Highwoods Properties Inc (HIW) 2010 Q2 法說會逐字稿

Ladies and Gentlemen, thank you for standing by. Welcome to the Highwoods Properties second 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) As a reminder this conference is being recorded. I would now like to turn the conference over to Tabitha Zane, please go ahead, ma'am.

Thank you and good afternoon. On the call today are Ed Fritsch, President and Chief Executive Officer; Terry Stevens, Chief Financial Officer; and Mike Harris, Chief Operating Officer. If 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. Please note in yesterday's press release, we have announced the plan date for our next financial release and conference call for the third quarter. Also, following the conclusion of today's conference call, we will post senior management's formal remarks on the investor relations section of our website under the presentation section.

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, the terms and timing of anticipated financing, joint ventures, rollover rents, occupancy, revenue trends and so forth. 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 10-K for the year-ended December 31, 2009, 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 management's view of the usefulness and risks of FFO and NOI can be found towards 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 afternoon. Thank you for joining us today. Before discussing our quarterly results, I'll make a few comments about the economic environment. Given the volume of highly publicized conflicting data on the US and global economy, such as recovery versus double dip, it's hard for anyone to know what to expect over the next 6, 12, 18 months. Clearly, most indicators suggest it will take a while for our economy to return to sustained growth. Here is what we do know.

The employment picture is not getting worse. The extent of home foreclosures is more quantifiable, expense inflation is being contained, interest rates are still very low, and equity is plentiful. Given the remaining economic, political and regulatory uncertainties, it's hard to say when conditions are going to materially improve, but appears conditions are not continuing their trend of being worse today than they were six months ago. Despite this uncertain environment, given our progress to the first half of the year and our projections for the remainder of the year, we have updated our 2010 FFO guidance. We raised the bottom end by $0.09 to $2.40 and lowered the top end by $0.01 to $2.48 per share.

Turning to our results, leasing volume was solid and better than a year ago. Office leasing in the first half of 2010 totals 1.8 million square feet compared to 1.3 million square feet leased in the first half of 2009. Some of the larger deals we achieved over the past six months have come with higher leasing CapEx but these transactions were carefully vetted and stand nicely on their own merits. They are long term, long on credit and strong wins for Highwoods. OpEx and G&A are lower as we continue to be successful in our ongoing efforts to reduce expenses and improve efficiencies throughout our Company. This has resulted in better same-store NOI and G&A forecasts in our updated FFO guidance. Our office occupancy remains significantly better than the markets as a whole as we continued to differentiate ourselves from our competitors through our healthy balance sheet. This strategy has proven to be effective as exhibited by recent wins of the larger deals in a number of our markets.

Turning to investment activity, we're extremely pleased to have deployed $52.6 million to acquire Crescent Center. This purchase is a bullseye on our acquisition score card. It improves the overall quality of our portfolio. It is a terrific asset in a core in-fill submarket, it strengthens our dominance in Memphis' best submarket, it has a stable diversified customer base with no material near-term rolls. We acquired it at 30 plus percent below replacement cost and it is immediately accretive to FFO. While the breadth of our current acquisition opportunities remains narrow and well below historic norms, we are seeing the cadence of offering memorandums increase. While they are not all higher quality assets, the few that are seem to be garnering a "scarcity" premium. Time will tell whether the higher quality assets will come to market and scale and if the apparent substantial amount of sideline cash waiting to be deployed will be quickly flushed out.

While Crescent Center is a bullseye, we would also consider properties off the center mark but still in our target. This would include well conceived but under leased development projects and under occupied class A office buildings and in-fill locations. These cases the real estate would have good bones and be acquired at a discount enabling us to offer below-market rents.

On the disposition front, we sold our unconsolidated equity interest in the Des Moines joint ventures which had a $200 million in gross asset value. As a reminder, these assets were highly levered with $170 million of non-recourse secured debt. While Des Moines has historically been a good investment for our Company generating a 16% annual leverage cash return over the past 12 years, we felt the time was right to exit these joint ventures. Des Moines is a non-core market and there is a significant customer concentration within the portfolio. To put that in context, a single customer accounts for 23% of the Des Moines JV's annual revenues. By comparison, the largest customer in our wholly owned portfolio, other than the Federal Government, contributes just 3.5% of Highwoods annual revenue. This sale also provided us with additional dry powder to fund future growth.

