Cogdell Spencer Inc.
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
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þ |
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended March 31, 2006
OR
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o |
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number 001-32649
COGDELL SPENCER INC.
(Exact name of registrant as specified in its charter)
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Maryland
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20 -3126457 |
(State or other jurisdiction of
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(I.R.S. Employer |
incorporation or organization)
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Identification No.) |
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4401 Barclay Downs Drive, Suite 300 |
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Charlotte, North Carolina
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28209 |
(Address of principal executive offices)
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(Zip code) |
(704) 940-2900
(Registrants telephone number, including area code)
N/A
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filed, or a non-accelerated filer. See definition of accelerated filer and large accelerated
filer in Rule 12b-2 of the Exchange Act (Check one):
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Large accelerated filer [ ]
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Accelerated filer [ ]
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Non-accelerated filer [X]. |
Indicate by check mark whether the registrant is a shell company (as defined in rule 12b-2 of
the Exchange Act). o Yes þ No
Indicate the number of shares outstanding of each of the issuers classes of common stock as
of the latest practicable date: 7,997,574 shares of common stock, par value $.01 per share,
outstanding as of May 1, 2006.
TABLE OF CONTENTS
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Page |
PART I |
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FINANCIAL INFORMATION |
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Item 1 |
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Consolidated and Combined Financial Statements (Unaudited) |
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1 |
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Item 2 |
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Managements Discussion and Analysis of Financial Condition and Results of Operations |
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11 |
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Item 3 |
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Quantitative and Qualitative Disclosures about Market Risk |
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19 |
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Item 4 |
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Controls and Procedures |
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19 |
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PART II |
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Other Information |
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Item 1 |
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Legal Proceedings |
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19 |
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Item 1A |
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Risk Factors |
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20 |
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Item 2 |
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Unregistered Sales of Equity Securities and Use of Proceeds |
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20 |
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Item 3 |
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Defaults Upon Senior Securities |
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20 |
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Item 4 |
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Submission of Matters to a Vote of Security Holders |
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20 |
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Item 5 |
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Other Information |
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20 |
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Item 6 |
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Exhibits |
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20 |
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
COGDELL SPENCER INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
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As of |
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As of |
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March 31, 2006 |
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December 31, 2005 |
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(unaudited) |
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(audited) |
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Assets |
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Real estate properties: |
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Land |
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$ |
22,907 |
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$ |
17,047 |
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Buildings and improvements |
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314,099 |
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243,090 |
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Construction in progress |
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1,874 |
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1,099 |
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Less: Accumulated depreciation |
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(7,874 |
) |
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(2,713 |
) |
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Total real estate properties, net |
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331,006 |
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258,523 |
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Cash and cash equivalents |
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3,897 |
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9,571 |
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Restricted cash |
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817 |
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779 |
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Investment in capital lease |
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6,448 |
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6,499 |
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Acquired above market leases, net of accumulated
amortization of $73 in 2006 and $25 in 2005 |
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1,089 |
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852 |
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Acquired in place lease value and deferred leasing
costs, net of accumulated amortization of $3,515
in 2006 and $1,399 in 2005 |
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24,540 |
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21,220 |
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Acquired ground leases, net of accumulated
amortization of $38 in 2006 and $15 in 2005 |
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3,015 |
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2,919 |
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Deferred financing costs, net of accumulated
amortization of $79 in 2006 and $31 in 2005 |
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890 |
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913 |
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Goodwill |
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2,875 |
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2,875 |
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Other assets |
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3,808 |
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4,331 |
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Total assets |
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$ |
378,385 |
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$ |
308,482 |
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Liabilities and stockholders equity |
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Notes payable under line of credit |
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$ |
85,850 |
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$ |
19,600 |
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Mortgage loans |
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145,273 |
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140,634 |
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Accounts payable and accrued liabilities |
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5,901 |
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4,699 |
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Accrued dividends and distributions |
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4,328 |
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Acquired below market leases, net of accumulated
amortization of $413 in 2006 and $164 in 2005 |
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3,754 |
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2,893 |
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Interest rate swap agreements |
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74 |
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170 |
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Total liabilities |
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245,180 |
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167,996 |
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Commitments and contingencies |
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Minority interests in real estate partnership |
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108 |
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Minority interests in operating partnership |
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59,668 |
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62,018 |
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Stockholders equity: |
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Preferred stock, $0.01 par value; 50,000 shares
authorized, none issued or outstanding |
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Common Stock; $0.01 par value; 200,000 shares
authorized, 8,000 shares issued and outstanding
in 2006 and 2005 |
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80 |
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80 |
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Additional paid-in capital |
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85,088 |
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85,855 |
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Accumulated deficit |
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(11,739 |
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(7,467 |
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Total stockholders equity |
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73,429 |
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78,468 |
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Total liabilities and stockholders equity |
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$ |
378,385 |
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$ |
308,482 |
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See notes to consolidated and combined financial statements.
1
COGDELL SPENCER INC. AND COGDELL SPENCER INC. PREDECESSOR
CONSOLIDATED AND COMBINED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(unaudited)
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Company |
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Predecessor |
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Three Months Ended |
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Three Months Ended |
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March 31, 2006 |
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March 31, 2005 |
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Revenues: |
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Rental |
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$ |
11,778 |
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$ |
4,196 |
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Rental related party |
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6,457 |
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Fee revenue |
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429 |
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538 |
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Expense reimbursements |
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174 |
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164 |
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Interest and other income |
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292 |
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224 |
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Total revenues |
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12,673 |
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11,579 |
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Expenses: |
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Property operating |
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4,114 |
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3,866 |
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General and administrative |
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1,995 |
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963 |
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Depreciation |
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4,330 |
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2,504 |
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Amortization |
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2,156 |
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24 |
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Interest |
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2,410 |
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1,731 |
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Total expenses |
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15,005 |
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9,088 |
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Income (loss) from operations before
equity in earnings (loss) of
unconsolidated real estate partnerships,
minority interest in real estate partnership
and minority interests in operating
partnership |
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(2,332 |
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2,491 |
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Equity in earnings (loss) of unconsolidated
real estate partnerships |
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5 |
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(16 |
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Minority interests in real estate partnership |
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(31 |
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Minority interests in operating partnership |
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833 |
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Net income (loss) |
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$ |
(1,525 |
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$ |
2,475 |
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Basic and diluted loss per share |
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$ |
(0.19 |
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Weighted average common shares -
basic and diluted |
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7,973 |
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See notes to consolidated and combined financial statements.
2
COGDELL SPENCER INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY
(In thousands)
(Unaudited)
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Number of |
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Additional |
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Common |
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Common |
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Paid-in |
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Accumulated |
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Shares |
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Stock |
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Capital |
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Deficit |
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Total |
Balance at December 31, 2005 |
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8,000 |
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$ |
80 |
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$ |
85,855 |
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$ |
(7,467 |
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$ |
78,468 |
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Cummulative effect adjustment
associated with the implementation
of EITF 04-5 |
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(785 |
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53 |
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(732 |
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Amortization of restricted stock
compensation, net of minority
interests |
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18 |
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18 |
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Dividends |
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(2,800 |
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(2,800 |
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Net loss |
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(1,525 |
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(1,525 |
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Balance at March 31, 2006 |
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8,000 |
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$ |
80 |
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$ |
85,088 |
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$ |
(11,739 |
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$ |
73,429 |
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See notes to consolidated and combined financial statements.
