Highwoods Properties Inc (HIW) 2003 Q1 法說會逐字稿

Good morning. My name is Phyllis, and I will be your conference facilitator. At this time, I would like to welcome everyone to the Highwood Properties 2003 first quarter earnings conference call. As a reminder, this call is being recorded today, April 25th 2003. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. If you would like to ask a question during this time, simply press star, then the number 1 on your telephone keypad. If you would like to withdraw your question, press star, then the number two on your telephone keypad. Thank you. I will now turn the call over to Ms. Tabitha Zane, director of investors relations. Thank you.

Thank you. Good morning, everybody. Welcome to Highwood Properties first quarter conference call, on this call are Ron Gibson, Chief Executive Officer, Ed Fritsch, Chief Operating Officer, and Carman Liuzzo, Chief Financial Officer. If anyone on this call has not received a copy of our first quarter press release or supplemental package, please visit or website at www.highwoods.com or call 919-875-6717, and we'll fax or e-mail a copy to you.

Before we begin, I would like to remind you this conference call will include forward-looking statements concerning the company's operations and financial conditions, including estimates of asset dispositions and contributions to joint ventures, the reinvestment of disposition and joint venture proceeds, discussion of share repurchase activity, the cost and timing of development projects, rollover rents, occupancy expense, and revenue trends and funds from operation. Such statements are subject to various risks and uncertainties. Actual results could differ materially from those currently due to a number of factors, including those identified in the company's annual report on Form 10-K for the year ended December 31st, 2002. The company assumes no obligation to update or supplement forward-looking statements that become untrue because of subsequent events. I will now turn the call over to Ron Gibson.

Thanks, Tabitha. Good morning, everyone. Two months ago on our fourth quarter conference call, we indicated that signs we were seeing were pointing to some stabilization in many of our markets. Initial reports showed unemployment declining in January, and the number of white collar workers hired increasing 1.6% from the fourth quarter and a full 2% from a year ago. We saw positive net absorption in our top five markets for the first time in over a year and we had leased 1.6 million square feet, which was a record amount of leasing activity, compared to the previous four quarters. We had also signed leases for 2.5 million square feet of space with '03 starts, representing about 43% of our total lease expirations for the year. All indications pointed to a year that, while remaining challenging, was beginning to show some signs of improvement.

As you know, our company, as well as the entire office [REIT] industry continues to be plagued by rising unemployment and slumping economic trends, and you can see from our results that our markets remain weak. Although we leased two million square feet in the quarter, which is a 25% sequential increase, there was further erosion in our portfolios' occupancy in nine of our 11 markets. At the end of March, occupancy in our in-service portfolio was 83.2%, which was a decline of about 80 basis points from the fourth quarter. Tenant improvements and concessions while lower than last quarter, continued to take a bite out of our cash flow, and first-year cash rents in our office portfolio declined by 7.5%, which was at the high end of our range. Three of our top five markets reported negative absorption, with Atlanta and Raleigh-Durham experiencing the greatest decrease in occupancy. Atlanta alone went from a slightly positive net absorption in the fourth quarter to a negative absorption of 1.3 million square feet. So over the last year, the direct vacancy rate in Atlanta has grown from just over 15% to just over 18%, obviously a significant increase.

Independent market reports, while somewhat encouraging only a few months ago, are now negative in their outlook. Job growth is absolutely essential to the recovery in the long term health of our company, as well as the entire office REIT industry, and unfortunately it was reported last week that new claims for unemployment shot up to their second-highest level this year. In fact, some economists believe the nation's unemployment rate, which is now at 5.8% is likely to rise in the months ahead. So in light of these facts, our operating results and outlook for the rest of the year, we believe the prudent course is to revise downward in our outlook for this year and lower guidance for '03.

While we're still comfortable forecasting occupancy for the year in the range of 82 to 84%, we expect expect rent rolldowns to be in the range of 8 to 9%, compared to our original estimate of 6 to 8%. We've also seen lease termination fees virtually evaporate, and we don't believe they'll be meaningful for the remainder of the year. As a result of these and other factors, we now expect full-year FFO to be between 260 and 270 per share, so if you subtract FFO for this quarter, FFO for the next nine months should be $1.92 to $2.02 per share. And as we said in our lease, we still plan to sell between $75 and $175 million of assets.

We also reexamined our dividend coverage as we entered '03. We were aware that we would likely have a shortfall of 10 to 20 million, in order to maintain the dividend at its current level, and we were prepared to fund the shortfall through asset sales. We also anticipated a shortfall in '04 as well, but we had hoped that the shortfall would be in the face of rising occupancy, and again we were prepared to fund it. However, as I said on our last call, what we're not prepared to do is sacrifice the financial health and long-term growth prospects of our company, and given our outlook for the economy and our individual markets this year as well as next, we believe that adjusting the dividend to a level supported by the company's cash flow is necessary to -- is a necessary step to maintain the strength of our balance sheet and enhance our company's prospects over the long run. Reducing our annual dividend to $1.70 significantly improves our financial flexibility.

At yesterday's close, and based on our internal NAV calculations, which you can find on page 4 of the supplemental, we're trading at a significant discount to net asset value. Development activity remains virtually non-existent, and we believe that will continue that way, certainly for us, unless a project is significantly pre-leased. Acquisition opportunities are very limited, although we did pick up a high-quality asset in Richmond last quarter. It's an office building that's 95% occupied, and we paid pretty close to replacement cost for it. Ed and his entire team, are working hard. They're doing a great job in the face of so many negative economic trends. I don't want to steal Ed's thunder, but at the start of '03, we had 5.9 million square feet of space expiring. Through yesterday, we signed leases with ’03 starts for half of that amount. I think that's certainly speaks to the strength and commitment of our local management and leasing teams.

