UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
For the fiscal year ended December 31, 2003
OR
For the transition period from to
Commission file number 1-13100
HIGHWOODS PROPERTIES, INC.
(Exact name of registrant as specified in its charter)
(State or other jurisdiction
of incorporation or organization)
3100 Smoketree Court, Suite 600
Raleigh, N.C. 27604
(Address of principal executive offices) (Zip Code)
919-872-4924
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
Name of Each Exchange on
Which Registered
Common stock, $.01 par value
8 5/8% Series A Cumulative Redeemable Preferred Shares
8% Series B Cumulative Redeemable Preferred Shares
Securities registered pursuant to Section 12(g) of the Act:
NONE
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 ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment of this Form 10-K. ¨
Indicate by check mark whether the Registrant is an accelerated filer (as defined in rule 12b-2 of the Securities Exchange Act). Yes x No ¨
The aggregate market value of the shares of common stock held by non-affiliates (based upon the closing sale price on the New York Stock Exchange) on June 30, 2003 was approximately $52,030,410. As of February 18, 2004, there were 53,501,109 shares of common stock, $.01 par value, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant’s Proxy Statement in connection with its Annual Meeting of Shareholders to be held May 18, 2004, are incorporated by reference in Part II, Item 5 and Part III, Items 10, 11, 12, 13 and 14 of the Form 10-K.
TABLE OF CONTENTS
Item No.
1.
Business
2.
Properties
3.
Legal Proceedings
4.
Submission of Matters to a Vote of Security Holders
X.
Executive Officers of the Registrant
5.
Market for Registrant’s Common Stock and Related Stockholder Matters
6.
Selected Financial Data
7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
7A.
Quantitative and Qualitative Disclosures About Market Risk
8.
Financial Statements and Supplementary Data
9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
9A.
Controls and Procedures
10.
Directors and Executive Officers of the Registrant
11.
Executive Compensation
12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
13.
Certain Relationships and Related Transactions
14.
Principal Accountant Fees and Services
15.
Exhibits and Reports on Form 8-K
2
PART I
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 Operating Partnership’s common partnership interests as “Common Units,” and (5) the Operating Partnership’s preferred partnership interests as “Preferred Units.”
General
The Company is a self-administered and self-managed equity REIT that began operations through a predecessor in 1978. Since the Company’s initial public offering in 1994, we have evolved into one of the largest owners and operators of suburban office, industrial and retail properties in the southeastern and midwestern United States. At December 31, 2003, we:
The Company conducts substantially all of its activities through, and substantially all of its interests in the properties are held directly or indirectly by, the Operating Partnership. The Company is the sole general partner of the Operating Partnership. At December 31, 2003, the Company owned 100.0% of the Preferred Units and 88.9% of the Common Units in the Operating Partnership. Limited partners (including certain officers and directors of the Company) own the remaining Common Units. Holders of Common Units may redeem them for the cash value of one share of the Company’s Common Stock or, at the Company’s option, one share of Common Stock. The Preferred Units in the Operating Partnership were issued to the Company in connection with the Company’s three Preferred Stock offerings that occurred in 1997 and 1998.
The Company was incorporated in Maryland in 1994. The Operating Partnership was formed in North Carolina in 1994. Our executive offices are located at 3100 Smoketree Court, Suite 600, Raleigh, North Carolina 27604, and our telephone number is (919) 872-4924. We maintain offices in each of our primary markets.
In addition to this Annual Report, we file quarterly and special reports, proxy statements and other information with the SEC. All documents that we file with the SEC are made available as soon as reasonably practicable free of charge on our corporate website, which is http://www.highwoods.com. The information on this website is not and should not be considered part of this annual report on Form 10-K and is not incorporated by reference in this document. This website is only intended to be an inactive textual reference. You may also read and copy any document that we file at the public reference facilities of the SEC at 450 Fifth Street, N.W., Washington, D.C. 25049. Please call the SEC at (800) 732-0330 for further information about the public reference facilities. These documents also may be accessed through the SEC’s electronic data gathering, analysis and retrieval system (“EDGAR”) via electronic means, including the SEC’s home page on the Internet (http://www.sec.gov). In addition, since some of our securities are listed on the New York Stock Exchange, you can read our SEC filings at the offices of the New York Stock Exchange, 20 Broad Street, New York, New York 10005.
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Customers
The following table sets forth information concerning the 20 largest customers of our wholly-owned properties as of December 31, 2003:
Customer
Annualized
Rental Revenue (1)
Percent of Total
Rental Revenue(1)
Average
Remaining Lease
Term in Years
Federal Government
AT&T
PricewaterhouseCoopers
State of Georgia
Sara Lee
IBM
Northern Telecom
Volvo
Lockton Companies
US Airways
BB&T
ITC Deltacom (2)
Hartford Insurance
T-Mobile USA
WorldCom and Affiliates
Bank of America
Ikon
Carlton Fields
Ford Motor Company
CHS Professional Services
Total
Operating Strategy
Efficient, Customer Service-Oriented Organization. We provide a complete line of real estate services to our tenants and third parties. We believe that our in-house development, acquisition, construction management, leasing and property management services allow us to respond to the many demands of our existing and potential tenant base. We provide our tenants with cost-effective services such as build-to-suit construction and space modification, including tenant improvements and expansions. In addition, the breadth of our capabilities and resources provides us with market information not generally available. We believe that the operating efficiencies achieved through our fully integrated organization also provide a competitive advantage in setting our lease rates and pricing other services.
Capital Recycling Program. Our strategy has been to focus our real estate activities in markets where we believe our extensive local knowledge gives us a competitive advantage over other real estate developers and operators. Through our capital recycling program, we generally seek to:
4
Our capital recycling activities benefit from our local market presence and knowledge. Our division officers have significant real estate experience in their respective markets. Based on this experience, we believe that we are in a better position to evaluate capital recycling opportunities than many of our competitors. In addition, our relationships with our tenants and those tenants at properties for which we conduct third-party fee-based services may lead to development projects when these tenants seek new space.
The following summarizes our capital recycling program during the three years ended December 31, 2003:
Office, Industrial and Retail Properties:(rentable square feet in thousands)
Dispositions
Contributions to Joint Ventures
Developments Placed In-Service
Redevelopment
Acquisitions (including 1,319 from a joint venture in 2003)
Net Change of In-Service Properties
Apartment Properties:(in units)
Flexible Capital Structure. We are committed to maintaining a flexible capital structure that: (1) allows growth through development and acquisition opportunities; (2) promotes future earnings growth; and (3) provides access to the private and public equity and debt markets on favorable terms. Accordingly, we expect to meet our long-term liquidity requirements through a combination of any one or more of:
Geographic Diversification. Since the Company’s initial public offering in 1994, we have significantly reduced our dependence on any particular market. We initially owned a limited number of office properties located in North Carolina, most of which were in the Research Triangle. Today, including our various joint ventures, our portfolio consists primarily of office properties throughout the Southeast and retail and office properties in Kansas City, Missouri, including one significant mixed retail and office property.
Competition
Our properties compete for tenants with similar properties located in our markets primarily on the basis of location, rent, services provided and the design and condition of the facilities. We also compete with other REITs, financial institutions, pension funds, partnerships, individual investors and others when attempting to acquire, develop and operate properties.
Employees
As of December 31, 2003, the Company employed 554 persons.
5
Risk Factors
An investment in our equity and debt securities involves various risks. All investors should carefully consider the following risk factors in conjunction with the other information contained in this Annual Report before trading in our securities. If any of these risks actually occur, our business, operating results, prospects and financial condition could be harmed.
Our Performance is Subject to Risks Associated with Real Estate Investment. We are a real estate company that derives most of our income from the ownership and operation of our properties. There are a number of factors that may adversely affect the income that our properties generate, including the following:
6
Future acquisitions and development activities may fail to perform in accordance with our expectations and may require development and renovation costs exceeding our estimates. In the normal course of business, we typically evaluate potential acquisitions, enter into non-binding letters of intent, and may, at any time, enter into contracts to acquire additional properties. However, changing market conditions, including competition from others, may diminish our opportunities for making attractive acquisitions. Once made, our investments may fail to perform in accordance with our expectations. In addition, the renovation and improvement costs we incur in bringing an acquired property up to market standards may exceed our estimates. Although we anticipate financing future acquisitions and renovations through a combination of advances under our revolving loans and other forms of secured or unsecured financing, no assurance can be given that we will have the financial resources to make suitable acquisitions or renovations.
In addition to acquisitions, we periodically consider developing and constructing properties. Risks associated with development and construction activities include:
If new developments are financed through construction loans, there is a risk that, upon completion of construction, permanent financing for newly developed properties may not be available or may be available only on disadvantageous terms. Development activities are also subject to risks relating to our inability to obtain, or delays in obtaining, all necessary zoning, land-use, building, occupancy and other required governmental and utility company authorizations.
Because holders of our Common Units, including some of our officers and directors, may suffer adverse tax consequences upon the sale of some of our properties, it is possible that the Company may sometimes make decisions that are not in your best interest. Holders of Common Units may suffer adverse tax consequences upon the Company’s sale of certain properties. Therefore, holders of Common Units, including certain of our officers and directors, may have different objectives regarding the appropriate pricing and timing of a property’s sale. Although we are the sole general partner of the Operating Partnership and have the exclusive authority to sell all of our individual wholly-owned properties, officers and directors who hold Common Units may influence us not to sell certain properties even if such sale might be financially advantageous to stockholders or to enter into tax deferred exchanges with the proceeds of such sales when such a reinvestment might not otherwise be in the best interests of the Company.
The success of our joint venture activity depends upon our ability to work effectively with financially sound partners. Instead of owning properties directly, we have in some cases invested, and may continue to invest, as a partner or a co-venturer. Under certain circumstances, this type of investment may involve risks not otherwise present, including the possibility that a partner or co-venturer might become bankrupt or that a partner or co-venturer might have business interests or goals inconsistent with ours. Also, such a partner or co-venturer may take action contrary to our instructions or requests or contrary to provisions in our joint venture agreements that could harm us, including jeopardizing our qualification as a REIT.
Our insurance coverage on our properties may be inadequate. We carry comprehensive insurance on all of our properties, including insurance for liability, fire and flood. Insurance companies currently, however, limit coverage against certain types of losses, such as losses due to terrorist acts, named windstorms and toxic mold. Thus we may not have insurance coverage against certain types of losses and/or there may be decreases in the limits of insurance available. Should an uninsured loss or a loss in excess of our insured limits occur, we could lose all or a portion of the capital we have invested in a property or properties, as well as the anticipated future revenue from the property or properties. If any of our properties were to experience a catastrophic loss, it could disrupt our operations, delay revenue and result in large expenses to repair or rebuild the property. Such events could adversely affect our ability to pay dividends to our stockholders. Our existing insurance policies expire on June 30, 2004. We anticipate renewing or replacing these coverages at that time.
7
Our use of debt to finance our operations could have a material adverse effect on our cash flow and ability to make distributions. We are subject to risks normally associated with debt financing, such as the insufficiency of cash flow to meet required payment obligations, difficulty in complying with financial ratios and other covenants and the inability to refinance existing indebtedness. Approximately $13.1 million of principal payments on our existing long-term debt is due in 2004. If we fail to comply with the financial ratios and other covenants, including our revolving loan, we would likely not be able to borrow any further amounts under the revolving loan, which could adversely affect our ability to fund our operations, and our lenders could accelerate any debt outstanding thereunder. If our debt cannot be paid, refinanced or extended at maturity, in addition to our failure to repay our debt, we may not be able to pay dividends to stockholders at expected levels or at all. Furthermore, if any refinancing is done at higher interest rates, the increased interest expense could adversely affect our cash flow and ability to pay dividends to stockholders. Any such refinancing could also impose tighter financial ratios and other covenants that could restrict our ability to take actions that could otherwise be in our stockholders’ best interest, such as funding new development activity, making opportunistic acquisitions, repurchasing our securities or paying distributions. If we do not meet our mortgage financing obligations, any properties securing such indebtedness could be foreclosed on, which would have a material adverse effect on our cash flow and ability to make distributions.
We may be subject to taxation as a regular corporation if we fail to maintain our REIT status. Our failure to qualify as a REIT would have serious adverse consequences to our stockholders. Many of the requirements for taxation as a REIT, however, are highly technical and complex. The determination that we are a REIT requires an analysis of various factual matters and circumstances that may not be totally within our control. For example, to qualify as a REIT, at least 95.0% of our gross income must come from certain sources that are itemized in the REIT tax laws. We are also required to distribute to stockholders at least 90.0% of our REIT taxable income, excluding capital gains. The fact that we hold our assets through the Operating Partnership and its subsidiaries further complicates the application of the REIT requirements. Even a technical or inadvertent mistake could jeopardize our REIT status. Furthermore, Congress and the IRS might change the tax laws and regulations, and the courts might issue new rulings that make it more difficult, or impossible, for us to remain qualified as a REIT.
If we fail to qualify as a REIT, we would be subject to federal income tax at regular corporate rates. Also, unless the IRS granted us relief under certain statutory provisions, we would remain disqualified as a REIT for four years following the year we first failed to qualify. If we failed to qualify as a REIT, we would have to pay significant income taxes and would therefore have less cash available for investments or to pay dividends to stockholders. This would likely have a significant adverse effect on the value of our securities. In addition, we would no longer be required to pay dividends to stockholders.
Because provisions contained in Maryland law, our charter and our bylaws may have an anti-takeover effect, investors may be prevented from receiving a “control premium” for their shares. Provisions contained in our charter and bylaws, as well as Maryland general corporation law, may have anti-takeover effects that delay, defer or prevent a takeover attempt, and thereby prevent stockholders from receiving a “control premium” for their shares. For example, these provisions may defer or prevent tender offers for our common stock or purchases of large blocks of our common stock, thus limiting the opportunities for our stockholders to receive a premium for their common stock over then-prevailing market prices. These provisions include the following:
8
9
As of December 31, 2003, we owned 465 in-service office, industrial and retail properties, encompassing approximately 34.9 million rentable square feet, and 213 apartment units. The following table sets forth information about our wholly-owned in-service properties at December 31, 2003:
Market
Research Triangle (3)
Atlanta
Tampa
Kansas City
Nashville
Piedmont Triad (6)
Richmond
Charlotte
Memphis
Greenville
Columbia
Orlando
Other
10
The following table sets forth information about our wholly-owned in-service and development properties as of December 31, 2003 and 2002:
In-Service:
Office
Industrial
Retail (2)
Total or Weighted Average
Development:
Completed—Not Stabilized
In Process
Total:
Development Land
We estimate that we can develop approximately 14.0 million square feet of office, industrial and retail space on our wholly-owned development land. All of this development land is zoned and available for office, industrial or retail development, substantially all of which has utility infrastructure already in place. We believe that our commercially zoned and unencumbered land in existing business parks gives us a development advantage over other commercial real estate development companies in many of our markets. Any future development, however, is dependent on the demand for office, industrial or retail space in the area, the availability of favorable financing and other factors, and no assurance can be given that any construction will take place on the development land. In addition, if construction is undertaken on the development land, we will be subject to the risks associated with construction activities, including the risk that occupancy rates and rents at a newly completed property may not be sufficient to make the property profitable, construction costs may exceed original estimates and construction and lease-up may not be completed on schedule, resulting in increased debt service expense and construction expense. We may also dispose of certain parcels of development land that do not meet our development criteria and we may develop properties other than office, industrial and retail on certain parcels with unrelated joint venture partners.
11
As of December 31, 2003, we owned an interest (50.0% or less) in 65 in-service office and industrial properties, encompassing approximately 6.8 million rentable square feet and 418 apartment units. The following table sets forth information about these properties at December 31, 2003:
Des Moines
Research Triangle
Piedmont Triad
12
Lease Expirations
The following tables set forth scheduled lease expirations for existing leases at our wholly-owned properties (excluding apartment units) as of December 31, 2003. The table includes the effects of any early renewals exercised by tenants as of December 31, 2003.
Office Properties:
Lease Expiring (1)
2004 (3)
2005
2006
2007
2008
2009
2010
2011
2012
2013
Thereafter
Industrial Properties:
2004 (4)
13
Retail Properties:
14
We are a party to a variety of legal proceedings arising in the ordinary course of our business. We believe that we are adequately covered by insurance and indemnification agreements. Accordingly, none of such proceedings are expected to have a material adverse effect on our business, financial condition and results of operations.
We incurred $2.7 million in year ended December 31, 2002 for litigation expense related to various legal proceedings from previously completed mergers and acquisitions. These claims were fully settled by early 2003.
None.
15
The following table sets forth information with respect to our executive officers:
Name
Age
Position and Background
Ronald P. Gibson
Edward J. Fritsch
Gene H. Anderson
Michael F. Beale
Michael E. Harris
Carman J. Liuzzo
Mack D. Pridgen III
Terry L. Stevens
16
PART II
The Common Stock has been traded on the New York Stock Exchange (“NYSE”) under the symbol “HIW” since the Company’s initial public offering. The following table sets forth the quarterly high and low stock prices per share reported on the NYSE for the quarters indicated and the dividends paid per share during such quarter.
Quarter Ended
March 31
June 30
September 30
December 31
On February 25, 2004, the last reported stock price of the Common Stock on the NYSE was $26.00 per share and the Company had 1,455 stockholders of record.
The Company intends to continue to pay quarterly dividends to holders of shares of Common Stock and holders of Common Units. Future dividend payments by the Company will be at the discretion of the Board of Directors and will depend on the actual funds from operations of the Company, its financial condition, capital requirements, the annual dividend requirements under the REIT provisions of the Internal Revenue Code and such other factors as the Board of Directors deems relevant. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources –Stockholder Dividends.”
During 2003, the Company’s Common Stock dividends totaled $1.86 per share, $1.18 of which represented return of capital for income tax purposes. The minimum dividend per share of Common Stock required to maintain REIT status (excluding any net capital gains) was approximately $0.07 per share in 2003 and $0.90 per share in 2002.
The Company has a Dividend Reinvestment and Stock Purchase Plan under which holders of Common Stock may elect to automatically reinvest their dividends in additional shares of Common Stock and may make optional cash payments for additional shares of Common Stock. The Company may issue additional shares of Common Stock or repurchase Common Stock in the open market for purposes of satisfying its obligations under the Dividend Reinvestment and Stock Purchase Plan.
The Company has an Employee Stock Purchase Plan for all active employees. At the end of each three-month offering period, each participant’s account balance is applied to acquire shares of Common Stock at a cost that is calculated at 85.0% of the lower of the average closing price on the NYSE on the five consecutive days preceding the first day of the quarter or the five days preceding the last day of the quarter. A participant may contribute up to 25.0% of their pay. During 2003, employees purchased 50,812 shares of Common Stock under the Employee Stock Purchase Plan.
The section under the heading entitled “Equity Compensation Plan Information” of the Proxy Statement is incorporated herein by reference.
During the three months ended December 31, 2003, the Company issued 257,508 shares of Common Stock to holders of Common Units in the Operating Partnership upon the redemption of such Common Units in private offerings pursuant to Section 4(2) of the Securities Act. Each of the holders of the Common Units was an accredited investor under Rule 501 of the Securities Act. The Company has registered the resale of such shares under the Securities Act.
17
The following table sets forth selected financial and operating information for the Company as of and for the years ended December 31, 2003, 2002, 2001, 2000 and 1999 ($ in thousands, except per share amounts):
Rental revenue
Operating expenses:
Rental property
Depreciation and amortization
General and administrative (includes $3,700 nonrecurring compensation expense in 2002)
Litigation expense
Cost of unsuccessful transactions
Total operating expenses
Interest expense
Interest and other income
Income before gain on disposition of land and disposition and impairment of depreciable assets, minority interest and discontinued operations
Gain on disposition of land and disposition and impairment of depreciable assets, net
Income before minority interest and discontinued operations
Minority interest
Income from continuing operations
Discontinued operations, net of minority interest
Net income
Dividends on preferred stock
Net income available for common stockholders
Net (loss)/income per common share – basic:
(Loss)/income from continuing operations
Net (loss)/income per common share – diluted:
Dividends declared per common share
Balance Sheet Data:
Net real estate assets
Total assets
Total mortgages and notes payable
Cumulative redeemable preferred shares
Other Data:
Cash flows provided by operating activities
Cash flows provided by/(used in) investing activities
Cash flows used in financing activities
Funds from operations after minority interest (2)
Number of wholly-owned in-service properties
Total rentable square feet
18
You should read the following discussion and analysis in conjunction with the accompanying consolidated financial statements and related notes contained elsewhere in this Annual Report on Form 10-K.
DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
Some of the information in this Annual Report on Form 10-K 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:
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 elsewhere in this Annual Report.
Given these uncertainties, we caution you not to place undue reliance on forward-looking statements. We undertake no obligation to publicly release the results of any revisions to these forward-looking statements that may be made to reflect any future events or circumstances or to reflect the occurrence of unanticipated events.
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OVERVIEW
We are a fully integrated, self-administered REIT that provides leasing, management, development, construction and other customer-related services for our properties and for third parties. As of December 31, 2003, we own or have an interest in 530 in-service office, industrial and retail properties encompassing approximately 41.7 million square feet. We also own 1,305 acres of development land which is suitable to develop approximately 14.0 million rentable square feet of office, industrial and retail space. 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.
Results of Operations
During 2003, approximately 82.5% of our rental revenue was derived from our office properties (See Note 1 to our Consolidated Financial Statements for further discussion on the accounting for our rental revenue). As a result, while we own and operate a limited number of industrial and retail properties, our operating results depend heavily on successfully leasing our office properties. Furthermore, since most of our office properties are located in Florida, Georgia and North Carolina, employment 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 revenue stream are average occupancy and rental rates. During the past several years, as the average occupancy of our portfolio has decreased, our same property rental revenue has declined. 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, while average occupancy generally declines during times of slower economic growth, when new vacancies tend to outpace our ability to lease space. Asset acquisitions and dispositions also impact our rental revenues and could impact our average occupancy, depending upon the occupancy percentage of the properties that are acquired or sold.
Whether or not our rental revenue tracks average occupancy proportionally depends upon whether rents under new leases are higher or lower than the rents under the previous leases. During 2003, the average rate per square foot on a GAAP basis on new leases was only 0.7% lower than the average rate per square foot on the expired leases. A further indicator of the predictability of future revenues is the expected lease expirations of our portfolio. Our average suburban office lease term, excluding renewal periods is 4.5 years. In 2004, leases on approximately 4.7 million square feet of space will expire that have not been renewed as of December 31, 2003. This square footage represents approximately 14.7% of our annualized revenue. As of February 19, 2004, we have renewed or signed new leases aggregating 1.5 million square feet of space with 2004 start dates, or 32.0% of the square footage expiring during 2004. 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. For more information regarding our lease expirations, see “Properties – Lease Expirations.”
Our expenses primarily consist of depreciation and amortization, general & administrative expenses, rental property expenses and interest expense. 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. General and administrative expenses, net of amounts capitalized, consist primarily of management and employee salaries and other personnel costs, corporate overhead and long term incentive compensation, and generally remain relatively consistent from period to period and have ranged from 5.7% to 6.2% of our total expenses over the past few years. Rental property expenses are expenses associated with our ownership and operating of rental properties and include variable expenses, such as common area maintenance and utilities, and fixed expenses, such as property taxes and insurance. Some of these variable expenses may be lower as our average occupancy declines, while the fixed expenses remain constant regardless of average occupancy. Interest expense depends upon the amount of our borrowings, the weighted average interest rates on our debt and the amount capitalized on development projects.
Under Generally Accepted Accounting Principles (“GAAP”), certain expenses related to the development, construction and leasing of properties, such as construction costs, interest costs, real estate taxes, salaries and other costs relating to such activities, are capitalized rather than expensed as incurred. As a result, during times of increased development, construction and successful leasing activity, certain of our general and administrative expenses may actually be lower because some fixed overhead costs are properly capitalized, and then amortized over the lives of various projects rather than expensed during the period incurred.
