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, 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.  xYes  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
(Do not check if a smaller reporting company)

 

Smaller reporting company o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  o Yes  x No

 

The number of shares of common stock, $0.01 par value, outstanding as of November 5, 2012 was 37,973,640.

 

 

 



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 September 30, 2012 and December 31, 2011

3

 

 

 

 

Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2012 and 2011

4

 

 

 

 

Condensed Consolidated Statements of Comprehensive Income (Loss) for the three and nine months ended September 30, 2012 and 2011

5

 

 

 

 

Condensed Consolidated Statements of Equity for the nine months ended September 30, 2012 and 2011

6

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 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

33

 

 

 

 

Item 3: Quantitative and Qualitative Disclosures about Market Risk Operations

52

 

 

 

 

Item 4: Controls and Procedures

53

 

 

 

PART II

OTHER INFORMATION

 

 

 

 

 

Item 1: Legal Proceedings

53

 

 

 

 

Item 1A: Risk Factors

53

 

 

 

 

Item 6: Exhibits

53

 

 

 

 

SIGNATURE

54

 

 

 

 

EXHIBIT INDEX

55

 



Table of Contents

 

THE HOWARD HUGHES CORPORATION

 

CONDENSED CONSOLIDATED BALANCE SHEETS

 

UNAUDITED

 

 

 

September 30,

 

December 31,

 

 

 

2012

 

2011

 

 

 

(In thousands, except share amounts)

 

Assets:

 

 

 

 

 

Investment in real estate:

 

 

 

 

 

Master Planned Community assets

 

$

1,585,514

 

$

1,602,437

 

Land

 

253,867

 

236,363

 

Buildings and equipment

 

646,459

 

556,786

 

Less: accumulated depreciation

 

(106,387

)

(92,494

)

Developments in progress

 

224,370

 

195,034

 

Net property and equipment

 

2,603,823

 

2,498,126

 

Investment in Real Estate Affiliates

 

36,162

 

62,595

 

Net investment in real estate

 

2,639,985

 

2,560,721

 

Cash and cash equivalents

 

272,854

 

227,566

 

Accounts receivable, net

 

13,425

 

15,644

 

Municipal Utility District receivables, net

 

105,487

 

86,599

 

Notes receivable, net

 

28,677

 

35,354

 

Tax indemnity receivable, including interest

 

326,150

 

331,771

 

Deferred expenses, net

 

12,740

 

10,338

 

Prepaid expenses and other assets, net

 

124,752

 

127,156

 

Total assets

 

$

3,524,070

 

$

3,395,149

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

Mortgages, notes and loans payable

 

$

683,804

 

$

606,477

 

Deferred tax liabilities

 

75,538

 

75,966

 

Warrant liabilities

 

290,488

 

127,764

 

Uncertain tax position liability

 

135,468

 

129,939

 

Accounts payable and accrued expenses

 

136,760

 

125,404

 

Total liabilities

 

1,322,058

 

1,065,550

 

 

 

 

 

 

 

Commitments and Contingencies (see Note 13)

 

 

 

 

 

 

 

 

 

 

 

Equity:

 

 

 

 

 

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

 

 

 

Common stock: $.01 par value; 150,000,000 shares authorized, 37,973,640 shares issued and outstanding as of September 30, 2012 and 37,945,707 shares issued and outstanding as of December 31, 2011

 

379

 

379

 

Additional paid-in capital

 

2,714,258

 

2,711,109

 

Accumulated deficit

 

(508,686

)

(381,325

)

Accumulated other comprehensive loss

 

(9,590

)

(5,578

)

Total stockholders’ equity

 

2,196,361

 

2,324,585

 

Noncontrolling interests

 

5,651

 

5,014

 

Total equity

 

2,202,012

 

2,329,599

 

Total liabilities and equity

 

$

3,524,070

 

$

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 September 30,

 

Nine Months Ended September 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

 

 

(In thousands, except per share amounts)

 

Revenues:

 

 

 

 

 

 

 

 

 

Master Planned Community land sales

 

$

40,218

 

$

34,152

 

$

120,235

 

$

75,692

 

Builder price participation

 

1,867

 

1,233

 

4,208

 

2,351

 

Minimum rents

 

23,135

 

19,403

 

62,609

 

53,098

 

Tenant recoveries

 

6,065

 

5,398

 

17,932

 

14,537

 

Condominium unit sales

 

 

9,071

 

267

 

19,495

 

Resort and conference center revenues

 

8,328

 

7,200

 

29,954

 

7,200

 

Other land revenues

 

6,385

 

5,537

 

13,433

 

9,093

 

Other rental and property revenues

 

8,817

 

4,679

 

19,879

 

9,130

 

Total revenues

 

94,815

 

86,673

 

268,517

 

190,596

 

Expenses:

 

 

 

 

 

 

 

 

 

Master Planned Community cost of sales

 

21,439

 

27,033

 

63,096

 

51,907

 

Master Planned Community operations

 

9,936

 

10,734

 

30,962

 

22,313

 

Rental property real estate taxes

 

3,574

 

2,010

 

10,583

 

7,793

 

Rental property maintenance costs

 

2,263

 

2,155

 

6,304

 

5,278

 

Other property operating costs

 

16,933

 

14,961

 

46,306

 

34,413

 

Condominium unit cost of sales

 

 

5,470

 

96

 

13,722

 

Resort and conference center operations

 

6,965

 

6,352

 

21,750

 

6,352

 

Provision for (recovery of) doubtful accounts

 

240

 

(141

)

285

 

174

 

General and administrative

 

9,339

 

8,673

 

25,896

 

21,156

 

Depreciation and amortization

 

6,764

 

7,208

 

17,715

 

13,592

 

Total expenses

 

77,453

 

84,455

 

222,993

 

176,700

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

17,362

 

2,218

 

45,524

 

13,896

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

2,375

 

2,341

 

7,048

 

7,097

 

Interest expense

 

(445

)

 

(646

)

 

Early extinguishment of debt

 

 

(11,305

)

 

(11,305

)

Warrant liability gain (loss)

 

(64,303

)

169,897

 

(162,724

)

100,762

 

Reduction in tax indemnity receivable

 

(2,873

)

 

(11,655

)

 

Investment in Real Estate Affiliate basis adjustment

 

 

(6,053

)

 

(6,053

)

Equity in earnings from Real Estate Affiliates

 

310

 

166

 

3,432

 

7,787

 

Income (loss) before taxes

 

(47,574

)

157,264

 

(119,021

)

