EQC 6.30.15 10-Q
Table of Contents

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
 
ý      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 
For the quarterly period ended June 30, 2015
OR
 
o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 1-9317
EQUITY COMMONWEALTH
(Exact Name of Registrant as Specified in Its Charter)
Maryland
 
04-6558834
(State or Other Jurisdiction of Incorporation or Organization)
 
(IRS Employer Identification No.)
Two North Riverside Plaza, Suite 600, Chicago, IL
 
60606
(Address of Principal Executive Offices)
 
(Zip Code)
(312) 646-2800
(Registrant’s Telephone Number, Including Area Code)
 
Indicate by check mark whether the registrant:  (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ý  No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes ý  No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check One):
Large accelerated filer x
 
Accelerated filer o
 
 
 
Non-accelerated filer o
 
Smaller reporting company o
(Do not check if a smaller reporting company)
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No ý
Number of registrant’s common shares of beneficial interest, $0.01 par value per share, outstanding as of July 31, 2015:  129,760,214.
 

Table of Contents

EQUITY COMMONWEALTH
 
FORM 10-Q
 
June 30, 2015
 
INDEX
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

Table of Contents


 
EXPLANATORY NOTE
 
References in this Quarterly Report on Form 10-Q to the Company, EQC, we, us or our, refer to Equity Commonwealth and its consolidated subsidiaries as of June 30, 2015, unless the context indicates otherwise.


i
Table of Contents

PART I.      Financial Information

Item 1.         Financial Statements.

EQUITY COMMONWEALTH
 
CONDENSED CONSOLIDATED BALANCE SHEETS
(amounts in thousands, except share data)
(unaudited)
 
June 30,
2015
 
December 31,
2014
 
 
 
(audited)
ASSETS
 
 
 
Real estate properties:
 
 
 
Land
$
456,614

 
$
714,238

Buildings and improvements
3,834,855

 
5,014,205

 
4,291,469

 
5,728,443

Accumulated depreciation
(913,303
)
 
(1,030,445
)
 
3,378,166

 
4,697,998

Properties held for sale
360,781

 
—

Acquired real estate leases, net
121,912

 
198,287

Cash and cash equivalents
1,286,902

 
364,516

Restricted cash
31,351

 
32,257

Rents receivable, net of allowance for doubtful accounts of $10,008 and $6,565, respectively
209,089

 
248,101

Other assets, net
159,845

 
220,480

Total assets
$
5,548,046

 
$
5,761,639

 
 
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Senior unsecured debt, net
$
1,460,131

 
$
1,598,416

Mortgage notes payable, net
513,561

 
609,249

Liabilities related to properties held for sale
20,336

 
—

Accounts payable and accrued expenses
128,590

 
162,204

Assumed real estate lease obligations, net
5,728

 
26,784

Rent collected in advance
21,860

 
31,359

Security deposits
10,610

 
14,044

Total liabilities
2,160,816

 
2,442,056

 
 
 
 
Shareholders’ equity:
 
 
 
Preferred shares of beneficial interest, $0.01 par value: 50,000,000 shares authorized;
 
 
 
Series D preferred shares; 6 1/2% cumulative convertible; 4,915,196 and 4,915,497 shares issued and outstanding, respectively, aggregate liquidation preference of $122,880 and $122,887, respectively
119,263

 
119,266

Series E preferred shares; 7 1/4% cumulative redeemable on or after May 15, 2016; 11,000,000 shares issued and outstanding, aggregate liquidation preference $275,000
265,391

 
265,391

Common shares of beneficial interest, $0.01 par value: 350,000,000 shares authorized; 129,760,214 and 129,607,279 shares issued and outstanding, respectively
1,298

 
1,296

Additional paid in capital
4,495,244

 
4,487,133

Cumulative net income
2,260,098

 
2,233,852

Cumulative other comprehensive loss
(5,963
)
 
(53,216
)
Cumulative common distributions
(3,111,868
)
 
(3,111,868
)
Cumulative preferred distributions
(636,233
)
 
(622,271
)
Total shareholders’ equity
3,387,230

 
3,319,583

Total liabilities and shareholders’ equity
$
5,548,046

 
$
5,761,639

See accompanying notes.

1
Table of Contents

EQUITY COMMONWEALTH
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(amounts in thousands, except per share data)
(unaudited)
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
Revenues:
 
 
 
 
 
 
 
Rental income
$
163,697

 
$
172,407

 
$
331,669

 
$
344,447

Tenant reimbursements and other income
39,997

 
42,787

 
85,080

 
88,007

Total revenues
203,694

 
215,194

 
416,749

 
432,454

Expenses:
 
 
 
 
 
 
 
Operating expenses
89,686

 
92,701

 
187,557

 
194,432

Depreciation and amortization
53,637

 
59,831

 
116,336

 
111,480

General and administrative
10,911

 
24,097

 
27,469

 
48,945

Loss on asset impairment
15,258

 
22,683

 
17,162

 
17,922

Acquisition related costs
—

 
—

 
—

 
5

Total expenses
169,492

 
199,312

 
348,524

 
372,784

Operating income
34,202

 
15,882

 
68,225

 
59,670

Interest and other income
728

 
281

 
4,176

 
665

Interest expense (including net amortization of debt discounts, premiums and deferred financing fees of $(177), $(300), $(148) and $(609), respectively)
(27,973
)
 
(37,899
)
 
(57,815
)
 
(75,834
)
Gain on early extinguishment of debt
10,426

 
—

 
9,998

 
—

Loss on sale of equity investment
—

 
(33
)
 
—

 
(33
)
Gain on issuance of shares by an equity investee
—

 
16,911

 
—

 
17,020

Foreign currency exchange gain
856

 
—

 
856

 
—

(Loss) gain on sale of properties
(2,708
)
 
—

 
3,160

 
—

Income (loss) from continuing operations before income taxes and equity in earnings of investees
15,531

 
(4,858
)
 
28,600

 
1,488

Income tax expense
(2,915
)
 
(908
)
 
(2,354
)
 
(1,463
)
Equity in earnings of investees
—

 
12,454

 
—

 
23,388

Income from continuing operations
12,616

 
6,688

 
26,246

 
23,413

Discontinued operations:
 
 
 
 
 
 
 
Income from discontinued operations
—

 
4,114

 
—

 
8,125

Loss on asset impairment from discontinued operations
—

 
(2,072
)
 
—

 
(2,360
)
Loss on early extinguishment of debt from discontinued operations
—

 
(3,345
)
 
—

 
(3,345
)
Net income
12,616

 
5,385

 
26,246

 
25,833

Preferred distributions
(6,981
)
 
(6,982
)
 
(13,962
)
 
(18,133
)
Excess fair value of consideration over carrying value of preferred shares
—

 
(16,205
)
 
—

 
(16,205
)
Net income (loss) attributable to Equity Commonwealth common shareholders
$
5,635

 
$
(17,802
)
 
$
12,284

 
$
(8,505
)
Amounts attributable to Equity Commonwealth common shareholders:
 
 
 
 
 
 
 
Income (loss) from continuing operations
$
5,635

 
$
(16,499
)
 
$
12,284

 
$
(10,925
)
Income from discontinued operations
—

 
4,114

 
—

 
8,125

Loss on asset impairment from discontinued operations
—

 
(2,072
)
 
—

 
(2,360
)
Loss on early extinguishment of debt from discontinued operations
—

 
(3,345
)
 
—

 
(3,345
)
Net income (loss)
$
5,635

 
$
(17,802
)
 
$
12,284

 
$
(8,505
)
Weighted average common shares outstanding — basic
129,733

 
123,812

 
129,714

 
121,121

Weighted average common shares outstanding — diluted
130,537

 
123,812

 
130,205

 
121,121

Basic and diluted earnings per common share attributable to Equity Commonwealth common shareholders:
 
 
 
 
 
 
 
Income (loss) from continuing operations
$
0.04

 
$
(0.13
)
 
$
0.09

 
$
(0.09
)
(Loss) income from discontinued operations
$
—

 
$
(0.01
)
 
$
—

 
$
0.02

Net income (loss)
$
0.04

 
$
(0.14
)
 
$
0.09

 
$
(0.07
)
Distributions declared per common share
$
—

 
$
—

 
$
—

 
$
0.25

See accompanying notes.

