American Assets Trust, Inc. — Q2 2018 Form 10-Q
Business context and period. The filing covers the quarter and six months ended June 30, 2018, compared with the corresponding 2017 periods. American Assets Trust is a REIT operating through its consolidated Operating Partnership, in which it held a 73.2% interest. The portfolio comprised 26 retail, office, multifamily and mixed-use properties, plus land and projects in development or construction.
Key financial metrics
Amounts below are in millions of dollars unless otherwise indicated. Results are consolidated; per-share earnings and dividends are for American Assets Trust, Inc.
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Total revenue | $85.0 | $77.1 | $165.8 | $150.9 |
| Net income | $4.4 | $7.6 | $3.7 | $17.9 |
| Net income attributable to AAT stockholders | $3.1 | $5.5 | $2.6 | $12.9 |
| Basic and diluted EPS | $0.07 | $0.12 | $0.06 | $0.28 |
| Property operating income (NOI) | $55.5 | $49.4 | $107.3 | $95.8 |
| Operating cash flow | Not presented quarterly | Not presented quarterly | $82.3 | $83.0 |
| Dividends declared per common share | $0.27 | $0.26 | $0.54 | $0.52 |
Q2 total revenue rose 10%; property operating income rose 12%. Revenue growth included higher rental income and a 94% increase in other property income. H1 revenue rose 10%, while NOI rose 12%. NOI margin was approximately 65.3% in Q2 versus 64.0% a year earlier, and 64.7% for H1 versus 63.5%.
GAAP operating income was $17.2 million in Q2 versus $20.0 million, and $30.2 million for H1 versus $43.4 million. The corresponding operating margins were approximately 20.3% and 26.0% for Q2, and 18.2% and 28.7% for H1. Depreciation and amortization increased 36% in Q2 and 57% in H1, substantially weighing on reported profit.
For the six months, investing activities used $23.4 million, primarily for capital expenditures and leasing commissions; financing activities used $90.2 million. Cash, cash equivalents and restricted cash declined $31.2 million to $60.7 million, comprising $51.3 million unrestricted cash and $9.4 million restricted cash.
At June 30, total debt principal was approximately $1.28 billion: $205.4 million secured notes, $1.05 billion unsecured notes and $22 million drawn on the revolving facility. The balance sheet reports debt net of issuance costs. The unsecured facility provides a $350 million revolver and a $100 million term loan; approximately $328 million of revolver capacity remained undrawn. AAT, Inc. itself reported no indebtedness; debt is held by the Operating Partnership. The company reported compliance with debt covenants.
Material changes versus the prior period
- Q2 net income attributable to stockholders fell 44%; H1 fell 80%. Higher depreciation and amortization—especially at Waikele Center and Lloyd District Portfolio—was the principal reported pressure, including accelerated depreciation associated with redevelopment and lease terminations.
- Q2 other property income increased $4.0 million, largely from office lease-termination fees at Lloyd District Portfolio and Torrey Point. H1 other property income increased $4.7 million, also mainly due to lease-termination fees. These items contributed to NOI growth and may not recur.
- Rental growth reflected acquisitions, higher rents and occupancy. Pacific Ridge Apartments and Gateway Marketplace contributed to year-over-year growth; same-store rental income increased 3% in H1. H1 same-store NOI increased 6%.
- Secured debt declined after repayment of the $73.7 million Loma Palisades mortgage in March 2018. The company drew $22 million on its revolver by quarter-end. H1 operating cash flow was broadly stable, while 2017 financing cash flows had included significant debt and equity proceeds.
Outlook, commentary and risks
- Management expects leasing volume for the remainder of 2018 to be in line with historical averages and anticipates overall positive rental-income increases, while cautioning that signed leases may not commence, tenants may not pay, and rent changes may be positive or negative. No numeric earnings or FFO guidance is provided.
- Management is pursuing same-store growth, development and redevelopment, and selective acquisitions. Future Lloyd District phases depend on market conditions and acceptable risk-adjusted returns. Projects and acquisitions may be delayed or not proceed; funding may use cash, operating cash flow, debt or equity.
- Q2 comparable-space leasing showed mixed retail results: comparable retail leases overall had average cash rent increases of 1.3%, while new comparable retail leases had a 10.2% decrease; comparable renewals increased 4.7%. Comparable office leases overall increased 16.5% on a cash basis. These figures relate to leases signed, not necessarily rent already recognized.
- Key risks include economic and property-market weakness, tenant defaults or vacancies, interest-rate and financing exposure, development execution, concentrated geographic and sector exposure, REIT qualification requirements, litigation, environmental matters and natural disasters. Thirteen properties were in Southern California; retail and office tenants generated 31.7% and 34.9% of H1 revenue, respectively.
- Variable-rate debt was $272 million; interest-rate swaps hedge portions of exposure. A 1% rate increase was estimated to reduce the fair value of fixed-rate debt by $22.4 million; this is a fair-value sensitivity, not an estimate of earnings impact.
- Commitments include approximately $36.7 million of remaining payments under ground/building leases. Del Monte Center groundwater remediation continues, with remaining work funded by seller-funded escrow that management believes is sufficient; excess costs could fall to the company. Potential Embassy Suites franchise termination payments were estimated as high as $7.6 million based on performance through June 30, 2018.
- Management stated that it had adequate working capital for the next 12 months and that no material adverse effect was expected from the disclosed legal proceedings. These are management assessments, not assurances. Disclosure controls were reported effective, with no material changes to internal control over financial reporting identified.
Important facts for investors to verify
- Whether reported rental and NOI growth can be sustained after separating same-store performance, acquisitions and nonrecurring lease-termination fees.
- The drivers and expected duration of elevated depreciation, including redevelopment-related and lease-termination-related charges.
- Debt maturities and refinancing plans, particularly the 2019 mortgage and term-loan maturities; available revolver capacity; and compliance with covenants.
- Whether leasing spreads translate into commenced leases, occupancy and collected rent, and what tenant improvement and incentive costs those leases require.
- Remaining development, redevelopment and capital-spending needs, and whether operating cash flow and financing sources are sufficient to fund them alongside dividends and debt service.
- Potential costs from environmental remediation and hotel franchise obligations, and any subsequent developments in legal matters or other contingencies.