摩根士丹利 (MS) 2002 Q2 法說會逐字稿

Good morning.

Good morning.My name is Samantha and I will be your conference facilitator today.

At this time, I would like to welcome everyone to the Crescent Real Estate second quarter 2002 earnings conference with our host, Miss Keira Moody.

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question-and-answer period.

If you would like to ask a question during this time, simply press star then the number 1 on your telephone keypad, and questions will be taken in the order they are received.

If you would like to withdraw your question, you may do so by pressing the pound key.

In order to ensure that all participants will be allowed to present their question, we ask that each participant limit themselves to one question and one follow-up question before re-entering queue.

And as a reminder, if you are on a speaker phone, please pick up your handset before presenting your question.

I would like to turn the call over to our host, Miss Keira Moody, Vice President of Investor Relations for Crescent Real Estate, Incorporated.

Thank you.

Ms. Moody, you may begin your conference.

Good morning, everyone and welcome to our second quarter call.

In the room, we have John Goff, CEO, Denny Alberts, President and COO, Jane Mody, Capital Markets and Jerry Crenshaw, CFO.

We are hosting a live webcast, and we hope you have had a chance to pull up the presentation investor supplement on our website.

The address is cei-crescent.com in the investor relations section if you wish to do that now.

I want to remind that you certain statements made in this call may be considered forward-looking statements within the meaning of the Federal Securities laws.

All love we believe that they are based upon reasonable assumptions, Crescent's future operations and its actual performance may different materially from those indicated in any forward-looking statements.

Additional information that could cause actual results to differ materially from these statements, are detailed in the earnings release issued this morning, and from time to time in Crescents's SEC report.

I'll go ahead and turn the call over to John Goff.

Good morning, everyone.

And thank you for joining Crescent's second quarter conference call.

As Keira mentioned, please feel free to follow along with the slides on our website, and Denny and I will periodically refer to a slide number.

First, let me cover probably the most pressing topic of the day, which is corporate governance and disclosure issues.

This has always been a very important topic for our management team, as well as our Board, something we take very seriously.

And I want to share with you recent changes that we have made, or intend to make, and I have four primary points here.

First, we will begin expensing stock options in the first quarter of 2003.

Historically, we have complied with APB 25 and FASB-1 23, and included in our footnotes, the amount of compensation expense associated with stock options.

But beginning in the first quarter of 2003, we will actually begin expensing new stock option grants.

Obviously, we will take into account any guidance that may be published or announced by either the SEC or the FASB between now and that first quarter reporting.

Secondly, we recently announced the expansion of our Board of Trust Managers to 9.

We added two new independent trustees bringing the total number of independent members to 6 out of the 9.

Those two new independent trustees were Bob Stallings and Terry Worrall.

Both of these gentlemen built businesses from scratch.

They took them public, ran them as public companies, ultimately sold the businesses, they have significant experience, both in running public companies, growing businesses, running significant infrastructures, and they both have a significant amount of Board experience.

And I think they'll be tremendous assets for our Board, and in representing our shareholder base.

Additionally, you know, Richard Rainwater is technically considered an insider, but he is NonExecutive Chairman of the company.

He is the company's largest shareholder.

He is not an officer of the company.

And he has never taken any compensation from the company, other than options that he received at the IPO eight years ago.

Those options have been exercised since then, and he still holds those shares.

So I really view Richard as I'd say a -- from a practical standpoint, as more as an independent trustee than I do as an insider.

We will be meeting as a Board in a Board retreat in October, to discuss a lot of the pressing issues related to corporate governance in general, just ensuring ourselves that we are doing everything that needs to be done to address all issues, with respect to corporate governance and, you know, we look forward to that meeting.

Third, we have received very positive feedback on the 10Q supplement that we initiated this year, and we will continue to enhance and expand this disclosure document.

New additions to the document in this quarter include, first of all, unconsolidated balance sheet and income statements by business segment; secondly, capital expenditures for signed leasing activity.

We have segregated that by non-incremental revenue generating, as well as incremental revenue generating capital expenditures.

And then we have even subcategorized it between, capital expenditures, tenant improvement dollars, and leasing costs.

So I think you'll find that very helpful.

Third, we have included quarterly lease expirations by major market.

Fourth, we have included FFO funds from operations guidance by segment.

And that's guidance looking at it on a prospective basis.

And fifth, we have expanded our list of major customers to the top 25.

Previously, we had the top 20.

