Prologis Inc (PLD) 2003 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Catellus Development Corporation’s First Quarter 2003 Earnings Conference Call.

At this time, all participants are in a listen-only mode.

Later, we will conduct a question-and-answer session; instructions will be given at that time.

If you should require assistance during the call, press zero and then star.

And as a reminder, this conference is being recorded.

Now, I’d like to turn the conference over to Ms. Minnie Wright.

Please go ahead.

Thank you.

Good morning, everyone.

Thank you again for standing by for Catellus’s First Quarter 2003 Earnings Conference Call.

With us today are Nelson Rising, Chairman and Chief Executive Officer, and Bill Hosler, Senior Vice President and Chief Financial Officer.

Both Nelson and Bill will be making a few comments regarding the highlights of our earnings release this morning.

We will then open the phone lines for questions.

Today, we will also be discussing our 2003 earnings guidance, and we have posted a summary of the guidance on our website at www.Catellus.com.

You’ll find the summary, as well as our release and supplemental, on the home page and in the Investor Relations section.

Before we continue, I would like to state that this conference call will contain projections and other forward-looking statements regarding future events and the future financial performance of the Company.

We’d refer you to the documents the Company files from time to time with the SEC, including our Form 10-K for the year ending December 31, 2002 and the Registration statement on Form S-4 of Catellus’ [Sub-Co][ph], Inc., which was filed with the Securities and Exchange Commission on May 2, 2003.

These documents contain important factors that could cause actual results to differ materially from those contained in the Company’s projections or forward-looking statements.

Additionally, the broadcast of this call is the property of Catellus Development Corporation.

Any redistribution, retransmission or rebroadcast of this call in any form without the express written consent of Catellus is strictly prohibited.

Thank you, and with all that said, it gives me great pleasure to turn the call over to Catellus’s Chairman and CEO, Nelson Rising.

Well, good morning or afternoon, depending, I guess, where you may be.

We’re talking to you from San Francisco this morning, and I will spend a few minutes summarizing results of the first quarter of 2003 and then give you a brief update on the reconversion process.

After that, Bill will make some additional comments, and then we’d both be pleased to take your questions.

Our earnings per share for the first quarter were 26 cents, compared to 35 cents in the first quarter of 2002.

This decline was anticipated and mainly due to our success in accelerating residential lot sales in the first part of last year, as well as a level-three termination fee.

The 26 cents for the first quarter represents a 13-percent increase over the 23 cents for the fourth quarter of 2002.

As stated in our press release, we confirm our guidance of 10-percent growth in earnings per share as adjusted for reconversion items for 2003.

Bill will discuss the implications in his comments of our first quarter 2003 results on pro forma FFO.

Reviewing the results of the quarter, we’re very pleased that our occupancy remains solid at 93.9 percent in these challenging economic times.

We’re also pleased that our first quarter net operating income from the rental portfolio increased 12.6 percent over the same period in 2002.

We’re particularly pleased by the results of our development activities.

We started approximately a million square feet in three buildings in Atlanta.

We think this was very important for Catellus for a variety of reasons.

First, it is a market we’ve wanted to enter, and the best way we can think of entering a new market is with build-to-suit transactions.

We are particularly pleased that we are doing yet another series of transactions with APL, a very valued customer with whom we’ve done transactions in several other markets.

We’ve started construction in the first quarter on 220,000 square feet for Ford Motor Company in Kansas, and after the end of the first quarter, we entered into a 10-year lease with Ford on a 250,000-square-foot building in Virginia.

When these two buildings are completed, Ford will lease a total of 1.8m square feet of distribution warehouse space in six locations and significantly all of which have been developed since May of 2002.

Subsequent to the end of the first quarter, we entered into a lease with Kellogg USA for more than 50,000 square feet of a distribution facility in Kaiser Commerce Center in Fontana.

This transaction represents, I think, the strength of the [L&Empire][ph] market; we think probably the strongest market in the country.

And, again, it’s repeat business with another value to the customer.

During the quarter, we continued our efforts to acquire additional land for industrial developments, and we’re very pleased that we were able to acquire an additional site into the Denver market that can accommodate approximately four million square feet of additional development.

It’s still a very challenging time to find land at prices that support our hurdle rates since land prices are still not reflecting current market fundamentals.

This is not surprising to us.

Land prices usually lag the market at both ends of the business cycle.

Bill will have additional comments to make about the quarter results, and I’d like to shift now, if I could, to give you a brief update on our reconversion.

Last Friday, we filed a Form S-4 registration statement with the Securities and Exchange Commission.

It’s a very comprehensive document and contains the proxy and prospectus necessary for our annual shareholders’ meeting, which is still anticipated to take place in the third quarter.

The S-4 is still subject to review by the Securities and Exchange Commission and any comments they may have.

I’ll just mention that the first several pages contain a detailed summary of the conversion, and you will see that it is consistent with what we’ve laid out for you two months ago when we announced our intention to elect REIT status.

Also included are the normal proxy materials for an annual stockholders’ meeting, including the election of directors.

You’ll recall, when we announced our intention to convert to a REIT in early March, the Board had not yet decided how to deal with outstanding stock options.

It is now decided how to address this issue, and there’s a description under Proposal Three in the S-4.

After Bill’s comments, we’ll be pleased to answer any questions you have about the reconversion and the S-4.

And with that, Bill?

Thank you, Nelson.

Good morning or afternoon, everyone.

Just want to point out again one item in our supplemental package, which is on the website.

I would encourage users looking at [NAV][ph] to start again with page 14.

This provides detail about the balance sheet, including a breakout of our assets, as well as our share count at quarter-end.

And as Nelson mentioned, everyone should be reading our preliminary proxy prospectus on Form S-4 we filed last week.

Our income portfolio continues to perform well.

Our occupancy ended the quarter at 93.9 percent.

The decline from year-end is a little over 200,000 square feet.

It’s due to two or three items.

