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Section 1: 10-Q (10-Q)

Document

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
☒    Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the quarterly period ended March 31, 2018
 
or
 
☐    Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
Commission file number 001-34856
 
THE HOWARD HUGHES CORPORATION
(Exact name of registrant as specified in its charter)
 
 
 
Delaware
36-4673192
(State or other jurisdiction of
(I.R.S. employer
incorporation or organization)
identification number)
 
13355 Noel Road, 22nd Floor, Dallas, Texas 75240
(Address of principal executive offices, including zip code)
 
(214) 741-7744
(Registrant’s telephone number, including area code)
 
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    ☐ No
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
☒ Yes    ☐ No
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
 
 
 
 
Large accelerated filer ☒
 
Accelerated filer ☐
Non-accelerated filer ☐ (Do not check if a smaller reporting company)
 
Smaller reporting company ☐
 
 
Emerging growth company ☐
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
☐ Yes    ☒ No
 
The number of shares of common stock, $0.01 par value, outstanding as of April 25, 2018 was 43,019,093.
 



Table of Contents


THE HOWARD HUGHES CORPORATION
 
INDEX
 
 
 
 
PAGE
NUMBER
 
 
 
 
PART I FINANCIAL INFORMATION 
 
 
 
 
 
 
Item 1:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2:
 
 
 
 
 
Item 3:
 
 
 
 
 
Item 4:
 
 
 
 
PART II   OTHER INFORMATION 
 
 
 
 
 
Item 1:
 
 
 
 
 
Item 1A:
 
 
 
 
 
Item 2:
 
 
 
 
 
Item 3:
 
 
 
 
 
Item 4:
 
 
 
 
 
Item 5:
 
 
 
 
 
Item 6:
 
 
 
 
 
 
 
 
 


2
 

Table of Contents



THE HOWARD HUGHES CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS 
UNAUDITED
(In thousands, except share amounts)
 
March 31, 2018
 
December 31, 2017
Assets:
 
 
 
 
Investment in real estate:
 
 
 
 
Master Planned Community assets
 
$
1,633,492

 
$
1,642,278

Buildings and equipment
 
2,365,773

 
2,238,617

Less: accumulated depreciation
 
(325,026
)
 
(321,882
)
Land
 
273,444

 
277,932

Developments
 
1,412,153

 
1,196,582

Net property and equipment
 
5,359,836

 
5,033,527

Investment in Real Estate and Other Affiliates
 
85,911

 
76,593

Net investment in real estate
 
5,445,747

 
5,110,120

Cash and cash equivalents
 
632,838

 
861,059

Restricted cash
 
132,105

 
103,241

Accounts receivable, net
 
14,384

 
13,041

Municipal Utility District receivables, net
 
203,436

 
184,811

Notes receivable, net
 
8,310

 
5,864

Deferred expenses, net
 
90,839

 
80,901

Prepaid expenses and other assets, net
 
210,327

 
370,027

Total assets
 
$
6,737,986

 
$
6,729,064

 
 
 
 
 
Liabilities:
 
 
 
 
Mortgages, notes and loans payable, net
 
$
2,895,771

 
$
2,857,945

Deferred tax liabilities
 
143,581

 
160,850

Accounts payable and accrued expenses
 
619,271

 
521,718

Total liabilities
 
3,658,623

 
3,540,513

 
 
 
 
 
Commitments and Contingencies (see Note 10)
 


 


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

 

Common stock: $.01 par value; 150,000,000 shares authorized, 43,491,595 shares
issued and 42,986,302 outstanding as of March 31, 2018 and 43,300,253 shares
issued and 43,270,880 outstanding as of December 31, 2017
 
436

 
433

Additional paid-in capital
 
3,310,421

 
3,302,502

Accumulated deficit
 
(175,879
)
 
(109,508
)
Accumulated other comprehensive loss
 
(797
)
 
(6,965
)
Treasury stock, at cost, 505,293 and 29,373 shares as of March 31, 2018 and December 31, 2017, respectively
 
(60,743
)
 
(3,476
)
Total Stockholders' equity
 
3,073,438

 
3,182,986

Noncontrolling interests
 
5,925

 
5,565

Total equity
 
3,079,363

 
3,188,551

Total liabilities and equity
 
$
6,737,986

 
$
6,729,064

 
See Notes to Condensed Consolidated Financial Statements.


3
 

Table of Contents


THE HOWARD HUGHES CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS 
UNAUDITED
 
 
Three Months Ended March 31,
(In thousands, except per share amounts)
 
2018
 
2017
Revenues:
 
 
 
 
Condominium rights and unit sales
 
$
10,837

 
$
80,145

Master Planned Community land sales
 
46,565

 
53,481

Minimum rents
 
49,395

 
46,326

Tenant recoveries
 
12,760

 
11,399

Hospitality revenues
 
23,061

 
19,711

Builder price participation
 
5,081

 
4,661

Other land revenues
 
4,131

 
10,582

Other rental and property revenues
 
9,849

 
5,457

Total revenues
 
161,679

 
231,762

 
 
 
 
 
Expenses:
 
 
 
 
Condominium rights and unit cost of sales
 
6,729

 
60,483

Master Planned Community cost of sales
 
26,043

 
25,869

Master Planned Community operations
 
10,325

 
9,394

Other property operating costs
 
23,175

 
18,508

Rental property real estate taxes
 
8,127

 
7,537

Rental property maintenance costs
 
3,197

 
3,028

Hospitality operating costs
 
15,567

 
13,845

Provision for doubtful accounts
 
776

 
535

Demolition costs
 
6,671

 
65

Development-related marketing costs
 
6,078

 
4,205

General and administrative
 
24,264

 
18,117

Depreciation and amortization
 
28,188

 
25,524

Total expenses
 
159,140

 
187,110

 
 
 
 
 
Operating income before other items
 
2,539

 
44,652

 
 
 
 
 
Other:
 
 
 
 
Gains on sales of properties
 

 
32,215

Other income, net
 

 
687

Total other
 

 
32,902

 
 
 
 
 
Operating income
 
2,539

 
77,554

 
 
 
 
 
Interest income
 
2,076

 
622

Interest expense
 
(16,609
)
 
(17,858
)
Loss on redemption of senior notes due 2021
 

 
(46,410
)
Warrant liability loss
 

 
(12,562
)
Gain on acquisition of joint venture partner's interest
 

 
5,490

Equity in earnings from Real Estate and Other Affiliates
 
14,386

 
8,520

Income before taxes
 
2,392

 
15,356

Provision for income taxes
 
558

 
9,697

Net income
 
1,834

 
5,659

Net income attributable to noncontrolling interests
 
(360
)
 

Net income attributable to common stockholders
 
$
1,474

 
$
5,659

 
 
 
 
 
Basic income per share:
 
$
0.03

 
$
0.14

 
 
 
 
 
Diluted income per share:
 
$
0.03

 
$
0.13

See Notes to Condensed Consolidated Financial Statements.

4
 

Table of Contents


 THE HOWARD HUGHES CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) 
UNAUDITED
 
 
Three Months Ended March 31,
(In thousands)
 
2018
 
2017
Net income
 
$
1,834

 
$
5,659

Other comprehensive income:
 
 
 
 
Interest rate swaps (a)
 
8,045

 
433

Capitalized swap interest income (expense) (b)
 
10

 
(75
)
Adoption of ASU 2018-02 (c)
 
(1,148
)
 

Adoption of ASU 2017-12 (d)
 
(739
)
 

Other comprehensive income
 
6,168

 
358

Comprehensive income
 
8,002

 
6,017

Comprehensive income attributable to noncontrolling interests
 
(360
)
 

Comprehensive income attributable to common stockholders
 
$
7,642

 
$
6,017

 
(a)
Amounts are shown net of deferred tax expense of $2.1 million and $0.3 million for the three months ended March 31, 2018 and 2017, respectively.
(b)
The deferred tax impact was immaterial for the three months ended March 31, 2018. Amount is net of deferred tax benefit of $0.1 million for the three months ended March 31, 2017.
(c)
The Company adopted Accounting Standards Update ("ASU") 2018-02, Income Statement-Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, as of January 1, 2018. See Note 2 - Accounting Policies and Pronouncements for further discussion.
(d)
The Company adopted ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities, as of January 1, 2018. See Note 2 - Accounting Policies and Pronouncements for further discussion.

