波士頓物產 (BXP) 2003 Q2 法說會逐字稿

At this time, I would like to welcome everyone to the Boston Properties second quarter 2003 results conference call. (CALLER INSTRUCTIONS). Ms. Koeneman, you may begin your conference.

Hi, good morning, and welcome, everyone to Boston Properties second quarter conference call. The press release and supplemental disclosure package were distributed last night as well as furnished on Form 8-K to provide access to the widest possible audience. In the supplemental disclosure package, Boston Properties has reconciled all non-GAAP financial measures to the most direct comparable GAAP measures in accordance with Reg G. requirements. If you did not receive a copy, these documents are readily available on the Company's web site at www.BostonProperties.com in the Investor Section. Additionally, we're hosting a live webcast of today's call, which you can also access and in that section. Following this live call, an audio Webcast will be available for twelve months on the Company's Website, as well, located in the Investor section under the header "audio archive." To be added to the Company quarterly distribution list, please contact the Investor Relations Department of BXP at 617-236-3322.

At this time, management would like me to inform you that certain statements made during this conference call which are not historical may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Although Boston Properties believes that expectations reflected in any forward-looking statements are based on reasonable assumptions, it can give no assurance that its expectations will be attained. Factors and risks that could cause actual results to differ materially from those expressed or implied by forward-looking statements are detailed in yesterday's press release and from time to time in the Company's filings with the SEC. The Company does not undertake a duty to update any forward-looking statements.

Having said all of that, I would now like to turn the call over to management. With us today we have Ed Linde, President and Chief Executive Officer, and Doug Linde, Chief Financial Officer. Additionally, several members of management will be available during the Q&A portion of the conference call. Without further ado, I will turn this over to Doug.

Thank you, Claire. Good morning, everyone and thanks for joining us for our review of the second quarter results and our comments on the outlook for the remainder of '03. I hope you will find that our remarks this morning are consistent with the views that we've been giving and sharing during the last few quarters. While recent monetary, and certainly, people may disagree with the stimulus that the President has put in place, but with the stimulus package has been fashioned in an attempt to stimulate economy. From our window on the world, we have not yet seen any significant impact on business if any. Nationally, there's no evidence of job growth. And as we review our own portfolio, on the one hand, we have seen occasional examples of expansion in the financial services sector, where we have profit from the consolidation, but it's probably reduced overall occupied space in the market. We have had isolated pockets of growth by some successful technology-related enterprises. And we have had expansion by tenants closely associated with government agencies or procurement.

On the other hand, we have continued to suffer, albeit on a limited basis, from bankruptcies and restructuring the weaker companies in a diverse group of industries. To add some anecdotal evidence to these observations, in the last quarter, we had a New York City law firm take additional space in 599 as it took on lawyers from a rival firm that was disbanding. A semiconductor company grew from 7000 to 28,000 square feet in our Waltham Weston project. And a defense contractor requested for us to build a parking garage so they could expand their headcount in a facility in Northern Virginia. At the same time, a Philadelphia-based law firm defaulted on its lease in Boston at 265 Franklin Street. And an insurance company located in Embarcadero Center was taken into receivership by the State of California, and it rejected its lease.

We have not seen any generalized pattern of real estate demand recovery in the markets that we follow. As we will discuss later, there is activity in our markets. Our leasing associates are making significant progress in the portfolio. Our relative outperformance of the market continues to increase, and in certain regions, there is some positive absorption. In fact, we had true net absorption in Northern Virginia last quarter, where we actually raised rents by 50 cents a square foot during a recent lease negotiation. And while we're optimistic that market conditions will not deteriorate further, we don't expect to see any meaningful improvement in '03, and well into '04.

The current economic environment notwithstanding, we are pleased, pleased, pleased with our corporate performance, which is a testament to our strategy of developing and acquiring a portfolio of the highest quality assets, leased on a long average term basis to tenants with strong balance sheets. During the last quarter, we took the opportunity to further lock in long-term fixed-rate debt; and on May 22nd, we issued an additional $250 million of 12 year notes at a yield of 5.075 percent. Our floating rate debt now consists almost entirely of our construction loans on Time Square Tower and the New Dominion project in Virginia, about $308 million in total, as well as our joint venture debt on Two Freedom Square in Reston and 265 Franklin Street in Boston. Floating rate debt now encompasses 7.2 percent of our total debt. We refinanced $430 million of short-term debt during the quarter, and we ended the quarter with a cash balance of $159 million. Clearly, holding the cash is dilutive in the short run by about 5 cents per share per year. We have been operating BP for 33 years, the last six as a public company, and as we said before, we are prepared to sacrifice short-term results for long-term financial stability and performance.

