Hudson Pacific Properties, Inc. — Q2 2016 Form 10-Q
Business context and reporting period. This unaudited filing covers the quarter and six months ended June 30, 2016. Hudson Pacific is a REIT focused primarily on office and media and entertainment properties in California and the Pacific Northwest. At quarter-end it owned 51 office properties and two media and entertainment properties. The company owned approximately 68.5% of its operating partnership; the partnership holds substantially all assets and conducts substantially all business. Unless noted, amounts below are in U.S. dollars.
Key financial metrics
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Total revenue | $154.3 million | $151.8 million | $307.9 million | $214.6 million |
| Income from operations | $19.8 million | $16.1 million | $38.8 million | $29.4 million |
| Consolidated net income (loss) | $4.0 million | $(36.1) million | $10.0 million | $(11.5) million |
| Net income (loss) attributable to common stockholders | $0.8 million; $0.01/share | $(25.2) million; $(0.28)/share | $3.1 million; $0.03/share | $(6.0) million; $(0.07)/share |
| FFO attributable to common stockholders and unitholders | $62.9 million | $30.9 million | $126.1 million | $43.4 million |
| Net cash from operating activities | Not reported by quarter | Not reported by quarter | $107.7 million | $63.6 million |
Q2 revenue increased 2%; six-month revenue increased 43%. Six-month FFO rose about 191%. FFO is a non-GAAP measure and excludes, among other items, real estate depreciation and gains or losses on property sales; it is not a substitute for GAAP earnings or cash flow.
Property operations: Q2 total NOI was $98.9 million, down 1% year over year. Same-store NOI rose 7% to $65.7 million, while non-same-store NOI fell 14% to $33.2 million, primarily reflecting property sales. Six-month NOI increased 42% to $198.8 million, largely reflecting the EOP Northern California portfolio acquired in April 2015. Same-store office average occupancy was 93.9% in Q2 versus 95.3%; ending leased occupancy was 96.2% versus 95.6%. Media and entertainment average occupancy improved to 85.3% from 76.5%.
Balance sheet and liquidity: At June 30, cash and cash equivalents were $337.4 million; total assets were $6.28 billion; and notes payable were $2.36 billion gross ($2.34 billion net on the balance sheet), up from $2.28 billion gross at year-end 2015. The company reported $400 million of revolving-credit capacity, of which $250 million was drawn. Pro-rata debt to total market capitalization was approximately 34.8%. About 60.2% of debt was variable-rate, with $839.5 million of variable-rate debt covered by interest-rate contracts. Operating cash flow was $107.7 million; investing activities provided $160.2 million, principally from property dispositions; financing activities provided $15.9 million. The company reported compliance with debt covenants and no loan defaults.
Material changes versus comparable periods
- Results reflect the EOP portfolio for all of the first half of 2016, compared with only the period from its April 1, 2015 acquisition in the prior-year half. This substantially increased revenue and non-same-store NOI.
- Q2 and first-half GAAP earnings improved from losses to income. The prior-year periods included $37.5 million and $43.5 million, respectively, of EOP acquisition-related expenses; current-period acquisition-related expenses were approximately $0.1 million in each period.
- First-half interest expense increased 78% to $34.9 million, and depreciation and amortization increased 48% to $134.5 million, primarily reflecting the larger portfolio and additional debt.
- The company sold Bayhill Office Center, Patrick Henry Drive and One Bay Plaza for gross proceeds totaling approximately $287.4 million in the first half. The sales generated $8.5 million of gains. A separate $80 million sale agreement for 12655 Jefferson was classified as held for sale at quarter-end.
- In May, the company issued 10.1 million shares for net proceeds of $294.2 million and used the proceeds to redeem an equivalent value of operating-partnership units, including 10 million units held by Blackstone.
Outlook, risks and unusual items
- Guidance: The filing provides no numerical earnings or FFO guidance. Management said it expects to meet short-term liquidity needs with cash, operating cash flow and, if needed, the revolving facility; longer-term needs may be funded through operations, debt and equity issuance.
- Subsequent acquisition and financing: On July 1, 2016, the company purchased its 500,475-square-foot corporate-headquarters building at 11601 Wilshire for $311 million from a Blackstone affiliate. The filing describes the opportunity to lease vacant space and re-lease space at higher market rents. The acquisition was funded with disposition proceeds, a $150 million private placement of 3.98% notes, repayment of a note receivable and revolver borrowings. An additional $50 million note placement was secured but undrawn.
- Subsequent equity transaction: On July 21, the company issued 19.2 million shares and used proceeds to redeem 19.2 million partnership units held by Blackstone and Farallon-affiliated funds.
- Interest-rate exposure: Derivative liabilities increased to $26.5 million from $2.0 million at year-end; the company recorded $2.5 million of first-half losses on ineffective hedge portions. It expected $8.9 million of accumulated hedge losses to be reclassified to interest expense over the following 12 months. Post-quarter hedge redesignations raised the effective rates on certain hedged term-loan balances.
- Risks and commitments: Properties are concentrated in California; technology and media and entertainment tenants account for approximately 29% and 13.5% of rentable square feet, respectively. No tenant represented more than 10% of rentable area. Risks include tenant defaults or nonrenewals, vacancy and rent declines, interest-rate increases, access to financing, acquisitions and development, natural hazards, and maintaining REIT status. Future debt principal payments include $692.5 million in 2020; stated future ground-lease payments total $474.7 million. Management assessed ordinary-course legal claims as not expected to have a material adverse effect.
- Related-party consideration: The 11601 Wilshire seller was a Blackstone affiliate; a company director is associated with a tenant in the building. The filing also describes Blackstone governance, transfer and redemption rights, and a Blackstone-affiliate margin loan secured by company shares and partnership units. The company stated it is not party to that margin loan and did not independently verify its disclosure.
Important facts for investors to verify
- How much of revenue and NOI growth reflects the EOP acquisition versus comparable-property leasing, occupancy and rent trends; also assess the effect of dispositions on recurring results.
- The 11601 Wilshire purchase accounting, lease-up assumptions, financing mix and related-party terms, including the director-linked tenant relationship.
- Debt maturities, variable-rate exposure, hedge effectiveness and liquidity after the July acquisition and subsequent share issuance and unit redemption.
- Whether occupancy and leasing gains can offset higher operating costs, general and administrative expense, depreciation and interest expense.
- Exposure to California markets and concentration in technology and media and entertainment tenants, along with the status and proceeds of the 12655 Jefferson sale.