112,184

 

Provision (benefit) for income taxes

 

2,618

 

(7,760

)

7,703

 

(4,344

)

Net income (loss)

 

(50,192

)

165,024

 

(126,724

)

116,528

 

Net income (loss) attributable to noncontrolling interests

 

781

 

(729

)

(637

)

(777

)

Net income (loss) attributable to common stockholders

 

$

(49,411

)

$

164,295

 

$

(127,361

)

$

115,751

 

 

 

 

 

 

 

 

 

 

 

Basic income (loss) per share:

 

$

(1.30

)

$

4.33

 

$

(3.36

)

$

3.05

 

 

 

 

 

 

 

 

 

 

 

Diluted income (loss) per share:

 

$

(1.30

)

$

(0.14

)

$

(3.36

)

$

0.38

 

 

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 September 30,

 

Nine Months Ended September 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

 

 

(In thousands)

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income (loss), net of tax:

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

(50,192

)

$

165,024

 

$

(126,724

)

$

116,528

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

Interest rate swaps (a)

 

(954

)

(2,024

)

(3,115

)

(2,772

)

Capitalized swap interest (b)

 

(328

)

 

(897

)

 

Other comprehensive loss

 

(1,282

)

(2,024

)

(4,012

)

(2,772

)

Comprehensive income (loss)

 

(51,474

)

163,000

 

(130,736

)

113,756

 

Comprehensive income (loss) attributable to noncontrolling interests

 

781

 

(729

)

(637

)

(777

)

Comprehensive income (loss) attributable to common stockholders

 

$

(50,693

)

$

162,271

 

$

(131,373

)

$

112,979

 

 


(a)         Net of deferred taxes of $1.1 million during both the three and nine months ended September 30, 2011. Net of deferred taxes of $ 0.1 million and $ 0.2 million during the three and nine months ended September 30, 2012, respectively.

(b)         Net of deferred taxes of $ 0.2 million and $0.5 million during the three and nine months ended September 30, 2012, respectively.

 

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)

 

 

 

 

 

115,751

 

 

777

 

116,528

 

Adjustment to noncontrolling interests

 

 

 

 

 

 

 

3,700

 

3,700

 

Acquisitions

 

 

 

 

 

 

 

(248

)

(248

)

Interest rate swaps, net of tax $1,100

 

 

 

 

 

 

(2,772

)

 

(2,772

)

Stock plan activity

 

37,601

 

 

2,500

 

 

 

 

2,500

 

Balance, September 30, 2011

 

37,942,107

 

$

379

 

$

2,710,536

 

$

(412,754

)

$

(4,399

)

$

5,053

 

$

2,298,815

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance January 1, 2012

 

37,945,707

 

$

379

 

$

2,711,109

 

$

(381,325

)

$

(5,578

)

$

5,014

 

$

2,329,599

 

Net income (loss)

 

 

 

 

 

(127,361

)

 

637

 

(126,724

)

Interest rate swaps, net of tax $212

 

 

 

 

 

 

(3,115

)

 

(3,115

)

Capitalized swap interest, net of tax $523

 

 

 

 

 

 

(897

)

 

(897

)

Stock plan activity

 

27,933

 

 

3,149

 

 

 

 

3,149

 

Balance, September 30, 2012

 

37,973,640

 

$

379

 

$

2,714,258

 

$

(508,686

)

$

(9,590

)

$

5,651

 

$

2,202,012

 

 

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

 

 

 

Nine Months Ended
September 30,

 

 

 

2012

 

2011

 

 

 

(In thousands)

 

Cash Flows from Operating Activities:

 

 

 

 

 

Net income (loss)

 

$

(126,724

)

$

116,528

 

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

 

 

 

 

 

Reduction in tax indemnity receivable

 

11,655

 

 

Equity in earnings (loss) from Real Estate Affiliates, net of distributions

 

14

 

(3,693

)

Investment in Real Estate Affiliate basis adjustment

 

 

6,053

 

Provision for doubtful accounts

 

285

 

174

 

Depreciation

 

14,062

 

11,235

 

Amortization

 

3,653

 

2,357

 

Amortization of deferred financing costs and debt market rate adjustments, net

 

(49

)

393

 

Amortization of intangibles other than in-place leases

 

(263

)

(1,205

)

Straight-line rent amortization

 

(379

)

(1,223

)

Deferred income taxes

 

6,454

 

(4,730

)

Restricted stock and stock option amortization

 

3,149

 

2,500

 

Warrant liability loss (gain)

 

162,724

 

(100,762

)

Master Planned Community and condominium development expenditures

 

(72,741

)

(65,813

)

Master Planned Community and condominium cost of sales

 

60,407

 

65,359

 

Net changes:

 

 

 

 

 

Accounts and notes receivable

 

13,284

 

(1,822

)

Prepaid expenses and other assets

 

1,168

 

(3,463

)

Deferred expenses

 

(2,377

)

(872

)

Accounts payable and accrued expenses

 

(15,341

)

2,393

 

Other, net

 

279

 

(1,457

)

Cash provided by operating activities

 

59,260

 

21,952

 

 

 

 

 

 

 

Cash Flows from Investing Activities:

 

 

 

 

 

Real estate and property expenditures

 

(36,815

)

(25,015

)

Cash acquired from The Woodlands acquisition, net of cash consideration

 

 

5,493

 

Reimbursement for infrastructure improvements from municipality

 

 

5,560

 

Proceeds from dispositions

 

 

1,130

 

Consideration paid to acquire Millennium Waterway Apartments, net of cash acquired

 

(2,721

)

 

Distribution from Millennium Waterway Apartments

 

6,876

 

 

Proceeds from sales of investment in Real Estate Affiliates

 

8,579

 

 

Investments in Real Estate Affiliates, net

 

(496

)

 

Decrease in restricted cash

 

4,251

 

 

Cash used in investing activities

 

(20,326

)

(12,832

)

 

 

 

 

 

 

Cash Flows from Financing Activities:

 

 

 

 

 

Proceeds from issuance of mortgages, notes and loans payable

 

44,828

 

241,644

 

Principal payments on mortgages, notes and loans payable

 

(37,193

)

(241,148

)

Deferred financing costs

 

(1,281

)

(2,935

)

Proceeds from issuance of management warrants

 

 

2,000

 

Cash provided by (used in) financing activities

 

6,354

 

(439

)

Net change in cash and cash equivalents

 

45,288

 

8,681

 

Cash and cash equivalents at beginning of period

 

227,566

 

284,682

 

