Document
Table of Contents

 
 
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________________________________
FORM 10-Q
______________________________________
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2018
or
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.)
Commission File Number: 333-202799-01 (Hudson Pacific Properties, L.P.)
______________________________________
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., Ninth Floor
Los Angeles, California 90025
(Address of principal executive offices) (Zip Code)
(310) 445-5700
(Registrant’s telephone number, including area code)

N/A
(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 Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    
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, 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.
    
Hudson Pacific Properties, Inc.
Large accelerated filer x
Accelerated filer o   
Non-accelerated filer o 
 
 
(Do not check if a smaller reporting company) 
Smaller reporting company o  
Emerging growth company o 
 

Hudson Pacific Properties, L.P
Large accelerated filer o
Accelerated filer o   
Non-accelerated filer x
 
 
(Do not check if a smaller reporting company) 
Smaller reporting company o  
Emerging growth company o 
 
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.
Hudson Pacific Properties, Inc. o
Hudson Pacific Properties, L.P. 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 of Hudson Pacific Properties, Inc. outstanding at May 1, 2018 was 156,680,066.



Table of Contents

EXPLANATORY NOTE
This report combines the quarterly reports on Form 10-Q for the period ended March 31, 2018 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” or “the operating partnership” refer to Hudson Pacific Properties, L.P. together with its consolidated subsidiaries.
Hudson Pacific Properties, Inc. is a real estate investment trust, or REIT, and the sole general partner of our operating partnership. As of March 31, 2018, Hudson Pacific Properties, Inc. owned approximately 99.6% of the outstanding common units of partnership interest (including unvested restricted units) in our operating partnership, or common units. The remaining approximately 0.4% of outstanding common units at March 31, 2018 were owned by certain of our executive officers and directors, certain of their affiliates and other outside investors. As the sole general partner of our operating partnership, Hudson Pacific Properties, Inc. 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 Hudson Pacific Properties, Inc. and the 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 disclosures apply 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. Hudson Pacific Properties, Inc. is a REIT, the only material assets of which are the units of partnership interest in our operating partnership. As a result, Hudson Pacific Properties, Inc. 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. Hudson Pacific Properties, Inc. itself does not issue any indebtedness but guarantees some of the debt of our operating partnership. Our operating partnership, which is structured as a partnership with no publicly traded equity, holds substantially all of the assets of our Company and conducts substantially all of our business. Except for net proceeds from equity issuances by Hudson Pacific Properties, Inc., 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 its operations, its incurrence of indebtedness or through the issuance of units of partnership interest in our operating partnership.
Non-controlling interest, 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 a non-controlling interest in our Company’s consolidated financial statements. The differences between stockholders’ equity, partners’ capital and non-controlling interest result from the differences in the equity issued by our Company and our operating partnership.
To help investors understand the significant differences between our Company and our operating partnership, this report presents the consolidated financial statements and Note 15, earnings per share, separately for our Company and our operating partnership. All other sections of this report, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” 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 Part I, Item 4 “Controls and

2



Table of Contents

Procedures” sections and separate Exhibit 31 and 32 certifications for each of Hudson Pacific Properties, Inc. and our operating partnership.

3





HUDSON PACIFIC PROPERTIES, INC. AND HUDSON PACIFIC PROPERTIES, L.P.
QUARTERLY REPORT FOR THE THREE MONTHS ENDED MARCH 31, 2018
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.
 


4



Table of Contents
PART I—FINANCIAL INFORMATION
ITEM 1.
FINANCIAL STATEMENTS OF HUDSON PACIFIC PROPERTIES, INC.
HUDSON PACIFIC PROPERTIES, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)


 
March 31, 2018
(unaudited)
 
December 31, 2017
ASSETS
 
 
 
Investment in real estate, at cost
$
6,499,393

 
$
6,423,441

Accumulated depreciation and amortization
(574,814
)
 
(533,498
)
Investment in real estate, net
5,924,579

 
5,889,943

Cash and cash equivalents
64,080

 
78,922

Restricted cash
10,900

 
22,358

Accounts receivable, net
5,945

 
4,363

Straight-line rent receivables, net
119,436

 
109,457

Deferred leasing costs and lease intangible assets, net
241,912

 
244,554

Prepaid expenses and other assets, net
69,735

 
61,138

Assets associated with real estate held for sale
11,704

 
211,335

TOTAL ASSETS
$
6,448,291

 
$
6,622,070

 
 
 
 
LIABILITIES AND EQUITY
 
 
 
Notes payable, net
$
2,240,688

 
$
2,421,380

Accounts payable and accrued liabilities
146,588

 
163,107

Lease intangible liabilities, net
45,651

 
49,930

Security deposits and prepaid rent
65,692

 
64,031

Derivative liabilities

 
265

Liabilities associated with real estate held for sale
630

 
2,216

TOTAL LIABILITIES
2,499,249

 
2,700,929

6.25% Series A cumulative redeemable preferred units of the operating partnership
10,177

 
10,177

EQUITY
 
 
 
Hudson Pacific Properties, Inc. stockholders’ equity:
 
 
 
Common stock, $0.01 par value, 490,000,000 authorized, 155,626,055 shares and 155,602,508 shares outstanding at March 31, 2018 and December 31, 2017, respectively
1,556

 
1,556

Additional paid-in capital
3,625,673

 
3,622,988

Accumulated other comprehensive income
22,936

 
13,227

Retained earnings
9,500

 

Total Hudson Pacific Properties, Inc. stockholders’ equity
3,659,665

 
3,637,771

Non-controlling interest—members in consolidated entities
263,556

 
258,602

Non-controlling interest—units in the operating partnership
15,644

 
14,591

TOTAL EQUITY
3,938,865

 
3,910,964

TOTAL LIABILITIES AND EQUITY
$
6,448,291

 
$
6,622,070



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


HUDSON PACIFIC PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited, in thousands, except share data)

 
Three Months Ended March 31,
 
2018
 
2017
REVENUES
 
 
 
Office
 
 
 
Rental
$
130,082

 
$
133,516

Tenant recoveries
20,904

 
17,401

Parking and other
5,546

 
5,899

Total Office revenues
156,532

 
156,816

Studio
 
 
 
Rental
10,383

 
6,685

Tenant recoveries
354

 
665

Other property-related revenue
6,435

 
4,042

Other
414

 
77

Total Studio revenues
17,586

 
11,469

TOTAL REVENUES
174,118

 
168,285

OPERATING EXPENSES
 
 
 
Office operating expenses
53,240

 
47,954

Studio operating expenses
9,664

 
7,251

General and administrative
15,564

 
13,810

Depreciation and amortization
60,553

 
70,767

TOTAL OPERATING EXPENSES
139,021

 
139,782

INCOME FROM OPERATIONS
35,097

 
28,503

OTHER EXPENSE (INCOME)
 
 
 
Interest expense
20,503

 
21,930

Interest income
(9
)
 
(30
)
Unrealized gain on ineffective portion of derivatives

 
(6
)
Transaction-related expenses
118

 

Other income
(404
)
 
(678
)
TOTAL OTHER EXPENSES
20,208

 
21,216

 INCOME BEFORE GAINS ON SALE OF REAL ESTATE
14,889

 
7,287

Gains on sale of real estate
37,674

 
16,866

NET INCOME
52,563

 
24,153

Net income attributable to preferred stock and units
(159
)
 
(159
)
Net income attributable to participating securities
(327
)
 
(240
)
Net income attributable to non-controlling interest in consolidated entities
(3,323
)
 
(3,037
)
Net income attributable to non-controlling interest in the operating partnership
(177
)
 
(202
)
Net income attributable to Hudson Pacific Properties, Inc. common stockholders
$
48,577

 
$
20,515

Basic and diluted per share amounts:
 
 
 
Net income attributable to common stockholders—basic
$
0.31

 
$
0.14

Net income attributable to common stockholders—diluted
$
0.31

 
$
0.14

Weighted average shares of common stock outstanding—basic
155,626,055

 
147,950,594

Weighted average shares of common stock outstanding—diluted
156,714,822

 
149,950,346

Dividends declared per share
$
0.25

 
$
0.25


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


HUDSON PACIFIC PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(unaudited, in thousands)


 
Three Months Ended March 31,
 
2018
 
2017
Net income
$
52,563

 
$
24,153

Other comprehensive income: change in fair value of derivatives
9,513

 
2,864

Comprehensive income
62,076

 
27,017

Comprehensive income attributable to preferred stock and units
(159
)
 
(159
)
Comprehensive income attributable to participating securities
(391
)
 
(240
)
Comprehensive income attributable to non-controlling interest in consolidated entities
(3,323
)
 
