##### 



UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549
 FORM 10-Q
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
1934
 For the quarterly period ended March 31, 2005 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
 For the transition period from ____________ to _____________. Commission File Number 1-31824 FIRST POTOMAC REALTY TRUST (Exact name of registrant as specified in its charter) MARYLAND
    
    37-1470730(State or other jurisdiction of
    
    (I.R.S. Employerincorporation or organization)
    
    Identification No.)
 7200 Wisconsin Avenue, Suite 310, Bethesda, MD 20814
(Address of principal executive offices) (Zip Code) (301) 986-9200
(Registrants telephone number, including area code) 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 an accelerated filer (as defined in Rule 12b-2 of
the Exchange Act). YES o NO o As of May 6, 2005, there were 16,454,417 shares of beneficial interest, par value $.001 per share,
outstanding.




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FIRST POTOMAC REALTY TRUST
FORM 10-Q INDEX PagePart I: Financial InformationItem 1. Financial StatementsCondensed consolidated balance sheets as of March 31, 2005 (unaudited) and December 31, 2004
    
    
    3Condensed consolidated statements of operations (unaudited) for the three months ended March 31, 2005 and
2004
    
    
    4Condensed consolidated statements of cash flows (unaudited) for the three months ended March 31, 2005 and
2004
    
    
    5Notes to condensed consolidated financial statements (unaudited)
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    13Item 3. Quantitative and Qualitative Disclosure about Market Risk
    
    
    21Item 4. Controls and Procedures
    
    
    21Part II: Other InformationItem 6. Exhibits and Reports on Form 8-K
    
    
    22Signatures
 2




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FIRST POTOMAC REALTY TRUST
Condensed Consolidated Balance Sheets March 31, 2005(Unaudited)
    
    
    December 31, 2004Assets:Rental property, net
    
    $
    471,962,227
    
    
    $
    463,936,562Intangible assets, net
    
    
    25,375,923
    
    
    
    26,008,351Cash and cash equivalents
    
    
    2,224,974
    
    
    
    2,532,269Escrows and reserves
    
    
    7,994,682
    
    
    
    6,301,465Accounts and other receivables, net of
allowance for doubtful accounts of
$231,127 and $147,649, respectively
    
    
    2,970,387
    
    
    
    2,767,879Accrued straight-line rents, net of
allowance for doubtful accounts of
$36,607 and $18,209 respectively
    
    
    2,634,159
    
    
    
    2,309,576Deferred costs, net
    
    
    4,143,435
    
    
    
    4,196,229Prepaid expenses and other assets
    
    
    3,371,080
    
    
    
    2,023,823Total assets
    
    $
    520,676,867
    
    
    $
    510,076,154Liabilities:Mortgage loans
    
    $
    257,902,423
    
    
    $
    259,039,281Accounts payable and accrued expenses
    
    
    3,225,058
    
    
    
    4,058,025Accrued interest
    
    
    1,185,822
    
    
    
    799,974Rents received in advance
    
    
    1,901,573
    
    
    
    1,744,022Tenant security deposits
    
    
    3,007,611
    
    
    
    2,804,287Credit facility
    
    
    10,000,000
    
    
    
    39,679,912Deferred market rent, net
    
    
    5,165,447
    
    
    
    5,266,728Total liabilities
    
    
    282,387,934
    
    
    
    313,392,229Minority interests
    
    
    18,681,196
    
    
    
    18,991,052Shareholders equity:Common stock, $0.001 par value, 100,000,000
shares authorized: 16,266,671 and
14,154,000 shares and outstanding,
respectively
    
    
    16,267
    
    
    
    14,154Additional paid-in capital
    
    
    254,350,937
    
    
    
    209,268,156Deficit
    
    
    (34,759,467
    )
    
    
    (31,589,437
    )Total shareholders equity
    
    
    219,607,737
    
    
    
    177,692,873Total liabilities and shareholders equity
    
    $
    520,676,867
    
    
    $
    510,076,154
 See accompanying notes to condensed consolidated financial statements. 3




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##### 



FIRST POTOMAC REALTY TRUST
Condensed Consolidated Statements of Operations
(Unaudited) Three Months Ended March 31,2005
    
    
    2004Revenues:Rental
    
    $
    14,136,651
    
    
    $
    6,526,445Tenant reimbursements and other
    
    
    2,291,587
    
    
    
    987,014Total revenue
    
    
    16,428,238
    
    
    
    7,513,459Operating expenses:Property operating
    
    
    3,006,886
    
    
    
    1,443,641Real estate taxes and insurance
    
    
    1,395,404
    
    
    
    673,038General and administrative
    
    
    1,870,738
    
    
    
    823,188Depreciation and amortization
    
    
    5,076,695
    
    
    
    2,540,122Total operating expenses
    
    
    11,349,723
    
    
    
    5,479,989Operating income
    
    
    5,078,515
    
    
    
    2,033,470Other expenses (income):Interest expense
    
    
    4,515,394
    
    
    
    2,067,606Interest and other income
    
    
    (14,538
    )
    
    
    (35,062
    )Loss from early retirement of debt
    
    
    
    
    
    
    212,250Total other expenses
    
    
    4,500,856
    
    
    
    2,244,794Income (loss) from continuing operations before
minority interests and discontinued operations
    
    
    577,659
    
    
    
    (211,324
    )Minority interests
    
    
    (51,354
    )
    
    
    29,451Income (loss) from continuing operations
    
    
    526,305
    
    
    
    (181,873
    )Income from discontinued operations
    
    
    
    
    
    
    11,267Net income (loss)
    
    $
    526,305
    
    
    $
    (170,606
    )Weighted average common shares outstanding  basic
    
    
    14,238,112
    
    
    
    8,634,000Weighted average common shares outstanding  diluted
    
    
    14,412,019
    
    
    
    8,634,000Income (loss) from continuing operations and income
(loss) per share  basic and diluted
    
    $
    0.04
    
    
    $
    (0.02
    )
 See accompanying notes to condensed consolidated financial statements. 4




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##### 



FIRST POTOMAC REALTY TRUST
Condensed Consolidated Statements of Cash Flows
(Unaudited) Three Months Ended March 31,2005
    
    
    2004Cash flow from operating activitiesNet income (loss)
    
    $
    526,305
    
    
    $
    (170,606
    )Adjustments to reconcile net income (loss) to net cash
provided by operating activities:Discontinued operations:Depreciation and amortization
    
    
    
    
    
    
    64,789Minority interests
    
    
    
    
    
    
    1,822Depreciation and amortization
    
    
    5,285,971
    
    
    
    2,721,541Bad debt expense
    
    
    129,417
    
    
    
    171,367Stock based compensation
    
    
    81,950
    
    
    
    Amortization of deferred market rent
    
    
    (265,019
    )
    
    
    (3,225
    )Minority interests
    
    
    51,354
    
    
    
    (29,451
    )Loss from early retirement of debt
    
    
    
    
    
    
    212,250Changes in assets and liabilities:Escrows and reserves
    
    
    (1,693,217
    )
    
    
    854,330Accounts and other receivables
    
    
    (313,526
    )
    
    
    (277,687
    )Accrued straight-line rents
    
    
    (342,982
    )
    
    
    (72,432
    )Prepaid expenses and other assets
    
    
    384,327
    
    
    
    (1,912,392
    )Tenant security deposits
    
    
    203,324
    
    
    
    47,012Accounts payable and accrued expenses
    
    
    (809,619
    )
    
    
    (207,282
    )Accrued interest
    
    
    385,848
    
    
    
    280,212Rent received in advance
    
    
    157,551
    
    
    
    239,822Deferred costs
    
    
    (224,050
    )
    
    
    (150,632
    )Total adjustments
    
    
    3,031,329
    
    
    
    1,940,044Net cash provided by operating activities
    
    
    3,557,634
    
    
    
    1,769,438Cash flows from investing activitiesPurchase deposit on future acquisitions
    
    
    (1,750,000
    )
    