We completed about 75,000 feet – well, 150,000 feet of new development.

About half of it was not leased in the first quarter.

Now, we add buildings to our portfolio when they hit 50-percent occupancy, as opposed to about a 90-percent-or-higher point.

So one of the reasons our occupancy’s down is just we added a building that was only 50-percent leased at this point.

We also had two lease terminations, one, a tenant in some financial difficulty downsized by about 130,000 feet.

Another 75,000-foot tenant wanted more of a flex base and moved out of one of our industrial buildings.

We also sold about 65,000 square feet of empty space.

So the decline in occupancy, 200,000 feet, due to really three or four items.

Our current vacancy is 2.2m square feet, but about 800,000 of that is already signed, under negotiation, or is likely to be sold.

Almost half of the rest represents recently completed development, primarily in Louisville and Dallas.

For the remainder of the year, we have about 2.7m square feet of space rolling in the portfolio, and of that, we have about 1.7 already committed or a high expectation to renew, leaving about a million square feet uncertain.

That million square feet is about the same amount we have leased or committed of our existing vacancy, so, therefore, we expect occupancy to be fairly flat for the year.

Again, though, I want to comment that although we’ve enjoyed this stable occupancy, our vacancy could bounce around a few percent as we have many buildings over 300,000 square feet, each representing about 1 percent or more of the occupancy.

Same-space growth for the quarter was actually down 2.5 percent over the same quarter last year.

It was actually up versus the fourth quarter of 2002.

The supplemental package on our website provides more detail on page 22.

The decline in this year over last is primarily due to 165,000-square-foot in two buildings that were built and leased for level three in 2001.

We terminated that lease in the beginning, the first quarter of 2002, after two months of rent.

We terminated it with about a two-year rent termination payment, so that building was occupied at a fairly high rent for the first two months of ’02 and not occupied on ’03.

That accounts for the majority of the same-store – the vast majority of the same-store drop.

And as a side note, you’ll be happy to know we’ve released those buildings now, occupancy starting in the third quarter of this year.

For the year, we do expect same-store to be down slightly and because we have very few completions scheduled for this year, we expect NOI, particularly in the second and third quarter, to decline from the first quarter, primarily to two things.

We sold a build-to-suit right at the end of the first quarter that won’t be contributing, clearly, going forward, and, also, we tend to run higher repair and maintenance expenditures in the second and third quarters of the year due to weather.

In our guidance, we’re still projecting about 10-percent NOI growth overall this year compared to last year.

Development starts picked up.

We’ve started 1.2m square feet in the quarter, all of them build-to-suits, all repeat business.

Subsequent to the quarter, we signed another deal with Ford, one with Kellogg, again both repeat customers.

On page 16 of the Supplemental Package, we provide detail on capital spending and indicate there our TI leasing commissions and building improvements for the first quarter.

We ran about $6m.

For the quarter, we capitalized G&A of about $3.3m but received reimbursements of about $400,000, so the net capitalization was about $2.9m.

Capitalized interest net was about $3.8m for the quarter.

In terms of guidance for the year, Nelson mentioned we’re projecting about 10-percent growth in EPS adjusted for the REIT transition items.

These items go both ways in terms of advisory fees and other restructure costs and reversal of a significant amount of deferred taxes anticipated in the fourth quarter this year due to the REIT conversion.

As I’m sure you know, our earnings will be variable quarter to quarter.

Most of our sale activity this year seems to be falling in the third and fourth quarter.

We have begun providing FFO as a supplemental measure, and we calculate it using a pro forma EPS number that is meant to show the effect on taxes as though we qualified for a REIT today.

Tables provided in the supplemental package and attached to the press release provide full reconciliations.

FFO is at a high run rate this quarter, at 43 cents, given our guidance of $1.54 for the year, and I’ll refer to the guidance that Minnie referred to earlier, which is now up on our website.

And we expect the future quarters to be lower, to come in at guidance, closer to 37 cents a quarter.

The decline is primarily due to the NOI decline that I talked about before.

It’s important to know that our FFO calculations will exclude REIT transition items.

As that number gets bigger, we’ll provide a breakout of the cost so you can judge yourself what to include or not to include.

We will exclude advisory costs, other employment-related costs, costs related to stock option exchange offer that Nelson mentioned, and our deferred tax reversal, which will be an income item.

For the first quarter, these costs totaled about $1.6m pretax.

As Minnie mentioned in the opening remarks, our website provides detail of the adjusted EPS and FFO guidance.

We show in there a point estimate of $1.24 in adjusted EPS -- that’s the 10-percent number we’ve been referring to – and $1.54 in FFO for 2003.

Again, these are just point estimates, as opposed to a range, but a range would apply around these.

One dollar 54 ($1.54) in pro forma FFO contains about a nickel in gains from industrial land sales and build-to-suit sales but includes no effects of residential or urban land sales for income portfolio building sales.

And with that, we’re happy to take questions.

[Caller instructions.]

The first question today is from the line of Greg Whyte with Morgan Stanley.

Please go ahead.

Good morning, guys.

Bill, you alluded in the macro, the aggregate to the TI leasing costs, and I just wondered, can you give a little more color on the trend in those by asset class and maybe even on a square footage basis?

You know, I don’t see that we are seeing a dramatic trend other than clearly the little bit of office we have is, like everyone else, requiring a little bit more in all those categories.

But I don’t see that being a meaningful change of the overall portfolio versus what we’ve had and what we expect over the next year or two.

So the strength in your occupancy numbers posted was not a function of dramatically higher costs then?

I don’t think so, Greg.

I think a lot of our occupancy, the change we had was due to some kind of special circumstances.

We’re not rolling that much of our space in any given quarter, and we’re not seeing dramatically different costs.

Again, outside of the office sector, you know, we have a four- or five-building complex down in San Jose and a building in downtown Chicago, and I’d say on the margin, clearly, those are costing a little bit more money, but it’s not really reflecting in the aggregate numbers very much.

