**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

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**FORM 10-Q**

 

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**QUARTERLY REPORT PURSUANT TO SECTION 13OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For thefiscal quarter ended June 30, 2005**

 

**Commissionfile number 1-31908**

 

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**CATELLUS DEVELOPMENTCORPORATION**

(Exactname of Registrant as specified in its charter)

 
| **Delaware**                                                     | ** ** | **94-2953477**                         |
|------------------------------------------------------------------|------------|----------------------------------------|
| (State  or other jurisdiction of  incorporation or organization) |       | (I.R.S.  Employer  Identification No.) |

 

**201 MissionStreet**

**SanFrancisco, California 94105**

(Addressof principal executive offices and zip code)

 

Registrant’stelephone number, including area code:

**(415) 974-4500**

 

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Indicate by check markwhether the Registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the Registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.    Yes  ý    No  o

 

Indicate by check mark whetherthe registrant is an accelerated filer (as defined in Rule 12b-2 of theExchange Act).    ý  Yes    o  No

 

As of August 1, 2005 therewere 103,678,456 issued and outstanding shares of the Registrant’s CommonStock.

 

 

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**CATELLUSDEVELOPMENT CORPORATION**

 
|                               | **Page No.**                                                                                                    |
|------------------------------------|-----------------------------------------------------------------------------------------------------------------|
| **INDEX**                          | ** **                                                                                                      |
|                               |                                                                                                            |
| PART I. FINANCIAL INFORMATION | 3                                                                                                               |
| Item 1.                       | Financial Statements  (Unaudited)                                                                               | 3 |
|                               | Condensed Consolidated Balance Sheets as of June 30, 2005 and December 31,  2004                      | 3 |
|                               | Condensed Consolidated Statements of Operations for the three and six  months ended June 30, 2005 and 2004 | 4 |
|                               | Condensed Consolidated Statements of Cash Flows for six months ended June 30,  2005 and 2004               | 5 |
|                               | Notes to Condensed Consolidated Financial Statements                                                            | 6 |
| Item 2.                       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                     | 24 |
| Item 3.                       | Quantitative and Qualitative Disclosures  about Market Risk                                                     | 53 |
| Item 4.                       | Controls and Procedures                                                                                         | 53 |
| PART II.  OTHER INFORMATION   | 53                                                                                                              |
| Item 1.                       | Legal Proceedings                                                                                               | 53 |
| Item 2.                       | Unregistered Sales of Equity Securities and  Use of Proceeds                                                    | 53 |
| Item 3.                       | Defaults Upon Senior Securities                                                                                 | 53 |
| Item 4.                       | Submission of Matters to a Vote of Security  Holders                                                            | 54 |
| Item 5.                       | Other Information                                                                                               | 54 |
| Item 6.                       | Exhibits                                                                                                        | 54 |
| SIGNATURES                         | 55                                                                                                              |

 

2

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**PART I. FINANCIAL INFORMATION**

 

**Item 1. Financial Statements (Unaudited)**

 

**CATELLUSDEVELOPMENT CORPORATION**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(Inthousands)**

 
| ** **                                                                                                                                                                     | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                     | ** ** | **(Unaudited)**         | ** ** |
| **Assets**                                                                                                                                                                     |       |                    |       |                        |       |
| Properties                                                                                                                                                                     |       | $                       | 2,381,584  |                        | $          | 2,316,289 |   |
| Less  accumulated depreciation                                                                                                                                                 |       | (487,227                | )          | (490,409                    | )          |
|                                                                                                                                                                           |       | 1,894,357               |       | 1,825,880                   |       |
| Other assets  and deferred charges, net                                                                                                                                        |       | 206,377                 |       | 224,932                     |       |
| Notes  receivable, less allowance                                                                                                                                              |       | 236,170                 |       | 329,758                     |       |
| Accounts  receivable, less allowance                                                                                                                                           |       | 26,902                  |       | 35,800                      |       |
| Assets held  for sale                                                                                                                                                          |       | 55,484                  |       | 10,336                      |       |
| Restricted  cash and investments                                                                                                                                               |       | 12,852                  |       | 29,569                      |       |
| Cash and  cash equivalents                                                                                                                                                     |       | 61,265                  |       | 252,069                     |       |
| Total                                                                                                                                                                          |       | $                       | 2,493,407  |                        | $          | 2,708,344 |   |
|                                                                                                                                                                           |       |                    |       |                        |       |
| **Liabilities  and stockholders’ equity**                                                                                                                                 |       |                    |       |                        |       |
| Mortgage and  other debt                                                                                                                                                       |       | $                       | 1,208,835  |                        | $          | 1,440,528 |   |
| Accounts  payable and accrued expenses                                                                                                                                         |       | 110,872                 |       | 201,238                     |       |
| Deferred  credits and other liabilities                                                                                                                                        |       | 284,187                 |       | 286,780                     |       |
| Liabilities  associated with assets held for sale                                                                                                                              |       | 81,891                  |       | 88                          |       |
| Deferred income  taxes                                                                                                                                                         |       | 51,231                  |       | 36,119                      |       |
| Total  liabilities                                                                                                                                                             |       | 1,737,016               |       | 1,964,753                   |       |
| Commitments  and contingencies (Note 8)                                                                                                                                        |       |                    |       |                        |       |
| Stockholders’  equity                                                                                                                                                     |       |                    |       |                        |       |
| Common  stock, $0.01 par value, 105,086 and 104,720 shares issued, and 103,941 and  103,317 shares outstanding at June 30, 2005 and December 31, 2004,  respectively |       | 1,051                   |       | 1,047                       |       |
| Paid-in  capital                                                                                                                                                               |       | 517,089                 |       | 509,407                     |       |
| Unearned  value of restricted stock and restricted stock unit grants (1,145 and 1,403  shares at June 30, 2005 and December 31, 2004, respectively)                  |       | (21,474                 | )          | (23,049                     | )          |
| Accumulated  earnings                                                                                                                                                          |       | 259,725                 |       | 256,186                     |       |
| Total  stockholders’ equity                                                                                                                                               |       | 756,391                 |       | 743,591                     |       |
| Total                                                                                                                                                                          |       | $                       | 2,493,407  |                        | $          | 2,708,344 |   |

 

See notes to CondensedConsolidated Financial Statements.

 

3

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**CATELLUSDEVELOPMENT CORPORATION**

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

**(Inthousands, except per share data)**

 
| ** **                                                  | ** ** | **Three Months Ended****June 30,** | ** ** | **Six Months Ended****June 30,** | ** ** |
|-------------------------------------------------------------|------------|-----------------------------------------|------------|---------------------------------------|------------|
| ** **                                                  | ** ** | **2005**                                | ** ** | **2004**                              | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                  | ** ** | **(Unaudited)**                         | ** ** | **(Unaudited)**                       | ** ** |
| **Revenues**                                                | ** ** | ** **                              | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Rental  revenue                                             |       | $                                       | 74,725     |                                  | $          | 72,428 |   | $ | 148,924 |   | $ | 144,203 |   |
| Sales  revenue                                              |       | 31,990                                  |       | 7,299                                 |       | 65,134 |   | 44,990 |   |
| Management,  development and other fees                     |       | 3,250                                   |       | 758                                   |       | 10,794 |   | 2,457 |   |
|                                                        |       | 109,965                                 |       | 80,485                                |       | 224,852 |   | 191,650 |   |
| **Costs  and expenses**                                     |       |                                    |       |                                  |       |   |   |   |   |
| Property  operating costs                                   |       | (20,782                                 | )          | (18,092                               | )          | (41,057 | ) | (36,932 | ) |
| Cost of  sales                                              |       | (20,141                                 | )          | (4,874                                | )          | (43,036 | ) | (27,964 | ) |
| Selling,  general and administrative expenses               |       | (13,234                                 | )          | (12,611                               | )          | (25,524 | ) | (25,562 | ) |
| Depreciation  and amortization                              |       | (17,587                                 | )          | (18,045                               | )          | (35,505 | ) | (34,939 | ) |
|                                                        |       | (71,744                                 | )          | (53,622                               | )          | (145,122 | ) | (125,397 | ) |
| **Operating  income**                                       |       | 38,221                                  |       | 26,863                                |       | 79,730 |   | 66,253 |   |
| **Other  income**                                           |       |                                    |       |                                  |       |   |   |   |   |
| Equity in  earnings of operating joint ventures, net        |       | 2,665                                   |       | 2,379                                 |       | 5,498 |   | 4,793 |   |
| Equity in  earnings of development joint ventures, net      |       | 6,651                                   |       | 3,391                                 |       | 11,737 |   | 4,618 |   |
| Gain on  non-strategic asset sales                          |       | —                                  |       | 16,380                                |       | 20 |   | 16,441 |   |
| Interest  income                                            |       | 8,883                                   |       | 2,461                                 |       | 17,778 |   | 5,238 |   |
| Other                                                       |       | 780                                     |       | 956                                   |       | 869 |   | 1,257 |   |
|                                                        |       | 18,979                                  |       | 25,567                                |       | 35,902 |   | 32,347 |   |
| **Other  expenses**                                         |       |                                    |       |                                  |       |   |   |   |   |
| Interest  expense                                           |       | (15,017                                 | )          | (15,314                               | )          | (31,339 | ) | (29,627 | ) |
| REIT  transition costs                                      |       | —                                  |       | (208                                  | )          | — |   | (420 | ) |
| Other                                                       |       | 158                                     |       | (1,819                                | )          | (1,340 | ) | (2,249 | ) |
|                                                        |       | (14,859                                 | )          | (17,341                               | )          | (32,679 | ) | (32,296 | ) |
| **Income  before income taxes and discontinued operations** |       | 42,341                                  |       | 35,089                                |       | 82,953 |   | 66,304 |   |
| Income tax  expense                                         |       | (9,246                                  | )          | (982                                  | )          | (17,394 | ) | (1,913 | ) |
| **Income  from continuing operations**                      |       | 33,095                                  |       | 34,107                                |       | 65,559 |   | 64,391 |   |
| Discontinued  operations, net of income tax:                |       |                                    |       |                                  |       |   |   |   |   |
| (Loss) gain  from disposal of discontinued operations       |       | (17                                     | )          | 398                                   |       | 716 |   | 2,014 |   |
| (Loss)  income from discontinued operations                 |       | (6,896                                  | )          | 829                                   |       | (6,775 | ) | 1,020 |   |
| Net (loss)  gain from discontinued operations               |       | (6,913                                  | )          | 1,227                                 |       | (6,059 | ) | 3,034 |   |
| **Net  income**                                             |       | $                                       | 26,182     |                                  | $          | 35,334 |   | $ | 59,500 |   | $ | 67,425 |   |
| **Income  per share from continuing operations**            |       |                                    |       |                                  |       |   |   |   |   |
| Basic                                                       |       | $                                       | 0.32       |                                  | $          | 0.33 |   | $ | 0.63 |   | $ | 0.63 |   |
| Assuming  dilution                                          |       | $                                       | 0.31       |                                  | $          | 0.33 |   | $ | 0.62 |   | $ | 0.62 |   |
| **(Loss)  income per share from discontinued operations**   |       |                                    |       |                                  |       |   |   |   |   |
| Basic                                                       |       | $                                       | (0.07      | )                                     | $          | 0.01 |   | $ | (0.06 | ) | $ | 0.03 |   |
| Assuming  dilution                                          |       | $                                       | (0.06      | )                                     | $          | 0.01 |   | $ | (0.06 | ) | $ | 0.03 |   |
| **Net  income per share**                                   |       |                                    |       |                                  |       |   |   |   |   |
| Basic                                                       |       | $                                       | 0.25       |                                  | $          | 0.34 |   | $ | 0.57 |   | $ | 0.66 |   |
| Assuming  dilution                                          |       | $                                       | 0.25       |                                  | $          | 0.34 |   | $ | 0.56 |   | $ | 0.65 |   |
| Average number  of common shares outstanding-basic          |       | 103,912                                 |       | 103,023                               |       | 103,832 |   | 102,933 |   |
| Average  number of common shares outstanding-diluted        |       | 105,457                                 |       | 104,078                               |       | 105,406 |   | 104,116 |   |
| **Dividends  declared per share**                           |       | $                                       | 0.27       |                                  | $          | 0.27 |   | $ | 0.54 |   | $ | 0.54 |   |

 

See notes to CondensedConsolidated Financial Statements.

 

4

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**CATELLUSDEVELOPMENT CORPORATION**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Inthousands)**

 
| ** **                                                                         | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                         | ** ** | **2005**                            | ** ** | **2004** | ** ** |
| ** **                                                                         | ** ** | **(Unaudited)**                     | ** ** |
| **Cash  flows from operating activities:**                                         |       |                                |       |   |   |
| Net income                                                                         |       | $                                   | 59,500     |   | $ | 67,425 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |       |                                |       |   |   |
| Depreciation  and amortization                                                     |       | 35,505                              |       | 34,939 |   |
| Deferred  income tax (benefit) provision                                           |       | 15,112                              |       | (5,237 | ) |
| Deferred  gain recognized                                                          |       | (4,524                              | )          | (8,707 | ) |
| Amortization  of deferred loan fees and other costs                                |       | 2,588                               |       | 2,624 |   |
| Equity in  earnings of joint ventures                                              |       | (17,235                             | )          | (9,411 | ) |
| Gain on  sales of investment property                                              |       | (540                                | )          | (2,014 | ) |
| Operating  distributions from joint ventures                                       |       | 3,948                               |       | 18,540 |   |
| Cost of  development property and non-strategic assets sold                        |       | 41,585                              |       | 47,056 |   |
| Capital  expenditures for development property                                     |       | (28,340                             | )          | (33,119 | ) |
| Other, net                                                                         |       | 3,805                               |       | 4,729 |   |
| Change in  notes receivable                                                        |       | 93,588                              |       | 24,459 |   |
| Change in  deferred credits and other liabilities                                  |       | 12,645                              |       | 18,581 |   |
| Change in  other operating assets and liabilities                                  |       | (11,023                             | )          | (54,587 | ) |
| Net cash  provided by operating activities                                         |       | 206,614                             |       | 105,278 |   |
|                                                                               |       |                                |       |   |   |
| **Cash  flows from investing activities:**                                         |       |                                |       |   |   |
| Property  acquisitions                                                             |       | (42,627                             | )          | (3,316 | ) |
| Capital  expenditures for investment property                                      |       | (78,684                             | )          | (100,110 | ) |
| Tenant  improvements                                                               |       | (3,554                              | )          | (3,042 | ) |
| Reimbursable  construction costs                                                   |       | —                              |       | 2,313 |   |
| Net proceeds  from sale of investment property                                     |       | 2,852                               |       | 9,649 |   |
| Contributions  to joint ventures                                                   |       | (2,130                              | )          | (600 | ) |
| Decrease in  restricted cash and investments                                       |       | 16,717                              |       | 61,135 |   |
| Net cash  used in investing activities                                             |       | (107,426                            | )          | (33,971 | ) |
|                                                                               |       |                                |       |   |   |
| **Cash  flows from financing activities:**                                         |       |                                |       |   |   |
| Borrowings                                                                         |       | —                              |       | 107,131 |   |
| Repayment of  borrowings                                                           |       | (190,380                            | )          | (132,025 | ) |
| Dividends                                                                          |       | (102,265                            | )          | (55,418 | ) |
| Proceeds  from issuance of common stock                                            |       | 2,653                               |       | 3,718 |   |
| Net cash  used in financing activities                                             |       | (289,992                            | )          | (76,594 | ) |
| **Net  decrease in cash and cash equivalents**                                     |       | (190,804                            | )          | (5,287 | ) |
| Cash and  cash equivalents at beginning of period                                  |       | 252,069                             |       | 45,931 |   |
| Cash and  cash equivalents at end of period                                        |       | $                                   | 61,265     |   | $ | 40,644 |   |
| **Supplemental  disclosures of cash flow information:**                            |       |                                |       |   |   |
| Cash paid  during the year for:                                                    |       |                                |       |   |   |
| Interest  (net of amount capitalized)                                              |       | $                                   | 31,545     |   | $ | 29,789 |   |
| Income taxes                                                                       |       | $                                   | 1,632      |   | $ | 24,796 |   |
| Non-cash  financing activities:                                                    |       |                                |       |   |   |
| Debt  forgiveness-property reconveyance/reduction                                  |       | $                                   | (2,383     | ) | $ | (8,946 | ) |

** **

See notes to Condensed ConsolidatedFinancial Statements.

 

5

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**CATELLUSDEVELOPMENT CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**June 30,2005**

**(Unaudited)**

 

**Note 1. Description of Business**

 

Catellus Development Corporation(together with its subsidiaries, “Catellus” or the “Company”) owns and developsprimarily industrial properties located in major markets in California,Illinois, Texas, Colorado, and Georgia, with recent expansion into New Jersey.The Company operated as a fully taxable C-corporation through December 31,2003. At December 31, 2003, the Company reorganized its operations inorder to operate as a real estate investment trust (“REIT”) commencing January 1,2004 (*see* Note 11). Allreferences to Catellus or the Company mean the current Catellus or itspredecessor, as the context requires.

 

On June 6, 2005, theCompany and ProLogis announced that their boards had unanimously approved adefinitive merger agreement under which ProLogis will acquire all of theoutstanding common stock of Catellus for a total consideration of approximately$5.6 billion, including assumed liabilities and transaction costs (*see*Note 13).

 

**Note 2. Interim Financial Data**

 

The accompanying CondensedConsolidated Financial Statements should be read in conjunction with theCompany’s 2004 Annual Report on Form 10-K as filed with the Securities andExchange Commission. In the opinion of management, the accompanying financialinformation includes all normal and recurring adjustments necessary to presentfairly the financial position, results of operations, and cash flows for theinterim periods presented.

 

*Partnership accounting*

 

At June 30, 2005, theCompany holds significant variable interests in three variable interestentities that do not qualify for consolidation under the provisions of FASBInterpretation No. 46-R, “Consolidation of Variable Interest Entities – aninterpretation of ARB No. 51”. The Company’s significant variableinterests are in the form of equity interests in two of its unconsolidatedjoint ventures and its participation in a master development agreement:

 

•       BergstromPartners, L.P. was formed in January 2003 to redevelop and market 624acres of land at a former missile test site in Travis County, Texas. No furthercontributions are required.

 

•       SAMSVenture, LLC was formed in January 2003 to initially develop a new 545,000square foot office park for the Los Angeles Air Force Base, convey thatproperty to the United States Air Force in exchange for three parcels of landtotaling 56 acres and other consideration, and finally either sell or developfor sale the three parcels. The Company’s exposure will increase should thisjoint venture require additional contributions from its joint venture partners.

 

•       ACompany subsidiary entered into a master development agreement with the City ofAustin, Texas in December 2004 to redevelop and market the propertyformerly known as the Robert Mueller Municipal Airport.  The Company’s exposure will increase shouldpublic financing and sales revenues be insufficient to meet current orprojected financial requirements.

 

The Company’s exposure inthe current financial statements as a result of its involvement with thesevariable interest entities is $17.5 million as of June 30, 2005.

 

6

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*Accounting for stock-basedcompensation*

 

At June 30, 2005, theCompany has six stock-based employee compensation plans. The Company accountsfor those plans under the recognition and measurement principles of APB OpinionNo. 25, “*Accounting for Stock Issued toEmployees*” (“APB 25”), and related Interpretations. All options whengranted under those plans had an exercise price equal to the market value ofthe underlying common stock on the date of grant. As a result of a stock optionexchange offer related to the REIT conversion, the Company is required torecognize compensation expense related to the outstanding grants of $0.3million and $0.5 million for the three months ended June 30, 2005 and2004, respectively, and $(0.03) million and $1.7 million for the six monthsended June 30, 2005 and 2004, respectively (*see* Note 11). The following table illustrates the effect onnet income and earnings per share if the Company had applied the fair valuerecognition provisions of FASB Statement No. 123, “*Accounting for Stock-Based Compensation*,”to stock-based employee compensation.

 
| ** **                                                                                                        | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                                        | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                                        | ** ** | **(In thousands)**                    | ** ** | **(In thousands)**                  | ** ** |
| Net income,  as reported                                                                                          |       | $                                     | 26,182     |                                | $          | 35,334 |   | $ | 59,500 |   | $ | 67,425 |   |
| Add:  Stock-based employee compensation (credit) expense included in reported net  income                         |       | 257                                   |       | 471                                 |       | (34 | ) | 1,661 |   |
| Deduct:  Total stock-based employee compensation expense determined under fair value  based method for all awards |       | (123                                  | )          | (367                                | )          | (261 | ) | (749 | ) |
| Pro forma  net income                                                                                             |       | $                                     | 26,316     |                                | $          | 35,438 |   | $ | 59,205 |   | $ | 68,337 |   |
| Earnings per  share:                                                                                              |       |                                  |       |                                |       |   |   |   |   |
| Basic—as  reported                                                                                           |       | $                                     | 0.25       |                                | $          | 0.34 |   | $ | 0.57 |   | $ | 0.66 |   |
| Basic—pro  forma                                                                                             |       | $                                     | 0.25       |                                | $          | 0.34 |   | $ | 0.57 |   | $ | 0.66 |   |
| Diluted—as  reported                                                                                         |       | $                                     | 0.25       |                                | $          | 0.34 |   | $ | 0.56 |   | $ | 0.65 |   |
| Diluted— pro  forma                                                                                          |       | $                                     | 0.25       |                                | $          | 0.34 |   | $ | 0.56 |   | $ | 0.66 |   |

 

During 2004, the Compensation and Benefits Committeeof the Company’s Board of Directors established two performance-based executiveaward plans under the Company’s 2003 Performance Award Plan: the 2004Transition Incentive Plan (“TIP”) and the 2004 Long-Term Incentive Plan (“LTIP”).Awards under the TIP were granted in 2004 and LTIP were granted in 2004 and2005. The awards granted are non-voting units of measurement (“PerformanceUnits”) that are deemed to represent one share of the Company’s common stock.Performance Units are entitled to dividend equivalents representing dividendson an equal number of shares of the Company’s common stock. Dividendequivalents are credited to participants’ accounts as additional PerformanceUnits. The initial performance period under the LTIP and the performance periodunder the TIP are from January 1, 2004 through December 31, 2006.Subsequent awards under the LTIP were granted in 2005 with a performance periodfrom January 1, 2005 to December 31, 2007.  The earliest date TIP awards were eligible tobegin vesting was December 31, 2004 if at least 50% of defined performancetargets were achieved by that date and certain time vesting requirements as tocertain participants were met.  If anydefined performance targets are not 100% achieved by December 31, 2006,the remaining unvested performance units will be forfeited. TIP awards arepayable in the Company’s common stock. The initial and subsequent LTIP awardsvest at December 31, 2006 and 2007, respectively, if the Company’s totalstockholder return, relative to the total stockholder returns of a certaingroup of peer companies, meets certain performance targets. LTIP awards arepayable 50% in the Company’s common stock and 50% in cash.

 

7

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At June 30, 2005,312,278 Performance Units, representing the aggregate number initially awardedunder both plans, less vested TIP Performance Units distributed in commonstock, plus additional Performance Units from dividend equivalents onpreviously existing Performance Units, have been credited to participants’accounts, subject to the vesting requirements discussed in the precedingparagraph. As required by APB 25, the Company has recognized $1.2 million and$1.3 million as compensation expense during the three months ended June 30,2005 and 2004, respectively, and $2.1 million and $2.6 million during the sixmonths ended June 30, 2005 and 2004, respectively, with the correspondingliability recorded in “Accounts payable and accrued expenses” in theaccompanying Condensed Consolidated Balance Sheet. For purposes of recognizingcompensation expense, TIP performance is based on the Company’s currentestimate of the timing for achieving performance targets, and LTIP performanceis measured on the basis of actual results as of June 30, 2005. TheCompany estimates that as of June 30, 2005, 95.7% of the TIP performancetargets have been achieved. Actual performance under the LTIP is notdeterminable until the performance periods for the initial and subsequentawards end on December 31, 2006 and 2007, respectively. Certain TIPperformance targets were 100% achieved as of December 31, 2004, andtherefore were eligible for 100% vesting. However, for purposes of vestingunder the TIP, since at least 50% but less than 100% of the other definedperformance targets were met as of December 31, 2004, the Compensation andBenefits Committee could only certify the achievement of 50% of such targets asof December 31, 2004. In February 2005 and May 2005, theCompensation and Benefits Committee certified the achievement of the definedperformance targets to an extent which resulted in the performance vesting of85% of all TIP Performance Units, subject to the time vesting requirements asto certain participants, as discussed in the preceding paragraph.

 

During 2005, the Company granted to certainofficers and employees an aggregate of 169,845 shares of restricted stock witha fair market value of $4.8 million as of the grant date.  Shares of restricted stock are entitled todividends.

 

During 2005,the Company granted to non-employee directors an aggregate of 14,744 DirectorRestricted Stock Units with a fair market value of $0.4 million as of the grantdate. Director Restricted Stock Units are entitled to dividend equivalents.

 

The Company expenses dividends paid on unvestedrestricted stock and dividend equivalents paid on restricted stock units,Director Restricted Stock Units, and Director Stock Units.  For the three months ended June 30, 2005and 2004, such dividends and dividend equivalents paid were $0.4 million and$0.3 million, respectively, and $0.9 million and $0.7 million for the sixmonths ended June 30, 2005 and 2004, respectively.

 

If the proposed merger under the definitive mergeragreement between the Company and ProLogis (as announced on June 6, 2005)is completed, all outstanding vested and unvested stock options will be canceledas of the effective time of the merger. Each holder of a canceled stock option will receive $33.81 for eachshare of Catellus common stock subject to the canceled option, less theexercise price and any applicable withholding taxes, payable in the form of 65%ProLogis common shares and 35% cash.  Inaddition, if the merger is completed, the outstanding TIP and LTIP PerformanceUnits, restricted stock units, Director Restricted Stock Units and DirectorStock Units will be canceled as of the effective time of the merger.  The holder of each such canceled unit willreceive $33.81 for each share subject to the canceled unit, less any applicablewithholding taxes, payable in the form of 65% ProLogis common shares and 35%cash.

