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 March 31, 2012

 

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 001-34856

 

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, 22nd Floor, 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 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 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).  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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

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 number of shares of Common Stock, $0.01 par value, outstanding on May 7, 2012 was 37,942,707.

 

 

 



Table of Contents

 

THE HOWARD HUGHES CORPORATION

 

INDEX

 

 

 

PAGE

 

 

NUMBER

 

 

 

PART I

FINANCIAL INFORMATION

 

 

Item 1:

Condensed Consolidated Financial Statements (Unaudited)

 

 

 

 

 

 

Condensed Consolidated Balance Sheets as of March 31, 2012 and December 31, 2011

3

 

 

 

 

 

 

Condensed Consolidated Statements of Operations for the three months ended March 31, 2012 and 2011

4

 

 

 

 

 

 

Condensed Consolidated Statements of Comprehensive Income (Loss) for the three months ended March 31, 2012 and 2011

5

 

 

 

 

 

 

Condensed Consolidated Statements of Equity for the three months ended March 31, 2012 and 2011

6

 

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2012 and 2011

7

 

 

 

 

 

 

Notes to Condensed Consolidated Financial Statements

8

 

 

 

 

 

Item 2:

Management’s Discussion and Analysis of Financial Condition and Results of Operations

29

 

 

 

 

 

Item 3:

Quantitative and Qualitative Disclosures about Market Risk Operations

44

 

 

 

 

 

Item 4:

Controls and Procedures Operations

44

 

 

 

 

PART II

OTHER INFORMATION

 

 

 

 

 

Item 1:  Legal Proceedings

45

 

 

 

 

Item 1A: Risk Factors

45

 

 

 

 

Item 6:  Exhibits

45

 

 

 

 

SIGNATURE

46

 

 

 

 

EXHIBIT INDEX

47

 

2



Table of Contents

 

THE HOWARD HUGHES CORPORATION

 

CONDENSED CONSOLIDATED BALANCE SHEETS

 

(UNAUDITED)

 

 

 

March 31,

 

December 31,

 

 

 

2012

 

2011

 

 

 

(In thousands, except share amounts)

 

Assets:

 

 

 

 

 

Investment in real estate:

 

 

 

 

 

Master Planned Community assets

 

$

1,601,385

 

$

1,602,437

 

Land

 

238,699

 

236,363

 

Buildings and equipment

 

559,192

 

556,786

 

Less: accumulated depreciation

 

(96,692

)

(92,494

)

Developments in progress

 

200,552

 

195,034

 

Net property and equipment

 

2,503,136

 

2,498,126

 

Investments in Real Estate Affiliates

 

63,091

 

62,595

 

Net investment in real estate

 

2,566,227

 

2,560,721

 

Cash and cash equivalents

 

209,974

 

227,566

 

Accounts receivable, net

 

13,991

 

15,644

 

Municipal Utility District receivables, net

 

90,428

 

86,599

 

Notes receivable, net

 

33,690

 

35,354

 

Tax indemnity receivable, including interest

 

333,750

 

331,771

 

Deferred expenses, net

 

11,609

 

10,338

 

Prepaid expenses and other assets, net

 

130,619

 

127,156

 

Total assets

 

$

3,390,288

 

$

3,395,149

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

Mortgages, notes and loans payable

 

$

598,287

 

$

606,477

 

Deferred tax liabilities

 

77,868

 

75,966

 

Warrant liabilities

 

249,615

 

127,764

 

Uncertain tax position liability

 

131,934

 

129,939

 

Accounts payable and accrued expenses

 

113,944

 

125,404

 

Total liabilities

 

1,171,648

 

1,065,550

 

 

 

 

 

 

 

Commitments and Contingencies (see Note 12)

 

 

 

 

 

 

 

 

 

 

 

Equity:

 

 

 

 

 

Preferred stock: $.01 par value; 50,000,000 shares authorized, none issued

 

 

 

Common stock: $.01 par value; 150,000,000 shares authorized, 37,945,707 shares issued and outstanding as of March 31, 2012 and 37,945,707 shares issued and outstanding as of December 31, 2011

 

379

 

379

 

Additional paid-in capital

 

2,711,980

 

2,711,109

 

Accumulated deficit

 

(493,583

)

(381,325

)

Accumulated other comprehensive loss

 

(5,886

)

(5,578

)

Total stockholders’ equity

 

2,212,890

 

2,324,585

 

Noncontrolling interest

 

5,750

 

5,014

 

Total equity

 

2,218,640

 

2,329,599

 

Total liabilities and equity

 

$

3,390,288

 

$

3,395,149

 

 

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

 

3



Table of Contents

 

THE HOWARD HUGHES CORPORATION

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 

(UNAUDITED)

 

 

 

Three Months Ended March 31,

 

 

 

2012

 

2011

 

 

 

(In thousands, except per share amounts)

 

Revenues:

 

 

 

 

 

Master Planned Community land sales

 

$

36,089

 

$

23,392

 

Builder price participation

 

813

 

521

 

Minimum rents

 

18,898

 

16,719

 

Tenant recoveries

 

5,871

 

4,524

 

Condominium unit sales

 

134

 

3,764

 

Resort and conference center revenues

 

9,657

 

 

Other land revenues

 

3,516

 

1,248

 

Other rental and property revenues

 

4,787

 

2,933

 

Total revenues

 

79,765

 

53,101

 

Expenses:

 

 

 

 

 

Master Planned Community cost of sales

 

18,739

 

15,436

 

Master Planned Community operations

 

9,713

 

5,714

 

Rental property real estate taxes

 

3,839

 

3,474

 

Rental property maintenance costs

 

1,959

 

1,559

 

Condominium unit cost of sales

 

59

 

2,980

 

Resort and conference center operations

 

7,414

 

 

Other property operating costs

 

14,058

 

9,721

 

Provision for doubtful accounts

 

 

11

 

General and administrative

 

9,822

 

5,017

 

Depreciation and amortization

 

5,058

 

3,199

 

Total expenses

 

70,661

 

47,111

 

 

 

 

 

 

 

Operating income

 

9,104

 

5,990

 

 

 

 

 

 

 

Interest income

 

2,332

 

2,512

 

Interest expense

 

 

 

Warrant liability loss

 

(121,851

)

(126,045

)

Equity in earnings from Real Estate Affiliates

 

2,677

 

5,513

 

Loss before taxes

 

(107,738

)

(112,030

)

Provision for income taxes

 

(3,784

)

(2,457

)

Net loss from continuing operations

 

(111,522

)

(114,487

)

Net loss

 

(111,522

)

(114,487

)

Net earnings attributable to noncontrolling interests

 

(736

)

(28

)

Net loss attributable to common stockholders

 

$

(112,258

)

$

(114,515

)

 

 

 

 

 

 

Basic Loss Per Share:

 

$

(2.96

)

$

(3.02

)

 

 

 

 

 

 

Diluted Loss Per Share:

 

$

(2.96

)

$

(3.02

)

 

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

 

4



Table of Contents

 

THE HOWARD HUGHES CORPORATION

 

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

 

(UNAUDITED)

 

 

 

Three Months Ended March 31,

 

 

 

2012

 

2011

 

 

 

(In thousands, except per share amounts)

 

Comprehensive Loss, Net of Tax:

 

 

 

 

 

Net loss

 

$

(111,522

)

$

(114,487

)

Other comprehensive income (loss):

 

 

 

 

 

Interest rate swap

 

102

 

 

Capitalized swap interest

 

(410

)

 

Pension plan adjustment

 

 

(65

)

Other comprehensive loss

 

(308

)

(65

)

Comprehensive loss

 

(111,830

)

(114,552

)

Comprehensive earnings attributable to noncontrolling interests

 

(736

)

(28

)

Comprehensive loss attributable to common stockholders

 

$

(112,566

)

$

(114,580

)

 

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

 

5


 


Table of Contents

 

THE HOWARD HUGHES CORPORATION

 

CONDENSED CONSOLIDATED STATEMENTS OF EQUITY

 

(UNAUDITED)

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

Noncontrolling

 

 

 

 

 

 

 

