Filed Pursuant To Rule 424(b)(3)

Registration No. 333-142178

 

SUPPLEMENT NO. 4

DATED NOVEMBER 9, 2007

TO THE PROSPECTUS DATED MAY 4, 2007

OF

HIGHWOODS PROPERTIES, INC.

 

This document supplements, and should be read in conjunction with, the prospectus of Highwoods Properties, Inc. dated May 4, 2007, as amended by the prospectus supplements dated May 10, 2007, June 25, 2007 and August 9, 2007. On November 9, 2007, we filed with the Securities and Exchange Commission our Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2007. This Quarterly Report (excluding the exhibits thereto) is attached as Annex A to this Supplement No. 4. Unless otherwise defined in this Supplement No. 4, capitalized terms used in this supplement have the same meanings as set forth in the prospectus.

 

 

 

 

 

ANNEX A

 

QUARTERLY REPORT ON FORM 10-Q

FOR THE

QUARTERLY PERIOD ENDED SEPTEMBER 30, 2007

 

 

 

 

 

 


 

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

______________

 

FORM 10-Q

 

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

THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2007

 

Commission file number: 001-13100

 

______________

 

HIGHWOODS PROPERTIES, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Maryland

56-1871668

 

 

(State or other jurisdiction
of incorporation or organization)

(I.R.S. Employer
Identification Number)

 

 

 

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

(Address of principal executive office)

 

27604

(Zip Code)

 

(919) 872-4924

(Registrant’s telephone number, including area code)

 

______________

 

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

 

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer or a

non-accelerated filer. See definition of ‘accelerated filer’ and ‘large accelerated filer’ in Rule 12b-2 of the Securities Exchange Act. Large accelerated filer x Accelerated filer o Non-accelerated filer o

 

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

 

The Company had 57,158,461 shares of common stock outstanding as of September 30, 2007.

 


 

 

 

HIGHWOODS PROPERTIES, INC.

 

QUARTERLY REPORT FOR THE PERIOD ENDED SEPTEMBER 30, 2007

 

TABLE OF CONTENTS

 

 

 

 

 

Page

 

PART I

 

FINANCIAL INFORMATION

 

 

 

Item 1.

 

Financial Statements

 

2

 

 

 

Consolidated Balance Sheets as of September 30, 2007 and December 31, 2006

 

3

 

 

 

Consolidated Statements of Income for the three and nine months ended
September 30, 2007 and 2006

 

4

 

 

 

Consolidated Statement of Stockholders’ Equity for the nine months ended
September 30, 2007

 

5

 

 

 

Consolidated Statements of Cash Flows for the nine months ended September 30, 2007
and 2006

 

6

 

 

 

Notes to Consolidated Financial Statements

 

8

 

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

31

 

 

 

Disclosure Regarding Forward-Looking Statements

 

31

 

 

 

Overview

 

31

 

 

 

Results of Operations

 

34

 

 

 

Liquidity and Capital Resources

 

39

 

 

 

Critical Accounting Estimates

 

45

 

 

 

Funds From Operations

 

45

 

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

 

48

 

Item 4.

 

Controls and Procedures

 

49

 

 

 

 

 

 

 

PART II

 

OTHER INFORMATION

 

 

 

Item 1.

 

Legal Proceedings

 

51

 

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

51

 

Item 5.

 

Other Information

 

51

 

Item 6.

 

Exhibits

 

52

 

 

 

 

 

 

PART I - FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

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

 

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

 

The aforementioned financial statements should be read in conjunction with the notes to Consolidated Financial Statements, Management’s Discussion and Analysis of Financial Condition and Results of Operations and Risk Factors included herein and in our 2006 Annual Report on Form 10-K.

 

 

2

 

 

HIGHWOODS PROPERTIES, INC.

Consolidated Balance Sheets

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

 

 

 

September 30,
2007

 

December 31,
2006

 

Assets:

 

 

 

 

 

 

Real estate assets, at cost:

 

 

 

 

 

 

 

Land

 

$

353,659

 

$

345,548

 

Buildings and tenant improvements

 

 

2,663,378

 

 

2,573,032

 

Development in process

 

 

134,088

 

 

101,899

 

Land held for development

 

 

111,384

 

 

111,517

 

 

 

 

3,262,509

 

 

3,131,996

 

Less-accumulated depreciation

 

 

(638,265

)

 

(588,307

)

Net real estate assets

 

 

2,624,244

 

 

2,543,689

 

Real estate and other assets, net, held for sale

 

 

3,200

 

 

35,446

 

Cash and cash equivalents

 

 

3,468

 

 

16,690

 

Restricted cash

 

 

19,367

 

 

2,027

 

Accounts receivable, net of allowance of $1,007 and $1,253, respectively

 

 

27,263

 

 

23,347

 

Notes receivable, net of allowance of $133 and $786, respectively

 

 

5,430

 

 

7,871

 

Accrued straight-line rents receivable, net of allowance of $410 and $301,
respectively

 

 

71,328

 

 

68,364

 

Investment in unconsolidated affiliates

 

 

57,970

 

 

60,359

 

Deferred financing and leasing costs, net of accumulated amortization

 

 

71,178

 

 

66,352

 

Prepaid expenses and other assets

 

 

23,475

 

 

20,708

 

Total Assets

 

$

2,906,923

 

$

2,844,853

 

 

 

 

 

 

 

 

 

Liabilities, Minority Interest and Stockholders' Equity:

 

 

 

 

 

 

 

Mortgages and notes payable

 

$

1,601,474

 

$

1,465,129

 

Accounts payable, accrued expenses and other liabilities

 

 

167,716

 

 

156,737

 

Financing obligations

 

 

34,919

 

 

35,530

 

Total Liabilities

 

 

1,804,109

 

 

1,657,396

 

Commitments and Contingencies (see Note 11)

 

 

 

 

 

 

 

Minority interest

 

 

70,716

 

 

79,726

 

Stockholders' Equity:

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

8 5/8% Series A Cumulative Redeemable Preferred Shares (liquidation
preference $1,000 per share), 82,937 and 104,945 shares issued and
outstanding at September 30, 2007 and December 31, 2006, respectively

 

 

82,937

 

 

104,945

 

8% Series B Cumulative Redeemable Preferred Shares (liquidation
preference $25 per share), 2,100,000 and 3,700,000 shares issued and
outstanding at September 30, 2007 and December 31, 2006, respectively

 

 

52,500

 

 

92,500

 

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

 

 

 

 

 

 

 

57,158,461 and 56,211,148 shares issued and outstanding at
September 30, 2007 and December 31, 2006, respectively

 

 

572

 

 

562

 

Additional paid-in capital

 

 

1,446,609

 

 

1,449,337

 

Distributions in excess of net earnings

 

 

(549,436

)

 

(538,098

)

Accumulated other comprehensive loss

 

 

(1,084

)

 

(1,515

)

Total Stockholders' Equity

 

 

1,032,098

 

 

1,107,731

 

Total Liabilities, Minority Interest and Stockholders' Equity

 

$

2,906,923

 

$

2,844,853

 

 

See accompanying notes to consolidated financial statements.

 

3

 

 

HIGHWOODS PROPERTIES, INC.

Consolidated Statements of Income

(Unaudited and in thousands, except per share amounts)

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Rental and other revenues

 

$

110,166

 

$

103,395

 

$

325,384

 

$

305,853

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

Rental property and other expenses

 

 

39,958

 

 

38,895

 

 

117,530

 

 

111,511

 

Depreciation and amortization

 

 

32,517

 

 

28,168

 

 

92,275

 

 

84,000

 

Impairment of assets held for use

 

 

789

 

 

-

 

 

789

 

 

-

 

General and administrative

 

 

9,649

 

 

8,546

 

 

31,428

 

 

26,298

 

Total operating expenses

 

 

82,913

 

 

75,609

 

 

242,022

 

 

221,809

 

Interest expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

Contractual

 

 

23,728

 

 

23,809

 

 

69,514

 

 

71,855

 

Amortization of deferred financing costs

 

 

616

 

 

557

 

 

1,791

 

 

1,883

 

Financing obligations

 

 

981

 

 

850

 

 

2,968

 

 

3,190

 

 

 

 

25,325

 

 

25,216

 

 

74,273

 

 

76,928

 

Other income/(expense):

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest and other income

 

 

1,471

 

 

1,174

 

 

5,105

 

 

4,287

 

Loss on debt extinguishments

 

 

-

 

 

-

 

 

-

 

 

(467

)

 

 

 

1,471

 

 

1,174

 

 

5,105

 

 

3,820

 

Income before disposition of property, insurance gain, minority

 

 

 

 

 

 

 

 

 

 

 

 

 

interest and equity in earnings of unconsolidated affiliates

 

 

3,399

 

 

3,744

 

 

14,194

 

 

10,936

 

Gains on disposition of property, net

 

 

1,288

 

 

2,977

 

 

20,372

 

 

8,295

 

Gain from property insurance settlement

 

 

-

 

 

-

 

 

4,128

 

 

-

 

Minority interest

 

 

(307

)

 

(445

)

 

(3,324

)

 

(1,276

)

Equity in earnings of unconsolidated affiliates

 

 

1,207

 

 

1,342

 

 

12,930

 

 

5,349

 

Income from continuing operations

 

 

5,587

 

 

7,618

 

 

48,300

 

 

23,304

 

Discontinued operations:

 

 

 

 

 

 

 

 

 

 

 

 

 

Income/(loss) from discontinued operations, net of minority interest

 

 

205

 

 

(1,304

)

 

981

 

 

1,386

 

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

 

 

6,175

 

 

2,595

 

 

24,533

 

 

4,638

 

Release of FASB FIN 48 tax liability

 

 

1,473

 

 

