FORM 10-Q

TABLE OF CONTENTS

				PAGE NO.
PART I.	FINANCIAL INFORMATION			3
	Item 1.	Financial Statements		3
		Consolidated Balance Sheets as of June 30, 2008 (unaudited) and December 31, 2007		3
		Consolidated Statements of Operations for the three and six months ended June 30, 2008 and 2007 (unaudited)		4
		Consolidated Statements of Cash Flows for the six months ended June 30, 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		20
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk		26
	Item 4.	Controls and Procedures		26
PART II.	OTHER INFORMATION			27
	Item 1.	Legal Proceedings		27
	Item 1A.	Risk Factors		27
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		27
	Item 3.	Defaults Upon Senior Securities		27
	Item 4.	Submission of Matters to a Vote of Security Holders		27
	Item 5.	Other Information		28
	Item 6.	Exhibits		28
	SIGNATURES			29

 

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PART I.  FINANCIAL INFORMATION

Item 1.  Financial Statements

Consolidated Balance Sheets

(in thousands, except for share data)

		June 30, 2008				December 31, 2007
		(unaudited)
Assets
Investment in real estate
Land		$	890,148			$	825,560
Buildings and improvements			5,515,561				4,978,124
Tenant improvements and lease intangibles			530,368				460,486
			6,936,077				6,264,170
Less: accumulated depreciation			(362,721	)			(242,114	)
Net investment in real estate			6,573,356				6,022,056
Cash and cash equivalents			2,764				5,843
Tenant receivables, net			553				955
Deferred rent receivables, net			28,447				20,805
Interest rate contracts			94,932				84,600
Acquired lease intangible assets, net			21,701				24,313
Other assets			25,636				31,396
Total assets		$	6,747,389			$	6,189,968
Liabilities
Secured notes payable, including loan premium		$	3,734,941			$	3,105,677
Accounts payable and accrued expenses			58,262				62,704
Security deposits			35,298				31,309
Acquired lease intangible liabilities, net			219,730				218,371
Interest rate contracts			133,769				129,083
Dividends payable			22,760				19,221
Total liabilities			4,204,760				3,566,365
Minority interests			568,844				793,764
Stockholders’ Equity
Common stock, $0.01 par value 750,000,000 authorized, 121,385,617 and 109,833,903 outstanding at June 30, 2008 and December 31, 2007, respectively.			1,214				1,098
Additional paid-in capital			2,275,364				2,019,716
Accumulated other comprehensive income			(88,178	)			(101,163	)
Accumulated deficit			(214,615	)			(89,812	)
Total stockholders’ equity			1,973,785				1,829,839
Total liabilities and stockholders’ equity		$	6,747,389			$	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 June 30,								Six Months Ended June 30,
		2008				2007				2008				2007
Revenues
Office rental
Rental revenues		$	111,213			$	92,884			$	210,229			$	184,496
Tenant recoveries			7,269				5,575				12,637				13,761
Parking and other income			13,911				11,098				26,571				22,198
Total office revenues			132,393				109,557				249,437				220,455
Multifamily rental
Rental revenues			16,423				16,879				33,647				33,393
Parking and other income			559				526				1,119				1,017
Total multifamily revenues			16,982				17,405				34,766				34,410
Total revenues			149,375				126,962				284,203				254,865
Operating expenses
Office expense			36,574				31,337				67,938				64,631
Multifamily expense			3,759				3,872				7,636				8,795
General and administrative			5,729				5,120				11,014				10,162
Depreciation and amortization			63,858				50,494				120,607				101,615
Total operating expenses			109,920				90,823				207,195				185,203
Operating income			39,455				36,139				77,008				69,662
Interest and other income			123				372				532				454
Interest expense			(51,791	)			(38,313	)			(92,994	)			(76,615	)
Loss before minority interests			(12,213	)			(1,802	)			(15,454	)			(6,499	)
Minority interests			2,785				542				3,526				1,966
Net loss		$	(9,428	)		$	(1,260	)		$	(11,928	)		$	(4,533	)
Net loss per common share – basic and diluted		$	(0.08	)		$	(0.01	)		$	(0.10	)		$	(0.04	)
Dividends declared per common share		$	0.1875			$	0.175			$	0.375			$	0.35
Weighted average shares of common stock outstanding -basic and diluted			121,313,515				114,861,872				119,798,547				114,933,468

See notes to consolidated financial statements.