    
    Additions to rental property
    
    
    (476,925
    )
    
    
    (838,324
    )Acquisition of rental property and associated
intangible assets
    
    
    (11,743,285
    )
    
    
    Net cash used in investing activities
    
    
    (13,970,210
    )
    
    
    (838,324
    )Cash flows from financing activitiesFinancing costs
    
    
    
    
    
    
    (189,661
    )Repayments of debt
    
    
    (45,816,770
    )
    
    
    (7,297,109
    )Dividends to shareholders
    
    
    (3,696,335
    )
    
    
    (863,400
    )Distributions to minority interests
    
    
    (361,210
    )
    
    
    (139,552
    )Proceeds from debt
    
    
    15,000,000
    
    
    
    Proceeds from issuance of shares, net
    
    
    44,979,596
    
    
    
    Net cash provided by (used in) financing activities
    
    
    10,105,281
    
    
    
    (8,489,722
    )Net decrease in cash and cash equivalents
    
    
    (307,295
    )
    
    
    (7,558,608
    )Cash and cash equivalents at beginning of period
    
    
    2,532,269
    
    
    
    16,307,508Cash and cash equivalents at end of period
    
    $
    2,224,974
    
    
    $
    8,748,900
 See accompanying notes to condensed and consolidated financial statements. 5




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FIRST POTOMAC REALTY TRUST NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (1) Summary of Significant Accounting Policies (a) Description of Business First Potomac Realty Trust (the Company) is a self-managed, self-administered Maryland real
estate investment trust. The Company focuses on owning and operating industrial and flex
properties in the Washington, D.C. metropolitan area and other major markets in Virginia and
Maryland, which we collectively refer to as the southern Mid-Atlantic region. As of March 31, 2005,
the Company owned a 40-property portfolio consisting of 84-buildings totaling approximately 5.4
million square feet. The Company operates so as to qualify as a real estate investment trust
(REIT) for federal income tax purposes. The Company owns all of its properties and conducts its business through First Potomac Realty
Investment Limited Partnership, the Companys operating partnership (the Operating Partnership).
At March 31, 2005, the Company was the sole general partner of and owned a 92% interest in the
Operating Partnership. The remaining interests in the Operating Partnership consist of limited
partnership interests owned by third parties who have contributed properties and other assets to
the Company and are presented as minority interests for accounting purposes. (b) Principles of Consolidation The unaudited condensed consolidated financial statements of the Company include the accounts
of the Company, the Operating Partnership, the property owning subsidiaries of the Operating
Partnership and FPM Management LLC. All intercompany balances and transactions have been
eliminated in consolidation. We have condensed or omitted certain information and footnote disclosures normally
included in financial statements presented in accordance with U.S. generally accepted accounting
principles, or GAAP, in the accompanying unaudited condensed consolidated financial statements. We
believe the disclosures made are adequate to prevent the information presented from being
misleading. However, the unaudited condensed consolidated financial statements should be read in
conjunction with the consolidated financial statements and notes thereto included in our Annual
Report on Form 10-K for the year ended December 31, 2004 and as amended from time to time in other
filings with the Securities and Exchange Commission. In our opinion, the accompanying unaudited condensed consolidated financial statements
reflect all adjustments necessary to present fairly our financial position as of March 31, 2005 and
the results of our operations and cash flows for the quarters ended March 31, 2005 and 2004.
Interim results are not necessarily indicative of full year performance due in part to the impact
of mid-year acquisitions. (c) Revenue Recognition The Company generates substantially all of its revenue from leases on its properties. The
Company recognizes rental revenue on a straight-line basis over the life of the respective leases
in accordance with SFAS No. 13, Accounting for Leases. Accrued straight-line rents represent the
difference between rental revenue recognized on a straight-line basis over the term of the
respective lease agreements and the rental payments contractually due for leases that contain
abatement or fixed periodic increases. The Company considers current information and events
regarding the tenants ability to pay their obligations in determining if accrued straight-line
rents are ultimately collectible. The uncollectible portion of accrued straight-line rents is
charged to rental revenues in the period in which the determination is made. Tenant leases generally contain provisions under which the tenants reimburse the Company for a
portion of property operating expenses and real estate taxes incurred by the Company. The Company
records a provision for losses on estimated uncollectible accounts receivable based on its analysis
of risk of loss on specific accounts. (d) Intangibles Other intangible assets include the value of tenant or customer relationships, and the
origination value of leases in accordance with SFAS No. 141, Business Combinations. Customer
relationship values are determined based on our evaluation of the
specific characteristics of each
tenants lease and our overall relationship with the tenant. Characteristics we 6




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consider include the nature and extent of our existing business relationships with the tenant,
growth prospects for developing new business with the tenant, the tenants credit quality and
expectations of lease renewals. The value of customer relationship intangible assets is amortized
to expense over the lesser of the initial lease term and any expected renewal periods or the
remaining useful life of the building. We determine the fair value of the cost of acquiring
existing tenants by estimating the lease commissions avoided by having in-place tenants and avoided
lost operating income for the estimated period required to lease the space occupied by existing
tenants at the acquisition date. The cost of acquiring existing tenants is amortized to expense
over the initial term of the respective leases. Should a tenant terminate its lease, the
unamortized portion of the in-place lease value is charged to expense on the date of termination. Deferred market rent liability consists of the effect of leases with below market rents.
Above market rents are included in intangible assets. Above market and below market in-place
lease values are determined on a lease by lease basis based on the present value (using an
interest rate which reflects the risks associated with the leases acquired) of the difference
between (a) the contractual amounts to be paid under the lease and (b) our estimate of the fair
market lease rate for the corresponding space over the remaining non-cancellable terms of the
related leases. The capitalized below market lease values are amortized as an increase to rental
income over the initial term and any below market renewal periods of the related leases.
Capitalized above market lease values are amortized as a decrease to rental income over the
initial term of the related leases. In conjunction with the Companys initial public offering in October 2003 and related
formation transactions, First Potomac Management, Inc. contributed all of the Companys capital
interests in FPM Management LLC, the entity that manages our properties, to the Operating
Partnership. The $2.1 million fair value of the in-place workforce acquired has been classified
as goodwill from third parties in accordance with SFAS No. 141, Business Combinations.
Goodwill is assessed for impairment at the end of our fiscal year and in interim periods if
certain events, such as the loss of key personnel, occur indicating the carrying value is
impaired. The Company will recognize an impairment loss when the discounted expected future cash
flows associated with management contracts is less than the carrying cost of the goodwill in
accordance with SFAS No. 142, Goodwill and Other Intangibles. No events occurred during the
three months ended March 31, 2005 to cause us to test for impairment. The accumulated
amortization of intangible assets was $7,214,904 and $5,585,556 at March 31, 2005 and December 31,
2004, respectively. (e) Income Taxes The Company has elected to be taxed as a REIT. To maintain its status as a REIT, the Company
is required to distribute at least 90% of its ordinary taxable income annually to its shareholders.
The Company intends to make timely distributions sufficient to satisfy the annual distribution
requirements and to avoid corporate income tax and any nondeductible excise tax. The Company has
two taxable REIT subsidiaries (TRS) which have generated taxable income during 2005; however, the
Company has determined any tax expense resulting from TRS activity would be inconsequential and,
accordingly, no provision has been disclosed for state or federal income taxes in the accompanying
condensed consolidated financial statements for 2005. (f) Minority Interests Minority interests relate to the interests in the Operating Partnership not owned by the
Company. The Company owned 86% of the outstanding Operating Partnership units at March 31, 2004.
Subsequent to the completion of issuances of common shares in June 2004 and March 2005, the Company
owned 92% of the units outstanding in the Operating Partnership on March 31, 2005. The remaining
interests in the Operating Partnership are owned by limited partners who contributed properties and
other assets to the Operating Partnership in exchange for Operating Partnership units. Limited
partners have the right to tender their units for redemption, at the Companys option, for common
shares of the Company or an equivalent amount of cash. Unitholders receive distributions per unit
equivalent to the dividend per common share. There were no redemptions of units during the three
months ended March 31, 2005. (g) Income Per Share Basic earnings per share (EPS) is calculated by dividing net income by the weighted average
number of the Companys common shares outstanding. Diluted EPS is computed after adjusting the
basic EPS computation for the effect of diluted common equivalent shares outstanding during the
period. The effect of stock options, if dilutive, is computed using the treasury stock method. The following table sets forth the computation of the Companys basic and diluted earnings per
share from continuing operations and income available to common shareholders: 7




