fma 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

For the Quarterly Period Ended: September 30, 2016

 

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

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES  ☒    NO  ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted 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 and post such files).    ☒  Yes    ☐  No

 

Indicate by check mark whether the registrant is a large accelerated filer, accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

 

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 October 31, 2016, there were 221,111,773 shares of the registrant’s common stock outstanding.

 

 

 

 

 

 

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Table of Contents

 

 

 

 

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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).

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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).

 

 

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PARAMOUNT GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

 

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, Washington, D.C. and San Francisco.

 

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 83.0% of, the Operating Partnership as of September 30, 2016. As of September 30, 2016, our portfolio consisted of 12 Class A office properties aggregating approximately 10.4 million square feet.  

 

 

 

2.    Basis of Presentation and Significant Accounting Policies

 

Basis of Presentation

 

The accompanying consolidated financial statements include the accounts of Paramount and its consolidated subsidiaries, including the Operating Partnership. All significant inter-company amounts have been eliminated. In our opinion, all adjustments (which include only normal recurring adjustments) necessary to present fairly the financial position, results of operations and changes in cash flows have been made. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted. These condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q of the Securities and Exchange Commission (“SEC”) and 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, 2015, as filed with the SEC.

 

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 from those estimates. The results of operations for the three and nine months ended September 30, 2016, are not necessarily indicative of the operating results for the full year.

 

 

Significant Accounting Policies

 

There were no material changes to our significant accounting policies disclosed in our Annual Report on Form 10-K for the year ended December 31, 2015.

 

 

Segment Reporting

 

Our determination of segments is primarily based on our method of internal reporting. On January 1, 2016, as a result of certain organizational and operational changes, we redefined our reportable segments to be 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. Accordingly, our reportable segments were separated by region based on the three regions in which we conduct our business: New York, Washington, D.C. and San Francisco. In connection therewith, we have reclassified the prior period segment financial data to conform to the current period presentation.

 

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PARAMOUNT GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

Recently Issued Accounting Literature

 

In May 2014, the Financial Accounting Standard’s Board (“FASB”) issued an Accounting Standards Update (“ASU”) (“ASU 2014-09”) to Accounting Standard Codification (“ASC”) Topic 606, Revenue from Contracts with Customers. ASU 2014-09, which was subsequently amended by “ASU 2015-14,” “ASU 2016-08,” “ASU 2016-10” and “ASU 2016-12”, revises accounting guidance on revenue recognition and will supersede nearly all existing revenue recognition guidance under U.S. GAAP. The core principal of this guidance is that an entity should recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration which the entity expects to receive in exchange for those goods or services.  This guidance also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. This guidance is effective for fiscal years beginning after December 15, 2017, and for interim periods within those fiscal years, and can be applied using a full retrospective or modified retrospective approach. We are currently evaluating the impact of the adoption of this guidance on our consolidated financial statements.

 

In June 2014, the FASB issued an update (“ASU 2014-12”) Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period to ASC Topic 718, Compensation – Stock Compensation.  ASU 2014-12 requires an entity to treat performance targets that can be met after the requisite service period of a share-based award has ended, as a performance condition that affects vesting.  ASU 2014-12 is effective for interim and annual reporting periods in fiscal years that begin after December 15, 2015. We adopted the provisions of ASU 2014-12 on January 1, 2016, using the prospective method. This adoption did not have an impact on our consolidated financial statements.

 

In February 2015, the FASB issued an update (“ASU 2015-02”) Amendments to the Consolidation Analysis to ASC Topic 810, Consolidation. ASU 2015-02 modifies the evaluation of whether limited partnerships and similar legal entities are VIEs or voting interest entities, eliminates the presumption that a general partner should consolidate a limited partnership and affects the consolidation analysis of reporting entities that are involved with VIEs, particularly those that have fee arrangements and related party relationships. ASU 2015-02 is effective for interim and annual reporting periods in fiscal years that begin after December 15, 2015. We adopted the provisions of ASU 2015-02 on January 1, 2016, using the modified retrospective method. The adoption of ASU 2015-02 resulted in the deconsolidation of all of our real estate fund investments that were accounted for at fair value, except for Paramount Group Residential Development Fund, LP (the “Residential Fund”), which is accounted for at historical cost and will continue to be consolidated into our consolidated financial statements. See Note 4, Real Estate Fund Investments.

 

In April 2015, the FASB issued an update (“ASU 2015-03”) Simplifying the Presentation of Debt Issuance Costs to ASC Topic 835, Interest – Imputation of Interest. ASU 2015-03 requires an entity to present debt issuance costs in the balance sheet as a direct deduction from the related debt liability rather than as an asset. Amortization of debt issuance costs will continue to be reported as interest expense. ASU 2015-03 is effective for interim and annual reporting periods in fiscal years that begin after December 15, 2015.  In August 2015, the FASB issued an update (“ASU 2015-15”) Interest – Imputation of Interest (Subtopic 835-30): Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements - Amendments to SEC Paragraphs Pursuant to Staff Announcement at 18 June 2015 EITF Meeting. ASU 2015-15 clarifies the exclusion of line-of-credit arrangements from the scope of ASU 2015-03. Therefore, debt issuance costs related to line-of-credit arrangements can be deferred and presented as an asset that is subsequently amortized over the time of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement. We adopted the provisions of ASU 2015-03 on January 1, 2016, and have retrospectively reclassified $18,914,000 of deferred financing costs that were included in “deferred charges, net” as of December 31, 2015, to “notes and mortgages payable, net”.  The deferred financing costs related to our $1.0 billion revolving credit facility continue to be reported as an asset on our consolidated balance sheets.

 

In September 2015, the FASB issued an update (“ASU 2015-16”) Simplifying the Accounting for Measurement-Period Adjustments to ASC Topic 805, Business Combinations. ASU 2015-16 eliminates the requirement to retrospectively account for adjustments made to provisional amounts recognized in a business combination. ASU 2015-16 is effective for interim and annual reporting periods in fiscal years that begin after December 15, 2015. We adopted the provisions of ASU 2015-16 on January 1, 2016, using the prospective method. This adoption did not have an impact on our consolidated financial statements.

 

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PARAMOUNT GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

In February 2016, the FASB issued an update (“ASU 2016-02”) Leases to ASC Topic 842, Leases. ASU 2016-02 supersedes the provision of leasing guidance and establishes a right-of-use model that requires a lessee to record a right-of-use asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either financing or operating. ASU 2016-02 requires lessors to account for leases using an approach that is substantially similar to existing guidance for sales-type leases, direct financing leases and operating leases. 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 are currently evaluating the impact of the adoption of ASU 2016-02 on our consolidated financial statements.

 

In March 2016, the FASB issued an update (“ASU 2016-09”) Improvements to Employee Share-Based Payment Accounting to ASC Topic 718, Compensation – Stock Compensation. ASU 2016-09 improves the accounting for share-based payments including income tax consequences and the classification of awards as either equity awards or liability awards. ASU 2016-09 is effective for interim and annual reporting periods in fiscal years that begin after December 15, 2016, with early adoption permitted. We are currently evaluating the impact of ASU 2016-09 on our consolidated financial statements.

 

In June 2016, the FASB issued an update (“ASU 2016-13”) Measurement of Credit Losses on Financial Instruments 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. ASU 2016-13 is effective for interim and annual reporting periods in fiscal years that begin after December 15, 2019, with early adoption permitted for fiscal years beginning after December 15, 2018. We are currently evaluating the impact of ASU 2016-13 on our consolidated financial statements.

 

In August 2016, the FASB issued an update (“ASU 2016-15”) Classification of Certain Cash Receipts and Cash Payments to ASC Topic 230, Statement of Cash Flows to provide guidance for areas where there is diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. ASU 2016-15 is effective for interim and annual reporting periods in fiscal years that begin after December 15, 2017, with early adoption permitted. We are currently evaluating the impact of ASU 2016-15 on our consolidated financial statements.

 

 

 

 

One Front Street

 

On September 12, 2016, we entered into an agreement to acquire One Front Street, a 651,000 square foot Class A office building, in San Francisco, California for $521,000,000. In connection therewith, we made a $50,000,000 non-refundable deposit, which is included in “other assets” on our consolidated balance sheet.  The transaction, which is subject to customary closing conditions, is expected to close by the end of the fourth quarter of 2016.

 

 

On January 1, 2016, we adopted ASU 2015-02 Amendments to the Consolidation Analysis using the modified retrospective method. The adoption of ASU 2015-02 resulted in the deconsolidation of all of our real estate fund investments that were accounted for at fair value, except for the Residential Fund, which is accounted for at historical cost and will continue to be consolidated into our consolidated financial statements.  See Note 2, Basis of Presentation and Significant Accounting Policies – Recently Issued Accounting Literature.  

11

 

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PARAMOUNT GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

Unconsolidated Real Estate Funds

 

The following tables summarize our investments in unconsolidated real estate funds as of September 30, 2016, and income or loss recognized from these investments for the three and nine months ended September 30, 2016.  

