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PKY > SEC Filings for PKY > Form 10-Q on 5-Nov-2012All Recent SEC Filings

Show all filings for PARKWAY PROPERTIES INC

Form 10-Q for PARKWAY PROPERTIES INC


5-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Overview

Parkway is a self-administered real estate investment trust ("REIT") specializing in the ownership of quality office properties in higher growth submarkets in the Sunbelt region of the United States. At October 1, 2012, Parkway owns or has an interest in 39 office properties located in nine states with an aggregate of approximately 10.1 million square feet of leasable space.
Fee-based real estate services are offered through wholly owned subsidiaries of the Company, which in total manage and/or lease approximately 11.6 million square feet for third-party owners at October 1, 2012. Unless otherwise indicated, all references to square feet represent net rentable area.

Occupancy. Parkway's revenues are dependent on the occupancy of its office buildings. At October 1, 2012, occupancy of Parkway's office portfolio was 89.6% compared to 87.4% at July 1, 2012 and 84.4% at October 1, 2011. Not included in the October 1, 2012 occupancy rate is the impact of 13 signed leases totaling 81,000 square feet expected to take occupancy between now and the first quarter of 2013, of which the majority will commence during the fourth quarter of 2012. Including these signed leases, the Company's portfolio was 90.4% leased at October 1, 2012. The Company's average occupancy for the three months and nine months ended September 30, 2012 was 88.1% and 86.2%, respectively, and Parkway currently projects an average annual occupancy range of 85.5% to 86.5% during 2012 for its office properties and ending occupancy of 88.0% to 88.5%.
To combat rising vacancy, Parkway utilizes innovative approaches to produce new leases. These include the Broker Bill of Rights, a short-form service agreement and customer advocacy programs that are models in the industry and have historically helped the Company maintain occupancy over time.

During the third quarter of 2012, 65 renewal, expansion and new leases were signed totaling 439,000 rentable square feet. Included in this total were 35 renewal leases totaling 253,000 rentable square feet at an average rent per square foot of $21.88, representing a 8.8% rate of decrease from the expiring rate, and at an average cost of $2.75 per square foot per year of the lease term. During the nine months ended September 30, 2012, 207 renewal, expansion and new leases were signed totaling 1.2 million rentable square feet. Included in this total were 109 renewal leases totaling 631,000 rentable square feet at an average rent per square foot of $21.13, representing a 9.1% rate decrease from the expiring rate, and at an average cost of $2.17 per square foot per year of the lease term.

During the third quarter of 2012, 10 expansion leases were signed totaling 62,000 rentable square feet at an average rent per square foot of $25.49 and at an average cost of $5.53 per square foot per year of the lease term. During the nine months ended September 30, 2012, 33 expansion leases were signed totaling 131,000 rentable square feet at an average rent per square foot of $23.50 and at an average cost of $5.00 per square foot per year of the lease term.

During the third quarter of 2012, 20 new leases were signed totaling 124,000 rentable square feet at an average rent per square foot of $19.73 and at an average cost of $3.78 per square foot per year of the term. During the nine months ended September 30, 2012, 65 new leases were signed totaling 440,000 rentable square feet at an average rent per square foot of $20.89 and at an average cost of $5.05 per square foot per year of the term.

Rental Rates. An increase in vacancy rates in a market or at a specific property has the effect of reducing market rental rates. Inversely, a decrease in vacancy rates in a market or at a specific property has the effect of increasing market rental rates. Parkway's leases typically have three to seven year terms, though the Company does enter into leases with terms that are either shorter or longer than that typical range from time to time. As leases expire, the Company seeks to replace the existing leases with new leases at the current market rental rate. For Parkway's properties owned as of October 1, 2012, management estimates that it has approximately $0.59 per square foot in rental rate embedded loss in its office property leases. Embedded loss is defined as the difference between the weighted average in-place cash rents including operating expense reimbursements and the weighted average estimated market rental rate.

