Item 1. Financial Statements
ITEM 1. FINANCIAL STATEMENTS
PHILLIPS EDISON & COMPANY, INC.
CONSOLIDATED BALANCE SHEETS
AS OF JUNE 30, 2020 AND DECEMBER 31, 2019
(Condensed and Unaudited)
(In thousands, except per share amounts)
June 30, 2020
December 31, 2019
ASSETS
Investment in real estate:
Land and improvements
$
1,544,975
$
1,552,562
Building and improvements
3,206,224
3,196,762
In-place lease assets
441,067
442,729
Above-market lease assets
65,863
65,946
Total investment in real estate assets
5,258,129
5,257,999
Accumulated depreciation and amortization
(841,154
)
(731,560
)
Net investment in real estate assets
4,416,975
4,526,439
Investment in unconsolidated joint ventures
41,545
42,854
Total investment in real estate assets, net
4,458,520
4,569,293
Cash and cash equivalents
53,262
17,820
Restricted cash
26,068
77,288
Goodwill
29,066
29,066
Other assets, net
135,274
128,690
Real estate investment and other assets held for sale
—
6,038
Total assets
$
4,702,190
$
4,828,195
LIABILITIES AND EQUITY
Liabilities:
Debt obligations, net
$
2,320,719
$
2,354,099
Below-market lease liabilities, net
105,857
112,319
Earn-out liability
22,000
32,000
Derivative liabilities
65,376
20,974
Deferred income
15,659
15,955
Accounts payable and other liabilities
85,110
124,054
Total liabilities
2,614,721
2,659,401
Commitments and contingencies (Note 8)
—
—
Equity:
Preferred stock, $0.01 par value per share, 10,000 shares authorized, zero shares issued and
outstanding at June 30, 2020 and December 31, 2019
—
—
Common stock, $0.01 par value per share, 1,000,000 shares authorized, 290,465 and 289,047
shares issued and outstanding at June 30, 2020 and December 31, 2019, respectively
2,905
2,890
Additional paid-in capital (“APIC”)
2,795,434
2,779,130
Accumulated other comprehensive loss (“AOCI”)
(60,075
)
(20,762
)
Accumulated deficit
(991,939
)
(947,252
)
Total stockholders’ equity
1,746,325
1,814,006
Noncontrolling interests
341,144
354,788
Total equity
2,087,469
2,168,794
Total liabilities and equity
$
4,702,190
$
4,828,195
See notes to consolidated financial statements.
2
PHILLIPS EDISON & COMPANY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2020 AND 2019
(Condensed and Unaudited)
(In thousands, except per share amounts)
Three Months Ended June 30,
Six Months Ended June 30,
2020
2019
2020
2019
Revenues:
Rental income
$
115,654
$
129,030
$
244,120
$
257,890
Fees and management income
2,760
3,051
4,925
6,312
Other property income
626
500
1,518
1,148
Total revenues
119,040
132,581
250,563
265,350
Operating Expenses:
Property operating
19,629
20,933
41,391
43,799
Real estate taxes
16,453
17,930
33,565
35,278
General and administrative
9,806
13,540
20,546
26,750
Depreciation and amortization
56,370
59,554
112,597
120,543
Impairment of real estate assets
—
25,199
—
38,916
Total operating expenses
102,258
137,156
208,099
265,286
Other:
Interest expense, net
(22,154
)
(25,758
)
(44,929
)
(50,842
)
(Loss) gain on disposal of property, net
(541
)
(1,266
)
(2,118
)
5,855
Other (expense) income, net
(500
)
(10,573
)
9,369
(3,037
)
Net (loss) income
(6,413
)
(42,172
)
4,786
(47,960
)
Net loss (income) attributable to noncontrolling interests
825
5,602
(605
)
6,195
Net (loss) income attributable to stockholders
$
(5,588
)
$
(36,570
)
$
4,181
$
(41,765
)
Earnings per common share:
Net (loss) income per share attributable to stockholders - basic and diluted (Note 10)
$
(0.02
)
$
(0.13
)
$
0.01
$
(0.15
)
Comprehensive loss
Net (loss) income
$
(6,413
)
$
(42,172
)
$
4,786
$
(47,960
)
Other comprehensive loss:
Change in unrealized value on interest rate swaps
(1,747
)
(23,645
)
(45,111
)
(38,006
)
Comprehensive loss
(8,160
)
(65,817
)
(40,325
)
(85,966
)
Net loss (income) attributable to noncontrolling interests
825
5,602
(605
)
6,195
Other comprehensive loss attributable to noncontrolling interests
224
3,168
5,798
5,106
Comprehensive loss attributable to stockholders
$
(7,111
)
$
(57,047
)
$
(35,132
)
$
(74,665
)
See notes to consolidated financial statements.
3
PHILLIPS EDISON & COMPANY, INC.
CONSOLIDATED STATEMENTS OF EQUITY
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2020 AND 2019
(Condensed and Unaudited)
(In thousands, except per share amounts)
Three Months Ended June 30, 2020 and 2019
Common Stock
APIC
AOCI
Accumulated Deficit
Total Stockholders’ Equity
Noncontrolling Interests
Total Equity
Shares
Amount
Balance at April 1, 2019
281,549
$
2,815
$
2,693,946
$
(61
)
$
(745,740
)
$
1,950,960
$
398,225
$
2,349,185
Dividend reinvestment plan (“DRIP”)
1,558
15
17,225
—
—
17,240
—
17,240
Share repurchases
(541
)
(5
)
(5,989
)
—
—
(5,994
)
—
(5,994
)
Change in unrealized value on interest
rate swaps
—
—
—
(20,477
)
—
(20,477
)
(3,168
)
(23,645
)
Common distributions declared, $0.17
per share
—
—
—
—
(48,048
)
(48,048
)
—
(48,048
)
Distributions to noncontrolling interests
—
—
—
—
—
—
(7,061
)
(7,061
)
Share-based compensation
24
1
629
—
—
630
1,891
2,521
Conversion of noncontrolling interests
1,180
12
13,060
—
—
13,072
(13,072
)
—
Net loss
—
—
—
—
(36,570
)
(36,570
)
(5,602
)
(42,172
)
Balance at June 30, 2019
283,770
$
2,838
$
2,718,871
$
(20,538
)
$
(830,358
)
$
1,870,813
$
371,213
$
2,242,026
Balance at April 1, 2020
290,416
$
2,903
$
2,793,803
$
(58,552
)
$
(986,292
)
$
1,751,862
$
341,944
$
2,093,806
Change in unrealized value on interest
rate swaps
—
—
—
(1,523
)
—
(1,523
)
(224
)
(1,747
)
Share-based compensation
5
1
1,332
—
—
1,333
808
2,141
Conversion of noncontrolling interests
50
1
555
—
—
556
(556
)
—
Other
(6
)
—
(256
)
—
(59
)
(315
)
(3
)
(318
)
Net loss
—
—
—
—
(5,588
)
(5,588
)
(825
)
(6,413
)
Balance at June 30, 2020
290,465
$
2,905
$
2,795,434
$
(60,075
)
$
(991,939
)
$
1,746,325
$
341,144
$
2,087,469
Six Months Ended June 30, 2020 and 2019
Common Stock
APIC
AOCI
Accumulated Deficit
Total Stockholders’ Equity