20
We also record income from our investments in unconsolidated affiliates, which are our joint ventures. These joint ventures are not consolidated on our balance sheet. We record in “equity in earnings of unconsolidated affiliates” our proportionate share of the joint venture’s net income or loss as part of “other income.” During 2003, income earned from our joint ventures accounted for approximately 8.5% of our total net income.
Additionally, SFAS 144 requires us to record net income received from properties sold or held for sale separately as “income from discontinued operations.” As a result, we separately record revenues and expenses from these properties. During 2003, income, including gains and losses from the sale of properties, from discontinued operations accounted for approximately 57.2% of our total net income.
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. 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 than reletting to a new customer. However, market conditions such as supply of available space on 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.
Because we are a REIT, we are required under the federal tax laws to distribute at least 90.0% of our REIT taxable income to our stockholders. We generally use rents received from customers to fund our operating expenses, recurring capital expenditures and stockholder dividends. To fund property acquisitions, development activity or building renovations, we incur debt from time to time. As of December 31, 2003, we had approximately $823.8 million of secured debt outstanding and $735.0 million of unsecured debt outstanding. Our debt consists of mortgage debt, unsecured debt securities and borrowings under our revolving loan. As of March 3, 2004, we have $133.4 million of additional borrowing availability under our revolving loan. As of the date of this filing, our short-term cash needs include the funding of $28.8 million in development activity and $13.1 million in principal payments due on our long term debt in the next year.
Our revolving loan and the indenture governing our outstanding long-term unsecured debt securities each 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. While we are currently in compliance with these covenants and ratios and expect to remain so for the foreseeable future, we cannot provide any assurance of such continued compliance and any failure to remain in compliance 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 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, 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.
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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 have limited those efforts during the past five years because of our ability to generally incur debt at a lower cost. We currently have an effective shelf registration statement with the SEC pursuant to which the Company could sell up to $900.0 million of common stock and the Operating Partnership could sell up to $600.0 million of unsecured debt securities.
Management’s Analysis
In measuring, analyzing and comparing our operating performance, we use a number of different criteria, including GAAP financial measures, such as net income, and non-GAAP financial measures, such as funds from operations (“FFO”). FFO does not represent net income or cash flows from operating, investing or financing activities as defined by GAAP and should not be considered as an alternative to net income as an indicator of our operating performance or to cash flows as a measure of liquidity. See “Funds From Operations and Cash Available for Distributions.” However, we believe that FFO is one of several indicators of the performance of an equity REIT. FFO can facilitate comparisons of operating performance between periods and between other REITs because it excludes factors, such as depreciation, amortization and gains and losses from sales of real estate assets, which are based on historical cost and may be of limited relevance in evaluating current performance. FFO as disclosed by other REITs may not be comparable to our calculation of FFO.
In measuring, analyzing and comparing our financial condition, management uses a number of other criteria, such as total debt as a percentage of total market capitalization, the weighted average interest rate of our secured and unsecured debt, our borrowing capacity and cash available for distributions (“CAD”). CAD provides us with an additional basis to evaluate our ability to incur and service debt, fund acquisitions, leasing and other capital expenditures and pay dividends to stockholders. CAD, which is a non-GAAP financial measure, does not represent net income or cash flows from operating, investing or financing activities as defined by GAAP. See “Funds From Operations and Cash Available for Distribution.”
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RESULTS OF OPERATIONS
On January 1, 2002, we adopted Financial Accounting Standards Board Statement No. 144, “Accounting for the Impairment and Disposal of Long-Lived Assets”, (“SFAS 144”). As described in Note 12 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 properties were either sold during 2003 and 2002 or were held for sale at December 31, 2003 and met certain conditions as stipulated by SFAS 144. Accordingly, the operations and gain/(loss) from those properties disposed of during 2001 and certain properties disposed of during 2002 were not reclassified to discontinued operations.
Comparison of 2003 to 2002
The following table sets forth information regarding our results of operations for the years ended December 31, 2003 and 2002 ($ in millions):
Year Ended
December 31,
2003
to 2002
$ Change
General and administrative (includes $3.7 nonrecurring compensation expense in 2002)
Interest expense:
Contractual
Amortization of deferred financing costs
Other income:
Equity in earnings of unconsolidated affiliates
Income before gain on disposition of land and depreciable assets, minority interest and discontinued operations
Gain on disposition of land
Gain on disposition of depreciable assets
Discontinued operations:
Income from discontinued operations, net of minority interest
Gain on sale of discontinued operations, net of minority interest
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Rental Revenue
The decrease in rental revenue from continuing operations was primarily a result of a decrease in average occupancy rates from 85.9% for the year ended December 31, 2002 to 81.6% for the year ended December 31, 2003. The decrease in average occupancy rates was primarily a result of the bankruptcies of WorldCom and US Airways, which decreased average occupancy rates by 2.8% and rental revenue from continuing operations by $15.4 million. Same property rental revenue decreased by $12.0 million. (See below for additional discussion on same property rental revenue). Partly offsetting these decreases, during 2002, approximately 2.0 million square feet of development properties were placed in-service and, as a result, increased rental revenues from continuing operations by approximately $8.6 million. In addition, the acquisition of certain MG-HIW, LLC assets in July 2003 have increased rental revenues by $8.7 million. (See Note 3 to the Consolidated Financial Statements for further discussion). Recovery income from certain operating expenses have decreased in the year ended December 31, 2003 due to lower occupancy.
Same property rental revenue generated from the 31.4 million square feet of our 426 wholly-owned in-service properties that were owned throughout the period from January 1, 2002 to December 31, 2003, decreased $27.4 million, or 6.4%, for the year ended December 31, 2003 compared to the year ended December 31, 2002. This decrease is primarily a result of lower same property average occupancy, which decreased from 88.3% in 2002 to 84.2% in 2003. The decrease in same property average occupancy was primarily a result of the bankruptcies of WorldCom and US Airways, which decreased same property average occupancy rates by 2.9% and same property rental revenue from continuing operations by $15.4 million.
During the year ended December 31, 2003, 954 second generation leases representing 7.6 million square feet of office, industrial and retail space were executed. The average rate per square foot on a GAAP basis over the lease term for leases executed in the year ended December 31, 2003 was only 0.7% lower than the rent paid by previous customers.
As of the date of this filing, we are beginning to see a modest improvement in employment trends in a few of our markets and an improving economic climate in the Southeast. However, we expect a lag between positive employment growth and positive absorption of office space due to the significant amount of vacancies, under-utilized space and space available for sublease in our markets.
We anticipate that occupancy in our in-service portfolio will decrease slightly in the first half of 2004 and increase slightly in the second half of 2004. This outlook is based on the level of leasing activity we have experienced over the past 12 months, which we expect to continue through 2004, our expected renewal rates and other factors. In 2004, leases on approximately 4.7 million square feet of space will expire that have not been renewed as of December 31, 2003. This square footage represents approximately 14.7% of our annualized revenue. As of February 19, 2004, we have renewed or signed new leases aggregating 1.5 million square feet of space with 2004 start dates, or 32.0% of the square footage expiring during 2004. Because of an oversupply of office space in many of our southeastern markets, we continue to expect straight-line rents under new leases to be lower than the straight-line rents under the expiring leases. As noted above, during 2003, the average rate per square foot on a GAAP basis on new leases was only 0.7% lower than the average rate per square foot on the expired leases.
Operating Expenses
The increase in rental operating expenses from continuing operations (real estate taxes, utilities, insurance, repairs and maintenance and other property-related expenses) was a result of an increase in certain fixed operating expenses that do not vary with net changes in our occupancy percentages, such as real estate taxes, insurance and utility rate changes, and an increase in operating expenses which resulted from the acquisition of certain MG-HIW assets in July 2003. In addition, we had 2.0 million square feet of development properties placed in service during 2002 which resulted in an increase in rental operating expenses from continuing operations.
Rental operating expenses as a percentage of rental revenue increased from 31.8% for the year ended December 31, 2002 to 34.9% for the year ended December 31, 2003. The increase was a result of the increases in rental operating expenses as described above and a decrease in rental revenue, primarily due to lower average occupancy, as described above.
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Same property rental operating expenses, which are the expenses related to the wholly-owned in-service properties that were owned throughout the period from January 1, 2002 to December 31, 2003, increased $1.0 million, or 1.0%, for the year ended December 31, 2003, compared to the year ended December 31, 2002. The increase was a result of increases in certain fixed operating expenses that do not vary with net changes in our occupancy percentages, such as real estate taxes, insurance and utility rate changes.
Same property rental operating expenses as a percentage of related revenue increased from 31.9% for the year ended December 31, 2002 to 34.3% for the year ended December 31, 2003. The increase in these expenses as a percentage of related revenue was a result of the increase in same property rental operating expenses as described above and a decrease in same property rental revenue, primarily due to the bankruptcies of WorldCom and US Airways, as previously discussed. In addition, operating expenses of $0.6 million that would have been paid by WorldCom if the leases were not rejected were paid by us and included in same property operating expenses during the year ended December 31, 2003.
We expect property operating expenses to increase slightly in 2004 due to inflationary increases along with increases in certain fixed operating expenses that do not vary with occupancy such as real estate taxes and utility rate changes.
The increase in depreciation and amortization from continuing operations related to buildings, leasing commissions and tenant improvement expenditures for properties placed in-service during 2002 and the write-off of deferred leasing costs and tenant improvements for customers who vacated their space prior to lease expiration. In addition, the increase resulted from the acquisition of certain MG-HIW assets in July 2003 and depreciation and amortization on 2.0 million rentable square feet of development properties placed in service during 2002.
General and administrative expenses from continuing operations, net of amounts capitalized, as a percentage of the aggregate of rental revenues, and interest and other income for both continuing and discontinued operations and equity in earnings of unconsolidated affiliates, was 5.3% for the year ended December 31, 2003 and 4.8% for the year ended December 31, 2002. The increase was primarily attributable to a decrease of capitalization of general and administrative costs due to the decrease in development and leasing activity in 2003 and an increase in long-term incentive compensation expense as a result of the issuance of restricted and phantom stock during 2002 and 2003. In 2003, general and administrative expenses also included higher expenses related to employee compensation. In addition, rental revenue and interest and other income decreased for the year ended December 31, 2003 as compared to the year ended December 31, 2002. Partly offsetting these increases was a $3.7 million non-recurring compensation expense in 2002.
We incurred $2.7 million in the year ended December 31, 2002 for litigation expense related to various legal proceedings from previously completed mergers and acquisitions. These claims were fully settled by early 2003.
In 2004, general and administrative expenses are expected to increase due to inflationary increases in compensation, benefits and other expenses related to the implementation of the Sarbanes-Oxley Act.
Interest Expense
As a result of decreased development activity in 2003, capitalized interest decreased from $7.0 million for the year ended December 31, 2002 to $1.2 million for the year ended December 31, 2003, resulting in an increase in interest expense from continuing operations in 2003. Partly offsetting this increase was a decrease in the average outstanding debt balance of $65.7 million from 2002 to 2003 and a decrease in average interest rates from 7.0% in 2002 to 6.9% in 2003. Interest expense for the years ended December 31, 2003 and 2002 included $3.1 million and $1.4 million, respectively, of amortization of deferred financing costs. The increase of $1.7 million was primarily a result of financing costs incurred in connection with the refinancing of the MandatOry Par Put Remarketed Securities (“MOPPRS”). See “Liquidity and Capital Resources” for further discussion on the refinancing.
Interest expense is expected to decline in 2004 primarily due to the December 1, 2003 refinancing of certain long term debt, see – “Liquidity and Capital Resources” for further discussion of this refinancing, offset by any increases in average debt balances resulting from acquisitions or other activities.
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Interest and Other Income
The decrease in interest and other income is primarily related to the collection of a legal settlement recorded in the year ended December 31, 2002 related to previously completed mergers and acquisitions along with a decrease in interest income due to the collection of notes receivable during the years ended December 31, 2002 and 2003 and lower interest rates earned on cash reserves. Leasing fee income and development fee income decreased in the year ended December 31, 2003 due to lower demand for real estate slightly offset by an increase in management fee income due to the Company retaining the management of some of our properties that were sold to third parties or contributed to joint ventures during the years ended December 31, 2002 and 2003.
The decrease in equity in earnings from continuing operations of unconsolidated affiliates was primarily a result of a charge of $2.4 million, which represents our proportionate share of the impairment loss of $12.1 million recorded by the MG-HIW, LLC joint venture in the year ended December 31, 2003, related to our acquisition of the assets of the MG-HIW, LLC joint venture and lower occupancy in 2003 for certain joint ventures. Partly offsetting these decreases was an increase of $0.5 million in equity in earnings in 2003 related to a charge of $0.3 million taken in 2002 due to an early extinguishment of debt loss taken by a certain joint venture and an increase in equity in earnings in 2003 of $0.2 million as a result of a gain recognized by a certain joint venture related to the disposition of land in 2003.
Gain on Disposition of Land and Depreciable Assets
In 2003, the majority of the gain was comprised of a $3.2 million gain related to the disposition of 108.5 acres of land and a gain of approximately $1.0 million related to the condemnation of 4.0 acres of land. Partly offsetting these gains was an impairment loss of $0.5 million related to three land parcels held for sale at December 31, 2003. In 2002, the majority of the gain was comprised of a $15.6 million gain related to the disposition of 533,263 square feet of office properties, that did not meet certain conditions to be classified as discontinued operations as described in Note 12 of the Consolidated Financial Statements, and a $6.9 million gain related to the disposition of 112.7 acres of land. The gains were partly offset by an impairment loss of approximately $9.1 million recorded in 2002 related to a property that has been demolished and will be redeveloped into a class A suburban office property.
Discontinued Operations
In accordance with SFAS 144, we classified net income of $14.3 million and $21.7 million, net of minority interest, as discontinued operations for the year ended December 31, 2003 and 2002, respectively. These amounts pertained to 5.5 million square feet of property, four apartment units and 122.8 acres of revenue-producing land sold during 2002 and 2003 and 438,073 square feet of property and 88 apartment units held for sale at December 31, 2003. We also classified as discontinued operations gain on the sale of these properties of $17.8 million and $15.2 million, net of minority interest, in 2003 and 2002, respectively. Partly offsetting these gains were impairment charges of $0.3 million and $3.6 million, net of minority interest, in 2003 and 2002, respectively. In addition, in accordance with SFAS 66, “Accounting for Sales of Real Estate,” we deferred the recognition of an additional gain of $6.9 million relating to the disposition to a third party buyer of 225,220 square feet during the fourth quarter of 2002 for which we guaranteed the buyer up to $20.5 million of rental shortfalls or re-tenanting costs. Additionally, in 2003 we have deferred the recognition of additional gain of $6.8 million relating to the dispositions to third party buyers of approximately 2.3 million rentable square feet for which we have guaranteed the buyers certain rental shortfalls and re-tenanting costs. (See Note 15 of the Consolidated Financial Statements for further discussion).
Preferred Stock Dividends
We recorded $30.9 million in preferred stock dividends in each of the years ended December 31, 2003 and 2002.
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Net Income
We recorded net income in 2003 of $55.7 million, which was a 40.4% decrease from net income of $93.5 million in 2002, primarily due to a decrease in rental revenues as a result of lower occupancy and the bankruptcies of WorldCom and US Airways, the disposition of certain properties under our capital recycling plan, an increase in rental property operating expenses, an increase in depreciation and amortization and a decrease in gain on the disposition of land and depreciable assets. In 2004, we expect net income to be lower as compared with 2003 due to flat average occupancy and pressure on rental rates, higher depreciation and amortization, higher property operating costs, and higher general and administrative costs, offset by lower interest expense.
Comparison of 2002 to 2001
The following table sets forth information regarding our results of operations for the years ended December 31, 2002 and 2001 ($ in millions):
2002
to 2001
% of
Change
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The decrease in rental revenue from continuing operations was primarily due to a decrease in average occupancy rates from 91.6% for the year ended December 31, 2001 to 86.0% for the year ended December 31, 2002. The average occupancy decreased mainly due to tenant rollover and early lease terminations at various properties where vacant space was not re-leased due to the lack of demand for office space coupled with an increasing supply of competitive space. During 2002, approximately 2.0 million square feet of development properties were placed in-service which have leased-up slower than expected and as a result, have also adversely affected the occupancy of our overall portfolio. Rental revenue also decreased due to the impact of dispositions during 2002 and 2001 that were not classified as discontinued operations as more fully described in Note 12 of our Consolidated Financial Statements.
In addition, as a result of the bankruptcy of WorldCom and its affiliates, we wrote off approximately $3.1 million of accrued straight-line rent receivable in the year ended December 31, 2002.
Same property rental revenue, generated from the 33.6 million square feet of 460 wholly-owned in-service properties that were owned throughout the period from January 1, 2001 to December 31, 2002, decreased $20.2 million for the year ended December 31, 2002 compared to the year ended December 31, 2001. This decrease is primarily a result of lower same store average occupancy, which decreased from 93.0% in 2001 to 88.0% in 2002, and a decrease in straight-line rental income primarily as a result of the bankruptcy of WorldCom and its affiliates.
During the year ended December 31, 2002, 840 second generation leases representing 5.6 million square feet of office, industrial and retail space were executed at an average rate per square foot which was 5.5% lower than the average rate per square foot on the expired leases.
Rental operating expenses from continuing operations (real estate taxes, utilities, insurance, repairs and maintenance and other property-related expenses) as a percentage of rental revenue increased from 30.9% for the year ended December 31, 2001 to 31.8% for the year ended December 31, 2002. The increase in these expenses as a percentage of revenue was a result of increases in repairs and maintenance and certain fixed operating expenses such as real estate taxes that do not vary with net changes in our occupancy average.
Same property rental operating expenses of the in-service properties wholly-owned that were owned throughout the period from January 1, 2001 to December 31, 2002, decreased $0.2 million or 0.2%, for the year ended December 31, 2002, compared to the year ended December 31, 2001. Same property rental operating expenses as a percentage of related revenue increased 1.5% from 30.4% for the year ended December 31, 2001 to 31.9% for the year ended December 31, 2002. The increase as a percentage of revenue was a result of increases in repairs and maintenance and certain fixed operating expenses such as real estate taxes that do not vary with net changes in our occupancy average.
The increase in depreciation and amortization from continuing operations was due to an increase in amortization related to leasing commissions and tenant improvement expenditures for properties placed in-service during 2001 and 2002 and the write-off of $5.8 million of deferred leasing costs primarily related to the leases rejected by WorldCom at December 31, 2002. These increases were partially offset by a decrease in depreciation for properties disposed of during 2002 and 2001 that are not classified as discontinued operations in accordance with SFAS 144.
General and administrative expenses from continuing operations, net of amounts capitalized, as a percentage of the aggregate of rental revenues, interest and other income for both continuing and discontinued operations and equity in earnings of unconsolidated affiliates was 4.8% in 2002 and 4.0% in 2001. Included in general and administrative expenses in 2002 was a nonrecurring compensation charge of $3.7 million related to the exercise of options. Such exercises were recorded as compensation expense under FASB Interpretation No. 44 (“Accounting For Certain Transactions Involving Stock Options, An Interpretation of APB Opinion No. 25”). We no longer settle option exercises in a manner which would require recognition of compensation expense under FASB Interpretation No. 44. In the event we decide to repurchase shares after an option exercise, we will require the option holder to pay the cash for the strike price and then separately repurchase a corresponding number of shares in the market under our stock repurchase program.
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We incurred $2.7 million in the year ended December 31, 2002 for litigation expense related to various legal proceedings from previously completed mergers and acquisitions. These claims were fully settled in early 2003.
Capitalized interest decreased from $16.9 million for the year ended December 31, 2001 to $7.0 million for the year ended December 31, 2002, resulting in an increase in interest expense from continuing operations in 2002. Partly offsetting this increase was a decrease in average interest rates from 7.2% in 2001 to 7.0% in 2002. The average outstanding debt balance remained relatively consistent for 2002 and 2001. Interest expense for the years ended December 31, 2002 and 2001 included $1.4 million and $2.0 million, respectively, of amortization of deferred financing costs and costs related to our interest rate hedge contracts.
The decrease in interest and other income from continuing operations primarily resulted from a decrease in leasing and development fee income in the year ended December 31, 2002 and a decrease in interest income in the year ended December 31, 2002 due to the collection of notes receivable during 2001 and 2002.
The decrease in equity in earnings of unconsolidated affiliates was primarily a result of lower lease termination fees and lower property operating expense reimbursements in 2002. The decrease in earnings was partly offset by lower interest expense incurred during 2002 as a result of lower weighted average borrowing rates and earnings from certain joint ventures formed with unrelated investors during 2002.
In 2002, the majority of the gain was comprised of a gain related to the disposition of 533,263 square feet of office properties that did not meet certain conditions to be classified as discontinued operations as described in Note 12 of the Consolidated Financial Statements and a gain related to the disposition of 112.7 acres of land. The gain is partly offset by an impairment loss of approximately $9.1 million recorded in 2002 related to a property that has been demolished and will be redeveloped into a class A suburban office property. In 2001, the majority of the gain was comprised of a gain related to the disposition of 1,672 apartment units and a gain related to the disposition of 180.3 acres of land.
In accordance with SFAS 144, we classified net income of $21.7 million and $24.5 million, net of minority interest, as discontinued operations for the years ended December 31, 2002 and 2001, respectively, which pertained to 5.5 million square feet of property, four apartment units and 122.8 acres of revenue-producing land sold during 2002 and 2003 and 438,073 square feet of property and 88 apartment units held for sale at December 31, 2003. We also classified as discontinued operations in 2002 the gain on the sale of these properties of $15.2 million, net of minority interest, partly offset by impairment charges of $3.6 million, net of minority interest. In addition, in accordance with SFAS 66, “Accounting for Sales of Real Estate,” we deferred the recognition of additional gain of $6.9 million, $6.1 million net of minority interest, relating to the disposition to a third party buyer of 225,220 square feet during the fourth quarter of 2002 for which we guaranteed the buyer up to $20.5 million of rental shortfalls or re-tenanting costs. (See Note 15 of the Consolidated Financial Statements for further discussion).
We recorded $30.9 million and $31.5 million in preferred stock dividends for each of the years ended December 31, 2002 and 2001, respectively. The decrease resulted from the Company’s repurchase of $18.5 million of its preferred stock during 2001.
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LIQUIDITY AND CAPITAL RESOURCES
Statement of Cash Flows
As required by GAAP, we report and analyze our cash flows based on operating activities, investing activities and financing activities. The following table sets forth the changes in the Company’s cash flows from 2002 to 2003 ($ in thousands):
Cash Provided By Operating Activities
Cash Provided By Investing Activities
Cash Used in Financing Activities
Total Cash Flows
In calculating cash flow from operating activities, GAAP requires us to add depreciation and amortization, which are non-cash expenses, 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, disposition and joint venture activity. During periods of significant net acquisition activity, our cash used in such investing activities will generally exceed cash provided by investing activities, which typically would consist of cash received upon the sale of properties or distributions from our joint ventures. During 2003 and 2002, since our disposition and joint venture activity slightly outpaced our acquisition activity, we recorded positive cash flow from investing activities in both years.
Cash used in financing activities generally relates to stockholder dividends, incurrence and repayment of debt and sales or repurchases of common stock and preferred stock. As discussed previously, we use a significant amount of our cash to fund stockholder dividends. Whether or not we incur significant new debt during a period depends generally upon the net effect of our acquisition, disposition, development and joint venture activity. We use our revolving loan for working capital purposes, which means that during any given period, in order to minimize interest expense associated with balances outstanding under the revolving loan, we will likely record significant repayments and borrowings under the revolving loan.
