Prologis Inc (PLD) 2003 Q3 法說會逐字稿

Good day ladies and gentlemen.

Welcome to the Third Quarter Catellus Development Corporation Earnings Conference Call.

My name is Kelera, and I will be your coordinator for today.

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

We will be facilitating a Question and Answer Session towards the end of this conference.

If you require assistance at any time during the call, please press star followed by zero and a coordinator will be happy to assist you.

As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today’s call, Ms Minnie Wright, Director of Investor Relations.

Please proceed maam.

Thank you.

Good morning everyone and thank you for standing by for the Catellus Third 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.

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 refer you to the documents the company files from time to time with the SEC, including our Form 10KA for the year ended December 31, 2002, our Form 10Q for the second quarter of 2003 and the Proxy Statement Prospectus dated August 15, 2003.

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

The broadcast of this call is the property of Catellus Development Corporation.

Any re-distribution, re-transmission or re-broadcast 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 the Catellus’ Chairman and CEO, Nelson Rising.

Thank you Minnie.

Good morning.

I will briefly summarize the highlights of the third quarter and then I will provide an overview of the status of our REIT conversion.

Bill Hosler will then provide a more detailed discussion of the re-conversion, particularly with respect to the E&P distribution and then he will provide more details of our third quarter results.

One of the most important aspects of the third quarter is that our rental portfolio continues to perform very well.

At September 30 our occupancy was 95.3%.

This compares to 94.4% at June 30 of this year.

It is our view that our high occupancy is contributable to a variety of factors.

First the high quality of our industrial properties that have an average age of 6.4 years.

Secondly, our buildings that we have built have the state of the art specs that make them very attractive to our tenants.

We also think the location of our properties accounts for our high occupancy and we do also believe our aggressive leasing strategy is a very significant factor.

All those factors combined leave us with a very attractive 95.3% occupancy at the end of the third quarter.

Our total square footage at the end of the third quarter was 38.2 million square feet and that represents an 800 million square foot addition.

This was from two buildings a 578,000 square foot building at our Kaiser Commerce Center, in the Inland Empire of Southern California.

That is one of the strongest markets in the country and we were very pleased to have Excel be the tenant for that 578,000 square foot building.

Also included in that total new additions is a 233,000 square foot build-to-suit in Shawnee, Kansas for Ford Motor Company.

We are very pleased that this is the sixth transaction we have concluded with the Ford Motor Company and we truly value the relationship we have established with them.

These two buildings are 100% leased and represent a total investment of $28.7m with a projected return on cost of 10.4%.

We are also pleased by the impacts of our strong performance from our rental portfolio that has led to 11.1% increase in our net operating income year-to-date 2003, over the same period of 2002.

We are very pleased by this increase in our net operating income.

Development activity continued during the third quarter.

At quarter-end we had 3.4 million square feet under construction, of which 2.4 million square foot consisting of eight buildings will be added to our rental portfolio.

The projected total cost of development of these buildings is $83.1m.

They are currently 70% leased and when fully leased are projected to yield a return on cost of 9.8%.

We believe this in turn reflects the downward pressure we are seeing on rents due in part to low interest rates.

While the spread between interest rates and capped rates is still very attractive, there is pressure on rents as a result of the continued low interest rates.

Included in that total of 2.4 million square feet are 700,000 square feet consisting of two spec buildings and we are very close to leasing both these buildings.

We do not like to announce the transactions until they are closed, but we feel very optimistic about how we are proceeding on those two spec buildings.

You will recall at our last conference call, we announced the acquisition of a site in [indiscernible], New Jersey at Exit 12.

We have recently acquired a site in Quakertown, Pennsylvania that can accommodate 1.3 million square foot of distribution warehouse facilities.

This is in the High Valley of Pennsylvania approximately 60 miles from the [indiscernible] site, so it demonstrates our interest in this overall market area.

We are very pleased by the acquisitions we have been able to make.

The sales activity in the third quarter has picked up significantly and this appears to be continuing in the fourth quarter as well.

I previously said on these calls that it is difficult to compare quarter-to-quarter results from our sales activity.

For example our sales activities in 2002 were heavily weighted to the first two quarters and in 2003 they will be disproportionately weighted towards the second-half of the year.

In the third quarter we sold a site near Denver, Colorado called Vista Ridge, a residential community that was entitled for 2,149 homes.

We completed the sale of another parcel, at our Santa Fe depot site for 285 condominium units.

We only have three parcels left at that site and we expect two will flow within the fourth quarter and the remainder parcel will close next year.

At quarter-end we had a total backlog of sales of $175m, approximately half of which is in residential joint ventures.

We previously announced that in the third quarter, we had re-entitled a portion of Pacific Commons, that is our business park located in the Silicon Valley.

The re-entitlement was from office and hotel to retail.

A total of 800,000 square feet of retail was approved.

We had previously completed two ground leases that can accommodate 260,000 square feet of retail space.

We recently executed a third ground lease with Costco for land that will support retail space and a garden center of approximately 157,000 square feet.

When this development is completed, it is projected – this retail development that is – is projected that it will generated approximately $7m in annual FFO.

I think our team is to be commended for the outstanding job they did in re-entitling that property.

The office market obviously leaves something to be desired in the Silicon Valley and being able to have this retail use leaves us a very important activity for this year and this quarter.

Now I will shift, if I may, to the REIT conversion and just give as I said an overview.

Our stockholders approved the company’s conversion to a REIT at our annual meeting in September.

Then at our October 8, Board Meeting, the Catellus Board of Directors declared a distribution of accumulated earnings and profits, or E&P, of $3.83 per share or approximately $350m.

This special dividend is payable on December 18 of this year to stockholders of record at the close of business November 4, 2003.

This Friday, November 7, election materials will be sent to stockholders of record on November 4, providing three options for how they wish to receive the E&P distributions.