Cash and cash equivalents at end of period

 

$

272,854

 

$

293,363

 

 

 

 

 

 

 

Supplemental Disclosure of Cash Flow Information:

 

 

 

 

 

Interest paid

 

$

16,398

 

$

15,272

 

Interest capitalized

 

19,737

 

16,687

 

Income taxes paid

 

966

 

 

 

 

 

 

 

 

Non-Cash Transactions:

 

 

 

 

 

Acquisition of Millennium Waterway Apartments

 

 

 

 

 

Land

 

(15,917

)

 

Building and equipment

 

(56,002

)

 

Other Assets

 

(2,669

)

 

Mortgages, notes and loans payable

 

55,584

 

 

Other liabilities

 

754

 

 

Acquisition of 70 CCC

 

 

 

 

 

Land

 

(1,281

)

 

Building and equipment

 

(13,089

)

 

Other Assets

 

(2,957

)

 

Mortgages, notes and loans payable

 

16,037

 

 

Other liabilities

 

1,290

 

 

Reduction in investments in Real Estate Affiliates due to the Millennium Waterway Apartments’ acquisition

 

22,405

 

 

Special Improvement District bond transfers associated with land sales

 

(2,689

)

(3,188

)

Real estate and property expenditures

 

11,984

 

 

Reduction in investments in Real Estate Affiliates due to The Woodlands’ acquisition

 

 

(128,764

)

Acquisition note related to The Woodlands (See Note 4)

 

 

96,500

 

Debt assumed from The Woodlands’ acquisition (See Note 4)

 

 

296,695

 

Prepetition liabilities funded by GGP

 

 

3,323

 

MPC land contributed to Real Estate Affiliate

 

(2,190

)

 

Purchase of land from GGP

 

(1,315

)

 

 

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

 

7



Table of Contents

 

THE HOWARD HUGHES CORPORATION

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

UNAUDITED

 

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 Securities Exchange Commission (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. 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. We have made certain reclassifications in 2011 to conform to the 2012 presentation. In 2011, we reclassified $4.7 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. We reclassified certain salaries and overhead costs relating to land development activities for The Woodlands from general and administrative expenses to Master Planned Community operations of $1.5 million and $4.0 million related to the three and nine months ended September 30, 2011, respectively. In addition, we reclassified operating costs related to the Columbia office properties from general and administrative expenses to other property costs. The results for the interim period ended September 30, 2012 and 2011 are not necessarily indicative of the results to be expected for the full fiscal year.

 

As more fully described in Note 4, on July 1, 2011, we acquired our partner’s 47.5% economic interest in The Woodlands not previously owned by us. As a result of this acquisition, beginning on July 1, 2011, we consolidated the financial results of The Woodlands which were previously accounted for under the equity method. Our condensed consolidated statements of operations and cash flows for the nine months ended September 30, 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.

 

NOTE 2        SPONSORS 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 and the number of shares of common stock underlying each warrant are 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 which may be adjusted pursuant to a net settlement option 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 $230.2 million fair value for the Sponsors Warrants and estimated $60.3 million fair value for the Management Warrants as of September 30, 2012, have been recorded as liabilities because the holders of these warrants could require us to settle such warrants in cash upon a change of control. The fair values were estimated

 

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Table of Contents

 

THE HOWARD HUGHES CORPORATION

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

UNAUDITED

 

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 $102.6 million and $25.2 million, respectively, as of December 31, 2011. Increases (loss) and decreases (gain) in the fair value of the Sponsors Warrants and the Management Warrants are recognized in earnings.

 

NOTE 3        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 is 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 September 30,

 

Nine Months Ended September 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

 

 

(In thousands, except per share amounts)

 

Basic EPS:

 

 

 

 

 

 

 

 

 

Numerator:

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

(50,192

)

$

165,024

 

$

(126,724

)

$

116,528

 

Net income (loss) attributable to noncontrolling interests

 

781

 

(729

)

(637

)

(777

)

Net income (loss) attributable to common stockholders

 

$

(49,411

)

$

164,295

 

$

(127,361

)

$

115,751

 

 

 

 

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

 

 

 

 

Weighted average basic common shares outstanding

 

37,916

 

37,912

 

37,909

 

37,907

 

 

 

 

 

 

 

 

 

 

 

Diluted EPS:

 

 

 

 

 

 

 

 

 

Numerator:

 

 

 

 

 

 

 

 

 

Net income (loss) attributable to common stockholders

 

$

(49,411

)

$

164,295

 

$

(127,361

)

$

115,751

 

Less: Warrant liability gain

 

 

(169,897

)

 

(100,762

)

Adjusted net income (loss) available to common stockholders

 

$

(49,411

)

$

(5,602

)

$

(127,361

)

$

14,989

 

 

 

 

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average basic common shares outstanding

 

37,916

 

37,912

 

37,909

 

37,907

 

Restricted stock and stock options

 

 

 

 

5

 

Warrants

 

 

843

 

 

1,585

 

 

 

 

 

 

 

 

 

 

 

Weighted average diluted common shares oustanding

 

37,916

 

38,755

 

37,909

 

39,497

 

 

 

 

 

 

 

 

 

 

 

Basic earnings (loss) per share:

 

$

(1.30

)

$

4.33

 

$

(3.36

)

$

3.05

 

 

 

 

 

 

 

 

 

 

 

Diluted earnings (loss) per share:

 

$

(1.30

)

$

(0.14

)

$

(3.36

)

$

0.38

 

 

9



Table of Contents

 

THE HOWARD HUGHES CORPORATION

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

UNAUDITED

 

The diluted EPS computations for the three and nine months ended September 30, 2012 exclude 843,962 stock options, 57,933 shares of restricted stock, 8,000,000 shares of common stock underlying the Sponsor Warrants and 2,862,687 shares of common stock underlying the Management Warrants because their inclusion would have been anti-dilutive.

 

Additionally, the diluted EPS computation for the three months ended September 30, 2011 excludes 692,362 stock options and 38,953 shares of restricted stock because their inclusion would have been anti-dilutive. The diluted EPS computation for the nine months ended September 30, 2011 excludes 692,362 stock options because their inclusion would have been anti-dilutive.

