Overview

Parkway is a self-administered and self-managed REIT specializing in the acquisition, operation, leasing and ownership of office properties. The Company is geographically focused on the Southeastern and Southwestern United States and Chicago. At October 1, 2009, Parkway owned or had an interest in 65 office properties located in 11 states with an aggregate of approximately 13.4 million square feet of leasable space. Included in the portfolio are one discretionary fund and several partnership arrangements which encompass 21 properties totaling 3.9 million square feet, representing 28.8% of the portfolio. With the discretionary fund and/or partnerships, the Company receives fees for asset management, property management, leasing and construction management services and potentially receives incentive fees upon sale if certain investment targets are achieved. Increasing the number of co-investments, and consequently the related fee income, is part of the Company's strategy to transform itself to an operator-owner versus an owner-operator. The strategy capitalizes on the Company's strength in providing excellent service in the operation and acquisition of office properties for investment clients in addition to its direct ownership of real estate assets. Fee-based real estate services are offered through the Company's wholly owned subsidiary, Parkway Realty Services LLC, which also currently manages and/or leases approximately 1.3 million square feet for third party owners. The Company generates revenue primarily by leasing office space to its customers and providing management and leasing services to third party office property owners (including joint venture interests). The primary drivers behind Parkway's revenues are occupancy, rental rates and customer retention.

Occupancy. Parkway's revenues are dependent on the occupancy of its office buildings. At October 1, 2009, occupancy of Parkway's office portfolio was 88.3% compared to 88.7% at July 1, 2009 and 90.4% at October 1, 2008. Not included in the October 1, 2009 occupancy rate are 23 signed leases totaling 133,000 square feet, which commence during the fourth quarter of 2009 through the first quarter of 2010 and will raise Parkway's percentage leased to 89.3%. 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 which are models in the industry and have helped the Company maintain occupancy around 90% during a time when the national occupancy rate is approximately 82.8%. Parkway currently projects an average annual occupancy range of approximately 89.0% to 89.5% during 2009 for its office properties.

Rental Rates. An increase in vacancy rates has the effect of reducing market rental rates and vice versa. Parkway's leases typically have three to seven year terms. As leases expire, the Company replaces the existing leases with new leases at the current market rental rate. At October 1, 2009, Parkway had $0.60 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 and the weighted average 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 customer. In making this estimate, Parkway takes into account the sum of revenue lost during downtime on the space plus leasing costs, which rise as market vacancies increase. Therefore, Parkway focuses a great deal of energy on customer retention. Parkway's operating philosophy is based on the premise that it is in the customer retention business. 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 72.5% customer retention rate. Parkway's customer retention rate was 58.0% for the quarter ending September 30, 2009, as compared to 68.8% for the quarter ending June 30, 2009, and 66.7% for the quarter ending September 30, 2008. Customer retention for the nine months ended September 30, 2009, and September 30, 2008, was 61.0% and 71.5%, respectively.

Discretionary Funds. On July 6, 2005, Parkway, through affiliated entities, entered into a limited partnership agreement forming a $500.0 million discretionary fund with Ohio PERS ("Ohio PERS Fund I") for the purpose of acquiring high-quality multi-tenant office properties. Ohio PERS is a 75% investor and Parkway is a 25% investor in the fund, which is capitalized with approximately $200.0 million of equity capital and $300.0 million of non-recourse, fixed-rate first mortgage debt. At February 15, 2008, the Ohio PERS Fund I was fully invested.

The Ohio PERS Fund I targeted properties with an anticipated leveraged internal rate of return of greater than 11%. Parkway serves as the general partner of the fund and provides asset management, property management, leasing and construction management services to the fund, for which it is paid market-based fees. After each partner has received a 10% annual cumulative preferred return and a return of invested capital, 20% of the excess cash flow will be paid to the general partner and 80% will be paid to the limited partners. Through its general partner and limited partner ownership interests, Parkway may receive a distribution of the cash flow equivalent to 40%. The term of Ohio PERS Fund I will be seven years until February 2015, with provisions to extend the term for two additional one-year periods.

