Attached files

file filename
EX-32.2 - EXHIBIT 32.2 - Douglas Emmett Inca2017q1exhibit322-cfo906ce.htm
EX-32.1 - EXHIBIT 32.1 - Douglas Emmett Inca2017q1exhibit321-ceo906ce.htm
EX-31.2 - EXHIBIT 31.2 - Douglas Emmett Inca2017q1exhibit312-cfo302ce.htm
EX-31.1 - EXHIBIT 31.1 - Douglas Emmett Inca2017q1exhibit311-ceo302ce.htm
United States
Securities and Exchange Commission
Washington, D.C. 20549
 
FORM 10-Q
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended March 31, 2017
 
Commission file number 001-33106

deiblacklogo.jpg
Douglas Emmett, Inc.

(Exact name of registrant as specified in its charter)
Maryland
20-3073047
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
 
808 Wilshire Boulevard, Suite 200, Santa Monica, California
90401
(Address of principal executive offices)
(Zip Code)
 
(310) 255-7700
(Registrant’s telephone number, including area code)
 
N/A
(Former name, former address and former fiscal year, if changed since last report)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of "large accelerated filer", "accelerated filer", "smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer  x     
Accelerated filer ¨
Non-accelerated filer ¨ (Do not check if a smaller reporting company)
Smaller reporting company ¨
Emerging growth company ¨
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ¨ No x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
 
Class
 
Outstanding at
April 28, 2017
Common Stock, $0.01 par value per share
 
154,584,972
shares

1


DOUGLAS EMMETT, INC.
FORM 10-Q

Table of Contents
 
 
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2


Abbreviations used in this document:
ASU
Accounting Standards Updates
ATM
At-the-Market
BOMA
Building Owners and Managers Association
CEO
Chief Executive Officer
CFO
Chief Financial Officer
Code
Internal Revenue Code of 1986, as amended
DEI
Douglas Emmett, Inc.
EPS
Earnings Per Share
Exchange Act
Securities Exchange Act of 1934, as amended
FASB
Financial Accounting Standards Board
FDIC
Federal Deposit Insurance Corporation
FFO
Funds from Operations
Fund X
Douglas Emmett Fund X, LLC
Funds
Unconsolidated institutional real estate funds (Fund X and Partnership X)
GAAP
Generally Accepted Accounting Principles (United States)
JV
Joint Venture
LIBOR
London Interbank Offered Rate
LTIP Units
Long-Term Incentive Plan Units
NAREIT
National Association of Real Estate Investment Trusts
OP Units
Operating Partnership Units
Operating Partnership
Douglas Emmett Properties, LP
Partnership X
Douglas Emmett Partnership X, LP
PCAOB
Public Company Accounting Oversight Board (United States)
REIT
Real Estate Investment Trust
Report
Quarterly Report on Form 10-Q
SEC
Securities and Exchange Commission
Securities Act
Securities Act of 1933, as amended
TRS
Taxable REIT subsidiary(ies)
US
United States
VIE
Variable Interest Entity(ies)

Defined terms used in this document:
Annualized rent
Annualized cash base rent (excludes tenant reimbursements, parking income, lost rent recovered
from insurance and other revenue) before abatements under leases commenced as of the reporting
date. For our triple net Burbank and Honolulu office properties, annualized rent is calculated by
adding expense reimbursements to base rent.

Consolidated Portfolio
Includes the properties in our consolidated results, which includes the properties owned by our consolidated JVs.
Leased Rate
Signed leases not yet commenced as of the reporting date.
Rentable Square Feet

Based on the BOMA remeasurement and consists of leased square feet (including square feet with
respect to signed leases not commenced), available square feet, building management use square
feet and square feet of BOMA adjustment on leased space.

Total Portfolio

Includes our Consolidated Portfolio plus the properties owned by our unconsolidated real estate
Funds.



3

Forward Looking Statements


This Report contains forward-looking statements within the meaning of the Section 27A of the Securities Act and Section 21E of the Exchange Act. You can find many (but not all) of these statements by looking for words such as “believe”, “expect”, “anticipate”, “estimate”, “approximate”, “intend”, “plan”, “would”, “could”, “may”, “future” or other similar expressions in this Report. We claim the protection of the safe harbor contained in the Private Securities Litigation Reform Act of 1995. We caution investors that any forward-looking statements used in this Report, or those that we make orally or in writing from time to time, are based on our beliefs and assumptions, as well as information currently available to us. Actual outcomes will be affected by known and unknown risks, trends, uncertainties and factors beyond our control or ability to predict. Although we believe that our assumptions are reasonable, they are not guarantees of future performance and some will inevitably prove to be incorrect. As a result, our future results can be expected to differ from our expectations, and those differences may be material. Accordingly, investors should use caution when relying on previously reported forward-looking statements, which were based on results and trends at the time they were made, to anticipate future results or trends. Some of the risks and uncertainties that could cause our actual results, performance or achievements to differ materially from those expressed or implied by forward-looking statements include the following:

adverse economic or real estate developments in Southern California and Honolulu, Hawaii;
a general downturn in the economy, such as the global financial crisis that commenced in 2008;
competition from other real estate investors in our markets;
decreased rental rates or increased tenant incentive and vacancy rates;
defaults on, early termination of, or non-renewal of leases by tenants;
increased interest rates and operating costs;
failure to generate sufficient cash flows to service our outstanding debt;
failure to generate sufficient cash flows to make payments on a ground lease for one of our properties;
difficulties in raising capital;
difficulties in identifying properties to acquire and failure to complete acquisitions successfully;
failure to successfully operate acquired properties;
real estate investments are generally illiquid and difficult to sell quickly;
possible adverse changes in rent control laws and regulations;
environmental uncertainties;
risks related to natural disasters;
lack or insufficient amount of insurance, or increases in the cost of maintaining existing insurance coverage;
inability to successfully expand into new markets and submarkets;
risks associated with property development;
risks associated with JVs;
conflicts of interest with our officers and reliance on key personnel;    
changes in real estate zoning laws and increases in real property tax rates;
adverse results of litigation or governmental proceedings;
complying with laws, regulations and covenants that are applicable to our properties;
difficulty in liquidating our short term investments;
the consequences of any possible terrorist attacks or wars;
the consequences of any possible cyber attacks or intrusions;
adoption of new accounting pronouncements could adversely affect our operating results;
weaknesses in our internal controls over financial reporting could result in restatements of our operating results;
failure to maintain our REIT status under federal tax laws; and
changes to tax laws that could adversely affect us.

For further discussion of these and other risk factors see Item 1A. "Risk Factors” in our 2016 Annual Report on Form 10-K. This Report and all subsequent written and oral forward-looking statements attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in this section. We do not undertake any obligation to release publicly any revisions to our forward-looking statements to reflect events or circumstances after the date of this Report.


4


PART I. FINANCIAL INFORMATION

Item 1. Financial Statements
Douglas Emmett, Inc.
Consolidated Balance Sheets
(Unaudited; in thousands, except share data)
 
March 31, 2017
 
December 31, 2016
Assets
 

 
 

Investment in real estate:
 

 
 

Land
$
1,022,340

 
$
1,022,340

Buildings and improvements
7,223,644

 
7,221,124

Tenant improvements and lease intangibles
703,537

 
696,197

Property under development
70,416

 
58,459

Investment in real estate, gross
9,019,937

 
8,998,120

Less: accumulated depreciation and amortization
(1,844,009
)
 
(1,789,678
)
Investment in real estate, net
7,175,928

 
7,208,442

Cash and cash equivalents
85,533

 
112,927

Tenant receivables, net
3,391

 
2,165

Deferred rent receivables, net
96,754

 
93,165

Acquired lease intangible assets, net
4,833

 
5,147

Interest rate contract assets
41,234

 
35,656

Investment in unconsolidated real estate funds
142,655

 
144,289

Other assets
36,371

 
11,914

Total assets
$
7,586,699

 
$
7,613,705

 
 
 
 
Liabilities
 

 
 

Secured notes payable and revolving credit facility, net
$
4,391,410

 
$
4,369,537

Interest payable, accounts payable and deferred revenue
97,316

 
75,229

Security deposits
46,153

 
45,990

Acquired lease intangible liabilities, net
62,685

 
67,191

Interest rate contract liabilities
2,600

 
6,830

Dividends payable
35,228

 
34,857

Total liabilities
4,635,392

 
4,599,634

 
 
 
 
Equity
 

 
 

Douglas Emmett, Inc. stockholders' equity:
 

 
 

Common Stock, $0.01 par value, 750,000,000 authorized, 153,144,327 and 151,530,210 outstanding at March 31, 2017 and December 31, 2016, respectively
1,531

 
1,515

Additional paid-in capital
2,676,960

 
2,725,157

Accumulated other comprehensive income
22,858

 
15,156

Accumulated deficit
(836,859
)
 
(820,685
)
Total Douglas Emmett, Inc. stockholders' equity
1,864,490

 
1,921,143

Noncontrolling interests
1,086,817

 
1,092,928

Total equity
2,951,307

 
3,014,071

Total liabilities and equity
$
7,586,699

 
$
7,613,705


See accompanying notes to the consolidated financial statements.

5

Douglas Emmett, Inc.
Consolidated Statements of Operations
(Unaudited; in thousands, except per share data)



 
Three Months Ended March 31,
 
2017
 
2016
 
 
 
 
Revenues
 

 
 

Office rental
 

 
 

Rental revenues
$
133,016

 
$
111,006

Tenant recoveries
11,050

 
10,211

Parking and other income
26,282

 
23,162

Total office revenues
170,348

 
144,379

 
 
 
 
Multifamily rental
 

 
 

Rental revenues
22,241

 
22,427

Parking and other income
1,892

 
1,766

Total multifamily revenues
24,133

 
24,193

 
 
 
 
Total revenues
194,481

 
168,572

 
 
 
 
Operating Expenses
 

 
 

Office expenses
54,885

 
47,883

Multifamily expenses
5,947

 
6,031

General and administrative
10,156

 
8,071

Depreciation and amortization
67,374

 
55,552

Total operating expenses
138,362

 
117,537

 
 
 
 
Operating income
56,119

 
51,035

 
 
 
 
Other income
2,162

 
2,089

Other expenses
(1,724
)
 
(3,004
)
Income, including depreciation, from unconsolidated real estate funds
2,177

 
1,586

Interest expense
(36,954
)
 
(35,660
)
Net income
21,780

 
16,046

Less:  Net income attributable to noncontrolling interests
(2,731
)
 
(680
)
Net income attributable to common stockholders
$
19,049

 
$
15,366

 
 
 
 
Net income attributable to common stockholders per share – basic
$
0.124

 
$
0.104

Net income attributable to common stockholders per share – diluted
$
0.123

 
$
0.101

 
 
 
 
Dividends declared per common share
$
0.23

 
$
0.22

 
See accompanying notes to the consolidated financial statements.

6

Douglas Emmett, Inc.
Consolidated Statements of Comprehensive Income
(Unaudited and in thousands)



 
Three Months Ended March 31,
 
2017
 
2016
 
 
 
 
Net income
$
21,780

 
$
16,046

Other comprehensive income (loss): cash flow hedges
9,829

 
(20,608
)
Comprehensive income (loss)
31,609

 
(4,562
)
Less: Comprehensive (income) loss attributable to noncontrolling interests
(4,858
)
 
1,900

Comprehensive income (loss) attributable to common stockholders
$
26,751

 
$
(2,662
)
 
See accompanying notes to the consolidated financial statements.