The decrease of $47.9 million in cash provided by operating activities was primarily a result of lower net income due to the disposition of certain properties under our capital recycling program, a decrease in average occupancy rates for our wholly-owned portfolio and the bankruptcies of WorldCom and US Airways. In addition, the level of net cash provided by operating activities is affected by the timing of receipt of revenues and payment of expenses.
The decrease of $130.1 million in cash provided by investing activities was primarily a result of a decrease in proceeds from dispositions of real estate assets of approximately $57.0 million and an increase in additions to real estate assets of approximately $72.5 million.
The decrease of $175.0 million in cash used in financing activities was primarily a result of a decrease of $161.4 million in net repayments on the unsecured revolving loan, mortgages and notes payable and a decrease of $29.4 million in distributions paid on Common Stock and Common Units, partly offset by an increase of $14.2 million for the repurchase of common stock and units and the settlement of an interest rate swap agreement for $3.9 million for the year ended December 31, 2003.
In 2004, we expect to continue our capital recycling program of selectively disposing of non-core properties or other properties in order to use the net proceeds for investments or other purposes. At December 31, 2003, we had 438,073 square feet of office properties, 88 apartment units and 168.1 acres of land under letter of intent or contract for sale in various transactions with a carrying value of $65.7 million. These transactions are subject to customary closing conditions, including due diligence and documentation, and are expected to close during 2004. However, we can provide no assurance that these transactions will be consummated.
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During 2004, we expect to have positive cash flows from operating activities. The net cash flows from investing activities in 2004 could be positive or negative, depending on the level and timing of property dispositions, property acquisitions and capitalized leasing and improvement costs. Any positive cash flows from investing activities in 2004 are expected to be used to pay stockholder and unitholder distributions, required debt amortization, and recurring capital expenditures.
Capitalization
The following table sets forth our capitalization as of December 31, 2003 and December 31, 2002 ($ in thousands, except per share amounts):
Mortgages and notes payable, at recorded book value
Preferred stock, at redemption value
Common shares and units outstanding
Per share stock price at period end
Market value of common equity
Total market capitalization with debt
Based on our total market capitalization of approximately $3.5 billion at December 31, 2003 (at the December 31, 2003 per share stock price of $25.40 and assuming the redemption for shares of Common Stock of the 6.6 million Common Units of minority interest in the Operating Partnership), our debt represented approximately 45.2% of our total market capitalization. Our total indebtedness at December 31, 2003 was approximately $1.6 billion and was comprised of $823.8 million of secured indebtedness with a weighted average interest rate of 6.9% and $735.0 million of unsecured indebtedness with a weighted average interest rate of 6.2%. As of December 31, 2003, our outstanding mortgage and loans payable and the secured revolving loan were secured by real estate assets with an aggregate carrying value of approximately $1.4 billion.
We do not intend to reserve funds to retire existing secured or unsecured debt upon maturity. For a more complete discussion of our long-term liquidity needs, see “Liquidity and Capital Resources - Current and Future Cash Needs.”
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The following table sets forth a summary regarding our known contractual obligations at December 31, 2003 ($ in thousands):
Fixed Rate Debt: (1)
Unsecured
Put Option Notes
Notes
Secured:
Mortgage Loans Payable (2)
Total Fixed Rate Debt
Variable Rate Debt:
Unsecured:
Term Loan
Revolving Loan
Total Variable Rate Debt
Total Long Term Debt
Operating Lease Obligations:
Land Lease (3)
Purchase Obligations:
MG-HIW, LLC (4)
MG-HIW, LLC Letter of Credit (4)
MG-HIW Metrowest I and II, LLC (4)
Completion Contracts (3)
Other Long Term Liabilities Reflected on the Balance Sheet:
MG-HIW, LLC Lease Guarantee (5)
Plaza Colonade Debt Repayment Guarantee (4)
Plaza Colonnade Completion Guarantee (4)
SF-HIW Harborview Lease Guarantee (5)
Capital One Lease Guarantee (5)
Industrial Portfolio Lease Guarantee (5)
Highwoods DLF 98/29, LP Lease Guarantee (5)
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Refinancings in 2003
On February 3, 2003, the Operating Partnership repurchased 100.0% of the principal amount of the MandatOry Par Put Remarketed Securities (“MOPPRS”) due February 1, 2013 from the sole holder thereof in exchange for a secured note in the principal amount of $142.8 million. The secured note bears interest at a fixed rate of 6.03% and has a maturity date of February 28, 2013. This transaction was accounted for as an exchange of indebtedness under EITF 96-19, “Debtor’s Accounting for a Modification or Exchange of Debt Instruments”. In accordance with EITF 96-19, the intermediaries acted as principals and the present value of the cash flows under the terms of the new debt instrument using the MOPPRS effective interest rate was less than 10.0% different from the present value of the remaining cash flows under the terms of the MOPPRS. Accordingly, the transaction was considered an exchange, not an extinguishment and no loss was recognized. The option premium paid to the lender was $17.7 million and was recorded as a deferred financing cost and will be amortized to interest expense over the remaining term of the new debt. Fees paid by us to third parties (such as legal fees) were expensed as incurred.
On July 17, 2003, we amended and restated our existing revolving loan. The amended and restated $250.0 million revolving loan (the “Revolving Loan”) is from a group of ten lender banks, matures in July 2006 and replaces our previous $300.0 million revolving loan. The Revolving Loan carries an interest rate based upon our senior unsecured credit ratings. As a result, interest currently accrues on borrowings under the Revolving Loan at a rate of LIBOR plus 105 basis points. The terms of the Revolving Loan require us to pay an annual facility fee equal to .25% of the aggregate amount of the Revolving Loan. We currently have a credit rating of BBB- assigned by Standard & Poor’s and Fitch Inc. In August 2003, Moody’s Investor Service downgraded our credit rating from Baa3 to Ba1. We cannot provide any assurances Moody’s or the other rating agencies will not further change our credit ratings. If Standard and Poor’s or Fitch Inc. were to lower our credit ratings without a corresponding increase by Moody’s, the interest rate on borrowings under our revolving loan would be automatically increased by 60 basis points.
On December 1, 2003, $146.5 million of our 8.0% Notes and $100.0 million of our 6.75% Notes matured. We refinanced $127.5 million with 10-year secured debt at an effective rate of 5.25%. $100.0 million was refinanced with a two-year unsecured term loan with a floating rate initially set at 1.3% over LIBOR. The balance, equaling $19.0 million, was repaid using funds from our $250.0 million Revolving Loan.
Anticipated Refinancings in 2004
In 1997, a trust formed by the Operating Partnership sold $100.0 million of Exercisable Put Option Securities due June 15, 2004 (“X-POS”). The assets of the trust consist of, among other things, $100.0 million of Exercisable Put Option Notes due June 15, 2011 (the “Put Option Notes”), issued by the Operating Partnership. The Put Option Notes bear an interest rate of 7.19% from the date of issuance through June 15, 2004. After June 15, 2004, the interest rate to maturity on the Put Option Notes will be 6.39% plus the applicable spread determined as of June 15, 2004. In connection with the initial issuance of the Put Option Notes, a counter party was granted an option to purchase the Put Option Notes from the trust on June 15, 2004 at 100.0% of the principal amount. If the counter party elects not to exercise this option, the Operating Partnership would be required to repurchase the Put Option Notes from the Trust on June 15, 2004 at 100.0% of the principal amount plus accrued and unpaid interest.
We currently anticipate that no later than June 15, 2004 we will call or repurchase $100.0 million of the X-POS and the third party purchase option. We will exchange the X-POS for a similar amount of new bonds. We anticipate that these transactions will be accounted for as an exchange of indebtedness under EITF 96-19 and accordingly no gain or loss would be recorded. Additionally, we anticipate the transaction will have no material effect on future interest expense assuming current market rates and conditions remain constant. However, any such transaction will depend upon our ability to favorably access the credit market and, accordingly, no assurances can be provided that we will be successful in refinancing the Put Option Note on favorable terms, if at all.
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Operating and Financial Covenants and Performance Ratios
The terms of the revolving loan and the indentures that govern our outstanding notes require us to comply with certain operating and financial covenants and performance ratios. We are currently in compliance with all such requirements. Although we expect to remain in compliance with the covenants and ratios under our revolving loans for at least the next several quarters, depending upon our future operating performance and property and financing transactions, we cannot assure you that we will continue to be in compliance.
The following table sets forth more detailed information about the Company’s ratio and covenant compliance under the revolving loan as of December 31, 2003 and 2002. Certain of these definitions may differ from similar terms used in the consolidated financial statements and may, for example, consider our proportionate share of investments in unconsolidated affiliates. For a more detailed description of the covenants in our revolving loan, including definitions of certain relevant terms, see the credit agreement governing our revolving loan which is incorporated by reference in this Annual Report as Exhibit 10.13.
Total Liabilities Less Than or Equal to 57.5% of Total Assets
Unencumbered Assets Greater Than or Equal to 2 times Unsecured Debt
Secured Debt Less Than or Equal to 35% of Total Assets
Adjusted EBDITA Greater Than 2.10 times Interest Expense
Adjusted EBDITA Greater Than 1.55 times Fixed Charges
Adjusted NOI Unencumbered assets Greater Than 2.25 times Interest on Unsecured Debt
Tangible Net Worth Greater Than $1.574 Billion
Restricted Payments, including distributions to shareholders, Less Than or Equal to 95% of CAD
The following table sets forth more detailed information about the Operating Partnership’s ratio and covenant compliance under the Operating Partnership’s indenture as of December 31, 2003 and 2002. Certain of these definitions may differ from similar terms used in the consolidated financial statements and may, for example, consider our proportionate share of investments in unconsolidated affiliates. For a more detailed discussion of the covenants in our indenture, including definitions of certain relevant terms, see the indenture governing our unsecured notes which is incorporated by reference in this Annual Report as Exhibit 4.2.
Overall Debt Less Than or Equal to 60% of Adjusted Total Assets
Secured Debt Less Than or Equal to 40% of Adjusted Total Assets
Income Available for debt service Greater Than 1.50 times Annual Service Charge
Total Unencumbered Assets Greater Than 200% of Unsecured Debt
Current and Future Cash Needs
Historically, rental revenue has been the principal source of funds to meet our short-term liquidity requirements, which primarily consist of operating expenses, debt service, stockholder dividends, any guarantee obligations and recurring capital expenditures. In addition, construction management, maintenance, leasing and management fees have provided sources of cash flow. Major capital improvements to the existing properties total $18.1 million, as indicated in the Known Contractual Obligation Summary. In addition, we could incur tenant improvements and lease commissions related to any releasing of space previously leased by WorldCom and US Airways or other vacant space.
In addition to the requirements discussed above, our short-term (within the next 12 months) liquidity requirements also include the funding of approximately $28.8 million of our existing development activity (as of the date of this filing) and first generation tenant improvements and lease commissions on properties placed in-service that are not fully leased. We expect to fund our short-term liquidity requirements through a combination of working capital, cash flows from operations and the following:
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Our long-term liquidity needs generally include the funding of existing and future development activity, selective asset acquisitions and the retirement of mortgage debt, amounts outstanding under the two revolving loans and long-term unsecured debt. We remain committed to maintaining a flexible capital structure. Accordingly, we expect to meet our long-term liquidity needs through a combination of (1) the issuance by the Operating Partnership of additional unsecured debt securities, (2) the issuance of additional equity securities by the Company and the Operating Partnership as well as (3) the sources described above with respect to our short-term liquidity. We expect to use such sources to meet our long-term liquidity requirements either through direct payments or repayment of borrowings under the unsecured revolving loan. As mentioned above, we do not intend to reserve funds to retire existing secured or unsecured indebtedness upon maturity. Instead, we will seek to refinance such debt at maturity or retire such debt through the issuance of equity or debt securities.
We anticipate that our available cash and cash equivalents and cash flows from operating activities, with cash available from borrowings and other sources, will be adequate to meet our capital and liquidity needs in both the short and long term. However, if these sources of funds are insufficient or unavailable, our ability to pay dividends to stockholders and satisfy other cash payments may be adversely affected.
Stockholder Dividends
To maintain our qualification as a REIT, we must distribute to stockholders at least 90.0% of our REIT taxable income. REIT taxable income, the calculation of which is determined by the federal tax laws, does not necessarily equal net income under GAAP. We generally expect to use our cash flow from operating activities for dividends to stockholders and for payment of recurring capital expenditures. Future dividends will be made at the discretion of the our Board of Directors. The following factors will affect our cash flows and, accordingly, influence the decisions of the Board of Directors regarding dividends:
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Off Balance Sheet Arrangements
The Company has several off balance sheet joint venture and guarantee arrangements. The joint ventures were formed with unrelated investors to generate additional capital to fund property acquisitions, repay outstanding debt or fund other strategic initiatives and to lessen the ownership risks typically associated with owning 100.0% of a property. When we create a joint venture with a strategic partner, we usually contribute one or more properties that we own to a newly formed entity in which we retain an interest of 50.0% or less. In exchange for an equal or minority interest in the joint venture, we generally receive cash from the partner and retain the management income relating to the properties in the joint venture.
As of December 31, 2003, our joint ventures had $814.0 million of total assets and $558.0 million of total liabilities. During 2003, these joint ventures earned $13.3 million of total net income, net of a $12.1 million impairment charge related to our purchase of the MG-HIW, LLC assets. We have a 34.3% weighted average equity interest in these joint ventures. For a more detailed discussion of our joint venture activity, see Note 2 in the Consolidated Financial Statements.
As required by GAAP, we have accounted for our joint venture activity using the equity method of accounting, as we do not control these joint ventures. As a result, the assets and liabilities of our joint ventures are not included on our balance sheet and the results of operations of the joint ventures are not included on our income statement, other than as equity in earnings of unconsolidated affiliates. In other words, 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.
As of December 31, 2003, our joint ventures had $534.0 million of outstanding debt. The following table sets forth the principal payments due on that outstanding long-term debt as recorded on the respective joint venture’s books at December 31, 2003 ($ in thousands):
Percent
Owned
Board of Trade Investment Company
Dallas County Partners (1)
Dallas County Partners II (1)
Fountain Three (1)
RRHWoods, LLC (1)
4600 Madison Associates, LP
Highwoods DLF 98/29, LP
Highwoods DLF 97/26 DLF 99/32, LP
Highwoods-Markel Associates, LLC
MG-HIW, LLC
MG-HIW Metrowest II, LLC
Concourse Center Associates, LLC
Plaza Colonnade, LLC
SF-HIW Harborview, LP
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In connection with the Des Moines joint venture guarantees, the maximum potential amount of future payments we could be required to make under the guarantees is $25.5 million. Of this amount, $8.6 million arose from housing revenue bonds that require credit enhancements in addition to the real estate mortgages. The bonds bear a floating interest rate, which currently averages 1.3% and mature in 2015. Guarantees of $9.5 million will expire upon two industrial buildings becoming 93.8% and 95.0% leased. Currently, these buildings are 90.0% and 64.0% leased, respectively. The remaining $7.4 million in guarantees relate to loans on four office buildings that were in the lease-up phase at the time the loans were initiated. Each of the loans will expire by May 2008. The average occupancy of the four buildings at December 31, 2003 is 91.0%. If the joint ventures are unable to repay the outstanding balance under the loans, we will be required, under the terms of the agreements, to repay the outstanding balance. Recourse provisions exist to enable us to recover some or all of our losses from the joint ventures’ assets and/or the other partner. The joint ventures currently generate sufficient cash flow to cover the debt service required by the loans.
In connection with the RRHWoods, LLC joint venture, we renewed our guarantee of $6.2 million to a bank in July 2003. The bank provides a letter of credit securing industrial revenue bonds, which mature in 2015. We would be required to perform under the guarantee should the joint venture be unable to repay the bonds. We have recourse provisions in order to recover from the joint venture’s assets and the other partner for amounts paid in excess of our proportionate share. The property collateralizing the bonds is 100.0% leased and currently generates sufficient cash flow to cover the debt service required by the bond financing.
With respect to the Plaza Colonnade, LLC joint venture, we have included $2.8 million in other liabilities and adjusted the investment in unconsolidated affiliates by $2.8 million on our consolidated balance sheet at December 31, 2003 related to two separate guarantees of a construction loan agreement and a construction completion agreement. The construction loan matures in February 2006, with two one-year options to extend the maturity date that are conditional on completion and lease-up of the project. The term of the construction completion agreement requires the core and shell of the building to be completed by December 15, 2005. Currently, the building is scheduled to be completed in December 2004. Both guarantees arose from the formation of the joint venture to construct an office building. If the joint venture is unable to repay the outstanding balance under the construction loan agreement or complete the construction of the office building, we would be required, under the terms of the agreements, to repay our 50.0% share of the outstanding balance under the construction loan and complete the construction of the office building. The maximum potential amount of future payments by us under these agreements is $34.9 million. No recourse provisions exist that would enable us to recover from the other partner amounts paid under the guarantee. However, given that the loan is collateralized by the building, we and our partner could obtain and liquidate the building to recover the amounts paid should we be required to perform under the guarantee.
In addition to the Plaza Colonnade, LLC construction loan and completion agreement described above, the partners have collectively provided $12.0 million in letters of credit, $6.0 million by us and $6.0 million by our partner. We and our partner would be held liable under the letter of credit agreements should the joint venture not complete construction of the building. The letters of credit expire in December 31, 2004. No recourse provisions exist that would enable us to recover from the other partner amounts drawn under the letter of credit.
In December 2000, we guaranteed our 80.0% partner in MG-HIW, LLC joint venture, a minimum internal rate of return on $50.0 million of their equity investment in the remaining assets of the joint venture (the “Orlando assets”). On July 29, 2003, we entered into an option agreement to acquire Miller Global’s 80.0% interest in the Orlando assets for between $62.5 and $65.2 million depending on the closing date and the distributions from the joint venture prior to closing. Based on the terms of the agreement, the purchase option price range satisfies the internal rate of return guarantee. In connection with the option agreement, we entered into a letter of credit in the amount of $7.5 million in favor of Miller Global, which can be drawn by Miller Global in the event we do not exercise our option to purchase their 80.0% interest in the remaining assets of MG-HIW, LLC by March 24, 2004.
On March 2, 2004, we exercised our option and acquired our partner’s 80.0% equity interest in the remaining assets of MG-HIW, LLC, which consists of five properties encompassing 1.3 million square feet located in the central business district of Orlando (“Orlando properties”). The properties were 83.8% leased as of December 31, 2003 and were encumbered by $136.2 million of floating rate debt with interest based on LIBOR plus 200 basis points, which has been assumed by the Company. At the closing of the transaction, the Company paid its partner, Miller Global, $62.5 million and the $7.5 million letter of credit was cancelled. The transaction implies a valuation (100% ownership) of $214.3 million, which includes the properties and other net assets of the joint venture.
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In January 2004, we signed a Letter of Intent with Kapital-Consult, manager for Dreilander-Fonds, a European investment firm, under which Kapital-Consult will acquire a 60% equity interest in the Orlando properties for approximately $45.5 million, excluding certain development rights to be retained by us. Although the transaction is subject to documentation and other closing conditions, it is expected to close no later than the end of the second quarter of 2004.
As part of the MG-HIW, LLC acquisition on July 29, 2003, we entered into an option agreement with our partner, Miller Global, to acquire their 50.0% interest in the assets of MG-HIW Metrowest I, LLC and MG-HIW Metrowest II, LLC for $3.2 million. The $7.4 million construction loan to fund the development of this property, of which $7.3 million is outstanding at December 31, 2003, will be either paid in full or assumed by us in connection with the acquisition of the remaining assets. We have guaranteed 50.0% of the construction loan, such that if the joint venture is unable to repay the outstanding balance, we would be required, under the terms of the agreement, to repay 50.0% of the outstanding balance. The maximum potential amount of future payments by us under the agreement is $3.7 million, however, we are able to seek recourse from our partner for 50.0% of that amount.
On March 2, 2004, we exercised our option and acquired our partner’s 50.0% equity interest in the assets of MG-HIW Metrowest I, LLC and MG-HIW Metrowest II, LLC for $3.2 million. The assets in MG-HIW Metrowest I, LLC and MG-HIW Metrowest II, LLC include 87,832 square feet of property and 7.0 acres of development land zoned for the development of 90,000 square feet of office space. The $7.4 million construction loan to fund the development of this property was paid in full by us at closing.
Certain properties owned in joint ventures with unaffiliated parties have buy/sell options that may be exercised to acquire the other partner’s interest by either us or our joint venture partner if certain conditions are met as set forth in the respective joint venture agreement. Our partner in SF-HIW Harborview, LP has the right to put its 80.0% equity interest in the partnership to us in cash at anytime during the one-year period commencing on September 11, 2014. As a result, we have deferred a gain of $1.0 million until the expiration of the put option. The value of the equity interest will be determined based upon the then fair market value of SF-HIW Harborview, LP assets and liabilities.
Interest Rate Hedging Activities
To meet in part our long-term liquidity requirements, we borrow funds at a combination of fixed and variable rates. Borrowings under our revolving loan bears interest at variable rates. Our long-term debt, which consists of long-term financings and the unsecured issuance of debt securities, typically bears interest at fixed rates. In addition, we have assumed fixed rate and variable rate debt in connection with acquiring properties. Our interest rate risk management objective is to limit the impact of interest rate changes on earnings and cash flows and to lower our overall borrowing costs. To achieve these objectives, from time to time we enter into interest rate hedge contracts such as collars, swaps, caps and treasury lock agreements in order to mitigate our interest rate risk with respect to various debt instruments.
The following table sets forth information regarding our interest rate hedge contracts as of December 31, 2003 ($ in thousands):
Type of Hedge
Interest Rate Swap
The interest rate on all of our variable rate debt is adjusted at one and three month intervals, subject to settlements under these contracts. We also enter into treasury lock agreements from time to time in order to limit our exposure to an increase in interest rates with respect to future debt offerings. During 2003, only a nominal amount was received from counter parties under interest rate hedge contracts.
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Related Party Transactions
We have previously reported that we have had a contract to acquire development land in the Bluegrass Valley office development project from GAPI, Inc., a corporation controlled by Mr. Anderson. On January 17, 2003, we acquired an additional 23.46 acres of this land from GAPI, Inc. for cash and shares of Common Stock valued at $2.3 million. In May 2003, 4.0 acres of the remaining acres not yet taken down was taken by the Georgia Department of Transportation to develop a roadway interchange for consideration of $1.8 million. The Department of Transportation took possession and title of the property in June 2003. As part of the terms of the contract between us and Bluegrass, we were entitled to the proceeds from the condemnation of $1.8 million, less the contracted purchase price between us and Bluegrass for the condemned property of $737,348. On September 30, 2003, as a result of the condemnation, we received the proceeds of $1.8 million. A related party payable of $737,348 to Bluegrass related to the condemnation of the development land is included in accounts payable, accrued expenses and other liabilities in our Consolidated Balance Sheet at December 31, 2003 and a gain of $1.0 million related to the condemnation of the development land is included in gain on disposition of land in our Consolidated Statement of Income for the year ended December 31, 2003. We believe that the purchase price with respect to each transaction did not exceed market value. These transactions were unanimously approved by the executive committee and the full Board of Directors (with Mr. Anderson abstaining from the vote).
During 2000, in connection with the formation of the MG-HIW Peachtree Corners III, LLC, a construction loan was made by an affiliate of ours to this joint venture. Interest accrued at a rate of LIBOR plus 200 basis points. This construction loan was repaid in full in July 2003 when we were assigned our partner’s 50.0% equity interest in the single property encompassing 53,896 square feet owned by MG-HIW Peachtree Corners III, LLC.
We advanced $0.8 million to an officer and director related to certain expenses paid by us on behalf of the officer and director. During 2002, this advance, along with accrued interest, was repaid by the officer and director.
