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HIW > SEC Filings for HIW > Form 10-Q on 30-Oct-2012All Recent SEC Filings

Show all filings for HIGHWOODS PROPERTIES INC

Form 10-Q for HIGHWOODS PROPERTIES INC


30-Oct-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The Company is a fully integrated, self-administered and self-managed equity REIT that provides leasing, management, development, construction and other customer-related services for our properties and for third parties. The Company conducts virtually all of its activities through the Operating Partnership. The Operating Partnership is managed by the Company, its sole general partner. At September 30, 2012, we owned or had an interest in 333 in-service office, industrial and retail properties, encompassing approximately 34.1 million square feet, which includes one office property under development encompassing 228,000 square feet and a 12.5% interest in a 261,000 square foot office property directly owned by the Company (not included in the Operating Partnership's Consolidated Financial Statements); five for-sale residential condominiums and a 215-unit rental residential property under development. We are based in Raleigh, North Carolina, and our properties and development land are located in Florida, Georgia, Missouri, North Carolina, Pennsylvania, South Carolina, Tennessee and Virginia. Additional information about us can be found on our website at www.highwoods.com. Information on our website is not part of this Quarterly Report.

You should read the following discussion and analysis in conjunction with the accompanying Consolidated Financial Statements and related notes contained elsewhere in this Quarterly Report.

Disclosure Regarding Forward-Looking Statements

Some of the information in this Quarterly Report may contain forward-looking statements. Such statements include, in particular, statements about our plans, strategies and prospects under this section. You can identify forward-looking statements by our use of forward-looking terminology such as "may," "will," "expect," "anticipate," "estimate," "continue" or other similar words. Although we believe that our plans, intentions and expectations reflected in or suggested by such forward-looking statements are reasonable, we cannot assure you that our plans, intentions or expectations will be achieved. When considering such forward-looking statements, you should keep in mind the following important factors that could cause our actual results to differ materially from those contained in any forward-looking statement:

the financial condition of our customers could deteriorate;

we may not be able to lease or release second generation space, defined as previously occupied space that becomes available for lease, quickly or on as favorable terms as old leases;

we may not be able to lease our newly constructed buildings as quickly or on as favorable terms as originally anticipated;

we may not be able to complete development, acquisition, reinvestment, disposition or joint venture projects as quickly or on as favorable terms as anticipated;

development activity by our competitors in our existing markets could result in an excessive supply of office, industrial and retail properties relative to customer demand;

our markets may suffer declines in economic growth;

unanticipated increases in interest rates could increase our debt service costs;

unanticipated increases in operating expenses could negatively impact our operating results;

we may not be able to meet our liquidity requirements or obtain capital on favorable terms to fund our working capital needs and growth initiatives or to repay or refinance outstanding debt upon maturity; and

the Company could lose key executive officers.

This list of risks and uncertainties, however, is not intended to be exhaustive. You should also review the other cautionary statements we make in "Item 1A. Business - Risk Factors" set forth in our 2011 Annual Report on Form 10-K. Given these uncertainties, you should not place undue reliance on forward-looking statements. We undertake no obligation to publicly release the results of any revisions to these forward-looking statements to reflect any future events or circumstances or to reflect the occurrence of unanticipated events.


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Executive Summary

Our Strategic Plan focuses on:

owning high-quality, differentiated real estate assets in the better submarkets in our core markets;

improving the operating results of our existing properties through concentrated leasing, asset management, cost control and customer service efforts;

developing and acquiring office properties in key infill submarkets that improve the overall quality of our portfolio and generate attractive returns over the long-term for our stockholders;

selectively disposing of properties no longer considered to be core assets primarily due to location, age, quality and overall strategic fit; and

maintaining a conservative, flexible balance sheet with ample liquidity to meet our funding needs and growth prospects.

While we own and operate a limited number of industrial, retail and residential properties, our operating results depend heavily on successfully leasing and operating our office properties. Economic growth and employment levels in our core markets are and will continue to be important determinative factors in predicting our future operating results.

The key components affecting our rental and other revenues are average occupancy, rental rates, new developments placed in service, acquisitions and dispositions. Average occupancy generally increases during times of improving economic growth, as our ability to lease space outpaces vacancies that occur upon the expirations of existing leases. Average occupancy generally declines during times of slower economic growth, when new vacancies tend to outpace our ability to lease space. Asset acquisitions, dispositions and new developments placed in service directly impact our rental revenues and could impact our average occupancy, depending upon the occupancy rate of the properties that are acquired, sold or placed in service. A further indicator of the predictability of future revenues is the expected lease expiration schedule of our portfolio. As a result, in addition to seeking to increase our average occupancy by leasing current vacant space, we also must concentrate our leasing efforts on renewing leases on expiring space.

