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Parkway Properties, Inc. (NYSE:PKY)

Q4 2008 Earnings Call

February 10, 2009 11:00 AM ET

Executives

Sarah P. Clark - Senior Vice President of Strategic Planning and Investor Relations

Steven G. Rogers - President and Chief Executive Officer

William R. Flatt - Executive Vice President and Chief Operating Officer

J. Mitchell Collins - Executive Vice President, Chief Financial Officer and Secretary

James M. Ingram - Executive Vice President and Chief Investment Officer

Analysts

Irwin Guzman - Citigroup

Jordan Sadler - KeyBanc

Napoleon Overton - Morgan, Keegan & Company, Inc.

Christopher Haley - Wachovia Securities

Stephanie M. Krewson - Janney Montgomery Scott

David Tannehill - Morgan Asset Management

Operator

Good day and welcome to the Parkway Properties Fourth Earnings Conference Call. Today's call is being recorded. With us today are the Chief Executive Officer Mr. Steve Rogers, Chief Financial Officer Mr. Mitch Collins; Chief Operating Officer, Mr. Will Flatt; Chief Investment Officer Mr. Jim Ingram and Senior Vice President, Miss Sarah Clark.

At this time I would like to turn the call over to Miss Sarah Clark.

Sarah P. Clark

Thank you and good morning everyone and welcome to Parkway's 2008 fourth quarter conference call.

Before we get started with this morning's presentation, I would like to direct you to our website at pky.com and you can click on the fourth quarter conference call icon to find a printable version of today's slide presentation. On our website you will also find copies of yesterday's press release and the supplemental information package for the fourth quarter, both of which include a reconciliation of non-GAAP measures that will be discussed today to their most directly comparable GAAP financial measure.

Certain statements contained in this presentation that are not in the present tense or that discuss the company's expectations are forward-looking statements within the meaning of the Federal Securities laws. Although the company believes that the expectations reflected in such forward-looking statements are based upon reasonable assumptions, it can give no assurance that its expectations will be achieved. Please see the forward-looking statement disclaimer in Parkway's press release for factors that could cause material differences between forward-looking statements and actual results.

I would now like to turn the call over to Steve.

Steven G. Rogers

Thanks, Sarah. And thank you for calling in today. Since we spoke in December, our 2009 earnings outlook call the most fundamental of all of our drivers of our business, jobs, have continued to work against us. Lay-offs by major companies have accelerated and dominate today's headlines. With unemployment at 7.6% and continuing to decline this will work its way into our operating results gradually but certainly.

I do believe we've adequately budgeted for this in 2009. And despite the jobs, reports and other economic conditions, we are pleased to announce that Parkway finished the fourth quarter of 2008 inline with our previous earnings outlook and met the goal of our three year GEAR UP plan. This is Parkway's third strategic plan in the last ten years and this is the third time that we've achieved the major points and the overall financial goal of each strategic plan. While there are many goals of the GEAR UP plan that were met, as outlined in our report card on page three of the web presentation, exceeding the financial goal in a tough market is at testament to the dedication of our team.

We achieved cumulative, adjusted FAD a $7.20 per diluted share as compared to our 7.18 goal. We completed our $500 million Fund I investment with Ohio PERS, with the total purchases of 13 class A and B plus office properties in major SNSAs.

We also announced the formation of our second discretionary fund, a $750 million investment with Teacher Retirement System of Texas. While we do not sell all of the assets originally identified in GEAR UP, we did sales 13 assets for over $240 million during the last three years as part of our normal asset recycling. You've heard me say before, we may have to go into extra innings to finish the 100% of the asset recycling goal. Parkway was also recognized by the NAREIT Leader in Light program for the past two years, was named one of the best 25 medium size companies to work for in America for the second time and achieved a 72% customer retention rate of the three years of the plan. These qualitative accolades do not increase the value of our stock immediately but do contribute to the values that we believe in.

For 2008 the company reported FFO of $3.67 per diluted share, which was reduced by a net $3.4 million or $0.23 per share of unusual items recorded during the year. Excluding those unusual items we achieved recurring FFO of $3.90 per diluted share as compared to $3.92 in 2007. This was mainly achieved through substantially holding our forecasted occupancy and rate through the fourth quarter, along with operational savings and utilities and that below on taxes as well as reduced interest expense. Additionally, as noted on page 22 of our web presentation, our FAD for 2008 was $34.9 million, covered our dividend as adjusted for the impairment charges of $2.5 million or $0.17 per diluted share.

Parkway is in good shape from a debt maturity standpoint in 2009; with only $22 million in mortgage maturities. The mortgaged assets are in Houston, Texas and are currently 96.7% leased. Actually we have these assets in the market for sale and if we achieve a reasonable sale price then our only debt maturity this year will be put to bid. Plan B would be place a first mortgage on these assets based on loan quotes that we are currently receiving from life insurance companies today. Ultimately, if we're not able to place first mortgage debts then plan C is to use our line of credit to refinance this maturity.

We have also recently entered in the contract to sale Luna II non-strategic assets with gross proceeds estimated to be at $15.5 million and net proceeds from these sales will be used to reduce borrowings under our line of credit. We expect that these sales will be completed in the first quarter of 2009. This is part of the extraneous work I mentioned above as both of these assets were part of the original GEAR UP plan disposition list. Our financial covenants remained stable during the fourth quarter and we have sufficient borrowing capacity under our line of credit to handle all of our existing debt maturities through 2010.

