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Section 1: 10-Q (10-Q)

Q2-2013 10Q
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 June 30, 2013
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 001-34789
______________________________________
Hudson Pacific Properties, Inc.
(Exact name of Registrant as specified in its charter)
______________________________________
Maryland
 
27-1430478
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification Number)
11601 Wilshire Blvd., Suite 1600
Los Angeles, California
 
90025
(Address of principal executive offices)
 
(Zip Code)
(310) 445-5700
(Registrant’s telephone number, including area code)
(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.    Yes  x   No  o.
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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  o.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
o
Accelerated filer
 
x
Non-accelerated filer
 
o
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).    Yes  o    No  x.
The number of shares of common stock outstanding at August 1, 2013 was 56,711,202.
 
 
 
 
 


Table of Contents

Hudson Pacific Properties, Inc.
FORM 10-Q
June 30, 2013
TABLE OF CONTENTS
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
ITEM 2.
 
 
 
ITEM 3.
 
 
 
ITEM 4.
 
 
 
 
 
ITEM 1.
 
 
 
ITEM 1A.
 
 
 
ITEM 2.
 
 
 
ITEM 3.
 
 
 
ITEM 4.
 
 
 
ITEM 5.
 
 
 
ITEM 6.
 
 


2

Table of Contents

PART I—FINANCIAL INFORMATION

HUDSON PACIFIC PROPERTIES, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
 
 
June 30,
2013
 
December 31,
2012
 
(Unaudited)
 
 
ASSETS
 
 
 
REAL ESTATE ASSETS
 
 
 
Land
$
507,823

 
$
478,273

Building and improvements
965,946

 
831,791

Tenant improvements
84,721

 
75,094

Furniture and fixtures
14,408

 
11,545

Property under development
32,699

 
23,961

Total real estate held for investment
1,605,597

 
1,420,664

Accumulated depreciation and amortization
(94,775
)
 
(80,303
)
Investment in real estate, net
1,510,822

 
1,340,361

Cash and cash equivalents
96,330

 
18,904

Restricted cash
14,518

 
14,322

Accounts receivable, net
10,188

 
12,167

Notes receivable

 
4,000

Straight-line rent receivables
16,673

 
12,732

Deferred leasing costs and lease intangibles, net
88,893

 
81,010

Deferred finance costs, net
7,092

 
8,175

Interest rate contracts
123

 
71

Goodwill
8,754

 
8,754

Prepaid expenses and other assets
22,615

 
4,588

Assets associated with real estate held for sale
53,152

 
54,608

TOTAL ASSETS
$
1,829,160

 
$
1,559,692

LIABILITIES AND EQUITY
 
 
 
Notes payable
$
637,118

 
$
582,085

Accounts payable and accrued liabilities
17,528

 
18,578

Below-market leases
35,216

 
31,560

Security deposits
5,671

 
5,291

Prepaid rent
8,719

 
11,276

Obligations associated with real estate held for sale
1,269

 
1,205

TOTAL LIABILITIES
705,521

 
649,995

6.25% series A cumulative redeemable preferred units of the Operating Partnership
12,475

 
12,475

EQUITY
 
 
 
Hudson Pacific Properties, Inc. stockholders’ equity:
 
 
 
Preferred stock, $0.01 par value, 10,000,000 authorized; 8.375% series B cumulative redeemable preferred stock, $25.00 liquidation preference, 5,800,000 shares outstanding at June 30, 2013 and December 31, 2012, respectively
145,000

 
145,000

Common stock, $0.01 par value, 490,000,000 authorized, 56,709,792 shares and 47,496,732 shares outstanding at June 30, 2013 and December 31, 2012, respectively
567

 
475

Additional paid-in capital
904,805

 
726,605

Accumulated other comprehensive loss
(1,177
)
 
(1,287
)
Accumulated deficit
(39,478
)
 
(30,580
)
Total Hudson Pacific Properties, Inc. stockholders’ equity
1,009,717

 
840,213

Non-controlling interest—members in Consolidated Entities
46,883

 
1,460

Non-controlling common units in the Operating Partnership
54,564

 
55,549

TOTAL EQUITY
1,111,164

 
897,222

TOTAL LIABILITIES AND EQUITY
$
1,829,160

 
$
1,559,692



The accompanying notes are an integral part of these consolidated financial statements.
3


Table of Contents

HUDSON PACIFIC PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(in thousands, except share and per share amounts)
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
Revenues
 
 
 
 
 
 
 
Office
 
 
 
 
 
 
 
Rental
$
29,286

 
$
21,158

 
$
56,090

 
$
42,122

Tenant recoveries
5,348

 
5,522

 
11,097

 
10,867

Parking and other
3,108

 
2,433

 
7,046

 
4,525

Total office revenues
37,742

 
29,113

 
74,233

 
57,514

Media & entertainment
 
 
 
 
 
 
 
Rental
5,417

 
5,805

 
11,185

 
11,256

Tenant recoveries
323

 
417

 
741

 
665

Other property-related revenue
3,708

 
3,697

 
8,198

 
6,321

Other
200

 
62

 
436

 
102

Total media & entertainment revenues
9,648

 
9,981

 
20,560

 
18,344

Total revenues
47,390

 
39,094

 
94,793

 
75,858

Operating expenses
 
 
 
 
 
 
 
Office operating expenses
14,079

 
13,057

 
27,425

 
23,766

Media & entertainment operating expenses
6,429

 
6,289

 
11,997

 
11,059

General and administrative
5,186

 
4,151

 
10,175

 
8,665

Depreciation and amortization
14,382

 
13,192

 
32,813

 
24,806

Total operating expenses
40,076

 
36,689

 
82,410

 
68,296

Income from operations
7,314

 
2,405

 
12,383

 
7,562

Other expense (income)
 
 
 
 
 
 
 
Interest expense
5,762

 
4,575

 
11,354

 
9,466

Interest income
(90
)
 
(2
)
 
(240
)
 
(7
)
Acquisition-related expenses
509

 
299

 
509

 
360

Other expenses
9

 
46

 
54

 
90

 
6,190

 
4,918

 
11,677

 
9,909

Income (loss) from continuing operations
1,124

 
(2,513
)
 
706

 
(2,347
)
 
 
 
 
 
 
 
 
Income from discontinued operations
883

 
284

 
1,618

 
586

Impairment loss from discontinued operations
(5,435
)
 

 
(5,435
)
 

Net (loss) income from discontinued operations
(4,552
)
 
284

 
(3,817
)
 
586

Net loss
(3,428
)
 
(2,229
)
 
(3,111
)
 
(1,761
)
Net income attributable to preferred stock and units
(3,231
)
 
(3,231
)
 
(6,462
)
 
(6,462
)
Net income attributable to restricted shares
(79
)
 
(79
)
 
(158
)
 
(157
)
Net loss attributable to non-controlling interest in Consolidated Entities
291

 

 
281

 

Net loss attributable to common units in the Operating Partnership
263

 
322

 
394

 
525

Net loss attributable to Hudson Pacific Properties, Inc. common stockholders
$
(6,184
)
 
$
(5,217
)
 
$
(9,056
)
 
$
(7,855
)
Basic and diluted per share amounts:
 
 
 
 
 
 
 
Net loss from continuing operations attributable to common stockholders
$
(0.03
)
 
$
(0.14
)
 
$
(0.10
)
 
$
(0.23
)
Net (loss) income from discontinued operations
(0.08
)
 
0.01

 
(0.07
)
 
0.02

Net loss attributable to common stockholders’ per share—basic and diluted
$
(0.11
)
 
$
(0.13
)
 
$
(0.17
)
 
$
(0.21
)
Weighted average shares of common stock outstanding—basic and diluted
56,075,747

 
39,772,030

 
54,140,594

 
36,546,240

Dividends declared per share of common stock
$
0.1250

 
$
0.1250

 
$
0.2500

 
$
0.2500


The accompanying notes are an integral part of these consolidated financial statements.
4


Table of Contents

HUDSON PACIFIC PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited)
(in thousands, except share and per share amounts)

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
Net loss
$
(3,428
)
 
$
(2,229
)
 
$
(3,111
)
 
$
(1,761
)
Other comprehensive income (loss): cash flow hedge adjustment
98

 
(262
)
 
115

 
(353
)
Comprehensive loss
(3,330
)
 
(2,491
)
 
(2,996
)
 
(2,114
)
Comprehensive income attributable to preferred stock and units
(3,231
)
 
(3,231
)
 
(6,462
)
 
(6,462
)
Comprehensive income attributable to restricted shares
(79
)
 
(79
)
 
(158
)
 
(157
)
Comprehensive loss attributable to non-controlling interest in consolidated real estate entities
291

 

 
281

 

Comprehensive loss attributable to common units in the Operating Partnership
259

 
337

 
389

 
546

Comprehensive loss attributable to Hudson Pacific Properties, Inc. stockholders
$
(6,090
)
 
$
(5,464
)
 
$
(8,946
)
 
$
(8,187
)

The accompanying notes are an integral part of these consolidated financial statements.
5


Table of Contents

HUDSON PACIFIC PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF EQUITY
(Unaudited)
(in thousands, except share and per share amounts)


 
Hudson Pacific Properties, Inc. Stockholders’ Equity
 
 
 
 
Shares of Common
Stock
Stock
Amount
Series B Cumulative Redeemable Preferred Stock
Additional
Paid in
Capital
Accumulated
Deficit
Accumulated
Other
Comprehensive
(Deficit)
Income
Non-
controlling
Interests —
Common units
in the
Operating
Partnership
Total Equity
Non-
controlling
Interests —
Series A
Cumulative
Redeemable
Preferred
Units
Balance, January 1, 2012
33,840,854

$
338

$
87,500

$
552,043

$
(13,685
)
$
(883
)
$
63,356

$
688,669

$
12,475

Proceeds from sale of common stock, net of underwriters’ discount
13,225,000

132

 
190,666

 
 
 
190,798

 
Common stock issuance transaction costs
 
 
 
(107
)
 
 
 
(107
)
 
Issuance of Series B Cumulative Redeemable Preferred Stock
 
 
57,500

 
 
 
 
57,500

 
Series B stock issuance transaction costs
 
 
 
(1,865
)
 
 
 
(1,865
)
 
Issuance of unrestricted stock
3,748

 
 
 
 
 
 

 
Issuance of restricted stock
21,567


 


 
 
 

 
Shares repurchased
(28,896
)
 
 
(503
)
 
 
 
(503
)
 
Declared Dividend
 
 
(6,072
)
(10,158
)
 
 
(625
)
(16,855
)
(390
)
Amortization of stock based compensation
 
 
 
2,016

 
 
 
2,016

 
Net income (loss)
 
 
6,072

 
(7,698
)
 
(525
)
(2,151
)
390

Cash Flow Hedge Adjustment
 
 
 
 
 
(332
)
(21
)
(353
)
 
Exchange of Non-controlling Interests — Common units in the Operating Partnership for common stock
155,878

2

 
3,780

 
 
(3,782
)

 
Balance, June 30, 2012
47,218,151

$
472

$
145,000

$
735,872

$
(21,383
)
$
(1,215
)
$
58,403

$
917,149

$
12,475



The accompanying notes are an integral part of these consolidated financial statements.
6


Table of Contents

 
Hudson Pacific Properties, Inc. Stockholders’ Equity
 
 
 
 
 
Shares of Common
Stock
Stock
Amount
Series B Cumulative Redeemable Preferred Stock
Additional
Paid in
Capital
Accumulated
Deficit
Accumulated
Other
Comprehensive
(Deficit)
Income
Non-
controlling
Interests —
Common units
in the
Operating
Partnership
Non-controlling Interest - Members in Consolidated Entities
Total Equity
Non-
controlling
Interests —
Series A
Cumulative
Redeemable
Preferred
Units
Balance, January 1, 2013
47,496,732