 

NOTE 4        ACQUISITIONS AND DISPOSITIONS

 

On August 15, 2012, we acquired 70 Columbia Corporate Center (“70 CCC”), a 169,590 square foot Class A office building located in the Columbia, Maryland town center by assuming a promissory note which encumbered the property and providing a participation right to the lender for 30% of the appreciation in the market value of the building less our preferred return. The promissory note bears interest at 4.25% and matures on August 31, 2017. The building was approximately 23.7% leased at closing. Simultaneous with the closing of the transaction, we executed a lease for 76,308 square feet that will increase occupancy to approximately 68.7% when the tenants take possession which is estimated to occur in March 2013. As part of the transaction, we deposited approximately $5.0 million into an escrow account for capital expenditures, tenant improvements and leasing commissions at the property. We are entitled to a 10% cumulative preferred return, after debt service, on our invested capital in the property. Cash flow is then split pro-rata based on our original contributed equity of $5.0 million plus any additional equity contributed and the loan amount. Excess proceeds from a capital event, after repayment of outstanding debt and the preferred return will be split 30% to the lender and 70% to us. The acquisition was recorded at fair value of $17.5 million and consists of land and a building that was valued as if it were vacant and the “as-if-vacant” value was allocated between the land and building. The “as-if-vacant” value was derived by estimating the value of the property assuming it was generating stabilized cash flows using market lease, capitalization and discount rates based on recent comparable market transactions, reduced by the estimated lease-up and carrying costs that we would incur to achieve stabilized cash flow if the property were vacant. The fair value of the liabilities assumed was determined using a discounted cash flow analysis. 70 CCC is included in our Operating segment.

 

On July 6, 2012, we sold 11.5 acres including 104,705 square feet of mostly vacant retail space in Pocatello, ID (Alameda Plaza) for $4.5 million. Our net earnings recognized on the sale was $2.0 million. As the sale of certain development assets is an integral part of our business strategy, we recognize the proceeds as revenue in the condensed consolidated statements of operations.

 

On May 31, 2012, we acquired our partner’s interest in the 393-unit Millennium Waterway Apartments for $6.9 million, following the funding of a $55.6 million ten-year non-recourse mortgage bearing a 3.75% interest rate. Total assets of $78.6 million and liabilities of $56.4 million, including the recently funded loan, were consolidated into our financial statements at fair value as of the acquisition date. Prior to the acquisition, we accounted for our investment in Millennium Waterway Apartments under the equity method. We now own 100% of this stabilized Class A multi-family property located in The Woodlands Town Center. Included in the condensed consolidated statements of operations are revenues of $1.9 million and $2.5 million and net earnings of $0.6 million and $0.9 million since the acquisition date, for the three and nine months ended September 30, 2012, respectively. In conjunction with this acquisition, we entered into a new joint venture with the partner to construct a 314-unit Class A multi-family property. Please refer to Note 7 — Real Estate Affiliates for information about the new joint venture.

 

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.  As a result of the acquisition, we now consolidate The Woodlands operations into our financial statements: therefore, our condensed consolidated financial statements are not comparable for the nine months ended September 30, 2011.

 

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Table of Contents

 

THE HOWARD HUGHES CORPORATION

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

UNAUDITED

 

Please refer to Note 15 — Segments for a presentation of the results as if we consolidated The Woodlands for all periods presented. Prior to such acquisition, we accounted for The Woodlands using the equity method. Our acquisition of The Woodlands net assets resulted in a $3.9 million after-tax loss on the re-measurement relating to our existing 52.5% economic interest which had a $134.8 million net book value at June 30, 2011. The loss is recorded in the Investment in Real Estate Affiliate basis adjustment line on our Condensed Consolidated Statements of Operations. Included in the Condensed Consolidated Statement of Operations for the three months and nine months ended September 30, 2011, are revenues of $40.3 million and a net loss of $7.9 million for the quarter ended September 30, 2011. The net loss includes the impact of purchase accounting adjustments, including an $8.6 million increase in cost of sales to reflect the step-up in basis of finished lot inventory sold during the three months ended September 30, 2011.

 

Pro Forma Information

 

The following pro forma information for the nine months ended September 30, 2011 was prepared as if The Woodlands’ acquisition had occurred as of the beginning of such period:

 

 

 

Nine Months Ended
September 30, 2011

 

 

 

(In thousands)

 

Total revenues

 

$

276,240

 

Net income (loss) attributable to common shareholders

 

112,393

 

 

Pro forma adjustments were made for: (1) purchase accounting, including (a) depreciation for the step-up in basis for net property 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 our 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 5        IMPAIRMENT

 

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. Generally accepted accounting principles 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.

 

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 during the three or nine months ended September 30, 2012 or 2011.

 

11



Table of Contents

 

THE HOWARD HUGHES CORPORATION

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

UNAUDITED

 

NOTE 6                                           FAIR VALUE OF FINANCIAL INSTRUMENTS

 

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

 

 

 

September 30, 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

 

$

290,488

 

$

 

$

 

$

290,488

 

$

127,764

 

$

 

$

 

$

127,764

 

Interest rate swaps

 

7,724

 

 

7,724

 

 

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 related to the warrants, exercise price of the warrants, term, 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 the fair value measurements using significant unobservable inputs (Level 3):

 

 

 

2012

 

2011

 

 

 

(In thousands)

 

Balance as of December 31,

 

$

127,764

 

$

227,348

 

Warrant liability (gain) loss

 

162,724

 

(100,762

)

Purchases

 

 

2,000

 

Balance as of September 30,

 

$

290,488

 

$

128,586

 

 

The significant unobservable input used in the fair value measurement of our warrants designated as Level 3 as of September 30, 2012 is as follows:

 

 

 

Fair Value

 

Valuation
Technique

 

Unobservable
Input

 

Range/
Average

 

 

 

(In thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Warrants

 

$

290,488

 

Option Pricing
Valuation Model

 

Expected
Volatility (a)

 

27%-28%
(28%)

 

 


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

 

12



Table of Contents

 

THE HOWARD HUGHES CORPORATION

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

UNAUDITED

 

The expected volatility in the table above is a significant unobservable input used to estimate the fair value of our warrant liabilities. An increase in expected volatility would increase the fair value of the liability, while a decrease in expected volatility would decrease the fair value of the liability.

 

The following tables summarize our assets and liabilities that were measured at fair value on a non-recurring basis:

 

 

 

Total Fair
Value
Measurement

 

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

 

Significant
Other
Observable
Inputs (Level 2)

 

Significant
Unobservable Inputs
(Level 3)

 

Total Loss (Gain)
Three and Nine
Months Ended
September 30,
2012

 

 

 

(In thousands)

 

Investment in Real Estate Affiliates

 

$

22,405

 

$

22,405

(a)

$

 

$

 

$

 

 


(a)         We measured our equity interest in Millennium Waterway Apartments based on our purchase of our partner’s 23.5% economic interest in Millennium Waterway Apartments. We used Level 1 inputs for the cash payment.