Other disposition activity in the quarter included the sale of 1.3 million square feet of non-core assets in the Triad for $25 million. These sales included Madison Park, a 472,000 square foot seven-building office park in Winston-Salem that was 51% occupied, and Chimney Rock, an 837,000 square foot six-building industrial park in Greensboro that was 58% occupied. With regard to development, we are in the hunt for seven build-to-suite projects approximating $150 million investment. Given today's economic environment customer decisions making process for build-to-suites is much more deliberate. Work sessions with our customers and prospects are ongoing, so stay tuned.

During the quarter we placed one development project in service, River Pointe in Atlanta, 200,000 square foot industrial property that is 50% leased. Our wholly owned development pipeline now consists of two office projects encompassing 208,000 square feet which are 46% leased. We're also developing 171,000 square foot build-to-suite office building in a joint venture for the GSA in Charlotte.

In closing my remarks I underscore that we continue to be out beating the bushes to increase market share and enhance FFO through leasing, development, and acquisitions. Mike.

Thanks, Ed, and good afternoon, everyone. Across our entire portfolio, this quarter we signed 178 leases for 1.4 million square feet of second generation space with good activity in all three property types. Second quarter office leasing activity was decent across most divisions and almost 10% greater than the same period a year ago. The average term for office leases signed this quarter was 4.8 years, in line with our five quarter average. Occupancy in our wholly owned portfolio increased 150 basis points from the first quarter to 89.3%, helped by the sale of our second quarter dispositions. Occupancy in our office portfolio at quarter end was 88.6%, a 90 basis point increase from the first quarter and our portfolios office occupancy continues to outperform our markets. Lease economics still favor the customer with respect to rental rates, lease concessions, and TIs. Cash rent growth for office leases signed this quarter declined 10.3% and GAAP rents were down 1.8%. CapEx related to office leasing was $12.55 per square foot in the second quarter which was impacted heavily by two new lease transactions, a 32,000 square foot lease in Memphis and a 60,000 square foot lease in Raleigh. Both are excellent long-term deals with good credit customers. Without those two transactions leasing CapEx for the quarter would have been $10.02 per square foot, well below our five quarter average of $11.27 per square foot.

I am pleased to report for the first time since the second quarter of 2008 every one of our top five Markets reported positive net absorption totaling 1.1 million square feet. Office sublease space in our top five markets declined 20 basis points from the first quarter to 1.5%. Looking at some of our markets, the overall Raleigh market reported positive absorption of 300,000 square feet and for the first time in over two years, market vacancy did not increase. Leasing volume in our Raleigh portfolio was solid and occupancy increased 250 basis points to the first quarter to 86%. We signed a 60,000 square foot 15 year lease with Duke Medicine repositioning River Birch to a medical office building. We also signed 229,000 square feet of second generation space with an average term of over five years. Second gen leasing included the 60,000 square foot expansion with INC Research announced in May.

Adding to this good news, just last week we signed a 163,000 square foot extension and expansion with Telecris in our Research Commons Office Park. This was an 11-year deal and included 40,000 square feet of expansion with a solid long time customer. Nashville continues to be a strong market and our occupancy there is a solid 90.6%. In Tampa, occupancy in our office portfolio continues to outperform the market 90.8% versus 77.8%. Tampa reported positive absorption of 184,000 square feet this quarter and with no new office construction, we are hopeful this market is on the path to recovery.

Looking out to the remainder of the year, we expect to see continued pressure on deal terms in all of our markets. While competition for customers is aggressive, our strong balance sheet and willingness to commit leasing CapEx to financially strong customers and prospects positions us to take advantage of their concerns about the financial health of their landlord. We also continue to benefit from having a well respected brand and a strong reputation for quality and service. Terry.

Thanks, Mike. We are pleased with our financial and operating results for the second quarter, with FFO of $0.64 per share which compares to $0.70 per share in the second quarter of 2009 and $0.61 per share in the preceding first quarter of 2010. Core FFO, which we define to exclude lease termination fees and condo gains, was $0.62 per share for the quarter compared to $0.68 per share in the second quarter of 2009 and up from $0.60 per share in the preceding first quarter of 2010. Net income per share this quarter was $0.50, the same as second quarter last year. Net income in both quarters had significant non-FFO gains from disposition of JV interests and from wholly owned properties. All per share results this quarter and for the first six months were impacted from higher rated average shares outstanding, 75.6 million diluted shares this quarter versus 70.2 million in the second quarter of last year. This increase is mainly from our 7 million common share offering completed in the second quarter of 2009. The $0.03 increase in total FFO this quarter compared to the proceeding first quarter, was primarily due to 1.5 cents in higher term fee income, 1.4 cents in lower operating expenses net of CAM recoveries and 1.2 cents in lower G&A offset by $0.7 of a cent in lower JV FFO mostly due to the sale of our JV interest in Des Moines that occurred in May.

