurred in excess of billings
8,247
9,372
12,967
11,376
Investment in The KEYW Holding Corporation
Our investment in KEYW reflected above consists of common stock and warrants to purchase additional shares of common stock of KEYW. At March 31, 2011 and December 31, 2010, we owned 3.1 million shares, or approximately 12%, of KEYW’s common stock. We use the equity method of accounting for our investment in the common stock. The carrying value of our equity method investment in these common shares was $22.7 million at March 31, 2011 and $22.3 million at December 31, 2010. Our investment in these common shares had a fair value of $37.7 million at March 31, 2011 based on the closing price of KEYW’s common stock on the NASDAQ Stock Market on that date. In March 2011, we entered into a sales plan, which complies with the requirements of Rule 10b5-1(c) under the Securities Exchange Act of 1934, as amended, to sell up to 1.6 million shares of our KEYW common stock in 2011.
At March 31, 2011 and December 31, 2010, we owned warrants to purchase 50,000 additional shares of KEYW common stock at an exercise price of $9.25 per share. We account for these warrants as derivatives reported at fair value using the Black-Scholes option-pricing model. The estimated fair value of these warrants was $337,000, or $6.74 per warrant, at March 31, 2011 and $466,000, or $9.32 per warrant, at December 31, 2010.
Mortgage and Other Investing Receivables
Mortgage and other investing receivables consisted of the following (in thousands):
Mortgage loans receivable
14,822
14,227
Note receivable from City of Huntsville
5,751
4,643
Our mortgage loans receivable reflected above consist of two loans secured by properties in the Baltimore/Washington Corridor. Our note receivable from the City of Huntsville was to fund infrastructure costs in connection with our LW Redstone Company, LLC joint venture. We do not have an allowance for credit losses in connection with theses receivables at March 31, 2011 or December 31, 2010. The fair value of our mortgage and other investing receivables totaled $20.6 million at March 31, 2011 and $18.8 million at December 31, 2010.
Operating Notes Receivable
We had operating notes receivables due from tenants with terms exceeding one year totaling $596,000 at March 31, 2011 and $655,000 at December 31, 2010. We carried allowances for estimated losses for most of these balances.
12
7. Debt
Our debt consisted of the following (dollars in thousands):
Scheduled
Carrying Value at
Maturity
Availability at
Stated Interest Rates
Dates at
March 31, 2011
at March 31, 2011
Mortgage and Other Secured Loans:
Fixed rate mortgage loans (1)
N/A
1,169,688
1,173,358
5.20% - 7.87% (2)
2011 - 2034 (3)
Revolving Construction Facility
225,000
161,612
142,339
LIBOR + 1.60% to 2.00% (4)
May 2, 2012
Variable rate secured loans
310,236
310,555
LIBOR + 2.25% to 3.00% (5)
2012-2014 (6)
Other construction loan facility
23,400
16,753
LIBOR + 2.75% (7)
2011 (8)
Total mortgage and other secured loans
1,658,289
1,643,005
Revolving Credit Facility
800,000
348,000
295,000
LIBOR + 0.75% to 1.25% (9)
September 30, 2011 (8)
Unsecured notes payable
4,968
1,947
0% (10)
2015-2026
Exchangeable Senior Notes:
4.25% Exchangeable Senior Notes
224,686
223,846
4.25%
April 2030 (11)
3.5% Exchangeable Senior Notes
160,852
159,883
3.50%
September 2026 (12)
Total debt
(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 $2.9 million at March 31, 2011 and $3.2 million at December 31, 2010.
(2) The weighted average interest rate on these loans was 5.97% at March 31, 2011.
(3) A loan with a balance of $4.5 million at March 31, 2011 that matures in 2034 may be repaid in March 2014, subject to certain conditions.
(4) The weighted average interest rate on this loan was 1.87% at March 31, 2011.
(5) Certain of the loans in this category at March 31, 2011 were subject to floor interest rates ranging from 4.25% to 5.50%.
(6) Includes $221.4 million maturing in 2012 that may be extended for a one-year period at our option, subject to certain conditions.
(7) The interest rate on this loan was 3.02% at March 31, 2011.
(8) These loans may be extended for a one-year period at our option, subject to certain conditions.
(9) The weighted average interest rate on the Revolving Credit Facility was 1.12% at March 31, 2011.
(10) 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 $2.0 million at March 31, 2011 and $1.1 million at December 31, 2010.