$
475

$
145,000

$
726,605

$
(30,580
)
$
(1,287
)
$
55,549

$
1,460

$
897,222

$
12,475

Contributions
 
 
 
 
 
 
 
45,704

45,704

 
Proceeds from sale of common stock, net of underwriters' discount
9,200,000

92

 
189,796

 
 
 
 
189,888

 
Common stock issuance transaction costs
 
 
 
(392
)
 
 
 
 
(392
)
 
Issuance of Series B Cumulative Redeemable Preferred Stock
 
 


 
 
 
 
 

 
Series B stock issuance transaction costs
 
 
 


 
 
 
 

 
Issuance of unrestricted stock
2,804

 
 
 
 
 
 
 

 
Issuance of restricted stock
44,219

 
 
 
 
 
 
 

 
Forfeiture of restricted stock
(3,415
)
 
 
 
 
 
 
 

 
Shares repurchased
(30,548
)
 
 
(650
)
 
 
 
 
(650
)
 
Declared Dividend
 
 
(6,072
)
(14,177
)
 
 
(596
)
 
(20,845
)
(390
)
Amortization of stock based compensation
 
 
 
3,623

 
 
 
 
3,623

 
Net income (loss)
 
 
6,072

 
(8,898
)
 
(394
)
(281
)
(3,501
)
390

Cash Flow Hedge Adjustment
 
 
 
 
 
110

5

 
115

 
Balance, June 30, 2013
56,709,792

$
567

$
145,000

$
904,805

$
(39,478
)
$
(1,177
)
$
54,564

$
46,883

$
1,111,164

$
12,475


The accompanying notes are an integral part of these consolidated financial statements.
7


Table of Contents

HUDSON PACIFIC PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands) 
 
Six Months Ended June 30,
 
2013
 
2012
CASH FLOWS FROM OPERATING ACTIVITIES
 
 
 
Net loss
$
(3,111
)
 
$
(1,761
)
Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
33,602

 
25,840

Amortization of deferred financing costs and loan premium, net
462

 
644

Amortization of stock based compensation
3,512

 
2,002

Straight-line rent receivables
(4,702
)
 
(2,473
)
Amortization of above-market leases
1,365

 
1,921

Amortization of below-market leases
(4,127
)
 
(3,010
)
Amortization of lease incentive costs
37

 
45

Bad debt expense
(32
)
 
406

Amortization of ground lease
124

 
124

Impairment loss
5,435

 

Change in operating assets and liabilities:
 
 
 
Restricted cash
3,039

 
(720
)
Accounts receivable
2,216

 
(1,916
)
Deferred leasing costs and lease intangibles
(9,276
)
 
(1,963
)
Prepaid expenses and other assets
1,683

 
(934
)
Accounts payable and accrued liabilities
3,093

 
4,445

Security deposits
460

 
564

Prepaid rent
(2,789
)
 
(813
)
Net cash provided by operating activities
30,991

 
22,401

CASH FLOWS FROM INVESTING ACTIVITIES
 
 
 
Additions to investment property
(38,623
)
 
(10,019
)
Property acquisitions
(9,994
)
 
(93,476
)
Deposits for property acquisitions
(20,000
)
 
(8,900
)
Net cash used in investing activities
(68,617
)
 
(112,395
)
CASH FLOWS FROM FINANCING ACTIVITIES
 
 
 
Proceeds from notes payable
8,720

 
83,000

Payments of notes payable
(61,279
)
 
(132,158
)
Proceeds from issuance of common stock
189,888

 
190,798

Common stock issuance transaction costs
(392
)
 
(107
)
Proceeds from issuance of Series B cumulative redeemable preferred stock

 
57,500

Series B stock issuance transaction costs

 
(1,865
)
Dividends paid to common stock and unit holders
(14,773
)
 
(10,783
)
Dividends paid to preferred stock and unit holders
(6,462
)
 
(6,462
)
Repurchase of vested restricted stock
(650
)
 

Payment of loan costs

 
(1,109
)
Net cash provided by financing activities
115,052

 
178,814

Net increase in cash and cash equivalents
77,426

 
88,820

Cash and cash equivalents—beginning of period
18,904

 
13,705

Cash and cash equivalents—end of period
$
96,330

 
$
102,525

Supplemental disclosure of cash flow information
 
 
 
Cash paid for interest, net of amounts capitalized
$
10,954

 
$
9,054

Supplemental schedule of noncash investing and financing activities
 
 
 
Accounts payable and accrued liabilities for investment in property
$
3,279

 
$
3,031

See footnote 3 for additional non-cash disclosures related to acquisition related activities.


The accompanying notes are an integral part of these consolidated financial statements.
8


Table of Contents


Notes to Consolidated Financial Statements
(Unaudited and in thousands, except square footage and share data or as otherwise noted)

1. Organization

Hudson Pacific Properties, Inc. (which is referred to in these financial statements as the “Company,” “we,” “us,” or “our”) is a Maryland corporation formed on November 9, 2009 that did not have any meaningful operating activity until the consummation of our initial public offering and the related acquisition of our predecessor and certain other entities on June 29, 2010 (“IPO”). Concurrently with the closing of our IPO, we combined with our predecessor and Howard Street Associates, LLC and acquired certain other entities.

We determined that one of the entities comprising our predecessor, SGS Realty II, LLC, was the acquirer for accounting purposes in our formation transactions that occurred in connection with our IPO. In addition, we concluded that any interests contributed by the controlling member of the other entities comprising our predecessor and Howard Street Associates, LLC in connection with our IPO was a transaction between entities under common control. As a result, the contribution of interests in each of these entities was recorded at historical cost.

Since the completion of the IPO, the concurrent private placement, and the related formation transactions, we have been a fully integrated, self-administered, and self-managed real estate investment trust (“REIT”). Through our controlling interest in Hudson Pacific Properties, L.P. (our “Operating Partnership”) and its subsidiaries, we own, manage, lease, acquire and develop real estate, consisting primarily of office and media and entertainment properties. As of June 30, 2013, we owned a portfolio of 21 office properties and two media and entertainment properties. All of these properties are located in California. The results of operations for properties acquired after our IPO are included in our consolidated statements of operations from the date of each such acquisition.

2. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying consolidated financial statements of the Company are prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). The effect of all significant intercompany balances and transactions has been eliminated.

The accompanying unaudited interim financial statements have been prepared pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in the financial statements prepared in accordance with accounting principles generally accepted in the United States may have been condensed or omitted pursuant to SEC rules and regulations, although we believe that the disclosures are adequate to make their presentation not misleading. The accompanying unaudited financial statements include, in our opinion, all adjustments, consisting of normal recurring adjustments, necessary to present fairly the financial information set forth therein. The results of operations for the interim periods are not necessarily indicative of the results that may be expected for the year ended December 31, 2013. The interim financial statements should be read in conjunction with the consolidated financial statements in our 2012 Annual Report on Form 10-K and the notes thereto. Any reference to the number of properties and square footage are unaudited and outside the scope of our independent registered public accounting firm’s review of our financial statements in accordance with the standards of the United States Public Company Accounting Oversight Board.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of commitments and contingencies at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, the Company evaluates its estimates, including those related to acquiring, developing and assessing the carrying values of its real estate properties, its accrued liabilities, and its performance-based equity compensation awards. The Company bases its estimates on historical experience, current market conditions, and various other assumptions that are believed to be reasonable under the circumstances. Actual results could materially differ from these estimates.


9

Table of Contents
Notes to Consolidated Financial Statements—(Continued)
(Unaudited and in thousands, except square footage and share data)


Investment in Real Estate Properties

The properties are carried at cost less accumulated depreciation and amortization. The Company assigns the cost of an acquisition, including the assumption of liabilities, to the acquired tangible assets and identifiable intangible assets and liabilities based on their estimated fair values in accordance with GAAP. The Company assesses fair value based on estimated cash flow projections that utilize discount and/or capitalization rates and available market information. Estimates of future cash flows are based on a number of factors including historical operating results, known and anticipated trends, and market and economic conditions. The fair value of tangible assets of an acquired property considers the value of the property as if it was vacant.

Acquisition-related expenses associated with acquisition of operating properties are expensed in the period incurred.

The Company records acquired “above and below” market leases at fair value using discount rates that reflect the risks associated with the leases acquired. The amount recorded is based on the present value of the difference between (i) the contractual amounts to be paid pursuant to each in-place lease and (ii) management’s estimate of fair market lease rates for each in-place lease, measured over a period equal to the remaining term of the lease for above-market leases and the initial term plus the extended term for any leases with below-market renewal options. Other intangible assets acquired include amounts for in-place lease values that are based on the Company’s evaluation of the specific characteristics of each tenant’s lease. Factors considered include estimates of carrying costs during hypothetical expected lease-up periods, market conditions and costs to execute similar leases. In estimating carrying costs, the Company includes estimates of lost rents at market rates during the hypothetical expected lease-up periods, which are dependent on local market conditions. In estimating costs to execute similar leases, the Company considers leasing commissions, legal and other related costs.

The Company capitalizes direct construction and development costs, including predevelopment costs, interest, property taxes, insurance and other costs directly related and essential to the acquisition, development or construction of a real estate project. Indirect development costs, including salaries and benefits, office rent, and associated costs for those individuals directly responsible for and who spend their time on development activities are also capitalized and allocated to the projects to which they relate. Capitalized personnel costs for the three and six months ended June 30, 2013 and 2012, were approximately $0.5 million and $1.0 million and $0.2 million and $0.4 million, respectively. Interest is capitalized on the construction in progress at a rate equal to the Company’s weighted average cost of debt. Construction and development costs are capitalized while substantial activities are ongoing to prepare an asset for its intended use. The Company considers a construction project as substantially complete and held available for occupancy upon the completion of tenant improvements, but no later than one year after cessation of major construction activity. Costs incurred after a project is substantially complete and ready for its intended use, or after development activities have ceased, are expensed as incurred. Costs previously capitalized related to abandoned acquisitions or developments are charged to earnings. Expenditures for repairs and maintenance are expensed as incurred.

The Company computes depreciation using the straight-line method over the estimated useful lives of a range of 39 years for building and improvements, 15 years for land improvements, 5 or 7 years for furniture and fixtures and equipment, and over the shorter of asset life or life of the lease for tenant improvements. Above- and below-market lease intangibles are amortized to revenue over the remaining non-cancellable lease terms and bargain renewal periods, if applicable. Other in-place lease intangibles are amortized to expense over the remaining non-cancellable lease term. Depreciation is discontinued when a property is identified as held for sale.

Impairment of Long-Lived Assets

The Company assesses the carrying value of real estate assets and related intangibles whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable in accordance with GAAP. Impairment losses are recorded on real estate assets held for investment when indicators of impairment are present and the future undiscounted cash flows estimated to be generated by those assets are less than the assets’ carrying amount. The Company recognizes impairment losses to the extent the carrying amount exceeds the fair value of the properties. Properties held for sale are recorded at the lower of cost or estimated fair value less cost to sell. The Company recorded $5.4 million of impairment charges related to a property held for sale during the three and six months ended June 30, 2013 with no comparable charge for the three and six months ended 2012. There was one property held for sale at June 30, 2013 and no properties held for sale at December 31, 2012.


10

Table of Contents
Notes to Consolidated Financial Statements—(Continued)
(Unaudited and in thousands, except square footage and share data)


Goodwill

Goodwill represents the excess of acquisition cost over the fair value of net tangible and identifiable intangible assets acquired and liabilities assumed in business combinations. Our goodwill balance as of June 30, 2013 was $8,754. We do not amortize this asset but instead analyze it on an annual basis for impairment. No impairment indicators have been noted during the three and six months ended June 30, 2013 and 2012.

Cash and Cash Equivalents

Cash and cash equivalents are defined as cash on hand and in banks, plus all short-term investments with a maturity of three months or less when purchased.

