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Corporate Office Properties Trust 10-Q 2011
UNITED STATES 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 September 30, 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)
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.
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 October 17, 2011, 71,986,146 of the Company’s Common Shares of Beneficial Interest, $0.01 par value, were issued and outstanding.
FORM 10-Q
Corporate Office Properties Trust and Subsidiaries (in thousands, except share data) (unaudited)
See accompanying notes to consolidated financial statements.
Corporate Office Properties Trust and Subsidiaries Consolidated Statements of Operations (in thousands, except per share data) (unaudited)
See accompanying notes to consolidated financial statements.
Corporate Office Properties Trust and Subsidiaries Consolidated Statements of Equity (in thousands, except share data) (unaudited)
See accompanying notes to consolidated financial statements.
Corporate Office Properties Trust and Subsidiaries Consolidated Statements of Cash Flows (in thousands) (unaudited)
See accompanying notes to consolidated financial statements.
Corporate Office Properties Trust and Subsidiaries Consolidated Statements of Cash Flows (in thousands) (unaudited)
See accompanying notes to consolidated financial statements.
Corporate Office Properties Trust and Subsidiaries
Notes to Consolidated Financial Statements (unaudited)
1. Organization
Corporate Office Properties Trust (“COPT”) and subsidiaries (collectively, the “Company,” “we” or “us”) is a fully-integrated and self-managed real estate investment trust (“REIT”) that focuses primarily on 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 September 30, 2011, our investments in real estate included the following:
· 246 wholly owned operating office properties totaling 20.2 million square feet; · 16 wholly owned office properties under construction, development or redevelopment that we estimate will total approximately 2.1 million square feet upon completion, including three partially operational properties included above; · wholly owned land parcels totaling 1,520 acres that we believe are potentially developable into approximately 13.1 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 September 30, 2011 follows:
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 September 30, 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.
Reclassifications
We reclassified certain amounts from prior periods to conform to the current period presentation of our consolidated financial statements with no effect on previously reported net income or equity.
Recent Accounting Pronouncements
In May 2011, the Financial Accounting Standards Board (“FASB”) issued guidance to amend measurement and disclosure requirements related to fair value measurements to improve consistency with International Financial Reporting Standards. This guidance will be effective prospectively for interim and annual periods beginning after December 15, 2011. We are in the process of evaluating this guidance and currently do not believe that it will have a material effect on our consolidated financial statements.
In June 2011, the FASB issued guidance on the presentation of comprehensive income that will require us to present the total of comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. This guidance eliminates the option to present the components of other comprehensive income as part of the statement of equity. This guidance requires retrospective application and is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011.
In September 2011, the FASB issued guidance on the testing of goodwill for impairment that will permit us to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. This guidance eliminates the requirement to calculate the fair value of a reporting unit unless the entity determines that it is more likely than not that its fair value is less than its carrying amount. The guidance will be effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. We are in the process of evaluating this guidance and currently do not believe that it will have a material effect on our consolidated financial statements.
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 September 30, 2011 and the hierarchy level of inputs used in measuring their respective fair values under applicable accounting standards (in thousands):
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.
For additional fair value information, please refer to Note 7 for mortgage loans receivable, Note 8 for debt and Note 9 for interest rate derivatives.
4. Properties, net
Operating properties, net consisted of the following (in thousands):
Properties under construction or development consisted of the following (in thousands):
Strategic Reallocation Plan and Impairment Losses
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, and 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”). We subsequently identified additional properties with an increased likelihood of a shortened holding period. 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. Accordingly, during the second quarter of 2011, we recognized aggregate non-cash impairment losses of $44.6 million (including $14.5 million classified as discontinued operations and excluding $4.6 million in related income tax benefit) for the amounts by which the carrying values of the Impaired Properties exceeded their respective estimated fair values.
The properties to be disposed of pursuant to the Strategic Reallocation Plan consist primarily of office properties in certain submarkets in the Greater Baltimore, Suburban Maryland and St. Mary’s County regions that no longer fit our strategic focus. 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. We completed the sale of the following properties under the Strategic Reallocation Plan during the nine months ended September 30, 2011 (dollars in thousands):
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, 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 March 2011 for the amount by which the carrying value of the property exceeded its estimated fair value.
2011 Acquisition
On August 9, 2011, we acquired 310 The Bridge Street, a 138,000 square foot office property in Huntsville, Alabama that was 100% leased, for $33.4 million. The table below sets forth the allocation of the acquisition costs of this property (in thousands):
Intangible assets recorded in connection with the above acquisitions included the following (dollars in thousands):
We expensed $152,000 in the nine months ended September 30, 2011 in connection with acquisitions of operating properties that are included in business development expenses on our consolidated statements of operations.
