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Executives

Steven G. Rogers – President, Chief Executive Officer

William R. Flatt - Chief Operating Officer

J. Mitchell Collins – Chief Financial Officer

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

James M. Ingram – Chief Investment Officer

Analysts

David Aubuchon - Robert W. Baird & Co.

Richard Anderson - BMO Capital Markets

[Craig Melman] - Keybanc Capital Markets

[David Shimus] - Citigroup

Jason Payne - Morgan Keegan

Mitchell Germain - Banc of America Securities

Stephanie Krewson - Janney Montgomery Scott LLC

Parkway Properties, Inc. (PKY) Q1 2008 Earnings Call May 6, 2008 11:00 AM ET

Operator

Good day and welcome to the Parkway Properties first quarter earnings conference call. Today's call is being recorded.

With us today are the President and Chief Executive Officer, Steve Rogers; Chief Financial Officer, Mitch Collins; Chief Operating Officer, Will Flatt; Senior Vice President, Sarah Clark, and Chief Investment Officer, Jim Ingram.

At this time I would like to turn the call over to Sarah Clark. Please go ahead.

Sarah Clark

Good morning, everyone. Welcome to Parkway's 2008 first quarter conference call.

Before we get started with this morning presentation, I would like to direct you to our website at PKY.com, where you can click on the first quarter conference call icon and find the presentation that accompanies today's call. On our website you will also find copies of yesterday's press release and the supplemental information package for the first quarter, both of which include a reconciliation of non-GAAP measures that will be discussed today to the most directly comparable GAAP financial measure. The press release and supplemental package, as well as this conference call, will be archived on our website for the next 12 months.

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 good morning, everyone.

Since our last call, headlines have persisted regarding a softening in the economy, primarily due to job losses and uncertainty in the housing market. Parkway is clearly not insulated from the macro effects of the U.S. economy. With that said, our leasing activity remains steady across all of our markets.

On a more granular review, our three largest markets - Houston, Atlanta and Chicago, which comprise approximately 56% of our revenues - all had positive job growth over the last 12 months and remain in the top 15 job growth markets in the country. In fact, Houston remains number one, with a solid 2.8% in job growth forecasted for 2008 and Atlanta is coming in as the fifth highest job growth market. Chicago continues to do reasonably well given its diverse economy and limited supply forecast over the next few years.

On the operating front, our overall embedded growth rose 7.4% since January 1 to $1.30 per square foot. Our Houston market, which represents 16% of our total portfolio, led this increase with nearly 97% occupancy and over $3.70 per square foot in embedded rental rate growth. Out Atlanta market, which represents nearly 13% of our portfolio, also experienced solid rent growth for the first quarter at over 3.6% to $21.64 per square foot. Our Chicago portfolio also showed continued improvement in same-store occupancy to 92.6%.

All this resulted in Parkway achieving FFO of $0.95 per diluted share for the first quarter 2008 as compared to $1.02 per diluted share in '07. Excluding unusual charges of $0.07 per diluted share that Mitch will discuss shortly, our first quarter 2008 FFO results were in line with our expectations, and we're on track to meet our earnings outlook for 2008.

Regarding our capital structure, I'd like for you to know that I'm committed to reducing Parkway's overall short-term debt and our target debt level to around 50% as compared to today's 57%. This reduction will be produced in a responsible fashion through our normal asset recycling program, whereby proceeds from sale of assets may be used to pay down our line of credit, thus freeing up sufficient capacity to pursue fund-like opportunities that require less capital from Parkway. Over time, this strategy should reduce the company's overall leverage given the FFO and dividend growth potential that our fund opportunities provide.

Yesterday we announced a refinancing of our only 2008 debt maturity, gaining over $18 million in loan proceeds to pay down our line of credit. Additionally, we only have $22 million of remaining debt maturities through the end of 2009. As Mitch will discuss in more detail, we are in compliance with all of our debt covenants, and I think the key takeaways here are that we're covering our current dividends with our FAD, we have no remaining loans maturing in '08, and our only required capital need is the potential funding opportunity that may be presented from the successful completion of a second fund.

In the area of asset recycling, during the first quarter of '08 we were pleased to have completed our Ohio PERS Fund One with the acquisitions of three class A office investments. Madison Capital, a subsidiary of Mass Mutual Insurance Company, stepped up to provide long-term non-recourse fixed rate mortgages at favorable rates on these new acquisitions. With these purchases, our $500 million total investment for Fund One was completed ahead of schedule.

In addition to noting the solid returns to Ohio PERS, it's a good time to step back and look at the overall returns of the fund structure to our shareholders. We have provided a great amount of detail to you in the past regarding each individual fund purchase and now we can offer you the full scope of the positive impact of Fund One in our per share FFO growth.

The average going in cap rate for Fund One was 6.2% at a purchase price of $175 per square foot, representing a 27% discount to estimated replacement cost. These assets today are yielding a current return to Parkway of nearly 9% when you include the asset management, property management and leasing and construction fees. Additionally, on a leverage-neutral basis, Fund One will contribute approximately $0.36 per diluted share in FFO on an annualized basis, which should continue to grow with further lease up potential. This is significant FFO accretion to Parkway and represents our highest capital allocation alternative.

At this time we'd like to point you to another chart on our website and in our annual report that shows the transformation of our assets under management. Please note from the shaded area on the chart that part of our asset base that is significantly growing is held jointly with other partners. This strategy has resulted in dramatic growth in our recurring fee income, which is also shown on this page. Now that Fund One is fully invested, we expect our total recurring fees to exceed $6 million related to Fund One, joint venture partnerships and third-party management contracts. When you add the incremental fees earned on our wholly owned portfolio, our total fee income is projected to exceed $13 million for 2008, which is approaching $1 per share in recurring FFO.

