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Form 10-Q

 

UNITED STATES

 

SECURITIES AND EXCHANGE COMMISSION

 

Washington, D.C. 20549

 

ý

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

For the quarterly period ended June 30, 2004

 

 

OR

 

 

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

For the transition period from                         to                         

 

Commission File Number    001-11543

 

(Exact name of registrant as specified in its charter)

 

Maryland

 

52-0735512

(State or other jurisdiction of
incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

 

 

10275 Little Patuxent Parkway
Columbia, Maryland

 

21044-3456

(Address of principal executive offices)

 

(Zip Code)

 

 

 

Registrant’s telephone number, including area code  (410) 992-6000

 

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 is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

 

Yes

ý

 

No

o

 

 

Indicate the number of shares outstanding of the issuer’s common stock as of August 2, 2004:

 

Common Stock, $0.01 par value

 

102,720,733

Title of Class

 

Number of Shares

 

 



 

Part I.      Financial Information

Item 1.    Financial Statements.

 

THE ROUSE COMPANY AND SUBSIDIARIES

 

Condensed Consolidated Statements of Operations and Comprehensive Income

Three and Six Months Ended June 30, 2004 and 2003

(Unaudited; in thousands, except per share data)

 

 

 

Three months
ended June 30,

 

Six months
ended June 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

Revenues:

 

 

 

 

 

 

 

 

 

Rents from tenants

 

$

207,704

 

$

180,522

 

$

406,904

 

$

358,874

 

Land sales

 

96,203

 

88,256

 

205,188

 

157,439

 

Other

 

15,389

 

14,442

 

28,252

 

28,410

 

Total revenues

 

319,296

 

283,220

 

640,344

 

544,723

 

Operating expenses, exclusive of provision for bad debts, depreciation and amortization:

 

 

 

 

 

 

 

 

 

Operating properties

 

(86,584

)

(77,346

)

(172,312

)

(153,676

)

Land sales operations

 

(57,672

)

(59,117

)

(125,434

)

(99,680

)

Other

 

(9,292

)

(20,502

)

(19,497

)

(35,357

)

Total operating expenses, exclusive of provision for bad debts, depreciation and amortization

 

(153,548

)

(156,965

)

(317,243

)

(288,713

)

Interest expense

 

(59,963

)

(52,931

)

(118,247

)

(109,678

)

Provision for bad debts

 

(1,982

)

(1,502

)

(4,650

)

(2,685

)

Depreciation and amortization

 

(48,521

)

(40,567

)

(96,346

)

(78,567

)

Other income, net

 

945

 

4,549

 

2,339

 

4,189

 

Other provisions and losses, net

 

(2,086

)

(8,631

)

(6,180

)

(19,757

)

Earnings before income taxes, equity in earnings of unconsolidated real estate ventures, net gains on dispositions of interests in operating properties and discontinued operations

 

54,141

 

27,173

 

100,017

 

49,512

 

Income taxes, primarily deferred

 

(20,498

)

(15,993

)

(39,114

)

(26,578

)

Equity in earnings of unconsolidated real estate ventures

 

5,337

 

6,781

 

8,635

 

14,281

 

Earnings before net gains on dispositions of interests in operating properties and discontinued operations

 

38,980

 

17,961

 

69,538

 

37,215

 

Net gains on dispositions of interests in operating properties

 

14,096

 

21,573

 

13,888

 

21,804

 

Earnings from continuing operations

 

53,076

 

39,534

 

83,426

 

59,019

 

Discontinued operations

 

8,163

 

98,558

 

44,927

 

103,213

 

Net earnings

 

61,239

 

138,092

 

128,353

 

162,232

 

Other items of comprehensive income (loss):

 

 

 

 

 

 

 

 

 

Minimum pension liability adjustment

 

229

 

390

 

(1,637

)

390

 

Unrealized net gains (losses) on derivatives designated as cash flow hedges

 

4,859

 

153

 

2,103

 

(3,199

)

Unrealized net gains (losses) on available-for-sale securities

 

(160

)

 

426

 

 

Comprehensive income

 

$

66,167

 

$

138,635

 

$

129,245

 

$

159,423

 

Net earnings applicable to common shareholders

 

$

61,239

 

$

135,054

 

$

128,353

 

$

156,156

 

Earnings per share of common stock

 

 

 

 

 

 

 

 

 

Basic:

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

.52

 

$

.41

 

$

.83

 

$

.60

 

Discontinued operations

 

.08

 

1.13

 

.45

 

1.19

 

Total

 

$

.60

 

$

1.54

 

$

1.28

 

$

1.79

 

Diluted:

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

.50

 

$

.40

 

$

.81

 

$

.59

 

Discontinued operations

 

.08

 

1.10

 

.43

 

1.16

 

Total

 

$

.58

 

$

1.50

 

$

1.24

 

$

1.75

 

Dividends per share:

 

 

 

 

 

 

 

 

 

Common stock

 

$

.47

 

$

.42

 

$

.94

 

$

.84

 

Preferred stock

 

$

 

$

.75

 

$

 

$

1.50

 

 

The accompanying notes are an integral part of these statements.

 

2



 

Part I.      Financial Information

Item 1.    Financial Statements.

 

THE ROUSE COMPANY AND SUBSIDIARIES

 

Condensed Consolidated Balance Sheets

June 30, 2004 and December 31, 2003

(In thousands, except share data)

 

 

 

June 30,
2004

 

December 31,
2003

 

 

 

(Unaudited)

 

 

 

Assets:

 

 

 

 

 

Property and property-related deferred costs:

 

 

 

 

 

Operating properties:

 

 

 

 

 

Property

 

$

5,830,436

 

$

5,351,748

 

Less accumulated depreciation

 

973,241

 

897,277

 

 

 

4,857,195

 

4,454,471

 

Deferred costs

 

251,346

 

238,122

 

Less accumulated amortization

 

103,146

 

94,424

 

 

 

148,200

 

143,698

 

Net operating properties

 

5,005,395

 

4,598,169

 

 

 

 

 

 

 

Properties in development

 

224,732

 

167,073

 

Properties held for sale

 

8,241

 

138,823

 

Investment land and land held for development and sale

 

455,494

 

414,666

 

Total property and property-related deferred costs

 

5,693,862

 

5,318,731

 

Investments in unconsolidated real estate ventures

 

573,541

 

628,305

 

Advances to unconsolidated real estate ventures

 

14,222

 

19,562

 

Prepaid expenses, receivables under finance leases and other assets

 

559,379

 

479,409

 

Accounts and notes receivable

 

67,147

 

53,694

 

Investments in marketable securities

 

25,187

 

22,313

 

Cash and cash equivalents

 

36,220

 

117,230

 

Total assets

 

$

6,969,558

 

$

6,639,244

 

Liabilities:

 

 

 

 

 

Debt:

 

 

 

 

 

Property debt not carrying a Parent Company guarantee of repayment

 

$

2,604,864

 

$

2,768,288

 

Debt secured by properties held for sale

 

 

110,935

 

Parent Company debt and debt carrying a Parent Company guarantee of repayment:

 

 

 

 

 

Property debt

 

181,548

 

179,150

 

Other debt

 

1,778,504

 

1,386,119

 

 

 

1,960,052

 

1,565,269

 

Total debt

 

4,564,916

 

4,444,492

 

Accounts payable and accrued expenses

 

156,838

 

179,530

 

Other liabilities

 

657,907

 

611,042

 

 

 

 

 

 

 

Parent Company-obligated mandatorily redeemable preferred securities of a trust holding solely Parent Company subordinated debt securities

 

 

79,216

 

Shareholders’ equity:

 

 

 

 

 

Series B Convertible Preferred stock with a liquidation preference of $202,500

 

 

41

 

Common stock of 1¢ par value per share; authorized 500,000,000 shares in 2004 and 250,000,000 shares in 2003; issued 102,612,050 shares in 2004 and  91,759,723 shares in 2003

 

1,026

 

918

 

Additional paid-in capital

 

1,579,015

 

1,346,890

 

Retained earnings (accumulated deficit)

 

20,858

 

(10,991

)

Accumulated other comprehensive income (loss):

 

 

 

 

 

Minimum pension liability adjustment

 

(6,265

)

(4,628

)

Unrealized net losses on derivatives designated as cash flow hedges

 

(5,163

)

(7,266

)

Unrealized net gains on available-for-sale securities

 

426

 

 

Total shareholders’ equity

 

1,589,897

 

1,324,964

 

Total liabilities and shareholders’ equity

 

$

6,969,558

 

$

6,639,244

 

 

The accompanying notes are an integral part of these statements.

 

3



 

Part I.      Financial Information

Item 1.    Financial Statements.

 

THE ROUSE COMPANY AND SUBSIDIARIES

 

Condensed Consolidated Statements of Cash Flows

Six Months Ended June 30, 2004 and 2003

(Unaudited, in thousands)

 

 

 

2004

 

2003

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

Rents from tenants and other revenues received

 

$

425,732

 

$

446,753

 

Proceeds from land sales and notes receivable from land sales

 

188,784

 

173,509

 

Interest received

 

3,709

 

3,847

 

Operating expenditures

 

(212,292

)

(232,258

)

Land development and acquisition expenditures

 

(88,187

)

(75,487

)

Interest paid

 

(115,350

)

(125,146

)

Income taxes paid

 

(15,859

)

(2,881

)

Operating distributions from unconsolidated real estate ventures

 

18,815

 

27,733

 

Net cash provided by operating activities

 

205,352

 

216,070

 

Cash flows from investing activities:

 

 

 

 

 

Expenditures for properties in development

 

(54,177

)

(98,015

)

Expenditures for improvements to existing properties

 

(32,013

)

(32,794

)

Expenditures for acquisitions of interests in properties and other assets

 

(291,412

)

(1,501

)

Proceeds from dispositions of interests in properties

 

88,402

 

264,772

 

Other distributions from unconsolidated real estate ventures

 

31,518

 

 

Expenditures for investments in unconsolidated real estate ventures

 

(4,620

)

(23,834

)

Other

 

(451

)

4,702

 

Net cash provided (used) by investing activities

 

(262,753

)

113,330

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from issuance of property debt

 

6,825

 

193,560

 

Repayments of property debt:

 

 

 

 

 

Scheduled principal payments

 

(36,643

)

(37,889

)

Other payments

 

(442,866

)

(271,848

)

Proceeds from issuance of other debt

 

502,736

 

6,747

 

Repayments of other debt

 

(89,000

)

(121,690

)

Repayments of Parent Company-obligated mandatorily redeemable preferred securities

 

(79,751

)

(9,750

)

Purchases of common stock

 

(31,117

)

(20,886

)

Proceeds from issuance of common stock

 

221,917

 

 

Proceeds from exercise of stock options

 

24,554

 

31,684

 

Dividends paid

 

(96,506

)

(79,802

)

Other

 

(3,758

)

(8,430

)

Net cash used by financing activities

 

(23,609

)

(318,304

)

Net increase (decrease) in cash and cash equivalents

 

(81,010

)

11,096

 

Cash and cash equivalents at beginning of period

 

117,230

 

41,633

 

Cash and cash equivalents at end of period

 

$

36,220

 

$

52,729

 

 

The accompanying notes are an integral part of these statements.

 

4



 

Part I.      Financial Information

Item 1.    Financial Statements.

 

THE ROUSE COMPANY AND SUBSIDIARIES

 

Condensed Consolidated Statements of Cash Flows, continued

Six Months Ended June 30, 2004 and 2003

(Unaudited, in thousands)

 

 

 

2004

 

2003

 

Reconciliation of net earnings to net cash provided by operating activities:

 

 

 

 

 

Net earnings

 

$

128,353

 

$

162,232

 

Adjustments to reconcile net earnings to net cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

97,325

 

90,580

 

Change in undistributed earnings of unconsolidated real estate ventures

 

10,180

 

14,352

 

Net gains on dispositions of interests in operating properties

 

(58,602

)

(91,606

)

Impairment losses on operating properties

 

270

 

 

Losses (gains) on extinguishment of debt

 

3,312

 

(21,169

)

Participation expense pursuant to Contingent Stock Agreement

 

36,001

 

36,120

 

Land development and acquisition expenditures in excess of cost of land sales

 

(16,339

)

 

Provision for bad debts

 

4,664

 

3,568

 

Debt assumed by purchasers of land

 

(4,723

)

(16,585

)

Deferred income taxes

 

30,057

 

22,466

 

Decrease (increase) in accounts and notes receivable

 

(17,600

)

2,440

 

Decrease in other assets

 

24,662

 

14,856

 

Increase (decrease) in accounts payable, accrued expenses and other liabilities

 

(37,539

)

3,435

 

Other, net

 

5,331

 

(4,619

)

Net cash provided by operating activities

 

$

205,352

 

$

216,070

 

Schedule of noncash investing and financing activities:

 

 

 

 

 

Common stock issued pursuant to Contingent Stock Agreement

 

$

13,177

 

$

21,058

 

Capital lease obligations incurred

 

6,938

 

1,429

 

Lapses of restrictions on common stock awards and grants of common stock

 

4,108

 

6,839

 

Debt assumed by purchasers of land

 

4,723

 

16,585

 

Debt assumed by purchasers of operating properties

 

130,787

 

276,588

 

Debt and other liabilities assumed or issued in acquisition of assets

 

340,524

 

226,567

 

Debt extinguished in excess of cash paid

 

 

28,026

 

Property and other assets contributed to an unconsolidated real estate venture

 

 

164,306

 

Debt and other liabilities related to property contributed to an unconsolidated real estate venture

 

 

163,406

 

 

5



 

Part I.      Financial Information

Item 1.    Financial Statements.

 

THE ROUSE COMPANY AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

June 30, 2004

 

(1)           SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

(a)          Basis of presentation

 

The unaudited consolidated financial statements include the accounts of The Rouse Company, our subsidiaries and ventures (“we,” “Rouse” or “us”) in which we have a majority voting interest and control.  We also consolidate the accounts of variable interest entities where we are the primary beneficiary.  We account for investments in other ventures using the equity or cost methods as appropriate in the circumstances.  Significant intercompany balances and transactions are eliminated in consolidation.

 

The unaudited condensed consolidated financial statements include all adjustments which are necessary, in the opinion of management, to fairly present our financial position and results of operations. All such adjustments are of a normal recurring nature. The statements have been prepared using the accounting policies described in our 2003 Annual Report to Shareholders.

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and judgments that affect the reported amounts of assets and liabilities and disclosures of contingencies at the date of the financial statements and revenues and expenses recognized during the reporting period.  Significant estimates are inherent in the preparation of our financial statements in a number of areas, including the cost ratios and completion percentages used for land sales, evaluation of impairment of long-lived assets (including operating properties and properties held for development or sale), evaluation of collectibility of accounts and notes receivable and allocation of the purchase price of acquired properties.  Actual results could differ from these and other estimates.

 

In April 2004, we reclassified certain costs and expenses (primarily employee termination benefits) related to organizational changes and early retirements from other provisions and losses, net to operating expenses. We made these reclassifications because these expenses are neither infrequent nor unusual and are becoming a normal cost of doing business. The amounts reclassified were $5.2 million and $3.9 million in the three and six months ended June 30, 2003, respectively, and $1.0 million in the three months ended March 31, 2004.

 

Certain amounts for 2003 have been reclassified to conform to our current presentation.

 

(b)          Property and property-related deferred costs

 

Properties to be developed or held and used in operations are carried at cost reduced for impairment losses, where appropriate.  Acquisition, development and construction costs of properties in development are capitalized including, where applicable, salaries and related costs, real estate taxes, interest and preconstruction costs directly related to the project. The preconstruction stage of development of an operating property (or an expansion of an existing property) includes efforts and related costs to secure land control and zoning, evaluate feasibility and complete other initial tasks which are essential to development. Provisions are made for costs of potentially unsuccessful preconstruction efforts by charges to operations.  Development and construction costs and costs of significant improvements and replacements and renovations at operating properties are capitalized, while costs of maintenance and repairs are expensed as incurred.

 

Direct costs associated with leasing of operating properties are capitalized as deferred costs and amortized using the straight-line method over the terms of the related leases.

 

Depreciation of each operating property is computed using the straight-line method.  The annual rate of depreciation for each retail center (with limited exceptions) is based on a 55-year composite life and a salvage value of approximately 10%.  Office buildings and other properties are depreciated using composite lives of 40 years.  Furniture and fixtures and certain common area improvements are depreciated using estimated useful lives ranging from 2 to 10 years.

 

6



 

Part I.      Financial Information

Item 1.    Financial Statements.

 

THE ROUSE COMPANY AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements (Unaudited), continued

 

If events or circumstances indicate that the carrying value of an operating property to be held and used may be impaired, a recoverability analysis is performed based on estimated undiscounted future cash flows to be generated from the property.  If the analysis indicates that the carrying value is not recoverable from future cash flows, the property is written down to estimated fair value and an impairment loss is recognized.  Fair values are determined based on appraisals and/or estimated future cash flows using appropriate discount and capitalization rates.

 

Properties held for sale are carried at the lower of their carrying values (i.e. cost less accumulated depreciation and any impairment loss recognized, where applicable) or estimated fair values less costs to sell.  The net carrying values of operating properties are classified as properties held for sale when the properties are actively marketed, their sale is considered probable within one year and various other criteria relating to their disposition are met.  Depreciation of these properties is discontinued at that time, but operating revenues, interest and other operating expenses continue to be recognized until the date of sale. Revenues and expenses of properties that are classified as held for sale are presented as discontinued operations for all periods presented in the statements of operations if the properties will be or have been sold on terms where we have limited or no continuing involvement with them after the sale.  If active marketing ceases or the properties no longer meet the criteria to be classified as held for sale, the properties are reclassified as operating, depreciation is resumed, depreciation for the period the properties were classified as held for sale is recognized and deferred selling costs, if any, are charged to expense. Additionally, we present other assets and liabilities of properties classified as held for sale separately in the balance sheet, if material.

 

Gains from dispositions of interests in operating properties are recognized using the full accrual method provided that various criteria relating to the terms of the transactions and any subsequent involvement by us with the properties disposed of are met.  Gains relating to transactions that do not meet the established criteria are deferred and recognized when the criteria are met or using the installment or cost recovery methods, as appropriate in the circumstances.

 

(c)           Acquisitions of operating properties

 

We allocate the purchase price of acquired properties to tangible and identified intangible assets based on their fair values.  In making estimates of fair values for purposes of allocating purchase price, we use a number of sources, including independent appraisals that may be obtained in connection with the acquisition or financing of the respective property and other market data.  We also consider information obtained about each property as a result of our pre-acquisition due diligence, marketing and leasing activities in estimating the fair value of the tangible and intangible assets acquired.

 

The fair values of tangible assets are determined on an “if-vacant” basis.  The “if-vacant” fair value is allocated to land, where applicable, buildings, tenant improvements and equipment based on property tax assessments and other relevant information obtained in connection with the acquisition of the property.

 

Our intangible assets arise primarily from contractual rights and include leases with above- or below-market rents (including ground leases where we are lessee), in-place lease and customer relationship values and a real estate tax stabilization agreement.

