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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, 2019
 
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
Securities registered pursuant to Section 12(b) of the Act:
Title of each class:
 
Trading Symbol(s)
 
Name of each exchange on which registered:
Common stock, $0.01 par value per share
 
HHC
 
New York Stock Exchange
 
The number of shares of common stock, $0.01 par value, outstanding as of April 30, 2019 was 43,139,311.
 


Table of Contents


THE HOWARD HUGHES CORPORATION
 
TABLE OF CONTENTS
 
 
 
 
PAGE
NUMBER
 
 
 
 
 
 
 
 
 
 
Item 1:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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 

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

THE HOWARD HUGHES CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS 
UNAUDITED
(In thousands, except par values and share amounts)
 
March 31, 2019
 
December 31, 2018
Assets:
 
 
 
 
Investment in real estate:
 
 
 
 
Master Planned Communities assets
 
$
1,665,037

 
$
1,642,660

Buildings and equipment
 
3,082,749

 
2,932,963

Less: accumulated depreciation
 
(410,315
)
 
(380,892
)
Land
 
303,384

 
297,596

Developments
 
1,384,212

 
1,290,068

Net property and equipment
 
6,025,067

 
5,782,395

Investment in real estate and other affiliates
 
106,800

 
102,287

Net investment in real estate
 
6,131,867

 
5,884,682

Cash and cash equivalents
 
452,908

 
499,676

Restricted cash
 
134,398

 
224,539

Accounts receivable, net
 
16,030

 
12,589

Municipal Utility District receivables, net
 
246,231

 
222,269

Notes receivable, net
 
4,723

 
4,694

Deferred expenses, net
 
104,101

 
95,714

Operating lease right-of-use assets, net
 
72,105

 

Prepaid expenses and other assets, net
 
253,644

 
411,636

Total assets
 
$
7,416,007

 
$
7,355,799

 
 
 
 
 
Liabilities:
 
 
 
 
Mortgages, notes and loans payable, net
 
$
3,241,985

 
$
3,181,213

Operating lease obligations
 
71,888

 

Deferred tax liabilities
 
165,690

 
157,188

Accounts payable and accrued expenses
 
628,971

 
779,272

Total liabilities
 
4,108,534

 
4,117,673

 
 
 
 
 
Commitments and contingencies (see Note 9)
 


 


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

 

Common stock: $.01 par value; 150,000,000 shares authorized, 43,659,708 shares issued and 43,139,859 outstanding as of March 31, 2019 and 43,511,473 shares issued and 42,991,624 outstanding as of December 31, 2018
 
437

 
436

Additional paid-in capital
 
3,325,499

 
3,322,433

Accumulated deficit
 
(88,520
)
 
(120,341
)
Accumulated other comprehensive loss
 
(14,759
)
 
(8,126
)
Treasury stock, at cost, 519,849 shares as of March 31, 2019 and December 31, 2018
 
(62,190
)
 
(62,190
)
Total stockholders' equity
 
3,160,467

 
3,132,212

Noncontrolling interests
 
147,006

 
105,914

Total equity
 
3,307,473

 
3,238,126

Total liabilities and equity
 
$
7,416,007

 
$
7,355,799

See Notes to Condensed Consolidated Financial Statements.
THE HOWARD HUGHES CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS 
UNAUDITED
 
 
Three Months Ended March 31,
(In thousands, except per share amounts)
    
2019
 
2018
Revenues:
 
 

 
 

Condominium rights and unit sales
 
$
198,310

 
$
10,837

Master Planned Communities land sales
 
41,312

 
46,565

Minimum rents
 
54,086

 
49,395

Tenant recoveries
 
13,508

 
12,760

Hospitality revenues
 
22,929

 
23,061

Builder price participation
 
5,195

 
5,081

Other land revenues
 
4,729

 
4,131

Other rental and property revenues
 
13,821

 
9,849

Total revenues
 
353,890

 
161,679

 
 
 
 
 
Expenses:
 
 
 
 
Condominium rights and unit cost of sales
 
137,694

 
6,729

Master Planned Communities cost of sales
 
16,818

 
26,043

Master Planned Communities operations
 
11,695

 
10,325

Other property operating costs
 
37,264

 
23,175

Rental property real estate taxes
 
9,831

 
8,127

Rental property maintenance costs
 
4,177

 
3,197

Hospitality operating costs
 
15,623

 
15,567

(Recovery) provision for doubtful accounts
 
(2
)
 
776

Demolition costs
 
49

 
6,671

Development-related marketing costs
 
5,702

 
6,078

General and administrative
 
25,332

 
24,264

Depreciation and amortization
 
36,131

 
28,188

Total expenses
 
300,314

 
159,140

 
 
 
 
 
Other:
 
 
 
 
Loss on sale or disposal of real estate
 
(6
)
 

Other income, net
 
173

 

Total other
 
167

 

 
 
 
 
 
Operating income
 
53,743

 
2,539

 
 
 
 
 
Interest income
 
2,573

 
2,076

Interest expense
 
(23,326
)
 
(16,609
)
Equity in earnings from real estate and other affiliates
 
9,951

 
14,386

Income before taxes
 
42,941

 
2,392

Provision for income taxes
 
11,016

 
558

Net income
 
31,925

 
1,834

Net income attributable to noncontrolling interests
 
(104
)
 
(360
)
Net income attributable to common stockholders
 
$
31,821

 
$
1,474

 
 
 
 
 
Basic income per share:
 
$
0.74

 
$
0.03

 
 
 
 
 
Diluted income per share:
 
$
0.74

 
$
0.03

See Notes to Condensed Consolidated Financial Statements.

3
 

Table of Contents


 THE HOWARD HUGHES CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
UNAUDITED
 
 
Three Months Ended March 31,
(In thousands)
 
2019
 
2018
Net income
 
$
31,925

 
$
1,834

Other comprehensive (loss) income:
 
 
 
 
Interest rate swaps (a)
 
(5,944
)
 
8,045

Capitalized swap interest (expense) income (b)
 
(51
)
 
10

Adoption of ASU 2018-02 (c)
 

 
(1,148
)
Adoption of ASU 2017-12 (d)
 

 
(739
)
Terminated swap amortization
 
(638
)
 

Other comprehensive (loss) income
 
(6,633
)
 
6,168

Comprehensive income
 
25,292

 
8,002

Comprehensive income attributable to noncontrolling interests
 
(104
)
 
(360
)
Comprehensive income attributable to common stockholders
 
$
25,188

 
$
7,642

 
(a)
Amounts are shown net of deferred tax benefit of $2.2 million and deferred tax expense of $2.1 million for the three months ended March 31, 2019 and 2018, respectively.
(b)
The deferred tax impact was not meaningful for the three months ended March 31, 2019 and 2018.
(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.
(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 Notes to Condensed Consolidated Financial Statements.


