Highwoods Properties Inc (HIW) 2004 Q4 法說會逐字稿

Good morning. My name is Katie and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Highwoods Properties earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. (OPERATOR INSTRUCTIONS).

I would now like to turn the call over to Tabitha Zane. Please go ahead, ma'am.

Thank you, Katie. Good morning, everybody. On the call today are Ed Fritsch, President and Chief Executive Officer, and Terry Stevens, Chief Financial Officer.

If anyone has not received a copy of today's press release or the two supplemental financial packages we distributed, please visit our Web site at www.Highwoods.com or call 919-431-1521 and we'll have on e-mailed 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, reinvestment of disposition and joint venture proceeds, the effect of tenant bankruptcies, costs and timing of development projects, rollover rents, occupancy revenue trends and so forth. 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 at the bottom of today's release and 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 no obligation to update or supplement forward-looking statements that become untrue because of subsequent events.

During this call, we will also discuss non-GAAP financial measures such as FFO. A definition of FFO and management's view of the usefulness and risks of FFO, together with a reconciliation of prior-period FFO to net income as defined by GAAP are available on the Investor Relations section of the Web at Highwoods.com.

I will now turn the call over to Ed Fritsch.

Good morning and thank you for joining us today. Today's call will focus on our financial results for 2004 and for the first quarter of 2005, which Terry will cover in a few minutes. Our May 26 release detailed our first-quarter leasing and operating results and we reviewed that information during our conference call held that same day, so we won't dedicate time to those same results again today.

We anticipate filing our 2004 10-K as well as our first quarter 2005 10-Q within the next few weeks. The 10-K will include our full 2004 and restated 2003 and 2002 financial statements for which we expect to receive an unqualified audit opinion from Ernst & Young. This truly has been a lengthy and detailed process, and I applaud Terry and his team for their hard work and tenacity.

We expect to be back on a normal reporting schedule with our second-quarter results, so we will discuss our second-quarter leasing progress and other financial and operational statistics in our next conference call, which we expect to host sometime in the first half of August.

The impact of the restatement on our historical financial statements was in line with our previously disclosed expectations. As we stated on May 26, we expect that the cumulative impact of the restatement on historical FFO for the three-year period to be a reduction of $0.07 to $0.08 per share and it came in at $0.08 per share. Going forward, the impact of these non-cash accounting adjustments is expected to reduce annual and FFO by $0.02 to $0.03 per share, which is exactly what we forecasted in May. As a reminder, this future impact is primarily due to the lease incentives reclassification.

Before turning the call over to Terry, I want to briefly review the progress we've made on our strategic management plan over the past six months. The key component of this plan is the upgrading of our overall portfolio by December 31, 2007. Through the disposition of 450 to $550 million of noncore assets and the development of 200 to $300 million of properties in key, infill locations in many of our markets, we believe that a higher-quality portfolio will lead to greater cash flow stability and more insulation from future cyclical downturns.

This year, our goal is to dispose of 100 to $300 million of noncore assets. As of June 30, we have sold $101 million of properties, which includes the sales of buildings 2 and 4 at Highwoods Preserve in Tampa to MetLife. This transaction closed last Thursday. When the closed on the sale of our Charlotte portfolio and the Sabal Park properties in Tampa expected to occur later this quarter, we're looking at $329 million of dispositions for the full year, obviously well in excess of the upper end of our range and certainly achieved faster than anticipated. As we've discussed previously, we anticipate using a substantial portion of these sales proceeds to redeem some of our outstanding high coupon preferred stock and to pay off a $26.2 million 8.2% secured loan that is callable on August 15 of this year. The payoff of this loan would unencumber approximately $73 million of assets.

We're also close to announcing two multitenant office development projects. These projects would be located in submarkets where occupancy in those specific areas exceeds 93% and where we have little to no existing inventory. The investment in these 2005 development starts would likely be between 45 and $50 million.

Just a brief update on Highwoods Preserve, the 800,000 square foot campus that was leased to WorldCom -- our initial investment in the Preserve was approximately $104 million. We estimate that, based on sales, subsequent capital expenditures, current leasing and anticipated lease transactions for the remaining 91,000 square feet in Building 5 and including the $14.4 million settlement from WorldCom that we received in mid-2004, the proceeds received plus the implied fair value of the remaining owned assets using an 8.25% cap rate would approximate $107 million.