 

Above-market and below-market in-place lease values are recorded based on the present value (using an interest rate which reflects the risks associated with the leases acquired) of the difference between (i) the contractual amounts to be received or paid pursuant to the in-place leases and (ii) our estimate of fair market lease rates for the corresponding space, measured over a period equal to the remaining non-cancelable term of the lease (including those under bargain renewal options).  The capitalized above- and below-market lease values are amortized as adjustments to rental income or rental expense over the remaining terms of the respective leases (including periods under bargain renewal options).

 

7



 

Part I.      Financial Information

Item 1.    Financial Statements.

 

THE ROUSE COMPANY AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements (Unaudited), continued

 

The aggregate fair values of in-place leases and customer relationship assets acquired are measured based on the difference between (i) the property valued with existing in-place leases adjusted to market rental rates and (ii) the property valued as if vacant.  This value is allocated to in-place lease and customer relationship assets (both anchor stores and tenants).  The fair value of in-place leases is based on our estimates of carrying costs during the expected lease-up periods and costs to execute similar leases.  Our estimate of carrying costs includes real estate taxes, insurance and other operating expenses and lost rentals during the expected lease-up periods considering current market conditions.  Our estimate of costs to execute similar leases includes leasing commissions, legal and other related costs. The fair value of anchor store agreements is determined based on our experience negotiating similar relationships (not in connection with property acquisitions). The fair value of tenant relationships is based on our evaluation of the specific characteristics of each tenant’s lease and our overall relationship with that respective tenant.  Characteristics we consider in determining these values include the nature and extent of our existing business relationships with the tenant, growth prospects for developing new business with the tenant, the tenant’s credit quality and expectations of lease renewals, among other factors.  The value of in-place leases is amortized to expense over the initial term of the respective leases, primarily ranging from two to ten years.  The value of anchor store agreements is amortized to expense over the estimated term of the anchor store’s occupancy in the property.  Should an anchor store vacate the premises, the unamortized portion of the related intangible is charged to expense.  The value of tenant relationship intangibles is amortized to expense over the initial term and any renewal periods in the respective leases, but in no event does the amortization period exceed the remaining depreciable life of the building.  Should a tenant terminate its lease, the unamortized portion of the in-place lease value and customer relationship intangibles is charged to expense. The value allocated to the tax stabilization agreement was determined based on the difference between the present value of estimated market real estate taxes and amounts due under the agreement and is amortized to operating expense over the term of the agreement, which is approximately 24 years.

 

The aggregate purchase price of properties acquired in 2004 and 2003 was allocated to intangible assets and liabilities as follows (in millions):

 

 

 

2004

 

2003

 

 

 

 

 

 

 

Above-market leases

 

$

3.8

 

$

1.1

 

In-place lease assets

 

2.9

 

2.0

 

Tenant relationships

 

6.5

 

0.6

 

Below-market leases

 

4.2

 

4.7

 

Anchor store agreements

 

1.5

 

2.5

 

Below-market ground lease

 

14.5

 

 

Real estate tax stabilization agreement

 

94.2

 

 

 

(d)          Investments in marketable securities and cash and cash equivalents

 

Our investment policy defines authorized investments and establishes various limitations on the maturities, credit quality and amounts of investments held.  Authorized investments include U.S. government and agency obligations, certificates of deposit, bankers’ acceptances, repurchase agreements, commercial paper, money market mutual funds and corporate debt and equity securities.  We may also invest in mutual funds to closely match the investment selections of participants in nonqualified deferred compensation plans.

 

Debt security investments with maturities at dates of purchase in excess of three months are classified as marketable securities and carried at amortized cost as it is our intention to hold these investments until maturity.  Short-term investments with maturities at dates of purchase of three months or less are classified as cash equivalents. Most investments in marketable equity securities are classified as trading securities and are carried at market value with changes in values recognized in earnings. Investments in marketable equity securities subject to significant restrictions on sale or transfer are classified as available-for-sale and are carried at market value with unrealized changes in values recognized in other comprehensive income.

 

8



 

Part I.      Financial Information

Item 1.    Financial Statements.

 

THE ROUSE COMPANY AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements (Unaudited), continued

 

Other income, net in the three and six months ended June 30, 2004 and 2003 is summarized as follows (in thousands):

 

 

 

Three months
ended June 30,

 

Six months
ended June 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

$

611

 

$

570

 

$

1,194

 

$

1,161

 

Dividends

 

22

 

22

 

52

 

46

 

Gains on trading securities, net

 

312

 

3,957

 

1,093

 

2,982

 

 

 

$

945

 

$

4,549

 

$

2,339

 

$

4,189

 

 

(e)           Revenue recognition and related matters

 

Minimum rent revenues are recognized on a straight-line basis over the terms of the leases.  Rents based on tenant sales are recognized when tenant sales exceed contractual thresholds.

 

Revenues related to variable recoveries from tenants of real estate taxes, utilities, maintenance, insurance and other expenses pursuant to leases are recognized in the period in which the related expenses are incurred. Fixed contributions from tenants related to these expenses are recognized when due.  Lease termination fees are recognized when the related agreements are executed.  Management fee revenues are calculated as a fixed percentage of revenues of the managed properties and are recognized as the managed properties’ revenues are earned.

 

Revenues from land sales are recognized using the full accrual method provided that various criteria relating to the terms of the transactions and any subsequent involvement by us with the land sold are met.  Revenues relating to transactions that do not meet the established criteria are deferred and recognized when the criteria are met or using the installment or cost recovery methods, as appropriate in the circumstances.  For land sale transactions under the terms of which we are required to perform additional services and incur significant costs after title has passed, revenues and cost of sales are recognized on a percentage of completion basis.

 

Cost of land sales is determined as a specified percentage of land sales revenues recognized for each community development project.  The cost ratios used are based on actual costs incurred and estimates of development costs and sales revenues to completion of each project.  The ratios are reviewed regularly and revised for changes in sales and cost estimates or development plans.  Significant changes in these estimates or development plans, whether due to changes in market conditions or other factors, could result in changes to the cost ratio used for a specific project.  The specific identification method is used to determine cost of sales for certain parcels of land, including acquired parcels we do not intend to develop or for which development is complete at the date of acquisition.

 

(f)            Derivative financial instruments

 

We use derivative financial instruments to reduce risk associated with movements in interest rates.  We may choose to reduce cash flow and earnings volatility associated with interest rate risk exposure on variable-rate borrowings and/or forecasted fixed-rate borrowings.  In some instances, lenders may require us to do so.  In order to limit interest rate risk on variable-rate borrowings, we may enter into pay fixed-receive variable interest rate swaps or interest rate caps to hedge specific risks.  In order to limit interest rate risk on forecasted borrowings, we may enter into forward-rate agreements, forward starting swaps, interest rate locks and interest rate collars. We may also enter into pay variable-receive fixed interest rate swaps to hedge the fair values of fixed-rate borrowings. In addition, we may use derivative financial instruments to reduce risk associated with movements in currency exchange rates if and when we are exposed to such risk.  We do not use derivative financial instruments for speculative purposes.

 

Under interest rate cap agreements, we make initial premium payments to the counterparties in exchange for the right to receive payments from them if interest rates exceed specified levels during the agreement period. Under interest rate swap agreements, we and the counterparties agree to exchange the difference between fixed-rate and variable-rate interest amounts calculated by reference to specified notional principal amounts during the agreement period.  Notional principal amounts are used to express the volume of these transactions, but the cash requirements and amounts subject to credit risk are substantially less.

 

9



 

Part I.      Financial Information

Item 1.    Financial Statements.

 

THE ROUSE COMPANY AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements (Unaudited), continued

 

Parties to interest rate exchange agreements are subject to market risk for changes in interest rates and risk of credit loss in the event of nonperformance by the counterparty.  We do not require any collateral under these agreements but deal only with highly rated financial institution counterparties (which, in certain cases, are also the lenders on the related debt) and expect that all counterparties will meet their obligations.

 

All of the pay fixed-receive variable interest rate swaps and other pay fixed-receive variable derivative financial instruments we used in 2004 and 2003 qualified as cash flow hedges and hedged our exposure to forecasted interest payments on variable-rate LIBOR-based debt or the forecasted issuance of fixed-rate debt.  Accordingly, the effective portion of the instruments’ gains or losses is reported as a component of other comprehensive income and reclassified into earnings when the related forecasted transactions affect earnings.  If we discontinue a cash flow hedge because it is probable that the original forecasted transaction will not occur, the net gain or loss in accumulated other comprehensive income is immediately reclassified into earnings.  If we discontinue a cash flow hedge because the variability of the probable forecasted transaction has been eliminated, the net gain or loss in accumulated other comprehensive income is reclassified to earnings over the term of the designated hedging relationship. Any subsequent changes in the fair value of the derivative are immediately recognized in earnings.

 

In 2004, we entered into pay variable-receive fixed interest rate swaps designated as fair value hedges of fixed-rate debt instruments.  These hedges and the hedged instruments are carried at their fair values with changes in their fair values recorded in earnings. Because the hedges are highly effective, the changes in their values are substantially equal and offsetting.

 

We have not recognized any losses as a result of hedge discontinuance, and the expense that we recognized related to changes in the time value of interest rate cap agreements was insignificant for 2004 and 2003.

 

Amounts receivable or payable under interest rate cap and swap agreements are accounted for as adjustments to interest expense on the related debt.

 

10



 

Part I.      Financial Information

Item 1.    Financial Statements.

 

THE ROUSE COMPANY AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements (Unaudited), continued

 

(g)          Stock-based compensation

 

We apply the intrinsic value-based method of accounting prescribed by Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations to account for stock-based employee compensation plans.  Under this method, compensation cost is recognized for awards of shares of common stock or stock options to our officers and employees only if the quoted market price of the stock at the grant date (or other measurement date, if later) is greater than the amount the grantee must pay to acquire the stock.  The following table summarizes the pro forma effects on net earnings (in thousands) and earnings per share of common stock of using the fair value-based method, rather than the intrinsic value-based method, to account for stock-based compensation awards made since 1995.

 

 

 

Three months
ended June 30,

 

Six months
ended June 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

 

 

 

 

 

 

 

 

 

 

Net earnings, as reported

 

$

61,239

 

$

138,092

 

$

128,353

 

$

162,232

 

 

 

 

 

 

 

 

 

 

 

Add: Stock-based employee compensation expense included in reported net earnings, net of related tax effects and amounts capitalized

 

735

 

1,259

 

1,668

 

3,095

 

 

 

 

 

 

 

 

 

 

 

Deduct: Total stock-based employee compensation expense determined under fair value-based method, net of related tax effects and amounts capitalized

 

(3,093

)

(2,418

)

(5,514

)

(5,754

)

Pro forma net earnings

 

$

58,881

 

$

136,933

 

$

124,507

 

$

159,573

 

 

 

 

 

 

 

 

 

 

 

Earnings per share of common stock:

 

 

 

 

 

 

 

 

 

Basic:

 

 

 

 

 

 

 

 

 

As reported

 

$

.60

 

$

1.54

 

$

1.28

 

$

1.79

 

Pro forma

 

$

.57

 

$

1.53

 

$

1.24

 

$

1.76

 

 

 

 

 

 

 

 

 

 

 

Diluted:

 

 

 

 

 

 

 

 

 

As reported

 

$

.58

 

$

1.50

 

$

1.24

 

$

1.75

 

Pro forma

 

$

.56

 

$

1.49

 

$

1.21

 

$

1.73

 

 

The per share weighted-average estimated fair values of options granted during 2004 and 2003 were $6.83 and $3.37, respectively.  These fair values were estimated on the dates of each grant using the Black-Scholes option-pricing model with the following assumptions:

 

 

 

Three months ended
June 30,

 

Six months ended
June 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

Risk-free interest rate

 

3.9

%

2.0

%

3.5

%

3.2

%

Dividend yield

 

4.5

%

4.5

%

4.0

%

5.4

%

Volatility factor

 

20.0

%

20.0

%

20.0

%

20.0

%

Expected life in years

 

5.4

 

4.0

 

6.4

 

6.5

 

 

11



 

Part I.      Financial Information

Item 1.    Financial Statements.

 

THE ROUSE COMPANY AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements (Unaudited), continued

 

(2)           TAX MATTERS

 

We elected to be taxed as a real estate investment trust (“REIT”) pursuant to the Internal Revenue Code of 1986, as amended, effective January 1, 1998.  We believe that we met the qualifications for REIT status as of June 30, 2004 and intend to meet the qualifications in the future.

 

A REIT is permitted to own securities of taxable REIT subsidiaries (“TRS”) in an amount up to 20% of the fair value of its assets.  TRS are taxable corporations that are used by REITs generally to engage in nonqualifying REIT activities or perform nonqualifying services.  We own and operate several TRS that are principally engaged in the development and sale of land for residential, commercial and other uses, primarily in and around Columbia, Maryland, Summerlin, Nevada and Houston, Texas.  The TRS also operate and/or own several retail centers and office and other properties.  Except with respect to the TRS, management does not believe that we will be liable for significant income taxes at the Federal level or in most of the states in which we operate in 2004 and future years. Current Federal income taxes of the TRS are likely to increase in future years as we exhaust the net loss carryforwards of certain TRS and complete certain land development projects.  These increases could be significant.

 

In connection with our election to be taxed as a REIT, we also elected to be subject to the “built-in gain” rules.  Under these rules, during the ten-year period following conversion, a corporate level tax will be payable, at the time and to the extent that the net unrealized gains on our assets at the date of our conversion to REIT status (January 1, 1998) are recognized in taxable dispositions of such assets.  Such net unrealized gains were approximately $2.5 billion on January 1, 1998.  We believe that we will not be required to make significant payments of taxes on built-in gains throughout the ten-year period due to the availability of our net operating loss carryforward to offset built-in gains which might be recognized and the potential for us to make nontaxable dispositions through like-kind exchanges, if necessary.  It may be necessary to recognize a liability for such taxes in the future if our plans and intentions with respect to our REIT asset dispositions or the related tax laws change.

 

Our net deferred tax assets were $81.0 million and our deferred tax liabilities were $112.0 million at June 30, 2004.  Our net deferred tax assets were $91.0 million and our deferred tax liabilities were $86.4 million at December 31, 2003.  Deferred income taxes will become payable as temporary differences reverse (primarily due to the completion of land development projects) and TRS net operating loss carryforwards are exhausted.

 

(3)           DISCONTINUED OPERATIONS

 

We may sell interests in retail centers that are not consistent with our long-term business strategies or not meeting our investment criteria and office and other properties that are not located in our master-planned communities or not part of urban mixed-use properties.  We may also dispose of properties for other reasons.

 

In May 2004, we agreed to sell our interests in two office buildings in Hunt Valley, Maryland. These sales are expected to settle by the end of 2004. We recorded aggregate impairment losses of $1.4 million in the fourth quarter of 2003 and $0.3 million in the second quarter of 2004 related to these properties. These properties are classified as held for sale at June 30, 2004.

 

In May 2004, we sold our interest in one office building in Hughes Center, a master-planned business park in Las Vegas, Nevada, as part of the 2003 agreements under which we acquired interests in entities developing The Woodlands, a master-planned community in the Houston, Texas metropolitan area, for cash of $7.0 million and the assumption by the buyer of $3.5 million of mortgage debt. We recorded a gain on this sale of $5.5 million. In January and February 2004, we sold interests in five office buildings and seven parcels subject to ground leases in Hughes Center as part of the same 2003 agreements, for cash of $64.3 million and the assumption by the buyer of $107.3 million of mortgage debt. We recorded aggregate gains on these sales in the first quarter of 2004 of approximately $35.3 million (net of deferred income taxes of $2.7 million). In December 2003, in related transactions, we sold interests in two office buildings and two parcels subject to ground leases in Hughes Center.

 

We also recorded, in the three months ended June 30, 2004, net gains of $2.8 million (net of deferred income taxes of $0.4 million) related to the resolutions of certain contingencies related to disposals of properties in 2002, 2003 and 2004.

 

12



 

Part I.      Financial Information

Item 1.    Financial Statements.

 

THE ROUSE COMPANY AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements (Unaudited), continued

 

In March 2004, we sold our interests in Westdale Mall, a retail center in Cedar Rapids, Iowa, for cash of $1.3 million and the assumption by the buyer of $20.0 million of mortgage debt. We recognized a gain of $0.8 million relating to this sale. We recorded an impairment loss of $6.5 million in the third quarter of 2003 related to this property.

 

In August 2003, we sold The Jacksonville Landing, a retail center in Jacksonville, Florida.

 

In May and June 2003, we sold eight office and industrial buildings in the Baltimore-Washington corridor for net proceeds of $46.6 million and recorded aggregate gains of $4.4 million.

 

In April and May 2003, we sold six retail centers in the Philadelphia metropolitan area and, in a related transaction, acquired Christiana Mall from a party related to the purchaser.  In connection with these transactions, we received net cash proceeds of $218.4 million, the purchaser assumed $276.6 million of property debt, and we assumed a participating mortgage secured by Christiana Mall.  We recognized aggregate gains of $65.4 million relating to the monetary portions of these transactions. We recorded an impairment loss of $38.8 million in the fourth quarter of 2002 related to one of the retail centers sold.

 

We also recorded a net gain of $26.9 million related to the extinguishment of debt secured by two of the properties sold in the Philadelphia metropolitan area when the lender released the mortgages for a cash payment by us of less than the aggregate carrying amount of the debt.

 

The operating results of the properties included in discontinued operations are summarized as follows (in thousands):

 

 

 

Three months
ended June 30,

 

Six months
ended June 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

599

 

$

24,884

 

$

3,604

 

$

65,220

 

Operating expenses, exclusive of depreciation and amortization

 

(294

)

(12,574

)

(1,490

)

(31,342

)

Interest expense

 

(11

)

(5,832

)

(737

)

(15,197

)

Depreciation and amortization

 

(84

)

(4,445

)

(979

)

(12,013

)

Other provisions and losses, net

 

 

26,896

 

 

26,896

 

Impairment losses on operating properties

 

(270

)

 

(270

)

 

Gains on dispositions of interests in operating properties, net

 

8,278

 

69,760

 

44,714

 

69,802

 

Income tax benefit (provision), primarily deferred

 

(55

)

(131

)

85

 

(153

)

Discontinued operations

 

$

8,163

 

$

98,558

 

$

44,927

 

$

103,213

 

 

(4)           UNCONSOLIDATED REAL ESTATE VENTURES

 

We own interests in unconsolidated real estate ventures that own and/or develop properties, including master-planned communities.  We use these ventures to limit our risk associated with individual properties and to reduce our capital requirements.  We may also contribute interests in properties we own to unconsolidated ventures for cash distributions and interests in the ventures to provide liquidity as an alternative to outright property sales.  We account for the majority of these ventures using the equity method because the ventures do not meet the definition of a variable interest entity and we have joint interest and control of these properties with our venture partners.  For those ventures where we own less than a 5% interest and have virtually no influence on the venture’s operating and financial policies, we account for our investments using the cost method.

 

At December 31, 2003, these ventures were primarily partnerships and corporations which own retail centers (most of which we manage) and ventures developing the master-planned communities known as The Woodlands, near Houston, Texas, and Fairwood, in Prince George’s County, Maryland. In January 2004, we acquired our partners’ interests in the joint venture that is developing Fairwood, increasing our ownership interest to 100%.  Prior to this transaction, we held a noncontrolling interest in this venture and accounted for our investment as an investment in unconsolidated real estate ventures. We consolidated the venture in our financial statements from the date of the acquisition.

