Highwoods Properties Inc (HIW) 2004 Q2 法說會逐字稿

Good afternoon. My name is Bonnie and I will be your conference facilitator. At this time, I'd like to welcome everyone to the Highwood Properties conference call. All lines have been placed on mute to prevent any background noise. (Operator Instructions). Thank you. Ms. Zane, you may begin your conference.

Thanks, Bonnie. Good afternoon everybody and welcome to Highwoods Properties' conference call. On the call today are Ed Fritsch, President and Chief Executive Officer; Mike Harris, Chief Operating Officer and Terry Stevens, Chief Financial Officer.

If anyone on this call has not received a copy of today's press release or supplemental financial package, please visit our Web site at www.highwoods.com, or call 919-875-6717 and we will fax or e-mail a copy to you.

Before we begin, I would like to remind you that this conference call will include forward-looking statements concerning the Company's operations and financial conditions, including estimates of asset dispositions, the reinvestment of disposition and joint venture proceeds, the cost and timing and development of projects, rollover rents, occupancy expense and revenue trends in funds from operations. Such statements are subject to various risks and uncertainties. Actual results could differ materially from those currently estimated due to a number of factors, including those identified in the Company's amended annual report on form 10-K for the year ended December 31, 2003 and subsequent reports filed with the SEC.

The Company assumes the obligation to update or supplement forward-looking statements that become untrue because of subsequent events. During this call, we will discuss non-GAAP financial measures, such as FFO. A reconciliation of FFO and other non-GAAP financial measures to net income as defined by GAAP is available on the investor relations section of our Web site at www.highwoods.com. I will now turn the call over to Ed Fritsch.

Good afternoon and welcome to our conference call to discuss our second and third quarter financial results and our restatement. Needless to say, the restatement has been a long and comprehensive process, and as you can imagine, has involved a significant amount of work. It has obviously taken longer than any of us had anticipated. However, we're pleased with the thoroughness of the effort and are happy to have this process behind us.

We're also pleased with our operating results, particularly the 180 basis point increase in occupancy, our growing development pipeline, and our progress at the Highwoods Preserve. As most of you are aware, this morning, we filed our amended form 10-K, which includes reaudited financial statements for 2001 through 2003, and our form 10-Q, which includes restated unaudited quarterly information for the first quarter. Here's the bottom line.

First, the impact of the changes that were made are not expected to have any material impact on FFO going forward. This means our improving operating fundamentals will not be diluted by these historic accounting changes. Two, none of these three statements nor the accounting methodology changes have impacted our cash position, except for the expenses incurred for professional services to complete the restatement and fees to secure bank amendments that were needed due to the impacts of the accounting changes on our covenants for historical periods. And three, we have received an unqualified audit opinion from Ernst & Young on our restated annual financial statements.

The press release includes a table summarizing the impact on net income and FFO for 2001 through 2003, and for the first three quarters of 2004. All told, the total cumulative impact on FFO for the years 2001 through 2003 and for the first nine months of 2004 is a reduction of $20.6 million, or 40 cents per diluted share. This is higher than the range we had estimated in August, largely due to an adjustment in accounting for the previously disclosed MOPRS (ph) debt retirement, which occurred in February 2003. Terry will cover all of this in detail in just a few minutes.

I'm sure all of you have two basic questions -- what happened, and how are we going to improve our financial statement reporting process going forward? Based on all of the work that has been done, we believe that the adjustments required to be made to our historical financial statements were the result of the unintentional misapplication of GAAP, particularly during the earlier years covered by the restatement, a majority of the adjustments made as part of the restatement related to sales transactions or accounting methods that occurred or were adopted between 1997 and 2002. While a number of the early adjustments have continuing effects into 2003 and 2004, only a few of the adjustments related to matters that originated in the last two years.

Our financial statements and the conformity with GAAP are clearly management's responsibility and we fully accept that responsibility. Many of the transactions requiring adjustments were complex, as we mentioned in our August call. As is common, we consulted with our auditors, Ernst & Young, over the years to advise us on the application of GAAP for many of our transactions. This included accounting advice for many of excess transactions with continuing involvement, the MOPRS debt retirement in early 2003, the accounting for minority interest in our operating partnership and the counting for Ron Gibson's retirement package in the first quarter 2004.

So while we believe we were properly following GAAP at the time and have received unqualified audit reports, we have since determined through this process that adjustments were needed to conform to various transactions and methods with GAAP. In recent years, we have increased the size of our accounting department and added several experienced staff members, including an assisting controller and a director of financial standards and compliance. We added a senior director of investor relations and hired Terry Stevens as our CFO last December so that Carmen (ph), who had been wearing all three hats, could focus on strategic analysis.

We have also implemented other improvements on our internal controls, particularly surrounding accounting for real estate sales transactions. In August, when we held our conference call to discuss the restatement, I made the point that the SEC's Division of Corporate Finance was satisfied with our responses to their comment letter and the changes we agreed to make. This is still true. However, subsequent to that call, we received a non-public informal inquiry letter from the Atlanta Office of the SEC's Division of Enforcement. They have us for our voluntary existence in providing them with information related to our accounting for real estate sales transactions and other items being restated and documents related to communications with Ernst & Young in connection with such matters. We understand it is not unusual for the SEC to undertake such a fact-finding inquiry for companies that announce a restatement of their financial statements. You can be assured that we're cooperating fully with the SEC and hope to resolve all of their questions regarding our restatement as quickly as possible.

While the restatement has occupied a good deal of our time, we've been very busy on the operational side of our business and are generally excited about the strides we have made. Our occupancy is up 180 basis points since the first quarter, leasing if strong and our top five markets combined reported positive absorption of well over a million square feet in both the second and third quarters.

During the third quarter, we announced our decision to list our Charlotte assets for sale with CB Richard Ellis' Atlanta regional offices. Charlotte is a market where we don't have a dominant share, and this, coupled with a strong pricing environment and our intense focus on strengthening our balance sheet, led us to conclude that it's the right time to evaluate the sale of these 23 office buildings and garner the G&A savings from closing our Charlotte office. CB Richard Ellis will distribute an offering memorandum this week. Given it will be a bid process, we're making no comments as to anticipated pricing or the estimated timetable for closing.