 

 

 

 

 

 

 

As of September 30, 2016, we own a 10.0% interest in Fund II, a 3.1% interest in Fund III, and a 7.5% interest in Fund VII, which are accounted for under the equity method.  The following tables provide summarized financial information for Fund II, Fund III and Fund VII as of the dates and for the periods set forth below.

 

 

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PARAMOUNT GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

Consolidated Real Estate Funds

 

Below is a summary of the fair value of our Property Funds and the Alternative Investment Fund that were consolidated on our balance sheet as of December 31, 2015 and income from fund investments for the three and nine months ended September 30, 2015.

 

 

 

 

 

 

 

5.     Preferred Equity Investments

 

As of September 30, 2016, we own a 24.4% interest in PGRESS Equity Holdings L.P., an entity that owns certain preferred equity investments.  The following is a summary of the preferred equity investments.

 

 

 

13

 

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PARAMOUNT GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

6.     Investments in Unconsolidated Joint Ventures

 

The following tables summarize our investments in unconsolidated joint ventures as of September 30, 2016 and December 31, 2015 and income from these investments for the three and nine months ended September 30, 2016 and 2015.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

712 Fifth Avenue

 

The following tables provide summarized financial information of 712 Fifth Avenue as of the dates and for the periods set forth below.

 

 

 

 

 

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PARAMOUNT GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

7.Intangible Assets and Liabilities

 

The following summarizes our intangible assets (primarily acquired above-market leases and acquired in-place leases) and intangible liabilities (primarily acquired below-market leases) as of September 30, 2016 and December 31, 2015.

 

 

Amortization of acquired below-market leases, net of acquired above-market leases, resulted in an increase to rental income of $3,112,000 and $1,477,000 for the three months ended September 30, 2016 and 2015, respectively, and $6,593,000 and $3,239,000 for the nine months ended September 30, 2016 and 2015, respectively.  The three and nine months ended September 30, 2016 include $2,485,000 and $10,315,000 of income, respectively, from the accelerated amortization of a below-market lease liability in connection with a tenant’s lease modification and $1,743,000 and $11,577,000 of expense, respectively, from the write-off above-market lease assets in connection with lease terminations.  Estimated annual amortization of acquired below-market leases, net of acquired above-market leases, for each of the five succeeding years commencing January 1, 2017 is as follows.

 

Amortization of acquired in-place leases (a component of depreciation and amortization expense) was $21,917,000 and $29,376,000 for the three months ended September 30, 2016 and 2015, respectively and $76,072,000 and $100,006,000 for the nine months ended September 30, 2016 and 2015, respectively.  Estimated annual amortization of acquired in-place leases for each of the five succeeding years commencing January 1, 2017 is as follows.

 

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PARAMOUNT GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

On May 3, 2016, we completed a $500,000,000 refinancing of 31 West 52nd Street, a 786,647 square foot Class A office building located between Fifth Avenue and Avenue of the Americas in Midtown Manhattan. The new 10-year loan is interest-only at a fixed rate of 3.80%. We realized net proceeds of $64,538,000 after the repayment of the existing $413,490,000 loan and $21,972,000 of costs, primarily for swap breakage. The existing loan was scheduled to mature in December 2017 and had a weighted average interest rate of 4.23%.

 

The following is a summary of our outstanding debt.

 

 

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PARAMOUNT GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

9.     Derivative Instruments and Hedging Activities

 

We manage our market risk on variable rate debt by entering into interest rate swaps to fix the rate on all or a portion of the debt for varying periods through maturity. These interest rate swaps are accounted for as derivative instruments and, pursuant to ASC Topic 815, are recorded on our consolidated balance sheets at fair value. Changes in the fair value of interest rate swaps are accounted for based on the hedging relationship and their designation and qualification. 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 September 30, 2016, the fair value of these derivative obligations was $82,046,000, which was recorded as a liability and reflected as “interest rate swap liabilities” on our consolidated balance sheet.

 

 

Interest Rate Swaps – Non-designated Hedges

 

As of September 30, 2016, we had 11 interest rate swaps with an aggregate notional amount of $1.0 billion that were not designated as hedges. Changes in the fair value of interest rate swaps that are not designated as hedges are recognized in earnings.  We recognized unrealized gains from the changes in the fair value of these interest rate swaps of $12,728,000 and $15,772,000 for the three months ended September 30, 2016 and 2015, respectively and $29,661,000 and $49,497,000 for the nine months ended September 30, 2016 and 2015, respectively. The table below provides additional details on our interest rate swaps that are not designated as hedges.

 

 

 

 

 

Interest Rate Swaps – Designated as Cash Flow Hedges

 

As of September 30, 2016, we had three interest rate swaps with an aggregate notional amount of $1.0 billion that were designated as cash flow hedges.  We also have entered into a forward starting interest rate swap with an aggregate notional amount of $400,000,000 to extend the maturity of one of the three swaps for an additional year.  Changes in the fair value of interest rate swaps that are designated as cash flow hedges are recognized in accumulated other comprehensive loss (outside of earnings). We recognized other comprehensive income of $7,802,000 and other comprehensive loss of $18,602,000 for the three months ended September 30, 2016 and 2015, respectively, and other comprehensive losses of $33,812,000 and $18,602,000 for the nine months ended September 30, 2016 and 2015, respectively, from the changes in the fair value of these interest rate swaps.  During the next twelve months, we estimate that $11,127,000 of the amounts recognized in accumulated other comprehensive loss will be reclassified as an increase to interest expense.  The table below provides additional details on our interest rate swaps that are designated as cash flow hedges.  

 

 

 

 

 

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PARAMOUNT GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

10.     Accumulated Other Comprehensive Loss

The following table sets forth changes in accumulated other comprehensive loss, by component for the three and nine months ended September 30, 2016 and 2015.

 

 

 

 

11.     Noncontrolling Interests

 

Consolidated Real Estate Funds

 

At December 31, 2015, noncontrolling interest in consolidated real estate funds aggregated $414,637,000 and consisted of equity interest in the real estate funds that were not wholly owned by us, but were required to be consolidated into our consolidated financial statements because we were the sole general partner of such funds.  On January 1, 2016, we adopted ASU 2015-02 using the modified retrospective method, which resulted in the deconsolidation of all of our real estate fund investments that were accounted for at fair value, except for the Residential Fund, which is accounted for at historical cost and will continue to be consolidated into our consolidated financial statements. See Note 4, Real Estate Fund Investments. As of September 30, 2016, the noncontrolling interest in consolidated real estate funds aggregated $62,790,000 and represents the noncontrolling interest of the Residential Fund.  

 

Consolidated Joint Ventures

 

Noncontrolling interests in consolidated joint ventures consists of equity interests held by third parties in properties and investments that are consolidated into our consolidated financial statements because we exercise control over the entities that own such properties and investments. As of September 30, 2016 and December 31, 2015, noncontrolling interests in consolidated joint ventures on our consolidated balance sheets was comprised of the equity interests held by third parties in One Market Plaza and PGRESS Equity Holdings, L.P. and aggregated to $244,234,000 and $236,849,000, respectively.  

 

Operating Partnership

 

Noncontrolling interests in the Operating Partnership represents 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 September 30, 2016 and December 31, 2015, noncontrolling interests in the Operating Partnership on our consolidated balance sheets had a carrying amount of $758,940,000 and $898,047,000, respectively and a redemption value of $736,187,000 and $935,048,000, respectively.

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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 determined to be the primary beneficiary.

 

Consolidated VIEs

 

We are the sole general partner of, and own approximately 83.0% of, the Operating Partnership as of September 30, 2016. 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 September 30, 2016, the Operating Partnership held variable interests in the entities owning certain real estate fund investments, preferred equity and a property that were determined to be VIEs.  As of December 31, 2015, the Operating Partnership held variable interests in the entities owning certain funds that were determined to be VIEs.  The Operating Partnership is required to consolidate its interest in these entities because it is deemed to be the primary beneficiary and has the power to direct the activities of these entities that most significantly affect economic performance and the obligation to absorb losses and rights to receive benefits that could potentially be significant to the entity. 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 table below summarizes the assets and liabilities of consolidated VIEs of the Operating Partnership.

 

 

Unconsolidated VIEs

 

The adoption of ASU 2015-02 using the modified retrospective method resulted in the deconsolidation of all of our real estate funds that were accounted for at fair value, except for the Residential Fund, which is accounted for at historical cost.  The table below summarizes our investments in these unconsolidated real estate funds that are VIEs.