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Three Months EndedMarch 31, 2005
    
    
    March 31, 2004Numerator for basic and diluted per share calculations:Income (loss) from continuing operations
    
    $
    526,305
    
    
    $
    (181,873
    )Income from discontinued operations
    
    
    
    
    
    
    11,267Net income (loss)
    
    $
    526,305
    
    
    $
    (170,606
    )Denominator for basic and diluted per share calculations:Weighted average shares outstanding  basic:
    
    
    14,238,112
    
    
    
    8,634,000Effect of dilutive shares:Employee stock option awards
    
    
    173,907
    
    
    
    Denominator for diluted per share amounts
    
    
    14,412,019
    
    
    
    8,634,000Income from continuing operations and net income (loss)
per share, basic and diluted
    
    $
    0.04
    
    
    $
    (0.02
    )
 (h) Stock Based Compensation In compliance with SFAS No. 123, Accounting for Stock Based Compensation, the Company has
elected to follow the intrinsic value-based method of accounting prescribed by the Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related
interpretations, in accounting for its fixed plan share options. As such, compensation expense
would be recorded only if the current market price of the underlying shares on the date of grant
exceeded the exercise price. On January 3, 2005, the Company granted 60,171 restricted common shares to executive officers.
These grants vest upon achieving certain financial performance measures over the term of the
award. The Company recognized $81,950 of stock- based compensation expense during the quarter ended March 31, 2005. Under
SFAS No. 123, compensation expense of $140,574 and $44,024 would have been recorded
during the three months ended March 31, 2005 and 2004, respectively for the Equity Compensation
Plan based upon the fair value of the option awards. Pro forma net income (loss) and net income (loss) per share would have been as follows: Three Months EndedMarch 31, 2005
    
    
    March 31, 2004Net income (loss), as reported
    
    $
    526,305
    
    
    $
    (170,606
    )Add: total stock-based compensation
included in reported net income
(loss)
    
    
    81,950
    
    
    
    Deduct: total stock-based employee
compensation expense determined under
fair value based method for all
awards, net of minority interests
    
    
    (140,574
    )
    
    
    (44,024
    )Pro forma net income (loss)
    
    $
    467,681
    
    
    $
    (214,630
    )Net income (loss) per share, as
reported  basic and diluted
    
    $
    0.04
    
    
    $
    (0.02
    )Pro forma net income (loss) per share
 basic and diluted
    
    $
    0.03
    
    
    $
    (0.02
    )
 (i) Derivatives The Company has interest rate cap agreements with a notional amount of $25.5 million providing
that the maximum rate payable, or cap, attributable to the LIBOR portion of the interest rate on
its floating rate mortgages, exclusive of the spread is 5% through November and December 2005.
The Companys cap agreements have not been designated as cash flow hedges. These agreements have
been recorded at their fair value as a component of prepaid and other assets. 8




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(j) Use of Estimates The preparation of financial statements requires management of the Company to make a number of
estimates and assumptions relating to the reported amounts of assets and liabilities and the
disclosure of contingent assets and liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the period. Actual results could differ from those
estimates. (k) Application of New Accounting Standards In December 2004, the FASB issued SFAS No. 123R, Share-Based Payment, (FAS 123R), which
requires that the cost resulting for all share-based payment transactions be recognized in the
financial statements. The statement requires a public entity to measure the cost of employee
services received in exchange for an award of equity instruments based on the grant-date fair value
of the award (with limited exceptions). That cost will be recognized over the period during which
an employee is required to provide service in exchange for the award  the requisite service period
(usually the vesting period). No compensation cost is recognized for equity instruments for which
employees do not render the requisite service. Employee share purchase plans will not result in
recognition of compensation cost if certain conditions are met; those conditions are much the same
as the related conditions in FAS 123. During the first quarter of 2005, the effective date of the
provisions of FAS 123R were changed to periods beginning after December 15, 2005. The Company will
adopt this standard in 2006 and expects this new standard may have a material effect on its
consolidated financial position and results of operations. The Company will value all options using
the Black-Scholes option-pricing model. (l) Reclassifications Certain prior year amounts have been reclassified to conform to the current year presentation. (2) Rental Property Rental property represents 40 rental properties located in Maryland and Virginia. Rental
property is comprised of the following: March 31, 2005
    
    
    December 31, 2004Land
    
    $
    111,754,330
    
    
    $
    109,757,972Buildings and improvements
    
    
    369,505,696
    
    
    
    361,025,011Tenant improvements
    
    
    11,260,355
    
    
    
    10,542,159Furniture, fixtures and equipment
    
    
    9,738,938
    
    
    
    9,705,397502,259,319
    
    
    
    491,030,539Less: accumulated depreciation
    
    
    (30,297,092
    )
    
    
    (27,093,977
    )$
    471,962,227
    
    
    $
    463,936,562
 On March 18, 2005, the Company acquired Reston Business Campus, a four-building,
83,000-square-foot flex property in Reston, Virginia, for $11.7 million. The property was 92%
leased to six tenants. The acquisition was funded with borrowings under the Companys credit
facility. The aggregate purchase cost of Reston Business Campus was allocated as follows: Land
    
    $
    1,996,358Acquired tenant improvements
    
    
    383,612Building and improvements
    
    
    8,371,884In-place leases intangible
    
    
    1,006,761Above and below market leases, net
    
    
    (15,330
    )Total
    
    $
    11,743,285
 9




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##### 



Pro Forma Financial Information The pro forma financial information set forth below presents results as if all of the
Companys 2005 and 2004 acquisitions through March 31, 2005 and dispositions had occurred on
January 1, 2004. The pro forma information is not necessarily indicative of the results that actually would
have occurred nor does it intend to indicate future operating results. Three Months EndedMarch 31, 2005
    
    
    March 31, 2004Pro forma total revenues
    
    $
    16,793,732
    
    
    $
    16,103,222Pro forma net income (loss)
    
    
    637,140
    
    
    
    (129,527
    )Pro forma diluted income (loss) per share
    
    $
    0.04
    
    
    $
    (0.01
    )
 (3) Discontinued Operations Income from discontinued operations includes revenues and expenses associated with 6251
Ammendale Road. The Company classified this property as held for sale during 2004 and subsequently
sold the property in November 2004. The Company has no continuing involvement with the property
subsequent to its disposal. The following table summarizes the components of income from discontinued operations for the
three months ended March 31, 2004: Revenue
    
    $
    199,041Property expenses
    
    
    121,161Depreciation and amortization
    
    
    64,789Income from operations
    
    
    13,091Minority interests in discontinued operations
    
    
    1,824Income from discontinued operations
    
    $
    11,267
 (4) Mortgage Loans The Companys borrowings consist of the following: March 31,
    
    
    December 31,2005
    
    
    2004Mortgage debt with interest rates ranging from 4.9%
to 8.5% maturing at various dates through February
2013.
    