And lastly, we have created a certification committee.

If you are familiar with the specific provisions of the Sarbanes-Oxley act, section 906 requires that both Jerry as CFO, and myself as CEO, certify our 10Q's in 10K filings.

What we have done is created a certification committee that's going to be comprised of all of our senior officers of the company, who are responsible for financial results of any particular segment of the business, and they are going to have to certify to both Jerry and myself as to their respective reporting area.

We will meet as a group.

We will go over the filings in detail, and I will tell you, this basically, I would say, formalizes a process that we have already been doing for years.

We have always been very thoughtful and careful about the process of public filings, and ensuring that everyone has reviewed them.

But this does formalize it, and it specifically addresses section 906 of the Sarbanes-Oxley act.

Slide 7 refers to our strategy in the current environment.

I would love to say that we are seeing definitive significant signs of recovery in the economy, and I think it would be misleading to say that.

I can -- I can point to specific data that may lead to that, but I could also point to data that may lead to an opposite conclusion.

But what we are seeing is specific data that, uhm, our markets have bottomed out.

Specifically, if you look at the to Torto-Wheaton information that just recently came out, it shows that both Dallas and Houston have shown slight positive absorption in the second quarter of this year.

I think that's the first time in the last five quarters.

And Austin was still negative, although much less so than last quarter.

Denny's going to cover the specifics of those markets and, in particular, some pretty significant positive signs we're seeing in Houston.

But again, you know, we think things have bottomed out.

I think the recovery is going to be very slow in the making.

And just our quick take on that, just big picture on the economy.

Clearly, we are in a very tough economic environment.

You know we've got so many different issues as an economy that we're faced with with here, that it's particularly difficult to climb our way out of this hole.

Most industries are in a significant state of overcapacity.

Demand has been less of an issue.

The consumer is at an all-time high in terms of credit.

And the Fed action, in my opinion, is not having the intended result, because it's really tough to generate, or to alleviate excess capacity with excess credit.

Demand has been less of an issue, and the Fed action tends to point in my opinion, more towards demand or impact demand than it does excess capacity.

So I think it's going take a while for bankruptcies, et cetera, to really wring out the excess in the system.

And then on top of all that, we have the crisis of confidence in the capitalistic system which, uhm, you know, appears to be continuing.

On a positive note, though, the real estate industry does not have significant excess capacity.

It's more of a demand issue.

And I think we should see a relatively quick recovery, subsequent to the national economy.

It obviously will tail the national economies, but I think with that backdrop, let me just talk about our strategy as a company in this environment.

First of all, we have been significant conservers of capital.

We're very stingy with our capital around here.

We have been a net seller of assets because it's been very interesting in this environment.

We're able to sell assets at very attractive pricing.

We've raised additional capital whenever possible.

In quarter 2 alone, we raised $500 million, $375 million in unsecured bonds, and $125 million in preferred stock offerings.

All completed in Q2.

Secondly, we value greatly our customer base, our existing relationships.

As I've always said, it's much cheaper to renew existing relationships than to start new ones.

We've got very positive, favorable trends in our tenant retention numbers, and Denny will cover that.

We even recently won a national award on customer service.

We continue to keep a very close eye on credit quality, and knock on wood, we so far are maintaining what I think has been a very stellar track record with respect to bad debt expense.

We're not seeing any significant increases there.

We're not giving in -- I think this is probably one of the most important points.

We're not giving in to pricing pressure in our markets.

I'm referring to the office business.

We have no interest around here in boosting short-term earnings to the detriment of long-term value.

Specifically, if we wanted to be 92 percent occupied today, if we wanted to be 95 percent occupied today, we could do it!

We could do it.

It's not an issue of capturing the demand.

It's an issue of what is the most effective way to drive long-term value.

And it gets down to a mathematical model.

And we are very analytical within this company when we analyze decisions on whether or not we lease space, the costs incurred in leasing that space, and whether or not that is cost-effective.

What are the returns on those dollars?

If we spend money on a lease, it's no different than spending money to buy an asset.

What is the return on that investment?

Because it is in fact an additional investment.

And so what we have done is we've tried to be very measured about accepting deals in this environment, because it is our belief that in many cases, if we sign a long-term lease, we may be giving up significant long-term value, and when we run the model, in many cases we're better off holding that space, warehousing that space until we are in a better environment, and then lease it at that time.

This is all on the margin.