Can you just, sort of to continue that point a little bit, can you give – and maybe Nelson give even subjective comments on where you think we are in the cycle for industrial?

I mean have we actually seen the bottom here?

Well, it’s hard to make a generalization that is meaningful for the whole country.

We take it market by market.

I think you’ll see the strongest market in the country, from our experience anyway, the markets we’re in, is the Southern California market.

We seem to be in a good position with supply and demand equilibrium.

The second other thing, Greg, it’d be difficult to deal with an overall -- whether bottom or not -- is that industrial, particularly distribution industrial.

Looking at a vacancy rate or an occupancy rate, you have to consider obsolescence.

A building could be vacant that’s 18-foot-clear height and be a distribution warehouse and not be competitive with a 32-foot-clear height.

So with those qualifications, I would say that – but reading anything that defines a trend in the vacancy or occupancy numbers, I would suggest that if you look at the history since World War II, the industrial has tracked job growth.

We don’t have job growth right now.

So I think that that’s sort of a negative.

Until we get out of the jobless recovery phase of the recovery, I think that it’s going to be challenging in most industrial markets.

Secondly, trade [close][ph] have had a great significance or impact over time on the distribution side.

And so if you look at those two underlying factors, it’s not surprising then to see what we are seeing, that the industrial asset class has experienced increased vacancies.

That’s the bad news part.

The good news part is we’ve also seen a reduction in starts, and the industrial business is very attractive to us because it has a tendency not to overbuild because the construction cycle is shorter.

And so we think while it’s challenged in many markets, it’s still a very good asset class, and I think that as the economy continues to improve, we will see the bottom hit.

Whether it’s hit today, Greg, to answer your question directly, I don’t know.

In some markets, I feel it has, particularly Southern California.

Just in terms of some of the build-to-suits, the Kellogg and Ford, can you give us any indication of rates, even if it’s in the aggregate, for all of the – you know, for a bunch of those leases?

Well, I think we’d rather talk about it in terms of return on cost, Bill?

Yes, I’ll tell you, the rates for like the ATL buildings in Chicago are very low because it’s three brand new buildings we’re building on fairly inexpensive land, and the total building cost is very low.

We would target for tenants like that to be somewhere north of a 9, 9.5-return on cost, and that’s where those deals – those deals fall north of that.

But not – you know, historically, we’ve been doing deals as high as – and I go back two or three years – you know, 11-plus return on cost, and I think our expectations now are more in the mid- to high-9’s.

Well, I think the spread – even though the return on cost was not as high as it was in 2001, the spread was greater between the 10-year and the return on cost.

And just one final sort of question.

Can you just comment on the sort of sequencing and timing of the necessary filings and events for the conversions?

Are we on track, or are we ahead or behind in any way?

We are on track.

The big unknown is the timing of and the extent of SEC comments.

We can’t obviously predict what that would be, but it’s still our view that we will be on track, as we said two months ago, for a third quarter shareholders’ meeting.

And assuming the vote is positive, then we -- although it’s going to be a very busy year with lots of things we need to accomplish, we think we are on track for Catellus to be operating as a REIT as of 1/1/04.

Thank you very much, guys.

We have a question from the line of [Don Vendetti][ph] with Wachovia.

Good afternoon.

A couple quick questions.

I wanted to know what type of contractual rent bumps that you’re getting on these recent build-to-suit transactions, such as Kellogg and Ford?

Yes, I don’t know off the top of my head, and Kellogg’s a five-year lease, so there’s probably no contractual bump.

And the Ford deal’s been variable.

So I don’t know.

Our typical deal is a mid-term bump –

On a 10-year –

-- on a 10-year lease in year five, and sometimes in also mid-year bump or mid-term bumps on seven-year leases as well.

We’ll get back to you with the specifics on that.

Okay.

I will say, in general, just to echo the comments before, it’s still difficult out there.

Yup.

And it seems like congratulations on landing these deals.

Can you give us an idea of how you think you are winning these transactions over some of your competitors?

Well, I think there are a variety of reasons why we’ve been successful.

One is that our business plan has been to acquire larger parcels of land, parcels larger than the need for the individual requirement.

And we have used our development skills to entitle the property and to end up in a situation where – you have to assume when you buy land, you buy it at market but that if you then improve that land in a way that you end up with a parcel that is actually your cost is below market, that gives you an advantage, and that advantage will then stay with you as you attempt to lease.

So our return on cost can be attractive to us, and we can still be the low-cost provider because of the land position.

And, I guess, very important, necessity has always been the mother of invention for Catellus, and we started with a historic land portfolio that we needed to develop in order to realize the value that was in it.

Since that time, we’ve developed through a lot of that portfolio but have been able to acquire parcels that have been developed in a way that gives us an advantage on the overall land price of the site in question, specific building site.

Further, if you look at the ongoing relationships with the tenants we’re getting repeat business from, it is a question of us being able -- building a larger site.

We can locate the building, set in a different way due to the geometry and the different way and lighter truck courts and the like.

So it’s a combination of things.

The relationship based on the way we transact our business, coupled with the advantage we have because of the way we develop the land.

And these particular deals were all repeat business, some of them in new locations.

Okay, great.

And one last question.

Bill, what are your assumptions for the redeployment of your cash over – in 2003?

I’m sorry, what are my assumptions of the --?

What are the assumptions in 2003 for the redeployment of cash?

I think you’re expecting to have at least a healthy cash balance post REIT conversion.

What have you assumed you’d do with that cash through the remainder of ’04?

I’m sorry.

You know, the cash – it’ll be a function of how we finance going forward, but I don’t envision the cash balance changing dramatically through year-end.

We do have a significant E&P distribution coming up at year-end, which we’ll reserve for – set aside cash for, and then, of course, the quarterly dividends.

And then the big variable is just monetization of assets and the generation of cash from them.

