3Q14 10Q-DOC
Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2014
or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from             to             
Commission file number: 001-35030
 
 
AMERICAN ASSETS TRUST, INC.
(Exact Name of Registrant as Specified in its Charter)
 
 
 
Maryland
(State of Organization)
27-3338708
(IRS Employer Identification No.)
 
 
 
 
 
11455 El Camino Real, Suite 200,
San Diego, California
(Address of Principal Executive Offices)
92130
(Zip Code)
 
(858) 350-2600
(Registrant’s Telephone Number, Including Area Code)
 
 
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.    x  Yes   o   No
Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files).    x  Yes      o  No
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large Accelerated Filer
x
 
Accelerated Filer
o
Non-Accelerated Filer
o
(Do not check if a smaller reporting company)
Smaller reporting company
o
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).      o  Yes    x  No
The number of Registrant’s common shares outstanding on November 7, 2014 was 43,614,913.

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Table of Contents

AMERICAN ASSETS TRUST, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2014
 
PART 1. FINANCIAL INFORMATION
 
Item 1.
Financial Statements
 
 
 
 
 
 
Item 2.
Item 3.
Item 4.
PART II. OTHER INFORMATION
 
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.

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Table of Contents

PART 1 - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS



American Assets Trust, Inc.
Consolidated Balance Sheets
(In Thousands, Except Share Data)
 
 
September 30,
 
December 31,
 
2014
 
2013
 
(unaudited)
 
 
ASSETS
 
 
 
Real estate, at cost
 
 
 
Operating real estate
$
1,927,359

 
$
1,919,015

Construction in progress
153,958

 
67,389

Held for development
9,139

 
9,013

 
2,090,456

 
1,995,417

Accumulated depreciation
(352,417
)
 
(318,581
)
Net real estate
1,738,039

 
1,676,836

Cash and cash equivalents
95,145

 
48,987

Restricted cash
11,835

 
9,124

Accounts receivable, net
7,552

 
7,295

Deferred rent receivables, net
34,814

 
32,531

Other assets, net
51,275

 
57,670

TOTAL ASSETS
$
1,938,660

 
$
1,832,443

LIABILITIES AND EQUITY
 
 
 
LIABILITIES:
 
 
 
Secured notes payable
$
953,190

 
$
952,174

Term loan
100,000

 

Line of credit

 
93,000

Accounts payable and accrued expenses
53,231

 
37,063

Security deposits payable
5,276

 
5,163

Other liabilities and deferred credits, net
55,992

 
58,465

Total liabilities
1,167,689

 
1,145,865

Commitments and contingencies (Note 10)

 


EQUITY:
 
 
 
American Assets Trust, Inc. stockholders’ equity
 
 
 
Common stock, $0.01 par value, 490,000,000 shares authorized, 43,614,913 and 40,512,563 shares issued and outstanding at September 30, 2014 and December 31, 2013, respectively
436

 
405

Additional paid-in capital
794,432

 
692,196

Accumulated dividends in excess of net income
(57,269
)
 
(44,090
)
Accumulated other comprehensive loss
624

 

Total American Assets Trust, Inc. stockholders’ equity
738,223

 
648,511

Noncontrolling interests
32,748

 
38,067

Total equity
770,971

 
686,578

TOTAL LIABILITIES AND EQUITY
$
1,938,660

 
$
1,832,443

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

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Table of Contents

American Assets Trust, Inc.
Consolidated Statements of Comprehensive Income
(Unaudited)
(In Thousands, Except Shares and Per Share Data)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2014
 
2013
 
2014
 
2013
REVENUE:
 
 
 
 
 
 
 
Rental income
$
63,593

 
$
62,405

 
$
182,868

 
$
181,332

Other property income
3,750

 
2,913

 
10,654

 
9,080

Total revenue
67,343

 
65,318

 
193,522

 
190,412

EXPENSES:
 
 
 
 
 
 
 
Rental expenses
17,374

 
17,430

 
50,494

 
50,402

Real estate taxes
5,899

 
5,768

 
17,054

 
16,044

General and administrative
4,682

 
4,031

 
13,929

 
12,658

Depreciation and amortization
16,352

 
16,648

 
50,902

 
50,614

Total operating expenses
44,307

 
43,877

 
132,379

 
129,718

OPERATING INCOME
23,036

 
21,441

 
61,143

 
60,694

Interest expense
(13,325
)
 
(14,764
)
 
(40,396
)
 
(44,244
)
Other income (expense), net
(621
)
 
(419
)
 
352

 
(763
)
NET INCOME
9,090

 
6,258

 
21,099

 
15,687

Net income attributable to restricted shares
(95
)
 
(132
)
 
(259
)
 
(397
)
Net income attributable to unitholders in the Operating Partnership
(2,578
)
 
(1,903
)
 
(6,108
)
 
(4,752
)
NET INCOME ATTRIBUTABLE TO AMERICAN ASSETS TRUST, INC. STOCKHOLDERS
$
6,417

 
$
4,223

 
$
14,732

 
$
10,538

 
 
 
 
 
 
 
 
EARNINGS PER COMMON SHARE
 
 
 
 
 
 
 
Earnings per common share, basic
$
0.15

 
$
0.11

 
$
0.35

 
$
0.27

Weighted average shares of common stock outstanding - basic
42,539,019

 
39,816,753

 
41,653,229

 
39,439,488

 
 
 
 
 
 
 
 
Earnings per common share, diluted
$
0.15

 
$
0.11

 
$
0.35

 
$
0.27

Weighted average shares of common stock outstanding - diluted
60,444,276

 
57,777,667

 
59,559,944

 
57,423,959

 
 
 
 
 
 
 
 
DIVIDENDS DECLARED PER COMMON SHARE
$
0.22

 
$
0.21

 
$
0.66

 
$
0.63

 
 
 
 
 
 
 
 
COMPREHENSIVE INCOME
 
 
 
 
 
 
 
Net income
$
9,090

 
$
6,258

 
$
21,099

 
$
15,687

Other comprehensive income - unrealized gain on swap derivatives during the period
2,439

 

 
882

 

Comprehensive income
11,529

 
6,258

 
21,981

 
15,687

Comprehensive income attributable to non-controlling interest
(3,300
)
 
(1,903
)
 
(6,366
)
 
(4,752
)
Comprehensive income attributable to American Assets Trust, Inc.
$
8,229

 
$
4,355

 
$
15,615

 
$
10,935


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

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Table of Contents

American Assets Trust, Inc.
Consolidated Statement of Equity
(Unaudited)
(In Thousands, Except Share Data)
 
 
American Assets Trust, Inc. Stockholders’ Equity
 
Noncontrolling Interests - Unitholders in the Operating Partnership
 
Total
 
Common Shares
 
Additional
Paid-in
Capital
 
Accumulated
Dividends in
Excess of Net
Income
 
Accumulated Other Comprehensive Loss
 
 
Shares
 
Amount
 
 
Balance at December 31, 2013
40,512,563

 
$
405

 
$
692,196

 
$
(44,090
)
 
$

 
$
38,067

 
$
686,578

Net income

 

 

 
14,991

 

 
6,108

 
21,099

Common shares issued
3,110,067

 
31

 
104,117

 

 

 

 
104,148

Issuance of restricted stock
117,983

 
1

 
(1
)
 

 

 

 

Forfeiture of restricted stock
(941
)
 

 

 

 

 

 

Conversion of operating partnership units
11,852

 

 
(133
)
 

 

 
133

 

Dividends declared and paid

 

 

 
(28,170
)
 

 
(11,818
)
 
(39,988
)
Stock-based compensation

 

 
2,571

 

 

 

 
2,571

Shares withheld for employee taxes
(136,611
)
 
(1
)
 
(4,318
)
 

 

 

 
(4,319
)
Other comprehensive income - change in value of interest rate swap

 

 

 

 
624

 
258

 
882

Balance at September 30, 2014
43,614,913

 
$
436

 
$
794,432

 
$
(57,269
)
 
$
624

 
$
32,748

 
$
770,971

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

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Table of Contents

American Assets Trust, Inc.
Consolidated Statements of Cash Flows
(Unaudited)
(In Thousands)
 
Nine Months Ended September 30,
 
2014
 
2013
OPERATING ACTIVITIES
 
 
 
Net income
$
21,099

 
$
15,687

Adjustments to reconcile income from operations to net cash provided by operating activities:
 
 
 
Deferred rent revenue and amortization of lease intangibles
(4,360
)
 
(3,593
)
Depreciation and amortization
50,902

 
50,614

Amortization of debt issuance costs and debt fair value adjustments
3,046

 
2,949

Stock-based compensation expense
2,571

 
2,119

Settlement of forward interest rate swap agreement

1,617

 

Other, net
(839
)
 
804

Changes in operating assets and liabilities
 
 
 
Change in restricted cash
(1,438
)
 
(1,549
)
Change in accounts receivable
(195
)
 
(1,019
)
Change in other assets
(168
)
 
(68
)
Change in accounts payable and accrued expenses
7,298

 
8,071

Change in security deposits payable
113

 
154

Change in other liabilities and deferred credits
1,751

 
321

Net cash provided by operating activities
81,397

 
74,490

INVESTING ACTIVITIES
 
 
 
Capital expenditures
(94,877
)
 
(33,503
)
Change in restricted cash
(1,272
)
 
305

Leasing commissions
(2,805
)
 
(1,977
)
Net cash used in investing activities
(98,954
)
 
(35,175
)
FINANCING ACTIVITIES
 
 
 
Change in restricted cash

 
(1,400
)
Repayment of secured notes payable
(1,169
)
 
(2,749
)
Proceeds from term loan
100,000

 

Repayment of line of credit
(93,000
)
 

Debt issuance costs
(1,957
)
 

Proceeds from issuance of common stock, net
104,148

 
24,790

Dividends paid to common stock and unitholders
(39,988
)
 
(36,645
)
Deferred offering costs

 
(68
)
Shares withheld for employee taxes
(4,319
)
 

Net cash provided by (used in) financing activities
63,715

 
(16,072
)
Net increase in cash and cash equivalents
46,158

 
23,243

Cash and cash equivalents, beginning of period
48,987

 
42,479

Cash and cash equivalents, end of period
$
95,145

 
$
65,722

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

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Table of Contents
American Assets Trust, Inc.
Notes to Consolidated Financial Statements
September 30, 2014
(Unaudited)



NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business and Organization
American Assets Trust, Inc. (which may be referred to in these financial statements as the “Company,” “we,” “us,” or “our”) is a Maryland corporation formed on July 16, 2010 that did not have any operating activity until the consummation of our initial public offering on January 19, 2011. The Company is the sole general partner of American Assets Trust, L.P., a Maryland limited partnership formed on July 16, 2010 (the “Operating Partnership”). The Company’s operations are carried on through our Operating Partnership and its subsidiaries, including our taxable real estate investment trust ("REIT") subsidiary ("TRS"). Since the formation of our Operating Partnership, the Company has controlled our Operating Partnership as its general partner and has consolidated its assets, liabilities and results of operations.
We are a full service vertically integrated and self-administered REIT with approximately 118 employees providing substantial in-house expertise in asset management, property management, property development, leasing, tenant improvement construction, acquisitions, repositioning, redevelopment and financing.
As of September 30, 2014, we owned or had a controlling interest in 23 office, retail, multifamily and mixed-use operating properties, the operations of which we consolidate. Additionally, as of September 30, 2014, we owned land at five of our properties that we classify as held for development and/or construction in progress. A summary of the properties owned by us is as follows:
Retail
Carmel Country Plaza
Del Monte Center
 
