10-Q 1 hpi1q08_final.htm FORM 10Q MARCH 2008

 


 

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

______________

 

FORM 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2008

 

Commission file number: 001-13100

 

______________

 

HIGHWOODS PROPERTIES, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Maryland

56-1871668

 

 

(State or other jurisdiction
of incorporation or organization)

(I.R.S. Employer
Identification Number)

 

 

3100 Smoketree Court, Suite 600, Raleigh, N.C.

(Address of principal executive office)

 

27604

(Zip Code)

 

(919) 872-4924

(Registrant’s telephone number, including area code)

 

______________

 

Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

 

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of ‘accelerated filer,’ ‘large accelerated filer’ and ‘smaller reporting company’ in Rule 12b-2 of the Securities Exchange Act.

 

Large accelerated filer x

Accelerated filer o

Non-accelerated filer o

Smaller reporting company o

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act). Yes o No x

 

The Company had 57,309,347 shares of common stock outstanding as of March 31, 2008.

 


 

 

 

 

HIGHWOODS PROPERTIES, INC.

 

QUARTERLY REPORT FOR THE PERIOD ENDED MARCH 31, 2008

 

TABLE OF CONTENTS

 

PART 1 - FINANCIAL INFORMATION

 

 

ITEM 1. FINANCIAL STATEMENTS

2

 

 

Consolidated Balance Sheets as of March 31, 2008 and December 31, 2007

3

 

 

Consolidated Statements of Income for the three months ended March 31, 2008 and 2007

4

 

 

Consolidated Statement of Stockholders’ Equity for the three months ended March 31, 2008

5

 

 

Consolidated Statements of Cash Flows for the three months ended March 31, 2008 and 2007

6

 

 

Notes To Consolidated Financial Statements

8

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS

31

 

 

Disclosure Regarding Forward-Looking Statements

31

 

 

Overview

31

 

 

Results of Operations

34

 

 

Liquidity and Capital Resources

37

 

 

Critical Accounting Estimates

42

 

 

Funds From Operations

42

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

44

 

ITEM 4. CONTROLS AND PROCEDURES

45

 

PART II - OTHER INFORMATION

 

 

ITEM 1. LEGAL PROCEEDINGS

46

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

46

 

ITEM 6. EXHIBITS

46

 

 

 

 

 

Table of Contents

 

PART I - FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

We refer to (1) Highwoods Properties, Inc. as the “Company,” (2) Highwoods Realty Limited Partnership as the “Operating Partnership,” (3) the Company’s common stock as “Common Stock,” (4) the Company’s preferred stock as “Preferred Stock,” (5) the Operating Partnership’s common partnership interests as “Common Units,” (6) the Operating Partnership’s preferred partnership interests as “Preferred Units” and (7) in-service properties (excluding rental residential units) to which the Company and/or the Operating Partnership have title and 100.0% ownership rights as the “Wholly Owned Properties.”

 

The information furnished in the accompanying Consolidated Financial Statements reflects all adjustments (consisting of normal recurring accruals) that are, in our opinion, necessary for a fair presentation of the aforementioned financial statements for the interim period.

 

The aforementioned financial statements should be read in conjunction with the notes to Consolidated Financial Statements, Management’s Discussion and Analysis of Financial Condition and Results of Operations and Risk Factors included herein and in our 2007 Annual Report on Form 10-K.

 

 

2

 

 

Table of Contents

HIGHWOODS PROPERTIES, INC.

CONSOLIDATED BALANCE SHEETS

(Unaudited and in thousands, except share and per share amounts)

 

 

 

March 31,
2008

 

December 31,
2007

 

Assets:

 

 

 

 

 

 

Real estate assets, at cost:

 

 

 

 

 

 

 

Land

 

$

360,836

 

$

356,199

 

Buildings and tenant improvements

 

 

2,743,659

 

 

2,701,004

 

Development in process

 

 

107,129

 

 

101,661

 

Land held for development

 

 

96,839

 

 

103,365

 

 

 

 

3,308,463

 

 

3,262,229

 

Less-accumulated depreciation

 

 

(664,944

)

 

(647,685

)

Net real estate assets

 

 

2,643,519

 

 

2,614,544

 

Real estate and other assets, net, held for sale

 

 

18,299

 

 

18,309

 

Cash and cash equivalents

 

 

6,595

 

 

3,140

 

Restricted cash

 

 

13,862

 

 

15,896

 

Accounts receivable, net of allowance of $1,038 and $935, respectively

 

 

20,782

 

 

23,521

 

Notes receivable, net of allowance of $157 and $68, respectively

 

 

3,036

 

 

5,226

 

Accrued straight-line rents receivable, net of allowance of $667 and $440,
respectively

 

 

76,715

 

 

74,313

 

Investment in unconsolidated affiliates

 

 

58,054

 

 

58,046

 

Deferred financing and leasing costs, net of accumulated amortization

 

 

72,693

 

 

72,007

 

Prepaid expenses and other assets

 

 

44,263

 

 

41,953

 

Total Assets

 

$

2,957,818

 

$

2,926,955

 

 

 

 

 

 

 

 

 

Liabilities, Minority Interest and Stockholders' Equity:

 

 

 

 

 

 

 

Mortgages and notes payable

 

$

1,703,238

 

$

1,641,987

 

Accounts payable, accrued expenses and other liabilities

 

 

142,139

 

 

157,766

 

Financing obligations

 

 

35,296

 

 

35,071

 

Total Liabilities

 

 

1,880,673

 

 

1,834,824

 

Commitments and Contingencies (see Note 12)

 

 

 

 

 

 

 

Minority interest

 

 

67,596

 

 

70,098

 

Stockholders' Equity:

 

 

 

 

 

 

 

Preferred Stock, $.01 par value, 50,000,000 authorized shares;

 

 

 

 

 

 

 

8 5/8% Series A Cumulative Redeemable Preferred Shares (liquidation
preference $1,000 per share), 82,937 shares issued and
outstanding at both March 31, 2008 and December 31, 2007

 

 

82,937

 

 

82,937

 

8% Series B Cumulative Redeemable Preferred Shares (liquidation
preference $25 per share), 2,100,000 shares issued and
outstanding at both March 31, 2008 and December 31, 2007

 

 

52,500

 

 

52,500

 

Common stock, $.01 par value, 200,000,000 authorized shares;

 

 

 

 

 

 

 

57,309,347 and 57,167,193 shares issued and outstanding at
March 31, 2008 and December 31, 2007, respectively

 

 

573

 

 

572

 

Additional paid-in capital

 

 

1,447,958

 

 

1,448,055

 

Distributions in excess of net earnings

 

 

(572,591

)

 

(561,093

)

Accumulated other comprehensive loss

 

 

(1,828

)

 

(938

)

Total Stockholders' Equity

 

 

1,009,549

 

 

1,022,033

 

Total Liabilities, Minority Interest and Stockholders' Equity

 

$

2,957,818

 

$

2,926,955

 

 

See accompanying notes to consolidated financial statements.

 

3

 

 

Table of Contents

HIGHWOODS PROPERTIES, INC.

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited and in thousands, except per share amounts)

 

 

 

Three Months Ended
March 31,

 

 

 

2008

 

2007

 

Rental and other revenues

 

$

114,780

 

$

106,108

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

Rental property and other expenses

 

 

39,128

 

 

37,936

 

Depreciation and amortization

 

 

31,041

 

 

28,965

 

General and administrative

 

 

9,711

 

 

10,911

 

Total operating expenses

 

 

79,880

 

 

77,812

 

Interest expenses:

 

 

 

 

 

 

 

Contractual

 

 

23,463

 

 

22,689

 

Amortization of deferred financing costs

 

 

638

 

 

566

 

Financing obligations

 

 

740

 

 

992

 

 

 

 

24,841

 

 

24,247

 

Other income:

 

 

 

 

 

 

 

Interest and other income

 

 

803

 

 

1,514

 

 

 

 

803

 

 

1,514

 

Income before disposition of property, insurance gain, minority interest and

 

 

 

 

 

 

 

equity in earnings of unconsolidated affiliates

 

 

10,862

 

 

5,563

 

Gains on disposition of property, net

 

 

 

 

16,743

 

Gain from property insurance settlement

 

 

 

 

4,128

 

Minority interest

 

 

(837

)

 

(2,580

)

Equity in earnings of unconsolidated affiliates

 

 

1,989

 

 

9,717

 

Income from continuing operations

 

 

12,014

 

 

33,571

 

Discontinued operations:

 

 

 

 

 

 

 

Income from discontinued operations, net of minority interest

 

 

146

 

 

725

 

Gains on sales of discontinued operations, net of minority interest

 

 

3,483

 

 

18,262

 

 

 

 

3,629

 

 

18,987

 

Net income

 

 

15,643

 

 

52,558

 

Dividends on preferred stock

 

 

(2,838

)

 

(4,113

)

Net income available for common stockholders

 

$

12,805

 

$

48,445

 

 

 

 

 

 

 

 

 

Net income per common share - basic:

 

 

 

 

 

 

 

Income from continuing operations

 

$

0.16

 

$

0.52

 

Income from discontinued operations

 

 

0.07

 

 

0.34

 

Net income

 

$

0.23

 

$

0.86

 

Weighted average common shares outstanding - basic

 

 

56,729

 

 

56,040

 

 

 

 

 

 

 

 

 

Net income per common share - diluted:

 

 

 

 

 

 

 

Income from continuing operations

 

$

0.16

 

$

0.52

 

Income from discontinued operations

 

 

0.06

 

 

0.33

 

Net income

 

$

0.22

 

$

0.85

 

Weighted average common shares outstanding - diluted

 

 

61,050

 

 

61,900

 

Dividends declared per common share

 

$

0.425

 

$

0.425

 

 

See accompanying notes to consolidated financial statements.

 

4

 

 

Table of Contents

HIGHWOODS PROPERTIES, INC.

CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY

For the Three Months Ended March 31, 2008

(Unaudited and in thousands, except share amounts)

 

 

 

 

Number of
Common
Shares

 

Common
Stock

 

Series A
Preferred

 

Series B
Preferred

 

Additional
Paid-In
Capital

 

Accum-
ulated
Other
Compre-
hensive
Loss

 

Distri-
butions
in Excess
of Net
Earnings

 

Total

 

Balance at December 31, 2007

 

57,167,193

 

$

572

 

$

82,937

 

$

52,500

 

$

1,448,055

 

$

(938

)

$

(561,093

)

$

1,022,033

 

Issuance of Common Stock, net

 

(24,225

)

 

 

 

 

 

 

 

(686

)

 

 

 

 

 

(686

)

Common Stock dividends

 

 

 

 

 

 

 

 

 

 

 

 

 

(24,303

)

 

(24,303

)

Preferred Stock dividends

 

 

 

 

 

 

 

 

 

 

 

 

 

(2,838

)

 

(2,838

)

Adjustment to minority interest of unitholders in the Operating Partnership

 

 

 

 

 

 

 

 

 

(1,637

)

 

 

 

 

 

(1,637

)

Issuance of restricted stock, net

 

166,379

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amortization of restricted stock and stock options

 

 

 

1

 

 

 

 

 

 

2,226

 

 

 

 

 

 

2,227

 

Comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

 

 

 

 

 

 

 

 

15,643

 

 

15,643

 

Other comprehensive income/(loss)

 

 

 

 

 

 

 

 

 

 

 

(890

)

 

 

 

(890

)

Total comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

14,753

 

Balance at March 31, 2008

 

57,309,347

 

$

573

 

$

82,937

 

$

52,500

 

$

1,447,958

 

$

(1,828

)

$

(572,591

)

$

1,009,549

 

 

See accompanying notes to consolidated financial statements.