 

In December 2003, we acquired a 50% interest in the retail and certain office components of Mizner Park, a mixed-use project in Boca Raton, Florida. In January 2004, we acquired a 50% interest in additional office components of Mizner Park.

 

13



 

Part I.      Financial Information

Item 1.    Financial Statements.

 

THE ROUSE COMPANY AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements (Unaudited), continued

 

In April 2004, we sold most of our interest in Westin New York, a hotel in New York City, for net proceeds of $15.8 million and recognized a gain of approximately $1.4 million (net of deferred income taxes of $0.8 million).

 

(5)           DEBT

 

Debt is summarized as follows (in thousands):

 

 

 

June 30, 2004

 

December 31, 2003

 

 

 

Total

 

Due in one
year

 

Total

 

Due in one
year

 

 

 

 

 

 

 

 

 

 

 

Mortgages and bonds

 

$

2,725,227

 

$

603,960

 

$

3,025,802

 

$

484,588

 

Medium-term notes

 

45,500

 

43,500

 

45,500

 

 

Credit facility borrowings

 

182,000

 

 

271,000

 

 

3.625% Notes due March 2009

 

378,999

 

 

 

 

8% Notes due April 2009

 

200,000

 

 

200,000

 

 

7.2% Notes due September 2012

 

399,579

 

 

399,553

 

 

5.375% Notes due November 2013

 

453,864

 

 

350,000

 

 

Other loans

 

179,747

 

64,762

 

152,637

 

32,147

 

Total

 

$

4,564,916

 

$

712,222

 

$

4,444,492

 

$

516,735

 

 

The amounts due in one year represent maturities under existing loan agreements, except where refinancing commitments from outside lenders have been obtained.  In these instances, maturities are determined based on the terms of the refinancing commitments.

 

We expect to repay the debt due in one year with operating cash flows, proceeds from property financings (including refinancings of maturing mortgages), credit facility borrowings, proceeds from corporate debt offerings or other available corporate funds.

 

During the first quarter of 2004, we repaid approximately $443 million of mortgage loans with proceeds from borrowings under our credit facility. In March 2004, we issued $400 million of 3.625% Notes due in March 2009 and $100 million of 5.375% Notes due in November 2013 for net proceeds of approximately $503 million. The proceeds were primarily used to repay credit facility borrowings.

 

At June 30, 2004 and December 31, 2003, approximately $82 million and $83 million, respectively, of our debt provided for payments of additional interest based on operating results of the related properties in excess of stated levels.  The participating debt primarily relates to a retail center where the lender receives a fixed interest rate of 7.625% and a 5% participation in cash flows.  The lender also will receive a payment at maturity (November 2004) equal to the greater of 5% of the value of the property in excess of the debt balance or the amount required to provide an internal rate of return of 8.375% over the term of the loan.  The internal rate of return of the lender is limited to 12.5%.  We recognize interest expense on this debt at a rate required to provide the lender the required minimum internal rate of return (8.375%) and monitor the accrued liability and the fair value of the projected payment due on maturity.  Based on our analysis, we believe that the payment at maturity will be the balance needed to provide the specified minimum internal rate of return.

 

At June 30, 2004, we had interest rate swap agreements and forward-starting swap agreements in place that effectively fix the LIBOR rate on a portion of our variable-rate debt through December 2006.  Information related to the in-place swap agreements as of June 30, 2004 is as follows (dollars in millions):

 

Total notional amount

 

$

564.4

 

Average fixed effective rate (pay rate)

 

2.1

%

Average variable interest rate of related debt (receive rate)

 

1.3

%

Fair values of assets

 

$

1.9

 

Fair values of liabilities

 

$

2.1

 

 

14



 

Part I.      Financial Information

Item 1.    Financial Statements.

 

THE ROUSE COMPANY AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements (Unaudited), continued

 

As discussed above, we issued $400 million of 3.625% Notes in March 2004. We simultaneously entered into agreements to effectively convert this fixed-rate debt to variable-rate debt for the term of these notes. Under these agreements, we receive a fixed rate of 3.625% and pay a variable rate based on the six-month LIBOR rate, set in arrears, plus an average spread of 19.375 basis points. The expected pay rate was 2.47% at June 30, 2004. The fair value of these agreements was a liability of $19.8 million at June 30, 2004.

 

(6)                     PENSION PLANS

 

We have a qualified defined benefit pension plan (“funded plan”) covering substantially all employees, and separate nonqualified unfunded defined benefit pension plans primarily covering participants in the funded plan whose defined benefits exceed the plan’s limits (“supplemental plan”).  In February 2003, our Board of Directors approved modifications to our funded plan and supplemental plan so that covered employees would not earn additional benefits for future services.  The curtailment of the funded and supplemental plans required us to immediately recognize substantially all unamortized prior service cost and unrecognized transition obligation and resulted in a curtailment loss of $10.2 million for the six months ended June 30, 2003.  We also incurred settlement losses of $2.9 million and $7.4 million for the six months ended June 30, 2004 and 2003, respectively, related to lump-sum distributions made primarily to employees retiring as a result of organizational changes and early retirement programs offered in 2003 and 2002 and a change in the senior management organizational structure in March 2003.  The lump-sum distributions were paid to participants primarily from assets of our funded plan, or with respect to the supplemental plan, from contributions made by us.

 

In February 2004, we adopted a proposal to terminate our funded and supplemental plans.  When we complete the terminations, we will be required to settle the obligations of the funded plan by paying accumulated benefits to eligible participants.  Depending on the market value of the assets of the funded plan and the relevant interest rates at the time of settlement, we may be required to make additional contributions to that plan, which could be significant if we do not terminate the plan in 2004.  At June 30, 2004, the funded plan had sufficient assets to settle its obligations without additional contributions by us.  At the time of settlement of the obligations of the funded plan, we will recognize any unrecognized losses associated with that plan.  At June 30, 2004, these unrecognized losses were approximately $26.5 million.  The unrecognized losses may change depending on interest rates and other factors if we do not terminate the plan in 2004.  We expect that a portion of these losses will be recognized prior to the final distribution of plan assets as plan participants retire or otherwise terminate employment in the normal course of business.  The review period for the Pension Benefit Guaranty Corporation has expired. We expect to settle all of the plan’s remaining obligations in the fourth quarter of 2004. In connection with the adoption of the proposal to terminate the plans, we transferred the assets of the funded plan to cash and cash equivalents to mitigate market risk during the period prior to distributions to participants.

 

Concurrent with the distribution of funded plan assets, we will terminate the supplemental plan by merger into our nonqualified supplemental defined contribution plan and expect to establish and fund an irrevocable trust for benefits earned under that plan and recognize settlement losses equal to any unrecognized loss at that date.  At June 30, 2004, these unrecognized losses were approximately $5.8 million and may change depending on interest rates and other factors if we do not terminate the pension plan in 2004.  The supplemental plan obligations were $17.7 million at June 30, 2004.

 

We have a qualified defined contribution plan and a nonqualified supplemental defined contribution plan available to substantially all employees.  In 2004 and 2003, we matched 100% of participating employees’ pre-tax contributions up to a maximum of 3% of eligible compensation and 50% of participating employees’ pre-tax contributions up to an additional maximum of 2% of eligible compensation.

 

In an action related to the curtailment of the funded and supplemental plans, we added new components to the defined contribution plans under which we either make or accrue discretionary contributions to the plans for all employees who were previously covered by the defined benefit pension plans.  Expenses related to these plans were $1.4 million and $2.8 million for the three and six months ended June 30, 2004, respectively, and $2.5 million and $3.4 million for the three and six months ended June 30, 2003, respectively.

 

15



 

Part I.      Financial Information

Item 1.    Financial Statements.

 

THE ROUSE COMPANY AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements (Unaudited), continued

 

The normal date for measurement of our pension plan obligations is December 31 of each year, unless more recent measurements of both plan assets and obligations are available, or if a significant event occurs, such as a plan amendment or curtailment, that would ordinarily call for such measurements.  In February 2004, we adopted a plan to terminate our funded and supplemental plans.  Due to the termination of the plans, we measured our benefit obligations as of March 31, 2004, including the impact of the termination.  Information relating to the obligations, assets and funded status of the plans at March 31, 2004 and December 31, 2003 is summarized as follows (dollars in thousands):

 

 

 

Pension Plans

 

Postretirement

 

 

 

Funded

 

Supplemental and Other

 

Plan

 

 

 

March 31,
2004

 

December 31,
2003

 

March 31,
2004

 

December 31,
2003

 

March 31,
2004

 

December 31,
2003

 

Projected benefit obligation at end of period

 

$

64,862

 

$

56,228

 

$

18,441

 

$

17,855

 

$

N/A

 

$

N/A

 

Accumulated benefit obligation at end of period

 

64,862

 

56,228

 

18,441

 

17,846

 

17,645

 

17,555

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Benefit obligations at end of period

 

$

64,862

 

$

56,228

 

$

18,441

 

$

17,855

 

$

17,645

 

$

17,555

 

Fair value of plan assets at end of period

 

65,304

 

65,339

 

 

 

 

 

Funded status

 

$

442

 

$

9,111

 

$

(18,441

)

$

(17,855

)

$

(17,645

)

$

(17,555

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted-average assumptions at period end:

 

 

 

 

 

 

 

 

 

 

 

 

 

Discount rate

 

5.12

%

6.00

%

5.16

%

6.00

%

6.00

%

6.00

%

Lump sum rate

 

5.12

 

6.00

 

5.16

 

6.00

 

 

 

Expected rate of return on plan assets

 

5.12

 

8.00

 

 

 

 

 

Rate of compensation increase

 

N/A

 

N/A

 

N/A

 

N/A

 

N/A

 

N/A

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted-average assumptions used to determine net periodic benefit cost:

 

 

 

 

 

 

 

 

 

 

 

 

 

Discount rate

 

6.00

%

6.50

%

6.00

%

6.50

%

6.00

%

6.50

%

Lump sum rate

 

6.00

 

6.00

 

6.00

 

6.00

 

 

 

Expected rate of return on plan assets

 

8.00

 

8.00

 

8.00

 

 

 

 

Rate of compensation increase

 

N/A

 

4.50

 

N/A

 

4.50

 

N/A

 

N/A

 

 

16



 

Part I.      Financial Information

Item 1.    Financial Statements.

 

THE ROUSE COMPANY AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements (Unaudited), continued

 

The assets of the funded plan historically consisted primarily of fixed income and marketable equity securities.  The primary investment objective for the funded plan had been to provide for growth of capital with a moderate level of volatility. In connection with the approval to terminate the plans, we transferred the assets of the funded plan to cash and cash equivalents to mitigate market risk during the period prior to distributions to participants.

 

The net pension cost includes the following components (in thousands):

 

 

 

Three months
ended June 30,

 

Six months
ended June 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

 

 

 

 

 

 

 

 

 

 

Service cost

 

$

 

$

(1

)

$

 

$

 

Interest cost on projected benefit obligations

 

1,044

 

1,179

 

2,121

 

2,587

 

Expected return on funded plan assets

 

(818

)

(1,154

)

(2,108

)

(2,433

)

Prior service cost recognized

 

6

 

8

 

15

 

388

 

Net actuarial loss recognized

 

401

 

634

 

779

 

1,462

 

Amortization of transition obligation

 

 

 

 

17

 

Net pension cost before special events

 

633

 

666

 

807

 

2,021

 

Special events:

 

 

 

 

 

 

 

 

 

Settlement losses

 

2,086

 

2,951

 

2,868

 

7,419

 

Curtailment loss

 

 

 

 

10,212

 

Net pension cost

 

$

2,719

 

$

3,617

 

$

3,675

 

$

19,652

 

 

The curtailment loss in 2003 and settlement losses for the three and six months ended June 30, 2004 and 2003 are included in other provisions and losses, net, in the condensed consolidated statements of operations.

 

The net postretirement benefit cost includes the following components (in thousands):

 

 

 

Three months
ended June 30,

 

Six months
ended June 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

 

 

 

 

 

 

 

 

 

 

Service cost

 

$

121

 

$

99

 

$

241

 

$

198

 

Interest cost on accumulated benefit obligations

 

255

 

259

 

509

 

516

 

Net actuarial loss recognized

 

35

 

28

 

71

 

56

 

Amortization of prior service cost

 

(61

)

(61

)

(121

)

(121

)

Net postretirement benefit cost

 

$

350

 

$

325

 

$

700

 

$

649

 

 

(7)           SEGMENT INFORMATION

 

We have five business segments: retail centers, office and other properties, community development, commercial development and corporate.  The retail centers segment includes the operation and management of regional shopping centers, downtown specialty marketplaces, the retail components of mixed-use projects and community retail centers.  The office and other properties segment includes the operation and management of office and industrial properties and the nonretail components of the mixed-use projects.  The community development segment includes the development and sale of land, primarily in large-scale, long-term community development projects in and around Columbia, Maryland, Summerlin, Nevada and Houston, Texas.  The commercial development segment includes the evaluation of all potential new development projects (including expansions of existing properties) and acquisition opportunities and the management of them through the development or acquisition process.  The corporate segment is responsible for shareholder and director services, financial management, strategic planning and certain other general and support functions.  Our business segments offer different products or services and are managed separately because each requires different operating strategies or management expertise.

 

17



 

Part I.      Financial Information

Item 1.    Financial Statements.

 

THE ROUSE COMPANY AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements (Unaudited), continued

 

The operating measure used to assess operating results for the business segments is Net Operating Income (“NOI”). Prior to April 1, 2004, we excluded certain expenses related to organizational changes and early retirement costs from our definition of NOI. Effective April 1, 2004, we revised our definition to include these amounts in our corporate segment. We made these reclassifications because these expenses are neither infrequent nor unusual and are becoming a normal cost of doing business. Prior to July 1, 2003, we included certain income taxes in our definition of NOI. Effective July 1, 2003, we revised our definition to exclude these amounts from NOI, affecting primarily the presentation of our community development activities.  We made this change because we now assess the operating results of our segments on a pre-tax basis and believe this revised measure better reflects the performance of the underlying assets.  Amounts for prior periods have been reclassified to conform to the current definition.

 

The accounting policies of the segments are the same as those used to prepare our condensed consolidated financial statements, except that:

 

                  we consolidate the venture developing the community of The Woodlands and reflect the other partner’s share of NOI as an operating expense rather than using the equity method;

 

                  we account for other real estate ventures in which we have joint interest and control and certain other minority interest ventures (“proportionate share ventures”) using the proportionate share method rather than the equity method;

 

                  we include our share of NOI less interest expense and ground rent expense of other unconsolidated minority interest ventures (“other ventures”) in revenues; and

 

                  we include discontinued operations and minority interests in NOI rather than presenting them separately.

 

These differences affect only the reported revenues and operating expenses of the segments and have no effect on our reported net earnings.

 

Operating results for the segments are summarized as follows (in thousands):

 

 

 

Retail
Centers

 

Office and
Other
Properties

 

Community
Development

 

Commercial
Development

 

Corporate

 

Total

 

Three months ended
June 30, 2004

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

219,109

 

$

59,566

 

$

124,963

 

$

 

$

 

$

403,638

 

Operating expenses

 

84,054

 

33,430

 

85,601

 

2,466

 

6,114

 

211,665

 

NOI

 

$

135,055

 

$

26,136

 

$

39,362

 

$

(2,466

)

$

(6,114

)

$

191,973

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended
June 30, 2003

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

206,821

 

$

50,370

 

$

88,452

 

$

 

$

 

$

345,643

 

Operating expenses

 

82,476

 

19,482

 

59,157

 

3,047

 

10,055

 

174,217

 

NOI

 

$

124,345

 

$

30,888

 

$

29,295

 

$

(3,047

)

$

(10,055

)

$

171,426

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Six months ended
June 30, 2004

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

424,788

 

$

119,943

 

$

256,053

 

$

 

$

 

$

800,784

 

Operating expenses

 

166,189

 

67,270

 

175,359

 

5,092

 

11,835

 

425,745

 

NOI

 

$

258,599

 

$

52,673

 

$

80,694

 

$

(5,092

)

$

(11,835

)

$

375,039

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Six months ended
June 30, 2003

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

423,178

 

$

100,217

 

$

158,927

 

$

 

$

 

$

682,322

 

Operating expenses

 

169,186

 

39,449

 

99,719

 

7,975

 

14,353

 

330,682

 

NOI

 

$

253,992

 

$

60,768

 

$

59,208

 

$

(7,975

)

$

(14,353

)

$

351,640

 

 

18



 

Part I.      Financial Information

Item 1.    Financial Statements.

 

THE ROUSE COMPANY AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements (Unaudited), continued

 

Segment operating expenses include provision for bad debts, losses (gains) on marketable securities classified as trading, net losses (gains) on sales of properties developed for sale and our partner’s share of NOI of the venture developing The Woodlands and exclude income taxes, ground rent expense, distributions on Parent Company-obligated mandatorily redeemable preferred securities and other subsidiary preferred stock and real estate depreciation and amortization.

 

Reconciliations of total revenues and operating expenses reported above to the related amounts in the condensed consolidated financial statements and of NOI reported above to earnings before net gains on dispositions of interests in operating properties and discontinued operations in the condensed consolidated financial statements are summarized as follows (in thousands):

 

 

 

Three months
ended June 30,

 

Six months
ended June 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

Revenues:

 

 

 

 

 

 

 

 

 

Total reported above

 

$

403,638

 

$

345,643

 

$

800,784

 

$

682,322

 

Our share of revenues of proportionate share and other ventures and revenues of The Woodlands community development venture

 

(83,743

)

(37,576

)

(156,836

)

(72,466

)

Revenues of discontinued operations

 

(599

)

(24,884

)

(3,604

)

(65,220

)

Other

 

 

37

 

 

87

 

Total in condensed consolidated financial statements

 

$

319,296

 

$

283,220

 

$

640,344

 

$

544,723

 

Operating expenses, exclusive of provision for bad debts, depreciation and amortization:

 

 

 

 

 

 

 

 

 

Total reported above

 

$

211,665

 

$

174,217

 

$

425,745

 

$

330,682

 

Our share of operating expenses of proportionate share ventures and operating expenses of The Woodlands community development venture and partner’s share of its NOI

 

(58,055

)

(12,637

)

(107,884

)

(25,256

)

Operating expenses of discontinued operations

 

(294

)

(12,082

)

(1,372

)

(30,102

)

Other

 

232

 

7,467

 

754

 

13,389

 

Total in condensed consolidated financial statements

 

$

153,548

 

$

156,965

 

$

317,243

 

$

288,713

 

 

 

 

 

 

 

 

 

 

 

Operating results:

 

 

 

 

 

 

 

 

 

NOI

 

$

191,973

 

$

171,426

 

$

375,039

 

$

351,640

 

Interest expense

 

(59,963

)

(52,931

)

(118,247

)

(109,678

)

NOI of discontinued operations

 

(305

)

(12,802

)

(2,232

)

(35,118

)

Depreciation and amortization

 

(48,521

)

(40,567

)

(96,346

)

(78,567

)

Other provisions and losses, net

 

(2,086

)

(8,631

)

(6,180

)

(19,757

)

Income taxes, primarily deferred

 

(20,498

)

(15,993

)

(39,114

)

(26,578

)

Our share of interest expense, ground rent expense, depreciation and amortization, other provisions and losses, net, income taxes and gains on operating properties of unconsolidated real estate ventures, net

 

(20,351

)

(18,158

)

(40,317

)

(32,929

)

Other

 

(1,269

)

(4,383

)

(3,065

)

(11,798

)

Earnings before net gains on dispositions of interests in operating properties and discontinued operations in condensed consolidated financial statements

 

$

38,980

 

$

17,961

 

$

69,538

 

$

37,215

 

 

19



 

Part I.                 Financial Information

Item 1.             Financial Statements.

