American Assets Trust, Inc. — Q3 2019 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2019. American Assets Trust is a REIT whose operations and debt are primarily held through its consolidated operating partnership. Unless stated otherwise, financial amounts below are in millions of dollars.
Business context
The company owned or controlled 28 operating properties across retail, office, multifamily and mixed-use segments, with approximately 6.6 million rentable square feet of retail and office space, 2,112 residential units and a 369-room hotel. It owned land or had construction in progress at three properties. The company held approximately 78.4% of the operating partnership.
Financial performance and liquidity
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Total revenue | $98.4 | $82.5 | $267.8 | $248.3 |
| Operating income | $30.4 | $27.3 | $83.7 | $57.4 |
| Net income | $16.5 | $14.3 | $43.7 | $18.0 |
| Net income attributable to AAT stockholders | $12.9 | $10.4 | $32.9 | $13.0 |
| Diluted EPS | $0.22 | $0.22 | $0.63 | $0.28 |
| FFO per diluted share/unit | $0.57 | Not presented | $1.63 | Not presented |
- Q3 property operating income (NOI) was $63.4 million, up 21%; same-store NOI rose 9% to $47.1 million. NOI is a non-GAAP measure and excludes corporate costs, interest, depreciation and other items.
- Q3 revenue grew 19%, while operating expenses increased 23% to $68.0 million. Operating margin was approximately 30.9%, versus 33.1% a year earlier; property operating income margin improved to approximately 64.5% from 63.4%.
- Nine-month operating cash flow was $122.1 million, compared with $118.9 million. Investing cash outflow was $574.0 million, principally reflecting the La Jolla Commons acquisition and capital spending; financing provided $520.7 million. Cash, cash equivalents and restricted cash totaled $126.1 million at September 30.
- At September 30, net carrying debt was approximately $1.358 billion: $162.2 million secured notes and $1.196 billion unsecured notes; no revolver balance was outstanding. Principal debt was approximately $1.362 billion. The company reported $250 million of variable-rate debt, which it said was hedged such that a 1% rate change would have approximately no annual interest expense impact. Financial covenants were met.
- Cash dividends declared were $0.28 per share for Q3, versus $0.27 a year earlier. The nine-month declared dividend was $0.84 per share.
Material changes versus prior periods
- La Jolla Commons, two San Diego office towers totaling approximately 724,000 square feet plus development land and parking, was acquired June 20 for approximately $525 million before seller credits and closing costs. It contributed $10.6 million revenue and $0.5 million operating income from acquisition through September 30.
- June’s underwritten share offering raised approximately $472.6 million net, and the company issued $150 million of 3.91% senior notes due 2030. Share count rose to approximately 60.0 million at September 30 from 47.3 million at year-end 2018.
- Q3 stockholder-attributable net income rose 24%, but diluted EPS was unchanged at $0.22, reflecting a substantially larger weighted-average share count. Nine-month net income rose sharply partly because 2018 included higher depreciation and amortization; the 2019 period also included a $0.6 million gain on a property sale.
- Office was the main growth contributor: Q3 office rental revenue increased 56%, with La Jolla Commons and same-store rent growth contributing. Nine-month same-store NOI increased 6% overall; same-store retail NOI rose 7% and same-store office NOI rose 7%.
- The company sold Solana Beach–Highway 101 in May for approximately $9.4 million net proceeds, recording a $0.6 million nine-month gain. It also adopted the new lease accounting standard in 2019, recognizing approximately $7.7 million of right-of-use assets and lease liabilities.
Outlook, commentary and risks
- No numerical earnings or FFO guidance was provided. Management said it expected leasing volume through the remainder of 2019 to be in line with historical averages and anticipated overall positive rental-income increases, while cautioning that signed leases may not commence or pay as contracted.
- Management was cautiously optimistic about leasing trends and described continued evaluation of development, redevelopment and acquisition opportunities, including future phases at Lloyd District and La Jolla Commons. These plans depend on market conditions and acceptable risk-adjusted returns.
- Q3 comparable-space lease spreads were positive: retail leases averaged increases of 2.8% cash and 9.3% GAAP; office leases averaged increases of 12.0% cash and 29.2% GAAP. Tenant improvements and incentives for comparable new leases were $23.57 per square foot in retail and $55.43 in office.
- Key exposures include tenant defaults, lease expirations and vacancy, economic and real estate market weakness, interest rates, financing availability, development execution, and operating-cost and property-tax increases. Fourteen properties were in Southern California; retail and office tenants accounted for 30.3% and 37.6% of nine-month revenue, respectively.
- Del Monte Center has ongoing groundwater remediation, with long-term monitoring expected for five to seven years; the company believes seller-funded escrow is sufficient, but additional costs could arise. The Embassy Suites franchise agreement could entail a termination payment of up to $7.6 million if terminated for specified failures. Management said it did not expect existing legal matters to have a material adverse effect. No material risk-factor changes were reported.
- Management stated that liquidity was adequate for the next 12 months and that available cash, operating cash flow and credit-facility capacity were expected to support near-term needs. It also noted that financing access is not assured and that deteriorating markets could prompt project delays, fewer acquisitions, spending reductions or dividend-policy reassessment.
Important facts for investors to verify
- La Jolla Commons’ ongoing lease-up, operating contribution and development requirements, and the assumptions behind its purchase price and pro forma results.
- Same-store rent and occupancy trends by segment, particularly multifamily occupancy, which fell to 91.6% for Q3 from 93.3%, and the effects of retail redevelopment and lease expirations.
- Debt maturities, interest-rate hedges, covenant headroom and access to the $350 million revolver; confirm actual availability under the credit facility.
- Whether cash flow after capital expenditures, tenant improvements, leasing commissions and distributions supports the dividend. Nine-month capital expenditures and leasing commissions together were substantial.
- Progress and potential costs associated with Del Monte Center remediation, hotel franchise requirements and other commitments.