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Highwoods Properties, Inc. (NYSE:HIW)

Q2 2010 Earnings Call

July 29, 2010 12:00 p.m. ET

Executives

Tabitha Zane - VP, IR

Ed Fritsch - President & CEO

Mike Harris - EVP & COO

Terry Stevens - SVP & CFO

Analysts

Chris Caton - Morgan Stanley

Jamie Feldman - Bank of America Merrill Lynch

Brendan Maiorana - Wells Fargo

John Stewart - Green Street Advisors

John Guinee - Stifel Nicolaus

Suzanne Kim - Credit Suisse

Dave Rodgers - RBC Capital Markets

Chris Lucas - Robert Baird

Operator

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 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.

Tabitha Zane

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 planned dates 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 condition, including estimates and effects of asset disposition and acquisitions; the cost and timing of development projects; the terms and timings of anticipated financings, 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 highwoods.com.

I'll now like to turn the call over to Ed Fritsch.

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 U.S. and global economy, such as recovery versus double debt, it's hard for anyone to know what to expect over the next 6, 12, 18 months. Clearly most indicators suggest that it will take a while for economy to return to sustain growth.

Here's what we do know. The important 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 it appears conditions are not continuing in the 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 lower the top end by a $0.01to $2.48 per share.

Turning to our results, leasing volumes were solid and better than a year ago. Office leasing in the first half of 2010 totaled 1.8 million square feet, compared to 1.3 million square feet lease 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 non-credit and strong wins for Highwoods.

OpEx and G&A are lower as we continued to be successful on our ongoing efforts to reduce expenses and improve efficiencies throughout our company. This has resulted in better same store NOI and G&A forecast in our updated FFO guidance.

Our office occupancy remains significantly better than the market as a whole as we continue to differentiate our sales from our competitors to our healthy balance sheet. This strategy has proven to be effective as exhibited by recent wins of the larger deals in the 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 bulls eye on our acquisition scorecard. It improves the overall quality of our portfolio. It is a terrific asset in the core infield submarket. It strengthens our dominance in Memphis's best submarket. It has a stable diversified customer-based with no material near-term roles. We acquired a 30% plus 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 seeing 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 side line cash waiting to be deployed will be quickly flushed out. While Crescent Center is a bulls eye, we would also consider properties off the center mark but still on our target.

This would include well concede but under leased development projects and under occupied class A office buildings in infield 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 a $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 this 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 builder suite projects of approximately -- approximating a $150 million investment. Given today's economic environment, customer decisions making process for builder suites is much more deliberate. Work sessions with out customers and prospects are ongoing. So stay tuned.

During in the quarter we placed one development project in service. River Point 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 are also developing a 171,000 square foot build a 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?

Mike Harris

Thanks Ed and good afternoon everyone. Across our entire portfolio, this quarter we signed 178 leases for 1.4 million square feet of 2nd generation space with good activity in all three property types. Second quarter office leasing activity was descent 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, inline with our give 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. This economics still favor the customer with respect to run rates, lease concessions and TIs.

Cash rent growth for office lease assigned 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'm 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 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 from the first quarter to 86%. We signed a 60,000 square foot 15 year lease with the Duke Medicine repositioning [River Birds] to a medical office building.

We also signed 229,000 square 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 Talecris in our Research Common office part. This was a 11 year ideal that included 40,000 square feet of expansion for the 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 will hope this market is on the path to recovery.

Looking at 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 lease and CapEx to financially strong customers in prospects position us to take advantage of their concerns about the financial health of their landlord.

We also continue to benefit from having a well brand, respective brand and a strong reputation for quality and service. Terry?

Terry Stevens

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 of last year. Net income in both quarters had significant non-FFO gains from disposition of JV interest and from wholly owned properties.

