On October 4, 2006, the Partnership issued $300 million aggregate principal amount of exchangeable guaranteed notes due October 15, 2026 with a coupon of 3.875%. On October 16, 2006, the Partnership issued an additional $45 million aggregate principal amount of notes to cover over-allotments.
The Partnership used the net proceeds from the sale of the notes to repurchase approximately $60 million of outstanding common units (1,829,000 common units at a price of $32.80 per unit); to repay approximately $180 million under the Partnership’s revolving credit facility; and to invest the balance in short term securities pending redemption of the Partnership’s $300 million Floating Rate Guaranteed Notes due 2009 on January 2, 2007.
The notes will be exchangeable for cash and common shares at an initial exchange rate of 25.4065 common shares per $1,000 principal amount of notes (equivalent to an initial exchange price of approximately $39.36 per common share). The initial exchange price represents a 20% premium to the last reported sales price prior to issuance for the common shares on the New York Stock Exchange on September 28, 2006. The exchange value will be based on the exchange rate and the then trading price of the common shares. The initial exchange rate is subject to adjustment in certain circumstances.
The repurchase of 1,829,000 common shares with a portion of the proceeds of the notes did not reduce the 2,319,800 common shares that may be repurchased under the Company’s Board-approved share repurchase program.
Back to Contents
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements. This Quarterly Report on Form 10-Q and other materials filed by us with the SEC (as well as information included in oral or other written statements made by us) contain statements that are forward-looking, including statements relating to business and real estate development activities, acquisitions, dispositions, future capital expenditures, financing sources, governmental regulation (including environmental regulation) and competition. The words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “will,” “should” and similar expressions, as they relate to us, are intended to identify forward-looking statements. Although we believe that the expectations reflected in such forward-looking statements are based on reasonable assumptions, we can give no assurance that our expectations will be achieved. As forward-looking statements, these statements involve important risks, uncertainties and other factors that could cause actual results to differ materially from the expected results and, accordingly, such results may differ from those expressed in any forward-looking statements made by us or on our behalf. Factors that could cause actual results to differ materially from our expectations include, but are not limited to, changes in general economic conditions, changes in local real estate conditions (including changes in rental rates and the number of competing properties), changes in the economic conditions affecting industries in which our principal tenants compete, our failure to lease unoccupied space in accordance with our projections, our failure to re-lease occupied space upon expiration of leases, the bankruptcy of major tenants, changes in prevailing interest rates, the unavailability of equity and debt financing, unanticipated costs associated with the acquisition and integration of our acquisitions, unanticipated costs to complete and lease-up pending developments, impairment charges, increased costs for, or lack of availability of, adequate insurance, including for terrorist acts, demand for tenant services beyond those traditionally provided by landlords, potential liability under environmental or other laws, earthquakes and other natural disasters, the existence of complex regulations relating to our status as a REIT and to our acquisition, disposition and development activities, the adverse consequences of our failure to qualify as a REIT, the impact of newly adopted accounting principles on our accounting policies and on period-to-period comparisons of financial results and the other risks identified in the “Risk Factors” section and elsewhere in our Annual Report on Form 10-K for the year ended December 31, 2005. Given these uncertainties, we caution readers not to place undue reliance on forward-looking statements. We assume no obligation to update or supplement forward-looking statements that become untrue because of subsequent events except as required by law.
OVERVIEW
As of September 30, 2006, we managed our portfolio within nine geographic segments: (1) Pennsylvania—West, (2) Pennsylvania—North, (3) New Jersey, (4) Urban, (5) Richmond, Virginia, (6) California—North, (7) California—South, (8) Mid-Atlantic and (9) Southwest. We believe we have established an effective platform in these office and industrial markets for maximizing market penetration, optimizing operating economies of scale and creating long-term investment value.
Through our January 2006 acquisition of Prentiss, we acquired interests in properties that contain an aggregate of 14.0 million net rentable square feet. Through this acquisition, we also entered into new markets, including markets in California, Northern Virginia, Maryland, and Texas.
Subsequent to our acquisition of Prentiss and the related sale of certain of Prentiss’s properties to Prudential, we sold 11 additional properties that contain an aggregate of 2.3 million net rentable square feet and one parcel of land containing 10.9 acres.
As of September 30, 2006, our portfolio consisted of 277 office properties, 23 industrial facilities and one mixed-use property that contain an aggregate of approximately 30.0 million net rentable square feet. We held economic interests in 11 unconsolidated real estate ventures that contain approximately 2.7 million net rentable square feet (the “Real Estate Ventures”) formed with third parties to develop or own commercial properties. In addition, as of September 30, 2006 we owned interests in four consolidated real estate ventures that own 15 office properties containing approximately 1.5 million net rentable square feet.
We receive income primarily from rental revenue (including tenant reimbursements) from our properties and, to a lesser extent, from the management of properties owned by third parties and from investments in the Real Estate Ventures.
32
Back to Contents
Our financial performance is dependent upon the demand for office, industrial and other commercial space in our markets and upon prevailing interest rates.
We continue to seek revenue growth through an increase in occupancy of our portfolio and our investment strategies. Our occupancy was 91.3% at September 30, 2006, or 90.2% including four lease-up properties that we acquired in our September 2004 acquisition of a portfolio of 14 properties (the “TRC Properties” or the “TRC acquisition”).
The Prentiss acquisition and the TRC acquisition, and to a lesser extent, other property acquisitions have already or will materially impact our operations. Accordingly, the reported historical financial information for periods prior to these transactions is not believed to be fully indicative of our future operating results or financial condition.
As we seek to increase revenue through our operating activities, our management also focuses on strategies to minimize operating risks, including (i) tenant rollover risk, (ii) tenant credit risk and (iii) development risk.
Tenant Rollover Risk:
We are subject to the risk that tenant leases, upon expiration, are not renewed, that space may not be relet, or that the terms of renewal or reletting (including the cost of renovations) may be less favorable to us than the current lease terms. Leases accounting for approximately 2.9% of our aggregate annualized base rents as of September 30, 2006 (representing approximately 2.9% of the net rentable square feet of the Properties) expire without penalty through the end of 2006. We maintain an active dialogue with our tenants in an effort to achieve a high level of lease renewals. Our retention rate for leases that were scheduled to expire in the nine-month period ended September 30, 2006 was 73.4%. If we were unable to renew leases for a substantial portion of the space under expiring leases, or to promptly relet this space, at anticipated rental rates, our cash flow would be adversely impacted.
Tenant Credit Risk:
In the event of a tenant default, we may experience delays in enforcing our rights as a landlord and may incur substantial costs in protecting our investment. Our management regularly evaluates our accounts receivable reserve policy in light of its tenant base and general and local economic conditions. The accounts receivable allowances were $8.8 million or 8.9% of total receivables (including accrued rent receivable) as of September 30, 2006 compared to $4.9 million or 7.6% of total receivables (including accrued rent receivable) as of December 31, 2005.
Development Risk:
As of September 30, 2006, we had in development or redevelopment eleven sites aggregating approximately 2.2 million square feet. We estimate the total cost of these projects to be $523.2 million and we had incurred $302.9 million of these costs as of September 30, 2006. We are actively marketing space at these projects to prospective tenants but can provide no assurance as to the timing or terms of any leases of space at these projects. As of September 30, 2006, we owned approximately 378 acres of undeveloped land. Risks associated with development of this land include construction cost increases or overruns and construction delays, insufficient occupancy rates, building moratoriums and inability to obtain zoning, land-use, building, occupancy and other required governmental approvals.
ACQUISITIONS AND DISPOSITIONS OF REAL ESTATE INVESTMENTS
On January 5, 2006, we acquired Prentiss pursuant to an Agreement and Plan of Merger that we entered into with Prentiss on October 3, 2005. In conjunction with our acquisition of Prentiss, designees of The Prudential Insurance Company of America (“Prudential”) acquired certain Prentiss properties that contain an aggregate of approximately 4.32 million net rentable square feet for total consideration of approximately $747.7 million. Through our acquisition of Prentiss (and after giving effect to the Prudential acquisition of certain Prentiss properties), we acquired a portfolio of 79 office properties (including 13 properties that are owned by consolidated real estate ventures and seven properties that are owned by unconsolidated real estate ventures) that contain an aggregate of 14.0 million net rentable square feet.
