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, 2010

 

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 1-11656

 

THE HOWARD HUGHES CORPORATION

(Exact name of registrant as specified in its charter)

 

Delaware

 

36-4673192

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification Number)

 

13355 Noel Road, Suite 950, Dallas, Texas 75240

(Address of principal executive offices, including Zip Code)

 

(214) 741-7744

(Registrant’s telephone number, including area code)

 

N / A

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

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 (the “Exchange Act”) 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. o Yes  x No

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o  No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.

 

Large accelerated filer o

 

Accelerated filer o

 

 

 

Non-accelerated filer x

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

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 registrant commenced operations on November 9, 2010.

 

As of November 10, 2010, there were 37,716,453 shares of the registrant’s common stock outstanding.

 

 

 



Table of Contents

 

The Howard Hughes Corporation

 

INDEX

 

 

 

PAGE
NUMBER

Part I

FINANCIAL INFORMATION

 

 

Item 1: Combined Financial Statements (Unaudited)

 

 

 

 

 

Combined Balance Sheets
as of September 30, 2010 and December 31, 2009

3

 

 

 

 

Combined Statements of Loss and Comprehensive Loss
for the three and nine months ended September 30, 2010 and 2009

4

 

 

 

 

Combined Statements of Equity
for the nine months ended September 30, 2010 and 2009

5

 

 

 

 

Combined Statements of Cash Flows
for the nine months ended September 30, 2010 and 2009

6

 

 

 

 

Notes to Combined Financial Statements

7

 

Note 1: Organization

7

 

Note 2: Intangible Assets and Liabilities

17

 

Note 3: Real Estate Affiliates

18

 

Note 4: Mortgages, Notes and Loans Payable

20

 

Note 5: Income Taxes

21

 

Note 6: Transactions with GGP and Other GGP Subsidiaries

22

 

Note 7: Other Assets and Liabilities

22

 

Note 8: Commitments and Contingencies

23

 

Note 9: Recently Issued Accounting Pronouncements

24

 

Note 10: Segments

24

 

Note 11: Management Appointments on November 22, 2010

28

 

Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations

28

 

Liquidity and Capital Resources

36

 

Item 3: Quantitative and Qualitative Disclosures about Market Risk

37

 

Item 4: Controls and Procedures

38

 

 

 

Part II

OTHER INFORMATION

 

 

Item 1: Legal Proceedings

38

 

Item 1A: Risk Factors

38

 

Item 2: Unregistered Sales of Equity Securities and Use of Proceeds

38

 

Item 3: Defaults Upon Senior Securities

38

 

Item 5: Other Information

38

 

Item 6: Exhibits

38

 

SIGNATURE

39

 

EXHIBIT INDEX

40

 

2



Table of Contents

 

THE HOWARD HUGHES CORPORATION

 

COMBINED BALANCE SHEETS

(UNAUDITED)

 

 

 

September 30,

 

December 31,

 

 

 

2010

 

2009

 

 

 

(In thousands)

 

Assets:

 

 

 

 

 

Investment in real estate:

 

 

 

 

 

Land

 

$

194,181

 

$

194,700

 

Buildings and equipment

 

447,696

 

451,279

 

Less accumulated depreciation

 

(94,697

)

(85,639

)

Developments in progress

 

266,216

 

258,807

 

Net property and equipment

 

813,396

 

819,147

 

Investment in Real Estate Affiliates

 

146,537

 

140,558

 

Investment property and property held for development and sale

 

1,775,904

 

1,782,470

 

Net investment in real estate

 

2,735,837

 

2,742,175

 

Cash and cash equivalents

 

2,811

 

3,204

 

Accounts and notes receivable, net

 

14,055

 

17,359

 

Deferred expenses, net

 

6,894

 

7,444

 

Prepaid expenses and other assets

 

132,824

 

135,045

 

Total assets

 

$

2,892,421

 

$

2,905,227

 

 

 

 

 

 

 

Liabilities and Equity:

 

 

 

 

 

Liabilities not subject to compromise:

 

 

 

 

 

Mortgages, notes and loans payable

 

$

272,825

 

$

208,860

 

Deferred tax liabilities

 

715,516

 

782,817

 

Accounts payable and accrued expenses

 

225,883

 

134,191

 

Liabilities not subject to compromise

 

1,214,224

 

1,125,868

 

Liabilities subject to compromise

 

138,093

 

275,839

 

Total liabilities

 

1,352,317

 

1,401,707

 

 

 

 

 

 

 

Equity:

 

 

 

 

 

GGP Equity

 

1,540,857

 

1,504,364

 

Accumulated other comprehensive loss

 

(1,556

)

(1,744

)

Total GGP equity

 

1,539,301

 

1,502,620

 

Noncontrolling interests in Combined Real Estate Affiliates

 

803

 

900

 

Total equity

 

1,540,104

 

1,503,520

 

Total liabilities and equity

 

$

2,892,421

 

$

2,905,227

 

 

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

 

3



Table of Contents

 

THE HOWARD HUGHES CORPORATION

 

COMBINED STATEMENTS OF LOSS AND COMPREHENSIVE LOSS

(UNAUDITED)

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

(In thousands)

 

Revenues:

 

 

 

 

 

 

 

 

 

Minimum rents

 

$

16,349

 

$

15,873

 

$

50,349

 

$

49,390

 

Tenant recoveries

 

4,637

 

5,045

 

13,891

 

14,827

 

Overage rents

 

826

 

615

 

1,738

 

1,465

 

Land sales

 

10,034

 

7,409

 

22,141

 

38,843

 

Other

 

614

 

1,318

 

3,762

 

855

 

Total revenues

 

32,460

 

30,260

 

91,881

 

105,380

 

Expenses:

 

 

 

 

 

 

 

 

 

Real estate taxes

 

4,131

 

3,829

 

11,161

 

10,111

 

Property maintenance costs

 

1,484

 

1,389

 

4,766

 

3,617

 

Marketing

 

248

 

278

 

755

 

738

 

Other property operating costs

 

8,746

 

9,224

 

26,440

 

25,244

 

Land sales operations

 

10,057

 

8,124

 

30,654

 

40,578

 

Provision for doubtful accounts

 

744

 

 

1,101

 

1,212

 

Property management and other costs

 

3,467

 

4,561

 

12,463

 

12,992

 

Strategic initiatives

 

 

266

 

 

5,380

 

Provisions for impairment

 

92

 

40,582

 

578

 

180,762

 

Depreciation and amortization

 

4,109

 

4,434

 

12,535

 

15,221

 

Total expenses

 

33,078

 

72,687

 

100,453

 

295,855

 

Operating loss

 

(618

)

(42,427

)

(8,572

)

(190,475

)

 

 

 

 

 

 

 

 

 

 

Interest income

 

59

 

155

 

118

 

487

 

Interest expense

 

(681

)

(186

)

(1,888

)

(768

)

Loss before income taxes, equity in income (loss) of Real Estate Affiliates, reorganization items and noncontrolling interests

 

(1,240

)

(42,458

)

(10,342

)

(190,756

)

Benefit from (provision for) income taxes

 

350

 

21,897

 

(17,603

)

24,810

 

Equity in income (loss) of Real Estate Affiliates

 

1,222

 

(2,004

)

6,394

 

2,117

 

Reorganization items

 

(16,515

)

(1,814

)

(43,129

)

(3,831

)

Net loss

 

(16,183

)

(24,379

)

(64,680

)

(167,660

)

Allocation to noncontrolling interests

 

(47

)

(35

)

(121

)

(100

)

Net loss attributable to GGP

 

$

(16,230

)

$

(24,414

)

$

(64,801

)

$

(167,760

)

 

 

 

 

 

 

 

 

 

 

Comprehensive Income (loss), Net:

 

 

 

 

 

 

 

 

 

Net loss

 

$

(16,183

)

$

(24,379

)

$

(64,680

)

$

(167,660

)

Other comprehensive income

 

88

 

163

 

188

 

489

 

Comprehensive loss

 

(16,095

)

(24,216

)

(64,492

)

(167,171

)

Comprehensive loss allocated to noncontrolling interests

 

(47

)

(35

)

(121

)

(100

)

Comprehensive loss attributable to GGP

 

$

(16,142

)

$

(24,251

)

$

(64,613

)

$

(167,271

)

 

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

 

4



Table of Contents

 

THE HOWARD HUGHES CORPORATION

 

COMBINED STATEMENTS OF EQUITY

(UNAUDITED)

 

 

 

 

 

Accumulated

 

Noncontrolling

 

 

 

 

 

 

 

Other

 

Interests in

 

 

 

 

 

GGP

 

Comprehensive

 

Combined Real

 

Total

 

 

 

Equity

 

Income (Loss)

 

Estate Affiliates

 

Equity

 

 

 

(In thousands)

 

 

 

 

 

 

 

 

 

 

 

Balance, January 1, 2009

 

$

1,986,938

 

$

(2,926

)

$

1,803

 

$

1,985,815

 

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

(167,760

)

 

100

 

(167,660

)

Distributions to noncontrolling interests

 

 

 

(103

)

(103

)

Other comprehensive income

 

 

489

 

 

489

 

Contributions from GGP, net

 

26,716

 

 

 

26,716

 

 

 

 

 

 

 

 

 

 

 

Balance, September 30, 2009

 

$

1,845,894

 

$

(2,437

)

$

1,800

 

$

1,845,257

 

 

 

 

 

 

 

 

 

 

 

Balance, January 1, 2010

 

$

1,504,364

 

$

(1,744

)

$

900

 

$

1,503,520

 

Net income (loss)

 

(64,801

)

 

121

 

(64,680

)

Distributions to noncontrolling interests

 

 

 

(218

)

(218

)

Other comprehensive income

 

 

188

 

 

188

 

Contributions from GGP, net

 

101,294

 

 

 

101,294

 

 

 

 

 

 

 

 

 

 

 

Balance, September 30, 2010

 