All per share results this quarter and for the first six months were impacted from higher weighted average shares outstanding, 75.6 million diluted shares of 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 preceding first quarter was primarily due to $1.05 in higher term fee income, $1.04 in lower operating expenses net-of CAM recoveries and $1.02 in lower G&A, offset by $0.007 in lower JV FFO mostly due to the sale of our JV interest in Des Moines that had 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 cost 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 quarter is expected to be lowered in the second quarter. Total revenues from continuing operations were up 2.4 million this quarter or 2.2%, compared to the second quarter of 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 0.008%. 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. 0.003% reduction in average occupancy and negative through ops 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 excludes 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 and 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 in 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 of 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 to mostly 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 $2.31to $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 expense acquisition-related cost.

Operator, we are now ready for questions.

Question-and-Answer Session

Operator

Thank you. Ladies and gentlemen (Operators Instructions) Our first question comes from the line of Chris Caton with Morgan Stanley. Please proceed with your question.

Chris Caton - Morgan Stanley

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 it's a real capital with a 91 cap and then also the discount replacement cost, it sounds like I think it's about 225 a foot maybe if you can add a little color on that.

Ed Fritsch

Sure. You're right. Our cash return cap rate year one is a 91 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 dips higher than that as we go forward based on projections. We did target a replacement cost of 225 to 230, and part that's driven obviously by the structured parking in the rented side of the building and the size of the building and the value of the land to where some, a third discounted from what we would expect today's replacement cost to be.

This has been the acquisition that we've had on our active wish list since the inception of our wish list. Our division head, Steve Guinn 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 top recorder in Memphis and we think that this gives us an even better shot at the -- been in the deal flow as these transactions occur in the Memphis market.

Chris Caton - Morgan Stanley

And how competitive was the bidding process? Did you feel like you had to, you mentioned Scarcity premium you have to pay, Scarcity Premium here for this asset?

Ed Fritsch

We don't feel like there was a frantic amount of bidding on this. We think that is 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 off 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 is difficult to define a trend.

Chris Caton - Morgan Stanley

Thank you very much.

Ed Fritsch

Your welcome Chris.

Operator

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

Jamie Feldman - Bank of America Merrill Lynch

Thank you. I was hoping you could provide a little bit more color on just kind of, if there is any change and sense in it, both among businesses in your region and brokers and tenants in your region this quarter versus last quarter given -- we are seeing kind of 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 pick up a little bit here.

Ed Fritsch

Yeah, 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 bouncing along the bottom and we hear that, both from our existing customers and in conversations with prospects and in conversations with tenant rate brokers. There does seem as we said last quarter to be more confidence in the users 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 be out of the decision making process and customers going forward, that's occurring but its just happening in a much longer timeframe. We're also seeing that on the builder 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 it's a 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.

Jamie Feldman - Bank of America Merrill Lynch

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

Ed Fritsch

I think the brokerage community is still running long on creating activity to generate these by reaching out to future explorations 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 exploration was too far out in the future and they were suggesting it's never too far out. If you want it to modify your lease, you'll 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 build out now or I maybe 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 them to co-call.

Terry Stevens

About a year ago there was a little bit of a panic going on. At that point of the economy and the brokers seized on it, today things have stabilized a little bit; just less churning is going on there.

Jamie Feldman - Bank of America Merrill Lynch

Okay, thank you.

Ed Fritsch

Thanks Jimmy.

Operator

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

Brendan Maiorana - Wells Fargo

Thanks, good afternoon. So Ed, you talked in the beginning of your script about how you had a couple of larger deals that kind of drove the CapEx levels up a little bit, and 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 got net absorption that's moving positive in the markets. Is this just kind of a type of environment that you are in, and maybe this you getting a couple of large deals every quarter with high CapEx levels, is sort of a norm and that's what we should expect going forward?