We're probably talking about, uhm, 100 to 300 basis points in occupancy variance as a result of managing the business this way.

But it has driven our occupancies -- our occupancies now are down a bit, and we think they will probably remain flat through the end of the year.

And Denny will cover that in a few minutes.

With respect to stock repurchase, we continue to think the stock is very attractive.

I'll discuss why in just a moment.

We acquired shares in -- recently of 1.5 million at a price of $19 per share.

It may not look particularly smart right now, but I will tell you I think it's very smart.

I think the stock is cheap at $19.

I think the stock is incredibly cheap at $16.

The total of that purchase was $28.5 million.

To date, we have bought 20.3 million shares, or 16.6 percent of our outstanding share base, total acquisition price of $387 million.

Average price of $19.04.

I still feel very good about that decision.

Any further repurchases as we continue have continued to say will, be on a leveraged neutral basis.

Slide 8, to talk about second quarter results and guidance for 2002.

Second quarter FFO was $53.2 million, or 45 cents per share.

Year-to-date FFO was $117.3 million, or 99 cents per share.

Second quarter net income, $6.7 million, or 7 cents per share.

Year to date net income was $17.3 million or 17 cents per share.

The delayed economic recovery was the primary reason we have, uhm, gone with a -- kind of narrowed in our 2002 FFO guidance to the lower end of our previous guidance we issued.

We have narrowed it into $2 to $2.10.

With the third quarter, we're projecting to come in at 40 to 45 cents per share.

This delayed economic recovery, we think, is going to keep occupancies a bit at bay here, projecting year-end occupancy more around 90 percent versus where we were before which was I think 92.4 percent, and that impact is roughly $10 million.

Our stock is cheap.

As I mentioned before, I have to admit, I'm a little frustrated with it.

Uhm...

Our stock is cheap on any measure when you measure either against our peers, or if you simply look at it on an absolute basis.

And clearly, if you look at it relative to other opportunities in the market.

When looking at net asset value, depending on your estimate of net asset value, whether you are using, uhm, consensus analyst estimates, or our own estimates, which are $24 to $25 bucks, we're trading at 30 to 50 percent discount to NAB.

On a book value basis, we're currently trading at our undepreciated book value.

If you bought the stock today, you're buying Greenway Plaza for what we paid for.

You're buying Houston Center for what we paid for it.

You're buying the Crescent for what we paid for it.

And when we bought those assets, they clearly were not earning what they are earning today.

On an earnings[INAUDIBLE] basis, while our earnings I think are temporarily depressed, our multiple still ranks below the peer group.

It's at the low end of the peer group.

On a yield basis, highly attractive at a 9.4 percent yield, so you get paid handsomely while you wait for the recovery.

Highly attractive in this environment.

On a per square foot basis, by the pound, however you want to measure it, I think the stock is very cheap.

And if you look at our per square foot value based on our valuation of the company, it's still only in the $130 to $135 per foot range on the office sector.

If you discount that 30 to 50 percent where the stock is today, that is incredibly cheap for the quality of the asset base, that resides in this company.

The potential growth opportunist in this company, while this is probably the most difficult piece to measure, I think is much higher than many of the peers, because you are in at a low basis per foot, uhm, there is not much room for rental rates to drop from where they are, particularly when you look at where rental rates are in our market relative to the rest of the nation.

They're still among the cheapest in the nation.

And we reside right in these growth markets that are going to benefit dramatically when the economy does recover.

I'm a believer in the integrity of the stock market on the long-term basis, and I believe that ultimately the true value of Crescent will be in fact reflected in the stock price.

Granted, we've got work to do here, but, uhm, the good news is,it's offensive work, and in that vein I have to tell you that I'm personally really having fun again.

This is a really fun business to be a part of, because it's enduring times like this that I think really interesting opportunities arise, we're starting to see those, and we have an extremely talented management team to take advantage of those opportunities, and to manage this business, and to leverage our platform this team now has been together as a complete group for over a year.

And they're all chomping at the bit so to speak to put offensive points on the board.

We are already leveraging our significant infrastructure, by managing more outside capital from pension funds.

This is a big part of our strategy going forward, matching a few Crescent dollars with a lot of dollars from pension funds.

We have done already $250 million in joint ventures with pension funds.

We have in the works an additional $200 million in joint ventures.

And lastly, we are in the final throes of a fund which we can't announce the details of, but it will be in the range of $400 to $450 million which will be two-thirds outside capital, one-third our capital, and that will target office opportunities.