Regarding Texas fund II, we are actively looking for assets but given the ambiguity in values, we remain disciplined and on the sidelines for now. This much as evident, with rising cap rates we expect these purchases to result in higher FFO accretion than we initially estimated. In late 2008, we reduced the dividend to an annualized rate of a $1.30 per share as a measure of capital conservation. In conserving capital, we're addressing what I consider to be the most fundamental root cause of the meltdown last fall in reprices, the actual and perceived lack of liquidity in our industry. I define liquidity not as the ability to meet current obligations, as I believe that is not the issue facing most companies, more is the ability to fund acceptable debt financing for new investments, refinancing existing debt and development. In our case, it is clear to me that smaller first mortgages under 50 million have multiple refinancing options and alternatives and new investments with low leverage such as the fund are imminently financeable.

Now let's move on to the future; planning of our next strategic plan has been challenging to say the least as we have a wide range of use on the U.S. economy even within our company. We still think we should have a strategic plan in good times or bad even if there are differences in opinion as to when we will emerge from the recession.

So, in January 2009, we initiated a new strategic and operating plan called FOCUS. The FOCUS Plan is our strategy to concentrate on the key drivers of profitability and the key elements of balance sheet stability during the four year period of 2009 to 2012, with our focus on delivering superior returns to our shareholders. We’re still finalizing the detailed plans and financial model, all of which will be released after our quarterly Board meeting.

With that I'd like to turn the call over to Will for an operations update.

William R. Flatt

Thank you Steve. Considering the economic downturn, I was generally pleased with our fourth quarter performance. We ended 2008 with an occupancy of 90.1% as compared to October 1st occupancy of 90.4%, which includes the addition of the Pinnacle development that is currently 82% leased. Customer retention was 68% for the fourth quarter of 2008 and 71% for the year. Our leasing velocity remains constant... consistent with 2008 total leasing of 2.5 million square feet as compared to 2.3 million square feet in 2007.

During the fourth quarter, we completed 418,000 square feet of renewal or expansion leasing at an average rate of $22.09, up from an average existing rate of $20.73 which is a 6.6% increase over the in place rent. The average costs for these leases were $2.19 per square foot per year. Included in renewals this quarter; neighbors exercised just one year extension option for 205,000 square feet at a rental rate increase of 10.5% that extends this lease in Houston until December of 2010.

We also completed 94,000 square feet of new leasing during the quarter at an average rate of $20.99 with $5.32 per square foot per year in committed capital. When annualized over the 12 month period, our total capital for new leases averaged $4.28 per square foot per year in 2008 which is in line with $4.21 per square foot per year incurred in 2007.

I've seen on page 13 of the web presentation, the weighted average NPV per square foot per year of all leases signed during the quarter, using a 9% discount rate as $8.06 which continues to remain steady. During 2008 we've signed 2 million square feet of renewals and expansions at an average rate that was $1.03 above the in place rental rate or 5% higher.

Looking to 2009, we have a total of on point million square feet expiring, in imbedded rent growth on those leases of a $1.08 per square foot. We do recognize that rental rate will be under pressure in 2009 which has been taken into account into our earnings outlook. The majority of our 2009 role occurs in the later half for the year with no single lease greater than 32,000 square feet expiring before August. 65% of those leases expiring are our three largest markets Houston, Chicago, Atlanta and we're in the process of the renewing the majority of these customers. Most of our markets that not experienced the sharp increase in rental rates that were seen in the costal markets which supports our belief that the rental rates in our market will not decline at the same rapid pace as those hyper markets. While leasing is continuing to occur, velocity has slowed in early 2009 with leasing decisions by many customers being put on hold until there is more certainty and clarity in the economy and credit markets.

Despite a slow start to 2009, leasing is taking place, notable leases include a new lease for 39,000 square feet commencing in April with Southeastern Data Cooperative and Atlanta Asset that is part of our Oprah's fund. In Houston we extended our long standing relationship with the Honeywell Corporation through a renewal of over 112,000 square feet which extends this lease from its previous expiration of 2010 to new an expiration of 2019. We are proud to have these fine firms make these significant commitments to us and both of these occurred subsequent to quarter end.

The Lincoln status report shows us on supplement package page 29, rents leases that have signed but not yet occupied the space and will commence paying around in the next few quarters. As of January 16, the day of the published report the portfolio was 90.8% leased. Rolling forward to yesterday which includes all leases thus far in the first quarter, the number was 91.2%. This does include a previously announced new lease with Bourneville for 31,000 square feet in Phoenix that will commence on May 1.

Parkway has not been exempt from the wide spread job losses and corporate downsizing. It demonstrates about total fourth quarter bad debt expense of 540,000. Parkway's share of fourth quarter bad debt expense was inline with our latest forecast and is consistent with our 2009 earnings outlook assumptions. For the near-term, we expect to see customers remain under pressure to reduce occupancy cost, to restructure leases, downsizing and consolidation. Focus on customer retention is not new for Parkway and we expect that our long standing relationship with customers will have support our retention.

Our growth rents receivable at year-end was 3.9 million which is inline with our historical balance and reflects only 1.5% of our annual revenue of over 260 million.

On the same-store basis, average rents for the quarter increased 1.9% to $22.24 per square foot as compared to the fourth quarter of 2007 and 2.5% to $22.16 for the full year 2008 compared to 2007. For the full year 2008, average occupancy was 90.6% compared to 90.9% for 2007.

