Kilroy Realty - 10-Q quarterly report FY

As of May 9, 2002, 27,698,160 shares of common stock, par value $.01 per share, were outstanding.

Kilroy Realty Corporation (the “Company”) owns, develops, and operates office and industrial real estate, primarily in Southern California. The Company operates as a self-administered real estate investment trust (“REIT”). As of March 31, 2002, the Company’s stabilized portfolio of operating properties consisted of 88 office buildings (the “Office Properties”) and 61 industrial buildings (the “Industrial Properties”), which encompassed an aggregate of approximately 7.3 million and 5.1 million rentable square feet, respectively, and was approximately 94.2% occupied. The Company’s stabilized portfolio of operating properties consists of all of the Company’s Office Properties and Industrial Properties excluding properties currently under construction, renovation or in pre-development and “lease-up” properties. The Company defines “lease-up” properties as properties recently developed by the Company that have not yet reached 95% occupancy and are within one year of substantial building shell completion. Lease-up properties are included in land and improvements and building and improvements on the consolidated balance sheets upon building shell completion. As of March 31, 2002, the Company had three office properties encompassing an aggregate of approximately 213,900 rentable square feet which were in the lease-up phase. In addition, as of March 31, 2002, the Company had five office properties under construction or committed for construction and one property under renovation which when completed are expected to encompass an aggregate of approximately 696,500 and 78,000 rentable square feet, respectively.

The Company owns its interests in all of its properties through Kilroy Realty, L.P. (the “Operating Partnership”) and Kilroy Realty Finance Partnership, L.P. (the “Finance Partnership”) and conducts substantially all of its operations through the Operating Partnership. The Company owned an 86.0% general partnership interest in the Operating Partnership as of March 31, 2002. Unless otherwise indicated, all references to the Company include the Operating Partnership, the Finance Partnership and all wholly-owned subsidiaries and controlled entities.

In 1999, the Company, through the Operating Partnership, became a 50% managing member in two limited liability companies (the “Development LLCs”) which were formed to develop two multi-phased office projects in San Diego, California. The Allen Group, a group of affiliated real estate development and investment companies based in San Diego, California, was the other 50% member of the Development LLCs. On March 25, 2002, the Company acquired The Allen Group’s interest in the assets and assumed The Allen Group’s proportionate share of the liabilities of the Development LLCs (see Notes 2 and 5). Subsequent to this transaction, the Development LLCs were liquidated and dissolved. The Development LLCs were consolidated for financial reporting purposes prior to their dissolution on March 25, 2002 since the Company controlled all significant development and operating decisions.

The accompanying interim financial statements have been prepared by the Company’s management in accordance with generally accepted accounting principles (“GAAP”) and in conjunction with the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures required for annual financial statements have been condensed or excluded pursuant to SEC rules and regulations. Accordingly, the interim financial statements do not include all of the information and footnotes required by GAAP in the United States of America for complete financial statements. In the opinion of management, the interim financial statements presented herein reflect all adjustments of a normal and recurring nature which are considered necessary for a fair presentation of the results for the interim periods presented. The results of

On January 1, 2002, the Company adopted the provisions of SFAS 142 “Goodwill and Other Intangible Assets” (“SFAS 142”) and SFAS 144 “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”). SFAS 142 discontinues the practice of amortizing goodwill and other intangible assets and requires a periodic review process for impairment. SFAS 144 addresses financial accounting and reporting for the disposal of long-lived assets and supercedes FAS 121 “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.” The adoption of these statements did not have a material effect on the Company’s results of operations or financial condition.

On March 25, 2002, the Company acquired The Allen Group’s interest in the assets of the Development LLCs which included nine San Diego office properties encompassing approximately 848,300 rentable square feet, and three San Diego development sites, encompassing approximately 11.9 acres (see Notes 1 and 5).

