Highwoods Properties Inc (HIW) 2002 Q3 法說會逐字稿

Good day ladies and gentlemen and welcome to the Highwoods Properties Third Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session and instructions will follow at that time. As a reminder this conference call is being recorded. I would like to introduce the host of your call, Carmen Liuzzo, Chief Financial Officer. You may begin.

Good morning, everyone. What I would like to do first before turning the call over to Ron is go through the customary safe harbor statement. And even before that if any participant on the call has not received a copy of our third quarter press release or a copy of our third quarter supplemental package we inside you to visit our web side at www.highwoods.com or call 919-875-6717 and we will fax or email a copy to you.

This conference call will include forward-looking statements concerning the company's operation and financial continue including the effect of tenant bankruptcy, estimates of asset dispositions, and contributions to joint ventures, the reinvestment of disposition and joint venture proceeds, share repurchase activity, the cost and timing of development projects, rollover rents, occupancy forecasts, expense and revenue trends and funds from operations. Such forward-looking statements are subject to various risks and uncertainties in the company's operations and business environment. Actual results could differ materially from those currently anticipated due to a number of factors, including those identified in the bottom paragraph of the earnings release and in the company's annual report on form 10K for the year ending December 31, 2001 and other documents subsequently filed with the SEC. The company assumed no obligation to update statements that become untrue because of subsequent events. I would like to turn the call over to Ron Gibson.

Thank you, Carman. Good morning, everyone. Welcome to our third quarter call. Obviously, Carman is on the call with me today as is Ed Fritsch, our Chief Operating Officer. I would like to open the call this morning with our view of the economy, WorldCom, US Airways and our strategy for the balance of the year as well as next year. Ed will then discuss our real estate markets, leasing development operations and Carman will review financial information for the quarter and provide guidance for the remainder of '02 and all of '03, then as usual, we will close with Q and A.

Let me begin this morning with our view on the economy. In short, nothing has really changed for the better since last quarter there continues to be an absence of meaningful job growth in our core markets and obviously without growth, our markets continue to produce negative absorption of office space. This quarter, the absorption in our top five office markets was a negative 1.5 million square feet compared to 1.4 million last quarter and negative 600,000 square feet in the first quarter of '02. Direct vacancy rates moved up about 60 basis points to about 16%. With each of those five markets those markets include Tampa, Research Triangle, Nashville, Atlanta and Richmond registering a vacancy rate of 15% or more.

As we said on our call last quarter, it feels like the bottom, but unless we begin to see positive job growth, we will likely see negative absorption. Ed will cover our leasing efforts in detail later but I want to tell you that in my view, this is one of the toughest leasing markets I have ever seen, both in terms of volume and deal terms. But I also think it is really important to bear in mind as tough of a these conditions are they are certainly not unprecedented. We have got a very experienced management team here at Highwoods, worked through several down cycles before, we know how to do it and we are certainly committed to coming out of this one on top. Obviously these market conditions color our results this quarter, recurring FFO of 85 cents per share, 10.5% below last year and also color our forecast for the fourth quarter and for next year.

Just take a minute to talk about our strategy. Since we spoke last quarter, our strategy hasn't changed, while our long-term goal is to deliver maximum profitability and FFO growth, our near term strategy obviously due to the existing economic environment is focused on prudently managing our business, preserving and securing occupancy and protecting our balance sheet as well as maintaining financial flexibility. We continue to focus on blocking, tackling and managing our organization through these challenging times and most importantly, we continue to emphasize occupancy and I can't repeat that enough. We continue to emphasize occupancy, occupancy, occupancy. We also have the objective of reducing our debt level in short, we’re looking to protect our balance sheet during these tough times and certainly a priority for us.

We are pleased with our capital recycling efforts year-to-date, closed transactions totaling $116m and during the quarter, we also sold an 80% interest in a 250,000 square foot office property in Tampa, which valued the property at $38.5m or $18 per square foot and that is the highest valuation ever realized in the Tampa marketplace. We also have an additional $162m assets under contract, the majority which we expect to close later this year or early in '03. All of these transactions are at very attractive pricing and clearly demonstrate our ability to create value. We will utilize the proceeds first to pay down debt, secondly, we’ll evaluate share repurchases and/or acquisitions after considering the importance of financial flexibility.