 

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PARAMOUNT GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

ASC Topic 820, Fair Value Measurement and Disclosures, defines fair value and establishes a framework for measuring fair value.  The objective of fair value is to determine the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (the exit price).  ASC Topic 820 establishes a fair value hierarchy that prioritizes observable and unobservable inputs used to measure fair value into three levels: Level 1 – quoted prices (unadjusted) in active markets that are accessible at the measurement date for assets or liabilities; Level 2 – observable prices that are based on inputs not quoted in active markets, but corroborated by market data; and Level 3 – unobservable inputs that are used when little or no market data is available. The fair value hierarchy gives the highest priority to Level 1 inputs and the lowest priority to Level 3 inputs. In determining fair value, we utilize valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible, as well as consider counterparty credit risk in our assessment of fair value.  Considerable judgment is necessary to interpret Level 2 and 3 inputs in determining the fair value of our financial and non-financial assets and liabilities.  Accordingly, our fair value estimates, which are made at the end of each reporting period, may be different than the amounts that may ultimately be realized upon sale or disposition of these assets.   

 

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 (which represent the assets in our deferred compensation plan, for which there is a corresponding liability on our consolidated balance sheets), real estate fund investments and interest rate swaps. The table below aggregates the fair values of these financial assets and liabilities at September 30, 2016 and December 31, 2015, based on their levels in the fair value hierarchy.

 

 

 

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PARAMOUNT GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

Property Funds

 

As of December 31, 2015, the Property Funds had four investments.  These investments were classified as Level 3. We used a discounted cash flow valuation technique to estimate the fair value of each of these investments, which was updated quarterly by personnel responsible for the management of each investment and reviewed by senior management at each reporting period. The discounted cash flow valuation technique required us to estimate cash flows for each investment over the anticipated holding period, which ranged from 1.0 to 10.0 years.  Cash flows were derived from property rental revenue (base rents plus reimbursements) less operating expenses, real estate taxes and capital and other costs, plus projected sales proceeds in the year of exit. Property rental revenue was based on leases currently in place and our estimates for future leasing activity, which were based on market rents for similar space. Similarly, estimated real estate taxes and operating expenses were based on amounts incurred in the period plus a projected growth factor for future periods. Anticipated sales proceeds at the end of an investment’s expected holding period were determined based on the net cash flow of the investment in the year of exit, divided by a terminal capitalization rate, less estimated selling costs.  The fair value of each property was calculated by discounting future cash flows (including anticipated sales proceeds), using an appropriate discount rate.  The fair value of the investment was calculated by subtracting property level debt, if any, from the fair value of the property.

 

Significant unobservable inputs used in determining the fair value of each investment included capitalization rates and discount rates. These rates were based on, among other factors, location and type of property.  Significant unobservable quantitative inputs in the table below were utilized in determining the fair value of the Property Fund investments as of December 31, 2015.

 

 

The above inputs were subject to change based on changes in economic and market conditions and/or changes in use or timing of exit. Changes in discount rates and terminal capitalization rates result in increases, or decreases, in the fair values of these investments. The discount rates encompass, among other things, uncertainties in the valuation models with respect to terminal capitalization rates and the amount and timing of cash flows. Therefore, a change in the fair value of these investments resulting from a change in the terminal capitalization rate may be partially offset by a change in the discount rate. Significant increases (decreases) in any of these inputs in isolation would have resulted in a significantly lower (higher) fair value, respectively.

 

Alternative Investment Fund

 

As of December 31, 2015, the investments in the Alternative Investment Fund were comprised of mezzanine loans and a senior mortgage loan. These investments were classified as Level 3. Estimates of the fair value of these instruments are determined by the standard practice of modeling the contractual cash flows required and discounting it back to its present value at the appropriate risk adjusted interest rate. The balances were updated quarterly by a third party and reviewed by senior management at each reporting period.

 

Significant unobservable inputs used in determining the fair value of these investments included preferred returns and credit spreads. Significant increases (decreases) in any of these inputs in isolation would have resulted in a significantly lower (higher) fair value, respectively. Significant unobservable quantitative inputs in the table below were utilized in determining the fair value of the investment in the Alternative Investment Fund as of December 31, 2015.

 

 

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PARAMOUNT GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

Interest Rate Swaps

 

Interest rate swaps are valued by a third-party specialist. The valuation of these interest rate swaps is determined using widely accepted valuation techniques, including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the interest rate swaps and uses observable market-based inputs, including interest rate curves and implied volatilities. The fair values of interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash receipts (or payments) and the discounted expected variable cash payments (or receipts). The variable cash payments (or receipts) are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. Interest rate swaps are classified as Level 2.

 

Financial Assets and Liabilities Not Measured at Fair Value

 

Financial assets not measured at fair value on our consolidated balance sheets consists of cash equivalents and would be classified as Level 1 as their carrying amount approximates their fair value, due to their short-term nature.  Financial liabilities not measured at fair value include notes and mortgages payable and the revolving credit facility.  Estimates of the fair value of these instruments are determined by the standard practice of modeling the contractual cash flows required under the instrument and discounting them back to their present value at the appropriate current risk adjusted interest rate, which is provided by a third-party specialist. For floating rate debt, we use forward rates derived from observable market yield curves to project the expected cash payments we would be required to make under the instrument. These instruments would be classified as Level 2.

 

 

The following is a summary of the carrying amounts and fair value of these financial instruments as of September 30, 2016 and December 31, 2015.

 

 

 

 

22

 

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PARAMOUNT GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

 

The following table sets forth the details of our fee and other income.

 

 

 

 

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

 

 

 

  

16.     Interest and Debt Expense

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

23

 

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PARAMOUNT GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

17.  Incentive Compensation

 

       Stock-Based Compensation

 

We account for all stock-based compensation in accordance with ASC Topic 718, Compensation – Stock Compensation.  As of September 30, 2016, we have 12,227,090 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 $2,583,000 and $1,613,000 for the three months ended September 30, 2016 and 2015, respectively, and $8,766,000 and $6,018,000 for the nine months ended September 30, 2016 and 2015, respectively. Stock-based compensation expense for the nine months ended September 30, 2016 and 2015 includes $1,855,000 and $1,861,000 of expense, respectively, related to the acceleration of vesting of stock awards in connection with certain separation agreements.

 

In March 2016, our Compensation Committee approved the 2016 Performance Program, a multi-year performance-based equity compensation program. The purpose of the 2016 Performance Program is to further align the interests of our stockholders with that of management by encouraging our senior officers to create stockholder value in a “pay for performance” structure. Under the 2016 Performance Program, participants may earn awards in the form of Long Term Incentive Plan (“LTIP”) units of our operating partnership based on our total return to stockholders (“TRS”) over a three-year performance measurement period beginning on March 18, 2016, and continuing through March 17, 2019, on both an absolute basis and relative basis. 25.0% of the award is earned if we outperform a predetermined absolute TRS and the remaining 75.0% is earned if we outperform a predetermined relative TRS. Specifically, participants begin to earn awards under the 2016 Performance Program if our TRS for the performance measurement period equals or exceeds 21.0% on an absolute basis and is within 250 basis points of the performance of the SNL Office REIT Index on a relative basis, and awards will be fully earned if our TRS for the performance measurement period equals or exceeds 36.0% on an absolute basis and exceeds the performance of the SNL Office REIT Index by 400 basis points on a relative basis. Participants will not earn any awards under the 2016 Performance Program if our TRS during the performance measurement period does not meet either of these minimum thresholds. The number of LTIP units that are earned if performance is above the minimum thresholds, but below the maximum thresholds, will be determined based on linear interpolation between the percentages earned at the minimum and maximum thresholds. During the performance measurement period, participants will receive per unit distributions equal to one-tenth of the per share dividends otherwise payable to our common stockholders with respect to their LTIP units. If the LTIP units are ultimately earned based on the achievement of the designated performance objectives, participants will receive cash or additional LTIP units based on the additional amount the participants would have received if per unit distributions during the performance measurement periods for the earned LTIP units had equaled per share dividends paid to our common stockholders less the amount of distributions participants actually received during the performance measurement period.

If the designated performance objectives are achieved, awards earned under the 2016 Performance Program will also be subject to vesting based on continued employment with us through March 17, 2020, with 50.0% of each award vesting following the conclusion of the performance measurement period, and the remaining 50.0% vesting on March 17, 2020.  The fair value of the awards granted under the 2016 Performance Program on the date of the grant was $10,914,000 and is being amortized into expense over the four-year vesting period using a graded vesting attribution method.

 

24

 

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PARAMOUNT GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

18.    Earnings Per Share

 

The following table provides a summary of net (loss) income and the number of common shares used in the computation of basic and diluted income (loss) per common share, which includes the weighted average number of common shares outstanding and the effect of dilutive potential common shares, if any.               

 

 

 

Due to Affiliates

 

As of September 30, 2016 and December 31, 2015, we had an aggregate of $27,299,000 of liabilities that were due to affiliates. These liabilities were comprised of a $24,500,000 note payable to CNBB-RDF Holdings, LP, which is an entity partially owned by Katharina Otto-Bernstein (a member of our Board of Directors), and a $2,799,000 note payable to a different entity owned by members of the Otto Family, both of which were made in lieu of certain cash distributions prior to the completion of our initial public offering. The notes are due in October 2017 and bear interest at a fixed rate of 0.50%.  For the three months ended September 30, 2016 and 2015, we recognized $43,000 and $32,000, respectively, of interest expense and for the nine months ended September 30, 2016 and 2015, we recognized $112,000 and 101,000, respectively, of interest expense in connection with these notes.