Noncontrolling Interests
Total Equity
Shares
Amount
Balance at January 1, 2019
279,803
$
2,798
$
2,674,871
$
12,362
$
(692,573
)
$
1,997,458
$
414,911
$
2,412,369
DRIP
3,161
31
34,927
—
—
34,958
—
34,958
Share repurchases
(1,146
)
(11
)
(12,663
)
—
—
(12,674
)
—
(12,674
)
Change in unrealized value on interest
rate swaps
—
—
—
(32,900
)
—
(32,900
)
(5,106
)
(38,006
)
Common distributions declared, $0.34
per share
—
—
—
—
(96,020
)
(96,020
)
—
(96,020
)
Distributions to noncontrolling interests
—
—
—
—
—
—
(14,228
)
(14,228
)
Share-based compensation
64
1
856
—
—
857
2,730
3,587
Conversion of noncontrolling interests
1,888
19
20,880
—
—
20,899
(20,899
)
—
Net loss
—
—
—
—
(41,765
)
(41,765
)
(6,195
)
(47,960
)
Balance at June 30, 2019
283,770
$
2,838
$
2,718,871
$
(20,538
)
$
(830,358
)
$
1,870,813
$
371,213
$
2,242,026
Balance at January 1, 2020
289,047
$
2,890
$
2,779,130
$
(20,762
)
$
(947,252
)
$
1,814,006
$
354,788
$
2,168,794
DRIP
1,436
14
15,926
—
—
15,940
—
15,940
Share repurchases
(288
)
(3
)
(2,697
)
—
—
(2,700
)
—
(2,700
)
Change in unrealized value on interest
rate swaps
—
—
—
(39,313
)
—
(39,313
)
(5,798
)
(45,111
)
Common distributions declared, $0.17
per share
—
—
—
—
(48,809
)
(48,809
)
—
(48,809
)
Distributions to noncontrolling interests
—
—
—
—
—
—
(7,105
)
(7,105
)
Share-based compensation
108
2
1,472
—
—
1,474
518
1,992
Conversion of noncontrolling interests
168
2
1,859
—
—
1,861
(1,861
)
—
Other
(6
)
—
(256
)
—
(59
)
(315
)
(3
)
(318
)
Net income
—
—
—
—
4,181
4,181
605
4,786
Balance at June 30, 2020
290,465
$
2,905
$
2,795,434
$
(60,075
)
$
(991,939
)
$
1,746,325
$
341,144
$
2,087,469
See notes to consolidated financial statements.
4
PHILLIPS EDISON & COMPANY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2020 AND 2019
(Condensed and Unaudited)
(In thousands)
Six Months Ended June 30,
2020
2019
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)
$
4,786
$
(47,960
)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization of real estate assets
109,709
117,170
Impairment of real estate assets
—
38,916
Depreciation and amortization of corporate assets
2,888
3,373
Net amortization of above- and below-market leases
(1,583
)
(2,224
)
Amortization of deferred financing expenses
2,495
2,522
Amortization of debt and derivative adjustments
1,884
4,482
Loss (gain) on disposal of property, net
2,118
(5,855
)
Change in fair value of earn-out liability
(10,000
)
(7,500
)
Straight-line rent
(1,331
)
(4,456
)
Share-based compensation
1,992
3,793
Other impairment charges
—
9,661
Other
1,239
1,705
Changes in operating assets and liabilities:
Other assets, net
(12,821
)
(1,553
)
Accounts payable and other liabilities
(11,470
)
(12,005
)
Net cash provided by operating activities
89,906
100,069
CASH FLOWS FROM INVESTING ACTIVITIES:
Real estate acquisitions
(4,343
)
(49,880
)
Capital expenditures
(28,540
)
(27,221
)
Proceeds from sale of real estate
25,778
47,857
Return of investment in unconsolidated joint ventures
639
2,257
Net cash used in investing activities
(6,466
)
(26,987
)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net change in credit facility
—
(73,359
)
Proceeds from mortgages and loans payable
—
60,000
Payments on mortgages and loans payable
(35,200
)
(4,835
)
Distributions paid, net of DRIP
(49,083
)
(60,787
)
Distributions to noncontrolling interests
(9,406
)
(13,841
)
Repurchases of common stock
(5,211
)
(11,802
)
Other
(318
)
(206
)
Net cash used in financing activities
(99,218
)
(104,830
)
NET DECREASE IN CASH, CASH EQUIVALENTS, AND RESTRICTED CASH
(15,778
)
(31,748
)
CASH, CASH EQUIVALENTS, AND RESTRICTED CASH:
Beginning of period
95,108
84,304
End of period
$
79,330
$
52,556
RECONCILIATION TO CONSOLIDATED BALANCE SHEETS:
Cash and cash equivalents
$
53,262
$
17,772
Restricted cash
26,068
34,784
Cash, cash equivalents, and restricted cash at end of period
$
79,330
$
52,556
5
PHILLIPS EDISON & COMPANY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2020 AND 2019
(Condensed and Unaudited)
(In thousands)
2020
2019
SUPPLEMENTAL CASH FLOW DISCLOSURE, INCLUDING NON-CASH INVESTING AND FINANCING ACTIVITIES:
Cash paid for interest
$
40,980
$
44,169
Right-of-use (“ROU”) assets obtained in exchange for new lease liabilities
551
1,444
Accrued capital expenditures
2,884
2,960
Change in distributions payable
(16,214
)
275
Change in distributions payable - noncontrolling interests
(2,301
)
387
Change in accrued share repurchase obligation
(2,511
)
872
Distributions reinvested
15,940
34,958
See notes to consolidated financial statements.
6
Phillips Edison & Company, Inc.
Notes to Consolidated Financial Statements
(Condensed and Unaudited)
1. ORGANIZATION
Phillips Edison & Company, Inc. (“we,” the “Company,” “our,” or “us”) was formed as a Maryland corporation in October 2009. Substantially all of our business is conducted through Phillips Edison Grocery Center Operating Partnership I, L.P., (the “Operating Partnership”), a Delaware limited partnership formed in December 2009. We are a limited partner of the Operating Partnership, and our wholly owned subsidiary, Phillips Edison Grocery Center OP GP I LLC, is the sole general partner of the Operating Partnership.
We are a real estate investment trust (“REIT”) that invests primarily in well-occupied, grocery-anchored, neighborhood and community shopping centers that have a mix of creditworthy national, regional, and local retailers that sell necessity-based goods and services in strong demographic markets throughout the United States. In addition to managing our own shopping centers, our third-party investment management business provides comprehensive real estate and asset management services to three institutional joint ventures, in which we have a partial ownership interest, and one private fund (collectively, the “Managed Funds”).