See Notes to Condensed Consolidated Financial Statements.


5
 

Table of Contents


THE HOWARD HUGHES CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF EQUITY
UNAUDITED
 
 
 
 
 
 
 
 
 
 
Accumulated
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Additional
 
 
 
Other
 
 
 
 
 
Total
 
 
 
 
 
 
Common Stock
 
Paid-In
 
Accumulated
 
Comprehensive
 
Treasury Stock
 
Stockholders'
 
Noncontrolling
 
Total
(In thousands, except shares)
 
Shares
 
Amount
 
Capital
 
Deficit
 
Income (Loss)
 
Shares
 
Amount
 
Equity
 
Interests
 
Equity
Balance December 31, 2016
 
39,802,064

 
$
398

 
$
2,853,269

 
$
(277,912
)
 
$
(6,786
)
 
(12,061
)
 
$
(1,231
)
 
$
2,567,738

 
$
3,772

 
$
2,571,510

Net income
 

 

 

 
5,659

 

 

 

 
5,659

 

 
5,659

Interest rate swaps, net of tax of $254
 

 

 

 

 
433

 

 

 
433

 

 
433

Capitalized swap interest, net of tax of $41
 

 

 

 

 
(75
)
 

 

 
(75
)
 

 
(75
)
Stock plan activity
 
249,378

 
3

 
8,841

 

 

 

 

 
8,844

 

 
8,844

Exercise of Warrants
 
272,598

 
3

 
30,932

 

 

 

 

 
30,935

 

 
30,935

Balance, March 31, 2017
 
40,324,040

 
404

 
2,893,042

 
(272,253
)
 
(6,428
)
 
(12,061
)
 
(1,231
)
 
2,613,534

 
3,772

 
2,617,306

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance December 31, 2017
 
43,300,253

 
433

 
3,302,502

 
(109,508
)
 
(6,965
)
 
(29,373
)
 
(3,476
)
 
3,182,986

 
5,565

 
3,188,551

Net income
 

 

 

 
1,474

 

 

 

 
1,474

 
360

 
1,834

Preferred dividend payment on behalf of subsidiary
 

 

 

 

 

 

 

 

 

 

Interest rate swaps, net of tax of $2,126
 

 

 

 

 
8,045

 

 

 
8,045

 

 
8,045

Capitalized swap interest, net of tax of $3
 

 

 

 

 
10

 

 

 
10

 

 
10

Adoption of ASU 2014-09
 

 

 

 
(69,732
)
 

 

 

 
(69,732
)
 

 
(69,732
)
Adoption of ASU 2017-12
 

 

 

 
739

 
(739
)
 

 

 

 

 

Adoption of ASU 2018-02
 

 

 

 
1,148

 
(1,148
)
 

 

 

 

 

Repurchase of common shares
 

 

 

 

 

 
(475,920
)
 
(57,267
)
 
(57,267
)
 

 
(57,267
)
Stock plan activity
 
191,342

 
3

 
7,919

 

 

 

 

 
7,922

 

 
7,922

Balance, March 31, 2018
 
43,491,595

 
$
436

 
$
3,310,421

 
$
(175,879
)
 
$
(797
)
 
(505,293
)
 
$
(60,743
)
 
$
3,073,438

 
$
5,925

 
$
3,079,363

 
See Notes to Condensed Consolidated Financial Statements.


6
 

Table of Contents


THE HOWARD HUGHES CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS 
UNAUDITED
 
 
Three Months Ended March 31,
(In thousands)
 
2018
 
2017
Cash Flows from Operating Activities:
 
 
 
 
Net income
 
$
1,834

 
$
5,659

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

 
 

Depreciation
 
24,850

 
21,540

Amortization
 
3,002

 
3,984

Amortization of deferred financing costs
 
1,469

 
1,638

Amortization of intangibles other than in-place leases
 
336

 
(483
)
Straight-line rent amortization
 
(3,052
)
 
(1,291
)
Deferred income taxes
 
248

 
8,888

Restricted stock and stock option amortization
 
2,684

 
1,906

Gains on sales of properties
 

 
(32,215
)
Gain on acquisition of joint venture partner's interest
 

 
(5,490
)
Warrant liability loss
 

 
12,562

Loss on redemption of senior notes due 2021
 

 
46,410

Equity in earnings from Real Estate and Other Affiliates, net of distributions
 
(9,532
)
 
(4,281
)
Provision for doubtful accounts
 
776

 
535

Master Planned Community land acquisitions
 
(506
)
 
(1,415
)
Master Planned Community development expenditures
 
(42,092
)
 
(43,623
)
Master Planned Community cost of sales
 
23,189

 
23,327

Condominium development expenditures
 
(78,964
)
 
(86,279
)
Condominium rights and unit cost of sales
 
6,729

 
60,483

Percentage of completion revenue recognition from sale of condominium rights and unit sales
 

 
(80,145
)
Net changes:
 
 

 
 

Accounts and notes receivable
 
(6,100
)
 
3,178

Prepaid expenses and other assets
 
1,590

 
16,509

Change in restricted cash operating accounts
 

 

Condominium deposits received
 
40,762

 
11,847

Deferred expenses
 
(3,759
)
 
(1,682
)
Accounts payable and accrued expenses
 
(49,885
)
 
(59,109
)
Other, net
 

 
128

Cash used in operating activities
 
(86,421
)
 
(97,419
)
 
 
 
 
 
Cash Flows from Investing Activities:
 
 

 
 

Property and equipment expenditures
 
(1,295
)
 
(2,559
)
Operating property improvements
 
(17,600
)
 
(4,722
)
Property developments and redevelopments
 
(90,682
)
 
(111,674
)
Acquisition of partner's interest in Las Vegas 51s
 

 
(15,404
)
Proceeds for reimbursement of development costs
 

 
10,597

Proceeds from sales of properties
 

 
36,000

Proceeds from Tax Increment Financings
 
11,731

 

Distributions from Real Estate and Other Affiliates
 
748

 

Note issued to Real Estate and Other Affiliates
 
(2,783
)
 

Proceeds from repayment of note to Real Estate Affiliate
 

 
(724
)
Maturity of long term investment
 

 
3,455

Cash used in investing activities
 
(99,881
)
 
(85,031
)
 
 
 
 
 
Cash Flows from Financing Activities:
 
 

 
 

Proceeds from mortgages, notes and loans payable
 
62,967

 
944,663

Principal payments on mortgages, notes and loans payable
 
(24,059
)
 
(881,476
)
Premium paid to redeem 2021 senior notes
 

 
(39,966
)
Purchase of treasury stock
 
(57,267
)
 

Special Improvement District bond funds released from escrow
 
230

 
581

Deferred financing costs and bond issuance costs, net
 
(163
)
 
(9,215
)
Taxes paid on stock options exercised and restricted stock vested
 
(1,713
)
 
(4,589
)
Stock options exercised
 
6,950

 
11,271

Cash (used in) provided by financing activities
 
(13,055
)
 
21,269

 
 
 
 
 
Net change in cash, cash equivalents and restricted cash
 
(199,357
)
 
(161,181
)
Cash, cash equivalents and restricted cash at beginning of period
 
964,300

 
915,139

Cash, cash equivalents and restricted cash at end of period
 
$
764,943

 
$
753,958


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Table of Contents


THE HOWARD HUGHES CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
UNAUDITED
 
 
Three Months Ended March 31,
(In thousands)
 
2018
 
2017
Supplemental Disclosure of Cash Flow Information:
 
 

 
 

Interest paid
 
$
45,652

 
$
42,997

Interest capitalized
 
17,500

 
16,305

Income taxes paid
 

 
429

 
 
 
 
 
Non-Cash Transactions:
 
 

 
 

Special Improvement District bond transfers associated with land sales
 
2,854

 
2,542

Accrued interest on construction loan borrowing
 
252

 
1,011

Capitalized stock compensation
 
533

 
531

Acquisition of Las Vegas 51s
 


 


Furniture and fixtures
 

 
87

Developments
 

 
65

Accounts receivable
 

 
633

Other assets
 

 
33,313

Other liabilities
 

 
(2,294
)
 
See Notes to Condensed Consolidated Financial Statements.