Carmel Mountain Plaza
Geary Marketplace
 
South Bay Marketplace
The Shops at Kalakaua
 
Rancho Carmel Plaza
Waikele Center
 
Lomas Santa Fe Plaza
Alamo Quarry Market
 
Solana Beach Towne Centre
 
 
Office
Torrey Reserve Campus
Lloyd District Portfolio
 
Solana Beach Corporate Centre
City Center Bellevue
 
The Landmark at One Market
 
 
One Beach Street
 
 
First & Main
 
 
Multifamily
Loma Palisades
 
 
Imperial Beach Gardens
 
 
Mariner's Point
 
 
Santa Fe Park RV Resort
 
 
Mixed-Use
 
 
Waikiki Beach Walk Retail and Embassy Suites™ Hotel
 
Held for Development and Construction in Progress
Solana Beach Corporate Centre – Land
 
 
Solana Beach – Highway 101 – Land
 
 
Sorrento Pointe – Land
 
 
Torrey Reserve – Land
 
 
Lloyd District Portfolio – Land
 
 

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Table of Contents
American Assets Trust, Inc.
Notes to Consolidated Financial Statements—(Continued)
September 30, 2014
(Unaudited)


Basis of Presentation
Our consolidated financial statements include the accounts of the Company, our Operating Partnership and our subsidiaries. The equity interests of other investors in our Operating Partnership are reflected as noncontrolling interests.
All significant intercompany transactions and balances are eliminated in consolidation.
The accompanying consolidated financial statements of the Company have been prepared in accordance with the rules applicable to Form 10-Q and include all information and footnotes required for interim financial statement presentation, but do not include all disclosures required under accounting principles generally accepted in the United States (“GAAP”) for annual financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments, except as otherwise noted) considered necessary for a fair presentation have been included. These financial statements should be read in conjunction with the audited consolidated financial statements and notes therein included in the Company's annual report on Form 10-K for the year ended December 31, 2013.
The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that in certain circumstances affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities, and revenues and expenses. These estimates are prepared using our best judgment, after considering past, current and expected events and economic conditions. Actual results could differ from these estimates.
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.
Consolidated Statements of Cash Flows—Supplemental Disclosures
The following table provides supplemental disclosures related to the Consolidated Statements of Cash Flows (in thousands): 
 
Nine Months Ended September 30,
 
2014
 
2013
Supplemental cash flow information
 
 
 
Total interest costs incurred
$
43,912

 
$
45,692

Interest capitalized
$
3,516

 
$
1,448

Interest expense
$
40,396

 
$
44,244

Cash paid for interest, net of amounts capitalized
$
37,557

 
$
41,189

Cash paid for income taxes
$
319

 
$
868

Supplemental schedule of noncash investing and financing activities
 

 
 

Accounts payable and accrued liabilities for construction in progress
$
8,982

 
$
3,188

Accrued leasing commissions
$
(124
)
 
$
488

Reduction to capital for prepaid offering costs
$

 
$
437


 Significant Accounting Policies

We describe our significant accounting policies in Note 1 to the consolidated financial statements in Item 8 of our Annual Report on Form 10-K for the year ended December 31, 2013. There have been no changes to our significant accounting policies during the nine months ended September 30, 2014.


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American Assets Trust, Inc.
Notes to Consolidated Financial Statements—(Continued)
September 30, 2014
(Unaudited)


We record all derivatives on the balance sheets at fair value.  The accounting for changes in the fair value of derivatives depends on the intended use of such derivatives, whether we have elected to designate a derivative as being in a hedging relationship, whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting and applying such hedge accounting.  Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges.  Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges.  Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge.  When we terminate a derivative for which cash flow hedging was being applied, the balance which was recorded in other comprehensive income is amortized to interest expense over the remaining contractual term of the swap. We include cash payments and receipts made to terminate interest rate swaps as an operating activity on the statement of cash flows, given the nature of the underlying cash flows that the derivative was hedging.

Hedge ineffectiveness has not impacted earnings as of September 30, 2014, and we do not anticipate it will have a significant effect in the future.
Segment Information
Segment information is prepared on the same basis that our management reviews information for operational decision-making purposes. We operate in four business segments: the acquisition, redevelopment, ownership and management of retail real estate, office real estate, multifamily real estate and mixed-use real estate. The products for our retail segment primarily include rental of retail space and other tenant services, including tenant reimbursements, parking and storage space rental. The products for our office segment primarily include rental of office space and other tenant services, including tenant reimbursements, parking and storage space rental. The products for our multifamily segment include rental of apartments and other tenant services. The products of our mixed-use segment include rental of retail space and other tenant services, including tenant reimbursements, parking and storage space rental and operation of a 369-room all-suite hotel.
Reclassification
Certain amounts in the consolidated financial statements for prior periods have been reclassified to conform to current presentations.
Recent Accounting Pronouncements
In February 2013, the Financial Accounting Standards Board (the "FASB") issued ASU 2013-2, Comprehensive Income (Topic 220): Reporting Amounts Reclassified Out of Accumulated Other Comprehensive Income. ASU 2013-2 requires entities to disclose certain information relating to amounts reclassified out of accumulated other comprehensive income. This pronouncement became effective for us in the first quarter of 2013 and did not have a significant impact on our consolidated financial statements.
In April 2014, the FASB issued ASU 2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. ASU 2014-08 revises the definition of a discontinued operation to a disposal, sale or held-for-sale component or group of components that represents a strategic shift that will have a major effect on an entity's operations and financial results. This pronouncement is effective in 2015, however, calendar year-end companies may early adopt during the first quarter of 2014. We have chosen to early adopt this pronouncement and it became effective for us in the first quarter of 2014. This pronouncement did not have a significant impact on our consolidated financial statements.
In May 2014, the FASB issued Update No. 2014-09, Revenue from Contracts with Customers. Update No. 2014-09 establishes that companies may recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This pronouncement is effective for annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period; early adoption is not permitted. We are in the process of evaluating the impact this pronouncement will have on our consolidated financial statements.

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Table of Contents
American Assets Trust, Inc.
Notes to Consolidated Financial Statements—(Continued)
September 30, 2014
(Unaudited)


NOTE 2. ACQUIRED IN-PLACE LEASES AND ABOVE/BELOW MARKET LEASES
The following summarizes our acquired lease intangibles and leasing costs, which are included in other assets and other liabilities and deferred credits, as of September 30, 2014 and December 31, 2013 (in thousands): 
 
September 30, 2014
 
December 31, 2013
In-place leases
$
54,024

 
$
62,813

Accumulated amortization
(34,131
)
 
(38,279
)
Above market leases
22,541

 
28,279

Accumulated amortization
(16,968
)
 
(20,880
)
Acquired lease intangible assets, net
$
25,466

 
$
31,933

Below market leases
$
70,070

 
$
76,502

Accumulated accretion
(25,959
)
 
(28,592
)
Acquired lease intangible liabilities, net
$
44,111

 
$
47,910

NOTE 3. FAIR VALUE OF FINANCIAL INSTRUMENTS
A fair value measurement is based on the assumptions that market participants would use in pricing an asset or liability. The hierarchy for inputs used in measuring fair value is as follows:

1.
Level 1 Inputs—quoted prices in active markets for identical assets or liabilities
2.
Level 2 Inputs—observable inputs other than quoted prices in active markets for identical assets and liabilities
3.
Level 3 Inputs—unobservable inputs
Except as disclosed below, the carrying amounts of our financial instruments approximate their fair value. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement.
We measure the fair value of our deferred compensation liability, which is included in other liabilities and deferred credits on the consolidated balance sheet, on a recurring basis using Level 2 inputs. We measure the fair value of this liability based on prices provided by independent market participants that are based on observable inputs using market-based valuation techniques.

The fair value of the interest rate swap agreement on our term loan of $100 million is based on the estimated amounts we would receive or pay to terminate the contracts at the reporting date and are determined using interest rate pricing models and interest rate related observable inputs. The fair value of our swap at September 30, 2014 was a liability of $0.7 million and is included in "other liabilities and deferred credits" on our consolidated balance sheets. For the three and nine months ended September 30, 2014, the change in valuation on our interest rate swaps was a increase of $0.8 million and a decrease of $0.7 million, respectively. The effective portion of changes in the fair value of the derivatives that are designated as cash flow hedges are being recorded in accumulated other comprehensive loss and will be subsequently reclassified into earnings during the period in which the hedged forecasted transaction affects earnings.

The Company incorporates credit valuation adjustments to appropriately reflect both its own non-performance risk and the respective counterparty’s non-performance risk in the fair value measurements. In adjusting the fair value of its derivative contract for the effect of non-performance risk, the Company has considered the impact of netting and any applicable credit enhancements, such as collateral postings, thresholds, mutual puts, and guarantees.


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Table of Contents
American Assets Trust, Inc.
Notes to Consolidated Financial Statements—(Continued)
September 30, 2014
(Unaudited)


Although the Company has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, as of September 30, 2014 the Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative position and has determined that the credit valuation adjustments are not significant to the overall valuation of its derivatives. As a result, the Company has determined that its derivative valuation in its entirety is classified in Level 2 of the fair value hierarchy.

A summary of our financial liabilities that are measured at fair value on a recurring basis, by level within the fair value hierarchy is as follows (in thousands):
 
September 30, 2014
 
December 31, 2013
 
Level 1
Level 2
Level 3
Total
 
Level 1
Level 2
Level 3
Total
Deferred compensation liability
$

$
897

$

$
897

 
$

$
769

$

$
769

Interest rate swap
$

$
735

$

$
735

 
$

$

$

$

 The fair value of our secured notes payable is sensitive to fluctuations in interest rates. Discounted cash flow analysis using observable market interest rates (Level 2) is generally used to estimate the fair value of our secured notes payable, using rates ranging from 3.6% to 5.4%.
Considerable judgment is necessary to estimate the fair value of financial instruments. The estimates of fair value presented herein are not necessarily indicative of the amounts that could be realized upon disposition of the financial instruments. The carrying values of our revolving credit facility and term loan set forth below are deemed to be at fair value since the outstanding debt is directly tied to monthly LIBOR contracts. A summary of the carrying amount and fair value of our secured financial instruments, all of which are based on Level 2 inputs, is as follows (in thousands):  
 
September 30, 2014
 
December 31, 2013
 
Carrying Value
 
Fair Value
 
Carrying Value
 
Fair Value
Secured notes payable
$
953,190

 
$
987,508

 
$
952,174

 
$
990,296

Term loan
$
100,000

 
$
100,000

 
$

 
$

Line of credit
$

 
$

 
$
93,000

 
$
93,000

NOTE 4. DERIVATIVE AND HEDGING ACTIVITIES

Our objectives in using interest rate derivatives are to add stability to interest expense and to manage our exposure to interest rate movements.  To accomplish these objectives, we primarily use interest rate swaps as part of our interest rate risk management strategy.  Interest rate swaps designated as cash flow hedges involve the receipt of variable-rate amounts from a counterparty in exchange for us making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. 
Concurrent with the closing of our amended and restated credit facility, we entered into an interest rate swap agreement that is intended to fix the interest rate associated with the term loan at approximately 3.08% through its maturity date and extension options, subject to adjustments based on our consolidated leverage ratio. The following is a summary of the terms of the interest rate swap as of September 30, 2014 (dollars in thousands):
Swap Counterparty
 
Notional Amount
 
Effective Date
 
Maturity Date
 
Fair Value
Bank of America, N.A.
 
