FORM 10-Q

TABLE OF CONTENTS

			PAGE NO.
PART I.	FINANCIAL INFORMATION		3
	Item 1.	Financial Statements	3
		Consolidated Balance Sheets as of September 30, 2009 and December 31, 2008 (unaudited)	3
		Consolidated Statements of Operations for the three and nine months ended September 30, 2009 and 2008 (unaudited)	4
		Consolidated Statements of Cash Flows for the nine months ended September 30, 2009 and 2008 (unaudited)	5
		Notes to Consolidated Financial Statements	6
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	24
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	30
	Item 4.	Controls and Procedures	30
PART II.	OTHER INFORMATION		31
	Item 1.	Legal Proceedings	31
	Item 1A.	Risk Factors	31
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	31
	Item 3.	Defaults Upon Senior Securities	31
	Item 4.	Submission of Matters to a Vote of Security Holders	32
	Item 5.	Other Information	32
	Item 6.	Exhibits	32
	SIGNATURES		33

 

 

---

 

PART I.  FINANCIAL INFORMATION

Item 1.  Financial Statements

Consolidated Balance Sheets

(unaudited and in thousands, except for share data)

 

		September 30, 2009				December 31, 2008
Assets
Investment in real estate:
Land		$	835,407			$	900,213
Buildings and improvements			5,014,894				5,528,567
Tenant improvements and lease intangibles			521,909				552,536
			6,372,210				6,981,316
Less: accumulated depreciation			(634,123	)			(490,125	)
Net investment in real estate			5,738,087				6,491,191
Cash and cash equivalents			63,834				8,655
Tenant receivables, net			1,530				2,427
Deferred rent receivables, net			38,108				33,039
Interest rate contracts			129,901				176,255
Acquired lease intangible assets, net			12,901				18,163
Investment in unconsolidated real estate fund			99,189				-
Other assets			29,349				31,304
Total assets		$	6,112,899			$	6,761,034
Liabilities
Secured notes payable, including loan premium		$	3,274,743			$	3,692,785
Accounts payable and accrued expenses			75,916				69,445
Security deposits			32,034				35,890
Acquired lease intangible liabilities, net			147,548				195,036
Interest rate contracts			283,591				407,492
Dividends payable			12,155				22,856
Other liabilities			-				57,316
Total liabilities			3,825,987				4,480,820
Equity
Douglas Emmett, Inc. stockholders' equity:
Common stock, $0.01 par value 750,000,000 authorized, 121,554,388 and 121,897,388 outstanding at September 30, 2009 and December 31, 2008, respectively.			1,216				1,219
Additional paid-in capital			2,289,094				2,284,429
Accumulated other comprehensive income (loss)			(210,152	)			(274,111	)
Accumulated deficit			(290,948	)			(236,348	)
Total Douglas Emmett, Inc. stockholders' equity			1,789,210				1,775,189
Noncontrolling interests			497,702				505,025
Total equity			2,286,912				2,280,214
Total liabilities and equity		$	6,112,899			$	6,761,034

See notes to consolidated financial statements.

 

3 

---

 

Douglas Emmett, Inc.

Consolidated Statements of Operations

(unaudited and in thousands, except for share data)

		Three Months Ended September 30,								Nine Months Ended September 30,
		2009				2008				2009				2008
Revenues
Office rental
Rental revenues		$	99,463			$	112,787			$	307,219			$	323,016
Tenant recoveries			8,059				8,335				23,159				22,523
Parking and other income			15,939				18,967				49,977				53,772
Total office revenues			123,461				140,089				380,355				399,311
Multifamily rental
Rental revenues			15,980				16,483				48,174				50,130
Parking and other income			986				1,081				3,110				3,083
Total multifamily revenues			16,966				17,564				51,284				53,213
Total revenues			140,427				157,653				431,639				452,524
Operating Expenses
Office expense			38,691				44,201				115,668				121,924
Multifamily expense			4,560				4,369				13,363				12,888
General and administrative			5,585				5,243				17,895				16,257
Depreciation and amortization			55,529				63,611				172,332				184,218
Total operating expenses			104,365				117,424				319,258				335,287
Operating income			36,062				40,229				112,381				117,237
Gain on disposition of interest in unconsolidated   real estate fund			-				-				5,573				-
Interest and other income			56				(43	)			3,030				489
Loss, including depreciation, from unconsolidated    real estate fund			(1,904	)			-				(4,710	)			-
Interest expense			(45,326	)			(52,586	)			(139,154	)			(145,580	)
Net loss			(11,112	)			(12,400	)			(22,880	)			(27,854	)
Less:  Net loss attributable to noncontrolling interests			2,306				2,704				4,725				6,230
Net loss attributable to common stockholders		$	(8,806	)		$	(9,696	)		$	(18,155	)		$	(21,624	)
Net loss attributable to common stockholders
per share – basic and diluted		$	(0.07	)		$	(0.08	)		$	(0.15	)		$	(0.18	)
Dividends declared per common share		$	0.1000			$	0.1875			$	0.3000			$	0.5625
Weighted average shares of common stock
outstanding – basic and diluted			121,485,711				121,509,098				121,547,569				120,372,893

See notes to consolidated financial statements.

 

4 

---

 

Douglas Emmett, Inc.