-

 

 

1,473

 

 

-

 

 

 

 

7,853

 

 

1,291

 

 

26,987

 

 

6,024

 

Net income

 

 

13,440

 

 

8,909

 

 

75,287

 

 

29,328

 

Dividends on preferred stock

 

 

(2,680

)

 

(4,113

)

 

(10,639

)

 

(12,950

)

Excess of preferred stock redemption cost over carrying value

 

 

(842

)

 

-

 

 

(2,285

)

 

(1,803

)

Net income available for common stockholders

 

$

9,918

 

$

4,796

 

$

62,363

 

$

14,575

 

Net income per common share - basic:

 

 

 

 

 

 

 

 

 

 

 

 

 

Income from continuing operations

 

$

0.04

 

$

0.07

 

$

0.63

 

$

0.16

 

Income from discontinued operations

 

 

0.14

 

 

0.02

 

 

0.48

 

 

0.11

 

Net income

 

$

0.18

 

$

0.09

 

$

1.11

 

$

0.27

 

Weighted average common shares outstanding - basic

 

 

56,628

 

 

54,470

 

 

56,376

 

 

54,069

 

Net income per common share - diluted:

 

 

 

 

 

 

 

 

 

 

 

 

 

Income from continuing operations

 

$

0.04

 

$

0.07

 

$

0.62

 

$

0.15

 

Income from discontinued operations

 

 

0.13

 

 

0.02

 

 

0.47

 

 

0.11

 

Net income

 

$

0.17

 

$

0.09

 

$

1.09

 

$

0.26

 

Weighted average common shares outstanding - diluted

 

 

61,396

 

 

61,457

 

 

61,611

 

 

60,786

 

Dividends declared per common share

 

$

0.425

 

$

0.425

 

$

1.275

 

$

1.275

 

 

See accompanying notes to consolidated financial statements.

 

4

 

 

HIGHWOODS PROPERTIES, INC.

Consolidated Statement of Stockholders’ Equity

For the Nine Months Ended September 30, 2007

(Unaudited and in thousands, except share amounts)

 

 

 

 

Number of
Common
Shares

 

Common
Stock

 

Series A
Preferred

 

Series B
Preferred

 

Additional
Paid-In
Capital

 

Accumulated
Other
Compre-
hensive Loss

 

Distributions
in Excess of
Net Earnings

 

Total

 

Balance at December 31, 2006

 

56,211,148

 

$

562

 

$

104,945

 

$

92,500

 

$

1,449,337

 

$

(1,515

)

$

(538,098

)

$

1,107,731

 

Cumulative effect adjustment resulting from the adoption of FASB Interpretation No. 48

 

-

 

 

-

 

 

-

 

 

-

 

 

-

 

 

-

 

 

(1,424

)

 

(1,424

)

Issuance of Common Stock

 

679,726

 

 

7

 

 

-

 

 

-

 

 

6,709

 

 

-

 

 

-

 

 

6,716

 

Redemption of Common Units for Common Stock

 

55,836

 

 

1

 

 

-

 

 

-

 

 

2,165

 

 

-

 

 

-

 

 

2,166

 

Common Stock dividends

 

-

 

 

-

 

 

-

 

 

-

 

 

-

 

 

-

 

 

(72,277

)

 

(72,277

)

Preferred Stock dividends

 

-

 

 

-

 

 

-

 

 

-

 

 

-

 

 

-

 

 

(10,639

)

 

(10,639

)

Adjustment to minority interest of unitholders in the Operating Partnership

 

-

 

 

-

 

 

-

 

 

-

 

 

(17,451

)

 

-

 

 

-

 

 

(17,451

)

Redemption/repurchase of Preferred Stock

 

-

 

 

-

 

 

(22,008

)

 

(40,000

)

 

2,037

 

 

-

 

 

(2,285

)

 

(62,256

)

Issuance of restricted stock, net

 

211,751

 

 

-

 

 

-

 

 

-

 

 

-

 

 

-

 

 

-

 

 

-

 

Amortization of restricted stock and stock options

 

-

 

 

2

 

 

-

 

 

-

 

 

3,812

 

 

-

 

 

-

 

 

3,814

 

Other comprehensive income

 

-

 

 

-

 

 

-

 

 

-

 

 

-

 

 

431

 

 

-

 

 

431

 

Net income

 

-

 

 

-

 

 

-

 

 

-

 

 

-

 

 

-

 

 

75,287

 

 

75,287

 

Balance at September 30, 2007

 

57,158,461

 

$

572

 

$

82,937

 

$

52,500

 

$

1,446,609

 

$

(1,084

)

$

(549,436

)

$

1,032,098

 

 

See accompanying notes to consolidated financial statements.

 

5

 

 

HIGHWOODS PROPERTIES, INC.

Consolidated Statements of Cash Flows

(Unaudited and in thousands)

 

 

 

Nine Months Ended
September 30,

 

 

 

2007

 

2006

 

Operating activities:

 

 

 

 

 

 

 

Net income

 

$

75,287

 

$

29,328

 

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

 

 

 

 

 

 

 

Depreciation and amortization

 

 

92,957

 

 

87,655

 

Amortization of lease incentives

 

 

719

 

 

623

 

Amortization of restricted stock and stock options

 

 

3,814

 

 

2,933

 

Amortization of deferred financing costs

 

 

1,791

 

 

1,883

 

Amortization of accumulated other comprehensive loss

 

 

431

 

 

531

 

Impairments of assets held for use

 

 

789

 

 

2,600

 

Loss on debt extinguishments

 

 

-

 

 

467

 

Net gains on disposition of property

 

 

(46,835

)

 

(13,340

)

Gain from property insurance settlement

 

 

(4,128

)

 

-

 

Minority interest

 

 

5,329

 

 

1,828

 

Equity in earnings of unconsolidated affiliates

 

 

(12,930

)

 

(5,349

)

Release of FASB FIN 48 tax liability

 

 

(1,424

)

 

-

 

Change in financing obligations

 

 

302

 

 

896

 

Distributions of earnings from unconsolidated affiliates

 

 

5,169

 

 

5,458

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

Accounts receivable

 

 

(3,555

)

 

3,800

 

Prepaid expenses and other assets

 

 

(4,209

)

 

(2,832

)

Accrued straight-line rents receivable

 

 

(3,367

)

 

(6,191

)

Accounts payable, accrued expenses and other liabilities

 

 

10,669

 

 

(1,115

)

Net cash provided by operating activities

 

 

120,809

 

 

109,175

 

Investing activities:

 

 

 

 

 

 

 

Additions to real estate assets and deferred leasing costs

 

 

(212,148

)

 

(133,539

)

Proceeds from disposition of real estate assets

 

 

109,639

 

 

186,894

 

Proceeds from property insurance settlement

 

 

4,940

 

 

-

 

Distributions of capital from unconsolidated affiliates

 

 

14,998

 

 

11,204

 

Net repayments in notes receivable

 

 

2,714

 

 

1,107

 

Contributions to unconsolidated affiliates

 

 

(4,716

)

 

(100

)

Cash assumed upon consolidation of unconsolidated affiliate

 

 

-

 

 

645

 

Changes in restricted cash and other investing activities

 

 

(13,345

)

 

12,478

 

Net cash (used in)/provided by investing activities

 

 

(97,918

)

 

78,689

 

Financing activities:

 

 

 

 

 

 

 

Distributions paid on Common Stock and Common Units

 

 

(77,717

)

 

(75,916

)

Redemption/repurchase of Preferred Stock

 

 

(62,256

)

 

(50,000

)

Dividends paid on Preferred Stock

 

 

(10,639

)

 

(12,950

)

Distributions to minority partner in consolidated affiliate

 

 

(1,893

)

 

(420

)

Net proceeds from the sale of Common Stock

 

 

6,716

 

 

28,203

 

Repurchase of Common Units

 

 

(27,402

)

 

(15,369

)

Borrowings on revolving credit facility

 

 

318,800

 

 

498,500

 

Repayments of revolving credit facility

 

 

(509,000

)

 

(392,500

)

Borrowings on mortgages and notes payable

 

 

413,491

 

 

-

 

Repayments of mortgages and notes payable

 

 

(87,012

)

 

(157,247

)

Payments on financing obligations

 

 

(913

)

 

-

 

Contributions from minority interest partner

 

 

5,111

 

 

-

 

Additions to deferred financing costs

 

 

(3,399

)

 

(3,853

)

Net cash used in financing activities

 

 

(36,113

)

 

(181,552

)

Net (decrease)/increase in cash and cash equivalents

 

$

(13,222)

 

$

6,312

 

Cash and cash equivalents at beginning of the period

 

 

16,690

 

 

1,212

 

Cash and cash equivalents at end of the period

 

$

3,468

 

$

7,524

 

 

See accompanying notes to consolidated financial statements.

 

6

 

 

HIGHWOODS PROPERTIES, INC.

Consolidated Statements of Cash Flows - Continued

(Unaudited and in thousands)

 

Supplemental disclosure of cash flow information:

 

 

 

Nine Months Ended
September 30,

 

 

 

2007

 

2006

 

Cash paid for interest, net of amounts capitalized (excludes cash distributions to
owners of sold properties accounted for as financings of $1,676 and $1,283 for
2007 and 2006, respectively)

 

$

69,220

 

$

69,810

 

 

Supplemental disclosure of non-cash investing and financing activities:

 

The following table summarizes the net asset acquisitions and dispositions subject to mortgage notes payable and other non-cash transactions. There were no non-cash investing and financing activities during the nine months ended September 30, 2007.