3
COGDELL SPENCER INC. AND COGDELL SPENCER INC. PREDECESSOR
CONSOLIDATED AND COMBINED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
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Company |
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Predecessor |
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Three Months Ended |
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Three Months Ended |
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March 31, 2006 |
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March 31, 2005 |
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Operating activities: |
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Net income (loss) |
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$ |
(1,525 |
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$ |
2,475 |
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Adjustments to reconcile net income (loss) to cash
provided by operating activities: |
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Minority interests in operating partnership |
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(833 |
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Minority interests in real estate partnership |
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31 |
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Depreciation of real estate properties |
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4,305 |
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2,482 |
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Corporate depreciation and amortization |
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41 |
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22 |
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Amortization of acquired ground leases, acquired
in place lease value and deferred leasing costs |
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2,140 |
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24 |
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Amortization of acquired above market leases and
acquired below market leases, net |
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(201 |
) |
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3 |
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Amortization of debt premium |
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(50 |
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Amortization of deferred finance costs |
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47 |
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172 |
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Amortization of restricted stock compensation |
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28 |
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Equity in (earnings) loss of unconsolidated
real estate partnerships |
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(5 |
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16 |
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Change in fair value of interest rate swap agreements |
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(309 |
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(1,342 |
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Changes in operating assets and liabilities: |
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Other assets |
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(87 |
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(79 |
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Accounts payable and accrued expenses |
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893 |
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(471 |
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Net cash provided by operating activities |
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4,475 |
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3,302 |
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Investing activities: |
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Acquisition and development of real estate properties |
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(71,689 |
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(1,776 |
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Proceeds from sale of real estate properties and capital lease |
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51 |
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18 |
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Distributions received from real estate partnerships |
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2 |
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18 |
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Decrease (increase) in restricted cash |
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(38 |
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50 |
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Net cash used in investing activities |
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(71,674 |
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(1,690 |
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Financing activities: |
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Proceeds from mortgage notes payable |
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1,070 |
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Repayments of mortgage notes payable |
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(4,829 |
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(1,168 |
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Proceeds from line of credit |
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68,250 |
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400 |
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Repayments to line of credit |
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(2,000 |
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Dividends and distributions |
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(4,009 |
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Distributions to minority interests in real estate partnership |
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(85 |
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Payment of deferred financing costs |
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(24 |
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(15 |
) |
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Net cash provided by (used in) financing activities |
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61,312 |
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(3,722 |
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Decrease in cash and cash equivalents |
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(5,887 |
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(2,110 |
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Balance at beginning of period |
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9,571 |
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13,459 |
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Cummulative effect adjustment associated with the
implementation of EITF 04-5 |
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213 |
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Balance at end of period |
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$ |
3,897 |
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$ |
11,349 |
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Supplemental disclosure of cash flow information: |
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Cash paid for interest, net of capitalized interest |
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$ |
2,539 |
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$ |
3,253 |
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Supplemental cash flow information noncash
investing and financing activities: |
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Debt assumed with purchase of property |
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5,178 |
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Accrued dividends and distributions |
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4,328 |
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|
See notes to consolidated and combined financial statements.
4
COGDELL SPENCER INC. AND COGDELL SPENCER INC. PREDECESSOR
NOTES TO CONSOLIDTED AND COMBINED FINANCIAL STATEMENTS
(Unaudited)
1. Organization and Ownership
Cogdell Spencer Inc. (the Company) is engaged in the business of owning, developing,
redeveloping, acquiring, and managing medical office buildings and other healthcare related
facilities primarily in the southeastern United States. The Company was incorporated on July 5,
2005, in Maryland and has elected to operate as a fully-integrated and self-administered real estate
investment trust (a REIT) under Sections 856 through 860 of the Internal Revenue Code of 1986, as
amended. The Company continues the operations of Cogdell Spencer Inc. Predecessor (the
Predecessor). The Predecessor is not a legal entity, but represents a combination of certain real
estate entities based on common management. During all periods presented in the Predecessors
accompanying combined financial statements the Predecessor had the responsibility for the
day-to-day operations of such combined entities. Cogdell Spencer Advisors, Inc. has management
agreements with other entities which have not been combined with the Predecessor as other partners
or members did not contribute their interests in the formation transactions discussed below.
The Company completed its initial public offering (the Offering) on November 1, 2005. On
November 1, 2005, concurrent with the consummation of the Offering, the Company and a newly formed
majority-owned limited partnership, Cogdell Spencer LP (the Operating Partnership), and its
taxable REIT subsidiary (the TRS), together with the partners and members of the affiliated
partnerships and limited liability companies of the Predecessor, engaged in certain formation
transactions (the Formation Transactions). The Operating Partnership received a contribution of
interests in the Predecessor in exchange for units of limited partnership interest in the Operating
Partnership, shares of the Companys common stock and/or cash. Substantially all of the operations
of the Company are carried out through the Operating Partnership.
2. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying consolidated and combined financial statements have been prepared in conformity
with accounting principles generally accepted in the United States (GAAP) and represent the
assets and liabilities and operating results of the Company and the Predecessor. The consolidated
financial statements include the Companys accounts, its wholly-owned subsidiaries, as well as the
Operating Partnership and its subsidiaries. The consolidated financial statements also include any
partnerships for which the Company or its subsidiaries is the general partner or the managing
member and the rights of the limited partners do not overcome the presumption of control by the
general partner or managing member. All significant intercompany balances and transactions have
been eliminated in consolidation and combination. The accounting policies of the Predecessor and
the Company are consistent with each other, except as noted in the accompanying financial
statements or in the Companys Annual Report on Form 10-K for the year ended December 31, 2005.
Interim Financial Information
The financial information for the three months ended March 31, 2006 and 2005 is unaudited, but
includes all adjustments, consisting of normal recurring adjustments that, in the opinion of
management, are necessary for a fair presentation of the Companys and the Predecessors financial
position, results of operations, and cash flows for such periods. Operating results for the three
months ended March 31, 2006 and 2005 are not necessarily indicative of results that may be expected
for any other interim period or for the full fiscal years of 2006 or 2005 or any other future
period. These consolidated and combined financial statements do not include all disclosures
required by accounting principles generally accepted in the United States of America for annual
consolidated and combined financial statements. The Companys audited consolidated financial
statements and the Predecessors audited combined financial statements are contained in the
Companys Annual Report on Form 10-K for the year ended December 31, 2005.
5
Use of Estimates in Financial Statements
The preparation of financial statements in conformity with GAAP requires management to make
estimates and assumptions that affect amounts reported in the financial statements and accompanying
notes. Significant estimates and assumptions are used by management in determining the useful lives
of real estate properties and the initial valuations and underlying allocations of purchase price
in connection with real estate property acquisitions. Actual results may differ from those
estimates.
Adoption of Recent Accounting Pronouncement
In June 2005, the Financial Accounting Standards Board ratified the Emerging Issues Task Forces
consensus on Issue No. 04-5 Determining Whether a General Partner, or the General Partners as a
Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain
Rights (EITF 04-5). This consensus establishes the presumption that general partners in a
limited partnership control that limited partnership regardless of the extent of the general
partners ownership interest in the limited partnership. The consensus further establishes that
the rights of the limited partners can overcome the presumption of control by the general partners,
if the limited partners have either (a) the substantive ability to dissolve (liquidate) the limited
partnership or otherwise remove the general partners without cause or (b) substantive participating
rights. Whether the presumption of control is overcome is a matter of judgment based on facts and
circumstances, for which the consensus provides additional guidance. This consensus was applicable
in 2005 for new or modified partnerships, and is applicable to existing partnerships beginning in
2006. This consensus applies to limited partnerships or similar entities, such as limited liability
companies that have governing provisions that are the functional equivalent of a limited
partnership.
