Highwoods Properties
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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

AMENDMENT NO. 1

 

x Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the fiscal year ended December 31, 2003

 

OR

 

¨ Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the transition period from                      to                     

 

Commission file number 1-13100

 

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 No.)

 

3100 Smoketree Court, Suite 600

Raleigh, N.C. 27604

(Address of principal executive offices) (Zip Code)

 

919-872-4924

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Each Class


  

Name of Each Exchange on

Which Registered


Common stock, $.01 par value    New York Stock Exchange
8 5/8% Series A Cumulative Redeemable Preferred Shares    New York Stock Exchange
8% Series B Cumulative Redeemable Preferred Shares    New York Stock Exchange
Depositary Shares Each Representing a 1/10 Fractional Interest in an 8% Series D Cumulative Redeemable Preferred Share    New York Stock Exchange

 

Securities registered pursuant to Section 12(g) of the Act:

 

NONE

 

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

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment of this Form 10-K. ¨

 

Indicate by check mark whether the Registrant is an accelerated filer (as defined in rule 12b-2 of the Securities Exchange Act). Yes x    No ¨

 

The aggregate market value of the shares of common stock, par value $0.01 per share, held by non-affiliates (based upon the closing sale price on the New York Stock Exchange) on June 30, 2004 was approximately $1,262,333,990. As of October 22, 2004, there were 53,713,181 shares of common stock outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the Registrant’s Proxy Statement in connection with its Annual Meeting of Stockholders held May 18, 2004, are incorporated by reference in Part II, Item 5 and Part III, Items 10, 11, 12, 13 and 14 of the Form 10-K.

 



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EXPLANATORY NOTE

 

The Company is filing this amended Annual Report on Form 10-K for the year ended December 31, 2003 to restate its previously reported financial results for fiscal years 2001 through 2003. These restatements are primarily due to adjustments relating to the accounting for a limited number of the Company’s prior real estate sales transactions with continuing involvement occurring between 1999 and 2003, reclassifications related to discontinued operations, accounting for minority interest, accounting for a debt retirement transaction and other items. For more details, see Note 18 to the Consolidated Financial Statements contained herein.

 

Management of the Company is ultimately responsible for preparing and presenting the Company’s financial statements in accordance with GAAP. As part of these processes, we consulted with Ernst & Young LLP in their capacity as our independent auditors regarding the application of GAAP. In particular, we consulted with Ernst & Young LLP regarding certain of the real estate sales transactions with continuing involvement, accounting for the MOPPRS debt extinguishment in 2003, accounting for minority interest in the Operating Partnership, and accounting for the compensation costs to be recognized in 2004 in connection with the retirement if the Company’s former CEO.

 

Real Estate Sales Transactions. As part of its previously disclosed capital recycling program, the Company has completed a significant number of real estate sales transactions during the last five years. Certain transactions involved sales where the Company retained a partial ownership interest or had continuing involvement with the properties. The forms of continuing involvement included guarantees of a return on investment, guarantees of rental income from specific tenants, seller financing, or, in one instance, a 97.0% fair-market-value put option granted to the buyer.

 

In the Company’s historical financial statements, these transactions were accounted for as sales, and a portion or all of the resultant gains from these transactions were deferred because of the continuing involvement. The nature of all material continuing involvement was disclosed in the Company’s quarterly and annual regulatory and financial filings with the Securities and Exchange Commission and the Company’s annual reports.

 

Adjustments have been made with respect to the accounting treatment for certain of those transactions where the Company had some form of continuing involvement to comply with the guidance of Statement of Financial Accounting Standards (“SFAS”) No. 66, “Accounting for Sales of Real Estate.” For three of the transactions, the largest of which is the sale in late 2000 of properties into the previously disclosed MG-HIW, LLC joint venture, the Company has adjusted its Consolidated Financial Statements to account for these three transactions as financing and/or profit-sharing arrangements rather than as sales. Accordingly, the assets, related liabilities and operations are now included in the Company’s Consolidated Financial Statements. In the other instances, the transactions have continued to be reported as sales, but the timing and amount of gain recognition changed due to the Company’s continuing involvement. This is also in accordance with SFAS No. 66.

 

Discontinued Operations. Certain properties were sold to joint ventures where the Company retained a minority interest. In addition, in other sales transactions the Company was retained by the buyer to perform management and leasing services. Since January 1, 2002, the Company applied discontinued operations presentation under SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” for the operations of those sold properties for the periods prior to the date of sale. Due to the partial interest retained through joint ventures and the continuing management fee income earned from such sold properties, the properties do not require discontinued operations presentation under SFAS No. 144. Accordingly, the Company has adjusted its Consolidated Statements of Income for 2001 through 2003 to classify such items as continuing operations; these reclassifications do not impact net income.

 

Minority Interest. In its Consolidated Financial Statements, the Company previously computed minority interest in the net income of its majority owned subsidiary, Highwoods Realty Limited Partnership (the “Operating Partnership”), for each reporting period by applying the weighted average ownership percentage of the minority common unitholders times the Operating Partnership’s net income available to common unitholders (continuing operations and discontinued operations) for the period before deducting distributions to preferred unitholders. In the restated Consolidated Financial Statements, minority interest has been adjusted by applying the weighted average ownership percentage of the minority common unitholders times the Operating Partnership’s net income (continuing operations and discontinued operations) for the period after deducting distributions to preferred unitholders.