But it’s – we are in the process -- going back to one of the questions, a subset of the question that Greg asked – we are in the process of a revenue ruling, a private letter ruling, that will determine how much cash will be needed in the E&P distribution.

And so until that’s [inaudible] known, we will probably keep our cash balances [indiscernible] 2003 about where they are.

Now, getting to 2004, as Bill said, as we accomplish our goal to recycle capital out of the suburban residential business and out of the assets that we monetize in the urban group, then those proceeds will be allocated to expanding our industrial development capacity with land acquisitions, particularly, in expanded markets.

But [for the] foreseeable future, we plan on staying relatively liquid.

We have a question from the line of David Copp with RBC Capital.

Hey, good morning, guys.

Could you walk through some of the details on the Aurora deal?

You know, this is in one of your peer’s back yards.

How did this deal come to you guys specifically?

And then could you talk a bit about what you’re expecting in terms of timing?

You know, when you might get vertical, how much we’re looking for infrastructure costs here, etcetera, etcetera?

Yes, when you say it’s one of our peer’s back yard, it’s just down the road from an existing development we have at Stapleton Airport, which is essentially all built out.

So, you know, I view that as kind of home territory for us.

This is out at the intersection.

I would tell you, it’s kind of a next site out.

It’s at the intersection of a new beltway going in in Denver, so it’s a green field site.

One of our competitors has a site right across the freeway.

You know, the first deal we’ll do there would be more than likely a build-to-suit, as opposed to a spec building.

The cost going in was around $7m.

I think the total infrastructure cost of the – by the time we net out, you know, municipal financing against it, will be another $6m or $7m, but that’s pretty preliminary.

We won’t really start on the infrastructure until we have a tenant – until we start the building – we won’t start the building until we have a tenant.

So that’s a “stay tuned.”

And so under those infrastructure cost assumptions, you know, where does that put your land costs on a competitive basis?

You know, I don’t have those specific numbers, David.

I can get back to you.

I would say that, you know, $1.50 to $2.00 a land foot, but I’m guessing.

Okay.

And then could you talk a bit – you know, refresh my memory on what’s the buildable balance now down at Kaiser?

Boy, let’s see.

We have had – while he’s looking for that, we have plans to start in June on about 600,000 square feet of space to be built simultaneously with the building of the Kaiser building, which we mentioned earlier is [pre-REIT].

Kellogg’s building.

The Kellogg building.

Yes, there’s about 3.2m feet left at quarter-end, but about a million of that’s about to be absorbed between Kellogg’s and another potential building that we’re looking at.

Okay.

And then how are you competing against the spec building that you’re building for [CB][ph] down there?

We’re not.

That’s their job to lease that.

Okay.

And then who’s the new tenant for the level-three buildings?

A company called [Synex][ph].

They are a reseller in the – broadly defined – the technology area.

Okay.

It’s going to be their new corporate headquarters.

The reason they were attracted to our building is that we have an ability to – you know, the overall space fit their needs pretty well, and they ultimately are thinking they want to own the building, so they have a purchase option on that building.

Bill and Nelson, Jay Leupp with just a quick follow-up.

Hi, Jay.

Hi, Nelson.

Back on these two larger deals that you have done, Kellogg and Ford – and Kellogg, in particular – is there any concern on your part that for a building of this size, that a five-year lease term is a bit on the short side?

And then, secondly, on both of these deals, if you were to put them up for sale, what do you think that the sale cap rates would be?

Let me take the first part of the question and let Bill talk about the second.

We’re not terribly concerned about that because the building size – what we try to do is build buildings that have more of a rectangular configuration that allows them to be broken down into segments if we needed to re-lease them, so it’s not required then to just have a 400,000 or 400,000-square-foot tenant or be vacant.

Also, the way we designed the buildings with the flexibility built in for more doors and the way we designed the truck court.

So we feel comfortable that we’re building a very high-quality asset.

We would obviously love to have it leased for 10 years rather than five, but we’d rather have it five rather than not have the transaction.

Yes, I’d say that’s right in the heart of Kaiser, which is, you know, pretty much not disputed one of the best sites in the Western [indiscernible] empire, which there are virtually no sites left.

So, you know, David mentioned a while ago, there’s a deal we started last year where we’re just building a building empty and giving it to an investor, selling it to an investor essentially as though it was leased.

So it has very good economics to us.

It’s in that same site.

The demand in that area is very, very strong, and that continues to be one of the largest industrial markets.

In terms of cap rates for, you know, Kellogg, a five-year deal clearly is not as good as 10, but giving that we’re selling empty buildings at implied market cap rates that are in the low eights, a five-year leased building, I would expect would go better than that.

Thank you.

We have a question from the line of David Harris with Lehman Brothers.

Yes, hi.

It’s David Shulman here, guys.

Good morning, David.

Hi, everybody.

First question – capex in the quarter was $112m.

Can you tell [inaudible] of that was?

Well, about half of it related to our purchase of a joint venture interest.

The remainder is scattered probably two-thirds in buildings and a third in land and infrastructure.

Along with [JV Insurance]?

[JV Insurance] was a subsidiary we had that essentially was a financing vehicle for us that we bought out.

Shows up in the balance sheet under the line item Minority Interest.

You can see that kind of went away from year-end to first quarter.

It’s just that it was a financing vehicle.

Okay.

Next question is what exactly [is on] non-FFO operations, and from an ongoing reporting basis?

Predominantly, they are urban and residential land sale activities, as well as the desert land, which we’ve always kind of pulled out of our numbers.

But isn’t – under the new [inaudible] rules, the new rules that most firms seem to be following, aren’t people [inaudible] SEC 12-G, aren’t we really going to have to report GAAP net income, which includes all of that stuff?

Which we do.

Oh, so you add on FFO, and this non-FFO operation really should be a part of FFO in terms of ongoing reporting [inaudible]?

Well, we’ve taken the major decision to pull that out of the FFO, separately disclose it, as it’s a business that’s declining.