The Company maintains some of its cash in bank deposit accounts that, at times, may exceed the federally insured limit. No losses have been experienced related to such accounts.

Restricted Cash

Restricted cash consists of amounts held by lenders to provide for future real estate taxes and insurance expenditures, repairs and capital improvements reserves, general and other reserves and security deposits.

Accounts Receivable and Allowance for Doubtful Accounts

Accounts receivable consist of amounts due for monthly rents and other charges. The Company maintains an allowance for doubtful accounts for estimated losses resulting from tenant defaults or the inability of tenants to make contractual rent and tenant recovery payments. The Company monitors the liquidity and creditworthiness of its tenants and operators on an ongoing basis. This evaluation considers industry and economic conditions, property performance, credit enhancements and other factors. For straight-line rent amounts, the Company’s assessment is based on amounts estimated to be recoverable over the term of the lease. At June 30, 2013 and December 31, 2012, respectively, the Company has reserved $7 and $8 of straight-line receivables. The Company evaluates the collectability of accounts receivable based on a combination of factors. The allowance for doubtful accounts is based on specific identification of uncollectible accounts and the Company’s historical collection experience. The Company recognizes an allowance for doubtful accounts based on the length of time the receivables are past due, the current business environment and the Company’s historical experience. Historical experience has been within management’s expectations. The Company recognized $(32) and $406 of bad debt (recovery) expense for the six months ended June 30, 2013 and 2012.

The following summarizes our accounts receivable net of allowance for doubtful accounts as of:

 
 
June 30, 2013
 
December 31, 2012
Accounts receivable
 
10,820

 
13,742

Allowance for doubtful accounts
 
(632
)
 
(1,575
)
Accounts receivable, net
 
10,188

 
12,167


Notes Receivable

Notes receivable consist of a loan we acquired on August 14, 2012 from Jeffries LoanCore LLC in the amount of $4.0 million. The borrower under the loan was WIP 3401 Expo BLVD Mezz, LLC (“WEBM”), which was the sole member of WIP 3401 Expo BLVD, LLC (“WEB”), the owner of that certain property located at 3401 Exposition Blvd. in Santa Monica, California (“3401 Exposition Boulevard”). The property is an approximately 65,000 square-foot office and industrial building currently being renovated for creative office uses. The loan was secured by, among other things, WEBM’s membership interest in WEB, bore interest at the rate of LIBOR plus 1300 basis points (subject to a 100 basis points floor on LIBOR), and was scheduled to mature on June 9, 2014, subject to three one-year extension options. The interest recognized on this loan is included in interest income in the accompanying consolidated statements of operations. The carrying value of the loan approximated fair value as it was negotiated based upon fair value of loans with similar characteristics. The loan generated income of $155 for the six months ended June 30, 2013.


11

Table of Contents
Notes to Consolidated Financial Statements—(Continued)
(Unaudited and in thousands, except square footage and share data)


In connection with the Company’s purchase of 3401 Exposition Boulevard on May 22, 2013, the Company canceled the note associated with this loan and eliminated the note receivable.

Revenue Recognition

The Company recognizes rental revenue from tenants on a straight-line basis over the lease term when collectability is reasonably assured and the tenant has taken possession or controls the physical use of the leased asset. If the lease provides for tenant improvements, the Company determines whether the tenant improvements, for accounting purposes, are owned by the tenant or the Company. When the Company is the owner of the tenant improvements, the tenant is not considered to have taken physical possession or have control of the physical use of the leased asset until the tenant improvements are substantially completed. When the tenant is the owner of the tenant improvements, any tenant improvement allowance that is funded is treated as a lease incentive and amortized as a reduction of revenue over the lease term. Tenant improvement ownership is determined based on various factors including, but not limited to:

whether the lease stipulates how and on what a tenant improvement allowance may be spent;

whether the tenant or landlord retains legal title to the improvements at the end of the lease term;

whether the tenant improvements are unique to the tenant or general-purpose in nature; and

whether the tenant improvements are expected to have any residual value at the end of the lease.

Certain leases provide for additional rents contingent upon a percentage of the tenant’s revenue in excess of specified base amounts or other thresholds. Such revenue is recognized when actual results reported by the tenant, or estimates of tenant results, exceed the base amount or other thresholds. Such revenue is recognized only after the contingency has been removed (when the related thresholds are achieved), which may result in the recognition of rental revenue in periods subsequent to when such payments are received.

Other property-related revenue is revenue that is derived from the tenants’ use of lighting, equipment rental, parking, power, HVAC and telecommunications (phone and Internet). Other property-related revenue is recognized when these items are provided.

Tenant recoveries related to reimbursement of real estate taxes, insurance, repairs and maintenance, and other operating expenses are recognized as revenue in the period during which the applicable expenses are incurred. The reimbursements are recognized and presented gross, as the Company is generally the primary obligor with respect to purchasing goods and services from third-party suppliers, has discretion in selecting the supplier and bears the associated credit risk.

The Company recognizes gains on sales of properties upon the closing of the transaction with the purchaser. Gains on properties sold are recognized using the full accrual method when (i) the collectability of the sales price is reasonably assured, (ii) the Company is not obligated to perform significant activities after the sale, (iii) the initial investment from the buyer is sufficient and (iv) other profit recognition criteria have been satisfied. Gains on sales of properties may be deferred in whole or in part until the requirements for gain recognition have been met.

Deferred Financing Costs

Deferred financing costs are amortized over the term of the respective loan.

Derivative Financial Instruments

The Company manages interest rate risk associated with borrowings by entering into interest rate derivative contracts. The Company recognizes all derivatives on the consolidated balance sheet at fair value. Derivatives that are not hedges are adjusted to fair value and the changes in fair value are reflected as income or expense. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of derivatives are either offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings, or recognized in other comprehensive income, which is a component of equity. The ineffective portion of a derivative’s change in fair value is immediately recognized in earnings.


12

Table of Contents
Notes to Consolidated Financial Statements—(Continued)
(Unaudited and in thousands, except square footage and share data)


The Company held two interest rate contracts as of June 30, 2013 and December 31, 2012, which have been accounted for as cash flow hedges as more fully described in note 6 below.

Stock-Based Compensation

Accounting Standard Codification, or ASC, Topic 718, Compensation—Stock Compensation (referred to as ASC Topic 718 and formerly known as FASB 123R), requires us to recognize an expense for the fair value of equity-based compensation awards. Grants of stock options, restricted stock, restricted stock units and performance units under our equity incentive award plans are accounted for under ASC Topic 718. Our compensation committee will regularly consider the accounting implications of significant compensation decisions, especially in connection with decisions that relate to our equity incentive award plans and programs.

Income Taxes

Our taxable income prior to the completion of our IPO is reportable by the members of the limited liability companies that comprise our predecessor. Our property-owning subsidiaries are limited liability companies and are treated as pass-through entities for income tax purposes. Accordingly, no provision has been made for federal income taxes in the accompanying consolidated financial statements for the activities of these entities.

We have elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended (the “Code”) commencing with our initial taxable year. To qualify as a REIT, we are required to distribute at least 90% of our REIT taxable income to our stockholders and meet the various other requirements imposed by the Code relating to such matters as operating results, asset holdings, distribution levels and diversity of stock ownership. Provided we qualify for taxation as a REIT, we are generally not subject to corporate level income tax on the earnings distributed currently to our stockholders that we derive from our REIT qualifying activities. If we fail to qualify as a REIT in any taxable year, and are unable to avail ourselves of certain savings provisions set forth in the Code, all of our taxable income would be subject to federal income tax at regular corporate rates, including any applicable alternative minimum tax.

We have elected, together with one of our subsidiaries, to treat such subsidiary as a taxable REIT subsidiary (“TRS”) for federal income tax purposes. Certain activities that we undertake must be conducted by a TRS, such as non-customary services for our tenants, and holding assets that we cannot hold directly. A TRS is subject to federal and state income taxes.

The Company is subject to the statutory requirements of the state in which it conducts business.

The Company periodically evaluates its tax positions to determine whether it is more likely than not that such positions would be sustained upon examination by a tax authority for all open tax years, as defined by the statute of limitations, based on their technical merits. As of June 30, 2013, the Company has not established a liability for uncertain tax positions.

Fair Value of Assets and Liabilities

Under GAAP, the Company is required to measure certain financial instruments at fair value on a recurring basis. In addition, the Company is required to measure other financial instruments and balances at fair value on a non-recurring basis (e.g., carrying value of impaired real estate and long-lived assets). Fair value is defined as the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The GAAP fair value framework uses a three-tiered approach. Fair value measurements are classified and disclosed in one of the following three categories:

Level 1: unadjusted quoted prices in active markets that are accessible at the measurement date for identical assets or liabilities;

Level 2: quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-derived valuations in which significant inputs and significant value drivers are observable in active markets; and

Level 3: prices or valuation techniques where little or no market data is available that requires inputs that are both significant to the fair value measurement and unobservable.


13

Table of Contents
Notes to Consolidated Financial Statements—(Continued)
(Unaudited and in thousands, except square footage and share data)


When available, the Company utilizes quoted market prices from an independent third-party source to determine fair value and classifies such items in Level 1 or Level 2. In instances where the market for a financial instrument is not active, regardless of the availability of a nonbinding quoted market price, observable inputs might not be relevant and could require the Company to make a significant adjustment to derive a fair value measurement. Additionally, in an inactive market, a market price quoted from an independent third party may rely more on models with inputs based on information available only to that independent third party. When the Company determines the market for a financial instrument owned by the Company to be illiquid or when market transactions for similar instruments do not appear orderly, the Company uses several valuation sources (including internal valuations, discounted cash flow analysis and quoted market prices) and establishes a fair value by assigning weights to the various valuation sources.

Changes in assumptions or estimation methodologies can have a material effect on these estimated fair values. In this regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, may not be realized in an immediate settlement of the instrument.

The Company considers the following factors to be indicators of an inactive market: (i) there are few recent transactions, (ii) price quotations are not based on current information, (iii) price quotations vary substantially either over time or among market makers (for example, some brokered markets), (iv) indexes that previously were highly correlated with the fair values of the asset or liability are demonstrably uncorrelated with recent indications of fair value for that asset or liability, (v) there is a significant increase in implied liquidity risk premiums, yields, or performance indicators (such as delinquency rates or loss severities) for observed transactions or quoted prices when compared with the Company’s estimate of expected cash flows, considering all available market data about credit and other nonperformance risk for the asset or liability, (vi) there is a wide bid-ask spread or significant increase in the bid-ask spread, (vii) there is a significant decline or absence of a market for new issuances (that is, a primary market) for the asset or liability or similar assets or liabilities, and (viii) little information is released publicly (for example, a principal-to-principal market).

The Company considers the following factors to be indicators of non-orderly transactions: (i) there was not adequate exposure to the market for a period before the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets or liabilities under current market conditions, (ii) there was a usual and customary marketing period, but the seller marketed the asset or liability to a single market participant, (iii) the seller is in or near bankruptcy or receivership (that is, distressed), or the seller was required to sell to meet regulatory or legal requirements (that is, forced), and (iv) the transaction price is an outlier when compared with other recent transactions for the same or similar assets or liabilities.    

The Company’s interest rate contract agreements are classified as Level 2 and their fair value is derived from estimated values obtained from observable market data for similar instruments.

As of June 30, 2013, the Company had the following outstanding interest rate derivatives that were designated as cash flow hedges of interest rate risk:

Interest Rate Derivative
Number of Instruments
Notional Amount
Interest Rate Caps
2
$92.0 million

Non-designated Hedges

For the six months ended June 30, 2013 and 2012, all of the Company’s derivatives were designated as cash flow hedges.

