Hudson Pacific Properties, Inc. annual report, FY2011

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Business context and reporting period

Hudson Pacific Properties, Inc. filed this Form 10-K for the fiscal year ended December 31, 2011. The company is a California-focused REIT owning and operating office and media and entertainment properties. At year-end, its stabilized operating portfolio comprised approximately 4.4 million square feet across 15 office properties and two media and entertainment properties.

Comparisons are significantly affected by portfolio growth: many office properties were acquired in 2010 or 2011, and 2010 included only a partial year of operations as a public company following its June 2010 IPO.

Key financial and operating metrics

  • Revenue: $142.2 million in 2011, up from $60.6 million in 2010. Office revenue was $105.2 million; media and entertainment revenue was $37.0 million.
  • Profitability: GAAP net loss was $2.2 million, versus a $2.7 million loss in 2010. Net loss attributable to common shareholders was $10.4 million, or $0.35 per diluted share, reflecting preferred distributions and other attribution items. Segment NOI, a non-GAAP measure, was $75.0 million versus $30.6 million; NOI was approximately 52.7% of revenue.
  • Cash flow: Operating cash flow was $32.1 million, investing cash flow was negative $130.6 million, and financing cash flow was positive $63.4 million. Cash and cash equivalents fell to $13.7 million from $48.9 million; restricted cash was $9.5 million.
  • Balance sheet and debt: Total assets were $1.153 billion and total liabilities were $451.6 million. Notes payable were $399.9 million, including an unamortized loan premium; principal debt was $397.9 million. Year-end debt included $121.0 million drawn on a $200 million secured revolving facility. The company reported covenant compliance. At March 1, 2012, management reported debt to total market capitalization of approximately 36.3%, counting Series A preferred units as debt.
  • Liquidity after year-end: The company subsequently raised $43.0 million through a First Financial term loan, $30.0 million through a 10950 Washington term loan, and approximately $56.1 million net of underwriting discounts from a Series B preferred offering. It used proceeds to repay the revolver; the filing states the facility had no outstanding balance as of the report date and approximately $159.9 million of availability.
  • Leasing and distributions: Office occupancy was 91.0% including signed but uncommenced leases (88.6% excluding them); media and entertainment occupancy averaged 70.1% for the year. The company declared common dividends of $0.50 per share for 2011. Series B preferred stock carries an 8.375% cumulative dividend rate.

Material changes versus the prior comparable period

  • Revenue rose 134% year over year, chiefly because of properties acquired in 2010 and 2011, rather than solely same-property growth. Office revenue increased to $105.2 million from $26.5 million; media and entertainment revenue rose to $37.0 million from $34.1 million.
  • Operating expenses increased to $124.9 million from $50.4 million, including higher property expenses, depreciation and corporate general and administrative costs. Interest expense nearly doubled to $17.5 million, principally due to increased indebtedness.
  • Office segment NOI increased to $60.5 million from $16.3 million, while media and entertainment NOI was $14.5 million versus $14.3 million.
  • 2011 acquisitions included four office properties and two small properties ancillary to Sunset Gower. The company also acquired the remaining 49% interest in Rincon Center and repaid several property loans. Year-end cash declined, while operating cash flow improved.

Outlook, commentary, risks and unusual items

  • Management described a value-add strategy focused on leasing, active property management, capital improvements, cost control and acquisitions in California growth markets. It cited an acquisition pipeline and expected to fund liquidity needs through operating cash flow, existing cash, debt and equity markets. No numerical earnings, revenue or occupancy guidance is provided.
  • Near-term leasing risk is material: approximately 9.0% of office space was available at year-end, and 6.8% of office space was scheduled to expire in 2012. Office lease expirations are concentrated in 2013 and 2017; most media and entertainment leases, other than KTLA’s, were due to expire in 2012 or 2013. Media leases are generally short-term.
  • Tenant concentration is significant: the ten largest office tenants generated 54.8% of office annualized base rent; Bank of America alone represented 10.9%. Its leases at 1455 Market have staggered early termination rights. Saatchi & Saatchi may terminate its Del Amo lease early, subject to specified fees.
  • All properties are in California, exposing the company to regional economic, regulatory and earthquake risks. Other key risks include refinancing and interest-rate exposure, competition, tenant defaults and concessions, acquisition execution, ground-lease termination, environmental and ADA obligations, and maintaining REIT status.
  • Year-end variable-rate exposure included the $121 million revolver and a $92 million media-campus loan, partly hedged by an interest-rate cap. Management estimated that a 100-basis-point increase in one-month LIBOR would increase future interest expense by $2.1 million based on year-end debt and hedges. No real estate impairment charges were recorded in 2011.
  • Management and Ernst & Young reported effective internal control over financial reporting; the auditor issued unqualified opinions on the financial statements and internal controls. The company reported no material pending legal proceedings or off-balance-sheet arrangements.

Important facts for investors to verify

  1. Review acquisition-adjusted and same-property operating performance; reported revenue growth is heavily influenced by portfolio additions.
  2. Confirm current occupancy, lease-up progress, renewal economics and tenant-improvement commitments, particularly for 2012–2013 expirations and media properties.
  3. Track Bank of America’s staggered termination rights and the credit and renewal status of other major tenants.
  4. Reconcile debt balances and maturities after the post-year-end refinancing and preferred-stock issuance, and assess covenant headroom, interest-rate hedges and refinancing needs.
  5. Assess recurring cash available for dividends against capital expenditures, debt service, preferred distributions and REIT distribution requirements; distinguish consolidated net loss from loss attributable to common shareholders.