If we could rewrite the rules on discontinued operations, it would fall into that category.

It’s because those businesses aren’t being sold in total, they don’t fall into that category.

So that’s a line of income that we’re trying to demonstrate will ultimately want to be volatile, and ultimately, it’ll go away.

But, also, David, we’d mentioned this before, that we are including in the FFO, to follow on Bill’s point -- if we buy, for example, a 200-acre industrial site and has been our practice, sell perhaps 10 to 20 percent of that to third-party developers to build product types we don’t want to hold in our portfolio, or as has been our practice, we do occasional build-to-sell transactions of buildings that have not been in our portfolio.

Since that’s part of our industrial business ongoing, that will be included in what we call FFO, and our “non-FFO” is simply to give the investor the ability to see which – where the income is likely to be continuing ongoing operations, as opposed to –

And, David, it’s not really treated any different than income property sales, which are also excluded from FFO.

We’re just putting it essentially in that category.

We’re just providing more information as to what the source of those monies are.

But it seems to me is if you report that as part of FFO, and that is what it is, and then you just [indiscernible] portion of FFO would be in “non-FFO operations.”

Well, yes, certainly if you like, you can add the number back in and then subtract it.

I mean it’s all there, so you can treat it as you like.

Okay, next question is, since you reported 47 cents, you know, pro forma FFO from your dilution in the quarter, maintaining guidance in the low $1.50s, and then basically you have FFO dropping down to 37, 38 cents, the remaining quarter.

Could you just go over again what’s driving the [inaudible]?

No, FFO is predominantly driven by rental income and interest going forward and a little bit from industrial land gains, but those, as I mentioned, maybe total a nickel the whole year.

We see some seasonality to the NOI for a couple reasons.

One, you know, we had these hotel joint ventures.

They add about $2.5m the first quarter.

A big source of that is the hotel in New Orleans, which participates in Mardi Gras.

So it’s first seasonality.

That hotel provides a lot more in the first quarter than the rest of the year.

So that line item is going to decline a little bit.

In terms of property operating expenses, we tend to do more of our repair and maintenance in the second and third quarter, so that drives up expenses and drives down NOI in the summer months.

We also – you know, you experience a little bit higher utilities in the – on some of the office product in the summer months.

We also had a built-to-suit in Kaiser that we completed toward the end of last year.

We put it in the portfolio.

The tenant exercised their purchase option.

That was purchased right at the end of the first quarter.

It was a fairly large building -- I believe 600,000 feet – that’s gone, so that won’t contribute to rental income, so it’s a sum total of a lot of small things are going to drive down our NOI.

We expect to have a little bit of negative same-store growth, and then I’d tell you we’re a little bit on the conservative side overall. [Inaudible.]

Let me also go back to the Kellogg lease question.

Yes.

Isn’t it really – when you really cut to the chase, it’s a five-year lease because Kellogg wanted a five-year lease and didn’t want a 10-year lease?

Absolutely.

We would’ve definitely pushed for a 10-year lease.

They wanted a five-year lease.

Thank you.

We have a question from the line of Chris Haley with Wachovia.

Hey, good afternoon, good morning, everybody.

Hi, Chris.

Nelson, when you do think you could get a ruling from the IRS on the cash portion?

July/August time period.

Roughly July/August.

Okay.

Is there a necessary grace period between shareholder vote completion and when you can officially declare [REITdom][ph], meaning if things get pushed back a month or two, does that push things back?

Not really.

There’s cushion built into the system, and to declare [REITdom][ph] is a calendar-year event under the tax code.

Right.

In other words, REITs can’t begin in September.

They have to be a REIT for the whole calendar year.

We clearly don’t qualify this calendar year.

Right.

We have some time after the shareholder vote to complete the operating partnership merger and be in a position to be operating and comfortable January 1.

You know, the key is that January 1 we need to operate for the year as a REIT to meet all those REIT rules.

Okay.

The actual election takes place when you file the tax return for 2004.

But you can’t file the tax return election unless you’ve operated for a whole 12 months as a REIT.

Right.

So we think we’re in good shape on that.

As I said, the one issue that we can’t control is the timing of or the extensiveness of the comments, what the SEC might have, which, as you can see, is a very comprehensive document to be filed.

It’s a page-turner.

Second question would have to do with personnel and structure from a C Corp to a REIT and how, I guess, an egregious [kind of] will be your de-emphasizing your urban and residential activities.

How do you foresee, or what do you see as the risks in terms of personnel losses, some of the changes that have occurred and may occur?

Well, on the residential side, first, we made some significant changes in how we were structuring the residential group in 2002.

And so I don’t anticipate any changes there.

With the urban group, you’ll note that we have described – discussed this in some detail in the urban section of the S-4.

And we point out that our decision not to expand our development to new mixed-use projects and the progress we’ve made in the San Diego project and Mission Bay, particularly, are such that there will be reductions in force.

We mentioned that [Doug Gardner][ph] and [Mark Shue][ph] are both going to stay on during this transition period but probably will depart – we’re not sure of the exact date but early ’04.

We are very pleased with the work that they’ve done for us, and one of the things they’ve done is created an extraordinary team there, and so we feel that the team that’s in place will be able to help us carry out our stated mission of developing out those urban assets.

And so at this point, we feel that the changes that are a logical extension of our strategic change in direction will be taking place and that we will be able to manage the human resources aspect of those changes.

And the slack or the replacements or the fill-ins, how will that be taken care of with regard to these larger projects?

Will you take a more active role, or will the remaining group take a more active role?

Yes, as I mentioned – or as we stated in the S-4, the urban group has always directly reported directly to me, and that will continue.

And I have a keen interest in the success of those projects, and so I would anticipate that my involvement will certainly not decrease.

And, again, as I said, the extraordinary work that Doug was able to accomplish in getting the plan through the approval process and getting the plan designed and laid out at Mission Bay will put us in great stead, and then the great accomplishment that both he and Mark were able to do was to build a team which will give us the ability to carry out those projects.

