ITEM 1. BUSINESS
THE COMPANY
Urban Shopping Centers, Inc. (the "Company") is in the business of owning, acquiring, managing, leasing, developing and redeveloping super-regional and regional malls located throughout the United States. Substantially all of the Company's assets and interests in investment properties (the "Properties") are held by, and substantially all of its operations are conducted through, Urban Shopping Centers, L.P. (the "Operating Partnership").
On December 29, 1998, in connection with the Company's acquisition of a 50% equity interest in Woodland Hills Mall, in Tulsa, Oklahoma, the Company issued $25,000,000 in cumulative convertible redeemable preferred stock ("Series B Preferred Stock") with a liquidation preference of $32.32 per share. Quarterly dividends on the Series B Preferred Stock are equal to the greater of (i) $0.525 per share or (ii) the quarterly dividend then payable on the shares of common stock into which the Series B Preferred Stock is convertible. The Series B Preferred Stock is convertible into common stock, at the option of the holder, at a conversion price of $32.32 per share (subject to antidilution adjustments) at anytime after September 1999. After six years, the Series B Preferred Stock may be redeemed, at the option of the Company, for cash at a redemption price of $32.32 per share.
On November 13, 1997, in connection with the Company's acquisitions of Fox Valley Center and Hawthorn Center, the Company issued $100,000,000 in cumulative convertible redeemable preferred stock ("Series A Preferred Stock") with a liquidation preference of $33.34 per share. Quarterly dividends on the Series A Preferred Stock are equal to the greater of (i) $0.50 per share or (ii) the quarterly dividend then payable on the shares of common stock into which the Series A Preferred Stock is convertible. The Series A Preferred Stock is convertible into common stock, at the option of the holder, at a conversion price of $33.34 per share (subject to antidilution adjustments) at anytime after August 1998. After six years, the Series A Preferred Stock may be redeemed, at the option of the Company, for cash at a redemption price of $33.34 per share.
As of December 31, 1998, the Company, which is the sole general partner of the Operating Partnership, owns approximately 67% of the common units ("Units") in the Operating Partnership; JMB Realty Corporation ("JMB Realty") and certain of its affiliates ("JMB Partners") and certain other parties own limited partnership interests in the Operating Partnership representing approximately 33% of the Units and also own $28,000,000 of convertible preferred units. The convertible preferred units have a liquidation preference of $27.50 per unit, a distribution rate of 7%, a redemption price of $27.50 per unit and a conversion price of $27.50 per unit to common units which in turn are convertible to common stock. After seven years, the convertible preferred units may be redeemed at the option of the Company for cash or may be converted at the option of the holder into common units. Each Unit may be exchanged for one share of common stock. In general, for financial reporting purposes, the net profits and losses of the Operating Partnership are allocated to the general and limited partners in accordance with their percentage ownership. The Company operates as a real estate investment trust ("REIT") for Federal income tax purposes.
The Company has a preferred stock investment in Urban Retail Properties Co. (the "Management Company") and is generally entitled to 95% of the distributions, profits and losses from the Management Company's management, leasing and development business and 5% of the net distributions, profits and losses from certain land parcels owned by the Management Company.
THE REGIONAL MALL BUSINESS
There are several types of retail shopping centers, varying primarily by size and marketing strategy. Retail shopping centers range from neighborhood centers of generally less than 100,000 square feet of GLA ("community centers") to regional and super-regional shopping centers. Retail shopping centers in excess of 400,000 square feet of GLA are generally referred to as "regional" shopping centers, while those centers having in excess of 800,000 square feet of GLA are generally referred to as "super-regional" shopping centers. In this report, the term "regional malls" refers to both regional and super-regional shopping centers and the term "Regional Malls" refers to the Company's fifteen operating regional malls at December 31, 1998. The term "Community Centers" refers to the Company's three operating community centers and the term "Properties" refers to the Regional Malls and the Community Centers. The term "GLA" refers to gross retail space, including anchors and mall tenant areas, and the term "Mall GLA" refers to gross retail space, excluding anchors. The term "anchor" refers to a department store or other large retail store. The term "mall tenants" refers to stores (other than anchors) that are typically specialty retailers and lease space in shopping centers.