As of December 31, 2003, the Company had a $1.7 million receivable due from a joint venture. The amount has been subsequently paid in full.
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CRITICAL ACCOUNTING ESTIMATES
The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses for the reporting period. Actual results could differ from our estimates.
The estimates used in the preparation of our Consolidated Financial Statements are described in Note 1 to our Consolidated Financial Statements for the year ended December 31, 2003. However, certain of our significant accounting policies contain an increased level of assumptions used or estimates made in determining their impact on our Consolidated Financial Statements. Management has reviewed our critical accounting policies and estimates with the audit committee of the Company’s Board of Directors and the Company’s independent auditors.
We consider our critical accounting estimates to be those used in the determination of the reported amounts and disclosure related to the following:
Real Estate Assets
Expenditures directly related to the development and construction of real estate assets are included in net real estate assets at cost in the consolidated balance sheets. Expenditures directly related to the leasing of properties are included in other assets at cost in the consolidated balance sheets. With regard to the general and administrative costs, including compensation, we annually calculate the capitalization percentages which are based on employee hours allocated to successful efforts in development, construction and leasing, and adjust the financial statements to reflect any change in those allocations. If those allocations prove to be incorrect, the resulting adjustments could impact earnings.
Development expenditures include pre-construction costs essential to the development of properties, development and construction costs, real estate taxes, interest costs, compensation and other costs incurred during the period of development. The interest costs are capitalized at the building’s vacancy percentage until either the building reaches 90.0% occupancy or one year after the issuance of a certificate of occupancy, whichever occurs first. The compensation costs are capitalized based on the capitalization percentage described above related to development activities. Construction expenditures include all general and administrative costs, including compensation and are capitalized based on the capitalization percentage related to specific construction projects. The leasing expenditures include all general and administrative costs, including compensation and are capitalized based on the capitalization percentage related to successfully securing leases on the properties. Estimated costs related to unsuccessful development and leasing as well as estimated costs related to non-specific construction projects are expensed as incurred.
All capitalizable costs related to the improvement or replacement of commercial real estate properties are capitalized. Depreciation is computed using the straight-line method over the estimated useful life of 40 years for buildings, 15 years for building improvements and five to seven years for furniture, fixtures and equipment. If these estimated lives are too short or too long, future adjustments to depreciation expense may be required. Tenant improvements are amortized over the life of the respective leases, using the straight-line method. Real estate assets are stated at the lower of cost or fair value, if impaired.
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Upon the acquisition of real estate, we assess the fair value of acquired tangible assets such as land, buildings and tenant improvements, intangible assets such as above and below market leases, acquired-in place leases and other identified intangible assets and assumed liabilities in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 141. We allocate the purchase price to the acquired assets and assumed liabilities based on their relative fair values. We assess and consider fair value based on estimated cash flow projections that utilize appropriate discount and/or capitalization rates, as well as available market information. Estimates of future cash flows are based on a number of factors including the historical operating results, known and anticipated trends, and market and economic conditions. The fair value of the tangible assets of an acquired property considers the value of the property as if it were vacant.
Above and below market leases acquired are recorded at their fair value. Fair value is calculated as the present value of the difference between (1) the contractual amounts to be paid pursuant to each in-place lease and (2) management’s estimate of fair market lease rates for each corresponding in-place lease, using a discount rate which reflects the risks associated with the leases acquired and measured over a period equal to the remaining term of the lease for above-market leases and the initial term plus the term of any below-market fixed rate renewal options for below-market leases. The capitalized above-market lease values are amortized as a reduction of based rental revenue over the remaining term of the respective leases and the capitalized below-market lease values are amortized as an increase to based rental revenue over the remaining term of the respective leases.
The value of in-place leases is based on our evaluation of the specific characteristics of each tenant’s lease. Factors considered include estimates of carrying costs during hypothetical expected lease-up periods, current market conditions, and cost to execute similar leases. In estimating carrying costs, we include real estate taxes, insurance and other operating expenses and estimates of lost rentals at market rates during the expected lease-up periods, depending on local market conditions. In estimating costs to execute similar leases, we consider tenant improvements, leasing commissions, legal and other related expenses. The value of in-place leases are amortized to depreciation and amortization expense over the remaining term of the respective leases. If a tenant vacates its space prior to its contractual expiration date, any unamortized balance of their related intangible asset is expensed.
The value of tenant relationships is based on our overall relationship with the respective tenant. Factors considered include the tenant’s credit quality and expectations of lease renewals. The value of tenant relationships is amortized to expense over the initial term and any renewal periods defined in the respective leases. Based on our acquisitions to date, we have deemed relationships to be immaterial and have not allocated any amounts to this intangible asset.
Real estate and leasehold improvements are classified as long-lived assets held for sale or as long-lived assets to be held and used. In accordance with Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-lived Assets”, we record assets held for sale at the lower of the carrying amount or estimated fair value. Fair value is equal to the estimated or contracted sales price with a potential buyer less cost to sell. The impairment loss is the amount by which the carrying amount exceeds the estimated fair value. With respect to assets classified as held and used, if events or changes in circumstances, such as significant decline in occupancy and change in use, indicate that the carrying value may be impaired, we perform an impairment analysis. Such analysis consists of determining whether the asset’s carrying amount will be recovered from its undiscounted estimated future operating cash flows. These cash flows are estimates based on a number of assumptions that are subject to economic and market uncertainties including, among others, demand for space, competition for tenants, changes in market rental rates and costs to operate each property. If the carrying amount of a held and used asset exceeds the sum of its undiscounted future operating cash flows, an impairment loss would be recorded for the difference between the discounted cash flows and the net book value. As the factors used in generating these cash flows are difficult to predict and are subject to future events that may alter our assumptions, the undiscounted future operating cash flows estimated by us in our impairment analyses may not be achieved and we may be required to recognize future impairment losses on our properties.
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Allowance for Doubtful Accounts
Accounts receivable are reduced by an allowance for amounts that may become uncollectible in the future. We evaluate the adequacy of our allowance for doubtful accounts on a quarterly basis. The evaluation primarily consists of reviewing past due account balances and considering such factors as the credit quality of our tenants, historical trends of the tenant and/or other debtor, current economic conditions and changes in customer payment terms. Additionally, with respect to tenants in bankruptcy, we estimate the expected recovery through bankruptcy claims and increase the allowance for amounts deemed uncollectible. If our assumptions regarding the collectibility of accounts receivable prove incorrect, we could experience write-offs of accounts receivable or accrued straight-line rents receivable in excess of our allowance for doubtful accounts.
Property Operating Expense Recoveries
Property operating cost recoveries from tenants (or cost reimbursements) are determined on a lease-by-lease basis. The most common types of cost reimbursements in our leases are common area maintenance (“CAM”) and real estate taxes, where the tenant pays its pro-rata share of operating and administrative expenses and real estate taxes.
The computation of cost reimbursements from tenants for CAM and real estate taxes is complex and involves numerous judgements including interpretation of terms and other tenant lease provisions. Leases are not uniform in dealing with such cost reimbursements and there are hundreds of variations in the computations dealing with such matters as: which costs are includable or not includable for reimbursement, what is the square footage of the overall property space to determine the pro-rata percentages, and the applicability of cost limitation provisions, among other things. Most tenants make monthly fixed payments of CAM, real estate taxes and other cost reimbursement items. We record these payments as income each month. We also make adjustments, positive or negative, to cost recovery income to adjust the recorded amounts to our best estimate of the final amounts to be billed and collected with respect to the cost reimbursements. After the end of the calendar year, we compute each tenant’s final cost reimbursements and issue a bill or credit for the full amount, after considering amounts paid by the tenants during the year. The differences between the amounts billed, less previously received payments and the accrual adjustment are recorded as increases or decreases to cost recovery income when the final bills are prepared, usually beginning in March and completed by June or July. The net amounts of any such adjustments have not been material in any of the years ended December 31, 2002 and 2001. Final adjustments for the year ended December 31, 2003 have not yet been determined.
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FUNDS FROM OPERATIONS ANDCASH AVAILABLE FOR DISTRIBUTION
We believe that funds from operations (“FFO”) is one of several indicators of the performance of an equity REIT. FFO can facilitate comparisons of operating performance between periods and between other REITs because it excludes factors, such as depreciation, amortization and gains and losses from sales of real estate assets, which are based on historical cost and may be of limited relevance in evaluating current performance. FFO as disclosed by other REITs may not be comparable to our calculation of FFO as described below. Cash available for distribution (“CAD”) is another useful financial performance measure of an equity REIT. CAD provides an additional basis to evaluate the ability of a REIT to incur and service debt, fund acquisitions and other capital expenditures and pay distributions. CAD does not measure whether cash flow is sufficient to fund all cash needs. FFO and CAD are non-GAAP financial measures and do not represent net income or cash flows from operating, investing or financing activities as defined by GAAP. They should not be considered as alternatives to net income as an indicator of our operating performance or to cash flows as a measure of liquidity.
Our calculation of FFO, which we believe is consistent with the calculation of FFO as defined by the National Association of Real Estate Investment Trusts (NAREIT), is as follows:
CAD is defined as FFO reduced by non-revenue enhancing capital expenditures for building improvements and tenant improvements and lease commissions related to second generation space. In addition, CAD includes both recurring and nonrecurring operating results. As a result, nonrecurring items that are not defined as “extraordinary” under GAAP are reflected in the calculation of CAD. In addition, nonrecurring items included in the calculation of CAD for periods ended after March 28, 2003 meet the requirements of Item 10(e) of Regulation S-K, as amended January 22, 2003.
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FFO, FFO per share and cash available for distribution for the years ended December 31, 2003, 2002 and 2001 are summarized in the following table ($ in thousands):
Funds from operations:
Dividends to preferred shareholders
Net income applicable to common shares
Add/(Deduct):
Depreciation and amortization of real estate assets (1)
Gain on disposition of depreciable real estate assets (2)
Minority interest from the Operating Partnership in income from operations
Transition adjustment upon adoption of SFAS 133
Unconsolidated affiliates:
Discontinued operations (4):
Gain on sale, net of minority interest from the Operating Partnership (2)
Minority interest from the Operating Partnership in income from discontinued operations
Funds from operations before amounts allocable to minority interest from the Operating Partnership (3)
Minority interest from the Operating Partnership in funds from operations
Funds from operations applicable to common shares (3)
Cash available for distribution:
Funds from operations before amounts allocable to minority interest from the Operating Partnership
Rental income from straight-line rents
Amortization of intangible lease assets
Depreciation of non-real estate assets (1)
Impairment charges
Non-recurring compensation expense
Non-incremental revenue generating capital expenditures:
Building improvements paid
Second generation tenant improvements paid
Second generation lease commissions paid
Cash available for distribution
Dividend payout data:
Dividends paid per common share/common unit
Funds from operations
Weighted average shares outstanding - diluted
Weighted average shares/units outstanding - diluted (5)
Net cash provided by/(used in):
Operating activities
Investing activities
Financing activities
Net increase/(decrease) in cash and cash equivalents
44
Continuing Operations:
Gain on disposition of depreciable real estate assets per FFO calculation
Impairment losses
Gain on disposition and impairment of depreciable assets, net per Consolidated Statements of Income
Discontinued Operations:
In addition to the impairment losses detailed above, FFO for the year ended December 31, 2003 also includes a $2.4 million impairment loss included in our equity in earnings of unconsolidated affiliates related to the acquisition of certain assets of the MG-HIW, LLC joint venture by the Company.
As a result of the changes to the FFO calculation as outlined in footnotes (1), (2) and (3), FFO has been reduced by the following in dollars and per share amounts:
FFO in dollars before amounts allocable to minority interest from the Operating Partnership
FFO per share
The effects of potential changes in interest rates are discussed below. Our market risk discussion includes “forward-looking statements” and represents an estimate of possible changes in fair value or future earnings that would occur assuming hypothetical future movements in interest rates. These disclosures are not precise indicators of expected future losses, but only indicators of reasonably possible losses. As a result, actual future results may differ materially from those presented. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources” and the Notes to Consolidated Financial Statements for a description of our accounting policies and other information related to these financial instruments.
45
To meet in part our long-term liquidity requirements, we borrow funds at a combination of fixed and variable rates. Borrowings under our two revolving loans bear interest at variable rates. Our long-term debt, which consists of secured and unsecured long-term financings and the issuance of unsecured debt securities, typically bears interest at fixed rates. In addition, we have assumed fixed rate and variable rate debt in connection with acquiring properties. Our interest rate risk management objective is to limit the impact of interest rate changes on earnings and cash flows and to lower our overall borrowing costs. To achieve these objectives, from time to time we enter into interest rate hedge contracts such as collars, swaps, caps and treasury lock agreements in order to mitigate our interest rate risk with respect to various debt instruments. We do not hold or issue these derivative contracts for trading or speculative purposes.
As of December 31, 2003, we had approximately $223.7 million of variable rate debt outstanding that was not protected by interest rate hedge contracts. If the weighted average interest rate on this variable rate debt is 100 basis points higher or lower during the 12 months ended December 31, 2004, our interest expense would be increased or decreased approximately $2.2 million.
For a discussion of our interest rate hedge contracts in effect at December 31, 2003 see “Management’s Discussion and Analysis of Financial Conditions and Results of Operations – Liquidity and Capital Resources – Interest Rate Hedging Activities.” If interest rates increase by 100 basis points, the aggregate fair market value of these interest rate hedge contracts as of December 31, 2003 would increase by approximately $0.3 million. If interest rates decrease by 100 basis points, the aggregate fair market value of these interest rate hedge contracts as of December 31, 2003 would decrease by approximately $0.2 million.
In addition, we are exposed to certain losses in the event of nonperformance by the counter parties under the hedge contracts. We expect the counter parties, which are major financial institutions, to perform fully under the contracts. However, if either of the counter parties was to default on its obligation under an interest rate hedge contract, we could be required to pay the full rates on our debt, even if such rates were in excess of the rate in the contract.
See page F-1 of the financial report included herein.
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our annual and periodic reports filed with the SEC is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. These disclosure controls and procedures are further designed to ensure that such information is accumulated and communicated to our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), to allow timely decisions regarding required disclosure. SEC rules require that we disclose the conclusions of our CEO and CFO about the effectiveness of our disclosure controls and procedures.
The CEO and CFO evaluation of our disclosure controls and procedures included a review of the controls’ objectives and design, the controls’ implementation by the Company and the effect of the controls on the information generated for use in this Annual Report. In the course of the evaluation, we sought to identify data errors, control problems or acts of fraud and to confirm that appropriate corrective action, including process improvements, were being undertaken. Our disclosure controls and procedures are also evaluated on an ongoing basis by the following:
46
Among other matters, we sought in our evaluation to determine whether there were any “significant deficiencies” or “material weaknesses” in our disclosure controls and procedures, or whether we had identified any acts of fraud involving personnel who have a significant role in our disclosure controls and procedures. In the professional auditing literature, “significant deficiencies” are referred to as “reportable conditions,” which are control issues that could have a significant adverse effect on the ability to record, process, summarize and report financial data in the financial statements. A “material weakness” is defined in the auditing literature as a particularly serious reportable condition where the internal control does not reduce to a relatively low level the risk that misstatements caused by error or fraud may occur in amounts that would be material in relation to the financial statements and not be detected within a timely period by employees in the normal course of performing their assigned functions.
Our management, including the CEO and CFO, does not expect that our disclosure controls and procedures will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of disclosure controls and procedures must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
Based on the most recent evaluation, which was completed as of December 31, 2003, our CEO and CFO believe that our disclosure controls and procedures are effective to ensure that material information relating to us and our consolidated subsidiaries is made known to management, including the CEO and CFO, particularly during the period when our periodic reports are being prepared, and that our disclosure controls and procedures are effective to provide reasonable assurance that our financial statements are fairly presented in conformity with GAAP.
Since the date of this most recent evaluation, there have been no significant changes in our internal controls or in other factors that could significantly affect the internal controls subsequent to the date we completed our evaluation.
47
PART III
The Company intends to file a Proxy Statement for the Annual Meeting of Stockholders to be held May 18, 2004 within 120 days of December 31, 2003. The section under the heading “Election of Directors” of such Proxy Statement for the Annual Meeting of Stockholders to be held May 18, 2004 is incorporated herein by reference for information on directors of the Company. See ITEM X in Part I hereof for information regarding executive officers of the Company.
The Section under the heading “Committees of the Board of Directors – Audit Committee” of the Proxy Statement is incorporated herein by reference.
We have adopted a code of ethics that applies to our CEO and Senior Financial Officers, a copy of which is available free of charge on our corporate website, which is http://www.highwoods.com. We intend to satisfy the disclosure requirement under Item 10 of Form 8-K regarding an amendment to, or a waiver from, a provision of this code of ethics by posting such information on our website as identified above. Our website also includes our board committee charters and our corporate governance guidelines. Alternatively, you may request any of this information free of charge by writing to us at Highwoods Properties, Inc., Investor Relations, 3100 Smoketree Court, Suite 600, Raleigh, NC 27604.
The section under the heading “Election of Directors” entitled “Compensation of Directors” of the Proxy Statement and the section titled “Executive Compensation” of the Proxy Statement are incorporated herein by reference.
The sections under the headings “Voting Securities and Principal Stockholders” and “Equity Compensation Plan Information” of the Proxy Statement are incorporated herein by reference.
The section under the heading “Related Party Transactions” of the Proxy Statement is incorporated herein by reference.
The section under the heading “Ratification of Appointment of Independent Auditors” of the Proxy Statement is incorporated herein by reference.
48
PART IV
Description
49
The Company will provide copies of any exhibit, upon written request, at a cost of $.05 per page.
50
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Raleigh, State of North Carolina, on March 15, 2004.
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons in the capacities and on the dates indicated.
Signature
Title
Date
/s/ O. Temple Sloan, Jr.
O. Temple Sloan, Jr.
Chairman of the Board of Directors
/s/ Ronald P. Gibson
Chief Executive Officer and Director
/s/ Edward J. Fritsch
President, Chief Operating Officer, and Director
/s/ John L. Turner
John L. Turner
Vice Chairman of the Board and Director
/s/ Gene H. Anderson
Senior Vice President and Director
/s/ Thomas W. Adler
Thomas W. Adler
Director
/s/ Kay N. Callison
Kay N. Callison
/s/ William E. Graham, Jr.
William E. Graham, Jr.
/s/ Lawrence S. Kaplan
Lawrence S. Kaplan
/s/ L. Glenn Orr, Jr.
L. Glenn Orr, Jr.
/s/ Willard H. Smith, Jr.
Willard H. Smith, Jr.
/s/ F. William Vandiver, Jr.
F. William Vandiver, Jr.
/s/ Terry L. Stevens
Vice President, Chief Financial Officer and Treasurer
51
INDEX TO FINANCIAL STATEMENTS
Highwoods Properties, Inc.
Report of Independent Auditors
Consolidated Balance Sheets as of December 31, 2003 and 2002
Consolidated Statements of Income for the Years Ended December 31, 2003, 2002 and 2001
Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2003, 2002 and 2001
Consolidated Statements of Cash Flows for the Years Ended December 31, 2003, 2002 and 2001
Notes to Consolidated Financial Statements
Schedule II
Schedule III
All other schedules are omitted because they are not applicable, or because the required information is included in the consolidated financial statements or notes thereto.
F-1
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
We have audited the accompanying consolidated balance sheets of Highwoods Properties, Inc. as of December 31, 2003 and 2002, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2003. Our audits also included the financial statement schedules listed in the Index at Item 15(a). These financial statements and schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Highwoods Properties, Inc. at December 31, 2003 and 2002, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
In 2003, as discussed in Note 1 to the consolidated financial statements, the Company adopted the provisions of Statement of Financial Accounting Standards No. 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections.” In 2002, as discussed in Note 12 to the consolidated financial statements, the Company adopted the provisions of Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”.
/S/ ERNST & YOUNG LLP
Raleigh, North Carolina
February 20, 2004, except for Note 19
as to which the date is March 2, 2004
F-2
Consolidated Balance Sheets
($ in thousands)
Assets:
Real estate assets, at cost:
Land and improvements
Buildings and tenant improvements
Development in process
Land held for development
Furniture, fixtures and equipment
Less – accumulated depreciation
Property held for sale
Cash and cash equivalents
Restricted cash
Accounts receivable, net of allowance of $1,235 and $1,450, respectively
Notes receivable
Accrued straight-line rents receivable
Investments in unconsolidated affiliates
Other assets:
Deferred leasing costs
Deferred financing costs
Prepaid expenses and other
Less – accumulated amortization
Other assets, net
Total Assets
Liabilities and Stockholders’ Equity:
Mortgages and notes payable
Accounts payable, accrued expenses and other liabilities
Total Liabilities
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), 104,945 shares issued and outstanding at December 31, 2003 and 2002
8% Series B Cumulative Redeemable Preferred Shares (liquidation preference $25 per share), 6,900,000 shares issued and outstanding at December 31, 2003 and 2002
8% Series D Cumulative Redeemable Preferred Shares (liquidation preference $250 per share), 400,000 shares issued and outstanding at December 31, 2003 and 2002
Common stock, $.01 par value, 200,000,000 authorized shares; 53,474,403 and 53,400,195 shares issued and outstanding at December 31, 2003 and 2002, respectively
Additional paid-in capital
Distributions in excess of net earnings
Accumulated other comprehensive loss
Deferred compensation
Total Stockholders’ Equity
Total Liabilities and Stockholders’ Equity
See accompanying notes to consolidated financial statements.
F-3
Consolidated Statements of Income
($ in thousands, except per share amounts)
For the Years Ended December 31, 2003, 2002 and 2001
Gain on disposition and impairment of depreciable assets, net
Net income/(loss) per common share – basic:
Income/(loss) from continuing operations
Income from discontinued operations
Weighted average common shares outstanding – basic
Net income/(loss) per common share – diluted:
Weighted average common shares outstanding – diluted
F-4
Consolidated Statements of Stockholders’ Equity
($ in thousands, except for number of common shares)
Balance at December 31, 2000
Issuance of Common Stock
Common Stock Dividends
Preferred Stock dividends
Issuance of restricted stock
Amortization of deferred compensation
Repurchase of Common Stock
Repurchase of Preferred Stock
Other comprehensive loss
Balance at December 31, 2001
Conversion of Common Units to Common Stock
Other comprehensive income
Balance at December 31, 2002
Fair value of stock options issued
Balance at December 31, 2003
F-5
Consolidated Statements of Cash Flows
Operating activities:
Adjustments to reconcile income from continuing operations to net cash provided by operating activities:
Depreciation
Amortization of lease commissions
Amortization of accumulated other comprehensive loss
Gain on disposition of land and depreciable assets
Transition loss upon adoption of SFAS 133
Loss on ineffective portion of derivative instruments
Discontinued operations
Changes in operating assets and liabilities:
Accounts receivable
Prepaid expenses and other assets
Net cash provided by operating activities
Investing activities:
Additions to real estate assets
Proceeds from disposition of real estate assets
Repayments from unconsolidated affiliates
Distributions from unconsolidated affiliates
Investments in notes receivable
Other investing activities
Net cash provided by/(used in) investing activities
Financing activities:
Distributions paid on common stock and common units
Settlement of interest rate swap agreement
Dividends paid on preferred stock
Repurchase of preferred stock
Net proceeds from the sale of common stock
Repurchase of common stock and common units
Borrowings on revolving loans
Repayment of revolving loans
Borrowings on mortgages and notes payable
Repayment of mortgages and notes payable
Net change in deferred financing costs
Net cash used in financing activities
Cash and cash equivalents at beginning of the period
Cash and cash equivalents at end of the period
Supplemental disclosure of cash flow information:
Cash paid for interest
F-6
Consolidated Statements of Cash Flows—Continued
Supplemental disclosure of non-cash investing and financing activities:
The following table summarizes the net assets contributed by the holders of Common Units in the Operating Partnership, the net assets acquired subject to mortgage notes payable and other non-cash transactions:
Investment in unconsolidated affiliates
Liabilities:
Equity:
F-7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003
1. DESCRIPTIONOF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
Description of the Company
Highwoods Properties, Inc. (the “Company”) is a self-administered and self-managed real estate investment trust (“REIT”) that operates in the southeastern and midwestern United States. The Company’s wholly-owned assets include: 465 in-service office, industrial and retail properties; 213 apartment units; 1,305 acres of undeveloped land suitable for future development; and an additional four properties under development.