(3,037
)
Comprehensive income attributable to non-controlling interest in the operating partnership
(211
)
 
(230
)
Comprehensive income attributable to Hudson Pacific Properties, Inc. common stockholders
$
57,992

 
$
23,351


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


HUDSON PACIFIC PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF EQUITY
(unaudited, in thousands, except share data)


 
Hudson Pacific Properties, Inc. Stockholders’ Equity
 
 
 
 
Shares of Common Stock
Stock
Amount
Additional
Paid-in
Capital
Retained Earnings (Accumulated Deficit)
Accumulated
Other
Comprehensive
(Loss) Income
Non-
controlling
Interest—Units in the
Operating
Partnership
Non-controlling Interest—Members in Consolidated Entities
Total Equity
Balance at January 1, 2017
136,492,235

$
1,364

$
3,109,394

$
(16,971
)
$
9,496

$
294,859

$
304,608

$
3,702,750

Contributions






3,870

3,870

Distributions






(74,836
)
(74,836
)
Proceeds from sale of common stock, net of underwriters’ discount and transaction costs
18,656,575

187

647,195





647,382

Issuance of unrestricted stock
917,086

9

(9
)





Shares withheld to satisfy tax withholding
(463,388
)
(4
)
(16,037
)




(16,041
)
Declared dividend


(106,269
)
(51,619
)

(656
)

(158,544
)
Amortization of stock-based compensation


13,249



2,666


15,915

Net income



68,590


375

24,960

93,925

Change in fair value of derivatives




7,353

45


7,398

Redemption of common units in the operating partnership


(24,535
)

(3,622
)
(282,698
)

(310,855
)
Balance at December 31, 2017
155,602,508

1,556

3,622,988


13,227

14,591

258,602

3,910,964

Cumulative adjustment related to adoption of ASU 2017-12



(231
)
230

1



Contributions






2,691

2,691

Distributions






(1,060
)
(1,060
)
Proceeds from sale of common stock, net of underwriters’ discount and transaction costs


(173
)




(173
)
Issuance of unrestricted stock
43,900








Shares withheld to satisfy tax withholding
(20,353
)

(693
)




(693
)
Declared dividend



(39,173
)

(178
)

(39,351
)
Amortization of stock-based compensation


3,551



1,019


4,570

Net income



48,904


177

3,323

52,404

Change in fair value of derivatives




9,479

34


9,513

Balance at March 31, 2018
155,626,055

$
1,556

$
3,625,673

$
9,500

$
22,936

$
15,644

$
263,556

$
3,938,865


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


Table of Contents


HUDSON PACIFIC PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in thousands)

 
Three Months Ended March 31,
 
2018
 
2017
CASH FLOWS FROM OPERATING ACTIVITIES
 
 
 
Net income
$
52,563

 
$
24,153

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
60,553

 
70,767

Non-cash portion of interest expense
1,658

 
1,186

Amortization of stock-based compensation
4,338

 
3,902

Straight-line rents
(9,942
)
 
2,366

Straight-line rent expenses
136

 
381

Amortization of above- and below-market leases, net
(3,811
)
 
(5,732
)
Amortization of above- and below-market ground lease, net
624

 
637

Amortization of lease incentive costs
303

 
379

Other non-cash adjustments(1)
256

 
539

Gains on sale of real estate
(37,674
)
 
(16,866
)
Change in operating assets and liabilities:
 
 
 
Accounts receivable
(1,782
)
 
4,650

Deferred leasing costs and lease intangibles
(6,614
)
 
(6,635
)
Prepaid expenses and other assets
3,313

 
(1,072
)
Accounts payable and accrued liabilities
(33
)
 
12,378

Security deposits and prepaid rent
559

 
(5,313
)
Net cash provided by operating activities
64,447

 
85,720

CASH FLOWS FROM INVESTING ACTIVITIES
 
 
 
Additions to investment property
(103,512
)
 
(76,225
)
Proceeds from sale of real estate
237,004

 
81,707

Contributions to unconsolidated entity

 
(1,071
)
Deposits for property acquisitions

 
(56,323
)
Net cash provided by (used in) investing activities
133,492

 
(51,912
)
CASH FLOWS FROM FINANCING ACTIVITIES
 
 
 
Proceeds from notes payable
130,000

 

Payments of notes payable
(308,529
)
 
(300,642
)
Proceeds from issuance of common stock, net
(173
)
 
647,675

Payment for redemption of common units in the operating partnership

 
(310,855
)
Distributions paid to common stock and unitholders
(39,351
)
 
(39,919
)
Distributions paid to preferred unitholders
(159
)
 
(159
)
Contributions from non-controlling member in consolidated entities
2,691

 
103

Distributions to non-controlling member in consolidated entities
(1,060
)
 
(310
)
Payments to satisfy tax withholding
(693
)
 
(4,203
)
Payments of loan costs
(6,965
)
 

Net cash used in financing activities
(224,239
)
 
(8,310
)
Net increase in cash and cash equivalents and restricted cash
(26,300
)
 
25,498

Cash and cash equivalents and restricted cash—beginning of period
101,280

 
108,192

Cash and cash equivalents and restricted cash—end of period
$
74,980

 
$
133,690

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
 
 
 
Cash paid for interest, net of capitalized interest
$
12,915

 
$
16,172

NON-CASH INVESTING ACTIVITIES:
 
 
 
Accounts payable and accrued liabilities for real estate investments
$
20,462

 
$
3,501

_____________ 
(1)
Represents bad debt expense/recovery and unrealized loss/gain on ineffective portion of derivative instruments.


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


Table of Contents
ITEM 1.
FINANCIAL STATEMENTS OF HUDSON PACIFIC PROPERTIES, L.P.

HUDSON PACIFIC PROPERTIES, L.P
CONSOLIDATED BALANCE SHEETS
(in thousands, except unit data)


 
March 31, 2018
(unaudited)
 
December 31, 2017
ASSETS
 
 
 
Investment in real estate, at cost
$
6,499,393

 
$
6,423,441

Accumulated depreciation and amortization
(574,814
)
 
(533,498
)
Investment in real estate, net
5,924,579

 
5,889,943

Cash and cash equivalents
64,080

 
78,922

Restricted cash
10,900

 
22,358

Accounts receivable, net
5,945

 
4,363

Straight-line rent receivables, net
119,436

 
109,457

Deferred leasing costs and lease intangible assets, net
241,912

 
244,554

Prepaid expenses and other assets, net
69,735

 
61,138

Assets associated with real estate held for sale
11,704

 
211,335

TOTAL ASSETS
$
6,448,291

 
$
6,622,070

 
 
 
 
LIABILITIES
 
 
 
Notes payable, net
$
2,240,688

 
$
2,421,380

Accounts payable and accrued liabilities
146,588

 
163,107

Lease intangible liabilities, net
45,651

 
49,930

Security deposits and prepaid rent
65,692

 
64,031

Derivative liabilities

 
265

Liabilities associated with real estate held for sale
630

 
2,216

TOTAL LIABILITIES
2,499,249

 
2,700,929

6.25% Series A cumulative redeemable preferred units of the operating partnership
10,177

 
10,177

CAPITAL
 
 
 
Hudson Pacific Properties, L.P. partners’ capital:
 
 
 
Common units, 156,195,100 and 156,171,553 issued and outstanding at March 31, 2018 and December 31, 2017, respectively.
3,652,289

 
3,639,086

Accumulated other comprehensive income
23,020

 
13,276

Total Hudson Pacific Properties, L.P. partners’ capital
3,675,309

 
3,652,362

Non-controlling interest—members in consolidated entities
263,556

 
258,602

TOTAL CAPITAL
3,938,865

 
3,910,964

TOTAL LIABILITIES AND CAPITAL
$
6,448,291

 
$
6,622,070



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


Table of Contents


HUDSON PACIFIC PROPERTIES, L.P.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited, in thousands, except unit data)

 
Three Months Ended March 31,
 
2018
 
2017
REVENUES
 
 
 
Office
 
 
 
Rental
$
130,082

 
$
133,516

Tenant recoveries
20,904

 
17,401

Parking and other
5,546

 
5,899

Total Office revenues
156,532

 
156,816

Studio
 
 
 
Rental
10,383

 
6,685

Tenant recoveries
354

 
665

Other property-related revenue
6,435

 
4,042

Other
414

 
77

Total Studio revenues
17,586

 
11,469

TOTAL REVENUES
174,118

 
168,285

OPERATING EXPENSES
 
 
 