 

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Douglas Emmett, Inc.

Consolidated Statements of Cash Flows

(unaudited and in thousands)

		Six Months Ended June 30,
		2008				2007
Operating Activities
Net loss		$	(11,928	)		$	(4,533	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Minority interests			(3,526	)			(1,966	)
Depreciation and amortization			120,607				101,615
Net accretion of acquired lease intangibles			(21,690	)			(19,937	)
Amortization of deferred loan costs			840				500
Amortization of loan premium			(2,336	)			(2,205	)
Non-cash market value adjustments on interest rate contracts			7,339				6,529
Non-cash amortization of stock-based compensation			4,340				1,362
Change in working capital components
Tenant receivables			402				3,303
Deferred rent receivables			(7,642	)			(9,007	)
Accounts payable, accrued expenses and security deposits			(3,772	)			3,571
Other			8,145				(133	)
Net cash provided by operating activities			90,779				79,099
Investing Activities
Capital expenditures and property acquisitions			(642,750	)			(58,435	)
Net cash used in investing activities			(642,750	)			(58,435	)
Financing Activities
Proceeds from borrowings			1,052,700				285,500
Deferred loan costs			(3,225	)			(1,122	)
Repayment of borrowings			(383,600	)			(145,500	)
Net change in short-term borrowings			(37,500	)			-
Contribution by minority interest partner to consolidated joint venture			319				-
Distributions to minority interests			(14,753	)			(14,824	)
Redemption of minority interests			(23,758	)			(29,211	)
Issuance of common stock			667				-
Repurchase of common stock			-				(20,155	)
Cash dividends paid on common stock			(41,958	)			(33,927	)
Net cash provided by financing activities			548,892				40,761
Increase (decrease) in cash and cash equivalents			(3,079	)			61,425
Cash and cash equivalents at beginning of period			5,843				4,536
Cash and cash equivalents at end of period		$	2,764			$	65,961

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 incorporated 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 June 30, 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 June 30, 2008 and December 31, 2007 and for the three and six months ended June 30, 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 U.S. 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 the consolidated financial statements in 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 United States Public Company Accounting Oversight Board.

 

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 materially 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.  We do not use any other derivative instruments.

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 of 1986, as amended (IRC) 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 IRC relating 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 IRC, 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 are subject to taxation by various state and local (and potentially foreign) jurisdictions, including those in which we transact business or reside.  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.

 

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 and six months ended June 30, 2008 and 2007, 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 meant January 1, 2008.  We did not elect the fair value measurement option for any financial assets or liabilities during the first six months 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 January 1, 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 will require that transaction costs such as legal, accounting and advisory fees be expensed.  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 January 1, 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 June 30, 2008.

The table below presents the assets and liabilities measured at fair value on a recurring basis as of June 30, 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 June 30, 2008
Assets
Interest Rate Contracts		$              -		$94,932		$              -		$94,932
Liabilities
Interest Rate Contracts		$              -		$133,769		$              -		$133,769

 

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Douglas Emmett, Inc.