$100,000
 
1/9/2014
 
1/9/2019
 
$
735

The effective portion of changes in the fair value of the derivatives that are designated as cash flow hedges are being recorded in accumulated other comprehensive income and will be subsequently reclassified into earnings during the period in which the hedged forecasted transaction affects earnings.

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Table of Contents
American Assets Trust, Inc.
Notes to Consolidated Financial Statements—(Continued)
September 30, 2014
(Unaudited)


The valuation of these instruments is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of the derivative.  This analysis reflects the contractual terms of the derivative, including the period to maturity, and uses observable market-based inputs, including interest rate curves, and implied volatilities.  The fair value of the interest rate swaps is determined using the market standard methodology of netting the discounted future fixed cash receipts (or payments) and the discounted expected variable cash payments (or receipts).  The variable cash payments (or receipts) are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. 
Forward Starting Swap

On August 19, 2014, we entered into a one-month forward-starting seven-year swap contract with Wells Fargo Bank, N.A. to reduce the interest rate variability exposure of the projected interest cash flows of our then-prospective Series A Notes (as defined below).  The forward-starting seven-year swap contract had a notional amount of $150 million, a termination date of October 31, 2014, a fixed pay rate of 2.1305%, a receive rate equal to the one-month LIBOR, with fixed rate payments due quarterly on the last day of each January, April, July and October commencing January 30, 2015, floating payments due quarterly on the last day of each January, April, July and October commencing January 30, 2015, and floating reset dates two days prior to the first day of each calculation period.  The forward-starting seven-year swap contract accrual period, October 31, 2014 to October 31, 2021, was designed to match the expected tenor of the Series A Notes.

The forward-starting seven-year swap contract was deemed to be a highly effective cash flow hedge and we elected to designate the forward-starting swap contract as an accounting hedge. We settled the forward-starting seven-year swap contract on September 19, 2014 resulting in a gain of approximately $1.6 million.  This gain is included in accumulated other comprehensive income and will be amortized to interest expense over the life of the Series A Notes.
NOTE 5. OTHER ASSETS

Other assets consist of the following (in thousands): 
 
September 30, 2014
 
December 31, 2013
Leasing commissions, net of accumulated amortization of $20,496 and $19,606 respectively
$
17,316

 
$
18,071

Acquired above market leases, net
5,573

 
7,399

Acquired in-place leases, net
19,893

 
24,534

Lease incentives, net of accumulated amortization of $2,868 and $2,590, respectively
832

 
1,110

Other intangible assets, net of accumulated amortization of $1,553 and $1,554, respectively
497

 
655

Debt issuance costs, net of accumulated amortization of $3,847 and $2,985, respectively
3,727

 
2,632

Prepaid expenses and other
3,437

 
3,269

Total other assets
$
51,275

 
$
57,670


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Table of Contents
American Assets Trust, Inc.
Notes to Consolidated Financial Statements—(Continued)
September 30, 2014
(Unaudited)


NOTE 6. OTHER LIABILITIES AND DEFERRED CREDITS
Other liabilities and deferred credits consist of the following (in thousands):
 
September 30, 2014
 
December 31, 2013
Acquired below market leases, net
$
44,111

 
$
47,910

Prepaid rent and deferred revenue
6,994

 
7,506

Interest rate swap liability
735

 

Deferred rent expense and lease intangible
651

 
829

Deferred compensation
897

 
769

Deferred tax liability
233

 
233

Straight-line rent liability
2,263

 
1,145

Other liabilities
108

 
73

Total other liabilities and deferred credits, net
$
55,992

 
$
58,465

Straight-line rent liability relates to leases which have rental payments that decrease over time or one-time upfront payments for which the rental revenue is deferred and recognized on a straight-line basis.
NOTE 7. DEBT
The following is a summary of our total secured notes payable outstanding as of September 30, 2014 and December 31, 2013 (in thousands):
 
Principal Balance as of
 
Stated Interest Rate
 
Stated Maturity Date
Description of Debt
September 30, 2014
 
December 31, 2013
 
as of September 30, 2014
Waikele Center (1)(2)
$
140,700

 
$
140,700

 
5.15
%
 
November 1, 2014
The Shops at Kalakaua (1)
19,000

 
19,000

 
5.45
%
 
May 1, 2015
The Landmark at One Market (1)(3)
133,000

 
133,000

 
5.61
%
 
July 5, 2015
Del Monte Center (1)
82,300

 
82,300

 
4.93
%
 
July 8, 2015
First & Main (1)
84,500

 
84,500

 
3.97
%
 
July 1, 2016
Imperial Beach Gardens (1)
20,000

 
20,000

 
6.16
%
 
September 1, 2016
Mariner’s Point (1)
7,700

 
7,700

 
6.09
%
 
September 1, 2016
South Bay Marketplace (1)
23,000

 
23,000

 
5.48
%
 
February 10, 2017
Waikiki Beach Walk—Retail (1)
130,310

 
130,310

 
5.39
%
 
July 1, 2017
Solana Beach Corporate Centre III-IV (4)
36,487

 
36,804

 
6.39
%
 
August 1, 2017
Loma Palisades (1)
73,744

 
73,744

 
6.09
%
 
July 1, 2018
One Beach Street (1)
21,900

 
21,900

 
3.94
%
 
April 1, 2019
Torrey Reserve—North Court (4)
21,152

 
21,377

 
7.22
%
 
June 1, 2019
Torrey Reserve—VCI, VCII, VCIII (4)
7,127

 
7,200

 
6.36
%
 
June 1, 2020
Solana Beach Corporate Centre I-II (4)
11,347

 
11,475

 
5.91
%
 
June 1, 2020
Solana Beach Towne Centre (4)
37,823

 
38,249

 
5.91
%
 
June 1, 2020
City Center Bellevue (1)
111,000

 
111,000

 
3.98
%
 
November 1, 2022
 
961,090

 
962,259

 
 
 
 
Unamortized fair value adjustment
(7,900
)
 
(10,085
)
 
 
 
 
Total Secured Notes Payable Outstanding
$
953,190

 
$
952,174

 
 
 
 
(1)
Interest only.
(2)
Loan repaid in full, without premium or penalty, on October 31, 2014 in connection with the closing of our privately placed debt offering of $150 million of seven-year senior guaranteed notes with an effective rate of approximately 3.88% (including interest rate swap costs).
(3)
Maturity Date is the earlier of the loan maturity date under the loan agreement, or the “Anticipated Repayment Date” as specifically defined in the loan agreement, which is the date after which substantial economic penalties apply if the loan has not been paid off.
(4)
Principal payments based on a 30-year amortization schedule.

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Table of Contents
American Assets Trust, Inc.
Notes to Consolidated Financial Statements—(Continued)
September 30, 2014
(Unaudited)


Certain loans require us to comply with various financial covenants. As of September 30, 2014, we were in compliance with these financial covenants.

On October 31, 2014, we entered into a Note Purchase Agreement with a group of institutional purchasers that provided for the private placement of an aggregate of $350 million of senior guaranteed notes, of which (i) $150 million are designated as 4.04% Senior Guaranteed Notes, Series A, due October 31, 2021 (the “Series A Notes”), (ii) $100 million are designated as 4.45% Senior Guaranteed Notes, Series B, due February 2, 2025 (the “Series B Notes”) and (iii) $100 million are designated as 4.50% Senior Guaranteed Notes, Series C, due April 1, 2025 (the “Series C Notes”, and collectively with the Series A Notes and Series B Notes, are referred to herein as, the “Notes”). The Series A Notes were issued on October 31, 2014. The Series B Notes are expected to be issued on February 2, 2015 and the Series C Notes are expected to be issued on April 1, 2015, each subject to customary closing conditions. Upon issuance, the Notes will pay interest quarterly on the last day of January, April, July and October until their respective maturities. (Note 16)
We may prepay at any time all, or from time to time any part of, the Notes, in an amount not less than 5% of the aggregate principal amount of any series of the Notes then outstanding in the case of a partial prepayment, at 100% of the principal amount so prepaid plus a Make-Whole Amount (as defined in the Note Purchase Agreement).

The Note Purchase Agreement contains a number of customary financial covenants, including, without limitation, tangible net worth thresholds, secured and unsecured leverage ratios and fixed charge coverage ratios. Subject to the terms of the Note Purchase Agreement and the Notes, upon certain events of default, including, but not limited to, (i) a default in the payment of any principal, Make-Whole Amount or interest under the Notes, and (ii) a default in the payment of certain other indebtedness by us or our subsidiaries, the principal, accrued and unpaid interest, and the Make-Whole Amount on the outstanding Notes will become due and payable at the option of the purchasers.
Our obligations under the Notes are fully and unconditionally guaranteed by us and certain of our subsidiaries.
Credit Facility
On January 9, 2014, we entered into an amended and restated credit agreement (the "Amended and Restated Credit Facility") which amended and restated the then in-place credit facility. The Amended and Restated Credit Facility provides for aggregate, unsecured borrowing of $350 million, consisting of a revolving line of credit of $250 million (the "Revolver Loan") and a term loan of $100 million (the "Term Loan"). The Amended and Restated Credit Facility has an accordion feature that may allow us to increase the availability thereunder up to an additional $250 million, subject to meeting specified requirements and obtaining additional commitments from lenders.
Borrowings under the Amended and Restated Credit Facility initially bear interest at floating rates equal to, at our option, either (1) LIBOR, plus a spread which ranges from (a) 1.35%-1.95% (with respect to the Revolver Loan) and (b) 1.30% to 1.90% (with respect to the Term Loan), in each case based on our consolidated leverage ratio, or (2) a base rate equal to the highest of (a) the prime rate, (b) the federal funds rate plus 50 bps or (c) the Eurodollar rate plus 100 bps, plus a spread which ranges from (i) 0.35%-0.95% (with respect to the Revolver Loan) and (ii) 0.30% to 0.90% (with respect to the Term Loan), in each case based on our consolidated leverage ratio. If we obtain an investment-grade debt rating, under the terms set forth in the Amended and Restated Credit Facility, the spreads will further improve.
The Revolver Loan initially matures on January 9, 2018, subject to our option to extend the Revolver Loan up to two times, with each such extension for a six-month period. The Term Loan initially matures on January 9, 2016, subject to our option to extend the Term Loan up to three times, with each such extension for a 12-month period. The foregoing extension options are exercisable by us subject to the satisfaction of certain conditions.
Concurrent with the closing of the Amended and Restated Credit Facility, we drew down on the entirety of the $100 million Term Loan and entered into an interest rate swap agreement that is intended to fix the interest rate associated with the Term Loan at approximately 3.08% through its maturity date and extension options, subject to adjustments based on our consolidated leverage ratio.