Additionally, these recurring fees are more resilient during a softening economy than cash flows from fee simple ownership due to the fixed nature of their calculation.

On the disposition front, we have recently completed the marketing effort for 111 East Wacker and 233 North Michigan buildings in Chicago. None of the offers received were acceptable to us, and we've decided to hold these assets in a fee simple format. In making this strategic decision, we note that these assets continue to do well as the combined occupancy of 233 and 111 is 92.2% and the property level NOI has grown from $29 million when purchased to $36 million projected for 2008.

In today's environment, Chicago should be recognized for its diverse economy and lack of exposure to any single industry. In the CBD, there is only 2.5% of the stock under construction and minimal deliveries in 2008, which combine to create an environment of stability and reasonable growth. Long-term trends continue to be positive, with expectations for additional population and job growth in Chicago as it takes advantage of its educational, transportation, infrastructure and other amenities to be a center for professional services. Our significant presence in Chicago complements our fund strategy, as our many recent discussions with partners indicate that they also view Chicago favorably due to its size, diversification and limited supply additions.

Additionally, these assets have in-place mortgages of approximately $248 million, of which $139 million mature in 2016 and $84 million matures in 2011, requiring no financing needs for the foreseeable future.

We are also in the market with several buildings that have been and are part of our normal asset recycling program. We have reassembled the smaller portfolios into fully and partially leased buildings and are aiming to recycle the fully leased assets in an orderly fashion during 2008.

We currently have four assets in the market. One of these assets, our Wachovia Plaza Building in St. Petersburg, Florida, received numerous offers last week and is going to the best and final offer next week. Any proceeds on sales will be used to reduce the company's leverage.

We remain reasonably optimistic about our fund type opportunities. Even with the difficulties in the CMBS market, assets under $150 million in size can still find sufficient and competitive underwriting for loan-to-value levels of 60% to 65%. For Parkway, this underwriting size and leverage point is well within our normal acquisition target. Since 2004 we have purchased 22 office properties for approximately $1.1 million at an average purchase price of approximately $48 million and leverage of around 60%. Even with spreads widening, the drop in Treasuries has offset most of the spread increase, thus making the blended debt rate still reasonable for our underwriting standards.

What does it all mean to us? In short, with the highly leveraged buyers being forced to the sideline given the foreseeable debt underwriting levels, we view the future as a good opportunity for Parkway to continue to grow through its fund-like investments.

Which really leads into what most of you probably saw last week in our press release regarding the Teacher Retirement System of Texas $263 million equity commitment to Parkway related to a second fund. Those negotiations are still ongoing, and we'll hopefully be able to discuss this opportunity with you in greater detail at a later date. What I can say today is that Parkway is making significant progress with a fund investment opportunity similar to our recently completed OPERS Fund One that, if completed, should provide the company solid FFO growth over the long term.

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

William R. Flatt

Thank you, Steve. I want to begin by complimenting our team on the successful completion of our Fund One investment with Ohio PERS. In finishing Fund One with our partner, we acquired 13 high quality assets in growing markets for approximately $500 million, and we're looking forward to growing those cash flows. These assets have provided solid returns to both OPERS and our shareholders. Every day that we operate well we lay the groundwork for future funds.

Our embedded growth has seen an increase from a negative $0.74 per square foot at the beginning of the gear up plan to a positive $1.30 per square foot at April 1, 2008, up 7.4% since January 1, 2008.

Our core portfolio performance was steady, and we've continued to push rents in many of our markets. Overall, portfolio rents improved 5% to $21.73 per square foot for the first quarter of 2008 and same-store rents also increased 2.1% to $21.58 per square foot over the same period. In addition to strong rental rate growth in our Houston market, our Phoenix, Atlanta, Memphis markets also experienced solid in-place rental rate growth of a combined 3.9% as compared to the prior year.

Portfolio average occupancy declined 10 basis points to 91% for the first quarter as compared to 91.1% for last year. Impacting portfolio occupancy are three buildings acquired in the first quarter as part of Fund One which have significant lease up opportunities with an average occupancy of 85%. Same-store average occupancy increased 70 basis points to 91.2% as compared to 90.5% for the first quarter of 2007.

Included in our supplemental package is a leasing status report showing leases that have been signed but have not yet occupied the space and will commence paying rent over the next few quarters. This is on Page 25. As of April 11, the percentage was 91.2% and included 33,000 square feet for the State of Tennessee in Nashville and 30,000 square feet in Chicago.

Rolling forward, for additional activities subsequent to this last leasing status report, the number would adjust forward to approximately 91.7% and is based on diverse leasing across the portfolio. This additional leasing includes a further expansion by the State of Tennessee of 7,000 square feet.

Other significant activity this quarter included an expansion of Morgan Keegan in Memphis at 26,000 square feet, bringing the Morgan Keegan tower to close to 100% occupancy. In Atlanta we executed a renewal with Cox Communications for 90,000 square feet at Peachtree Dunwoody Pavilion.

Customer retention for the quarter was 58%, primarily due to the First NLC bankruptcy representing approximately 50,000 square feet. Excluding this lease, our customer retention for the quarter would have been 63%. The total amount of space occupied by First NLC was 70,000 square feet. We were able to keep 20,000 square feet of customers that have been in place as subleases. Of the remaining 50,000 square feet of subsequent to quarter end, we've leased 10,000 square feet or approximately 20% of this space.