At this point, let me now turn it over to Denny to cover our operations in more detail.

Denny.

Thank you, John.

John asked me to take a few minutes to bring you up to date on our second quarter business operations.

And basically, we came in as expected, all of our business segments were on plan for the second quarter.

And I'm going to take a few minutes today to give you some real detail-specific guidance for each of those business segments for 2002.

If you will turn to slide 9, we'll start with our office segment, and as you know, our business strategy is focused really on our core business, which is owning and managing very high-quality, class A, AA office buildings.

And our plan and our strategy over time is to grow that office portfolio, from 70 percent of our total assets to 80 to 85 percent.

As of 6/30, the office portfolio was about 70 percent of FFO, and we were 90.4 percent leased.

This is what we expected, and it was exactly the same level of leasing that we reported to you in the first quarter of 2002.

Our office FFO for the first quarter and the second quarter, was identical at $80.5 million.

We estimate for the year, our office FFO should be in the $320 million to $329 million range.

This level of FFO would give us an office return on investment capital, of about 11 percent on an unleveraged basis.

We think that's pretty good.

Our second quarter leasing level of 90.4 percent was down from 92.6 percent at year end.

As we mentioned to you before, this was expected and was primarily caused by ARCO lease that expired, was 400,000 feet, it expired the first of 2002.

This took our Denver CBD occupancy from the 98 percent down to 58 percent so we had some work to do.

We have signed, or are in final negotiations to backfill approximately 325,000 square feet of that space.

The ARCO lease expired at $17.

We're leasing that space at $20 to $22.

So we're feeling pretty good about that.

However, 125,000 feet of that space was converting MCI from sublet space to direct space.

Which we all know the problem there.

Our rent is current through August, and obviously, we will wait and see what happens with the bankruptcy, and whether our lease will be confirmed or not.

Most of the space is used for the US West acquisition that they made a few years ago, and certainly we will not record any rent from MCI unless we receive cash.

In addition to Denver, we also have 41,000 square feet in Miami, 22,000 feet in Austin and 24,000 feet in Dallas.

The space in Miami contains MCI's switching equipment, so that should continue to be needed.

MCI's rent to Crescent totals approximately $400,000 per month.

And it represents less than 1 percent of our FFO.

I will say that overall, the credit quality of our portfolio, as John said, has held up very well.

Year to date, we have had charge-offs of only $800,000, or 3/10ths of one percent of our revenues.

We think that's good.

For all of 2001, we only took $2.3 million dollars, which was about 4/10ths of one percent of over $500 million in revenue.

We have been very fortunate in our buildings, not to have any Arthur Andersen space to deal with.

We had no Enron space to deal with.

As a matter of fact, we have actually picked up space from our accounting customers.

EY, and KPMG, as some of the Arthur Anderson people have come into their companies, and they had a need for additional space.

You also recall that we sold off, over the last couple of years our B assets, and we think this has upgraded our portfolio, and helped our overall credit quality of our customers.

As you can see on slide 9, our second quarter same-store NOI growth was down slightly.

Again, this was consistent with what you've seen with the other office reads.

Our lower same-store sales numbers were directly and primarily driven because of the decline in occupancy.

We have been able to roll up our rents, and continue to roll up our rents, as leases have expired.

Our second quarter we realized a 4 percent increase in our net effective rent.

Year to date we have generated a 9 percent increase.

I will cover some of that in more detail when we get to our individual markets.

And as John said, we have continued to be a pricing leader in our marketplace.

We have not bought occupancy, which would impair, we think long-term asset value as some of our competitors have done.

Instead, we have been working very hard to build our brand, and deliver exceptional customer value.

Earlier this year, we did get recognition from Boma, and CEO as one of the top five real estate companies in the U.S. for customer service, and we're real proud of that.

In today's market and environment, our focus is truly on execution.

I think we have got exceptional people in place.

We are working very diligently to effectively lease our property and manage our buildings.

Our emphasis is very much on customer retention.

And those numbers are coming in strong.

Today we have either signed or are in negotiation for approximately 70 percent of our office space that expires in 2002.

We have also got a good start on 2003.

We've got, uhm, about a fourth of that space taken care of now, and another 25 percent of it in negotiations.

So we're getting a good start on '03.

As John said, no doubt 2002 is going to be a choppy year for us.

Business leaders have been slow to expand, given the uncertainty in the economy.

They have been slow to make space decisions and timing has been pushed out.