On May 14, 2008, Parkway, through affiliated entities, entered into a limited partnership agreement forming a $750.0 million discretionary fund, known as Parkway Properties Office Fund II, L.P., ("Texas Teachers Fund II") with the Teacher Retirement System of Texas ("TRS") for the purpose of acquiring high-quality multi-tenant office properties. TRS is a 70% investor and Parkway is a 30% investor in the fund, which will be capitalized with approximately $375.0 million of equity capital and $375.0 million of non-recourse, fixed-rate first mortgage debt. Parkway's share of the equity contribution for the fund will be $112.5 million and will be funded with proceeds from asset sales, line of credit advances and/or sales of equity securities. The Texas Teachers Fund II targets acquisitions in the core markets of Houston, Austin, San Antonio, Chicago, Atlanta, Phoenix, Charlotte, Memphis, Nashville, Jacksonville, Orlando, Tampa/St. Petersburg, and other growth markets to be determined by Parkway.

The Texas Teachers Fund II targets properties with an anticipated leveraged internal rate of return of greater than 10%. Parkway serves as the general partner of the fund and provides asset management, property management, leasing and construction management services to the fund, for which it will be 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 TRS and 44% to Parkway. Parkway has four years, or through May 2012, to identify and acquire properties (the "Investment Period"), with funds contributed as needed to close acquisitions. Parkway will exclusively represent the fund in making acquisitions within the target markets and acquisitions with certain predefined criteria. Parkway will not be prohibited from making fee-simple or joint venture acquisitions in markets outside of the target markets, acquiring properties within the target markets that do not meet Texas Teachers Fund II's specific criteria or selling or joint venturing currently owned properties. The term of Texas Teachers Fund II will be seven years from the expiration of the Investment Period, with provisions to extend the term for two additional one-year periods at the discretion of Parkway.

Financial Condition

Comments are for the balance sheet dated September 30, 2009 compared to the balance sheet dated December 31, 2008.

Office and Parking Properties. In 2009, Parkway continued the execution of its strategy of operating and acquiring office properties, joint venturing interests in office assets, as well as liquidating non-core assets and office assets that no longer meet the Company's investment criteria or the Company has determined value will be maximized by selling. During the nine months ended September 30, 2009, total assets decreased $44.0 million or 2.6% and office and parking properties and real estate development (before depreciation) decreased $5.1 million or 0.3%.

Dispositions and Improvements. Parkway's investment in office and parking properties and real estate development decreased $45.9 million net of depreciation to a carrying amount of $1.4 billion at September 30, 2009, and consisted of 59 office and parking properties. The primary reason for the decrease in office and parking properties relates to the net effect of the building improvements, development costs, the sale of two office properties, and depreciation recorded during the period.

On February 20, 2009, the Company sold Lynnwood Plaza, an 82,000 square foot office property located in Hampton Roads, Virginia, for a gross sales price of $7.8 million. Parkway received net cash proceeds from the sale of $7.1 million, which were used to reduce amounts outstanding under the Company's line of credit. During the fourth quarter of 2008, the Company recognized an impairment loss of $1.1 million related to this property. Parkway Realty Services LLC, a subsidiary of the Company, was retained to provide management and leasing services for the property under a one-year agreement. Therefore, all revenue and expenses for this property are included as a component of continuing operations.

On June 1, 2009, the Company sold 1717 St. James Place, a 110,000 square foot office property located in Houston, Texas, for a gross sales price of $8.7 million, and Parkway received net cash proceeds from the sale of $8.4 million. Parkway Realty Services, LLC, a subsidiary of the Company, was retained to provide management and leasing services for the property under a one-year agreement. Therefore, all revenue and expenses for this property are included as a component of continuing operations.