 

 Management Agreements

 

We provide property management, leasing and other related services to certain properties owned by members of the Otto Family. We recognized an aggregate of $195,000 and $314,000 for the three months ended September 30, 2016 and 2015 and $594,000 and $562,000 for the for the nine months ended September 30, 2016 and 2015, respectively, of fee income, in connection with these agreements, which is included as a component of “fee and other income” on our consolidated statements of income. As of September 30, 2016, amounts owed to us under these agreements aggregated $80,000, which are included as a component of “accounts and other receivables, net” on our consolidated balance sheets.

 

We also provide property management, asset management, leasing and other related services to our unconsolidated joint ventures and real estate funds.  During the three and nine months ended September 30, 2016, we recognized $3,227,000 and $7,826,000, respectively, of fee income in connection with these agreements. As of September 30, 2016, amounts owed to us under these agreements aggregated $1,499,000, which are included as a component of “accounts and other receivables, net” on our consolidated balance sheets.

25

 

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PARAMOUNT GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

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 a feeder vehicle for Fund VIII. Pursuant to this agreement, we have agreed to pay HTC for the costs incurred to sell investments in this feeder vehicle, 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. During the three and nine months ended September 30, 2016, we incurred $137,000 and $694,000 of expense, respectively, in connection with these agreements, which is included as a component of “acquisition and transaction related costs” on our consolidated statements of income.

 

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 6,790 square feet at 712 Fifth Avenue, our 50.0% owned unconsolidated joint venture.  During the three and nine months ended September 30, 2016, we recognized $101,000 and $305,000, respectively, for our pro rata share of rental income from this lease.

 

 

 

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 September 30, 2016, we believe we are in compliance with all of our covenants.

26

 

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PARAMOUNT GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

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 partner in the joint venture that owns 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 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 after the four-year anniversary of the sale of its interest in 718 Fifth Avenue (i.e., September 10, 2018) upon 12 months written notice with the actual purchase occurring no earlier than the five-year anniversary of such sale (i.e., September 10, 2019). If the put right is exercised and the 712 Fifth Avenue joint venture acquires the 50.0% tenancy-in-common interest in the property that will be held by our joint venture partner following the sale of its interest to our joint venture partner, we will own a 25.0% interest in 718 Fifth Avenue.

 

 

60 Wall Street - Option Agreement

 

We own an interest in 60 Wall Street, a 47-story, 1.6 million square foot office building, located in the heart of New York’s financial district through Fund II and Fund III, which collectively own an aggregate of 62.3% of a joint venture that owns the property, and the remainder is owned by the funds’ joint venture partner. In connection with the formation transactions, we entered into an option agreement with each of Fund II and Fund III pursuant to which we have the right to acquire their joint venture interests in the property. We have the right to acquire these interests at any time before November 24, 2016 (two years after the completion of the initial public offering) at a purchase price equal to (i) the fair value of the property (subject to a minimum floor price) as set forth in the option agreement, and (ii) the net assets and liabilities of the joint venture. We can acquire these interests for either cash, or shares of our common stock, based on the fair value at the time the option is exercised. Our acquisition of these interests upon exercise of the option will be subject to Fund II and Fund III obtaining all applicable consents or waivers, including the consent or waiver of any lenders or tenants to the extent required. The purchase option contains provisions wherein the purchase price could increase to the extent we enter into any new lease or lease amendment at the property within 90 days after the closing that would have resulted in the fair value of the property increasing by more than one percent if such lease or lease amendment had been in place as of the date used to determine the fair value of the property. If we were to exercise the option, we have agreed to provide our joint venture partner with the right to “tag-along” and transfer their interests in the joint venture that owns the property at the same purchase price. If we were to exercise the option and our joint venture partner did not exercise its right to “tag-along”, we would continue to act as the general partner of the joint venture that is in charge of the property’s day-to-day operations. We are currently evaluating various alternatives with respect to exercising our option.

 

 

 

 

27

 

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PARAMOUNT GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

 

Our determination of segments is primarily based on our method of internal reporting. On January 1, 2016, as a result of certain organizational and operational changes, we redefined our reportable segments to be 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. Accordingly, our reportable segments were separated by region based on the three regions in which we conduct our business: New York, Washington, D.C. and San Francisco. In connection therewith, we have reclassified the prior period segment financial data to conform to the current period presentation.

 

The following tables provide NOI for each reportable segment for the three and nine months ended September 30, 2016 and 2015.

 

 

 

28

 

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PARAMOUNT GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

The following table provides a reconciliation of NOI to net (loss) income attributable to common stockholders for the three and nine months ended September 30, 2016 and 2015.

 

The following table provides the selected balance sheet data for each of our reportable segments as of September 30, 2016.

 

 

 

 

On October 6, 2016, we completed an $850,000,000 financing of 1301 Avenue of the Americas, a 1.8 million square foot Class A office building in New York.  The five-year interest-only loan matures in October 2021, has two one-year extension options and has an initial weighted average interest rate of 2.77%, based on a $500,000,000 tranche at a fixed rate of 3.05% and a $350,000,000 tranche at a floating rate of LIBOR plus 180 basis points (2.36% at closing). We retained net proceeds of $827,187,000 after closing costs.

 

On October 6, 2016, we repaid the $274,337,000 mortgage loan on 900 Third Avenue, a 596,270 square foot Class A office building in New York. The loan was scheduled to mature in November 2017 and had a weighted average interest rate of 4.26%. In connection with the repayment, we incurred $7,729,000 of swap breakage costs.

 

On October 7, 2016, we repaid the $210,000,000 mortgage loan on Waterview, a 647,243 square foot office building in Washington, D.C. The loan was scheduled to mature in June 2017 and had a fixed interest rate of 5.76%.  In connection with the repayment, we incurred $4,734,000 of defeasance costs.  

 

 

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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. The 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, 2015.

 

 

Overview

 

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, Washington, D.C. and San Francisco. We conduct our business through, and substantially all of our interests 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 83.0% of, the Operating Partnership as of September 30, 2016.

 

Acquisitions

 

On September 12, 2016, we entered into an agreement to acquire One Front Street, a 651,000 square foot Class A office building, in San Francisco, California for $521,000,000. In connection therewith, we made a $50,000,000 non-refundable deposit, which is included in “other assets” on our consolidated balance sheet.  The transaction, which is subject to customary closing conditions, is expected to close by the end of the fourth quarter of 2016.

 

Financings

 

On October 6, 2016, we completed an $850,000,000 financing of 1301 Avenue of the Americas, a 1.8 million square foot Class A office building in New York.  The five-year interest-only loan matures in October 2021, has two one-year extension options and has an initial weighted average interest rate of 2.77%, based on a $500,000,000 tranche at a fixed rate of 3.05% and a $350,000,000 tranche at a floating rate of LIBOR plus 180 basis points (2.36% at closing).  We retained net proceeds of $330,387,000 after closing costs and the repayment of the existing debt at 900 Third Avenue and Waterview, including swap breakage and defeasance costs. We plan to use the remaining proceeds to fund a portion of the acquisition of One Front Street, which is expected to close by the end of the fourth quarter of 2016.

 

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Leasing Activity

 

Three Months Ended September 30, 2016

 

In the three months ended September 30, 2016, we leased 188,840 square feet at a weighted average initial rent of $60.91 per square foot. This leasing activity, offset by lease expirations during the three months, decreased portfolio wide leased occupancy by 60 basis points to 92.3% at September 30, 2016 from 92.9% at June 30, 2016. The decrease in leased occupancy was driven by lease expirations in our New York portfolio, partially offset by an increase in leased occupancy in our Washington, D.C. portfolio. Of the 188,840 square feet leased in the three months, 142,623 square feet represents second generation space (space that has been vacant for less than twelve months) for which we achieved rental rate increases of 29.7% on a GAAP basis and 6.1% on a cash basis.  The weighted average lease term for leases signed during the three months was 8.6 years and weighted average tenant improvements and leasing commissions on these leases were $5.44 per square foot per annum, or 8.9% of initial rent.  The rental rates for the three months ended September 30, 2016 includes the effect of a 36,580 square foot above-market lease in our New York portfolio that was terminated and subsequently released at market rates. Excluding the impact of this lease, we achieved rental rate increases of 31.0% and 22.6% on a GAAP basis and cash basis, respectively.

 

 

New York:

 

In the three months ended September 30, 2016, we leased 139,935 square feet in our New York portfolio, at a weighted average initial rent of $56.17 per square foot. This leasing activity, offset by lease expirations during the three months, caused our New York portfolio leased occupancy to decrease by 140 basis points to 90.4% at September 30, 2016 from 91.8% at June 30, 2016. Of the 139,935 square feet leased in the three months, 133,716 square feet represents second generation space for which we achieved rental rate increases of 26.1% on a GAAP basis and 4.7% on a cash basis. The weighted average lease term for leases signed during the three months was 8.1 years and weighted average tenant improvements and leasing commissions on these leases were $2.41 per square foot per annum, or 4.3% of initial rent. The rental rates for the three months ended September 30, 2016 includes the effect of the aforementioned 36,580 square foot above-market lease that was terminated and subsequently released at market rates. Excluding the impact of this lease, we achieved rental rate increases of 24.9% and 23.1% on a GAAP basis and cash basis, respectively, for our New York portfolio.

