Business context and reporting period
Highwoods Properties, Inc. is an office REIT operating through Highwoods Realty Limited Partnership. This Form 10-Q covers the quarter and six months ended June 30, 2016. At quarter-end, the company owned or held interests in 31.1 million rentable square feet of in-service properties, 1.1 million square feet under development and approximately 500 acres of development land, across nine core markets.
Financial performance and position
Amounts below are in millions, except per-share data and percentages.
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Rental and other revenue | $166.9 | $148.5 | $331.7 | $293.8 |
| Net operating income (NOI), continuing operations | $109.3 | $96.2 | $216.6 | $188.9 |
| Income from continuing operations | $33.5 | $22.2 | $61.7 | $39.1 |
| Net income | $33.5 | $26.9 | $480.3 | $47.7 |
| Diluted EPS | $0.32 | $0.27 | $4.78 | $0.47 |
| FFO per diluted share | $0.82 | $0.77 | $1.64 | $1.49 |
- Q2 NOI margin was approximately 65.5%, versus 64.7% a year earlier; first-half margin was approximately 65.3%, versus 64.3%.
- Same-property NOI increased 4.7% in Q2 and 4.6% in the first half. Office occupancy was 92.0% at June 30, compared with 92.6% at year-end 2015; Q2 average occupancy was 92.9%, versus 92.3%.
- Operating cash flow was $137.8 million for the first half, versus $122.3 million. Investing activities provided $253.8 million, largely reflecting property-sale proceeds; financing activities used $394.2 million. Cash and cash equivalents ended at $2.4 million, alongside $265.2 million of restricted cash.
- Net mortgages and notes payable were $2.08 billion, down from $2.49 billion at year-end. The company reported a 37.5% leverage ratio against its stated 38%–43% target range. Debt weighted-average rates were 4.35% on secured debt and 3.70% on unsecured debt.
- At June 30, $608 million of debt was floating-rate and unhedged; a 1 percentage-point rate increase would raise annual interest expense by an estimated $6.1 million. The company was in compliance with debt covenants.
- Q2 common dividend declared was $0.425 per share, unchanged from 2015; first-half dividends were $0.85 per share.
Material changes versus the prior comparable period
- Revenue rose 12.3% in Q2 and 12.9% in the first half, reflecting prior acquisitions, developments placed in service and higher same-property revenue, partly offset by dispositions.
- Q2 income from continuing operations available to common stockholders increased to $31.6 million from $20.6 million. Q2 diluted EPS rose to $0.32 from $0.27, despite higher weighted-average shares.
- First-half net income and EPS were dominated by the $414.5 million gain on the March sale of substantially all Country Club Plaza assets in Kansas City. First-half diluted EPS from continuing operations was $0.60, compared with $0.39 in 2015; reported net income per share was $4.78, compared with $0.47.
- Interest expense declined 10.8% in Q2 and 6.7% in the first half, primarily due to lower average interest rates and higher capitalized interest.
Outlook, management commentary, risks and unusual items
- Management expected office occupancy to remain approximately 92%–93% through the rest of 2016, and expected same-property NOI and continuing-operations NOI to exceed 2015 levels.
- Second-generation office leases signed in Q2 covered 906,915 square feet; weighted-average GAAP rent of $24.57 per square foot was 15.4% above prior rents for the same spaces.
- At June 30, five development projects totaled approximately 1.31 million square feet, were 72.2% pre-leased and had estimated total investment of $445.0 million, of which $209.7 million had been invested. Expected remaining expenditure on started or committed developments was approximately $238 million.
- Management anticipated paying a special dividend of at least $0.75 per share by January 31, 2017, to holders of record by December 31, 2016; the amount could be up to $0.25 per share higher, subject to taxable gains and cash flows. Approximately $205 million of Plaza-sale proceeds remained in escrow and was expected to be used to reduce revolving-credit borrowings on August 26, 2016.
- At July 25, revolving-credit borrowings were $272.0 million, with $202.8 million of unused capacity; management reported $352.8 million of combined availability from working capital and credit facilities. A $150 million unsecured term facility, maturing in January 2022, had no borrowings at quarter-end or July 25.
- Risks include tenant financial deterioration, leasing and development execution, weaker market conditions, rising interest rates and operating costs, access to capital and refinancing, and potential tax consequences if Section 1031 exchanges do not qualify. Distributions may also require borrowing if taxable income exceeds available cash.
- Unusual item: a first-quarter sale of a 32,000-square-foot building to a family business controlled by a company director generated $4.7 million in proceeds; the filing states the price exceeded an independent appraisal and the buyer leased 79% of the building.
Important facts for investors to verify
- Separate recurring operating performance from the Plaza disposition gain; review continuing-operations EPS and FFO alongside GAAP net income.
- Confirm completion and tax treatment of the Section 1031 reinvestments, use of escrowed proceeds, and the final special-dividend amount and timing.
- Track occupancy, lease renewals, same-property NOI, development leasing and remaining project costs against management’s expectations.
- Monitor refinancing and liquidity, unhedged floating-rate debt exposure, covenant compliance and the effect of dividends on available cash.
- Review the director-related property sale and relevant disclosures, as well as subsequent events: the July Pittsburgh land purchase for $18.5 million and a joint-venture sale expected to generate a $1.9 million gain to Highwoods.