Ed Fritsch

I think that's fair bringing it. We've reached it for a couple of deals in this environment and it's basically been under the umbrella of poaching. If you take for example, the two deals 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 a 100,000 square feet at the over 800 we leased of the total 1255 on page 13 of our supplemental for total CapEx spend goes down to $10 and $0.02, so it has a dramatic impact just those two deals, but both of them we were able to attract customers with very good credit for long-term leases, and we brought -- we basically were able to get the amount of brand access buildings and put them into Highwoods buildings. So, we will continue to do that, and I think that your comment about maybe that's a trend that will still each quarter have and less than a handful of these, but those which are material as our leasing team continues to be out trying to leverage our balance sheet you're basically poaching brings some customers into our buildings and increase our percent of market share.

Brendan Maiorana - Wells Fargo

If I look at your occupancy level when we strip out the piedmont sale, it seems like the occupancy was outside of the pickup you got from closing those low occupied buildings was pretty much flat, so does that assume that if your --

Ed Fritsch

That's correct.

Brendan Maiorana - Wells Fargo

Poaching some tenet to grow your occupancy a little bit, than you've got sort of debt contractions on the rest of it, so kind of net, net you're flat overall?

Ed Fritsch

Well, remember that you know these what's on page 13, or deal 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, bid it, build it. So, there is 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 are still, are some customers that are contracting and they are still some that are going out of business. That you just can't, you 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 yearend occupancy and we factored in the benefit of the two sales in the Triad.

Brendan Maiorana - Wells Fargo

Sure, okay. So fair enough. And then if I look at the midpoint of guidance for the back half of the year, it would suggest that FFO levels on a quarterly basis are at around $0.60 a share per quarter and in this quarter you had a bad level that was a little bit lower than your dividend if you got FFO that's going down and now we have got straight line rent expectations and are higher than what they were previously.

Is it kind of fair to assume that we are not going to get positive dividend coverage at least for the back half of the year?

Ed Fritsch

Terry and I will both, let me just go first Terry, couple across there 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 annualized we come out slightly negative. We did front end load this year, the BI, we spent a significantly amount of our BI budget in the first half of the year particularly second quarter or normally that comes towards the later part of the year.

And the impetus for that is the preponderance of a dollar spent in BI were related to HVAC and energy management system so that we can 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 are able to reduce your overall electrical spend by 10 to 15%.

It's already paying back even the degree days we have 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 will be for CAD for both 2010 and 2011. We will continue to reach out to try and expand our market share by attracting customers and leveraging our balance sheet but I don't see us to be a dramatically negative, I see as a continuing to hard the positive negative line for the remainder of '10 and into '11 and you want to just extrapolate a little bit further and as a result I don't see us modifying our dividend policy in the near term meaning anything in the next 18 months. Terry?

Terry Stevens

Okay nothing to add to that.

Brendan Maiorana - Wells Fargo

Okay so just to clarify, last year the BI was around 16 or 17 million this year it's gone I think a little over 10 in the first half. So, the expectations are kind of for the full year 2010 would be roughly in line with the full year 2009?

Ed Fritsch

That's exactly right.

Brendan Maiorana - Wells Fargo

Okay and then just lastly bill pursuits, the guidance is up a little bit at the midpoint and you mentioned seven deals that you are kind of pursuing. Are any of those GSA deals and is the Obama memo that was out. Did that sort of put any change in thinking about the opportunity with respect to GSA build a suite deals.

Terry Stevens

Another pretty 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.

Brendan Maiorana - Wells Fargo

Okay. Thank you.

Terry Stevens

I will be glad to comment more on Obama but Tabitha gets pretty wild when I do that.

Brendan Maiorana - Wells Fargo

We will leave that for now.

Ed Fritsch

Thank you for your discretion.

Operator

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

John Stewart - Green Street Advisors

Thank you. Ed, I understand that, understand your description of Crescent Center and how it fit 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 a double digit decline and I realize this are year-over-year comps. Can you give us some additional color in terms of your thoughts on the Memphis market?