 

*New accounting standards*

 

In December 2004, theFASB issued Statement of Accounting Standards No. 123R, “*Share-Based Payment*” (“SFAS 123R”). SFAS123R establishes standards for the accounting for transactions in which anentity exchanges its equity investments for goods or services.  This statement is effective for fiscal yearsthat begin after June 15, 2005 (as extended by the Securities and ExchangeCommission).  The Company will adopt SFAS123R in the time frame required and it is anticipated that the Company willelect the modified prospective application transition method withoutrestatement of prior interim periods. The initial adoption of SFAS 123R will not have a significant effect onthe financial position, results of operations, or cash flow of the Company.

 

*Acquisition of joint venture interest*

 

On June 1, 2005, the Company acquiredthe remaining 50 percent interest in Pacific Market Investment Company, LLC, aninvestment previously held as a joint venture.  In accordance with FAS141, *Business Combinations*, theresults of Pacific Market Investment Company, LLC’s operations have beenincluded in the consolidated financial statements since the acquisitiondate.  The aggregate purchase price was $36.7 million and included a $19.7million loan assumption, and $17.0 million of cash.  The value of the hotel was determined basedon the current market price for investments of similar age, condition, andlocation.  Pacific Market InvestmentCompany, LLC owns and operates an Embassy Suites Hotel in San Diego,California.

 

8

----

 

*IncomeTaxes*

 

The Company was restructuredto operate as a REIT effective January 1, 2004. In general, a corporationthat elects REIT status and distributes at least 90% of its taxable income toits stockholders and complies with certain other requirements (relatingprimarily to the nature of its assets and the sources of its revenues) is notsubject to federal income taxation to the extent it distributes its taxableincome. The Company began operating so as to qualify as a REIT beginning January 1,2004, and paid at least 90% of REIT taxable income to stockholders in 2004.Based on these considerations, the Company believes that it will not be liablefor taxes (except with respect to the items discussed below) and, in 2003,reversed approximately $232 million of deferred tax liabilities.

 

In 2003, as part of therestructuring activities to enable the Company to operate as a REIT, theCompany created subsidiaries that qualify (subject to certain size limitations)as taxable REIT subsidiaries under the REIT rules (“TRS”), which aresubject to federal and state income taxes. Accordingly, the Company will stillbe liable for federal and state taxes with respect to income earned in the TRS.As a result of this future tax liability, certain assets of the TRS carrytemporary differences between book and tax amounts that are reflected as netdeferred tax liabilities at the TRS and in the Condensed Consolidated BalanceSheet. Also, a majority of the Company’s assets owned as of December 31,2003, which were transferred into the REIT, had values in excess of tax basis (“built-in-gain”)of approximately $1.7 billion. Under the REIT rules, the Company is liable forthe tax on this built-in-gain if it is realized in a taxable transaction (asfor example by sale of the asset) before January 1, 2014. The Companybelieves that it will pay taxes on built-in-gains on the Company’s assetssubject to purchase options in the event the Company cannot effectuate atax-free exchange. As a result of this future tax liability, the temporarydifferences between book and tax amounts for these assets will continue to bereflected as net deferred tax liabilities in the Condensed Consolidated BalanceSheet. In addition, the Company’s 1999 and later federal and state tax returnsare still open with certain returns currently under audit, which may result inadditional taxes with respect to these prior years. In 2003, the Company hasprovided for a current tax liability, currently totaling approximately $126 million,related to certain transactions under audit where it has taken a tax benefit,but the tax impact is uncertain. Lastly, the Company expects that once certaintasks are completed, certain of the Company’s assets not currently in the TRSwill later be contributed to the TRS and carry temporary differences betweenbook and tax amounts which will result in current tax liabilities.

 

To initially qualify as aREIT, among other things, the Company distributed all of its accumulatedearnings and profits (“E&P”) to the Company’s stockholders in one or moretaxable dividends. In order to meet the required distribution of accumulatedE&P, the Company made a distribution of $128 million in cash and 10.7million shares of Catellus common stock valued at $252 million in the fourthquarter of 2003. The amount of the distributions was based, in part, upon theestimated amount of accumulated E&P at year-end 2003. Although the Companybelieves that the distributions were sufficient to eliminate all of itsaccumulated E&P, to the extent that adjustments, if any, to prior years’taxable income results in higher cumulative E&P, the Company will make anadditional taxable distribution (in the form of cash and/or securities) at thattime.

 

Income tax expense for thesix months ended June 30, 2005 was generated at both the REIT level andthe TRS. The TRS income before income taxes was $36.7 million with an effectiveoverall rate of 41.22%. The Company has accrued $2.3 million for state taxes atthe REIT level to reflect state tax liability resulting from projected taxableincome in California in excess of federal taxable income that is notdistributed to stockholders and additional taxes with respect to a proposedCalifornia adjustment for a mortgage REIT subsidiary. Income tax (expense)benefit for the six months ended June 30, 2004 was generated only at theTRS level. The TRS income before income taxes for the six months ended June 30,2004 was $4.8 million with an effective overall rate of 40.08%.

 

Income tax (expense) benefiton consolidated income from continuing operations is as follows:

 
| ** ** | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** ** | ** ** | **2005**                             | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** ** | ** ** | **(In thousands)**                   | ** ** | **(In thousands)**                 | ** ** |
| Current    |       | $                                    | 4,088      |                               | $          | (2,120 | ) | $ | (2,282 | ) | $ | (7,150 | ) |
| Deferred   |       | (13,334                              | )          | 1,138                              |       | (15,112 | ) | 5,237 |   |
| Total      |       | $                                    | (9,246     | )                                  | $          | (982 | ) | $ | (17,394 | ) | $ | (1,913 | ) |

 

*Non-strategic asset sales*

 

During thesecond quarter 2004, the Company sold substantially all of its remainingdessert properties for $16.4 million.

 

**Note 3. Restricted Cash andInvestments**

 

Of the total restricted cashand investments of $12.9 million at June 30, 2005, and $29.6 million at December 31,2004, $0.2 million and $18.9 million, respectively, represent proceeds fromproperty sales held in separate cash accounts at trust companies in order topreserve the Company’s option to reinvest the proceeds on a tax-deferredbasis.  Approximately $12.0 million and$10.0 million at June 30, 2005 and December 31, 2004, respectively,represents funds in escrow for environmental work related to a landacquisition. Approximately $0.7 million at June 30, 2005 and December 31,2004, represent funds held in pledge accounts at a bank until certain loancollateral pool requirements are met.

 

9

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**Note 4. Income Per Share**

 

Income from continuing anddiscontinued operations per share of common stock applicable to commonstockholders is computed by dividing respective income by the weighted averagenumber of shares of common stock and equivalents outstanding during the period(*see* table below for effect ofdilutive securities).

 
| ** **                                                      | ** ** | **Three months Ended June 30,**       | ** ** |
|-----------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                      | ** ** | **2005**                                   | ** ** | **2004** | ** ** |
| ** **                                                      | ** ** | **Income**                                 | ** ** | **Shares** | ** ** | **Per Share  Amount** | ** ** | **Income** | ** ** | **Shares** | ** ** | **Per Share  Amount** | ** ** |
| ** **                                                      | ** ** | **(In thousands, except per share  data)** | ** ** |
| Income from  continuing operations                              |       | $                                          | 33,095     |   | 103,912 |   | $ | 0.32 |   | $ | 34,107 |   | 103,023 |   | $ | 0.33 |   |
|                                                            |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Effect of  dilutive securities:                                 |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Stock  options                                                  |       | —                                     |       | 570 |   |   |   | — |   | 699 |   |   |   |
| Restricted  stock and restricted stock units                    |       | —                                     |       | 763 |   |   |   | — |   | 350 |   |   |   |
| Other  compensation incentive plans                             |       | —                                     |       | 212 |   |   |   | — |   | 6 |   |   |   |
|                                                            |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Income from  continuing operations assuming dilution            |       | $                                          | 33,095     |   | 105,457 |   | $ | 0.31 |   | $ | 34,107 |   | 104,078 |   | $ | 0.33 |   |
|                                                            |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Net (loss)  gain from discontinued operations                   |       | $                                          | (6,913     | ) | 103,912 |   | $ | (0.07 | ) | $ | 1,227 |   | 103,023 |   | $ | 0.01 |   |
|                                                            |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Effect of  dilutive securities:                                 |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Stock  options                                                  |       | —                                     |       | 570 |   |   |   | — |   | 699 |   |   |   |
| Restricted  stock and restricted stock units                    |       | —                                     |       | 763 |   |   |   | — |   | 350 |   |   |   |
| Other  compensation incentive plans                             |       | —                                     |       | 212 |   |   |   | — |   | 6 |   |   |   |
|                                                            |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Net (loss)  gain from discontinued operations assuming dilution |       | $                                          | (6,913     | ) | 105,457 |   | $ | (0.06 | ) | $ | 1,227 |   | 104,078 |   | $ | 0.01 |   |
|                                                            |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Net income                                                      |       | $                                          | 26,182     |   | 103,912 |   | $ | 0.25 |   | $ | 35,334 |   | 103,023 |   | $ | 0.34 |   |
|                                                            |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Effect of  dilutive securities:                                 |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Stock  options                                                  |       | —                                     |       | 570 |   |   |   | — |   | 699 |   |   |   |
| Restricted  stock and restricted stock units                    |       | —                                     |       | 763 |   |   |   | — |   | 350 |   |   |   |
| Other  compensation incentive plans                             |       | —                                     |       | 212 |   |   |   | — |   | 6 |   |   |   |
|                                                            |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Net income  assuming dilution                                   |       | $                                          | 26,182     |   | 105,457 |   | $ | 0.25 |   | $ | 35,334 |   | 104,078 |   | $ | 0.34 |   |

 

10

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| ** **                                                      | ** ** | **Six months Ended June 30,**         | ** ** |
|-----------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                      | ** ** | **2005**                                   | ** ** | **2004** | ** ** |
| ** **                                                      | ** ** | **Income**                                 | ** ** | **Shares** | ** ** | **Per Share  Amount** | ** ** | **Income** | ** ** | **Shares** | ** ** | **Per Share  Amount** | ** ** |
| ** **                                                      | ** ** | **(In thousands, except per share  data)** | ** ** |
| Income from  continuing operations                              |       | $                                          | 65,559     |   | 103,832 |   | $ | 0.63 |   | $ | 64,391 |   | 102,933 |   | $ | 0.63 |   |
|                                                            |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Effect of  dilutive securities:                                 |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Stock  options                                                  |       | —                                     |       | 594 |   |   |   | — |   | 780 |   |   |   |
| Restricted  stock and restricted stock units                    |       | —                                     |       | 757 |   |   |   | — |   | 396 |   |   |   |
| Other  compensation incentive plans                             |       | —                                     |       | 223 |   |   |   | — |   | 7 |   |   |   |
|                                                            |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Income from  continuing operations assuming dilution            |       | $                                          | 65,559     |   | 105,406 |   | $ | 0.62 |   | $ | 64,391 |   | 104,116 |   | $ | 0.62 |   |
|                                                            |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Net (loss)  gain from discontinued operations                   |       | $                                          | (6,059     | ) | 103,832 |   | $ | (0.06 | ) | $ | 3,034 |   | 102,933 |   | $ | 0.03 |   |
|                                                            |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Effect of  dilutive securities:                                 |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Stock  options                                                  |       | —                                     |       | 594 |   |   |   | — |   | 780 |   |   |   |
| Restricted  stock and restricted stock units                    |       | —                                     |       | 757 |   |   |   | — |   | 396 |   |   |   |
| Other  compensation incentive plans                             |       | —                                     |       | 223 |   |   |   | — |   | 7 |   |   |   |
|                                                            |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Net (loss)  gain from discontinued operations assuming dilution |       | $                                          | (6,059     | ) | 105,406 |   | $ | (0.06 | ) | $ | 3,034 |   | 104,116 |   | $ | 0.03 |   |
|                                                            |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Net income                                                      |       | $                                          | 59,500     |   | 103,832 |   | $ | 0.57 |   | $ | 67,425 |   | 102,933 |   | $ | 0.66 |   |
|                                                            |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Effect of  dilutive securities:                                 |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Stock  options                                                  |       | —                                     |       | 594 |   |   |   | — |   | 780 |   |   |   |
| Restricted  stock and restricted stock units                    |       | —                                     |       | 757 |   |   |   | — |   | 396 |   |   |   |
| Other  compensation incentive plans                             |       | —                                     |       | 223 |   |   |   | — |   | 7 |   |   |   |
|                                                            |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Net income  assuming dilution                                   |       | $                                          | 59,500     |   | 105,406 |   | $ | 0.56 |   | $ | 67,425 |   | 104,116 |   | $ | 0.65 |   |

 

11

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**Note 5. Mortgage and Other Debt**

 

Mortgage and other debt at June 30,2005 and December 31, 2004, are summarized as follows:

 
| ** **                            | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|---------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                            | ** ** | **(In thousands)**      | ** ** |
| Fixed rate  mortgage loans            |       | $                       | 1,059,686  |                        | $          | 1,084,259 |   |
| Floating  rate mortgage loans         |       | 87,874                  |       | 114,689                     |       |
| Assessment  district bonds            |       | 60,531                  |       | 63,210                      |       |
| Construction  loans                   |       | —                  |       | 30,000                      |       |
| Revolving  credit facility            |       | —                  |       | 148,000                     |       |
| Other loans                           |       | 744                     |       | 370                         |       |
| Mortgage and  other debt              |       | 1,208,835               |       | 1,440,528                   |       |
| Liabilities  of assets held for sale: | ** ** | ** **              | ** ** | ** **                  | ** ** |
| Fixed rate  mortgage loans            |       | 54,755                  |       | —                      |       |
| Floating  rate mortgage loans         |       | 25,297                  |       | —                      |       |
| Total  mortgage and other debt        |       | $                       | 1,288,887  |                        | $          | 1,440,528 |   |
|                                  |       |                    |       |                        |       |
| Due within  one year                  |       | $                       | 190,939    |                        | $          | 142,429 |   |

 

During the second quarter of2005, the Company acquired the remaining 50% interest in Pacific MarketInvestment Company (“PMIC”) from its joint venture partner (*see* Note 2).  As a result, it now consolidates the assetsand liabilities of PMIC which include a $40.7 million fixed rate mortgage loanbearing interest at 6.56% with a 25-year amortization schedule andmaturity in April 2013.

 

Interest costs relating tomortgage and other debt for the three and six months ended June 30, 2005and 2004, are summarized as follows:

 
| ** **                                   | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                   | ** ** | **2005**                             | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                   | ** ** | **(In thousands)**                   | ** ** | **(In thousands)**                 | ** ** |
| Total  interest incurred                     |       | $                                    | 20,783     |                               | $          | 21,443 |   | $ | 42,035 |   | $ | 43,017 |   |
| Interest  capitalized                        |       | (4,495                               | )          | (4,751                             | )          | (8,166 | ) | (10,572 | ) |
| Interest  expensed                           |       | 16,288                               |       | 16,692                             |       | 33,869 |   | 32,445 |   |
| Less  discontinued operations                |       | (1,271                               | )          | (1,378                             | )          | (2,530 | ) | (2,818 | ) |
| Interest  expense from continuing operations |       | $                                    | 15,017     |                               | $          | 15,314 |   | $ | 31,339 |   | $ | 29,627 |   |

 

12

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**Note 6. Property**

 

Book value by property typeconsists of the following:

 
| ** **                                | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|-------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                | ** ** | **(In thousands)**      | ** ** |
| Rental  properties:                       |       |                    |       |                        |       |
| Industrial  buildings                     |       | $                       | 1,299,473  |                        | $          | 1,278,227 |   |
| Office  buildings                         |       | 285,488                 |       | 383,763                     |       |
| Retail  buildings                         |       | 134,768                 |       | 105,066                     |       |
| Ground  leases and other                  |       | 257,299                 |       | 178,007                     |       |
| Investment  in operating joint ventures   |       | (13,512                 | )          | (21,184                     | )          |
|                                      |       | 1,963,516               |       | 1,923,879                   |       |
| Developable  properties:                  |       |                    |       |                        |       |
| Commercial                                |       | 211,918                 |       | 173,305                     |       |
| Urban                                     |       | 55,292                  |       | 80,959                      |       |
| Investment  in development joint ventures |       | 28,409                  |       | 13,852                      |       |
|                                      |       | 295,619                 |       | 268,116                     |       |
| Work-in-process:                          |       |                    |       |                        |       |
| Commercial                                |       | 99,726                  |       | 97,624                      |       |
| Urban                                     |       | —                  |       | 8,380                       |       |
|                                      |       | 99,726                  |       | 106,004                     |       |
|                                      |       |                    |       |                        |       |
| Furniture,  fixtures and equipment        |       | 22,017                  |       | 17,584                      |       |
| Other                                     |       | 706                     |       | 706                         |       |
| Gross book  value                         |       | 2,381,584               |       | 2,316,289                   |       |
| Accumulated  depreciation                 |       | (487,227                | )          | (490,409                    | )          |
| Net book  value                           |       | $                       | 1,894,357  |                        | $          | 1,825,880 |   |

 

During the second quarter of2005, the Company acquired the remaining 50% interest in Pacific MarketInvestment Company (*see* Note2).  The acquisition increased the bookvalue of the Company’s properties $62.3 million.

 

At June 30, 2005, twooffice properties with a book value of $94.9 million were under contract to be soldand therefore classified as “Assets held for sale” on the CondensedConsolidated Balance Sheet (*see*Note 10).

 

**Note 7. Segment Reporting**

 

The Company’s reportablesegments are based on the Company’s method of internal reporting, whichdisaggregates its business between long-term operations and those which theCompany intends to transition out of over time and before the adjustments fordiscontinued operations. The Company has two reportable segments: Core Segment,and Urban, Residential and Other Segment (“URO”). Core Segment includes (1) themanagement and leasing of the Company’s rental portfolio, (2) commercialdevelopment activities, which focuses primarily on acquiring and developingsuburban commercial business parks for the Company’s own rental portfolio andselling land and/or buildings that the Company has developed to users and otherparties, and (3) select land development opportunities that may not alwaysbe industrial, especially projects that may not require significant capitalinvestment on the Company’s part, where the Company can utilize its landdevelopment skills. URO includes the remaining residential projects, urbandevelopment activities and desert land sales, which the Company intends totransition out of over time of which a majority portion was sold during 2004,and REIT transition costs, including tax matters prior to becoming a REIT.

 

Inter-segment gains andlosses are not recognized. Debt and interest-bearing assets are allocated tosegments based upon the grouping of the underlying assets. All other assets andliabilities are specifically identified.

 

13

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Financial data by reportablesegment is as follows:

 
| ** **                                                  |   | **Core**           | ** ** | **URO** | ** ** | **Subtotal** | ** ** | **Discontinued  Operations** | ** ** | **Total** |   |
|-------------------------------------------------------------|--------|--------------------|------------|---------|------------|--------------|------------|------------------------------|------------|-----------|--------|
| ** **                                                  |   | **(In thousands)** |       |
| **Three  Months Ended June 30, 2005**                  |   |               |       |    |       |         |       |                         |       |      |   |
| **Revenue**                                                 |   |               |       |    |       |         |       |                         |       |      |   |
| Rental  revenue                                             |   | $                  | 78,714     |    | $          | —       |       | $                            | 78,714     |      | $      | (3,989 | ) | $ | 74,725 |   |
| Sales  revenue                                              |   | 18,726             |       | 13,264  |       | 31,990       |       | —                       |       | 31,990    |   |
| Management,  development and other fees                     |   | 3,250              |       | —  |       | 3,250        |       | —                       |       | 3,250     |   |
|                                                        |   | 100,690            |       | 13,264  |       | 113,954      |       | (3,989                       | )          | 109,965   |   |
|                                                        |   |               |       |    |       |         |       |                         |       |      |   |
| **Costs  and expenses**                                     |   |               |       |    |       |         |       |                         |       |      |   |
| Property  operating costs                                   |   | (22,830            | )          | —  |       | (22,830      | )          | 2,048                        |       | (20,782   | )      |
| Cost of  sales                                              |   | (16,318            | )          | (3,840  | )          | (20,158      | )          | 17                           |       | (20,141   | )      |
| Selling,  general and administrative expenses               |   | (10,392            | )          | (2,842  | )          | (13,234      | )          | —                       |       | (13,234   | )      |
| Depreciation  and amortization                              |   | (18,271            | )          | (93     | )          | (18,364      | )          | 777                          |       | (17,587   | )      |
|                                                        |   | (67,811            | )          | (6,775  | )          | (74,586      | )          | 2,842                        |       | (71,744   | )      |
| **Operating  income**                                       |   | 32,879             |       | 6,489   |       | 39,368       |       | (1,147                       | )          | 38,221    |   |
|                                                        |   |               |       |    |       |         |       |                         |       |      |   |
| **Other  income**                                           |   |               |       |    |       |         |       |                         |       |      |   |
| Equity in  earnings of operating joint ventures, net        |   | 2,665              |       | —  |       | 2,665        |       | —                       |       | 2,665     |   |
| Equity in  earnings of development joint ventures, net      |   | 1,307              |       | 5,344   |       | 6,651        |       | —                       |       | 6,651     |   |
| Gain on  non-strategic asset sales                          |   | —             |       | —  |       | —       |       | —                       |       | —    |   |
| Interest  income                                            |   | 7,878              |       | 1,005   |       | 8,883        |       | —                       |       | 8,883     |   |
| Other                                                       |   | 645                |       | 135     |       | 780          |       | —                       |       | 780       |   |
|                                                        |   | 12,495             |       | 6,484   |       | 18,979       |       | —                       |       | 18,979    |   |
| **Other  expenses**                                         |   |               |       |    |       |         |       |                         |       |      |   |
| Interest  expense                                           |   | (16,288            | )          | —  |       | (16,288      | )          | 1,271                        |       | (15,017   | )      |
| Other                                                       |   | (6,206             | )          | (425    | )          | (6,631       | )          | 6,789                        |       | 158       |   |
|                                                        |   | (22,494            | )          | (425    | )          | (22,919      | )          | 8,060                        |       | (14,859   | )      |
| **Income  before income taxes and discontinued operations** |   | 22,880             |       | 12,548  |       | 35,428       |       | 6,913                        |       | 42,341    |   |
| Income tax  expense                                         |   | (1,328             | )          | (7,918  | )          | (9,246       | )          | —                       |       | (9,246    | )      |
| **Income  from continuing operations**                      |   | 21,552             |       | 4,630   |       | 26,182       |       | 6,913                        |       | 33,095    |   |
| **Discontinued  operations, net of tax:**                   |   |               |       |    |       |         |       |                         |       |      |   |
| Loss from  disposal of discontinued operations              |   | —             |       | —  |       | —       |       | (17                          | )          | (17       | )      |
| Loss from  discontinued operations                          |   | —             |       | —  |       | —       |       | (6,896                       | )          | (6,896    | )      |
| Net loss  from discontinued operations                      |   | —             |       | —  |       | —       |       | (6,913                       | )          | (6,913    | )      |
| **Net  income**                                             |   | $                  | 21,552     |    | $          | 4,630        |       | $                            | 26,182     |      | $      | — |   | $ | 26,182 |   |

 

14

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Financial data by reportable segment is as follows:

 
| ** **                                                  |   | **Core**           |   | **URO** | ** ** | **Subtotal** | ** ** | **Discontinued  Operations** | ** ** | **Total** |       |
|-------------------------------------------------------------|--------|--------------------|--------|---------|------------|--------------|------------|------------------------------|------------|-----------|------------|
| ** **                                                  |   | **(In thousands)** |   |
| **Three  Months Ended June 30, 2004**                  |   |               |   |    |       |         |       |                         |       |      |       |
| **Revenue**                                                 |   |               |   |    |       |         |       |                         |       |      |       |
| Rental  revenue                                             |   | $                  | 78,011 |    | $          | —       |       | $                            | 78,011     |      | $          | (5,583 | ) | $ | 72,428 |   |
| Sales  revenue                                              |   | 10,980             |   | 2,691   |       | 13,671       |       | (6,372                       | )          | 7,299     |       |
| Management,  development and other fees                     |   | 542                |   | 216     |       | 758          |       | —                       |       | 758       |       |
|                                                        |   | 89,533             |   | 2,907   |       | 92,440       |       | (11,955                      | )          | 80,485    |       |
| **Costs  and expenses**                                     |   |               |   |    |       |         |       |                         |       |      |       |
| Property  operating costs                                   |   | (20,283            | )      | —  |       | (20,283      | )          | 2,191                        |       | (18,092   | )          |
| Cost of  sales                                              |   | (8,311             | )      | (2,537  | )          | (10,848      | )          | 5,974                        |       | (4,874    | )          |
| Selling,  general and administrative expenses               |   | (7,247             | )      | (5,364  | )          | (12,611      | )          | —                       |       | (12,611   | )          |
| Depreciation  and amortization                              |   | (18,957            | )      | (273    | )          | (19,230      | )          | 1,185                        |       | (18,045   | )          |
|                                                        |   | (54,798            | )      | (8,174  | )          | (62,972      | )          | 9,350                        |       | (53,622   | )          |
| **Operating  income (loss)**                                |   | 34,735             |   | (5,267  | )          | 29,468       |       | (2,605                       | )          | 26,863    |       |
| **Other  income**                                           |   |               |   |    |       |         |       |                         |       |      |       |
| Equity in  earnings of operating joint ventures, net        |   | 2,379              |   | —  |       | 2,379        |       | —                       |       | 2,379     |       |
| Equity in  earnings of development joint ventures, net      |   | —             |   | 3,391   |       | 3,391        |       | —                       |       | 3,391     |       |
| Gain on  non-strategic asset sales                          |   | —             |   | 16,380  |       | 16,380       |       | —                       |       | 16,380    |       |
| Interest  income                                            |   | 1,813              |   | 648     |       | 2,461        |       | —                       |       | 2,461     |       |
| Other                                                       |   | (18                | )      | 974     |       | 956          |       | —                       |       | 956       |       |
|                                                        |   | 4,174              |   | 21,393  |       | 25,567       |       | —                       |       | 25,567    |       |
| **Other  expenses**                                         |   |               |   |    |       |         |       |                         |       |      |       |
| Interest  expense                                           |   | (16,692            | )      | —  |       | (16,692      | )          | 1,378                        |       | (15,314   | )          |
| REIT  transition costs                                      |   | —             |   | (208    | )          | (208         | )          | —                       |       | (208      | )          |
| Other                                                       |   | (731               | )      | (1,088  | )          | (1,819       | )          | —                       |       | (1,819    | )          |
|                                                        |   | (17,423            | )      | (1,296  | )          | (18,719      | )          | 1,378                        |       | (17,341   | )          |
|                                                        |   |               |   |    |       |         |       |                         |       |      |       |
| **Income  before income taxes and discontinued operations** |   | 21,486             |   | 14,830  |       | 36,316       |       | (1,227                       | )          | 35,089    |       |
| Income taxes                                                |   | (553               | )      | (429    | )          | (982         | )          | —                       |       | (982      | )          |
| **Income  from continuing operations**                      |   | 20,933             |   | 14,401  | ** ** | 35,334       |       | (1,227                       | )          | 34,107    | ** ** |
| **Discontinued  operations, net of tax:**                   |   |               |   |    |       |         |       |                         |       |      |       |
| Gain from  disposal of discontinued operations              |   | —             |   | —  |       | —       |       | 398                          |       | 398       |       |
| Income from  discontinued operations                        |   | —             |   | —  |       | —       |       | 829                          |       | 829       |       |
| Net gain  from discontinued operations                      |   | —             |   | —  |       | —       |       | 1,227                        |       | 1,227     |       |
| **Net  income**                                             |   | $                  | 20,933 |    | $          | 14,401       |       | $                            | 35,334     |      | $          | — |   | $ | 35,334 |   |