(11) As described further in our 2010 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 20.8011 shares per one thousand dollar principal amount of the notes (exchange rate is as of March 31, 2011 and is equivalent to an exchange price of $48.07 per common share). The carrying value of these notes included a principal amount of $240.0 million and an unamortized discount totaling $15.3 million at March 31, 2011 and $16.2 million at December 31, 2010. 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, 2011 and December 31, 2010 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
Interest expense at stated interest rate
2,550
Interest expense associated with amortization of discount
840
3,390
(12) As described further in our 2010 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 (up to the principal amount of the notes) and, with respect to any excess exchange value, may be exchangeable into (at our option) cash, our common shares or a combination of cash and our common shares at an exchange rate (subject to adjustment) of 19.2648 shares per one thousand dollar principal amount of the notes (exchange rate is as of March 31, 2011 and is equivalent to an exchange price of $51.91 per common share). The carrying value of these notes included a principal amount of $162.5 million and an unamortized discount totaling $1.6 million at March 31, 2011 and $2.6 million at December 31, 2010. The effective interest rate under the notes, including amortization of the issuance costs, was 5.97%. Because the closing price of our common shares at March 31, 2011 and December 31, 2010 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):
13
1,422
969
913
2,391
2,335
We capitalized interest costs of $4.3 million in the three months ended March 31, 2011 and $3.9 million in the three months ended March 31, 2010.
The following table sets forth information pertaining to the fair value of our debt (in thousands):
December 31, 2010
Carrying
Estimated
Amount
Fair Value
Fixed-rate debt
1,560,194
1,574,532
1,559,034
1,579,022
Variable-rate debt
836,601
840,203
764,647
769,247
2,414,735
2,348,269
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
One-Month
Effective
Expiration
LIBOR Base
$ 120,000
1.7600
1/2/2009
5/1/2012
(1,730
(2,062
100,000
1.9750
1/1/2010
(1,675
(2,002
50,000
0.5025
1/3/2011
1/3/2012
(61
(64
0.4400
1/4/2011
(37
40,000
(1)
3.8300
11/2/2010
11/2/2015
644
(2,629
(3,582
(1) The notional amount of this instrument is scheduled to amortize to $36.2 million.
Each of these interest rate swaps 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):
Derivatives Designated as Hedging Instruments
Balance Sheet Location
Interest rate swaps
(3,564
(4,226
The table below presents the effect of our interest rate derivatives on our consolidated statements of operations and comprehensive income (in thousands):
Amount of loss recognized in AOCL (effective portion)
(136
(2,385
Amount of loss reclassified from AOCL into interest expense (effective portion)
(1,104
(911
14
Over the next 12 months, we estimate that approximately $3.9 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, 2011, the fair value of interest rate derivatives in a liability position related to these agreements was $3.6 million, excluding the effects of accrued interest. As of March 31, 2011, 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 $3.9 million.
9. Shareholders’ Equity
During the three months ended March 31, 2011, holders of 16,725 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 $0.4125 in the three months ended March 31, 2011 and $0.3925 in the three months ended March 31, 2010.
See Note 11 for disclosure of common share activity pertaining to our share-based compensation plans.
The table below sets forth activity in the accumulated other comprehensive loss component of shareholders’ equity (in thousands):
Beginning balance
Amount of loss reclassified from AOCL to income (effective portion)
1,104
911
Adjustment to AOCL attributable to noncontrolling interests
(2
103
Ending balance
The table below sets forth total comprehensive income and total comprehensive income attributable to COPT (in thousands):
Amount of loss recognized in AOCL
Amount of loss reclassified from AOCL to income
Total comprehensive (loss) income
(17,598
9,201
Net loss (income) attributable to noncontrolling interests
776
(737
Other comprehensive (loss) income attributable to noncontrolling interests
(62
121
Total comprehensive (loss) income attributable to COPT
(16,884
8,585
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10. Information by Business Segment
As of March 31, 2011, we had nine primary office property segments comprised of: the Baltimore/Washington Corridor; Greater Baltimore; Northern Virginia; Colorado Springs; Suburban Maryland; San Antonio; Washington, DC — Capitol Riverfront; Greater Philadelphia; and St. Mary’s and King George Counties. We also had a wholesale data center segment.
The table below reports segment financial information for our real estate operations (in thousands). Our segment entitled “Other” includes assets and operations not specifically associated with the other defined segments, including certain properties as well as corporate assets and investments in unconsolidated entities. We measure the performance of our segments through a measure we define as net operating income from real estate operations (“NOI from real estate operations”), which is derived by subtracting property expenses from revenues from real estate operations. We believe that NOI from real estate operations is an important supplemental measure of operating performance for a REIT’s operating real estate because it provides a measure of the core operations that is unaffected by depreciation, amortization, financing and general and administrative expenses; this measure is particularly useful in our opinion in evaluating the performance of geographic segments, same-office property groupings and individual properties.