As of June 30, 2020 , we wholly-owned 284 real estate properties. Additionally, we owned a 20% equity interest in Necessity Retail Partners (“NRP”), a joint venture that owned seven properties; a 15% interest in Grocery Retail Partners I LLC (“GRP I”), a joint venture that owned 17 properties; and a 10% interest in Grocery Retail Partners II LLC (“GRP II”), a joint venture that owned three properties.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Set forth below is a summary of the significant accounting estimates and policies that management believes are important to the preparation of our consolidated interim financial statements. Certain of our accounting estimates are particularly important for an understanding of our financial position and results of operations and require the application of significant judgment by management. For example, significant estimates and assumptions have been made with respect to the useful lives of assets, recoverable amounts of receivables, and other fair value measurement assessments required for the preparation of the consolidated financial statements. As a result, these estimates are subject to a degree of uncertainty.
During the first quarter of 2020, a novel coronavirus (“COVID-19”) began spreading globally, with the outbreak being classified as a pandemic by the World Health Organization on March 11, 2020. Because of the adverse economic conditions that exist as a result of the impacts of the COVID-19 pandemic, it is possible that the estimates and assumptions that have been utilized in the preparation of the consolidated financial statements could change significantly. Specifically as it relates to our business, the current economic situation resulted in temporary tenant closures at our shopping centers, often as a result of “stay-at-home” government mandates which limited travel and movement of the general public to essential activities only and required all non-essential businesses to close.
Temporary closures of tenant spaces at our centers peaked in April and have significantly decreased as states have reduced or removed restrictions on business operations and the travel and movement of the general public. Certain tenants remain temporarily closed, have since closed after reopening, are limiting the number of customers allowed in their locations, or have modified their operations in other ways that may impact their profitability, either as a result of government mandates or self-elected efforts to reduce the spread of COVID-19. Some states and localities have temporarily reinstated certain mandates in response to increasing reported cases of COVID-19. These actions could result in increased permanent store closings and could reduce the demand for leasing space in our shopping centers and result in a decline in occupancy and rental revenues in our real estate portfolio. All of this activity impacts our estimates around the collectability of revenue and valuation of real estate assets, goodwill and other intangible assets, and certain liabilities, among others.
There were no changes to our significant accounting policies during the six months ended June 30, 2020 . For a full summary of our accounting policies, refer to our 2019 Annual Report on Form 10-K filed with the SEC on March 11, 2020.
Basis of Presentation and Principles of Consolidation —The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. Readers of this Quarterly Report on Form 10-Q should refer to our audited consolidated financial statements for the year ended December 31, 2019 , which are included in our 2019 Annual Report on Form 10-K. In the opinion of management, all normal and recurring adjustments necessary for the fair presentation of the unaudited consolidated financial statements for the periods presented have been included in this Quarterly Report. Our results of operations for the three and six months ended June 30, 2020 are not necessarily indicative of the operating results expected for the full year.
The accompanying consolidated financial statements include our accounts and those of our majority-owned subsidiaries. All intercompany balances and transactions are eliminated upon consolidation.
Leases —Lease receivables are reviewed continually to determine whether or not it is probable that we will realize all amounts owed to us for each of our tenants (i.e., whether a tenant is deemed to be a credit risk). If we determine that the tenant is not a credit risk, no reserve or reduction of revenue is recorded, except in the case of disputed charges. If we determine that the
7
tenant is a credit risk, revenue for that tenant is recorded on a cash basis, including any amounts relating to straight-line rent receivables and/or receivables for recoverable expenses. The COVID-19 pandemic has increased the uncertainty of collecting rents from a number of our tenants. For the three and six months ended June 30, 2020 , we had $12.0 million and $14.8 million , respectively, in revenue that will not be recognized until cash is collected or the tenant resumes payment and is considered creditworthy.
In our efforts to maximize collections in the near term while also supporting our tenants as they operate through this pandemic, we have begun negotiating rent relief primarily in the form of payment plans and deferrals on rent and recovery charges, which allow for changes in the timing of payments, but not the total amount of consideration due to us under the lease. In a limited number of instances, we may also agree to waive certain charges due to us under the lease. During the three months ended June 30, 2020 , our negotiated rent relief was minimal.
Income Taxes —Our consolidated financial statements include the operations of wholly owned subsidiaries that have jointly elected to be treated as Taxable REIT Subsidiaries and are subject to U.S. federal, state, and local income taxes at regular corporate tax rates. During the three and six months ended June 30, 2020 , an insignificant amount of federal income tax benefit was reported, and we recorded a full valuation allowance for our net deferred tax asset. We recorded no income tax expense or benefit for the three and six months ended June 30, 2019 . We recognized an insignificant amount of state and local income tax expense for the three and six months ended June 30, 2020 and 2019 . All income tax amounts are included in Other (Expense) Income, Net on the consolidated statements of operations and comprehensive loss (“consolidated statements of operations”).
Recently Issued and Newly Adopted Accounting Pronouncements — In response to the COVID-19 pandemic, the Financial Accounting Standards Board (“FASB”) issued interpretive guidance addressing the accounting treatment for lease concessions attributable to the pandemic. Under this guidance, entities may elect to account for such lease concessions consistent with how they would be accounted for under ASC Topic 842, Leases, (“ASC 842”) if the enforceable rights and obligations for the lease concessions already existed within the lease agreement, regardless of whether such enforceable rights and obligations are explicitly outlined within the lease. This accounting treatment may only be applied if (1) the lease concessions were granted as a direct result of the pandemic, and (2) the total cash flows under the modified lease are less than or substantially the same as the cash flows under the original lease agreement. As a result, entities that make this election will not have to analyze each lease to determine whether enforceable rights and obligations for concessions exist within the contract, and may elect not to account for these concessions as lease modifications within the scope of ASC 842.
Some concessions will provide a deferral of payments, which may affect the timing of cash receipts without substantively impacting the total consideration per the original lease agreement. The FASB has stated that there are multiple acceptable methods to account for deferrals under the interpretive guidance:
•
Account for the concession as if no changes to the lease contract were made, increasing the lease receivable as payments accrue and continuing to recognize income; or
•
Account for deferred lease payments as variable lease payments.
We have elected not to account for any qualifying lease concessions granted as a result of the COVID-19 pandemic as lease modifications and will account for any qualifying concessions granted as if no changes to the lease contract were made. This will result in an increase to the related lease receivable as payments accrue while we continue to recognize rental income. We will, however, assess the impact of any such concessions on estimated collectability of the related lease payments and will reflect any adjustments as necessary as an offset to Rental Income on the consolidated statements of operations.