4
 

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
 
(Loss) Income
 
Shares
 
Amount
 
Equity
 
Interests
 
Equity
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

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

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, December 31, 2018
 
43,511,473

 
$
436

 
$
3,322,433

 
$
(120,341
)
 
$
(8,126
)
 
(519,849
)
 
$
(62,190
)
 
$
3,132,212

 
$
105,914

 
$
3,238,126

Net income
 

 

 

 
31,821

 

 

 

 
31,821

 
104

 
31,925

Interest rate swaps, net of tax of $2,187
 

 

 

 

 
(5,944
)
 

 

 
(5,944
)
 

 
(5,944
)
Terminated swap amortization
 

 

 

 

 
(638
)
 

 

 
(638
)
 

 
(638
)
Capitalized swap interest, net of tax of $14
 

 

 

 

 
(51
)
 

 

 
(51
)
 

 
(51
)
Contributions to joint ventures
 

 

 

 

 

 

 

 

 
40,988

 
40,988

Stock plan activity
 
148,235

 
1

 
3,066

 

 

 

 

 
3,067

 

 
3,067

Balance, March 31, 2019
 
43,659,708

 
$
437

 
$
3,325,499

 
$
(88,520
)
 
$
(14,759
)
 
(519,849
)
 
$
(62,190
)
 
$
3,160,467

 
$
147,006

 
$
3,307,473

 
See Notes to Condensed Consolidated Financial Statements.

5
 

Table of Contents


THE HOWARD HUGHES CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS 
UNAUDITED
 
 
Three Months Ended March 31,
(In thousands)
 
2019
 
2018
Cash Flows from Operating Activities:
 
 
 
 
Net income
 
$
31,925

 
$
1,834

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

 
 

Depreciation
 
32,905

 
24,850

Amortization
 
3,086

 
3,002

Amortization of deferred financing costs
 
2,201

 
1,469

Amortization of intangibles other than in-place leases
 
278

 
336

Straight-line rent amortization
 
(1,548
)
 
(3,052
)
Deferred income taxes
 
10,703

 
248

Restricted stock and stock option amortization
 
3,069

 
2,684

Equity in earnings from real estate and other affiliates, net of distributions
 
(4,606
)
 
(9,532
)
Provision for doubtful accounts
 
(2
)
 
776

Master Planned Communities land acquisitions
 
(752
)
 
(506
)
Master Planned Communities development expenditures
 
(56,772
)
 
(42,092
)
Master Planned Communities cost of sales
 
16,744

 
23,189

Condominium development expenditures
 
(40,559
)
 
(78,964
)
Condominium rights and unit cost of sales
 
137,694

 
6,729

Net changes:
 
 

 
 

Accounts and notes receivable
 
(5,679
)
 
(6,100
)
Prepaid expenses and other assets
 
1,881

 
1,590

Condominium deposits received
 
(115,774
)
 
40,762

Deferred expenses
 
(17,191
)
 
(3,759
)
Accounts payable and accrued expenses
 
(57,286
)
 
(49,885
)
Cash used in operating activities
 
(59,683
)
 
(86,421
)
 
 
 
 
 
Cash Flows from Investing Activities:
 
 

 
 

Property and equipment expenditures
 
(1,178
)
 
(1,295
)
Operating property improvements
 
(25,854
)
 
(17,600
)
Property development and redevelopment
 
(148,894
)
 
(90,682
)
Reimbursements under Tax Increment Financings
 

 
11,731

Distributions from real estate and other affiliates
 
315

 
748

Notes issued to real estate and other affiliates
 

 
(2,783
)
Investments in real estate and other affiliates, net
 
(222
)
 

Cash used in investing activities
 
(175,833
)
 
(99,881
)
 
 
 
 
 
Cash Flows from Financing Activities:
 
 

 
 

Proceeds from mortgages, notes and loans payable
 
61,614

 
62,967

Principal payments on mortgages, notes and loans payable
 
(4,587
)
 
(24,059
)
Purchase of treasury stock
 

 
(57,267
)
Special Improvement District bond funds released from (held in) escrow
 
936

 
230

Deferred financing costs and bond issuance costs, net
 
(343
)
 
(163
)
Taxes paid on stock options exercised and restricted stock vested
 

 
(1,713
)
Stock options exercised
 

 
6,950

Contributions from noncontrolling interest
 
40,987

 

Cash provided by (used in) financing activities
 
98,607

 
(13,055
)

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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)
 
2019
 
2018
Net change in cash, cash equivalents and restricted cash
 
(136,909
)
 
(199,357
)
Cash, cash equivalents and restricted cash at beginning of period
 
724,215

 
964,300

Cash, cash equivalents and restricted cash at end of period
 
$
587,306

 
$
764,943

 
 
 
 
 
Supplemental Disclosure of Cash Flow Information:
 
 

 
 

Interest paid
 
$
52,905

 
$
45,652

Interest capitalized
 
18,370

 
17,500

Income taxes refunded, net
 
(1,839
)
 

 
 
 
 
 
Non-Cash Transactions:
 
 

 
 

Accrued property improvements, developments and redevelopments
 
24,774

 

Special Improvement District bond transfers associated with land sales
 
74

 
2,854

Accrued interest on construction loan borrowing
 
860

 
252

Capitalized stock compensation
 
441

 
533

 
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, 2018, filed with the SEC on February 27, 2019 (the "Annual Report"). 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, 2019 are not necessarily indicative of the results that may be expected for the year ending December 31, 2019 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 was filed.
 