Baltimore/ Washington Corridor
Greater Baltimore
Northern Virginia
Colorado Springs
Suburban Maryland
San Antonio
Washington, DC - Capitol Riverfront
Greater Philadelphia
St. Mary’s & King George Counties
Wholesale Data Center
Three Months Ended March 31, 2011
Revenues from real estate operations
53,252
17,612
18,274
5,920
5,609
7,663
4,590
1,939
3,534
1,210
2,838
122,441
21,390
8,540
7,671
2,436
2,718
3,869
1,627
446
1,016
706
486
NOI from real estate operations
31,862
9,072
10,603
3,484
2,891
3,794
2,963
1,493
2,518
504
2,352
71,536
Additions to properties, net
24,755
11,826
2,137
421
1,175
2,290
63
2,233
3,250
24,070
3,131
75,351
Segment assets at March 31, 2011
1,405,746
589,750
543,677
263,548
176,866
155,928
118,407
124,971
101,370
154,245
231,301
Three Months Ended March 31, 2010
52,058
17,865
18,659
6,332
5,829
3,938
1,202
3,589
3,524
112,996
22,155
9,010
7,313
2,309
1,629
763
1,107
1,309
48,296
29,903
8,855
11,346
4,023
3,128
439
2,482
2,215
64,700
15,959
7,240
4,910
813
1,541
4,939
10,058
411
12,476
58,347
Segment assets at March 31, 2010
1,339,080
568,361
452,105
269,338
172,971
139,977
115,023
94,033
247,464
3,398,352
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The following table reconciles our segment revenues to total revenues as reported on our consolidated statements of operations (in thousands):
Segment revenues from real estate operations
Less: Revenues from discontinued operations (Note 13)
(74
(768
The following table reconciles our segment property operating expenses to property operating expenses as reported on our consolidated statements of operations (in thousands):
Segment property operating expenses
Less: Property operating expenses from discontinued operations (Note 13)
(161
Total property operating expenses
As previously discussed, we provide real estate services such as property management, construction and development and heating and air conditioning 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):
(20,618
(36,399
NOI from service operations
410
The following table reconciles our NOI from real estate operations for reportable segments and NOI from service operations to (loss) income from continuing operations as reported on our consolidated statements of operations (in thousands):
Other adjustments:
Depreciation and other amortization associated with real estate operations
(33,020
(27,596
(27,742
(6,777
(5,900
(488
(155
Interest expense on continuing operations
NOI from discontinued operations
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. We did not allocate interest expense, depreciation and amortization and impairment loss 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, interest and other income, equity in income (loss) of unconsolidated entities, income taxes and noncontrolling interests because these items represent general corporate items not attributable to segments.
11. Share-Based Compensation
Performance Share Units (“PSUs”)
On March 3, 2011, our Board of Trustees granted 56,883 PSUs to executives. The PSUs have a performance period beginning on the grant date and concluding on the earlier of March 2, 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 or greater
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:
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· 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 $49.15 per PSU using a Monte Carlo model, which included assumptions of, among other things, the following: baseline common share value of $35.17; expected volatility for our common shares of 61.1%; and risk-free interest rate of 1.32%. We are recognizing the grant date fair value in connection with these PSU awards over a three-year period that commenced on March 3, 2011.
The PSUs granted to our executives on March 4, 2010, as described in our 2010 Annual Report on Form 10-K, were also outstanding at March 31, 2011.
Restricted Shares
During the three months ended March 31, 2011, certain employees and a member of our Board of Trustees were granted a total of 236,859 restricted shares with a weighted average grant date fair value of $35.37 per share. Restricted shares granted to employees vest based on increments and over periods of time set forth under the terms of the respective awards provided that the employees remain employed by us. The grant of restricted shares to the Trustee vests on the first anniversary of the grant date provided that the Trustee remains in her position. During the three months ended March 31, 2011, forfeiture restrictions lapsed on 278,351 previously issued common shares; these shares had a weighted average grant date fair value of $31.87 per share, and the aggregate intrinsic value of the shares on the vesting dates was $9.9 million.
Options
During the three months ended March 31, 2011, 24,667 options to purchase common shares (“options”) were exercised. The weighted average exercise price of these options was $14.03 per share, and the aggregate intrinsic value of the options exercised was $518,000.
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12. Income Taxes
We own a taxable REIT subsidiary (“TRS”) that is subject to Federal and state income taxes. Our TRS’ provision for income tax consisted of the following (in thousands):
For the Three Months Ended March 31,
Deferred
Federal
(447
State
(100
(547
Current
49
Total income tax (benefit) expense
(544
52
Reported on line entitled income tax (benefit) expense
41
Reported on line entitled gain on sale of real estate, net
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 and net operating losses that are not deductible until future periods.
Our TRS’ combined Federal and state effective tax rate was 34.7% for the three months ended March 31, 2011 and 38.6% for the three months ended March 31, 2010.
13. Discontinued Operations
Income from discontinued operations primarily includes revenues and expenses associated with the following:
· 11101 McCormick Road property in the Greater Baltimore region that was sold on February 1, 2010; and
· 431 and 437 Ridge Road properties in Central New Jersey (included in the Other region) that were sold on September 8, 2010.