8
The following table provides a brief description of newly adopted accounting pronouncements and their effect on our consolidated financial statements:
Standard
Description
Date of Adoption
Effect on the Financial Statements or Other Significant Matters
Accounting Standards Update (“ASU”) 2016-13, Financial Instruments - Credit Losses (Topic 326):
Measurement of Credit Losses on Financial Instruments
ASU 2018-19, Financial Instruments - Credit Losses (Topic 326): Codification Improvements
ASU 2019-05, Financial Instruments - Credit Losses (Topic 326): Targeted Transition Relief
ASU 2019-11, Codification Improvements to Topic 326, Financial Instruments - Credit Losses
ASU 2020-02, Financial Instruments - Credit Losses (Topic 326) and Leases (Topic 842)
The amendments in this update replaced the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. It clarified that receivables arising from operating leases are not within the scope of Accounting Standards Codification (“ASC”) Topic 326. Instead, impairment of receivables arising from operating leases will be accounted for in accordance with Topic 842. It also allowed election of the fair value option on certain financial instruments.
January 1, 2020
The adoption of this standard did not have a material impact on our consolidated financial statements. The majority of our financial instruments result from operating lease transactions, which are not within the scope of this standard.
ASU 2018-17, Consolidation (Topic 810): Targeted Improvements to Related Party Guidance for Variable Interest Entities
This ASU amended two aspects of the related-party guidance in Topic 810: (1) added an elective private-company scope exception to the variable interest entity guidance for entities under common control and (2) indirect interests held through related parties in common control arrangements will be considered on a proportional basis for determining whether fees paid to decision makers and service providers are variable interests.
January 1, 2020
The adoption of this standard did not have a material impact on our consolidated financial statements.
ASU 2019-04, Codification Improvements to Topic 326, Financial Instruments—Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments
This ASU amended a variety of topics, improving certain aspects of previously issued ASUs, including ASU 2016-01, Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, and ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities.
January 1, 2020
The adoption of this standard did not have a material impact on our consolidated financial statements.
ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting
This ASU contains practical expedients for reference rate reform related activities that impact debt, leases, derivatives and other contracts. The guidance in ASU 2020-04 is optional and may be elected over time as reference rate reform activities occur.
March 12, 2020
We have elected to apply the hedge accounting expedients related to probability and the assessments of effectiveness for future LIBOR-indexed cash flows to assume that the index upon which future hedged transactions will be based matches the index on the corresponding derivatives. Application of these expedients preserves the presentation of derivatives consistent with past presentation. We continue to evaluate the impact of the guidance and may apply other elections as applicable as additional changes in the market occur.
Reclassifications —The following line item on our consolidated balance sheet as of December 31, 2019 was reclassified to conform to current year presentation:
•
Corporate Intangible Assets, Net was included in Other Assets, Net.
The following line items on our consolidated statement of cash flows for the six months ended June 30, 2019 were reclassified to conform to current year presentation:
•
Amortization of Debt and Derivative Adjustments was listed on a separate line from Other Cash Flows from Operating Activities; and
•
Equity in Net Loss of Unconsolidated Joint Ventures was included in Other Cash Flows from Operating Activities.
9
3. LEASES
Lessor —The majority of our leases are largely similar in that the leased asset is retail space within our properties, and the lease agreements generally contain similar provisions and features, without substantial variations. All of our leases are currently classified as operating leases. Lease income related to our operating leases was as follows for the three and six months ended June 30, 2020 and 2019 (dollars in thousands):
Three Months Ended June 30,
Six Months Ended June 30,
2020
2019
2020
2019
Rental income related to fixed lease payments
$
97,276
$
98,841
$
195,510
$
196,354
Rental income related to variable lease payments
30,659
28,951
62,497
59,478
Amortization of lease assets
786
1,080
1,565
2,198
Lease buyout income
214
223
308
456
Adjustments for collectability (1)
(13,281
)
(65
)
(15,760
)
(596
)
Total rental income
$
115,654
$
129,030
$
244,120
$
257,890
(1)
Contains general reserves as well as revenue adjustments for tenants deemed to be non-creditworthy.
Approximate future fixed contractual lease payments to be received under non-cancelable operating leases in effect as of June 30, 2020 , assuming no new or renegotiated leases or option extensions on lease agreements, are as follows (in thousands):
Year
Amount
Remaining 2020
$
191,883
2021
353,229
2022
316,888
2023
268,211
2024
212,229
Thereafter
569,201
Total
$
1,911,641
As of June 30, 2020 , executed payment plans and rent concessions related to the COVID-19 pandemic were not material.
No single tenant comprised 10% or more of our aggregate annualized base rent (“ABR”) as of June 30, 2020 . As of June 30, 2020 , our real estate investments in Florida and California represented 12.3% and 10.6% of our ABR, respectively. As a result, the geographic concentration of our portfolio makes it particularly susceptible to adverse weather or economic events, including the impact of the COVID-19 pandemic, in the Florida and California real estate markets.
Lessee —Lease assets and liabilities, grouped by balance sheet line where they are recorded, consisted of the following as of June 30, 2020 and December 31, 2019 (in thousands):
Balance Sheet Information
Balance Sheet Location
June 30, 2020
December 31, 2019
ROU assets, net - operating leases (1)
Investment in Real Estate
$
3,924
$
7,613
ROU assets, net - operating and finance leases
Other Assets, Net
2,198
2,111
Operating lease liability
Accounts Payable and Other Liabilities
6,030
9,453
Finance lease liability
Debt Obligations, Net
312
443
(1)
During the six months ended June 30, 2020 , one of our acquisitions was land upon which one of our shopping centers is situated that was previously subject to a ground lease in which the lessor controlled an option requiring us to purchase the land subject to the lease. Our valuation of the ROU asset and lease liability as of December 31, 2019 for this ground lease reflected the assumption that the lessor would exercise this option and that we would purchase the underlying land asset.
10
4. REAL ESTATE ACTIVITY
Property Sales —The following table summarizes our real estate disposition activity (dollars in thousands):
Six Months Ended June 30,
2020
2019
Number of properties sold (1)
4
6
Number of outparcels sold
—
1
Proceeds from sale of real estate
$
25,778
$
47,857
(Loss) gain on sale of properties, net (2)
(1,436
)
6,627
(1)
We retained certain outparcels of land associated with one of our property dispositions during the six months ended June 30, 2020 , and as a result, this property is still included in our total property count.
(2)
The (loss) gain on sale of properties, net does not include miscellaneous write-off activity, which is also recorded in (Loss) Gain on Disposal of Property, Net on the consolidated statements of operations.
Subsequent to June 30, 2020 , we sold one property for $8.5 million .
Impairment of Real Estate Assets —During the three and six months ended June 30, 2020 , we did not recognize any impairment charges. During the three and six months ended June 30, 2019 , we recognized impairment charges totaling $25.2 million and $38.9 million , respectively. The impairments were associated with certain anticipated property dispositions where the net book value exceeded the estimated fair value. Our estimated fair value was based upon the contracted price to sell or the marketed price for disposition, less estimated costs to sell. We applied reasonable estimates and judgments in determining the amount of impairment recognized.
Acquisitions —During the six months ended June 30, 2020 , we acquired two parcels of land for a total of $4.3 million , both of which are either underneath or adjacent to shopping centers that we own. During the six months ended June 30, 2019 , we acquired one property and one outparcel for a total of $49.9 million .