 

15

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| ** **                                                  | ** ** | **Core**           | ** ** | **URO**    | ** ** | **Subtotal** | ** ** | **Discontinued  Operations** | ** ** | **Total** | ** ** |
|-------------------------------------------------------------|------------|--------------------|------------|------------|------------|--------------|------------|------------------------------|------------|-----------|------------|
| ** **                                                  | ** ** | **(In thousands)** | ** ** |
| **Six  Months Ended June 30, 2005**                    |       |               |       |       |       |         |       |                         |       |      |       |
|                                                        |       |               |       |       |       |         |       |                         |       |      |       |
| **Revenue**                                                 |       |               |       |       |       |         |       |                         |       |      |       |
| Rental  revenue                                             |       | $                  | 157,114    |       | $          | —       |       | $                            | 157,114    |      | $          | (8,190 | ) | $ | 148,924 |   |
| Sales  revenue                                              |       | 41,042             |       | 26,978     |       | 68,020       |       | (2,886                       | )          | 65,134    |       |
| Management,  development and other fees                     |       | 6,960              |       | 3,834      |       | 10,794       |       | —                       |       | 10,794    |       |
|                                                        |       | 205,116            |       | 30,812     |       | 235,928      |       | (11,076                      | )          | 224,852   |       |
| **Costs  and expenses**                                     |       |               |       |       |       |         |       |                         |       |      |       |
| Property  operating costs                                   |       | (45,130            | )          | —     |       | (45,130      | )          | 4,073                        |       | (41,057   | )          |
| Cost of  sales                                              |       | (30,265            | )          | (14,941    | )          | (45,206      | )          | 2,170                        |       | (43,036   | )          |
| Selling,  general and administrative expenses               |       | (20,113            | )          | (5,411     | )          | (25,524      | )          | —                       |       | (25,524   | )          |
| Depreciation  and amortization                              |       | (36,874            | )          | (204       | )          | (37,078      | )          | 1,573                        |       | (35,505   | )          |
|                                                        |       | (132,382           | )          | (20,556    | )          | (152,938     | )          | 7,816                        |       | (145,122  | )          |
| **Operating  income (loss)**                                |       | 72,734             |       | 10,256     |       | 82,990       |       | (3,260                       | )          | 79,730    |       |
| **Other  income**                                           |       |               |       |       |       |         |       |                         |       |      |       |
| Equity in  earnings of operating joint ventures, net        |       | 5,498              |       | —     |       | 5,498        |       | —                       |       | 5,498     |       |
| Equity in  earnings of development joint ventures, net      |       | 2,841              |       | 8,896      |       | 11,737       |       | —                       |       | 11,737    |       |
| Gain on  non-strategic asset sales                          |       | —             |       | 20         |       | 20           |       | —                       |       | 20        |       |
| Interest  income                                            |       | 15,861             |       | 1,917      |       | 17,778       |       | —                       |       | 17,778    |       |
| Other                                                       |       | 662                |       | 207        |       | 869          |       | —                       |       | 869       |       |
|                                                        |       | 24,862             |       | 11,040     |       | 35,902       |       | —                       |       | 35,902    |       |
| **Other  expenses**                                         |       |               |       |       |       |         |       |                         |       |      |       |
| Interest  expense                                           |       | (33,869            | )          | —     |       | (33,869      | )          | 2,530                        |       | (31,339   | )          |
| Other                                                       |       | (7,761             | )          | (368       | )          | (8,129       | )          | 6,789                        |       | (1,340    | )          |
|                                                        |       | (41,630            | )          | (368       | )          | (41,998      | )          | 9,319                        |       | (32,679   | )          |
| **Income  before income taxes and discontinued operations** |       | 55,966             |       | 20,928     |       | 76,894       |       | 6,059                        |       | 82,953    |       |
| Income taxes                                                |       | (4,564             | )          | (12,830    | )          | (17,394      | )          | —                       |       | (17,394   | )          |
| **Income  from continuing operations**                      | ** ** | 51,402             |       | 8,098      |       | 59,500       |       | 6,059                        |       | 65,559    |       |
| **Discontinued  operations, net of tax:**                   |       |               |       |       |       |         |       |                         |       |      |       |
| Gain from  disposal of discontinued operations              |       | —             |       | —     |       | —       |       | 716                          |       | 716       |       |
| (Loss)  income from discontinued operations                 |       | —             |       | —     |       | —       |       | (6,775                       | )          | (6,775    | )          |
| Net loss  from discontinued operations                      | ** ** | **—**         | ** ** | **—** | ** ** | **—**   |       | (6,059                       | )          | (6,059    | )          |
| **Net  income**                                             | ** ** | $                  | 51,402     |       | $          | 8,098        |       | $                            | 59,500     |      | $          | — |   | $ | 59,500 |   |
|                                                             |            |                    |            |            |            |              |            |                              |            |           |            |  |  |  |  |  |  |  |  |  |

 

16

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| ** **                                                  | ** ** | **Core**           | ** ** | **URO** | ** ** | **Subtotal** | ** ** | **Discontinued  Operations** | ** ** | **Total** | ** ** |
|-------------------------------------------------------------|------------|--------------------|------------|---------|------------|--------------|------------|------------------------------|------------|-----------|------------|
| ** **                                                  | ** ** | **(In thousands)** | ** ** |
| **Six  Months Ended June 30, 2004**                    |       |               |       |    |       |         |       |                         |       |      |       |
|                                                        |       |               |       |    |       |         |       |                         |       |      |       |
| **Revenue**                                                 |       |               |       |    |       |         |       |                         |       |      |       |
| Rental  revenue                                             |       | $                  | 155,176    |    | $          | —       |       | $                            | 155,176    |      | $          | (10,973 | ) | $ | 144,203 |   |
| Sales  revenue                                              |       | 41,564             |       | 13,348  |       | 54,912       |       | (9,922                       | )          | 44,990    |       |
| Management,  development and other fees                     |       | 1,526              |       | 931     |       | 2,457        |       | —                       |       | 2,457     |       |
|                                                        |       | 198,266            |       | 14,279  |       | 212,545      |       | (20,895                      | )          | 191,650   |       |
| **Costs  and expenses**                                     |       |               |       |    |       |         |       |                         |       |      |       |
| Property  operating costs                                   |       | (41,699            | )          | —  |       | (41,699      | )          | 4,767                        |       | (36,932   | )          |
| Cost of  sales                                              |       | (23,167            | )          | (12,705 | )          | (35,872      | )          | 7,908                        |       | (27,964   | )          |
| Selling,  general and administrative expenses               |       | (13,887            | )          | (11,675 | )          | (25,562      | )          | —                       |       | (25,562   | )          |
| Depreciation  and amortization                              |       | (36,734            | )          | (573    | )          | (37,307      | )          | 2,368                        |       | (34,939   | )          |
|                                                        |       | (115,487           | )          | (24,953 | )          | (140,440     | )          | 15,043                       |       | (125,397  | )          |
| **Operating  income (loss)**                                |       | 82,779             |       | (10,674 | )          | 72,105       |       | (5,852                       | )          | 66,253    |       |
| **Other  income**                                           |       |               |       |    |       |         |       |                         |       |      |       |
| Equity in  earnings of operating joint ventures, net        |       | 4,793              |       | —  |       | 4,793        |       | —                       |       | 4,793     |       |
| Equity in  earnings of development joint ventures, net      |       | —             |       | 4,618   |       | 4,618        |       | —                       |       | 4,618     |       |
| Gain on  non-strategic asset sales                          |       | —             |       | 16,441  |       | 16,441       |       | —                       |       | 16,441    |       |
| Interest  income                                            |       | 4,188              |       | 1,050   |       | 5,238        |       | —                       |       | 5,238     |       |
| Other                                                       |       | 266                |       | 991     |       | 1,257        |       | —                       |       | 1,257     |       |
|                                                        |       | 9,247              |       | 23,100  |       | 32,347       |       | —                       |       | 32,347    |       |
| **Other  expenses**                                         |       |               |       |    |       |         |       |                         |       |      |       |
| Interest  expense                                           |       | (32,445            | )          | —  |       | (32,445      | )          | 2,818                        |       | (29,627   | )          |
| REIT  transition costs                                      |       | —             |       | (420    | )          | (420         | )          | —                       |       | (420      | )          |
| Other                                                       |       | (749               | )          | (1,500  | )          | (2,249       | )          | —                       |       | (2,249    | )          |
|                                                        |       | (33,194            | )          | (1,920  | )          | (35,114      | )          | 2,818                        |       | (32,296   | )          |
| **Income  before income taxes and discontinued operations** |       | 58,832             |       | 10,506  |       | 69,338       |       | (3,034                       | )          | 66,304    |       |
| Income taxes                                                |       | (5,885             | )          | 3,972   |       | (1,913       | )          | —                       |       | (1,913    | )          |
| **Income  from continuing operations**                      |       | 52,947             |       | 14,478  |       | 67,425       |       | (3,034                       | )          | 64,391    |       |
| **Discontinued  operations, net of tax:**                   |       |               |       |    |       |         |       |                         |       |      |       |
| Gain from  disposal of discontinued operations              |       | —             |       | —  |       | —       |       | 2,014                        |       | 2,014     |       |
| Income from  discontinued operations                        |       | —             |       | —  |       | —       |       | 1,020                        |       | 1,020     |       |
| Net gain  from discontinued operations                      |       | —             |       | —  |       | —       |       | 3,034                        |       | 3,034     |       |
| **Net  income**                                             | ** ** | $                  | 52,947     |    | $          | 14,478       |       | $                            | 67,425     |      | $          | — |   | $ | 67,425 | ** ** |

 

17

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**Note 8. Commitments and Contingencies**

 

The Company has standbyletters of credit related to various development projects, various debt anddebt service guarantees, and capital contribution commitments related tocertain unconsolidated real estate joint ventures. These standby letters ofcredit, guarantees and capital contribution commitments as of June 30,2005, are summarized in the following categories (in thousands):

 
| **Off-balance  sheet liabilities:**         |   |   |   |
|---------------------------------------------|--------|--------|--------|
| Standby  letters of credit                  |   | $      | 52,689 |   |
| Debt service  guarantees                    |   | 213    |   |
| Contribution  requirements                  |   | 6,850  |   |
| Sub-total                                   |   | 59,752 |   |
| **Liabilities  included in balance sheet:** |   |   |   |
| Standby  letters of credit                  |   | 10,836 |   |
| Total                                       |   | $      | 70,588 |   |
|                                             |        |        |        |  |  |

 

Standby letters of creditconsist of two types: performance and financial. Performance standby letters ofcredit are to guarantee the construction of infrastructure and publicimprovements as a requirement of entitlement. Financial standby letters ofcredit are a form of credit enhancement commonly required in real estatedevelopment when bonds are issued to finance public improvements. As of June 30,2005, the Company has a total of $63.5 million in these standby letters ofcredit, which are scheduled to expire between August 2005 and June 2006.  Of this total, $52.7 million is off-balancesheet ($46.5 million in financial letters of credit and $6.2 million inperformance letters of credit).  Theremaining $10.8 million is related to obligations that are reflected in “Mortgageand other debt” in the Company’s Condensed Consolidated Balance Sheet and wereissued as additional security for liabilities already recorded on the balancesheet for separate accounting reasons (primarily assessment bond obligations ofassessment districts whose operating boards the Company controls). This isdifferent from the $52.7 million in letters of credit that are related tonon-balance sheet items. When the assessment district bonds are consolidated,the full issuance proceeds amount is consolidated in “Mortgage and other debt”with a corresponding asset in “Other assets and deferred charges, net.” Anexample of the type of event that would require the Company to perform underthe performance standby letters of credit would be the failure of the Companyto construct or complete the required improvements. An example of the type of eventthat would require the Company to perform under the financial standby lettersof credit would be a debt service shortfall in the municipal district thatissued the municipal bonds. At June 30, 2005, the Company has not beenrequired to satisfy any of these standby letters of credit.

 

The Company has made debtservice guarantees for one of its unconsolidated joint ventures. At June 30,2005, based on the joint venture’s outstanding balance, these debt guaranteestotaled $0.2 million and are scheduled to expire between October 2005 and December 2005.Debt service guarantees are typical business arrangements commonly required ofreal estate developers. An example of the types of event that would require theCompany to provide a cash payment pursuant to a guarantee include a loandefault, which would result from failure of the primary borrower to service itsdebt when due, or non-compliance of the primary borrower with financialcovenants or inadequacy of asset collateral. At June 30, 2005, the Companyhas not been required to satisfy any amounts under these debt serviceguarantees.

 

18

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The Company is required tomake additional capital contributions to four of its unconsolidated jointventures if additional capital contributions are necessary to fund developmentcosts or operating shortfalls. The Company agreed with two unconsolidated jointventures, Serrano Associates, LLC and SAMS Venture, LLC, to make additionalcontributions should there be insufficient funds to meet its current orprojected financial requirements. As of June 30, 2005, the Companycumulatively contributed $20.0 million to Serrano Associates, LLC as additionalcontributions and $4.0 million as additional contributions to SAMS Venture,LLC. The Company is also required to make additional capital contributions toanother two of its unconsolidated joint ventures should additional capitalcontributions be necessary (*see*chart below). As of June 30, 2005, the Company does not expect to fund anysignificant capital contributions beyond the maximum capital requirements.

 
| ** **               | ** ** | **Contribution  Committed** | ** ** | **RemainingContributionCommitment** | ** ** |
|--------------------------|------------|-----------------------------|------------|-------------------------------------|------------|
| ** **               | ** ** | **(In thousands)**          | ** ** |
| Talega  Village, LLC (1) |       | $                           | 14,000     |                                | $          | 4,570 |   |
| Parkway  Company, LLC    |       | 38,000                      |       | 2,280                               |       |
|                     |       | $                           | 52,000     |                                | $          | 6,850 |   |

 

----

(1)     Talega Village, LLC has substantially wound upoperations and the Company does not expect to make any future capitalcontributions.

 

Generally, any funding ofoff-balance sheet guarantees would result in the increase of Catellus’ownership interest in a project or entity similar to the treatment of aunilateral additional capital contribution to an investee.

 

In addition to thecontingent liabilities summarized in the table above, the Company also has thefollowing contingencies:

 

Prior to the November 2004sales of a significant portion of the Company’s remaining urban and residentialdevelopment assets to FOCIL Holdings LLC (“FOCIL”), an affiliate of FarallonCapital Management, L.L.C. (*see*Note12), the Company had already negotiated on certain land asset sales and agreedto provide acquisition financings, up to $164 million, to these third partypurchasers.  A substantial portion of themoney required to fund the $164 million financing will come from the paydownsunder the loans to FOCIL as part of the FOCIL transaction in November 2004.  These land parcels were ultimately includedas part of the assets sold to FOCIL. Therefore, as FOCIL eventually finalizesthe sale of these land parcels, the Company will provide the financing to thesethird party purchasers, as previously agreed. As of June 30, 2005, theCompany has financed $26.2 million on one of these sales.  During the second quarter of 2005, twoadditional sales were closed, however, approximately $23 million of theagreed-upon acquisition financings was not required. Therefore, subsequent tothe end of this quarter, the remaining agreed-upon acquisition financing isapproximately $115 million.

 

As of June 30, 2005,$30.0 million of Community Facility District bonds were sold to finance publicinfrastructure improvements at a Company project. The Company is required tosatisfy any shortfall in annual debt service obligation for these bonds if taxrevenues generated by the project is insufficient. As of June 30, 2005,the Company does not expect to be required to satisfy any shortfall in annualdebt service obligation for these bonds other than through its payment ofnormal project and special district taxes. Subsequently, on July 21, 2005,an additional $38.0 million of Community Facility District bonds were sold.

 

The Company is a party to anumber of legal actions arising in the ordinary course of business. The Companycannot predict with certainty the final outcome of these proceedings.Considering current insurance coverages and the substantial legal defensesavailable, however, management believes that none of these actions, whenfinally resolved, will have a material adverse effect on the consolidatedfinancial conditions, results of operations, or cash flows of the Company.Where appropriate, the Company has established reserves for potentialliabilities related to legal actions or threatened legal actions. Thesereserves are necessarily based on estimates and probabilities of the occurrenceof events and therefore are subject to revision from time to time.

 

Inherent in the operationsof the real estate business is the possibility that environmental liability mayarise from the current or past ownership, or current or past operation, of realproperties. The Company may be required in the future to take action to corrector reduce the environmental effects of prior disposal or release of hazardoussubstances by third parties, the Company, or its corporate predecessors. Futureenvironmental costs are difficult to estimate because of such factors as theunknown magnitude of possible contamination, the unknown timing and extent ofthe corrective actions that may be required, the determination of the Company’spotential liability in proportion to that of other potentially responsibleparties, and the extent to which such costs are recoverable from insurance.Also, the Company does not generally have access to properties sold by it inthe past.

 

19

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At June 30, 2005,management estimates that future costs for remediation of environmentalcontamination on operating properties and properties previously soldapproximate $2.3 million, and has provided a reserve for that amount. It isanticipated that such costs will be incurred over the next several years.Management also estimates approximately $8.6 million of similar costs relatingto the Company’s properties to be developed or sold. In addition, the Companyhas approximately $12.0 million in escrow for environmental work related to aland acquisition (*see* Note 3).The Company may incur additional costs related to management of excesscontaminated soil from our projects; however, the necessity of this activitydepends on the type of future development activities, and, therefore, therelated costs are not currently determinable. These costs will be capitalizedas components of development costs when incurred, which is anticipated to beover a period of approximately twenty years, or will be deferred and charged tocost of sales when the properties are sold. Environmental costs capitalizedduring the six months ended June 30, 2005 and 2004 totaled $0.2 millionand $1.9 million, respectively. The Company’s estimates were developed based onreviews that took place over several years based upon then-prevailing law andidentified site conditions. Because of the breadth of its portfolio, and pastsales, the Company is unable to review each property extensively on a regularbasis. Such estimates are not precise and are always subject to theavailability of further information about the prevailing conditions at thesite, the future requirements of regulatory agencies, and the availability andability of other parties to pay some or all of such costs.

 

The Company owns an interest in a limited liability company of aresidential project near Sacramento, California.****** At June 30, 2005, the book value of ourinvestment is approximately $17.6 million and the terms of the investmentrequire additional contributions from the members should there be insufficientoperating funds (*see* Liquidityand Capital Resources section). The project is located in a county known tocontain naturally occurring asbestos in native rock material.  The EPA has conducted studies for potentialrisks associated with asbestos exposure from the native rock materials atvarious locations, including at a school site that is adjacent to the Company’sproject, and the EPA has concluded that its initial exposure study raisesfurther concerns. At this time the Company does not know if the results of thestudies will have any adverse impact on the project, and the ultimate impact toits financial statements is undeterminable.

 

**Note 9. Related Party Transactions**

 

The entities below areconsidered related parties because the listed transactions are with entities inwhich the Company has an ownership interest. There are no affiliated personsinvolved with these entities.

 

The Company providesdevelopment and management services and loan guarantees to variousunconsolidated joint venture investments. Fees earned were $0.2 million and$0.4 million for the three and six months ended June 30, 2005,respectively, primarily from SAMS Venture, LLC. Fees earned were $0.3 millionand $1.2 million for the three and six months ended June 30, 2004,respectively, primarily from Third and King Investors, LLC, with the remainderprimarily from SAMS Venture, LLC. Deferred fees of $1.5 million primarily fromSAMS Venture, LLC, Serrano Associates, LLC and Bergstrom Partners, L.P. at June 30,2005, will be earned as completed projects are sold or the venture is sold orliquidated. In 2004, the Company sold its investment in Third and KingInvestors, LLC.

 

In 2001, the Company enteredinto a 99-year ground lease with one of its unconsolidated joint ventureinvestments, Third and King Investors, LLC. Rent and reimbursable payments of$1.3 million and $2.5 million were received and recognized as rental incomeduring the three and six months ended June 30, 2004, respectively. Thisjoint venture investment was sold in 2004.

 

The Company has a $4.6million collateralized 9.0% note receivable from an unconsolidated jointventure, East Baybridge Partners, LP, for project costs plus accrued interest.The note is collateralized by property owned by the joint venture and maturesin October 2028. The Company has entered into various lease agreementswith this unconsolidated joint venture. As lessee, rent expense was $34,000 foreach of the three-month periods ended June 30, 2005 and 2004, and $68,000for each of the six-month periods ended June 30, 2005 and 2004. This leasewill expire in November 2011. As lessor, the Company entered into a groundlease, which will expire in August 2054. The Company earned rental incomeof $0.1 million for each of the three-month periods ended June 30, 2005and 2004, $0.2 million for each of the six-month periods ended June 30,2005 and 2004 and has recorded a $2.8 million receivable and a $1.3 millionreserve associated with this lease. The venture’s current projection reflectsapproximately $0.2 million available funds, per year, to pay down thisreceivable.

 

In January 2004, theCompany sold its 45% investment interest in Colorado International Center, anunconsolidated joint venture, for its capital investment balance of $0.3million to an entity whose principal was a former Company employee.

 

20

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**Note 10. Discontinued Operations**

 

In general, sales of rentalproperty are classified as discontinued operations. Therefore, income or lossattributed to the operations and gain or loss on rental property sold or heldfor sale is presented in the statement of operations as discontinuedoperations, net of applicable income tax. Prior period statements of operationshave been reclassified to reflect as discontinued operations the income or lossrelated to rental properties that were sold or held for sale and presented asdiscontinued operations during the period up to June 30, 2005.Additionally, all periods presented will likely require furtherreclassification in future periods as additional sales of rental propertiesoccur.

 

Discontinued operationsactivities for the three and six months ended June 30, 2005 and 2004, aresummarized as follows:

 
| ** **                                      | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                      | ** ** | **2005**                             | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                      | ** ** | **(In thousands)**                   | ** ** |
| Gain from  disposal of discontinued operations  |       |                                 |       |                               |       |   |   |   |   |
| Sales  revenue                                  |       | $                                    | —     |                               | $          | 6,372 |   | $ | 2,886 |   | $ | 9,922 |   |
| Cost of  sales                                  |       | (17                                  | )          | (5,974                             | )          | (2,170 | ) | (7,908 | ) |
|                                            |       | (17                                  | )          | 398                                |       | 716 |   | 2,014 |   |
| Income tax  expense                             |       | —                               |       | —                             |       | — |   | — |   |
| Net (loss)  gain                                |       | $                                    | (17        | )                                  | $          | 398 |   | $ | 716 |   | $ | 2,014 |   |
| Rental  Revenue                                 |       | $                                    | 3,989      |                               | $          | 5,583 |   | $ | 8,190 |   | $ | 10,973 |   |
| (Loss)  income from discontinued operations (1) |       | $                                    | (6,896     | )                                  | $          | 829 |   | $ | (6,775 | ) | $ | 1,020 |   |
| Income tax  expense                             |       | —                               |       | —                             |       | — |   | — |   |
| Net (loss)  income                              |       | $                                    | (6,896     | )                                  | $          | 829 |   | $ | (6,775 | ) | $ | 1,020 |   |

 

----

(1)    Animpairment charge of $6.8 million was recognized in the second quarter of 2005for an office building which is under contract to be sold.