For the remainder of 2002, I think our leasing levels will be about flat on a net basis.

And I will cover that individually in a second.

Clearly, Houston, we have seen some very good activity and very good velocity there, more so than Dallas.

We're looking and giving guidance for the average occupancy of our portfolio to be around 89 to 90 percent at year end.

Our same-store NOI growth should be roughly down 1 percentage point to flat.

As I said earlier, we're giving office segment guidance of $320 to $329 million.

And all this is outlined in detail in your supplement.

The economy recovers in '03, as John, said I think, in our demand-driven type markets we could see a nice rebound.

We do think our markets have bottomed out.

And particularly because of the lack of new construction, and the lack of what I call overhang in the market for new space, we could see a bounce in 2003 or early 2004.

If you'll turn to slide 10, we continue to focus on our office business, and our four key markets which are Houston, Dallas, Austin and Denver.

In Houston you can see that our portfolio was 92 percent leased as of 6/30.

This compared to 88 percent for class A space in the market, which we think we're holding up well to our competitors.

We have seen a real marked pickup in leasing velocity in Houston.

We've signed two new very important customers for us, Exxon has leased 215,000 feet at Greenway.

We're also talking about possibly upsizing that 50,000 feet.

We also signed a lease with Halliburton, as they move their corporate headquarters into Houston.

We signed 30,000 feet at five Houston centers, so we were very pleased with that.

But in addition to that, we also have over a million feet that we have active negotiations with in Houston, which I think could have a very nice effect for us in 2003, and of that million feet, about half of it is either signed or just about to sign momentarily.

The rest of it is in deep negotiations.

Approximately 70 percent of the leases that are expiring in 2002 in Houston, have been signed, or are in negotiation, and we continue to improve the percentage of that number that is signed.

Our flagship, Houston Center property, which is about 3 million feet, has now increased from 95 percent leased to 97 percent leased.

We are still rolling up leases in this particular property as the leases mature.

The level of leases that have matured have been in the $19, $20 range.

We are continuing to roll up those leases to $26, $27, $28.

So we're pleased with that.

Our five Houston Center project, which we're scheduled to open in November, it's on time, it's on budget.

We are over 90 percent committed there.

And again, the leases have come in at proforma, we are holding in the low $30 range.

Tenant improvement and leasing commissions.

We are under budget in Houston.

We are under budget in Dallas.

We're actually at lower levels than we reported in 2001, and that detail is provided also this quarter in your supplement.

The biggest question in Houston is obviously Enron, what's going to happen to that building.

Those buildings, the two buildings, that total about a little over two million feet, it now looks like the buildings are going to be sold at a biding in New York, possibly the latter part of September.

With the closing to come fairly shortly thereafter.

At that time, we are going to have a better idea of who owns the building, and what it's going to look like.

Obviously, if it goes back as multi-tenant, or substantially multi-tenant, we'll see pressure on the CBD occupancies, but I still think we're well positioned.

We are on the other side of town, if you will, of the CBD.

We're 97 percent leased, as I said and virtually out of space.

Turn to slide 11, which is Dallas.

The Dallas market continues to be competitive.

But our people are seeing signs that maybe we're bouncing along the bottom here in Dallas.

We have seen the level of sublet space stabilize over the last two quarters.

We are starting to see rental rate declines starting to subside.

The concession packages that are discussed in the marketplace, a lot of times by the media and the brokers, are probably not as bad as has been advertised.

I can provide more color on that really in Q&A

As of 6/30, we are 89 percent leased in Dallas compared to 83 percent for the overall market.

The 89 percent is exactly where we were the first quarter.

On a net basis for the remainder of the year, I see the totals being about flat, and we do expect some pickup really in '03.

Got a--some signed leases that I wanted to discuss here just briefly.

As John said, we are winning the business based on value, not on rate.

For example, we just signed several leases.

We signed 100,000 feet at $20.

Our competitor was offering space at $17.

We won that lease.

We won a lease at 40,000 feet, our price was $21.

Our competitor was $16.50.

A 45,000-foot lease as $23.50, our competitor was at $17.

A 35,000-foot lease at $22.

Our competitor was $18. 100,000-plus foot customer, we signed at $24.

Our competitor was at $19.

So we are able to win on value, and we will continue to do that.

By getting these higher rates, it significantly helps our long term NAB, because every dollar in additional rent, is $11 in NAB.

So that's our strategy.