BUSINESS OF THE COMPANY
A discussion of the business of the Company is hereby incorporated by reference to the discussion appearing on pages 1 through 10 of the Company's 1998 annual report to shareholders (the "Annual Report") under the captions "To Our Shareholders," "Development," "Asset Management," "Leasing," and "Property Management."
THE MANAGEMENT COMPANY BUSINESS
A discussion of the Management Company business is hereby incorporated by reference to the discussion appearing on pages 2 and 10 of the Annual Report under the captions "To Our Shareholders - Third-party business," and "Property Management."
ANCHORS
Regional malls (and many smaller centers) usually contain one or more anchors. Anchors, which include traditional department stores, general merchandise stores, large fashion specialty stores, value oriented specialty stores and discount stores, usually inventory a broad range of products that appeal to many shoppers. Anchors are one of the most important factors in differentiating among regional malls.
Anchors either own their own stores and parking areas or lease their stores from the owner of the mall. Although the rent and other charges paid by anchors is usually much less (on a per square foot basis) than the rent paid by tenants occupying Mall GLA, their presence typically attracts many shoppers and enhances the value of a shopping center.
Anchors in the Regional Malls occupy approximately 9.7 million square feet of GLA (approximately 61.4% of total GLA of the Regional Malls) and accounted for approximately 9.4% of total shopping center revenues of the Regional Malls in 1998. The table on the following page summarizes the square footage owned and leased by anchors in the Regional Malls at December 31, 1998:
MAJOR TENANTS
Non-anchor tenants owned by major national retail chains lease a considerable amount of space in the Regional Malls. In addition to enhancing a regional mall's popularity with shoppers, tenants affiliated with national chains help regional malls lease space by attracting many local and regional tenants.
Ten major national retail chains which had stores open and operating at December 31, 1998 accounted for 28.7% of the Mall GLA in the Regional Malls at December 31, 1998 and 25.4% of 1998 minimum rent of the Regional Malls. The largest of these chains, in terms of square footage and rent received, is The Limited, Inc., which, through all of its subsidiaries, accounted for 10.6% of the Mall GLA in the Regional Malls at December 31, 1998 and 8.0% of 1998 minimum rent of the Regional Malls. No other chain accounted for more than 3.7% of the Mall GLA in the Regional Malls at December 31, 1998 or 3.8% of 1998 minimum rent of the Regional Malls.
The following table summarizes the square feet leased by the ten major national retail chains in the Regional Malls at December 31, 1998:
ENVIRONMENTAL MATTERS
The Properties have been subjected to varying degrees of environmental assessment. Where formal environmental studies have been performed, the purpose of such studies has been to identify existing or potential environmental hazards and to seek cost effective remedies. All of the Properties have been the subject of Phase I environmental assessments, each of which either was conducted or updated since 1989. None of the environmental assessments has revealed, nor is the Company aware of, any environmental liability (including asbestos-related liability) that the Company believes would have a material adverse effect on the Company's business, assets or results of operations. However, no assurances can be given that environmental liabilities will not arise in the future that could have a material adverse impact on the financial condition or operations of the Company. There can be no assurance that there are no existing conditions on the Properties which have not been identified by the limited environmental assessments which have been conducted to date.
EMPLOYEES
At December 31, 1998, the Company, the Operating Partnership and the Management Company employed a total of 1,705 persons. The Management Company employs substantially all of the professional employees that are currently engaged in the management, leasing and development businesses, and certain of the professionals engaged in asset management and administration.
COMPETITION
All of the Properties are located in developed retail and commercial areas. There may be other neighborhood and community shopping centers within a five-mile radius of each of the Community Centers. In addition, with respect to most of the Regional Malls, there are one or more regional malls within a fifteen-mile radius. Certain of the Regional Malls are located near, and may compete with, certain regional malls owned by third parties managed by the Management Company or owned by JMB Partners and certain other parties or their affiliates; in addition, certain retailers are contractually restricted from operating at competing malls.
