3.	*Segments*

Net operating income (segment revenues minus segment expenses) is the measure used by Armada Hoffler’s chief operating decision-maker to assess segment performance. Net operating income is not a measure of operating income or cash flows from operating activities as measured by GAAP and is not indicative of cash available to fund cash needs. As a result, net operating income should not be considered an alternative to cash flows as a measure of liquidity. Not all companies calculate net operating income in the same manner. Armada Hoffler considers net operating income to be an appropriate supplemental measure to net income because it assists both investors and management in understanding the core operations of Armada Hoffler’s real estate and construction businesses.

Net operating income of Armada Hoffler’s reportable segments for the three and nine months ended September 30, 2014 and 2013 was as follows (in thousands):


	Three Months Ended September 30,				Nine Months Ended September 30,
	2014		2013		2014		2013
	(Unaudited)
Office real estate
Rental revenues	$	7,295	$	6,364	$	20,363	$	19,270
Property expenses		2,351		2,081		6,453		5,967

Segment net operating income		4,944		4,283		13,910		13,303

Retail real estate
Rental revenues		6,086		5,683		17,559		16,071
Property expenses		1,795		1,745		5,310		5,054

Segment net operating income		4,291		3,938		12,249		11,017

Multifamily residential real estate
Rental revenues		3,332		2,852		9,303		7,187
Property expenses		1,748		1,331		4,698		3,224

Segment net operating income		1,584		1,521		4,605		3,963

General contracting and real estate services
Segment revenues		31,532		21,896		71,261		63,143
Segment expenses		30,468		20,907		67,807		60,868

Segment net operating income		1,064		989		3,454		2,275

Net operating income	$	11,883	$	10,731	$	34,218	$	30,558

General contracting and real estate services revenues for the three and nine months ended September 30, 2014 exclude revenue from intercompany construction contracts of $24.2 million and $68.8 million, respectively. General contracting and real estate services expenses for the three and nine months ended September 30, 2014 exclude expenses for intercompany construction contracts of $24.1 million and $68.2 million, respectively. General contracting and real estate services expenses for the three and nine months ended September 30, 2014 include noncash stock compensation of less than $0.1 million and $0.2 million, respectively.

General contracting and real estate services revenues for the three and nine months ended September 30, 2013 exclude revenue from intercompany construction contracts of $13.3 million and $18.9 million, respectively. General contracting and real estate services expenses for the three and nine months ended September 30, 2013 exclude expenses for intercompany construction contracts of $13.1 million and $18.7 million, respectively.

The following table reconciles net operating income to net income for the three and nine months ended September 30, 2014 and 2013 (in thousands):


	Three Months Ended September 30,						Nine Months Ended September 30,
	2014			2013			2014			2013
	(Unaudited)
Net operating income	$	11,883		$	10,731		$	34,218		$	30,558
Depreciation and amortization		(4,567	)		(3,933	)		(12,593	)		(11,112	)
General and administrative expenses		(1,741	)		(1,638	)		(5,768	)		(5,212	)
Acquisition, development and other pursuit costs		(174	)		—			(174	)		—
Impairment charges		(15	)		—			(15	)		(533	)
Interest expense		(2,734	)		(2,598	)		(7,977	)		(9,802	)
Loss on extinguishment of debt		—			(1,127	)		—			(2,252	)
Gain on acquisitions		—			—			—			9,460
Other income (loss)		59			(109	)		(23	)		343
Income tax benefit (provision)		43			(74	)		(135	)		137

Net income	$	2,754		$	1,252		$	7,533		$	11,587

General and administrative expenses represent costs not directly associated with the operation and management of Armada Hoffler’s real estate properties and general contracting business. General and administrative expenses include office personnel salaries and benefits, bank fees, accounting fees, legal fees and other corporate office expenses. General and administrative expenses for the three and nine months ended September 30, 2014 include noncash stock compensation of $0.2 million and $0.5 million, respectively. General and administrative expenses for the three and nine months ended September 30, 2013 include noncash stock compensation of $0.2 million and $1.0 million, respectively.

During the three and nine months ended September 30, 2014, the Company recognized $0.2 million of acquisition, development and other pursuit costs related primarily to the acquisition of Dimmock Square.

During the nine months ended September 30, 2013, the Company recognized a $0.5 million impairment of unamortized leasing assets related to two vacated retail tenants.

During the three months ended September 30, 2013, the Company defeased $13.9 million of debt and, as a result, recognized a $1.1 million loss on extinguishment of debt. During the nine months ended September 30, 2013, the Company used proceeds from the IPO and borrowings under the credit facility to repay $150.0 million of debt. The Company recognized a $1.1 million loss on extinguishment of debt representing $0.6 million of fees and $0.5 million of unamortized debt issuance costs.

Substantially concurrent with the completion of the IPO on May 13, 2013 and in connection with the Formation Transactions, the Operating Partnership acquired 100% of the interests in Bermuda Crossroads and Smith’s Landing. The acquisitions of controlling interests in Bermuda Crossroads and Smith’s Landing were accounted for as purchases at fair value under the acquisition method of accounting. Prior to the acquisition date, the Predecessor accounted for its noncontrolling interests in Bermuda Crossroads and Smith’s Landing as equity method investments. The Company recognized a $9.5 million gain on acquisitions as a result of remeasuring the Predecessor’s prior equity interests in Bermuda Crossroads and Smith’s Landing on the acquisition date.

Rental revenues of Armada Hoffler’s reportable segments for the three and nine months ended September 30, 2014 and 2013 comprised the following (in thousands):


	Three Months Ended September 30,				Nine Months Ended September 30,
	2014		2013		2014		2013
	(Unaudited)
Minimum rents
Office	$	6,954	$	6,059	$	19,326	$	18,264
Retail		5,167		4,759		14,760		13,733
Multifamily		2,813		2,370		7,906		6,060
Percentage rents⁽¹⁾
Office		—		—		45		104
Retail		36		35		173		88
Multifamily		19		21		78		84
Other⁽²⁾
Office		341		304		992		901
Retail		883		890		2,626		2,251
Multifamily		500		461		1,319		1,043

Rental revenues	$	16,713	$	14,899	$	47,225	$	42,528

(1)	Percentage rents are based on tenants’ sales.

(2)	Other rental revenue includes cost reimbursements for real estate taxes, property insurance and common area maintenance as well as termination fees.

Property expenses of Armada Hoffler’s reportable segments for the three and nine months ended September 30, 2014 and 2013 comprised the following (in thousands):


	Three Months Ended September 30,				Nine Months Ended September 30,
	2014		2013		2014		2013
	(Unaudited)
Rental expenses
Office	$	1,742	$	1,536	$	4,756	$	4,341
Retail		1,255		1,230		3,764		3,593
Multifamily		1,417		1,074		3,710		2,534

Total	$	4,414	$	3,840	$	12,230	$	10,468

Real estate taxes
Office	$	609	$	545	$	1,697	$	1,626
Retail		540		515		1,546		1,461
Multifamily		331		257		988		690

Total	$	1,480	$	1,317	$	4,231	$	3,777

Property expenses	$	5,894	$	5,157	$	16,461	$	14,245

Rental expenses represent costs directly associated with the operation and management of Armada Hoffler’s real estate properties. Rental expenses include asset management fees, property management fees, repairs and maintenance, insurance and utilities.