Clearly our results are being impacted by the negative trends of this economy. It's not just getting any easier and it won't until our customers begin to feel more comfortable with the direction of the general economy. Our management teams, as we’ve said repeatedly, have substantial experience operating in difficult economic environments, and we believe that our company will be positioned very well when this economy and our markets turn around. With that, I'm going to turn it over to Ed.

Good morning. Two months ago in our last conference call, I said that I wasn't sure if the positive signs we were seeing were indicative of recovery or more a collection of mirages. Unfortunately, the latter appears to be true. Recent news citing steep job losses in February and March point to the strong possibility that we'll see additional deterioration in demand for office and industrial space this year. These trends were confirmed in a report published by Reese late last week noting that noted the industry is entering its third consecutive year of negative absorption and the continued fall of negative effective rents. For Highwood’s Properties, our first quarter was relatively strong in terms of renewal activity. In total we leased just shy of two million square feet of space office, industrial, and retail, of which 75% was renewals. Occupancy in our in-service portfolio fell to 83.2%, an 80-basis point decline from the fourth quarter. This decline was driven primary by two factors.

First, we placed one development project, Seven Springs, in Nashville in service which was 14% occupied and is now 76% leased. Second, occupancy was negatively impacted as a result of the lease rejections by USAirways, which we discussed on our last call, and began to impact occupancy this quarter. On the square footage released this quarter, 1.1 million square feet was office space. This was slightly higher than fourth quarter, which was exceedingly strong, and the highest level of office leasing we've experienced in over two years. We also saw significant sequential decline in leasing CAPEX and concessions, which fell 38% from the fourth quarter to $1.39 per square foot per year for both TI and commissions, and 14 cents per square feet per year for concessions.

In fact, these numbers are closer to the level of CAPEX we were paying in the second quarter of last year. We believe these numbers were lower than originally anticipated, because the majority of the leases signed were renewals, which generally have lower CAPEX cost. For the remainder of this year, we expect TIs and leasing commissions to run between eight and nine dollars per square foot. Cash rents for office leases signed in the first quarter declined 7.5% from a year ago with the research triangle, Nashville, Tampa, and Atlanta, all reporting double-digit percentage drops. While this decrease is in line with the projections we gave last quarter it is the high end of our range. Going forward, we expect office rents on singed leases to roll down 8 to 10%. On a straight line or GAAP rent comparison, the average rent over the life of the leases for new deals was 2.7% higher than the rent paid under the previous leases. We leased approximately 857,000 square feet of industrial space this quarter. While that is greater than our rolling five-quarter average of 613 square feet, which is shown on page 15 of the supplemental, it does not include a 200,000 -- it does include a 200,000 square foot six-month lease extension. Excluding this short-term lease, the average term of the industrial leases signed in the first quarter was 3.2 years versus the 2.6 years reported in the supplemental.

First-year cash rents rolled down by 9.3% and CAPEX on the industrial transactions was 43 cents per square foot, well below the rolling five-quarter average of 63 cents. Same-property net operating income for the quarter declined by 11% from a year ago, primarily driven by the decline in average occupancy to 84.8% versus 89.5% a year ago. Of course, a substantial part of this same-property decline is due to the loss of WorldCom, which rejected the Tampa-based 816,000 square foot lease at the end of last year.

Another driver behind the NOI decline was a increase in operating expenses, which was primarily due to picking up the expenses at Highway to preserve heavy first quarter ice, snow removal costs, higher utility expenses, and increased insurance premiums. Looking at page 11 of the supplemental, from an occupancy perspective, you can see that Richmond and Kansas city remain our best markets, while Research Triangle and Charlotte and Atlanta continue to struggle. While the overall outlook for the Tampa market appears positive based on recent economic reports, it did have a rough quarter with negative net absorption of 97,000 square feet, this compares to positive net absorption of 462,000 square feet last quarter. Charlotte suffered significant vacancy loss for the quarter declining from 84% in the fourth quarter to 79.1% in the first quarter mostly driven by Alltel’s relocation to one of their underutilized owned facilities. Our view of the Research Triangle market being the worst in our system was further substantiated by Moody's recent ranks of Raleigh, North Carolina as the worst commercial real estate market in the country across all property types, a ranking we are very anxious to shed. Occupancy in Nashville dropped 170 basis points from the fourth quarter as a direct result of one property, Seven Springs, a 131,000 square foot office building that was placed in service this quarter with an occupancy of 14%. That property is now 76% leased; excluding this property occupancy in Nashville would have been 89.5%, a 180 basis point increase from the fourth quarter.

This market has also had positive net absorption for four quarters in a row. Atlanta remains one of our weaker markets. After reports showed Atlanta with positive net absorption in the fourth quarter we were hopeful this market had positive stabilization going forward. Unfortunately, the first quarter reports show the opposite, and the outlook for this city has only worsened the vacancy rate for the Atlanta market as a whole jumped from 16.6% in the fourth quarter to 18.1%, a negative absorption was 1.3 million square feet, the highest level in over a year. Available office sublease space in our top five markets declined slightly from 4.1% to 3.9% of the market, and subleased space within our portfolio stayed in the low 3% range -- in fact 3.1%.

Turning to lease expirations on page 17 of the supplemental, you can see that we have 13.4% of our annualized revenues expiring through the end of the year. This is down from 18.5% on January 1. To update you further, we continue to make strong progress on this front. Through yesterday, April 24th, we have signed leases with 2003 starts, further reducing our 2003 annualized revenue exposure from 13.4% to 9.1%. Our present-day development pipeline consists of only three properties totaling 200,000 square feet. These projects are 85% funded and 36% pre-leased. We will not undertake any new developments this year unless a project is substantially pre-leased.