Going forward we don't expect term fees to run at the second quarter rate and operating expenses are typically lowest in the second quarter and highest in the third quarter reflecting seasonality in utility costs and timing of repairs and maintenance projects which are typically higher in summer and early fall. Accordingly, FFO per share in the third and fourth quarters is expected to be lower than second quarter.

Total revenues from continuing operations were up $2.4 million this quarter or 2.2% compared to the second quarter last year due mostly to $2.7 million in higher straight line rental income and $1.5 million in higher term fee income offset by $1.8 million in lower cash revenues. Total revenues from same properties, those in service since January 1, 2009, were down $900,000 or 0.8%. This was due to a reduction in same property cash revenues of $4.5 million partly offset by $2.1 million in higher straight line rental income and $1.5 million in higher term fees. Lower cash revenues this quarter largely reflected the impact of higher cash concessions on recent leasing, 0.3% of a reduction in average occupancy, and negative trueups on prior year CAM accruals. Revenues from non-same properties were up $3.3 million quarter-over-quarter from recent development projects and from the fourth quarter 2009 acquisition of 4200 Cypress in Tampa.

Cash NOI from same property operations which exclude straight line rents and lease termination fees was down by only $2.9 million or 4.2% in the second quarter compared to second quarter of 2009 as the reduction in same property cash revenues was offset by $1.6 million in lower operating expenses. Total same property NOI was up $800,000 due to $2.1 million in higher straight line rents and $1.5 million in higher term fee income. As we've discussed on a number of prior calls we continue to put significant attention on controlling operating expenses in G&A. G&A for the quarter was approximately $2.5 million lower than second quarter 2009. The quarter-over-quarter improvement was driven by $900,000 in lower incentive compensation and $1.1 million from the deferred comp valuation adjustment which was $400,000 positive this quarter compared to $700,000 negative last year. This deferred comp impact, as we've discussed before, is fully offset by corresponding impacts in other income. Finally, there was $500,000 of reductions in various other areas of G&A this quarter.

Net interest expense this quarter was up $1.6 million compared to last year due mostly to $900,000 in lower capitalized interest from fewer development projects in the pipeline and $500,000 in higher fees related to the $400 million credit facility we closed in late 2009. Our balance sheet remains in great shape. We have nothing outstanding under our $400 million credit facility and we have $36 million of cash on hand at the end of the quarter.

Finally, as Ed noted, we narrowed the range of our full year FFO guidance to $2.40 to $2.48 per share from $2.31 to $2.49 per share and also adjusted certain specific guidance assumptions. While total FFO in the first half was $1.25 per share, we expect lower FFO in the second half particularly in the third quarter largely because of the seasonality impact on our operating expenses, lower lease term fees and lost NOI from second quarter dispositions, partly offset by the Crescent Center acquisition net of expensed acquisition related costs. Operator, we are now ready for questions.

Thank you. (Operator Instructions) Our first question comes from the line of [Chris Caton] with Morgan Stanley. Please proceed with your question.

Hi, thank you. Can you maybe, Ed, talk a little bit about the Crescent Center acquisition? Can you provide a little more color on cap rate and the pricing metrics? I think I saw real capital with a 9-1 cap and then also the discount replacement cost, it sounds like it's about $225 a foot, maybe you could provide a little color on that?

Sure. You're right. Our cash return cap rate year one is a 9-1 based on our expected revenues or NOI in the ensuing 12 months. The cash return cap rate over the first five years is somewhere around five to eight bips higher than that as we go forward based on projections. We did target a replacement cost of $225 to $230 and in part that's driven obviously by the structured parking and the granite facade of the building and size of the building and the value of the land so we're a third discounted from what we would expect today's replacement cost to be. This has been acquisition that we've had on our active wish list since the inception of our wish list. Our division head, [Steve Gwynn] there has done a terrific job of bird-dogging it and the team here that did the due diligence on the property also did a superb job. We're pleased to increase the volume of ownership that we have particularly in that section of the Poplar corridor in Memphis and we think this gives us an even better shot at being in the deal flow as lease transactions occur in the Memphis market.

And how competitive was the bidding process? Did you feel like you had to, you mentioned scarcity premiums. Did you have to pay scarcity premiums for this asset?

We don't feel like there was a frantic amount of bidding this. We think that it was appropriately priced. The scarcity premium that I referenced in my prepared comments is we have seen some deals come to market where it seems like the bidding has gotten out of sync with the risk profile of the asset and we wonder whether that's due to something that we might be missing in the underwriting which we're doubtful of versus the need for some just to get cash out, and we're hopeful that if it's the latter that that quickly flushes itself out of the market and things return to a norm but, again, I guide all of us that there are so few data points out there today that it's difficult to define a trend.

