UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

For the Quarterly Period Ended: March 31, 2019

 

OR

 

For the transition period from                      to                     

 

Commission File Number: 001-36746

 

 

PARAMOUNT GROUP, INC.

(Exact name of registrant as specified in its charter)

 

 

 

 

Registrant’s telephone number, including area code: (212) 237-3100

 

Securities registered pursuant to Section 12(b) of the Act:

 

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 every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    ☒  Yes    ☐  No

 

Indicate by check mark whether the registrant is a large accelerated filer, 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.

 

 

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  ☒

 

As of April 15, 2019, there were 234,477,998 shares of the registrant’s common stock outstanding.

 

 

 

 

 

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Table of Contents

 

 

 

 

2

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PART I – FINANCIAL INFORMATION

ITEM 1.  CONSOLIDATED FINANCIAL STATEMENTS

 

 

PARAMOUNT GROUP, INC.

CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

 

 

 

 

 

 

See notes to consolidated financial statements (unaudited).

3

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PARAMOUNT GROUP, INC.

CONSOLIDATED STATEMENTS OF INCOME

(UNAUDITED)

 

 

 

 

See notes to consolidated financial statements (unaudited).

4

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PARAMOUNT GROUP, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(UNAUDITED)

 

 

 

 

See notes to consolidated financial statements (unaudited).

 

 

5

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PARAMOUNT GROUP, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

(UNAUDITED)

 

 

 

 

See notes to consolidated financial statements (unaudited).

 

6

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PARAMOUNT GROUP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 

 

 

 

See notes to consolidated financial statements (unaudited).

7

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PARAMOUNT GROUP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED

(UNAUDITED)

 

 

 

 

See notes to consolidated financial statements (unaudited).

8

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PARAMOUNT GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

1.     Organization and Business

 

 

As used in these consolidated financial statements, unless otherwise indicated, all references to “we,” “us,” “our,” the “Company,”  and “Paramount” refer to Paramount Group, Inc., a Maryland corporation, and its consolidated subsidiaries, including Paramount Group Operating Partnership LP (the “Operating Partnership”), a Delaware limited partnership. We are a fully-integrated real estate investment trust (“REIT”) focused on owning, operating, managing, acquiring and redeveloping high-quality, Class A office properties in select central business district submarkets of New York City, San Francisco and Washington, D.C. As of March 31, 2019, our portfolio consisted of 13 Class A office properties aggregating approximately 12.2 million square feet. We conduct our business through, and substantially all of our interests in properties and investments are held by, the Operating Partnership. We are the sole general partner of, and owned approximately 90.5% of, the Operating Partnership as of March 31, 2019.

 

 

 

 

 

Basis of Presentation

 

The accompanying consolidated financial statements are unaudited and have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and in conjunction with the instructions to Form 10-Q of the Securities and Exchange Commission (“SEC”). Accordingly, certain information and footnote disclosures required by GAAP for complete financial statements have been condensed or omitted. These consolidated financial statements include the accounts of Paramount and its consolidated subsidiaries, including the Operating Partnership. In the opinion of management, all significant adjustments (which include only normal recurring adjustments) and eliminations (which include intercompany balances and transactions) necessary to present fairly the financial position, results of operations and changes in cash flows have been made. The consolidated balance sheet as of December 31, 2018 was derived from audited financial statements as of that date, but does not include all information and disclosures required by GAAP. These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2018, as filed with the SEC.

 

 

Significant Accounting Policies

 

There are no material changes to our significant accounting policies as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2018.

 

 

Use of Estimates

 

We have made estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ materially from those estimates. The results of operations for the three months ended March 31, 2019, are not necessarily indicative of the operating results for the full year.

 

 

Reclassifications

 

Certain prior year balances have been reclassified to conform to current year presentation.

 

 

9

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PARAMOUNT GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

Recently Issued Accounting Pronouncements Not Materially Impacting Our Financial Statements

 

 

In June 2016, the FASB issued ASU 2016-13, an update to ASC Topic 326, Financial Instruments – Credit Losses. ASU 2016- 13 requires measurement and recognition of expected credit losses on financial instruments measured at amortized cost at the end of each reporting period rather than recognizing the credit losses when it is probable that the loss has been incurred in accordance with current guidance. In November 2018, the FASB issued ASU 2018-19, which clarified that receivables arising from operating leases are not within the scope of ASC Topic 326, and instead, impairment of receivables arising from operating leases should be accounted for under the scope of ASC Topic 842, Leases. ASU 2016-13 is effective for interim and annual reporting periods in fiscal years that begin after December 15, 2019, with early adoption permitted. We do not believe the adoption of ASU 2016-13 will have a material impact on our consolidated financial statements.

 

 

In August 2018, the FASB issued ASU 2018-13, an update to ASC Topic 820, Fair Value Measurements. ASU 2018-13 modifies the disclosure requirements in ASC Topic 820, by (i) removing certain disclosure requirements related to transfers between Level 1 and Level 2 of the fair value hierarchy and the valuation processes for Level 3 fair value measurements, (ii) modifying existing disclosure requirements related to measurement uncertainty and (iii) adding new disclosure requirements related to changes in unrealized gains or losses for the period included in other comprehensive income for recurring Level 3 fair value measurements and disclosures related to the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. ASU 2018-13 is effective for interim and annual reporting periods in fiscal years that begin after December 15, 2019, with early adoption permitted. We are evaluating the impact of ASU 2018-13 but do not believe the adoption will have an impact on our consolidated financial statements.

 

 

In December 2018, the FASB issued ASU 2018-20, an update to ASC Topic 842, Leases. ASU 2018-20 allows lessors to make an accounting policy election not to evaluate whether sales taxes and similar taxes imposed by a governmental authority on a specific lease transaction and collected by the lessor from the lessee are the primary obligation of the lessor. A lessor that makes this election must exclude from the consideration in the contract and from variable payments not included in the consideration in the contract all taxes within the scope of the election and make additional disclosures. ASU 2018-20 requires a lessor to exclude lessor costs paid directly by a lessee to third parties on the lessor’s behalf from variable payments, but lessor costs that are paid by the lessor and reimbursed by the lessee are required to be included in variable payments. The effective date of ASU 2018-20 is required to coincide with the effective date of ASU 2016-02. We adopted the provisions of ASU 2018-20 on January 1, 2019 in conjunction with the adoption of ASU 2016-02. This adoption did not have an impact on our consolidated financial statements.

 

 

 

10

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PARAMOUNT GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

Recently Issued Accounting Pronouncements Impacting or Potentially Impacting Our Financial Statements

 

 

In February 2016, the FASB issued ASU 2016-02, an update to ASC Topic 842, Leases. ASU 2016-02 amends the existing guidance for lease accounting by requiring lessees to, among other things, (i) recognize most leases on their balance sheets, (ii) classify leases as either financing or operating, and (iii) record a right-of-use asset and a lease liability for all leases with a term greater than 12 months. ASU 2016-02 is effective for interim and annual reporting periods in fiscal years that begin after December 15, 2018, with early adoption permitted. We adopted the provisions of ASU 2016-02 on January 1, 2019, using the alternative modified retrospective method, also known as the transition relief method, permitted under ASU 2018-11 which allows companies to not recast comparative periods in the period of adoption. Accordingly, we have applied the provisions of the standard on January 1, 2019, the date of adoption. Upon adoption of this ASU, we recorded a $4,184,000 right-of-use asset and a lease liability for leases in which we are a lessee, which are included as components of “other assets” and “other liabilities”, respectively, on our consolidated balance sheet as of March 31, 2019.

