FORM 10-Q

TABLE OF CONTENTS

 

				PAGE NO.
PART I.	FINANCIAL INFORMATION				3
	Item 1.	Financial Statements			3
		Consolidated Balance Sheets as of March 31, 2008 (unaudited) and December 31, 2007			3
		Consolidated Statements of Operations for the three months ended March 31, 2008 and 2007 (unaudited)			4
		Consolidated Statements of Cash Flows for the three months ended March 31, 2008 and 2007 (unaudited)			5
		Notes to Consolidated Financial Statements			6
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations			19
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk			24
	Item 4.	Controls and Procedures			24
PART II.	OTHER INFORMATION				25
	Item 1.	Legal Proceedings			25
	Item 1A.	Risk Factors			25
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds			25
	Item 3.	Defaults Upon Senior Securities			25
	Item 4.	Submission of Matters to a Vote of Security Holders			25
	Item 5.	Other Information			25
	Item 6.	Exhibits			26
	SIGNATURES				27

 

 

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Consolidated Balance Sheets

(in thousands, except for share data)

		March 31, 2008				December 31, 2007
		(unaudited)
Assets
Investment in real estate
Land		$	887,453			$	825,560
Buildings and improvements			5,475,767				4,978,124
Tenant improvements and lease intangibles			531,315				460,486
			6,894,535				6,264,170
Less: accumulated depreciation			(298,863	)			(242,114	)
Net investment in real estate			6,595,672				6,022,056
Cash and cash equivalents			4,493				5,843
Tenant receivables, net			252				955
Deferred rent receivables, net			25,076				20,805
Interest rate contracts			149,633				84,600
Acquired lease intangible assets, net			22,210				24,313
Other assets			27,037				31,396
Total assets		$	6,824,373			$	6,189,968
Liabilities
Secured notes payable, including loan premium		$	3,729,368			$	3,105,677
Accounts payable and accrued expenses			66,882				62,704
Security deposits			34,278				31,309
Acquired lease intangible liabilities, net			206,070				218,371
Interest rate contracts			286,762				129,083
Dividends payable			22,737				19,221
Total liabilities			4,346,097				3,566,365
Minority interests			556,125				793,764
Stockholders’ Equity
Common stock, $0.01 par value 750,000,000 authorized, 121,263,847
and 109,833,903 outstanding at March 31, 2008 and December 31, 2007,    respectively.			1,213				1,098
Additional paid-in capital			2,272,234				2,019,716
Accumulated other comprehensive income			(192,009	)			(101,163	)
Accumulated deficit			(159,287	)			(89,812	)
Total stockholders’ equity			1,922,151				1,829,839
Total liabilities and stockholders’ equity		$	6,824,373			$	6,189,968

See notes to consolidated financial statements.

 

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Douglas Emmett, Inc.

Consolidated Statements of Operations

(unaudited and in thousands, except for share data)

		Three Months Ended March 31,
		2008				2007
Revenues
Office rental
Rental revenues		$	99,016			$	91,612
Tenant recoveries			5,368				8,186
Parking and other income			12,660				11,100
Total office revenues			117,044				110,898
Multifamily rental
Rental revenues			17,224				16,514
Parking and other income			560				491
Total multifamily revenues			17,784				17,005
Total revenues			134,828				127,903
Operating expenses
Office expense			31,364				33,294
Multifamily expense			3,877				4,923
General and administrative			5,285				5,042
Depreciation and amortization			56,749				51,121
Total operating expenses			97,275				94,380
Operating income			37,553				33,523
Interest and other income			409				82
Interest expense			(41,203	)			(38,302	)
Loss before minority interests			(3,241	)			(4,697	)
Minority interests			741				1,424
Net loss		$	(2,500	)		$	(3,273	)
Net loss per common share – basic and diluted		$	(0.02	)		$	(0.03	)
Dividends declared per common share		$	0.1875			$	0.175
Weighted average shares of common stock outstanding -basic and diluted			118,283,579				115,005,860

See notes to consolidated financial statements.

 

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Douglas Emmett, Inc.