 

Asset and liability balancesof rental properties under contract to be sold at June 30, 2005 and December 31,2004, consist of the following:

 
| ** **                | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|---------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                | ** ** | **(In thousands)**      | ** ** |
|                      |       |                    |       |                        |       |
| **Assets**                |       |                    |       |                        |       |
| Properties                |       | $                       | 94,908     |                        | $          | 10,949 |   |
| Accumulated  depreciation |       | (43,869                 | )          | (894                        | )          |
| Net                       |       | 51,039                  |       | 10,055                      |       |
| Other assets              |       | 4,445                   |       | 281                         |       |
| Total assets              |       | 55,484                  |       | 10,336                      |       |
|                      |       |                    |       |                        |       |
| **Liabilities**           |       |                    |       |                        |       |
| Mortgage and  other debt  |       | (80,052                 | )          | (—                     | )          |
| Payable                   |       | (1,214                  | )          | (27                         | )          |
| Other  liabilities        |       | (625                    | )          | (61                         | )          |
| Total  liabilities        |       | (81,891                 | )          | (88                         | )          |
| Net  (liabilities) assets |       | $                       | (26,407    | )                           | $          | 10,248 |   |
|                           |            |                         |            |                             |            |  |  |  |  |

 

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**Note 11. REIT Conversion**

 

On January 5, 2004, theCompany announced that it had completed the restructuring of its operations toqualify as a REIT and began operating as a REIT as of January 1, 2004. TheREIT conversion had the following effects on the financial statements as of orfor the three months ended June 30, 2005 and 2004:

 

•                      onMay 4, 2005, the Company’s Board declared a regular cash dividend for thequarter ended June 30, 2005, of $0.27 per share of common stock, or $28.0million, that was paid on July 15, 2005 to stockholders of record at theclose of business on June 28, 2005. Subsequently, on July 27, 2005,the Company’s Board declared a regular cash dividend for the quarter ending September 30,2005, of $0.27 per share of common stock payable on August 31, 2005, tostockholders of record at the close of business on August 16, 2005. In December 2004,the Company’s Board declared a regular cash dividend for the quarter ending December 31,2004, of $0.27 per share of common stock, or $27.9 million, and a specialdividend of $0.45 per share of common stock, or $46.5 million, that were paidon January 18, 2005. Cash dividends of $0.27 per common share for thefourth quarter 2003 and the first, second, and third quarters of 2004 and firstquarter of 2005 were paid on January 15, 2004, April 15, 2004, July 15,2004, October 15, 2004, and April 15, 2005; respectively. The actualamount of the dividends for subsequent quarters will be as determined anddeclared by the Company’s Board of Directors and will depend on the Company’sfinancial condition, earnings, and other factors, many of which are beyond theCompany’s control;

 

•                      conversionand related restructuring costs of $0.2 million and $0.4 million were paid tothird parties for the three and six months ended June 30, 2004,respectively;

 

•                      one-timecosts associated with the stock option exchange offer approximated $32 million,which includes the costs for the restricted stock and restricted stock units of$25.6 million (such cost will be amortized over three years until December 31,2006), and compensation expenses of $6.6 million as a result of the requiredvariable accounting treatment for the remaining outstanding options upon the expirationof the exchange offer program on October 29, 2003 (such expense will beamortized over the remaining vesting period of the options from November 2003).Amortization costs, for the three months ended June 30, 2005 and 2004associated with the 2003 stock option exchange offer, which includes the costsfor the restricted stock and restricted stock units, were $1.9 million and $2.5million, respectively, and compensation expenses of $0.3 million and $0.5million, respectively, were recognized as a result of the required variableaccounting treatment for options. Amortization costs, for the six months ended June 30, 2005 and 2004associated with the 2003 stock option exchange offer, which includes the costsfor the restricted stock and restricted stock units, were $4.1 million and $5.0million, respectively, and compensation (benefit) expense of $(0.03) millionand $1.7 million, respectively, was recognized as a result for the requiredvariable accounting treatment for options.

 

**Note 12. Sale of Non-Core Assets**

 

In November 2004, theCompany sold a significant portion of its remaining urban and residentialdevelopment assets, with a book value of $295.9 million, to FOCIL for $343.3million.  A sales gain of $4.6 millionhas been deferred at June 30, 2005 until certain future requirements aremet. The purchase price consisted of $68.7 million in cash and $274.6 millionin debt financed by the Company that is collateralized by the assets sold.  The financings provided to FOCIL and theadditional agreed-upon financings as disclosed at Note 8 were considered indetermining initial and continuing involvement for purposes of ensuring theappropriate revenue recognition method. FOCIL has engaged the Company to act asdevelopment manager for the assets.  Forthe three months ended June 30, 2005, the Company has earned $6.3 millionin interest and $3.0 million in development and other fees.  For the six months ended June 30, 2005,the Company has earned $13.0 million in interest and $9.6 million indevelopment and other fees, and at June 30, 2005 has deferred therecognition of an additional $10.0 million of development fees until certainfuture requirements are met.

 

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**Note 13. Merger withProLogis**

 

 On June 6,2005, the Company and ProLogis announced that their boards have unanimouslyapproved a definitive merger agreement under which ProLogis will acquire all ofthe outstanding common stock of Catellus for a total consideration ofapproximately $5.6 billion, including assumed liabilities and transactioncosts.  Under the terms of the mergeragreement, each Catellus stockholder has the right to elect to receive either0.822 of a ProLogis common share or $33.81 in cash, without interest, for eachshare of the Company’s common stock that the stockholder owns immediately priorto the effective time of the merger. Catellus stockholder elections will be reallocated and prorated to fixthe aggregate cash consideration to be paid by ProLogis pursuant to the mergeragreement at $1.255 billion, which means that the total merger consideration(regardless of what form of consideration Catellus stockholders may elect toreceive) will consist of about 65% ProLogis common shares and about 35%cash.  On July 13, 2005, ProLogisfiled with the Securities and Exchange Commission a registration statement on Form S-4,which contains a preliminary joint proxy statement/prospectus. The preliminaryjoint proxy statement/prospectus provides important information, includingdetailed risk factors, regarding the proposed merger.  There are a number of conditions that mustoccur for the merger to close. These conditions include the approval of themerger agreement by the stockholders of both Catellus and ProLogis. It isanticipated that the merger will be completed in September 2005.

 

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**Item2.    Management’s Discussion andAnalysis of Financial Condition and Results of Operations**

 

**The Company**

 

Catellus DevelopmentCorporation is a publicly traded real estate development company that beganoperating as a REIT effective January 1, 2004. We operated as aC-corporation through December 31, 2003. We focus on managing, acquiring,and developing predominantly industrial rental property in many of the country’smajor distribution centers and transportation corridors. Catellus’ principalobjective is sustainable, long-term growth in earnings, which we seek toachieve by applying our strategic resources: a lower-risk/higher-return rentalportfolio, a focus on expanding that portfolio through development, and thedeployment of our proven land development skills to select opportunities thatmay not always be industrial, especially projects that may not requiresignificant capital investments on our part.

 

Catellus was originallyformed in 1984 to conduct the non-railroad real estate activities of the SantaFe Pacific Corporation and was spun off to stockholders effective in 1990. Ourrailroad heritage gave us a diverse base of developable properties located neartransportation corridors in major western United States markets. This land hasproven suitable for the development of a variety of product types, includingindustrial, retail, office, and residential. Over time, we have expanded ourbusiness by acquiring land suitable for primarily industrial development inmany of the same suburban locations where we have an established presence aswell as additional locations including recent expansion into northern NewJersey.

 

Our rental portfolioprovides a relatively consistent source of earnings and our developmentactivities provide cash flow through sales of land or the conversion of ourdevelopable land to property that is either added to our portfolio or sold totenants, developers, investors or other interested parties. We invest in newland to ensure our potential for growth. As of June 30, 2005 we owned 41.1million square feet of commercial rental properties, of which approximately 90%is industrial space. Our industrial rental portfolio is geographically diverse,located in major transportation corridors and distribution centers such assouthern California, Chicago, Dallas, and Atlanta. The majority of our rentalportfolio is of newer construction and leased to diverse, high quality tenantsthrough long-term leases with staggered lease expirations.

 

On June 6,2005, Catellus and ProLogis announced that their boards had unanimouslyapproved a definitive merger agreement under which ProLogis will acquire all ofour outstanding common stock for a total consideration of approximately $5.6billion, including assumed liabilities and transaction costs.  Under the terms of the merger agreement, eachof our stockholders has the right to elect to receive either 0.822 of aProLogis common share or $33.81 in cash, without interest, for each share ofour common stock that the stockholder owns immediately prior to the effectivetime of the merger. Catellus stockholder elections will be reallocated andprorated to fix the aggregate cash consideration to be paid by ProLogis pursuantto the merger agreement at $1.255 billion, which means that the total mergerconsideration (regardless of what form of consideration Catellus stockholdersmay elect to receive) will consist of about 65% ProLogis common shares andabout 35% cash. On July 13, 2005, ProLogis filed with theSecurities and Exchange Commission a registration statement on Form S-4,which contains a preliminary joint proxy statement/prospectus. The preliminaryjoint proxy statement/prospectus provides important information, includingdetailed risk factors, regarding the proposed merger.  There are a number of conditions that mustoccur for the merger to close. These conditions include the approval of themerger agreement by the stockholders of both Catellus and ProLogis.  It is anticipated that the merger willbe completed in September 2005.

 

**Critical Accounting Policies**

 

Our discussion and analysisof financial condition and results of operations is based on our CondensedConsolidated Financial Statements, which have been prepared in accordance withaccounting principles generally accepted in the United States. The preparationof our Condensed Consolidated Financial Statements requires us to makeestimates and judgments that affect the reported amounts of assets,liabilities, revenues and expenses, and related disclosure of contingent assetsand liabilities. On an on-going basis, we evaluate our estimates, includingthose related to revenue recognition, impairment of real estate assets,capitalization of costs, including job costing, allowances for doubtfulaccounts, environmental and legal reserves, stock-based compensation plans, andincome taxes. We base our estimates on historical experience and various otherassumptions that we believe to be reasonable under the circumstances, theresults of which form the basis for making judgments about the carrying valuesof assets and liabilities that are not readily apparent from other sources.Actual results may differ from these estimates under different assumptions orconditions.

 

We believe the followingcritical accounting policies reflect our more significant judgments andestimates used in the preparation of the Condensed Consolidated FinancialStatements.

 

*Revenue and profit recognition*

 

Our revenue is primarilyderived from three sources: rental revenue from our rental portfolio,management, development and other fees, and property sales.

 

Rental revenue is recognizedwhen due from tenants. Revenue from leases with rent concessions or fixedescalations is recognized on a straight-line basis over the initial term of therelated lease. The financial terms of leases are contractually defined. Rentalrevenue is not accrued when a tenant vacates the premises and ceases to makerent payments or files for bankruptcy. We have various retail and ground leases that provide for rentalrevenues which are contingent upon the lessee’s operations. Contingent rentalincome on these leases is recognized when the specified target is achieved.

 

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Revenue from sales ofproperties is recognized using the accrual method. If a sale does not qualifyfor the accrual method of recognition, other deferral methods are used asappropriate including the percentage-of-completion method. In certaininstances, when we receive an inadequate cash down payment and take apromissory note for the balance of the sale price, the sale is deferred untilsuch time as sufficient cash is received to meet minimum down paymentrequirements. Specific identification and relative sales value methods are alsoused to determine the cost of sales. A change in circumstances that causes theestimate of future costs, such as carrying costs and construction costs, toincrease or decrease significantly would affect the gain or loss recognized onfuture sales.

 

Management, development, andother fees are recognized as earned. Fees earned from our unconsolidated jointventures are recognized to the extent of outside ownership with our sharedeferred. These deferred fees will be recognized when the assets or venture iseither sold or liquidated, as appropriate.

 

We mayreceive fees from tenants as consideration for early termination of their leaseagreement. These lease termination fees are amortized over the revisedremaining lease term, if any. In conjunction with the receipt of leasetermination fees, we perform a review of all lease related assets andliabilities to determine if impairment has occurred and whether or not theamortization period continues to be appropriate.

 

*Impairment of real estate assets*

 

We assess the impairment ofa real estate asset when events or changes in circumstances indicate that thenet book value may not be recoverable, as well as on a quarterly basis.Indicators we consider important which could trigger an impairment reviewinclude the following:

 

•                      asignificant negative industry or economic trend;

 

•                      asignificant underperformance relative to historical or projected futureoperating results;

 

•                      asignificant change in the manner in which an asset is used; and

 

•                      anaccumulation of costs significantly in excess of the amount originally expectedto construct an asset.

 

Real estate is stated atcost and impairments are evaluated using the methodology described as follows: (a) foroperating properties and properties held for development, a write-down toestimated fair value is recognized when a property’s estimated undiscountedfuture cash flow based on the projected holding period, is less than its netbook value; and (b) for properties held for sale, a write-down to estimatedfair value is recorded when we determine that the net book value exceeds theestimated selling price, less cost to sell. Fair value is determined by acombination of expected cash flow and recent comparable sales and theseevaluations are made on a property-by-property basis. When we determine thatthe net book value of an asset may not be recoverable based upon the estimatedundiscounted cash flow, we measure any impairment write-down based on projecteddiscounted cash flows, using an estimated market discount rate; thesediscounted cash flows are also probability weighted. When performing theimpairment review, we consider capitalized interest and other expenses as costsof development in cost projections; value from comparable property sales will alsobe considered. The evaluation of future cash flows, discount rates, and fairvalue of individual properties requires significant judgment and assumptions,including estimates of market value, lease terms, development absorption,development costs, lease up costs, and financings. Significant adverse changesin circumstances affecting these judgments and assumptions in future periodscould cause a significant impairment adjustment to be recorded.

 

*Capitalization of costs*

 

We capitalize directconstruction and development costs, including predevelopment costs, propertytaxes, insurance, and certain indirect project costs, including a portion ofour general and administrative costs that are associated with the acquisition,development, or construction of a project. General and administrative costs arecapitalized based on projected activities on actual projects. Interest iscapitalized in accordance with FAS 34 (i.e., interest costs incurred duringconstruction/development periods to get the assets ready for their intendeduse).  Costs previously capitalizedrelated to any abandoned sales or acquisition opportunities are written off.Should development activity decrease, a portion of interest, property taxes,insurance, and certain general and administrative costs would no longer beeligible for capitalization and would be expensed as incurred.

 

*Allowance for doubtful accounts*

 

We make estimates withrespect to the collectability of our receivables and provide for doubtfulaccounts based on several factors, including our estimate of collectability andthe age of the outstanding balances. Our estimate of collectability is based onour contacts with the debtors, collection agencies, our knowledge of thedebtors’ credit and financial condition, debtors’ payment terms, and currenteconomic trends. If a debtor becomes insolvent or files for bankruptcy, weprovide an allowance for the entire outstanding amount of the debtors’receivable. Significant judgments and estimates must be made and used inconnection with establishing allowances in any accounting period. Materialdifferences may result in the amount and timing of our allowances for anyperiod if adverse general economic conditions cause widespread financialdifficulties among our tenants.

 

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*Environmental and legal reserves*

 

We incur ongoingenvironmental remediation costs, including cleanup costs, consulting fees forenvironmental studies and investigations, monitoring costs, and legal costsrelating to cleanup, litigation defense, and the pursuit of responsible thirdparties. We maintain a reserve for estimated costs of environmental remediationto be incurred in connection with operating properties and propertiespreviously sold. These reserves, when established, are expensed. Costs relatingto undeveloped land are capitalized as part of development costs, and costsincurred for properties to be sold are deferred and charged to cost of saleswhen the properties are sold. It is anticipated that these costs may be incurredover an extended period. Our estimates are developed based on reviews that tookplace over many years based upon then-prevailing law and identified siteconditions. Because of the breadth of our portfolio, and past sales, we areunable to review each property extensively on a regular basis. Such estimatesare not precise and are always subject to the availability of furtherinformation about the prevailing conditions at the site, the futurerequirements of regulatory agencies, and the availability and ability of otherparties to pay some or all of such costs. Should a previously undetected,substantial environmental hazard be found on our properties, significantliquidity could be consumed by the resulting cleanup requirements, and amaterial expense may be recorded.

 

We are a party to a numberof legal actions arising in the ordinary course of business. We cannot predictwith certainty the final outcome of the proceedings. Where appropriate, we haveestablished reserves for potential liabilities related to legal actions orthreatened legal actions. Environmental and legal reserves are establishedbased on estimates and probabilities of the occurrence of events and thereforeare subject to revision from time to time. Should the circumstances affecting theseestimates change significantly, a material expense may be recognized.

 

*Stock-Based Compensation Plans*

 

During 2004, two performance-based executive awardplans were established under our 2003 Performance Award Plan: the 2004Transition Incentive Plan (“TIP”) and the 2004 Long-Term Incentive Plan (“LTIP”).Awards under the TIP were granted in 2004 and LTIP were granted in 2004 and2005. The awards granted are non-voting units of measurement (“PerformanceUnits”) that are deemed to represent one share of our common stock. PerformanceUnits are entitled to dividend equivalents representing dividends on an equalnumber of shares of our common stock. Dividend equivalents are credited toparticipants’ accounts as additional Performance Units. The initial performanceperiod under the LTIP and the performance period under the TIP are from January 1,2004 through December 31, 2006. Subsequent awards under the LTIP weregranted in 2005 with a performance period from January 1, 2005 to December 31,2007. The earliest date TIP awards were eligible to begin vesting was December 31,2004 if at least 50% of defined performance targets were achieved by that dateand certain time vesting requirements as to certain participants were met. Ifany defined performance targets are not 100% achieved by December 31,2006, the remaining unvested performance units will be forfeited. TIP awardsare payable in our common stock. The initial and subsequent LTIP awards vest atDecember 31, 2006 and 2007, respectively, if our total stockholder return,relative to the total stockholder returns of a certain group of peer companies,meets certain performance targets. LTIP awards are payable 50% in our commonstock and 50% in cash.

 

At June 30, 2005, 312,278 Performance Units,representing the aggregate number initially awarded under both plans, lessvested TIP Performance Units distributed in common stock, plus additionalPerformance Units from dividend equivalents on previously existing PerformanceUnits, have been credited to participants’ accounts, subject to the vestingrequirements discussed in the preceding paragraph. As required by APB 25, wehave recognized $1.2 million and $1.3 million as compensation expense duringthe three months ended June 30, 2005 and 2004, respectively, and $2.1million and $2.6 million during the six months ended June 30, 2005 and2004, respectively, with the corresponding liability recorded in “Accountspayable and accrued expenses” in the accompanying Condensed ConsolidatedBalance Sheet. For purposes of recognizing compensation expense, TIPperformance is based on our current estimate of the timing for achievingperformance targets, and LTIP performance is measured on the basis of actualresults as of June 30, 2005. We estimate that as of June 30, 2005,95.7% of the TIP performance targets have been achieved. Actual performanceunder the LTIP is not determinable until the performance periods for theinitial and subsequent awards end on December 31, 2006 and 2007,respectively. Certain TIP performance targets were 100% achieved as of December 31,2004, and therefore were eligible for 100% vesting.  However, for purposes of vesting under theTIP, since at least 50% but less than 100% of the other defined performancetargets were met as of December 31, 2004, the Compensation and BenefitsCommittee could only certify the achievement of 50% of such targets as of December 31,2004. In February 2005 and May 2005, the Compensation and BenefitsCommittee certified the achievement of the defined performance targets to an extentwhich resulted in the performance vesting of 85% of all TIP Performance Units,subject to the time vesting requirements as to certain participants, asdiscussed in the preceding paragraph.

 

During 2005, we granted to certain officersan aggregate of 169,845 shares of restricted stock with a fair market value of$4.8 million as of the grant date. Shares of restricted stock are entitled todividends.

 

During 2005, we granted to non-employeedirectors an aggregate of 14,744 shares of Director Restricted Stock Units witha fair market value of $0.4 million as of the grant date. Director RestrictedStock Units are entitled to dividend equivalents.

 

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We expense dividends paid on unvestedrestricted stock and dividend equivalents paid on restricted stock units,Director Restricted Stock Units, and Director Stock Units.  For the three months ended June 30, 2005and 2004, such dividends and dividend equivalents paid were $0.4 million and$0.3 million, respectively, and $0.9 million and $0.7 million for the sixmonths ended June 30, 2005 and 2004, respectively (*see*Note 2).

 

If the proposed merger under the definitive mergeragreement between the Company and ProLogis (as announced on June 6, 2005)is completed, all outstanding vested and unvested stock options will becanceled as of the effective time of the merger.  Each holder of a canceled stock option willreceive $33.81 for each share of Catellus common stock subject to the canceledoption, less the exercise price and any applicable withholding taxes, payablein the form of 65% ProLogis common shares and 35% cash.  In addition, if the merger is completed, theoutstanding TIP and LTIP Performance Units, restricted stock units, DirectorRestricted Stock Units and Director Stock Units will be canceled as of theeffective time of the merger.  The holderof each such canceled unit will receive $33.81 for each share subject to thecanceled unit, less any applicable withholding taxes, payable in the form of65% ProLogis common shares and 35% cash.

 

*Income taxes*

 

As part of the process ofpreparing our Condensed Consolidated Financial Statements, significantmanagement judgment is required to estimate our income taxes. Our estimates arebased on interpretation of tax laws. We estimate our actual current tax due andassess temporary differences resulting from differing treatment of items forbook and tax purposes. The temporary differences result in deferred tax assetsand liabilities, which are included within our Condensed Consolidated BalanceSheet. Where we have taken a deduction for a non-routine transaction in whichthe tax impact is uncertain, no financial statement benefit is taken until theimpact is certain. Adjustments may be required by a change in assessment of ourdeferred tax assets and liabilities, changes in assessments of the recognitionof tax benefits for certain non routine transactions changes due to auditadjustments by federal and state tax authorities, our inability to qualify as aREIT, the potential for built-in-gain recognition, changes in the assessment ofproperties to be contributed to TRS, and changes in tax laws. Adjustmentsrequired in any given period are included within the tax provision in thestatement of operations and/or balance sheet. Any applicable interest chargesassociated with an audit settlement would be recorded as interest expense.These adjustments could materially impact our statement of operations andliquidity.

 

**General**

 

**Business Segment Descriptions:**

 

Our reportable segments arebased on our method of internal reporting, which disaggregates our businessbetween long-term operations and those which we intend to transition out ofover time and before the adjustments for discontinued operations. We have tworeportable segments: (1) Core Segment and (2) Urban, Residential andOther Segment, or URO. Core segment includes (a) the management andleasing of our rental portfolio, (b) commercial development activities,which focuses on acquiring and developing suburban commercial business parksfor our own rental portfolio, and selling land and/or buildings that we havedeveloped to users and other parties, and (c) select land developmentopportunities that may not always be industrial, especially projects that maynot require significant capital investment on our part where we can utilize ourland development skills. URO includes the remaining residential projects, urbandevelopment activities and desert land sales, of which a majority portion wassold during 2004, and REIT transition costs, including the matters prior tobecoming a REIT.

 

Consistentwith our previously announced strategy of monetizing our Non-Core assets, in November of2004, we sold substantially all of the remaining land and entitlements atMission Bay (excluding a 9.65-acre parcel currently subject to a lease optionagreement with the University of California); West Bluffs, a 114-unitresidential development in Westchester - Playa del Rey, California; Bayport, a 485-unitresidential development in Alameda, California; and the remaining land at SantaFe Depot, in San Diego, California to FOCIL. We plan to transition out of the URO Segment over time as the remainingassets are dissolved and the URO Segment will eventually be eliminated.

 

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**Property Portfolio**

 

**Rental Portfolio**

 

Our rental portfolio iscomprised of commercial rental property, ground leases and other properties,and interests in several joint ventures. We own 41.1 million square feet ofcommercial rental property of which 89.7% is industrial, 7.6% is office, and2.7% is retail.