Tabular Disclosure of Fair Values of Derivative Instruments on the Balance Sheet

The table below presents a gross presentation, the effects of offsetting, and a net presentation of the Company’s derivatives as of June 30, 2013 and December 31, 2012. The net amounts of derivative assets or liabilities can be reconciled to the tabular disclosure of fair value. The tabular disclosure of fair value provides the location that derivative assets and liabilities are presented on the consolidated balance sheets.


14

Table of Contents
Notes to Consolidated Financial Statements—(Continued)
(Unaudited and in thousands, except square footage and share data)


 
 
Asset Derivatives
 
Liability Derivatives
 
 
 
Fair Value as of
 
 
Fair Value as of
 
 
Balance Sheet Location
June 30, 2013
 
December 31, 2012
 
Balance Sheet Location
June 30, 2013
 
December 31, 2012
Derivatives designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
Interest rate products
 
Interest rate contracts
$
123

 
$
71

 
Interest rate contracts

 

 
 
 
 
 
 
 
 
 
 
 
Total
 
 
$
123

 
$
71

 
 

 


Tabular Disclosure of the Effect of Derivative Instruments on the Income Statement

The tables below present the effect of the Company’s derivative financial instruments on the Statement of Operations for the three months ended June 30, 2013 and 2012.

 
 
Six Months Ended June 30,
 
 
2013
 
2012
Beginning Balance of OCI related to interest rate contracts
 
1,465

 
1,036

Unrealized Loss Recognized in OCI Due to Change in Fair Value of interest rate contracts
 
(52
)
 
356

Loss Reclassified from OCI into Income (as Interest Expense)
 
(63
)
 
(3
)
Net Change in OCI
 
(115
)
 
353

Ending Balance of Accumulated OCI Related to Derivatives
 
1,350

 
1,389


Credit-Risk-Related Contingent Features

As of June 30, 2013, the Company did not have any derivatives that were in a net liability position.

Recently Issued Accounting Literature

Changes to GAAP are established by the FASB in the form of ASUs. We consider the applicability and impact of all ASUs. Recently issued ASUs not listed below are not expected to have a material impact on our consolidated financial position and results of operations, because either the ASU is not applicable or the impact is expected to be immaterial.

3. Investment in Real Estate

Acquisitions

During 2013, we acquired the following properties: 3401 Exposition and Pinnacle II. The results of operations for each of these acquisitions are included in our consolidated statements of operations from the date of acquisition. The following table represents our purchase price accounting for each of these acquisitions:



15

Table of Contents
Notes to Consolidated Financial Statements—(Continued)
(Unaudited and in thousands, except square footage and share data)


 
3401 Exposition
 
Pinnacle II
 
 
Date of Acquisition
May 22, 2013
 
June 14, 2013
 
Total
Consideration paid
 
 
 
 
 
Cash consideration
$
8,489

 
$
1,505

 
$
9,994

Debt Assumed
13,233

 
89,066

 
102,299

Non-controlling interest in consolidated real estate entity

 
45,704

 
45,704

Total consideration
$
21,722

 
$
136,275

 
$
157,997

Allocation of consideration paid
 
 
 
 
 
Investment in real estate, net
25,439

 
134,289

 
159,728

Leases in place

 
9,805

 
9,805

Other lease intangibles

 
2,832

 
2,832

Fair market unfavorable debt value

 
(5,820
)
 
(5,820
)
Below-market leases

 
(7,783
)
 
(7,783
)
Other (liabilities) asset assumed, net
(3,717
)
 
2,952

 
(765
)
Total consideration paid
$
21,722

 
$
136,275

 
$
157,997


During 2012, we acquired the following properties: 10900 Washington, 901 Market Street, Element LA (Olympic Bundy), 1455 Gordon Street and Pinnacle I. The results of operations for each of these acquisitions are included in our consolidated statements of operations from the date of acquisition. The following table represents our purchase price accounting for each of these acquisitions:

 
10900 Washington
 
901 Market
 
Element LA
 
1455 Gordon Street
 
Pinnacle I
 
 
Date of Acquisition
April 5, 2012
 
June 1, 2012
 
September 5, 2012
 
September 21, 2012
 
November 8, 2012
 
Total
Consideration paid
 
 
 
 
 
 
 
 
 
 
 
Cash consideration
$
2,605

 
$
90,871

 
$
88,436

 
$
2,385

 
$
208,023

 
$
392,320

Debt Assumed

 

 

 

 

 

Non-controlling interest in consolidated real estate entity

 

 

 

 
1,481

 
1,481

Total consideration
$
2,605

 
$
90,871

 
$
88,436

 
$
2,385

 
$
209,504

 
$
393,801

Allocation of consideration paid
 
 
 
 
 
 
 
 
 
 
 
Investment in real estate, net
2,600

 
97,187

 
88,024

 
2,384

 
200,175

 
390,370

Above-market leases

 

 

 

 
167

 
167

Leases in place

 
2,968

 
1,325

 
96

 
11,710

 
16,099

Other lease intangibles

 
548

 
46

 
22

 
3,456

 
4,072

Fair market unfavorable debt value

 

 

 

 

 

Below-market leases

 
(10,249
)
 
(666
)
 
(27
)
 
(5,076
)
 
(16,018
)
Other (liabilities) asset assumed, net
5

 
417

 
(293
)
 
(90
)
 
(928
)
 
(889
)
Total consideration paid
$
2,605

 
$
90,871

 
$
88,436

 
$
2,385

 
$
209,504

 
$
393,801


The table below shows the pro forma financial information for the six months ended June 30, 2013 and 2012 as if these properties had been acquired as of January 1, 2012.
 
 
Six Months Ended June 30,
 
2013
2012
Total revenues
$
99,095

$
94,206

Net loss
$
(5,432
)
$
(4,744
)

16

Table of Contents
Notes to Consolidated Financial Statements—(Continued)
(Unaudited and in thousands, except square footage and share data)


During the six months ended June 30, 2013, we made a deposit of approximately 20.0 million in connection with acquisition of a four-building, 836,419 square-foot office portfolio in Seattle, Washington (the “Seattle Portfolio”) from Spear Street Capital which closed on July 31, 2013. See note 13 for further details.

Dispositions

On May 31, 2013, the Company entered into an agreement to sell its City Plaza property for approximately $56.0 million (before certain credits, prorations, and closing costs). The transaction closed on July 12, 2013. The transaction resulted in an approximately $5.4 million impairment loss. The Company reclassified City Plaza’s results of operations for the three and six months ended June 30, 2013 and 2012 to discontinued operations on its consolidated statements of operations.

The following table sets forth the discontinued operations for the three and six months ended June 30, 2013 and 2012 for the City Plaza:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
Total office revenues
1,966

 
1,521

 
3,962

 
2,988

Office operating expenses
(768
)
 
(721
)
 
(1,555
)
 
(1,368
)
Depreciation and amortization
(315
)
 
(516
)
 
(789
)
 
(1,034
)
Income from discontinued operations
883

 
284

 
1,618

 
586

 
4. Lease Intangibles
The following summarizes our deferred leasing cost and lease intangibles as of:
 
 
June 30,
2013
 
December 31,
2012
Above-market leases
$
17,283

 
$
17,283

Leases in place
74,127

 
67,097

Below-market ground leases
7,513

 
7,513

Other lease intangibles
31,756

 
30,747

Deferred leasing costs
18,087

 
9,302

 
148,766

 
131,942

Accumulated amortization
(59,873
)
 
(50,932
)
Deferred leasing costs and lease intangibles, net
$
88,893

 
$
81,010

 
 
 
 
Below-market leases
52,875

 
46,042

Accumulated accretion
(17,659
)
 
(14,482
)
Acquired lease intangible liabilities, net
$
35,216

 
$
31,560

 
 
 
 

5. Notes Payable

Senior Unsecured Revolving Credit Facility

On August 3, 2012, we replaced our $200.0 million secured revolving credit facility with a $250.0 million unsecured revolving credit facility with a group of lenders for which Wells Fargo Bank, N.A. acts as administrative agent and its affiliate acts as joint lead arranger, Bank of America, N.A. acts as joint lead arranger and, together with Barclays Capital, acts as joint syndication agent, and Keybank, N.A., acts as documentation agent. Our Operating Partnership is the borrower under our new unsecured revolving credit facility. The facility is required to be guaranteed by us and all of our subsidiaries that own unencumbered properties. The facility includes an accordion feature that allows us to increase the availability by $150.0 million, to $400.0 million, under specified circumstances and subject to receiving commitments from lenders.

17

Table of Contents
Notes to Consolidated Financial Statements—(Continued)
(Unaudited and in thousands, except square footage and share data)


Our facility bears interest at a rate per annum equal to LIBOR plus 155 basis points to 220 basis points, depending on our leverage ratio. If the Company obtains a credit rating for its senior unsecured long term indebtedness, it may make an irrevocable election to change the interest rate for the facility to a rate per annum equal to LIBOR plus 100 basis points to 185 basis points, depending on the credit rating. Our facility is subject to a facility fee in an amount equal to our unused commitments multiplied by a rate per annum equal to 25 basis points to 35 basis points, depending on our usage of the facility, or, if we make the credit rating election, in an amount equal to the aggregate amount of our commitments multiplied by a rate per annum equal to 15 basis points to 45 basis points, depending upon the credit rating. The amount available for us to borrow under the facility is subject to compliance with certain covenants, including the following financial covenants:
a maximum leverage ratio (defined as consolidated total indebtedness plus our pro rata share of indebtedness of unconsolidated affiliates to total asset value) of 0.60:1.00;
a minimum fixed charge coverage ratio (defined as consolidated earnings before interest, taxes, depreciation and amortization (“EBITDA”) plus our pro rata share of EBITDA of unconsolidated affiliates to fixed charges) of 1.50:1.00;
a maximum secured indebtedness leverage ratio (defined as consolidated secured indebtedness plus our pro rata share of secured indebtedness of unconsolidated affiliates to total asset value) of 0.60:1:00 through and including August 3, 2014 and 0.55:1:00 thereafter;
a maximum unencumbered leverage ratio (defined as consolidated unsecured indebtedness plus our pro rata share of unsecured indebtedness of unconsolidated affiliates to total unencumbered asset value) of 0.60:1:00;
a minimum unsecured interest coverage ratio (defined as consolidated net operating income from unencumbered properties plus our pro rata share of net operating income from unencumbered properties to unsecured interest expense) of 1.60:1.00; and
a maximum recourse debt ratio (defined as recourse indebtedness other than indebtedness under the revolving credit facility but including unsecured lines of credit to total asset value) of 0.15:1.00.

In addition to these covenants, the facility also includes certain limitations on dividend payouts and distributions, limits on certain types of investments outside of our primary business, and other customary affirmative and negative covenants. Our ability to borrow under the facility is subject to continued compliance with these covenants.
As of June 30, 2013, we were in compliance with our facility’s financial covenants. As of June 30, 2013, we had approximately $240.6 million of total capacity under our unsecured revolving credit facility, of which nothing had been drawn.
The following table sets forth information as of June 30, 2013 with respect to our outstanding indebtedness.
 