 

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

 

 

 

September 30, 2012

 

December 31, 2011

 

 

 

Carrying
Amount

 

Estimated
Fair Value

 

Carrying
Amount

 

Estimated
Fair Value

 

 

 

(In thousands)

 

Assets:

 

 

 

 

 

 

 

 

 

Notes receivable, net

 

$

28,677

 

$

28,677

 

$

35,354

 

$

35,354

 

Tax indemnity receivable, including interest

 

326,150

 

(c)

 

331,771

 

(c)

 

 

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

Fixed-rate debt

 

$

159,098

 

$

160,689

 

$

83,164

 

$

85,047

 

Variable-rate debt (a)

 

473,778

 

473,778

 

468,100

 

468,100

 

SID bonds (b)

 

50,928

 

50,928

 

55,213

 

55,213

 

Total mortgages, notes and loans payable

 

683,804

 

685,395

 

606,477

 

608,360

 

 


(a) As more fully described below, $172.0 million of variable-rate debt has been swapped to a fixed rate for the term of the related debt.

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

(c) It is not practicable to estimate the fair value of the tax indemnity receivable, including interest, as the timing and ultimate amount received under contract is highly dependent on numerous future events that cannot be reliably predicted.

 

Notes receivables are carried at net realizable value which approximates fair value. The estimated fair values of these notes receivable are categorized as Level 3 due to certain factors, such as current interest rates, terms of the note and credit worthiness of the borrower.

 

The fair value of debt in the table above was estimated based on a discounted future cash payment model using Level 2 inputs which includes risk premiums for loans of comparable quality and a risk free rate derived from the current London Interbank Offered Rate (“LIBOR) or U.S. Treasury obligation interest rates. The discount rates reflect our judgment as to what the approximate current lending rates for loans or groups of loans with similar

 

13



Table of Contents

 

THE HOWARD HUGHES CORPORATION

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

UNAUDITED

 

maturities and credit quality would be if credit markets were operating efficiently and assuming that the debt is outstanding through maturity.

 

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

 

NOTE 7                                                 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 which are referred to as real estate affiliates. 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 partnerships or joint ventures at inception to determine if any meet the qualifications of a variable interest entity (“VIE”). We consider a partnership or joint venture to be 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.

 

On October 11, 2011, we entered into a joint venture with two local developers and formed HHMK Development, LLC to explore the development of a luxury condominium tower at the Ala Moana Center, Honolulu, HI. On June 14, 2012, we formed another 50:50 joint venture, KR Holdings, LLC (“KR Holdings”), with the same partner. The initial capital contribution which is due at closing for the construction loan will include our interest in the condominium declaration and air rights for the condominium tower and cash from our partner. We anticipate the construction loan to close in June 2013. We determined that KR Holdings is a VIE, and that we are not the primary beneficiary. Accordingly, we account for our investment in KR Holdings using the equity method. On September 17, 2012, KR Holdings closed on two $20.0 million non-recourse mezzanine loan commitments with List Island Properties, LLC and A & B Properties, Inc. These loans have a blended interest rate of 12%, must be drawn in full at the construction loan closing date and mature on April 30, 2018 with the option to extend for one year. In addition to the mezzanine loans, A & B Properties and List Island Properties, LLC, both have a back-end profit interest in KR Holdings, LLC, which entitles them to receive a share of the profits after we get a return of our capital plus a 13% preferred return on our capital. LIST Co., Ltd, the parent of List Island Properties, LLC, will serve as an exclusive representative for buyers in Japan for the residences. Three million dollars of the $40.0 million provided by the mezzanine lenders may be drawn and used to fund the pre-development costs of the venture. Per the terms of the mezzanine loans, the venture is not required to repay this $3.0 million if the construction loan fails to close or the project fails to go forward. Of the committed pre-development costs, $2.0 million has been funded as of September 30, 2012 and is non-interest bearing.

 

14



Table of Contents

 

THE HOWARD HUGHES CORPORATION

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

UNAUDITED

 

On May 14, 2012, we entered into a joint venture, Millennium Woodlands Phase II, LLC (“Millennium Phase II”), with the same partner from Millennium Waterway Apartments as discussed in Note 4 for the construction of a 314-unit Class A multi-family complex in The Woodlands Town Center. Our partner is the managing member of Millennium Phase II.  As the managing member, our partner controls, directs, manages and administers the affairs of Millennium Phase II. Millennium Phase II is a variable interest entity, and although we have the majority ownership interest in the joint venture, we determined that we are not the primary beneficiary because our partner has the power to direct activities that most significantly impact the economic performance of the joint venture (81.43%). On July 5, 2012, Millennium Phase II was capitalized by our contribution of 4.8 acres of land valued at $15.5 million to the joint venture, our partner’s contribution of $3.0 million in cash, and by a construction loan in the amount of $37.7 million which is guaranteed by our partner. The development of Millennium Phase II further expands our multi-family portfolio in The Woodlands Town Center.

 

On October 30, 2012, we funded $4.5 million in cash to the Bridges at Mint Hill joint venture in accordance with the venture’s operating agreement. The cash was used to repay a mortgage secured by land to be contributed by our partner. As a result, our ownership percentage increased to 90.5% from 79.0%, and we now have the ability to direct the significant economic activities of the entity; therefore, we will begin consolidating this joint venture in the fourth quarter of 2012.

 

The Bridges at Mint Hill, LLC, HHMK Development, LLC, KR Holdings, LLC, Millennium Woodlands Phase II, LLC and the Parcel D Development, LLC joint venture entities included in the table below are VIEs. The aggregate carrying value of the unconsolidated VIEs was $7.9 million and $3.2 million as of September 30, 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 and nine months ended September 30, 2012. 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.