 

 

Washington, D.C.:

 

In the three months ended September 30, 2016, we leased 30,727 square feet in our Washington, D.C. portfolio, at a weighted average initial rent of $70.51 per square foot. This leasing activity during the three months caused our Washington, D.C. portfolio leased occupancy to increase by 190 basis points to 94.3% at September 30, 2016 from 92.4% at June 30, 2016.  All of the space leased in the three months was previously vacant.  The weighted average lease term for leases signed during the three months was 12.1 years and weighted average tenant improvements and leasing commissions on these leases were $14.70 per square foot per annum, or 20.8% of initial rent.

 

 

San Francisco:

 

In the three months ended September 30, 2016, we leased 18,178 square feet at One Market Plaza at a weighted average initial rent of $107.03 per square foot. This asset continues to remain very strongly leased at 98.8% as of September 30, 2016, an increase of 40 basis points from 98.4% at June 30, 2016.  All of the space leased in the three months represents second generation space, of which our pro rata share was 8,907 square feet, for which we achieved rental rate increases of 66.6% on a GAAP basis and 20.3% on a cash basis. The weighted average lease term for leases signed during the three months was 5.4 years and weighted average tenant improvements and leasing commissions on these leases were $7.13 per square foot per annum, or 6.7% of initial rent.

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The following table presents additional details on the leases signed during the three months ended September 30, 2016 and 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”).

 

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Nine Months Ended September 30, 2016

 

In the nine months ended September 30, 2016, we leased 492,687 square feet at a weighted average initial rent of $70.18 per square foot. This leasing activity, offset by lease expirations during the nine months, decreased portfolio wide leased occupancy by 300 basis points to 92.3% at September 30, 2016 from 95.3% at December 31, 2015. The decrease in leased occupancy was driven by lease expirations in our New York portfolio, partially offset by an increase in leased occupancy in our Washington, D.C. portfolio. Of the 492,687 square feet leased in the nine months, 275,719 square feet represents second generation space (space that has been vacant for less than twelve months) for which we achieved rental rate increases of 18.8% on a GAAP basis and 5.0% on a cash basis.  The weighted average lease term for leases signed during the nine months was 7.7 years and weighted average tenant improvements and leasing commissions on these leases were $6.79 per square foot per annum, or 9.7% of initial rent.  The rental rates for the nine months ended September 30, 2016 includes the effect of two above-market leases in our New York portfolio aggregating 89,135 square feet that were terminated and subsequently released at market rates.  Excluding the impact of these leases, we achieved rental rate increases of 25.3% and 24.1% on a GAAP basis and cash basis, respectively.

 

 

New York:

 

In the nine months ended September 30, 2016, we leased 361,033 square feet in our New York portfolio, at a weighted average initial rent of $68.02 per square foot. This leasing activity, offset by lease expirations during the nine months, caused our New York portfolio leased occupancy to decrease by 530 basis points to 90.4% at September 30, 2016 from 95.7% at December 31, 2015. Of the 361,033 square feet leased in the nine months, 243,741 square feet represents second generation space for which we achieved rental rate increases of 17.2% on a GAAP basis and 1.2% on a cash basis. The weighted average lease term for leases signed in the nine months was 7.7 years and weighted average tenant improvements and leasing commissions on these leases were $5.48 per square foot per annum, or 8.1% of initial rent. The rental rates for the nine months ended September 30, 2016 includes the effect of the aforementioned above-market leases aggregating 89,135 square feet that were terminated and subsequently released at market rates. Excluding the impact of these leases, we achieved rental rate increases of 24.1% and 20.9% on a GAAP basis and cash basis, respectively, for our New York portfolio.

 

 

Washington, D.C.:

 

In the nine months ended September 30, 2016, we leased 68,872 square feet in our Washington, D.C. portfolio, at a weighted average initial rent of $71.13 per square foot. This leasing activity increased our Washington, D.C. portfolio leased occupancy by 400 basis points to 94.3% at September 30, 2016 from 90.3% at December 31, 2015.  The majority of the space leased in the nine months ended September 30, 2016 was previously vacant.  The weighted average lease term for leases signed in the nine months was 8.4 years and weighted average tenant improvements and leasing commissions on these leases were $12.89 per square foot per annum, or 18.1% of initial rent.

 

 

San Francisco:

 

In the nine months ended September 30, 2016, we leased 62,782 square feet at One Market Plaza at a weighted average initial rent of $94.51 per square foot. This asset continues to remain very strongly leased at 98.8% as of September 30, 2016, an increase of 40 basis points from 98.4% at December 31, 2015. Of the 62,782 square feet leased in 2016, 28,045 square feet represents second generation space, for which we achieved rental rate increases of 33.8% on a GAAP basis and 41.4% on a cash basis. The weighted average lease term for leases signed in the nine months was 5.7 years and weighted average tenant improvements and leasing commissions on these leases were $5.81 per square foot per annum, or 6.1% of initial rent.

 

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The following table presents additional details on the leases signed during the nine months ended September 30, 2016 and is not intended to coincide with the commencement of rental revenue in accordance with GAAP.

 

 

35

 

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Financial Results

 

Three Months Ended September 30, 2016 and 2015

 

Net loss attributable to common stockholders was $139,000, or $0.00 per diluted share, for the three months ended September 30, 2016, compared to net income attributable to stockholders of $1,116,000, or $0.01 per diluted share, for the three months ended September 30, 2015. Funds from Operations (“FFO”) attributable to common stockholders was $50,615,000, or $0.23 per diluted share, for the three months ended September 30, 2016, compared to $51,810,000, or $0.24 per diluted share, for the three months ended September 30, 2015. FFO attributable to common stockholders for the three months ended September 30, 2016 and 2015 includes the impact of non-core items, which are listed in the table on page 62.  The aggregate of these items, net of amounts attributable to noncontrolling interests, increased FFO attributable to common stockholders for the three months ended September 30, 2016 and 2015 by $6,523,000 and $9,480,000, or $0.03 and $0.04 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 62, was $44,092,000, or $0.20 per diluted share, for the three months ended September 30, 2016, compared to $42,330,000, or $0.20 per diluted share, for the three months ended September 30, 2015.  

 

 

Nine Months Ended September 30, 2016 and 2015

 

Net loss attributable to common stockholders was $3,445,000, or $0.02 per diluted share, for the nine months ended September 30, 2016, compared to $13,324,000, or $0.06 per diluted share, for the nine months ended September 30, 2015.  FFO attributable to common stockholders was $154,106,000, or $0.71 per diluted share, for the nine months ended September 30, 2016, compared to $147,790,000, or $0.70 per diluted share, for the nine months ended September 30, 2015. FFO attributable to common stockholders for the nine months ended September 30, 2016 and 2015 includes the impact of non-core items, which are listed in the table on page 62.  The aggregate of these items, net of amounts attributable to noncontrolling interests, increased FFO attributable to common stockholders for the nine months ended September 30, 2016 and 2015 by $11,633,000 and $20,182,000, or $0.05 and $0.10 per diluted share, respectively. Core FFO attributable to common stockholders, which excludes the impact of the non-core items listed on page 62, was $142,473,000, or $0.66 per diluted share, for the nine months ended September 30, 2016, compared to $127,608,000, or $0.60 per diluted share for the nine months ended September 30, 2015.

 

See page 62 “Non-GAAP Financial Measures – Funds from Operations (“FFO”) and Core Funds From Operations (“Core FFO”)” for a reconciliation of net income to FFO attributable to common stockholders and Core FFO attributable to common stockholders and the reasons why we believe these non-GAAP measures are useful.

 

 

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Critical Accounting Policies

 

There were no material changes to our critical accounting policies disclosed in our Annual Report on Form 10-K for the year ended December 31, 2015.

 

 

Segment Reporting

 

Our determination of segments is primarily based on our method of internal reporting. On January 1, 2016, as a result of certain organizational and operational changes, we redefined our reportable segments to be 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. Accordingly, our reportable segments were separated by region based on the three regions in which we conduct our business: New York, Washington, D.C. and San Francisco. In connection therewith, we have reclassified the prior period segment financial data to conform to the current period presentation.

 

 

Recently Issued Accounting Literature

 

In May 2014, the Financial Accounting Standard’s Board (“FASB”) issued an Accounting Standards Update (“ASU”) (“ASU 2014-09”) to Accounting Standard Codification (“ASC”) Topic 606, Revenue from Contracts with Customers.  ASU 2014-09, which was subsequently amended by “ASU 2015-14,” “ASU 2016-08,” “ASU 2016-10” and “ASU 2016-12”, revises accounting guidance on revenue recognition and will supersede nearly all existing revenue recognition guidance under U.S. GAAP. The core principal of this guidance is that an entity should recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration which the entity expects to receive in exchange for those goods or services.  This guidance also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. This guidance is effective for fiscal years beginning after December 15, 2017, and for interim periods within those fiscal years, and can be applied using a full retrospective or modified retrospective approach. We are currently evaluating the impact of the adoption of this guidance on our consolidated financial statements.

 

In June 2014, the FASB issued an update (“ASU 2014-12”) Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period to ASC Topic 718, Compensation – Stock Compensation.  ASU 2014-12 requires an entity to treat performance targets that can be met after the requisite service period of a share-based award has ended, as a performance condition that affects vesting.  ASU 2014-12 is effective for interim and annual reporting periods in fiscal years that begin after December 15, 2015. We adopted the provisions of ASU 2014-12 on January 1, 2016, using the prospective method. This adoption did not have an impact on our consolidated financial statements.

 

In February 2015, the FASB issued an update (“ASU 2015-02”) Amendments to the Consolidation Analysis to ASC Topic 810, Consolidation. ASU 2015-02 modifies the evaluation of whether limited partnerships and similar legal entities are VIEs or voting interest entities, eliminates the presumption that a general partner should consolidate a limited partnership and affects the consolidation analysis of reporting entities that are involved with VIEs, particularly those that have fee arrangements and related party relationships. ASU 2015-02 is effective for interim and annual reporting periods in fiscal years that begin after December 15, 2015. We adopted the provisions of ASU 2015-02 on January 1, 2016, using the modified retrospective method. The adoption of ASU 2015-02 resulted in the deconsolidation of all of our real estate fund investments that were accounted for at fair value, except for Paramount Group Residential Development Fund, LP (the “Residential Fund”), which is accounted for at historical cost and will continue to be consolidated into our consolidated financial statements. See Note 4, Real Estate Fund Investments.

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In April 2015, the FASB issued an update (“ASU 2015-03”) Simplifying the Presentation of Debt Issuance Costs to ASC Topic 835, Interest – Imputation of Interest. ASU 2015-03 requires an entity to present debt issuance costs in the balance sheet as a direct deduction from the related debt liability rather than as an asset. Amortization of debt issuance costs will continue to be reported as interest expense. ASU 2015-03 is effective for interim and annual reporting periods in fiscal years that begin after December 15, 2015.  In August 2015, the FASB issued an update (“ASU 2015-15”) Interest – Imputation of Interest (Subtopic 835-30): Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements - Amendments to SEC Paragraphs Pursuant to Staff Announcement at 18 June 2015 EITF Meeting. ASU 2015-15 clarifies the exclusion of line-of-credit arrangements from the scope of ASU 2015-03. Therefore, debt issuance costs related to line-of-credit arrangements can be deferred and presented as an asset that is subsequently amortized over the time of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement. We adopted the provisions of ASU 2015-03 on January 1, 2016, and have retrospectively reclassified $18,914,000 of deferred financing costs that were included in “deferred charges, net” as of December 31, 2015, to “notes and mortgages payable, net”.  The deferred financing costs related to our $1.0 billion revolving credit facility continue to be reported as an asset on our consolidated balance sheets.

 

In September 2015, the FASB issued an update (“ASU 2015-16”) Simplifying the Accounting for Measurement-Period Adjustments to ASC Topic 805, Business Combinations. ASU 2015-16 eliminates the requirement to retrospectively account for adjustments made to provisional amounts recognized in a business combination. ASU 2015-16 is effective for interim and annual reporting periods in fiscal years that begin after December 15, 2015. We adopted the provisions of ASU 2015-16 on January 1, 2016, using the prospective method. This adoption did not have an impact on our consolidated financial statements.

 

In February 2016, the FASB issued an update (“ASU 2016-02”) Leases to ASC Topic 842, Leases. ASU 2016-02 supersedes the provision of leasing guidance and establishes a right-of-use model that requires a lessee to record a right-of-use asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either financing or operating. ASU 2016-02 requires lessors to account for leases using an approach that is substantially similar to existing guidance for sales-type leases, direct financing leases and operating leases. 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 are currently evaluating the impact of the adoption of ASU 2016-02 on our consolidated financial statements.

 

In March 2016, the FASB issued an update (“ASU 2016-09”) Improvements to Employee Share-Based Payment Accounting to ASC Topic 718, Compensation – Stock Compensation. ASU 2016-09 improves the accounting for share-based payments including income tax consequences and the classification of awards as either equity awards or liability awards. ASU 2016-09 is effective for interim and annual reporting periods in fiscal years that begin after December 15, 2016, with early adoption permitted. We are currently evaluating the impact of ASU 2016-09 on our consolidated financial statements.

 

In June 2016, the FASB issued an update (“ASU 2016-13”) Measurement of Credit Losses on Financial Instruments 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. ASU 2016-13 is effective for interim and annual reporting periods in fiscal years that begin after December 15, 2019, with early adoption permitted for fiscal years beginning after December 15, 2018. We are currently evaluating the impact of ASU 2016-13 on our consolidated financial statements.

 

In August 2016, the FASB issued an update (“ASU 2016-15”) Classification of Certain Cash Receipts and Cash Payments to ASC Topic 230, Statement of Cash Flows to provide guidance for areas where there is diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. ASU 2016-15 is effective for interim and annual reporting periods in fiscal years that begin after December 15, 2017, with early adoption permitted. We are currently evaluating the impact of ASU 2016-15 on our consolidated financial statements.

 

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Results of Operations – Three Months Ended September 30, 2016 Compared to September 30, 2015

 

The following pages summarize our consolidated results of operations for the three months ended September 30, 2016 and 2015.

 

 

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Revenues

 

Our revenues, which consist primarily of rental income, tenant reimbursement income, and fee and other income, were $171,318,000 for the three months ended September 30, 2016, compared to $167,726,000 for the three months ended September 30, 2015, an increase of $3,592,000. 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 acquisition and transaction related costs, were $143,918,000 for the three months ended September 30, 2016, compared to $141,159,000 for the three months ended September 30, 2015, an increase of $2,759,000. Below are the details of the increase (decrease) by segment.

 

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Income from Real Estate Fund Investments

 

Income from real estate fund investments was $10,933,000 for the three months ended September 30, 2015, and represents income from our consolidated real estate funds that were accounted for at fair value.  On January 1, 2016, we adopted ASU 2015-02 using the modified retrospective method, which resulted in the deconsolidation of these funds. The following table sets forth the details of income from these funds, including our share thereof.

 

 

 

 

Loss from Unconsolidated Real Estate Funds

 

Prior to January 1, 2016, these funds were consolidated into our consolidated financial statements and accordingly 100% of the income or loss from these funds was reported as “income from real estate fund investments” and the noncontrolling share of such income or loss was reflected as “net (income) loss attributable to noncontrolling interests in consolidated real estate funds”. On January 1, 2016, we adopted ASU 2015-02 using the modified retrospective method, which required us to deconsolidate all of our real estate funds that were previously accounted for at fair value, except for our Residential Fund, which is accounted for at historical cost and will continue to be consolidated into our consolidated financial statements.  The following table sets forth the details of loss from unconsolidated real estate funds.

 

 

 

 

 

Income from Unconsolidated Joint Ventures

 

Income from unconsolidated joint ventures was $1,792,000 for the three months ended September 30, 2016, compared to $1,458,000 for the three months ended September 30, 2015, an increase of $334,000.  This increase was primarily due to higher income attributable to 712 Fifth Avenue, of which our share was $339,000.

 

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Interest and Other Income (Loss), net

 

Interest and other income was $2,299,000 for the three months ended September 30, 2016, compared to a loss of $1,763,000 for the three months ended September 30, 2015, an increase in income of $4,062,000. This increase resulted from:

 

 

 

Interest and Debt Expense

 

Interest and debt expense was $38,278,000 for the three months ended September 30, 2016, compared to $42,821,000 for the three months ended September 30, 2015, a decrease of $4,543,000.  This decrease resulted primarily from (i) $3,619,000 of lower interest from the $1.0 billion refinancing of 1633 Broadway in December 2015 and (ii) $682,000 of lower interest from the expiration of certain interest rate swaps at 900 Third Avenue in November 2015.

 

 

Unrealized Gain on Interest Rate Swaps

 

Unrealized gain on interest rate swaps represent the change in the fair value of the interest rate swap derivative instruments that are not designated as hedges. Unrealized gain on interest rate swaps was $12,728,000 for the three months ended September 30, 2016, compared to $15,772,000 for the three months ended September 30, 2015, a decrease of $3,044,000. This decrease was primarily due to (i) $6,886,000 of unrealized gains in 2015 relating to swaps aggregating $772,100,000 that were terminated in connection with the refinancing of 1633 Broadway in December 2015 and (ii) $1,899,000 of unrealized gains in 2015 relating to swaps aggregating $237,600,000 that were terminated in connection with the refinancing of 31 West 52^nd Street in May 2016, partially offset by (iii) $5,080,000 of higher unrealized gains in 2016 relating to swaps aggregating $840,000,000 on One Market Plaza due to increase in LIBOR rates.

