Douglas Emmett Inc - Quarter Report: 2006 September (Form 10-Q)

United States
Securities and Exchange Commission

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13
OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarter ended September 30, 2006

Commission file number 1-33106

DOUGLAS EMMETT, INC.

(Exact name of registrant as specified in its charter)

 

808 Wilshire Boulevard,

Suite 200

Santa Monica, California 90401

(Address and zip code of principal executive offices)

(310) 255-7700

Registrant’s telephone number, including area code:

None

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  x     No  o                 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  o     Accelerated filer  o     Non-accelerated filer  x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes  o     No  x                 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

DOUGLAS EMMETT, INC.
FORM 10-Q
TABLE OF CONTENTS

 

2

Part I. FINANCIAL INFORMATION
Item 1. Financial Statements

Douglas Emmett, Inc.
Consolidated Balance Sheets
(in thousands, except for share data)

 

The accompanying notes are an integral part of the consolidated financial statements.

3

Douglas Emmett, Inc.
Consolidated Statements of Income
(Unaudited and in thousands, except for share data)

 

The accompanying notes are an integral part of the consolidated financial statements.

4

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

 

The accompanying notes are an integral part of the consolidated financial statements.

5

Douglas Emmett, Inc.
Notes to Consolidated Financial Statements
September 30, 2006
(Unaudited and in thousands, except for share data)

1. Organization and Basis of Presentation

Douglas Emmett, Inc. is a Maryland corporation formed on June 28, 2005 which did not have any meaningful operating activity until the consummation of our initial public offering and the related acquisition of our predecessor and certain other entities in October 2006. Accordingly, we believe that a discussion of the results of Douglas Emmett, Inc. would not be meaningful for the periods covered by these financial statements.

As described in Footnote 13, we acquired our predecessor and certain other entities simultaneously with the closing of our initial public offering on October 30, 2006. In these transactions:

·       In our initial public offering we issued a total of 75,900,000 shares of our common stock in exchange for net proceeds of approximately $1.52 billion in cash.

·       In our formation transactions, we acquired certain assets of our predecessor and other entities in exchange for the assumption or discharge of $2.54 billion in indebtedness and preferred equity, the payment of $1.89 billion in cash, and the issuance of 49.1 million common units of our operating partnership and 39.1 million shares of our common stock.

·       We increased the amount of our existing $1.76 billion term loan financing by $545.0 million and also entered into a $250.0 million senior secured revolving credit facility, with an accordion feature to increase the availability to $500.0 million under specified circumstances.

Because these transactions did not occur until after September 30, 2006, the historical financial results in these financial statements relate to our accounting predecessor only. Our predecessor includes Douglas Emmett Realty Advisors, Inc., or DERA, as the accounting acquirer, and nine consolidated real estate limited partnerships that owned, directly or indirectly, office and multifamily properties and fee interests in land subject to ground leases, which we refer to collectively as the “institutional funds”. For all periods presented, DERA was the general partner of, and had responsibility for the asset management of, our predecessor. As of each of September 30, 2006 and December 31, 2005, our predecessor owned 42 office properties and the fee interest in two parcels of land that we lease to third parties under long-term ground leases, and as of September 30, 2006 and December 31, 2005, our predecessor owned six and five multifamily properties, respectively.

Our predecessor does not include certain other entities we acquired at the time of initial public offering (“IPO”), including Douglas, Emmett and Company, or DECO, P.L.E. Builders, Inc., or PLE, and seven California limited partnerships and one California limited liability company, which we refer to collectively as the “single-asset entities.” DECO provided property management and leasing services to all of the properties acquired in the formation transactions, and PLE provided construction services in connection with improvements to tenant suites and common areas in the properties. Each single-asset entity owns, directly or indirectly, one multifamily or office property (or, in one case, a fee interest in land subject to a ground lease).