$

1,540,857

 

$

(1,556

)

$

803

 

$

1,540,104

 

 

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

 

5



Table of Contents

 

THE HOWARD HUGHES CORPORATION

 

COMBINED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 

 

 

Nine Months Ended

 

 

 

September 30,

 

 

 

2010

 

2009

 

 

 

(In thousands)

 

Cash Flows from Operating Activities:

 

 

 

 

 

Net loss

 

$

(64,680

)

$

(167,660

)

Adjustments to reconcile net loss to net cash used in operating activities:

 

 

 

 

 

Equity in income of Real Estate Affiliates

 

(6,394

)

(2,117

)

Provision for doubtful accounts

 

1,101

 

1,212

 

Distributions received from Real Estate Affiliates

 

 

1,406

 

Depreciation

 

11,012

 

13,071

 

Amortization

 

1,523

 

2,150

 

Amortization (accretion) of deferred financing costs and debt market rate adjustments

 

1,600

 

756

 

Amortization of intangibles other than in-place leases

 

144

 

167

 

Straight-line rent amortization

 

(574

)

(459

)

Provisions for impairment

 

578

 

180,762

 

Land/residential development and acquisitions expenditures

 

(39,115

)

(33,377

)

Cost of land sales

 

7,089

 

20,147

 

Reorganization items - finance costs related to emerged entities

 

1,311

 

 

Non-cash reorganization items

 

(2,880

)

(260

)

Net changes:

 

 

 

 

 

Accounts and notes receivable

 

3,306

 

(836

)

Prepaid expenses and other assets

 

10,209

 

(1,926

)

Deferred expenses

 

(1,426

)

(1,531

)

Accounts payable and accrued expenses and deferred taxes

 

16,529

 

(29,119

)

Other, net

 

168

 

711

 

Net cash used in operating activities

 

(60,499

)

(16,903

)

 

 

 

 

 

 

Cash Flows from Investing Activities:

 

 

 

 

 

Development of real estate and property additions/improvements, primarily previously accrued

 

(71,069

)

(23,760

)

Proceeds from sales of investment properties

 

 

6,392

 

Increase in investments in Real Estate Affiliates

 

(10

)

(1,247

)

Decrease in restricted cash

 

 

202

 

Net cash used in investing activities

 

(71,079

)

(18,413

)

 

 

 

 

 

 

Cash Flows from Financing Activities:

 

 

 

 

 

Change in GGP investment, net

 

137,411

 

41,698

 

Principal payments on mortgages, notes and loans payable

 

(4,697

)

(7,556

)

Finance costs related to emerged entities

 

(1,311

)

 

Distributions to noncontrolling interests

 

(218

)

(103

)

Net cash provided by financing activities

 

131,185

 

34,039

 

Net change in cash and cash equivalents

 

(393

)

(1,277

)

Cash and cash equivalents at beginning of period

 

3,204

 

4,963

 

Cash and cash equivalents at end of period

 

$

2,811

 

$

3,686

 

 

 

 

 

 

 

Supplemental Disclosure of Cash Flow Information:

 

 

 

 

 

Interest paid

 

$

14,831

 

$

15,036

 

Interest capitalized

 

15,443

 

15,284

 

Reorganization items paid

 

46,009

 

4,091

 

 

 

 

 

 

 

Non-Cash Transactions:

 

 

 

 

 

Change in accrued capital expenditures included in accounts payable and accrued expenses

 

$

(64,454

)

$

(11,467

)

Change in CSA contingent liability

 

(15,000

)

 

Mortgage debt market rate adjustment related to emerged entities

 

2,382

 

 

Other non-cash GGP equity transactions

 

(36,117

)

(14,982

)

Recognition of note payable in conjunction with land held for development and sale

 

 

6,520

 

 

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

 

6



Table of Contents

 

THE HOWARD HUGHES CORPORATION

 

NOTE 1         ORGANIZATION

 

Readers of this Quarterly Report should refer to the Company’s (as defined below) audited Combined Financial Statements for the year ended December 31, 2009 which are included in the Company’s Registration Statement on Form 10 for the fiscal year ended December 31, 2009 (Commission File No. 001-34856), as certain footnote disclosures which would substantially duplicate those contained in our Registration Statement have been omitted from this report.  Capitalized terms used, but not defined, in this Quarterly Report have the same meanings as in our Registration Statement.

 

General

The Howard Hughes Corporation (‘‘HHC’’ or the ‘‘Company’’) is a newly formed Delaware corporation that was created to hold certain assets and liabilities of General Growth Properties, Inc. (‘‘GGP’’) and its subsidiaries (collectively, the ‘‘Predecessors’’). On April 16, 2009 and April 22, 2009 (collectively, the ‘‘Petition Date’’), GGP and certain of its subsidiaries (the ‘‘Debtors’’) filed voluntary petitions under Chapter 11 of Title 11 of the United States Code (the ‘‘Chapter 11 Cases’’) with the Bankruptcy Court for the Southern District of New York (the ‘‘Bankruptcy Court’’). On October 21, 2010, the Bankruptcy Court entered an order confirming the plan of reorganization (the “Plan”) of GGP and certain of the Debtors still remaining in the Chapter 11 Cases (the “TopCo Debtors”). Pursuant to the Plan, the TopCo Debtors emerged from bankruptcy and HHC received certain of the assets and liabilities of the Predecessors (the ‘‘Separation’’), which we refer to as our business or ‘‘the HHC Businesses”. The reorganization of GGP was completed on November 9, 2010 (such time of completion being referred to as the ‘‘Effective Date’’) as described in “Transactions on the Effective Date”, below.

 

As of September 30, 2010, we had not conducted any business as a separate company and had no separate material assets or liabilities. The operations of the business transferred to us by the Predecessors is presented as if the transferred business was our business for all historical periods described and at the historical cost/carrying value of such assets and liabilities reflected in GGP’s books and records. Unless the context otherwise requires, references to ‘‘we,’’ ‘‘us’’ and ‘‘our’’ refer to HHC and its combined subsidiaries after giving effect to the transfer of assets and liabilities from the Predecessors.

 

On the Effective Date, our assets consisted of the following:

 

·      four master planned communities with an aggregate of 14,653 remaining saleable acres;

 

·      nine mixed-use development opportunities comprised of 1,129 acres;

 

·      four mall developmental projects comprised of 647 acres;

 

·                  seven redevelopment-opportunity retail malls with approximately 1 million square feet of existing gross leasable space; and

 

·      interests in eleven other real estate assets or projects.

 

Our ownership interests in properties in which we own a majority or controlling interest are combined under accounting principles generally accepted in the United States of America (‘‘GAAP’’).  Our interests in TWCPC Holdings, L.P., (‘‘The Woodlands Commercial’’), the Woodlands Operating Company, L.P. (‘‘The Woodlands Operating’’) and the Woodlands Land Development Company, L.P. (‘‘The Woodlands MPC’’), all located in Houston, Texas and, collectively, the ‘‘Woodlands Partnerships’’, and our interests in Westlake Retail Associates, Ltd (‘‘Circle T Ranch’’) and 170 Retail Associates Ltd (‘‘Circle T Power Center’’) and, together with Circle T Ranch, ‘‘Circle T’’, located in Dallas/Fort Worth, Texas, are held through joint venture entities in which we own non-controlling interests and are accounted for on the equity method. The Woodlands Partnerships, Circle T and certain cost method investments (see Note 3) are collectively referred to in this report as our ‘‘Real Estate Affiliates’’.

 

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Table of Contents

 

THE HOWARD HUGHES CORPORATION

 

Principles of Combination and Basis of Presentation

The accompanying combined financial statements include the accounts of the HHC Businesses in which we have a controlling interest and are presented on a combined basis as all such HHC Businesses have common control and ownership by GGP. The noncontrolling equity holders’ share of the assets, liabilities and operations are reflected in noncontrolling interests within permanent equity of the Company. All significant intercompany balances and transactions between the HHC Businesses have been eliminated.

 

As discussed above, we were formed for the purpose of receiving, via a tax-free distribution, certain assets and assuming certain liabilities of GGP pursuant to the Plan. We conducted no business and had no separate material assets or liabilities until the Separation was consummated. No previous historical financial statements for the HHC Businesses have been prepared and, accordingly, our combined financial statements are derived from the books and records of GGP and were carved-out from GGP at a carrying value reflective of such historical cost in such GGP records.  Our historical financial results reflect allocations for certain corporate expenses which include, but are not limited to, costs related to property management, human resources, security, payroll and benefits, legal, corporate communications, information services and restructuring and reorganizations.  Costs of the services that were allocated or charged to us were based on either actual costs incurred or a proportion of costs estimated to be applicable to us based on a number of factors, most significantly the Company’s percentage of GGP’s adjusted revenue and assets and the number of properties.  We believe these allocations are reasonable; however, these results do not reflect what our expenses would have been had the Company been operating as a separate, stand-alone public company. In addition, the HHC Businesses were operated as subsidiaries of GGP, which operates as a real estate investment trust (‘‘REIT’’). We will operate as a taxable corporation. The historical combined financial information presented will therefore not be indicative of the results of operations, financial position or cash flows that would have been obtained if we had been an independent, stand-alone entity during the periods shown or of our future performance as an independent, stand-alone entity.

 

The Debtors’ Bankruptcy

As the Debtors had significant past due, or imminently due, and cross-collateralized or cross-defaulted debt, on the Petition Date, GGP, on behalf of itself and certain of its domestic subsidiaries including certain wholly-owned HHC Businesses, filed voluntary petitions for the Chapter 11 Cases. The Debtors that sought protection under Chapter 11 that are part of HHC are collectively referred to as the ‘‘HHC Debtors’’ and on the Petition Date comprised 33 entities with approximately $268.4 million of secured mortgage loans. However, the entities that own our Bridgeland and Columbia master planned communities, the entities that own substantially all of our eight undeveloped land parcels and our joint ventures, The Woodlands Partnerships and Circle T, among others (collectively, the ‘‘HHC Non-Debtors’’), did not seek such relief.