During the three months ended March 31, 2002, the Company added the following development projects to the Company’s stabilized portfolio:

At March 31, 2002, the Company had the following three office properties in the lease-up phase:

In March 2002, the Company obtained a new $425 million unsecured revolving credit facility (the “New Credit Facility”) with a bank group led by J.P. Morgan Securities, Inc. to replace its previous $400 million unsecured revolving credit line (the “Old Credit Facility”) which was scheduled to mature in November 2002. In connection with obtaining the New Credit Facility, the Company repaid its $100 million unsecured debt facility which was also scheduled to mature in September 2002. The New Credit Facility bears interest at an annual rate between LIBOR plus 1.13% and LIBOR plus 1.75% (3.40% at March 31, 2002), depending upon the Company’s leverage ratio at the time of borrowing, and matures in March 2005. At March 31, 2002, the Company had borrowings of $284 million outstanding under the New Credit Facility and availability of approximately $140 million. The fee for unused funds ranges from an annual rate of 0.20% to 0.35% depending on the Company’s leverage ratio. The New Credit Facility contains financial covenants consistent with those under the Old Credit Facility. The Company expects to use the New Credit Facility to finance development expenditures, to fund potential acquisitions and for general corporate uses.

In January 2002, the Company borrowed $80.0 million under a mortgage loan that is secured by 11 industrial properties, requires monthly principal and interest payments based on a fixed annual interest rate of 6.70% and matures in January 2012. The Company used the proceeds from the loan to repay borrowings under the Old Credit Facility.

In February 2002, the Company repaid the $9.1 million principal balance of an existing construction loan, which had a stated maturity of April 2002. In March 2002, in connection with the acquisition of The Allen Group’s interest in the Development LLC properties (see Notes 2 and 5), the Company repaid three construction loans which had outstanding principal balances totaling $78.8 million. These loans had been secured by certain of the Development LLCs’ properties and had stated maturities ranging from April 2002 through May 2003. All of the repayments were funded with borrowings under the Company’s Credit Facility and did not require prepayment penalties.

Total interest capitalized for the three months ended March 31, 2002 and 2001 was $3.8 million and $3.3 million, respectively.

In March 2002, the Company entered into a new interest rate swap agreement with a total notional amount of $50 million, which expires in January 2005. The agreement requires the Company to pay fixed interest payments based on an annual interest rate of 4.46% and receive variable interest payments based on LIBOR. As of March 31, 2002, the Company also had an existing swap agreement with a notional amount of $150 million, which expires in November 2002 and requires the Company to pay fixed interest payments based on an annual interest rate of 5.48% and receive variable interest payments based on LIBOR. As of March 31, 2002, the Company reported a liability of $3.1 million for the fair value of these two instruments, which is included in other liabilities in the consolidated balance sheets.

In March 2002, the Company entered into two new interest rate cap agreements with a total notional amount of $100 million and a LIBOR based annual cap rate of 4.25% that expire in January 2005. The $2.4 million cost will be amortized over the life of the agreements. As of March 31, 2002, the Company reported an asset of $2.5 million for the fair value of these instruments, which is included in deferred financing costs in the consolidated balance sheets.

All of the instruments described above have been designated as cash flow hedges. For the three months ended March 31, 2002, the Company did not record any gains or losses attributable to cash flow hedge

Minority interests represent the preferred limited partnership interests in the Operating Partnership, the common limited partnership interests in the Operating Partnership not owned by the Company, and interests held by The Allen Group in the Development LLCs prior to their dissolution on March 25, 2002 (see Notes 2 and 5). The Company owned an 86.0% general partnership interest in the Operating Partnership as of March 31, 2002.

On March 25, 2002, the Company acquired The Allen Group’s minority interest in the assets and assumed The Allen Group’s proportionate share of the liabilities of the Development LLCs. The net consideration was approximately $40.9 million. The acquisition was funded with $2.2 million in cash and 1,398,068 common limited partnership units of the Operating Partnership valued at $38.7 million based upon the closing share price of the Company’s common stock as reported on the New York Stock Exchange. In connection with the acquisition, the Company recognized $3.9 million of preferred return income that had been previously earned but had been fully reserved for financial reporting purposes until the acquisition was complete and the related litigation between the parties was settled. The preferred return investment earned a 12.5% rate of return. In connection with the acquisition, the Company repaid three construction loans which were secured by certain of the Development LLC properties (see Note 3).            