The Company conducts substantially all of its activities through, and substantially all of its interests in the properties are held directly or indirectly by, Highwoods Realty Limited Partnership (the “Operating Partnership”). The Company is the sole general partner of the Operating Partnership. At December 31, 2003, the Company owned 100.0% of the preferred partnership interests (“Preferred Units”) and 88.9% of the common partnership interests (“Common Units”) in the Operating Partnership. In 2003, the Company repurchased from limited partners (including certain officers and directors of the Company) 453,635 Common Units back into the Operating Partnership, which increased the percentage of common partnership units owned by the Company from 88.4% at December 31, 2002 to 88.9% at December 31, 2003. Holders of Common Units may redeem them for the cash value of one share of the Company’s Common Stock, $.01 par value (the “Common Stock”), or, at the Company’s option, one share of Common Stock. The three series of Preferred Units in the Operating Partnership were issued to the Company in connection with the Company’s three Preferred Stock offerings in 1997 and 1998. The net proceeds raised from each of the three Preferred Stock issuances were contributed by the Company to the Operating Partnership in exchange for preferred interests in the Operating Partnership. The terms of each series of Preferred Units generally parallel the terms of the respective Preferred Stock as to dividends, liquidation and redemption rights as more fully described in Note 9.
Basis of Presentation
The consolidated financial statements include the accounts of the Company and the Operating Partnership and its majority-owned affiliates. All significant intercompany balances and transactions have been eliminated in the consolidated financial statements.
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 (the “Code”), as amended. As a REIT, the Company generally will not be subject to federal or state income taxes on its net income that it distributes to stockholders. 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. In June 1994, the Company formed a taxable REIT subsidiary, as permitted under the Code, through which it conducts certain business activities; the taxable REIT subsidiary is subject to federal and state income taxes on its net taxable income and the Company records provisions for such taxes to the extent required based on its income recognized for financial statement purposes, including the effects of temporary differences between such income and that recognized for tax purposes.
Minority interest. Minority interest in the accompanying consolidated financial statements relate to the common ownership interests in the Operating Partnership owned by various individuals and entities other than the Company. As of December 31, 2003, the minority interest in the Operating Partnership consisted of 6.2 million common units. Minority interest is computed by applying the percentage of common units to the total number of outstanding common units and common shares to the Operating Partnership’s income from continuing operations and its discontinued operations as reflected in the income statement. The result is the amount of minority interest expense recorded for the period. In addition, when a common unit holder 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.
F-8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
1. DESCRIPTION OF BUSINESS AND SIGNIFICANTACCOUNTING POLICIES - Continued
Real estate assets. All capitalizable costs related to the improvement or replacement of commercial real estate properties are capitalized. Depreciation is computed using the straight-line method over the estimated useful life of 40 years for buildings, 15 years for building improvements and five to seven years for furniture, fixtures and equipment. Tenant improvements are amortized over the life of the respective leases, using the straight-line method. Real estate assets are stated at the lower of cost or fair value, if impaired.
Expenditures directly related to the development and construction of real estate assets are included in net real estate assets and are stated at cost in the consolidated balance sheets. Expenditures directly related to the leasing of properties are included in other assets and are stated at cost in the consolidated balance sheets. The development expenditures include pre-construction costs essential to the development of properties, development and construction costs, interest costs, real estate taxes, salaries and other costs incurred during the period of development. The construction expenditures include all general and administrative costs, including compensation incurred in connection with specific construction projects. The leasing expenditures include all general and administrative costs, including compensation incurred in connection with successfully securing leases on the properties. Estimated costs related to unsuccessful activities are expensed as incurred. If the Company’s assumptions regarding the successful efforts of development, construction and leasing are incorrect, the resulting adjustments could impact earnings.
Upon the acquisition of real estate, the Company assesses the fair value of acquired tangible assets such as land, buildings and tenant improvements, intangible assets such as above and below market leases, acquired-in place leases and other identified intangible assets and assumed liabilities in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 141. The Company allocates the purchase price to the acquired assets and assumed liabilities based on their relative fair values. The Company assesses and considers fair value based on estimated cash flow projections that utilize appropriate discount and/or capitalization rates, as well as available market information. The fair value of the tangible assets of an acquired property considers the value of the property as if it were vacant.
Above and below market leases acquired are recorded at their fair value. The capitalized above-market lease values are amortized as a reduction of based rental revenue over the remaining term of the respective leases and the capitalized below-market lease values are amortized as an increase to based rental revenue over the remaining term of the respective leases.
The value of in-place leases is based on the Company’s evaluation of the specific characteristics of each tenant’s lease. Factors considered include estimates of carrying costs during hypothetical expected lease-up periods, current market conditions, and cost to execute similar leases. The value of in-place leases are amortized to depreciation and amortization expense over the remaining term of the respective leases. If a tenant vacates its space prior to its contractual expiration date, any unamortized balance of their related intangible asset is expensed.
The value of tenant relationships is based on the Company’s overall relationship with the respective tenant. Factors considered include the tenant’s credit quality and expectations of lease renewals. The value of tenant relationships is amortized to expense over the initial term and any renewal periods defined in the respective leases. Based on the Company’s acquisitions to date, the Company has deemed relationships to be immaterial and have not allocated any amounts to this intangible asset.
F-9
Real estate and leasehold improvements are classified as long-lived assets held for sale or as long-lived assets to be held and used. In accordance with Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, the Company records assets held for sale at the lower of the carrying amount or fair value less cost to sell. The impairment loss is the amount by which the carrying amount exceeds the fair value less cost to sell. With respect to assets classified as held and used, the Company periodically reviews these assets to determine whether its carrying amount will be recovered from their undiscounted future operating cash flows and the Company recognizes an impairment loss to the extent it believes the carrying amount is not recoverable. The Company’s estimates of the undiscounted future operating cash flows expected to be generated are based on a number of assumptions that are subject to economic and market uncertainties including, among others, demand for space, competition for tenants, changes in market rental rates, and costs to operate each property. As these factors are difficult to predict and are subject to future events that may alter the Company’s assumptions, the undiscounted future operating cash flows estimated by the Company in its impairment analyses may not be achieved and the Company may be required to recognize future impairment losses on its properties.
As of December 31, 2003, the Company had 438,073 square feet of property, 88 apartment units and 168.1 acres of land under contract for sale or letter of intent in various transactions totaling $90.3 million. These real estate assets have a carrying value of $65.7 million and have been classified as assets held for sale in the accompanying financial statements.
Rental revenue. Rental revenue is comprised of base rent, property operating cost recoveries from tenants, parking and other income and termination fees which relate to specific tenants each of whom has paid a fee to terminate its lease obligation before the end of the contracted term on the lease.
In accordance with Generally Accepted Accounting Principles (“GAAP”), base rental revenue is recognized on a straight-line basis over the terms of the respective leases. This means that, with respect to a particular lease, actual amounts billed in accordance with the lease during any given period may be higher or lower than the amount of rental revenue recognized for the period. Accrued straight-line rents receivable represents the amount by which straight-line rental revenue exceeds rents currently billed in accordance with lease agreements. Termination fees are recognized as revenue when the following four conditions are met:
Property operating cost recoveries from tenants (or cost reimbursements) are determined on a lease-by-lease basis. The most common types of cost reimbursements in the Company’s leases are common area maintenance (“CAM”) and real estate taxes, where the tenant pays its pro-rata share of operating and administrative expenses and real estate taxes.
F-10
The computation of cost reimbursements from tenants for CAM and real estate taxes is complex and involves numerous judgments including interpretation of terms and other tenant lease provisions. Most tenants make monthly fixed payments of CAM, real estate taxes and other cost reimbursement items. The Company records these payments as income each month. The Company also makes adjustments, positive or negative, to cost recovery income to adjust the recorded amounts to the Company’s best estimate of the final amounts to be billed and collected with respect to the cost reimbursements. After the end of the calendar year, the Company computes each tenant’s final cost reimbursements and issues a bill or credit for the full amount, after considering amounts paid by the tenants during the year. The differences between the amounts billed, less previously received payments and the accrual adjustment are recorded as increases or decreases to cost recovery income when the final bills are prepared, usually beginning in March and completed by June or July. The net amounts of any such adjustments have not been material in any of the years ended December 31, 2002 and 2001. Final adjustments for the year ended December 31, 2003 have not yet been determined.
Allowance for doubtful accounts. Accounts receivable are reduced by an allowance for amounts that may become uncollectible in the future. The Company’s receivable balance is comprised primarily of rents and operating cost recoveries due from tenants as well as accrued rental rate increases to be received over the life of the existing leases. The Company regularly evaluates the adequacy of its allowance for doubtful accounts. The evaluation primarily consists of reviewing past due account balances and considering such factors as the credit quality of the Company’s tenants, historical trends of the tenant and/or other debtor, current economic conditions and changes in customer payment terms. Additionally, with respect to tenants in bankruptcy, the Company estimates the expected recovery through bankruptcy claims and increases the allowance for amounts deemed uncollectible. If the Company’s assumptions regarding the collectibility of accounts receivable prove incorrect, the Company could experience write-offs of accounts receivable or accrued straight-line rents receivable in excess of its allowance for doubtful accounts.
Investments in joint ventures. The Company’s investments in unconsolidated affiliates consist of one corporation, nine limited liability companies, four limited partnerships and three general partnerships. The Company accounts for its investments in unconsolidated affiliates under the equity method of accounting as the Company exercises significant influence, but does not have financial or operating control. These investments are initially recorded at cost, as investments in unconsolidated affiliates, and are subsequently adjusted for equity in earnings and cash contributions and distributions. Any difference between the carrying amount of these investments on the Company’s balance sheet and the underlying equity in net assets is amortized as an adjustment to equity in earnings of unconsolidated affiliates over the life of the property, generally 40 years.
From time to time, the Company contributes real estate assets to an unconsolidated joint venture in exchange for a combination of cash and an equity interest in the venture. The Company records a partial gain on the contribution of the real estate assets to the extent of the third party investor’s interest and records a deferred gain to the extent of its continuing interest in the unconsolidated joint venture.
Additionally, the joint ventures will frequently borrow money on their 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, typically on a non-recourse or limited recourse basis. The Company generally is not liable for the debts of their joint ventures, except to the extent of the Company’s equity investment, unless the Company has directly guaranteed any of that debt. (See Note 15 for further discussion). In most cases, the Company and/or its strategic partners are required to guarantee customary exceptions to non-recourse liability in non-recourse loans.
F-11
Cash equivalents. The Company considers highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.
Restricted cash. Restricted cash includes security deposits for the Company’s commercial properties and construction-related escrows. In addition, the Company maintains escrow and reserve funds for debt service, real estate taxes and property insurance established pursuant to certain mortgage financing arrangements.
Income taxes. The Company is a REIT for federal income tax purposes. A corporate REIT is a legal entity that holds real estate assets, and through the payment of dividends to stockholders, is permitted to reduce or avoid the payment of federal and state income taxes at the corporate level. As of December 31, 2003, to maintain qualification as a REIT, the Company was required to distribute to stockholders at least 90.0% of REIT taxable income, excluding capital gains.
No provision has been made for federal and state income taxes during the years ended December 31, 2003, 2002 and 2001 because the Company qualified as a REIT, distributed the necessary amount of taxable income and, therefore, incurred no income tax expense during the periods. In addition, no provision has been required for federal and state income taxes with respect to the Company’s taxable REIT subsidiary because it has had no taxable income for financial reporting purposes since its formation.
Concentration of credit risk. Management of the Company performs ongoing credit evaluations of its tenants. As of December 31, 2003, the wholly-owned properties (excluding apartment units) were leased to 2,407 tenants in 14 geographic locations. The Company’s tenants engage in a wide variety of businesses. No single tenant currently generates revenue greater than 3.4%.
Stock compensation. The Company grants stock options for a fixed number of shares to employees with an exercise price equal to the fair value of the shares at the date of grant. As described in Note 14 included herein, the Company elected to follow Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) and related interpretations in accounting for its stock options for options issued through December 31, 2002. During 2002, the Financial Accounting Standards Board issued SFAS 148, “Accounting for Stock-Based Compensation – Transition and Disclosure”, which provides methods of transition to the fair value based method of accounting for stock-based employee compensation. This standard is effective for financial statements issued for fiscal years beginning after December 15, 2002. The Company elected the prospective method as defined by SFAS 148 for options issued on or after January 1, 2003.
Fair value of derivative instruments.In the normal course of business, the Company is exposed to the effect of interest rate changes. The Company limits its exposure by following established risk management policies and procedures including the use of derivatives. To mitigate its exposure to unexpected changes in interest rates, derivatives are used primarily to hedge against rate movements on the Company’s related debt. The Company is required to recognize all derivatives as either assets or liabilities in the consolidated balance sheets and to measure those instruments at fair value. Changes in fair value will affect either stockholders’ equity or net income depending on whether the derivative instrument qualifies as a hedge for accounting purposes.
To determine the fair value of derivative instruments, the Company uses a variety of methods and assumptions that are based on market conditions and risks existing at each balance sheet date. For the majority of financial instruments, including most derivatives, standard market conventions and techniques such as discounted cash flow analysis, option pricing models, replacement cost and termination cost are used to determine fair value. All methods of assessing fair value result in a general approximation of value, and such value may never actually be realized.
Per share information. Per share information is calculated using the weighted average number of shares of Common Stock outstanding (including common share equivalents).
F-12
Use of estimates. The preparation of financial statements in accordance with generally accepted accounting principles 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.
Reclassifications. Certain amounts in the December 31, 2002 and 2001 financial statements have been reclassified to conform to the December 31, 2003 presentation and accounting for discontinued operations (See Note 12 for further discussion). These reclassifications had no effect on net income or stockholder’s equity as previously reported.
Impact of Newly Adopted and Issued Accounting Standards
In April 2002, the FASB issued Statement No. 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections” (“SFAS 145”), which rescinds Statement No. 4, which required all gains and losses from the extinguishment of debt to be aggregated, and if material, classified as an extraordinary item, net of related income tax effect. The provisions of SFAS 145 related to the rescission of Statement No. 4 are effective for financial statements issued for fiscal years beginning after May 15, 2002. The statement also requires gains and losses from the extinguishment of debt classified as an extraordinary item in prior periods presented that do not meet the criteria in Accounting Principles Board (“APB”) Opinion 30 for classification as an extraordinary item to also be reclassified. The Company adopted SFAS 145 in the first quarter of 2003. In accordance with the statement, the Company reclassified losses on early extinguishment of debt of $0.4 million and $0.7 million, respectively, from an extraordinary item to interest expense in its Consolidated Statements of Income for the years ended December 31, 2002 and 2001.
In November 2002, the FASB issued Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (“FIN 45”), which changes the accounting for, and disclosure of, certain guarantees. Beginning with transactions entered into after December 31, 2002, certain guarantees are to be recorded at fair value, which differs from prior practice, under which a liability was recorded only when a loss was probable and could be reasonably estimated. In general, the change applies to contracts or indemnification agreements that contingently require the Company to make payments to a guaranteed third-party based on changes in an underlying asset, liability, or equity security of the guaranteed party. However, a guarantee or an indemnification whose existence prevents the guarantor from being able to either account for a transaction as the sale of an asset that is related to the underlying guarantee or recognize in earnings the profit from that sale transaction is exempt from the interpretation. The disclosure requirements in this Interpretation are effective for interim and annual periods ending after December 15, 2002. The Company adopted the accounting and disclosures requirements under FIN 45 on January 1, 2003. As of December 31, 2003, the Company had various guarantees as further discussed in Note 15.
In December 2002, the FASB issued Statement No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure” (“SFAS 148”), which amends FASB No. 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, the statement amends the disclosure requirements of Statement No. 123 to require prominent disclosures in both annual and interim financial statements related to the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The standard is effective for financial statements issued for fiscal years beginning after December 15, 2002. On January 1, 2003, the Company adopted the fair value recognition provision prospectively for all awards granted on or after January 1, 2003. Under this provision, total compensation expense related to stock options is determined using the fair value of the stock options on the date of grant and is recognized on a straight-line basis over the option vesting period. The Company continues to account for stock options issued prior to January 1, 2003 under the guidance of APB Opinion 25, “Accounting for Stock Issued to Employees and Related Interpretations.” (See Note 14 for further discussion).
F-13
In January 2003, the FASB issued Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities” (“VIEs”), the primary objective of which is to provide guidance on the identification of entities for which control is achieved through means other than voting rights and to determine when and which business enterprise should consolidate the VIEs. This new model applies when either (1) the equity investors (if any) do not have a controlling financial interest or (2) the equity investment at risk is insufficient to finance the entity’s activities without additional financial support. FIN 46 also requires additional disclosures. The Company adopted the provisions of FIN 46 for the Company’s interests in VIEs acquired subsequent to January 31, 2003. According to FASB Interpretation No. 46 (revised December 2003), entities shall apply the Interpretation only to special-purpose entities subject to the Interpretation no later than December 31, 2003 and all other entities no later than March 31, 2004. Special-purpose entities are defined as any entity whose activities are primarily related to securitizations or other forms of asset-backed financings or single-lessee leasing arrangements. Given the Company has no significant variable interests in special-purpose entities, the Interpretation is effective March 31, 2004. As of December 31, 2003, it was initially believed that when the Interpretation becomes effective, it was reasonably possible the Company would consolidate or disclose information about variable interest entities. Those entities would have consisted of three joint ventures with unrelated investors in which the Company had retained 50.00% or less minority equity interests (See Note 2 for further discussion). These joint ventures were formed for the development, management and leasing of office properties. However, on March 2, 2004, the Company acquired its partner’s interests in these entities, which will eliminate any FIN 46 impact that was previously anticipated related to these joint ventures. (See Note 19 for further discussion). FIN 46 requires the Company to disclose its maximum exposure to loss as a result of its involvement with these entities, which would have been $24.8 million at December 31, 2003. The maximum exposure to loss assumes the Company would be required to fully satisfy its debt guarantees and experiences a complete loss of its equity investment in such entities.
In April 2003, the FASB issued Statement No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities” (“SFAS 149”). SFAS 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under Statement 133. SFAS 149 is effective for contracts entered into or modified after June 30, 2003, with some exceptions, and for hedging relationships designated after June 30, 2003. The guidance was applied prospectively. The provisions of SFAS No. 149 did not have an impact on our financial condition and results of operations. See Note 10 for further discussion on the Company’s derivative instruments.
In May 2003, the FASB issued Statement No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity” (“SFAS 150”). SFAS 150 establishes standards on the classification and measurement of certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in certain circumstances). This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective July 1, 2003. It is to be implemented by reporting the cumulative effect of a change in an accounting principle for financial instruments created before the issuance date of this Statement and still existing at the beginning of the interim period of adoption. As of December 31, 2003, the provisions of SFAS 150 do not have a material impact on the Company’s financial condition or results of operations. The Company initially believed the implementation of FIN 46 at March 31, 2004, as mentioned above, would result in minority interest in VIEs, which is classified as non-controlling interests in finite-life entities under SFAS 150. However, on March 2, 2004, the Company acquired its partner’s interests in these entities, which will eliminate the minority interest in VIEs that was expected upon the implementation of FIN 46. (See Note 19 for further discussion). Additionally, at its October 29, 2003 meeting, the FASB voted to defer indefinitely SFAS 150 as it relates to non-controlling interests in finite-life entities.
F-14
2. INVESTMENTS IN UNCONSOLIDATED AFFILIATES
During the past several years, the Company has formed various joint ventures with unrelated investors. The Company has retained minority equity interests ranging from 12.50% to 50.00% in these joint ventures. As required by GAAP, the Company has accounted for its joint venture activity using the equity method of accounting, as the Company does not control these joint ventures. As a result, the assets and liabilities of the Company’s joint ventures are not included on its balance sheet.
The following tables set forth information regarding the Company’s joint venture activity as recorded on the joint venture’s books at December 31, 2003 and 2002 ($ in thousands):
Kessinger/Hunter, LLC
MG-HIW Peachtree Corners III, LLC
MG-HIW Metrowest I, LLC
Depr/
Amort
Income Statement Data:
Board of Trade Investment
Company
HIghwoods DLF 97/26 DLF 99/32, LP
MG-HIW Rocky Point, LLC
F-15
2. INVESTMENTS IN UNCONSOLIDATED AFFILIATES - Continued
The following summarizes the formation and principal activities of the various joint ventures in which the Company has a minority equity interest.
Board of Trade Investment Company, Kessinger/Hunter, LLC, 4600 Madison Associates, LP
In connection with the Company’s merger with J.C. Nichols Company in July 1998, the Company acquired a 49.0% interest in Board of Trade Investment Company, a 30.0% interest in Kessinger/Hunter, LLC, and a 12.5% interest in 4600 Madison Associates, L.P. The Company is the sole and exclusive property manager of Board of Trade Investment Company and 4600 Madison Associates, L.P. joint ventures, for which it received fees of $0.1 million in 2003, 2002 and 2001. In addition, Kessinger/Hunter, LLC provides property management, leasing and brokerage services and provides certain construction related services for certain wholly-owned properties of the Company, and received $2.7 million, $3.0 million and $5.8 million for these related services from the Company in 2003, 2002 and 2001, respectively. During 2002, the Company decreased its ownership interest in Kessinger/Hunter, LLC to 26.5%.
Des Moines Joint Ventures
In addition, in connection with the Company’s merger with J.C. Nichols Company in July 1998, the Company succeeded to the interests of J.C. Nichols in a strategic alliance with R&R Investors, Ltd. pursuant to which R&R Investors manages and leases certain joint venture properties located in the Des Moines area. As a result of the merger, the Company acquired an ownership interest of 50.0% or more in a series of nine joint ventures with R&R Investors (the “Des Moines Joint Ventures”). Certain of these properties were previously included in the Company’s consolidated financial statements. On June 2, 1999, the Company agreed with R&R Investors to reorganize its respective ownership interests in the Des Moines Joint Ventures such that each would own a 50.0% interest.
Highwoods DLF 98/29, L.P.
On March 15, 1999, the Company closed a transaction with Schweiz-Deutschland-USA Dreilander Beteiligung Objekt DLF 98/29-Walker Fink-KG (“DLF”), pursuant to which the Company sold or contributed certain office properties valued at approximately $142.0 million to a newly created limited partnership (the “DLF I Joint Venture”). DLF contributed approximately $56.0 million for a 77.19% interest in the DLF I Joint Venture, and the DLF I Joint Venture borrowed approximately $71.0 million from third-party lenders. The Company retained the remaining 22.81% interest in the DLF I Joint Venture, received net cash proceeds of approximately $124.0 million and is the sole and exclusive property manager and leasing agent of the DLF I Joint Venture’s properties, for which the Company received fees of $0.9 million, $0.9 million and $0.8 million in 2003, 2002 and 2001, respectively.
Highwoods DLF 97/26 DLF 99/32, L.P.