 

THE ROUSE COMPANY AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements (Unaudited), continued

 

The assets by segment and the reconciliation of total segment assets to the total assets in the condensed consolidated financial statements are as follows (in thousands):

 

 

 

June 30,
2004

 

December 31,
2003

 

 

 

 

 

 

 

Retail centers

 

$

5,607,595

 

$

5,069,644

 

Office and other properties

 

1,054,129

 

1,165,599

 

Community development

 

833,199

 

835,525

 

Commercial development

 

143,255

 

114,439

 

Corporate

 

241,084

 

327,294

 

Total segment assets

 

7,879,262

 

7,512,501

 

Our share of assets of unconsolidated proportionate share ventures

 

(1,481,827

)

(1,464,329

)

Investments in and advances to unconsolidated proportionate share ventures

 

572,123

 

591,072

 

Total assets in condensed consolidated financial statements

 

$

6,969,558

 

$

6,639,244

 

 

Investments in and advances to unconsolidated real estate ventures, by segment, are summarized as follows (in thousands):

 

 

 

June 30,
2004

 

December 31,
2003

 

 

 

 

 

 

 

Retail centers

 

$

309,754

 

$

345,486

 

Office and other properties

 

158,738

 

158,360

 

Community development

 

119,271

 

144,021

 

Total

 

$

587,763

 

$

647,867

 

 

(8)                                 OTHER PROVISIONS AND LOSSES, NET

 

Other provisions and losses, net consist of the following (in thousands):

 

 

 

Three months
ended June 30,

 

Six months
ended June 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

 

 

 

 

 

 

 

 

 

 

Pension plan settlement losses (see note 6)

 

$

2,086

 

$

2,898

 

$

2,868

 

$

7,364

 

Pension plan curtailment loss (see note 6)

 

 

 

 

10,212

 

Net losses on early extinguishment of debt

 

 

5,733

 

3,312

 

5,727

 

Other, net

 

 

 

 

(3,546

)

Total

 

$

2,086

 

$

8,631

 

$

6,180

 

$

19,757

 

 

As discussed in note 6 above, we curtailed our defined benefit pension plans in the first quarter of 2003 and recognized a loss.

 

During the six months ended June 30, 2004, we recognized net losses of $3.3 million, primarily unamortized issuance costs, related to the extinguishment of debt not associated with discontinued operations prior to scheduled maturity and to the redemption of the Parent Company-obligated mandatorily redeemable securities. During the three and six months ended June 30, 2003, we recognized net losses of $5.7 million, primarily prepayment penalties related to the extinguishment of debt not associated with discontinued operations prior to scheduled maturity.

 

The other amount for the six months ended June 30, 2003 consists primarily of a fee of $3.8 million that we earned on the facilitation of a real estate transaction between two parties that are unrelated to us.

 

20



 

Part I.                 Financial Information

Item 1.             Financial Statements.

 

THE ROUSE COMPANY AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements (Unaudited), continued

 

(9)                                 NET GAINS ON DISPOSITIONS OF INTERESTS IN OPERATING PROPERTIES

 

Net gains on dispositions of interests in operating properties included in earnings from continuing operations are summarized as follows (in thousands):

 

 

 

Three months
ended June 30,

 

Six months
ended June 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

 

 

 

 

 

 

 

 

 

 

Regional retail centers

 

$

 

$

21,561

 

$

 

$

21,561

 

Office and other properties

 

14,096

 

 

14,096

 

 

Other

 

 

12

 

(208

)

243

 

Total

 

$

14,096

 

$

21,573

 

$

13,888

 

$

21,804

 

 

In 2000, we contributed our ownership interests in 37 buildings in two industrial parks to a joint venture in exchange for cash and a minority interest in the venture. We also guaranteed $44.0 million of indebtedness of the venture and, because of the nature of our continuing involvement in the venture, deferred gains of approximately $14.4 million. In June 2004, we redeemed our interest in the venture and terminated our guarantee of its indebtedness. Accordingly, we recognized the previously deferred gain, net of deferred income taxes of approximately $1.7 million.

 

In April 2004, we sold most of our interest in Westin New York, a hotel in New York City, for net proceeds of $15.8 million and recognized a gain of $1.4 million (net of deferred income taxes of $0.8 million).

 

In 2003, in a transaction related to the sale of retail centers in the Philadelphia metropolitan area (see note 3), we acquired Christiana Mall from a party related to the purchaser and assumed a participating mortgage secured by Christiana Mall.  The participating mortgage had a fair value of $160.9 million.  The holder of this mortgage had the right to receive $120 million in cash and participation in cash flows and the right to convert this participation feature into a 50% equity interest in Christiana Mall.  The holder exercised this right in June 2003.  We recorded a portion of the cost of Christiana Mall based on the historical cost of the properties we exchanged to acquire this property because a portion of the transaction was considered nonmonetary under EITF Issue 01-2, “Interpretations of APB Opinion No. 29.”  As a consequence, when we subsequently disposed of the 50% interest in the property, we recognized a gain of $21.6 million.

 

(10)                          PREFERRED STOCK

 

The shares of Series B Convertible Preferred stock had a liquidation preference of $50 per share and earned dividends at an annual rate of 6% of the liquidation preference.  At the option of the holders, each share of the Series B Convertible Preferred stock was convertible into shares of our common stock at a conversion price of $38.125 per share (equivalent to a conversion rate of approximately 1.311 shares of common stock for each share of Preferred stock).  The conversion price was subject to adjustment in certain circumstances such as stock dividends, stock splits, rights offerings, mergers and similar transactions.  In addition, these shares of Preferred stock were redeemable for shares of common stock at our option, subject to certain conditions related to the market price of our common stock. There were 4,047,555 shares of Preferred stock issued and outstanding at December 31, 2003. On January 7, 2004, we called for the redemption of all outstanding shares of the Series B Convertible Preferred stock pursuant to the terms of its issuance and established February 10, 2004 as the redemption date. In the first quarter of 2004, we issued 5,308,199 shares of common stock upon conversion or redemption of all of the outstanding shares of Series B Convertible Preferred stock.

 

21



 

Part I.                 Financial Information

Item 1.             Financial Statements.

 

THE ROUSE COMPANY AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements (Unaudited), continued

 

(11)                          EARNINGS PER SHARE

 

Information relating to the calculations of earnings per share (“EPS”) of common stock for the three months ended June 30, 2004 and 2003 is summarized as follows (in thousands):

 

 

 

2004

 

2003

 

 

 

Basic

 

Diluted

 

Basic

 

Diluted

 

 

 

 

 

 

 

 

 

 

 

Earnings from continuing operations

 

$

53,076

 

$

53,076

 

$

39,534

 

$

39,534

 

Dividends on unvested common stock awards and other

 

(164

)

(548

)

(165

)

(165

)

Dividends on Series B Convertible Preferred stock

 

 

 

(3,038

)

(3,038

)

Adjusted earnings from continuing operations used in EPS computation

 

$

52,912

 

$

52,528

 

$

36,331

 

$

36,331

 

 

 

 

 

 

 

 

 

 

 

Weighted-average shares outstanding

 

102,436

 

102,436

 

87,628

 

87,628

 

Dilutive securities:

 

 

 

 

 

 

 

 

 

Options, unvested common stock awards and other

 

 

1,883

 

 

2,296

 

Series B Convertible Preferred stock

 

 

 

 

 

Adjusted weighted-average shares used in EPS computation

 

102,436

 

104,319

 

87,628

 

89,924

 

 

Information relating to the calculations of earnings per share (“EPS”) of common stock for the six months ended June 30, 2004 and 2003 is summarized as follows (in thousands):

 

 

 

2004

 

2003

 

 

 

Basic

 

Diluted

 

Basic

 

Diluted

 

 

 

 

 

 

 

 

 

 

 

Earnings from continuing operations

 

$

83,426

 

$

83,426

 

$

59,019

 

$

59,019

 

Dividends on unvested common stock awards and other

 

(335

)

(335

)

(343

)

(343

)

Dividends on Series B Convertible Preferred stock

 

 

 

(6,076

)

(6,076

)

Adjusted earnings from continuing operations used in EPS computation

 

$

83,091

 

$

83,091

 

$

52,600

 

$

52,600

 

 

 

 

 

 

 

 

 

 

 

Weighted-average shares outstanding

 

100,191

 

100,191

 

87,180

 

87,180

 

Dilutive securities:

 

 

 

 

 

 

 

 

 

Options, unvested common stock awards and other

 

 

1,978

 

 

1,918

 

Series B Convertible Preferred stock

 

 

938

 

 

 

Adjusted weighted-average shares used in EPS computation

 

100,191

 

103,107

 

87,180

 

89,098

 

 

Effects of potentially dilutive securities are presented only in periods in which they are dilutive.

 

22



 

Part I.                 Financial Information

Item 1.             Financial Statements.

 

THE ROUSE COMPANY AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements (Unaudited), continued

 

(12)                          COMMITMENTS AND CONTINGENCIES

 

Other commitments and contingencies (that are not reflected in the condensed consolidated balance sheets) at June 30, 2004 and December 31, 2003 are summarized as follows (in millions):

 

 

 

June 30,
2004

 

December 31,
2003

 

Guarantee of debt of unconsolidated real estate ventures:

 

 

 

 

 

Village of Merrick Park

 

$

100.0

 

$

100.0

 

Hughes Airport-Cheyenne Centers

 

 

28.8

 

Construction contracts for properties in development:

 

 

 

 

 

Consolidated subsidiaries, primarily related to Fashion Show and The Shops at La Cantera

 

106.1

 

103.1

 

Our share of unconsolidated real estate ventures, primarily related to the Village of Merrick Park and the venture developing The Woodlands

 

14.6

 

9.5

 

Contract to purchase an interest in Mizner Park

 

 

18.0

 

Construction contracts for land development:

 

 

 

 

 

Consolidated subsidiaries, primarily Columbia and Summerlin operations

 

67.0

 

83.1

 

Our share of the unconsolidated venture developing The Woodlands

 

21.4

 

 

Our share of long-term ground lease obligations of unconsolidated real estate ventures

 

120.6

 

121.1

 

Bank letters of credit and other

 

16.1

 

14.9

 

 

 

$

445.8

 

$

478.5

 

 

We have guaranteed up to $100 million for the repayment of a mortgage loan of the unconsolidated real estate venture that owns the Village of Merrick Park.  The amount of the guarantee may be reduced or eliminated upon the achievement of certain lender requirements.  The fair value of the guarantee is not material. Additionally, venture partners have provided guarantees to us for their share (60%) of the loan guarantee.

 

We determined that several of our consolidated partnerships are limited-life entities.  We estimate the fair values of minority interests in these partnerships at June 30, 2004 aggregated approximately $54.4 million.  The aggregate carrying values of the minority interests were approximately $29.4 million at June 30, 2004.

 

We and certain of our subsidiaries are defendants in various litigation matters arising in the ordinary course of business, some of which involve claims for damages that are substantial in amount.  Some of these litigation matters are covered by insurance.  We are also aware of claims arising from disputes in the ordinary course of business.  We record provisions for litigation matters and other claims when we believe a loss is probable and can be reasonably estimated.  We continuously monitor these claims and adjust recorded liabilities as developments warrant.  We further believe that any losses we may suffer for litigation and other claims in excess of the recorded aggregate liabilities are not material.  Accordingly, in our opinion, adequate provision has been made for losses with respect to litigation matters and other claims, and the ultimate resolution of these matters is not likely to have a material effect on our consolidated financial position or results of operations.  Our assessment of the potential outcomes of these matters involves significant judgment and is subject to change based on future developments.

 

(13)                          SUBSEQUENT EVENTS

 

In August 2004, we agreed to purchase Oxmoor Center, a regional retail center in Louisville, Kentucky. We expect to assume mortgage debt with a face value of approximately $60 million and to pay $63 million in cash to the seller, using the proceeds of borrowings under our revolving credit facility and/or other borrowings. We expect this transaction, which is subject to lender consent and other customary closing conditions, to close in September 2004.

 

23



 

Part I.                 Financial Information

Item 1.             Financial Statements.

 

THE ROUSE COMPANY AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements (Unaudited), continued

 

(14)                          NEW FINANCIAL ACCOUNTING STANDARDS

 

In January 2003, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”).  FIN 46 addresses the consolidation of variable interest entities (“VIEs”) in which the equity investors lack one or more of the essential characteristics of a controlling financial interest or where the equity investment at risk is not sufficient for the entity to finance its activities without additional subordinated financial support.  In December 2003, the FASB issued Interpretation No. 46 (revised December 2003), “Consolidation of Variable Interest Entities” (“FIN 46R”).  FIN 46R or FIN 46 applies in the fourth quarter of 2003 to all special purpose entities (“SPEs”) and to VIEs formed after January 31, 2003 and in the first quarter of 2004 to all other VIEs.  Application of FIN 46 in 2003 and 2004 had no effect on our financial statements as we previously consolidated the SPE that issued our Parent Company-obligated mandatorily redeemable preferred securities and, at June 30, 2004, held no interests in other VIEs formed after January 31, 2003.  Full application of FIN 46R in 2004 did not have a material effect on our results of operations or financial condition.

 

24



 

Part I.                 Financial Information

Item 2.             Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

THE ROUSE COMPANY AND SUBSIDIARIES

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion and analysis covers any material changes in our financial condition since December 31, 2003 and any material changes in our results of operations for the three and six months ended June 30, 2004 as compared to the same period in 2003.  This discussion and analysis should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our 2003 Annual Report to Shareholders.

 

GENERAL

 

Through our subsidiaries and affiliates, we acquire, develop and manage a diversified portfolio of operating properties located throughout the United States and develop and sell land for residential, commercial and other uses, primarily in our master-planned communities.

 

We have three operating lines of business:

 

                  retail center operations;

 

                  mixed-use, office and industrial operations; and

 

                  community development and land sales.

 

We are one of the largest publicly traded real estate companies in the United States of America. We have been publicly traded since 1957 and began operating as a real estate investment trust (“REIT”) on January 1, 1998. We engage in our real estate business through subsidiaries and affiliates.

 

We elected to be taxed as a REIT pursuant to the Internal Revenue Code of 1986, as amended, effective January 1, 1998.  In general, a corporation that distributes at least 90% of its REIT taxable income to shareholders in any taxable year and complies with certain other requirements (relating primarily to the nature of its assets and the sources of its revenues) is not subject to Federal income taxation to the extent of the income which it distributes.  We believe that we met the qualifications for REIT status as of June 30, 2004 and intend to meet the qualifications in the future and to distribute at least 90% of our REIT taxable income (determined after taking into account any net operating loss deductions) to shareholders in 2004 and subsequent years.  In 2001, we elected to treat certain subsidiaries as Taxable REIT Subsidiaries (“TRS”), which are subject to Federal and state income taxes.  We conduct our community development activities in TRS.

 

We own most of our interests in our operating properties through The Rouse Company LP, which we refer to as the “operating partnership.”  One of our wholly owned subsidiaries is the sole general partner and another wholly owned subsidiary is the sole limited partner of the operating partnership.  We own interests in our master-planned communities, some operating properties and our management company (which manages operating properties not wholly owned by us) through TRS.  This operating partnership structure is designed to allow us to acquire properties in exchange for limited partnership interests in the operating partnership.  Using this structure, we could issue limited partnership interests of the operating partnership to persons transferring properties to us who wish to defer taxes on the transfers, and who want to receive a right to convert their limited partnership interests into shares of our common stock at a future date in a taxable transaction.  We have agreed with the lenders under some of our credit facilities that, when and if the operating partnership issues limited partnership interests to unrelated parties in exchange for properties or we transfer to the operating partnership all or substantially all of the properties not held by the operating partnership, the operating partnership will become jointly and severally liable for all of our obligations under those credit facilities.  Concurrently, we will cause the operating partnership to become jointly and severally liable for our obligations under all of our outstanding public debt.

 

25



 

Part I.                 Financial Information

Item 2.             Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

Revenues from our retail center, office, mixed-use and industrial operations are derived primarily from tenant rents.  Tenant leases in our retail centers generally provide for minimum rent, additional rent based on tenant sales in excess of stated levels and reimbursement of real estate taxes and other operating expenses.  Tenant leases in our office and other properties generally provide for minimum rent and reimbursement of real estate taxes and other operating expenses in excess of stated amounts.  The profitability of our retail centers depends primarily on occupancy and rent levels which, in turn, are affected by the profitability of the tenants.  Tenant profitability depends on a number of factors, including consumer spending, business and consumer confidence, competition and general economic conditions in the markets in which they and we operate.  The profitability of our office and other properties also depends on occupancy and rent levels and is affected by a number of factors, including tenants’ profitability and space needs due to growth or contraction in employment levels, business confidence and competition and general economic conditions in the markets in which they and we operate.

 

Revenues from our community development and land sales business are derived primarily from land sales to developers and homebuilders and participations with homebuilders in their sales of finished homes to homebuyers.  The profitability of our community development business is affected by demand for housing, mortgage interest rates, consumer confidence, and general economic conditions in the Baltimore-Washington, Las Vegas and Houston metropolitan areas.

 

Our strategies include improving the quality of our retail portfolio through acquisitions and development, expanding and diversifying our community development business and increasing the number of our operating properties unencumbered by mortgage debt.  Actions we have taken or plan to take to implement these strategies include the following:

 

                  Acquiring or developing premier retail properties and disposing of other retail properties as appropriate.  Since the early 1990’s, we have upgraded the quality of our portfolio of retail properties by acquiring interests in premier retail centers, expanding and improving our existing centers and disposing of properties that were not consistent with our long-term business strategies or not meeting our investment criteria.  We use an internal rating system based on sales volume, productivity, anchor performance, regional demographics, quality of tenancy and competitive position in the local market to evaluate each of our shopping centers.

 

                  Realigning our office and industrial portfolio by disposing of interests in buildings not located in our master-planned communities of Columbia, Maryland and Summerlin, Nevada, or not part of class “A” urban mixed-use projects.

 

                  Acquiring strategically located landholdings in and around major metropolitan areas in the United States.  During 2003, we purchased land for community development near Houston, Texas (which we have named “Bridgelands”) and an interest in The Woodlands, a master-planned community also near Houston. In 2004, we acquired our partners’ interests in a joint venture that is developing Fairwood, a master-planned community in Prince George’s County, Maryland, increasing our ownership interest to 100%. We intend to use our experience and resources to develop and sell finished lots or tracts, including infrastructure and amenities within our planned communities, in addition to undeveloped property, to housing developers.  We also intend to continue to sell finished and undeveloped lots to commercial developers and develop commercial properties ourselves.  In addition, we have increased the profitability of our community development business by implementing and increasing participations with builders in their sales of finished homes to homebuyers.