Ed Fritsch

Sure. We think Memphis is a strong, long-term player for us. We like being in Tennessee, Nashville as well. And Nashville has proved to be a very strong market for us. The building net 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 it's a number that with regard to same stores, it's 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 you have anything? You still pay taxes?

Terry Stevens

John, 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 sixth month call, and you'll see that Memphis was down only 2.7% for the full six months and what happened there was, some FX in the first quarter, where Memphis was significantly positive and they went negative due to the timing of some prior year tax rebates and the prior year tax or adjustments to the CAM billing that related to the taxes. So, they kind of flip flop between quarters. But overall for the sixth months, and where we would expect that to continue to run, it is much closer to the sixth month as oppose to the second quarter which was more of an anomaly.

Ed Fritsch

John, to give you whole perspective on the strategic importance of Crescent, I lived in Memphis for many years. It is a stretch of about a mile and half from I240 out to the city limits in Germantown and that's Memphis's goal 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 at proper address, which is very important in Memphis, you pretty much have to come to Highwoods and that's something that we've always achieved to do is to have a, sometimes on air we're going to dominate in the market particularly a great sub-market like that. So, we feel 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.

Mike Harris

And it's running about 400 bps. Its occupancy is about 400 bps better than in Class A vacancy right now.

John Stewart - Green Street Advisors

Okay. That's helpful. Thank Terry with respect to the guidance it looks like certainly some of it is attributable to G&A selling. And I guess the question is how much of that is deferred comp and how much is more of a permanent cash nature?

Terry Stevens

John, we did lower the full year estimate for G&A from about 32 million to 34 million, down to 30 to 31.5 million, about a 2 million or so reduction. About a 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 in another income. That's about 25% of the FX. Another half million or so is just a projection now that we think we can drive half million of the 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 the part of it is just the incentive comp as well. And we just updating the guidance here in July we felt confident enough to bring that guidance in G&A.

Mike Harris

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 and that it comes out in one line, it goes into another line so it's a wash but in order to help mitigate the noise that creates, we've taken on a policy here that effective, the first to this year that we've suspended any -- the ability for any officer to contribute to that plan anymore.

So overtime, obviously what's invested in it now will stay but overtime, that number would just continue to get smaller and smaller as that money is distributed, the pay that they earned that was put into these mutual fund accounts as those are distributed overtime to those who are in the dollar. They will become less and less volatile.

John Stewart - Green Street Advisors

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

Ed Fritsch

Sure, the government as a standard policy with how bumps are incorporated into their leases and government feels just like in any private sector deal, we always tried to get two things, a direct operating cost pass through or some type of expense stock 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 hits. Clearly, the government prefers that it'd be flat or some modified CPI of 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.

John Stewart - Green Street Advisors

So, on those two deals in particular, there's some form of bump.

Ed Fritsch

Well, I am sorry which two?

John Stewart - Green Street Advisors

Jackson FBI or the FAA in Atlanta.

Ed Fritsch

The FAA, I believe there is and I can't remember --

Mike Harris

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

Ed Fritsch

So we deal bumps in both. Yes.

John Stewart - Green Street Advisors

Okay, it's very helpful, thank you.

Ed Fritsch

Sure, thanks John.

Operator

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

John Guinee - Stifel Nicolaus

Great color on Memphis given the history of Clark Tower on the next go-around.

Ed Fritsch

We don't own it.

John Guinee - Stifel Nicolaus

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

Ed Fritsch

It's a little more difficult as you said is 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 as well to wait a little while before we put more than very bottom out to market. We have tested a few things and they haven't flown exceedingly well. So, we are 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. We look at that on a deal by deal basis.

We will continue to put elbow grease behind getting these other assets out the door. I think the girth of the total sale proceeds that we experienced in '05 through '07 will moderate as we have seen this year going from 250 to 350 down to about a 125 thus far this year.

Fortunately, we can afford to be patient on these aside from the fact that we 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 like to see acquisition activity pick up to help offset some of the delusion that may occur as these asset sales would close.