Impact of new accounting standard related to Leases
In February 2016, the Financial Accounting Standards Board ("FASB") issued ASU No. 2016-02, Leases (Topic 842) to increase transparency and comparability among organizations by requiring the recognition of right-of-use assets and lease liabilities on the balance sheet. The Company adopted Topic 842 (the "New Leases Standard") as of January 1, 2019 (the "Adoption Date") using the modified retrospective approach that provides a method for applying the guidance to leases that had commenced as of the beginning of the reporting period in which the standard is first applied with a cumulative-effect adjustment as of that date. The Company elected the package of practical expedients permitted under the transition guidance within the New Leases Standard, which allowed the Company to carry forward the historical lease classification for leases that existed at the beginning of the reporting period.
The Company elected the practical expedient to not separate lease components from nonlease components of its lease agreements for all classes of underlying assets including ground leases, office leases and other leases. Certain of the Company’s lease agreements include nonlease components such as fixed common area maintenance charges.

The Company elected the hindsight practical expedient to determine the lease term for existing leases where it is the lessee. The Company’s election of the hindsight practical expedient resulted in the extension of lease terms for certain existing leases. In the application of hindsight, the Company evaluated the performance of the property and associated markets in relation to its overall strategies, which resulted in the determination that most renewal options would not be reasonably certain in determining the expected lease term.

Adoption of the New Leases Standard resulted in the recording of right-of-use assets and lease liabilities of $73.1 million and $72.0 million, respectively, as of the Adoption Date. The standard did not materially impact the Company’s consolidated net income and had no impact on cash flows.

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

Segment Presentation

Starting in the first quarter of 2019, the Seaport District has been moved out of the Company's existing segments and into a stand-alone segment for disclosure purposes. The Company believes that by providing this additional detail, investors and analysts will be able to better track the Company's progress towards stabilization. See Note 16 -Segments for results of the new segment. The respective segment earnings and total segment assets presented in these Condensed Consolidated Financial Statements and elsewhere in this Quarterly Report have been adjusted in all periods reported to reflect this change.


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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 October 2018, the FASB issued ASU 2018-17, Consolidation (Topic 810): Targeted Improvements to Related Party Guidance for Variable Interest Entities. This standard is intended to improve the accounting when considering indirect interests held through related parties under common control for determining whether fees paid to decision makers and service providers are variable interests. The effective date of the standard is for fiscal years, and interim periods within those years, beginning after December 15, 2019. The new standard must be adopted retrospectively with early adoption permitted. The Company is currently evaluating the impact that the adoption of ASU 2018-17 may have on its consolidated financial statements.
In August 2018, the FASB issued ASU 2018-15, Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. This standard is intended to align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal use software (and hosting arrangements that include an internal use software license). The standard requires an entity in a hosting arrangement that is a service contract to follow the guidance in Subtopic 350-40 to determine which implementation costs to capitalize as an asset related to the service contract and which costs to expense. This standard also requires the entity to expense the capitalized implementation costs of a hosting arrangement that is a service contract over the term of the hosting arrangement. The effective date of the standard is for fiscal periods, and interim periods within those years, beginning after December 15, 2019. The new standard may be adopted prospectively or retrospectively 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 August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement that eliminates, adds and modifies certain disclosure requirements for fair value measurements. The effective date of the standard is for fiscal periods, and interim periods within those years, beginning after December 15, 2019. The amendments on changes in unrealized gains and losses, the range and weighted-average of significant unobservable inputs used to develop Level-3 fair value measurements, and the narrative description of measurement uncertainty should be applied prospectively. All other amendments should be applied retrospectively. Early adoption is permitted. The Company is currently evaluating the impact that the adoption of ASU 2018-13 may have on its consolidated financial statements.
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. In computing the implied fair value of goodwill under step two, an entity determined the fair value at the impairment testing date of its assets and liabilities, including unrecognized assets and liabilities, following the procedure that would be required in determining the fair value of assets acquired and liabilities assumed in a business combination. 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 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 impact that the adoption of ASU 2016-13 may have on its consolidated financial statements.
The New Leases Standard and related policy updates
As discussed in Note 1 - Basis of Presentation and Organization, as of the Adoption Date of the New Leases Standard, the recognition of right-of-use assets and lease liabilities is required on the balance sheet. The Company determines whether an arrangement is a lease at inception. Operating leases are included in operating lease right-of-use assets and operating lease liabilities

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED

on the condensed consolidated balance sheet. Right-of-use assets represent HHCs right to use an underlying asset for the lease term and lease liabilities represent the Company's obligation to make lease payments arising from the lease. Operating lease right-of-use assets and liabilities are recognized at commencement date based on the present value of future minimum lease payments over the lease term. As most of HHC's leases do not provide an implicit rate, HHC uses an estimate of the incremental borrowing rate based on the information available at the lease commencement date in determining the present value of future lease payments. The operating lease right-of-use asset also includes any lease payments made, less any lease incentives and initial direct costs incurred. The Company does not have any finance leases as of March 31, 2019.

The Company’s lessee agreements consist of operating leases primarily for ground leases and other real estate. The Company’s leases have remaining lease terms of less than one year to 54 years. Most leases include one or more options to renew, with renewal terms that can extend the lease term from two to 40 years, and some of which may include options to terminate the leases within one year. The Company considers its strategic plan and the life of associated agreements in determining when options to extend or terminate lease terms are reasonably certain of being exercised. Leases with an initial term of 12 months or less are not recorded on the balance sheet; the Company recognizes lease expense for these leases on a straight-line basis over the lease term. Certain of the Company’s lease agreements include variable lease payments based on a percentage of income generated through subleases, changes in price indices and market rates, and other costs arising from operating, maintenance, and taxes. The Company’s lease agreements do not contain residual value guarantees or restrictive covenants. The Company leases certain buildings and office space constructed on its ground leases to third parties.