We’re going through a transition, so I can’t be terribly specific on all the questions you asked, but it’s important to note that that transition is going to be headed by Doug and Mark through the end of this year into next year, early part of next year, and as we move forward, we will be able to resolve the specifics of this.

But, yes, I’ll be involved, and the team that he’s put in place is outstanding.

I’ve got just two more questions.

Any update on the Austin developer agreement?

We are working on it.

It’s coming along.

It’s a comprehensive plan that we set up with the city that we would not only have the economics worked out by the time we’re prepared to move forward, but we’d also have all the entitlements in place.

And so it may seem to be unduly long, but in order to have both of those goals accomplished, we think that it’s the right way to go.

So it’s moving ahead.

We’re very pleased with our relationship with the city.

They’re working very diligently.

We’ve got a very good team working on that, and we’re excited about where it’s headed.

All right.

Don asked before about the Ford mid-term rent bumps.

They generally run about 10 percent.

I’m sorry; they generally run about what percent?

Ten percent, mid-term at five years.

But years six to 10 will be a 9 to 10-percent bump over the [inaudible].

Before I ask my last question, I would just like to pass on my sense that the work your team is doing is excellent.

I think your activities both on the industrial side and the decision to convert to a REIT is a clear positive, and I want to make sure that I give full credit to the whole team, particularly on the industrial side with [Ted Antonucci][ph] in the group that’s he’s doing.

As I’m on a train right now, I was looking at L.A.

Union Station, and there’s a little bit of activity now and potentially in downtown L.A.

Could you give us a sense as to where you stand, what type of rents, at least with Catellus’s position, would be justified for coming out of the ground, either with a build-to-suit or a spec activity?

Give us a sense as to your position there and what’s the long-term prognosis?

I would not anticipate Catellus doing spec in that marketplace.

You’re correct, Chris, that the Los Angeles market is strengthened.

If you look at it from a net absorption standpoint, there’s almost no market in the country where you have a strong office market, but, you know, Los Angeles has gone through an enormous amount of pain in the ‘90s, and that’s behind it now.

But I think this is probably the strongest market, office market, clearly in California and perhaps one of the stronger in the country.

But it’s not yet someplace we’d like to build spec.

We are looking at a variety of things with respect to Union Station, Chris, one of which is residential.

If you see the success that people have been having in rental projects in downtown Los Angeles, it’s very encouraging.

Many have had a dream [inaudible] this will be a 24-hour city, and it’s coming closer to becoming a reality.

So we feel good about that.

I think that one of the most important events that’s going to take place is the opening of capacity in the [gold line][ph] towards the middle, the end of this year, and that is going to add density to density, which is the key to making transit more attractive.

The tenants we have talked to, potential tenants we’ve talked to, have all been interested in Union Station because it’s the one place they can locate that can allow their workforce to half an hour commute by train and, therefore, have more affordable housing.

But it’s not to a point where we’re having to announce yet that we are encouraged by the overall marketplace.

Where do the economics make sense for you to come out of the ground on an effective or cash basis, rental rates?

You know, that’s hard for me to give you a number on because so much depends on the special requirements of the tenant as far as [core and shell].

Right.

But we’re going to look to trying to get our yields in the 9.5 to 10.5-percent return on cost, but, again, that’s somewhat driven by the spread over cap rates.

So I’m reluctant to give a number because I almost am certain whatever number I give you will change.

Okay.

Do you have any entitlements or tax structures or abatements related to your site that might give you a competitive advantage in that market?

Yes, there are several.

It’s considered into certain impact zones, and there are certain advantages we can offer to attract tenants, yes.

Okay.

All right.

Thanks again.

Question from the line of Jim Sullivan with Green Street Advisor.

Hey, guys.

Hello, Jim.

The corporate restructuring that’s required to effect the reconversion, will that in any way be deemed a sale of properties for purposes of California property taxes?

No, we’ve structured it as a – as I’m sure you’re carefully reading the S-4, we’ve structured it as a merger of Catellus as it exists today into a new entity that will become an operating partnership.

And by structuring the merger, we believe we’re not going to trigger a property revaluation or reassessment.

Okay.

MCI –

The primary reason for structuring it that way instead of a different way.

Okay.

MCI, one of your top-10 tenants, what sort of assumptions, expectations have you baked into your guidance?

You know, MCI’s in about 120,000 feet down in San Jose right now and they have indicated that they’re going to probably go down to a little less than half that, about 57,000 square feet.

The GAAP rent on the space is $1.80 gross, and it’s going to go down to $1.50 gross on the remaining space.

So that’s going to hit us about $400,000 in NOI a quarter, which will, by itself, create about a 1-percent same-store drop.

And is $1.50 gross the market for the balance of the space?

Well, since they’re negotiating from a point of bankruptcy, I would guess that that’s pretty much market.

Your FFO definition -- in your guidance, you take out income property gain on sale.

Does that include properties that you’re building on a merchant building basis that you intend to sell shortly after completion?

The way we’re running it is anything that we’ve collected rent on and then sell won’t run through FFO.

But if we build a building for a tenant and they buy it upon completion, then that’s a merchant building activity that will go into FFO.

And I think, as I said before, between that and land sales, by the time you affect them with tax and everything, shouldn’t –it’ll end up being about five cents of the total FFO.

A couple of industrial REITs don’t do it that way, REITS that you’ll be increasingly compared against, I would think, by a bunch of different measures.

Why not include those gains on sale like CenterPoint does or First Industrial?

Of the income property?

Yup.

I think that that gets more into a question of the basis of your properties and is less reflective of the change in value you created, which [inaudible].

But I think, also, Jim, the – what we’re trying to do is to have a predictable number, and without saying that there’s a right or wrong here, this is very close – this is the [indiscernible] REIT definition, as we understand it, and that we want to make – that would have a number that the investor, the shareholder, can look to that it’s a number reflective of longer-term obligations, like a lease, and that, therefore, they can understand what the impacts are of that on their dividend distribution.