 

                  Increasing the number of our operating properties unencumbered by mortgage debt.  By doing so, we expect that we will be able to receive a higher senior unsecured debt credit rating. In June 2004, Standard & Poor’s Ratings Services announced that it was assigning a “positive” outlook to our unsecured debt rating and stated that “as additional high quality malls become unencumbered, the senior unsecured debt rating could be raised to BBB from BBB-.” We cannot make any assurances that such a change will occur. In the near term, we intend to refinance a portion of the Company’s maturing secured debt on an unsecured basis.  We also may use proceeds from dispositions of assets to reduce our overall leverage.  In the first six months of 2004, we used borrowings under our credit facility to repay approximately $442.9 million of debt secured by our operating properties and later repaid those borrowings using proceeds from the issuance of unsecured notes. In 2003, we repaid $215.4 million of debt secured by our operating properties using proceeds from the issuance of unsecured notes.

 

26



 

Part I.                 Financial Information

Item 2.             Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

Our strategies and our plans for the future are based on our beliefs that:

 

                  space in high-quality, dominant retail centers in densely populated, affluent areas will continue to be in demand by retailers and that these retail centers are better able to withstand difficult conditions in the overall economy and in the real estate and retail industries;

 

                  demand for housing in the metropolitan areas of Las Vegas, Houston and the Baltimore-Washington corridor will remain strong, particularly for housing in high-quality, master-planned communities; and

 

                  office and industrial properties will provide capacity for employment growth in our master-planned communities.

 

Operating Properties

 

Our primary business strategies relating to operating properties include (1) owning and operating premier properties – shopping centers and large-scale mixed-use projects in major markets across the United States and (2) owning and operating geographically concentrated office and industrial buildings, principally complementing community development activities.  In order to execute our strategies, with respect to operating properties, we evaluate opportunities to acquire or develop properties and to redevelop, expand and/or renovate properties in our portfolio.  We have made and plan to continue making substantial investments to acquire, develop and expand and/or renovate properties as follows:

 

                  In April 2003, we acquired Christiana Mall, a regional retail center in Newark, Delaware.  We subsequently conveyed a 50% interest in this property in June 2003 pursuant to the terms of a participating mortgage that we assumed in the acquisition.

 

                  In August 2003, we acquired the remaining interest in Staten Island Mall, a regional retail center in Staten Island, New York.

 

                  In December 2003, we acquired a 50% interest in the retail component and certain office components of Mizner Park, a mixed-use property in Boca Raton, Florida. In January 2004, we acquired a 50% interest in the remaining office components of Mizner Park.

 

                  In December 2003, we acquired certain office buildings and a 52.5% economic interest in entities (which we refer to as the “Woodlands Entities”) that own The Woodlands, a master-planned community in the Houston, Texas metropolitan area. In addition to developable land, we acquired interests in operating properties owned by the Woodlands Entities, including three golf course complexes, a resort conference center, a hotel, interests in seven office buildings and other assets.

 

                  In March 2004, we acquired Providence Place, a regional retail center in Providence, Rhode Island.

 

                  We are an investor in a consolidated joint venture that is developing The Shops at La Cantera, a regional retail center in San Antonio, Texas, expected to open in 2005.

 

                  We are developing a regional retail center in Miami-Dade County, Florida.

 

                  We are developing a regional retail center in Summerlin, Nevada.

 

27



 

Part I.                 Financial Information

Item 2.             Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

We continually assess whether properties in which we own interests are consistent with our business strategies. We have disposed of interests in more than 50 retail centers and numerous other properties since 1993 (at times using tax-deferred exchanges or joint ventures) and may continue to dispose of selected properties that are not meeting or are not considered to have the potential to continue to meet our investment criteria.  We may also dispose of interests in properties for other reasons.  We have disposed of interests in the following properties during 2003 and 2004:

 

                  In April and May 2003, we sold six retail centers in the Philadelphia metropolitan area (Cherry Hill Mall, Echelon Mall, Exton Square, Gallery at Market East, Moorestown Mall and Plymouth Meeting).

 

                  In May and June 2003, we sold eight office and industrial buildings in the Baltimore-Washington corridor.

 

                  In August 2003, we sold The Jacksonville Landing, a retail center in Jacksonville, Florida.

 

                  In December 2003, we sold our investment in Kravco Investments, L.P.

 

                  In December 2003 and January, February and May 2004, we disposed of interests in eight office properties and nine parcels subject to ground leases in Hughes Center, a master-planned business park in Las Vegas, Nevada, in connection with our acquisition of a 52.5% economic interest in The Woodlands.

 

                  In March 2004, we sold Westdale Mall, a retail center in Cedar Rapids, Iowa.

 

                  In April 2004, we sold most of our interest in Westin New York, a hotel in New York City.

 

Community Development

 

Our primary business strategy relating to community development is to expand and diversify this line of business and to develop and sell land in our planned communities in a manner that increases the value of the remaining land to be developed and sold and to provide current cash flows.  Our major land development projects include communities in and around Columbia, Maryland, Summerlin, Nevada, and Houston, Texas.  In addition, at December 31, 2003, we were an investor in an unconsolidated real estate venture that is developing Fairwood, a planned community in Prince George’s County, Maryland.  In January 2004, we acquired our partners’ interests in this joint venture, increasing our ownership interest to 100%.  With a view toward using our experience and diversifying and enhancing our community development business, we seek and evaluate opportunities to acquire new and/or existing community development projects.  In May 2003, we purchased approximately 8,060 acres of investment land and land to be held for development and sale in the Houston, Texas metropolitan area on which we intend to develop Bridgelands, a master-planned community.  We have also acquired a total of 947 acres of contiguous land in separate transactions executed in the second half of 2003 and early 2004. We expect to begin significant development activities at Bridgelands in 2004 and to begin selling this land in 2005.  In December 2003, we acquired a 52.5% economic interest in The Woodlands, an existing master-planned community in the Houston, Texas metropolitan area, which includes, among other assets, approximately 5,500 acres of saleable land.

 

We acquired Summerlin, our master-planned community in suburban Las Vegas, Nevada, in the acquisition of The Hughes Corporation (“Hughes”) in 1996.  In connection with the acquisition of Hughes, we entered into a Contingent Stock Agreement (“Contingent Stock Agreement”) for the benefit of the former Hughes owners or their successors (“beneficiaries”).  Under terms of the Contingent Stock Agreement, shares of Rouse common stock are issuable to the beneficiaries based on the appraised values of defined asset groups, including Summerlin, at specified termination dates to 2009 and/or cash flows from the development and/or sale of those assets prior to the termination dates.  We account for the beneficiaries’ share of earnings from the assets as an operating expense. We account for any distributions to the beneficiaries as of the termination dates related to assets we own as of the termination dates as additional investments in the related assets (that is, contingent consideration). At the time of acquisition of Hughes, we reserved 20 million shares of common stock for possible issuance under the Contingent Stock Agreement, of which 9,359,217 common shares remain reserved after giving effect to issuances under the Contingent Stock Agreement through June 30, 2004. The number of shares initially reserved was determined based on estimates made at the time of the acquisition. The actual number of shares issuable will be determined only from events occurring over the term of the Contingent Stock Agreement, including the values of the remaining assets on the termination dates, cash flows prior to the termination dates and the value of our common stock, and could substantially exceed the number of shares reserved.

 

28



 

Part I.                 Financial Information

Item 2.             Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

OPERATING RESULTS

 

The following discussion and analysis of operating results covers each of our business segments, as management believes that a segment analysis provides the most effective means of understanding our business.  It also provides information about other elements of the condensed consolidated statements of operations that are not included in the segment results.  You should refer to the condensed consolidated statements of operations and note 7 to the condensed consolidated financial statements when reading this discussion and analysis.

 

Comparisons of Net Operating Income and net earnings from one year to another are affected significantly by property acquisition, disposition and development activity. As discussed in more detail below, other factors that have contributed to our operating results in 2004 and 2003 include the following:

 

                  maintenance of high occupancy levels in retail properties;

 

                  higher rents on re-leased space;

 

                  strong demand for land in and around Columbia and Summerlin;

 

                  refinancings of project-related debt at lower interest rates;

 

                  repayments of debt;

 

                  redemption of Parent Company-obligated mandatorily redeemable securities;

 

                  cost reduction measures;

 

                  costs related to organizational changes; and

 

                  pension plan curtailment and settlement losses.

 

The operating measure used to assess operating results for the business segments is Net Operating Income (“NOI”).  We define NOI as segment revenues less segment operating expenses (including provision for bad debts, losses (gains) on marketable securities classified as trading, net losses (gains) on sales of properties developed for sale and our partner’s share of NOI of the venture developing The Woodlands, but excluding income taxes, ground rent expense, distributions on Parent Company-obligated mandatorily redeemable preferred securities and other subsidiary preferred stock and real estate depreciation and amortization).  Additionally, discontinued operations, equity in earnings of unconsolidated real estate ventures and minority interests are adjusted to reflect NOI on the same basis.  Prior to April 1, 2004, we excluded certain expenses related to organizational changes and early retirement costs from our definition of NOI. Effective April 1, 2004, we revised our definition to include these amounts in our corporate segment.  We made these reclassifications because these expenses are neither infrequent nor unusual and are becoming a normal cost of doing business.  Prior to July 1, 2003, we included certain income taxes in our definition of NOI. Effective July 1, 2003, we revised our definition to exclude these amounts from NOI, affecting primarily the presentation of our community development activities.  We made this change because we now assess the operating results of our segments on a pre-tax basis and believe this revised measure better reflects the performance of the underlying assets.  Amounts for prior periods have been reclassified and conform to the current definition.

 

The accounting policies of the segments are the same as those used to prepare our condensed consolidated financial statements, except that:

 

                  we consolidate the venture developing the community of The Woodlands and reflect the other partner’s share of NOI as an operating expense rather than using the equity method;

 

                  we account for other real estate ventures in which we have joint interest and control and certain other minority interest ventures (“proportionate share ventures”) using the proportionate share method rather than the equity method;

 

                  we include our share of NOI less interest expense and ground rent expense of other unconsolidated minority interest ventures (“other ventures”) in revenues; and

 

                  we include discontinued operations and minority interests in NOI rather than presenting separately.

 

These differences affect only the reported revenues and operating expenses of the segments and have no effect on our reported net earnings.

 

29



 

Part I.                 Financial Information

Item 2.             Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

Operating results for the segments are summarized as follows (in millions):

 

 

 

Retail
Centers

 

Office and
Other
Properties

 

Community
Development

 

Commercial
Development

 

Corporate

 

Total

 

Three months ended
June 30, 2004

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

219.1

 

$

59.5

 

$

125.0

 

$

 

$

 

$

403.6

 

Operating expenses

 

84.0

 

33.4

 

85.6

 

2.5

 

6.1

 

211.6

 

NOI

 

$

135.1

 

$

26.1

 

$

39.4

 

$

(2.5

)

$

(6.1

)

$

192.0

 

Three months ended
June 30, 2003

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

206.9

 

$

50.3

 

$

88.4

 

$

 

$

 

$

345.6

 

Operating expenses

 

82.5

 

19.4

 

59.1

 

3.1

 

10.1

 

174.2

 

NOI

 

$

124.4

 

$

30.9

 

$

29.3

 

$

(3.1

)

$

(10.1

)

$

171.4

 

Six months ended
June 30, 2004

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

424.8

 

$

119.9

 

$

256.1

 

$

 

$

 

$

800.8

 

Operating expenses

 

166.2

 

67.3

 

175.4

 

5.1

 

11.8

 

425.8

 

NOI

 

$

258.6

 

$

52.6

 

$

80.7

 

$

(5.1

)

(11.8

)

$

375.0

 

Six months ended
June 30, 2003

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

423.2

 

$

100.2

 

$

158.9

 

$

 

$

 

$

682.3

 

Operating expenses

 

169.2

 

39.4

 

99.7

 

8.0

 

14.4

 

330.7

 

NOI

 

$

254.0

 

$

60.8

 

$

59.2

 

$

(8.0

)

$

(14.4

)

$

351.6

 

 

Note:

 

Segment operating expenses include provision for bad debts, losses (gains) on marketable securities classified as trading, net losses (gains) on sales of properties developed for sale and our partner’s share of NOI of the venture developing The Woodlands and exclude income taxes, ground rent expense, distributions on Parent Company-obligated mandatorily redeemable preferred securities and other subsidiary preferred stock and real estate depreciation and amortization.

 

30



 

Part I.                 Financial Information

Item 2.             Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

Reconciliations of total revenues and operating expenses reported above to the related amounts in the condensed consolidated financial statements and of NOI reported above to earnings before net gains on dispositions of interests in operating properties and discontinued operations in the condensed consolidated financial statements are summarized as follows (in millions):

 

 

 

Three months
ended June 30,

 

Six months
ended June 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

Revenues:

 

 

 

 

 

 

 

 

 

Total reported above

 

$

403.6

 

$

345.6

 

$

800.8

 

$

682.3

 

Our share of revenues of proportionate share and other ventures and revenues of The Woodlands community development venture

 

(83.7

)

(37.6

)

(156.9

)

(72.5

)

Revenues of discontinued operations

 

(0.6

)

(24.9

)

(3.6

)

(65.2

)

Other

 

 

0.1

 

 

0.1

 

Total in condensed consolidated financial statements

 

$

319.3

 

$

283.2

 

$

640.3

 

$

544.7

 

Operating expenses, exclusive of provision for bad debts,  depreciation and amortization:

 

 

 

 

 

 

 

 

 

Total reported above

 

$

211.6

 

$

174.2

 

$

425.8

 

$

330.7

 

Our share of operating expenses of proportionate share ventures and operating expenses of The Woodlands community development venture and partner’s share of its NOI

 

(58.1

)

(12.7

)

(107.9

)

(25.3

)

Operating expenses of discontinued operations

 

(0.3

)

(12.1

)

(1.4

)

(30.1

)

Other

 

0.3

 

7.6

 

0.7

 

13.4

 

Total in condensed consolidated financial statements

 

$

153.5

 

$

157.0

 

$

317.2

 

$

288.7

 

Operating results:

 

 

 

 

 

 

 

 

 

NOI reported above

 

$

192.0

 

$

171.4

 

$

375.0

 

$

351.6

 

Interest expense

 

(60.0

)

(53.0

)

(118.3

)

(109.7

)

NOI of discontinued operations

 

(0.3

)

(12.8

)

(2.3

)

(35.1

)

Depreciation and amortization

 

(48.5

)

(40.5

)

(96.3

)

(78.6

)

Other provisions and losses, net

 

(2.1

)

(8.6

)

(6.2

)

(19.8

)

Income taxes, primarily deferred

 

(20.5

)

(16.0

)

(39.1

)

(26.6

)

Our share of interest expense, ground rent expense,  depreciation and amortization, other provisions and losses, net, income taxes and gains on operating properties of unconsolidated real estate ventures, net

 

(20.4

)

(18.1

)

(40.3

)

(32.9

)

Other

 

(1.2

)

(4.4

)

(3.0

)

(11.7

)

Earnings before net gains on dispositions of interests in operating properties and discontinued operations in condensed consolidated financial statements

 

$

39.0

 

$

18.0

 

$

69.5

 

$

37.2

 

 

The reasons for significant changes in revenues and expenses comprising NOI are discussed below in the Business Segment Information section of this Management’s Discussion and Analysis.

 

31



 

Part I.                 Financial Information

Item 2.             Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

Business Segment Information

 

Operating Properties:

 

We report the results of our operating properties in two segments:  (1) retail centers and (2) office and other properties.  Our tenant leases provide the foundation for the performance of our operating properties.  In addition to minimum rents, the majority of retail and office tenant leases provide for other rents which reimburse us for certain operating expenses.  Substantially all of our retail leases also provide for additional rent (percentage rent) based on tenant sales in excess of stated levels.  As leases expire, space is re-leased, minimum rents are adjusted to market rates, expense reimbursement provisions are updated and new percentage rent levels are established for retail leases. Expense reimbursement provisions in our retail leases have historically required tenants to pay their variable shares of a property’s operating costs. We have begun revising the expense reimbursement provisions so that tenants continue to pay their shares of a property’s real estate tax and utility expenses while paying stated rates for all other operating expenses.  The stated rate increases annually based on negotiated amounts or the consumer price index.  We believe this new approach to tenant reimbursements will simplify lease negotiations, facilitate collections and, over the longer-term, allow us to reduce our lease administration costs.

 

Some portions of our discussion and analysis focus on “comparable” properties.  Comparable properties exclude those that have been acquired or disposed of, newly developed or undergone significant expansion in either of the two periods being compared and exclude South Street Seaport. South Street Seaport is a retail center in lower Manhattan that we own and operate. We do not consider South Street Seaport as a comparable property because, with its location near the World Trade Center site, it continues to be significantly affected by lower pedestrian and other traffic and other commercial activity in the area.

 

Retail Centers:

 

Operating results of retail centers are summarized as follows (in millions):

 

 

 

Three months
ended June 30,

 

Six months
ended June 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

219.1

 

$

206.9

 

$

424.8

 

$

423.2

 

Operating expenses

 

84.0

 

82.5

 

166.2

 

169.2

 

NOI

 

$

135.1

 

$

124.4

 

$

258.6

 

$

254.0

 

 

The changes in segment revenues for the three and six months ended June 30, 2004, respectively, compared to the same periods in 2003 are summarized as follows (in millions):

 

 

 

Three months
ended June 30, 2004

 

Six months
ended June 30, 2004

 

 

 

 

 

 

 

Decrease due to dispositions of interests in operating properties

 

$

(15.3

)

$

(44.6

)

Receipt of business interruption insurance claim at South Street Seaport in 2003

 

 

(1.5

)

Increase due to acquisitions of interests in properties

 

22.7

 

38.3

 

Increase due to openings of expansions and new development(1)

 

3.8

 

7.9

 

Other(2)

 

1.0

 

1.5

 

Net increase

 

$

12.2

 

$

1.6

 

 


(1)          2003 openings of the second phase of Fashion Show expansion and additional components of the Village of Merrick Park.

 

(2)          Attributable to higher rents on re-leased space and change in occupancy at comparable retail centers. Our comparable retail centers had average occupancy levels of approximately 92.3% and 92.8% during the six months ended June 30, 2004 and 2003, respectively.

 

32



 

Part I.                 Financial Information

Item 2.             Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

The changes in segment operating expenses for the three and six months ended June 30, 2004, respectively, compared to the same periods in 2003 are summarized as follows (in millions):

 

 

 

Three months
ended June 30, 2004

 

Six months
ended June 30, 2004

 

 

 

 

 

 

 

Decrease due to dispositions of interests in operating properties

 

$

(8.2

)

$

(22.2

)

Increase due to acquisitions of interests in properties

 

9.6

 

16.6

 

Increase due to openings of expansions and new development(1)

 

1.7

 

3.6

 

Other

 

(1.6

)

(1.0

)

Net increase (decrease)

 

$

1.5

 

$

(3.0

)

 


(1)          2003 openings of the second phase of Fashion Show expansion and additional components of the Village of Merrick Park.