 

 

Additional

 

 

 

Other

 

Interests in

 

 

 

 

 

 

 

Common

 

Paid-In

 

Accumulated

 

Comprehensive

 

Consolidated

 

Total

 

(In thousands, except shares) 

 

Shares

 

Stock

 

Capital

 

Deficit

 

Income (Loss)

 

Ventures

 

Equity

 

Balance January 1, 2011

 

37,904,506

 

$

379

 

$

2,708,036

 

$

(528,505

)

$

(1,627

)

$

824

 

$

2,179,107

 

Net income (loss)

 

 

 

 

 

(114,515

)

 

28

 

(114,487

)

Distributions to noncontrolling interests

 

 

 

 

 

 

 

(62

)

(62

)

Other comprehensive loss

 

 

 

 

 

 

(65

)

 

(65

)

Stock plan activity

 

20,000

 

 

129

 

 

 

 

129

 

Balance, March 31, 2011

 

37,924,506

 

$

379

 

$

2,708,165

 

$

(643,020

)

$

(1,692

)

$

790

 

$

2,064,622

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance January 1, 2012

 

37,945,707

 

$

379

 

$

2,711,109

 

$

(381,325

)

$

(5,578

)

$

5,014

 

$

2,329,599

 

Net income (loss)

 

 

 

 

 

(112,258

)

 

736

 

(111,522

)

Interest rate swaps, net of tax of $101

 

 

 

 

 

 

102

 

 

102

 

Capitalized swap interest, net of tax of $244

 

 

 

 

 

 

(410

)

 

(410

)

Stock plan activity

 

 

 

871

 

 

 

 

871

 

Balance, March 31, 2012

 

37,945,707

 

$

379

 

$

2,711,980

 

$

(493,583

)

$

(5,886

)

$

5,750

 

$

2,218,640

 

 

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

 

6



Table of Contents

 

THE HOWARD HUGHES CORPORATION

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

(UNAUDITED)

 

 

 

Three Months Ended March 31,

 

 

 

2012

 

2011

 

 

 

(In thousands)

 

Cash Flows from Operating Activities:

 

 

 

 

 

Net loss

 

$

(111,522

)

$

(114,487

)

 

 

 

 

 

 

Adjustments to reconcile net loss to cash provided by operating activities:

 

 

 

 

 

Equity in earnings from Real Estate Affiliates, net of distributions

 

(151

)

(1,619

)

Provision for doubtful accounts

 

 

11

 

Depreciation

 

4,214

 

2,748

 

Amortization

 

844

 

451

 

Amortization of deferred financing costs and debt market rate adjustments

 

156

 

(1,709

)

Amortization of intangibles other than in-place leases

 

(44

)

33

 

Straight-line rent amortization

 

(265

)

(835

)

Deferred income taxes

 

3,728

 

2,423

 

Restricted stock and stock option amortization

 

871

 

 

Warrant liability loss

 

121,851

 

126,045

 

Master Planned Community and condominium development expenditures

 

(24,284

)

(18,687

)

Master Planned Community and condominium cost of sales

 

17,857

 

18,416

 

Net changes :

 

 

 

 

 

Accounts and notes receivable

 

3,770

 

(75

)

Prepaid expenses and other assets

 

(2,791

)

(387

)

Deferred expenses

 

(1,432

)

(62

)

Accounts payable and accrued expenses

 

(13,193

)

(7,538

)

Other, net

 

(487

)

(58

)

Cash (used in) provided by operating activities

 

(878

)

4,670

 

 

 

 

 

 

 

Cash Flows from Investing Activities:

 

 

 

 

 

Real estate and property expenditures

 

(7,605

)

(9,140

)

Investments in Real Estate Affiliates

 

(345

)

(10

)

Distributions received from Real Estate Affiliates in excess of income

 

 

79

 

Increase in restricted cash

 

(1,001

)

 

Cash used in investing activities

 

(8,951

)

(9,071

)

 

 

 

 

 

 

Cash Flows from Financing Activities:

 

 

 

 

 

Proceeds from issuance of mortgages, notes and loans payable

 

217

 

 

Principal payments on mortgages, notes and loans payable

 

(7,465

)

(1,738

)

Deferred financing costs

 

(515

)

 

Proceeds from issuance of management warrants

 

 

2,000

 

Distributions to noncontrolling interests

 

 

(62

)

Cash (used in) provided by financing activities

 

(7,763

)

200

 

Net change in cash and cash equivalents

 

(17,592

)

(4,201

)

Cash and cash equivalents at beginning of period

 

227,566

 

284,682

 

Cash and cash equivalents at end of period

 

$

209,974

 

$

280,481

 

 

 

 

 

 

 

Supplemental Disclosure of Cash Flow Information:

 

 

 

 

 

Interest paid

 

$

6,070

 

$

3,597

 

Interest capitalized

 

6,692

 

4,224

 

Income taxes paid

 

132

 

 

 

 

 

 

 

 

Non-Cash Investing and Financing Transactions:

 

 

 

 

 

Special Improvement District bond transfers associated with land sales

 

978

 

 

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

 

1,711

 

(5,687

)

 

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

 

7



Table of Contents

 

NOTE 1         BASIS OF PRESENTATION AND ORGANIZATION

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial statements and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X as issued by the SEC. Such condensed consolidated financial statements do not include all of the information and disclosures required by GAAP for complete financial statements. In addition, readers of this Quarterly Report on Form 10-Q (“Quarterly Report”) should refer to The Howard Hughes Corporation’s (“HHC” or the “Company”) audited Consolidated Financial Statements for the year ended December 31, 2011 which are included in the Company’s Annual Report on Form 10-K (the “Annual Report”) for the fiscal year ended December 31, 2011. Capitalized terms used, but not defined in this Quarterly Report have the same meanings as in the Annual Report. In the opinion of management, all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods have been included. In 2011, we reclassified $2.4 million of deferred income taxes from accounts payable and accrued expenses on the Condensed Consolidated Statements of Cash Flows to conform to the 2012 presentation. The results for the interim period ended March 31, 2012 and 2011 are not necessarily indicative of the results to be expected for the full fiscal year.

 

As more fully described in Note 3, on July 1, 2011 we acquired from our partner the remaining 47.5% economic interest in The Woodlands not owned by us. As a result of the acquisition, beginning on July 1, 2011, we consolidated the financial results of The Woodlands which were previously accounted for under the equity method. Our financial statements as of and for the three months ended March 31, 2012 are not comparable to the same period in 2011 due to the consolidation of The Woodlands.

 

Management has evaluated all material events occurring subsequent to the date of the condensed consolidated financial statements up to the date and time this Quarterly Report is filed on Form 10-Q.

 

Sponsor and Management Warrants

 

On November 9, 2010 (the “Effective Date”), we issued warrants to purchase 8.0 million shares of our common stock to certain of the sponsors (the “Sponsors Warrants”) with an estimated initial value of approximately $69.5 million. The initial exercise price for the warrants of $50.00 per share is subject to adjustment for future stock dividends, splits or reverse splits of our common stock or certain other events. Approximately 6.1 million warrants are immediately exercisable and approximately 1.9 million warrants are exercisable upon 90 days prior notice for the first 6.5 years after issuance and are subsequently exercisable without notice any time thereafter. The Sponsors Warrants expire on November 9, 2017.

 

In November 2010 and February 2011, we entered into certain warrant agreements (the “Management Warrants”) with David R. Weinreb, our Chief Executive Officer, Grant Herlitz, our President, and Andrew C. Richardson, our Chief Financial Officer, in each case prior to his appointment to such position. The Management Warrants representing 2,862,687 underlying shares were issued pursuant to such agreements at fair value in exchange for a combined total of approximately $19.0 million in cash from such executives at the commencement of their respective employment. Mr. Weinreb and Mr. Herlitz’s warrants have exercise prices of $42.23 per share and Mr. Richardson’s warrant has an exercise price of $54.50 per share. Generally, the Management Warrants become exercisable in November 2016 and expire by February 2018.