Consolidated Statements of Cash Flows

(unaudited and in thousands)

		Three Months Ended March 31,
		2008				2007
Operating Activities
Net loss		$	(2,500	)		$	(3,273	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Minority interests			(741	)			(1,424	)
Depreciation and amortization			56,749				51,121
Net accretion of acquired lease intangibles			(10,198	)			(9,863	)
Amortization of deferred loan costs			362				249
Amortization of loan premium			(1,160	)			(1,095	)
Non-cash market value adjustments on interest rate contracts			1,800				3,768
Non-cash amortization of stock-based compensation			3,291				670
Change in working capital components
Tenant receivables			703				245
Deferred rent receivables			(4,271	)			(4,505	)
Accounts payable, accrued expenses and security deposits			3,282				6,427
Other			6,726				269
Net cash provided by operating activities			54,043				42,589
Investing Activities
Capital expenditures and property acquisitions			(627,103	)			(13,471	)
Net cash used in investing activities			(627,103	)			(13,471	)
Financing Activities
Proceeds from borrowings			833,850				31,500
Deferred loan costs			(2,010	)			-
Repayment of borrowings			(205,000	)			(41,500	)
Net change in short-term borrowings			(4,000	)			-
Issuance of minority interest in consolidated joint venture			100				-
Distributions to minority interests			(8,251	)			(6,003	)
Redemption of minority interests			(23,758	)			-
Cash dividends			(19,221	)			(13,801	)
Net cash provided by (used in) financing activities			571,710				(29,804	)
Decrease in cash and cash equivalents			(1,350	)			(686	)
Cash and cash equivalents at beginning of period			5,843				4,536
Cash and cash equivalents at end of period		$	4,493			$	3,850

See notes to consolidated financial statements for additional non-cash items.

 

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Douglas Emmett, Inc.

Notes to Consolidated Financial Statements

(in thousands, except shares and per share data)

1. Organization and Description of Business

Douglas Emmett, Inc, a Maryland corporation formed on June 28, 2005, is a fully integrated, self-administered, and self-managed Real Estate Investment Trust (REIT).  We did not have any meaningful operating activity until the consummation of our initial public offering (IPO) and the related acquisition of our predecessor and certain other entities on October 30, 2006.  Through our interest in Douglas Emmett Properties, LP (our operating partnership) and its subsidiaries, we own, manage, lease, acquire and develop real estate.  As of March 31, 2008, we owned a portfolio of 55 office properties (including ancillary retail space) and nine multifamily properties, as well as the fee interests in two parcels of land that we lease to third parties.  All of these properties are located in Los Angeles County, California and Honolulu, Hawaii.  We qualified as a REIT for federal income tax purposes beginning with our initial taxable year ending December 31, 2006 and expect to maintain such qualification.

2. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying consolidated financial statements as of March 31, 2008 and December 31, 2007 and for the three months ended March 31, 2008 and 2007 are the consolidated financial statements of Douglas Emmett, Inc. and its subsidiaries including our operating partnership.  All significant intercompany balances and transactions have been eliminated in the consolidated financial statements.  Certain prior period amounts have been reclassified to conform with current period presentation.

 

Unaudited Interim Financial Information

 

 

The accompanying unaudited interim financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Certain information and footnote disclosure normally included in the financial statements prepared in accordance with accounting principles generally accepted in the United States (GAAP) may have been condensed or omitted pursuant to such rules and regulations, although we believe that the disclosures are adequate to make the presentation not misleading. The accompanying unaudited 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 ended December 31, 2008. The interim financial statements should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2007 and notes thereto.  Any reference to the number of properties and square footage are unaudited and outside the scope of our independent registered public accounting firm’s review of our financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States).

 

Use of Estimates

The preparation of financial statements in conformity with GAAP requires us to make certain estimates and assumptions, for example with respect to the allocation of the purchase price of acquisitions among land, buildings, improvements, equipment and any related intangible assets and liabilities.  These estimates and assumptions are subjective and affect the reported amounts in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

 

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Douglas Emmett, Inc.

Notes to Consolidated Financial Statements--(continued)

(in thousands, except shares and per share data)

Cash and Cash Equivalents

For purposes of the consolidated statements of cash flows, we consider short-term investments with maturities of three months or less when purchased to be cash equivalents.

Interest Rate Contracts

We manage our interest rate risk associated with borrowings by obtaining interest rate swap and interest rate cap contracts. No other derivative instruments were used.

Statement of Financial Accounting Standards (FAS) No. 133, Accounting for Derivative Instruments and Hedging Activities (FAS 133), as amended and interpreted, establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities.  As required by FAS 133, we record all derivatives on the balance sheet at fair value.  The accounting for changes in the fair value of derivatives depends on the intended use of the derivative and the resulting designation. Derivatives used to hedge the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, are considered fair value hedges. Derivatives used to hedge the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges.

Our objective in using derivatives is to add stability to interest expense and to manage our exposure to interest rate movements or other identified risks.  To accomplish this objective, we primarily use interest rate swaps as part of our cash flow hedging strategy.  Interest rate swaps designated as cash flow hedges involve the receipt of variable-rate amounts in exchange for fixed-rate payments over the life of the agreements without exchange of the underlying principal amount.  For derivatives designated as cash flow hedges, the effective portion of changes in the fair value of the derivative is initially reported in other comprehensive income (outside of earnings) and subsequently reclassified to earnings when the hedged transaction affects earnings.  The ineffective portion of changes in the fair value of the derivative is recognized directly in earnings.  We assess the effectiveness of each hedging relationship by comparing the changes in fair value or cash flows of the derivative hedging instrument with the changes in fair value or cash flows of the designated hedged item or transaction. For derivatives not designated as hedges, changes in fair value are recognized in earnings.  See Note 8 for the accounting of our interest rate hedges.