Subsequent to our acquisition of Prentiss and the related sale of properties to Prudential, through September 30, 2006, we sold 11 additional properties acquired from Prentiss that contain an aggregate of 2.3 million net rentable square feet and one parcel of land containing 10.9 acres.
33
Back to Contents
In our acquisition of Prentiss, each then outstanding Prentiss common share was converted into the right to receive 0.69 of a Brandywine common share and $21.50 in cash except that 497,884 Prentiss common shares held in the Prentiss Deferred Compensation Plan converted solely into 720,737 Brandywine common shares. In addition, each then outstanding unit of limited partnership interest in Prentiss’s operating partnership subsidiary was, at the option of the holder, converted into Prentiss Common Shares with the right to receive the per share merger consideration or 1.3799 Class A Units of our Operating Partnership. Accordingly, based on 49,375,723 Prentiss common shares outstanding and 139,000 Prentiss OP Units electing to receive merger consideration at closing of the acquisition, we issued 34,541,946 Brandywine common shares and paid an aggregate of approximately $1.05 billion in cash for the accounts of the former Prentiss shareholders. Based on 1,572,612 Prentiss OP Units outstanding at closing of the acquisition, we issued 2,170,047 Brandywine Class A Units. In addition, options issued by Prentiss that were exercisable for an aggregate of 342,662 Prentiss common shares were converted into options exercisable for an aggregate of 496,037 Brandywine common shares at a weighted average exercise price of $22.00 per share. Through our acquisition of Prentiss we assumed approximately $611.2 million in aggregate principal amount of Prentiss debt.
Each Brandywine Class A Unit that we issued in the merger is subject to redemption at the option of the holder. At our option, we may satisfy the redemption either for an amount, per unit, of cash equal to the then market price of one Brandywine common share (based on the prior ten-day trading average) or for one Brandywine common share.
In addition to the acquisition activity related to Prentiss, during the nine-month period ended September 30, 2006, we also acquired four office properties containing 681,688 net rentable square feet and 76.6 acres of developable land for an aggregate purchase price of $180.6 million. In addition to sales of assets acquired in the Prentiss merger, we sold two office properties containing 216,554 net rentable square feet and two parcels of land containing 6.8 acres for an aggregate $43.5 million, realizing net gains totaling $6.0 million.
In addition to the acquisition activity related to Prentiss, during the three-month period ended September 30, 2006, we acquired two office properties containing 443,581 net rentable square feet for $133.2 million. In addition to sales of assets acquired in the Prentiss merger, we sold two office properties containing 216,554 net rentable square feet for $38.6 million, realizing net gains totaling $3.4 million.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Certain accounting policies are considered to be critical accounting policies, as it requires management to make assumptions about matters that are highly uncertain at the time the estimate is made and changes in accounting policies are reasonably likely to occur from period to period. Management bases its estimates and assumptions on historical experience and current economic conditions. On an on-going basis, management evaluates its estimates and assumptions including those related to revenue, impairment of long-lived assets and the allowance for doubtful accounts. Actual results may differ from those estimates and assumptions.
Our Annual Report on Form 10-K for the year ended December 31, 2005 contains a discussion of our critical accounting policies. There have been no significant changes in our critical accounting policies since December 31, 2005. See also Note 2 in our unaudited consolidated financial statements for the nine-month period ended September 30, 2006 as set forth herein. Management discusses our critical accounting policies and management’s judgments and estimates with our Audit Committee.
34
Back to Contents
RESULTS OF OPERATIONS
Comparison of the Three-Month Periods Ended September 30, 2006 and 2005
The table below shows selected operating information for the Same Store Property Portfolio and the Total Portfolio. The Same Store Property Portfolio consists of 238 Properties containing an aggregate of approximately 17.8 million net rentable square feet that we owned for the entire three-month periods ended September 30, 2006 and 2005. This table also includes a reconciliation from the Same Store Property Portfolio to the Total Portfolio net income (i.e., all properties owned by us during the three-month periods ended September 30, 2006 and 2005) by providing information for the properties which were acquired, under development (including lease-up assets) or placed into service and administrative/elimination information for the three-month periods ended September 30, 2006 and 2005 (in thousands).
35
Back to Contents
Comparison of three-months ended September 30, 2006 to the three-months ended September 30, 2005
| | Same Store Property Portfolio | | Prentiss
Portfolio | | Properties
Acquired | | Development
Properties (a) | | Administrative/
Eliminations (b) | | Total Portfolio | |
| |
| |
| |
| |
| |
| |
| |
(dollars in thousands) | | 2006 | | 2005 | | Increase/
(Decrease) | | %
Change | | 2006 | | 2005 | | 2006 | | 2005 | | 2006 | | 2005 | | 2006 | | 2005 | | 2006 | | 2005 | | Increase/
(Decrease) | | %
Change | |
| |
| |
| |
| |
| |
| |
| |
| |
| |
| |
| |
| |
| |
| |
| |
| |
| |
Revenue: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Cash rents | | $ | 75,669 | | $ | 73,742 | | $ | 1,927 | | 3 | % | $ | 54,059 | | $ | — | | $ | 3,231 | | $ | 41 | | $ | 6,518 | | $ | 1,916 | | $ | 157 | | $ | 41 | | $ | 139,634 | | $ | 75,740 | | $ | 63,894 | | 84 | % |
Straight-line rents | | | 1,272 | | | 3,461 | | | (2,189 | ) | -63 | % | | 2,602 | | | — | | | 230 | | | — | | | 3,379 | | | 825 | | | — | | | — | | | 7,483 | | | 4,286 | | | 3,197 | | 75 | % |
Rents - FAS 141 | | | 688 | | | 324 | | | 364 | | 112 | % | | 1,413 | | | — | | | 218 | | | — | | | (62 | ) | | (62 | ) | | — | | | — | | | 2,257 | | | 262 | | | 1,995 | | 761 | % |
| |
|
| |
|
| |
|
| |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| |
Total rents | | | 77,629 | | | 77,527 | | | 102 | | 0 | % | | 58,074 | | | — | | | 3,679 | | | 41 | | | 9,835 | | | 2,679 | | | 157 | | | 41 | | | 149,374 | | | 80,288 | | | 69,086 | | 86 | % |
Tenant reimbursements | | | 14,026 | | | 11,397 | | | 2,629 | | 23 | % | | 8,566 | | | — | | | 253 | | | 3 | | | 890 | | | 217 | | | 67 | | | 93 | | | 23,802 | | | 11,710 | | | 12,092 | | 103 | % |
Other (c) | | | 5,127 | | | 1,176 | | | 3,951 | | 336 | % | | 454 | | | — | | | 156 | | | — | | | 52 | | | 528 | | | 2,629 | | | 1,325 | | | 8,418 | | | 3,029 | | | 5,389 | | 178 | % |
| |
|
| |
|
| |
|
| |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| |
Total revenue | | | 96,782 | | | 90,100 | | | 6,682 | | 7 | % | | 67,094 | | | — | | | 4,088 | | | 44 | | | 10,777 | | | 3,424 | | | 2,853 | | | 1,459 | | | 181,594 | | | 95,027 | | | 86,567 | | 91 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Operating Expenses: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Property operating expenses | | | 30,856 | | | 27,748 | | | 3,108 | | 11 | % | | 20,319 | | | — | | | 900 | | | 8 | | | 3,797 | | | 1,537 | | | (2,407 | ) | | (2,629 | ) | | 53,465 | | | 26,664 | | | 26,801 | | 101 | % |
Real estate taxes | | | 9,619 | | | 8,851 | | | 768 | | 9 | % | | 6,332 | | | — | | | 389 | | | 2 | | | 1,173 | | | 768 | | | 707 | | | 123 | | | 18,220 | | | 9,744 | | | 8,476 | | 87 | % |
Administrative expenses | | | — | | | — | | | — | | 0 | % | | — | | | — | | | — | | | — | | | — | | | — | | | 6,490 | | | 4,486 | | | 6,490 | | | 4,486 | | | 2,004 | | 45 | % |
| |
|
| |
|
| |
|
| |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| |