2
Table of Contents

EQUITY COMMONWEALTH
 
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(amounts in thousands)
(unaudited)
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2015
 
2014
 
2015
 
2014
Net income
$
12,616

 
$
5,385

 
$
26,246

 
$
25,833

 
 
 
 
 
 
 
 
Other comprehensive income, net of tax:
 
 
 
 
 
 
 
Unrealized gain (loss) on derivative instruments and other assets
958

 
627

 
(1,664
)
 
1,627

Foreign currency translation adjustments
65,307

 
4,961

 
48,917

 
15,548

Equity in unrealized loss of an investee
—

 
(69
)
 
—

 
(49
)
Total comprehensive income
$
78,881

 
$
10,904

 
$
73,499

 
$
42,959


See accompanying notes.


3
Table of Contents

EQUITY COMMONWEALTH
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(amounts in thousands)
(unaudited)
 
Six Months Ended June 30,
 
2015
 
2014
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income
$
26,246

 
$
25,833

Adjustments to reconcile net income to cash provided by operating activities:
 
 
 
Depreciation
86,374

 
80,512

Net amortization of debt discounts, premiums and deferred financing fees
(148
)
 
(612
)
Straight line rental income
(1,611
)
 
(7,201
)
Amortization of acquired real estate leases
20,413

 
27,806

Other amortization
12,782

 
9,579

Share-based compensation
8,110

 
3,354

Loss on asset impairment
17,162

 
20,282

(Gain) loss on early extinguishment of debt
(9,998
)
 
3,345

Equity in earnings of investees
—

 
(23,388
)
Loss on sale of equity investments
—

 
33

Gain on issuance of shares by an equity investee
—

 
(17,020
)
Distributions of earnings from investees
—

 
20,680

Net gain on sale of properties
(3,160
)
 
—

Other non-cash expenses
—

 
15,048

Change in assets and liabilities:
 
 
 
Restricted cash
(2,917
)
 
641

Rents receivable and other assets
(20,462
)
 
(19,856
)
Accounts payable and accrued expenses
(847
)
 
(7,833
)
Rent collected in advance
(8,539
)
 
(2,339
)
Security deposits
597

 
241

Due to related persons
—

 
47

Cash provided by operating activities
124,002

 
129,152

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Real estate improvements
(28,623
)
 
(60,437
)
Principal payments received from direct financing lease
3,789

 
3,612

Proceeds from sale of properties, net
962,003

 
185,179

Proceeds from sale of securities
27,068

 
—

Proceeds from sale of equity investments, net
—

 
5,776

Increase in restricted cash
(2,313
)
 
(3,661
)
Cash provided by investing activities
961,924

 
130,469

CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Payments on borrowings
(141,908
)
 
(15,998
)
Deferred financing fees
(7,143
)
 
—

Distributions to common shareholders
—

 
(29,597
)
Distributions to preferred shareholders
(13,962
)
 
(11,151
)
Cash used in financing activities
(163,013
)
 
(56,746
)
 
 
 
 
Effect of exchange rate changes on cash
(527
)
 
757

 
 
 
 
Increase in cash and cash equivalents
922,386

 
203,632

Cash and cash equivalents at beginning of period
364,516

 
217,032

Cash and cash equivalents at end of period
$
1,286,902

 
$
420,664

See accompanying notes.

4
Table of Contents

EQUITY COMMONWEALTH 
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(amounts in thousands)
(unaudited)

 
Six Months Ended June 30,
 
2015
 
2014
SUPPLEMENTAL CASH FLOW INFORMATION:
 
 
 
Interest paid
$
62,094

 
$
77,120

Taxes paid
3,088

 
2,732

 
 
 
 
NON-CASH INVESTING ACTIVITIES:
 
 
 
Increase in capital expenditures recorded as liabilities
$
523

 
$
13,368


See accompanying notes.


5
Table of Contents

EQUITY COMMONWEALTH
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


Note 1.  Basis of Presentation

The accompanying condensed consolidated financial statements of EQC have been prepared without audit.  Certain information and footnote disclosures required by U.S. generally accepted accounting principles, or GAAP, for complete financial statements have been condensed or omitted.  We believe the disclosures made are adequate to make the information presented not misleading.  However, the accompanying condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes contained in our Annual Report on Form 10-K (Annual Report) for the year ended December 31, 2014.  Capitalized terms used, but not defined in this Quarterly Report, have the same meanings as in our Annual Report.

In the opinion of our management, all adjustments, which include only normal recurring adjustments considered necessary for a fair presentation, have been included.  All intercompany transactions and balances with or among our subsidiaries have been eliminated.  Operating results for interim periods are not necessarily indicative of the results that may be expected for the full year.  Reclassifications have been made to the prior years’ financial statements to conform to the current year’s presentation.

The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect reported amounts.  Actual results could differ from those estimates.  Significant estimates in the condensed consolidated financial statements include the allowance for doubtful accounts, purchase price allocations, useful lives of fixed assets and impairment of real estate and intangible assets.

Share amounts are presented in whole numbers, except where noted.

Note 2.  Recent Accounting Pronouncements

In April 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity, or ASU 2014-08.  ASU 2014-08 changes the criteria for reporting a discontinued operation.  Under the new pronouncement, a disposal of a part of an organization that has a major effect on its operations and financial results is a discontinued operation.  We adopted ASU 2014-08 on January 1, 2015, and determined that our individual 2015 dispositions and properties held for sale as of June 30, 2015 do not represent a strategic shift, as defined by the standard, that has or will have a major effect on our operations and financial results.

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, which provides guidance for revenue recognition. This update is effective for interim and annual reporting periods beginning after December 15, 2017.  We are currently in the process of evaluating the impact, if any, the adoption of this ASU will have on our condensed consolidated financial statements.

In April 2015, the FASB issued ASU No. 2015-03, Simplifying the Presentation of Debt Issuance Costs. This standard amends existing guidance to require the presentation of debt issuance costs in the balance sheet as a deduction from the carrying amount of the related debt liability instead of as a deferred charge. It is effective for annual reporting periods beginning after December 15, 2015, but early adoption is permitted. We do not expect that the adoption of this standard will have a material impact on our condensed consolidated financial statements.

Note 3.  Board of Trustees

On March 18, 2014, Related Fund Management, LLC (Related) and Corvex Management LP (Corvex) together, (Related/Corvex), delivered written consents which they represented were from a sufficient number of holders of our outstanding common shares to remove all of our then Trustees (former Trustees) and any other person or persons elected or appointed to our Board of Trustees prior to the effective time of the Related/Corvex removal proposal. After inspection, our then Board of Trustees determined that holders of more than two-thirds of our outstanding common shares as of the February 18, 2014 record date consented to the Related/Corvex proposal, reaching the threshold required to remove all of our then Trustees and any other person or persons appointed as a Trustee prior to the effective time of the Related/Corvex removal proposal. Accordingly, on March 25, 2014, all of our former Trustees certified their removal as Trustees of EQC.