The Company implemented EITF 04-5 effective January 1, 2006 for existing partnerships. As a result
of the implementation, the Company determined that Rocky Mount MOB LLC (Rocky Mount MOB) is
required to be included in the Companys consolidated financial results. The Company owns 34.5% of
Rocky Mount MOB. Pursuant to the transition guidance contained in EITF 04-5, the Company has
included a cumulative effect adjustment related to the consolidation of Rocky Mount MOB effective
January 1, 2006. The Companys investment in Rocky Mount MOB of $0.8 million has been eliminated,
which reduced other assets and additional paid in capital. The following was Rocky Mount MOBs
balance sheet as of January 1, 2006, which has been added to the Companys consolidated balance
sheet (in thousands):
|
|
|
|
|
Assets |
|
|
|
|
Real estate property: |
|
|
|
|
Land |
|
$ |
229 |
|
Buildings and improvements |
|
|
4,992 |
|
Less: Accumulated depreciation |
|
|
(856 |
) |
|
|
|
|
Total real estate property, net |
|
|
4,365 |
|
Cash and cash equivalents |
|
|
213 |
|
Other assets |
|
|
8 |
|
|
|
|
|
Total assets |
|
$ |
4,586 |
|
|
|
|
|
|
|
|
|
|
Liabilities and members equity |
|
|
|
|
Mortgage loans |
|
|
4,340 |
|
Accounts payable and accrued liabilities |
|
|
128 |
|
|
|
|
|
Total liabilities |
|
|
4,468 |
|
Members equity |
|
|
118 |
|
|
|
|
|
Total liabilities and members equity |
|
$ |
4,586 |
|
|
|
|
|
6
3. Property acquisitions
During the quarter ended March 31, 2006, the Company, through its Operating Partnership, acquired
four properties. On February 15, 2006, the Company acquired Methodist Processional Center One,
located on the Methodist Hospital Campus of Clarian Health Partners, in Indianapolis, Indiana. The
property has 171,755 square feet of medical office space and an adjacent 951-space parking deck.
As of March 31, 2006, the property was 95.2% leased. The property was acquired for $39.9 million,
inclusive of transaction costs. The Company received credits from the seller of $0.5 million
related to potential future capital improvements, which reduced the purchase price to $39.4
million. The following table is a preliminary allocation of the purchase price (in thousands):
|
|
|
|
|
Building and improvements |
|
$ |
37,754 |
|
Acquired in place lease value and deferred leasing costs |
|
|
1,690 |
|
Acquired ground lease |
|
|
120 |
|
Acquired above market leases |
|
|
180 |
|
Acquired below market leases |
|
|
(297 |
) |
|
|
|
|
Total purchase price allocated |
|
$ |
39,447 |
|
|
|
|
|
On March 30, 2006, the Company acquired Hanover Medical Office Building One in Mechanicsville,
Virginia and the 1808/1818 Verdugo Boulevard properties in Glendale, California. The properties
have 163,403 square feet of medical office space and were 98.5% leased as of March 31, 2006. The
portfolio was acquired for $36.2 million, inclusive of transaction costs. The Company received
credits from the seller of $0.8 million related to potential future capital improvements, which
reduced the purchase price to $35.4 million. The following table is a preliminary allocation of
the purchase price (in thousands):
|
|
|
|
|
Land |
|
$ |
5,638 |
|
Building and improvements |
|
|
26,729 |
|
Acquired in place lease value and deferred leasing costs |
|
|
3,745 |
|
Acquired above market leases |
|
|
105 |
|
Acquired below market leases |
|
|
(813 |
) |
|
|
|
|
Total purchase price allocated |
|
$ |
35,404 |
|
|
|
|
|
The following summary of selected unaudited pro forma results of operations presents
information as if the purchase of Methodist Professional Center One, Hanover Medical Office
Building One, and 1808 and 1818 Verdugo Boulevard properties had occurred at the beginning of each
period presented. The pro forma information is provided for informational purposes only and is not
indicative of results that would have occurred or which may occur in the future (in thousands,
except per share amounts):
|
|
|
|
|
|
|
|
|
|
|
Company |
|
Predecessor |
|
|
Three Months Ended |
|
Three Months Ended |
|
|
March 31, 2006 |
|
March 31, 2005 |
Total revenues |
|
$ |
14,956 |
|
|
|
13,868 |
|
Net income (loss) |
|
|
(2,089 |
) |
|
|
1,987 |
|
Per share information: |
|
|
|
|
|
|
|
|
|
Basic and diluted loss per share
|
|
$ |
(0.26 |
) |
|
|
|
|
|
|
|
|
|
|
4. Mortgages and Notes Payable Under Line of Credit
In February 2006, the Company refinanced the St. Francis Medical Plaza mortgage note payable that
matured on February 15, 2006. In connection with this refinancing, the Company repaid $2.0 million
in principal related to this note payable and repaid $2.0 million in principal related to the St.
Francis Property MOB mortgage note payable. The St. Francis Medical Plaza mortgage note payable now
matures in December 2006 and has an interest rate of LIBOR plus 1.425% (6.26% at March 31, 2006).
7
On March 30, 2006, as part of the Hanover Medical Office Building One acquisition, the Company
assumed $5.2 million of mortgage debt. The mortgage note payable matures on November 1, 2009, and
requires monthly principal and interest payments of $35,630 based on a fixed interest rate of 6%
and a 25-year amortization. The fair value of the mortgage note
payable was $5.2 million at March 30, 2006.
The acquisitions during the quarter were primarily funded by the Companys $100.0 million unsecured
Credit Facility. As of March 31, 2006, the Company had $85.9 million outstanding under this Credit
Facility.
5. Derivative Financial Instruments Interest Rate Swap Agreements
Interest rate swap agreements are utilized to reduce exposure to variable interest rates associated
with certain mortgage notes payable. These agreements involve an exchange of fixed and floating
interest payments without the exchange of the underlying principal amount (the notional amount).
The net difference between the interest paid and the interest received is reflected as an
adjustment to interest expense.
The interest rate swap agreements have been recorded on the balance sheet at their estimated fair
values and included in Other assets or Interest rate swap agreements. The agreements have not
been designated for hedge accounting and, accordingly, any changes in fair values are recorded in
interest expense. For the three months ended March 31, 2006 and 2005, $0.3 million and $1.3
million, respectively, was recorded as a decrease to interest expense as a result of the change in
the interest rate swap agreements fair value. The following table summarizes the terms of the
agreements and their fair values at March 31, 2006 (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Notional |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amount as of |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2006 |
|
|
|
March 31, |
|
|
|
|
|
|
|
|
|
|
Effective |
|
|
Expiration |
|
|
|
|
|
|
|
Entity |
|
2006 |
|
|
Receive Rate |
|
|
Pay Rate |
|
|
Date |
|
|
Date |
|
|
Asset |
|
|
Liability |
|
Beaufort Medical Plaza, LLC |
|
$ |
5,137 |
|
|
1 Month LIBOR |
|
|
5.81 |
% |
|
|
10/25/1999 |
|
|
|
7/25/2008 |
|
|
$ |
|
|
|
$ |
74 |
|
Gaston MOB, LLC |
|
|
17,160 |
|
|
1 Month LIBOR |
|
|
3.25 |
|
|
|
1/23/2003 |
|
|
|
11/22/2007 |
|
|
|
517 |
|
|
|
|
|
Medical Investors I, LLC |
|
|
8,923 |
|
|
1 Month LIBOR |
|
|
4.82 |
|
|
|
2/10/2003 |
|
|
|
12/10/2007 |
|
|
|
25 |
|
|
|
|
|
River Hills Medical Associates, LLC |
|
|
3,138 |
|
|
1 Month LIBOR |
|
|
3.63 |
|
|
|
3/10/2003 |
|
|
|
12/15/2008 |
|
|
|
118 |
|
|
|
|
|
Roper MOB, LLC |
|
|
10,084 |
|
|
1 Month LIBOR |
|
|
4.45 |
|
|
|
7/26/2004 |
|
|
|
7/10/2009 |
|
|
|
205 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
865 |
|
|
$ |
74 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5. Investments in Real Estate Partnerships
As of March 31, 2006, the Company has an ownership interest in six limited liability companies or
limited partnerships. The following is a description of each of the entities:
|
|
|
Cabarrus Land Company, LLC, a North Carolina limited liability company, founded in
1987, 5.0% owned by the Company, and owns one medical office building; |
|
|
|
|
Mary Black MOB Limited Partnership, a South Carolina limited partnership, founded in
1988, 9.6% owned by the Company, and owns one medical office building; |
|
|
|
|
Mary Black MOB II Limited Partnership, a South Carolina limited partnership, founded
in 1993, 1.0% owned by the Company, and owns one medical office building; |
|
|
|
|
Mary Black Westside Medical Park I Limited Partnership, a South Carolina limited
partnership, founded in 1991, 5.0% owned by the Company, and owns one medical office
building; |
|
|
|
|
McLeod Medical Partners, LLC, a South Carolina limited liability company, founded in
1982, 1.1% owned by the Company, and owns three medical office buildings; and |
|
|
|
|
Rocky Mount MOB, LLC, a North Carolina limited liability company, founded in 2002,
34.5% owned by the Company, and owns one medical office building. |
The Company is the general partner or managing member of these real estate partnerships and manages
the properties owned by these entities. The Company, through its TRS, receives property management
fees, leasing fees, and expense reimbursements from the partnerships.