Total property operating expenses | | | 40,475 | | | 36,599 | | | 3,876 | | 11 | % | | 26,651 | | | — | | | 1,289 | | | 10 | | | 4,970 | | | 2,305 | | | 4,790 | | | 1,980 | | | 78,175 | | | 40,894 | | | 37,281 | | 91 | % |
Subtotal | | | 56,307 | | | 53,501 | | | 2,806 | | 5 | % | | 40,443 | | | — | | | 2,799 | | | 34 | | | 5,807 | | | 1,119 | | | (1,937 | ) | | (521 | ) | | 103,419 | | | 54,133 | | | 49,286 | | 91 | % |
Depreciation and amortization | | | 29,588 | | | 26,581 | | | 3,007 | | 11 | % | | 31,875 | | | — | | | 1,048 | | | — | | | 5,157 | | | 1,704 | | | 609 | | | (55 | ) | | 68,277 | | | 28,230 | | | 40,047 | | 142 | % |
| |
|
| |
|
| |
|
| |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| |
Operating Income (loss) | | $ | 26,719 | | $ | 26,920 | | $ | (201 | ) | -1 | % | $ | 8,568 | | $ | — | | $ | 1,751 | | $ | 34 | | $ | 650 | | $ | (585 | ) | $ | (2,546 | ) | $ | (466 | ) | $ | 35,142 | | $ | 25,903 | | $ | 9,239 | | 36 | % |
Number of properties | | | 238 | | | | | | | | | | | 61 | | | | | | 6 | | | | | | 11 | | | | | | | | | | | | 316 | | | | | | | | | |
Square feet | | | 17,828 | | | | | | | | | | | 10,590 | | | | | | 964 | | | | | | 2,101 | | | | | | | | | | | | 31,483 | | | | | | | | | |
Other Income (Expense): | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Interest income | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 2,479 | | | 304 | | | 2,175 | | 715 | % |
Interest expense | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | (45,402 | ) | | (17,762 | ) | | (27,640 | ) | 156 | % |
Equity in income of real estate ventures | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 370 | | | 745 | | | (375 | ) | -50 | % |
Net gain on sales of interests in real estate | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | — | | | 4,640 | | | (4,640 | ) | 100 | % |
Gain on termination of purchase contract | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 3,147 | | | — | | | 3,147 | | 100 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
|
| |
|
| |
|
| |
| |
Income (loss) before minority interest | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | (4,264 | ) | | 13,830 | | | (18,094 | ) | -131 | % |
Minority interest - partners’ share of consolidated real estate ventures | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 279 | | | (41 | ) | | 320 | | -780 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
|
| |
|
| |
|
| |
| |
Income (loss) from continuing operations | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | (3,985 | ) | | 13,789 | | | (17,774 | ) | -129 | % |
Income (loss) from discontinued operations | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 4,273 | | | 2,406 | | | 1,867 | | 78 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
|
| |
|
| |
|
| |
| |
Net Income (loss) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | $ | 288 | | $ | 16,195 | | $ | (15,907 | ) | -98 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
|
| |
|
| |
|
| |
| |
Earnings per common partnership unit | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | $ | (0.02 | ) | $ | 0.24 | | $ | (0.26 | ) | -108 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
|
| |
|
| |
|
| |
| |
EXPLANATORY NOTES
(a) - Results include: three redevelopments; four lease-up assets; three properties placed in service; and Cira Centre
(b) - Represents certain revenues and expenses at the corporate level as well as various intercompany costs that are eliminated in consolidation
(c) - Includes net termination fee income of $4,338 for 2006 and $510 for 2005 for the same store property portfolio and $165 for 2006 for the Prentiss portfolio
36
Back to Contents
Revenue
Revenue increased by $86.6 million primarily due to the acquisition of Prentiss, which represents $67.1 million of this increase. The increase is also the result of two properties that we acquired in the fourth quarter of 2005, one property acquired in the first quarter of 2006, one property acquired in the second quarter of 2006, two properties acquired in the third quarter of 2006 and additional tenant occupancy at Cira Centre (included in Development Properties).
Revenues also increased by $2.6 million for tenant reimbursements as a result of increased property operating expenses for our same store portfolio. Our termination fee income increased by $3.8 million as result of tenant move-outs.
Operating Expenses and Real Estate Taxes
Property operating expenses increased by $26.8 million primarily due to the acquisition of Prentiss, which represents $20.3 million of this increase. Property operating expenses attributable to the occupied portion of Cira Centre and other properties acquired accounted for $4.7 million of the increase with the remainder of the increase attributable to increased property operating expenses for our same store portfolio.
Real estate taxes increased by $8.5 million primarily due to the acquisition of Prentiss, which represents $6.3 million of this increase. The remainder of the increase is primarily the result of increased real estate tax assessments in our same store properties and properties acquired or under development.
Depreciation and Amortization Expense
Depreciation and amortization increased by $40.0 million primarily due to the acquisition of Prentiss, which increased total portfolio depreciation expense by $31.9 million. The remaining increase is the result of the timing of assets being placed in service upon completion of tenant improvement and capital improvement projects subsequent to the end of the three month period ending September 30, 2005. A significant portion of the remaining increased depreciation for tenant improvements relates to Cira Centre where tenants have taken occupancy.
Administrative Expenses
Administrative expenses increased by approximately $2.0 million primarily due to the acquisition of Prentiss. Of this increase, $0.9 million was primarily attributable to increased payroll and related costs associated with employees that we hired as part of the acquisition of Prentiss. We also incurred an additional $0.6 million in professional fees in connection with our merger integration activities. The remainder of the increase reflects other increased costs of the combined companies.
Interest Income/ Expense
Interest expense increased by approximately $27.6 million primarily as a result of 14 fixed rate mortgages, three unsecured notes, and one note secured by U.S. treasury notes (“PPREFI debt”) that we assumed or entered into to finance the Prentiss merger. The mortgages assumed have maturity dates ranging from July 2009 through March 2016 and the unsecured notes have maturities of March, April, and July 2035, and the PPREFI debt has a maturity of February 2007.
The PPREFI debt was defeased by Prentiss in the fourth quarter of 2005 and is secured by an investment in U.S. treasury notes. The interest earned on the treasury notes is included in interest income and substantially offsets the amount of interest expense incurred on the PPREFI debt, resulting in an immaterial amount of net interest expense incurred. The increase of $2.2 million in interest income is primarily attributable to the interest income earned on these treasury notes.
See the Notes to the Unconsolidated Combined Financial Statements in Part I, Item I for details of our mortgage indebtedness and unsecured notes outstanding.
37
Back to Contents
Minority Interest-partners’ share of consolidated real estate ventures
Minority interest-partners’ share of consolidated real estate ventures increased by $0.3 million from the prior year as a result of our acquisition of one consolidated joint venture as part of our acquisition of Prentiss. This consolidated joint venture, of which we own 51%, owns 13 properties which aggregate approximately 1.2 million square feet of office space.
Subsequent to our acquisition of Prentiss, we entered into a joint venture with IBM. We consolidate this joint venture, and own a 50% interest in it.
As of September 30, 2006 we held an ownership interest in 15 properties through consolidated joint ventures, compared to two properties owned by consolidated joint ventures at September 30, 2005.