It continues to be a challenging environment in all of our markets. While we are making good progress on renewing or releasing the space we have expiring this year, it is generally on less favorable terms than in the past. The volume of new transactions remains limited, and ultimately it is a demand for this new space that we need in order to recognize any real increases in occupancy. Regardless, I can assure you that our people are working extremely hard. Our property managers continue to build higher barriers to exit for our existing customers and our leasing agents remain tenacious in their efforts to renew leases and identify new demand. Carman?

Thanks, Ed. What I'd like to do first, and this has been touched on by both Ed and Ron, is turn you to page 1, in our supplemental package, where the consolidated statement of operation on the press release. You'll note for the quarter, we recorded rental property revenue of about $109 million, down a little over $3 million from the quarter ended December 31st. With that, we had an increase in operating expenses of almost $1.4 million, which translates into net operating income from real estate of 71.7 million for this quarter, compared to $76.2 million for the quarter ended December 31st.

Again, as these guys have pointed out, the principal drivers behind that were increasing occupancy due in part to WorldCom and then other declines across the portfolio, and net increase in the fixed component of our portfolio and other increases in expenses at the other properties. Interest expense for the quarter, we recorded capitalized interest of $331,000 down from a level of a year ago that was almost $4 million, which reflects a decline in the development pipeline that Ed alluded to in his remarks. Other income and G&A were at historical trends, and the interest in other income in particular declined from 4.8 million last quarter to almost 2.9 million this quarter. On the balance sheet, which is on page 3, and there's really not a lot to highlight there, but what I would like to point out is that the mauppers or structured put bond refinance that we talked about on the earnings call for the fourth quarter was affected in these financial statements and resulted in an increase in the debt level from the 1.528 billion at the end of December to 1.580b at March 31st. Along with that refinance, we also made our property tax payments, or substantially all of our property tax payments in the first quarter, which you'll note declined in the line below, in accounts payable and other liabilities so we funded the property taxes which also caused our debt level to go up.

As Ron mentioned, on page 4, we've included a net asset value calculation, an estimation of net asset value for this quarter. It's in the traditional format. I just want to caution you, it is an estimate and not a true liquidation value, because it doesn't have, among other things, taxes and prepayments penalties considered, but it's in a format you all you are accustomed to seeing. Lastly, on page 6, we've added the components of discontinued operations, which is another series of data points that you all have been asking for and we've included that in the supplemental package. With that, operator, I'd like to open up the call to questions.

Thank you. At this time, I would like to remind everyone, if you would like to ask a question, press star , then the number 1 on your telephone keypad. We'll pause for just a moment to compile the roster. Your first question comes from the line of Greg White of Morgan Stanley.

Good morning, guys. Just a couple questions here. Given the level to which you've taken the dividend, can you give us some comfort that this is -- you know, this is enough? When we look at the new dividend level as a percentage of sort of some sort of an AFFO range based on your new guidance, it still looks as though it's sort close to the 90, maybe even 95% level. So I guess I'm just curious to know if you can walk us through how you got to that sort of dividend cut level, and what your comfort level is.

Greg, this is Carman. We took a lot of facts into consideration there, and, you know, we looked at our CAPEX numbers, and I think if you take into consideration at the lower end of the range that that would imply a lower leasing activity that, you know, we're comfortable in the short run, you know, running in the high 80s to low 90s payout ratio, and that that's, you know, what we think is prudent. When we factored all that into the analysis, we really felt that $1.70 was the appropriate level.

Well, can you give us an indication -- you've obviously did a decent job in the first quarter, you know, of sort of taking the remaining sort NOI rolling through the balance. I think Ed said it's now down to 9%. Can you talk about which markets you have major exposure in and what the sensitivities are to that role?

Sure. Greg, it's Ed. The markets that we have the greatest expose really, as far as future rolldown, would be Atlanta, Charlotte and Raleigh. We're negotiating a lot of those leases. Some of them are government-driven leases, either federal or state, that have, you know, automatic renewals in them and they keep them -- the automatic renewal clause in there because of government budgeting, but we anticipate those to continue to roll into renewals.

We have one -- our largest known moveout would be a company called Farm America in Tampa, but they're relocating to another existing Highwoods building and it would be a wash. We know that we have BellSouth coming out of a building in Atlanta, and we have re-let about 24,000 square feet of that and have good prospects for another 80,000 square feet or so. So the exposure is focused primarily in Raleigh, Atlanta, Charlotte, Tampa.

And then just, if we can turn a little bit to tenants that you may have some issues with or concerns, can you maybe just highlight for us which of your, say, top 20 or 30 tenants are on a watch list right now that may not be in the lease rollover category but maybe an unanticipated roll at some point?

You know, we continue to have leases with MCI WorldCom, about 166,000 square feet with them. They have not rejected any of those leases, and obviously we're working to protect the obligations that they have to us under those contractual obligations. On our top 20 list, we have no others that, present day, are exposure beyond what we are aware of.

Thanks a lot, guys.

From a financial perspective. You're welcome.

Your next question comes from the line of Chris Hailey of Wachovia Securities.

Ron, Carman --

Chris.

Tough medicine, but I wanted to try to get your sense as to why you might be making the change on the dividend now versus maybe taking a mid-year assessment. Was it the fundamentals deteriorating quicker than you had thought, or that you're trying to play an earlier recovery from a Highwoods corporate perspective.

Chris, as I always said, maintaining our dividend was a high priority but we obviously didn't want to sacrifice the financial health of the company. In the fourth quarter, we really saw some signs of improvement in the general economy as well as our markets, and having observed what's happening internally with our company, evaluating what we're seeing from third-party published reports, the economy's still in the doldrums.

Our markets are not improving. In some cases, they're deteriorating, so the board felt it really was the most prudent course of action, predicated upon the visibility that we have now, to go ahead and cut the dividend at this point in time and protect the company's operating cash flow.

And based upon what -- given you're cutting it now to a level, that -- the $1.70 level, what makes you feel that that is the right number to cut it to? At this point.

