Douglas Emmett, Inc. — Q3 2010 Form 10-Q
Business context and period. This unaudited report covers the quarter and nine months ended September 30, 2010, compared with the same periods in 2009. Douglas Emmett is a REIT focused on office and multifamily properties in Los Angeles County and Honolulu. At quarter-end, it owned 50 office and nine multifamily properties and managed six additional properties through unconsolidated funds. In June 2010, it acquired Honolulu’s Bishop Square office complex for a contract price of $232 million.
Key financial results
Amounts below are in millions of dollars, except per-share data and percentages.
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Total revenue | $148.1 | $140.4 | $425.1 | $431.6 |
| Operating income | $35.3 | $36.1 | $107.9 | $112.4 |
| Net loss attributable to common stockholders | $(3.9) | $(8.8) | $(21.2) | $(18.2) |
| Basic and diluted loss per share | $(0.03) | $(0.07) | $(0.17) | $(0.15) |
| Operating margin | 23.8% | 25.7% | 25.4% | 26.0% |
| Cash provided by operating activities | Not separately stated | $136.6 | $144.7 |
Q3 revenue increased 5.4%, while operating income declined 2.1%; the operating margin contracted. For the nine-month period, revenue fell 1.5% and operating income fell 3.9%, while the common-stockholder net loss widened. The company declared dividends of $0.10 per share each quarter, or $0.30 per share for the nine months.
Balance sheet, debt and liquidity
- Cash and cash equivalents were $281.7 million at September 30, 2010, versus $72.7 million at December 31, 2009. Total assets were $6.32 billion; total equity was $2.27 billion.
- Secured debt principal was $3.658 billion, plus an $11.5 million unamortized loan premium. The weighted-average remaining debt life was 2.9 years. The filing reports debt equal to 57.3% of market capitalization.
- During Q3, the company borrowed $400 million under a seven-year term loan, effectively fixed at 4.45%, and terminated its $350 million revolving credit facility after repaying any outstanding balance.
- About 69% of debt was hedged at quarter-end. Swaps covering $545 million were scheduled to mature December 1, 2010; a further $1.11 billion of debt had become floating-rate after swaps matured in Q3. Management estimated a 50-basis-point LIBOR change would affect annual earnings by about $5.7 million at quarter-end, potentially by an additional $2.8 million if the $545 million hedge were not replaced.
- Operating cash flow decreased $8.1 million year over year. Investing cash outflow was $275.8 million, primarily reflecting Bishop Square; financing cash inflow was $348.2 million, largely from the $400 million term loan. Cash increased by $208.9 million during the nine months.
Operating trends and material changes
- Q3 office rental revenue rose 2.1%, with $4.0 million of incremental rent from Bishop Square partly offset by lower occupancy, rental rates and below-market lease accretion elsewhere. Office recoveries also benefited from property acquisition and completion of prior-year common-area-maintenance reconciliations.
- Q3 office expenses rose 12.3%, partly due to Bishop Square, higher utilities and property-tax assessments. General and administrative expense rose 27.1%, primarily from a change in bonus accrual estimates.
- For the nine months, office rental revenue declined, reflecting the 2009 deconsolidation of six properties, weaker occupancy and rental rates, and lower below-market rent accretion; Bishop Square partly offset these effects. Multifamily revenue was broadly flat.
- Interest expense declined 15.1% in Q3 and 7.1% for the nine-month period, principally following swap expirations and, year to date, lower average debt associated with the previously deconsolidated properties.
- Losses, including depreciation, from unconsolidated real estate funds were $5.5 million for the nine months, compared with $1.2 million in 2009. The prior-year period included a $5.6 million disposition gain.
Outlook, risks and contingencies
- Management expected cash on hand and operating cash flow to meet liquidity needs for at least the next 12 months. It did not expect available funds alone to cover all long-term needs and cited borrowing, securities issuance, property dispositions and joint ventures as potential funding sources. No earnings or revenue guidance was provided.
- After quarter-end, the company obtained four cross-collateralized, ten-year loans totaling $388.08 million, with swaps fixing the rate at approximately 3.65% for seven years. Proceeds repaid four loans scheduled to mature in June 2012.
- Derivative fair-value liabilities were $159.9 million, against derivative assets of $59.4 million. The company estimated $75.0 million of accumulated hedge losses would be reclassified to interest expense as an increase over the next 12 months. Derivative counterparties may terminate certain contracts if cash falls below $1 million; no derivative defaults were reported.
- Key stated risks include regional economic weakness, lower rents or occupancy, tenant defaults and non-renewals, higher rates and operating costs, debt-service capacity, access to capital, property acquisition and development risks, environmental matters, disasters, and maintaining REIT status. No material change to previously reported risk factors was disclosed.
- Ordinary-course legal matters were not expected to materially affect the company. Asbestos was identified at 20 properties; removal obligations have indeterminable settlement dates and could not be reasonably estimated. The company also retained limited indemnities and swap-related contingent exposure for a fund loan, with maximum future swap payments of about $27.6 million; the fund had performed its obligations to date.
Most important facts for investors to verify
- Whether occupancy, rental rates and same-property cash flows stabilize or continue to weaken, and how much reported growth reflects Bishop Square and CAM reconciliations.
- Debt maturities, refinancing execution and the extent to which expiring swaps leave exposure to floating rates.
- Whether operating cash flow and liquidity remain sufficient alongside dividends, capital spending and debt service.
- The future earnings and cash-flow impact of derivative settlements, hedge reclassifications and counterparty exposure.
- Performance and funding obligations of unconsolidated funds, including the company’s remaining commitments and contingent guarantees.