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FPO > SEC Filings for FPO > Form 10-Q on 6-Aug-2013All Recent SEC Filings

Show all filings for FIRST POTOMAC REALTY TRUST

Form 10-Q for FIRST POTOMAC REALTY TRUST


6-Aug-2013

Quarterly Report


ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of the Company's financial condition and results of operations should be read in conjunction with the condensed consolidated financial statements and notes thereto appearing elsewhere in this Form 10-Q. The discussion and analysis is derived from the consolidated operating results and activities of First Potomac Realty Trust. This discussion may contain forward-looking statements based upon current expectations that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2012 and included elsewhere in this Quarterly Report on Form 10-Q. See "Special Note About Forward-Looking Statements" above.

Overview

First Potomac Realty Trust (the "Company") is a leader in the ownership, management, development and redevelopment of office and business park properties in the greater Washington, D.C. region. The Company separates its properties into four distinct reporting segments, which it refers to as the Washington, D.C., Maryland, Northern Virginia and Southern Virginia reporting segments. The Company strategically focuses on acquiring and redeveloping properties that it believes can benefit from its intensive property management and seeks to reposition these properties to increase their profitability and value. The Company's portfolio primarily contains a mix of single-tenant and multi-tenant office properties and business parks. Office properties are single-story and multi-story buildings that are used primarily for office use; and business parks contain buildings with office features combined with some industrial property space.

The Company conducts its business through First Potomac Realty Investment Limited Partnership, the Company's operating partnership (the "Operating Partnership"). The Company is the sole general partner of, and, as of June 30, 2013, owned a 95.8% interest in the Operating Partnership. The remaining interests in the Operating Partnership, which are presented as noncontrolling interests in the Operating Partnership in the accompanying unaudited condensed consolidated financial statements, are limited partnership interests, some of which are owned by several of the Company's executive officers who contributed properties and other assets to the Company upon its formation, and other unrelated parties.

At June 30, 2013, the Company wholly-owned or had a controlling interest in properties totaling 9.3 million square feet and had a noncontrolling ownership interest in properties totaling an additional 0.9 million square feet through five unconsolidated joint ventures. The Company also owned land that can accommodate approximately 1.5 million square feet of additional development. The Company's consolidated properties were 84.0% occupied by 574 tenants. The Company does not include square footage that is in development or redevelopment in its occupancy calculation, which totaled 0.1 million square feet at June 30, 2013. The Company derives substantially all of its revenue from leases of space within its properties. As of June 30, 2013, the Company's largest tenant was the U.S. Government, which along with government contractors, accounted for 23% of the Company's total annualized cash basis rent.

The primary source of the Company's revenue and earnings is rent received from tenants under long-term (generally three to ten years) operating leases at its properties, including reimbursements from tenants for certain operating costs. Additionally, the Company may generate earnings from the sale of assets either outright or contributed into joint ventures.

The Company's long-term growth will principally be driven by its ability to:

maintain and increase occupancy rates and/or increase rental rates at its properties;

continue to grow its portfolio through acquisition of new properties, potentially through joint ventures;

sell assets to third parties, or contribute properties to joint ventures, at favorable prices; and

execute initiatives designed to increase balance sheet capacity and expand the sources of capital necessary to achieve investment-grade metrics over time.

Executive Summary

For the three and six months ended June 30, 2013, the Company had net income of $14.5 million and $16.4 million, respectively, compared with a net loss of $13.2 million and $16.7 million during the three and six months ended June 30, 2012, respectively.


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Funds From Operations ("FFO") increased for the three and six months ended June 30, 2013 compared with the same periods in 2012 primarily due to a reduction in loss on debt extinguishment and reduced legal and accounting fees. During the second quarter of 2013, the Company sold the majority of its industrial portfolio (including I-66 Commerce Center), which is explained in greater detail below, for aggregate gross proceeds of $259.0 million. In connection with the sale, the Company prepaid $42.7 million of debt associated with the sold properties and used a portion of the proceeds from the sale to prepay a $16.4 million mortgage loan that encumbered Cloverleaf Center, which resulted in an aggregate $4.6 million loss on debt extinguishment for the three months ended June 30, 2013. During the second quarter of 2012, the Company recorded $13.2 million of debt extinguishment charges from the prepayment of its senior notes, and $2.5 million of legal and accounting fees associated with the Company's completed internal investigation.