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Table of Contents
American Assets Trust, Inc.
Notes to Consolidated Financial Statements—(Continued)
September 30, 2014
(Unaudited)


Additionally, the Amended and Restated Credit Facility includes a number of customary financial covenants, including:
A maximum leverage ratio (defined as total indebtedness net of certain cash and cash equivalents to total asset value) of 60%, and during any material acquisition period the maximum leverage ratio allowable is 65%,
A maximum secured leverage ratio (defined as total secured debt to secured total asset value) of 45% at any time prior to December 31, 2015, and 40% thereafter, during a material acquisition period the maximum secured leverage ratio is increased to 50% at any time prior to December 31, 2015 and 45% thereafter,
A minimum fixed charge coverage ratio (defined as consolidated earnings before interest, taxes, depreciation and amortization to consolidated fixed charges) of 1.50x,
A minimum unsecured interest coverage ratio of 1.75x,
A maximum unsecured leverage ratio of 60%, and during any material acquisition period the maximum unsecured leverage ratio allowable is 65%,
A minimum tangible net worth of $721.16 million, and 75% of the net proceeds of any additional equity issuances (other than additional equity issuances in connection with any dividend reinvestment program), and
Recourse indebtedness at any time cannot exceed 15% of total asset value.
The Amended and Restated Credit Facility provides that our annual distributions may not exceed the greater of (1) 95% of our funds from operations or (2) the amount required for us to (a) qualify and maintain our real estate investment trust ("REIT") status and (b) avoid the payment of federal or state income or excise tax. If certain events of default exist or would result from a distribution, we may be precluded from making distributions other than those necessary to qualify and maintain our status as a REIT.
As of September 30, 2014, we were in compliance with the Amended and Restated Credit Facility financial covenants.

On October 16, 2014, we entered into a First Amendment to the Amended and Restated Credit Agreement that amends
provisions of the Amended and Restated Credit Agreement to, among other things, (i) describe the treatment of our pari passu obligations under the Amended and Restated Credit Agreement and (ii) remove the material acquisition provisions previously set forth in the Amended and Restated Credit Agreement. (Note 16)
NOTE 8. EQUITY
Stockholders' Equity
On May 6, 2013, we entered into an at-the-market (“ATM”) equity program with four sales agents in which we may, from time to time, offer and sell shares of our common stock having an aggregate offering price of up to $150.0 million. The sales of shares of our common stock made through the ATM equity program are made in "at-the-market" offerings as defined in Rule 415 of the Securities Act of 1933, as amended. During the three and nine months ended September 30, 2014, the following shares of common stock and related proceeds were sold through the ATM equity program (in thousands, except per share data):
 
Three Months Ended September 30, 2014
 
Nine Months Ended September 30, 2014
Number of shares of common stock issued through ATM program
599,582

 
2,710,067

Weighted average price per share
$35.01
 
$33.84
 
 
 
 
Proceeds, gross
$
20,994

 
$
91,707

Sales agent compensation
(210
)
 
(918
)
Offering costs
(49
)
 
(145
)
Proceeds, net
$
20,735

 
$
90,644

 

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Table of Contents
American Assets Trust, Inc.
Notes to Consolidated Financial Statements—(Continued)
September 30, 2014
(Unaudited)


We intend to use the net proceeds from the ATM equity program to fund our development or redevelopment activities, repay amounts outstanding from time to time under our revolving credit facility or other debt financing obligations, fund potential acquisition opportunities and/or for general corporate purposes. As of September 30, 2014, we had the capacity to issue up to an additional $32.3 million in shares of our common stock under our ATM equity program. Actual future sales will depend on a variety of factors including, but not limited to, market conditions, the trading price of our common stock and our capital needs. We have no obligation to sell the remaining shares available for sale under the ATM equity program.

On September 12, 2014, we entered into a common stock purchase agreement (the “Purchase Agreement”) with Insurance Company of the West, a California corporation ("ICW") which is an insurance company majority owned and controlled by Ernest Rady, the Executive Chairman of our board of directors. The Purchase Agreement provided for the sale by us to ICW, in a private placement, of 400,000 shares of our common stock at a purchase price of $33.76 per share, resulting in gross proceeds to us of approximately $13.5 million. The price per share paid by ICW was equal to the closing price of a share of our common stock on the New York Stock Exchange on the date of the Purchase Agreement. These shares are characterized as “restricted securities” under the federal securities laws inasmuch as they are being acquired from us in a transaction not involving a public offering and that under such laws and applicable regulations such securities may be resold without registration under securities laws only in certain limited circumstances. ICW must bear the economic risk of this investment indefinitely unless the shares are registered pursuant to applicable securities laws, or an exemption from registration is available.

Noncontrolling Interests

Noncontrolling interests in our Operating Partnership are interests in the Operating Partnership that are not owned by us. Noncontrolling interests consisted of 17,905,257 common units (the “noncontrolling common units”), and represented approximately 29.3% of the ownership interests in our Operating Partnership at September 30, 2014. Common units and shares of our common stock have essentially the same economic characteristics in that common units and shares of our common stock share equally in the total net income or loss distributions of our Operating Partnership. Investors who own common units have the right to cause our Operating Partnership to redeem any or all of their common units for cash equal to the then-current market value of one share of our common stock, or, at our election, shares of our common stock on a one-for-one basis.
During the nine months ended September 30, 2014, approximately 11,852 common units were converted into shares of our common stock.
Dividends
The following table lists the dividends declared and paid on our shares of common stock and noncontrolling common units during the nine months ended September 30, 2014: 
Period
 
Amount  per
Share/Unit
 
Period Covered
 
Dividend Paid Date
First Quarter 2014
 
$
0.22

 
January 1, 2014 to March 31, 2014
 
March 28, 2014
Second Quarter 2014
 
$
0.22

 
April 1, 2014 to June 30, 2014
 
June 27, 2014
Third Quarter 2014
 
$
0.22

 
July 1, 2014 to September 30, 2014
 
September 26, 2014
Taxability of Dividends
Earnings and profits, which determine the taxability of distributions to stockholders and holders of common units, may differ from income reported for financial reporting purposes due to the differences for federal income tax purposes in the treatment of revenue recognition and compensation expense and in the basis of depreciable assets and estimated useful lives used to compute depreciation.
Stock-Based Compensation

We follow the FASB guidance related to stock compensation which establishes financial accounting and reporting standards for stock-based employee compensation plans, including all arrangements by which employees receive shares of stock or other equity instruments of the employer, or the employer incurs liabilities to employees in amounts based on the price of the employer's stock.  The guidance also defines a fair value-based method of accounting for an employee stock option or similar equity instrument.

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Table of Contents
American Assets Trust, Inc.
Notes to Consolidated Financial Statements—(Continued)
September 30, 2014
(Unaudited)


On March 25, 2014, we awarded 112,119 shares of restricted common stock pursuant to our 2011 Equity Incentive Award Plan (the “2011 Plan”), which are subject to performance-based vesting. Up to one-third of the shares of restricted stock may vest on November 30, 2014, 2015 and 2016 based upon pre-defined market specific performance criteria.

In addition, on the date of each annual meeting of our stockholders, each non-employee director who continues to serve on our board of directors (the "Board") following such annual meeting will be granted restricted shares of our common stock pursuant to the 2011 Plan. On June 17, 2014, we awarded a total of 5,864 shares of restricted common stock pursuant to our 2011 Plan to our non-employee directors. These awards of restricted stock will vest subject to the director's continued service on the Board on the earlier of (i) the one year anniversary of the date of grant or (ii) the date of the next annual meeting of our stockholders, if such non-employee director continues his or her service on the Board until the next annual meeting of stockholders, but not thereafter, pursuant to our independent director compensation policy.
For the performance-based stock awards, the fair value of the awards were estimated using a Monte Carlo Simulation model. Our stock price, along with the stock prices of a group of peer REITs, is assumed to follow the Multivariate Geometric Brownian Motion Process. Multivariate Geometric Brownian Motion is a common assumption when modeling in financial markets, as it allows the modeled quantity (in this case, the stock price) to vary randomly from its current value and take any value greater than zero. The volatilities of the returns on the stock price of the Company and the group of REITs were estimated based on a three year look-back period. The expected growth rate of the stock prices over the “derived service period” of the employee is determined with consideration of the risk free rate as of the grant date.
The following table summarizes the activity of restricted stock awards during the nine months ended September 30, 2014:
 
Units
 
Weighted Average Grant Date Fair Value
Nonvested at January 1, 2014
629,058

 
$
15.58

Granted
117,983

 
30.17

Vested
(313,998
)
 
15.57

Forfeited
(941
)
 
29.96

Nonvested at September 30, 2014
432,102

 
$
19.54

We recognize noncash compensation expense ratably over the vesting period, and accordingly, we recognized $2.6 million and $2.1 million, respectively, in noncash compensation expense for the nine months ended September 30, 2014 and 2013, which is included in general and administrative expense on the consolidated statements of comprehensive income. Unrecognized compensation expense was $2.6 million at September 30, 2014.
Earnings Per Share
We have calculated earnings per share (“EPS”) under the two-class method. The two-class method is an earnings allocation methodology whereby EPS for each class of common stock and participating security is calculated according to dividends declared and participation rights in undistributed earnings. The weighted average unvested shares outstanding, which are considered participating securities, were 432,311 and 629,835 for the three months ended September 30, 2014 and 2013, respectively, and 423,502 and 630,464 for the nine months ended September 30, 2014 and 2013, respectively. Therefore, we have allocated our earnings for basic and diluted EPS between common shares and unvested shares as these unvested shares have nonforfeitable dividend equivalent rights.
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. For the three and nine months ended September 30, 2014 and 2013, diluted shares exclude incentive restricted stock as these awards are considered contingently issuable. Additionally, the unvested restricted stock awards subject to time vesting are anti-dilutive for all periods presented, and accordingly, have been excluded from the weighted average common shares used to compute diluted EPS.