6
Table of Contents

EQUITY COMMONWEALTH
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)



On May 23, 2014, at a special meeting of our shareholders (Special Meeting), the following seven individuals were elected to serve on our Board of Trustees: Sam Zell, who serves as the Chairman of the new Board of Trustees, James S. Corl, Edward A. Glickman, David A. Helfand, Peter Linneman, James L. Lozier, Jr. and Kenneth Shea.  Each of the foregoing individuals was nominated to serve on the new Board of Trustees by Related/Corvex. On July 31, 2014, our shareholders re-elected the seven individuals listed above and elected Martin L. Edelman, Mary Jane Robertson, Gerald A. Spector and James A. Star to serve on our Board of Trustees, bringing our total number of Trustees to eleven (new Board of Trustees). At the 2015 annual meeting of shareholders held on June 16, 2015, our shareholders re-elected each of our eleven Trustees to serve on our Board of Trustees for the 2015-2016 term.

Note 4.  Real Estate Properties

During the six months ended June 30, 2015 and 2014, we made improvements to our properties totaling $27.8 million and $47.0 million, respectively.

Properties Held For Sale:

We classify all properties that meet the criteria outlined in the Property, Plant and Equipment Topic of the FASB Accounting Standards Codification (Codification) as held for sale on our condensed consolidated balance sheets.  As of June 30, 2015, we classified Illinois Center and 16th and Race Street (together, two properties and three buildings), with a combined 2,698,787 square feet, as held for sale. On August 4, 2015 we sold Illinois Center (see Note 18). The sale of 16th and Race Street is projected to close in the third quarter of 2015, subject to customary closing conditions. There is no certainty that these conditions will be met or that this transaction will close. As of December 31, 2014, we had no properties classified as held for sale. 

Summarized balance sheet information for all properties classified as held for sale is as follows (in thousands):

 
June 30, 2015
Real estate properties
$
341,263

Acquired real estate leases
13,238

Other assets, net
6,280

Properties held for sale
$
360,781

 
 
Accounts payable and accrued expenses
$
12,387

Assumed real estate lease obligations
6,516

Rent collected in advance
113

Security deposits
1,320

Liabilities related to properties held for sale
$
20,336


During March 2014, the former management team ceased to actively market two CBD properties (two buildings) and 29 suburban properties (65 buildings) with a combined 5,641,450 square feet that we had previously classified as held for sale as of December 31, 2013.  These properties were not under agreement for sale when our former Trustees were removed in March 2014.  These properties were reclassified to properties held and used in operations because they no longer met the requirements under GAAP for classification as held for sale.  Operating results for these properties were reclassified from discontinued operations to continuing operations for all periods presented herein.  In connection with this reclassification, we reversed previously recorded impairment losses totaling $4.8 million, which included the elimination of estimated costs to sell.








7
Table of Contents

EQUITY COMMONWEALTH
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


Property Dispositions:
During the six months ended June 30, 2015, we disposed of the following properties (dollars in thousands):
Asset
 
Date Disposed
 
Segment
 
Number of
Properties
 
Number of
Buildings
 
Square
Footage
 
Gross Sales Price
 
Gain (Loss) on Sale
Properties
 
 

 
 

 
 

11350 North Meridian Street
 
January 2015
 
 Suburban
 
1

 
1

 
72,264

 
$
4,200

 
$
766

333 Laurel Oak Drive(1)
 
March 2015
 
 Suburban
 
—

 
1

 
27,164

 
2,450

 
251

1921 E. Alton Avenue
 
March 2015
 
 Suburban
 
1

 
1

 
67,846

 
14,533

 
4,851

46 Inverness Center Parkway
 
April 2015
 
 Suburban
 
—

 
—

 
—

 
2,000

 
1,857

225 Water Street(2)
 
May 2015
 
CBD
 
1

 
1

 
318,997

 
—

 
—

Sorrento Valley Business Park
 
June 2015
 
 Suburban
 
1

 
4

 
105,003

 
23,500

 
11,896

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Portfolio of properties
 
 
 
 
 
 
7450 Campus Drive
 
May 2015
 
 Suburban
 
1

 
1

 
77,411

 
 
 
 
129 Worthington Ridge Road
 
May 2015
 
 Suburban
 
1

 
1

 
227,500

 
 
 
 
599 Research Parkway
 
May 2015
 
 Suburban
 
1

 
1

 
48,249

 
 
 
 
181 Marsh Hill Road
 
May 2015
 
 Suburban
 
1

 
1

 
162,036

 
 
 
 
101 Barnes Road
 
May 2015
 
 Suburban
 
1

 
1

 
45,755

 
 
 
 
15 Sterling Drive
 
May 2015
 
 Suburban
 
1

 
1

 
173,015

 
 
 
 
35 Thorpe Avenue
 
May 2015
 
 Suburban
 
1

 
1

 
79,862

 
 
 
 
50 Barnes Industrial Road North
 
May 2015
 
 Suburban
 
1

 
1

 
154,255

 
 
 
 
5-9 Barnes Industrial Road
 
May 2015
 
 Suburban
 
1

 
1

 
38,006

 
 
 
 
860 North Main Street
 
May 2015
 
 Suburban
 
1

 
1

 
31,165

 
 
 
 
One Barnes Industrial Road South
 
May 2015
 
 Suburban
 
1

 
1

 
30,170

 
 
 
 
Village Lane
 
May 2015
 
 Suburban
 
1

 
2

 
58,185

 
 
 
 
100 Northfield Drive
 
May 2015
 
 Suburban
 
1

 
1

 
116,986

 
 
 
 
905 Meridian Lake Drive
 
May 2015
 
 Suburban
 
1

 
1

 
74,652

 
 
 
 
1717 Deerfield Road
 
May 2015
 
 Suburban
 
1

 
1

 
141,186

 
 
 
 
1955 West Field Court
 
May 2015
 
 Suburban
 
1

 
1

 
59,130

 
 
 
 
5015 S. Water Circle
 
May 2015
 
 Suburban
 
1

 
1

 
113,524

 
 
 
 
Adams Place
 
May 2015
 
 Suburban
 
1

 
2

 
230,259

 
 
 
 
Cabot Business Park
 
May 2015
 
 Suburban
 
1

 
2

 
252,755

 
 
 
 
2300 Crown Colony Drive
 
May 2015
 
 Suburban
 
1

 
1

 
45,974

 
 
 
 
Myles Standish Industrial Park
 
May 2015
 
 Suburban
 
1

 
2

 
74,800

 
 
 
 
340 Thompson Road
 
May 2015
 
 Suburban
 
1

 
1

 
25,000

 
 
 
 
100 South Charles Street
 
May 2015
 
CBD
 
1

 
1

 
159,616

 
 
 
 
6710 Oxon Hill
 
May 2015
 
 Suburban
 
1

 
1

 
118,336

 
 
 
 
8800 Queen Avenue South
 
May 2015
 
 Suburban
 
1

 
1

 
280,822

 
 
 
 
9800 Sherlard Parkway
 
May 2015
 
 Suburban
 
1

 
1

 
46,765

 
 
 
 
Rosedale Corporate Plaza
 
May 2015
 
 Suburban
 
1

 
3

 
149,116

 
 
 
 
1000 Shelard Parkway
 
May 2015
 
 Suburban
 
1

 
1

 
62,499

 
 
 
 
525 Park Street
 
May 2015
 
CBD
 
1

 
1

 
75,636

 
 
 
 
1900 Meyer Drury Drive
 
May 2015
 
 Suburban
 
1

 
1

 
65,225

 
 
 
 
131-165 West Ninth Street
 
May 2015
 
 Suburban
 
1

 
1

 
75,517

 
 
 
 
7-9 Vreeland Road
 
May 2015
 
 Suburban
 
1

 
1

 
155,891

 
 
 
 
5 Paragon Drive
 
May 2015
 
 Suburban
 
1

 
1

 
119,089

 
 
 
 

8
Table of Contents

EQUITY COMMONWEALTH
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


Asset
 
Date Disposed
 
Segment
 
Number of
Properties
 
Number of
Buildings
 
Square
Footage
 
Gross Sales Price
 
Gain (Loss) on Sale
1000 Vorhees Drive and 400 Laurel Oak Drive(1)
 