On May 9, 2000, the Company closed a transaction with Dreilander-Fonds 97/26 and 99/32 (“DLF II”) pursuant to which the Company contributed five in-service office properties encompassing 570,000 rentable square feet and a 246,000-square-foot development project valued at approximately $110.0 million to a newly created limited partnership (the “DLF II Joint Venture”). DLF II contributed $24.0 million in cash for a 40.0% ownership interest in the DLF II Joint Venture, and the DLF II Joint Venture borrowed approximately $50.0 million from a third-party lender. The Company initially retained the remaining 60.0% interest in the DLF II Joint Venture and received net cash proceeds of approximately $73.0 million. During 2001 and 2000, DLF II contributed an additional $10.7 million in cash to the DLF II Joint Venture. As a result, the Company decreased its ownership percentage to 42.93% as of December 31, 2001. The Company is the sole and exclusive property manager and leasing agent of the DLF II Joint Venture’s properties, for which the Company received fees of $0.5 million in 2003, 2002 and 2001.
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Highwoods-Markel Associates, LLC, Concourse Center Associates, LLC
During 1999 and 2001, the Company closed two transactions with Highwoods-Markel Associates, LLC and Concourse Center Associates, LLC pursuant to which the Company sold or contributed certain office properties to newly created limited liability companies. Unrelated investors contributed cash for a 50.0% ownership interest in the joint ventures. The Company retained the remaining 50.0% interest, received net cash proceeds and is the sole and exclusive property manager and leasing agent of the joint ventures’ properties, for which the Company received fees of $0.1 million, $0.1 million and $0.05 million in 2003, 2002 and 2001, respectively.
On December 29, 2003, the Company contributed an additional three in-service office properties encompassing approximately 290,853 rentable square feet valued at approximately $35.6 million to the Highwoods-Markel, LLC joint venture. The joint venture’s other partner, Markel Corporation, contributed an additional $3.6 million in cash to maintain their 50.0% ownership interest and the joint venture borrowed and refinanced approximately $40.0 million from a third party lender. The Company retained its 50.0% ownership interest in the joint venture and received net cash proceeds of approximately $31.9 million. The Company is the sole and exclusive manager and leasing agent for the properties and receives customary management fees and leasing commissions, which have been included in the totals above.
MG-HIW Joint Ventures
On December 19, 2000, the Company formed or agreed to form five joint ventures with Denver-based Miller Global Properties, LLC (“Miller Global”). In the first joint venture, MG-HIW, LLC, the Company sold or contributed 19 in-service office properties encompassing approximately 2.5 million rentable square feet valued at approximately $335.0 million. As part of the formation of MG-HIW, LLC, Miller Global contributed approximately $85.0 million in cash for an 80.0% ownership interest and the joint venture borrowed approximately $238.8 million from a third-party lender. The Company retained a 20.0% ownership interest and received net cash proceeds of approximately $307.0 million. During 2001, the Company contributed a 39,000 square foot development project to MG-HIW, LLC for $5.1 million. The joint venture borrowed an additional $3.7 million under its existing debt agreement with a third party and the Company retained its 20.0% ownership interest and received net cash proceeds of approximately $4.8 million. In the remaining four joint ventures, the Company contributed approximately $7.5 million of development land to various newly created limited liability companies and retained a 50.0% ownership interest. Three of these joint ventures have developed three properties encompassing 347,000 rentable square feet that costs approximately $50.4 million in the aggregate. The fourth joint venture, MG-HIW Metrowest I, LLC is expected to develop one property encompassing 88,000 rentable square feet with a budgeted cost of approximately $10.8 million. The Company is the sole and exclusive developer of these properties, and received $0.03 million and $0.6 million in development fees in 2002 and 2001, respectively. The Company did not receive development fees in 2003. In addition, the Company is the sole and exclusive property manager and leasing agent for the properties in all of these joint ventures and received fees of $2.0 million, $2.9 million and $1.5 million in 2003, 2002 and 2001, respectively.
On June 26, 2002, the Company acquired Miller Global’s interest in MG-HIW Rocky Point, LLC, which owned Harborview Plaza, a 205,000 rentable square foot office property, to bring its ownership interest in that entity to 100.0%. At that time, the Company consolidated the assets and liabilities, and recorded revenues and expenses on a consolidated basis. (See also SF-HIW Harborview, LP discussion).
On July 29, 2003, the Company acquired the assets and/or its partner’s 80.0% equity interest related to 15 properties encompassing 1.3 million square feet owned by MG-HIW, LLC. (See Note 3 for further discussion on this acquisition).
On March 2, 2004, the Company exercised its options and acquired its partner’s 80.0% interest in the remaining assets of MG-HIW, LLC and its partner’s 50.0% interests in MG-HIW Metrowest I, LLC and MG-HIW, Metrowest II, LLC. (See Note 19 for further discussion).
F-17
On June 14, 2002, the Company contributed $1.1 million cash to Plaza Colonnade, LLC, a newly formed limited liability company to construct a 285,000 square foot development property. The total project costs are estimated at $70.6 million. The Company has retained a 50.0% interest in this joint venture. On February 12, 2003, Plaza Colonnade, LLC signed a $61.3 million construction loan to fund the development of this property which is expected to cost $69.7 million. The Company is a co-developer of this property and received development fees of $0.4 million in 2003. The construction loan requires that the joint venture invest $9.3 million, $4.6 million of which will be the Company’s share. The Company and its partners in this joint venture have each guaranteed 50.0% of the loan. The loan repayment guarantees are reduced upon the project reaching certain predetermined criteria. In addition to the construction loan, the partners collectively provided $12.0 million in letters of credit, $6.0 million by the Company and $6.0 million by its partner. (See Note 15 for further discussion).
On September 11, 2002, the Company contributed Harborview Plaza to SF-HIW Harborview Plaza, LP, a newly formed joint venture with a different partner, in exchange for a 20.0% limited partnership interest and $12.1 million in cash. The Company is the sole and exclusive property manager and leasing agent of this joint venture’s property, for which it received fees of $0.2 million and $0.06 million in 2003 and 2002, respectively.
3. ACQUISITION OF JOINT VENTURE ASSETS AND EQUITY INTERESTS
On July 29, 2003, the Company acquired the assets and/or its partner’s 80.0% equity interest related to 15 properties encompassing 1.3 million square feet owned by MG-HIW, LLC. The properties are located in Atlanta, Raleigh and Tampa. At the closing of the transaction, the Company paid Miller Global $28.1 million, repaid $41.4 million of debt related to the properties and assumed $64.7 million of debt. The transaction implies a valuation (100.0% ownership) of $141.2 million, which includes the properties and other net assets. The Company accounted for the acquisition in accordance with the provisions of Statement of Financial Accounting Standards No. 141, “Business Combinations” (“SFAS 141”). The Company allocated $125.7 million of the purchase price to net tangible assets and $11.7 million to identified intangible assets acquired based on their fair values. The Company assessed fair value based on available market information and estimated cash flow projections that utilize discount and capitalization rates deemed appropriate by management. The weighted average amortization period of the identified intangible assets is approximately five years. The results of operations subsequent to this acquisition are included in the Company’s Consolidated Statements of Income for the year ended December 31, 2003.
An impairment charge of $12.1 million was recorded by MG-HIW, LLC joint venture for assets classified as held for sale as of June 30, 2003, which were subsequently sold by MG-HIW, LLC to the Company on July 29, 2003. The Company’s share of this charge of $2.4 million reduced the Company’s equity in earnings of unconsolidated affiliates for the year ended December 31, 2003.
Also as a part of the MG-HIW, LLC acquisition on July 29, 2003, the Company was assigned Miller Global’s 50.0% equity interest in the single property encompassing 53,896 square feet owned by MG-HIW Peachtree Corners III, LLC. The construction loan, which was made to this joint venture by an affiliate of the Company had an interest rate of LIBOR plus 200 basis points and was paid in full on July 29, 2003 in connection with the assignment.
Additionally, the Company entered into an option agreement to acquire Miller Global’s 80.0% interest in the remaining assets of MG-HIW, LLC. The remaining assets of MG-HIW, LLC are five properties encompassing 1.3 million square feet located in the central business district of Orlando. The properties were 83.8% leased as of December 31, 2003 and are encumbered by $136.2 million of floating rate debt with interest based on LIBOR plus 200 basis points, which will be assumed by the Company at closing. The Company acquired this 80.0% interest on March 2, 2004. (See Notes 15 and 19 for further discussion).
F-18
3. ACQUISITION OF JOINT VENTURE ASSETS ANDEQUITY INTERESTS - Continued
Also as part of the MG-HIW, LLC acquisition on July 29, 2003, the Company entered into an option agreement with its partner, Miller Global, to acquire their 50.0% interest in the assets encompassing 87,832 square feet of property and 7.0 acres of development land of MG-HIW Metrowest I, LLC and MG-HIW Metrowest II, LLC for $3.2 million. The $7.4 million construction loan to fund the development of this property, of which $7.3 million is outstanding at December 31, 2003, will be either paid in full or assumed by the Company in connection with the acquisition of the remaining assets. The Company acquired this 50.0% interest on March 2, 2004. (See Notes 15 and 19 for further discussion).
The following unaudited pro forma information has been prepared assuming the acquisition of the MG-HIW joint venture properties described above occurred January 1, 2002 ($ in thousands, except per share amounts):
Rental revenue and other income
Net income per share - basic
Net income per share - diluted
The pro forma information is not necessarily indicative of what the Company’s results of operations would have been if the transaction had occurred at the beginning of the period presented. Additionally, the pro forma information does not purport to be indicative of the Company’s results of operations for future periods.
4. DISPOSITIONS
During 2003, the Company contributed to joint ventures or sold approximately 3.6 million rentable square feet of office, industrial and retail properties, 122.8 acres of revenue-producing land and 108.5 acres of development land for gross proceeds of $257.2 million. The Company recognized gains totaling $23.5 million related to these dispositions and deferred the recognition of additional gain of $2.7 million in accordance with Statement of Financial Accounting Standards No. 66, “Accounting for Sales of Real Estate” (“SFAS 66”) as a result of the Company retaining its 50.0% equity interest in Highwoods-Markel Associates, LLC after contributing the buildings to the joint venture. See Note 2 for further discussion of the Highwoods-Markel Associates, LLC transaction and Note 15 for further discussion of the deferral of gains due to rental shortfall and re-tenanting cost guarantees.
During 2002, the Company contributed to joint ventures or sold approximately 2.5 million rentable square feet of office and industrial properties and 137.7 acres of development land for gross proceeds of $302.2 million. The Company recognized a gain of $24.5 million related to these dispositions and deferred the recognition of additional gain of $1.0 million as a result of the outstanding put option related to SF-HIW Harborview, LP. See Note 15 for further discussion of the deferral of gains due to rental shortfall and re-tenanting cost guarantees.
During 2001, the Company contributed to joint ventures or sold approximately 425,000 rentable square feet of office and industrial properties, 215.7 acres of development land and 1,672 apartment units for gross proceeds of $180.3 million. The Company recognized a gain of $16.2 million related to these dispositions.
F-19
5. MORTGAGES AND NOTES PAYABLE
The Company’s mortgages and notes payable consisted of the following at December 31, 2003 and 2002:
Mortgage loans payable:
9.0% mortgage loan due 2005
8.1% mortgage loan due 2005
8.2% mortgage loan due 2007
7.8% mortgage loan due 2009
7.9% mortgage loan due 2009
7.8% mortgage loan due 2010
6.0% mortgage loan due 2013
5.7% mortgage loan due 2013
4.5% to 9.1% mortgage loans due between 2005 and 2022
Variable rate mortgage loan due 2006
Variable rate mortgage loan due 2007
Unsecured indebtedness:
6.75% notes due 2003
8.0% notes due 2003
7.0% notes due 2006
7.125% notes due 2008
8.125% notes due 2009
MOPPRS due 2013
Put Option Notes due 2011
7.5% notes due 2018
Term loan due 2005
Unsecured Revolving Loan due 2006
F-20
5. MORTGAGES AND NOTES PAYABLE - Continued
The following table sets forth the principal payments due on the Company’s long-term debt as of December 31, 2003 ($ in thousands):
Fixed Rate Debt:
Unsecured (1):
Put Option Notes (2)
Mortgage loans payable (3)
Term Loans
Revolving Loan (4)
F-21
On February 3, 2003, the Operating Partnership repurchased 100.0% of the principal amount of the MandatOry Par Put Remarketed Securities (“MOPPRS”) due February 1, 2013 from the sole holder thereof in exchange for a secured note in the principal amount of $142.8 million. The secured note bears interest at a fixed rate of 6.03% and has a maturity date of February 28, 2013. This transaction was accounted for as an exchange of indebtedness under EITF 96-19, “Debtor’s Accounting for a Modification or Exchange of Debt Instruments”. In accordance with EITF 96-19, the intermediaries acted as principals and the present value of the cash flows under the terms of the new debt instrument using the MOPPRS effective interest rate was less than 10.0% different from the present value of the remaining cash flows under the terms of the MOPPRS. Accordingly, the transaction was considered an exchange, not an extinguishment and no loss was recognized. The option premium paid to the lender was $17.7 million and was recorded as a deferred financing cost and will be amortized to interest expense over the remaining term of the new debt. Fees paid by the Company to third parties (such as legal fees) were expensed as incurred.
The terms of the revolving loan and the indenture that governs the Company’s outstanding notes require the Company to comply with certain operating and financial covenants and performance ratios. The Company is currently in compliance with all such requirements.
Other Information
Total interest capitalized was approximately $1.2 million, $7.0 million and $16.9 million in 2003, 2002 and 2001, respectively.
As of December 31, 2003, the Company had $46.2 million of deferred financing costs, with $22.5 million of accumulated amortization. Deferred financing costs include deferred loan fees, which are included in depreciation and amortization expense, and discounts on bonds, notes payable and public debt issuance costs, which are included in interest expense. The Company estimates future amortization of deferred financings costs will be as follows ($ in thousands):
2004
6. EMPLOYEEBENEFIT PLANS
Management Compensation Program
The Company’s officers participate in an annual cash incentive bonus program whereby they are eligible for cash bonuses based on a percentage of their annual base salary. Each officer’s target level bonus is determined by competitive analysis and the executive’s ability to influence overall performance of the Company and, assuming certain levels of the Company’s performance, ranges from 40.0% to 85.0% of base salary depending on position in the Company. The eligible bonus percentage for each officer is determined by a weighted average of the Company’s actual performance versus its annual plan using the following measures: return on invested capital; growth in funds from operations (“FFO”) per share; property level cash flow as a percentage of plan; general and administrative expenses as a percentage of revenue; and growth in same property net operating income. To the extent this weighted average is less than or exceeds the Company’s targeted performance level, the bonus percentage paid is proportionally reduced or increased on a predetermined scale. Depending on the Company’s performance, annual incentive bonuses could range from zero to 200.0% of an officer’s target level bonus. Bonuses are accrued in the year earned and are included in accrued expenses in the Consolidated Balance Sheets.
F-22
6. EMPLOYEE BENEFIT PLANS - Continued
Certain other members of management participate in an annual cash incentive bonus program whereby a target level cash bonus is established based upon the job responsibilities of their position. Cash bonus eligibility ranges from 5.0% to 40.0%. The actual cash bonus is determined by the overall performance of the Company and the individual’s performance during each year.
On January 1, 1999, the Company established a compensation program which allows officers and certain other members of management to participate in a long term incentive plan which includes annual grants of stock options, restricted shares and grants of units in the Shareholder Value Plan. The stock options vest ratably over four years and remain outstanding for ten years from date of grant.
The restricted shares vest 50.0% three years from the date of grant and the remaining 50.0% five years from date of grant. The restricted share awards are recorded at market value on the date of grant as unearned compensation expense and amortized over the restriction periods. Recipients are eligible to receive dividends on restricted stock issued. Restricted stock and annual expense information is as follows:
Restricted shares outstanding at January 1
Number of restricted shares awarded
Restricted shares repurchased or cancelled
Restricted shares outstanding at December 31
Annual expense, net
Average fair value per share at date of grant
The Shareholder Value Plan rewards the officers of the Company when the total shareholder returns measured by increases in the market value of the Common Stock plus the dividends on those shares exceed a comparable index of the Company’s peers over a three year period. The payout for this program is determined by the Company’s percent change in shareholder return compared to the composite index of its peer group. If the Company’s performance is not at least 100.0% of the peer group index, no payout is made. To the extent performance exceeds the peer group, the payout increases. A new three year plan cycle begins each year under this program. There were no payouts under this plan in 2003, 2002 or 2001.
The Company established a deferred compensation plan pursuant to which various officers could elect to defer a portion of the compensation that would otherwise be paid to the officer for investment in units of phantom stock or other investments unrelated to the Company’s securities. At the end of each calendar quarter, any officer that elects to defer compensation in phantom stock is credited with units of phantom stock at a 15.0% discount. The units of phantom stock accrue dividends in an amount equal to the dividends paid on the Company’s common stock. If the officer leaves Highwoods employ for any reason (other than death, disability, normal retirement or voluntary termination by Highwoods) within two years after the end of the year in which such officer has deferred compensation, such officer will incur a penalty. Over the two-year vesting period, the Company records compensation expense equal to the 15.0% discount, the accrued dividends and any changes in the market value of the Company’s common stock from the date of the deferral. Compensation expense of $0.7 million and $0.2 million were recorded by the Company for the years ended December 31, 2003 and 2002.
F-23
401(k) Savings Plan
The Company has a 401(k) savings plan covering substantially all employees who meet certain age and employment criteria. The Company matches the first 6.0% of compensation deferred at the rate of 75.0% of employee contributions. During 2003, 2002 and 2001, the Company contributed $1.0 million, $0.9 million and $0.6 million, respectively, to the 401(k) savings plan. Administrative expenses of the plan are paid by the Company.
Employee Stock Purchase Plan
The Company has an Employee Stock Purchase Plan for all active employees under which employees can elect to contribute up to 25.0% of their base compensation. At the end of each three-month offering period, the contributions in each participant’s account balance is applied to acquire shares of Common Stock at a cost that is calculated at 85.0% of the lower of the average closing price on the New York Stock Exchange on the five consecutive days preceding the first day of the quarter or the five days preceding the last day of the quarter. Employees purchased 50,812, 47,488 and 40,935 shares of Common Stock under the Employee Stock Purchase Plan during the years ended December 31, 2003, 2002 and 2001, respectively. The discount on issued shares is expensed by the Company as additional compensation, and aggregated to $0.2 million and $0.1 million in 2003 and 2002, respectively.
7. RENTAL INCOME
The Company’s real estate assets are leased to tenants under operating leases, substantially all of which expire over the next 10 years. The minimum rental amounts under the leases are generally either subject to scheduled fixed increases or adjustments based on the Consumer Price Index. Generally, the leases also require that the tenants reimburse the Company for increases in certain costs above the base year costs.
Expected future minimum rents to be received over the next five years and thereafter from tenants for leases in effect at December 31, 2003, are as follows ($ in thousands):
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8. RELATED PARTY TRANSACTIONS
The Company has previously reported that it has had a contract to acquire development land in the Bluegrass Valley office development project from GAPI, Inc., a corporation controlled by Mr. Anderson. On January 17, 2003, the Company acquired an additional 23.46 acres of this land from GAPI, Inc. for cash and shares of Common Stock valued at $2.3 million. In May 2003, 4.0 acres of the remaining acres not yet taken down was taken by the Georgia Department of Transportation to develop a roadway interchange for consideration of $1.8 million. The Department of Transportation took possession and title of the property in June 2003. As part of the terms of the contract between the Company and Bluegrass, the Company was entitled to the proceeds from the condemnation of $1.8 million, less the contracted purchase price between the Company and Bluegrass for the condemned property of $737,348. On September 30, 2003, as a result of the condemnation, the Company received the proceeds of $1.8 million. A related party payable of $737,348 to Bluegrass related to the condemnation of the development land is included in accounts payable, accrued expenses and other liabilities in the Company’s Consolidated Balance Sheet at December 31, 2003 and a gain of $1.0 million related to the condemnation of the development land is included in gain on disposition of land in the Company’s Consolidated Statement of Income for the year ended December 31, 2003. The Company believes that the purchase price with respect to each transaction did not exceed market value. These transactions were unanimously approved by the executive committee and the full Board of Directors (with Mr. Anderson abstaining from the vote).
During 2000, in connection with the formation of the MG-HIW Peachtree Corners III, LLC, a construction loan was made by an affiliate of the Company to this joint venture. Interest accrued at a rate of LIBOR plus 200 basis points. This construction loan was repaid in full in July 2003 when the Company was assigned its partner’s 50.0% equity interest in the single property encompassing 53,896 square feet owned by MG-HIW Peachtree Corners III, LLC.
The Company advanced $0.8 million to an officer and director related to certain expenses paid by the Company on behalf of the officer and director. During 2002, this advance, along with accrued interest, was repaid by the officer and director.
9. STOCKHOLDERS’ EQUITY
Dividends paid on Common Stock were $1.86, $2.34 and $2.31 per share for the years ended December 31, 2003, 2002 and 2001, respectively.
For federal income tax purposes, the following table summarizes the estimated taxability of dividends paid:
Per share:
Ordinary income
Capital gains
Return of capital
The Company’s tax returns for the year ended December 31, 2003 have not yet been filed, and the taxability information for 2003 is based upon the best available data. The Company’s tax returns have not been examined by the IRS, and therefore the taxability of dividends is subject to change.
As of December 31, 2003, the tax basis of the Company’s assets was $2.4 billion.
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9. STOCKHOLDERS’ EQUITY - Continued
On February 2, 2004, the Board of Directors declared a cash dividend of $0.425 per common share payable on March 5, 2004, to stockholders of record on February 13, 2004.
Preferred Stock
On February 12, 1997, the Company issued 125,000 8 5/8% Series A Cumulative Redeemable Preferred Shares (the “Series A Preferred Shares”). The Series A Preferred Shares are non-voting and have a liquidation preference of $1,000.00 per share for an aggregate liquidation preference of $125.0 million plus accrued and unpaid dividends. The net proceeds (after underwriting commission and other offering costs) of the Series A Preferred Shares issued were $121.8 million. Holders of the Series A Preferred Shares are entitled to receive, when, as and if declared by the Company’s Board of Directors, out of funds legally available for payment of dividends, cumulative preferential cash distributions at a rate of 8 5/8% of the liquidation preference per annum (equivalent to $86.25 per share). On or after February 12, 2027, the Series A Preferred Shares may be redeemed for cash at the option of the Company. The redemption price (other than the portion thereof consisting of accrued and unpaid dividends) is payable solely out of the sale proceeds of other capital shares of the Company, which may include shares of other series of preferred stock. On June 19, 2001, the Company repurchased in a privately negotiated transaction 20,055 of these shares at $922.50 per share, for a total purchase price of $18.5 million. For each Series A Preferred Share repurchased by the Company, one equivalent Series A Preferred Unit was retired. Of the $86.25 dividend paid per Series A Preferred Share in 2003, $49.24 will be taxed as ordinary income and $37.01 will be taxed as capital gain.
On September 25, 1997, the Company issued 6,900,000 8% Series B Cumulative Redeemable Preferred Shares (the “Series B Preferred Shares”). The Series B Preferred Shares are non-voting and have a liquidation preference of $25.00 per share for an aggregate liquidation preference of $172.5 million plus accrued and unpaid dividends. The net proceeds (after underwriting commission and other offering costs) of the Series B Preferred Shares issued were $166.3 million. Holders of the Series B Preferred Shares are entitled to receive, when, as and if declared by the Company’s Board of Directors, out of funds legally available for payment of dividends, cumulative preferential cash distributions at a rate of 8.0% of the liquidation preference per annum (equivalent to $2.00 per share). On or after September 25, 2002, the Series B Preferred Shares may be redeemed for cash at the option of the Company. The redemption price (other than the portion thereof consisting of accrued and unpaid dividends) is payable solely out of the sale proceeds of other capital shares of the Company, which may include shares of other series of preferred stock. Of the $2.00 dividend paid per Series B Preferred Share in 2003, $1.14 will be taxed as ordinary income and $0.86 will be taxed as capital gain.