We certainly think that’s important income.

If you have a gain on sale, whether it’s a piece of land from the residential group, whether it’s a piece of land at our site in San Diego in the urban group, that was very important income, and that income’s going to be recycled into productive investments for our shareholders just as a sale from a building in the portfolio.

But we just have made the decision that we think this is a more --

The way we’re choosing to do it.

-- the way we’re choosing to do it.

I won’t explain the value judgment.

I’m just saying it’s the way we are choosing to do it.

Okay.

But to be clear, if we do build a building for specifically a tenant who wants to buy the building and own it at the end of the construction period, that will wind its way through FFO.

But like this building we just built in Kaiser, we completed it for the tenant.

They were likely to purchase it, but they wanted some time to decide, so we completed, I think, in the fourth quarter, they leased it, and we collected NOI in the first quarter, and then they bought it at the end of the first quarter.

We didn’t run that gain through FFO.

Just the way we’ve decided to draw the line.

Okay.

And then, finally, in the S-4, the page-turner that you referred to, Bill, the proposal to convert options to restricted stock for management, can you walk through the logic, the strategy, the thought process in doing that?

Let me take a crack at that, Jim.

First of all, we have both existing vested and unvested stock options.

The options of a C Corp. under a Black-Scholes valuation are significantly more valuable than the options of a REIT because a significant portion of the total return from the shareholder REIT is from dividends.

The option holder in a REIT doesn’t receive those dividends unless they have a dividend-equivalent instrument.

And so that – and the other reason is because of the dividends being a significant portion of total return, the volatility of a REIT is lower, so, hence, the Black-Scholes option value is lower.

So if you follow that logic, we’re saying that there is – the situation with vested options where – or all options, rather, in a C Corp. versus a REIT, there is a diminishing value from one form of ownership – one form of structure rather than the other.

What the Board has decided to do is to make on vested options, make no adjustment for the fact that the option holder does not get a dividend or the fact that the stock -- the value of the option is reduced because of less volatility.

It has decided to make an adjustment under 1044 to make the option holders whole as it relates to the [ENP][ph] distribution, which does not go to the option holder but does go to the shareholder, so [indiscernible] the ENP distribution is made, the option holder would have something less valuable, and so the table in the S-4 shows that the calculation, which can only be made in final form, then the ENP distribution.

There is that adjustment that makes the option holder whole in that regard, but there is no adjustment under the vested options for those shares – options on shares that are vested to make up for the fact that they’re not getting dividends or they have less volatility.

The proposal you referred to in the exchange offer applies to unvested options.

In that category of options, the Board has determined that there should be an exchange offer, not required by the option holder, to exchange their existing options for restricted stock.

The formula is a 15-percent discount to the Black-Scholes value.

The end result of that plan is on the unvested options.

The approximately 3.4m shares – or options on approximately 3.4m shares will be exchanged for 1.4m shares of restricted stock.

And, importantly, the restricted stock will have new three-year vesting tied to it, which, I think in all cases, is a longer vesting period than exists on the –

Remaining options.

-- remaining options.

So this is what’s basically two ways to treat vested [indiscernible] – ways to treat two different types of options, vested and non-vested, and the Board deliberated on this for an extensive period of time and management and the Board, I think, agreed that this is a fair way to treat it.

Was it an objective of the Board to make this an economically mutual transaction from the standpoint of management?

The objective was to – yeah –

To make it fair.

-- make it fair.

That was the overall objective.

Because recognizing there’s no way on each individual item you can track it but that overall the objective was to be fair, but the management would not be disadvantaged by this conversion.

The difficulty is that economically equivalent is what you can argue between, you know, whether or not you believe the full value, Black-Scholes value, etcetera.

So I think a better way – the proposal three there shows you some charts and some of the economics.

I think a better way to describe it is that there was –it was the fair way to do it.

Yes.

Thank you.

Thank you.

We have a follow-up from the line of David Harris with Lehman Brothers.

Yes, hi.

It’s David Shulman again.

Hi, David.

What was the reaction of the Austin city officials to the changing personnel in the urban group?

None, because the urban group is not doing the Austin project.

Some people on the urban scene have been down there to – when we first were looking at the project had been to Austin, and they were very, very valuable input, and those people are remaining with Catellus.

The commercial group is the group that’s doing the Austin project –

Suburban because it’s more low-rise and more low-density single-family housing involved.

But, obviously, the question that anyone would ask is does the fact that we’re making this strategic change in direction lower the extent of Catellus’s interest in performing under the obligations that will be existent there?

And the answer is no.

As we’ve said, we’re going to continue the project we started, and the question is going forward, we’ll be [indiscernible] more on industrial.

So they did not have a negative reaction about the urban situation that I’m aware of simply because the urban group is not involved in that project.

Okay, thank you, guys.

Thank you.

And we have a follow-up from the line of Chris Haley with Wachovia.

Yes, just a question, Bill, again.

Assuming this shareholder proposal – well, first, the shareholder proposal, probably the proposal for the unvested options is – we’re assuming a 15-percent discount in the value calculated by the Black-Scholes model.

Correct.

Is that –did I hear the correct? – okay.

And this is the maximum cost.

That’s actually how it’s described as somewhat of a maximum cost, which obviously could be lower than that depending upon how many people actually subscribe to it, correct?

Correct.

There won’t be – I mean all the options that are going to be subject to exchange already exist.

So you can’t increase the options that are subject to it.

And, in fact, you know, can only go – only be reduced either because people decide they’re leaving or not participating or whatever.

And this will be a – this will be an item that will, one, not be included in your FFO definition for the three-year vesting period on whatever amount and will run through – I’m sure we talked – was it G&A?

Or is it going to run through – where’s that going to run through?

We’ll probably highlight it so you can see it in the REIT Transition Items line item.