Customer Retention. Keeping existing customers is important as high customer retention leads to increased occupancy, less downtime between leases, and reduced leasing costs. Parkway estimates that it costs five to six times more to replace an existing customer with a new one than to retain the existing customer. In making this estimate, Parkway takes into account the sum of revenue lost during downtime on the space plus leasing costs, which typically rise as market vacancies increase. Therefore, Parkway focuses a great amount of energy on customer retention. Parkway seeks to retain its customers by continually focusing on operations at its office properties. The Company believes in providing superior customer service; hiring, training, retaining and empowering each employee; and creating an environment of open communication both internally and externally with customers and stockholders. Over the past ten years, Parkway maintained an average 65% customer retention rate. Parkway's customer retention rate was 76.0% for the quarter ended September 30, 2012, as compared to 63.2% for the quarter ended June 30, 2012, and 45.4% for the quarter ended September 30, 2011.

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Business Objective and Operating Strategies

Our business objective is to maximize long-term stockholder value by generating sustainable cash flow growth and increasing the long-term value of our real estate assets. We intend to achieve this objective by executing on the following business and growth strategies:

Create Value as the Leading Owner of Quality Assets in Core Sunbelt Submarkets. Our investment strategy is to pursue attractive returns by focusing primarily on owning high-quality office buildings and portfolios that are well-located and competitively positioned within central business district and urban infill locations within our core submarkets in the Sunbelt region of the United States. We also seek to pursue value-add investment opportunities on a limited basis, for example by acquiring under-leased assets at attractive purchase prices and increasing occupancy at those assets over time, to complement the balance of the core portfolio. Further, we intend to pursue an efficient capital allocation strategy that maximizes the returns on our invested capital. This may include selectively disposing of properties when we believe returns have been maximized and redeploying capital into acquisitions or other opportunities.

Maximize Cash Flow by Continuing to Enhance the Operating Performance of Each Property. We provide property and asset management and leasing services to our portfolio, actively managing our properties and leveraging our customer relationships to improve operating performance, maximize long-term cash flow and enhance stockholder value. By developing an ownership plan for each of our properties and then continually managing our properties to those plans throughout our ownership, we seek to attain a favorable customer retention rate by providing outstanding property management and customer service programs responsive to the varying needs of our diverse customer base. We will also employ a judicious prioritization of capital projects to focus on projects that enhance the value of a property through increased rental rates, occupancy, service delivery, or enhanced reversion value.

Realize Leasing and Operational Efficiencies and Gain Local Advantage. We expect to concentrate our real estate portfolio in submarkets where we believe that we can maximize market penetration by accumulating a critical mass of properties and thereby enhance operating efficiencies. We believe that strengthening our local presence and leveraging our extensive market relationships will yield superior market information and service delivery and facilitate additional investment opportunities to create long-term stockholder value.

Joint Ventures and Partnerships

Management views investing in wholly owned properties as the highest priority of our capital allocation. However, the Company intends to selectively pursue joint ventures if and when we determine that such a structure will allow us to reduce anticipated risks related to a property or portfolio or to address unusual operational risks. Under the terms of these joint ventures and partnerships, where applicable, Parkway will seek to manage all phases of the investment cycle including acquisition, financing, operations, leasing and dispositions. The Company will seek to receive fees for providing these services.

At September 30, 2012, Parkway had one partnership structured as a discretionary fund.

Parkway Properties Office Fund II, L.P. ("Fund II"), a $750.0 million discretionary fund, was formed on May 14, 2008 and was fully invested at February 10, 2012. Fund II was structured such that Teacher Retirement System of Texas ("TRST") would be a 70% investor and Parkway a 30% investor in the fund, with an original target capital structure of approximately $375.0 million of equity capital and $375.0 million of non-recourse, fixed-rate first mortgage debt. Fund II acquired 13 properties totaling 4.2 million square feet in Atlanta, Charlotte, Phoenix, Jacksonville, Orlando, Tampa and Philadelphia. In August 2012, Fund II increased its investment capacity by $20.0 million to purchase Hayden Ferry Garage, a 2,500 space parking garage, a 21,000 square foot office property and a vacant parcel of development land, all adjacent to Hayden Ferry I and Hayden Ferry II in Phoenix.