 

5

 

 

Table of Contents

HIGHWOODS PROPERTIES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited and in thousands)

 

 

 

Three Months Ended
March 31,

 

 

 

2008

 

2007

 

Operating activities:

 

 

 

 

 

 

 

Net income

 

$

15,643

 

$

52,558

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

 

 

Depreciation

 

 

27,358

 

 

26,139

 

Amortization of lease commissions

 

 

3,751

 

 

3,607

 

Amortization of lease incentives

 

 

222

 

 

222

 

Amortization of restricted stock and stock options

 

 

2,227

 

 

1,132

 

Amortization of deferred financing costs

 

 

638

 

 

566

 

Amortization of accumulated other comprehensive loss

 

 

80

 

 

142

 

Net gains on disposition of property

 

 

(3,726

)

 

(36,486

)

Gain from property insurance settlement

 

 

 

 

(4,128

)

Minority interest

 

 

1,091

 

 

4,119

 

Equity in earnings of unconsolidated affiliates

 

 

(1,989

)

 

(9,717

)

Change in financing obligations

 

 

225

 

 

(1

)

Distributions of earnings from unconsolidated affiliates

 

 

1,899

 

 

1,962

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

Accounts receivable

 

 

2,739

 

 

(1,057

)

Prepaid expenses and other assets

 

 

(3,316

)

 

223

 

Accrued straight-line rents receivable

 

 

(2,403

)

 

(1,572

)

Accounts payable, accrued expenses and other liabilities

 

 

(23,625

)

 

(11,965

)

Net cash provided by operating activities

 

 

20,814

 

 

25,744

 

Investing activities:

 

 

 

 

 

 

 

Additions to real estate assets and deferred leasing costs

 

 

(55,532

)

 

(66,275

)

Proceeds from disposition of real estate assets

 

 

6,072

 

 

65,028

 

Proceeds from property insurance settlement

 

 

 

 

4,940

 

Distributions of capital from unconsolidated affiliates

 

 

804

 

 

6,383

 

Net repayments in notes receivable

 

 

2,190

 

 

576

 

Contributions to unconsolidated affiliates

 

 

(841

)

 

 

Changes in restricted cash and other investing activities

 

 

2,387

 

 

(15,582

)

Net cash used in investing activities

 

 

(44,920

)

 

(4,930

)

Financing activities:

 

 

 

 

 

 

 

Distributions paid on Common Stock and Common Units

 

 

(25,982

)

 

(25,766

)

Dividends paid on Preferred Stock

 

 

(2,838

)

 

(4,113

)

Distributions to minority partner in consolidated affiliate

 

 

(258

)

 

(928

)

Net proceeds from the sale of Common Stock

 

 

(686

)

 

988

 

Repurchase of Common Units

 

 

(3,293

)

 

(27,402

)

Borrowings on revolving credit facility

 

 

203,200

 

 

106,400

 

Repayments of revolving credit facility

 

 

(184,100

)

 

(416,900

)

Borrowings on mortgages and notes payable

 

 

144,579

 

 

401,571

 

Repayments of mortgages and notes payable

 

 

(102,459

)

 

(68,696

)

Contributions from minority interest partner

 

 

 

 

1,045

 

Additions to deferred financing costs

 

 

(602

)

 

(2,776

)

Net cash provided by/(used in) financing activities

 

 

27,561

 

 

(36,577

)

Net increase/(decrease) in cash and cash equivalents

 

 

3,455

 

 

(15,763

)

Cash and cash equivalents at beginning of the period

 

 

3,140

 

 

16,690

 

Cash and cash equivalents at end of the period

 

$

6,595

 

$

927

 

 

See accompanying notes to consolidated financial statements.

 

6

 

 

Table of Contents

HIGHWOODS PROPERTIES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS - Continued

(Unaudited and in thousands)

 

Supplemental disclosure of cash flow information:

 

 

 

Three Months Ended
March 31,

 

 

 

2008

 

2007

 

Cash paid for interest, net of amounts capitalized (excludes cash distributions to
owners of sold properties accounted for as financings of $200 and $663 for
2008 and 2007, respectively)

 

$

29,977

 

$

22,666

 

 

Supplemental disclosure of non-cash investing and financing activities:

 

The following table summarizes the net asset acquisitions and dispositions subject to mortgage notes payable and other non-cash transactions. There were no non-cash investing and financing activities during the three months ended March 31, 2007.

 

 

 

Three Months Ended
March 31,

 

 

 

2008

 

2007

 

Assets:

 

 

 

 

 

 

 

Prepaid expenses and other assets

 

$

(561

)

 

 

 

 

$

(561

)

$

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

Accounts payable, accrued expenses and other liabilities

 

$

409

 

 

 

 

 

$

409

 

$

 

 

 

 

 

 

 

 

 

Minority Interest and Stockholders’ Equity

 

$

(970

)

$

 

 

See accompanying notes to consolidated financial statements.

 

 

7

 

 

Table of Contents

HIGHWOODS PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2008

(tabular dollar amounts in thousands, except per share data)

(Unaudited)

 

1.

DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES

 

Description of Business

 

Highwoods Properties, Inc., together with its consolidated subsidiaries (the "Company"), is a fully-integrated, self-administered and self-managed equity real estate investment trust ("REIT") that operates in the southeastern and midwestern United States. The Company conducts virtually all of its activities through Highwoods Realty Limited Partnership (the “Operating Partnership”). At March 31, 2008, the Company and/or the Operating Partnership wholly owned: 314 in-service office, industrial and retail properties; 96 rental residential units; 616 acres of undeveloped land suitable for future development, of which 475 acres are considered core holdings; and an additional 12 properties under development.

 

At March 31, 2008, the Company owned all of the preferred partnership interests (“Preferred Units”) and 93.5% of the common partnership interests ("Common Units") in the Operating Partnership. Limited partners (including certain officers and directors of the Company) own the remaining Common Units. Generally, the Operating Partnership is required to redeem each Common Unit at the request of the holder thereof for cash equal to the value of one share of the Company’s Common Stock, $.01 par value (the “Common Stock”), based on the average of the market price for the 10 trading days immediately preceding the notice date of such redemption, provided that the Company at its option may elect to acquire any such Common Units presented for redemption for cash or one share of Common Stock. The Common Units owned by the Company are not redeemable. During the three months ended March 31, 2008, the Company redeemed 106,613 Common Units for $3.3 million in cash, which increased the percentage of Common Units owned by the Company from 93.3% at December 31, 2007 to 93.5% at March 31, 2008. Preferred Units in the Operating Partnership were issued to the Company in connection with the Company’s Preferred Stock offerings in 1997 and 1998 (the “Preferred Stock”). The net proceeds raised from each of the Preferred Stock issuances were contributed by the Company to the Operating Partnership in exchange for the Preferred Units. The terms of each series of Preferred Units parallel the terms of the respective Preferred Stock as to dividends, liquidation and redemption rights.

 

Basis of Presentation

 

Our Consolidated Financial Statements are prepared in accordance with U.S. Generally Accepted Accounting Principles (“GAAP”). As more fully described in Notes 4 and 10, as required by Statement of Financial Accounting Standard No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” (“SFAS No. 144”), the Consolidated Balance Sheet at December 31, 2007 was revised from previously reported amounts to reflect in real estate and other assets held for sale those properties held for sale at March 31, 2008. The Consolidated Statement of Income for the three months ended March 31, 2007 was also revised from previously reported amounts to reflect in discontinued operations the operations of any property sold or held for sale in the first three months of 2008.

 

The Consolidated Financial Statements include the Operating Partnership, wholly owned subsidiaries and those subsidiaries in which we own a majority voting interest with the ability to control operations of the subsidiaries and where no substantive participating rights or substantive kick out rights have been granted to the minority interest holders. In accordance with Emerging Issues Task Force (“EITF”) Issue No. 04-5, “Determining Whether a General Partner or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights,” we consolidate partnerships, joint ventures and limited liability companies when we control the major operating and financial policies of the entity through majority ownership or in our capacity as general partner or managing member. In addition, we consolidate those entities, if any, where we are deemed to be the primary beneficiary in a variable interest entity (as defined by Financial Accounting Standards Board (“FASB”) Interpretation No. 46 (revised December 2003) “Consolidation of Variable Interest Entities” (“FIN 46(R)”)). All significant intercompany transactions and accounts have been eliminated.

 

8

 

 

Table of Contents

HIGHWOODS PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(tabular dollar amounts in thousands, except per share data)

 

 

 

1.

DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES - Continued

 

The accompanying unaudited financial information, in the opinion of management, contains all adjustments (including normal recurring accruals) necessary for a fair presentation of our financial position, results of operations and cash flows. We have condensed or omitted certain notes and other information from the interim financial statements presented in this Quarterly Report on Form 10-Q. These financial statements should be read in conjunction with our 2007 Annual Report on Form 10-K.

 

The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

 

Restricted Cash

 

Restricted cash represents cash deposits that are legally restricted or held by third parties on our behalf. They include security deposits from sales contracts on residential condominiums, construction-related escrows, property disposition proceeds set aside and designated or intended to fund future tax-deferred exchanges of qualifying real estate investments, escrows and reserves for debt service, real estate taxes and property insurance established pursuant to certain mortgage financing arrangements, and deposits given to lenders to un-encumber secured properties.

 

Income Taxes

 

The Company has elected and expects to continue to qualify as a REIT under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the “Code”). A corporate REIT is a legal entity that holds real estate assets and, through the payment of dividends to stockholders, is generally permitted to reduce or avoid the payment of federal and state income taxes at the corporate level. To maintain qualification as a REIT, the Company is required to distribute to its stockholders at least 90.0% of its annual REIT taxable income, excluding capital gains. Continued qualification as a REIT depends on the Company’s ability to satisfy the dividend distribution tests, stock ownership requirements and various other qualification tests prescribed in the Code. If the Company fails to qualify as a REIT in any taxable year, it will be subject to federal and state income taxes and may not be able to qualify as a REIT for four subsequent taxable years. We conduct certain business activities through a taxable REIT subsidiary, as permitted under the Code. The taxable REIT subsidiary is subject to federal and state income taxes on its net taxable income. We record provisions for income taxes, to the extent required under SFAS No. 109, “Accounting for Income Taxes” (“SFAS No. 109”), based on its income recognized for financial statement purposes, including the effects of temporary differences between such income and the amount recognized for tax purposes. Additionally, beginning January 1, 2007, we began to recognize and measure the effects of uncertain tax positions under FASB Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes, an interpretation of SFAS No. 109.” See Note 13 for discussion of the effect of FIN 48 on our accounting for income taxes.

 

9

 

 

Table of Contents

HIGHWOODS PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(tabular dollar amounts in thousands, except per share data)

 

 

 

1.

DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES - Continued

 

Minority Interest

 

Minority interest in the accompanying Consolidated Financial Statements relates primarily to the ownership by various individuals and entities other than the Company of Common Units in the Operating Partnership. In addition, minority interest is also recorded for the 50.0% interest in a consolidated affiliate, Highwoods-Markel Associates, LLC (“Markel”), the equity interest owned by a third party in a consolidated venture formed during 2006 with Real Estate Exchange Services (“REES”), and the 7% equity interest owned by a third party in Plaza Residential, LLC, a consolidated joint venture formed in February 2007 related to a residential condominium project, as described below. As of March 31, 2008, minority interest in the Operating Partnership consisted of approximately 4.0 million Common Units, which had an aggregate market value of $122.7 million based on the $31.07 per share closing price of the Common Stock as of such date. Minority interest in the net income of the Operating Partnership is computed by applying the weighted average percentage of Common Units not owned by the Company during the period (as a percent of the total number of outstanding Common Units) to the Operating Partnership’s net income after deducting distributions on Preferred Units. The result is the amount of minority interest expense (or income) recorded for the period. In addition, when a minority unitholder redeems a Common Unit for a share of Common Stock or cash, the minority interest is reduced and the Company’s share in the Operating Partnership is increased. At the end of each reporting period, the Company determines the amount that represents the minority unitholders’ share of the net assets (at book value) of the Operating Partnership and compares this amount to the minority interest balance that resulted from transactions during the period involving minority interest. The Company adjusts the minority interest liability to the computed share of net assets with an offsetting adjustment to the Company’s paid in capital.

 

The organizational documents of Markel require the entity to be liquidated through the sale of its assets upon reaching December 31, 2100. As controlling partner, we have an obligation to cause this property-owning entity to distribute proceeds of liquidation to the minority interest partner in these partially owned properties only if the net proceeds received by the entity from the sale of our assets warrant a distribution as determined by the agreement. This estimated settlement value is based on estimated third party consideration realizable by the entity upon a hypothetical disposition of the properties and is net of all other assets and liabilities. The actual amount of any distributions to the minority interest holder in this entity is difficult to predict due to many factors, including the inherent uncertainty of real estate sales. If the entity’s underlying assets are worth less than the underlying liabilities on the date of such liquidation, we would have no obligation to remit any consideration to the minority interest holder.

