Q2-2015 10Q


 
 
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________________________________
FORM 10-Q
______________________________________
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2015
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from ______ to ______
Commission File Number 001-34789
______________________________________
Hudson Pacific Properties, Inc.
Hudson Pacific Properties, L.P.
(Exact name of Registrant as specified in its charter)

Hudson Pacific Properties, Inc.

Maryland
(State or other jurisdiction of incorporation or organization)
27-1430478
(I.R.S. Employer Identification Number)
Hudson Pacific Properties, L.P.

Maryland
(State or other jurisdiction of incorporation or organization)
80-0579682
(I.R.S. Employer Identification Number)
11601 Wilshire Blvd., Sixth Floor
Los Angeles, California 90025
(Address of principal executive offices) (Zip Code)
(310) 445-5700
(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:
Registrant
 
Title of Each Class
 
Name of Each Exchange on Which Registered
Hudson Pacific Properties, Inc.
 
Common Stock, $.01 par value
 
New York Stock Exchange
Hudson Pacific Properties, Inc.
 
8.375% Series B Cumulative Redeemable Preferred Stock, $.01 par value
 
New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act:
Registrant
 
Title of Each Class
 
Name of Each Exchange on Which Registered
Hudson Pacific Properties, L.P.
 
Common Units Representing Limited Partnership Interests
 
None
(Former name, former address and
former fiscal year if changed since last report)
______________________________________ 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    
Hudson Pacific Properties, Inc. Yes  x   No  o        Hudson Pacific Properties, L.P. Yes  x   No  o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    
Hudson Pacific Properties, Inc. Yes  x    No  o        Hudson Pacific Properties, L.P. Yes  x   No  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
    
Hudson Pacific Properties, Inc.

Large accelerated filer x   Accelerated filer o   Non-accelerated filer o   Smaller reporting company o

Hudson Pacific Properties, L.P.
Large accelerated filer o   Accelerated filer o   Non-accelerated filer x   Smaller reporting company o

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

The number of shares of common stock outstanding at August 5, 2015 was 89,490,025.





EXPLANATORY NOTE
This report combines the quarterly reports on Form 10-Q for the three months ended June 30, 2015 of Hudson Pacific Properties, Inc., a Maryland corporation, and Hudson Pacific Properties, L.P., a Maryland limited partnership. Unless otherwise indicated or unless the context requires otherwise, all references in this report to “we,” “us,” “our,” or “our Company” refer to Hudson Pacific Properties, Inc. together with its consolidated subsidiaries, including Hudson Pacific Properties, L.P. Unless otherwise indicated or unless the context requires otherwise, all references to “our operating partnership” refer to Hudson Pacific Properties, L.P. together with its consolidated subsidiaries.
Our Company is a real estate investment trust, or REIT, and the sole general partner of our operating partnership. As of June 30, 2015, we owned approximately 61.4% of the outstanding common units of partnership interest in our operating partnership, or common units. The remaining approximately 38.6% of outstanding common units are owned by certain of our executive officers and directors, certain of their affiliates, and other outside investors, including funds affiliated with Farallon Capital Management, LLC and Blackstone Real Estate Partners V and VI (“Blackstone”). As the sole general partner of our operating partnership, our Company has the full, exclusive and complete responsibility for our operating partnership’s day-to-day management and control.
We believe combining the quarterly reports on Form 10-Q of our Company and our operating partnership into this single report results in the following benefits:
enhancing investors’ understanding of our Company and our operating partnership by enabling investors to view the business as a whole in the same manner as management views and operates the business;
eliminating duplicative disclosure and providing a more streamlined and readable presentation because a substantial portion of the disclosure applies to both our Company and our operating partnership; and
creating time and cost efficiencies through the preparation of one combined report instead of two separate reports.

There are a few differences between our Company and our operating partnership, which are reflected in the disclosures in this report. We believe it is important to understand the differences between our Company and our operating partnership in the context of how we operate as an interrelated, consolidated company. Our Company is a REIT, the only material assets of which are the partnership units of our operating partnership. As a result, our Company does not conduct business itself, other than acting as the sole general partner of our operating partnership, issuing equity from time to time and guaranteeing certain debt of our operating partnership. Our Company itself does not issue any indebtedness but guarantees some of the debt of our operating partnership. We own our interests in all of our properties and conduct substantially all of our business through our operating partnership, of which we serve as the sole general partner.  Our operating partnership is structured as a partnership and has no public traded equity. Except for net proceeds from equity issuances by our Company, which are generally contributed to our operating partnership in exchange for units of partnership interest in our operating partnership, our operating partnership generates the capital required by our Company’s business through our operating partnership’s operations, our operating partnership’s incurrence of indebtedness or through the issuance of units of partnership interest in our operating partnership.
The presentation of non-controlling common units, stockholders’ equity and partners’ capital are the main areas of difference between the consolidated financial statements of our Company and those of our operating partnership. The common units in our operating partnership are accounted for as partners’ capital in our operating partnership’s consolidated financial statements and, to the extent not held by our Company, as non-controlling common units in our Company’s consolidated financial statements. The differences between stockholders’ equity, partners’ capital and non-controlling common units result from the differences in the equity issued by our Company and our operating partnership.
To help investors understand the few but significant differences between our Company and our operating partnership, this report presents the consolidated financial statements separately for our Company and our operating partnership. All other sections of this report, including “Selected Financial Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Quantitative and Qualitative Disclosures About Market Risk,” are presented together for our Company and our operating partnership.
In order to establish that the Chief Executive Officer and the Chief Financial Officer of each entity have made the requisite certifications and that our Company and our operating partnership are compliant with Rule 13a-15 or Rule 15d-15 of the Securities Exchange Act of 1934, or the Exchange Act and 18 U.S.C. §1350, this report also includes separate “Item 4. Controls and Procedures” sections and separate Exhibit 31 and 32 certifications for each of our Company and our operating partnership.





Hudson Pacific Properties, Inc.
Hudson Pacific Properties, L.P.
FORM 10-Q
June 30, 2015
TABLE OF CONTENTS
 
 
 
Page
 
ITEM 1.
Financial Statements of Hudson Pacific Properties, Inc.
 
 
 
 
 
 
ITEM 1.
Financial Statements of Hudson Pacific Properties, L.P.
 
 
 
 
 
 
 
ITEM 2.
ITEM 3.
ITEM 4.
 
ITEM 1.
ITEM 1A.
ITEM 2.
ITEM 3.
ITEM 4.
ITEM 5.
ITEM 6.
 


