NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2017
(unaudited)
Note 1—Organization
Parkway, Inc. (the “Company”) is an independent, publicly traded, self-managed real estate investment trust (“REIT”) that owns and operates high-quality office properties located in submarkets in Houston, Texas. At June 30, 2017, the Company owned or had an interest, including an interest held in an unconsolidated joint venture, in a portfolio consisting of
five
assets comprising
19
buildings and totaling approximately
8.7 million
rentable square feet (unaudited) in the Galleria, Greenway and Westchase submarkets of Houston, providing geographic focus and significant operational scale and efficiencies.
In addition, the Company operates a fee-based real estate service (the “Third-Party Services Business” and together with the Houston real properties, the “Houston Business”) through a wholly owned subsidiary, Eola Office Partners, LLC and its wholly owned subsidiaries (collectively, “Eola”), which managed in total approximately
8.7 million
square feet, including
5.0 million
square feet related to interests held in an unconsolidated joint venture and the remainder related to properties held by third-party property owners. Unless otherwise indicated, all references to square feet represent net rentable square feet.
The Company’s Pending Merger with the Canada Pension Plan Investment Board
On June 29, 2017, the Company, Parkway LP and certain subsidiaries of the Canada Pension Plan Investment Board (“CPPIB”) entered into an agreement and plan of merger (the “Merger Agreement”) pursuant to which CPPIB will acquire
100%
of the Company for
$1.2 billion
, or
$23.05
per share. The
$23.05
per share cash consideration consists of
$19.05
per share plus a
$4.00
per share special dividend to be paid prior to closing. The transaction is not subject to a financing condition and is expected to close in the fourth quarter of 2017, subject to customary closing conditions, including approval by the Company's stockholders.
The Company’s Spin-Off from Cousins
On October 7, 2016, Cousins Properties Incorporated (“Cousins”) completed the spin-off of the Company by distributing all of the Company’s outstanding shares of common and limited voting stock to the holders of Cousins common and limited voting preferred stock as of the record date, October 6, 2016 (the “Spin-Off”). The Spin-Off was effected pursuant to that certain Agreement and Plan of Merger (the “Legacy Parkway Merger Agreement”), dated as of April 28, 2016, by and among Parkway Properties, Inc. (“Legacy Parkway”), Parkway Properties LP (“Parkway LP”), Cousins and Clinic Sub Inc., a wholly owned subsidiary of Cousins, and pursuant to that certain Separation, Distribution and Transition Services Agreement (the “Separation and Distribution Agreement”), dated as of October 5, 2016, among the Company, Cousins and certain other parties thereto.
Prior to the Spin-Off, the Company was incorporated on June 3, 2016 as a wholly owned subsidiary of Legacy Parkway. On October 6, 2016, pursuant to the Legacy Parkway Merger Agreement, Legacy Parkway merged with and into Clinic Sub Inc., with Clinic Sub Inc. continuing as the surviving corporation and a wholly owned subsidiary of Cousins (the “Legacy Parkway Merger”). In connection with the Legacy Parkway Merger, the Company became a subsidiary of Cousins. Immediately following the effective time of the Legacy Parkway Merger, in accordance with the Legacy Parkway Merger Agreement, Cousins separated the portion of its combined businesses relating to the ownership of real properties in Houston, Texas, as well as Legacy Parkway’s Third-Party Services Business, from the remainder of the combined businesses (the “Separation”). In connection with the Separation, the Company and Cousins reorganized the businesses through a series of transactions (the “UPREIT Reorganization”), pursuant to which the Houston Business was transferred to the Company, and the remainder of the combined business was transferred to Cousins Properties LP, a Delaware limited partnership (“Cousins LP”), the operating partnership of Cousins. Following the Separation and UPREIT Reorganization, Cousins effected the Spin-Off on October 7, 2016.
Greenway Properties Joint Venture
On February 17, 2017, the Company, through Parkway Operating Partnership LP (the “Operating Partnership”) and certain other subsidiaries, entered into an Omnibus Contribution and Partial Interest Assignment Agreement (the “Contribution Agreement”) with an affiliate of CPPIB and an entity controlled by TH Real Estate Global Asset Management and Silverpeak Real Estate Partners (“TIAA/SP”). Pursuant to the Contribution Agreement, on April 20, 2017, the Company completed the sale of an aggregate
49%
interest in Greenway Plaza and Phoenix Tower (collectively, the “Greenway Properties”). As a result, the Operating Partnership, through a joint venture with CPPIB and TIAA/SP (the “Greenway Properties joint venture”), owns a
51%
indirect interest in the Greenway Properties (with
1%
held by a subsidiary acting as the general partner of the Greenway Properties
joint venture and
50%
held by a subsidiary acting as a limited partner of the Greenway Properties joint venture), and each of CPPIB and TIAA/SP owns a
24.5%
indirect interest. While the Company has significant influence over the operations of the Greenway Properties joint venture, CPPIB and TIAA/SP hold substantive participating rights. As a result, the Company deconsolidated the Greenway Properties, and the retained interest is accounted for under the equity method. During the six months ended June 30, 2017, the Company recorded a
$15.0 million
impairment loss on real estate in connection with the excess of its carrying value over its estimated fair value, less costs to sell, of the properties related to the Greenway Properties joint venture.
On April 17, 2017, certain subsidiaries of the Greenway Properties joint venture (collectively, the “Borrowers”) entered into a loan agreement (the “Loan Agreement”) with Goldman Sachs Mortgage Company (“Lender”).The Loan Agreement, which was executed while the Borrowers were still wholly-owned subsidiaries of the Company, provides for a loan in the original principal amount of
$465 million
(the “Loan”), and was fully funded to the Operating Partnership at the initial closing of the Greenway Properties joint venture on April 17, 2017. The Operating Partnership used the proceeds of the Loan to (i) repay all amounts outstanding under the Company’s Credit Agreement, dated as of October 6, 2016, by and among the Operating Partnership, as borrower, the Company, Bank of America, N.A., as Administrative Agent, and the lenders party thereto (the “Credit Agreement”), providing for a
three
-year,
$100 million
senior secured revolving credit facility (the “Revolving Credit Facility”), and a
three
-year,
$350 million
senior secured term loan facility (the “Term Loan” and, together with the Revolving Credit Facility, the “Credit Facility”), and (ii) to fund a credit to the Greenway Properties joint venture with respect to certain outstanding contractual lease obligations and in-process capital expenditures. The Loan has a term of
five
years, maturing on May 6, 2022, and bears interest at a rate of
3.8%
per annum. The Loan is secured by, among other things, a first priority mortgage lien against the Borrowers’ fee simple interest in the Greenway Properties (other than the Phoenix Tower asset).
Immediately following the execution of the Loan Agreement and funding of proceeds to the Operating Partnership, CPPIB and TIAA/SP each acquired a
24.5%
interest in the Borrowers, and the assets and liabilities, including the Loan, were deconsolidated by the Company. The Greenway Properties joint venture also assumed the existing mortgage debt secured by Phoenix Tower, which had an outstanding balance of approximately
$75.9 million
at April 17, 2017 and matures on March 1, 2023. The Company recorded a non-cash loss on extinguishment of debt of approximately
$7.6 million
during the three and six months ended June 30, 2017 related to the termination of the Credit Facility.