May 2015
 
 Suburban
 
1

 
2

 
125,415

 
 
 
 
1601 Veterans Highway
 
May 2015
 
 Suburban
 
1

 
1

 
63,608

 
 
 
 
Two Corporate Center Drive
 
May 2015
 
 Suburban
 
1

 
1

 
291,230

 
 
 
 
11311 Cornell Park Drive
 
May 2015
 
 Suburban
 
1

 
1

 
93,413

 
 
 
 
5300 Kings Island Drive
 
May 2015
 
 Suburban
 
1

 
1

 
159,421

 
 
 
 
3 Crown Point Court
 
May 2015
 
 Suburban
 
1

 
1

 
73,987

 
 
 
 
515 Pennsylvania Avenue
 
May 2015
 
 Suburban
 
1

 
1

 
82,000

 
 
 
 
443 Gulph Road
 
May 2015
 
 Suburban
 
1

 
1

 
21,000

 
 
 
 
4350 Northern Pike
 
May 2015
 
 Suburban
 
1

 
1

 
503,885

 
 
 
 
Thunderbolt Place
 
May 2015
 
 Suburban
 
1

 
2

 
100,505

 
 
 
 
6160 Kempsville Circle
 
May 2015
 
 Suburban
 
1

 
1

 
129,565

 
 
 
 
448 Viking Drive
 
May 2015
 
 Suburban
 
1

 
1

 
75,374

 
 
 
 
Portfolio of small office and industrial assets
 
 
 
 
 
45

 
53

 
5,287,790

 
$
376,000

 
$
(7,915
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2501 20th Place South
 
June 2015
 
CBD
 
1

 
1

 
125,722

 
 
 
 
420 20th Street North
 
June 2015
 
CBD
 
1

 
1

 
514,893

 
 
 
 
Inverness Center
 
June 2015
 
 Suburban
 
1

 
4

 
475,951

 
 
 
 
701 Poydras Street
 
June 2015
 
CBD
 
1

 
1

 
1,256,971

 
 
 
 
300 North Greene Street
 
June 2015
 
CBD
 
1

 
1

 
324,305

 
 
 
 
1320 Main Street
 
June 2015
 
CBD
 
1

 
1

 
334,075

 
 
 
 
AL, LA, NC, SC office portfolio
 
 
 
 
 
6

 
9

 
3,031,917

 
$
417,450

 
$
41,596

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
12655 Olive Boulevard
 
June 2015
 
 Suburban
 
1

 
1

 
98,588

 
 
 
 
1285 Fern Ridge Parkway
 
June 2015
 
 Suburban
 
1

 
1

 
66,510

 
 
 
 
St. Louis portfolio
 
 
 
 
 
2

 
2

 
165,098

 
$
14,300

 
$
(2,338
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
310-314 Invermay Road(3)
 
April 2015
 
 Suburban
 
1

 
1

 
47,480

 
 
 
 
253-293 George Town Road(3)
 
April 2015
 
 Suburban
 
1

 
1

 
143,914

 
 
 
 
7 Modal Crescent
 
June 2015
 
 Suburban
 
1

 
1

 
164,160

 
 
 
 
71-93 Whiteside Road
 
June 2015
 
 Suburban
 
1

 
1

 
303,488

 
 
 
 
9-13 Titanium Court
 
June 2015
 
 Suburban
 
1

 
1

 
69,664

 
 
 
 
16 Rodborough Road
 
June 2015
 
 Suburban
 
1

 
1

 
90,525

 
 
 
 
22 Rodborough Road
 
June 2015
 
 Suburban
 
1

 
1

 
43,427

 
 
 
 
127-161 Cherry Lane
 
June 2015
 
 Suburban
 
1

 
1

 
278,570

 
 
 
 
310-320 Pitt Street
 
June 2015
 
CBD
 
1

 
1

 
313,865

 
 
 
 
44-46 Mandarin Street
 
June 2015
 
 Suburban
 
1

 
1

 
226,718

 
 
 
 
19 Leadership Way
 
June 2015
 
 Suburban
 
1

 
1

 
76,714

 
 
 
 
Australia portfolio(4)
 
 
 
 
 
11

 
11

 
1,758,525

 
$
232,955

 
$
(47,804
)
 
 
 
 
 
 
68

 
83

 
10,834,604

 
$
1,087,388

 
$
3,160

(1)
This property contains three buildings. We sold one building in March 2015 and two buildings in May 2015.
(2)
Title to this property was transferred to the lender pursuant to a consensual foreclosure in full satisfaction of the mortgage debt with a principal balance of $40.1 million, resulting in a gain on early extinguishment of debt of $17.3 million for the three and six months ended June 30, 2015. See Note 8 for additional information.

9
Table of Contents

EQUITY COMMONWEALTH
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


(3)
These properties were sold in a separate transaction to a different buyer than other Australian properties.
(4)
The loss on sale includes a $63.2 million cumulative foreign currency translation adjustment reclassified from cumuluative other comprehensive loss due to the disposition of the Australian portfolio.
On June 27, 2014, we sold one CBD property (two buildings) and 13 suburban properties (41 buildings) with a combined 2,784,098 square feet for an aggregate sales price of $215.9 million, excluding mortgage debt repayments and closing costs. In conjunction with this transaction, we recognized a loss on asset impairment of $2.4 million and a loss on early extinguishment of debt of $3.3 million.

Results of operations for properties sold prior to December 31, 2014 are included in discontinued operations in our condensed consolidated statements of operations. Summarized income statement information for properties included in discontinued operations is as follows (in thousands):

 
Three Months Ended
 
Six Months Ended
 
June 30, 2014
Rental income
$
6,962

 
$
14,236

Tenant reimbursements and other income
801

 
1,323

Total revenues
7,763

 
15,559

 
 
 
 
Operating expenses
3,375

 
6,854

General and administrative
—

 
3

Total expenses
3,375

 
6,857

Operating income
4,388

 
8,702

Interest expense
(274
)
 
(577
)
Income from discontinued operations
$
4,114

 
$
8,125


Note 5.  Investment in Direct Financing Lease

We have an investment in a direct financing lease that relates to a lease with a term that exceeds 75% of the useful life of an office tower located within a mixed use property in Phoenix, AZ.  We recognize income using the effective interest method to produce a level yield on funds not yet recovered.  The carrying amount of our net investment of $8.7 million and $12.5 million as of June 30, 2015 and December 31, 2014, respectively, is included in other assets in our condensed consolidated balance sheets. 

We monitor the payment history and credit profile of the tenant and have determined that no allowance for losses related to our direct financing lease was necessary at June 30, 2015 and December 31, 2014.  Our direct financing lease has an expiration date in 2045.

Note 6.  Equity Investments
  
Investment in SIR

SIR is a REIT that is primarily focused on owning and investing in net leased, single tenant properties. SIR was an unconsolidated equity method investment from July 2, 2013 until July 9, 2014. On July 9, 2014, we sold our entire stake of 22,000,000 common shares of SIR. As a result of this sale, we no longer hold any interest in SIR.

For the three and six months ended June 30, 2014, we recorded equity in earnings of $12.4 million and $23.4 million, respectively, related to our investment in SIR on our condensed consolidated statement of operations. During the three and six months ended June 30, 2014, we received cash distributions from SIR totaling $10.6 million and $20.7 million, respectively.
 

