Douglas Emmett, Inc. — Q2 2010 Form 10-Q
Reporting period: Three and six months ended June 30, 2010. Douglas Emmett is a REIT focused on office and multifamily properties in Los Angeles County and Honolulu. At quarter-end, its consolidated portfolio included 50 office and nine multifamily properties; it also managed six properties held by unconsolidated funds. Financial amounts below are in millions unless noted.
Financial performance and liquidity
| Metric | Q2 2010 | Q2 2009 | Six months 2010 | Six months 2009 |
|---|---|---|---|---|
| Total revenue | $139.2 | $139.8 | $277.0 | $291.2 |
| Operating income | $36.7 | $37.2 | $72.6 | $76.3 |
| Net loss attributable to common stockholders | $(9.0) | $(7.5) | $(17.3) | $(9.3) |
| Basic and diluted loss per share | $(0.07) | $(0.06) | $(0.14) | $(0.08) |
| Cash from operating activities | Not stated for the quarter | $83.6 | $95.7 |
- Q2 operating margin was approximately 26.4% of revenue, versus 26.6% a year earlier. Total segment profit was $97.6 million, down from $98.8 million.
- At June 30, cash and cash equivalents were $21.2 million; total assets were $6.11 billion and total equity was $2.28 billion.
- Secured notes payable, including loan premium, totaled $3.43 billion. Approximately 95% of debt was hedged or effectively fixed, at a reported overall rate of 5.10% on an actual/360-day basis.
- The $350 million secured revolver had $154.5 million drawn and approximately $195 million available. It was scheduled to mature October 30, 2010, with a one-year extension option subject to conditions.
- The quarterly dividend remained $0.10 per share ($0.40 annualized). Six-month cash dividends were $24.4 million.
Changes versus prior comparable periods
- Q2 revenue declined 0.4%; six-month revenue declined 4.9%. Office revenue was nearly flat in Q2 but lower for the half-year, partly because six properties contributed to an institutional fund were included in 2009 results only through February. Lower below-market lease accretion also reduced rental revenue.
- Lower office parking income, attributed in part to lower occupancy, weighed on revenue. Q2 office expense increased 1.5%, primarily from higher property taxes; six-month office expense fell 4.8%, partly reflecting the properties no longer consolidated and lower electricity rates.
- Six-month operating cash flow fell $12.1 million, primarily because of higher cash interest timing and the absence of cash flows from the six deconsolidated properties. Investing cash use increased to $257.9 million from $28.0 million, mainly due to the Bishop Square acquisition.
- Six-month net loss attributable to common stockholders widened to $17.3 million from $9.3 million. The 2009 comparison included a $5.6 million gain on disposition of an interest in an unconsolidated fund; 2010 also recorded a $3.7 million loss from unconsolidated funds versus a $0.7 million gain in 2009.
Acquisition, outlook, risks, and unusual items
- On June 29, 2010, the company acquired Bishop Square, an approximately 960,000-square-foot Honolulu office project, for a contract price of $232 million. The preliminary purchase price allocation was $229.6 million of net assets acquired and remained subject to revision during the purchase-accounting period. Its results were included only from the acquisition date.
- Management expected operating cash flow and revolver borrowings to meet liquidity needs for at least the next 12 months. Longer-term needs, including acquisitions, capital projects and debt repayment, were expected to require operating cash flow and potentially borrowing, securities issuance, property sales or joint ventures. No specific earnings or revenue guidance was provided.
- Interest-rate exposure warrants attention: swaps covering $1.11 billion matured August 1, 2010, and swaps covering another $545 million were scheduled to mature December 1, 2010. The filing estimated that a 50-basis-point LIBOR change would affect annual earnings by approximately $0.9 million under then-current hedges; without replacement hedges on the specified maturities, the additional potential 2010 impact was estimated at $2.6 million.
- Derivative liabilities were $174.6 million gross; the filing reported a $117 million net liability position by counterparty. Management estimated $85 million would be reclassified from accumulated other comprehensive loss to interest expense over the next 12 months.
- Risks cited include weaker Southern California or Honolulu real estate markets, lower rents or occupancy, tenant defaults and lease nonrenewals, higher interest rates and operating costs, refinancing or capital-raising challenges, REIT qualification, environmental matters and natural disasters. The company reported no material changes to the risk factors in its 2009 Form 10-K.
- Ordinary-course legal matters were not expected by management to have a material adverse effect. Asbestos was identified at 20 properties; removal obligations had indeterminable settlement dates and could not be reasonably estimated. The company also remained subject to limited indemnities and potential swap-guarantee exposure related to a fund, with maximum future swap payments of approximately $31.2 million; the fund had performed its obligations to date.
- Management concluded disclosure controls were effective at June 30, 2010, and reported no material change in internal control over financial reporting during the period.
Key facts for investors to verify
- Whether the revolver extension was available and exercised, and the status of refinancing or repayment plans for the major 2012 debt maturity.
- Whether replacement hedges were entered into after the August and December 2010 swap expirations, and the resulting interest expense and sensitivity.
- Bishop Square’s final purchase accounting, contribution to occupancy and rental revenue, and funding costs.
- Comparable-property occupancy, leasing activity, rent trends and tenant recoveries, particularly given lower parking income and the filing’s cited occupancy pressure.
- Cash generation and capital needs relative to the dividend, debt service and planned investment; the interim filing cautions that results are not necessarily indicative of full-year results.