Hudson Pacific Properties, Inc. — Q2 2015 Form 10-Q
Reporting period: Three and six months ended June 30, 2015. Hudson Pacific is a REIT focused on office and media and entertainment properties, primarily in California and Washington. The filing presents the Company and its operating partnership on a consolidated basis; amounts below are in U.S. dollars.
Business context and major transaction
On April 1, 2015, the Company acquired Blackstone’s EOP Northern California Portfolio: 26 office properties totaling approximately 8.2 million square feet and two development parcels. The stated total consideration was approximately $3.82 billion, including about $1.72 billion cash and common shares/units. The Company also acquired the 120,937-square-foot 4th & Traction property for approximately $49.3 million. At quarter-end, the portfolio comprised 53 office and two media and entertainment properties.
Financial results and key metrics
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Revenue | $151.8 million | $62.1 million | $214.6 million | $117.7 million |
| Operating income | $16.1 million | $13.2 million | $29.4 million | $24.4 million |
| Consolidated net income (loss) | ($36.1 million) | $6.7 million | ($11.5 million) | $11.2 million |
| Net cash from operations | Not separately reported for quarter | Not separately reported for quarter | $63.6 million | $35.9 million |
| FFO attributable to common stock/unit holders | $30.9 million | $20.2 million | $43.4 million | $37.2 million |
Revenue growth largely reflects the April acquisition. Q2 net loss included $37.5 million of acquisition-related expense and a $0.6 million loss adjustment on a property sale; six-month acquisition-related expense was $43.5 million. Six-month results also included a $22.1 million gain on sale of real estate. FFO is a non-GAAP measure and is not a substitute for GAAP earnings or cash flow.
Q2 property net operating income (NOI, a non-GAAP measure) was $100.1 million, up $62.3 million year over year, primarily due to the acquired portfolio. Same-store NOI decreased 5.2% in Q2, but increased 2.4% for the first half. Same-store office average occupancy was 92.5% in Q2 versus 90.9% a year earlier; average annual rent per square foot rose 7.6% to $34.38. Same-store media occupancy averaged 72.0%, compared with 72.7%.
Cash, debt and liquidity
At June 30, cash and cash equivalents were $40.3 million and restricted cash was $17.3 million. Notes payable were $2.12 billion, compared with $960.5 million at December 31, 2014 per the debt schedule. The Company reported debt to total market capitalization of approximately 33.2%. About 83.6% of debt was variable-rate; interest-rate contracts hedged portions of that exposure. A 100-basis-point increase in one-month LIBOR was estimated to increase annual interest expense by $10.5 million.
Six-month investing cash outflow was $1.75 billion, chiefly from property acquisitions; financing cash inflow was $1.71 billion, including new borrowing and equity issuance. Operating cash flow was $63.6 million. The $400 million unsecured revolver had $45 million drawn at quarter-end; the Company stated it was in compliance with its financial covenants. The filing also reports $3.3 million of outstanding letters of credit.
Changes, outlook and risks
- The acquisition materially expanded the asset base and drove much of the increase in revenue and NOI, while also increasing depreciation, interest expense and transaction costs. Management said the acquired portfolio was being integrated into internal financial controls; disclosure controls were assessed as effective.
- No formal earnings or operating guidance was provided. Management described expected funding sources as operating cash flow, available credit, long-term debt and equity issuance, subject to market access, leverage and lender restrictions.
- Management expected to close a previously announced purchase of two downtown Los Angeles redevelopment properties for $40 million in Q3 2015. After quarter-end, the Company agreed to sell Bay Park Plaza for approximately $90 million, with closing expected before the end of Q3. The ICON development was estimated for completion in Q4 2016 and stabilization in Q3 2018.
- Key risks include California market concentration, tenant defaults or non-renewals, vacancy and rental-rate changes, interest-rate exposure, refinancing and access to capital, acquisition integration, and maintaining REIT status. Credit facilities contain leverage, coverage and other restrictive covenants. The Company reported no material pending legal proceedings and assessed material loss from ordinary-course legal matters as remote.
- The EOP transaction involved Blackstone affiliates and included substantial share/unit consideration and governance rights, including board nomination rights and restrictions on certain equity issuances and significant transactions. The filing also discloses related-party arrangements.
Investor verification priorities
- Confirm post-acquisition occupancy, leasing trends and property-level contribution from the EOP portfolio; reported year-over-year comparisons include a major change in portfolio size.
- Review debt maturities, covenant headroom, variable-rate exposure and hedging terms, particularly the $550 million two-year term loan maturing in 2017.
- Assess recurring earnings and cash available for distributions apart from acquisition costs, depreciation, sale gains and other non-cash items; compare GAAP results with FFO and cash flow.
- Verify completion and proceeds of the announced Bay Park Plaza sale and downtown Los Angeles acquisition, and monitor the cost, timing and leasing progress of ICON.
- Review Blackstone-related governance, registration, transfer and unit-redemption rights, as well as the terms and potential dilution of future equity issuance.