Although our customer base is diverse in terms of geography and type of business which helps mitigate risk in a softening economy, we continue to proactively monitor the credit quality of our mortgage, title, and homebuilding customers on a frequent basis.

Moving to same-store operations, our net operating income decreased approximately $260,000 or 0.9% in the first quarter as compared to the first quarter of 2007. On a cash basis, same-store net operating income increased approximately $450,000 or 1.5% for the first quarter of 2008 as compared to the prior year. Items affecting the increase in cash net operating income primarily include $875,000 of net lease termination fees, partially offset by approximately $420,000 of an increase in bad debt expense, including write offs of First NLC as well as several other small customers that have been hit hard by the credit crunch.

During the quarter we renewed or expanded 71 leases on 413,000 square feet at an average rent per square foot of $21.30 or a 1.8% increase and an average of $3.59 per square foot in annual leasing costs. Additionally, 27 new leases were signed in 87,000 square feet at an average rental rate of $21.57 per square foot and at a cost $4.32 per square foot in annual leasing costs.

In our web presentation we show the weighted average MPV of all leases signed during each quarter since January 2005 using a 9% discount rate. This schedule has been [hashed] to detail MPVs by lease type as well, and you'll note a 13.6% increase since January '05 to the first quarter of 2008 MPV of $6.58.

With that, I'd now like to turn the call over to Mitch Collins.

J. Mitchell Collins

Thanks, Will. I want to welcome everyone on the call today as the newest member of the Parkway team. I look forward to hopefully meeting most of you soon. Now let's move on to our operating results.

Our FFO for the first quarter of 2008 was $0.95 per diluted share as compared to $1.02 per diluted share in the prior year. As Steve previously discussed, for the quarter we had two unusual items that negatively affected FFO by approximately $1.1 million or $0.07 per diluted share. Excluding these unusual items, our FFO was in line with our expectations for the first quarter.

Approximately $660,000 of the unusual charge was a one-time adjustment related to an intangible purchase price allocation for three of our recently acquired assets. This adjustment is non-cash and non-recurring in nature. Additionally, we incurred approximately $400,000 in debt prepayment penalties related to retiring $3.5 million in mortgage debt that carried an interest rate of 8.25% per annum. Please see our press release and website for a detailed table of the information regarding the unusual and other items impacting FFO for this quarter as compared to last year.

Our FAD of $10.2 million for the three months ending March 31, 2008 covered the dividends that were paid of $9.8 million.

Non-revenue generating capital expenditures were approximately $940,000 or $0.07 per square foot for the quarter.

Customer improvement and leasing commissions totaled nearly $3.6 million for the quarter. Please note the chart on our web presentation which illustrates dividend coverage by our FAD.

On the balance sheet, I also recognize our need to reduce our debt to total market cap leverage to around 50% versus the 57% that exists today, and this is one of my primary goals. Even with this debt to total market cap, our modified fixed coverage ratio remained at 2.14 times for the quarter. In reducing leverage, I believe that this can be accomplished in reasonable order by disposing of assets under our normal asset recycling program and redeploying lesser amounts of capital into fund-type opportunities.

As Steve mentioned, on May 2, 2008 we completed a $60 million mortgage loan related to the refinance of a $42 million mortgage loan that was scheduled to mature in September. This loan was competitively bid and ultimately executed with Regions Bank and Compass Bank, two important lenders in our line of credit. This loan is secured by our Capitol City Plaza Building in Atlanta, Georgia. The interest rate on the loan is a variable rate based on LIBOR plus 165 basis points. The loan term is for two years, with a one-year extension option at the company's discretion. The excess loan proceeds of approximately $18 million were used to pay down our line of credit.

Additionally, for 2009 we have only $22 million of debt maturities related to three assets in Houston which are currently 97% leased and have a 2008 forecasted NOI of nearly $4.2 million.

On May 2, 2008 the company owed an estimated $238 million related to its $311 million line of credit. The company is in compliance with all covenants under the line of credit, and our line of credit does not mature until 2011, assuming that we exercise our one-year extension option. Based on the availability under our line of credit of nearly $45 million today, we can substantially complete an Ohio PERS fund-type investment while remaining in full compliance with our respective debt covenants.

Additionally, the only significant required capital outlay remaining for 2008 is the completion of our Pinnacle building project in Jackson at a remaining cost of $29 million, in which our financing is already in place and no additional funds will need to be borrowed from our line of credit.

In our outlook for 2008 we are reiterating the previously announced earnings outlook of FFO between $4 to $4.20 per diluted share. As we stated in our last conference call, we will not update guidance on a quarterly basis unless our internal projections are outside of the yearly range. The assumptions used in preparing the original outlook are listed on the website and in our press release dated November 26, 2007, and have been updated to include the acquisitions made during the first quarter. This guidance does not include any additional acquisitions, dispositions or fund-type investments.

Our internally measured NAV is $57 to [$44] per share based on a 7% to 8% range of cap rates, which we believe is reasonable based on what we're seeing in the market today.

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

Steven G. Rogers

Thank you, Mitch. We're very pleased to have Mitch Collins join our team, bringing new energy, expertise and teamwork to Parkway.

In closing, I believe we're on track to meet our 2008 goals. We are pleased to have refinanced our only significant debt maturity for '08. We're making good progress on Fund Two, and this strategy should provide significant FFO growth for our future.

Before opening up for questions, I'd like to invite each of you to attend our investor and analyst meeting in Atlanta, Georgia on May 21.

With that, we'll be happy to answer any questions you may have at this time.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Your first question comes from David Aubuchon - Robert W. Baird & Co.

David Aubuchon - Robert W. Baird & Co.