The Company’s leased assets and liabilities are as follows:
(In thousands)
 
March 31, 2019
Assets
 
 
Operating lease right-of-use assets
 
$
72,105

Total leased assets
 
$
72,105

 
 
 
Liabilities
 
 
Operating lease liabilities
 
$
71,888

Total leased liabilities
 
$
71,888


The components of lease expense are as follows:
(In thousands)
 
Three Months Ended
Lease Cost
 
March 31, 2019
Operating lease cost
 
$
2,365

Variable lease costs
 
82

Sublease income
 

Net lease cost
 
$
2,447

Future minimum lease payments as of March 31, 2019 are as follows:

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED

(In thousands)
 
Operating
Year Ended December 31,
 
Leases
2019 (excluding the three months ended March 31, 2019)
 
$
5,174

2020
 
7,272

2021
 
7,111

2022
 
6,373

2023
 
6,389

Thereafter
 
273,287

Total lease payments
 
305,606

Less: imputed interest
 
(233,718
)
Present value of lease liabilities
 
$
71,888


Other information related to the Company’s lessee agreements is as follows:
(In thousands)
 
Three Months Ended
Supplemental Condensed Consolidated Statements of Cash Flows Information
 
March 31, 2019
Cash paid for amounts included in the measurement of lease liabilities:
 
 
Operating cash flows from operating leases
 
$
1,495

Other Information
 
March 31, 2019
Weighted-average remaining lease term (years)
 
 
Operating leases
 
36.8

Weighted-average discount rate
 
 
Operating leases
 
7.7
%
The Company receives rental income from the leasing of retail, office, multi-family and other space under operating leases, as well as certain variable tenant recoveries. Such operating leases are with a variety of tenants and have a remaining average term of approximately five years. Lease terms generally vary among tenants and may include early termination options, extension options and fixed rental rate increases or rental rate increases based on an index. The minimum rentals based on operating leases of the consolidated properties held as of March 31, 2019 are as follows:

 
 
Three Months Ended
(In thousands)
 
March 31, 2019
Total Minimum Rent Payments
 
$
52,854


Total future minimum rents associated with operating leases are as follows:

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED

 
 
Total
 
 
Minimum
Year Ending December 31,
 
Rent
 
 
(In thousands)
2019 (excluding the three months ended March 31, 2019)
 
$
133,675

2020
 
187,566

2021
 
201,353

2022
 
209,225

2023
 
188,926

Thereafter
 
1,194,101

Total
 
$
2,114,846

Minimum rent revenues are recognized on a straight‑line basis over the terms of the related leases when collectability is reasonably assured and the tenant has taken possession of, or controls, the physical use of the leased asset. Percentage rent in lieu of fixed minimum rent is recognized as sales are reported from tenants. Minimum rent revenues reported on the Condensed Consolidated Statements of Operations also include amortization related to above and below‑market tenant leases on acquired properties.


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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED

NOTE 3 REAL ESTATE AND OTHER AFFILIATES
 
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)
 
2019
 
2018
 
2019
 
2018
 
2019
 
2018
Equity Method Investments
 
 
 
 
 
 
 
 
 
 

 
 

Operating Assets:
 
 
 
 
 
 
 
 
 
 

 
 

The Metropolitan Downtown Columbia (a)
 
50
%
 
50
%
 
$

 
$

 
$
183

 
$
80

Stewart Title of Montgomery County, TX
 
50
%
 
50
%
 
3,822

 
3,920

 
102

 
82

Woodlands Sarofim #1
 
20
%
 
20
%
 
2,780

 
2,760

 
20

 
20

m.flats/TEN.M
 
50
%
 
50
%
 
3,486

 
4,701

 
(1,221
)
 
(937
)
Master Planned Communities:
 
 
 
 
 
 
 
 
 
 
 
 
The Summit (b)
 
%
 
%
 
78,573

 
72,171

 
7,837

 
11,128

Seaport District:
 
 
 
 
 
 
 
 
 
 

 
 

Mr. C Seaport
 
35
%
 
35
%
 
8,088

 
8,721

 
(632
)
 

Strategic Developments:
 
 
 
 
 
 
 
 
 
 
 
 
Circle T Ranch and Power Center
 
50
%
 
50
%
 
6,024

 
5,989

 
35

 

HHMK Development
 
50
%
 
50
%
 
10

 
10

 

 

KR Holdings
 
50
%
 
50
%
 
161

 
159

 
2

 
672

 
 
 
 
 
 
102,944

 
98,431

 
6,326

 
11,045

Cost method investments
 
 
 
 
 
3,856

 
3,856

 
3,625

 
3,341

Investment in real estate and other affiliates
 
 
 
$
106,800

 
$
102,287

 
$
9,951

 
$
14,386

 
(a)
The Metropolitan Downtown Columbia was in a deficit position of $4.0 million and $3.8 million at March 31, 2019 and December 31, 2018, respectively, due to distributions from operating cash flows in excess of basis. These deficit balances are presented in Accounts payable and accrued expenses at March 31, 2019 and December 31, 2018.
(b)
Please refer to the discussion below for a description of the joint venture ownership structure.

As of March 31, 2019, the Company is not the primary beneficiary of any of the joint ventures listed above because it does not have the power to direct activities that significantly impact the economic performance of the joint ventures; therefore, the Company reports its interests in accordance with the equity method. As of March 31, 2019 and at December 31, 2018, the Mr. C Seaport variable interest entity ("VIE") does not have sufficient equity at risk to finance its operations without additional financial support. The aggregate carrying value of Mr. C Seaport is $8.1 million and is classified as Investment in real estate and other affiliates in the Condensed Consolidated Balance Sheets. The Company's maximum exposure to loss as a result of this investment is limited to the aggregate carrying value of the investment as the Company has not provided any guarantees or otherwise made firm commitments to fund amounts on behalf of this VIE. As of March 31, 2019, approximately $202.0 million of indebtedness was secured by the properties owned by the Company's real estate and other affiliates of which the Company's share was approximately $96.4 million based upon economic ownership. All of this indebtedness is without recourse to the Company.

As of March 31, 2019 and December 31, 2018, the Company is the primary beneficiary of six VIEs, Bridges at Mint Hill, 110 North Wacker and Ward Village's four homeowners' associations, which are consolidated in its financial statements. The creditors of the consolidated VIEs do not have recourse to the Company, except for 18%, or $9.0 million, of the 110 North Wacker outstanding loan balance. As of March 31, 2019, the carrying values of the assets and liabilities associated with the operations of the consolidated VIEs were $241.7 million and $111.5 million, respectively. As of December 31, 2018, the carrying values of the assets and liabilities associated with the operations of the consolidated VIEs were $190.6 million and $99.8 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.

110 North Wacker

During the second quarter of 2018, the Company's partnership with the local developer executed a joint venture agreement with USAA related to 110 North Wacker. At execution, the Company contributed land with a carrying value of $33.6 million and an agreed upon fair value of $85.0 million, and USAA contributed $64.0 million in cash. The Company has subsequent capital

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED

obligations of $42.7 million, and USAA is required to fund up to $105.6 million in addition to its initial contribution. The Company and its joint venture partners have also entered into a construction loan agreement further described in Note 6 -Mortgages, Notes and Loans Payable, Net. The Company has concluded that it is the primary beneficiary of the VIE because it has the power to direct activities that most significantly impact the joint venture’s economic performance during the development phase of the project.