 

15



Table of Contents

 

THE HOWARD HUGHES CORPORATION

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

UNAUDITED

 

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

 

 

 

Economic/ Legal Ownership

 

Carrying Value

 

Share of Earnings/Dividends

 

 

 

September 30,

 

December 31,

 

September 30,

 

December 31,

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

2012

 

2011

 

2012

 

2011

 

 

 

(In percentages)

 

(In thousands)

 

(In thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The Woodlands (a)

 

 

 

 

 

$

 

$

 

$

 

$

 

$

 

$

3,727

 

Bridges at Mint Hill, LLC (b)

 

79.00

%

79.00

%

673

 

180

 

 

 

 

 

Circle T

 

50.00

%

50.00

%

9,004

 

9,004

 

 

 

 

 

Forest View Apartments (c) (d)

 

 

50.00

%

 

5,358

 

 

1

 

2

 

1

 

HHMK Development, LLC

 

50.00

%

50.00

%

947

 

 

 

 

 

 

KR Holdings, LLC

 

50.00

%

 

 

 

 

 

 

 

Millennium Waterway Apartments (e)

 

100.00

%

83.55

%

 

21,998

 

 

14

 

406

 

14

 

Millennium Woodlands Phase II, LLC

 

81.43

%

 

2,190

 

 

 

 

 

 

Parcel D Development, LLC

 

50.00

%

50.00

%

4,084

 

2,990

 

 

 

 

 

Stewart Title (c)

 

50.00

%

50.00

%

3,758

 

3,643

 

324

 

85

 

640

 

85

 

Timbermill Apartments (c) (d)

 

 

50.00

%

 

3,988

 

 

1

 

2

 

1

 

Woodlands Sarofim #1 (c)

 

20.00

%

20.00

%

2,462

 

2,456

 

(14

)

30

 

6

 

30

 

Other investments

 

 

 

 

 

300

 

 

 

 

 

 

 

 

 

 

 

 

23,418

 

49,617

 

310

 

131

 

1,056

 

3,858

 

Cost basis investments (f)

 

 

 

 

 

12,744

 

12,978

 

 

35

 

2,376

 

3,929

 

Total

 

 

 

 

 

$

36,162

 

$

62,595

 

$

310

 

$

166

 

$

3,432

 

$

7,787

 

 


(a)              As of July 1, 2011, The Woodlands is consolidated and no longer a Real Estate Affiliate (Refer to Note 4). Prior to July 1, 2011, we owned 52.5% economic interest in The Woodlands.

(b)             Ownership percentage as of October 30, 2012 is 90.50%

(c)              Equity investment consolidated into our financial statements as part of the acquisition of our partner’s economic interest in The Woodlands on July 1, 2011.

(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.

(e)              On May 31, 2012, we acquired our partner’s interest for $6.9 million and consolidated this property.

(f)               Includes dividends received from Summerlin Hospital Medical Center.

 

As of September 30, 2012, approximately $9.1 million of indebtedness was secured by the properties owned by our Real Estate Affiliates in which our share was approximately $2.5 million (KR Holdings, LLC - $1.0 million; Millennium Woodlands Phase II - $0.1 million; and Woodlands Sarofim #1 - $1.4 million) based upon our economic ownership. The debt is non-recourse to us.

 

NOTE 8                                                 MORTGAGES, NOTES AND LOANS PAYABLE

 

Mortgages, notes and loans payable are summarized as follows:

 

 

 

September 30,

 

December 31,

 

 

 

2012

 

2011

 

 

 

(In thousands)

 

Fixed-rate debt:

 

 

 

 

 

Collateralized mortgages, notes and loans payable

 

$

159,098

 

$

83,164

 

Special Improvement District bonds

 

50,928

 

55,213

 

Variable-rate debt:

 

 

 

 

 

Collateralized mortgages, notes and loans payable

 

473,778

 

468,100

 

Total mortgages, notes and loans payable

 

$

683,804

 

$

606,477

 

 

16



Table of Contents

 

THE HOWARD HUGHES CORPORATION

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

UNAUDITED

 

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

 

 

 

 

 

 

 

Maximum

 

Carrying Value

 

 

 

Final Maturity (a)

 

Interest
Rate

 

Facility
Amount

 

September 30,
2012

 

December 31,
2011

 

 

 

 

 

 

 

 

 

(In thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

110 N. Wacker (b)

 

October 2019

 

5.21

%

 

 

$

29,000

 

$

29,000

 

 

 

 

 

 

 

 

 

 

 

 

 

70 Columbia Corporate Center

 

August 2017

 

4.25

%

 

 

16,037

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other Financing Arrangements

 

July 2015

 

 

 

 

754

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Bridgeland

 

 

 

 

 

 

 

 

 

 

 

Land Loan (d)

 

June 2022

 

5.50

%

 

 

18,066

 

 

Development Loan (e)

 

June 2015

 

5.00

%

$

30,000

 

2,757

 

 

Various mortgage notes

 

 

 

 

 

 

20,604

 

Bridgeland Total

 

 

 

 

 

 

 

20,823

 

20,604

 

 

 

 

 

 

 

 

 

 

 

 

 

Special Improvement District bonds

 

 

 

 

 

 

 

 

 

 

 

Summerlin South - S108

 

December 2016

 

5.95

%

 

 

1,183

 

1,302

 

Summerlin South - S124

 

December 2019

 

5.95

%

 

 

342

 

378

 

Summerlin South - S128

 

December 2020

 

7.30

%

 

 

825

 

862

 

Summerlin South - S128C

 

December 2030

 

6.05

%

 

 

5,847

 

5,956

 

Summerlin South - S132

 

December 2020

 

6.00

%

 

 

5,067

 

5,378

 

Summerlin South - S151

 

June 2025

 

6.00

%

 

 

11,064

 

12,293

 

Summerlin West - S808

 

April 2021

 

5.71

%

 

 

 

682

 

Summerlin West - S809

 

April 2023

 

6.65

%

 

 

 

1,000

 

Summerlin West - S810

 

April 2031

 

7.13

%

 

 

22,185

 

22,770

 

The Shops at Summerlin Centre - S128

 

December 2030

 

6.05

%

 

 

3,765

 

3,829

 

The Shops at Summerlin Centre - S108

 

December 2016

 

5.95

%

 

 

650

 

713

 

SID Payable to Nevada Cancer Institute

 

December 2019

 

5.95

%

 

 

 

50

 

Special Improvement District bonds Total

 

 

 

 

 

 

 

50,928

 

55,213

 

 

 

 

 

 

 

 

 

 

 

 

 

The Woodlands

 

 

 

 

 

 

 

 

 

 

 

Master Credit Facility (f)

 

March 2015

 

5.00

%

$

270,000

 

176,704

 

183,000

 

Resort and Conference Center (g)

 

October 2013

 

6.00

%

 

 

36,100

 

36,100

 

2201 Lake Woodlands Drive

 

November 2016

 

5.25

%

 

 

 

4,803

 

Weiner Tract

 

January 2013

 

6.25

%

 

 

 

1,479

 

Land in Montgomery Co.