Thank you very much.

You're welcome, Chris.

Our next question comes from the line of Jamie Feldman with Banc of America Merrill Lynch. Please proceed with your question.

Thank you. I was hoping you could provide a little bit more color on just kind of if there's any change in sentiment both among businesses in your region and brokers and tenants in your region this quarter versus last quarter, given we are seeing mixed economic signals but it does seem like our conversations with brokers suggest that markets are starting to find a bottom and occupancy is starting to tic up a little bit here.

Yes, good morning, Jamie. This is Ed. I think that it's a little bit tough to disseminate exactly what's going on right now because summer doldrums are a common occurrence every year. We do feel like we're balancing along the bottom. We hear that both from our existing customers and in conversations with prospects and in conversations with tenant brokers. There does seem, as we said last quarter, to be more confidence in the user's decision process, although decisions still remain protracted, but I think that what we've talked about again in our scripted comments with regard to fear of being out of the decision-making process and customers going forward, that's occurring but it's just happening in a much longer time frame. We're also seeing in that on the build-to-suites. As we mentioned, we're chasing a number of deals. We may not get any of them or we may get lucky and get all of them but the process that is being undertaken for those is very deliberate with regard to test fits and value engineering and pricing and negotiations, et cetera. I don't mean to suggest that the beat down but it's a thorough evaluation of how are we going to consume the space and what would be the right move for our business at this point in time.

And then in terms of the brokerage community, any change in sentiment there?

I think the brokerage community is still running long on creating activity to generate fees by reaching out to future expirations, but that is starting to run a little bit thin. There was a fair amount of that type of activity over the last two quarters where they were reaching out into the future where the customer was thinking that no need for them to talk to their landlord because their lease expiration was too far out in the future and they were suggesting it's never too far out. If you wanted to modify your lease, let me go talk to your landlord on your behalf and what you'll have to give in exchange is more term but I can get you some CapEx if you need that for buildout now or I may be able to get you some modification on present day rent in exchange for term. Those conversations are still occurring, but I think the volume of those conversations has lessened because the list is only so long for them to cold call.

About a year ago there was a little bit of a panic going on at that time of the economy and the brokers seized on it. Today things have stabilized a little bit, less churning going on there.

Okay, thank you.

Thanks, Jamie.

Our next question comes from the line of Brendan Maiorana with Wells Fargo. Please proceed with your question.

Thanks, good afternoon. So Ed, you talked in the begin of your script about how you had a couple of larger deals that kind of drove the CapEx levels up a little bit, and that outside of those deals the CapEx levels would have been a little bit more normal. I seem to recall that I think a couple of quarters ago you guys had deals that were a little bit higher than average as well and if we've got net absorption that's moving positive in the markets, is this just kind of the type of environment that you're in and maybe getting a couple large deals every quarter with high CapEx levels is sort of the norm and that's what we should expect going forward?

I think that's fair, Brendan. We've reached for a couple deals in this environment and it's basically been under the umbrella of poaching. If you take, for example, the two deals that I didn't state by name but if you take the two, one was in Memphis and one was in Raleigh, and you net them out, they totaled just under 100,000 square feet of the over 800 we leased, the 1255 on page 13 of our supplemental for a total CapEx spend goes down to $10.02, so it has a dramatic impact, just those two deals, but both of them were where we were able to attract customers with very good credit for long-term leases and we basically were able to get the amount of brand X's buildings and put them into Highwoods buildings, so we'll continue to do that and I think that your comment about maybe that's a trend that we'll still each quarter have less than a handful of these but those that which are material as our leasing team continues to be out trying to leverage our balance sheet to basically poach and bring some customers into our buildings and increase our percent of market share.

But if I look at your occupancy level and we strip out the Piedmont sale, it seems like the occupancy was outside of the pick up you got from disposing those low occupied buildings was pretty much flat, so does that assume that-- ?

That's correct.

If you're poaching some tenants to grow your occupancy a little bit then you've got sort of net contractions on the rest of it so kind of net-net you're flat overall?

Well, remember that what's on page 13 are deals signed in the quarter and some of these won't occupy for six months out by the time we define what their layout is going to be, get a permit, get it, build it, so there's a little disparity between the timing of occupancy today versus these leases but, again, I think that an aspect of your point is valid in that there still some customers that are contracting and there's still some that are going out of business that you just can't offer them a package attractive enough to keep them if they are shutting down. We expect occupancy to be continue to be lumpy but we're still very comfortable with what we gave regarding year-end occupancy and we factored in the benefit of the two sales in the Triad.