 

In summary, the changes in NOI for the three and six months ended June 30, 2004, respectively, compared to the same periods in 2003 were attributable primarily to (in millions):

 

 

 

Three months
ended June 30, 2004

 

Six months
ended June 30, 2004

 

 

 

 

 

 

 

Decrease due to dispositions of interests in operating properties

 

$

(7.1

)

$

(22.4

)

Receipt of business interruption insurance claim at South Street Seaport in 2003

 

 

(1.5

)

Increase due to acquisitions of interests in properties

 

13.1

 

21.7

 

Increase due to openings of expansions and new development

 

2.1

 

4.3

 

Other

 

2.6

 

2.5

 

Net increase

 

$

10.7

 

$

4.6

 

 

We believe that the ability to increase rents and maintain high average occupancy levels at our comparable retail centers in spite of difficult economic conditions is indicative of the high demand that retailers have for our space.

 

We anticipate growth in NOI from retail centers in 2004, as we expect to benefit from the 2003 acquisitions of interests in Christiana Mall, Staten Island Mall and Mizner Park, the 2004 acquisition of Providence Place and the 2003 and 2004 openings of additional space at Fashion Show and additional components of the Village of Merrick Park.  Additionally, we expect to maintain high occupancy levels in our comparable retail properties and to achieve higher rents on re-leased space because of the high quality of our retail centers and the demand that retailers have for space in them.  These increases will be partially offset by the NOI of the properties we disposed of in 2003 and 2004.

 

Office and Other Properties:

 

Operating results of office and other properties are summarized as follows (in millions):

 

 

 

Three months
ended June 30,

 

Six months
ended June 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

59.5

 

$

50.3

 

$

119.9

 

$

100.2

 

Operating expenses

 

33.4

 

19.4

 

67.3

 

39.4

 

NOI

 

$

26.1

 

$

30.9

 

$

52.6

 

$

60.8

 

 

33



 

Part I.                 Financial Information

Item 2.             Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

The changes in segment revenues for the three and six months ended June 30, 2004, respectively, compared to the same periods in 2003 are summarized as follows (in millions):

 

 

 

Three months
ended June 30, 2004

 

Six months
ended June 30, 2004

 

 

 

 

 

 

 

Increase due to acquisitions of interests in properties(1)

 

$

19.6

 

$

38.1

 

Decrease due to dispositions of interests in operating properties

 

(10.2

)

(18.0

)

Other(2)

 

(0.2

)

(0.4

)

Net increase

 

$

9.2

 

$

19.7

 

 


(1)          Includes acquisition of interests in office facilities at Mizner Park and the office, hotel and conference facilities owned by the Woodlands Entities.

 

(2)          Includes effect of lower average occupancy levels at comparable office and other properties. Our comparable office and other properties had average occupancy levels of approximately 84.9% and 87.1% during the six months ended June 30, 2004 and 2003, respectively.

 

The changes in segment operating expenses for the three and six months ended June 30, 2004, respectively, compared to the same periods in 2003 are summarized as follows (in millions):

 

 

 

Three months
ended June 30, 2004

 

Six months
ended June 30, 2004

 

 

 

 

 

 

 

Increase due to acquisitions of interests in properties(1)

 

$

17.3

 

$

34.0

 

Decrease due to dispositions of interests in operating properties

 

(3.7

)

(6.5

)

Other

 

0.4

 

0.4

 

Net increase

 

$

14.0

 

$

27.9

 

 


(1)          Includes acquisition of interests in office facilities at Mizner Park and the office, hotel and conference facilities owned by the Woodlands Entities.

 

In summary, the changes in NOI for the three and six months ended June 30, 2004, respectively, compared to the same periods in 2003 were attributable primarily to (in millions):

 

 

 

Three months
ended June 30, 2004

 

Six months
ended June 30, 2004

 

 

 

 

 

 

 

Increase due to acquisitions of interests in properties

 

$

2.3

 

$

4.1

 

Decrease due to dispositions of interests in operating properties

 

(6.5

)

(11.5

)

Other

 

(0.6

)

(0.8

)

Net decrease

 

$

(4.8

)

$

(8.2

)

 

Difficult general economic conditions and weakening office demand led to higher vacancy rates in our office portfolio.  We expect NOI from our office and other properties segment to decline in 2004 due to the disposal of properties in 2004 and 2003, as well as what we believe is a continuing national trend of weakened demand for office space.

 

Community Development:
 

Community development operations relate to the communities of Summerlin, Nevada; Columbia, Emerson and Stone Lake in Howard County, Maryland; Fairwood in Prince George’s County, Maryland; and The Woodlands in Houston, Texas.  We have also acquired developable land in the Houston, Texas metropolitan area (which we call “Bridgelands”) and expect to begin significant development activities at the Bridgelands in 2004 and to begin selling this land in 2005.  We refer to the Maryland properties as our Columbia-based operations.

 

34



 

Part I.                 Financial Information

Item 2.             Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

Revenues and operating income from land sales are affected by such factors as the availability to purchasers of construction and permanent mortgage financing at acceptable interest rates, consumer and business confidence, regional economic conditions in the Baltimore-Washington, Las Vegas and Houston metropolitan areas, levels of homebuilder inventory, availability of saleable land for particular uses and our decisions to sell, develop or retain land.  We believe that land sales in 2004 and 2003 benefited from strong housing demand, low interest rates, availability of mortgage financing and growing consumer confidence.  Should interest rates increase significantly or consumer confidence decline, land sales may be adversely affected.  Revenues for community development include land sales to developers and participations with builders in their sales of finished homes to homebuyers.

 

Operating results of community development are summarized as follows (in millions):

 

 

 

Three months
ended June 30,

 

Six months
ended June 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

Nevada-based Operations:

 

 

 

 

 

 

 

 

 

Revenues:

 

 

 

 

 

 

 

 

 

Summerlin

 

$

79.4

 

$

85.2

 

$

124.0

 

$

133.3

 

Other

 

0.7

 

0.2

 

36.1

 

0.5

 

Operating costs and expenses:

 

 

 

 

 

 

 

 

 

Summerlin

 

49.2

 

56.8

 

76.5

 

89.6

 

Other

 

0.4

 

0.8

 

29.9

 

1.0

 

NOI

 

$

30.5

 

$

27.8

 

$

53.7

 

$

43.2

 

Columbia-based Operations:

 

 

 

 

 

 

 

 

 

Revenues

 

$

16.1

 

$

3.0

 

$

45.0

 

$

25.1

 

Operating costs and expenses

 

8.1

 

1.5

 

19.0

 

9.1

 

NOI

 

$

8.0

 

$

1.5

 

$

26.0

 

$

16.0

 

Houston Operations:

 

 

 

 

 

 

 

 

 

Revenues

 

$

28.8

 

$

 

$

51.0

 

$

 

Operating costs and expenses

 

27.9

 

 

50.0

 

 

NOI

 

$

0.9

 

$

 

$

1.0

 

$

 

Total:

 

 

 

 

 

 

 

 

 

Revenues

 

$

125.0

 

$

88.4

 

$

256.1

 

$

158.9

 

Operating costs and expenses

 

85.6

 

59.1

 

175.4

 

99.7

 

NOI

 

$

39.4

 

$

29.3

 

$

80.7

 

$

59.2

 

 

 

 

 

 

 

 

 

 

 

Operating Margins (NOI divided by Revenues):

 

 

 

 

 

 

 

 

 

Summerlin

 

38.0

%

33.3

%

38.3

%

32.8

%

Columbia

 

49.7

 

50.0

 

57.8

 

63.7

 

 

Revenues from Summerlin operations decreased $5.8 million and NOI increased $1.8 million for the three months ended June 30, 2004 compared to the same period in 2003. Revenues from Summerlin operations decreased $9.3 million and NOI increased $3.8 million for the six months ended June 30, 2004 compared to the same period in 2003. The decreases in revenues are attributable primarily to fewer acres sold in 2004, partially offset by higher pricing and participation in homebuilders’ sales of finished homes. The increases in NOI are attributable primarily to higher participation in sales of finished homes and to higher margins on land sold for residential and commercial purposes. The increase in operating margins was due primarily to the effects of higher pricing resulting from high demand and the limited availability of land for similar uses in the area.

 

Revenues from other Nevada-based operations increased $0.5 million and NOI increased $0.9 million for the three months ended June 30, 2004 compared to the same period in 2003. Revenues from other Nevada-based operations increased $35.6 million and NOI increased $6.7 million for the six months ended June 30, 2004 compared to the same period in 2003. These changes were attributable primarily to the sale of substantially all remaining investment land at Hughes Center in Las Vegas and in California.

 

35



 

Part I.                 Financial Information

Item 2.             Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

Revenues from Columbia-based operations increased $13.1 million and NOI increased $6.5 million for the three months ended June 30, 2004 compared to the same period in 2003. Revenues from Columbia-based operations increased $19.9 million and NOI increased $10.0 million for the six months ended June 30, 2004 compared to the same period in 2003. These increases were attributable to increased residential land sales and higher land prices in our Howard County communities and land sales in Fairwood, in which we acquired our partners’ interests in January 2004. The declines in operating margins were due primarily to the higher levels of sales in Fairwood. Margins in Fairwood are lower than those in other Columbia-based communities, primarily because we recently acquired our partners’ interests in the project.

 

Revenues and NOI from Houston operations relate to community development activities at The Woodlands, in which we acquired an interest on December 31, 2003. Most of the land sold in The Woodlands was completely developed at the date we acquired our interest in The Woodlands. As we allocated our purchase price to the assets of The Woodlands based on their fair values, we recognized little profit on this land. We expect margins to improve as land values appreciate and as additional land is developed and sold.

 

We expect the results of community development to remain strong in 2004, assuming continued favorable market conditions in the Las Vegas, Howard County and Prince George’s County regions.  We also expect to continue to benefit from our 2003 acquisition of an interest in The Woodlands and our 2004 acquisition of our partners’ interests in Fairwood.

 

Commercial Development:
 

Commercial development expenses were $2.5 million and $5.1 million in the three and six months ended June 30, 2004, respectively, and $3.1 million and $8.0 million in the three and six months ended June 30, 2003, respectively. These costs consist primarily of new business expenses and preconstruction expenses.

 

New business expenses relate primarily to acquisition activities (evaluation of acquisition opportunities and transaction closings), feasibility studies of development opportunities and disposition activities.  These expenses were $2.4 million and $4.9 million in the three and six months ended June 30, 2004 and $2.8 million and $6.0 million in the three and six months ended June 30, 2003. New business expenses decreased in 2004 primarily as a result of lower levels of acquisition and disposition activities.

 

Preconstruction expenses relate to retail and office and other property development opportunities which may not go forward to completion.  Preconstruction expenses were $0.1 million and $0.2 million in the three and six months ended June 30, 2004 and $0.2 million and $1.9 million in the three and six months ended June 30, 2003.  The lower level of expenses in 2004 was attributable primarily to lower costs for retail project opportunities which may not go forward to completion.

 

Corporate:
 

Corporate operating expenses consist of costs associated with Company-wide activities which include shareholder relations, the Board of Directors, financial management, organizational changes, strategic planning and equity in operating results of miscellaneous corporate investments.

 

Corporate operating expenses were $6.1 million and $11.8 million in the three and six months ended June 30, 2004 and $10.1 million and $14.4 million in the three and six months ended June 30, 2003. The decreases in 2004 were primarily attributable to lower provisions for organizational changes and early retirement costs. The provision for organizational changes and early retirement costs in 2003 related to costs incurred to reduce the size of our workforce and the retirement of a member of executive management in March 2003 and consisted primarily of termination benefits.

 

36



 

Part I.                 Financial Information

Item 2.             Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

Other Operating Information

 

Continuing operations

 

Interest:

 

Interest expense increased $7.0 million and $8.6 million for the three and six months ended June 30, 2004 compared to the same periods in 2003.  These increases were attributable primarily to interest costs on debt issued and assumed related to acquisitions in 2003 and 2004.

 

Depreciation and amortization:
 

Depreciation and amortization expense increased $8.0 million and $17.7 million in the three and six months ended June 30, 2004, compared to the same periods in 2003.  These increases were attributable primarily to property acquisitions in 2004 and 2003 and the opening of the second phase of Fashion Show expansion in 2003.

 

Other provisions and losses, net:
 

The other provisions and losses, net are summarized as follows (in millions):

 

 

 

Three months
ended June 30,

 

Six months
ended June 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

 

 

 

 

 

 

 

 

 

 

Pension plan settlement losses

 

$

2.1

 

$

2.9

 

$

2.9

 

$

7.4

 

Pension plan curtailment loss

 

 

 

 

10.2

 

Net losses on early extinguishment of debt

 

 

5.7

 

3.3

 

5.7

 

Other, net

 

 

 

 

(3.5

)

 

 

$

2.1

 

$

8.6

 

$

6.2

 

$

19.8

 

 

In February 2003, our Board of Directors approved modifications to certain of our defined benefit pension plans so that covered employees would not earn additional benefits for future services.  The curtailment of the plans required us to immediately recognize substantially all unamortized prior service cost and unrecognized transition obligation and resulted in a curtailment loss of $10.2 million for the six months ended June 30, 2003.  We also incurred settlement losses of $2.1 million and $2.9 million for the three and six months ended June 30, 2004 and $2.9 million and $7.4 million for the three and six months ended June 30, 2003, respectively, related to lump-sum distributions made primarily to employees retiring as a result of organizational changes and early retirement programs offered in 2003 and 2002 and a change in the senior management organizational structure in March 2003.

 

In February 2004, we adopted a proposal to terminate our funded and supplemental plans.  When we complete the terminations, we will be required to settle the obligations of the funded plan by paying accumulated benefits to eligible participants.  Depending on the market value of the assets of the funded plan and the relevant interest rates at the time of settlement, we may be required to make additional contributions to that plan, which could be significant if we do not terminate the plan in 2004.  At June 30, 2004, the funded plan had sufficient assets to settle its obligations without additional contributions by us.  At the time of settlement of the obligations of the funded plan, we will recognize any unrecognized losses associated with that plan.  At June 30, 2004, these unrecognized losses were approximately $26.5 million.  The unrecognized losses may change depending on interest rates and other factors if we do not terminate the plan in 2004.  We expect that a portion of these losses will be recognized prior to the final distribution of plan assets as plan participants retire or otherwise terminate employment in the normal course of business.  The review period for the Pension Benefit Guaranty Corporation has expired. We expect to settle all of the plan’s remaining obligations in the fourth quarter of 2004.  In connection with the adoption of the proposal to terminate the plans, we transferred the assets of the funded plan to cash and cash equivalents to mitigate market risk during the period prior to distributions to participants.

 

Concurrent with the distribution of funded plan assets, we will terminate the supplemental plan by merger into our nonqualified supplemental defined contribution plan and expect to establish and fund an irrevocable trust for benefits earned under that plan and recognize settlement losses equal to any unrecognized loss at that date.  At June 30, 2004, these unrecognized losses were approximately $5.8 million and may change depending on interest rates and other factors if we do not terminate the pension plan in 2004.  The supplemental plan obligations were $17.7 million at June 30, 2004.

 

37



 

Part I.                 Financial Information

Item 2.             Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

During the six months ended June 30, 2004, we recognized net losses of $3.3 million, primarily unamortized issuance costs, related to the extinguishment of debt not associated with discontinued operations prior to scheduled maturity and to the redemption of the Parent Company-obligated mandatorily redeemable securities. During the three and six months ended June 30, 2003, we recognized net losses of $5.7 million, primarily prepayment penalties related to the extinguishment of debt not associated with discontinued operations prior to scheduled maturity.

 

The other amount for the six months ended June 30, 2003 consists primarily of a fee of $3.8 million that we earned on the facilitation of a real estate transaction between two parties that are unrelated to us.

 

Net gains on dispositions of interests in operating properties:
 

Net gains on dispositions of interests in operating properties included in earnings from continuing operations are summarized as follows (in millions):

 

 

 

Three months
ended June 30,

 

Six months
ended June 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

 

 

 

 

 

 

 

 

 

 

Regional retail centers

 

$

 

$

21.6

 

$

 

$

21.6

 

Office and other properties

 

14.1

 

 

14.1

 

 

Other

 

 

 

(0.2

)

0.2

 

Total

 

$

14.1

 

$

21.6

 

$

13.9

 

$

21.8

 

 

In 2000, we contributed our ownership interests in 37 buildings in two industrial parks to a joint venture in exchange for cash and a minority interest in the venture. We also guaranteed $44.0 million of indebtedness of the venture and, because of the nature of our continuing involvement in the venture, deferred gains of approximately $14.4 million. In June 2004, we redeemed our interest in the venture and terminated our guarantee of its indebtedness. Accordingly, we recognized the previously deferred gain, net of deferred income taxes of approximately $1.7 million.

 

In April 2004, we sold most of our interest in Westin New York, a hotel in New York City, for net proceeds of $15.8 million and recognized a gain of $1.4 million (net of deferred income taxes of $0.8 million).

 

In 2003, in a transaction related to the sale of retail centers in the Philadelphia metropolitan area (see note 2), we acquired Christiana Mall from a party related to the purchaser and assumed a participating mortgage secured by Christiana Mall.  The participating mortgage had a fair value of $160.9 million.  The holder of this mortgage had the right to receive $120 million in cash and participation in cash flows and the right to convert this participation feature into a 50% equity interest in Christiana Mall.  The holder exercised this right in June 2003.  We recorded a portion of the cost of Christiana Mall based on the historical cost of the properties we exchanged to acquire this property because a portion of the transaction was considered nonmonetary under EITF Issue 01-2, “Interpretations of APB Opinion No. 29.”  As a consequence, when we subsequently disposed of the 50% interest in the property, we recognized a gain of $21.6 million.

 

Income taxes:
 

We and certain wholly owned subsidiaries have made a joint election to treat the subsidiaries as taxable REIT subsidiaries (“TRS”) for Federal and certain state income tax purposes, which election allows us to engage in certain non-qualifying REIT activities.  With respect to the TRS, we are liable for income taxes at the Federal and state levels.  Our current and deferred income tax provisions relate primarily to the earnings of the TRS.  The income tax provisions from continuing operations (excluding taxes related to gains on sales of operating properties) were $20.5 million and $39.1 million in the three and six months ended June 30, 2004 and $16.0 million and $26.6 million in the three and six months ended June 30, 2003, respectively, and related primarily to the earnings of TRS.

 

As discussed above, we conduct our community development activities in TRS.  Income tax expense will increase in future years as we continue our community development activities. Participation expense pursuant to the Contingent Stock Agreement is not deductible for Federal income tax purposes.  Accordingly, we also expect our income tax expense to increase as a percentage of community development NOI.