Some of the out of town landlords have offered free rent.

That's a big question that's -- that comes up.

We have offered very little free rent.

We have done it in a handful -- absolutely a handful of circumstances, in the four to five-month range, and they're in areas or locations in our building that is what we would consider weak space.

And like Houston, our tenant improvement packages in Dallas are below budget and below last year.

Just quick , the weakest area in Dallas is the Telcom quarter as you would expect up in Richardson.

Right now, we are well leased in that quarter.

But we do have 150,000-square-foot lease with Nortel, that matures in December, that we will get that space back and it is not addressed.

So we have work to do there.

Probably the good news for Dallas is that we continue to be a capital constrained market for new class A construction.

It's virtually non-existent right now.

As of the end of the first quarter, it was slightly less than 400,000 feet.

So again, when we see the economy recover because of a lack of overhang of new construction, I think we could be surprised by the bounce.

And also think that our strategy will reward us long term, by being disciplined in our pricing strategy.

Before we go to the resort business, I did want to make just a couple of other comments about the office segment.

John mentioned that we have generated approximately $500 million in the second quarter from bond and preferred stock offerings, which is really enhanced our liquidity.

We're also working on joint venturing two of our existing buildings, as we have done in the past, and selling two non-strategic office assets.

And these transactions could generate between $175 million and $200 million of cash, if consummated.

In addition to the pension fund activity, the $400 to $450 million available from the pension fund, for new acquisitions that John discussed earlier.

We are looking at, and seeing some interesting strategic office opportunities, that are in our core market that would fit in very well with our existing properties.

It looks like there may be an opportunity to acquire at discounts to replacement cost, and at some attractive yields.

So we may, over the next few quarters be trading some non-strategic, what I call low-growth office assets, for some more strategic higher-growth replacements.

As John said, we do plan to bring in joint venture partners, with the majority of the office investments that we make going forward.

This allows us to receive management fees and leasing fees to push our yields up.

So, for example, if we bought an asset at 9.25 percent cap rate or return on an unleveraged basis, we could effectively increase our return on capital 100 to 200 basis points because of using -- taking in some of this fee income, could produce our unleveraged yields in the 10.25 to 11.25 type range.

So, we think it makes sense for to us leverage our expertise and leverage our operating platform.

Obviously, all investments that we make will measure against buying back our own stock.

Let's turn to slide 12 and talk about our resort business.

As we saw in the first quarter, second quarter, we had a tough comparison second quarter of 2002 to 2001 but we were pleased with the dollar level of results that we got in the second quarter in FFO with one exception.

And that is Sonoma Mission Inn.

Kenyon Ranch seems to continue to defy gravity, if you will, and we do expect that to continue in that business.

The issue with Sonoma seems to fall basically into two categories.

The first is continued economic weakness, naturally, in the San Francisco Bay Area.

The second really is the lack of weekday occupancy that we are getting, both from transient business and what I call the corporate meeting segment.

We think we can materially enhance the performance of Sonoma by bringing in an outside operator, and bringing in one of the leading resort operators.

We think that their stronger national marketing capabilities would enhance the performance of this asset.

We're working on such an arrangement right now.

We think that it will be completed by year end.

And so for 2003 we hope to gain the benefit of that type of strategic move.

On a consolidated basis for 2002, our resort FFO, we expect that to come in to $37 to $39 million range.

Let's go to slide 13, residential.

Some quick comments here.

The Woodlands lot sales were down in the second quarter, compared to the second quarter of '01, which we expected.

We are, though, lowering our guidance on the Woodlands from a lot sale standpoint, to between 1300 -- 1350 and 1450 lots compared to our original estimate of 1550 to 1800 lots.

Although the lot sales are down, we are seeing a strong demand for some commercial land sales, particularly corners that service the Woodlands residential infrastructure.

So on a net basis, the Woodlands we still expect them to meet their 2002 FFO budget.

Desert Mountain had a good second quarter, reporting 25 lots sold.

The third quarter is typically a seasonally slow month at Desert Mountain.

It's just too hot to sell lots.

But we do expect to pick up in the fourth quarter, and our discussions with Desert Mountain management, I think we will exceed our FFO expectations in that business.

Turn to slide 14.

Finally, Harry Frampton, on the residential side.

Harry's year to date activity as far as residential lots are concerned, he closed 159.

This compares to 74 in 2001.

So he had a good first six months.

He's also closed 206 condo units, through the first six months, compared to 12 in 2001.