Parkway share same-store NOI for the year increased 545,000 or 45% compared on a GAAP basis and 807,000 or 0.8% on a cash basis. For the fourth quarter, we benefited by substantially holding our leasing and realizing lower than expected electricity costs and volume (ph) taxes which resulted in recurring same-store NOI margin of 53.1%. For the year, excluding unusual items, recurring same-store NOI margin decreased 150 basis points to 51.7% on a GAAP basis.

As we shared during the 2009 earnings outlook in December, we recognized that operating in a difficult environment and we can draw on our company's deep experience in down cycles in real estate to take the appropriate actions necessary on a daily basis. This includes reacting and responding quickly when making leasing decisions. Focus on capturing our share of growth absorption, recognizing that leases continue to expire during all economic cycles. Leveraging existing tenant improvements to limit capital requirements and also employing selective demolition in pre-built spaces to help control costs.

Knowing our customers, so we can facilitate transaction between customers including subsidized deals from companies needing to downsize or buyout or linked then in term to minimize capital in the future and as always control operating expenses. We believe these actions will help mitigate the effects of the downturn in 2009. And I will now turn it over to Mitch for an update on financials.

J. Mitchell Collins

Thanks, Will. Our team has worked hard in this challenging economic environment and we were pleased to close 2008, at the high-end of the previous earnings outlook and recurring FFO. We achieved FFO for the fourth quarter and year ended December 31, 2008 of $0.77 and $3.67 per diluted share respectively. These results included a reduction in FFO of net unusual items totaling 3.4 million or $0.23 per diluted share for the year, consisting of large lease termination fees, non-cash impairment charges, losses on extinguishment of debt, Hurricane Ike expenses, a non-cash purchase accounting adjustment and restricted stock expense related to the achievement of the GEAR UP plan goals. Excluding these net unusual items, Parkway generated recurring FFO of $1.01 per diluted share for the quarter and $3.90 for the year. We believe that excluding these unusual items gives you a better picture of our core operating performance for both the quarter and the full year of 2008.

Parkway generated a FAD of $4.4 million for the three months ending December 31, 2008 versus $10.1 million in 2007. Excluding the non-cash impairment charges, our fourth quarter FAD would have been approximately $7 million. Capital preservation remains on the forefront of everyone's mind. So, let me move on to the balance sheet and discuss our long-term debt and our line of credit.

At quarter-end, the company added a 186 million related to our line of credit, down from 258 million at the end of the first quarter 2008. All of our financial covenants remain stable during the fourth quarter of 2008, as illustrated in the chart of our coverage ratios on page 23 of our web presentation. As a reminder, in the second half of 2008, we exercised our option to extend our line of credit resulting in $311 million in total line capacity now maturing in April 2011.

Our balance sheet is in good shape from a debt maturity perspective. We have only $22 million in maturing debt in 2009, which relates to three assets in Houston that are currently 96.7% leased. As Steve noted earlier, these properties were in the market to be sold, but if an acceptable price is not achieved, we have quotes in hand from several lenders to refinance the loan. The loan could also be repaid with the availability under our line of credit, until either a sell or mortgage refinanced is closed.

As a reminder; in 2010 we have a $126 million in loan maturities of which $60 million represents the loan on our Capital City Plaza asset in Atlanta that has a one year extension option at our discretion. Assuming that this extension option is exercised, our estimated maturities for 2009 and 2010 are approximately $88 million. Our existing line capacity could handle all of our 2009 and 2010 loan maturities, if the first mortgage debt markets drive up today, which we don't anticipate.

The Pinnacle development in Jackson, Mississippi, opened in early December 2008, at a total cost of $50.4 million, including the value of the adjacent parking facility. The development consists of a 194,000 square foot Class-A office property and a 1734 space public parking garage. Parkway marketed this project during the second half of 2008 under a non traditional marketing approach that targeted private investors who could off-set the Go Zone bonus depreciation. Unfortunately, the capital markets unraveled in October 2008 and the Company did not achieve its syndication goal. This however, does not preclude the company from a pursuing a more traditional joint venture of its combined Jackson assets in the future.

Once stabilized, we estimate that this development will yield a 7.4% cap rate. In the area of recycling, we've entered in the contract to sell two non-strategic office properties with 375,000 in combined non-refundable deposits. We estimate the gross proceeds will be approximately $15.5 million with net proceeds from the sales used to reduce volumes under our line of credit. The assets under contract are in Hampton Roads, Virginia and Columbia, South Carolina at an estimated combined cap rate of 8.9% and is detailed on page 19 of our web presentation.

In connection with the sales one asset, the Company expects to sell or finance a $5.4 million note receivable that will bear interest at 6.75% per annum through maturity in 2014. In conjunction with these sales and a change in valuation on a small parcel of the land that we own in New Orleans, we recorded $2.5 million in non-cash impairment charges $0.17 per diluted share. We expect the asset sales to be completed in the first quarter of 2009.