7

Douglas Emmett, Inc.
Consolidated Statements of Cash Flows
(Unaudited and in thousands)


 
Three Months Ended March 31,
 
2017
 
2016
Operating Activities
 

 
 

Net income
$
21,780

 
$
16,046

Adjustments to reconcile net income to net cash provided by operating activities:
 

 
 

Income, including depreciation, from unconsolidated real estate funds
(2,177
)
 
(1,586
)
Depreciation and amortization
67,374

 
55,552

Net accretion of acquired lease intangibles
(4,192
)
 
(3,304
)
Straight-line rent
(3,588
)
 
(2,919
)
Bad debt (recovery) expense
(6
)
 
679

Amortization of deferred loan costs
2,098

 
1,319

Non-cash market value adjustments on interest rate contracts
13

 

Amortization of stock-based compensation
2,708

 
2,379

Operating distributions from unconsolidated real estate funds
2,177

 
375

Change in working capital components:
 

 
 

Tenant receivables
(1,220
)
 
(2,440
)
Interest payable, accounts payable and deferred revenue
22,641

 
18,444

Security deposits
163

 
4,331

Other assets
(219
)
 
965

Net cash provided by operating activities
107,552

 
89,841

 
 
 
 
Investing Activities
 

 
 

Capital expenditures for improvements to real estate
(25,280
)
 
(15,556
)
Capital expenditures for developments
(9,905
)
 
(1,412
)
Property acquisitions

 
(1,257,513
)
Deposits for property acquisitions
(24,000
)
 

Loan payments received from related parties

 
763

Capital distributions from unconsolidated real estate funds
1,407

 
15,773

Net cash used in investing activities
(57,778
)
 
(1,257,945
)
 
 
 
 
 
 
 
 
Financing Activities
 

 
 

Proceeds from borrowings
88,000

 
900,000

Repayment of borrowings
(68,145
)
 
(31,194
)
Loan cost payments
(85
)
 
(11,444
)
Contributions from noncontrolling interests in consolidated JVs
250

 
320,000

Distributions paid to noncontrolling interests
(9,632
)
 
(6,098
)
Dividends paid to common stockholders
(34,852
)
 
(32,322
)
Taxes paid on exercise of stock options
(52,704
)
 
(445
)
Net cash (used in) provided by financing activities
(77,168
)
 
1,138,497

 
 
 
 
Decrease in cash and cash equivalents
(27,394
)
 
(29,607
)
Cash and cash equivalents at the beginning of the year
112,927

 
101,798

Cash and cash equivalents at quarter end
$
85,533

 
$
72,191


8

Douglas Emmett, Inc.
Consolidated Statements of Cash Flows
(Unaudited and in thousands)


 
Three Months Ended March 31,
 
2017
 
2016
SUPPLEMENTAL CASH FLOWS INFORMATION
 
 
 
Cash paid for interest, net of capitalized interest
$
33,400

 
$
32,893

Capitalized interest paid
$
521

 
$
238

 
 
 
 
NON-CASH INVESTING TRANSACTIONS
 
 
 
Accrual increase/(decrease) for capital expenditures for improvements to real estate
$
(2,593
)
 
$

Accrual increase/(decrease) for capital expenditures for developments
$
2,039

 
$

Capitalized stock-based compensation for improvements to real estate and developments
$
228

 
$
217

Removal of fully depreciated and amortized building and tenant improvements and lease intangibles
$
13,044

 
$
4,230

Removal of fully amortized acquired lease intangible assets
$
65

 
$
150

Removal of fully accreted acquired lease intangible liabilities
$
2,073

 
$
6,424

Application of deposit to purchase price of property
$

 
$
75,000

 
 
 
 
NON-CASH FINANCING TRANSACTIONS
 
 
 
Gain (loss) from market value adjustments - consolidated derivatives
$
4,722

 
$
(28,812
)
Gain (loss) from market value adjustments - unconsolidated Funds' derivatives
$
99

 
$
(611
)
Dividends declared
$
35,223

 
$
32,424

Common stock issued in exchange for OP Units
$
4,523

 
$
5,847


See accompanying notes to the consolidated financial statements.



9

Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (unaudited)




1. Overview

Organization and Business Description

Douglas Emmett, Inc. is a fully integrated, self-administered and self-managed REIT. We are one of the largest owners and operators of high-quality office and multifamily properties in Los Angeles County, California and Honolulu, Hawaii. We focus on owning, acquiring, developing and managing a substantial share of top-tier office properties and premier multifamily communities in neighborhoods that possess significant supply constraints, high-end executive housing and key lifestyle amenities.

Through our interest in our Operating Partnership and its subsidiaries, our consolidated JVs and our unconsolidated Funds, we own or partially own, acquire, develop and manage real estate, consisting primarily of office and multifamily properties in Los Angeles, California and Honolulu, Hawaii. The terms "us," "we" and "our" as used in these financial statements refer to Douglas Emmett, Inc. and its subsidiaries on a consolidated basis. As of March 31, 2017, our portfolio of properties consisted of:

 
Consolidated Portfolio(1)
 
Total Portfolio(1)
Office(2)
 
 
 
Wholly-owned properties
52
 
52
JV properties
7
 
7
Fund properties
 
8
 
59
 
67
 
 
 
 
Multifamily
 
 
 
Wholly-owned properties
10
 
10
 
 
 
 
Total
69
 
77
__________________________________________________
(1)
In addition to our properties, we own fee interests in two parcels of land subject to ground leases from which we earn ground rent income.
(2)
Office portfolio includes ancillary retail space.

Basis of Presentation

The accompanying financial statements are the consolidated financial statements of Douglas Emmett, Inc. and its subsidiaries, including our Operating Partnership and our consolidated JVs.  All significant intercompany balances and transactions have been eliminated in our consolidated financial statements. Our Operating Partnership and consolidated JVs are VIEs and we are the primary beneficiary. As of March 31, 2017, the total consolidated assets, liabilities and equity of the VIEs was $7.59 billion  (of which $7.18 billion related to investment in real estate), $4.64 billion and $2.95 billion (of which $1.09 billion related to noncontrolling interest), respectively.

The accompanying unaudited interim financial statements have been prepared pursuant to the rules and regulations of the SEC. Certain information and footnote disclosures normally included in the financial statements prepared in accordance with GAAP may have been condensed or omitted pursuant to SEC rules and regulations, although we believe that the disclosures are adequate to make their presentation not misleading. The accompanying unaudited interim financial statements include, in our opinion, all adjustments, consisting of normal recurring adjustments, necessary to present fairly the financial information set forth therein. The results of operations for the interim periods are not necessarily indicative of the results that may be expected for the year ending December 31, 2017. The interim financial statements should be read in conjunction with the consolidated financial statements in our 2016 Annual Report on Form 10-K and the notes thereto. References in this report to the number of properties, square footage, per square footage amounts, apartment units and geography, are outside the scope of our independent registered public accounting firm’s review of our financial statements in accordance with the standards of the PCAOB.


10

Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (unaudited) (continued)

2. Summary of Significant Accounting Policies

We adopted ASU No. 2017-01, "Clarifying the Definition of a Business" in the first quarter of 2017. The ASU changes our accounting policy "Investment in Real Estate" disclosed in our 2016 Annual Report on Form 10-K. The ASU will impact our future financial position, results of operations and disclosures because we expect that our property acquisitions will be accounted for as asset purchases, and the related acquisition expenses will be capitalized as part of the respective asset. We historically accounted for our property acquisitions as business combinations and expensed the related acquisition expenses as incurred. See "Recently issued and adopted accounting literature below". We have not made any other changes during the period covered by this Report to our significant accounting policies disclosed in our 2016 Annual Report on Form 10-K.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make certain estimates that affect the reported amounts in the consolidated financial statements and accompanying notes. Actual results could differ materially from those estimates.

Income Taxes

We have elected to be taxed as a REIT under the Code. Provided that we qualify for taxation as a REIT, we are generally not subject to corporate-level income tax on the earnings distributed currently to our stockholders that we derive from our REIT qualifying activities. We are subject to corporate-level tax on the earnings that we derive through our TRS.

New Accounting Pronouncements 

Changes to GAAP are established by the FASB in the form of ASUs.  We consider the applicability and impact of all ASUs.

Recently Issued and Adopted Accounting Pronouncements

In March 2016, the FASB issued ASU No. 2016-07, "Simplifying the Transition to the Equity Method of Accounting" which amends "Investments-Equity Method and Joint Ventures" (Topic 323). The ASU simplifies the transition to the equity method of accounting by eliminating the requirement that an entity retroactively adopt the equity method of accounting if an investment qualifies for equity method accounting as a result of an increase in the level of ownership or degree of influence. The ASU requires that the equity method investor add the cost of acquiring the additional interest in the investee to the current basis of the investor’s previously held interest and adopt the equity method of accounting as of the date the investment qualifies for equity method accounting. The ASU is effective for fiscal years beginning after December 15, 2016, including interim periods within those years, which for us would be the first quarter of 2017, and early adoption is permitted. The amendments in this ASU should be applied prospectively. We adopted the ASU in the first quarter of 2017 and it did not have a material impact on our financial position, results of operations or disclosures.

In March 2016, the FASB issued ASU No. 2016-09, "Improvements to Employee Share-Based Payment Accounting" which amends "Compensation-Stock Compensation" (Topic 718). This ASU simplifies the accounting for several aspects of share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. Some of the areas for simplification apply only to nonpublic entities. The ASU is effective for fiscal years beginning after December 15, 2016, including interim periods within those years, which for us would be the first quarter of 2017, and early adoption is permitted. The ASU amendments are applied on a prospective or retrospective basis depending on the specific amendment. We adopted the ASU in the first quarter of 2017 and it did not have a material impact on our financial position, results of operations or disclosures.

In October 2016, the FASB issued ASU No. 2016-17, "Interests Held Through Related Parties That Are Under Common Control". The ASU provides guidance regarding the consolidation of VIEs. The ASU is effective for fiscal years beginning after December 15, 2016, including interim periods within those years, which for us would be the first quarter of 2017. The amendments in this ASU should be applied retrospectively. We adopted the ASU in the first quarter of 2017 and it did not have a material impact on our financial position, results of operations or disclosures.


11

Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (unaudited) (continued)

In January 2017, the FASB issued ASU No. 2017-01, "Clarifying the Definition of a Business". The ASU provides guidance regarding the definition of a business with the objective of providing guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The ASU is effective for fiscal years beginning after December 15, 2017, including interim periods within those years, which for us would be the first quarter of 2018. The ASU should be applied prospectively and early adoption is permitted. We adopted the ASU in the first quarter of 2017 and it did not have a material impact on our financial position, results of operations or disclosures upon adoption. The ASU will impact our future financial position, results of operations and disclosures because we expect that our property acquisitions will be accounted for as asset purchases, and the related acquisition expenses will be capitalized as part of the respective asset. We historically accounted for our property acquisitions as business combinations and expensed the related acquisition expenses as incurred.

Recently Issued Accounting Pronouncements

In February 2016, the FASB issued ASU No. 2016-02, "Leases" (Topic 842). The main difference between previous GAAP and Topic 842 is the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under prevailing GAAP. The accounting applied by a lessor is largely unchanged from that applied under prevailing GAAP. For example, the vast majority of operating leases will remain classified as operating leases, and lessors will continue to recognize lease income for those leases on a straight-line basis over the lease term. Topic 842 requires an entity to separate the lease components from the non-lease components (for example, maintenance services or other activities that transfer a good or service to the customer) in a contract. Only the lease components must be accounted for in accordance with Topic 842. The consideration in the contract is allocated to the lease and non-lease components on a relative standalone price basis (for lessees) or in accordance with the allocation guidance in Topic 606 (for lessors). Topic 842 defines initial direct costs of a lease (which may be capitalized) as costs that would not have been incurred had the lease not been executed. Costs to negotiate a lease that would have been incurred regardless of whether the lease was executed, such as fixed employee salaries, are not considered to be initial direct costs, and may not be capitalized. The ASU is effective for fiscal years beginning after December 15, 2018, including interim periods within those years, which for us would be the first quarter of 2019, and early adoption is permitted.