So that's shaping up, that side of the business.

For 2002 on a consolidated residential FFO basis, we think that we will be in the $61 to $65 million range, which is well ahead as we reported in the press release, to our 2001 levels.

So turn to slide 15 and 16 and I'll summarize just real quickly.

As you can see, we are providing some detailed guidance here to our various business segments.

Our total business segment FFO should be in the $463 million to $482 million range, as outlined in our supplement.

This level of activity should produce about a $2 to $2.10 FFO range for us, and we are confident with that.

We are at the beginning stages of working on our 2003 budgeting plan, so it's really a little too early to offer that kind of 2003 guidance, but we will at the appropriate time.

And as John said, as most of you think we are looking toward an economic recovery in '03, and we think that it will help our business, and we have an opportunity to bounce back in '03 pretty quickly.

John?

Let's open it up for questions.

Thank you.

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Your first question comes from Greg Whyte with Morgan Stanley.

Good morning, guys.

John, can you give any indication of what you think the option expensing might be, had you done if it in '02?

Yeah.

If we were to start it based on kind of inception of options, it would have been $4.4 million.

If it would have been just been options in '02 that were granted in '02, it would have been 1.8 million.

Next year, that $4.4 would have been $3, 1.

Okay.

And then, uhm, just to jump around a little bit here, but ahh--can you give some timing on the fund inception?

Is that an '02 event or was that '03?

Greg, it's an '02 event.

It's something that we have got negotiated.

It is in final, final stages, wwe're looking at putting some acquisitions in that fund right now, and when we close our first acquisition, we plan to announce the details of it at that time.

Okay.

On the Enron building, you said the second half of September bidding process, are you guys going to be at the auction?

You know, it's certainly a building that we have an interest in because we know that market as well as anybody.

And we are pretty darned full in terms of occupancy but I'd like to just leave it at that.

Okay.

John, can you give a quick update on the Copi situation?

Everything is tracking well.

There have been no issues that have arisen.

Timing is just taken probably a little longer than we thought, but there's no, no surprises there.

It's just, you know, again down to mechanics, getting it closed.

Promptly working through the SEC comments.

Ok.

And then ahh--Denny you mentioned, well you took guidance for Woodlands down a little bit, I just wanted to understand what is percipitating that?

I just think it's a general economy, Greg, and ahh--you know Houston has held up pretty well, although you know, employment and job growth city wide is down, somewhat from last year, obviously.

But it's still positive.

The Woodlands activity is been good out there, but it's a function, and part of it is a function of the builders not holding big lot inventories right now.

You know they had pretty good size inventories at the end of the year going into the early part of the year.

Some of them are public companies, they've continued to scrutinize their--the level of lot inventories, so that has slowed it down a little bit.

Ok.

If I look at your guidance, full year, and what you're guiding for third quarter, that would imply somewhere between a 55-65 cents range for fourth quarter.

I've got to assume most of that is on the residential side, and the resort.

Is that accurate?

There'll be some pickup in office, but you're exactly right.

We're--it's really a fourth quarter business, residential, for us quite a bit.

And so the anser to that is yes.

Ok.

And then ahh--cold storage, notable by it's absence, really in any comment, I did see some stuff, obviously from [INAUDIBLE] this morning.

Can you give a little update on the John?

Sure.

Business is actually tracking quite well, they are 11 percent ahead of budget through the June quarter.

So first six months of the year, 11 percent ahead of budget, they did $64.6 million of EBITDA versus a budget of $58.2.

They're tracking slightly ahead of last year, about $400,000 ahead on an EBITDA basis, over last year.

And that is net of $2 million of a pension fund, funding catch up they had to make and expense this year.

So, on a real kind of apples to apples comparison, they're tracking about $2.4 ahead of last year.

So,given the fact that, obviously this was sort of accrual going on there, I mean, are you going to restructure the lease, or should we just expect it to stay the same and then have a writeoff?

What do you think?

Let me emphasize, and we emphasize this every quarter, but I don't think we emphasize it enough.

We do not book the deferred rent.

We book this on a cash basis.

Right.

We cleaned up a lot of the outstanding deferred rent last year, and, you know, again we put things on a cash basis.

In terms of a lease restructure, I think we are just watching the business, and that's something we will reevaluate down the road.

Okay.

That's very helpful.

Thanks John.

You bet.

Your next question comes from Todd Boyt with Cliffwood Partner.

Yes, good morning.