Whether or not our rental revenue tracks average occupancy proportionally depends upon whether rents under new leases signed are higher or lower than the rents under the previous leases. Annualized rental revenues from second generation leases signed during any particular year are generally less than 15% of our total annual rental revenues. During the third quarter of 2012, we leased 0.9 million square feet of second generation office space, defined as space previously occupied under our ownership that becomes available for lease or acquired vacant space, with a weighted average term of 5.8 years. On average, tenant improvements for such leases were $14.66 per square foot, lease commissions were $4.80 per square foot and rent concessions were $3.27 per square foot. Annualized GAAP rents under such office leases were $20.91 per square foot, or 2.4% higher than under previous leases.

We strive to maintain a diverse, stable and creditworthy customer base. We have an internal guideline whereby customers that account for more than 3% of our revenues are periodically reviewed with the Company's Board of Directors. Currently, no customer accounts for more than 3% of our revenues other than the Federal Government, which accounted for 7.2% of our revenues on an annualized basis, as of September 30, 2012.

Our expenses primarily consist of rental property expenses, depreciation and amortization, general and administrative expenses and interest expense. From time to time, expenses also include impairments of assets held for use. Rental property expenses are expenses associated with our ownership and operation of rental properties and include expenses that vary somewhat proportionately to occupancy levels, such as common area maintenance and utilities, and expenses that do not vary based on occupancy, such as property taxes and insurance. Depreciation and amortization is a non-cash expense associated with the ownership of real property and generally remains relatively consistent each year, unless we buy, place in service or sell assets, since we depreciate our properties and related building and tenant improvement assets on a straight-line basis over a fixed life. General and administrative expenses, net of amounts capitalized, consist primarily of management and employee salaries and other personnel costs, corporate overhead and long-term incentive compensation.


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We intend to maintain a conservative and flexible balance sheet that allows us to capitalize on favorable development and acquisition opportunities as they arise. As of September 30, 2012, our mortgages and notes payable represented 43.0% of the undepreciated book value of our assets. We expect this ratio to remain under 50% during the remainder of 2012.

Results of Operations

Three Months Ended September 30, 2012 and 2011

Rental and Other Revenues

Rental and other revenues from continuing operations were $10.9 million, or 9.3%, higher in the third quarter of 2012 as compared to 2011 primarily due to recent acquisitions, which accounted for $11.8 million of the increase. In addition, same property revenues were $0.6 million higher in the third quarter of 2012 as compared to 2011 primarily due to a slight increase in same property average occupancy and annualized GAAP rents per square foot from 90.0% and $18.72, respectively, in the third quarter of 2011 to 90.4% and $18.73, respectively, in the third quarter of 2012 and higher operating expense recoveries. These increases were partly offset by lower construction income of $1.7 million. We expect rental and other revenues for the remainder of 2012, adjusted for any future acquisitions, to be higher compared to 2011 primarily due to the contribution of recent acquisitions and slightly higher average occupancy in our same property portfolio.

Operating Expenses

Rental property and other expenses were $3.2 million, or 7.3%, higher in the third quarter of 2012 as compared to 2011 primarily due to recent acquisitions, which accounted for $5.0 million of the increase, partly offset by $1.7 million lower cost of construction income. In addition, same property operating expenses were $0.5 million lower in the third quarter of 2012 as compared to 2011 primarily due to lower real estate taxes. We expect rental property and other expenses for the remainder of 2012, adjusted for any future acquisitions, to be higher compared to 2011 primarily due to the contribution of recent acquisitions.

Operating margin, defined as rental and other revenues less rental property and other expenses expressed as a percentage of rental and other revenues, was higher at 63.2% in the third quarter of 2012 as compared to 62.5% in 2011. Operating margin is expected to be similar for the remainder of 2012 as compared to 2011.

Depreciation and amortization was $3.6 million, or 10.3%, higher in the third quarter of 2012 as compared to 2011 primarily due to recent acquisitions, which accounted for $4.0 million of the increase. We expect depreciation expense for the remainder of 2012, adjusted for any future acquisitions, to be higher compared to 2011 for a similar reason as stated above.

Impairments of assets held for use was $2.4 million lower in the third quarter of 2012 as compared to 2011 primarily due to the impairment of two office properties located in Orlando, FL in the third quarter of 2011 which resulted from a change in the assumed timing of future dispositions. Impairments can arise from a number of factors; accordingly, there can be no assurances that we will not be required to record additional impairment charges in the future.

General and administrative expenses were $2.5 million, or 20.4%, lower in the third quarter of 2012 as compared to 2011 primarily due to lower acquisition costs which accounted for $3.6 million of the decrease, partly offset by higher salaries and incentive compensation and by higher deferred compensation expense caused by changes in valuation which is fully offset by a corresponding adjustment from higher values of the related segregated assets recorded in interest and other income. We expect general and administrative expenses for the remainder of 2012, adjusted for any future acquisitions, to be similar to 2011.