Those options are – all stock; all cash; or 20% cash and 80% stock.

The total cash distribution will be limited to $100m and if more than $100m in cash were to be elected, only those stockholders electing cash would have the cash portion of the distribution reduced on a pro rata basis, with the remainder paid in stock.

Bill will go into more details on the E&P distributions as I mentioned in his comments.

The Board of Directors also declared Catellus’ first quarterly dividend at its Board Meeting on October 8 for the quarter ended September 30.

This dividend of $0.30 per common share will be payable on November 25 to stockholders of record as at the close of business on November 4.

I want to note that the stock received as part of the E&P distribution on December 8 will not be entitled to the regular third quarter dividend, because of the record date I mentioned earlier.

With that brief overview, I am going to turn it over to Bill Hosler to continue the discussion of the REIT conversion and third quarter results.

Thanks Nelson and good morning everyone.

I have a lot of housekeeping items to cover before I get into the quarter’s operating performance.

I think many of you have seen from the material we put out as a result of the comments from the SEC as part of our [S4] process, and also to better comply with the intention of the White Paper, we have enhanced our reporting of FFO.

Going forward we will provide FFO in two segments as well as a total.

We refer to the first segment as our core segment.

This reflects that portion of our business that we anticipate will be ongoing after we fully transition the assets and operations of the company over the next couple of years.

The core segment corresponds directly to what we have historically provided as FFO, and reflects the income property and suburban development business.

The core segment FFO for the third quarter of $0.35 reflects the same definition of FFO we have used since we announced our REIT conversion and is the same amount reflective of the $1.50 to $1.55 guidance we have previously given for FFO this year.

It is important to note that this is merely a new term for FFO and not a new calculation method.

The rest of our business is in what we call the ‘Urban/Residential/Other Segment’.

It contributed an additional $0.14 of FFO this quarter, bringing the total FFO under full REIT definition to $0.49.

We have historically and will continue to focus primarily on the core segment as we feel that best reflects the operations of a more typical REIT.

The contribution from the Urban/Residential/Other segment while important and valuable, is very difficult to predict, will be volatile quarter-to-quarter and will eventually decline as those assets are sold and those businesses rolling down.

As that happens, we will generate capital, which can then be invested in the core segment providing fuel for growth of the core segment FFO.

All of the FFO numbers we provide are adjusted by the hypothetical tax savings as though we had been a REIT in 2003.

Next, as Nelson mentioned, we have announced that our Board has declared a regular dividend for the third quarter of $0.30 per share and the special E&P dividend of $3.83 per share, totaling $4.13 per share.

Both of these dividends have the same record date of yesterday, November 4.

As a result our stock traded ex-dividend last Friday to the tune of $4.13 per share.

Since the stock closed last Thursday night at $26.25, it was adjusted on the exchange to open at $22.12 on Friday ex-dividend.

It then traded up about $0.15 for the day, closing at $22.27.

Now this Friday we will begin mailing out our E&P election forms to all stockholders of record as of yesterday.

These forms will allow each stockholder one of three choices, as Nelson mentioned, in receiving their $3.83 distribution.

All stock, all cash or a 20% cash and 80% stock mix.

We have limited as we have pointed out in the past, the total amount of cash at $100m of the total $350m distribution.

As a result, if the total cash elected by the stockholders exceeds the $100m, those stockholders electing all cash will have their cash portion reduced pro rata until the total cash distributed equals $100m.

The remainder of the $3.83 distribution for those shareholders will then be paid in stock.

It is important to note that only those stockholders electing all cash will receive their cash amounts reduced if we hit the £100m limit.

The stockholders electing to 20% cash and 80% stock option, will receive 20% cash in any scenario.

In no event will any stockholder electing any amount of cash receive less than 20% cash.

I would encourage everyone to respond in a timely manner to these election forms.

They are due to the paying agent by December 1.

The total election time is a little over three weeks from when we mail the forms and one of these weeks is Thanksgiving Week.

For those with stock in street name, there is an extra step involved through your broker custodian, so again, I would suggest responding in a timely manner.

If we do not receive your election form or for some reason it is not filled out correctly, the election will default to all stock.

So again, I encourage everyone to pay attention to that when it comes in next week.

The number of shares of stock distributed, as part of this E&P distribution will be calculated based on the average closing price from December 2 through December 8.

The cash and stock will be paid on December 18.

If we assume the full $100m in cash is distributed and the average closing price from December 2 through December 8 is equal to yesterday’s closing price of $22.24, we would expect to distribute about 11.3 million shares to those stockholders receiving stock.

As we discussed back at the time of the REIT conversion announcement, this will result in a retroactive adjustment in all of our per share numbers by about 11%.

In other words, our core segment FFO for the third quarter, which we just reported at $0.35 will be re-reported at $0.31 once the distribution is complete.

Our previous guidance of $1.50 to $1.55 gets adjusted as a result of this distribution to $1.34 to $1.38 and our indicated dividend rate, which is $0.30, gets adjusted to $0.27 on the new shares outstanding.

It is important to point out though, however, multiples and growth rates do not change as the stock is going ex-dividend.

Lastly, on the E&P distribution, we currently anticipate that the distribution will be about 75% taxable, 25% will be a return on capital to the extent of basis.

This is regardless of whether you receive stock or cash.

Remember with the tax proportion will qualify for the CCorp dividend treatment and be taxed at a 15% federal rate.

The third quarter dividend paid the end of this month is all taxable but again at the CCorp 15% federal rate.

Now I am going to turn to the operating side.

Our numbers are showing a large increase in the property operating costs in the third quarter versus the second quarter, causing NOI overall to drop sequentially about $2m.

The main reason is in the interim income from the Urban Development Properties, which saw increased property tax costs, due primarily to supplemental taxes for CFD infrastructure bonds at Mission Bay and a catch-up on this with prior periods as the tax amounts have been finally established.