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, which represents an economic interest of approximately 33% for the Company. Under this method, the Company recognizes income or loss in Equity in earnings from real estate and other affiliates based on the change in its underlying share of the venture's net assets on a hypothetical liquidation basis as of the reporting date. After USAA receives a 9.0% preferred return on its capital contribution, the Company is entitled to cash distributions from the venture until it receives a 9.0% return. Subsequently, USAA is entitled to cash distributions equal to 11.11% of the amount distributed to the Company that resulted in a 9.0% return. Thereafter, the Company and USAA are entitled to distributions pari passu to their profit ownership interests of 90% and 10%, respectively.

Significant activity for real estate and other affiliates and the related accounting considerations are described below.

The Summit

During the first quarter of 2015, the Company formed DLV/HHPI Summerlin, LLC (“The Summit”), a joint venture with Discovery Land Company (“Discovery”). The Company contributed land with a carrying value 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 are 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 HLBV method. Under this method, the Company 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)
 
2019
 
2018
Total Assets
 
$
217.8

 
$
218.9

Total Liabilities
 
137.1

 
144.6

Total Equity
 
80.7

 
74.3

 
 
 
Three Months Ended March 31,
(In millions)
 
2019
 
2018
Revenues (a)
 
$
30.5

 
$
23.4

Net income
 
7.4

 
11.1

Gross Margin
 
8.3

 
13.3

 
(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 ASU 2014-09, Revenues from Contracts with Customers (Topic 606) and will adopt by the end of 2019.

NOTE 4 IMPAIRMENT
  

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THE HOWARD HUGHES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED

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, 2019 or during the year ended December 31, 2018. The Company periodically evaluates its strategic 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 5 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)
 
2019
 
2018
Condominium inventory
 
$
69,110

 
$
198,352

Straight-line rent
 
51,985

 
50,493

Intangibles
 
33,785

 
33,955

Security and escrow deposits
 
20,129

 
17,670

Special Improvement District receivables
 
18,054

 
18,838

Prepaid expenses
 
15,202

 
16,981

Equipment, net of accumulated depreciation of $8.7 million and $8.3 million, respectively
 
15,125

 
15,543

Other
 
10,950

 
20,364

Tenant incentives and other receivables
 
8,625

 
8,745

In-place leases
 
5,677

 
6,539

TIF receivable
 
3,896

 
2,470

Above-market tenant leases
 
906

 
1,044

Federal income tax receivable
 
200

 
2,000

Interest rate swap derivative assets
 

 
346

Below-market ground leases
 

 
18,296

Prepaid expenses and other assets, net
 
$
253,644

 
$
411,636


The $158.0 million net decrease primarily relates to $129.2 million and $18.3 million decreases in Condominium inventory and Below-market ground leases, respectively. Condominium inventory represents units at completed projects for which sales have not yet closed. The decrease from December 31, 2018 is primarily attributable to all of the contracted units at Ae‘o, which have closed in the first quarter of 2019. The decrease in Below-market ground leases is attributable to the adoption of the New Leases Standard as of January 1, 2019. The balance of unamortized below-market ground leases was reclassified to Operating lease right-of-use assets upon adoption.


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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)
 
2019
 
2018
Construction payables
 
$
298,235

 
$
258,749

Condominium deposit liabilities
 
147,861

 
263,636

Deferred income
 
54,082

 
42,734

Accounts payable and accrued expenses
 
26,512

 
38,748

Interest rate swap derivative liabilities
 
24,160

 
16,517

Tenant and other deposits
 
21,805

 
20,893

Accrued payroll and other employee liabilities
 
17,109

 
42,591

Other
 
16,150

 
29,283

Accrued real estate taxes
 
12,542

 
26,171

Accrued interest
 
10,515

 
23,080

Straight-line ground rent liability
 

 
16,870

Accounts payable and accrued expenses
 
$
628,971

 
$
779,272

 
The $150.3 million net decrease in total Accounts payable and accrued expenses primarily relates to a $115.8 million decrease in Condominium deposit liabilities primarily attributable to all of the contracted units at Ae‘o, which have closed in the first quarter of 2019; a $25.5 million decrease in Accrued payroll and other employee liabilities due to payment in the first quarter of 2019 of annual incentive bonus for 2018; and a $16.9 million decrease in Straight-line ground rent liability attributable to the adoption of the New Leases Standard as of January 1, 2019.




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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED

NOTE 6 MORTGAGES, NOTES AND LOANS PAYABLE, NET
 
Mortgages, notes and loans payable, net are summarized as follows: 
 
 
March 31,
 
December 31,
(In thousands)
 
2019
 
2018
Fixed-rate debt:
 
 
 
 
Unsecured 5.375% Senior Notes
 
$
1,000,000

 
$
1,000,000

Secured mortgages, notes and loans payable
 
660,229

 
648,707

Special Improvement District bonds
 
14,978

 
15,168

Variable-rate debt:
 
 
 
 
Mortgages, notes and loans payable (a)
 
1,599,172

 
1,551,336

Unamortized bond issuance costs
 
(5,889
)
 
(6,096
)
Unamortized deferred financing costs
 
(26,505
)
 
(27,902
)
Total mortgages, notes and loans payable, net
 
$
3,241,985

 
$
3,181,213

 
(a)
As more fully described in Note 8 -Derivative Instruments and Hedging Activities, as of March 31, 2019 and December 31, 2018, $615.0 million of variable‑rate debt has been swapped to a fixed rate for the term of the related debt. An additional $50.0 million of variable-rate debt was subject to interest rate collars and $75.0 million of variable-rate debt was capped at a maximum interest rate as of March 31, 2019 and December 31, 2018.

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, 2019, land, buildings and equipment and developments with a net book value of $4.4 billion have been pledged as collateral for HHC's Mortgages, notes and loans payable, net. As of March 31, 2019, the Company was in compliance with all of its financial covenants included in the agreements governing its indebtedness.