FFO is a non-GAAP financial measure. For a description of FFO, including why management believes its presentation is useful and a reconciliation of FFO to net income (loss) attributable to First Potomac Realty Trust, see "Funds From Operations."

Significant Transactions

Executed on the industrial portfolio sale, a key component of the updated strategic and capital plan, which generated total gross proceeds of $259.0 million.

Successfully completed the public offering of 7,475,000 common shares, the proceeds of which were largely utilized to pay down debt.

Executed 540,000 square feet of leases, including 234,000 square feet of new leases.

Brought Redland Corporate Center, a 349,000 square foot office property in Rockville, Maryland, from 44% leased at acquisition to 100% leased.

Signed first office lease at 440 First Street, NW on Capitol Hill with Associated Builders and Contractors, Inc. for approximately 20,000 square feet.

Industrial Portfolio Sale

Consistent with the updated strategic and capital plan announced in January, during the second quarter of 2013, the Company sold 24 industrial properties, which comprised the majority of the Company's industrial portfolio and consisted of approximately 4.3 million square feet, 2.6 million square feet of which are located in Southern Virginia (the "Industrial Portfolio Sale"). The aggregate sales price of the Industrial Portfolio Sale, which consisted of two separate transactions, was $259.0 million. Specifically, on May 7, 2013, the Company sold I-66 Commerce Center, a 236,000 square foot industrial property in Haymarket, Virginia, for $17.5 million. On June 18, 2013, the Company completed the sale of the remaining 23 industrial properties to an affiliate of Blackstone Real Estate Partners VII for $241.5 million.

Proceeds from the Industrial Portfolio Sale were partially utilized to repay $42.7 million of mortgage and other indebtedness secured by the properties and to pay associated prepayment penalties and closing costs. In addition, the Company used a portion of the net proceeds from the sale to prepay a $16.4 million mortgage loan that encumbered Cloverleaf Center and to repay $121.0 million of the outstanding balance under its unsecured revolving credit facility. For tax planning purposes, the Company also placed $28.2 million of the net proceeds with a qualified intermediary in order to facilitate a potential tax-free exchange. At the time of this filing, the Company has identified several potential acquisitions that would meet the requirements for a tax-free exchange; however, the Company can provide no assurances that it will be able to complete any of the potential acquisitions, as a tax-free exchange, or at all. The Company reported a gain on the sale of the portfolio of $18.7 million in its second quarter results, and recorded an aggregate loss on debt extinguishment of $4.4 million that was associated with the repayment of debt related to the industrial properties sold in the second quarter.

Informal SEC Inquiry

As previously disclosed in the Company's Annual Report on Form 10-K for the year ended December 31, 2012, the Company has been informed that the SEC has initiated an informal inquiry relating to the matters that were the subject of the Audit Committee's internal investigation regarding the material weakness previously identified in the Company's Annual Report on Form 10-K for the year ended December 31, 2011. The SEC staff has informed the Company that this inquiry should not be construed as an indication by the SEC or its staff that any violations of law have occurred, nor considered a reflection upon any person, entity or security. The Company has been, and intends to continue, voluntarily cooperating fully with the SEC. The scope and outcome of this matter cannot be determined at this time.


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Properties:

The following sets forth certain information for the Company's consolidated properties by reporting segment as of June 30, 2013 (including properties in development and redevelopment, dollars in thousands):

WASHINGTON, D.C. REGION



                                                                                     Annualized
                                                                      Square         Cash Basis           Leased at               Occupied at
Property                               Buildings    Sub-Market(1)      Feet           Rent(2)          June 30, 2013(3)         June 30, 2013(3)
Downtown DC-Office
500 First Street, NW                       1        Capitol Hill       129,035      $      4,522                   100.0 %                  100.0 %
840 First Street, NE                       1            NoMA           247,146             7,011                   100.0 %                  100.0 %
1005 First Street, NE(4)                   1            NoMA            30,414             2,496                   100.0 %                  100.0 %
1211 Connecticut Avenue, NW                1             CBD           125,119             3,513                    97.1 %                   97.1 %

