Highwoods Properties Inc (HIW) 2008 Q4 法說會逐字稿

Good morning and welcome to (inaudible - bad audio) fourth quarter conference call. During the presentation all participants will be in a listen-only mode. Afterwards we will conduct a question and answer session. (Operator instructions)

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

Thank you and good morning. On the call today are Ed Fritsch, President and Chief Executive Officer, Terry Stevens, Chief Financial Officer, and Mike Harris, Chief Operating Officer. In anyone has not received a copy of yesterday's press release or the supplemental, please visit our website at www.Highwoods.com or call 919-431-1529 and we will e-mail copies to you. Before we begin I would like to remind you that this call will include forward-looking statements concerning the company's operations and financial conditions, including estimates and effects of asset dispositions and acquisitions, the cost and timing of development projects, rollover rents, occupancy, revenue trends and so fourth. Such statements are subject to various risks and uncertainties. Actual results could materially differ from those currently anticipated due to a number of factors, including those identified at the bottom of yesterday's release and those identified in the company's annual report on Form 10K for the year-ended December 31, 2007, 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 and NOI. Definitions of FFO and NOI and an explanation of managements' view of the usefulness and risks of FFO and NOI can be found toward the bottom of yesterday's release and are also available on the Investor Relations section of the web at www.Highwoods.com. I'll now turn the call over to Ed Fritsch.

Good morning, and thank you for joining us today. I'll start by providing a brief review of 2008 and our outlook for 2009. Then after Mike and Terry have concluded their remarks, I'll have a few closing words about how we view the world today and how we are adapting to this challenging economic environment. 2008 was another year of solid accomplishments for Highwoods. Full year FFO was $2.78 per share, excluding a fourth quarter impairment charge related to certain non-core assets in Winston-Salem. FFO from core operations was $2.67 up 11% from 2007. Our strong performance was due to same property NOI growth, NOI from new developments, lower G&A, lower interest expense and less preferred dividends. We're also pleased to announce that Moody's recently affirmed its rating on our debt and upgraded our outlook from stable to positive.

In addition in 2008 we leased 4.7 million sq. ft. of first and second generation space and at the year with 91% of occupancy. Delivered $201 million of development, including RBC Plaza, 33-story mixed-use building in Raleigh that is 93% leased. Sold $57 million of non-core properties with average age of 26 years and 86% average occupancy. Sold 45 acres of non-core land. Acquired $43 million of non-core office buildings, including Penmark Building on Poplar Avenue in Memphis and a 25% JV interest in Forum, a 635,000 sq. ft. office park in core Raleigh submarket. Completed sale of 65 RBC Plaza condominiums for $27.4 million of proceeds, and $4.3 million gain to HIW and raised $195 million through an equity offering of 5.5m shares.

Two properties were placed in service this quarter, Enterprise II, a 418,000 square foot industrial building in Greensboro that is 91% leased and Bay Center One, a 208,000 square foot office building in Tampa that is 88% leased. Our current development pipeline which includes projects still under construction as well as those that have delivered but not yet stabilized, stands at $260 million, only $56 million of which remains to be funded. In 2009, we will deliver $93 million of development including two build to suits for the Federal Government, FAA in Atlanta and FBI in Jackson. Dispositions in the fourth quarter consisted of three non-core office buildings in Nashville encompassing 193,000 square feet for gross proceeds of $20.9 million. These buildings were on average 30 years old and 83.7% occupied.

We took a $32.8 million non-cash impairment charge in the fourth quarter related to non-core assets in Winston-Salem including 11 office buildings that are on average 55% occupied and 23 years old. This market has high vacancy, negative absorption and limited opportunities for meaningful growth. For these strategic reasons, our plan continues to be to sell our remaining assets in Winston-Salem.

Despite a horrific residential market nationwide, since the first RBC condo units were COd on October 13th, we have generated $30.5 million of gross proceeds to the sale of 73 units. Buyers unfortunately have defaulted on 53 units forfeiting $1.4 million of earnest money deposits and 13 units remain under contract. The RBC condos are a very unique product in Raleigh and the traffic volume of potential buyers is encouraging. Our '09 guidance assumes we close half of the remaining units this year and the other half in 2010. Terry will discuss our balance sheet, but just a heads-up that we exercised our option to extend our $450 million credit facility for one year. It now matures in May of 2010. Mike?