Sure, okay. So fair enough, and then if I look at the mid point of guidance for the back half of the year would suggest that FFO levels kind of on a quarterly basis are call it around $0.60 a share per quarter and in this quarter you had a level that was a little bit lower than your dividend, if you've got FFO going down and now we've got straight line rent expectations that are higher than what they were previously, is it kind of fair to assume we're not going to get positive dividend coverage at least for the back half of the year?

Yes, Terry and I will both -- let me go first, Terry. A couple thoughts there, Brendan. First is that if we take the first half of the year and annualize that with regard to CAD, we come out slightly positive. If we take second quarter and annualize it, we come out slightly negative, we did front end load this year the BI. We spent a significant amount of our BI budget in the first half of the year, particularly second quarter, where normally that comes towards the latter part of the year, and the impetus for that is the preponderance of the dollar spent in BI were related to HVAC and energy management systems so that we could Garner some electrical savings which have already proved out. For example, we did 10 chillers already this year and when you replace a chiller, you were able to reduce your overall electrical spend by 10% to 15%, and it's already paying back given the degree days we've experienced here in the last 30 to 45 days. I think that the BI aspect of this can't be ignored as we evaluate where we'll be for CAD for both 2010 and 2011. We'll continue to reach out to try and expand our market share by attracting customers in leveraging our balance sheet, but I don't see us to be dramatically negative. I see us continuing to hug the positive/negative line for the remainder of 2010 and into 2011 and just to extrapolate a little bit further and as a result I don't see us modifying our dividend policy in the near term meaning any time in the next 18 months. Terry, do you have anything?

I have nothing to add to that.

Okay, so just to clarify, I mean last year, the BI was around $16 million or $17 million. This year, you've done I think a little over $10 million in the first half so the expectations are kind of for the full year 2010 would be sort of roughly in line with the full year 2009?

That's exactly right.

Okay, and then just lastly, built to suits, the guidance is up a little bit at the mid point and you mentioned seven deals you're kind of pursuing. Are any of those GSA deals and is the Obama memo that was out, does that sort of put any change in thinking about the opportunity set with respect to GSA build-to-suite deals?

Another very good question. Yes, three of the seven are GSA proposals and we don't think that the now famous Obama memo will have any impact on those three particular SFOs that are in the market right now.

Okay, thank you.

I'd be glad to comment more on Obama but Tabitha gets pretty riled when I do that.

We'll leave it at that for now.

Thank you for your discretion.

Our next question comes from the line of John Stewart with Green Street Advisors. Please proceed with your question.

Thank you. Ed, I understand your description of Crescent Center and how it fits into the wish list and how you're describing that asset but when I look particularly at your same-store disclosure and see Memphis is the only market with the double digit decline and I realize these are year-over-year comps but still, can you give us some additional color in terms of your thoughts or the Memphis market?

Sure. We think Memphis is a strong long term play for us. We like being in Tennessee, Nashville as well, and Nashville has proved to be a very strong market for us. The building that we bought has little rollover. It's a very stable rent roll. There are synergies that will come to us in that this building is directly across the street and down the street from others that we own. I think that the number that with regard to same-store is a one quarter number. Overall, Memphis has performed well from the date that we went in there and I think that us being in a prime spot such as we are continues to put us in a dominant role with regard to deal flow in the Memphis market. Mike, do you have anything, you still pay taxes?

I do.

Yes, this is Terry. I'll address your question about the same-store drop in Memphis in second quarter. If you look just next to that in the six-month column you'll see that Memphis was down only 2.7% for the full six months and what happened there was some effects in the first quarter where Memphis was significantly positive and then went negative due to the timing of some prior year tax rebates and the prior year tax or adjustments to the CAM billings related to the taxes so it kind of flip flopped between quarters but overall for the six months and where we would expect it to continue to run is much closer to the six months as opposed to the second quarter which was more of an anomaly.

John to give you a little perspective on the strategic importance of Crescent, and I lived in Memphis for many years, there's a stretch of about a mile and a half from I-240 out to the city limits in Germantown, and that's Memphis' Gold Coast if you would where there are basically three major intersections and office properties sitting on seven of those intersections. We now pretty much control six of the seven, so if you want a popular address, which is very important in Memphis, you pretty much have to mom to Highwoods and that's something we've always achieved to do is have sometimes a dominance in the market, particularly a great submarket like that, so we felt like it was a great play for us and I've competed with Crescent Center for many years so we're delighted to have it in the fold.