Lastly, we received payments from US Airways for July in full and while we're growing increasingly optimistic that they will fulfill their terms of their lease obligations, we continue to account for them on a cash basis and exclude any future revenues from our guidance.

Terry?

Thank you, Ed.

As we stated in our May 26, 2005 press release and the related conference call held the same day, we have now restated first, second and third quarter of 2004 and prior-year financial results. The adjustments involved were identified during the process of closing the books for 2004, from finalizing our previously disclosed review of lease accounting practices and from the year-end audit process. These restatement adjustments generally related to transactions where accounting processes had been in place for some time. The prior-period components of these adjustments individually or in the aggregate would not, in our opinion, have had a material effect on net income in any individual prior year. However, the cumulative impact of all the prior-year components of these adjustments, if all were reported in 2004, would have had a material effect on our 2004 GAAP. Accordingly, as we stated earlier, on May 26, we have recorded these adjustments by restating prior-year results. The final adjustments were in line with the estimates we provided on May 26.

Total net effect of the adjustments on GAAP net income for years 2002, 2003 and 2004 combined is a reduction of approximately $3.2 million or $0.06 per share, of which approximately $900,000 or $0.02 per share relates to 2004. The total net effect on net income for all periods prior to 2002 was approximately 4.9 million or $0.08 per share. The cumulative impact on FFO for years 2002, 2003 and 2004 combined is a reduction of approximately $4.8 million or $0.08 per share, of which approximately 1.7 million or $0.03 per share relates to 2004. The total effect on FFO for periods prior to '02 was approximately 3.7 million or $0.06 per share.

These restatement adjustments related mainly to lease incentives, depreciation and amortization expense, straight-line ground lease expense and internal cost capitalization. The nature of all these adjustments were explained in detail during our May 26 conference call and a table showing the amount of these adjustments by period is included in the press release tables we issued this morning. Accordingly, I won't repeat the detailed explanations again on this call but would be pleased to respond to any questions later. Our earnings release and supplemental included a number of financial tables that summarized our earnings and a FFO by quarter and full year for '02 -- or '03 and '04, all on a restated basis, first-quarter '05 earnings and FFO, and a summary of the major aspects of the restatement.

I'd like to provide some additional comments on our financial results starting with first quarter '05 compared to first quarter '04. As stated in the release, FFO for first quarter '05 is $0.60 a share, compared to $0.50 per share for the first quarter '04. Both quarters were impacted by certain charges and credits. First quarter of 2005 was negatively impacted by $2.6 million impairment charge relating to Baltimore, Maryland land holdings. There was approximately $115,000 of other land gains in the quarter for a net negative impact from land of $2.5 million or $0.04 per share. This negative effect was offset by lease termination fee income this quarter of $2.6 million or $0.04 per share.

First quarter 2005 included revenue from our U.S. Air leases, which contributed about $0.01 per share in the quarter. Also, the average occupancy was higher in first quarter '05 compared to '04, which contributed to higher same-property NOI and approximately $0.02 in FFO.

First quarter 2004 was negatively impacted by $3.2 million or $0.05 per share in retirement costs related to our former CEO. Interest costs were also higher last year by about $1.9 million, or $0.03 per share, due mostly to higher average debt balances last year compared to this year. These adjustments were offset by land sale gains and termination fee income in the first quarter of '04 which aggregated $1.4 million or $0.02 per share.

Turning to '04, full-year FFO for 2004 was $2.11 per share versus $2.46 per share for 2003. Both years were impacted by a number of unusual or non-recurring charges and credits, as we noted in the tables to the press release. If all those items were added -- listed in the release were excluded, 2004 FFO would have been approximately $2.38 per share and 2003 FFO would have been approximately $2.43 per share.

Cost to comply with SOX 404 and our external audit costs, while not included as one of these items, were approximately $0.02 per share higher in '04 compared to '03. In addition, net gains on land sales amounted to $3 million in 2004 or $0.05 per share compared to $3.7 million or $0.06 per share in 2003. Termination fee income was $4 million, or $0.07 per share in 2004, compared to $6 million, or $0.10 per share in 2003.