I want to move on to talk about WorldCom and US Airways and yesterday's press release, we provided updated information on our exposure to both WorldCom and U.S. air. Let me tell you what we know today. Both WorldCom and U.S. Airways are current on rent payment through November of '02 with the exception of 12 days of pre-bankruptcy petition, rent about $185,000 due from U.S. Airways. And WorldCom has rejected a small lease, approximately 3600 square feet and hasn't notified us of their intentions related to the 983,000 square feet they lease from us on the 13 other separate leases. U.S. Airways also, hasn't indicated which of the leases will be accepted or rejected, if any, by the court, and while we can't accurately predict how and when this will be resolved, we can tell that you we are planning around a loss of about to 1m square feet of space currently leased by WorldCom and U.S. Airways.

Next I would like to take a minute to talk about our dividend. The past several years, we have worked very diligently to bring our cash available for distribution payout ratio t a very, very low level. For the last several years that dividend payout has averaged less than 80% of CAD. For nine months ended September 30th, the payout ratio was 80% in this quarter and increased to approximately 90%. We have stated previously that our occupancy would have to reach a level of 82 to 83% for the dividend to equal 100% of CAD, however, given than 3% of our occupancy loss next year is likely to result from the office leases with above average rents currently occupied by WorldCom and U.S. Airways, our payout ratio most likely will approach 100% at an 83 to 84% occupancy level.

So, let me summarize a probable scenario for next year. Given our expectations for core portfolio occupancy of approximately 86 to 87% for ‘03 and then factoring in a loss of a substantial portion of the WorldCom and U.S. Airways rent, coupled with higher recurring tenant improvement and leasing commission costs, we anticipate our payout ratio will likely reach 100% for '03. Accordingly, protecting and maintaining our current dividend level is, and will remain our highest priority. With that I would like to turn the call over to Ed Fritsch.

Thank’s, Ron. As indicated an as everyone knows it is all about occupancy right now therefore, my comments will focus on third quarter leasing activity, our expectations for the fourth quarter and our 2003 forecast. Our in service occupancy for the quarter ended September 30, increased slightly from 86.2% last quarter to 86.7% this quarter. Much of the increase can be traced to Charlotte-based 345,000 square foot industrial lease we signed during September and pushed the increase in our industrial portfolio from 83.5% last quarter to 86.2% at September 30. On September 30 of last year, our industrial portfolio was 92.3% occupied.

Office occupancy for the quarter declined slightly from 86.7% last quarter to 86.3$ while our Kansas city-based retail remains extremely strong and stable at 95.4% leased, actually up 30 points over this time last year. As depicted in our supplemental package and press release, leasing activity for the quarter was relatively consistent with the volume of leasing we completed in the second quarter, which was almost double the square footage we executed during the last quarter of 2001 and the first quarter of this year.

During the quarter, we executed 184 office leases totaling 882,000 square feet and the capital expenditures required for these leases ran $1.66 per square foot per year of the lease term, which is an increase over last quarter by 24 cents but lower than the four quarter trend of $1.75. Concessions averaged 22 cents per square foot per year, which is up from last year's level of 14 cents per square foot, with the average office lease having a lease term of 3.6 years. As you know, our methodology for reporting rent growth is very conservative. The calculation we use is the “All in last year's cash rent paid compared with first year rent with rental concessions taken into consideration”. Using this measure, third quarter office rents declined by 10.2%. Using a straight line rent comparison, the average represent for the new deals was 2% higher than the straight line rate on old basis on the old deals, which is the GAAP comparison.

On the industrial side, we leased 593,000 square feet below average capex and average lease term of 1.6 years, however it is to be noted that the approximately half of the 593,000 square feet leased was for a term of less than one year, netting this out the average term was over 3 years. Cash rents, using a conservative measure fell 6.3% and on a GAAP basis, percentage decline was about 1.5%. Last quarter we communicated on this call we were cautiously optimist about achieving an 88% average occupancy for calendar year 2002 and a December 31 occupancy rate of 89%. Today, another three months behind us an the year quickly come to be a close, our average occupancy target for 2002 is now closer to 87% as opposed to the 88% and year end occupancy is forecast as a hold at our present day mid-86% level. While we are actively signing leases that would have got us very close to our stated target, we simply have not been able to execute them with November and December 2002 start dates. While on the surface it appears that the opportunities are ample, we continue to find that with each significant success comes an announced decision by the user to postpone the deal and place it on the back burner or we encounter an unpredictable contraction or a deal that simply doesn't make sense. However, we have signed leases totaling 1.5 million square feet, with fourth quarter 2002 lease commence dates and with this level of leasing activity, we will at a minimum, maintain our current occupancy level.