It's running about 400 bips better than Class A vacancy right now.

Okay, that's helpful, thank you.

Sure.

Terry, with respect to the guidance, it looks like certainly some of it is attributable to G&A savings and I guess the question is how much of that is deferred comp and how much is more of a permanent cash nature?

John, we did lower the full year estimate for G&A from about $32 million to $34 million down to $30 million to $31.5 million, about a $2 million or so reduction. About half a million of that is just due to that deferred comp adjustment that flows through there but that doesn't impact bottom line or FFO because of the offset and other income, so that's about 25% of the effect. Another half million or so is just a projection now that we think we can derive a half million of savings spread across a lot of different line items, from outside consultants and audit fees and lawyers and other things and then there's also a little bit lower amount in incentive comp as we look at the impact of stock price on certain of our incentive plans and so forth and so part of it is just the incentive comp as well and we just updating the guidance here in July, we felt confidence enough to bring that guidance down in G&A.

And, John, just one footnote on the deferred comp, it doesn't impact FFO and we know that it creates significant volatility in the numbers in that it comes out in one line and goes in another line so it's a wash, but in order to help mitigate the noise that that creates, we've taken on a policy here that is effective the first of this year that we've suspended the ability for any officer to contribute to that plan anymore. So over time, obviously what's invested in it now will stay but over time that number will just continue to get smaller and smaller as that money is distributed, the pay that they earn that was put in to these mutual fund accounts as those are distributed over time to those who earn the dollars it will become less and less volatile.

Okay, thank you. And then lastly, Ed, can you comment on how common place it is for you guys to get rent bumps on your built to suit activity with the GSA, particularly looking at deals like either Jackson FBI or the FAA in Atlanta?

Sure. The government has a standard policy with how bumps are incorporated into their leases. We, in the government feels just like in any private sector deal, we always try to get two things, a direct operating cost pass through or some type of expense stop to keep us whole with regard to what our margin is and then we also shoot for an annual kicker to prevent us against inflation and inflation heads. Clearly, the government prefers that it be flat or some modified CPI that is not as robust as the typical CPI, but we've been relatively successful in getting some form of bump and it may not be annual but it may be every two years, every three years or on the fifth anniversary.

So on those two deals in particular, is there some form of bump?

I'm sorry, which two?

Jackson FBI and the FAA in Atlanta?

The FAA I believe there is and I can't remember.

It was a direct negotiated deal with the FAA. It was not a GSA driven deal. That went direct through the agency where as Jackson is more of the traditional deal where you have the CPI increase that you come in, you're allowed to get taxes above your stop and minimal bumps.

So we do have bumps in both.

Okay, that's very helpful, thank you.

Sure. Thanks, John.

Our next question comes from the line of John Guinee with Stifel Nicolaus.

Great color on Memphis. You should give them the history of Clark Tower on the next go around.

The reason we don't own it.

For a decade the largest Suburban of the building in the country. Anyhow, what you guys are doing it looks to me as continuing to clean up the bottom side of the portfolio in terms of selling 1.3 million square feet of pretty challenged real estate as evidenced by the sale price and also getting out of one of your larger joint ventures. Can you walk through the ability or the interest in continuing to peel off the last quartile of real estate in the portfolio?

Sure, John. It's a little more difficult as you said as evidenced by the pricing of both Madison Park and Chimney Rock. We did them again more strategic than financial driven. I think that in this current environment that it may serve us well to wait a little while before we put more of the very bottom out to market. We've tested a few things and they haven't flown exceedingly well, so we're trying to balance what might be a somewhat thin appetite for these assets versus the operating risk, so what's our exposure with regard to leases that are in place that may roll in them versus what we might be able to garner out in the market and we look at that on a deal by deal basis. We'll continue to put elbow grease behind getting these other assets out the door, but I think the girth of the total sale proceeds that we experienced in 2005 through 2007 will moderate as we've seen this year, going from $250 to $350 down to about $125 thus far this year. Fortunately, we can afford to be patient on these aside from the fact we're going to have to look at the CapEx and the exposure that comes and just try to pick the best timing for that. I also think that we would like to see acquisition activity pick up to help offset some of the dilution that may occur as these asset sales would close.

How about the joint ventures?

The joint ventures, we have some very good joint venture partners, but we are smaller today than where we were. We're very happy to be out of Des Moines. We didn't have a presence in Des Moines. We were concerned about some upcoming roles in Des Moines in the volume of customer concentration that we had there and quite frankly, it's just not one of our core markets and we've never talked much about it. We've monitored what our performances was there and this performance was solid but it seems to be some near-term erosion coming up that was difficult for us. We also have what we call war and complexity here and there were certain aspects that JV that created reporting and administrative demands that may be considered a distraction from our core business.