10
Table of Contents

EQUITY COMMONWEALTH
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


The following unaudited summarized income statement information of SIR as reported in SIR's Quarterly Report on Form 10-Q for the three and six months ended June 30, 2014 is as follows (in thousands, except per share data):
 
 
Three Months Ended
 
Six Months Ended
 
June 30, 2014
Rental income
$
48,465

 
93,528

Tenant reimbursements and other income
8,092

 
16,057

Total revenues
56,557

 
109,585

 
 
 
 
Operating expenses
9,985

 
19,964

Depreciation and amortization
10,495

 
19,789

Acquisition related costs
136

 
374

General and administrative
2,198

 
7,374

Total expenses
22,814

 
47,501

Operating income
33,743

 
62,084

Interest expense
(3,634
)
 
(6,992
)
Gain on early extinguishment of debt
—

 
243

Income before income tax expense and equity in earnings of an investee
30,109

 
55,335

Income tax expense
(19
)
 
(90
)
Equity in earnings of an investee
118

 
21

Net income
$
30,208

 
$
55,266

Weighted average common shares outstanding
54,178

 
52,021

Net income per common share
$
0.56

 
$
1.06


Investment in AIC

As of May 9, 2014, we had a net investment of $5.8 million in AIC, an insurance company that was owned in equal proportion by us, our former manager Reit Management & Research LLC (RMR), SIR and five other companies to which RMR provides management services. 

On May 9, 2014, as a result of the removal of the former Trustees and in accordance with the terms of the shareholder agreement between us and the other AIC shareholders, the other AIC shareholders exercised their right to purchase all of the 20,000 shares of AIC we then owned.  We received $5.8 million in aggregate proceeds from this sale.  We no longer own any interest in AIC.  For the period from April 1, 2014 through May 9, 2014 and for the period from January 1, 2014 through May 9, 2014, we recorded equity in earnings (loss) of $0.04 million and $(0.1) million, respectively, related to our investment in AIC on our condensed consolidated statement of operations.

Our participation in the AIC property insurance program expired in June 2014.  See Note 17 for additional information about our investment in AIC.

Note 7.  Real Estate Mortgages Receivable
 
As of June 30, 2015 and December 31, 2014, we had total real estate mortgages receivable with an aggregate carrying value of $8.1 million included in other assets in our condensed consolidated balance sheets.  We provided mortgage financing totaling $7.7 million at 6.0% per annum in connection with our sale of three suburban office and industrial properties (18 buildings) in January 2013 in Dearborn, MI; this real estate mortgage requires monthly interest payments and matures on January 24, 2023.  We also provided mortgage financing totaling $0.4 million at 6.0% per annum in connection with our sale of a suburban office property in Salina, NY in April 2012. This real estate mortgage requires monthly interest payments and matures on April 30, 2019.


11
Table of Contents

EQUITY COMMONWEALTH
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


We monitor the payment history of the borrowers and have determined that no allowance for losses related to these real estate mortgages receivable were necessary at June 30, 2015 and December 31, 2014. 

Note 8.  Indebtedness
 
Unsecured Revolving Credit Facility and Term Loan:
 
Prior to January 29, 2015, we had a $750.0 million unsecured revolving credit facility. The unsecured revolving credit facility was set to mature on October 19, 2015, and had an interest rate of LIBOR plus a spread, which was 150 basis points as of December 31, 2014.  We paid a facility fee of 35 basis points per annum on the total amount of lending commitments under our revolving credit facility.  Prior to January 29, 2015, we also had a $400.0 million unsecured term loan that was set to mature on December 15, 2016.  Our term loan had an interest rate of LIBOR plus a spread, which was 185 basis points as of December 31, 2014. 
On January 29, 2015, we entered into a new credit agreement, pursuant to which the lenders agreed to provide (i) a $750.0 million unsecured revolving credit facility, (ii) a $200.0 million 5-year term loan facility and (iii) a $200.0 million 7-year term loan facility. The new agreement replaced our prior credit agreement, dated as of August 9, 2010, and our prior term loan agreement, dated as of December 16, 2010.  In connection with the new agreement, we recognized a loss on early extinguishment of debt of $0.4 million from the write-off of unamortized deferred financing fees for the six months ended June 30, 2015. The revolving credit facility has a scheduled maturity date of January 28, 2019, which maturity date may be extended for up to two additional periods of six months at our option subject to satisfaction of certain conditions and the payment of an extension fee of 0.075% of the aggregate amount available under the revolving credit facility. The 5-year term loan and the 7-year term loan have scheduled maturity dates of January 28, 2020 and January 28, 2022, respectively. We used the proceeds of borrowings under the credit agreement to repay all amounts outstanding and due under the previous term loan agreement.

The credit agreement permits us to utilize up to $100.0 million of the revolving credit facility for the issuance of letters of credit. Amounts outstanding under the credit agreement generally may be prepaid at any time without premium or penalty, subject to certain exceptions. We have the right to request increases in the aggregate maximum amount of borrowings available under the revolving credit facility and term loans up to an additional $1.15 billion, subject to certain conditions.

Borrowings under the 5-year term loan and 7-year term loan will, subject to certain exceptions, bear interest at a LIBOR rate plus a margin of 90 to 180 basis points for the 5-year term loan and 140 to 235 basis points for the 7-year term loan, in each case depending on our credit rating. Borrowings under the revolving credit facility will, subject to certain exceptions, bear interest at a rate equal to, at our option, either a LIBOR rate or a base rate plus a margin of 87.5 to 155 basis points for LIBOR rate advances and 0 to 55 basis points for base rate advances, in each case depending on our credit rating. In addition, we are required to pay a facility fee of 12.5 to 30 basis points, depending on our credit rating, on the borrowings available under the revolving credit facility, whether or not utilized.

Borrowings under our revolving credit facility currently bear interest at LIBOR plus a spread, which was 125 basis points as of June 30, 2015.  As of June 30, 2015, the interest rate payable on borrowings under our revolving credit facility was 1.44%.  As of June 30, 2015, we had no balance outstanding and $750.0 million available under our revolving credit facility. Our term loans currently bear interest at a rate of LIBOR plus a spread, which was 140 and 180 basis points for the 5-year and 7-year term loan, respectively, as of June 30, 2015.  As of June 30, 2015, the interest rates for the amounts outstanding under our 5-year term loan and 7-year term loan were 1.59% and 1.99%, respectively.  As of June 30, 2015, we had $200.0 million outstanding under each of our 5-year and 7-year term loans.

Debt Covenants:
 
Our public debt indenture and related supplements, our revolving credit facility agreement and our term loan agreement contain a number of financial and other covenants, including covenants that restrict our ability to incur indebtedness or to make distributions under certain circumstances and require us to maintain financial ratios and a minimum net worth.  At June 30, 2015, we believe we were in compliance with all of our respective covenants under our public debt indenture and related supplements, our revolving credit facility and our term loan agreements.


12
Table of Contents

EQUITY COMMONWEALTH
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


Senior Unsecured Notes:

On May 1, 2015, we redeemed at par $138.8 million of our 5.75% senior unsecured notes due 2015 and recognized a loss on early extinguishment of debt of $0.1 million from the write-off of an unamortized discount and unamortized deferred financing fees.

Mortgage Notes Payable:
 
At June 30, 2015, seven of our properties (11 buildings) with an aggregate net book value of $605.5 million had secured mortgage notes totaling $513.6 million (including net premiums and discounts) maturing from 2016 through 2026.

During the quarter ended June 30, 2014, we made the decision to cease making loan servicing payments on 225 Water Street in Jacksonville, Florida.  The first payment we determined not to make for this property was due on June 11, 2014.  The property was secured by a non-recourse mortgage loan. On October 10, 2014, we were notified by the lender that our decision to cease making loan servicing payments created an event of default effective July 11, 2014, and the lender exercised its option to accelerate the maturity of the unpaid balance of the loan. Beginning July 11, 2014, we accrued interest on this loan at 10.03%, to include the 4.0% of default interest. The lender filed a suit of foreclosure for this property and we cooperated with the lender to allow for a consensual foreclosure process.  On May 22, 2015, title to 225 Water Street was transferred to the lender pursuant to the consensual foreclosure in full satisfaction of the mortgage debt, with a principal balance of $40.1 million. The transaction resulted in a gain on early extinguishment of debt of $17.3 million for the excess of the debt principal balance over the net book value of the property for the three and six months ended June 30, 2015.