 

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Table of Contents
THE HOWARD HUGHES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED


NOTE 1 BASIS OF PRESENTATION AND ORGANIZATION
 
The accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”), with intercompany transactions between consolidated subsidiaries eliminated. In accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X as issued by the Securities and Exchange Commission (the “SEC”), these Condensed Consolidated Financial Statements do not include all of the information and disclosures required by GAAP for complete financial statements. Readers of this Quarterly Report on Form 10-Q (“Quarterly Report”) should refer to The Howard Hughes Corporation’s (“HHC” or the “Company”) audited Consolidated Financial Statements, which are included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2017 (the “Annual Report”), filed on February 26, 2018 with the SEC. Approximately $103.2 million in restricted cash was reclassified from Prepaid expenses and other assets, net at December 31, 2017 to conform to the 2018 presentation. In the opinion of management, all normal recurring adjustments necessary for a fair presentation of the financial position, results of operations, comprehensive income, cash flows and equity for the interim periods have been included. The results for the three months ended March 31, 2018 are not necessarily indicative of the results that may be expected for the year ending December 31, 2018 and future fiscal years.

Management has evaluated for disclosure or recognition all material events occurring subsequent to the date of the Condensed Consolidated Financial Statements up to the date and time this Quarterly Report on Form 10-Q was filed.
 
Impact of new accounting standard related to Revenue
In May 2014, the Financial Accounting Standards Board (“FASB”) and International Accounting Standards Board issued Accounting Standards Update (“ASU”) 2014-09, Revenues from Contracts with Customers (Topic 606). The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. HHC adopted Topic 606 and all its related amendments (the “New Revenue Standard”) as of January 1, 2018 (the “Adoption Date”) using the modified retrospective transition method. Accordingly, prior period amounts presented have not been adjusted.
HHC recorded a cumulative effect adjustment of $69.7 million, net of taxes of $19.6 million, to increase Accumulated deficit as of the Adoption Date due to the impact of adopting Topic 606. As discussed in the Company's Annual Report, condominium rights and unit sales revenues were previously required to be recognized under the percentage of completion method. Under the new guidance, revenue and cost of sales for condominium units sold are not recognized until the construction is complete, the sale closes and the title to the property has transferred to the buyer (point in time). Additionally, certain real estate selling costs, such as the costs related to the Company's condominium model units, are either expensed immediately or capitalized as property and equipment and depreciated over their estimated useful life. The cumulative effect adjustments as of the Adoption Date consists of:

A decrease in Condominium receivables of $154.2 million,
An increase in Buildings and equipment, net, of $3.4 million,
An increase to Developments of $150.8 million,
An increase to Prepaid expenses and other assets of $5.6 million,
An increase to Accounts payable and accrued expenses of $95.0 million,
A decrease to Deferred tax liabilities of $19.6 million, and
An increase in Accumulated deficit of $69.7 million, net of taxes of $19.6 million.

9
 

Table of Contents
THE HOWARD HUGHES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED

For the three months ended March 31, 2018, the following financial statement line items are affected as a result of HHC's adoption of the New Revenue Standard:


 
Three Months Ended March 31, 2018
Condensed Consolidated Balance Sheet
 
Recognition Under Previous Guidance
Impact of Adoption of ASC Topic 606
Recognition Under ASC Topic 606
Buildings and equipment, net
 
$
2,038,288

$
2,459

$
2,040,747

Developments
 
1,171,469

240,684

1,412,153

Deferred expenses, net
 
84,001

6,838

90,839

Prepaid expenses and other assets, net
 
487,731

(277,404
)
210,327

Deferred tax liabilities
 
174,340

(30,759
)
143,581

Accounts payable and accrued expenses
 
511,323

107,948

619,271

Accumulated deficit
 
(71,266
)
(104,613
)
(175,879
)

 
 
 
 
Condensed Consolidated Statement of Operations
 
 
 
 
Condominium rights and unit sales
 
153,702

(142,865
)
10,837

Condominium rights and unit cost of sales
 
104,587

(97,858
)
6,729

Depreciation and amortization
 
27,199

989

28,188

Operating income before other items
 
48,536

(45,997
)
2,539

Provision for income taxes
 
11,674

(11,116
)
558

Net income
 
36,714

(34,880
)
1,834

Net income attributable to common stockholders
 
36,354

(34,880
)
1,474


 
 
 
 
Condensed Consolidated Statement of Comprehensive Income
 
 
 
 
Net income
 
36,714

(34,880
)
1,834

Comprehensive income
 
42,882

(34,880
)
8,002

Comprehensive income attributable to common stockholders
 
42,522

(34,880
)
7,642


 
 
 
 
Condensed Consolidated Statement of Cash Flows
 
 
 
 
Net income
 
36,714

(34,880
)
1,834

Depreciation and amortization
 
27,199

989

28,188

Deferred income taxes
 
11,364

(11,116
)
248

Condominium rights and unit cost of sales
 
104,587

(97,858
)
6,729

Percentage of completion revenue recognition from sale of condominium rights and unit sales
 
(142,865
)
142,865



See Note 2 - Accounting Policies and Pronouncements for further discussion of accounting policies impacted by the Company's adoption of the New Revenue Standard and disclosures required by the New Revenue Standard.


10
 

Table of Contents
THE HOWARD HUGHES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED

NOTE 2 ACCOUNTING POLICIES AND PRONOUNCEMENTS
 
The following is a summary of recently issued and other notable accounting pronouncements which relate to HHC's business.
 