Moving on to our outlook, we are reiterating our 2009 FFO outlook of $3.50 to $3.85 per diluted share. The 2009 earnings outlook was based on our original outlook issued on December 11, 2008. Our major assumptions have not changed since the December call and are listed in our press release dated December 11. To remind everyone, we now project G&A savings of approximately $1.5 million; a meaningful 18% reduction of over 2008 recurring G&A of $8.3 million. Recurring G&A is defined as actual G&A in 2008, minus $1.4 million in onetime non-cash GEAR UP restricted stock expense1. Also, this outlook range today excludes any Texas fund to purchases and any further asset sales. The two assets under contract to sale are not expected to materially affect Parkway's outlook range for 2009.

With that, I'd like to turn the call back over to Steve.

Steven G. Rogers

Thank you, Mitch. In closing, I'd like to recognize Leland Speed, our long standing Chairmen for receiving NAREIT Man of the Year Award for 2008 at the recent meeting we held in Santiago. And I would also like to say that I look forward to sharing more details with you in the near future and focus on our four strategic plan. And with that, we'd be happy to open up for questions at this time.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). And we'll take our first question from Michael Bilerman with Citigroup.

Irwin Guzman - Citigroup

Good morning. It's Irwin Guzman here.

Steven Rogers

Hey Irwin.

Irwin Guzman - Citigroup

Steve, can you just tell us a little about many your conversations you had with Texas Teachers since we last spoke, whether their mindset has changed on their commitment at all, how they feel about sort of the pushback on acquisitions, and just kind of update us on where their heads at?

Steven Rogers

Yes, I'd be happy to do that. I cannot think of a better alignment that we have with a great long-term partner than that which we have with our Ohio PERS and Texas Teachers. I visited them in November face-to-face and since by phone on several occasions. And I must say that their view of world is precisely what our view of the world is. And so that makes for good partners. And they were pleased that we haven't purchased anything since our May closing. They liked the discipline that we demonstrated, and we showed them everything we've looked at. We don't have to, but we have. And we've showed them the cap rates, the deals, the investments, everything we're doing. And they liked the discipline. They are perfectly content with the commitment they've made. That is valid iron-clad commitment and unlike maybe rumors to the contrary with other pension funds and Western Part of the United States, there is no wavering whatsoever on their commitment to Parkway or this fund.

Irwin Guzman - Citigroup

And Mitch, maybe just one other thing on guidance, I would imagine that the floating rates have moved a little bit since the last time we spoke in December, has there been any shift maybe, I realized that you haven't changed the assumptions in the guidance that you've provided. But would it be safe to assume that just sort of leaving yourself little bit more cushion on the operating side?

J. Mitchell Collins

Well you mean with respect to the interest to arbitrage, yeah, the initial guidance, the assumed interest expense is higher than what we are incurring today. We have roughly $150 million of floating rate debt and everybody knows where LIBOR is, today we're doing contracts at 50 over... or LIBOR plus 130 and weekly monthly LIBOR is locking in at about 50 or so. To answer that is, we're not changing anything on the operating assumption side, but yes, to your question, Irwin, we would be having some interest to arbitrage and those numbers at these rates stay low for the year.

Irwin Guzman - Citigroup

Okay, thanks.

Operator

We'll take our next question from Jordan Sadler with KeyBanc.

Jordan Sadler - KeyBanc

Thanks. Good morning.

Steven Rogers

Good morning Jordan.

Jordan Sadler - KeyBanc

Steve, could just give us your expectations on asset sales and purchases, I know they are not guidance, any additional asset sales but just anything out, the market or what you're thinking in terms of sales? And then on the other side, I know last call you said that you were content to hang out till the opportunities sort of fully really present themselves in Fund II and just updating thoughts there will be helpful?

Steven Rogers

Yeah. I think as a reminder, we've kind of a few years ago decided not to give out a lot of capital activity because it was becoming less and less certain when we'd announce something and therefore creating more volatility and our estimates to the street and all the intended messages, they come from that. So, that's the reason why we haven't, but we've always been quick to add and just as evidenced by our announcement today, we're just going to stay with this market, Jordan. I mean we're going to stay with it every single day. And we've got assets that we deemed to be non-core assets for years ago, we announced those assets to the world. And as I have said jokingly many times, but I'm serious about it, is that the game is closed formally over at 12/31/'08 on hereof, but we're into extra trainings. And we're going to play a little bit harder and make sales as we're doing right now.

So the short answer is, that we'll continue to work the GEAR UP list and we'll announce them as we get contracts that's part of this plan. As far as some color on that, I'll tell you, it's a tougher market out there today. I mean our Chief Investment Officer is sitting across from me and every time we go to market now, it is just tougher. There is less bidders, there's some a lot of bottom fishing going on out there. I mean look we've made... we've had offers coming in at 11, 12, 13 and we not accepted those as you can tell, but I mean there are people out there trying to get things that... they are reading the Wall Street Journal, their cap rates are going 500 basis points and they can offer and try it out on.

So, I think that it's just less offers, I mean we've got kind of sit through them more, and we're going to have to work hard. We're going to have to do sell our financing, we're going to have to find users. We're going to have to put loans on the buildings to facilitate the sales. Our Treasurer and Chief Financial Officer is out there now looking for debt to place on buildings, not so much for Parkway, as a Plan B we can do it for Parkway, but as a Plan A to facilitate the sale. In other words, we're lining up the debt for the people that we're selling it to. And the last time I did that was quite frankly, it was 1991, 1992, 1993 and 1994. Okay, so we're sort of back to the beginning.

And on the buy side, we're just kind of I think we're just sitting back and letting the market come to us. I think it's a rising cap rate market, we don't need to get in a big hurry here, I want buy high quality assets at great prices and I am firmly believe we will be able to do that, it's just not right.