After the completion of the IPO and the related formation transactions which occurred subsequent to the period covered by these financial statements, we are a fully integrated, self-administered, and self-managed Real Estate Investment Trust (“REIT”). Through our controlling interest in Douglas Emmett Properties, LP (the Operating Partnership) and its subsidiaries, we own, manage, lease, acquire and

6

---

Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (Continued)
September 30, 2006
(Unaudited and in thousands, except for share data)

develop real estate, consisting primarily of office and multifamily properties and owned, as of October 31, 2006, a portfolio of 46 office properties (including ancillary retail space) and nine multifamily properties, as well as the fee interests in three parcels of land subject to ground leases. All of these properties are located in Los Angeles County, California and Honolulu, Hawaii. We expect to qualify as a REIT for federal income tax purposes beginning with our initial taxable year ending December 31, 2006.

2. Summary of Significant Accounting Policies

Basis of Presentation

In March 2005, the Emerging Issues Task Force (EITF) of the Financial Accounting Standards Board (FASB) reached a consensus on Issue No. 04-5, Investor’s Accounting for an Investment in a Limited Partnership When the Investor is the Sole General Partner and the Limited Partners Have Certain Rights. EITF 04-5 clarifies certain aspects of Statement of Positions 78-9 Accounting for Investments in Real Estate Ventures, and provides guidance on determining whether a sole general partner in a limited partnership should consolidate its investment in a limited partnership. DERA is the sole general partner of the institutional funds and the limited partners of the institutional funds do not have substantive “kick-out” or participation rights as defined by EITF 04-5. DERA early adopted the guidance of EITF 04-5 and has consolidated the institutional funds retrospectively.

The accompanying consolidated financial statements represent the historical financial statements of our predecessor. They include the accounts of DERA and the institutional funds, but do not include the accounts of the non predecessor entities which were acquired at the time of the IPO as discussed in Note 1. All significant intercompany balances and transactions have been eliminated in the consolidated financial statements.

Unaudited Interim Financial Information

The accompanying unaudited interim financial statements have been prepared by the Company’s management pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosure normally included in the financial statements prepared in accordance with U.S. generally accepted accounting principals may have been condensed or omitted pursuant to such rules and regulations, although management believes that the disclosures are adequate to make the presentation not misleading. The accompanying unaudited financial statements include, in the opinion of management, 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, 2006. The interim financial statements should be read in conjunction with the predecessor’s audited financial statements for the year ended December 31, 2005 and notes thereto included in our Prospectus.

Use of Estimates

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make certain estimates and assumptions that affect the reported amounts in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

7

---

Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (Continued)
September 30, 2006
(Unaudited and in thousands, except for share data)

Segment Information

Statement of Financial Accounting Standards (SFAS) 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 the Company’s management reviews information for operational decision making purposes. Our predecessor operated two business segments: the acquisition, redevelopment, ownership and management of office real estate and the acquisition, redevelopment, ownership and management of multifamily real estate.

The products for the office segment include primarily rental of office space and other tenant services including parking and storage space rental. The products for the multifamily segment include rental of apartments and other tenant services including parking and storage space rental.

Investment in Real Estate

Acquisitions of properties subsequent to June 30, 2001, the effective date of SFAS No. 141, Business Combinations, are accounted for utilizing the purchase method and accordingly, the results of operations of acquired properties are included in our results of operations from the respective dates of acquisition. Estimates of future cash flows and other valuation techniques are used to allocate the purchase price of acquired property between land, buildings and improvements, equipment and identifiable intangible assets and liabilities such as amounts related to in-place at-market leases, acquired above-market ground leases, acquired above and below-market leases and tenant relationships. Initial valuations are subject to change until such information is finalized, but no later than 12 months from the acquisition date.

The net above and below market tenant and ground lease liability is summarized as follows:

(1)          Included in other assets in our predecessor’s consolidated balance sheets.