In May 2014, the FASB issued ASU No. 2014-09, "Revenue from Contracts with Customers" (Topic 606), which provides guidance for the accounting of revenue from contracts with customers. The guidance supersedes the revenue recognition requirements in Topic 605, "Revenue Recognition", and most industry-specific guidance throughout the Industry Topics of the Codification. In March 2016, the FASB issued ASU No. 2016-08, "Principal versus Agent Considerations (Reporting Revenue Gross versus Net)" which amends Topic 606. The ASU clarifies the guidance for principal versus agent considerations. In April 2016, the FASB issued ASU No. 2016-10, "Identifying Performance Obligations and Licensing" which amends Topic 606. The ASU provides guidance for identifying performance obligations and licensing. In May 2016, the FASB issued ASU No. 2016-12, "Narrow-Scope Improvements and Practical Expedients" which amends Topic 606. The ASU provides guidance for a variety of revenue recognition related topics. In August 2015, the FASB issued ASU No. 2015-14, which defers the effective date of ASU No. 2014-09 (Topic 606) by one year. In February 2017, the FASB issued ASU No. 2017-05 "Other Income - Gains and Losses from the Derecognition of Nonfinancial Assets" (Subtopic 610-20). The ASU provides guidance for recognizing gains and losses from the transfer of nonfinancial assets in contracts with noncustomers. As a result, the various ASUs listed above are now effective for fiscal years, and interim periods within those years, beginning after December 15, 2017, which for us is the first quarter of 2018. Earlier application is permitted for fiscal years beginning after December 15, 2016, including interim reporting periods within those years, which for us is the first quarter of 2017. The amendments in this ASU should be applied retrospectively. We are not planning on early adopting the ASU and we expect to use the modified retrospective method of adoption. We are currently evaluating the potential impact to our accounting, particularly with respect to our tenant recovery revenues, and whether such changes will be material to our future results of operations and financial position. As noted above, ASU 2016-02 "Leases" requires that non-lease components such as tenant recovery revenues be accounted for in accordance with ASU 2014-09, which means that the classification and timing of our tenant recovery revenues could be impacted.

The FASB has not issued any other ASUs during 2017 that we expect to be applicable and have a material impact on our future financial position, results of operations or disclosures.


12

Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (unaudited) (continued)

3. Investment in Real Estate

The results of operations from our acquisitions are included in our consolidated statements of operations after the respective acquisition dates. The purchase accounting for our 2016 acquisitions is subject to adjustment within twelve months of the acquisition date because they were accounted for as business combinations.

2017 First Quarter Acquisitions

We did not acquire any properties during the first quarter of 2017. See Note 17 regarding our purchase of two Class A office properties in April 2017.

2016 First Quarter Acquisitions

Westwood Portfolio Acquisition

On February 29, 2016 (Acquisition Date), a consolidated JV which we manage and in which we own an equity interest acquired four Class A office properties located in Westwood, California (Westwood Portfolio) for a contract price of $1.34 billion. As of the Acquisition Date, we had contributed sixty-percent of the equity to the JV, which was subsequently reduced to thirty-percent on May 31, 2016 (Sell Down Date) when we sold half of our equity interest to a third party investor. The table below (in thousands) summarizes our purchase accounting and funding sources for the acquisition:
Sources and Uses of Funds
Actual at Closing(1)
Pro Forma Sell Down Adjustments(2)
Pro Forma
 
 
 
 
Building square footage
1,725

 
1,725

 
 
 
 
Uses of funds - Investment in real estate:
 
 
 
Land
$
94,996

 
$
94,996

Buildings and improvements
1,236,786

 
1,236,786

Tenant improvements and lease intangibles
50,439

 
50,439

Acquired above and below-market leases, net(3)
(49,708
)
 
(49,708
)
Net assets and liabilities acquired(4)
$
1,332,513

 
$
1,332,513

 
 
 
 
Source of funds:
 
 
 
Cash on hand(5)
$
153,745

$

$
153,745

Credit facility(6)
290,000

(240,000
)
50,000

Non-recourse term loan, net(7)
568,768


568,768

Noncontrolling interests
320,000

240,000

560,000

Total source of funds
$
1,332,513

$

$
1,332,513

________________________________________________    
(1)
Reflects the purchase of the Westwood Portfolio on the Acquisition Date when we contributed sixty-percent of the equity to the consolidated JV.
(2)
Reflects our sale of thirty-percent of the equity in the JV on the Sell Down Date, presented as of the Acquisition Date, treated as in-substance real estate, which reduced our ownership interest in the JV to thirty-percent. We sold the interest for the $240.0 million we contributed plus an additional $1.1 million to compensate us for our costs of holding the investment. We recognized a gain on the sale of $1.1 million. We used the proceeds from the sale to pay down the balance owed on our revolving credit facility.
(3)
As of the Acquisition Date, the weighted average remaining life of the acquired above-and below-market leases was approximately 4.4 years.
(4)
The difference between the contract and purchase price related to credits received for prorations and similar matters.
(5)
Cash paid included a $75.0 million deposit, $67.5 million paid at closing and $11.2 million spent on loan costs in connection with securing the $580.0 million term loan.
(6)
Reflects borrowings using the Company's credit facility, which bears interest at LIBOR + 1.40%.

13

Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (unaudited) (continued)

(7)
Reflects 100% (not the Company's pro rata share) of a $580.0 million interest-only non-recourse loan, net of deferred loan costs of $11.2 million incurred to secure the loan. The loan has a seven-year term and is secured by the Westwood Portfolio. Interest on the loan is floating at LIBOR + 1.40%, which has been effectively fixed at 2.37% per annum for five years through interest rate swaps. See Note 7 for information regarding our consolidated debt.

The table below (in thousands) presents the revenues and net income attributable to common stockholders from the
Westwood Portfolio included in the consolidated statement of operations after the Acquisition Date:

 
Three Months Ended March 31,
 
2017
2016
 
 
 
Total office revenues
$
23,949

$
8,223

Net income (loss) attributable to common stockholders(1)
$
1,034

$
(2,214
)
______________________________________________________
(1)
Excluding transaction costs, net income (loss) attributable to common stockholders was $1.0 million and $(0.3) million for the three months ended March 31, 2017 and 2016, respectively.

The table below (in thousands, except per share information) presents the historical results of Douglas Emmett, Inc. and the Westwood Portfolio on a combined basis as if the acquisition was completed on January 1, 2016, based on our thirty-percent ownership interest and includes adjustments that give effect to events that are (i) directly attributable to the acquisition, (ii)  expected to have a continuing impact on us, and (iii) are factually supportable. The pro forma reflects the hypothetical impact of the acquisition on us and does not purport to represent what our results of operations would have been had the acquisition occurred on January 1, 2016, or project the results of operations for any future period. The information does not reflect cost savings or operating synergies that may result from the acquisition or the costs to achieve any such potential cost savings or operating synergies. Transaction costs related to the acquisition have been excluded.
 
 
Three months ended March 31, 2016
 
 
Pro forma revenues
$
181,900

Pro forma net income attributable to common stockholders
$
16,404

Pro forma net income attributable to common stockholders per share – basic
$
0.111

Pro forma net income attributable to common stockholders per share – diluted
$
0.108










14

Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (unaudited) (continued)

4. Acquired Lease Intangibles

Summary of our Acquired Lease Intangibles

The table below (in thousands) summarizes our above/below-market leases:
 
March 31, 2017
 
December 31, 2016
 
 
 
 
Above-market tenant leases
$
5,045

 
$
5,110

Accumulated amortization - above-market tenant leases
(2,608
)
 
(2,379
)
Below-market ground leases
3,198

 
3,198

Accumulated amortization - below-market ground leases
(802
)
 
(782
)
Acquired lease intangible assets, net
$
4,833

 
$
5,147

 
 
 
 
Below-market tenant leases
$
102,852

 
$
104,925

Accumulated accretion - below-market tenant leases
(43,662
)
 
(41,241
)
Above-market ground leases
4,017

 
16,200

Accumulated accretion - above-market ground leases
(522
)
 
(12,693
)
Acquired lease intangible liabilities, net
$
62,685

 
$
67,191

 
Impact on the Consolidated Statements of Operations

The table below (in thousands) summarizes the net amortization/accretion related to our above/below-market leases:
 
Three Months Ended March 31,
 
2017
 
2016
 
 
 
 
Net accretion of above/below-market tenant leases(1)
$
4,184

 
$
3,295

Amortization of above-market ground lease(2)
(4
)
 
(4
)
Accretion of above-market ground lease(3)
12

 
13

Total
$
4,192

 
$
3,304

_______________________________________________
(1)
Recorded as a net increase to office and multifamily rental revenues.
(2)
Ground lease from which we earn ground rent income. Recorded as a decrease to office parking and other income.
(3)
Ground lease from which we incur ground rent expense. Recorded as a decrease to office expense.



15

Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (unaudited) (continued)

5. Investments in Unconsolidated Real Estate Funds

Description of our Funds

We manage and own equity interest in two unconsolidated Funds, Fund X and Partnership X, through which we and investors own eight office properties totaling 1.8 million square feet.  At March 31, 2017, we held equity interests of 68.61% of Fund X and 24.25% of Partnership X. Our Funds pay us fees and reimburse us for certain expenses related to property management and other services we provide. We also receive distributions based on invested capital and on any profits that exceed certain specified cash returns to the investors. The table below presents (in thousands) cash distributions received from our Funds:

 
Three Months Ended March 31,
 
2017
 
2016
 
 
 
 
Operating distributions received
$
2,177

 
$
375

Capital distributions received
1,407

 
15,773

Total distributions received
$
3,584

 
$
16,148



Summarized Financial Information for our Funds

The accounting policies of the Funds are consistent with ours. The tables below present (in thousands) selected financial information for the Funds on a combined basis.  The amounts presented represent 100% (not our pro-rata share) of amounts related to the Funds, and are based upon historical acquired book value:

 
March 31, 2017
 
December 31, 2016
 
 
 
 
Total assets
$
688,492

 
$
689,991

Total liabilities
$
449,994

 
$
448,522

Total equity
$
238,498

 
$
241,469


 
Three Months Ended March 31,
 
2017
 
2016
 
 
 
 
Total revenues
$
18,625

 
$
17,475

Operating income
$
4,926

 
$
4,242

Net income
$
2,161

 
$
1,404



16

Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (unaudited) (continued)

6. Other Assets

Other assets consisted of the following (in thousands):
 
March 31, 2017
 
December 31, 2016
 
 
 
 
Restricted cash
$
121

 
$
121

Prepaid expenses
7,300

 
6,779

Other indefinite-lived intangible
1,988

 
1,988

Deposits in escrow
24,000

 

Furniture, fixtures and equipment, net
984

 
1,093

Other
1,978

 
1,933

Total other assets
$
36,371

 
$
11,914








17

Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (unaudited) (continued)

7. Secured Notes Payable and Revolving Credit Facility, Net


The following table summarizes (in thousands) our secured notes payable and revolving credit facility:
Description
 
Maturity
Date(1)
 
Principal Balance as of March 31, 2017
 
Principal Balance as of December 31, 2016
 
Variable Interest Rate
 
Fixed Interest
Rate(2)
 
Swap Maturity Date
 
 
 
 
 
 
 
 
 
 
 
 
 
Wholly Owned Subsidiaries
Term Loan(3)
 
 
 
$

 
$
1,000

 
N/A
 
3.00%
 
 --
Term Loan(4)
 
8/5/2018
 
348,379

 
349,933

 
 N/A
 
4.14%
 
 --
Term Loan(4)
 