Thanks, Ed, and good morning, everyone. As we announced a few weeks ago, leasing activity in the fourth quarter was solid, 156 leases were signed totaling 1.2 million square feet of second generation space, 71% of which was office. This is in line with our five quarter average of second generation leasing. Occupants in our office portfolio continues to be higher than the overall markets occupancy in each of our markets with the exception of Winston-Salem. We believe this is principally due to our efforts over the past four years to concentrate our properties in the best submarkets within each division. This has been accomplished through a combination of culling out non-core assets and developing in-fill projects resulting in a higher performance for Highwoods. Our leasing agents are actively communicating our financial strength to existing customers, brokers and prospects. In this unique economic environment this is a distinct advantage for Highwoods as we've seen some competitors face funding issues for TIs and lease commissions.

Several brokers have told us that they are only showing their clients space owned and operated by financially solid firms. Brokers are not going to risk the chance that their clients get left holding the bag on unfulfilled PI obligations nor do they want to get stiffed on their commission. While we are aggressively pursuing all deals it is worth noting that average in place cash rental rates compared to a year ago were up 5.6% across our total portfolio and were up 5.3% in our office portfolio. While cash rent growth for office leases signed this quarter declined 2.9%, GAAP rents for office leases signed in the quarter were up 9.7%. 81% of the office leases signed in the fourth quarter were renewals, keeping a lid on leasing CapEx which was $9.72 per square foot in the fourth quarter below our 2008 guidance of $10 to $12 per square foot.

We have many positive stats to report but there's no doubt the leasing environment is weakening. According to [Twardo Wheaton], net absorption of our top five office markets was 427,000 square feet compared to over three million square feet a year ago. Customers are asking and in some cases getting more concessions and flexibility in their lease terms. Office sublease space in our markets is creeping up, but is still less than 2% of total square footage. One silver lining to the capital crunch is that we don't expect subleased space to be as big a competitive factor as it has been in previous downturns. This go around we did not have the same widespread overconsumption of space, plus sublandlords and subtenants are both extremely reluctant to spend their own capital to retrofit sublease space. Another positive from operating in a capital constrained market is that there was no new lease office starts in our markets in our fourth quarter.

Our projected 2009 drop in occupancy is driven primarily from industrial move-outs in Greensboro from which we have viable prospects. As you know while the impact of industrial move-outs is [substantive] to occupancy the impact NOI is proportionately much less as compared to an office move out. While the leasing environment is tough, deals are getting done and as we noted in our third quarter call, most customers are accusing to renew, sit tight, and ride out the storm. As an example, one customer recently renewed two leases totaling 105,000 square feet for a five-year term and expanded by 7,000 square feet, while the cash rent declined 7.3%, GAAP rent increased 5% and the TI was only $1.50 per square foot. In summary we are optimistic our portfolio will continue to outperform the market. We're aggressively going after every deal and emphasizing our staying power. Terry?

Thanks, Mike. As Ed and Mike noted we are pleased with our financial and operating results for the fourth quarter and full year of 2008. Fourth quarter FFO per share before impairment charges taken on certain non-core assets in Winston-Salem was $0.68 per share which compares to $0.65 in the fourth quarter of 2007. Core FFO was $0.63 per share for the quarter and $2.67 for the full year. Full year core FFO was up $0.27 from 2007 or 11.3%. As a reminder, 2007 core FFO was 9% higher than 2006. The increase in 2009 full year core FFO resulted primarily from the impact of well leased development projects coming online, growth in average occupancy, and lower costs on our debt and preferred capital, partly offset by higher diluted shares outstanding from our $195 million common stock offering last September. Core FFO in the fourth quarter was down compared to third quarter as we had forecasted on last quarter's call primarily due to dilution from the common offering and from higher property operating expenses in the quarter, largely repairs and other costs.