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Parkway serves as the general partner of Fund II and provides asset management, property management, leasing and construction management services to the fund, for which it is paid market-based fees. Cash will be distributed pro rata to each partner until a 9% annual cumulative preferred return is received and invested capital is returned. Thereafter, 56% will be distributed to TRST and 44% to Parkway. The term of Fund II will be seven years from the date the fund was fully invested, or until February 2019, with provisions to extend the term for two additional one-year periods at the discretion of Parkway.

As previously disclosed, the Company entered into an agreement to sell its interest in Parkway Properties Office Fund, L.P. ("Fund I"), which included 13 office properties totaling 2.7 million square feet to its existing partner in the fund for a gross sales price of $344.3 million. As of July 1, 2012, the Company has completed the sale of all Fund I assets. Parkway received approximately $14.2 million in net proceeds for the completed sales of the Fund I assets, and the proceeds were used to reduce amounts outstanding under the Company's credit facilities. Upon sale, the buyer assumed a total of $292.0 million in mortgage loans, of which $82.4 million was Parkway's share.

Financial Condition

Comments are for the balance sheet dated September 30, 2012 compared to the balance sheet dated December 31, 2011.

Office and Parking Properties. In 2012, Parkway continued the execution of its strategy of operating and acquiring office properties as well as liquidating non-core assets that no longer meet the Company's investment criteria or that the Company has determined value will be maximized by selling. During the nine months ended September 30, 2012, total assets decreased $52.0 million or 3.2%.

Acquisitions and Improvements. Parkway's investment in office and parking properties increased $330.7 million net of depreciation to a carrying amount of $1.3 billion at September 30, 2012 and consisted of 38 office and parking properties and excluded properties classified as held for sale. The primary reason for the increase in office and parking properties relates to the purchase of four office properties.

On January 11, 2012, Fund II purchased The Pointe, a 252,000 square foot office building located in the Westshore submarket of Tampa, Florida. The gross purchase price for The Pointe was $46.9 million and Parkway's ownership share is 30%. Parkway's equity contribution of $7.0 million was funded through availability under the Company's senior unsecured revolving credit facility

On February 10, 2012, Fund II purchased Hayden Ferry Lakeside II ("Hayden Ferry II"), a 300,000 square foot Class A+ office building located in the Tempe submarket of Phoenix and directly adjacent to Hayden Ferry Lakeside I ("Hayden Ferry I") which was purchased by Fund II in the second quarter of 2011. The gross purchase price was $86.0 million and Parkway's ownership share is 30%.
Parkway's equity contribution of $10.8 million was funded through availability under the Company's senior unsecured revolving credit facility. This investment in Hayden Ferry II completed the investment period of Fund II.

On June 6, 2012, Parkway purchased Hearst Tower, a 972,000 square foot office tower located in the central business district of Charlotte, North Carolina.
The gross purchase price was $250.0 million. The purchase of Hearst Tower was financed with proceeds received from the investment in the Company by TPG VI Pantera Holdings L.P., (together with its affiliates, ("TPG")) combined with borrowings on the Company's credit facility. For more information on TPG's investment see Note M.

On August 31, 2012, Parkway purchased a 2,500 space parking garage, a 21,000 square foot office building and a vacant parcel of developable land (collectively the "Hayden Ferry Garage"), all adjacent to Parkway's currently owned Hayden Ferry I and Hayden Ferry II assets in Tempe, Arizona. The gross purchase price was $18.2 million on behalf of Fund II. Fund II increased its investment capacity to pursue the purchase, and Parkway's share in this investment is 30%. Parkway's equity contribution of $5.5 million was funded using the Company's revolving credit facility.