    $
    257,902,423
    
    
    $
    259,039,281Credit facility with a variable rate of LIBOR +1.70%
    
    
    10,000,000
    
    
    
    39,679,912$
    267,902,423
    
    
    $
    298,719,193
 (a) Credit Facility On November 30, 2004, the Company entered into a $75 million unsecured credit facility with
Key Bank N.A. and Wells Fargo National Bank, with Key Bank N.A. as managing administrative agent.
The credit facility matures on December 31, 2006; however, the credit facility can be extended for

a period of one year. The Company has the option to increase the facility up to an additional $75
million prior to December 31, 2006. Availability under the facility is based upon the value of the
Companys unencumbered assets. Borrowings under the facility bear interest at LIBOR plus 170 to
250 basis points. At March 31, 2005, the borrowing under the credit facility was LIBOR (3.12% at
March 31, 2005) plus 170 basis points. The exact interest payable under the facility depends upon
the ratio of our total indebtedness to total asset value, and this ratio cannot exceed 65%. The
Company is required to pay commitment fees that will vary based on the amount of unused capacity
under the credit facility which varies from 0.15% to 0.25%. The unsecured facility contains
financial and other covenants with which the Company must comply, all of which the Company met as
of March 31, 2005. Failure to comply with any of the covenants under our unsecured debt facility
could result in default. 10




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##### 



The Company repaid $44.7 million of borrowings and accrued interest outstanding on the credit
facility on March 31, 2005 using proceeds from the issuance of common shares that closed on the
same date. (b) Mortgage Debt The Companys mortgage debt is recourse solely to specific assets. The Company had 32
properties that secured mortgage debt at March 31, 2005. Future minimum principal payments on the Companys mortgage loans as of March 31, 2005,
including amortization of the fair value impact on principal balances, are as follows: 2005
    
    $
    14,284,0192006
    
    
    20,164,9712007
    
    
    50,231,4572008
    
    
    91,255,1322009
    
    
    3,745,992Thereafter
    
    
    78,220,852$
    257,902,423
 At March 31, 2005 and December 31, 2004, the Companys mortgage debt was as follows.
Effective rates apply to mortgages assumed by the Company in conjunction with the acquisitions of
the related property only. March 31,
    
    
    December 31,2005
    
    
    2004Van Buren Business Park, 6600 Business Parkway, 13129 Airpark Road and Plaza 500, 7.26%,
matures December 2007.
    
    $
    38,564,452
    
    
    $
    38,719,5874200 Tech Court, 8.07%, matures October 2009.
    
    
    1,812,730
    
    
    
    1,818,1784212 Tech Court, 8.53% matures June 2010.
    
    
    1,760,750
    
    
    
    1,765,342Crossways Commerce Center, 6.70%, matures October 2012.
    
    
    26,279,490
    
    
    
    26,338,201Newington Business Park Center, 6.70%, matures October 2012.
    
    
    16,577,044
    
    
    
    16,614,078Interstate Plaza, 7.45%, effective interest rate of 5.30%, matures January 2007.
    
    
    8,730,089
    
    
    
    8,795,754Herndon Corporate Center, 5.11%, effective interest rate of 5.66%, matures April 2008.
    
    
    8,848,363
    
    
    
    8,877,703Aquia Commerce Center, 6.5%, effective interest rate of 6.5%, matures February 2013.
    
    
    1,000,143
    
    
    
    1,022,811Suburban Maryland Portfolio, 6.71%, effective interest rate of 5.54%, matures September 2008.
    
    
    79,635,561
    
    
    
    80,129,447Norfolk Commerce Park II, 6.90%, effective interest rate of 5.28%, matures August 2008.
    
    
    7,755,218
    
    
    
    7,804,6344612 Navistar Drive, 7.48%, effective interest rate of 5.20%, matures July 2011.
    
    
    14,672,294
    
    
    
    14,753,542Campus at Metro Park North, 7.11%, effective interest rate of 5.25%, matures February 2012.
    
    
    26,766,289
    
    
    
    26,900,004Greenbrier Technology Center II and Norfolk Business Center, floating rate mortgage of LIBOR
+ 2.45%, matures November 2005.
    
    
    10,500,000
    
    
    
    10,500,000Rumsey Center and Snowden Center, floating rate mortgage of LIBOR + 2.35%, matures December
2006.
    
    
    15,000,000
    
    
    
    15,000,000$
    257,902,423
    
    
    $
    259,039,281
 (5) Segment Information The Company operates in one segment, industrial and flex office properties. All of the
Companys properties are located in the southern Mid-Atlantic region of the United States of
America. (6) Shareholders Equity On March 31, 2005, the Company sold 2,050,000 common shares to an investor at $21.95 per
share. The transaction generated net proceeds of approximately $44.9 million of which $44.7
million was used to repay borrowings and accrued interest outstanding on the Companys credit
facility. 11




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##### 



(7) Supplemental Disclosure of Cash Flow Information Supplemental disclosures of cash flow information for the three months ended March 31 are as
follows: 2005
    
    
    2004Cash paid for interest on indebtedness
    
    $
    4,221,481
    
    
    $
    1,666,948Non-cash financing activityIssuance of common share to trustees
    
    $
    56,348
    
    
    $
    
 (8) Subsequent Events On April 8, 2005, the Company acquired 1400 Cavalier Boulevard, a 300,000-square-foot
industrial property in Chesapeake, Virginia, for $13.2 million. The property was 94% leased to
eight tenants. The acquisition was financed with borrowings under the Companys credit facility. On April 14, 2005, the Company acquired Enterprise Center, a four-building,
189,116-square-foot flex property in Chantilly, Virginia for $29.5 million. The property was 90%
leased to ten tenants. The acquisition was financed, in part, by the assumption of $17.9 million
of existing mortgage debt maturing in 2010 at an interest rate of 8.0%. The balance of the
acquisition cost was funded with borrowings under the Companys credit facility. 12




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##### 



ITEM 2: MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis of the Companys financial condition and results of
operations should be read in conjunction with the financial statements and notes thereto appearing
elsewhere in this Form 10-Q. The discussion and analysis is derived from the consolidated
operating results and activities of First Potomac Realty Trust. The Company is a self-managed, self-administered Maryland real estate investment trust. The
Company operates so as to qualify as a real estate investment trust (REIT) for federal income tax
purposes. The Company focuses on owning and operating industrial and flex properties in the
Washington, D.C. metropolitan area and other major markets in Virginia and Maryland, which we
collectively refer to as the southern Mid-Atlantic region. The Company strategically focuses on
acquiring properties that management believes can benefit from the Companys intensive property
management and seeks to reposition these properties to increase their profitability and value. The
Companys portfolio of properties contains a mix of single-tenant and multi-tenant industrial and
flex properties. Industrial properties generally are used as warehouse, distribution and
manufacturing facilities, while flex properties combine office building features with industrial
property space. As of March 31, 2005, the Company owned 40 properties which were approximately 94%
leased to a total of 391 tenants in 478 leases. The Companys largest tenant is the U.S.
Government, representing 17% of the Companys annualized base rental revenue as of March 31, 2005.
The Company derives substantially all of its revenue from leases on its properties. The Company owns all of its properties and conducts its business through First Potomac Realty
Investment Limited Partnership, the Companys operating partnership (Operating Partnership). At
March 31, 2005, the Company was the sole general partner of and owned a 92% interest in the
Operating Partnership. The remaining interests in the Operating Partnership consist of limited
partnership interests owned by contributors of properties and other assets to our Operating
Partnership and are presented as minority interests for accounting purposes. Executive Summary Net income for the Company for the first quarter of 2005 was $0.5 million, or $0.04 per share,
compared with a net loss of $0.2 million for the first quarter of 2004. For the three months ended
March 31, 2005, the Companys funds from operations were $5.7 million, or $0.36 per diluted share
compared with funds from operations of $2.4 million, or $0.24 per diluted share for the first
quarter of 2004. See Funds from Operations. In addition, per share amounts reflect a higher
weighted average share count resulting from the June 2004 and March 2005 issuances of common
shares. Significant First Quarter Developments  
    Raised approximately $44.9 million through the sale of 2,050,000 common shares at $21.95
per share to an investor in a transaction that closed on March 31, 2005;
    Acquired Reston Business Campus, a four-building, 83,000-square-foot flex property in
Reston, Virginia, for $11.7 million. The acquisition was funded with borrowings under the
Companys credit facility;
    Posted $1.8 million in earnest money deposits for the acquisitions of Enterprise Center
and 1400 Cavalier Boulevard that closed subsequent to March 31, 2005; and
    Entered into a sublease related to the relocation of the Companys corporate
headquarters to 7600 Wisconsin Avenue in Bethesda, Maryland. Commencing July 1, 2005, the
Company will lease 18,095 square feet over an 88 month term with a total rent obligation of
$4,037,718. Critical Accounting Policies and Estimates The Companys consolidated and combined financial statements are prepared in accordance with
accounting principles generally accepted in the United States of America (GAAP) that require the
Company to make certain estimates and assumptions. Critical accounting policies and estimates are
those that require subjective or complex judgments and are the policies and estimates that the
Company deems most important to the portrayal of its financial condition and results of operations.
The use of different reasonable estimates or assumptions in making these judgments could result
in materially different amounts being reported in our Consolidated Financial Statements. The
Companys critical accounting policies relate to revenue recognition, including evaluation of the
collectibility of accounts receivable, impairment of long-lived assets and purchase accounting for
acquisitions of real estate. 13