2011 Construction and Redevelopment Activities
During the nine months ended September 30, 2011, we had two newly constructed office properties totaling 228,000 square feet, including one in the Baltimore/Washington Corridor and one in Greater Baltimore, become fully operational (79,000 of these square feet were placed into service in 2010) and placed into service 61,000 square feet in one partially operational office property in the Baltimore/Washington Corridor.
As of September 30, 2011, we had construction underway on ten office properties totaling 1.2 million square feet, including four in the Baltimore/Washington Corridor, two in Greater Baltimore, one in San Antonio, one in Northern Virginia, one in Huntsville, Alabama and one in St. Mary’s County. We also had redevelopment underway on two office properties totaling 297,000 square feet, including one in Northern Virginia and one in Greater Philadelphia.
5. Real Estate Joint Ventures
During the nine months ended September 30, 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 (dollars in thousands):
The following table sets forth condensed balance sheets for this unconsolidated real estate joint venture (in thousands):
The following table sets forth condensed statements of operations for this unconsolidated real estate joint venture (in thousands):
The table below sets forth information pertaining to our investments in consolidated real estate joint ventures at September 30, 2011 (dollars in thousands):
(1) Excludes amounts eliminated in consolidation. (2) This joint venture’s properties are in College Park, Maryland (in the Suburban Maryland region). (3) This joint venture’s property is in Huntsville, Alabama. (4) This joint venture’s property is in Hanover, Maryland (in the Baltimore/Washington Corridor). (5) This joint venture’s property is in Charles County, Maryland. (6) This joint venture’s property is in Lanham, Maryland (in the Suburban Maryland region).
Our commitments and contingencies pertaining to our real estate joint ventures are disclosed in Note 16.
6. Intangible Assets on Real Estate Acquisitions
Intangible assets on real estate acquisitions consisted of the following (in thousands):
Amortization of the intangible asset categories set forth above totaled $20.7 million in the nine months ended September 30, 2011 and $18.8 million in the nine months ended September 30, 2010. The approximate weighted average amortization periods of the categories set forth above follow: in-place lease value: seven years; tenant relationship value: eight years; above-market cost arrangements: 26 years; above-market leases: five years; and market concentration premium: 31 years. The approximate weighted average amortization period for all of the categories combined is ten years. Estimated amortization expense associated with the intangible asset categories set forth above for the next five years is: $5.7 million for the three months ending December 31, 2011; $18.5 million for 2012; $14.3 million for 2013; $12.0 million for 2014; $10.0 million for 2015; and $8.6 million for 2016.
7. Prepaid Expenses and Other Assets
Prepaid expenses and other assets consisted of the following (in thousands):
Investment in The KEYW Holding Corporation
Our investment in KEYW consists of common stock and warrants to purchase additional shares of common stock of KEYW. We owned 2.6 million shares, or approximately 10%, of KEYW’s common stock at September 30, 2011 and 3.1 million shares, or approximately 12%, at December 31, 2010. The carrying value of our equity method investment in these common shares was $22.3 million at December 31, 2010, which was included in prepaid expenses and other assets on our consolidated balance sheet as of such date. In March 2011, we entered into a sales plan that 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; we completed the sale of 500,000 shares under this plan in the three months ended June 30, 2011, resulting in $2.1 million in gain recognized. We subsequently suspended this plan effective June 30, 2011. We used the equity method of accounting for our investment in the common stock until the resignation of our Chief Executive Officer from the Board of Directors of KEYW effective July 1, 2011, at which time we began accounting for our investment in KEYW’s common stock as a trading marketable equity security to be reported at fair value, with unrealized gains and losses recognized through earnings. Our investment in these common shares had a fair value of $18.3 million at September 30, 2011 based on the closing price of KEYW’s common stock on the NASDAQ Stock Market on that date and is included in the line entitled “restricted cash and marketable securities” on our consolidated balance sheet. We recognized an unrealized loss on our investment in KEYW’s common stock of $883,000 during the three months ended September 30, 2011.
At September 30, 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 $121,000, or $2.42 per warrant, at September 30, 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):
Our mortgage loans receivable reflected above consists of three loans secured by properties in the Baltimore/Washington Corridor and Greater Baltimore. Our notes receivable from the City of Huntsville funded infrastructure costs in connection with our LW Redstone Company, LLC joint venture. We did not have an allowance for credit losses in connection with these receivables at September 30, 2011 or December 31, 2010. The fair value of our mortgage and other investing receivables totaled $36.0 million at September 30, 2011 and $18.8 million at December 31, 2010.
Operating Notes Receivable
We had operating notes receivable due from tenants with terms exceeding one year totaling $628,000 at September 30, 2011 and $655,000 at December 31, 2010. We carried allowances for estimated losses for most of these balances.
8. Debt
Our debt consisted of the following (dollars in thousands):
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