 

December 2012

 

6.00

%

 

 

 

649

 

Land in Harris Co.

 

January 2013

 

6.00

%

 

 

 

381

 

Capital lease obligation

 

 

2.84

%

 

 

67

 

147

 

CVS

 

upon sale

 

3.25

%

 

 

 

101

 

4 Waterway Square

 

December 2023

 

4.88

%

 

 

40,359

 

41,000

 

9303 New Trails

 

December 2023

 

4.88

%

 

 

13,781

 

14,000

 

3 Waterway Square (h)

 

January 2017

 

3.25

%

$

43,295

 

217

 

 

20/25 Waterway

 

May 2022

 

4.79

%

 

 

14,450

 

 

Millennium Waterway Apartments (i)

 

June 2022

 

3.75

%

 

 

55,584

 

 

The Woodlands Total

 

 

 

 

 

 

 

337,262

 

281,660

 

 

 

 

 

 

 

 

 

 

 

 

 

Ward Centers (j)

 

September 2016

 

3.40

%

$

250,000

 

229,000

 

220,000

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

683,804

 

$

606,477

 

 


(a)   Maturity date includes any extension option periods which are within our control.

(b)   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.

(c)   The loan was refinanced during the second quarter of 2012.

(d)   Loan is for ten year term. First five years interest is fixed at 5.50% and for second five years interest rate is floating based on three-month LIBOR +2.75%.

(e)   Revolving development loan provides for a maximum of $30.0 million outstanding balance at any time with all draws not to exceed $140.0 million. The loan bears interest at three-month LIBOR + 3.25% and has a 5.00% minimum rate.

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

(g)   Loan currently bears interest at one-month LIBOR + 5.00% and has a 1.00% LIBOR floor. The rate increases by 0.5% every six months after March 23, 2012 until maturity.

(h)   Loan bears interest at one-month LIBOR + 2.65%.

(i)    Loan payments are interest only until June 2017, then monthly principal and interest payment of $257,418 with unpaid balance due at maturity.

(j)    Loan has a stated interest rate of one-month LIBOR + 2.50%. $143.0 million of the outstanding principal balance is swapped to a 3.80% fixed rate through maturity.

 

17



Table of Contents

 

THE HOWARD HUGHES CORPORATION

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

UNAUDITED

 

The weighted average interest rate on our mortgages, notes and loans payable was 4.52% and 4.68% as of September 30, 2012 and December 31, 2011, respectively.

 

Mortgages, Notes and Loans Payable

 

As of September 30, 2012, we had $683.8 million of mortgages, notes and loans payable. Approximately $337.3 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 parent guarantee associated with the 110 N. Wacker mortgage, which is more fully discussed below.

 

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 September 30, 2012, the TWL Facility had an outstanding balance of $176.7 million. The TWL Facility bears interest at one-month LIBOR plus 4.00% with a 1.00% 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 September 30, 2012, leverage was approximately 37.90%. There was $11.0 million of undrawn and available borrowing capacity under the TWL Facility based on the collateral underlying the facility and covenants as of September 30, 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, 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.

 

On August 15, 2012, we assumed a $16.0 million loan as part of the acquisition of 70 CCC. The non-recourse, interest only promissory note matures on August 31, 2017, has a fixed rate of 4.25% and is secured by the property. Please refer to Note 4 — Acquisitions and Dispositions for description of the acquisition.

 

The Woodlands Resort and Conference Center loan has a $36.1 million outstanding balance as of September 30, 2012. The maturity date has been extended to December 2012 and may be further extended to October 2013 at our option. The loan bears interest at one-month LIBOR plus 5.00% as of September 30, 2012 and has a 1.00% LIBOR floor. The rate began to increase by 0.50% every six months after March 23, 2012 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.

 

During the second quarter of 2012, we refinanced $18.1 million of existing debt related to our Bridgeland master planned community with a ten-year term loan facility at a fixed interest rate of 5.50% for the first five years and three-month LIBOR plus 2.75% for the remaining term and maturing on June 29, 2022. Beginning on June 29, 2014, annual principal payments are required in the amount of 5.00% of the then outstanding principal balance. In addition, we simultaneously entered into a three-year revolving credit facility with aggregate borrowing capacity of $140.0 million and which has a $30.0 million maximum outstanding loan amount at any time. The revolving loan bears interest at the greater of 5.00% or LIBOR plus 3.25% and matures on June 29, 2015. This loan is intended to provide working capital at Bridgeland in order to accelerate development efforts to meet the demand of homebuilders for finished lots in the community. The Bridgeland loans are cross collateralized and cross-defaulted and the Bridgeland Master Planned Community serves as collateral for the loans. The loans also require that Bridgeland maintain a minimum $3.0 million cash balance and a minimum net worth of $250.0 million. Additionally, we are restricted from making cash distributions from Bridgeland unless the revolver has no outstanding balance and one year of real estate taxes and debt service on the term loan have been escrowed with the lender.

 

18



Table of Contents

 

THE HOWARD HUGHES CORPORATION

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

 UNAUDITED

 

On May 31, 2012, as part of our acquisition of the partner’s interest in Millennium Waterway Apartments, we consolidated a $55.6 million non-recourse first mortgage loan. The proceeds from the mortgage were used to refinance the joint venture’s existing debt and to fund our acquisition of the partner’s interest in the property. The loan matures on June 1, 2022 and has a fixed interest rate of 3.75%. Payments are interest only until June 2017, then monthly principal and interest payments of $257,418 with the unpaid principal balance due at maturity.

 

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.

 

On February 2, 2012, we secured non-recourse financing totaling $43.3 million for the construction of 3 Waterway Square, an eleven-story, 232,021-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, we closed on a $250.0 million first mortgage financing secured by the Ward Centers in Honolulu, HI, 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 3.80% fixed rate for the term of the loan. The loan had a weighted-average interest rate of 3.40% as of September 30, 2012. 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% of the property’s appraised value and the borrowers are required to have a minimum 10% debt yield to draw additional loan proceeds under the facility. The loan also permits partial repayment during its term in connection with property releases for development. On September 17, 2012, we drew an additional $9.0 million on the loan. As a result, the unused portion of this mortgage is $21.0 million as of September 30, 2012.

 

On May 10, 2011, we closed a $29.0 million first mortgage financing secured by our office building located at 110 N. Wacker Drive in Chicago, IL which bears 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. We provided a $7.0 million repayment guarantee for the loan, which is reduced on a dollar for dollar basis during the amortization period.

 

As of September 30, 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.