Total revenues from continuing operations were up $4 million this quarter or 3.6% compared to the same period of 2007. For the full year, revenues from continuing operations were up $32.6 million of which $24.5 million came from development properties that were completed but not yet included in the same property portfolio. The remaining $8 million increase came from the same property portfolio. Same property cash NOI which excludes straight line rents and termination fees was up .8% for the fourth quarter compared to the same quarter in 2007. As we discussed in our last call, we typically have higher operating expenses in the second half of the year due to seasonality, which is primarily why same property NOI growth in the third and fourth quarters was lower than the first and second quarters of this year. These higher operating expenses include certain planned repair and maintenance and utilities. For full year same property cash NOI was up 2.3% over 2007.

G&A for the quarter was approximately $1.5 million lower or $0.02 per share than the same quarter in 2007. The primary reasons were nearly $1 million for lower deferred compensation expense which is fully offset by a decrease in other income and about $800,000 from lower audit and legal expenses. These reductions were partly offset by the 2008 cost of living increases implemented earlier in the year and higher healthcare costs. G&A for full year 2008 is lower than last year by $3.5 million or $0.06 per share of which $2.5 million is related to deferred compensation expense, again fully offset by a decrease in other income. G&A for 2008 also benefited from lower audit, legal, and consulting fees. As noted in the guidance section of our press release, we expect G&A to be even lower in 2009.

Net interest expense this quarter was down $1.7 million or $0.03 per share compared to last year due to lower average debt balances resulting from pay downs using proceeds raised in our common offering and from lower average interest rates in the quarter, partly offset by lower capitalized interest. Preferred dividends were lower by $1.2 million or $0.02 per share this quarter compared to last year as a result of our retirement of $53.8 million of preferred stock in September. The per share impact from the significant reductions in interest expense and preferred dividends in the fourth quarter was more than offset by the higher number of shares outstanding in the fourth quarter from the September equity offering. On a net basis, the equity offering was about $0.02 per share dilutive in the fourth quarter. As Ed mentioned we recorded a $32.8 million impairment in the fourth quarter related to non-core assets in Winston-Salem including $400,000 for a land parcel. Under the REIT definition of FFO, building impairments are included in FFO while building gains are excluded.

We had $18.6 million of gains from building sales in 2008 and $46 million of gains in 2007, none of which were reflected in FFO. Since most of you are familiar with impairment accounting for real estate assets, I won't go into too much detail in the GAAP accounting rules. The punch line is that all REITs are required to regularly assess their assets for impairment. If the undiscounted estimated future cash flows coupled with the anticipated exit proceeds are less than net book value, then the basis of the building must be written down to estimated current fair value. Fair value can be based on appraisals, sales comps and other estimates. The impairments recorded on the Winston-Salem assets occurred because of the increased uncertainty over projected cash flows for these assets resulting from current economic conditions coupled with shorter holding periods given our desire to exit this market.

Turning to financing and capital markets. Last month, we paid off $50 million of our bonds using our credit facility, and this month we extended the maturity date of our credit facility to May 2010. As a result, we now have remaining loan maturities in 2009 totaling just $118 million, $109 million of which is a low leveraged secured loan bearing interest at 7.8% that will mature in November 2009. We plan to refinance this mortgage either with the existing lender or a combination of lenders. We are well positioned with 61% of our NOI stream unincumbered by secured loans. This large pool of unincumbered assets is a significant financing and credit strength of the Company. Secured debt is available but at less attractive terms than a year ago.

We currently have $263 million of unused capacity on the credit facility. On page eight of the supplemental is a list of the banks that participate in the facility, their aggregate commitments and outstanding borrowings as of year-end. We are in the early stages of working with our lead bank about strategies regarding the extension or renewal of this facility prior to the May 2010 maturity. In addition we recently obtained a term sheet for a new $20 million, three-year unsecured loan that we expect to close by early second quarter. We also have $43 million of unused capacity on a secured construction facility which matures in December 2010 that can be extended for up to two additional years at our option. This facility is currently being used to fund our two active GSA development projects. So given our current $306 million of unused capacity on our facilities, combined with proceeds we expect from future dispositions, new secured and unsecured loans, our free cash flow and other potential capital sources, we are well positioned to handle our 2009 maturity and funded development pipeline.