In accordance with the agreement to sell 1320 Main Street, we were required to deliver the property unencumbered. On June 3, 2015, prior to the sale, we defeased the $38.7 million outstanding balance of the mortgage loan secured by 1320 Main Street. This debt is no longer reflected in the accompanying condensed consolidated balance sheet as of June 30, 2015. The defeasance costs and write off of the unamortized deferred financing costs, net of the write off of the unamortized premium, resulted in a net loss on early extinguishment of debt of $6.2 million for the three and six months ended June 30, 2015.

In accordance with the agreement to sell 2501 20th Place South, we were required to deliver the property unencumbered. On June 5, 2015, we prepaid $10.0 million of 7.36% mortgage debt at 2501 20th Place South and recognized a loss on early extinguishment of debt totaling $0.6 million for the three and six months ended June 30, 2015, which consisted of a prepayment premium and the write off of unamortized deferred financing fees, net of the write off of an unamortized premium.

Note 9.  Shareholders’ Equity
 
Common Share Issuances:
 
During the six months ended June 30, 2015, we issued 144 common shares to holders of 301 of our series D cumulative convertible preferred shares (series D preferred shares) who elected to convert their series D preferred shares into our common shares.

During 2014, we issued 10,412,499 common shares to holders of 10,264,503 of our series D preferred shares who converted their series D preferred shares into our common shares.

See Note 13 for information regarding equity issuances related to share-based compensation.



13
Table of Contents

EQUITY COMMONWEALTH
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


Preferred Share Distributions:

In 2015, our Board of Trustees declared distributions on our series D preferred shares and series E cumulative redeemable preferred shares to date as follows:

Declaration Date
 
Record Date
 
Payment Date
 
Series D Dividend Per Share
 
Series E Dividend Per Share
January 16, 2015
 
February 2, 2015
 
February 17, 2015
 
$
0.40625

 
$
0.453125

April 8, 2015
 
May 1, 2015
 
May 15, 2015
 
$
0.40625

 
$
0.453125

July 9, 2015
 
July 31, 2015
 
August 17, 2015
 
$
0.40625

 
$
0.453125


Series D Preferred Shares:
 
The removal of our former Trustees on March 25, 2014, triggered a Fundamental Change Conversion Right of the series D preferred shares, as defined in our Articles Supplementary dated October 10, 2006, setting forth the terms of the series D preferred shares.  Pursuant to such right, the holders of series D preferred shares had the option to elect to convert all or any portion of their series D preferred shares at any time from April 9, 2014 until the close of business on May 14, 2014 into a number of common shares per $25.00 liquidation preference of the series D preferred shares equal to the sum of such $25.00 liquidation preference plus accrued and unpaid dividends to, but not including, May 14, 2014, divided by 98% of the average of the closing sale prices of the common shares for the five consecutive trading days ending on May 9, 2014, or the Fundamental Change Conversion Rate.  Holders of 10,263,003 series D preferred shares elected to exercise their Fundamental Change Conversion Right and converted their series D preferred shares into 10,411,779 of our common shares.  As a result of this transaction, we recorded a distribution of $16.2 million, for the excess of the market value of the common shares issued above the carrying value of the series D preferred shares redeemed. As of June 30, 2015, we had 4,915,196 outstanding series D preferred shares that were convertible into 2,363,103 of our common shares.

Note 10.  Cumulative Other Comprehensive Loss
 
The following tables present the amounts recognized in cumulative other comprehensive loss by component for the three and six months ended June 30, 2015 (in thousands):
 
 
Three Months Ended June 30, 2015
 
Unrealized Loss
on Derivative
Instruments and Other Assets
 
Foreign Currency
Translation
Adjustments
 
Total
Balances as of March 31, 2015
$
(6,921
)
 
$
(65,307
)
 
$
(72,228
)
 
 
 
 
 
 
Other comprehensive (loss) income before reclassifications
(274
)
 
2,100

 
1,826

Amounts reclassified from cumulative other comprehensive loss to net income
1,232

 
63,207

 
64,439

Net current period other comprehensive income
958

 
65,307

 
66,265

 
 
 
 
 
 
Balances as of June 30, 2015
$
(5,963
)
 
$
—

 
$
(5,963
)

14
Table of Contents

EQUITY COMMONWEALTH
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


 
Six Months Ended June 30, 2015
 
Unrealized Loss
on Derivative
Instruments and Other Assets
 
Foreign Currency
Translation
Adjustments
 
Total
Balances as of December 31, 2014
$
(4,299
)
 
$
(48,917
)
 
$
(53,216
)
 
 
 
 
 
 
Other comprehensive loss before reclassifications
(1,043
)
 
(14,290
)
 
(15,333
)
Amounts reclassified from cumulative other comprehensive loss to net income
(621
)
 
63,207

 
62,586

Net current period other comprehensive (loss) income
(1,664
)
 
48,917

 
47,253

 
 
 
 
 
 
Balances as of June 30, 2015
$
(5,963
)
 
$
—

 
$
(5,963
)

The following tables present reclassifications out of cumulative other comprehensive loss for the three and six months ended June 30, 2015 (in thousands):
 
 
 
Amounts Reclassified from Cumulative Other Comprehensive Loss to Net Income
 
 
Details about Cumulative Other Comprehensive Loss Components
 
Three Months Ended June 30, 2015
 
Six Months Ended June 30, 2015
 
Affected Line Items in the Statement of Operations
Interest rate swap contracts
 
$
1,232

 
$
2,459

 
Interest expense
Foreign currency translation adjustment activity
 
63,207

 
63,207

 
(Loss) gain on sale of properties
Realized gain on available for sale securities
 
—

 
(3,080
)
 
Interest and other income
 
 
$
64,439

 
$
62,586

 
 
 

Note 11.  Income Taxes
 
We have elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended, and are generally not subject to federal and state income taxes provided we distribute a sufficient amount of our taxable income to our shareholders and meet other requirements for qualifying as a REIT.  Federal income tax expense for the three and six months ended June 30, 2015 relates to taxes incurred incurred as a result of a taxable built-in gain triggered by the sale of a property that was previously owned by a C corporation. We are also subject to certain state, local and Australian taxes without regard to our REIT status. 

Our provision for income taxes consists of the following (in thousands):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
Current:
 
 
 
 
 
 
 
State
$
90

 
$
227

 
$
180

 
$
261

Federal
525

 
—

 
525

 
—

Foreign
2,450

 
681

 
2,404

 
1,202

 
3,065

 
908

 
3,109

 
1,463

 
 
 
 
 
 
 
 
Deferred:
 
 
 
 
 
 
 
Foreign
(150
)
 
—

 
(755
)
 
—

 
(150
)
 
—

 
(755
)
 
—

 
 
 
 
 
 
 
 
Income tax expense
$
2,915

 
$
908

 
$
2,354

 
$
1,463



15
Table of Contents

EQUITY COMMONWEALTH
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


Note 12.  Derivative Instruments

Risk Management Objective of Using Derivatives

We are exposed to certain risks relating to our ongoing business operations, including the effect of changes in foreign currency exchange rates and interest rates.  The only risk we currently manage by using derivative instruments is a part of our interest rate risk. 