INFLATION
Inflation has remained relatively low during the past three years and has not had a significant impact on the Company. Substantially all of the tenants' leases contain provisions designed to protect the Company from the impact of inflation. Such provisions include clauses enabling the Company to receive percentage rentals based on tenants' gross sales, which generally increase as prices rise, and/or escalation clauses, which generally increase rental rates periodically during the terms of the leases. In addition, certain of the leases are for terms of less than 10 years which may enable the Company to replace existing leases with new leases at higher base and/or percentage rentals if rents of the existing leases are below then-existing market rates. Substantially all of the leases require the tenants to pay their share of operating expenses, including common area maintenance, real estate taxes and insurance, thereby reducing the Company's exposure to increases in costs and operating expenses resulting from inflation. However, inflation may have a negative impact on some of the Company's other operating expenses. Interest and general and administrative expenses may be adversely affected by inflation as these specified costs could increase at a rate higher than rents. Also, for tenant leases with stated periodic rent increases, inflation may have a negative effect as the stated rent increases in these leases could be lower than the increase in inflation at any given time.
The following two tables set forth certain rental information with respect to the Company's operating properties (including the Company's unconsolidated investment properties):
CONTRACTUAL STEPS
In certain cases, tenant leases contain provisions for periodic increases in the minimum rental rate. These increases do not necessarily result in increased funds available for distribution of a corresponding amount. The amount of the increase is mitigated by possible changes in a tenant's percentage rent breakpoint or amount, lease expirations and terminations and the Company's ownership interest in a property. The table below shows contractual rent steps for the years 1999 through 2003 for the Properties in total and for the Company's pro rata share of the Properties (based on the Company's percentage ownership in each property):
CONTRACTUAL STEPS COMPANY'S (in thousands of dollars) TOTAL PRO RATA SHARE - ------------------------- ------- --------------
1999. . . . . . . . . . . . . . $ 1,998 $ 1,683 2000. . . . . . . . . . . . . . 2,324 1,649 2001. . . . . . . . . . . . . . 1,966 1,474 2002. . . . . . . . . . . . . . 1,942 1,536 2003. . . . . . . . . . . . . . 1,329 1,186
LEASE EXPIRATIONS
The table below shows the square footage of lease expirations and the average rent per square foot of the expirations for the Company's retail tenants (excluding anchors, movie theaters and temporary tenants) for the years 1999 through 2003 for the Properties in total and for the Company's pro rata share of the Properties (based on the Company's percentage ownership in each property):
TOTAL COMPANY'S PRO RATA SHARE --------------------------- --------------------------- EXPIRATIONS AVERAGE EXPIRATIONS AVERAGE YEAR (S.F.) RENT/S.F. (S.F.) RENT/S.F. - ---- ----------- ---------- ----------- ----------
1999 . . . . . 253,852 $ 27.98 201,846 $ 25.79 2000 . . . . . 279,364 29.46 226,245 27.73 2001 . . . . . 273,195 35.36 234,935 33.40 2002 . . . . . 364,388 32.04 250,906 29.39 2003 . . . . . 381,850 31.82 290,083 29.82
OAKBROOK CENTER GROUND LEASE
The following is a description of the Oakbrook Center ground lease.
On December 31, 1990, Oak Brook Urban Venture (a consolidated venture) sold the land underlying Oakbrook Center for $75,000,000 ("ground sale-leaseback proceeds" or "Lessor Base Amount") and leased it back for a period of 50 years with options to renew for an additional 49 years. For financial reporting purposes, the ground sale-leaseback proceeds were accounted for as a financing transaction. Minimum annual rent to the ground lessor accrues at 5% of the Lessor Base Amount, a portion of which may be deferred based on available cash flow (as defined) from Oakbrook Center. Deferred amounts accrue interest at 5% per annum. In each of the years 1998, 1997 and 1996, Oak Brook Urban Venture reported rent expense of $3,750,000 of which payment of $2,150,000 has been deferred in 1998 and $2,350,000 has been deferred in 1997 and 1996. Interest has been accrued and deferred of approximately $1,143,000, $982,000 and $823,000 for 1998, 1997 and 1996, respectively, on the deferred balance. The total deferred interest and ground lease rent included in the accompanying consolidated balance sheet at December 31, 1998 is approximately $24,984,000.