 

In the fourth quarter of 2006, we entered into an agreement with REES to ground lease certain development land to special purpose entities owned by REES. Under the agreement, REES will contribute 7% of the costs of constructing properties on this land not to exceed $4.0 million outstanding at any time. REES will generally earn an agreed fixed return for its economic investment in these entities. The balance of development costs will be funded by third party construction loans. If third party construction loans are not obtained, the remaining 93% of costs are loaned to the entities by us. Subject to the exercise of a purchase option, it is expected that we will acquire the properties in the future at an amount generally equal to the actual development costs incurred plus the fixed return earned by REES for its economic investment in these entities. As we are considered the primary beneficiary, we consolidate these entities in accordance with FIN 46(R). These entities will be re-evaluated for primary beneficiary status when the entities undertake additional activity, such as placing the development projects in-service. REES’s investment in the entities is included in minority interest as shown in the tables below. All costs to form the entities and other related fees have been expensed as incurred.

 

10

 

 

Table of Contents

HIGHWOODS PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(tabular dollar amounts in thousands, except per share data)

 

 

 

1.

DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES - Continued

 

In the first quarter of 2007, our taxable REIT subsidiary formed Plaza Residential, LLC with Dominion Partners, LLC (“Dominion”). Plaza Residential was formed to develop and sell 139 residential condominiums to be constructed above an office tower being developed by us in Raleigh, NC. Dominion has a 7% equity interest in the joint venture, will perform development services for the joint venture for a market development fee and guarantees 40.0% of the construction financing. Dominion will also receive 35.0% of the net profits from the joint venture once the partners have received distributions equal to their equity plus a 12.0% return on their equity. We are consolidating this majority owned joint venture and intercompany transactions have been eliminated in the Consolidated Financial Statements. At March 31, 2008, binding sale contracts had been executed for all of the residential condominiums. $4.1 million of deposits related to these contracts (non-refundable unless we default in our obligation to deliver the units) had been received and are reflected in restricted cash with a corresponding amount in other liabilities. We will account for the sale of the residential condominiums in accordance with SFAS No. 66, “Accounting for Sales of Real Estate” (“SFAS No. 66”) and will record the sales when the related closings take place.

 

Following is minority interest as reflected in our Consolidated Statements of Income and Consolidated Balance Sheets:

 

 

 

Three Months Ended
March 31,

 

 

 

2008

 

2007

 

Amount shown as minority interest in continuing operations (1)

 

$

(837

)

$

(2,580

)

Amount related to income from discontinued operations

 

 

(11

)

 

(58

)

Amount related to gains on sales of discontinued operations

 

 

(243

)

 

(1,481

)

Total minority interest in net income

 

$

(1,091

)

$

(4,119

)

______________

(1)

Minority interest related to the consolidated entities other than the Operating Partnership amounted to $0.2 million for each of the three months ended March 31, 2008 and 2007.

 

 

 

March 31,
2008

 

December 31,
2007

 

Minority interest in the Operating Partnership

 

$

60,852

 

$

63,294

 

Minority interest in Markel

 

 

3,386

 

 

3,446

 

Minority interest in REES

 

 

2,561

 

 

2,561

 

Minority interest in Plaza Residential

 

 

797

 

 

797

 

Total minority interest

 

$

67,596

 

$

70,098

 

 

 

11

 

 

Table of Contents

HIGHWOODS PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(tabular dollar amounts in thousands, except per share data)

 

 

 

1.

DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES - Continued

 

Impact of Newly Adopted and Issued Accounting Standards

 

In September 2006, the FASB issued Statement No. 157, “Fair Value Measurements” (“SFAS No. 157”), which defines fair value, establishes a framework for using fair value to measure assets and liabilities, and expands disclosures about fair value measurements. The statement applies whenever other statements require or permit assets or liabilities to be measured at fair value. SFAS No. 157 became effective for fiscal years beginning after November 15, 2007, except for nonfinancial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis, for which application has been deferred for one year. We adopted SFAS No. 157 in the first quarter of 2008 (See Note 9).

 

In November 2006, the FASB ratified EITF Issue No. 06-8, “Applicability of the Assessment of a Buyer’s Continuing Investment under FASB Statement No. 66 for Sales of Condominiums.” EITF No. 06-8 provided additional guidance on whether the seller of a condominium unit is required to evaluate the buyer’s continuing investment under SFAS No. 66 in order to recognize profit from the sale under the percentage of completion method. The EITF concluded that both the buyer’s initial and continuing investment must meet the criteria in SFAS No. 66 in order for condominium sale profits to be recognized under the percentage of completion method. Sales of condominiums not meeting the continuing investment test must be accounted for under the deposit method. We adopted EITF No. 06-8 in the first quarter of 2008 and such adoption did not have an effect on our financial condition or results of operations.

 

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS No. 159”), which permits all entities to choose to measure eligible items at fair value at specified election dates. We adopted SFAS No. 159 on January 1, 2008 and such adoption did not have an effect on our financial condition or results of operations.

 

In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations” (“SFAS No. 141(R)”), which addresses principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed and any noncontrolling interest in the acquiree. SFAS No. 141(R) becomes effective for us on January 1, 2009. We are currently evaluating the impact SFAS No. 141(R) will have on our financial condition and results of operations.

 

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements – an amendment of ARB No. 51” (“SFAS No. 160”), which establishes accounting and presentation standards for a noncontrolling interest in a subsidiary and amends certain of ARB No. 51’s consolidation procedures for consistency with other business combination standards. SFAS No. 160 becomes effective for us on January 1, 2009. We are currently evaluating the impact SFAS No. 160 will have on our financial condition and results of operations.

 

In December 2007, the FASB ratified EITF Issue No. 07-6 “Accounting for the Sale of Real Estate Subject to the Requirements of FASB Statement No. 66, Accounting for Sales of Real Estate, When the Agreement Includes a Buy-Sell Clause” (“EITF No. 07-6”), which addresses whether a buy-sell clause represents a prohibited form of continuing involvement that would preclude partial sale and profit recognition pursuant to SFAS No. 66. We adopted EITF No. 07-6 in the first quarter of 2008 and such adoption did not have an effect on our financial condition or results of operations.

 

12

 

 

Table of Contents

HIGHWOODS PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(tabular dollar amounts in thousands, except per share data)

 

 

 

1.

DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES - Continued

 

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities” (“SFAS No. 161”), which amends and expands the disclosure requirements of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” This statement is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. SFAS No. 161 becomes effective for us on January 1, 2009. We are currently evaluating the impact SFAS No. 161 will have on our financial condition and results of operations.

 

2.

INVESTMENTS IN UNCONSOLIDATED AND OTHER AFFILIATES

 

We have retained equity interests ranging from 12.5% to 50.0% in various joint ventures with unrelated investors. We account for our unconsolidated joint ventures using the equity method of accounting. As a result, the assets and liabilities of these joint ventures for which we use the equity method of accounting are not included on our Consolidated Balance Sheet.

 

During the third quarter of 2006, three of our joint ventures made distributions aggregating $17.0 million as a result of a refinancing of debt related to various properties held by the joint ventures. We received 50.0% of such distributions. As a result of these distributions, our investment account in these joint ventures became negative. The new debt is non-recourse; however, we and our partner have guaranteed other debt and have contractual obligations to support the joint ventures, which are included in the Guarantees and Other Obligations table in Note 12. Therefore, in accordance with SOP 78-9, “Accounting for Investments in Real Estate Ventures,” we recorded the distributions as a reduction of the investment account and included the resulting negative investment balances of $10.9 million in accounts payable, accrued expenses and other liabilities in the Consolidated Balance Sheet at March 31, 2008.

 

Four of our joint ventures are consolidated. SF-HIW Harborview Plaza, LP is accounted for as a financing arrangement pursuant to SFAS No. 66, as described in Note 3 to the Consolidated Financial Statements in our 2007 Annual Report on Form 10-K. Markel, REES and Plaza Residential, which are discussed in Note 1, are each consolidated.

 

 

13

 

 

Table of Contents

HIGHWOODS PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(tabular dollar amounts in thousands, except per share data)

 

 

 

2.

INVESTMENTS IN UNCONSOLIDATED AND OTHER AFFILIATES - Continued

 

Investments in unconsolidated affiliates as of March 31, 2008 and combined summarized income statements for our unconsolidated joint ventures for the three months ended March 31, 2008 and 2007 were as follows:

 


Joint Venture

 


Location of Properties

 

Ownership
Interest

 

 

Board of Trade Investment Company

 

Kansas City, MO

 

49.00

%

 

Kessinger/Hunter, LLC

 

Kansas City, MO

 

26.50

%

 

4600 Madison Associates, LLC

 

Kansas City, MO

 

12.50

%

 

Plaza Colonnade, LLC

 

Kansas City, MO

 

50.00

%

 

Dallas County Partners I, LP

 

Des Moines, IA

 

50.00

%

 

Dallas County Partners II, LP

 

Des Moines, IA

 

50.00

%

 

Dallas County Partners III, LP

 

Des Moines, IA

 

50.00

%

 

Fountain Three

 

Des Moines, IA

 

50.00

%

 

RRHWoods, LLC

 

Des Moines, IA

 

50.00

%

 

Highwoods DLF 98/29, LP

 

Atlanta, GA; Charlotte, NC; Greensboro, NC;
Raleigh, NC; Orlando, FL; Baltimore, MD

 

22.81

%

 

Highwoods DLF 97/26 DLF 99/32, LP

 

Atlanta, GA; Greensboro, NC; Orlando, FL

 

42.93

%

 

Highwoods KC Glenridge Office, LP

 

Atlanta, GA

 

40.00

%

 

Highwoods KC Glenridge Land, LP

 

Atlanta, GA

 

40.00

%

 

HIW-KC Orlando, LLC

 

Orlando, FL

 

40.00

%

 

Concourse Center Associates, LLC

 

Greensboro, NC

 

50.00

%

 

Highwoods DLF Forum, LLC

 

Raleigh, NC

 

25.00

%

 

 

 

 

 

Three Months Ended
March 31,

 

 

 

2008

 

2007

 

Income Statements:

 

 

 

 

 

 

 

Revenues

 

$

38,529

 

$

38,017

 

Expenses:

 

 

 

 

 

 

 

Operating expenses

 

 

18,431

 

 

15,163

 

Depreciation and amortization

 

 

7,458

 

 

7,253

 

Interest expense and loan cost amortization

 

 

8,487

 

 

8,632

 

Total expenses

 

 

34,376

 

 

31,048

 

Income before disposition of property

 

 

4,153

 

 

6,969

 

Gains on disposition of property

 

 

 

 

20,621

 

Net income

 

$

4,153

 

$

27,590

 

Our share of:

 

 

 

 

 

 

 

Net income (1)

 

$

1,989

 

$

9,717

 

Depreciation and amortization (real estate related)

 

$

2,935

 

$

2,866

 

Interest expense and loan cost amortization

 

$

3,529

 

$

3,661

 

Gains on disposition of property

 

$

 

$

7,158

 

______________

(1)

Our share of net income differs from our weighted average ownership percentage in the joint ventures’ net income due to our purchase accounting and other related adjustments.

 

14

 

 

Table of Contents

HIGHWOODS PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(tabular dollar amounts in thousands, except per share data)

 

 

 

2.

INVESTMENTS IN UNCONSOLIDATED AND OTHER AFFILIATES - Continued

 

On September 27, 2004, we and an affiliate of Crosland, Inc. (“Crosland”) formed Weston Lakeside, LLC, in which we had a 50.0% ownership interest. Crosland managed and operated this joint venture, which constructed 332 rental residential units in three buildings at a total cost of approximately $33.7 million. Crosland received 3.25% of all project costs other than land as a development fee and 3.5% of the gross revenue of the joint venture in management fees. We provided certain development services for the project and received a fee equal to 1.0% of all project costs excluding land. We accounted for this joint venture using the equity method of accounting. On February 22, 2007, the joint venture sold the 332 rental residential units to a third party for gross proceeds of $45.0 million and paid off all of its outstanding debt and various development related costs. The joint venture recorded a gain of $11.3 million in the first quarter of 2007 related to this sale and we recorded $5.0 million as our proportionate share through equity in earnings of unconsolidated affiliates. Our share of the gain was less than 50.0% due to Crosland’s preferred return as the developer. We received aggregate net distributions of $6.2 million. Weston Lakeside, LLC has been dissolved.

 

We have a 22.81% interest in a joint venture (“DLF I”) with Schweiz-Deutschland-USA Dreilander Beteiligung Objekt DLF 98/29-Walker Fink-KG ("DLF"). We are the property manager and leasing agent of DLF I’s properties and receive customary management and leasing fees. On March 12, 2007, DLF I sold five properties to a third party for gross proceeds of $34.2 million and recorded a gain of $9.3 million related to this sale. We recorded $2.1 million as our proportionate share of this gain through equity in earnings of unconsolidated affiliates. On May 21, 2007, DLF I acquired Eola Park Centre, a 167,000 square foot office building in Orlando, Florida, for $39.3 million. In June 2007, the joint venture obtained a $27.7 million loan secured by Eola Park Centre. Simultaneously with DLF I’s acquisition of Eola Park Centre, we separately acquired an adjacent parcel of development land for $2.0 million on a wholly-owned basis.