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##### 



The following section is a summary of certain aspects of these critical accounting
policies. Revenue Recognition Rental income with scheduled rent increases is recognized using the straight-line method over
the term of the leases. Accrued straight-line rents included in the Companys consolidated and
combined balance sheets represents the aggregate excess of rental revenue recognized on a
straight-line basis over cash received under applicable lease provisions. The Companys leases
generally contain provisions under which the tenants reimburse the Company for a portion of
property operating expenses and real estate taxes incurred by it. 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. The Company must make estimates related to the collectibility of its accounts receivable
related to minimum rent, deferred rent, tenant 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 doubtful accounts receivable, however, the Company cannot be certain its
estimates regarding the collectibility of its accounts receivable will be accurate. These
estimates have a direct impact on the Companys net income because a higher bad debt allowance
would result in lower net income and a lower bad debt allowance would result in higher net income. Investments in Real Estate and Real Estate Entities Investments in real estate are recorded at cost. Improvements and replacements are capitalized
when they extend the useful life, increase capacity, or improve the efficiency of the asset.
Repairs and maintenance are charged to expense as incurred. Depreciation and amortization are recorded on a straight-line basis over the estimated
useful lives as follows: Buildings and improvements
    
    39 yearsTenant improvements
    
    Shorter of the useful lives or the terms of the related leasesFurniture, fixtures, and equipment
    
    5 to 15 years
 The Company is required to make subjective assessments as to the useful lives of its
properties for purposes of determining the amount of depreciation to record on an annual basis with
respect to its rental properties. These assessments have a direct impact on the Companys net
income because if it were to shorten the expected useful lives of its rental properties, the
Company would depreciate such investments over fewer years, resulting in more depreciation expense
and lower net income on an annual basis. When circumstances such as adverse market conditions indicate a possible impairment of the
value of a property, the Company reviews the recoverability of the propertys carrying value. The
review of recoverability is based on an estimate of the future undiscounted cash flows (excluding
interest charges) expected to result from the real estate investments use and eventual
disposition. These cash flows consider factors such as expected future operating income, trends and
prospects, as well as the effects of leasing demand, competition and other factors. If impairment
exists due to the inability 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. The Company is required to make subjective assessments as to whether there are
impairments in the values of its investments in real estate, including any indirect investments in
real estate through entities that the Company does not control and which it accounts for using the
equity method of accounting. These assessments have a direct impact on the Companys net income
because recording an impairment loss results in an immediate negative adjustment to net income. The Company estimates the fair value of rental properties using a discounted cash flow
analysis that includes projections of future revenues, expenses and capital improvement costs, or a
capitalization of the propertys in place net operating income. These methodologies are similar to
the income approach that is commonly used by appraisers. The Company will classify a building as held for sale in the period in which it has made the
decision to dispose of the building, a binding agreement to purchase the property has been signed
under which the buyer has committed a significant amount of nonrefundable cash and no significant
financing contingencies exist which could cause the transaction not to be completed in a timely
manner. If these criteria are met, the Company will record an impairment loss if the fair value
reduced by selling costs is lower than the carrying amount of the building, and the Company will
cease incurring depreciation. The 14




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##### 



Company will classify the impairment loss, together with the buildings operating results, as
discontinued operations on its statement of operations and classify the assets and related
liabilities as held for sale on the balance sheet. During the fourth quarter of 2004, the Company sold its property located at 6251 Ammendale
Road located in Beltsville, Maryland. As a result, operating results for that asset are reflected
as discontinued operations in the Companys Condensed Consolidated Statement of Operations for the
three months ended March 31, 2004. Purchase Accounting The Company is required to make subjective assessments as to the fair value of assets and
liabilities in connection with purchase accounting adjustments recorded related to rental
properties and additional interests in real estate entities acquired. These assessments include
allocating the purchase price of real estate acquired to the fair value of the building, land,
tenant improvements, in-place leases and other intangibles. The Company allocates the components of real estate acquisitions using relative fair values
computed that are based on its estimates and assumptions. These estimates and assumptions affect
the amount of costs allocated between land, building, tenant improvements, furniture, fixtures and
equipment and certain intangible assets. These allocations also impact depreciation expense and
gains or losses recorded on sales of real estate. The Company also values in-place operating
leases carrying rents above or below market as of the date of the acquisition; it then amortizes
such values over the lives of the related leases. The Companys determination of these values
requires it to estimate market rents for each of the leases and make certain other assumptions.
These estimates and assumptions affect the recognition of rental revenue, depreciation expense and
amortization expense. Results of Operations Comparison of the Three months Ended March 31, 2005 to the Three months Ended March 31, 2004 The results of operations for the three months ended March 31, 2005 and 2004 are presented
below. 2004 Acquisitions The Company acquired the following 23 properties during 2004: Herndon Corporate Center, Aquia
Commerce Center I & II, Deer Park, 6900 English Muffin Way, Gateway Center, Gateway West, 4451
Georgia Pacific Boulevard, 20270 Goldenrod Lane, 15 Wormans Mill Court, Girard Business Center,
Girard Place, Old Courthouse Square, Patrick Center, 7561 Lindbergh Drive, West Park, Woodlands
Business Center, Airpark Place Business Center, 15395 John Marshall Highway, Norfolk Commerce Park
II, Crossways II, Windsor at Battlefield, 4612 Navistar Drive and Campus at Metro Park North.
Collectively, the properties are referred to as the 2004 acquisitions. The balance of the
portfolio is referred to as the remaining portfolio. Total Revenues Rental revenue is summarized as follows: Three Months Ended March 31,
    
    
    
    
    
    
    Percent2005
    
    
    2004
    
    
    Increase
    
    
    ChangeRental revenue
    
    $
    14,136,651
    
    
    $
    6,526,445
    
    
    $
    7,610,206
    
    
    
    117
    %Tenant reimbursements & other
    
    
    2,291,587
    
    
    
    987,014
    
    
    
    1,304,573
    
    
    
    132
    %
 Rental Revenues Rental revenue is comprised of contractual rent, including the impacts of straight-line
revenue, and deferred market rental revenue. Rental revenue increased $7,610,206 for the three
months ended March 31, 2005, compared to the same period in 2004 primarily as a result of the 2004
acquisitions, which, in the aggregate, contributed $7,158,764 in rental revenue. The additional
increase can be attributed to the remaining portfolio as a result of increased rental rates and
higher occupancy. Average rental rates on new and renewal leases increased 8.2% and 9.9%,
respectively. The Companys overall portfolio was 94.2% leased at March 31, 2005 compared to 89.7% leased at
March 31, 2004. The 2004 acquisitions and remaining portfolio were 93.4% and 95% leased at March
31, 2005, respectively. The improvement in 15