Total/Weighted Average                     4                           531,714            17,542                    99.3 %                   99.3 %

Redevelopment
440 First Street, NW                       1        Capitol Hill       138,352                -
Unconsolidated Joint Venture
1750 H Street, NW                          1             CBD           112,269             3,993                   100.0 %                   93.8 %

Region Total/Weighted Average              6                           782,335      $     21,535                    99.4 %                   98.4 %

(1) CBD = Central Business District; NoMA = North of Massachusetts Avenue.

(2) Annualized cash basis rent, which is calculated as the contractual rent due under the terms of the lease, without taking into account rent abatements, is reflected on a triple-net equivalent basis, by deducting operating expense reimbursements that are included, along with base rent, in the contractual payments of the Company's full service leases. The operating expense reimbursements primarily relate to real estate taxes and insurance expenses.

(3) Does not include space in development or redevelopment.

(4) The property was acquired through a consolidated joint venture in which the Company has a 97% controlling economic interest.


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MARYLAND REGION



                                                                                  Annualized
                                                                                  Cash Basis         Leased at           Occupied at
Property                             Buildings     Location     Square Feet        Rent(1)         June 30, 2013        June 30, 2013
Business Park
Ammendale Business Park(2)               7        Beltsville         312,846     $      4,083               100.0 %               97.0 %
Gateway 270 West                         6        Clarksburg         255,917            2,493                70.9 %               67.6 %
Girard Business Center(3)                7       Gaithersburg        297,422            2,775                79.9 %               78.9 %
Owings Mills Business Park(4)            4       Owings Mills        180,475            1,493                53.7 %               51.7 %
Rumsey Center                            4         Columbia          134,689            1,380                94.9 %               92.3 %
Snowden Center                           5         Columbia          145,180            2,144                98.9 %               98.9 %
Triangle Business Center(5)              4        Baltimore           74,429              362                50.2 %               50.2 %

Total Business Park                     37                         1,400,958           14,730                81.2 %               79.2 %
Office
Annapolis Business Center                2        Annapolis          102,374            1,689                98.8 %               98.8 %
Campus at Metro Park North               4        Rockville          190,720            3,709               100.0 %               89.6 %
Cloverleaf Center                        4        Germantown         173,766            2,065                74.1 %               74.1 %
Gateway Center                           2       Gaithersburg         44,010              510                67.1 %               67.1 %
Hillside Center                          2         Columbia           85,631              908                74.4 %               74.4 %
10320 Little Patuxent Parkway(6)         1         Columbia          136,193            1,706                81.4 %               81.0 %
Patrick Center                           1        Frederick           66,269              968                77.1 %               77.1 %
Redland Corporate Center                 2        Rockville          349,267            7,878               100.0 %               87.8 %
West Park                                1        Frederick           28,390              267                81.7 %               81.7 %
Worman's Mill Court                      1        Frederick           40,099              381                87.6 %               87.6 %

Total Office                            20                         1,216,719           20,081                89.0 %               83.9 %

Total Consolidated                      57                         2,617,677           34,811                84.8 %               81.4 %

Unconsolidated Joint Ventures
Aviation Business Park                   3       Glen Burnie         120,285              778                44.3 %               41.0 %
Rivers Park I and II                     6         Columbia          307,747            3,963                92.9 %               89.1 %

Total Joint Ventures                     9                           428,032            4,741                79.2 %               75.6 %

Region Total/Weighted Average           66                         3,045,709     $     39,552                84.1 %               80.6 %

(1) Annualized cash basis rent, which is calculated as the contractual rent due under the terms of the lease, without taking into account rent abatements, is reflected on a triple-net equivalent basis, by deducting operating expense reimbursements that are included, along with base rent, in the contractual payments of the Company's full service leases. The operating expense reimbursements primarily relate to real estate taxes and insurance expenses.

(2) Ammendale Business Park consists of the following properties: Ammendale Commerce Center and Indian Creek Court.