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The table below sets forth the components of discontinued operations reported on our consolidated statements of operations (in thousands):
Revenue from real estate operations
768
Expenses from real estate operations:
161
Depreciation and amortization
Expenses from real estate operations
168
Operating income from real estate operations
600
(65
297
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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Summaries of the numerator and denominator for purposes of basic and diluted EPS calculations are set forth below (in thousands, except per share data):
Numerator:
Gain on sales of real estate, net
Loss (income) from continuing operations attributable to noncontrolling interests
781
(669
Income from continuing operations attributable to restricted shares
(282
(290
Numerator for basic and diluted EPS from continuing operations attributable to COPT common shareholders
(22,166
4,859
Discontinued operations, net attributable to noncontrolling interests
(5
(68
Numerator for basic and diluted EPS on net (loss) income attributable to COPT common shareholders
(22,097
5,623
Denominator (all weighted averages):
Denominator for basic EPS (common shares)
66,340
57,844
Dilutive effect of share-based compensation awards
364
Denominator for diluted EPS
58,208
Basic EPS:
(Loss) income from continuing operations attributable to COPT common shareholders
Discontinued operations attributable to COPT common shareholders
Diluted EPS:
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
Conversion of common units
4,396
5,017
Conversion of convertible preferred units
176
Conversion of convertible preferred shares
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, 2011 and 2010 of 651,000 and 661,000, respectively; and
· weighted average options for the three months ended March 31, 2011 and 2010 of 1.2 million and 662,000, 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.
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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.
Fort Ritchie Litigation
In 2005, a suit was initiated in the United States District Court for the District of Columbia against The Secretary of the Army, PenMar Development Corporation (“PMDC”) and us, as defendants, in connection with our then pending acquisition of Fort Ritchie. The case was dismissed by the United States District Court in 2006 due to the plaintiffs’ lack of standing but upon the filing of an appeal, the findings of the District Court were reversed and the case remanded to the District Court for further proceedings. We subsequently acquired from PMDC fee simple title to 500 acres of the 591 acres comprising Fort Ritchie on October 5, 2006 and the remaining 91 acres on November 29, 2007.
On November 10, 2009, the District Court issued an Order, together with a Memorandum Opinion, which precludes us from proceeding with the implementation of our development plan until the Army either re-issues an amended Record of Environmental Consideration (“REC”) or a Supplemental Environmental Impact Statement (“SEIS”) that complies with the District Court’s Memorandum Opinion. The Memorandum Opinion highlights various areas of the existing REC which could be revised to include greater detail on the Army’s deliberative process whereby the Army determined that a SEIS was not necessary. We are working with both the Army’s counsel and the Army representative on re-submission of the amended REC to the Court in order to lift the restrictions imposed by the Court.
On January 8, 2010, the Army filed an appeal in the United States Court of Appeals for the District of Columbia Circuit, and, on January 19, 2011, the appeal was dismissed. On January 21, 2011, the District Court issued an order for the parties to meet and confer to provide a status report. On February 15 and 17, 2011, the Army provided us disclosures regarding the past testing and use of tactical defoliants/herbicides at the property. The Army is in the process of determining the precise locations and extent of the testing conducted at the property.
In the event that this matter is not favorably resolved, we may be unable to execute our development plans for the property. We recognized a non-cash impairment loss on the property of $27.7 million in the three months ended March 31, 2011. Since our carrying value of the property is no longer a material amount, we do not intend to provide additional information regarding this litigation in the future.
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.
On February 15, 2011, the Army disclosed to PMDC and us a study published by the Department of Defense in December 2006 regarding the past testing and use of tactical defoliants/herbicides at various military installations throughout the United States, including Fort Ritchie. In addition, on February 17, 2011, the Army disclosed to PMDC and us a report published in 1956 by Chemical Corps Research & Development Command Biological Warfare Laboratories titled “Defoliation Investigations During 1954
23
and 1955,” which describes other testing and use of tactical defoliants/herbicides at the property. The Army is in the process of determining the precise locations and extent of the testing conducted at the property. The Army has certain environmental indemnity obligations regarding the property, including its obligation, subject to the Anti-Deficiency Act (which prohibits the United States government from entering into a contract which obligates an agency of the government to expend funds in the absence of an appropriation adequate for the needs of such contract), to hold harmless, defend and indemnify the subsidiary of ours that owns the property, and any of such subsidiary’s successors, assignees or transferees, with respect to any cost, expense or fee arising from a requirement or claim for personal injury, environmental remediation or property damage resulting from the release of hazardous substances all as more particularly described and limited by Section 330 of the Department of Defense Authorization Act of 1993, Public Law 102-484. Therefore, we do not expect to incur any material future cash expenditures relating to this matter.
Joint Ventures
In connection with our 2005 contribution of properties to an unconsolidated partnership in which we hold a limited partnership interest, we entered into standard nonrecourse loan guarantees (environmental indemnifications and guarantees against fraud and misrepresentation, including 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 $66 million. We are entitled to recover 20% of any amounts paid under the guarantees from an affiliate of the general 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, 2011.
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.