Other positive news over these past two months includes the $14.4 million settlement we received from WorldCom. It sure is good to have this cash in the bank. Also, we signed an 85,000 square foot ten-year lease with T-Mobile at Highwood Preserve. This lease starts December 1 and when the depository trust completes their upcoming move, Highwood Preserve will be housing nearly 1000 people. Momentum continues to build and we have good prospects interested in either buying or leasing space at the Preserve.

In September, we were awarded a $21.4 million, 110,000 square foot build to suit by the General Services Administration to develop a Class A building at our Century Center office park in Atlanta for additional offices for the CDC. We will start construction this quarter and should be done by the end of the third quarter '05. This build to suit is in addition to the 112,000 square foot build to suit office building for Saxon Capital in Richmond that we announced on September 1. Today, our 683,000 square-foot wholly-owned $83.3 million office development pipeline is 100 percent pre-leased.

Now I turn the call over to Mike Harris for some brief comments regarding lease activity, and then Terry will review the financials. Mike?

Thanks, Ed, and good afternoon. Let me open my comments by saying that our field operations, in particular our division VPs and leasing personnel, have done an excellent job of delivering good results in some pretty tough markets. We're still operating at a very competitive environment, and make no mistake; it is still a tenant's market. But we are encouraged by indications that our markets are improving, although marginally.

Total occupancy in the portfolio increased 140 basis points from the second to the third quarter and 80 basis points year-over-year. Every one of our portfolios in each of our markets, except Columbia, S.C., reported an increase in occupancy in the third quarter. For both the second and third quarters, our top five office markets combined reported the largest positive absorption since the second quarter of 2001. As Ed mentioned earlier, our leasing velocity continues to be strong. We signed leases for almost 1.4 million square feet of office space in each of the second and third quarters, which is the highest leasing activity reported since the first quarter of 1999.

Year-to-date, our customer retention is 73 percent, which is a meaningful accomplishment in his competitive environment and indicates that our commitment to customer service is paying off.

Office GAAP (ph) rents increased about half a percentage point in the second quarter, a decline by 1 percent in the third quarter. A number of you have asked that we once again provide cash rent comparisons, so we have added it back to our disclosure this quarter. You will find this cash rent number reported on page 14 of the third quarter supplemental.

For the second quarter, office cash rents decline 8.7 percent and for the third quarter, office cash rents declined 9.7 percent. To make this cash rent comparison, we took the actual base rent plus 10 (ph) pass-throughs for the last year of the previous lease and compared it to the annualized base rent for the first 12 months of the new lease after any rent abatement period that expired. So pre-rent is stripped from this equation to give an apples-to-apples comparison. Given the breadth of this call, I'm not going to walk you through individual conditions in each of our markets. However, I would like to make a few comments about our five largest markets.

We're particularly pleased with our performance in Raleigh where occupancy in our portfolio increased 170 basis points in the third quarter, primarily due to 90,000 square feet of new lease starts. Also, over the last six months, occupancy in our Atlanta portfolio, a market that has struggled for some time now, increased 250 basis points. Occupancy in our Nashville portfolio increased 360 basis points since the first quarter, primarily as a result of 151,000 square feet of new lease starts.

As Ed mentioned earlier, our Tampa portfolio received a boost with the signing of the 85,000 square foot lease with T-Mobile at Highwood Preserve, and we also executed two long-term leases totaling 106,000 square feet, backfilling recent vacancy in our Cypress One and One Harbor Place Buildings.

Our Richmond division pulled off a coup of sorts by backfilling 65,000 square feet in Inns Lake Center for less than 90 days of downtime between leases. This will take that building from zero to 100 percent occupancy once the tenant takes full occupancy.

Before turning the call over to Terry, I also want to announce that we've created a new position at Highwoods -- Corporate Vice President of Leasing. This will be filled by Skip Hill. As a further commitment to our goal of improving leasing and occupancy across all divisions, we created this position to better cultivate best practices, conserve as a valuable resource for our field operations and to boost overall business development. Skip will also champion our Corporate Host Program, which will enhance our ability to expand multi-locational relationships with our larger clients. Currently, Skip is the Senior Director of Leasing and Development in our Triad Division and he has done an outstanding job there. Skip will be relocating to Raleigh and will assume this new position effective as of January 1.

In closing, let me state what I hope has been obvious to all of you this past year -- our entire company is focused on increasing occupancy. To borrow a phrase coined by Ford Motors, this is our Job One. The new management team is now officially in place. We're looking forward to have Skip join us here in Raleigh and we're energized and focused on taking advantage of all of the opportunities in the marketplace. Thanks. Terry?

Thank you, Mike. As Ed mentioned, we filed our amended 10-K for 2003 and the amended 10-Q for the first quarter of '04 earlier today. The restatement adjustments are described in detail in notes 3, 5, 18 and 19 in the financial statements in the 10-K, and in note 11 in the amended form 10-Q. We have a lot of financial information to cover today and I'm going to talk first on the restatement and then end up by going over the financial results for the quarters.

If you turn to the last phase of the tables that were attached to the press release, we've summarized the overall effects of the restatement. The effects through 9/30/04 from the new accounting for real estate sales transactions that we talked about in August remain the most significant of the adjustments made in the restatement as to net income and were the second most significant of the adjustments with respect to their effect on FFO.

In addition to the real estate adjustments that we knew about in August, during the rest in the process, we identified several other adjustments. The two most individually significant were, first, accounting for the extinguishment of $125 million of mandatory par put remarketed securities, or MPPRS as we call them, that occurred in early February 2003. When we adjusted for that, that decreased both net income and FFO for full year 2003 by 11.8 million, or 22 cents a share. This change will increase net income and FFO for the next nine years by about 1.3 million a year since the cost of the transaction that had been previously deferred and were being amortized as interest expense are no longer recorded on the books as amortizable assets.

The second item is accounting for minority interest in our operating partnership, the adjustments to which increased previously reported net income by 3.8 million, 3.7 million and 3.4 million for '01, '02 and '03, respectively, and by 800,000 a quarter for each quarter in '04. This effect -- adjustment had no effect on FFO allocable to common shareholders or on FFO per-share, and I'll cover that a little bit later.