Finally, a few comments about our 2009 FFO guidance, which is $2.53 to $2.72 per share. The mid point of the range is just over 5% lower than last years adjusted FFO of $2.78 per share and 2008 was a very strong year for the Company. It is important to keep in mind that 2009 guidance also includes $0.12 to $0.18 per share in dilution from expected property sales and debt financings that we are pursuing in order to enhance our liquidity. Without this projected dilution, our FFO guidance range would have been $2.65 to $2.90 per share. Ed?

Thanks, Terry. All of us recognize that we're operating in a challenging environment and it will take some time before the economy begins to recover. Highwoods is fortunate to have manageable debt maturities, a right size [land] inventory, free cash flow, respectable leasing activity and a manageable development pipeline that is a continuing source of new FFO. Two key goals for 2009 are to preserve cash and tightly manage operating expenses and G&A. Officers will not receive base pay increases in '09, discretionary spending has been significantly curtailed. We are negotiating rate cuts with our vendors, speculative development is off the table and financial and strategic returns must be very compelling for us to consider using our dry powder for build to suits or acquisitions at this time. Terry outlined the options available to us for continuing to maintain a strong balance sheet. One option a number of REITs have chosen relates to dividend policy, either a dividend reduction or a stock dividend. Many of you have voiced your opinions on this topic, some negative and some positive.

While it is prudent to never rule out anything that may at some point be in the company's best long term interest, its management and the board's preference to maintain our dividend at its current level and to continue to pay 100% of it in cash. Right now, our focus is on leasing, customer retention, expense management and the preservation of capital. Long term our focus remains unchanged, disciplined and opportunist. We strive to own the best assets and the best submarkets and maintain a strong and flexible balance sheet. We remain committed to transparent consistent and timely communications in good times and in bad and we expect to emerge from this cycle poised for growth. Our team is energized and cycle tested and we continue to be disciplined in our decision-making and good stewards of our shareholder's money. Operator? We now welcome any questions.

Thank you, sir. (Operator instructions) One moment please. And our first question comes from the line of Cedrik Lachance with Green Street Advisors. Please go ahead.

Thanks. Just on Winston-Salem, how big is the portfolio and what's the resulting value per foot, absent your impairment charge? Can you guys hear me?

Yes, Cedrik, it's Ed. You'll have to do the math on the resulting value. The whole portfolio is 1.4 million square feet.

And what's the value of the portfolio now?

Of what we've impaired or the portfolio as a whole in the triad?

You've only impaired the Winston-Salem assets, right?

Well, no. It's a subset of the Winston-Salem assets. It's 11 buildings. It's not the entire portfolio.

Okay, so what's the resulting value per foot on what's been impaired?

On what's been impaired, blended it's probably around $50 a square foot.

Okay. In regards to the occupancy guidance for next year, do you have any specific tenants that you know are going to be vacating or is it your best guess as to what's going to happen?

Well we've talked with all of the customers that will allow us to talk with them. We do know of a number that we expect to vacate, some of which we've backfilled as we announced the -- for example, the EMI lease in Nashville, we expected them to leave and they ended up staying, Qualcomm in Raleigh for about 50,000 square feet, so there are a number that are in the forecast, but we also have some of the space that's been realized.

The most significant impact, Cedrik, would be on the industrial space that we know or have good reason to believe will be vacating principally in Greensboro and is pointed out in my scripted remarks. We believe the impact on NOIs is not significant given this industrial versus office. And it represents about almost 250 depths of occupancy just with those industrial vacancies.

Okay. What is the industrial business that is so negative going forward, is it related to the tenants you have or is there anything else?

It's mostly related to the residential industry where materials are being stored for distribution in warehouses.

Okay. In regards to land values, you've provided your estimated market value for land parcels. It seems to not really have changed much of late. What do you see there that's holding land values when it seems that most property values are declining fairly rapidly?

We think that in what we've seen, obviously we haven't seen much land trade that's for our product type. We've traditionally been at the low end of values that we've disclosed, but the property type that we've seen the most dramatic move on for land values has been large single family track residential as opposed to core infill sites which is what our focus is. So we would want to own land and where we own land that of which we consider core, we really haven't seen much moving on that, Cedrik.

Okay. Maybe just one final question on the RBC condos. I thought you generally avoided speculators there, so what lead to such a large number of people not closing on the units?