Discontinued Operations
Income from discontinued operations increased by $1.9 million from the prior year as a result of the sale of one property in Dallas, TX and one property in Chicago, IL that we acquired in the Prentiss acquisition. We also sold two properties that were previously included in our same store portfolio. These four properties combined had net income of $1.2 million and gains on sale of $5.2 million during the quarter ended September 30, 2006. Included in the gain on sale amount was $1.8 million attributable to minority interest in the Chicago property. During the quarter ended September 30, 2005, we sold one property that had net income of $0.1 million and a gain on sale of $2.2 million.
Net Income
Net income declined in the third quarter of 2006, compared to the third quarter of 2005, by $15.2 million as increased revenues were offset by increases in operating costs (primarily depreciation and amortization) and financing costs. All major financial statement captions increased as a result of our acquisition of Prentiss and the related financing required to complete the transaction. A significant element of these costs relate to additional depreciation and amortization charges relating to the significant property additions (including both the TRC acquisition and the Prentiss acquisition) and the values ascribed to related acquired intangibles (e.g., in-place leases). These charges do not affect our ability to pay dividends and may not be comparable to those of other real estate companies that have not made such acquisitions. Such charges can be expected to continue until the values ascribed to the lease intangibles are fully amortized. These intangibles are amortizing over the related lease terms or estimated tenant relationship.
Earnings Per Common Partnership Unit
Earnings per partnership unit was $0.24 in the third quarter of 2005 as compared to a loss per unit of $(0.02) in the third quarter of 2006 as a result of the factors described in “Net Income” above and an increase in the average number of common units outstanding. We issued 34.6 million of our common units in our acquisition of Prentiss.
38
Back to Contents
Comparison of the Nine-Month Periods Ended September 30, 2006 and 2005
The table below shows selected operating information for the Same Store Property Portfolio and the Total Portfolio. The Same Store Property Portfolio consists of 238 Properties containing an aggregate of approximately 17.8 million net rentable square feet that we owned for the entire nine-month periods ended September 30, 2006 and 2005. This table also includes a reconciliation from the Same Store Property Portfolio to the Total Portfolio net income (i.e., all properties owned by us during the nine-month periods ended September 30, 2006 and 2005) by providing information for the properties which were acquired, under development (including lease-up assets) or placed into service and administrative/elimination information for the nine-month periods ended September 30, 2006 and 2005 (in thousands).
39
Back to Contents
Comparison of the nine-months ended September 30, 2006 to the nine-months ended September 30, 2005
| | Same Store Property Portfolio | | Prentiss
Portfolio | | Properties
Acquired | | Development
Properties (a) | | Administrative/
Eliminations (b) | | Total Portfolio | |
| |
| |
| |
| |
| |
| |
| |
(dollars in thousands) | | 2006 | | 2005 | | Increase/
(Decrease) | | %
Change | | 2006 | | 2005 | | 2006 | | 2005 | | 2006 | | 2005 | | 2006 | | 2005 | | 2006 | | 2005 | | Increase/
(Decrease) | | %
Change | |
| |
| |
| |
| |
| |
| |
| |
| |
| |
| |
| |
| |
| |
| |
| |
| |
| |
Revenue: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Cash rents | | $ | 226,393 | | $ | 224,811 | | $ | 1,582 | | 1 | % | $ | 158,050 | | $ | — | | $ | 6,843 | | $ | 41 | | $ | 16,743 | | $ | 5,069 | | $ | 531 | | $ | 125 | | $ | 408,560 | | $ | 230,046 | | $ | 178,514 | | 78 | % |
Straight-line rents | | | 6,591 | | | 8,346 | | | (1,755 | ) | -21 | % | | 8,424 | | | — | | | 483 | | | — | | | 7,464 | | | 1,854 | | | — | | | — | | | 22,962 | | | 10,200 | | | 12,762 | | 125 | % |
Rents - FAS 141 | | | 1,938 | | | 951 | | | 987 | | 104 | % | | 4,486 | | | — | | | 152 | | | — | | | (186 | ) | | (180 | ) | | 1 | | | 190 | | | 6,391 | | | 961 | | | 5,430 | | 565 | % |
| |
|
| |
|
| |
|
| |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| |
Total rents | | | 234,922 | | | 234,108 | | | 814 | | 0 | % | | 170,960 | | | — | | | 7,478 | | | 41 | | | 24,021 | | | 6,743 | | | 532 | | | 315 | | | 437,913 | | | 241,207 | | | 196,706 | | 82 | % |
Tenant reimbursements | | | 34,803 | | | 33,665 | | | 1,138 | | 3 | % | | 20,429 | | | — | | | 560 | | | 3 | | | 1,987 | | | 554 | | | 424 | | | 494 | | | 58,203 | | | 34,716 | | | 23,487 | | 68 | % |
Other (c) | | | 8,009 | | | 7,377 | | | 632 | | 9 | % | | 1,264 | | | — | | | 157 | | | 2 | | | 93 | | | 593 | | | 7,933 | | | 3,841 | | | 17,456 | | | 11,813 | | | 5,643 | | 48 | % |
| |
|
| |
|
| |
|
| |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| |
Total revenue | | | 277,734 | | | 275,150 | | | 2,584 | | 1 | % | | 192,653 | | | — | | | 8,195 | | | 46 | | | 26,101 | | | 7,890 | | | 8,889 | | | 4,650 | | | 513,572 | | | 287,736 | | | 225,836 | | 78 | % |
Operating Expenses: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Property operating expenses | | | 87,154 | | | 85,779 | | | 1,375 | | 2 | % | | 58,229 | | | — | | | 2,252 | | | 8 | | | 10,072 | | | 4,936 | | | (7,879 | ) | | (7,044 | ) | | 149,828 | | | 83,679 | | | 66,149 | | 79 | % |
Real estate taxes | | | 27,858 | | | 25,997 | | | 1,861 | | 7 | % | | 18,556 | | | — | | | 807 | | | 2 | | | 3,087 | | | 2,553 | | | 895 | | | 211 | | | 51,203 | | | 28,763 | | | 22,440 | | 78 | % |
Administrative expenses | | | — | | | — | | | — | | 0 | % | | — | | | — | | | — | | | — | | | — | | | — | | | 22,704 | | | 13,616 | | | 22,704 | | | 13,616 | | | 9,088 | | 67 | % |
| |
|
| |
|
| |
|
| |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| |
Total property operating expenses | | | 115,012 | | | 111,776 | | | 3,236 | | 3 | % | | 76,785 | | | — | | | 3,059 | | | 10 | | | 13,159 | | | 7,489 | | | 15,720 | | | 6,783 | | | 223,735 | | | 126,058 | | | 97,677 | | 77 | % |
Subtotal | | | 162,722 | | | 163,374 | | | (652 | ) | 0 | % | | 115,868 | | | — | | | 5,136 | | | 36 | | | 12,942 | | | 401 | | | (6,831 | ) | | (2,133 | ) | | 289,837 | | | 161,678 | | | 128,159 | | 79 | % |
Depreciation and amortization | | | 92,168 | | | 77,454 | | | 14,714 | | 19 | % | | 94,344 | | | — | | | 2,051 | | | — | | | 9,009 | | | 4,364 | | | 1,703 | | | 2,165 | | | 199,275 | | | 83,983 | | | 115,292 | | 137 | % |
| |
|
| |
|
| |
|
| |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| |
Operating Income (loss) | | $ | 70,554 | | $ | 85,920 | | $ | (15,366 | ) | -18 | % | $ | 21,524 | | $ | — | | $ | 3,085 | | $ | 36 | | $ | 3,933 | | $ | (3,963 | ) | $ | (8,534 | ) | $ | (4,298 | ) | $ | 90,562 | | $ | 77,695 | | $ | 12,867 | | 17 | % |
Number of properties | | | 238 | | | | | | | | | | | 61 | | | | | | 6 | | | | | | 11 | | | | | | | | | | | | 316 | | | | | | | | | |
Square feet | | | 17,828 | | | | | | | | | | | 10,590 | | | | | | 964 | | | | | | 2,101 | | | | | | | | | | | | 31,483 | | | | | | | | | |
Other Income (Expense): | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Interest income | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 7,702 | | | 966 | | | 6,736 | | 697 | % |
Interest expense | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | (128,869 | ) | | (53,366 | ) | | (75,503 | ) | 141 | % |
Equity in income of real estate ventures | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 1,798 | | | 2,296 | | | (498 | ) | -22 | % |
Net gain on sales of interests in real estate | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 2,608 | | | 4,640 | | | (2,032 | ) | -44 | % |
Gain on termination of purchase contract | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 3,147 | | | — | | | 3,147 | | 100 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
|
| |
|
| |
|
| |
| |
Income (loss) before minority interest | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | (23,052 | ) | | 32,231 | | | (55,283 | ) | -172 | % |
Minority interest - partners' share of consolidated real estate ventures | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 560 | | | (213 | ) | | 773 | | -633 | % |
Income (loss) from continuing operations | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | (22,492 | ) | | 32,018 | | | (54,510 | ) | -170 | % |
Income (loss) from discontinued operations | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 7,591 | | | 3,029 | | | 4,562 | | 151 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
|
| |
|
| |
|
| |
| |