 

 

 

Nine Months Ended
September 30,

 

 

 

2007

 

2006

 

Assets:

 

 

 

 

 

 

 

Net real estate assets

 

$

-

 

$

44,512

 

Restricted cash

 

 

-

 

 

(1,865

)

Accounts receivable

 

 

-

 

 

102

 

Accrued straight-line rents receivable

 

 

-

 

 

962

 

Investments in unconsolidated affiliates

 

 

-

 

 

(1,938

)

Deferred financing and leasing costs, net

 

 

-

 

 

287

 

 

 

$

-

 

$

42,060

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

Mortgages and notes payable

 

$

-

 

$

40,736

 

Accounts payable, accrued expenses and other liabilities

 

 

-

 

 

(1,652

)

Financing obligation

 

 

-

 

 

1,048

 

 

 

$

-

 

$

40,132

 

 

 

 

 

 

 

 

 

Minority Interest and Stockholders’ Equity

 

$

-

 

$

1,928

 

 

See accompanying notes to consolidated financial statements.

 

 

7

 

 

HIGHWOODS PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2007

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

(Unaudited)

 

1.

DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES

 

Description of Business

 

Highwoods Properties, Inc., together with its consolidated subsidiaries (the "Company"), is a fully-integrated, self-administered and self-managed equity real estate investment trust ("REIT") that operates in the southeastern and midwestern United States. The Company conducts virtually all of its activities through Highwoods Realty Limited Partnership (the “Operating Partnership”). At September 30, 2007, the Company and/or the Operating Partnership wholly owned: 312 in-service office, industrial and retail properties; 109 rental residential units; 648 acres of undeveloped land suitable for future development, of which 523 acres are considered core holdings; and an additional 20 properties under development.

 

At September 30, 2007, the Company owned all of the preferred partnership interests (“Preferred Units”) and 93.3% of the common partnership interests ("Common Units") in the Operating Partnership. Limited partners (including certain officers and directors of the Company) own the remaining Common Units. Generally, the Operating Partnership is required to redeem each Common Unit at the request of the holder thereof for cash equal to the value of one share of the Company’s Common Stock, $.01 par value (the “Common Stock”), based on the average of the market price for the 10 trading days immediately preceding the notice date of such redemption, provided that the Company at its option may elect to acquire any such Common Units presented for redemption for cash or one share of Common Stock. The Common Units owned by the Company are not redeemable. During the nine months ended September 30, 2007, the Company redeemed 618,257 Common Units for $27.4 million in cash and redeemed 55,836 Common Units for a like number of shares of Common Stock, which increased the percentage of Common Units owned by the Company from 92.2% at December 31, 2006 to 93.3% at September 30, 2007. Preferred Units in the Operating Partnership were issued to the Company in connection with the Company’s Preferred Stock offerings in 1997 and 1998 (the “Preferred Stock”). The net proceeds raised from each of the Preferred Stock issuances were contributed by the Company to the Operating Partnership in exchange for the Preferred Units. The terms of each series of Preferred Units parallel the terms of the respective Preferred Stock as to dividends, liquidation and redemption rights.

 

Basis of Presentation

 

Our Consolidated Financial Statements are prepared in accordance with U.S. Generally Accepted Accounting Principles (“GAAP”). Certain amounts in the December 31, 2006 Consolidated Balance Sheet have been reclassified to conform to the current presentation. As more fully described in Note 9, as required by Statement of Financial Accounting Standard No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” (“SFAS No. 144”), the Consolidated Balance Sheet at December 31, 2006 was revised from previously reported amounts to reflect in real estate and other assets held for sale those properties held for sale at September 30, 2007. The Consolidated Statements of Income for the three and nine months ended September 30, 2006 were also revised from previously reported amounts to reflect in discontinued operations the operations of any property sold in the first nine months of 2007.

 

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

 

8

 

HIGHWOODS PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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

 

 

 

1.

DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES - Continued

 

The accompanying unaudited financial information, in the opinion of management, contains all adjustments (including normal recurring accruals) necessary for a fair presentation of our financial position, results of operations and cash flows. We have condensed or omitted certain notes and other information from the interim financial statements presented in this Quarterly Report on Form 10-Q. These financial statements should be read in conjunction with our 2006 Annual Report on Form 10-K.

 

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

 

Restricted Cash

 

Restricted cash represents cash deposits that are legally restricted or held by third parties on our behalf. They include security deposits from sales contracts on residential condominiums, construction-related escrows, property disposition proceeds set aside and designated or intended to fund future tax-deferred exchanges of qualifying real estate investments, escrows and reserves for debt service, real estate taxes and property insurance established pursuant to certain mortgage financing arrangements, and deposits given to lenders to un-encumber secured properties. See Note 14 for further information regarding adjustments impacting cash and restricted cash and investing cash flows as of and for the three and six month periods ended March 31 and June 30, 2007, respectively.

 

Income Taxes

 

The Company has elected and expects to continue to qualify as a REIT under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the “Code”). A corporate REIT is a legal entity that holds real estate assets and, through the payment of dividends to stockholders, is generally permitted to reduce or avoid the payment of federal and state income taxes at the corporate level. To maintain qualification as a REIT, the Company is required to distribute to its stockholders at least 90.0% of its annual REIT taxable income, excluding capital gains. Aggregate dividends paid on Preferred Stock exceeded REIT taxable income (excluding capital gains) in 2006, which resulted in no required dividend on Common Stock in 2006 for REIT qualification purposes. 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. We conduct certain business activities through a taxable REIT subsidiary, as permitted under the Code. The taxable REIT subsidiary is subject to federal and state income taxes on its net taxable income. We record provisions for income taxes, to the extent required under SFAS No. 109, “Accounting for Income Taxes” (“SFAS No. 109”), based on its income recognized for financial statement purposes, including the effects of temporary differences between such income and the amount recognized for tax purposes. Additionally, beginning January 1, 2007, we began to recognize and measure the effects of uncertain tax positions under FASB Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes, an interpretation of SFAS No. 109.” See Impact of Newly Adopted and Issued Accounting Standards below and Note 12 for discussion of the effect of FIN 48 on our accounting for income taxes.

 

9

 

HIGHWOODS PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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

 

 

 

1.

DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES - Continued

 

Minority Interest

 

Minority interest in the accompanying Consolidated Financial Statements relates primarily to the ownership by various individuals and entities other than the Company of Common Units in the Operating Partnership. In addition, minority interest is also recorded for the 50.0% interest in a consolidated affiliate, Highwoods-Markel Associates, LLC (“Markel”), the equity interest owned by a third party in a consolidated venture formed during 2006 with Real Estate Exchange Services (“REES”), and the 7% equity interest owned by a third party in Plaza Residential, LLC, a consolidated joint venture formed in February 2007 related to a residential condominium project, as described below. As of September 30, 2007, minority interest in the Operating Partnership consisted of approximately 4.1 million Common Units, which had an aggregate market value of $148.8 million based on the $36.67 per share closing price of the Common Stock as of such date. Minority interest in the net income of the Operating Partnership is computed by applying the weighted average percentage of Common Units not owned by the Company during the period (as a percent of the total number of outstanding Common Units) to the Operating Partnership’s net income after deducting distributions on Preferred Units. The result is the amount of minority interest expense (or income) recorded for the period. In addition, when a minority unitholder redeems a Common Unit for a share of Common Stock or cash, the minority interest is reduced and the Company’s share in the Operating Partnership is increased. At the end of each reporting period, the Company determines the amount that represents the minority unitholders’ share of the net assets (at book value) of the Operating Partnership and compares this amount to the minority interest balance that resulted from transactions during the period involving minority interest. The Company adjusts the minority interest liability to the computed share of net assets with an offsetting adjustment to the Company’s paid in capital.

 

The organizational documents of Markel require the entity to be liquidated through the sale of its assets upon reaching December 31, 2100. As controlling partner, we have an obligation to cause this property-owning entity to distribute proceeds of liquidation to the minority interest partner in these partially owned properties only if the net proceeds received by the entity from the sale of our assets warrant a distribution as determined by the agreement. In accordance with the disclosure provisions of SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (“SFAS No. 150”), we estimate the value of minority interest distributions would have been approximately $16.3 million had the entity been liquidated as of September 30, 2007. This estimated settlement value is based on estimated third party consideration realizable by the entity upon a hypothetical disposition of the properties and is net of all other assets and liabilities. The actual amount of any distributions to the minority interest holder in this entity is difficult to predict due to many factors, including the inherent uncertainty of real estate sales. If the entity’s underlying assets are worth less than the underlying liabilities on the date of such liquidation, we would have no obligation to remit any consideration to the minority interest holder.

 

In the first quarter of 2007, our taxable REIT subsidiary formed Plaza Residential, LLC with Dominion Partners, LLC (“Dominion”). Plaza Residential was formed to develop and sell 139 residential condominiums to be constructed above an office tower being developed by us in Raleigh, NC. Dominion has a 7% equity interest in the joint venture, will perform development services for the joint venture for a market development fee and guarantees 40.0% of the construction financing. Dominion will also receive 35.0% of the net profits from the joint venture once the partners have received distributions equal to their equity plus a 12.0% return on their equity. We are consolidating this majority owned joint venture and intercompany transactions have been eliminated in the Consolidated Financial Statements. At September 30, 2007, binding sale contracts had been executed for all of the residential condominiums. $3.5 million of deposits related to these contracts (non-refundable unless we default in our obligation to deliver the units) had been received and are reflected in restricted cash with a corresponding amount in other liabilities. We will account for the sale of the residential condominiums in accordance with SFAS No. 66, “Accounting for Sales of Real Estate” (“SFAS No. 66”) and will record the sales when the related closings take place, which are expected to occur in late 2008 and early 2009.

 

10

 

HIGHWOODS PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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

 

 

 

1.

DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES - Continued

 

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

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Amount shown as minority interest in continuing operations (1)

 

$

(307

)

$

(445

)

$

(3,324

)

$

(1,276

)

Amount related to income from discontinued operations

 

 

(15

)

 

123

 

 

(75

)

 

(145

)

Amount related to gains on sales of discontinued operations

 

 

(442

)

 

(243

)

 

(1,930

)

 

(407

)

Total minority interest in net income

 

$

(764

)

$

(565

)

$

(5,329

)

$

(1,828

)

______________

(1)

Minority interest related to the consolidated entities other than the Operating Partnership amounted to $0.2 million and $0.1 million for the three months ended September 30, 2007 and 2006 and $0.5 million and $0.4 million for the nine months ended September 30, 2007 and 2006.

 

 

 

September 30,
2007

 

December 31,
2006

 

Minority interest in the Operating Partnership

 

$

64,102

 

$

76,848

 

Minority interest in Markel

 

 

3,459

 

 

2,118

 

Minority interest in REES

 

 

2,899

 

 

760

 

Minority interest in Plaza Residential

 

 

256

 

 

-

 

Total minority interest

 

$

70,716

 

$

79,726

 

 

Impact of Newly Adopted and Issued Accounting Standards

 

In June 2006, the FASB issued FIN 48, which we adopted as of January 1, 2007. See Note 12 for further discussion.

 

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a framework for measuring fair value and expands disclosures concerning fair value measurements. SFAS No. 157 becomes effective for us on January 1, 2008. We are currently evaluating the impact SFAS No. 157 will have on our financial condition and results of operations.

 

In November 2006, the FASB ratified EITF Issue No. 06-8, “Applicability of the Assessment of a Buyer’s Continuing Investment under FASB Statement No. 66 for Sales of Condominiums.” EITF No. 06-8 provided additional guidance on whether the seller of a condominium unit is required to evaluate the buyer’s continuing investment under SFAS No. 66 in order to recognize profit from the sale under the percentage of completion method. The EITF concluded that both the buyer’s initial and continuing investment must meet the criteria in SFAS No. 66 in order for condominium sale profits to be recognized under the percentage of completion method. Sales of condominiums not meeting the continuing investment test must be accounted for under the deposit method. EITF No. 06-8 is effective January 1, 2008. We do not expect that the adoption of EITF No. 06-8 will have a material impact on our financial position or results of operations.

 

 

11

 

HIGHWOODS PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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

 

 

 

1.

DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES - Continued

 

In December 2006, the FASB issued FSP EITF 00-19-2, “Accounting for Registration Payment Arrangements,” to specify that the contingent obligation to make future payments or otherwise transfer consideration under a registration payment arrangement should be separately recognized and measured in accordance with FASB Statement No. 5, “Accounting for Contingencies.” The FSP is effective immediately for registration payment arrangements and the financial instruments subject to those arrangements that are entered into or modified subsequent to the issuance date of this FSP and effective for fiscal years beginning after December 15, 2006 and interim periods within those fiscal years for arrangements that were entered into prior to the issuance of this FSP. Our adoption of this FSP as of January 1, 2007 had no impact on our financial condition or results of operations.

 

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS No. 159”), which permits all entities to choose to measure eligible items at fair value at specified election dates. SFAS No. 159 becomes effective for us on January 1, 2008. We are currently evaluating the impact SFAS No. 159 will have on our financial condition and results of operations.

 

2.

INVESTMENTS IN UNCONSOLIDATED AND OTHER AFFILIATES

 

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

 

During the third quarter of 2006, three of our joint ventures made distributions aggregating $17.0 million as a result of a refinancing of debt related to various properties held by the joint ventures. We received 50.0% of such distributions. As a result of these distributions, our investment account in these joint ventures became negative. The new debt is non-recourse; however, we and our partner have guaranteed other debt and have contractual obligations to support the joint ventures, which are included in the Guarantees and Other Obligations table in Note 11. Therefore, in accordance with SOP 78-9, “Accounting for Investments in Real Estate Ventures,” we recorded the distributions as a reduction of the investment account and included the resulting negative investment balances of $7.2 million in accounts payable, accrued expenses and other liabilities in the Consolidated Balance Sheet at September 30, 2007.

 

12

 

HIGHWOODS PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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

 

 

 

2.

INVESTMENTS IN UNCONSOLIDATED AND OTHER AFFILIATES - Continued

 

A number of our joint ventures are consolidated. SF-HIW Harborview Plaza, LP is accounted for as a financing arrangement pursuant to SFAS No. 66, as described in Note 3 to the Consolidated Financial Statements in our 2006 Annual Report on Form 10-K; The Vinings at University Center, LLC was consolidated pursuant to FIN 46(R) until late 2006 upon the sale of the venture’s assets and distribution of our net cash assets to our partners; and Markel, REES and Plaza Residential, which are discussed in Note 1, are each consolidated.

 

Investments in unconsolidated affiliates as of September 30, 2007 and combined summarized income statements for our unconsolidated joint ventures for the three and nine months ended September 30, 2007 and 2006 were as follows:

 

Joint Venture

 

Location of Properties

 

Total Rentable
Square Feet
(000)

 

Ownership
Interest

 

Board of Trade Investment Company

 

Kansas City, MO

 

166

 

49.00

%

 

Dallas County Partners I, LP

 

Des Moines, IA

 

641

 

50.00

%

 

Dallas County Partners II, LP

 

Des Moines, IA

 

273

 

50.00

%

 

Dallas County Partners III, LP

 

Des Moines, IA

 

7

 

50.00

%

 

Fountain Three

 

Des Moines, IA

 

785

 

50.00

%

 

RRHWoods, LLC

 

Des Moines, IA

 

800

(1)

50.00

%

 

Kessinger/Hunter, LLC

 

Kansas City, MO

 

(2)

26.50

%

 

4600 Madison Associates, LLC

 

Kansas City, MO

 

262

 

12.50

%

 

Plaza Colonnade, LLC

 

Kansas City, MO

 

290

 

50.00

%

 

Highwoods DLF 98/29, LP

 

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

 

1,089

 

22.81

%

 

Highwoods DLF 97/26 DLF 99/32, LP

 

Atlanta, GA; Greensboro, NC; Orlando, FL

 

822

 

42.93

%

 

Highwoods KC Glenridge Office, LP

 

Atlanta, GA

 

185

 

40.00

%

 

Highwoods KC Glenridge Land, LP

 

Atlanta, GA

 

 

40.00

%

 

HIW-KC Orlando, LLC

 

Orlando, FL

 

1,274

 

40.00

%

 

Concourse Center Associates, LLC

 

Greensboro, NC

 

118

 

50.00

%

 

Total

 

 

 

6,712

(3)

 

 

 

______________

(1)

Includes a 31,000 square foot office building currently under development and 418 rental residential units.

(2)

This joint venture provides property management, leasing and brokerage services and provides certain construction-related services to certain Wholly Owned Properties; therefore, no rentable square feet is provided.

(3)

Total does not include in-service operating properties held by consolidated joint ventures totaling 618,000 square feet.

 

 

13

 

HIGHWOODS PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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

 

 

 

2.

INVESTMENTS IN UNCONSOLIDATED AND OTHER AFFILIATES - Continued

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Income Statements:

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

34,350

 

$

35,960

 

$

107,507

 

$

103,762

 

Expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating expenses

 

 

15,844

 

 

15,920

 

 

46,000

 

 

44,591

 

Depreciation and amortization

 

 

8,196

 

 

7,338

 

 

22,977

 

 

21,328

 

Interest expense and loan cost amortization

 

 

8,675

 

 

8,369

 

 

25,665

 

 

25,094

 

Loss on debt extinguishment

 

 

-

 

 

1,448

 

 

-

 

 

1,448

 

Total expenses

 

 

32,715

 

 

33,075

 

 

94,642

 

 

92,461

 

Income before disposition of property

 

 

1,635

 

 

2,885

 

 

12,865

 

 

11,301

 

Gains on disposition of property

 

 

-

 

 

-

 

 

20,621

 

 

-

 

Net income

 

$

1,635

 

$

2,885

 

$

33,486

 

$

11,301

 

Our share of:

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income (1)

 

$

1,207

 

$

1,342

 

$

12,930

 

$

5,349

 

Depreciation and amortization (real estate related)

 

$

3,107

 

$

2,790

 

$

8,851

 

$

8,143

 

Interest expense and loan cost amortization

 

$

3,617

 

$

3,507

 

$

10,836

 

$

10,509

 

Loss on debt extinguishment

 

$

-

 

$

724

 

$

-

 

$

724

 

Gains on disposition of property

 

$

-

 

$

-

 

$

7,158

 

$

-

 

______________

(1)

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

 

On September 27, 2004, we and an affiliate of Crosland, Inc. (“Crosland”) formed Weston Lakeside, LLC, in which we had a 50.0% ownership interest. On June 29, 2005, we contributed 22.4 acres of land at an agreed upon value of $3.9 million to this joint venture, and Crosland contributed approximately $2.0 million in cash. Immediately thereafter, the joint venture distributed approximately $1.9 million to us and we recorded a gain of $0.5 million. Crosland managed and operated this joint venture, which constructed 332 rental residential units in three buildings at a total cost of approximately $33.7 million. Crosland received 3.25% of all project costs other than land as a development fee and 3.5% of the gross revenue of the joint venture in management fees. The joint venture financed the development with a $28.4 million construction loan guaranteed by Crosland. We provided certain development services for the project and received a fee equal to 1.0% of all project costs excluding land. We accounted for this joint venture using the equity method of accounting. On February 22, 2007, the joint venture sold the 332 rental residential units to a third party for gross proceeds of $45.0 million. Mortgage debt in the amount of $27.1 million was paid off and various development related costs were paid. The joint venture recorded a gain of $11.3 million in the first quarter of 2007 related to this sale and we recorded $5.0 million as our proportionate share through equity in earnings of unconsolidated affiliates. Our share of the gain was less than 50.0% due to Crosland’s preferred return as the developer. We received aggregate net distributions of $6.2 million. Weston Lakeside, LLC has been dissolved.

