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HIW > SEC Filings for HIW > Form 10-K on 10-Feb-2014All Recent SEC Filings

Show all filings for HIGHWOODS PROPERTIES INC

Form 10-K for HIGHWOODS PROPERTIES INC


10-Feb-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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

Disclosure Regarding Forward-Looking Statements

Some of the information in this Annual Report may contain forward-looking statements. Such statements include, in particular, statements about our plans, strategies and prospects under this section and under the heading "Item 1. Business." 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 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 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 this Annual Report. 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;

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

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

While we own and operate a limited number of industrial and retail 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 factors in predicting our future operating results.

The key components affecting our rental and other revenues are average occupancy, rental rates, 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 our existing leases prior to expiration. For more information regarding our lease expirations, see "Item 2. Properties - Lease Expirations." Our occupancy declined from 90.9% at December 31, 2012 to 89.9% at December 31, 2013 primarily due to a scheduled expiration of a large customer in Tampa, FL and the acquisition of relatively low occupied buildings in Atlanta, GA, Nashville, TN and Orlando, FL and the disposition of relatively high occupied industrial buildings in Atlanta, GA.

Whether or not our rental revenue tracks average occupancy proportionally depends upon whether rents under signed new and renewal leases are higher or lower than the rents under the previous leases. Annualized rental revenues from second generation leases expiring 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 signed during the fourth quarter of 2013 (we define second generation leases as leases with new customers and renewals of existing customers in space that has been previously occupied under our ownership and leases with respect to vacant space in acquired buildings):

                                         Office                   Industrial                  Retail
                                    New        Renewal        New         Renewal        New        Renewal
Leased space (in rentable square
feet)                             407,513      383,286       18,000       172,022            -        5,304
Rentable square foot weighted
average term (in years)               6.3          5.7          3.2           2.8            -          3.4
Base rents (per rentable square
foot) (1)                        $  24.23     $  22.20     $   4.23     $    3.28     $      -     $  37.77
Rent concessions (per rentable
square foot) (1)                    (0.91 )      (0.56 )      (0.28 )       (0.23 )          -            -
GAAP rents (per rentable square
foot) (1)                        $  23.32     $  21.64     $   3.95     $    3.05     $      -     $  37.77
Tenant improvements (per
rentable square foot) (1)        $   3.73     $   1.16     $   0.09     $    0.07     $      -     $   3.61
Leasing commissions (per
rentable square foot) (1)        $   0.90     $   0.55     $   0.16     $    0.05     $      -     $   1.21


__________


(1) Weighted average per rentable square foot on an annual basis over the lease term.


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Compared to previous leases in the same spaces, annual combined GAAP rents for new and renewal leases signed in the fourth quarter were $22.51 per rentable square foot, or 8.5% higher, for office leases, $3.14 per rentable square foot, or 8.3% higher, for industrial leases and $37.77 per rentable square foot, or 9.7% lower, for retail 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 less than 10.0% of our revenues on an annualized basis, as of December 31, 2013. See "Item 2. Properties - Customers."

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 maintenance, repairs 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 fixed lives. General and administrative expenses consist primarily of management and employee salaries and other personnel costs, corporate overhead and short 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 $150 million of new development in 2014. Such projects would likely not be placed in service until 2015 or beyond. We also anticipate acquiring up to $300 million of new properties and selling up to $175 million of non-core properties in 2014. We generally seek to acquire and develop assets that 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 funds from operations ("FFO") in any given period depends upon a number of factors, including whether the net operating income for any such period exceeds the actual cost of capital used to finance the acquisition. Forward-looking information regarding 2014 operating performance contained below under "Results of Operations" excludes the impact of any potential acquisitions or dispositions.

Results of Operations

Comparison of 2013 to 2012

Rental and Other Revenues

Rental and other revenues from continuing operations were $71.8 million, or 14.8%, higher in 2013 as compared to 2012 primarily due to recent acquisitions and development properties placed in service, which accounted for $70.9 million of the increase. Same property rental and other revenues in 2013 were flat with 2012 as average occupancy in the same property portfolio was substantially unchanged as well. We expect 2014 rental and other revenues to increase over 2013 primarily due to the full year contribution of acquisitions closed in 2013, contribution of development properties and slightly higher same property revenues resulting from higher expected cost recovery income and higher average GAAP rents per rentable square foot.