We may use derivative financial instruments, including interest rate swaps, caps, options, floors and other interest rate derivative contracts, to hedge all or a portion of the interest rate risk associated with our borrowings. The principal objective of such arrangements is to minimize the risks and/or costs associated with our operating and financial structure as well as to hedge specific anticipated transactions. We do not intend to utilize derivatives for speculative or other purposes other than interest rate risk management. The use of derivative financial instruments carries certain risks, including the risk that the counterparties to these contractual arrangements are not able to perform under the agreements. To mitigate this risk, we only enter into derivative financial instruments with counterparties with high credit ratings and with major financial institutions with which we and our affiliates may also have other financial relationships. We do not anticipate that any of the counterparties will fail to meet their obligations.

Cash Flow Hedges of Interest Rate Risk

Our objectives in using interest rate derivatives are to add stability to interest expense and to manage our exposure to interest rate movements. To accomplish this objective, we periodically use interest rate swaps, caps, or other similar instruments as part of our interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable-rate amounts from a counterparty in exchange for us making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount.

The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in accumulated other comprehensive income and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. During 2015, such derivatives were used to hedge the variable cash flows associated with variable-rate debt. The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings.

Amounts reported in cumulative other comprehensive loss related to derivatives will be reclassified to interest expense as interest payments are made on our variable-rate debt. During the next twelve months, we estimate that an additional $4.5 million will be reclassified from cumulative other comprehensive loss as an increase to interest expense.

We have interest rate swap agreements to manage our interest rate risk exposure on $170.6 million of mortgage debt due 2019, which require interest at a spread over LIBOR.  The interest rate swap agreements utilized by us qualify as cash flow hedges and effectively modify our exposure to interest rate risk by converting our floating interest rate debt to a fixed interest rate basis for this loan through December 1, 2016, thus reducing the impact of interest rate changes on future interest expense.  As of June 30, 2015, we had the following outstanding interest rate derivatives that were designated as cash flow hedges of interest rate risk:
Interest Rate Derivative
 
Number of Instruments
 
Notional Amount (in thousands)
Interest rate swap
 
2

 
$170,573

The table below presents the fair value of our derivative financial instruments as well as their classification on the condensed consolidated balance sheets as of June 30, 2015 and December 31, 2014 (amounts in thousands):

 
 
 
 
Fair Value as of
Interest Rate Derivative Designated as Hedging Instrument
 
Balance Sheet Location
 
June 30,
2015
 
December 31,
2014
Pay-fixed swaps
 
Accounts payable and accrued expenses
 
$
5,963

 
$
7,462



16
Table of Contents

EQUITY COMMONWEALTH
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


The table below details the location in the financial statements of the gain or loss recognized on interest rate derivatives designated as cash flow hedges for the three and six months ended June 30, 2015 and 2014 (amounts in thousands):

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
Balance at beginning of period
$
(6,921
)
 
$
(10,706
)
 
$
(7,462
)
 
$
(11,706
)
Amount of loss recognized in cumulative other comprehensive loss
(274
)
 
(632
)
 
(960
)
 
(861
)
Amount of loss reclassified from cumulative other comprehensive loss into interest expense
1,232

 
1,259

 
2,459

 
2,488

Unrealized gain on derivative instruments
958

 
627

 
1,499

 
1,627

Balance at end of period
$
(5,963
)
 
$
(10,079
)
 
$
(5,963
)
 
$
(10,079
)

Credit-risk-related Contingent Features

We have agreements with each of our derivative counterparties that contain a provision where if we either default or are capable of being declared in default on any of our indebtedness, then we could also be declared in default on our derivative obligations.

As of June 30, 2015, the fair value of derivatives in a net liability position including accrued interest but excluding any adjustment for nonperformance risk related to these agreements was $6.5 million. As of June 30, 2015, we have 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 aggregate termination value of $6.5 million at June 30, 2015.

Note 13. Share-Based Compensation
Equity Commonwealth 2015 Omnibus Incentive Plan

On June 16, 2015, at our 2015 annual meeting of shareholders, our shareholders approved the Equity Commonwealth 2015 Omnibus Incentive Plan (the 2015 Incentive Plan). The 2015 Incentive Plan replaced the Equity Commonwealth 2012 Equity Compensation Plan (as amended, the 2012 Plan). The Board of Trustees approved the 2015 Incentive Plan, subject to shareholder approval, on March 18, 2015 (the Effective Date). The following description of certain terms of the 2015 Incentive Plan is qualified in all respects by the terms of the 2015 Incentive Plan.

Eligibility. Awards may be granted under the 2015 Incentive Plan to employees, officers and non-employee directors of the Company, its subsidiaries or its affiliates, or consultants and advisors (who are natural persons) providing services to the Company, its subsidiaries or its affiliates, or any other person whose participation in the 2015 Incentive Plan is determined by the Compensation Committee to be in the best interests of the Company.

Term. The 2015 Incentive Plan terminates automatically ten years after the Effective Date, unless it is terminated earlier by the Board of Trustees.

Shares Available for Issuance. Subject to adjustment as provided in the 2015 Incentive Plan, the maximum number of common shares of the Company that are available for issuance under the 2015 Incentive Plan is 3,250,000 shares.

Awards. The following types of awards may be made under the 2015 Incentive Plan, subject to limitations set forth in the 2015 Incentive Plan:
· Stock options;
· Stock appreciation rights;
· Restricted stock;
· Restricted stock units;
· Unrestricted stock;
· Dividend equivalent rights;

17
Table of Contents

EQUITY COMMONWEALTH
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


· Performance shares and other performance-based awards;
· Limited partnership interests in any partnership entity through which the Company may conduct its business in the future;
· Other equity-based awards; and
· Cash bonus awards.

Recipients of the Company’s restricted shares have the same voting rights as any other common shareholder. During the period of restriction, the Company’s unvested restricted shareholders are eligible to receive dividend payments on their shares at the same rate and on the same date as any other common shareholder. Recipients of the Company’s restricted stock units (RSUs) are entitled to receive dividends with respect to the common shares underlying the RSUs if and when the RSUs are earned, at which time the recipient will be entitled to receive an amount in cash equal to the aggregate amount of ordinary cash dividends that would have been paid in respect of the common shares underlying the recipient’s earned RSUs had such common shares been issued to the recipient on the first day of the performance period.

Administration. The 2015 Incentive Plan will be administered by the Compensation Committee, which will determine all terms and recipients of awards under the 2015 Incentive Plan.

2012 Equity Compensation Plan

In the past, the Company has granted equity-based compensation under the 2012 Plan. The 2012 Plan authorized grants of the Company’s restricted common shares and RSUs. The 2015 Incentive Plan replaced the 2012 Plan. No future grants will be made under the 2012 Plan, although the terms and conditions of the 2012 Plan will continue to govern any outstanding awards granted under the 2012 Plan.

2015 Equity Award Activity

On June 16, 2015, in accordance with the Company’s compensation plan for independent Trustees, the Committee awarded each of the nine independent Trustees $0.1 million in restricted shares as part of their compensation for the 2015-2016 year of service on the Board of Trustees. These awards equated to 3,843 shares per Trustee, for a total of 34,587 shares, valued at $26.02 per share, the closing price of our common shares on the NYSE on that day. These shares vest one year after the date of the award.
During the three and six months ended June 30, 2015, due to employee terminations, 8,115 restricted shares were forfeited with an average per share fair value at grant date of $26.64, and 16,475 RSUs were forfeited with an average per share fair value at grant date of $20.50.
Equity Grants for 2014 Performance
On January 28, 2015, the Committee approved a grant of 126,319 restricted common shares and 256,467 RSUs at target to the Company’s officers, certain employees and to Mr. Zell, the Chairman of our Board of Trustees, as part of their compensation for fiscal year 2014.  
The restricted shares are service based awards and vest over a four-year period. The restricted shares were granted on January 28, 2015 and were valued at $26.58 per share, the closing price of our common shares on the NYSE on that day.
As of June 30, 2015, the estimated future compensation expense for all unvested restricted share grants was $17.5 million. Compensation expense for the restricted share awards is being recognized on a straight-line basis over the requisite service period for each separately vesting portion of the award. The weighted average period over which the compensation expense will be recorded for the restricted shares is approximately 3.3 years.
The RSUs are market based awards with a service condition and grant recipients may earn between 0% - 100% of the RSU grant based on the Company’s total shareholder return (TSR) relative to the TSR's for the constituent REITs that comprise the NAREIT Office Index for the performance period of January 28, 2015 - January 28, 2018. Following the end of the performance period on January 28, 2018, the number of earned awards will be determined. The earned awards vest in two tranches with 50% of the earned award vesting on January 28, 2018 and the remaining 50% of the earned award vesting on January 28, 2019, subject to the grant recipient’s continued employment. Recipients of the Company’s RSUs are entitled to receive dividends with respect to the common shares underlying the RSUs if and when the RSUs are earned. To the extent that