John Guinee - Stifel Nicolaus

How about the joint ventures?

Ed Fritsch

The joint ventures we have some very good joint venture partners but we are smaller today than where we were. We are very happy to be out of Des Moines. We didn't have a presence in Des Moines. We were concerned about some upcoming rules 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 have never talked much about it and we have 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 of that JV that created reporting and administrative demands that maybe considered distraction from our core business.

Mike Harris

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

Ed Fritsch

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

John Guinee - Stifel Nicolaus

Got you. Okay, thanks.

Ed Fritsch

Thanks John.

Operator

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

Suzanne Kim - Credit Suisse

Good morning how are you, or good afternoon.

Mike Harris

Good afternoon.

Suzanne Kim - Credit Suisse

I am asking about the guidance that you provided for the higher actually it's much higher the midpoint than before and I am wondering right now your occupancies are 89.3, and what would get you sort of to the higher end of that range either in particular markets that you're seeing some type of action on, and are these higher paying, higher rental rates in these markets?

Ed Fritsch

Yeah 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 is another 140 some million dollars with of acquisitions, but by the time that that would happen, given that we're already basically at August 1, how much benefit of that would you get in this calendar year, but if you look at some of the other items with regards to G&A term fees, rents etcetera you would have to the high end of each range in order to put us there. We are very comfortable with this.

Suzanne Kim - Credit Suisse

To put you at the higher, I guess --

Ed Fritsch

I'm sorry.

Suzanne Kim - Credit Suisse

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

Ed Fritsch

Yeah, we will take some significant leasing to get there. We gave a yearend occupancy revise that we tighten it from 87 to 89 to a range of 88.5 to 90. Right now as you said were a 89.3, so we will take some occupancy see -- take some leasing to not only occur, but for the leases to commence prior to yearend.

Terry Stevens

Or some unexpected holdovers that were, we're expecting second half rollouts in the tenant side to stay in, that we're projecting. Otherwise that could back and add to it.

Suzanne Kim - Credit Suisse

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?

Ed Fritsch

Well, sure we were -- we have a healthy list of lease in prospect similar between suspect prospects and potential renewals, but we wouldn't want to dial in and say here is where we're the beyond what we have given in the way of yearend guidance at this point in time. It's hard to predict this as time rolls over the next nine months, but certainly 90% is doable otherwise we wouldn't have disclosed that.

Suzanne Kim - Credit Suisse

So I was checking your list and it seems that Raleigh and Piedmont Triad actually went up, and the ones that went down and we already discussed that. You already discussed and the other is Tampa which one is in Orlando. Could you provide a little bit more color what's going on in Tampa because it seems like that market would be -- it's coming out the cost the TI seem to be higher than your portfolio average as well as the BEO, the lease rate as well. Could you discuss that in the morning?

Ed Fritsch

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 to accomplish that without the involvement of the tenant rep broker. So it's 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 Westshore submarket. Westshore is the most improved submarket and our folks in Tampa continue to do a phenomenal job of outpacing the market is a whole. In fact think, if you look at the spread between our occupancy and the market occupancy, it's the widest. It's about 1300 bps in Tampa, our portfolio versus the overall market.

Terry Stevens

You will find some of the best in our growth year-over-year in Tampa than any of our other markets.

Ed Fritsch

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

Suzanne Kim - Credit Suisse

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

Mike Harris

In, general?

Suzanne Kim - Credit Suisse

Yeah, just sort of a general macro prospective.

Ed Fritsch

Just from a general market turmoil and stock market etc., it's hard to say. There is a decision maker in Richmond in Virginia pull back on signing a 20,000 square feet lease because Greece is having trouble and the euro is moving -- the world is smaller but how do you connect those dots and like we said in our scripted remarks here the things we have quantified and there are things that are unquantifiable that are uncertainties in every decision makers mind whether it be economy, whether it be global, whether it be U.S. 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 is a high level of confidence today but I don't think that you could do a biopsy on any decision makers brain and it would be void of concerns that are both national and global.