---



##### 



occupancy in 2005 was due primarily to the 2004 acquisitions and occupancy increases at our
Culpeper, Virginia Center and Van Buren properties. Tenant Reimbursement and Other Revenues Tenant reimbursement revenue includes operating and common area maintenance costs reimbursed
by the Companys tenants as well as incidental other revenues such as late fees. Tenant
reimbursements and other revenues increased $1,304,573 during the three months ended March 31,
2005, compared with the same period in 2004 due primarily to the impact from the 2004 acquisitions.
These acquisitions collectively resulted in $1,185,429 of additional tenant reimbursement revenue
during the three months ended March 31, 2005. The remaining portfolio contributed the balance of
the increase due to increased occupancy and an increase in triple-net leases that, in turn, result
in more recovery of operating expenses. The Company typically converts full-service or industrial
gross leases to triple-net leases when renewing tenants, as well as negotiating triple-net
recoveries on new leases, providing for higher reimbursement of operating expenses such as
insurance, taxes and common area maintenance. Total Expenses Property Operating Expenses Property operating expenses are summarized as follows: Three Months Ended March 31,
    
    
    
    
    
    
    Percent2005
    
    
    2004
    
    
    Increase
    
    
    ChangeProperty operating expenses
    
    $
    3,006,886
    
    
    $
    1,443,641
    
    
    $
    1,563,245
    
    
    
    108
    %Real estate taxes & insurance
    
    
    1,395,404
    
    
    
    673,038
    
    
    $
    722,366
    
    
    
    107
    %
 Property Operating Expenses.Property operating expenses increased $1,563,245 for the three
months ended March 31, 2005 compared to 2004 substantially as a result of the $1,513,730 of
property operating expenses associated with the 2004 acquisitions. The original portfolio
contributed the remaining increase during the three months ended March 31, 2005. Real Estate Taxes and Insurance.Real estate taxes and insurance increased $722,366 for the
three months ended March 31, 2005 compared to 2004 due primarily to $702,494 in real estate taxes
and insurance costs related to the 2004 acquisitions during the respective periods. The remaining
increase can be attributed to higher real estate taxes on the remaining portfolio as a result of
higher actual and anticipated increases in real estate assessments in 2005. This increase was
partially offset by lower insurance costs on the remaining portfolio which decreased due to a
reduction in insurance premiums. Other Operating Expenses General and administrative expenses are summarized as follows: Three Months Ended March 31,
    
    
    
    
    
    
    Percent2005
    
    
    2004
    
    
    Increase
    
    
    ChangeGeneral & administrative
    
    $
    1,870,738
    
    
    $
    823,188
    
    
    $
    1,047,550
    
    
    
    127
    %
 General and administrative expenses increased in 2005 from 2004 primarily due to increased
personnel resulting in higher compensation expense. The number of employees of the Company
increased to 61 as of March 31, 2005 compared to 24 as of March 31, 2004. The Company also
incurred higher shareholder related costs and professional fees as a result of the significant
growth throughout 2004, including increased accounting fees due in part to costs incurred as a
result of compliance with PCAOB Standard No. 2, An Audit of Internal Control Over Financial
Reporting Performed in Conjunction with an Audit of Financial Statements. 16




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##### 



Real estate depreciation and amortization expenses are summarized as follows: Three Months Ended March 31,
    
    
    
    
    
    
    Percent2005
    
    
    2004
    
    
    Increase
    
    
    ChangeDepreciation & amortization
    
    $
    5,076,695
    
    
    $
    2,540,122
    
    
    $
    2,536,573
    
    
    
    100
    %
 Depreciation and amortization expense increased $2,536,573 for the three months ended March
31, 2005, compared to 2004 primarily due to depreciation and amortization associated with the 2004
acquisitions, which generated $3,035,442 in depreciation and amortization expense. This was offset
by lower depreciation and amortization expense on the remaining portfolio primarily as a result of
certain five-year personal property associated with the Companys 1998 and 1999 acquisitions fully
depreciating during 2004. Interest Expense Interest expense on indebtedness is summarized as follows: Three Months Ended March 31,
    
    
    
    
    
    
    Percent2005
    
    
    2004
    
    
    Increase
    
    
    ChangeInterest expense
    
    $
    4,515,394
    
    
    $
    2,067,606
    
    
    $
    2,447,788
    
    
    
    118
    %
 Interest expense increased $2,447,788 for the three months ended March 31, 2005 compared to
the same period in 2004. The increase in interest expense for the three months ended March 31,
2005, is primarily due to $1,959,990 of interest expense associated with mortgage loans assumed
with the 2004 acquisitions. Interest expense associated with variable rate borrowings on our
credit facility increased $497,198 in 2005 as a result of a substantially higher average balance
outstanding during first-quarter 2005. The Company repaid approximately $44.7 million of our
credit facility borrowings and accrued interest on March 31, 2005 using proceeds from the issuance
of 2,050,000 common shares on that date. Loss from Early Retirement of Debt Loss from early retirement of debt is summarized as follows: Three Months Ended March 31,
    
    
    
    
    
    
    Percent2005
    
    
    2004
    
    
    Change
    
    
    ChangeLoss from early
retirement of debt
    
    $
    
    
    
    $
    212,250
    
    
    $
    (212,250
    )
    
    
    100
    %
 The 2004 loss from early retirement of debt was attributed to the write-off of unamortized
debt costs associated with the January 2004 repayment of $7 million of the $22 million first
mortgage loan encumbering the Rumsey and Snowden properties. This transaction resulted in
extending the loans maturity date one year and reducing the effective interest rate on the loan.
The Company incurred no prepayment penalties on this transaction. Minority Interests Minority interests are summarized as follows: Three Months Ended March 31,
    
    
    
    
    
    
    Percent2005
    
    
    2004
    
    
    Change
    
    
    ChangeMinority interests
    
    $
    51,354
    
    
    $
    (29,451
    )
    
    $
    80,805
    
    
    
    274
    %
 Minority interests reflect the ownership interests of the Operating Partnership held by
parties other than the Company. At March 31, 2005, 7.9% of the interests were owned by limited
partners compared to 13.9% at March 31, 2004. The reduction in minority interests is attributable
to the Companys offerings of 5,520,000 and 2,050,000 common shares in June 2004 and March 2005,
respectively, which increases the Companys percentage ownership of the Operating Partnership. The
minority interests share of earnings from continuing operations was $51,354 for the three months
ended March 31, 2005. Minority interests for the three months ended March 31, 2004, represented
the allocation of net loss to the minority owners. 17




---



##### 



Income from Discontinued Operations Three Months Ended March 31,
    
    
    
    
    
    
    Percent2005
    
    
    2004
    
    

Change
    
    
    ChangeIncome from
discontinued
operations
    
    $
    
    
    
    $
    11,267
    
    
    $
    (11,267
    )
    