 

 

Income Tax Expense

 

Income tax expense was $218,000 for the three months ended September 30, 2016, compared to $789,000 for the three months ended September 30, 2015, a decrease of $571,000.  This decrease was primarily due to lower taxable income attributable to our taxable REIT subsidiaries.

 

 

Net (Income) Loss Attributable to Noncontrolling Interests in Consolidated Real Estate Funds

 

Net loss attributable to noncontrolling interests in consolidated real estate funds was $67,000 for the three months ended September 30, 2016, compared to income attributable to noncontrolling interest of $7,936,000 for the three months ended September 30, 2015, a decrease in income attributable to the noncontrolling interests of $8,003,000. The current period net loss is attributable to noncontrolling interests in our Residential Fund, which continues to be consolidated into our consolidated financial statements and is accounted for at historical cost.  The prior period net income was comprised of (i) $8,763,000 of income attributable to the noncontrolling interest in our consolidated real estate funds that were accounted for at fair value, partially offset by (ii) $827,000 of loss attributable to noncontrolling interests in our Residential Fund. The decrease in the current period resulted primarily from the deconsolidation of our real estate funds that were accounted for at fair value pursuant to our adoption of ASU 2015-02 on January 1, 2016 using the modified retrospective method.  

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Net Income Attributable to Noncontrolling Interests in Consolidated Joint Ventures

 

Net income attributable to noncontrolling interest in consolidated joint ventures was $4,703,000 for the three months ended September 30, 2016, compared to $33,000 for the three months ended September 30, 2015, an increase of $4,670,000. The net income attributable to noncontrolling interests in consolidated joint ventures for the three months ended September 30, 2016 is comprised of (i) $1,105,000 of income attributable to the noncontrolling interests in our consolidated preferred equity investment, PGRESS Equity Holdings L.P., which was acquired in December 2015 and (ii) $3,598,000 of income attributable to the noncontrolling interests in our consolidated joint venture property, One Market Plaza.  The net income attributable to noncontrolling interests in consolidated joint ventures of $33,000 for the three months ended September 30, 2015 was comprised of (i) $305,000 of income attributable to the noncontrolling interests in 31 West 52^nd Street, which was acquired by us on October 1, 2015, partially offset by (ii) $272,000 of net loss attributable to the noncontrolling interests in our consolidated joint venture property, One Market Plaza.  

 

 

Net (Income) Loss Attributable to Noncontrolling Interests in Operating Partnership

Net loss attributable to noncontrolling interests in Operating Partnership was $28,000 for the three months ended September 30, 2016, compared to net income attributable to noncontrolling interest in Operating Partnership of $272,000 for the three months ended September 30, 2015, a decrease in income attributable to noncontrolling interests of $300,000. This decrease resulted from lower income subject to allocation to the unitholders of the Operating Partnership.

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Results of Operations – Nine Months Ended September 30, 2016 Compared to September 30, 2015

 

The following pages summarize our consolidated results of operations for the nine months ended September 30, 2016 and 2015.

 

 

 

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Revenues

 

Our revenues, which consist primarily of rental income, tenant reimbursement income, and fee and other income, were $516,539,000 for the nine months ended September 30, 2016, compared to $491,880,000 for the nine months ended September 30, 2015, an increase of $24,659,000. Below are the details of the increase by segment.

 

 

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Expenses

 

Our expenses, which consist primarily of operating, depreciation and amortization, general and administrative, and acquisition and transaction related costs, were $436,499,000 for the nine months ended September 30, 2016, compared to $444,921,000 for the nine months ended September 30, 2015, a decrease of $8,422,000. Below are the details of the (decrease) increase by segment.

 

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Income from Real Estate Fund Investments

 

Income from real estate fund investments was $30,226,000 for the nine months ended September 30, 2015, and represents income from our consolidated real estate funds that were accounted for at fair value.  On January 1, 2016, we adopted ASU 2015-02 using the modified retrospective method, which resulted in the deconsolidation of these funds. The following table sets forth the details of income from these funds, including our share thereof.

 

 

 

 

Loss from Unconsolidated Real Estate Funds

 

Loss from unconsolidated real estate funds was $2,540,000 for the nine months ended September 30, 2015 and is comprised of a loss of $2,637,000 from Property Funds, partially offset by income of $97,000 from our Alternative Investment Fund. Prior to January 1, 2016, these funds were consolidated into our consolidated financial statements and accordingly 100% of the income or loss from these funds was reported as “income from real estate fund investments” and the noncontrolling share of such income or loss was reflected as “net (income) loss attributable to noncontrolling interests in consolidated real estate funds”. On January 1, 2016, we adopted ASU 2015-02 using the modified retrospective method, which required us to deconsolidate all of our real estate funds that were previously accounted for at fair value, except for our Residential Fund, which is accounted for at historical cost and will continue to be consolidated into our consolidated financial statements.  The following table sets forth the details of loss from unconsolidated real estate funds.

 

 

 

 

 

Income from Unconsolidated Joint Ventures

 

Income from unconsolidated joint ventures was $5,291,000 for the nine months ended September 30, 2016, compared to $4,444,000 for the nine months ended September 30, 2015, an increase of $847,000. This increase was primarily attributable to an increase in our share of income from 712 Fifth Avenue of $875,000 primarily due to lower interest expense resulting from the expiration of interest rate swaps on $90,000,000 of debt in March 2015 and higher income from tenant requested work.  This increase was offset by a decrease in our share of income from Oder-Center of $28,000 primarily due to a decrease in operating income of the property.

 

 

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Interest and Other Income (Loss), net

 

Interest and other income was $5,029,000 for the nine months ended September, 2016, compared to a loss of $397,000 for the nine months ended September 30, 2015, an increase of income of $5,426,000. This increase resulted from:

 

 

Interest and Debt Expense

 

Interest and debt expense was $113,406,000 for the nine months ended September 30, 2016, compared to $126,945,000 for the nine months ended September 30, 2015, a decrease of $13,539,000.  This decrease resulted primarily from (i) $10,364,000 of lower interest from the $1.0 billion refinancing of 1633 Broadway in December 2015, (ii) $1,937,000 of lower interest from the refinancing of 31 West 52^nd Street and (iii) $1,838,000 of lower interest expense from the expiration of interest rate swaps at 900 Third Avenue in November 2015, on $93,000,000 of debt.

 

 

Unrealized Gain on Interest Rate Swaps

 

Unrealized gain on interest rate swaps represent the change in the fair value of the interest rate swap derivative instruments that are not designated as hedges. Unrealized gain on interest rate swaps was $29,661,000 for the nine months ended September 30, 2016, compared to $49,497,000 for the nine months ended September 30, 2015, a decrease of $19,836,000. The decrease was primarily due to (i) $20,148,000 of unrealized gains in 2015 relating to swaps aggregating $772,100,000 that were terminated in connection with the refinancing of 1633 Broadway in December 2015 and (ii) $5,014,000 of lower unrealized gains relating to swaps aggregating $237,600,000 that were terminated in connection with the refinancing of 31 West 52^nd Street in May 2016, partially offset by (iii) $5,969,000 of higher unrealized gains in 2016 relating to swaps aggregating $840,000,000 on One Market Plaza due to increase in LIBOR rates.

 

 

Income Tax Benefit (Expense)

 

Income tax benefit was $817,000 for the nine months ended September 30, 2016, compared to an expense of $2,706,000 for the nine months ended September 30, 2015, an increase in benefit of $3,523,000.  This increase is primarily due to a benefit recognized in the nine months ended September 30, 2016 as result of a change in position for filing the unincorporated business tax returns for our Washington, D.C. properties and lower taxable income attributable to our taxable REIT subsidiaries.

 

 

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Net (Income) Loss Attributable to Noncontrolling Interests in Consolidated Real Estate Funds

 

Net loss attributable to noncontrolling interests in consolidated real estate funds was $819,000 for the nine months ended September 30, 2016, compared to income attributable to noncontrolling interest of $16,677,000 for the nine months ended September 30, 2015, a decrease in income attributable to the noncontrolling interests of $17,496,000. The current period net loss is attributable noncontrolling interests in our Residential Fund, which continues to be consolidated into our consolidated financial statements and is accounted for at historical cost.  The prior period net income was comprised of (i) $19,283,000 of income attributable to the noncontrolling interest in our consolidated real estate funds that were accounted for at fair value, partially offset by (ii) $2,606,000 of net loss attributable to noncontrolling interests in our Residential Fund. The decrease in the current period resulted primarily from the deconsolidation of our real estate funds that were accounted for at fair value pursuant to our adoption of ASU 2015-02 on January 1, 2016 using the modified retrospective method.  