17

Table of Contents
American Assets Trust, Inc.
Notes to Consolidated Financial Statements—(Continued)
September 30, 2014
(Unaudited)


The computation of basic and diluted EPS is presented below (dollars in thousands, except share and per share amounts): 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2014
 
2013
 
2014
 
2013
NUMERATOR
 
 
 
 
 
 
 
Income from operations
$
9,090

 
$
6,258

 
$
21,099

 
$
15,687

Less: Net income attributable to restricted shares
(95
)
 
(132
)
 
(259
)
 
(397
)
Less: Income from operations attributable to unitholders in the Operating Partnership
(2,578
)
 
(1,903
)
 
(6,108
)
 
(4,752
)
Net income attributable to common stockholders—basic
$
6,417

 
$
4,223

 
$
14,732

 
$
10,538

Income from operations attributable to American Assets Trust, Inc. common stockholders—basic
$
6,417

 
$
4,223

 
$
14,732

 
$
10,538

Plus: Income from operations attributable to unitholders in the Operating Partnership
2,578

 
1,903

 
6,108

 
4,752

Net income attributable to common stockholders—diluted
$
8,995

 
$
6,126

 
$
20,840

 
$
15,290

DENOMINATOR
 
 
 
 
 
 
 
Weighted average common shares outstanding—basic
42,539,019

 
39,816,753

 
41,653,229

 
39,439,488

Effect of dilutive securities—conversion of Operating Partnership units
17,905,257

 
17,960,914

 
17,906,715

 
17,984,471

Weighted average common shares outstanding—diluted
60,444,276

 
57,777,667

 
59,559,944

 
57,423,959

 
 
 
 
 
 
 
 
Earnings per common share, basic
$
0.15

 
$
0.11

 
$
0.35

 
$
0.27

Earnings per common share, diluted
$
0.15

 
$
0.11

 
$
0.35

 
$
0.27

NOTE 9. INCOME TAXES
We elected to be taxed as a REIT and operate in a manner that allows us to qualify as a REIT for federal income tax purposes commencing with our initial taxable year. 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. Taxable income from non-REIT activities managed through our TRS is subject to federal and state income taxes.
We lease our hotel property to a wholly owned TRS that is subject to federal and state income taxes. We account for income taxes using the asset and liability method, under which deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between GAAP carrying amounts and their respective tax bases. Additionally, we classify certain state taxes as income taxes for financial reporting purposes in accordance with ASC Topic 740, Income Taxes.
A deferred tax liability of $0.2 million as of September 30, 2014 and December 31, 2013 is included in our consolidated balance sheets in relation to real estate asset basis differences of property subject to the Texas margin tax and certain prepaid expenses of our TRS.
Income tax expense is recorded in other income (expense), net in our consolidated statements of comprehensive income. For the three and nine months ended September 30, 2014 we recorded an income tax expense of $0.7 million and $0.5 million, respectively. For the three and nine months ended September 30, 2013 we recorded an income tax expense of $0.5 million and $0.9 million, respectively.
NOTE 10. COMMITMENTS AND CONTINGENCIES
Legal
We are sometimes involved in various disputes, lawsuits, warranty claims, environmental and other matters arising in the ordinary course of business. Management makes assumptions and estimates concerning the likelihood and amount of any potential loss relating to these matters.

18

Table of Contents
American Assets Trust, Inc.
Notes to Consolidated Financial Statements—(Continued)
September 30, 2014
(Unaudited)


We are currently a party to various legal proceedings. We accrue a liability for litigation if an unfavorable outcome is probable and the amount of loss can be reasonably estimated. If an unfavorable outcome is probable and a reasonable estimate of the loss is a range, we accrue the best estimate within the range; however, if no amount within the range is a better estimate than any other amount, the minimum within the range is accrued. Legal fees related to litigation are expensed as incurred. We do not believe that the ultimate outcome of these matters, either individually or in the aggregate, could have a material adverse effect on our financial position or overall trends in results of operations; however, litigation is subject to inherent uncertainties. Also, under our leases, tenants are typically obligated to indemnify us from and against all liabilities, costs and expenses imposed upon or asserted against us as owner of the properties due to certain matters relating to the operation of the properties by the tenant.
Commitments
At The Landmark at One Market, we lease, as lessee, a building adjacent to The Landmark under an operating lease effective through June 30, 2016, which we have the option to extend until 2026 by way of two five-year extension options.
At Waikiki Beach Walk, we sublease a portion of the building of which Quiksilver is currently in possession, under an operating lease effective through December 31, 2021, which we have the option to extend at fair rental value in the event the sublessor extends its lease for the space with the master landlord. The lease payments under the lease will increase by approximately 3.4% annually through 2017 and, thereafter, will be equal to fair rental value, as defined in the lease, through lease expiration.
Current minimum annual payments under the leases are as follows, as of September 30, 2014 (in thousands): 
Year Ending December 31,
 
 
2014 (three months ending December 31, 2014)
$
649

 
2015
2,636

 
2016
1,709

 
2017
736

(1) 
2018
740


Thereafter
2,221

 
Total
$
8,691

 
(1)
Lease payments on the Waikiki Beach Walk lease will be equal to fair rental value from March 2017 through the end of the lease term. In the table, we have shown the lease payments for this period based on the stated rate for the month of February 2017 of $61,690.
We have management agreements with Outrigger Hotels & Resorts or an affiliate thereof (“Outrigger”) pursuant to which Outrigger manages each of the retail and hotel portions of the Waikiki Beach Walk property. Under the management agreement with Outrigger relating to the retail portion of Waikiki Beach Walk (the “retail management agreement”), we pay Outrigger a monthly management fee of 3.0% of net revenues from the retail portion of Waikiki Beach Walk. Pursuant to the terms of the retail management agreement, if the agreement is terminated in certain instances, including our election not to repair damage or destruction at the property, a condemnation or our failure to make required working capital infusions, we would be obligated to pay Outrigger a termination fee equal to the sum of the management fees paid for the two calendar months immediately preceding the termination date. The retail management agreement may not be terminated by us or by Outrigger without cause. Under our management agreement with Outrigger relating to the hotel portion of Waikiki Beach Walk (the “hotel management agreement”), we pay Outrigger a monthly management fee of 6.0% of the hotel's gross operating profit, as well as 3.0% of the hotel's gross revenues; provided that the aggregate management fee payable to Outrigger for any year shall not exceed 3.5% of the hotel's gross revenues for such fiscal year. Pursuant to the terms of the hotel management agreement, if the agreement is terminated in certain instances, including upon a transfer by us of the hotel or upon a default by us under the hotel management agreement, we would be required to pay a cancellation fee calculated by multiplying (1) the management fees for the previous 12 months by (2) (a) eight, if the agreement is terminated in the first 11 years of its term, or (b) four, three, two or one, if the agreement is terminated in the twelfth, thirteenth, fourteenth or fifteenth year, respectively, of its term. The hotel management agreement may not be terminated by us or by Outrigger without cause.

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American Assets Trust, Inc.
Notes to Consolidated Financial Statements—(Continued)
September 30, 2014
(Unaudited)


A wholly owned subsidiary of our Operating Partnership, WBW Hotel Lessee LLC, entered into a franchise license agreement with Embassy Suites Franchise LLC, the franchisor of the brand “Embassy Suites™,” to obtain the non-exclusive right to operate the hotel under the Embassy SuitesTM brand for 20 years. The franchise license agreement provides that WBW Hotel Lessee LLC must comply with certain management, operational, record keeping, accounting, reporting and marketing standards and procedures. In connection with this agreement, we are also subject to the terms of a product improvement plan pursuant to which we expect to undertake certain actions to ensure that our hotel's infrastructure is maintained in compliance with the franchisor's brand standards. In addition, we must pay to Embassy Suites Franchise LLC a monthly franchise royalty fee equal to 4.0% of the hotel's gross room revenue through December 2021 and 5.0% of the hotel's gross room revenue thereafter, as well as a monthly program fee equal to 4.0% of the hotel's gross room revenue. If the franchise license is terminated due to our failure to make required improvements or to otherwise comply with its terms, we may be liable to the franchisor for a termination payment, which could be as high as $6.5 million based on operating performance through September 30, 2014.
We had a property management agreement with Langley Investment Properties, Inc. (“Langley”) pursuant to which Langley managed and operated Lloyd District Portfolio, and we paid Langley a monthly management fee of 3.5% of “gross receipts,” as defined in the property management agreement, as well as leasing commissions and construction oversight fees in certain situations. The property management agreement was terminated on February 1, 2013 by mutual consent of both parties. Langley continued to provide development consulting services to us until June 30, 2013 and leasing services to us until December 31, 2013 pursuant to a development, consulting, leasing and transition services and management termination agreement.
Our Del Monte Center property has ongoing environmental remediation related to ground water contamination. The environmental issue existed at purchase and remains in remediation. The final stages of the remediation will include routine, long term ground monitoring by the appropriate regulatory agency over the next two to ten years. The work performed is financed through an escrow account funded by the seller upon purchase of the Del Monte Center. We believe the funds in the escrow account are sufficient for the remaining work to be performed. However, if further work is required costing more than the remaining escrow funds, we could be required to pay such overage, although we may have a contractual claim for such costs against the prior owner or our environmental remediation consultant.
In connection with our initial public offering, we entered into tax protection agreements with certain limited partners of our Operating Partnership. These agreements provide that if we dispose of any interest with respect to Carmel Country Plaza, Carmel Mountain Plaza, Del Monte Center, Loma Palisades, Lomas Santa Fe Plaza, Waikele Center or the ICW Plaza portion of Torrey Reserve Campus, in a taxable transaction during the period from the closing of our initial public offering through January 19, 2018, we will indemnify such limited partners for their tax liabilities attributable to their share of the built-in gain that existed with respect to such property interest as of the time of our initial public offering and tax liabilities incurred as a result of the reimbursement payment. Subject to certain exceptions and limitations, the indemnification rights will terminate for any such protected partner that sells, exchanges or otherwise disposes of more than 50% of his or her common units. We have no present intention to sell or otherwise dispose of the properties or interest therein in taxable transactions during the restriction period. If we were to trigger the tax protection provisions under these agreements, we would be required to pay damages in the amount of the taxes owed by these limited partners (plus additional damages in the amount of the taxes incurred as a result of such payment).
Concentrations of Credit Risk
Our properties are located in Southern California, Northern California, Hawaii, Oregon, Texas, and Washington. 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. Twelve of our consolidated properties are located in Southern California, which exposes us to greater economic risks than if we owned a more geographically diverse portfolio. Tenants in the retail industry accounted for 36.6% of total revenues for the nine months ended September 30, 2014. This makes us susceptible to demand for retail rental space and subject to the risks associated with an investment in real estate with a concentration of tenants in the retail industry. Furthermore, tenants in the office industry accounted for 35.5% of total revenues for the nine months ended September 30, 2014. This makes us susceptible to demand for office rental space and subject to the risks associated with an investment in real estate with a concentration of tenants in the office industry. For the nine months ended September 30, 2014 and 2013, no tenant accounted for more than 10% of our total rental revenue.

