DDR Ddr Corp.

Notes to Condensed Consolid ated Financial Statements

Nature of Business

DDR Corp. and its related consolidated real estate subsidiaries (collectively, the “Company” or “DDR”) and unconsolidated joint ventures are primarily engaged in the business of acquiring, owning, developing, redeveloping, expanding, leasing, financing and managing shopping centers.  Unless otherwise provided, references herein to the Company or DDR include DDR Corp. and its wholly-owned subsidiaries and consolidated joint ventures.  The Company’s tenant base primarily includes national and regional retail chains and local retailers.  Consequently, the Company’s credit risk is concentrated in the retail industry.  

Use of Estimates in Preparation of Financial Statements

The preparation of financial statements in conformity with generally accepted accounting principles (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities and the reported amounts of revenues and expenses during the year.  Actual results could differ from those estimates.  

Reclassifications

Certain reclassifications have been made to the Company’s 2016 financial statements to conform to the 2017 presentation.

Unaudited Interim Financial Statements

These financial statements have been prepared by the Company in accordance with generally accepted accounting principles for interim financial information and the applicable rules and regulations of the Securities and Exchange Commission.  Accordingly, they do not include all information and footnotes required by generally accepted accounting principles for complete financial statements.  However, in the opinion of management, the interim financial statements include all adjustments, consisting of only normal recurring adjustments, necessary for a fair statement of the results of the periods presented.  The results of operations for the three months ended March 31, 2017 and 2016, are not necessarily indicative of the results that may be expected for the full year.  These condensed consolidated financial statements should be read in conjunction with the Company’s audited financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016 .

Principles of Consolidation

The consolidated financial statements include the results of the Company and all entities in which the Company has a controlling interest or has been determined to be the primary beneficiary of a variable interest entity (“VIE”).  All significant inter-company balances and transactions have been eliminated in consolidation.  Investments in real estate joint ventures in which the Company has the ability to exercise significant influence, but does not have financial or operating control, are accounted for using the equity method of accounting.  Accordingly, the Company’s share of the earnings (or loss) of these joint ventures is included in consolidated net income (loss).  

The Company has two unconsolidated joint ventures included in the Company’s joint venture investments that are considered VIEs for which the Company is not the primary beneficiary.  The Company’s maximum exposure to losses associated with these VIEs is limited to its aggregate investment, which was $329.5 million and $405.4 million as of March 31, 2017 and December 31, 2016, respectively.  

Common Shares

Common share dividends declared were $0.19 per share for each of the three months ended March 31, 2017 and 2016.

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Business Combinations

In September 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2015-16, Business Combinations (Topic 805) . ASU No. 2015-16 provides guidance pertaining to entities that have reported provisional amounts for items in a business combination for which the accounting is incomplete by the end of the reporting period in which the combination occurs and during the measurement period have an adjustment to provisional amounts recognized.  The guidance requires that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined.  Any adjustments should be calculated as if the accounting had been completed at the acquisition date.  The guidance is effective for public companies for fiscal years beginning after December 15, 2016.  In addition, in January 2017, the FASB issued ASU No. 2017-01, Business Combinations (Topic 805) - Clarifying the Definition of a Business .  ASU No. 2017-01 clarifies the definition and provides a more robust framework to use in determining when a set of assets and activities constitutes a business.  ASU No. 2017-01 is intended to provide guidance when evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses.  The guidance is effective for public companies for fiscal years beginning after December 15, 2017. Early adoption is permitted for both standards.  Application of the guidance is prospective.  

The Company adopted the standards effective January 1, 2017, with respect to its asset acquisitions.  Under these new standards, the Company’s purchase of a shopping center is expected to be classified as an acquisition of an asset and not classified as an acquisition of a business.  Transaction costs from the acquisition of a business are expensed as incurred, in contrast to transaction costs from the acquisition of an asset, which are capitalized to real estate assets upon acquisition.  As a result of these new standards, the majority of the transaction costs incurred related to the acquisition of shopping centers are capitalized to real estate assets (Note   3).   This change did not have a material impact on the Company’s financial statements.  

