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HIW > SEC Filings for HIW > Form 10-Q on 30-Apr-2013All Recent SEC Filings

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Form 10-Q for HIGHWOODS PROPERTIES INC


30-Apr-2013

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 March 31, 2013, we wholly owned: 303 in-service office, industrial and retail properties, comprising 30.1 million square feet; 649 acres of undeveloped land suitable for future development, of which 566 acres are considered core assets; and two office development properties. In addition, we owned interests (50.0% or less) in 31 in-service office properties, a rental residential development property and 11 acres of undeveloped land suitable for future development, which includes 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). 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 2012 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 key infill business districts 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 business districts 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, levels of cost recovery income, 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 expirations 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. For more information regarding our lease expirations, see "Item 2. Properties - Lease Expirations" in our 2012 Annual Report. Our occupancy declined from 90.9% at December 31, 2012 to 90.6% at March 31, 2013. Due to the scheduled expirations later this year of large customers in Tampa, FL and Atlanta, GA, we expect average occupancy to be approximately 90.0% throughout the rest of 2013.

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. The following table sets forth information regarding second generation leases, which we define as space previously occupied under our ownership that becomes available for lease or acquired vacant space, that were signed during the first quarter of 2013:

                                         Office                   Industrial                  Retail
                                    New        Renewal        New         Renewal        New       Renewal
Leased space (in rentable square
feet)                             293,370      501,836       89,474       264,095      10,519       12,203
Square foot weighted average
term (in years)                       7.7          5.2          4.8           3.6         7.2          2.6
Annual GAAP rents (per square
foot) (1)                        $  20.64     $  20.79     $   4.33     $    3.81     $ 53.35     $  21.63
Tenant improvements (per square
foot)                            $  23.91     $  10.55     $   2.56     $    1.15     $ 51.85     $   7.61
Leasing commissions (per square
foot)                            $   7.97     $   3.38     $   0.82     $    0.34     $ 14.93     $      -
Rent concessions (per square
foot)                            $   7.33     $   1.95     $   1.12     $    0.56     $     -     $   1.38


__________


(1) Amounts net of free rent concessions.


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Annual GAAP rents for new and renewal leases combined, net of free rent concessions, under office, industrial and retail leases were $20.73 per square foot, or 0.1% higher, $3.95 per square foot, or 11.6% lower and $36.31 per square foot, or 35.4% higher, respectively, 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 6.7% of our revenues on an annualized basis, as of March 31, 2013.

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 real estate assets. 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.

We intend to maintain a conservative and flexible balance sheet that allows us to capitalize on favorable development and acquisition opportunities as they arise. We anticipate commencing up to $200.0 million of new development in 2013. Any such projects would not be placed in service until 2014 or beyond. We also anticipate acquiring up to $325.0 million of new properties and selling up to $175.0 million of non-core properties in 2013. We generally seek to acquire and develop assets that are consistent with our Strategic Plan, improve the average quality of our overall portfolio and deliver consistent and sustainable value for our stockholders over the long-term. Whether or not an asset acquisition or new development results in higher per share net income or FFO in any given period depends upon a number of factors, including whether the capitalization rate using projected GAAP net operating income for any such period exceeds the actual cost of capital used to finance the acquisition. We generally intend to grow the Company on a leverage-neutral basis by maintaining a leverage ratio, defined as the percentage of mortgages and notes payable and outstanding preferred stock to the undepreciated book value of our assets, of 42-48%. As of March 31, 2013, this ratio was 43.9%. Forward-looking information regarding 2013 operating performance contained below under "Results of Operations" excludes the impact of any potential acquisitions or dispositions.

Results of Operations

Three Months Ended March 31, 2013 and 2012

Rental and Other Revenues

Rental and other revenues from continuing operations were $12.1 million, or 9.7%, higher in the first quarter of 2013 as compared to 2012 primarily due to recent acquisitions, which accounted for $11.3 million of the increase, development properties recently placed in service and higher same property revenues of $0.3 million. Same property revenues were higher in the first quarter of 2013 as compared to 2012 primarily due to an increase in average occupancy to 90.4% in the first quarter of 2013 from 89.8% in the first quarter of 2012, partly offset by a decrease in annualized GAAP rent per occupied square foot to $19.35 in the first quarter of 2013 from $19.45 in the first quarter of 2012 and lower net termination fees and cost recovery income. We expect rental and other revenues for the remainder of 2013 to increase over 2012 primarily due to the full year contribution of acquisitions closed in 2012, partly offset by slightly lower average occupancy in our same property portfolio and lower net termination fees.