For the six months ended June 30, 2020 , our acquisitions did not have any lease intangibles. The fair value and weighted-average useful life at acquisition for lease intangibles acquired as part of acquisitions in the six months ended June 30, 2019 are as follows (dollars in thousands, weighted-average useful life in years):
Six Months Ended June 30, 2019
Fair Value
Weighted-Average Useful Life
In-place leases
$
4,736
11
Above-market leases
825
8
Below-market leases
(2,097
)
16
11
5. OTHER ASSETS, NET
The following is a summary of Other Assets, Net outstanding as of June 30, 2020 and December 31, 2019 , excluding amounts related to assets classified as held for sale (in thousands):
June 30, 2020
December 31, 2019
Other assets, net:
Deferred leasing commissions and costs
$
40,172
$
38,738
Deferred financing expenses
13,971
13,971
Office equipment, ROU assets, and other
21,222
19,430
Corporate intangible assets
4,883
4,883
Total depreciable and amortizable assets
80,248
77,022
Accumulated depreciation and amortization
(40,706
)
(35,055
)
Net depreciable and amortizable assets
39,542
41,967
Accounts receivable, net (1)
53,265
46,125
Accounts receivable - affiliates
935
728
Deferred rent receivable, net
30,542
29,291
Derivative assets
—
2,728
Prepaid expenses and other
10,990
7,851
Total other assets, net
$
135,274
$
128,690
(1)
Net of $5.7 million and $6.9 million of general reserves for uncollectible amounts, excluding $19.4 million and $6.9 million in receivables that were removed for tenants considered to be non-creditworthy as of June 30, 2020 and December 31, 2019 , respectively.
6. DEBT OBLIGATIONS
The following is a summary of the outstanding principal balances and interest rates, which include the effect of derivative financial instruments, for our debt obligations as of June 30, 2020 and December 31, 2019 (dollars in thousands):
Interest Rate (1)
June 30, 2020
December 31, 2019
Revolving credit facility (2)
LIBOR + 1.4%
$
—
$
—
Term loans (3)
2.58% - 4.59%
1,622,500
1,652,500
Secured loan facilities
3.35% - 3.52%
395,000
395,000
Mortgages
3.45% - 7.91%
319,654
324,578
Finance lease liability
312
443
Assumed market debt adjustments, net
(1,352
)
(1,218
)
Deferred financing expenses, net
(15,395
)
(17,204
)
Total
$
2,320,719
$
2,354,099
(1)
Interest rates are as of June 30, 2020 .
(2)
We had $255.0 million of gross borrowings and payments under our revolving credit facility during the six months ended June 30, 2020 . The gross borrowings and payments under our revolving credit facility were $105.6 million and $179.0 million , respectively, during the six months ended June 30, 2019 .
(3)
Our term loans carry an interest rate of LIBOR plus a spread. While a majority of the rates are fixed through the use of swaps, some of these rates are not fixed through a swap, and thus are still indexed to LIBOR.
In January 2020, we made the final $30 million payment on our term loan maturing in 2021. Following this payment, the next term loan maturity is in April 2022.
In April 2020, we borrowed $200 million on our revolving credit facility to meet our operating needs for a sustained period due to the COVID-19 pandemic. In June 2020, we paid down the outstanding balance on our revolving credit facility. Our debt is subject to certain covenants, and as of June 30, 2020 , we were in compliance with the restrictive covenants of our outstanding debt obligations.
12
The allocation of total debt between fixed-rate and variable-rate as well as between secured and unsecured, excluding market debt adjustments and deferred financing expenses, net, as of June 30, 2020 and December 31, 2019 , is summarized below (in thousands):
June 30, 2020
December 31, 2019
As to interest rate: (1)
Fixed-rate debt
$
1,756,966
$
2,122,021
Variable-rate debt
580,500
250,500
Total
$
2,337,466
$
2,372,521
As to collateralization:
Unsecured debt
$
1,622,500
$
1,652,500
Secured debt
714,966
720,021
Total
$
2,337,466
$
2,372,521
Weighed-average interest rate (1)
3.1
%
3.4
%
(1)
Includes the effects of derivative financial instruments (see Notes 7 and 12 ).
7. DERIVATIVES AND HEDGING ACTIVITIES
Risk Management Objective of Using Derivatives —We are exposed to certain risks arising from both our business operations and economic conditions. We principally manage our exposure to a wide variety of business and operational risks through management of our core business activities. We manage economic risks, including interest rate, liquidity, and credit risk, primarily by managing the amount, sources, and duration of our debt funding, and through the use of derivative financial instruments. Specifically, we enter into interest rate swaps to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates. Our derivative financial instruments are used to manage differences in the amount, timing, and duration of our known or expected cash receipts and our known or expected cash payments principally related to our investments and borrowings.
Cash Flow Hedges of Interest Rate Risk —Interest rate swaps designated as cash flow hedges involve the receipt of variable amounts from a counterparty in exchange for our making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount.
The changes in the fair value of derivatives designated, and that qualify, as cash flow hedges are recorded in AOCI and are subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. During the six months ended June 30, 2020 and 2019 , such derivatives were used to hedge the variable cash flows associated with certain variable-rate debt. Amounts reported in AOCI related to these derivatives will be reclassified to Interest Expense, Net as interest payments are made on the variable-rate debt. During the next twelve months, we estimate that an additional $19.7 million will be reclassified from AOCI as an increase to Interest Expense, Net.
The following is a summary of our interest rate swaps that were designated as cash flow hedges of interest rate risk as of June 30, 2020 and December 31, 2019 (notional amounts in thousands):
June 30, 2020
December 31, 2019
Count
6
9
Notional amount
$
1,042,000
$
1,402,000
Fixed LIBOR
1.3% - 2.9%
0.8% - 2.9%
Maturity date
2021 - 2025
2020 - 2025
The table below details the nature of the gain or loss recognized on interest rate derivatives designated as cash flow hedges in the consolidated statements of operations (in thousands):
Three Months Ended June 30,
Six Months Ended June 30,
2020
2019
2020
2019
Amount of (loss) recognized in other comprehensive income on derivatives
$
(6,614
)
$
(22,348
)
$
(51,530
)
$
(35,205
)
Amount of loss (gain) reclassified from AOCI into interest expense
4,867
(1,297
)
6,419
(2,801
)
13
Credit-risk-related Contingent Features —We have agreements with our derivative counterparties that contain provisions where, if we default, or are capable of being declared in default, on any of our indebtedness, we could also be declared to be in default on our derivative obligations. As of June 30, 2020 , the fair value of our derivatives in a net liability position, which included accrued interest but excluded any adjustment for nonperformance risk related to these agreements, was approximately $65.4 million . As of June 30, 2020 , we had not posted any collateral related to these agreements and were not in breach of any agreement provisions. If we had breached any of these provisions, we could have been required to settle our obligations under the agreements at their termination value of $65.4 million .