 

14

 

HIGHWOODS PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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

 

 

 

2.

INVESTMENTS IN UNCONSOLIDATED AND OTHER AFFILIATES - Continued

 

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

 

For additional information regarding our other investments in unconsolidated and other affiliates, see Note 2 to the Consolidated Financial Statements in our 2006 Annual Report on Form 10-K.

 

3.

FINANCING ARRANGEMENTS

 

For information regarding sale transactions that have been accounted for as financing arrangements under paragraphs 25 through 29 of SFAS No. 66, see Note 5 herein and Note 3 to the Consolidated Financial Statements in our 2006 Annual Report on Form 10-K.

 

4.

INVESTMENT ACTIVITIES

 

Dispositions

 

Gains, losses and impairments on disposition of properties, net, from dispositions not classified as discontinued operations, consisted of the following:

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Gains on disposition of land

 

$

225

 

$

2,103

 

$

17,029

 

$

5,143

 

Impairments on land

 

 

-

 

 

-

 

 

-

 

 

(74

)

Gains on disposition of depreciable properties

 

 

1,063

 

 

874

 

 

3,343

 

 

3,226

 

Total

 

$

1,288

 

$

2,977

 

$

20,372

 

$

8,295

 

 

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

 

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

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Gains on disposition of depreciable properties

 

$

7,001

 

$

2,838

 

$

26,847

 

$

5,045

 

Impairments on disposition of depreciable properties

 

 

(384

)

 

-

 

 

(384

)

 

-

 

Allocable minority interest

 

 

(442

)

 

(243

)

 

(1,930

)

 

(407

)

Total

 

$

6,175

 

$

2,595

 

$

24,533

 

$

4,638

 

 

See Note 9 for information on discontinued operations and impairment of long-lived assets.

 

15

 

HIGHWOODS PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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

 

 

 

4.

INVESTMENT ACTIVITIES - Continued

 

Development

 

We currently have under development 20 office, industrial and retail properties aggregating 2.9 million square feet and 139 for-sale residential units. The aggregate cost of these properties is currently expected to total approximately $497 million when fully leased and completed, of which $292 million was incurred as of September 30, 2007. The weighted average pre-leasing of such development projects was 75.0% at September 30, 2007. Nine of these properties aggregating 1.5 million square feet and $170 million total investment have been completed and transferred to completed real estate assets at various times prior to September 30, 2007, but had not yet reached projected 95% stabilized occupancy. The remaining development properties are still under construction and are included in Development in Process in the Consolidated Balance Sheet.

 

In addition to the development projects discussed above, during the nine months ended September 30, 2007, two 100% leased build-to-suit properties were completed and placed in service. The total investment of these two properties aggregated approximately $30 million.

 

5.

MORTGAGES, NOTES PAYABLE AND FINANCING OBLIGATIONS

 

Our consolidated mortgages and notes payable consisted of the following at September 30, 2007 and December 31, 2006:

 

 

 

September 30,
2007

 

December 31,
2006

 

Secured mortgage loans

 

$

669,328

 

$

741,629

 

Unsecured loans

 

 

932,146

 

 

723,500

 

Total

 

$

1,601,474

 

$

1,465,129

 

 

As of September 30, 2007, our outstanding mortgages and notes payable were secured by real estate assets with an aggregate undepreciated book value of approximately $1.0 billion.

 

Our $450.0 million unsecured revolving credit facility is initially scheduled to mature on May 1, 2009. Assuming no default exists, we have an option to extend the maturity date by one additional year and, at any time prior to May 1, 2008, may request increases in the borrowing availability under the credit facility by up to an additional $50 million. The interest rate is LIBOR plus 80 basis points and the annual base facility fee is 20 basis points. The revolving credit facility had $256.4 million of availability as of November 1, 2007.

 

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

 

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

 

16

 

HIGHWOODS PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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

 

 

 

5.

MORTGAGES, NOTES PAYABLE AND FINANCING OBLIGATIONS - Continued

 

On June 5, 2007, two three-year secured construction loans totaling $24.7 million with interest at 175 basis points over LIBOR were obtained by REES, a consolidated joint venture (see Note 1). Subsequently, on July 17, 2007, REES obtained an additional $13.7 million, three-year secured construction loan with interest at 165 basis points over LIBOR. At September 30, 2007, $11.9 million had been borrowed under these three loans and is included in mortgages and notes payable.

 

Financing Obligations

 

Our financing obligations consisted of the following at September 30, 2007 and December 31, 2006:

 

 

 

September 30,
2007

 

December 31,
2006

 

SF-HIW Harborview, LP financing obligation (1)

 

$

16,430

 

$

16,157

 

Tax increment financing obligation (2)

 

 

17,395

 

 

18,308

 

Capitalized ground lease obligation (3)

 

 

1,094

 

 

1,065

 

Total

 

$

34,919

 

$

35,530

 

______________

(1)

See Note 3 to the Consolidated Financial Statements in our 2006 Annual Report on Form 10-K for further discussion of this financing obligation.

(2)

In connection with tax increment financing for construction of a public garage related to an office building constructed by us in 2000, we are obligated to pay fixed special assessments over a 20-year period. The net present value of these assessments, discounted at 6.93% at the inception of the obligation, which represents the interest rate on the underlying bond financing, is shown as a financing obligation in the Consolidated Balance Sheet. We also receive special tax revenues and property tax rebates recorded in interest and other income, which are intended, but not guaranteed, to provide funds to pay the special assessments.

(3)

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

 

 

17

 

HIGHWOODS PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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

 

 

 

6.

EMPLOYEE BENEFIT PLANS

 

Compensation Programs

 

During the nine months ended September 30, 2007 and 2006, we recognized approximately $3.9 million and $2.9 million, respectively, of stock-based compensation expense. As of September 30, 2007, there was $12.1 million of total unrecognized stock-based compensation costs, which will be recognized over a weighted average remaining contractual term of 2.1 years.

 

For additional information regarding our compensation programs, see Note 6 to the Consolidated Financial Statements in our 2006 Annual Report on Form 10-K.

 

Deferred Compensation

 

We have a deferred compensation plan pursuant to which each executive officer and director can elect to defer a portion of their base salary and/or annual non-equity incentive payment (or director fees) for investment in various unrelated mutual funds, which aggregated $6.9 million at September 30, 2007 and are included in prepaid expenses and other assets. Such deferred compensation is expensed in the period earned by the officers and directors. Deferred amounts ultimately payable to the officers and directors are based on the value of the related mutual fund investments (recorded in prepaid expenses and other assets). Accordingly, changes in the value of the marketable mutual fund investments are recorded in other income and the corresponding offsetting changes in the deferred compensation liability are recorded in general and administration expense. As a result, there is no effect on our net income subsequent to the time the compensation is deferred and fully funded. Prior to January 1, 2006, executive officers and directors also could elect to defer cash compensation for investment in units of phantom stock, which are not recorded as assets in our financial statements. At the end of each calendar quarter, any executive officer and director who deferred compensation into phantom stock was credited with units of phantom stock at a 15.0% discount. Dividends on the phantom units are assumed to be issued in additional units of phantom stock at a 15.0% discount. If an officer that deferred compensation under this plan leaves our employ voluntarily or for cause within two years after the end of the year in which such officer deferred compensation for units of phantom stock, at a minimum, the 15.0% discount and any deemed dividends are forfeited. Over the two-year vesting period, we record additional compensation expense equal to the 15.0% discount, the accrued dividends and any changes in the market value of Common Stock from the date of the deferral. For the nine months ended September 30, 2007, the effect of the reduction in the trading value of Common Stock as reflected on the NYSE offset the expense related to the discount and accrued dividends, resulting in no net expense for us. These expenses aggregated $1.2 million for the nine months ended September 30, 2006. Cash payments from the plan for the nine months ended September 30, 2007 and 2006 were $0.3 million and $0.4 million, respectively. Transfers made from the phantom stock investment to other investments in the deferred compensation plan for the nine months ended September 30, 2007 were $1.5 million. At September 30, 2007, the total liability for deferred compensation aggregated $8.9 million and is recorded in accounts payable, accrued expenses and other liabilities.

 

401(k) Savings Plan

 

We have a 401(k) savings plan covering substantially all employees who meet certain age and employment criteria. We contribute amounts for each participant at a rate of 75% of the employee’s contribution (up to 6% of each employee’s salary). During the nine months ended September 30, 2007 and 2006, we contributed $1.0 million and $0.9 million, respectively, to the 401(k) savings plan. Administrative expenses of the plan are paid by us.

 

18

 

HIGHWOODS PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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

 

 

 

6.

EMPLOYEE BENEFIT PLANS - Continued

 

Employee Stock Purchase Plan

 

We have an Employee Stock Purchase Plan for all active employees under which employees can elect to contribute up to 25.0% of their base and annual non-equity incentive compensation for the purchase of Common Stock. At the end of each three-month offering period, the contributions in each participant's account balance, which includes accrued dividends, are 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. The Operating Partnership issues one Common Unit to us in exchange for the price paid for each share of Common Stock. In the nine months ended September 30, 2007, we issued 15,711 shares of Common Stock under the Employee Stock Purchase Plan. The discount on newly issued shares is expensed by us as additional compensation and aggregated $0.09 million in the nine months ended September 30, 2007.

 

7.