It wasn't necessarily speculator driven. It was homeowner driven whose plot in life has changed from where they were back when they put these under contract in July of 2007. There's still a good volume of traffic going through. Last weekend we had north of 40, the weekend before we had north of 50 people come through the model units, and we have 13 that are under contract now, and our guidance reflects that we would anticipate closing about half of what we have left this year and then the other half in 2010. But we're still probably a little shamelessly proud of having done almost $31 million worth of sales, as I mentioned in the script, in the face of probably one of the worst real estate markets that most of us have experienced. So I think that underscores the $31 million that it is a unique product and that the community still has an interest in them.

And where is pricing on units that you're selling to those versus what you sold early in the projects life?

We're still on average over $400,000 a unit.

Okay, so your pricing hasn't really changed?

It has not.

Not significantly if at all.

Okay. Thank you.

Thank you.

(Operator instructions) Our next question comes from the line of David (Laminsky) with Robert W. Baird & Company. Please go ahead.

Hi, everybody. Just a couple of quick questions. On the secured debt that you guys are seeking, what are you guys seeing in that environment in terms of rate, LTV, and debt service coverage ratios?

David, this is Terry. We've recently gotten some bids in on one building that we are seeking to put fixed rate financing. The LTVs are probably in the high [50s] at best and the rates are in I would say the [mid-sevens] for five to 10 year money. Clearly that's a lot different than what it had been. Banks or the lenders are requiring amortization on the loans, interest only which we were able to secure in the past, it's really not on the table on fixed rate debt right now. Can't really give you an exact answer on the debt service coverage, but with the lower leverage, if you can meet the leverage test, you're meeting whatever the lenders are requiring on the debt service at this time.

Okay, and then if you were to refinance the mature unsecured debt is there any risk of an equity gap or more positively an opportunity for a cash out?

The loan that comes due at the end of November is fairly low levered. We estimate below 50% at this time using current estimates of value, so there could be a possibility for a small cash out, not much, and certainly I see a very minimal risk for us to have to put a little bit of equity in at this point.

Okay, and then going back to Winston-Salem portfolio, are you guys -- is that being marketed right now or are you guys just holding off on that?

Yes, to both. We had announced in '07 that we had expected to get out of Winston-Salem and then things didn't come together the way that we had hoped, so we've since undertaken an effort to get out of it rather than the portfolio as a whole, maybe one street address at a time. So we have 100% exited any of the industrial that we owned in the Winston-Salem market, and now we're striving to exit the remaining which is all office. We've sold one or two, but we've got quite a ways to go and we're working on that.

Okay.

We still believe it's a market to exit.

Okay, great. And then a couple quick questions regarding your JVs. What is the appetite of your partners to put additional capital in it for new opportunities?

I would say that it's moderate to good. We've had conversations with all of our JV partners over the last 60 days, particularly to be sure that the credit strength is equal to what we believed it to be, and we're very comfortable with the credit strength of our JV partners. And more than one of them have mentioned that they want to continue to pursue opportunities with us out in the marketplace particularly if distressed sellers of high quality assets hit the market.

Okay, and is there specific cap rate or pricing metrics that they and you guys would look for there, for those types of opportunities?

No. I think that it's driven first by the quality of the asset and then we look at the pricing thereafter, but there haven't been guidelines that have been established for that.

Okay, and then lastly, what kind of market conditions would cause you guys to take impairments on those JVs, is it cap rates at a certain level in the market or occupancy declines?

This is Terry again. We did look as part of our impairment process at the end of the fourth quarter at our JV investments as well, and none of those required impairment at this time, so it would take further declines in future cash flows of some size before we would face any kind of significant impairments in our JV assets, but that was looked at careful at year-end when we did the others.

Okay, great. Thanks.

Thank you.

(Operator instructions) One moment please. And our next question comes from the line of Jamie Feldman with UBS. Please proceed.

Thank you very much. I was hoping you could speak generally in terms of where you think we might be in the cycle in terms of business closures and bankruptcies in your markets. I assume we're probably at the pretty early stages, but just want to get your views.