 

While accounting for lessors under ASU 2016-02 is substantially similar to existing lease accounting guidance, lessors are required to separate payments received pursuant to a lease between lease components (payments received towards the leased space) and non-lease components (payments received towards common area maintenance activities). In July 2018, the FASB issued ASU 2018-11, which provided lessors with a practical expedient to not separate lease and non-lease components, if certain criteria are met. Upon the adoption of ASU 2016-02, we elected this practical expedient and accordingly, have combined lease and non-lease components into rental revenue on our consolidated statements of income. We account for both components under ASC Topic 842. ASU 2016-02 also requires companies to account for the impairment of receivables arising from operating leases (previously recorded as bad debt expense, a component of “operating expenses”), as a reduction to “rental income”. Accordingly, beginning on January 1, 2019, impairment of receivables arising from operating leases have been recorded as a reduction of rental income and are no longer reflected as bad debt expense.

 

Furthermore, ASU 2016-02 also updates the definition of initial direct costs for both lessees and lessors to include only incremental costs of a lease that would not have been incurred if the lease had not been obtained. This ASU also provides a package of practical expedients which permits companies not to reassess under ASC Topic 842, its prior conclusions about lease identification, lease classification and initial direct costs. Upon adoption of ASU 2016-02, we elected this practical expedient and accordingly, effective January 1, 2019, we no longer capitalize internal leasing costs.

 

 

In October 2018, the FASB issued ASU 2018-17, an update to ASC Topic 810, Consolidations. ASU 2018-17 requires reporting entities to consider indirect interests held by related parties under common control on a proportional basis rather than as the equivalent of a direct interest in its entirety in determining whether a decision-making fee is a variable interest. ASU 2018-17 is effective for interim and annual reporting periods in fiscal years that begin after December 15, 2019, with early adoption permitted. We are evaluating the impact of ASU 2018-17 on our consolidated financial statements.     

 

11

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PARAMOUNT GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

 

 

On February 7, 2019, we completed the acquisition of 111 Sutter Street, a 293,000 square foot office building in San Francisco, California. Simultaneously with closing, we brought in a joint venture partner to acquire 51.0% of the equity interest. We have retained the remaining 49.0% equity interest and manage and lease the asset. The purchase price was $227,000,000. In connection with the acquisition, the joint venture completed a $138,200,000 financing of the property. The four-year loan is interest only at LIBOR plus 215 basis points and has three one-year extension options. We began accounting for our investment in 111 Sutter Street, under the equity method, from the date of the acquisition.

 

On March 29, 2019, our consolidated Residential Development Fund (“RDF”) acquired an additional 5.0% economic interest in One Steuart Lane from one of its joint venture partners for $9,339,000. Subsequent to this transaction, RDF owns a 30.0% economic interest in the property and the remaining 70.0% interest is owned by the joint venture partners. We own a 7.4% interest in RDF and continue to consolidate RDF and reflect the 92.6% interest we do not own, as noncontrolling interests. As of March 31, 2019, our economic interest in the One Steuart Lane (based on our ownership of RDF) was 2.22%.

 

The following tables summarize our investments in unconsolidated joint ventures as of the dates thereof and the income or loss from these investments for the periods set forth below.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

12

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PARAMOUNT GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

The following tables provide the combined summarized financial information of our unconsolidated joint ventures as of the dates and for the periods set forth below.

 

 

 

 

 

 

13

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PARAMOUNT GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

 

 

We are the general partner and investment manager of Paramount Group Real Estate Fund VII, LP (“Fund VII”) and its parallel fund, Paramount Group Real Estate Fund VII-H, LP (“Fund VII-H”), our Property Funds. On January 25, 2019, Fund VII and Fund VII-H sold their only remaining asset, 0 Bond Street, a 64,532 square foot creative office building in the NoHo submarket of Manhattan, for $130,500,000. 

 

We also manage Paramount Group Real Estate Fund VIII, LP (“Fund VIII”) and Paramount Group Real Estate Fund X, LP (“Fund X”), our Alternative Investment Funds, which invest in mortgage and mezzanine loans and preferred equity investments. As of March 31, 2019, Fund VIII has invested $617,250,000 of capital and has $157,950,000 in remaining capital commitments, and Fund X, which completed its initial closing in December 2018, has $167,000,000 of capital commitments.

 

The following tables summarize our share of investments in these unconsolidated real estate funds as of the dates thereof and our share of the income or loss recognized for the periods set forth below.

 

 

 

 

 

 

14

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PARAMOUNT GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

The following tables provide the combined summarized financial information of our unconsolidated real estate funds with respect to capital that has been called and/or invested, as of the dates and for the periods set forth below but does not include uncalled capital that has been committed.

 

 

 

 

 

 

 

 

We own a 24.4% interest in PGRESS Equity Holdings LP (“PGRESS”), an entity that owned a preferred equity investment in a partnership that owned 470 Vanderbilt, a 686,000 square foot office building in Brooklyn, New York. The preferred equity had a dividend rate of 10.3%, of which 8.0% was paid in cash through February 2016 and the unpaid portion accreted to the balance of the investment. Subsequent to February 2016, the entire 10.3% dividend was paid in cash. On March 1, 2019, the partnership that owned 470 Vanderbilt redeemed the preferred equity investment for $36,089,000 consisting of the investment balance and accrued interest.

  

15

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PARAMOUNT GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

 

 

The following tables summarize our intangible assets (acquired above-market leases and acquired in-place leases) and intangible liabilities (acquired below-market leases) and the related amortization as of the dates and for the periods set forth below.

 

 

 

 

 

The following table sets forth annual amortization of acquired above and below-market leases, net and amortization of acquired in-place leases for each of the five succeeding years commencing from January 1, 2020.

 

 

16

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PARAMOUNT GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

 

 

The following table summarizes our outstanding debt.

 

 

 

 

 

 

 

Interest Rate Swaps – Designated as Cash Flow Hedges

 

We have interest rate swaps with an aggregate notional amount of $1.0 billion that are designated as cash flow hedges. We also have entered into forward starting interest rate swaps with an aggregate notional amount of $400,000,000 to extend the maturity of certain swaps for an additional year. Changes in the fair value of interest rate swaps that are designated as cash flow hedges are recognized in “other comprehensive income” (outside of earnings). We recognized other comprehensive loss of $9,026,000 and other comprehensive income of $14,551,000 for the three months ended March 31, 2019 and 2018, respectively, from the changes in fair value of these interest rate swaps. See Note 9, Accumulated Other Comprehensive Income (Loss). During the next twelve months, we estimate that $5,966,000 of the amounts recognized in accumulated other comprehensive income (loss) will be reclassified as a decrease to interest expense.

17

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PARAMOUNT GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

The following table summarizes the fair value of our interest rate swaps that are designated as cash flow hedges.

 

 

We have agreements with various derivative counterparties that contain provisions wherein a default on our indebtedness could be deemed a default on our derivative obligations, which would require us to either post collateral up to the fair value of our derivative obligations or settle the obligations for cash. As of March 31, 2019, we did not have any obligations relating to our swaps.

   

 

 

 

The following table sets forth changes in accumulated other comprehensive income (loss) by component for the three months ended March 31, 2019 and 2018, including amounts attributable to noncontrolling interests in the Operating Partnership.

 

 

 

 

 

 

Consolidated Joint Ventures

 

Noncontrolling interests in consolidated joint ventures consist of equity interests held by third parties in One Market Plaza, 50 Beale Street and PGRESS Equity Holdings LP As of March 31, 2019 and December 31, 2018, noncontrolling interests in our consolidated joint ventures aggregated $367,012,000 and $394,995,000, respectively.  