3



PART I—FINANCIAL INFORMATION

HUDSON PACIFIC PROPERTIES, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
 
 
June 30,
2015
 
December 31,
2014
 
(unaudited)
 
(audited)
ASSETS
 
 
 
REAL ESTATE ASSETS
 
 
 
Land
$
1,399,207

 
$
620,805

Building and improvements
4,103,152

 
1,284,602

Tenant improvements
272,779

 
116,317

Furniture and fixtures
9,952

 
13,721

Property under development
124,582

 
135,850

Total real estate held for investment
5,909,672

 
2,171,295

Accumulated depreciation and amortization
(181,163
)
 
(134,657
)
Investment in real estate, net
5,728,509

 
2,036,638

Cash and cash equivalents
40,327

 
17,753

Restricted cash
17,319

 
14,244

Accounts receivable, net
12,312

 
16,247

Notes receivable
28,476

 
28,268

Straight-line rent receivables
47,137

 
33,006

Deferred leasing costs and lease intangibles, net
381,370

 
102,023

Deferred finance costs, net
18,384

 
8,723

Interest rate contracts
8,689

 
3

Goodwill
8,754

 
8,754

Prepaid expenses and other assets
21,853

 
6,692

Assets associated with real estate held for sale

 
68,534

TOTAL ASSETS
$
6,313,130

 
$
2,340,885

LIABILITIES AND EQUITY
 
 
 
Notes payable
$
2,119,157

 
$
918,059

Accounts payable and accrued liabilities
75,205

 
36,844

Lease intangible liabilities, net
125,795

 
40,969

Security deposits
21,100

 
6,257

Prepaid rent
21,909

 
8,600

Interest rate contracts
1,766

 
1,750

Liabilities associated with real estate held for sale
275

 
43,214

TOTAL LIABILITIES
2,365,207

 
1,055,693

6.25% series A cumulative redeemable preferred units of the Operating Partnership
10,177

 
10,177

EQUITY
 
 
 
Hudson Pacific Properties, Inc. stockholders’ equity:
 
 
 
Preferred stock, $0.01 par value, 10,000,000 authorized; 8.375% series B cumulative redeemable preferred stock, $25.00 liquidation preference, 5,800,000 shares outstanding at June 30, 2015 and December 31, 2014, respectively
145,000

 
145,000

Common stock, $0.01 par value, 490,000,000 authorized, 89,078,401 shares and 66,797,816 shares outstanding at June 30, 2015 and December 31, 2014, respectively
890

 
668

Additional paid-in capital
1,739,088

 
1,070,833

Accumulated other comprehensive income (loss)
2,856

 
(2,443
)
Accumulated deficit
(40,766
)
 
(34,884
)
Total Hudson Pacific Properties, Inc. stockholders’ equity
1,847,068

 
1,179,174

Non-controlling interest—members in Consolidated Entities
262,756

 
42,990

Non-controlling common units in the Operating Partnership
1,827,922

 
52,851

TOTAL EQUITY
3,937,746

 
1,275,015

TOTAL LIABILITIES AND EQUITY
$
6,313,130

 
$
2,340,885



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




HUDSON PACIFIC PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited, in thousands, except share and per share amounts)
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2015
 
2014
 
2015
 
2014
Revenues
 
 
 
 
 
 
 
Office
 
 
 
 
 
 
 
Rental
$
120,052

 
$
39,905

 
$
161,628

 
$
75,915

Tenant recoveries
17,790

 
5,988

 
23,854

 
11,559

Parking and other
5,716

 
7,013

 
11,011

 
11,492

Total office revenues
143,558

 
52,906

 
196,493

 
98,966

Media & entertainment
 
 
 
 
 
 
 
Rental
5,394

 
5,958

 
10,861

 
11,407

Tenant recoveries
253

 
384

 
493

 
704

Other property-related revenue
2,556

 
2,811

 
6,665

 
6,445

Other
58

 
70

 
131

 
203

Total media & entertainment revenues
8,261

 
9,223

 
18,150

 
18,759

Total revenues
151,819

 
62,129

 
214,643

 
117,725

Operating expenses
 
 
 
 
 
 
 
Office operating expenses
46,691

 
18,573

 
63,826

 
34,500

Media & entertainment operating expenses
5,069

 
5,838

 
11,074

 
11,843

General and administrative
10,373

 
6,579

 
19,573

 
12,355

Depreciation and amortization
73,592

 
17,944

 
90,750

 
34,612

Total operating expenses
135,725

 
48,934

 
185,223

 
93,310

Income from operations
16,094

 
13,195

 
29,420

 
24,415

Other (income) expense
 
 
 
 
 
 
 
Interest expense
14,113

 
6,445

 
19,606

 
12,969

Interest income
(48
)
 
(11
)
 
(101
)
 
(20
)
Acquisition-related expenses
37,481

 

 
43,525

 
105

Other expenses
40

 
12

 
(1
)
 
13

Total other expenses
51,586

 
6,446

 
63,029

 
13,067

(Loss) income from continuing operations before (loss) gain on sale of real estate
(35,492
)
 
6,749

 
(33,609
)
 
11,348

(Loss) gain on sale of real estate
(591
)
 

 
22,100

 

(Loss) income from continuing operations
(36,083
)
 
6,749

 
(11,509
)
 
11,348

Loss from discontinued operations

 
(60
)
 

 
(126
)
Net loss from discontinued operations

 
(60
)
 

 
(126
)
Net (loss) income
(36,083
)
 
6,689

 
(11,509
)
 
11,222

Net income attributable to preferred stock and units
(3,195
)
 
(3,195
)
 
(6,390
)
 
(6,395
)
Net income attributable to restricted shares
(80
)
 
(69
)
 
(150
)
 
(138
)
Net (income) loss attributable to non-controlling interest in consolidated entities
(1,893
)
 
61

 
(3,395
)
 
104

Net loss (income) attributable to common units in the Operating Partnership
16,008

 
(121
)
 
15,412

 
(168
)
Net (loss) income attributable to Hudson Pacific Properties, Inc. common stockholders
$
(25,243
)
 
$
3,365

 
$
(6,032
)
 
$
4,625

Basic and diluted per share amounts:
 
 
 
 
 
 
 
Net (loss) income from continuing operations attributable to common stockholders
(0.28
)
 
0.05

 
(0.07
)
 
0.07

Net (loss) income attributable to common stockholders’ per share—basic and diluted
$
(0.28
)
 
$
0.05

 
$
(0.07
)
 
$
0.07

Weighted average shares of common stock outstanding—basic
88,894,258

 
66,485,639

 
82,906,087

 
65,063,596

Weighted average shares of common stock outstanding—diluted
88,894,258

 
69,421,621

 
82,906,087

 
67,997,167

Dividends declared per share of common stock
$
0.1250

 
$
0.1250

 
$
0.2500

 
$
0.2500


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




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

 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2015
 
2014
 
2015
 
2014
Net (loss) income
$
(36,083
)
 
$
6,689

 
$
(11,509
)
 