 

Accounting for MOPPRS Debt Retirement. This transaction, which occurred in early February 2003, is described in detail in Note 5. The Company had previously accounted for the transaction as an exchange of indebtedness under EITF 96-19, “Debtor’s Accounting for a Modification or Exchange of Debt Instruments” and recorded $14.7 million in deferred financing costs, representing the excess of amounts paid to retire the MOPPRS and the related remarketing option over the MOPPRS’ net carrying value and related deferred credits. The Company has now determined that this transaction should have been accounted for as a debt extinguishment under EITF 96-19. Accordingly, the $14.7 million has been charged to loss on debt extinguishment in the first quarter of 2003 rather than as deferred financing costs as previously recorded. In addition, the amortization expense related to the

 

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previous net deferred financing costs, which aggregated approximately $250,000 in the first quarter of 2003 and approximately $370,000 per quarter thereafter, have been reversed in the restated Consolidated Financial Statements.

 

Other Matters. In addition to the above, the Company has identified several other matters that have been adjusted, as described in Note 18 to the Consolidated Financial Statements.

 

Impact on Financial Statements. The impact of these restatements on the Company’s Consolidated Balance Sheets as of December 31, 2003 and 2002 and Statements of Income for the three years in the period ended December 31, 2003 is shown in tables in Note 18 to the Consolidated Financial Statements.

 

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HIGHWOODS PROPERTIES, INC.

 

TABLE OF CONTENTS

 

Item No.

        Page No.

     PART I     
   1.    Business    5
   2.    Properties    13
   3.    Legal Proceedings    18
   4.    Submission of Matters to a Vote of Security Holders    18
   X.    Executive Officers of the Registrant    19
     PART II     
   5.    Market for Registrant’s Common Stock and Related Stockholder Matters    21
   6.    Selected Financial Data    22
   7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations    23
7A.    Quantitative and Qualitative Disclosures About Market Risk    52
   8.    Financial Statements and Supplementary Data    53
   9.    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure    53
9A.    Controls and Procedures    53
     PART III     
  10.    Directors and Executive Officers of the Registrant    56
  11.    Executive Compensation    56
  12.    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters    57
  13.    Certain Relationships and Related Transactions    57
  14.    Principal Accountant Fees and Services    57
     PART IV     
  15.    Exhibits and Reports on Form 8-K    58

 

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PART I

 

We refer to (1) Highwoods Properties, Inc. as the “Company,” (2) Highwoods Realty Limited Partnership as the “Operating Partnership,” (3) the Company’s common stock as “Common Stock,” (4) the 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 apartment units) to which the Company has title and 100.0% ownership rights as the “Wholly Owned Properties.”

 

ITEM 1. BUSINESS

 

General

 

The Company is a self-administered and self-managed equity REIT that began operations through a predecessor in 1978. Since the Company’s initial public offering in 1994, we have evolved into one of the largest owners and operators of suburban office, industrial and retail properties in the southeastern and midwestern United States. At December 31, 2003, we:

 

  wholly owned 465 in-service office, industrial and retail properties, encompassing approximately 34.9 million rentable square feet, and 213 apartment units;

 

  owned an interest (50.0% or less) in 65 in-service office and industrial properties, encompassing approximately 6.8 million rentable square feet and 418 apartment units. Six of the in-service properties are consolidated at December 31, 2003 as a result of our continuing involvement with these properties in accordance with SFAS No. 66. See Note 1 to the Consolidated Financial Statements for further description of the Company’s accounting policy for investments in joint ventures;

 

  wholly owned 1,305 acres of undeveloped land that is suitable to develop approximately 14.3 million rentable square feet of office, industrial and retail space; and

 

  were developing an additional seven properties, which will encompass approximately 959,000 rentable square feet (including three properties encompassing 357,000 rentable square feet that we are developing with a 50.0% joint venture partner).

 

The Company conducts substantially all of its activities through, and substantially all of its interests in the properties are held directly or indirectly by the Operating Partnership. The Company is the sole general partner of the Operating Partnership. At December 31, 2003, the Company owned 100.0% of the Preferred Units and 89.5% of the Common Units in the Operating Partnership. Limited partners (including certain officers and directors of the Company) own the remaining Common Units. Holders of Common Units may redeem them for the cash value of one share of the Company’s Common Stock or, at the Company’s option, one share of Common Stock. The Company’s weighted average ownership of Common Units during the year ended December 31, 2003 was 88.9%. The Preferred Units in the Operating Partnership were issued to the Company in connection with the Company’s three Preferred Stock offerings that occurred in 1997 and 1998.

 

The Company was incorporated in Maryland in 1994. The Operating Partnership was formed in North Carolina in 1994. Our executive offices are located at 3100 Smoketree Court, Suite 600, Raleigh, North Carolina 27604 and our telephone number is (919) 872-4924. We maintain offices in each of our primary markets.

 

The business of the Company is the acquisition, development and operation of rental real estate properties. The Company operates office, industrial and retail properties and apartment units. There are no material inter-segment transactions. See Note 17 to the Consolidated Financial Statements for a summary of the rental income, net operating income and assets for each reportable segment.