 

 

Net Income Attributable to Noncontrolling Interests in Consolidated Joint Ventures

 

Net income attributable to noncontrolling interests in consolidated joint ventures was $10,062,000 of income for the nine months ended September 30, 2016, compared to $964,000 for the nine months ended September 30, 2015, an increase of $9,098,000. The net income attributable to noncontrolling interests in consolidated joint ventures for the nine months ended September 30, 2016, is comprised of (i) $3,252,000 of income attributable to the noncontrolling interests in our consolidated preferred equity investment, PGRESS Equity Holdings L.P., which was acquired in December 2015 and (ii) $6,810,000 of income attributable to the noncontrolling interests in our consolidated joint venture property, One Market Plaza.  The net income of $964,000 for the nine months ended September 30, 2015 was comprised of (i) $1,328,000 of net income attributable to the noncontrolling interests in 31 West 52^nd Street, which was acquired by us on October 1, 2015, partially offset by (ii) $364,000 of net loss attributable to the noncontrolling interests in our consolidated joint venture property, One Market Plaza.  

 

 

Net Loss Attributable to Noncontrolling Interests in Operating Partnership

Net loss attributable to noncontrolling interests in Operating Partnership was $906,000 for the nine months ended September 30, 2016, compared to $3,239,000 for the nine months ended September 30, 2015, a decrease of $2,333,000. This decrease resulted from lower losses subject to allocation to the unitholders of the Operating Partnership.

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Liquidity and Capital Resources

Our primary sources of liquidity include existing cash balances, cash flow from operations and borrowings available under our $1.0 billion revolving credit facility, which could be increased to $1.25 billion, subject to certain conditions. 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, and the issuance of long-term debt or equity.

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.

 

 

Liquidity

 

As of September 30, 2016, we had $863,585,000 of liquidity comprised of $83,281,000 of cash and cash equivalents, $30,304,000 of restricted cash and $750,000,000 of borrowing capacity under our $1.0 billion revolving credit facility.  

 

As of September 30, 2016, our outstanding consolidated debt (including amounts outstanding under our revolving credit facility) aggregated $3.089 billion.  In October 2016, we completed an $850,000,000 financing of 1301 Avenue of the Americas and used the net proceeds to repay our 2017 debt maturities at 900 Third Avenue and Waterview, including swap breakage and defeasance costs.  In connection therewith, we retained net proceeds of $330,387,000, which will be used fund a portion of the previously announced acquisition of One Front Street, which is expected to close by the end of the fourth quarter of 2016.

 

 

Dividend Policy

 

On September 15, 2016, we declared a regular quarterly cash dividend of $0.095 per share of common stock for the third quarter ending September 30, 2016, which was paid on October 14, 2016 to stockholders of record as of the close of business on September 30, 2016.  This dividend policy, if continued, would require us to pay out approximately $25,200,000 each quarter to common stockholders and unitholders.

 

 

Off Balance Sheet Arrangements

As of September 30, 2016, our unconsolidated joint ventures had $269,637,000 of outstanding indebtedness, of which our share was $125,448,000. We do not guarantee the indebtedness of unconsolidated joint ventures other than providing customary environmental indemnities and guarantees of specified non-recourse carveouts 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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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 of 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 requires 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 September 30, 2016, we believe we are in compliance with all of our covenants.

 

 

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 were $83,281,000 and $143,884,000 as of September 30, 2016 and December 31, 2015, respectively, a decrease of $60,603,000.  Our December 31, 2015 cash and cash equivalents included $7,987,000 relating to our real estate funds, which were deconsolidated as of January 1, 2016.  Excluding the impact of deconsolidation of these real estate funds, cash and cash equivalents decreased by $52,616,000. The following table sets forth the changes in cash flow.

 

 

 

Operating Activities

 

Nine months ended September 30, 2016 – We generated $69,954,000 of cash from operating activities for the nine months ended September 30, 2016, primarily from (i) $121,046,000 of net income (after $116,154,000 of noncash adjustments) and (ii) $5,938,000 of distributions from unconsolidated joint ventures and real estate funds, partially offset by (iii) $57,030,000 of net changes in operating assets and liabilities.  Noncash adjustments of $116,154,000 were primarily comprised of depreciation and amortization, straight-lining of rental income and unrealized gain on interest rate swaps.  The net changes in operating assets and liabilities were primarily due to prepaid real estate taxes and additions to deferred charges.

 

Nine months ended September 30, 2015 – We generated $58,216,000 of cash from operating activities for the nine months ended September 30, 2015, primarily from (i) $116,499,000 of net income (after $115,421,000 of noncash adjustments) and (ii) $3,102,000 of distributions from unconsolidated joint ventures, partially offset by (iii) $61,385,000 of net changes in operating assets and liabilities. Noncash adjustments of $115,421,000 were primarily comprised of depreciation and amortization, straight-lining of rental income and unrealized gain on interest rate swaps and realized and unrealized net gains on real estate fund investments.  The net changes in operating assets and liabilities were primarily due to prepaid real estate taxes and additions to deferred charges.

 

 

Investing Activities

 

Nine months ended September 30, 2016 – We used $146,955,000 of cash for investing activities for the nine months ended September 30, 2016, primarily due to (i) $107,445,000 of additions to rental properties, which was comprised of spending for tenant improvements and other building improvements, (ii) $50,000,000 deposit on rental property, (iii) $1,084,000 of contributions to unconsolidated real estate funds, partially offset by (iv) $11,380,000 decrease in restricted cash.

 

Nine months ended September 30, 2015 – We used $95,436,000 of cash for investing activities for the nine months ended September 30, 2015, primarily due to (i) $68,484,000 of additions to rental properties, and a (ii) $26,971,000 increase in restricted cash.

 

 

Financing Activities

 

Nine months ended September 30, 2016 – We generated $24,385,000 of cash from financing activities for the nine months ended September 30, 2016, primarily from (i) $509,578,000 of proceeds from notes and mortgages payable, primarily from the refinancing of 31 West 52nd Street and (ii) $110,000,000 of borrowings under the revolving credit facility, partially offset by (iii) $414,564,000 of repayments of notes and mortgages payable, primarily for the repayment of 31 West 52nd Street loan, (iv) $80,000,000 of repayments of the amounts borrowed under the revolving credit facility, (v) $75,365,000 of dividends and distributions paid to common stockholders and unitholders, (vi) $16,040,000 for the settlement of swap liabilities and (vii) $6,532,000 for the payment of debt issuance costs.

 

Nine months ended September 30, 2015 – We generated $16,716,000 of cash from financing activities for the nine months ended September 30, 2015, primarily from (i) $133,111,000 of contributions from noncontrolling interests, partially offset by (ii) $60,396,000 of dividends and distributions paid to common stockholders and unitholders and (iii) $54,975,000 of distributions to noncontrolling interests.

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Non-GAAP Financial Measures

 

We use and present NOI, Cash 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.

 

Net Operating Income (“NOI”)

 

We use NOI to measure the operating performance of our properties.  NOI consists of property-related revenue (which includes rental income, tenant reimbursement income and certain other income) less operating expenses (which includes building 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 our pro rata 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 these metrics 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 the property level. Other real estate companies may use different methodologies for calculating NOI and Cash NOI, and accordingly, our presentation of NOI and Cash NOI may not be comparable to other real estate companies.

 

The following tables present reconciliations of net income (loss) to NOI and Cash NOI for the three and nine months ended September 30, 2016 and 2015.

 

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Same Store NOI

 

The tables below set forth the reconciliations of our pro rata share of NOI to Same Store NOI and Same Store Cash NOI for the three months ended September 30, 2016 and 2015. 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 Cash NOI excludes the effect of non-cash items such as the straight-lining of rental revenue and the amortization of above and below-market leases.

 

 

 

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The following tables set forth reconciliations of our pro rata share of NOI to Same Store NOI and Same Store Cash NOI for the nine months ended September 30, 2016 and 2015.

 

 

 

 

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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 GAAP net income or loss adjusted to exclude net gains from sales of depreciated real estate assets, impairment losses on depreciable real estate and depreciation and amortization expense from real estate assets, including the pro rata 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 acquisition and transaction related costs, unrealized gains or losses on interest rate swaps, severance costs and defeasance and debt breakage costs, 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. Other REITs may use different methodologies for calculating FFO and Core FFO or use other definitions of FFO and Core FFO and, accordingly, our presentation of these measures may not be comparable to other real estate companies.  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.

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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 September 30, 2016.

 

 

In addition to the above, our unconsolidated joint ventures had $269,637,000 of outstanding indebtedness as of September 30, 2016, of which our share was $125,448,000.

The following table summarizes our fixed rate debt that has been swapped from floating rate to fixed as of September 30, 2016.

 

 

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The following table summarizes our pro rata 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. 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, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

As of September 30, 2016, 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 at the end of the period covered by this Report. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded, as of that time, 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.

 

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 September 30, 2016, 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, 2015.

 

 

 

None.

 

 

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 attached 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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EXHIBIT INDEX

 

 

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