8
Rocky Mount MOB is included in the Companys consolidated financial statements because the limited
partners do not have sufficient participation rights in the partnership to overcome the presumption
of control by the Company as the managing member. The limited partners do have certain protective
rights such as the ability to prevent the sale of building, the dissolution of the partnership, or
the incurrence of additional indebtedness. The information set forth below reflects the financial
position and operations of Rocky Mount MOB in its entirety, not just the Companys interest in the real estate partnership (in
thousands):
|
|
|
|
|
|
|
March 31, 2006 |
Financial position: |
|
|
|
|
Total assets |
|
$ |
4,512 |
|
Total liabilities |
|
|
4,347 |
|
Members equity |
|
|
165 |
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
March 31, 2006 |
Results of operations: |
|
|
|
|
Revenues |
|
$ |
208 |
|
Operating and general and administrative expenses |
|
|
60 |
|
Net income |
|
|
47 |
|
The Companys other five real estate partnerships are unconsolidated and accounted for under
the equity method of accounting based on the Companys ability to exercise significant influence.
The following is a summary of financial information for the limited liability companies and limited
partnerships as of March 31, 2006 and for the three months ended March 31, 2006. The information
set forth below reflects the financial position and operations of the entities in their entirety,
not just the Companys interest in the real estate partnership (in thousands):
|
|
|
|
|
|
|
March 31, 2006 |
Financial position: |
|
|
|
|
Total assets |
|
$ |
27,834 |
|
Total liabilities |
|
|
19,354 |
|
Members equity |
|
|
8,480 |
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
March 31, 2006 |
Results of operations: |
|
|
|
|
Revenues |
|
$ |
1,359 |
|
Operating and general and administrative expenses |
|
|
675 |
|
Net income |
|
|
143 |
|
6. Dividends and Distributions
On March 10, 2006, the Company declared a dividend to common stockholders of record and the
Operating Partnership declared a distribution to Unitholders of record, in each case as of March
22, 2006, totaling $4.3 million or $0.35 per share or unit, covering the period from January 1,
2006 through March 31, 2006. The dividend and distribution were paid on April 17, 2006. The
dividend and distribution were equivalent to an annual rate of $1.40 per share and unit.
7. Loss per Share
The following is a summary of the elements used in calculating basic and diluted loss per share (in
thousands, except per share amount):
|
|
|
|
|
|
|
Three Months Ended |
|
|
March 31, 2006 |
Net loss |
|
$ |
(1,525 |
) |
Weighted average shares outstanding basic and diluted(1) |
|
|
7,973 |
|
Net loss per share basic and diluted |
|
$ |
(0.19 |
) |
|
|
|
(1) |
|
27 shares of unvested restricted common stock are anti-dilutive due to the net loss. |
9
8. Minority Interests in Operating Partnership
Minority interests of unit holders in the Operating Partnership at March 31, 2006, were $59.5
million.
As of March 31, 2006, there were 12,364,613 units of limited partnership in the Operating
Partnership (OP Units) outstanding, of which 7,999,574, or 64.7%, were owned by the Company and
4,365,039, or 35.3%, were owned by other partners (including certain of the Companys directors and
senior management).
9. Segment Reporting
The Company defines business segments by their distinct customer base and service provided based on
the financial information used by the Companys chief operating decision maker to make resource
allocation decisions and assess performance. There are two identified reportable segments: (1)
property operations and (2) real estate services. Management evaluates each segments performance
based on net operating income, which is defined as income before corporate general and
administrative expenses, depreciation, amortization, interest expense, loss on early extinguishment
of debt, gain on sale of real estate property, equity in earnings of unconsolidated real estate
partnerships, and minority interests in operating partnership. Management does not include the
property revenues and property operating expenses of Rocky Mount MOB in evaluating the property
operations segment. Intersegment revenues and expenses are reflected at the contractually
stipulated amounts and eliminated in consolidation or combination. The following table represents
the segment information for the three months ended March 31, 2006 and 2005 (in thousands):
|
|
|
|
|
|
|
|
|
|
|
Company |
|
|
Predecessor |
|
|
|
Three Months Ended |
|
|
Three Months Ended |
|
|
|
March 31, 2006 |
|
|
March 31, 2005 |
|
Property operations: |
|
|
|
|
|
|
|
|
Rental revenues |
|
$ |
11,572 |
|
|
$ |
10,653 |
|
Interest and other income |
|
|
173 |
|
|
|
224 |
|
Property operating expenses |
|
|
(4,072 |
) |
|
|
(3,866 |
) |
Intersegment expenses |
|
|
(827 |
) |
|
|
(810 |
) |
|
|
|
|
|
|
|
Net operating income |
|
$ |
6,846 |
|
|
$ |
6,201 |
|
|
|
|
|
|
|
|
Total segment assets, end of period |
|
$ |
367,168 |
|
|
$ |
173,441 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real estate services: |
|
|
|
|
|
|
|
|
Fee revenue |
|
$ |
437 |
|
|
$ |
538 |
|
Expense reimbursements |
|
|
182 |
|
|
|
164 |
|
Interest and other income |
|
|
117 |
|
|
|
|
|
Intersegment revenues |
|
|
827 |
|
|
|
810 |
|
Real estate operating expenses |
|
|
(678 |
) |
|
|
(537 |
) |
|
|
|
|
|
|
|
Net operating income |
|
$ |
885 |
|
|
$ |
975 |
|
|
|
|
|
|
|
|
Total segment assets, end of period |
|
$ |
3,886 |
|
|
$ |
1,399 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reconciliations: |
|
|
|
|
|
|
|
|
Total segment revenues |
|
$ |
13,308 |
|
|
$ |
12,389 |
|
Elimination of intersegment revenues |
|
|
(827 |
) |
|
|
(810 |
) |
Rocky Mount MOB and elimination of related intersegment revenues |
|
|
192 |
|
|
|
|
|
|
|
|
|
|
|
|
Total revenues |
|
$ |
12,673 |
|
|
$ |
11,579 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total segment net operating income |
|
$ |
7,731 |
|
|
$ |
7,176 |
|
Corporate general and administrative expenses |
|
|
(1,315 |
) |
|
|
(426 |
) |
Depreciation and amortization expense |
|
|
(6,453 |
) |
|
|
(2,528 |
) |
Interest expense |
|
|
(2,343 |
) |
|
|
(1,731 |
) |
Equity in earnings (loss) of unconsolidated real estate partnerships |
|
|
5 |
|
|
|
(16 |
) |
Net income of Rocky Mount MOB, net of minority intetests |
|
|
17 |
|
|
|
|
|
Minority interests in operating partnership |
|
|
833 |
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) |
|
$ |
(1,525 |
) |
|
$ |
2,475 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total segment assets |
|
$ |
371,054 |
|
|
$ |
174,840 |
|
Corporate total assets |
|
|
2,439 |
|
|
|
|
|
Rocky Mount MOB total assets |
|
|
4,512 |
|
|
|
|
|
|
|
|
|
|
|
|
Total assets, end of period |
|
$ |
378,005 |
|
|
$ |
174,840 |
|
|
|
|
|
|
|
|
10
ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
When used in this discussion and elsewhere in this Quarterly Report on Form 10-Q, the words
believes, anticipates, projects, should, estimates, expects, and similar expressions
are intended to identify forward-looking statements with the meaning of that term in Section 27A of
the Securities Act of 1933, as amended, and in Section 21F of the Securities and Exchange Act of
1934, as amended. Actual results may differ materially due to uncertainties including:
|
|
|
the Companys business strategy; |
|
|
|
|
the Companys ability to obtain future financing arrangements; |
|
|
|
|
estimates relating to the Companys future distributions; |
|
|
|
|
the Companys understanding of the Companys competition; |
|
|
|
|
the Companys ability to renew the Companys ground leases; |
|
|
|
|
changes in the reimbursement available to the Companys tenants by government or
private payors; |
|
|
|
|
the Companys tenants ability to make rent payments; |
|
|
|
|
defaults by tenants; |
|
|
|
|
market trends; and |
|
|
|
|
projected capital expenditures. |
Forward-looking statements are based on estimates as of the date of this report. The Company
disclaims any obligation to publicly release the results of any revisions to these forward-looking
statements reflecting new estimates, events or circumstances after the date of this report.