 
Outstanding
 
 
 
 
Debt
June 30, 2013
 
December 31, 2012
 
Interest Rate(1)
 
Maturity
Date
Unsecured Revolving Credit Facility
$

 
$
55,000

 
LIBOR+1.55% to 2.20%
 
8/3/2016
Mortgage loan secured by 625 Second Street(2)
33,700

 
33,700

 
5.85%
 
2/1/2014
Mortgage loan secured by 3401 Exposition Blvd.(3)
13,233

 

 
LIBOR+3.80%
 
5/31/2014
Mortgage loan secured by 6922 Hollywood Boulevard(4)
40,858

 
41,243

 
5.58%
 
1/1/2015
Mortgage loan secured by 275 Brannan(5)
3,858

 
138

 
LIBOR+2.00%
 
10/5/2015
Mortgage loan secured by Sunset Gower/Sunset Bronson(6)
92,000

 
92,000

 
LIBOR+3.50%
 
2/11/2016
Mortgage loan secured by Pinnacle II(7)
89,066

 

 
6.313%
 
9/1/2016
Mortgage loan secured by 901 Market(8)
49,600

 
49,600

 
LIBOR+2.25%
 
10/31/2016
Mortgage loan secured by Rincon Center(9)
106,803

 
107,492

 
5.134%
 
5/1/2018
Mortgage loan secured by First Financial(10)
43,000

 
43,000

 
4.58%
 
2/1/2022
Mortgage loan secured by 10950 Washington(11)
29,506

 
29,711

 
5.316%
 
3/11/2022
Mortgage loan secured by Pinnacle I
129,000

 
129,000

 
3.954%
 
11/7/2022
Subtotal
$
630,624

 
$
580,884

 
 
 
 
Unamortized loan premium, net(12)
6,494

 
1,201

 
 
 
 
Total
$
637,118

 
$
582,085

 
 
 
 
__________________ 
(1)
Interest rate with respect to indebtedness is calculated on the basis of a 360-day year for the actual days elapsed, excluding the amortization of loan fees and costs.
(2)
This loan was assumed on September 1, 2011 in connection with the closing of our acquisition of the 625 Second Street property.
(3)
This loan was assumed on May 22, 2013 in connection with the closing of our acquisition of the 3401 Exposition Boulevard property.

18

Table of Contents
Notes to Consolidated Financial Statements—(Continued)
(Unaudited and in thousands, except square footage and share data)


(4)
This loan was assumed on November 22, 2011 in connection with the closing of our acquisition of the 6922 Hollywood Boulevard property.
(5)
On October 5, 2012, we obtained a loan for our 275 Brannan property pursuant to which we have the ability to draw up to $15,000 for budgeted base building, tenant improvements, and other costs associated with the renovation and lease-up of that property.
(6)
On February 11, 2011, we closed a five-year term loan totaling $92,000 with Wells Fargo Bank, N.A., secured by our Sunset Gower and Sunset Bronson media and entertainment properties. The loan bears interest at a rate equal to one-month LIBOR plus 3.50%. $37,000 of the loan was subject to an interest rate contract, which swaps one-month LIBOR to a fixed rate of 0.75% through April 30, 2011. On March 16, 2011, we purchased an interest rate cap in order to cap one-month LIBOR at 3.715% with respect to $50,000 of the loan through its maturity on February 11, 2016. On January 11, 2012 we purchased an interest rate cap in order to cap one-month LIBOR at 2.00% with respect to $42,000 of the loan through its maturity on February 11, 2016. Beginning with the payment due February 1, 2014, monthly debt service will include principal payments based on a 30-year amortization schedule, for total annual debt amortization of $1,113.
(7)
This loan was assumed on June 14, 2013 in connection with the contribution of the Pinnacle II building to the Company’s joint venture for The Pinnacle.
(8)
On October 29, 2012, we obtained a loan for our 901 Market property pursuant to which we borrowed $49,600 upon closing, with the ability to draw up to an additional $11,900 for budgeted base building, tenant improvements, and other costs associated with the renovation and lease-up of that property.
(9)
On April 29, 2011, we closed a seven-year term loan totaling $110,000 with JPMorgan Chase Bank, National Association, secured by our Rincon Center property. The loan bears interest at a fixed annual rate of 5.134%
(10)
The loan bears interest only for the first two years. Beginning with the payment due March 1, 2014, monthly debt service will include principal payments based on a 30-year amortization schedule, for total annual debt service of $2,639.
(11)
On February 11, 2012, we closed a 10-year term loan totaling $30,000 with Cantor Commercial Real Estate Lending, L.P., secured by our 10950 Washington property. The loan bears interest at a fixed annual rate of 5.316% and will mature on March 11, 2022.
(12)
Represents unamortized amount of the non-cash mark-to-market adjustment on debt associated with 625 Second Street, 6922 Hollywood Boulevard and Pinnacle II.

The Company presents its financial statements on a consolidated basis. Notwithstanding such presentation, except to the extent expressly indicated, such as in the case of the project financing for our Sunset Gower and Sunset Bronson properties, our separate property-owning subsidiaries are not obligors of or under the debt of their respective affiliates and each property-owning subsidiary’s separate liabilities do not constitute obligations of its respective affiliates.

The minimum future annual principal payments due on our secured and unsecured notes payable at June 30, 2013, excluding the non-cash loan premium amortization, were as follows (in thousands):

    
2013 (six months ending December 31, 2013)
$
2,662

2014
53,139

2015
48,397

2016
228,309

2017
3,456

2018
101,713

Thereafter
192,948

Total
$
630,624


6. Interest Rate Contracts

On February 11, 2011, we closed a five-year term loan totaling $92.0 million with Wells Fargo Bank, N.A., secured by our Sunset Gower and Sunset Bronson media and entertainment campuses. The loan bears interest at a rate equal to one-month LIBOR plus 3.50%. On March 16, 2011, we purchased an interest rate cap in order to cap one-month LIBOR at 3.715% on $50.0 million of the loan through its maturity on February 11, 2016. On January 11, 2012 we purchased an interest rate cap in order to cap one-month LIBOR at 2.00% with respect to $42.0 million of the loan through its maturity on February 11, 2016. We designated both of these interest rate cap contracts as a cash flow hedge for accounting purposes.

The combined fair market value of the interest rate caps at June 30, 2013 and December 31, 2012 was $123 and $71, respectively.

7. Future Minimum Base Rents and Lease Payments Future Minimum Rents

Our properties are leased to tenants under operating leases with initial term expiration dates ranging from 2013 to 2020. Approximate future combined minimum rentals (excluding tenant reimbursements for operating expenses and without regard to cancellation options) for properties at June 30, 2013 are as follows for the years/periods ended December 31. The table below does not include rents under leases at our media and entertainment properties with terms of one year or less.
 

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Table of Contents
Notes to Consolidated Financial Statements—(Continued)
(Unaudited and in thousands, except square footage and share data)


2013 (six months ending December 31, 2013)
$
54,532

2014
110,698

2015
116,185

2016
111,814

2017
91,485

2018
76,383

Thereafter
287,542

Total
$
848,639

Future Minimum Lease Payments
In conjunction with the acquisition of the Sunset Gower property, our subsidiary, SGS Realty II, LLC, assumed a ground lease agreement (expiring March 31, 2060) for a portion of the land with an unrelated party. As a result of the March 2011 rent adjustment, monthly rent increased to $31, whereas the monthly rent totaled $14 at the time of acquisition. The rental rate is subject to adjustment again in March 2018 and every seven years thereafter.
In conjunction with the acquisition of the Del Amo Office building, our subsidiary, Hudson Del Amo Office, LLC, assumed a ground sublease (expiring June 30, 2049) with an unrelated party. Rent under the ground sublease is $1.00 per year, with the sublessee being responsible for all impositions, insurance premiums, operating charges, maintenance charges, construction costs and other charges, costs and expenses that arise or may be contemplated under any provisions of the ground sublease.
In conjunction with the acquisition of the 9300 Wilshire Boulevard building, our subsidiary, Hudson 9300 Wilshire, LLC, assumed a ground lease (expiring August 14, 2032) with an unrelated party. Minimum rent under the ground lease is $75 per year (additional rent under this lease of 6% of gross rentals less minimum rent, as defined in such lease, is not included in this amount).
In conjunction with the acquisition of the 222 Kearny Street building, our subsidiary, Hudson 222 Kearny, LLC, assumed a ground lease (expiring June 14, 2054) with an unrelated party. Minimum rent under the ground lease is the greater of $975 per year or 20.0% of the first $8,000 of the tenant’s “Operating Income” during any “Lease Year,” as such terms are defined in the ground lease. The chart below reflects the $975 per year lease payment.
The following table provides information regarding our future minimum lease payments at June 30, 2013 under these lease agreements.
 
2013 (six months ending December 31, 2013)
$
709

2014
1,417

2015
1,417

2016
1,417

2017
1,417

2018
1,417

Thereafter
50,825

Total
$
58,619


8. Fair Value of Financial Instruments

The carrying values of cash and cash equivalents, restricted cash, receivables, payables, and accrued liabilities are reasonable estimates of fair value because of the short-term maturities of these instruments. Fair values for notes payable are estimates based on rates currently prevailing for similar instruments of similar maturities using Level 2 instruments. The estimated fair values of interest-rate contract/cap arrangements were derived from estimated values based on observable market data for similar instruments.
 

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Table of Contents
Notes to Consolidated Financial Statements—(Continued)
(Unaudited and in thousands, except square footage and share data)


 
June 30, 2013
 
December 31, 2012
 
Carrying 
Value
 
Fair Value
 
Carrying 
Value
 
Fair Value
Notes payable
$
637,118

 
$
647,813

 
$
582,085

 
$
588,191

Derivative assets, disclosed as “Interest rate contracts”
123

 
123

 
71

 
71

 
9. Equity

Non-controlling Interests

Common units in the Operating Partnership

Common units in the operating partnership consisted of 2,382,563 common units of partnership interests, or common units, not owned by us. Common units and shares of our common stock have essentially the same economic characteristics as they share equally in the total net income or loss distributions of our operating partnership. Investors who own common units have the right to cause our operating partnership to redeem any or all of their common units for cash equal to the then-current market value of one share of common stock or, at our election, issue shares of our common stock in exchange of common units on a one-for-one basis. In February 2012, one of our common unit holders required us to redeem 155,878 common units, and in December 2012, one of our common unit holders required us to redeem 72,500 common units. In both cases, we elected to issue shares of our common stock in exchange for the common units to satisfy the redemption notice and our outstanding common units decreased from 2,610,941 common units outstanding to the current 2,382,563 common units outstanding, with a corresponding increase to our outstanding common stock as of the date of such exchanges, as reflected in the table below under the caption “—Exchange of Common Units for Common Stock.”

Non-controlling interest—members in consolidated entities

Non-controlling interest—members in consolidated entities refers to our joint venture partner, Media Center Partners, LLC, a California limited liability company (“MCP”), with which we have entered into a joint venture, Hudson MC Partners, LLC, a Delaware limited liability company (the “Pinnacle JV”), to acquire The Pinnacle, a two-building (Pinnacle I and Pinnacle II), 625,640 square-foot office property located in Burbank, California. As of June 30, 2013, we own a 65.0% in the Pinnacle JV, which owned the 625,640 square-foot project known as The Pinnacle. As of December 31, 2012 and until the acquisition by the Pinnacle JV of the 231,864 square-foot Pinnacle II building on June 14, 2013, we owned a 98.25% interest in the Pinnacle JV, which owned the 393,776 square-foot Pinnacle I building.

6.25% series A cumulative redeemable preferred units of the Operating Partnership

6.25% series A cumulative redeemable preferred units of the Operating Partnership are 499,014 series A preferred units of partnership interest in our operating partnership, or series A preferred units, that are not owned by us. These series A preferred units are entitled to preferential distributions at a rate of 6.25% per annum on the liquidation preference of $25.00 per unit and became convertible at the option of the holder into common units or redeemable into cash or, at our option, exchangeable for registered shares of common stock, after June 29, 2013. For a description of the conversion and redemption rights of the series A preferred units, please see “Description of the Partnership Agreement of Hudson Pacific Properties, L.P.Material Terms of Our Series A Preferred Units” in our June 23, 2010 Prospectus.

8.375% Series B Cumulative Redeemable Preferred Stock

8.375% series B cumulative redeemable preferred stock are 5,800,000 shares of 8.375% preferred stock, with a liquidation preference of $25.00 per share, $0.01 par value per share. In December 2010 we completed the public offering of 3,500,000 share of our series B preferred stock (including 300,000 shares of series B preferred stock issued and sold pursuant to the exercise of the underwriters’ option to purchase additional shares in part). Total proceeds from the offering, after deducting underwriting discount, were approximately $83.9 million (before transaction costs). On January 23, 2012, we completed the public offering of 2,300,000 of our series B cumulative preferred stock (including 300,000 shares of series B preferred stock issued and sold pursuant to the exercise of the underwriters’ option to purchase additional shares in full). Total proceeds from the offering, after deducting underwriting discount, were approximately $57.5 million (before transaction costs).