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 $3.6 million liability through March 31, 2011 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 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
24
by the State of New Jersey, up to the point that the state declares the remediation to be complete. Under the lease agreement, we agreed to the following:
· to indemnify the tenant against losses covered under the prior owner’s indemnity agreement if the prior owner fails to indemnify the tenant for such losses. This indemnification is capped at $5.0 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.
16. Subsequent Event
Approval of Strategic Reallocation Plan
In April 2011, we completed a review of our portfolio and identified a number of properties that are no longer closely aligned with our strategy. On April 25, 2011, our Board of Trustees approved a plan by management to dispose of some of these properties during the next three years (the “Strategic Reallocation Plan”). While we expect to recognize gains on the dispositions of some of these properties, we also determined that the carrying amounts of certain of these properties (the “Impaired Properties”) will not likely be recovered from the cash flows from the operations and sales of such properties over the shorter holding periods resulting from the Strategic Reallocation Plan. Accordingly, during the three months ending June 30, 2011, we will recognize aggregate non-cash impairment losses of approximately $39.9 million for the amounts by which the carrying values of the Impaired Properties exceed their respective estimated fair values.
The properties to be disposed of pursuant to the Strategic Reallocation Plan consist primarily of smaller, non strategic office properties in certain submarkets in the Greater Baltimore, Suburban Maryland and St. Mary’s County regions. We expect that net proceeds from the execution of the Strategic Reallocation Plan after the repayment of debt secured by the properties will approximate $200 million. We expect to invest the proceeds in properties that will serve customers in the United States Government, defense information technology and related data sectors.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
We are a specialty office real estate investment trust (“REIT”) that focuses primarily on strategic customer relationships and specialized tenant requirements in the United States Government, defense information technology sectors and data centers serving such 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 strong markets that we believe possess growth opportunities.
During the three months ended March 31, 2011, we:
· had a decrease in net income attributable to common shareholders of $27.7 million as compared to the three months ended March 31, 2010, which resulted primarily from an impairment loss of $27.7 million on our property in Cascade, Maryland that was formerly the Army base known as Fort Ritchie (“Fort Ritchie”);
· had a decrease of $2.8 million, or 4%, from the three months ended March 31, 2010 in our net operating income (“NOI”) from continuing real estate operations (defined below) attributable to properties that were owned and 100% operational throughout the two periods (properties that we refer to collectively as “Same Office Properties”);
· finished the period with occupancy of our portfolio of wholly owned office properties at 87.0%; and
· placed into service an aggregate of 126,000 square feet in two newly constructed office properties.
In this section, we discuss our financial condition and results of operations as of and for the three months ended March 31, 2011. This section includes discussions on, among other things:
· our results of operations and why various components of our consolidated statements of operations changed for the three months ended March 31, 2011 compared to the same period in 2010;
· our cash flows;
· how we expect to generate cash for short and long-term capital needs; and
· our commitments and contingencies at March 31, 2011.
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 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;
· 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;
· governmental actions and initiatives; and
· environmental requirements.
We undertake no obligation to update or supplement forward-looking statements.
Occupancy and Leasing
The tables below set forth occupancy information pertaining to our portfolio of wholly owned operating office properties:
Occupancy rates at period end
87.0
88.2
Baltimore/Washington Corridor
89.1
89.5
86.4
91.9
83.6
85.0
100.0
76.1
76.2
95.4
98.5
St. Mary’s and King George Counties
88.8
86.8
70.1
71.4
Average contractual annual rental rate per square foot at period end (1)
25.75
25.56
(1) Includes estimated expense reimbursements.
Rentable
Occupied
Square Feet
(in thousands)
19,990
17,628
Square feet vacated upon lease expiration (1)
(421
Square feet retenanted after lease expiration (2)
Square feet constructed
162
188
Other changes
31
20,183
17,551
(1) Includes lease terminations and space reductions occurring in connection with lease renewals.
(2) Excludes retenanting of vacant square feet acquired or developed.
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The table below sets forth occupancy information pertaining to operating office properties in which we have a partial ownership interest:
Occupancy Rates at
Geographic Region
Interest
Greater Harrisburg, Pennsylvania (1)
20.0
72.0
74.3
Suburban Maryland (2)
50.0
88.3
Baltimore/Washington Corridor (3)
6.0
(1) Includes 16 properties totaling 671,000 square feet.
(2) Includes three properties totaling 298,000 square feet.
(3) Includes one property with 144,000 square feet.
Our shell-complete wholesale data center property was 17% leased at March 31, 2011 and December 31, 2010 to tenants with an initial critical load of three megawatts and further expansion rights of up to a combined five megawatts.
Results of Operations
One manner in which we evaluate the operating performance of our properties is through a measure we define as NOI from real estate operations, which is derived by subtracting property operating expenses from revenues from real estate operations. We believe that NOI from real estate operations is an important supplemental measure of 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. The amount of NOI from real estate operations included in income from continuing operations is referred to herein as NOI from continuing real estate operations. We view our NOI from continuing real estate as being comprised of the following primary categories:
· operating properties owned and 100% operational throughout the current and prior year reporting periods. We define these as changes from “Same Office Properties”;
· operating properties acquired during the current and prior year reporting periods; and
· constructed properties placed into service that were not 100% operational throughout the current and prior year reporting periods.