The Summerlin master planned community ("MPC") uses Special Improvement District (“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, 2019, no new SID bonds were issued and $0.1 million in obligations were assumed by buyers.

Recent Financing Activity

On April 9, 2019, the Company modified the HHC 242 Self-Storage and HHC 2978 Self-Storage facilities to reduce the total commitments to $5.5 million and $5.4 million, respectively. The loans have an initial maturity date of December 31, 2021 and a one-year extension option.

Financing Activity During the Three Months Ended March 31, 2019

On March 12, 2019, the Company closed on an $18.0 million construction loan for Creekside Park West, bearing interest at one-month London Interbank Offered Rate ("LIBOR") plus 2.25% with an initial maturity date of March 12, 2023 and a one-year extension option.

On February 28, 2019, the Company amended the $62.5 million Woodlands Resort & Conference Center financing to extend the initial maturity date to December 30, 2021. The financing bears interest at one-month LIBOR plus 2.50% and has two, one-year extension options.


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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED

NOTE 7 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, 2019
 
December 31, 2018
 
 
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:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Interest rate derivative assets
 
$

 
$

 
$

 
$

 
$
346

 
$

 
$
346

 
$

Liabilities:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Interest rate derivative liabilities
 
24,160

 

 
24,160

 

 
16,517

 

 
16,517

 


The fair values of interest rate derivatives 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.

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, 2019
 
December 31, 2018
(In thousands)
 
Fair Value
Hierarchy
 
Carrying
Amount
 
Estimated
Fair Value
 
Carrying
Amount
 
Estimated
Fair Value
Assets:
 
 
 
 
 
 
 
 
 
 
Cash and restricted cash
 
Level 1
 
$
587,306

 
$
587,306

 
$
724,215

 
$
724,215

Accounts receivable, net (a)
 
Level 3
 
16,030

 
16,030

 
12,589

 
12,589

Notes receivable, net (b)
 
Level 3
 
4,723

 
4,701

 
4,694

 
4,694

 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 

 
 

 
 

 
 

Fixed-rate debt (c)
 
Level 2
 
1,675,207

 
1,676,153

 
1,663,875

 
1,608,635

Variable-rate debt (c)
 
Level 2
 
1,599,172

 
1,599,172

 
1,551,336

 
1,551,336

 
(a)Accounts receivable, net is shown net of an allowance of $10.4 million and $10.7 million at March 31, 2019 and December 31, 2018, respectively.
(b)Notes receivable, net is shown net of an allowance of $0.1 million at March 31, 2019 and December 31, 2018.
(c)Excludes related unamortized financing costs.

The carrying amounts of Cash and restricted cash and Accounts receivable, net approximate fair value because of the short‑term maturity of these instruments. The fair value of Notes receivable, net with a fixed interest rate is based on a discounted future cash receipt model, which includes risk premiums and risk-free rates derived from the current LIBOR or U.S. Treasury obligation interest rates and assumes that the notes are outstanding through maturity. The carrying amounts for the Company's variable-rate

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED

notes receivable approximate fair value given that the interest rates are variable and adjust with current market rates for instruments with similar risks and maturities.

The fair value of the Company's $1.0 billion5.375% senior notes due 2025, 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 6 -Mortgages, Notes and Loans Payable, Net in the Company's Condensed Consolidated Financial Statements), was estimated based on a discounted future cash payment model, which includes risk premiums and risk-free rates derived from the current 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.

NOTE 8 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, collars 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 collars designated as cash flow hedges involve the receipt of variable amounts from a counterparty if interest rates rise above an established ceiling rate and payment of variable amounts to a counterparty if interest rates fall below an established floor rate, in exchange for an up-front premium. No payments or receipts are exchanged on interest rate collar contracts unless interest rates rise above or fall below the established ceiling and floor rates. 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 on the balance sheet.
 
Assessments of hedge effectiveness are performed quarterly using regression analysis. 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.

The Company 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, 2019 and December 31, 2018, there was one termination event and four termination events, respectively, as discussed below. There were no events of default as of March 31, 2019 and December 31, 2018.
 
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 in accordance with the original strategy, any related amounts previously recorded in AOCI are recognized in earnings immediately. During the three months ended March 31, 2019, the Company recorded a $1.1 million reduction in Interest expense related to the amortization of terminated swaps.

During the three months ended March 31, 2019, the Company settled one interest rate cap agreement with a notional amount of $230.0 million and received payment of $0.2 million. During the year ended December 31, 2018, the Company settled four interest rate swap agreements with notional amounts of $18.9 million, $250.0 million$40.0 million and $119.4 million, all designated as cash flow hedges of interest rate variability, and received total payments of $15.8 million, net of a termination fee of $0.3 million. The Company has deferred the effective portion of the fair value changes of three interest rate swap agreements in Accumulated other comprehensive loss on the accompanying Condensed Consolidated Balance Sheets and will recognize the impact as a component of Interest expense, net, over the next 8.8, 2.5 and 1.1 years, which are what remain of the original forecasted periods.


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THE HOWARD HUGHES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED

Amounts reported in AOCI related to derivatives will be reclassified to Interest expense as interest payments are made on the Company's variable‑rate debt. Over the next 12 months, HHC estimates that an additional $0.1 million of net loss will be reclassified to Interest expense.

The following table summarizes certain terms of the Company's derivative contracts:
 
 
 
 
 
 
 
 
Fixed
 
 
 
 
 
Fair Value Asset (Liability)
 
 
 
 
 
 
Notional
 
Interest
 
Effective
 
Maturity
 
March 31,
 
December 31,
(In thousands)
 
 
 
Balance Sheet Location
 
Amount
 
Rate (a)
 
Date
 
Date
 
2019
 
2018
Derivative instruments not designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate cap
 
(b)
 
Prepaid expenses and other assets, net
 
$
75,000

 
5.00
%
 
9/1/2017
 
8/31/2019
 
$

 
$

Interest rate cap
 
(b) (c)
 
Prepaid expenses and other assets, net
 
230,000

 
2.50
%
 
12/22/2016
 
12/23/2019
 

 
333

Derivative instruments designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate collar
 
(d)
 
Prepaid expenses and other assets, net
 
51,353

 
1.50% - 2.50%

 
7/1/2018
 
5/1/2019
 

 
13

Interest rate collar
 
(d)
 