2/1/2019
 
149,188

 
149,911

 
 N/A
 
4.00%
 
 --
Term Loan(4)
 
6/5/2019
 
284,578

 
285,000

 
N/A
 
3.85%
 
 --
Fannie Mae Loan
 
10/1/2019
 
145,000

 
145,000

 
LIBOR + 1.25%
 
N/A
 
 --
Term Loan(4)(5)
 
3/1/2020
 
344,314

 
345,759

 
 N/A
 
4.46%
 
 --
Fannie Mae Loans
 
11/1/2020
 
388,080

 
388,080

 
LIBOR + 1.65%
 
3.65%
 
11/1/2017
Term Loan(6) 
 
4/15/2022
 
340,000

 
340,000

 
LIBOR + 1.40%
 
2.77%
 
4/1/2020
Term Loan(6) 
 
7/27/2022
 
180,000

 
180,000

 
LIBOR + 1.45%
 
3.06%
 
7/1/2020
Term Loan(6) 
 
11/1/2022
 
400,000

 
400,000

 
LIBOR + 1.35%
 
2.64%
 
11/1/2020
Term Loan(6) 
 
6/23/2023
 
360,000

 
360,000

 
LIBOR + 1.55%
 
2.57%
 
7/1/2021
Term Loan(6) 
 
12/23/2023
 
220,000

 
220,000

 
LIBOR + 1.70%
 
3.62%
 
12/23/2021
Term Loan(6) 
 
1/1/2024
 
300,000

 
300,000

 
LIBOR + 1.55%
 
3.46%
 
1/1/2022
Fannie Mae Loan(6)
 
4/1/2025
 
102,400

 
102,400

 
LIBOR + 1.25%
 
2.84%
 
3/1/2020
Fannie Mae Loan(6)
 
12/1/2025
 
115,000

 
115,000

 
LIBOR + 1.25%
 
2.76%
 
12/1/2020
Revolving credit facility(7)
 
8/21/2020
 
25,000

 

 
LIBOR + 1.40%
 
N/A
 
 --
Total Wholly Owned Debt
3,701,939

 
3,682,083

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated JVs
Term Loan
 
7/21/2019
 
146,000

 
146,000

 
LIBOR + 1.55%
 
N/A
 
 --
Term Loan(6)
 
2/28/2023
 
580,000

 
580,000

 
LIBOR + 1.40%
 
2.37%
 
3/1/2021
Total Consolidated Debt(8) (9)(10)
4,427,939

 
4,408,083

 
 
 
 
 
 
Deferred loan costs, net(11)
 
(36,529
)
 
(38,546
)
 
 
 
 
 
 
Total Consolidated Debt, net
$
4,391,410

 
$
4,369,537

 
 
 
 
 
 
___________________________________________________
(1)
Maturity dates include the effect of extension options.
(2)
Includes the effect of interest rate swaps and excludes the effect of prepaid loan fees. See Note 9 for details of our interest rate swaps.
(3)
At March 31, 2017, this loan had been paid off.
(4)
Requires monthly payments of principal and interest. Principal amortization is based upon a 30-year amortization schedule.
(5)
Interest is fixed until March 2018.
(6)
Loan agreement includes a zero-percent LIBOR floor. The corresponding swaps do not include such a floor.
(7)
$400.0 million revolving credit facility. Unused commitment fees range from 0.15% to 0.20%.
(8)
See Note 12 for our fair value disclosures.

18

Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (unaudited) (continued)

(9)
At March 31, 2017, the minimum future principal payments due on our secured notes payable and revolving credit facility, excluding any maturity extension options, were as follows (in thousands):
Twelve months ending March 31:
 
 
 
2018
$
358,828

2019
493,590

2020
565,040

2021
708,080

2022
300,000

Thereafter
2,002,401

Total future principal payments
$
4,427,939


(10)
At March 31, 2017, the weighted average remaining life, including extension options, of our total consolidated term debt (excluding our revolving credit facility) was 4.6 years. For the $4.11 billion of term debt on which the interest rate was fixed under the terms of the loan or a swap, the weighted average (i) remaining life was 4.8 years, (ii) remaining period during which interest was fixed was 2.9 years, (iii) annual interest rate was 3.28% and (iv) effective interest rate was 3.43% (including the non-cash amortization of deferred loan costs). Except as otherwise noted below, each loan (including our revolving credit facility) is secured by one or more separate collateral pools consisting of one or more properties, requiring monthly payments of interest only, with the outstanding principal due upon maturity. The following table summarizes (in thousands) our fixed and floating rate debt:
Description
 
Principal Balance as of March 31, 2017
 
Principal Balance as of December 31, 2016
 
 
 
 
 
Aggregate swapped to fixed rate loans
 
$
2,985,480

 
$
2,985,480

Aggregate fixed rate loans
 
1,126,459

 
1,131,603

Aggregate floating rate loans
 
316,000

 
291,000

Total Debt
 
$
4,427,939

 
$
4,408,083


(11)
Deferred loan costs are net of accumulated amortization of $17.5 million and $15.4 million at March 31, 2017 and December 31, 2016 respectively. The table below (in thousands) sets forth amortization of deferred loan costs, which is included in Interest Expense in our consolidated statement of operations:
 
Three Months Ended March 31,
 
2017
 
2016
 
 
 
 
Deferred loan cost amortization
$
2,098

 
$
1,319



8. Interest Payable, Accounts Payable and Deferred Revenue

Interest payable, accounts payable and deferred revenue consisted of the following (in thousands):

 
March 31, 2017
 
December 31, 2016
 
 
 
 
Interest payable
$
11,000

 
$
9,561

Accounts payable and accrued liabilities
57,111

 
36,880

Deferred revenue
29,205

 
28,788

Total interest payable, accounts payable and deferred revenue
$
97,316

 
$
75,229



19

Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (unaudited) (continued)

9. Derivative Contracts

Derivative Summary

As of March 31, 2017, all of our interest rate swaps, which include the interest rate swaps of our consolidated JVs and our unconsolidated Funds, were designated as cash flow hedges:
 
 
Number of Interest Rate Swaps
 
Notional
  (in thousands)
 
 
 
 
 
Consolidated derivatives(1)
 
22
 
$
2,985,480

Unconsolidated Funds' derivatives(2)
 
2
 
$
435,000

___________________________________________________
(1)
The notional amount includes 100%, not our pro-rata share, of our consolidated JVs' derivatives.
(2)
The notional amount includes 100%, not our pro-rata share, of our unconsolidated Funds' derivatives.

Credit-risk-related Contingent Features

We have agreements with each of our interest rate swap counterparties that contain a provision under which we could also be declared in default on our derivative obligations if we default on the underlying indebtedness that we are hedging. As of March 31, 2017, there have been no events of default with respect to our interest rate swaps or our unconsolidated Funds' interest rate swaps. We do not post collateral for our swaps in a liability position. The fair value of our interest rate swaps in a liability position were as follows (in thousands):
 
Fair value of derivatives in a liability position(1)
 
March 31, 2017
 
December 31, 2016
 
 
 
 
 
Consolidated derivatives(2)
 
$
3,596

 
$
7,689

Unconsolidated Funds' derivatives(3)
 
$

 
$


__________________________________________________________________________________
(1)
Includes accrued interest and excludes adjustments for credit risk.
(2)
Includes 100%, not our pro-rata share, of our consolidated JVs' derivatives.
(3)
Our unconsolidated Funds did not have any derivatives in a liability position.
 
Counterparty Credit Risk

We are also subject to credit risk from the counterparties on our interest rate swap and interest rate cap contracts. We seek to minimize our credit risk by entering into agreements with a variety of high quality counterparties with investment grade ratings. We do not receive collateral for our swaps in an asset position. The fair value of our interest rate swaps in an asset position were as follows (in thousands):

Fair value of derivatives in an asset position(1)
 
March 31, 2017
 
December 31, 2016
 
 
 
 
 
Our derivatives(2)
 
$
40,748

 
$
35,144

Our Funds' derivatives(3)
 
$
3,904

 
$
3,724

___________________________________________________
(1)
Includes accrued interest and excludes adjustments for credit risk.
(2)
Includes 100%, not our pro-rata share, of our consolidated JVs' derivatives.
(3)
Includes 100%, not our pro-rata share, of our unconsolidated Funds' derivatives.


20

Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (unaudited) (continued)

Impact of Hedges on AOCI and Consolidated Statements of Operations

The table below presents (in thousands) the effect of derivative instruments on our AOCI and statements of operations:
 
Three Months Ended March 31,
 
2017
 
2016
Derivatives Designated as Cash Flow Hedges:
 
 
 
Gain (loss) recorded in AOCI - Consolidated derivatives(1)(5)
$
4,722

 
$
(28,812
)
Gain (loss) recorded in AOCI - unconsolidated Funds' derivatives(2)(5)
$
99

 
$
(611
)
Loss reclassified from AOCI - Consolidated derivatives(3)(5)
$
(5,100
)
 
$
(8,710
)
Gain (loss) reclassified from AOCI - unconsolidated Funds' derivatives(4)(5)
$
92

 
$
(105
)
Gain (loss) recorded - Consolidated derivatives(6)
$
13

 
$

 
 
 
 
Derivatives Not Designated as Cash Flow Hedges:
 

 
 

Gain (loss) recorded as interest expense(7)
$

 
$

___________________________________________________
(1)
Represents the effective portion of the change in fair value of interest rate swaps.
(2)
Represents our share of the effective portion of the change in fair value of our unconsolidated Funds' interest rate swaps.
(3)
Reclassified from AOCI as an increase to Interest expense.
(4)
Reclassified from AOCI as a increase (decrease) to Income, including depreciation, from unconsolidated real estate funds (our share).
(5)
See the reconciliation of our AOCI in Note 10.
(6)
Represents the ineffective portion of the change in fair value of interest rate swaps, which is recorded as a reduction (increase) to interest expense.
(7)
We do not have any derivatives that are not designated as cash flow hedges.

Future Reclassifications from AOCI

At March 31, 2017, our estimate of the AOCI related to derivatives, designated as cash flow hedges, that will be reclassified to earnings during the next twelve months as swap interest payments are made, is presented in the table below (in thousands):

Consolidated derivatives(1)
$
5,279

Unconsolidated Funds' derivatives(2)
$
(158
)
________________________________________
(1)
Reclassified as an increase to Interest expense.
(2)
Reclassified as a decrease to Income, including depreciation, from unconsolidated real estate funds (our share).



21

Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (unaudited) (continued)

10.  Equity

Equity Transactions

During the three months ended March 31, 2017, we (i) acquired 337 thousand OP Units in exchange for issuing an equal number of shares of our common stock to the holders of the OP Units, and (ii) issued 1.3 million shares of our common stock for the exercise of 3.9 million stock options on a net settlement basis (net of the exercise price and related taxes). See Note 17 regarding our common stock sales in April 2017.

During the three months ended March 31, 2016, we (i) created a JV which acquired the Westwood Portfolio, and investors contributed $320.0 million directly to the JV for a forty-percent interest, see Note 3 for more information regarding the JV, (ii) acquired 426 thousand OP Units in exchange for issuing an equal number of shares of our common stock to the holders of the OP Units, and (iii) issued 24 thousand shares of our common stock for the exercise of 65 thousand stock options on a net settlement basis (net of the exercise price and related taxes).