The primary manner in which we evaluate the operating performance of our construction contract 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 GAAP measure for both NOI from continuing 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 continuing real estate operations and NOI from service operations to operating income reported on our consolidated statement of operations (in thousands):
NOI from continuing real estate operations
71,462
64,093
Depreciation and amortization associated with continuing real estate operations
General and administrative expense
Comparison of the Three Months Ended March 31, 2011 to the Three Months Ended March 31, 2010
Variance
122,367
112,228
10,139
(16,337
(6,198
2,770
5,424
(15,781
877
333
21,365
(27,563
(4,290
(134
235
585
(31,167
(758
2,684
(29,241
1,513
(27,728
29
NOI from Continuing Real Estate Operations
Same Office Properties
107,401
110,538
(3,137
Acquired properties
7,262
Constructed properties placed in service
7,372
733
6,639
332
957
(625
45,278
45,603
2,829
1,800
249
1,551
998
2,283
(1,285
62,123
64,935
(2,812
4,433
5,572
484
5,088
(666
(1,326
660
7,369
As the table above indicates, much of our change in NOI from continuing real estate operations was attributable to the additions of properties through acquisition and construction activities.
With regard to changes in NOI from continuing real estate operations attributable to Same Office Properties:
· the decrease in revenues included the following:
· a $2.3 million decrease in rental revenue attributable primarily to changes in occupancy and rental rates between the two periods (average occupancy of Same Office Properties was 86.7% in the current period versus 88.8% in the prior period); and
· a $817,000 decrease in tenant recoveries and other revenue; and
· the decrease in property operating expenses included the following:
· a $3.6 million decrease in snow removal expenses due primarily to record snowfall in Maryland and Northern Virginia in the prior period; offset in part by
· an $860,000 increase in heating and air conditioning repairs and maintenance that was predominantly attributable to an increase in heating and air conditioning systems utilization at a property in San Antonio; and
· a $753,000 increase in common area utilities.
NOI from Service Operations
(556
NOI from service operations decreased due primarily to a lower volume of construction activity in connection with one large construction contract.
Depreciation and Amortization Associated with Real Estate Operations
Depreciation and amortization expense associated with real estate included in continuing operations increased due primarily to expense attributable to properties added into operations through acquisition and construction activities.
The increase in interest expense included the effect of a $288.5 million increase in our average outstanding debt resulting from our financing of acquisition and construction activities and an increase in our weighted average interest rates of debt from 4.8% to 4.9%.
On February 15 and 17, 2011, the Army provided us disclosures regarding the past testing and use of tactical defoliants/herbicides at Fort Ritchie. Upon receipt of these disclosures, we commenced a review of our development plans and prospects for the property. We believe that these disclosures by the Army are likely to cause further delays in the resolution of certain existing litigation related to the property (discussed in Note 15 to the consolidated financial statements), and that they also increase the level of uncertainty as to our ultimate development rights at the property and future residential and commercial demand for the property. We analyzed various possible outcomes and resulting cash flows expected from the operations and ultimate disposition of the property. After determining that the carrying amount of the property will not likely be recovered from those cash flows, we recognized a non-cash impairment loss of $27.7 million in the three months ended March 31, 2011 for the amount by which the carrying value of the property exceeded its estimated fair value.
The increase in gain on sales of real estate was attributable primarily to the sale of a land parcel in Hunt Valley, Maryland in the current period.
Funds From Operations
Funds from operations (“FFO”) is defined as net income computed using GAAP, excluding gains on sales of previously depreciated operating properties, plus real estate-related depreciation and amortization. Gains from sales of newly-developed properties less accumulated depreciation, if any, required under GAAP are included in FFO on the basis that development services are the primary revenue generating activity; we believe that inclusion of these development gains is in accordance with 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 previously depreciated operating properties and excluding real estate-related depreciation and amortization, FFO can help one compare our operating performance between periods. In addition, since most equity REITs provide FFO information to the investment community, we believe that FFO is useful to investors as a supplemental measure for comparing our results to those of other equity REITs. We believe that net income is the most directly comparable GAAP measure to FFO.
Since FFO excludes certain items includable in net income, reliance on the measure has limitations; management compensates for these limitations by using the measure simply as a supplemental measure that is weighed in the balance with other GAAP and non GAAP measures. FFO is not necessarily an indication of our cash flow available to fund cash needs. Additionally, it should not be used as an alternative to net income when evaluating our financial performance or to cash flow from operating, investing and financing activities when evaluating our liquidity or ability to make cash distributions or pay debt service.
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 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 acquisition costs and impairment losses. 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.