(3) Girard Business Center consists of the following properties: Girard Business Center and Girard Place.

(4) Owings Mills Business Park consists of the following properties: Owings Mills Business Center and Owings Mills Commerce Center.

(5) On July 15, 2013, the Company entered into a contract to sell Triangle Business Center. The sale is expected to be completed in the third quarter of 2013. However, the Company can provide no assurances regarding the timing or pricing of the sale, or that such sale will occur at all.

(6) Previously referred to as the Merrill Lynch Building.


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NORTHERN VIRGINIA REGION



                                                                                    Annualized
                                                                                    Cash Basis         Leased at           Occupied at
Property                             Buildings      Location      Square Feet        Rent(1)         June 30, 2013        June 30, 2013
Business Park
Corporate Campus at Ashburn Center       3          Ashburn            194,184     $      2,562               100.0 %              100.0 %
Gateway Centre Manassas                  3          Manassas           102,579              639                60.4 %               60.4 %
Linden Business Center                   3          Manassas           109,787            1,058                97.4 %               70.5 %
Prosperity Business Center               1         Merrifield           71,343              914               100.0 %              100.0 %
Sterling Park Business Center(2)         7          Sterling           474,808            4,417                94.9 %               91.8 %

Total Business Park                     17                             952,701            9,590                92.9 %               88.2 %
Office
Atlantic Corporate Park                  2          Sterling           219,526            1,511                40.6 %               35.3 %
Cedar Hill                               2       Tyson's Corner        102,632            2,174               100.0 %              100.0 %
Herndon Corporate Center                 4          Herndon            128,084            1,514                82.6 %               82.6 %
Lafayette Business Center(3)             5         Chantilly           221,585            3,324                85.3 %               85.3 %
One Fair Oaks                            1          Fairfax            214,214            5,284               100.0 %              100.0 %
Reston Business Campus                   4           Reston             82,372            1,075                83.2 %               76.8 %
Three Flint Hill                         1           Oakton            180,714            2,700                84.7 %               84.7 %
Van Buren Office Park                    5          Herndon            107,409            1,330                93.9 %               79.5 %
Windsor at Battlefield                   2          Manassas           155,511            1,996                90.3 %               90.3 %

Total Office                            26                           1,412,047           20,908                82.4 %               80.1 %
Industrial
Newington Business Park Center           7           Lorton            255,431            2,319                82.2 %               80.4 %
Plaza 500                                2         Alexandria          505,050            4,929                74.6 %               74.6 %

Total Industrial                         9                             760,481            7,248                77.1 %               76.5 %

Total Consolidated                      52                           3,125,229           37,746                84.3 %               81.7 %

Unconsolidated Joint Venture
Prosperity Metro Plaza                   2         Merrifield          325,987            5,933                86.0 %               86.0 %

Region Total/Weighted Average           54                           3,451,216     $     43,679                84.5 %               82.1 %

(1) Annualized cash basis rent, which is calculated as the contractual rent due under the terms of the lease, without taking into account rent abatements, is reflected on a triple-net equivalent basis, by deducting operating expense reimbursements that are included, along with base rent, in the contractual payments of the Company's full service leases. The operating expense reimbursements primarily relate to real estate taxes and insurance expenses.

(2) Sterling Park Business Center consists of the following properties: 403/405 Glenn Drive, Davis Drive, and Sterling Park Business Center.

(3) Lafayette Business Center consists of the following properties: Enterprise Center and Tech Court. On June 5, 2013, the Company sold a 32,000 square foot building at the property. The Company expects to sell an additional 34,000 square foot building at the property in the third quarter of 2013; however, the Company can provide no assurances regarding the timing or pricing of the sale of the building, or that such sale will occur at all.