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During the nine months ended September 30, 2012, the Company capitalized building improvements of $19.3 million and recorded depreciation expense of $36.4 million related to its office and parking properties.

Dispositions. During the nine months ended September 30, 2012, the Company completed a significant portion of its previously disclosed dispositions as part of its strategic objective of becoming a leading owner of high-quality office assets in higher growth markets in the Sunbelt. As previously disclosed, the Company entered into an agreement to sell its interest in 13 office properties totaling 2.7 million square feet owned by Fund I to its existing partner in the fund for a gross sales price of $344.3 million. As of December 31, 2011, Parkway had completed the sale of 9 of these 13 assets. During the nine months ended September 30, 2012, the Company completed the sale of the remaining four Fund I assets totaling 770,000 square feet. Upon sale, the buyer assumed a total of $292.0 million in mortgage loans, of which $82.4 million was Parkway's share. Parkway received net proceeds for the sale of the Fund I assets of $14.2 million, which were used to reduce amounts outstanding under the Company's credit facilities. Additionally, during the nine months ended September 30, 2012, the Company completed the sale of the 15 properties included in its strategic sale of a portfolio of non-core assets, for a gross sales price of $147.7 million and generating net proceeds to Parkway of approximately $94.3 million, with the buyer assuming $41.7 million in mortgage loans upon sale, of which $31.9 million was Parkway's share. The 15 assets that were sold include five assets in Richmond, four assets in Memphis, and six assets in Jackson. The Company completed the sale of three additional assets during the nine months ended September 30, 2012, including the sale of 111 East Wacker, a 1.0 million square foot office property located in Chicago, the Wink building, a 32,000 square foot office property in New Orleans, Louisiana, and Falls Pointe, a 107,000 square foot office property located in Atlanta and owned by Parkway Properties Office Fund II, L.P. ("Fund II") for a gross sales price of $157.4 million. Parkway received approximately $4.8 million in net proceeds from these sales, which were used to reduce amounts outstanding under the Company's revolving credit facility. In connection with the sale of 111 East Wacker, the buyer assumed a $147.9 mortgage loan upon sale.

Mortgage Loans. In connection with the previous sale of One Park Ten, the Company had seller-financed a $1.5 million note receivable that bore interest at 7.3% per annum on an interest-only basis through maturity in June 2012. On April 2, 2012, the borrower prepaid the note receivable and all accrued interest in full.

On April 10, 2012, the Company transferred its rights, title and interest in the B participation piece (the "B piece") of a first mortgage secured by an 844,000 square foot office building in Dallas, Texas known as 2100 Ross. The B piece was purchased at an original cost of $6.9 million in November 2007. The B piece was originated by Wachovia Bank, N.A., a Wells Fargo Company, and had a face value of $10.0 million, a stated coupon rate of 6.1% and a scheduled maturity in May 2012. During 2011, the Company recorded a non-cash impairment loss on the mortgage loan in the amount of $9.2 million, thereby reducing its investment in the mortgage loan to zero. Under the terms of the transfer, the Company is entitled to certain payments if the transferee is successful in obtaining ownership of 2100 Ross or if the transferee is successful in obtaining payment on the amount due on the note receivable. During the third quarter of 2012, the transferee successfully obtained ownership of 2100 Ross and as a result the Company received a $500,000 payment which is classified as recovery of losses on mortgage loan receivable and other assets in the Company's Consolidated Statements of Operations and Comprehensive Income.

Intangible Assets, Net. For the nine months ended September 30, 2012, intangible assets net of related amortization increased $18.4 million or 19.2% and was primarily due to the purchase of four office properties.