 

 

Consolidated Real Estate Fund

 

Noncontrolling interests in our consolidated real estate fund consists of equity interests held by third parties in RDF. As of March 31, 2019 and December 31, 2018, the noncontrolling interest in our consolidated real estate fund aggregated $81,434,000 and $66,887,000, respectively.

 

 

Operating Partnership

 

Noncontrolling interests in the Operating Partnership represent common units of the Operating Partnership that are held by third parties, including management, and units issued to management under equity incentive plans. Common units of the Operating Partnership may be tendered for redemption to the Operating Partnership for cash. We, at our option, may assume that obligation and pay the holder either cash or common shares on a one-for-one basis. Since the number of common shares outstanding is equal to the number of common units owned by us, the redemption value of each common unit is equal to the market value of each common share and distributions paid to each common unitholder is equivalent to dividends paid to common stockholders. As of March 31, 2019 and December 31, 2018, noncontrolling interests in the Operating Partnership on our consolidated balance sheets had a carrying amount of $417,313,000 and $428,982,000, respectively, and a redemption value of $349,759,000 and $315,595,000, respectively.

18

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PARAMOUNT GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

.

 

 

In the normal course of business, we are the general partner of various types of investment vehicles, which may be considered VIEs. We may, from time to time, own equity or debt securities through vehicles, each of which are considered variable interests. Our involvement in financing the operations of the VIEs is generally limited to our investments in the entity. We consolidate these entities when we are deemed to be the primary beneficiary.

 

 

Consolidated VIEs

 

We are the sole general partner of, and owned approximately 90.5% of, the Operating Partnership as of March 31, 2019. The Operating Partnership is considered a VIE and is consolidated in our consolidated financial statements. Since we conduct our business through and substantially all of our interests are held by the Operating Partnership, the assets and liabilities on our consolidated financial statements represent the assets and liabilities of the Operating Partnership. As of March 31, 2019 and December 31, 2018, the Operating Partnership held interests in consolidated VIEs owning properties, a real estate fund and preferred equity investments that were determined to be VIEs. The assets of these consolidated VIEs may only be used to settle the obligations of the entities and such obligations are secured only by the assets of the entities and are non-recourse to the Operating Partnership or us. The following table summarizes the assets and liabilities of consolidated VIEs of the Operating Partnership.

 

 

 

Unconsolidated VIEs

 

As of March 31, 2019, the Operating Partnership held variable interests in entities that own our unconsolidated real estate funds that were deemed to be VIEs. The following table summarizes our investments in these unconsolidated real estate funds and the maximum risk of loss from these investments.  

 

 

19

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PARAMOUNT GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

 

 

Financial Assets and Liabilities Measured at Fair Value

 

Financial assets and liabilities that are measured at fair value on our consolidated balance sheets consist of marketable securities and interest rate swaps. The following table summarizes the fair values of these financial assets and liabilities as of the dates set forth below, based on their levels in the fair value hierarchy.

 

 

 

 

Financial Assets and Liabilities Not Measured at Fair Value

 

Financial assets and liabilities not measured at fair value on our consolidated balance sheets consists of preferred equity investments, notes and mortgages payable and the revolving credit facility. The following table summarizes the carrying amounts and fair value of these financial instruments as of the dates set forth below.

 

20

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PARAMOUNT GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

 

 

Our revenues consist of rental revenues and revenues from contracts with customers. The following table sets forth the details of our revenues.

 

 

 

 

Rental Revenue

 

Rental revenue is recognized in accordance with ASC Topic 842, Leases, and consists of (i) cash rents, which represents revenue each tenant pays in accordance with the terms of its respective lease and that is recognized on a straight-line basis over the non-cancellable term of the lease, and includes the effects of rent steps and rent abatements under the leases, (ii) amortization of acquired above and below-market leases, net, (iii) tenant reimbursements, which are recoveries of all or a portion of the operating expenses and real estate taxes of the property and is recognized in the same period as the expenses are incurred and (iv) lease termination income. Our leases, which comprise the lease-up of office, retail and storage space to tenants, primarily under non-cancellable operating leases, have terms generally ranging from five to fifteen years. Most of our leases provide tenants with extension options at either fixed or market rates and few of our leases provide tenants with options to early terminate, but such options generally impose an economic penalty on the tenant upon exercising.  

 

The following table is a schedule of future undiscounted cash flows under non-cancelable operating leases in effect as of March 31, 2019, for the nine month period from April 1, 2019 through December 31, 2019 and each of the five succeeding years commencing January 1, 2020.

 

 

 

21

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PARAMOUNT GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

Revenue from Contracts with Customers

 

Revenue from contracts with customers, which is primarily comprised of (i) property management fees, (ii) asset management fees, (iii) fees relating to acquisitions, dispositions and leasing services and (iv) other fee income, is recognized in accordance with ASC Topic 606, Revenue From Contracts With Customers. Fee income is generated from the various services we provide to our customers and is disaggregated based on the types of services we provide pursuant to ASC Topic 606.

 

Fee income is recognized as and when we satisfy our performance obligations pursuant to contractual agreements. Property management and asset management services are provided continuously over time and revenue is recognized over that time. Fee income relating to acquisitions, dispositions and leasing services is recognized upon completion of the acquisition, disposition or leasing services as required in the contractual agreements. The amount of fee income to be recognized is stated in the contract as a fixed price or as a stated percentage of revenues, contributed capital or transaction price. Fee income is reported in a non-operating segment, and therefore is shown as a reconciling item to net income in Note 20, Segments. 

     

 

 

 

The following table sets forth the details of interest and other income, net.

 

 

 

 

 

15.Interest and Debt Expense

 

 

The following table sets forth the details of interest and debt expense.

 

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PARAMOUNT GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

 

 

Stock-Based Compensation

 

We account for all stock-based compensation in accordance with ASC 718, Compensation – Stock Compensation. As of March 31, 2019, we have 8,552,820 shares available for future grants under the 2014 Equity Incentive Plan (“Plan”), if all awards granted are full value awards, as defined in the Plan. Stock-based compensation expense was $7,602,000 and $6,265,000 for the three months ended March 31, 2019 and 2018, respectively.  

 

 

2018 Performance-Based Awards Program (“2018 Performance Program”)

 

On January 14, 2019, the Compensation Committee of our Board of Directors (the “Compensation Committee”) approved the 2018 Performance Program. Under the 2018 Performance Program, participants may earn awards in the form of Long Term Incentive Plan (“LTIP”) units based on our Total Shareholder Return (“TSR”) over a three-year performance measurement period beginning on January 1, 2019 and continuing through December 31, 2021, on both an absolute basis and relative basis. Awards granted to our Chief Executive Officer, under the 2018 Performance Program include an additional performance feature requiring threshold TSR performance on both an absolute and a relative basis in order for any awards to be earned. If the designated performance objectives are achieved, awards earned under the 2018 Performance Program are subject to vesting based on continued employment with us through December 31, 2022, with 50.0% of each award vesting upon the conclusion of the performance measurement period, and the remaining 50.0% vesting on December 31, 2022. Furthermore, our Named Executive Officers are required to hold earned awards for an additional year following vesting. The fair value of the awards granted under the 2018 Performance Program on the date of the grant was $8,106,000 and is being amortized into expense over the four-year vesting period using a graded vesting attribution method.    

 

2015 Performance-Based Awards Program (“2015 Performance Program”)

 

On March 18, 2019, the Compensation Committee determined that the performance goals set forth in the 2015 Performance Program were not satisfied during the performance measurement period, which ended on March 17, 2019. Accordingly, all of the 1,109,358 outstanding LTIP units that were granted on March 18, 2016, were forfeited, with no awards being earned. This award had a grant date fair value of $10,914,000 and a remaining unrecognized compensation cost of $1,027,000 as of March 31, 2019, which will be amortized over a weighted-average period of 1.0 year.