In February 2018, the FASB issued ASU 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, that allows a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act. The effective date of the standard is for fiscal periods, and interim periods within those years, beginning after December 15, 2018. The amendments must be applied either in the period of adoption or retrospectively to each period (or periods) in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Cuts and Jobs Act is recognized. Early adoption is permitted. The Company adopted ASU 2018-02 as of January 1, 2018, and an election was made to reclassify $1.1 million from accumulated other comprehensive income to retained earnings.
In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities, to enable entities to better portray the economic results of their risk management activities in their financial statements. The ASU expands an entity’s ability to hedge nonfinancial and financial risk components and reduce complexity in fair value hedges of interest rate risk and eases certain documentation and assessment requirements and modifies the accounting for components excluded from the assessment of hedge effectiveness. The ASU also eliminates the requirement to separately measure and report hedge ineffectiveness and generally requires the entire change in the fair value of a hedging instrument to be presented in the same Consolidated Statements of Operations line as the hedged item. The effective date of the standard is for fiscal periods, and interim periods within those years, beginning after December 15, 2018. The new standard must be adopted using a modified retrospective approach with early adoption permitted. The Company adopted ASU 2017-12 as of January 1, 2018 and, as a result, $0.7 million of ineffectiveness recognized prior to 2018 for its swaps was reclassified to Accumulated deficit from Accumulated other comprehensive income.
In May 2017, the FASB issued ASU 2017-09, Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting, to provide clarity and reduce the diversity in practice and cost and complexity when applying the guidance in Topic 718, Compensation-Stock Compensation. Stakeholders observed that the definition of the term “modification” is broad and that its interpretation results in diversity in practice. The ASU states that when an entity concludes that a change is not substantive, then modification accounting does not apply. The effective date of the standard is for fiscal periods, and interim periods within those years, beginning after December 15, 2017. The new standard must be adopted prospectively to an award modified on or after the adoption date. Early adoption is permitted. The Company adopted ASU 2017-09 as of January 1, 2018 and, as a result, will apply this guidance to any modifications made to either the stock option or restricted stock award plans. 
In February 2017, the FASB issued ASU 2017-05, Other Income - Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20). The standard defines an “in-substance non-financial asset” as a financial asset promised to a counterparty in a contract if substantially all the fair value of the assets is concentrated in nonfinancial assets. The ASU also provides guidance for accounting for partial sales of non-financial assets such as real estate. The effective date of the standard is for fiscal periods, and interim periods within those years, beginning after December 15, 2017. The new standard must be adopted retrospectively with early adoption permitted. The Company adopted ASU 2017-05 as of January 1, 2018, and it did not have a material effect on the Company’s financial position or results of operations as the Company has no partial sales in the current period.
In January 2017, the FASB issued ASU 2017-04, Intangibles - Goodwill and Other (Topic 350). This standard is intended to simplify the subsequent measurement of goodwill by eliminating step two from the goodwill impairment test. Instead, an entity will perform only step one of its quantitative goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount and then recognizing the impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value. An entity will still have the option to perform a qualitative assessment for a reporting unit to determine if the quantitative step one impairment test is necessary. The effective date of the standard is for fiscal periods, and interim periods within those years, beginning after December 15, 2019. The new standard must be adopted prospectively with early adoption permitted. The Company does not expect the adoption of this ASU to have a material impact on its consolidated financial statements.
In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows - Restricted Cash, which requires entities to show the changes in the total of cash, cash equivalents, restricted cash and restricted cash equivalents in the statement of cash flows. The effective date of the standard is for fiscal periods, and interim periods within those years, beginning after December 15, 2017. As required, the Company adopted ASU 2016-18 retrospectively as of January 1, 2018, resulting in presentation of an additional

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THE HOWARD HUGHES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED

$39.7 million in cash used in operating activities and $2.5 million in cash provided for investing activities for the three months ended March 31, 2017, related to an additional $37.2 million of changes in restricted cash on the consolidated statements of cash flows in the respective period. The nature of these restrictions relates primarily to escrowed condominium deposits and other amounts related to taxes, insurance, legally restricted security deposits and leasing costs held in escrow.
In August 2016, the FASB issued ASU 2016-15, Classification of Certain Cash Receipts and Cash Payments. The standard addresses how certain cash receipts and payments are presented and classified in the statement of cash flows, including debt extinguishment costs, distributions from equity method investees and contingent consideration payments made after a business combination. The effective date of this standard is for fiscal years, and interim periods within those years, beginning after December 15, 2017. The Company adopted this standard retrospectively, as of January 1, 2018. ASU 2016-15 had no impact on the Company's presentation of operating, investing and financing activities related to certain cash receipts and payments on its consolidated statements of cash flows for the three months ended March 31, 2017.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses. The standard modifies the impairment model for most financial assets, including trade accounts receivables and loans, and will require the use of an “expected loss” model for instruments measured at amortized cost. Under this model, entities will be required to estimate the lifetime expected credit loss on such instruments and record an allowance to offset the amortized cost basis of the financial asset, resulting in a net presentation of the amount expected to be collected on the financial asset. The effective date of the standard is for fiscal years, and for interim periods within those years, beginning after December 15, 2019, with early adoption permitted. The Company is currently evaluating the adoption of ASU 2016-13 on its consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02, Leases. ASU 2016-02 is codified in Accounting Standards Codification (“ASC”) 842. The standard amends the existing accounting standards for lease accounting, including requiring lessees to recognize most leases on their balance sheets and making targeted changes to lessor accounting. The effective date of this standard is for fiscal years, and interim periods within those years, beginning after December 15, 2018, with early adoption permitted. The standard requires a modified retrospective transition approach for all leases existing at, or entered into after, the date of initial application. The Company is currently evaluating the impact of adopting ASU 2016-02 on the consolidated financial statements. The Company anticipates a material increase to assets and liabilities as it will be required to capitalize its ground leases, office leases and certain office equipment leases where the Company is the lessee.
In January 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities, which will require entities to recognize changes in equity investments with readily determinable fair values in net income. For equity investments without readily determinable fair values, the ASU permits the application of a measurement alternative using the cost of the investment, less any impairments, plus or minus changes resulting from observable price changes for an identical or similar investment of the same issuer. The effective date of the standard is for fiscal periods, and interim periods within those years, beginning after December 15, 2017, and it must be adopted via a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The Company adopted the guidance as of January 1, 2018. As none of the Company's equity investments have readily determinable fair values, the adoption of this ASU does not have an impact on its consolidated financial statements.
The New Revenue Standard and related policy updates
As discussed in Note 1 - Basis of Presentation and Organization, as of the Adoption Date of the New Revenue Standard, revenues from contracts with customers (excluding lease-related revenues) are recognized when control of the promised goods or services is transferred to HHC's customers in an amount that reflects the consideration the Company expects to be entitled to in exchange for those goods or services.

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THE HOWARD HUGHES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED

The following table presents HHC revenues disaggregated by revenue source:
 
 
Three Months Ended
(In thousands)
 
March 31, 2018
Revenues
 
 
From contracts with customers
 
 
Recognized at a point in time:
 
 
Condominium rights and unit sales
 
$
10,837

Master Planned Community land sales
 
46,565

Hospitality revenues
 
23,061

Builder price participation
 
5,081

Total revenue from contracts with customers
 
85,544

 
 
 
Recognized at a point in time and/or over time:
 
 
Other land revenues
 
4,131

Other rental and property revenues
 
9,849

Total other income
 
13,980

 
 
 
Rental and other income (lease-related revenues)
 
 
Minimum rents
 
49,395

Tenant recoveries
 
12,760

Total rental income
 
62,155

 
 
 
Total revenues
 
$
161,679

 
 
 
Revenues by segment
 
 
Master Planned Community Revenue
 
$
55,765

Operating Segment Revenue
 
91,258

Strategic Developments Revenue
 
14,656

 
 
 
Total revenues
 
$
161,679


Below is a discussion of the performance obligations, significant judgments and other required disclosures related to revenues from contracts with customers.

Condominium Rights and Unit Sales

Revenue from the sale of an individual unit in a condominium project is recognized at a point in time (i.e., the closing) when HHC satisfies the single performance obligation to construct a condominium project and transfer control of a completed unit to a buyer. The transaction price, which is the amount of consideration the Company receives upon delivery of the completed condominium unit to the buyer, is allocated to this single obligation and is received at closing less any amounts previously paid on deposit.

The Company receives cash payments in the form of escrowed condominium deposits from customers who have contracted to purchase a condominium unit based on billing schedules established in HHC's condominium purchase agreement contracts. The Company holds these contract assets in Restricted cash, unless released from escrow in accordance with the escrow agreement and on approval of HHC's lender to fund construction of a project. A corresponding condominium contract deposit liability is established at the date of receipt, representing a portion of HHC's unsatisfied performance obligation at each reporting date. These

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED

deposits, along with the balance of the contract value, are recognized at closing upon satisfaction of HHC's performance obligation and transfer of title to the buyer. Condominium receivables, a conditional right to consideration for satisfaction of HHC's completed obligations, were established under legacy GAAP for condominium units for which revenue was previously recognized under the percentage of completion method. As of the Adoption Date, condominium receivables are recorded only in limited circumstances.