Office operating expenses
53,240

 
47,954

Studio operating expenses
9,664

 
7,251

General and administrative
15,564

 
13,810

Depreciation and amortization
60,553

 
70,767

TOTAL OPERATING EXPENSES
139,021

 
139,782

INCOME FROM OPERATIONS
35,097

 
28,503

OTHER EXPENSE (INCOME)
 
 
 
Interest expense
20,503

 
21,930

Interest income
(9
)
 
(30
)
Unrealized gain on ineffective portion of derivatives

 
(6
)
Transaction-related expenses
118

 

Other income
(404
)
 
(678
)
TOTAL OTHER EXPENSES
20,208

 
21,216

 INCOME BEFORE GAINS ON SALE OF REAL ESTATE
14,889

 
7,287

Gains on sale of real estate
37,674

 
16,866

NET INCOME
52,563

 
24,153

Net income attributable to non-controlling interest in consolidated entities
(3,323
)
 
(3,037
)
Net income attributable to Hudson Pacific Properties, L.P.
49,240

 
21,116

Net income attributable to preferred units
(159
)
 
(159
)
Net income attributable to participating securities
(327
)
 
(240
)
Net income available to common unitholders
$
48,754

 
$
20,717

Basic and diluted per unit amounts:
 
 
 
Net income attributable to common unitholders—basic
$
0.31

 
$
0.14

Net income attributable to common unitholders—diluted
$
0.31

 
$
0.14

Weighted average shares of common units outstanding—basic
156,195,100

 
149,407,796

Weighted average shares of common units outstanding—diluted
157,283,867

 
150,334,796

Dividends declared per unit
$
0.25

 
$
0.25


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


Table of Contents


HUDSON PACIFIC PROPERTIES, L.P.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(unaudited, in thousands)


 
Three Months Ended March 31,
 
2018
 
2017
Net income
$
52,563

 
$
24,153

Other comprehensive income: change in fair value of derivatives
9,513

 
2,864

Comprehensive income
62,076

 
27,017

Comprehensive income attributable to preferred units
(159
)
 
(159
)
Comprehensive income attributable to participating securities
(391
)
 
(240
)
Comprehensive income attributable to non-controlling interest in consolidated entities
(3,323
)
 
(3,037
)
Comprehensive income attributable to Hudson Pacific Properties, L.P. partners’ capital
$
58,203

 
$
23,581



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


Table of Contents


HUDSON PACIFIC PROPERTIES, L.P.
CONSOLIDATED STATEMENTS OF CAPITAL
(unaudited, in thousands, except unit data)

 
Hudson Pacific Properties, L.P. Partners’ Capital
 
 
 
 
Number of Common Units
Common Units
Accumulated Other Comprehensive (Loss) Income
Total Partners’ Capital
Non-controlling Interest—Members in Consolidated Entities
Total Capital
Balance at January 1, 2017
145,942,855

$
3,392,264

$
5,878

$
3,398,142

$
304,608

$
3,702,750

Contributions




3,870

3,870

Distributions




(74,836
)
(74,836
)
Proceeds from sale of common units, net of underwriters’ discount and transaction costs
18,656,575

647,382


647,382


647,382

Issuance of unrestricted units
917,086






Units withheld to satisfy tax withholding
(463,388
)
(16,041
)

(16,041
)

(16,041
)
Declared distributions

(158,544
)

(158,544
)

(158,544
)
Amortization of unit-based compensation

15,915


15,915


15,915

Net income

68,965


68,965

24,960

93,925

Change in fair value of derivative instruments


7,398

7,398


7,398

Redemption of common units
(8,881,575
)
(310,855
)

(310,855
)

(310,855
)
Balance at December 31, 2017
156,171,553

3,639,086

13,276

3,652,362

258,602

3,910,964

Cumulative adjustment related to adoption of ASU 2017-12

(231
)
231




Contributions




2,691

2,691

Distributions




(1,060
)
(1,060
)
Proceeds from sale of common units, net of underwriters’ discount and transaction costs

(173
)

(173
)

(173
)
Issuance of unrestricted units
43,900






Units withheld to satisfy tax withholding
(20,353
)
(693
)

(693
)

(693
)
Declared distributions

(39,351
)

(39,351
)

(39,351
)
Amortization of unit-based compensation

4,570


4,570


4,570

Net income

49,081


49,081

3,323

52,404

Change in fair value of derivative instruments


9,513

9,513


9,513

Balance at March 31, 2018
156,195,100

$
3,652,289

$
23,020

$
3,675,309

$
263,556

$
3,938,865



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


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


 
Three Months Ended March 31,
 
2018
 
2017
CASH FLOWS FROM OPERATING ACTIVITIES
 
 
 
Net income
$
52,563

 
$
24,153

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
60,553

 
70,767

Non-cash portion of interest expense
1,658

 
1,186

Amortization of unit-based compensation
4,338

 
3,902

Straight-line rents
(9,942
)
 
2,366

Straight-line rent expenses
136

 
381

Amortization of above- and below-market leases, net
(3,811
)
 
(5,732
)
Amortization of above- and below-market ground lease, net
624

 
637

Amortization of lease incentive costs
303

 
379

Other non-cash adjustments(1)
256

 
539

Gains on sale of real estate
(37,674
)
 
(16,866
)
Change in operating assets and liabilities:
 
 
 
Accounts receivable
(1,782
)
 
4,650

Deferred leasing costs and lease intangibles
(6,614
)
 
(6,635
)
Prepaid expenses and other assets
3,313

 
(1,072
)
Accounts payable and accrued liabilities
(33
)
 
12,378

Security deposits and prepaid rent
559

 
(5,313
)
Net cash provided by operating activities
64,447

 
85,720

CASH FLOWS FROM INVESTING ACTIVITIES
 
 
 
Additions to investment property
(103,512
)
 
(76,225
)
Proceeds from sale of real estate
237,004

 
81,707

Contributions to unconsolidated entity

 
(1,071
)
Deposits for property acquisitions

 
(56,323
)
Net cash provided by (used in) investing activities
133,492

 
(51,912
)
CASH FLOWS FROM FINANCING ACTIVITIES
 
 
 
Proceeds from notes payable
130,000

 

Payments of notes payable
(308,529
)
 
(300,642
)
Proceeds from issuance of common units, net
(173
)
 
647,675

Payments for redemption of common units

 
(310,855
)
Distributions paid to common unitholders
(39,351
)
 
(39,919
)
Distributions paid to preferred unitholders
(159
)
 
(159
)
Contributions from non-controlling member in consolidated entities
2,691

 
103

Distributions to non-controlling member in consolidated entities
(1,060
)
 
(310
)
Payments to satisfy tax withholding
(693
)
 
(4,203
)
Payments of loan costs
(6,965
)
 

Net cash used in financing activities
(224,239
)
 
(8,310
)
Net (decrease) increase in cash and cash equivalents and restricted cash
(26,300
)
 
25,498

Cash and cash equivalents and restricted cash—beginning of period
101,280

 
108,192

Cash and cash equivalents and restricted cash—end of period
$
74,980

 
$
133,690

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
 
 
 
Cash paid for interest, net of capitalized interest
$
12,915

 
$
16,172

NON-CASH INVESTING ACTIVITIES:
 
 
 
Accounts payable and accrued liabilities for real estate investments
$
20,462

 
$
3,501

_____________ 
(1)
Represents bad debt expense/recovery and unrealized loss/gain on ineffective portion of derivative instruments.


The accompanying notes are an integral part of these consolidated financial statements.
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Table of Contents
Hudson Pacific Properties, Inc. and Hudson Pacific Properties, L.P.
Notes to Unaudited Consolidated Financial Statements
(Unaudited, tabular amounts in thousands, except square footage, share and unit data)


1. Organization

Hudson Pacific Properties, Inc. is a Maryland corporation formed on November 9, 2009 as a fully integrated, self-administered and self-managed real estate investment trust (“REIT”). Through its controlling interest in the operating partnership and its subsidiaries, Hudson Pacific Properties, Inc. owns, manages, leases, acquires and develops real estate, consisting primarily of office and studio properties. Unless otherwise indicated or unless the context requires otherwise, all references in these financial statements to “the 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” or “the operating partnership” refer to Hudson Pacific Properties, L.P. together with its consolidated subsidiaries.

On April 1, 2015, the Company completed the acquisition of the EOP Northern California Portfolio (“EOP Acquisition”) from Blackstone Real Estate Partners V and VI (“Blackstone”). The EOP Acquisition consisted of 26 high-quality office assets totaling approximately 8.2 million square feet and two development parcels located throughout Northern California. The total consideration paid for the EOP Acquisition before certain credits, prorations and closing costs included a cash payment of $1.75 billion and an aggregate of 63,474,791 shares of common stock of Hudson Pacific Properties, Inc. and common units in the operating partnership.
 
The Company’s portfolio consists of properties located throughout Northern and Southern California and the Pacific Northwest. The following table summarizes the Company’s portfolio as of March 31, 2018:
Segments
 
Number of Properties
 
Square Feet
(unaudited)
Office
 
51

 
13,398,362

Studio
 
3

 
1,204,927

Total(1)
 
54

 
14,603,289

_________________
(1)
Includes redevelopment, development and held for sale properties.

2. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying consolidated financial statements of the Company and the operating partnership are prepared in accordance with generally accepted accounting principles in the United States (“GAAP”) applicable to interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Certain information and footnote disclosures required for annual financial statements have been condensed or excluded pursuant to the Securities and Exchange Commission (“SEC”) rules and regulations. Accordingly, the interim financial statements do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, the accompanying interim financial statements reflect all adjustments of a normal and recurring nature that are considered necessary for a fair presentation of the results for the interim periods presented.

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, 2018. The interim consolidated financial statements should be read in conjunction with the consolidated financial statements in the 2017 Annual Report on Form 10-K of Hudson Pacific Properties, Inc. and Hudson Pacific Properties, L.P. and the notes thereto.

Principles of Consolidation

The unaudited interim consolidated financial statements of the Company include the accounts of the Company, the operating partnership and all wholly owned and controlled subsidiaries. The consolidated financial statements of the operating partnership include the accounts of the operating partnership and all wholly owned and controlled subsidiaries. All intercompany balances and transactions have been eliminated in the consolidated financial statements.


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


Under the consolidation guidance, the Company first evaluates an entity using the variable interest model, then the voting model. The Company ultimately consolidates all entities that the Company controls through either majority ownership or voting rights, including all variable interest entities (“VIEs”) of which the Company is considered the primary beneficiary. The Company accounts for all other unconsolidated joint ventures using the cost or equity method of accounting. In addition, the Company continually evaluates each legal entity that is not wholly owned for reconsideration based on changing circumstances.

VIEs are defined as entities in which equity investors do not have:

the characteristics of a controlling financial interest;

sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties; and/or

the entity is structured with non-substantive voting rights.
    
The entity that consolidates a VIE is known as its primary beneficiary and is generally the entity with both the power to direct the activities that most significantly affect the VIE’s economic performance and the right to receive benefits from the VIE or the obligation to absorb losses of the VIE that could be significant to the VIE. As of March 31, 2018, the Company has determined that four joint ventures and our operating partnership met the definition of a VIE. Three of the joint ventures are consolidated entities and one joint venture is a non-consolidated entity.

Consolidated Entities

As of March 31, 2018, the operating partnership has determined that three of its joint ventures met the definition of a VIE and are consolidated:
Entity
 
Property
 
Ownership Interest

Hudson 1455 Market, L.P.
 
1455 Market
 
55.0
%
Hudson 1099 Stewart, L.P.
 
Hill7
 
55.0
%
HPP-MAC WSP, LLC
 
Westside Pavilion(1)
 
75.0
%
_________________ 
(1)
As of March 31, 2018, this joint venture was formed but no significant contributions of cash or property have been made by the partners.

On March 1, 2018, the Company entered into a joint venture agreement with Macerich WSP, LLC (“Macerich”) to form HPP-MAC WSP, LLC (“HPP-MAC JV”) to redevelop Westside Pavilion, a shopping mall in West Los Angeles, into approximately 500,000 square feet of state-of-the-art creative office space, with approximately 100,000 square feet of existing retail and entertainment space. The HPP-MAC JV is held 75% by the Company and 25% by Macerich, with the Company serving as the managing member and developer. As of March 31, 2018, the assets held by the HPP-MAC JV include pre-development costs and the initial contributions from the members. Pursuant to the joint venture agreement, it is anticipated that the Company and Macerich will enter into a contribution agreement within a year to contribute Westside Pavilion to the joint venture. The contribution is valued at approximately $190.0 million before certain credits, prorations, closing costs and debt assumption. Total costs of the HPP-MAC JV will be funded 75% by the Company and 25% by Macerich. If either party defaults on its obligation to contribute to the joint venture, the defaulting party is required to pay a $25.0 million fee to the other member. The joint venture agreement lacks substantive participating or kick-out rights and is therefore a VIE. The Company, through its subsidiaries, has the right to (i) receive benefits and absorb losses and (ii) has the power to direct the activities that most significantly affect the joint venture.

As of March 31, 2018, the Company has determined that its operating partnership met the definition of a VIE and is consolidated. Substantially all of the assets and liabilities of the Company are related to VIEs.

Non-consolidated Entities

On June 16, 2016, the Company entered into a joint venture to co-originate a loan secured by land in Santa Clara, California. The assets of the joint venture consist of notes receivable. As of March 31, 2018, the Company has determined it is not the primary beneficiary of the joint venture that meets the definition of a VIE. Due to its significant influence over the non-

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


consolidated entity, the Company accounts for it using the equity method of accounting. Under the equity method, the Company initially records the investment at cost and subsequently adjusts for equity in earnings or losses and cash contributions and distributions. The Company’s net equity investment is reflected within prepaid expenses and other assets on the Consolidated Balance Sheets which represents the Company’s maximum exposure for loss. The Company’s share of net income or loss from the entity is included within other income on the Consolidated Statements of Operations. The Company owns 21% of the non-consolidated entity.

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.

Revenue Recognition

The Company has compiled an inventory of its sources of revenues and has identified the following material revenue streams: (i) rental revenues (ii) tenant recoveries (iii) ancillary revenues (iv) guest parking revenues and (v) sale of real estate.
Revenue Stream
 
Components
 
Financial Statement Location
Rental revenues
 
Office rentals, stage rentals and storage rentals
 
Office and Studio Segments: rental
Tenant recoveries
 
Reimbursement of real estate taxes, insurance, repairs and maintenance, other operating expenses and monthly parking revenues
 
Office Segment: tenant recoveries and parking and other
Studio Segment: tenant recoveries and other property-related revenue
Ancillary revenues
 
Revenues derived from tenants’ use of lighting, equipment rental, power, HVAC and telecommunications (i.e., telephone and internet)
 
Studio Segment: other property-related revenue
Guest parking revenues
 
Parking revenue that is not associated with lease agreements
 
Office Segment: parking and other
Studio Segment: other property-related revenue
Sale of real estate
 
Gains on sales derived from cash consideration less cost basis
 
Gains on sale of real estate


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


Currently rental revenues are accounted for under ASC 840, Leases. Rental revenues will be accounted for under ASC 842, Leases (“ASC 842”), which the Company plans to adopt on January 1, 2019.
    
Currently tenant recoveries are accounted for under ASC 605, Revenue Recognition (“ASC 605”). Tenant recoveries will be accounted for under ASC 606, Revenue from Contracts with Customers (“ASC 606”), on January 1, 2019, when the Company adopts ASC 842. Under the current ASC 842 guidance, the Company would be required to classify its tenant recoveries into lease and non-lease components. On March 28, 2018, the FASB agreed to issue an amendment to ASC 842, which if elected, permits the Company to classify tenant recoveries as a single lease component and accounted for with rental revenues in the Consolidated Statement of Operations. Please refer to our Update on ASC 842 implementation section below for details.

Ancillary revenues and guest parking revenues have been accounted for under ASC 606 since the Company adopted this standard on January 1, 2018. This standard requires the Company to recognize revenues based on a five-step model and will result in the consideration being recognized once all performance obligations are satisfied. The timing and pattern of revenue recognition as it relates to ancillary revenues and guest parking revenues have not changed from those under ASC 605.

Sale of real estate has been accounted for under ASC 610, Other Income, since the Company adopted this standard on January 1, 2018. This standard requires the Company to apply certain recognition and measurement principles in ASC 606 when it derecognizes nonfinancial assets and in substance nonfinancial assets, and the counterparty is not a customer. This is the case for the Company's sales of real estate, and therefore, the Company is required to evaluate the sales of real estate based on transfer of control. If a real estate sale contract includes ongoing involvement by the seller with the sold property, the seller must evaluate each promised good or service under the contract to determine whether it represents a performance obligation, constitutes a guarantee or prevents the transfer of control. The timing and pattern of revenue recognition might change as it relates to gains of sale of real estate if the sale includes continued involvement that represents a separate performance obligation.


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


Recently Issued Accounting Pronouncements

Changes to GAAP are established by the Financial Accounting Standards Board (the “FASB”) in the form of Accounting Standards Update (“ASU”). The following ASUs were adopted by the Company in 2018:
Standard
 
Description
 
Effect on the Financial Statements or Other Significant Matters
ASU 2018-04, Investments—Debt Securities (Topic 320) and Regulated Operations (Topic 980): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 117 and SEC Release No. 33-9273 (SEC Update)

ASU 2018-03, Technical Corrections and Improvements to Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities

ASU 2016-01, Financial Instruments— Overall (Subtopic 825-10), Recognition and
Measurement of Financial Assets and Financial Liabilities

 
The guidance no longer allows the use of cost method of accounting for equity instruments that do not have a readily determinable fair value and Companies are now required to measure equity investments at fair value through net income. Companies are permitted to elect a measurement alternative that allows for measuring equity instruments at cost, less any impairment, plus or minus changes resulting from observable price changes, adjusted as of the date that an observable transaction takes place, rather than report date. For equity investments that do not have a readily determinable fair value, this guidance is adopted prospectively for all investments that exist as of the date of adoption. The guidance allows entities to use a prospective transition approach only for securities they elect to measure using the measurement alternative.
 
The Company adopted this guidance during Q1 2018 using the prospective approach. The Company has elected to measure our equity instruments using the measurement alternative. Please see Note 12 for details.

ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities
 
The guidance eliminates the requirement to separately measure and report hedge ineffectiveness and generally requires the entire change in the fair value of a hedging instrument to be presented in the same income statement line as the hedged item. Therefore, a cumulative effect adjustment related to elimination of ineffectiveness measurement is required to be recorded to the opening balance of retained earnings as of the beginning of the fiscal year of adoption for cash flow hedge. The guidance also eases certain documentation and assessment requirements and modifies the accounting for components excluded from the assessment of hedge effectiveness. This guidance must be applied using a modified retrospective approach.
 
The Company adopted this guidance during Q1 2018 using the modified retrospective approach. As a result of the adoption, the concept of ineffectiveness from an accounting perspective is eliminated. Subsequent changes in fair value for a hedging instrument that has been designated and qualifies as a cash flow hedge will be recognized as a component in other comprehensive income. Additionally, the Company eliminated any previously recorded ineffectiveness with a cumulative effect adjustment. Please see Note 9 for details.
ASU 2017-09, Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting
 
The guidance clarifies when changes to the terms or conditions of a share-based payment award must be accounted for as modifications. This guidance must be applied prospectively.
 
The Company adopted this guidance during Q1 2018 on a prospective basis. The adoption did not have an impact on the Consolidated Financial Statements.


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


Standard
 
Description
 
Effect on the Financial Statements or Other Significant Matters
ASU 2017-05, Other Income—Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20): Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets
 
The guidance updates the definition of an in substance nonfinancial asset and clarifies the scope of ASC 610-20 on the sale or transfer of nonfinancial assets to noncustomers, including partial sales. It also clarifies the derecognition guidance for nonfinancial assets to conform with the new revenue recognition standard. Either a full or modified retrospective approach can be applied.
 
The Company adopted this guidance during Q1 2018 using the modified retrospective approach. The Company has not had variable consideration in our sale of real estate, or partial sales of nonfinancial assets or contribution of a nonfinancial asset to form a joint venture with retained noncontrolling interest, therefore the guidance does not currently impact the Company.
ASU 2014-09, Revenue from Contracts with Customers amended by ASU 2016-08, Revenue from Contracts with Customers—Principal versus Agent Considerations (Reporting Revenue Gross versus Net)
 
Issued on May 28, 2014, ASU 2014-09 outlines a single comprehensive model for entities to use in accounting for revenues arising from contracts with customers and specifically notes that lease contracts with customers are a scope exception. Issued on March 17, 2016, ASU 2016-08 clarifies certain aspects of the principal-versus-agent guidance in its new revenue recognition standard related to the determination of whether an entity is a principal-versus-agent and the determination of the nature of each specified good or service. The guidance provides for practical expedients associated with the determination of whether a significant financing component exists and the expedient for recording an immediate expense for certain incremental costs of obtaining a contract with a customer.

 
The Company adopted this guidance during Q1 2018 using the modified retrospective approach and is using the practical expedients associated with expensing incremental costs of obtaining a contract with a customer with terms of one year or less. The adoption of this ASU did not result in any changes with respect to the timing and pattern of revenue recognition. Please refer to the revenue recognition paragraph above for the additional disclosures.
        
Update on ASC 842 implementation

On February 25, 2016, the FASB issued ASU 2016-02, Leases, to amend the accounting guidance for leases and set out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a lease agreement (i.e., lessees and lessors). This ASU is effective for annual reporting periods (including interim periods) beginning after December 15, 2018. A modified retrospective approach must be applied for leases that exist or are entered into after January 1, 2017, the beginning of the earliest comparative period presented in the 2019 consolidated financial statements, with a cumulative adjustment to the opening balance of retained earnings (accumulated deficit) on January 1, 2017, and restatement of the amounts presented prior to January 1, 2019.

On March 28, 2018, the FASB agreed to issue an amendment to ASU 842 that would provide an entity the optional transition method to initially account for the impact of the adoption with a cumulative adjustment to retained earnings (accumulated deficit) on the effective date of the ASU, January 1, 2019, rather than January 1, 2017, which would eliminate the need to restate amounts presented prior to January 1, 2019.     

This guidance requires all lessees to record a lease liability at lease inception, with a corresponding right-of-use asset, except for short-term leases. Lessor accounting will not be fundamentally changed.

ASC 842 provides practical expedients that allow entities to not (i) reassess whether any expired or existing contracts are considered or contain leases; (ii) reassess the lease classification for any expired or existing leases; and (iii) reassess initial direct costs for any existing leases.

The Company plans to adopt the standard on January 1, 2019 and expects to elect the use of practical expedients. If the proposed amendment to ASU 842 is adopted, the Company would elect the transition method for adoption as described above.

Lessor Accounting
    
The Company recognized rental revenues and tenant recoveries of $161.7 million and $158.3 million for the three months ended March 31, 2018 and March 31, 2017. This ASU requires companies to identify lease and non-lease components

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


of a lease agreement. Lease components relate to the right to use the leased asset and non-lease components relate to payments for goods or services that are transferred separately from the right to use the underlying asset. Total lease consideration is allocated to lease and non-lease components on a relative standalone basis. The recognition of revenues related to lease components will be governed by ASC 842 while revenue related to non-lease components will be subject to ASC 606.

Under current accounting standards, 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. 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, have discretion in selecting the supplier and bear the associated credit risk.
In the March 28, 2018 FASB meeting, the FASB agreed to issue an amendment to ASC 842 which would allow lessors to elect, as a practical expedient, not to allocate the total consideration to lease and non-lease components based on their relative standalone selling prices. Once the amendment is adopted, this practical expedient will allow lessors to elect a combined single lease component presentation if (i) the timing and pattern of the transfer of the combined single lease component is the same, and (ii) the related lease component and, the combined single lease component would be classified as an operating lease.

The Company has not completed its analysis of this ASU. Once the amendments discussed during the March 28, 2018 FASB meeting are issued, adopted and elected, tenant recoveries that qualify as non-lease components will be combined under a single lease component presentation.

The ASU also requires lessors to capitalize only those costs that are defined as initial direct costs. Under the current accounting standards, the Company capitalizes initial direct and indirect leasing costs. During the three months ended March 31, 2018 and March 31, 2017, the Company capitalized $1.8 million and $1.4 million of indirect leasing costs, respectively. Under this new ASU, these costs will be expensed as incurred.

Lessee Accounting

As of March 31, 2018, the future undiscounted minimum lease payments under the Company’s ground leases totaled $449.3 million. This guidance requires lessees to record a lease liability at lease inception, with a corresponding right-of-use asset, except for short-term leases. The Company continues to evaluate the amount of right-of-use asset and lease liability that will ultimately be recorded with respect to its ground lease agreements, where it is the lessee.

Other recently issued ASUs

The Company considers the applicability and impact of all ASUs. The following table lists the recently issued ASUs that have not been disclosed in the Company’s 2017 Annual Report on Form 10-K and have not been adopted by the Company. The list excludes those ASUs that are not expected to have a material impact on the Company’s consolidated financial statements.
Standard
 
Description
 
Effective Date
 
Effect on the Financial Statements or Other Significant Matters
ASU 2018-01, Leases (Topic 842): Land Easement Practical Expedient for Transition to Topic 842
 
The amendments in this update permit an entity to elect an optional transition practical expedient to not evaluate under Topic 842 land easements that exist or expired before the entity’s adoption of Topic 842 and that were not previously accounted for as leases under Topic 840. An entity that elects this practical expedient should apply the practical expedient consistently to all of its existing or expired land easements that were not previously accounted for as leases under Topic 840. Once an entity adopts Topic 842, it should apply that Topic prospectively to all new (or modified) land easements to determine whether the arrangement should be accounted for as a lease.
 
The effective date and transition requirements are the same as that in Update 2016-02 (Effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years.)
 
The Company is currently evaluating the impact of this update.
    

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


3. Investment in Real Estate

Real estate held for investment

The following table summarizes the Company’s investment in real estate, at cost as of:
 
March 31, 2018
 
December 31, 2017
Land
$
1,302,907

 
$
1,302,907

Building and improvements
4,476,124

 
4,480,993

Tenant improvements
425,624

 
411,706

Furniture and fixtures
8,371

 
8,608

Property under development
286,367

 
219,227

Investment in real estate, at cost(1)
$
6,499,393

 
$
6,423,441

_____________ 
(1)
Excludes balances related to properties that have been classified as held for sale.

Acquisitions

The Company’s acquisitions are accounted for using the acquisition method. The results of operations for each of these acquisitions are included in the Company’s Consolidated Statements of Operations from the date of acquisition.

The Company evaluates each acquisition to determine if the integrated set of assets and activities acquired meet the definition of a business and need to be accounted for as a business combination in accordance with ASC 805, Business Combinations. An integrated set of assets and activities would fail to qualify as a business if either (i) substantially all of the fair value of the gross assets acquired is concentrated in either a single identifiable asset or a group of similar identifiable assets or (ii) the integrated set of assets and activities is lacking, at a minimum, an input and a substantive process that together significantly contribute to the ability to create outputs (i.e., revenue generated before and after the transaction). An acquired process is considered substantive if (i) the process includes an organized workforce (or includes an acquired contract that provides access to an organized workforce) that is skilled, knowledgeable and experienced in performing the process, (ii) the process cannot be replaced without significant cost, effort, or delay or (iii) the process is considered unique or scarce.

The Company assesses fair value based on Level 2 and Level 3 inputs within the fair value framework, which includes estimated cash flow projections that utilize appropriate discount, capitalization rates, renewal probability and available market information, which includes market rental rate and market rent growth rates. 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 were vacant. The fair value of acquired “above- and below-” market leases are based on the estimated cash flow projections utilizing 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 below-market 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.


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


The Company had no acquisitions during the three months ended March 31, 2018.

Dispositions

The following table summarizes the properties sold during the three months ended March 31, 2018. These properties were non-strategic assets to the Company’s portfolio and were classified as held for sale as of December 31, 2017:
Property
 
Month of Disposition
 
Square Feet
 
Sales Price(1) 
(in millions)
2600 Campus Drive (building 6 of Peninsula Office Park)
 
January 2018
 
63,050

 
$
22.5

Embarcadero Place
 
January 2018
 
197,402

 
136.0

2180 Sand Hill
 
March 2018
 
45,613

 
82.5

Total dispositions
 
 
 
306,065

 
$
241.0

_________________ 
(1)
Represents gross sales price before certain credits, prorations and closing costs.

These dispositions met the criteria in ASC 610 for recognizing gains of $37.7 million for the three months ended March 31, 2018, which is included in the gains on sale of real estate line item in the Consolidated Statements of Operations.
    
Held for Sale

In December 2017, the Company entered into an agreement to sell its 9300 Wilshire property for $13.8 million (before certain credits, prorations and closing costs). As of December 31, 2017 and March 31, 2018, the Company determined that this property met the criteria to be classified as held for sale. 9300 Wilshire was subsequently sold on April 10, 2018, which resulted in a gain.

As of December 31, 2017, the Company had 4 properties that met the criteria to be classified as held for sale.

The following table summarizes the components of assets and liabilities associated with real estate held for sale as of:
 
 
March 31, 2018
 
December 31, 2017
ASSETS
 
 
 
 
Investment in real estate, net
 
$
8,775

 
$
204,895

Accounts receivable, net
 
28

 
85

Straight-line rent receivables, net
 
420

 
2,234

Deferred leasing costs and lease intangible assets, net
 
2,394

 
4,063

Prepaid expenses and other assets, net
 
87

 
58

Assets associated with real estate held for sale
 
$
11,704

 
$
211,335

 
 
 
 
 
LIABILITIES
 
 
 
 
Accounts payable and accrued liabilities
 
$
393

 
$
782

Lease intangible liabilities, net
 

 
95

Security deposits and prepaid rent
 
237

 
1,339

Liabilities associated with real estate held for sale
 
$
630

 
$
2,216


Impairment of Long-Lived Assets

No impairment indicators have been noted and the Company recorded no impairment charges for the three months ended March 31, 2018.


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


4. Deferred Leasing Costs and Lease Intangibles, net

The following summarizes the Company’s deferred leasing costs and lease intangibles as of:
 
March 31, 2018
 
December 31, 2017
Above-market leases
$
11,526

 
$
19,222

Accumulated amortization
(8,507
)
 
(15,731
)
Above-market leases, net
3,019

 
3,491

Deferred leasing costs and in-place lease intangibles
298,042

 
311,599

Accumulated amortization
(120,436
)
 
(132,426
)
Deferred leasing costs and in-place lease intangibles, net
177,606

 
179,173

Below-market ground leases
68,388

 
68,388

Accumulated amortization
(7,101
)
 
(6,498
)
Below-market ground leases, net
61,287

 
61,890

Deferred leasing costs and lease intangible assets, net(1)
$
241,912

 
$
244,554

 
 
 
 
Below-market leases
$
100,259

 
$
105,233

Accumulated amortization
(55,560
)
 
(56,265
)
Below-market leases, net
44,699

 
48,968

Above-market ground leases
1,095

 
1,095

Accumulated amortization
(143
)
 
(133
)
Above-market ground leases, net
952

 
962

Lease intangible liabilities, net(1)
$
45,651

 
$
49,930

_____________ 
(1)
Excludes balances related to properties that have been classified as held for sale.
    
The Company recognized the following amortization related to deferred leasing costs and lease intangibles:
 
Three Months Ended March 31,
 
2018
 
2017
Above-market leases(1)
$
(474
)
 
$
(1,356
)
Deferred leasing costs and in-place lease intangibles(2)
(11,696
)
 
(19,793
)
Below-market ground leases(3)
(635
)
 
(648
)
Below-market leases(1)
4,285

 
7,088

Above-market ground leases(3)
11

 
11

__________________ 
(1)
Amortization is recorded in revenues in the Consolidated Statements of Operations.
(2)
Amortization is recorded in depreciation and amortization expenses and office rental revenues in the Consolidated Statements of Operations.
(3)
Amortization is recorded in office operating expenses in the Consolidated Statements of Operations.


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


5. Accounts Receivable, net

The Company’s accounting policy and methodology used to estimate the allowance for doubtful accounts is discussed in the Company’s 2017 Annual Report on Form 10-K. The following table summarizes the Company’s accounts receivable, net of allowance for doubtful accounts as of:
 
March 31, 2018
 
December 31, 2017
Accounts receivable
$
8,442

 
$
6,835

Allowance for doubtful accounts
(2,497
)
 
(2,472
)
Accounts receivable, net(1)
$
5,945

 
$
4,363

_____________ 
(1)
Excludes balances related to properties that have been classified as held for sale.

6. Straight-line Rent Receivables, net
 
The Company’s accounting policy and methodology used to estimate the allowance for doubtful accounts is discussed in the Company’s 2017 Annual Report on Form 10-K. The following table represents the Company’s straight-line rent receivables, net of allowance for doubtful accounts as of:
 
March 31, 2018
 
December 31, 2017
Straight-line rent receivables
$
119,436

 
$
109,457

Allowance for doubtful accounts

 

Straight-line rent receivables, net(1)
$
119,436

 
$
109,457

_____________ 
(1)
Excludes balances related to properties that have been classified as held for sale.

7. Prepaid Expenses and Other Assets, net    

The following table summarizes the Company’s prepaid expenses and other assets, net as of:
 
March 31, 2018
 
December 31, 2017
Derivative assets
$
21,922

 
$
12,586

Investment in unconsolidated entities
14,052

 
14,240

Goodwill
8,754

 
8,754

Other
25,007

 
25,558

Prepaid expenses and other assets, net(1)
$
69,735

 
$
61,138

_____________ 
(1)
Excludes balances related to properties that have been classified as held for sale.

No goodwill impairment indicators have been noted during the three months ended March 31, 2018.


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


8. Notes Payable, net
    
The following table sets forth information with respect to our outstanding indebtedness:
 
March 31, 2018
 
December 31, 2017
 
Interest Rate(1)
 
Contractual Maturity Date
 
UNSECURED NOTES PAYABLE
 
 
 
 
 
 
 
 
Unsecured Revolving Credit Facility(2)(3)
$
20,000

 
$
100,000

 
LIBOR + 1.05% to 1.50%
 
3/13/2022
(4) 
Term Loan A(2)(5)
300,000

 
300,000

 
LIBOR + 1.20% to 1.70%
 
4/1/2020
(6) 
Term Loan C(2)
75,000

 
75,000

 
LIBOR + 1.30% to 2.20%
 
11/17/2020
 
Term Loan B(2)(7)
350,000

 
350,000

 
LIBOR + 1.20% to 1.70%
 
4/1/2022
 
Term Loan D(2)(8)
125,000

 
125,000

 
LIBOR + 1.20% to 1.70%
 
11/17/2022
 
Series A Notes
110,000

 
110,000

 
4.34%
 
1/2/2023
 
Series E Notes
50,000

 
50,000

 
3.66%
 
9/15/2023
 
Series B Notes
259,000

 
259,000

 
4.69%
 
12/16/2025
 
Series D Notes
150,000

 
150,000

 
3.98%
 
7/6/2026
 
Registered Senior Notes(9)
400,000

 
400,000

 
3.95%
 
11/1/2027
 
Series C Notes
56,000

 
56,000

 
4.79%
 
12/16/2027
 
TOTAL UNSECURED NOTES PAYABLE
1,895,000


1,975,000

 
 
 
 
 
 
 
 
 
 
 
 
 
 
SECURED NOTES PAYABLE
 
 
 
 
 
 
 
 
Sunset Gower Studios/Sunset Bronson Studios(10)
5,001

 
5,001

 
LIBOR + 2.25%
 
3/4/2019
(4) 
Met Park North(11)
64,500

 
64,500

 
LIBOR + 1.55%
 
8/1/2020
 
10950 Washington(12)
27,281

 
27,418

 
5.32%
 
3/11/2022
 
Element LA
168,000

 
168,000

 
4.59%
 
11/6/2025
 
Hill7(13)
101,000

 
101,000

 
3.38%
 
11/6/2028
 
Rincon Center

 
98,392

 
5.13%
 
N/A
 
TOTAL SECURED NOTES PAYABLE
365,782

 
464,311

 
 
 
 
 
TOTAL NOTES PAYABLE
2,260,782

 
2,439,311

 
 
 
 
 
Unamortized deferred financing costs and loan discounts(14)
(20,094
)
 
(17,931
)
 
 
 
 
 
TOTAL NOTES PAYABLE, NET
$
2,240,688

 
$
2,421,380

 
 
 
 
 
_________________
(1)
Interest rate with respect to indebtedness is calculated on the basis of a 360-day year for the actual days elapsed. Interest rates are as of March 31, 2018, which may be different than the interest rates as of December 31, 2017 for corresponding indebtedness.
(2)
The Company has an option to make an irrevocable election to change the interest rate depending on the Company’s credit rating or a specified base rate plus an applicable margin. As of March 31, 2018, no such election had been made.
(3)
The Company has a total capacity of $600.0 million under its unsecured revolving credit facility.
(4)
The maturity date may be extended once for an additional one-year term.
(5)
The outstanding balance of the term loan was effectively fixed at 2.56% to 3.06% per annum through the use of two interest rate swaps. See Note 9 for details.
(6)
The maturity date may be extended twice, each time for an additional one-year term.
(7)
The outstanding balance of the term loan was effectively fixed at 2.96% to 3.46% per annum through the use of two interest rate swaps. See Note 9 for details.
(8)
The outstanding balance of the term loan was effectively fixed at 2.63% to 3.13% per annum through the use of an interest rate swap. See Note 9 for details.
(9)
On October 2, 2017, the Company completed an underwritten public offering of $400.0 million of senior notes, which were issued at 99.815% of par.
(10)
The Company has the ability to draw up to $257.0 million under its construction loan, subject to lender required submissions.
(11)
This loan bears interest only. Interest on the full loan amount has been effectively fixed at 3.71% per annum through the use of an interest rate swap. See Note 9 for details.
(12)
Monthly debt service includes annual debt amortization payments based on a 30-year amortization schedule with a balloon payment at maturity.
(13)
The Company owns 55% of the ownership interest in the consolidated joint venture that owns the Hill7 property. The full amount of the loan is shown. This loan bears interest only at 3.38% until November 6, 2026, at which time the interest rate will increase and monthly debt service will include principal payments with a balloon payment at maturity.
(14)
Excludes deferred financing costs related to establishing the Company’s unsecured revolving credit facility.

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



Current year activity

On February 1, 2018, the Company paid in full the debt secured by its Rincon Center property, which was due to mature in May 2018.

On March 13, 2018, the operating partnership entered into the Amended and Restated Credit Agreement (as defined below) with various financial institutions. The Amended and Restated Credit Agreement modifies the operating partnership’s unsecured revolving credit facility and its term loans as discussed under the Term Loan and Credit Facility section below.

Indebtedness

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

Loan agreements include events of default that the Company believes are usual for loan and transactions of this type. As of the date of this filing, there have been no events of default associated with the Company’s loans.
 
The following table summarizes the minimum future principal payments due (before the impact of extension options, if applicable) on the operating partnership’s secured and unsecured notes payable as of March 31, 2018:
Year
 
Annual Principal Payments
Remaining 2018
 
$
400

2019
 
5,569

2020
 
440,095

2021
 
632

2022
 
520,086

Thereafter
 
1,294,000

Total
 
$
2,260,782


Term Loan and Credit Facility

On March 13, 2018, the operating partnership entered into a Third Amended and Restated Credit Agreement (the “Amended and Restated Credit Agreement”) with various financial institutions. The Amended and Restated Credit Agreement amends and restates and replaces (i) the operating partnership’s existing Second Amended and Restated Credit Agreement, entered into on March 31, 2015 (the “Prior Credit Agreement”), which governed its $400.0 million unsecured revolving credit facility, $300.0 million unsecured 5-year term loan facility and $350.0 million unsecured 7-year term loan facility, and (ii) the operating partnership’s Term Loan Credit Agreement, entered into on November 17, 2015 (together with the Prior Credit Agreement, the “Existing Credit Agreements”), which governed its $75.0 million unsecured 5-year term loan facility and $125.0 million unsecured 7-year term loan facility.

The Amended and Restated Credit Agreement provides for (i) the increase of the operating partnership’s unsecured revolving credit facility to $600.0 million and the extension of the term to March 13, 2022 and (ii) term loans in amount and tenor equal to the term loans outstanding under the Existing Credit Agreements ($300.0 million term loan A maturing April 1, 2020, $350.0 million term loan B maturing April 1, 2022, $75.0 million term loan C maturing November 17, 2020 and $125.0 million term loan D maturing November 17, 2022).

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




The Company uses the unsecured revolving credit facility to finance the acquisition of other properties, to provide funds for tenant improvements and capital expenditures and to provide for working capital and other corporate purposes.
The following table summarizes the balance and key terms of the unsecured revolving credit facility as of:
 
March 31, 2018
 
December 31, 2017
Outstanding borrowings
$
20,000

 
$
100,000

Remaining borrowing capacity
580,000

 
300,000

Total borrowing capacity
$
600,000

 
$
400,000

Interest rate(1)(2)
LIBOR + 1.05% to 1.50%
 
LIBOR + 1.15% to 1.85%
Facility fee-annual rate(1)
0.15% or 0.30%
 
0.20% or 0.35%
Contractual maturity date(3)
3/13/2022
 
4/1/2019
_________________
(1)
The rate is based on the operating partnership’s leverage ratio. The Company has the option to make an irrevocable election to change the interest rate depending on the Company’s credit rating. As of March 31, 2018, no such election had been made.
(2)
The Company has the option to make an irrevocable election to change the interest rate depending on the Company’s specified base rate plus an applicable margin. As of March 31, 2018, no such election had been made.
(3)
The maturity date may be extended once for an additional one-year term.

Debt Covenants

The operating partnership’s ability to borrow under its unsecured loan arrangements remains subject to ongoing compliance with financial and other covenants as defined in the respective agreements. Certain financial covenant ratios are subject to change in the occurrence of material acquisitions as defined in the respective agreements. Other covenants include certain limitations on dividend payouts and distributions, limits on certain types of investments outside of the operating partnership’s primary business and other customary affirmative and negative covenants.
 
The following table summarizes existing covenants and their covenant levels related to our unsecured revolving credit facility, term loans, and series A, B, D, and E notes, when considering the most restrictive terms:
Covenant Ratio
 
Covenant Level
Total Liabilities to Total Asset Value
 
≤ 60%
Unsecured Indebtedness to Unencumbered Asset Value
 
≤ 60%
Adjusted EBITDA to Fixed Charges
 
≥ 1.5x
Secured Indebtedness to Total Asset Value
 
≤ 45%
Unencumbered NOI to Unsecured Interest Expense
 
≥ 2.0x

The following table summarizes existing covenants and their covenant levels related to our registered senior notes:
Covenant Ratio
 
Covenant Level
Debt to Total Assets
 
≤ 60%
Total Unencumbered Assets to Unsecured Debt
 
 ≥ 150%
Consolidated Income Available for Debt Service to Annual Debt Service Charge
 
≥ 1.5x
Secured Debt to Total Assets
 
≤ 45%

The operating partnership was in compliance with its financial covenants as of March 31, 2018.


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


Repayment Guarantees

Registered Senior Notes

The Company has fully and unconditionally guaranteed the operating partnership’s $400.0 million registered senior notes due November 1, 2027.

Sunset Gower Studios and Sunset Bronson Studios Loan    

In connection with the loan secured by the Sunset Gower Studios and Sunset Bronson Studios properties, the Company has guaranteed in favor of and promised to pay to the lender 19.5% of the principal payable under the loan in the event the borrower, a wholly-owned entity of the operating partnership, does not do so. As of March 31, 2018, the outstanding balance was $5.0 million, which results in a maximum guarantee amount for the principal under this loan of $1.0 million. The Company has the ability to draw up to $257.0 million under its construction loan, subject to lender required submissions. Furthermore, the Company agreed to guarantee the completion of the construction improvements, including tenant improvements, as defined in the agreement, in the event of any default of the borrower. If the borrower fails to complete the remaining required work, the guarantor agrees to perform timely all of the completion obligations, as defined in the agreement. As of the date of this filing, there has been no event of default associated with this loan.

Other Loans

Although the rest of the operating partnership’s loans are secured and non-recourse, the operating partnership provides limited customary secured debt guarantees for items such as voluntary bankruptcy, fraud, misapplication of payments and environmental liabilities.

Interest Expense

The following table represents a reconciliation from the gross interest expense to the amount on the interest expense line item in the Consolidated Statements of Operations:
 
Three Months Ended March 31,
 
2018
 
2017
Gross interest expense(1)
$
22,431

 
$
23,190

Capitalized interest
(3,586
)
 
(2,446
)
Amortization of deferred financing costs and loan discount, net
1,658

 
1,186

Interest expense
$
20,503

 
$
21,930

_________________
(1)
Includes interest on the Company’s notes payable and hedging activities.
    
9. Derivatives

The Company enters into derivatives in order to hedge interest rate risk. The Company had six interest rate swaps with aggregate notional amounts of $839.5 million as of March 31, 2018 and December 31, 2017. These derivatives were designated as effective cash flow hedges for accounting purposes. There is no impact on the Company’s Consolidated Statements of Cash Flows.

The Company’s derivatives are classified as Level 2 and their fair values are derived from estimated values obtained from observable market data for similar instruments.

The following table summarizes the Company’s derivative instruments as of March 31, 2018:

29



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


 
 
 
 
 
 
 
 
 
 
Strike Rate Range(1)
 
 
Underlying Debt Instrument
 
Number of Hedges
 
Notional Amount
 
Effective Date
 
Maturity Date
 
Low
 
High
 
Fair Value
Met Park North
 
1
 
$
64,500

 
Aug 2013
 
August 2020
 
2.16%
 
2.16%
 
$
322

Term Loan A(2)
 
2
 
300,000

 
July 2016
 
April 2020
 
2.56%
 
3.06%
 
5,313

Term Loan B(3)
 
2
 
350,000

 
July 2016
 
April 2022
 
2.96%
 
3.46%
 
10,143

Term Loan D(4)
 
1
 
125,000

 
June 2016
 
November 2022
 
2.63%
 
3.13%
 
6,144

_____________ 
(1)
The rate is based on the operating partnership’s leverage ratio.
(2)
On March 13, 2018, the underlying debt instrument that was hedged was amended. Prior to the amendment, the interest was effectively fixed at 2.75% to 3.65%.
(3)
On March 13, 2018, the underlying debt instrument that was hedged was amended. Prior to the amendment, the interest was effectively fixed at 3.36% to 4.31%.
(4)
On March 13, 2018, the underlying debt instrument that was hedged was amended. Prior to the amendment, the interest was effectively fixed at 3.03% to 3.98%.

On January 1, 2018, the Company early adopted ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities (“ASU 2017-12”). As a result of the adoption, the Company is no longer recognizing unrealized gains or losses related to ineffective portions of its derivative instruments. The Company recognized a $231 thousand cumulative-effect adjustment to other comprehensive income, with a corresponding adjustment to the opening balance of retained earnings (accumulated deficit). For the three months ended March 31, 2017, the Company recognized an unrealized gain of $6 thousand, reflected in the unrealized gain on ineffective portion of derivative instruments line item on the Consolidated Statements of Operations.

The fair market value of derivative instruments is presented on a gross basis in prepaid and other expenses, net and derivative liabilities line items on the Consolidated Balance Sheets. The derivative assets as of March 31, 2018 and December 31, 2017 were $21.9 million and $12.6 million, respectively. The derivative liabilities as of March 31, 2018 and December 31, 2017 were $0.0 million and $0.3 million, respectively.

The Company reclassifies into earnings in the same period during which the hedged forecasted transaction affects earnings. As of March 31, 2018, the Company expects $4.6 million of unrealized gain included in accumulated other comprehensive income will be reclassified to interest expense in the next 12 months.

10. Income Taxes
    
Hudson Pacific Properties, Inc. has elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended (“the Code”), commencing with its taxable year ended December 31, 2010. Provided it continues to qualify for taxation as a REIT, Hudson Pacific Properties, Inc. is generally not subject to corporate level income tax on the earnings distributed currently to its stockholders. The Company has elected, together with one of its subsidiaries, to treat such subsidiary as a taxable REIT subsidiary (“TRS”) for federal income tax purposes.

The Company’s property-owning subsidiaries are limited liability companies and treated as pass-through entities or disregarded entities (or, in the case of the entities that own the 1455 Market and Hill7 properties, REITs) 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.

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 March 31, 2018, the Company has not established a liability for uncertain tax positions.

The Company and its TRS file income tax returns with the U.S. federal government and various state and local jurisdictions. The Company and its TRS are no longer subject to tax examinations by tax authorities for years prior to 2013. The Company has assessed its tax positions for all open years, which include 2013 to 2017, and concluded that there are no material uncertainties to be recognized.



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


11. Future Minimum Lease Payments
        
Contingent rental expense is recorded in the period in which the contingent event becomes probable. The following table summarizes rent expense for ground leases as follows:
 
Three Months Ended March 31,
 
2018
 
2017
Contingent rental expense
$
3,095

 
$
2,184

Minimum rental expense
3,337

 
3,196


The following table provides information regarding the Company’s future minimum lease payments for its ground leases (before the impact of extension options, if applicable) as of March 31, 2018:
Year
 
Ground Leases (1)(2)
Remaining 2018
 
$
10,601

2019
 
14,161

2020
 
14,161

2021
 
14,161

2022
 
14,161

Thereafter
 
382,070

Total
 
$
449,315

_________________
(1)
In situations where ground lease obligation adjustments are based on third-party appraisals of fair market land value, CPI adjustments and/or percentage of gross income that exceeds the minimum annual rent, the future minimum lease amounts above include the lease rental obligations in effect as of March 31, 2018.
(2)
Balance includes future minimum ground lease obligation for 9300 Wilshire, which was sold on April 10, 2018.

12. Fair Value of Financial Instruments
    
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 require inputs that are both significant to the fair value measurement and unobservable.

In September 2016, the Company entered into an agreement to receive shares of a nonpublic company in lieu of rental and tenant recovery revenues that were valued at $1.8 million. The shares were accounted for under the cost method of accounting as there was no readily determinable fair value. The investment in the shares has been accounted for under ASC 825-10, Recognition and Measurement of Financial Assets and Financial Liabilities, since the Company adopted ASU 2016-01 on January 1, 2018, at which point the Company elected the measurement alternative. This standard requires the Company to mark the investment in shares to fair value, which are based on recent transactions. There have been no other transactions since the Company obtained its shares in 2016 and therefore there have been no adjustments to the carrying value.


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


The Company’s financial assets and liabilities measured and reported at fair value on a recurring basis include the following as of:
 
 
March 31, 2018
 
December 31, 2017
 
 
Level 1
 
Level 2
 
Level 3