Well , you know, I think you need to look at it on an aggregate basis. At the low end of the guidance, and assuming -- taking our CAPEX assumptions of about $8 a square foot, you're looking at a cash surplus for the next three quarters, combined, of a little over $1 million. That amount would increase by almost $2.5 million at the high end of the range. So we've actually gone from funding the shortfall to a surplus. So in a nutshell, we believe that $1.70 is the appropriate level.

You're saying that is a quarterly or monthly net cash positive? I'm sorry. I'm not running through your numbers --

That's an aggregate number.

For each of the three quarters?

Combined.

Okay. So why not -- again , why not just cut it further, to give you the ability to retain more cash?

Well, we felt like it was appropriate to maintain the dividend at that level, given where we are relative to the peer groups and our comfort level with the cash flow.

Okay. Thanks.

Thank you, Chris.

Your next question comes from the line of Lou Taylor of Deutsche Bank.

Thanks. Carman, can you break down for us the components of the lower guidance from the 3-3.75 range to the new range. You know, how much was due to lower occupancy, how much was due to higher expenses, et cetera.

Lou, this is Carman. What I'm going to do here is I’m going to give you, you know, the components, and then just tell you that, you know, the guidance for the – we’ve lowered -- first and foremost, because of just the significant uncertainty that we're seeing in our business, you know, from the top line to expenses throughout. We are expecting higher operating expenses, at levels higher than historical, much like we saw this quarter.

That certainly is an important driver. We've taken out of the numbers the effect of lease termination fees and a substantial portion of the land-sale gains that we have included in the past. And then frankly, we just wanted to include from an occupancy standpoint more toward the lower end of what we've communicated, and then just factoring in additional uncertainty around those numbers. I mean, that, in a nutshell, is, you know how we came up with, you know a more conservative lower guidance range.

Okay. And what does this range assume for, say, the preferreds that are callable later on this year, and I guess whether you do anything with the bonds that are due in December?

Lou, for '03, we have not made any assumptions in these numbers related to any refinancing transactions, given that the bonds have a year-end maturity, or essentially a year-end maturity, and we have not made any assumptions today in this forecast for the possible redemption of the preferred.

Nothing on the preferred. Okay.

Yes.

Alright. Then maybe, Ron, if you could talk about the dispositions. Why such a big volume and what do you expect to do with the money?

Lou, we have seen some extremely aggressive pricing in some of the development properties that we have completed, and we feel like it's prudent to recognize the value that we've created there. The pricing is significantly above production and/or replacement cost. In terms of the proceeds, we plan to not only repurchase stock, but to reduce our debt proportionately and take advantage of any opportunities that we might see for acquisitions and properties within our markets.

Alright, and then for the purposes of the guidance, Carman, when do you assume these sales occur within the year?

We have factored them in really toward the back end of the year. Given we’ve got -- as I think we say in the press release, they're under negotiation, contract, et cetera but there still remains a lot of work to do to get them closed.

Alright. So if they closed earlier in the year, it would nick your numbers a bit more, potentially?

Depending on the use of proceeds.

Okay. All right. Thank you.

Your next question comes from the line of Lee Schalop of Banc of America Securities.

Everyone. I wanted to follow up on Ed's comments about how the re-leasing looks for 2003. Could you just provide a little more color on that, and also give us some sense of how it's looking over the course of the quarter? Because the numbers that remain to be re-leased are pretty substantial.

Sure, Lee. Let me just recant, if I can, some of the prepared comments. Basically we had just shy of nine million square feet of

leases expiring at the start of the year, which represented about 5.9, six million square feet of leases expiring, which represents about 18.5% of our revenues.

At this point in time, we've gotten that number from 5.9 down to 4.4 at the time of the end of the quarter, which was 13.4% of revenues And as of today, we have the 4.4 down to three million. So we basically cut it in half, and we're down to 9.1% of revenues, and we started the year at 18.5. So with just about four months burned off in the year and eight months to go, we have the other half to complete. If we're able to maintain near the level that we have for the past two quarters, that provides us with a comfort that we would be able to maintain occupancy level about where it is today, and that's barring any unexpected substantial moveouts that we don't currently have any knowledge of.

And in terms of the guidance that's been prepared, it's assuming that you get the full 5.9 million release re-leased?

That's right, having knocked out half of it within the first four months of the year.

How about just thinking about it from the flip side? Given the strength that, you know, you've put three million square feet to bed, is there a chance that you'll end up doing better than you've laid out in the guidance, or make the case that the guidance is extremely conservative.

I'll like to make – yes, I'd like to stick with the second part of that, but we want to shy away from giving you any indication that we might do better. I’d like to stick with we’ll be able to stay in that 82 to 84 and right now we're at 83 and we're hopeful we'll hit the end of the year right at that 83.

Last question. Just given the increase in velocity, just from the last few weeks, it appears 1.4 million square feet got leased in just, from March 31st to today, is there anything different there in terms of rents or TIs? Are you guys having to give it away to get it done? Or say it’s just -- it's leasing time of the year and people are signing leases? That's why the trend appears to have accelerated?

Yeah. Just one point, is that clearly it came down first quarter over fourth quarter, you saw we were at about 991 at the end of fourth quarter for transactions, and then this first quarter came down to 5.67 a square foot. And the activity has been pretty decent.

It's just been so hard to predict, Lee, and that's been reflected by the reports that have come out from independent parties that things look like they're stabilizing in the fourth quarter and then you turn around and you have negative absorption 1.3m square feet in Atlanta, and you have four million negative square feet of absorption country-wide. After 0.5m square feet positive absorption countrywide in the fourth quarter. It's difficult to predict, but if we're able to, as I said, maintain the pace close to where we were for all of fourth quarter and all of first quarter we should be there, and I want to keep the CAPEX number in that $8 square foot range, despite the fact that we got it done for less this first quarter.

Got it. Thanks.

You're welcome.