 

In March 2008, we and an affiliate of DLF formed a new joint venture, Highwoods DLF Forum, LLC, in which we have a 25.00% ownership interest. Upon formation of this joint venture, we contributed $0.8 million of cash. On April 3, 2008, Highwoods DLF Forum, LLC, acquired The Forum, which is a 635,000 square foot office park in Raleigh, North Carolina, for approximately $113 million. We contributed an additional $11.5 million to Highwoods DLF Forum, LLC and, simultaneously with the acquisition of The Forum, the joint venture obtained a $67.5 million secured loan. We are the property manager and leasing agent for the office park and receive customary management fees and leasing commissions. We will account for this unconsolidated joint venture using the equity method of accounting.

 

For additional information regarding our other investments in unconsolidated and other affiliates, see Note 2 to the Consolidated Financial Statements in our 2007 Annual Report on Form 10-K.

 

3.

FINANCING ARRANGEMENTS

 

For information regarding sale transactions that have been accounted for as financing arrangements under paragraphs 25 through 29 of SFAS No. 66, see Notes 5 and 9 herein and Note 3 to the Consolidated Financial Statements in our 2007 Annual Report on Form 10-K.

 

 

15

 

 

Table of Contents

HIGHWOODS PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(tabular dollar amounts in thousands, except per share data)

 

 

 

4.

INVESTMENT ACTIVITIES AND IMPAIRMENT OF LONG-LIVED ASSETS

 

Dispositions

 

Gains from dispositions not classified as discontinued operations consisted of the following:

 

 

 

Three Months Ended
March 31,

 

 

 

2008

 

2007

 

Gains on disposition of land

 

$

 

$

15,835

 

Gains on disposition of depreciable properties

 

 

 

 

908

 

Total

 

$

 

$

16,743

 

 

Net gains on sales of discontinued operations, net of minority interest, consisted of the following:

 

 

 

Three Months Ended
March 31,

 

 

 

2008

 

2007

 

Gains on disposition of depreciable properties

 

$

3,726

 

$

19,743

 

Allocable minority interest

 

 

(243

)

 

(1,481

)

Total

 

$

3,483

 

$

18,262

 

 

See Note 10 for information on discontinued operations.

 

The above gains on land and depreciable properties include deferred gain recognition from prior sales.

 

Development

 

We currently have under development 12 office, industrial and retail properties aggregating 2.1 million square feet and 139 for-sale residential units. The aggregate cost of these properties is currently expected to total approximately $343 million when fully leased and completed, of which $215 million was incurred as of March 31, 2008. The weighted average pre-leasing of such development projects was 68% at March 31, 2008. Six of these properties aggregating 1.2 million square feet and $127 million total investment have been completed and transferred to completed real estate assets at various times prior to March 31, 2008, but had not yet reached projected 95% stabilized occupancy. The remaining development properties are still under construction and are included in Development in Process in the Consolidated Balance Sheet.

 

In addition to the development projects discussed above, during the three months ended March 31, 2008, four properties were completed and placed in service. The weighted average pre-leasing of these properties was 88% and the total investment aggregated approximately $51.7 million at March 31, 2008.

 

Impairments of Long-Lived Assets

 

SFAS No. 144 also requires that a long-lived asset classified as held for sale be measured at the lower of the carrying value or fair value less cost to sell. During the three months ended March 31, 2008 and 2007, there were no properties held for sale which had a carrying value that was greater than fair value less cost to sell; therefore, no impairment loss was recognized in the Consolidated Statements of Income for the three months ended March 31, 2008 and 2007.

 

16

 

 

Table of Contents

HIGHWOODS PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(tabular dollar amounts in thousands, except per share data)

 

 

 

4.

INVESTMENT ACTIVITIES AND IMPAIRMENT OF LONG-LIVED ASSETS - Continued

 

SFAS No. 144 also requires that if indicators of impairment exist, the carrying value of a long-lived asset classified as held for use be compared to the sum of its estimated undiscounted future cash flows. If the carrying value is greater than the sum of its undiscounted future cash flows, an impairment loss should be recognized for the excess of the carrying amount of the asset over its estimated fair value. In each of the three months ended March 31, 2008 and 2007, no indicators of impairment existed for assets held for use. Therefore, no impairment losses were recorded in the three months ended March 31, 2008 and 2007.

 

5.

MORTGAGES, NOTES PAYABLE AND FINANCING OBLIGATIONS

 

Our consolidated mortgages and notes payable consisted of the following at March 31, 2008 and December 31, 2007:

 

 

 

March 31,
2008

 

December 31,
2007

 

Secured mortgage loans

 

$

669,931

 

$

665,311

 

Unsecured loans

 

 

1,033,307

 

 

976,676

 

Total

 

$

1,703,238

 

$

1,641,987

 

 

As of March 31, 2008, our secured mortgage loans were secured by real estate assets with an aggregate undepreciated book value of approximately $1.1 billion.

 

Our $450 million unsecured revolving credit facility is initially scheduled to mature on May 1, 2009. Assuming no default exists, we have an option to extend the maturity date by one additional year. The interest rate is LIBOR plus 80 basis points and the annual base facility fee is 20 basis points. The revolving credit facility had $201 million of availability at March 31, 2008.

 

On March 22, 2007, the Operating Partnership issued $400 million aggregate principal amount of 5.85% Notes due March 15, 2017, net of original issue discount of $1.2 million. We used the net proceeds from the issuance of the notes to repay borrowings outstanding under an unsecured non-revolving credit facility that was obtained on January 31, 2007 (which was subsequently terminated) and under the revolving credit facility.

 

On June 5, 2007, two three-year secured construction loans totaling $24.7 million with interest at 175 basis points over LIBOR were obtained by REES, a consolidated joint venture (see Note 1). Subsequently, on July 17, 2007, REES obtained an additional $13.7 million, three-year secured construction loan with interest at 165 basis points over LIBOR. In October 2007, REES paid off one of the original secured construction loans, which had accounted for $4.4 million of the original $24.7 million. At March 31, 2008, $24.4 million was outstanding under these two remaining loans.

 

On December 20, 2007, we closed a $70 million secured revolving construction facility. The loan matures on December 20, 2010. The interest rate is based on LIBOR plus 85 basis points. At March 31, 2008, there were no amounts outstanding on this revolving facility.

 

In December 2007, Plaza Residential, LLC, a consolidated joint venture (see Note 1), obtained a two-year, $34.1 million secured construction loan with interest at 140 basis points over LIBOR. At March 31, 2008, there was $2.5 million outstanding on this loan.

 

On February 1, 2008, we paid off at maturity $100.0 million of 7.125% unsecured notes using borrowings under our revolving credit facility. On February 26, 2008, we closed a $137.5 million three-year term loan that bears interest at LIBOR plus 110 basis points. Proceeds from this loan were used to reduce the outstanding borrowings under our revolving credit facility and for short-term investments.

 

17

 

 

Table of Contents

HIGHWOODS PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(tabular dollar amounts in thousands, except per share data)

 

 

 

5.

MORTGAGES, NOTES PAYABLE AND FINANCING OBLIGATIONS - Continued

 

Our revolving credit facility, our term loan and the indenture that governs the Operating Partnership’s outstanding notes require us to comply with customary operating covenants and various financial and operating ratios. We and the Operating Partnership are each currently in compliance with all such requirements.

 

Financing Obligations

 

Our financing obligations consisted of the following at March 31, 2008 and December 31, 2007:

 

 

 

March 31,
2008

 

December 31,
2007

 

SF-HIW Harborview, LP financing obligation (1)

 

$

16,781

 

$

16,566

 

Tax increment financing obligation (2)

 

 

17,395

 

 

17,395

 

Capitalized ground lease obligation (3)

 

 

1,120

 

 

1,110

 

Total

 

$

35,296

 

$

35,071

 

______________

(1)

See Note 3 to the Consolidated Financial Statements in our 2007 Annual Report on Form 10-K for further discussion of this financing obligation. See Note 9 for Fair Value Measurement disclosure.

(2)

In connection with tax increment financing for construction of a public garage related to an office building, we are obligated to pay fixed special assessments over a 20-year period. The net present value of these assessments, discounted at 6.93% at the inception of the obligation, which represents the interest rate on the underlying bond financing, is shown as a financing obligation in the Consolidated Balance Sheet. We also receive special tax revenues and property tax rebates recorded in interest and other income, which are intended, but not guaranteed, to provide funds to pay the special assessments.

On December 3, 2007, we acquired for $20.9 million the remaining outstanding bonds, at par value, that were issued by a municipal authority in connection with this tax increment financing. These available for sale securities are carried at estimated fair value with unrealized gains or losses reported in other comprehensive income, in accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” See Note 9 for Fair Value Measurement disclosure.

(3)

Represents a capitalized lease obligation to the lessor of land on which we are constructing a new building. We are obligated to make fixed payments to the lessor through October 2022 and the lease provides for fixed price purchase options in the ninth and tenth years of the lease. We intend to exercise the purchase option in order to prevent an economic penalty related to conveying the building to the lessor at the expiration of the lease. The net present value of the fixed rental payments and purchase option through the ninth year was calculated using a discount rate of 7.1%. The assets and liabilities under the capital lease are recorded at the lower of the present value of minimum lease payments or the fair value. The liability accretes each month for the difference between the interest rate on the financing obligation and the fixed payments. The accretion will continue until the liability equals the purchase option of the land in the ninth year of the lease.

 

6.

EMPLOYEE BENEFIT PLANS

 

Compensation Programs

 

During the three months ended March 31, 2008, we granted under our Amended and Restated 1994 Stock Option Plan (the “Stock Option Plan”) 0.3 million stock options at an exercise price equal to the closing market price of a share of our common stock on the date of grant. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model, which resulted in a weighted-average grant date fair value per share of $3.18. We also granted 0.09 million shares of time-based restricted stock and 0.07 million shares of performance-based and total return-based restricted stock with a weighted-average grant date fair value per share of $30.09 and $30.18, respectively. Shares of total return-based restricted stock issued in 2008 will generally vest only to the extent our absolute total return for the three-year period ended December 31, 2010 is at least 22% or if our total return exceeds 100% of the peer group index. See Note 6 to the Consolidated Financial Statements in our 2007 Annual Report on Form 10-K for additional information regarding our equity incentive and other compensation plans.

 

18

 

 

Table of Contents

HIGHWOODS PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(tabular dollar amounts in thousands, except per share data)

 

 

 

6.

EMPLOYEE BENEFIT PLANS - Continued

 

During the three months ended March 31, 2008 and 2007, we recognized approximately $2.2 million and $1.2 million, respectively, of stock-based compensation expense. As of March 31, 2008, there was $13.9 million of total unrecognized stock-based compensation costs, which will be recognized over a weighted average remaining contractual term of 2.5 years.

 

7.

DERIVATIVE FINANCIAL INSTRUMENTS AND OTHER FINANCIAL INSTRUMENTS HELD FOR SALE

 

Accumulated Other Comprehensive Loss (“AOCL”) at March 31, 2008 was $1.8 million and consisted of deferred gains and losses from past cash flow hedging instruments, deferred losses on current cash flow hedges and the mark to market adjustment for bonds that are classified as held for sale.

 

The amount of deferred gains and losses from past cash flow hedging instruments which are being recognized as interest expense over the terms of the related debt aggregated $0.8 million (see Note 8). We expect that the portion of the cumulative loss recorded in AOCL at March 31, 2008 associated with these derivative instruments, which will be recognized as interest expense within the next 12 months, will be approximately $0.03 million.

 

In January 2008, we entered into two floating-to-fixed interest rate swaps for a one-year period with respect to an aggregate of $50 million of borrowings outstanding under our revolving credit facility and other floating rate debt. These swaps fix the underlying LIBOR rate under which interest on such borrowings is based at 3.26% for $30 million of borrowings and 3.24% for $20 million of borrowings. These swaps were designated as hedges under SFAS No. 133. Accordingly, the swaps are being accounted for as cash flow hedges. We expect that the portion of the cumulative loss recorded in AOCL at March 31, 2008 associated with these derivative instruments, which will be recognized within the next 12 months, will be $0.4 million. See Note 9 for Fair Value Measurement disclosure.