 

38



 

Part I.                 Financial Information

Item 2.             Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

Equity in earnings of unconsolidated real estate ventures:
 

Equity in earnings of unconsolidated real estate ventures is summarized as follows (in millions):

 

 

 

Three months
ended June 30,

 

Six months
ended June 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

 

 

 

 

 

 

 

 

 

 

Net operating income

 

$

25.6

 

$

24.9

 

$

49.0

 

$

47.2

 

Ground rent expense

 

(0.5

)

(0.4

)

(1.0

)

(0.8

)

Interest expense

 

(9.8

)

(8.9

)

(19.6

)

(16.1

)

Depreciation and amortization

 

(10.0

)

(8.8

)

(19.8

)

(16.0

)

Equity in earnings of unconsolidated real estate ventures

 

$

5.3

 

$

6.8

 

$

8.6

 

$

14.3

 

 

For segment reporting purposes, our share of the NOI of unconsolidated real estate ventures is included in the operating results of retail centers, office and other properties, community development and commercial development as discussed above in this Management’s Discussion and Analysis.  The increase in NOI, interest expense and depreciation and amortization was attributable primarily to acquisitions in 2003 and 2004. Beginning in the second quarter of 2003, we owned a 50% interest in Christiana Mall. In December 2003 and January 2004, we acquired 50% interests in the retail and certain office components of Mizner Park. The increases were offset by the December 2003 disposition of our investment in Kravco Investments, L.P. and the April 2004 disposition of most of our interest in Westin New York. Also, in August 2003, we acquired the remaining interest in Staten Island Mall, in which we previously had a noncontrolling interest and accounted for as an unconsolidated real estate venture.

 

Discontinued operations
 

The operating results of discontinued operations are summarized as follows (in millions):

 

 

 

Three months
ended June 30,

 

Six months
ended June 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

0.6

 

$

24.9

 

$

3.6

 

$

65.2

 

Operating expenses, exclusive of depreciation and amortization

 

(0.3

)

(12.6

)

(1.5

)

(31.4

)

Interest expense

 

 

(5.8

)

(0.7

)

(15.1

)

Depreciation and amortization

 

(0.1

)

(4.4

)

(1.0

)

(12.0

)

Other provisions and losses, net

 

 

26.9

 

 

26.9

 

Impairment losses on operating properties

 

(0.3

)

 

(0.3

)

 

Gains on dispositions of interests in operating properties, net

 

8.3

 

69.8

 

44.7

 

69.8

 

Income tax benefit (provision), primarily deferred

 

 

(0.2

)

0.1

 

(0.2

)

Discontinued operations

 

$

8.2

 

$

98.6

 

$

44.9

 

$

103.2

 

 

We may sell interests in retail centers that are not consistent with our long-term business strategies or not meeting our investment criteria and office and other properties that are not located in our master-planned communities or not part of urban mixed-use properties.  We may also dispose of properties for other reasons.  Discontinued operations include the operating results of properties sold during 2004 and 2003 in which we do not have significant continuing involvement.  For segment reporting purposes, our share of the NOI of the properties in discontinued operations is included in the operating results of retail centers, office and other properties or commercial development as discussed above in this Management’s Discussion and Analysis.

 

In May 2004, we agreed to sell our interests in two office buildings in Hunt Valley, Maryland. These sales are expected to settle by the end of 2004. We recorded aggregate impairment losses of $1.4 million in the fourth quarter of 2003 and $0.3 million in the second quarter of 2004 related to these properties. These properties are classified as held for sale at June 30, 2004.

 

39



 

Part I.                 Financial Information

Item 2.             Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

In May 2004, we sold our interest in one office building in Hughes Center, a master-planned business park in Las Vegas, Nevada, as part of the 2003 agreements under which we acquired interests in entities developing The Woodlands, a master-planned community in the Houston, Texas metropolitan area, for cash of $7.0 million and the assumption by the buyer of $3.5 million of mortgage debt. We recorded a gain on this sale of $5.5 million. In January and February 2004, we sold interests in five office buildings and seven parcels subject to ground leases in Hughes Center as part of the same 2003 agreements, for cash of $64.3 million and the assumption by the buyer of $107.3 million of mortgage debt. We recorded aggregate gains on these sales in the first quarter of 2004 of approximately $35.3 million (net of deferred income taxes of $2.7 million). In December 2003, in related transactions, we sold interests in two office buildings and two parcels subject to ground leases in Hughes Center.

 

We also recorded, in the three months ended June 30, 2004, net gains of $2.8 million (net of deferred income taxes of $0.4 million) related to the resolutions of certain contingencies related to disposals of properties in 2002, 2003 and 2004.

 

In March 2004, we sold our interests in Westdale Mall, a retail center in Cedar Rapids, Iowa, for cash of $1.3 million and the assumption by the buyer of $20.0 million of mortgage debt. We recognized a gain of $0.8 million relating to this sale. We recorded an impairment loss of $6.5 million in the third quarter of 2003 related to this property.

 

In August 2003, we sold The Jacksonville Landing, a retail center in Jacksonville, Florida.

 

In May and June 2003, we sold eight office and industrial buildings in the Baltimore-Washington corridor for net proceeds of $46.6 million and recorded aggregate gains of $4.4 million.

 

In April and May 2003, we sold six retail centers in the Philadelphia metropolitan area and, in a related transaction, acquired Christiana Mall from a party related to the purchaser.  In connection with these transactions, we received net cash proceeds of $218.4 million, the purchaser assumed $276.6 million of property debt, and we assumed a participating mortgage secured by Christiana Mall.  We recognized aggregate gains of $65.4 million relating to the monetary portions of these transactions. We recorded an impairment loss of $38.8 million in the fourth quarter of 2002 related to one of the retail centers sold.

 

We also recorded a net gain of $26.9 million related to the extinguishment of debt secured by two of the properties sold in the Philadelphia metropolitan area when the lender released the mortgages for a cash payment by us of less than the aggregate carrying amount of the debt.

 

Net earnings:
 

Net earnings were $61.2 million and $128.4 million for the three and six months ended June 30, 2004 and $138.1 million and $162.2 million for the three and six months ended June 30, 2003. The changes in net earnings for the three and six months ended June 30, 2004 as compared to the same periods in 2003 were attributable to the factors discussed above, primarily the change in gains on dispositions of interests in operating properties included in discontinued operations.

 

Funds From Operations:
 

We use Funds From Operations (“FFO”) as a supplement to our reported net earnings.  Historical cost accounting for real estate assets implicitly assumes that the value of real estate assets diminishes over time as reflected through depreciation and amortization expenses.  We believe that the value of real estate assets does not diminish predictably over time, as historical cost accounting implies, and instead fluctuates due to market and other conditions.  Accordingly, we believe FFO provides investors with useful information about our operating performance because it excludes real estate depreciation and amortization expense.  We use the definition of FFO adopted by the National Association of Real Estate Investment Trusts.  Accordingly, FFO is defined as net earnings (computed in accordance with accounting principles generally accepted in the United States of America (“GAAP”)), excluding gains (losses) on dispositions of interests in depreciated operating properties and real estate depreciation and amortization expense.  Also, beginning July 1, 2003, we include impairment losses on operating properties in FFO. FFO for all periods presented conforms to this definition.  Our calculation of FFO may not be comparable to similarly titled measures reported by other companies because all companies do not calculate FFO in the same manner.  FFO is not a liquidity measure and should not be considered as an alternative to cash flows or indicative of cash available for distribution.  It also should not be considered an alternative to net earnings, as determined in accordance with GAAP, as an indication of our financial performance.

 

40



 

Part I.                 Financial Information

Item 2.             Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

Net earnings is reconciled to FFO as follows (in millions):

 

 

 

Three months
ended June 30,

 

Six months
ended June 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

 

 

 

 

 

 

 

 

 

 

Net earnings

 

$

61.2

 

$

138.1

 

$

128.4

 

$

162.2

 

Depreciation and amortization

 

58.6

 

53.8

 

117.0

 

106.6

 

Net gains on dispositions of interests in operating properties

 

(22.3

)

(91.3

)

(58.6

)

(91.6

)

Funds From Operations

 

$

97.5

 

$

100.6

 

$

186.8

 

$

177.2

 

 

Depreciation and amortization and net gains on dispositions of interests in operating properties include our share of the depreciation and amortization and net gains on dispositions of interests in operating properties of unconsolidated real estate ventures and of those properties classified as discontinued operations.

 

The increase in FFO for the three and six months ended June 30, 2004 compared to the same periods in 2003 was attributable to factors discussed above in this Management’s Discussion and Analysis.

 

Financial condition, liquidity and capital resources:
 

Our primary cash requirements are for operating expenses, land development and acquisition expenditures, debt service, development of new properties, expansions and improvements to existing properties and acquisitions.  We believe that our liquidity and capital resources are adequate for our near-term and longer-term requirements.  We had cash and cash equivalents and investments in marketable securities totaling $61.4 million and $139.5 million at June 30, 2004 and December 31, 2003, respectively.

 

We have historically relied primarily on fixed-rate, nonrecourse loans from private institutional lenders to finance most of our operating properties. We have also made use of the public equity and debt markets to meet our capital needs, principally to repay or refinance corporate debt and to provide funds for project development and acquisition costs and other corporate purposes. We have recently issued unsecured corporate debt to repay debt secured by our operating properties as part of our strategy to increase the number of our operating properties unencumbered by mortgage debt.

 

We have a credit facility with a group of lenders that provides for borrowings of up to $900 million.  The facility is available until July 2006, subject to a one-year renewal option.  The facility bears interest at LIBOR plus a margin.  The margin is determined based on the ratings assigned to our senior unsecured long-term debt securities by Moody’s Investors Service, Inc. (“Moody’s”) and Standard & Poor’s Ratings Services (“S&P”) and may range from 0.6% to 1.25%.  At June 30, 2004 our rating was Baa3 by Moody’s and BBB- by S&P, which resulted in a margin of .90% on our credit facility. In June 2004, S&P announced that it was assigning a “positive” outlook to our unsecured debt rating and stated that "as additional high quality malls become unencumbered, the senior unsecured debt rating could be raised to BBB from BBB-."  The margin on our credit facility will not decline unless both Moody's and S&P raise the ratings assigned to our senior unsecured debt securities.  We cannot provide assurance that Moody's and S&P will raise their ratings.  The revolving credit facility may be used for various purposes, including land and project development costs, property acquisitions, liquidity and other corporate needs.  It may also be used to pay some portion of existing debt, including secured debt.  Availability under the facility was $718 million at June 30, 2004.

 

We are continually evaluating sources of capital and believe that there are satisfactory sources available for all requirements.  Selective dispositions of properties and interests in properties may provide capital resources in 2004 and may also provide them in subsequent years.

 

We had a shelf registration statement for the sale of up to an aggregate of approximately $2.25 billion (based on the public offering price) of common stock, preferred stock and debt securities. In February 2004, we issued $223 million of common stock under the shelf registration statement. With the issuance of the $500 million of notes in March 2004, the availability under our shelf registration was exhausted. We plan to file a new shelf registration in 2004 covering the possible future offering and sale of equity and debt securities.

 

41



 

Part I.                 Financial Information

Item 2.             Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

Our debt at June 30, 2004 is summarized as follows (in millions):

 

 

 

June 30, 2004

 

 

 

Total

 

Due in one
year

 

 

 

 

 

 

 

Mortgages and bonds

 

$

2,725.3

 

$

603.9

 

Medium-term loans

 

45.5

 

43.5

 

Credit facility borrowings

 

182.0

 

 

3.625% Notes due March 2009

 

378.9

 

 

8% Notes due April 2009

 

200.0

 

 

7.2% Notes due September 2012

 

399.6

 

 

5.375% Notes due November 2013

 

453.9

 

 

Other loans

 

179.7

 

64.8

 

Total

 

$

4,564.9

 

$

712.2

 

 

As of June 30, 2004, our debt due in one year includes balloon payments of $629.1 million that are expected to be paid at or before the scheduled maturity dates of the related loans from proceeds of property refinancings (including refinancings of the maturing mortgages), credit facility borrowings, proceeds from the issuance of public debt and other available corporate funds.  We may obtain extensions of maturities on certain loans.  We may use distributions of financing proceeds from unconsolidated real estate ventures to provide liquidity.  We may also sell interests in operating properties or contribute operating properties or development projects to joint ventures in exchange for cash distributions from and ownership interests in the joint ventures.

 

We expect to spend more than $135 million for new developments, expansions and improvements to existing consolidated properties in the remainder of 2004.  A substantial portion of these expenditures relates to new retail properties and retail center redevelopment/expansions, and it is expected that most of these costs will be financed by debt, including borrowings under existing property-specific construction loans and/or our credit facility.  In addition, we are an investor in several unconsolidated joint ventures that are developing certain projects, with the other venturers funding a portion of development costs.  We expect to invest approximately $15 million in these joint ventures in the remainder of 2004.

 

We also expect to establish an irrevocable trust for the participants in our nonqualified defined benefit supplemental pension plan and our nonqualified supplemental defined contribution plan. We expect to fund this trust concurrent with the settlement of our funded pension plan. We expect to contribute to the trust most of our marketable securities (which we have purchased to closely match the obligations of the nonqualified defined contribution plan) and cash equal to supplemental pension plan obligations ($17.7 million at June 30, 2004) and other deferred compensation obligations ($3.7 million at June 30, 2004).

 

Net cash provided by operating activities was $205.4 million for the six months ended June 30, 2004 and $216.1 million for the six months ended June 30, 2003.  The level of cash flows provided by operating activities is affected by the timing of receipts of rents, proceeds from land sales and other revenues and payment of operating and interest expenses and community development costs.  The level of cash provided by operating distributions from unconsolidated real estate ventures is affected by the timing of receipt of their revenues (including land sales revenues), payment of operating and interest expenses and other sources and uses of cash. The decrease in net cash provided of $10.7 million was attributable primarily to the effects of the properties sold in 2004 and 2003 and higher land development and acquisition expenditures, partially offset by proceeds from land sales and the operating cash flows of the properties acquired in 2004 and 2003.

 

Net cash used by investing activities was $262.8 million for the six months ended June 30, 2004 and net cash provided by investing activities was $113.3 million for the six months ended June 30, 2003.

 

Net cash used by investing activities in 2004 was primarily:

 

                  Expenditures for acquisitions of interests in properties ($291.4 million, primarily Providence Place and Mizner Park) and

 

                  Expenditures for properties in development ($54.2 million, primarily Fashion Show and La Cantera).

 

42



 

Part I.                 Financial Information

Item 2.             Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

These expenditures were partially offset by:

 

                  Proceeds from dispositions of interests in properties ($88.4 million, primarily Hughes Center and Westin New York) and

 

                  Distribution of financing proceeds from the unconsolidated venture that owns Mizner Park ($30.0 million).

 

Net cash provided by investing activities in 2003 was primarily proceeds from the sale of six retail centers in the Philadelphia metropolitan area ($218.3 million, net of the acquisition of Christiana Mall) and eight office and industrial buildings in the Baltimore-Washington corridor ($46.6 million), partially offset by:

 

                  Expenditures for properties in development ($98.0 million, primarily Fashion Show) and

 

                  Expenditures for improvements to existing properties ($32.8 million) and investments in unconsolidated ventures ($23.8 million, primarily the Village of Merrick Park).

 

Cash used by investing activities also includes expenditures for properties in development and improvements to existing properties. These expenditures related to project development activity, primarily retail property redevelopment/expansions.  A substantial portion of the costs of properties in development was financed with construction or similar loans and/or credit facility borrowings.  In some cases, long-term fixed-rate debt financing is arranged before completion of construction.  Improvements to existing properties consist primarily of costs of renovation and remerchandising programs and other tenant improvement costs.

 

Net cash used by financing activities was $23.6 million for the six months ended June 30, 2004 and $318.3 million for the six months ended June 30, 2003.

 

Net cash provided by financing activities in 2004 was primarily:

 

                  Net proceeds from the issuance of 4.6 million shares of common stock ($222 million) in February 2004, which were used primarily to fund our acquisition of Providence Place;

 

                  Proceeds from the issuance of the 3.625% Notes and the 5.375% Notes in March 2004 ($503 million), which were used primarily to repay the credit facility borrowings that were used to repay property debt and fund our acquisition of Providence Place; and

 

                  Proceeds from the exercise of stock options ($24.6 million).

 

These proceeds were partially offset by:

 

                  Repayments of property debt, primarily debt secured by Fashion Show ($240.3 million), Woodbridge ($121.5 million), Faneuil Hall ($55.0 million) and West Kendall ($22.8 million);

 

                  Repayments of Parent Company-obligated mandatorily redeemable preferred securities ($79.8 million);

 

                  Purchases of common stock ($31.1 million); and

 

                  Payment of dividends on common stock ($96.5 million).

 

Net cash used by financing activities in 2003 was primarily:

 

                  Repayment of property debt, primarily debt secured by Christiana Mall ($120 million) and other property debt ($151.8 million);

 

                  Payment of dividends on common stock and preferred stock ($79.8 million);

 

                  Net repayments under our credit facility ($121.7 million); and

 

                  Purchases of common stock ($20.9 million).

 

These uses of cash were partially offset by proceeds from the issuance of property debt ($193.6 million, primarily debt secured by Christiana Mall, $120 million) and proceeds from the exercise of stock options ($31.7 million).

 

Off-balance sheet arrangements and unconsolidated ventures:
 

We own interests in unconsolidated real estate ventures that own and/or develop properties, including master-planned communities.  We use these ventures to limit our risk associated with individual properties and to reduce our capital requirements.  We may also contribute our interests in properties to unconsolidated ventures for cash distributions and interests in the ventures to provide liquidity as an alternative to outright property sales.  These ventures own properties managed by us for a fee and are controlled jointly by our venture partners and us.  At June 30, 2004, these ventures also include the joint venture that is developing the planned community of The Woodlands.  These ventures are accounted for using the equity or cost method, as appropriate.

 

43



 

Part I.                 Financial Information

Item 2.             Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

At June 30, 2004, we had other commitments and contingencies related to unconsolidated ventures.  These commitments and contingencies are summarized as follows (in millions):

 

Guarantee of debt:

 

 

 

Village of Merrick Park

 

$

100.0

 

Construction contracts for properties in development

 

14.6

 

Construction contracts for land development

 

21.4

 

Long-term ground lease obligations

 

120.6

 

 

 

$

256.6

 

 

We have guaranteed up to $100 million for the repayment of a mortgage loan of the unconsolidated real estate venture that owns the Village of Merrick Park.  The amount of the guarantee may be reduced or eliminated upon the achievement of certain lender requirements.  The fair value of the guarantee is not material. Additionally, venture partners have provided guarantees to us for their share (60%) of the loan guarantee.

 

We determined that several of our consolidated partnerships are limited-life entities.  We estimate the fair values of minority interests in these partnerships at June 30, 2004 aggregated approximately $54.4 million.  The aggregate carrying values of the minority interests were approximately $29.4 million at June 30, 2004.

 

Subsequent events:
 

In August 2004, we agreed to purchase Oxmoor Center, a regional retail center in Louisville, Kentucky. We expect to assume mortgage debt with a face value of approximately $60 million and to pay $63 million in cash to the seller, using the proceeds of borrowings under our revolving credit facility and/or other borrowings. We expect this transaction, which is subject to lender consent and other customary closing conditions, to close in September 2004.

 

Critical accounting policies:
 

Critical accounting policies are those that are both important to the presentation of our financial condition and results of operations and require management’s most difficult, complex or subjective judgments.  Our critical accounting policies are those applicable to the evaluation of impairment of long-lived assets, the evaluation of the collectibility of accounts and notes receivable, profit recognition on land sales and allocation of the purchase price of acquired properties.