Interest Expense

Interest expense was $0.7 million, or 2.7%, lower in the third quarter of 2012 as compared to 2011 primarily due to lower average debt balances, average interest rates and financing obligation interest expense and higher capitalized interest. We anticipate interest expense will decrease for the remainder of 2012 as compared to 2011 for similar reasons as stated above.

Gains on Disposition of Investment in Unconsolidated Affiliates

Gains on disposition of investment in unconsolidated affiliates was $2.3 million lower in the third quarter of 2012 as compared to 2011 due to our partner exercising its option to acquire our 10.0% equity interest in one of our unconsolidated joint ventures in 2011.


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Net Gains on Disposition of Discontinued Operations

Net gains on disposition of discontinued operations were $20.4 million higher in the third quarter of 2012 as compared to 2011 due to higher disposition activity.

Nine Months Ended September 30, 2012 and 2011

Rental and Other Revenues

Rental and other revenues from continuing operations were $42.6 million, or 12.6%, higher in the nine months ended September 30, 2012 as compared to 2011 primarily due to recent acquisitions, which accounted for $36.5 million of the increase. In addition, same property revenues were $7.2 million higher in the nine months ended September 30, 2012 as compared to 2011 primarily due to an increase in same property average occupancy and annualized GAAP rents per square foot from 89.9% and $18.52, respectively, in the nine months ended September 30, 2011 to 90.7% and $18.75, respectively, in the nine months ended September 30, 2012, higher operating expense recoveries and higher net termination fees. These increases were partly offset by lower construction income of $1.7 million.

Operating Expenses

Rental property and other expenses were $15.8 million, or 12.9%, higher in the nine months ended September 30, 2012 as compared to 2011 primarily due to recent acquisitions, which accounted for $16.5 million of the increase, partly offset by $1.7 million lower cost of construction income. In addition, same property operating expenses were $0.4 million higher in the nine months ended September 30, 2012 as compared to 2011 primarily due to higher repairs and maintenance costs, partly offset by lower utilities and real estate taxes.

Operating margin, defined as rental and other revenues less rental property and other expenses expressed as a percentage of rental and other revenues, was lower at 63.9% in the nine months ended September 30, 2012, as compared to 64.0% in 2011.

Depreciation and amortization was $16.1 million, or 16.2%, higher in the nine months ended September 30, 2012 as compared to 2011 primarily due to recent acquisitions, which accounted for $14.2 million of the increase.

Impairments of assets held for use was $2.4 million lower in the nine months ended September 30, 2012 as compared to 2011 primarily due to the impairment of two office properties located in Orlando, FL in the third quarter of 2011 which resulted from a change in the assumed timing of future dispositions.

General and administrative expenses were $0.3 million, or 1.1%, higher in the nine months ended September 30, 2012 as compared to 2011 primarily due to lower acquisition and dead deal costs, offset by higher salaries and incentive compensation and by higher deferred compensation expense caused by changes in valuation which is fully offset by a corresponding adjustment from higher values of the related segregated assets recorded in interest and other income.

Interest Expense

Interest expense was $1.2 million, or 1.7%, higher in the nine months ended September 30, 2012 as compared to 2011 primarily due to higher average debt balances, partly offset by lower average interest rates and financing obligation interest expense.

Gains on Disposition of Investment in Unconsolidated Affiliates

Gains on disposition of investment in unconsolidated affiliates was $2.3 million lower in the nine months ended September 30, 2012 as compared to 2011 due to our partner exercising its option to acquire our 10.0% equity interest in one of our unconsolidated joint ventures in 2011.

Equity in Earnings of Unconsolidated Affiliates

Equity in earnings of unconsolidated affiliates was $1.3 million lower in the nine months ended September 30, 2012 as compared to 2011 primarily due to our share of impairments of real estate assets on two office properties in our DLF I joint venture in 2011.


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Net Gains on Disposition of Discontinued Operations

Net gains on disposition of discontinued operations were $26.9 million higher in the nine months ended September 30, 2012 as compared to 2011 due to higher disposition activity.

Dividends on Preferred Stock and Excess of Preferred Stock Redemption/Repurchase Cost Over Carrying Value

Dividends on Preferred Stock were $2.0 million lower in the nine months ended September 30, 2012 as compared to 2011 and excess of Preferred Stock redemption/repurchase cost over carrying value was $1.9 million lower in the nine months ended September 30, 2012 as compared to 2011 due to the redemption of all remaining Series B Preferred Shares in 2011.


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Liquidity and Capital Resources

Overview

Our goal is to maintain a conservative and flexible balance sheet with access to multiple sources of debt and equity capital and sufficient availability under our revolving credit facility. We generally use rents received from customers to fund our operating expenses, capital expenditures and distributions. To fund property acquisitions, development activity or building renovations and repay debt upon maturity, we may use current cash balances, sell assets, obtain new debt and/or issue equity. Our debt generally consists of mortgage debt, unsecured debt securities and borrowings under our revolving credit facility.

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