 

Income Taxes

 

We elected to be taxed as a REIT under the Internal Revenue Code (the “Code”) commencing with our initial taxable year ending December 31, 2006. To qualify as a REIT, we are required to distribute at least 90% of our REIT taxable income to our stockholders and meet the various other requirements imposed by the Code related to such matters as operating results, asset holdings, distribution levels and diversity of stock ownership. Provided we qualify for taxation as a REIT, we generally will not be subject to corporate-level income tax on the earnings distributed currently to our stockholders that we derive from our REIT qualifying activities. We will be subject to corporate-level tax on the earnings we derive through our taxable REIT subsidiary (TRS). If we fail to qualify as a REIT in any taxable year, and are unable to avail ourselves of certain savings provisions set forth in the Code, all of our taxable income would be subject to federal income tax at regular corporate rates, including any applicable alternative minimum tax.

 

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Douglas Emmett, Inc.

Notes to Consolidated Financial Statements--(continued)

(in thousands, except shares and per share data)

In addition, we will be subject to taxation by various state and local (and potentially foreign) jurisdictions, including those in which we transact business or reside.  Our predecessor was an S-Corporation and the institutional funds it sponsored were limited partnerships. Our non-TRS subsidiaries, including the operating partnership, are either partnerships or disregarded entities for federal income tax purposes.  Under applicable federal and state income tax rules, the allocated share of net income or loss from the limited partnerships and S-Corporation is reportable in the income tax returns of the respective partners and stockholders.  Accordingly, no income tax provision is included in the accompanying consolidated financial statements other than the 1.5% tax due on taxable income of S-Corporations in the State of California attributable to periods prior to our formation transactions.

 

Earnings Per Share (EPS)

 

Basic EPS is calculated by dividing the net income applicable to common stockholders for the period by the weighted average of common shares outstanding during the period. Diluted EPS is calculated by dividing the net income applicable to common stockholders for the period by the weighted average number of common and dilutive instruments outstanding during the period using the treasury stock method.  Since we were in a net loss position during the three months ended March 31, 2007 and 2008, all potentially dilutive instruments are anti-dilutive and have been excluded from our computation of weighted average dilutive shares outstanding.

 

Recently Issued Accounting Literature

In February 2007, the Financial Accounting Standards Board (FASB) issued FAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities Including an Amendment of FASB Statement No. 115.  This standard permits entities to choose to measure many financial instruments and certain other items at fair value and is effective for the first fiscal year beginning after November 15, 2007, which for us means 2008.  We did not elect the fair value measurement option for any financial assets or liabilities during the first quarter of 2008, nor do we currently expect to elect this option for any financial assets or liabilities in the near future.

In December 2007, the FASB issued FAS No. 160, Non-controlling Interests in Consolidated Financial Statements-an Amendment of Accounting Research Bulletin No. 51 (FAS 160).  FAS 160 establishes new accounting and reporting standards for a non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary.  Specifically, this statement requires the recognition of a non-controlling interest (minority interest) as equity in the consolidated financial statements separate from the parent’s equity.  The amount of net income attributable to the non-controlling interest will be included in consolidated net income on the face of the income statement.  FAS 160 clarifies that changes in a parent’s ownership interest in a subsidiary that do not result in deconsolidation are equity transactions if the parent retains its controlling financial interest.  In addition, this statement requires that a parent recognize a gain or loss in net income when a subsidiary is deconsolidated.  Such gain or loss will be measured using the fair value of the non-controlling equity investment on the deconsolidation date.  FAS 160 also includes expanded disclosure requirements regarding the interests of the parent and its non-controlling interest. FAS 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008, which for us means 2009.  We are currently evaluating the impact that FAS 160 will have on our financial statements.

In December 2007, the FASB issued FAS No. 141 (Revised 2007), Business Combinations (FAS 141R).  FAS 141R will significantly change the accounting for business combinations.  Under FAS 141R, an acquiring entity will be required to recognize all the assets acquired and liabilities assumed in a transaction at the acquisition-date fair value with limited exceptions.  FAS 141R also includes a substantial number of new disclosure requirements.  FAS 141R applies prospectively to business combinations occurring in any reporting period beginning on or after December 15, 2008, which for us means 2009.  We are currently evaluating the impact that FAS 141R will have on our financial statements.

 

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Douglas Emmett, Inc.