Accounts payable and accrued expenses
 
193,967

 
2.00% - 3.00%

 
5/1/2019
 
5/1/2020
 
(57
)
 
(37
)
Interest rate collar
 
(d)
 
Accounts payable and accrued expenses
 
354,217

 
2.25% - 3.25%

 
5/1/2020
 
5/1/2021
 
(1,055
)
 
(730
)
Interest rate collar
 
(d)
 
Accounts payable and accrued expenses
 
381,404

 
2.75% - 3.50%

 
5/1/2021
 
4/30/2022
 
(2,719
)
 
(1,969
)
Interest rate swap
 
(e)
 
Accounts payable and accrued expenses
 
615,000

 
2.96
%
 
9/21/2018
 
9/18/2023
 
(20,329
)
 
(13,781
)
Total fair value derivative assets
 
 
 
 
 
 
 
 
 
 
 
$

 
$
346

Total fair value derivative liabilities
 
 
 
 
 
 
 
 
 
$
(24,160
)
 
$
(16,517
)
 
(a)
These rates represent the strike rate on HHC's interest swaps, caps and collars.
(b)
Interest income of $0.2 million is included in the Condensed Consolidated Statements of Operations for the three months ended March 31, 2019 and the year ended December 31, 2018, related to these contracts.
(c)
The Company settled this Interest rate cap on February 1, 2019.
(d)
On May 17, 2018 and May 18, 2018, the Company entered into these interest rate collars which are designated as cash flow hedges.
(e)
Concurrent with the funding of the new $615.0 million Term Loan on September 21, 2018, the Company entered into this interest rate swap which is designated as a cash flow hedge.

The tables below present the effect of the Company's derivative financial instruments on the Condensed Consolidated Statements of Operations for the three months ended March 31, 2019 and 2018 (in thousands):
 
 
Amount of (Loss) Gain Recognized
 
 
in AOCI on Derivative
 
 
Three Months Ended March 31,
Derivatives in Cash Flow Hedging Relationships
 
2019
 
2018
Interest rate derivatives
 
$
(5,816
)
 
$
8,261

 
 
 
Amount of Gain Reclassified from
 
 
AOCI into Operations
 
 
Three Months Ended March 31,
Location of Gain Reclassified from AOCI into Operations
 
2019
 
2018
Interest expense
 
$
128

 
$
216


 
 
Total Interest Expense Presented
 
 
in the Results of Operations in which
 
 
the Effects of Cash Flow Hedges are Recorded
 
 
Three Months Ended March 31,
Interest Expense Presented in Results of Operations
 
2019
 
2018
Interest expense
 
$
23,326

 
$
16,609



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THE HOWARD HUGHES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED

Credit-risk-related Contingent Features

The Company has agreements with certain derivative counterparties that contain a provision where if the Company defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then the Company could also be declared in default on its derivative obligations. The Company also has agreements with certain derivative counterparties that contain a provision where the Company could be declared in default on its derivative obligations if repayment of the underlying indebtedness is accelerated by the lender due to the Company's default on the indebtedness.

As of March 31, 2019 and December 31, 2018, the fair value of derivatives in a net liability position, which includes accrued interest but excludes any adjustment for nonperformance risk related to these agreements was $26.2 million and $18.2 million, respectively. As of March 31, 2019, the Company has not posted any collateral related to these agreements. If the Company had breached any of these provisions at March 31, 2019, it could have been required to settle its obligations under the agreements at their termination value of $26.2 million.

NOTE 9 COMMITMENTS AND CONTINGENCIES
 
In the normal course of business, from time to time, the Company is involved in legal proceedings relating to the ownership and operations of its properties. In addition, on June 14, 2018, the Company was served with a petition involving approximately 500 individuals or entities who claim that their properties, located in the Timarron Park neighborhood of The Woodlands, were damaged by flood waters that resulted from the unprecedented rainfall that occurred throughout Harris County and surrounding areas during Hurricane Harvey in August 2017. The complaint was filed in State Court in Harris County of the State of Texas. In general, the plaintiffs allege negligence in the development of Timarron Park and violations of Texas’ Deceptive Trade Practices Act and name as defendants The Howard Hughes Corporation, The Woodlands Land Development Company and two unaffiliated parties involved in the planning and engineering of Timarron Park. The plaintiffs are seeking restitution for damages to their property and diminution of their property values. The Company intends to vigorously defend the matter as it believes that these claims are without merit and that it has substantial legal and factual defenses to the claims and allegations contained in the complaint. Based upon the present status of this matter, the Company does not believe it is probable that a loss will be incurred. Accordingly, the Company has not recorded a charge as a result of this action.     
 
In management’s opinion, the liabilities, if any, that may ultimately result from normal course of business legal actions, and The Woodlands legal proceeding discussed above, are not expected to have a material effect on the Company's consolidated financial position, results of operations or liquidity.

As of March 31, 2019 and December 31, 2018, the Company had outstanding letters of credit totaling $15.3 million and surety bonds totaling $110.1 million and $101.2 million, respectively. These letters of credit and bonds were issued primarily in connection with insurance requirements, special real estate assessments and construction obligations.

The Company leases land or buildings at certain properties from third parties. As discussed in Note 2 - Accounting Policies and Pronouncements, the Company adopted the New Leases Standard on January 1, 2019 and recorded right-of-use assets and lease liabilities on the balance sheet. See Note 2 - Accounting Policies and Pronouncements for further discussion. Prior to the adoption of the New Leases Standard, rental payments were expensed as incurred and, to the extent applicable, straight-lined over the term of the lease. Contractual rental expense, including participation rent, was $2.6 million for the three months ended March 31, 2018. The amortization of above and below‑market ground leases and straight‑line rents included in the contractual rent amount for the three months ended March 31, 2018 was not significant.

The Company has entered into guarantee agreements as part of certain development projects. In conjunction with the execution of the ground lease for the Seaport District NYC, the Company executed a completion guarantee for the redevelopment of Seaport District NYC - Pier 17 and Seaport District NYC - Tin Building. As part of the Funding Agreement for the Downtown Columbia Redevelopment District TIF bonds, one of the Company's wholly-owned subsidiaries has agreed to complete certain defined public improvements and to indemnify Howard County, Maryland for certain matters. The Company has guaranteed these obligations, with a limit of $1.0 million, expiring on October 31, 2020. To the extent that increases in taxes do not cover debt service payments on the TIF bonds, the Company’s wholly-owned subsidiary is obligated to pay special taxes. The Company evaluates the likelihood of future performance under these guarantees and did not record an obligation as of March 31, 2019 and December 31, 2018.
 