 

 

 

 

The following table summarizes our net income and the number of common shares used in the computation of basic and diluted income per common share, which includes the weighted average number of common shares outstanding and the effect of dilutive potential common shares, if any.

 

 

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PARAMOUNT GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

 

 

Management Agreements

 

We provide property management, leasing and other related services to certain properties owned by members of the Otto Family. We recognized fee income of $209,000 for each of the three months ended March 31, 2019 and 2018 in connection with these agreements, which is included as a component of “fee and other income” on our consolidated statements of income. As of December 31, 2018, we were owed $51,000 under these agreements, which is included as a component of “accounts and other receivables, net” on our consolidated balance sheet. There were no amounts owed to us under these agreements as of March 31, 2019.

 

We also provide property management, asset management, leasing and other related services to our unconsolidated joint ventures and real estate funds. We recognized fee income of $4,547,000 and $2,536,000 for the three months ended March 31, 2019 and 2018, respectively, in connection with these agreements. As of March 31, 2019 and December 31, 2018, amounts owed to us under these agreements aggregated $1,254,000, and $1,836,000, respectively, which are included as a component of “accounts and other receivables, net” on our consolidated balance sheets.

 

 

Hamburg Trust Consulting GMBH (“HTC”)

 

We have an agreement with HTC, a licensed broker in Germany, to supervise selling efforts for our private equity real estate funds (or investments in feeder vehicles for these funds) to investors in Germany, including distribution of securitized notes of  feeder vehicles for Fund VIII and Fund X. Pursuant to this agreement, we have agreed to pay HTC for the costs incurred to sell investments in these feeder vehicles, which primarily consist of commissions paid to third party agents, and other incremental costs incurred by HTC as a result of the engagement, plus, in each case, a mark-up of 10%. HTC is 100% owned by Albert Behler, our Chairman, Chief Executive Officer and President.  We incurred expense of $624,000 and $18,000 for the three months ended March 31, 2019 and 2018, respectively, in connection with this agreement, which is included as a component of “transaction related costs” on our consolidated statements of income. As of March 31, 2019 and December 31, 2018, we owed $61,000 and $40,000, respectively, to HTC under this agreement, which are included as a component of “accounts payable and accrued expenses” on our consolidated balance sheets.  

 

 

Mannheim Trust

 

Dr. Martin Bussmann (a member of our Board of Directors) is also a trustee and a director of Mannheim Trust, a subsidiary of which leases office space at 712 Fifth Avenue, our 50.0% owned unconsolidated joint venture. The Mannheim Trust, which is for the benefit of Dr. Bussmann’s children, leases 5,593 square feet, which expires in April 2023. Our share of rental income from this lease was $91,000 and $92,000, for the three months ended March 31, 2019 and 2018, respectively.  

 

 

Due from Affiliates

 

At March 31, 2019, we had an $11,000,000 receivable from Fund VIII, which is included as a component of “other assets” on our consolidated balance sheet. On April 26, 2019, the receivable was paid.

24

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PARAMOUNT GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

 

 

Insurance

 

We carry commercial general liability coverage on our properties, with limits of liability customary within the industry. Similarly, we are insured against the risk of direct and indirect physical damage to our properties including coverage for the perils such as floods, earthquakes and windstorms. Our policies also cover the loss of rental income during an estimated reconstruction period. Our policies reflect limits and deductibles customary in the industry and specific to the buildings and portfolio. We also obtain title insurance policies when acquiring new properties. We currently have coverage for losses incurred in connection with both domestic and foreign terrorist-related activities. While we do carry commercial general liability insurance, property insurance and terrorism insurance with respect to our properties, these policies include limits and terms we consider commercially reasonable. In addition, there are certain losses (including, but not limited to, losses arising from known environmental conditions or acts of war) that are not insured, in full or in part, because they are either uninsurable or the cost of insurance makes it, in our belief, economically impractical to maintain such coverage. Should an uninsured loss arise against us, we would be required to use our own funds to resolve the issue, including litigation costs. We believe the policy specifications and insured limits are adequate given the relative risk of loss, the cost of the coverage and industry practice and, in consultation with our insurance advisors, we believe the properties in our portfolio are adequately insured.

 

 

Other Commitments and Contingencies

 

We are a party to various claims and routine litigation arising in the ordinary course of business. Some of these claims or others to which we may be subject from time to time, including claims arising specifically from the formation transactions, in connection with our initial public offering, may result in defense costs, settlements, fines or judgments against us, some of which are not, or cannot be, covered by insurance. Payment of any such costs, settlements, fines or judgments that are not insured could have an adverse impact on our financial position and results of operations. Should any litigation arise in connection with the formation transactions, we would contest it vigorously. In addition, certain litigation or the resolution of certain litigation may affect the availability or cost of some of our insurance coverage, which could adversely impact our results of operations and cash flow, expose us to increased risks that would be uninsured, and/or adversely impact our ability to attract officers and directors.

 

 

The terms of our mortgage debt and certain side letters in place include certain restrictions and covenants which may limit, among other things, certain investments, the incurrence of additional indebtedness and liens and the disposition or other transfer of assets and interests in the borrower and other credit parties, and require compliance with certain debt yield, debt service coverage and loan to value ratios. In addition, our revolving credit facility contains representations, warranties, covenants, other agreements and events of default customary for agreements of this type with comparable companies. As of March 31, 2019, we believe we are in compliance with all of our covenants.

 

 

718 Fifth Avenue - Put Right

 

Prior to the formation transactions, an affiliate of our predecessor owned a 25.0% interest in 718 Fifth Avenue, a five-story building containing 19,050 square feet of prime retail space that is located on the southwest corner of 56th Street and Fifth Avenue in New York, (based on its 50.0% interest in a joint venture that held a 50.0% tenancy-in-common interest in the property). Prior to the completion of the formation transactions, this interest was sold to its partner in the 718 Fifth Avenue joint venture, who is also our joint venture partner in 712 Fifth Avenue, New York, New York. In connection with this sale, we granted our joint venture partner a put right, pursuant to which the 712 Fifth Avenue joint venture would be required to purchase the entire direct or indirect interests then held by our joint venture partner or its affiliates in 718 Fifth Avenue at a purchase price equal to the fair market value of such interests. The put right may be exercised at any time with the actual purchase occurring no earlier than 12 months after written notice is provided. If the put right is exercised and the 712 Fifth Avenue joint venture acquires the 50.0% tenancy-in-common interest in the property by our joint venture partner, we will own a 25.0% interest in 718 Fifth Avenue based on current ownership interests.

 

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PARAMOUNT GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

Transfer Tax Assessments

 

During 2017, the New York City Department of Finance issued Notices of Determination (“Notices”) assessing additional transfer taxes (including interest and penalties) in connection with the transfer of interests in certain properties during our 2014 initial public offering. We believe, after consultation with legal counsel, that the likelihood of a loss is reasonably possible, and while it is not possible to predict the outcome of these Notices, we estimate the range of loss could be between $0 and $40,700,000. Since no amount in this range is a better estimate than any other amount within the range, we have not accrued any liability arising from potential losses relating to these Notices in our consolidated financial statements.

 

 

 

 

Our reportable segments are separated by region based on the three regions in which we conduct our business: New York, San Francisco and Washington, D.C. Our determination of segments is aligned with our method of internal reporting and the way our Chief Executive Officer, who is also our Chief Operating Decision Maker, makes key operating decisions, evaluates financial results and manages our business.

 

The following tables provide Net Operating Income (“NOI”) for each reportable segment for the periods set forth below.

 

 

 

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PARAMOUNT GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

The following table provides a reconciliation of NOI to net income attributable to common stockholders for the periods set forth below.