As stated in the press release, we updated our current FFO guidance for '05 to a range of $2.27 to $2.33 per share. For those of you who model using quarterly run rates, let me mention a few things to keep in mind about our first quarter. The FFO results in first quarter '05 of $0.60 per share had virtually no dilution from property sales, since the sales occurred late in the quarter. As Ed noted, we expect to exceed the high-end of our original goal for dispositions in 2005, and we now estimate from $0.05 to $0.07 per share in FFO dilution for the remainder of the year from our completed and expected dispositions. We expect net G&A for full year 2005 to be about $0.04 to $0.05 per share higher than the annualized first-quarter run rate due to timing factors. The Company's annual salary merit increases take effect on April 1, for example. We expect incentive comp expense to be higher for the rest of the year, some of which fluctuates based on our stock price, which declined 3% in the first quarter from year end '04 but which increased over 10% since the end of the first quarter, and from other factors. Similarly, property operating expenses for the full year are expected to be somewhat higher than the annualized first-quarter run rate due to timing of certain expenditures and utility usage, among other things.

Our occupancy declined slightly at March 31 from year end 2004 and is expected to remain below first quarter's average until later in the year. Offsetting these effects, we will begin to benefit from NOI contributions from pre-lease developments that will be placed in service towards the latter part of 2005. We should also have positive contribution from termination fee income in land sale gains, which were neutral to FFO in the first quarter on a combined net basis.

This concludes our prepared remarks. Operator, we are now ready to turn the call over to you for questions.

(OPERATOR INSTRUCTIONS). John Stewart with Smith Barney.

It's John Stewart here with Jon Litt. I had a couple of clarification points on the guidance. First of all, I just wanted to be sure that you said, in the press release, guidance did not include any impairments on actual or potential property dispositions. Would that include the charge that you took in the first quarter?

No, that includes the first-quarter charge, John, but just any future charges that may occur.

Okay. Then what about severance-related in Charlotte?

Severance should not be included in that guidance number either. It's sort of as an unusual event for us, but it's not expected to be that large -- somewhere about $0.01 per share, we think.

Do you have the cap rate on the first-quarter dispositions?

I think -- hang on.

The second quarter was 8.9, and the first quarter was about a 9 -- 9.3, John.

That doesn't include, John, the effect from Highwoods Preserve.

It excludes the Preserve; obviously, with the preserve, it's an infant (ph).

But it was a negative NOI from the operating expenses.

But the -- in looking at the 8.9 for second quarter, it's important to note that one of those buildings was on a month-to-month lease with Sara Lee, about 86,000 square feet.

Can you give us a bit of background on the lease termination fee during the quarter and what your expectation is for the rest of the year?

They were from about three different leases. I'm not going to name the tenants, but -- and for the rest of the year, I believe, John, we expect another $0.02 to $0.03 of additional termination fee income for the balance of '05.

Okay. I can see why you would have raised the low end of the range here, but I'm a bit unclear as to what has changed that would cause you to shift $0.02 up the high-end. Can you give us a sense for what has changed there?

The primary driver on that, John, is the girth and the speed with which we've achieved the dispositions. You know, we has said 100 to 300 million, and we are at 329 today, or expect to be closed with 329 by the first half of this third quarter. We also obviously have the lease incentives impact that we spoke of earlier; that's approximately $0.02 per share, which ties immediately to the pullback from 2.35 to 2.33.

Okay. Then lastly, can you give us an update on the SEC inquiry?

There really isn't anything to update there. We've said all we can say on there. We're fully cooperating with the SEC and there is generally no update.

They haven't given you any expectation in terms of when they might wrap up their inquiry?

We do not have that and you know, there's just not a whole lot we can say there, but again, there is generally not a whole lot to update you on.

Greg Whyte with Morgan Stanley.

Just a couple of additional questions. Terry, you mentioned the lower sort of sequential quarterly occupancy levels in the first quarter, and you also suggested that it could be lower for the balance of the year. Can we get a little color on what is driving the lower number in the first quarter and why you expect it to continue? I mean, is it entirely due to asset sales or is it something else?