During the nine months ended September 30, 2009, the Company capitalized building improvements and additional purchase expenses of $18.1 million and recorded depreciation expense of $50.4 million related to its office and parking properties.

Rents Receivable and Other Assets. For the nine months ended September 30, 2009, rents receivable and other assets decreased $6.5 million or 5.5%. The net decrease is primarily due to the decrease in escrow bank account balances, which was caused by the release of funds in connection with payment of property taxes and office property capital expenditures, the decrease in the receivables for insurance proceeds related to Hurricane Ike and amortization of existing capitalized lease commissions.

Intangible Assets, Net. For the nine months ended September 30, 2009, intangible assets net of related amortization decreased $12.7 million or 15.9% and was primarily due to the effect of amortization of the existing intangible assets for the period.

Cash and Cash Equivalents. For the nine months ended September 30, 2009, cash and cash equivalents increased $20.3 million, or 132.6% to a carrying amount of $35.6 million. The increase is primarily attributable to proceeds received from the sale of 1717 St. James Place in Houston, Texas and reimbursements received from escrow accounts.

Notes Payable to Banks. Notes payable to banks decreased $85.9 million or 46.2% during the nine months ended September 30, 2009. At September 30, 2009, notes payable to banks totaled $100.0 million and the net decrease is primarily attributable to proceeds received from the sale of Lynnwood Plaza in Hampton Roads, Virginia, the placement of a non-recourse first mortgage secured by two office buildings in Houston, Texas and the Company's common stock offering, offset by advances under the line of credit to make improvements to office properties and retire existing debt.

Mortgage Notes Payable. During the nine months ended September 30, 2009, mortgage notes payable decreased $13.3 million or 1.5% and is due to the net effect of scheduled principal payments on mortgages of $10.0 million, the retirement of existing mortgage debt of $21.8 million, and the placement of mortgage debt of $18.5 million.

On February 27, 2009, the Company paid off the mortgage note payable secured by 1717 St. James, 5300 Memorial and Town and Country office buildings in Houston, Texas, with a total principal balance of $21.8 million with advances under the Company's line of credit. The mortgage had an interest rate of 4.83% and was scheduled to mature on March 1, 2009. The mortgage represented the Company's only outstanding maturity in 2009.

On May 4, 2009, the Company placed an $18.5 million seven-year non-recourse first mortgage with a fixed interest rate of 7.6% per annum, and the proceeds were used to reduce borrowings under the line of credit. The mortgage is secured by two office buildings in Houston, Texas totaling 303,000 square feet.

The Company expects to continue seeking 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 the total debt to total asset value ratio as defined in the loan agreements for the $311.0 million unsecured line of credit. In addition to the total debt to total asset value ratio, the Company monitors interest, fixed charge and modified fixed charge coverage ratios and the 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 debt to EBITDA multiple is computed by comparing Parkway's share of total debt to EBITDA computed for a trailing 12-month period. Management believes the total debt to total asset value, interest coverage, fixed charge coverage, modified fixed charge coverage and the debt to EBITDA multiple provide useful information on total debt levels as well as the Company's ability to cover interest, principal and/or preferred dividend payments with current income.

The computation of the interest, fixed charge and modified fixed charge coverage ratios, the debt to EBITDA multiple and the reconciliation of net income (loss) to EBITDA is as follows for the nine months ended September 30, 2009 and 2008 (in thousands):

                                                                  Nine Months Ended
                                                                    September 30
                                                                2009           2008
                                                                     (Unaudited)
Net income (loss)                                             $  (1,424)    $    15,167
Adjustments to net income (loss):
Interest expense                                                 40,164          44,647
Amortization of financing costs                                   1,772           1,322
Prepayment expense - early extinguishment of debt                     -           2,153
Depreciation and amortization                                    68,701          68,532
Amortization of share-based compensation                          1,940           1,381
Net gain on real estate and involuntary conversion               (1,212)        (22,588)
Tax expense                                                           2               2
EBITDA adjustments - unconsolidated joint ventures                1,014             945
EBITDA adjustments - noncontrolling interest in real estate
partnerships                                                    (24,356)        (23,067)
EBITDA (1)                                                    $  86,601     $    88,494