Note 2—Basis of Presentation and Summary of Significant Accounting Policies
Basis of Presentation and Principles of Consolidation
The Company, through its wholly owned subsidiary Parkway Properties General Partners, Inc. (“PPGP”), is the sole, indirect general partner of the Operating Partnership and, as of June 30, 2017, owned a
98.2%
interest in the Operating Partnership directly and through its subsidiaries PPGP and Parkway LP. The remaining
1.8%
interest is indirectly held by certain persons through their limited partnership interests in Parkway LP. As the sole, indirect general partner of the Operating Partnership, the Company has full and complete authority over the Operating Partnership’s operations and management.
The accompanying unaudited consolidated financial statements have been prepared by the Company’s management (“management”) in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and the requirements of the Securities and Exchange Commission (“SEC”).
The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. The Company also consolidates subsidiaries where the entity is a variable interest entity (a “VIE”) and the Company is the primary beneficiary because it has the power to direct the activities of the VIE and has the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE. The Operating Partnership was determined to be a VIE, and the Company is considered to be the primary beneficiary. All significant intercompany transactions and accounts have been eliminated in the accompanying financial statements.
The equity method of accounting is used for those joint ventures that do not meet the criteria for consolidation and where the Company does not control these joint ventures, but exercises significant influence. The cost method of accounting is used for investments in which the Company does not have significant influence. These investments are reviewed for impairment when indicators of impairment exist.
The accompanying unaudited consolidated financial statements reflect all adjustments that are, in the opinion of management, necessary for a fair presentation of the results for the interim period presented. All such adjustments are of a normal recurring nature. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could
differ from these estimates. Operating results for the three and six months ended June 30, 2017 are not necessarily indicative of the results that may be expected for the year ending December 31, 2017. These financial statements should be read in conjunction with the Annual Report on Form 10-K for the year ended December 31, 2016 and the audited financial statements included therein and the notes thereto.
The balance sheet at December 31, 2016 has been derived from the audited financial statements as of that date but does not include all of the information and footnotes required by GAAP for complete financial statements.
The Company’s operations are exclusively in the real estate industry and principally involve the operation, leasing, acquisition and ownership of office buildings in Houston, Texas.
Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers (Topic 606)” (“ASU 2014-09”). The objective of ASU 2014-09 is to establish a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and will supersede most of the existing revenue recognition guidance, including industry-specific guidance. The core principle is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The Company's revenues that will be impacted by this standard include revenues earned from fee-based real estate services, sales of real estate assets including land parcels and operating properties and other ancillary income. The Company expects that the amount and timing of revenue recognition from its fee-based real estate services referenced above will be generally consistent with its current measurement and pattern of recognition. The Company currently anticipates utilizing the modified retrospective method of adoption on January 1, 2018 and continues to evaluate the adoption impacts of this standard.
In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842)” (“ASU 2016-02”). ASU 2016-02 requires companies to recognize lease assets and lease liabilities of lessees on the balance sheet and disclose key information about leasing arrangements. Lessor accounting will remain substantially similar to the current accounting; however, certain refinements were made to conform the standard with the recently issued revenue recognition guidance in ASU 2014-09, specifically related to the allocation and recognition of contract consideration earned from lease and non-lease revenue components. Additionally, certain leasing costs that are eligible to be capitalized as initial direct costs are also limited by ASU 2016-02. The Company expects to adopt this guidance effective January 1, 2019 and will utilize the modified retrospective method of adoption. Substantially all of the Company's revenues are earned from arrangements that are within the scope of ASU 2016-02, thus we anticipate that the timing of recognition and financial statement presentation of certain revenues, including revenues that related to consideration from non-lease components, may be affected. The Company is still assessing the impact of adopting this guidance.
In January 2017, the FASB issued ASU 2017-01, “Business Combinations (Topic 805)” (“ASU 2017-01”). ASU 2017-01 clarifies the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The guidance is effective for periods beginning after December 15, 2017, including interim periods within those periods. The Company adopted this standard prospectively as of January 1, 2017.
In February 2017, the FASB issued ASU 2017-05, “Other Income—Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20)” (“ASU 2017-05”). ASU 2017-05 clarifies the scope of asset derecognition guidance and accounting for partial sales of nonfinancial assets. Partial sales of nonfinancial assets are common in the real estate industry and include transactions in which the seller retains an equity interest in the entity that owns the assets or has an equity interest in the buyer. ASU 2017-05 requires the re-measurement to fair value of a retained interest in a partial sale. The guidance is effective for annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. The Company is currently assessing the impact of this guidance.
Note 3—Real Estate Related Investments, Net
At June 30, 2017, real estate related investments, net consisted of CityWestPlace, San Felipe Plaza, and Post Oak Central, which are indirectly wholly owned by the Company, were comprised of
eight
buildings totaling approximately
3.7 million
rentable square feet, located in the Galleria and Westchase submarkets of Houston. At December 31, 2016, real estate related investments, net consisted of
five
office assets located in the Galleria, Greenway and Westchase submarkets of Houston, comprising
19
buildings and
two
adjacent parcels of land totaling approximately
8.7 million
rentable square feet.
Balances of major classes of depreciable assets and their respective estimated useful lives are (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Asset Category
|
|
Useful Life
|
|
June 30,
2017
|
|
December 31,
2016
|
|
Land
|
|
Non-depreciable
|
|
$
|
134,978
|
|
|
$
|
417,315
|
|
|
Buildings and garages
|
|
7 to 40 years
|
|
529,642
|
|
|
1,095,815
|
|
|
Building improvements
|
|
5 to 40 years
|
|
24,593
|
|
|
55,093
|
|
|
Tenant improvements
|
|
Lesser of useful life or term of lease
|
|
93,386
|
|
|
296,445
|
|
|
|
|
|
|
$
|
782,599
|
|
|
$
|
1,864,668
|
|
The Company is geographically concentrated in Houston, Texas. For the three months ended June 30, 2017, four tenants in the Company's wholly owned portfolio represented
15.1%
,
11.1%
,
6.0%
and
5.5%
of income from office properties, respectively. For the six months ended June 30, 2017, three tenants in the Company's wholly owned portfolio represented
10.7%
,
8.5%
and
7.8%
of income from office properties, respectively.