8. COMMITMENTS AND CONTINGENCIES
Litigation —We are involved in various claims and litigation matters arising in the ordinary course of business, some of which involve claims for damages. Many of these matters are covered by insurance, although they may nevertheless be subject to deductibles or retentions. Although the ultimate liability for these matters cannot be determined, based upon information currently available, we believe the resolution of such claims and litigation will not have a material adverse effect on our consolidated financial statements.
Environmental Matters —In connection with the ownership and operation of real estate, we may potentially be liable for costs and damages related to environmental matters. In addition, we may own or acquire certain properties that are subject to environmental remediation. Depending on the nature of the environmental matter, the seller of the property, a tenant of the property, and/or another third party may be responsible for environmental remediation costs related to a property. Additionally, in connection with the purchase of certain properties, the respective sellers and/or tenants may agree to indemnify us against future remediation costs. We also carry environmental liability insurance on our properties that provides limited coverage for any remediation liability and/or pollution liability for third-party bodily injury and/or property damage claims for which we may be liable. We are not aware of any environmental matters which we believe are reasonably likely to have a material effect on our consolidated financial statements.
Captive Insurance —Our captive insurance company, Silver Rock Insurance, Inc. (“Silver Rock”) provides general liability insurance, wind, reinsurance, and other coverage to us and our related-party joint ventures. We capitalize Silver Rock in accordance with applicable regulatory requirements.
Silver Rock established annual premiums based on the past loss experience of the insured properties. An independent third party was engaged to perform an actuarial estimate of projected future claims, related deductibles, and projected future expenses necessary to fund associated risk management programs. Premiums paid to Silver Rock may be adjusted based on these estimates, and such premiums may be reimbursed by tenants pursuant to specific lease terms.
As of June 30, 2020 , we had four cash collateralized letters of credit outstanding totaling approximately $8.0 million to provide security for our obligations under Silver Rock’s insurance and reinsurance contracts.
COVID-19 —As of June 30, 2020 , we were not aware of any significant liabilities or obligations to waive rent that we have incurred under force majeure or co-tenancy clauses in tenant leases.
9. EQUITY
General —The holders of common stock are entitled to one vote per share on all matters voted on by stockholders, including one vote per nominee in the election of our board of directors (“Board”). Our charter does not provide for cumulative voting in the election of directors.
On May 6, 2020, our Board decreased the estimated value per share (“EVPS”) of our common stock to $8.75 based substantially on the estimated market value of our portfolio of real estate properties and our third-party investment management business as of March 31, 2020. The decrease was primarily driven by the negative impact of the COVID-19 pandemic on PECO’s non-grocery tenants resulting from social distancing and stay-at-home guidelines and the uncertainty of the duration and full effect on the overall economy. We engaged a third-party valuation firm to provide a calculation of the range in EVPS of our common stock as of March 31, 2020, which reflected certain balance sheet assets and liabilities as of that date. Previously, our EVPS was $11.10 , based substantially on the estimated market value of our portfolio of real estate properties and our third-party investment management business as of March 31, 2019.
Dividend Reinvestment Plan —The DRIP allows stockholders to invest distributions in additional shares of our common stock, subject to certain limits. Stockholders who elect to participate in the DRIP may choose to invest all or a portion of their cash distributions in shares of our common stock at a price equal to our most recent EVPS.
Stockholders who elect to participate in the DRIP, and who are subject to U.S. federal income taxation laws, will incur a tax liability on an amount equal to the fair value on the relevant distribution date of the shares of our common stock purchased with reinvested distributions, even though such stockholders have elected not to receive the distributions in cash.
On March 27, 2020, the DRIP was temporarily suspended and remains suspended as of June 30, 2020 . The March 2020 distribution was paid all in cash on April 1, 2020.
Distributions —On March 27, 2020, our Board temporarily suspended stockholder distributions, effective after the payment of the March 2020 distribution on April 1, 2020, as a result of the uncertainty surrounding the COVID-19 pandemic, including the impact that the pandemic and the measures taken by governmental authorities and tenants in response to the pandemic are expected to continue to have on our shopping centers and our financial condition, liquidity sources, and capital needs.
14
Share Repurchase Program (“SRP”) —The SRP provides an opportunity for stockholders to have shares of common stock repurchased, subject to certain restrictions and limitations. The Board reserves the right, in its sole discretion, at any time and from time to time, to reject any request for repurchase.
On August 7, 2019, the Board suspended the SRP with respect to standard repurchases. The SRP for death, qualifying disability, or determination of incompetence was also suspended, effective March 27, 2020. Both the SRP with respect to standard repurchases and the SRP for death, qualifying disability, or determination of incompetence remain suspended as of June 30, 2020 .
Convertible Noncontrolling Interests —Under the terms of the Fourth Amended and Restated Agreement of Limited Partnership (the “Partnership Agreement”), Operating Partnership unit (“OP unit”) holders may elect to exchange OP units. The Operating Partnership controls the form of the redemption, and may elect to exchange OP units for shares of our common stock, provided that the OP units have been outstanding for at least one year, or for cash. As the form of redemption for OP units is within our control, the OP units outstanding as of June 30, 2020 and December 31, 2019 are classified as Noncontrolling Interests within permanent equity on our consolidated balance sheets. The distributions that have been paid on OP units are included in Distributions to Noncontrolling Interests on the consolidated statements of equity. During the six months ended June 30, 2020 and 2019 , 0.2 million and 1.9 million OP units were converted into shares of our common stock at a 1:1 ratio, respectively. There were approximately 42.7 million OP units outstanding as of June 30, 2020 and December 31, 2019 . Additionally, certain of our outstanding time- and performance-based equity awards will result in the issuance of shares or OP units upon vesting in future periods.
10. EARNINGS PER SHARE
We use the two-class method of computing earnings per share (“EPS”), which is an earnings allocation formula that determines EPS for common stock and any participating securities according to dividends declared (whether paid or unpaid). Under the two-class method, basic EPS is computed by dividing Net (Loss) Income Attributable to Stockholders by the weighted-average number of shares of common stock outstanding for the period. Diluted EPS reflects the potential dilution that could occur from share equivalent activity.
OP units held by limited partners other than us are considered to be participating securities because they contain non-forfeitable rights to dividends or dividend equivalents, and have the potential to be exchanged for an equal number of shares of our common stock in accordance with the terms of the the Partnership Agreement.
In previous periods, we issued certain share-based awards to employees which are tied to the value of our EVPS, but that are paid in cash upon vesting. We have a small number of these awards that remain outstanding, however, they are not considered to be participating securities as they are not convertible into common stock, and as such are not included as a component of our basic or diluted EPS calculation.
The impact of outstanding OP units on basic and diluted EPS has been calculated using the two-class method whereby earnings are allocated to the OP units based on dividends declared and the OP units’ participation rights in undistributed earnings. The effects of the two-class method on basic and diluted EPS were immaterial to the consolidated financial statements as of June 30, 2020 and 2019 .