On February 26, 2002, the Company’s Compensation Committee granted an aggregate of 81,729 restricted shares of the Company’s Common Stock to certain executive officers under the Company’s 1997 Stock Option and Incentive Plan (the “1997 Plan”). All of the shares issued were granted at a value of $25.74 per share, the Company’s closing share price on the grant date, against the payment of the par value or $0.01 per share. Of the shares granted 20,541, vest over a one-year period and 61,188 vest over a two-year period. Compensation expense for these restricted shares will be amortized on a straight-line basis over the vesting periods. The restricted shares have the same dividend and voting rights as common stock.

On February 26, 2002, the Company’s Compensation Committee approved two new programs under the 1997 Plan for the future potential issuance of restricted stock to certain key employees as part of their annual and long-term incentive compensation. The number of shares that will ultimately be issued under these programs will be contingent upon both the Company and the individuals meeting certain financial and operating performance targets during each fiscal year. These awards will vest over one to two years, depending upon the specific program. The awards are payable at the discretion of the Compensation Committee and will be expensed over both the performance and vesting periods.

The Company’s reportable segments consist of the two types of commercial real estate properties for which management internally evaluates operating performance and financial results: Office Properties and Industrial Properties. The Company also has certain corporate level activities including legal administration, accounting, finance, and management information systems which are not considered separate operating segments.

The Company evaluates the performance of its segments based upon net operating income. Net operating income is defined as operating revenues (rental income, tenant reimbursements and other income) less property and related expenses (property expenses, real estate taxes and ground leases) and does not include interest income and expense, depreciation and amortization and corporate general and administrative expenses. All operating revenues are comprised of amounts received from third-party tenants.

Basic earnings per share is computed by dividing net income by the weighted-average number of common shares outstanding for the period. Diluted earnings per share is computed by dividing net income by the sum of the weighted-average number of common shares outstanding for the period plus the number of common shares issuable assuming the exercise of all dilutive securities. The Company does not consider common units of the Operating Partnership to be dilutive since the exchange of common units into common stock is on a one-for-one basis and would not have any effect on diluted earnings per share. The following table reconciles the numerator and denominator of the basic and diluted per-share computations for net income.

At March 31, 2002, Company employees and directors held options to purchase 88,000 shares of the Company’s common stock that were antidilutive to the diluted earnings per share computation. These options could become dilutive in future periods if the average market price of the Company’s common stock exceeds the exercise price of the outstanding options.

On April 17, 2002, aggregate distributions of approximately $15.2 million were paid to common stockholders and common unitholders of record on March 29, 2002.

The following discussion relates to the consolidated financial statements of the Company and should be read in conjunction with the financial statements and notes thereto appearing elsewhere in this report. Statements contained in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” that are not historical facts may be forward-looking statements. Such statements are subject to certain risks and uncertainties, which could cause actual results to differ materially from those projected. Some of the enclosed information presented is forward-looking in nature, including information concerning projected future occupancy rates, rental rate increases, project development timing and investment amounts. Although the information is based on the Company’s current expectations, actual results could vary from expectations stated here. Numerous factors will affect the Company’s actual results, some of which are beyond its control. These include the timing and strength of regional economic growth, the strength of commercial and industrial real estate markets, competitive market conditions, future interest rate levels and capital market conditions. You are cautioned not to place undue reliance on this information, which speaks only as of the date of this report. The Company assumes no obligation to update publicly any forward-looking information, whether as a result of new information, future events or otherwise, except to the extent the Company is required to do so in connection with its ongoing requirements under Federal securities laws to disclose material information. For a discussion of important risks related to the Company’s business, and an investment in its securities, including risks that could cause actual results and events to differ materially from results and events referred to in the forward-looking information, see the discussion under the caption “Business Risks” in the Company’s annual report on Form 10-K for the year ended December 31, 2001 and under the caption “Factors Which May Influence Future Results of Operations” below. In light of these risks, uncertainties and assumptions, the forward-looking events contained herein might not occur.

Kilroy Realty Corporation (the “Company”) owns, develops, and operates office and industrial real estate, primarily in Southern California. The Company operates as a self-administered real estate investment trust (“REIT”). The Company owns its interests in all of its properties through Kilroy Realty, L.P. (the “Operating Partnership”) and Kilroy Realty Finance Partnership, L.P. and conducts substantially all of its operations through the Operating Partnership. The Company owned an 86.0% general partnership interest in the Operating Partnership as of March 31, 2002.