The market rent estimates that you provided in the supplemental for 2008 and 2009, how conservative do you believe those are and how comfortable, I guess, do you feel that those won't slide going forward?

Steven G. Rogers

What David is referring to is on Page 23 and 24 of our supplemental package. I think it's important to note how we calculate market rent and that we do not escalate market rent going forward. It is the rent that we're deriving at the building, either through signs, leases that are recent or executed leases in buildings adjacent of comparable quality to Parkway. We do not increase rent going forward, so if you're looking out at 9, 10, 11 and 12, then the market rent that we're showing you is the actual rent that is currently being received by the company today. We figure you can make your own determinations of whether that number goes up or down. We're just simply saying to the world, "This is what we're fetching today, and we're getting it."

David Aubuchon - Robert W. Baird & Co.

And do you care to provide any type of forward-looking commentary about what you're seeing in the market rent? I mean, have those changed materially from a quarter ago or two quarters ago?

William R. Flatt

They're actually up, and what we're seeing today is we are meeting it this quarter. All of the leases we signed, you know, met our embedded growth on average. And we haven't - those numbers continue to have upward pressure. Now, looking into the future, there's obviously folks knowing more about the economy than I do commenting on the future. We are, in our part of the world, still just seeing modest expansions.

I alluded to a roll forward of our leasing activity that would bump us up to almost 92% leased, and I named one lease, which was an additional 7,000 square feet, the State of Tennessee, bringing that total to 40,000. And it's actually pretty diverse across the portfolio and industry types. We have 6,000 feet here, 8,000 feet there, and I would say maybe deal time has increased slightly and decision-making, but we are not seeing great downward pressure on rental rates.

David Aubuchon - Robert W. Baird & Co.

And Will, how aggressive do you plan to be related to your 2009 expirations, because it's about 15% of your portfolio, obviously a larger expiration than typical?

William R. Flatt

Aggressive in getting them early or pushing rate?

David Aubuchon - Robert W. Baird & Co.

Yes.

William R. Flatt

Yes. I mean, we certainly - it depends on the market, but we are always actively trying to get out and mitigate that and never do we go into a year - if you look, it's 15% today; my guess is it'll be slightly mitigated downward by 2009. So we're always actively working the portfolio to extend those leases, and I'd say that there's an impetus to be more proactive today given just - as a conservative measure. So yes, we are obviously working all of those.

David Aubuchon - Robert W. Baird & Co.

And then in relation to the bullet point that you have in the first cover of your press release on the earnings, it talked about embedded rent growth of 7.4%, so is that related to the market rent estimates that you have in the supplemental or is that just an internal projection.

William R. Flatt

That would be the market rent estimates for the quarter.

Steven G. Rogers

From $1.21 to $1.30 per share, I mean, per square foot.

David Aubuchon - Robert W. Baird & Co.

And that's embedded?

Steven G. Rogers

We've got a chart of that on the website, Dave, if you'd like to take a look at that. What's the title of that chart? I guess, is it all under just - on the left hand column, Office Markets - take a look on the left-hand column of the web presentation, double click on Office Markets, and you'll see it was $1.21 at the end of last quarter. It's $1.30 today, and that's the 74% increase.

David Aubuchon - Robert W. Baird & Co.

And, I'm sorry, that is what? That is what you're projecting right now?

Steven G. Rogers

That would be the current expiring cash rent at the building today versus the rent that we can fetch from the marketplace today. It's a real-time snapshot of the delta between the expiring cash rent and real rent that we can get.

David Aubuchon - Robert W. Baird & Co.

And looking at that same chart, you also see the slide just given from the last recession. Steve, what do you believe  how shallow or how deep do you think this cycle is going to be relative to the last?

Steven G. Rogers

I'm looking at that. I think it's always illustrative to go back to this chart and remind ourselves that we are in a cyclical business, and that chart sort of bottomed out for the office guys somewhere around '03 and '04. You know, we sort of declared that the economy was out of a recession shortly after we went into it in late '01. I think [in] '02, the government had said we were out of a recession. Office guys tend to go into the recession later, tend to come out of it later.

So by recession standards, I thought the last one was pretty painful, to be honest with you. I mean, 1991 was my worst in my life. I guess the Great Depression was worse than that. I thankfully wasn't alive then. But this guy doesn't feel bad yet. It feels like it's very financially oriented, Dave. There's a lot of concern in the financial world. It doesn't appear to be driven as across the board yet. The job losses, while they are there, have yet to have been felt deeply in Middle America. So I think the jury's still out on sort of what to expect here.

We're just calling it a softening right now. We've not experienced it yet in the company, but there is a softening taking place out there.

William R. Flatt

And I would add to that, since we've been sort of seeing this turn, we've gotten the question of where do you think it's going? Where do you think it'll go back to? And the only - the best metric that we've, as far as being a good rate predictor, that we've hypothesized is looking forward and saying replacement cost. And if you look at replacement cost today versus replacement cost the last time we hit a peak, there's a significant increase.

So if I were going to just try to find some metric to create a forward-looking projection, if I only had one I'd probably pick replacement cost rents in office buildings and then sort of look to create a new sort of peak and valley from that.

David Aubuchon - Robert W. Baird & Co.

A second question, I guess, related to the fund. The last couple of acquisitions exceeded the maximum for the fund. Is there any particular reason why that occurred, or did that just - those assets just kind of lined up with the investment parameters of that fund and you just happened to feel that those were good investments? That's kind of Part A, why is that happening or is that an inefficient part of the market, then B, is the next fund going to see a larger maximum, I guess.