Note 4—Investment in Unconsolidated Joint Venture
As of June 30, 2017, in addition to the
eight
buildings included in the consolidated financial statements, the Company also invested in the Greenway Properties joint venture, comprising
11
buildings and totaling approximately
5.0 million
rentable square feet in the Greenway submarket of Houston. As of June 30, 2017, the Company's net investment in the Greenway Properties joint venture was
$264.0 million
. The assets (including identifiable intangible assets) and liabilities for the Greenway Properties joint venture were recorded at their respective fair values as of April 17, 2017. The following table summarizes the balance sheet of the Greenway Properties joint venture at June 30, 2017 (in thousands):
|
|
|
|
|
|
|
|
|
June 30, 2017
|
|
Assets
|
|
|
Real estate related investments:
|
|
|
|
Office properties
|
$
|
923,334
|
|
|
Accumulated depreciation
|
(7,730
|
)
|
|
Total real estate related investments, net
|
915,604
|
|
|
|
|
|
Cash and cash equivalents
|
22,828
|
|
|
Receivables and other assets
|
105,280
|
|
|
In-place lease intangibles, net of accumulated amortization of $6,230
|
118,242
|
|
|
Other intangible assets, net of accumulated amortization of $781
|
18,741
|
|
|
Total assets
|
$
|
1,180,695
|
|
|
|
|
|
Liabilities
|
|
|
Mortgage notes payable, net
|
$
|
533,408
|
|
|
Accounts payable and other liabilities
|
34,303
|
|
|
Accrued tenant improvements
|
66,352
|
|
|
Accrued property taxes
|
14,125
|
|
|
Below market leases, net of accumulated amortization of $567
|
14,938
|
|
|
Total liabilities
|
663,126
|
|
|
|
|
|
Equity
|
|
|
Partner's equity
|
517,569
|
|
|
Total liabilities and equity
|
$
|
1,180,695
|
|
The following table summarizes the statement of operations of the Greenway Properties joint venture from April 17, 2017, the date of inception of the Greenway Properties joint venture, to June 30, 2017 (in thousands):
|
|
|
|
|
|
|
|
|
From April 17, 2017 (Date of Inception) to June 30, 2017
|
|
Revenues
|
|
|
|
Income from office properties
|
$
|
32,735
|
|
|
Expenses
|
|
|
Property operating expenses
|
14,542
|
|
|
Depreciation and amortization
|
14,859
|
|
|
Total expenses
|
29,401
|
|
|
Operating income
|
3,334
|
|
|
Other expenses
|
|
|
|
Interest expense
|
(4,452
|
)
|
|
Net loss
|
$
|
(1,118
|
)
|
The following table presents a reconciliation of net loss of the Greenway Properties joint venture to the Company's equity in earnings of unconsolidated joint venture for the period from April 17, 2017, the date of inception of the Greenway Properties joint venture, to June 30, 2017 (in thousands):
|
|
|
|
|
|
|
|
|
From April 17, 2017 (Date of Inception) to June 30, 2017
|
|
Net loss of Greenway Properties joint venture
|
$
|
(1,118
|
)
|
|
Company's interest in Greenway Properties joint venture
|
51
|
%
|
|
Company's share of net loss of Greenway Properties joint venture
|
(570
|
)
|
|
Company's elimination of management company income
|
1,149
|
|
|
Company's equity in earnings of unconsolidated joint venture
|
$
|
579
|
|
Note 5—Capital and Financing Transactions
Notes Payable to Banks, Net
A summary of notes payable to banks, net at June 30, 2017 and December 31, 2016 is as follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Rate at December 31, 2016
|
|
Outstanding Balance at June 30, 2017
|
|
Outstanding Balance at December 31, 2016
|
|
$100.0 Million Revolving Credit Facility
|
3.8%
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$350.0 Million Three-Year Term Loan
|
3.7%
|
|
—
|
|
|
350,000
|
|
|
Notes payable to banks outstanding
|
|
|
—
|
|
|
350,000
|
|
|
Unamortized debt issuance costs, net
|
|
|
—
|
|
|
(8,398
|
)
|
|
Total notes payable to banks, net
|
|
|
$
|
—
|
|
|
$
|
341,602
|
|
Credit Facility
In connection with the Separation and the UPREIT Reorganization, on October 6, 2016, the Company and the Operating Partnership, as borrower, entered into a credit agreement providing for (i) a
three
-year,
$100 million
senior secured revolving credit facility (the “Revolving Credit Facility”), and (ii) a
three
-year,
$350 million
senior secured term loan facility (the “Term Loan” and, together with the Revolving Credit Facility, the “Credit Facility”), with Bank of America, N.A., as Administrative Agent, and the lenders party thereto (collectively, the “Lenders”). The Credit Facility had an initial maturity date of October 6, 2019, but was subject to a
one
-year extension option at the election of the Operating Partnership. The exercise of the extension option required the payment of an extension fee and the satisfaction of certain other customary conditions. The credit agreement also permitted the Operating Partnership to utilize up to
$15 million
of the Revolving Credit Facility for the issuance of letters of credit. Interest on the Credit Facility accrued at a rate based on LIBOR or a base rate plus an applicable margin. The Credit Facility was prepayable at the election of the borrower (upon not less than
three
business days’ written notice to the administrative agent) without premium or penalty (other than customary breakage fees), and did not require any scheduled repayments of principal prior
to the maturity date. The Credit Facility was guaranteed pursuant to a Guaranty Agreement entered into on October 6, 2016, by the Company, all wholly owned material subsidiaries of the Operating Partnership that are not otherwise prohibited from guarantying the Credit Facility, PPGP and Parkway LP.
On April 17, 2017, in connection with completion of the Greenway Properties joint venture transaction, the Operating Partnership repaid in full all amounts outstanding under the Credit Facility and terminated the Credit Facility. The Company recorded a non-cash loss on extinguishment of debt of approximately
$7.6 million
during the three and six months ended June 30, 2017 related to the termination of the Credit Facility.
Mortgage Notes Payable, Net
A summary of mortgage notes payable, net at June 30, 2017 and December 31, 2016 is as follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Office Properties
|
Fixed Rate
|
|
Maturity Date
|
|
June 30, 2017
|
|
December 31, 2016
|
|
San Felipe Plaza
|
4.8%
|
|
12/01/2018
|
|
$
|
105,156
|
|
|
$
|
106,085
|
|
|
CityWestPlace III and IV
|
5.0%
|
|
03/05/2020
|
|
87,852
|
|
|
88,700
|
|
|
Post Oak Central
|
4.3%
|
|
10/01/2020
|
|
176,487
|
|
|
178,285
|
|
|
Phoenix Tower
|
3.9%
|
|
03/01/2023
|
|
—
|
|
|
76,561
|
|
|
Unamortized premium, net
|
|
|
|
|
6,601
|
|
|
2,600
|
|
|
Unamortized debt issuance costs, net
|
|
|
|
|
(566
|
)
|
|
(654
|
)
|
|
Total mortgage notes payable, net
|
|
|
|
|
$
|
375,530
|
|
|
$
|
451,577
|
|
The Greenway Properties joint venture assumed the existing mortgage debt secured by Phoenix Tower, which had an outstanding balance of approximately
$75.9 million
at April 17, 2017 and matures on March 1, 2023. See “Note 1—Organization” for additional information regarding the assumption of the Phoenix Tower mortgage by the Greenway Properties joint venture.
Note 6—Fair Values of Financial Instruments
FASB ASC “Fair Value Measurements and Disclosures,” (“ASC 820”) defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC 820 also provides guidance for using fair value to measure financial assets and liabilities. The codification requires disclosure of the level within the fair value hierarchy in which the fair value measurements fall, including measurements using quoted prices in active markets for identical assets or liabilities (Level 1), quoted prices for similar instruments in active markets or quoted prices for identical or similar instruments in markets that are not active (Level 2), and significant valuation assumptions that are not readily observable in the market (Level 3).
Fair values of financial instruments were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2017
|
|
December 31, 2016
|
|
|
Carrying
Amount
|
|
Fair
Value
|
|
Carrying
Amount
|
|
Fair
Value
|
|
Financial Assets:
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
$
|
448,416
|
|
|
$
|
448,416
|
|
|
$
|
230,333
|
|
|
$
|
230,333
|
|
|
Financial Liabilities:
|
|
|
|
|
|
|
|
|
|
|
Notes payable to banks
(1)
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
350,000
|
|
|
$
|
349,372
|
|
|
Mortgage notes payable
(1)
|
369,495
|
|
|
384,108
|
|
|
449,631
|
|
|
452,753
|
|
(1) The carrying amounts of notes payable to banks and mortgage notes payable represent par values.
The methods and assumptions used to estimate fair value for each class of financial asset or liability are discussed below:
Cash and cash equivalents:
The carrying amount for cash and cash equivalents approximates fair value.
Notes payable to banks:
The fair value of the Company’s notes payable to banks is estimated by discounting expected cash flows at current market rates. This information is considered a Level 2 input as defined by ASC 820.
Mortgage notes payable:
The fair value of mortgage notes payable is estimated by discounting expected cash flows at current market rates. This information is considered a Level 2 input as defined by ASC 820.