Notes to Consolidated Financial Statements--(continued)

(in thousands, except shares and per share data)

 

On January 1, 2008, we adopted FAS No. 157, Fair Value Measurements (FAS 157).  FAS 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements.  FAS 157 applies to reported balances that are required or permitted to be measured at fair value under existing accounting pronouncements; accordingly, the standard does not require any new fair value measurements of reported balances.  FAS 157 emphasizes that fair value is a market-based measurement, not an entity-specific measurement.  Therefore, a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability.  As a basis for considering market participant assumptions in fair value measurements, FAS 157 establishes a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entity’s own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy).  Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that we have the ability to access. Level 2 inputs are inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs may include quoted prices for similar assets and liabilities in active markets, as well as inputs that are observable for the asset or liability (other than quoted prices), such as interest rates, foreign exchange rates, and yield curves that are observable at commonly quoted intervals.

Currently, we use interest rate swaps and caps to manage interest rate risk resulting from variable interest payments on our floating rate debt.  The valuation of these instruments is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves and implied volatilities.

To comply with the provisions of FAS 157, we incorporate credit valuation adjustments to appropriately reflect both our own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements.  In adjusting the fair value of our derivative contracts for the effect of nonperformance risk, we considered the impact of netting and any applicable credit enhancements, such as collateral postings, thresholds, mutual puts, and guarantees.  We have determined that our derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.  We do not have any fair value measurements using significant unobservable inputs (Level 3) as of March 31, 2008.

The table below presents the assets and liabilities measured at fair value on a recurring basis as of March 31, 2008, aggregated by the level in the fair value hierarchy within which those measurements fall.

		Quoted Prices in Active Markets for Identical Assets and Liabilities (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Balance at March 31, 2008
Assets
Interest Rate Contracts		$  -		$149,633		$  -		$149,633
Liabilities
Interest Rate Contracts		$  -		$286,762		$  -		$286,762

 

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Douglas Emmett, Inc.

Notes to Consolidated Financial Statements--(continued)

(in thousands, except shares and per share data)

3. Acquisitions

 

On March 26, 2008, we acquired a 1.4 million square foot office portfolio consisting of six Class “A” buildings all located in our core Los Angeles submarkets – Santa Monica, Beverly Hills, Sherman Oaks/Encino and Warner Center/Woodland Hills – for a contract price of approximately $610 million.  An affiliate of the seller provided $380 million of first trust deed bridge financing at a floating rate of LIBOR plus 200 basis points for nine months.

 

 

On February 13, 2008, we acquired a two-thirds interest in a 78,298 square-foot office building located in Honolulu, Hawaii.  As part of the same transaction, we also acquired all of the assets of The Honolulu Club, a private membership athletic and social club, which is located in the building.  The aggregate contract price was approximately $18 million and the purchase was made in a consolidated joint venture with our local partner.  The joint venture financed the acquisition with an $18 million loan at a floating interest rate of LIBOR plus 125 basis points.  The loan has a term of two years with a one-year extension.

 

 

The results of operations for the acquired properties are included in our consolidated statement of operations for the three months ended March 31, 2008 since the date of acquisition.  We acquired these properties near the end of the quarter, and as such, the following table represents our preliminary purchase price allocation.  These amounts are likely to change based on a more thorough calculation to be performed during the one-year purchase accounting window provided under the relevant accounting standards.  We did not acquire any properties during the first three months of 2007.

 

		2008 Acquisitions
Investment in real estate:
Land	$	61,870
Buildings and improvements		494,958
Tenant improvements and other in-place lease assets		61,870
Tenant receivables and other assets		2,386
Accounts payable, accrued expenses and tenant security deposits		(6,190)
Acquired intangible assets other than leases		658
Net acquisition cost	$	615,552

Our acquired lease intangibles related to above/below-market leases is summarized as of:

		March 31, 2008				December 31, 2007
Above-market tenant leases		$	32,770			$	32,770
Accumulated amortization			(13,648	)			(11,564	)
Below-market ground leases			3,198				3,198
Accumulated amortization			(110	)			(91	)
Acquired lease intangible assets, net		$	22,210			$	24,313
Below-market tenant leases		$	261,260			$	261,260
Accumulated accretion			(69,006	)			(57,112	)
Above-market ground leases			16,200				16,200
Accumulated accretion			(2,384	)			(1,977	)
Acquired lease intangible liabilities, net		$	206,070			$	218,371

 

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Douglas Emmett, Inc.