Steven G. Rogers

The first part of your question is, specifically, Desert Ridge was $80 million, $82 million, and the maximum in our OPERS agreement was $80 million, so a very minor adjustment. And we elected to make that additional incremental investment because we felt like it was a good investment.

The Citicorp Plaza Building was $100 million. We made the additional $20 million investment for the same reason, that we felt like it was a good investment and, when looked at, weighted for the $80 million going into the fund and the $20 million being fee simple, it met all of our buying criteria and financial objectives.

So that's just sort of a normal thing to have happen, Dave. While we do have full discretion or have full discretion in OPERS, it's always discretion within a box. And the box is defined by geography, office type and size, and we honored that discretionary box.

It's hard to guess going forward because I'd get a little bit into, you know, the marketing effort that we're going through, and I think it's just premature for me to comment on Fund Two. I think I'm on record saying we've made significant and meaningful progress with Fund Two, and I think you all would expect a very detailed and thorough announcement from us giving all of that type information when and if the fund is complete.

David Aubuchon - Robert W. Baird & Co.

My last question has to do with your leverage and your stated goal of getting that down to 50%. Since your stock price obviously has a big component of that, do you think it's more realistic to focus on fixed charge coverage and kind of what are your goals there?

Steven G. Rogers

Okay, I'm going to - I do is the short answer. I'm going to let Mitch Collins, as our new chief financial officer, answer that one, and then I'll add some color if necessary from my perspective.

J. Mitchell Collins

Yes, to your point, I mean, the drop in the debt to market cap has been a reflection of the stock price decline really over the last two quarters and we don't believe is indicative of where we're headed from a financial standpoint. You know, we talked about the capacity on the line that exists today.

We also talked about several of the assets that are in play in the market, but I think we would point to our modified fixed coverage charge as the more relative measure. That's on Page 3 of 26 of the supplemental package. And you can see that over this period from March of last year through 3/31/08, the modified fixed coverage charge has remained relatively flat. It's moved about 14 bips from 2.28 at 3/31/07, and I think that's the more meaningful measure, how we're trying to manage, you know, our interest and our coverage ratios versus the market cap, debt to market cap, that we put in the press release.

Steven G. Rogers

The only thing I would add is that you've got a chart of that under the balance sheet section under the webcast which sort of shows a graphic depiction of those coverage ratios, and they've been pretty flat for the last four or five quarters.

So my take, Dave, is just all I really want to kind of go on and let you know is that I feel like that we should reduce short-term debt. I just feel like it's a responsible thing to do and I'm committed to it. And it's something we talk about a lot. We know why we've lifted debt up, why we did, and we did it for a good reason, we say good high MPV projects and felt like that's precisely why we have a line of credit is to fund high MPV projects in the fund.

Now that we've done that and we're making good progress on Fund Two, then our challenge is just to fund our future, which is the kind of challenges we enjoy. We're funding very high MPV, very highly accretive projects going forward, and that's really where we need to be.

David Aubuchon - Robert W. Baird & Co.

So just to be clear, so you're comfortable with where the fixed charge coverage is now; you just want to have a little bit less short-term debt?

Steven G. Rogers

Well, I'd like for the fixed charge coverage ratio to be higher, okay? And so it's going to require a combination of two things. One, we've got to get our NOI and our EBITDA up a little bit. In other words, we've got to do a little better operationally. That's the numerator effect.

The denominator effect is the amount of debt that we have on the balance sheet, and it's specifically fixed short-term debt. I just simply feel like that we ought to pay some down. So as we go through the normal asset recycling process, we've got four assets in the market today. They're smaller, kind of more manageable assets. I think those should be applied to short-term debt, and then we can draw back on that line as necessary to fund Fund Two.

J. Mitchell Collins

And I guess the other point is, too, on potential asset sales, you're collecting, you know, 100% of the proceeds today and you're redeploying. Using the Ohio PERS example, you're only putting 25% of the required capital out the door so over time that leverage should drop as you're selling and recycling certain assets and redeploying capital at a lesser amount into high MPV projects.

Operator

Your next question comes from Richard Anderson - BMO Capital Markets.

Richard Anderson - BMO Capital Markets

Just on the recurring fees, someone mentioned $13 million total fees but that includes - this is a wholly owned portfolio, right? It's six and change that's outside of the wholly owned portfolio?

Steven G. Rogers

That is correct.

Richard Anderson - BMO Capital Markets

So in terms of the wholly owned portfolio, I mean, that's a wash on your income statement, correct?

Steven G. Rogers

Well, it's a wash but it does - it is cash flow to us in the sense that we're not paying it out to a third party. We net it against G&A as just sort of the GAAP treatment of the matter, so we do account to you for this because it was one of our goals in the gear up plan.

Richard Anderson - BMO Capital Markets

But in terms of its benefit to the bottom line, it's basically zero, right?

Steven G. Rogers

It's a wash in that sense.

Richard Anderson - BMO Capital Markets

In terms of the same store, I mean, I guess when I look at some of the figures for the quarter, occupancy maybe dipped a little but you have some embedded rent growth that you're enjoying. Why would it be - can you do the math for me why NOI, same-store NOI on a GAAP basis actually declined during the quarter? How did that happen?

J. Mitchell Collins

On a same-store basis?

Richard Anderson - BMO Capital Markets

Yes.

William R. Flatt

A couple of things. Some of the adjustments that Mitch and Steve alluded to are flowing through the GAAP income statement, and I'd say that's the most material so if you translate that to the cash, you see that most of those wash out.

Richard Anderson - BMO Capital Markets

And so did you provide what - I'm sorry, I might have missed it - but have you changed anything about your same-store outlook for the future?