We also started booking supplemental tax payments for these and other bonds as operating costs instead of interest expense.

So about $1m of property operating costs is merely moved from interest expense up into operating costs.

Additionally in the third quarter we typically experienced higher utility costs at our office properties that accounted for about $600,000 increase and that is clearly a seasonal number.

Given all this, we would expect the operating costs apples-to-apples to decline in the fourth quarter about $1.5m to a more normalized level without much change in the rental income.

Because we are now accounting for infrastructure bond payments in property taxes within the property operating cost line item, for those looking at NAV, notice that we have about $65m of infrastructure debt on the balance sheet, which should be backed out of NAV as the debt cost is already accounted for in the property NOI.

I can explain that more later and in more detail if people have questions.

Nelson mentioned portfolio occupancy over 95%.

Over 96% in our industrial portfolio.

We have only three markets where the occupancy is under 95% in the industrial portfolio and those are the secondary tertiary markets of Ohio and Kentucky where we have about 1.5 million square feet in total space with 250,000 square feet available.

The other market is Texas, particularly in Dallas, where we have sizeable building with just about 300,000 square feet available.

Combined those three markets account for about half of our vacant space.

Our biggest market Southern California remains strong at over 98% occupied with no vacancy in the Inland Empire.

Only a third of our overall 1.8 million square feet of vacancy portfolio-wide is in retail and office.

We are seeing the weakest office performance in San Jose and Chicago.

Retail is fine overall, one particularly center in Arizona accounts for most of the vacancy, more due to a tenant credit issue than necessarily market conditions, although market conditions are difficult.

On the same source side we were slightly positive in the third quarter versus last year on a GAAP basis.

We had an increase in the industrial side of 2.5%, but an 8% decline in office.

I would caution that our quarter-to-quarter performance will be lumpy due to the timing of certain accounting entries and true ups and may not be reflective of any trends.

Our industrial leases that we have done over the last several months have been flat.

In terms of rollover we have about 11% of the portfolio rolling next year, right around 4 million square feet.

Of this, we would currently expect about 60% gets renewed with existing tenants, 13% to 15% gets released to new tenants.

Based on our current projections most newly vacant space then for next year’s rollover will be made up for by leasing some of the existing vacant space.

We expect our occupancy to continue to be in the 94%, 95% range overall.

At this point I will open it up for any questions.

Ladies and gentlemen, if you wish to ask a question please key star followed by one on your touchtone phone.

If your question has been answered or you wish to withdraw your question, please key star followed by two.

Again, if you wish to ask a question, please press star one on your touchtone telephone.

We will now pause for a moment while questions register.

Once again, ladies and gentlemen that is star one to ask questions and we are pausing while questions register.

We are ready to start.

There must be some questions.

Your first question comes from Greg Whyte of Morgan Stanley.

Please go ahead.

Good afternoon guys.

Bill if I could just focus in a little bit on the expense stuff and you gave some color on both the bond issue at Mission Bay and some of the office seasonality.

Are both of those in the property operating costs side?

They both are, they are in the property operating cost side.

Of that number, just the property operating costs alone sequentially moved almost $3m up.

Okay and what was the split there Bill, between the office operating costs and the Mission Bay bonds.

Utilities were probably about $600,000 seasonally higher.

There were two things on the bond side.

One is at Mission Bay we had issued bonds a year or two years ago and those payments now start kicking in.

Some of those property taxes get capitalized but because we have some property operating income at Mission Bay and some of the parking lots and the industrial buildings, some of that property tax is now going to go to operating expense.

In the third quarter we finally agreed with the town as to what all the tax adjustments were in the property over the last couple of years and so there was a bit of a catch-up, almost $1.3m, came through this quarter just due to that.

So of the $3m in total, $1.3m is for the non-recurring, $600,000 is office utilities and the balance is the recurring cost of the bonds?

That is pretty fair.

The $1.3m I said that is non-recurring, there are still some adjustments being made up in the fourth quarter, because not all the parcels were settled.

I think that is a fair statement.

We would expect property operating costs to drop down about $1.5m next quarter.

Okay.

Just on the corporate admin side, that increased pretty sharply as well.

Can you just reconcile that for us?

You know I saw your note that came out a couple of minutes ago – on the corporate operating expense the one item that comes to mind is we did a lot of our 4 04 work in the third quarter.

That would have been one item that hit corporate.

On the SG&A side, we did incur some severance costs in the third quarter that accounts for most of that change in SG&A.

And that SG&A cost, when you say severance – I am just curious to know you did not allocate that into the REIT conversion?

Correct.

Most of the severance costs were associated with the Urban Residential segment, so it was allocated there.

Yes, the severance costs were not put in the REIT conversion expenses, I think I got a little bit of grief from someone out there about that six months ago when we talked about doing that, so we are just going to run those through SG&A.

Okay.

You did a sort of a reasonable breakdown of the likely renewal process on the space rolling.

When you look at the specifics of the leases rolling and where they are today in terms of win rate, what do you think they look like versus market rents or put differently is it some roll down exposure and what is that?

I guess if I break through the different markets, Southern California rental rates close to Inland Empire I would say those given the way the economy is now, probably roll flat.

Some of the other markets, Northern California, we have a building in Stockton that rolls next year.

That rent will roll down 10% plus probably.

Then we have some roll in Dallas, I would say that is probably going to roll down 10% plus and a little bit in Chicago, which is probably between zero and 10%.

That is kind of a quick and varied.

Okay.

Just one sort of quick final thing here.

I mean in terms of your guidance you are sticking with $1.50 to $1.55 which implies somewhere between say $0.30 and $0.35 for the fourth quarter, just doing simple arithmetic there and if I reflect on some of Nelson’s comments and your comments that either you are going to get more in the non-core that is not affecting your guidance; or you guys are being very conservative?