Your next question comes from the line of John Letsius from Green Street Advisrs.

Ed, did you just say that the average occupancy you expect for the year will still be in the 82 to 84% range?

Yes.

I don't understand how the guidance changed as much as it did given that that's the case. Can you help me understand why it's been so difficult to get a handle on where FFO’s going to fall out?

John, this is Carman. First off, let me just say the guidance we gave last quarter was an annual number. We had factored into that guidance a number of factors, both on the positive side, which we hoped were -- wouldn't materialize, and also on the negative side.

As it turns out, given the operating environment in which we operate in, the uncertainty with that, more of the negatives were realized and very few, if any of the positives. And we have also taken a much more conservative view, given this quarter's experience with operating expenses, which are the fixed component, particularly in declining occupancy environment, and much higher. And, you know, the rental rates that we have been achieving have been more negative, and the -- you know, the concession environment has been tough, and I think we're seeing more of those as well. So I mean, it's just -- it's a culmination of a lot of factors, and that's our view of it.

Okay . Ron, can you just take a minute and make some broad comments about this downturn, as compared to the one in the early 90s? And along the way, can you mention where you think property values on a per square foot basis bottomed out in the early 90s and where they might bottom out in this office recession?

That's -- you know, this current environment, John, is an interesting contradiction. If you compare this to the early 90s, there was -- the interest rate environment was very different. There was negative cash flow on buildings at reasonably high occupancy rates. So there were material defaults, that -- you had to combine that with the mindset of the banks industry and the banking regulators and the pressure for the banks to eliminate those real estate loans. It created a pretty pressure-packed environment for owners who ultimately defaulted on their loan commitments. And the flip to the RTC and the ultimate sell-off there put extreme pressure on pricing.

And rather than putting a number with it, I would suggest to you that for a per square foot number, I would suggest that in the 90s, buildings sold at, you know, 60%, 70% of replacement cost as a result of that pressure. Today, given the interest rate environment we see, a lot of properties are cash flowing at very low occupancy rates, and quite frankly, I haven't experienced -- we haven't experienced in any of our markets any significant pressure for any property, even though they may be -- have low leasing activity.

We haven't seen the pressure for those properties to be disposed of. Combine that with the institutional interest in quality assets, prices have remained very stable, and in some of our markets, the price per square foot that buildings are selling for significantly exceed replacement cost. So the contradiction is the Lease-up experience we're having in a number of our markets is worse than in the early '90s but the effect on pricing is quite different this time around.

And in the 90s, too, that was heavily driven by overbuilding, as opposed to the absence of any positive absorption. And the building is clearly silenced in all of our markets, but the job growth isn't there to support any positive absorption.

Are there property owner bankruptcies in your markets, or if there aren't in a material way today, do you expect them coming up?

John, I'm not aware of any, and my suggestion would be if the interest rate environment stays where it is today, you won't see a lot.

Okay. Turning to another subject, you folks own Country Club Plaza. Retail properties are very much in demand by investors, even more so than office. What are your current plans for Country Club? Why haven't you sold yet? Is it something that you can do? Is it something that you want to do?

We've had this discussion on previous calls, and I think a number of times directly with you, but our view is that we have been able to create significant value in rolling those rents up to market within the plaza, but there's still an awful lot of growth potential remaining in that asset. We are aware of the value that the market has created and the value that we've created in the plaza , but we believe there's a ways to go on that at this point in time. I would also suggest that that is a reasonably complicated acquisition that we made, and there are some tax issues that we have to balance when we evaluate our long-term strategy with the plaza, but the primary reason that we have maintained our ownership of the plaza is because not only has it performed very well, but it continues to demonstrate upside for us going in the future.

Jonathan, to perpetuate my footnoting here, the diversity hasn't hurt us in this tough time either. The plaza has maintained 93-94% occupancy and done extremely well for us in a difficult time as far as a constant cash flow back to the company.

What's your time frame for reaching stabilization. You talked about the upside you've been harvesting there. When will it be stabilized?

Jon, my view is I think we have another couple years before we have totally repositioned that asset, and it would -- it's again , plenty of opportunities for us to continue to do that there. And it certainly won't occur -- the repositioning effort won't be complete probably for another 18 months, two years.

That shouldn't suggest we'll be out of it in 18 months-two years, but I think we'll continue to evaluate that opportunity, the tax impacts, the diversity, et cetera long term.

Okay. Thank you.

You're welcome.

Your next question comes from Frank Greywitt of McDonald Investments.

How much of your income was received from USAir that won't occur going forward?

Do you have that number, Carman?

Frank, this is Tabitha. I'll call you off-line after the call on that. We just have to look it up.

You also indicated that lease terminations have basically evaporated. Does that mean -- were they zero for the quarter?

Lease termination fees were a couple hundred thousand dollars, versus historical trend levels that's been well in excess of a million a quarter.

Okay.

To put that in perspective. That compares to a number of about five million last year.

For the whole year?

For the year.

Heating, snow removal costs, you indicated were up. Can you indicate how much they were above your budget and what percent of the total amount were recaptured?

Well, they will be recaptured. We typically recover approximately 50% of that. It just depends on the occupancy of the properties in which it occurred. Most of that occurred in North Carolina between Raleigh, the triad, and Charlotte and Tennessee. So it just depends on the property mix. But it was a minority component of the increase in the operating expenses.

Okay. Now, in your leases rolling in 2003 there's the three million Remaining; are any of those the government leases with automatic renewals?

Yes, approximately 100,000 square feet, 150,000 square feet of that.

And could you indicate what percentage of the revenues that would be? Or is it an equal percentage?

It probably represents about three quarter of a million dollars in annualized income. Hang on. About $1.2m. Yeah, the third lease. Yeah, $1.2m.

1.2 million?

Right.

Thanks.

You're welcome.

Your next question comes from the line of Dan Mooney of Bear Stearns.