Jordan Sadler - KeyBanc

It's helpful. Could you maybe, Mitch, give us a little bit more detail on the assets that are sold here, the $15.5 million, the gross proceeds just maybe the split and/or occupancies on those assets?

J. Mitchell Collins

I'm going give that, if it's okay, Jordan, I'll give that to Jim. We're not going to be able to give you the split, but Jim maybe you can explain the detail behind...

James Ingram

Yeah, I'd be happy to. Jordan on these assets, we cannot give you the individual pricing for each asset. But both assets were principally leased in the 96% to 97% range. We went to market in November and as Steve mentioned, we did, we saw fewer offers than we had anticipated, but at the end of the day we found the right buyers at the right price for both of these assets.

Jordan Sadler - KeyBanc

And is there any... was there any significant upcoming roll in either of those?

James Ingram

Each building has 15% to 20% roll annualized basis, so it's typical for what we would see on assets.

Steven Rogers

And these are pretty small buildings as evidenced by the size and price and in secondary markets. So, we typically do five year leases in those type markets and you would expect 20% a year, like Jim said.

Jordan Sadler - KeyBanc

And on the seller financing, where would you say that is relative to market, it seems with that five year money and that's interest only?

Steven Rogers

Yeah. Look, in a perfect world we'd have got the cash price, and now Jordan and I'd loved to be doing that. But we're leaving in an imperfect world today. We're just going to have act and respond accordingly and not yet everything we won't. So, when we get somebody up to the closing table and they got have seller financing to go forward. I am not going back all from it. I mean, that was 500 over the two year or close to it, and our 500 over the two years, not far off but we're getting quoted today for that type price of money. And it's a good mortgage, meaning the normal carve outs and everything that we're used to getting in a mortgage. So, it's a traditional non-recourse first mortgage and they'll pay us off. And, if they don't, we'll own asset, we'll be able to richer for it.

J. Mitchell Collins

Well I think we can't give you the splits. So, don't assume that there is a 90% effective leverage or anything like that. There is sufficient equity and we're taking paper back, its five year money interest only.

Steven Rogers

Yeah, they said we didn't have to go up to any of those goofy levels of financing. It's just routine seller financing. I'll do more up.

Jordan Sadler - KeyBanc

That's helpful. Lastly, just I see that you took the impairments on the New Orleans piece of land. And I was just curious as you go through and do your quarterly due diligence or annual due diligence as it relates to asset impairments. What the sell process or approach is on the joint ventures, namely in Fund I with some of the assets that were purchased in a more frothy period?

Steven Rogers

The thought process on the impairment is pretty pristine, I've been doing it for 25 years every quarter. We are required do a net realize of a value on every asset that we hold in the organization that has any degree of maybe an approaching an impairment of its book value. Again, I vividly remember doing land values in 1983, when I joined the company, exactly as we're doing them today. So, this is nothing new, but it always comes out at a time when values are falling that these items pop up. And reading our brethrens announcements here this week, impairment was kind of a four letter word for the industry for the fourth quarter. So, what we do is just systematically go through everything.

Now, the two buildings that we sold, obviously at contract causes you to kind of reexamine that impairment, and we did it. Both of these were slightly below their book value. And so, we took that impairment as required. And then the land was really just look post Hurricane Katrina, we all sort of intuitively knew that New Orleans had been devalued, but our auditors and our audit committee and our Board and all of us just felt like that we needed something to sink our teeth into before we just arbitrarily valued a piece of land. And it took, until now, to get a couple of sales comparables on a per square foot basis, one up on (inaudible) service road, was better than our valuation and one right south was of us more comparable sales prices. That's about the only way you can really value land in today's world. And so, that's why we took the impairment. As the later part of your question, on the Fund I, we go through a very rigorous process, Ohio uses fair market value accounting. I don't know if you are aware of that. Most of these fund guys do that on fund accounting. We give internal valuations to Ohio. We're not required to disclose those internal values to the world. Because we do not do fair market value, we do GAAP accounting. And so, what we're really looking at is just internal disclosures to Ohio, but with no requirement or really any GAAP responsibility to kind of talk in any detail about the fund.

Jordan Sadler - KeyBanc

Is that because you're consolidating it? Is that just from an accounting perspective?

Steven Rogers

We consolidated it using historical costs, that's right, that is just...

Jordan Sadler - KeyBanc

If you were equity and income, you'd have to use the fair market valuation.

Steven Rogers

No, we've seen others announce it that way. But not real clear on what maybe they've adopted fair market value accounting. It's an option, not a requirement.

J. Mitchell Collins

I think the takeaway here, as we look at our consolidated balance sheet, Jordan, it's not just fund, it's wholly owned, it's everything. We're looking at every building from an impairment analysis; quarterly and annually. So, I just want to...

Steven Rogers

We've seen some pretty big headlines that comes in... that have done it done that way Jordan. It's just not, it's not a standard GAAP requirement.

Jordan Sadler - KeyBanc

Okay. That's helpful. Thank you

Operator

We'll go next to Nap Overton with Morgan Keegan.

Napoleon Overton - Morgan, Keegan & Company, Inc.

Yeah, good morning. Could you remind us how long you have to complete the investments in that Texas Fund 2?