I'd like to spend a little bit more time in going over these three primary adjustments, and then I will also briefly discuss some of the other less significant adjustments.

As we mentioned on our August call, as part of our capital recycling program, we completed a significant number of real estate sales transactions during the last five-plus years or so and also entered into a number of joint ventures to which we contributed real estate assets. Certain of these transactions involve sales where the Company retained a partial ownership interest or had other forms of continuing involvement with the properties. The forms of continuing involvement included guarantees, in certain cases, the buyers, to give them a return on their investment, or guarantees of rental income from certain tenants or for certain spaces, guarantees to pay certain leasing costs and so forth.

In the historical financial statements, all of these transactions were accounted for sales. And either a portion or all of the resultant gains were deferred because of the continuing involvement or the guarantees that we had given. The nature of the Company's material continuing involvement from such sales, or JB contributions, were disclosed in our quarterly and annual filings. While we believe those were fully disclosed, we recognize that the presentation of such information could be improved and we have now aggregated all of these disclosures in tabular form with explanatory notes in Note 15 in amended 10-K.

In the restatement, adjustments were made for a certain of these transactions where we had where we had continuing involvement to comply with the guidance and Statement of Financial Accounting Standards No. 66 -- Accounting For Sales of Real Estate. For three of these transactions, the largest and most complicated of which was the sale in late 2000 of properties into the previously disclosed MG-HIW joint venture. The transactions are now accounted for in the remanded (ph) financial statements as financing and/or profit sharing arrangements, rather than the sales. Accordingly, the assets, related liabilities and operations are now consolidated in the Company's financial statements.

The additional NOI that we receive is then backed out of the total as either financing, expense or co-venture expense.

In other instances, the transactions have continued to be reported as sales, but the timing and amount of gain recognition or other aspects of the sale accounting were adjusted due to the Company's continuing involvement or to apply certain other aspects of GAAP to the transactions. From January 1 '01 through the end of the third quarter '04, the real estate sales adjustments in total reduced FFO by 7.3 million, and with only a very minimal of impact to FFO in the second and third quarters of '04.

Turning next to the MPPRS debt retirement, this first quarter '03 transaction was described in our prior filings and had been accounted for as an exchange of indebtedness. After consulting with our auditors and other advisors at the time, we originally concluded that a qualified for exchange accounting and as a result, the net cost incurred to affect the MPPRS retirement and the exchange, which was about 14.7 million, were deferred and were being amortized over a ten-year term of the new exchange mortgage debt. As part of the restatement and the reaudit process, we and Ernst & Young reevaluated the original accounting for this transaction and concluded that the transaction did not sufficiently meet the criteria to qualify as an exchange, particularly in light of an SEC speech given in December of 2003 that dealt specifically with such exchange transactions.

Accordingly, we have now determined that this February '03 transaction should have been accounted for as a debt extinguishment and the deferred costs written off as a debt extinguishment loss. After considering the offsetting reduction in amortization of deferred financing costs during the remainder of '03, the impact to net income after minority interest and to FFO in 2003 was 11.8 million, or 22 cents a share.

Turning now to minority interest accounting, our prior method of determining minority interest expense in the operating partnership had been previously disclosed in the notes our statements. We've consistently computed minority interest -- the minority interest minority ownership interest and the income of the operating partnership by applying the average minority ownership percentage times the operating partnership's net income. In 1997 and 1998, the Company issued preferred stock and contributed the net proceeds to the operating partnership in exchange for corresponding issuances of preferred units in the operating partnership. These preferred units were 100 percent owned by the Company and there are no minority interests in the preferred units.

The Company continued to apply to minority interest percentage to the OP's net income before preferred distributions. However, we have now determined that the computation method should have been adjusted beginning at the time by deducting the preferred distributions from the OP's net income, and then applying the minority ownership interest to this lower amount. As a result, previously recorded minority interest expense was overstated and net income understated going back to the time the preferred units were first issued in 1997 and 1998. From January 1, 2001 through the end of the third quarter '04, this adjustment increased consolidated net income by 13.3 million and this increase to net income will continue in the future and will amount to about 3.2 million for full-year 2004.

In computing FFO per-share, minority interest expense is added back, and so there was no impact from this to the prior or to future FFO per-share.

Finally, and as described more fully in Note 18 in the financial statements, during the restatement process, we adjusted for several other matters that were individually less significant than amounts in those discussed above. Over the period from January 1, 2001 to the end of the third quarter of '04, these other adjustments in the aggregate had no material impact to net income, although the adjustments did cause increases and decreases in certain of the periods. Over this same period, these items impacted FFO allocable to common shareholders by a 2.4 million decrease, or about 5 cents a share.

So in the aggregate over this period, the impact on net income from all of the restatement was 17.1 million, or 32 cents per share, which represented about 6 percent of the total of net income recorded by the Company during the period. The impact to FFO was 20.6 million, or 40 cents a share, which was 3.6 percent of the total FFO reported during the period.

As is fairly typical in the context of a restatement and partly with the advantage of hindsight, we and Ernst & Young identified certain material weaknesses in our internal control system that existed during the restatement periods, the earlier years of which were periods of rapid growth and high transaction volumes for the Company. These weaknesses included inadequate procedures for appropriately assessing and applying accounting principles to complex transactions, lack of adequate finance and accounting staff, inadequate procedures to ensure critical information regarding a transaction is communicated to the people who are accounting for those transaction, and finally, lack of application to GAAP to transactions due to perceived immateriality of the accounting for those transactions. These items were all disclosed in our 10-K.

As Ed noted, the Company has made a number of improvements in the system of internal accounting controls, including increasing by about 40 percent the overall size of the accounting departments since 1999 while the Company's size has remained roughly the same since that time. We've added several experienced staff to the financing and accounting department that Ed mentioned. We've expanded certain supervisory activities and monitoring procedures over financial reporting and accounting, we've improved certain procedures do ensure that the information relating to transactions is getting communicated to the accounting department and those who have to account for it, and we have implemented enhanced checklist and other documentation procedures for transactions, and particularly for real estate and real estate sales transactions. We will continue to evaluate our controls and make improvements as we consider appropriate in the future.