Non-financial assets and liabilities recorded at fair value on a non-recurring basis include the following: (1) non-financial assets and liabilities measured at fair value in a business combination, if any, and (2) impairment or disposal of long-lived assets measured at fair value. The fair values assigned to the Company’s purchase price assignments utilize Level 2 and Level 3 inputs as defined by ASC 820. The fair value assigned to the long-lived assets for which there was impairment recorded utilize Level 2 inputs as defined by ASC 820.
Note 7—Commitments and Contingencies
The Company and its subsidiaries may be involved from time to time in various legal proceedings that arise in the ordinary course of its business, including, but not limited to commercial disputes, environmental matters and litigation in connection with transactions including acquisitions and divestitures. The Company believes that such litigation, claims and administrative proceedings will not have a material adverse impact on the financial position or the results of operations. The Company will record a liability when a loss is considered probable and the amount can be reasonably estimated.
The Company has a
1%
limited partnership interest in 2121 Market Street Associates, LP (“2121 Market Street”). A mortgage loan secured by a first trust deed on 2121 Market Street is guaranteed by the Company up to a maximum amount of
$14.0 million
expiring in December 2022.
Obligations for tenant improvements, lease commissions and lease incentives recorded on the consolidated balance sheet at June 30, 2017 are as follows (in thousands):
|
|
|
|
|
|
|
|
2017
|
$
|
7,489
|
|
|
2018
|
479
|
|
|
2019
|
—
|
|
|
2020
|
1,093
|
|
|
2021
|
—
|
|
|
Thereafter
|
—
|
|
|
Total
|
$
|
9,061
|
|
Note 8—Share-Based and Long-Term Compensation Plans
In September 2016, the Company adopted the Parkway, Inc. and Parkway Operating Partnership LP 2016 Omnibus Equity Incentive Plan (the “2016 Plan”), pursuant to which the following types of awards may be granted to the Company’s employees, directors and consultants: (i) options, including nonstatutory stock options and incentive stock options; (ii) stock appreciation rights; (iii) restricted shares; (iv) restricted stock units; (v) profits interest units (LTIP units); (vi) dividend equivalents; (vii) other forms of awards payable in or denominated by reference to shares of common stock; or (viii) cash. The Registration Statement on Form S-8, filed with the SEC on October 7, 2016, covered (i)
5,000,000
shares of the Company’s common stock, plus (ii) up to
1,300,000
shares of common stock issuable pursuant to equity awards of the Company resulting from awards originally granted under Legacy Parkway’s equity incentive plan that were assumed by the Company in connection with the Legacy Parkway Merger and the Spin-Off (the “Assumed Awards”). Ultimately, there were
1,002,596
Assumed Awards granted in connection with the Legacy Parkway Merger and the Spin-Off, such that the total number of shares reserved under the 2016 Plan is
6,002,596
shares of the Company’s common stock.
Through June 30, 2017, the Company had stock options and restricted stock units (“RSUs”) outstanding under the 2016 Plan, each as described below.
Long-Term Equity Incentives
At June 30, 2017, a total of
773,617
shares underlying stock options with an aggregate fair value of
$1.2 million
had been granted to officers of the Company and former officers of Legacy Parkway and remained outstanding and exercisable under the 2016 Equity Plan. The options have exercise prices that range from
$21.91
to
$22.00
and expire on March 2, 2023.
At June 30, 2017, a total of
209,125
time-vesting RSUs had been granted to officers and certain other employees of the Company and remained outstanding and unvested under the 2016 Equity Plan. The time-vesting RSUs are valued at
$4.3 million
, which equates to an average price per share of
$20.55
. A total of
114,490
time-vesting RSU awards vested on January 1, 2017,
75,267
time-vesting RSU awards will vest in increments of
25%
per year on each of the first, second, third and fourth anniversaries of the grant date and
133,858
time-vesting RSU awards will vest in increments of
33%
per year on each of the first, second and third anniversaries of the grant date, subject to the grantee’s continued service.
At June 30, 2017, a total of
283,099
performance-vesting RSUs had been granted to officers and certain other employees of the Company and remained outstanding and unvested under the 2016 Equity Plan. The performance-vesting RSUs are valued at approximately
$2.4 million
, which equates to an average price per share of
$8.60
. Grant date fair values of the performance-vesting RSUs are estimated using a Monte Carlo simulation model and the resulting expense is recorded regardless of whether the total stockholder return (“TSR”) performance measures are achieved if the required service is delivered. Each performance-vesting RSU will vest based on the attainment of TSR targets during the applicable performance period, subject to the grantee’s continued service.
Total compensation expense related to stock options and RSUs of
$528,000
and
$1.0 million
was recognized in general and administrative expenses on the Company’s consolidated statements of operations for the three and six months ended June 30, 2017. Total compensation expense related to non-vested awards not yet recognized was
$5.5 million
at June 30, 2017. The weighted average period over which this expense is expected to be recognized is approximately
2.7 years
.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options
|
|
Time-Vesting RSUs
|
|
Performance-Vesting RSUs
|
|
|
# of Options
|
Weighted Average Grant-Date Fair Value
|
|
# of Stock Units
|
Weighted Average Grant-Date Fair Value
|
|
# of Stock Units
|
Weighted Average Grant-Date Fair Value
|
|
Balance at December 31, 2016
|
33,011
|
|
$
|
1.57
|
|
|
270,815
|
|
$
|
20.85
|
|
|
159,899
|
|
$
|
11.82
|
|
|
Granted
|
—
|
|
—
|
|
|
52,800
|
|
19.60
|
|
|
123,200
|
|
4.41
|
|
|
Vested
|
(33,011
|
)
|
1.57
|
|
|
(114,490
|
)
|
20.81
|
|
|
—
|
|
—
|
|
|
Balance at June 30, 2017
|
—
|
|
$
|
—
|
|
|
209,125
|
|
$
|
20.55
|
|
|
283,099
|
|
$
|
8.60
|
|
Note 9—Net Loss per Common Share
The computation of basic and diluted earnings per share (“EPS”) is as follows (in thousands, except per share data):
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30, 2017
|
|
Six Months Ended June 30, 2017
|
|
Numerator:
|
|
|
|
|
Basic and diluted net loss attributable to common stockholders
|
$
|
(10,460
|
)
|
|
$
|
(23,009
|
)
|
|
Denominator:
|
|
|
|
|
Basic and diluted weighted average shares outstanding
|
49,206
|
|
|
49,200
|
|
|
|
|
|
|
|
Basic net loss per common share attributable to common stockholders
|
$
|
(0.21
|
)
|
|
$
|
(0.47
|
)
|
|
Diluted net loss per common share attributable to common stockholders
|
$
|
(0.21
|
)
|
|
$
|
(0.47
|
)
|
The computation of diluted EPS for the three and six months ended June 30, 2017 does not include the effect of net loss attributable to noncontrolling interest - unitholders in the numerator and partnership units and time-vesting RSUs in the denominator as their inclusion would have been anti-dilutive. Terms and conditions of these awards are described in “Note 8—Share-Based and Long-Term Compensation Plans.”
Note 10—Related Party Transactions
Certain of the Company’s executive officers own interests in properties that are managed and leased by Eola. For the three and six months ended June 30, 2017, the Company recorded approximately
$41,000
and
$86,000
in management fees and approximately
$144,000
and
$259,000
in reimbursements, respectively, related to the management and leasing of these properties.