The following table provides a reconciliation of the numerator and denominator of the earnings per share calculations (in thousands, except per share amounts):
Three Months Ended June 30,
Six Months Ended June 30,
2020
2019
2020
2019
Numerator:
Net (loss) income attributable to stockholders - basic
$
(5,588
)
$
(36,570
)
$
4,181
$
(41,765
)
Net (loss) income attributable to convertible OP units (1)
(825
)
(5,643
)
605
(6,426
)
Net (loss) income - diluted
$
(6,413
)
$
(42,213
)
$
4,786
$
(48,191
)
Denominator:
Weighted-average shares - basic
290,464
283,010
290,209
282,148
OP units (1)
42,743
43,288
42,818
43,640
Dilutive restricted stock awards
—
—
393
—
Adjusted weighted-average shares - diluted
333,207
326,298
333,420
325,788
Earnings per common share:
Basic and diluted (loss) income per share
$
(0.02
)
$
(0.13
)
$
0.01
$
(0.15
)
(1) OP units include units that are convertible into common stock or cash, at the Operating Partnership’s option. The Operating Partnership income or loss attributable to these OP units, which is included as a component of Net Loss (Income) Attributable to Noncontrolling Interests on the consolidated statements of operations, has been added back in the numerator as these OP units were included in the denominator for all years presented.
Approximately 1.1 million time-based and 2.7 million performance-based unvested stock awards were outstanding as of June 30, 2020 . Approximately 1.1 million time-based and 1.5 million performance-based unvested stock awards were outstanding as of June 30, 2019 . These securities were anti-dilutive for the three months ended June 30, 2020 and the three
15
and six months ended June 30, 2019 . As a result, their impact was excluded from the weighted-average common shares used to calculate diluted EPS for those periods.
11. REVENUE RECOGNITION AND RELATED PARTY TRANSACTIONS
Revenue —Summarized below are amounts included in Fees and Management Income. The revenue includes the fees and reimbursements earned by us from the Managed Funds, and other revenues that are not in the scope of ASC Topic 606, Revenue from Contracts with Customers, but that are included in this table for the purpose of disclosing all related party revenues (in thousands):
Three Months Ended June 30,
Six Months Ended June 30,
2020
2019
2020
2019
Recurring fees (1)
$
1,182
$
1,639
$
2,398
$
3,221
Transactional revenue and reimbursements (2)
960
827
1,390
2,049
Insurance premiums (3)
618
585
1,137
1,042
Total fees and management income
$
2,760
$
3,051
$
4,925
$
6,312
(1)
Recurring fees include asset management fees and property management fees.
(2)
Transactional revenue includes items such as leasing commissions, construction management fees, and acquisition fees.
(3)
Insurance premium income from other parties includes amounts from third parties not affiliated with us.
During the six months ended June 30, 2019, we recognized a net charge of $1.9 million in Other Expense, Net on our consolidated statements of operations. The charge was related to a reduction in our related party accounts receivable and organization and offering costs payable for amounts incurred in connection with the Phillips Edison Grocery Center REIT III, Inc. (“REIT III”) public offering. Remaining accounts receivable and organization and offering costs payable that were outstanding as of June 30, 2019 related to REIT III were settled when we merged with REIT III in October 2019.
Other Related Party Matters —We are the limited guarantor for up to $190 million , capped at $50 million in most instances, of debt for our NRP joint venture. We are also the limited guarantor of a $175 million mortgage loan for GRP I. Our guaranty in both cases is limited to being the non-recourse carveout guarantor and the environmental indemnitor. We are also party to a separate agreement with our joint venture partner in which any potential liability under our guaranty for GRP I will be apportioned between us and our joint venture partner based on our respective ownership percentages in GRP I. We have no liability recorded on our consolidated balance sheets for either guaranty as of June 30, 2020 and December 31, 2019 .
12. FAIR VALUE MEASUREMENTS
The following describes the methods we use to estimate the fair value of our financial and nonfinancial assets and liabilities:
Cash and Cash Equivalents, Restricted Cash, Accounts Receivable, and Accounts Payable —We consider the carrying values of these financial instruments to approximate fair value because of the short period of time between origination of the instruments and their expected realization.
Real Estate Investments —The purchase prices of the investment properties, including related lease intangible assets and liabilities, were allocated at estimated fair value based on Level 3 inputs, such as discount rates, capitalization rates, comparable sales, replacement costs, income and expense growth rates, and current market rents and allowances as determined by management.
Debt Obligations —We estimate the fair value of our debt by discounting the future cash flows of each instrument at rates currently offered for similar debt instruments of comparable maturities by our lenders using Level 3 inputs. The discount rates used approximate current lending rates for loans or groups of loans with similar maturities and credit quality, assuming the debt is outstanding through maturity and considering the debt’s collateral (if applicable). We have utilized market information, as available, or present value techniques to estimate the amounts required to be disclosed.
16
The following is a summary of borrowings as of June 30, 2020 and December 31, 2019 (in thousands):
June 30, 2020
December 31, 2019
Recorded Principal Balance (1)
Fair Value
Recorded Principal Balance (1)
Fair Value
Term loans
$
1,608,378
$
1,595,050
$
1,636,470
$
1,656,765
Secured portfolio loan facilities
390,890
391,157
390,780
399,054
Mortgages (2)
321,451
328,611
326,849
337,614
Total
$
2,320,719
$
2,314,818
$
2,354,099
$
2,393,433
(1)
Recorded principal balances include net deferred financing expenses of $15.4 million and $17.2 million as of June 30, 2020 and December 31, 2019 , respectively. Recorded principal balances also include assumed market debt adjustments of $1.4 million and $1.2 million as of June 30, 2020 and December 31, 2019 , respectively. There are deferred financing expenses related to our revolving credit facility that are in an asset position and thus are not included in these balances.
(2)
Our finance lease liability is included in the mortgages line item, as presented .
Recurring and Nonrecurring Fair Value Measurements —Our earn-out liability and interest rate swaps are measured and recognized at fair value on a recurring basis, while certain real estate assets and liabilities are measured and recognized at fair value as needed. Fair value measurements that occurred as of and during the six months ended June 30, 2020 and the year ended December 31, 2019 , were as follows (in thousands):
June 30, 2020
December 31, 2019
Level 1
Level 2
Level 3
Level 1
Level 2
Level 3
Recurring
Derivative assets (1)
$
—
$
—
$
—
$
—
$
2,728
$
—
Derivative liabilities (1)
—
(65,376
)
—
—
(20,974
)
—
Earn-out liability
—
—
(22,000
)
—
—
(32,000
)
Nonrecurring
Impaired real estate assets, net (2)
—
—
—
—
280,593
—
Impaired corporate intangible asset, net (3)
—
—
—
—
—
4,401
(1)
We record derivative assets in Other Assets, Net and derivative liabilities in Derivative Liabilities on our consolidated balance sheets.
(2)
The carrying value of impaired real estate assets may have subsequently increased or decreased after the measurement date due to capital improvements, depreciation, or sale.