In connection with the Sarbanes-Oxley 404 requirements, we are also completing our testing of internal controls over financial reporting, which encompass all of the controls designed to provide reasonable assurance regarding the reliability of transaction processing, financial reporting and the preparation of financial statements in accordance with GAAP. Later this year, Ernst & Young will complete their own examination of these controls and both management and Ernst & Young will report on the results of our respective testing in our 2004 form 10-K.

So in concluding my remarks on the restatement, it was a long process for sure. And while we were all anxious to get it completed, we also wanted to ensure that we did it in a thorough and thoughtful way, and I think that is what we've done.

Turning now to the second and third quarter results, as we reported, FFO per-share for the nine months of '04 was $1.59. By quarter, it was 50 cents in Q1, 29 cents in Q2 and 80 cents in Q3. There are a number of unusual charges and credits impacting all of the quarters in 2004. In the press release, we identified those items and indicate that FFO per-share, if you adjust for these unusual charges and credits, would have been 56 cents in Q1, 58 cents in Q2 and 61 cents in the third quarter, or $1.75 in total. These particular items were the compensation costs recorded for the retirement of Ron Gibson, our former CEO, which was 7.5 cents per share in the first and second quarters; impairments on depreciable assets which are now required to be in FFO, and these relate primarily to the network operations center of Highwoods Preserve that was sold in the second quarter, which was about 7 cents per share; the debt extinguishment loss on the Expo's (ph) bond retirement that we took in the second quarter of 21 cents a share and G&A costs for the previously terminated discussions regarding a strategic transaction and for the costs of the restatement effort, which in aggregate, were about 4.5 cents per share.

These negative effects were offset by the WorldCom settlement income in the third quarter, which was 24 cents. The total impact overall of these items was about 16 cents per share over the nine-month period.

Just touching briefly on some of these unusual items, we had previously disclosed the compensation costs for Ron's retirement when we had our original first quarter earnings call. The original estimate made an amount of his retirement package was 6.3 million, which was to be recognized in the first quarter 4.6 million and 1.9 million in the second quarter. Subsequent to our release and as part of the restatement effort, we and Ernst & Young recognized that a transition accounting rule had not been factored in when determining the costs for his options, which has been extended as part of the retirement package. We had originally used the so-called intrinsic value to expense these options, rather than use other valuation techniques, which was appropriate. And this resulted in a reduction in the reported expense for Ron for the retirement package by about 1.7 million.

Also, as we previously reported, we incurred impairment charges in the second quarter of 3.7 million, or 6 cents per share related to the network operations center at Highwoods Preserve. That closed in late Jane and generated about 18.6 million in cash proceeds. There were two other small impairments on operating properties in the second and third quarter, aggregating about $600,000. And as you know, impairments on operating and depreciable assets are now required to be included in FFO.

G&A costs in the second and third quarters of -- were up due mainly to the professional service costs incurred for the strategic (indiscernible) transaction that I mentioned and the restatement and reaudits. Combined, these were 235,000 in the second quarter and about 2.5 million in the third quarter. In the fourth quarter, we will continue to incur cost on the reaudits, which could be an additional 600,000 or so. And this excludes any legal fees or related cost that may be incurred in connection with responding to the FCC informal inquiry, which Ed referred to. The fourth quarter G&A will also reflect higher audit fees that will be incurred then for the Sarbanes-Oxley 404 testing.

In addition to these items, the FFO in '04 versus FFO in '03 for the nine months was impacted by a number of other factors. Let me just walk you through those. First was the MPPRS loss that we talked about, which impacted '03 results in the first quarter of '03. Second was a gain on settlement of the MG-HIW (indiscernible) assets, which are now treated as a financing under the new accounting methodology. This was $16.9 million of a gain on settlement of the financing obligation, or 27 cents a share that was recorded in the third quarter of '03, and there is no equivalent gain in '04. Gains on land sales were 3.5 million in the first nine months of '03 versus a $200,000 loss in '04, or a period to period swing of about 6 cents per share. 2004 had gains of about 1.7 million, but these were offset by an impairment charge on lands in the second quarter of about 1.9 million. The impairment relates mostly to land located in Baltimore that we later sold in the third quarter and generated 5.4 million of cash proceeds.

We had another sale in the fourth quarter which generated 1.2 million in gain, and there are several more that could close before year-end. To date so far this year, we've generated almost 21 million of proceeds from land sales, although not nearly as much in gain obviously, and we have all also generated almost 22 million in proceeds from sales of vacant assets, which were the network operating center of Highwoods Preserve and another building in Tampa that had been vacant since early 2004.

Contractual interest expense is better than '03 by 10.4 million, or 17 cents per share due to the impact of refinancing bonds in late '03 with lower interest rate instruments and the refinancing of the Expo bonds in June of '04 and elimination of about $136 million of debt related to the MG Orlando assets that were consolidated on our books and were sold in June to a joint venture. In addition, amortization of deferred financing costs was lower by 400,000, or about 1 cent in '04 compared to '03.

Net income from our properties at both continuing and discontinued properties net of financing and obligation and co-venture expense, is down 9.7 million due to lower same-center NOI and due to the effects from property sales that we had in '03 and in 04.

G&A expense, excluding the items I've already talked about, is higher in '04 by about 2.9 million, or 5 cents a share due to higher salaries and benefit costs, the impact of long-term incentive programs, higher costs from Sarbanes-Oxley compliance. Legal settlements -- we had a gain in '03 on a legal settlement and a small charge in '04 which caused a net swing of 800,000, and that goes through G&A.

We had higher FFO from equity investments in our joint ventures this year compared to last year by 2.6 million, or 4 cents a share. This included a onetime 500,000 land sale in one of our joint ventures. That was our share of the landfill.