Steven Rogers

Sure. Yeah. Four years, which started in May of 2008 and there is no requirement of anything, during any month or quarter or year, it's just four years. A lot of flexibility and again our partner is perfectly align and we can take as much time as we need to make sure we get some great assets and great rates of return.

Napoleon Overton - Morgan, Keegan & Company, Inc.

Okay. And totally separate question, was the 6.6% increase in average rents per square foot a cash or a GAAP number?

J. Mitchell Collins

That was a cash number.

Napoleon Overton - Morgan, Keegan & Company, Inc.

That's a cash number?

J. Mitchell Collins

Yeah. Let me... you're talking about 2073?

Napoleon Overton - Morgan, Keegan & Company, Inc.

Yeah, in the context of...

Steven Rogers

2073, that'd cash.

J. Mitchell Collins

That's over expiring rates.

Steven Rogers

Yeah.

Napoleon Overton - Morgan, Keegan & Company, Inc.

Correct.

Steven Rogers

That's not a portfolio that changed now. That's just the subscribing rates.

Napoleon Overton - Morgan, Keegan & Company, Inc.

Correct.

Steven Rogers

Yeah.

Napoleon Overton - Morgan, Keegan & Company, Inc.

Okay. And then could you just tell, you mentioned that you had some quotes in hand for the loans that mature this year should those properties not be sold, could you share with us what the terms of those quotes are for refinancing those pieces of debt?

Steven Rogers

Well, we've, without naming names, we have received quotes as low as I think 6.7%, as high as 8%. All of the proceeds I believe we've been quoted, Mitch, and correct me if I'm wrong, but every quarter we've got is greater than the principal outstanding of the loan in place in Houston. In other words, small buildings, small mortgages are just, that's business not as usual but it's just business is being done out there. These are great insurance companies and for household names.

J. Mitchell Collins

And what we're sort of seen, I can say is that I happen to attend the conference last week and that seven sort of seems to be the regardless of what swaps do or where the rate is that they are just an absolute value of seven, it seems to be about to the flow in the marketplace today and that proved true for what we just did. But that's with not a lot of data points that seems to be...

Napoleon Overton - Morgan, Keegan & Company, Inc.

Yeah.

J. Mitchell Collins

Where the market is, seven plus. And we are still seeing quotes in the form 50 to 65% leverage.

Steven Rogers

And these are all non-recourse, ten year maturities, in most cases 25-year amortization schedules, in a couple of cases some interest only and there believe it not and I don't know it just sort of inline with what we expect.

Napoleon Overton - Morgan, Keegan & Company, Inc.

Okay. And did I understand Mitch, did you say correctly the 50 to 65% LTV.

J. Mitchell Collins

We've quotes at 50 and quotes up to 65, yeah.

Napoleon Overton - Morgan, Keegan & Company, Inc.

Okay.

Steven Rogers

And most of our fund stuff is going to do... as we do fund work here, we will do it with a 50%, but when we sell an asset we're obviously trying to put as much on it as possible you know given the lenders preference because most buyers are trying to minimize their equity requirement and they're better priced for Parkway. So we're helping to get maximum amount out of debt we can on it.

Napoleon Overton - Morgan, Keegan & Company, Inc.

Okay. Thanks very much.

Steven Rogers

Yes, sir.

Operator

(Operator Instructions). We'll go next to Chris Haley with Wachovia.

Christopher Haley - Wachovia Securities

Hi, good morning. It's Brendan with Chris.

Steven Rogers

Hi, good morning.

Christopher Haley - Wachovia Securities

Steve, when we talked at the end of last year, I think you said that your expectations going into the first part of an economic recession would be that retention levels would probably be relatively high relative to kind of a mid-cycle range and that CapEx cost would be down, because it's reluctant to move. If I look at your portfolio, in this quarter your retention ratio is probably kind of inline with before it runs historically, but your CapEx and leasing costs were up a little bit. Is there anything particular that happened in the quarter and that what will be your expectations as we go forward through '09?

Steven Rogers

Let me answer that retention question which is the easier one and then I'll point to hard one over here to Will or Mitch. But we've run 72.47% average retention for the past decade. And that would bring in the recession, the live recession of 2001 where we actually ran 80% that year Brendan. So, I mean there is some data suggesting at least in my book of business here in 25 years at Parkway that people don't like to move during a recession, because they're worried about other things, quite frankly. And they darn sure don't want to be submitting out pink slips to their employees and then moving to the Taj Mahal next door. So, nobody wants to trade up on cost. What they really want to do is just sort of hold on what they got. And so what impacts our retention is not the customers move out, is that they downsize. And that our measurement of retention subtracts from the percentage any downsizing.

So if you got a mortgage company for 50,000 feet and they renew for 15,000, then we don't count that as a renewal, we only count 15,000 in the numerator. So, but, that's where we, if you're going to get hit on your retention, that's tends to be where you get hit. May I pass the other portion of the question on CapEx along to you guys.

William Flatt

I will tell you, I think that in the CapEx number this quarter there's a couple of big leases that were actually signed earlier in the year, it includes a monitor, (inaudible) in Chicago. It includes the Bourneville lease, since that's committed TI, we went ahead and created a leasing commission. The leasing commission is in this quarter. And so, some of that was done prior to October and is occurring later. And then there are a couple of other leases that on our share count, actually add up. I would say that that belief or expectations for lower TI still holds just based on conversations we've had over the past. I have had at least in over the past three months, which is customers are much happier with existing conditions or trying to make something work, and is all about current occupancy cost and less about the condition of space. So, I think, we will continue to see pressure on rates with to the benefit of reduced pressure on TI and costs. And I think, to the extent that we as a company can make sure that we sell the space that we have that is improved. I mentioned selectively demolition or doing pre-built space, and all about controlling costs these days. And that's it.