 

The estimated $199.2 million fair value for the Sponsors Warrants and estimated $50.4 million fair value for the Management Warrants as of March 31, 2012, have been recorded as a liability because the holders of these warrants could require HHC to settle such warrants in cash upon a change of control. The fair values were estimated using an option pricing model and Level 3 inputs due to the unavailability of comparable market data. The estimated fair values for the Sponsor Warrants and Management Warrants were $275.8 million and $79.6 million, respectively as of March 31, 2011. Changes in the fair value of the Sponsors Warrants and the Management Warrants are recognized in earnings and, accordingly, warrant liability losses reflecting increases in value of approximately $121.9 million and $126.0 million were recognized for the quarters ended March 31, 2012 and 2011, respectively.

 

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NOTE 2         EARNINGS PER SHARE

 

Basic earnings per share (“EPS”) is computed by dividing net income available to common stockholders by the weighted-average number of common shares outstanding. Diluted EPS is computed after adjusting the numerator and denominator of the basic EPS computation for the effects of any potentially dilutive common shares. The dilutive effect of options and non-vested stock issued under stock-based compensation plans is computed using the “treasury stock” method. The dilutive effect of the Sponsors Warrants and Management Warrants are computed using the if-converted method. Gains, if any, associated with the Sponsors Warrants and Management Warrants are excluded from the numerator in computing diluted earnings per share because inclusion of such gains in the computation would be anti-dilutive.

 

Information related to our EPS calculations is summarized as follows:

 

 

 

Three Months Ended March 31,

 

(In thousands, except per share amounts)

 

2012

 

2011

 

 

 

(In thousands)

 

 

 

 

 

 

 

Basic EPS:

 

 

 

 

 

Numerator:

 

 

 

 

 

Net loss from continuing operations

 

$

(111,522

)

$

(114,487

)

Net earnings attributable to noncontrolling interests

 

(736

)

(28

)

Net loss attributable to common stockholders

 

$

(112,258

)

$

(114,515

)

 

 

 

 

 

 

Denominator:

 

 

 

 

 

Weighted average number of common shares outstanding - basic

 

37,903

 

37,905

 

 

 

 

 

 

 

Diluted EPS *:

 

 

 

 

 

Numerator:

 

 

 

 

 

Net loss attributable to common stockholders

 

$

(112,258

)

$

(114,515

)

Less: Warrant liability gain

 

 

 

Adjusted net loss available to common stockholders

 

$

(112,258

)

$

(114,515

)

Denominator:

 

 

 

 

 

Weighted average number of common shares outstanding - basic

 

37,903

 

37,905

 

Restricted stock and stock options

 

 

 

Warrants

 

 

 

Weighted average number of common shares outstanding - diluted

 

37,903

 

37,905

 

 

 

 

 

 

 

Basic Loss Per Share:

 

$

(2.96

)

$

(3.02

)

 

 

 

 

 

 

Diluted Loss Per Share:

 

$

(2.96

)

$

(3.02

)

 


*Due to the net loss for the three months ended March 31, 2012 and 2011, basic shares were used to calculate diluted earnings per share. Inclusion of such securities would result in anti-dilution.

 

9



Table of Contents

 

The diluted EPS computation as of March 31, 2012 excludes 731,437 stock options 42,553 shares of restricted stock and 10,862,687 Sponsors and Management warrants because their inclusion would have been anti-dilutive. The diluted EPS computations as of March 31, 2011 excludes 653,837 stock options, 26,895 shares of restricted stock and 10,862,687 Sponsors and Management Warrants because their inclusion would have been anti-dilutive.

 

NOTE 3         ACQUISITION

 

On July 1, 2011, we acquired our partner’s 47.5% economic interest (represented by a 57.5% legal interest) in TWCPC Holdings, L.P., The Woodlands Operating Company, L.P. and TWLDC Holdings, L.P. (collectively referred to as “The Woodlands”) for $117.5 million. The Woodlands is located near Houston, Texas.  We made the acquisition so that we can control attractive residential and commercial future development opportunities and assets as well as to internalize The Woodlands platform to benefit our MPC business. As a result of the acquisition, we now consolidate The Woodlands operations and our condensed consolidated financial statements are therefore not comparable to prior periods. Please refer to Note 14 — Segments for a presentation of the results as if we owned 100% of The Woodlands for all periods presented. Prior to such acquisition, we accounted for The Woodlands using the equity method.

 

Pro Forma Information

 

The following pro forma information for the three months ended March 31, 2011 was prepared as if The Woodlands acquisition had occurred as of the beginning of such period:

 

 

 

Three Months
Ended March 31,

 

 

 

2011

 

 

 

(In thousands)

 

Total Revenues

 

$

90,261

 

Net loss

 

(110,590

)

 

The pro forma information reflects adjustments for (1) purchase accounting, including (a) depreciation for the step-up in basis for property, plant and equipment (b) amortization of in-place and above/below market leases (c) Land Cost of Sales increase for step-up in land basis for finished lots acquired and sold and (d) amortization of deferred financing costs, prepaid commissions and deferred profits which were eliminated and (2) adjustments for interest expense which is capitalizable in accordance with the Company’s interest capitalization policy.

 

The pro forma information is not necessarily indicative of the results that would have occurred had the acquisition occurred as of the beginning of the period presented, nor is it necessarily indicative of future results.

 

NOTE 4         IMPAIRMENT

 

The generally accepted accounting principles related to accounting for the impairment or disposal of long-lived assets require 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. The impairment analysis does not consider the timing of future cash flows and whether the asset is expected to earn an above or below market rate of return. We review our real estate assets, including operating assets, 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.

 

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Our 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. If the decrease in value of our investment in a Real Estate Affiliate is deemed to be other-than-temporary, our investment in such Real Estate Affiliate is reduced to its estimated fair value.

 

There were no impairment charges recorded for the quarters ended March 31, 2012 and 2011.

 

NOTE 5                                              FAIR VALUE OF FINANCIAL INSTRUMENTS

 

In May 2011, the FASB issued “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs”, and it is effective for fiscal years beginning after December 15, 2011. The adoption of this policy did not have an impact on our financial statements.

 

The following table presents, for each of the fair value hierarchy levels required under ASC 820, “Fair Value Measurement,” our assets and liabilities that are measured at fair value on a recurring basis.

 

 

 

March 31, 2012

 

December 31, 2011

 

 

 

Fair Value Measurements Using

 

Fair Value Measurements Using

 

 

 

Total

 

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

 

Significant
Other
Observable
Inputs
(Level 2)

 

Significant
Unobservable
Inputs
(Level 3)

 

Total

 

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

 

Significant
Other
Observable
Inputs
(Level 2)

 

Significant
Unobservable
Inputs
(Level 3)

 

 

 

(In thousands)

 

(In thousands)

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Warrants

 

$

249,615

 

$

 

$

 

$

249,615

 

$

127,764

 

$

 

$

 

$

127,764

 

Interest rate swaps

 

4,166

 

 

4,166

 

 

4,367

 

 

4,367

 

 

 

The valuation of warrants is based on an option pricing valuation model. The inputs to the model include the fair value of the stock underlying to the warrants, exercise price of the warrants, term, restrictions, expected volatility, risk-free interest rate and dividend yield.

 

The fair values of interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash payments and the discounted expected variable cash receipts and includes consideration of counterparty credit risk. The variable cash receipts are based on an expectation of future interest rates derived from observable market interest rate curves.

 

The following table presents a reconciliation of the beginning and ending balances of our warrants which are presented in the table above as a fair value measurement using significant unobservable inputs (Level 3):

 

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Table of Contents

 

 

 

(In thousands)

 

Balance as of December 31, 2011

 

$

127,764

 

Warrant liability loss

 

121,851

 

Balance as of March 31, 2012

 

$

249,615

 

 

The significant unobservable input used in the fair value measurement of our warrants designated as Level 3 is as follows:

 

 

 

Fair Value

 

Valuation
Technique

 

Unobservable
Input

 

Range
Median or
Average

 

 

 

(In thousands)

 

 

 

 

 

 

 

Warrants

 

$

249,615

 

Option Pricing Valuation Model

 

Expected Volatility (a)

 

27%-33% (29.4%)

 

 


(a) Based on the asset volatility of comparable companies.

