HIW

Highwoods Properties, Inc. - 10-Q Summary (Period Ended June 30, 2006)

Business Context and Reporting Period

This report covers the quarterly period ended June 30, 2006. Highwoods Properties, Inc. is a fully-integrated, self-administered equity REIT operating in the southeastern and midwestern United States. As of the reporting date, the Company owned or had an interest in 418 in-service office, industrial, and retail properties (35.1 million square feet) and 96 apartment units. The Company also held 830 acres of undeveloped land.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Rental revenues increased 3.3% year-over-year, 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 and property dispositions.
• Net Income Decline: Net income decreased 37.4% primarily due to a significant reduction in gains from discontinued operations. In the prior year, the Company recorded $14.7 million in net gains on sales of discontinued operations, compared to only $2.0 million in the current period.
• Operating Expenses: Total operating expenses increased 3.5%, largely due to inflationary increases in property taxes, utilities, and salaries, as well as the consolidation of the Markel joint venture.
• Debt Management: The Company paid off $196.2 million of outstanding loans during the period and redeemed $50 million of Series B Preferred Stock in the first quarter of 2006. A new $350 million revolving credit facility was obtained in May 2006 (later upsized to $450 million in August 2006).

Guidance, Outlook, Risks, and Unusual Items

• Capital Recycling: The Company continues its strategy of selectively disposing of non-core properties to fund investments and debt reduction. Proceeds from dispositions were used to redeem preferred stock and pay down secured debt.
• Development Commitments: As of August 23, 2006, expected future capital expenditures for started or committed new development projects were approximately $256 million.
• Internal Controls: The Company disclosed that its internal control over financial reporting was not effective as of June 30, 2006, due to material weaknesses identified in the prior year regarding real estate asset accounting and journal entry approval processes. Remediation plans are underway but not yet complete.
• Regulatory Risks: The Company is subject to an ongoing SEC investigation regarding a previous restatement of financial results. Additionally, the Company received state excise tax assessments of approximately $5.1 million for periods 2002-2004, which it intends to dispute vigorously.
• Unusual Items: The Company recorded a $0.5 million loss on debt extinguishment related to refinancing its revolving credit facility. There were no impairment losses on assets held for use in the current period, compared to $3.2 million in the prior year.

Investor Verification Checklist

• Discontinued Operations Impact: Verify the sustainability of earnings by analyzing results excluding the significant one-time gains from discontinued operations present in the 2005 period but absent in 2006.
• Internal Control Remediation: Monitor the progress of remediation plans for material weaknesses in financial reporting, specifically regarding lease incentive accounting and journal entry controls.
• Debt Maturities: Review the schedule for $110 million of unsecured notes maturing in December 2006 and $63 million of secured debt maturing in February 2007 to assess refinancing risks.
• SEC Investigation Status: Track any updates regarding the SEC Division of Enforcement investigation into the Company's historical financial restatement.
• Development Pipeline: Assess the $256 million in committed capital expenditures against current cash flow and liquidity positions to ensure funding adequacy.