Net Income (loss) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | $ | (14,901 | ) | $ | 35,047 | | $ | (49,948 | ) | -143 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
|
| |
|
| |
|
| |
| |
Earnings per common partnership unit | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | ($0.22 | ) | $ | 0.51 | | $ | (0.73 | ) | -143 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
|
| |
|
| |
|
| |
| |
EXPLANATORY NOTES
(a) - Results include: three redevelopments; four lease-up assets; three properties placed in service; and Cira Centre |
(b) - Represents certain revenues and expenses at the corporate level as well as various intercompany costs that are eliminated in consolidation
(c) - Includes net termination fee income of $5,890 for 2006 and $5,888 for 2005 for the same store property portfolio and $479 for 2006 for the Prentiss portfolio
40
Back to Contents
Revenue
Revenue increased by $225.8 million primarily due to the acquisition of Prentiss, which represents $195.4 million of this increase. The operations of the properties acquired from Prentiss contributed $192.7 million to this increase and $2.7 million resulted from additional third party management fees as a result of management contracts assumed and entered into at the time of acquisition. The increase is also the result of two properties that were acquired in the fourth quarter of 2005, one property acquired in the first quarter of 2006, one property acquired in the second quarter of 2006 and two properties acquired in the third quarter of 2006, as well as additional tenant occupancy at Cira Centre (included in development properties) that will continue throughout 2006.
The increase in revenue of $2.6 million for our same store portfolio is due to increased occupancy and increased tenant reimbursements resulting from increased property operating expenses.
Operating Expenses and Real Estate Taxes
Property operating expenses increased by $66.1 million primarily due to the acquisition of Prentiss, which represents $58.2 million of this increase. Property operating expenses attributable to the occupied portion of Cira Centre and other property acquisitions accounted for the remainder of the increase.
Real estate taxes increased by $22.4 million primarily due to the acquisition of Prentiss, which represents $18.6 million of this increase. The remainder of the increase primarily is the result of increased real estate tax assessments in our same store portfolio and properties acquired or under development.
Depreciation and Amortization Expense
Depreciation and amortization increased by $115.3 million primarily due to the acquisition of Prentiss, which increased total portfolio depreciation expense by $94.3 million. A significant portion of the increase is also due to accelerated depreciation expense for one of our properties totaling $11.9 million that is associated with the planned demolition of an existing building as part of an office park development in suburban Philadelphia. This property was part of our same store portfolio; therefore the remaining increase in depreciation and amortization for our same store portfolio is $2.8 million. This increase resulted from the timing of assets being placed in service upon completion of tenant improvement and capital improvement projects subsequent to the end of the nine month period ending September 30, 2005. The six properties that we acquired subsequent to September 30, 2005 caused an increase of $2.1 million in depreciation and amortization expense. Depreciation and amortization for our development properties increased by $4.6 million as a result of Cira Centre where tenants have taken occupancy.
Administrative Expenses
Administrative expenses increased by approximately $9.1 million primarily due to the acquisition of Prentiss. Of this increase, $3.0 million was primarily attributable to increased payroll and related costs associated with employees that we hired as part of the acquisition of Prentiss. We also incurred an additional $3.6 million in professional fees in connection with our merger integration activities. The remainder of the increase reflects other increased costs of the combined companies which includes an increase in deferred compensation expense of $1.0 million.
Interest Income/ Expense
Interest expense increased by approximately $75.5 million primarily as a result of 14 fixed rate mortgages, three unsecured notes, and one note secured by U.S. treasury notes (“PPREFI debt”) that we assumed or entered into to finance the Prentiss merger. The mortgages assumed have maturity dates ranging from July 2009 through March 2016 and the unsecured notes have maturities of March, April, and July 2035, and the PPREFI debt has a maturity of February 2007.
The PPREFI debt was defeased by Prentiss in the fourth quarter of 2005 and is secured by an investment in U.S. treasury notes. The interest earned on the treasury notes is included in interest income and substantially offsets the amount of interest expense incurred on the PPREFI debt, resulting in an immaterial amount of net interest expense incurred. The increase of $6.7 million in interest income is primarily attributable to the interest income earned on these treasury notes.
41
Back to Contents
See the Notes to the Unconsolidated Combined Financial Statements in Part I, Item I for details of our mortgage indebtedness and unsecured notes outstanding.
Minority Interest-partners’ share of consolidated real estate ventures
Minority interest-partners’ share of consolidated real estate ventures increased by $0.8 million from the prior year as a result of our acquisition of one consolidated joint venture as part of our acquisition of Prentiss. This consolidated joint venture, of which we own 51%, owns 13 properties which aggregate approximately 1.2 million square feet of office space.
Subsequent to our acquisition of Prentiss, we entered into a joint venture with IBM. We consolidate this joint venture, and own a 50% interest in it.
As of September 30, 2006 we hold an ownership interest in 15 properties through consolidated joint ventures, compared to two properties owned by consolidated joint ventures at September 30, 2005.
Discontinued Operations
Income from discontinued operations increased by $4.6 million from the prior year as a result of the sale of eight properties in Chicago, IL, two in Dallas, TX, and one in Allen, TX that we acquired in the Prentiss acquisition. We also sold two properties that were previously included in our same store portfolio. These 13 properties combined had net income of $5.0 million and gain on sale of $5.2 million during the nine month period ended September 30, 2006. Included in the gain on sale amount was $1.8 million attributable to minority interest in the Chicago property. During the nine-month ended September 30, 2005, we sold one property that had net operating income of $0.1 million and a gain on sale of $2.2 million. The two properties that we sold from our same store portfolio during the quarter ended September 30, 2006 had net income of $0.2 million.
Net Income
Net income declined in the nine month period ending September 30, 2006, compared to the same period in 2005 by $47.8 million as increased revenues were offset by increases in operating costs (primarily depreciation and amortization) and financing costs. All major financial statement captions increased as a result of our acquisition of Prentiss and the related financing required to complete the transaction. A significant element of these costs relate to additional depreciation and amortization charges relating to the significant property additions (including both the TRC acquisition and the Prentiss acquisition) and the values ascribed to related acquired intangibles (e.g., in-place leases). These charges do not affect our ability to pay dividends and may not be comparable to those of other real estate companies that have not made such acquisitions. Such charges can be expected to continue until the values ascribed to the lease intangibles are fully amortized. These intangibles are amortizing over the related lease terms or estimated tenant relationship. In addition, a significant portion of the decrease in net income is attributable to the $11.9 million in depreciation expense described in the Depreciation and Amortization Expense section above.
Earnings Per Common Partnership Unit
Earnings per partnership unit was $0.51 for the nine month period ended September 30, 2005 as compared to a loss per unit of $(0.22) in the nine month period ended September 30, 2006 as a result of the factors described in “Net Income” above and an increase in the average number of common units outstanding. We issued 34.6 million of our common units in our acquisition of Prentiss.