Statement of Cash Flows

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows:  Classification of Certain Cash Receipts and Cash Payments.   ASU No. 2016-15 provides guidance on certain specific cash flow issues, including, but not limited to, debt prepayment or extinguishment costs, contingent consideration payments made after a business combination and distributions received from equity method investees.  In addition, in November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230: Restricted Cash .  ASU No. 2016-18 clarifies certain existing principles in Accounting Standards Codification (“ASC”) 230, including providing additional guidance related to transfers between cash and restricted cash and how entities present, in their statements of cash flows, the cash receipts and cash payments that directly affect the restricted cash accounts.  These standards are effective for periods beginning after December 15, 2017, and shall be applied retrospectively where practicable.  Early adoption is permitted.  

The Company adopted the updated standards effective January 1, 2017.  The adoption of these standards modified the Company's 2017 presentation of certain activities within the consolidated statements of cash flows and related disclosures.

New Accounting Standards to Be Adopted

Revenue Recognition

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers .  The objective of ASU No. 2014-09 is to establish a single comprehensive five-step model for entities to use in accounting for revenue arising from contracts with customers that will supersede most of the existing revenue recognition guidance, including industry-specific guidance.  The core principle of this standard is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an

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amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.  ASU No. 2014-09 applies to all contracts with customers except those that are within the scope of other topics in the ASC .  The new guidance is effective for public companies for annual reporting periods (including interim periods within those periods) beginning after December 15, 2017.  Entities have the option of using either a full retrospective or modified approach to adopt ASU No. 2014-09.  The Company has not yet selected the method of adoption.  

The Company is in the process of evaluating the impact that the adoption of ASU No. 2014-09 will have on its consolidated financial statements and disclosures.  Most significantly for the real estate industry, leasing transactions are not within the scope of the new standard.  A majority of the Company’s tenant-related revenue is recognized pursuant to lease agreements and will be governed by the recently issued leasing guidance discussed below.  Excluding revenue related to leasing transactions, the Company anticipates that upon adoption of ASU No. 2014-09, the recognition of lease commission income earned pursuant to its management agreements with unconsolidated joint ventures most likely will be accelerated into an earlier quarter than recognized in current GAAP.  The majority of the Company’s lease commission income is recognized 50% upon lease execution and 50% upon tenant rent commencement.  Under the new standard, the Company anticipates that a lease commission will be recognized in its entirety upon lease execution.  This revenue is not considered material to the Company’s consolidated financial statements.

Accounting for Leases

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842).   The amendments in this update govern a number of areas including, but not limited to, accounting for leases, replacing the existing guidance in ASC No. 840, Leases .  Under this standard, among other changes in practice, a lessee’s rights and obligations under most leases, including existing and new arrangements, would be recognized as assets and liabilities, respectively, on the balance sheet.  Other significant provisions of this standard include (i) defining the “lease term” to include the noncancellable period together with periods for which there is a significant economic incentive for the lessee to extend or not terminate the lease, (ii) defining the initial lease liability to be recorded on the balance sheet to contemplate only those variable lease payments that depend on an index or that are in substance “fixed,” (iii) a dual approach for determining whether lease expense is recognized on a straight-line or accelerated basis, depending on whether the lessee is expected to consume more than an insignificant portion of the leased asset’s economic benefits and (iv) a requirement to bifurcate certain lease and non-lease components.  The lease standard is effective for fiscal years beginning after December 15, 2018, (including interim periods within those fiscal years) with early adoption permitted.  The Company has not yet selected the method of adoption.  

The Company is in the process of evaluating the impact that the adoption of ASU No. 2016-02 will have on its consolidated financial statements and disclosures.  The Company has currently identified several areas within its accounting policies it believes could be impacted by the new standard.  The Company may have a change in presentation on its consolidated statement of operations with regards to Recoveries from Tenants which includes reimbursements from tenants for certain operating expenses, real estate taxes and insurance.  Tenant expense reimbursements with a service obligation are not covered within the scope of ASU No. 2016-02.  The Company also has certain lease arrangements with its tenants for space at its shopping centers in which the contractual amounts due under the lease by the lessee are not allocated between the rental and expense reimbursement components (“Gross Leases”).  The aggregate revenue earned under Gross Leases is presented as Minimum Rents in the consolidated statements of operations.  As a result, the Company anticipates it will be required to bifurcate the presentation of certain expense reimbursements as well as allocate the fair value of the embedded revenue associated with these reimbursements for Gross Leases, which represent an immaterial portion of the Company’s lease portfolio, and separately present such amounts in its consolidated statements of operations based upon materiality.  In addition, the Company has ground lease agreements in which the Company is the lessee for land underneath all or a portion of the buildings at five shopping centers.  Currently, the Company accounts for these arrangements as operating leases.  Under the new standard, the Company will record its rights and obligations under these leases as an asset and liability on its consolidated balance sheets.  The Company is currently in the process of evaluating the inputs required to calculate the amount that will be recorded on its balance sheet for each ground lease.  Lastly, this standard impacts the lessor’s ability to capitalize costs related to the leasing of vacant space.  However, the Company does not believe this change regarding capitalization will have a material impact on its consolidated financial statements.  

