HIW

Highwoods Properties, Inc. - 10-Q Summary (Period Ended Sept 30, 2002)

Business Context and Reporting Period

Highwoods Properties, Inc. is a self-administered and self-managed equity REIT operating in the southeastern and midwestern United States. The company owns and operates office, industrial, and retail properties, as well as apartment units. This report covers the quarterly period ended September 30, 2002, and the nine months ended on that date. As of September 30, 2002, the company owned 502 in-service properties encompassing approximately 38.0 million rentable square feet.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Rental revenue decreased 1.8% ($2.1 million) for the quarter and 3.0% ($10.7 million) for the nine months compared to the prior year. This was primarily driven by a drop in average occupancy rates from 92.7% to 86.3% (quarterly) and 93.4% to 87.5% (nine months).
• Net Income Drop: Net income available to common shareholders fell significantly, down 79.9% for the quarter and 45.3% for the nine months. This decline was exacerbated by non-recurring charges.
• Non-Recurring Charges: The company recorded a $2.7 million litigation reserve and a $3.7 million non-recurring compensation expense related to stock option exercises in the third quarter. Additionally, a $3.1 million write-off of accrued straight-line rent receivables from WorldCom occurred in the second quarter.
• Discontinued Operations: The company recognized a $3.3 million loss on the sale of discontinued operations in the quarter, including impairment charges on properties held for sale.
• Capital Recycling: Despite lower occupancy, the company continued its capital recycling program, placing 1.6 million square feet of new properties in service during 2002.

Guidance, Outlook, Risks, and Unusual Items

• Major Tenant Bankruptcies: Significant risks stem from the Chapter 11 filings of WorldCom and US Airways. WorldCom leases 982,921 square feet (3.7% of annualized revenue), and US Airways leases 414,059 square feet (1.5% of annualized revenue). The company is currently recording revenue from these tenants on a cash basis rather than straight-line.
• Liquidity: The company maintains a $300 million unsecured revolving credit facility (with $151.5 million outstanding) and a $55.2 million secured facility. Management expects cash flows and borrowing capacity to be adequate for short and long-term needs.
• Development Pipeline: As of September 30, 2002, the company had 884,000 square feet of development projects in process or completed but not stabilized, with an anticipated total investment of $95.0 million. Pre-leasing for these projects averaged 24%.
• Accounting Changes: The company adopted SFAS No. 144 regarding the impairment of long-lived assets, resulting in the classification of certain property sales as discontinued operations. It also recorded a $4.5 million impairment loss on three office properties held for sale.

Investor Verification Checklist

• Occupancy Trends: Verify the trajectory of occupancy rates, which have declined significantly (from ~93% to ~87%), and assess the impact of the current economic environment on lease renewals.
• WorldCom/US Airways Exposure: Monitor the bankruptcy proceedings of WorldCom and US Airways to determine the likelihood of lease rejections or rent reductions, which could materially impact future cash flows.
• Non-Recurring Charges: Confirm that the $3.7 million compensation expense and $2.7 million litigation reserve are truly one-time items and do not signal broader operational or legal issues.
• Debt Maturity Profile: Review the maturity schedule of the $1.63 billion debt load, particularly the $125 million MOPPRS and $100 million Put Option Notes due in 2003 and 2004, to assess refinancing risks.
• Development Stabilization: Track the leasing progress of the 884,000 square feet of new development, as these assets are currently under-leased (24% pre-leased) and require capital to reach stabilization.