HIW

Business Context and Reporting Period

Company: Highwoods Properties, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2005
Business Overview: Highwoods is a fully-integrated, self-administered equity REIT operating in the southeastern and midwestern United States. As of June 30, 2005, the portfolio included 424 in-service office, industrial, and retail properties, 156 apartment units, and 1,011 acres of undeveloped land. The company conducts operations primarily through Highwoods Realty Limited Partnership.

Key Financial Metrics

Material Changes vs. Prior Period

• Profitability Surge: Net income available to common stockholders improved from a loss of $2.8 million in the prior year to a profit of $17.2 million. This was driven primarily by a significant gain on the sale of discontinued operations ($14.7 million) and a reduction in interest expense.
• Discontinued Operations: The company reclassified operations of sold or held-for-sale properties to discontinued operations. This resulted in a net gain of $14.7 million in the six months ended June 30, 2005, compared to $0.6 million in the prior year.
• Interest Expense Reduction: Total interest expense decreased by $7.7 million (12.2%) due to lower average borrowings ($1.558 billion vs. $1.726 billion) and the elimination of financing obligations related to the Orlando City Group properties.
• Asset Dispositions: Proceeds from the disposition of real estate assets increased by $14.5 million compared to the prior year period, totaling $106.1 million.
• Impairment Charges: The company recorded $3.2 million in impairment losses on assets held for use (land parcels) in the current period, compared to none in the prior year.

Guidance, Outlook, and Risks

Capital Recycling and Liquidity: The company continues a capital recycling program, disposing of non-core properties to fund investments. As of June 30, 2005, $219.9 million in assets were classified as held for sale. Future capital expenditures for committed development projects are estimated at approximately $200 million.

Debt Management:

• The company secured a new $350 million unsecured revolving credit facility in May 2006 (post-period), replacing previous facilities with improved terms (LIBOR + 80 bps).
• Approximately $110 million of unsecured notes mature in December 2006, and $63 million of secured debt matures in February 2007. Management expects to refinance these via dispositions or new debt issuance.

Risks and Contingencies:

• SEC Investigation: The SEC's Division of Enforcement has issued a confidential formal order of investigation regarding the company's previous financial restatement. While cooperating, the company notes potential adverse actions.
• Internal Controls: Management reported that internal controls over financial reporting were not effective as of December 31, 2004, and expected to remain ineffective as of December 31, 2005, due to material weaknesses in real estate asset accounting and financial statement close processes. Remediation plans are underway.
• Market Risk: Approximately $389 million of debt is variable rate. A 100 basis point increase in rates would increase interest expense by approximately $3.9 million annually.

Investor Verification Checklist

• Discontinued Operations Impact: Verify the sustainability of earnings by analyzing Net Income excluding the $14.7 million gain from discontinued operations.
• Internal Control Remediation: Monitor progress on remediation of material weaknesses in accounting processes and the status of the SEC investigation.
• Debt Maturities: Assess the company's ability to refinance $173 million in debt maturing in late 2006 and early 2007 given current market conditions.
• Development Pipeline: Review the $200 million in committed capital expenditures and the status of the 2.5 million square feet of properties held for sale.
• FFO vs. GAAP: Compare Funds From Operations ($1.20/share) against GAAP Net Income per share ($0.32) to understand the impact of non-cash depreciation and asset sales.