(2)          Included in accounts payable, accrued expenses and tenant security deposits in our predecessor’s consolidated balance sheets.

8

---

Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (Continued)
September 30, 2006
(Unaudited and in thousands, except for share data)

(3)          Included in accounts payable, accrued expenses and tenant security deposits in our predecessor’s consolidated balance sheets and amortized into office rental operating expenses.

Interest Rate Agreements

Our predecessor managed its interest rate risk associated with borrowings by obtaining interest rate swap and interest rate cap contracts. No other derivative instruments were used.

In June 1998, the FASB issued SFAS No. 133 Accounting for Derivative Instruments and Hedging Activities (SFAS No. 133, as amended by SFAS No. 138). The statement requires our predecessor to recognize all derivatives on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value and the changes in fair value must be reflected as income or expense. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of derivatives are either offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings or recognized in other comprehensive income, a component of stockholders’ equity (deficit) until the hedged item is recognized in earnings. The ineffective portion of a derivative’s change in fair value is immediately recognized in earnings. Our predecessor’s investments in interest rate swap and interest rate cap contracts did not qualify as effective hedges, and as such, the changes in such contracts’ fair market values are being recorded in earnings.

Income Taxes

As a REIT, we will be permitted to deduct distributions paid to our stockholders, eliminating the federal taxation of income represented by such distributions at the company level. REITs are subject to a number of organizational and operational requirements. If we fail to qualify as a REIT in any taxable year, we will be subject to federal income tax (including any applicable alternative minimum tax) on our taxable income at regular corporate tax rates.

DERA was an S-Corporation and the institutional funds were limited partnerships. 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.

3. Investment in Real Estate

Investment in real estate for the predecessor consists of the following:

 

9

---

Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (Continued)
September 30, 2006
(Unaudited and in thousands, except for share data)

In March 2006, DERA acquired from unrelated parties a multifamily property in Honolulu, Hawaii. The aggregate acquisition costs of this property approximated $113,730 (2006 acquisition).

In January 2005, DERA acquired from unrelated parties an office building in Woodland Hills, California and a multifamily property in Honolulu, Hawaii (2005 acquisition). The aggregate acquisition costs of these properties approximated $270,370.

The following table summarizes the allocation of estimated fair values of the assets acquired and liabilities assumed at the date of acquisition.

 

4. Other Assets

Other assets for the predecessor consist of the following:

 

DERA incurred deferred loan cost amortization expense of $625 and $7,570 for the three months ended September 30, 2006 and 2005, and $2,304 and $9,878 for the nine months ended September 31, 2006 and 2005, respectively. The deferred loan cost amortization is included as a component of interest expense in the consolidated statements of income.

10

---

Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (Continued)
September 30, 2006
(Unaudited and in thousands, except for share data)

5. Minimum Future Lease Rentals

Our predecessor 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 for the three months ended September 30, 2006 and 2005 were $4,364 and $3,267, respectively. Operating expense reimbursements for the nine months ended September 30, 2006 and 2005 were $13,267 and $9,866, respectively.

Our predecessor leased space to certain tenants under noncancelable leases which provide for contingent rents based upon tenant revenues. The contingent rental income for the three months ended September 30, 2006 and 2005 totaled $190 and $242, respectively. The contingent rental income for the nine months ended September 30, 2006 and 2005 totaled $763 and $711, respectively.

Future minimum base rentals for our predecessor on noncancelable operating leases at September 30, 2006, are as follows:

 

The above future minimum lease payments exclude 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.

6. Secured Notes Payable

A summary of secured notes payable of our predecessor is as follows:

(1)           All of our floating rate debt has been fixed through interest rate swaps. See note 8 for our predecessor’s interest rate agreements outstanding at September 30, 2006. The effective interest rate disclosed includes the impact of our predecessor’s interest rate swaps.

11

---

Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (Continued)
September 30, 2006
(Unaudited and in thousands, except for share data)

(2)           Secured by the following properties and combined in seven separate cross collateralized pools: Studio Plaza, Gateway Los Angeles, Bundy/Olympic, Brentwood Executive Plaza, Palisades Promenade, 12400 Wilshire, First Federal Square, 11777 San Vicente, Landmark II, Sherman Oaks Galleria, Second Street Plaza, Olympic Center, MB Plaza, Valley Office Plaza, Coral Plaza, Westside Towers, Valley Executive Tower, Encino Terrace, Westwood Place, Century Park Plaza, Lincoln/Wilshire, 100 Wilshire, Encino Gateway, Encino Plaza, 1901 Avenue of the Stars, Columbus Center, Warner Center Towers, Beverly Hills Medical Center, Harbor Court and Bishop Place.

(3)           Requires monthly payments of interest only, with outstanding principal due upon maturity.

(4)           Fannie Mae Discount Mortgage-Backed Security (DMBS). The Fannie Mae DMBS generally tracks 90-day LIBOR.

(5)           This note was repaid on October 30, 2006 in conjunction with the formation transactions.

Upon completion of the IPO and formation transactions, our existing $1.76 billion modified term loan financing was amended increasing the term loan by $545.0 million, which we refer to herein as the amended modified term loan. The amended modified term loan matures on September 1, 2012, subject to the existence of no default and the payment of a fee on the fifth and sixth anniversary of August 25, 2005, and bears interest at a rate per annum equal to the London Interbank Offer Rate, or LIBOR, plus 85 basis points.

The minimum future principal payments due on the predecessor’s secured notes payable at September 30, 2006, are as follows:

 

Senior Secured Revolving Credit Facility

In conjunction with our IPO and formation transactions, we entered into a $250.0 million secured revolving credit facility with a group of banks led by Bank of America, NA and Banc of America Securities, LLC, which bears interest at a rate per annum equal to LIBOR plus 70 basis points if the amount outstanding is $175.0 million or less and at LIBOR plus 80 basis points if the amount outstanding is greater than $175.0 million. The senior secured revolving credit facility contains an accordion feature that allows us to increase the availability by $250.0 million, to $500.0 million, under specified circumstances. The facility bears interest at 15 basis points on the undrawn balance. The facility has a term of three years and two one-year extensions.

12

Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (Continued)
September 30, 2006
(Unaudited and in thousands, except for share data)

7. Accounts Payable, Accrued Expenses and Tenant Security Deposits

Accounts payable, accrued expenses and tenant security deposits for our predecessor consist of the following:

 

8. Interest Rate Agreements

The table below lists our predecessor’s derivative instruments, and their fair values as of September 30, 2006 and December 31, 2005:

 

Any change in fair value of interest rate contracts of our predecessor was recorded as a gain or loss in the statement of operations because such contracts did not qualify as effective hedges under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS 133, as amended by SFAS 138). In conjunction with the offering, we entered into a series of interest rate swaps that effectively offset any future changes in the fair value of all of our existing interest rate contracts. These new interest rate contracts will also not qualify for hedge accounting under SFAS 133. Our existing interest rate contracts resulted in an asset with a fair value of approximately $72.8 million as of the closing of our IPO.

13

---

Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (Continued)
September 30, 2006
(Unaudited and in thousands, except for share data)

Interest rate contracts resulted in this value being “locked-in” after the completion of our IPO. We will collect over the remaining life of these interest rate contracts an amount equal to the net fair value recorded.

We also entered into a new series of $2.205 billion of interest rate swap contracts that effectively hedged our variable rate debt from future changes in interest rates. Unlike the interest rate contracts described above, we expect the new interest rate contracts to qualify for cash flow hedge accounting treatment under SFAS 133, and as such, all future changes in fair value of the new interest rate contracts for periods after this offering will be recognized in other comprehensive income until the hedged item is recognized in earnings. Any ineffective portion of the new interest rate contracts’ change in fair value is immediately recognized in earnings.

On October 31, 2006 we executed $545 million of fixed-to-floating interest rate swaps at a rate of approximately 4.90%. These swaps effectively fixed our $545 million in additional borrowings on our amended modified term loan at a rate of 5.75%. These swaps mature on December 1, 2010. We expect these swaps to also qualify for cash flow hedge accounting treatment under SFAS No. 133.

9. Minority Interests in Consolidated Real Estate Partnerships

Our predecessor reflected unaffiliated partners’ interests in the institutional funds as minority interest in consolidated real estate partnerships. Minority interest in consolidated real estate partnerships represented the minority partners’ share of the underlying net assets of our predecessor’s consolidated real estate partnerships. When these consolidated real estate partnerships made cash distributions to partners in excess of the carrying amount of the minority interest, our predecessor generally recorded a charge equal to the amount of such excess distributions, even though there was no economic effect or cost. If the excess distributions previously absorbed by our predecessor were recovered through the future earnings of the consolidated real estate partnership, our predecessor would record income in the period of recovery. Our predecessor reported this charge and any subsequent recovery in the consolidated statements of operations as deficit recovery (distributions) from (to) minority partners, net.

After the completion of the IPO and formation transactions, the continuing investors (including our predecessor principals and our executive officers) that elected to own our Operating Partnership units comprise the minority interests in our Operating Partnership.

A preferred minority investor invested $99,000 and $85,000, in 2005 and 2004, respectively, in two of our predecessor’s consolidated subsidiaries. In return, the preferred minority investor received a profit participation of 8.75% per annum on its unreturned capital contribution. The preferred investor’s contributed capital is reflected in the predecessor’s balance sheets as a component of minority interests as of September 30, 2006 and December 31, 2005.  The preferred minority investor’s interest was redeemed in conjunction with the IPO and formation transactions.

10. Related-Party Transactions

Our predecessor paid $1,673 and $1,816 in real estate commissions to an operating company owned by the stockholders of DERA for the three months ended September 30, 2006 and 2005, and $5,626 and

14

---

Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (Continued)
September 30, 2006
(Unaudited and in thousands, except for share data)

$4,713 for the nine months ended September 30, 2006 and 2005, respectively. The commissions paid to the operating company are accounted for as leasing costs and are included in our predecessor’s investment in real estate in the consolidated balance sheets.

Our predecessor contributed its share of discretionary profit-sharing contribution (subject to statutory limitations), totaling $192 and $180 for the three and nine months ended September 30, 2006 and 2005, for services rendered by employees of an operating company owned by the stockholders of DERA.

Property management fees related to management services were paid to an operating company owned by the stockholders of DERA. The management fees are based upon percentages of the rental cash receipts collected by the properties. The fees range from 1.75% to 4.00% of the cash receipts. Our predecessor expensed $2,649 and $2,270 in such property management fees for the three months ended September 30, 2006 and 2005, and $7,356 and $6,727 for the nine months ended September 30, 2006 and 2005, respectively. At September 30, 2006 and December 31, 2005, our predecessor had $823 and $600, respectively, in accrued and unpaid property management fees.

Our predecessor contracted with an operating company owned by the stockholders of DERA to provide building and tenant improvement work. For the three and nine months ended September 30, 2006 and 2005, amounts totaling $5,593 and $4,903 and $10,425 and $10,607, respectively, were paid to the operating company for contracting work performed. These amounts are included in the costs basis of the buildings and in tenant improvements.

Our predecessor leased approximately 26,785 square feet of office space to two operating companies owned or controlled by the stockholders of DERA. The rents from these leases totaled $200 for the three months ended September 30, 2006 and 2005 and $599 for the nine months ended September 30, 2006 and 2005.

On March 15, 2006, DERA’s stockholders contributed $60,000 to DERA in the form of promissory notes. As part of the IPO and formation transactions, these notes were repaid.