 

**Rental portfolio by state:**

 

**Square Feet by State—As of June 30,2005**

(in thousands, except for %’s)

 
| ** **           | ** ** | **Industrial**   | ** ** | **Office**      | ** ** | **Retail**       | ** ** | **Total**       | ** ** |
|----------------------|------------|------------------|------------|-----------------|------------|------------------|------------|-----------------|------------|
| ** **           | ** ** | **Square  Feet** | ** ** | **% of  Total** | ** ** | **Square  Feet** | ** ** | **% of  Total** | ** ** | **Square  Feet** | ** ** | **% of  Total** | ** ** | **Square  Feet** | ** ** | **% of  Total** | ** ** |
| ** **           | ** ** | ** **       | ** ** | ** **      | ** ** | ** **       | ** ** | ** **      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Southern  California |       | 14,214           |       | 34.6            | %          | 524              |       | 1.3             | %          | 216 |   | 0.5 | % | 14,954 |   | 36.4 | % |
| Illinois             |       | 6,385            |       | 15.6            | %          | 594              |       | 1.4             | %          | — |   | 0.0 | % | 6,979 |   | 17.0 | % |
| Northern  California |       | 5,023            |       | 12.2            | %          | 807              |       | 2.0             | %          | 689 |   | 1.7 | % | 6,519 |   | 15.9 | % |
| Texas                |       | 3,401            |       | 8.3             | %          | 871              |       | 2.1             | %          | — |   | 0.0 | % | 4,272 |   | 10.4 | % |
| Colorado             |       | 2,701            |       | 6.6             | %          | 273              |       | 0.7             | %          | 100 |   | 0.2 | % | 3,074 |   | 7.5 | % |
| Arizona              |       | 1,123            |       | 2.7             | %          | —           |       | 0.0             | %          | 75 |   | 0.2 | % | 1,198 |   | 2.9 | % |
| Georgia              |       | 980              |       | 2.4             | %          | —           |       | 0.0             | %          | — |   | 0.0 | % | 980 |   | 2.4 | % |
| Ohio                 |       | 966              |       | 2.3             | %          | —           |       | 0.0             | %          | — |   | 0.0 | % | 966 |   | 2.3 | % |
| Oregon               |       | 545              |       | 1.3             | %          | 57               |       | 0.1             | %          | 37 |   | 0.1 | % | 639 |   | 1.5 | % |
| Kentucky             |       | 549              |       | 1.3             | %          | —           |       | 0.0             | %          | — |   | 0.0 | % | 549 |   | 1.3 | % |
| Maryland             |       | 471              |       | 1.1             | %          | —           |       | 0.0             | %          | — |   | 0.0 | % | 471 |   | 1.1 | % |
| Kansas               |       | 293              |       | 0.7             | %          | —           |       | 0.0             | %          | — |   | 0.0 | % | 293 |   | 0.7 | % |
| Virginia             |       | 252              |       | 0.6             | %          | —           |       | 0.0             | %          | — |   | 0.0 | % | 252 |   | 0.6 | % |
| Total                |       | 36,903           |       | 89.7            | %          | 3,126            |       | 7.6             | %          | 1,117 |   | 2.7 | % | 41,146 |   | 100.0 | % |

 

28

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**Rental revenue and propertyoperating costs:**

 
| ** **                                           | ** ** | **Rental Revenue  Three Months Ended  June 30,** | ** ** | **Rental Revenue  Six Months Ended  June 30,** | ** ** |
|------------------------------------------------------|------------|-------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                           | ** ** | **2005**                                              | ** ** | **2004**                                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                           |       | **(In thousands)**                                    |       | **(In thousands)**                                  |       |
| **Rental  Revenue**                                  |       | ** **                                            |       | ** **                                          |       |
| Industrial                                           |       | $                                                     | 47,278     |                                                | $          | 47,781 |   | $ | 94,001 |   | $ | 93,747 |   |
| Office                                               |       | 15,837                                                |       | 16,992                                              |       | 32,481 |   | 34,350 |   |
| Retail                                               |       | 5,692                                                 |       | 3,742                                               |       | 11,073 |   | 7,581 |   |
| Ground  leases and other properties                  |       | 9,907                                                 |       | 9,496                                               |       | 19,559 |   | 19,498 |   |
| Less:  Discontinued operations                       |       | (3,989                                                | )          | (5,583                                              | )          | (8,190 | ) | (10,973 | ) |
|                                                 |       | 74,725                                                |       | 72,428                                              |       | 148,924 |   | 144,203 |   |
| Hotel  operations-Embassy Suites Hotel               |       | 515                                                   |       | —                                              |       | 515 |   | — |   |
| Equity in  earnings of operating joint ventures, net |       | 2,665                                                 |       | 2,379                                               |       | 5,498 |   | 4,793 |   |
| Total rental  revenue, net                           |       | $                                                     | 77,905     |                                                | $          | 74,807 |   | $ | 154,937 |   | $ | 148,996 |   |

 
| ** **                          | ** ** | **Property Operating Cost  Three Months Ended  June 30,** | ** ** | **Property Operating Cost  Six Months Ended  June 30,** | ** ** |
|-------------------------------------|------------|----------------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                          | ** ** | **2005**                                                       | ** ** | **2004**                                                     | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                          |       | **(In thousands)**                                             |       | **(In thousands)**                                           |       |
| **Property  Operating Costs**       |       | ** **                                                     |       | ** **                                                   |       |
| Industrial                          |       | $                                                              | (11,604    | )                                                            | $          | (10,551 | ) | $ | (22,144 | ) | $ | (20,922 | ) |
| Office                              |       | (6,666                                                         | )          | (6,460                                                       | )          | (13,220 | ) | (13,492 | ) |
| Retail                              |       | (1,932                                                         | )          | (1,440                                                       | )          | (3,822 | ) | (2,650 | ) |
| Ground  leases and other properties |       | (2,628                                                         | )          | (1,832                                                       | )          | (5,944 | ) | (4,635 | ) |
| Less:  Discontinued operations      |       | 2,048                                                          |       | 2,191                                                        |       | 4,073 |   | 4,767 |   |
|                                |       | $                                                              | (20,782    | )                                                            | $          | (18,092 | ) | $ | (41,057 | ) | $ | (36,932 | ) |

 
| ** **                                           | ** ** | **Rental Revenue Less  Property Operating Costs  Three Months Ended  June 30,** | ** ** | **Rental Revenue Less  Property Operating Costs  Six Months Ended  June 30,** | ** ** |
|------------------------------------------------------|------------|--------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------|------------|
| ** **                                           | ** ** | **2005**                                                                             | ** ** | **2004**                                                                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                           |       | **(In thousands)**                                                                   |       | **(In thousands)**                                                                 |       |
| **Rental  Revenue Less Property Operating Costs**    |       | ** **                                                                           |       | ** **                                                                         |       |
| Industrial                                           |       | $                                                                                    | 35,674     |                                                                               | $          | 37,230 |   | $ | 71,857 |   | $ | 72,825 |   |
| Office                                               |       | 9,171                                                                                |       | 10,532                                                                             |       | 19,261 |   | 20,858 |   |
| Retail                                               |       | 3,760                                                                                |       | 2,302                                                                              |       | 7,251 |   | 4,931 |   |
| Ground  leases and other properties                  |       | 7,279                                                                                |       | 7,664                                                                              |       | 13,615 |   | 14,863 |   |
| Less:  Discontinued operations                       |       | (1,941                                                                               | )          | (3,392                                                                             | )          | (4,117 | ) | (6,206 | ) |
|                                                 |       | 53,943                                                                               |       | 54,336                                                                             |       | 107,867 |   | 107,271 |   |
| Hotel  operations-Embassy Suites Hotel               |       | 515                                                                                  |       | —                                                                             |       | 515 |   | — |   |
| Equity in  earnings of operating joint ventures, net |       | 2,665                                                                                |       | 2,379                                                                              |       | 5,498 |   | 4,793 |   |
| Total rental  revenue less property operating costs  |       | $                                                                                    | 57,123     |                                                                               | $          | 56,715 |   | $ | 113,880 |   | $ | 112,064 |   |

 

**Operating Joint Venture Portfolio**

 

We had direct or indirectequity interests in three joint ventures that owned rental properties as of June 30,2005. We acquired the remaining 50% interest in one of our joint ventures which,owned and operated an Embassy Suites Hotel in June 2005. The jointventures provided us with cash distributions of $3.9 million and earnings of$5.5 million for the six months ended June 30, 2005. The joint ventureagreements of these joint ventures contain provisions with certain safeguardfeatures for our investments, such as voting rights in major decisions of thejoint ventures, and venture partners’ consents on sales of a venture partner’sownership interest.

 

In entering into jointventure transactions, we evaluate the merits and risks of the joint ventureassets and structure as well as the financial condition of other co-ownershipentities in making our investment decision. We have no formal policies onstructural issues such as voting control requirements, veto powers, or purchaseprovisions, but instead, we evaluate the investment opportunity in its entiretywhen making such a decision.

 

29

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We owned joint ventureinterests in the following operating properties for the periods presented.

 
| ** **     | ** ** | ** **                   | ** ** | ** **             | ** ** | ** **            | ** ** | **Equity in Earnings** | ** ** | **Equity in Earnings** | ** ** |
|----------------|------------|------------------------------|------------|------------------------|------------|-----------------------|------------|------------------------|------------|------------------------|------------|
| ** **     | ** ** | **As of June 30, 2005** | ** ** | **Three Months Ended** | ** ** | **Six Months  Ended** | ** ** |
| ** **     | ** ** | **No. of**              | ** ** | ** **             | ** ** | **Ownership **   | ** ** | **June 30,**      | ** ** | **June 30,**      | ** ** | **June 30,** | ** ** | **June 30,** | ** ** |
| ** **     | ** ** | **Ventures**                 | ** ** | **Size**               | ** ** | **Interest**          | ** ** | **2005**               | ** ** | **2004**               | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **     | ** ** | ** **                   | ** ** | ** **             | ** ** | ** **            | ** ** | **(In thousands)**     | ** ** | **(In thousands)**     | ** ** |
| Hotel (1) |       | 2                            |       | 1,600 rooms            |       | 25-42                 | %          | $                      | 2,591      |                   | $          | 2,333 |   | $ | 5,149 |   | $ | 4,599 |   |
| Office         |       | 1                            |       | 202,000 sq.  ft.       |       | 67                    | %          | 74                     |       | 46                     |       | 349 |   | 194 |   |
| Total          |       | 3                            |       |                   |       |                  |       | $                      | 2,665      |                   | $          | 2,379 |   | $ | 5,498 |   | $ | 4,793 |   |

 

----

(1)                   Includes ahotel parking lot joint venture. We acquired the remaining interest in one ofour hotel joint ventures in June of 2005.

 

**Ground Leases and Other Properties:**

 

**GroundLeases**

 

We own approximately 5,600acres of ground leases that we intend to hold but do not consider part of ourrental portfolio square footage presentation.

 

The following tablesummarizes our ground leases for the periods presented:

 
| ** **                                 | ** ** | **Revenues**       | ** ** | **Property  Operating  Costs** | ** ** | **Rental Revenue  Less Property  Operating  Costs** | ** ** |
|--------------------------------------------|------------|--------------------|------------|--------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                 | ** ** | **(In thousands)** | ** ** |
| **Three  Months Ended June 30, 2005** | ** ** | ** **         | ** ** | ** **                     | ** ** | ** **                                          | ** ** |
| Northern  California                       |       | $                  | 5,755      |                           | $          | (1,623                                              | )          | $ | 4,132 |   |
| Southern  California                       |       | 2,310              |       | (44                            | )          | 2,266                                               |       |
| Other states                               |       | 770                |       | (30                            | )          | 740                                                 |       |
| Totals                                     |       | $                  | 8,835      |                           | $          | (1,697                                              | )          | $ | 7,138 |   |

 
| ** **                               | ** ** | **Revenues**       | ** ** | **Property Operating  Costs** | ** ** | **Rental Revenue  Less Property  Operating  Costs** | ** ** |
|------------------------------------------|------------|--------------------|------------|-------------------------------|------------|-----------------------------------------------------|------------|
| ** **                               | ** ** | **(In thousands)** | ** ** |
| **Six  Months Ended June 30, 2005** | ** ** | ** **         |       |                          |       |                                                |       |
| Northern  California                     |       | $                  | 11,074     |                          | $          | (3,494                                              | )          | $ | 7,580 |   |
| Southern  California                     |       | 4,729              |       | (36                           | )          | 4,693                                               |       |
| Other states                             |       | 1,506              |       | (98                           | )          | 1,408                                               |       |
| Totals                                   |       | $                  | 17,309     |                          | $          | (3,628                                              | )          | $ | 13,681 |   |

 

30

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**OtherProperties**

 

As of June 30, 2005, inaddition to 41.1 million square feet of buildings in our rental portfolio, wealso own two train stations aggregating approximately 121,000 square feet and10 acres of ground leases that are being marketed for sale (“Other Property”).

 

The following tablesummarizes our Other Property portfolio as of, and for, periods presented:

 
| ** **                                 | ** ** | **Number of  Buildings**                            | ** ** | **Square Feet(1)** | ** ** | **Revenues(2)** | ** ** | **Property  Operating  Costs(2)** | ** ** | **Rental Revenue  Less Property  Operating  Costs(2)** | ** ** |
|--------------------------------------------|------------|-----------------------------------------------------|------------|--------------------|------------|-----------------|------------|-----------------------------------|------------|--------------------------------------------------------|------------|
| ** **                                 | ** ** | **(In thousands, except for  number of buildings)** | ** ** |
| **Three  Months Ended June 30, 2005** |       |                                                |       |               |       |            |       |                              |       |                                                   |       |
| Northern  California                       |       | —                                              |       | —             |       | $               | (6         | )                                 | $          | (140                                                   | )          | $ | (146 | ) |
| Southern  California                       |       | 2                                                   |       | 121                |       | 1,068           |       | (791                              | )          | 277                                                    |       |
| Other states                               |       | —                                              |       | —             |       | 10              |       | —                            |       | 10                                                     |       |
| Totals                                     |       | 2                                                   |       | 121                |       | $               | 1,072      |                              | $          | (931                                                   | )          | $ | 141 |   |

 
| ** **                               | ** ** | **Number of  Buildings**                            | ** ** | **Square Feet** | ** ** | **Revenues** | ** ** | **Property  Operating Costs** | ** ** | **Rental Revenue  Less Property  Operating Costs** | ** ** |
|------------------------------------------|------------|-----------------------------------------------------|------------|-----------------|------------|--------------|------------|-------------------------------|------------|----------------------------------------------------|------------|
| ** **                               | ** ** | **(In thousands, except for  number of buildings)** | ** ** |
| **Six  Months Ended June 30, 2005** |       |                                                |       |            |       |         |       |                          |       |                                               |       |
| Northern  California                     |       | —                                              |       | —          |       | $            | 59         |                          | $          | (520                                               | )          | $ | (461 | ) |
| Southern  California                     |       | 2                                                   |       | 121             |       | 2,168        |       | (1,785                        | )          | 383                                                |       |
| Other states                             |       | —                                              |       | —          |       | 23           |       | (11                           | )          | 12                                                 |       |
| Totals                                   |       | 2                                                   |       | 121             |       | $            | 2,250      |                          | $          | (2,316                                             | )          | $ | (66 | ) |

 

----

(1)                   Other Propertyis not included in the total square feet of rental portfolio.

(2)                   These amountsdo not consider the effect of discontinued operations; s*ee*Note 7 to Condensed ConsolidatedFinancial Statements for reconciliation to Statement of Operations format.

 

31

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**Core Segment Developable LandInventory**

 

Our existing Core segmentdevelopable land can support an estimated 36.0 million square feet of newcommercial development based upon current entitlements.

 

For the six months ended June 30,2005, we invested approximately $25.8 million in the acquisition of landcapable of supporting approximately 5.0 million square feet of commercialdevelopment.

 

The following tablesummarizes our Core segment developable land inventory as of June 30,2005:

 
| **Project Name**                   | ** ** | **City/Location**                  | ** ** | **June 30, 2005**          | ** ** |
|------------------------------------|------------|------------------------------------|------------|---------------------------------|------------|
| ** **                         | ** ** | ** **                         | ** ** | **Square Feet  (In thousands)** | ** ** |
| **Southern California**            | ** ** | ** **                         | ** ** | ** **                      | ** ** |
| Kaiser Commerce Center             |       | San Bernardino County              |       | 245                             |       |
| Crossroads Business Park           |       | Ontario                            |       | 2,058                           |       |
| San Bernardino                     |       | San Bernardino                     |       | 105                             |       |
| Pacific Center                     |       | Anaheim                            |       | 44                              |       |
| Subtotal  Southern California      |       |                               |       | 2,452                           |       |
| **Northern California**            | ** ** | ** **                         | ** ** | ** **                      | ** ** |
| Tracy                              |       | Tracy                              |       | 3,333                           |       |
| Pacific Commons                    |       | Fremont                            |       | 1,546                           |       |
| Duck Creek                         |       | Stockton                           |       | 2,100                           |       |
| Spreckels Business Park            |       | Manteca                            |       | 350                             |       |
| Subtotal  Northern California      |       |                               |       | 7,329                           |       |
| Subtotal  California               |       |                               |       | 9,781                           |       |
| **Illinois**                       | ** ** | ** **                         | ** ** | ** **                      | ** ** |
| Minooka                            |       | Minooka                            |       | 4,533                           |       |
| Internationale Centre              |       | Woodridge                          |       | 605                             |       |
| Prairie Glen Corporate Campus      |       | Glenview                           |       | 70                              |       |
| Joliet                             |       | Joliet                             |       | 403                             |       |
| Subtotal  Illinois                 |       |                               |       | 5,611                           |       |
| **Texas**                          | ** ** | ** **                         | ** ** | ** **                      | ** ** |
| Hobby Business Park                |       | Houston                            |       | 1,495                           |       |
| Gateway Corporate Center           |       | Coppell                            |       | 1,178                           |       |
| Stellar Way Business Park          |       | Grand Prairie                      |       | 635                             |       |
| Gateway East Business Park         |       | Garland                            |       | 690                             |       |
| Plano                              |       | Plano                              |       | 450                             |       |
| Subtotal  Texas                    |       |                               |       | 4,448                           |       |
| **Other**                          | ** ** | ** **                         | ** ** | ** **                      | ** ** |
| Eastgate                           |       | Aurora, CO                         |       | 4,300                           |       |
| Stapleton Business Park            |       | Denver, CO                         |       | 150                             |       |
| South Shore Corp. Park             |       | Portland / Gresham, OR             |       | 617                             |       |
| Circle Point Corporate Center      |       | Westminster, CO                    |       | 280                             |       |
| Cedar Grove Business Park          |       | Louisville, KY                     |       | 530                             |       |
| Quakertown                         |       | Milford, Bucks County, PA          |       | 1,071                           |       |
| Port Reading Business Park         |       | Carteret & Woodbridge, NJ |       | 3,278                           |       |
| Elizabeth Seaport Business Park    |       | City of Elizabeth, NJ              |       | 1,082                           |       |
| **Subtotal Other**                 |       |                               |       | 11,308                          |       |
| **Subtotal Outside of California** |       |                               |       | 21,367                          |       |
| **Total Owned Land**               |       |                               |       | 31,148                          |       |
| **Option/Controlled Land**         |       |                               |       |                            |       |
| Alameda (FISC)                     |       | Alameda, CA                        |       | 1,300                           |       |
| Prairie Glen Corporate Campus      |       | Glenview, IL                       |       | 298                             |       |
| RMMA                               |       | Austin, TX                         |       | 3,230                           |       |
| **Total Inventory**                |       |                               |       | 35,976                          |       |

 

32

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**Summary of Remaining Non-Core Assetsas of June 30, 2005**

 

•                    The remainingdevelopment land at Los Angeles Union Station (36.5 acres and 5.3 millionsquare feet). The book value for the development land at LAUS is $51.3 millionas of June 30, 2005.

 

•                 Parkway, aresidential community development in Sacramento, California, which will besubstantially complete by the end of 2006. The book value for Parkway is $3.1 million as of June 30, 2005.

 

•                 Serrano, aresidential community development in Sacramento, California, with a book valueof $17.6 million as of June 30, 2005.

 

•                 Cash flow fromtax increment at Victoria-by-the-Bay, a completed residential development inHercules, California, is expected to total $3.5 million annually by 2008, atfull build-out, and grow annually through 2044, as property assessmentsincrease. In addition, we anticipate receiving profit participation fromhomebuilders of approximately $8.2 million. The total expected cash flow fromtax increment at Victoria-by-the-Bay is $168.1 million as of June 30,2005.

 

**FinancialCondition and Results of Operations**

** **

The following discussion andanalysis of our financial condition and results of operations should be read inconjunction with the Condensed Consolidated Financial Statements and relatednotes appearing elsewhere in this Form 10-Q.

 

**Net Income**

 

Our net income for the threemonths ended June 30, 2005 and 2004, was $26.2 million and $35.3 million,respectively.  Our net income for the sixmonths ended June 30, 2005 and 2004, was $59.5 million and $67.4 million,respectively. The discussion and analysis of our net income should be read inconjunction with the Funds From Operations appearing in the following pages ofthis Form 10-Q (*see*Note 7to Condensed Consolidated Financial Statements for Reconciliation to Statementof Operations.)

 

**Funds From Operations**

 

As a REIT, we provide FundsFrom Operations (“FFO”) as a supplemental measure of performance calculated inaccordance with the definition adopted by the National Association of RealEstate Investment Trusts (“NAREIT”). FFO, as defined by NAREIT, represents netincome (loss) (computed in accordance with GAAP), excluding sales ofincome-producing assets, and cumulative effects of changes in accountingprinciples, plus depreciation and amortization (excluding depreciation onpersonal property) and after adjustments for unconsolidated entities.Adjustments for unconsolidated entities are calculated on the same basis. Ourmanagement generally believes that FFO, as defined by NAREIT, is a meaningfulsupplemental measure of operating performance because historical costaccounting for real estate assets in accordance with GAAP implicitly assumesthat the value of real estate assets diminishes predictably over time. Sincereal estate values instead have historically risen or fallen with market conditions,many industry investors and analysts have considered presentation of operatingresults for real estate companies that use historical cost accounting to beinsufficient by themselves. Thus, NAREIT created FFO as a supplemental measureof REIT operating performance that excludes historical cost depreciation, amongother items, from GAAP net income. The use of FFO, combined with the requiredprimary GAAP presentations, has been fundamentally beneficial, improving theunderstanding of operating results of REITs among the investing public andmaking comparisons of REIT operating results more meaningful. We generallyconsider FFO to be a useful measure for reviewing our comparative operating andfinancial performance (although FFO should be reviewed in conjunction with netincome which remains the primary measure of performance) because by excludinggains or losses related to sales of previously depreciated operating realestate assets and excluding real estate asset depreciation and amortization,FFO can help one compare the operating performance of a company’s real estatebetween periods or to the operating performance of different companies. Ourcomputation of FFO does include gains (losses) on sales of land andbuild-to-suit development projects other than non-strategic asset sales.

 

33

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Below is a summary of netincome by segment and FFO for the three months ended June 30, 2005:

 
| ** **                                             | ** ** | **Core**           | ** ** | **URO** | ** ** | **Total****(a)** | ** ** |
|--------------------------------------------------------|------------|--------------------|------------|---------|------------|------------------|------------|
| ** **                                             | ** ** | **(In thousands)** | ** ** |
| **Revenue**                                            |       |               |       |    |       |             |       |
| Rental  revenue                                        |       | $                  | 78,714     |    | $          | —           |       | $ | 78,714 |   |
| Sales  revenue                                         |       | 18,726             |       | 13,264  |       | 31,990           |       |
| Management,  development and other fees                |       | 3,250              |       | —  |       | 3,250            |       |
|                                                   |       | 100,690            |       | 13,264  |       | 113,954          |       |
| **Costs  and expenses**                                |       |               |       |    |       |             |       |
| Property  operating costs                              |       | (22,830            | )          | —  |       | (22,830          | )          |
| Cost of  sales                                         |       | (16,318            | )          | (3,840  | )          | (20,158          | )          |
| Selling,  general and administrative expenses          |       | (10,392            | )          | (2,842  | )          | (13,234          | )          |
| Depreciation  and amortization                         |       | (18,271            | )          | (93     | )          | (18,364          | )          |
|                                                   |       | (67,811            | )          | (6,775  | )          | (74,586          | )          |
| **Operating  income**                                  |       | 32,879             |       | 6,489   |       | 39,368           |       |
| **Other  income**                                      |       |               |       |    |       |             |       |
| Equity in  earnings of operating joint ventures, net   |       | 2,665              |       | —  |       | 2,665            |       |
| Equity in  earnings of development joint ventures, net |       | 1,307              |       | 5,344   |       | 6,651            |       |
| Interest  income                                       |       | 7,878              |       | 1,005   |       | 8,883            |       |
| Other                                                  |       | 645                |       | 135     |       | 780              |       |
|                                                   |       | 12,495             |       | 6,484   |       | 18,979           |       |
| **Other  expenses**                                    |       |               |       |    |       |             |       |
| Interest  expense                                      |       | (16,288            | )          | —  |       | (16,288          | )          |
| Other                                                  |       | (6,206             | )          | (425    | )          | (6,631           | )          |
|                                                   |       | (22,494            | )          | (425    | )          | (22,919          | )          |
| Income  before income taxes                            |       | 22,880             |       | 12,548  |       | 35,428           |       |
| Income tax  expense                                    |       | (1,328             | )          | (7,918  | )          | (9,246           | )          |
| **Net  income**                                        |       | 21,552             |       | 4,630   |       | 26,182           |       |
| Depreciation(b)                                        |       | 18,932             |       | 62      |       | 18,994           |       |
| Less gain on  rental property sales                    |       | (51                | )          | —  |       | (51              | )          |
| NAREIT  defined funds from operations (FFO)            |       | $                  | 40,433     |    | $          | 4,692            |       | $ | 45,125 |   |

 

----

(a)                      Asdiscussed in the Business Segment Description section of this MD&A,these amounts do not consider the effect of discontinued operations. *See* Note 7 to the Condensed ConsolidatedFinancial Statements for reconciliation to Statement of Operations.

 

(b)                     Depreciation,for FFO purposes, excludes depreciation on personal property of $0.3 millionand includes depreciation from unconsolidated joint ventures of $0.9 million.

 

34

----

 

Below is a summary of netincome by segment and FFO for the three months ended June 30, 2004:

 
| ** **                                             | ** ** | **Core**           | ** ** | **URO** | ** ** | **Total****(a)** | ** ** |
|--------------------------------------------------------|------------|--------------------|------------|---------|------------|------------------|------------|
| ** **                                             | ** ** | **(In thousands)** | ** ** |
| **Revenue**                                            |       |               |       |    |       |             |       |
| Rental  revenue                                        |       | $                  | 78,011     |    | $          | —           |       | $ | 78,011 |   |
| Sales  revenue                                         |       | 10,980             |       | 2,691   |       | 13,671           |       |
| Management,  development and other fees                |       | 542                |       | 216     |       | 758              |       |
|                                                   |       | 89,533             |       | 2,907   |       | 92,440           |       |
| **Costs  and expenses**                                |       |               |       |    |       |             |       |
| Property  operating costs                              |       | (20,283            | )          | —  |       | (20,283          | )          |
| Cost of  sales                                         |       | (8,311             | )          | (2,537  | )          | (10,848          | )          |
| Selling,  general and administrative expenses          |       | (7,247             | )          | (5,364  | )          | (12,611          | )          |
| Depreciation  and amortization                         |       | (18,957            | )          | (273    | )          | (19,230          | )          |
|                                                   |       | (54,798            | )          | (8,174  | )          | (62,972          | )          |
| **Operating  income (loss)**                           |       | 34,735             |       | (5,267  | )          | 29,468           |       |
| **Other  income**                                      |       |               |       |    |       |             |       |
| Equity in  earnings of operating joint ventures, net   |       | 2,379              |       | —  |       | 2,379            |       |
| Equity in  earnings of development joint ventures, net |       | —             |       | 3,391   |       | 3,391            |       |
| Gain on non-strategic  asset sales                     |       | —             |       | 16,380  |       | 16,380           |       |
| Interest  income                                       |       | 1,813              |       | 648     |       | 2,461            |       |
| Other                                                  |       | (18                | )          | 974     |       | 956              |       |
|                                                   |       | 4,174              |       | 21,393  |       | 25,567           |       |
| **Other  expenses**                                    |       |               |       |    |       |             |       |
| Interest  expense                                      |       | (16,692            | )          | —  |       | (16,692          | )          |
| REIT  transition costs                                 |       | —             |       | (208    | )          | (208             | )          |
| Other                                                  |       | (731               | )          | (1,088  | )          | (1,819           | )          |
|                                                   |       | (17,423            | )          | (1,296  | )          | (18,719          | )          |
| Income  (loss) before income taxes                     |       | 21,486             |       | 14,830  |       | 36,316           |       |
| Income taxes  expense                                  |       | (553               | )          | (429    | )          | (982             | )          |
| **Net  income**                                        |       | 20,933             |       | 14,401  |       | 35,334           |       |
| Depreciation  (b)                                      |       | 19,632             |       | 181     |       | 19,813           |       |
| Less gain on  rental property sales                    |       | (395               | )          | —  |       | (395             | )          |
| NAREIT  defined funds from operations (FFO)            |       | $                  | 40,170     |    | $          | 14,582           |       | $ | 54,752 |   |

 

----

(a)                   As discussed inthe Business Segment Description section of this MD&A, these amountsdo not consider the effect of discontinued operations. *See* Note 7 to the Condensed ConsolidatedFinancial Statements for reconciliation to Statement of Operations.