Overview
The Company is a fully-integrated, self-administered and self-managed REIT that invests in
specialty office buildings for the medical profession, including medical offices, ambulatory
surgery and diagnostic centers. The Company focuses on the ownership, development, redevelopment,
acquisition and management of strategically located medical office buildings and other healthcare
related facilities primarily in the southeastern United States. The Company has been built around
understanding and addressing the specialized real estate needs of the healthcare industry. The
Company believes the southeastern United States is a large and growing market with favorable macro
healthcare trends and favorable demographic trends that prompt expanding healthcare needs.
The Company derives a significant portion of its revenues from rents received from tenants under
existing leases in medical office buildings and other healthcare related facilities. The Companys
portfolio is stable with a 95.3% occupancy rate as of March 31, 2006, and favorable leases
generally with CPI increases and cost pass through to the tenants. The Company derives a lesser
portion of its revenues from fees that are paid for managing and developing medical office
buildings and other healthcare related facilities for third parties. The Companys management
believes a strong internal property management capability is a vital component of the Companys
business, both for the properties the Company owns and for those that the Company manages. Strong
internal property management allows the Company to control costs, increase tenant satisfaction, and
reduce tenant turnover, which reduces capital costs.
11
The Companys management team has developed long-term and extensive relationships through
developing and maintaining modern, customized medical office buildings and healthcare related
facilities. Approximately 76% of the net rentable square feet of the Companys wholly owned
properties are situated on hospital campuses. As such, the Company believes its assets occupy a
premier franchise location in relationship to local hospitals, providing its properties with a
distinct competitive advantage over alternative medical office space in an area. The Company
believes that its property locations and relationships with hospitals will allow the Company to
capitalize on the increasing healthcare trend of outpatient procedures.
The Companys growth strategy includes leveraging strategic relationships for new developments and
off-market acquisitions. The Company will also continue to enter into development joint ventures
with hospitals and physicians. The Company is active in seeking new client relationships in new
markets. During the three months ended March 31, 2006, the Company acquired properties totaling
approximately $74.9 million in three new markets, which increased the Companys total assets to
$378.4 million at March 31, 2006, from $308.5 million at December 31, 2005.
As of March 31, 2006, the Company owned and/or managed 76 medical office buildings and healthcare
related facilities, serving 21 hospital systems in 10 states. The Companys aggregate portfolio was
comprised of:
|
|
49 wholly owned properties; |
|
|
|
eight joint venture properties; and |
|
|
|
19 properties owned by third parties (17 of which are for clients with whom the
Company has an existing investment relationship). |
At March 31, 2006, the Companys aggregate portfolio contains approximately 3.8 million net
rentable square feet, consisting of approximately 2.5 million net rentable square feet from
wholly-owned properties, approximately 0.4 million net rentable square feet from joint venture
properties, and approximately 0.9 million net rental square feet from properties owned by third
parties and managed by the Company.
Factors Which May Influence Future Results of Operations
Generally, the Companys revenues and expenses have remained consistent except for development fees
and changes in the fair value of interest rate swap agreements reflected in interest expense. The
Companys development fees will continue to vary from period to period due to the level of
development activity at that time.
Changes in fair values related to the Companys interest rate swap agreements, which vary from
period to period based on changes in market interest rates, are recorded in interest expense.
Generally, increases (decreases) in market interest rates will increase (decrease) the fair value
of the derivative, which will decrease (increase) current period interest expense for the change in
fair value.
The Company has used, and will continue to use, external consultants to assist management with the
documentation, remediation, and testing of financial reporting internal controls in order to comply
with Section 404 of the Sarbanes-Oxley Act of 2002. These costs are variable and may be significant
depending on the volume of remediation and testing necessary to be in compliance with Section 404
of the Sarbanes-Oxley Act of 2002 at December 31, 2006.
Critical Accounting Policies
The Companys discussion and analysis of financial condition and results of operations are based
upon the Companys consolidated financial statements and the Companys Predecessors combined
financial statements, which have been prepared on the accrual basis of accounting in conformity
with GAAP. All significant intercompany balances and transactions have been eliminated in
consolidation and combination.
12
The preparation of financial statements in conformity with GAAP requires management to make
estimates and assumptions that affect the reported amounts of assets and liabilities at the date of
the financial statements and the reported amount of revenues and expenses in the reporting period.
The Companys actual results may differ from these estimates. Management has provided a summary of
the Companys significant accounting policies in Note 2 to the Companys consolidated and combined
financial statements included in its Annual Report on Form 10-K for the year ended December 31,
2005. Critical accounting policies are those judged to involve accounting estimates or assumptions
that may be material due to the levels of subjectivity and judgment necessary to account for
uncertain matters or susceptibility of such matters to change. Other companies in similar
businesses may utilize different estimation policies and methodologies, which may impact the
comparability of the Companys results of operations and financial condition to those companies.
Investments in Real Estate
Acquisition of real estate. The price that the Company pays to acquire a property is impacted by
many factors, including the condition of the buildings and improvements, the occupancy of the
building, the existence of above and below market tenant leases, the creditworthiness of the
tenants, favorable or unfavorable financing, above or below market ground leases and numerous other
factors. Accordingly, the Company is required to make subjective assessments to allocate the
purchase price paid to acquire investments in real estate among the assets acquired and liabilities
assumed based on the Companys estimate of the fair values of such assets and liabilities. This
includes determining the value of the buildings and improvements, land, any ground leases, tenant
improvements, in-place tenant leases, tenant relationships, the value (or negative value) of above
(or below) market leases and any debt assumed from the seller or loans made by the seller to the
Company. Each of these estimates requires significant judgment and some of the estimates involve
complex calculations. The Companys calculation methodology is summarized in Note 2 to the
Companys audited consolidated and combined financial statements included its Annual Report on Form
10-K for the year ended December 31, 2005. These allocation assessments have a direct impact on the
Companys results of operations because if the Company were to allocate more value to land there
would be no depreciation with respect to such amount or if the Company were to allocate more value
to the buildings as opposed to allocating to the value of tenant leases, this amount would be
recognized as an expense over a much longer period of time, since the amounts allocated to
buildings are depreciated over the estimated lives of the buildings whereas amounts allocated to
tenant leases are amortized over the terms of the leases. Additionally, the amortization of value
(or negative value) assigned to above (or below) market rate leases is recorded as an adjustment to
rental revenue as compared to amortization of the value of in-place leases and tenant
relationships, which is included in depreciation and amortization in the Companys consolidated and
combined statements of operations.
Useful lives of assets. The Company is required to make subjective assessments as to the useful
lives of the Companys properties for purposes of determining the amount of depreciation to record
on an annual basis with respect to the Companys investments in real estate. These assessments have
a direct impact on the Companys net income (loss) because if the Company were to shorten the
expected useful lives of the Companys investments in real estate the Company would depreciate such
investments over fewer years, resulting in more depreciation expense and lower net income (loss) on
an annual basis.