J. Mitchell Collins

I'll have one final comment to Will, and if you look back, we're reaffirming '09 range on CapEx and leasing is $20 million to $25 million, we incurred $24 million in 2008.

Christopher Haley - Wachovia Securities

That's very helpful. Just as I think abut your comments and pressure on rates, which we can certainly understand, and then, likely will be some relief on the CapEx cost. How do you think about the... as you guys put the NPV of doing new leases as you go forward in '09. Would we expect that to be an overall positive number, relative to your expirations as we go forward, or do you think that number would actually turn negative?

J. Mitchell Collins

I am being hesitant to say that. I mean, I think that obviously there is... you're moving a couple of variables around. But, in general, things are getting worse rather than better. So, there maybe one or two deals that have a very high NPV, because they are two year renewals with no TI and low rate. But, I wouldn't, even if on NPV per square foot basis, is maybe shorter deals as I would not view that as a positive overall with obviously some exceptions.

Steven Rogers

Yeah. If you look at our website, page 13, Brendan, you'll see I mean trajectory looks great. And if you follow the red line, I mean, it sort of looks like we're going to the moon from here. And I concur with Will, that's just not going to happen. Okay? So, I mean, we just need to be cognizant of that, but in a tight good old fashion recession, I'd be happy to hold on to NPV right now, and hold on. And I think that's really kind of where our mindset is, we're not running scared of customer renewals. We want to keep a high customer retention rate. And if where we can hang on to the rate, we're going to hang and keep the recession, I mean, the concessions out as best possible and what that means to me is probably holding NPV.

Christopher Haley - Wachovia Securities

Okay. That's helpful, Steve. I guess for Mitch, I know 2011 is kind of a long way off. But, if I just look at, is there any early indications that just looking at your line in terms of the capacity that you guys would like to keep as we go forward just thinking about 2011 as a year where you've got some significant mortgage maturities and the line matures as well?

J. Mitchell Collins

I mean, we'd obviously like to keep all of the capacity of the 311. It's going to be contingent on the bank group, the residual bank group that's existing out there, three years from now two and half years from now. We have some big debts that you're aware of, we got a debt on 233 that material out in summer of '11, and then we've got our Cap City loan in Atlanta, that will also mature assuming the one year extension option from 2010. But, needless to say, it is on our radar and we're working plans towards '11, and I think that the point that we will... we really want to make sure everybody is comfortable with at least for '09 and '10 as we manage through these two years as we have sufficient capital under the line to take on everyone of the mortgages we had to if it dried up. But that clearly is not management's intent, our intent is to sell assets that we need to sell, to refinance what we need to refinance but this will be a top of mind agenda, I think going forward.

Steven Rogers

We also have evidence just from listening to bankers, there has not been any quote to Parkway that people are reducing capacity on the lines and our company is just simply planning for some reduction on the line of credit. And so, it just means that we'll be working on debt pay down. We would also expect, I don't think it's any secret that banks price the loans in a time period that was different from today. And so we were at LIBOR one-third... over with 130, and we just probably don't... I mean we're not planning in our FOCUS plan to get 130 over LIBOR.

Christopher Haley - Wachovia Securities

Okay.

Steven Rogers

Correct. So we just know distinctively that in a time like this you should expect to get a little less proceed and pay a little more for the money. But let me tell what I do also expect, we have a great relationship with ten great banks in our line and it's going to pay big dividends to Parkway at a time like this. They like us, they respect us, we've treated them well and they're going to rely.

Christopher Haley - Wachovia Securities

Okay. That's helpful, thank you, Steve and Mitch. And then just lastly, could you just refresh my memory on the Pinnacle development, what the original cost and yield expectations were, and then how that compares to the cost and yield expectations today?

J. Mitchell Collins

We budgeted a little over 52 million originally, we came in at $50.4 million, we came in under budget, principally due to interest expense and some fees being lower. We came in on time, we scheduled to finish the building this fall and we did. The original cap rate was eight, we're coming in mid sevens. So, that's kind of the math on it and we're just sort of hang on to it and go from there.

Christopher Haley - Wachovia Securities

Great. Thank you.

Operator

We'll go next to Stephanie Krewson with Janney Montgomery.

Stephanie Krewson - Janney Montgomery Scott

Thanks. Good afternoon.

Steven Rogers

Hi, Steph.

Stephanie Krewson - Janney Montgomery Scott

You guys had a big change in your property operating margins. Was that driven by true ups in Ad Valorem taxes or what was moving that NOI margin in the fourth quarter?

William Flatt

There were some true ups in that number, there is some utility cost decreases due to as we mentioned earlier in the year, we were hurting from the price of natural gas. And so that came down in the fourth quarter, there's some true ups I think, I've sort of been on record on that we can bounce around 51 to 53. And again it can be meaningful for only one quarter but we should be in that range seasonality throughout all things considered. So, I think that I wouldn't expect that would there will be any sort of run-rate at all on this quarter's NOI margin.