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At March 31, 2017 and December 31, 2016, the Company had ownership interests in various unconsolidated joint ventures that had an investment in 150 and 151 shopping center properties, respectively.  Condensed combined financial information of the Company’s unconsolidated joint venture investments is as follows (in thousands):

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Service fees and income earned by the Company through management, financing, leasing and development activities performed related to all of the Company’s unconsolidated joint ventures are as follows (in millions):

The Company’s joint venture agreements generally include provisions whereby each partner has the right to trigger a purchase or sale of its interest in the joint venture or to initiate a purchase or sale of the properties after a certain number of years or if either party is in default of the joint venture agreements.  The Company is not obligated to purchase the interests of its outside joint venture partners under these provisions.  

An affiliate of Blackstone is the managing member and effectively owns 95% of the common equity of each of the two BRE DDR Joint Ventures, and consolidated affiliates of DDR effectively own the remaining 5%.  The Company provides leasing and property management services to all of the joint venture properties.  The Company cannot be removed as the property and leasing manager until the preferred equity, as discussed below, is redeemed in full (except for certain specified events).  

The Company’s preferred interests are entitled to certain preferential cumulative distributions payable out of operating cash flows and certain capital proceeds pursuant to the terms and conditions of the preferred investments.  The preferred distributions are recognized as Interest Income within the Company’s consolidated statements of operations and are classified as a note receivable in Investments in and Advances to Joint Ventures on the Company’s consolidated balance sheets.  Blackstone has the right to defer up to

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23.5% of the preferred fixed distributions as a payment in kind distribution or “PIK.”  The preferred investment s have an annual distribution rate of 8.5% including any deferred and unpaid preferred distributions.  Blackstone has made this PIK deferral election since the formation of both joint ventures.  The cash portion of the preferred fixed distributions is gene rally payable first out of operating cash flows and is current for both BRE DDR Joint Ventures.  The Company has no expectation that the preferred fixed distribution will become impaired.  

The unpaid preferred investment (and any accrued distributions) is payable (1) at Blackstone’s option, in whole or in part, subject to early redemption premiums in certain circumstances during the first three years of the joint ventures; (2) at varying equity sharing levels with the common members under certain circumstances including specified financial covenants, upon a sale of properties over a certain threshold; (3) at DDR’s option after seven years (2021 for BRE DDR III and 2022 for BRE DDR IV); and (4) upon the incurrence of additional indebtedness by the joint ventures in excess of a certain threshold.  Specifically, for BRE DDR III the use of net asset sale proceeds prior to 2021 to repay the preferred investment is first subject to a remaining minimum net asset sales threshold of $46.3 million payable to common equity members only, with net asset sale proceeds generated thereafter allocated at 51.5% to the preferred member.  For BRE DDR IV, the preferred investment is collateralized by assets in which DDR has a 5% common equity interest for 95% of the value and by an additional six assets in which DDR has a nominal interest.  The repayment of the BRE DDR IV preferred investment prior to 2022 is first subject to a remaining minimum net asset sales threshold of $26.0 million, of which $6.0 million is allocated to the preferred member.  The net asset sale proceeds generated thereafter are expected to be available to repay the preferred member.  