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SOUTHERN VIRGINIA REGION



                                                                               Annualized
                                                                               Cash Basis         Leased at           Occupied at
Property                            Buildings    Location    Square Feet        Rent(1)         June 30, 2013        June 30, 2013
RICHMOND
Business Park
Chesterfield Business Center(2)        11        Richmond         320,321     $      1,830                85.2 %               85.2 %
Hanover Business Center                 4        Ashland          183,670              844                68.0 %               68.0 %
Park Central                            3        Richmond         204,755            2,133                91.9 %               91.9 %
Virginia Center Technology Park         1       Glen Allen        118,436            1,251                85.6 %               85.6 %

Total Richmond                         19                         827,182            6,058                83.1 %               83.1 %

NORFOLK
Business Park
Battlefield Corporate Center            1       Chesapeake         96,720              795               100.0 %              100.0 %
Crossways Commerce Center(3)            9       Chesapeake      1,087,239           11,252                94.2 %               94.2 %
Greenbrier Business Park(4)             4       Chesapeake        412,526            3,921                79.7 %               74.5 %
Norfolk Commerce Park(5)                3        Norfolk          261,848            2,492                89.6 %               78.4 %

Total Business Park                    17                       1,858,333           18,460                90.6 %               87.9 %
Office
Greenbrier Towers                       2       Chesapeake        172,609            1,685                83.1 %               82.0 %

Total Office                            2                         172,609            1,685                83.1 %               82.0 %

Total Norfolk                          19                       2,030,942           20,145                90.0 %               87.4 %

Region Total/Weighted Average          38                       2,858,124     $     26,203                88.0 %               86.1 %

(1) Annualized cash basis rent, which is calculated as the contractual rent due under the terms of the lease, without taking into account rent abatements, is reflected on a triple-net equivalent basis, by deducting operating expense reimbursements that are included, along with base rent, in the contractual payments of the Company's full service leases. The operating expense reimbursements primarily relate to real estate taxes and insurance expenses.

(2) Chesterfield Business Center consists of the following properties: Airpark Business Center, Chesterfield Business Center, and Pine Glen.

(3) Crossways Commerce Center consists of the following properties: Coast Guard Building, Crossways Commerce Center I, Crossways Commerce Center II, 1434 Crossways Boulevard, and 1408 Stephanie Way.

(4) Greenbrier Business Park consists of the following properties: Greenbrier Technology Center I, Greenbrier Technology Center II, and Greenbrier Circle Corporate Center.

(5) Norfolk Commerce Park consists of the following properties: Norfolk Business Center, Norfolk Commerce Park II, and Gateway II.


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Development and Redevelopment Activity

The Company constructs office buildings and/or business parks on a build-to-suit basis or with the intent to lease upon completion of construction. Also, the Company owns developable land that can accommodate 1.5 million square feet of additional building space, of which, 0.7 million is located in the Washington D.C reporting segment, 0.1 million in the Maryland reporting segment, 0.6 million in the Northern Virginia reporting segment and 0.1 million in the Southern Virginia reporting segment. During the second quarter of 2013, the Company sold the majority of its industrial portfolio, which included 0.9 million square feet of developable land and a parcel of land that was under development.

On December 28, 2010, the Company acquired 440 First Street, NW, a vacant eight-story office building in the Company's Washington, D.C. reporting segment. In 2011, the Company purchased 30,000 square feet of transferable development rights for $0.3 million. The Company anticipates completing the redevelopment of the 138,000 square foot property in the third quarter of 2013. At June 30, 2013, the Company's total investment in the redevelopment project was $47.3 million, which included the original cost basis of the property of $23.6 million.

During the second quarter of 2013, the Company did not place in-service any development or redevelopment efforts.

Lease Expirations

Approximately 6.2% of the Company's annualized cash basis rent, excluding month-to-month leases (which represent 0.4% of the Company's annualized cash basis rent), is scheduled to expire during the remainder of 2013. Current tenants are not obligated to renew their leases upon the expiration of their terms. If non-renewals or terminations occur, the Company may not be able to locate qualified replacement tenants and, as a result, could lose a significant source of revenue while remaining responsible for the payment of its financial obligations. Moreover, the terms of a renewal or new lease, including the amount of rent, may be less favorable to the Company than the current lease terms, or the Company may be forced to provide tenant improvements at its expense or provide other concessions or additional services to maintain or attract tenants. We continually strive to increase our portfolio occupancy, and the amount of vacant space in our portfolio at any given time may impact our willingness to . . .

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