During the three and six months ended June 30, 2017, the Company paid director fees for the
two
directors nominated by TPG VI Pantera Holdings, L.P. (“TPG Pantera”) totaling approximately
$32,000
and
$106,000
, respectively, to TPG VI Management, LLC (“TPG Management,” and together with TPG Pantera, the “TPG Parties”).
On September 28, 2016, Eola entered into an agreement and side letter with affiliates of the TPG Parties pursuant to which Eola performs property management, accounting and finance services for such affiliates of the TPG Parties at certain assets owned by such affiliates (collectively, the “TPG Owner”) that were purchased from Legacy Parkway on September 27, 2016. The agreement has a
one
-year term and automatically renews for successive one-year terms unless otherwise terminated in accordance with the terms of the agreement. Pursuant to the agreement and side letter, Eola receives a monthly management fee equal to approximately
2.5%
of the aggregate gross revenues received from the operation of the properties and is reimbursed for certain personnel expenses. During the three and six months ended June 30, 2017, Eola recorded approximately
$176,000
and
$301,000
for management fees and
$143,000
and
$270,000
for salary reimbursements, respectively.
During the three and six months ended June 30, 2017, the Company recorded management fees of approximately
$452,000
and reimbursements, net of elimination, related to the unconsolidated joint venture of approximately
$1.1 million
.
Concurrently with the execution of the Legacy Parkway Merger Agreement, Legacy Parkway and Parkway LP entered into a letter agreement (the “Thomas Letter Agreement”) with Mr. James A. Thomas, then chairman of the Legacy Parkway board of directors and the current chairman of the Company’s board of directors, and certain unitholders of Parkway LP who are affiliated with Mr. Thomas. Pursuant to the Separation and Distribution Agreement, the Thomas Letter Agreement is binding on the Company. On March 14, 2017, the Operating Partnership and Parkway LP entered into a Debt Guaranty Agreement (the “Debt Guaranty Agreement”) with Mr. Thomas and certain affiliates of Mr. Thomas (the “Thomas Investors”) that implements those provisions of the Thomas Letter Agreement regarding debt guarantee opportunities made available to Mr. Thomas and the Thomas Investors. Consistent with the Thomas Letter Agreement, pursuant to the Debt Guaranty Agreement, the Operating Partnership made available to Mr. Thomas and the Thomas Investors certain debt guarantee opportunities corresponding to specified mortgage loans of the Company, of which Mr. Thomas and the Thomas Investors entered into contribution agreements with respect to
$109 million
(representing an additional
$70 million
over their existing
$39 million
guarantee). In the event these specified mortgage loans become unavailable for guarantee (whether because the Company repays them, sells the corresponding asset, or otherwise), the Company is required to use commercially reasonable efforts to provide a replacement guarantee or contribution opportunity to the extent of the Company’s remaining qualifying debt (but not in excess of
$109 million
). The Company has agreed to maintain any such debt for the remainder of the
five
-year period following October 2016, subject to early termination in the event of a going private transaction, sale of all or substantially all of the Company’s assets or certain similar transactions.
Note 11—Subsequent Events
On August 2, 2017, a purported federal securities class action related to the Merger Agreement, Price v. Parkway, Inc., et al., was filed in the United States District Court for the Southern District of Texas, Civil Action No. 4:17-cv-2367, against the Company and the members of the Company's board of directors. On August 9, 2017, another purported federal securities class action related to the Merger Agreement, Scarantino v. Parkway, Inc., et al., was filed in the United States District Court for the Southern District of Texas, Civil Action No. 4:17-cv-02441, against the Company, Parkway LP, CPPIB, certain affiliates of CPPIB and the members of the Company's board of directors. Each lawsuit, which purports to have been brought on behalf of all holders of the Company's common stock, generally alleges that the preliminary proxy statement filed by the Company with the SEC on July 27, 2017 failed to disclose material information about the pending merger transaction with CPPIB. Each complaint seeks to enjoin the defendants from proceeding with the stockholder vote on the Company-level merger at the special meeting or consummating the merger transaction unless and until the Company discloses the allegedly omitted information. Each complaint also seeks damages allegedly suffered by the plaintiffs as a result of the asserted omission, as well as related attorneys’ fees and expenses. The defendants believe that all of the allegations against them lack merit and intend to defend against the lawsuits vigorously. No assurance can be made as to the outcome of such lawsuits or the lawsuits described above, including the amount of costs associated with defending these claims or any other liabilities that may be incurred in connection with the litigation of these claims.
PARKWAY HOUSTON
COMBINED STATEMENT OF OPERATIONS
(in thousands)
(unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30, 2016
|
|
Six Months Ended June 30, 2016
|
|
Revenues
|
|
|
|
|
Income from office properties
|
$
|
26,650
|
|
|
$
|
55,779
|
|
|
Management company income
|
1,287
|
|
|
2,592
|
|
|
Total revenues
|
27,937
|
|
|
58,371
|
|
|
|
|
|
|
|
Expenses
|
|
|
|
|
Property operating expenses
|
12,828
|
|
|
26,367
|
|
|
Management company expenses
|
1,225
|
|
|
2,006
|
|
|
Depreciation and amortization
|
9,640
|
|
|
21,005
|
|
|
General and administrative
|
1,261
|
|
|
2,893
|
|
|
Total expenses
|
24,954
|
|
|
52,271
|
|
|
Operating income
|
2,983
|
|
|
6,100
|
|
|
Other income and expenses
|
|
|
|
|
Interest and other income
|
70
|
|
|
131
|
|
|
Gain on extinguishment of debt
|
154
|
|
|
154
|
|
|
Interest expense
|
(3,002
|
)
|
|
(6,955
|
)
|
|
Loss before income taxes
|
205
|
|
|
(570
|
)
|
|
Income tax expense
|
(267
|
)
|
|
(760
|
)
|
|
Net loss
|
$
|
(62
|
)
|
|
$
|
(1,330
|
)
|
See notes to combined financial statements.
PARKWAY HOUSTON
COMBINED STATEMENT OF CASH FLOWS
(in thousands)
(unaudited)
|
|
|
|
|
|
|
|
|
Six Months Ended June 30, 2016
|
|
Operating activities
|
|
|
Net loss
|
$
|
(1,330
|
)
|
|
Adjustments to reconcile net loss to cash used in operating activities:
|
|
|
Depreciation and amortization of office properties
|
21,005
|
|
|
Amortization of management contract intangibles, net
|
378
|
|
|
Amortization of below market leases, net
|
(3,487
|
)
|
|
Amortization of financing costs
|
21
|
|
|
Amortization of debt premium, net
|
(1,431
|
)
|
|
Deferred income tax expense
|
256
|
|
|
Gain on extinguishment of debt
|
(154
|
)
|
|
Increase in deferred leasing costs
|
(4,919
|
)
|
|
Changes in operating assets and liabilities:
|
|
|
Change in receivables and other assets
|
1,197
|
|
|
Change in accounts payable and other liabilities
|
(11,666
|
)
|
|
Cash used in operating activities
|
(130
|
)
|
|
Investing activities
|
|
|
|
Improvements to real estate
|
(10,885
|
)
|
|
Cash used in investing activities
|
(10,885
|
)
|
|
Financing activities
|
|
|
|
Principal payments on mortgage notes payable
|
(116,985
|
)
|
|
Change in Parkway investment, net
|
124,012
|
|
|
Cash provided by financing activities
|
7,027
|
|
|
Change in cash and cash equivalents
|
(3,988
|
)
|
|
Cash and cash equivalents at beginning of period
|
11,961
|
|
|
Cash and cash equivalents at end of period
|
$
|
7,973
|
|
|
|
|
|
Supplemental Cash Flow Information:
|
|
|
Cash paid for interest
|
$
|
8,728
|
|
|
Cash paid for income taxes
|
1,043
|
|
See notes to combined financial statements.