Well okay.

Again quarter-to-quarter Greg, there is always going to be a couple of pennies of things and I do not want to comment that we are being conservative, but in general the fourth quarter is kind of when you look at things a little bit harder.

I think in that range is the right range to look at.

Okay.

So when I think of Nelson’s comments about the potential for second-half sales being – that is going to go into your non-core right?

In the Urban Residential segment, correct.

That we envision being fairly robust.

Okay and just one last thing.

Pacific Commons has obviously been through a lot in the last variety of years, and now we are starting to see some real movement there following the re-zoning.

Can you just give us a little more color, like how much land is left there, what is the zone today, do you anticipate getting different entitlements going forward?

Greg, going back if you remember we did the [Cisco] ground leads a couple of years ago, so that land is from our standpoint spoken for.

The remaining land after we have – and we have some industrial buildings that are already being developed there.

There is approximately 1,200,000 square feet of industrial buildings have been developed and are leased.

Right.

So when we narrow that down we have probably got about 100 acres left, 80 of which go into this retail development.

When we are all sitting here a year or so from now, absent any new activity, Pacific Commons will have about 20 acres which is entitled for probably about 1.2m square feet of office which will be pretty high office, pretty high density.

That is what we would have left, about 20 acres.

Okay.

All right, thanks a lot guys.

Your next question comes from Jim Sullivan of Green Street Advisors.

Please go ahead.

Thanks.

Bill can you kind of give us a [tiff] 101 on what you did at Mission Bay?

What did you do, how do you account for it and I guess most importantly to the extend that development of the project needs to reflect the current market, that is it is slow.

Do you guys start coming out of pocket at some point to pay the property taxes beyond what was reserved in the bond offering?

Jim when you say a [tiff] 101, should I go back and summarize the overall nature of the transaction?

I do not want to get into too much detail, but if you could give us an overview?

Just from an overview standpoint – ultimately the tax increment generated by the vertical development in the property value increase is going to be used to pay the bond that were issued and will be issued to build the infrastructure for the public facilities, public improvements.

We initially then did a community facilities district in order to get the improvements for infrastructure put in that would allow the development of the site.

It is in that context, it is a facility district –

There is a two-stage bond issue, the bond issues we have done already and we issued just about $100m in the South [indiscernible] there at Mission Bay, which has generally about a two-year interest reserve.

I think the weight average out of that is probably just under 6%.

So that interest reserve is starting to run out right now.

This year we will be making some tax payments.

That was why there was a lot of activity in the third quarter by figuring out exactly what the property taxes were.

The tax payments we make in the South will be offset somewhat by the buildings that are built.

Right now the GAP building is the only one that is contributing to the increment in any substantial way.

The north of Channel there is considerable development which will –

Yes.

North of Channel we had a separate bond issue, a total of about $40m.

There really will not be any out-of-pocket on that.

In the South it will be a couple of years until more vertical happens hopefully on the residential side until that is made up.

In theory, you could argue just about all of that should be capitalized as part of a land development, but we are expensing a fair amount through the NOI now because we do collect some rent on some of those properties.

Can you quantify the out-of-pocket for say 2004 on the South of Channel portion?

$5.5m in total probably.

Versus how much in 2003?

A third of that, just because of the timing of the bond issue.

Okay.

And no out-of-pocket north of Channel, why is that?

North of channel we issued, well one there is a lot more development north of channel, the increment is kicking in much faster.

We issued floating rate bonds and the reserve fund because rates drops turned out to be much larger.

We have already started reciging tax increment in the north of Channel and it will first go to pay the current debt service on the CFD as it builds a little bit larger, we have a couple of buildings under construction now.

We will start kicking in significant property tax next year.

We will actually be in position to issue tax increment bonds which can either pay for infrastructure or pay down the community facilities district bonds.

And going back to the south of Channel, what needs to happen to transfer the property tax burden of $5.5m from you to someone else?

Well what needs to happen is that we need to develop the property and there are both residential and biotechnology possibilities which we feel are very attractive, recognizing offices are going to be aways away.

So that is what needs to happen there.

Yes, so property sales and vertical development.

Okay, great.

Thanks that was very helpful.

Looking at the statement of cash flow, you share the cash factors this year through nine months were $58m.

How does that compare to maybe your expectations at the beginning of the year?

I think we are generally in line with where we thought.

Earlier in the year we talked about how this was going to be a big tax paying year for Catellus for a few reasons, not the least of which is we do expect still substantial sale activities.

So taxes are estimated kind of for the full-year and then we put them in on a quarterly basis.

We have to make tax estimates for the year, so a lot of our activity is going to be in the fourth quarter we think on the tax generation side.

I would say the taxes are in line with what we thought.

A lot of it relates to either the sale of residential and urban land or the deferred sale recognition of some of those assets.

Do you want to quantify the fourth quarter number?

Well our tax rate is – it is hard for me to pinpoint exactly what the EPS was going to be and the sale gains, there are a couple of things swinging around, but it will relate to NOI for the property like it did in the third quarter, but there will be a bigger chunk from the sale of some assets.

The fourth quarter, Jim, is also going to be – we are going to have to spend some time going through that because at the end of the fourth quarter we will deem hopefully that we have converted to a REIT and a lot of things will change in the tax category.

We will unwind a fair amount of the deferred taxes, so we will have sit and harsh that out for you at the time, what is actually paid in cash and what is not paid in cash.

Thanks a lot.

Your next question comes from Steve Sakwa of Merrill Lynch.

Please go ahead.

Good afternoon.

A couple questions.

Bill, I know it’s small.

But could you just maybe talk about the increase in expenses on the retail portion of the same store.

Revenues were about flat.

And I think expenses were up about 12%.

I’ll have to get back to you on that Steve.