42
Back to Contents
LIQUIDITY AND CAPITAL RESOURCES
General
Our principal liquidity needs for the next twelve months are as follows:
| • | fund normal recurring expenses, |
| • | fund capital expenditures, including capital and tenant improvements and leasing costs, |
| • | fund current development and redevelopment costs, and |
| • | fund distributions declared by the Company’s Board of Trustees. |
We believe that our liquidity needs will be satisfied through cash flows generated by operations and financing activities. Rental revenue, expense recoveries from tenants, and other income from operations are our principal sources of cash that we use to pay operating expenses, debt service, recurring capital expenditures and the minimum distributions required to maintain the Company’s REIT qualification. We seek to increase cash flows from our properties by maintaining quality standards for our properties that promote high occupancy rates and permit increases in rental rates while reducing tenant turnover and controlling operating expenses. Our revenue also includes third-party fees generated by our property management, leasing, development and construction businesses. We believe our revenue, together with proceeds from equity and debt financings, will continue to provide funds for our short-term liquidity needs. However, material changes in our operating or financing activities may adversely affect our net cash flows. Such changes, in turn, would adversely affect our ability to fund distributions, debt service payments and tenant improvements. In addition, a material adverse change in our cash provided by operations would affect the financial performance covenants under our unsecured credit facility and unsecured notes.
Our principal liquidity needs for periods beyond twelve months are for costs of developments, redevelopments, property acquisitions, scheduled debt maturities, major renovations, expansions and other non-recurring capital improvements. We draw on multiple financing sources to fund our long-term capital needs. We use our credit facility for general business purposes, including the acquisition, development and redevelopment of properties and the repayment of other debt. In March 2006 and December 2005, we sold $850 million and $300 million, respectively of unsecured notes and expect to utilize the debt and equity markets for other long-term capital needs.
As a result of our acquisition of Prentiss, we will have additional short and long-term liquidity requirements. Historically, we have satisfied these types of requirements principally through the most advantageous source of capital at that time, which has included public offerings of unsecured debt and private placements of secured and unsecured debt, sales of common and preferred equity, capital raised through the disposition of assets, and joint venture transactions. We believe these sources of capital will continue to be available in the future to fund our capital needs.
We funded the approximately $1.05 billion cash portion of the Prentiss merger consideration, related transaction costs and prepayments of approximately $543.3 million in Prentiss mortgage debt at the closing of the merger through (i) a $750 million unsecured term loan that originally matured on January 4, 2007; (ii) approximately $676.5 million of cash from Prudential’s acquisition of certain of the Prentiss properties; and (iii) approximately $195.0 million through borrowing under our revolving credit facility. We repaid in full the $750 million term loan on March 28, 2006 with the proceeds of the $850 million unsecured notes described more fully in Capitalization below.
Our ability to incur additional debt is dependent upon a number of factors, including our credit ratings, the value of our unencumbered assets, our degree of leverage and borrowing restrictions imposed by our current lenders. We currently have investment grade ratings for prospective unsecured debt offerings from three major rating agencies. If a rating agency were to downgrade our credit rating, our access to capital in the unsecured debt market would be more limited and the interest rate under our existing credit facility would increase.
The Company’s ability to sell common and preferred shares is dependent on, among other things, general market conditions for REITs, market perceptions about our company and the current trading price of our shares. We regularly analyze which source of capital is most advantageous to us at any particular point in time. The equity markets may not be consistently available on terms that we consider attractive.
43
Back to Contents
Cash Flows
The following summary discussion of our cash flows is based on the consolidated statement of cash flows and is not meant to be an all-inclusive discussion of the changes in our cash flows for the periods presented.
As of September 30, 2006 and December 31, 2005, we maintained cash and cash equivalents of $16.5 million and $7.2 million, respectively, an increase of $9.3 million. This increase was the result of the following changes in cash flow from our activities for the nine-month period ended September 30 (in thousands):
Activity | | 2006 | | 2005 | |
| |
| |
| |
Operating | | $ | 213,679 | | $ | 103,766 | |
Investing | | | (1,053,043 | ) | | (206,150 | ) |
Financing | | | 848,728 | | | 110,378 | |
| |
|
| |
|
| |
Net cash flows | | $ | 9,364 | | $ | 7,994 | |
| |
|
| |
|
| |
Our increased cash flow from operating activities in the nine-months ended September 30, 2006 compared to the same period in 2005 is primarily attributable to our acquisition of Prentiss.
The increase in cash outflows from investing activities is primarily attributable to our acquisition of Prentiss and other property and land acquisitions totaling $1,105.3 million. In addition, we incurred approximately $180.7 million of capital expenditures for the properties that we own. These increases in investing activity are offset by the net proceeds of $221.3 million received from the sale of eight properties in Chicago and three in Texas that we acquired in our acquisition of Prentiss and subsequently sold. We received net proceeds of $37.6 million from sales of properties in our same store portfolio.
Increased cash flow from financing activities is primarily attributable to the issuance of $850.0 million of unsecured notes resulting in net proceeds of $847.8 million. The proceeds of the note issuance were used to satisfy the $750.0 million term loan that was obtained in connection with the acquisition of Prentiss, as well to repay a portion of the outstanding borrowings on our credit facility. We also had net borrowings of $160.0 million on our line of credit. These cash inflows are offset by our repurchase of common shares totaling $34.5 million and our three distribution payments totaling $110.1 million.
Capitalization
Indebtedness
On October 4, 2006 we consummated the offering of $300,000,000 aggregate principal amount of 3.875% exchangeable guaranteed notes due October 15, 2026 (the “2026 Notes”). On October 16, 2006, our Operating Partnership issued an additional $45,000,000 aggregate principal amount of 3.875% exchangeable guaranteed notes due October 15, 2026 to cover over-allotments. The Partnership used the net proceeds from the sale of the notes to repurchase approximately $60 million of outstanding common shares (1,829,000 common shares at a price of $32.80 per share); to repay approximately $180 million under the Partnership’s revolving credit facility; and to invest the balance in short term securities pending redemption of the Partnership’s $300 million Floating Rate Guaranteed Notes due 2009 on January 2, 2007.
On March 28, 2006, we consummated the public offering of (1) $300,000,000 aggregate principal amount of its unsecured floating rate notes due 2009 (the “2009 Notes”), (2) $300,000,000 aggregate principal amount of its 5.75% notes due 2012 (the “2012 Notes”) and (3) $250,000,000 aggregate principal amount of its 6.00% notes due 2016 (the “2016 Notes” and, together with the 2009 Notes and 2012 Notes, the “Notes”). The Company guaranteed the payment of principal of and interest on the Notes.
On March 28, 2006, we terminated, and repaid all amounts outstanding under, the $750 million Term Loan Agreement that we entered into on January 5, 2006 with JPMorgan Chase Bank, N.A., as Administrative Agent and Syndication Agent, J.P. Morgan Securities Inc., as Lead Arranger and Sole Bookrunner, and the lenders identified therein. We entered into the Term Loan Agreement in connection with our acquisition through the merger of Prentiss on January 5, 2006.
44
Back to Contents
As of September 30, 2006, we had approximately $3.2 billion of outstanding indebtedness. The table below summarizes our mortgage notes payable, our secured note payable, our unsecured notes and our revolving credit facility at September 30, 2006 and December 31, 2005:
| | September 30,
2006 | | December31,
2005 | |
| |
| |
| |
| | (dollars in thousands) | |
Balance: | | | | | | | |
Fixed rate | | $ | 2,558,664 | | $ | 1,417,611 | |
Variable rate | | | 629,216 | | | 103,773 | |
| |
|
| |
|
| |
Total | | $ | 3,187,880 | | $ | 1,521,384 | |
| |
|
| |
|
| |
Percent of Total Debt: | | | | | | | |
Fixed rate | | | 80 | % | | 93 | % |
Variable rate | | | 20 | % | | 7 | % |
| |
|
| |
|
| |
Total | | | 100 | % | | 100 | % |
| |
|
| |
|
| |
Weighted-average interest rate at period end: | | | | | | | |
Fixed rate | | | 5.9 | % | | 5.9 | % |
Variable rate | | | 5.8 | % | | 5.3 | % |
Total | | | 5.8 | % | | 5.8 | % |
The variable rate debt shown above generally bears interest based on various spreads over LIBOR (the term of which is selected by us).