We have currently signed deals with 2003 commencement dates representing about 10% of next year's 4.6 million square feet of exposure. As I'm sure you know, our average customer is relatively small and next year's expirations involve nearly 700 leases averaging 6,500 square feet per deal. 569 of those leases are office and average less than 6,000 square feet. Based upon our preliminary budget, we are forecasting 2003 occupancy, and again, before any reductions for WorldCom and/or U.S. Airways, to remain flat with this year at approximately 87% plus or minus 1%. Also, ours asset repositioning efforts will have a slight negative impact on occupancy as the projects that are currently in the hopper for disposition have an average occupancy level of 92%. Our development pipeline now totals 884,000 square feet, with an anticipated total investment of less than $100m. These projects, with the exception of one, were started in 2002 and are currently 24% pre-leased. Recently, we have seen increasing interest in these projects, particularly in the 568,000 square feet of completed but not stabilized office projects, by users ranging in size from 5,000 to 100,000 square feet. We are currently in negotiations on a number of leases for these project and encouraged by -- that by next quarter, we will be able to have our pre-lease on a completed but not stabilized office development pipeline, triple from its current level of 17% to plus or minus 50% pre-leased. As you would expect, these large deals are very competitive but our people are working hard and smart to distinguish our products, services and lease terms from that of the competition in order to security best possible deals for Highwoods.

Consistent with what we reported last quarter, our best markets remain Richmond and Kansas City and we are seeing marked improvement in Nashville. While the Research Triangle, Atlanta and Tampa remain our most challenging markets. A few of the takeaways from the market surveys as follows. The occupancy of our portfolio and our top five markets continues to outperform the overall market by 300 basis points. Sublease space in our top five market which is 38% higher than third quarter last year is about 4-plus of inventory. Statistically, the volume appears to be stabilizing, but what we are seeing at the beginning of these leases expiring and the vacant sublease space is simply moving to the direct market vacancy column. Sublease space can be tough to lease for the landlord or the existing leaseholder but continues to be an intimidating market factor as prospects and brokers use the sublease offerings as a negotiation whip.

There is no new development to speak of in the existing development pipelines and our top five markets represent about 1% of inventory. Absorption has been negative for the past four quarters, asking rates in our markets are approximately 10 to 15% lower than -- 10 to 15% than prior year. In closing my comments, I want to underscore that our people remain focused they leverage every opportunity they can unearth. While we obviously can’t have influence on this unpredictable economy and uncertain state of warfare, I can assure you that everyone on our team is doing all they can on behalf of our shareholders I'm extremely proud of the focus, tenacity and positive “we’ll find a way” attitude they bring to their jobs every day. Carman?

Thank’s, Ed. What I would like to do this morning is first cover the nonrecurring charges that impacted FFO for this quarter. Next, we’ll review a handful of income statement trends, cover a couple of relevant items from the balance sheet, and then close with some color for our guidance for the fourth quarter and 2003.

First let’s talk about the nonrecurring items. As you all know, we have an excellent disclosure track record that we are proud of. And given that philosophy we have provided ample disclosure in the press release discussing these items. The first item relating to nonrecurring compensation expense, a charge of $3.7m, or $0.6 per share. This charge related to how we administered our option program in the past. In the past when an option holder elected to exercise options, in lieu of issuing new shares upon the exercise and then repurchasing shares on the open market, we settled the option exercise by paying the option holder the net difference in cash between the [inaudible] and the market value of the underlying shares. We believe that was an efficient way to administer our share buy back program. This is, again, nonrecurring, and we believe no impact on our operational cash flow.

The second item related to litigation and those items or this charge arose from certain claims related to prior years' mergers and acquisitions which became probable and [estimatable] this quarter. And, therefore, accruable under generally accepted accounting principles. These claims were not known at the time of the various mergers and represented a very small percentage, less than a half of one percent of their respective purchase prices. Without the effect of these two items on FFO, we recorded FFO per share of 85 cents, as Ron mentioned, down 10% from the prior year’s 95%. This FFO was lower than our expectation due to lower occupancy, slightly lower land sale gains and lease termination fees, and lower FFO generated from our various joint ventures, offset by lower G&A expenses. All of these various items were equal contributors to the short fall.