I don’t know the answer to that.

Okay.

And then secondly, maybe you guys could just talk a little bit about the purchase you made in the [Le High] Valley, maybe just give us some kind of cost estimates, what you think it’s going to cost to develop out, and expected rents for that type of project.

Yeah.

We bought a – we paid about $8m for a site that is fully entitled, and actually ready to go for about a million three square feet.

So about $6 of buildable foot for the site.

Once we build a building there, it will probably be all in somewhere in the low thirties.

So we could easily compete with rents in kind of the mid to low $3 range, which would make us competitive in that market.

And any sense as to timing, as to when – I mean are you looking to start projects kind of now or - ?

You know, our sense is that’s going to be one large building.

So that would probably be marketed more as a build-to-suit than a speculative development.

What we are seeing is a trend of people wanting larger and larger buildings, particularly near the major port cities.

And is this near major highways?

I mean where exactly is this?

It’s Exit 32, the Quaker Town Interchange of the Pennsylvania Turnpike.

And it’s about 60 miles from our site in [Carteret], New Jersey, 22 miles north of Philadelphia.

Okay.

Thank you.

Your next question comes from Christine McElroy of Banc of America Securities.

Please go ahead.

Hi.

I’m here with Lee Schalop as well.

Can you give us a sense of some of the trends that you’re seeing in the overall industrial market, especially with regard to leasing?

And also, what you’re seeing in each of your major markets?

Yes.

I’ll take a crack at that.

And Bill, chime in.

First of all, Southern California remains by far the strongest market, I think, not only for us, but I think for anyone else in the country.

One of the major trends that we see there is that it’s driven in no small measure by the tremendous amount of volume that goes through the ports of Los Angeles and Long Beach.

And we think that’s only going to increase because of the amount of imports that are coming in to be distributed, to the country to be distributed to the retail consumer.

We see the same – we have the same view of what will happen in the port market of Northern New Jersey.

That’s why we like that market so well.

We think that the demand for goods in the port cities on both coasts is very attractive, and I think robust.

The big issue that will happen – and I’ll give you the general overview on this, and then Bill, chime in, is that industrial demand, particularly for a distribution warehouse, is related to inventory.

And inventory accumulations are just starting.

If you looked at the numbers that were released for the third quarter GDP, it was very robust GDP growth.

But inventories were still at a low level.

So we think that pricing power will reappear as those inventories are increased, which I think is inevitable.

So you are actually seeing a buildup in inventory levels?

No.

We haven’t seen that.

Oh, you haven’t seen it yet.

The inventory levels are very attractive in the port related cities.

But I’m talking about the inventories in the rest of the country.

And even there, they haven’t built up fully in those markets.

But no, we haven’t seen it yet.

But when you have a situation for inventories are down, one can expect when the economy rebounds that will happen.

Going back, there are many who would think that the fundamentals overall in our business are near bottom.

I am not predicting that it is bottom, or that the bottom is going to bounce back quickly.

But that simply - recovery, when it comes later this year or next year, in job growth, if in fact it does come, I think it will be positive.

I am not looking for it to be terribly robust in ’04.

If you look at the demand, again I’m giving you an overview, demand for industrial space is related to inventory levels.

And it’s also related to job growth.

And we haven’t seen much in job growth.

So we think that it will pick up.

And, as I said, we’re very pleased with where it is in the markets, essentially in Southern California.

Yeah.

We need to parse out a little bit that most of the product we have is relatively new.

It’s big box distribution warehouse industrial, predominantly consumer products goods.

Some manufactured goods going through those warehouses.

Where we’ve seen decent activity is in the big port area in Southern California, in the Inland Empire, that continues to be pretty strong.

And the model there really seems to be bigger is better.

The bigger the building, the better to handle these larger ships coming in.

In some of the other center of the country markets – Dallas and Chicago – Dallas continues to be pretty slow.

Chicago, if anything, has a few more positive signs, or seems to be more at least activity, whatever, however you want to describe that.

But I would just echo what Nelson said.

There hasn’t been a big increase in demand in industrial, with the exception of the import flows coming into the ports.

Okay.

And you mentioned that your leasing has been pretty aggressive.

Can you give us a sense of how aggressive, and how that relates to your rents, and keeping up occupancy?

Well aggressive, when I used that phrase I had two thoughts in mind.

It’s aggressive in the sense that we are very focused on retention.

And we are trying to get out in front of the power curve on tenants.

With respect to rents, we think they’re fairly stable.

As we went through the numbers that Bill gave you earlier about the same store growth, we’re not experiencing –

Rents certainly aren’t increasing.

And again, for our particular segment, a lot of our rents are driven by the cost and the yield on new construction.

And as interest rates stay low, rents stay low, because you can build a building and offer a rent that gives you a lower yield today than you wanted two or three years ago, because your financing costs are lower.

Yeah.

That was the point that I made earlier in my comments, that we see downward pressure on rents, not just for our rollover, but for new development, in part caused by demand issues in some markets, but also because of the downward pressure resulting from low interest rates, but still attractive as to our spreads.

So those are the two combinations of pressures that are there.

And we are trying to meet those pressures with – excuse my phrase again – being aggressive, but also being aggressive in trying to get renewals before they expire.

Yeah, I guess strategically we’d always rather keep buildings leased than un-leased.

And that’s not going to be any brainstorm there.

But we’re very quick to cut to market, whatever it is, when deals are available.

So I think the term aggressive leasing for us is we’re very focused, and keep everyone very focused on keeping tenants in the building at the deal you can get.

But clearly leasing is more important than waiting for rents to increase.

Great.

Thanks guys.

Steve Sakwa, I just wanted to get back to you.

Someone very efficiently here has told me that our retail expenses went up about $120,000.

And almost all of that was due to this re-class of property tax infrastructure bond payments that got moved from interest expense up into operating costs.