Notes to Consolidated Financial Statements--(continued)

(in thousands, except shares and per share data)

4. Other Assets

Other assets consist of the following at:

		March 31,				December 31,
		2008				2007
Deferred loan costs, net of accumulated amortization of $1,666 and $1,304 at March 31, 2008 and December 31, 2007, respectively		$	6,635			$	4,987
Deposits in escrow			-				4,000
Restricted cash			2,833				2,848
Prepaid interest			3,997				7,944
Prepaid expenses			2,873				3,095
Interest receivable			3,818				3,229
Other indefinite-lived intangible			1,988				1,988
Other			4,893				3,305
		$	27,037			$	31,396

We incurred deferred loan cost amortization expense of $362 and $249 for the three months ended March 31, 2008 and 2007, respectively.  The deferred loan cost amortization is included as a component of interest expense in the consolidated statements of operations.

5. Minimum Future Lease Rentals

 We have leased space to tenants primarily under noncancelable operating leases, which generally contain provisions for a base rent plus reimbursement for certain operating expenses. Operating expense reimbursements are reflected in our consolidated statements of operations as tenant recoveries.

We have leased space to certain tenants under noncancelable leases, which provide for percentage rents based upon tenant revenues. Percentage rental income for the three months ended March 31, 2008 and 2007 totaled $244 and $264, respectively.

Future minimum base rentals on noncancelable office and ground operating leases at March 31, 2008 are as follows:

April 1, 2008 to December 31, 2008	$	383,171
2009		355,705
2010		305,977
2011		252,424
2012		202,993
Thereafter		529,343
Total future minimum base rentals	$	2,029,613

The above future minimum lease payments exclude residential leases, which typically have a term of one year or less, as well as tenant reimbursements, amortization of deferred rent receivables and above/below-market lease intangibles. Some leases are subject to termination options. In general, these leases provide for termination payments should the termination options be exercised. The preceding table is prepared assuming such options are not exercised.

 

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Douglas Emmett, Inc.

Notes to Consolidated Financial Statements--(continued)

(in thousands, except shares and per share data)

6. Accounts Payable and Accrued Expenses

Accounts payable and accrued expenses consist of the following as of:

		March 31, 2008			December 31, 2007
Accounts payable		$	45,298		$	43,449
Accrued interest payable			15,290			13,963
Deferred revenue			6,294			5,292
		$	66,882		$	62,704

7. Secured Notes Payable

During the first quarter of 2008, we borrowed an additional $623 million of long-term variable rate debt, as follows:

·	We obtained a $380 million bridge loan from an affiliate of the seller in the March 2008 acquisitions described in Note 3.  This loan has an interest rate of LIBOR plus 200 basis points and a nine-month term.

·

We obtained a non-recourse $340 million term loan secured by four of our previously unencumbered office properties.  This loan bears interest at a floating rate equal to LIBOR plus 150 basis points, but we have entered into interest rate swap contracts that effectively fix the interest rate at 4.84%, effective in the second quarter of 2008 until January 2, 2013.  This loan facility matures on April 1, 2015.  Proceeds from this loan were utilized to repay our secured revolving credit facility and for general corporate purposes.  At March 31, 2008, $225 million was outstanding, leaving $115 million available to us under this loan.  See Note 13.

·	The joint venture, in which we have a two-thirds interest, obtained an $18 million loan that financed the February 2008 acquisition described in Note 3.  This loan has an interest rate of LIBOR plus 125 basis points and a two-year term with a one-year extension.

 

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Douglas Emmett, Inc.

Notes to Consolidated Financial Statements--(continued)

(in thousands, except shares and per share data)

A summary of our secured notes payable is as follows:

Type of Debt	March 31, 2008		December 31, 2007		Fixed/Floating Rate		Effective Annual Interest Rate(1)		Maturity Date		Swap Maturity Date
Variable Rate Swapped to Fixed Rate:
Modified Term Loan I(2)(3)	$2,300,000		$2,300,000		LIBOR + 0.85%		5.20%		08/31/12		08/01/10-08/01/12
Term Loan II(4)(5)	225,000		-		LIBOR + 1.50%		--(5)		04/01/15		--
Fannie Mae Loan I (6)	293,000		293,000		DMBS + 0.60%		4.76		06/01/12		08/01/11
Fannie Mae Loan II(6)	95,080		95,080		DMBS + 0.60%		5.86		06/01/12		08/01/11
Fannie Mae Loan III(6)	36,920		36,920		DMBS + 0.60%		5.86		02/01/15		08/01/11
Fannie Mae Loan IV(6)	75,000		75,000		DMBS + 0.76%		4.93		02/01/15		08/01/11
Fannie Mae Loan V(6)	82,000		82,000		LIBOR + 0.62%		5.70		02/01/16		03/01/12
Fannie Mae Loan VI(6)	18,000		18,000		LIBOR + 0.62%		5.90		06/01/17		06/01/12
Subtotal	3,125,000	(7)	2,900,000				5.20%
Variable Rate:
General Electric Bridge Loan	380,000		--		LIBOR + 2.00%				01/02/09		--
Wells Fargo Loan(8)	18,000		--		LIBOR + 1.25%				03/01/10		--
$370 Million Senior Secured Revolving Credit Facility(9)	182,300		180,450		LIBOR / Fed Funds+(10)				10/30/09		--
Subtotal	3,705,300		3,080,450
Unamortized Loan Premium(11)	24,068		25,227
Total	$3,729,368		$3,105,677

(1)	Includes the effect of interest rate contracts.  Based on actual/365-day basis and excludes amortization of loan fees and unused fees on credit line.