Asset impairment valuation. The Company reviews the carrying value of the Companys properties when
circumstances, such as adverse market conditions, indicate a potential impairment may exist. The
Company bases the Companys review on an estimate of the future cash flows (excluding interest
charges) expected to result from the real estate investments use and eventual disposition. The
Company considers factors such as future operating income, trends and prospects, as well as the
effects of leasing demand, competition and other factors. If the Companys evaluation indicates
that the Company may be unable to recover the carrying value of a real estate investment, an
impairment loss is recorded to the extent that the carrying value exceeds the estimated fair value
of the property. These losses have a direct impact on the Companys net income because recording an
impairment loss results in an immediate negative adjustment to net income. The evaluation of
anticipated cash flows is highly subjective and is based in part on assumptions regarding future
occupancy, rental rates and capital requirements that could differ materially from actual results
in future periods. Since cash flows on properties considered to be long-lived assets to be held and
used are considered on an undiscounted basis to determine whether an asset has been impaired, the
Companys strategy of holding properties over the long-term directly decreases the likelihood of
recording an impairment loss. If the Companys strategy changes or market conditions otherwise
dictate an earlier sale date, an impairment loss may be recognized and such loss could be material. If the Company
determines that impairment has occurred, the affected assets must be reduced to their fair value.
No such impairment losses have been recognized to date. The Company estimates the fair value of
rental properties utilizing a discounted cash flow analysis that includes projections of future
revenues, expenses and capital improvement costs, similar to the income approach that is commonly
13
utilized by appraisers. The Company reviews the value of Goodwill using an income approach on an
annual basis and when circumstances indicate a potential impairment may exist.
Revenue Recognition
Rental income related to non-cancelable operating leases is recognized using the straight line
method over the terms of the tenant leases. Deferred rents included in the Companys combined
balance sheets represent the aggregate excess of rental revenue recognized on a straight line basis
over the rental revenue that would be recognized under the terms of the leases. The Companys
leases generally contain provisions under which the tenants reimburse the Company for all property
operating expenses and real estate taxes incurred by the Company. Such reimbursements are
recognized in the period that the expenses are incurred. Lease termination fees are recognized when
the related leases are canceled and the Company has no continuing obligation to provide services to
such former tenants. As discussed above, the Company recognizes amortization of the value of
acquired above or below market tenant leases as a reduction of rental income in the case of above
market leases or an increase to rental revenue in the case of below market leases. The Company
receives fees for property management and development and consulting services from time to time
from third parties which is reflected as fee revenue. Management fees are generally based on a
percentage of revenues for the month as defined in the related property management agreements.
Development and consulting fees are recorded on a percentage of completion method using
managements best estimate of time and costs to complete projects. The Company has a long history
of developing reasonable and dependable estimates related to development or consulting contracts
with clear requirements and rights of the parties to the contracts. Although not frequent,
occasionally revisions to estimates of costs are necessary and are reflected as a change in
estimate when known. Other income shown in the statement of operations, generally includes interest
income, primarily from the amortization of unearned income on a sales-type capital lease recognized
in accordance with Statement of Financial Accounting Standards No. 13, and other income incidental
to the Companys operations and is recognized when earned.
The Company must make subjective estimates as to when the Companys revenue is earned and the
collectibility of the Companys accounts receivable related to minimum rent, deferred rent, expense
reimbursements, lease termination fees and other income. The Company specifically analyzes accounts
receivable and historical bad debts, tenant concentrations, tenant creditworthiness, and current
economic trends when evaluating the adequacy of the allowance for bad debts. These estimates have a
direct impact on the Companys net income because a higher bad debt allowance would result in lower
net income, and recognizing rental revenue as earned in one period versus another would result in
higher or lower net income for a particular period.
REIT Qualification Requirements
The Company is subject to a number of operational and organizational requirements to qualify and
then maintain qualification as a REIT. If the Company does not qualify as a REIT, its income would
become subject to U.S. federal, state and local income taxes at regular corporate rates that would
be substantial and the Company cannot re-elect to qualify as a REIT for five years. The resulting
adverse effects on the Companys results of operations, liquidity and amounts distributable to
stockholders would be material.
Results of Operations
The Companys income (loss) from operations is generated primarily from operations of its
properties and development and property management fee revenue. The changes in operating results
from period to period reflect changes in existing property performance and changes in the number of
properties due to development, acquisition, or disposition of properties. To better understand the
overall operating performance, the Companys properties have been categorized into four status
groups. The Company considers a property to be stabilized when it has attained a physical
occupancy level of at least 90%. A property that the Company developed is deemed same-property
when stabilized for at least one year as of the beginning of the current year. A property that the
Company has acquired remains an acquisition property until deemed same-property when the Company has owned it for one year or more as of the
beginning of the current year. A property is deemed to be a development property until deemed
same-property when stabilized as of the beginning of the current year. A disposition property
is one which the Company has sold in current or prior years.
14
Comparison of the three months ended March 31, 2006 and March 31, 2005
Overview. The following is an activity summary of the Companys property portfolio (excluding
unconsolidated real estate partnerships) for the three months ended March 31, 2006 and 2005:
|
|
|
|
|
|
|
|
|
|
|
Company |
|
Predecessor |
|
|
2006 |
|
2005 |
Properties at January 1 |
|
|
44 |
|
|
|
43 |
|
Consolidation of Rocky Mount MOB LLC |
|
|
1 |
|
|
|
|
|
Acquisitions |
|
|
4 |
|
|
|
|
|
Development that began rental operations |
|
|
|
|
|
|
1 |
|
|
|
|
|
|
|
|
|
|
Properties at March 31 |
|
|
49 |
|
|
|
44 |
|
|
|
|
|
|
|
|
|
|
The above table excludes East Jefferson Medical Specialty Building, which is accounted for as
a sales-type capital lease. Three of the four acquired properties were added on March 30, 2006, and
as a result, the operations for these properties for the three months ended March 31, 2006, was
minimal.
Revenue. Total revenue increased $1.1 million, or 9.4%, for the three months ended March 31, 2006.
This increase is primarily due to an increase in property rental revenue of $1.1 million.
Property rental revenue increased $1.1 million, or 10.6%, for the three months ended March 31,
2006. Same-property rental revenue increased $0.3 million, or 3.3%. This increase is due
primarily to general increases in rent related to consumer price index, or CPI, escalation clauses.
Rental revenue from acquisition and development properties increased $0.8 million.
Fee revenue decreased $0.1 million, or 20.3%, for the three months ended March 31, 2006 due to the
timing of services performed related to third party development projects. For the three months
ended March 31, 2006, there was one active project, which was nearing completion, versus two active
projects for the three months ended March 31, 2005.
Property operating expenses. Property operating expenses increased $0.2 million, or 6.4%, for the
three months ended March 31, 2006. Same-property operating expenses increased approximately $14,000, or 0.4%. Acquisition and development property operating expenses increased $0.2 million.
Interest expense. Interest expense increased $0.7 million, or 39.2%, for the three months ended
March 31, 2006. Excluding the decrease in interest expense in each period due to changes in
interest rate swap fair values, interest expense decreased $0.4 million from $3.1 million for the
three months ended March 31, 2005 to $2.7 million for the three months ended March 31, 2006. This
decrease is primarily due to a change in the Companys capital structure as a result of the
Offering, the proceeds of which were used in part to reduce debt principal balances. The decrease
as a result of lower debt principal balances was offset by borrowings to fund the four property
acquisitions during the quarter and higher interest payments due to increasing interest rates on
variable rate debt.
Changes in interest rate swap fair values are recorded as a decrease or increase to interest
expense. For the three months ended March 31, 2005, the interest rate swap agreement fair values
increased $1.3 million, which resulted in a reduction of interest expense of the same amount. For
the three months ended March 31, 2006, the interest rate swap agreement fair values increased $0.3
million, which resulted in a reduction of interest expense of $0.3 million, but the reduction is
$1.0 million less than the reduction experienced in the same quarter in 2005. For the three months
ended March 31, 2006, there were five derivative interest rate swap agreements with an aggregate
notional amount of $44.4 million versus eight instruments with an aggregate notional amount of
$81.8 million in the same quarter in 2005.