 

 

 

The following table provides the total assets for each of our reportable segments as of the dates set forth below.

 

 

 

 

 

 

 

 

 

 

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The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements, including the related notes included therein.

 

Forward-Looking Statements

 

We make statements in this Quarterly Report on Form 10-Q that are considered “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act, which are usually identified by the use of words such as “anticipates,” “believes,” “estimates,” “expects,” “intends,” “may,” “plans,” “projects,” “seeks,” “should,” “will,” and variations of such words or similar expressions. We intend these forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 and are including this statement for purposes of complying with those safe harbor provisions. These forward-looking statements reflect our current views about our plans, intentions, expectations, strategies and prospects, which are based on the information currently available to us and on assumptions we have made. Although we believe that our plans, intentions, expectations, strategies and prospects as reflected in or suggested by those forward-looking statements are reasonable, we can give no assurance that the plans, intentions, expectations or strategies will be attained or achieved. Furthermore, actual results may differ materially from those described in the forward-looking statements and will be affected by a variety of risks and factors that are beyond our control including, without limitation:

 

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Accordingly, there is no assurance that our expectations will be realized. Except as otherwise required by the U.S. federal securities laws, we disclaim any obligations or undertaking to publicly release any updates or revisions to any forward-looking statement contained herein (or elsewhere) to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based. A reader should review carefully our consolidated financial statements and the notes thereto, as well as Item 1A entitled “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2018.

 

 

Critical Accounting Policies

 

There are no material changes to our critical accounting policies disclosed in our Annual Report on Form 10-K for the year ended December 31, 2018.

 

 

Recently Issued Accounting Literature

 

A summary of our recently issued accounting literature and their potential impact on our consolidated financial statements, if any, are included in Note 2, Basis of Presentation and Significant Accounting Policies, to our consolidated financial statements in this Quarterly Report on Form 10-Q.

 

 

Business Overview

 

We are a fully-integrated REIT focused on owning, operating, managing, acquiring and redeveloping high-quality, Class A office properties in select central business district submarkets of New York City, San Francisco, and Washington, D.C. We conduct our business through, and substantially all of our interests in properties and investments are held by, Paramount Group Operating Partnership LP, a Delaware limited partnership (the “Operating Partnership”). We are the sole general partner of, and owned approximately 90.5% of the Operating Partnership as of March 31, 2019.

 

 

Acquisitions

 

On February 7, 2019, we completed the acquisition of 111 Sutter Street, a 293,000 square foot office building in San Francisco, California. Simultaneously with closing, we brought in a joint venture partner to acquire 51.0% of the equity interest. We have retained the remaining 49.0% equity interest and manage and lease the asset. The purchase price was $227,000,000. In connection with the acquisition, the joint venture completed a $138,200,000 financing of the property. The four-year loan is interest only at LIBOR plus 215 basis points and has three one-year extension options.

 

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Leasing Results - Three Months Ended March 31, 2019

 

 

In the three months ended March 31, 2019, we leased 353,262 square feet, of which our share was 247,888 square feet that was leased at a weighted average initial rent of $97.24 per square foot. This leasing activity, offset by lease expirations in the three months and the acquisition of 111 Sutter Street in February 2019, a 70.6% leased asset, decreased leased occupancy by 40 basis points to 96.0% at March 31, 2019 from 96.4% at December 31, 2018. Same store leased occupancy (properties owned by us during both reporting periods), which excludes the impact of 111 Sutter Street, was 96.4% at March 31, 2019, in-line with the same store leased occupancy reported at December 31, 2018. Of the 353,262 square feet leased in the three months, 180,162 square feet represented our share of second generation space (space that had been vacant for less than twelve months) for which we achieved rental rate increases of 13.2% on a GAAP basis and 5.6% on a cash basis. The weighted average lease term for leases signed during the three months was 11.2 years and weighted average tenant improvements and leasing commissions on these leases were $10.11 per square foot per annum, or 10.4% of initial rent.

 

 

New York:

 

In the three months ended March 31, 2019, we leased 159,588 square feet in our New York portfolio, of which our share was 142,493 square feet that was leased at a weighted average initial rent of $91.75 per square foot. This leasing activity, partially offset by lease expirations during the three months, increased our leased occupancy and same store leased occupancy by 60 basis points to 96.6% at March 31, 2019 from 96.0% at December 31, 2018. Of the 159,588 square feet leased in the three months, 77,715 square feet represented our share of second generation space for which rental rates decreased by 3.9% on a GAAP basis and 6.7% on a cash basis. The decrease was primarily due to a prior tenant’s lease, which was previously extended on a short-term basis for which we had achieved above-market rents during the short-term extension period. The weighted average lease term for leases signed during the three months was 14.4 years and weighted average tenant improvements and leasing commissions on these leases were $10.63 per square foot per annum, or 11.6% of initial rent.

 

 

San Francisco:

 

In the three months ended March 31, 2019, we leased 183,964 square feet in our San Francisco portfolio, of which our share was 95,685 square feet that was leased at a weighted average initial rent of $106.31 per square foot. This leasing activity, offset by lease expirations in the three months and the acquisition of 111 Sutter Street in February 2019, a 70.6% leased asset, decreased our leased occupancy by 360 basis points to 94.4% at March 31, 2019 from 98.0% at December 31, 2018. Same store leased occupancy, which excludes 111 Sutter Street, decreased by 160 basis points to 96.4% at March 31, 2019 from 98.0% at December 31, 2018. Of the 183,964 square feet leased in the three months, 95,379 square feet represented our share of second generation space for which we achieved rental rate increases of 29.5% on GAAP basis and 17.2% on a cash basis. The weighted average lease term for leases signed during the three months was 6.9 years and weighted average tenant improvements and leasing commissions on these leases were $9.01 per square foot per annum, or 8.5% of initial rent.

 

 

Washington, D.C.:

 

In the three months ended March 31, 2019, we leased 9,710 square feet in our Washington, D.C. portfolio, at a weighted average initial rent of $88.24 per square foot. This leasing activity which was offset by lease expirations, decreased our leased occupancy and same store leased occupancy by 400 basis points to 94.0% at March 31, 2019 from 98.0% at December 31, 2018. Of the 9,710 square feet leased in the three months, 7,068 represented our share of second generation space for which we achieved rental rate increases of 6.9% on GAAP basis and 5.0% on a cash basis. The weighted average lease term for leases signed during the three months was 6.9 years and weighted average tenant improvements and leasing commissions on these leases were $5.11 per square foot per annum, or 5.8% of initial rent.

 

 

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The following table presents additional details on the leases signed during the three months ended March 31, 2019. It is not intended to coincide with the commencement of rental revenue in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The leasing statistics, except for square feet leased, represent office space only.

 

 

 

 

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Financial Results - Three Months Ended March 31, 2019 and 2018

 

 

Net Income, FFO and Core FFO

 

Net income attributable to common stockholders was $3,709,000, or $0.02 per diluted share, for the three months ended March 31, 2019, compared to $1,114,000, or $0.00 per diluted share, for the three months ended March 31, 2018.

 

Funds from Operations (“FFO”) attributable to common stockholders was $55,225,000, or $0.24 per diluted share, for the three months ended March 31, 2019, compared to $53,653,000, or $0.22 per diluted share, for the three months ended March 31, 2018. FFO attributable to common stockholders for the three months ended March 31, 2019 and 2018 includes the impact of non-core items, which are listed in the table on page 44. The aggregate of these items, net of amounts attributable to noncontrolling interests, decreased FFO attributable to common stockholders for the three months ended March 31, 2019 and 2018 by $1,888,000 and $1,310,000, or $0.00 and $0.01 per diluted share, respectively.