(2)	Secured by seven separate cross collateralized pools.  Requires monthly payments of interest only, with outstanding principal due upon maturity.

(3)	Includes $1.11 billion swapped to 4.89% until August 1, 2010; $545.0 million swapped to 5.75% until December 1, 2010; $322.5 million swapped to 4.98% until August 1, 2011; and $322.5 million swapped to 5.02% until August 1, 2012.

(4)

Represents a $340 million loan facility, of which $225 million was funded on March 18, 2008.  The remaining $115 million will be funded on May 1, 2008.  Secured by four properties in a separate cross-collateralized pool.  Requires monthly payments of interest only, with outstanding principal due upon maturity.

(5)	During the first quarter, we entered into interest rate swap contracts that effectively fix the interest rate on this $340 million facility at 4.84% (or 4.77% on an actual/360-day basis) effective in the second quarter of 2008.

(6)	Secured by four separate collateralized pools.  Fannie Mae Discount Mortgage-Backed Security (DMBS) generally tracks 90-day LIBOR.

(7)

As of March 31, 2008, the weighted average remaining life of our total outstanding debt is 4.3 years, and the weighted average remaining life of the interest rate swaps is 3.0 years.  Adjusting for the $340 million of swaps that take effect in the second quarter of 2008, the weighted average remaining life of the interest rate swaps is 3.2 years.  These swaps lower the overall effective hedged rate of 5.20% at March 31, 2008 to 5.18% (based on actual/365-day basis).

(8)	This loan is carried by a consolidated joint venture formed in 2008, of which our Operating Partnership owns a two-thirds interest.

(9)	This credit facility is secured by nine properties and has two-one year extension options available.

(10)	This revolver bears interest at either LIBOR +0.70% or Fed Funds +0.95% at our election.  If the amount outstanding exceeds $262.5 million, the credit facility bears interest at either LIBOR +0.80% or Fed Funds +1.05% at our election.

(11)	Represents non-cash mark-to-market adjustment on variable rate debt associated with office properties.

 

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Douglas Emmett, Inc.

Notes to Consolidated Financial Statements--(continued)

(in thousands, except shares and per share data)

The minimum future principal payments due on our secured notes payable, excluding the non-cash loan premium amortization, at March 31, 2008 are as follows:

 

April 1, 2008 to December 31, 2008	$	-
2009		562,300
2010		18,000
2011		-
2012		2,688,080
Thereafter		436,920
Total future principal	$	3,705,300

Senior Secured Revolving Credit Facility

We have a $370 million revolving credit facility.  Our secured revolving credit facility is with a group of banks led by Bank of America, NA and Banc of America Securities, LLC, and bears interest at a rate per annum equal to either LIBOR plus 70 basis points or Federal Funds Rate plus 95 basis points if the amount outstanding is $262.5 million or less and at either LIBOR plus 80 basis points or Federal Funds Rate plus 105 basis points if the amount outstanding is greater than $262.5 million. Our secured revolving credit facility contains an accordion feature that allows us to increase the availability by an additional $130 million, to $500 million, under specified circumstances.  The facility bears interest at 15 basis points on the undrawn balance.  The facility expires in 2009 with two one-year extensions at our option.

8. Interest Rate Contracts

We have executed interest rate swaps with a notional amount of $3.2 billion to protect against interest rate fluctuations on our existing variable-rate term loan facilities, including $340 million executed in the first quarter of 2008.  These derivatives were designated and qualify as highly effective cash flow hedges under FAS 133 and remove the variability from the hedged cash flows.  An unrealized loss of $90.8 million and $11.9 million was recorded in accumulated other comprehensive income in our consolidated balance sheets, representing the change in fair value of the cash flow hedges for the three months ended March 31, 2008 and 2007, respectively.  An immaterial amount of hedge ineffectiveness has also been recorded in interest expense.

 

The components of comprehensive income consist of the following:

 

	Three Months Ended March 31,
	2008				2007
Net loss		$	(2,500	)		$	(3,273	)
Cash flow hedge adjustment			(90,846	)			(11,888	)
Comprehensive income		$	(93,346	)		$	(15,161	)

 

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Douglas Emmett, Inc.