 

In addition to this amended Annual Report, we file quarterly and special reports, proxy statements and other information with the SEC. All documents that we file with the SEC are made available as soon as reasonably practicable free of charge on our corporate website, which is http://www.highwoods.com. The information on this website is not and should not be considered part of this amended Annual Report on Form 10-K and is not incorporated by reference in this document. This website is only intended to be an inactive textual reference. You may also read and copy any document that we file at the public reference facilities of the SEC at 450 Fifth Street,

 

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N.W., Washington, D.C. 25049. Please call the SEC at (800) 732-0330 for further information about the public reference facilities. These documents also may be accessed through the SEC’s electronic data gathering, analysis and retrieval system (“EDGAR”) via electronic means, including the SEC’s home page on the Internet (http://www.sec.gov). In addition, since some of our securities are listed on the New York Stock Exchange, you can read our SEC filings at the offices of the New York Stock Exchange at 20 Broad Street, New York, New York 10005.

 

Customers

 

The following table sets forth information concerning the 20 largest customers of our Wholly Owned Properties as of December 31, 2003:

 

Customer


   Rental
Square Feet


   Annualized
Rental Revenue (1)


   Percent of Total
Annualized
Rental Revenue (1)


    Average
Remaining Lease
Term in Years


          (in thousands)           

Federal Government

   639,883    $ 13,971    3.34 %   6.6

AT&T

   612,092      11,493    2.74     3.6

PricewaterhouseCoopers

   297,795      6,957    1.66     6.3

State of Georgia

   359,565      6,858    1.64     5.4

Sara Lee

   1,198,534      4,697    1.12     3.6

IBM

   194,934      4,097    0.98     1.9

Northern Telecom

   246,000      3,651    0.87     4.2

Volvo

   267,717      3,431    0.82     5.5

Lockton Companies

   132,718      3,294    0.79     11.2

US Airways (2)

   295,046      3,217    0.77     4.0

BB&T

   241,075      3,186    0.76     7.2

ITC Deltacom (3)

   147,379      2,947    0.70     1.4

Hartford Insurance

   129,641      2,861    0.68     2.2

T-Mobile USA

   120,561      2,801    0.67     2.5

WorldCom and Affiliates

   144,623      2,787    0.67     2.5

Bank of America

   146,842      2,705    0.65     5.3

Ikon

   181,361      2,531    0.60     3.9

Carlton Fields

   95,771      2,435    0.58     0.5

Ford Motor Company

   125,989      2,426    0.58     6.1

CHS Professional Services

   145,781      2,380    0.57     3.3
    
  

  

 

Total

   5,723,307    $ 88,725    21.19 %   4.7
    
  

  

 

(1) Annualized Rental Revenue is December 2003 rental revenue (base rent plus operating expense pass-throughs) multiplied by 12.

 

(2) In August 2002, US Airways filed voluntary petitions for reorganization under Chapter 11 of the US Bankruptcy Code. US Airways emerged from Chapter 11 bankruptcy protection in March 2003. On September 12, 2004, US Airways again filed voluntary petitions for reorganization under Chapter 11. No action has been taken to date with respect to the Company’s leases with US Airways.

 

(3) ITC Deltacom (formerly Business Telecom) leases space in a property that, as of December 31, 2003, is under contract for sale. Although no assurances can be made, the sale is expected to close in late 2004 or early 2005.

 

Operating Strategy

 

Efficient, Customer Service-Oriented Organization. We provide a complete line of real estate services to our tenants and third parties. We believe that our in-house development, acquisition, construction management, leasing and property management services allow us to respond to the many demands of our existing and potential tenant base. We provide our tenants with cost-effective services such as build-to-suit construction and space modification, including tenant improvements and expansions. In addition, the breadth of our capabilities and resources provides us with market information not generally available. We believe that the operating efficiencies achieved through our fully integrated organization also provide a competitive advantage in setting our lease rates and pricing other services.

 

Capital Recycling Program. Our strategy has been to focus our real estate activities in markets where we believe our extensive local knowledge gives us a competitive advantage over other real estate developers and operators. Through our capital recycling program, we generally seek to:

 

  engage in the development of office and industrial projects in our existing geographic markets, primarily in suburban business parks;

 

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  acquire selective suburban office and industrial properties in our existing geographic markets at prices below replacement cost that offer attractive returns; and

 

  selectively dispose of non-core properties or other properties in order to use the net proceeds for investments or other purposes.

 

Our capital recycling activities benefit from our local market presence and knowledge. Our division officers have significant real estate experience in their respective markets. Based on this experience, we believe that we are in a better position to evaluate capital recycling opportunities than many of our competitors. In addition, our relationships with our tenants and those tenants at properties for which we conduct third-party fee-based services may lead to development projects when these tenants seek new space.

 

The following summarizes the change in our Wholly Owned Properties during the three years ended December 31, 2003:

 

     2003

    2002

    2001

 

Office, Industrial and Retail Properties:

                  

(rentable square feet in thousands)

                  

Dispositions (includes 225 in 2002 related to the Eastshore transaction)

   (3,298 )   (2,270 )   (268 )

Contributions to Joint Ventures (includes 205 to SF-HIW Harborview, LLP in 2002)

   (291 )   (205 )   (118 )

Developments Placed In-Service

   191     2,214     1,351  

Redevelopment

   (221 )   (52 )   —    

Acquisitions (including 1,319 and 205 from MG-HIW, LLC in 2003 and 2002)

   1,429     205     72  
    

 

 

Net Change of In-Service Wholly Owned Properties

   (2,190 )   (108 )   1,037  
    

 

 

Apartment Properties:

                  

(in units)

                  

Dispositions

   —       —       (1,672 )
    

 

 

 

Flexible Capital Structure. We are committed to maintaining a flexible capital structure that: (1) allows growth through development and acquisition opportunities; (2) promotes future earnings growth; and (3) provides access to the private and public equity and debt markets on favorable terms. Accordingly, we expect to meet our long-term liquidity requirements through a combination of any one or more of:

 

  cash flow from operating activities;

 

  borrowings under our unsecured and secured revolving credit facilities;

 

  the issuance of unsecured debt;

 

  the issuance of secured debt;

 

  the issuance of equity securities by both the Company and the Operating Partnership;

 

  the selective disposition of non-core properties or other properties; and

 

  private equity capital raised from unrelated joint venture partners that may involve the sale or contribution of our Wholly Owned Properties, development projects and development land to joint ventures formed with unrelated investors.