$
11,222

Other comprehensive income (loss) cash flow hedge adjustment
9,650

 
(812
)
 
9,025

 
(1,364
)
Comprehensive income
(26,433
)
 
5,877

 
(2,484
)
 
9,858

Comprehensive income attributable to preferred stock and units
(3,195
)
 
(3,195
)
 
(6,390
)
 
(6,395
)
Comprehensive income attributable to restricted shares
(80
)
 
(69
)
 
(150
)
 
(138
)
Comprehensive (income) loss attributable to non-controlling interest in consolidated real estate entities
(1,893
)
 
61

 
(3,395
)
 
104

Comprehensive income attributable to common units in the Operating Partnership
12,263

 
(93
)
 
11,686

 
(120
)
Comprehensive income attributable to Hudson Pacific Properties, Inc. stockholders
$
(19,338
)
 
$
2,581

 
$
(733
)
 
$
3,309


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




HUDSON PACIFIC PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF EQUITY
(Unaudited, in thousands, except share and per share amounts)
 
Hudson Pacific Properties, Inc. Stockholders’ Equity
 
 
 
 
 
Shares of Common
Stock
Stock
Amount
Series B Cumulative Redeemable Preferred Stock
Additional
Paid in
Capital
Accumulated
Deficit
Accumulated
Other
Comprehensive
(Loss)
Income
Non-
controlling
Interests —
Common units in the
Operating
Partnership
Non-controlling Interests — Members in Consolidated Entities
Total Equity
Non-
controlling
Interests —
Series A
Cumulative
Redeemable
Preferred
Units
Balance at January 1, 2014
57,230,199

$
572

$
145,000

$
903,984

$
(45,113
)
$
(997
)
$
53,737

$
45,683

$
1,102,866

$
10,475

Distributions







(2,842
)
(2,842
)

Proceeds from sale of common stock, net of underwriters’ discount
9,563,500

96


197,372





197,468


Equity offering transaction costs



(1,599
)




(1,599
)

Redemption of Series A Cumulative Redeemable Preferred Units









(298
)
Issuance of unrestricted stock
6,922










Issuance of restricted stock










Forfeiture of restricted stock










Shares repurchased
(2,805
)


(3,129
)




(3,129
)

Declared dividend


(12,144
)
(33,774
)


(1,192
)

(47,110
)
(641
)
Amortization of stock-based compensation



7,979





7,979


Net income


12,144


10,229


359

149

22,881

641

Cash flow hedge adjustment





(1,446
)
(53
)

(1,499
)

Balance at December 31, 2014
66,797,816

$
668

$
145,000

$
1,070,833

$
(34,884
)
$
(2,443
)
$
52,851

$
42,990

$
1,275,015

$
10,177

Contributions








217,795

217,795


Distributions







(1,424
)
(1,424
)

Proceeds from sale of common stock, net of underwriters’ discount
12,650,000

127


385,462





385,589


Transaction related costs



(4,754
)




(4,754
)

Issuance of unrestricted stock
8,754,881

87


285,358





285,445


Issuance of Common units for acquisition of properties






1,814,936


1,814,936


Issuance of restricted stock










Forfeiture of restricted stock










Shares repurchased
(59,024
)
(1
)

(1,833
)




(1,834
)

Declared Dividend


(6,072
)
(21,176
)


(7,335
)

(34,583
)
(318
)
Amortization of stock-based compensation



4,363





4,363


Net income


6,072


(5,882
)

(15,412
)
3,395

(11,827
)
318

Cash Flow Hedge Adjustment





5,299

3,726


9,025


Exchange of Non-controlling Interests — Common units in the Operating Partnership for common stock
934,728

9


20,835



(20,844
)



Balance at June 30, 2015
89,078,401

$
890

$
145,000

$
1,739,088

$
(40,766
)
$
2,856

$
1,827,922

$
262,756

$
3,937,746

$
10,177


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




HUDSON PACIFIC PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands) 
 
Six Months Ended June 30,
 
2015
 
2014
CASH FLOWS FROM OPERATING ACTIVITIES
 
 
 
Net (loss) income
$
(11,509
)
 
$
11,222

Adjustments to reconcile net (loss) income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
90,750

 
34,612

Amortization of deferred financing costs and loan premium, net
1,915

 
178

Amortization of stock-based compensation
4,152

 
3,255

Straight-line rent receivables
(14,789
)
 
(7,294
)
Amortization of above-market leases
4,262

 
1,110

Amortization of below-market leases
(16,119
)
 
(3,950
)
Amortization of lease incentive costs
282

 
133

Bad debt expense
391

 
121

Amortization of ground lease
577

 
124

Amortization of discount and net origination fees on purchased and originated loans
(208
)


Gain from sale of real estate
(22,100
)
 

Change in operating assets and liabilities:
 
 
 
Restricted cash
(236
)
 
(932
)
Accounts receivable
3,610

 
26

Deferred leasing costs and lease intangibles
(13,766
)
 
(4,541
)
Prepaid expenses and other assets
(13,859
)
 
(39
)
Accounts payable and accrued liabilities
21,838

 
(2,550
)
Security deposits
14,517

 
(138
)
Prepaid rent
13,843

 
4,554

Net cash provided by operating activities
63,551

 
35,891

CASH FLOWS FROM INVESTING ACTIVITIES
 
 
 
Additions to investment property
(69,621
)
 
(51,506
)
Property acquisitions
(1,764,596
)
 
(75,580
)
Proceeds from sale of real estate
87,680

 

Deposits for property acquisitions
(1,500
)
 

Net cash used in investing activities
(1,748,037
)
 
(127,086
)
CASH FLOWS FROM FINANCING ACTIVITIES
 
 
 
Proceeds from notes payable
1,368,155

 
92,787

Payments of notes payable
(208,633
)
 
(170,439
)
Proceeds from issuance of common stock
385,589

 
197,468

Common stock issuance transaction costs
(4,754
)
 
(653
)
Dividends paid to common stock and unit holders
(28,511
)
 
(17,355
)
Dividends paid to preferred stock and unit holders
(6,390
)
 
(6,395
)
Contributions by members
217,795

 

Redemption of 6.25% series A cumulative redeemable preferred units

 
(298
)
Distribution to non-controlling member in consolidated real estate entity
(1,424
)
 
(1,531
)
Repurchase of vested restricted stock
(1,834
)
 

Payment of loan costs
(12,933
)
 
52

Net cash provided by financing activities
1,707,060

 
93,636

Net increase in cash and cash equivalents
22,574

 
2,441

Cash and cash equivalents—beginning of period
17,753

 
30,356

Cash and cash equivalents—end of period
$
40,327

 
$
32,797


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




HUDSON PACIFIC PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS—(Continued)
(Unaudited, in thousands) 