William R. Flatt

We have not.

Richard Anderson - BMO Capital Markets

And you don't change it despite the fact that, you know, the job picture has gotten materially worse in the past three months?

William R. Flatt

Well, you know, it depends on what markets you're looking at. And I would say again that I know that those are the expectations, and while we can opine to you - again, the folks on the phone see a lot more than we do - we can opine to you the leasing we're seeing in our markets, which, you know, we never had just sort of tremendous volume. We're just still seeing steady expansion in new leasing, Rich, as measured by 6,000 feet, 15,000 feet, and so we see no reason to change our outlook on the future.

Steven G. Rogers

If we do, we'll be happy - you know, if our outlook carries us outside of the 4 to 420 range, we will update you on that and give you that in a public disclosure.

Richard Anderson - BMO Capital Markets

And last question, I guess maybe this one is for Steve, you mentioned that, you know, this one doesn't feel as bad as others, and you called '91 the worst ever for you in your lifetime. But what has been the track record about peer rates of job loss in the country? Does it typically take longer to materialize in the middle of the country in your markets or do you have any sort of historical perspective on how job loss progresses throughout the country?

Steven G. Rogers

Well, it's funny, Rich. Each one has been different. I can go back to the 80s, where the job loss was greatly disproportionate to my part of the world, mainly based on the oil and gas, you know, meltdown in the price of oil going from $36 a barrel to $8 a barrel in one year, in 1984. That was very ugly for the oil patch - Houston, Dallas, Oklahoma, New Orleans, some places we were invested back in those days. It was an extraordinarily disproportionate recession for where we sat.

'91 was kind of a unified recession in that it just took everybody down equally. It was principally driven by a confluence of events of the FIRREA, the change in the Tax Act of 1986, overbuilding all across the United States, and a complete meltdown in the financial markets as a result of the wasting of S&Ls from the FIRREA Act. So that one I think was the worst as measured by vacancy. Vacancy rate got up to 21% on a national level, and I still use vacancy kind of as the proxy for how good or bad a recession is.

This last recession the vacancy rate went up to 16% or 17%, but it was a very disproportionate recession. The East and West Coast really didn't feel it, just to be perfectly honest. In fact, Manhattan, you know, didn't feel it at all. Yet the middle part of the United States felt it tremendously, and it was disproportionately heavier in kind of the noncoastal markets than I ever recall.

I'm not trying to make a prediction about this current one as much as we're just saying that the softening that we see here, read about, talk to daily appears to have picked more on the Coastal zones than the middle part of America where we are invested because we're still seeing reasonable leasing activity. And so that's kind of what we're basing our assumption on.

William R. Flatt

And with some exception, you know, we don't have the same confluence of massive supply delivery at the same time we're going into recession. This recession's caused by other factors. And so, having been a leasing agent in 2001 in Chicago, you know we had massive supply and job loss and sort of retraction of demand from sublease space, and we're just not seeing that, you know, with the exception of Phoenix, which seems to be having supply delivery at the same time of contraction. You know, we're not seeing that across our markets.

Richard Anderson - BMO Capital Markets

Can you comment on subleased space? How has that changed over the past three months, if at all?

Steven G. Rogers

I really haven't noticed any significant amount of sublease space. I'm looking around the table, checking the body language. Nobody here really - and we're just not feeling it, Rich.

William R. Flatt

Phoenix has got some.

Steven G. Rogers

Phoenix would be an exception to that. We're just not feeling it yet. We're not saying it's not out there. We're respectful of the impact of a macroeconomic recession. I'm very respectful of it. It's just we hadn't gotten it yet.

Operator

Your next question comes from [Craig Melman] - Keybanc Capital Markets.

Craig Melman - Keybanc Capital Markets

Can you guys give us an update on the Neighbors and DHL lease expirations in '08? Then also have you had any conversations with the Federal Home Loan Bank, Forman Perry, Schlumberger about their option to cancel?

William R. Flatt

Sure. Happy to take those. The first is Neighbors had an in place right to extend that they've exercised, and that lease now is extended out for another year. DHL, we are in progress, discussions with and feel, you know, we've had that for a long time, feel good about that renewal. So that, for those not familiar, that's a Houston, Texas lease that is in November of this year. So we've taken care of Neighbors, which was in December; DHL, we're in discussions and feel good about.

The other customers, what was your question?

Craig Melman - Keybanc Capital Markets

Perry, Schlumberger and Federal Home Loan Bank Board.

William R. Flatt

Federal Home Loan Bank's has expired, I think. It's passed. And part of one of the things you see this quarter is we actually took some space back from Federal Home Loan Bank, and it's in vacancy today. And we've released it to a group called the Monitor Company, and extended that lease. So we've really, in part, tried to help Federal Loan Bank restructure some of the space they gave back and have done that, so that one has passed.

And the other, there are no indication of anything immediately.

Steven G. Rogers

The only I know of Forman Perry, which is a 160,000 square foot lease here in Jackson, Mississippi, is that, you know, we feel good about them. They're a law firm with whom we do business, and we're not really  have any indications of any change there.

And, of course, Schlumberger in Houston, Houston is without question our strongest market if not the best market in America, don't know if they'll do anything but, if they do do something, it's in the market that we like the best.

Craig Melman - Keybanc Capital Markets

And on Neighbors, was there any step up in the extension?

William R. Flatt

There was. I don't have it in front of me. There was an OTI and I think, let's say, call it at least a 3% step up.

Craig Melman - Keybanc Capital Markets

Then could you guys just bridge the gap between the 91% average lease as of the end of the quarter and, I guess, the 92.9% that you put out in your initial guidance? I know it was more backend loaded, I think 93.5% in the second half, but could you just kind of bridge how you're going to get there from the 91%?