 

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Geographic Diversification. Since the Company’s initial public offering in 1994, we have significantly reduced our dependence on any particular market. We initially owned a limited number of office properties located in North Carolina, most of which were in the Research Triangle. Today, including our various joint ventures, our portfolio consists primarily of office properties throughout the Southeast and retail and office properties in Kansas City, Missouri, including one significant mixed retail and office property.

 

Competition

 

Our properties compete for tenants with similar properties located in our markets primarily on the basis of location, rent, services provided and the design and condition of the facilities. We also compete with other REITs, financial institutions, pension funds, partnerships, individual investors and others when attempting to acquire, develop and operate properties.

 

Employees

 

As of December 31, 2003, the Company employed 554 persons.

 

Risk Factors

 

An investment in our equity and debt securities involves various risks. All investors should carefully consider the following risk factors in conjunction with the other information contained in this amended Annual Report before trading in our securities. If any of these risks actually occur, our business, operating results, prospects and financial condition could be harmed.

 

Our Performance is Subject to Risks Associated with Real Estate Investment. We are a real estate company that derives most of our income from the ownership and operation of our properties. There are a number of factors that may adversely affect the income that our properties generate, including the following:

 

  Economic Downturns. Downturns in the national economy, particularly in the Southeast, generally will negatively impact the demand for our properties.

 

  Oversupply of Space. An oversupply of space in our markets would typically cause rental rates and occupancies to decline, making it more difficult for us to lease space at attractive rental rates.

 

  Competitive Properties. If our properties are not as attractive to tenants (in terms of rents, services or location) as other properties that are competitive with ours, we could lose tenants to those properties or suffer lower rental rates.

 

  Renovation Costs. In order to maintain the quality of our properties and successfully compete against other properties, we periodically have to spend money to maintain, repair and renovate our properties.

 

  Customer Risk. Our performance depends on our ability to collect rent from our customers. While no customer in our wholly owned portfolio accounted for more than 3.4% of the annualized rental revenue of these respective properties at December 31, 2003, our financial position may be adversely affected by financial difficulties experienced by a major customer, or by a number of smaller customers, including bankruptcies, insolvencies or general downturns in business.

 

  Reletting Costs. As leases expire, we try to either relet the space to an existing customer or attract a new customer to occupy the space. In either case, we likely will incur significant costs in the process, including potentially substantial tenant improvement expense. In addition, if market rents have declined since the time the expiring lease was executed, the terms of any new lease signed likely will not be as favorable to us as the terms of the expiring lease, thereby reducing the income earned from that space.

 

  Regulatory Costs. There are a number of government regulations, including zoning, tax and accessibility laws that apply to the ownership and operation of office buildings. Compliance with existing and newly adopted regulations may require us to spend a significant amount of money on our properties.

 

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  Fixed Nature of Costs. Most of the costs associated with owning and operating our properties are not necessarily reduced when circumstances such as market factors and competition cause a reduction in rental revenues from the property.

 

  Environmental Problems. Federal, state and local laws and regulations relating to the protection of the environment may require a current or previous owner or operator of real property to investigate and clean up hazardous or toxic substances or petroleum product releases at the property. The clean up can be costly. The presence of or failure to clean up contamination may adversely affect our ability to sell or lease a property or to borrow funds using a property as collateral.

 

  Competition. A number of other major real estate investors with significant capital compete with us. These competitors include publicly-traded REITs, private REITs, private real estate investors and private institutional investment funds.

 

Future acquisitions and development properties may fail to perform in accordance with our expectations and may require development and renovation costs exceeding our estimates. In the normal course of business, we typically evaluate potential acquisitions, enter into non-binding letters of intent, and may, at any time, enter into contracts to acquire additional properties. However, changing market conditions, including competition from others, may diminish our opportunities for making attractive acquisitions. Once made, our investments may fail to perform in accordance with our expectations. In addition, the renovation and improvement costs we incur in bringing an acquired property up to market standards may exceed our estimates. Although we anticipate financing future acquisitions and renovations through a combination of advances under our revolving loan (see Note 5 to the Consolidated Financial Statements) and other forms of secured or unsecured financing, no assurance can be given that we will have the financial resources to make suitable acquisitions or renovations.

 

In addition to acquisitions, we periodically consider developing and constructing properties. Risks associated with development and construction activities include:

 

  the unavailability of favorable financing;

 

  construction costs exceeding original estimates;

 

  construction and lease-up delays resulting in increased debt service expense and construction costs; and

 

  insufficient occupancy rates and rents at a newly completed property causing a property to be unprofitable.

 

If new developments are financed through construction loans, there is a risk that, upon completion of construction, permanent financing for newly developed properties will not be available or will be available only on disadvantageous terms. Development activities are also subject to risks relating to our inability to obtain, or delays in obtaining, all necessary zoning, land-use, building, occupancy and other required governmental and utility company authorizations.