Depreciation and amortization expenses. Depreciation and amortization expenses increased $4.0
million, or 156.6%, for the three months ended March 31, 2006. The increase was primarily due to
the increase in the cost basis for the real estate properties and intangible assets as a result of
the purchase accounting for the Formation Transactions on November 1, 2005.
15
General and administrative expenses. General and administrative expenses increased $1.0 million, or
107.2% for the three months ended March 31, 2006 primarily due to following increases: $0.4 million
related to the financial statement audit, $0.2 million related to internal audit and internal
control documentation consulting services, $0.1 million related to legal, $0.1 million related to
bonus accruals, $0.1 million related to tax compliance, approximately $56,000 related to Officers
and Directors insurance, approximately $46,000 related to compensation to Board of Directors
members, and approximately $41,000 related to investor relations and marketing.
Cash Flows
Comparison of the three months ended March 31, 2006 and March 31, 2005
Cash provided by operating activities was $4.5 million and $3.3 million during the three months
ended March 31, 2006 and 2005, respectively. The increase of $1.2 million was primarily due to an
increase in accounts payable and accrued expenses of $0.9 million for the three months ended March
31, 2006, compared to a decrease of $0.5 million for the three months ended March 31, 2005. Trade
accounts payable increased $1.2 million from March 31, 2005 to March 31, 2006 due to timing of
payment of trade payables and increased expenses incurred in 2006 versus 2005.
Cash used in investing activities was $71.7 million and $1.7 million during the three months ended
March 31, 2006 and 2005, respectively. The increase in 2006 was primarily due to the acquisition of
four properties with an aggregate cash outflow of $69.6 million.
Cash provided by (used in) financing activities was $61.3 million and ($3.7 million) for the three
months ended March 31, 2006 and 2005, respectively. For 2006, the Company borrowed $68.3 million
under its Credit Facility to fund the acquisitions during the quarter offset by $6.8 million of
principal repayments. In 2005, the Predecessor entities made distributions to their members and
partners of $4.0 million, generally related to cash flow from operations for the second half of
2004.
Liquidity and Capital Resources
As of March 31, 2006, the Company had $3.9 million available in cash and cash equivalents. The
Company will be required to distribute at least 90% of the Companys net taxable income, excluding
net capital gains, to the Companys stockholders on an annual basis due to qualification
requirements as a REIT. Therefore, as a general matter, it is unlikely that the Company will have
any substantial cash balances that could be used to meet the Companys liquidity needs. Instead,
these needs must be met from cash generated from operations and external sources of capital.
The Company has a $100.0 million unsecured revolving credit facility (the Credit Facility), with
a syndicate of financial institutions (including Bank of America, N.A., Citicorp North America,
Inc. and Branch Banking & Trust Company) (collectively, the Lenders). The Credit Facility shall
be available to fund working capital and other corporate purposes; finance acquisition and
development activity; and refinance existing and future indebtedness. The Credit Facility permits
the Company to borrow up to $100.0 million of revolving loans, with sub-limits of $25.0 million for
swingline loans and $25.0 million for letters of credit.
The Credit Facility shall terminate and all amounts outstanding thereunder shall be due and payable
in full, three years from November 1, 2005, subject to a one-year extension at the Companys
option. The Credit Facility also allows for up to $150.0 million of increased availability (to a
total aggregate available amount of $250.0 million), at the Companys option but subject to each
Lenders option to increase its commitments. The interest rate on loans under the Credit Facility
equals, at the Companys election, either (1) LIBOR plus a margin of between 100 to 130 basis
points based on the Companys leverage ratio or (2) the higher of the federal funds rate plus 50
basis points or Bank of America, N.A.s prime rate.
The Credit Facility contains customary terms and conditions for credit facilities of this type,
including: (1) limitations on the Companys ability to (A) incur additional indebtedness, (B) make
distributions to the Companys stockholders, subject to complying with REIT requirements, and (C) make certain
investments; (2) maintenance of a pool of unencumbered assets subject to certain minimum valuations
thereof; and (3) requirements for us to maintain certain financial coverage ratios. These customary
financial coverage ratios and other conditions include a maximum leverage ratio (65%, with
flexibility for one two quarter increase to not more than 75%), minimum fixed charge coverage ratio
(175%), maximum combined secured indebtedness (50%), maximum recourse indebtedness (15%), maximum
unsecured indebtedness (60%, with flexibility for one two quarter increase to not more than 75%),
minimum unencumbered interest coverage ratio (200%)
16
and minimum combined tangible net worth ($30 million plus 85% of net proceeds of equity issuances
by the Company and its subsidiaries after November 1, 2005).
As of March 31, 2006, there was $13.6 million available under the Companys Credit Facility. There
is $85.9 million outstanding at March 31, 2006 and $0.5 million of availability is restricted
related to an outstanding letter of credit.
The Company believes that it will have sufficient capital resources as a result of operations and
the borrowings in place to fund ongoing operations.
On March 10, 2006, the Company declared a dividend to common stockholders of record and the
Operating Partnership declared a distribution to unitholders of record, in each case as of March
22, 2006, totaling $4.3 million or $0.35 per share or unit, covering the period from January 1,
2006 through March 31, 2006. The dividend and distribution were paid on April 17, 2006. The
dividend and distribution were equivalent to an annual rate of $1.40 per share and unit. On April
16, 2006, the Company borrowed $2.5 million under its Credit Facility to partially fund the
declared dividend and distribution.
Long-Term Liquidity Needs
The Companys principal long-term liquidity needs consist primarily of new property development,
property acquisitions, principal payments under various mortgages and other credit facilities and
non-recurring capital expenditures. The Company does not expect that its net cash provided by
operations will be sufficient to meet all of these long-term liquidity needs. Instead, the Company
expects to finance new property developments through modest cash equity capital contributed by the
Company together with construction loan proceeds, as well as through cash equity investments by its
tenants. The Company expects to fund property acquisitions through a combination of borrowings
under its Credit Facility and traditional secured mortgage financing. In addition, the Company
expects to use OP Units issued by the operating partnership to acquire properties from existing
owners seeking a tax deferred transaction. The Company expects to meet other long-term liquidity
requirements through net cash provided by operations and through additional equity and debt
financings, including loans from banks, institutional investors or other lenders, bridge loans,
letters of credit, and other lending arrangements, most of which will be secured by mortgages. The
Company may also issue unsecured debt in the future. However, in view of the Companys strategy to
grow its portfolio over time, the Company does not, in general, expect to meet its long-term
liquidity needs through sales of its properties. In the event that, notwithstanding this intent,
the Company was in the future to consider sales of its properties from time to time, the proceeds
that would be available to the Company from such sales, may be reduced by amounts that the Company
may owe under the tax protection agreements or those properties would need to be sold in a tax
deferred transaction which would require reinvestment of the proceeds in another property. In
addition, the Companys ability to sell certain of its assets could be adversely affected by the
general illiquidity of real estate assets and certain additional factors particular to our
portfolio such as the specialized nature of its target property type, property use restrictions and
the need to obtain consents or waivers of rights of first refusal or rights of first offers from
ground lessors in the case of sales of its properties that are subject to ground leases.
The Company intends to repay indebtedness incurred under its Credit Facility from time to time, for
acquisitions or otherwise, out of cash flow and from the proceeds of additional debt or equity
issuances. In the future, the Company may seek to increase the amount of its credit facilities,
negotiate additional credit facilities or issue corporate debt instruments. Any indebtedness
incurred or issued by the Company may be secured or unsecured, short-, medium- or long-term, fixed
or variable interest rate and may be subject to other terms and conditions the Company deems
acceptable. The Company intends to refinance at maturity the mortgage notes payable that have
balloon payments at maturity.