Dividends on our series B preferred stock are cumulative from the date of original issue and payable quarterly on or about the last calendar day of each March, June, September and December, at the rate of 8.375% per annum of its $25.00 per share liquidation preference (equivalent to $2.0938 per share per annum). If following a change of control of the Company,

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Table of Contents
Notes to Consolidated Financial Statements—(Continued)
(Unaudited and in thousands, except square footage and share data)


either our series B preferred stock (or any preferred stock of the surviving entity that is issued in exchange for our series B preferred stock) or the common stock of the surviving entity, as applicable, is not listed on the New York Stock Exchange, or NYSE, or quoted on the NASDAQ Stock Market, or NASDAQ (or listed or quoted on a successor exchange or quotation system), holders of our series B preferred stock will be entitled to receive cumulative cash dividends from, and including, the first date on which both the change of control occurred and either our series B preferred stock (or any preferred stock of the surviving entity that is issued in exchange for our series B preferred stock) or the common stock of the surviving entity, as applicable, is not so listed or quoted, at the increased rate of 12.375% per annum per share of the liquidation preference of our series B preferred stock (equivalent to $3.09375 per annum per share) for as long as either our series B preferred stock (or any preferred stock of the surviving entity that is issued in exchange for our series B preferred stock) or the common stock of the surviving entity, as applicable, is not so listed or quoted. Except in instances relating to preservation of our qualification as a REIT or in connection with a change of control of the Company, our series B preferred stock is not redeemable prior to December 10, 2015. On and after December 10, 2015, we may redeem our series B preferred stock in whole, at any time, or in part, from time to time, for cash at a redemption price of $25.00 per share, plus any accrued and unpaid dividends to, but not including, the date of redemption. If at any time following a change of control either our series B preferred stock (or any preferred stock of the surviving entity that is issued in exchange for our series B preferred stock) or the common stock of the surviving entity, as applicable, is not listed on the NYSE or quoted on NASDAQ (or listed or quoted on a successor exchange or quotation system), we will have the option to redeem our series B preferred stock, in whole but not in part, within 90 days after the first date on which both the change of control has occurred and either our series B preferred stock (or any preferred stock of the surviving entity that is issued in exchange for our series B preferred stock) or the common stock of the surviving entity, as applicable, is not so listed or quoted, for cash at $25.00 per share, plus accrued and unpaid dividends, if any, to, but not including, the redemption date. Our series B preferred stock has no maturity date and will remain outstanding indefinitely unless redeemed by us, and it is not subject to any sinking fund or mandatory redemption and is not convertible into any of our other securities. For a full description of the Series B cumulative redeemable preferred stock, please see “Description of our Preferred Stock” in our December 7, 2010 Prospectus.

May 2012 Common Stock Offering

On May 18, 2012, we completed the public offering of 13,225,000 shares of common stock and the exercise of the underwriters’ option to purchase an additional 1,725,000 shares of our common stock at the public offering price of $15.00 per share. Funds affiliated with Farallon Capital Management, L.L.C. acquired 2,000,000 of the shares of common stock offered in this offering.

Total proceeds from the public offering, after underwriters’ discount, were approximately $190.8 million (before transaction costs).

February 2013 Common Stock Offering

On February 12, 2013, we completed the public offering of 8,000,000 shares of common stock and the exercise of the underwriters’ option to purchase an additional 1,200,000 shares of our common stock at the public offering price of $21.50 per share.

Total proceeds from the public offering, after underwriters’ discount, were approximately $189.9 million (before transaction costs).

Exchange of Common Units for Common Stock

In February 2012, we elected to issue 155,878 shares of our common stock in exchange for a corresponding number of
common units to satisfy the common unit redemption notice of Glenborough Fund XIV, L.P.

In December 2012, we elected to issue 72,500 shares of our common stock in exchange for a corresponding number of common units to satisfy the common unit redemption notice of Howard S. Stern.

The table below represents the net income attributable to stockholders and transfers from non-controlling interest (in thousands) for the six months ended:


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Table of Contents
Notes to Consolidated Financial Statements—(Continued)
(Unaudited and in thousands, except square footage and share data)


 
 
June 30,
 
 
2013
 
2012
Net loss attributable to Hudson Pacific Properties, Inc.
 
$
(2,826
)
 
$
(1,626
)
Transfers from the non-controlling interests
 
 
 
 
Increase in common stockholders additional paid-in capital for exchange of common units
 

 
3,780

Change from net income attributable to common stockholders and transfer from non-controlling interests
 
$
(2,826
)
 
$
2,154


Dividends

During the second quarter for 2013, we declared dividends on our common stock and non-controlling common partnership interests of $0.125 per share and unit. We also declared dividends on our series A preferred partnership interests of $0.3906 per unit. In addition, we declared dividends on our series B preferred shares of $0.5234 per share. The second quarter dividends were declared on June 10, 2013 to holders of record on June 20, 2013.

Taxability of Dividends

Earnings and profits, which determine the taxability of distributions to stockholders, may differ from income reported for financial reporting purposes due to the differences for federal income tax purposes in the treatment of loss on extinguishment of debt, revenue recognition, and compensation expense and in the basis of depreciable assets and estimated useful lives used to compute depreciation.

Stock-Based Compensation

The Board of Directors awards restricted shares to non-employee board members on an annual basis as part of such board members’ annual compensation and to newly elected non-employee board members in accordance with our Board of Directors compensation program. The share-based awards are generally issued in the second quarter, and the individual share awards vest in equal annual installments over the applicable service vesting period, which will be three years.

In addition, the Board of Directors awards restricted shares to employees on an annual basis as part of the employees’ annual compensation. The share-based awards are generally issued in the fourth quarter, and the individual share awards vest in equal annual installments over the applicable service vesting period, which will be three years.
    
The following table summarizes the restricted share activity for the six months ended June 30, 2013 and status of all unvested restricted share awards, to our non-employee board members and employees at June 30, 2013:

Non-vested Shares
 
Shares
Weighted-Average Grant-Date Fair Value
Outstanding at January 1, 2013
 
632,344

$
17.12

Granted
 
44,219

22.50

Vested
 
(106,045
)
16.77

Canceled
 
(3,415
)
16.09

Outstanding at June 30, 2013
 
567,103

$
17.61


Six Months Ended June 30,
 
Non-Vested Shares Issued
 
Weighted Average Grant - dated Fair Value
 
Vested Shares
Total Vest-Date Fair Value (in thousands)
2013
 
44,219

 
$
22.50

 
(106,045
)
$
2,258

2012
 
21,567


16.23

 
(95,554
)
1,702


We recognize the total compensation expense for time-vested shares on a straight-line basis over the vesting period based on the fair value of the award on the date of grant.


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Table of Contents
Notes to Consolidated Financial Statements—(Continued)
(Unaudited and in thousands, except square footage and share data)


Hudson Pacific Properties, Inc. 2012 Outperformance Program

On January 1, 2012, the Compensation Committee of our Board of Directors adopted the Hudson Pacific Properties, Inc. 2012 Outperformance Program, or the 2012 Outperformance Program.  Participants in the 2012 Outperformance Program may earn, in the aggregate, up to $10.0 million of stock-settled awards based on our total shareholder return (“TSR”) for the three-year period beginning January 1, 2012 and ending December 31, 2014.  Under the 2012 Outperformance Program, participants will be entitled to share in a performance pool with a value, subject to the $10.0 million cap, equal to the sum of: (i) 4% of the amount by which our TSR during the performance period exceeds 9% simple annual TSR (“the absolute TSR component”), plus (ii) 4% of the amount by which our TSR during the performance period exceeds that of the SNL Equity REIT Index over the performance period (“the relative TSR component”), except that the relative TSR component will be reduced on a linear basis from 100% to 0% for absolute TSR ranging from 7% to 0% simple annual TSR over the performance period. In addition, the relative TSR component may be a negative value equal to 4% of the amount by which we underperform the SNL Equity REIT Index by more than 3% per year during the performance period (if any). If we attain pro-rated TSR performance goals during 2012 and/or 2013 that yield hypothetical bonus pools of up to $2 million for 2012 performance and/or up to $4 million for combined 2012/2013 performance, stock awards issued under the final bonus pool at the end of the performance period will cover a number of shares in the aggregate at least equal to the number of shares that would have been subject to stock awards issued at the end of 2012 or 2013 (whichever is greater) based on our TSR performance and common stock price for such prior years (subject to reduction to comply with the $10.0 million bonus pool limitation). At the end of the three-year performance period, participants who remain employed with us will be paid their percentage interest in the bonus pool as stock awards based on the value of our common stock at the end of the performance period. Half of each such participant's bonus pool interest will be paid in fully vested shares of our common stock and the other half will be paid in restricted stock units (“RSUs”) that vest in equal annual installments over the two years immediately following the performance period (based on continued employment). In addition to these share/RSU payments, each 2012 Outperformance Program award entitles its holder to a cash payment equal to the aggregate dividends that would have been paid during the performance period on the total number of shares and RSUs ultimately issued or granted in respect of such 2012 Outperformance Program award, had such shares and RSUs been outstanding throughout the performance period.

If a participant’s employment is terminated without “cause,” for “good reason” or due to the participant’s death or disability during the performance period (referred to as qualifying terminations), the participant will be paid his or her 2012 Outperformance Program award at the end of the performance period entirely in fully vested shares (except for the performance period dividend equivalent, which will be paid in cash at the end of the performance period). Any such payment will be pro-rated in the case of a termination without “cause” or for “good reason” by reference to the participant’s period of employment during the performance period. If we experience a change in control or a participant experiences a qualifying termination of employment, in either case, after December 31, 2014, any unvested RSUs that remain outstanding will accelerate and vest in full upon such event.

The cost of the 2012 Outperformance Plan (approximately $3.49 million, subject to a forfeiture adjustment equal to 6% of the total cost) will be amortized through the final vesting period under a graded vesting expense recognition schedule. 

The 2012 Outperformance Program was valued, in accordance with ASC Topic 718, at an aggregate of approximately $3.49 million utilizing a Monte Carlo simulation to estimate the probability of the performance vesting conditions being satisfied. The Monte Carlo simulation used a statistical formula underlying the Black-Scholes and binomial formulas and such simulation was run 100,000 times. For each simulation, the payoff is calculated at the settlement dates, which is then discounted to the award date at a risk-free interest rate. The average of the values over all simulations is the expected value of the unit on the award date. Assumptions used in the valuations included (1) factors associated with the underlying performance of the Company’s stock price and total shareholder return over the term of the performance awards including total stock return volatility and risk-free interest and (2) factors associated with the relative performance of the Company’s stock price and total shareholder return when compared to the SNL Equity REIT Index. The valuation was performed in a risk-neutral framework, so no assumption was made with respect to an equity risk premium. The fair value of the 2012 OPP Units is based on the sum of: (1) the present value of the expected payoff to the OPP Award on the measurement dates, if the TSR over the applicable measurement period exceeds performance hurdles of the absolute and the relative TSR components; and (2) the present value of the distributions payable on the 2012 OPP Units. The ultimate reward realized on account of the OPP Award by the holders of the 2012 OPP Units is contingent on the TSR achieved on the measurement dates, both in absolute terms and relative to the TSR of the SNL Equity REIT Index. The per unit fair value of each 2012 OPP Unit was estimated on the date of grant using the following assumptions in the Monte Carlo valuation: expected price volatility for the Company and the SNL Equity REIT index of 36% and 35%, respectively; a risk free rate of 0.40%; and total dividend payments over the measurement period of $1.62 per share.