We have used credit facility borrowings for general business purposes, including the acquisition, development and redevelopment of properties and the repayment of other debt. In December 2005, we replaced our then existing unsecured credit facility with a $600 million unsecured credit facility (the “Credit Facility”) that matures in December 2009, subject to a one year extension option upon payment of a fee and the absence of any defaults. Borrowings under the new Credit Facility generally bear interest at LIBOR (LIBOR was 5.32% as of September 30, 2006) plus a spread over LIBOR ranging from 0.55% to 1.10% based on our unsecured senior debt rating. We have an option to increase the maximum borrowings under the Credit Facility to $800 million subject to the absence of any defaults and our ability to obtain additional commitments from our existing or new lenders. The Credit Facility requires the maintenance of certain ratios related to minimum net worth, debt to total capitalization and fixed charge coverage and various non-financial covenants. We believe that we are in compliance with all financial covenants as of September 30, 2006.
We utilize unsecured notes as a long-term financing alternative. The indentures and note purchase agreements relating to our unsecured notes contain financial restrictions and requirements, including (1) a leverage ratio not to exceed 60%, (2) a secured debt leverage ratio not to exceed 40%, (3) a debt service coverage ratio of greater than 1.5 to 1.0, and (4) an unencumbered asset value of not less than 150% of unsecured debt. In addition, the note purchase agreement relating to the 2008 Notes contains covenants that are similar to the above covenants. At September 30, 2006, we were in compliance with each of these financial restrictions and requirements.
We have mortgage loans that are collateralized by certain of our properties. Payments on mortgage loans are generally due in monthly installments of principal and interest, or interest only.
We intend to refinance our mortgage loans as they mature, primarily through the use of unsecured debt or equity.
45
Back to Contents
The amount of indebtedness that we may incur, and the policies with respect thereto, are not limited by the Company’s declaration of trust and bylaws or our Partnership Agreement, and are solely within the discretion of the Company’s board of trustees, limited only by various financial covenants in our credit agreements.
Equity
On September 18, 2006, we declared a $0.44 per unit cash distribution to holders of Class A Units totaling $2.0 million. On August 15, 2006, we acquired two office properties in Northern Virginia. In connection with these acquisitions, we issued 424,608 Class A Units valued at $32.546 per unit totaling $13.8 million.
On September 18, 2006, we declared a distribution of $0.44 per Common Partnership Unit, totaling $39.8 million, which was paid on October 16, 2006 to unitholders of record as of October 5, 2006. On September 18, 2006, we declared distributions on our Series D Preferred Mirror Units and Series E Preferred Mirror Units to holders of record as of September 30, 2006. These units are entitled to a preferential return of 7.50% and 7.375%, respectively. Distributions paid on October 16, 2006 to holders of Series D Preferred Mirror Units and Series E Preferred Mirror Units totaled $0.9 million and $1.1 million, respectively.
At September 30, 2006, the Company had a share repurchase program under which the Company’s Board has authorized it to repurchase from time to time up to 6,700,000 common shares. Through September 30, 2006, the Company had repurchased approximately 4.4 million common shares under this program at an average price of $20.82 per share. The Company’s Board placed no time limit on the duration of the program. As of September 30, 2006, the Company may purchase an additional 2,319,800 additional shares under the plan. When the Company repurchases Common Shares, we repurchase an equal number of Common Partnership Units.
We used a portion of the net proceeds from the issuance of the 2026 Notes to repurchase 1,829,000 common shares. This repurchase did not reduce the number of common shares that may be repurchased under the Board-approved share repurchase program.
Shelf Registration Statement
Together with the Company, we maintain a shelf registration statement that registered common shares, preferred shares, depositary shares and warrants and unsecured debt securities. Subject to our ongoing compliance with securities laws, and if warranted by market conditions, we may offer and sell equity and debt securities from time to time under the registration statement.
Short- and Long-Term Liquidity
We believe that our cash flow from operations is adequate to fund its short-term liquidity requirements. Cash flow from operations is generated primarily from rental revenues and operating expense reimbursements from tenants and management services income from providing services to third parties. We intend to use these funds to meet short-term liquidity needs, which are to fund operating expenses, debt service requirements, recurring capital expenditures, tenant allowances, leasing commissions and the minimum distributions required to maintain the Company’s REIT qualification under the Internal Revenue Code.
We expect to meet our long-term liquidity requirements, such as for property acquisitions, development, investments in real estate ventures, scheduled debt maturities, major renovations, expansions and other significant capital improvements, through cash from operations, borrowings under its Credit Facility, other long-term secured and unsecured indebtedness, the issuance of equity securities and the proceeds from the disposition of selected assets.
Inflation
A majority of our leases provide for reimbursement of real estate taxes and operating expenses either on a triple net basis or over a base amount. In addition, many of our office leases provide for fixed base rent increases. We believe that inflationary increases in expenses will be significantly offset by expense reimbursement and contractual rent increases.
46
Back to Contents
Commitments and Contingencies
The following table outlines the timing of payment requirements related to our contractual commitments as of September 30, 2006:
| | Payments by Period (in thousands) | |
| | |
| |
| | Total | | Less than
1 Year | | 1-3 Years | | 3-5 Years | | More than
5 Years | |
| | |
| |
| |
| |
| |
| |
Mortgage notes payable (a) | | $ | 877,615 | | $ | 17,965 | | $ | 197,467 | | $ | 228,381 | | $ | 433,802 | |
Secured note payable | | | 181,759 | | | 181,759 | | | — | | | — | | | — | |
Revolving credit facility | | | 249,998 | | | — | | | 249,998 | | | — | | | — | |
Unsecured debt (a) | | | 1,866,610 | | | — | | | 688,000 | | | 600,000 | | | 578,610 | |
Ground leases (b) | | | 280,413 | | | 1,736 | | | 3,472 | | | 3,636 | | | 271,569 | |
Other liabilities | | | 688 | | | — | | | — | | | — | | | 688 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| | $ | 3,457,083 | | $ | 201,460 | | $ | 1,138,937 | | $ | 832,017 | | $ | 1,284,669 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
(a) | Amounts do not include unamortized discounts and/or premiums. |
(b) | Future minimum rental payments under the terms of all non-cancelable ground leases under which we are the lessee are expensed on a straight-line basis regardless of when payments are due. |
We intend to refinance or repay our mortgage notes payable as they become due or repay those that are secured by properties being sold.
As part of our acquisition of the TRC Properties in September 2004, we agreed to issue to the sellers up to a maximum of $9.7 million of Class A Units of the Operating Partnership if certain of the acquired properties achieve at least 95% occupancy prior to September 21, 2007. The maximum number of Units that we are obligated to issue declines monthly and, as of September 30, 2006, the maximum balance payable under this arrangement was $2.4 million, with no amount currently due.
As part of the TRC acquisition, we acquired our interest in Two Logan Square, a 696,477 square foot office building in Philadelphia, primarily through a second and third mortgage secured by this property. We currently do not expect to take title to Two Logan Square until, at the earliest, September 2019. In the event that we take fee title to Two Logan Square upon a foreclosure of our mortgage, we have agreed to make a payment to an unaffiliated third party with a residual interest in the fee owner of this property. The amount of the payment would be $0.6 million if we must pay a state and local transfer upon taking title, and $2.9 million if no transfer tax is payable upon the transfer.