Operating Expenses

Rental property and other expenses were $4.6 million, or 10.3%, higher in the first quarter of 2013 as compared to 2012 primarily due to recent acquisitions, which accounted for $4.0 million of the increase, and higher same property operating expenses of $0.6 million. Same property operating expenses were higher in the first quarter of 2013 as compared to 2012 primarily due to higher contract services, insurance premiums and utilities, partly offset by lower real estate taxes and repairs and maintenance. We expect rental property and other expenses for the remainder of 2013 to increase over 2012 primarily due to the full year contribution of acquisitions closed in 2012 and continuing slight increases in same property operating expenses.

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 64.3% in the first quarter of 2013, as compared to 64.5% in the first quarter of 2012. Operating margin is expected to remain relatively consistent for the remainder of 2013 as compared to 2012.

Depreciation and amortization was $5.2 million, or 14.0%, higher in the first quarter of 2013 as compared to 2012 almost entirely due to recent acquisitions. We expect depreciation and amortization for the remainder of 2013 to increase over 2012 primarily due to the full year contribution of acquisitions closed in 2012.


Table of Contents

We recorded impairments of real estate assets held for use of $0.4 million in the first quarter of 2013 related to two industrial properties located in Atlanta, GA, which resulted from a change in the assumed timing of future dispositions and leasing assumptions. We recorded no such impairments in the first quarter of 2012. 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 $0.9 million, or 9.4%, higher in the first quarter of 2013 as compared to 2012 primarily due to higher acquisition costs and higher long-term equity incentive compensation recognized for certain employees who met or are approaching the age and service eligibility requirements under our retirement plan in the first quarter of 2013. Long-term equity incentive compensation awards are typically issued during the first quarter of each year. We expect general and administrative expenses for the remainder of 2013 to decrease when compared with 2012 primarily due to lower short-term incentive compensation and acquisition costs, partly offset by higher salaries.

Interest Expense

Interest expense was $0.8 million, or 3.3%, lower in the first quarter of 2013 as compared to 2012 primarily due to lower average interest rates, lower average debt balances and higher capitalized interest, partly offset by higher financing obligation interest expense. We expect interest expense for the remainder of 2013 to decrease when compared with 2012 for similar reasons as stated above.

Other Income

Other income was $0.6 million, or 27.4%, lower in the first quarter of 2013 as compared to 2012 primarily due to a decrease in interest income on notes receivable resulting from the repayment in 2012 of a secured loan we made in 2011 to our DLF I joint venture and a loss on debt extinguishment. We expect other income for the remainder of 2013 to remain consistent as compared to 2012.

Equity in Earnings/(Losses) of Unconsolidated Affiliates

Equity in earnings/(losses) of unconsolidated affiliates was $0.6 million higher in the first quarter of 2013 as compared to 2012 primarily due to our share of a gain on disposition of an office property in our DLF II joint venture of $0.4 million in the first quarter of 2013. In each of the first quarters of 2013 and 2012, we recorded our share of impairments of real estate assets of $1.0 million on certain office properties in our DLF I joint venture, both of which resulted from a change in the assumed timing of future dispositions and leasing assumptions.

Impairments of Real Estate Assets Held for Sale

We recorded impairments of real estate assets held for sale of $0.7 million in the first quarter of 2013 related to five industrial properties located in Atlanta, GA requiring discontinued operations presentation which resulted from a change in the assumed timing of future dispositions and leasing assumptions. We recorded no such impairments in the first quarter of 2012. 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.

Net Gains on Disposition of Discontinued Operations

Net gains on disposition of discontinued operations were $3.9 million lower in the first quarter of 2013 as compared to 2012 due to the net effect of our disposition activity.


Table of Contents

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, recurring 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, bank term loans and borrowings under our revolving credit facility.

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