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American Assets Trust, Inc.
Notes to Consolidated Financial Statements—(Continued)
September 30, 2014
(Unaudited)


NOTE 11. OPERATING LEASES
Our leases with office, retail, mixed-use and residential tenants are classified as operating leases. Leases at our office and retail properties and the retail portion of our mixed-use property generally range from three to ten years (certain leases with anchor tenants may be longer), and in addition to minimum rents, usually provide for cost recoveries for the tenant’s share of certain operating costs and also may include percentage rents based on the tenant’s level of sales achieved. Leases on apartments generally range from 7 to 15 months, with a majority having 12-month lease terms. Rooms at the hotel portion of our mixed-use property are rented on a nightly basis.
As of September 30, 2014, minimum future rentals from noncancelable operating leases, before any reserve for uncollectible amounts and assuming no early lease terminations, at our office and retail properties and the retail portion of our mixed-use property are as follows (in thousands):
 
Year Ending December 31,
 
2014 (three months ending December 31, 2014)
$
38,749

2015
157,238

2016
139,280

2017
122,082

2018
89,807

Thereafter
193,123

Total
$
740,279

 
The above future minimum rentals exclude residential leases, which typically have a term of 12 months or less, and exclude the hotel, as rooms are rented on a nightly basis.
NOTE 12. COMPONENTS OF RENTAL INCOME AND EXPENSE
The principal components of rental income are as follows (in thousands): 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2014
 
2013
 
2014
 
2013
Minimum rents
 
 
 
 
 
 
 
Retail
$
17,841

 
$
17,384

 
$
52,581

 
$
51,971

Office
20,534

 
20,736

 
60,970

 
61,534

Multifamily
3,992

 
3,837

 
11,723

 
11,107

Mixed-use
2,523

 
2,443

 
7,489

 
7,120

Cost reimbursement
7,405

 
7,093

 
21,115

 
20,006

Percentage rent
732

 
504

 
1,548

 
1,324

Hotel revenue
10,122

 
9,984

 
26,167

 
27,010

Other
444

 
424

 
1,275

 
1,260

Total rental income
$
63,593

 
$
62,405

 
$
182,868

 
$
181,332

Minimum rents include $0.8 million and $0.6 million for the three months ended September 30, 2014 and 2013, respectively, and $2.4 million and $1.8 million for the nine months ended September 30, 2014 and 2013, respectively, to recognize minimum rents on a straight-line basis. In addition, net amortization of above and below market leases included in minimum rents were $0.7 million and $1.0 million for the three months ended September 30, 2014 and 2013, respectively, and $2.0 million and $1.8 million for the nine months ended September 30, 2014 and 2013, respectively.

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American Assets Trust, Inc.
Notes to Consolidated Financial Statements—(Continued)
September 30, 2014
(Unaudited)


The principal components of rental expenses are as follows (in thousands): 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2014
 
2013
 
2014
 
2013
Rental operating
$
6,644

 
$
6,538

 
$
19,602

 
$
19,282

Hotel operating
5,777

 
5,654

 
16,303

 
16,574

Repairs and maintenance
2,404

 
2,727

 
7,398

 
7,330

Marketing
355

 
356

 
1,137

 
1,052

Rent
612

 
596

 
1,837

 
1,820

Hawaii excise tax
1,080

 
1,071

 
2,880

 
2,962

Management fees
502

 
488

 
1,337

 
1,382

Total rental expenses
$
17,374

 
$
17,430

 
$
50,494

 
$
50,402

NOTE 13. OTHER INCOME (EXPENSE), NET
The principal components of other income (expense), net, are as follows (in thousands):
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2014
 
2013
 
2014
 
2013
Interest and investment income
$
44

 
$
54

 
$
101

 
$
88

Income tax benefit (expense)
(665
)
 
(473
)
 
(494
)
 
(861
)
Termination fee income, net

 

 
745

 
10

Total other income (expense), net
$
(621
)
 
$
(419
)
 
$
352

 
$
(763
)
NOTE 14. RELATED PARTY TRANSACTIONS
At ICW Plaza, we lease space to Insurance Company of the West, a California corporation ("ICW") which is an insurance company majority owned and controlled by Ernest Rady, our Executive Chairman of the Board. Rental revenue recognized on the leases of $1.6 million for each of the nine months ended September 30, 2014 and 2013, respectively, is included in rental income. Additionally, on July 1, 2014, we entered into a workers' compensation insurance policy with ICW. The policy premium is approximately $0.4 million for the period July 1, 2014 through July 1, 2015.
On September 12, 2014, we entered into a Purchase Agreement with ICW. The Purchase Agreement provides for the sale by us to ICW, in a private placement, of 400,000 shares of common stock at a price of $33.76 per share, resulting in gross proceeds to us of approximately $13.5 million. The price per share paid by ICW was equal to the closing price of a share of our common stock on the New York Stock Exchange on the date of the Purchase Agreement. As of September 30, 2014, Mr. Rady and his affiliates owned approximately 13.7% of our outstanding common stock and 24.3% of our outstanding common units, which together represent an approximate 33.8% beneficial interest in our company on a fully diluted basis.
The Waikiki Beach Walk entities have a 47.7% investment in WBW CHP LLC, an entity that was formed to, among other things, construct a chilled water plant to provide air conditioning to the property and other adjacent facilities. The operating expenses of WBW CHP LLC are recovered through reimbursements from its members, and reimbursements to WBW CHP LLC of $0.9 million and $0.8 million were made for the nine months ended September 30, 2014 and 2013, respectively, and are included in rental expenses on the statements of comprehensive income.
NOTE 15. SEGMENT REPORTING
Segment information is prepared on the same basis that our management reviews information for operational decision-making purposes. We operate in four business segments: the acquisition, redevelopment, ownership and management of retail real estate, office real estate, multifamily real estate and mixed-use real estate. The products for our retail segment primarily include rental of retail space and other tenant services, including tenant reimbursements, parking and storage space rental. The products for our office segment primarily include rental of office space and other tenant services, including tenant reimbursements, parking and storage space rental. The products for our multifamily segment include rental of apartments and

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American Assets Trust, Inc.
Notes to Consolidated Financial Statements—(Continued)
September 30, 2014
(Unaudited)


other tenant services. The products of our mixed-use segment include rental of retail space and other tenant services, including tenant reimbursements, parking and storage space rental and operation of a 369-room all-suite hotel.
We evaluate the performance of our segments based on segment profit, which is defined as property revenue less property expenses. We do not use asset information as a measure to assess performance and make decisions to allocate resources. Therefore, depreciation and amortization expense is not allocated among segments. General and administrative expenses, interest expense, depreciation and amortization expense and other income and expense are not included in segment profit as our internal reporting addresses these items on a corporate level.
Segment profit is not a measure of operating income or cash flows from operating activities as measured by GAAP, 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 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 (in thousands): 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2014
 
2013
 
2014
 
2013
Total Retail
 
 
 
 
 
 
 
Property revenue
$
24,177

 
$
23,524

 
$
70,746

 
$
69,175

Property expense
(6,197
)
 
(6,445
)
 
(18,703
)
 
(17,476
)
Segment profit
17,980

 
17,079

 
52,043

 
51,699

Total Office
 
 
 
 
 
 
 
Property revenue
23,416

 
22,664

 
68,721

 
67,598

Property expense
(6,813
)
 
(6,636
)
 
(19,791
)
 
(19,656
)
Segment profit
16,603

 
16,028

 
48,930

 
47,942

Total Multifamily
 
 
 
 
 
 
 
Property revenue
4,320

 
4,155

 
12,660

 
12,004

Property expense
(1,532
)
 
(1,525
)
 
(4,513
)
 
(4,383
)
Segment profit
2,788

 
2,630

 
8,147

 
7,621

Total Mixed-Use
 
 
 
 
 
 
 
Property revenue
15,430

 
14,975

 
41,395

 
41,635

Property expense
(8,731
)
 
(8,592
)
 
(24,541
)
 
(24,931
)
Segment profit
6,699

 
6,383

 
16,854

 
16,704

Total segments’ profit
$
44,070

 
$
42,120

 
$
125,974

 
$
123,966

The following table is a reconciliation of segment profit to net income attributable to stockholders (in thousands):

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American Assets Trust, Inc.
Notes to Consolidated Financial Statements—(Continued)
September 30, 2014
(Unaudited)


 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2014
 
2013
 
2014
 
2013
Total segments’ profit
$
44,070

 
$
42,120

 
$
125,974

 
$
123,966

General and administrative
(4,682
)
 
(4,031
)
 
(13,929
)
 
(12,658
)
Depreciation and amortization
(16,352
)
 
(16,648
)
 
(50,902
)
 
(50,614
)
Interest expense
(13,325
)
 
(14,764
)
 
(40,396
)
 
(44,244
)
Other income (expense), net
(621
)
 
(419
)
 
352

 
(763
)
Net income
9,090

 
6,258

 
21,099

 
15,687

Net income attributable to restricted shares
(95
)
 
(132
)
 
(259
)
 
(397
)
Net income attributable to unitholders in the Operating Partnership
(2,578
)
 
(1,903
)
 
(6,108
)
 
(4,752
)
Net income attributable to American Assets Trust, Inc. stockholders
$
6,417

 
$
4,223

 
$
14,732

 
$
10,538

The following table shows net real estate and secured note payable balances for each of the segments (in thousands):
 
September 30, 2014
 
December 31, 2013
Net Real Estate
 
 
 
Retail
$
641,406

 
$
651,707

Office
754,608

 
750,890

Multifamily
146,302

 
74,612

Mixed-Use
195,723

 
199,627

 
$
1,738,039

 
$
1,676,836

Secured Notes Payable (1)
 
 
 
Retail
$
302,823

 
$
303,249

Office
426,513

 
427,256

Multifamily
101,444

 
101,444

Mixed-Use
130,310

 
130,310

 
$
961,090

 
$
962,259

(1)
Excludes unamortized fair market value adjustments of $7.9 million and $10.1 million as of September 30, 2014 and December 31, 2013, respectively.

Capital expenditures for each segment for the three and nine months ended September 30, 2014 and 2013 were as follows (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2014
 
2013
 
2014
 
2013
Capital Expenditures (1)
 
 
 
 
 
 
 
Retail
$
2,094

 
$
616

 
$
4,725

 
$
3,143

Office
7,247

 
6,785

 
22,928

 
20,674

Multifamily
25,007

 
5,256

 
66,647

 
11,017

Mixed-Use
445

 
275

 
3,382

 
646

 
$
34,793

 
$
12,932

 
$
97,682

 
$
35,480

(1)
Capital expenditures represent cash paid for capital expenditures during the period and include leasing commissions paid.

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American Assets Trust, Inc.
Notes to Consolidated Financial Statements—(Continued)
September 30, 2014
(Unaudited)


NOTE 16. SUBSEQUENT EVENTS

On October 16, 2014, we entered into a First Amendment to the Amended and Restated Credit Agreement that amends
provisions of the Amended and Restated Credit Agreement to, among other things, (i) describe the treatment of our pari passu obligations under the Amended and Restated Credit Agreement and (ii) remove the material acquisition provisions previously set forth in the Amended and Restated Credit Agreement.

On October 31, 2014, we entered into a Note Purchase Agreement with a group of institutional purchasers that provided for the private placement of an aggregate of $350 million of senior guaranteed notes, of which (i) $150 million are designated as 4.04% Senior Guaranteed Notes, Series A, due October 31, 2021 (the “Series A Notes”), (ii) $100 million are designated as 4.45% Senior Guaranteed Notes, Series B, due February 2, 2025 (the “Series B Notes”) and (iii) $100 million are designated as 4.50% Senior Guaranteed Notes, Series C, due April 1, 2025 (the “Series C Notes”, and collectively with the Series A Notes and Series B Notes, are referred to herein as, the “Notes”). The Series A Notes were issued on October 31, 2014. The Series B Notes are expected to be issued on February 2, 2015 and the Series C Notes are expected to be issued on April 1, 2015, each subject to customary closing conditions. Upon issuance, the Notes will pay interest quarterly on the last day of January, April, July and October until their respective maturities.
We may prepay at any time all, or from time to time any part of, the Notes, in an amount not less than 5% of the aggregate principal amount of any series of the Notes then outstanding in the case of a partial prepayment, at 100% of the principal amount so prepaid plus a Make-Whole Amount (as defined in the Note Purchase Agreement).