Projected Future Occupancy Rates, Rental Rate Increases and Operating Result Trends.    For the three months ended March 31, 2002 and 2001, average occupancy in the Company’s stabilized portfolio was 94.6% and 96.8%, respectively. Prior to the first quarter of 2002, the Company had achieved historical average occupancy levels of above 95.0% since the time of its IPO in 1997. The Company believes that maintaining average occupancy levels above 95.0% will not be sustainable given the current economic environment as evidenced by the Company’s average occupancy of 94.6% at March 31, 2002. In addition, as of March 31, 2002, leases representing approximately 2.2% and 11.3% of the square footage of the Company’s stabilized portfolio are scheduled to expire during the remaining nine months of 2002 and in 2003, respectively. Although the Company has stringent lease underwriting standards and continually evaluates the financial capacity of both its prospective and existing tenants to proactively manage portfolio credit risk, a downturn in tenants’ businesses may weaken tenants’ financial conditions and could result in defaults under lease obligations.

As of March 31, 2002, the Office and Industrial Properties represented 80.1% and 19.9%, respectively, of the Company’s annualized base rent. Leases representing approximately 958,000 square feet of office space, or 8.9% of the Company’s annualized base rent, and approximately 602,000 square feet of industrial space, or 2.3% of the Company’s annualized base rent, are scheduled to expire during the remainder of 2002 and in 2003. Management believes that the average rental rates for its Office Properties are below currently quoted market

The Company’s operating results are and will continue to be affected by uncertainties and problems associated with the deregulation of the utility industry in California since 94.7% of the total rentable square footage of the Company’s stabilized portfolio is located in California. Energy deregulation has resulted in higher utility costs in some areas of the state and intermittent service interruptions. In addition, as a result of the events of September 11, 2001, the Company’s insurance costs increased across its portfolio approximately 18%. As of the date of this report, the Company has not experienced any material negative effects arising from either of these issues because approximately 75% (based on net rentable square footage) of the Company’s current leases require tenants to pay utility costs and property insurance premiums directly, thereby limiting the Company’s exposure. The remaining 25% of the Company’s leases provide that the tenants reimburse the Company for these costs in excess of a base year amount.

Current Submarket Information.    While the Company has been encouraged by the recent improvement in the demand for rental space in the San Diego and Orange County regions, the demand for space in the Los Angeles County region continues to not be as strong as the Company experienced from 1998 through 2000. Consequently, management cannot predict when the Company will see significant positive leasing momentum given the concentration of sublease space currently available in this market. At March 31, 2002, the Company’s Los Angeles office portfolio was 86.3% occupied with approximately 513,000 rentable square feet available for lease. In addition, as of March 31, 2002, leases representing an aggregate of approximately 68,200 and 643,600 rentable square feet were scheduled to expire during the remainder of 2002 and in 2003, respectively, in the Company’s Los Angeles stabilized portfolio. At March 31, 2002, the Company had two in-process development projects in the Los Angeles region encompassing an aggregate of 284,700 rentable square feet, 151,000 of which is presently expected to become available for lease in the second quarter of 2002 and 133,700 of which is presently expected to become available for lease in the third quarter of 2002. If the Company is unable to lease a significant portion of this available space or space scheduled to expire in 2002, if existing tenants do not renew their leases in this region, or if rental rates for the Company’s Los Angeles properties decrease, the Company’s results of operations, financial condition and cash flows would be adversely affected.

Projected Development Trends.    During the three months ended March 31, 2002, the Company stabilized two office buildings encompassing an aggregate of approximately 131,300 rentable square feet for a total estimated investment of approximately $32 million. Management believes that the most significant part of the Company’s expected revenue growth within the next two years will come from the lease-up and stabilization of approximately 911,500 rentable square feet of office space in lease-up, under construction or committed construction at March 31, 2002, and its development pipeline of approximately 1.1 million rentable square feet of office space presently expected to be developed over the next four years. Given the recent economic downturn, the Company may not be able to maintain the same level of development activity in the future, or may not be able to complete and lease development projects to stabilized portfolio occupancy rates within the timeframes experienced by the Company during the last two to three years. The Company has a proactive development planning process which continually evaluates the size, timing, and scope of the Company’s development program in 2002 and beyond, will be evaluated and, as necessary, scaled to reflect the economic conditions and the real estate fundamentals that exist in the Company’s submarkets.