 

During the pendency of the Chapter 11 Cases, the Debtors operated as Debtors-in-Possession.  A debtor is afforded certain protection against its creditors and creditors are prohibited from taking certain actions (such as pursuing collection efforts or proceeding to foreclose on secured obligations) related to debts that were owed prior to the commencement of the Chapter 11 Cases. Accordingly, although the commencement of the Chapter 11 Cases triggered defaults on substantially all debt obligations of the Debtors, creditors were stayed from taking any action as a result of such defaults.

 

During December 2009, three of the HHC Debtors (the ‘‘Emerged Debtors’’) with $215.3 million of secured mortgage loans filed consensual plans of reorganization (the ‘‘Emerged Plans’’). As of December 31, 2009, two of the Emerged Debtors with $146.8 million secured debt had emerged from bankruptcy. The plan of reorganization and emergence from bankruptcy of the remaining Emerged Debtor occurred on July 23, 2010. The HHC Debtors that remained in Chapter 11 at September 30, 2010 (the ‘‘Remaining HHC Debtors’’) emerged from bankruptcy pursuant to the Plan on the Effective Date.

 

Transactions on the Effective Date

On the Effective Date, approximately 32.5 million shares of common stock of HHC were distributed to the common and preferred unit holders of GGPLP, which includes GGP, and then GGP distributed its portion of such shares pro-rata to holders of GGP common stock (the ‘‘Distribution’’). GGP has not retained any ownership interest in HHC. The Plan generally provided for the payment/settlement or reinstatement of claims against the TopCo Debtors, funded with new equity capital provided by investors sponsoring the Plan (the

 

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THE HOWARD HUGHES CORPORATION

 

‘‘Plan Sponsors’’). As part of the Plan, approximately 5.3 million shares of our common stock were purchased by certain of the investors sponsoring the Plan for $250 million.  Additionally as part of the Plan, on the Effective Date, we issued warrants to purchase up to approximately 8 million shares of our common stock to the Plan Sponsors.  The warrants have an initial exercise price of $50.00 per share. Approximately 6.08 million warrants are immediately exercisable and approximately 1.92 million warrants are exercisable upon 90 days prior notice for the first 6.5 years after issuance and exercisable without notice any time thereafter.  Each warrant has a term of seven years from the closing date of the investments.

 

Unaudited Pro Forma Condensed Combined Balance Sheet

The following unaudited pro forma condensed combined balance sheet has been developed based on currently available information by applying certain pro forma adjustments which reflect the Separation of HHC from the Predecessors and other transactions provided by the Plan, to the September 30, 2010 historical combined balance sheet that appears elsewhere in this Quarterly Report. The unaudited pro forma condensed combined balance sheet gives effect to such transactions as if they had occurred on September 30, 2010 and are described more fully in the notes to the unaudited pro forma combined balance sheet which should be read in conjunction with such pro forma condensed combined balance sheet.  The unaudited pro forma condensed combined balance sheet presented below is for illustrative purposes only and is not necessarily indicative of the financial position that would have actually been reported had the transactions reflected in the pro forma adjustments occurred as of September 30, 2010.  In addition, the unaudited pro forma condensed combined balance sheet should be read in conjunction with the combined financial statements and related notes.

 

The accounting by HHC to reflect the emergence from bankruptcy of the Emerged Debtors is limited to recording the liabilities of such Debtors that are impacted by confirmed plans of reorganization at the estimated present values of the amounts expected to be paid upon emergence from bankruptcy since the provisions of the Plan do not meet the criteria for fresh-start reporting under generally accepted accounting principles (ASC 852-10-45-29). Historical liability amounts presented in the unaudited pro forma balance sheet for debtors which have emerged from bankruptcy at September 30, 2010 reflect these fair value adjustments in mortgages, notes and loans payable not subject to compromise. However, as certain of the HHC Debtors remain in bankruptcy at September 30, 2010, their liabilities remain subject to compromise and, therefore, the HHC historical balance sheet at September 30, 2010 has no such present value adjustment.

 

Fresh-start reporting does not apply to HHC because existing holders of GGP common stock received greater than 50% (approximately 79.7%) of the voting shares of HHC and the reorganization value of HHC’s assets exceeds the total of all post-petition liabilities and allowed claims (ASC 852-10-45-19). Further, the acquisition method of accounting does not apply to HHC at emergence because the criteria for application of the acquisition method of accounting, specifically, a transaction or event yielding a change of control, that is, a business combination, has not occurred. Since the provisions of the Plan provide that the Distribution occurs such that all members with each class of equity are treated equally, the Distribution is treated as a pro-rata spin-off and such non-monetary transaction is accounted for at the recorded or historical carrying values (ASC 505-60 and ASC 845-10-30-10).

 

In addition to the impact of the debt and equity recapitalization events described above, the significant transactions included in this pro forma balance sheet also occurred on the Effective Date in accordance with the Plan, and will be recorded by GGP, and/or HHC, as applicable in the fourth quarter of 2010.

 

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September 30, 2010

 

 

 

Historical

 

Adjustments

 

Footnote

 

Pro forma

 

 

 

(In thousands)

 

Assets:

 

 

 

 

 

 

 

 

 

Investment in real estate:

 

 

 

 

 

 

 

 

 

Net property and equipment

 

$

813,396

 

$

 

 

 

$

813,396

 

Investment in and loans to/from Real Estate Affiliates

 

146,537

 

 

 

 

146,537

 

Investment property and property held for development and sale

 

1,775,904

 

 

 

 

1,775,904

 

Net investment in real estate

 

2,735,837

 

 

 

 

2,735,837

 

Cash and cash equivalents

 

2,811

 

253,303

 

(1) (2)

 

256,114

 

Accounts and notes receivable and deferred expenses, net and prepaid expenses and other assets

 

153,773

 

340,105

 

(3) (4)

 

493,878

 

Total assets

 

$

2,892,421

 

$

593,408

 

 

 

$

3,485,829

 

 

 

 

 

 

 

 

 

 

 

Liabilities and Equity:

 

 

 

 

 

 

 

 

 

Liabilities not subject to compromise:

 

 

 

 

 

 

 

 

 

Mortgages, notes and loans payable

 

$

272,825

 

$

47,951

 

(5) (6)

 

$

320,776

 

Deferred tax liabilities

 

715,516

 

(537,912

)

(7)

 

177,604

 

Accounts payable and accrued expenses

 

225,883

 

13,821

 

(5) (8)

 

239,704

 

Liabilities not subject to compromise

 

1,214,224

 

(476,140

)

 

 

738,084

 

Liabilities subject to compromise

 

138,093

 

(138,093

)

(5)

 

 

Total liabilities

 

1,352,317

 

(614,233

)

 

 

738,084

 

Equity:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1) (2) (3)

 

 

 

 

 

 

 

 

 

(4) (5) (6)

 

 

 

Total equity

 

1,540,104

 

1,207,641

 

(7) (8)

 

2,747,745

 

Total liabilities and equity

 

$

2,892,421

 

$

593,408

 

 

 

$

3,485,829

 

 


Notes to Pro Forma Condensed Combined Balance Sheet

 

(1) Reflects the initial $250 million investment by the Plan Sponsors (approximately 5,250,000 shares of our common stock).

 

(2) Reflects the withdrawal by GGP of all permitted cash or cash equivalent balances from the HHC Accounts totaling $2.8 million, excluding $6.1 million of net proceeds from sales at our Summerlin Master Planned Community closing in October, 2010, in accordance with the Separation Agreement.

 

(3) Reflects the right to receive payments approximating the capital lease revenue that GGP receives from the Arizona 2 Office in Phoenix, Arizona totaling $31.4 million in accordance with the Plan.

 

(4) Reflects establishment of the Tax Indemnity Cap of $303.8 million based upon our current estimates of the components of the Indemnity Cap in the Investment Agreements (See Note 5- Income Taxes). Also includes the establishment of an obligation of GGP to pay up to $5.0 million of pre-petition liabilities.

 

(5) Reflects the reclassification of $64.0 million of mortgages, notes and loans payable and $74.1 million of accounts payable and accrued expenses subject to compromise to the appropriate categories of liabilities not subject to compromise. The adjustment also eliminates $27.7 million of pre-petition mechanics and materialmens’ liens payable included in the historical combined balance sheet because any remaining amounts due relating to these liabilities at the Effective Date were retained by GGP in accordance with the Plan. The amount of liens to be retained by GGP at emergence was substantially lower than the historical amount at September 30, 2010 due to settlement activity since such date.

 

(6) Reflects the prepayment of a portion of the loan obligation on the 110 N. Wacker property totaling $16.0 million by GGP.

 

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(7) Reflects an adjustment of $537.9 million for the re-measurement of the deferred tax liability utilizing the pro forma carrying amounts of HHC assets and liabilities, and the current taxable and non-taxable entities to be held by HHC.

 

(8) Reflects the settlement/or conversion to equity of intercompany balances in accordance with the Separation Agreement.

 

Accounting for Reorganization

The accompanying combined financial statements and the combined condensed financial statements of the HHC Debtors presented below have been prepared in accordance with GAAP related to financial reporting by entities in reorganization under the Bankruptcy Code, and on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. Such accounting guidance also provides that if a debtor, or group of debtors, has significant combined assets and liabilities of entities which have not sought Chapter 11 bankruptcy protection, the debtors and non-debtors should continue to be combined. However, separate disclosure of financial statement information solely relating to the debtor entities should be presented. Therefore, the combined condensed financial statements presented below solely reflect the financial position and results of operations for the HHC Debtors which had not emerged from bankruptcy as of September 30, 2010.