    
    100
    %
 The Company sold its property located at 6251 Ammendale Road during the fourth quarter of
2004; therefore, the results of operations for this property for the three months ended March 31,
2004 are presented as income from discontinued operations. During the first quarter of 2004, the
Company recognized income from discontinued operations of $11,267, net of minority interest of
$1,822. Liquidity and Capital Resources The Company expects to meet short-term liquidity requirements generally through working
capital, net cash provided by operations, and, if necessary, borrowings on its credit facility.
As a REIT, the Company is required to distribute at least 90% of its taxable income to its
stockholders on an annual basis. The Company also regularly requires capital to invest in its
existing portfolio of operating assets for capital projects. These capital projects include routine
capital improvements and maintenance and leasing-related costs, including tenant improvements and
leasing commissions. In addition, the Company has $10.5 million in mortgage debt maturing in
November 2005 and anticipates refinancing this debt or repaying it by borrowing on the credit
facility. On November 30, 2004, the Company entered into a $75 million unsecured credit facility with
Key Bank N.A. and Wells Fargo National Bank, with Key Bank N.A. as managing administrative agent,
to replace the Companys secured credit facility with Fleet National Bank. Upon entering into
this new facility, the Company terminated its secured credit facility with Fleet National Bank. The
new credit facility matures on December 31, 2006; however, the Company can extend the line for a
period of one year. The Company also has the option to increase the facility by up to an
additional $75 million prior to December 31, 2006. Availability under the facility is based upon
the value of the Companys unencumbered assets. Borrowings under the facility bear interest at
LIBOR (3.12% at March 31, 2005) plus 170 to 250 basis points. The exact interest payable under the
facility depends upon the ratio of our total indebtedness to total asset value, and this ratio
cannot exceed 65%. At March 31, 2005, borrowings under the credit facility bore interest at LIBOR
plus 170 basis points. The Company is required to pay commitment fees that vary from 0.15% to
0.25% based on the amount of unused capacity under the credit facility. The unsecured facility
contains financial and other covenants with which the Company must comply, all of which the Company
met as of March 31, 2005. Failure to comply with any of the covenants under our unsecured debt
facility could result in default. The Company drew on the credit facility to finance the acquisitions of 15395 John Marshall
Highway, Windsor at Battlefield, 4612 Navistar Drive, Campus at Metro Park in 2004, and Reston
Business Campus in 2005. Approximately $44.7 million of borrowings and accrued interest was
repaid on March 31, 2005 using proceeds from the issuance of 2,050,000 common shares at $21.95 per
share on the same date. The April 2005 acquisitions of 1400 Cavalier Boulevard and Enterprise
Center were financed with borrowings under the Companys credit facility and the assumption of
$17.9 million of existing mortgage debt. The Company intends to meet long-term liquidity requirements for the funding of property
acquisitions and other non-recurring capital improvements through net cash from operations,
long-term secured and unsecured indebtedness, including borrowings under its credit facility, and
the issuance of equity and debt securities. The Companys ability to raise funds through sales of
debt and equity securities is dependent on, among other things, general economic conditions,
general market conditions for REITs, rental rates, occupancy levels, market perceptions and the
trading price of the Companys shares. The Company will continue to analyze which source of
capital is most advantageous to it at any particular point in time, but the capital markets may not
be consistently available on terms that are attractive. The Company has an effective S-3
registration statement with the Securities and Exchange Commission to allow it to issue up to $300
million in debt and equity securities with approximately $250 million available for issuance at
March 31, 2005. The Company could also fund property acquisitions and other non-recurring capital improvements
by using borrowings, by refinancing properties in connection with their acquisition or through
joint ventures. The Company could also issue units of 18




---



##### 



limited partnership interest in the Operating Partnership to fund a portion of the purchase
prices for some of its future property acquisitions. The Company is subject to cash management agreements with most of its lenders. These
agreements generally require that income generated by the subject property be deposited into a
clearing account and then swept into a cash collateral account for the benefit of the lender from
which cash is distributed only after funding capital improvements, leasing and maintenance reserves
and payment of debt service, insurance, taxes, capital expenditures and leasing costs. Cash Flows Consolidated cash flow information is summarized as follows: Three Months Ended March 31,2005
    
    
    2004
    
    
    ChangeCash and cash equivalents
    
    $
    2,224,974
    
    
    $
    8,748,900
    
    
    $
    (6,523,926
    )Cash provided by operating activities
    
    
    3,557,634
    
    
    
    1,769,438
    
    
    
    1,788,196Cash used in investing activities
    
    
    (13,970,210
    )
    
    
    (838,324
    )
    
    
    (13,131,886
    )Cash provided by (used in) financing activities
    
    
    10,105,281
    
    
    
    (8,489,722
    )
    
    
    18,595,003
 Net cash provided by operating activities increased $1,788,196 in 2005. This increase was due
largely to the increase in operating income provided by the 2004 acquisitions. The increase in
escrows and reserves, accounts payable and accrued expenses associated with these acquisitions was
substantially offset by additional cash provided by the operations of these properties and the
overall portfolio. Cash used in investing activities increased $13,131,886 in 2005 due primarily to the
acquisition of Reston Business Campus for $11,743,285 and the $1,750,000 in earnest money deposits
included in prepaid expenses and other assets related to the subsequent acquisitions of 1400
Cavalier Boulevard ($500,000) and Enterprise Center ($750,000) that closed in April 2005 and a
$500,000 earnest money deposit for a pending acquisition anticipated to close in the second quarter
of 2005. The Company invested $476,925 in capital and tenant improvement costs during the three
months ended March 31, 2005 as compared to $838,324 during the first quarter of 2004. Net cash provided by financing activities increased $18,595,003 in 2005 due primarily to the
$44,979,596 of net proceeds from the sale of 2,050,000 common shares that closed on March 31, 2005.
Borrowings of $15,000,000 under the Companys credit facility were used to finance the Reston
Business Campus acquisition and to partially finance the earnest money deposit for the 1400
Cavalier Boulevard and Enterprise Center acquisitions that closed in April 2005. The Company
repaid debt including interest and principal amortization of $45,816,770, including a $44,679,912
partial paydown of the credit facility. The Company repaid debt of $7,297,109, including a
$7,000,000 partial paydown of the $22,000,000 of mortgage debt that encumbered Rumsey Center and
Snowden Center, during the first quarter of 2004. Additionally, the Company paid dividends to
shareholders and distributions to minority interests of $4,057,545 in 2005 as compared to
$1,002,952 during the first quarter of 2004. Dividends and Distributions The Company is required to distribute to its shareholders at least 90% of its taxable income
in order to qualify as a REIT, including taxable income we recognize for tax purposes but with
regard to which we do not receive corresponding cash. Funds used by the Company to pay dividends
on its common shares are provided through distributions from the Operating Partnership. For every
common share of beneficial interest of the Company, the Operating Partnership has issued to the
Company a corresponding common unit. As of March 31, 2005, the Company is the sole general partner
of and owns 92% of the Operating Partnerships units. The remaining 8% of the units are held by
various third-party limited partners who have contributed properties to the Operating Partnership,
including some of the Companys executive officers and trustees. As a general rule, when the
Company pays a common dividend, the Operating Partnership pays an equivalent per unit distribution
on all common units. The Companys current policy on dividends is generally to distribute 75%  80% of its funds
from operations as a dividend. See Funds from Operations. 19




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On April 19, 2005, the Company declared a dividend of $0.275 per common share for the quarter
ended March 31, 2005. The dividend will be paid on May 10, 2005, to shareholders of record on
April 30, 2005. Funds From Operations Investors and analysts following the real estate industry utilize funds from operations
(FFO) as a supplemental performance measure. The Company considers FFO an appropriate
supplemental measure given its wide use by and relevance to investors and analysts. FFO,
reflecting the assumption that real estate asset values rise or fall with market conditions,
principally adjusts for the effects of GAAP depreciation and amortization of real estate assets,
which assume that the value of real estate diminishes predictably over time. The Company uses FFO
in preparing internal budgets, in assessing acquisitions and as a metric in determining executive
compensation. As defined by the National Association of Real Estate Investment Trusts, or NAREIT in its
March 1995 White Paper (as amended in November 1999 and April 2002), FFO represents net income
(loss) (computed in accordance with GAAP), excluding gains (losses) on sales of real estate, plus
real estate-related depreciation and amortization and after adjustments for unconsolidated
partnerships and joint ventures. We compute FFO in accordance with the NAREIT definition, which
may differ from the methodology for calculating FFO, or similarly titled measures used by other
companies, and this may not be comparable to those presentations. FFO should not be viewed as a
substitute measure of the Companys operating performance to net income since it does not reflect
either depreciation and amortization costs or the level of capital expenditures and leasing costs
necessary to maintain the operating performance of the Companys properties, which are significant
economic costs that could materially impact the Companys results of operations. The following table presents a reconciliation of net income to FFO available to common share
and unitholders for the three month periods ended March 31, 2005 and March 31, 2004. Funds From OperationsThree Months EndedMarch 31, 2005
    
    
    March 31, 2004Net income (loss)
    
    $
    526,305
    
    
    $
    (170,606
    )Add: Real estate
depreciation and
amortization
    
    
    5,076,695
    
    
    