Recent Information Regarding Significant Tenants.    As of March 31, 2002, the Company’s largest tenant, The Boeing Company, leased an aggregate of approximately 1.1 million rentable square feet of office space

On May 6, 2002, one of the Company’s tenants, Peregrine Systems, Inc., announced that its Chairman and Chief Executive Officer, and its Chief Financial Officer, resigned following the revelation by its new auditors of potential accounting inaccuracies. Peregrine currently leases four office buildings totaling 423,874 square feet under four separate leases. The Company is also developing a fifth property which, when completed, will encompass 114,780 square feet that upon completion is to be leased to Peregrine. The buildings are all located in a five-building campus designed for multi-tenant use in the Del Mar submarket of San Diego, California.

Peregrine Systems was current on all its rent obligations due through May 1, 2002 under its four leases. Under the terms of its leases, Peregrine is required to provide a letter of credit if it fails to meet certain financial covenants. Based on Peregrine’s most recently reported financial results dated January 24, 2002, Peregrine had met its financial requirements under the leases and was not obligated to post letters of credit.

Additional details of the leases are as follows:

The Company’s financial position, revenues and results of operations would be materially adversely affected if the Company’s significant tenants failed to renew their leases at all or renewed leases on terms less favorable to the Company, or if they become bankrupt or insolvent.

A significant part of the Company’s revenue growth for the three-month period ended March 31, 2002 was attributable to its recently completed development projects. During the three months ended March 31, 2002, the Company completed the development of two office buildings encompassing an aggregate of approximately 131,300 rentable square feet that were added to the Company’s stabilized portfolio of operating properties. During the year ended December 31, 2001, the Company completed the development of four office buildings encompassing an aggregate of approximately 312,400 rentable square feet, all of which were included in the Company’s stabilized portfolio of operating properties at March 31, 2002. The Company’s stabilized portfolio of operating properties consists of all of the Company’s office and industrial properties, excluding properties recently developed by the Company that have not yet reached 95% occupancy (“lease-up” properties) and projects currently under construction, renovation or in pre-development. At March 31, 2002, the Company had three office buildings encompassing an aggregate of approximately 213,900 rentable square feet in the lease-up phase and one renovation property encompassing approximately 78,000 rentable square feet. The Company’s development pipeline at March 31, 2002 included five office projects under construction or committed for construction which are expected to be completed and stabilized over the next two years and encompass an aggregate of approximately 696,500 rentable square feet. In addition, as of March 31, 2002, the Company owned

The Company did not acquire any operating properties during the three months ended March 31, 2002. During the year ended December 31, 2001, the Company acquired a 75% tenancy-in-common interest in a three-building office complex encompassing an aggregate of approximately 366,000 rentable square feet. The initial 25% tenancy-in-common interest was acquired by a wholly-owned subsidiary of the Company in October 2000. During the three months ended March 31, 2002, the Company did not dispose of any properties. During the year ended December 31, 2001, the Company disposed of two office and seventeen industrial buildings encompassing an aggregate of approximately 80,100 and 721,900 rentable square feet, respectively, for aggregate sales price of $70.4 million and a net gain of approximately $4.7 million.

As a result of the properties disposed of subsequent to March 31, 2001 and the one renovation project taken out of service during 2001, net of the development projects completed and added to the Company’s stabilized portfolio of operating properties subsequent to March 31, 2001, rentable square footage in the Company’s portfolio of stabilized properties decreased by an aggregate of approximately 390,000 rentable square feet, or 3.1%, to 12.4 million rentable square feet at March 31, 2002, compared to 12.8 million rentable square feet at March 31, 2001. As of March 31, 2002, the Company’s stabilized portfolio was comprised of 88 office properties (the “Office Properties”) encompassing an aggregate of approximately 7.3 million rentable square feet and 61 industrial properties (the “Industrial Properties”) encompassing an aggregate of approximately 5.1 million rentable square feet. The stabilized portfolio occupancy rate at March 31, 2002 was 94.2%, with the Office Properties and Industrial Properties 91.2% and 98.5% occupied, respectively.