 

Unaudited Combined Condensed Balance Sheets

 

 

 

September 30, 2010

 

December 31, 2009

 

 

 

(In thousands)

 

Net investment in real estate

 

$

1,783,738

 

$

1,805,287

 

Cash and cash equivalents

 

1,087

 

1,285

 

Accounts and notes receivable, net

 

4,911

 

7,488

 

Other

 

114,014

 

111,213

 

Total assets

 

$

1,903,750

 

$

1,925,273

 

 

 

 

 

 

 

Liabilities not subject to compromise:

 

 

 

 

 

Deferred tax liabilities

 

$

759,311

 

$

827,264

 

Accounts payable and accrued expenses

 

212,665

 

121,247

 

Liabilities subject to compromise

 

138,093

 

206,952

 

Equity

 

793,681

 

769,810

 

Total liabilities and equity

 

$

1,903,750

 

$

1,925,273

 

 

As described above, certain of the HHC Debtors had emerged from bankruptcy protection as of September 30, 2010. The unaudited combined condensed statements of operations, for the three months ended September 30, 2010 and 2009 and the nine months ended September 30, 2010, as well as the unaudited combined condensed statements of cash flows for the nine months ended September 30, 2010 presented below include the Topco Debtors that are HHC Businesses, and exclude Emerged Debtors.  Since the HHC Debtors commenced their respective Chapter 11 Cases on two different dates in April 2009, the unaudited combined condensed statements of operations and cash flows of the Topco Debtors that are HHC Businesses have been prepared for the period May 1, 2009 to September 30, 2009.

 

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Unaudited Combined Condensed Statements of Operations

 

 

 

Three Months
Ended
September 30,
2010

 

Three Months
Ended
September 30,
2009

 

Nine Months
Ended
September 30,
2010

 

May 1, 2009 to
September 30,
2009

 

 

 

(In thousands)

 

Operating revenues

 

$

14,533

 

$

14,458

 

$

42,198

 

$

24,002

 

Operating expenses

 

20,605

 

21,770

 

68,320

 

94,447

 

Provision for impairment

 

92

 

40,582

 

578

 

40,816

 

Operating loss

 

(6,164

)

(47,894

)

(26,700

)

(111,261

)

Interest income, net

 

1,561

 

2,367

 

4,489

 

3,024

 

(Provision) for benefit from income taxes

 

361

 

9,183

 

(17,078

)

10,139

 

Equity in income (loss) of Real Estate Affiliates

 

274

 

(708

)

889

 

(774

)

Reorganization items

 

(15,328

)

(1,866

)

(41,428

)

(3,883

)

Net loss

 

(19,296

)

(38,918

)

(79,828

)

(102,755

)

Allocation to noncontrolling interests

 

(82

)

(52

)

(271

)

(409

)

Net loss attributable to GGP

 

$

(19,378

)

$

(38,970

)

$

(80,099

)

$

(103,164

)

 

Unaudited Combined Condensed Statements of Cash Flows

 

 

 

Nine Months Ended
September 30, 2010

 

May 1, 2009 to
September 30, 2009

 

 

 

(In thousands)

 

Net cash used in:

 

 

 

 

 

Operating activities

 

$

(198

)

$

(3,751

)

Investing activities

 

 

 

Financing activities

 

 

 

Net decrease in cash and cash equivalents

 

(198

)

(3,751

)

Cash and cash equivalents, beginning of period

 

1,285

 

6,065

 

Cash and cash equivalents, end of period

 

$

1,087

 

$

2,314

 

 

 

 

 

 

 

Cash paid for reorganization items

 

$

(1,707

)

$

 

 

Classification of Liabilities Not Subject to Compromise

Liabilities not subject to compromise include: (1) liabilities held by HHC Non-Debtors; (2) liabilities incurred after the Petition Date; (3)  pre-Petition Date liabilities the Emerged Debtors expect to pay in full, even though certain of these amounts may not be paid until a plan of reorganization is effective; and (4) liabilities related to pre-petition contracts that affirmatively have not been rejected.

 

All liabilities incurred by the Debtors prior to the Petition Date other than those specified above are considered liabilities subject to compromise. The amounts of the various categories of liabilities that are subject to compromise are set forth below. These amounts represent the Company’s estimates of known or potential pre-Petition Date claims that are likely to be resolved in connection with the bankruptcy filings. Such claims remain subject to future adjustments. Adjustments may result from negotiations, actions of the Bankruptcy Court, rejection of executory contracts and unexpired leases, the determination as to the value of any collateral securing claims, proofs of claim, or other events.  The amounts subject to compromise consisted of the following items:

 

 

 

September 30, 2010

 

December 31, 2009

 

 

 

(In thousands)

 

Mortgages and secured notes

 

$

63,951

 

$

133,973

 

Accounts payable and accrued liabilities

 

74,142

 

141,866

 

Total liabilities subject to compromise

 

$

138,093

 

$

275,839

 

 

The classification of liabilities “not subject to compromise” versus liabilities “subject to compromise” is based on currently available information and analysis. Debtors subject to the remaining Chapter 11 Cases had their plans of reorganization confirmed as of October 21, 2010, and the Plan provides that these Debtors will pay 100% of allowed pre-petition liability claims, including those relating to the HHC assets. However, additional analysis remains to be completed and the Bankruptcy Court may be requested to rule on pre-petition liabilities to be allowed and paid pursuant to

 

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the Plan.  Accordingly, the amounts in these two categories ultimately paid may change.  The amount of any such changes could be significant.

 

Reorganization Items

Reorganization items under the Chapter 11 Cases are expense or income items that were incurred or realized by the HHC Debtors as a result of the Chapter 11 Cases and are presented separately in the Combined Statements of Loss and Comprehensive Loss and in the combined condensed statements of operations of the HHC Debtors presented above. These items include professional fees and similar types of expenses and gains and interest earned on cash accumulated by the HHC Debtors, all as a result of the Chapter 11 Cases.  Reorganization items specific to the HHC Businesses have been allocated to us and have been reflected in our combined financial statements and in the tables presented below.

 

The key employee incentive program (the “KEIP”) was intended to retain certain key employees of GGP during the pendency of the Chapter 11 Cases and provided for payment (in two installments) to these GGP employees upon successful emergence from bankruptcy.  The first KEIP payment was made on November 12, 2010. As certain of these employees became our employees on the Effective Date, a portion of the KEIP has been deemed to relate to us and therefore, we are recognizing our estimated KEIP expense in the period from the date the KEIP was approved by the Bankruptcy Court to November 9, 2010, our date of emergence from bankruptcy.  We accrued a liability for the KEIP in Accounts payable and accrued expenses on the Combined Balance Sheets of $11.7 million as of September 30, 2010 and $2.3 million as of December 31, 2009.  In addition, we recognized the resulting expense in Reorganization items on the Combined Statements of Loss and Comprehensive Loss of $3.6 million for the three months ended September 30, 2010 and $9.4 million for the nine months ended September 30, 2010.  No expense was recognized during the nine months ended September 30, 2009 as the KEIP was approved by the Bankruptcy Court in October 2009.

 

Reorganization items are as follows:

 

Reorganization Items

 

Three Months
Ended
September 30,
2010

 

Three Months
Ended
September 30,
2009

 

Nine Months
Ended
September 30,
2010

 

Nine Months
Ended
September 30,
2009

 

 

 

(In thousands)

 

Gains on liabilities subject to compromise - vendors (1)

 

$

(216

)

$

(138

)

$

(498

)

$

(214

)

Gains on liabilities subject to compromise, net - mortgage debt (2)

 

(2,747

)

(46

)

(2,382

)

(46

)

Interest income (3)

 

(13

)

(2

)

(14

)

(3

)

U.S. Trustee fees (4)

 

142

 

93

 

412

 

93

 

Restructuring costs (5)

 

19,349

 

1,907

 

45,611

 

4,001

 

Total reorganization items

 

$

16,515

 

$

1,814

 

$

43,129

 

$

3,831

 

 


(1)   This amount includes gains from repudiation, rejection or termination of contracts or guarantee of obligations.  Such gains reflect agreements reached with certain critical vendors, which were authorized by the Bankruptcy Court and for which payments on an installment basis began in July 2009.

 

(2)   Such net gains include the Fair Value adjustments of mortgage debt relating to entities that emerged from bankruptcy.

 

(3)   Interest income primarily reflects amounts earned on cash accumulated as a result of our Chapter 11 cases.

 

(4)   Estimate of fees due remains subject to confirmation and review by the Office of the United States Trustee (“U.S. Trustee”).

 

(5)   Restructuring costs primarily include professional fees incurred related to the bankruptcy filings, our allocated share of the estimated KEIP payment, finance costs incurred by the Emerged Debtors and the write off of unamortized deferred finance costs related to the Emerged Debtors.

 

Impairment

Properties, developments in progress and land held for development or redevelopment, including assets to be sold after such development or redevelopment

GAAP related to the accounting for the impairment or disposal of long-lived assets requires that if impairment indicators exist and the undiscounted cash flows expected to be generated by an asset are less than its carrying amount, an impairment provision should be recorded to write down the carrying amount of such asset to its Fair Value (defined in Fair Value Measurements below). We review our combined and uncombined real estate

 

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assets, including operating properties, land held for development and sale and developments in progress, for potential impairment indicators whenever events or changes in circumstances indicate that the carrying amount may not be recoverable.

 

Impairment indicators for our Master Planned Communities segment (defined in Note 10) are assessed separately for each community and include, but are not limited to, significant decreases in sales pace or average selling prices, significant increases in expected land development and construction costs or cancellation rates, and projected losses on expected future sales.

 

Impairment indicators for our Strategic Development segment (defined in Note 10) are assessed separately for each property and include, but are not limited to, significant decreases in comparable property sale prices, in real estate property net operating income and occupancy percentages.

 

Impairment indicators for pre-development costs, which are typically costs incurred during the beginning stages of a potential development, and developments in progress are assessed by project and include, but are not limited to, significant changes in projected completion dates, revenues or cash flows, development costs, market factors and sustainability of development projects.