Next I would like to reference our income statement, which is on page 1 of the supplemental package, first table to the press release. Operating expenses this quarter totaled 31.6% of rental revenues up from the prior year’s number of 30%. This is a reflection of lower occupancy and a fixed component of operating expenses that remain in our expense structure. Going forward, I think this number will set in the 31 to 32% range, for the last quarter of this year and 2003.

Capitalized interest this quarter totaled $1.7 million, down from last year's level significantly. As Ed mentioned our development pipeline is much [lower] therefore, our capitalized number has declined and will decline further into '03 and will approach zero unless we start new development. A G&A run rate that I would like to put on the table is $5 to 5.5m per quarter. Our number this quarter was $4.1 million, down from last quarter’s $5.5m, but if you look at the prior year third quarter number, it represented 3.6% of revenues this quarter's number, 3.4% of revenues. We had lower variable costs primarily incentive compensation in both of those two quarters.

Interest and other income $2.6 to 2.8m is the expected run rate for that line item and then lastly, I mentioned, the equity and earnings of our joint ventures, I believe a $2m equity and earnings number is appropriate, as you will see, that number this quarter was $1.2 almost $1.3m.

Next, just a couple of points on the balance sheet. We have successfully reduced our debt level this quarter by over $49m and our credit facility is now less than half drawn, at a balance of about $150m. As I'm sure you know, next year, we have $246m of bonds that mature in December. The first year that we have had substantial maturities and we are planning around those maturities today and our expectation is that we would fund those mature with a combination of asset sales, secured debt and unsecured debt, depending on their respective costs and our capital structure as we move into next year. Based upon the average interest rate of about 7.5% on the debt that matures late next year, we really don't see material upside or dilution from our refinancing transactions.

Lastly, I would like to highlight the guidance we provided in the earnings announcement and before doing so like to say as I have heard on other calls it is awfully early, given the uncertainty, to be talking about this, but going to put our best estimate on the table today based upon the budget information that we have in our view of the real estate markets for next year. And we had in the press release provided you with our view of WorldCom and WorldCom and U.S. Airways, and these numbers, the range for next year reflect a million square feet of vacancy from a combination of WorldCom and U.S. Airways and a reduction of approximately 30 cents in funds from operation. What we have assumed there is that million square feet is out of our portfolio and not rent producing for all of next year.

For the fourth quarter, we assume we have collected rent through November from both companies and we assume that our forecast that we will not collect December’s rent. Again, as we said in the release, we do not know one way or the other, but these estimates include rent for those two months and not the third. Our estimate for the fourth quarter is a range of 82 to 84 cents based upon the occupancy guidance that Ed discussed and the impact of one month of WorldCom and U.S. Airways rent being out at the 70% level or equivalent of 1m square feet. For next year, December 31, 2003, our estimates are 320 to 330 per share. Again, reflecting a 30 cent reduction on average for WorldCom and U.S. Airways, which is again just to reiterate this, 1m square feet of space which represents about 70% of their square footage out of our numbers for the full year. With that, operator, I would like to open up the call to questions.

Thank you. If you have a question at this time, please press the 1 key on your touchtone telephone. If your question has been answered or wish to remove yourself from the queue, press the pound key. Now a question from Gregory Whyte of Morgan Stanley.

Hi, Good morning guys, Carmen, can you talk a little more about the [inaudible] reduction here for the comp expenses, you're calling nonrecurring. Can you talk about how you would handle the option exercise going forward.

Sure, Greg, thanks. What we plan on -- what we will do with options going forward is the option hold letter pay the company the proceeds based upon [the option price] and the number of shares and will be issued the shares directly. At that time if we elect to buy shares back in the market, we will buy the snares the open market but not from the option holder. And that is how we plan to administer the program going forward.

I mean obviously, I can't expect you to give guidance of what that might be but there will be a -- there could be some sort of a recurring expense?

Greg there will not be. If we administer the program under that method, there will not -- well there will not be compensation expense under APB 25. As we mentioned on the last call, under FAS 125 there is option expense we indicated would be a charge next year based upon the implementation of that pronouncement, which we mentioned would be approximately a penny a share. In '03 from accounting for options under the fair market value method, using [inaudible] and administering it on a prospective basis. This is separate from that I want to make sure that is clear. This under APB 25 with an Interpretation Number 44, is what generated this expense, not the implementation we talked about on last quarter's call.