In March 2017, the Company recorded a valuation allowance on each of the BRE DDR III and BRE DDR IV preferred investment interests of $70.0 million and $6.0 million, respectively, or $76.0 million in the aggregate.  The valuation allowances were triggered late in the first quarter by an increase in the estimated market capitalization rates for the underlying real estate collateral of the investments.  The values of open air shopping centers anchored by big box national retailers, particularly in secondary markets, have been under increasing pressure and most recently decreased due to the continued perceived threat of internet retail competition and recent tenant bankruptcies.  Several large national retailers filed for bankruptcy in March and April 2017.  A majority of the shopping centers collateralizing the preferred investments are those which have been most impacted by the rising capitalization rates.  These factors have also reduced the number of potential investors and well-capitalized buyers for these types of assets.  The managing member of the two joint ventures exercises significant influence over the timing of asset sales.  Due to the Company’s expectation regarding the likely timing of asset sales, the valuation of the Company’s investments considers how management believes a third party market participant would value the securities in the current higher capitalization rate environment.  As a result, the investments were impaired to reflect the risk that the securities are not repaid in full in advance of the Company’s redemption rights in 2021 and 2022.  The Company will continue to monitor the investments and related valuation allowance which could be increased or decreased in future periods, as appropriate.

The preferred 8.5% distribution rate has two components, a cash interest rate of 6.5% and an accrued PIK of 2.0%.  As a result of the valuation allowances recorded, effective in March 2017, the Company will no longer recognize as interest income the 2.0% PIK.  Although Blackstone has the right to change its payment election, the Company expects future preferred distributions to continue to include the PIK component.  The recognition of the PIK interest income will be reevaluated based upon any future adjustments to the aggregate valuation allowance, as appropriate.

In January 2017, the Company acquired one shopping center in Chicago, Illinois, for $81.0 million.  This acquisition was accounted for as an asset acquisition and the fair value was allocated as follows (in thousands):

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Total consideration for the acquisition was paid in cash.  The costs related to the acquisition of this asset were capitalized to real estate assets (Note 1).   Included in the Company’s consolidated statements of operations are $1.5 million in total revenu es from the date of acquisition through March 31, 2017, for the acquired property .

The Company has notes receivable, including accrued interest, that are collateralized by certain rights in development projects, partnership interests, sponsor guaranties and/or real estate assets, some of which are subordinate to other financings.  

At March 31, 2017 and December 31, 2016, the Company had loans and other receivables outstanding of $49.9 million and $49.5 million, respectively, with maturity dates ranging from September 2017 to June 2023 and interest rates ranging from 5.6% to 12.0%.  The following table reconciles the loans receivable on real estate (in thousands):

At March 31, 2017, the Company did not have any loans outstanding that were past due.  In April 2017, a loan receivable of $30.6 million with a maturity date of September 2017 was repaid in full.

Other assets consist of the following (in thousands):  

The following table discloses certain information regarding the Company’s Revolving Credit Facilities (as defined below) (in millions):

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The Company maintains an unsecured revolving credit facility with a syndicate of financial institutions, arranged by J.P. Morgan Securities, LLC and Wells Fargo Securities, LLC (the “Unsecured Credit Facility”).  The Unsecured Credit Facility provides for borrowings of up to $750 million, i f certain financial covenants are maintained, two six-month options to extend the maturity to June 2020 upon the Company’s request and an accordion feature for expansion of availability up to $1.25 billion, provided that new or existing lenders agree to th e existing terms of the facility and increase their commitment level.  The Unsecured Credit Facility includes a competitive bid option on periodic interest rates for up to 50% of the facility.  The Unsecured Credit Facility also provides for an annual faci lity fee, which was 20 basis points on the entire facility at March 31, 2017.

The Company also maintains a $50 million unsecured revolving credit facility with PNC Bank, National Association (the “PNC Facility” and, together with the Unsecured Credit Facility, the “Revolving Credit Facilities”).  The PNC Facility terms are substantially consistent with those contained in the Unsecured Credit Facility.  

The Company’s borrowings under the Revolving Credit Facilities bear interest at variable rates at the Company’s election, based on either LIBOR, plus a specified spread (1.0% at March 31, 2017) or the prime rate, as defined in the respective facility.  The specified spreads vary depending on the Company’s long-term senior unsecured debt rating from Moody’s Investors Service and Standard and Poor’s.  The Company is required to comply with certain covenants under the Revolving Credit Facilities relating to total outstanding indebtedness, secured indebtedness, maintenance of unencumbered real estate assets and fixed charge coverage.  The Company was in compliance with these financial covenants at March 31, 2017.  