Condensed Consolidated Statements of Equity

The tables below present (in thousands) our condensed consolidated statements of equity:

 
DEI Stockholders' Equity
 
Noncontrolling Interests
 
Total Equity
 
 
 
 
 
 
Balance as of January 1, 2017
$
1,921,143

 
$
1,092,928

 
$
3,014,071

Net income
19,049

 
2,731

 
21,780

Cash flow hedge fair value adjustments
7,702

 
2,127

 
9,829

Contributions to consolidated JV

 
250

 
250

Dividends and distributions
(35,223
)
 
(9,632
)
 
(44,855
)
Exchange of OP units for common stock
4,523

 
(4,523
)
 

Exercise of stock options(1)
(52,704
)
 

 
(52,704
)
Stock-based compensation

 
2,936

 
2,936

Balance as of March 31, 2017
$
1,864,490

 
$
1,086,817

 
$
2,951,307

__________________________________________________
(1) Reflects withholding taxes. We issued shares of our common stock for the exercise of stock options on a net settlement basis (net of the exercise price and related taxes).
 
DEI Stockholders' Equity
 
Noncontrolling Interests
 
Total Equity
 
 
 
 
 
 
Balance as of January 1, 2016
$
1,926,211

 
$
355,337

 
$
2,281,548

Net income
15,366

 
680

 
16,046

Cash flow hedge fair value adjustments
(18,028
)
 
(2,580
)
 
(20,608
)
Contributions

 
320,000

 
320,000

Dividends and distributions
(32,424
)
 
(6,098
)
 
(38,522
)
Exchange of OP units for common stock
5,847

 
(5,847
)
 

Exercise of stock options
(445
)
 

 
(445
)
Stock-based compensation

 
2,596

 
2,596

Balance as of March 31, 2016
$
1,896,527

 
$
664,088

 
$
2,560,615



22

Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (unaudited) (continued)

Noncontrolling Interests

Our noncontrolling interests consist of interests in our Operating Partnership and consolidated JVs which are not owned by us. Noncontrolling interests in our Operating Partnership consist of OP Units and fully-vested LTIP Units, and represented approximately 14% of our Operating Partnership's total interests as of March 31, 2017 when we and our Operating Partnership had 153.1 million shares of common stock and 25.3 million OP Units and fully-vested LTIP Units outstanding. A share of our common stock, an OP Unit and an LTIP Unit (once vested and booked up) have essentially the same economic characteristics, sharing equally in the distributions from our Operating Partnership.  Investors who own OP Units have the right to cause our Operating Partnership to redeem their OP Units for an amount of cash per unit equal to the market value of one share of our common stock at the date of redemption, or, at our election, exchange their OP Units for shares of our common stock on a one-for-one basis. LTIP Units have been granted to our key employees and non-employee directors as part of their compensation. These awards generally vest over the service period and once vested can generally be converted to OP Units.

Changes in our Ownership Interest in our Operating Partnership

The table below presents (in thousands) the effect on our equity from net income attributable to common stockholders and changes in our ownership interest in our Operating Partnership:
 
Three Months Ended March 31,
 
2017
 
2016
 
 
 
 
Net income attributable to common stockholders
$
19,049

 
$
15,366

 
 
 
 
Transfers from noncontrolling interests:
 
 
 
Exchange of OP Units with noncontrolling interests
4,523

 
5,847

Net transfers from noncontrolling interests
4,523

 
5,847

 
 
 
 
Change from net income attributable to common stockholders and transfers from noncontrolling interests
$
23,572

 
$
21,213



23

Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (unaudited) (continued)

AOCI Reconciliation(1) 

The table below presents (in thousands) a reconciliation of our AOCI, which consists solely of adjustments related to derivatives designated as cash flow hedges for the three months ended March 31:
 
2017
 
2016
 
 
 
 
Beginning balance
$
15,156

 
$
(9,285
)
 
 
 
 
Other comprehensive income (loss) before reclassifications - our derivatives
4,722

 
(28,812
)
Other comprehensive income (loss) before reclassifications - our Fund's derivatives
99

 
(611
)
Reclassifications from AOCI - our derivatives(2)
5,100

 
8,710

Reclassifications from AOCI - our Fund's derivatives(3)
(92
)
 
105

Net current period OCI
9,829

 
(20,608
)
Less OCI attributable to noncontrolling interests
(2,127
)
 
2,580

OCI attributable to common stockholders
7,702

 
(18,028
)
 
 
 
 
Ending balance
$
22,858

 
$
(27,313
)
___________________________________________________
(1)
See Note 9 for the details of our derivatives and Note 12 for our derivative fair value disclosures.
(2)
Reclassification as an increase to Interest expense.
(3)
Reclassification as an (increase) decrease to Income, including depreciation, from unconsolidated real estate funds.

Equity Compensation

On June 2, 2016, the Douglas Emmett 2016 Omnibus Stock Incentive Plan ("2016 Plan") became effective after receiving stockholder approval, superseding our prior plan, the Douglas Emmett 2006 Omnibus Stock Incentive Plan ("2006 Plan"), both of which allow for awards to our directors, officers, employees and consultants. The key terms of the two plans are substantially identical, except for the date of expiration, the number of shares authorized for grants and various technical provisions. Grants after June 2, 2016 were awarded under the 2016 Plan, while grants prior to that date were awarded under the 2006 Plan (grants under the 2006 Plan remain outstanding according to their terms). Both plans are administered by the compensation committee of our board of directors.  Total net stock-based compensation expense was $2.7 million and $2.4 million for the three months ended March 31, 2017 and 2016, respectively. These amounts are net of capitalized stock-based compensation of $228 thousand and $217 thousand for the three months ended March 31, 2017 and 2016, respectively. The total intrinsic value of options exercised for the three months ended March 31, 2017 and 2016 was $102.1 million and $1.1 million, respectively.




24

Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (unaudited) (continued)

11. EPS

We calculate basic EPS by dividing the net income attributable to common stockholders for the period by the weighted average number of common shares outstanding during the period. We calculate diluted EPS by dividing the net income attributable to common stockholders for the period by the weighted average number of common shares and dilutive instruments outstanding during the period using the treasury stock method. We account for unvested LTIP awards that contain nonforfeitable rights to dividends as participating securities and include these securities in the computation of basic and diluted EPS using the two-class method. The table below presents the calculation of basic and diluted EPS:
 
Three Months Ended March 31,
 
2017

2016
Numerator (in thousands):
 

 
 

Net income attributable to common stockholders
$
19,049

 
$
15,366

Allocation to participating securities: Unvested LTIP Units
(98
)
 
(84
)
Numerator for basic and diluted net income attributable to common stock holders
$
18,951

 
$
15,282

 
 
 
 
Denominator (in thousands):
 
 
 
Weighted average shares of common stock outstanding - basic
152,490

 
147,236

Effect of dilutive securities: Stock options(1)
1,165

 
4,215

Weighted average shares of common stock and common stock equivalents outstanding - diluted
153,655

 
151,451

 
 
 
 
Basic EPS:
 
 
 

Net income attributable to common stockholders per share
$
0.124

 
$
0.104

 
 
 
 
Diluted EPS:
 

 
 

Net income attributable to common stockholders per share
$
0.123

 
$
0.101

____________________________________________________
(1)
The following securities (in thousands) were excluded from the computation of the weighted average shares of common stock and common stock equivalents outstanding - diluted because the effect of including them would be anti-dilutive to the calculation of diluted EPS:
 
Three Months Ended March 31,
 
2017
 
2016
 
 
 
 
OP Units
24,661

 
25,549

Vested LTIP Units
762

 
815


25

Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (unaudited) (continued)

12. Fair Value of Financial Instruments

Our estimates of the fair value of financial instruments were determined using available market information and widely used valuation methods.  Considerable judgment is necessary to interpret market data and determine an estimated fair value.  The use of different market assumptions or valuation methods may have a material effect on the estimated fair values. The FASB fair value framework hierarchy distinguishes between assumptions based on market data obtained from sources independent of the reporting entity, and the reporting entity’s own assumptions about market-based inputs.  The hierarchy is as follows:
 
Level 1 - inputs utilize unadjusted quoted prices in active markets for identical assets or liabilities.  
Level 2 - inputs are observable either directly or indirectly for similar assets and liabilities in active markets.  
Level 3 - inputs are unobservable assumptions generated by the reporting entity

As of March 31, 2017, we did not have any fair value estimates of financial instruments using Level 3 inputs.

Financial instruments disclosed at fair value

Short term financial instruments: The carrying amounts for cash and cash equivalents, tenant receivables, revolving credit line, interest payable, accounts payable, security deposits and dividends payable approximate fair value because of the short-term nature of these instruments.

Secured notes payable: See Note 7 for the details of our secured notes payable. We estimate the fair value of our secured notes payable, which includes the secured notes payable of our consolidated JVs, by calculating the credit-adjusted present value of the principal and interest payments for each secured note payable. The calculation incorporates observable market interest rates which we consider to be Level 2 inputs, assumes that the loans will be outstanding through maturity, and excludes any maturity extension options. The table below presents (in thousands) the estimated fair value of our secured notes payable:
Secured Notes Payable:
March 31, 2017
 
December 31, 2016
 
 
 
 
Fair value
$
4,418,661

 
$
4,429,224

Carrying value
$
4,402,939

 
$
4,408,083


Financial instruments measured at fair value

Derivative instruments: See Note 9 for the details of our derivatives. We present our derivatives on the balance sheet at fair value, on a gross basis, excluding accrued interest.  We estimate the fair value of our derivative instruments by calculating the credit-adjusted present value of the expected future cash flows of each derivative.  The calculation incorporates the contractual terms of the derivatives, observable market interest rates which we consider to be Level 2 inputs, and credit risk adjustments to reflect the counterparty's as well as our own nonperformance risk. Our derivatives are not subject to master netting arrangements.  The table below presents (in thousands) the estimated fair value of our derivatives:
 
March 31, 2017
 
December 31, 2016
Derivative Assets:
 
 
 
Fair value - consolidated derivatives(1)
$
41,234

 
$
35,656

Fair value - unconsolidated Funds' derivatives(2)
$
3,840

 
$
3,605

 
 
 
 
Derivative Liabilities:
 
 
 
Fair value - consolidated derivatives(1)
$
2,600

 
$
6,830

Fair value - unconsolidated Funds' derivatives(2)
$

 
$

____________________________________________________
(1)
Consolidated derivatives, which include 100%, not our pro-rata share, of our consolidated JVs' derivatives, are included in interest rate contracts in our consolidated balance sheet. The fair value excludes accrued interest which is included in interest payable in the consolidated balance sheet.
(2)
Represents 100%, not our pro-rata share, of our unconsolidated Funds' derivatives. Our pro-rata share of the amounts related to the unconsolidated Funds' derivatives is included in our Investment in unconsolidated real estate funds in our consolidated balance sheet. See Note 5 for more information regarding our unconsolidated Funds.

26

Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (unaudited) (continued)

13. Segment Reporting

Segment information is prepared on the same basis that our management reviews information for operational decision-making purposes.  We operate in two business segments: (i) the acquisition, development, ownership and management of office real estate and (ii) the acquisition, development, ownership and management of multifamily real estate.  The services for our office segment primarily include rental of office space and other tenant services, including parking and storage space rental.  The services for our multifamily segment include rental of apartments and other tenant services, including parking and storage space rental.

Asset information by segment is not reported because we do not use this measure to assess performance or make decisions to allocate resources.  Therefore, depreciation and amortization expense is not allocated among segments.  General and administrative expenses and interest expense are not included in segment profit as our internal reporting addresses these items on a corporate level. Segment profit is not a measure of operating income or cash flows from operating activities as measured by GAAP, it is not indicative of cash available to fund cash needs, and it should not be considered as an alternative to cash flows as a measure of liquidity.  Not all companies may calculate segment profit in the same manner.  We consider segment profit to be an appropriate supplemental measure to net income because it can assist both investors and management in understanding the core operations of our properties. The table below presents (in thousands) the operating activity of our reportable segments:

 
Three Months Ended March 31,
 
2017
 
2016
Office Segment
 
 
 
Total office revenues
$
170,348

 
$
144,379

Office expenses
(54,885
)
 
(47,883
)
Office Segment profit
115,463

 
96,496

 
 
 
 
Multifamily Segment
 
 
 
Total multifamily revenues
24,133

 
24,193

Multifamily expenses
(5,947
)
 
(6,031
)
Multifamily Segment profit
18,186

 
18,162

 
 
 
 
Total profit from all segments
$
133,649

 
$
114,658



The table below (in thousands) is a reconciliation of the total profit from all segments to net income attributable to common stockholders:
 
Three Months Ended March 31,
 
2017
 
2016
 
 
 
 
Total profit from all segments
$
133,649

 
$
114,658

General and administrative
(10,156
)
 
(8,071
)
Depreciation and amortization
(67,374
)
 
(55,552
)
Other income
2,162

 
2,089

Other expenses
(1,724
)
 
(3,004
)
Income, including depreciation, from unconsolidated real estate funds
2,177

 
1,586

Interest expense
(36,954
)
 
(35,660
)
Net income
21,780

 
16,046

Less: Net income attributable to noncontrolling interests
(2,731
)
 
(680
)
Net income attributable to common stockholders
$
19,049

 
$
15,366


27

Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (unaudited) (continued)

14. Future Minimum Lease Rental Receipts

We lease space to tenants primarily under non-cancelable operating leases that generally contain provisions for a base rent plus reimbursement of certain operating expenses, and we own fee interests in two parcels of land subject to ground leases from which we earn ground rent income. The table below presents (in thousands) the future minimum base rentals on our non-cancelable office tenant and ground leases at March 31, 2017:

Twelve months ending March 31:
 
 
 
2018
$
493,666

2019
428,623

2020
372,372

2021
306,184

2022
230,853

Thereafter
634,361

Total future minimum base rentals(1)
$
2,466,059

_____________________________________________________
(1)
Does not include (i) residential leases, which typically have a term of one year or less, (ii) holdover rent, (iii) other types of rent such as storage rent and antenna rent, (iv) tenant reimbursements, (v) straight line rent, (vi) amortization/accretion of acquired above/below-market lease intangibles and (vii) percentage rents.  The amounts assume that early termination options held by tenants are not exercised.

15. Future Minimum Lease Rental Payments

We incurred ground rent expense for a ground lease of $183 thousand for the three months ended March 31, 2017 and 2016. The table below (in thousands) presents the future minimum ground lease payments as of March 31, 2017:
  
Twelve months ending March 31:
 
 
 
2018
$
733

2019
733

2020
733

2021
733

2022
733

Thereafter
47,461

Total future minimum lease payments(1)
$
51,126

___________________________________________________
(1)
Lease term ends on December 31, 2086. Ground rent is fixed at $733 thousand per year until February 28, 2019, and will then reset to the greater of the existing ground rent or market. The table above assumes that the rental payments will continue to be $733 thousand per year after February 28, 2019.

28

Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (unaudited) (continued)

16. Commitments, Contingencies and Guarantees

Legal Proceedings

From time to time, we are party to various lawsuits, claims and other legal proceedings that arise in the ordinary course of our business.  Excluding ordinary, routine litigation incidental to our business, we are not currently a party to any legal proceedings that we believe would reasonably be expected to have a materially adverse effect on our business, financial condition or results of operations.

Concentration of Risk

We are subject to credit risk with respect to our tenant receivables and deferred rent receivables related to our tenant leases. Our tenants' ability to honor the terms of their respective leases remains dependent upon economic, regulatory and social factors. We seek to minimize our credit risk from our tenant leases by (i) targeting smaller, more affluent tenants, from a diverse mix of industries, (ii) performing credit evaluations of prospective tenants and (iii) obtaining security deposits or letters of credit from our tenants.  For the three months ended March 31, 2017 and 2016, no tenant accounted for more than 10% of our total revenues.  

All of our properties, including the properties of our consolidated JVs and unconsolidated Funds, are located in Los Angeles County, California and Honolulu, Hawaii, and we are therefore susceptible to adverse economic and regulatory developments, as well as natural disasters, in those markets.

We are also subject to credit risk with respect to our interest rate swap counterparties that we use to manage the risk associated with our floating rate debt. We do not post or receive collateral with respect to our swap transactions. See Note 9 for the details of our interest rate contracts. We seek to minimize our credit risk by entering into agreements with a variety of high quality counterparties with investment grade ratings.

We have significant cash balances invested in a variety of short-term money market funds that are intended to preserve principal value and maintain a high degree of liquidity while providing current income. These investments are not insured against loss of principal and there is no guarantee that our investments in these funds will be redeemable at par value. We also have significant cash balances in bank accounts with high quality financial institutions with investment grade ratings.  Interest bearing bank accounts at each U.S. banking institution are insured by the FDIC up to $250 thousand.

Asset Retirement Obligations

Conditional asset retirement obligations represent a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement is conditional on a future event that may or may not be within our control.  A liability for a conditional asset retirement obligation must be recorded if the fair value of the obligation can be reasonably estimated.  Environmental site assessments have identified twenty-five buildings in our Consolidated Portfolio and four buildings owned by our unconsolidated Funds which contain asbestos, and would have to be removed in compliance with applicable environmental regulations if these properties are demolished or undergo major renovations.  As of March 31, 2017, the obligations to remove the asbestos from these properties have indeterminable settlement dates, and we are unable to reasonably estimate the fair value of the associated conditional asset retirement obligation.

Development Contracts

During the first quarter of 2016, we commenced building an additional 475 apartments (net of existing apartments to be removed) at our Moanalua Hillside Apartments in Honolulu, Hawaii. The $120.0 million estimated cost of the new apartments does not include the cost of the land which we already owned before beginning the project. We also plan to invest additional capital to upgrade the existing apartments, improve the parking and landscaping, build a new leasing and management office, and construct a new recreation and fitness facility with a new pool. In West Los Angeles, we plan to build a high-rise apartment building with 376 apartments. We expect the cost of the development to be approximately $120.0 million to $140.0 million, which does not include the cost of the land or the existing underground parking garage, both of which we owned before beginning the project. As of March 31, 2017, we had an aggregate remaining contractual commitment for these development projects of $94.1 million.


29

Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (unaudited) (continued)

Other Contracts

As of March 31, 2017, we had an aggregate remaining contractual commitment for capital expenditure projects and repositionings was approximately $8.8 million.

Guarantees

We made certain environmental and other limited indemnities and guarantees covering customary non-recourse carve- outs for our unconsolidated Funds' debt. We also guaranteed the related swaps. Our Funds have agreed to indemnify us for any amounts that we would be required to pay under these agreements. As of March 31, 2017, all of the obligations under the related debt and swap agreements have been performed in accordance with the terms of those agreements. The table below summarizes our Funds' debt as of March 31, 2017. The amounts represent 100% (not our pro-rata share) of amounts related to our Funds:

Fund(1)
 
Loan Maturity Date
 
Principal Balance
(in millions)
 
Variable Interest Rate
 
Swap Fixed Interest Rate
 
Swap Maturity Date
 
 
 
 
 
 
 
 
 
 
 
Fund X(2)
 
5/1/2018
 
$
325.0

 
LIBOR + 1.75%
 
2.35%
 
5/1/2017
Partnership X(3)
 
3/1/2023
 
110.0

 
LIBOR + 1.40%
 
2.30%
 
3/1/2021
 
 
 
 
$
435.0

 
 
 
 
 
 
___________________________________________________
(1)
See Note 5 for more information regarding our unconsolidated Funds.
(2)
Floating rate term loan, swapped to fixed, which is secured by six properties and requires monthly payments of interest only, with the outstanding principal due upon maturity. As of March 31, 2017, assuming a zero-percent LIBOR interest rate during the remaining life of the swap, the maximum future payments under the swap agreement were $0.2 million.
(3)
Floating rate term loan, swapped to fixed, which is secured by two properties and requires monthly payments of interest only, with the outstanding principal due upon maturity. As of March 31, 2017, assuming a zero-percent LIBOR interest rate during the remaining life of the swap, the maximum future payments under the swap agreement were $3.9 million.

17. Subsequent Events

On April 25, 2017, a consolidated joint venture that we manage and in which we own a twenty-percent interest acquired two Class A office properties in downtown Santa Monica totaling approximately 293,000 square feet for a combined purchase price of $352.8 million. The properties are located at 1299 Ocean Avenue and 429 Santa Monica Blvd. The joint venture financed a portion of the purchase price with a $142 million secured, non–recourse, interest only loan that matures in July 2019 and bears interest at LIBOR + 1.55%.
During April, 2017, we sold approximately 1.1 million shares of our common stock under our ATM program for net proceeds of $43.9 million after commissions.
 




30


Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with our consolidated financial statements and related notes in Part I, Item 1 of this Report, and our Forward Looking Statements disclaimer. Our results of operations for the three months ended March 31, 2017 and 2016 were affected by property acquisitions - see Note 3 to our consolidated financial statements in Item 1 of this Report for more information.

Business Description

Douglas Emmett, Inc. is a fully integrated, self-administered and self-managed REIT. We are one of the largest owners and operators of high-quality office and multifamily properties in Los Angeles County, California and in Honolulu, Hawaii. We focus on owning, acquiring, developing and managing a substantial share of top-tier office properties and premier multifamily communities in neighborhoods that possess significant supply constraints, high-end executive housing and key lifestyle amenities.
As of March 31, 2017, our portfolio consisted of the following:

 
 
 
 
 
 
 
 
Consolidated Portfolio(1)
 
Total Portfolio(2)
 
 
Office
 
 
 
 
 
Class A Properties(3) 
59
 
67
 
 
Rentable square feet (in thousands)
15,886
 
17,710
 
 
Leased rate
91.7%
 
91.7%
 
 
Occupied rate
89.5%
 
89.6%
 
 
 
 
 
 
 
 
Multifamily
 
 
 
 
 
Properties
10
 
10
 
 
Units
3,320
 
3,320
 
 
Leased rate
99.6%
 
99.6%
 
 
Occupied rate
98.1%
 
98.1%
 
 
 
 
 
 
 
__________________________________________________
(1)
Our Consolidated Portfolio includes all of the properties included in our consolidated results. We own 100% of these properties except for seven office properties totaling 2.3 million square feet, which we own through three consolidated JVs. Our Consolidated Portfolio also includes two parcels of land from which we earn ground rent income from ground leases to the owners of a Class A office building and a hotel.
(2)
Our Total Portfolio includes our Consolidated Portfolio plus eight properties totaling 1.8 million square feet owned by our unconsolidated Funds, in which we own a weighted average of approximately 60% based on square footage. See Note 5 to our consolidated financial statements in Item 1 of this Report for our unconsolidated Funds' disclosures.
(3) Office portfolio includes ancillary retail space.

Annualized rent

Annualized rent from our Consolidated Portfolio was derived as follows as of March 31, 2017:

a2016q110-q_rentsegmenta08.jpg______a2016q110-q_rentlocationa08.jpg

31


Acquisitions, Financings, Developments and Repositionings
 
Acquisitions
 
In April 2017, one of our consolidated JVs acquired two office properties. See Note 17 to our consolidated financial statements in Item 1 of this Report for more information regarding these acquisitions and the related financing.

Financings

During April, 2017, we sold approximately 1.1 million shares of our common stock under our ATM program for net proceeds of $43.9 million after commissions.

Developments
We are developing two multifamily projects, one in our Brentwood submarket in Los Angeles, California, and one in Honolulu, Hawaii. Each development is on land which we already own:

We are building an additional 475 apartments (net of existing apartments removed) at our Moanalua Hillside Apartments in Honolulu, which we expect will cost approximately $120.0 million excluding the cost of the land which we already owned before beginning the project. We also plan to invest additional capital to upgrade the existing apartments, improve the parking and landscaping, build a new leasing and management office, and construct a new recreation and fitness facility with a new pool.
In West Los Angeles, we are planning to build a high-rise apartment building with 376 apartments. We expect the cost of the development to be approximately $120.0 million to $140.0 million, which does not include the cost of the land or the existing underground parking garage, both of which we owned before beginning the project.

Repositionings

    We often strategically purchase properties with large vacancies or expected near-term lease roll-over and use our knowledge of the property and submarket to reposition the property for the optimal use and tenant mix. The work we undertake to reposition a building typically takes months or even years, and could involve a range of improvements from a complete structural renovation to a targeted remodeling of selected spaces. We generally select a property for repositioning at the time we purchase it, although repositioning efforts can also occur at properties that we already own. During the repositioning, the affected property may display depressed rental revenue and occupancy levels which impacts our results and, therefore, comparisons of our performance from period to period.

In addition to our Moanalua Hillside Apartments in Honolulu, described above under "Developments", as of March 31, 2017, we were repositioning two properties: (i) a 661,000 square foot office property in Woodland Hills, California, which included a 35,000 square foot gym, and (ii) a 79,000 square foot office property in Honolulu, Hawaii owned by a consolidated JV in which we own a two-thirds interest.


32


Rental Rate Trends - Total Portfolio

Office Rental Rates

The table below presents the average annual rental rate per leased square foot and the annualized lease transaction costs per leased square foot for leases executed in our total office portfolio during each period:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three months ended
 
Twelve Months Ended December 31,
 
 
Historical straight-line rents:(1)
 
March 31, 2017
 
2016
 
2015
 
2014
 
2013
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Average rental rate(2)
 
$45.92
 
$43.21
 
$42.65
 
$35.93
 
$34.72
 
 
Annualized lease transaction costs(3)
 
$5.59
 
$5.74
 
$4.77
 
$4.66
 
$4.16
 
 
 
 
 
 
 
 
 
 
 
 
 
 
___________________________________________________
(1)
Because straight-line rent takes into account the full economic value of each lease, including rent concessions and escalations, we believe that it may provide a better comparison than ending cash rents, which include the impact of the annual escalations over the entire term of the lease. However, care should be taken in any comparison, as the averages are often significantly affected from period to period by factors such as the buildings, submarkets, and types of space and terms involved in the leases executed during the respective reporting period.
(2)
Reflects the weighted average straight-line annualized base rent (i.e., excludes tenant reimbursements, parking and other revenue) per leased square foot.  For our triple net leases, annualized rent is calculated by adding estimated expense reimbursements to base rent.
(3)
Reflects the weighted average leasing commissions and tenant improvement allowances divided by the weighted average number of years for the leases.

Office Rent Roll Up

During the three months ended March 31, 2017,

Straight-line rent roll up. The average straight-line rent of $45.92 per square foot under new and renewed leases that we signed during the three months ended March 31, 2017 was 29.0% greater than the average straight-line rent of $35.59 per square foot on the expiring leases for the same space.  The rent roll up reflects continuing increases in average starting rental rates and more leases containing annual rent escalations in excess of 3% per annum.

Cash rent roll up. The average starting cash rental rate of $43.84 per square foot under new and renewed leases that we signed during the three months ended March 31, 2017 was 28.0% greater than the average starting cash rental rate of $34.26 per square foot on the expiring leases for the same space, and 12.9% greater than the average ending cash rental rate of $38.83 per square foot on those expiring leases.

Our office rent roll up can fluctuate from period to period as a result of changes in our submarkets, buildings and term of the expiring leases, making these metrics difficult to predict.


33


Office Lease Expirations

As of March 31, 2017, assuming non-exercise of renewal options and early termination rights, we expect to see expiring cash rents in our total office portfolio as presented in the graph below:

a2017q110-q_chartx04676.jpg
____________________________________________________
(1) Average of the percentage of leases at March 31, 2014, 2015, 2016 with the same remaining duration as the leases for the labeled year had at March 31, 2017. Acquisitions are included in the prior year average commencing in the quarter after the acquisition.
 
Multifamily Rental Rates

The table below presents the average annual rental rate per leased unit for new tenants.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three months ended
 
Twelve Months Ended December 31,
 
 
Average annual rental rate - new tenants:
 
March 31, 2017
 
2016
 
2015
 
2014
 
2013
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Rental rate(1)
 
$
28,049

 
$
28,435

 
$
27,936

 
$
28,870

 
$
27,392

 
 
 
 
 
 
 
 
 
 
 
 
 
 
_____________________________________________________
(1)
2016 and 2015 include the impact of a property acquisition in Honolulu at the end of the 2014, so the numbers are not directly comparable with prior years.
 

Multifamily Rent Roll Up

During the three months ended March 31, 2017, average rent on leases to new tenants at our residential properties were 4.0% higher for the same unit at the time it became vacant.


34


Occupancy Rates - Total Portfolio

The tables below present the occupancy rates for our total office portfolio and multifamily portfolio:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31,
 
 
Occupancy Rates(1) as of:
 
March 31, 2017
 
2016
 
2015
 
2014
 
2013
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Office portfolio
 
89.6
%
 
90.4
%
 
91.2
%
 
90.5
%
 
90.4
%
 
 
Multifamily portfolio
 
98.1
%
 
97.9
%
 
98.0
%
 
98.2
%
 
98.7
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three months ended
 
Twelve Months Ended December 31,
 
 
Average Occupancy Rates(1)(2):
 
March 31, 2017
 
2016
 
2015
 
2014
 
2013
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Office portfolio
 
90.0
%
 
90.6
%
 
90.9
%
 
90.0
%
 
89.7
%
 
 
Multifamily portfolio
 
98.0
%
 
97.6
%
 
98.2
%
 
98.5
%
 
98.6
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
___________________________________________________
(1)
Occupancy rates include the impact of property acquisitions, most of whose occupancy rates at the time of acquisition were below that of our existing portfolio.
(2)
Average occupancy rates are calculated by averaging the occupancy rates at the end of each of the quarters in the period and at the end of the quarter immediately prior to the start of the period.

Comparison of three months ended March 31, 2017 to three months ended March 31, 2016

Revenues

Office Rental Revenue:  Office rental revenue increased by $22.0 million, or 19.8%, to $133.0 million for the three months ended March 31, 2017, compared to $111.0 million for the three months ended March 31, 2016.  The increase was primarily due to rental revenues of $19.1 million from properties that we acquired in 2016 and an increase in rental revenues of $4.0 million from the properties that we owned throughout both periods, partially offset by a decrease of $1.1 million in rental revenues from a property that we sold during 2016. The increase in rental revenue of $4.0 million from the properties that we owned throughout both periods was primarily due to an increase in rental rates, which was partially offset by a decrease of $0.5 million in the accretion from below-market leases. See Note 3 to our consolidated financial statements in Item 1 of this Report for more information regarding our acquisitions.

Office Tenant Recoveries:  Office tenant recoveries increased by $0.8 million, or 8.2%, to $11.1 million for the three months ended March 31, 2017, compared to $10.2 million for the three months ended March 31, 2016.  The increase was primarily due to tenant recoveries of $0.8 million from properties that we acquired in 2016.

Office Parking and Other Income: Office parking and other income increased by $3.1 million, or 13.5%, to $26.3 million for the three months ended March 31, 2017, compared to $23.2 million for the three months ended March 31, 2016. The increase was primarily due to parking and other income of $2.2 million from properties that we acquired in 2016 and an increase of $1.1 million in parking and other income from properties that we owned throughout both periods, partially offset by a decrease in parking and other income of $0.2 million from a property that we sold during 2016. The increase in parking and other income from the properties that we owned throughout both periods primarily reflects increases in rates.

Multifamily Revenue:  Total multifamily revenue decreased by $0.1 million, or 0.2%, to $24.1 million for the three months ended March 31, 2017, compared to $24.2 million for the three months ended March 31, 2016.  The decrease was primarily due to a decrease of $0.8 million in the accretion from below-market leases, almost entirely offset by an increase in rental revenues and parking income. The decrease in the accretion from below-market leases was due to the completion in 2016 of the amortization of below-market lease intangibles recorded at the time of our IPO.


35


Operating Expenses

Office Rental Expenses:  Office rental expenses increased by $7.0 million, or 14.6%, to $54.9 million for the three months ended March 31, 2017, compared to $47.9 million for the three months ended March 31, 2016. The increase was due to rental expenses of $7.2 million from properties that we acquired during 2016 and an increase of $0.2 million from properties that we owned throughout both periods, partially offset by a decrease of $0.4 million from a property that we sold during 2016.

Multifamily Rental Expenses:  Multifamily rental expense decreased by $0.1 million, or 1.4%, to $5.9 million for the three months ended March 31, 2017, compared to $6.0 million for the three months ended March 31, 2016.  The decrease was primarily due to a decrease in payroll expense, legal fees and excise taxes.

General and Administrative Expenses:  General and administrative expenses increased by $2.1 million, or 25.8%, to $10.2 million for the three months ended March 31, 2017, compared to $8.1 million for the three months ended March 31, 2016. The increase was primarily due to payroll taxes of $1.4 million related to the exercise of options as well as a $0.4 million increase in equity compensation expense.

Depreciation and Amortization:  Depreciation and amortization expense increased by $11.8 million, or 21.3%, to $67.4 million for the three months ended March 31, 2017, compared to $55.6 million for the three months ended March 31, 2016. The increase was primarily due to depreciation and amortization of $10.2 million from properties that we acquired during 2016.

Non-Operating Income and Expenses

Other Income and Other Expenses: Other income increased by $0.1 million, or 3.5%, to $2.2 million for the three months ended March 31, 2017, compared to $2.1 million for the three months ended March 31, 2016, and other expenses decreased by $1.3 million, or 42.6% to $1.7 million for the three months ended March 31, 2017 compared to $3.0 million for the three months ended March 31, 2016. The increase in other income was primarily due to an increase in revenue for management services that we provide to our unconsolidated Funds and an increase in revenue from the health club that we own and operate. The decrease in other expenses was primarily due to $1.5 million of acquisition-related expenses incurred in connection with the acquisition of the Westwood Portfolio by one of our consolidated JVs during the three months ended March 31, 2016, partly offset by an increase in expenses related to management services that we provide to our unconsolidated Funds and an increase in expenses from the health club that we own and operate. We adopted ASU No. 2017-01, "Clarifying the Definition of a Business" in the first quarter
of 2017, as a result, our property acquisitions qualify as asset purchases (not businesses) and the related acquisition expenses are capitalized as part of the purchase price of the respective property. See Note 2.
 
Income, Including Depreciation, from Unconsolidated Real Estate Funds:  Our share of the income, including depreciation, from our unconsolidated Funds increased by $0.6 million, or 37.3%, to $2.2 million for the three months ended March 31, 2017 compared to $1.6 million for the three months ended March 31, 2016. The increase was primarily due to an increase in rental revenues for our unconsolidated Funds, which primarily reflects an increase in rental rates. See Note 5 to our consolidated financial statements in Item 1 of this Report for more information regarding our unconsolidated Funds.

Interest Expense:  Interest expense increased by $1.3 million, or 3.6%, to $37.0 million for the three months ended March 31, 2017, compared to $35.7 million for the three months ended March 31, 2016.  The increase was due to interest expense of $4.0 million on debt related to our JV acquisitions during 2016, partially offset by a decrease in interest expense of $2.7 million on our remaining debt as a result of refinancing at lower interest rates during 2016. See Notes 7 and 9 to our consolidated financial statements in Item 1 of this Report for more information regarding our debt and derivative contracts.