Okay. Just changing tack a little bit, there were no buy backs effectively in the third quarter and Ron you said that proceeds from sales and stuff you would use to address balance sheet issues first. Can you maybe give us Parham terse, starting where do you need to see the balance sheet get to before you would start thinking about buy backs again?

Greg this is Carman. Let me address that like to put it first in the context of the disposition and repositioning numbers that Ron mentioned in his prepared remarks. If we are in the upper end of that range, meaning we complete what we have in the held for sale category today which is, call it $160m. If we were to exceed $100m and anywhere between $100 and 160m and our share prices that are at the depressed level today, we would use the proceeds of the surgery to buy back stock.. I think in doing so, you would see our debt level which is today at about 46% of assets, it would be down in the, you know, 45, 44, 45 level and at that time, begin evaluating the share buy back.

Okay. Then on the leasing side, I mean, you did get some color on the one industrial lease which obviously sort of reduced the average term on that, could you give a little color – it seem like a fairly significant amount of space to sign a lease for such short period of time?

Sure, this is Ed. Basically, the customer is dependant upon a contract with a vendor and they [were] in a position where they could commit long-term, they’re in negotiations, actually with their supplier for a distribution system and as soon as they reach agreement with them, then they will sit back down with us and discuss a revised and extended term.

You would expect to maybe turn that out a little longer?

Yes, within first quarter of '03 we will be addressing that with them. We didn't want to say, no you know it is either long-term or you're gone in that they were in a bit of abeyance with their customer.

And Carmen, assuming that dish think you said lease termination fees were lower in third quarter. Can you tell us exactly what that number was?

Yes, the number was approximately $800,000 dollars compared to about $700,000 a year ago and what we have experienced at a trend level of $1.2 to 1.4m per quarter. Just to understand this, last quarter, it was a low number as well. So our trend level going forward of lease termination fees we expect to be between 800 and $1m and not 1.2 to 1.4. So, we’ve revised the trend for term fees down modestly.

Then just real quick, I appreciate the extra color on WorldCom and U.S. Airways. The million square feet in total, if we want to try to understand what the sort of --the worst case scenario and that is you are saying the 30 cent reduction for the million square feet, what would that FFO reduction be if we saw them reject all of the space that they have with you?

Greg, an additional 10 to 12 cents.

All right. Thanks a lot, guys.

Thank you, Greg.

Next question from Steve Cannon (ph.) of News and Observer.

Hi there, guys. I had two questions I was looking at. One is if I think I -- if I got the numbers right, the cash available for distribution that you guys were putting out to the dividend was -- I think it was 80% for the third quarter and that is a lot higher -- was it previously 65%? Was it 65% the second quarter?

Steve, let me help with you that we -- again the two numbers here are cash available for distribution for the nine months, 80% and that approximated the trend for the company for the last several years. 80% [inaudible] I think 65% you are referring to is on an FFO basis. This quarter for three months, again, sometimes it is hard to look at trends just on a three-month basis, was 90%.

Now but -- you guys are expecting that -- that will actually increase in the coming quarters?

Yes. Steve this is Ron. As I have said in my remarks, we think given the situation with WorldCom and U.S. air and the occupancy level we anticipate on the remaining portfolio that we will approach, likely approach 100% of CAD and obviously, the last thing that we want to do is cut our dividends, so, I would just tell you, should we exceed 100% of CAD, there is a range of payout ratio in excess of 100% within which we believe it would be prudent to fund the dividend, either through asset sales or borrowing or potentially a combination of both. To put a little color with that a 1% change in the path equals about $1.3m. Obviously if and when we get to that point, the extent to which we would fund the dividend in excess of 100% of CAD, it would certainly depend on our view of general economic conditions and lease up opportunities within our markets.

So if you felt good about the economy, felt like things might get better sooner then you might actually pay out more of your CAD, you might pay out more than 100% of your CAD for the dividend?

Just a full dividend.

Just to beef up –

Meet our dividend.

I got it okay. And is there anything specifically you can do to try to -- I guess it all comes down how much money is coming in but anything you can do to try to get that cushion back on the CAD?

Well, you know that and obvious things. Obviously, it would be materially beneficial if we can improve occupancy, which we are working on. We also have a capex budget that we need to manage carefully and obviously, we can eliminate some discretionary capital expenditures and another obvious one is we could reduce our overhead and expenses. They are the obvious ones, Steve.