17
Contractual Obligations
The following table summarizes the Companys contractual obligations as of March 31, 2006,
including the maturities and scheduled principal repayments and the commitments due in connection
with the Companys ground leases and operating leases for the periods indicated (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Through |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Remainder |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
of 2006 |
|
|
2007 |
|
|
2008 |
|
|
2009 |
|
|
2010 |
|
|
Thereafter |
|
|
Total |
|
Obligation: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term debt principal
payments and maturities(1) |
|
$ |
12,145 |
|
|
$ |
39,187 |
|
|
$ |
113,400 |
|
|
$ |
16,440 |
|
|
$ |
1,456 |
|
|
$ |
47,842 |
|
|
$ |
230,470 |
|
Standby letters of credit(2) |
|
|
500 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
500 |
|
Interest payments(3) |
|
|
10,057 |
|
|
|
11,880 |
|
|
|
7,451 |
|
|
|
3,591 |
|
|
|
2,986 |
|
|
|
7,533 |
|
|
|
43,498 |
|
Ground leases(4) |
|
|
116 |
|
|
|
155 |
|
|
|
155 |
|
|
|
155 |
|
|
|
155 |
|
|
|
5,296 |
|
|
|
6,032 |
|
Operating leases(5) |
|
|
200 |
|
|
|
251 |
|
|
|
327 |
|
|
|
338 |
|
|
|
346 |
|
|
|
383 |
|
|
|
1,845 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
23,018 |
|
|
$ |
51,473 |
|
|
$ |
121,333 |
|
|
$ |
20,524 |
|
|
$ |
4,943 |
|
|
$ |
61,054 |
|
|
$ |
282,345 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Includes notes payable under the Companys Credit Facility |
|
(2) |
|
As collateral for performance on a mortgage note payable, the Company is contingently
liable under a standby letter of credit, which also reduces the availability under the
Credit Facility |
|
(3) |
|
Assumes one-month LIBOR of 4.83% and Prime Rate of 7.75% |
|
(4) |
|
Substantially all of the ground leases effectively limit our control over various
aspects of the operation of the applicable property, restrict our ability to transfer the
property and allow the lessor the right of first refusal to purchase the building and
improvements. All of the ground leases provide for the property to revert to the lessor
for no consideration upon the expiration or earlier termination of the ground lease. |
|
(5) |
|
Payments under operating lease agreements relate to various of our properties
equipment and office space leases. The future minimum lease commitments under these leases
are as indicated above. |
Off-Balance Sheet Arrangements
The Company guarantees debt in connection with certain of its development activities, including
joint ventures. The Company has guaranteed, in the event of a default, the mortgage notes payable
for two limited liability companies. An initial liability of $0.1 million has been recorded for
these guarantees using expected present value measurement techniques. For one mortgage note payable
with a principal balance of $13.0 million at March 31, 2006, the guarantee will be released upon
completion of the project and commencement of rental income, which is expected to occur in the
second quarter of 2006. The other guarantee, with a principal balance of $9.1 million at March 31,
2006, will be released upon the full repayment of the mortgage note payable, which matures in
December 2006. The mortgages are collateralized by property and the collateral will revert to the
guarantor in the event the guarantee is performed.
As the Company has never had to perform on debt that the Company has guaranteed, the probability
the Company will have to perform on any guarantees in the future is minimal and therefore the
Company does not expect the Companys guarantees to have a material impact on the Companys
financial statements.
Real Estate Taxes
The Companys leases generally require the tenants to be responsible for all real estate taxes.
Inflation
Inflation in the United States has been relatively low in recent years and did not have a material
impact on the results of operations for the periods shown in the consolidated and combined
financial statements. Although the impact of inflation has been relatively insignificant in recent
years, it remains a factor in the United States economy and may increase the cost of acquiring or
replacing properties.
18
Seasonality
The Company does not consider its business to be subject to material seasonality fluctuations.
Recent Accounting Pronouncements
Based on the Companys review of recent accounting pronouncements released during the quarter ended
March 31, 2006, the Company has not identified any standard requiring adoption that would have a
material impact on the Companys financial position or results of operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Companys future income, cash flows and fair values relevant to financial instruments are
dependent upon prevalent market interest rates. Market risk refers to the risk of loss from adverse
changes in market prices and interest rates. The Company uses some derivative financial instruments
to manage, or hedge, interest rate risks related to the Companys borrowings. The Company does not
use derivatives for trading or speculative purposes and only enter into contracts with major
financial institutions based on their credit rating and other factors.
As of March 31, 2006, the Company had $230.5 million of consolidated debt outstanding (excluding
any discounts or premiums related to assumed debt). $120.2 million, or 52.1%, of the Companys
total consolidated debt was variable rate debt that are not subject to variable to fixed rate
interest rate swap agreements. $110.3 million, or 47.9%, of the Companys total indebtedness was
subject to fixed interest rates, including variable rate debt that is subject to variable to fixed
rate swap agreements.
If LIBOR were to increase by 100 basis points, the increase in interest expense on the Companys
variable rate debt would decrease future earnings and cash flows by approximately $1.2 million.
Interest rate risk amounts were determined by considering the impact of hypothetical interest rates
on the Companys financial instruments. These analyses do not consider the effect of any change in
overall economic activity that could occur in that environment. Further, in the event of a change
of that magnitude, the Company may take actions to further mitigate the Companys exposure to the
change. However, due to the uncertainty of the specific actions that would be taken and their
possible effects, these analyses assume no changes in the Companys financial structure.
ITEM 4. CONTROLS AND PROCEDURES
The Companys Chief Executive Officer and Chief Financial Officer, based on the evaluation of the
Companys disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the
Securities and Exchange Act of 1934, as amended) required by paragraph (b) of Rule 13a-15 or Rule
15d-15, have concluded that as of the end of the period covered by this report, the Companys
disclosure controls and procedures were effective to give reasonable assurances to the timely
collection, evaluation and disclosure of information relating to the Company that would potentially
be subject to disclosure under the Securities Exchange Act of 1934, as amended, and the rules and
regulations promulgated thereunder.
During the three month period ended March 31, 2006, there was no change in the Companys internal
control over financial reporting that has materially affected, or is reasonably likely to
materially affect, the Companys internal control over financial reporting.
Notwithstanding the foregoing, a control system, no matter how well designed and operated, can
provide only reasonable, not absolute assurance that it will detect or uncover failures within the
Company to disclose material information otherwise required to be set forth in our periodic
reports.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is not involved in any material litigation nor, to the Companys knowledge, is any
material litigation pending or threatened against us, other than routine litigation arising out of
the ordinary course of business or which is expected to be covered by insurance and not expected to
harm the Companys business, financial condition or results of operations.
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ITEM 1A. RISK FACTORS
See the Companys Annual Report on Form 10-K for the year ended December 31, 2005, for risk
factors. There have been no significant changes to the Companys risk factors during the three
months ended March 31, 2006.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS
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10.1
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Methodist Professional Center
Purchase and Sale Agreement dated December 13, 2005 |
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10.2
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Hanover Medical Office Building One and 1808/1818 Verdugo Boulevard Purchase and Sale
Agreement dated March 1, 2006 |
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31.1
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Certification of Chief Executive Officer pursuant to Section 302 of Sarbanes -Oxley
Act of 2002. |
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31.2
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Certification of Chief Financial Officer pursuant to Section 302 of Sarbanes -Oxley
Act of 2002. |
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32.1
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Certification of Chief Executive and Chief Financial Officer pursuant to 18 U.S.C.
Section 1350 as adapted pursuant to Section 906 of the Sarbanes -Oxley Act of 2002. |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the Registrant has
duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
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Cogdell Spencer Inc. |
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Registrant |
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Date: May 15, 2006
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/s/ Frank C. Spencer |
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Frank C. Spencer |
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President and Chief Executive Officer |
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Date: May 15, 2006
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/s/ Charles M. Handy |
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Charles M. Handy |
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Senior Vice President and Chief Financial Officer |
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