Management evaluates the operations of its portfolio based on operating property type. The following tables compare the net operating income, defined as operating revenues (rental income, tenant reimbursements and other income) less property and related expenses (property expenses, real estate taxes and ground leases) before depreciation, for the Office Properties and for the Industrial Properties for the three months ended March 31, 2002 and 2001.

Total revenues from Office Properties increased $3.7 million, or 9.7% to $42.1 million for the three months ended March 31, 2002 compared to $38.4 million for the three months ended March 31, 2001. Net of a provision for bad debts and unbilled deferred rents receivable, rental income from Office Properties increased $2.0 million, or 5.9% to $36.1 million for the three months ended March 31, 2002 compared to $34.1 million for the three months ended March 31, 2001. For the quarter ended March 31, 2002, the Company recorded a provision for bad debts and unbilled deferred rent of approximately 2.4% of recurring revenue. For the quarter ended March 31, 2001, the Company recorded a provision for bad debts and unbilled deferred rent of approximately 1.8% of recurring revenue, excluding amounts recorded specifically for the eToys default. The gross increase in the provision for the first quarter 2002 compared to the first quarter 2001 was $0.3 million. The Company evaluates its reserve for bad debts and unbilled deferred rent on a quarterly basis. During 2001 and in the first quarter of 2002, the Company increased its reserve levels due to the state of the overall economy and its effect on the collection of outstanding receivable balances. These reserve levels could continue to increase if the economy continues to weaken and/or due to an increased incidence in defaults under existing leases. Rental income generated by the Core Office Portfolio decreased $0.2 million, or 0.8% for the three months ended March 31, 2002 as compared to the three months ended March 31, 2001. This decrease was primarily attributable to a decline in occupancy in this portfolio. Average occupancy in the Core Office Portfolio decreased 2.5% to 93.3% for the three months ended March 31, 2002 compared to 95.8% for the three months ended March 31, 2001. An increase of $2.5 million was generated by the office properties developed by the Company in 2002 and 2001 (the “Office Development Properties”), offset by a decrease of $0.3 million attributable to the office properties sold during 2001, net of the office property acquired in 2001 (the “Net Office Dispositions”).

Tenant reimbursements from Office Properties increased $0.3 million, or 7.6% to $4.5 million for the three months ended March 31, 2002 compared to $4.2 million for the three months ended March 31, 2001. An increase of $0.5 million, or 14.8% in tenant reimbursements was generated by the Core Office Portfolio and was primarily due to an increase in insurance and utility costs, which were reimbursable by tenants. This increase was partially

Total expenses from Office Properties increased $1.2 million, or 13.1% to $10.5 million for the three months ended March 31, 2002 compared to $9.3 million for the three months ended March 31, 2001. Property expenses from Office Properties increased $0.8 million, or 12.9% to $7.1 million for the three months ended March 31, 2002 compared to $6.3 million for the three months ended March 31, 2001. An increase of $0.6 million in property expenses was attributable to the Core Office Portfolio and was offset by an increase in tenant reimbursements. This increase was primarily attributable to higher insurance and utility costs due to an increase in rates. Of the remaining increase of $0.2 million, an increase of $0.3 million generated by the Office Development Properties was offset by a decrease of $0.1 million attributable to the Net Office Dispositions. Real estate taxes increased $0.4 million, or 15.9% to $3.0 million for the three months ended March 31, 2002 as compared to $2.6 million for the three months ended March 31, 2001. Real estate taxes for the Core Office Portfolio increased $0.2 million, or 8.2% for the three months ended March 31, 2002 compared to the comparable period in 2001. This increase was primarily due to supplemental real estate taxes paid during the three months ended March 31, 2002 and real estate tax refunds received during the three months ended March 31, 2001. The remaining increase of $0.2 million was attributable to the Office Development Properties. Ground lease expense from Office Properties remained consistent for both periods.

Net operating income, as defined, from Office Properties increased $2.5 million, or 8.7% to $31.5 million for the three months ended March 31, 2002 compared to $29.0 million for the three months ended March 31, 2001. Of this increase, $0.7 million was generated by the Core Office Portfolio and represented a 2.8% increase in net operating income for the Core Office Portfolio. The remaining increase of $1.8 million was generated by an increase of $2.1 million from the Office Development Properties, offset by a decrease of $0.3 million attributable to the Net Office Dispositions.