NOTE 10 STOCK BASED PLANS

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THE HOWARD HUGHES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED

 
The Company's stock based plans are described and informational disclosures are provided in the Notes to the Condensed Consolidated Financial Statements included in the Annual Report.

Stock Options
 
The following table summarizes the Company's stock option plan activity for the three months ended March 31, 2019:
 
 
Stock
Options
 
Weighted
Average
Exercise Price
Stock Options outstanding at December 31, 2018
 
817,998

 
$
105.06

Granted
 
9,500

 
110.35

Forfeited
 
(4,600
)
 
121.04

Stock Options outstanding at March 31, 2019
 
822,898

 
$
105.06

 
Compensation costs related to stock options were $0.7 million for the three months ended March 31, 2019, of which $0.2 million were capitalized to development projects. Compensation costs related to stock options were $0.7 million for the three months ended March 31, 2018, of which $0.3 million were capitalized to development projects.
 
Restricted Stock
 
The following table summarizes restricted stock activity for the three months ended March 31, 2019:
 
 
Restricted
Stock
 
Weighted
Average Grant
Date Fair Value
Restricted stock outstanding at December 31, 2018
 
406,544

 
$
82.10

Granted
 
150,216

 
84.48

Forfeited
 
(1,981
)
 
70.94

Restricted stock outstanding at March 31, 2019
 
554,779

 
$
82.78

 
Compensation costs related to restricted stock awards were $2.3 million for the three months ended March 31, 2019, of which $0.3 million were capitalized to development projects. Compensation costs related to restricted stock awards were $2.0 million for the three months ended March 31, 2018, of which $0.3 million were capitalized to development projects.

NOTE 11 INCOME TAXES
 
The Company has significant permanent differences, primarily from stock compensation deductions and non-deductible executive compensation, which cause the effective tax rate to deviate from statutory rates. The effective tax rate, based upon actual 2019 estimated operating results, was 25.7% for the three months ended March 31, 2019, compared to 27.4% for the three months ended March 31, 2018.

NOTE 12 WARRANTS
  
On October 7, 2016, the Company entered into a warrant agreement with its Chief Financial Officer, David R. O’Reilly, (the "O'Reilly Warrant") prior to his appointment to the position. Upon exercise of his warrant, Mr. O’Reilly may acquire 50,125 shares of common stock at an exercise price of $112.08 per share. The O'Reilly Warrant was issued at fair value in exchange for a $1.0 million payment in cash from Mr. O'Reilly. The O'Reilly Warrant becomes exercisable on April 6, 2022, subject to earlier exercise upon certain change in control, separation and termination provisions. On June 16, 2017 and October 4, 2017, the Company entered into warrant agreements with its Chief Executive Officer, David R. Weinreb, (the "Weinreb Warrant") and President, Grant Herlitz, (the "Herlitz Warrant") to acquire 1,965,409 shares and 87,951 shares of common stock for the purchase prices of $50.0 million and $2.0 million, respectively. The Weinreb Warrant becomes exercisable on June 15, 2022, at an exercise price of $124.64 per share, and the Herlitz Warrant becomes exercisable on October 3, 2022, at an exercise price of $117.01 per share, subject to earlier exercise upon certain change in control, separation and termination provisions. The purchase prices paid by the respective executives

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THE HOWARD HUGHES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED

for the O’Reilly Warrant, the Weinreb Warrant and the Herlitz Warrant, which qualify as equity instruments, are included within Additional paid-in capital in the Condensed Consolidated Balance Sheets at March 31, 2019 and December 31, 2018.

NOTE 13 ACCUMULATED OTHER COMPREHENSIVE LOSS

The following tables summarize changes in AOCI by component, all of which are presented net of tax: 
(In thousands)
 
 
Balance as of December 31, 2017
 
$
(6,965
)
Other comprehensive income before reclassifications
 
8,271

Gain reclassified from accumulated other comprehensive loss to net income
 
(216
)
Adjustment related to adoption of ASU 2018-02
 
(1,148
)
Adjustment related to adoption of ASU 2017-12
 
(739
)
Net current-period other comprehensive income
 
6,168

Balance as of March 31, 2018
 
$
(797
)
 
 
 
Balance as of December 31, 2018
 
$
(8,126
)
Other comprehensive loss before reclassifications
 
(5,867
)
Gain reclassified from accumulated other comprehensive loss to net income
 
(128
)
Terminated swap amortization
 
(638
)
Net current-period other comprehensive loss
 
(6,633
)
Balance as of March 31, 2019
 
$
(14,759
)
 
 
The following table summarizes the amounts reclassified out of AOCI:
 
 
Amounts reclassified from 
Accumulated Other
Comprehensive Income (Loss)
 
 
(In thousands)
 
Three Months Ended March 31,
 
Affected line items in the
Accumulated Other Comprehensive Income (Loss) Components
 
2019
 
2018
 
Statements of Operations
(Gains) losses on cash flow hedges
 
$
(162
)
 
$
(273
)
 
Interest expense
Interest rate swap contracts
 
34

 
57

 
Provision for income taxes
Total reclassifications of (income) loss for the period
 
$
(128
)
 
$
(216
)
 
Net of tax
  
NOTE 14 EARNINGS PER SHARE
 
Basic earnings per share (“EPS”) is computed by dividing net income available to common stockholders by the weighted‑average number of common shares outstanding. Diluted EPS is computed after adjusting the numerator and denominator of the basic EPS computation for the effects of all potentially dilutive common shares. The dilutive effect of options and nonvested stock issued under stock‑based compensation plans is computed using the treasury stock method. The dilutive effect of the warrants is computed using the if‑converted method. Gains associated with the changes in the fair value of the warrants are excluded from the numerator in computing diluted earnings per share because inclusion of such gains in the computation would be anti‑dilutive.


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

Information related to the Company's EPS calculations is summarized as follows: 
 
 
Three Months Ended March 31,
(In thousands, except per share amounts)
 
2019
 
2018
Basic EPS:
 
 
 
 
Numerator:
 
 
 
 
Net income
 
$
31,925