This is actually Sue Brenner with Bear Stearns. Just two quick questions. If you could just go over again, I don’t know if you have any additional thoughts on how you were going to fund your remaining maturities this year? And secondly if you've had any conversations with the rating agencies with in regards to the dividend cut and your share repurchase program?

This is Carman. With respect to the remaining maturities, just to put it in perspective, $250 million, an average interest rate of 7.5, they're unsecured bonds, today sitting here, we think we have an opportunity to refinance them either on a secured basis or an unsecured -- with unsecured debt.

We continue to evaluate that. Also add to that we have the possibility of utilizing proceeds from asset sales to fund a portion of the debt that's coming due. So we don't really see it as a significant event in terms of earnings dilution or earnings pickup. Nor do we envision having difficulty refinancing that debt.

We have a significant pool of unencumbered assets that we could use if we choose to go the secured route. I think our preference would be if we-- depending on where spreads are, that, you know, replacing it with unsecured debt would be our preference today. With respect to the dividend cuts and the share buyback, we have been conservative in our discussions with respect to the rating agencies with the dividend, and we have really in our recent meetings or conversations really shown that at its current levels. With the share buy-back, there's essentially no change there for us.

We are going to continue with the buy-back on a leveraged neutral basis, and it will be funded primarily with the proceeds from asset sales or a portion of asset sales. In recognizing that, we may have some free cash flow pickup from, you know, the dividend reduction but I think it was pointed out earlier on the call, we will have some pre-cash flow near term but it will not really grow substantially until next year and beyond.

Okay. Great. Thank you.

Your next question comes from the line of Chris Grimm of Lehman Brothers.

Hey guys. Following up on Sue’s question. Carman, can you give me an update on your status with your line of credit banks? And two, can you give me an update on your [covenant] calculations; the erosion of EBITDA brings this quarter you tighter, I would presume to both your interest coverage, but probably more particularly your [inaudible] coverage [inaudible] and line of credit.

Chris, I think I've gotten most of your question there. I think as we said on prior calls, we are planning to recast the credit facility this year, and those discussions are under way. We have recently affected amendments to covenants and we are in compliance today, and we expect to be in compliance with those covenants through the end of the term of the current facility, and we'll build that flexibility into the new one. I will tell you we have taken into consideration these uncertainties, the decline that was expected in EBITDA mostly came from WorldCom and USAir, and that was taken into consideration when we had our discussions with the banks recently.

To make sure I’m certain here. You said you amended the covenants and you've amended them post your 10-K disclosure.

That's correct.

Which outlines particularly the fixed charge of 1.75? That’s now lower?

That’s correct.

Do you care to disclose us the same test as in the 10-K?

We will make that disclosure as part of our filed 10-Q, and that's going to be the way we intend to communicate all of our quarterly debt compliance information. That's just more appropriate in that form, given the complexity of the calculations and needs to be in the context of that document.

Then just for follow-up on Sue’s comment, not to beat you up on this, but typically necessary waivers on bank covenants are not looked upon favorably by the rating agencies. Are they aware of this and have they expressed comfort have they expressed any opinion based on this disclosure?

All I will say is we have discussed with them the recasting of the credit facility.

Okay. I'll look forward to seeing those numbers. Thanks.

Your next question comes from the line of Jon Litt of Smith Barney.

Good morning, it's Gary Boston and Jon Litt. Carman, in terms of the expense ratio, you indicated that it would continue at the higher level the occupancies started going. Is this 34.2% rate a good run rate or is it too high for the balance of 9 year?

Gary, I don't think it's too high. I think what I attempted to say earlier is we expect it to remain at levels above historical, taken into consideration the decline in occupancy and the WorldCom vacancy, and I think 34 in that range is a fair number.

Okay. Could you give us any update on the Highwoods Preserves situation?

We continue to have tire kickers come in and walk through it, and RFPs to respond to, but nothing to report with regard to any type of LOIs.

Okay, great. I think John had something.

Good morning. I want to congratulate you for stepping up. I think the dividend cut was something we have been talking about for a while and probably was long overdue. My sense is it probably should have happened two or three quarters ago, company-specific issues, relating to tenant concentrations and excessive development coming on line as the markets got weaker. I'm not convinced the past two months' experience brought to you this decision, particularly given the velocity of leasing has increased, tenant improvements have declined, and your lease termination fees have gone to zero. I'm curious how you can make national losses conclusions based on your experience? Again despite leasing velocity increases, tenant improvements decreasing and zero lease termination fees, which are all signs we're seeing stabilization, wouldn't your own statistics be a better guide than the recent national office statistics.

To my question is if the NAV discount is as great as you suggest in the supplemental, and you suggest it on this call, how about being more aggressive with the stock buyback or considering a sale of the company?

Well, Jon, relative to our view of sustaining the dividend, we had a very active fourth quarter, and the signs we were seeing encouraged us to believe that we were evaluating the dividend in an environment that was going to be more positive and the recovery would be sooner rather than later. It became more obvious to us that that wasn't going to occur. And at that point, as we said in the past, if we ever recognized that we weren't selling into a positive environment, that we would make the hard choice and cut the dividend.

We agree that one quarter doesn't make a trend, but again, with our reconnaissance combined with what we have seen from other companies and other 3rd-party sources, the economy is just not improving unless we can get companies expanding and we can get job growth, it doesn't bode well for our opportunities. So that was the rationale with the dividend cut.

I agree with the dividend cut I think it probably should have happened a long time ago, but I'm not sure based upon your leasing velocity, that this was necessarily the catalyst.

To that point, Jon, if you look at our leasing activity, a significant part of what we have done at this point in time, of the leasing that we have accomplished, has been renewals, internal to our portfolio, at a higher percentage than what we have seen in new business.