DERIVATIVE FINANCIAL INSTRUMENTS

 

Accumulated Other Comprehensive Loss (“AOCL”) at September 30, 2007 and December 31, 2006 was $1.1 million and $1.5 million, respectively, and consisted of deferred gains and losses from past cash flow hedging instruments which are being recognized as interest expense over the terms of the related debt (see Note 8). We expect that the portion of the cumulative loss recorded in AOCL at September 30, 2007 associated with these derivative instruments, which will be recognized as interest expense within the next 12 months, will be approximately $0.3 million.

 

8.

OTHER COMPREHENSIVE INCOME

 

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

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Net income

 

$

13,440

 

$

8,909

 

$

75,287

 

$

29,328

 

Other comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

Amortization of hedging gains and losses included in other comprehensive income

 

 

146

 

 

177

 

 

431

 

 

531

 

Total other comprehensive income

 

 

146

 

 

177

 

 

431

 

 

531

 

Total comprehensive income

 

$

13,586

 

$

9,086

 

$

75,718

 

$

29,859

 

 

 

19

 

HIGHWOODS PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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

 

 

 

9.

DISCONTINUED OPERATIONS AND THE IMPAIRMENT OF LONG-LIVED ASSETS

 

As part of our business strategy, we from time to time selectively dispose of non-core properties in order to use the net proceeds for investments, for repayment of debt and/or retirement of Preferred Stock, or other purposes. The table below sets forth the net operating results of those assets classified as discontinued operations in our Consolidated Financial Statements. These assets classified as discontinued operations comprise 3.8 million square feet of office and industrial properties and 173 rental residential units sold during 2006 and the nine months ended September 30, 2007. These long-lived assets relate to disposal activities that were initiated subsequent to the effective date of SFAS No. 144, or that met certain stipulations prescribed by SFAS No. 144. The operations of these assets have been reclassified from our ongoing operations to discontinued operations, and we will not have any significant continuing involvement in the operations after the disposal transactions:

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Rental and other revenues

 

$

699

 

$

4,454

 

$

2,951

 

$

13,307

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

Rental property and other expenses

 

 

334

 

 

1,838

 

 

1,225

 

 

5,031

 

Depreciation and amortization

 

 

147

 

 

1,109

 

 

682

 

 

3,655

 

Impairment of assets held for use

 

 

-

 

 

2,600

 

 

-

 

 

2,600

 

General and administrative

 

 

-

 

 

75

 

 

-

 

 

75

 

Total operating expenses

 

 

481

 

 

5,622

 

 

1,907

 

 

11,361

 

Interest expense

 

 

-

 

 

277

 

 

-

 

 

482

 

Other income

 

 

2

 

 

18

 

 

12

 

 

67

 

Income/(loss) before minority interest in the Operating Partnership and
gains on sales of discontinued operations

 

 

220

 

 

(1,427

)

 

1,056

 

 

1,531

 

Minority interest in discontinued operations

 

 

(15

)

 

123

 

 

(75

)

 

(145

)

Income/(loss) from discontinued operations, net of minority interest in
the Operating Partnership

 

 

205

 

 

(1,304

)

 

981

 

 

1,386

 

Net gains on sales of discontinued operations

 

 

6,617

 

 

2,838

 

 

26,463

 

 

5,045

 

Minority interest in discontinued operations

 

 

(442

)

 

(243

)

 

(1,930

)

 

(407

)

Net gains on sales of discontinued operations, net of minority interest in
the Operating Partnership

 

 

6,175

 

 

2,595

 

 

24,533

 

 

4,638

 

Net income from discontinued operations before release of FASB FIN 48
tax liability

 

 

6,380

 

 

1,291

 

 

25,514

 

 

6,024

 

Release of FASB FIN 48 tax liability

 

 

1,473

 

 

-

 

 

1,473

 

 

-

 

Total discontinued operations

 

$

7,853

 

$

1,291

 

$

26,987

 

$

6,024

 

 

The net book value of properties classified as discontinued operations that were sold during 2006 and the nine months ended September 30, 2007 aggregate $255.5 million.

 

SFAS No. 144 also requires that a long-lived asset classified as held for sale be measured at the lower of the carrying value or fair value less cost to sell. During the nine months ended September 30, 2007, we recorded an impairment loss of $0.4 million related to one property sold. During the nine months ended September 30, 2006, there were no properties held for sale which had a carrying value that was greater than fair value less cost to sell; therefore, no impairment loss was recognized in the Consolidated Statements of Income for the nine months ended September 30, 2006.

 

20

 

HIGHWOODS PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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

 

 

 

9.

DISCONTINUED OPERATIONS AND THE IMPAIRMENT OF LONG-LIVED ASSETS - Continued

 

SFAS No. 144 also requires that if indicators of impairment exist, the carrying value of a long-lived asset classified as held for use be compared to the sum of its estimated undiscounted future cash flows. If the carrying value is greater than the sum of its undiscounted future cash flows, an impairment loss should be recognized for the excess of the carrying amount of the asset over its estimated fair value. For the nine months ended September 30, 2007 and 2006, a land parcel and a property, respectively, had indicators of impairment where the carrying value exceeded the sum of estimated undiscounted future cash flows. Therefore, impairment losses of $0.8 million and $2.6 million were recorded in the nine months ended September 30, 2007 and 2006, respectively.

 

The following table includes the major classes of assets and liabilities of the properties classified as held for sale as of September 30, 2007 and December 31, 2006:

 

 

 

September 30,
2007

 

December 31,
2006

 

Land

 

$

-

 

$

3,462

 

Land held for development

 

 

3,153

 

 

15,454

 

Buildings and tenant improvements

 

 

-

 

 

21,949

 

Accumulated depreciation

 

 

-

 

 

(6,829

)

Net real estate assets

 

 

3,153

 

 

34,036

 

Deferred leasing costs, net

 

 

-

 

 

435

 

Accrued straight line rents receivable

 

 

-

 

 

727

 

Prepaid expenses and other

 

 

47

 

 

248

 

Total assets

 

$

3,200

 

$

35,446

 

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

 

$

107

 

$

525

 

______________

(1)

Included in accounts payable, accrued expenses and other liabilities.

 

 

21

 

HIGHWOODS PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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

 

 

 

10.

EARNINGS PER SHARE

 

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

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Basic income per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

Numerator:

 

 

 

 

 

 

 

 

 

 

 

 

 

Income from continuing operations

 

$

5,587

 

$

7,618

 

$

48,300

 

$

23,304

 

Preferred Stock dividends

 

 

(2,680

)

 

(4,113

)

 

(10,639

)

 

(12,950

)

Excess of Preferred Stock redemption costs over carrying value

 

 

(842

)

 

-

 

 

(2,285

)

 

(1,803

)

Income from continuing operations available for common
stockholders

 

 

2,065

 

 

3,505

 

 

35,376

 

 

8,551

 

Income from discontinued operations

 

 

7,853

 

 

1,291

 

 

26,987

 

 

6,024

 

Net income available for common stockholders

 

$

9,918

 

$

4,796

 

$

62,363

 

$

14,575

 

Denominator:

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

 

56,628

 

 

54,470

 

 

56,376

 

 

54,069

 

Basic earnings per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

Income from continuing operations

 

$

0.04

 

$

0.07

 

$

0.63

 

$

0.16

 

Income from discontinued operations

 

 

0.14

 

 

0.02

 

 

0.48

 

 

0.11

 

Net income

 

$

0.18

 

$

0.09

 

$

1.11

 

$

0.27

 

Diluted income per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

Numerator:

 

 

 

 

 

 

 

 

 

 

 

 

 

Income from continuing operations

 

$

5,587

 

$

7,618

 

$

48,300

 

$

23,304

 

Preferred Stock dividends

 

 

(2,680

)

 

(4,113

)

 

(10,639

)

 

(12,950

)

Excess of Preferred Stock redemption costs over carrying value

 

 

(842

)

 

-

 

 

(2,285

)

 

(1,803

)

Minority interest in the Operating Partnership

 

 

137

 

 

328

 

 

2,806

 

 

830

 

Income from continuing operations available for common
stockholders

 

 

2,202

 

 

3,833

 

 

38,182

 

 

9,381

 

Income from discontinued operations

 

 

7,853

 

 

1,291

 

 

26,987

 

 

6,024

 

Minority interest in the Operating Partnership in discontinued
operations

 

 

457

 

 

120

 

 

2,005

 

 

552

 

Income from discontinued operations

 

 

8,310

 

 

1,411

 

 

28,992

 

 

6,576

 

Net income available for common stockholders

 

$

10,512

 

$

5,244

 

$

67,174

 

$

15,957

 

Denominator:

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

 

56,628

 

 

54,470

 

 

56,376

 

 

54,069

 

Add:

 

 

 

 

 

 

 

 

 

 

 

 

 

Employee and director stock options and warrants

 

 

494

 

 

1,592

 

 

744

 

 

1,335

 

Common Units

 

 

4,061

 

 

5,171

 

 

4,234

 

 

5,280

 

Unvested restricted stock

 

 

213

 

 

224

 

 

257

 

 

102

 

Denominator for diluted earnings per share – adjusted weighted
average shares and assumed conversions (2)

 

 

61,396

 

 

61,457

 

 

61,611

 

 

60,786

 

Diluted earnings per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

Income from continuing operations

 

$

0.04

 

$

0.07

 

$

0.62

 

$

0.15

 

Income from discontinued operations

 

 

0.13

 

 

0.02

 

 

0.47

 

 

0.11

 

Net income

 

$

0.17

 

$

0.09

 

$

1.09

 

$

0.26

 

______________

 

22

 

HIGHWOODS PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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

 

 

 

10.