Total revenues from Industrial Properties decreased $1.3 million, or 11.4% to $10.3 million for the three months ended March 31, 2002 compared to $11.6 million for the three months ended March 31, 2001. Net of a

Tenant reimbursements from Industrial Properties decreased $0.2 million, or 17.4% to $1.1 million for the three months ended March 31, 2002 compared to $1.3 million for three months ended March 31, 2001. This decrease was attributable to the Industrial Dispositions. Tenant reimbursements in the Core Industrial Portfolio remained consistent for both periods.

Total expenses from Industrial Properties decreased $0.3 million, or 17.4% to $1.4 million for the three months ended March 31, 2002 compared to $1.7 million for the three months ended March 31, 2001. Property expenses from Industrial Properties decreased $0.1 million, or 13.9% to $0.6 million for the three months ended March 31, 2002 compared to $0.7 million for the three months ended March 31, 2001. An increase of $0.1 million in property expenses for the Core Industrial Portfolio was offset by a decrease of $0.2 million attributable to the Industrial Dispositions. The increase in the Core Industrial Portfolio was primarily due to higher insurance and utility costs due to an increase in rates. Real estate taxes decreased $0.2 million, or 19.8% to $0.8 million for the three months ended March 31, 2002 compared to $1.0 million the three months ended March 31, 2001. Real estate taxes for the Core Industrial Portfolio decreased $0.1 million, or 5.1% for the three months ended March 31, 2002 compared to the same period in 2001 due to supplemental real estate taxes that were paid during the three months ended March 31, 2001. The remaining decrease of $0.1 million was attributable to the Industrial Dispositions.

Net operating income, as defined, from Industrial Properties decreased $1.0 million, or 10.3% to $8.9 million for the three months ended March 31, 2002 compared to $9.9 million for the three months ended March 31, 2001. Net operating income for the Core Industrial Portfolio increased $0.4 million, or 4.5% for the three months ended March 31, 2002 compared to the same period in 2001, which was offset by a decrease of $1.4 million attributable to the Industrial Dispositions.

Interest income decreased $0.1 million, or 34.6% to $0.3 million for the three months ended March 31, 2002 compared to $0.4 million for the three months ended March 31, 2001. A decrease of approximately $82,000 was attributable to interest income earned in January 2001 on a note receivable from a related party. This note was repaid in January 2001. In addition, a decrease of approximately $27,000 was attributable to interest earned on restricted cash balances held at Qualified Intermediaries in January 2001, which were used in a tax deferred property exchange. The Company did not have any cash balances at Qualified Intermediaries in 2002.

General and administrative expenses remained relatively consistent for the three months ended March 31, 2002 and 2001.

Net interest expense decreased $1.4 million, or 13.3% to $9.4 million for the three months ended March 31, 2002 compared to $10.8 million for the three months ended March 31, 2001. Gross interest expense, before the effect of capitalized interest, decreased $0.9 million or 6.3% to $13.2 million for the three months ended March 31, 2002 from $14.1 million for the three months ended March 31, 2001 primarily due to a decrease in the Company’s weighted average interest rate. The Company’s weighted average interest rate decreased to 6.1% at March 31, 2002 compared to 7.6% at March 31, 2001. Total capitalized interest and loan fees increased $0.5 million or 16.6% to $3.8 million for the three months ended March 31, 2002 from $3.3 million for the three months ended March 31, 2001 primarily due to higher average construction in progress balances in the first quarter of 2002 as compared to the comparable period in 2001.

Depreciation and amortization decreased $0.7 million, or 5.5% to $12.9 million for the three months ended March 31, 2002 compared to $13.6 million for the three months ended March 31, 2001. The decrease was due primarily to the effect of properties disposed of by the Company subsequent to March 31, 2001 partially offset by the development properties completed and added to the Company’s stabilized portfolio of operating properties subsequent to March 31, 2001.

The Company expects that its primary growth over the next several years will continue to come from the Company’s development program. At March 31, 2002, the Company had the following eight development projects in lease-up, under construction or committed for construction.