So our view is that the leasing opportunities we have going forward for the remainder of the year will be a little more difficult, because we have to attract new business at a higher rate. For example, the renewals represented about 70%, 75% of the activity we have, which is good, but again, if you believe what we are suggesting to you, that the job growth isn't there, and the new customers are going to be more difficult to find, you can see with the benefit of that information, we would be a bit more pessimistic about being able to accelerate our lease-up. On your other point, relative to increasing the share repurchase, our board did increase the authorizations up to 5.9 million shares on the open market, or in private transactions, for that matter.

That was up from, like, what, 2.5 or something?

Yes.

What about – I mean you’re selling $175m worth of assets, you could certainly be more aggressive, and if the NAV discount is as great as it is, you could sell more assets and be more aggressive.

You can bet we'll be evaluating that.

Thank you.

Thank you.

Your next question comes from the line of Jim Sullivan of Prudential.

Thank you. I'm going to ask a question that I think previous callers have probably asked, but maybe in a slightly different way. This would really be for you, Carman, and this regards the extent of the decline in the guidance. Basically the reasons you have given for the decline in the guidance are factors in that drive the same-store net operating income. I don't think your assumptions regarding external activities, sales dispositions, developments et cetera, have really changed here since the last quarter. And certainly the dividend cut makes available a lot more free cash flow for the company than was the case 90 days ago. So I'm assuming that it's fair to say that virtually the entire decline outside of any variance in sales estimate, outside of that, the entire decline would be in same-store NOI. Including lease termination fees. Is that fair to say?

I think that much of what is driving this is that the property level net operating income line, which is a combination of revenue trends and this increase in expense ratio that we've discussed earlier. So that's fair.

So same-store NOI, we knew it was going to decline sequentially because of the situation with WorldCom and USAir, so that was known 90 days ago. I guess the bottom-line question is this, excluding WorldCom and U.S. Air, inform when you reported the fourth quarter, and gave us guidance at that time, your outlook for same store NOI including lease termination fees, has deteriorated. I wonder if you can tell us what your bottom-line outlook is for same- store NOI for the full year now, excluding the impact of WorldCom and U.S. Air.

Okay. For the full year, and I get I'll start with, because we reported in the supplemental with that in there, is 11% to 13% down, with the effect of U.S. Air and WorldCom in this number. If you take them out for this quarter, this was a decline of about 6%. So without the two of those leases and the rejections, the same-store number would be 8% to 9% down without the effect of those two leases.

And so I guess the bottom line is 90 days ago, you would have had maybe a tough first quarter, but your same store NOI comparison would have been improving sequentially from here. However, based on what you're saying is it's more likely going to improve and it may even deteriorate. Is that fair?

I think that's a fair assessment.

Okay. Good. Thank you.

Your next question comes from the line of Abbott Keller of Kestrel Investment Management.

Can you talk about the rationale for increasing the buyback authorization at this point?

We just felt, and I think it was touched on earlier by a previous caller, if we met the upper end of our disposition program that we would have the capacity, combined with potential for additional free cash flow from the dividend reduction to effect that level of buyback on a leverage-neutral basis. And given the share price is discounted as I think John Litt mentioned, you know, we -- we're comfortable with that level, and we think it's appropriate.

I think that's it in a nutshell. As long as we continue to trait at a significant discount to NAV, with the authorization of the Board, we'll continue to look at repurchasing shares.

Okay. Thank you.

Your next question comes from the line of Chris Haley of what Wachovia securities.

Yes. I wanted to reconcile the comment you made earlier, Ron, to my question about what type of free cash flow you expect to see , and it's a follow-up -- first I want to clarify , you're saying a million dollars net cash flow, positive cash flow, FFO, less all CAPEX, minus the dividend is a million dollars for the rest of the year based upon your budget?

The range was basically for a surplus of a million to 2.5.

So that's for the rest of the year cumulative.

That's right.

The next 9 months. So that would imply roughly $1.05 per share and deduct for capitalized items and straight-line rents. Is that correct?

That's right.

Carman, can you give me some detail on your CAPEX assumptions like you did last quarter in terms of TI, recurring CAPEX, and straight line?

Well, I think what Ed said -- covered in his remarks was about an $8 in the aggregate, TI and lease commission on any leasing activities it would be for the balance of the year.

That's a weighted average.

Office, industry, retail.

Weighted average office, industrial, retail, renewal and new?

Yes.

And what's your retention assumption?

Just to interrupt, that excludes, Chris, the three new development projects.

That's just all 2nd-generation. Okay. So $8 a foot blended. What's your retention assumption for the rest of the year?

That we would end up at the 83%.

No, retention.

Ratio renewal toss new deals, about 50%.

Is that unchanged from where you were at the beginning of the year?

For the full year, yes.

That's the same number you had at the beginning of the year?

Yes.

Okay. And so that's $8, that's TI and leasing commissions or just TI? Sorry.

That's both.

And what do you have for recurring CAPEX?

Building improvements?

Yeah.

About 10 to 12 million dollars.

Okay. And straight -line rent?

I would look to this quarter and take that in a possible trend.

Okay. The next question has to do with leasing strategies. We have, from our field trips, we've heard different things, maybe not as dour, or maybe a little more optimistic in some of the secondary or tertiary markets in the southeast, and wanted to know whether or not you guys might have a different leasing approach or a leasing strategy, at least more recently? And then what might you do, what can you do at this point in time given market conditions? What -- do you plan on changing tack?

Well is to keep what we have. So we're out early, and have been for some time trying to renew those leases that are due to expire at any point in time for the next two years. We’re in discussions, on those, and some customers want to talk now and some don't, just depending on their mindset and the expiration date.

I can't imagine that any of our people are doing anything less. I hear your comment about us maybe being more dour than others. I can assure you we versus our competition, and we can evidence this, are asking to see credit when someone wants us to spend significant dollars for a TI and full-blown commission, and we've seen brokers come in and say your competitors aren't even asking for credit on this, and you guys are. We think that is a prudent move, and if that puts us into a penalty box for doing a deal that has significant TI requirement and commission requirement, so be it, we'll step away from it.