32
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.
The table below sets forth the computation of the above stated measures for the three months ended March 31, 2011 and 2010 and provides reconciliations to the GAAP measures associated with such measures (dollars and shares in thousands, except per share data):
Add: Real estate-related depreciation and amortization
27,603
Add: Depreciation and amortization on unconsolidated real estate entities
119
175
Less: Gain on sales of previously depreciated operating properties, net of income taxes
(297
FFO
14,573
38,156
Noncontrolling interests-preferred units in the Operating Partnership
Noncontrolling interests-other consolidated entities
Depreciation and amortization allocable to noncontrolling interests in other consolidated entities
Basic and Diluted FFO allocable to restricted shares
(379
Basic and Diluted FFO
9,498
33,260
Operating property acquisition costs
Diluted FFO, as adjusted for comparability
37,263
33,279
Weighted average common shares
Conversion of weighted average common units
Weighted average common shares/units - Basic FFO
70,736
62,861
261
Weighted average common shares/units - Diluted FFO
70,997
63,225
Diluted FFO per share
0.13
0.53
Diluted FFO per share, as adjusted for comparability
0.52
Numerator for diluted EPS
(Loss) income allocable to noncontrolling interests-common units in the Operating Partnership
(1,479
527
Real estate-related depreciation and amortization
Depreciation and amortization of unconsolidated real estate entities
Numerator for diluted EPS allocable to restricted shares
282
290
Basic and diluted FFO allocable to restricted shares
Gain on sales of previously depreciated operating properties, net of income taxes
Weighted average common units
Anti-dilutive EPS effect of share-based compensation awards
Denominator for diluted FFO per share measures
33
Investing and Financing Activities During the Three Months Ended March 31, 2011
During the three months ended March 31, 2011, we placed into service an aggregate of 126,000 square feet in newly constructed space in two office properties. These properties included one property totaling 151,000 square feet that became fully operational in 2011 (31,000 of these square feet were placed into service in 2010). Costs incurred on the fully operational property through March 31, 2011 totaled $26.0 million.
The table below sets forth the major components of our additions to the line entitled “Total properties, net” on our consolidated balance sheet for the three months ended March 31, 2011 (in thousands):
60,657
12,704
1,990
(1) Tenant improvement costs incurred on newly-constructed properties are classified in this table as construction, development and redevelopment.
Construction, development and redevelopment activities underway for office properties at March 31, 2011 included the following:
Square Feet (in
Expected Year
Number of
thousands) or
Remaining Costs
For Costs to be
Properties
Critical Load
(in millions)
Incurred Through
Construction of new office properties
1,244
163.4
2013
Development of new office properties
991
203.1
2014
Redevelopment of existing office properties
868
34.0
2012
Completion of wholesale data center
18 MW
128.0
Investing and Financing Activity Subsequent to the Three Months Ended March 31, 2011
Cash Flows
We expect to continue to use cash flow provided by operations as the primary source to meeting our short-term capital needs, including all 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 capital improvements and leasing costs. Our cash flow provided by financing activities increased $9.4 million
34
when comparing the three months ended March 31, 2011 and 2010 due primarily to a $16.1 million decrease in net debt repayments in the current period.
Liquidity and Capital Resources
Our primary cash requirements are for operating expenses, debt service, development of new properties, improvements to existing properties and acquisitions. While we may experience increasing challenges discussed elsewhere herein and in our 2010 Annual Report on Form 10-K due to the current economic environment, we believe that our liquidity and capital resources are adequate for our near-term and longer-term requirements. We maintain sufficient cash and cash equivalents to meet our operating cash requirements and short term investing and financing cash requirements. When we determine that the amount of cash and cash equivalents on hand is more than we need to meet such requirements, we may pay down our unsecured revolving credit facility (the “Revolving Credit Facility”) or forgo borrowing under construction loan credit facilities to fund development activities.
We rely primarily on fixed-rate, non-recourse mortgage loans from banks and institutional lenders to finance most of our operating properties. We have also made use of the public equity and debt markets to meet our capital needs, principally to repay or refinance corporate and property secured debt and to provide funds for project development and acquisitions.
Our Revolving Credit Facility provides for borrowings of up to $800 million, $447.8 million of which was available at March 31, 2011; this facility is available through September 2011 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 0.125% of the total availability of the facility. We often use our Revolving Credit Facility initially to finance much of our investing activities. We then pay down the facility using proceeds generated from long-term borrowings and equity issuances. Amounts available under the facility are computed based on 65% of our unencumbered asset value, as defined in the agreement.
In addition, we have a construction loan agreement with an aggregate commitment by the lenders that is restorable (the “Revolving Construction Facility”), which provides for borrowings of up to $225.0 million, $63.4 million of which was available at March 31, 2011 to fund future construction costs; this facility is available until May 2012.