    2,540,122Add: Discontinued operations
depreciations and
amortization
    
    
    
    
    
    
    64,789Add: Minority interests
    
    
    51,354
    
    
    
    (27,629
    )FFO available to common
share and unitholders
    
    $
    5,654,354
    
    
    $
    2,406,676
 Forward Looking Statements This report contains forward-looking statements within the meaning of the federal securities
laws. Forward-looking statements, which are based on certain assumptions and describe future
plans, strategies and expectations of the Company, are generally identifiable by use of the words
believe, expect, intend, anticipate, estimate, project or similar expressions. The
Companys ability to predict results or the actual effect of future plans or strategies is
inherently uncertain. Certain factors that could cause actual results to differ materially from
the Companys expectations include changes in general or regional economic conditions; the
Companys ability to timely lease or re-lease space at current or anticipated rents; changes in
interest rates; changes in operating costs; the Companys ability to complete current and future
acquisitions; the Companys ability to sell additional equity or debt securities; and other risks
detailed in the Companys Annual Report on Form 10-K. Many of these factors are beyond the
Companys ability to control or predict. Forward-looking statements are not guarantees of
performance. For forward-looking statements herein, the Company claims the protection of the safe
harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of
1995. The Company assumes no obligation to update or supplement forward-looking statements that
become untrue because of subsequent events. The Company had no off-balance sheet arrangement as of
March 31, 2005. 20




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ITEM 3: QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT
MARKET RISK The Companys future income, cash flows and fair values relevant to financial instruments are
dependent upon prevailing market interest rates. Market risk refers to the risk of loss from
adverse changes in market interest rates. The Company uses derivative financial instruments to
seek to manage, or hedge, interest rate risks related to its borrowings. The Company does not use
derivatives for trading or speculative purposes and only enters into contracts with major financial
institutions based on their credit rating and other factors. The Company had $35.5 million in variable rate debt, or 13%, of the total $267.9 million debt
outstanding as of March 31, 2005. For fixed rate debt, changes in interest rates generally affect the fair value of debt but not
the earnings or cash flow of the Company. The Company estimates the fair value of its fixed rate
mortgage debt outstanding at March 31, 2005 to be $237 million compared to the $232.4 million
carrying value at that date. The Company uses interest rate protection, or cap agreements to reduce the impact of
interest rate changes on its variable rate debt. The Company had interest rate cap agreements with
a notional amount of $25.5 million as of March 31, 2005. Under the terms of these agreements, the
Company made an initial premium payment to a counterparty in exchange for the right to receive
payments from the counterparty if interest rates exceed specified levels on $25.5 million of the
Companys outstanding variable rate debt during the term of the agreement. The Company is subject
to market risk for changes in interest rates and credit risk in the event of non-performance by the
counterparty to the cap agreement. The Company will only enter into these agreements with highly
rated institutional counterparts and does not expect that any counterparties will fail to meet
contractual obligations. The change in fair market value of these caps during the quarter ended
March 31, 2005 was considered inconsequential. ITEM 4: CONTROLS AND PROCEDURES The Company carried out an evaluation with the participation of the Companys management,
including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the
Companys disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities
Exchange Act of 1934, as amended (the Exchange Act)) as of the end of the period covered by this
report. Based upon that evaluation, the Companys Chief Executive Officer and Chief Financial
Officer concluded that the Companys disclosure controls and procedures are effective to ensure
that information required to be disclosed by the Company in the reports that the Company files, or
submits under the Exchange Act, is recorded, processed, summarized and reported, within the time
periods specified in the SECs rules and forms, and that such information is accumulated and
communicated to the Companys management, including its Chief Executive Officer and Chief Financial
Officer, as appropriate, to allow timely decisions regarding required disclosure. There has been no change in the Companys internal control over financial reporting during the
quarter ended March 31, 2005, that has materially affected, or is reasonably likely to materially
affect, the Companys internal control over financial reporting. 21




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##### 



PART II: OTHER INFORMATION Item 6. Exhibits No.
    
    Description10.1
    
    Employment Agreement, dated February 14, 2005 by and between Joel F.
Bonder and the Registrant (incorporated by reference to Exhibit 10.1
to the Companys current report on Form 8-K filed on February 17,
2005).10.2
    
    Enterprise Purchase Agreement (incorporated by reference to Exhibit
10.2 to the Companys current report on Form 8-K/A filed on March 18,
2005).10.3
    
    Consent to Sub-Sublease and Sub-Sublease (incorporated by reference
to Exhibit 10.3 to the Companys current report on Form 8-K filed on
April 28, 2005).99.1
    
    Purchase Agreement dated March 25, 2005, by and between RREEF
America, LLC and the Company (incorporated by reference to Exhibit
99.1 to the Companys current report on Form 8-K filed on March 31,
2005).31.1
    
    Certification of Chief Executive Officer pursuant to Rule 13a -
14(a)/15d-14(a) of the Securities Exchange Act of 1934, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    Certification of Chief Financial Officer pursuant to Rule 13a -
14(a)/15d-14(a) of the Securities Exchange Act of 1934, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1
    
    Certification of Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 (This exhibit shall not be deemed filed
for purposes of Section 18 of the Securities Exchange Act of 1934, as
amended, or otherwise subject to the liability of that section.
Further, this exhibit shall not be deemed to be incorporated by
reference into any filing under the Securities Act of 1933, as
amended, or the Securities Exchange Act of 1934, as amended.)32.2
    
    Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 (This exhibit shall not be deemed filed
for purposes of Section 18 of the Securities Exchange Act of 1934, as
amended, or otherwise subject to the liability of that section.
Further, this exhibit shall not be deemed to be incorporated by
reference into any filing under the Securities Act of 1933, as
amended, or the Securities Exchange Act of 1934, as amended.)
 22




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##### 



SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto duly authorized. FIRST POTOMAC REALTY TRUSTDate: May 9, 2005
    
    /s/ Douglas J. DonatelliDouglas J. DonatelliPresident and Chief Executive OfficerDate: May 9, 2005
    
    /s/ Barry H. BassBarry H. BassExecutive Vice President and Chief Financial Officer(Principal Financial Officer)
 23




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##### 



EXHIBIT INDEX No.
    
    Description10.1
    
    Employment Agreement, dated February 14, 2005 by and between Joel F.
Bonder and the Registrant (incorporated by reference to Exhibit 10.1
to the Companys current report on Form 8-K filed on February 17,
2005).10.2
    
    Enterprise Purchase Agreement (incorporated by reference to Exhibit
10.2 to the Companys current report on Form 8-K/A filed on March 18,
2005).10.3
    
    Consent to Sub-Sublease and Sub-Sublease (incorporated by reference
to Exhibit 10.3 to the Companys current report on Form 8-K filed on
April 28, 2005).99.1
    
    Purchase Agreement dated March 25, 2005, by and between RREEF
America, LLC and the Company (incorporated by reference to Exhibit
99.1 to the Companys current report on Form 8-K filed on March 31,
2005).31.1
    
    Certification of Chief Executive Officer pursuant to Rule 13a -
14(a)/15d-14(a) of the Securities Exchange Act of 1934, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    Certification of Chief Financial Officer pursuant to Rule 13a -
14(a)/15d-14(a) of the Securities Exchange Act of 1934, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1
    
    Certification of Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 (This exhibit shall not be deemed filed
for purposes of Section 18 of the Securities Exchange Act of 1934, as
amended, or otherwise subject to the liability of that section.
Further, this exhibit shall not be deemed to be incorporated by
reference into any filing under the Securities Act of 1933, as
amended, or the Securities Exchange Act of 1934, as amended.)32.2
    
    Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 (This exhibit shall not be deemed filed
for purposes of Section 18 of the Securities Exchange Act of 1934, as
amended, or otherwise subject to the liability of that section.
Further, this exhibit shall not be deemed to be incorporated by
reference into any filing under the Securities Act of 1933, as
amended, or the Securities Exchange Act of 1934, as amended.)
 24