 

Impairment of long-lived assets:  If events or changes in circumstances indicate that the carrying values of operating properties, properties in development or land held for development and sale may be impaired, a recovery analysis is performed based on the estimated undiscounted future cash flows to be generated from the property.  If the analysis indicates that the carrying value of the tested property is not recoverable from estimated future cash flows, the property is written down to estimated fair value and an impairment loss is recognized.  Fair values are determined based on estimated future cash flows using appropriate discount and capitalization rates.  The estimated cash flows used for the impairment analyses and to determine estimated fair values are based on our plans for the tested asset and our views of market and economic conditions.  The estimates consider matters such as current and historical rental rates, occupancies for the tested property and comparable properties and recent sales data for comparable properties.  Changes in estimated future cash flows due to changes in our plans or views of market and economic conditions could result in recognition of impairment losses which, under the applicable accounting guidance, could be substantial.

 

Properties held for sale, including land held for sale, are carried at the lower of their carrying values (i.e., cost less accumulated depreciation and any impairment loss recognized, where applicable) or estimated fair values less costs to sell.  Accordingly, decisions by us to sell certain operating properties, properties in development or land held for development and sale will result in impairment losses if carrying values of the specific properties exceed their estimated fair values less costs to sell.  The estimates of fair value consider matters such as recent sales data for comparable properties and, where applicable, contracts or the results of negotiations with prospective purchasers.  These estimates are subject to revision as market conditions and our assessment of them change.

 

44



 

Part I.                 Financial Information

Item 2.             Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

Collectibility of accounts and notes receivable:  The allowance for doubtful accounts and notes receivable is established based on quarterly analysis of the risk of loss on specific accounts.  The analysis places particular emphasis on past-due accounts and considers information such as the nature and age of the receivables, the payment history of the tenants or other debtors, the financial condition of the tenants and management’s assessment of their ability to meet their lease obligations, the basis for any disputes and the status of related negotiations, among other things.  Our estimate of the required allowance is subject to revision as these factors change and is sensitive to the effects of economic and market conditions on tenants.

 

Profit recognition on land sales:  Cost of land sales is determined as a specified percentage of land sales revenues recognized for each community development project. The cost ratios used are based on actual costs incurred and estimates of development costs and sales revenues to completion of each project.  The ratios are reviewed regularly and revised for changes in sales and cost estimates or development plans.  Significant changes in these estimates or development plans, whether due to changes in market conditions or other factors, could result in changes to the cost ratio used for a specific project.  The specific identification method is used to determine cost of sales for certain parcels of land, including acquired parcels we do not intend to develop or for which development is complete at the date of acquisition.

 

Allocation of the purchase price of acquired properties:  We allocate the purchase price of acquired properties to tangible and identified intangible assets based on their fair values.  In making estimates of fair values for purposes of allocating purchase price, we use a number of sources, including independent appraisals that may be obtained in connection with the acquisition or financing of the respective property and other market data.  We also consider information obtained about each property as a result of our pre-acquisition due diligence, marketing and leasing activities in estimating the fair value of the tangible and intangible assets acquired.

 

The fair values of tangible assets are determined on an “if-vacant” basis.  The “if-vacant” fair value is allocated to land, where applicable, buildings, tenant improvements and equipment based on property tax assessments and other relevant information obtained in connection with the acquisition of the property.

 

Our intangible assets arise primarily from contractual rights and include leases with above- or below-market rents (including ground leases where we are lessee), in-place lease and customer relationship values and a real estate tax stabilization agreement.

 

Above-market and below-market in-place lease values are recorded based on the present value (using an interest rate which reflects the risks associated with the leases acquired) of the difference between (i) the contractual amounts to be received or paid pursuant to the in-place leases and (ii) our estimate of fair market lease rates for the corresponding space, measured over a period equal to the remaining non-cancelable term of the lease (including those under bargain renewal options).  The capitalized above- and below-market lease values are amortized as adjustments to rental income or rental expense over the remaining terms of the respective leases (including periods under bargain renewal options).

 

45



 

Part I.                 Financial Information

Item 2.             Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

The aggregate fair values of in-place leases and customer relationship assets acquired are measured based on the difference between (i) the property valued with existing in-place leases adjusted to market rental rates and (ii) the property valued as if vacant.  This value is allocated to in-place lease and customer relationship assets (both anchor stores and tenants).  The fair value of in-place leases is based on our estimates of carrying costs during the expected lease-up periods and costs to execute similar leases.  Our estimate of carrying costs includes real estate taxes, insurance and other operating expenses and lost rentals during the expected lease-up periods considering current market conditions.  Our estimate of costs to execute similar leases includes leasing commissions, legal and other related costs. The fair value of anchor store agreements is determined based on our experience negotiating similar relationships (not in connection with property acquisitions). The fair value of tenant relationships is based on our evaluation of the specific characteristics of each tenant’s lease and our overall relationship with that respective tenant.  Characteristics we consider in determining these values include the nature and extent of our existing business relationships with the tenant, growth prospects for developing new business with the tenant, the tenant’s credit quality and expectations of lease renewals, among other factors.  The value of in-place leases is amortized to expense over the initial term of the respective leases, primarily ranging from two to ten years.  The value of anchor store agreements is amortized to expense over the estimated term of the anchor store’s occupancy in the property.  Should an anchor store vacate the premises, the unamortized portion of the related intangible is charged to expense.  The value of tenant relationship intangibles is amortized to expense over the initial term and any renewal periods in the respective leases, but in no event does the amortization period exceed the remaining depreciable life of the building.  Should a tenant terminate its lease, the unamortized portion of the in-place lease value and customer relationship intangibles is charged to expense. The value allocated to the tax stabilization agreement was determined based on the difference between the present value of estimated market real estate taxes and amounts due under the agreement and is amortized to operating expense over the term of the agreement, which is approximately 24 years.

 

New financial accounting standards:
 

In January 2003, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”).  FIN 46 addresses the consolidation of variable interest entities (“VIEs”) in which the equity investors lack one or more of the essential characteristics of a controlling financial interest or where the equity investment at risk is not sufficient for the entity to finance its activities without additional subordinated financial support.  In December 2003, the FASB issued Interpretation No. 46 (revised December 2003), “Consolidation of Variable Interest Entities” (“FIN 46R”).  FIN 46R or FIN 46 applies in the fourth quarter of 2003 to all special purpose entities (“SPEs”) and to VIEs formed after January 31, 2003 and in the first quarter of 2004 to all other VIEs.  Application of FIN 46 in 2003 and 2004 had no effect on our financial statements as we previously consolidated the SPE that issued our Parent Company-obligated mandatorily redeemable preferred securities and, at June 30, 2004, held no interests in other VIEs formed after January 31, 2003.  Full application of FIN 46R in 2004 did not have a material effect on our results of operations or financial condition.

 

Impact of inflation:
 

The major portion of our operating properties, our retail centers, is substantially protected from declines in the purchasing power of the dollar.  Retail leases generally provide for minimum rents plus percentage rents based on sales over a minimum base.  In many cases, increases in tenant sales (whether due to increased unit sales or increased prices from demand or general inflation) will result in increased rental revenue.  A substantial portion of the tenant leases (retail and office) also provide for other rents which reimburse us for certain operating expenses; consequently, increases in these costs do not have a significant impact on our operating results.  We have a significant amount of fixed-rate debt which, in a period of inflation, will result in a holding gain since debt will be paid off with dollars having less purchasing power.

 

46



 

Part I.                 Financial Information

Item 2.             Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

Information relating to forward-looking statements:
 

This report on Form 10-Q includes forward-looking statements which reflect our current views with respect to future events and financial performance.  Such forward-looking statements include, among others, statements regarding our strategy, statements regarding expectations as to operating results from our retail centers, our office and other properties and our community development activities, expectations as to our ability to lease vacating and expiring space, expectations as to the completion of pending sale transactions, expectations as to operating results from acquisitions, expectations regarding income taxes in future years and our beliefs as to our liquidity and capital resources and as to our expenditures for new developments, expansions and improvements.

 

Forward-looking statements are subject to certain risks and uncertainties, including those identified below which could cause actual results to differ materially from historical results or those anticipated.  The words “will,” “plan,” “believe,” “expect,” “anticipate,” “target,” “intend” and similar expressions identify forward-looking statements.  Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of their dates.  We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.  The following are among the factors that could cause actual results to differ materially from historical results or those anticipated: (1) changes in the economic climate; (2) our dependence on rental income from real property; (3) uncertainty from terrorist attacks and volatility in the financial markets; (4) our lack of geographical diversification; (5) possible environmental liabilities; (6) special local economic and environmental risks in Nevada; (7) real estate development and investment risks; (8) the effect of uninsured loss; (9) the cost and adequacy of insurance; (10) the illiquidity of real estate investments; (11) competition; (12) real estate investment trust risks; (13) changes in tax laws or regulations; and (14) risks associated with the acquisition of assets from Rodamco North America N.V.  Further, domestic or international incidents could affect general economic conditions and our business.  For a more detailed discussion of these and other factors, see attached Exhibit 99.1.

 

47



 

Part I.                 Financial Information

Item 3.             Quantitative and Qualitative Disclosures about Market Risk.

 

Market Risk Information:
 

The market risk associated with financial instruments and derivative financial and commodity instruments is the risk of changes in market prices or rates.  Our market risk arises primarily from interest rate risk relating to debt obligations. We manage our exposure to this risk by maintaining our ratio of variable-rate debt to total debt at levels specified by management and based on market conditions. We use interest rate exchange agreements, including cash flow hedges and fair value hedges, to manage this risk.  We do not enter into interest rate exchange agreements for speculative purposes.

 

Our interest rate risk is monitored closely by management.  The table below presents the annual maturities, weighted-average interest rates on outstanding debt at the end of each year (based on a LIBOR rate of 1.3%) and fair values required to evaluate expected cash flows under debt agreements at June 30, 2004.  Information relating to debt maturities is based on expected maturity dates and is summarized as follows (in millions):

 

 

 

Remaining
2004

 

2005

 

2006

 

2007

 

2008

 

Thereafter

 

Total

 

Fair
Value

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed-rate debt

 

$

131

 

$

180

 

$

297

 

$

239

 

$

499

 

$

2,280

 

$

3,626

 

$

3,815

 

Average interest rate

 

6.6

%

6.5

%

6.4

%

6.3

%

6.2

%

6.2

%

6.2

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Variable-rate LIBOR debt

 

$

6

 

$

460

 

$

206

 

$

260

 

$

2

 

$

5

 

$

939

 

$

939

 

Average interest rate

 

2.4

%

2.4

%

2.4

%

3.6

%

3.8

%

3.8

%

2.7

%

 

 

 

At June 30, 2004, approximately $145.5 million of our variable-rate LIBOR debt related to borrowings under construction loans that we expect to repay with proceeds of long-term, fixed-rate debt in 2005 and 2006 when we expect to complete construction of the related projects and/or the loans reach maturity.

 

We had interest rate swap agreements and forward-starting swap agreements in place at June 30, 2004 that effectively fix the LIBOR rate on a portion of our variable-rate debt through 2006. The weighted-average notional amounts of these agreements and their terms are summarized as follows (in millions):

 

 

 

Remaining
2004

 

2005

 

2006

 

 

 

 

 

 

 

 

 

Weighted-average notional amount

 

$

518.7

 

$

102.7

 

$

10.4

 

Weighted-average fixed effective rate (pay rate)

 

2.2

%

1.9

%

4.7

%

Weighted-average variable interest rate of related debt (receive rate) based on LIBOR at June 30, 2004

 

1.3

%

1.3

%

1.4

%

 

The fair values of the assets and liabilities related to these agreements were $1.9 million and $2.1 million, respectively, at June 30, 2004.

 

We also had interest rate swap agreements at June 30, 2004 that effectively converted $400 million of debt with a fixed rate of 3.625% to variable-rate debt through March 2009. The agreements have a weighted-average pay rate of six-month LIBOR (set in arrears) plus a spread of 19.375 basis points. The pay rate based on the projected six-month LIBOR rate at June 30, 2004 was 2.47%. The fair values of these instruments are recorded as liabilities of $19.8 million at June 30, 2004.

 

As the table incorporates only those exposures that exist as of June 30, 2004, it does not consider exposures or positions which could arise after that date.  As a result, our ultimate realized gain or loss with respect to interest rate fluctuations will depend on the exposures that arise after June 30, 2004, our hedging strategies during that period and interest rates.

 

We had investments in fixed income and marketable equity securities of $25.2 million at June 30, 2004.  Our market risk related to these securities is limited to changes in their fair values and such changes are not likely to have a material effect on our consolidated financial position. Most of our investments in marketable securities closely match our liabilities related to certain deferred compensation plans.  As a result, changes in the market values of these investments do not have a significant effect on our earnings. Marketable securities classified as available for sale are not material.

 

Based on our outstanding variable-rate LIBOR debt and interest rate swaps in effect at June 30, 2004, a hypothetical LIBOR increase of 1% would cause annual interest expense to increase $8.2 million.

 

48



 

Part I.                 Financial Information

Item 4.             Controls and Procedures.

 

Controls and Procedures:
 

Evaluation of Disclosure Controls and Procedures: As of June 30, 2004, we carried out an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a – 15(e) under the Securities Exchange Act of 1934).  Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective.

 

During our evaluation, we did not identify any changes in our internal control over financial reporting that occurred during the quarter ended June 30, 2004 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

49



 

Part II.             Other Information

 

Item 1.                 Legal Proceedings.

 

None

 

Item 2.                 Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities.

 

ISSUER PURCHASES OF EQUITY SECURITIES

 

Period

 

Total Number
of Shares
Purchased (1)

 

Average Price
Paid per Share

 

Total Number
of Shares
Purchased as
Part of
Publicly
Announced
Plans or
Programs

 

Maximum Number
(or Approximate
Dollar Value) of
Shares that May
Yet Be Purchased
Under the Plans or
Programs (2)

 

 

 

 

 

 

 

 

 

 

 

April 1-April 30, 2004

 

13,072

 

$

50.15

 

 

 

 

 

 

 

 

 

 

 

 

 

May 1-May 31, 2004

 

534,326

 

41.15

 

 

 

 

 

 

 

 

 

 

 

 

 

June 1-June 30, 2004

 

478,469

 

46.58

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

1,025,867

 

$

43.80

 

 

 

 


(1)          Shares repurchased in May and June 2004 include 563,200 shares (at average price of $45.16) repurchased in open market transactions and to be used to satisfy obligations under the Contingent Stock Agreement for the benefit of the former Hughes owners or their successors. Remaining shares repurchased in April, May and June 2004 were surrendered by grantees in connection with their exercise of stock options.

 

(2)          In 1999, our Board of Directors authorized the repurchase of common shares for up to $250 million, subject to certain pricing restrictions. No shares were repurchased under this program in the quarterly period ended June 30, 2004.

 

Item 3.                 Defaults Upon Senior Securities.

 

None

 

Item 4.                 Submission of Matters to a Vote of Security Holders.

 

On May 6, 2004, we held our Annual Meeting of Shareholders at our headquarters in Columbia, Maryland.

 

At the meeting, we announced the retirement of Mark R. Tercek and Gerard J.M. Vlak from the Board of Directors and our shareholders reelected two individuals to the Board of Directors for three-year terms.

 

The individuals below were elected to the Board of Directors for three-year terms ending at the 2007 Annual Meeting of Stockholders by the vote set forth below:

 

 

 

Votes For

 

Votes Withheld

 

 

 

 

 

 

 

Jeremiah E. Casey

 

85,915,546

 

6,097,698

 

 

 

 

 

 

 

Roger W. Schipke

 

87,715,940

 

4,297,304

 

 

50



 

Part II.             Other Information

 

The remaining members of the Board of Directors are as follows:

 

 

 

Term Expires

 

 

 

 

 

David H. Benson

 

2005

 

Platt W. Davis, III

 

2005

 

Anthony W. Deering

 

2006

 

Rohit M. Desai

 

2006

 

Bruce W. Duncan

 

2005

 

Juanita T. James

 

2005

 

Bert N. Mitchell

 

2006

 

John G. Schreiber

 

2006

 

 

At the meeting, our shareholders also approved an Amendment to the Charter of The Rouse Company increasing the total number of authorized shares of Common Stock by the votes set forth below:

 

Votes For

 

Votes Against

 

 

 

 

 

79,811,769

 

12,129,427

 

 

Item 5.                 Other Information.

 

None

 

Item 6.                 Exhibits and Reports on Form 8-K.

 

(a)                Exhibits

 

Exhibit 3.1–Articles Supplementary to the Charter of The Rouse Company, effective May 6, 2004

 

Exhibit 3.2–Articles of Amendment to the Charter of The Rouse Company, effective May 6, 2004

 

Exhibit 31.1–Certification Pursuant to Rule 13a–14(a) by Anthony W. Deering, Chairman of the Board, President and Chief Executive Officer

 

Exhibit 31.2–Certification Pursuant to Rule 13a–14(a) by Thomas J. DeRosa, Vice Chairman and
Chief Financial Officer

 

Exhibit 32.1–Certification Pursuant to 18 U.S.C. Section 1350–Chief Executive Officer

 

Exhibit 32.2–Certification Pursuant to 18 U.S.C. Section 1350–Chief Financial Officer

 

Exhibit 99.1–Factors Affecting Future Operating Results

 

The Registrant agrees to furnish to the Securities and Exchange Commission upon request a copy of any instrument with respect to long-term debt not filed herewith as to which the total amount of securities authorized thereunder does not exceed 10 percent of the total assets of the Registrant and its subsidiaries on a consolidated basis.

 

(b)               Reports on Form 8-K

 

Current Report on Form 8-K was furnished to the Securities and Exchange Commission on May 6, 2004.  The Form provided our press release regarding earnings for the first quarter of 2004 and certain supplemental information not included in the press release.

 

Current Report on Form 8-K was furnished to the Securities and Exchange Commission on May 21, 2004.  The Form provided information presented to analysts and investors on May 24, 2004 regarding cash flows, other provisions and losses and land sales of the registrant.

 

51



 

Signatures

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

 

 

on behalf of
THE ROUSE COMPANY and as

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Principal Financial Officer:

 

 

 

 

 

 

 

Date:

August 6, 2004

 

By

/s/ Thomas J. DeRosa

 

 

 

 

 

Thomas J. DeRosa

 

 

 

 

 

Vice Chairman and Chief Financial Officer

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Principal Accounting Officer:

 

 

 

 

 

 

 

Date:

August 6, 2004

 

By

/s/ Melanie M. Lundquist

 

 

 

 

 

Melanie M. Lundquist

 

 

 

 

 

Senior Vice President and Corporate Controller

 

 

52



 

Exhibit Index

 

Exhibit No.

 

 

 

 

 

3.1

 

Articles Supplementary to the Charter of The Rouse Company, effective May 6, 2004

 

 

 

3.2

 

Articles of Amendment to the Charter of The Rouse Company, effective May 6, 2004

 

 

 

31.1

 

Certification Pursuant to Rule 13a–14(a) by Anthony W. Deering, Chairman of the Board, President and Chief Executive Officer

 

 

 

31.2

 

Certification Pursuant to Rule 13a–14(a) by Thomas J. DeRosa, Vice Chairman and Chief Financial Officer

 

 

 

32.1

 

Certification Pursuant to 18 U.S.C. Section 1350–Chief Executive Officer

 

 

 

32.2

 

Certification Pursuant to 18 U.S.C. Section 1350–Chief Financial Officer

 

 

 

99.1

 

Factors Affecting Future Operating Results

 

53