PARKWAY HOUSTON
NOTES TO COMBINED FINANCIAL STATEMENTS
June 30, 2016
(unaudited)
Note 1—Organization
On April 28, 2016, Cousins Properties Incorporated, a Georgia corporation (“Cousins”), and Parkway Properties, Inc., a Maryland corporation (“Legacy Parkway”), entered into that certain Agreement and Plan of Merger, dated as of April 28, 2016 (the “Legacy Parkway Merger Agreement”), by and among Legacy Parkway, Parkway Properties LP, Cousins and Clinic Sub Inc., a wholly owned subsidiary of Cousins. On October 6, 2016, pursuant to the Legacy Parkway Merger Agreement, Legacy Parkway merged with and into Clinic Sub Inc., with Clinic Sub Inc. continuing as the surviving corporation and a wholly owned subsidiary of Cousins (the “Legacy Parkway Merger”). Immediately following the effective time of the Legacy Parkway Merger, in accordance with the Legacy Parkway Merger Agreement, Cousins separated the portion of its combined businesses relating to the ownership of real properties in Houston, Texas, as well as Legacy Parkway’s fee-based real estate services (the “Third-Party Services Business” and together with the Houston real properties, the “Houston Business”), from the remainder of the combined businesses (the “Separation”). In connection with the Separation, Cousins and Legacy Parkway reorganized the combined businesses through a series of transactions (the “UPREIT Reorganization”) pursuant to which the Houston Business was transferred to Parkway, Inc. (the “Company”). On October 7, 2016, Cousins completed the spin-off of the Company, by distributing all of the outstanding shares of common and limited voting stock of the Company to the holders of Cousins common and limited voting preferred stock as of the record date, October 6, 2016 (the “Spin-Off”).
The combined financial statements included herein represent the combined accounts and combined operations of the Houston Business previously owned and operated by Legacy Parkway (“Parkway Houston”).
As of June 30, 2016, the Company had not conducted any business as a separate company and had no material assets or liabilities. The operations of Parkway Houston, which were transferred to the Company immediately following the effective time of the Legacy Parkway Merger, are presented as if the transferred business was Parkway Houston’s business for all historical periods described and at the carrying value of such assets and liabilities reflected in Legacy Parkway’s books and records.
Note 2—Basis of Presentation and Consolidation
The accompanying combined financial statements include the accounts of Parkway Houston presented on a combined basis as the ownership interests were under common control and ownership of Legacy Parkway. All significant intercompany balances and transactions have been eliminated.
These combined financial statements are derived from the books and records of Legacy Parkway and were carved out from Legacy Parkway at a carrying value reflective of such historical cost in such Legacy Parkway records. Parkway Houston’s historical financial results reflect charges for certain corporate costs and Parkway Houston believes such charges are reasonable; however, such results do not necessarily reflect what Parkway Houston's expenses would have been had Parkway Houston been operating as a separate stand-alone public company. Costs of the services that were charged to Parkway Houston were based on either actual costs incurred or a proportion of costs estimated to be applicable to Parkway Houston. The historical combined financial information presented may therefore not be indicative of the results of operations, financial position or cash flows that would have been obtained if Parkway Houston had been an independent, stand-alone public company during the periods presented or of Parkway Houston's future performance as an independent, stand-alone company.
Parkway Houston is a predecessor, as defined in applicable rules and regulations for the Securities and Exchange Commission, to the Houston Business, which commenced operations on the date of the Spin-Off.
These combined financial statements reflect the consolidation of properties that are wholly owned or properties in which, prior to the Legacy Parkway Merger, the Separation, the UPREIT Reorganization and the Spin-Off, Legacy Parkway owned less than a
100%
interest but that Legacy Parkway controlled. Control of a property is demonstrated by, among other factors, Parkway Houston’s ability to refinance debt and sell the property without the consent of any other partner or owner and the inability of any other partner or owner to replace Legacy Parkway. Eola Capital, LLC (“Eola Capital”), Phoenix Tower, CityWestPlace and San Felipe Plaza were all indirectly wholly owned by Legacy Parkway for all periods presented.
Parkway Houston consolidates its Murano residential condominium project which it controls. Parkway Houston’s partner has a stated ownership interest of
27%
. Net proceeds from the project were distributed, to the extent available, based on an order of preferences described in the partnership agreement. Parkway Houston may receive distributions, if any, in excess of its stated
73%
ownership interest if certain return thresholds are met.
Note 3—Commitments and Contingencies
Parkway Houston and its subsidiaries are, from time to time, parties to litigation arising from the ordinary course of business. Parkway Houston does not believe that any such litigation will materially affect Parkway Houston's financial position or operations.
Note 4—Mortgage Notes Payable, Net
On April 6, 2016, Legacy Parkway paid in full the
$114.0 million
mortgage debt secured by CityWest Place I and II and recognized a gain on extinguishment of debt of
$154,000
for the three and six months ended June 30, 2016.
Note 5—Related Party Transactions
On May 18, 2011, Legacy Parkway entered into the Contribution Agreement pursuant to which Eola Capital contributed its property management company (the “Management Company”) to Parkway Houston. In connection with the Eola Capital contribution of its Management Company to Legacy Parkway, a subsidiary of Legacy Parkway made a
$3.5 million
preferred equity investment in an entity
21%
owned by Mr. James R. Heistand. This investment provides that Legacy Parkway will be paid a preferred equity return equal to
7%
per annum of the preferred equity outstanding. For the three and six months ended June 30, 2016, Legacy Parkway received preferred equity distributions on this investment in the aggregate amounts of approximately
$61,000
and
$122,000
, respectively. This preferred equity investment was approved by the board of directors of Legacy Parkway, and recorded as a cost method investment.
Certain of Legacy Parkway’s executive officers own interests in properties that are managed and leased by the Management Company. Parkway Houston recorded approximately
$77,000
and
$156,000
in management fees, respectively, and
$193,000
and
$388,000
in reimbursements, respectively, related to the management and leasing of these assets for the three and six months ended June 30, 2016.
As discussed in Note 1 and Note 2, the accompanying combined financial statements present the operations of Parkway Houston as carved out from the financial statements of Legacy Parkway. Transactions between the entities have been eliminated in the combined presentation. The combined financial statements include payroll costs and benefits for on-site personnel employed by Legacy Parkway allocated to Parkway Houston. These costs are reflected in property operating expenses on the combined statements of operations. A summary of these costs for the period presented is as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended June 30, 2016
|
|
For the Six Months Ended June 30, 2016
|
|
Charged to property operating expense:
|
|
|
|
|
Direct payroll charges
|
$
|
804
|
|
|
$
|
1,607
|
|
|
Management fees
|
705
|
|
|
1,434
|
|
|
Other allocated expenses
|
771
|
|
|
771
|
|
|
Total
|
$
|
2,280
|
|
|
$
|
3,812
|
|
Lease commissions and development fees paid to Legacy Parkway’s personnel and other leasing costs incurred by Parkway Houston are capitalized and amortized over the respective lease term. For the three and six months ended June 30, 2016, Parkway Houston capitalized
$154,000
and
$258,000
, respectively, in commissions and other leasing costs to the properties.
The expenses charged by Legacy Parkway for these services are not necessarily indicative of the expenses that would have been incurred had Parkway Houston been a separate, independent entity.