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Table of Contents
Notes to Consolidated Financial Statements—(Continued)
(Unaudited and in thousands, except square footage and share data)


Hudson Pacific Properties, Inc. 2013 Outperformance Program

On January 1, 2013, the Compensation Committee of our Board of Directors adopted the Hudson Pacific Properties, Inc. 2013 Outperformance Program, or the 2013 Outperformance Program. Participants in the 2013 Outperformance Program may earn, in the aggregate, up to $11.0 million of stock-settled awards based on our total shareholder return (“TSR”) for the three-year period beginning January 1, 2013 and ending December 31, 2015. Under the 2013 Outperformance Program, participants will be entitled to share in a performance pool with a value, subject to the $11.0 million cap, equal to the sum of: (i) 4% of the amount by which our TSR during the performance period exceeds 9% simple annual TSR (the “absolute TSR component”), plus (ii) 4% of the amount by which our TSR during the performance period exceeds that of the SNL Equity REIT Index (determined on a percentage basis that is then multiplied by the sum of (A) our market capitalization on that date, plus (B) the aggregate per share dividend over the performance period through such date) (the “relative TSR component”), except that the relative TSR component will be reduced on a linear basis from 100% to zero percent for absolute TSR ranging from 7% to zero percent simple annual TSR over the performance period. In addition, the relative TSR component may be a negative value equal to 4% of the amount by which we underperform the SNL Equity REIT Index by more than 3% per year during the performance period (if any). If we attain pro-rated TSR performance goals during 2013 and/or 2014 that yield hypothetical bonus pools of up to $2 million for 2013 performance and/or up to $4 million for combined 2013/2014 performance, stock awards issued under the final bonus pool at the end of the performance period will cover a number of shares in the aggregate at least equal to the number of shares that would have been subject to stock awards issued at the end of 2013 or 2014 (whichever is greater) based on our TSR performance and common stock price for such prior years (subject to reduction to comply with the $11.0 million bonus pool limitation). At the end of the three-year performance period, participants who remain employed with us will be paid their percentage interest in the bonus pool as stock awards based on the value of our common stock at the end of the performance period. Half of each such participant’s bonus pool interest will be paid in fully vested shares of our common stock and the other half will be paid in restricted stock units (“RSUs”) that vest in equal annual installments over the two years immediately following the performance period (based on continued employment) and which carry tandem dividend equivalent rights. However, if the performance period is terminated prior to December 31, 2015 in connection with a change in control, 2013 Outperformance Program awards will be paid entirely in fully vested shares of our common stock immediately prior to the change in control. In addition to these share/RSU payments, each 2013 Outperformance Program award entitles its holder to a cash payment equal to the aggregate dividends that would have been paid during the performance period on the total number of shares and RSUs ultimately issued or granted in respect of such 2013 Outperformance Program award, had such shares and RSUs been outstanding throughout the performance period.

If a participant’s employment is terminated without “cause,” for “good reason” or due to the participant’s death or disability during the performance period (referred to as qualifying terminations), the participant will be paid his or her 2013 Outperformance Program award at the end of the performance period entirely in fully vested shares (except for the performance period dividend equivalent, which will be paid in cash at the end of the performance period). Any such payment will be pro-rated in the case of a termination without “cause” or for “good reason” by reference to the participant’s period of employment during the performance period. If we experience a change in control or a participant experiences a qualifying termination of employment, in either case, after December 31, 2015, any unvested RSUs that remain outstanding will accelerate and vest in full upon such event.

The cost of the 2013 Outperformance Program (approximately $4.14 million, subject to a forfeiture adjustment equal to 6% of the total cost) will be amortized through the final vesting period under a graded vesting expense recognition schedule.

The 2013 Outperformance Program was valued, in accordance with ASC topic 718, at an aggregate of approximately $4.14 million utilizing a Monte Carlo simulation to estimate the probability of the performance vesting conditions being satisfied. The Monte Carlo simulation used a statistical formula underlying the Black-Scholes and binomial formulas and such simulation was run 100,000 times. For each simulation, the payoff is calculated at the settlement dates, which is then discounted to the award date at a risk-free interest rate. The average of the values over all simulations is the expected value of the unit on the award date. Assumptions used in the valuations included (1) factors associated with the underlying performance of the Company’s stock price and total shareholder return over the term of the performance awards including total stock return volatility and risk-free interest and (2) factors associated with the relative performance of the Company’s stock price and total shareholder return when compared to the SNL Equity REIT Index. The valuation was performed in a risk-neutral framework, so no assumption was made with respect to an equity risk premium. The fair value of the 2013 OPP Units is based on the sum of: (1) the present value of the expected payoff to the OPP Award on the measurement dates, if the TSR over the applicable measurement period exceeds performance hurdles of the absolute and the relative TSR components; and (2) the present value of the distributions payable on the 2013 OPP Units. The ultimate reward realized on account of the OPP Award by the holders of the 2013 OPP Units is contingent on the TSR achieved on the measurement dates, both in absolute terms and relative to the TSR of the SNL Equity REIT Index. The per unit fair value of each 2013 OPP Unit was estimated on the date of grant using the

25

Table of Contents
Notes to Consolidated Financial Statements—(Continued)
(Unaudited and in thousands, except square footage and share data)


following assumptions in the Monte Carlo valuation: expected price volatility for the Company and the SNL Equity REIT index of 33% and 25%, respectively; a risk free rate of 0.38%; and total dividend payments over the measurement period of $1.50 per share.

For the six months ended June 30, 2013 and 2012, $3,623 and $2,016 of non-cash compensation expense for all stock compensation was recognized as additional paid-in capital, of which $3,512 and $2,002 was included in general and administrative expenses, with the remaining $111 and $14 of stock compensation capitalized to tenant improvement and deferred leasing costs and lease intangibles, net.

10. Related Party Transactions

Effective July 31, 2012, we consented to the assignment of a lease with a tenant of our 222 Kearny Street property to its subtenant, FJM Investments, LLC. The lease comprises approximately 3,707 square feet of the property’s space and has a remaining term through May 31, 2014. The annual rental obligation under the lease for calendar year 2012 is $125, the base rent component of which is subject to three percent annual increases. FJM Investments, LLC was co-founded by and is co-owned by one of our independent directors, Robert M. Moran, Jr.

11. Commitments and Contingencies

Legal

From time to time, the Company is party to various lawsuits, claims and other legal proceedings arising out of, or incident to, our ordinary course of business. Management believes, based in part upon consultation with legal counsel, that the ultimate resolution of all such claims will not have a material adverse effect on the Company’s results of operations, financial position or cash flows. As of June 30, 2013, the risk of material loss from such legal actions impacting the Company’s financial condition or results from operations has been assessed as remote.

Concentrations

As of June 30, 2013, all of the Company’s properties were located in California, which exposes the Company to greater economic risks than if it owned a more geographically dispersed portfolio. Further, for the six months ended June 30, 2013 and 2012, approximately 22%, of the Company’s revenues were derived from tenants in the media and entertainment industry, which makes the Company susceptible to demand for rental space in such industry. Consequently, the Company is subject to the risks associated with an investment in real estate with a concentration of tenants in that industry.

12. Segment Reporting
The Company’s reporting segments are based on the Company’s method of internal reporting, which classifies its operations into two reporting segments: (i) office properties, and (ii) media and entertainment properties. The Company evaluates performance based upon property net operating income from continuing operations (“NOI”) of the combined properties in each segment. NOI is not a measure of operating results or cash flows from operating activities as measured by GAAP, is not indicative of cash available to fund cash needs and should not be considered an alternative to cash flows as a measure of liquidity. All companies may not calculate NOI in the same manner. The Company considers NOI to be an appropriate supplemental financial measure to net income because it helps both investors and management to understand the core operations of the Company’s properties. The Company defines NOI as operating revenues (including rental revenues, other property-related revenue, tenant recoveries and other operating revenues), less property-level operating expenses (which includes external management fees and property-level general and administrative expenses). NOI excludes corporate general and administrative expenses, depreciation and amortization, impairments, gain/loss on sale of real estate, interest expense, acquisition-related expenses and other non-operating items.
Summary information for the reportable segments for the six months ended June 30, 2013 is as follows:
 
 
Office Properties
 
Media and  Entertainment
Properties
 
Total
Revenue
$
74,233

 
$
20,560

 
$
94,793

Operating expenses
27,425

 
11,997

 
39,422

Net operating income
$
46,808

 
$
8,563

 
$
55,371


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Notes to Consolidated Financial Statements—(Continued)
(Unaudited and in thousands, except square footage and share data)


Summary information for the reportable segments for the six months ended June 30, 2012 is as follows:
 
 
Office Properties
 
Media and  Entertainment
Properties
 
Total
Revenue
$
57,514

 
$
18,344

 
$
75,858

Operating expenses
23,766

 
11,059

 
34,825

Net operating income
$
33,748

 
$
7,285

 
$
41,033

The following is reconciliation from NOI to reported net income, the most direct comparable financial measure calculated and presented in accordance with GAAP:
 
 
June 30, 2013
 
June 30, 2012
Net operating income
$
55,371

 
$
41,033

General and administrative
(10,175
)
 
(8,665
)
Depreciation and amortization
(32,813
)
 
(24,806
)
Interest expense
(11,354
)
 
(9,466
)
Interest income
240

 
7

Acquisition-related expenses
(509
)
 
(360
)
Other expense
(54
)
 
(90
)
Income from continuing operations
$
706

 
$
(2,347
)
There were no inter-segment sales or transfers during either of the six months ended June 30, 2013 and 2012.
 
13. Subsequent Events

Seattle Acquisition    
 
On June 11, 2013, the Company entered into a purchase agreement to acquire a four-building, 836,419 square-foot office portfolio in Seattle, Washington (the “Seattle Portfolio”) from Spear Street Capital for approximately $368.6 million (net of certain credits and before closing costs and prorations). The Company closed this transaction on July 31, 2013. The purchase price was paid from a combination of cash-on-hand, asset-level indebtedness and borrowings under the Company’s unsecured revolving credit facility. The Seattle Portfolio consists of the following:

A two-building, 472,881 square-foot waterfront property located in the Pioneer Square submarket of downtown Seattle, which we refer to as the First & King property. This property is 90% leased to tenants such as Capital One/ING Direct, EMC Corporation and Nuance Communications;

A189,762 square-foot Class-A office building located in the South Lake Union submarket of downtown Seattle, which we refer to as the Met Park North property. This building is 99% leased, with 74% of the building to be occupied by Amazon.com, Inc. under a ten-year lease expected to commence in November 2013; and

A173,776 square-foot building located in the Edmonds/Lynnwood submarket of Seattle’s Northend, which we refer to as the Northview property. This building is 89% leased to tenants such as Automatic Data Processing, Inc. and the Federal Emergency Management Agency.

City Plaza Disposition

On May 31, 2013, the Company entered into an agreement to sell its City Plaza property for approximately $56.0 million (before certain credits, prorations, and closing costs). The transaction closed on July 12, 2013. Proceeds from the disposition were used toward the acquisition of the Seattle portfolio pursuant to a like-kind exchange under Internal Revenue Code Section 1031. City Plaza is a nineteen-story, 333,922 rentable square-foot Class-A office building located in Orange, California, that was acquired by the Company’s predecessor in August of 2008 and contributed to the Company in connection with its June 29, 2010 initial public offering.

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Financings    

In connection with the acquisition of the Seattle Portfolio, on July 31, 2013, the Company closed a seven-year loan totaling $64.5 million with Union Bank, N.A., secured by the Company’s Met Park North property. The loan bears interest only at a rate equal to one-month LIBOR plus 155 basis points. The full loan is subject to an interest rate contract that swapped one-month LIBOR to a fixed rate of 2.1644% through the loans maturity on August 1, 2020. Proceeds from the loan were used toward the purchase the Seattle Portfolio.