On April 23, 1998, the Company issued 4,000,000 depositary shares (the “Series D Depositary Shares”), each representing a 1/10 fractional interest in an 8.0% Series D Cumulative Redeemable Preferred Share (the “Series D Preferred Shares”). The Series D Preferred Shares are non-voting and have a liquidation preference of $250.00 per share for an aggregate liquidation preference of $100.00 million plus accrued and unpaid dividends. The net proceeds (after underwriting commission and other offering costs) of the Series D Preferred Shares issued were $96.8 million. Holders of Series D Preferred Shares are entitled to receive, when, as and if declared by the Company’s Board of Directors, out of funds legally available for payment of dividends, cumulative preferential cash distributions at a rate of 8.0% of the liquidation preference per annum (equivalent to $20.00 per share). On or after April 23, 2003, the Series D Preferred Shares may be redeemed for cash at the option of the Company. The redemption price (other than the portion thereof consisting of accrued and unpaid dividends) is payable solely out of the sale proceeds of other capital shares of the Company, which may include shares of other series of Preferred Stock. Of the $20.00 dividend paid per Series D Preferred Share in 2003, $11.42 will be taxed as ordinary income and $8.58 will be taxed as capital gain.
The net proceeds raised from each of three preferred stock issuances were contributed by the Company to the Operating Partnership in exchange for preferred interests in the Operating Partnership (“Preferred Units”). The terms of each series of Preferred Units generally parallel the terms of the respective preferred stock as to distributions, liquidation and redemption rights.
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Shareholder Rights Plan
The Company currently has in effect a shareholder rights plan pursuant to which existing shareholders would have the ability to acquire additional common stock at a significant discount in the event a person or group attempts to acquire the Company on terms of which the Company’s current board does not approve. These rights are designed to deter a hostile takeover by increasing the takeover cost. As a result, such rights could discourage offers for the Company or make an acquisition of the Company more difficult, even when an acquisition is in the best interest of the Company’s stockholders. The rights plan should not interfere with any merger or other business combination the board of directors approves since the Company may generally terminate the plan at any time at nominal cost.
Dividend Reinvestment Plan
The Company has instituted a Dividend Reinvestment and Stock Purchase Plan under which holders of Common Stock may elect to automatically reinvest their dividends in additional shares of Common Stock and may make optional cash payments for additional shares of Common Stock. The Company currently repurchases Common Stock in the open market for purposes of financing its obligations under the Dividend Reinvestment and Stock Purchase Plan, but may elect to issue additional shares of Common Stock in lieu of open market purchases.
Stock Repurchases
During 2003, the Company repurchased a total of 446,600 Common Stock at a weighted average price of $20.73 per share. Since commencement of its initial repurchase plan in 1999, the Company has repurchased 10.0 million shares of Common Stock at a weighted average price of $23.87 per share for a total purchase price of $237.9 million. At December 31, 2003, the Company has 5.1 million Common Shares/Units remaining under its previously announced share repurchase programs.
10. DERIVATIVE FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standard (“SFAS”) No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended by Statement No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities”, requires the Company to recognize all derivatives on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through income. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of the derivative will either be offset against the change in fair value of the hedged assets, liabilities or firm commitments through earnings, or recognized in Accumulated Other Comprehensive Loss (“AOCL”) until the hedged item is recognized in earnings. The ineffective portion of a derivative’s change in fair value is recognized in earnings.
The Company’s interest rate risk management objective is to limit the impact of interest rate changes on earnings and cash flows and to lower overall borrowing costs. To achieve these objectives, the Company enters into interest rate hedge contracts such as collars, swaps, caps and treasury lock agreements in order to mitigate its interest rate risk with respect to various debt instruments. The Company does not hold these derivatives for trading or speculative purposes.
The interest rate on all of the Company’s variable rate debt is currently adjusted at one to three month intervals, subject to settlements under these contracts. The Company received only a nominal amount of payments under the interest rate hedge contracts in 2003. Net payments made to counter parties under interest rate hedge contracts were $0.4 million and $1.0 million in 2002 and 2001, respectively, and were recorded as increases to interest expense.
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10. DERIVATIVE FINANCIAL INSTRUMENTS - Continued
In addition, the Company is exposed to certain losses in the event of non-performance by the counter party under the interest rate hedge contract. The Company expects the counter party, which is a major financial institution, to perform fully under the contract. However, if the counter party was to default on its obligations under the interest rate hedge contract, the Company could be required to pay the full rates on its debt, even if such rates were in excess of the rate in the contract.
On the date that the Company enters into a derivative contract, the Company designates the derivative as (1) a hedge of the variability of cash flows that are to be received or paid in connection with a recognized liability (a “cash flow” hedge), (2) a hedge of changes in the fair value of an asset or a liability attributable to a particular risk (a “fair value” hedge), or (3) an instrument that is held as a non-hedge derivative. Changes in the fair value of highly effective cash flow hedges, to the extent that the hedge is effective, are recorded in AOCL, until earnings are affected by the hedged transaction (i.e. until periodic settlements of a variable-rate liability are recorded in earnings). Any hedge ineffectiveness (which represents the amount by which the changes in the fair value of the derivative exceed the variability in the cash flows of the transaction) is recorded in current-period earnings. For derivatives designated as fair value hedges, changes in the fair value of the derivative and the hedged item related to the hedged risk are recognized in current-period earnings. Changes in the fair value of non-hedging instruments are reported in current-period earnings.
The Company formally documents all relationships between hedging instruments and hedged items, as well as its risk-management objective and strategy for undertaking various hedge transactions. This process includes linking all derivatives that are designated as cash flow hedges to (1) specific assets and liabilities on the balance sheet or (2) forecasted transactions. The Company also assesses and documents, both at the hedging instrument’s inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in cash flows associated with the hedged items. When the Company determines that a derivative is not (or has ceased to be) highly effective as a hedge, the Company discontinues hedge accounting prospectively.
During the year ended December 31, 2003, the Company entered into and subsequently terminated a treasury lock agreement to hedge the change in the fair market value of the MandatOry Par Put Remarketable Securities (“MOPPRS”) issued by the Operating Partnership. The termination of this treasury lock agreement resulted in a payment of $1.5 million to the Company. Because this gain was offset by an increase in the fair value of the MOPPRS of $1.5 million, no gain or loss was recognized during the year ended December 31, 2003.
In addition, during the year ended December 31, 2003, the Company entered into and subsequently terminated three interest rate swap agreements related to a ten-year fixed rate financing completed on December 1, 2003. These swap agreements were designated as cash flow hedges and the unamortized effective portion of the cumulative gain on these derivative instruments was $3.9 million at December 31, 2003 and is being reported as a component of AOCL in stockholders’ equity. This deferred gain will be recognized in net income as a reduction of interest expense in the same period or periods during which interest expense on the hedged fixed rate financing effects net income. The Company expects that approximately $0.3 million will be recognized in 2004.
In 2003, the Company also entered into two interest rate swaps related to a floating rate credit facility. The swaps effectively fix the one month LIBOR rate on $20.0 million of floating rate debt at 0.99% from August 1, 2003 to January 1, 2004 and at 1.59% from January 2, 2004 until May 31, 2005. These swap agreements are designated as cash flow hedges and the effective portion of the cumulative gain on these derivative instruments was $0.02 million at December 31, 2003. The Company expects that the portion of the cumulative gain recorded in AOCL at December 31, 2003 associated with these derivative instruments, which will be recognized within the next 12 months, will be approximately $0.04 million.
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At December 31, 2003, approximately $6.0 million of deferred financing costs from past cash flow hedging instruments remain in AOCL. These costs will be recognized as interest expense as the underlying debt is repaid. The Company expects that the portion of the cumulative loss recorded in AOCL at December 31, 2003 associated with these derivative instruments, which will be recognized within the next 12 months, will be approximately $0.8 million.
11. OTHER COMPREHENSIVE INCOME/(LOSS)
Other comprehensive income/(loss) represents net income plus the results of certain non-stockholders’ equity changes not reflected in the Consolidated Statements of Income. The components of other comprehensive income/(loss) are as follows ($ in thousands):
Other comprehensive income/(loss):
Realized derivative gains/(losses) on cashflow hedges
Amortization of hedging gains and losses included in other comprehensive income/(loss)
Total other comprehensive income
Total comprehensive income
12. DISCONTINUEDOPERATIONS AND THE IMPAIRMENT OF LONG-LIVED ASSETS
In October 2001, the FASB issued SFAS No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets.” SFAS 144 supercedes SFAS No. 121 “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be disposed of” and the accounting and reporting provisions for disposals of a segment of business as addressed in APB 30 “Reporting the Results of Operations-Reporting the Effects of the Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions.” SFAS 144 is effective as of January 1, 2002 and extends the reporting requirements of discontinued operations to include those long-lived assets which:
Per SFAS 144, those long-lived assets which were sold during 2002 and resulted from disposal activities initiated prior to January 1, 2002 should be accounted for in accordance with SFAS 121 and APB 30. During 2002, the Company sold three properties which resulted from disposal activities initiated prior to January 1, 2002, and the gains realized on these sales are appropriately included in the gain/(loss) on disposition of depreciable assets in the Company’s Consolidated Statements of Income.
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12. DISCONTINUED OPERATIONS AND THE IMPAIRMENTOF LONG-LIVED ASSETS - Continued
As part of its business strategy, the Company will from time to time selectively dispose of non-core properties or other properties in order to use the net proceeds for investments or other purposes. The table below sets forth the net operating results and net carrying value of 5.5 million square feet of property, four apartment units and 122.8 acres of revenue-producing land sold during 2002 and 2003 and 438,073 square feet of property and 88 apartment units held for sale at December 31, 2003. These were a result of disposal activities that were initiated subsequent to the effective date of SFAS 144 and are classified as discontinued operations in the Company’s Consolidated Statements of Income ($ in thousands):
Total revenue
Rental operating expenses
Income before gain on sale of discontinued operations and minority interest from the Operating Partnership
Minority interest from the Operating Partnership
Income from discontinued operations, net of minority interest from the Operating Partnership
Gain on sale/impairment of discontinued operations
Gain on sale/impairment of discontinued operations, net of minority interest from the Operating Partnership
Total discontinued operations
Carrying value of assets held for sale and assets sold during the year
In addition, SFAS 144 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 2003, the Company had determined that the carrying value of two office properties held for sale, which have now been sold, was greater than their fair value less cost to sell and has recognized a $0.3 million, net of minority interest from the Operating Partnership, impairment loss, which is included in gain on sale of discontinued operations in the Consolidated Statements of Income for the year ended December 31, 2003. For 2002, the impairment loss related to two additional properties whose carrying value was greater than their fair value less cost to sell, which have now been sold, was $3.6 million, net of minority interest. This impairment loss is included in gain on sale of discontinued operations in the Consolidated Statements of Income for the year ended December 31, 2002.
SFAS 144 also requires that the carrying value of a long-lived asset classified as held and used be compared to the sum of its estimated future undiscounted cash flows. If the carrying value is greater than the sum of its undiscounted future cash flows, an impairment loss should be recognized. At December 31, 2003, because there were no properties held for use with a carrying value exceeding the sum of their undiscounted future cash flows, no impairment loss related to properties held for use was recognized during the year ended December 31, 2003. For the year ended December 31, 2002, the impairment loss based on this criteria was $0.8 million, and is included in gain on disposition of depreciable assets in the Consolidated Statements of Income for the year ended December 31, 2002. In addition, in 2002, the Company recognized a $9.1 million impairment loss related to one office property that has been demolished and will be redeveloped into a class A suburban office property and whereby the carrying value exceeded the sum of the property’s undiscounted future cash flows. This impairment loss is included in gain on disposition of depreciable assets in the Consolidated Statements of Income for the year ended December 31, 2002.
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13. EARNINGS PER SHARE
FASB Statement No. 128 replaced the calculation of primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effects of options, warrants and convertible securities. Diluted earnings per share is computed using the weighted average number of shares of Common Stock and the dilutive effect of options, warrants and convertible securities outstanding, using the “treasury stock” method. Earnings per share data is required for all periods for which an income statement or summary of earnings is presented, including summaries outside the basic financial statements. All earnings per share amounts for all periods presented have, where appropriate, been restated to conform to the FASB Statement 128 requirements.
The following table sets forth the computation of basic and diluted earnings per share:
Numerator:
Non-convertible preferred stock dividends (1)
Numerator for basic earnings per share — income available to common stockholders
Numerator for diluted earnings per share – net income available to common stockholders – after assumed conversions
Denominator:
Denominator for basic earnings per share - weighted-average shares
Effect of dilutive securities:
Employee stock options (1)
Warrants (1)
Dilutive potential common shares
Denominator for diluted earnings per share – adjusted weighted average shares and assumed conversions
Basic earnings per common share
Diluted earnings per common share
The number of potentially convertible shares of common stock related to warrants and stock options are as follows:
Outstanding warrants
Outstanding stock options
Possible future issuance under stock option plan
As of December 31, 2003, the Company had 146,525,597 common shares available to be issued.
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14. STOCK OPTIONS AND WARRANTS
As of December 31, 2003, 6.0 million shares of the Company’s authorized Common Stock were reserved for issuance under the Amended and Restated 1994 Stock Option Plan. Stock options granted under this plan generally vest over a four- or five-year period beginning with the date of grant.
In 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation”, (“SFAS 123”). SFAS 123 recommends the use of a fair value based method of accounting for an employee stock option whereby compensation cost is measured at the grant date on the fair value of the award and is recognized over the service period (generally the vesting period of the award). However, SFAS 123 specifically allows an entity to continue to measure compensation cost under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) so long as pro forma disclosures of net income and earnings per share are made as if SFAS 123 had been adopted. Through December 31, 2002, the Company elected to follow APB 25 and related interpretations in accounting for its employee stock options.
In December 2002, the FASB issued SFAS 148 to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, the statement amends the disclosure requirements of Statement No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. On January 1, 2003, the Company adopted the fair value method of accounting for stock-based compensation provisions of SFAS 123. The Company applied the prospective method of accounting and expensed all employee stock options (and similar awards) issued on or after January 1, 2003 over the vesting period based on the fair value of the award on the date of grant. The adoption of this statement did not have a material impact on the Company’s results of operations.
Under SFAS 123, the fair value of a stock option is estimated by using an option-pricing model that takes into account as of the grant date the exercise price and expected life of the options, the current price of the underlying stock and its expected volatility, expected dividends on the stock, and the risk-free interest rate for the expected term of the option. SFAS 123 provides examples of possible pricing models and includes the Black-Scholes pricing model, which the Company used to develop its pro forma disclosures. The Black-Scholes model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable, rather than for use in estimating the fair value of employee stock options subject to vesting and transferability restrictions.
Because SFAS 123 is applicable only to options granted subsequent to December 31, 1994, only options granted subsequent to that date were valued using this Black-Scholes model. The fair value of the options granted in 2003 was estimated at the dates of the grant using the following weighted average assumptions: risk-free interest rates of 2.98% and 3.94%, dividend yield of 8.71% and 11.05, expected volatility of 17.10 and 20.39% and a weighted average expected life of the options of four years. The fair value of the options granted in 2002 was estimated at the dates of the grant using the following weighted average assumptions: risk-free interest rates ranging between 3.64% and 4.06%, dividend yield of 8.70%, expected volatility of 22.72% and a weighted average expected life of the options of four years. The fair value of the options granted in 2001 was estimated at the dates of grant using the following weighted average assumptions: risk-free interest rates ranging between 5.76% and 6.11%, dividend yield of 9.00%, expected volatility of 17.20% and a weighted average expected life of the options of four years. Had the compensation cost for the Company’s stock option plans for options issued before January 1, 2003 been determined based on the fair value at the dates of grant for awards granted between January 1, 1995 and December 31, 2002 consistent with the provisions of SFAS 123, the Company’s net income and net income per share would have decreased to the pro forma amounts as indicated:
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14. STOCK OPTIONS AND WARRANTS - Continued
Net income available for common stockholders — as reported
Add: Stock option expense included in reported net income
Deduct: Total stock option expense determined under fair value recognition method for all awards
Pro forma net income available for common stockholders
Basic net income per common share - as reported
Basic net income per common share - pro forma
Diluted net income per common share - as reported
Diluted net income per common share - pro forma
The following table summarizes information about employees’ and Board of Directors’ stock options outstanding at December 31, 2003, 2002 and 2001:
Balances at December 31, 2000
Options granted
Options terminated
Options exercised
Balances at December 31, 2001
Balances at December 31, 2002
Balances at December 31, 2003
December 31, 2001
December 31, 2002
Exercise prices for options outstanding as of December 31, 2003 ranged from $14.59 to $31.14. The weighted average remaining contractual life of those options is 6.4 years. Using the Black-Scholes options valuation model, the weighted average fair value of options granted during 2003, 2002 and 2001 was $0.93, $0.72 and $1.11, respectively, for each option share.
Warrants
In connection with various acquisitions in 1995, 1996 and 1997, the Company issued warrants to purchase shares of Common Stock.
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The following table sets forth information regarding warrants outstanding as of December 31, 2003:
Date of Issuance
February 1995
April 1996
October 1997
December 1997
The warrants granted in February 1995, April 1996 and December 1997 expire 10 years from the respective dates of issuance. All warrants are exercisable from the dates of issuance. The warrants granted in October 1997 do not have an expiration date.
15. COMMITMENTS AND CONTINGENCIES
Concentration of Credit Risk
The Company maintains its cash and cash equivalent investments at financial institutions. The combined account balances at each institution typically exceed the 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. Management of the Company believes that the risk is not significant.
Land Leases
Certain properties in the Company’s 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 or on a predetermined schedule.
For three properties, the Company has the option to purchase the leased land during the lease term at the greater of 85.0% of appraised value or $0.03 million per acre.
The obligation for future minimum lease payments is as follows ($ in thousands):
Contracts
The Company has entered into contracts related to tenant improvements and the development of certain properties totaling $24.0 million as of December 31, 2003. The amounts remaining to be paid under these contracts as of December 31, 2003 totaled $18.1 million.
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15. COMMITMENTS AND CONTINGENCIES - Continued
Environmental Matters
Substantially all of the Company’s 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.
Joint Ventures
Certain properties owned in joint ventures with unaffiliated parties have buy/sell options that may be exercised to acquire the other partner’s interest by either the Company or its joint venture partner if certain conditions are met as set forth in the respective joint venture agreement. The Company’s partner in SF-HIW Harborview, LP has the right to put its 80.0% equity interest in the partnership to the Company in exchange for cash at anytime during the one-year period commencing on September 11, 2014. As a result, the Company has deferred a gain of $1.0 million until the expiration of the put option. The value of the equity interest will be determined based upon the then fair market value of SF-HIW Harborview, LP assets and liabilities.
In connection with several of our joint venture partners with unaffiliated parties, the Company has agreed to guarantee certain rent shortfalls and re-tenanting costs for certain properties contributed or sold to the joint ventures. As of December 31, 2003, the Company has $10.9 million accrued for obligations related to these agreements. The Company believes that its estimates related to these agreements are adequate. However, if its assumptions and estimates prove to be incorrect, future losses may occur.
Other Guarantees
The following is a discussion of the various guarantees existing at December 31, 2003 that fall under the initial recognition and measurement requirements of FIN 45. The following discussion also includes those guarantees in existence prior to the January 1, 2003 effective date which only fall under the disclosure requirements of the Interpretation and as such no liability was recorded.
In December 2000, the Company guaranteed its 80.0% partner in MG-HIW, LLC joint venture a minimum internal rate of return on $50.0 million of their equity investment in the remaining assets of the joint venture (the “Orlando assets”). On July 29, 2003, the Company entered into an option agreement to acquire Miller Global’s 80.0% interest in the Orlando assets for between $62.5 and $65.2 million depending on the closing date and the distributions from the joint venture prior to closing. Based on the terms of the agreement, the purchase option price range satisfies the internal rate of return guarantee. In connection with the option agreement, the Company entered into a letter of credit in the amount of $7.5 million in favor of Miller Global, which can be drawn by Miller Global in the event the Company does not exercise its option to purchase their 80.0% interest in the remaining assets of MG-HIW, LLC by March 24, 2004. Given the Company intends to exercise its option in March 2004, the fair value of the letter of credit guarantee liability does not have a material impact on the Company’s financial condition or results of operations and is therefore not recorded as a liability in the Company’s Balance Sheet. (See Note 19 for further discussion).
As part of the MG-HIW, LLC acquisition on July 29, 2003, the Company entered into an option agreement with its partner, Miller Global, to acquire their 50.0% interest in the assets encompassing 87,832 square feet of property and 7.0 acres of development land of MG-HIW Metrowest I, LLC and MG-HIW Metrowest II, LLC for $3.2 million. The $7.4 million construction loan to fund the development of this property, of which $7.3 million is outstanding at December 31, 2003, will be either paid in full or assumed by the Company in connection with the acquisition of the assets. On January 29, 2002, the Company guaranteed 50.0% of the construction loan such that if the joint venture is unable to repay the outstanding balance, the Company would be required, under the terms of the agreement, to repay 50.0% of the outstanding balance. The maximum potential amount of future payments by the Company under the agreement is $3.7 million, however, the Company is able to seek recourse from their partner for 50.0% of that amount. (See Note 19 for further discussion).
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In connection with the Des Moines joint venture guarantees in place prior to January 1, 2003, the maximum potential amount of future payments the Company could be required to make under the guarantee is $25.5 million. Of this amount, $8.6 million arose from housing revenue bonds that require credit enhancements in addition to the real estate mortgages. The bonds bear a floating interest rate, which currently averages 1.3% and mature in 2015. Guarantees of $9.5 million will expire upon two industrial buildings becoming 93.8% and 95.0% leased. Currently, these buildings are 90.0% and 64.0% leased, respectively. The remaining $7.4 million in guarantees relate to loans on four office buildings that were in the lease-up phase at the time the loans were initiated. Each of the loans will expire by May 2008. The average occupancy of the four buildings at December 31, 2003 is 91.0%. If the joint ventures are unable to repay the outstanding balance under the loans, the Company will be required, under the terms of the agreements, to repay the outstanding balance. Recourse provisions exist to enable the Company to recover some or all of its losses from the joint ventures’ assets and/or the other partner. The joint ventures currently generate sufficient cash flow to cover the debt service required by the loans.
In connection with the RRHWoods, LLC joint venture, the Company renewed its guarantee of $6.2 million to a bank in July 2003. The bank provides a letter of credit securing industrial revenue bonds, which mature in 2015. The Company would be required to perform under the guarantee should the joint venture be unable to repay the bonds. The Company has recourse provisions in order to recover from the joint venture’s assets and the other partner for amounts paid in excess of their proportionate share. The property collateralizing the bonds is 100.0% leased and currently generates sufficient cash flow to cover the debt service required by the bond financing. As a result, no liability has been recorded in the Company’s Balance Sheet.
With respect to the Plaza Colonnade, LLC joint venture, the Company has included $2.8 million in other liabilities and adjusted the investment in unconsolidated affiliates by $2.8 million on its consolidated balance sheet at December 31, 2003 related to two separate guarantees of a construction loan agreement and a construction completion agreement. The construction loan matures in February 2006, with two one-year options to extend the maturity date that are conditional on completion and lease-up of the project. The term of the construction completion agreement requires the core and shell of the building to be completed by December 15, 2005. Currently, the building is scheduled to be completed in December 2004. Both guarantees arose from the formation of the joint venture to construct an office building. If the joint venture is unable to repay the outstanding balance under the construction loan agreement or complete the construction of the office building, the Company would be required, under the terms of the agreements, to repay its 50.0% share of the outstanding balance under the construction loan and complete the construction of the office building. The maximum potential amount of future payments by the Company under these agreements is $34.9 million. No recourse provisions exist that would enable the Company to recover from the other partner amounts paid under the guarantee. However, given that the loan is collateralized by the building, the Company and their partner could obtain and liquidate the building to recover the amounts paid should the Company be required to perform under the guarantee.