EARNINGS PER SHARE - Continued

(1)

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

(2)

Options and warrants aggregating approximately 0.2 million shares were outstanding during the three months ended September 30, 2007, and 0.1 million and 0.08 million shares were outstanding during the nine months ended September 30, 2007 and 2006, respectively, but were not included in the computation of diluted earnings per share because the exercise prices of the options and warrants were higher than the average market price of Common Stock during these periods. The amount of shares reported for the three months ended September 30, 2006 that would have been anti-dilutive due to the option or warrant exercise price being less than the average stock price for the period was immaterial.

 

11.

COMMITMENTS AND CONTINGENCIES

 

Concentration of Credit Risk

 

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

 

Land Leases

 

Certain properties in our wholly owned portfolio are subject to land leases expiring through 2082. Rental payments on these leases are adjusted annually based on either the consumer price index (CPI) or on a pre-determined schedule. Land leases subject to increases under a pre-determined schedule are accounted for under the straight-line method. Total expense recorded for land leases was $1.0 million for each of the nine months ended September 30, 2007 and 2006.

 

For one property owned at September 30, 2007, we have the option to purchase the leased land in the third year of the lease term at a purchase price of $1.1 million, which increases 2% annually beginning in year three through the fifteenth year of the lease.

 

As of September 30, 2007, our payment obligations for future minimum payments on operating leases (which include scheduled fixed increases, but exclude increases based on CPI) were as follows:

 

Remainder of 2007

 

$

268

 

2008

 

 

1,077

 

2009

 

 

1,118

 

2010

 

 

1,135

 

2011

 

 

1,155

 

Thereafter

 

 

45,543

 

 

 

$

50,296

 

 

Environmental Matters

 

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

 

23

 

HIGHWOODS PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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

 

 

 

11.

COMMITMENTS AND CONTINGENCIES - Continued

 

Guarantees and Other Obligations

 

The following is a tabular presentation and related discussion of various guarantees and other obligations as of September 30, 2007:

 

Entity or Transaction

 

Type of
Guarantee or Other Obligation

 

Amount
Recorded/
Deferred

 

Date
Guarantee
Expires

 

Des Moines Joint Ventures (1),(5)

 

Debt

 

$

 

11/2015

 

RRHWoods, LLC (2),(6)

 

Indirect Debt (4)

 

$

403

 

8/2010

 

Plaza Colonnade (2),(7)

 

Indirect Debt (4)

 

$

37

 

12/2009

 

Eastshore (Capital One) (3),(8)

 

Rent (4)

 

$

745

 

11/2007

 

Industrial (3),(9)

 

Environmental costs (4)

 

$

125

 

Until Remediated

 

Highwoods DLF 97/26 DLF 99/32, LP (2),(10)

 

Rent (4)

 

$

419

 

6/2008

 

RRHWoods, LLC and Dallas County Partners (2),(11)

 

Indirect Debt (4)

 

$

49

 

6/2014

 

RRHWoods, LLC (2),(13)

 

Indirect Debt (4)

 

$

28

 

11/2009

 

HIW-KC Orlando, LLC (3),(12)

 

Rent (4)

 

$

347

 

4/2011

 

HIW-KC Orlando, LLC (3),(12)

 

Leasing Costs

 

$

296

 

Until Paid

 

Capitalized Lease Obligations (14)

 

Debt

 

$

368

 

Various

 

Brickstone (2),(15)

 

Debt

 

$

 

5/2017

 

______________

(1)

Represents guarantees entered into prior to the January 1, 2003 effective date of FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (“FIN 45”) for initial recognition and measurement.

(2)

Represents guarantees that fall under the initial recognition and measurement requirements of FIN 45.

(3)

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

(4)

The maximum potential amount of future payments disclosed for these guarantees assumes we pay the maximum possible liability under the guaranty with no offsets or reductions. With respect to the rent guarantee, if the space is leased, we assume the existing tenant defaults at September 30, 2007 and the space remains unleased through the remainder of the guaranty term. If the space is vacant, we assume the space remains vacant through the expiration of the guaranty. Since it is assumed that no new tenant will occupy the space, lease commissions, if applicable, are excluded.

(5)

We have guaranteed certain loans in connection with the Des Moines joint ventures. The maximum potential amount of future payments that we could be required to make under the guarantees is $8.6 million at September 30, 2007. This amount relates to housing revenue bonds that require credit enhancements in addition to the real estate mortgages. The bonds bear a floating interest rate, which at September 30, 2007 averaged 3.77%, and mature in 2015. If the joint ventures are unable to repay the outstanding balance under these housing revenue bonds, we will be required to repay our maximum exposure under these loans. Recourse provisions exist that enable us to recover some or all of such payments from the joint ventures’ assets. The joint venture currently generates sufficient cash flow to cover the debt service required by the loan.

 

24

 

HIGHWOODS PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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

 

 

 

11.

COMMITMENTS AND CONTINGENCIES - Continued

(6)

In connection with the RRHWoods, LLC joint venture, we guaranteed $3.1 million relating to a letter of credit and corresponding master lease, which expires in August 2010. The guarantee requires us to pay under a contingent master lease if the cash flows from the building securing the letter of credit do not cover at least 50% of the minimum debt service. The letter of credit along with the building secure the industrial revenue bonds used to finance the property. These bonds mature in 2015. Recourse provisions exist such that we could recover some or all of the payments made under the letter of credit guarantee from the joint venture’s assets. For the nine months ended September 30, 2007, we have made master lease payments of $0.1 million. At September 30, 2007, we recorded a $0.4 million deferred charge included in other assets and liabilities on our Consolidated Balance Sheet with respect to this guarantee. Our maximum potential exposure under this guarantee was $3.1 million at September 30, 2007.

(7)

The Plaza Colonnade, LLC joint venture has a $50 million non-recourse mortgage that bears a fixed interest rate of 5.7%, requires monthly principal and interest payments and matures on January 31, 2017. We and our joint venture partner have signed a contingent master lease limited to 30,772 square feet, which expires in December 2009. Our maximum exposure under this master lease was $1.0 million at September 30, 2007. However, the current occupancy level of the building is sufficient to cover all debt service requirements.

(8)

As more fully described in Note 3 to the Consolidated Financial Statements in our 2006 Annual Report on Form 10-K, in connection with the sale of three office buildings to a third party in 2002 (the “Eastshore” transaction), we agreed to guarantee rent shortfalls and re-tenanting costs for a five-year period from the date of sale (through November 2007). Our maximum exposure to loss under these agreements as of September 30, 2007 was $0.7 million. These three buildings were leased to a single tenant, Capital One Services, Inc., a subsidiary of Capital One Financial Services, Inc., under leases that expire from May 2006 to March 2010. This transaction had been accounted for as a financing transaction and was recorded as a completed sale transaction in the third quarter of 2005 when the maximum exposure to loss under these guarantees became less than the related deferred gain; gain is now being recognized as the maximum exposure under the guarantees is reduced.

(9)

In December 2003, we sold 1.9 million square feet of industrial property. As part of the sale, we agreed to indemnify and hold the buyer harmless with respect to environmental concerns on the property of up to $0.1 million. As a result, $0.1 million of the gain was deferred at the time of sale and will remain deferred until the environmental concerns are remediated.

(10)

In the Highwoods DLF 97/26 DLF 99/32, LP joint venture, a single tenant currently leases an entire building under a lease scheduled to expire on June 30, 2008. The tenant also leases space in other buildings owned by us. In conjunction with an overall restructuring of the tenant’s leases with us and with this joint venture, we agreed to certain changes to the lease with the joint venture in September 2003. The modifications included allowing the tenant to vacate the premises on January 1, 2006, reducing the rent obligation by 50.0% and converting the “net” lease to a “full service” lease with the tenant liable for 50.0% of these costs at that time. In turn, we agreed to compensate the joint venture for any economic losses incurred as a result of these lease modifications. As of September 30, 2007, we have approximately $0.4 million in other liabilities and $0.4 million as a deferred charge in other assets recorded on our Consolidated Balance Sheet to account for the lease guarantee. However, should new tenants occupy the vacated space prior to the end of the guarantee period, in June 2008, our liability under the guarantee would diminish. Our maximum potential amount of future payments with regard to this guarantee as of September 30, 2007 was $0.3 million. No recourse provisions exist to enable us to recover any amounts paid to the joint venture under this lease guarantee.

(11)

RRHWoods, LLC and Dallas County Partners financed the construction of two buildings with a $7.4 million ten-year loan. As an inducement to make the loan at a 6.3% long-term rate, we and our partner agreed to master lease the vacant space and each guaranteed $0.8 million of the debt with limited recourse. As leasing improves, the guarantee obligations under the loan agreement diminish. As of September 30, 2007, no master lease payments have been made. We currently have recorded $0.05 million in other liabilities and $0.05 million as a deferred charge included in other assets on its Consolidated Balance Sheet with respect to this guarantee. The maximum potential amount of future payments that we could be required to make based on the current leases in place was approximately $2.0 million as of September 30, 2007. The likelihood of us paying on our $0.8 million guarantee is remote since the joint venture currently satisfies the minimum debt coverage ratio and should we have to pay our portion of the guarantee, we would be entitled to recover the $0.8 million from other joint venture assets.

 

25

 

HIGHWOODS PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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

 

 

 

11.

COMMITMENTS AND CONTINGENCIES - Continued

(12)

As more fully described in Note 2 to the Consolidated Financial Statements in our 2006 Annual Report on Form 10-K, in connection with the formation of HIW-KC Orlando, LLC, we agreed to guarantee rent to the joint venture for 3,248 rentable square feet commencing in August 2004 and expiring in April 2011. The maximum potential amount of future payments with regard to this guarantee is $0.3 million as of September 30, 2007. Additionally, we agreed to guarantee the initial leasing costs, originally estimated at $4.1 million, for approximately 11% of the total square feet of the property owned by the joint venture. We have paid approximately $0.06 million in 2007 under this guarantee, and approximately $0.3 million is estimated to remain under the guarantee at September 30, 2007.