So that’s why that was up.

Your next question comes from David Copp of RBC Capital.

Please go ahead.

Hi.

Good morning guys.

Here with Jay Leupp as well.

A couple of quick questions on the retail deals in Fremont.

Are you guys going to be very involved in the development there?

Or is this just a straight land lease?

I.e., will you be receiving any fees or anything associated with these deals?

Yes.

We would receive fees.

And we will be involved in most of the development – not all.

Yeah.

The big – the three big deals – I guess you’d call them anchors are ground leases.

There will be some kind of smaller shop in-line space that will be, for the most part, pre-leased, that we will build a little bit of.

Okay.

And then with regard to your thought process on doing land leases as opposed to a straight out sale, historically that has cyclically been kind of tax motivated.

With the conversion of the REIT, are you in any way changing your thought process with regard to doing a land lease versus a straight out sale?

Well the land lease has the great virtue of producing FFO.

And that is a very valuable thing for our shareholders, to have that recurring form of income.

The sale, depending on the tax base in the property, or if it’s impossible due to an exchange, but the sale does – we are very aggressively pursuing sales activities on properties that don’t make a lot of sense for land leases.

For example, single-tenant residential sites, they must be sales to be marketable.

Condominium sites in our urban projects, they will be sales.

On the other hand, an apartment developer, building a rental apartment project, would be inclined to look favorably on a land lease.

So we’re looking at them very realistically as what we can do.

But we would certainly like an [inaudible] as income.

And I don’t see that changing.

Yeah.

I’d say definitely with regard to land, we’d much rather generally lease than sell.

But one way or the other, we’d like to get something done.

Got you.

The whole object of our sales program is to increase the FFO for Catellus.

But we would do that in the case of a sale which is not the core FFO, but our other segment FFO, if it pays down debt, or if we use it to reinvest, we’ll generate FFO.

If we do a land lease, it goes directly to the FFO line.

And so that’s where we’d be looking.

But we take what the market gives us.

We’d rather do a sale than not have a transaction.

Okay.

And then so are these deals structured more like a typical land lease, where you receive monthly payments, as opposed to something like the Cisco, where you’re getting any sort of accelerated payment?

Yes.

Monthly payments.

Yes.

Okay.

And then a balance sheet question for Bill.

If you fast forward to say January 1, post reconversion, post one-time payout, post December dividend payment, what do you expect your cash balance to be post-conversion, given what you know about your land sales and the return on capital you are expecting in the fourth quarter?

I would answer that generally that cash balances should start to become minimal as a REIT.

And we’ll probably generally hold more in the way of unlevered assets on the balance sheet.

So I don’t know if that answered your question.

Do with that morsel what I will, huh?

Okay great.

Thanks guys.

Your next question comes from Chris Haley of Wachovia.

Please go ahead.

Good morning.

Bill, on your page 11 balance sheet detail, I noticed you have a revolving credit facility now.

I am interested in that decision, and where that might lead to over the next year to two years in terms of a –

That actually ties in with Mr. Copp’s question.

We did put in place a $200m credit facility, lead managed by BofA in the second quarter.

And it’s what I’d call fairly typical.

In other words, it’s backed by – it’s not secured by property.

But it is backed by a pool of unlevered properties.

And again, the objective now going forward in a REIT is really to still maximize liquidity, but minimize it in the form of cash.

So directionally we’ll be using that type of facility, like many of our REIT peers, to manage day to day, month to month, quarter to quarter cash needs.

And then take our cash and either pay down existing debt or build on an unlevered basis.

A lot of questions.

Nelson, are you confirming your 10-15% EPS for ’03 versus ’02?

Yes.

I believe it was 10.

But yes.

That would bring you – what kind of EPS number are you expecting for full year?

Chris this gets – and I don’t mean to be evasive.

It gets a little bit difficult, because according to the SEC, for us to give you guidance, we have to give it on a GAAP number, and then reconcile it to non-GAAP.

The issue with EPS this year is we’re going to have a very interesting fourth quarter with regard to a lot of REIT conversion, both income and expenses, particularly, as we talked about, around the deferred tax reversals, the exchange offer we just completed, etc.

So when we’ve been giving guidance historically, it’s been on what I call an adjusted EPS number, which I am now told I am really not supposed to be able to talk about anymore.

Let’s simply look at your released statement.

I am looking at a nine month FFO from urban, residential and other of around $22m.

Would you have any idea what’s the cash generated year to date from your urban residential activities that will not be included in your core segment FFO?

I can do some work for you.

I don’t have it off the top of my head.

A couple of those sales have been – we’ve taken back notes.

So the cash portion today may not be what you would otherwise think.

Those notes then pay off over the next year or so, and turn to cash then.

So if you are looking for what the basis is underlying it -

Yeah.

Well actually –

I have to do some work towards that.

We plan at year end to kind of go over all of that in more detail for the end of the year, to show where we are on kind of that scorecard.

Recall, when we announced the REIT conversion intent in March, we talked about a net worth value in assets that were in the urban group, as well as in the residential group of approximately $4.50 a share at net book value.

And we are very motivated and interested in generating the cash from those assets, either in the form of long term land leases, or in the form of sales proceeds that would indeed enable us to invest in our core business, or pay down debt.

So that was what Bill was referring to.

We hope at the end of the – at this quarter, the fourth quarter, to start a regular scorecard on how we’re doing on that.

On your gross margin on your property sales, you’re still, on a GAAP basis, still in the mid-thirties, which is up from your six month number.

Does that – when you look at your backlog into the fourth quarter and into early ’04, what kind of GAAP margin or cash margin would you expect?

On GAAP, just running through a lot of the projects in my mind, I pick a number like 20-30, about 30% from a margin standpoint on the sales of property we own.

Okay.

And that backlog – is that a six month?