The following methods and assumptions were used by the Company in estimating fair value disclosures of financial instruments:

Notes Receivable and Advances to Affiliates

The fair value is estimated using a discounted cash flow analysis in which the Company uses unobservable inputs such as market interest rates determined by the loan to value and market capitalization rates related to the underlying collateral at which management believes similar loans would be made and classified as Level 3 in the fair value hierarchy.  The fair value of these notes was approximately $371.1 million and $445.2 million at March 31, 2017 and December 31, 2016, respectively, as compared to the carrying amounts of $369.6 million and $443.3 million, respectively.  

Debt

The fair market value of senior notes is determined using the trading price of the Company’s public debt.  The fair market value for all other debt is estimated using a discounted cash flow technique that incorporates future contractual interest and principal payments and a market interest yield curve with adjustments for duration, optionality and risk profile, including the Company’s non-performance risk and loan to value.  The Company’s senior notes and all other debt are classified as Level 2 and Level 3, respectively, in the fair value hierarchy.  

Considerable judgment is necessary to develop estimated fair values of financial instruments.  Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize on disposition of the financial instruments.  

Debt instruments with carrying values that are different than estimated fair values are summarized as follows (in thousands):

Accrued Expense

During the first quarter of 2017, the Company recorded a separation charge aggregating $11.5 million which is comprised of $9.4 million related to the March 2, 2017, management transition and $2.1 million related to other contractual staffing reductions.  These charges are the result of the termination without cause of several of its executives under the terms of their respective employment agreements.  This charge included stock-based compensation expense of approximately $3.3 million relating to the acceleration of expense associated with the grant date fair value of the unvested stock-based awards.  At March 31, 2017,

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approxi mately $8.2 million was included in accounts payable and accrued expenses related to the charge in the Company’s consolidated balance sheet.  The Company expects to record an additional $5 million charge in the second quarter of 2017 reflecting the remaini ng separation costs associated with the restructuring announced on April 3, 2017.

The changes in accumulated other comprehensive loss by component are as follows (in thousands):

The Company recorded impairment charges and reserves based on the difference between the carrying value of the assets or investments and the estimated fair market value as follows (in millions):  

Items Measured at Fair Value on a Non-Recurring Basis

The Company is required to assess the fair value of certain impaired consolidated and unconsolidated joint venture investments.  The valuation of impaired real estate assets and investments is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each asset, as well as the income capitalization approach considering prevailing market capitalization rates, analysis of recent comparable sales transactions, actual sales negotiations and bona fide purchase offers received from third parties and/or consideration of the amount that currently would be required to replace the asset, as adjusted for obsolescence.  In general, the Company considers multiple valuation techniques when measuring fair value of an investment.  However, in certain circumstances, a single valuation technique may be appropriate.  

For operational real estate assets, the significant valuation assumptions included the capitalization rate used in the income capitalization valuation as well as the projected property net operating income.  For projects under development or not at stabilization, the significant valuation assumptions included the discount rate, the timing and the estimated costs for the construction completion and project stabilization, projected net operating income and the exit capitalization rate.  For the valuation of the preferred equity interests, the significant assumptions used in the discounted cash flow analysis included the discount rate, projected net operating income, the timing of the expected redemption and the exit capitalization rates.  These valuations were calculated based on market conditions and assumptions made by management at the time the valuation adjustments were recorded, which may differ materially from actual results if market conditions or the underlying assumptions change.  

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The following table presents information about the Company’s impairment charges on both financial and nonfinancial assets that were measured on a fair value basis for the three months ended March 31, 2017, and the year ended December 31, 2016.  The table also indicates the fair value hierarchy of the valuation techniques used by the Company to determine such fair value (in millions).  

The following table presents quantitative information about the significant unobservable inputs used by the Company to determine the fair value of non-recurring items (in millions, except price per square foot, which is in thousands):

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The following table provides a reconciliation of net (loss) income from continuing operations and the number of common shares used in the computations of “basic” earnings per share (“EPS”), which utilizes the weighted-average number of common shares outstanding without regard to dilutive potential common shares, and “diluted” EPS, which includes all such shares (in thousands, except per share amounts):

Shares subject to issuance under the Company’s 2016 VSEP were not considered in the computation of diluted EPS for the three months ended March 31, 2017 and 2016, as the calculation was anti-dilutive.  

The tables below present information about the Company’s reportable operating segments (in thousands):