Consolidated Statements of Cash Flows

(unaudited and in thousands)

 

		Nine Months Ended September 30,
		2009					2008
Operating Activities
Net loss		$	(22,880	)			$	(27,854	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Non-cash profit sharing allocation to consolidated real estate fund			660					-
Loss, including depreciation, from unconsolidated real estate fund			4,710					-
Depreciation and amortization			172,332					184,218
Net accretion of acquired lease intangibles			(25,470	)				(32,330	)
Gain on disposition of interest in unconsolidated real estate fund			(5,573	)				-
Amortization of deferred loan costs			1,573					1,417
Amortization of loan premium			(3,742	)				(3,530	)
Non-cash market value adjustments on interest rate contracts			14,971					12,908
Non-cash amortization of stock-based compensation			3,558					3,263
Change in working capital components:
Tenant receivables			753					267
Deferred rent receivables			(6,674	)				(10,886	)
Accounts payable, accrued expenses and security deposits			15,115					6,599
Other assets			(4,677	)				2,746
Net cash provided by operating activities			144,656					136,818
Investing Activities
Capital expenditures and property acquisitions			(31,266	)				(656,758	)
Deconsolidation of Douglas Emmett Fund X, LLC			(6,625	)				-
Net cash used in investing activities			(37,891	)				(656,758	)
Financing Activities
Proceeds from long-term borrowings			82,640					1,510,425
Deferred loan costs			(21	)				(6,745	)
Repayment of borrowings			(106,665	)				(858,400	)
Net change in short-term borrowings			(25,275	)				(20,300	)
Contributions by Douglas Emmett Fund X, LLC investors			66,074					-
Contributions by noncontrolling interests			450					319
Distributions to noncontrolling interests			(13,426	)				(21,239	)
Redemption of noncontrolling interests			(2,880	)				(23,758	)
Issuance of common stock		─						667
Repurchase of common stock			(5,337	)			─
Cash dividends			(47,146	)				(64,717	)
Net cash (used in) provided by financing activities			(51,586	)				516,252
Increase (decrease) in cash and cash equivalents			55,179					(3,688	)
Cash and cash equivalents at beginning of period			8,655					5,843
Cash and cash equivalents at end of period		$	63,834				$	2,155
Noncash transactions:
Investing activity related to contribution of properties to unconsolidated real estate fund		$	476,852				$	─
Financing activity related to contribution of debt and noncontrolling interest to unconsolidated real estate fund		$	(483,477	)			$	─

 

  See notes to consolidated financial statements.

 

5 

---

 

Douglas Emmett, Inc.

Notes to Consolidated Financial Statements

(in thousands, except shares and per share data)

1. Overview

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).  Through our interest in Douglas Emmett Properties, LP (our operating partnership) and our subsidiaries, we own, manage, lease, acquire and develop real estate.  As of September 30, 2009, we owned a portfolio of 49 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 our properties are 100% owned except Honolulu Club (78,000 square feet), which is owned by a consolidated joint venture in which we own a 66.7% interest. We also own an interest in six additional properties totaling 1.4 million square feet, through our ownership of an equity interest in an unconsolidated real estate fund, Douglas Emmett Fund X, LLC (Fund X), which we manage.  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.

We are one of the largest owners and operators of high-quality office and multifamily properties in Los Angeles County, California and in Honolulu, Hawaii.  Our presence in Los Angeles and Honolulu is the result of a consistent and focused strategy of identifying submarkets that are supply constrained, have high barriers to entry and typically exhibit strong economic characteristics such as population and job growth and a diverse economic base.  In our office portfolio, we focus primarily on owning and acquiring a substantial share of top-tier office properties within submarkets located near high-end executive housing and key lifestyle amenities. In our multifamily portfolio, we focus primarily on owning and acquiring select properties at premier locations within these same submarkets.  Our properties are concentrated in nine premier Los Angeles County submarkets—Brentwood, Olympic Corridor, Century City, Santa Monica, Beverly Hills, Westwood, Sherman Oaks/Encino, Warner Center/Woodland Hills and Burbank—as well as in Honolulu, Hawaii.

Basis of Presentation

The accompanying consolidated financial statements as of September 30, 2009 and December 31, 2008 and for the three and nine months ended September 30, 2009 and 2008 are the consolidated financial statements of Douglas Emmett, Inc. and our subsidiaries including our operating partnership.  As described in Note 2 below, the results of the six properties we acquired in March 2008 were included in our consolidated results until the end of February 2009, when we completed the transaction to contribute these properties to Fund X in return for an equity interest.  All significant intercompany balances and transactions have been eliminated in our consolidated financial statements.  Certain prior period amounts have been reclassified to conform with current period presentation.

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 disclosures 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 SEC rules and regulations, although we believe that the disclosures are adequate to make their 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, 2009.  The interim financial statements should be read in conjunction with the consolidated financial statements in our 2008 Annual Report on Form 10-K 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.

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.

 

6 

---

 

Douglas Emmett, Inc.

Notes to Consolidated Financial Statements—(continued)

(in thousands, except shares and per share data)

2. Acquisitions, Dispositions and Other Transfers

We did not make any acquisitions during the nine months ended September 30, 2009.

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 through a consolidated joint venture with our local partner.  The joint venture financed the acquisition with an $18 million loan.  See Note 7 for a description of the debt.  On May 1, 2008, the operations of the athletic club were sold to a third party for a nominal cost.  Simultaneously, the acquirer leased from us the space occupied by the athletic club.  The results of operations and loss on sale of the assets of the athletic club were not material.

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.  Subsequent to acquiring the properties, we entered into a non-recourse $365 million term loan secured by the six-property portfolio.

In connection with the initial closing of Fund X in October 2008, (i) we contributed to Fund X the portfolio of six Class A office properties that we acquired in March 2008 and (ii) we transferred to Fund X the related $365 million term loan.  In exchange, we received an interest in the common equity of Fund X.  Because the net value of the contributed properties (as valued under the Fund X operating agreement) exceeded our required capital contribution, Fund X distributed cash to us for the excess. We received part of the cash in October 2008 and the remainder at the end of February 2009, at which point Fund X became an unconsolidated real estate fund in which we retained an equity investment.  We recognized a gain of $5,573 on the disposition of the interest in Fund X we did not retain.

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, and in the case of the properties contributed to Fund X, only until the end of February 2009, when the properties were deconsolidated from our financial statements.  Beginning in February 2009, we have accounted for our interest in Fund X under the equity method.

 

7 

---

 

Douglas Emmett, Inc.

Notes to Consolidated Financial Statements—(continued)

(in thousands, except shares and per share data)

 
 

3. Segment Reporting

Segment information is prepared on the same basis that our management reviews information for operational decision-making purposes. We operate in two business segments: (i) the acquisition, 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 primarily include 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 segment profit as our internal reporting addresses these items on a corporate level.

Segment profit is not a measure of operating income or cash flows from operating activities as measured by GAAP, 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 segment profit in the same manner.  We consider segment profit 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 September 30,								Nine Months Ended September 30,
Office Segment		2009				2008				2009				2008
Rental revenue		$	123,461			$	140,089			$	380,355			$	399,311
Rental expense			(38,691	)			(44,201	)			(115,668	)			(121,924	)
Segment profit			84,770				95,888				264,687				277,387
Multifamily Segment
Rental revenue			16,966				17,564				51,284				53,213
Rental expense			(4,560	)			(4,369	)			(13,363	)			(12,888	)
Segment profit			12,406				13,195				37,921				40,325
Total segments' profit		$	97,176			$	109,083			$	302,608			$	317,712

The following table is a reconciliation of segment profit to net loss attributable to common stockholders:
		Three Months Ended September 30,								Nine Months Ended September 30,
			2009				2008				2009				2008
Total segments' profit		$	97,176			$	109,083			$	302,608			$	317,712
General and administrative expenses			(5,585	)			(5,243	)			(17,895	)			(16,257	)
Depreciation and amortization			(55,529	)			(63,611	)			(172,332	)			(184,218	)
Gain on disposition of interest in
unconsolidated real estate fund			-				-				5,573				-
Interest and other income			56				(43	)			3,030				489
Loss, including depreciation,
from unconsolidated real estate fund			(1,904	)			-				(4,710	)			-
Interest expense			(45,326	)			(52,586	)			(139,154	)			(145,580	)
Net loss			(11,112	)			(12,400	)			(22,880	)			(27,854	)
Less: Net loss attributable to
noncontrolling interests			2,306				2,704				4,725				6,230
Net loss attributable to common stockholders		$	(8,806	)		$	(9,696	)		$	(18,155	)		$	(21,624	)

 

8

---

 

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 as of:

 

		September 30, 2009				December 31, 2008
Deferred loan costs, net of accumulated amortization of $4,544 and    $3,336 at September 30, 2009 and December 31, 2008, respectively		$	4,839			$	9,714
Restricted cash			2,941				2,934
Prepaid interest			347				4,360
Prepaid expenses			5,762				3,845
Interest receivable			9,924				5,938
Other indefinite-lived intangible			1,988				1,988
Other			3,548				2,525
Total other assets		$	29,349			$	31,304

We incurred deferred loan cost amortization expense of $483 and $577 for the three months ended September 30, 2009 and 2008, respectively, and $1,573 and $1,417 for the nine months ended September 30, 2009 and 2008, respectively.  Deferred loan cost amortization is included as a component of interest expense in the consolidated statements of operations.

5. Accounts Payable and Accrued Expenses

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

 

		September 30, 2009				December 31, 2008
Accounts payable		$	36,789			$	30,429
Accrued interest payable			26,020				22,982
Deferred revenue			13,107				16,034
Total accounts payable and accrued expenses		$	75,916			$	69,445

 

6. Acquired Lease Intangibles

The following summarizes our acquired lease intangibles related to above/below-market leases as of:

 

		September 30, 2009				December 31, 2008
Above-market tenant leases		$	32,770			$	34,227
Accumulated amortization			(22,842	)			(19,094	)
Below-market ground leases			3,198				3,198
Accumulated amortization			(225	)			(168	)
Acquired lease intangible assets, net		$	12,901			$	18,163
Below-market tenant leases		$	261,523			$	288,437
Accumulated accretion			(127,375	)			(106,950	)
Above-market ground leases			16,200				16,200
Accumulated accretion			(2,800	)			(2,651	)
Acquired lease intangible liabilities, net		$	147,548			$	195,036

 

 

9 

---

 

Douglas Emmett, Inc.

Notes to Consolidated Financial Statements—(continued)

(in thousands, except shares and per share data)

7. Secured Notes Payable

The following summarizes our secured notes payable at:

 

Type of Debt		Maturity Date (1)			September 30, 2009				December 31, 2008			Variable Rate		Effective Annual Fixed Rate (2)		Swap Maturity Date (1)
Variable Rate Swapped to Fixed Rate:
Fannie Mae Loan I (3)		06/01/12		$	293,000			$	293,000			DMBS + 0.60%		4.70%		08/01/11
Fannie Mae Loan II (3)		06/01/12			95,080				95,080			DMBS + 0.60%		5.78		08/01/11
Modified Term Loan (4)(5)		08/31/12			2,300,000				2,300,000			LIBOR + 0.85%		5.13		08/01/10-08/01/12
Term Loan (6)		08/18/13			-				365,000			--		--		--
Fannie Mae Loan III (3)		02/01/15			36,920				36,920			DMBS + 0.60%		5.78		08/01/11
Fannie Mae Loan IV (3)		02/01/15			75,000				75,000			DMBS + 0.76%		4.86		08/01/11
Term Loan (7)		04/01/15			340,000				340,000			LIBOR + 1.50%		4.77		01/02/13
Fannie Mae Loan V (3)		02/01/16			82,000				82,000			LIBOR + 0.62%		5.62		03/01/12
Fannie Mae Loan VI (3)		06/01/17			18,000				18,000			LIBOR + 0.62%		5.82		06/01/12
Subtotal					3,240,000				3,605,000					5.10%
Variable Rate:
Wells Fargo Loan (8)		03/01/10(9)			18,000				18,000			LIBOR + 1.25%		--		--
Secured Revolving Credit Facility (10)		10/30/09(11)			-				49,300			LIBOR / Fed Funds+(12)		--		--
Subtotal					3,258,000				3,672,300
Unamortized Loan Premium (13)					16,743				20,485
Total				$	3,274,743			$	3,692,785

 

(1)	As of September 30, 2009, the weighted average remaining life of our total outstanding debt is 3.3 years, and the weighted average remaining life of the interest rate swaps is 1.6 years.
(2)	Includes the effect of interest rate contracts.  Based on actual/360-day basis and excludes amortization of loan fees and unused fees on credit line.  The total effective rate on an actual/365-day basis is 5.17% at September 30, 2009.
(3)	Secured by four separate collateralized pools.  Fannie Mae Discount Mortgage-Backed Security (DMBS) generally tracks 90-day LIBOR, although volatility may exist between the two rates, resulting in an immaterial amount of swap ineffectiveness.
(4)	Secured by seven separate collateralized pools.  Requires monthly payments of interest only, with outstanding principal due upon maturity.
(5)	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.  Each of these rates is based on actual/360-day basis.
(6)	This loan was transferred to an unconsolidated real estate fund in which our operating partnership holds an equity interest.  Secured by six properties in a collateralized pool.  These properties were also transferred to the same unconsolidated real estate fund.
(7)	Secured by four properties in a collateralized pool.  Requires monthly payments of interest only, with outstanding principal due upon maturity.
(8)	This loan is held by a consolidated entity in which our operating partnership holds a two-thirds interest.  The loan has a one-year extension option.
(9)	Represents maturity date of March 1, 2010, which we have the option to extend to March 1, 2011.
(10)	This revolving credit facility is secured by nine properties and has no borrowings outstanding.  We exercised a one-year extension option and renewed the credit facility for $350 million (reduced from $370 million, but on the same pricing and otherwise on the same terms and conditions as prior to the extension).  A second one-year extension option remains available.  See Note 15.
(11)	Represents maturity date of October 30, 2009, which we have the option to extend to October 30, 2011.  We have exercised the first one-year extension option.  See Note 15 for further information.
(12)	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.
(13)	Represents non-cash mark-to-market adjustment on variable rate debt associated with office properties.

 

10 

---

 

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 at September 30, 2009, excluding the non-cash loan premium amortization, were as follows:

 

Twelve months ending September 30:
2010		$	18,000
2011			-
2012			2,688,080
2013			-
2014			-
Thereafter			551,920
Total future principal payments		$	3,258,000

Secured Revolving Credit Facility

We have a revolving credit facility with a group of banks led by Bank of America, N.A. and Banc of America Securities, LLC.  At September 30, 2009, there were no borrowings outstanding, so the entire balance was available to us under this credit facility.  Amounts outstanding under the facility bear interest at a rate per annum equal to either LIBOR plus 70 basis points or Federal Funds Rate plus 95 basis points if the total amount outstanding is $262.5 million or less.  However, if the total amount outstanding is greater than $262.5 million, then the amounts bear interest at a rate per annum equal to either LIBOR plus 80 basis points or Federal Funds Rate plus 105 basis points.  Undrawn amounts under the credit facility bear interest at 15 basis points.  We have exercised the first of two one-year extension options and have renewed the facility through October 2010 for $350 million under the same terms and conditions that existed prior to the extension.  See Note 15 for further information.

8. Interest Rate Contracts

Risk Management Objective of Using Derivatives

We manage our interest rate risk associated with borrowings by obtaining interest rate swap and interest rate cap contracts.  The interest rate swap agreements we utilize effectively modify our exposure to interest rate risk by converting our floating-rate debt to a fixed-rate basis, thus reducing the impact of interest-rate changes on future interest expense and cash flows.  These agreements involve the receipt of floating-rate amounts in exchange for fixed-rate interest payments over the life of the agreements without an exchange of the underlying principal amount. We do not use any other derivative instruments.

Cash Flow Hedges of Interest Rate Risk

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.  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 (loss) (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.  The ineffectiveness attributable to a mismatch in the underlying rate indices of the hedged item and the related derivative resulted in our recording a loss of $218 and $97 for the three months ended September 30, 2009 and 2008, respectively, and recording a loss of $498 and $11 for the nine months ended September 30, 2009 and 2008, respectively.  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.  The fair value of these hedges is obtained through independent third-party valuation sources that use conventional valuation algorithms.

 

11 

---

 

Douglas Emmett, Inc.

Notes to Consolidated Financial Statements—(continued)

(in thousands, except shares and per share data)

Amounts accumulated in other comprehensive income (loss) related to derivatives will be reclassified to interest expense as interest payments are made on our variable-rate debt. For derivatives designated as cash flow hedges, we estimate an additional $131.5 million will be reclassified within the next 12 months from accumulated other comprehensive income (loss) to interest expense as an increase to interest expense.

As of September 30, 2009, approximately 99% of our outstanding debt had interest payments designated as hedged transactions to receive-floating/pay-fixed interest rate swap agreements, which qualify as highly effective cash flow hedges, as summarized below:

Interest Rate Derivative	Number of Instruments (Actual)	Notional
Interest Rate Swaps	36	$3,240,000

Non-designated Hedges

Derivatives not designated as hedges are not speculative.  Prior to the initial public offering (IPO) of Douglas Emmett, Inc., we entered into $2.2 billion notional of pay-fixed swaps at swap rates ranging between 4.04% and 5.00%, as well as $600 million of purchased caps to manage our exposure to interest rate movements and other identified risks.  At the time of our IPO, we entered into offsetting $2.2 billion notional of receive-fixed swaps at swap rates ranging between 4.96% and 5.00%, as well as $600 million of sold caps, which were intended to largely offset the future cash flows and future change in fair value of our pre-IPO pay-fixed swaps and purchased caps to reduce the effect on our reported earnings.  Accordingly, as of September 30, 2009, we had the following outstanding interest rate derivatives that were not designated for accounting purposes as hedging instruments, but were used to hedge our economic exposure to interest rate risk:

Interest Rate Derivative	Number of Instruments (Actual)	Notional
Pay-Fixed Swaps	25	$2,205,000
Receive-Fixed Swaps	25	$2,205,000
Purchased Caps	19	$600,000
Sold Caps	15	$600,000

None of the swaps or caps in the preceding table was designated as an accounting hedge and, as a result, the changes in fair value of these interest rate swaps have been recognized in earnings for all periods.  The aggregate net asset fair value of these swaps decreased $4.8 million and $5.5 million for the three months ended September 30, 2009 and 2008, respectively, and $14.5 million and $12.9 million for the nine months ended September 30, 2009 and 2008, respectively.  The decrease in net asset fair value was recorded as additional interest expense. Included in the net $12.9 million decrease is a $1.2 million increase related to the credit value adjustment resulting from our initial application of a new accounting pronouncement related to fair value measurements in the first quarter of 2008.

 

12 

---

 

Douglas Emmett, Inc.

Notes to Consolidated Financial Statements—(continued)

(in thousands, except shares and per share data)

 

Accounting for Interest Rate Contracts

We record all derivatives on the balance sheet at fair value, using the framework for measuring fair value established by the Financial Accounting Standards Board (FASB).  Hedge accounting generally provides for the timing of gain or loss recognition on the hedging instrument to match the earnings effect of the hedged forecasted transactions in a cash flow hedge.  All other changes in fair value, with the exception of hedge ineffectiveness, are recorded in accumulated other comprehensive income (loss), which is a component of equity outside of earnings.  Amounts reported in accumulated other comprehensive income (loss) related to derivatives designated as accounting hedges will be reclassified to interest expense as interest payments are made on our hedged variable-rate debt.  We may enter into derivative contracts that are intended to hedge certain economic risks, even though hedge accounting does not apply, or for which we elect to not apply hedge accounting.

The change in net unrealized gains and losses on cash flow hedges reflects a reclassification from accumulated other comprehensive income (loss) to interest expense, which increased interest expense by $36.8 million and $19.1 million for the three months ended September 30, 2009 and 2008, respectively, and $107.1 million and $45.3 million for the nine months ended September 30, 2009 and 2008, respectively.

The following table represents the fair values of derivative instruments as of September 30, 2009:

Derivative fair values, disclosed as “Interest Rate Contracts”:	Assets				Liabilities
Derivatives designated as accounting hedges	$	─			$	182,091
Derivatives not designated as accounting hedges		129,901				101,500
Total derivatives	$	129,901			$	283,591

 

13 

---

 

Douglas Emmett, Inc.

Notes to Consolidated Financial Statements—(continued)

(in thousands, except shares and per share data)

The following table represents the effect of derivative instruments on our consolidated statements of operations for the three and nine months ended September 30, 2009:

		Interest Rate Contracts
Derivatives in Designated Cash Flow Hedging Relationships:		Three months ended September 30, 2009				Nine months ended September 30, 2009
Amount of gain (loss) recognized in OCI on derivatives (effective portion)		$	(28,462	)		$	(37,415	)
Amount of gain (loss) reclassified from accumulated OCI into earnings (effective portion)		$	(36,832	)		$	(107,147	)
Location of gain (loss) reclassification from accumulated OCI into earnings (effective portion)		Interest expense				Interest expense
Amount of gain (loss) recognized in earnings on derivatives (ineffective portion and amount excluded from effectiveness testing)		$	(218	)		$	(498	)
Location of gain (loss) recognized in earnings on derivatives (ineffective portion and amount excluded from effectiveness testing)		Interest expense				Interest expense

 

		Interest Rate Contracts
Derivatives Not Designated as Cash Flow Hedges:		Three months ended September 30, 2009				Nine months ended September 30, 2009
Amount of realized and unrealized gain (loss) recognized in earnings on derivatives		$	61			$	(156	)
Location of gain (loss) recognized in earnings on derivatives		Interest expense				Interest expense

 

Credit-risk-related Contingent Features

We have agreements with each of our derivative counterparties that contain a provision under which we could also be declared in default on our derivative obligations if we default on any of our indebtedness, including any default where repayment of the indebtedness has not been accelerated by the lender.  We have agreements with certain of our derivative counterparties that contain a provision under which, if we fail to maintain a minimum cash and cash equivalents balance of $1 million, then the derivative counterparty would have the right to terminate the derivative.  There have been no events of default on any of our derivatives.

As of September 30, 2009, the fair value of derivatives in a net liability position was $169.0 million, which includes accrued interest but excludes any adjustment for nonperformance risk related to these agreements.

 

14 

---

 

Douglas Emmett, Inc.

Notes to Consolidated Financial Statements—(continued)

(in thousands, except shares and per share data)

Fair Value Measurement

The FASB has established a framework for measuring fair value and expanded disclosures about fair value measurements.  It 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, the FASB established 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.

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 September 30, 2009.

The table below presents the derivative assets and liabilities, presented in our financial statements on a gross basis without reflecting any net settlement positions with the same counterparty.  The derivatives shown below are measured at fair value as of September 30, 2009 and 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 September 30, 2009
Assets
Interest Rate Contracts	$	─	$	129,901	$	─	$	129,901
Liabilities
Interest Rate Contracts	$	─	$	283,591	$	─	$	283,591

 

15 

---

 

Douglas Emmett, Inc.

Notes to Consolidated Financial Statements—(continued)

(in thousands, except shares and per share data)

9. Stockholders’ Equity

Noncontrolling Interests

Noncontrolling interests in our operating partnership relate to interests in the partnership that are not owned by us.  Noncontrolling interests represented approximately 22% of our operating partnership at September 30, 2009.  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.  Prior to January 1, 2009 (the effective date for a new accounting pronouncement on noncontrolling interests), we calculated the book value of net assets allocable to noncontrolling interests (formerly referred to as minority interests), and adjusted the balance to reflect the calculated amount with a reclass to or from the retained earnings (accumulated deficit) balance.

Noncontrolling 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 September 30, 2009.

The table below represents our condensed consolidated statement of stockholders’ equity:

 

		Total Equity				Douglas Emmett, Inc. Stockholders' Equity				Noncontrolling Interests
Balance as of January 1, 2009, as reported		$	2,280,214			$	1,775,189			$	505,025
Comprehensive income (loss):
Net loss			(22,880	)			(18,155	)			(4,725	)
Other comprehensive income (loss)			69,732				52,069				17,663
Comprehensive income (loss)			46,852				33,914				12,938
Contributions			450				-				450
Dividends and distributions			(49,660	)			(36,445	)			(13,215	)
Redemption of operating partnership units			(8,217	)			2,435				(10,652	)
Stock compensation			5,373				2,227				3,146
Deconsolidation of Douglas Emmett Fund X, LLC			11,900				11,890				10
Balance as of September 30, 2009		$	2,286,912			$	1,789,210			$	497,702

The table below represents our consolidated statements of comprehensive income (loss):

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2009				2008				2009				2008
Net loss		$	(11,112	)		$	(12,400	)		$	(22,880	)		$	(27,854	)
Cash flow hedge adjustment			9,428				(7,866	)			69,286				5,119
Equity interest in other comprehensive income (loss)
of unconsolidated real estate fund			(1,058	)			-				446				-
Comprehensive income (loss)			(2,742	)			(20,266	)			46,852				(22,735	)
Less: Comprehensive income (loss) attributable to
noncontrolling interests			658				2,704				(12,938	)			6,230
Comprehensive income (loss) attributable to
common stockholders		$	(2,084	)		$	(17,562	)		$	33,914			$	(16,505	)

 

 

16 

---

 

Douglas Emmett, Inc.

Notes to Consolidated Financial Statements—(continued)

(in thousands, except shares and per share data)

Dividends

During the first nine months of 2009 and 2008, we declared quarterly dividends of $0.10 and $0.1875 per share, respectively, which equals an annualized rate of $0.40 and $0.75 per share, respectively.

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.

Equity Conversions and Repurchases

During the nine months ended September 30, 2009, 476,500 operating partnership units were converted to shares of common stock.  During the nine months ended September 30, 2009, we repurchased 819,500 share equivalents in open market transactions and 250,000 share equivalents in a private transaction for a total combined consideration of approximately $8.2 million.  We may make additional purchases of our share equivalents from time to time in private transactions or in the public markets, but have no commitments to do so.

The table below represents the net income attributable to common stockholders and transfers (to) from the noncontrolling interests:

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2009				2008				2009				2008
Net loss attributable to common stockholders		$	(8,806	)		$	(9,696	)		$	(18,155	)		$	(21,624	)
Transfers from the noncontrolling interests:
Increase in common stockholders paid-in capital
for redemption of operating partnership units			2,307				4,707				7,044				193,330
Change from net income attributable to common
stockholders and transfers from
noncontrolling interests		$	(6,499	)		$	(4,989	)		$	(11,111	)		$	171,706

 

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, and was amended in 2009 to increase the maximum number of shares of our stock available for issuance under that plan by 24,080,163 shares and to make certain other amendments.  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 2008 Annual Report on Form 10-K and our proxy statement, which was filed with the SEC on April 30, 2009.

During the first quarter of 2009, we granted approximately 3.6 million long-term incentive units and stock options with a total fair market value of $6.5 million. No additional grants were made during the first nine months of 2009. Upon the vesting of equity awards, we recognized non-cash compensation expense of $1.2 million and $1.1 million for the three months ended September 30, 2009 and 2008, respectively, and $3.4 million and $3.3 million for the nine months ended September 30, 2009 and 2008, respectively.  An additional $1.4 million of immediately-vested equity awards were granted during the first quarter of 2009 to satisfy a portion of the bonuses accrued during 2008 and an additional $2.2 million of immediately-vested equity awards were granted during the first quarter of 2008 to satisfy a portion of the bonuses accrued during 2007.

 

17 

---

 

Douglas Emmett, Inc.

Notes to Consolidated Financial Statements—(continued)

(in thousands, except shares and per share data)

10. Future Minimum Lease Receipts and Payments

Future Minimum Lease Receipts

 We lease space to tenants primarily under noncancelable operating leases that 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 lease space to certain tenants under noncancelable leases that provide for percentage rents based upon tenant revenues. Percentage rental income for the three months ended September 30, 2009 and 2008 totaled $162 and $232, respectively, and $471 and $661 for the nine months ended September 30, 2009 and 2008, respectively.

Future minimum base rentals on our non-cancelable office and ground operating leases at September 30, 2009 were as follows:

Twelve months ending September 30:

2010		$	355,183
2011			311,739
2012			262,490
2013			215,008
2014			155,418
Thereafter			402,166
Total future minimum base rentals		$	1,702,004

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, generally upon payment of a termination fee. The preceding table assumes that these options are not exercised.

Future Minimum Lease Payments

We currently lease portions of the land underlying two of our office properties after acquiring, in December 2008, the fee title to a third parcel of land that we leased during 2008 as more fully described in the notes to consolidated financial statements contained in our 2008 Annual Report on Form 10-K. We expensed ground lease payments in the amount of $546 and $809 for the three months ended September 30, 2009 and 2008, respectively, and $1,602 and $2,400 for the nine months ended September 30, 2009 and 2008, respectively.

The following is a schedule of our minimum ground lease payments as of September 30, 2009:

Twelve months ending September 30:
2010		$	733
2011			733
2012			733
2013			733
2014			733
Thereafter			3,237
Total future minimum lease payments		$	6,902

 

18 

---

 

Douglas Emmett, Inc.

Notes to Consolidated Financial Statements—(continued)

(in thousands, except shares and per share data)

 

11. Fair Value of Financial Instruments

Our estimates of the fair value of financial instruments at September 30, 2009 were determined using available market information and appropriate valuation methods. Considerable judgment is necessary to interpret market data and develop estimated fair value. The use of different market assumptions or estimation methods may have a material effect on the estimated fair value amounts.

The carrying amounts for cash and cash equivalents, restricted cash, rents and other receivables, due from affiliates, accounts payable and other liabilities approximate fair value because of the short-term nature of these instruments.  We calculate the fair value of our secured notes payable based on a currently available market rate; assuming the loans are outstanding through maturity and considering the collateral.  At September 30, 2009, the aggregate fair value of our secured notes payable and secured revolving credit facility is estimated to be approximately $3.2 billion, based on a credit-adjusted present value of the principal and interest payments that are at floating rates.

Currently, we use interest rate swaps and caps to manage interest rate risk resulting from variable interest payments on our floating rate debt.  These financial instruments are carried on our balance sheet at fair value based on the assumptions that market participants would use in pricing the asset or liability.  See Note 8.

12. Related Party Transactions

On March 26, 2008, we acquired a 1.4 million square foot office portfolio consisting of six Class A buildings.  Subsequent to acquiring the properties, we entered into a 5-year non-recourse $365 million interest-only floating rate term loan secured by the six-property portfolio. At the time we entered into the loan, we entered into an interest rate swap agreement to mitigate interest rate risk by converting the floating-rate debt to a fixed-rate basis, thus reducing the impact of interest-rate changes on future interest expense and cash flows.  The swap agreement involves the receipt of floating-rate amounts in exchange for fixed-rate interest payments over the life of the agreements without an exchange of the underlying principal amount.

In October 2008, we contributed these six properties, the related $365 million term loan, and the benefits and burdens of the related swap agreement to Fund X in exchange for an interest in the common equity of Fund X, which became an unconsolidated equity investment in February 2009.  See Note 2 for further information.  If Fund X fails to perform any obligations under the swap agreement, we remain liable to the swap counterparties.  The maximum future payments under the swap agreements was approximately $41.9 million as of September 30, 2009. As of September 30, 2009, all obligations under the swap agreements have been performed by Fund X in accordance with the terms of the agreements. 

 

19 

---

 

Douglas Emmett, Inc.

Notes to Consolidated Financial Statements—(continued)

(in thousands, except shares and per share data)

13. 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, 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 $250 under the increased limit that the U.S. Congress has temporarily granted until December 31, 2009.  We have not experienced any losses to date 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

Conditional asset retirement obligations represent a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement is conditional on a future event that may or may not be within our control.  A liability for a conditional asset retirement obligation must be recorded if the fair value of the obligation can be reasonably estimated.  Environmental site assessments and investigations have identified 23 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 September 30, 2009, 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.

 
 

Tenant Concentrations

For the nine months ended September 30, 2009 and 2008, no tenant accounted for more than 10% of our total rental revenue and tenant recoveries.

 

 

20 

---

 

Douglas Emmett, Inc.

Notes to Consolidated Financial Statements—(continued)

(in thousands, except shares and per share data)

 

14. Summary of Significant Accounting Policies

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.

Income Taxes

We have 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 are generally not subject to corporate-level income tax on the earnings distributed currently to our stockholders that we derive from our REIT qualifying activities. We are subject to corporate-level tax on the earnings 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.

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 nine months ended September 30, 2009 and 2008, all potentially dilutive instruments are anti-dilutive and have been excluded from our computation of weighted average dilutive shares outstanding.

 

21 

---

 

Douglas Emmett, Inc.

Notes to Consolidated Financial Statements—(continued)

(in thousands, except shares and per share data)

Recently Issued Accounting Literature

On July 1, 2009 the FASB released the authoritative version of the FASB Accounting Standards Codification as the single source of authoritative nongovernmental U.S. GAAP.  Codification Topic 105, Generally Accepted Accounting Principles, established that the Codification is effective for interim and annual periods ending after September 15, 2009.  All existing accounting standard documents are superseded.  All other accounting literature not included in the Codification will be considered nonauthoritative.  Rules and interpretive releases of the SEC under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants, therefore the Codification includes all relevant SEC guidance organized using the same topical structure in separate sections within the Codification.  All previous references to FASB Accounting Standards (FASs), FASB Staff Positions (FSPs) or Emerging Issues Task Force Abstracts (EITFs) are now replaced by the Accounting Standards Codification Topics (ASCs) that contain the relevant and current accounting pronouncements.  Modifications to the Codification, will come in the form of Accounting Standards Updates (ASUs) which will serve to update the Codification, provide background information about the guidance and provide the basis for conclusions on the changes to the Codification.  The Codification is not intended to change GAAP, but it will change the way GAAP is organized and presented.  The Codification is effective for our financial statements for the fiscal quarter ending September 30, 2009 and the principal impact is limited to disclosures as all future references to authoritative accounting literature will be referenced in accordance with the Codification.

On January 1, 2009, we adopted new FASB guidance contained in ASC 805, which changes the method of accounting for business combinations.  Under ASC 805, an acquiring entity is required to recognize all the assets acquired and liabilities assumed in a transaction at the acquisition-date fair value with limited exceptions.  ASC 805 requires that transaction costs such as legal, accounting and advisory fees be expensed.  ASC 805 also includes a substantial number of new disclosure requirements.  The adoption of ASC 805 did not have a material effect on our financial position or results of operations.

On January 1, 2009, we adopted new FASB guidance contained in ASC 810, which establishes new accounting and reporting standards for noncontrolling interests in a subsidiary and for the deconsolidation of a subsidiary.  Specifically, this statement requires the recognition of a noncontrolling interest (minority interest) as equity in the consolidated financial statements separate from the parent’s equity.  The amount of net income attributable to the noncontrolling interest is included in consolidated net income on the face of the income statement.  ASC 810 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 noncontrolling equity investment on the deconsolidation date.  ASC 810 also includes expanded disclosure requirements regarding the interests of the parent and its noncontrolling interests.  The adoption of ASC 810 did not have a material effect on our financial position or results of operations, other than presentation differences.

On January 1, 2009, we adopted new FASB guidance contained in ASC 815, which expands disclosure requirements for an entity's derivative and hedging activities.  Under ASC 815, 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, 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 must 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.  The adoption of ASC 815 did not have a material effect on our financial position or results of operations as this statement only addresses disclosures.

On January 1, 2009, we adopted new FASB guidance contained in ASC 260, which clarifies that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities, and as participating securities, they must be included in the computation of EPS pursuant to the two-class method.  The adoption of ASC 260 did not have a material effect on our financial position or results of operations.

22

---

On April 1, 2009, we adopted new FASB guidance contained in ASC 825, which requires disclosures about the fair value of financial instruments for interim reporting periods of publicly-traded companies as well as in annual financial statements.  The adoption of ASC 825 did not have a material effect on our financial position or results of operations as this statement only addresses disclosures.

On April 1, 2009, we adopted new FASB guidance contained in ASC 855, which establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued.  The adoption of ASC 855 did not have a material effect on our financial position or results of operations as this statement only addresses disclosures.  See Note 15 for subsequent events disclosure.

In June 2009, the FASB issued FAS No. 167, Amendments to FASB Interpretation No. 46(R) (FAS 167).  The statement is not yet effective, and therefore has not been assigned a topic number under the Codification.  This standard requires an enterprise to perform an analysis to determine whether an enterprise’s variable interest or interests give it a controlling financial interest in a variable interest entity.  Additionally, an enterprise is required to assess whether it has an implicit financial responsibility to ensure that a variable interest entity operates as designed when determining whether it has the power to direct the activities of the variable interest entity that most significantly impact the entity’s economic performance.  FAS 167 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after November 15, 2009, which for us means January 1, 2010.  We are currently evaluating the impact that FAS 167 will have on our financial statements.

15. Subsequent Events

Prior to quarter end, we exercised the first of two one-year extension options that were available to us on our secured revolving credit facility.  On October 30, 2009, we completed the extension of the facility through October 30, 2010 for $350 million (reduced from $370 million, but on the same pricing and otherwise on the same terms and conditions as prior to the extension).  The extended facility has one additional one-year extension available.

We evaluated subsequent events through November 5, 2009, the date on which these financial statements were issued, and were not aware of any other events that were material.

 

23

---