Finally, we had lower termination fee income of 900,000, or about half a cent, and lower straight-line rent of about 1.1 million, or 2 cents in '04, compared to '03. The lower straight-line rents also include a reserve of about 700,000 that we booked in the second quarter for USAir's straight-line rent, and we booked that reserve in recognition of their filing for Chapter 11 bankruptcy protection, although they are still in all of our buildings and they're current in all of their rents at this time.

That concludes my comments on the financial results. Now I will turn the call back to Ed for some closing remarks.

Thanks, Terry, for the thorough overview on that. This restatement has been a thorough process, as you have heard, and I thank our audit committee, the Board, Terry and our accounting department for all of their hard work and commitment to seeing this through. I knew Terry was a great hire when he joined Highwoods last December, but I don't think any of us truly realized how valuable he would be until these last few months. His impeccable accounting credentials and extensive public accounting experience have been invaluable throughout this process.

We've talked a lot about the changes in accounting methodologies and their impact on historical net income and FFO. At the end of the day, these are our financial statements and we take full responsibility for them. Let me emphasize that we believe that the changes that are made will essentially be neutral to FFO on a go-forward basis.

Lastly, I thank all of our employees for their hard work. Everyone can be assured that this team is focused on operations and results are improving. We've experienced strong leasing activities and increase in occupancy and expanded development pipeline and we're keenly focused on improving our balance sheet. Bonnie, will you now please open the call for questions.

(Operator Instructions) Jim Sullivan, Greenstreet Advisers.

Thank you for all of the information and the update. A question on your NAV (ph) page in your supplemental page 5. The cap rates for office and industrial say 9 percent at the mid-range strike me as surprisingly high. How representative are those supposed to be of what is actually happening in the market, with respect what you're buying and what you're selling, other deals that you're looking at?

We've tried to take a relatively conservative tact (ph) on this page for some time. Clearly, the assets that we have pursued from an acquisitions perspective have been pretty pricey. We feel like this is a fair representation from a conservative ilk (ph).

Okay. And with respect your cash rents, if understood you correctly, you provided the cash rent decline on new leases -- I appreciate that -- but I think you mentioned that you exclude the free rent from that calculation. How prevalent is free rent on the leases that you're doing?

It varies by markets. We show the concession number on page -- 15 (ph) -- I think each of the product types -- I think it's page 15, 16 and 17 of the supplemental. It really varies based on the particular space, on the particular building and particular submarket. I would say all in all, we need to stay cognizant of the fact that concessions remain in the marketplace and they continue to be some aspect of virtually every deal we do. It may be a parking ratio in one deal, it may be lease term in another, it may be some up-front free rent or TI in another.

Okay. When I look at the drop in cash rents and the improved occupancy, is it a deliberate strategy on your part to trade rent for occupancy at this point?

We see vacancy to be pretty much equal to free rent, with the exception of the variable operating expenses. So, we're willing to give some up-front free rent and trade-off from picking up those variable operating expenses in order to garner some increase in occupancy.

Okay. And then switching to the balance sheet, it looks like in '05 and '06, $550 million worth of maturing debt, average rate 4.3 percent. Can you talk a little bit about the strategies that look forward, with respect to that pretty sizable slug of debt that's coming due?

The '05 and -- we have some secure debt coming due in both '05 and '06. You can see this on page 9 of the supplement, Jim. The unsecured debt in '05 is a term bank loan, which will probably roll or extend. And then in, '06 a lot of that represents any unsecured debt is two things. It's the line of credit, which will mature in mid '06. And the balance of that is some bonds that will mature I think in late '06, I think December of '06. So our expectation is that we would be rolling all of that debt at the time and that's it. Anything else?

Just one more from me. With respect to the dividend, the gap between cash being generated and the dividend is, there's been a shortfall for some time. And it looks like that cash flow shortfall is widening. Can you comment on the dividend and what the plans might be there?

Sure, Jim. This is Ed again. As you know, we like virtually every other company, look at it on a routine basis. We have covered the shortfall with sales from land proceeds. You know we have a fair amount of land in our portfolio that remains non-core and we're working through that. We've sold a fair amount this year, about $20.5 million, and we have more under contract for closing. We are hoping to work our way to where occupancy and CAD are breakeven. That's our goal right now, is to maintain a dividend and work our way out of this shortfall. But we are taking it a quarter at a time and I can assure you that management is monitoring this closely, as well as our Board.

Thank you.

Thanks for your questions, Jim.

(Operator Instructions) Chris Haley, Wachovia.

Good afternoon and congratulations on getting through this process. Not having tremendous experience with informal SEC investigations, what exactly -- how does the process work, in terms of time, effort in terms of senior management -- what is involved in this process?

Let me make -- be sure that everybody on the call understands, and you bring up a good point, Chris, that this is a nonpublic informal inquiry, not a formal inquiry, not an investigation. We are voluntarily cooperating fully with the SEC on a nonpublic informal inquiry.

I guess I can say fortunately, I like you don't have much familiarity with this in the past. But what we're doing is we're providing the SEC with the documents they requested. We have provided some information to them already. Obviously on the heels of this restatement in this morning's filing, we will have more information to provide to them. They requested documents relating to the restatements, including the sales transactions and some other adjustments that we have made. We continue to respond to any questions that they have. We think that this informal inquiry will work out over due course and we will get in good shape with this regard.

It's not a question of nondisclosure of material transactions in any way (indiscernible) has been defined as an unintentional misapplication of GAAP. And we don't anticipate that this inquiry will have any influence on our day-to-day operations. And you have heard about how strong leasing has been and development opportunities and we're continuing to focus on the balance sheet.

So we're keeping the business ops in separate from this inquiry and we expect to work through it as quickly as we can. We do know, based on conversations we have had with counsel and others, that they typically don't provide a timeline and they typically don't provide you with a letter that says when they are done.

Okay. So what other companies have gone through a nonpublic, nonformal fact-finding review that you are aware of?

It's our understanding that there have been a lot of companies that have done this. Not all of them disclose. It's not a requirement to disclose at all. In general, lots of companies don't disclose the fact. The letter does say it is a confidential non-public informal inquiry. We chose to disclose it. So who gets them and doesn't disclose them, we are not to say. But we felt it was appropriate to put this information out.