In 2011, we expect to create a new facility that will replace our existing Revolving Credit Facility and Revolving Construction Facility. We expect to satisfy our 2011 debt maturities and fund the construction of properties under construction at period end or expected to be started during the remainder of 2011 using capacity under our credit facilities and by accessing the secured debt market, unsecured debt market and/or public equity market. We are continually evaluating sources of capital and believe that there are satisfactory sources available to meet our capital requirements without necessitating property sales. However, selective dispositions of operating properties and other assets are expected to provide capital resources during the remainder of 2011 and in future years.
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, 2011, we were in compliance with 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 2010 Annual Report on Form 10-K.
35
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, 2011 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,
2011 (1)
2015
Thereafter
Long term debt:
Fixed rate debt (2)
$274,832
$48,648
$144,615
$162,009
$363,596
$582,520
$1,576,220
Weighted average interest rate
4.33
6.36
5.62
6.40
4.66
6.02
5.43
Variable rate debt
$365,720
$384,355
$1,433
$48,216
$36,877
$—
$836,601
(1) Includes $364.8 million in maturities that may be extended for a one-year period, subject to certain conditions.
(2) Represents principal maturities only and therefore excludes net discounts of $16.0 million.
The fair market value of our debt was $2.4 billion at March 31, 2011. If interest rates had been 1% lower, the fair value of our fixed-rate debt would have increased by $62.4 million at March 31, 2011.
The following table sets forth information pertaining to interest rate swap contracts in place as of March 31, 2011 and their respective fair values (dollars in thousands):
120,000
Based on our variable-rate debt balances, including the effect of interest rate swap contracts, our interest expense would have increased by $739,000 in the three months ended March 31, 2011 if short-term interest rates had been 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, 2011. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures as of March 31, 2011 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.
PART II
Item 1. Legal Proceedings
In 2005, a suit was initiated in the United States District Court for the District of Columbia against The Secretary of the Army, PenMar Development Corporation (“PMDC”) and us, as defendants, in connection with our then pending acquisition of the former Army base known as Fort Ritchie located in Cascade, Maryland. The case was dismissed by the United States District Court in 2006 due to the plaintiffs’ lack of standing but upon the filing of an appeal, the findings of the District Court were reversed and the case remanded to the District Court for further proceedings. We subsequently acquired from PMDC fee simple title to 500 acres of the 591 acres comprising Fort Ritchie on October 5, 2006 and the remaining 91 acres on November 29, 2007.
On January 8, 2010, the Army filed an appeal in the United States Court of Appeals for the District of Columbia Circuit, and, on January 19, 2011, the appeal was dismissed. On January 21, 2011, the District Court issued an order for the parties to meet and confer to provide a status report. On February 15 and 17, 2011, the Army provided us disclosures regarding the past testing and use of tactical defoliants/herbicides at the property. The Army is in the process of determining the precise locations and extent of the testing conducted at the property. In the event that this matter is not favorably resolved, we may be unable to execute our development plans for the property. We recognized a non-cash impairment loss on the property of $27.7 million in the three months ended March 31, 2011. Since our carrying value of the property is no longer a material amount, we do not intend to provide additional information regarding this litigation in the future.
We are not currently involved in any other material litigation nor, to our knowledge, is any material litigation currently threatened against the Company (other than routine litigation arising in the ordinary course of business, substantially all of which is expected to be covered by liability insurance).
Item 1A. Risk Factors
There have been no material changes to the risk factors included in our 2010 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, 2011, 16,725 of the Operating Partnership’s common units were exchanged for 16,725 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
Item 4. Removed and Reserved
Item 5. Other Information
Not applicable
Item 6. Exhibits
(a) Exhibits:
EXHIBIT NO.
DESCRIPTION
10.1
Twenty-Seventh Amendment to Second Amended and Restated Limited Partnership Agreement of Corporate Office Properties, L.P., dated February 3, 2011 (filed with the Company’s Current Report on Form 8-K dated February 3, 2011 and incorporated herein by reference).
31.1
Certification of the Chief Executive Officer of Corporate Office Properties Trust required by Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended (filed herewith).
31.2
Certification of the Chief Financial Officer of Corporate Office Properties Trust required by Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended (filed herewith).
32.1
Certification of the Chief Executive Officer of Corporate Office Properties Trust required by Rule 13a-14(b) under the Securities Exchange Act of 1934, as amended. (This exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liability of that section. Further, this exhibit shall not be deemed to be incorporated by reference into any filing under the Securities Exchange Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended.) (Furnished herewith).
32.2
Certification of the Chief Financial Officer of Corporate Office Properties Trust required by Rule 13a-14(b) under the Securities Exchange Act of 1934, as amended. (This exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liability of that section. Further, this exhibit shall not be deemed to be incorporated by reference into any filing under the Securities 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).
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 29, 2011
By:
/s/ Randall M. Griffin
Randall M. Griffin
Chief Executive Officer
/s/ Stephen E. Riffee
Stephen E. Riffee
Executive Vice President and Chief Financial Officer