William R. Flatt

Sure. The first thing I would put out is that I think there's about 70 basis points due to vacancy that we purchased, so leasing opportunity we purchased through the fund. When we put out those occupancy numbers, those are consolidated so it includes our wholly owned and our fund. So I think there is - that accounts for part of it.

You know, this quarter we did mention that we lost 50,000 square feet of First NLC, and so to get back to where we said we would be, I mentioned in the call notes on page - I may have said Page 25; it's Page 29, which is the leasing activity report. I'm sorry, this is my old - it is page - the leasing activity report.

Steven G. Rogers

Page 25 of 26 in the supplemental.

William R. Flatt

And if you look, we've got 127,000 feet pending. I mentioned, you know, two of those that you can get your hands around, which is 33,000 feet in Nashville, an additional 30,000 feet in Chicago. A big portion of that is the space I mentioned we took back from Federal Home Loan.

And sort of subsequent to that, we published this as of April 11. If you were to roll that forward to what we'll have on May 11, then we've seen additional leasing that really got that number up to 91.8%. So there's some leasing that is in place and done that's carried forward to the end of the year that keeps us in line with - we have some leasing to do that's speculative, but I'd say versus prior years, we have good opportunity for doing what we said we're going to do.

Steven G. Rogers

I would also add to that, if I may, Craig, that the amount of lease up, if you call it ramp or ramp up, if you will, is the least amount of ramp we've had probably in five years. That was done in November, looking forward into a year when we did expect it to be a softening economy. So while 91 to 92 point something does seem - it certainly upward in projecting, it is the least amount of upward projecting number that we've projected in five years.

Craig Melman - Keybanc Capital Markets

Then was there anything in management income? It looked like it dipped sequentially from about - it looked like it was down about $100,000? We thought that might tick up now that the fund is fully invested.

Steven G. Rogers

You're talking about on a net basis?

Craig Melman - Keybanc Capital Markets

Yes. I think it was about $8,000 net versus $108,000 last quarter.

William R. Flatt

There are some corporate allocations that go into management company expense, and so I think that - I don't know if we have the chart up - we have a recurring fee chart on our website, and so I think if you look at that breakdown you should follow those fees a little more closely in terms of how they're broken out. And so, no, there's no reduction in any one item. There'd be an expense allocation. And I would draw your attention - that's also in the supplemental  to that fee chart that breaks out property management, asset management, and other fees by type and by ownership and follow the change in that.

Craig Melman - Keybanc Capital Markets

So you would expect it to come back up next quarter more to the normalized rate?

William R. Flatt

I think so.

Steven G. Rogers

We're not sure we can answer that.

William R. Flatt

Not sure I can answer that exactly.

Craig Melman - Keybanc Capital Markets

You guys had mentioned Chicago; you kind of shelved it because of pricing. How far off from expectations were the offers?

Steven G. Rogers

You know, we obviously have that answer, Craig, and I just - I'd prefer just to leave that one where we've put it out today. We went through a good, fully marketed process here. We did receive offers. It's just a matter of the strategic decision that we made was based on its best for us to hold this asset fee simple going forward, given everything I know today about it, and I'd prefer not to get into any individual pricing discussion on it.

Operator

Your next question comes from [David Shimus] - Citigroup.

David Shimus - Citigroup

Regarding the Chicago assets again, just want to confirm, so we can't really assume that these assets will be sold anytime soon over the next couple of years?

William R. Flatt

Correct.

David Shimus - Citigroup

And I may have missed this, but for the lease term fees in this quarter, where did they come from?

William R. Flatt

The biggest was related to Federal Home Loan Bank. Again, it was partial take back, and so that would be the biggest number. And part of that's going to be used to fund OTI for the Monitor Group, which will show up probably next quarter. And the balance are pretty small.

David Shimus - Citigroup

And how long should that space be vacant?

William R. Flatt

Well, if you go, again, back to Page 25 of the supplemental, it's the 19,245 square feet showing commencing in the third quarter at 111 East Wacker.

David Shimus - Citigroup

Regarding the assets that were purchased in Phoenix and Orlando, given the housing weakness in those markets what made you pursue those assets?

Steven G. Rogers

The decision to purchase in a market is broader than any one, you know, quarter or couple of quarters worth of negative news or positive news, for that matter. You know, we believe that Phoenix and Orlando represent very good growth markets for the very long term, David, and that's the reason that we made the purchases.

We're not blind to the fact that the housing market has slowed down in both of those markets. That's a fact. But it doesn't weigh very heavily on a long-term decision as we invest our money for Parkway or for a partner that has a 10 to 12 time horizon. It just is baked into the overall decision of where we want to be for the long term, you know, in our company and with our partners.

Operator

Your next question comes from Jason Payne - Morgan Keegan.

Jason Payne - Morgan Keegan

Real quick maintenance question is all I've got left. I missed what you guys said was the average going and cap rate for all the Fund One purchases?

J. Mitchell Collins

6.2%

Steven G. Rogers

6.2% for the fund and with the fees that Parkway derives from asset management and leasing, etc., it's approaching 9% for Parkway.

Operator

Your next question comes from Mitchell Germain - Banc of America Securities.

Mitchell Germain - Banc of America Securities

Steve, you had mentioned, I guess, four assets for sale. Am I not mistaken? One was in St. Petersburg.

Steven G. Rogers

That is correct.

Mitchell Germain - Banc of America Securities

Have you provided details on the other couple of assets that you're marketing right now?