 
Six Months Ended June 30,
 
2015
 
2014
 
 
 
 
SUPPLEMENTAL CASH FLOWS INFORMATION:
 
 
 
Cash paid for interest, net of amounts capitalized
$
32,107

 
$
15,694

NON-CASH INVESTING ACTIVITIES:
 
 
 
Accounts payable and accrued liabilities for investment in property
$
(15,770
)
 
$
5,129

Issuance of Common stock in connection with property acquisition (Note 3)
87

 

Additional paid-in capital in connection with property acquisition (Note 3)
285,358

 

Non-controlling common units in the Operating Partnership in connection with property acquisition (Note 3)
1,814,936

 

Assumption of other (assets) and liabilities in connection with property acquisitions, net (Note 3)

 
(449
)
 
 
 
 


The accompanying notes are an integral part of these consolidated financial statements.
9




HUDSON PACIFIC PROPERTIES, L.P.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
 
 
June 30, 2015
 
December 31, 2014
 
(unaudited)
 
(audited)
ASSETS
 
 
 
REAL ESTATE ASSETS
 
 
 
Land
$
1,399,207

 
$
620,805

Building and improvements
4,103,152

 
1,284,602

Tenant improvements
272,779

 
116,317

Furniture and fixtures
9,952

 
13,721

Property under development
124,582

 
135,850

Total real estate held for investment
5,909,672

 
2,171,295

Accumulated depreciation and amortization
(181,163
)
 
(134,657
)
Investment in real estate, net
5,728,509

 
2,036,638

Cash and cash equivalents
40,327

 
17,753

Restricted cash
17,319

 
14,244

Accounts receivable, net
12,312

 
16,247

Notes receivable
28,476

 
28,268

Straight-line rent receivables
47,137

 
33,006

Deferred leasing costs and lease intangibles, net
381,370

 
102,023

Deferred finance costs, net
18,384

 
8,723

Interest rate contracts
8,689

 
3

Goodwill
8,754

 
8,754

Prepaid expenses and other assets
21,853

 
6,692

Assets associated with real estate held for sale

 
68,534

TOTAL ASSETS
$
6,313,130

 
$
2,340,885

LIABILITIES
 
 
 
Notes payable
$
2,119,157

 
$
918,059

Accounts payable and accrued liabilities
75,205

 
36,844

Lease intangible liabilities, net
125,795

 
40,969

Security deposits
21,100

 
6,257

Prepaid rent
21,909

 
8,600

Interest rate contracts
1,766

 
1,750

Liabilities associated with real estate held for sale
275

 
43,214

TOTAL LIABILITIES
2,365,207

 
1,055,693

6.25% series A cumulative redeemable preferred units of the Operating Partnership
10,177

 
10,177

CAPITAL
 
 
 
Partners’ Capital:
 
 
 
8.375% series B cumulative redeemable preferred units, 5,800,000 units issued and outstanding at June 30, 2015 and December 31, 2014, respectively ($25.00 per unit liquidation preference.)
145,000

 
145,000

Common units, 145,374,716 and 69,180,379 issued and outstanding at June 30, 2015 and December 31, 2014, respectively
3,529,990

 
1,087,025

Total Hudson Pacific Properties, Inc. Capital
3,674,990

 
1,232,025

Non-controlling interest—members in Consolidated Entities
262,756

 
42,990

TOTAL CAPITAL
3,937,746

 
1,275,015

TOTAL LIABILITIES AND CAPITAL
$
6,313,130

 
$
2,340,885



The accompanying notes are an integral part of these consolidated financial statements.
10




HUDSON PACIFIC PROPERTIES, L.P.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited, in thousands, except share and per unit amount)
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2015
 
2014
 
2015
 
2014
Revenues
 
 
 
 
 
 
 
Office
 
 
 
 
 
 
 
Rental
$
120,052

 
$
39,905

 
$
161,628

 
$
75,915

Tenant recoveries
17,790

 
5,988

 
23,854

 
11,559

Parking and other
5,716

 
7,013

 
11,011

 
11,492

Total office revenues
143,558

 
52,906

 
196,493

 
98,966

Media & entertainment
 
 
 
 
 
 
 
Rental
5,394

 
5,958

 
10,861

 
11,407

Tenant recoveries
253

 
384

 
493

 
704

Other property-related revenue
2,556

 
2,811

 
6,665

 
6,445

Other
58

 
70

 
131

 
203

Total media & entertainment revenues
8,261

 
9,223

 
18,150

 
18,759

Total revenues
151,819

 
62,129

 
214,643

 
117,725

Operating expenses
 
 
 
 
 
 
 
Office operating expenses
46,691

 
18,573

 
63,826

 
34,500

Media & entertainment operating expenses
5,069

 
5,838

 
11,074

 
11,843

General and administrative
10,373

 
6,579

 
19,573

 
12,355

Depreciation and amortization
73,592

 
17,944

 
90,750

 
34,612

Total operating expenses
135,725

 
48,934

 
185,223

 
93,310

Income from operations
16,094

 
13,195

 
29,420

 
24,415

Other (income) expense
 
 
 
 
 
 
 
Interest expense
14,113

 
6,445

 
19,606

 
12,969

Interest income
(48
)
 
(11
)
 
(101
)
 
(20
)
Acquisition-related expenses
37,481

 

 
43,525

 
105

Other income
40

 
12

 
(1
)
 
13

Total other expenses
51,586

 
6,446

 
63,029

 
13,067

Loss (income) from continuing operations before (loss) gain on sale of real estate
(35,492
)
 
6,749

 
(33,609
)
 
11,348

(Loss) gain on sale of real estate
(591
)
 

 
22,100

 

Loss (income) from continuing operations
(36,083
)
 
6,749

 
(11,509
)
 
11,348

Loss from discontinued operations

 
(60
)
 

 
(126
)
Net (loss) income
$
(36,083
)
 
$
6,689

 
$
(11,509
)
 
$
11,222

Net loss (income) attributable to non-controlling interest in consolidated entities
(1,893
)
 
61

 
(3,395
)
 
104

Net (loss) income attributable to Hudson Pacific Properties, L.P.
$
(37,976
)
 
$
6,750

 
$
(14,904
)
 
$
11,326

Preferred distributions—Series A units
(159
)
 
(159
)
 
(318
)
 
(323
)
Preferred distributions—Series B units
(3,036
)
 
(3,036
)
 
(6,072
)
 
(6,072
)
Total preferred distributions
$
(3,195
)
 
$
(3,195
)
 
$
(6,390
)
 
$
(6,395
)
Net income attributable to restricted shares
$
(80
)
 
$
(69
)
 