Real estate project costs directly associated with a condominium project, which are HHC's costs to fulfill contracts with condominium buyers, are capitalized while all other costs are expensed as incurred. Total estimated project costs include direct costs such as the carrying value of the land, site planning, architectural, construction and financing costs, as well as indirect cost allocations. The allocations include costs which clearly relate to the specific project, including certain infrastructure and amenity costs which benefit the project as well as others, and are based upon the relative sales value of the units. Costs incurred to sell condominium units are evaluated for capitalization in accordance with ASC 340-40, and incremental costs of obtaining a contract and costs to fulfill a contract are capitalized only if the costs relate directly to a specifically identified contract, enhance resources to satisfy performance obligations in the future and are expected to be recovered.

Master Planned Community Land Sales

Revenues from land sales are recognized at a point in time when the land sale closing process is complete. The transaction price has both fixed and variable components, with the fixed price stipulated in the contract and representative of a single performance obligation. See Builder Price Participation ("BPP") below for a discussion of the variable component. The fixed transaction price, which is the amount of consideration received in full upon transfer of the land title to the buyer, is allocated to this single obligation and is received at closing of the land sale less any amounts previously paid on deposit.

The Company receives cash payments in the form of land purchase deposits from homebuilders or other commercial buyers who have contracted to purchase land, and HHC holds any escrowed deposits in Restricted cash or Cash and cash equivalents based on the terms of the contract.

In situations where the Company has completed the closing of a developed land parcel or superpad and consideration is paid in full, but a portion of HHC's performance obligation relating to the enhancement of the land is still unsatisfied, revenue related to HHC's obligation is recognized over time. The Company recognizes only the portion of the improved land sale where the improvements are fully satisfied based on a cost input method. The aggregate amount of the transaction price allocated to the unsatisfied obligation is recorded as deferred land sales and is presented in Accounts payable and accrued expenses. The Company measures the completion of HHC's unsatisfied obligation based on the costs remaining relative to the total cost at the date of closing.

When developed residential or commercial land is sold, the cost of sales includes actual costs incurred and estimates of future development costs benefiting the property sold. In accordance with ASC 970-360-30-1, when developed land is sold, costs are allocated to each sold superpad or lot based upon the relative sales value. For purposes of allocating development costs, estimates of future revenues and development costs are re-evaluated throughout the year, with adjustments being allocated prospectively to the remaining parcels available for sale. For certain parcels of land, including acquired parcels that the Company does not intend to develop or for which development was complete at the date of acquisition, the specific identification method is used to determine the cost of sales.

Hospitality revenues

Hospitality revenues are recognized at a point in time in accordance with the pattern of each related service. Lodging is recognized on daily increments, while retail services such as food and beverage are recognized at the point of sale. The transaction price is fixed, clearly stipulated and representative of a single performance obligation in all cases. The duration of all contracts with customers of HHC's hospitality lodging and related services is generally short.

Builder Price Participation

BPP is the variable component of the transaction price for Master Planned Community Land Sales. BPP is earned when a developer that acquired land from HHC develops and sells a home to an end user at a price higher than a predetermined breakpoint. The excess over the breakpoint is shared between HHC and the developer at the time of closing on the sale of the home based on a percentage previously agreed upon.

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THE HOWARD HUGHES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED

The Company concluded that as of the Adoption Date and as of March 31, 2018, BPP was constrained and accordingly, the Company did not recognize an estimate of variable consideration. The Company's conclusion is based on the following factors:

BPP is highly susceptible to factors outside HHC's influence such as unemployment and interest rates;
The time between the sale of land to a developer and closing on a completed home can take up to three years; and
Historical experience is of little value when it comes to predicting future home prices.

The Company evaluates contracts with homebuilders with respect to BPP at each reporting period to determine whether a change in facts and circumstances has eliminated the constraint and will record an estimate of BPP revenue, if applicable.

Other land revenues - over time and point in time

Other land revenues recognized over time include ground maintenance revenue, HOA fee revenue and revenue from providing exclusive cable and internet services at the Company's Master Planned Communities ("MPCs") for the benefit of the tenants and owners of the communities. These revenues are recognized over time, as time elapses. The amount of consideration and the duration are fixed, as stipulated in the related agreements, and represent a single performance obligation.

Other land revenues also include transfer fees on the secondary sales of homes in the MPCs segment, forfeitures of earnest money deposits by buyers of HHC's condominium units, and other miscellaneous items. These items are recognized at a point in time when the real estate closing process is complete or HHC has a legal right to the respective fee or deposit.

Other rental and property revenue - over time and point in time

Other rental and property revenues related to contracts with customers is generally comprised of baseball related ticket sales, retail operations, advertising and sponsorships. Season ticket sales are recognized over time as games take place. Sponsorships generally cover a season and the related revenue is recognized over time, as time elapses. Single tickets and retail operations are recognized at a point in time, at the time of sale. In all cases, the transaction prices are fixed, stipulated in the ticket, contract, or product, and representative in each case of a single performance obligation. From time to time, the Company enters into advertising and sponsorship agreements that allow third parties to display their advertising and products at HHC's venues for a certain amount of time. Consideration for these services is fixed as specified in each respective agreement, is related to a single performance obligation in each case and HHC recognizes the related revenue over time, as time elapses.

Contract Assets and Liabilities

Contract assets are the Company's right to consideration in exchange for goods or services that have been transferred to a customer, excluding any amounts presented as receivable. Contract liabilities are the Company's obligation to transfer goods or services to a customer for which the Company has received consideration.

The Company had no contract assets as of January 1, 2018 and as of March 31, 2018. The beginning and ending balances of contract liabilities and significant activity during the period is as follows:
 
 
Contract
(In thousands)
 
Liabilities
Balance as of January 1, 2018
 
$
179,179

Consideration earned during the period
 
(8,067
)
Consideration received during the period
 
44,043

Balance as of March 31, 2018
 
$
215,155

Remaining Unsatisfied Performance Obligations

The Company’s remaining unsatisfied performance obligations as of March 31, 2018 represent a measure of the total dollar value of work to be performed on contracts executed and in progress. These performance obligations are associated with contracts that generally are noncancellable by the customer after 30 days; however, purchasers of HHC's condominium units have the right to

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED

cancel the contract should the Company elect not to construct the condominium unit within a certain period of time or materially change the design of the condominium unit. The aggregate amount of the transaction price allocated to the Company's remaining unsatisfied performance obligations as of March 31, 2018 is $1.1 billion. The Company expects to recognize this amount as revenue over the following periods:
(In thousands)
 
Less than 1 year
 
1-2 years
 
3 years and thereafter
Total remaining unsatisfied performance obligations
 
$
690,059

 
$
202,716

 
$
234,609


The Company’s remaining performance obligations are adjusted to reflect any known project cancellations, revisions to project scope and cost, and deferrals, as appropriate. These amounts exclude estimated amounts of variable consideration which are constrained, such as BPP, as discussed above.