Operating Expenses

Rental property and other expenses were $26.6 million, or 15.1%, higher in 2013 as compared to 2012 primarily due to recent acquisitions, which contributed $27.1 million to the net increase. Same property operating expenses in 2013 were flat with 2012 as average occupancy was substantially unchanged and lower utility costs and property taxes offset inflationary effects on other costs. We expect 2014 rental property and other expenses to increase over 2013 primarily due to the full year contribution of acquisitions closed in 2013 and slightly higher same property operating expenses resulting from higher expected utility costs and higher property 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 slightly lower at 63.5% for 2013, as compared to 63.6% for 2012. Operating margin is expected to be slightly lower in 2014 as compared to 2013.

Depreciation and amortization was $30.6 million, or 20.9%, higher in 2013 as compared to 2012 primarily due to recent acquisitions. We expect 2014 depreciation and amortization to increase over 2013 primarily due to the full year contribution of acquisitions closed and developments placed in service in 2013.


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General and administrative expenses were $0.2 million, or 0.5%, lower in 2013 as compared to 2012 primarily due to lower incentive compensation, partly offset by higher salaries and acquisition costs. We expect 2014 general and administrative expenses to slightly decrease relative to 2013 primarily due to lower incentive compensation, partially offset by higher company-wide base salaries and employee benefit costs.

Interest Expense

Interest expense was $3.4 million, or 3.5%, lower in 2013 as compared to 2012 primarily due to lower average interest rates and higher capitalized interest, partly offset by higher average debt balances. We expect 2014 interest expense to decrease over 2013 primarily due to lower average interest rates and higher capitalized interest, partially offset by higher average debt balances.

Other Income

Other income was relatively unchanged in 2013 as compared to 2012 primarily due to a decrease in interest income on notes receivable in 2013 resulting from the 2012 repayment of a secured loan made to our Highwoods DLF 98/29, LLC joint venture and a bankruptcy settlement in 2012, offset by a higher loss on debt extinguishment in 2012. We expect 2014 other income to decrease over 2013 primarily due to lower interest income as a result of the January 2014 repayment of seller financing provided in conjunction with a 2010 disposition transaction.

Gain on Acquisition of Controlling Interest in Unconsolidated Affiliate

We recorded a gain on acquisition of controlling interest in unconsolidated affiliate of $7.5 million in 2013 due to the acquisition of our joint venture partner's 60.0% interest in our HIW-KC Orlando, LLC joint venture. We had no similar transactions in 2012.

Equity in Earnings of Unconsolidated Affiliates

Equity in earnings of unconsolidated affiliates was $2.8 million lower in 2013 as compared to 2012 primarily due to our $4.5 million share of impairments of real estate assets on certain office properties in our Highwoods DLF 98/29, LLC joint venture, the acquisition of our joint venture partner's 60.0% interest in our HIW-KC Orlando, LLC joint venture in 2013 and the sale of office properties in our Highwoods DLF 98/29, LLC and Highwoods DLF 97/26 DLF 99/32, LP joint ventures in late 2012 and early 2013. Partly offsetting this decrease was $3.2 million, net of taxes, that we recorded as our share of a gain recognized by the Lofts at Weston, LLC joint venture upon the sale of 215 residential units to an unrelated third party. Additionally offsetting this decrease was our $1.0 million share of impairments of real estate assets on two office properties in our Highwoods DLF 98/29, LLC joint venture in 2012. The impairments in 2013 and 2012 were due to a change in the assumed timing of future dispositions and/or leasing assumptions. We expect 2014 equity in earnings of unconsolidated affiliates to remain consistent to 2013 due to impairments of real estate assets recorded in 2013 offset by the reduction of our overall joint venture investments in 2013.