 

Because holders of our Common Units, including some of our officers and directors, may suffer adverse tax consequences upon the sale of some of our properties, it is possible that the Company may sometimes make decisions that are not in your best interest. Holders of Common Units may suffer adverse tax consequences upon the Company’s sale of certain properties. Therefore, holders of Common Units, including certain of our officers and directors, may have different objectives than our stockholders regarding the appropriate pricing and timing of a property’s sale. Although we are the sole general partner of the Operating Partnership and have the exclusive authority to sell all of our individual Wholly Owned Properties, officers and directors who hold Common Units may influence us not to sell certain properties even if such sale might be financially advantageous to stockholders or influence us to enter into tax deferred exchanges with the proceeds of such sales when such a reinvestment might not otherwise be in the best interests of the Company.

 

The success of our joint venture activity depends upon our ability to work effectively with financially sound partners. Instead of owning properties directly, we have in some cases invested, and may continue to invest, as a partner or a co-venturer. Under certain circumstances, this type of investment may involve risks not otherwise

 

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present, including the possibility that a partner or co-venturer might become bankrupt or that a partner or co-venturer might have business interests or goals inconsistent with ours. Also, such a partner or co-venturer may take action contrary to our instructions or requests or contrary to provisions in our joint venture agreements that could harm us, including jeopardizing our qualification as a REIT.

 

Our insurance coverage on our properties may be inadequate. We carry comprehensive insurance on all of our properties, including insurance for liability, fire and flood. Insurance companies currently, however, limit coverage against certain types of losses, such as losses due to terrorist acts, named windstorms and toxic mold. Thus we may not have insurance coverage, or sufficient insurance coverage, against certain types of losses and/or there may be decreases in the limits of insurance available. Should an uninsured loss or a loss in excess of our insured limits occur, we could lose all or a portion of the capital we have invested in a property or properties, as well as the anticipated future revenue from the property or properties. If any of our properties were to experience a catastrophic loss, it could disrupt our operations, delay revenue and result in large expenses to repair or rebuild the property. Such events could adversely affect our ability to pay dividends to our stockholders. Our existing insurance policies were renewed in June 2004 and expire on June 30, 2005. We anticipate renewing or replacing these policies at that time.

 

Our use of debt to finance our operations could have a material adverse effect on our cash flow and ability to make distributions. We are subject to risks normally associated with debt financing, such as the insufficiency of cash flow to meet required payment obligations, difficulty in complying with financial ratios and other covenants and the inability to refinance existing indebtedness. Approximately $214.8 million of principal payments on our existing long-term debt is due in 2004 and 2005 which excludes $100.0 million related to the Put Option Notes, which were extinguished in June, 2004. If we fail to comply with the financial ratios and other covenants, including our Revolving Loan, we would likely not be able to borrow any further amounts under the Revolving Loan, which could adversely affect our ability to fund our operations, and our lenders could accelerate outstanding debt. If our debt cannot be paid, refinanced or extended at maturity, in addition to our failure to repay our debt, we may not be able to pay dividends to stockholders at expected levels or at all. Furthermore, if any refinancing is done at higher interest rates, the increased interest expense could adversely affect our cash flow and ability to pay dividends to stockholders. Any such refinancing could also impose tighter financial ratios and other covenants that could restrict our ability to take actions that could otherwise be in our stockholders’ best interest, such as funding new development activity, making opportunistic acquisitions, repurchasing our securities or paying distributions. If we do not meet our mortgage financing obligations, any properties securing such indebtedness could be foreclosed on, which would have a material adverse effect on our cash flow and ability to make distributions.

 

We may be subject to taxation as a regular corporation if we fail to maintain our REIT status. Our failure to qualify as a REIT would have serious adverse consequences to our stockholders. Many of the requirements for taxation as a REIT, however, are highly technical and complex. The determination that we are a REIT requires an analysis of various factual matters and circumstances that may not be totally within our control. For example, to qualify as a REIT, at least 95.0% of our gross income must come from certain sources that are itemized in the REIT tax laws. We are also required to distribute to stockholders at least 90.0% of our REIT taxable income, excluding capital gains. The fact that we hold our assets through the Operating Partnership and its subsidiaries further complicates the application of the REIT requirements. Even a technical or inadvertent mistake could jeopardize our REIT status. Furthermore, Congress and the IRS might change the tax laws and regulations and the courts might issue new rulings that make it more difficult, or impossible, for us to remain qualified as a REIT.

 

If we fail to qualify as a REIT, we would be subject to federal income tax at regular corporate rates. Also, unless the IRS granted us relief under certain statutory provisions, we would remain disqualified as a REIT for four years following the year we first failed to qualify. If we failed to qualify as a REIT, we would have to pay significant income taxes and would, therefore, have less cash available for investments or to pay dividends to stockholders. This would likely have a significant adverse effect on the value of our securities. In addition, we would no longer be required to pay dividends to stockholders.

 

Because provisions contained in Maryland law, our charter and our bylaws may have an anti-takeover effect, investors may be prevented from receiving a “control premium” for their shares. Provisions contained in our charter and bylaws as well as Maryland general corporation law may have anti-takeover effects that delay, defer or prevent a takeover attempt, and thereby prevent stockholders from receiving a “control premium” for their shares. For example, these provisions may defer or prevent tender offers for our Common Stock or purchases of large blocks of our Common Stock, thus limiting the opportunities for our stockholders to receive a premium for their Common Stock over then-prevailing market prices. These provisions include the following:

 

  Ownership limit. Our charter prohibits direct or constructive ownership by any person of more than 9.8% of our outstanding capital stock. Any attempt to own or transfer shares of our capital stock in excess of the ownership limit without the consent of our Board of Directors will be void.