Greg, this is Ed. It's more driven by some expirations that we had actually forecasted when we had our call early in the year, and I believe even late in the '04, when we disclosed what our year-end 2004 occupancy was at 85, we suggested that it would dip in the first part of 2005 and then rise towards the latter part of the year and exceed the 85% with year end 2005. So, these are expirations that were expected. A fair amount of it falls in the Piedmont triad with some larger industrial but relatively low NOI expirations.

Okay. Then on the US Airways lease, you know, I guess, in prior discussions, you've been positively surprised as they continued payments there, but you continue, however, to exclude it (indiscernible) guidance for the balance of the year, although I think I heard you say that you were sort positive or encouraged at the prospects for that. Can you give us a little more color on what's going on there and what discussions you may or may not have had with the tenant?

Sure, Greg. They've done a fine job of staying in communications with our folks in Winston-Salem. The utilization of the space itself has maintained at its level since they closed down their other call center and added some of that activity to the call center that they house with us. We understand that their discussions with AM West continues to progress in a positive direction, so given that the fact that they are in bankruptcy and they still have the right to reject leases and make changes as it would impact our NOI, we continue to believe that, despite the fact that they have done a superb job paying, not only paying but paying on a very timely basis, the rent has traditionally been in our lockbox on or before the due date, but we still feel that it's the proper and cautious -- and I think we put out every number we can with regard to those leases so that anybody can use those numbers to put them into their model as they please.

So in the guidance that you guys have given, you think I think they were current through July, so your guidance includes sort of rent for them obviously for the first half, but you are not including anything for taking the third quarter -- for third and fourth quarters, is that correct?

That's basically correct.

Right.

Just again, pardon my not recording this, but it was a penny a quarter, is that correct?

Yes, it's about $270 -- $270,000 of NOI per month.

Greg, back to your occupancy question, just to be sure I was clear on that, we had anticipated to end the year 2004 at 83.4, and we actually ended it at 85.0, and at that -- when we announced the 85-even, we said we expected some occupancy dip in 2005 with anticipated expirations. We still anticipate 2005 to end higher than '05, even though '04 ended at a number that was 160 bits higher than what we had anticipated it to be.

Can we just use that as a segue? Can you talk a little bit about where you are on the space rolling in the second half and maybe even into '06, both in terms of success at re-leasing as well as rates versus sort of expiration rates or what you were expecting? What I'm looking for is really is kind above sort of a market comment for you as well as a commentary on your specific space.

Yes, let me give you a general commentary and then I'd like to be able to speak with much more specifics when we put out our second-quarter numbers in six weeks or so.

Just in general, we are continuing to see a decent amount of activity. We do have three markets where free rent has really gone out of the negotiations, and that's mostly Orlando, Nashville and Richmond. It's not to say that we wouldn't do a deal here and there with some three rent depending on some certain circumstances, but in general, free rent is out of the discussions in those three markets.

We still see some softness in Atlanta. We've had some very good progress in Tampa. Raleigh has had certain pockets of progress and other pockets that remain a little bit quiet. But overall, we see things continuing to sputter in a positive direction.

Thanks a lot, guys.

Michael Dimmler (ph) with UBS.

Good morning. Just wanted to get some color on NOI growth for first quarter and fourth quarter.

NOI growth -- same-center NOI growth was, if you back out the termination fees -- and this is in our supplemental, Michael. If you would turn to Page 26, you would see that. Excluding termination fee income, which runs through revenues, same-center NOI was up 2.1% or about $1.4 million.

Michael, this is Ed. Just a footnote to that, if you are looking at Page 26 on the first-quarter supplemental, you'll see that the most significant roll-back was in Charlotte, and as you know, we are under contract to close on that sometime in the first half of the third quarter.

Okay. I'm looking at the supplemental, and I'm not seeing -- on Page 26, I'm not seen the NOI numbers.

Is the header of the page "Same-Property Performance"?

No.

Well, what quarter -- well, it's the same on both.

So joint ventures.

It's one or two pages earlier, Michael. I'm not sure why it's not showing up as Page 26 on what you're looking at.

Okay, I will talk to you off-line on that.

It may have been the way that it printed for you, the header on the page should be "Same-Property Performance" and the NOI component is in the middle of the page.

Okay, I will talk to you off-line on that.

A follow-up, though, is regarding guidance on asset sales for the remainder of the year, you are already ahead of your stated target. What does the second half look like?

Well, the second half will include what we anticipate closing in Charlotte and Tampa, the $228 million sale there. Beyond that, we would expect that it would be plus or minus possibly another $10 million worth of dispositions.

Jim Sullivan with Green Street Advisors.

Thanks. A question on the dilution from the asset sales -- I'm trying to understand why the dilution is as severe as it sounds like it will become, given that a number of the assets that you're selling are properties with low occupancy, which would imply a low cap rate on the sale, you're selling Highwoods Preserve at a negative NOI. Then the use of proceeds is to pay off debt with numbers like 8.6 and 8.2 on the interest rate and the preferred stock at 8. Are the asset sales going to be $0.05 to $0.07 dilutive as opposed to something closer to 0 or even accretive?

Jim, this is Ed. Let me take the first one and then turn it over to Terry, but about 1.6 million, 1.7 million of the dispositions are very high leased. The 1.2 million that we sold in the first quarter were 99.3%. If you exclude the Preserve from the second quarter, you're left with about 451,000 square feet of space that was 91.1%, so the occupancy actually was quite high at about 1.6 million, 1.7 million of dispositions.

Then I think, with regard to our plans for reinvestment, obviously there's a component of that that is a part of time delay. We are required to provide notice if we were to call in preferreds, and we don't want to do that until we have our money in-hand from the closing. So, once we have money in-hand, then the notice period is a number of 30 days, so we do have a little bit of downtime in there with the money, although we will put it towards bringing in our line or paying off the secured loans, one of which you know we paid, another one that's in the queue to be paid off on August 15.

Terry?

The only thing I would add, Ed, is that there is some part of the proceeds that will go to pay down the line and there could be some to help with some of the development costs that we will be incurring later in the year, so the proceeds, Jim, wouldn't all be put to work at the rates that you were indicating. Certainly the part that we do use for preferreds to be at 8% and the two loans that we -- the one we paid off in April and the one we intend to pay off in the third quarter are a bit little over 8%, but the weighted average return on the proceeds is not that high. That really accounts, plus the delay that Ed mentioned, really accounts for that relatively modest dilution.

Okay, that helps. The cap rate, 8.9 in the second quarter, 9.3 in the first quarter. When I look at your estimated NAB on Page 5 of the supplemental, how should I think about those cap rates on the executed sales versus the cap rates that you show in your estimated NAB?

Two silos for that answer, Jim. One is that, as we've said, these are some older, noncore -- the second-quarter sales included a 89,600 square foot building that was on a month-to-month lease. The buildings that we sold down in Atlanta, on average, they are 31 years old; they are clearly older, noncore assets. The sale that we have under contract, Sabal in Charlotte, is a 7.4 on $228 million. Also in the first quarter, it included a building that was approximately 160,000 square feet that was going dark. A large component of it was going out; BTI or ITC Deltacom actually occupied a majority of that building, and that lease expired on March 31, the day that we closed.

Okay. Then switching to the new development, the new office development, where is that going to be?

We anticipate being in a position to announce that near-term. The markets that are making a lot of sense to us right now are primarily driven by specific submarkets. We have some submarkets in Nashville that have very low vacancy and we have very little existing product available to lease. So that's appealing to us. Then we're looking at a couple of other options where we have land that we own and infill buildings that are fully designed, and we're looking at what the prospects are to pull the trigger on those right now with some early commitments.

Is the submarket strength enough to lead you to do spec?

I would say, in Nashville, it is. 98% lease is a submarket (ph) and we are 100% leased in our portfolio. We don't have any product and there is demand in the growing submarket. We are also in a position of either we're going to capture our growing customer base or the competition is, and we'd rather be the ones to do it. So, so our overall portfolio in Nashville is extremely well-leased. The buildings within that submarket are fully leased and the submarket is extremely well-leased.

Okay. Then finally, the impairment charge that you took on the land, can you help me understand where you have land that's worth less than what you bought it for?

Baltimore, Maryland. (LAUGHTER).

What happened there?

We bought a company many years ago; it included a landholding. We sold out of the improved assets and we've continued to own the land. We have sold about 30 acres of the 97 to date. We have about 53 of those acres under contract, and we are marketing the remaining 14.

Okay, thank you.

Susan Berliner with Bear Stearns.

Yes, Elizabeth Carter (ph) for Sue. I'd like to get some color on your recent conversations with the rating agencies.

Yes, this is Terry. We've been in regular contact with the rating agencies, including most recently a full day visit and property tour with Fitch. I think the communications are going well with them. I don't know if there's anything specific you want, but we do try to keep in close contact with the rating agencies.

Okay, thanks. Can you provide unencumbered NOI?

That's not something that we (indiscernible) we provided. It's been asked for a couple of times. We may consider doing that but it's not something that we have done and I can't really give it to you over the phone. (multiple speakers).

Okay, thank you.

John Guinee with Legg Mason.

Can you walk through what else you've got going on with your rather extensive land inventory? You mentioned Baltimore. What else do you have on the market now?

John, we've said that we anticipate selling 60 to $70 million worth of land within this three-year window of the strategic management plan. So we've given guidance on what we expect to do in calendar year 2005 and the total amount that we would expect to do would be 60 to $70 million over the three-year window.

Okay. The second question, on your two develop deals, on a per-square-foot basis, what do you think they will be, all-in?

I didn't fall asleep; let me just pull out my calculator. (LAUGHTER). One, if we do, one of the ones that we're thinking of, it would have structured parking; the other would not, so I would say that, you know, on a blend, we would be in the 145 to 150 range.

Structured in Raleigh and surfaced in Nashville?

We would do structured in a number of our markets. If we did anything in downtown Orlando, for example, we would have structured. We would consider it in some other markets as well.

(OPERATOR INSTRUCTIONS). Jamie Feldman with Prudential Equity Group.

Where do you expect same-store NOI without lease termination fees to come in for the year?

We think, for the full year, same-center NOI would be somewhere flat to up plus 1% or so. First quarter was -- without term fees was 2% but as I also mentioned, Jamie, operating expenses were a little bit lower in the first quarter compared to what think the run rate will be, due to some seasonality. That helped a little bit in the first quarter relative to full year.

Okay. Then if you could mark the 2005 leases to market, what would that be? The same with 2006?

I don't have that information readily at hand, Jamie. Maybe we can get back to you.

Jamie, we've said that, on a GAAP basis, that we expect it to be -- (inaudible) basically flat, negative 2% to flat. On a cash basis, we've said that the rent growth would be negative 5 to 10%. We haven't seen a reduction in last year's asking rate versus this year's asking rate, so we feel that we've clearly bottomed out on that and that stabilized.

As I mentioned earlier, in a few of our markets, we've seen the concession component shrank on virtually all the deals in those respective markets, and we're beginning to see signs of that in some of the other markets but concessions remain a significant component. So year-over-year asking rates have stabilized and in a few markets actually improved with regard to the absence of free rent concessions. Then the cash rent, negative 5 to 10%, the GAAP flat to negative 2. Is that fair?

That's very fair. Do you have any perspective on '06 yet?

I wish I did. I just can't see that far out right now. I think that it would be fair to put into the calculation that most developers have remained at bay. Construction as a percent of market in our top five markets as of the end of the first quarter was only 1.1% versus same time a year ago; it was 1.2%. So, no substantive move there. I do know that there are developers that have drawn complete and in-the-canister and ready to pull the trigger on, but a lot of people are being much more deliberate nowadays with regard to pre-commitments before they put a stake in the ground.

Then related to development, what type of yields do you think you can develop to?

Our GAAP yields are in the mid-9s, and what we have underway right now, all of which is scheduled to deliver between now and year-end, would be about high 9s to 10.

That's all for me; thank you.

Lou Taylor with Deutsche Bank.

Ed, it looks like you guys were pretty closed to covering your dividend from an FAD basis, at least based on committed (indiscernible) dollars and commissions. What's your expectation for FAD for the second half of the year?