 

We currently have an investment in bonds that were issued by a municipal authority in connection with tax increment financing (see Note 5). These bonds are currently being held for sale and thus are being recorded at fair value with the offset recorded in AOCL. The amount of unrealized loss at March 31, 2008 was $0.6 million. See Note 9 for Fair Value Measurement disclosure.

 

8.

OTHER COMPREHENSIVE INCOME

 

Other comprehensive income represents net income plus the changes in certain amounts deferred in accumulated other comprehensive income/(loss) related to hedging and other activities not reflected in the Consolidated Statements of Income. The components of other comprehensive income are as follows:

 

 

 

Three Months Ended
March 31,

 

 

 

2008

 

2007

 

Net income

 

$

15,643

 

$

52,558

 

Other comprehensive income:

 

 

 

 

 

 

 

Unrealized loss on available for sale securities

 

 

(561

)

 

 

Loss on cash-flow hedge

 

 

(409

)

 

 

Amortization of hedging gains and losses included in other comprehensive income

 

 

80

 

 

142

 

Total other comprehensive (loss)/income

 

 

(890

)

 

142

 

Total comprehensive income

 

$

14,753

 

$

52,700

 

 

 

19

 

 

Table of Contents

HIGHWOODS PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(tabular dollar amounts in thousands, except per share data)

 

 

 

9.

FAIR VALUE MEASUREMENTS

 

As stated in Note 1, on January 1, 2008, we adopted SFAS No. 157 for our financial assets and liabilities. Our adoption of SFAS No. 157 did not impact our financial position, results of operations or liquidity. In accordance with FASB Staff Position No. FAS 157-2, “Effective Date of FASB Statement No. 157” (“FSP FAS 157-2”), we elected to defer until January 1, 2009 the adoption of SFAS No. 157 for all nonfinancial assets and nonfinancial liabilities that are not recognized or disclosed at fair value in the financial statements on a recurring basis. The adoption of SFAS No. 157 for those assets and liabilities within the scope of FSP FAS 157-2 is not expected to have a material impact on our financial position, results of operations or liquidity.

 

SFAS No. 157 provides a framework for measuring fair value and requires expanded disclosure regarding fair value measurements. SFAS No. 157 defines fair value as the price that would be received for an asset or the exit price that would be paid to transfer a liability in the principal or most advantageous market in an orderly transaction between market participants on the measurement date. SFAS No. 157 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs, where available. The following summarizes the three levels of inputs required by the standard that we use to measure fair value, as well as the assets and liabilities that we value using those levels of inputs.

 

Level 1. Quoted prices in active markets for identical assets or liabilities. Our Level 1 assets are comprised of investments in marketable securities which we use to pay benefits under our deferred compensation plan. Our Level 1 liabilities are our obligations to pay certain deferred compensation plan benefits whereby participants have designated investment options (primarily mutual funds) to serve as the basis for measurement of the notional value of their accounts.

 

Level 2. Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the related assets or liabilities. Our Level 2 assets are bonds that are not routinely traded whose fair value is determined using an estimate of projected redemption value predicated upon quoted bid/ask prices for similar unrated bonds. Our Level 2 liabilities are interest rate swaps whose fair value is determined using a price model predicated upon observable market inputs.

 

Level 3. Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Our Level 3 liabilities consist of the right of our joint venture partner in SF-HIW Harborview, LP to put its 80% equity interest in SF-HIW Harborview Plaza, LP to us in exchange for cash at any time during the one-year period commencing September 11, 2014. Because of the put option, this transaction is accounted for as a financing transaction. Accordingly, the assets and liabilities and operations related to the Harborview Plaza, the property owned by SF-HIW Harborview Plaza, LP, including any new financing by the partnership, remain in our Consolidated Financial Statements. As a result, we have established a financing obligation equal to the net equity contributed by the other partner. At the end of each annual reporting period, the balance of the financing obligation is adjusted to equal the greater of the original financing obligation or the current fair value of the put option. Due to the lack of observable market quotes for the put option, we utilize a valuation model predicated upon capitalization rates and discounted cash flows, which take into account estimates such as future lease rollovers, lease up activity and future expenditures, to calculate the estimated fair value of the put option. The estimated fair value of the put option was $15.9 million and $15.6 million at March 31, 2008 and December 31, 2007, respectively. This amount is adjusted by a related valuation allowance account, which is being amortized prospectively through September 2014 as interest expense on financing obligation. The amount of the valuation allowance account was $0.9 million and $1.0 million at March 31, 2008 and December 31, 2007, respectively. The amount amortized into interest expense from the valuation allowance was $0.03 million during the three months ended March 31, 2008. For more information regarding this joint venture, see Note 3 to the Consolidated Financial Statements in our 2007 Annual Report on Form 10-K.

 

 

20

 

 

Table of Contents

HIGHWOODS PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(tabular dollar amounts in thousands, except per share data)

 

 

 

9.

FAIR VALUE MEASUREMENTS - Continued

 

The following table sets forth the financial assets and liabilities as of March 31, 2008 that we measured at fair value on a recurring basis by level within the fair value hierarchy. As required by SFAS No. 157, assets and liabilities measured at fair value are classified in their entirety based on the lowest level of input that is significant to their fair value measurement.

 

 

 

 

 

 

Fair Value Measurements Using

 

 

 

 

 

Level 1

 

Level 2

 

Level 3

 

 

 

Balance at
March 31, 2008

 

Quoted Prices in
Active Markets
for Identical
Assets

 

Significant
Other
Observable
Inputs

 

Significant
Unobservable
Inputs

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

Marketable securities (1)

 

$

7,225

 

$

7,225

 

$

 

$

 

Taxable bonds

 

 

20,354

 

 

 

 

20,354

 

 

 

Total Assets

 

$

27,579

 

$

7,225

 

$

20,354

 

$

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate swaps

 

$

917

 

$

 

$

917

 

$

 

Deferred compensation

 

 

7,225

 

 

7,225

 

 

 

 

 

Harborview financing obligation

 

 

15,869

 

 

 

 

 

 

15,869

 

Harborview valuation allowance

 

 

912

 

 

 

 

 

 

912

 

Total Liabilities

 

$

24,923

 

$

7,225

 

$

917

 

$

16,781

 

______________

 

(1)

The marketable securities are held through our officer deferred compensation plans.

 

21

 

 

Table of Contents

HIGHWOODS PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(tabular dollar amounts in thousands, except per share data)

 

 

 

10.

DISCONTINUED OPERATIONS

 

As part of our business strategy, we from time to time selectively dispose of non-core properties in order to use the net proceeds for investments, for repayment of debt and/or retirement of Preferred Stock, or other purposes. The table below sets forth the net operating results of those assets classified as discontinued operations in our Consolidated Financial Statements. These assets classified as discontinued operations comprise 1.3 million square feet of office and industrial properties and 13 rental residential units sold during 2007 and the three months ended March 31, 2008 and 0.1 million square feet of office properties held for sale at March 31, 2008. These long-lived assets relate to disposal activities that were initiated subsequent to the effective date of SFAS No. 144, or that met certain stipulations prescribed by SFAS No. 144. The operations of these assets have been reclassified from our ongoing operations to discontinued operations, and we will not have any significant continuing involvement in the operations after the disposal transactions:

 

 

 

Three Months Ended
March 31,

 

 

 

2008

 

2007

 

Rental and other revenues

 

$

506

 

$

2,876

 

Operating expenses:

 

 

 

 

 

 

 

Rental property and other expenses

 

 

282

 

 

1,323

 

Depreciation and amortization

 

 

68

 

 

781

 

Total operating expenses

 

 

350

 

 

2,104

 

Other income

 

 

1

 

 

11

 

Income before minority interest and gains on sales of discontinued operations

 

 

157

 

 

783

 

Minority interest in discontinued operations

 

 

(11

)

 

(58

)

Income from discontinued operations, net of minority interest

 

 

146

 

 

725

 

Gains on sales of discontinued operations

 

 

3,726

 

 

19,743

 

Minority interest in discontinued operations

 

 

(243

)

 

(1,481

)

Gains on sales of discontinued operations, net of minority interest

 

 

3,483

 

 

18,262

 

Total discontinued operations

 

$

3,629

 

$

18,987

 

 

The net book value of properties classified as discontinued operations that were sold during 2007 and the three months ended March 31, 2008 and held for sale at March 31, 2008 aggregated $84.5 million.

 

 

22

 

 

Table of Contents

HIGHWOODS PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(tabular dollar amounts in thousands, except per share data)

 

 

 

10.

DISCONTINUED OPERATIONS - Continued

 

The following table includes the major classes of assets and liabilities of the properties classified as held for sale as of March 31, 2008 and December 31, 2007:

 

 

 

March 31,
2008

 

December 31,
2007

 

Land

 

$

1,642

 

$

1,642

 

Land held for development

 

 

10,404

 

 

10,404

 

Buildings and tenant improvements

 

 

8,003

 

 

7,985

 

Accumulated depreciation

 

 

(2,132

)

 

(2,080

)

Net real estate assets

 

 

17,917

 

 

17,951

 

Deferred leasing costs, net

 

 

178

 

 

181

 

Accrued straight line rents receivable

 

 

109

 

 

114

 

Prepaid expenses and other

 

 

95

 

 

63

 

Total assets

 

$

18,299

 

$

18,309

 

Tenant security deposits, deferred rents and accrued costs (1)

 

$

405

 

$

309

 

______________

(1)

Included in accounts payable, accrued expenses and other liabilities.

 

 

23

 

 

Table of Contents

HIGHWOODS PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(tabular dollar amounts in thousands, except per share data)

 

 

 

11.

EARNINGS PER SHARE

 

The following table sets forth the computation of basic and diluted earnings per share:

 

 

 

Three Months Ended
March 31,

 

 

 

2008

 

2007

 

Basic income per share:

 

 

 

 

 

 

 

Numerator:

 

 

 

 

 

 

 

Income from continuing operations

 

$

12,014

 

$

33,571

 

Preferred Stock dividends

 

 

(2,838

)

 

(4,113

)

Income from continuing operations available for common stockholders

 

 

9,176

 

 

29,458

 

Income from discontinued operations

 

 

3,629

 

 

18,987

 

Net income available for common stockholders

 

$

12,805

 

$

48,445

 

Denominator:

 

 

 

 

 

 

 

Denominator for basic earnings per share – weighted average shares (1)

 

 

56,729

 

 

56,040

 

Basic earnings per share:

 

 

 

 

 

 

 

Income from continuing operations

 

$

0.16

 

$

0.52

 

Income from discontinued operations

 

 

0.07

 

 

0.34

 

Net income

 

$

0.23

 

$

0.86

 

Diluted income per share:

 

 

 

 

 

 

 

Numerator:

 

 

 

 

 

 

 

Income from continuing operations

 

$

12,014

 

$

33,571

 

Preferred Stock dividends

 

 

(2,838

)

 

(4,113

)

Minority interest in the Operating Partnership

 

 

639

 

 

2,400

 

Income from continuing operations available for common stockholders

 

 

9,815

 

 

31,858

 

Income from discontinued operations

 

 

3,629

 

 

18,987

 

Minority interest in the Operating Partnership in discontinued operations

 

 

254

 

 

1,539

 

Income from discontinued operations

 

 

3,883

 

 

20,526

 

Net income available for common stockholders

 

$

13,698

 

$

52,384

 

Denominator:

 

 

 

 

 

 

 

Denominator for basic earnings per share – adjusted weighted average shares (1)

 

 

56,729

 

 

56,040

 

Add:

 

 

 

 

 

 

 

Employee and director stock options and warrants

 

 

232

 

 

1,060

 

Common Units

 

 

3,967

 

 

4,542

 

Unvested restricted stock

 

 

122

 

 

258

 

Denominator for diluted earnings per share – adjusted weighted average shares and
assumed conversions

 

 

61,050

(2)

 

61,900

 

Diluted earnings per share:

 

 

 

 

 

 

 

Income from continuing operations

 

$

0.16

 

$

0.52

 

Income from discontinued operations

 

 

0.06

 

 

0.33

 

Net income

 

$

0.22

 

$

0.85

 

______________

(1)

Weighted average shares exclude shares of unvested restricted stock pursuant to SFAS No. 128, “Earnings per Share.”

(2)

Options and warrants aggregating approximately 0.4 million shares were outstanding during the three months ended March 31, 2008, but were not included in the computation of diluted earnings per share because the exercise prices of the options and warrants were higher than the average market price of Common Stock during these periods.

 

24

 

 

Table of Contents

HIGHWOODS PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(tabular dollar amounts in thousands, except per share data)

 

 

 

12.