The Note Purchase Agreement contains a number of customary financial covenants, including, without limitation, tangible net worth thresholds, secured and unsecured leverage ratios and fixed charge coverage ratios. Subject to the terms of the Note Purchase Agreement and the Notes, upon certain events of default, including, but not limited to, (i) a default in the payment of any principal, Make-Whole Amount or interest under the Notes, and (ii) a default in the payment of certain other indebtedness by us or our subsidiaries, the principal, accrued and unpaid interest, and the Make-Whole Amount on the outstanding Notes will become due and payable at the option of the purchasers.
Our obligations under the Notes are fully and unconditionally guaranteed by us and certain of our subsidiaries.
    
On October 31, 2014 and concurrent with the closing of the Series A Notes, we repaid, without penalty or premium, the mortgage encumbering Waikele Center in the amount of approximately $140.7 million, utilizing funds raised from the issuance of the Series A Notes. The mortgage on Waikele Center had an original maturity date of November 1, 2014 and was secured by a first-priority deed of trust lien on the property, a security interest in all personal property used in connection with the property and an assignment of all leases, rents and security deposits relating to the property. As of November 7, 2014, $150.00 million of the Series A Notes was outstanding.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements
The following discussion should be read in conjunction with the consolidated financial statements and notes thereto appearing elsewhere in this report. We make statements in this report that are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (set forth in Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act). In particular, statements pertaining to our capital resources, portfolio performance and results of operations contain forward-looking statements. Likewise, all of our statements regarding anticipated growth in our funds from operations and anticipated market conditions, demographics and results of operations are forward-looking statements. You can identify forward-looking statements by the use of forward-looking terminology such as “believes,” “expects,” “may,” “will,” “should,” “seeks,” “approximately,” “intends,” “plans,” “pro forma,” “estimates” or “anticipates” or the negative of these words and phrases or similar words or phrases which are predictions of or indicate future events or trends and which do not relate solely to historical matters. You can also identify forward-looking statements by discussions of strategy, plans or intentions.
Forward-looking statements involve numerous risks and uncertainties and you should not rely on them as predictions of future events. Forward-looking statements depend on assumptions, data or methods which may be incorrect or imprecise and we may not be able to realize them. We do not guarantee that the transactions and events described will happen as described (or that they will happen at all). The following factors, among others, could cause actual results and future events to differ materially from those set forth or contemplated in the forward-looking statements:
adverse economic or real estate developments in our markets;
our failure to generate sufficient cash flows to service our outstanding indebtedness;
defaults on, early terminations of or non-renewal of leases by tenants, including significant tenants;
difficulties in identifying properties to acquire and completing acquisitions;
difficulties in completing dispositions;
our failure to successfully operate acquired properties and operations;
our inability to develop or redevelop our properties due to market conditions;
fluctuations in interest rates and increased operating costs;
risks related to joint venture arrangements;
our failure to obtain necessary outside financing;
on-going litigation;
general economic conditions;
financial market fluctuations;
risks that affect the general retail, office, multifamily and mixed-use environment;
the competitive environment in which we operate;
decreased rental rates or increased vacancy rates;
conflicts of interests with our officers or directors;
lack or insufficient amounts of insurance;
environmental uncertainties and risks related to adverse weather conditions and natural disasters;
other factors affecting the real estate industry generally;
limitations imposed on our business and our ability to satisfy complex rules in order for us to continue to qualify as a real estate investment trust, or REIT, for U.S. federal income tax purposes; and
changes in governmental regulations or interpretations thereof, such as real estate and zoning laws and increases in real property tax rates and taxation of REITs.


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While forward-looking statements reflect our good faith beliefs, they are not guarantees of future performance. We disclaim any obligation to publicly update or revise any forward-looking statement to reflect changes in underlying assumptions or factors, new information, data or methods, future events or other changes. For a further discussion of these and other factors, see the section entitled “Item 1A. Risk Factors” contained herein and in our annual report on Form 10-K for the year ended December 31, 2013.
Overview
References to “we,” “our,” “us” and “our company” refer to American Assets Trust, Inc., a Maryland corporation, together with our consolidated subsidiaries, including American Assets Trust, L.P., a Maryland limited partnership, of which we are the sole general partner and which we refer to in this report as our Operating Partnership.
We are a full service, vertically integrated and self-administered REIT that owns, operates, acquires and develops high quality retail, office, multifamily and mixed-use properties in attractive, high-barrier-to-entry markets in Southern California, Northern California, Oregon, Washington, Texas and Hawaii. As of September 30, 2014, our portfolio was comprised of eleven retail shopping centers; seven office properties; a mixed-use property consisting of a 369-room all-suite hotel and a retail shopping center; and four multifamily properties. Additionally, as of September 30, 2014, we owned land at five of our properties that we classified as held for development and/or construction in progress. Our core markets include San Diego; the San Francisco Bay Area; Portland, Oregon; Bellevue, Washington; and Oahu, Hawaii. We are a Maryland corporation formed on July 16, 2010 to acquire the entities owning various controlling and noncontrolling interests in real estate assets owned and/or managed by Ernest S. Rady or his affiliates, including the Ernest Rady Trust U/D/T March 13, 1983, or the Rady Trust, and did not have any operating activity until the consummation of our initial public offering on January 19, 2011. Our Company, as the sole general partner of our Operating Partnership, has control of our Operating Partnership and owned 70.7% of our Operating Partnership as of September 30, 2014. Accordingly, we consolidate the assets, liabilities and results of operations of our Operating Partnership.
Critical Accounting Policies
We identified certain critical accounting policies that affect certain of our more significant estimates and assumptions used in preparing our consolidated financial statements in our annual report on Form 10-K for the year ended December 31, 2013. We have not made any material changes to these policies during the periods covered by this report.

Interest rate swaps designated as cash flow hedges involve the receipt of variable-rate amounts from a counterparty in exchange for our making fixed-rate payments over the life of the agreements, without exchange of the underlying notional amount. We assess effectiveness of our cash flow hedges both at inception and on an ongoing basis. The effective portion of changes in fair value of the interest rate swaps associated with our cash flow hedges is recorded in accumulated other comprehensive income/loss and is subsequently reclassified into interest expense as interest is incurred on the related variable rate debt. Our cash flow hedges become ineffective if critical terms of the hedging instrument and the debt instrument do not perfectly match, such as notional amounts, settlement dates, reset dates, calculation period and LIBOR rate. In addition, we evaluate the default risk of the counterparty by monitoring the credit-worthiness of such counterparty. When ineffectiveness exists, the ineffective portion of changes in fair value of the interest rate swaps associated with our cash flow hedges is recognized in earnings in the period affected. Hedge ineffectiveness has not impacted earnings as of September 30, 2014, and we do not anticipate it will have a significant effect in the future.

Same-store

We have provided certain information on a total portfolio, same-store and redevelopment same-store basis. Information provided on a same-store basis includes the results of properties that we owned and operated for the entirety of both periods being compared except for properties for which significant redevelopment or expansion occurred during either of the periods being compared, properties under development, properties classified as held for development and properties classified as discontinued operations. Information provided on a redevelopment same-store basis includes the results of properties undergoing significant redevelopment for the entirety or portion of both periods being compared. Same-store and redevelopment same-store is considered by management to be an important measure because it assists in eliminating disparities due to the development, acquisition or disposition of properties during the particular period presented, and thus provides a more consistent performance measure for the comparison of the Company's stabilized and redevelopment properties, as applicable. Additionally, redevelopment same-store is considered by management to be an important measure because it assists in evaluating the timing of the start and stabilization of our redevelopment opportunities and the impact that these redevelopments have in enhancing our operating performance.

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While there is judgment surrounding changes in designations, we typically reclassify significant development, redevelopment or expansion properties into same-store properties once they are stabilized. Properties are deemed stabilized typically at the earlier of (i), reaching 90% occupancy or (ii) four quarters following a property's inclusion in operating real estate. We typically remove properties from same-store properties when the development, redevelopment or expansion has or is expected to have a significant impact on the property's annualized base rent, occupancy and operating income within the calendar year. Our evaluation of significant impact related to development, redevelopment or expansion activity is based on quantitative and qualitative measures including, but not limited to the following: the total budgeted cost of planned construction activity compared to the property’s annualized base rent, occupancy and property operating income within the calendar year; percentage of development, redevelopment or expansion square footage to total property square footage; and the ability to maintain historic occupancy and rental rates. In consideration of these measures, we generally remove properties from same-store properties when we see a decline in a property's annualized base rent, occupancy and operating income within the calendar year as a direct result of ongoing redevelopment, development or expansion activity. Acquired properties are classified into same-store properties once we have owned such properties for the entirety of comparable period(s) and the properties are not under significant development or expansion.

In our determination of same-store and redevelopment same-store properties, Lloyd District Portfolio and Torrey Reserve Campus have been identified as same-store redevelopment properties due to the significant construction activity noted above. Office same-store net operating income increased approximately 1.5% and decreased approximately 0.8%, respectively, for the three and nine months ended September 30, 2014 compared to the same periods in 2013. Office redevelopment same-store net operating income increased approximately 3.6% and 2.2%, respectively, for the three and nine months ended September 30, 2014 compared to the same periods in 2013.

Below is a summary of our same-store composition for the three and nine months ended September 30, 2014 and 2013. For the three months ended September 30, 2014, two acquired properties were classified into same-store properties and redevelopment same-store properties when compared to the designations for the three months ended September 30, 2013. For the nine months ended September 30, 2014, three acquired properties were classified into same-store properties and redevelopment same-store properties when compared to the designations for the nine months ended September 30, 2013.

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2014
 
2013
 
2014
 
2013
Same-Store
21

 
19

 
21

 
18

Non-Same Store
2

 
4

 
2

 
5

Total Properties
23

 
23

 
23

 
23

 
 
 
 
 
 
 
 
Redevelopment Same-Store
23

 
21

 
23

 
20

 
 
 
 
 
 
 
 
Total Development Properties
5

 
5

 
5

 
5


Outlook

We seek growth in earnings, funds from operations and cash flows primarily through a combination of the following: growth in our same-store portfolio, growth in our portfolio from property development and redevelopments and expansion of our portfolio through property acquisitions. Our properties are located in some of the nation's most dynamic, high-barrier-to-entry markets primarily in Southern California, Northern California, Oregon, Washington and Hawaii, which allow us to take advantage of redevelopment opportunities that enhance our operating performance through renovation, expansion, reconfiguration and/or retenanting. We evaluate our properties on an ongoing basis to identify these types of opportunities.

We continue our ongoing redevelopment efforts at Lloyd District Portfolio and are currently under construction to include approximately 47,000 square feet of retail space and 657 multi-family units in addition to the existing 581,000 square feet of office space. Construction of the project is expected to be complete in 2015, with an anticipated stabilization date in 2017. Projected costs of the development are approximately $192 million, of which approximately $101 million has been incurred to date. We expect the Lloyd District Portfolio redevelopment to be stabilized in 2017 with an estimated stabilized yield of approximately 6.25% to 7.25% based on initial estimates.