 

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  Preferred stock. Our charter authorizes our Board of Directors to issue Preferred Stock in one or more classes and to establish the preferences and rights of any class of Preferred Stock issued. These actions can be taken without soliciting stockholder approval. The issuance of Preferred Stock could have the effect of delaying or preventing someone from taking control of us, even if a change in control were in our stockholders’ best interest.

 

  Staggered board. Our Board of Directors is divided into three classes. As a result each director generally serves for a three-year term. This staggering of our Board may discourage offers for us or make an acquisition of us more difficult, even when an acquisition is in the best interest of our stockholders.

 

  Maryland control share acquisition statute. Maryland law limits the voting rights of “control shares” of a corporation in the event of a “control share acquisition.”

 

  Maryland unsolicited takeover statute. Under Maryland law, our Board of Directors could adopt various anti-takeover provisions without the consent of stockholders. The adoption of such measures could discourage offers for us or make an acquisition of us more difficult, even when an acquisition is in the best interest of our stockholders.

 

  Anti-Takeover protections of Operating Partnership agreement. Upon a change in control of the Company, the limited partnership agreement of the Operating Partnership contains provisions that require certain acquirors to maintain an UPREIT structure with terms at least as favorable to the limited partners as are currently in place. For instance, the acquiror would be required to preserve the limited partner’s right to continue to hold tax-deferred partnership interests that are redeemable for capital stock of the acquiror. These provisions may make a change of control transaction involving the Company more complicated and therefore might limit the possibility of such a transaction occurring, even if such a transaction would be in the best interest of the Company’s stockholders.

 

  Dilutive effect of Stockholder rights plan. We currently have in effect a stockholder rights plan pursuant to which our existing stockholders would have the ability to acquire additional Common Stock at a significant discount in the event a person or group attempts to acquire us on terms of which our Board of Directors does not approve. These rights are designed to deter a hostile takeover by increasing the takeover cost. As a result, such rights could discourage offers for us or make an acquisition of us more difficult, even when an acquisition is in the best interest of our stockholders. The rights plan should not interfere with any merger or other business combination the Board of Directors approves since we may generally terminate the plan at any time at nominal cost.

 

SEC communications. As part of the implementation of the Sarbanes-Oxley Act of 2002 and other related SEC rulemaking, the SEC’s Division of Corporation Finance has undertaken to routinely review the annual reports of public companies every two to three years. We recently received such a letter from the SEC’s Division of Corporation Finance providing comments on our 2003 Annual Report on Form 10-K. One of the comments from the SEC’s Division of Corporation Finance regarding the accounting treatment of sales transactions with continuing involvement under SFAS No. 66 led us to review substantially all of our sales transactions during the past five years. As a result, we subsequently determined that it was appropriate to restate our historical financial statements by making certain adjustments thereto as more fully described under “Explanatory Note” and in the restated Consolidated Financial Statements included under Item 15 herein. During subsequent communications with the SEC’s Division of Corporation Finance, we shared with the Staff our conclusions regarding the appropriate methodology for these transactions and shared with them language designed to enhance our accounting policy disclosures, which we have made in this amended Form 10-K and which we intend to include in future filings.

 

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On August 4, 2004, we announced that we intended to delay the release of our second quarter financial results because we expected to restate our previously reported financial results. Prior to this announcement, the SEC’s Division of Corporation Finance notified us that we had satisfactorily responded to its comments.

 

Subsequent to our August 4, 2004 announcement, we received a non-public, informal inquiry letter from the SEC’s Division of Enforcement asking us for our voluntary assistance in providing them with documentation regarding our review of real estate transactions undertaken as a result of the initial letter from the SEC’s Division of Corporation Finance and all documents relating to communications with our independent auditor in connection therewith. Even though we are cooperating fully, we cannot assure you that the SEC’s Division of Enforcement will not take any action that would adversely affect us.

 

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ITEM 2. PROPERTIES

 

General

 

As of December 31, 2003, we owned 100.0% interests in 465 in-service office, industrial and retail properties, encompassing approximately 34.9 million rentable square feet, and 213 apartment units. The following table sets forth information about our Wholly Owned Properties at December 31, 2003:

 

Market


   Rentable
Square Feet


    Occupancy

    Percentage of Annualized Rental Revenue (1)

 
       Office (2)

    Industrial

    Retail

    Total

 

Research Triangle (3)

   4,706,000     80.8 %   15.7 %   0.2 %   —       15.9 %

Atlanta

   6,919,000     78.4     11.5     3.3     —       14.8  

Tampa

   4,441,000     63.4 (4)   13.0     —       —       13.0  

Kansas City

   2,433,000 (5)   92.7     4.1     —       8.6 %   12.7  

Nashville

   2,869,000     91.5     11.2     —       —       11.2  

Piedmont Triad (6)

   6,688,000     90.0     6.4     4.0     —       10.4  

Richmond

   1,852,000     91.5     7.1     —       —       7.1  

Charlotte

   1,655,000     79.6     4.4     0.3     —       4.7  

Memphis

   1,216,000     81.0     4.6     —       —       4.6  

Greenville

   1,318,000     80.2     3.7     0.1     —       3.8  

Columbia

   426,000     57.9     0.8     —       —       0.8  

Orlando

   299,000     44.9     0.6     —       —       0.6  

Other

   100,000     64.1     0.4     —       —       0.4  
    

 

 

 

 

 

Total

   34,922,000     81.5 %(7)   83.5 %   7.9 %   8.6 %   100.0 %
    

 

 

 

 

 


(1) Annualized Rental Revenue is December 2003 rental revenue (base rent plus operating expense pass-throughs) multiplied by 12.