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

Forward-Looking Statements
We make statements in this quarterly report that are forward-looking statements within the meaning of the federal securities laws. In particular, statements pertaining to our capital resources, portfolio performance and results of operations contain forward-looking statements. You can identify forward-looking statements by the use of forward-looking terminology such as “believes,” “expects,” “may,” “will,” “should,” “seeks,” “approximately,” “intends,” “plans,” “pro forma,” “estimates” or “anticipates” or the negative of these words and phrases or similar words or phrases that are predictions of or indicate future events or trends and that do not relate solely to historical matters. You can also identify forward-looking statements by discussions of strategy, plans or intentions.
Forward-looking statements involve numerous risks and uncertainties and you should not rely on them as predictions of future events. Forward-looking statements depend on assumptions, data or methods that may be incorrect or imprecise and we may not be able to realize them. We do not guarantee that the transactions and events described will happen as described (or that they will happen at all). The following factors, among others, could cause actual results and future events to differ materially from those set forth or contemplated in the forward-looking statements:
adverse economic or real estate developments in our markets;
general economic conditions;
defaults on, early terminations of or non-renewal of leases by tenants;
fluctuations in interest rates and increased operating costs;
our failure to obtain necessary outside financing;
our failure to generate sufficient cash flows to service our outstanding indebtedness;
lack or insufficient amounts of insurance;
decreased rental rates or increased vacancy rates;
difficulties in identifying properties to acquire and completing acquisitions;
our failure to successfully operate acquired properties and operations;
our failure to maintain our status as a REIT;
environmental uncertainties and risks related to adverse weather conditions and natural disasters;
financial market fluctuations;
changes in real estate and zoning laws and increases in real property tax rates; and
other factors affecting the real estate industry generally.
While forward-looking statements reflect our good faith beliefs, they are not guarantees of future performance. We disclaim any obligation to publicly update or revise any forward-looking statement to reflect changes in underlying assumptions or factors, of new information, data or methods, future events or other changes. Additional information concerning these and other risks and uncertainties is contained in our other periodic filings with the Securities and Exchange Commission.

Historical Results of Operations

This Quarterly Report on Form 10-Q for Hudson Pacific Properties, Inc. for the six months ended June 30, 2013 represents an update to the more detailed and comprehensive disclosures included in our Annual Report on form 10-K for the year ended December 31, 2012. Accordingly, you should read the following discussion in conjunction with the information included in our Annual Report on form 10-K for the year ended December 31, 2012 as well as the unaudited financial statements included elsewhere in this Quarterly Report on Form 10-Q.

In addition, some of the statements and assumptions in this Quarterly Report on Form 10-Q are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 or Section 21E of the Securities Exchange Act of 1934, each as amended, including, in particular, statements about our plans, strategies and prospects as well as estimates of industry growth for the second quarter and beyond. See “Forward-Looking Statements.”

Overview

The following table identifies each of the properties in our portfolio acquired through June 30, 2013 and their date of acquisition.

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Properties
Acquisition/Completion Date
Square Feet
875 Howard Street
2/15/2007
286,270

Sunset Gower
8/17/2007
544,602

Sunset Bronson
1/30/2008
313,723

Technicolor Building
6/1/2008
114,958

City Plaza(1)
8/26/2008
333,922

First Financial
6/29/2010
222,423

Tierrasanta
6/29/2010
112,300

Del Amo Office
8/13/2010
113,000

9300 Wilshire Boulevard
8/24/2010
61,224

222 Kearny Street
10/8/2010
148,797

1455 Market
12/16/2010
1,012,012

Rincon Center
12/16/2010
580,850

10950 Washington
12/22/2010
159,024

604 Arizona
7/26/2011
44,260

275 Brannan
8/19/2011
54,673

625 Second Street
9/1/2011
136,906

6922 Hollywood Boulevard
11/22/2011
205,523

6050 Ocean Way & 1445 N. Beachwood Drive
12/16/2011
20,761

10900 Washington
4/5/2012
9,919

901 Market Street
6/1/2012
212,319

Element LA (Olympic Bundy)
9/5/2012
241,427

1455 Gordon Street
9/21/2012
6,000

Pinnacle I(2)
11/8/2012
393,777

3401 Exposition
5/22/2013
65,000

Pinnacle II(2)
6/14/2013
231,864

Total
 
5,625,534

(1) We sold the City Plaza property on July 12, 2013.
(2) We acquired a 98.25% joint venture interest in the Pinnacle I property on November 8, 2012. On June 14, 2013 our joint venture partner contributed its interest in Pinnacle II which reduced our entire interest in the joint venture to 65.0%

All amounts and percentages used in this discussion of our results of operations are calculated using the numbers presented in the financial statements contained in this report rather than the rounded numbers appearing in this discussion.

Comparison of the three months ended June 30, 2013 to the three months ended June 30, 2012

Revenue

Total Office Revenue. Total office revenue consists of rental revenue, tenant recoveries, and parking and other revenue. Total office revenues increased $8.6 million, or 29.6%, to $37.7 million for the three months ended June 30, 2013 compared to $29.1 million for the three months ended June 30, 2012. The period-over-period changes in the items that comprise total revenue are attributable primarily to the factors discussed below. During the three months ended June 30, 2013, the Company entered into an agreement to sell its City Plaza property in Orange, California. Accordingly, the City Plaza property was reclassified as held for sale and its financial results are accounted for as discontinued operations for the three months ended June 30, 2013 and June 30, 2012.


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Office Rental Revenue. Office rental revenue includes rental revenues from our office properties and percentage rent on retail space contained within those properties. Total office rental revenue increased $8.1 million, or 38.4%, to $29.3 million for the three months ended June 30, 2013 compared to $21.2 million for the three months ended June 30, 2012. The increase in rental revenue was primarily the result of a full quarter of operating results from the 901 Market property acquired on June 1, 2012, and the acquisitions of the Pinnacle I and Pinnacle II buildings on November 8, 2012 and June 14, 2013, respectively. During the three months ended June 30, 2013, the Company renewed nine office leases encompassing approximately 140,350 rentable square feet. The weighted average initial stabilized cash rents for those renewed leases were 6.6% above the expiring cash rents for the same space and the weighted average initial straight-line rents on those renewed leases were 16.7% above the expiring straight-line rents for the same space.

Office Tenant Recoveries. Office tenant recoveries remained relatively flat for the three months ended June 30, 2013 compared to the three months ended June 30, 2012.

Office Parking and Other Revenue. Office parking and other revenue increased $0.7 million, or 27.7%, to $3.1 million for the three months ended June 30, 2013 compared to $2.4 million for the three months ended June 30, 2012. The increase in parking and other revenue was primarily the result of a full quarter of operating results from the 901 Market property acquired on June 1, 2012, and the acquisitions of the Pinnacle I and Pinnacle II buildings on November 8, 2012 and June 14, 2013, respectively.

Total Media & Entertainment Revenue. Total media and entertainment revenue consists of rental revenue, tenant recoveries, other property-related revenue and other revenue. Total media and entertainment revenues decreased $0.3 million, or 3.3%, to $9.6 million for the three months ended June 30, 2013 compared to $10.0 million for the three months ended June 30, 2012. The period-over-period changes in the items that comprise total revenue are attributable primarily to the factors discussed below.

Media & Entertainment Rental Revenue. Media and entertainment rental revenue includes rental revenues from our media and entertainment properties and percentage rent on retail space contained within those properties. Total media and entertainment rental revenue decreased $0.4 million, or 6.7%, to $5.4 million for the three months ended June 30, 2013 compared to $5.8 million for the three months ended June 30, 2012. The decrease resulted from lower occupancy over the second quarter of 2013 compared to the same quarter a year ago.

Media & Entertainment Tenant Recoveries. Tenant recoveries remained relatively flat for the three months ended June 30, 2013 compared to the three months ended June 30, 2012.

Media & Entertainment Other Property-Related Revenue. Other property-related revenue is derived from the tenants’ rental of lighting and other equipment, parking, power, HVAC and telecommunications (telephone and Internet). Total other property-related revenue remained relatively flat for the three months ended June 30, 2013 compared to the three months ended June 30, 2012.

Media & Entertainment Other Revenue. Other revenue includes service-related revenue, including the rental of certain sound recording equipment at our media and entertainment properties. Total other revenue increased $0.1 million, or 222.6%, to $0.2 million for the three months ended June 30, 2013 compared to $0.1 million for the three months ended June 30, 2012. The increase in other revenue resulted from our acquisition of the Ocean Way recording studio equipment at our Sunset Gower media and entertainment property in January 2013.

Operating Expenses

Total Operating Expenses. Total operating expenses consist of property operating expenses, as well as property- and corporate-level general and administrative expenses, other property-related expenses, management fees and depreciation and amortization. Total operating expenses increased by $3.4 million, or 9.2%, to $40.1 million for the three months ended June 30, 2013 compared to $36.7 million for the three months ended June 30, 2012. This increase in total operating expenses reflects the factors discussed below. During the three months ended June 30, 2013, the Company entered into an agreement to sell its City Plaza property in Orange, California. Accordingly, the City Plaza property was reclassified as held for sale and its financial results are accounted for as discontinued operations for the three months ended June 30, 2013 and June 30, 2012.

Office Operating Expenses. Office operating expenses increased $1.0 million, or 7.8%, to $14.1 million for the three months ended June 30, 2013 compared to $13.1 million for the three months ended June 30, 2012. The increase in operating expenses was primarily the result of a full quarter of operating results from the 901 Market property acquired on June 1, 2012,

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and the acquisitions of the Pinnacle I and Pinnacle II buildings on November 8, 2012 and June 14, 2013, respectively. This increase in operating expenses also reflects a supplemental property tax expense associated with our Technicolor property, which occurred in the three months ended June 30, 2012, of approximately $0.9 million. If this supplemental property tax expense is disregarded, then operating expenses from continuing operations at the Company’s office properties would have increased by $1.9 million, or 16.0%, over the same quarter a year ago.

Media & Entertainment Operating Expenses. Media and entertainment operating expenses increased $0.1 million, or 2.2%, to $6.4 million for the three months ended June 30, 2013 compared to $6.3 million for the three months ended June 30, 2012. The increase in operating expenses was primarily the result of expenses associated with the Ocean Way recording studio, with no comparable expenses compared to the same quarter a year ago.

General and Administrative Expenses. General and administrative expenses includes wages and salaries for corporate-level employees, accounting, legal and other professional services, office supplies, entertainment, travel, and automobile expenses, telecommunications and computer-related expenses, and other miscellaneous items. General and administrative expenses increased $1.0 million, or 24.9%, to $5.2 million for the three months ended June 30, 2013 compared to $4.2 million for the three months ended June 30, 2012. The increase in general and administrative expenses was primarily due to the adoption of the 2013 Outperformance Program and increased staffing to meet operational needs stemming from growth through the acquisitions of office properties.

Depreciation and Amortization. Depreciation and amortization expense increased $1.2 million, or 9.0%, to $14.4 million for the three months ended June 30, 2013 compared to $13.2 million for the three months ended June 30, 2012. The increase was primarily the result of a full quarter of operating results from the 901 Market property acquired on June 1, 2012, and the acquisitions of the Pinnacle I and Pinnacle II buildings on November 8, 2012 and June 14, 2013, respectively.

Other Expense (Income)

Interest Expense. Interest expense increased $1.2 million, or 25.9%, to $5.8 million for the three months ended June 30, 2013 compared to $4.6 million for the three months ended June 30, 2012. At June 30, 2013, the Company had $637.1 million of notes payable, compared to $350.3 million at June 30, 2012. The increase was primarily due to the increase in indebtedness associated with our 901 Market property acquired on June 1, 2012, and the acquisitions of the Pinn