(3)
The carrying value of our impaired corporate intangible asset, net, which consists of in-place management contracts, subsequently decreased after the measurement date due to amortization as well as through derecognition as part of the merger with REIT III.
Derivative Instruments— As of June 30, 2020 and December 31, 2019 , we had interest rate swaps that fixed LIBOR on portions of our unsecured term loan facilities.
All interest rate swap agreements are measured at fair value on a recurring basis. The valuation of these instruments 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 derivatives, including the period to maturity, 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.
To comply with the provisions of ASC Topic 820, Fair Value Measurement , we incorporate credit valuation adjustments to appropriately reflect both our own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of our derivative contracts for the effect of nonperformance risk, we have considered the impact of netting and any applicable credit enhancements, such as collateral postings, thresholds, mutual puts, and guarantees.
Although we determined that the significant inputs used to value our derivatives fell within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with our counterparties and our own credit risk utilize Level 3 inputs, such as estimates of current credit spreads, to evaluate the likelihood of default by us and our counterparties. However, as of June 30, 2020 and December 31, 2019 , we have assessed the significance of the impact of the credit valuation adjustments on the overall valuation of our derivative positions and have determined that the credit valuation adjustments are not significant to the overall valuation of our derivatives. As a result, we have determined that our derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.
Earn-out —As part of our acquisition of Phillips Edison Limited Partnership (“PELP”), an earn-out structure was established which gave PELP the opportunity to earn additional OP units based upon the potential achievement of certain performance targets subsequent to the acquisition. After the expiration of certain provisions in 2019, PELP is now eligible to earn up to five million OP units based on the timing and valuation of a liquidity event for PECO, which can occur no later than December 31, 2021 in order for the performance targets to be achieved per the terms of the agreement.
We estimate the fair value of this liability on a quarterly basis using the Monte Carlo method. This method requires us to make assumptions about future dividend yields, volatility, and timing and pricing of liquidity events, which are unobservable and are
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considered Level 3 inputs in the fair value hierarchy. A change in these inputs to a different amount might result in a significantly higher or lower fair value measurement at the reporting date. In calculating the fair value of this liability as of June 30, 2020 , we have determined that the most likely range of potential outcomes includes a possibility of no additional OP units issued as well as up to a maximum of five million units being issued.
Changes in the fair value of the earn-out liability have been and will continue to be recognized in earnings. The following table presents a reconciliation of the change in the earn-out liability measured at fair value on a recurring basis using Level 3 inputs and recognized as Other (Expense) Income, Net in the consolidated statements of operations (in thousands):
Earn-Out Liability
Balance at December 31, 2019
$
32,000
Change in fair value recognized in Other (Expense) Income, Net
(10,000
)
Balance at June 30, 2020
$
22,000
Real Estate Asset Impairment —Our real estate assets are measured and recognized at fair value, less costs to sell for held-for-sale properties, on a nonrecurring basis dependent upon when we determine an impairment has occurred. During the three and six months ended June 30, 2019 , we impaired assets that were under contract or actively marketed for sale at a disposition price that was less than carrying value, or that had other operational impairment indicators. The valuation technique used for the fair value of all impaired real estate assets was the expected net sales proceeds, which we consider to be a Level 2 input in the fair value hierarchy. There were no impairment charges recorded during the three and six months ended June 30, 2020 .
On a quarterly basis, we employ a multi-step approach to assess our real estate assets for possible impairment and record any impairment charges identified. The first step is the identification of potential triggering events, such as significant decreases in occupancy or the presence of large dark or vacant spaces. If we observe any of these indicators for a shopping center, we then perform an additional screen test consisting of a years-to-recover analysis to determine if we will recover the net book value of the property over its remaining economic life based upon net operating income as forecasted for the current year. In the event that the results of this first step indicate a triggering event for a center, we proceed to the second step, utilizing an undiscounted cash flow model for the center to identify potential impairment. If the undiscounted cash flows are less than the net book value of the center as of the balance sheet date, we proceed to the third step. In performing the third step, we utilize market data such as capitalization rates and sales price per square foot on comparable recent real estate transactions to estimate fair value of the real estate assets. We also utilize expected net sales proceeds to estimate the fair value of any centers that are actively being marketed for sale. If the estimated fair value of the property is less than the recorded net book value at the balance sheet date, we record an impairment charge.
In addition to these procedures, we also review undeveloped or unimproved land parcels that we own for evidence of impairment and record any impairment charges as necessary. Primary impairment triggers for these land parcels are changes to our plans or intentions with regards to such properties, or planned dispositions at prices that are less than the current carrying values.
Our quarterly impairment procedures have not been altered by the COVID-19 pandemic, as we believe key impairment indicators such as temporary store closings and large dark or vacant spaces will continue to be identified in our review. We have utilized forecasts that incorporate estimated decreases in net operating income (“NOI”) and cash flows as a result of the COVID-19 pandemic in performing our review procedures for the three and six months ended June 30, 2020 . However, it is possible that we could experience unanticipated changes in assumptions that are employed in our impairment review which could impact our cash flows and fair value conclusions. Such unanticipated changes relative to our expectations may include but are not limited to: increases or decreases in the duration or permanence of tenant closures, increases or decreases in collectability reserves and write-offs, additional capital required to fill vacancies, extended lease-up periods, future closings of large tenants, changes in macroeconomic assumptions such as rate of inflation and capitalization rates, and changes to the estimated timing of disposition of the properties under review.
We recorded the following expense upon impairment of real estate assets (in thousands):
Three Months Ended June 30,
Six Months Ended June 30,
2020
2019
2020
2019
Impairment of real estate assets
$
—
$
25,199
$
—
$
38,916
Corporate Intangible Asset Impairment —In connection with our acquisition of PELP, we acquired a corporate intangible asset consisting of in-place management contracts. We evaluate our corporate intangible asset for impairment when a triggering event occurs, or circumstances change, that indicate the carrying value may not be recoverable. In June 2019, the suspension of the REIT III public offering constituted a triggering event for further review of the corporate intangible asset’s fair value compared to its carrying value.
We estimated the fair value of the corporate intangible asset using a discounted cash flow model, leveraging certain Level 3 inputs. The evaluation of corporate intangible assets for potential impairment required management to exercise significant judgment and to make certain assumptions. The assumptions utilized in the evaluation included future cash flows and a discount rate. For the corporate intangible asset during the three months ended June 2019, we used a discount rate of 19% in our discounted cash flow model.
Based on this analysis, we concluded the carrying value exceeded the estimated fair value of the corporate intangible asset, and an impairment charge of $7.8 million was recorded in Other (Expense) Income, Net on the consolidated statements of operations in the second quarter of 2019.
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13. SUBSEQUENT EVENTS
In preparing the condensed and unaudited consolidated financial statements, we have evaluated subsequent events through the filing of this report on Form 10-Q for recognition and/or disclosure purposes. Based on this evaluation, we have determined that there were no events that have occurred that require recognition or disclosure, other than certain events and transactions that have been disclosed elsewhere in these consolidated financial statements.
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Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.