And we did have last year I guess a sale of a couple of JV assets, one in Durham and one in North Winston so in terms of non-core within those JVs, those were taken care of pretty much last year.

And the Des Moines assets also had extremely high leverage as you saw, I think the total value was 200 and we had $170 million to $175 million worth of debt on them.

Got you. Okay, thanks.

Thanks, John.

Our next question comes from the line of [Suzanne Kim] with Credit Suisse. Please proceed with your question.

Good morning. How are you? Good afternoon.

Good afternoon.

I'm asking about the guidance that you provided for the higher actually it's much higher the mid point than before and I'm wondering right now, your occupancy is at 89.3% and what would get you sort of to the higher end of that range? Are there particular markets that you're seeing some type of action on and are these higher paying higher rental rates in these markets?

Yes, Suzanne, I think if you went to the line item guidance that we give, you really have to go towards the high end of each of those in order for that to happen. For example, there's another $140 million-some worth of acquisitions but by the time that would happen, given that we're already basically at August 1, how much benefit of that would you get yet in this calendar year but if you lack at some of the other line items with regard to G&A term fees, rents, et cetera, you would have to go to the high end of each range in order to put us there.

To put you at the higher end of the occupancy range?

Yes, well it takes some significant leasing to get there. We gave a year-end occupancy, we revised it, we tightened it from 87% to 89% to a range of 88.5% to 90%. Where right now as you said we're at 89.3%, so we'll take some leasing to not only occur but for the leases to commence prior to year-end.

Or some unexpected hold overs that we're expecting second half rollouts and the tenant sizes to stay in that we're projecting otherwise that could add to it.

So you don't see any visibility on any of your current markets that would get you to the high end of a occupancy guidance?

Well, we have a healthy list of leasing prospect, somewhere between suspects, prospects and potential renewals but we wouldn't want to dial in and say here is where we are beyond what we've given in the way of year-end guidance at this point in time. It's hard to predict these as time rolls over the next nine months but certainly 90% is doable, otherwise we wouldn't have disclosed that.

Because I was checking your list and it seems that Raleigh and Piedmont Triad went up and the ones that went down you already discussed Memphis, and there is Tampa, Richmond and Orlando. Could you provide a little bit more color what's going on in Tampa because it seems that market is coming at a cost, the TIs seem to be higher than your portfolio average as well as the lease rate as well, could you discuss that?

Well, I think in part what drove that is we were very successful in poaching a near 60,000 square foot customer into one of our buildings. In fact, we were able to accomplish that without the involvement of a tenant rep broker so it was a good win for us but it took some dollars to be able to attract them out of brand X and into our building. Most of our assets are in the West Shore submarket and West Shore is the most improved submarket and our folks in Tampa continue to do a phenomenal job of out pacing the market as a whole. In fact, I think if you look at the spread between our occupancy and the market occupancy it's the widest, it's about 1300 bips in Tampa our portfolio versus the overall market.

And also some of the best NOI growth year-over-year in Tampa than any other markets.

There's no doubt Tampa is a tough market. They suffered tremendously from the housing glut and that continues to be quite obvious in the overall market occupancy but I think that being 1300 bips above market is quite an accomplishment and keeps us bullish, we're bullish on Tampa long term for obvious reasons. We just bought a building there last November.

One last question. In terms of the turmoil that happened in the markets at the end of Q2, how much did that really impact leasing decisions that were sort of on the table?

In general?

Yes, just sort of a general macro perspective.

I'm sorry?

Just on the general market turmoil with the stock market, et cetera?

Yes.

Well, it's hard to say. Does a decision maker in Richmond, Virginia, pull back on signing a 20,000 square foot lease because Greece is having trouble and the Euro? How do you, the world is smaller but how do you connect those dots and like we said in our script or remarks, things that we have quantified and there are things that are unquantifiable that are uncertainties in every decision makers mind whether it be economic, whether it be global, whether it be US, whether it be political so we look at those but how do you know if she or he pulls back their pen from the signature page because of what's going on in the Gulf with regard to BP? I think that there's a higher level of confidence today but I don't think that you could do a biopsy on any decision maker's brain and it be void of concerns that are both national and global. We're heavily focused on the smaller size customer. Our average office size customer is about 11,000 square feet. We only have 37 leases that are for 75,000 square feet or more, so they tend to be more domestic and less exposed to international events, but I think that until this world gets our world gets back to getting 150,000 to 200,000 jobs a month in growth that things are going to be tough.