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Additionally, we continue our ongoing redevelopment efforts at Torrey Reserve Campus and are currently under construction to increase rentable office space by approximately 81,500 square feet. Construction of the project is expected to be complete during 2015, with an expected stabilization date in 2015. Projected costs of the redevelopment are approximately $34 million, of which approximately $28 million has been incurred to date. We expect the Torrey Reserve Campus redevelopment to be stabilized in 2015 with an estimated stabilized yield of approximately 8.6%.

Additionally, we continue our development efforts at Sorrento Pointe with planned construction to increase rentable office space by approximately 88,000 square feet. Construction of the project is expected to be complete in 2016, with an expected stabilization date in 2017. Projected costs of the development are approximately $46 million, of which approximately $7 million has been incurred to date.

We intend to opportunistically pursue the development of future phases of Lloyd District Portfolio, Torrey Reserve Campus and Sorrento Pointe based on, among other things, market conditions and our evaluation of whether such opportunities would generate appropriate risk-adjusted financial returns. Our redevelopment and development opportunities are subject to various factors, including market conditions and may not ultimately come to fruition.

We continue to review acquisition opportunities in our primary markets that would complement our portfolio and provide long-term growth opportunities. Some of our acquisitions do not initially contribute significantly to earnings growth; however, we believe they provide long-term re-leasing growth, redevelopment opportunities and other strategic opportunities. Any growth from acquisitions is contingent upon our ability to find properties that meet our qualitative standards at prices that meet our financial hurdles. Changes in interest rates may affect our success in achieving earnings growth through acquisitions by affecting both the price that must be paid to acquire a property, as well as our ability to economically finance a property acquisition. Generally, our acquisitions are initially financed by available cash, mortgage loans and/or borrowings under our revolving credit facility, which may be repaid later with funds raised through the issuance of new equity or new long-term debt.
Leasing

Our same-store growth is primarily driven by increases in rental rates on new leases and lease renewals and changes in portfolio occupancy. Over the long-term, we believe that the infill nature and strong demographics of our properties provide us with a strategic advantage, allowing us to maintain relatively high occupancy and increase rental rates. We have continued to see signs of improvement for many of our tenants, as well as increased interest from prospective tenants for our spaces. While there can be no assurance that these positive signs will continue, we remain cautiously optimistic regarding the improved trends we have seen over the past few years. We believe the locations of our properties and diverse tenant base mitigate the potentially negative impact of the current economic environment. However, any reduction in our tenants' abilities to pay base rent, percentage rent or other charges will adversely affect our financial condition and results of operations.

During the three months ended September 30, 2014, we signed 12 retail leases for a total of 49,920 square feet of retail space including 48,420 square feet of comparable space leases (leases for which there was a prior tenant), at an average rental rate increase of 16.0% on a cash basis and an increase of 16.8% on a straight-line basis. New retail leases for comparable spaces were signed for 3,650 square feet at an average rental rate increase of 29.6% on a cash basis and 62.3% on a straight-line basis. Renewals for comparable retail spaces were signed for 44,770 square feet at an average rental rate increase of 14.9% on a cash basis and 13.5% on a straight-line basis. Tenant improvements and incentives were $29.20 per square foot of retail space for comparable new leases for the three months ended September 30, 2014. Tenant improvements and incentives for comparable new leases is mainly attributed to tenants at Del Monte Center.

During the three months ended September 30, 2014, we signed 14 office leases for a total of 71,751 square feet of office space including 25,358 square feet of comparable space leases, at an average rental rate increase of 3.3% on a cash basis and average rental increase of 11.0% on a straight-line basis. New office leases for comparable spaces were signed for 4,737 square feet at an average rental rate decrease of 9.1% on a cash basis and 2.6% on a straight-line basis. Renewals for comparable office spaces were signed for 20,621 square feet at an average rental rate increase of 6.3% on a cash basis and 14.3% on a straight-line basis. Tenant improvements and incentives were $13.88 and $5.30 per square foot of office space for comparable new leases and comparable renewals, respectively, for the three months ended September 30, 2014. Tenant improvements and incentives for comparable new leases is mainly attributed to tenants at Solana Beach Corporate Center. Tenant improvements and incentives for comparable renewals is mainly attributed to tenants at Torrey Reserve Campus.

The rental increases associated with comparable spaces generally include all leases signed in arms-length transactions reflecting market leverage between landlords and tenants during the period. The comparison between average rent for expiring leases and new leases is determined by including minimum rent and percentage rent paid on the expiring lease and minimum

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rent and, in some instances, projections of first lease year percentage rent, to be paid on the new lease. In some instances, management exercises judgment as to how to most effectively reflect the comparability of spaces reported in this calculation. The change in rental income on comparable space leases is impacted by numerous factors including current market rates, location, individual tenant creditworthiness, use of space, market conditions when the expiring lease was signed, capital investment made in the space and the specific lease structure. Tenant improvements and incentives include the total dollars committed for the improvement of a space as it relates to a specific lease, but may also include base-building costs (i.e. expansion, escalators or new entrances) which are required to make the space leasable. Incentives include amounts paid to tenants as an inducement to sign a lease that do not represent building improvements.

The leases signed in 2014 generally become effective over the following year, though some may not become effective until 2015 and beyond. Further, there is risk that some new tenants will not ultimately take possession of their space and that tenants for both new and renewal leases may not pay all of their contractual rent due to operating, financing or other matters. However, we believe that these increases do provide information about the tenant/landlord relationship and the potential fluctuations we may achieve in rental income over time.

Through the remainder of 2014, we believe our leasing volume will be in-line with our historical averages and result in overall positive increases in rental income. However, changes in rental income associated with individual signed leases on comparable spaces may be positive or negative, and we can provide no assurance that the rents on new leases will continue to increase at the above disclosed levels, if at all.
Capitalized Costs

Certain external and internal costs directly related to the development and redevelopment of real estate, including pre-construction costs, real estate taxes, insurance, interest, construction costs and salaries and related costs of personnel directly involved, are capitalized. We capitalize costs under development until construction is substantially complete and the property is held available for occupancy. The determination of when a development project is substantially complete and when capitalization must cease involves a degree of judgment. We consider a construction project as substantially complete and held available for occupancy upon the completion of landlord-owned tenant improvements or when the lessee takes possession of the unimproved space for construction of its own improvements, but not later than one year from cessation of major construction activity. We cease capitalization on the portion substantially completed and occupied or held available for occupancy, and capitalize only those costs associated with any remaining portion under construction.

We capitalized external and internal costs related to both development and redevelopment activities combined of $36.23 million and $12.51 million for the three months ended September 30, 2014 and 2013, respectively. We capitalized external and internal costs related to both development and redevelopment activities combined of $85.79 million and $26.08 million for the nine months ended September 30, 2014 and 2013, respectively.
    
We capitalized external and internal costs related to other property improvements combined of $5.73 million and $4.39 million for the three months ended September 30, 2014 and 2013, respectively. We capitalized external and internal costs related to other property improvements combined of $18.08 million and $10.61 million for the nine months ended September 30, 2014 and 2013, respectively.

We capitalized internal costs for salaries and related benefits for development and redevelopment activities and other property improvements of $0.03 million and $0.03 million for the three months ended September 30, 2014 and 2013, respectively. We capitalized internal costs for salaries and related benefits for development and redevelopment activities and other property improvements of $0.10 million and $0.10 million for the nine months ended September 30, 2014 and 2013, respectively.
Interest costs on developments and major redevelopments are capitalized as part of developments and redevelopments not yet placed in service. Capitalization of interest commences when development activities and expenditures begin and end upon completion, which is when the asset is ready for its intended use as noted above. We make judgments as to the time period over which to capitalize such costs and these assumptions have a direct impact on net income because capitalized costs are not subtracted in calculating net income. If the time period for capitalizing interest is extended, however, more interest is capitalized, thereby decreasing interest expense and increasing net income during that period. We capitalized interest costs related to both development and redevelopment activities combined of $1.47 million and $0.60 million for the three months ended September 30, 2014 and 2013, respectively. We capitalized interest costs related to both development and redevelopment activities combined of $3.52 million and $1.45 million for the nine months ended September 30, 2014 and 2013, respectively.

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Results of Operations
For our discussion of results of operations, we have provided information on a total portfolio and same-store basis.
Comparison of the three months ended September 30, 2014 to the three months ended September 30, 2013
The following summarizes our consolidated results of operations for the three months ended September 30, 2014 compared to our consolidated results of operations for the three months ended September 30, 2013. As of September 30, 2014 and 2013, our operating portfolio was comprised of 23 retail, office, multifamily and mixed-use properties with an aggregate of approximately 5.8 million rentable square feet of retail and office space, including the retail portion of our mixed-use property, 922 residential units (including 122 RV spaces) and a 369-room hotel. Additionally, as of September 30, 2014 and 2013, we owned land at five of our properties that we classified as held for development and/or construction in progress.
The following table sets forth selected data from our unaudited consolidated statements of comprehensive income for the three months ended September 30, 2014 and 2013 (dollars in thousands):
 
 
Three Months Ended September 30,
 
Change
 
%
 
2014
 
2013
 
Revenues
 
 
 
 
 
 
 
Rental income
$
63,593

 
$
62,405

 
$
1,188

 
2
 %
Other property income
3,750

 
2,913

 
837

 
29

Total property revenues
67,343

 
65,318

 
2,025

 
3

Expenses
 
 
 
 
 
 
 
Rental expenses
17,374

 
17,430

 
(56
)
 

Real estate taxes
5,899

 
5,768

 
131

 
2

Total property expenses
23,273

 
23,198

 
75

 

Total property income
44,070

 
42,120

 
1,950

 
(1
)
General and administrative
(4,682
)
 
(4,031
)
 
(651
)
 
16

Depreciation and amortization
(16,352
)
 
(16,648
)
 
296

 
(2
)
Interest expense
(13,325
)
 
(14,764
)
 
1,439

 
(10
)
Other income (expense), net
(621
)
 
(419
)
 
(202
)
 
48

Total other, net
(34,980
)
 
(35,862
)
 
882

 
(2
)
Net income
9,090

 
6,258

 
2,832

 
45

Net income attributable to restricted shares
(95
)
 
(132
)
 
37

 
(28
)
Net income attributable to unitholders in the Operating Partnership
(2,578
)
 
(1,903
)
 
(675
)
 
35

Net income attributable to American Assets Trust, Inc. stockholders
$
6,417

 
$
4,223

 
$
2,194

 
52
 %

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Revenue
Total property revenues. Total property revenue consists of rental revenue and other property income. Total property revenue increased $2.0 million, or 3%, to $67.3 million for the three months ended September 30, 2014 compared to $65.3 million for the three months ended September 30, 2013. The percentage leased was as follows for each segment as of September 30, 2014 and 2013:
 
Percentage Leased  (1)
September 30,
 
2014
2013
Retail
98.7
%
 
95.6
%
Office
89.9
%
 
91.4
%
Multifamily