Interest coverage ratio:
EBITDA                                                        $  86,601     $    88,494
Interest expense:
Interest expense                                              $  40,164     $    44,647
Capitalized interest                                                  -            601
Interest expense - unconsolidated joint ventures                    376             382
Interest expense - noncontrolling interest in real estate
partnerships                                                     (9,209)         (8,750)
Total interest expense                                        $  31,331     $    36,880
Interest coverage ratio                                            2.76            2.40

Fixed charge coverage ratio:
EBITDA                                                        $  86,601     $    88,494
Fixed charges:
Interest expense                                              $  31,331     $    36,880
Preferred dividends                                               3,600           3,600
Principal payments (excluding early extinguishment of debt)      10,083          10,481
Principal payments - unconsolidated joint ventures                  108              40
Principal payments - noncontrolling interest in real estate
partnerships                                                       (695)           (250)
Total fixed charges                                           $  44,427     $    50,751
Fixed charge coverage ratio                                        1.95            1.74

Modified fixed charge coverage ratio:
EBITDA                                                        $  86,601     $    88,494
Modified fixed charges:
Interest expense                                              $  31,331     $    36,880
Preferred dividends                                               3,600           3,600
Total modified fixed charges                                  $  34,931     $    40,480
Modified fixed charge coverage ratio                               2.48            2.19

Debt to EBITDA multiple:
EBITDA - trailing 12 months                                   $ 114,316     $   118,436
Mortgage notes payable                                        $ 856,232     $   860,034
Notes payable to banks                                          100,000         180,316
Adjustments for unconsolidated joint ventures                     9,648           9,768
Adjustments for noncontrolling interest in real estate
partnerships                                                   (215,891)       (216,672)
Parkway's share of total debt                                 $ 749,989     $   833,446
Debt to EBITDA multiple                                            6.56            7.04

(1) Parkway defines EBITDA, a non-GAAP financial measure, as net income before interest, income taxes, depreciation, amortization, losses on early extinguishment of debt and other gains and losses. EBITDA, as calculated by us, is not comparable to EBITDA reported by other REITs that do not define EBITDA exactly as we do.

The Company believes that EBITDA helps investors and Parkway's management analyze the Company's ability to service debt and pay cash distributions. However, the material limitations associated with using EBITDA as a non-GAAP financial measure compared to cash flows provided by operating, investing and financing activities are that EBITDA does not reflect the Company's historical cash expenditures or future cash requirements for working capital, capital expenditures or the cash required to make interest and principal payments on the Company's outstanding debt. Although EBITDA has limitations as an analytical tool, the Company compensates for the limitations by using EBITDA only to supplement GAAP financial measures. Additionally, the Company believes that investors should consider EBITDA in conjunction with net income and the other required GAAP measures of its performance and liquidity to improve their understanding of Parkway's operating results and liquidity.

Parkway views EBITDA primarily as a liquidity measure and, as such, the GAAP financial measure most directly comparable to it is cash flows provided by operating activities. Because EBITDA is not a measure of financial performance calculated in accordance with GAAP, it should not be considered in isolation or as a substitute for operating income, net income, or cash flows provided by operating, investing and financing activities prepared in accordance with GAAP. The following table reconciles EBITDA to cash flows provided by operating activities for the nine months ended September 30, 2009 and 2008 (in thousands):