Notes to Consolidated Financial Statements--(continued)

(in thousands, except shares and per share data)

In March 2008, the FASB issued Statement No. 161, Disclosures about Derivative Instruments and Hedging Activities (FAS 161), an amendment of FAS 133, to expand disclosure requirements for an entity's derivative and hedging activities.  Under FAS 161, entities are required to provide enhanced disclosures about how and why an entity uses derivative instruments, how derivative instruments and related hedged items are accounted for under FAS 133 and its related interpretations, and how derivative instruments and related hedged items affect an entity's financial position, financial performance, and cash flows.  In order to meet these requirements, entities shall include quantitative disclosures about derivative fair values and gains/losses on derivative instruments, qualitative disclosures about objectives and strategies for using derivatives, and disclosures about credit-risk-related contingent features in derivative agreements. FAS 161 is effective for fiscal years and interim periods beginning after November 15, 2008, with early adoption encouraged.  We plan to adopt FAS 161 on January 1, 2009 and do not expect FAS 161 to have a significant impact as this statement only addresses disclosures.

 

 

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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 the London Interbank Offered Rate (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.  On May 1, 2008, the operations of the athletic club were transferred to a third party for a nominal cost.  Simultaneously, we entered into a lease of the space rented by the athletic club.  The results of operations and loss on sale of the assets of the athletic club were not material.

In May 2007, we acquired an approximate 50,000 rentable square foot Class “A” office building located in one of our core Los Angeles submarkets, Century City, for a contract price of $32 million.

 

The results of operations for each of the acquired properties are included in our consolidated statements of operations only from the date of each acquisition.  The following table summarizes the allocations of estimated fair values of the assets acquired and liabilities assumed at the date of acquisition.  The amounts shown for 2008 acquisitions represent our preliminary purchase price allocations.  These amounts are likely to change based on a more thorough calculation to be performed during the one-year purchase accounting period provided under the relevant accounting standards.

 

The following table represents acquisitions to our portfolio that impact the current reporting periods:

		2008 Acquisitions				2007 Acquisitions
Investment in real estate:
Land		$	64,558			$	3,650
Buildings and improvements			530,058				26,274
Tenant improvements and other in-place lease assets			51,063				3,024
Tenant receivables and other assets			-				24
Accounts payable, accrued expenses and tenant security deposits			(3,476	)			(988	)
Acquired lease intangible liabilities, net			(25,661	)			-
Net acquisition cost		$	616,542			$	31,984

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

		June 30, 2008				December 31, 2007
Above-market tenant leases		$	34,232			$	32,770
Accumulated amortization			(15,599	)			(11,564	)
Below-market ground leases			3,198				3,198
Accumulated amortization			(130	)			(91	)
Acquired lease intangible assets, net		$	21,701			$	24,313
Below-market tenant leases		$	288,383			$	261,260
Accumulated accretion			(82,301	)			(57,112	)
Above-market ground leases			16,200				16,200
Accumulated accretion			(2,552	)			(1,977	)
Acquired lease intangible liabilities, net		$	219,730			$	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:

		June 30,				December 31,
		2008				2007
Deferred loan costs, net of accumulated amortization of $2,144 and $1,304 at
at June 30, 2008 and December 31, 2007, respectively		$	7,372			$	4,987
Deposits in escrow			-				4,000
Restricted cash			2,835				2,848
Prepaid interest			3,480				7,944
Prepaid expenses			1,429				3,095
Interest receivable			5,038				3,229
Other indefinite-lived intangible			1,988				1,988
Other			3,494				3,305
		$	25,636			$	31,396

We incurred deferred loan cost amortization expense of $478 and $251 for the three months ended June 30, 2008 and 2007, and $840 and $500 for the six months ended June 30, 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 June 30, 2008 and 2007 totaled $185 and $357, respectively, and $429 and $621 for the six months ended June 30, 2008 and 2007, respectively.

Future minimum base rentals on noncancelable office and ground operating leases at June 30, 2008 were as follows:

July 1, 2008 to December 31, 2008		$	197,137
2009			371,293
2010			321,984
2011			266,867
2012			216,608
Thereafter			577,938
Total future minimum base rentals		$	1,951,827

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:

		June 30,				December 31,
		2008				2007
Accounts payable		$	31,018			$	43,449
Accrued interest payable			20,723				13,963
Deferred revenue			6,521				5,292
		$	58,262			$	62,704

7. Secured Notes Payable

During the first six months of 2008, we borrowed an additional $738 million of 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 one-month 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 one-month LIBOR plus 150 basis points, but we have entered into interest rate swap contracts that effectively fix the interest rate at 4.84%, 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.