Okay. Terry, you and your accounting partners' auditors made two other adjustments related to the MPPRS and obviously minority interest. Hopefully, this is it. What is your perspective regarding the Board's position on these changes? What other steps do you think need to be made? And then from a shareholder prospective, maybe for both you and Ed, what are we supposed to take away from this, in terms of whether or not personnel that have been involved in this in the past, even if it was unintentional, what happens to shareholders in this instance?

I would say that -- let me just back up and just give a little bit of perspective. When you look at the adjustments that were made, many of them began or had their origin with transactions that occurred back in the late '90s or three or four years ago when, again, our accounting department was much lower in terms of the staffing levels and we had a lot of transactions going. We were a very active company as those who know the Company are familiar. There were very few adjustments that had to be made in this restatement that had their origins over the last 18 months to two years. It was really things that had happened well in the past. And as you also heard, we've made a number of enhancements in the number of staff and people we've added over the last year or two.

So I am encouraged that, given the staffing changes that we've made to date and the lack of any significant adjustments in the more recent timeframe, that things are different recently than they had been at the time. Now again, we did not really identify all of these until we went through the process. But when they originated was earlier, not more recently. So that encourages me. I think the Board, which we have obviously kept the Board and the audit committee extremely well-informed throughout this entire process, I think they share largely the same view on that. So, yes, we have made changes. Could there be additional ones? I don't see any really major ones at this point. We are obviously always trying to improve our internal controls. We have to go through the 404 process yet this year. And again, just as a reminder that E&Y gave us an unqualified opinion on the restated financials. And so I hope that is responsive.

Chris, what I would add to that, it's not an issue of disclosure. It's more technical accounting. We've worked through these issues. I would not want a shareholder to draw a connection between the length of this process and any concerns that somebody may have. If we had a choice -- expediency versus discovery -- and we've pushed for discovery. We did not want to sacrifice discovery for the expediency. So it was a very thorough process. It was basically a zero materiality tolerance. And we wanted to be sure that we had a very firm set of books. And, given that we had this restatement and the books were open, we wanted to capture everything that could possibly be identified. And as issues were identified and they were identified serially, we basically found one and then worked through to find another. And then all of these issues were fully bedded with E&Y, and it was a time-consuming process by the time it went through their system. It went through with our audit committee, etc. So with regard to your question about shareholders, that was one disconnect we would not want to have happened.

Two specific questions, and thank you for that. On your lease expirations going into '05 and '06, can you provide your perspective on where you think GAAP and cash mark-to-market is for your office portfolio for their expirations in the near-term?

On a GAAP basis, we had said early in this year that we expected a negative 5 percent roll-down, and we've basically have been flat for this year. We've bounced plus 1, minus 1, plus a half and bounced it up the year. We have been very close to flat. We are working on providing guidance and we will do that for 2005 before the end of the year. But I would not expect it would be far off from the guidance that we provided on GAAP for this year.

On cash roll-downs, same thing. We said 10-15 percent. And I think year-to-date, we're somewhere around 9 or 10. So I would expect that we would stick close to that as well.

Okay. Also, on your asset value page, which obviously fluctuates depending upon the assumptions you could use, based upon your sales activity in Tampa, could you give us a perspective on the $80 number for your 640,000 for the Preserve? Whether that's a -- what is your comfort level with that number of versus where trades have come in this year?

I'm sorry -- I stepped on your words.

That's it, guys.

The bottom-line on that, Chris, is that we received an appraisal on that property at the $80 per square foot level. What you're referring to is the sale that we had with the knock (ph), which was just about $103 net.

And/or other asset sales in the area that might give us comps?

Fair enough. It's our belief that is we stick with the $80 that we have on the appraisal, and we haven't done appraisals on others, but the appraisal was done in '03, it was as-is, where-is. We feel like we're sticking with that number. And given that we may have some negotiations ongoing that if we put a number out there, we're going to be negotiating against ourselves. I trust everybody is understanding of that business approach. We have clearly disclosed the knock number, we have disclosed the source of the 80. And everybody has as good or better than we do, with regard to neighborhood sales (ph).

Your last question is the (indiscernible) asset value page, have you changed -- in prior periods, your first-quarter supplemental and your last, probably the one prior to that, you did change -- made adjustments to your cap rates to the value of either your office or retail portfolio. Have you made any adjustments to those?

We didn't change the cap rates at this time from what we had done at the first quarter. I think you're right. We did lower the cap rates slightly when we published the NAV table originally in the first quarter of '04. But since then, we have not changed those.

Okay, great. Thank you, Terry.

Greg Whyte, Morgan Stanley.

This is David Cohen for Greg Whyte, just a couple questions. First, with regards to your guidance, you currently are at 175 for three quarters. And I believe your earlier guidance was 240 to 250. And given your fourth quarter guidance of 57 to 60, that would put you at 232 to 235. I'm wondering if this is an apples-to-apples comparison and whether or not you've had any other changes to your assumptions?

Basically, it is an apples-to-apples comparison. We did say early on that with regard to the 240 to 250, that it would be at the low-end of the range because we had anticipated earlier in the year that we would be able to be successful on approximately $100 million worth of acquisitions. And then as we mentioned in our call for the first quarter, we looked through those acquisition opportunities and they were just shy of $0.5 billion worth of opportunity that we had pursued. As of that point and time, the average cap rate was in the low sevens, and that's when we pulled back and said that we were not going to bullishly chase acquisitions where we felt that the pricing was out of sync with the risk profile.

So as a result, we pulled back and we said we would be on the low-end of that. A few other things that have happened is same-store NOI is slightly less than what we anticipated and a percent of same-store NOI is equal to about 4 cents a share. And then we took some land sale impairments as a result of land that we were able to attract some activity on in Baltimore, and we felt it was the right thing to do to take the impairment to get the land out of the portfolio.

Okay. In terms of your TI and LCs, they seem to have come down the quarter and -- or in third quarter. I'm just wondering if this is a trend, or is this more -- I guess as compared to the first quarter, it's just a lot lower. So I'm just wondering if this is an improvement or just kind of more back to a normalized level?