 

Core Funds from Operations (“Core FFO”) attributable to common stockholders, which excludes the impact of the non-core items listed on page 44, was $57,113,000, or $0.24 per diluted share for the three months ended March 31, 2019, compared to $54,963,000, or $0.23 per diluted share, for the three months ended March 31, 2018.  

 

 

Same Store NOI

 

The table below summarizes the percentage increase (decrease) in our share of Same Store NOI and Same Store Cash NOI, by segment, for the three months ended March 31, 2019 versus March 31, 2018.

 

 

 

See pages 40-44 “Non-GAAP Financial Measures” for a reconciliation of these measures to the most directly comparable GAAP measure and the reasons why we believe these non-GAAP measures are useful.

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Results of Operations - Three Months Ended March 31, 2019 and 2018

 

 

The following pages summarize our consolidated results of operations for the three months ended March 31, 2019 and 2018.

 

 

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Revenues

 

Our revenues, which consist primarily of rental revenues and fee and other income, were $191,792,000 for the three months ended March 31, 2019, compared to $184,271,000 for the three months ended March 31, 2018, an increase of $7,521,000. Below are the details of the increase (decrease) by segment.

 

 

 

 

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Expenses

 

Our expenses, which consist primarily of operating, depreciation and amortization, general and administrative and transaction related costs, were $149,649,000 for the three months ended March 31, 2019, compared to $146,885,000 for the three months ended March 31, 2018, an increase of $2,764,000. Below are the details of the increase (decrease) by segment.

 

 

 

 

Loss from Unconsolidated Joint Ventures

 

Loss from unconsolidated joint ventures was $1,027,000 for the three months ended March 31, 2019, compared to $62,000 for the three months ended March 31, 2018, an increase in loss of $965,000. This increase resulted primarily from an $872,000 loss on 111 Sutter Street, which was acquired in February 2019.

 

 

Income (loss) from Unconsolidated Real Estate Funds

 

Income from unconsolidated real estate funds was $46,000 for the three months ended March 31, 2019, compared to a loss of $66,000 for the three months ended March 31, 2018, as increase in income of $112,000.

 

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Interest and Other Income, net

 

Interest and other income was $3,900,000 for the three months ended March 31, 2019, compared to $2,016,000 for the three months ended March 31, 2018, an increase of $1,884,000. This increase resulted from:

 

 

 

 

Interest and Debt Expense

 

Interest and debt expense was $36,924,000 for the three months ended March 31, 2019, compared to $36,082,000 for the three months ended March 31, 2018, an increase in expense of $842,000. This increase primarily resulted from higher interest on variable rate debt at 1301 Avenue of the Americas and 1633 Broadway.

 

 

Income Tax Expense

 

Income tax expense was $1,138,000 for the three months ended March 31, 2019, compared to $477,000 for the three months ended March 31, 2018, an increase in expense of $661,000. The increase was primarily due to higher income on our taxable REIT subsidiaries.

 

 

Net Income Attributable to Noncontrolling Interests in Consolidated Joint Ventures

 

Net income attributable to noncontrolling interest in consolidated joint ventures was $2,794,000 for the three months ended March 31, 2019, compared to $1,055,000 for the three months ended March 31, 2018, an increase in income allocated to noncontrolling interests in consolidated joint ventures of $1,739,000. This increase resulted from:

 

 

 

Net Income Attributable to Noncontrolling Interests in Consolidated Real Estate Fund

 

Net income attributable to noncontrolling interests in consolidated real estate fund was $94,000 for the three months ended March 31, 2019, compared to $430,000 for the three months ended March 31, 2018, a decrease in income attributable to the noncontrolling interests of $336,000.

 

 

Net Income Attributable to Noncontrolling Interests in Operating Partnership

Net income attributable to noncontrolling interests in Operating Partnership was $403,000 for the three months ended March 31, 2019, compared to $116,000 for the three months ended March 31, 2018, an increase in income attributable to noncontrolling interests of $287,000. This increase resulted from higher net income subject to allocation to the unitholders of the Operating Partnership for the three months ended March 31, 2019.

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Liquidity and Capital Resources

 

 

Liquidity

 

Our primary sources of liquidity include existing cash balances, cash flow from operations and borrowings available under our revolving credit facility. We expect that these sources will provide adequate liquidity over the next 12 months for all anticipated needs, including scheduled principal and interest payments on our outstanding indebtedness, existing and anticipated capital improvements, the cost of securing new and renewal leases, dividends to stockholders and distributions to unitholders, and all other capital needs related to the operations of our business. We anticipate that our long-term needs including debt maturities and the acquisition of additional properties will be funded by operating cash flow, mortgage financings and/or re-financings, the issuance of long-term debt or equity and cash on hand.

 

Although we may be able to anticipate and plan for certain of our liquidity needs, unexpected increases in uses of cash that are beyond our control and which affect our financial condition and results of operations may arise, or our sources of liquidity may be fewer than, and the funds available from such sources may be less than, anticipated or required.

 

As of March 31, 2019, we had $1.360 billion of liquidity comprised of $342,308,000 of cash and cash equivalents, $18,163,000 of restricted cash and $1.0 billion of borrowing capacity under our revolving credit facility. As of March 31, 2019, our outstanding consolidated debt aggregated $3.6 billion. We had no amounts outstanding under our revolving credit facility as of March 31, 2019 and none of our debt matures until 2021. We may refinance our maturing debt when it comes due or refinance or repay it early depending on prevailing market conditions, liquidity requirements and other factors. The amounts involved in connection with these transactions could be material to our consolidated financial statements.

 

 

Revolving Credit Facility

 

Our $1.0 billion revolving credit facility matures in January 2022 and has two six-month extension options. The interest rate on the facility, at current leverage levels, is LIBOR plus 115 basis points and has a 20 basis points facility fee. We also have an option, subject to customary conditions and incremental lender commitments, to increase the capacity under the facility to $1.5 billion at any time prior to the maturity date of the facility. The facility contains certain restrictions and covenants that require us to maintain, on an ongoing basis, (i) a leverage ratio not to exceed 60%, however, the leverage ratio may be increased to 65% for any fiscal quarter in which an acquisition of real estate is completed and for up to the next three subsequent consecutive fiscal quarters, (ii) a secured leverage ratio not to exceed 50%, (iii) a fixed charge coverage ratio of at least 1.50, (iv) an unsecured leverage ratio not to exceed 60%, however, the unsecured leverage ratio may be increased to 65% for any fiscal quarter in which an acquisition of real estate is completed and for up to the next three subsequent consecutive fiscal quarters and (v) an unencumbered interest coverage ratio of at least 1.75. The facility also contains customary representations and warranties, limitations on permitted investments and other covenants

 

 

Dividend Policy

 

On March 15, 2019, we declared a regular quarterly cash dividend of $0.10 per share of common stock for the first quarter ending March 31, 2019, which was paid on April 15, 2019 to stockholders of record as of the close of business on March 29, 2019. This dividend policy, if continued, would require us to pay out approximately $26,000,000 each quarter to common stockholders and unitholders.

 

 

Off Balance Sheet Arrangements

 

As of March 31, 2019, our unconsolidated joint ventures had $1,033,779,000 of outstanding indebtedness, of which our share was $248,481,000. We do not guarantee the indebtedness of our unconsolidated joint ventures other than providing customary environmental indemnities and guarantees of specified non-recourse carve outs relating to specified covenants and representations; however, we may elect to fund additional capital to a joint venture through equity contributions (generally on a basis proportionate to our ownership interests), advances or partner loans in order to enable the joint venture to repay this indebtedness upon maturity.