NOTE 3 REAL ESTATE AND OTHER AFFILIATES
 
The Company's investments in Real Estate and Other Affiliates that are reported in accordance with the equity and cost methods are as follows:
 
 
Economic/Legal Ownership
 
Carrying Value
 
Share of Earnings/Dividends
 
 
March 31,
 
December 31, 
 
March 31,
 
December 31, 
 
Three Months Ended March 31,
($ in thousands)
 
2018
 
2017
 
2018
 
2017
 
2018
 
2017
Equity Method Investments
 
 
 
 
 
 
 
 
 
 
 
 
Master Planned Communities:
 
 
 
 
 
 
 
 
 
 
 
 
The Summit (a)
 
%
 
%
 
$
57,015

 
$
45,886

 
$
11,128

 
$
5,280

Operating Assets:
 
 
 
 
 
 
 
 
 
 
 
 
Las Vegas 51s, LLC (b)
 
100
%
 
100
%
 

 

 

 
(152
)
Constellation (b)
 
100
%
 
100
%
 

 

 

 
64

The Metropolitan Downtown Columbia (c)
 
50
%
 
50
%
 

 

 
80

 
57

Stewart Title of Montgomery County, TX
 
50
%
 
50
%
 
3,579

 
3,673

 
82

 
26

Woodlands Sarofim #1
 
20
%
 
20
%
 
2,697

 
2,696

 
20

 
7

m.flats/TEN.M (d)
 
50
%
 
50
%
 
5,648

 
6,521

 
(937
)
 

Strategic Developments:
 
 
 
 
 
 
 
 
 
 
 
 
Circle T Ranch and Power Center
 
50
%
 
50
%
 
4,456

 
4,455

 

 

HHMK Development
 
50
%
 
50
%
 
10

 
10

 

 

KR Holdings
 
50
%
 
50
%
 

 
749

 
672

 
11

33 Peck Slip
 
35
%
 
35
%
 
8,651

 
8,651

 

 
(156
)
 
 
 
 
 
 
82,056

 
72,641

 
11,045

 
5,137

Cost method investments
 
 
 
 
 
3,855

 
3,952

 
3,341

 
3,383

Investment in Real Estate and Other Affiliates
 
 
 
 
 
$
85,911

 
$
76,593

 
$
14,386

 
$
8,520

 
(a)
Please refer to the schedules below and elsewhere in this Quarterly Report for relevant financial statement information.
(b)
HHC acquired this joint venture partner’s interest in 2017 and has fully consolidated the assets and liabilities of the entity.
(c)
The Metropolitan Downtown Columbia was in a deficit position of $3.1 million and $2.6 million at March 31, 2018 and December 31, 2017, respectively, due to distributions from operating cash flows in excess of basis. This deficit balance is presented in Accounts payable and accrued expenses at March 31, 2018 and December 31, 2017.
(d)
Property was transferred from Strategic Developments to Operating Assets during the three months ended March 31, 2018.

As of March 31, 2018, HHC is not the primary beneficiary of any of the joint ventures listed above because it does not have the power to direct activities that most significantly impact the economic performance of the joint ventures, and therefore, the Company reports its interests in accordance with the equity method. As of March 31, 2018, approximately $187.6 million of indebtedness was secured by the properties owned by HHC's Real Estate and Other Affiliates of which HHC's share was approximately $86.8 million based upon economic ownership. All of this indebtedness is without recourse to HHC.

HHC is the primary beneficiary of three variable interest entities ("VIEs") which are consolidated in the financial statements. The creditors of the consolidated VIEs do not have recourse to the Company. As of March 31, 2018, the carrying values of the assets and liabilities associated with the operations of the consolidated VIEs were $22.8 million and $1.2 million, respectively. As of December 31, 2017, the carrying values of the assets and liabilities associated with the operations of the consolidated VIEs were

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED

$24.8 million and $2.7 million, respectively. The assets of the VIEs are restricted for use only by the particular VIEs and are not available for the Company's general operations.

During the first quarter of 2015, HHC formed DLV/HHPI Summerlin, LLC (“The Summit”), a joint venture with Discovery Land Company (“Discovery”), contributed land with a book basis of $13.4 million and transferred Special Improvement District ("SID") bonds related to such land with a carrying value of $1.3 million to the joint venture at the agreed upon capital contribution value of $125.4 million, or $226,000 per acre. Discovery is required to fund up to a maximum of $30.0 million of cash as its capital contribution, and the Company has no further capital obligations. The gains on the contributed land will be recognized in Equity in earnings from Real Estate and Other Affiliates as the joint venture sells lots. 

After the Company receives its capital contribution of $125.4 million and a 5.0% preferred return on such capital contribution, Discovery is entitled to cash distributions by the joint venture until it has received two times its equity contribution. Any further cash distributions are shared equally. Given the nature of the venture’s capital structure and the provisions for the liquidation of assets, the Company's share of the venture’s income-producing activities is recognized based on the Hypothetical Liquidation Book Value ("HLBV") method. Under this method, HHC recognizes income or loss based on the change in its underlying share of the venture's net assets on a hypothetical liquidation basis as of the reporting date.

Relevant financial statement information for The Summit is summarized as follows:
 
 
March 31,
 
December 31,
(In millions)
 
2018
 
2017
Total Assets
 
$
189.8

 
$
166.9

Total Liabilities
 
131.9

 
118.9

Total Equity
 
57.9

 
48.0

 
 
 
Three Months Ended March 31,
(In millions)
 
2018
 
2017
Revenues (a)
 
$
23.4

 
$
11.5

Net income
 
11.1

 
5.3

Gross Margin
 
13.3

 
6.5

 
(a)
Revenues related to land sales at the joint venture are recognized on a percentage of completion basis as The Summit follows the private company timeline for implementation of the New Revenue Standard of January 1, 2019. The Company has evaluated this impact and concluded that it is not material to HHC's consolidated financial statements.
  
NOTE 4 RECENT TRANSACTIONS

On April 30, 2018, the Company closed on a $494.5 million construction loan for 110 North Wacker. The loan initially bears interest at LIBOR plus 3.00% and has an initial maturity date of April 30, 2022. On April 30, 2018, HHC executed a joint venture agreement with USAA. After execution of the joint venture agreement, HHC will own 32.70% of the joint venture's equity capital.

On February 23, 2018, the Company repurchased 475,920 shares of HHC common stock, par value $0.01 per share, in a private transaction with an unaffiliated entity at a purchase price of $120.33 per share, or approximately $57.3 million in the aggregate. The repurchase transaction was consummated on February 21, 2018 and was funded with cash on hand. The shares were added to the Company's treasury stock upon repurchase.

NOTE 5 IMPAIRMENT
  
The Company reviews its long-lived assets for potential impairment indicators whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. With respect to the Investment in Real Estate and Other Affiliates, a series of operating losses of an underlying asset or other factors may indicate that a decrease in value has occurred which is other‑than‑temporary. The investment in each Real Estate and Other Affiliate is evaluated periodically and as deemed necessary for recoverability and valuation declines that are other‑than‑temporary. No impairment charges were recorded during the three months ended March 31, 2018 or during the year ended December 31, 2017. The Company periodically evaluates its strategic

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED

alternatives with respect to each of its properties and may revise its strategy from time to time, including its intent to hold an asset on a long-term basis or the timing of potential asset dispositions. These changes in strategy could result in impairment charges in future periods.

NOTE 6 OTHER ASSETS AND LIABILITIES
 
Prepaid Expenses and Other Assets
 
The following table summarizes the significant components of Prepaid expenses and other assets:
 
 
March 31,
 
December 31,
(In thousands)
 
2018
 
2017
Straight-line rent
 
$
42,188

 
$
39,136

Intangibles
 
34,465

 
34,802

Special Improvement District receivable
 
26,371

 
26,430

Below-market ground leases
 
18,562

 
18,647

Security and escrow deposits
 
16,888

 
16,949

Equipment, net of accumulated depreciation of $7.1 million and $6.9 million, respectively
 
16,798

 
16,955

Prepaid expenses
 
12,247

 
11,731

Other
 
11,873

 
19,242

In-place leases
 
9,805

 
10,821

Interest rate swap derivative assets
 
9,011

 
4,470

Tenant incentives and other receivables
 
8,208

 
8,482

Federal income tax receivable
 
2,198

 
2,198

Above-market tenant leases
 
1,495

 
1,648

Condominium deposits
 
218

 