We are heavily focused on the smaller sized customer, our average office sized customer is about a 11,000 square feet, we have only 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 a 150 to 200,000 jobs a month in growth that -- things are going to be tough.

Mike Harris

There is a large multinational companies, that type of news may filter down to their real estate shops eventually but since there are typical 5 to 7,000 foot in a local company. They have got a business to run and they need to move, or they need to crow. They don't typical pay too much attention to what goes beyond their control.

Suzanne Kim - Credit Suisse

Great, thank you so much.

Ed Fritsch

Thanks Susan.

Operator

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

Dave Rodgers - RBC Capital Markets

Hey good afternoon everyone.

Ed Fritsch

Hey Dave.

Dave Rodgers - RBC Capital Markets

Ed I had a question for you. Political commentary aside, the end of your prepared comment suggested that you had a little bit more of a encouragement around the development build-to-suite opportunities. You gave a quite a bit of detail around what you were pursuing there and that's been fairly consistent.

On the other side of that equation what is the acquisition pipeline, you had some success in the recent term. Can you talk maybe more about what the volume look like in the acquisition pipeline, what percentage of these deals are kind of hitting your criteria and then ultimately fall out through the due diligence process.

Ed Fritsch

It's still; it's a very small number that are coming through. Our wish list is relatively largest as we have talked with you about before but the deals that are coming out and offering memorandums that would hit our bulls eye are still not plentiful and we are some that as I mentioned in the remarks, it hit the target but aren't necessarily in that yellow bulls eye.

So, we are trying to broaden the scope of what we would evaluate and we would be opportunistic but there is just not a lot of coming to market. We have a seen a [feasative] that have come to market that we 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 sink 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 all three 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.

Dave Rodgers - RBC Capital Markets

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

Mike Harris

Yeah, I think it's -- some days it feels like one step forward, two back and the next day it's would be two forward and one back. I think the volume of request for extending blends in contractions is not what it was. The industries that we continue to see have an appetite for space or 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.

Dave Rodgers - RBC Capital Markets

And do you think that your, maybe of course (inaudible) as well, do you think that your bad debts have really hit bottom here? Do you expect that you could see an uptick in that over the 9 to 12 months?

Ed Fritsch

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

Dave Rodgers - RBC Capital Markets

Okay. Thank you.

Terry Stevens

Thanks Dave.

Operator

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

Chris Lucas - Robert Baird

Good afternoon.

Ed Fritsch

Hey, Chris.

Chris Lucas - Robert Baird

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?

Ed Fritsch

Well, we're pushing almost 12% now of total revenues coming from Federal and State and about 3 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've got a long-term deal with them in the 1,800 building in Century Center, more than 10 years.

Chris Lucas - Robert Baird

Okay.

Ed Fritsch

And, -- 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 that the State of Georgia may eliminate some agencies as they experience budget cuts but the Department of Revenue will probably be the last to go.

Chris Lucas - Robert Baird

It's a fair point. And then just a follow up on the dispositions program. You entered the Des Moines; you are exiting the Piedmont Triad. You've got more to do there. Is it fair though to say that right now it's more of a function of calling out of existing markets rather than exiting any other markets?

Ed Fritsch

Yeah. Sure. I think that's a clear depiction. We still have about 800,000 square feet in 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, whether or not to get out it but if we screen all of our markets, that which would be on the far right would be Greenville after we exit Winston in total.

Chris Lucas - Robert Baird

Okay, great. Thanks a lot.

Ed Fritsch

Thanks Chris.

Mike Harris

Thanks Chris.

Operator

There are no further questions at this time.

Ed Fritsch

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 here at the shop. Thank you.

Operator

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.

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Source: Highwoods Properties, Inc. Q2 2010 Earnings Call Transcript
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