Lou, I think that part of that is a bit veiled because of the significant lease that we did in Tampa with Cinnaburst where we had very nominal CapEx spend, both TI and commission, so the first-quarter number was lower than what our traditional run had been as you would see in the supplemental. Last quarter, we were at 10.91; this quarter, we were at 7.89. We have stuck with our guidance of it running between 10 and $12 for the year, so I would expect that the number would pick up, particularly towards the latter part of the year as we anticipate to see some improved occupancy. This is probably too much of a silver lining, but obviously that number going negative -- if the ratios hold, that number going negative means we're simply improving occupancy and about every percentage point of occupancy costs us -- increase in occupancy costs us about $5 million.

Jim Sullivan with Green Street Advisors.

the minus 8.8, or the 8.8% drop in cash (indiscernible) during the quarter, is that representative of the portfolio overall if you were to mark-to-market?

Yes, I think, Jim, that's if fair to say that it's distorted by a couple of things. One is that it includes the Cinnaburst deal, which, you know, WorldCom was at a much more significant number than what we were able to re-lease it at, even though the triple-net lease rate was, in our view, extremely attractive. Also, if you look at the 8.8, it includes about 17% just from Charlotte, and you know, we're looking to get out of the Charlotte market, so hopefully we wouldn't have that significant drag going forward.

I would say that our range of the 5 to 10% is fair guidance for the rest of this year.

Okay. Then with respect to occupancy, if I understood your earlier comments, Ed, it sounds like your target occupancy for the portfolio at the end of the year is something like 85%? Is that correct?

No. What I didn't do a good job of explaining there, Jim, was that, for 2004 -- early in 2004, we said that we had hoped to be at 83.4 by year-end, and then we actually ended the year up at 85. We had then said, in early '05, that we had expected to be even higher than year-end 2004 from year-end 2005. So despite us being up 160 bips (ph) higher than we thought we would be, we're sticking with being able to be, at year-end '05, even higher than we were at year-end '04, so if we ended the year end of '04 at 85, I think it's fair to say that we are looking more to be in the 86 range come the end of this year.

How much of that growth is from positive leasing events? How much of it comes from the sale of assets?

It primarily excludes the sale of assets with the exception of the Preserve, because in that case it's 100% empty (ph) product and the sale of the Preserve I think has about a 0.5 point impact.

In your 86% number, is US Air in that or out of it?

It's out.

So you're talking about 240 basis points of improvement from where you are or where you were at the end of the first quarter, even assuming US Air doesn't stay in its space, is that right?

I haven't done the math, but that smells right. Yes.

Thank you.

John Stewart with Smith Barney.

Just a couple of quick follow-ups -- Ed, you mentioned that there were a couple of markets where you had seen a slight uptick in asking rent. Where those the same markets that you were referring to in terms of where free rent is off the table, or are those other markets?

Yes, those three markets -- really the net effective is improved because of the extraction of the free rent component from those deals -- Orlando, Richmond, Nashville.

Then Terry, will you expect to record a Topic D-42 (ph) charge when you redeem the preferred?

Yes, we will. For those of you that don't know or are not familiar with the Topic D-42, what that requires is when you calculate earnings per share, when you have a redemption of preferred stock, that you need to reduce net income by the original issuance costs that were incurred when that preferred was first issued. I don't have the exact amount, but our issuance costs were somewhere around 3% of the total amount of the preferred that was raised back in the '90s, so depending on how much is redeemed, we would incur roughly a 3% reduction in earnings available to common shareholders. That charge, John, is not included in our guidance, which exclude any "unusual items". That would not be factored into the guidance that we talked about.

I got you. Okay, thank you.

(OPERATOR INSTRUCTIONS). Susan Berliner with Bear Stearns.

Elizabeth Carter again for Sue. A quick follow-ups for you guys -- were there any mortgages on the properties you sold in the second quarter?

No.

No.

At this time, there are no further questions. Mr. Fritsch, are there any closing remarks?

Yes ma'am. Thanks, Katie. I thank all of you for your patience, interest and support throughout this process. Despite these accounting matters, our team has remained focused on achieving the goals of our strategic management plan, and I believe their efforts are already beginning to yield solid results. Terry and I also thank those of you who have taken the time to meet with us over the past six months to listen and understand our plan. We appreciate your continued interest and hope you are as enthusiastic about the positive progress being made here as we are.

Thank you. As always, please don't hesitate to call us if you have any questions at all. Thank you.

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