The Oakbrook Ground Lease was amended, effective upon closing of the Company's initial public offering, to escalate the minimum annual payment from $1,200,000 to $1,800,000 for the period 1994 to 2000. Payment of the portion of the annual rent of $3,750,000 in excess of the minimum annual payment is deferred to the extent that the rental income is inadequate to (i) pay all expenses (including debt service), (ii) provide an amount equal to the excess of 5.5% of gross revenues over property management fees actually paid to the property manager (currently 2.5% of gross revenues) and (iii) allow the lessee to recover a 10% yield on its investment (as defined) in Oakbrook Center (cumulative from the date of the amendment, subject to certain limitations). So long as the lessee has recouped such 10% yield, the rental income in excess of expenses (including debt service and minimum annual rental) is used to pay the deferred annual rental plus yield thereon of 5%. Excess rental income remaining after payment of the deferred annual rental plus the 5% yield will be used as follows: (i) the lessee is entitled to retain $1,250,000 per annum cumulative plus a yield thereon of 5% per annum and (ii) 50% of any remaining amount of rental income will be paid to the lessor as participating rent and 50% will be retained by the lessee.
No participating rent is owing upon the sale of the lessee's interest in the Oakbrook Ground Lease, unless the lessee elects to cause the ground lessor to join in the sale. If the lessee desires to sell its leasehold interest, the ground lessor has a right of first refusal and (if it does not elect to exercise the right of first refusal and purchase the lessee's interest) a right to approve (in its reasonable discretion) the transferee. If the lessee elects to cause the ground lessor to join in the sale, the combined net proceeds (after payment of the debt) would be divided between the ground lessor and lessee as follows: (i) the lessee would first be entitled to recoup its investment (as defined) in the project, plus any shortfalls in the 10% yield thereon (subject to certain limitations); (ii) next, the ground lessor would be entitled to any deferred annual rental plus a yield thereon of 5% per annum; (iii) next, the ground lessor would be entitled to $75,000,000; (iv) next, the lessee would be entitled to $25,000,000 plus any shortfalls in its 5% yield thereon (although the amount described in this sentence may instead have to be paid over to the ground lessor, to the extent that the ground lessor has not otherwise received from all rent and its share of sale proceeds $75,000,000 plus a 10% internal rate of return thereon from the commencement of the term of the ground lease, subject to a limitation based on what would be owing on the 10% internal rate of return if calculated as of the 50th anniversary of the lease); and (v) the balance is split 50% to the ground lessor and 50% to the lessee.
Pursuant to the Oakbrook Ground Lease, the lessor has the option, commencing seventeen years (fourteen years under certain circumstances) after the amendment of the Oakbrook Ground Lease, to put the property to the lessee for cash or, at the option of the Company, Units or shares of Common Stock, at a price based, in general, upon the ground rent for the twelve calendar month period preceding the exercise of the put. In calculating the price of the ground lease, the ground rent, as adjusted, is capitalized at a rate not lower than 50 basis points (.5%) over the dividend rate of the Company for twelve calendar months preceding the exercise of the option (using the average price per share during the twelve-month period). Several adjustments are made in calculating the application of the cash flow to ground rent for purposes of the put, including the following: (i) the ground lessor will be limited, as to rent deferred from prior years, to 5% of the balance thereof, (ii) the lessee will be limited to 10% of its investment and 10% of the cumulatively deferred yield (instead of the full deferred amount), subject to various limitations, (iii) as to the $1,250,000 per annum described above, the lessee will be limited to $1,250,000 for the current year plus 5% of the balance owing for previous years and (iv) capital expenditures and principal amortization are excluded from the expenses used in calculating the cash flow for purposes of determining the ground rent to capitalize.
ITEM 3. LEGAL PROCEEDINGS
The Company and its subsidiaries are not subject to any pending material legal proceedings. The Company and its subsidiaries are parties to a variety of legal proceedings arising in the ordinary course of their business. It is management's opinion that the ultimate resolution of these matters will not have a material adverse impact on the financial condition, results of operations or liquidity of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to the Company's shareholders during the fourth quarter of 1998.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The information required by this item is hereby incorporated by reference to the material appearing on pages 37 and 38 of the Annual Report under the captions "Quarterly Financial Summary" and "Shareholder Information."