Notes to Consolidated Financial Statements--(continued)

(in thousands, except shares and per share data)

We also have additional interest rate swaps that we acquired from our predecessor at the time of our IPO.  Our predecessor had $2.21 billion notional of pay-fixed interest rate swaps at swap rates ranging between 4.09% and 5.00%.  Concurrent with the completion of our IPO, we executed receive-fixed swaps for the same notional amount at swap rates ranging between 4.96% and 5.00%, which were intended to largely offset the future cash flows and future change in fair value of our predecessor’s pay-fixed swaps.  The acquired pay-fixed swaps and the new receive-fixed swaps were not designated as hedges under FAS 133 and as such, the changes in fair value of these interest rate swaps have been recognized in earnings for all periods.  The fair value of these swaps decreased $1.9 million for the three months ended March 31, 2008.  Included in the net $1.9 million decrease is a $1.2 million increase related to the credit value adjustment resulting from our initial application of FAS 157 (see Note 2).  The fair value of these swaps decreased $3.6 million for the three months ended March 31, 2007.

9. Stockholders’ Equity and Minority Interests

Minority interests in our operating partnership relate to interests in our operating partnership that are not owned by us, which amounted to approximately 22% at March 31, 2008.  A unit in our operating partnership and a share of our common stock have essentially the same economic characteristics as they share equally in the total net income or loss distributions of our operating partnership.  Investors who own units in our operating partnership, have the right to cause our operating partnership to redeem any or all of their units in our operating partnership for cash equal to the then-current market value of one share of common stock, or, at our election, shares of our common stock on a one-for-one basis.

During the first quarter of 2008, we formed a joint venture to purchase an office building in Honolulu, Hawaii.  The joint venture is two-thirds owned by our operating partnership and is consolidated in our financial statements as of March 31, 2008.

Dividends

During 2008 and 2007, we declared quarterly dividends of $0.1875 and $0.175 per share, respectively, which equals an annual rate of $0.75 and $0.70 per share, respectively.

Equity Conversions and Repurchases

During the first three months of 2008, investors converted 11.4 million units to shares and we repurchased approximately 1.1 million share equivalents in private transactions for a total consideration of approximately $23.8 million.  We may make additional purchases of our share equivalents from time to time in private transactions or in the public markets, but do not have any commitments to do so.

Taxability of Dividends

Earnings and profits, which determine the taxability of distributions to stockholders, will differ from income reported for financial reporting purposes due to the differences for federal income tax purposes in the treatment of loss on extinguishment of debt, revenue recognition, compensation expense and in the basis of depreciable assets and estimated useful lives used to compute depreciation.

 

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Douglas Emmett, Inc.

Notes to Consolidated Financial Statements--(continued)

(in thousands, except shares and per share data)

10. Stock-Based Compensation

On December 16, 2004, the FASB issued FAS No. 123 (revised 2004), Share-Based Payment (FAS 123R), which is a revision of FAS 123, Accounting for Stock-Based Compensation.  Generally, the approach in FAS 123R is similar to the approach described in FAS 123.  However, FAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values.

The Douglas Emmett, Inc. 2006 Omnibus Stock Incentive Plan, our stock incentive plan, was adopted by our board of directors and approved by our stockholders prior to the consummation of our IPO. Our stock incentive plan is administered by the compensation committee of our board of directors.  All full-time and part-time officers, employees, directors and other key persons (including consultants and prospective employees) are eligible to participate in our stock incentive plan.  For more information on our stock incentive plan, please refer to the notes to the consolidated financial statements in our 2007 Annual Report on Form 10-K.

During the first quarter of 2008, we granted approximately 2.7 million long-term incentive units and stock options with a total fair market value of $9.9 million.  For the three months ended March 31, 2008, we recognized non-cash compensation expense of $1.2  million upon the vesting of such equity awards, compared to $0.7 million for the three months ended March 31, 2007.  An additional $2.2 million of equity awards vested during the three months ended March 31, 2008 to satisfy a portion of the bonus accrued during 2007.

11. Commitments and Contingencies

We are subject to various legal proceedings and claims that arise in the ordinary course of business. These matters are generally covered by insurance. We believe that the ultimate outcome of these actions will not have a material adverse effect on our financial position and results of operations or cash flows.

Concentration of Credit Risk

Our properties are located in Los Angeles County, California and Honolulu, Hawaii. The ability of the tenants to honor the terms of their respective leases is dependent upon the economic, regulatory and social factors affecting the markets in which the tenants operate.  We perform ongoing credit evaluations of our tenants for potential credit losses.  Financial instruments that subject us to credit risk consist primarily of cash, accounts receivable, deferred rents receivable and interest rate contracts. We maintain our cash and cash equivalents with high quality financial institutions. Accounts at each institution are insured by the Federal Deposit Insurance Corporation up to $100, and to date, we have not experienced any losses on our deposited cash.

Asset Retirement Obligations

In March 2005, the FASB issued Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations—an interpretation of FASB Statement No. 143 (FIN 47).  FIN 47 clarifies that the term “conditional asset retirement obligation” as used in FAS No. 143, Accounting for Asset Retirement Obligations, represents 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 a company’s control.  Under this standard, 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 and investigations have identified 18 properties in our portfolio containing asbestos, which would have to be removed in compliance with applicable environmental regulations if these properties undergo major renovations or are demolished. As of March 31, 2008, the obligations to remove the asbestos from these properties have indeterminable settlement dates, and therefore, we are unable to reasonably estimate the fair value of the associated conditional asset retirement obligation.

 

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Douglas Emmett, Inc.

Notes to Consolidated Financial Statements--(continued)

(in thousands, except shares and per share data)

Future Minimum Lease Payments

We lease portions of the land underlying three of our office properties as more fully described in the notes to consolidated financial statements contained in our 2007 Annual Report on Form 10-K. We expensed ground lease payments in the amount of $786 and $861 for the three months ended March 31, 2008 and 2007, respectively.

The following is a schedule of minimum ground lease payments as of March 31, 2008:

April 1, 2008 to December 31, 2008	$	633
2009		707
2010		733
2011		733
2012		733
Thereafter		4,520
	$	8,059

Tenant Concentrations

For the three months ended March 31, 2008 and 2007, no tenant exceeded 10% of our total rental revenue and tenant reimbursements.

12. Segment Reporting

FAS No. 131, Disclosures about Segments of an Enterprise and Related Information, established standards for disclosure about operating segments and related disclosures about products and services, geographic areas and major customers. Segment information is prepared on the same basis that our management reviews information for operational decision-making purposes. We have operated in two business segments: (i) the acquisition, redevelopment, ownership and management of office real estate and (ii) the acquisition, redevelopment, ownership and management of multifamily real estate.  The products for our office segment include primarily rental of office space and other tenant services including parking and storage space rental. The products 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 and make decisions to allocate resources. Therefore, depreciation and amortization expense is not allocated among segments.  Interest and other income, management services, general and administrative expenses, interest expense, depreciation and amortization expense and net derivative gains and losses are not included in rental revenues less rental expenses as the internal reporting addresses these items on a corporate level.

 

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Douglas Emmett, Inc.

Notes to Consolidated Financial Statements--(continued)

(in thousands, except shares and per share data)

Rental revenues less rental expenses is not a measure of operating results or cash flows from operating activities as measured by GAAP, and it is not indicative of cash available to fund cash needs and should not be considered an alternative to cash flows as a measure of liquidity. Not all companies may calculate rental revenues less rental expenses in the same manner. We consider rental revenues less rental expenses to be an appropriate supplemental measure to net income because it assists both investors and management in understanding the core operations of our properties.

 

		Three Months Ended March 31, 2008
		Office				Multifamily				Total
Rental revenues		$	117,044			$	17,784			$	134,828
Percentage of total			87	%			13	%			100	%
Rental expenses		$	31,364			$	3,877			$	35,241
Percentage of total			89	%			11	%			100	%
Rental revenues less rental expenses		$	85,680			$	13,907			$	99,587
Percentage of total			86	%			14	%			100	%

 

		Three Months Ended March 31, 2007
		Office				Multifamily				Total
Rental revenues		$	110,898			$	17,005			$	127,903
Percentage of total			87	%			13	%			100	%
Rental expenses		$	33,294			$	4,923			$	38,217
Percentage of total			87	%			13	%			100	%
Rental revenues less rental expenses		$	77,604			$	12,082			$	89,686
Percentage of total			87	%			13	%			100	%

 

The following is a reconciliation of rental revenues less rental expenses to net loss:

		Three Months Ended March 31,
		2008				2007
Rental revenues less rental expenses		$	99,587			$	89,686
Interest and other income			409				82
General and administrative expenses			(5,285	)			(5,042	)
Interest expense			(41,203	)			(38,302	)
Depreciation and amortization			(56,749	)			(51,121	)
Minority interests			741				1,424
Net loss		$	(2,500	)		$	(3,273	)

13. Subsequent Events

On May 1, 2008, the remaining $115 million of debt described in Note 7 was funded.

As described in Note 3, in February 2008, we acquired an office building in Honolulu, Hawaii.  Located in this building is a private membership athletic and social club known as The Honolulu Club.  We acquired the net assets of the club as part of the transaction to acquire the building.  Subsequent to the end of the first quarter, we entered into an agreement to sell the net assets of The Honolulu Club to a third party, while retaining a lease for the space they occupy in the office building that we now own.  The total sales price was not material.

 

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