·	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 one-month 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)

The following summarizes our secured notes payable at:

Type of Debt	June 30, 2008		December 31, 2007		Variable Rate		Effective Annual Fixed 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)	340,000		-		LIBOR + 1.50%		4.84		04/01/15		01/02/13
Fannie Mae Loan I (5)	293,000		293,000		DMBS + 0.60%		4.76		06/01/12		08/01/11
Fannie Mae Loan II(5)	95,080		95,080		DMBS + 0.60%		5.86		06/01/12		08/01/11
Fannie Mae Loan III(5)	36,920		36,920		DMBS + 0.60%		5.86		02/01/15		08/01/11
Fannie Mae Loan IV(5)	75,000		75,000		DMBS + 0.76%		4.93		02/01/15		08/01/11
Fannie Mae Loan V(5)	82,000		82,000		LIBOR + 0.62%		5.70		02/01/16		03/01/12
Fannie Mae Loan VI(5)	18,000		18,000		LIBOR + 0.62%		5.90		06/01/17		06/01/12
Subtotal	3,240,000	(6)	2,900,000				5.17%
Variable Rate:
General Electric Bridge Loan	380,000		-		LIBOR + 2.00%				01/02/09		--
Wells Fargo Loan(7)	18,000		-		LIBOR + 1.25%				03/01/10		--
$370 Million Senior Secured Revolving Credit Facility(8)	74,050		180,450		LIBOR / Fed Funds+(9)				10/30/09		--
Subtotal	3,712,050		3,080,450
Unamortized Loan Premium(10)	22,891		25,227
Total	$3,734,941		$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)	Secured by four properties in a cross-collateralized pool.  Requires monthly payments of interest only, with outstanding principal due upon maturity.

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

(6)	As of June 30, 2008, the weighted average remaining life of our total outstanding debt is 4.2 years, and the weighted average remaining life of the interest rate swaps is 2.9 years.

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

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

(9)	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.

(10)	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 June 30, 2008 were as follows:

July 1, 2008 to December 31, 2008	$	-
2009		454,050
2010		18,000
2011		-
2012		2,688,080
Thereafter		551,920
Total future principal	$	3,712,050

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 $3.24 billion to protect against interest rate fluctuations on our existing variable-rate term loan facilities.  These derivatives were designated and qualify as highly effective cash flow hedges under FAS 133 and remove the variability from the hedged cash flows.  The change in fair value of these cash flow hedges was recorded as an unrealized gain during each of the respective reporting periods shown in the following table.  Such unrealized gains were recorded to accumulated other comprehensive income in our consolidated balance sheets.  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 June 30,								Six Months Ended June 30,
		2008				2007				2008				2007
Net loss		$	(9,428	)		$	(1,260	)		$	(11,928	)		$	(4,533	)
Cash flow hedge adjustment			103,831				42,673				12,985				30,785
Comprehensive income		$	94,403			$	41,413			$	1,057			$	26,252

 

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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 $2.2 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 aggregate fair value of these swaps decreased $5.5 million and $2.9 million for the three months ended June 30, 2008 and 2007, respectively, and $7.4 million and $6.5 million for the six months ended June 30, 2008 and 2007, respectively.

9. Stockholders’ Equity and Minority Interests

Minority interests in our operating partnership relate to interests in that partnership which are not owned by us.  Minority interests amounted to approximately 22% of our operating partnership at June 30, 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.  At the end of each reporting period, we calculate the book value of net assets allocable to minority interests, and adjust the balance to reflect the calculated amount with a reclass to or from the retained earnings (accumulated deficit) balance.