$
(150
)
 
$
(138
)
Net (loss) income available to common unitholders
$
(41,251
)
 
$
3,486

 
$
(21,444
)
 
$
4,793

Basic and diluted per unit amounts:
 
 
 
 
 
 
 
Net (loss) income from continuing operations attributable to common unitholders
$
(0.28
)
 
$
0.05

 
$
(0.19
)
 
$
0.07

Net (loss) income attributable to common unitholders per unit—basic
$
(0.28
)
 
$
0.05

 
$
(0.19
)
 
$
0.07

Net (loss) income attributable to common unitholders per unit—diluted
$
(0.28
)
 
$
0.05

 
$
(0.19
)
 
$
0.07

Weighted average shares of common units outstanding—basic
145,264,166

 
68,868.202

 
112,582.252

 
67,446.159

Weighted average shares of common units outstanding—diluted
145,264,166

 
71,804.184

 
112,582.252

 
70,379,730


The accompanying notes are an integral part of these consolidated financial statements.
11




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

 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2015
 
2014
 
2015
 
2014
Net (loss) income
$
(36,083
)
 
$
6,689

 
$
(11,509
)
 
$
11,222

Other comprehensive income (loss) cash flow hedge adjustment
9,650

 
(812
)
 
9,025

 
(1,364
)
Comprehensive income
(26,433
)
 
5,877

 
(2,484
)
 
9,858

Comprehensive income attributable to Series A preferred units
(159
)
 
(159
)
 
(318
)
 
(323
)
Comprehensive income attributable to Series B preferred units
(3,036
)
 
(3,036
)
 
(6,072
)
 
(6,072
)
Comprehensive income attributable to restricted shares
(80
)
 
(69
)
 
(150
)
 
(138
)
Comprehensive (income) loss attributable to non-controlling interest in consolidated real estate entities
(1,893
)
 
61

 
(3,395
)
 
104

Comprehensive income attributable to Hudson Pacific Properties, Inc. stockholders
$
(31,601
)
 
$
2,674

 
$
(12,419
)
 
$
3,429



The accompanying notes are an integral part of these consolidated financial statements.
12




HUDSON PACIFIC PROPERTIES, L.P.
CONSOLIDATED STATEMENTS OF CAPITAL
(Unaudited, in thousands, except share and per unit amounts)
 
Partners Capital
 
 
 
 
 
Preferred Units
Number of Common Units
Common Units
Total Partners Capital
Non-controlling Interests — Members in Consolidated Entities
Total Capital
Non-
controlling
Interests —
Series A
Cumulative
Redeemable
Preferred
Units
Balance at January 1, 2014
$
145,000

59,612,762

$
912,183

$
1,057,183

$
45,683

1,102,866

10,475

Distributions




(2,842
)
(2,842
)

Proceeds from sale of common units, net of underwriters’ discount

9,563,500

197,468

197,468


197,468


Equity offering transaction costs


(1,599
)
(1,599
)

(1,599
)

Redemption of Series A Cumulative Redeemable Preferred Units






(298
)
Issuance of unrestricted units

6,922






Units repurchased

(2,805
)
(3,129
)
(3,129
)

(3,129
)

Declared distributions
(12,144
)

(34,966
)
(47,110
)

(47,110
)
(641
)
Amortization of unit based compensation


7,979

7,979


7,979


Net income
12,144


10,588

22,732

149

22,881

641

Cash flow hedge adjustment


(1,499
)
(1,499
)

(1,499
)

Balance at December 31, 2014
$
145,000

69,180,379

$
1,087,025

$
1,232,025

$
42,990

$
1,275,015

$
10,177

Contributions




217,795

217,795


Distributions




(1,424
)
(1,424
)

Proceeds from sale of common units, net of underwriters’ discount

12,650,000

385,589

385,589


385,589


Equity offering transaction costs


(4,754
)
(4,754
)

(4,754
)

Issuance of unrestricted units

63,603,361

2,100,381

2,100,381


2,100,381


Units repurchased

(59,024
)
(1,834
)
(1,834
)

(1,834
)

Declared distributions
(6,072
)

(28,511
)
(34,583
)

(34,583
)
(318
)
Amortization of unit based compensation


4,363

4,363


4,363


Net income
6,072


(21,294
)
(15,222
)
3,395

(11,827
)
318

Cash Flow Hedge Adjustment


9,025

9,025


9,025


Balance at June 30, 2015
$
145,000

145,374,716

$
3,529,990

$
3,674,990

$
262,756

$
3,937,746

$
10,177



The accompanying notes are an integral part of these consolidated financial statements.
13




HUDSON PACIFIC PROPERTIES, L.P.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)
 
Six Months Ended June 30,
 
2015
 
2014
CASH FLOWS FROM OPERATING ACTIVITIES
 
 
 
Net (loss) income
$
(11,509
)
 
$
11,222

Adjustments to reconcile net (loss) income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
90,750

 
34,612

Amortization of deferred financing costs and loan premium, net
1,915

 
178

Amortization of stock-based compensation
4,152

 
3,255

Straight-line rent receivables
(14,789
)
 
(7,294
)
Amortization of above-market leases
4,262

 
1,110

Amortization of below-market leases
(16,119
)
 
(3,950
)
Amortization of lease incentive costs
282

 
133

Bad debt expense
391

 
121

Amortization of ground lease
577

 
124

Amortization of discount and net origination fees on purchased and originated loans
(208
)
 

Gain from sale of real estate
(22,100
)
 

Change in operating assets and liabilities:
 
 
 
Restricted cash
(236
)
 
(932
)
Accounts receivable
3,610

 
26

Deferred leasing costs and lease intangibles
(13,766
)
 
(4,541
)
Prepaid expenses and other assets
(13,859
)
 
(39
)
Accounts payable and accrued liabilities
21,838

 
(2,550
)
Security deposits
14,517

 
(138
)
Prepaid rent
13,843

 
4,554

Net cash provided by operating activities
63,551

 
35,891

CASH FLOWS FROM INVESTING ACTIVITIES
 
 
 
Additions to investment property
(69,621
)
 
(51,506
)
Property acquisitions
(1,764,596
)
 
(75,580
)
Proceeds from sale of real estate
87,680

 

Deposits for property acquisitions
(1,500
)
 

Net cash used in investing activities
(1,748,037
)
 
(127,086
)
CASH FLOWS FROM FINANCING ACTIVITIES
 
 
 
Proceeds from notes payable
1,368,155

 
92,787

Payments of notes payable
(208,633
)
 
(170,439
)
Proceeds from issuance of common units
385,589

 
197,468

Common units issuance transaction costs
(4,754
)
 
(653
)
Dividends paid to common unitholders
(28,511
)
 
(17,355
)
Dividends paid to preferred unitholders
(6,390
)
 
(6,395
)
         Contributions by members
217,795

 

Redemption of 6.25% series A cumulative redeemable preferred units

 
(298
)
Distribution to non-controlling member in consolidated real estate entity
(1,424
)
 
(1,531
)
Repurchase of vested restricted units
(1,834
)
 

Payment of loan costs
(12,933
)
 
52

Net cash provided by financing activities
1,707,060

 
93,636

Net increase in cash and cash equivalents
22,574

 
2,441

Cash and cash equivalents—beginning of period
17,753

 
30,356

Cash and cash equivalents—end of period
$
40,327

 
$
32,797


The accompanying notes are an integral part of these consolidated financial statements.
14




HUDSON PACIFIC PROPERTIES, L.P.
CONSOLIDATED STATEMENTS OF CASH FLOWS—(Continued)
(Unaudited, in thousands) 


 
Six Months Ended June 30,
 
2015
 
2014
 
 
 
 
SUPPLEMENTAL CASH FLOWS INFORMATION:
 
 
 
Cash paid for interest, net of amounts capitalized
$
32,107

 
$
15,694

NON-CASH INVESTING ACTIVITIES:
 
 
 
Accounts payable and accrued liabilities for investment in property
$
(15,770
)
 
$
5,129

Common units in the Operating Partnership in connection with property acquisition (Note 3)
$
2,100,381

 
$

Assumption of other (assets) and liabilities in connection with property acquisitions, net (Note 3)
$

 
$
(449
)


The accompanying notes are an integral part of these consolidated financial statements.
15


Hudson Pacific Properties, Inc. and Hudson Pacific Properties, L.P.
Notes to Consolidated Financial Statements
(Unaudited, tabular amounts in thousands, except square footage and share data or as otherwise noted)




1. Organization

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

Since the completion of the IPO and the related formation transactions, we have been a fully integrated, self-administered, and self-managed real estate investment trust (“REIT”). Through our controlling interest in Hudson Pacific Properties, L.P. (“our operating partnership” or the “Operating Partnership,” which is also referred to in these financial statements as the “Company,” “we,” “us,” or “our”) and its subsidiaries, we own, manage, lease, acquire and develop real estate, consisting primarily of office and media and entertainment properties. On April 1, 2015, the Company completed (the “Acquisition”) of the EOP Northern California Portfolio from Blackstone Real Estate Partners V and VI (“Blackstone”). The EOP Northern California Portfolio consists of 26 high-quality office assets totaling approximately 8.2 million square feet and two development parcels located throughout the San Francisco Peninsula, Redwood Shores, Palo Alto, Silicon Valley and San Jose Airport submarkets. The total consideration paid for the EOP Northern California Portfolio before certain credits, proration, and closing costs included a cash payment of $1.75 billion and an aggregate of 63,474,791 shares of common stock of the Company and common units in the Operating Partnership.  See Note 10, Related Party Transaction — Acquisition of EOP Northern California Portfolio for additional details.

As of June 30, 2015, we owned a portfolio of 53 office properties and two media and entertainment properties. These properties are located in California and Washington. The results of operations for properties acquired after our IPO are included in our consolidated statements of operations from the date of each such acquisition.

2. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying consolidated financial statements of the Company are prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). The unaudited interim financial statements of the Company include the consolidated financial position and results of operations of the Company, the Operating Partnership and all of our wholly owned and controlled subsidiaries. The unaudited interim financial statements of the Operating Partnership include the consolidated financial position and results of operations of the Operating Partnership and all wholly owned and controlled subsidiaries of the Operating Partnership. The effect of all significant intercompany balances and transactions has been eliminated.

The accompanying unaudited interim financial statements have been prepared pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”). Certain information and note disclosures normally included in the financial statements prepared in accordance with accounting principles generally accepted in the United States may have been condensed or omitted pursuant to SEC rules and regulations, although we believe that the disclosures are adequate to make their presentation not misleading. The accompanying unaudited financial statements include, in our opinion, all adjustments, consisting of normal recurring adjustments, necessary to present fairly the financial information set forth therein. The results of operations for the interim periods are not necessarily indicative of the results that may be expected for the year ended December 31, 2015. The interim financial statements should be read in conjunction with the consolidated financial statements in our 2014 Annual Report on Form 10-K and the notes thereto. Any reference to the number of properties and square footage are unaudited and outside the scope of our independent registered public accounting firm’s review of our financial statements in accordance with the standards of the United States Public Company Accounting Oversight Board.

Use of Estimates

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


16

Hudson Pacific Properties, Inc. and Hudson Pacific Properties, L.P.
Notes to Consolidated Financial Statements—(Continued)
(Unaudited, tabular amounts in thousands, except square footage and share data)



Investment in Real Estate Properties

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

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

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

The Company capitalizes direct construction and development costs, including predevelopment costs, interest, property taxes, insurance and other costs directly related and essential to the acquisition, development or construction of a real estate project. Indirect development costs, including salaries and benefits, office rent, and associated costs for those individuals directly responsible for and who spend their time on development activities are also capitalized and allocated to the projects to which they relate. Capitalized personnel costs for the three and six months ended June 30, 2015 were approximately $1.9 million and $2.8 million, respectively, and $0.7 million and $1.3 million for the three and six months ended June 30, 2014, respectively. Interest is capitalized on the construction in progress at a rate equal to the Company’s weighted average cost of debt. Capitalized interest for the three and six months ended June 30, 2015 was approximately $0.9 million and $3.0 million, respectively, and $1.7 million and $3.3 million for the three and six months ended June 30, 2014, respectively. Construction and development costs are capitalized while substantial activities are ongoing to prepare an asset for its intended use. The Company considers a construction project as substantially complete and held available for occupancy upon the completion of tenant improvements but no later than one year after cessation of major construction activity. Costs incurred after a project is substantially complete and ready for its intended use, or after development activities have ceased, are expensed as they are incurred. Costs previously capitalized related to abandoned acquisitions or developments are charged to earnings. Expenditures for repairs and maintenance are expensed as they are incurred.

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

Impairment of Long-Lived Assets

The Company assesses the carrying value of real estate assets and related intangibles whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable in accordance with GAAP. Impairment losses are recorded on real estate assets held for investment when indicators of impairment are present and the future undiscounted cash flows estimated to be generated by those assets are less than the assets’ carrying amount. The Company recognizes impairment losses to the extent the carrying amount exceeds the fair value of the properties. Properties held for sale are recorded at the lower of cost or estimated fair value less cost to sell. There were no properties held for sale at June 30, 2015 and one property held for sale at December 31, 2014. The Company recorded no impairment charges for the three and six months ended June 30, 2015 and 2014.


17

Hudson Pacific Properties, Inc. and Hudson Pacific Properties, L.P.
Notes to Consolidated Financial Statements—(Continued)
(Unaudited, tabular amounts in thousands, except square footage and share data)



Goodwill

Goodwill represents the excess of acquisition cost over the fair value of net tangible and identifiable intangible assets acquired and liabilities assumed in business combinations. Our goodwill balance as of June 30, 2015 was $8.8 million. We do not amortize this asset but instead analyze it on an annual basis for impairment. No impairment indicators have been noted during the three and six months ended June 30, 2015 and 2014.

Cash and Cash Equivalents

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

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

Restricted Cash

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

Accounts Receivable and Allowance for Doubtful Accounts

Accounts receivable consist of amounts due for monthly rents and other charges. The Company maintains an allowance for doubtful accounts for estimated losses resulting from tenant defaults or the inability of tenants to make contractual rent and tenant recovery payments. The Company monitors the liquidity and creditworthiness of its tenants and operators on an ongoing basis. This evaluation considers industry and economic conditions, property performance, credit enhancements and other factors. For straight-line rent amounts, the Company’s assessment is based on amounts estimated to be recoverable over the term of the lease. At June 30, 2015 and December 31, 2014, the Company had reserved $0.6 million and $0.6 million, respectively, of straight-line receivables. The Company evaluates the collectability of accounts receivable based on a combination of factors. The allowance for doubtful accounts is based on specific identification of uncollectible accounts and the Company’s historical collection experience. The Company recognizes an allowance for doubtful accounts based on the length of time the receivables are past due, the current business environment and the Company’s historical experience. Historical experience has been within management’s expectations. The Company recognized $0.39 million and $0.1 million of bad debt (recovery) expense for the six months ended June 30, 2015 and 2014, respectively.

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

 
June 30, 2015
 
December 31, 2014
Accounts receivable
$
13,616

 
$
17,287

Allowance for doubtful accounts
(1,304
)
 
(1,040
)
Accounts receivable, net
$
12,312

 
$
16,247


Notes Receivable

On August 19, 2014, the Company entered into a loan participation agreement for a loan with a maximum principal of $140.0 million. The Company’s share was 23.77%, or $33.3 million. The note receivable is secured by real property, has a balance of $28.5 million as of June 30, 2015, bears interest at 11.0% and matures on August 18, 2016. Interest is payable monthly with the principal due at maturity. The Company received a $0.4 million commitment fee as a result of this transaction. The balance as of June 30, 2015, net of the commitment fee, was $28.5 million and was classified as a note receivable on the consolidated balance sheet. The Company believes these balances are fully collectible.

Revenue Recognition

The Company recognizes rental revenue from tenants on a straight-line basis over the lease term when collectability is reasonably assured and the tenant has taken possession or controls the physical use of the leased asset. If the lease provides for tenant improvements, the Company determines whether the tenant improvements, for accounting purposes, are owned by the

18

Hudson Pacific Properties, Inc. and Hudson Pacific Properties, L.P.
Notes to Consolidated Financial Statements—(Continued)
(Unaudited, tabular amounts in thousands, except square footage and share data)



tenant or the Company. When the Company is the owner of the tenant improvements, the tenant is not considered to have taken physical possession or have control of the physical use of the leased asset until the tenant improvements are substantially completed. When the tenant is the owner of the tenant improvements, any tenant improvement allowance that is funded is treated as a lease incentive and amortized as a reduction of revenue over the lease term. Tenant improvement ownership is determined based on various factors including, but not limited to:

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

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

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

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

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

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

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

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

Deferred Financing Costs

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

Derivative Financial Instruments

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

The Company held seven and three interest rate contracts as of June 30, 2015 and December 31, 2014, respectively, all of which have been accounted for as cash flow hedges as more fully described in Note 6 below.


19

Hudson Pacific Properties, Inc. and Hudson Pacific Properties, L.P.
Notes to Consolidated Financial Statements—(Continued)
(Unaudited, tabular amounts in thousands, except square footage and share data)



Stock-Based Compensation

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

Income Taxes

Our property-owning subsidiaries are limited liability companies and are treated as pass-through entities or disregarded entities (or, in the case of the entity that owns the 1455 Market Street property, a REIT) for federal income tax purposes. Accordingly, no provision has been made for federal income taxes in the accompanying consolidated financial statements for the activities of these entities.

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

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

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

The Company periodically evaluates its tax positions to determine whether it is more likely than not that such positions would be sustained upon examination by a tax authority for all open tax years, as defined by the statute of limitations, based on their technical merits. As of June 30, 2015, the Company had not established a liability for uncertain tax positions.

The REIT and its TRS file income tax returns with the U.S. federal government and various state and local jurisdictions. The REIT and the TRS are no longer subject to tax examinations by taxing authorities for the years prior to 2011. Generally, the Company has assessed its tax positions for all open years, which includes 2011 to 2014, and concluded that there are no material uncertainties to be recognized.

Fair Value of Assets and Liabilities

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

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

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

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

20

Hudson Pacific Properties, Inc. and Hudson Pacific Properties, L.P.
Notes to Consolidated Financial Statements—(Continued)
(Unaudited, tabular amounts in thousands, except square footage and share data)




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

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

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

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

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

As of June 30, 2015, the Company had the following outstanding interest rate derivatives that were designated as cash flow hedges of interest rate risk:

Interest Rate Derivative
Number of Instruments
Notional Amount
Interest Rate Caps
2
$92.0 million
Interest Rate Swaps
5
$714.5 million

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

The table below presents a gross presentation of the Company’s derivatives as of June 30, 2015 and December 31, 2014. The tabular disclosure of fair value provides the location that derivative assets and liabilities are presented on the consolidated balance sheets.


21

Hudson Pacific Properties, Inc. and Hudson Pacific Properties, L.P.
Notes to Consolidated Financial Statements—(Continued)
(Unaudited, tabular amounts in thousands, except square footage and share data)



 
 
Asset Derivatives
 
Liability Derivatives
 
 
 
Fair Value as of
 
 
Fair Value as of
 
 
Balance Sheet Location
June 30, 2015
 
December 31, 2014
 
Balance Sheet Location
June 30, 2015
 
December 31, 2014
Derivatives designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
Interest rate products
 
Interest rate contracts
$
8,689

 
$
3

 
Interest rate contracts
$
1,766

 
$
1,750


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

The tables below present the effect of the Company’s derivative financial instruments on the Statement of Operations for the six months ended June 30, 2015 and 2014.

 
Six Months Ended 
 June 30, 2015
 
Six Months Ended 
 June 30, 2014
 
 
Beginning balance of OCI related to interest rate contracts
$
2,661

 
$
1,162

 
 
 
 
Unrealized loss recognized in OCI due to change in fair value of interest rate contracts
791

 
1,547

Loss reclassified from OCI into income (as interest expense)
(9,816
)
 
(183
)
Net change in OCI
(9,025
)
 
1,364

 
 
 
 
Ending balance of accumulated OCI related to derivatives
(6,364
)
 
2,526

Allocation of OCI, non-controlling interests
3,508

 
(213
)
Accumulated other comprehensive loss
$
(2,856
)
 
$
2,313


Credit-Risk-Related Contingent Features

As of June 30, 2015, the Company had one derivative that was in a net liability position.

Recently Issued Accounting Literature

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

On April 7, 2015 the FASB issued ASU No. 2015-03 (ASU 2015-03) “Simplifying the Presentation of Debt Issuance Cost” to amend the accounting guidance for the presentation of debt issuance costs. The standard requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. ASU 2015-03 is effective for public business entities for fiscal years beginning after December 15, 2015 and retrospective application is required. Early adoption of the guidance is permitted. The Company expects to adopt the guidance effective January 1, 2016 and our adoption of the guidance is not anticipated to have a material impact on our consolidated financial statements.

On April 1, 2015, the FASB voted to defer the effective date of ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606)” (ASU 2014-09), which outlines a single comprehensive model for entities to use in accounting for revenues arising from contracts with customers and notes that lease contracts with customers are a scope exception. Public business entities may elect to adopt the amendments as of the original effective date; however, if the proposed deferral is approved, adoption is required for annual reporting periods beginning after December 15, 2017. The Company is currently assessing the impact of the guidance on our consolidated financial statements or notes to our consolidated financial statements.


On February 18, 2015 the FASB issued ASU No. 2015-02 “Consolidation (Topic 810): Amendments to the Consolidation Analysis” (ASU 2015-02) to amend the accounting guidance for consolidation. The standard simplifies the current guidance for

22

Hudson Pacific Properties, Inc. and Hudson Pacific Properties, L.P.
Notes to Consolidated Financial Statements—(Continued)
(Unaudited, tabular amounts in thousands, except square footage and share data)



consolidation and reduces the number of consolidation models through the elimination of the indefinite deferral of Statement 167. Additionally, the standard places more emphasis on risk of loss when determining a controlling financial interest. ASU 2015-02 is effective for all entities for reporting periods (including interim periods) beginning after December 15, 2015, and early adoption is permitted. The Company expects to adopt the guidance effective January 1, 2016, and our adoption of the guidance is not anticipated to have a material impact on our consolidated financial statements.

On January 9, 2015, the FASB issued ASU No. 2015-01, “Income Statement — Extraordinary and Unusual Items (Subtopic 225-20): Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items,” (ASU 2015-01). ASU 2015-01 eliminates the concept of an extraordinary item from GAAP. As a result, an entity will no longer be required to segregate extraordinary items from the results of ordinary operations, to separately present an extraordinary item on its income statement, net of tax, after income from continuing operations or to disclose income taxes and earnings-per-share data applicable to an extraordinary item. However, ASU 2015-01 will still retain the presentation and disclosure guidance for items that are unusual in nature and occur infrequently. ASU 2015-01 will be effective for the Company’s fiscal year beginning January 1, 2016 and subsequent interim periods. The adoption of ASU 2015-01 is not expected to have a material effect on the Company’s consolidated financial statements.

On August 27, 2014, the FASB issued ASU 2014-15, “Presentation of Financial Statements — Going Concern: Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern” (ASU 2014-15). This update requires an entity to evaluate whether there are conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued (or within one year after the financial statements are available to be issued, when applicable) and to provide related footnote disclosures in certain circumstances.  This update is effective for the annual period ending after December 15, 2016, and for annual and interim periods thereafter with early adoption permitted. The implementation of this update is not expected to have a material effect on the Company’s consolidated financial statements.

3. Investment in Real Estate

The Company’s acquisitions are accounted for using the acquisition method. The results of operations for each of these acquisitions are included in our consolidated statements of operations from the date of acquisition.

Acquisitions

On April 1, 2015, the Company completed the acquisition of the EOP Northern California Portfolio from Blackstone Real Estate Partners V and VI (“Blackstone”). The EOP Northern California Portfolio consists of 26 high-quality office assets totaling approximately 8.2 million square feet and two development parcels located throughout the San Francisco Peninsula, Redwood Shores, Palo Alto, Silicon Valley and San Jose Airport submarkets. The total consideration paid for the EOP Northern California Portfolio before certain credits, proration, and closing costs included a cash payment of $1.75 billion (financed with proceeds received from the Company’s January 2015 common equity offering and $1.3 billion of new term debt), an aggregate of 63,474,791 shares of common stock of the company and common units in the Operating Partnership.

On May 22, 2015, the Company acquired a three-story, 120,937-square-foot former manufacturing facility known as “4th & Traction” in Los Angeles, California for $49.3 million (before certain credits, prorations and closing costs). The Company funded this off-market transaction with proceeds from its unsecured revolving credit facility.

Included in the Company’s consolidated financial statements for the six months ended June 30, 2015 were revenues and net income from 2015 acquisitions of $87.6 million and $6.6 million, respectively.


23

Hudson Pacific Properties, Inc. and Hudson Pacific Properties, L.P.
Notes to Consolidated Financial Statements—(Continued)
(Unaudited, tabular amounts in thousands, except square footage and share data)



The following table represents our aggregate preliminary purchase price allocation for each of these acquisitions:

 
EOP Northern California Portfolio
 
4th & Traction
 
 
Date of Acquisition
April 1, 2015
 
May 22, 2015
 
Total
Consideration paid
 
 
 
 
 
Cash consideration
$
1,715,346

 
$
49,250

 
$
1,764,596

Common stock
87

 

 
87

Additional paid-in capital
285,358

 

 
285,358

Non-controlling common units in the Operating Partnership
1,814,936

 

 
1,814,936

Total consideration
$
3,815,727

 
$
49,250

 
$
3,864,977

Allocation of consideration paid
 
 
 
 
 
Investment in real estate, net
$
3,611,294

 
$
49,250

 
$
3,660,544

Above-market leases
28,745

 

 
28,745

Above-market ground leases
51,180

 

 
51,180

Deferred leasing costs and lease intangibles, net
225,440

 

 
225,440

Below-market leases
(99,837
)
 

 
(99,837
)
Below-market ground leases
(1,095
)
 

 
(1,095
)
Total consideration paid
$
3,815,727

 
$
49,250

 
$
3,864,977


The table below shows the pro forma financial information for the six months ended June 30, 2015 and 2014 as if the EOP Northern California Portfolio had been acquired as of January 1, 2014.
 
 
Six Months Ended June 30, 2015