Right, okay.

And then treat it the way that one thinks is the –

Yes, and we will pull it out of FFO because we view it’s transitional – clearly, future grants and long-term compensation and all that will run through FFO.

Important thing – these are not new grants.

And what’s happening is we’re expensing 3.4m existing shares.

I don’t know what’s going to happen.

I don’t think anybody knows precisely what’s going to happen with expensing stock options, as FASB’s now looking at that.

But the – well, that’s a benefit to the shareholders if those shares are replaced by 1.4 going forward.

But if we were to issue new shares as opposed to exchanging, then we would treat that as an expense.

Correct.

So, Bill – just, I’m sorry, so from an income statement presentation basis under GAAP, where will this show up?

We have a new line item this quarter under the GAAP phase of the income statement called REIT Transition Costs or REIT Transition Items.

It will show up in there.

Okay.

So you’re not going to include it with one of the conventional line items?

Okay.

All right.

Thank you.

[Inaudible] it out so everybody can see it.

Yeah, okay, great.

Thanks.

[Caller instructions.]

We have a question from the line of [Jim Kiefer][ph] with [Artisan Partners][ph].

Hi, this is possibly an unfair question but since you guys tend to be more forthright than most people, I’ll take a crack at it.

There are a number of interesting tidbits in the S-4, as you mentioned.

Specifically, I think the background area is particularly interesting.

To my reading, there’s a certain implication there that you’re not done with your process once you convert to the REIT.

Specifically, you note in there Morgan Stanley’s recommendation that the highest value could be obtained through conversion to a REIT, followed by a sale or merger with another REIT.

You could argue that’s boilerplate, but you could also argue you didn’t necessarily have to put that in there.

So my question is, how seriously would you actually consider that avenue?

Well, first of all, it was in there because that’s what they said.

And we’re not going to be historical revisionists.

We are focused on converting to a REIT, background material, becoming a REIT and operating as a REIT, and that’s what we’re going to be doing.

And our view is that – our goal is to have a very unique approach with the development focus expanded in the industrial area.

We think that’s going to be very successful, and we’ll maximize shareholder values.

We have no discussions going on with anyone.

I can’t predict the future.

That statement was in there because that was a statement that was made, and our Board considered that.

I think when you see the background information is a very detailed description of our thought process to show we got to where we are.

But there’s nothing pending we’re thinking about or that is implied by the fact that we put a statement in there that was actually made to us.

We thought we had no choice but to put that in there.

Okay, fair enough.

Appreciate the information you did provide.

That wasn’t too tough.

That wasn’t too unfair.

Question from the line of [Timothy Goebel][ph] with [Areef][ph].

Hi, it’s [John Robertson][ph] and Tim Goebel.

Looking through the S-4, the page-turner, at the pro forma for REIT conversion and just trying to ballpark the value of the tax savings, this may look like a bit of a softball, but it looks as though the add-back ranges from $5m-10m a quarter and averages in at about $7.5m or so, which is what the first quarter of this year looks like.

Is it fair to ballpark the tax savings at $30m plus annually and climbing?

And then you could throw whatever multiple you want on that.

Yes, John, the guidance page that showed up on the website this morning talked about specifically our guidance for the year as kind of a $27m assumption, so that’s right in line with what you were saying.

And I think it is fair to say that that’s a reasonable number.

It will grow over time in theory for two reasons.

One is we continue to add otherwise-taxable income-producing property to our portfolio that won’t be taxed as a REIT, and, two, as the tax depreciation continues to decline on historic properties, would also cause that to increase over time.

But I think your – the answer to your question is, yes, I think that’s a fair number.

And then the second question relates to Lockheed.

Is it worth talking about that at all?

Or is that just a way-off project?

Which one?

Didn’t Lockheed award you guys a contract?

Oh, no [inaudible].

It’s called the Lockheed tract?

No, I think you may be – must be referring to the L.A.

Air Force base transaction?

No, wasn’t’ there a site in Austin?

We have a – we bought from the railroad a while ago some ground leases, and one of them, I think, relates to land adjacent to a Lockheed facility that they have – I guess I’m not sure what you’re talking about now that I think about it.

That wasn’t Lockheed either.

Wasn’t there some mention out of maybe Austin Business Journal where you guys were selected by some new landowners?

Okay, now I can guess.

Okay.

That is a site that used to be owned by Lockheed across from the new airport.

It’s an industrial site.

And we have been selected to be the developer of that site.

It’s about, what, 500 [acres]?

Yes, I’m not even that –

We haven’t thought about it in terms of prior ownership, and that’s why we were both kind of scratching our head.

But, yes, that’s the way it was referred to in the Austin paper.

Okay.

And apparently that – any benefit from that is a ways off?

Well, I don’t know.

It’s an extremely well located site.

We are going to be working very hard to find tenants who want to be at that location, so I can’t say how far it’s going to be in the future, but, certainly, we have nothing pending on it now.

It’s land for a build-to-suit opportunity in Austin, so it leverages off our abilities.

You know, our personnel are already there.

So it will hopefully generate income eventually.

Okay.

And there’s no cost to you?

You have no skin in that?

We don’t.

I think we do have an obligation if after – if we can’t monetize – and I’m going to be very rough with the numbers – some number of acres in the – tens of acres that we will have to – we’ll buy – I don’t remember the number of acres, but basically a building site after three years if we can’t otherwise monetize it.

Okay.

You’re right.

It’s about $1m-1.5m commitment ultimately.

The existing holder is held on to the property for a while and unable to get it going.

Okay.

So we provided them some comfort that we get at least something happening in three years.

Thanks.

At this time, there are no further questions in queue.

Well, thank you all very much for your interest and continued interest in Catellus.

I know that we’ve filed a very comprehensive document, and our intent was to have it be as complete as we could make it, and we will be keeping you posted as progress on that schedule and look forward to talking to you again at the end of the second quarter.

Thank you.

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