Would you that it’s kind of a three to six month backlog?

The total backlog is about $175m.

Seventy of that is actually within the residential joint ventures.

Most of that happens pretty immediately, although because we used the gross sales of the joint ventures, we clearly net a lower margin than the one I just gave you on those.

So it’s 70 of the 175.

Right.

And then the balance, there are sales which we would anticipate would close in this year, and in the first and second quarter of next year.

So there’s a significant amount of that, Chris, that would be within the next two quarters.

That’s right.

Before I go into some of the transition costs, if I could just think about this.

Given that your commercial or core segment development pipeline is still good size, down to where it has been, reflecting the economy, reflecting your opportunities, your sales activity is up.

Kind of looking at kind of first half/second half ’04, is it fair to say that you will be in a – your return on assets, including cash on your books, will be lower in the first half, thereby potentially suppressing cash flow?

I don’t know.

I haven’t followed what you’re trying to –

I’m trying to get what your results might look like on a core segment basis going into ’04, what type of earnings power there might be in ’04 versus ’03, given that you’re going to be building more cash, even after the conversion.

And your investment pipeline, you’re probably not going to be acquiring much.

But your development pipeline –

Yeah.

I think it’s fair to say that we are opportunity limited on the pipeline, on the industrial pipeline.

From the standpoint of acquisitions.

Well, and new development.

Yeah.

I mean I think if what you’re saying is that the overall building activity looks low relative to the last five years, I think that’s right.

And I think we expect that to continue for another couple quarters.

Okay.

Going into transaction costs, my recollection is that you had some costs that were going to be excluded from core segment FFO.

And those were transaction costs, transition costs, and the cost of the share conversion, or the equity plan conversion.

Yeah.

Where do those numbers stand today in terms of aggregate amount expected?

I’ll start first with what I call the third party reconversion costs.

These are for the third party consultants, lawyers, etc.

And I think that number, my guess for the year is going to be somewhere around $8m.

And that’s probably up a little bit from what we got last quarter.

I think last quarter we said something like 7-1/2.

And it’s those lawyers again Chris.

All right.

The exchange offer was completed here in the beginning of the fourth quarter.

That’s where – that was in the shareholder proposal three of the S-4.

That’s where employees had the right to have the option of exchanging some options for restricted stock, to try to get back on a value to value basis.

The accounting for that is you go from – we were APB25 on options.

So our options really had no charge directly on our Income Statement.

When those get exchanged for restricted stock, actually two things happen.

The restricted stock, which now vests over three years, starts to incur a charge that will happen over the next three years.

That number is probably in the $25-26m range.

In addition – that will be taken in essentially monthly over the next 36 months.

And, in addition, and this gets a little more complicated.

But just the nature of offering an option over to exchange his option triggers then variable accounting for options.

That will trigger about a $6m non-cash charge.

That will get amortized in, as those remaining options vest.

And these were options that were already granted.

Just we trigger variable accounting by going through this process.

That $6m will occur over the next kind of 18 months, but be fairly front-end loaded.

So there were three segments though.

I remember something called transition costs.

Yeah.

There were some transition costs relating to personnel.

We actually booked about $3.7m in the third quarter.

That’s in that SG&A line.

Yes.

In the SG&A, and not in the other category.

That’s 3.7 spent so far.

Yeah.

Of that $10m number?

Yeah.

Probably – yeah, that’s probably about right, maybe a little high.

There’s a couple million more to go in the fourth quarter, with some vesting provisions that get triggered.

Okay.

All right.

Thanks a bunch.

That’s all for now.

Thanks Chris.

Thanks.

Your next question comes from Jonathan Litt of Smith Barney.

Please go ahead.

Hi.

It’s John Litt.

I’m here with Gary Boston.

A couple questions.

First, in your FFO calculation, you have an estimate of taxes you’ll be paying as a REIT.

I guess I was wondering how do you come up with that?

And what do you think the chances are that you might have to revisit that after the fact?

Well it’s definitely pro forma for this year.

What we’ve done is we’ve made an assumption on all our assets and income, and what would be in a REIT if we were one, and what would be in the taxable subsidiary, if we had one.

And I think that we’ve tried to do a fairly good job reflecting what we think that will be, and how that then translates on a comparable basis to next year.

But it is just a pro forma.

In terms of revisiting it, I don’t know that we’d ever go back and say well in reality it would have been this, because we’re just guessing today.

And the income won’t be there I guess.

Well, I guess has it been running, since you first created the number, has it been kind of running – would it have been running where you have estimated it to run?

Yeah.

I think we’ve done a pretty good job up front, I think, of trying to allocate where we’re going to put certain assets and certain income activities.

And now, as we’re finalizing that, hopefully very shortly here, we’re not coming up with a lot of surprises.

For example, big chunks of income that we thought could be in the REIT that end up in the PRS and get taxable – we’re not seeing that at all.

Do you think that run rate is a good run rate for next year?

When you say the run rate?

For taxes?

Taxes saved or taxes paid?

Taxes paid?

Taxes that you’d have to pay.

Yeah.

I think that’s going to, in large measure John, depend on how quickly we’re able to monetize the residential and the urban assets through the sales process in the TRS.

And so if we’re very effective, that run rate will be higher.

And if we’re not so effective, it will be lower.

Yeah.

It’s going to be very – you know, we go through great pains and walk a lot of lines to kind of divide the company into two pieces, particularly into this – the SEC and Reg G and everything going on right now, so that we can provide kind of more clear guidance on part of the company.

But it’s very difficult for us to provide much in the way of guidance for the heavily sales oriented part of the company, the urban and residential.

And that’s going to drive the vast majority of the tax next year.

Can you talk about on your development, I guess north of the channel, the apartment complex, how that’s progressing, and what the environment is like there, and when that’s going to come on?

Yes, certainly.

