HIW

Business Context and Reporting Period

Company: Highwoods Properties, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2003
Business Overview: Highwoods is a self-administered equity REIT owning and operating suburban office, industrial, and retail properties in the southeastern and midwestern United States. As of June 30, 2003, the portfolio included 486 in-service properties (approx. 36.8 million rentable square feet) and interests in 78 joint venture properties.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Rental revenue decreased 4.3% ($9.5 million) year-over-year. This was primarily driven by a drop in average occupancy rates from 87.0% to 82.0% and the impact of bankruptcies (WorldCom and US Airways), which reduced revenue by approximately $8.7 million.
• Profitability Drop: Net income available to common stockholders fell 76% to $5.9 million. Income from continuing operations decreased significantly due to lower occupancy, higher operating expenses as a percentage of revenue, and a $2.4 million impairment charge related to the MG-HIW, LLC joint venture.
• Discontinued Operations: The company reclassified operations of certain properties sold or held for sale to discontinued operations. Income from discontinued operations was $8.6 million for the six months ended June 30, 2003, compared to $11.9 million in the prior year.
• Dividend Reduction: On April 24, 2003, the Board reduced the annual dividend rate from $2.34 to $1.70 per share due to lower expected funds from operations and higher capital expenditures.

Guidance, Outlook, and Risks

• Outlook: Management expects net income and FFO to be lower in the second half of 2003 compared to the second half of 2002. Key factors include lower occupancy, lower first-year cash rents, and general economic conditions in primary markets.
• Lease Expirations: Approximately 3.2 million square feet (10.3% of the portfolio) are scheduled to expire in the remainder of 2003. As of June 30, 42.9% of this space had been re-leased.
• Bankruptcy Impacts: WorldCom rejected leases totaling over 841,000 square feet. US Airways rejected leases but agreed to continue leasing 293,007 square feet under modified terms. The company has filed claims totaling $21.5 million related to WorldCom rejections.
• Capital Recycling: The company continues a program of selectively disposing of non-core properties. As of June 30, 2003, 3.1 million square feet of office properties and 330.7 acres of land were under contract for sale with a carrying value of $201.1 million.
• Subsequent Events: On July 29, 2003, the company acquired 15 properties (1.3 million sq. ft.) from the MG-HIW, LLC joint venture for $28.1 million cash plus debt assumption. An option to acquire remaining Orlando assets was also entered into.
• Liquidity: The company amended its revolving credit facility to $250 million on July 17, 2003. Management believes cash flows and borrowing capacity are adequate to meet short and long-term needs.

Investor Verification Checklist

• Occupancy Trends: Verify the re-leasing success rate for the 3.2 million square feet expiring in late 2003 and the impact of WorldCom/US Airways vacancies on same-property revenue.
• Dividend Coverage: Confirm the sustainability of the reduced dividend rate ($1.70 annual) given the 111.3% payout ratio against Cash Available for Distribution (CAD) for the six-month period.
• Joint Venture Acquisitions: Review the financial impact of the July 29, 2003 acquisition of MG-HIW assets and the terms of the option for the remaining Orlando properties.
• Debt Covenants: Monitor compliance with financial covenants under the amended $250 million revolving loan, particularly the Adjusted EBITDA to Interest Expense ratio (currently 2.33x).
• Impairment Risks: Assess the potential for further impairment charges on assets held for sale or in joint ventures given the current market conditions and the $12.1 million charge already recorded in the MG-HIW venture.