 

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Stock Repurchase Program

 

On August 1, 2017, we received authorization from our Board of Directors to repurchase up to $200,000,000 of our common stock from time to time, in the open market or in privately negotiated transactions. During the three months ended March 31, 2019, we did not repurchase any shares under the stock repurchase program. As of March 31, 2019, we have repurchased an aggregate of 7,555,601 shares, or $105,383,000 of our common stock, at a weighted average price of $13.95 per share. We currently have $94,617,000 available for future repurchases under the program. The amount and timing of future repurchases, if any, will depend on a number of factors, including, the price and availability of our shares, trading volume and general market conditions. The stock repurchase program may be suspended or discontinued at any time.

 

Insurance

 

We carry commercial general liability coverage on our properties, with limits of liability customary within the industry. Similarly, we are insured against the risk of direct and indirect physical damage to our properties including coverage for the perils such as floods, earthquakes and windstorms. Our policies also cover the loss of rental income during an estimated reconstruction period. Our policies reflect limits and deductibles customary in the industry and specific to the buildings and portfolio. We also obtain title insurance policies when acquiring new properties. We currently have coverage for losses incurred in connection with both domestic and foreign terrorist-related activities. While we do carry commercial general liability insurance, property insurance and terrorism insurance with respect to our properties, these policies include limits and terms we consider commercially reasonable. In addition, there are certain losses (including, but not limited to, losses arising from known environmental conditions or acts of war) that are not insured, in full or in part, because they are either uninsurable or the cost of insurance makes it, in our belief, economically impractical to maintain such coverage. Should an uninsured loss arise against us, we would be required to use our own funds to resolve the issue, including litigation costs. We believe the policy specifications and insured limits are adequate given the relative risk of loss, the cost of the coverage and industry practice and, in consultation with our insurance advisors, we believe the properties in our portfolio are adequately insured.

 

Other Commitments and Contingencies

 

We are a party to various claims and routine litigation arising in the ordinary course of business. Some of these claims or others to which we may be subject from time to time, including claims arising specifically from the formation transactions, in connection with our initial public offering, may result in defense costs, settlements, fines or judgments against us, some of which are not, or cannot be, covered by insurance. Payment of any such costs, settlements, fines or judgments that are not insured could have an adverse impact on our financial position and results of operations. Should any litigation arise in connection with the formation transactions, we would contest it vigorously. In addition, certain litigation or the resolution of certain litigation may affect the availability or cost of some of our insurance coverage, which could adversely impact our results of operations and cash flow, expose us to increased risks that would be uninsured, and/or adversely impact our ability to attract officers and directors.

 

The terms of our mortgage debt and certain side letters in place include certain restrictions and covenants which may limit, among other things, certain investments, the incurrence of additional indebtedness and liens and the disposition or other transfer of assets and interests in the borrower and other credit parties, and require compliance with certain debt yield, debt service coverage and loan to value ratios. In addition, our revolving credit facility contains representations, warranties, covenants, other agreements and events of default customary for agreements of this type with comparable companies. As of March 31, 2019, we believe we are in compliance with all of our covenants.

 

Transfer Tax Assessments

 

During 2017, the New York City Department of Finance issued Notices of Determination (“Notices”) assessing additional transfer taxes (including interest and penalties) in connection with the transfer of interests in certain properties during our 2014 initial public offering. We believe, after consultation with legal counsel, that the likelihood of a loss is reasonably possible, and while it is not possible to predict the outcome of these Notices, we estimate the range of loss could be between $0 and $40,700,000. Since no amount in this range is a better estimate than any other amount within the range, we have not accrued any liability arising from potential losses relating to these Notices in our consolidated financial statements.

 

Inflation

 

Substantially all of our leases provide for separate real estate tax and operating expense escalations. In addition, many of the leases provide for fixed base rent increases. We believe inflationary increases in expenses may be at least partially offset by the contractual rent increases and expense escalations described above. We do not believe inflation has had a material impact on our historical financial position or results of operations.

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Cash Flows

Cash and cash equivalents and restricted cash were $360,471,000 and $365,409,000 as of March 31, 2019 and December 31, 2018, respectively. The following table sets forth the changes in cash flow.

 

 

 

Operating Activities

 

Three months ended March 31, 2019 – We generated $94,451,000 of cash from operating activities for the three months ended March 31, 2019, primarily from (i) $64,281,000 of net income (before $57,281,000 of noncash adjustments), (ii) $2,339,000 from the receipt of accrued interest on preferred equity investment, (iii) $1,548,000 of distributions from unconsolidated joint ventures and real estate funds and (iv) $26,283,000 of net changes in operating assets and liabilities. Noncash adjustments of $57,281,000 were primarily comprised of depreciation and amortization, straight-lining of rental revenue, amortization of above and below market leases and amortization of stock-based compensation.

 

Three months ended March 31, 2018 – We generated $35,569,000 of cash from operating activities for the three months ended March 31, 2018, primarily from (i) $59,592,000 of net income (before $56,877,000 of noncash adjustments) and (ii) $668,000 of distributions from unconsolidated joint ventures and real estate funds, partially offset by (iii) $24,691,000 of net changes in operating assets and liabilities. Noncash adjustments of $56,877,000 were primarily comprised of depreciation and amortization, straight-lining of rental revenue, amortization of above and below market leases and amortization of stock-based compensation.

 

 

Investing Activities

 

Three months ended March 31, 2019 – We used $56,645,000 of cash from investing activities for the three months ended March 31, 2019, primarily due to (i) $49,239,000 for investments in and contributions of capital to unconsolidated joint ventures, (ii) $27,944,000 for additions to real estate, which were comprised of spending for tenant improvements and other building improvements, (iii) $11,000,000 for a receivable from an affiliate and (iv) $3,436,000 from the net purchases of marketable securities (which are held in our deferred compensation plan), partially offset by (v) $33,750,000 from the redemption of a preferred equity investment and (vi) $1,224,000 of net distributions from our unconsolidated real estate funds.

 

Three months ended March 31, 2018 – We used $53,345,000 of cash for investing activities for the three months ended March 31, 2018, primarily due to (i) $25,413,000 for additions to real estate, which were comprised of spending for tenant improvements and other building improvements, (ii) $16,115,000 for investments in unconsolidated joint ventures, (iii) $15,680,000 for escrow deposits and loans receivable for RDF and (iv) $157,000 for contributions to our unconsolidated real estate funds, partially offset by (v) $4,020,000 from net sales of marketable securities (which are held in our deferred compensation plan).

 

 

Financing Activities

 

Three months ended March 31, 2019 – We used $42,744,000 of cash for financing activities for the three months ended March 31, 2019, primarily due to (i) $30,777,000 for distributions to noncontrolling interests (ii) $25,902,000 for dividends and distributions paid to common stockholders and unitholders, (iii) $301,000 for the repurchase of shares related to stock compensation agreements and related tax withholdings and (iv) $260,000 for the payment of debt issuance costs, partially offset by (v) $14,496,000 of contributions from noncontrolling interests.

 

Three months ended March 31, 2018 – We generated $12,930,000 of cash from financing activities for the three months ended March 31, 2018, primarily due to (i) $29,920,000 of contributions from noncontrolling interests and (ii) $16,700,000 of proceeds from notes and mortgages payable, partially offset by (iii) $25,211,000 for dividends and distributions paid to common stockholders and unitholders, (iv) $6,351,000 for the payment of debt issuance costs, (v) $1,915,000 distributions to noncontrolling interests and (vi) $213,000 for the repurchase of shares related to stock compensation agreements and related tax withholdings.