As part of the Prentiss acquisition, the TRC acquisition and several of our other acquisitions, we agreed not to sell certain of the acquired properties. In the case of the TRC acquisition, we agreed not to sell certain of the acquired properties for periods ranging from three to 15 years from the acquisition date as follows: 201 Radnor Financial Center, 555 Radnor Financial Center and 300 Delaware Avenue (three years); One Rodney Square and 130/150/170 Radnor Financial Center (10 years); and One Logan Square, Two Logan Square and Radnor Corporate Center (15 years). In the case of the Prentiss acquisition, we assumed the obligation of Prentiss not to sell Concord Airport Plaza before March 2018 and 6600 Rockledge before July 2008. We also own 14 other properties that aggregate 1.0 million square feet and have agreed not to sell these properties for periods that expire by the end of 2008. Our agreements generally provide that we may dispose of the subject properties only in transactions that qualify as tax-free exchanges under Section 1031 of the Internal Revenue Code or in other tax deferred transactions. In the event that we sell any of the properties within the applicable restricted period in non-exempt transactions, we would be required to pay significant tax liabilities that would be incurred by the parties who sold us the applicable property.
We held a fifty percent economic interest in an approximately 141,724 square foot office building located at 101 Paragon Drive, Montvale, New Jersey. The remaining fifty percent interest was held by Donald E. Axinn, one of our Trustees. Although we and Mr. Axinn had each committed to provide one half of the $11 million necessary to repay the mortgage loan secured by this property, in February 2006, an unaffiliated third party entered into an agreement to purchase this property for $18.3 million. As a result of the purchase by an unaffiliated third party during August 2006, we recognized a $3.1 million gain on termination of our rights under a 1998 contribution agreement, modified in 2005, that entitled us to the 50% interest in the joint venture to operate the property. This gain is shown separately on our income statement as a gain on termination of purchase contract.
47
Back to Contents
We invest in our properties and regularly incur capital expenditures in the ordinary course to maintain the properties. We believe that such expenditures enhance our competitiveness. We also enter into construction, utility and service contracts in the ordinary course of business which may extend beyond one year. These contracts typically provide for cancellation with insignificant or no cancellation penalties.
Interest Rate Risk and Sensitivity Analysis
The analysis below presents the sensitivity of the market value of our financial instruments to selected changes in market rates. The range of changes chosen reflects our view of changes which are reasonably possible over a one-year period. Market values are the present value of projected future cash flows based on the market rates chosen.
Our financial instruments consist of both fixed and variable rate debt. As of September 30, 2006, our consolidated debt consisted of $892.3 million in fixed rate mortgages and $0.6 million in variable rate mortgage notes, $181.8 million in fixed rate secured note payable, $250.0 million variable rate borrowings under our Credit Facility and $1.9 billion in unsecured notes (net of discounts) of which $1.5 billion are fixed rate borrowings and $0.4 billion are variable rate borrowings. All financial instruments were entered into for other than trading purposes and the net market value of these financial instruments is referred to as the net financial position. Changes in interest rates have different impacts on the fixed and variable rate portions of our debt portfolio. A change in interest rates on the fixed portion of the debt portfolio impacts the net financial instrument position, but has no impact on interest incurred or cash flows. A change in interest rates on the variable portion of the debt portfolio impacts the interest incurred and cash flows, but does not impact the net financial instrument position.
If market rates of interest on our variable rate debt increase by 1%, the increase in annual interest expense on our variable rate debt would decrease future earnings and cash flows by approximately $6.3 million. If market rates of interest on our variable rate debt decrease by 1%, the decrease in interest expense on our variable rate debt would increase future earnings and cash flows by approximately $6.3 million.
If market rates of interest increase by 1%, the fair value of our outstanding fixed-rate debt would decrease by approximately $94.4 million. If market rates of interest decrease by 1%, the fair value of our outstanding fixed-rate debt would increase by approximately $101.2 million.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Market risk is the exposure to loss resulting from changes in interest rates, commodity prices and equity prices. In pursuing our business plan, the primary market risk to which we are exposed is interest rate risk. Changes in the general level of interest rates prevailing in the financial markets may affect the spread between our yield on invested assets and cost of funds and, in turn, our ability to make distributions or payments to our shareholders. While we have not experienced any significant credit losses, in the event of a significant rising interest rate environment and/or economic downturn, defaults could increase and result in losses to us which adversely affect our operating results and liquidity.
There have been no material changes in Quantitative and Qualitative disclosures in 2006 from the disclosures included in our Annual Report on Form 10-K for the year ended December 31, 2005. Reference is made to Item 7 included in our Annual Report on Form 10-K for the year ended December 31, 2005 and the caption “Interest Rate Risk and Sensitivity Analysis” under Item 2 of this Quarterly Report on Form 10-Q.
Item 4. Controls and Procedures
| (a) | Evaluation of disclosure controls and procedures. Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the Exchange Act) as of the end of the period covered by this quarterly report, have concluded that the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in the reports that it files under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. |
48
Back to Contents
| (b) | Changes in internal controls over financial reporting. There was no change in the Company’s internal control over financial reporting that occurred during the period covered by this quarterly report that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting. |
Part II. | OTHER INFORMATION |
Item 1. Legal Proceedings
Not applicable.
Item 1A. Risk Factors
There has been no material change to the risk factors previously disclosed by us in our Form 10-K for the fiscal year ended December 31, 2005.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
The following table summarizes the share repurchases during the three-month period ended September 30, 2006:
| | Total
Number of
Shares
Purchased | | Average
Price Paid Per
Share | | Purchased as
Part of Publicly
Announced Plans
or Programs | | Shares that May
Yet Be Purchased
Under the Plans
or Programs (a) | |
| |
| |
| |
| |
| |
2006: | | | | | | | | | |
July | | — | | | | — | | 2,319,800 | |
August | | — | | | | — | | 2,319,800 | |
September | | — | | | | — | | 2,319,800 | |
| |
| | | |
| | | |
Total | | — | | | | — | | | |
| |
| | | |
| | | |
(a) | On May 2, 2006, the Company’s Board of Trustees authorized an increase in the number of common shares that it may repurchase, whether in open-market or privately negotiated transactions. The Board authorized the Company to purchase up to an aggregate of 3,500,000 common shares (inclusive of the remaining share repurchase availability under the Board’s prior authorization from September 2001). There is no expiration date on the share repurchase program. When the Company repurchases Common Shares, the Operating Partnership repurchases an equal number of Common Partnership Units. |
Item 3. Dfaults Upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
Item 5. Other Information
Not applicable.
49
Back to Contents
Item 6. Exhibits
(a) Exhibits
10.1 | Form of Fifteenth Amendment to Agreement of Limited Partnership of Brandywine Operating Partnership, L.P. (incorporated by reference to Brandywine’s Current Report on Form 8-K filed on August 18, 2006) |
| |
10.2 | 2006 Long-Term Outperformance Compensation Program (incorporated by reference to Brandywine’s Current Report on Form 8-K filed on September 1, 2006)** |
| |
12.1 | Statement re Computation of Ratios |
| |
31.1 | Certification Pursuant to 13a-14 under the Securities Exchange Act of 1934 |
| |
31.2 | Certification Pursuant to 13a-14 under the Securities Exchange Act of 1934 |
| |
32.1 | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
| |
32.2 | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
| |
** | Management contract or compensatory plan or arrangement |
50
Back to Contents
SIGNATURES OF REGISTRANT
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.
| | | BRANDYWINE OPERATING PARTNERSHIP, L.P. (Registrant) |
| | | BRANDYWINE REALTY TRUST, as general partner |
Date: November 14, 2006
| | By: |
/s/ Gerard H. Sweeney
|
| | |
|
| | | Gerard H. Sweeney, President and Chief Executive Officer |
| | | (Principal Executive Officer) |
Date: November 14, 2006
| | By: |
/s/ Timothy M. Martin
|
| | |
|
| | | Timothy M. Martin, Vice President and Treasurer |
| | | (Principal Financial Officer) |
Date: November 14, 2006
| | By: |
/s/ Scott W. Fordham
|
| | |
|
| | | Scott W. Fordham, Vice President and Chief Accounting Officer |
| | | (Principal Accounting Officer) |
51
