Business Context and Reporting Period
Company: Highwoods Properties, Inc.
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2006
Business Overview: Highwoods is a fully-integrated, self-administered equity REIT specializing in suburban office, industrial, and retail properties in the southeastern and midwestern United States. As of December 31, 2006, the Company wholly owned 322 in-service properties (approx. 26.9 million rentable square feet) and held interests in 70 additional properties through joint ventures. The portfolio is heavily concentrated in office properties, which generated approximately 82% of rental revenue.
Key Financial Metrics
| Metric | 2006 | 2005 |
|---|---|---|
| Rental and Other Revenues | $416.8 million | $396.1 million |
| Net Income | $53.7 million | $62.5 million |
| Net Income Available to Common Stockholders | $34.9 million | $30.9 million |
| Funds From Operations (FFO) | $145.3 million ($2.37/share) | $127.2 million ($2.11/share) |
| Total Assets | $2.84 billion | $2.91 billion |
| Total Mortgages and Notes Payable | $1.47 billion | $1.47 billion |
| Operating Margin | 63.2% | 64.3% |
| Dividends Declared per Common Share | $1.70 | $1.70 |
Material Changes vs. Prior Period
- Revenue Growth: Rental revenues increased 5.2% to $416.8 million, driven by higher average occupancy, new developments placed in service, and the consolidation of the Markel joint venture effective January 1, 2006. This was partially offset by a decrease in lease termination fees.
- Net Income Decline: Total net income decreased 13.8% to $53.7 million, primarily due to a significant reduction in income from discontinued operations ($17.3 million in 2006 vs. $34.7 million in 2005) resulting from fewer property dispositions.
- Common Shareholder Income: Despite the drop in total net income, net income available to common stockholders increased 12.9% to $34.9 million. This was driven by reduced preferred stock dividends (due to redemptions) and lower preferred stock redemption costs.
- Impairments: Impairment of assets held for use decreased significantly to $2.6 million in 2006 from $7.6 million in 2005.
- Discontinued Operations: The Company sold approximately 3.0 million square feet of office and industrial properties in 2006, generating gross proceeds of approximately $241 million.
Guidance, Outlook, Risks, and Unusual Items
- Outlook: Management expects modest improvements in employment trends and economic climate in the Southeast. Approximately 1.1 million square feet of new office and industrial development is expected to be delivered by the end of 2007, with 38% pre-leased as of year-end 2006.
- Liquidity: The Company maintains a conservative balance sheet. As of February 15, 2007, it had approximately $216 million in combined borrowing availability under unsecured and secured credit facilities. A new $150 million unsecured non-revolving credit facility was obtained in January 2007.
- Internal Control Weaknesses: The Company disclosed that its internal control over financial reporting was not effective as of December 31, 2006. Material weaknesses were identified regarding the accrual of in-process tenant improvements, reimbursement of tenant improvements, and the review of real estate asset account reconciliations. Remediation efforts are ongoing.
- Legal Proceedings: The SEC closed its investigation into the Company's previous financial restatement in November 2006 with no action taken. The Company is disputing state excise tax assessments of approximately $4.5 million but has accrued $0.5 million for a probable settlement.
- Unusual Items: The Company recognized a $1.6 million gain from the settlement of a tenant bankruptcy claim in the fourth quarter of 2006. Additionally, a $4.0 million gain from a hurricane insurance claim is expected to be recognized in the first quarter of 2007.
Key Facts for Investor Verification
- Internal Control Remediation: Verify the progress of remediation activities for the material weaknesses in internal controls over financial reporting, specifically regarding accruals for tenant improvements and asset reconciliations.
- Discontinued Operations: Confirm the classification and future impact of properties sold or held for sale, as a significant portion of 2005 income was derived from discontinued operations which was lower in 2006.
- Debt Maturities and Refinancing: Review the schedule of debt maturities, noting that the Company does not intend to reserve funds to retire debt at maturity but plans to refinance. Monitor interest rate exposure on variable rate debt.
- Joint Venture Consolidation: Understand the impact of the consolidation of the Markel joint venture (50% owned) on 2006 financials compared to the equity method used in prior periods.
- Dividend Sustainability: Assess the ability to maintain the $1.70 per share dividend given the REIT requirement to distribute 90% of taxable income and the impact of preferred stock redemptions on common shareholder distributions.