The larger multi-national companies, that type of news may filter down to the real estate shops eventually is that 5,000 to 7,000 footer local company, they've got a business to run and they need to move or they need to grow, they don't typically pay too much attention to what goes beyond their control.

Great. Thank you so much.

Thanks, Suzanne.

Our next question comes from the line of Dave Rodgers with RBC Capital Markets. Please proceed with your question.

Hi, good afternoon everyone.

Hi, Dave.

Ed, I had a question for you. Political commentary aside the end of your prepared comments suggested you had a little bit of more encouragement around the development build-to-suite opportunities. You gave quite a bit of detail around what you were pursuing there and it's been fairly consistent. On the other side of that equation the acquisition pipeline. You've had some success recent term. Can you talk maybe more about what's the volume look on the acquisition pipeline, what percentage of these deals are hitting your criteria and ultimately fall out through the due diligence process?

Sure, Dave. It's a very small number coming through. Our wish list is relatively large as we've talked with you about before, but the deals that are coming out and offering memorandums that would hit our bullseye are still not plentiful, and we're seeing some that, as I mentioned in the remarks, hit the target but aren't necessarily in that yellow bullseye. So we're trying to broaden the scope of what we would evaluate and we would be opportunistic but there's just not a lot coming to market. We have seen a few that have come to market that we've bid on and haven't been successful because the bidding in our view and apparently a lot of the other bidders too got fairly out of sync with what the asset would bring to your bottom line, but we're actively pursuing a lot of different opportunities but I would like to see the volume of offering memorandums or the volume of brokers, owners or lenders open their doors wider for us to have more discussion about assets and I think the key is going to be patience.

Thank you for that commentary and then maybe, Mike, with respect to expansions or contractions within the portfolio you've seen, I think you've provided commentary in your prepared remarks but I'm wondering, too, do you have some more expansions versus contractions among the industry differentials what are you seeing in terms of which industry may be taking more or less space in your diverse set of markets?

I think it's some days it feels like one step forward, two back and the next day will be two forward and one back. I think the volume of requests for extend and blends and contractions is not what it was. The industries that we continue to see have an appetite for space. Our clinical research, education, financial services, the government, the Federal Government, healthcare, insurance, pharmaceutical and telecom and those that are contracting are still heavily related to the housing industry with builders and suppliers and mortgage lenders, title insurance, and then those things that typically get cut in tougher times like PR firms, marketing firms, advertising firms, those types of businesses.

And do you think that, maybe a question for Terry as well, do you think that your bad debts have really hit bottom here or do you expect you could see an uptick in that over the next 9 to 12 months?

They have leveled off Dave from where they were, had been running. I don't think they will go back down to two or three year ago levels but they clearly leveled off.

Okay, thank you.

Thanks, Dave.

Our next question comes from the line of Chris Lucas with Robert W. Baird. Please proceed with your questions.

Good afternoon.

Hi, Chris.

Ed just a quick follow-up. You mentioned state governments. What sort of exposure do you guys have generally to either state or local governments in your tenant roster?

Well, we're pushing almost 12% now of total revenues coming from federal and state and about three of that is from state and local. Most of it is state and the largest customer by far is the Department of Revenue for the state of Georgia which we just did a near $60 million lease with in the fourth quarter actually on New Years eve of 2009, so they are a large customer in about 375,000 square feet. We got a long term deal with them in the 1800 building in Century Center more than 10 years. I'm sorry, one footnote to that, Chris. Also the agencies we typically migrate towards, both federal and State are core agencies. It's likely the state of Georgia may eliminate as they experience budget cuts but the Department of Revenue will probably be the last to go.

It's a fair point. And then just a follow-up on the dispositions program, you exited Des Moines, you're exiting the Piedmont Triad, you've got more to do there, is it fair though to say right now it's more of a function of calling out of existing Markets rather than exiting any other markets?

Yes, sir. I think that's a clear depiction. We still have about 800,000 square feet and 11 buildings in the Winston market, about 50% to 60% of that is better than the other 40% of that. I think again the word patience is critical for us, we'll continue to call as we go. I think the only other market that we may circle would be Greenville, South Carolina. So we'll monitor that for proper timing and whether or not to get out of it, but if we screen all of our markets that which would be on the far right would be Greenville after we exited Winston in total.

Okay, great. Thanks a lot.

Thanks, Chris.

There are no further questions at this time.

I'd like to again thank everybody for their time and attention, if you have any additional questions as always please don't hesitate to give us a call at the shop. Thank you.

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.