Cash and Cash Equivalents. Cash and cash equivalents decreased $21.6 million or 28.8% during the nine months ended September 30, 2012 and is primarily due to equity contributions from Fund II limited partners received during 2011 for the purchase of office properties which closed during the first quarter of 2012, offset against proceeds from the $125 million unsecured term loan. Parkway's proportionate share of cash and cash equivalents at September 30, 2012 and December 31, 2011 was $30.1 million and $25.8 million, respectively.

Assets Held for Sale and Liabilities Related to Assets Held for Sale. For the nine months ended September 30, 2012, assets held for sale decreased $375.8 million or 98.2% and liabilities related to assets held for sale decreased $285.2 million or 99.9%. For a complete discussion of assets and liabilities held for sale, please reference "Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations - Discontinued Operations."

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Notes Payable to Banks. Notes payable to banks decreased $7.3 million or 5.5% during the nine months ended September 30, 2012. At September 30, 2012, notes payable to banks totaled $125.0 million and the net decrease is attributable to payments on the senior unsecured revolving credit facility from proceeds received from the sale of office properties, proceeds received from the issuance of common stock and Series E Cumulative Convertible preferred stock, offset by borrowings to fund the Company's proportionate share of four office property purchases as well as proceeds received from the placement of a $125 million unsecured term loan.

On March 30, 2012, the Company entered into an Amended and Restated Credit Agreement with a consortium of eight banks for its $190 million senior unsecured revolving credit facility. Additionally, the Company amended its $10 million working capital revolving credit facility under substantially the same terms and conditions, with the combined size of the facilities remaining at $200 million (collectively, the "New Facilities"). The New Facilities provide for modifications to the existing facilities by, among other things, extending the maturity date from January 31, 2014 to March 29, 2016, with an additional one-year extension option with the payment of a fee, increasing the size of the accordion feature from $50 million to as much as $160 million, lowering applicable interest rate spreads and unused fees, and modifying certain other terms and financial covenants. The interest rate on the New Facilities is based on LIBOR plus 160 to 235 basis points, depending on overall Company leverage (with the current rate set at 210 basis points). Additionally, the Company pays fees on the unused portion of the New Facilities ranging between 25 and 35 basis points based upon usage of the aggregate commitment (with the current rate set at 35 basis points). Wells Fargo Securities, LLC and Merrill Lynch, Pierce, Fenner & Smith Incorporated acted as Joint Lead Arrangers and Joint Book Runners on the senior facility. In addition, Wells Fargo Bank, N.A. acted as Administrative Agent and Bank of America, N.A. acted as Syndication Agent.
KeyBank, N.A., PNC Bank, N.A. and Royal Bank of Canada all acted as Documentation Agents. Other participating lenders include JPMorgan Chase Bank, Trustmark National Bank, and Seaside National Bank and Trust. The working capital revolving credit facility was provided solely by PNC Bank, N.A.

On September 27, 2012, the Company closed a $125 million unsecured term loan.
The term loan has a maturity date of September 27, 2017, and has an accordion feature that allows for an increase in the size of the term loan to as much as $250 million. Interest on the term loan is based on LIBOR plus an applicable margin of 150 to 225 basis points depending on overall Company leverage (with the current rate set at 150 basis points.) The term loan has substantially the same operating and financial covenants as required by the Company's current unsecured revolving credit facility. Keybanc Capital Markets, Inc. and Merrill Lynch, Pierce, Fenner & Smith Incorporated acted as Joint Lead Arrangers and Joint Bookrunners on the term loan. In addition, Keybank National Association acted as Administrative Agent; Bank of America, N. A. acted as Syndication Agent; and Wells Fargo Bank, National Association acted as Documentation Agent.
Other participating lenders include Royal Bank of Canada, PNC Bank, National Association, U. S. Bank National Association, and Trustmark National Bank.