 

(2) Substantially all of our office properties are located in suburban areas.

 

(3) Includes properties located in the Raleigh/Durham metropolitan area.

 

(4) Tampa’s occupancy would be 77.8% if the 816,000 square foot Highwoods Preserve campus where Intermedia (WorldCom) rejected its lease was excluded.

 

(5) Excludes basement space of 418,000 square feet.

 

(6) Includes properties located in the Greensboro/Winston-Salem metropolitan area.

 

(7) Total occupancy would have been 83.4% if the 816,000 square foot Highwoods Preserve campus where Intermedia (WorldCom) rejected its lease was excluded.

 

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The following table sets forth information about our Wholly Owned Properties and our development properties as of December 31, 2003 and 2002:

 

     December 31, 2003

    December 31, 2002

 
     Rentable
Square Feet


   Percent
Leased/
Pre-Leased


    Rentable
Square Feet


   Percent
Leased/
Pre-Leased


 

In-Service:

                      

Office

   25,303,000    79.2 %   25,342,000    82.3 %(1)

Industrial

   8,092,000    85.7     10,242,000    86.2  

Retail (2)

   1,527,000    96.3     1,528,000    97.0  
    
  

 
  

Total or Weighted Average

   34,922,000    81.5 %   37,112,000    84.0 %(1)
    
  

 
  

Development:

                      

Completed—Not Stabilized (3)

                      

Office

   140,000    36.0 %   231,000    61.3 %

Industrial

   —      —       60,000    50.0  
    
  

 
  

Total or Weighted Average

   140,000    36.0 %   291,000    59.0 %
    
  

 
  

In Process

                      

Office

   112,000    100.0 %   40,000    0.0 %

Industrial

   350,000    100.0     —      —    
    
  

 
  

Total or Weighted Average

   462,000    100.0 %   40,000    0.0 %
    
  

 
  

Total:

                      

Office

   25,555,000          25,613,000       

Industrial

   8,442,000          10,302,000       

Retail (2)

   1,527,000          1,528,000       
    
        
      

Total or Weighted Average

   35,524,000          37,443,000       
    
        
      

(1) The occupancy percentages have been reduced as a result of the rejection of the 816,000 square foot Intermedia (WorldCom) lease on December 31, 2002. The impact of the rejection on office occupancy and total occupancy in 2002 was 3.2% and 2.2%, respectively.

 

(2) Excludes basement space of 418,000 square feet.

 

(3) Not stabilized is defined as less than 95.0% occupied or a year from completion.

 

Development Land

 

We estimate that we can develop approximately 14.3 million square feet of office, industrial and retail space on our development land that was wholly-owned as of December 31, 2003. All of this development land is zoned and available for office, industrial or retail development, substantially all of which has utility infrastructure already in place. We believe that our commercially zoned and unencumbered land in existing business parks gives us a development advantage over other commercial real estate development companies in many of our markets. Any future development, however, is dependent on the demand for office, industrial or retail space in the area, the availability of favorable financing and other factors, and no assurance can be given that any construction will take place on the development land. In addition, if construction is undertaken on the development land, we will be subject to the risks associated with construction activities, including the risks that occupancy rates and rents at a newly completed property may not be sufficient to make the property profitable, construction costs may exceed original estimates and construction and lease-up may not be completed on schedule, resulting in increased debt service expense and construction expense. We may also dispose of certain parcels of development land that do not meet our development criteria and we may develop properties other than office, industrial and retail on certain parcels with unrelated joint venture partners.

 

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Table of Contents

Other Properties

 

As of December 31, 2003, we owned an interest (50.0% or less) in 65 in-service office and industrial properties, of which six are consolidated as a result of our continuing involvement with the properties. The properties encompass approximately 6.8 million rentable square feet and 418 apartment units. The following table sets forth information about these properties at December 31, 2003:

 

    

Rentable

Square Feet


    Occupancy

    Percentage of Annualized Rental Revenue – Our Share Only (1)

 

Market


       Office

    Industrial

    Retail

    Multi-
Family


    Total

 

Des Moines

   2,245,000 (2)   95.3 %(3)   33.5 %   4.2 %   1.2 %   4.3 %   43.2 %

Orlando

   1,764,000     85.6     17.9     —       —       —       17.9  

Atlanta

   650,000     86.7     11.8     —       —       —       11.8  

Research Triangle

   455,000     98.7     4.2     —       —       —       4.2  

Kansas City

   427,000     87.6     4.2     —       —       —       4.2  

Piedmont Triad

   364,000     100.0     4.7     —       —       —       4.7  

Tampa

   205,000     92.1     2.5     —       —       —       2.5  

Charlotte

   148,000     100.0     1.0     —       —       —       1.0  

Richmond

   412,000     99.0     9.9     —       —       —       9.9  

Other

   110,000     100.0     0.6     —       —       —       0.6  
    

 

 

 

 

 

 

Total

   6,780,000     92.2 %   90.3 %   4.2 %   1.2 %   4.3 %   100.0 %
    

 

 

 

 

 

 


(1) Annualized Rental Revenue is December 2003 rental revenue (base rent plus operating expense pass-throughs) multiplied by 12.