 

If an indicator of potential impairment exists, the asset is tested for recoverability by comparing its carrying amount to the estimated future undiscounted cash flows.  The cash flow estimates used both for determining recoverability and estimating Fair Value are inherently judgmental and reflect current and projected trends in development costs, land sales prices, rental, occupancy and capitalization rates, and estimated holding periods for the applicable assets.  Although the estimated Fair Value of certain assets may be exceeded by the carrying amount, a real estate asset is only considered to be impaired when its carrying amount cannot be recovered through estimated future undiscounted cash flows. To the extent an impairment provision is necessary; the excess of the carrying amount of the asset over its estimated Fair Value is expensed to operations.  In addition, the impairment provision is allocated proportionately to reduce the carrying amount of the asset.  The adjusted carrying amount, which represents the new cost basis of the asset, is depreciated over the remaining useful life of the asset.

 

We recorded impairment charges related to our properties held for development, redevelopment and sale and developments in progress of $0.1 million and $0.6 million for the three and nine months ended September 30, 2010 and $40.6 million and $180.8 million for the three and nine months ended September 30, 2009, respectively, as presented in the General section below.  All of these impairment charges are included in provisions for impairment in our combined financial statements.

 

Investment in Real Estate Affiliates

In accordance with GAAP related to the equity method of accounting for investments, a series of operating losses of an investee or other factors may indicate that a decrease in value of our investment in the Real Estate Affiliates has occurred which is other-than-temporary. The investment in each of the Real Estate Affiliates is evaluated periodically and as deemed necessary for recoverability and valuation declines that are other than temporary. Accordingly, in addition to the property-specific impairment analysis that we perform on the investment properties, land held for development and sale and developments in progress owned by such joint ventures (as part of our investment property impairment process described above), we also considered the ownership and distribution preferences and limitations and rights to sell and repurchase our ownership interests. Based on such evaluations, no provisions for impairment were recorded for the three and nine months ended September 30, 2010 and 2009 related to our investments in Real Estate Affiliates.  See Note 3 for further disclosure of the provisions for impairment related to certain properties within our Real Estate Affiliates.

 

General

Although all of the properties in our Master Planned Communities segment and two of our operating properties in our Strategic Development segment had impairment indicators and carrying values in excess of estimated Fair Value at September 30, 2010, aggregate undiscounted cash flows for such master planned communities properties and the two strategic development properties exceeded their respective aggregate book values. Based on the Company’s plans with respect to those properties, we believe that the carrying amounts are recoverable and therefore, under applicable GAAP guidance, no additional impairments were taken.  Nonetheless, if our plans regarding our assets change, additional impairment charges in the future could result.    In addition, we have a new Board of Directors and a new HHC management team, a group independent of GGP, as of the Effective Date, and our ability to execute our long-term development strategies will be dependent upon our ability to generate cash flows and additional capital as a separate, publicly-traded company.  Such new

 

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board and management team may change existing plans for the assets, which may result in future impairment provisions being required. Therefore, we can provide no assurance that material impairment charges with respect to our properties held for development, redevelopment and sale and development in progress and our investment in Real Estate Affiliates will not occur in future periods.  Accordingly, we will continue to monitor circumstances and events in future periods to determine whether additional impairments are warranted.

 

Impaired Asset

 

Location

 

Method of Determining Fair Value

 

Three Months
Ended
September 30,
2010

 

Nine Months
Ended
September 30,
2010

 

 

 

 

 

 

 

(In thousands)

 

 

 

 

 

 

 

 

 

 

 

Strategic Development:

 

 

 

 

 

 

 

 

 

Various pre-development costs

 

 

 

(2)

 

$

92

 

$

578

 

 

 

 

 

 

 

 

 

 

 

Impaired Asset

 

Location

 

Method of Determining Fair Value

 

Three Months
Ended
September 30,
2009

 

Nine Months
Ended
September 30,
2009

 

 

 

 

 

 

 

(In thousands)

 

Master Planned Communities:

 

 

 

 

 

 

 

 

 

Maryland- Fairwood Community

 

Columbia, MD

 

Projected sales price analysis (1) (3)

 

$

 

$

52,767

 

 

 

 

 

 

 

 

 

 

 

Strategic Development:

 

 

 

 

 

 

 

 

 

Allen

 

Allen, TX

 

Projected sales price analysis (1) (3)

 

 

24,166

 

Nouvelle at Natick

 

Natick, MA

 

Discounted cash flow analysis (3)

 

 

55,923

 

Redlands Promenade

 

Redlands, CA

 

Projected sales price analysis (1) (3)

 

 

6,667

 

The Village at Redlands

 

Redlands, CA

 

Projected sales price analysis (1) (3)

 

5,492

 

5,492

 

Kendall

 

Miami, FL

 

Projected sales price analysis (1) (3)

 

35,090

 

35,090

 

Various pre-development costs

 

 

 

(2)

 

 

657

 

Total Strategic Development

 

 

 

 

 

40,582

 

127,995

 

Total Provisions for impairment

 

 

 

 

 

$

40,582

 

$

180,762

 

 


(1)          Projected sales price analysis incorporates available market information and other management assumptions.

(2)          Related to the write down of various pre-development costs that were determined to be non-recoverable due to the related projects being terminated.

(3)          These impairments were primarily driven by the carrying value of the assets, including costs expected to be incurred, not being recoverable by the projected sales price of such assets.

 

Fair Value Measurements

Fair Value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants as of the measurement date.

 

The accounting principles for Fair Value measurements establish a three-tier Fair Value hierarchy, which prioritizes the inputs used in measuring Fair Value.  These tiers include:

 

·                  Level 1 - defined as observable inputs such as quoted prices for identical assets or liabilities in active markets;

·                  Level 2 - defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and

·                  Level 3 - defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.

 

The asset or liability Fair Value measurement level within the Fair Value hierarchy is based on the lowest level of any input that is significant to the Fair Value measurement.  Valuation techniques used need to maximize the use of observable inputs and minimize the use of unobservable inputs.  Any Fair Values utilized or disclosed in our combined financial statements were developed for the purpose of complying with the accounting principles established for Fair Value measurements.  The Fair Values of our assets or liabilities for enterprise value in our

 

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Chapter 11 Cases or as a component of our reorganization plan (see Note 1) reflected differing assumptions and methodologies. These estimates were subject to a number of approvals and reviews and therefore may have been materially different.

 

The following table summarizes our significant assets that were measured at Fair Value on a nonrecurring basis as of September 30, 2009.

 

 

 

 

 

 

 

Significant

 

 

 

Total (Loss) Gain

 

 

 

Total Fair
Value
Measurement

 

Quoted Prices in
Active Markets
for Identical
Assets (Level 1)

 

Other
Observable
Inputs
(Level 2)

 

Significant
Unobservable
Inputs
(Level 3)

 

Three Months
Ended
September 30,
2009

 

Nine Months
Ended
September 30,
2009

 

 

 

(In thousands)

 

Village at Redlands

 

$

7,500

 

$

 

$

 

$

7,500

 

$

(5,492

)

$

(5,492

)

Allen

 

29,511

 

 

29,511

 

 

 

(24,166

)

Redlands Promenade

 

6,727

 

 

 

6,727

 

 

(6,667

)

Kendall

 

13,931

 

 

 

13,931

 

(35,090

)

(35,090

)

Maryland - Fairwood Community

 

12,629

 

 

12,629

 

 

 

(52,767

)

Nouvelle At Natick (1)

 

64,661

 

 

 

64,661

 

 

(55,923

)

Total

 

$

134,959

 

$

 

$

42,140

 

$

92,819

 

$

(40,582

)

$

(180,105

)

 


(1) The Fair Value is based on estimated sales value.

 

Fair Value of Financial Instruments

The Fair Values of our financial instruments approximate their carrying amount in our financial statements except for debt.  GAAP guidance requires that management estimate the Fair Value of our debt. However, as a result of the HHC Debtors Chapter 11 cases, the Fair Value for the outstanding debt that is included in liabilities subject to compromise in our Combined Balance Sheets cannot be reasonably determined at September 30, 2010 as the Plan was not effective as of such date.  Such debt will be adjusted to Fair Value on the Effective Date, with such adjustment not expected to be material.  For the $272.8 million of mortgages, notes and loans payable outstanding that are not subject to compromise at September 30, 2010, management’s required estimates of Fair Value are presented below.  This Fair Value was estimated solely for financial statement reporting purposes and should not be used for any other purposes, including to estimate the value of any of the Company’s securities or to estimate the appropriate interest rate for consensual and non-consensual restructuring of secured debt in our Chapter 11 Cases. We estimated the Fair Value of this debt based on quoted market prices for publicly-traded debt, recent financing transactions (which may not be comparable), estimates of the Fair Value of the property that serves as collateral for such debt, historical risk premiums for loans of comparable quality, current London Interbank Offered Rate (“LIBOR”), a widely quoted market interest rate which is frequently the index used to determine the rate at which we borrow funds and US treasury obligation interest rates, and on the discounted estimated future cash payments to be made on such debt.  The discount rates estimated reflect our judgment as to what the approximate current lending rates for loans or groups of loans with similar maturities and credit quality would be if credit markets were operating efficiently and assume that the debt is outstanding through maturity. We have utilized market information as available or present value techniques to estimate the amounts required to be disclosed, or, in the case of the debt of the Emerged Debtors, recorded due to GAAP bankruptcy emergence guidance.  Since such amounts are estimates that are based on limited available market information for similar transactions and do not acknowledge transfer or other repayment restrictions that may exist in specific loans, it is unlikely that the estimated Fair Value of any of such debt could be realized by immediate settlement of the obligation.

 

 

 

September 30, 2010

 

December 31, 2009

 

 

 

Carrying
Amount

 

Estimated Fair
Value

 

Carrying
Amount

 

Estimated Fair
Value

 

 

 

(In thousands)

 

Fixed-rate debt

 

$

207,117

 

$

221,722

 

$

208,860

 

$

205,406

 

Variable-rate debt

 

65,708

 

66,207

 

 

 

 

 

$

 272,825

 

$

287,929

 

$

208,860

 

$

205,406

 

 

Revenue Recognition and Related Matters

Revenues from land sales are recognized using the full accrual method provided that various criteria relating to the terms of the transactions and our subsequent involvement with the land sold are met.  Criteria include the consummation of the sale, demonstration of the collectability of the sales price, the transfer of usual risks and

 

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rewards of ownership to the buyer and absence of substantial continuing involvement from the seller.  Revenues relating to transactions that do not meet the established criteria are deferred and recognized when the criteria are met or using the installment or cost recovery methods, as appropriate in the circumstances.  Revenues and cost of sales are recognized on a percentage of completion basis for land sale transactions in which we are required to perform additional services and incur significant costs after title has passed.

 

Nouvelle at Natick is a 215 unit residential condominium project, located in Natick, Massachusetts.  Pursuant to the Plan, only the unsold units at Nouvelle at Natick on the Effective Date were distributed to us and no deferred revenue or sales proceeds from unit closings prior to the Effective Date were allocated to us.  As of the Effective Date, 60 units were unsold at Nouvelle at Natick, six of which were under contract to close at various dates subsequent to the Effective Date through January 2011.  Income related to unit sales subsequent to the Effective Date is expected to be accounted for on the full accrual method on a unit by unit basis.

 

Minimum rent revenues are recognized on a straight-line basis over the terms of the related leases. Minimum rent revenues also include amounts collected from tenants to allow the termination of their leases prior to their scheduled termination dates and accretion related to above and below-market tenant leases on acquired properties.

 

Straight-line rent receivables, which represent the current net cumulative rents recognized prior to when billed and collectible as provided by the terms of the leases, of $2.5 million as of September 30, 2010 and $3.2 million as of December 31, 2009, are included in Accounts and notes receivable, net in our combined financial statements.  Percentage rent in lieu of fixed minimum rent received from tenants was $0.8 million and $2.6  million for the three and nine months ended September 30, 2010 and $0.7 million and $2.3 million for the three and nine months ended September 30, 2009, and is included in Minimum Rents in our combined financial statements.

 

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. For example, estimates and assumptions have been made with respect to useful lives of assets, capitalization of development and leasing costs, provision for income taxes, recoverable amounts of receivables and deferred taxes, initial valuations and related amortization periods of deferred costs and intangibles, impairment of long-lived assets, Fair Value of debt of the Emerged Debtors and cost ratios and completion percentages used for land sales. Actual results could differ from these and other estimates.

 

Earnings Per Share (“EPS”)

Presentation of EPS information is not applicable as all of our common stock, since the date of our formation on July 1, 2010, is owned by GGP.

 

Debt Market Rate Adjustments

We record market rate adjustments related to our mortgages, notes and loans payable primarily for debt held by the HHC Debtors upon emergence from bankruptcy.  Such debt market rate adjustments are recorded based on the estimated Fair Value of the debt at the time of emergence and are recorded within mortgages, notes and loans payable on our Combined Balance Sheets.  The debt market rate adjustments are amortized as interest expense over the remaining term of the loans using the effective interest method.

 

NOTE 2         INTANGIBLE ASSETS AND LIABILITIES

 

The following table summarizes our intangible assets and liabilities:

 

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Gross Asset
(Liability)

 

Accumulated
(Amortization)
/ Accretion

 

Net
Carrying
Amount

 

 

 

(In thousands)

 

As of September 30, 2010

 

 

 

 

 

 

 

Tenant leases:

 

 

 

 

 

 

 

In-place value

 

$

11,824

 

$

(10,092

)

$

1,732

 

Above-market

 

1,820

 

(1,634

)

186

 

Below-market

 

(78

)

73

 

(5

)

Ground leases:

 

 

 

 

 

 

 

Above-market

 

(16,968

)

2,778

 

(14,190

)

Below-market

 

23,096

 

(1,993

)

21,103

 

 

 

 

 

 

 

 

 

As of December 31, 2009

 

 

 

 

 

 

 

Tenant leases:

 

 

 

 

 

 

 

In-place value

 

$

13,063

 

$

(10,875

)

$

2,188

 

Above-market

 

2,323

 

(1,883

)

440

 

Below-market

 

(86

)

72

 

(14

)

Ground leases:

 

 

 

 

 

 

 

Above-market

 

(16,968

)

2,425

 

(14,543

)

Below-market

 

23,096

 

(1,739

)

21,357

 

 

The gross asset balances of the in-place value of tenant leases are included in Buildings and equipment in our Combined Balance Sheets. The above-market and below-market tenant and ground leases are included in Prepaid expenses and other assets and Accounts payable and accrued expenses (Note 7) in our Combined Balance Sheets.  The decrease in the gross asset (liability) accounts at September 30, 2010 compared to December 31, 2009 is primarily due to the write-off of fully amortized assets and liabilities in the nine months ended September 30, 2010.

 

NOTE 3         REAL ESTATE AFFILIATES

 

We own non-controlling investments in The Woodlands Partnerships and Circle T whereby, generally, we share in the profits and losses, cash flows and other matters relating to our investments in such Real Estate Affiliates in accordance with our respective ownership percentages. Our unaffiliated joint venture partners manage the properties owned by these joint ventures. As we have joint interest and control of these ventures with our venture partners, we account for these joint ventures using the equity method.

 

As of September 30, 2010, approximately $372.4 million of indebtedness was secured by the properties owned by our Real Estate Affiliates, our share of which was approximately $195.5 million.  There can be no assurance that we will be able to refinance or restructure such debt (including the $9.6 million of debt maturing in 2010 and $184.4 million of debt maturing in 2011) on acceptable terms or otherwise, or that joint venture operations or contributions by us and/or our partners will be sufficient to repay such loans.

 

Condensed Combined Financial Information of Certain Real Estate Affiliates

As The Woodlands Partnerships and Circle T are accounted for on the equity method, the following summarized financial information as of September 30, 2010 and December 31, 2009 and for the three and nine months ended September 30, 2010 and 2009 is presented below:

 

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September 30,

 

December 31,

 

 

 

2010

 

2009

 

 

 

(In thousands)

 

Condensed Combined Balance Sheets - Real Estate Affiliates

 

 

 

 

 

Assets:

 

 

 

 

 

Land

 

$

31,077

 

$

31,077

 

Buildings and equipment

 

239,696

 

207,051

 

Less accumulated depreciation

 

(79,557

)

(73,866

)

Developments in progress

 

26,490

 

55,996

 

Net property and equipment

 

217,706

 

220,258

 

Investment property and property held for development and sale

 

242,746

 

266,253

 

Net investment in real estate

 

460,452

 

486,511

 

Cash and cash equivalents

 

47,970

 

35,569

 

Accounts and notes receivable, net

 

57,751

 

66,460

 

Deferred expenses, net

 

1,291

 

1,189

 

Prepaid expenses and other assets

 

66,529

 

40,561

 

Total assets

 

$

633,993

 

$

630,290

 

 

 

 

 

 

 

Liabilities and Owners’ Equity:

 

 

 

 

 

Mortgages, notes and loans payable

 

$

372,385

 

$

377,964

 

Accounts payable, accrued expenses and other liabilities

 

110,657

 

107,700

 

Owners’ equity

 

150,951

 

144,626

 

Total liabilities and owners’ equity

 

$

633,993

 

$

630,290

 

 

 

 

 

 

 

Investment in Real Estate Affiliates, Net:

 

 

 

 

 

Owners’ equity

 

$

150,951

 

$

144,626

 

Less joint venture partners’ equity

 

(72,152

)

(69,147

)

Capital or basis differences and loans

 

67,738

 

65,079

 

 

 

 

 

 

 

Investment in Real Estate Affiliates, net

 

$

146,537

 

$

140,558

 

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

(In thousands)

 

Condensed Combined Statements of Income - Real Estate Affiliates

 

 

 

 

 

 

 

 

 

Revenues:

 

 

 

 

 

 

 

 

 

Minimum rents

 

$

2,563

 

$

5,546

 

$

7,104

 

$

16,339

 

Land sales

 

20,617

 

14,858

 

70,088

 

50,134

 

Other

 

13,417

 

12,390

 

43,596

 

46,397

 

Total revenues

 

36,597

 

32,794

 

120,788

 

112,870

 

 

 

 

 

 

 

 

 

 

 

Expenses:

 

 

 

 

 

 

 

 

 

Real estate taxes

 

503

 

373

 

1,489

 

1,097

 

Property maintenance costs

 

454

 

713

 

922

 

1,933

 

Other property operating costs

 

14,281

 

16,027

 

42,827

 

54,843

 

Land sales operations

 

17,376

 

11,856

 

55,020

 

39,456

 

Depreciation and amortization

 

1,976

 

1,988

 

5,652

 

5,819

 

Total expenses

 

34,590

 

30,957

 

105,910

 

103,148

 

Operating income

 

2,007

 

1,837

 

14,878

 

9,722

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

627

 

107

 

1,966

 

457

 

Interest expense

 

(2,943

)

(1,682

)

(8,575

)

(5,034

)

Provision for income taxes

 

448

 

239

 

(689

)

109

 

Net income attributable to joint venture partners

 

$

139

 

$

501

 

$

7,580

 

$

5,254

 

 

 

 

 

 

 

 

 

 

 

Equity In Income of Real Estate Affiliates:

 

 

 

 

 

 

 

 

 

Net income attributable to joint venture partners

 

$

139

 

$

501

 

$

7,580

 

$

5,254

 

Less joint venture partners’ share of income

 

(70

)

(234

)

(3,604

)

(2,489

)

Amortization of capital or basis differences

 

1,153

 

(2,271

)

2,418

 

(648

)

Equity in income (loss) of Real Estate Affiliates

 

$

1,222

 

$

(2,004

)

$

6,394

 

$

2,117

 

 

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NOTE 4         MORTGAGES, NOTES AND LOANS PAYABLE

 

Mortgages, notes and loans payable are summarized as follows:

 

 

 

September 30,

 

December 31,

 

 

 

2010

 

2009

 

 

 

(In thousands)

 

Fixed-rate debt:

 

 

 

 

 

Collateralized mortgages, notes and loans payable

 

$

271,068

 

$

342,833

 

 

 

 

 

 

 

Variable-rate debt:

 

 

 

 

 

Collateralized mortgages, notes and loans payable

 

65,708

 

 

Total mortgages, notes and loans payable

 

336,776

 

342,833

 

Less: Mortgages, notes and loans payable subject to compromise

 

(63,951

)

(133,973

)

Total mortgages, notes and loans payable not subject to compromise

 

$

272,825

 

$

208,860

 

 

As described in Note 1, on April 16 and 22, 2009, the Debtors filed voluntary petitions for relief under Chapter 11, which triggered defaults on substantially all debt obligations of the Debtors. However, under section 362 of Chapter 11, the filing of a bankruptcy petition automatically stays most actions against the debtor’s estate. Absent an order of the Bankruptcy Court, these pre-petition liabilities are subject to settlement under a plan of reorganization, and therefore are presented as Liabilities subject to compromise on the Combined Balance Sheets as of September 30, 2010 and December 31, 2009.  Of the total amount of debt presented above, $272.8 million and $208.9 million is not subject to compromise, consisting of the collateralized mortgages of the HHC Debtors that have emerged from bankruptcy as of September 30, 2010 and December 31, 2009, respectively, and the debt of the HHC Non-Debtors.

 

As of December 31, 2009, as described in Note 1, plans of reorganization for the Emerged Debtors, with approximately $146.8 million of mortgage debt, had been declared effective. The Emerged Plans for such Emerged Debtors provided for, in exchange for payment of certain extension fees and cure of previously unpaid amounts due on the applicable mortgage loans (primarily, principal amortization otherwise scheduled to have been paid since the Petition Date), the extension of the secured mortgage loans at previously existing non-default interest rates.  In addition, one HHC Debtor emerged from bankruptcy in July 2010.  The interest rate on this loan, with a carrying amount of $65.7 million, changed from a fixed rate of 5.523% to a floating rate of LIBOR (such LIBOR rate no lower than 1.0%) plus 2.50%, capped at 5.523%, and the maturity date was extended by five years to October, 2016.  As a result of the extensions, weighted average remaining duration of the secured loans associated with these properties is 5.27 years as of September 30, 2010. In conjunction with these extensions, certain financial and operating covenants and guarantees were created or reinstated.

 

With respect to the loans of the HHC Debtors that remain in bankruptcy at September 30, 2010, we are currently recognizing interest expense based on contract rates in effect prior to bankruptcy as the Bankruptcy Court has ruled that interest payments based on such contract rates constitute adequate protection to the secured lenders.  The debt that remains subject to compromise at September 30, 2010 was reinstated pursuant to the Plan.

 

The weighted average interest rate on our mortgages, notes and loans payable was 5.14% and 5.54% at September 30, 2010 and December 31, 2009, respectively. The interest rate used in the calculation at September 30, 2010 for the loan that converted to a variable rate in July, 2010 was 3.50%.

 

Collateralized Mortgages, Notes and Loans Payable

As of September 30, 2010, $337.1 million of land, buildings and equipment and developments in progress (before accumulated depreciation) have been pledged as collateral for our mortgages, notes and loans payable. Certain of these properties are cross-collateralized with other properties.  Substantially all of the $336.8 million of fixed and variable rate secured mortgage notes and loans payable are non-recourse.  In addition, certain mortgage loans as of September 30, 2010 contain other credit enhancement provisions which have been provided by the TopCo Debtors. These security or credit enhancement provisions were modified pursuant to the Plan, including, among other things, to substitute us for GGP as guarantor for certain HHC Debtor mortgage loans.  Certain mortgage notes payable may be prepaid but are generally subject to a prepayment penalty equal to a yield-maintenance premium, defeasance or a percentage of the loan balance.

 

Letters of Credit and Surety Bonds

We had outstanding letters of credit and surety bonds of $66.0 million as of September 30, 2010 and $76.5 million as of December 31, 2009. These letters of credit and bonds were issued primarily in connection with insurance requirements, special real estate assessments and construction obligations.

 

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NOTE 5         INCOME TAXES

 

Although GGP operated as a REIT prior to the Effective Date, certain of the HHC Businesses operated as taxable REIT subsidiaries.  After the Effective Date, we will not elect to be treated as a REIT and thus will generally be taxed as a C corporation.  However, one of our combined entities, Victoria Ward, Ltd. (“Ward”, substantially all of which is owned by us) elected to be taxed as a REIT under sections 856-860 of the Internal Revenue Code of 1986, as amended (the “Code”), commencing with the taxable year beginning January 1, 2002 and currently intends to maintain REIT status and operate as a REIT after the Effective Date.  To qualify as a REIT, Ward must meet a number of organizational and operational requirements, including requirements to distribute at least 90% of its ordinary taxable income and to distribute to stockholders or pay tax on 100% of capital gains and to meet certain asset and income tests.  Ward has satisfied such REIT distribution requirements for 2009 and we intend to satisfy such requirements for 2010.

 

The most significant component of the deferred tax liability is associated with the master planned communities and largely attributable to the difference between the basis and value determined as of the date of the acquisition by the Predecessors of The Rouse Company (“TRC”) in 2004 adjusted for sales that have occurred since that time.  The cash cost and timing of payment related to this deferred tax liability is dependent upon the sales price of future land sales and the method of accounting used for income tax purposes.  The deferred tax liability also includes an amount related to deferred income reflecting the difference between the income tax method of accounting and the financial statement method of accounting for prior sales of land in our master planned communities.

 

Unrecognized tax benefits recorded pursuant to uncertain tax positions were $124.9 million and $57.0 million as of September 30, 2010 and December 31, 2009, respectively, excluding interest, of which none would impact our future tax rate as of September 30, 2010 and December 31, 2009. Accrued interest related to these unrecognized tax benefits amounted to $27.5 million as of September 30, 2010 and $9.1 million as of December 31, 2009. We recognized an increase of interest expense related to the unrecognized tax benefits of $2.6 million for the three months ended September 30, 2010; $18.3 million for the nine months ended September 30, 2010; zero for the three months ended September 30, 2009 and $1.0 million for the nine months ended September 30, 2009.

 

Generally, we are currently open to audit under the statute of limitations by the Internal Revenue Service for the years ending December 31, 2005 through 2009 and are open to audit by state taxing authorities for the years ending December 31, 2004 through 2009.

 

Two of our subsidiaries are being audited by the IRS for the years ended December 31, 2007 and December 31, 2008, and in connection with such audits, the IRS has proposed changes resulting in $148.2 million of additional tax. We have disputed the proposed changes and it is the Company’s position that the tax law in question has been properly applied and reflected in the 2007 and 2008 returns for these two subsidiaries.  We rejected a settlement offer from the IRS and cannot predict when these audits will be resolved.  We have previously provided for the additional taxes sought by the IRS, through our uncertain tax position liability or deferred tax liabilities.  Although we believe our tax returns are correct, the final determination of tax examinations and any related litigation could be different than what was reported on the returns.  In the opinion of management, we have made adequate tax provisions for the years subject to examination. In addition, pursuant to the Tax Matters Agreement, we have agreed with GGP that interest and penalties, if any, that are ultimately due related to this matter will remain a GGP obligation.

 

Based on our assessment of the expected outcome of these examinations or examinations that may commence, or as a result of the expiration of the statute of limitations for specific jurisdictions, it is reasonably possible that the related unrecognized tax benefits, excluding accrued interest, for tax positions taken regarding previously filed tax returns will materially change from those recorded at September 30, 2010. A material change in unrecognized tax benefits could have a material effect on our statements of income and comprehensive income. As of September 30, 2010, there are not any unrecognized tax benefits, excluding accrued interest, which due to the reasons above, could significantly increase or decrease during the next twelve months.

 

Pursuant to the Investment Agreements, reorganized GGP will indemnify us from and against 93.75% of any and all losses, claims, damages, liabilities and reasonable expenses to which we and our subsidiaries become subject, in each case solely to the extent attributable to certain taxes related to sales of certain assets in our Master Planned Communities segment prior to March 31, 2010, in an amount up to the Indemnity Cap.  The Indemnity Cap is calculated as the lesser of $303.75 million and the Excess Surplus Amount.  The Excess Surplus Amount is determined using a complex formula described in the Investment Agreements.  Due to,

 

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among other things, the completion of an approximate $2.0 billion common stock offering by GGP on November 19, 2010, the Indemnity Cap will equal $303.75 million.  Such Indemnity Cap is not reflected as an asset of the Company at September 30, 2010.

 

NOTE 6         TRANSACTIONS WITH GGP AND OTHER GGP SUBSIDIARIES

 

Intercompany Transactions

As described in Note 1, the accompanying combined financial statements present the operations of the HHC Businesses as carved-out from the consolidated financial statements of GGP. Transactions between the HHC Businesses have been eliminated in the combined presentation. Also as described in Note 1, an allocation of certain centralized GGP costs incurred for activities such as employee benefit programs, property management and asset management functions, centralized treasury, payroll and administrative functions has been made to the property operating costs of HHC Businesses.  Accordingly, transactions between the HHC Businesses and GGP or other GGP subsidiaries have not been eliminated except that end-of-period intercompany balances between GGP and the HHC Businesses have been considered elements of HHC equity.

 

Incentive Stock Plans

Prior to the Chapter 11 Cases, the Predecessors granted qualified and non-qualified stock options and restricted stock to certain GGP officers and key employees whose compensation costs related specifically to our assets.  Accordingly, stock-based compensation costs pertaining to such employees have been reflected in our combined financial statements for the applicable periods.  A similar stock option and restricted stock plan is in place for our employees after the Effective Date.

 

Pursuant to the Plan, each outstanding option to acquire shares of GGP stock (the ‘‘GGP Option’’) was converted into (i) an option to acquire the same number of shares of common stock of reorganized GGP and (ii) a separate option to acquire approximately 0.098344 shares of our common stock (the ‘‘HHC Option’’) for each existing option for one share of GGP common stock. The replacement options generally have the same terms and conditions as the outstanding GGP Options with the exercise price adjusted for the conversion ratio of GGP common stock to HHC common stock and the relative trading values of such common stock. As of the Effective Date, 507,307 shares of common stock were issuable upon exercise of the HHC Options.

 

Notwithstanding the foregoing, pursuant to the terms of GGP’s 1998 Incentive Stock Plan, holders of any outstanding GGP Option issued thereunder shall have the right to elect, within sixty days after the Effective Date, to surrender such option as of the Effective Date for a cash payment.  Accordingly, the number of shares of HHC common stock that will be issuable as a result of converted GGP options will be less than 507,307 shares to the extent such alternative is elected.

 

Stock-Based Compensation Expense

The Predecessors evaluated stock-based compensation expense in accordance with GAAP related to share-based payments, which requires companies to estimate the Fair Value of share-based payment awards on the date of grant using an option-pricing model.  The value of the portion of an award to our employees that is ultimately expected to vest is recognized as expense over the requisite service periods in the Combined Statements of Loss and Comprehensive Loss.  The compensation expense for employees specifically attributed to the HHC Businesses have been included in the accompanying combined financial statements.

 

NOTE 7         OTHER ASSETS AND LIABILITIES

 

The following table summarizes the significant components of prepaid expenses and other assets.

 

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September 30,

 

December 31,

 

 

 

2010

 

2009

 

 

 

(In thousands)

 

Special Improvement District receivable

 

$

48,584

 

$

48,713

 

Receivables - other

 

29,764

 

37,355

 

Prepaid expenses

 

16,850

 

9,465

 

Below-market ground leases (Note 2)

 

21,103

 

21,357

 

Security and escrow deposits

 

6,589

 

9,487

 

Taxes receivable

 

5,208

 

 

Other

 

4,726

 

8,668

 

 

 

$

132,824

 

$

135,045

 

 

The following table summarizes the significant components of accounts payable, accrued expenses and other liabilities.

 

 

 

September 30,

 

December 31,

 

 

 

2010

 

2009

 

 

 

(In thousands)

 

Uncertain tax position liability

 

$

152,400

 

$

66,129

 

Construction payable

 

44,063

 

108,437

 

Payables to GGP

 

32,639

 

30,359

 

Accounts payable and accrued expenses

 

19,525

 

23,087

 

Above-market ground leases (Note 2)

 

14,190

 

14,543

 

Deferred gains/income

 

6,458

 

9,045

 

Accrued interest

 

6,286

 

3,816

 

Accrued real estate taxes

 

6,239

 

4,548

 

Tenant and other deposits

 

4,240

 

4,322

 

Insurance reserve

 

4,192

 

5,640

 

Accrued payroll and other employee liabilities

 

2,452

 

2,754

 

Other

 

7,341

 

3,377

 

Total accounts payable and accrued expenses

 

300,025

 

276,057

 

Less: amounts subject to compromise (Note 1)

 

(74,142

)*

(141,866

)

Accounts payable and accrued expenses not subject to compromise

 

$

225,883

 

$

134,191

 

 


* As of the Effective Date, accounts payable and accrued expenses subject to compromise were substantially paid pursuant to the Plan.  In addition, pursuant to the Separation Agreement, certain remaining construction payables remained a GGP obligation after the Effective Date.

 

NOTE 8         COMMITMENTS AND CONTINGENCIES

 

In the normal course of business, from time to time, we are involved in legal proceedings relating to the ownership and operations of our properties.  In management’s opinion, the liabilities, if any, that may ultimately result from such legal actions are not expected to have a material adverse effect on our combined financial position, results of operations or liquidity.

 

We lease land or buildings at certain properties from third parties. The leases generally provide us with a right of first refusal in the event of a proposed sale of the property by the landlord. Rental payments are expensed as incurred and have, to the extent applicable, been straight-lined over the term of the lease. Contractual rental expense, including participation rent, was $0.9 million for the three months ended September 30, 2010; $2.2 million for the nine months ended September 30, 2010; $0.5 million for the three months ended September 30, 2009 and $2.1 million for the nine months ended September 30, 2009.  The same rent expense excluding amortization of above and below-market ground leases and straight-line rents was $0.9 million for the three months ended September 30, 2010; $2.2 million for the nine months ended September 30, 2010; $0.6 million for the three months ended September 30, 2009 and $2.1 million for the nine months ended September 30, 2009.

 

See Note 5 for our obligations related to uncertain tax positions for disclosure of additional contingencies.

 

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Contingent Stock Agreement

In conjunction with GGP’s acquisition of The Rouse Company (“TRC”) in November 2004, GGP assumed TRC’s obligations under the Contingent Stock Agreement, (the “CSA”). TRC entered into the CSA in 1996 when it acquired The Hughes Corporation (“Hughes”). This acquisition included various assets, including Summerlin (the “CSA Assets”), a development in our Master Planned Communities segment.  The CSA was an unsecured obligation of GGP and therefore GGP’s obligations to the former Hughes owners or their successors (the “Beneficiaries”) under the CSA was subject to treatment in accordance with the Plan.

 

The Plan provides that the final payment and settlement of all other claims under the CSA will be a total of $230 million (down from the $245 million estimate at December 31, 2009), and such amount will be distributed by GGP after the Effective Date.  Accordingly, during 2010, we reduced our carrying value of the CSA assets, and the related GGP equity, by $15 million for this revised estimate.

 

NOTE 9         RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

 

On June 12, 2009, the FASB issued new generally accepted accounting guidance that amends the consolidation guidance applicable to variable interest entities.  The amendments to the consolidation guidance affect all entities and enterprises currently within the scope of the previous guidance and were effective on January 1, 2010.  We have adopted this new pronouncement and it did not have a material impact on our combined financial statements.

 

NOTE 10       SEGMENTS

 

We have two business segments which offer different products and services. Our segments are managed separately because each requires different operating strategies or management expertise.  We do not distinguish or group our combined operations on a geographic basis.  Further, all operations are within the United States and no customer or tenant comprises more than 10% of combined revenues. Our reportable segments are as follows:

 

·                  Master Planned Communities (“MPC”) - includes the development and sale of land, primarily in large-scale, long-term community development projects in and around Columbia, Maryland; Summerlin, Nevada; and Houston, Texas

 

·                  Strategic Development - includes all properties held for development and redevelopment, including the current rental property operations (primarily retail and other interests in real estate at such locations) as well as our one residential condominium project located in Natick (Boston), Massachusetts

 

The operating measure used to assess operating results for the business segments is adjusted earnings before interest, income taxes, depreciation and amortization (“Adjusted EBITDA”).  Adjusted EBITDA also excludes reorganization items, strategic initiatives, provisions for impairment and allocation to noncontrolling interest and, accordingly, management believes that Adjusted EBITDA provides useful information about a business segment’s or property’s operating performance.

 

The accounting policies of the segments are the same as those described in Note 1, except that we report the operations of our Real Estate Affiliates using the proportionate share method rather than the equity method.  Under the proportionate share method, our share of the revenues and expenses of our Real Estate Affiliates are aggregated with the revenues and expenses of combined properties. Under the equity method, our share of the net revenues and expenses of our Real Estate Affiliates are reported as a single line item, Equity in income (loss) of Real Estate Affiliates, in our Combined Statements of Loss and Comprehensive Loss. This difference affects only the reported revenues and operating expenses of the segments and has no effect on our reported net earnings.

 

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The total cash expenditures for additions to long-lived assets for the Master Planned Communities segment was $39.1 million for the nine months ended September 30, 2010 and $33.4 million for the nine months ended September 30, 2009. Similarly, cash used for long-lived assets for the Strategic Development segment were $71.1 million for the nine months ended September 30, 2010 and $23.8 million for the nine months ended September 30, 2009. Such amounts for the Master Planned Communities segment and the Strategic Development segment are included in the amounts listed as Land/residential development and acquisitions expenditures and Development of real estate and property additions/improvements, primarily previously accrued, respectively, in our Combined Statements of Cash Flows.

 

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Segment operating results are as follows:

 

 

 

Three Months Ended September 30, 2010

 

 

 

Combined

 

Real Estate

 

Segment

 

 

 

Properties

 

Affiliates

 

Basis

 

 

 

(In thousands)

 

Master Planned Communities

 

 

 

 

 

 

 

Land sales

 

$

10,034

 

$

10,824

 

$

20,858

 

Land sales operations

 

(10,057

)

(8,080

)

(18,137

)

Master Planned Communities Adjusted EBITDA

 

(23

)

2,744

 

2,721

 

 

 

 

 

 

 

 

 

Strategic Development

 

 

 

 

 

 

 

Property revenues:

 

 

 

 

 

 

 

Minimum rents

 

16,349

 

1,345

 

17,694

 

Tenant recoveries

 

4,637

 

 

4,637

 

Overage rents

 

826

 

 

826

 

Other

 

614

 

7,044

 

7,658

 

Total property revenues

 

22,426

 

8,389

 

30,815

 

Property operating expenses:

 

 

 

 

 

 

 

Real estate taxes

 

4,131

 

264

 

4,395

 

Property maintenance costs

 

1,484

 

238

 

1,722

 

Marketing

 

248

 

 

248

 

Other property operating costs

 

8,746

 

7,495

 

16,241

 

Provision for doubtful accounts

 

744

 

 

744

 

Property management and other costs

 

3,467

 

 

3,467

 

Total property operating expenses

 

18,820