On October 10, 2012, the Company exercised $25 million of the $160 million accordion feature of its existing unsecured revolving credit facility which matures in March 2016 and increased capacity from $190 million to $215 million with the additional borrowing capacity being provided by U.S. Bank National Association, bringing the total number of participating lenders to nine. The interest rate on the credit facility is currently LIBOR plus 160 basis points.
Other terms and conditions under the credit facility remain unchanged.

Mortgage Notes Payable. During the nine months ended September 30, 2012, mortgage notes payable increased $51.4 million or 10.3% and is due to the placement of non-recourse mortgage loans on two Fund II properties totaling $73.5 million, offset by the payoff of one mortgage loan in the amount of $16.3 million and scheduled principal payments of $5.8 million.

On January 11, 2012, in connection with the purchase of The Pointe in Tampa, Florida, Fund II obtained a $23.5 million non-recourse first mortgage loan, which matures in February 2019. The mortgage has a fixed rate of 4.0% and is interest only for the first 42 months of the term.

On February 10, 2012, Fund II obtained a $50.0 million non-recourse mortgage loan, of which $15.0 million is Parkway's share, secured by Hayden Ferry II, a 300,000 square foot office property located in the Tempe submarket of Phoenix, Arizona. The mortgage loan matures in July 2018 and bears interest at LIBOR plus the applicable spread which ranges from 250 to 350 basis points over the term of the loan. In connection with this mortgage, Fund II entered into an interest rate swap that fixes LIBOR at 1.5% through January 25, 2018, which equates to a total interest rate ranging from 4.0% to 5.0%. The mortgage loan is cross-collateralized, cross-defaulted, and coterminous with the mortgage loan secured by Hayden Ferry I.

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On March 9, 2012, the Company repaid a $16.3 million non-recourse mortgage loan secured by Bank of America Plaza, a 337,000 square foot office property in Nashville, Tennessee. The mortgage loan had a fixed rate of 7.1% and was scheduled to mature in May 2012. The Company repaid the mortgage loan using available proceeds under the senior unsecured revolving credit facilities.

The Company expects to continue seeking primarily fixed-rate, non-recourse mortgage financing with maturities from five to ten years typically amortizing over 25 to 30 years on select office building investments as additional capital is needed. The Company monitors a number of leverage and other financial metrics defined in the loan agreements for the Company's senior unsecured revolving credit facility and working capital unsecured credit facility, which include but are not limited to the Company's total debt to total asset value.
In addition, the Company monitors interest, fixed charge and modified fixed charge coverage ratios as well the net debt to earnings before interest, taxes, depreciation and amortization ("EBITDA") multiple. The interest coverage ratio is computed by comparing the cash interest accrued to EBITDA. The fixed charge coverage ratio is computed by comparing the cash interest accrued, principal payments made on mortgage loans and preferred dividends paid to EBITDA. The modified fixed charge coverage ratio is computed by comparing cash interest accrued and preferred dividends paid to EBITDA. The net debt to EBITDA multiple is computed by comparing Parkway's share of net debt to EBITDA computed for the current quarter as annualized and adjusted pro forma for any completed investment activity. Management believes all of the leverage and other financial metrics it monitors, including those discussed above, provides useful information on total debt levels as well as the Company's ability to cover interest, principal and/or preferred dividend payments. The Company currently targets a net debt to EBITDA multiple of 5.5 to 6.5 times.

Accounts Payable and Other Liabilities. For the nine months ended September 30, 2012, accounts payable and other liabilities decreased $10.5 million or 11.6% and is primarily due to the decrease in contingent consideration related to the Eola purchase for which 1.8 million operating partnership units ("OP units") were issued during the first quarter of 2012 offset by an increase in property tax payable and valuation allowances on interest rate swaps.

On December 30, 2011, Parkway and the former Eola principals amended certain post-closing provisions of the contribution agreement to provide, among other things, that if the Management Company achieved annual revenues in excess of the original 2011 target, all OP Units subject to the 2011 earn-out, the 2012 earn-out and the earn-up will be deemed earned and paid when the 2011 earn-out . . .

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