I think it's important, Dave, that you note -- if you look in the supplemental, you will see the numbers by division. And if you look at Orlando, the number, if I remember right, is 11 cents. And the reason for that is we did an approximate 150,000 square foot lease with FEMA on a one-year deal at Sunport. So if you strip out the FEMA deal that was done with no TI and a lease commission, that number would revise to from the 691 on office, would revise to 789. And with regard to the total CapEx, it would go from the 908 to 1029. It is also important to note that the term would go from 3.7 years to 4.1 years. So that places the number more in the trend of where we have been. We have said that we would be somewhere around 10 to 12 percent of releasing CapEx as a percent of term rent, and we have stayed right in that number. In fact, we are at 10.9 percent as of 9/30 for the year.

Okay. Your lease expirations for 2002, 2005 and 2006, I'm just wondering where you are in releasing or in addressing those expirations, and if you expect any large vacancies and downtime?

With respect to 2005, we have -- the markets which have the largest expirations is probably there in Raleigh, Tampa and Atlanta. And Raleigh in particular, there are several major transactions. One is BTI, which has been identified 140,000 square feet, and that building is actually under contract for sale and is expected to close in the first quarter. So it will actually close prior to the expirations, so that was pretty much taken care of. A few other major leases with -- one in Westin (ph) and one in RTP -- have already been taken care of, one in a long-term lease.

With respect to Atlanta, the largest expirations we have in that market are related to State of Georgia leases, one of our larger customers. And as you may be aware, those are typically on one-year leases that roll every year. And we expect those to continue to roll and be renewed as they come up.

With regards to Tampa, larger transactions there were T-Mobile, which is a renewal in our Tampa Bay Park, and that is a renewal that we're working on as we speak. We just did the 85,000 square-foot lease in Highwood Preserve and in conjunction with that, they have another 90,000 square feet in Tampa Bay Park, which we're working on right now. So that pretty much takes care of the major transactions in '05. We try to stay ahead on these transactions at least a year in advance with the tenants as they're rolling, particularly major tenants. '06, it's really a little early to be getting way out in front of us.

Let me just add one point also. With regard to Raleigh, 27 percent of the roll that's in there is in a building that we have under contract for sale. So a 140, 141,000 of the 5-plus, the 512 that is scheduled to roll is in a building that we will sell in the first quarter -- we have under contract for sale in the first quarter of '05.

And in that expiration schedule, is this net all of the transactions that you're talking about, or is it just the gross expirations?

It's the gross.

So can you tell me what the net would be after what you have taken care of?

We don't have that right here, but we will get that to you.

Also, just in terms of the other income line item and the financial obligations line item in the income statement, can you just discuss maybe those were changes due to the restatement. Can you just review those? Because I saw that the other income line item kind of changed from what you originally stated in 3Q '03 versus what you have in the supplement now?

I don't have the exact comment on that, but I will track that down for you. But you are correct, that there was a restatement adjustment. There were a number of reclassifications as well that really didn't impact the bottom line at all, but just reclassified certain items of income and expense in the new format that we have.

Currently, if you would look at the income statements for the quarters as they appear in the press release, the interest and other income line is fairly consistent right across the board. And over the nine months, is varied by maybe 10 percent or so, period over period. But I will have to research for you what it was in that third quarter '03 that we restated for you. I just don't know that off the top. But I will get that for you.

And the financial obligations line item -- what does that refer to?

The financing obligations, the one that's part of interest expense, as we explained on this call, and also in some detail on the call that we had in August, the three sales transactions that come back on our books as financing or profit-sharing arrangements, we record 100 percent of the revenues and expenses in those line items in our statements now under this revised accounting. But because there are other owners in these properties, we have to back out their share of the NOI to avoid double-pounding, obviously. And if it's a financing transaction, we back out their share of the NOI from these consolidated assets. In the line item, it's called financing obligations, which is part of interest. And if it's a so-called profit-sharing arrangement, if we're accounting for it that way, it's almost the same accounting, except that the NOI that we're backing out comes out down below in the line item that reads co-venture expense.

So those are just basically the line items where we are eliminating the NOI affects from properties that we are consolidating but don't 100 percent interest in under the new accounting.

Great, thank you very much.

Scott O'Shea, Deutsche Bank.

Thank you. You talked a little bit about potential balance sheet improvements. I was just wondering if you elaborate on that and point to any specifics, in terms of total leverage or reduction, secured debt levels, what might go into that?

You'll notice in the supplement, the total debt now is about 48.5 percent. We paid down some debt in this past period. I think the primary thing, Scott, is where we are now considering the disposition of our assets in Charlotte, we would use those proceeds primarily to pay down debt, some combination of our credit line and pulling in some of the preferreds. So we are focused on when we have an opportunity to create some value and reduce the debt in the balance sheet and provide us with some flexibility going forward.

That's helpful. Thank you.

Chris Haley, Wachovia.

Hi again. Could you give us a sense as to what type of timing today is between the lease signing and an occupancy actual rent paying that we should assume?

I think, again, so much varies by the market, the building and the prospect. If we are able to attract a long-term lease, and it's certainly one of our focuses right now, is to push lease term where we have a credit lease and we are having to spend additional capital above what we would normally like to spend, we are pushing for more term, which means we would probably give up a little more free rent on the front side. But from the time that we meet a suspect to the time that they become a prospect to the time we signed a deal and have rent coming in the door, it's really driven by (indiscernible) space that sat empty for 12, 18 months or is it a space that is in a prime building in a prime submarket and has only been emptied for a couple months.

Does it feel shorter or feel longer for your 5 to 20,000-footer, today versus six months ago?

They all seem long, Chris. Particularly when you get up to a 20,000 square feet, they just can't happen quick enough. And anybody and everybody is chasing the same prospect that we're chasing. They are in high demand. I would say overall that it would feel better today than it felt a year ago, primarily because sublease is no longer our enemy. Sublease space is really contracted. It's 3 percent in our markets. Our portfolio is 2.5 percent of our total portfolio valuable (ph) was subleased. And you'll easily remember when those numbers were double from what they are now.