36


Non-GAAP Supplemental Financial Measure: FFO

Usefulness to Investors

Many investors use FFO as one performance measure to compare the operating performance of REITs.  FFO represents net income (loss), computed in accordance with GAAP, excluding (i) gains (or losses) from sales of depreciable operating property, (ii) impairments of depreciable operating property, (iii) real estate depreciation and amortization (other than amortization of deferred financing costs), and (iv) the same adjustments for unconsolidated funds and consolidated JVs. We calculate FFO in accordance with the standards established by NAREIT. Like any metric, FFO has limitations as a measure of our performance, because it excludes depreciation and amortization, and captures neither the changes in the value of our properties that result from use or market conditions, nor the level of capital expenditures and leasing commissions necessary to maintain the operating performance of our properties, all of which have real economic effect and could materially impact our operating results.  Other REITs may not calculate FFO in accordance with the NAREIT definition and, accordingly, our FFO may not be comparable to the FFO of other REITs. Accordingly, FFO should be considered only as a supplement to net income as a measure of our performance.  FFO should not be used as a measure of our liquidity, nor is it indicative of cash available to fund our cash needs, including our ability to pay dividends.  FFO should not be used as a supplement to or a substitute measure for cash flow from operating activities computed in accordance with GAAP.

Comparison of Results

For the three months ended March 31, 2017, FFO increased by $7.6 million, or 9.9%, to $83.7 million, compared to $76.1 million for the three months ended March 31, 2016. The increase was primarily due to (i) an increase in operating income from our office portfolio due to acquisitions in 2016 and (ii) a decrease in acquisition-related expenses as a result of acquisition-related expenses incurred during the three months ended March 31, 2016 related to the acquisition of the Westwood Portfolio, partially offset by increases in (a) interest expense due to new debt related to acquisitions in 2016 and (b) general and administrative expenses due to payroll taxes related to option exercises and an increase in equity compensation.

Reconciliation to GAAP

The table below (in thousands) reconciles our FFO (the FFO attributable to our common stockholders and noncontrolling interests in our Operating Partnerships - which includes our share of our consolidated JVs and our unconsolidated Funds FFO) to net income attributable to common stockholders computed in accordance with GAAP:
 
 
 
 
 
 
 
 
Three Months Ended March 31,
 
 
 
2017
 
2016
 
 
 
 
 
 
 
 
Net income attributable to common stockholders
$
19,049

 
$
15,366

 
 
Depreciation and amortization of real estate assets
67,374

 
55,552

 
 
Net income attributable to noncontrolling interests
2,731

 
680

 
 
Adjustments attributable to unconsolidated funds(1)
4,036

 
3,933

 
 
Adjustments attributable to consolidated JVs(1)
(9,521
)
 
585

 
 
FFO
$
83,669

 
$
76,116

 
 
 
 
 
 
 
_____________________________________________________
(1)
Adjusts for our share of our unconsolidated Funds depreciation and amortization of real estate assets, and for the net income and depreciation and amortization of real estate assets that is attributable to the noncontrolling interests in our consolidated JVs.


37


Liquidity and Capital Resources

General

We have typically financed our capital needs through lines of credit and long-term secured loans. To mitigate the impact of fluctuations in interest rates on our cash flows from operations, some of our long-term secured loans carry fixed interest rates, and we generally enter into interest rate swap agreements with respect to our loans with floating interest rates.  These swap agreements generally expire between one to two years before the maturity date of the related loan, during which time we can refinance the loan without any interest penalty. See Notes 7 and 9 to our consolidated financial statements in Item 1 of this Report for more information regarding our debt and derivative contracts.  
  
Financing Activity for three months ended March 31, 2017

See "Acquisitions and Dispositions, Financings, Developments and Repositionings" above for a discussion of our financing activities during the three months ended March 31, 2017.

Short term liquidity

Excluding potential acquisitions and debt refinancings, we expect to meet our short term liquidity requirements, which includes our development projects, repositioning of properties and non-recurring capital expenditures, through cash on hand, cash generated by operations, and as necessary, our revolving credit facility. See Note 7 to our consolidated financial statements in Item 1 of this Report for more information regarding our revolving credit facility. See "Acquisitions and Dispositions, Financings, Developments and Repositionings" for more information regarding our developments.

Long term liquidity

Our long-term liquidity needs consist primarily of funds necessary to pay for acquisitions and debt refinancings. We do not expect that we will have sufficient funds on hand to cover these long-term cash requirements due to the nature of our business and the requirement to distribute a substantial majority of our income on an annual basis imposed by REIT federal tax rules. We plan to meet our long-term liquidity needs through long-term secured indebtedness, the issuance of equity securities, including OP Units, property dispositions and JV transactions. We also have an ATM program which would allow us, subject to market conditions, to sell up to $305 million in common stock as of the date of this Report.

Contractual Obligations

See Note 7 to our consolidated financial statements in Item 1 of this Report for information regarding our minimum future principal payments due on our secured notes payable and revolving credit facility, as well as the interest rates that determine our future periodic interest payments, Note 15 for information regarding our minimum future ground lease payments, and Note 16 for information regarding our contractual obligations related to our Moanalua development.

Cash Flows

Comparison of three months ended March 31, 2017 to three months ended March 31, 2016

Cash flows from operating activities

Our cash flows from operating activities are primarily dependent upon the occupancy and rental rates of our portfolio, the collectability of rent and recoveries from our tenants, and the level of our operating expenses and general and administrative costs.  Net cash provided by operating activities increased by $17.7 million to $107.6 million for the three months ended March 31, 2017 compared to $89.8 million for the three months ended March 31, 2016. The increase was primarily due to (i) an increase in operating income from our office portfolio due to acquisitions in 2016 and (ii) a decrease in acquisition-related expenses as a result of acquisition-related expenses incurred during the three months ended March 31, 2016 related to the acquisition of the Westwood Portfolio, partially offset by increases in (a) interest expense due to new debt related to acquisitions in 2016 and (b) general and administrative expenses due to payroll taxes related to option exercises.


38


Cash flows from investing activities

Our net cash used in investing activities is generally used to fund property acquisitions, developments and redevelopment projects, and recurring and non-recurring capital expenditures. Net cash used in investing activities decreased by $1.20 billion to $57.8 million for the three months ended March 31, 2017 compared to $1.26 billion for the three months ended March 31, 2016. The decrease is due to the acquisition of the Westwood Portfolio during the three months ended March 31, 2016.

Cash flows from financing activities

Our net cash related to financing activities is generally impacted by our borrowings and capital activities, as well as dividends and distributions paid to common stockholders and noncontrolling interests, respectively.  Net cash used in financing activities decreased by $1.22 billion to $77.2 million for the three months ended March 31, 2017, compared to $1.14 billion cash provided for the three months ended March 31, 2016. The decrease is due to the financing of the Westwood Portfolio acquisition during the three months ended March 31, 2016.

Off-Balance Sheet Arrangements

Debt of our Unconsolidated Funds

Our unconsolidated Funds have their own non-recourse debt, and we have made certain environmental and other limited indemnities and guarantees covering customary non-recourse carve-outs for loans related to both of our unconsolidated Funds. We have also guaranteed the related swaps. Our Funds have agreed to indemnify us for any amounts that we would be required to pay under these agreements. As of March 31, 2017, all of the obligations under these loans and swap agreements have been performed in accordance with the terms of those agreements. For information regarding our Funds and their' debt, see Notes 5 and 16, respectively, to our consolidated financial statements in Item 1 of this Report.

Critical Accounting Policies

We adopted ASU No. 2017-01, "Clarifying the Definition of a Business" in the first quarter of 2017. The ASU changes our accounting policy "Investment in Real Estate" disclosed in our 2016 Annual Report on Form 10-K. The ASU will impact our future financial position, results of operations and disclosures because we expect that our property acquisitions will be accounted for as asset purchases, and the related acquisition expenses will be capitalized as part of the respective asset. We historically accounted for our property acquisitions as business combinations and expensed the related acquisition expenses as incurred. We have not made any other changes during the period covered by this Report to our critical accounting policies disclosed in our 2016 Annual Report on Form 10-K. For a discussion of recently issued and adopted accounting literature, see Note 2 to our consolidated financial statements in Item 1 of this Report. Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with GAAP, and which requires us to make estimates of certain items, which affect the reported amounts of our assets, liabilities, revenues and expenses. While we believe that our estimates are based upon reasonable assumptions and judgments at the time that they are made, some of our estimates could prove to be incorrect, and those differences could be material. Some of our estimates are subject to adjustment as we believe appropriate, based on revised estimates, and reconciliation to actual results when available.


39


Item 3.  Quantitative and Qualitative Disclosures about Market Risk

We use derivative instruments to hedge interest rate risk related to our floating rate borrowings. However, our use of these instruments does expose us to credit risk from the potential inability of our counterparties to perform under the terms of those agreements. We attempt to minimize this credit risk by contracting with a variety of high-quality financial counterparties. See Notes 7 and 9 to our consolidated financial statements in Item 1 of this Report for more information regarding our debt and derivatives. At March 31, 20177.1% of our debt was unhedged floating rate debt. A fifty-basis point change in the one month USD LIBOR interest rate would result in an annual impact to our earnings (through interest expense) of approximately $1.6 million. We calculate interest sensitivity by multiplying the amount of unhedged floating rate debt by fifty-basis points.

Item 4.  Controls and Procedures
 
As of March 31, 2017, the end of the period covered by this Report, we carried out an evaluation, under the supervision and with the participation of management, including our CEO and CFO, regarding the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) at the end of the period covered by this Report. Based on the foregoing, our CEO and CFO concluded, as of that time, that our disclosure controls and procedures were effective in ensuring that information required to be disclosed by us in reports filed or submitted under the Exchange Act (i) is processed, recorded, summarized and reported within the time periods specified in the SEC’s rules and forms and (ii) is accumulated and communicated to our management, including our CEO and our CFO, as appropriate, to allow for timely decisions regarding required disclosure. There have not been any changes in our internal control over financial reporting that occurred during the quarter ended March 31, 2017, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.


40


PART II. OTHER INFORMATION

Item 1. Legal Proceedings

From time to time, we are party to various lawsuits, claims and other legal proceedings that arise in the ordinary course of our business. Excluding ordinary routine litigation incidental to our business, we are not currently a party to any legal proceedings that we believe would reasonably be expected to have a materially adverse effect on our business, financial condition or results of operations.

Item 1A.  Risk Factors

Except for any additional relevant information disclosed in our public reports during 2017, we are not aware of any other material changes to the risk factors disclosed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2016.

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds
 
None.
 
Item 3.  Defaults Upon Senior Securities

None.

Item 4.  Mine Safety Disclosures

Not applicable.

Item 5.  Other Information

None.

Item 6.  Exhibits

Exhibit Number    Description

31.1    Certificate of CEO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2    Certificate of CFO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1*    Certificate of CEO pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2*    Certificate of CFO pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS    XBRL Instance Document.
101.SCH    XBRL Taxonomy Extension Schema Document.
101.CAL    XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF    XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB    XBRL Taxonomy Extension Label Linkbase Document
101.PRE    XBRL Taxonomy Extension Presentation Linkbase Document.
________________________________________________
*    In accordance with SEC Release No. 33-8212, these exhibits are being furnished, and are not being filed as part of this Report on Form 10-Q or as a separate disclosure document, and are not being incorporated by reference into any Securities Act registration statement.

41


Pursuant to the requirements of the Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 
 
DOUGLAS EMMETT, INC.
 
 
 
 
 
 
 
 
Date:
May 5, 2017
By:
/s/ JORDAN L. KAPLAN
 
 
 
Jordan L. Kaplan
 
 
 
President and CEO
 
 
 
 
 
 
 
 
Date:
May 5, 2017
By:
/s/ MONA M. GISLER
 
 
 
Mona M. Gisler
 
 
 
CFO


42