Minority interests also includes the interest of a minority partner in a joint venture formed during the first quarter of 2008 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 June 30, 2008, with the minority interest eliminated.

Dividends

During the first six months of 2008 and 2007, we declared quarterly dividends of $0.1875 and $0.175 per share, respectively, which equals an annualized rate of $0.75 and $0.70 per share, respectively.

Equity Conversions and Repurchases

During the first six months of 2008, investors converted 11.5 million operating partnership units to shares of common stock 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.  Also, during the first six months of 2008, we issued approximately 31,000 shares of common stock to satisfy the exercise of certain vested employee stock options.

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

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.  No additional grants have been made during 2008.  Upon the vesting of equity awards, we recognized non-cash compensation expense of $1.0 million and $0.7 million for the three months ended June 30, 2008 and 2007 respectively, and $2.1 million and $1.4 million for the six months ended June 30, 2008 and 2007, respectively.  An additional $2.2 million of equity awards vested during the first quarter of 2008 to satisfy a portion of the bonuses 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 premier submarkets within 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 $100,000.00 and to date, we have not experienced any losses on our deposited cash.  All of our deposits are maintained at banks with investment grade ratings as evaluated by the predominant rating agencies.

Asset Retirement Obligations

FASB Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations—an interpretation of FASB Statement No. 143 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 June 30, 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 $805 and $843 for the three months ended June 30, 2008 and 2007, respectively, and $1,591 and $1,704 for the six months ended June 30, 2008 and 2007, respectively.

The following is a schedule of minimum ground lease payments as of June 30, 2008:

July 1, 2008 to December 31, 2008		$	288
2009			707
2010			733
2011			733
2012			733
Thereafter			4,520
		$	7,714

Tenant Concentrations

For the six months ended June 30, 2008 and 2007, no tenant accounted for more than 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.

    The following table represents operating activity within our reportable segments:

	Three Months Ended June 30, 2008												Three Months Ended June 30, 2007
		Office				Multifamily				Total				Office				Multifamily				Total
Rental revenues	$	132,393			$	16,982			$	149,375			$	109,557			$	17,405			$	126,962
Percentage of total		89	%			11	%			100	%			86	%			14	%			100	%
Rental expenses	$	36,574			$	3,759			$	40,333			$	31,337			$	3,872			$	35,209
Percentage of total		91	%			9	%			100	%			89	%			11	%			100	%
Rental revenues less rental expenses	$	95,819			$	13,223			$	109,042			$	78,220			$	13,533			$	91,753
Percentage of total		88	%			12	%			100	%			85	%			15	%			100	%

	Six months Ended June 30, 2008												Six months Ended June 30, 2007
		Office				Multifamily				Total				Office				Multifamily				Total
Rental revenues	$	249,437			$	34,766			$	284,203			$	220,455			$	34,410			$	254,865
Percentage of total		88	%			12	%			100	%			86	%			14	%			100	%
Rental expenses	$	67,938			$	7,636			$	75,574			$	64,631			$	8,795			$	73,426
Percentage of total		90	%			10	%			100	%			88	%			12	%			100	%
Rental revenues less rental expenses	$	181,499			$	27,130			$	208,629			$	155,824			$	25,615			$	181,439
Percentage of total		87	%			13	%			100	%			86	%			14	%			100	%

 

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

		Three Months Ended June 30,								Six Months Ended June 30,
		2008				2007				2008				2007
Rental revenues less rental expenses		$	109,042			$	91,753			$	208,629			$	181,439
Interest and other income			123				372				532				454
General and administrative expenses			(5,729	)			(5,120	)			(11,014	)			(10,162	)
Interest expense			(51,791	)			(38,313	)			(92,994	)			(76,615	)
Depreciation and amortization			(63,858	)			(50,494	)			(120,607	)			(101,615	)
Minority interests			2,785				542				3,526				1,966
Net loss		$	(9,428	)		$	(1,260	)		$	(11,928	)		$	(4,533	)

 

 

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