Note 6—Subsequent Events
The Legacy Parkway Merger, the Separation and the Reorganization were consummated on October 6, 2016, and the Spin-Off was completed on October 7, 2016.
See “Note 1—Organization” to the consolidated financial statements of the Company for additional information regarding the completion of the Greenway Properties joint venture transaction and the pending acquisition of the Company by the Canada Pension Plan Investment Board (“CPPIB”).
See “Note 11—Subsequent Events” to the consolidated financial statements of the Company for additional information regarding legal proceedings surrounding the pending acquisition of the Company by CPPIB.
COUSINS HOUSTON
COMBINED STATEMENT OF OPERATIONS
(unaudited, in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30, 2016
|
|
Six Months Ended June 30, 2016
|
|
Revenues:
|
|
|
|
|
Rental property revenues
|
$
|
44,427
|
|
|
$
|
87,696
|
|
|
Other
|
102
|
|
|
288
|
|
|
|
44,529
|
|
|
87,984
|
|
|
|
|
|
|
|
Costs and Expenses:
|
|
|
|
|
Rental property operating expenses
|
19,276
|
|
|
37,202
|
|
|
General and administrative expenses
|
1,799
|
|
|
4,976
|
|
|
Depreciation and amortization
|
15,740
|
|
|
31,168
|
|
|
Interest expense
|
1,965
|
|
|
3,939
|
|
|
|
38,780
|
|
|
77,285
|
|
|
Net Income
|
$
|
5,749
|
|
|
$
|
10,699
|
|
See notes to combined financial statements.
COUSINS HOUSTON
COMBINED STATEMENT OF CASH FLOWS
(unaudited, in thousands)
|
|
|
|
|
|
|
|
|
Six Months Ended June 30, 2016
|
|
Net income
|
$
|
10,699
|
|
|
Adjustments to reconcile net income to net cash provided by operating activities:
|
|
|
Depreciation and amortization
|
31,168
|
|
|
Amortization of loan closing costs
|
89
|
|
|
Effect of certain non-cash adjustments to rental revenues
|
(5,836
|
)
|
|
Changes in operating assets and liabilities:
|
|
|
Accounts receivable and assets, net
|
(2,411
|
)
|
|
Operating liabilities
|
(16,697
|
)
|
|
Net cash provided by operating activities
|
17,012
|
|
|
Cash Flows from Investing Activities
|
|
|
|
Property improvements and tenant asset expenditures
|
(18,112
|
)
|
|
Net cash used in investing activities
|
(18,112
|
)
|
|
Cash Flows from Financing Activities
|
|
|
|
Change in Cousins' investment, net
|
3,886
|
|
|
Repayment of note payable
|
(1,724
|
)
|
|
Net cash provided by financing activities
|
2,162
|
|
|
Net Increase in Cash
|
1,062
|
|
|
Cash at Beginning of Period
|
109
|
|
|
Cash at End of Period
|
$
|
1,171
|
|
|
|
|
|
Supplemental Cash Flow Information
|
|
|
Cash paid for interest
|
$
|
3,856
|
|
|
Change in accrued property and tenant asset expenditures
|
(286
|
)
|
See notes to combined financial statements.
COUSINS HOUSTON
NOTES TO COMBINED FINANCIAL STATEMENTS
June 30, 2016
(unaudited)
Note 1—Organization And Basis Of Presentation
Merger and Spin-Off
On October 6, 2016, Cousins Properties Incorporated (“Cousins”) and Parkway Properties, Inc. (“Legacy Parkway”) completed a stock-for-stock merger (the “Legacy Parkway Merger”) pursuant to that certain Agreement and Plan of Merger, dated April 28, 2016 (the “Legacy Parkway Merger Agreement”), by and among Cousins, Clinic Sub Inc., Legacy Parkway and Parkway Properties LP, followed on October 7, 2016 by a spin-off (the “Spin-Off”) of the combined Houston-based assets of both companies (the “Houston Business”) into a new publicly traded real estate investment trust, Parkway, Inc. (the “Company”).
Basis of Presentation
The combined financial statements included herein represent the combined accounts and combined operations of the portion of the Houston Business owned and operated by Cousins (“Cousins Houston”). Cousins Houston includes the combined accounts related to the office properties of Greenway Plaza and Post Oak Central, operated prior to the Legacy Parkway Merger and the Spin-Off through subsidiaries of Cousins for the six months ended June 30, 2016, and certain corporate costs. The assets and liabilities in these combined financial statements represent historical carrying amounts of the following properties:
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Acquisition Date
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Number of Office Buildings
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Total Square Feet
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Post Oak Central
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February 7, 2013
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3
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1,280,000
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Greenway Plaza
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September 9, 2013
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10
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4,348,000
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13
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5,628,000
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Cousins Houston is a predecessor, as defined in applicable rules and regulations of the Securities and Exchange Commission (the “SEC”), to the Company which commenced operations upon completion of the Spin-Off.
The combined financial statements are unaudited and were prepared by Cousins Houston in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and in accordance with the rules and regulations of the SEC. In the opinion of management, these financial statements reflect all adjustments necessary (which adjustments are of a normal and recurring nature) for the fair presentation of Cousins Houston’s results of operations for the six months ended June 30, 2016. The results of operations for the six months ended June 30, 2016 are not necessarily indicative of the results expected for the full year. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to the rules and regulations of the SEC. These combined financial statements should be read in conjunction with the consolidated financial statements and the notes thereto as of December 31, 2015 and 2014 and for the years ended December 31, 2015 and 2014 and for the period from February 7, 2013 (date of inception) to December 31, 2013 included in the Company's Information Statement dated September 27, 2016. The accounting policies employed are substantially the same as those shown in Note 2 to those financial statements.
For the periods presented, there were no items of other comprehensive income. Therefore, no presentation of comprehensive income is required.
Allocated Costs
The historical financial results for Cousins Houston include certain allocated corporate costs which Cousins Houston believes are reasonable. These costs were incurred by Cousins and estimated to be applicable to Cousins Houston based on proportionate leasable square footage. Such costs do not necessarily reflect what the actual costs would have been if Cousins Houston were operating as an independent, stand-alone public company. Additionally, the historical results for Cousins Houston include transaction costs that were incurred by Cousins related to the Spin-Off. These costs are discussed further in Note 3—Related Party Transactions.
Recently Issued Accounting Standards
Cousins Houston's operations ceased on October 6, 2016, and none of the recent accounting pronouncements impacted Cousins Houston's financial statement and notes. Therefore, this section is not applicable.
Note 2—Significant Accounting Policies
Real Estate Assets
Cost Capitalization
Cousins Houston capitalizes costs related to property and tenant improvements, including allocated costs of Cousins’ personnel working directly on projects. Cousins Houston capitalizes direct leasing costs related to leases that are probable of being executed. These costs include commissions paid to outside brokers, legal costs incurred to negotiate and document a lease agreement, and costs incurred by personnel of Cousins that are based on time spent on successful leases. Cousins Houston allocates these costs to individual tenant leases and amortizes them over the related lease term.
Impairment
For real estate assets that are considered to be held for sale according to accounting guidance, Cousins Houston records impairment losses if the fair value of the asset net of estimated selling costs is less than the carrying amount. For those long-lived assets that are held and used according to accounting guidance, management reviews each asset for the existence of any indicators of impairment. If indicators of impairment are present, Cousins Houston calculates the expected undiscounted future cash flows to be derived from such assets. If the undiscounted cash flows are less than the carrying amount of the asset, Cousins Houston reduces the asset to its fair value.