COMMITMENTS AND CONTINGENCIES

 

Concentration of Credit Risk

 

We maintain cash and cash equivalent investments and restricted cash at financial institutions. The combined account balances at each institution typically exceed FDIC insurance coverage and, as a result, there is a concentration of credit risk related to amounts on deposit in excess of FDIC insurance coverage.

 

Land Leases

 

Certain properties in our wholly owned portfolio are subject to land leases expiring through 2082. Rental payments on these leases are adjusted annually based on either the consumer price index (CPI) or on a pre-determined schedule. Land leases subject to increases under a pre-determined schedule are accounted for under the straight-line method. Total expense recorded for land leases was $0.4 million and $0.3 million for the three months ended March 31, 2008 and 2007, respectively.

 

As of March 31, 2008, our payment obligations for future minimum payments on operating leases (which include scheduled fixed increases, but exclude increases based on CPI) were as follows:

 

Remainder of 2008

 

$

809

 

2009

 

 

1,118

 

2010

 

 

1,135

 

2011

 

 

1,155

 

2012

 

 

1,175

 

Thereafter

 

 

44,368

 

 

 

$

49,760

 

 

Environmental Matters

 

Substantially all of our in-service properties have been subjected to Phase I environmental assessments (and, in certain instances, Phase II environmental assessments). Such assessments and/or updates have not revealed, nor is management aware of, any environmental liability that management believes would have a material adverse effect on the accompanying Consolidated Financial Statements.

 

25

 

 

Table of Contents

HIGHWOODS PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(tabular dollar amounts in thousands, except per share data)

 

 

 

12.

COMMITMENTS AND CONTINGENCIES - Continued

 

Guarantees and Other Obligations

 

The table below sets forth information about certain guarantees and other obligations as of March 31, 2008. The amounts reflected in the table assume we would be required to pay the maximum potential exposure with no offsets or reductions. With respect to a rent guarantee, if the space is leased, we assumed the existing tenant defaulted at March 31, 2008 and that the space will remain unleased through the remainder of the guaranty. If the space is vacant, we assumed the space will remain vacant through the remainder of the guaranty. Since it is assumed that no new tenant will occupy the space, lease commissions, if applicable, are excluded.

 


Entity or Transaction

 

Type of
Guarantee or Other Obligation

 

Amount
Recorded/
Deferred

 

Date
Guarantee
Expires

 

Des Moines Joint Ventures (1),(4)

 

Debt

 

$

 

11/2015

 

RRHWoods, LLC (2),(5)

 

Indirect Debt

 

$

324

 

8/2010

 

Plaza Colonnade (2),(6)

 

Indirect Debt

 

$

8

 

12/2009

 

Industrial (3),(7)

 

Environmental costs

 

$

125

 

Until Remediated

 

Highwoods DLF 97/26 DLF 99/32, LP (2),(8)

 

Rent

 

$

112

 

6/2008

 

RRHWoods, LLC and Dallas County Partners (2),(9)

 

Indirect Debt

 

$

68

 

6/2014

 

RRHWoods, LLC (1),(2),(11)

 

Indirect Debt

 

$

30

 

11/2009

 

HIW-KC Orlando, LLC (3),(10)

 

Rent

 

$

298

 

4/2011

 

HIW-KC Orlando, LLC (3),(10)

 

Leasing Costs

 

$

296

 

Until Paid

 

Capitalized Lease Obligations (12)

 

Debt

 

$

292

 

Various

 

Brickstone (2),(13)

 

Debt

 

$

 

5/2017

 

                                

(1)

Recourse provisions exist that would enable us to recover some or all of any such payments from the joint ventures’ assets.

(2)

Represents guarantees that fall under the initial recognition and measurement requirements of FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (“FIN 45”).

(3)

Represents guarantees that are excluded from the fair value accounting and disclosure provisions of FIN 45 because the existence of such guarantees prevents sale treatment and/or the recognition of profit from a sale transaction.

(4)

We and our joint venture each guaranteed $8.6 million of debt of the Des Moines joint ventures that was outstanding at March 31, 2008. The joint ventures currently generate sufficient cash flow to cover the required debt service. This guarantee was entered into prior to the January 1, 2003 effective date of FIN 45 for initial recognition and measurement.

(5)

To facilitate a financing by the RRHWoods, LLC joint venture, we and our joint venture partner each guaranteed $3.1 million relating to a letter of credit and a corresponding master lease through August 2010. The guarantee requires us to pay under a contingent master lease if the cash flows from the building securing the letter of credit do not cover at least 50% of the minimum debt service. During 2007, we made master lease payments of $0.1 million. As of March 31, 2008, we have recorded a $0.3 million deferred charge included in other assets and liabilities on our Consolidated Balance Sheet with respect to this guarantee. Our maximum potential exposure under this guarantee was $0.5 million at March 31, 2008.

(6)

To facilitate a financing by the Plaza Colonnade, LLC joint venture, we and our joint venture partner signed a contingent master lease relating to 30,772 square feet through December 2009. Our maximum potential exposure under this master lease was $0.9 million at March 31, 2008. The current occupancy level of the building has been sufficient to cover all debt service requirements and, accordingly, no payments have been required under the master lease.

 

26

 

 

Table of Contents

HIGHWOODS PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(tabular dollar amounts in thousands, except per share data)

 

 

 

12.

COMMITMENTS AND CONTINGENCIES - Continued

(7)

As part of the sale of an industrial property in December 2003, we indemnified the buyer with respect to environmental concerns of up to $0.1 million. As a result, $0.1 million of the gain was deferred at the time of sale and will remain deferred until the environmental concerns are remediated.

(8)

To facilitate the restructuring of a tenant’s leases with us and the Highwoods DLF 97/26 DLF 99/32, LP joint venture in September 2003, we agreed to compensate the joint venture for any economic losses incurred as a result of these lease modifications through June 2008. In connection with this arrangement, we have approximately $0.1 million in other liabilities and $0.1 million as a deferred charge in other assets recorded on our Consolidated Balance Sheet at March 31, 2008. Our maximum potential exposure under this arrangement was $0.1 million at March 31, 2008. During 2008, $0.1 million was charged to expense in connection with this arrangement.

(9)

To facilitate a financing by the RRHWoods, LLC and Dallas County Partners joint ventures, we and our joint venture partner agreed to master lease certain vacant space and each guarantee $0.8 million of debt through 2014. No master lease payments were necessary in 2007. We currently have recorded $0.1 million in other liabilities and $0.1 million as a deferred charge included in other assets on our Consolidated Balance Sheet with respect to the master lease payment guarantee. The maximum potential exposure under the master lease was $1.9 million at March 31, 2008. Because the joint ventures currently generate sufficient cash flow to cover the required debt service, no liability for the $0.8 million direct guarantee was recorded at March 31, 2008.

(10)

We have guaranteed rent to the HIW KC Orlando, LLC joint venture for 3,248 rentable square feet through April 2011. The maximum potential exposure under this guarantee was $0.3 million at March 31, 2008. Additionally, we agreed to guarantee the initial leasing costs, originally estimated at $4.1 million, for approximately 11% of the total square feet of the property owned by the joint venture. No payments have been made thus far in 2008 under this arrangement.

(11)

To facilitate a financing by the RRHWoods, LLC joint venture, we and our joint venture partner each agreed to guarantee $3.3 million of the joint venture’s debt through November 2009, but can be renewed through November 2011 at the joint venture’s option. Because the joint venture currently generates sufficient cash flow to cover the required debt service, no liability for this guarantee was recorded at March 31, 2008. In addition, we agreed to a master lease for 50% of the debt service should the joint venture not generate sufficient cash flow to cover the required debt service. As a result of this master lease, we have recorded $0.03 million in other liabilities and as a deferred charge in other assets on our Consolidated Balance Sheet at March 31, 2008.

(12)

Represents capitalized lease obligations of $0.3 million related to office equipment, which is included in accounts payable, accrued expenses and other liabilities on our Consolidated Balance Sheet at March 31, 2008.

(13)

To facilitate a financing by RRHWoods, LLC, our joint venture partner provided a $1.5 million letter of credit. We agreed to reimburse our partner for 50% of the letter of credit in the event of a default by the joint venture of the underlying debt. Because the joint venture currently generates sufficient cash flow to cover the required debt service, no liability for this obligation was recorded at March 31, 2008.

 

Litigation, Claims and Assessments

 

We are from time to time a party to a variety of legal proceedings, claims and assessments arising in the ordinary course of our business. We regularly assess the liabilities and contingencies in connection with these matters based on the latest information available. For those matters where it is probable that we have incurred or will incur a loss and the loss or range of loss can be reasonably estimated, the estimated loss is accrued and charged to income in the Consolidated Financial Statements. In other instances, because of the uncertainties related to both the probable outcome and amount or range of loss, a reasonable estimate of liability, if any, cannot be made. Based on the current expected outcome of such matters, none of these proceedings, claims or assessments is expected to have a material adverse effect on our business, financial condition, results of operations or cash flows.

 

27

 

 

Table of Contents

HIGHWOODS PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(tabular dollar amounts in thousands, except per share data)

 

 

 

13.

INCOME TAXES

 

Our financial statements include the operations of our taxable REIT subsidiary that is not entitled to a dividends paid deduction and is subject to corporate federal, state and local income taxes. As a REIT, we may also be subject to certain federal excise taxes if we engage in certain types of transactions.

 

Other than the liability for an uncertain tax position and related accrued interest under FIN 48 discussed below, no provision has been made pursuant to SFAS No. 109 for federal and state income taxes during the three months ended March 31, 2008 and 2007 because the Company qualified as a REIT, distributed the necessary amount of taxable income and, therefore, incurred no income tax expense during the periods. The taxable REIT subsidiary has operated at a cumulative taxable loss through March 31, 2008 of approximately $8.0 million and has paid no income taxes since its formation. In addition to the $3.1 million deferred tax asset for these cumulative tax loss carryforwards, the taxable REIT subsidiary also had net deferred tax assets of approximately $1.2 million comprised primarily of tax versus book basis differences in certain investments and depreciable assets held by the taxable REIT subsidiary. Because the future tax benefit of the cumulative losses is not assured, the approximate $4.3 million net deferred tax asset position of the taxable REIT subsidiary has been fully reserved as management does not believe that it is more likely than not that the net deferred tax asset will be realized. Accordingly, no tax benefit has been recognized in the accompanying Consolidated Financial Statements. The tax benefit of the cumulative losses could be recognized for financial reporting purposes in future periods to the extent the taxable REIT subsidiary generates sufficient taxable income.

 

We adopted FIN 48, on January 1, 2007 and recorded a $1.4 million liability, which included $0.2 million of accrued interest, for an uncertain tax position, with the related expense reflected as a reduction to the beginning balance of distributions in excess of net earnings. This liability was included in accounts payable, accrued expenses and other liabilities. During the third quarter of 2007, the liability for the uncertain tax position was released, and income recognized, upon the expiration of the applicable statute of limitations. In addition, the liability of $0.05 million of interest that was accrued in 2007 relating to this liability was also released. We continue to examine our tax positions and do not believe we have any uncertain tax positions that would result in a FIN 48 reserve as of March 31, 2008.

 

 

28

 

 

Table of Contents

HIGHWOODS PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(tabular dollar amounts in thousands, except per share data)

 

 

 

14.

SEGMENT INFORMATION

 

Our principal business is the acquisition, development and operation of rental real estate properties. We evaluate our business by product type and by geographic locations. These segments and our disclosures below are expanded from what we reported in our Annual Report on Form 10-K for 2007 due to expanded internal reporting information used by our chief operating decision maker starting in the first quarter of 2008. Each product type has different customers and economic characteristics as to rental rates and terms, cost per square foot of buildings, the purposes for which customers use the space, the degree of maintenance and customer support required and customer dependency on different economic drivers, among others. The operating results by geographic grouping are also regularly reviewed by our chief operating decision maker for assessing performance and other purposes. There are no material inter-segment transactions.

 

The accounting policies of the segments are the same as those described in Note 1 included herein. Further, all operations are within the United States and, at March 31, 2008, no tenant of the Wholly Owned Properties comprised more than 7.2% of our consolidated revenues.