In addition to the Plaza Colonnade, LLC construction loan and completion agreement described above, the partners collectively provided $12.0 million in letters of credit in December 2002, $6.0 million by the Company and $6.0 million by its partner in 2002. The Company and its partner would be held liable under the letter of credit agreements should the joint venture not complete construction of the building. The letters of credit expire in December 31, 2004. No recourse provisions exist that would enable the Company to recover from the other partner amounts drawn under the letter of credit.
In connection with the disposition of 225,220 square feet of property in 2002, fully leased to Capital One Services, Inc., a subsidiary of Capital One Financial Services, Inc., the Company agreed to guarantee any rent shortfalls and re-tenanting costs for a five year period of time from the date of sale. The Company’s contingent liability with respect to such guarantee as of December 31, 2003 is $16.5 million. Because of this guarantee, in accordance with SFAS 66, the Company deferred the gain of approximately $6.9 million, which will be recognized when the contingency period is concluded. The Company believes that its estimate related to the agreement is accurate. However, if its assumptions and estimates prove to be incorrect, future losses may occur.
F-36
In connection with the disposition of 298,000 square feet of property in 2003, fully leased to Capital One Services, Inc., a subsidiary of Capital One Financial Services, Inc., the Company agreed to guarantee, over various contingency periods through April 2006, any rent shortfalls on certain space. The Company’s contingent liability with respect to such guarantee as of December 31, 2003 is $4.4 million. Because of this guarantee, in accordance with SFAS 66, the Company deferred $4.4 million of the total $8.4 million gain. The deferred portion of the gain will be recognized when each contingency period is concluded.
In connection with the disposition of 1.9 million square feet of Industrial property at the end of 2003, the Company agreed to guarantee, over various contingency periods through December 2006, any rent shortfalls on 16.3% of the rentable square footage of the Industrial property, which is occupied by two tenants. The Company’s contingent liability with respect to such guarantee as of December 31, 2003 is $2.4 million. Because of this guarantee, in accordance with SFAS 66, the Company deferred $2.4 million of the total $5.2 million gain. The deferred portion of the gain will be recognized when each contingency period is concluded.
Litigation
The Company is party to a variety of legal proceedings arising in the ordinary course of its business. The Company believes that it is adequately covered by insurance. Accordingly, none of such proceedings are expected to have a material adverse effect on the Company’s business, financial condition and results of operations.
The Company incurred $2.7 million in year ended December 31, 2002 for litigation expense related to various legal proceedings from previously completed mergers and acquisitions. These were fully settled in early 2003.
16. DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The following disclosures of estimated fair value were determined by management using available market information and appropriate valuation methodologies. Considerable judgment is necessary to interpret market data and develop estimated fair values. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that the Company could realize upon disposition of the financial instruments. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair values. The carrying amounts and estimated fair values of the Company’s financial instruments at December 31, 2003 were as follows:
Accounts and notes receivable
The fair values for the Company’s fixed rate mortgages and notes payable were estimated using discounted cash flow analysis, based on the Company’s estimated incremental borrowing rate at December 31, 2003, for similar types of borrowing arrangements. The carrying amounts of the Company’s variable rate borrowings approximate fair value.
Disclosures about the fair value of financial instruments are based on relevant information available to the Company at December 31, 2003. Although management is not aware of any factors that would have a material effect on the fair value amounts reported herein, such amounts have not been revalued since that date and current estimates of fair value may significantly differ from the amounts presented herein.
F-37
17. SEGMENT INFORMATION
The sole business of the Company is the acquisition, development and operation of rental real estate properties. The Company operates office, industrial and retail properties and apartment units. There are no material inter-segment transactions.
The Company’s chief operating decision maker (“CDM”) assesses and measures operating results based upon property level net operating income. The operating results for the individual assets within each property type have been aggregated since the CDM evaluates operating results and allocates resources on a property-by-property basis within the various property types.
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 no tenant currently comprises more than 3.4% of consolidated revenues. The following table summarizes the rental income, net operating income and assets for each reportable segment for the years ended December 31, 2003, 2002 and 2001 ($ in thousands):
Rental Revenue (A):
Office segment
Industrial segment
Retail segment
Apartment segment
Total Rental Revenue
Net Operating Income (A):
Total Net Operating Income
Reconciliation to income before gain/(loss) on disposition of land and depreciable assets, minority interest and discontinued operations:
General and administrative expenses
Total Assets:
Corporate and other
F-38
18. QUARTERLY FINANCIAL DATA (Unaudited)
The following table sets forth quarterly financial information for the Company’s fiscal years ended December 31, 2003 and 2002 and have been adjusted to reflect the reporting requirements of discontinued operations under SFAS 144 ($ in thousands except per share amounts):
Net income per share – basic:
Net income per share – diluted:
F-39
19. SUBSEQUENT EVENTS
On March 2, 2004, the Company exercised its option and acquired its partner’s 80.0% equity interest in the remaining assets of MG-HIW, LLC, which consists of five properties encompassing 1.3 million square feet located in the central business district of Orlando (“Orlando properties”). The properties were 83.8% leased as of December 31, 2003 and were encumbered by $136.2 million of floating rate debt with interest based on LIBOR plus 200 basis points, which has been assumed by the Company. At the closing of the transaction, the Company paid its partner, Miller Global, $62.5 million and the $7.5 million letter of credit was cancelled. The transaction implies a valuation (100.0% ownership) of $214.3 million, which includes the properties and other net assets of the joint venture.
In January 2004, the Company signed a Letter of Intent with Kapital-Consult, manager for Dreilander-Fonds, a European investment firm, under which Kapital-Consult will acquire a 60.0% equity interest in the Orlando properties for approximately $45.5 million, excluding certain development rights to be retained by the Company. Although the transaction is subject to documentation and other closing conditions, it is expected to close no later than the end of the second quarter of 2004.
Also on March 2, 2004, the Company exercised its option and acquired its partner’s 50.0% equity interest in the assets of MG-HIW Metrowest I, LLC and MG-HIW Metrowest II, LLC for $3.2 million. The assets in MG-HIW Metrowest I, LLC and MG-HIW Metrowest II, LLC include 87,832 square feet of property and 7.0 acres of development land zoned for the development of 90,000 square feet of office space. The $7.4 million construction loan to fund the development of this property, of which $7.3 million was outstanding at December 31, 2003, was paid in full by the Company at closing.
See Note 3 for proforma information assuming the acquisition of the above assets had occurred on January 1, 2002.
F-40
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
For the years ended December 31, 2003, 2002 and 2001
Year ended December 31, 2003Allowance for doubtful accounts
Year ended December 31, 2002Allowance for doubtful accounts
Year ended December 31, 2001Allowance for doubtful accounts
F-41
SCHEDULE III—REAL ESTATE AND ACCUMULATED DEPRECIATION
12/31/2003
(In Thousand)
Encumberance
Cost Capitalized
Subsequent to
Acquistion
Gross Amount
at Which
Carried at Close
of Period
Accumulated
Date of
Construction
Life onWhich
is Computed
Building &
Improvements
Atlanta, GA
1035 Fred Drive
1700 Century Center
1700 Century Circle
1800 Century Boulevard
1825 Century Center (CDC)
1875 Century Boulevard
1900 Century Boulevard
2200 Century Parkway
2400 Century Center
2600 Century Parkway
2635 Century Parkway
2800 Century Parkway
400 North Business Park
50 Glenlake
5125 Fulton Industrial Drive
6348 Northeast Expressway
6438 Northeast Expressway
Bluegrass 12.72 Acres
Bluegrass Fl 12.13 Acres
Bluegrass Lakes I
Bluegrass Land Site V10
Bluegrass Land Site V14
Bluegrass PH 32.346 Acres
Bluegrass Phase 2
Bluegrass Place I
Bluegrass Place II
Bluegrass V93.04
Bluegrass Valley
Bluegrass Wet Land
Century Plaza I
Century Plaza II
Chastain Place I
Chastain Place II
Chastain Place III
Chattahoochee Avenue
Corporate Lakes
Cosmopolitan North
Deerfield I
Deerfield II
Deerfield III
EKA Chemical
Gwinnett Distribution Center
Highwoods Center I at Tradeport
Highwoods Center II at Tradeport
Highwoods Center III at Tradeport
Kennestone Corporate Center
La Vista Business Park
Newpoint Place I
Newpoint Place II
Newpoint Place III
Newpoint Place IV
Newpoint Place Land
Norcross I & II
Nortel
Oakbrook I
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Subsequent
Life on
Which
Oakbrook II
Oakbrook III
Oakbrook IV
Oakbrook V
Oakbrook Summit
Oxford Lake Business Center
Peachtree Corners II
Peachtree Corners III
Peachtree Corners Land
South Park Residential Land
South Park Site Land
Southside Distribution Center
Tradeport I
Tradeport II
Tradeport III
Tradeport IV
Tradeport V
Tradeport Land
Two Point Royal
Baltimore, MD
Sportsman Club Land
Charlotte, NC
4101 Stuart Andrew Boulevard
4105 Stuart Andrew Boulevard
4109 Stuart Andrew Boulevard
4201 Stuart Andrew Boulevard
4205 Stuart Andrew Boulevard
4209 Stuart Andrew Boulevard
4215 Stuart Andrew Boulevard
4301 Stuart Andrew Boulevard
4321 Stuart Andrew Boulevard
4601 Park Square
Eight Parkway Plaza Building
Eleven Parkway Plaza
First Citizens Building
Fourteen Parkway Plaza Building
Mallard Creek I
Mallard Creek III
Mallard Creek IV
Mallard Creek V
Mallard Creek VI
Oakhill Business Park English Oak
Oakhill Business Park Laurel Oak
Oakhill Business Park Live Oak
Oakhill Business Park Scarlet Oak
Oakhill Business Park Twin Oak
Oakhill Business Park Water Oak
Oakhill Business Park Willow Oak
Oakhill Land
Pinebrook
Ridgefield
One Parkway Plaza Building
Two Parkway Plaza Building
Three Parkway Plaza Building
Six Parkway Plaza Building
Seven Parkway Plaza Building
Twelve Parkway Plaza
University Center
University Center East
University Center—Land
Columbia, SC
Centerpoint I
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Subsequent toAcquistion
Gross Amountat Which
Carried at
Close of Period
Centerpoint II
Centerpoint V
Centerpoint VI
Fontaine I
Fontaine II
Fontaine III
Fontaine V
Greenville, SC
385 Building 1
385 Land
770 Pelham Road
Bank of America Plaza
Brookfield Plaza
Brookfield-Jacobs-Sirrine
MetLife @ Brookfield
Patewood Business Center
Patewood I
Patewood II
Patewood III
Patewood IV
Patewood V
Patewood VI
Verizon Wireless
Jacksonville, FL
Belfort Park VI—Land
Belfort Park VII—Land
Kansas City, MO
Country Club Plaza—48th & Penn
Country Club Plaza—Balcony Office
Country Club Plaza—Balcony Retail
Country Club Plaza—Court of the Penguins
Country Club Plaza—Esplanade Office
Country Club Plaza—Esplanade Retail
Country Club Plaza—Granada Shops
Country Club Plaza—Halls Block
Country Club Plaza—Macy Block
Country Club Plaza—Millcreek Office
Country Club Plaza—Millcreek Retail
Country Club Plaza—Nichols Block Office
Country Club Plaza—Nichols Retail
Country Club Plaza—Plaza Central
Country Club Plaza—Retail
Country Club Plaza—Savings South
Country Club Plaza—Seville Shops West
Country Club Plaza—Seville Square
Country Club Plaza—Swanson Block
Country Club Plaza—Theatre Office
Country Club Plaza—Theatre Retail
Country Club Plaza—Time Office
Country Club Plaza—Time Retail
Country Club Plaza—Triangle Block
Country Club Plaza—Valencia Place Retail
63rd & Brookside
Alameda Towers
Bannister Rd.
Brookside Shopping Center
Challenger—Land
Colonial Shops
Corinth Executive Building
Corinth Office Building
Corinth Shops South
Corinth Square North Shops
F-44
Fairway North
Fairway Shops
Fairway West
Residential—Land
Land—Hotel Land—Valencia
Land—JCN Parkway 4502-1
Land—JCN Parkway 4510 & 4518
Land—Lionsgate
Land—Woodsonia Commercial
Neptune Apartments
Parklane Apartments
Red Bridge & Holmes
Rental Houses
St. Charles Apartments
Wornall Road Apartments
Nichols Building
One Ward Parkway
Park Plaza
Parkway Building
Prairie Village Office Center
Prairie Village Rest & Bank
Prairie Village Shops
Shannon Valley Shopping Center
Somerset
Two Brush Creek
Valencia Place Office
WhiteHorse Commercial
Memphis, TN
3400 Players Club Parkway
6000 Poplar Ave
6060 Poplar Ave
Atrium I & II
Centrum
Hickory Hill Medical Plaza
International Place II
Shadow Creek I
Shadow Creek II
Southwind Office Center A
Southwind Office Center B
Southwind Office Center C
Southwind Office Center D
The Colonnade
Nashville, TN
3322 West End
3401 West End
5310 Maryland Way
BNA Corporate Center
Century City Plaza I
Cool Springs I
Cool Springs II
Cool Springs Land
Eakin & Smith
Eastpark I, II, & III
Harpeth on the Green II
Harpeth on the Green III
Harpeth on the Green IV
Harpeth on The Green V
Hickory Trace
Highwoods Plaza I
Highwoods Plaza II
Lakeview Ridge I
Lakeview Ridge II
F-45
Lakeview Ridge III
Seven Springs I
Seven Springs—Land I
Seven Springs—Land II
SouthPointe
Southwind Land
Sparrow Building
The Ramparts at Brentwood
Westwood South
Winners Circle
Norfolk, VA
Greenbrier Business Center
Orlando, FL
Capital Plaza III
In Charge Institute
Interlachen Village
Lake Mary Land
Metrowest Center
MetroWest Land
Sunport Center
Piedmont Triad, NC
101 Stratford
150 Stratford
160 Stratford—Land
2606 Phoenix Drive-100 Series
2606 Phoenix Drive-200 Series
2606 Phoenix Drive-300 Series
2606 Phoenix Drive-400 Series
2606 Phoenix Drive-500 Series
2606 Phoenix Drive-600 Series
2606 Phoenix Drive-700 Series
2606 Phoenix Drive-800 Series
500 Northridge
500 Radar Road
502 Radar Road
504 Radar Road
506 Radar Road
520 Northridge
540 Northridge
550 Northridge
531 Northridge Office
531 Northridge Warehouse
6348 Burnt Poplar
6350 Burnt Poplar
710 Almondridge
711 Almondridge
7341 West Friendly Avenue
7343 West Friendly Avenue
7345 West Friendly Avenue
7347 West Friendly Avenue
7349 West Friendly Avenue
7351 West Friendly Avenue
7353 West Friendly Avenue
7355 West Friendly Avenue
7906 Industrial Village Road
7908 Industrial Village Road
7910 Industrial Village Road
Airpark East-Building 1
Airpark East-Building 2
Airpark East-Building 3
Airpark East-Building A
Airpark East-Building B
F-46
Airpark East-Building C
Airpark East-Building D
Airpark East-Copier Consultants
Airpark East-HewlettPackard
Airpark East-Highland
Airpark East-Inacom Building
Airpark East-Service Center 1
Airpark East-Service Center 2
Airpark East-Service Center 3
Airpark East-Service Center 4
Airpark East-Service Court
Airpark East-Simplex
Airpark East-Warehouse 1
Airpark East-Warehouse 2
Airpark East-Warehouse 3
Airpark East-Warehouse 4
Airpark North—DC1
Airpark North—DC2
Airpark North—DC3
Airpark North—DC4
Airpark South Warehouse 1
Airpark South Warehouse 2
Airpark South Warehouse 3
Airpark South Warehouse 4
Airpark South Warehouse 6
Airpark West 1
Airpark West 2
Airpark West 4
Airpark West 5
Airpark West 6
ALO
Brigham Road—Land
Chesapeake
Chimney Rock A/B
Chimney Rock C
Chimney Rock D
Chimney Rock E
Chimney Rock F
Chimney Rock G
Consolidated Center/ Building I
Consolidated Center/ Building II
Consolidated Center/ Building III
Consolidated Center/ Building IV
Deep River Corporate Center
Enterprise Warehouse I
Forsyth Corporate Center
Highwoods Park Building I
Inman Road Land
Jefferson Pilot Land
Madison Park—Building 5610
Madison Park—Building 5620
Madison Park—Building 5630
Madison Park—Building 5635
Madison Park—Building 5640
Madison Park—Building 5650
Madison Park—Building 5655
Madison Park—Building 5660
Madison Parking Deck
Regency One-Piedmont Center
Regency Two-Piedmont Center
Sears Cenfact
The Knollwood—370
The Knollwood—380
The Knollwood—380 Retail
University Commercial Center-Archer 4
F-47
University Commercial Center-Landmark 3
University Commercial Center-Service Center 1
University Commercial Center-Service Center 2
University Commercial Center-Service Center 3
University Commercial Center-Warehouse 1
University Commercial Center-Warehouse 2
Westpoint Business Park Land
Westpoint Business Park-BMF
Westpoint Business Park-Fairchild
Westpoint Business Park-Luwabahnson
Westpoint Business Park-Wp 3&4
Westpoint Business Park-Wp 5
Westpoint Business Park-Wp 12
Westpoint Business Park-Wp 11
Westpoint Business Park-Wp 13
Research Triangle, NC
3600 Glenwood Avenue
3737 Glenwood Avenue
4101 Research Commons
4201 Research Commons
4301 Research Commons
4401 Research Commons
4501 Research Commons
4300 Six Forks Road
4800 North Park
4900 North Park
5000 North Park
3645 Trust Drive—One North Commerce Center
5200 Greens Dairy-One North Commerce Center
5220 Greens Dairy-One North Commerce Center
Phase I—One North Commerce Center
W Building—One North Commerce Center
801 Corporate Center
Aspen Building
Blue Ridge I
Blue Ridge II
Cape Fear
Catawba
Cedar East
Cedar West
CentreGreen One—Weston
CentreGreen Two—Weston
CentreGreen Three Land—Weston
CentreGreen Four
CentreGreen Five Land—Weston
Concourse
Cottonwood
Creekstone Crossings
Cypress
Day Tract Residential
Dogwood
EPA
GlenLake Land
GlenLake Bldg I
Global Software
Hawthorn
Healthsource
Highwoods Centre-Weston
Highwoods Office Center North Land
Highwoods Office Center South Land
Highwoods Tower One
Highwoods Tower Two
Holiday Inn Reservations Center
F-48
Inveresk Land Parcel 2
Inveresk Land Parcel 3
Ironwood
Kaiser
Lake Plaza East
Laurel
Leatherwood
Maplewood
Northpark—Wake Forest
Northpark Land—Wake Forest
Overlook
Pamlico
ParkWest One—Weston
ParkWest Two—Weston
ParkWest Three—Land—Weston
Progress Center Renovation
Pulse Athletic Club at Highwoods
Raleigh Corp Center Lot D
Red Oak
Rexwoods Center I
Rexwoods Center II
Rexwoods Center III
Rexwoods Center IV
Rexwoods Center V
Riverbirch
Situs I
Situs II
Situs III
Six Forks Center I
Six Forks Center II
Six Forks Center III
Smoketree Tower
South Square I
South Square II
Sycamore
WESPEC Tract 1
WESPEC Tract 2E
WESPEC—Tract 3
Weston—Land
Weston Commons Tract—2B
Weston Commons Tract—5A
Weston Commons Tract—5B
Weston Commons Tract—5C
Weston Commons Tract—6A
Weston Commons Tract—6A2
Weston Commons Tract—6B
Weston Commons Tract—6C
Weston Commons Tract—8A
Weston Oaks Court
Willow Oak
Other Property
Richmond, VA
1309 E. Cary Street
4900 Cox Road
Airport Center I
Airport Center II
Capital One Building I
Capital One Building II
Capital One Building III
Capital One Parking Deck
Colonade Building
Dominion Place—Pitts Parcel
East Shore IV
Grove Park I
F-49
Grove Park Buidling E
Grove Park Buidling H
Grove Park Buidling I
Grove Park Buidling J
Grove Park Square
Hamilton Beach
HDC Land Site—Parcel 6
HDC Land Site C—Parcel 5
HDC Land Site D—Parcel 4
HDC Land Site E—Parcel 3
Highwoods Distribution Center
Highwoods Commons
Highwoods Five
Highwoods One
Highwoods Plaza
Highwoods Two
Innsbrook Centre
Innslake Center
Liberty Mutual
Markel American
Mercer Plaza
North Park
North Shore Commons A
North Shore Commons B—Land
North Shore Commons C—Land
North Shore Commons D—Land
One Shockoe Plaza
Pavilion
Sadler & Cox Land
Stony Point F Land
Stony Point I
Stony Point II
Stony Point III
Technology Park 1
Technology Park 2
Vantage Place A
Vantage Place B
Vantage Place C
Vantage Place D
Vantage Pointe
Virginia Mutual
Waterfront Plaza
West Shore I
West Shore II
West Shore III
South Florida
The 1800 Eller Drive Building
Tampa, FL
380 Park Place
Anchor Glass
Atrium
Bay View Office Centre
Bay Vista Gardens
Bay Vista Gardens II
Bay Vista Office Building
Bay Vista Retail
Bayshore
Brookwood Day Care Center
Countryside Place
Cypress Center I
Cypress Center III
Cypress Center IV—Land
Cypress Commons
F-50
Cypress West
Feathersound Corporate Center II
Firemans Fund Building
Highwoods Preserve Energy Plant
Highwoods Preserve I
Highwoods Preserve II
Highwoods Preserve III
Highwoods Preserve IV
Highwoods Preserve V
Highwoods Preserve VI—Land
Highwoods Preserve Land
Horizon
LakePointe I
LakePointe II
Lakeside
Northside Square Office
Northside Square Office/Retail
One Harbour Place
Parkside
Pavilion Parking Garage
Registry I
Registry II
Registry Square
Sabal Business Center I
Sabal Business Center II
Sabal Business Center III
Sabal Business Center IV
Sabal Business Center V
Sabal Business Center VI
Sabal Business Center VII
Sabal Industrial Park Land
Sabal Lake Building
Sabal Park Plaza
Sabal Pavilion I
Sabal Pavilion II
Sabal Tech Center
Spectrum
Summit Office Building
Tower Place
USF&G
Watermark 10,14,15
Watermark 13
Westshore Square
F-51
HIGHWOODS PROPERTIES INC.
NOTE TO SCHEDULE III
(In Thousands)
As of December 31, 2003, 2002, and 2001
A summary of activity for Real estate and accumulated depreciation is as follows
Real Estate:
Balance at beginning of year
Additions
Acquisitions, Development and Improvements
Cost of real estate sold and retired
Balance at close of year (a)
Accumulated Depreciation
Depreciation expense
Real estate sold and retired
Balance at close of year (b)
(a) Reconciliation of total cost to balance sheet caption at December 31, 2003, 2002, and 2001 (in Thousands)
Total per schedule III.
Construction in progress exclusive of land included in schedule III.
Reclassification adjustment for discontinued operations
Total real estate assets at cost
(b) Reconciliation of total Accumulated Depreciation to balance sheet caption at December 31, 2003, 2002, and 2001 (in Thousands)
Total per Schedule III.
Accumulated Depreciation—furniture, fixtures and equipment
Total accumulated depreciation
F-52