Jamie, it's Ed. I think that it's a very difficult thing to predict. We haven't seen any material degradation in accounts receivables. We have gotten some calls from customers wanting to talk about extend and blends and some potential for rent relief, but it hasn't been widespread and we really haven't done much of that at all. Sublease space is still -- I'm just going to tell tales of what would indicate some of these widespread bankruptcies. We haven't seen a dramatic increase in sublease space in the market. It's still less than 2% of market, and back during worse times it would push 5%. We haven't seen a dramatic reduction in the use of space, so I think that you may very well be right that bankruptcies haven't bottomed out yet, but we at this point in time haven't seen a plethora of them come through our door. I do expect that we'll see a few and we've put some conservatism into our guidance for '09 to protect ourselves. We don't have specific names for those that we would expect to go, but I guess akin to what you're thinking is would expect to see some of that in 2009.

We did see a few bankruptcies late last year in the retail side out in Kansas City with Sharper image and Function Junction, and obviously we keep an eye on the retail world, but less certainly than office.

Thank you. I guess another way to ask it, do you think that the businesses in your region of the country have kind of adapted their business structure already to kind of the changed economy, or are still at the early stages of fixing things and still kind of scrambling?

I think it would be fair to say that most every business decision maker today is scrambling. We hear the word uncertainty in virtually every conversation we have almost regardless of the nature of the business, and I don't think that there are many industries or businesses that aren't intimidated to some degree by the current status of the economy.

I think we also have given that our average size customers relatively small they tend to be more nimble and able to adjust their business plans a little bit better. The larger national tenants obviously they have to look at country wide or global wide whether it's layoffs or changing their business model, it takes a lot longer for them to turn that battleship than the smaller tenants that are our core.

Okay, that's very helpful. And then Ed, I think on the last couple calls you talked about potentials for opportunistic buying. Can you give an update of how that looks right now?

Yes, not different at all from last time we talked. I think we're closer to them potentially hitting the market, but we have still yet to see a genuine material amount of distressed sellers with quality assets in the markets. And we need to get some more insight into where our refinancings are before we would dive into that head first. We are actively monitoring the assets, the status of the assets that we would like to own in each of our markets, and each of our division heads has that as a top three agenda item for 2009, but to date we haven't seen those come to market, which quite frankly works well for us timing wise, because right now Terry has a number of things under way from a financing perspective. If we can get that put to bed we would have a little bit better sense of the volume of dry powder we would have to deploy.

And a lot of the assets, particularly the trophies that we would be interested in, they were financed back a few years ago with CMBS, depending on when those mature, and that's when there's going to be somewhat of a day of reckoning for them and possibly an opportunity for us.

And we expect, Jamie, given the dry powder that we would be able to develop that we would be very specific and very disciplined about how we would put that to work.

Okay. And then finally, can you talk a little bit about how your pretty good capital position is giving you any kind of advantage versus competition in the market for leases, and how you're approaching maybe TIs or concessions as a result and what kind of advantage that's giving you?

Sure. We have messaged through our brokers to existing customers and prospective customers that, as Mike said in his script, that we have the ability to finance not only the broker commission but the buildout. And so if they want to bring a prospect to us or if we have a customer that needs a retrofit or relocation within our portfolio, that we can clearly accommodate that. And in fact also as Mike mentioned that there are brokers in the community who now have narrowed the scope of landlords to which they will bring a prospect, so that they themselves don't get hung out on the commission or that their customer doesn't get hung out with a slowdown or the absence of a delivery on the TI. So I think that that's an important competitive advantage for us, preponderance of our competitors are the local private developers, and we are hearing and seeing real signs of some, clearly not the majority but some, that are struggling and are getting the message out that they will be glad to do the lease, but they need to be extraordinarily frugal with regard to the allowance that they would have for the TI and the commissions which I think is a distinct advantage.

I also think that the absence offer these dollars will mean that the MO of sublease space in this current downturn will be different than prior because the sublandlord, as Michael labeled them in his comments, simply isn't going to be in the position or want to fund a significant TI. And given the absence of those dollars, that space is less of a competitive set this time than it was last time, where the rental rates were heavily discounted plus dollars were allocated for a full market commissions and full market TIs.

Okay, thank you very much.

Thanks, Jamie.

And we have no further questions at this time. I'd like to turn the call back to you, sir.

Okay, Frank, thanks. Thank you, everybody, and as always, if you have any questions whatsoever please don't hesitate to contact us. Thank you.

And ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.