But, you know, our people are at the top of the market as far as capability. Our division heads who are all officers of the company are actively involved in leasing. They're sitting at the table at the time of negotiations and making those deals happen. So it's not an issue of whether or not they're seasoned enough or have the capacity. We certainly have product in the right sub markets in order to be in the game when there is activity within the market.

Again, regarding ongoing dividend capabilities, what makes you comfort able that you can maintain a very thin margin between available cash and dividends going into '04 , if in fact -- obviously everyone wants to assume a more positive economic environment to '04, but if market rents continue to decline through '03 and through '04, I guess I'm trying to direct this question again toward the dividend. Why not create more cushion instead of potentially going back to the same scenario we were in three to six months ago where there was a ten to 20 million dollar shortfall?

Well, Chris, we believe we've got an adequate cushion there. When you look at the CAD number, the real issue is, in our -- in our business and in the real estate industry, is that CAD is such a lumpy number -- excuse me -- CAPEX is such a lumpy number; just because it jumps up in one quarter doesn't suggest that will be something that will you experience on a run rate.

So we took a really close look at that, and the number we focused on was a percent of our FFO, and that was about 65%, and so we're reasonably comfortable we can sustain that.

I would also just add that this quarter, if you take this quarter's numbers -- again it's not just one you'll use to make the analysis -- but you're at a number that’s somewhere between 67 and 71 cents of those adjustments or non-cap adjustments net. Our historical trend for capex has been in the 40 million to 45 million range, and what we plugged in at what you said, a dollar, is up about 35 or 40 -- it's a significant increase, which again we believe that to be conservative, but you never know in this uncertain market whether you're at $60 million, or $65m, or $45 million. And so we believe where we are with the analysis takes all that into consideration.

What do you expect taxable earnings or EPS to be this year?

You're getting to the minimum payout. All I can tell you is it was 90 cent per share last year. You can see the trend and book earnings -- taxable earnings is more difficult to predict based upon some of the capital transactions but it's safe to say it's more likely to be lower than higher than the 90 cents. So that's really not even an issue, I think, in whether -- what the appropriate level of the dividend.

Were there any one-time issues in the quarter on the expense side or G&A side or capitalized stuff?

Not other than the ones we talked about. I think I mentioned capital interest was lower, or capitalized interest was lower, and about $300,000, and I think the termination fees is probably a biggie, inasmuch as it was very close to zero, and this is a number that has been well over a million dollars. Last year, I think as Tabitha mentioned, it was $5 million for the full year.

Okay. Thank you.

Your next question comes from the line of Lou Taylor of Deutsche Bank.

Carman, your floating rate debt levels are very low here. Do you anticipate increasing them to hedge yourself against a further weakening economy?

We're considering all of that Lou, and there are other factors where some floating rate debt may give us flexibility in the event we want to make changes in our asset repositioning program as well. We're taking a look at all that. I think that's a very valid point.

Thank you.

Your next question comes from the line of Greg White of Morgan Stanley.

High, guys. I just wanted to follow up a little bit. You spoke about using some of the free cash flow and asset sales proceeds for stock buybacks. When I look at your NAV calculation you're using your annualized first quarter levels. If I take out the 68 cents you reported in the first quarter and just look at what the average will be for the rest of the year, it actually looks as though it may be a little less than that. So first I just question the -- how much lower might the NAV be, using your methodology, if we're using annualized numbers.

And secondarily,, can you give us some sort of indication -- obviously we can't ask you to give a sort of liquidation discount if you were to sell the whole portfolio, but can you give us an indication of what the tax issues are and what sort of a, quote unquote, after tax NAV might be?

Greg, with respect to the NAB our position on including that is one we want to make sure everyone understands that – how our broad-brush methodology that ties back to the financial statements. We're not going to include forward NAV forecasts, I think getting to your question on what we think is going to be the next quarter or following quarter. Then your last question in terms of quantifying the tax number, all I can tell you is that is very very complex. What I can tell you is if you go to the 10-K, there's a tax basis of the assets in there, which is a starting point of some of the information, but there's a number of other factors involved. It's how you structure transactions, and it's very difficult to even put a number out there or range of numbers.

Given the way you've sort of historically built this company, by buying out large portfolios and bringing the partners on, did you in any of those major transactions give sort of tax make hold guarantees on asset sales?

No, we have none of that, Greg.

Okay. Thanks a lot, guys.

Your next question comes from the line of Chris Haley, of Wachovia Securities.

Yes, I'm sorry. Another follow-up. On the line of credit -- separate from the line of credit are there any debt covenants, unsecured mortgage covenants that might come into play here with fixed charge coverage below two times, and particularly with an active buyback?

This is Carman. A line of credit covenants, if you go to the 10-K, are the most constraining. We have disclosed all the material covenants there, and the bond covenants are less restrictive. So no.

Okay. Anything on the preferred side besides just not being able to pay off the preferreds with debt?

That's correct, no covenants there, operating covenants.

Okay. What do you think your fixed-charge coverage is going to look like, second half this year?

Chris, we've not really forecast -- we have not communicated that number out there , but I think it really depends upon a number of factors you would plug into your individual models. I think we've given you all the components there, or as many as we can.

Okay. Thanks again.

Okay. In closing , since there are no more questions, let me say that it's obvious that our markets are tough, but our leasing performance in this venue has been exceptional and I think it reflects the high quality of our management team, our leasing teams. Good people, good product, good balance sheet, still a heck of a good company, and we'll work through this trough. When you economy turns, we have the resources in place in each of our markets to capture this updraft. So thank you all for the attendance on the call.

This concludes today 's conference. You may now disconnect.