Condominium receivables
 

 
158,516

Total prepaid expenses and other assets
 
$
210,327

 
$
370,027


The $159.7 million net decrease primarily relates to the following decreases: a $158.5 million decrease in Condominium receivables of which $154.2 million relates to the adoption of the New Revenue Standard; a $7.4 million decrease in Other and $1.0 million decrease in In-place leases. These decreases were partially offset by the following increases: a $4.5 million increase in Interest rate swap derivative assets; $3.1 million increase in Straight-line rent due to additional Operating Assets placed in service during the quarter; and $0.5 million increase in Prepaid expenses

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED

Accounts Payable and Accrued Expenses
 
The following table summarizes the significant components of Accounts payable and accrued expenses:
 
 
March 31,
 
December 31,
(In thousands)
 
2018
 
2017
Construction payables
 
$
244,192

 
$
217,838

Condominium deposit liabilities
 
196,337

 
55,975

Deferred income
 
52,758

 
53,337

Other
 
27,552

 
34,699

Accounts payable and accrued expenses
 
26,328

 
35,887

Tenant and other deposits
 
19,681

 
18,937

Accrued payroll and other employee liabilities
 
18,246

 
41,236

Straight-line ground rent liability
 
15,399

 
14,944

Accrued real estate taxes
 
11,271

 
22,289

Accrued interest
 
7,507

 
20,322

Interest rate swaps
 

 
5,961

Above-market ground leases
 

 
293

Total accounts payable and accrued expenses
 
$
619,271

 
$
521,718

 
The $97.6 million net increase in total accounts payable and accrued expenses primarily relates to the following increases: $140.4 million increase in Condominium deposit liabilities and $26.4 million increase in Construction payables for the towers under construction at Ward Village as the projects move toward completion; and $1.2 million in other increases. These increases are partially offset by a decrease of $23.0 million in Accrued payroll and other employee liabilities due to payment in the first quarter of 2018 of annual incentive bonus for 2017; a decrease of $12.8 million in Accrued interest primarily due to lower interest accrual activity relating to the issuance of the $1.0 billion, 5.375% senior notes due 2025 ("2025 Notes") at a lower rate than the 6.875% senior notes; an $11.0 million decrease in Accrued real estate taxes; a $9.6 million decrease in Accounts payable and accrued expenses; a $7.1 million decrease in Other; a $6.0 million decrease in Interest rate swaps; and $0.9 million in other decreases.

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Table of Contents
THE HOWARD HUGHES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED

NOTE 7 MORTGAGES, NOTES AND LOANS PAYABLE
 
Mortgages, notes and loans payable are summarized as follows: 
 
 
March 31,
 
December 31,
(In thousands)
 
2018
 
2017
Fixed-rate debt:
 
 
 
 
Unsecured 5.375% Senior Notes
 
$
1,000,000

 
$
1,000,000

Secured mortgages, notes and loans payable
 
497,960

 
499,299

Special Improvement District bonds
 
24,528

 
27,576

Variable-rate debt:
 
 
 
 
Mortgages, notes and loans payable (a)
 
1,392,732

 
1,350,914

Unamortized bond issuance costs
 
(6,701
)
 
(6,898
)
Deferred financing costs
 
(12,748
)
 
(12,946
)
Total mortgages, notes and loans payable, net
 
$
2,895,771

 
$
2,857,945

 
(a)
As more fully described in Note 9 - Derivative Instruments and Hedging Activities, $409.4 million and $428.3 million of variable‑rate debt has been swapped to a fixed-rate for the term of the related debt as of March 31, 2018 and December 31, 2017, respectively.

Certain of the Company's loans contain provisions which grant the lender a security interest in the operating cash flow of the property that represents the collateral for the loan. Certain mortgage notes may be prepaid subject to a prepayment penalty equal to a yield maintenance premium, defeasance or percentage of the loan balance. As of March 31, 2018, land, buildings and equipment and developments with a net book value basis of $3.8 billion have been pledged as collateral for HHC mortgages, notes and loans payable. As of March 31, 2018, the Company was in compliance with all of its financial covenants included in the debt agreements governing its indebtedness.
 
The Summerlin MPC uses SID bonds to finance certain common infrastructure improvements. These bonds are issued by the municipalities and are secured by the assessments on the land. The majority of proceeds from each bond issued is held in a construction escrow and disbursed to the Company as infrastructure projects are completed, inspected by the municipalities and approved for reimbursement. Accordingly, the SID bonds have been classified as debt, and the Summerlin MPC pays the debt service on the bonds semi‑annually. As Summerlin sells land, the buyers assume a proportionate share of the bond obligation at closing, and the residential sales contracts provide for the reimbursement of the principal amounts that the Company previously paid with respect to such proportionate share of the bond. In the three months ended March 31, 2018, no new SID bonds were issued and $2.9 million in obligations were assumed by buyers.
 
Financing Activity

On April 30, 2018, the Company closed on a $494.5 million construction loan for 110 North Wacker. The loan initially bears interest at LIBOR plus 3.00% and steps up or down based on various leasing thresholds.

On April 13, 2018, the Company repaid the $11.8 million loan for Lakeland Village Center at Bridgeland.

On March 27, 2018, the Company closed on a $44.1 million construction loan for Downtown Summerlin Apartments, bearing interest at one-month LIBOR plus 2.25% with an initial maturity date of October 1, 2021 and one, three-year extension option.

On January 25, 2018, the Company closed on a $15.5 million construction loan for Lake Woodlands Crossing Retail, a project located in The Woodlands, Texas. The loan bears interest at LIBOR plus 1.80%, matures on January 25, 2023, and has an initial maximum recourse of 50% of the outstanding balance prior to completion of construction, at which point the repayment guarantee will reduce to 15% provided the project is 90% leased.

On January 19, 2018, the Company paid off the $18.9 million mortgage loan for 110 North Wacker and settled the related swap liability of $0.3 million.


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Table of Contents
THE HOWARD HUGHES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED

On January 5, 2018, the Company modified and extended the $65.5 million Three Hughes Landing facility. The loan bears interest at one-month LIBOR plus 2.60% with an initial maturity of December 5, 2018, and two, one-year extension options.

NOTE 8 FAIR VALUE
 
ASC 820, Fair Value Measurement, emphasizes that fair value is a market-based measurement that should be determined using assumptions market participants would use in pricing an asset or liability. The standard establishes a hierarchal disclosure framework which prioritizes and ranks the level of market price observability used in measuring assets or liabilities at fair value. Market price observability is impacted by a number of factors, including the type of investment and the characteristics specific to the asset or liability. Assets or liabilities with readily available active quoted prices, or for which fair value can be measured from actively quoted prices, generally will have a higher degree of market price observability and a lesser degree of judgment used in measuring fair value.

The following table presents the fair value measurement hierarchy levels required under ASC 820 for each of the Company's assets and liabilities that are measured at fair value on a recurring basis:
 
 
 
March 31, 2018
 
December 31, 2017
 
 
Fair Value Measurements Using
 
Fair Value Measurements Using
(In thousands)
 
Total
 
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Total
 
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Assets:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Cash equivalents
 
$
50,272

 
$
50,272

 
$

 
$

 
$
50,135

 
$
50,135

 
$

 
$

Interest rate swap derivative assets
 
9,011

 

 
9,011

 

 
4,470

 

 
4,470

 

Liabilities:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Interest rate swap derivative liabilities
 

 

 

 

 
5,961

 

 
5,961

 

 
Cash equivalents consist of registered money market mutual funds which are invested in United States Treasury bills that are valued at the net asset value of the underlying shares in the funds as of the close of business at the end of each period.
 
The fair values of interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash payments and the discounted expected variable cash receipts. The variable cash receipts are based on an expectation of future interest rates derived from observable market interest rate curves.
 