Consistent with the valuation data we provided over the past few quarters from our portfolio sales, high-quality real estate office buildings in our markets are being sold in private transactions at historically high valuations. This continues. Just last week, we were dramatically outbid on a soon to be completed rehab mid-block DC office building. The building is 40 percent leased, and based on our underwriting, the building will trade at a stabilized cash NOI yield in '05 of just under 8 percent at a cost of over $470 per square foot, assuming the 60 percent vacancy is covered at acceptable rent. And in Princeton, two buildings adjacent to Carnegie Center, sold for over $250 per square foot, at a mid-eight NOI return just last week. Despite the strong performance in the equity markets, which might offer attractive alternative investments for capital, there continues to be a strong appetite for high-quality office properties in our core markets.

Within the context of the current business climate, we had a very strong quarter as demonstrated by the performance measures we will review in the next few minutes. Last night we reported, second quarter funds from operations on a fully diluted basis of $1.03 a share. This is slightly above the high end of our prior guidance, and 3 cents above First Call. Net income for the quarter was 64 cents per share diluted, reflecting increase of 8.5 percent over net income from the second quarter of '02 of 59 cents per share. These results include the effects of some gains on sales from properties and other assets. If you exclude the gains, net income for the quarter would have been 61 cents per share diluted, an increase of 3.4 percent. Our in-service portfolio occupancy was 92.8 percent as of June 30th, 2003, down slightly compared to 93 percent last quarter. The portfolio changed slightly, with the addition of our Shaw's project at the Prudential Center, and the completion of Two Freedom Square in Reston Town Center. The second quarter 2003 same property for occupancy, which is the measure we look at very carefully, dropped slightly from 92.7 percent compared to 93 percent in the first quarter of '03.

As we mentioned a few minutes ago, we experienced two unanticipated tenant defaults in the quarter. In May, 100,000 square foot insurance company located in San Francisco went into receivership. The good news is the space was entirely sublet. The bad news was that the rent that the tenant was paying was about $1.2 million per year more than the subtenant on an annual basis. The second situation involves a 45,000 square foot law firm in Boston that stopped paying rent in June. Although they continue to be in possession of the space, we have not accrued or collected rent since June 1st.

There were very few changes in our individual property occupancy statistics in the second quarter. The only significant change is the reduction of almost 9 percent in our Democracy Center occupancy -- that's in Montgomery County Maryland -- from the expiration of a 75,000 square foot lease. Not showing in the statistics yet are signed leases which bring our occupancy at 2 Discovery to 96 percent, and at 7435 and 7431 Boston Boulevard, which are in our VA 95 complex in Springfield, we have leased the remaining space to the GSA though possession won't occur until later in the year. At building 506 in Carnegie Center, we continue to receive contractual rent under a guarantee from Raytheon, so economically, that building is 100 percent leased; and we are now -- we have 16,000 square foot that is still covered by that guarantee, and we have a lease pending on 13,000 square feet. Finally, we have good activity at Weston Waltham Corporate Center; we're actively working on three transactions totaling more than 65,000 square feet.

We made significant leasing progress on our development properties during the quarter. We completed the leasing at Two Freedom Square, with a 13-year lease to Titan Systems, bringing that full building into service. And executing this transaction, we were also able to absorb all of the sublet space in the building and in fact require an existing tenant to relocate to an adjacent competitive building not owned by Boston Properties. At 901 New York Avenue, we signed a third lease and are now at 77 percent leased up from 60 percent last quarter. And in New York City, we signed an additional 57,000 square lease at Time Square Tower, which includes a future requirement to lease an additional 26,000 square feet; that is a 20-year lease. This brings the total lease space at Times Square to 23 percent of the office space.

We expect our occupancy to decrease in the third and fourth quarters as we've talked about in previous call, based upon uncovered 2003 lease expirations which take into effect. We anticipate losing somewhere between 75 and 100 basis points of occupancy during the second half of '03. The most significant vacancy comes from the the next four buildings. 170 Tracer Lane in Boston, we have 27,000 square feet that we are -- became vacant on July second. In Harvard Street in Boston suburbs, our one remaining industrial building, we have 170,000 square feet that becomes vacant in August. 651 Gateway in South San Francisco, 140,000 square feet will vacate in October. We are renewing AT&T on a couple of floors, but the vast majority of their space is rolling over on the dark. At Carnegie Center, Buildings 104 and 211, we have about 70,000 square feet rolling over in November. And in Baltimore, we're getting back a floor of about 40,000 square feet in November as well.

Including the above lease expirations, our remaining office lease rollover for '03 is at 2.5 percent, and is at 6.7 percent for '04. The average remaining lease term for the portfolio as of the end of the quarter still is 7.1 years.

In the second quarter, lease terms commenced on approximately 495,000 square feet of second-generation space for a net decrease of 22 percent, net to net on the rents on those deals that commenced in the quarter. Many of those leases were negotiated in prior periods, and it's important to emphasize that these results are consistent with our internal expectations, and with the guidance we've previously provided, and is likely to be consistent with what you see quarter after quarter for the foreseeable future.

Our regional results were as follows. In Boston, we leased 114,000 square feet. That was at a 14 percent decrease net rent to net rent. San Francisco, 243,000 square feet, a 39 percent decrease. That includes the change in lease from the tenant that went into receivership and the subtenant that then became prime tenants with the Company. In Washington D.C., 86,000 square feet, a 2 percent decrease. Princeton was negligible -- only 3000 square feet in the quarter, a 6 percent decrease. And in New York City, we released 49000 square feet, and that was actually a 25 percent increase. That makes sense because most of the leases that we have in New York City that are rolling over are generally tenant 15-year leases, and therefore, they were done in the late -- the early '80s to the mid-'80s, and therefore, as they come rolling over today, they still are below what the current market is.

To add some additional statistical color for these second-generation leasing activities, 114,000 square feet leased in Boston is made up of 19 leases, the largest was 21,000 square feet. Fifty-two percent of that was renewals or expansions. In D.C., the activity involved 15 leases. That does not include Two Freedom Square, or 901 New York Avenue, which are first generation. And 72 percent of that space was renewals or expansions. And in San Francisco, renewals and expansions made up 81 percent of the activity. In New York City, three tenants expanded into -- that 49000 square foot of additional space.

During the last call, we were asked to discuss our most recent leasing activity, i.e., the level transactions negotiated in the quarter. During the second quarter, we signed a total of 933,000 square foot of leases. That would be our gross activity. The majority of these leases didn't commence in the second quarter, and include early lease renewals, leases covering current and future vacancies, and leases involving our development properties. On a comparable basis, the number for last quarter, that same universe of space, is about 813,000 square feet. So, the trend is obviously popular.

Excluding the hotel results, same-store NOI growth was negative .2 percent on a GAAP basis, and positive 2.1 on a cash basis. And again, this is consistent with the guidance we have given of basically flat, same-store, year to year.

Our three Boston area hotels continue to have a tough time of it RevPAR was down 14 percent, and NOI was down 20 percent. And during the second quarter, the hotels were almost $1 million below our prior forecast. We are revising our second half 2003 hotel NOI contributions down to 11.2 from $11.9 million. The quarterly breakdown would be 41 percent for the third quarter, and 59 percent for the fourth quarter. The full-year hotel NOI contribution is now below our 1997 NOI numbers, and about 50 percent of its high in calendar year 2000. As we said last quarter, selling the hotels in this depressed market does not make any sense. When the hotels recover, they will be strong candidates for sale as part of our future capital recycling program.

Included in the second quarter results are termination fees totaling approximately $1.4 million, stemming from five transactions. This is in line with our budget and previous guidance of between 1 and $2 million per quarter. We continue to expect that on a going forward basis as we move on into the year. Ninety percent of this revenue came from two sources. We've collected a $420,000 security deposit from a 35,000 square foot tenant at E.C., where we have successfully released the majority of the space to a subtenant and we are in negotiations for the remaining space. And finally, we received $858,000 to cover transaction costs associated with the releasing of our Raytheon guarantee at Carnegie Center, and had to take that in as revenue in termination income.

We implemented an enhanced property expense budgeting package last quarter, and we are now reforecasting our property expenses quicker and with much more accuracy. During the second quarter, as we trued up, we had property level expense savings of $2.4 million across the portfolio based on revised budgets. Looking back at our second quarter margin over the last few years, exclusive of the hotels, generally it's been between 67.8 and 69.9 percent. This quarter, the margin actually surpassed the top end of the range landing at our historical high of 70.1 percent.

As we move forward, we expect to have more quarter-to-quarter variability based upon the seasonality of certain expenses like electricity, which we are truing up much sooner, especially during the third quarter which covers the majority of the summer cooling expense. Our third quarter property level expense is anticipated to be about 10 percent greater than the second quarter figure. In addition, the third and fourth quarters, we expect a reduction in our comparable period margins due to increases in base from operating expenses, increase in taxes and base from operating expenses as well as the increase of vacancy between 75 and 100 basis points I spoke about a few minutes ago.

Two quarters ago, we implemented an internal rating based analysis of our accrued rent asset to arrive at an appropriate reserve, calculated on a tenant by tenant basis, and we rate all our tenants between "strong performance" to "in bankruptcy". At the end of the first quarter, the reserve was $5.7 million, on an accrued rent balance of about $161 million. This quarter, the reserve is $5.9 million, so it went up slightly by $200,000 to -- on an accrued rent balance of $173 million. So as a percentage, it's obviously down. As you review our exposure to tenant defaults, we continue to see cost concerns, though the pace clearly seems to have slowed. We still see weaker companies failing even as we enter a period of economic growth. As we mentioned earlier, we did experience those two significant failures during the quarter. But on a positive note, this quarter after taking into consideration the write off associated with these defaults, our bad debt reserve against our second quarter revenues increased by only $75,000. And this is a testament to our collection efforts where we successfully recovered against other prior bad debt expense.

Our second generation office leasing costs, ends at about 85 percent of our average run rate at $13.61 per square foot. And we continue to complete a significant number of transactions on an as is basis with minimal tenant concessions. While we've seen dramatic declines in face rents, we have tried to minimize upfront capital costs wherever possible. We are not buying rent at the cost of providing extensive improvement allowances.

Our FAD ratio during the second quarter stood at 71.4 percent, including the total leasing costs associated with the leases beginning in the second quarter and recurring capital expenditures for all properties including the hotels. During the quarter, we also raised the common dividend 8 cents per share annually. The recurring capital expenditures for the second quarter were in line with our normalized quarterly rate of between 10 and 15 cents per square foot. We do expect to have an above normal recurring capital expenditure next quarter as we catch up on the spending that we had not anticipated -- spending that we didn't do in the first quarter of calendar year 2003.

During the quarter, we gave notice of redemption converting our Series One Preferred Units into 2.1 million common shares, effective August 12, 2003. So next quarter, this FAD ratio will need to be done after taking into effect our reduced preferred dividend as well as the increased common dividend.

Our estimates of average market rents in our markets are as follows. In the CBD of Boston, we have lowered from the high 30s from the low 40s. Suburban Boston continues to be in the mid-to-low 20s. San Francisco CBD, while there is an occasional deal with a four in front of it, the majority of our space is somewhere between 38 and $30 per square foot. So on average, about the high 30s. Suburban San Francisco, which is made up of Gateway, low 20s. CBD Washington D.C., low 40s. Northern Virginia, high 20s. Montgomery County, low 30s. Midtown Manhattan, low 60s. In Princeton, low 30s.

If we look at the portfolio on a regional basis, we still have a slight market to market positive in New York City, flat in D.C. and Princeton, and it continues to be negative in Boston and San Francisco. Since we have very little rollover in New York City in the next year, we'll continue to experience the roll down in face rents across the portfolio in the short run. The embedded marked to market is now standing negative $2.61 per square foot. And this translates to about 56 cents per year per year. Based on second quarter results, each one percent change in occupancy is about $11 million -- so at 92.8 percent occupancy, incremental revenue potential from the vacancy is $80 million or 63 cents per share.

Our G&A expense was $11 million in the second quarter, and we expect for the full year it could be between 44 and $46 million. This includes an anticipated 50 to 75 percent increase in our D&O premiums -- that's the insurance -- as well as the costs associated with a nine rather than a seven member Board of Directors and all the other legal and administrative costs associated with corporate governance.

Year-to-date, we have capitalized wages of $2.5 million, which are netted against the above G&A estimates. This number compares to about 2.5 million through the first half of '02, and we are budgeting capitalized wages of about the same for the remainder of '03.

During the third quarter, our share count -- excuse me -- during the second quarter, our share count increased by 1.4 million shares to 127.8 million shares on a fully diluted basis. This increase originated from two sources. First, our average weighted stock price went from 36.58 to 41.36. Accounting for employee options required an increase of 660,000 shares based upon the stock price depreciation. In addition, employees exercised 1 million options at an average price of $30.09. The Company's current practice is to issue shares and receive the option price from the employee. So an incremental 750,000 shares were added to the fully diluted share count during the quarter. To put the option exercises in perspective, the activity this quarter included 8.5 percent of the options outstanding. Options have a finite life, and for purposes of financial planning, employees of Boston Properties, including some members of senior management, made a decision that it was an appropriate time to sell a portion of their grants. You should also be aware that in February of '03, Boston Properties enacted a senior management ownership policy, which requires employees to reach and maintain equity ownership in amounts 2 to 3 times annual salary, depending on job responsibility. Options are not counted into fulfilling this requirement.

We provided FFO guidance of $3.98 to $4.04 per share last quarter. And at this time, we're now in our range of $3.99 to $4.02 as we reported last night in our press release. This was all based upon the new share count projections. The quarterly breakdown is in the release -- third quarter, 96 to 97, fourth quarter, 97 to 99. Net income for '03, 360 to 367; the quarterly breakdowns, third quarter, 51 to 54 cents; fourth quarter, 54 to 58. We are not comfortable providing any guidance for '04 at this point.

And our critical assumptions for the remainder of '03 are as follows. We have assumed about 100 basis point decrease in the occupancy of the portfolio, and assume no increases in short-term rental rates on a going forward basis into ' 03. The third quarter margin is expected to be somewhere between 66 and 67 percent, due to the timing of expenses in the quarter and the decline in occupancy. The margin in the fourth quarter is expected to rent -- to remain -- between that same range of 66 and 67 percent. These are margins for the office portfolio only, excluding the hotel income expenses, and we have given you the hotel NOI previously.

We look for flat to slightly negative same-store portfolio growth as we benefit from the full-year of 5 Times Square and 111. We anticipate few positive or negative surprises in '03 other than, as we experienced this quarter, the unexpected major tenant failures. We expect to have straight-line rents of approximately 22 million for the remainder of the year, as compared to 21.5 for the first six months. Again, we continue to expect to have termination fees of between $1 and $2 million per quarter. Our third party fee income is expected to continue to run at our expectation from last quarter of about $16 million for the full-year. We expect a lower contribution from the hotels, as I said, and are budgeting $11.2 million for the remainder of '03; that's $700,000 down from the previous guidance.

We are estimating G&A to be between 44 and $46 million. And on our January Board meeting, the comp committee approved granting -- the granting of restricted stock for officer level employees and certain other individuals and granted no stock options. I guess we were about six months in front of Microsoft. The 2003 award has a value of about $6.5 million and vests over the last three of the five-year period. However, about a fifth of this expense will be taken each year. So the 2003 G&A expense includes $1.5 million associated with the restricted stock.

We have assumed the acquisitions of Terrabrook's interest in One and Two Freedom Square during the third quarter. More information on this transaction will be provided when it is finalized.

Any new acquisitions will be subject to the effect of FASB 141, which in part involves the fair value of leases. Under this accounting rule, the non-cash charge associated with One and Two Discovery, acquired on April first, total about $167,000 for the quarter. This is highlighted in our supplemental information and is a non-cash deduction for purposes of calculating funds from operations.

The full impact of our revised financing activities are in our numbers. We now have $1.475 billion of floating rate debt that was replaced by $1.475 billion of fixed-rate debt. The average interest cost is 5.95 percent. This is an increase of about $7.5 million per year, on an annualized basis, from the assumption we provided last quarter. The low end of our range anticipates the early extension of leases with post-2003 expirations, which would have a negative short-term impact from return for recovering long-term tenant vacancy exposure. And we are negotiating such deals in Boston and in Washington D.C., each individually between 190,000 and 280,000 square feet.

With that, I will turn the call over to Ed.

Good morning, everyone. I intend my remarks to be quite brief this morning, and will allow plenty of time for Q&A. I don't want to be repetitious of what Doug has already gone over. In fact, as I prepared for this morning, I wondered whether I was going to simply be repeating comments from earlier calls since, in general, the conditions in the markets in which we operate have shown no significant change, and the factors which would signal a leasing turnaround has still not appeared. As Doug said, no job growth, no evidence that CEO confidence in a recovery matches economists' optimism that a recovery is underway. However, that being said, perhaps we are starting to see signs that if the upturn isn't immediate, at least an inflection point may be near. There is, in fact, positive absorption in some markets, and we are even hearing rumors that brokers may be telling clients that there is little room for further rental declines, and warning their clients that tenants who wait too long may face rising rather than falling rental rates.

Now, to-date, that really hasn't translated itself into actual increases in rents. And in fact, we are still seeing some landlords doing deals which only cover part of operating costs and real estate taxes, at least if they apply an honest rate of return to transaction costs. Fortunately we don't believe that is necessary for the better quality buildings in superior locations. And in fact, as we've said before, tenants seem to be taking advantage of the weak market to upgrade to higher quality space at rates that they know will be unapproachable when conditions change. That obviously plays to Boston Properties' strength.

It is that reason, along with a manageable rollover rate and the very hard work of our marketing staff that has enabled us to keep our portfolio in such good shape. Let me put just a little bit of additional color, region by region, on the statistics Doug has reported. As he mentioned, the Washington D.C. area has been one market where net absorption has been positive. And with the signing of the deals at 901 New York Avenue to bring us up to 80 percent committed more than a year before first occupancy, and our success in bringing our Reston Town Center portfolio with the two deals Doug mentioned up to 100 percent, and that is 100 percent of 1,650,000 square feet, we are feeling very good about our position in that market, especially when we compare ourselves to some of the more commodity buildings, which are having -- still having -- difficulty in attracting tenants. Those conditions apply to the rest of of our D.C. portfolio, which is characterized by low vacancy and low rollover.

In the Boston region, the overall market is still anemic. And, if you adjust for certain statistical anomalies, which actually, this quarter, showed that net absorption downtown was positive, when in fact, that really stems from certain buildings coming on stream that were fully leased, although much of the space is available for sublease -- we still see net absorption actually being negative. However, activity is up. And, we are working on deals that would bring, for example, our Weston Waltham Corporate Center up to an occupancy level of above 70 percent. And that would be -- that would be quite noteworthy in this market. And once again, I think it represents the impact of quality on tenants' perspective of where they want to be and what kind of buildings they want to move into at a time when they can move at very attractive rental rates. Unfortunately, much of this movement is lateral. So our good fortune comes at some other landlord's expense.

The normal summertime slowdown has reduced activity in the marketplace. But, I think all of our marketing associates would report that activity's certainly greater than it was this time last year. There are more tenants in the marketplace. They're looking at space. They're asking for proposals. And that, obviously, is a good sign.

Turning to New York -- our existing properties are in excellent shape. Our major exposure is obviously Times Square Tower. We are very pleased with the two-floor deal that Doug reported, but the Manhattan office market is still feeling the effects of continued job shedding by financial service firms. There are very few tenants seeking large blocks of space over the next few years. And while we are aggressively pursuing those that exist, we recognize that single through four or five-floor deals may be the way that we complete leasing this Tower. We are ignoring no potential user.

The San Francisco region remains the most challenging. Depending upon which brokerage company report you want to read, absorption in the CBD is either negative by several hundred thousand square feet or flat. And I suppose that's the good news, because probably a year ago, no broker's report showed flat absorption, or stability in the market; they were all showing major negative absorption. On the Peninsula and down at the Silicon Valley, vacancies remain at historical levels, with no relief in sight. Fortunately downtown, the highest quality north of Market Street downtown buildings, like Embarcadero Center, are holding their occupancy, but at significantly lower rents. New space still commands a premium, and we have made several attractive deals in the 10,000 to 30,000-square-foot category. Unfortunately, as Doug reported, bankruptcies and defaults have made our jobs harder, although in most cases, subtenants who have now become direct tenants, have ameliorated, although not eliminated, the pain.

In South San Francisco, the market to date has shown no signs of life. And we project increasing vacancy at a Gateway project as existing leases terminate either naturally or through bankruptcies.

Princeton is another region where the quality and location of our properties has confirmed the wisdom and the market focus central to our basic strategy. Carnegie Center has maintained 95 percent plus occupancy in a market where the overall vacancy is reported to be in the high teens. And rent levels at our project have remained constant in the low 30s.

With that, let me open the call to questions.

(CALLER INSTRUCTIONS). Jonathan Litt with Smith Barney.

Good morning. A couple of questions. First, Doug, and I will get this from you off-line, but you ran through the rents by market pretty quick. I'm going to hit a couple of them in my questions. I was intrigued by your comment where you said you thought that the market conditions will not deteriorate any more, but you'll see no improvement into ' 04. It seems as though market conditions may have weakened from what I did get from your rent -- would have from last quarter to this quarter -- your changes in rent -- what leads you to believe they're not going to deteriorate any more and that -- if that's the case, that there won't be any improvement?

This is Ed, John. I think the problem of course you have when you look at any statistics is that you're looking at, you know, you're looking at a very small snapshot of deals. So, any one particular deal may show a roll down in rent because of exactly where the building is or what the existing lease was. We are just not seeing further rental erosion, but we are not seeing an awful lot of activity. So, you know, there is just no pressure. And that means that we think things are just going to bump along for a while. And so, we don't see our occupancy increasing, but we don't see our rental rates having that much more downward movement in it either sense, you know, since there comes a point where we and the other landlords are just not going to make deals.

You have 1.8 million square feet in your office portfolio rolling in '04, at roughly $38 a foot. It seems as if there are a few key markets to be focusing on, where there's a lot of space rolling or expensive space rolling. The ones I had questions on were San Francisco, where you have over a half a million square feet rolling at $45 a foot. Sort of two questions here. One is, what do you think the market rent is for that space today? And the other is, are there tenants -- I mean, what do you think your renewal percentage will be? I assume if there's any real concerns there, you know about them by now.

John, just to be specific, and Bob Pester can chime in here if he's on the call with a line. The most significant piece of that is Orrick Heffington, which is, I think, (inaudible) in August of 2004. And that's about 143,000 square feet?

143,000.

And I think we have (multiple speakers)...

Are you worried about them?

They are moving.

We are not worried any more because they've already signed over at Foundry Square.

That's right. I forgot about that. So you got that. Anything else?

I think every other -- we have, in Embarcadero Center West, the 100,000 square feet that -- the tenant that went bankrupt,

Which will renew about half of that space. The balance of the expirations are miscellaneous partial or full floor tenants throughout the center.

And what do you think the rents are, at 45 at expiration?

Again, John, it depends on the location of the space and the view of the space. It's going to be in the mid 30s to low 40s across the board.

We clearly see rolldown in those rents, John.

Princeton seems to be the other market you have almost a half a million square feet there -- about 30 bucks. Anything to worry about there?

I don't think -- you've got to remember 180,000 square feet is our industrial building, which is at Cabot Drive in Pennsylvania, and that's di minimus. So, there's about 250,000 square feet rolling over in late '04. I would say more than 50 percent of that will be covered in the next call at six months. I think there will be a very slight rolldown, if a rolldown at all.

That's what I was looking for. And then Boston, $150,00 at $58 rolling next year?

Yeah, that includes retail, as well. The biggest of that, as I talk about before, the biggest rollover we have in the Boston market, in calendar year 2004 is a tenant at 101 Huntington Avenue, which is about 190,000 square feet. That is a tenant that we are working on. And if we sign a lease, we will announce it.

And you think, again, if I got my notes right, that that rent there are in the high 30s, low 40s?

For the average market rent?

Yeah, if I had to look at a 58 expiration using a 40 might be reasonable for a release?

Yeah, with a full T.I. package, if it was done on an as-is basis, it would be less than that.

It would be less than that?

Um-hum.

Just moving back to Times Square, what do you think you're going to get there by the time this thing was scheduled to open, in terms of getting to (multiple speakers)...

I think we've said before, John, that we will not get there as quickly as we had originally projected. And that it will take longer to lease the building because of current market conditions. So, we will open the building next spring with -- how many square feet?... (multiple speakers) 290,000 square feet lease.

And we expect to do some more between now and the end of the year, so we will have some more tenants. Will we be at one million square feet leased in April of 2004? Absolutely not.

Jay Leupp with RBC Capital Markets.

Good morning. I'm here with David Copp. Just a couple of questions, Doug, on the comments you made about cash conservation and refinancing activity given the $400 million of maturities and principal repayments due in 2004. Can you give us some color with your thoughts on refinancing that variable versus fixed refinancing? And then secondly, with respect to the dividend increase during the quarter, given your thoughts on cash conservation, what was your rationale for the dividend increase?

I will speak to the first one, let Ed speak to the dividend. On the rollover, we have $165 million, $167 million loan rolling over. The other loans have extensions and they're associated with the construction debt on Times Square, and we will just continue to keep that floating until the building is complete.

As far as the dividend increase, which we think was modest, the Board felt that, given our performance last year, that some increase in the dividend was appropriate. And that, you know, balancing the fact that we are in a strong -- do have a very strong balance sheet, do have a very strong ratio of -- FAD ratio -- that some increase in the dividend was appropriate.

Okay. And then just one follow-up, just on Page 23, your supplemental -- just some thoughts on your top 20 tenants, aside from the U.S. government, are there any tenants that have sort of moved to your watch list this past quarter?

It's the U.S. government that we're worried about.

The only tenant that's on our watch list of this group of significance is Parametric Technologies, which is a tenant we have owned a 25 percent interest in a building in with the New York Common Fund in -- outside of Boston. And largely, it's due to -- I mean, there are no issues with that company, other than that they're having a real hard time selling product, and their revenues have declined significantly over the past six to seven quarters. So they're in a very dramatic cost-cutting mode right now. But the company has cash on its balance sheet, but it's a company that we're concerned about.

Do you have any thoughts, Doug, on if or when you do any sort of restructuring on that particular lease?

We won't be doing any restructuring on that lease. Unless the tenant goes into bankruptcy, I mean, it's a market lease, and we have no intent on doing anything with the lease.

Ajid Kumar with Morgan Stanley.

This is Ajid Kumar. Could you please give some further color on the recent leasing activity at Five Times Square? And further color on tenant interest and rental rates there?

Five Times Square is 100 percent leased. That's the Ernst & Young building. Did you mean Times Square Tower?

Yes, I did. Sorry.

The leasing that was done there is we signed an additional -- we signed one lease with a tenant that will -- actually has committed to three floors, but two floors will be immediate and one is an expansion floor on a must take.

That was a twenty-year lease.

Okay. And with respect to total shares outstanding, what should we expect for the remainder of the year? Will there be further exercises in the coming quarters?

We can't predict about people exercising options. Obviously, that's a personal decision that each individual makes. So we really can't predict that. Nor, I guess, we can't predict our stock price, either, which affects the share count. So, you know, I think the only guidance we can give you is sort of where we are today.

Okay. Thanks.

Stuart Axelrod with Lehman Brothers.

Doug, I guess you had mentioned in Boston and D.C., you're working on 190 to 280,000 square feet. You talked about funding and extending leases '04 and '05 earlier, but we haven't really seen any evidence of that in the quarter.

That's because they haven't been signed yet. So those are the leases that we are talking about that I was describing. It's when those leases hit -- that's when that will occur.

Is the timing a function of the tenants that may be -- they're not missing anything by waiting another three months or so?

I think it's basically the difficulty of getting documentation finalized. That's another thing that characterizes this market. You know, there is no sense of urgency on the part of the tenant. So you know, you can press all you want about getting a lease signed, but, you know, the tenant basically says, yeah, we will get to it.

Okay. Can you talk about the potential buying of Terrabrook's other interests in One and Two Freedom Square?

I really can't. I mean, you know, we are talking to them about doing that, and I cannot give you any financial information. There is information, obviously, on the joint ventures in our supplemental. And you can, I guess extrapolate from that. But until the deal is completed and we close on a transaction, assuming we close on a transaction, we just cannot talk about the economics yet.

But have they made a strategic decision to exit Northern Virginia?

We'd rather not comment on -- you know, I don't think we should talk for them. I think that, you know, we are in discussions with them, so obviously, that indicates something. And, you know, we will announce -- if and when a transaction gets completed, we will announce the details of the transaction, obviously.

Dan Openheim with Banc of America Securities.

Thanks. Just a quick question for you on Times Square. I heard the comments about looking for smaller leases of a floor or few floors. I'm wondering if that says anything about your view of the New York market over the next couple of years, that you're not willing to wait a little bit longer to lease a larger block there?

Well, you know, I think it's a trade-off because waiting costs you something; and if there are tenants available in the 1, 2, 3, 4, 5 floor category, we just think that it's foolish to wait. I mean, I don't think we sacrifice something by making those deals. And in fact, you might even -- I think you could argue that some of those deals, we will get higher rents. So, you know, we are going to do the deals that come along, and we are not going to be -- we are not smart enough to say, gee, if we wait three years, we're going to find a guerrilla tenant that's going to pay a big price. We just believe in making deals when they are available to us.

Okay. And then secondly, in acquisition market, do you expect any real changes in pricing as interest rates increase, even though they're clearly still at very low levels?

You know, I won't speculate about what the private investor market is going to do. I am sure that some of the pricing that you see in the marketplace is a direct function of interest rates, because people have been able to borrow money at very low rates. And I am sure that has translated itself into their ability to pay a higher price. And, it would be natural to expect that if interest rates do come up, pricing may change.

Gary Callican (ph) with Goldman Sachs.

Thank you. On behalf of David Kostin. Just Doug, you mentioned that the rationale for some of the refinancing in the first half was to secure long-term interest rates here at relatively low levels. It also had the effect of unencumbering some assets, and it looks like you are unencumbered Five Times Square, Shaw's, Discovery Square in the quarter. Does that suggest that there is also a side agenda to unencumber some of those assets for potential sale? Or what is your appetite on selling assets in this environment?

I would say the answer to that question is, we are a believer in recycling capital if we have a use of proceeds. We obviously, you know, are in a business that is very capital-intensive. And unfortunately, selling assets without a use of proceeds has some negative tax implications associated with it. And we are aggressively looking to invest capital. And one of the significant ways that we could harvest the value from our portfolio would be to sell assets and use that -- redeploy that capital into other -- what we would perceive to be, you know, better value-added kinds of opportunities or assets that would improve the portfolio. We, unfortunately, have been very hard-pressed to find those kinds of opportunities over the past year or so. Aside from 399, we have been shut out by, you know, just the vociferous level of activity from the private capital markets, on assets. So, I wouldn't expect to see us selling anything unless it's associated with a major transaction.

Okay. Great. Just quickly on the Shaw's that you opened in the quarter, what is the status of your presumably more long-term thinking on the Star Market site?

The Shaw's is the Star Market that we have. There is a Star Market location, which is actually sort of tucked underneath the Prudential Center retail on Boylston Street. And there is somewhere between 15 and 20,000 square feet. On top of that rests a site that is under agreement to be sold to a hotel developer, who is going to be bringing Mandarin Oriental to the property, and that's going to obviously affect the clientele associated with that part of Boylton Street. And so, in the short-term, I would say we're going to be looking to do something on a temporary basis. And on a long-term, take advantage of what else is being created on Boylton Street to capture some pretty exciting retail.

Richard Prairie (ph) with Delphi Management.

My questions have been answered. Thank you, very much.

Jim Sullivan with Green Street Advisors.

Thank you. On your last call, I thought you did a really good job of pointing investors towards the importance of looking at net effective rents. Can you comment, on net effective rent trends in your markets? And, if you can, talk a little bit about net effective rents within your own portfolio, perhaps, for the quarter, and looking forward to the next half of the year.

Well, net effective rents are, you know -- well, when we do a net effective rent -- let me just remind you -- when we do a net effective rent calculation, we take the gross rent, subtract off operating costs and real estate taxes and then subtract off a rate of return on any transaction costs associated with doing those deals. And, we have -- the net effective rents vary as low as single digits on up into the high teens -- and -- at this particular point in the marketplace. And that is what we are experiencing. We haven't gone negative; we don't intend to go negative. We think some people are going negative. Obviously, it varies from market to market. It's -- they're higher in New York; Higher -- certainly higher in Washington; lower in the San Francisco region.

Do you think that net effective rents continue to decline at a more rapid rate than market rents?

No. I think that actually, that net effective rents have -- are stable. Low -- distressingly low, but stable. I think that net effective rents, if we look at -- and I review every NER calculation, and they've been basically stable, now, for a couple of quarters.

I would say that the trend, Jim has been, New York City is high because we just haven't done very many transactions in New York City on second-generation space. But they've averaged, you know, the mid-to-low teens down to the high-single digits across the portfolio. I mean I haven't seen a $20 net effective rent for quite some time.

(CALLER INSTRUCTIONS). There are no further questions at this time.

Let me thank everybody for being with us today. And we look forward to reporting again in 90 days. Bye, bye.

Thank you for participating in today's teleconference. You may now disconnect.

(CONFERENCE CALL CONCLUDED)