Acquisition of Operating Properties
Cousins Houston records the acquired tangible and intangible assets and assumed liabilities of operating property acquisitions at fair value at the acquisition date. The acquired assets and assumed liabilities for an operating property acquisition generally include but are not limited to: land, buildings and improvements, and identified tangible and intangible assets and liabilities associated with in-place leases, including leasing costs, value of above-market and below-market tenant leases, value of above-market and below-market ground leases, acquired in-place lease values, and tenant relationships, if any.
The fair value of land is derived from comparable sales of land within the same submarket and/or region. The fair value of buildings and improvements, tenant improvements, and leasing costs are based upon current market replacement costs and other relevant market rate information.
The fair value of the above-market or below-market component of an acquired in-place lease is based upon the present value (calculated using a market discount rate) of the difference between (i) the contractual rents to be paid pursuant to the lease over its remaining term and (ii) management’s estimate of the rents that would be paid using fair market rental rates and rent escalations at the date of acquisition over the remaining term of the lease. The amounts recorded for above-market and below-market leases are included in intangible assets and intangible liabilities, respectively, and are amortized on a straight-line basis into rental property operating revenues over the remaining terms of the applicable leases.
The fair value of acquired in-place leases is derived based on management’s assessment of lost revenue and costs incurred for the period required to lease the “assumed vacant” property to the occupancy level when purchased. The amount recorded for acquired in-place leases is included in intangible assets and amortized as an increase to depreciation and amortization expense over the remaining term of the applicable leases.
Depreciation and Amortization
Real estate assets are stated at depreciated cost less impairment losses, if any. Buildings are depreciated over their estimated useful lives, which range from
30
to
42 years
. The life of a particular building depends upon a number of factors including whether the building was developed or acquired and the condition of the building upon acquisition. Furniture, fixtures and equipment are depreciated over their estimated useful lives of
five years
. Tenant improvements, leasing costs and leasehold improvements are amortized over the term of the applicable leases or the estimated useful life of the assets, whichever is shorter. Cousins Houston accelerates the depreciation of tenant assets if it estimates that the lease term will end prior to the termination date. This acceleration
may occur if a tenant files for bankruptcy, vacates its premises or defaults in another manner on its lease. Deferred expenses are amortized over the period of estimated benefit. Cousins Houston uses the straight-line method for all depreciation and amortization.
Revenue Recognition
Cousins Houston recognizes contractual revenues from leases on a straight-line basis over the term of the respective lease. In addition, leases typically provide for reimbursement of the tenants’ share of real estate taxes, insurance, and other operating expenses to Cousins Houston. Operating expense reimbursements are recognized as the related expenses are incurred. For the three and six months ended June 30, 2016, Cousins Houston recognized
$15.5 million
and
$29.8 million
, respectively, in revenues from tenants for reimbursements of operating expenses.
Cousins Houston makes valuation adjustments to all tenant-related accounts receivable based upon its estimate of the likelihood of collectability. The amount of any valuation adjustment is based on the tenant’s credit and business risk, history of payment, and other factors considered by management.
Income Taxes
Through October 6, 2016, Cousins Houston’s properties were owned by Cousins, a Georgia corporation which has elected to be taxed as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as amended (the “Code”). As a REIT, Cousins is not subject to federal income tax provided it distributes annually its adjusted taxable income, as defined in the Code, to stockholders and meets certain other organizational and operating requirements. Accordingly, the combined financial statements of Cousins Houston do not include a provision for federal income tax.
Cash and Cash Equivalents
Cash and cash equivalents include cash and highly-liquid money market instruments with maturities of three months or less.
Segment Disclosure
Cousins Houston is in the business of the ownership, development and management of office real estate. Cousins Houston has aggregated its office operations into
one
reportable segment. This segment is the aggregation of the aforementioned Cousins Houston office properties as reported to the Chief Operating Decision Maker and is aggregated due to the properties having similar economic and geographic characteristics.
Fair Value Measurements
Level 1 fair value inputs are quoted prices for identical items in active, liquid and visible markets such as stock exchanges. Level 2 fair value inputs are observable information for similar items in active or inactive markets and appropriately consider counterparty creditworthiness in the valuations. Level 3 fair value inputs reflect Cousins Houston’s best estimate of inputs and assumptions market participants would use in pricing an asset or liability at the measurement date. The inputs are unobservable in the market and significant to the valuation estimate. Cousins Houston has no investments for which fair value is measured on a recurring basis using Level 3 inputs.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Note 3—Related Party Transactions
The combined financial statements include direct payroll costs and benefits for on-site personnel employed by Cousins. These costs are reflected in rental property operating expenses on the Combined Statements of Operations. As described in Note 2, also included are costs for certain functions and services performed by Cousins and these costs were allocated to Cousins Houston based on proportionate leasable square footage which management believes is an appropriate estimate of usage. These costs are reflected as general and administrative expenses on the Combined Statements of Operations. The expenses allocated to Cousins Houston for these services are not necessarily indicative of the expenses that would have been incurred had Cousins
Houston been a separate, independent entity that had otherwise managed these functions. A summary of these costs is as follows for the three and six months ended June 30, 2016 (in thousands):
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For the Three Months Ended June 30, 2016
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For the Six Months Ended June 30, 2016
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Charged to rental property operating expenses:
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Direct payroll charges
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$
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1,723
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$
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3,478
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Other allocated expenses
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503
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995
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Charged to general and administrative expenses:
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Office rental expense
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88
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180
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Payroll and other expenses
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1,711
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4,796
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Leasing commissions paid to Cousins’ personnel and other leasing costs incurred by Cousins are capitalized and amortized over the respective lease term. For the three and six months ended June 30, 2016, Cousins Houston capitalized
$383,000
and
$540,000
, respectively, in commissions and other leasing costs to the properties.
Note 4—Commitments and Contingencies
Litigation
Cousins Houston is subject to various legal proceedings, claims and administrative proceedings arising in the ordinary course of business, some of which are expected to be covered by liability insurance. Management makes assumptions and estimates concerning the likelihood and amount of any potential loss relating to these matters using the latest information available. Cousins Houston records a liability for litigation if an unfavorable outcome is probable and the amount of loss or range of loss can be reasonably estimated. If an unfavorable outcome is probable and a reasonable estimate of the loss is a range, Cousins Houston accrues the best estimate within the range. If no amount within the range is a better estimate than any other amount, Cousins Houston accrues the minimum amount within the range. If an unfavorable outcome is probable but the amount of the loss cannot be reasonably estimated, Cousins Houston discloses the nature of the litigation and indicates that an estimate of the loss or range of loss cannot be made. If an unfavorable outcome is reasonably possible and the estimated loss is material, Cousins Houston discloses the nature and estimate of the possible loss of the litigation. Cousins Houston does not disclose information with respect to litigation where an unfavorable outcome is considered to be remote or where the estimated loss would not be material. Based on current expectations, such matters, both individually and in the aggregate, are not expected to have a material adverse effect on the liquidity, results of operations, business or financial condition of Cousins Houston.
Note 5—Subsequent Events
The Legacy Parkway Merger and related separation and reorganization transactions pursuant to the Legacy Parkway Merger Agreement were consummated on October 6, 2016, and the Spin-Off was completed on October 7, 2016.
See “Note 1—Organization” to the consolidated financial statements of the Company for additional information regarding the completion of the Greenway Properties joint venture transaction and the pending acquisition of the Company by the Canada Pension Plan Investment Board (“CPPIB”).
See “Note 11—Subsequent Events” to the consolidated financial statements of the Company for additional information regarding legal proceedings surrounding the pending acquisition of the Company by CPPIB.