 

(b)                  Depreciation,for FFO purposes, excludes depreciation on personal property of $0.4 millionand includes depreciation from unconsolidated joint ventures of $0.9 million.

 

35

----

 

Below is a summary of netincome by segment and FFO for the six months ended June 30, 2005:

 
| ** **                                             | ** ** | **Core**           | ** ** | **URO** | ** ** | **Total(a)** | ** ** |
|--------------------------------------------------------|------------|--------------------|------------|---------|------------|--------------|------------|
| ** **                                             | ** ** | **(In thousands)** | ** ** |
| **Revenue**                                            |       |               |       |    |       |         |       |
| Rental  revenue                                        |       | $                  | 157,114    |    | $          | —       |       | $ | 157,114 |   |
| Sales  revenue                                         |       | 41,042             |       | 26,978  |       | 68,020       |       |
| Management,  development and other fees                |       | 6,960              |       | 3,834   |       | 10,794       |       |
|                                                   |       | 205,116            |       | 30,812  |       | 235,928      |       |
| **Costs  and expenses**                                |       |               |       |    |       |         |       |
| Property  operating costs                              |       | (45,130            | )          | —  |       | (45,130      | )          |
| Cost of  sales                                         |       | (30,265            | )          | (14,941 | )          | (45,206      | )          |
| Selling,  general and administrative expenses          |       | (20,113            | )          | (5,411  | )          | (25,524      | )          |
| Depreciation  and amortization                         |       | (36,874            | )          | (204    | )          | (37,078      | )          |
|                                                   |       | (132,382           | )          | (20,556 | )          | (152,938     | )          |
| **Operating  income**                                  |       | 72,734             |       | 10,256  |       | 82,990       |       |
| **Other  income**                                      |       |               |       |    |       |         |       |
| Equity in  earnings of operating joint ventures, net   |       | 5,498              |       | —  |       | 5,498        |       |
| Equity in  earnings of development joint ventures, net |       | 2,841              |       | 8,896   |       | 11,737       |       |
| Gain on  non-strategic asset sales                     |       | —             |       | 20      |       | 20           |       |
| Interest income                                        |       | 15,861             |       | 1,917   |       | 17,778       |       |
| Other                                                  |       | 662                |       | 207     |       | 869          |       |
|                                                   |       | 24,862             |       | 11,040  |       | 35,902       |       |
| **Other  expenses**                                    |       |               |       |    |       |         |       |
| Interest  expense                                      |       | (33,869            | )          | —  |       | (33,869      | )          |
| Other                                                  |       | (7,761             | )          | (368    | )          | (8,129       | )          |
|                                                   |       | (41,630            | )          | (368    | )          | (41,998      | )          |
| Income  before income taxes                            |       | 55,966             |       | 20,928  |       | 76,894       |       |
| Income tax  expense                                    |       | (4,564             | )          | (12,830 | )          | (17,394      | )          |
| **Net  income**                                        |       | 51,402             |       | 8,098   |       | 59,500       |       |
| Depreciation(b)                                        |       | 38,291             |       | 169     |       | 38,460       |       |
| Less gain on  rental property sales                    |       | (540               | )          | —  |       | (540         | )          |
| NAREIT  defined funds from operations (FFO)            |       | $                  | 89,153     |    | $          | 8,267        |       | $ | 97,420 |   |

 

----

(a)                      Asdiscussed in the Business Segment Description section of this MD&A,these amounts do not consider the effect of discontinued operations. *See* Note 7 to the Condensed ConsolidatedFinancial Statements for reconciliation to Statement of Operations.

 

(b)                     Depreciation,for FFO purposes, excludes depreciation on personal property of $0.5 millionand includes depreciation from unconsolidated joint ventures of $1.9 million.

 

36

----

 

Below is a summary of netincome by segment and FFO for the six months ended June 30, 2004:

 
| ** **                                             | ** ** | **Core**           | ** ** | **URO** | ** ** | **Total(a)** | ** ** |
|--------------------------------------------------------|------------|--------------------|------------|---------|------------|--------------|------------|
| ** **                                             | ** ** | **(In thousands)** | ** ** |
| **Revenue**                                            |       | $                  | 155,176    |    | $          | —       |       | $ | 155,176 |   |
| Rental  revenue                                        |       | 41,564             |       | 13,348  |       | 54,912       |       |
| Sales  revenue                                         |       | 1,526              |       | 931     |       | 2,457        |       |
| Management,  development and other fees                |       | 198,266            |       | 14,279  |       | 212,545      |       |
|                                                   |       |               |       |    |       |         |       |
| **Costs  and expenses**                                |       | (41,699            | )          | —  |       | (41,699      | )          |
| Property  operating costs                              |       | (23,167            | )          | (12,705 | )          | (35,872      | )          |
| Cost of  sales                                         |       | (13,887            | )          | (11,675 | )          | (25,562      | )          |
| Selling,  general and administrative expenses          |       | (36,734            | )          | (573    | )          | (37,307      | )          |
| Depreciation  and amortization                         |       | (115,487           | )          | (24,953 | )          | (140,440     | )          |
| **Operating  income (loss)**                           |       | 82,779             |       | (10,674 | )          | 72,105       |       |
| **Other  income**                                      |       |               |       |    |       |         |       |
| Equity in  earnings of operating joint ventures, net   |       | 4,793              |       | —  |       | 4,793        |       |
| Equity in  earnings of development joint ventures, net |       | —             |       | 4,618   |       | 4,618        |       |
| Gain on  non-strategic asset sales                     |       | —             |       | 16,441  |       | 16,441       |       |
| Interest  income                                       |       | 4,188              |       | 1,050   |       | 5,238        |       |
| Other                                                  |       | 266                |       | 991     |       | 1,257        |       |
|                                                   |       | 9,247              |       | 23,100  |       | 32,347       |       |
| **Other  expenses**                                    |       |               |       |    |       |         |       |
| Interest  expense                                      |       | (32,445            | )          | —  |       | (32,445      | )          |
| REIT  transition costs                                 |       | —             |       | (420    | )          | (420         | )          |
| Other                                                  |       | (749               | )          | (1,500  | )          | (2,249       | )          |
|                                                   |       | (33,194            | )          | (1,920  | )          | (35,114      | )          |
| Income  (loss) before income taxes                     |       | 58,832             |       | 10,506  |       | 69,338       |       |
| Income taxes  expense                                  |       | (5,885             | )          | 3,972   |       | (1,913       | )          |
| **Net  income**                                        |       | 52,947             |       | 14,478  |       | 67,425       |       |
| Depreciation  (b)                                      |       | 37,882             |       | 365     |       | 38,247       |       |
| Less gain on  rental property sales                    |       | (4,367             | )          | —  |       | (4,367       | )          |
| NAREIT  defined funds from operations (FFO)            |       | $                  | 86,462     |    | $          | 14,843       |       | $ | 101,305 |   |

 

----

(a)                   As discussed inthe Business Segment Description section of this MD&A, these amountsdo not consider the effect of discontinued operations. *See* Note 7 to the Condensed ConsolidatedFinancial Statements for reconciliation to Statement of Operations.

 

(b)                  Depreciation,for FFO purposes, excludes depreciation on personal property of $1.0 millionand includes depreciation from unconsolidated joint ventures of $1.9 million.

 

37

----

 

**Rental Revenue**

 

Rental revenues haveincreased for the three and six months ended June 30, 2005 primarilybecause of building additions. The increases, were partially offset by thedecreases in ground leases due to the Mission Bay properties sold and lowerrental from same space because of lower occupancy rates. Rental revenue forthree and six months ended June 30, 2005 and 2004, is summarized asfollows:

 
| ** **                      | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                      | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **Difference  2005/2004** | ** ** | **2005** | ** ** | **2004** | ** ** | **Difference  2005/2004** | ** ** |
| ** **                      | ** ** | **(In thousands)**                    | ** ** | ** **                          | ** ** | **(In thousands)** | ** ** | ** ** | ** ** |
| **Rental  revenue:**            |       |                                  |       |                                |       |   |   |   |   |   |   |   |   |
| Same space (1)                  |       | $                                     | 62,775     |                                | $          | 64,107 |   | $ | (1,332 | ) | $ | 126,191 |   | $ | 128,625 |   | $ | (2,434 | ) |
| Properties  added to portfolio  |       | 7,685                                 |       | 2,921                               |       | 4,764 |   | 14,250 |   | 4,202 |   | 10,048 |   |
| Properties  sold from portfolio |       | 1                                     |       | 1,233                               |       | (1,232 | ) | 157 |   | 2,349 |   | (2,192 | ) |
| Ground  leases                  |       | 8,253                                 |       | 9,750                               |       | (1,497 | ) | 16,516 |   | 20,000 |   | (3,484 | ) |
| Total (2)                       |       | $                                     | 78,714     |                                | $          | 78,011 |   | $ | 703 |   | $ | 157,114 |   | $ | 155,176 |   | $ | 1,938 |   |

 

----

(1)                      Samespace properties were owned and operated for the entire current year and theentire immediately preceding year.

(2)                      Theseamounts do not consider the effect of discontinued operations. *See* Note 7 to the Condensed ConsolidatedFinancial Statements for reconciliation to Statement of Operations.

 

We do not expect substantial changes inrental revenue from our same space rental portfolio; rather, we expect thatgrowth in overall portfolio rental revenue will result primarily from newproperties we will add to our rental portfolio over time.

 

**Ten Largest Tenants**

 

The following is a schedule ofthe largest ten tenants of our rental portfolio, based on GAAP rents:

 
| **Customer Name**                 | ** ** | **State**          | ** ** | **Type of  Product  Leased** | ** ** | **% of Total  Base Rent as  of June 30, 2005** | ** ** |
|-----------------------------------|------------|--------------------|------------|------------------------------|------------|-----------------------------------------------------|------------|
| The Gap (1)                       |       | CA                 |       | Office/Retail                |       | 6.5%                                                |       |
| APL Logistics, Inc.          |       | CA, IL, GA, KY, TX |       | Industrial                   |       | 5.6%                                                |       |
| Ford Motor Company                |       | CA, CO, TX, KS, VA |       | Industrial                   |       | 2.8%                                                |       |
| Exel Corporation                  |       | CA                 |       | Industrial                   |       | 1.9%                                                |       |
| J.C. Penney Company               |       | TX                 |       | Office                       |       | 1.9%                                                |       |
| Kellogg’s USA, Inc. (2) |       | CA, IL, CO         |       | Industrial                   |       | 1.8%                                                |       |
| Office Depot, Inc.           |       | CA                 |       | Industrial/Retail            |       | 1.6%                                                |       |
| Home Depot USA, Inc. (3)     |       | CA                 |       | Industrial/Retail            |       | 1.6%                                                |       |
| Mission Place, LLC                |       | CA                 |       | Ground Lease                 |       | 1.5%                                                |       |
| Gillette Company                  |       | CA, IL             |       | Industrial                   |       | 1.3%                                                |       |

 

----

(1)                   Includes a17,000 square foot lease doing business as Old Navy.

(2)                   Includes a 450,000square foot lease and 81,000 square foot lease doing business as Kellogg SalesCompany.

(3)                   Includes a117,000 square foot lease doing business as Home Expo.

 

**Property Operating Costs**

 

Property operating costshave increased primarily because of building additions and same space increaseddue to higher repair and maintenance expenses. Property operating costs for three months ended June 30, 2005 and2004, are summarized as follows:

 
| ** **                      | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                      | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **Difference  2005/2004** | ** ** | **2005** | ** ** | **2004** | ** ** | **Difference  2005/2004** | ** ** |
| ** **                      | ** ** | **(In thousands)**                    | ** ** | ** **                          | ** ** | **(In thousands)** | ** ** | ** ** | ** ** |
| **Property  operating costs:**  |       |                                  |       |                                |       |   |   |   |   |   |   |   |   |
| Same space                      |       | $                                     | (18,643    | )                                   | $          | (17,467 | ) | $ | (1,176 | ) | $ | (36,180 | ) | $ | (35,184 | ) | $ | (996 | ) |
| Properties  added to portfolio  |       | (1,421                                | )          | (650                                | )          | (771 | ) | (3,090 | ) | (991 | ) | (2,099 | ) |
| Properties  sold from portfolio |       | (84                                   | )          | (136                                | )          | 52 |   | (148 | ) | (558 | ) | 410 |   |
| Ground  leases                  |       | (2,682                                | )          | (2,030                              | )          | (652 | ) | (5,712 | ) | (4,966 | ) | (746 | ) |
|                            |       | $                                     | (22,830    | )                                   | $          | (20,283 | ) | $ | (2,547 | ) | $ | (45,130 | ) | $ | (41,699 | ) | $ | (3,431 | ) |

 

38

----

 

***Gain on Property Sales:***

 
| ** **                        | ** ** | **Three Months Ended June 30,  2005** | ** ** | **Three Months Ended June 30,  2004** | ** ** |
|-----------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|
| ** **                        | ** ** | **Core**                                   | ** ** | **URO**                                    | ** ** | **Total** | ** ** | **Core** | ** ** | **URO** | ** ** | **Total** | ** ** |
| ** **                        | ** ** | **(In thousands)**                         | ** ** |
| **Building  Sales**               |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Sales proceeds                    |       | $                                          | 15,424     |                                       | $          | 587 |   | $ | 16,011 |   | $ | 5,725 |   | $ | 755 |   | $ | 6,480 |   |
| Cost of  sales                    |       | (14,636                                    | )          | (75                                        | )          | (14,711 | ) | (5,459 | ) | (770 | ) | (6,229 | ) |
| Gain (loss)                       |       | 788                                        |       | 512                                        |       | 1,300 |   | 266 |   | (15 | ) | 251 |   |
| **Land/Lot  Sales**               |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Sales  proceeds                   |       | 3,302                                      |       | 12,677                                     |       | 15,979 |   | 4,608 |   | 1,896 |   | 6,504 |   |
| Cost of  sales                    |       | (1,758                                     | )          | (3,689                                     | )          | (5,447 | ) | (2,351 | ) | (1,179 | ) | (3,530 | ) |
| Gain                              |       | 1,544                                      |       | 8,988                                      |       | 10,532 |   | 2,257 |   | 717 |   | 2,974 |   |
| **Ground  Lease and Other Sales** |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Sales  proceeds                   |       | —                                     |       | —                                     |       | — |   | 647 |   | 40 |   | 687 |   |
| Cost of  sales                    |       | 76                                         |       | (76                                        | )          | — |   | (501 | ) | (588 | ) | (1,089 | ) |
| Gain (loss)                       |       | 76                                         |       | (76                                        | )          | — |   | 146 |   | (548 | ) | (402 | ) |
| **Total  sales proceeds**         |       | 18,726                                     |       | 13,264                                     |       | 31,990 |   | 10,980 |   | 2,691 |   | 13,671 |   |
| **Total  cost of sales**          |       | (16,318                                    | )          | (3,840                                     | )          | (20,158 | ) | (8,311 | ) | (2,537 | ) | (10,848 | ) |
| **Total  gain on property sales** |       | $                                          | 2,408      |                                       | $          | 9,424 |   | $ | 11,832 |   | $ | 2,669 |   | $ | 154 |   | $ | 2,823 |   |

 
| ** **                        | ** ** | **Six Months Ended June 30,  2005** | ** ** | **Six Months Ended June 30,  2004** | ** ** |
|-----------------------------------|------------|------------------------------------------|------------|------------------------------------------|------------|
| ** **                        | ** ** | **Core**                                 | ** ** | **URO**                                  | ** ** | **Total** | ** ** | **Core** | ** ** | **URO** | ** ** | **Total** | ** ** |
| ** **                        | ** ** | **(In thousands)**                       | ** ** |
| **Building  Sales**               |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
| Sales proceeds                    |       | $                                        | 22,349     |                                     | $          | 11,078 |   | $ | 33,427 |   | $ | 17,933 |   | $ | 6,819 |   | $ | 24,752 |   |
| Cost of  sales                    |       | (20,163                                  | )          | (10,060                                  | )          | (30,223 | ) | (13,803 | ) | (6,728 | ) | (20,531 | ) |
| Gain                              |       | 2,186                                    |       | 1,018                                    |       | 3,204 |   | 4,130 |   | 91 |   | 4,221 |   |
| **Land/Lot  Sales**               |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
| Sales  proceeds                   |       | 18,693                                   |       | 15,900                                   |       | 34,593 |   | 16,453 |   | 6,477 |   | 22,930 |   |
| Cost of  sales                    |       | (9,877                                   | )          | (4,805                                   | )          | (14,682 | ) | (7,727 | ) | (5,539 | ) | (13,266 | ) |
| Gain                              |       | 8,816                                    |       | 11,095                                   |       | 19,911 |   | 8,726 |   | 938 |   | 9,664 |   |
| **Ground  Lease and Other Sales** |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
| Sales  proceeds                   |       | —                                   |       | —                                   |       | — |   | 7,178 |   | 52 |   | 7,230 |   |
| Cost of  sales                    |       | (225                                     | )          | (76                                      | )          | (301 | ) | (1,637 | ) | (438 | ) | (2,075 | ) |
| Gain (loss)                       |       | (225                                     | )          | (76                                      | )          | (301 | ) | 5,541 |   | (386 | ) | 5,155 |   |
| **Total  sales proceeds**         |       | 41,042                                   |       | 26,978                                   |       | 68,020 |   | 41,564 |   | 13,348 |   | 54,912 |   |
| **Total  cost of sales**          |       | (30,265                                  | )          | (14,941                                  | )          | (45,206 | ) | (23,167 | ) | (12,705 | ) | (35,872 | ) |
| **Total  gain on property sales** |       | $                                        | 10,777     |                                     | $          | 12,037 |   | $ | 22,814 |   | $ | 18,397 |   | $ | 643 |   | $ | 19,040 |   |

 

Core Segment property salesare generated from the following sources: 1) purchase options exercised byexisting tenants for rental properties, 2) sale of older rental properties toimprove the overall quality of our rental portfolio, 3) select land parcelswithin our development projects, and 4) build-to-suit building sales.

 

URO Segment sales includeall residential and urban projects remaining at the time of REIT conversion,and desert land sales.

 

Gain from property salesdecreased $0.3 million in our Core Segment for the three months ended June 30,2005 because of lower land sale gains of $0.7 million and lower rental buildingsgains of $0.4 million, partially offset by higher build-to-suit buildings gainsof $0.8 million. During the three months ended June 30, 2005, we sold a335,000 square foot building and closed on the sale of improved land capable ofsupporting 34,000 square feet of commercial development. During the threemonths ended June 30, 2004, we sold an 84,000 square foot building, closedon the sale of improved land capable of supporting 0.3 million square feet ofcommercial development, and closed 6.5 acres of ground leases.

 

39

----

 

Gain from property salesdecreased $7.6 million in our Core Segment for the six months ended June 30,2005. This is due to $5.8 million lower ground lease and other sales mainlybecause of the recognition of $5.3 million of deferred gains in 2004 fromselling our interest in one of our joint ventures in September 2003, andlower rental buildings and build-to-suit buildings gain of $1.9 million. Duringthe six months ended June 30, 2005, we sold an 8,000 square feet rentalbuilding, two build-to-suit buildings totaling 440,000 square feet and closedon the sale of improved land capable of supporting 0.3 million square feet ofcommercial development. During the six months ended June 30, 2004, we soldtwo buildings totaling 136,000 square feet, two build-to-suit buildingstotaling 58,000 square feet, closed on the sale of improved land capable ofsupporting 3.2 million square feet of commercial development, and closed 6.5acres of ground leases.

 

Gain from property salesincreased $9.3 million in our URO Segment for the three months ended June 30,2005 due to higher land and lot gains, buildings, and ground lease sales.During the three months ended June 30, 2005, no building was sold but we hadadditional gain of $0.5 million related to the 48,000 square foot building thatwas sold in the first quarter of 2005, we also recognized a $2.6 million ofdeferred gain and a $1.7 million of post-closing adjustments related toproperties sold to FOCIL in November 2004. In addition, we recognized a$4.5 million profit participation related to the sale of residential lots.During the three months ended June 30, 2004, we sold a condominium at ourMission Bay project and recognized deferred gain of $0.7 million from the 2003sale of 1.0 acre of land capable of supporting development of 105 condominiumunits from the Mission Bay project.

 

Gain from property salesincreased $11.4 million in our URO Segment for the six months ended June 30,2005 due to higher land and lot gains of $10.2 million, higher buildings gainof $0.9 million, and higher ground lease sales of $0.3 million. During the sixmonths ended June 30, 2005, we sold a 48,000 square foot building with again of $1.0 million. In addition, we recognized a $2.6 million deferred gainand a $1.7 million of post-closing adjustments related to the FOCIL sale in November 2004.We also recognized of deferred gain of $0.1 million from the 2004 sale of 2.8acres of land at our LA Union Station project and $6.5 million from profitparticipation related to the sale of residential lots. During the six monthsended June 30, 2004, we sold 8 condominiums at our Mission Bay project,2.8 acres of land from the LA Union Station project, and certain ground leases.In addition, we recognized deferred gain of $0.7 million from the 2003 sale of1.0 acre of land capable of supporting development of 105 condominium unitsfrom the Mission Bay project. We sold all of our remaining desert land in 2004and we are transitioning out of the residential and historic urban developmentactivities over time.

 

**Management, Development and OtherFees**

 

Management, development andother fees primarily consists of fees earned related to development andconstruction management services provided to third parties as well as our jointventure projects and loan guarantee fees. Management, development and other fees in our Core Segment increased$2.7 million and $5.4 million for the three and six months ended June 30,2005, respectively, primarily because of development fees from managementactivities related to properties sold to FOCIL in November 2004.

 

Management, development andother fees in our URO Segment increased $2.9 million for the six months ended June 30,2005, primarily because of an earn-out fee recognized in 2005 related to thesale of Mission Bay assets on behalf of FOCIL of $3.8 million. This waspartially offset by a decrease of $0.8 million in loan guarantee and managementfees from the joint venture development at the Mission Bay project for the sixmonths ended June 30, 2005.

 

**Selling, General and AdministrativeExpenses**

 

Selling, general andadministrative expenses increased $3.1 million and $6.2 million in our CoreSegment for the three and six months ended June 30, 2005, respectively,primarily because of increased employee-related expenses due to transfer ofstaff from URO Segment as a result of the FOCIL transaction. Selling, generaland administrative expenses decreased $2.5 million and $6.3 million in our UROSegment for the three and six months ended June 30, 2005, primarilybecause of lower employee-related expenses due to transfer of staff to CoreSegment as a result of the FOCIL transaction.

 

**Depreciation and AmortizationExpense**

 

The decrease in depreciationand amortization expense of $0.7 million in our Core Segment for the threemonths ended June 30, 2005, was primarily attributable to lowerdepreciation from tenant improvements.

 

40

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**Other Income**

 

***Equity in Earnings of OperatingJoint Ventures, Net***

 

Equity in earnings ofoperating joint ventures, net, increased by $0.7 million in our Core Segmentfor the six months ended June 30, 2005. The increase was primarily becauseof higher occupancies in hotels owned by three joint ventures.  In June 2005, we acquired the remaininginterest in one of our operating joint ventures that owns and operates anEmbassy Suites Hotel.  We are expectingthe equity in earnings of operating joint ventures to decline as the incomefrom this hotel operations will be reported in other income after theacquisition.