The other thing was looking at occupancy, trying to figure out -- I figure over the next two years, you guys probably have a -- I don't know what percentage of your leases would be rolling over the next two years. I guess I was going to try to find out whether you guys are doing anything now to try to keep those people signed up in your building?

That’s part of our daily mantra, Steve. People are working on lease expirations today where a customer will entertain discussions with us that expire in '04 and '05 as well as '03.

Okay. Great, thanks very much.

Thank you.

Next question from Gary Boston of Salomon Smith Barney.

Good morning. Carmen I was on the rollover for '03, I had a couple of questions. The leases signed during the quarter I think were average cash rent of about 1620 for the first year. Which is a little bit below the roll – at least I’m looking at the office sector first. 1620 is that a pretty good number to sort of model in nest year.

Gary this is Ed. It’s really driven heavily by the mix of property that’s in there and we have a various range of office products from low B to a high C and it depends on what rolled and what hit in that particular quarter that drives that number.

I guess, okay -- in terms of the rolls for next year, you gave us occupancy expectations what’s the expectation on what happens to the rent?

We would expect somewhere in the neighborhood of a 10 to 15% rollout.

And that’s across office and industrial?

I think that is fair.

Gary just to make sure that 10% to 15% is a cash number based on the way Ed mentioned in his remarks, factors in any concession period. I would also point to our rental rate comparison on page 15. This quarter, we added the GAAP number on a property type and market basis which is the straight line rent under the old yield to the straight line rent under the new deal, which helps smooth the concession and is really what we will run through FFO.

So if I look at the spread there, given the 10 to 15% roll down on the cash basis, looking somewhere down 1% to up 2% maybe?

Yeah, I would say -- I think it is fair.

And Gary, and everyone, I think haw take away from this page 15 is that although we are having to give up concessions, also being very successful in negotiating contractual rent increases and think our leasing efforts, you know, have been very solid there and we are making up some of that through, you know, aggressive contractual ( inaudible ) that we are able to negotiate with the customers.

Right. In terms of again on the '03 roll. Looking at the pace of leasing this quarter and last quarter, I think it was pretty consistent in office, I’m not sure on the industrial side. I mean is that --using those run rates and looking at the roll just for the '03 roll looks like doesn’t take into account what’s left in ’02, there might be at least on the industrial side some pickup on occupancy it looks like you pretty much covered the ’03 leasing on the office runs there might be some pick up on the industrial side is there something wrong in that sort of methodology in terms of looking at the current run rate versus what you have got rolling over?

Gary, I think the only aspect of that we need to stay sensitive to is what occurs with the one lease that was 345,000 square feet on the ten-year term that we signed. That was a bit of an anomaly for us, because our industrial doesn't typically run that big and to have a hit of that size was a HELLUV a success but we don't anticipate seeing more of that size activity, we don't market that type of product.

So, the 593 number is probably not a good run rate?

If you go to the right side of the page that 643 I would say would be a bit on the high end on page 13.

Okay. Finally on the –back on the comp thing Carmen, is there no adjustments – is this just something that would just happened for the first half of this year or would a change in the accounting [inaudible] so there is n retroactive restatement of prior year’s as a result [of this] . . ..

No.

OK. Great.

It’s John, but I had a question as well. Is there anything in the office leasing you did the third quarter the 882,000 square feet that is unusual or you think that is a pace that is sustainable, similar to the question on industrial but some unusual stuff happening in the industrial?

John this is Ed. Liked at that pretty closely and don't see anything an [outlier], consistent with what we did in the second quarter we are certainly hopeful we are not reverting back to what we saw in fourth quarter last year, first quarter this year and this is a run rate we can sustain. We are monitoring the showings that our brokers, are having and the deal flow and we are optimistic it is a solid number there and no anomaly with that.

You had cited, I don't know if I got this right at the beginning of the call, there was negative absorption in the quarter of 4.5m square feet in your market, is that what you said?

No I think Ron was quoting those numbers in our top five markets there is about a million five that was total negative absorption. To break it down basically Atlanta was the big hit. We took about a negative 2.4m square feet there, Raleigh was a negative half million, Richmond was negative half million and Nashville and Tampa were basically flat for the quarter.

The pace of the negative absorption has been accelerating all year?