(13)

In connection with the RRHWoods, LLC joint venture, we and our partner each guaranteed $3.0 million to a combination of two banks. This guarantee expires in November 2009 and can be renewed, at the joint venture’s option, through November 2011. The bank provides a letter of credit securing industrial revenue bonds, which mature in November 2015. The joint venture’s industrial building secures the bonds. We would be required to perform under the guarantee should the joint venture be unable to repay the bonds. We have recourse provisions to recover from the joint venture’s assets. The property collateralizing the bonds generates sufficient cash flow to cover the debt service required by the bond financing. In addition to the direct guarantee, we are committed to a master lease for 50% of the debt service should the cash flow from the property not be able to pay the debt service of the bonds. As a result of this master lease, we have recorded $0.03 million in other liabilities and as a deferred charge in other assets on our Consolidated Balance Sheet at September 30, 2007.

(14)

Represents capitalized lease obligations of $0.4 million related to office equipment, which is included in accounts payable, accrued expenses and other liabilities on our Consolidated Balance Sheet at September 30, 2007.

(15)

In 2006, RRHWoods, LLC completed construction of an office building with a loan by our joint venture partner. In February 2007, the joint venture borrowed $4.1 million. The loan is non-recourse; however, since the building was only 35.0% leased at the time the loan closed, the lender required a $1.5 million letter of credit as additional collateral. At September 30, 2007, the building was 60% leased. Our joint venture partner agreed to provide the letter of credit and we have in turn agreed to reimburse our partner for 50.0%. We would be required to pay on our guarantee should the joint venture be unable to repay the outstanding loan balance. However, the joint venture currently generates sufficient cash flow to cover the debt service required by the loan. As a result, no liability was recorded for the letter of credit guarantee as of September 30, 2007.

 

Litigation, Claims and Assessments

 

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

 

In 2006 and March 2007, we received assessments for state excise taxes and related interest amounting to approximately $5.5 million, related to periods 2002 through 2005. In the fourth quarter of 2006, approximately $0.5 million was accrued and charged to operating expenses in anticipation of a probable settlement of these claims. We received an executed settlement agreement relating to these claims in October 2007, which resulted in no change to the amount previously accrued. Legal fees related to this matter were nominal and were charged to operating expenses as incurred in 2006 and 2007.

 

26

 

HIGHWOODS PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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

 

 

 

12.

INCOME TAXES

 

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

 

Other than the liability for an uncertain tax position and related accrued interest under FIN 48 discussed below, no provision has been made for federal and state income taxes for the REIT during the three month periods ended September 30, 2007 and 2006 because the Company qualifies as a REIT under the Code. The taxable REIT subsidiary has operated at a cumulative taxable loss through September 30, 2007 of approximately $11.4 million and has paid no income taxes since its formation. In addition to the $5.1 million deferred tax asset for these cumulative tax loss carryforwards, the taxable REIT subsidiary also had net deferred tax liabilities of approximately $1.8 million comprised primarily of tax versus book basis differences in certain investments and depreciable assets held by the taxable REIT subsidiary. Because the future tax benefit of all of the cumulative losses is not assured, the approximate $3.3 million net deferred tax asset position of the taxable REIT subsidiary has been fully reserved as management does not believe that it is more likely than not that the net deferred tax asset will be recognized. Accordingly, no tax benefit has been recognized in the accompanying Consolidated Financial Statements. The tax benefit of the cumulative losses could be recognized for financial reporting purposes in future periods to the extent the taxable REIT subsidiary generates sufficient taxable income.

 

In June 2006, the FASB issued FIN 48, which clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109. FIN 48 prescribes a comprehensive model for the recognition, measurement, presentation and disclosure in our financial statements for uncertain tax positions taken or expected to be taken in an income tax return. We adopted FIN 48 effective January 1, 2007.

 

In connection with the adoption of FIN 48, on January 1, 2007, we recorded a $1.4 million liability, which included $0.2 million of accrued interest, for an uncertain tax position, with the related expense reflected as a reduction to the beginning balance of distributions in excess of net earnings. This liability was included in accounts payable, accrued expenses and other liabilities. During the third quarter of 2007, the liability for the uncertain tax position was released, and income recognized, upon the expiration of the applicable statute of limitations. In addition, the liability of $0.05 million of interest that was accrued in 2007 relating to this liability was also released.

 

We are subject to federal, state and local income tax examinations by tax authorities for 2004 through 2006.

 

 

27

 

HIGHWOODS PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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

 

 

 

13.

SEGMENT INFORMATION

 

Our principal business is the acquisition, development and operation of rental real estate properties. We operate in four segments: office, industrial, retail and residential properties. Each segment has different customers and economic characteristics as to rental rates and terms, cost per square foot of buildings, the purposes for which customers use the space, the degree of maintenance and customer support required and customer dependency on different economic drivers, among others. There are no material inter-segment transactions.

 

The accounting policies of the segments are the same as those described in Note 1 included herein. Further, all operations are within the United States and, at September 30, 2007, no tenant of the Wholly Owned Properties comprised more than 6.8% of our consolidated revenues.

 

The following table summarizes the rental income, net operating income and assets for each reportable segment for the three and nine months ended September 30, 2007 and 2006:

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Rental and other revenues: (1)

 

 

 

 

 

 

 

 

 

 

 

 

 

Office segment

 

$

90,966

 

$

85,361

 

$

268,541

 

$

251,926

 

Industrial segment

 

 

7,601

 

 

7,457

 

 

22,635

 

 

22,055

 

Retail segment

 

 

11,280

 

 

10,272

 

 

33,270

 

 

30,956

 

Residential segment

 

 

319

 

 

305

 

 

938

 

 

916

 

Total rental and other revenues

 

$

110,166

 

$

103,395

 

$

325,384

 

$

305,853

 

Net operating income: (1)

 

 

 

 

 

 

 

 

 

 

 

 

 

Office segment

 

$

56,645

 

$

51,841

 

$

168,164

 

$

156,568

 

Industrial segment

 

 

5,825

 

 

5,603

 

 

17,263

 

 

16,787

 

Retail segment

 

 

7,578

 

 

6,918

 

 

22,041

 

 

20,579

 

Residential segment

 

 

160

 

 

138

 

 

386

 

 

408

 

Total net operating income

 

 

70,208

 

 

64,500

 

 

207,854

 

 

194,342

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

(32,517

)

 

(28,168

)

 

(92,275

)

 

(84,000

)

Impairment of assets held for use

 

 

(789

)

 

-

 

 

(789

)

 

-

 

General and administrative expense

 

 

(9,649

)

 

(8,546

)

 

(31,428

)

 

(26,298

)

Interest expense

 

 

(25,325

)

 

(25,216

)

 

(74,273

)

 

(76,928

)

Interest and other income

 

 

1,471

 

 

1,174

 

 

5,105

 

 

4,287

 

Loss on debt extinguishments

 

 

-

 

 

-

 

 

-

 

 

(467

)

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

 

$

3,399

 

$

3,744

 

$

14,194

 

$

10,936

 

 

 

 

September 30,
2007

 

December 31,
2006

 

Total Assets: (2)

 

 

 

 

 

 

 

Office segment

 

$

2,284,654

 

$

2,218,705

 

Industrial segment

 

 

233,904

 

 

230,103

 

Retail segment

 

 

244,346

 

 

247,887

 

Rental residential segment

 

 

22,836

 

 

21,933

 

Corporate and other

 

 

121,183

 

 

126,225

 

Total Assets

 

$

2,906,923

 

$

2,844,853

 

______________

(1)

Net of discontinued operations.

(2)

Real estate and other assets held for sale are included in this table according to the segment type.

 

28

 

HIGHWOODS PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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

 

 

 

14.

OTHER EVENTS

 

Gain on Property Insurance Settlement

 

In the fourth quarter of 2005, one of our office properties located in southeastern Florida sustained damage in a hurricane. The damages were fully insured except for a $341,000 deductible, which was expensed in the fourth quarter of 2005. We did not incur any significant loss of rental income as a result of the damages. In 2006, we received $2.4 million from the insurance company as advances on the final settlement; these amounts were primarily for clean up costs and certain repairs. We are in the process of completing final permanent repairs. During the first quarter of 2007, the insurance company paid us an additional $4.9 million upon finalization of the claim. We recorded a $4.1 million gain under FASB Interpretation No. 30, “Accounting for Involuntary Conversion of Non-Monetary Assets to Monetary Assets” in the first quarter of 2007.

 

Preferred Stock Transactions

 

On May 29, 2007, we redeemed 1.6 million of our outstanding Series B Preferred Shares, aggregating $40.0 million plus accrued and unpaid dividends. In connection with this redemption, the $1.4 million excess of the redemption cost over the net carrying amount of the redeemed shares was recorded as a reduction to net income available for common shareholders in the second quarter of 2007.

 

On August 6, 2007, we repurchased and retired 22,008 of our outstanding Series A Preferred Shares for an aggregate purchase price of $22.3 million. In connection with this repurchase, the $0.8 million excess of the purchase cost over the net carrying amount of the repurchased shares was recorded as a reduction to net income available for common shareholders in the third quarter of 2007.

 

Misstatement of Restricted Cash

 

Subsequent to the issuance of the interim financial statements for the period ended June 30, 2007, management determined that cash disposition proceeds that are set aside and designated or intended to fund future tax-deferred exchanges of qualifying real estate investments should have been presented as restricted cash rather than as cash and cash equivalents, as previously reported. As a result of this misstatement, we intend to restate our interim Consolidated Balance Sheets as of March 31, 200