In 2010 and 2011, the Company entered into warrant agreements (the "Sponsor Warrants and Management Warrants") with various parties to purchase shares of HHC common stock. As discussed further in Note 13 – Warrants, all Sponsor and Management warrants granted prior to 2016, which were accounted for as warrant liabilities, had been exercised as of December 31, 2017. The following table presents a rollforward of the valuation of the Company's Warrant liabilities:
 
(In thousands)
 
2018
 
2017
Balance as of January 1
 
$

 
$
332,170

Warrant liability loss (a)
 

 
12,562

Exercises of Sponsor and Management Warrants
 

 
(30,935
)
Balance as of March 31
 
$

 
$
313,797

 
(a)
For 2017, this amount represents losses recognized related to each Sponsor and Management Warrant prior to the respective exercise date. Changes in the fair value of the Sponsor Warrants and Management Warrants prior to exercise were recognized in net income as a warrant liability gain or loss.

The valuation of warrants was based on an option pricing valuation model, utilizing inputs which were classified as Level 3 due to the unavailability of comparable market data. The inputs to the valuation model included the fair value of stock related to the

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THE HOWARD HUGHES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED

warrants, exercise price and term of the warrants, expected volatility, risk-free interest rate, dividend yield and, as appropriate, a discount for lack of marketability. Generally, an increase in expected volatility would increase the fair value of the liability. The impact of the volatility on fair value diminished as the market value of the stock increased above the strike price. As the period of restriction lapsed, the marketability discount reduced to zero and increased the fair value of the warrants.

The estimated fair values of the Company's financial instruments that are not measured at fair value on a recurring basis are as follows:
 
 
 
 
March 31, 2018
 
December 31, 2017
(In thousands)
 
Fair Value
Hierarchy
 
Carrying
Amount
 
Estimated
Fair Value
 
Carrying
Amount
 
Estimated
Fair Value
Assets:
 
 
 
 
 
 
 
 
 
 
Cash and restricted cash
 
Level 1
 
$
714,671

 
$
714,671

 
$
914,165

 
$
914,165

Accounts receivable, net (a)
 
Level 3
 
14,384

 
14,384

 
13,041

 
13,041

Notes receivable, net (b)
 
Level 3
 
8,310

 
8,310

 
5,864

 
5,864

 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 

 
 

 
 

 
 

Fixed-rate debt (c)
 
Level 2
 
1,522,490

 
1,507,840

 
1,526,875

 
1,554,766

Variable-rate debt (c)
 
Level 2
 
1,392,732

 
1,392,732

 
1,350,914

 
1,350,914

 
(a)
Accounts receivable, net is shown net of an allowance of $7.2 million and $9.3 million at March 31, 2018 and December 31, 2017, respectively.
(b)
Notes receivable, net is shown net of an allowance of $0.1 million at March 31, 2018 and December 31, 2017.
(c)
Excludes related unamortized financing costs.

The fair value of the Company's 2025 Notes, included in fixed-rate debt in the table above, is based upon the trade price closest to the end of the period presented. The fair value of other fixed-rate debt in the table above (please refer to Note 7 – Mortgages, Notes and Loans Payable in the Company's Condensed Consolidated Financial Statements), was estimated based on a discounted future cash payment model, which includes risk premiums and a risk free rate derived from the current London Interbank Offered Rate (“LIBOR”) or U.S. Treasury obligation interest rates. The discount rates reflect the Company's judgment as to what the approximate current lending rates for loans or groups of loans with similar maturities and credit quality would be if credit markets were operating efficiently and assuming that the debt is outstanding through maturity.
 
The carrying amounts for the Company's variable-rate debt approximate fair value given that the interest rates are variable and adjust with current market rates for instruments with similar risks and maturities.
 
The carrying amounts of cash and cash equivalents and accounts receivable approximate fair value because of the short‑term maturity of these instruments. The fair value of the notes receivable is based on the fair value of the collateral which exceeds the carrying basis of the notes as of March 31, 2018.



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THE HOWARD HUGHES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED

NOTE 9 DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
 
The Company is exposed to interest rate risk related to its variable interest rate debt, and it manages this risk by utilizing interest rate derivatives. To add stability to interest costs by reducing the Company's exposure to interest rate movements, the Company uses interest rate swaps and caps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable amounts from a counterparty in exchange for the Company's fixed‑rate payments over the life of the agreements without exchange of the underlying notional amount. Interest rate caps designated as cash flow hedges involve the receipt of variable amounts from a counterparty if interest rates rise above the strike rate on the contract in exchange for an up‑front premium. The Company's interest rate caps are not currently designated as hedges, and therefore, any gain or loss is recognized in current period earnings. These derivatives are recorded on a gross basis at fair value.
 
The change in the fair value of derivatives designated and qualifying as cash flow hedges is recorded in Accumulated Other Comprehensive Income (“AOCI”) and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings within the same income statement line item being hedged. During the three months ended March 31, 2017, the ineffective portion recorded in Other income, net was $0.7 million. As discussed in Note 2 - Accounting Policies and Pronouncements, the Company reclassified this ineffectiveness to Accumulated deficit as of January 1, 2018, upon adoption of ASU 2017-12.
 
Assessments of hedge effectiveness are performed quarterly using regression analysis. HHC is exposed to credit risk in the event of non-performance by its derivative counterparties. The Company evaluates counterparty credit risk through monitoring the creditworthiness of counterparties, which includes review of debt ratings and financial performance. To mitigate its credit risk, the Company enters into agreements with counterparties that are considered credit-worthy, such as large financial institutions with favorable credit ratings. As of March 31, 2018 and 2017, there were no termination events or events of default related to the interest rate swaps.
 
If the derivative contracts are terminated prior to their maturity, the amounts previously recorded in AOCI are recognized into earnings over the period that the hedged transaction impacts earnings. If the hedging relationship is discontinued because it is probable that the forecasted transaction will not occur according to the original strategy, any related amounts previously recorded in AOCI are recognized in earnings immediately.

The following table summarizes certain terms of the Company's derivative contracts:
 
 
 
 
 
 
 
 
Fixed
 
 
 
 
 
Fair Value Asset (Liability)
 
 
 
 
 
 
 
 
Interest
 
Effective
 
Maturity
 
March 31,
 
December 31,
(In thousands)
 
 
 
Balance Sheet Location
 
Notional
 
Rate
 
Date
 
Date
 
2018
 
2017
Currently-paying contracts:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest Rate Swap
 
(a)
 
Accounts payable and accrued expenses
 
$
18,926

 
2.96
%
 
5/10/2011
 
10/31/2019
 
$

 
$
(286
)
Interest Rate Swap
 
(b)
 
Prepaid expenses and other assets, net
 
40,000

 
1.66
%
 
5/6/2015
 
5/1/2020
 
571

 
299

Interest Rate Swap
 
(b)
 
Prepaid expenses and other assets, net
 
119,359

 
1.14
%
 
10/3/2016
 
9/12/2021
 
5,313

 
4,007

Interest Rate Cap
 
(c)
 
Prepaid expenses and other assets, net
 
75,000

 
5.00
%
 
9/1/2017
 
8/31/2019
 
6

 

Interest Rate Cap
 
(d)
 
Prepaid expenses and other assets, net
 
230,000

 
2.50
%
 
12/22/2016
 
12/23/2019
 
469

 
164

Interest Rate Swap
 
(b)
 
Prepaid expenses and other assets, net
 
50,000

 
2.65
%
 
12/31/2017
 
12/31/2027
 
541

 
(1,124
)
Interest Rate Swap
 
(b)
 
Prepaid expenses and other assets, net
 
100,000

 
2.68
%
 
12/31/2017
 
12/31/2027
 
830

 
(2,509
)
Interest Rate Swap
 
(b)
 
Prepaid expenses and other assets, net
 
100,000

 
2.62
%
 
12/31/2017
 
12/31/2027
 
1,281

 
(2,042
)
Total fair value derivative assets
 
 
 
 
 
 
 
 
 
 
 
 
 
$
9,011

 
$
4,470

Total fair value derivative liabilities