 

The estimated fair values of the Company’s financial instruments that are not measured at fair value on a recurring basis are as follows:

 

 

 

March 31, 2012

 

December 31, 2011

 

 

 

Carrying
Amount

 

Estimated
Fair Value

 

Carrying
Amount

 

Estimated
Fair Value

 

 

 

(In thousands)

 

Fixed-rate debt

 

$

82,374

 

$

82,655

 

$

83,164

 

$

85,047

 

Variable-rate debt (a)

 

462,019

 

462,019

 

468,100

 

468,100

 

SID bonds (b)

 

53,894

 

53,894

 

55,213

 

55,213

 

Total

 

$

598,287

 

$

598,568

 

$

606,477

 

$

608,360

 

 


(a) As more fully described in Note 7, $172.0 million of variable-rate debt entered into during 2011 has been swapped to a fixed rate for the term of the related debt.

(b) Due to the uncertain repayment terms of Special Improvement District “SID” bonds, the carrying value approximates fair value.

 

The fair value of debt in the table above was estimated using Level 2 inputs based on quoted market prices for publicly traded debt, recent financing transactions, estimates of the fair value of the property that serves as collateral for such debt, historical risk premiums for loans of comparable quality, the 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, U.S. Treasury obligation interest rates and on the discounted estimated

 

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future cash payments to be made on such debt. The discount rates 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 available market information or present value techniques to estimate the amounts required to be disclosed. 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.

 

The carrying amounts of cash and cash equivalents and accounts and notes receivable approximate fair value because of the short-term maturity of these instruments.

 

NOTE 6                                              REAL ESTATE AFFILIATES

 

In the ordinary course of business, we enter into partnerships or joint ventures primarily for the development and operations of real estate assets.  These partnerships or joint ventures are typically characterized by a non-controlling ownership interest with decision making and distribution of expected gains and losses being proportionate to the ownership interest.  We account for these partnerships and joint ventures in accordance with ASC 810, as amended (“ASC 810”).

 

In accordance with ASC 810, we assess our joint ventures at inception to determine if any meet the qualifications of a variable interest entity (“VIE”). We consider a partnership or joint venture a VIE if: (a) the total equity investment is not sufficient to permit the entity to finance its activities without additional subordinated financial support; (b) characteristics of a controlling financial interest are missing (either the ability to make decisions through voting or other rights, the obligation to absorb the expected losses of the entity or the right to receive the expected residual returns of the entity); or (c) the voting rights of the equity holders are not proportional to their obligations to absorb the expected losses of the entity and/or their rights to receive the expected residual returns of the entity, and substantially all of the entity’s activities either involve or are conducted on behalf of an investor that has disproportionately few voting rights. Upon the occurrence of certain events outlined in ASC 810, we reassess our initial determination of whether the partnership or joint venture is a VIE. We also perform a qualitative assessment of each VIE to determine if we are the primary beneficiary, as required by ASC 810.

 

We account for investments in joint ventures deemed to be variable interest entities for which we are not considered to be the primary beneficiary using the equity method, and investments in joint ventures where we have virtually no influence on the joint venture’s operating and financial policies, on the cost method. Generally, the operating agreements with respect to our Real Estate Affiliates provide that assets, liabilities and funding obligations are shared in accordance with our ownership percentages.

 

The Bridges at Mint Hill, LLC, Parcel D Development, LLC, and the HHMK Development, LLC joint venture entities included in the table below are VIEs. The aggregate carrying value of the unconsolidated VIEs was $3.6 million and $3.2 million as of March 31, 2012 and December 31, 2011, respectively, and was classified as Investments in Real Estate Affiliates in the Condensed Consolidated Balance Sheet. Because these joint ventures are in the pre-development stage, there were no earnings for the three months ended March 31, 2012. We did not hold an interest in any VIEs as of or during the three months ended March 31, 2011. Our maximum exposure to loss as a result of these investments is limited to the aggregate carrying value of the investment, as we have not provided any guarantees on behalf of these VIEs. Our initial ownership in the Bridges at Mint Hill, LLC is 79.0%, and our ownership percentage could increase to 90.5% if we are required to make a $4.5 million cash contribution to the venture related to the mortgage secured land to be contributed by our partner.

 

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Below is a summary of our Investments in Real Estate Affiliates:

 

 

 

Economic Ownership

 

Carrying Value

 

Share of Earnings

 

 

 

March 31,

 

December 31,

 

March 31,

 

December 31,

 

Three months ended
March 31,

 

 

 

2012

 

2011

 

2012

 

2011

 

2012

 

2011

 

 

 

(In percentages)

 

(In thousands)

 

(In thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The Woodlands (a) 

 

 

 

 

 

$

 

$

 

$

 

$

1,619

 

Circle T

 

50.00

%

50.00

%

9,004

 

9,004

 

 

 

Millennium Waterway Apartments (b) (c) 

 

83.55

%

83.55

%

22,218

 

21,998

 

220

 

 

Woodlands Sarofim #1 (b) 

 

20.00

%

20.00

%

2,474

 

2,456

 

18

 

 

Stewart Title (b) 

 

50.00

%

50.00

%

3,552

 

3,643

 

59

 

 

Forest View/ Timbermill Apartments (b) (d) 

 

50.00

%

50.00

%

9,350

 

9,346

 

4

 

 

Bridges at Mint Hill, LLC

 

79.00

%

79.00

%

322

 

180

 

 

 

Parcel D Development, LLC

 

50.00

%

50.00

%

3,289

 

2,990

 

 

 

HHMK Development, LLC

 

50.00

%

50.00

%

 

 

 

 

 

 

 

 

 

 

50,209

 

49,617

 

301

 

1,619

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost basis investments (e) 

 

 

 

 

 

12,882

 

12,978

 

2,376

 

3,894

 

Investment in Real Estate Affiliates

 

 

 

 

 

$

63,091

 

$

62,595

 

$

2,677

 

$

5,513

 

 


(a)

As of July 1, 2011, The Woodlands is consolidated and no longer a Real Estate Affiliate (Refer to Note 3).

(b)

Equity investment owned by The Woodlands, which was a non-consolidated investment as of March 31, 2011.

(c)

On April 23, 2012, we agreed to acquire our partner’s interest in the Millennium Waterway Apartments at an implied valuation of $74.1 million for the property. The purchase is expected to close during the second quarter of 2012 upon completion of a $55.4 million ten-year agency financing.

(d)

On April 19, 2012, the joint ventures owning the Forest View and Timbermill apartments completed their sale to a third party. Our share of the distributable cash, after repayment of debt and transaction expenses, was $8.6 million. Also in April, we received approximately $0.8 million in distributions from earnings from these joint ventures.

(e)

Share of Earnings represents dividends received from Summerlin Hospital Medical Center.

 

As of March 31, 2012, approximately $59.8 million of indebtedness was secured by the properties owned by our Real Estate Affiliates in which our share was approximately $43.6 million (Millennium Waterway Apartments - $39.4 million; Woodlands Sarofim #1 - $1.4 million; and Forest View/Timbermill Apartments - $2.8 million) based upon our economic ownership. All of this debt is non-recourse to us.

 

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NOTE 7                                              MORTGAGES, NOTES AND LOANS PAYABLE

 

Mortgages, notes and loans payable are summarized as follows:

 

 

 

March 31,

 

December 31,

 

 

 

2012

 

2011

 

 

 

(In thousands)

 

Fixed-rate debt:

 

 

 

 

 

Collateralized mortgages, notes and loans payable

 

$

82,374

 

$

83,164

 

Special Improvement District bonds

 

53,894

 

55,213

 

Variable-rate debt:

 

 

 

 

 

Collateralized mortgages, notes and loans payable (a)

 

462,019

 

468,100

 

Total mortgages, notes and loans payable

 

$

598,287

 

$

606,477

 

 


(a)

As noted in the table below, $172.0 million of variable-rate debt has been swapped to a fixed rate for the term of the related debt.

 

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Table of Contents

 

The following table presents our mortgages, notes, and loans payable by property:

 

 

 

 

 

 

 

Maximum

 

Carrying Value

 

 

 

 

 

Interest

 

Facility

 

March 31,

 

December 31,

 

Property 

 

Final Maturity

 

Rate

 

Amount

 

2012

 

2011

 

 

 

 

 

 

 

 

 

(In thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

110 N. Wacker (a)

 

October 2019

 

5.21

%

 

 

$

29,000

 

$

29,000

 

 

 

 

 

 

 

 

 

 

 

 

 

Bridgeland

 

 

 

 

 

 

 

 

 

 

 

Note #1

 

May 2026

 

6.50

%

 

 

14,976

 

15,138

 

Note #2

 

December 2017

 

6.50

%

 

 

3,071

 

3,180

 

Note #3

 

June 2033

 

6.50

%

 

 

2,044

 

2,053

 

Note #4

 

December 2021

 

6.50

%

 

 

213

 

233

 

Bridgeland Total

 

 

 

 

 

 

 

20,304

 

20,604

 

 

 

 

 

 

 

 

 

 

 

 

 

Special Improvement District

 

 

 

 

 

 

 

 

 

 

 

Summerlin South - S108

 

December 2016

 

5.95

%

 

 

1,302

 

1,302

 

Summerlin South - S124

 

December 2019

 

5.95

%

 

 

378

 

378

 

Summerlin South - S128

 

December 2020

 

7.30

%

 

 

862

 

862

 

Summerlin South - S128C

 

December 2030

 

6.05

%

 

 

5,956

 

5,956

 

Summerlin South - S132

 

December 2020

 

7.88

%

 

 

5,352

 

5,378

 

Summerlin South - S151

 

June 2025

 

6.00

%

 

 

12,183

 

12,293

 

Summerlin West - S808

 

April 2021

 

5.71

%

 

 

318

 

682

 

Summerlin West - S809

 

April 2023

 

6.65

%

 

 

468

 

1,000

 

Summerlin West - S810

 

April 2031

 

7.13

%

 

 

22,483

 

22,770

 

The Shops at Summerlin Centre - S128

 

December 2030

 

6.05

%

 

 

3,829

 

3,829

 

The Shops at Summerlin Centre - S108

 

December 2016

 

5.95

%

 

 

713

 

713

 

SID Payable to Nevada Cancer Institute

 

December 2019

 

5.95

%

 

 

50

 

50

 

Special Improvement District bonds Total

 

 

 

 

 

 

 

53,894

 

55,213

 

 

 

 

 

 

 

 

 

 

 

 

 

The Woodlands

 

 

 

 

 

 

 

 

 

 

 

Master Credit Facility (b)

 

March 2015

 

5.00

%

$

270,000

 

176,703

 

183,000

 

Resort and Conference Center (c)

 

October 2013

 

6.00

%

 

 

36,100

 

36,100

 

2201 Lake Woodlands Drive

 

November 2016

 

5.25

%

 

 

4,709

 

4,803

 

Weiner Tract

 

January 2013

 

6.25

%

 

 

1,436

 

1,479

 

Land in Montgomery Co.

 

December 2012

 

6.00

%

 

 

616

 

649

 

Land in Harris Co.

 

January 2013

 

6.00

%

 

 

370

 

381

 

Capital lease obligation

 

 

2.72

%

 

 

121

 

147

 

CVS

 

upon sale

 

3.25

%

 

 

101

 

101

 

4 Waterway Square

 

December 2023

 

4.88

%

 

 

40,789

 

41,000

 

9303 New Trails

 

December 2023

 

4.88

%

 

 

13,928

 

14,000

 

3 Waterway Square (d)

 

January 2017

 

3.25

%

$

43,295

 

216

 

 

The Woodlands Total

 

 

 

 

 

 

 

275,089

 

281,660

 

 

 

 

 

 

 

 

 

 

 

 

 

Ward Centers

 

 

 

 

 

 

 

 

 

 

 

Victoria Ward (e)

 

September 2016

 

3.43

%

$

250,000

 

220,000

 

220,000

 

Ward Centers Total

 

 

 

 

 

 

 

220,000

 

220,000

 

 

 

 

 

 

 

 

 

$

598,287

 

$

606,477

 

 


(a)

Loan has a stated interest rate of one-month LIBOR + 2.25%. The $29.0 million outstanding principal balance is swapped to a 5.21% fixed rate through maturity.

(b)

Loan bears interest at one-month LIBOR + 4.00% and has a 1.00% LIBOR floor.

(c)

Loan bears interest at one-month LIBOR + 5.00% and has a 1.00% LIBOR floor. The rate increased by 0.5% on September 23, 2011 and 0.5% on March 23, 2012, and increases by 0.5% every six months thereafter until maturity.

(d)

Loan bears interest at PRIME + 2.65% for a balance up to $0.5 million. For balance over $0.5 million, loan bears interest of LIBOR + 2.65%.

(e)

Loan has a stated interest rate of one-month LIBOR + 2.50%. $143.0 million of the outstanding principal balance is swapped to a 3.81% fixed rate through maturity.

 

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The weighted average interest rate on our mortgages, notes and loans payable was 4.69% and 4.68% as of March 31, 2012 and December 31, 2011, respectively.

 

Collateralized Mortgages, Notes and Loans Payable

 

As of March 31, 2012, we had $598.3 million of collateralized mortgages, notes and loans payable. Approximately $275.1 million of the debt included in the table above is related to The Woodlands, which was consolidated on July 1, 2011. All of the debt is non-recourse and is secured by the individual properties as listed in the table above, except for The Woodlands Master Credit Facility and Resort and Conference Center Loans which are recourse to the partnerships that directly own The Woodlands operations, and a $7.0 million corporate recourse guarantee associated with the 110 N. Wacker mortgage, which is more fully discussed below. The Bridgeland MPC loan is secured by approximately 7,164 acres of land within the Bridgeland MPC and a security interest in its Municipal Utility District receivables. In addition, certain of our loans contain provisions which grant the lender a security interest in the operating cash flow of the property that represents the collateral for the loan.  Such provisions are not expected to impact our operations in 2012.  Certain mortgage notes may be prepaid, but may be subject to a prepayment penalty equal to a yield-maintenance premium, defeasance or a percentage of the loan balance.

 

The Woodlands Master Credit Facility is a $270.0 million facility consisting of a $170.0 million term loan and a $100.0 million revolving credit line (together, the “TWL Facility”). As of March 31, 2012, the TWL Facility had an outstanding balance of $176.7 million. The TWL Facility bears interest at one-month LIBOR plus 4.0% with a 1.0% LIBOR floor, has a March 29, 2014 initial maturity date and a one-year extension at borrower’s option. The TWL Facility also contains certain restrictions or covenants that, among other things, require the maintenance of specified financial ratios, restrict the incurrence of additional indebtedness at The Woodlands, and limit distributions from The Woodlands to us.  Until The Woodlands leverage, as defined by the credit agreement, is less than a 40.0% loan to value ratio, we must amortize the debt on a dollar for dollar basis for any distributions that we make from The Woodlands.  We have not distributed and do not currently intend to distribute cash from The Woodlands; therefore, this distribution provision has had no impact on us. As of March 31, 2012, leverage was approximately 44.6%. There was $19.9 million of undrawn and available borrowing capacity under the TWL Facility based on the collateral underlying the facility and covenants as of March 31, 2012. The TWL Facility also requires mandatory principal amortization payments during its initial term and during the extension period, if exercised.  Repayments of $25.0 million and $30.0 million are required on March 29 of 2013 and, if extended, 2014, respectively. Furthermore, $10.0 million is due on each of June 29, September 29 and December 29, 2014 during the extension period.

 

The Woodlands Resort and Conference Center loan has a $36.1 million outstanding balance as of March 31, 2012 matures on October 30, 2012 and may be extended for one year at our option. The loan bears interest at one-month LIBOR plus 5.0% as of March 31, 2012 and has a 1.0% LIBOR floor. The interest rate increased by 0.5% on September 23, 2011 and 0.5% on March 23, 2012, and increases by 0.5% every six months thereafter until maturity. The loan is secured by a 440-room and 40-acre conference center and resort located within The Woodlands, and requires the maintenance of specified financial ratios.

 

On February 2, 2012, we secured non-recourse financing totaling $43.3 million for 3 Waterway Square. Proceeds will be used to construct an eleven-story, 232,774-square foot office building in The Woodlands. The loan matures on January 31, 2015 and has two one-year extension options. The loan bears interest at LIBOR plus 2.65%.

 

On December 5, 2011, we secured a $41.0 million loan for 4 Waterway Square and a $14.0 million loan for 9303 New Trails. The non-recourse mortgages mature on December 11, 2023 and have fixed interest rates of 4.88%.

 

On September 30, 2011, the Company closed on a $250.0 million first mortgage financing secured by the Ward Centers in Honolulu, Hawaii, that bears interest at LIBOR plus 2.50%.  The loan matures on September 29, 2016, and $143.0 million of the principal balance was swapped to a 3.81% fixed rate for the term of the loan.  The loan may be drawn to a maximum $250.0 million to fund capital expenditures at the property, provided that the outstanding principal balance cannot exceed 65.0% of the property’s appraised value and the borrowers are required to have a minimum 10.0% debt yield in order to draw additional loan proceeds under the facility.  The loan also permits partial repayment during its term in connection with property releases for development.

 

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On May 10, 2011, the Company closed a $29.0 million first mortgage financing secured by its office building located at 110 N. Wacker Drive in Chicago, Illinois and bearing interest at LIBOR plus 2.25%. At closing, the interest rate on the loan was swapped to a 5.21% fixed rate for the term of the loan. The loan matures on October 31, 2019 and its term is coterminous with the expiration of the first term of the existing tenant’s lease. The loan has an interest-only period through April 2015 and, thereafter, amortizes ratably to $12.0 million through maturity. The Company provided a $7.0 million repayment guarantee for the loan, which is reduced on a dollar for dollar basis during the amortization period.

 

On April 26, 2012, we closed on a 10 year, fixed rate loan with interest at 4.79% secured by 20/25 Waterway Avenue. The proceeds from the loan were $13.6 million.

 

As of March 31, 2012, $1.1 billion of land, buildings and equipment and developments in progress (before accumulated depreciation) have been pledged as collateral for our mortgages, notes and loans payable of which $7.0 million is recourse to HHC.

 

Special Improvement District Bonds

 

The Summerlin master planned community uses Special Improvement District bonds to finance certain common infrastructure.  These bonds are issued by the municipalities and, although unrated, are secured by the assessments on the land and included in mortgages, notes and loan payable on the condensed consolidated balance sheets.  They are tax exempt to the holders of the notes for federal income tax purposes.  The majority of proceeds from each bond issued is held in a construction escrow and dispersed to us as infrastructure projects are completed, inspected by the municipalities and approved for reimbursement and, accordingly, the unspent proceeds of the Special Improvement District bonds have been classified as a receivable. The Summerlin master planned community pays the debt service on the bonds semi-annually, but receives reimbursement of all principal paid from most of the purchasers of its land; therefore, the asset and liability balances relating to the Special Improvement District bonds offset.  In addition, as Summerlin sells land, the purchasers assume a proportionate share of the bond obligation.

 

As of March 31, 2012, the Company was in compliance with all of the financial covenants related to its debt agreements.

 

NOTE 8                                              DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

 

We are primarily exposed to interest rate risks related to our variable interest debt, and we seek to manage this risk by utilizing interest rate derivatives. Our objectives in using interest rate derivatives are to add stability to interest costs by reducing our exposure to interest rate movements.  To accomplish this objective and predictability, we primarily use interest rate swaps and caps as part of our interest rate risk management strategy.  Interest rate swaps designated as cash flow hedges involve the receipt of variable amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. Interest rate caps designated as cash flow hedges involve the receipt of variable amounts from a counterparty if interest rates rise above the strike rate on the contract in exchange for an up-front premium.

 

The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in Accumulated Other Comprehensive Income (“AOCI”) and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. The outstanding derivatives at March 31, 2012 were used to hedge the variable cash flows associated with existing variable-rate debt. The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings. During the three months ended March 31, 2012, the amount of ineffectiveness recorded in earnings was insignificant.

 

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Amounts reported in AOCI related to derivatives will be reclassified to interest expense as interest payments are made on our variable-rate debt. Over the next 12 months, we estimate that an additional $2.2 million will be reclassified as an increase to interest expense.

 

As of March 31, 2012, the Company had gross notional amounts of $172.0 million of interest rate swaps and a $100.0 million interest rate cap that were designated as cash flow hedges of interest risk. The fair value of the interest rate cap derivative was insignificant.

 

The table below presents the fair value of the Company’s derivative financial instruments which are included in accounts payable and accrued liabilities in the Condensed Consolidated Balance Sheets:

 

 

 

March 31,

 

December 31,

 

 

 

2012

 

2011

 

 

 

Fair Value

 

Fair Value

 

 

 

(In thousands)

 

 

 

 

 

 

 

Interest Rate Swaps

 

$

(4,166

)

$

(4,367

)

Total derivatives designated as hedging instruments

 

$

(4,166

)

$

(4,367

)

 

The table below presents the effect of the Company’s derivative financial instruments on the Condensed Consolidated Income Statement:

`

 

 

Three months ended March 31,

 

 

 

Three months ended March 31,

 

 

 

2012

 

2011

 

 

 

2012

 

2011

 

Cash Flow Hedges

 

Amount of (Loss)
Recognized in
OCI

 

Amount of Gain
(Loss) Recognized in
OCI

 

Location of Gain
(Loss) Reclassified
from Accumulated
OCI into Earnings

 

Amount of (Loss)
Reclassified from
Accumulated OCI into
Earnings

 

Amount of Gain or
(Loss) Reclassified
from Accumulated
OCI into Earnings

 

 

 

(In thousands)

 

 

 

(In thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest Rate Swaps

 

$

(391

)

$

 

Interest Expense

 

$

(493

)

$

 

 

 

$

(391

)

$

 

 

 

$

(493

)

$

 

 

NOTE 9               INCOME TAXES

 

We are taxed as a C corporation.  One of our consolidated entities, Victoria Ward, Limited (“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.  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 2011, and presently we intend to continue to operate Ward as a REIT.

 

As a REIT, Ward is ordinarily not subject to income taxes; however, Ward is required to make annual distributions to its stockholders, and the stockholders are taxed on these distributions.

 

Realization of a deferred tax benefit is dependent upon generating sufficient taxable income in future periods. Our net operating loss carry-forwards are currently scheduled to expire in subsequent years through 2032. Some of the net operating loss carry-forward amounts are subject to annual limitations under Section 382 of the Code. This annual limitation under Section 382 is subject to modification if a taxpayer recognizes what are called ‘‘built-in

 

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gain items.” It is possible that we could, in the future, experience a change in control pursuant to Section 382 that could put additional limits on the benefit of deferred tax assets.

 

As described in the Annual Report, pursuant to the Tax Matters Agreement, GGP has indemnified us from and against 93.75% of any and all losses, claims, damages, liabilities and reasonable expenses to which we become subject (the “Tax Indemnity Cap”), in each case solely to the extent directly 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 $303.8 million, plus interest and penalties related to these amounts so long as GGP controls the action in the Tax Court related to the dispute with the IRS.  The unrecognized tax benefits and related accrued interest recorded through March 31, 2012 are primarily related to the taxes that are the subject of the Tax Indemnity Cap. We have recorded interest income receivable on the tax indemnity receivable in the amounts of $30.2 million and $28.0 million as of March 31, 2012 and December 31, 2011, respectively.

 

On May 6, 2011, GGP filed Tax Court petitions on behalf of the two former taxable REIT subsidiaries of GGP seeking a redetermination of federal income tax for the years 2007 and 2008. The petitions seek to overturn determinations by the IRS that the taxpayers were liable for combined deficiencies totaling $144.1 million. On October 20, 2011, GGP filed a motion in the United States Tax Court to consolidate the cases of the two former taxable REIT subsidiaries of GGP subject to litigation with the Internal Revenue Service due to the common nature of the cases’ facts and circumstances and the issues being litigated. The United States Tax Court granted the motion to consolidate. The litigation is currently in the discovery phase.

 

Unrecognized tax benefits recorded pursuant to uncertain tax positions were $101.4 million as of March 31, 2012 and December 31, 2011, excluding interest, none of which would impact our effective tax rate. Accrued interest related to these unrecognized tax benefits amounted to $30.5 million as of March 31, 2012 and $28.5 million as of December 31, 2011. We recognized an increase in interest expense related to the unrecognized tax benefits of $2.0 million for the three months ended March 31, 2012. Based on the expected outcome of existing examinations or examinations that may commence, or as a result of the expiration of the statute of limitations for specific jurisdictions, management does not believe that the unrecognized tax benefits, excluding accrued interest, for tax positions taken regarding previously filed tax returns will materially increase or decrease during the next twelve months.

 

NOTE 10               STOCK-BASED PLANS

 

Our stock based plans are described, and informational disclosures provided, in the notes to the Consolidated Financial Statements included in the Form 10-K for the year ended December 31, 2011. The following table summarizes our stock option plan activity:

 

 

 

Stock
Options

 

Weighted Average
Exercise Price

 

Stock Options Outstanding at December 31, 2011

 

712,640

 

$

57.72

 

Granted

 

30,000

 

64.14

 

Forfeited

 

(13,700

)

62.55

 

Stock Options Outstanding at March 31, 2012

 

728,940

 

$

57.89

 

 

Options granted vest ratably over five years and expire ten years after the grant date and generally do not become exercisable until 2017.

 

During the first three months of 2012, there were no restricted common stock shares awarded, and as of March 31, 2012, 42,553 restricted common stock shares remained outstanding.

 

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NOTE 11                                       OTHER ASSETS AND LIABILITIES

 

Prepaid Expenses and Other Assets

 

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

 

 

 

March 31,

 

December 31,

 

 

 

2012

 

2011

 

 

 

(In thousands)

 

Special Improvement District receivables

 

$

40,696

 

$

40,580

 

Other receivables

 

4,178

 

4,181

 

Federal income tax receivable

 

5,401

 

5,393

 

Prepaid expenses

 

7,995

 

6,507

 

Below-market ground leases

 

20,595

 

20,680

 

Security and escrow deposits

 

18,585

 

17,266

 

Above-market tenant leases

 

1,114

 

1,014

 

Uncertain tax position asset

 

12,633

 

11,935

 

In-place leases

 

11,411

 

11,865

 

Intangibles

 

3,000

 

3,074

 

Other

 

5,011

 

4,661

 

 

 

$

130,619

 

$

127,156

 

 

Accounts Payable and Accrued Expenses

 

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

 

 

 

March 31,
2012

 

December 31,
2011

 

 

 

(In thousands)

 

Construction payable

 

$

8,194

 

$

8,923

 

Accounts payable and accrued expenses

 

37,035

 

45,078

 

Membership deposits

 

17,028

 

16,033

 

Above-market ground leases

 

2,709

 

2,748

 

Deferred gains/income

 

8,450

 

5,739

 

Accrued interest

 

2,493

 

2,747

 

Accrued real estate taxes

 

4,695

 

3,439

 

Tenant and other deposits

 

6,401

 

5,966

 

Insurance reserve

 

4,025

 

4,728

 

Accrued payroll and other employee liabilities

 

5,063

 

9,658

 

Interest rate swap

 

4,166

 

4,367

 

Other

 

13,685

 

15,978

 

 

 

$

113,944

 

$

125,404

 

 

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NOTE 12                                       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 effect on our consolidated financial position, results of operations or liquidity.

 

We had outstanding letters of credit and surety bonds of $36.1 million as of March 31, 2012 and $41.6 million as of December 31, 2011. These letters of credit and bonds were issued primarily in connection with insurance requirements, special real estate assessments and construction obligations.

 

On December 12, 2011, we entered into a non-binding Letter of Intent (“LOI”) with the New York City Economic Development Corporation (“EDC”) which will enable us to pursue redevelopment plans for the South Street Seaport.  The EDC is the ground lessor and the LOI describes the business terms of future amendments to the ground lease, the first of which must be finalized by June 30, 2012. During the earlier of the construction period and 30 months, we will be entitled to a total $1.5 million rent reduction.  We also must provide a completion guarantee to New York City for the project. We agreed to pay approximately $1.1 million of esplanade maintenance costs over a five-year period as consideration for entering into the LOI.  This obligation will continue to exist regardless of whether the ground lease is amended.

 

See Note 9 for our obligations related to uncertain tax positions for disclosure of additional contingencies.

 

NOTE 13                                       TRANSACTIONS WITH GGP AND WITH RELATED PARTIES

 

Prior to the Effective Date, we entered into a transition services agreement (the “TSA”) whereby GGP agreed to

 

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provide to us, on a transitional basis, certain specified services on an interim basis for various terms not exceeding 24 months following the Separation, subject to our right of earlier termination. Concurrently, we entered into a Reverse Transition Services Agreement (“RTSA”) whereby we agreed to provide GGP with certain income tax and accounting support services, also subject to earlier termination prior to its scheduled expiration of November 9, 2013. We incurred $0.2 million of expenses related to the TSA and we received negligible reimbursements under the RTSA for the three months ended March 31, 2011. No services have been provided under the TSA and RTSA for the three months ended March 31, 2012, and we do not expect to provide or incur any services in the future.

 

In addition, GGP is the sole tenant at our 110 N. Wacker office property.  Under the 110 N. Wacker lease agreement, we recognized approximately $1.5 million of rental income from GGP and its subsidiaries for both the three months ended March 31, 2012 and 2011.

 

In January 2011, we entered into a Transition Agreement with TPMC Realty Services Group, Inc. (“TPMC”). David Weinreb, a director and our CEO, is the sole equity owner and the chief executive officer of TPMC and Grant Herlitz, our president, is the president of TPMC. The Transition Agreement provided for, among other things, certain mutual transactions and services that facilitated the continuity of Company management, the net value of which were not material for the three months ended March 31, 2011. Additionally, reflected in our general and administrative expense for the three months ended March 31, 2011 are reimbursements to TPMC of $0.9 million related to Mr. Weinreb’s employment agreement with us.

 

We also entered into a lease agreement for 3,253 square feet of office space in Los Angeles, California with an affiliate of TPMC, which commenced on May 1, 2011. Annual rental expense relating to the lease is approximately $111,965 per year and the lease expires in July 2016.

 

On January 31, 2011, we terminated a Management Services Agreement with Brookfield Advisors LP. Pursuant to the agreement which was executed on August 6, 2010. Brookfield Advisors LP provided us services that included strategic advice, project development oversight, financial planning, financing consultation, internal controls expertise and community and investor relations. This agreement provided for payments to Brookfield Advisors LP of $0.5 million per month.

 

NOTE 14                                       SEGMENTS

 

We have three business segments which offer different products and services. Our three segments are managed separately because each requires different operating strategies or management expertise and are reflective of our current management’s operating philosophies and methods. In addition, our current segments or assets within such segments could change in the future as development of certain properties commences or other operational or management changes occur. We do not distinguish or group our combined operations on a geographic basis. Furthermore, all operations are within the United States and no customer or tenant comprises more than 10% of revenues. Our reportable segments are as follows:

 

·                  Master Planned Communities — includes the development and sale of land, in large-scale, long-term community development projects in and around Las Vegas, Nevada; Houston, Texas; and Columbia, Maryland. In periods prior to July 1, 2011, this segment included certain commercial properties and other ownership interests owned by The Woodlands, and we had presented The Woodlands operations at our 52.5% proportionate economic share for segment reporting.  Beginning July 1, 2011 when we acquired our partner’s 47.5% economic interest in The Woodlands, for segment reporting, we also presented The Woodlands historical financial information at 100% so that operating performance between periods is comparable.

·                  Operating Assets — includes commercial, mixed-use and retail properties currently generating revenues, many of which we believe there is an opportunity to redevelop or reposition the asset to increase operating performance.

·                  Strategic Developments — 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.

 

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Table of Contents

 

The assets included in each segment as of March 31, 2012, are contained in the following chart:

 

 


* An equity or cost method investment

 

As our segments are managed separately, different operating measures are utilized to assess operating results and allocate resources. The one common operating measure used to assess operating results for the business segments is Real Estate Property Earnings Before Taxes (“REP EBT”) which represents the operating revenues of the properties less property operating expenses, as further described below. Management believes that REP EBT provides useful information about the operating performance of all of our assets, projects and property.

 

REP EBT, as it relates to our business, is defined as net income (loss) from continuing operations excluding general and administrative expenses, corporate interest income and depreciation expense, benefit from income taxes, warrant liability gain (loss) and the effects of the previously mentioned items within our equity in earnings (loss) from Real Estate Affiliates. We present REP EBT because we use this measure, among others, internally to assess the core operating performance of our assets. We also present this measure because we believe certain investors use it as a measure of a company’s historical operating performance and its ability to service and incur debt. We believe that the inclusion of certain adjustments to net income (loss) from continuing operations to calculate REP EBT is appropriate to provide additional information to investors because REP EBT excludes certain non-recurring and non-cash items, which we believe are not indicative of our core operating performance. REP EBT should not be considered as an alternative to GAAP net income (loss) attributable to common stockholders or GAAP net income (loss) from continuing operations, it has limitations as an analytical tool, and should not be considered in isolation, or as a substitute for analysis of our results as reported under GAAP.

 

As more fully discussed in this report, on July 1, 2011, we acquired our partner’s interest in The Woodlands’ master planned community. We now own 100% of The Woodlands and consolidate its operations. As such, The Woodlands operating results for historical periods when this investment was a Real Estate Affiliate are now analyzed internally on a non-GAAP consolidation basis by management in order to provide management comparability between periods for analyzing operating results. Segment information presented herein has also been restated for the three months ended March 31, 2011, to reflect The Woodlands on a consolidation basis and provide comparability for all periods. Prior to July 1, 2011, we had presented the operations of our equity method Real Estate Affiliates using the non-GAAP proportionate share method for segment reporting purposes. Under this method, we had presented our share of the revenues and expenses of

 

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these Real Estate Affiliates aggregated with the revenues and expenses of consolidated or combined properties. We previously reported the proportionate method because our 52.5% economic interest in The Woodlands represented a significant portion of our Master Planned Community segment. The remaining Real Estate Affiliates, including equity investments owned by The Woodlands, primarily represent entities that own single assets rather than a large business such as The Woodlands; therefore, we no longer use the proportionate share method for any Real Estate Affiliates. Rather, we account for the results of our Real Estate Affiliates other than The Woodlands using the equity or cost method, as appropriate.

 

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Segment operating results are as follows:

 

 

 

Three Months Ended March 31, 2012

 

 

 

Consolidated
Properties

 

Real Estate
Affiliates

 

Segment
Basis

 

 

 

(In thousands)

 

Master Planned Communities

 

 

 

 

 

 

 

Land sales

 

$

36,089

 

$

 

$

36,089

 

Builder price participation

 

813

 

 

813

 

Minimum rents

 

132

 

 

132

 

Other land revenues

 

3,485

 

 

3,485

 

Other rental and property revenues

 

16

 

 

16

 

Total revenues

 

40,535

 

 

40,535

 

Cost of sales - land

 

18,679

 

 

18,679

 

Land sales operations

 

7,489

 

 

7,489

 

Land sales real estate and business taxes

 

2,085

 

 

2,085

 

Rental property maintenance costs

 

4

 

 

4

 

Depreciation and amortization

 

2

 

 

2

 

Interest income

 

(70

)

 

(70

)

Interest expense (1)

 

(3,414

)

 

(3,414

)

Total expenses

 

24,775

 

 

24,775

 

MPC EBT

 

15,760

 

 

15,760

 

 

 

 

 

 

 

 

 

Operating Assets

 

 

 

 

 

 

 

Minimum rents

 

18,522

 

 

18,522

 

Tenant recoveries

 

5,830

 

 

5,830

 

Resort and conference center revenues

 

9,657

 

 

9,657

 

Other rental and property revenues

 

4,726

 

 

4,726

 

Total revenues

 

38,735

 

 

38,735

 

Rental property real estate taxes

 

2,619

 

 

2,619

 

Rental property maintenance costs

 

1,858

 

 

1,858

 

Resort and conference center operations

 

7,414

 

 

7,414

 

Other property operating costs

 

13,774

 

 

13,774

 

Depreciation and amortization

 

4,857

 

 

4,857

 

Interest income

 

(45

)

 

(45

)

Interest expense

 

3,346

 

 

3,346

 

Equity in Earnings from Real Estate Affiliates (2)

 

 

(2,677

)

(2,677

)

Total expenses

 

33,823

 

(2,677

)

31,146

 

Operating Assets EBT

 

4,912

 

2,677

 

7,589

 

 

 

 

 

 

 

 

 

Strategic Developments

 

 

 

 

 

 

 

Minimum rents

 

243

 

 

243

 

Tenant recoveries

 

34

 

 

34

 

Overage rent revenue

 

52

 

 

52

 

Condominium unit sales

 

134

 

 

134

 

Other land revenue

 

32

 

 

32

 

Total revenues

 

495

 

 

495

 

 

 

 

 

 

 

 

 

Condominium sales operations

 

117

 

 

117

 

Real estate taxes

 

1,219

 

 

1,219

 

Rental property maintenance costs

 

115

 

 

115

 

Other property operating costs

 

408

 

 

408

 

Depreciation and amortization

 

59

 

 

59

 

Interest expense

 

74

 

 

74

 

Total expenses

 

1,992

 

 

1,992

 

Strategic Developments EBT

 

(1,497

)

 

(1,497

)

REP EBT

 

$

19,175

 

$

2,677

 

$

21,852

 

 


(1) Negative interest expense relates to interest capitalized on debt assigned to our Operating Assets Segment.

(2) Includes the $2.4 million cash distribution from Summerlin Hospital Medical Center which is a Real Estate Affiliate accounted for using the cost method as described above.

 

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Table of Contents

 

 

 

Three Months Ended March 31, 2011

 

 

 

Consolidated
Properties

 

Real Estate
Affiliates

 

Segment
Basis

 

 

 

(In thousands)

 

Master Planned Communities

 

 

 

 

 

 

 

Land sales

 

$

23,392

 

$

21,408

 

$

44,800

 

Builder price participation

 

521

 

565

 

1,086

 

Minimum rents

 

 

7

 

7

 

Other land revenues

 

1,247

 

1,680

 

2,927

 

Total revenues

 

25,160

 

23,660

 

48,820

 

Cost of sales - land

 

15,436

 

11,490

 

26,926

 

Land sales operations

 

4,241

 

1,822

 

6,063

 

Land sales real estate and business taxes

 

1,511

 

1,007

 

2,518

 

Depreciation and amortization

 

 

23

 

23

 

Interest income

 

(1,165

)

(186

)

(1,351

)

Interest expense (1)

 

(2,526

)

(877

)

(3,403

)

Total expenses

 

17,497

 

13,279

 

30,776

 

Venture partner share of The Woodlands EBT

 

 

(4,931

)

(4,931

)

MPC EBT

 

7,663

 

5,450

 

13,113

 

 

 

 

 

 

 

 

 

Operating Assets

 

 

 

 

 

 

 

Minimum rents

 

16,507

 

1,400

 

17,907

 

Tenant recoveries

 

4,482

 

569

 

5,051

 

Resort and conference center revenues

 

 

8,665

 

8,665

 

Other rental and property revenues

 

1,899

 

2,866

 

4,765

 

Total revenues

 

22,888

 

13,500

 

36,388

 

Rental property real estate taxes

 

2,488

 

487

 

2,975

 

Rental property maintenance costs

 

1,356

 

131

 

1,487

 

Resort and conference center operations

 

 

6,701

 

6,701