 

The following table summarizes the rental income, net operating income and assets for each reportable segment for the three months ended March 31, 2008 and 2007:

 

 

 

Three Months Ended
March 31,

 

 

 

2008

 

2007

 

Rental and Other Revenues: (1) (2)

 

 

 

 

 

 

 

Office:

 

 

 

 

 

 

 

Atlanta, GA

 

$

11,526

 

$

10,387

 

Greenville, SC

 

 

3,216

 

 

3,097

 

Kansas City, MO

 

 

4,192

 

 

3,777

 

Memphis, TN

 

 

6,165

 

 

5,786

 

Nashville, TN

 

 

15,578

 

 

12,626

 

Orlando, FL

 

 

1,933

 

 

1,597

 

Piedmont Triad, NC

 

 

6,381

 

 

6,695

 

Raleigh, NC

 

 

18,521

 

 

15,797

 

Richmond, VA

 

 

11,467

 

 

10,671

 

Tampa, FL

 

 

15,834

 

 

15,355

 

Other

 

 

507

 

 

938

 

Total Office Segment

 

 

95,320

 

 

86,726

 

Industrial:

 

 

 

 

 

 

 

Atlanta, GA

 

 

4,123

 

 

3,803

 

Kansas City, MO

 

 

5

 

 

5

 

Piedmont Triad, NC

 

 

3,959

 

 

3,731

 

Total Industrial Segment

 

 

8,087

 

 

7,539

 

Retail:

 

 

 

 

 

 

 

Kansas City, MO

 

 

10,872

 

 

11,426

 

Piedmont Triad, NC

 

 

195

 

 

125

 

Total Retail Segment

 

 

11,067

 

 

11,551

 

Residential:

 

 

 

 

 

 

 

Kansas City, MO

 

 

306

 

 

292

 

Total Residential Segment

 

 

306

 

 

292

 

Total Rental and Other Revenues

 

$

114,780

 

$

106,108

 

 

 

29

 

 

Table of Contents

HIGHWOODS PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(tabular dollar amounts in thousands, except per share data)

 

 

14.

SEGMENT INFORMATION - Continued

 

 

 

Three Months Ended
March 31,

 

 

 

2008

 

2007

 

Net Operating Income: (1) (2)

 

 

 

 

 

 

 

Office:

 

 

 

 

 

 

 

Atlanta, GA

 

$

7,561

 

$

6,708

 

Greenville, SC

 

 

1,945

 

 

1,795

 

Kansas City, MO

 

 

2,155

 

 

1,868

 

Memphis, TN

 

 

3,653

 

 

3,510

 

Nashville, TN

 

 

10,626

 

 

8,168

 

Orlando, FL

 

 

1,113

 

 

976

 

Piedmont Triad, NC

 

 

4,024

 

 

4,115

 

Raleigh, NC

 

 

12,902

 

 

10,468

 

Richmond, VA

 

 

8,017

 

 

7,403

 

Tampa, FL

 

 

9,679

 

 

9,401

 

Other

 

 

331

 

 

72

 

Total Office Segment

 

 

62,006

 

 

54,484

 

Industrial:

 

 

 

 

 

 

 

Atlanta, GA

 

 

3,129

 

 

2,973

 

Kansas City, MO

 

 

2

 

 

2

 

Piedmont Triad, NC

 

 

3,152

 

 

2,947

 

Total Industrial Segment

 

 

6,283

 

 

5,922

 

Retail:

 

 

 

 

 

 

 

Kansas City, MO

 

 

7,045

 

 

7,542

 

Piedmont Triad, NC

 

 

151

 

 

96

 

Raleigh, NC

 

 

(23

)

 

(16

)

Total Retail Segment

 

 

7,173

 

 

7,622

 

Residential:

 

 

 

 

 

 

 

Kansas City, MO

 

 

190

 

 

144

 

Total Residential Segment

 

 

190

 

 

144

 

Total Net Operating Income

 

 

75,652

 

 

68,172

 

Reconciliation to income before disposition of property, insurance gain, minority
interest and equity in earnings of unconsolidated affiliates:

 

 

 

 

 

 

 

Depreciation and amortization

 

 

(31,041

)

 

(28,965

)

General and administrative expense

 

 

(9,711

)

 

(10,911

)

Interest expenses

 

 

(24,841

)

 

(24,247

)

Interest and other income

 

 

803

 

 

1,514

 

Income before disposition of property, insurance gain, minority interest and equity
in earnings of unconsolidated affiliates

 

$

10,862

 

$

5,563

 

______________

(1)

Net of discontinued operations.

(2)

The Piedmont Triad market encompasses the Greensboro and Winston-Salem metropolitan area.

 

30

 

 

Table of Contents

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

You should read the following discussion and analysis in conjunction with the accompanying Consolidated Financial Statements and related notes contained elsewhere in this Quarterly Report.

 

DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS

 

Some of the information in this Quarterly Report may contain forward-looking statements. Such statements include, in particular, statements about our plans, strategies and prospects under this section and under the heading "Business." You can identify forward-looking statements by our use of forward-looking terminology such as "may,” "will,” "expect,” "anticipate,” "estimate,” "continue" or other similar words. Although we believe that our plans, intentions and expectations reflected in or suggested by such forward-looking statements are reasonable, we cannot assure you that our plans, intentions or expectations will be achieved. When considering such forward-looking statements, you should keep in mind the following important factors that could cause our actual results to differ materially from those contained in any forward-looking statement:

 

 

speculative development activity by our competitors in our existing markets could result in an excessive supply of office, industrial and retail properties relative to tenant demand;

 

 

the financial condition of our tenants could deteriorate;

 

 

we may not be able to complete development, acquisition, reinvestment, disposition or joint venture projects as quickly or on as favorable terms as anticipated;

 

 

we may not be able to lease or release space quickly or on as favorable terms as old leases;

 

 

increases in interest rates would increase our debt service costs;

 

 

we may not be able to meet our liquidity requirements or obtain capital on favorable terms to fund our working capital needs and growth initiatives or to repay or refinance outstanding debt upon maturity;

 

 

we could lose key executive officers; and

 

 

our southeastern and midwestern markets may suffer declines in economic growth.

 

This list of risks and uncertainties, however, is not intended to be exhaustive. You should also review the other cautionary statements we make in “Business – Risk Factors” set forth in our 2007 Annual Report.

 

Given these uncertainties, you should not place undue reliance on forward-looking statements. We undertake no obligation to publicly release the results of any revisions to these forward-looking statements to reflect any future events or circumstances or to reflect the occurrence of unanticipated events.

 

OVERVIEW

 

We are a fully integrated, self-administered and self-managed equity REIT that provides leasing, management, development, construction and other customer-related services for our properties and for third parties. As of March 31, 2008, we owned or had an interest in 381 in-service office, industrial and retail properties, encompassing approximately 34.2 million square feet, which includes six in-service office, industrial and retail development properties that had not yet reached 95% stabilized occupancy aggregating approximately 1.2 million square feet, and 514 rental residential units. We are based in Raleigh, North Carolina, and our properties and development land are located in Florida, Georgia, Iowa, Kansas, Maryland, Missouri, North Carolina, South Carolina, Tennessee and Virginia. Additional information about us can be found on our website at www.highwoods.com. Information on our website is not part of this Quarterly Report.

 

31

 

 

Table of Contents

 

Results of Operations

 

Approximately 83% of our rental and other revenue from continuing operations is derived from our office properties. As a result, while we own and operate a limited number of industrial, retail and residential properties, our operating results depend heavily on successfully leasing our office properties. Furthermore, since approximately 80% of our annualized revenues from office properties come from properties located in Florida, Georgia, North Carolina and Tennessee, economic growth in those states is and will continue to be an important determinative factor in predicting our future operating results.

 

The key components affecting our rental revenue stream are dispositions, acquisitions, new developments placed in service, average occupancy and rental rates. Average occupancy generally increases during times of improving economic growth, as our ability to lease space outpaces vacancies that occur upon the expirations of existing leases. Average occupancy generally declines during times of slower economic growth, when new vacancies tend to outpace our ability to lease space. Asset acquisitions, dispositions and new developments placed in service directly impact our rental revenues and could impact our average occupancy, depending upon the occupancy rate of the properties that are acquired, sold or placed in service. A further indicator of the predictability of future revenues is the expected lease expirations of our portfolio. As a result, in addition to seeking to increase our average occupancy by leasing current vacant space, we also must concentrate our leasing efforts on renewing leases on expiring space. Whether or not our rental revenue tracks average occupancy proportionally depends upon whether rents under new leases signed are higher or lower than the rents under the previous leases.

 

Our expenses primarily consist of rental property expenses, depreciation and amortization, general and administrative expenses and interest expense. Rental property expenses are expenses associated with our ownership and operation of rental properties and include expenses that vary somewhat, such as common area maintenance and utilities, and relatively fixed expenses, such as property taxes and insurance. Some of these variable expenses may be lower when our average occupancy declines. Depreciation and amortization is a non-cash expense associated with the ownership of real property and generally remains relatively consistent each year, unless we buy or sell assets, since we depreciate our properties on a straight-line basis over fixed lives. General and administrative expenses, net of amounts capitalized, consist primarily of management and employee salaries and other personnel costs, corporate and division overhead and long-term incentive compensation. Interest expense depends primarily upon the amount of our borrowings, the weighted average interest rates on our debt and the amount of interest capitalized on development projects.

 

We record in “equity in earnings of unconsolidated affiliates” our proportionate share of net income or loss, adjusted for purchase accounting effects, of our unconsolidated joint ventures.

 

Additionally, SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” requires us to record net income received from properties sold or held for sale that qualify as discontinued operations under SFAS No. 144 separately as “income from discontinued operations.” As a result, we separately record revenues and expenses from these qualifying properties. As also required by SFAS No. 144, prior period results are reclassified to reflect the operations for such properties in discontinued operations.

 

Liquidity and Capital Resources

 

We incur capital expenditures to lease space to our customers and to maintain the quality of our properties to successfully compete against other properties. Tenant improvements are the costs required to customize the space for the specific needs of the customer. Lease commissions are costs incurred to find the customer for the space. Lease incentives are costs paid to or on behalf of tenants to induce them to enter into leases and that do not relate to customizing the space for the tenant’s specific needs. Building improvements are recurring capital costs not related to a customer to maintain the buildings. As leases expire, we either attempt to relet the space to an existing customer or attract a new customer to occupy the space. Generally, customer renewals require lower leasing capital expenditures than reletting to new customers. However, market conditions such as supply of available space in the market, as well as demand for space, drive not only customer rental rates but also tenant improvement costs. Leasing capital expenditures are amortized over the term of the lease and building improvements are depreciated over the appropriate useful life of the assets acquired. Both are included in depreciation and amortization in results of operations.

 

32

 

 

Table of Contents

 

Because we are a REIT, we are required under the federal tax laws to distribute at least 90% of our REIT taxable income, excluding capital gains, to our stockholders. We generally use rents received from customers and proceeds from sales of non-core development land to fund our operating expenses, recurring capital expenditures and stockholder dividends. To fund property acquisitions, development activity or building renovations, we may sell other assets and may incur debt from time to time. Our debt generally consists of mortgage debt, unsecured debt securities and borrowings under our credit facilities. As of March 31, 2008, we had approximately $201 million of additional borrowing availability under our unsecured revolving credit facility, and we had approximately $111 million of additional borrowing availability under our secured revolving construction loan facilities.

 

Our revolving credit facility and the indenture governing our outstanding long-term unsecured debt securities require us to satisfy various operating and financial covenants and performance ratios. As a result, to ensure that we do not violate the provisions of these debt instruments, we may from time to time be limited in undertaking certain activities that may otherwise be in the best interest of our stockholders, such as repurchasing capital stock, acquiring additional assets, increasing the total amount of our debt or increasing stockholder dividends. We review our current and expected operating results, financial condition and planned strategic actions on an ongoing basis for the purpose of monitoring our continued compliance with these covenants and ratios. Any unwaived event of default could result in an acceleration of some or all of our debt, severely restrict our ability to incur additional debt to fund short- and long-term cash needs or result in higher interest expense.

 

To generate additional capital to fund our growth and other strategic initiatives and to lessen the ownership risks typically associated with owning 100.0% of a property, we may sell some of our properties or contribute them to joint ventures. When we create a joint venture with a strategic partner, we usually contribute one or more properties that we own and/or vacant land to a newly formed entity in which we retain an interest of 50.0% or less. In exchange for our equal or minority interest in the joint venture, we generally receive cash from the partner and retain some or all of the management income relating to the properties in the joint venture. The joint venture itself will frequently borrow money on its own behalf to finance the acquisition of, and/or leverage the return upon, the properties being acquired by the joint venture or to build or acquire additional buildings. Such borrowings are typically on a non-recourse or limited recourse basis. We generally are not liable for the debts of our joint ventures, except to the extent of our equity investment, unless we have directly guaranteed any of that debt. In most cases, we and/or our strategic partners are required to guarantee customary exceptions to non-recourse liability in non-recourse loans. See Note 12 to the Consolidated Financial Statements for additional information on certain debt guarantees. We have historically also sold additional Common Stock or Preferred Stock or issued Common Units to fund additional growth or to reduce our debt, but we have limited those efforts since 1998 because funds generated from our capital recycling program in recent years have provided sufficient funds to satisfy our liquidity needs. In addition, we have recently used funds from our capital recycling program to redeem or repurchase Common Units and Preferred Stock for cash. In the future, we may from time to time retire some or all of our remaining outstanding Preferred Stock through redemptions, open market repurchases, privately negotiated acquisitions or otherwise.