 

***Equity in Earnings of DevelopmentJoint Ventures, Net***

 

Our equity in earnings ofdevelopment joint ventures, net, is generally related to land development andresidential activities. The tables below summarize our share of the activitiesof joint ventures for the three and six months ended June 30, 2005 and2004. The increases in our earnings for the three and six months ended June 30,2005 were primarily because of income from Sams Venture, LLC, higher salesmargin from Serrano, and the recognition of a $1.2 million profit participationfrom Parkway. Although our preference is generally to own property directly, wemay participate with other entities in property ownership through joint venturesor other types of co-ownership.

 
| ** **        | ** ** | **Three months ended June 30,  2005** | ** ** |
|-------------------|------------|--------------------------------------------|------------|
| **Projects**      | ** ** | **Lots/  Homes  Sold**                     | ** ** | **Sales/Loss** | ** ** | **Cost  of   Sales** | ** ** | **Gain   (loss)** | ** ** |
| ** **        | ** ** | **(In thousands, except  lots/homes)**     | ** ** |
| Talega  Village   |       | —                                     |       | $ | — |   | $ | — |   | $ | — |   |
| Serrano           |       | 23                                         |       | 19,348 |   | (15,184 | ) | 4,164 |   |
| Parkway (1)       |       | —                                     |       | 2,359 |   | (1,178 | ) | 1,181 |   |
| Sams Venture  (2) |       | —                                     |       | 1,306 |   | — |   | 1,306 |   |
| Other             |       | —                                     |       | — |   | — |   | — |   |
| Total             |       | 23                                         |       | $ | 23,013 |   | $ | (16,362 | ) | $ | 6,651 |   |

 
| ** **      | ** ** | **Three months ended June 30,  2004** | ** ** |
|-----------------|------------|--------------------------------------------|------------|
| **Projects**    | ** ** | **Lots/  Homes  Sold**                     | ** ** | **Sales** | ** ** | **Cost  of  Sales** | ** ** | **Gain  (loss)** | ** ** |
| ** **      | ** ** | **(In thousands, except  lots/homes)**     | ** ** |
| Talega  Village |       | —                                     |       | $ | — |   | $ | — |   | $ | — |   |
| Serrano         |       | 125                                        |       | 23,034 |   | (19,863 | ) | 3,171 |   |
| Parkway         |       | —                                     |       | 61 |   | 42 |   | 103 |   |
| Sams Venture    |       | —                                     |       | — |   | — |   | — |   |
| Other           |       | —                                     |       | 100 |   | 17 |   | 117 |   |
| Total           |       | 125                                        |       | $ | 23,195 |   | $ | (19,804 | ) | $ | 3,391 |   |

 
| ** **        | ** ** | **Six months ended June 30,  2005** | ** ** |
|-------------------|------------|------------------------------------------|------------|
| **Projects**      | ** ** | **Lots/  Homes  Sold**                   | ** ** | **Sales/Loss** | ** ** | **Cost  of  Sales** | ** ** | **Gain  (loss)** | ** ** |
| ** **        | ** ** | **(In thousands, except  lots/homes)**   | ** ** |
| Talega  Village   |       | —                                   |       | $ | — |   | $ | — |   | $ | — |   |
| Serrano           |       | 56                                       |       | 33,044 |   | (25,381 | ) | 7,663 |   |
| Parkway (1)       |       | —                                   |       | 2,422 |   | (1,189 | ) | 1,233 |   |
| Sams Venture  (2) |       | —                                   |       | 2,883 |   | — |   | 2,883 |   |
| Other             |       | —                                   |       | (42 | ) | — |   | (42 | ) |
| Total             |       | 56                                       |       | $ | 38,307 |   | $ | (26,570 | ) | $ | 11,737 |   |

 
| ** **      | ** ** | **Six**** ****months ended June 30, 2004** | ** ** |
|-----------------|------------|------------------------------------------------------|------------|
| **Projects**    | ** ** | **Lots/  Homes  Sold**                               | ** ** | **Sales** | ** ** | **Cost  of  Sales** | ** ** | **Gain  (loss)** | ** ** |
| ** **      | ** ** | **(In thousands, except  lots/homes)**               | ** ** |
| Talega  Village |       | —                                               |       | $ | — |   | $ | 588 |   | $ | 588 |   |
| Serrano         |       | 133                                                  |       | 27,552 |   | (23,636 | ) | 3,916 |   |
| Parkway         |       | —                                               |       | 93 |   | (96 | ) | (3 | ) |
| Sams Venture    |       | —                                               |       | — |   | — |   | — |   |
| Other           |       | —                                               |       | 100 |   | 17 |   | 117 |   |
| Total           |       | 133                                                  |       | $ | 27,745 |   | $ | (23,127 | ) | $ | 4,618 |   |

 

In 2003, we substantiallywound up operations in Talega Village. We expect to continue to reduce ourinvolvement in and earnings from development joint ventures over time.

 

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(1)          Parkway’s income was profit participationpayments received for home closings from third party homebuilders who hadpreviously purchased the lots from Parkway.

 

(2)          Sams Venture, LLC is currently recognizingrevenue by the percentage-of-completion method for a build-to-suit buildingproject which is under contract to be sold. The building is expected to be completed by the end of 2005.

 

***Interest Income***

 

Interest income increased$6.1 million and $11.7 million in our Core Segment for the three and six monthsended June 30, 2005 respectively, because of higher average note balances.This is attributable to the additional notes receivable of approximately $274.6million from the sale of the majority of our Non-Core assets in November of2004. Interest income increased $0.4 million and $0.9 million in our UROSegment for the three and six months ended June 30, 2005, respectively,because of higher cash flow from tax increments at Victoria-by-the Bay.

 

41

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***Other***

 

Other income consistsprimarily of lease termination fees and other miscellaneous income. Otherincome increased $0.7 million and $0.4 million in our Core Segment for thethree and six months ended June 30, 2005, respectively. The increase insix months of 2005 was primarily because in June 2005, we acquired theremaining interest in one of our operating joint ventures that owned andoperated an Embassy Suites Hotel. Earnings from this hotel’s operationsup to the acquisition date were previously reported in equity in earnings ofthe operating joint ventures, net.

 

Other income in our URO Segmentdecreased $0.8 million for the three and six months ended June 30, 2005,primarily because of the write-off of certain previously accrued liabilities in2004.

 

**Other Expenses**

 

***Interest Expense***

 

Following is a summary ofinterest expense:

 
| ** **               | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **               | ** ** | **2005**                             | ** ** | **2004**                           | ** ** | **Difference** | ** ** | **2005** | ** ** | **2004** | ** ** | **Difference** | ** ** |
| ** **               | ** ** | **(In thousands)**                   | ** ** | ** **                         | ** ** | **(In thousands)** | ** ** | ** ** | ** ** |
| Total  interest incurred |       | $                                    | 20,783     |                               | $          | 21,443 |   | $ | (660 | ) | $ | 42,035 |   | $ | 43,017 |   | $ | (982 | ) |
| Interest  capitalized    |       | (4,495                               | )          | (4,751                             | )          | 256 |   | (8,166 | ) | (10,572 | ) | 2,406 |   |
| Interest  expensed       |       | $                                    | 16,288     |                               | $          | 16,692 |   | $ | (404 | ) | $ | 33,869 |   | $ | 32,445 |   | $ | 1,424 |   |

 

Interest expense increased$1.4 million for the six months ended June 30, 2005, primarily because oflower capitalized interest as a result of decreased development activities. Weexpect capitalized interest to continue to decline due to the sale of asubstantial portion of our URO Segment assets in the fourth quarter of 2004.

 

***Real Estate Investment Trust (“REIT”)transition costs***

 

In 2003, we restructured ourbusiness operations in order to qualify as a REIT, effective January 1,2004. We have incurred conversion and related restructuring costs payable tothird parties. REIT transition costs are reflected in our URO Segment becauseof their non-recurring nature. We incurred REIT transition costs of $0.2million and $0.4 million for the three and six months ended June 30, 2004,respectively, primarily for consulting, legal, and tax services. We did notincur any additional costs after the second quarter of 2004.

 

***Other***

 

Other expenses consistprimarily of expenses related to previously capitalized costs, impairmentcharges, and other miscellaneous expenses. Other expenses for the three and sixmonths ended June 30, 2005 in our Core Segment increased $5.5 million and$7.0 million, respectively, primarily because of $6.8 million and $7.5 millionof impairment charges related to a rental building and certain tenantimprovements, which we expect to sell in 2005. When performing the impairmentreview, we consider capitalized interest and other expenses as costs ofdevelopment in cost projections; value from comparable property sales is alsoconsidered. The evaluation of future cash flows, discount rates, and fair valueof individual properties requires significant judgment and assumptions,including estimates of market value, lease terms, development absorption,development costs, lease up costs, and financings. Significant adverse changesin circumstances affecting these judgments and assumptions in future periodscould cause a significant impairment adjustment to be recorded. The increasesin our Core Segment for the three and six months ended June 30, 2005 werepartially offset by lower community facility district taxes and net real estateproperty taxes.

 

Other expenses in our UROSegment decreased $0.7 million and $1.1 million for the three and six monthsended June 30, 2005 primarily because of lower community facility districttaxes and net real estate property taxes.

 

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**IncomeTaxes**

 

 Currently, ourprojected annual current tax rate is 2.97% and deferred tax rate is 19.65% ascompared to the tax rates of 25.30% and (18.53)%, respectively, in 2004.  Our current tax rate decreased in the secondquarter 2005 compared to the second quarter of 2004 primarily due to costsexpected to be incurred with respect to the proposed merger.  The deferred tax rate increased primarily dueto reversing book deferred sales not recognized for tax purposes and certainmerger related costs related to stock compensation.

 

 The calculationof current taxes due involves the use of many estimates that are not finalizedand adjusted until our final tax returns are filed, usually in September ofthe following year.  Consequently, actualtaxes paid in regard to any given year will differ from the amounts shownabove; however, the differences have historically not been material, and arenot expected to be material in the future.

 

**Variability in Results**

 

Although our rentalproperties provide relatively stable operating results, our earnings fromperiod to period will be affected by the nature and timing of acquisitions andsales of property. Sales of assets are difficult to predict given fluctuatingeconomic conditions and are generally subject to lengthy negotiations andcontingencies that need to be resolved before closing. These factors may tendto “bunch” income in particular periods rather than producing a more evenpattern throughout the year or from year to year. In addition, gross marginsmay vary significantly as the mix of property varies. The cost basis of theproperties sold varies because (i) properties have been owned for varyingperiods of time; (ii) properties are owned in various geographiclocations; and (iii) development projects have varying infrastructurecosts and build-out periods.

 

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**Liquidity and Capital Resources**

 

***Off-balance sheet arrangements,contractual obligations, and commitments***

 

We have the followingoff-balance sheet arrangements, contractual obligations, and commitments, whichare discussed in various sections of the Condensed Consolidated FinancialStatements, Notes to Condensed Consolidated Financial Statements, and elsewherein Management’s Discussion and Analysis of Financial Condition and Results ofOperations. These arrangements exist in the following areas:

 

•                       Unconsolidatedreal estate joint ventures:

 

–Capitalcontribution requirements

 

–Debtand debt service guarantees

 

•                       Suretybonds, standby letters of credit and commitments

 

•                       Executedcontracts for construction and development activity

 

Generally any funding ofoff-balance sheet guarantees would result in the increase of our ownershipinterest in a project or entity, similar to the treatment of a unilateraladditional capital contribution to an investee.

 

*Unconsolidated real estate joint ventures- capitalcontribution requirements*

 

We have investments in nineunconsolidated real estate joint ventures, of which five joint ventures are inour Core Segment and the other four joint ventures are in our URO Segment.Three of the joint ventures are involved in the operation of rental real estateproperties and the remaining six are involved in real estate development forinvestment or sale. We use the equity method of accounting for eight of ourinvestments in unconsolidated joint ventures and the cost method of accountingfor one unconsolidated joint venture.

 

We arerequired to make additional capital contributions to four of our unconsolidatedjoint ventures should additional contributions be necessary to fund developmentcosts or operating shortfalls.

 

•  We are required to make additional capitalcontributions to two of the unconsolidated joint ventures should additionalcapital contributions be necessary to fund excess costs. Based upon the jointventure agreements, we are required to fund up to a maximum contribution of$52.0 million, of which we have cumulatively contributed $45.2 million. One ofthe joint ventures has substantially wound up operations and we do not expectto make any future capital contributions. As of June 30, 2005, we do not expect to fund any additionalcapital contributions beyond our maximum capital requirements to the otherjoint venture.

 

•  We agreed with two other unconsolidated jointventures to make additional contributions should there be insufficient funds tomeet their current or projected financial requirements. As of June 30,2005, we have cumulatively contributed $55.3 million to these unconsolidatedjoint ventures, including $24.0 million as additional contributions. As of June 30,2005, we are expecting to make additional contributions to SAMS Venture, LLC.

 

Additional contributionsmade to our development joint ventures would be reflected as investment indevelopment joint ventures. (*see*Note 8 of the accompanying Condensed Consolidated Financial Statements).

 

44

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*Unconsolidated real estate joint ventures- debt and debtservice guarantees*

 

We have made certain debtservice guarantees for one of our unconsolidated URO Segment development jointventures. At June 30, 2005, based on the joint ventures’ outstanding debtbalance, these debt service guarantees totaled $0.2 million. Debt serviceguarantees are typical business arrangements commonly required in real estatedevelopment. Examples of events that would require us to provide a cash paymentpursuant to a guarantee include a loan default, which would result from failureof the primary borrower to service the debt when due, or non-compliance of theprimary borrower with financial covenants and inadequacy of asset collateral.Our guarantee exposure is generally limited to situations in which the value ofthe collateral is not sufficient to satisfy the outstanding indebtedness. At June 30,2005, we have not been required to satisfy any amounts pursuant to these debtand debt service guarantees.

 

*Standby letters of credit and commitments*

 

As of June 30, 2005, wehave $52.7 million in outstanding standby letters of credit in favor of localmunicipalities or financial institutions, and $130.4 million in commitments toguarantee leases, the construction of real property improvements or financialobligations. The standby letters of credit are renewable and expire uponcompletion of the required improvements, and are a form of credit enhancementcommonly required in real estate development when bonds are issued to financepublic improvements.

 

*Executed contracts for construction and development activity*

 

At June 30, 2005, wehave open construction and development contracts with vendors totaling $69.8million related to our various projects, as compared to $108.3 million at December 31,2004. The following table summarizes our outstanding contractual obligations asof June 30, 2005, and the effect such obligations are expected to have onliquidity and cash flow in future periods:

 
| ** **                     | ** ** | **Payments Due by Period** | ** ** |
|--------------------------------|------------|----------------------------|------------|
| **Contractual Obligations**    | ** ** | **Total**                  | ** ** | **Due within  2005** | ** ** | **Due in  2006-2008** | ** ** | **Due in  2009-2010** | ** ** | **Due  Thereafter** | ** ** |
| ** **                     | ** ** | **(In thousands)**         | ** ** |
| Mortgage and  Other Debt       |       | $                          | 1,701,433  | (1) | $ | 220,523 |   | $ | 762,426 |   | $ | 129,897 |   | $ | 588,587 |   |
| Operating  Leases              |       | 3,018                      |       | 2,104 |   | 698 |   | 30 |   | 186 |   |
| Contracts                      |       | 69,828                     | (2)        | 64,293 |   | 5,535 |   | — |   | — |   |
| Total  Contractual Obligations |       | $                          | 1,774,279  |   | $ | 286,920 |   | $ | 768,659 |   | $ | 129,927 |   | $ | 588,773 |   |

 

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(1) Includesapproximately $412.6 million of future interest payable.

(2) A portion ofthese obligations is expected to be reimbursed by bond proceeds and variousthird parties.

 

Prior to the November 2004sales of a significant portion of our remaining urban and residentialdevelopment assets to FOCIL Holdings LLC (“FOCIL”), an affiliate of FarallonCapital Management, L.L.C. (*see*Note12), we had already negotiated on certain land asset sales and agreed toprovide acquisition financings, up to $164 million, to these third partypurchasers. A substantial portion of the money required to fund the $164million financing will come from the paydowns under the loans to FOCIL as partof the FOCIL transaction in November 2004. These land parcels wereultimately included as part of the assets sold to FOCIL. Therefore, as FOCILeventually finalizes the sale of these land parcels, we will provide thefinancing to these third party purchasers, as previously agreed. As of June 30,2005, we have financed $26.2 million on one of these sales.  During the second quarter of 2005, twoadditional sales were closed; however, approximately $23 million of theagreed-upon acquisition financings was not required. Therefore, subsequent tothe end of this quarter, the remaining agreed-upon acquisition financing isapproximately $115 million.

 

The following tablesummarizes our outstanding commitments as of June 30, 2005, and the effectsuch commitments may have on liquidity and cash flow in future periods:

 
| ** **                                 | ** ** | **Amount of Commitment Expiration  Per Period** | ** ** |
|--------------------------------------------|------------|-------------------------------------------------|------------|
| **Commitments**                            | ** ** | **Total Amounts  Committed**                    | ** ** | **Expire  within  2005** | ** ** | **Expire in  2006-2008** | ** ** | **Expire in  2009-2010** | ** ** | **Expire  Thereafter** | ** ** |
| ** **                                 | ** ** | **(In thousands)**                              | ** ** |
| Standby  Letters of Credit and Commitments |       | $                                               | 183,147    | (1) | $ | 94,272 |   | $ | 84,029 |   | $ | 1,979 |   | $ | 2,867 |   |
| Debt  Guarantees of Unconsolidated JVs     |       | 213                                             |       | 213 |   | — |   | — |   | — |   |
| Total  Commitments                         |       | $                                               | 183,360    |   | $ | 94,485 |   | $ | 84,029 |   | $ | 1,979 |   | $ | 2,867 |   |

 

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(1) Includesapproximately $34.3 million of commitments that have no specific expirationdates, which we have assumed to expire within one year for purposes of thistable. Excludes approximately $180.0 million of surety bonds for our own work,of which approximately $95 million has been indemnified by third parties.

 

45

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**Cash Flows from OperatingActivities**

 

Cash provided by operatingactivities reflected in the statement of cash flows for the six months ended June 30,2005, and 2004, were $206.6 million and $105.3 million, respectively. Theincrease of $101.3 million was primarily attributed to the following: (1) anincrease of $102.3 million due to higher payments received from our notesreceivable; (2) an increase of $23.2 million due to lower income tax paid;(3) and an increase of $4.8 million due to lower capital expenditures onour development properties partially offset by (4) a decrease of $25.0million due to lower cash proceeds from development sales of which our cost ofsales was approximately $14.6 million; (5) a decrease of $14.6 million dueto lower distributions from our joint ventures; (6) and a decrease of $1.8million due to higher interest paid.

 

**Cash Flows from InvestingActivities**

 

Net cash usedin investing activities reflected in the statement of cash flows for the sixmonths ended June 30, 2005 and 2004, were $107.4 million and $34.0million, respectively. The increase of $73.4 million in net cash used wasattributed to the following: (1) $44.4 million from lower investment inshort-term investments and restricted cash; (2) $25.3 million due tohigher property acquisitions primarily from the acquisition of a 278.4 acres ofdevelopable land in Elizabeth, New Jersey, Tracy, California and Douglas Hill,Georgia; (3) $14.0 million due to acquisition of the remaining interest inone of our operating joint ventures that owned and operated an Embassy SuitesHotel with 337 rooms; (4) $6.8 million due to lower proceeds from the saleof investment properties; (5) $2.3 million reimbursable predevelopment andinfrastructure costs received in 2004; (6) $1.5 million due to highercapital contributions made to our unconsolidated joint ventures; (7) $0.5million due to higher costs incurred for tenants, partially offset by (8) $21.4million due to lower capital expenditures for investment properties.

 

**Capital Expenditures**

 

Capital expendituresreflected in the statement of cash flows include the following:

 
| ** **                                                 | ** ** | **Six Months Ended June  30,** | ** ** |
|------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                 | ** ** | **2005**                            | ** ** | **2004** | ** ** |
| ** **                                                 | ** ** | **(In thousands)**                  | ** ** |
| **Capital  Expenditures from Operating Activities****(1)** |       |                                |       |   |   |
| Capital  expenditures for development properties           |       | $                                   | 18,977     |   | $ | 3,084 |   |
| Infrastructure  and other                                  |       | 3,371                               |       | 15,225 |   |
| Other  property acquisitions                               |       | 5,050                               |       | 11,842 |   |
| Capitalized  interest and property tax                     |       | 942                                 |       | 2,968 |   |
| Total  capital expenditures in operating activities        |       | 28,340                              |       | 33,119 |   |
| **Capital  Expenditures from Investing Activities****(2)** |       |                                |       |   |   |
| Capital  expenditures for investment properties            |       | 49,098                              |       | 53,067 |   |
| Rental  properties—building improvements              |       | 1,795                               |       | 1,544 |   |
| Predevelopment                                             |       | 993                                 |       | 3,285 |   |
| Infrastructure  and other                                  |       | 18,020                              |       | 32,870 |   |
| Commercial  property acquisitions                          |       | 42,627                              |       | 3,316 |   |
| Other  property acquisitions                               |       | 151                                 |       | 31 |   |
| Tenant  improvements                                       |       | 3,554                               |       | 3,042 |   |
| Capitalized  interest and property tax                     |       | 8,627                               |       | 9,313 |   |
| Capital  expenditures for investment properties            |       | 124,865                             |       | 106,468 |   |
| Contribution  to joint ventures                            |       | 2,130                               |       | 600 |   |
| Total  capital expenditures in investing activities        |       | 126,995                             |       | 107,068 |   |
| Total  capital expenditures(3)                             |       | $                                   | 155,335    |   | $ | 140,187 |   |

 

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(1)                   This categoryincludes capital expenditures for properties we intend to build and sell.

(2)                   This categoryincludes capital expenditures for properties we intend to hold for our ownaccount.

(3)                   Total capitalexpenditures include capitalized general and administrative expenses of $5.5million and $6.0 million for the six months ended June 30, 2005 and 2004,respectively.

 

46

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*Capitalexpenditures for development properties*—This item relates to the development of ourfor-sale development properties. The increase was primarily due to higherconstruction activity of build to sell projects in Minooka, Illinois, Fontana,California and Manteca, California.

 

*Capitalexpenditures for investment properties*—This item relates primarily to development of new properties held forlease. This development activity is summarized below (in square feet):

 
| ** **                                  | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                  | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                  | ** ** | **(In thousands)**                    | ** ** | **(In thousands)**                  | ** ** |
| **Development**                             |       |                                  |       |                                |       |   |   |   |   |
| Wholly  owned:                              |       |                                  |       |                                |       |   |   |   |   |
| Under  construction, beginning of period    |       | 3,536                                 |       | 2,979                               |       | 3,791 |   | 4,404 |   |
| Construction  starts                        |       | 2,414                                 |       | 499                                 |       | 2,414 |   | 905 |   |
| Completed—retained  in portfolio       |       | (500                                  | )          | (1,492                              | )          | (603 | ) | (3,255 | ) |
| Completed—design/build  or sold        |       | (335                                  | )          | (1                                  | )          | (487 | ) | (69 | ) |
| Subtotal  under construction, end of period |       | 5,115                                 |       | 1,985                               |       | 5,115 |   | 1,985 |   |
| Joint  Venture Projects:                    |       |                                  |       |                                |       |   |   |   |   |
| Under  construction, beginning of period    |       | 527                                   |       | 695                                 |       | 527 |   | 695 |   |
| Construction  starts                        |       | —                                |       | 338                                 |       | — |   | 338 |   |
| Completed                                   |       | —                                |       | —                              |       | — |   | — |   |
| Subtotal  under construction, end of period |       | 527                                   |       | 1,033                               |       | 527 |   | 1,033 |   |
| Total under  construction, end of period    |       | 5,642                                 |       | 3,018                               |       | 5,642 |   | 3,018 |   |

 

*Predevelopment*—Predevelopment costs from our operating andinvesting activities relate to amounts incurred for our development projects,primarily the Pacific Commons project in Fremont, California; Ontario andTracy, California; the Robert Mueller Airport project in Austin, Texas; andvarious other projects in the predevelopment stage.  Our predevelopment costs for 2005 were lowerbecause in the fourth quarter of 2004, we sold a majority of our Mission Bayproject in San Francisco, California; the Alameda project in Alameda,California; and the West Bluffs project in Playa Del Rey, California to FOCIL.

 

*Infrastructureand other*—Infrastructureand other costs from our operating and investing activities primarily relate tothe projects at Pacific Commons in Fremont, California; Los Angeles UnionStation in Los Angeles, California; Santa Fe Depot in San Diego, California;Carteret, New Jersey; Woodbridge, New Jersey; Fontana, California; Austin,Texas; and Minooka, Illinois.  Ourinfrastructure and other costs for 2005 were lower because in the fourthquarter of 2004, we sold a majority of our Mission Bay project in San Francisco,California; the Alameda project in Alameda, California; and the West Bluffsproject in Playa Del Rey, California to FOCIL.

 

*Operatingactivity property acquisitions*—For the six months ended June 30, 2005, we invested approximately$5.1 million for the acquisition of 102.1 acres of land in Elizabeth, NewJersey that was subsequently sold.

 

*Investingactivity property acquisitions*—For the six months ended June 30, 2005, we invested approximately$42.6 million in investing activity property acquisitions:  $25.8 million for the acquisition ofcommercial land, which added 5.0 million square feet of potentialdevelopment.  We also acquired theremaining interest in one of our joint ventures which owned a hotel with 337rooms in June of 2005 for approximately $14.0 million.

 

**Cash Flows from FinancingActivities**

 

Net cash usedin financing activities reflected in the statement of cash flows for the sixmonths ended June 30, 2005 and 2004, were $290.0 million and $76.6million, respectively.  The increase of $213.4million in net cash used was attributed to the following: (1) $165.5million due to lower net borrowings during the six months ended June 30,2005; (2) $46.8 million increase due primarily to a special dividenddistribution as a result of the sale of a majority of our URO assets to FOCILin November 2004; and (3) $1.1 million due to lower proceeds from theissuance of common stock primarily attributable to the exercise of stockoptions.

 

47

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**Reimbursable Predevelopment andInfrastructure Costs**

 

For the six months ended June 30,2005, we incurred approximately $3.0 million of reimbursable predevelopment andinfrastructure costs.

 

**REIT-related Distribution andQuarterly Dividends**

 

On May 4,2005, our Board of Directors declared a regular cash dividend for the quarterended June 30, 2005, of $0.27 per share of common stock, or $28.0 million,that was paid on July 15, 2005 to stockholders of record at the close ofbusiness on June 28, 2005. Subsequently, on July 27, 2005, our Boardof Directors declared a regular cash dividend for the quarter ending September 30,2005, of $0.27 per share of common stock payable on August 30, 2005, tostockholders of record at the close of business on August 16, 2005. TheCompany expects to continue to declare and pay regular quarterly dividends of$0.27 per share until the proposed merger with ProLogis is completed (*see* “ - The Company” of this Management’sDiscussion and Analysis of Financial Condition and Results of Operationssection).  The actual amount of thedividends will be as determined and declared by our Board of Directors and willdepend on the Company’s financial condition, earnings, and other factors, manyof which are beyond the Company’s control. Pursuant to the merger agreement with ProLogis, the Company agreed thatthe record date for the distribution of the Company’s quarterly dividends willbe the same as the record date for the distribution of the quarterly dividendsfor ProLogis common shares.