It depends on the market. In Atlanta, in the first quarter, they had positive absorption, certainly if the last two quarters very consistent with fourth quarter last year at a million one to a million three. In Nashville, you know, they have bumped along basically flat to some positive absorption. Raleigh has gotten worse. You are right on that score. It has gotten from around 100 up to now two and a quarter. In Richmond it is -- has been relatively consistent, about 100 a quarter, Tampa has been the most sporadic. Where in the first quarter it was about negative 266 then a positive 115 in the second quarter then a positive 79 in the third quarter.

Now, [inaudible ] your current leasing pace holds, you should be able to hold occupancy, how can you do that in the face of negative absorption in your markets are you just being much more competitive on rent? Is there a difference in quality or this negative absorption going to catch up to you?

We are hoping this is going to start to cut back some, in some of these markets, we have demonstrated that the we can do that in Richmond where you know, the vacancy in the market now is almost 16% and, you know, we are at 5, 5.5% vacant. We are outperforming the market by 300 basis points and we are trying to leverage ourselves from being [the] better provider of service in most of these mid-tier mark that is we are in. Atlanta is really the only exception of that, we have the good fortune of being we are the large dog on the porch. And I think that gives us a very positive leasing aspect when a customer comes to us in these uncertain times and says I am not in a position to commit to being locked into this amount of space for a ten-year term and we go to them and we say, look, we own, for example, in Raleigh, 65 buildings that are all in the same fee simple title and if you get to a point were you need to expand beyond what you're in now, we can accommodate that, more so than other landlords who have 25 to 5% of the market that we have. We also have more office parks, I think, than a lot of our competition, that offers connectivity between buildings where there is growth opportunities, synergies there and lastly, we have touched on this before and I hope people don't interpret it as a gimmick, I think it is real, those customers interested in service after sale, we positioned ourselves and very few other landlords have particularly in the mid-tier markets, we can evidence how we respond to our customers. When service request came in, when we arrived on the job, when we closed out the job. If that is important to them the way they run their business, employee satisfaction, the way they occupy our facilities, we are all over it.

I guess, the short lease term is probably attractive as well. Another question, did you guys scrub your numbers this quarter? Is that why this comp issue came up? Should we feel now there is not going to be more issues like this because did you scrub the numbers?

Hey, John, just on the short lease term, you are right, I just -- I just want to say that -- on deals where we are signing it well below market, we think it is prudent for us to sign a shorter term deal as opposed to locking in a longer term, because we’re hopeful in three to four years this thing is going to turnaround and we’re going to be back to signing some decent leases, so, in some cases, we are making the election to push it toward a shorter term.

John?

Yeah.

It was part of the normal interim work and I mean we believe our numbers are clean, if it’s something that we just frankly missed under the financial accounting Interpretation Number 44 and I wouldn't take anything more from it, that it’s is a recurring trend it is not.

Did you – was there any extra scrutiny that was applied given the certification you guys have to make now in sort of going back and revisiting a lot of your accounting treatments or --?

I think in the normal course we do that, we have a very active audit committee and you know we spent time, you know, through the certification process reviewing everything but we don't believe that the certification drove this at all. But again we are spending time diligently reviewing the numbers and, you know, the option numbers that we have exercised in the past have historically been very, very, very low.

Okay. Thank you.

Next question from Zenin (ph.) Newmark (ph.), a Private Investor.

Good morning. I have two questions. One assuming that the 2003 earnings and the occupants is as you indicated, $3.20 per year and occupancy of 86%, can we -- can you single any reason why the dividend would be lowered in 2003?

This is Carmen. Again, what Ron emphasized in his remarks was that those levels, we would -- be approaching 100% payout and he also said our first priority is to protect and maintain the dividends. In answer to your question, based upon what we know today and those numbers, the answer would be no.

You do not see any reason why to lower it?

Again, based upon those forecasts and our estimates of capital expenditures and what we expect WorldCom and U.S. Airways for next year, sitting where we are today, no.

Okay. Second question. In the third quarter, can you tell me if any of your officers have bought or sold shares in Highwoods Properties?

I don't know exactly during the third quarter, but again what’s been filed in the new two day filing, it’s all public, I think there has been purchases during the during the quarter, in particular by I believe a couple of directors and I think maybe one officer.

Okay, thank you. And finally one more question, what is negative absorption?

Negative absorption is basically the net effect of the total amount of space that is occupied within that market has contracted as opposed to expanded.