Stephanie Krewson - Janney Montgomery Scott

Picked out a like 52% margins, 51?

J. Mitchell Collins

Yeah. That's about we hit for the year, we got in Will's notes. Yes, let me hold on for a second. We're about 51, we did 51.7 for the year on a same-store basis, Stephanie and backing out unusual term fees and Hurricane Ike, 51.7, call it 52, and 53 for the quarter just given the seasonality of things Will talked about.

Stephanie Krewson - Janney Montgomery Scott

Okay. And can you provide some straight line rent adjustment guidance for 2009?

Steven Rogers

We have not given that guidance.

Stephanie Krewson - Janney Montgomery Scott

I know, that's why I'm asking.

Steven Rogers

Hey, you've got to figure out some of these things, Stephanie.

Stephanie Krewson - Janney Montgomery Scott

I mean we have our projection, but I am just curious how close we're getting.

Steven Rogers

Can we get back to you after the call, we just don't have that guidance.

Stephanie Krewson - Janney Montgomery Scott

Yeah.

Steven Rogers

If others want it, ask at the next call, we'll give thereby equally, but make sure Stephanie gets it today after the call.

Stephanie Krewson - Janney Montgomery Scott

Okay. Likewise offline I have a couple knit picky questions about Pinnacle and I'll just circle up with Mitch afterwards.

J. Mitchell Collins

Sure.

Steven Rogers

That will be great, we will be here.

Stephanie Krewson - Janney Montgomery Scott

Thank you, guys.

Steven Rogers

Yes ma'am.

Operator

And we'll go next to David Tannehill (ph) with Morgan Asset Management.

David Tannehill - Morgan Asset Management

Hey, guys.

Steven Rogers

Hi, David.

David Tannehill - Morgan Asset Management

My recollection, you had mortgage loan that you all purchased a few years ago, as a second or third lean, I think on a property in Houston or Dallas? I was curious if there is an update on that, how that's performing?

Steven Rogers

Yeah. Will, you want to take that one.

William Flatt

Sure. The borrower is current. We do keep up this very close to the property and in terms of formal reporting like any lender, and they then just our knowledge of the market. And Dallas has continued to produce jobs at a time when the rest of economy hasn't. And, my overall take of the building is that it is performing as it's opposed to date. So, no change in our position on the piece of paper.

Steven Rogers

Yeah, keep in mind, this one of those kind of goofy loans that gets written up about a lot. This was a 80 bucks a square foot on a Class-A office building in downtown Dallas, its 833,000 square feet. So, if you take first and the second, we have the second position there. It's really a BP, it's not really a second mortgage, you'll know the difference, but call it a BP, that's about $68 million bucks on 833,000 square foot building in the large District of Dallas.

J. Mitchell Collins

Quite frankly David, they are the owner type leasing pipeline as would allow, or anything we've got in the other of our markets. So, I think the owner is actually doing a very fine job today. And, again, the best thing we can do is say, it's current. And...

Steven Rogers

Hopefully they'll pay us all if they don't, we'll sort of work that angle at that point in time.

J. Mitchell Collins

It's... my takeaway is it's current, its $80 a foot, and its $7.5 million on a $1.5 billion balance sheet, its just not material to Parkway from an earnings standpoint.

David Tannehill - Morgan Asset Management

Are the operating statistics of that building included in along with the other buildings?

J. Mitchell Collins

There are not, that is all confidential information. So, I... well, we can comment on, and I don't think I'm saying that the owner is doing a fine job and if you want to knock around Dallas, I think the bill is healthy. All we can really say is that they are meeting their obligations to us.

David Tannehill - Morgan Asset Management

Okay. Your dividend, the cut that you all did a couple of quarters ago, quarter ago, I think was a right decision. I know you don't have to, but could you eliminate or reduce dividend to some nominal amount? And, at what point in the year would you have to make up to continue to qualify as a REIT? At what point in the year would you have to pay out the dividend to qualify as a REIT? If you decided to... to hold onto the cash?

Steven Rogers

Yeah, we've got room, if we ever wanted to cut the dividend further as we've cut it nearly down to the taxable income, which is required, and we left it at $1.30. And, I know there is a lot of discussion right now on stock dividends and the like and all of those things are, we're obviously keeping an open mind to so forth. But, I think, really we're just satisfied that the Board has set the dividend level at the correct level before we are in the cycle, and what we are doing here at Parkway today. So, I am comfortable with where the dividend sits today. Our Directors are comfortable with that. And, we'll just sort of take it up each quarter, kind of watch out this recession unfolds, and keep an open mind about it.

David Tannehill - Morgan Asset Management

Okay. Thank you.

Steven Rogers

Yes, sir.

Operator

And we'll take our next question from Steven Zedlick.

Unidentified Analyst

My question has been answered. Thank you.

Steven Rogers

Thank you, Steven.

Operator

It appears there are no more questions at this time.

Steven Rogers

Okay. Well look, I appreciate everyone following Parkway as closely as you do and signing up for the conference call today. We've got a meeting with our Directors coming up in a few weeks. And, once we have ample time to take a look at our FOCUS plan, we'll be back to you shortly with the details on that. So, thank you very much and good day.

J. Mitchell Collins

Thank you. Bye, bye.

Operator

This concludes today's conference. We thank you for your participation. You may now disconnect. Have a wonderful day.

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Source: Parkway Properties Q4 2008 Earnings Call Transcript
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