ITEM 6. SELECTED FINANCIAL DATA
The information required by this item is hereby incorporated by reference to the data appearing on page 37 of the Annual Report under the caption "Selected Financial Data."
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The information required by this item is hereby incorporated by reference to the material appearing on pages 14 through 21 of the Annual Report under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations."
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by this item is hereby incorporated by reference to the material appearing on pages 19 and 20 of the Annual Report under the caption "Financial Market Risk Disclosure."
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this item is hereby incorporated by reference to the "Consolidated Balance Sheets," "Consolidated Statements of Operations," "Consolidated Statements of Stockholders' Equity," "Consolidated Statements of Cash Flows," "Notes to Consolidated Financial Statements," "Independent Auditors' Report" and "Quarterly Financial Summary" appearing in the Annual Report on pages 22 through 37.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item is hereby incorporated by reference to the material appearing on pages 2 through 5 of the Company's definitive proxy statement for the annual meeting of shareholders to be held in 1999 (the "Proxy Statement"), under the captions "Election of Directors" and "Management - Directors and Executive Officers" and on page 23 of the Proxy Statement under the caption "Section 16(a) Beneficial Ownership Reporting Compliance."
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is hereby incorporated by reference to the material appearing on pages 6 through 12, 14 and 15 of the Proxy Statement under the captions "Executive Compensation - Summary Compensation Table," " - Aggregated Option Exercises in 1998 and Year-End Option Values," " - Option Plan," " - Incentive Unit Program," " - Incentive Compensation," " - 401 (k) Plan," " - Core Retirement Award Program," " - Deferred Cash Compensation Plan," " - Compensation of Directors," " - Employment Contracts, Termination of Employment and Change-in-Control Arrangements", " - Compensation Committee Interlocks and Insider Participation" and "Proposal 2 - Approval of Incentive Stock Program."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is hereby incorporated by reference to the material appearing on pages 21 through 23 of the Proxy Statement under the caption "Security Ownership."
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is hereby incorporated by reference to the material appearing on pages 19 and 20 of the Proxy Statement under the caption "Certain Relationships and Related Transactions."
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report:
(1) Financial Statements
The consolidated balance sheets as of December 31, 1998 and 1997 and the consolidated statements of operations, stockholders' equity and cash flows for each of the years ended December 31, 1998, 1997 and 1996 together with related notes and the independent auditors' report dated February 5, 1999, except as to note 12, which is as of March 1, 1999, appearing on pages 22 through 36 of the 1998 annual report to shareholders, which is filed as Exhibit 13.1 to this report.
(2) Financial Statement Schedule and Independent Auditors' Report
Title Schedule ----- ---------
Consolidated Real Estate and Accumulated Depreciation III
The independent auditors' report with respect to the financial statement schedule is on page 21.
(3) Exhibits
See Exhibit Index, which is hereby incorporated herein by reference.
(b) The following report on Form 8-K was filed during the fourth quarter of 1998.
(i) The Registrant's report on Form 8-K (describing the acquisition of Woodland Hills Mall) was filed on December 21, 1998 as an Item 5. Other Events filing.
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders Urban Shopping Centers, Inc.:
Under date of February 5, 1999, except as to note 12, which is as of March 1, 1999, we reported on the consolidated balance sheets of Urban Shopping Centers, Inc. and consolidated partnerships (the Company) as of December 31, 1998 and 1997, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1998, as contained in the 1998 annual report to shareholders. These consolidated financial statements and our report thereon are incorporated by reference in the annual report on Form 10-K for the year 1998. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related financial statement schedule as listed in Part IV, Item 14(a)(2). This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits.
In our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
KPMG LLP
Chicago, Illinois February 5, 1999
Consolidated Real Estate and Accumulated Depreciation - Continued December 31, 1998 ($000's omitted)
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(A) The initial cost to the Company approximates historical cost at October 14, 1993.
(B) The aggregate cost of real estate owned and the related accumulated depreciation at December 31, 1998, for Federal income tax purposes was approximately $1,165,000 and $129,000, respectively.
(C) Properties operated under ground leases; see Item 2