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Non-GAAP Financial Measures

 

We use and present NOI, Same Store NOI, FFO and Core FFO, as supplemental measures of our performance. The summary below describes our use of these measures, provides information regarding why we believe these measures are meaningful supplemental measures of our performance and reconciles these measures from net income or loss, the most directly comparable GAAP measure. Other real estate companies may use different methodologies for calculating these measures, and accordingly, our presentation of these measures may not be comparable to other real estate companies. These non-GAAP measures should not be considered a substitute for, and should only be considered together with and as a supplement to, financial information presented in accordance with GAAP.

 

 

Net Operating Income (“NOI”)

 

We use NOI to measure the operating performance of our properties.  NOI consists of rental revenue (which includes property rentals, tenant reimbursements and lease termination income) and certain other property-related revenue less operating expenses (which includes property-related expenses such as cleaning, security, repairs and maintenance, utilities, property administration and real estate taxes). We also present Cash NOI which deducts from NOI, straight-line rent adjustments and the amortization of above and below-market leases, including our share of such adjustments of unconsolidated joint ventures. In addition, we present PGRE's share of NOI and Cash NOI which represents our share of NOI and Cash NOI of consolidated and unconsolidated joint ventures, based on our percentage ownership in the underlying assets. We use NOI and Cash NOI internally as performance measures and believe they provide useful information to investors regarding our financial condition and results of operations because they reflect only those income and expense items that are incurred at property level.

 

The following tables present reconciliations of our net income (loss) to NOI and Cash NOI for the three months ended March 31, 2019 and 2018.

 

 

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Same Store NOI

 

The tables below set forth the reconciliations of our share of NOI to our share of Same Store NOI and Same Store Cash NOI for the three months March 31, 2019 and 2018. These metrics are used to measure the operating performance of our properties that were owned by us in a similar manner during both the current and prior reporting periods, and represents our share of Same Store NOI and Same Store Cash NOI from consolidated and unconsolidated joint ventures based on our percentage ownership in the underlying assets. Same Store NOI also excludes lease termination income, impairment of receivables arising from operating leases and certain other items that vary from period to period. Same Store Cash NOI excludes the effect of non-cash items such as the straight-line rent adjustments and the amortization of above and below-market leases.

 

 

 

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Funds from Operations (“FFO”) and Core Funds from Operations (“Core FFO”)

 

 

FFO is a supplemental measure of our performance. We present FFO in accordance with the definition adopted by the National Association of Real Estate Investment Trusts (“Nareit”). Nareit defines FFO as net income or loss, calculated in accordance with GAAP, adjusted to exclude depreciation and amortization from real estate assets, impairment losses on certain real estate assets and gains or losses from the sale of certain real estate assets or from change in control of certain real estate assets, including our share of such adjustments of unconsolidated joint ventures. FFO is commonly used in the real estate industry to assist investors and analysts in comparing results of real estate companies because it excludes the effect of real estate depreciation and amortization and net gains on sales, which are based on historical costs and implicitly assume that the value of real estate diminishes predictably over time, rather than fluctuating based on existing market conditions. In addition, we present Core FFO as an alternative measure of our operating performance, which adjusts FFO for certain other items that we believe enhance the comparability of our FFO across periods. Core FFO, when applicable, excludes the impact of certain items, including, transaction related costs, realized and unrealized gains or losses on real estate fund investments, unrealized gains or losses on interest rate swaps, severance costs and gains or losses on early extinguishment of debt, in order to reflect the Core FFO of our real estate portfolio and operations. In future periods, we may also exclude other items from Core FFO that we believe may help investors compare our results.

 

FFO and Core FFO are presented as supplemental financial measures and do not fully represent our operating performance. Neither FFO nor Core FFO is intended to be a measure of cash flow or liquidity. Please refer to our consolidated financial statements, prepared in accordance with GAAP, for purposes of evaluating our financial condition, results of operations and cash flows.

 

The following table presents a reconciliation of net income to FFO and Core FFO for the periods set forth below.

 

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ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

 

Market risk is the risk of loss from adverse changes in market prices and interest rates. Our future earnings, cash flows and fair values relevant to financial instruments are dependent upon prevalent market interest rates. Our primary market risk results from our indebtedness, which bears interest at both fixed and variable rates. We manage our market risk on variable rate debt by entering into swap agreements to fix the rate on all or a portion of the debt for varying periods through maturity. This in turn, reduces the risks of variability of cash flows created by variable rate debt and mitigates the risk of increases in interest rates. Our objective when undertaking such arrangements is to reduce our floating rate exposure and we do not enter into hedging arrangements for speculative purposes. Subject to maintaining our status as a REIT for Federal income tax purposes, we may utilize swap arrangements in the future.  

The following table summarizes our consolidated debt, the weighted average interest rates and the fair value as of March 31, 2019.

 

 

 

 

 

In addition to the above, our unconsolidated joint ventures had $1,033,779,000 of outstanding indebtedness as of March 31, 2019, of which our share was $248,481,000.

 

 

The following table summarizes our fixed rate debt that has been swapped from floating rate to fixed as of March 31, 2019.

 

 

 

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The following table summarizes our share of total indebtedness and the effect to interest expense of a 100 basis point increase in LIBOR.

 

 

 

 

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ITEM 4.CONTROLS AND PROCEDURES

 

 

Evaluation of Disclosure Controls and Procedures

 

We maintain disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) that are designed to ensure that information required to be disclosed in our reports under the Exchange Act is processed, recorded, summarized and reported within the time periods specified in the SEC’s rules and regulations, and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives.

 

As of March 31, 2019, the end of the period covered by this Quarterly Report on Form 10-Q, we carried out an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, regarding the effectiveness of our disclosure controls and procedures. Based on the foregoing evaluation, as of the end of the period covered by this Quarterly Report, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed by us in reports filed or submitted under the Exchange Act is processed, recorded, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure.

 

 

Changes in Internal Control over Financial Reporting

 

There were no changes to our internal control over financial reporting in connection with the evaluation referenced above that occurred during the period covered by this Quarterly Report on Form 10-Q that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.  

 

 

 

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PART II – OTHER INFORMATION

 

 

 

From time to time, we are a party to various claims and routine litigation arising in the ordinary course of business. As of March 31, 2019, we do not believe that the results of any such claims or litigation, individually or in the aggregate, will have a material adverse effect on our business, financial position, results of operations or cash flows.

 

 

 

Except to the extent additional factual information disclosed elsewhere in this Quarterly Report on Form 10-Q relates to such risk factors (including, without limitation, the matters discussed in Part I, “Item 2—Management’s Discussion and Analysis of Financial Condition and Results of Operations”), there were no material changes to the risk factors disclosed in Part I, “Item 1A. Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2018.

 

 

 

Recent Sales of Unregistered Securities

 

None.

 

Recent Purchases of Equity Securities

 

Stock Repurchase Program

 

On August 1, 2017, we received authorization from our Board of Directors to repurchase up to $200,000,000 of our common stock from time to time, in the open market or in privately negotiated transactions. During the three months ended March 31, 2019, we did not repurchase any shares under the stock repurchase program.  As of March 31, 2019, we have repurchased an aggregate of 7,555,601 shares, or $105,383,000 of our common stock, at a weighted average price of $13.95 per share. We currently have $94,617,000 available for future repurchases under the program. The amount and timing of future repurchases, if any, will depend on a number of factors, including, the price and availability of our shares, trading volume and general market conditions. The stock repurchase program may be suspended or discontinued at any time.

 

The following table summarizes our recent purchases of equity securities.

 

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None.

 

 

 

None.

 

 

 

None.

 

 

 

Exhibits required by Item 601 of Regulation S-K are filed herewith or incorporated herein by reference and are listed in the following Exhibit Index:

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EXHIBIT INDEX

 

 

 

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

 

 

 

 

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