 

In December 2004,our Board declared a regular cash dividend for the quarter ending December 31,2004, of $0.27 per share of common stock, or $27.9 million, and a specialdividend of $0.45 per share of common stock, or $46.5 million, that were paidon January 18, 2005. Cash dividends of $0.27 per common share for thefourth quarter 2003 and the first, second, and third quarters of 2004 and firstquarter of 2005 were paid on January 15, 2004, April 15, 2004, July 15,2004, October 15, 2004, and April 15, 2005; respectively.

 

On September 9, 2004,our Board of Directors declared a regular cash dividend for the quarter ending September 30,2004, of $0.27 per share of common stock that was paid on October 15,2004, to stockholders of record at the close of business on September 27,2004.

 

On May 5, 2004, ourBoard of Directors declared a regular cash dividend for the quarter ending June 30,2004, of $0.27 per share of common stock that was paid on July 15, 2004,to stockholders of record at the close of business on June 28, 2004.

 

On February 11, 2004,our Board of Directors declared a regular cash dividend for the quarter ending March 31,2004, of $0.27 per share of common stock that was paid on April 15, 2004,to stockholders of record at the close of business on March 29, 2004.

 

On December 3, 2003,our Board of Directors declared a regular cash dividend for the quarter ending December 31,2003, of $0.27 per share of common stock that was paid on January 15,2004, to stockholders of record at the close of business on December 29,2003.

 

**Cash Balances, AvailableBorrowings, and Capital Resources**

 

As of June 30, 2005, wehad total cash of $74.1 million, of which $12.9 million was restricted cash. Inaddition to the $74.1 million cash balance, we had $189 million in borrowing capacityunder our revolving credit facility, available upon satisfaction of certainconditions.

 

Our short-term and long-termliquidity and capital resources requirements are derived primarily from fivesources: (1) cash on hand, (2) ongoing income from our rentalportfolio, (3) proceeds from sales of developed properties, land andnon-strategic assets, (4) a revolving line of credit with a total capacityof $200 million, and (5) additional debt. As noted above, our existingrevolving credit facility is available for meeting certain short-term liquidityrequirements. Our ability to meet our mid- and long-term capital requirementsis, in part, dependent upon the ability to obtain additional financing for newconstruction, completed buildings, acquisitions, and currently unencumberedproperties. There is no assurance that we can obtain this financing or obtainthis financing on favorable terms.

 

*Debtcovenants*—Our $200million revolving credit agreement and one other credit agreement, of $40.5million, have corporate financial covenants including a minimum fixed chargecoverage ratio of 1.30 to 1, a maximum leverage ratio of 0.65 to 1, a maximumsecured indebtedness ratio of 0.50 to 1*, anda minimum tangible net worth of*$452.8 million, all terms as definedin those agreements. As of or for the period ending June 30, 2005 theactual results were 1.97 to 1; 0.53 to 1; 0.38 to 1; and $756.4 million,respectively. Outstanding borrowings under the revolving credit facility aresubject to a borrowing base consisting of various categories of assets. At June 30,2005, we had unused availability of $189 million under the line. Ourperformance against these covenants is measured on a quarterly basis, withfixed charge and debt service coverage ratios being measured on a four-quartertrailing basis. In the event we were to breach any of these covenants and wereunable to negotiate satisfactory waivers or amendments, our lenders in thesecredit facilities could declare amounts outstanding due and payable.

 

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***Bonds***

 

*AssessmentDistrict Bonds*—Thesebonds were issued through local municipalities to fund the construction ofpublic infrastructure and improvements, which benefit our properties. Debtservice on these bonds is collateralized by tax revenues, properties, or byletters of credit (*see* Note 8 ofthe accompanying Condensed Consolidated Financial Statements). These bonds arerecorded and presented as part of “Mortgage and other debt” in the accompanyingCondensed Consolidated Balance Sheet at June 30, 2005 (*see* Note 5 of the accompanying CondensedConsolidated Financial Statements). Certain infrastructure costs incurred arereimbursable from these bonds.

 

The following table presentsa summary of assessment district bonds that are included in the accompanyingCondensed Consolidated Balance Sheet at June 30, 2005 (in thousands exceptpercentages):

 
| ** **                | ** ** | **Amount** | ** ** | **Interest  Rate** | ** ** | **Cost  Incurred** | ** ** | **Cost  Reimbursed** | ** ** |
|---------------------------|------------|------------|------------|-------------------------|------------|-------------------------|------------|---------------------------|------------|
| **Development Projects**  | ** ** | ** ** | ** ** | ** **              | ** ** | ** **              | ** ** | ** **                | ** ** |
| Stapleton                 |       | $          | 22,745     |                    | 2.38       | %                       | $          | 19,809                    |       | $ | 18,760 |   |
| Kaiser                    |       | 10,575     |       | 5.83                    | %          | 19,157                  |       | 19,157                    |       |
| Westminster               |       | 9,140      |       | 2.38                    | %          | 4,758                   |       | 4,758                     |       |
| Rancho  Cucamonga         |       | 5,547      |       | 6.14                    | %          | 5,222                   |       | 5,222                     |       |
| Subtotal                  |       | 48,007     |       |                    |       | 48,946                  |       | 47,897                    |       |
| **Operating  properties** |       |       |       |                    |       |                    |       |                      |       |
| City of  Industry         |       | 4,663      |       | 7.87                    | %          | —                  |       | —                    |       |
| Emeryville                |       | 4,442      |       | 7.29                    | %          | —                  |       | —                    |       |
| Various  others           |       | 3,419      |       | 4.00-8.70               | %          | —                  |       | —                    |       |
| Subtotal                  |       | 12,524     |       |                    |       | —                  |       | —                    |       |
| Total                     |       | $          | 60,531     |                    |       |                    | $          | 48,946                    |       | $ | 47,897 |   |

 

*CommunityFacility District Bonds*—Thesebonds were issued to finance public infrastructure improvements at PacificCommons in Fremont, California and were not required to be recorded in ouraccompanying Condensed Consolidated Balance Sheet. These bonds have a series ofmaturities up to thirty years. Upon completion of the infrastructure improvements,for which $30 million of bonds were issued, the improvements will betransferred to the City of Fremont. Of the total cumulative reimbursable costincurred, approximately $11.7 million have been reimbursed as of June 30,2005, $80,000 was received in 2005. The remaining balance of $13.8 million ispresented in “Other assets and deferred charges, net” in the accompanyingCondensed Consolidated Balance Sheet at June 30, 2005. The $13.8 millionwill not be requested for reimbursement until the facility components arecompleted, inspected, and approved by the City of Fremont. Additional bonds areexpected to be issued.  Subsequently, on July 21,2005, an additional $38.0 million of Community Facility District Bonds weresold.

 

At Pacific Commons, developedand designated developed property is taxed first, and any shortfall in annualdebt service is paid by a tax on project vacant land.

 

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**Tax Audit**

 

***State Tax Audit***

** **

In 2002, the State of California FranchiseTax Board (“FTB”) began auditing a joint venture relating to our redemption in1999 of our interest in a real estate partnership formed by our predecessorrailroad company**. **In March 2004 we wereverbally notified that an audit adjustment was forthcoming.  Under California law (which differs fromfederal tax law) the tax in question was only deferred and was paid in 2003 aspart of our REIT conversion. We made the FTB aware of that fact.

 

In late February of 2005, we received anAudit Issue Presentation Sheet  (“AIPS”)which is a formal outline summarizing the FTB’s position with respect to thistransaction including their intention to assess substantial penalties.  Catellus will have the ability to respond tothis AIPS prior to the FTB issuing a formal “proposed adjustment.”   Based on the AIPS, if we were unsuccessfulthe maximum current potential exposure could be up to approximately $10million.  Catellus intends to vigorouslycontest the FTB’s position with respect to this transaction as well as the assessmentof any penalties.

 

In 2002, the FTB notified Catellus that itwould audit the corporate tax returns of Catellus for the years 1999 and 2000.In June of 2004, the FTB notified us that they would also audit the 1999and 2000 tax returns of a mortgage REIT subsidiary. Both audits are in process.No significant audit adjustments have been proposed with respect to thecorporate tax returns of Catellus. In June of 2005, we received an AIPSsummarizing the FTB’s position with respect to the mortgage REIT subsidiarytransaction disallowing deductions for “consent dividends” under Californiastate law.  The AIPS communicates the FTB’sintention to assess penalties.  Catelluswill have the ability to respond to this AIPS prior to the FTB issuing a formal“proposed adjustment.”   Based on theAIPS, if we were unsuccessful the maximum current potential exposure could beup to approximately $11.2 million. Catellus intends to vigorously contest the FTB’s position with respectto this transaction as well as the assessment of any penalties.

 

***IRS Audit***

 

In March 2003, we received notice thatthe Internal Revenue Service (“IRS”) intended to audit the 1999 tax returns ofCatellus and a mortgage REIT subsidiary. In the third quarter of 2003, the IRSinformed us it would also audit the 2000 returns as well as the returnsrelating to the real estate joint venture under audit by the FTB discussedabove.  In the third quarter of 2004, wewere notified the IRS would audit the 2001 and 2002 returns. In December 2004,the IRS issued requests for information relating to our tax deferred exchangesfor the years 1999-2002. In February 2005, we were told of the IRSintention to request an extension of these open tax years from September 2005to September 2006.    We havegranted that request.

 

No audit adjustments have been proposed. TheIRS has asked for all documents relating to the following issues:

 

1.   Charitable contributions deductions for thetransfer of certain properties where the appraised fair market value was inexcess of the consideration received,

2.   Tax treatment of thedeductions of interest paid to a mortgage REIT subsidiary,

3.   A redemption of our interestin a real estate partnership (described above), and

4.   Tax deferred exchanges ofreal property.

 

All but the first issue above resulted in asubstantial portion of the deferred taxes created during the time we operatedas a taxable C-corporation. At the time of our REIT conversion, as we expectedto no longer be taxed at the REIT level for REIT operations, we reversedapproximately $232 million in deferred taxes into income at year end 2003. Atthe same time, in part because of the ongoing audit described above, we took acharge to current taxes which total $124 million of the $232 million. The $124million charge to current taxes relate to the federal and state tax impact ofcertain of the above issues.  The amountsabove do not include any provision for possible interest and penalties.

 

If the audit results in an adjustment and ifthe Company exhausts all available remedies to contest the adjustment (ordecides not to contest such adjustment), then our provision above may not besufficient to cover the exposure and such adjustment could negatively impactour liquidity, statement of operations, and/or balance sheet.

 

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**Related Party Transactions**

 

The entities below areconsidered related parties because the listed transactions are with entities inwhich we have an ownership interest. There are no affiliated persons involvedwith these entities.

 

We provide development andmanagement services and loan guarantees to various unconsolidated joint ventureinvestments. Fees earned were $0.2 million and $0.4 million for the three andsix months ended June 30, 2005, respectively, primarily from SAMS Venture,LLC. Fees earned were $0.3 million and $1.2 million for the three and sixmonths ended June 30, 2004, respectively, primarily from Third and KingInvestors, LLC, with the remainder primarily from SAMS Venture, LLC. Deferredfees of $1.5 million primarily from SAMS Venture, LLC, Serrano Associates, LLC,and Bergstrom Partners, L.P. at June 30, 2005, will be earned as completedprojects are sold or the venture is sold or liquidated. In 2004, we sold ourinvestment in Third and King Investors, LLC.

 

In 2001, we entered into a 99-yearground lease with one of our unconsolidated joint venture investments, Thirdand King Investors, LLC. Rent and reimbursable payments of $1.3 million and$2.5 million were received and recognized as rental income during the three andsix months ended June 30, 2004, respectively. This joint ventureinvestment was sold in 2004.

 

We have a $4.6 millioncollateralized 9.0% note receivable from an unconsolidated joint venture, EastBaybridge Partners, LP, for project costs plus accrued interest. The note iscollateralized by property owned by the joint venture and matures in October 2028.We have entered into various lease agreements with this unconsolidated jointventure. As lessee, rent expense was $34,000 for each of the three-monthperiods ended June 30, 2005 and 2004, and $68,000 for each of thesix-month periods ended June 30, 2005 and 2004. This lease will expire in November 2011.As lessor, we entered into a ground lease, which will expire in August 2054.We earned rental income of $0.1 million for each of the three-month periodsended June 30, 2005 and 2004, $0.2 million for each of the six-monthperiods ended June 30, 2005 and 2004, and have recorded a $2.8 millionreceivable and a $1.3 million reserve associated with this lease. The venture’scurrent projection reflects approximately $0.2 million available funds, peryear, to pay down this receivable.

 

In January 2004, wesold our 45% investment interest in Colorado International Center, an unconsolidatedjoint venture, for our capital investment balance of $0.3 million to an entitywhose principal was a former Company employee.

 

**Partnership Accounting**

 

At June 30, 2005, wehold significant variable interests in three variable interest entities that donot qualify for consolidation under the provisions of FASB Interpretation No. 46-R,“Consolidation of Variable Interest Entities – an interpretation of ARB No. 51”.Our significant variable interests are in the form of equity interests in twoof our unconsolidated joint ventures and our participation in a masterdevelopment agreement:

 

• Bergstrom Partners, L.P. was formed inJanuary 2003 to redevelop and market 624 acres of land at a former missiletest site in Travis County, Texas. No further contributions are required.

 

• SAMS Venture, LLC was formed in January 2003to initially develop a new 545,000 square foot office park for the Los AngelesAir Force Base, convey that property to the United States Air Force in exchangefor three parcels of land totaling 56 acres and other consideration, andfinally either sell or develop for sale the three parcels. Our exposure willincrease should this joint venture require additional contributions from ourjoint venture partners.

 

• A Catellus subsidiary entered into amaster development agreement with the City of Austin, Texas in December 2004to redevelop and market the property formerly known as the Robert MuellerMunicipal Airport.  Our exposure willincrease should public financing and sales revenues be insufficient to meetcurrent or projected financial requirements.

 

• Our exposure in the current financialstatements as a result of our involvement with these variable interest entitiesis $17.5 million as of June 30, 2005.

 

51

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**Environmental Matters**

 

Many of our properties andour subsidiaries’ properties are in urban and industrial areas and may havebeen leased to or previously owned by commercial and industrial companies thatdischarged hazardous materials. We and our subsidiaries incur ongoingenvironmental remediation and disposal costs and legal costs relating to cleanup, defense of litigation, and the pursuit of responsible third parties. Costsincurred by the consolidated group in connection with operating properties andwith properties previously sold are expensed. Costs incurred for properties tobe sold by us or our subsidiaries are capitalized and will be charged to costof sales when the properties are sold (*see*Note 8 of the accompanying Condensed Consolidated Financial Statements forfurther discussion).

 

In recent years, certain ofour subsidiaries have acquired properties with known environmental problems forcleanup and redevelopment, and we expect that we may continue to formsubsidiaries to acquire such properties (or that existing subsidiaries willacquire such properties) when the potential benefits of development warrant.When our subsidiaries acquire such properties, they undertake due diligence todetermine the nature of the environmental problems and the likely cost ofremediation, and they manage the risk with undertakings from third parties,including the sellers and their affiliates, remediation contractors, thirdparty sureties, or insurers. The costs associated with environmental remediationare included in the costs estimates for properties to be developed.

 

 We own an interest in a limitedliability company of a residential project near Sacramento, California.****** At June 30, 2005, the book value of ourinvestment is approximately $17.6 million and the terms of the investmentrequire additional contributions from the members should there be insufficientoperating funds (*see* Note 8,Commitments and Contingencies). The project is located in a county known tocontain naturally occurring asbestos in native rock material. The EPA hasconducted studies for potential risks associated with asbestos exposure fromthe native rock materials at various locations, including at a school site thatis adjacent to our project, and the EPA has concluded that its initial exposurestudy raises further concerns. At this time we do not know if the results ofthe studies will have any adverse impact on the project, and the ultimateimpact to our financial statements is undeterminable.

 

**Forward-Looking Information andRisk Factors**

 

This report may contain orincorporate statements that constitute forward-looking statements within themeaning of Section 27A of the Securities Act of 1933, as amended, and Section 21Eof the Securities Exchange Act of 1934, as amended, and, as such, involve knownand unknown risks, uncertainties and other factors which may cause our actualresults, performance or achievements to be materially different from futureresults, performance or achievements expressed or implied by these forward-lookingstatements.

 

In some cases you canidentify forward-looking statements by terms such as “anticipate,” “project,” “may,”“intend,” “might,” “will,” “could,” “would,” “expect,” “believe,” “estimate,” “potential,”by the negative of these terms, and by similar expressions. Theseforward-looking statements reflect our current views with respect to futureevents and are based on assumptions and subject to risks and uncertainties,many of which are beyond our ability to control or predict. You should not putundue reliance on any forward-looking statements. These forward-lookingstatements present our estimates and assumptions only as of the date of thisreport.

 

Important factors that couldcause actual results to differ materially and adversely from those expressed orimplied by the forward-looking statements include:

 

•                  those identifiedin our annual report on Form 10-K for the fiscal year ended December 31,2004 under the following headings: **RisksRelated to Real Estate Investments, Other Risks Affecting Our Business andOperations, and Federal Income Tax Risks Relating to REIT Qualification;**

 

•                  failureto obtain the approval of stockholders of the Company and ProLogis to theproposed merger under the definitive merger agreement between the Company andProLogis that was announced on June 6, 2005, which failure would result inthe company having incurred substantial expenses and (under certaincircumstances) payments without realizing the expected benefits of the mergerand which could result in other business disruptions, adverse effects onrelationships with business partners and adverse market reactions;

 

•                  adversechanges in the real estate markets, including, among other things, competitionwith other companies and risks of real estate development, acquisitions anddispositions;

 

•                  governmentalactions and initiatives (including legislative and regulatory changes);

 

•                  otherrisks inherent in the real estate business; and

 

•                  actsof war, other geopolitical events, and terrorist activities that couldadversely affect any of the above factors.

 

The above list of factors that may affectfuture performance and the accuracy of forward-looking statements isillustrative but by no means exhaustive. Therefore, all forward-lookingstatements should be evaluated with the understanding of their inherent riskand uncertainty. Except for our ongoing obligation to disclose materialinformation as required by federal securities laws, we do not intend to updateyou concerning any future revisions to any forward-looking statements toreflect events or circumstances occurring after the date of this report.

 

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**Item 3. Quantitative and Qualitative Disclosures aboutMarket Risk**

 

Our primary market riskexposure is interest rate risk as our financial instruments are not subject toforeign exchange rate risk or commodity price risk. We continuously andactively monitor and manage interest costs on our debt and may enter intointerest rate-protection contracts based on changing market conditions. At June 30,2005, we did not have any interest rate protection contracts outstanding.

 

As of June 30, 2005,approximately 88.7% of our debt bears interest at fixed rates and has aweighted average maturity of 5.2 years and a weighted average coupon rate of6.65%. The interest rate risk for fixed rate debt does not have a significantimpact on the Company until such debt matures and may need to be refinanced.Our variable rate debt has a weighted average maturity of 4.0 years and a weightedaverage coupon rate of 4.47%. To the extent that we incur additional variablerate indebtedness, we increase our exposure to increases in interest rates. Ifthe coupon interest rate increased 100 basis points (1%), the annual short-termeffect would be an increase in interest expense and capitalized interest cost,which would have an impact on our cash position of approximately $0.7 million,based on the outstanding balance of our floating rate debt net of cashinvestments and restricted cash at June 30, 2005. We believe that moderateincreases in interest expense as a result of inflation will not materiallyaffect our financial position, results of operations, or cash flow.

 

As of June 30,2005, approximately $10.0 million of our $236.2 million of notes receivablecarry interest at variable rates. If interest rates on these variable noteschange 100 basis points (1%), the annual effect will be a change in ourinterest income of approximately $0.1 million. We believe that the moderatechange in interest income will not materially affect our financial position,results of operation, or cash flow.

 

**Item 4. Controls and Procedures**

 

The Company’s management,with the participation of the principal executive officer and principalfinancial officer, has evaluated the effectiveness of the Company’s disclosurecontrols and procedures (as defined in Rules 13a-15(e) or 15d-15(e) underthe Securities Exchange Act of 1934), and the principal executive officer andprincipal financial officer have concluded that the Company’s disclosurecontrols and procedures are effective as of June 30, 2005. No changes inthe Company’s internal control over financial reporting occurred during thequarter ended June 30, 2005 that have materially affected, or arereasonably likely to materially affect, the Company’s internal control overfinancial reporting.

 

**PART II OTHER INFORMATION**

 

**Item 1. Legal Proceedings**

 

The Company is subject tolawsuits, certain governmental proceedings (including environmental actions),and various environmental remediation orders of local governmental agencies, ineach case arising in the ordinary course of business. Although the outcome ofthese lawsuits or other proceedings against the Company and the cost ofcompliance with any governmental order cannot be predicted with certainty,management does not expect any of these matters to have a material adverseeffect on our business, future results of operation, financial condition, orliquidity.

 

Although the Company is aparty to routine proceedings incidental to its business, the Company is not aparty to, nor is its property the subject of, any material pending legalproceeding, except as provided below.

 

On March 12, 2002, theDepartment of Toxic Substances Control of the State of California (“DTSC”)notified the Company of an investigation of the Company, its generalcontractors, and subcontractors working for such general contractors,concerning the Mission Bay project. The investigation was initiated primarilyfor purposes of determining whether individuals and companies hauling soilwithin and from Mission Bay satisfied certain hazardous wastelicense/certification hauling requirements. The DTSC issued notices ofviolation, without fines or penalties, to the Company and one subcontractor on May 23,2002, citing the subcontractor’s failure to qualify as a registered hazardouswaste hauler. In June 2005, the DTSC notified the Company that the DTSCinvestigation had been closed and that the DTSC would not be pursuing anyenforcement action.

 

Also *see* Note 8, “Commitments andContingencies,” of the accompanying Condensed Consolidated FinancialStatements.

 

**Item 2. Unregistered Sales of Equity Securities andUse of Proceeds**

 

None.

 

**Item 3. Defaults Upon Senior Securities**

 

None.

 

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**Item 4. Submission of Matters to a Vote of SecurityHolders**

 

 At the Company’s annual meeting ofstockholders held on May 3, 2005, the stockholders voted on threeproposals.  The proposals and votingresults are listed below.  Voting was confidential,and the votes were tabulated by an independent inspector of election.

 

**Proposal 1.  Election of Nine Directors.** All ofthe directors of the Company are elected annually.  All nine nominees were elected as directors.

 
| **DIRECTOR**           | ** ** | **FOR**    | ** ** | **WITHHELD** | ** ** |
|------------------------|------------|------------|------------|--------------|------------|
| Peter K.  Barker       |       | 91,172,353 |       | 70,961       |       |
| Stephen F.  Bollenbach |       | 86,085,313 |       | 5,158,001    |       |
| Daryl J.  Carter       |       | 91,175,253 |       | 68,061       |       |
| Richard D.  Farman     |       | 91,172,299 |       | 71,015       |       |
| Christine  Garvey      |       | 90,975,857 |       | 267,457      |       |
| William M.  Kahane     |       | 91,175,169 |       | 68,145       |       |
| Leslie D.  Michelson   |       | 90,973,441 |       | 269,873      |       |
| Deanna W.  Oppenheimer |       | 91,174,642 |       | 68,672       |       |
| Nelson C.  Rising      |       | 90,915,899 |       | 327,415      |       |

 

**Proposal 2.  Ratification of Appointment ofPricewaterhouseCoopers LLP as Independent Auditors for 2005.**

 
| **For**    | ** ** | **Against** | ** ** | **Abstain** |   |
|------------|------------|-------------|------------|-------------|--------|
| 89,370,787 |       | 1,832,012   |       | 40,514      |   |

 

**Proposal 3.  Approval of Amended Policy RegardingStockholder Rights Plans.**

 
| **For**    | ** ** | **Against** | ** ** | **Abstain** |   |
|------------|------------|-------------|------------|-------------|--------|
| 90,833,765 |       | 324,039     |       | 85,509      |   |

 

There were no broker non-votes on any of thethree proposals.

 

**Item 5. Other Information**

 

None.

 

**Item 6. Exhibits**

 

See Exhibit Index.

 

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**SIGNATURES**

 

Pursuant to the requirementsof the Securities Exchange Act of 1934, Catellus Development Corporation hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 

 
|                             |   | CATELLUS DEVELOPMENT  CORPORATION                                                                     |
|----------------------------------|--------|-------------------------------------------------------------------------------------------------------|
|                             |   |                                                                                                  |
|                             |   |                                                                                                  |
|  Date: August 5,  2005 | By:    | /s/  C. WILLIAM HOSLER                                                                                |
|                             |   | C.  William Hosler  Senior Vice President and  Chief Financial Officer  (Principal Financial Officer) |
|                             |   |                                                                                                  |
|                             |   |                                                                                                  |
|  Date: August 5,  2005 | By:    | /s/  EDWARD F. SHAM                                                                                   |
|                             |   | Edward  F. Sham  Vice President and Controller  (Principal Accounting Officer)                        |

 

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**EXHIBIT INDEX**

 
| **Exhibit No.** |   |                                                                                                                                                                                                                                                                                             |
|----------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.1                  |   | Agreement and Plan of Merger dated June 5,  2005, by and among ProLogis, Palmtree Acquisition Corporation and Catellus  Development Corporation (“Catellus”). (Incorporated by reference to Exhibit 2.1  to Catellus’ Form 8-K filed on June 8, 2005.)        |
| 10.1                 |   | Amendment No. 2 to Amended and  Restated Memorandum of Understanding Regarding Employment executed on June 5,  2005, by and between Vanessa L. Washington and Catellus. (Incorporated by  reference to Exhibit 10.1 to Catellus’ Form 8-K filed on June 8,  2005.) |
| 31.1                 |   | Certification by the Chief Executive  Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                    |
|                 |   |                                                                                                                                                                                                                                                                                             |
| 31.2                 |   | Certification by the Chief Financial  Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                    |
|                 |   |                                                                                                                                                                                                                                                                                             |
| 32.1                 |   | Certification by the Chief Executive  Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                    |
|                 |   |                                                                                                                                                                                                                                                                                             |
| 32.2                 |   | Certification by the Chief Financial  Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                    |

 

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