Impairments of Real Estate Assets in Discontinued Operations

We recorded impairments of real estate assets of $1.1 million on seven industrial properties in Atlanta, GA and $1.1 million on four properties in a single office park in Winston-Salem, NC in 2013. These impairments were due to a change in the assumed timing of future dispositions and leasing assumptions. We recorded no such impairments in 2012.

Net Gains on Disposition of Discontinued Operations

Net gains on disposition of discontinued operations were $34.3 million higher in 2013 as compared to 2012 due to higher disposition activity in 2013.

Earnings Per Common Share - Diluted

Diluted earnings per common share was $0.42, or 41.2%, higher in 2013 as compared to 2012 due to an increase in net income for the reasons discussed above, offset by an increase in the weighted average Common Shares outstanding from the 2012 and 2013 issuances under our equity sales agreements and the August 2013 Common Stock offering.


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Comparison of 2012 to 2011

Rental and Other Revenues

Rental and other revenues from continuing operations were $53.1 million, or 12.3%, higher in 2012 as compared to 2011 primarily due to recent acquisitions, which accounted for $43.8 million of the increase, and higher same property revenues of $10.7 million, partly offset by lower construction income of $1.7 million. Same property revenues were higher primarily due to an increase in average occupancy to 91.0% in 2012 from 90.5% in 2011, an increase in annualized GAAP rent per rentable square foot to $20.45 in 2012 from $20.07 in 2011, higher cost recovery income, higher net termination fees and lower bad debt expense.

Operating Expenses

Rental property and other expenses were $19.4 million, or 12.4%, higher in 2012 as compared to 2011 primarily due to recent acquisitions, which accounted for $18.8 million of the increase and higher same property operating expenses of $1.6 million, partly offset by $1.7 million lower cost of construction expense. Same property operating expenses were higher primarily due to higher repairs and maintenance and insurance 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, remained constant at 63.6% at both 2012 and 2011.

Depreciation and amortization was $18.9 million, or 14.8%, higher in 2012 as compared to 2011 primarily due to recent acquisitions, which accounted for $16.5 million of the increase, and higher same property depreciation and amortization of $2.3 million.

General and administrative expenses were $1.7 million, or 4.6%, higher in 2012 as compared to 2011 primarily due to higher salaries and incentive compensation, partly offset by lower acquisition and dead deal costs.

Interest Expense

Interest expense was $0.6 million, or 0.6%, higher in 2012 as compared to 2011 primarily due to higher average debt balances, partly offset by lower average interest rates and lower financing obligation interest expense.

Other Income

Other income was $1.0 million, or 13.4%, lower in 2012 as compared to 2011 primarily due to recording a loss on debt extinguishment in 2012.

Gains on Disposition of Investments in Unconsolidated Affiliates

We recorded a gain on disposition of investment in unconsolidated affiliate of $2.3 million in 2011 due to our partner exercising its option to acquire our 10.0% equity interest in one of our unconsolidated joint ventures. We recorded no such gain in 2012.

Impairments of Real Estate Assets in Discontinued Operations

We recorded impairments of real estate assets of $2.4 million in 2011 related to two office properties in Orlando, FL which resulted from a change in the assumed timing of future dispositions. We recorded no such impairments in 2012.

Net Gains on Disposition of Discontinued Operations

Net gains on disposition of discontinued operations were $26.9 million higher in 2012 as compared to 2011 due to higher disposition activity in 2012.

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

Dividends on Preferred Stock and excess of Preferred Stock redemption/repurchase cost over carrying value were $2.0 million and $1.9 million lower, respectively, in 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, 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 unsecured debt securities, unsecured bank term loans, mortgage debt and borrowings under our unsecured revolving credit facility.

Statements of Cash Flows

We report and analyze our cash flows based on operating activities, investing
activities and financing activities. The following table sets forth the changes
in the Company's cash flows ($ in thousands):

                                             Year Ended December 31,
                                               2013            2012         Change
Net Cash Provided By Operating Activities $    256,437      $ 193,416     $  63,021
Net Cash (Used In) Investing Activities       (356,603 )     (238,812 )    (117,791 )
Net Cash Provided By Financing Activities       96,567         47,991        48,576
Total Cash Flows                          $     (3,599 )    $   2,595     $  (6,194 )

In calculating net cash related to operating activities, depreciation and amortization, which are non-cash expenses, are added back to net income. As a result, we have historically generated a positive amount of cash from operating activities. From period to period, cash flow from operations depends primarily upon changes in our net income, as discussed more fully above under "Results of Operations," changes in receivables and payables, and net additions or decreases in our overall portfolio, which affect the amount of depreciation and amortization expense.