                                                               Nine Months Ended
                                                                  September 30
                                                               2009         2008
 EBITDA                                                      $ 86,601      $ 88,494
 Amortization of above (below) market leases                      (98)          198
 Amortization of mortgage loan discount                          (447)         (380)
 Operating distributions from unconsolidated joint ventures       392           855
 Interest expense                                             (40,164)      (44,647)
 Prepayment expense - early extinguishment of debt                  -        (2,153)
 Tax expense                                                       (2)           (2)
 Change in deferred leasing costs                              (7,413)       (6,527)
 Change in receivables and other assets                         2,680         3,559
 Change in accounts payable and other liabilities               6,640         1,896
 Adjustments for noncontrolling interests                      16,848        15,933
 Adjustments for unconsolidated joint ventures                 (1,489)       (1,747)
 Cash flows provided by operating activities                 $ 63,548      $ 55,479

Equity. Total equity increased $57.3 million or 10.7 % during the nine months ended September 30, 2009, as a result of the following (in thousands):

                                                                       Increase
                                                                      (Decrease)
Net loss attributable to Parkway Properties, Inc.                     $    (1,424)
Net loss attributable to noncontrolling interest                           (7,508)
Net loss                                                                   (8,932)
Change in market value of interest rate swaps                               1,907
Comprehensive loss                                                         (7,025)
Common stock dividends declared                                           (19,042)
Preferred stock dividends declared                                         (3,600)
Shares issued through common stock offering                                84,457
Share-based compensation                                                    1,940
Shares withheld to satisfy tax withholding obligation on vesting of
restricted stock                                                              (42)
Share issued in lieu of Directors' fees                                        42
Net shares distributed from deferred compensation plan                        496
Contribution of capital by noncontrolling interest                             57
                                                                      $    57,283

On April 28, 2009, the Company sold 6.25 million shares of common stock to UBS Investment Bank at a gross offering price of $13.71 per share and a net price of $13.56 per share. The Company used the net proceeds of $84.5 million to reduce outstanding borrowings under the Company's line of credit and for general corporate purposes.

Results of Operations

Comments are for the three months and nine months ended September 30, 2009 compared to the three months and nine months ended September 30, 2008.

Net loss available to common stockholders for the three months ended September 30, 2009 was $2.8 million ($0.13 per basic common share) as compared to net income available to common stockholders of $18.5 million ($1.23 per basic common share) for the three months ended September 30, 2008. Net loss available to common stockholders for the nine months ended September 30, 2009 was $5.0 million ($0.27 per basic common share) as compared to net income available to common stockholders of $11.6 million ($0.77 per basic common share) for the nine months ended September 30, 2008. The primary reason for the decrease in net income available to common stockholders for the three months and nine months ended September 30, 2009 compared to the same periods for 2008 is due to the decrease in gain on sale of real estate from discontinued operations in the amount of $22.6 million, which is attributable to three assets sold in 2008. The decrease in gain as well as the discussion of other variances for income and expense items that comprise net loss available to common stockholders is discussed in detail below.

Office and Parking Properties. The analysis below includes changes attributable to same-store properties, acquisitions, development and dispositions of office properties. Same-store properties are consolidated properties that the Company owned for the current and prior year reporting periods, excluding properties classified as discontinued operations. At September 30, 2009, same-store properties consisted of 58 properties comprising 12.2 million square feet. One office property with 189,000 square feet was developed in 2008 and does not meet the definition for a same-store property for the three months ended September 30, 2009.

The following table represents revenue from office and parking properties for the three months and nine months ended September 30, 2009 and 2008 (in thousands):

                               Three Months Ended September 30                  Nine Months Ended September 30
                                                   Increase       %                              Increase       %
                            2009        2008      (Decrease)   Change       2009      2008      (Decrease)   Change
Revenue from office
and parking
  properties:
  Same-store            $     65,514  $  68,986 $      (3,472)   -5.0%    $ 190,152 $ 192,370 $      (2,218)   -1.2%
properties
  Properties acquired              -          -             -     0.0%        7,315     3,763         3,552    94.4%
in 2008
  Office property                963          -           963     0.0%        2,741         -         2,741     0.0%
development

. . .