Steven G. Rogers

We really haven't, but since each of the assets that we're currently marketing has a teaser out in the marketplace or a full-blown marketing package, I have no objection to exposing those today since I think if you're on a broker's mailing list, one would receive those anyway.

The four assets are Wachovia Plaza in St. Petersburg, Florida. Our strategic reason for putting it on the market is that is a single building in the market, and we've tried very hard to accumulate more assets there and have just been unable to do so over time.

The second asset is part of the Columbia, South Carolina portfolio. It's known as Capitol Center. It's a very high quality asset in Columbia, and it is in the process of getting its bids this week, so we're reasonably optimistic there.

The third building is Town Point Center. Town Point Center is located in Virginia Beach, downtown. It is a very high quality, class A asset, but a strategic reason for going forward with this is that we have just determined that that particular market would be best done in a joint venture or sale format for Parkway going forward.

And the last asset is the Buckhead building in Atlanta, Georgia - Buckhead location in Atlanta - which is the Capitol City Plaza Building. I get that one mixed up sometimes with Capitol Center. And it has just recently had a teaser go out on it into the marketplace, in fact, just two weeks ago.

Mitchell Germain - Banc of America Securities

And then the other assets that were slated for sale in Virginia and Columbia, I guess the goal is to continue to work on lease up prior to marketing them for sale?

William R. Flatt

Yes, sir. What we learned from last year  '07 was an awkward year for everyone out trying to sell assets  is that no one in '07 after the meltdown in the early part of the year would pay for lease up, where people in '06 and early '07 would pay for lease up. So if you had any, you could sell it in '06 and you couldn't in '07.

The other thing that we gleaned is that very large pools of assets that had heretofore sold better really sold worse. Size was your enemy, especially if it were items large enough that it had to get a CMBS loan, which clearly, that market is challenged and it makes it much rougher.

So what we decided to do after spending some time in that in '07 is to divide our portfolio into fully leased assets that were smaller and to break down even the smaller portfolios in Columbia and Richmond and Virginia Beach into individual assets. And while that is a manual labor exercise we're going to go through, we are still committed to going through a strategic asset recycling of most of those assets as the market will allow us to do so in the remainder of '08. And if we need to carry it into '09, then so be it. I mean, you know, the gear up plan is only an artificial date. We just look really more to cycles and things like that, but that's what we'll do.

Mitchell Germain - Banc of America Securities

Just talking about some of the markets, I guess you guys have done a pretty good job, you know, talking about the rent potential. Are there any markets, well, that you guys are seeing of moving, I guess, a negative moving in TIs or commissions, leasing costs, I guess?

William R. Flatt

We have not. I think decision time has been the metric that we've looked at as a negative move, and then, you know, Phoenix, I mentioned we wanted to get a little ahead of. And if anything, you know, Houston, we're still seeing very positive growth in rental rates and erosion of TI and people taking space as is. And so as we sit here today - now next quarter may come back and [inaudible] exactly what we're seeing, but I think we're just not seeing any concessions increasing.

Operator

(Operator Instructions) Your last question comes from Stephanie Krewson - Janney Montgomery Scott LLC.

Stephanie Krewson - Janney Montgomery Scott LLC

I have a couple more technical accounting questions which I'll spare the broader listening audience. Mitch, do you mind circling back with me after the call?

J. Mitchell Collins

Sure.

Stephanie Krewson - Janney Montgomery Scott LLC

Thanks. Just to stick to more fundamental things and forgive me if I missed this. I had to get out of my office a couple times on a couple of other calls going on today. Of the $1 million lease termination fee, how much of that was in your consolidated NOI number or was it all in there?

Steven G. Rogers

It was all of it.

J. Mitchell Collins

That's all. That's our allocable share.

Stephanie Krewson - Janney Montgomery Scott LLC

And then why did you retire the debt on your Houston, Texas assets or are you, I mean, that's something I would do if I were preparing to sell an asset as a concession to a buyer.

Steven G. Rogers

Well, it has an economic payback to it. We took an 8.25% interest rate, which we felt like was a little high at the time that we paid them off and moved it over to 4.5%, and that allowed for close to a 300 basis point margin pick up which, you know, hopefully improves our profit. In other words, it amortizes the prepayment penalty reasonably quickly.

Stephanie Krewson - Janney Montgomery Scott LLC

And then obviously the fine was an actual cash fine?

Steven G. Rogers

That's correct. Yes, they do fine you these days on these insurance company loans, and felt like that was a reasonable fine to pay in light of the pick up.

Stephanie Krewson - Janney Montgomery Scott LLC

Your G&A, are you still expecting around $7.5 million to $7.8 million for the year?

Steven G. Rogers

I think that's a good run rate. Anybody? Okay.

Stephanie Krewson - Janney Montgomery Scott LLC

And then there was a - in terms of your guidance, I'm looking at your first quarter guidance in your press release versus where you were in the fourth quarter, why the big increase in your depreciation and amortization guidance? That's just an adjustment I don't typically see.

J. Mitchell Collins

It's predominantly closing the assets we had projected to close to finish out Fund One in the middle of the year, Stephanie, and we closed them out early. That's the majority of that increase. So you had depreciation going up and you had some interest going up.

Operator

Thank you, and at this time we have no further questions. I'd like to turn it back over to Steve Rogers for any closing remarks.

Steven G. Rogers

Well, thank you very much for your attendance and listening today. We appreciate your support, and we'll close out and get back to work. Thank you.

Operator

Thank you. That concludes today's conference. We appreciate your participation. You may now disconnect.

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Source: Parkway Properties, Inc. Q1 2008 Earnings Call Transcript
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