So with that taken out of the market and the fact that construction as a percentage of market in our top five now is just over one percent, there's no new construction to be dealt with at the present time and the sublease is gone. So I think the election has lent some -- has removed some uncertainty from the equation, and hopefully, we will see some people stepping up even faster.

Chris, also you with respect to the -- you mentioned the rent commencement date. Some deals are not necessarily free rent driven, maybe a tenant that wants a turnkey or higher TI. And therefore, they may trade off free rent (indiscernible) pay rent from day one, but I want a higher TI, and that will show up in the CapEx line item.

Chris, one of the things that we probably haven't talked about enough on this call is, as verbose as we have been, is with regard to where we are with regard to leasing. We had said only on that we anticipated hitting 83.5 percent by year end, or 83.2 at the end of the quarter. We eventually have about 50,000 square feet of space to lease in order to hit that 83.5. And we certainly -- there's certainly opportunities to sign deals in this fourth quarter that will still start in this fourth quarter and enable us to hit our target.

About 50,000 feet as of today, Ed?

50,000 feet as of last week. They could include a renewal.

You mentioned the FEMA lease. Could you go through that again? I was interested in that, in terms of that was a pretty big impact here in your CapEx numbers.

Sure. It was the Sunport building, which we've talked with you about before. It's a building in Orlando that is outside of the CBD, and most everything we have in Orlando is CBD. The building has sat vacant for some time. FEMA, when the first hurricane was coming through, was interested in a large occupancy where they could bring people in. And they actually met the building and signed the lease in virtually the same day or committed to the space in the same day. They took the building as is. There was a 4 percent commission for the first six months of the deal. And as you know, subsequent to them committing to that space, additional weather came through the state of Florida and only drove the number of claims that they would have to manage out of that office. So it has been a good thing for them to be able to occupy this building. It's densely occupied and they've fully utilized not only the parking lot, but the additional land we had next-door.

And a number of improvements to the area paid for by FEMA with their nickel. So we came away with a better asset.

And the 1029 that you talked about, TI leasing commissions combined, that is with FEMA in the numbers?

No, that is with FEMA out. What shows on page 15, that 908, is with FEMA in. What I was trying to illustrate to David was the impact of the FEMA deal and that the 1029 is if you strip that out. But it's also important to note that if you strip that out, you're going to strip it out of the term too, and that pushes the average term up to 4-plus (indiscernible) years.

On your market rents, page 18 of your supplemental leasing statistics by market in the office, just quickly went back over the last couple of quarters and I am comparing the rents that you signed over the last couple of quarters. And the majority of the markets, you're signing rents at lower levels. Obviously, that could be different buildings or different states. But could you comment on your market rents where -- submarket or market rents where you are, and what you have seen this year?

I think you hit on it, Chris. It really depends on the space and the building that drives that. Different product, although office, but different variations within the office sector. We are pursuing deals. And if it takes cutting the rate a little, we will certainly evaluate it, but it has to be in sync with what the TI is and what the credit of the consumer is and the terms of the lease that we will be able to garner.

Overall, though, our sense is that activity is good. As we mentioned, absorption at top five markets is well over a million square feet in both the second and third quarter. That has not happened in any one quarter since early 2001. All of the other things that we've talked about with regard to the market activity, our leasing and upping the occupancy of our portfolio, we feel like these numbers are holding their own. And we really stick pretty close to what we're doing, Chris, with regard to GAAP rents. The GAAP rents, as we have said, have been pretty close to flat.

I have not seen the end numbers for your markets. I know you guys provide a sheet. Would you say your pickup in occupancy in your markets, those top five markets in the second and third quarter, has been higher or lower than the pickup in occupancy on a net absorption basis?

For the market as a whole?

Yes.

I would say we have outpaced the markets in most cases. With regard to our uptick in occupancy -- hang on, I'm going to tell you.

While you're doing that, Terry, on the Charlotte sales, what is the amount of debt on the Charlotte portfolio. And what where you do you think -- what kind of proceed range we're looking at, net proceed?

First on the proceeds, we're not announcing any kind of estimated proceeds or giving any guidance on that again, not wanting to kind of put out numbers because this is going to be a fully bid process. We just want to let the market react first. We have some debt on those properties in mortgage debt. But what will happen, rather than pay it off, we intend to probably substitute assets that we have elsewhere to free up the properties that -- those properties that are subject to secured mortgage debt in Charlotte.

So the net adjustment on your balance sheet for mortgage debt would do what?

The mortgage debt should not change from Charlotte, because we'll keep the debt in place because it's too expensive to pay it down. But a lot of our loans have substitution rights, so we can substitute other properties with equal NOI and keep the loan in place, rather than incur the prepayment penalties to take the loan out altogether.

So preferred capital reduction would be the likely way to go?

There will be opportunities to pay down certain debt that is maturing in '05. That was one of the questions earlier about the debt maturities. And there is some debt maturing in '05 that would be a use for some of the proceeds. And I think that debt, I don't have it exactly in front of me, but I think it had a fairly high handle, I think over 8 percent. So, that would be part of the use of proceeds. And then, depending on what else is going on, we do have two series of preferreds that are fully callable. They have an 8 percent coupon. And that is always available to us as well if we wanted to bring in some preferred stock, either to buy it in the market or call it. No decisions have been made on any of this, obviously, until we really get closer to having a transaction.

Chris, let me answer your question based on the sheet you referenced. The market has improved about 40 bips, and we are at 180 bips.

In the top five overall?

Correct.

Great, thank you.

Which is about two-thirds of our office revenue.

Thank you.

You're welcome, thank you.

Jim Sullivan, Greenstreet Advisors.

Thanks. Just a quick follow-up. In your portfolio occupancy specifics, you included the 1.3 million in Orlando in your first-quarter number. But then you took it out in the second quarter when you sold the equity interest. Did the sale of that partial interest, the 1.3 million (indiscernible) in your decision to take it out? Will the occupancy statistics help or hurt the portfolio occupancy?

It was entirely different.

Okay, thanks.

At this time, there are no further questions.

Well, I want to thank everybody for their questions. We appreciate your continued interest in Highwoods and we look forward to visiting with many of you at NAREIT and wish you safe travel to L.A. And, Bonnie, thanks for hosting the call.

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