I'd like to talk a little bit more about the residential side of the business.

And, uhm, I'm surprised that you're kind of lowering the amount of lots that you expect to move.

I say that only because, all the public home builders are, you know, priced for massive growth and because there's trading at such huge premiums to book.

They're having to pay silly money to get as much land as possible.

I'm surprised that you're' not being able to sell to a lot of public home builders.

Well, keep in mind that's typically not our customer.

The only product we have sold to home builders is the Woodlands, and that's it.

The rest in the bulk of the dollars and earnings, relate to sales of lots to home owners.

A builder gets, you know, occasionally those are sold to a builder on a speck basis but it's primarily sold to the end user.

Sure.

So we're going to be very measured about our outlook on end users' demand for that kind of product, just given where the economy is.

Sure.

Yeah, no, I think that's prudent, and would you consider selling a big block of that land to a home builder that, you know, it's kind of the few companies out there that have to buy?

Sure.

We would consider it.

But I don't think there's a builder that builds the quality on that kind of scale, uhm, these are typically more custom builders that do not -- you know, they're not public companies.

They're local companies that build on a, you know, very high-quality scale.

You should look at Toll Brothers!

They're kind of high-end owners, and they need to buy lots of land.

Yeah, I hear.

We are talking about, in many cases homes are built in the, you know, people invest anywhere between $500 and a thousand dollars a foot in the home, and they are, you know, at $2 to $5 million apiece.

So -- but, yeah, we would be interested.

Okay.

That would be great.

Thanks.

Thank you.

Again, in order to ask a question, please press star then the number 1 on your telephone keypad at this time. [ pause ] There are no further questions.

I was passed one question that came in not on the call directly that I want to answer.

While we are waiting for any other questions in queue.

And that is why didn't we take advantage of buying stock when the -- while the stock has been really down here, and, you know, why did we buy it at the $19 level, which is a good question.

And the simple answer is, we were blacked out during the last -- this recent period when the stock has been so depressed.

We had an opportunity to buy a block at $19, and we quickly jumped on it, because we thought that was a good price, and we still think that's a good price.

So we -- you know, we are very, very careful about only buying during periods of time that we can legitimately buy.

Excuse me, sir.

Do you have a question from Steve Sakwa with Merrill Lynch.

Okay.

Good morning.

John or Denny, could you guys maybe address the energy merchant situation, and maybe talk a little bit about Dnergy, and some of the financial problems that some of those companies are having, and its potential impact on the Houston economy?

Uhm, there's been obviously a lot of press on this, but if you really go to Houston and you talk to, uhm, you talk to the economists in Houston, and I can share with you some specifics on this, the extent of that business and its impact in Houston is pretty -- is really diminimus.

There's a lot more noise than there is substance in terms of the use of space of those companies.

That's point 1.

Point 2, that business is not going to go away, and it continue to be headquartered in Houston.

I think the deck chairs will get rearranged in terms of who controls that business, and I suspect what we'll see is more of Wall Street becoming part of that business, and acquiring it from perhaps some of the energy companies.

But there's going to be energy trading, and the energy trade will go occur in Houston, Texas.

That's where all the talent is in that business.

It will remain there.

Those individuals that were in the trading operation at Enron have all found new trading jobs and I -- I know a few of these individuals, and they have all stayed in, you know, stayed in Houston.

So clearly, it's -- you know, it's an area of, uhm, you know, if we were looking at an energy trading operation as a new customer, you know, we are going to be very careful in underwriting that credit.

But I will tell you its impact on Houston short term, long term, not anywhere near as pronounced as you may think or read in the paper.

Okay.

And then just secondly, could you just circle back, uhm, I just wanted to make sure I understood exactly what your sort of expectation were for acquisitions, and dispositions for perhaps the second half of this year and into next year?

Sure, Steve.

We are working on a couple of acquisitions right now.

They are likely to go into the fund.

So it would not entail an enormous amount of capital at least the first couple that we're doing.

But -- and so it's limited I think for this year, but I think in 2003 we are going to see a larger opportunity.

So maybe, you know, $100 million for the rest of this year.

And we'll see about next year.

And so your share would be 20, 25 percent of that hundred million?

About 30 percent.

30 percent.

And on the dispostition front?

The two dispositions we are working on right now would be in the $60 million range.

Okay.

Thanks.

You bet.

Okay.

At this time, there are no further questions.

Well, thank you very much for attending the call.

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