 

 

33

 

 

Table of Contents

RESULTS OF OPERATIONS

 

In accordance with SFAS No. 144 and as described in Note 10 to the Consolidated Financial Statements, we reclassified the operations and/or gain/(loss) from disposal of certain properties to discontinued operations for all periods presented if the operations and cash flows have been or will be eliminated from our ongoing operations and we will not have any significant continuing involvement in the operations after the disposal transaction and the properties were either sold during 2007 and the first three months of 2008 or were held for sale at March 31, 2008. There were no properties sold during 2007 and the first three months of 2008 that did not meet the conditions as stipulated by SFAS No. 144.

 

Three Months Ended March 31, 2008 and 2007

 

The following table sets forth information regarding our unaudited results of operations for the three months ended March 31, 2008 and 2007 ($ in millions):

 

 

 

Three Months Ended
March 31,

 

2008 to 2007

 

 

 

2008

 

2007

 

$ Change

 

% of Change

 

Rental and other revenues

 

$

114.8

 

$

106.1

 

$

8.7

 

8.2

%

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

Rental property and other expenses

 

 

39.1

 

 

37.9

 

 

1.2

 

3.2

 

Depreciation and amortization

 

 

31.1

 

 

29.0

 

 

2.1

 

7.2

 

General and administrative

 

 

9.7

 

 

10.9

 

 

(1.2

)

(11.0

)

Total operating expenses

 

 

79.9

 

 

77.8

 

 

2.1

 

2.7

 

Interest expenses:

 

 

 

 

 

 

 

 

 

 

 

 

Contractual

 

 

23.5

 

 

22.7

 

 

0.8

 

3.5

 

Amortization of deferred financing costs

 

 

0.6

 

 

0.5

 

 

0.1

 

20.0

 

Financing obligations

 

 

0.7

 

 

1.0

 

 

(0.3

)

(30.0

)

 

 

 

24.8

 

 

24.2

 

 

0.6

 

2.5

 

Other income:

 

 

 

 

 

 

 

 

 

 

 

 

Interest and other income

 

 

0.8

 

 

1.5

 

 

(0.7

)

(46.7

)

 

 

 

0.8

 

 

1.5

 

 

(0.7

)

(46.7

)

Income before disposition of property, minority interest and equity
in earnings of unconsolidated affiliates

 

 

10.9

 

 

5.6

 

 

5.3

 

94.6

 

Gains on disposition of property, net

 

 

 

 

16.7

 

 

(16.7

)

(100.0

)

Gain from property insurance settlement

 

 

 

 

4.1

 

 

(4.1

)

(100.0

)

Minority interest

 

 

(0.8

)

 

(2.6

)

 

1.8

 

69.2

 

Equity in earnings of unconsolidated affiliates

 

 

1.9

 

 

9.7

 

 

(7.8

)

(80.4

)

Income from continuing operations

 

 

12.0

 

 

33.5

 

 

(21.5

)

(64.2

)

Discontinued operations:

 

 

 

 

 

 

 

 

 

 

 

 

Income from discontinued operations, net of minority
interest

 

 

0.1

 

 

0.7

 

 

(0.6

)

(85.7

)

Net gains on sales of discontinued operations, net of minority
interest

 

 

3.5

 

 

18.3

 

 

(14.8

)

(80.9

)

 

 

 

3.6

 

 

19.0

 

 

(15.4

)

(81.1

)

Net income

 

 

15.6

 

 

52.5

 

 

(36.9

)

(70.3

)

Dividends on Preferred Stock

 

 

(2.8

)

 

(4.1

)

 

1.3

 

31.7

 

Net income available for common stockholders

 

$

12.8

 

$

48.4

 

$

(35.6

)

(73.6

)%

 

Rental and Other Revenues

 

Rental and other revenues increased $8.7 million in the first quarter of 2008 compared to 2007 primarily from higher average occupancy in certain locations in 2008 as compared to 2007, the contribution from developed

 

34

 

 

Table of Contents

 

properties placed in service in 2007 and the first three months of 2008 and higher escalation income in 2008 as a result of the increase in operating expenses for the same period. In addition, in the three months ended March 31, 2008, we recorded $1.9 million in lease termination income, primarily relating to expiration of a lease in our Raleigh division.

 

Rental Property and Other Expenses

 

Rental and other operating expenses from continuing operations (real estate taxes, utilities, insurance, repairs and maintenance and other property-related expenses) increased $1.2 million in the first quarter of 2008 compared to the first quarter of 2007, primarily as a result of general inflationary increases in certain operating expenses, such as utility costs, insurance costs and real estate taxes. In addition, rental property and operating expenses of developed properties placed in service in 2007 and the three months ended March 31, 2008 contributed to the increase in the first quarter of 2008.

 

Rental revenues less rental and other operating expenses increased in 2008 compared to 2007. This is primarily the result of higher revenues and higher average occupancy. In addition, we are benefiting from the lower operating costs associated with a younger and higher quality portfolio.

 

The $2.1 million increase in depreciation and amortization is primarily a result of the contribution from development properties placed in service in 2007 and the three months ended March 31, 2008, and an increase in building improvements, tenant improvements and deferred leasing costs related to those buildings placed in service.

 

The $1.2 million decrease in general and administrative expenses was primarily related to lower audit fees and lower costs written off related to the termination of certain pre-development projects and a decrease in the adjustment related or our deferred compensation liability (see Note 9 to the Consolidated Financial Statements). These decreases were party offset by higher amortization of restricted stock and stock options and the annual incentive increases and general inflationary effects.

 

Interest Expense

 

The increase in contractual interest expense is primarily the result of an increase in average borrowings from $1.45 billion in the three months ended March 31, 2007 to $1.66 billion in the three months ended March 31, 2008. Partly offsetting this increase was a decrease in weighted average interest rates on outstanding debt from 6.83% for the first quarter of 2007 compared to 6.26% for the first quarter of 2008. In addition, capitalized interest in 2008 was approximately $0.4 million higher compared to 2007.

 

Gains on Disposition of Property; Gain from Property Insurance Settlement; Minority Interest; Equity in Earnings of Unconsolidated Affiliates

 

Net gains on dispositions of properties not classified as discontinued operations was $16.7 million for the three months ended March 31, 2007. Gains are dependent on the specific assets sold, their historical cost basis and other factors, and can vary significantly from period to period. See Note 4 to the Consolidated Financial Statements for further discussion.

 

In the first quarter of 2007, we recorded a $4.1 million gain from finalization of a prior year insurance claim.

 

The increase in minority interest expense of $1.8 million was primarily due to a corresponding increase in the Operating Partnership’s income from continuing operations, after Preferred Unit distributions.

 

Equity in earnings of unconsolidated affiliates decreased $7.8 million from to 2007. The decrease primarily resulted from the following transactions. In 2007, the Weston Lakeside joint venture sold 332 rental residential units, recognizing a gain of approximately $11.3 million, which resulted in approximately $5.0 million in equity in earnings of unconsolidated affiliates. Five properties owned by our DLF I joint venture (“DLF I”) were sold and the joint venture recognized a gain of approximately $9.3 million, resulting in approximately $2.1 million in equity in earnings of unconsolidated affiliates in 2007. Additionally, in 2007, DLF I received a lease termination, of which the net effect was $2.7 million and resulted in approximately $0.6 million in equity in earnings of unconsolidated affiliates. (See Note 2 to the Consolidated Financial Statements for further discussion related to these transactions).

 

35

 

 

Table of Contents

 

Discontinued Operations

 

In accordance with SFAS No. 144, we classified net income of $3.6 million and $19.0 million, net of minority interest, as discontinued operations for the three months ended March 31, 2008 and 2007, respectively. These amounts relate to 1.3 million square feet of office and industrial properties and 13 rental residential units sold during 2007 and the three months ended March 31, 2008 and 0.1 million square feet of office properties held for sale at March 31, 2008. These amounts include net gains on the sale of these properties of $3.5 million and $18.3 million, net of minority interest, in the three months ended March 31, 2008 and 2007, respectively.

 

Preferred Dividends

 

Preferred dividends decreased $1.3 million due to the retirement of $62 million of Preferred Stock in 2007.

 

 

36

 

 

Table of Contents

 

LIQUIDITY AND CAPITAL RESOURCES

 

Statement of Cash Flows

 

As required by GAAP, we report and analyze our cash flows based on operating activities, investing activities and financing activities. The following table sets forth the changes in our cash flows in the first three months of 2008 as compared to the first three months of 2007 (in thousands):

 

 

 

Three Months Ended
March 31,

 

 

 

 

 

2008

 

2007

 

Change

 

Cash Provided By Operating Activities

 

$

20,814

 

$

25,744

 

$

(4,930

)

Cash Used In Investing Activities

 

 

(44,920

)

 

(4,930

)

 

(39,990

)

Cash Provided by/(Used In) Financing Activities

 

 

27,561

 

 

(36,577

)

 

64,138

 

Total Cash Flows

 

$

3,455

 

$

(15,763

)

$

19,218

 

 

In calculating cash flow from operating activities, depreciation and amortization, which are non-cash expenses, are added back to net income. As a result, we have historically generated a significant positive amount of cash from operating activities. From period to period, cash flow from operations depends primarily upon changes in our net income, as discussed more fully above under “Results of Operations,” changes in receivables and payables, and net additions or decreases in our overall portfolio, which affect the amount of depreciation and amortization expense.

 

Cash provided by or used in investing activities generally relates to capitalized costs incurred for leasing and major building improvements and our acquisition, development, disposition and joint venture activity. During periods of significant net acquisition and/or development activity, our cash used in such investing activities will generally exceed cash provided by investing activities, which typically consists of cash received upon the sale of properties and distributions of capital from our joint ventures.

 

Cash used in financing activities generally relates to stockholder dividends, distributions on Common Units, incurrence and repayment of debt and sales, repurchases or redemptions of Common Stock, Common Units and Preferred Stock. As discussed previously, we use a significant amount of our cash to fund stockholder dividends and Common Unit distributions. Whether or not we have increases in the outstanding balances of debt during a period depends generally upon the net effect of our acquisition, disposition, development and joint venture activity. We use our revolving credit facility for working capital purposes, which means that during any given period, in order to minimize interest expense, we will likely record significant repayments and borrowings under our revolving credit facility.

 

The decrease of $4.9 million in cash provided by operating activities in 2008 compared to 2007 was primarily the result of the net change in operating assets and liabilities, which resulted in a $12.2 million decrease in cash provided by operating activities. Offsetting these decreases were higher cash flows from net income as adjusted for changes in depreciation and amortization expense, amortization of stock based compensation, gains on disposition of properties, a gain from a property insurance settlement, minority interest, and equity in earnings of unconsolidated affiliates.

 

The increase of $40.0 million in cash used in investing activities in 2008 compared to 2007 was primarily a result of a $59.0 million decrease in proceeds from the disposition of assets, partly offset by an increase of $18.0 million related to proceeds from dispositions which were set aside and designated for potential future tax-deferred real estate transactions.

 

The increase of $64.1 million in cash provided by financing activities in 2008 compared to 2007 was primarily a result of a $38.9 million increase in net borrowings on the revolving credit facility and mortgages and notes payable, a decrease of $24.1 million in cash used in connection with the repurchase of Common Units, and a decrease of $1.3 million in cash used for the payment of dividends on Preferred Stock.

 

In 2008, we continued our capital recycling program of selectively disposing of non-core properties in order to use the net proceeds for investments or other purposes. At March 31, 2008, we had 40 acres of land and 0.1 million

 

37

 

 

Table of Contents

 

square feet of office properties classified as held for sale pursuant to SFAS No. 144 with a carrying value of $18.3 million.

 

Capitalization

 

The following table sets forth our capitalization as of March 31, 2008 and December 31, 2007 (in thousands, except per share amounts):

 

 

 

March 31,
2008

 

December 31,
2007

 

Mortgages and notes payable, at recorded book value

 

$

1,703,238

 

$

1,641,987

 

Financing obligations </