Net cash related to investing activities generally relates to capitalized costs incurred for leasing and major building improvements and our acquisition, development, disposition and joint venture capital activity. During periods of significant net acquisition and/or development activity, our cash used in such investing activities will generally exceed cash provided by investing activities, which typically consists of cash received upon the sale of properties and distributions of capital from our joint ventures.

Net cash related to financing activities generally relates to distributions, incurrence and repayment of debt, and issuances, repurchases or redemptions of Common Stock, Common Units and Preferred Stock. As discussed previously, we use a significant amount of our cash to fund distributions. Whether or not we have increases in the outstanding balances of debt during a period depends generally upon the net effect of our acquisition, disposition, development and joint venture activity. We generally use our revolving credit facility for working capital purposes, which means that during any given period, in order to minimize interest expense, we may record significant repayments and borrowings under our revolving credit facility.

The change in net cash related to operating activities in 2013 as compared to 2012 was primarily due to higher net cash from the operations of acquired properties and lower cash paid for operating expenses in 2013. We expect net cash related to operating activities to be higher in 2014 as compared to 2013 due to the full year impact of properties acquired in 2013 and higher cash flows from leases signed in 2013 and prior years as free rent periods expire.

The change in net cash related to investing activities in 2013 as compared to 2012 was primarily due to higher acquisition and development activity and higher expenditures on tenant and building improvements in 2013, partly offset by higher net proceeds from dispositions of real estate assets and higher distributions of capital from unconsolidated affiliates in 2013. We expect net cash related to investing activities to be lower in 2014 as compared to 2013 due to our plans to acquire $100 million to $300 million of office buildings and commence development of $75 million to $150 million of office buildings. Additionally, as of December 31, 2013, we have $136.4 million left to fund of our previously-announced development activity. We expect these uses of cash for investing activities will be partially offset by $100 million to $175 million of non-core dispositions and additional distributions of capital from unconsolidated affiliates in 2014.

The change in net cash related to financing activities in 2013 as compared to 2012 was primarily due to higher proceeds from the issuance of Common Stock and contributions from noncontrolling interests in consolidated affiliates in 2013, partly offset by


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higher dividends on Common Stock and higher net debt repayments in 2013. Assuming the net effect of our acquisition, disposition, development and joint venture activity in 2014 results in an increase in our assets, we would expect outstanding debt balances to increase. However, because we plan to continue to maintain a flexible and conservative balance sheet with mortgages and notes payable and outstanding preferred stock representing around 40% to 45% of the undepreciated book value of our assets, we would also expect higher outstanding balances of Common Stock in such event.

Capitalization

The following table sets forth the Company's capitalization (in thousands,
except per share amounts):

                                                           December 31,
                                                        2013           2012
Mortgages and notes payable, at recorded book value $ 1,956,299    $ 1,859,162
Financing obligations                               $    26,664    $    29,358
Preferred Stock, at liquidation value               $    29,077    $    29,077
Common Stock outstanding                                 89,921         80,311
Common Units outstanding (not owned by the Company)       2,944          3,733
Per share stock price at year end                   $     36.17    $     33.45
Market value of Common Stock and Common Units       $ 3,358,927    $ 2,811,272
Total capitalization                                $ 5,370,967    $ 4,728,869

At December 31, 2013, our mortgages and notes payable and outstanding preferred stock represented 37.0% of our total capitalization and 41.4% of the undepreciated book value of our assets.

Our mortgages and notes payable as of December 31, 2013 consisted of $488.7 million of secured indebtedness with a weighted average interest rate of 4.98% and $1,467.6 million of unsecured indebtedness with a weighted average interest rate of 4.07%. The secured indebtedness was collateralized by real estate assets . . .

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