We are looking to begin lease-up – you’re talking about the [N1] parcel.

And that’s 597 units, and 83,000 square feet of retail, and some 1,000 parking spaces, plus or minus.

The lease-up, we are to start our leasing activities at the end of this month.

We will start delivering units the first part of ’04.

And the market is firming for apartments in San Francisco.

We think that’s an outstanding project.

We’re optimistic with how we’re going to be able to proceed with it.

I can’t give you a precise feeling about the length of time it’s going to take us to lease it up, and the rents at which we’re going to be – that we’ll be achieving.

But the project going to be highly desirable.

My understanding is that the Avalon Bay lease-up is going very well.

And they – obviously they can speak to where they are as far as the amount of units they have left.

But we feel that the market in the bay area, although there are parts where it has not rebounded, I think that we’re very optimistic about that site.

Great.

Thank you.

Your final question comes from David Harris of Lehman Brothers.

Please go ahead.

Yeah, hello.

We’ll try and keep this brief if we can.

And David is with me here now.

Bill, I am just thinking back on the last quarter.

Did you indicate – maybe I am mistaken on this – that there was going to be some sales out of the investment portfolio?

I am looking here at a lower square footage that I modeled.

Sales out of the investment portfolio?

In the industrial and the investment portfolio.

I don’t think so.

Okay.

Maybe I was mistaken.

Were there any term fees included in this quarter’s numbers?

Any lease termination fees?

Yeah.

No.

Any expectation of any in the fourth quarter?

Nothing material.

Okay.

And would that be your best assessment as to the likely run in ’04?

Yeah.

They really – they only exist really for the office space.

And we’ve had a couple of terminations over the last 18 months leading up to a few months ago.

So, with our project in San Jose we had a couple of lease terminations, and in the Santa Fe Building in Chicago.

So really the material lease terminations we get, you can – the buildings you can count on one hand almost.

Okay.

When do you think you might be in a position to provide us with ’04 guidance?

Some time in early ’04.

We have to do a budget process, like a lot of people, with our Board meetings and budgeting in December.

And typically we don’t do it until we announce the year end.

We’ll see if we want to come out some time between –

I think Bill’s right.

I think it would be, given our budgeting process, and given the conversions of the REIT, I think that we would be looking for guidance some time early next year.

Can you just remind us how you’re booking the Cisco rent, and what magnitude of it?

Sure.

It is – the magnitude is about $3m a year, $750,000 a quarter.

And then that was originally around a $100m payment.

We’re amortizing it over the 34 year term.

So $100m divided by 34 gets you right around $3m a year, $750,000 a quarter.

Okay.

And I guess this is a question for Nelson.

Is there any greater clearness now about your sales, the shape of the sales of the non-core assets, the [inaudible]?

Or has that been really set aside [inaudible] with the REIT transition [inaudible]?

We are aggressively pursuing the sales transactions.

And the – we, as I mentioned, will be looking forward to giving a report card on that as transactions close.

We have a significant amount of activity.

But I can’t – consistent with our policy of not discussing things unless they are there, and closed or binding and non-refundable.

So we say that we’re encouraged.

But I don’t want to be more specific than that.

And you were – I can’t press you to give any comment as to [inaudible] go early?

Or are those likely to be in the back end of the [inaudible]?

I would prefer not to comment on that David.

I don’t want to raise expectations or to dash them.

I think right now to say – the fair thing to say is we’re aggressively pursuing the various alternatives.

But as far as being able to give a report card on that, I’d prefer to wait until things are more firm.

I understand.

Forgive me for trying Nelson.

No.

Good try.

I think David will have a few quick questions.

Yeah.

Hi Nelson.

Hi David.

In the [inaudible] in Playa Del Rey [inaudible] seems to be impaired by [inaudible] litigation and [inaudible].

Yes.

That’s a fair statement.

Both of those are true.

Do you think you’ll be clear on that [inaudible]?

Well the Coastal litigation – the [inaudible] litigation, rather, we won in the trail court, and we won in the Court of Appeals.

I am not certain whether they’re going to appeal that.

I guess they have appealed that to the Supreme Court.

The Coastal litigation, we were successful at the trial court level, at the appellate court level.

It’s on appeal to the Supreme Court.

Neither of those appeals have been accompanied by a stay.

So, as a result, we are vigorously pursuing the grading of the site.

And we have been able to work our way through those issues.

I think that – I’ve learned a long time ago David not to give estimates on how long a sequel litigation or other litigations regarding entitlements in California will take.

But we are quite a ways down the road on this.

And, again, the significant issue point to me is that none of the litigation has resulted in a stay that would prevent us from continuing to develop.

Are you going to sell the lots?

Or are you going to develop the houses on them?

Our intent would be to not develop the houses.

Our intent would be to sell the lots.

And so the [inaudible] haven’t been encumbered by this, absent the stay?

I mean that’s really the problem, is them coming in and saying I want to buy the lots for these?

Well what happened, we would need to – when we got into the point of marketing the site, we would need to have either the – we would need to have the litigation, I think, resolved.

Okay.

So that was my question.

Okay.

The litigation is holding up this.

So the litigation is basically holding up the sale.

Because my guess is, given the market there, you could probably hold an auction in 20 minutes and get it all done.

That’s a fair statement.

It’s a very, very attractive site, as you know.

Yes.

Okay.

Thanks a lot guys.

Thank you.

Gentlemen, there are no further questions at this time.

Please proceed with your closing remarks.

Well I want to thank you all for being with us again on this call, and thank you for following our conversion over the past year.

We’re very pleased with where we are.

And I am looking forward to getting us to the point where the next time we have a conversation, we’ll be having that as a REIT.

There’s no further questions.

We’re done [Kelera].

Thank you.

Thank you. (Caller instructions.) Thank you for your participation in today’s conference.

This concludes the presentation.