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 settlement of these actions will not have a material adverse effect to 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. 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. We perform ongoing credit evaluations of our tenants for potential credit losses.

15

---

Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (Continued)
September 30, 2006
(Unaudited and in thousands, except for share data)

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 SFAS 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. FIN 47 is effective for fiscal years ending after December 15, 2005. Environmental site assessments and investigations have identified 14 properties in our portfolio containing asbestos. If these properties undergo major renovations or are demolished, certain environmental regulations are in place, which specify the manner in which the asbestos must be handled and disposed. As of September 30, 2006, 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 conditional asset retirement obligation.

Future Minimum Lease Payments

At September 30, 2006, our predecessor has leased portions of the land underlying three of our office properties as more fully described in the notes to the predecessor’s December 31, 2005 consolidated financial statements contained in the Company’s Prospectus dated October 23, 2006. Our predecessor expensed ground lease payments in the amount of $845 and $829 for the three months ended September 30, 2006 and 2005 and $2,520 and $2,475 for the nine months ended September 30, 2006 and 2005, respectively.

The following is a schedule of minimum ground lease payments as of September 30, 2006:

 

Tenant Concentrations

For the nine months ended September 30, 2006 and 2005, no tenant exceeded 10% of our predecessor’s total rental revenue and tenant reimbursements.

16

---

Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (Continued)
September 30, 2006
(Unaudited and in thousands, except for share data)

12. Segment Reporting

Our predecessor’s segments are based on our predecessor’s method of internal reporting which classified its operations by property type. Our predecessor’s segments by property type included: Office and Multifamily.

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.

Rental revenues less rental expenses is not a measure of operating results or cash flows from operating activities as measured by U.S. generally accepted accounting principles, 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. All companies may not calculate rental revenues less rental expenses in the same manner. Our predecessor considered rental revenues less rental expenses to be an appropriate supplemental measure to net income because it assisted both investors and management to understand the core operations of our predecessor’s properties.

 

 

17

---

Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (Continued)
September 30, 2006
(Unaudited and in thousands, except for share data)

 

 

 

The following is a reconciliation of rental revenues less rental expenses to net (loss) income available to common stockholders:

 

13. Subsequent Events

On October 23, 2006, we adopted the Douglas Emmett, Inc. 2006 Omnibus Stock Incentive Plan. The stock incentive plan permits us to make grants of ‘‘incentive stock options, non-qualified stock options, stock appreciation rights, deferred stock awards, restricted stock awards, dividend equivalent rights and

18

---

Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (Continued)
September 30, 2006
(Unaudited and in thousands, except for share data)

other stock-based awards’’ within the meaning of Section 422 of the Code, or any combination of the foregoing. We have initially reserved 16,500,000 shares of our common stock for the issuance of awards under our stock incentive plan. The number of shares reserved under our stock incentive plan is also subject to adjustment in the event of a stock split, stock dividend or other change in our capitalization. Generally, shares that are forfeited or canceled from awards under our stock incentive plan also will be available for future awards. On October 23, 2006, pursuant to our stock incentive plan our operating partnership issued an aggregate of 1,089,000 LTIP units and we issued options to purchase an aggregate of 5,742,221 shares of our common stock at an exercise price of $21. Certain of these LTIP Units and options were immediately vested, while others vest over three to four years.

On October 30, 2006 (i) we issued a total of 75,900,000 shares of our common stock in our initial public offering in exchange for net proceeds of  approximately $1.52 billion in cash; (ii) we acquired certain assets of our predecessor and other entities in exchange for the assumption or discharge of $2.54 billion in indebtedness and preferred equity, the payment of $1.89 billion in cash, and the issuance of 49.1 million operating partnership units and 39.1 million shares of our common stock; and (iii) we increased the amount of our existing $1.76 billion term loan financing by $545.0 million and entered into a $250.0 million senior secured revolving credit facility.

19