18
Table of Contents

EQUITY COMMONWEALTH
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


an award does not vest, the dividends will be forfeited. Compensation expense for the RSU awards was determined using a Monte Carlo simulation model and is being recognized ratably from the grant date to the vesting date of each tranche.
As of June 30, 2015, the estimated future compensation expense for all unvested RSUs was $25.0 million. The weighted average period over which the compensation expense will be recorded for the RSUs is approximately 2.9 years.
The assumptions and fair values for the RSUs granted for the six months ended June 30, 2015 are included in the following table on a per share basis.
 
2015
Fair value of RSUs granted
$
38.55

Expected term (years)
4

Expected volatility
—

Expected dividend yield
1.88
%
Risk-free rate
0.81
%
During the three and six months ended June 30, 2015, we recorded $4.1 million and $8.1 million, respectively, of compensation expense, net of forfeitures, in general and administrative expense for grants to our Board of Trustees and the Company's employees related to our Plan. At June 30, 2015, 3,215,413 common shares remain available for issuance under the Plan.
Prior Equity Grants:
 
As a result of the removal of our former Trustees on March 25, 2014, the vesting of 130,914 common shares previously issued to our former officers and certain employees of RMR pursuant to our equity compensation plans accelerated in accordance with the terms of their governing share grants.  During the six months ended June 30, 2014, we recorded $3.4 million of general and administrative expense related to the vesting of these shares.

Note 14.  Fair Value of Assets and Liabilities
 
The table below presents certain of our assets and liabilities measured at fair value during 2015, categorized by the level of inputs used in the valuation of each asset and liability (dollars in thousands):
 
 
 
 
 
Fair Value at June 30, 2015 Using
 
 
 
 
Quoted Prices in Active Markets for
Identical Assets
 
Significant Other
Observable Inputs
 
Significant Unobservable
Inputs
Description
 
Total
 
(Level 1)
 
(Level 2)
 
(Level 3)
 
 
 
 
 
 
 
 
 
Recurring Fair Value Measurements:
 
 
 
 
 
 
 
 
Effective portion of interest rate swap contracts
 
$
(5,963
)
 
$
—

 
$
(5,963
)
 
$
—

Derivative liability
 
(8,919
)
 
—

 
—

 
(8,919
)

Effective Portion of Interest Rate Swap Contracts

The fair value of our interest rate swap contracts is determined using the net discounted cash flows of each derivative based on the market based interest rate curve (level 2 inputs) and adjusted for our credit spread and the actual and estimated credit spreads of the counterparties (level 3 inputs).  Although we have determined that the majority of the inputs used to value our derivatives fall within level 2 of the fair value hierarchy, the credit valuation adjustments associated with our derivatives utilize level 3 inputs, such as estimates of current credit spreads, to evaluate the likelihood of default by us and the counterparties.  As of June 30, 2015, 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

19
Table of Contents

EQUITY COMMONWEALTH
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


overall valuation of our derivatives.  As a result, we have determined that our derivative valuations in their entirety are classified as level 2 inputs in the fair value hierarchy.

Derivative Liability

On July 31, 2014, our shareholders voted to approve the reimbursement of expenses incurred by Related/Corvex (Note 17). Approximately $8.4 million will be reimbursed only if the average closing price of our common shares is at least $26.00 (as adjusted for any share splits or share dividends) during the one year period after the date on which the reimbursement was approved by shareholders, and the remaining approximately $8.4 million will be reimbursed only if the average closing price of our common shares is at least $26.00 (as adjusted for any share splits or share dividends) during the one year period between the first and second anniversaries of the date on which the reimbursement was approved by shareholders. The potential future reimbursement represents a derivative instrument as codified in ASC 815 Derivatives and Hedging which requires the potential future reimbursement to be recorded at fair value at each reporting date. The fair value of the derivative liability as of March 31, 2015 and December 31, 2014 was $(9.3) million and $(6.7) million, respectively. The change in the fair value was recorded in general and administrative expenses in our condensed consolidated statement of operations for the three and six months ended June 30, 2015. The valuation techniques and significant unobservable inputs used for our level 3 fair value measurement at June 30, 2015 were as follows:
Description
 
Fair Value at June 30, 2015
 
Primary
Valuation 
Technique
 
Unobservable Inputs
 
Rate
Derivative liability
 
$
(8,919
)
 
Monte Carlo simulation
 
Risk-free rate
 
0.30%
 
 
 
 
 
 
Volatility
 
20.0%

Financial Instruments

In addition to the assets and liabilities described in the above table, our financial instruments include our cash and cash equivalents, real estate mortgages receivable, restricted cash, senior unsecured debt and mortgage notes payable.  At June 30, 2015 and December 31, 2014, the fair value of these additional financial instruments were not materially different from their carrying values, except as follows (in thousands):
 
 
June 30, 2015
 
December 31, 2014
 
Carrying Amount
 
Fair Value
 
Carrying Amount
 
Fair Value
Senior unsecured debt and mortgage notes payable, net
$
1,973,692

 
$
2,033,171

 
$
2,207,665

 
$
2,263,535

 
The fair values of our senior notes and mortgage notes payable are based on estimates using discounted cash flow analyses and currently prevailing interest rates adjusted by credit risk spreads (level 3 inputs).
 
Other financial instruments that potentially subject us to concentrations of credit risk consist principally of rents receivable; however, as of June 30, 2015, no single tenant of ours is responsible for more than 3% of our total annualized rents.
 
Our derivative financial instruments, including interest rate swaps, are entered with major financial institutions and we monitor the amount of credit exposure to any one counterparty.

In July 2015, we transferred approximately $218.0 million in U.S. dollars from our Australian subsidiary to our U.S. bank accounts. As a result of these transfers, we expect to recognize foreign currency exchange losses of approximately $9.5 million in our third quarter 2015 consolidated financial statements. As of August 6, 2015, the Australia dollar cash and cash equivalents balance was approximately $7.0 million in U.S. dollars.


20
Table of Contents

EQUITY COMMONWEALTH
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


Note 15.  Earnings Per Common Share

The following table sets forth the computation of basic and diluted earnings per share (amounts in thousands except per share amounts):
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
Numerator for earnings per common share - basic and diluted:
 

 
 

 
 
 
 
Income from continuing operations
$
12,616

 
$
6,688

 
$
26,246

 
$
23,413

Preferred distributions
(6,981
)
 
(6,982
)
 
(13,962
)
 
(18,133
)
Excess fair value of consideration over carrying vale of preferred shares
—

 
(16,205
)
 
—

 
(16,205
)
Income (loss) from continuing operations attributable to Equity Commonwealth common shareholders
5,635

 
(16,499
)
 
12,284

 
(10,925
)
Discontinued operations
—

 
(1,303
)
 
—

 
2,420

Numerator for net income (loss) per share - basic and diluted
$
5,635

 
$
(17,802
)
 
$
12,284


$
(8,505
)
 
 
 
 
 
 
 
 
Denominator for earnings per common share - basic and diluted: