Kilroy Realty Corp (KRC) 2002 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Kilroy Realty corporation fourth quarter 2002 earnings conference call. During the President presentation, all participants will be in a listen-only mode, after which we will conduct a question and answer session. At that time, if you have a question, please press the 1 followed by the 4 on your telephone. As a reminder, this conference call is being recorded Tuesday, February 4, 2003. I would now like to turn the conference call over to Richard Moran, executive vice president and chief financial officer for Kilroy Realty Corporation. Please go ahead, sir.

Thank you, and good morning, everyone. Thank you all for joining us. I'm Dick Moran. With me are John Kilroy, CEO, Jeff Hawken, COO, Tyler Rose our Treasurer and Anne Marie Whitney, our controller. Some of the information we'll be discussing this morning is forward-looking in nature. Please refer to our supplemental package for a statement regarding the forward looking information in this call and in the supplemental. This call is being webcast live on our website and will be available for replay for the next seven days both by phone and over the Internet. Our press release is available on our website.

We released our fourth quarter financial results yesterday afternoon, FFO was 76 cents per share, 5 cents over consensus estimates for the year, FFO was $3.09 a share, up 3% from last year and 4 cents over consensus. Our results in the fourth quarter benefited from lease termination fees and bad debt experience. We'll give you more details later in the call. John will start, then I'll cover the financial highlights and we'll be happy to take your questions.

Thanks, Dick. Good day, everyone. We entered 2003 here in California with a challenging environment. According to employment officials, the state loss of 26,000 jobs last year. Prior year, California had a net loss of 38,000 jobs. By comparison, the state gained more than a half million net new jobs in 2000.

Two California specific factors impacting our economy right now are the ongoing slump in high technology that has cut deeply into employment, primarily in northern California, and California's large budget deficit, which has become a very contentious issue among the state's political and business leadership. As a practical matter, the deficit is beginning to affect government employment, and more layoffs at the state and local level are forecast. But the broader and more difficult to assess impact of the deficit is the uncertainty it's creating among both businesses and consumers in the state. It gives one more reason for private employers to defer hiring and capital spending, and, of course, that hesitancy is compounded by the national economic weakness and the possible of conflict in the Middle East.

Having said all that, let me add two important caveats. First, California's current problems pale in comparison to the recession that hit the state in the early 1990's. Back then, unemployment to topped out at nearly 10%, and the state shed more than a half million jobs. Today, the rate is 6.6%, and much of it is accounted for by ongoing job losses in one region, Silicon Valley.

That's my second point. There's been a dramatic reversal in the fortunes of Northern and Southern California. With high tech in the doldrums, Northern California continues to struggle. The state's southern half with its more diverse economic base is holding up comparatively well. In fact, San Bernardino, Riverside and San Diego counties all experienced net job gains last year, albeit modest ones, and while Los Angeles and Orange Counties had net losses they were small in comparison to what's going on up north.

Broadly speaking, you see the same economic -- or excuse me -- you see the same trends in commercial real estate markets. Average occupancies are down across the board. The mood among tenants remain passive and noncommittal with consolidation, cost cutting and declining credit quality all continuing trends. Here in the southern part of the state, the effects vary in intensity by market and even submarket.

Some of our industries in Southern California are actually gaining momentum. That list would include entertainment, defense, health care and life science, although this latter sector has slowed somewhat as well. A quick summary of our markets show that San Diego remains our strongest market for office properties from a demand perspective, although as you all know, we have been hit with some unusual tenant issues there.

The Orange County industrial market continues to perform well. We're once again seeing increased activity in our West Side Media Center in West L.A. and finally El Segundo continues to be our toughest market.

Given this backdrop our stabilized portfolio performed reasonably last year. Occupancy at year end stood at 93.7%. Within our development activities, we stabilized 436,000 square feet of office space, and six properties last year, all of which are 100% leased. Although 90,000 square feet of that is leased to Brobeck (ph), which we will discuss in more detail later. Looking forward, our total committed development pipeline now compasses just over 600,000 square feet and four properties. They are currently 53% leased and with LOI's, 60% committed.

Now let's take a more detailed look at our markets, starting with San Diego. We currently operate in four sub-markets in coastal San Diego. Our properties there had an overall occupancy rate of 93% at year-end. In both ranch owe Bernardo and the La Jolla UTC submarkets where we compete in the two-story product type, our properties are 100% occupied. From a market perspective, Rancho (ph) Bernardo has a 5% direct vacancy rate and a 6% total vacancy rate and UTC has a 7% direct vacancy rate and a 16% total vacancy rate.

Through year-end, our Surento Mesa (ph) properties were also 100% occupied. As we reported yesterday, in January, Ericsson terminated its lease on a 68,000 square foot Surento Mesa (ph) property that resulted in a $4.1 million lease termination fee. Dick will give you more financial details on the transaction in a few minutes.

One option we're actively considering is to convert the building to life science use. We currently have two prospective life science tenants that are evaluating the building to accommodate their future needs. Overall, the two-story product type in Surento Mesa (ph)currently has a direct vacancy rate of 10% and a total vacancy of about 17%.

Our fourth San Diego submarket is Del Mar, where both Peregrine and Brobeck are located. As we reported yesterday, Peregrine has indicated its intention to reject the remaining two leases it has with us, although it isn't clear yet when they may happen. Let me summarize where we are with each of the buildings that were formerly known as Peregrine systems corporate center. As most of you know, Peregrine held leases on 5 KRC buildings totaling 540,000 square feet. The five buildings are located in a master plan campus style complex and were built to accommodate single or multi-tenant use. Building 1 is the smallest of the five buildings and totals about 52,000 square feet. Its lease was rejected by Peregrine last year. The property has been vacant since last November. Since we ramped up our leasing efforts, we are now seeing a fair amount of activity from a diverse group of potential tenants.

Building 2 is currently Peregrine's headquarters building totaling 130,000 square feet. This is one of the two remaining leases that Peregrine has indicated that it intends to reject. Building 3 also 130,000 square feet, also had its lease rejected by Peregrine last year. The good news is that we now have entered into a letter of intent with a solid financial services company to lease the entire building for seven years. We expect this property to be fully occupied by late third quarter.

As we previously reported, the Linick (ph) Group of global distributor, especially semiconductors, signed a lease that commences in March for building 4, a 115,000 square foot building in the complex. They claim to use it as the company's global headquarters.

That leaves us with building 5, which is 112,000 square feet. This is the second remaining lease with Peregrine, which they have advised that they intend to reject. This building is 58% subleased to third party tenants and we expect that the rental obligations from the subtenants will continue.

So in summary, of the total 540,000 square feet in the complex, as of today, we currently have 90% of it leased or under LOI. Assuming Peregrine does reject its two remaining leases, we will have 57% or 310,000 square feet leased or under LOI. Dick will talk about how Peregrine's actions will impact our earnings a little later.

As most of you have heard last week, there were numerous press reports that the law firm of Brobeck, Phleger and Harrison is planning to dissolve and wind up its operations. Brobeck currently leases two buildings from us in Del Mar, totaling 162,000 square feet. One is a 72,000 square foot building they have occupied since its completion in early 2000, and the second is a 90,000 square foot building they leased last September but had not yet occupied. It is in shell condition.

While obviously this is not good news, since we have not received any formal notification of their intentions, we can't predict yet how this will end up. Various scenarios range from a complete default to the San Diego office of Brobeck remaining intact and continuing to lease all or a portion of the space. Dick will address the potential impact of the various scenarios. Market wide, Del Mar currently has a direct vacancy rate of 12% and a total vacancy rate of about 24%.

Moving northward, our Orange County industrial properties ended the year with an overall occupancy rate of 100%. In Long Beach, market conditions at the Kilroy Airport Center Long Beach remain soft, although with have recently leased some of the space vacate the vacated by Boeing at year-end to Phillips Petroleum. The center, seven buildings with approximately 1 million square feet, was 86% occupied at year-end. In the overall airport market, total vacancy is about 13%.

Continuing North, we come to El Segundo. This is undoubtedly our most challenging market right now. Tenant remand here remains significantly affected by the events stemming from 9/11 and the uncertainties in the economy in general. The direct vacancy rate has risen to 22%, and total vacancy is now 26%. As we have reported, Boeing will vacate this month at 250,000 square foot building that they and their predecessor, Hughes Aircraft Company, have occupied for 30 years at 909 Sepaldo (ph). As we reported last quarter, given the age of this building and the length of the prior lease, we're planning a significant renovation of the building.

Moving on to west L.A., we're seeing increased activity in our west side media project. While the west side market remains challenging, the entertainment industry is gaining momentum and our project is being well received by this industry. Overall, the west L.A. market has a direct vacancy rate of 17%, and a total vacancy of 22%.

To recap, phase 1 of our 380,000 square foot west side media center is 80,000 square feet and 100% leased. Phase 2 is 150,000 square feet, 50% leased, and with LOI's, is 54% committed. Phase III is also 150,000 square feet, is 23% leased and with LOI's at 50% committed.

That's an update of our key markets. Generally speaking, I think we would all agree that 2002 was not a great year for commercial real estate in Southern California. Vacancy rate in most markets have increased and indecision still prevails. While we're pleased that we delivered 3% share FFO growth under those conditions, we also recognize that the market is under pressure and uncertainty continues. Looking forward, we're still very cautious about the operating environment we see with so many unanswered questions about the economy and a host of other issues weighing on businesses around the state, we're not planning for any real positive change in market conditions until next year.

In the meantime, we remain focused on aggressive marketing program for our available properties. Given the current environment, we remain extreme lie cautious about initiating any new projects and will continue to link development starts with pre-leasing as we did last year with our project we're building for AMN (ph) Health Care.

As our 2002 results demonstrate, we've been successful in navigating challenges as they arise. While we've had our share of tenant issues, we are confident in our ability to work through them and create lasting value for our shareholder. Now Dick will cover the financial results, and then we'll take questions. Dick?

Thanks, John. FFO per share was 76 cents in the fourth quarter, up from 68 cents in the fourth quarter of 2002. For the year, FFO was $3.09, up from $3 in 2001. As I mentioned at the beginning of the call, results in both periods benefited from two factors. In the fourth quarter, we received a lease termination fee from an e-Commerce company that was leasing one of our San Diego properties. The property has already been fully released to a credit union for 15 years, cash rent 9% higher, GAAP rent -- 5Ded 3 cents per share to FFO in the fourth quarter and for the year. We also benefited from better bad debt experience in the fourth quarter when we received payments on rents that we had previously reserved.

From an overall perspective, both Peregrine bankruptcy filing and the generally poor market conditions affected our performance in 2002. The impact can be seen in our occupancy. We began the year with 95.8% occupancy in our stabilized portfolio. We ended the year -- 97.7 % industrial and nine -- given the recent news from Peregrine and Brobeck, we expect our occupancy rate to further moderate over the next few quarters. On a cash basis, same store NOI was basically flat for the quarter and up 2% for the year, on a GAAP basis, same store NOI was down 3.4% in the fourth quarter and 1% for the year. The quarterly decrease was primarily due to lower occupancy and higher property expenses and property taxes compared to the prior period.

Property expenses were up due to higher apparent maintenance costs in the quarter. That was primarily a timing issue since repair and maintenance costs were essentially flat for the year. Property taxes were up because we received some refunds in the fourth quarter of 2001 that made our year over year numbers unfavorable. Looking forward, we have 1.3 million square feet that will turn over this year with our renewal of the Boeing lease in Seattle for 211,000 square feet and the execution of a few other deals with completed leases for about 30% of our rollovers this year. We have another 17% in negotiation which leaves us a little over seven hundred thousand square feet or 53% of our rolling space to go. Of the 700,000 square feet, we know that Boeing will be moving out of about two hundred 50,000 square feet at El Segundo at the end of the month. We're left with about 450,000 square feet.

In terms of sublease space, besides one 300,000 square foot industrial lease that's now available, not much has changed from last quarter. In total, about 9% of our portfolio is available for sublease. Of that, about 5% is vacant space and the other 4% is occupied. Of the 9%, 7% relates to industrial leases and 2% relates to office leases. More than 50% of the sublease spaces in two Orange County industrial buildings with the remainder in smaller spaces in Orange County and San Diego. The other remaining term on the two Orange County buildings is nine years and the other subleased space is six years. Last month we received a $4.1 million lease termination fee from Ericsson for a 68,000 square foot building. That's equivalent to 13 cents a share. The rent on that lease was about 2 cents a share a quarter, so the net positive impact of the Ericsson lease termination on our first quarter 2003 results will be about 11 cents a share.

In dispositions, we sold four building on the fourth quarter totaling 468,000 square feet. Total proceeds were approximately 42 million, and quarterly gain of 6.1 billion. Total dispositions for 2002 were approximately $48 million. Pricing and demand in the asset sale market continues to be strong. The proceeds from these sales were used to help fund a development program in our stock buyback program in the fourth quarter, we bought back 508,200 shares at an average price of $22.39. Our committed development pipeline remains at four projects for the total investment of $198 million, of which 146 million has been spent to date. The pipeline is currently 53% leased and with LOI 60% committed. In the fourth quarter, we had $150 million. Interest rates expire, we subsequently ended into 100 million new interest rate swaps average term three and a half years. 77% -- as of the end of the year.

Let me finish with an update on earnings guidance. Let me start with the impact of the Peregrine situation. We obviously don't know definitively whether or when Peregrine will reject its last two leases, but they if he do in the second quarter, we estimate that the impact on our FFO for the rest of the year would be 7 cents a share, assuming we don't release the space before the end of the year. It's also worth mentioning that in Peregrine's reorganization plan as a creditor, we would potentially receive some reimbursement of our damages over time.

The impact on the Brobeck situation is a little hard to predict since it's just occurred and since there hasn't been any proposed dissolution, workout plans or legal proceedings yet. We have two leases, one on a building they've occupied since 2000, and the second is on a building completed last September but never occupied. If Brobeck defaults on its leases, the impact on our FFO would be 5 cents a share over the rest of the year on the first building and 10 cents a share on the second building, or a total potential impact of 15 cents a share for this year. We also do have some credit support on the Brobeck leases, but given the situation, we've been advised not to comment on that topic right now. If you add up the numbers, the worst case 2003 impacts of the Peregrine and Brobeck situations are 7 cents and 15 cents a share respectively, or 22 cents a share in total.

Our 2003 guidance last quarter was 2.75 to $3 a share. Given the Brobeck and Peregrine uncertainties, we're lowering our guidance 20 cents a share on the top end, and 15 cents on the bottom end to a range of 2.60 to 2.80 a share. That's the latest news from here. Operator, with that, we'd like to open the call for questions.

Thank you. Ladies and gentlemen, if you would like to register for a question for today's question and answer session, please press the 1 followed by the 4 on your telephone. You will hear a three-tone prompt to acknowledge your request. If your question has been answered and you wish to withdraw your registration, please press the 1 followed by the 3. If you are use ago speakerphone, please pick up your handset before entering your request. One moment please for the first question. Our first question comes from the line of Lee Schalop with Bank of America Securities.

Hey, there. Could you talk a little bit about the Ericsson lease termination? Given the overall difficult environment, and it seems with these various bankruptcies and other challenges, the vacancy in the portfolio keeps going up or the leasing that you need to do goes up. Why would you want to put yourself in a situation where you have now more space to lease?

Lee, this is John. Obviously we didn't know where Peregrine was going before they'd indicated that they were going to stay in the two buildings that they now just in the last few days have told us they intend to reject, and of course Brobeck was not an issue then. But nevertheless, Ericsson, if you recall, has had a very serious financial issues over the course of the last couple years, so we felt given the demand we have currently for life science facilities in that market and given the fact that we'd never -- well, Ericsson had been paying rent on the building for the last year and a half, they hadn't occupied it, we still have the tenant improvement allowance, so we feel that we're going to be able to remarket that building successfully. We were concerned about Ericsson's financial condition.

I see. Ok. So I was thinking Ericsson as a credit. So this was a situation where you looked at their credit and thought this is a way to attack something earlier rather than waiting.

Exactly.

Ok. Thanks.

Our next question comes from the line of Lou Taylor with Deutsche Bank. Please proceed with your question.

Thanks. Hi. So Dick, just to maybe summarize your guidance, the real change is just reflecting these two situations, the Peregrine rejection and the contingency, if you will, for Brobeck. Is that fair?

yeah. We obviously -- if you think of it this way, Lou, we were at 2.75 to $3 last quarter, and if you just took the major changes that we've talked about since then, they would be on the plus side. Ericsson had the 13-cent a share lease termination fee, but as we talked about the rent per quarter is about 2 cents, so if you round that, call that 5 cents a share positive, Peregrine and Brobeck, we talked about could be worst case 22 cents a share minus, so five plus, 22 minus is a in net of 17 cents a share minus, so from 2.75 and $3, if you subtract that, you get to $2.83, and we wound up to 2.62 2.80, so yes we've done exactly what you just said. We've adjusted our guidance essentially for those items and tightened it slightly.

Ok. Can you talk about the Brobeck lease with regards to who is on the lease? Is it a limited liability corporation, does it flow through the partners? I mean, beyond any kind of credit enhancement that the lease may have, who was the lease with?

I think, Lou, what we've been told is we really shouldn't talk about this because there is the potential that we might have to pursue it in litigation, but we have leases with what we -- we have leases with the law firm, put it that way, and we have credit support from individuals, and beyond that, I don't think we really want to comment.

Ok. So it's not a lease with the partnership, per se, but maybe with an LLC with some individual partner, you know, enhancement?

That's fair to say.

Ok. And then can you just go over the construction status of that second building again? You said it was leased, not occupied at the shell completion stage or beyond that?

The shell is done, the TI's have not been. So in terms of re-leasing, we would just need to do the TI's to finish it. And we'd be able to customize those obviously for a tenant or tenants.

Ok.

That's assuming -- if we get it back.

Yeah, Lou, just to add a little color -- this is John -- the vacancy rate in the market is reflected in the Peregrine building, the 90,000 footer, because they've been intending to only occupy a floor or two and sublease the balance, and until they -- what they were telling us, until they sort of figured out what they were going to do sublease-wise, they weren't going to proceed with their improvements so we have our tenant improvement dollars intact, and depending on what happens now, you know, it's too early to say what's going to happen.

Ok. Just going to Peregrine for a minute, on that headquarters Building No. 2, you said the lease is rejected. Is Peregrine going to have any space in any of the five buildings, do you think, when they're all said and done, say, a year from now?

No, they have rejected everything other than the two leases that remain as of today. That is the entirety of building two, which they occupy completely, that's their corporate headquarters, and they have the lease on building 5, which is 58% leased by others. And what they've advised us is that they intend to reject both of those leases and be out of what is formerly known as Peregrine Systems Corporate Center in entirety.

So they're going to be completely gone at some point.

Correct. Assuming they proceed with the rejection.

Right. And then if they do proceed and they're gone entirely, maybe if they exist, they'll have some, you know, headquarters or something somewhere else.

That's right.

That's fair to say? Ok. And can you just talk about the overall leasing activity in the west side market? I mean, has it picked up at all? Is the incremental leasing just some deals that have been around, you've been working on for an extended period? Has there been any improvement in the leasing activity?

Well, as we reported last quarter, things had picked up a little bit. We've done a deal with Viacom for 40 thousand square feet in another of our buildings and we've done a single floor transaction in building 3 of west side media center that represented, I think, 22, 23% of that building. Since that time, what we've seen is, this has been one of the pleasant surprises, is we've seen a marked increase in activity in our project here on the west side. Much of that is entertainment-based, media based. I'd say we have at least two, probably three or four times as much activity in people looking at space today than we did three or four months ago. And to put in perspective, as Dick mentioned, in Phase III, we're now 54 % leased or letter of intents. We were 43% at the third quarter. In Phase III, we were 23% leased at the third quarter. We're now 50% leased or under letter of intent, and we have a number of other prospects for the project. By the way, I should point out that it's nine tenants that make up that 54% in phase 2, and 3 tenants that make up the 50% in Phase III. So these aren't the larger deals that we were seeing a few years ago, but they're almost entirely entertainment-based companies, and that is the area that we're seeing the most demand from.

Ok. Now, last question, Dick, if you could just remind us with regards to your guidance in 03, what do you have in there in terms of dispositions and timing?

We assume $50 million of disposition in the middle of the year, in our numbers for 2003.

All right. Great. Thank you.

Our next question comes from the line of Anatole Pevnev with McDonald Investments.

This is actually Frank. A question on your stock buyback activity, especially in light of the recent announcements from a lot of your major tenants. Do you expect to be doing any of the stock buyback with capital constraint?

I think, Frank, the answer to that is that we'll continue to consider the stock buyback from time to time. I think the first priority is to make sure we have adequately, but we do regard the stock as a good investment in today's price. So that's a long way of saying, we'll see. More to co.

Are there any debt covenants out there that would prevent you from buying back stock?

Well, ultimately, yes, but they're not impinging us now.

Ok. And on your $76 million debt expiration in the fourth quarter, do you have any thoughts on how that might be refinanced?

We're working on that right now. If there have a bright spot in the Capital Markets for real estate companies right now, there's no shortage of debt providers out there, and we're just trading off very conventional alternatives of fixed rate replacement or a floating rate replacement with some sort of swap or cap, and we're looking at the alternatives, but there's an excess of demand for that product today, so we think we can improve our position on that.

Ok. And can you kind of talk a little bit about the tenant demand in Del Mar, especially after you've filled some of the Peregrine space and what you expect going forward?

Yeah. This is John Kilroy, Frank. Demand in Del Mar, there's about 500,000 square feet plus or minus tenant demand in Del Mar as we speak, and that's pretty broadly diversified. Software companies, number of law firms, both large and smaller uses, some service companies, finance companies, health care. So we're working obviously with everybody that we know about, and I think we know about everybody, in that marketplace. What Del Mar is a lot like most markets, probably throughout the country, certainly in most of Kilroy's markets, a lion's share of vacancy, in most markets consist of space that's fairly small, under 50,000 feet. We're dealing with a number of users that are above 50 50,000 square feet or larger and we think we're well positioned given the newness of the buildings we have, their size and location and so forth. So there is a far greater number of tenants in the marketplace today than we've seen over the last year.

Ok. Thanks.

Ladies and gentlemen, as a reminder, if do you have a question, please press the 1 followed by the 4 on your telephone. Our next question comes from the line of David Loeb with Friedman Billings Ramsey.

Couple questions. The cost went up in the fourth . Does that just reflect competition in the market, and then to follow on, can you give us a little idea about the timing of the rollover by quarter in 03?

David, I'll talk about the first one for a second. We had one unusual circumstance on an industrial building in the fourth quarter that was a complete anomaly. We actually wound up having a very heightened allowance on an industrial building in lieu of doing a lot of renovation work ourselves. It was the one case we've ever had like that, it wound up being a better real estate deal for us doing it that way. So we called the TI's because that's the way it's documented, but another way to look at it was that it was just some renovation to the building. So I don't think there's -- that our numbers were -- it was a small enough sample size that I'm not sure they were indicative by themselves of a trend. Of the trend more broadly, certainly is that TI's in the office business are up. There's no question about that. But I'd just caution, our numbers were distorted in the fourth quarter by that one particular deal.

But the office number in the fourth quarter then is a reasonable assumption about a run rate for going forward?

I'd say it's a little bit higher than that as well. I'm sorry, you're saying the office number -- The run rate will be a little bit higher than 2002.

More like the fourth quarter number, or higher than even the fourth quarter number?

No, between the fourth quarter number and the prior number.

Got it. Bigger than a bread box. Ok. Thanks. And how about the timing of the rollover?

In terms of timing, they're spread throughout the year, but I guess weighted, they're probably sort of a second quarter weighting.

Ok. Great. Thanks.

Our next question comes from the line of Chris Haley (ph) with Wachovia (ph) Securities. Please go ahead with your question.

Good afternoon. Good morning. Question on the re-lease of the Boeing space and at least with regard to Boeing and the others. Probably look at some of the risks for your company and the other office companies with some big tenant rollovers either in -- particularly in some single tenant buildings. How do you plan on recognizing expenditures both from a GAAP statement, whether you're going to capitalize some of these costs as you re-tenant, and then how do you plan on reporting first or capital expenditures to renovate some of the space either as first generation or second generation capex? Just wanted to get your philosophy on how you might report these.

Well, I think, Chris, generally, obviously when a lease expires, we're going to report it just as continuing -- as regular continuing second generation capex. There is one exception to that in our Boeing space. There's the building in El Segundo where they're vacating, they're the single tenant, and they succeeded -- they bought Hughes Aircraft, who had been there for roughly 40 years, and that building has a -- while it has a great location, we bought it as a renovation and rehabilitation play, and obviously what was then a better economy, so they're vacating at an inconvenient time for us. But we've always planned from the outset, and we've always said from the outset that we planned to renovate that building because if you look at the building, it has -- it's a very tired 1970's building, so it needs a complete, complete cosmetic renovation. So in that case, we plan to treat it as we would if we just went out today and bought a redevelopment building. We capitalize the cost of the improvements because we believe that's the logical way to do it. Otherwise, you'd get kind of a wacky distortion in our capex, the way we'd report it.

So in your GAAP FFO guidance, you're assuming any -- no impact in 03 in terms of that asset, the spread from its prior lease, and then from a capital expenditure basis, you're not going to -- you obviously would include that in first generation expenditures rather than second generation?

Yes.

Ok. And the same for any of these -- to go back to the other leases, on regular renewals or lost deals, you would characterize all those expenditures as second generation, even with this other tenant that you had recently heard from?

I'm sorry, what are you -- I lost track of your question there.

The other major tenant that you had just lost. A little bit of a surprise.

Brobeck?

Yeah.

Well, in that case, Chris, it breaks down this way. There are two buildings in there, and they would be treated differently.

Ok.

The first one to the extent that if they default and we have to re-tenant, that would, we suspect, be second generation space because it's already been occupied.

Right.

The first -- excuse me. Pardon me. The second building has never been occupied and we've never spent the tenant allowance. Obviously we're hypothesizing here, about what might occur, but if they default, if we re-lease it, and when that occurs, my guess is that we probably think that that was first generation capex and call it just that, because we've never spent any TI's on the building before.

Right.

It is true first generation space.

Right. Ok. In terms of your looking at your 03 budget for capital expenditures, I guess certainly just looking at Peregrine, would you care to provide a range of how much expenditures you would plan on spending in overall 2003 re-tenanting and upfits, and how much of that might be first generation versus second generation?

I think, Chris, that there's -- I don't think we want to get in to giving guidance on individual line items like that.

Ok.

Because we'd have to give so many caveats to it, and then I think we'd wind up feeling some responsibility then to continue to update it. That really is driven, as you'd expect, very much by leasing.

Right.

And how much and when that happens, given that we have quite a bit of space there in the Peregrine center and in the Brobeck space potentially, I'm just not sure that it's -- I'm not sure that we'd be terribly helpful because we'd have to give you so many numbers with so many caveats that at the end of the day, I'm not sure it would be helpful.

Ok. Well, I appreciate all the detail on the other ones. Thanks, Dick.

Thank you.

Once again, ladies and gentlemen, if you do have a question, please press the 1 followed by the 4. At this time, I'm seeing no further questions. Please continue with your presentation.

Thank you, all, very much for joining us in this busy time of the year for all of you, I'm sure. We appreciate your interest in KRC as always, and thank you, and have a good day.

Ladies and gentlemen, that does conclude your conference call for today. We thank you for your participation and ask that you please disconnect your lines.