 

Special Improvement District Bonds

 

The Summerlin master planned community uses Special Improvement District bonds to finance certain common infrastructure improvements.  These bonds are issued by the municipalities and, although unrated, are secured by the assessments on the land.  The majority of proceeds from each bond issued is held in a construction escrow and disbursed to us as infrastructure projects are completed, inspected by the municipalities and approved for reimbursement. Accordingly, the Special Improvement District bonds have been classified as debt. The Summerlin Master Planned Community pays the debt service on the bonds semi-annually. However, our residential land sales contracts provide for the reimbursement of the principal amounts included in these debt service payments. In addition, as Summerlin sells land, the purchasers assume a proportionate share of the bond obligation.

 

As of September 30, 2012, we were in compliance with all of the financial covenants related to our debt agreements.

 

19



Table of Contents

 

THE HOWARD HUGHES CORPORATION

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

UNAUDITED

 

NOTE 9                                              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 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 September 30, 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 and nine months ended September 30, 2012, the amount of ineffectiveness recorded in earnings was insignificant.

 

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 $2.3 million will be reclassified as an increase to interest expense.

 

As of September 30, 2012, we had gross notional amounts of $172.0 million for interest rate swaps and a $100.0 million interest rate cap that were designated as cash flow hedges of interest rate risk. The fair value of the interest rate cap derivative was insignificant.

 

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

 

 

 

September 30,

 

December 31,

 

 

 

2012

 

2011

 

 

 

(In thousands)

 

Interest Rate Swaps

 

$

7,724

 

$

4,367

 

Total derivatives designated as hedging instruments

 

$

7,724

 

$

4,367

 

 

The table below presents the effect of our derivative financial instruments on the Condensed Consolidated Statements of Operations:

 

 

 

Three months ended September 30,

 

 

 

Three months ended September 30,

 

 

 

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 AOCI into
Earnings

 

Amount of (Loss)
Reclassified from
AOCI into Earnings

 

Amount of Gain or
(Loss) Reclassified
from AOCI into
Earnings

 

 

 

(In thousands)

 

 

 

(In thousands)

 

Interest Rate Swaps

 

$

(1,466

)

$

(1,834

)

Interest Expense

 

$

(512

)

$

(205

)

 

 

$

(1,466

)

$

(1,834

)

 

 

$

(512

)

$

(205

)

 

20



Table of Contents

 

THE HOWARD HUGHES CORPORATION

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

UNAUDITED

 

 

 

Nine months ended September 30,

 

 

 

Nine months ended September 30,

 

 

 

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 AOCI into
Earnings

 

Amount of (Loss)
Reclassified from
AOCI into Earnings

 

Amount of Gain or
(Loss) Reclassified
from AOCI into
Earnings

 

 

 

(In thousands)

 

 

 

(In thousands)

 

Interest Rate Swaps

 

$

(4,627

)

$

(2,582

)

Interest Expense

 

$

(1,512

)

$

(316

)

 

 

$

(4,627

)

$

(2,582

)

 

 

$

(1,512

)

$

(316

)

 

NOTE 10                                             INCOME TAXES

 

Several of our subsidiaries are involved in a dispute with the IRS relating to years in which those subsidiaries were owned by GGP, and in connection therewith General Growth Properties (“GGP”) has provided us with an indemnity against certain potential tax liabilities. 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”), 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 (“MPC Taxes”), in an amount up to $303.8 million, plus interest and penalties related to these amounts (the “Indemnity Cap”) so long as GGP controls the action in the Tax Court related to the dispute with the IRS as described below.  We recorded the Tax Indemnity receivable at the Indemnity Cap amount as of the spinoff date. The unrecognized tax benefits and related accrued interest recorded through September 30, 2012 are primarily related to the taxes that are the subject of the Tax Indemnity. We have recorded interest income receivable on the Tax Indemnity receivable in the amounts of $34.0 million and $28.0 million as of September 30, 2012 and December 31, 2011, respectively.

 

The timing of the utilization of the tax assets attributable to indemnified and non-indemnified gains results in changes to the Tax Indemnity receivable and is dependent on numerous future events, such as the timing of recognition of indemnified and non-indemnified gains, the amount of each type of gain recognized in each year, the use of specific deductions and the ultimate amount of indemnified gains recognized. These non-cash changes could be material to our financial statements.  Resolution of the Tax Court case noted below could also result in changes to the master planned community deferred gains and the timing of utilization of the tax assets, both of which could result in changes to the Tax Indemnity receivable.  We record the Tax Indemnity receivable based on the amounts indemnified which are determined in accordance with the provisions set forth in ASC 740 (Income Taxes).

 

During the three and nine months ended September 30, 2012, the reduction in tax indemnity receivable of $2.9 million and $11.7 million, respectively, related to our utilization of tax assets that contractually limit the amount we can receive pursuant to the Tax Matters Agreement and changes to our deferred tax liability for the MPC Taxes.

 

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 scheduled for trial in November 2012.

 

Unrecognized tax benefits recorded pursuant to uncertain tax positions were $101.0 million as of September 30, 2012 and $101.4 as of December 31, 2011, excluding interest, of which this entire amount would not

 

21



Table of Contents

 

THE HOWARD HUGHES CORPORATION

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

UNAUDITED

 

impact our effective tax rate. Accrued interest related to these unrecognized tax benefits amounted to $34.5 million as of September 30, 2012 and $28.5 million as of December 31, 2011. We recognized an increase in interest expense related to the unrecognized tax benefits of $2.1 million and $6.0 million for the three and nine months ended September 30, 2012, respectively. A significant amount of the unrecognized tax benefits recorded in the financial statements are related to the tax court litigation and are expected to be resolved within the next twelve months.

 

We file a consolidated corporate tax return which includes all of our subsidiaries with the exception of Victoria Ward, Limited (“Ward”, substantially all of which is owned by us). Ward elected to be taxed as a REIT, commencing with the taxable year beginning January 1, 2002.  Ward has satisfied the REIT distribution requirements for 2011, and presently we intend to continue to operate Ward as a REIT.

 

NOTE 11                                             STOCK-BASED PLANS

 

Stock Options

 

Our stock based plans are described, and informational disclosures provided, in the notes to the Consolidated Financial Statements included in our Form 10-K for the year ended December 31, 2011. The following table summarizes our stock option plan activity for the nine months ended September 30, 2012:

 

 

 

Stock Options

 

Weighted
Average
Exercise Price

 

Stock Options Outstanding at December 31, 2011