I see. Thank you very much, sir.

You are welcome.

Next question from Stuart Seeley, UBS Warburg.

Good morning. The ’03 guidance it seems as though the big step down from the current run rate of FFO is $18 or 19 bucks a foot on a million square feet for WorldCom and U.S. Airways, [and that are more or less, call them the whales] in terms of bad dept and early lease exits. What are your thoughts of sort of run of the mill bad debt and early lease exits, what were they in the third quarter and what do you expect in the fourth quarter, and what are you budgeting for 2003.

Yeah Stuart our current goal in the reserves on that I can tell you that in the third quarter, we only saw one event, it was an approximate 50,000 square foot industrial user in Atlanta. Carmen do you want to talk about . . ..

[inaudible] in terms of forecast for occupancy next year, we have factored in some contraction. I would say it’s probably half a percentage point of the portfolio and that is -- that has been what we have experienced this year except for as you refer to them “the whales”. And then as you step back to maybe an appropriate [segment] just to talk about our reserves. I mean we have a reserve on our books right now that is in excess of our 90 day and over receivables and we also feel that we are adequately reserved on our straight line rent.

Did you take any additional reserves this quarter?

Yes we did we increased the reserves by about a half a penny a share. I’ve got 30, I mean 300 almost $400,000.

Thank you very much.

Thanks, Stewart.

Next question from Chris Carlin (ph.), Krestral Investment.

Good morning. Could you go over your outlook with respect to a share repurchase? You mentioned that you considered doing it in conjunction with option exercise. Is that the only situation in which you are planning on repurchasing stock going forward?

This is Carmen. Let me explain how we have executed the program over the past couple of years. We first executed our share buy back program on a leveraged neutral basis. We have sold in excess of $2b of assets and bought in the mid-200 million range of shares. You know, going forward and given these uncertain economic times, we think it is important to protect the balance sheet first, preserve financial flexibility, particularly when you’re at a 100% expected payout on CAD. If you were to outperform on the asset repositioning front, meaning you sell more assets than expect or get near the top of the range and your share prices remain at a discount to [NAV] which we believe we are today then we would deploy the excess proceeds to a share buy back.

Okay. So, clearly, any -- at least for 2003 any buy back activity has to come from asset sales . . ..

As it has in the past. We have not borrowed, we have not borrowed to buy back shares and will not do that.

Okay, then where do you draw the line then in terms of the use of asset sale proceeds to either be directed towards share repurchase or property acquisition?

Okay, let me go through the decision tree. Witness you get to a debt level of say the mid-40s, which we’re approaching, getting close to that, then you look at the return on un-leveraged return if you will on a share buy back versus the un-leveraged return on the assets. We have to have an asset transaction today that would have to return north of 11.5%, possibly 12 un-levered, for that to make sense economically. Now we have certain assets we sell that require us to do tax deferred exchanges and then economics maybe doesn't factor in there, we would have to match an asset but on just run-of-the-mill asset purchases, we would have to see returns much higher than we are seeing in the marketplace today for that to make sense. Assets are not trading out there 10% or more, at least what we are seeing hitting our core strategy.

That is what I would expect. So, effectively, especially considering that the shares repurchased in the past were at much higher levels than today, I imagine the priority from asset sales, given that it is cash available to you and not a tax deferred exchange, the first use would be share repurchase is that accurate?

Yes, I think it would be --I think that’s the appropriate way to look at that have to be a damn compelling asset acquisition for us to go after it versus a share buy back.

What is the target for asset sales in 2003?

$161m under contract today. I think the guidance for next year would be the low end of what we have done this year, probably $75 to 100m.

$75 to 100m additional . . . .

Over what we have in the pipeline right now.

Is the target.

And you would expect a meaningful portion of that to go towards share repurchase?

I can't -- um, I mean if we were to hit the 161 they would have under held for sale and contract today, letter of intent [inaudible] do another 75, [400] [inaudible] I think it is fair to say a portion of that would go to a share buy back.

Very well, thank you.

This concludes the question and answer session. I now would like to turn the program back to you.

Okay ladies and gentleman we appreciate you being part of our call and as usual we invite you to call us directly for questions we can field for you one-on-one. Thanks again for being part of the Highwood’s call.

Ladies and gentlemen this concludes today's conference call. Thank you for participation. You may disconnect at this time and have a good day.