 

(2) Excludes Des Moines’ apartment units.

 

(3) Excludes Des Moines’ apartment occupancy percentage of 90.0%.

 

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Table of Contents

Lease Expirations

 

The following tables set forth scheduled lease expirations for existing leases at our Wholly Owned Properties (excluding apartment units) as of December 31, 2003. The table includes the effects of any early renewals exercised by tenants as of December 31, 2003.

 

Office Properties:

 

Lease Expiring (1)


   Rentable
Square Feet
Subject to
Expiring
Leases


   Percentage of
Leased
Square Footage
Represented by
Expiring Leases


    Annualized
Rental Revenue
Under Expiring
Leases (2)


   Average
Annual
Rental Rate
Per Square
Foot for
Expirations


   Percent of
Annualized
Rental Revenue
Represented by
Expiring
Leases (2)


 
     ($ in thousands)  

2004 (3)

   2,803,876    14.0 %   $ 51,010    $ 18.19    14.6 %

2005

   3,538,106    17.6       63,790      18.03    18.1  

2006

   3,095,699    15.4       56,911      18.38    16.3  

2007

   1,779,659    8.9       29,637      16.65    8.5  

2008

   3,117,531    15.5       48,556      15.58    13.9  

2009

   1,802,308    9.0       28,596      15.87    8.2  

2010

   1,243,677    6.2       24,500      19.70    7.0  

2011

   1,092,047    5.4       20,816      19.06    5.9  

2012

   522,042    2.6       10,738      20.57    3.1  

2013

   548,879    2.7       9,266      16.88    2.6  

Thereafter

   543,880    2.7       6,191      11.38    1.8  
    
  

 

  

  

     20,087,704    100.0 %   $ 350,011    $ 17.42    100.0 %
    
  

 

  

  

 

Industrial Properties:

 

Lease Expiring (1)


   Rentable
Square Feet
Subject to
Expiring
Leases


   Percentage of
Leased
Square Footage
Represented by
Expiring Leases


    Annualized
Rental Revenue
Under Expiring
Leases (2)


   Average
Annual
Rental Rate
Per Square
Foot for
Expirations


   Percent of
Annualized
Rental Revenue
Represented by
Expiring
Leases (2)


 
     ($ in thousands)  

2004 (4)

   1,652,551    23.8 %   $ 7,970    $ 4.82    24.2 %

2005

   1,289,760    18.6       5,926      4.59    18.0  

2006

   887,007    12.8       4,447      5.01    13.5  

2007

   1,677,694    24.2       7,283      4.34    22.2  

2008

   384,012    5.5       1,862      4.85    5.7  

2009

   380,349    5.5       2,408      6.33    7.3  

2010

   104,570    1.5       432      4.13    1.3  

2011

   66,342    1.0       356      5.37    1.1  

2012

   44,447    0.6       261      5.87    0.8  

2013

   102,384    1.5       612      5.98    1.9  

Thereafter

   348,394    5.0       1,301      3.73    4.0  
    
  

 

  

  

     6,937,510    100.0 %   $ 32,858    $ 4.74    100.0 %
    
  

 

  

  


(1) Includes effects of any early renewals exercised by tenants on or before December 31, 2003.

 

(2) Annualized Rental Revenue is December 2003 rental revenue (base rent plus operating expense pass-throughs) multiplied by 12.

 

(3) Includes 96,000 square feet of leases that are on a month-to-month basis or 0.4% of total annualized rental revenue.

 

(4) Includes 165,000 square feet of leases that are on a month-to-month basis or 0.2% of total annualized rental revenue.

 

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Retail Properties:

 

Lease Expiring (1)


   Rentable
Square Feet
Subject to
Expiring
Leases


   Percentage of
Leased
Square Footage
Represented by
Expiring Leases


    Annualized
Rental Revenue
Under Expiring
Leases (2)


  

Average

Annual
Rental Rate
Per Square
Foot for
Expirations


   Percent of
Annualized
Rental Revenue
Represented by
Expiring
Leases (2)


 
     ($ in thousands)  

2004 (3)

   201,846    13.7 %   $ 2,697    $ 13.36    7.5 %

2005

   152,280    10.4       2,929      19.23    8.2  

2006

   91,821    6.3       2,239      24.38    6.2  

2007

   92,813    6.3       2,390      25.75    6.7  

2008

   144,700    9.9       4,585      31.69    12.8  

2009

   169,809    11.6       4,881      28.74    13.6  

2010

   85,386    5.8       2,343      27.44    6.5  

2011

   57,783    3.9       1,869      32.35    5.2  

2012

   97,132    6.6       2,233      22.99    6.2  

2013

   132,377    9.0       3,355      25.34    9.3  

Thereafter

   242,083    16.5       6,372      26.32    17.8  
    
  

 

  

  

     1,468,030    100.0 %   $ 35,893    $ 24.45    100.0 %
    
  

 

  

  

 

Total:

 

Lease Expiring (1)


   Rentable
Square Feet
Subject to
Expiring
Leases


   Percentage of
Leased
Square Footage
Represented by
Expiring Leases


    Annualized
Rental Revenue
Under Expiring
Leases (2)


  

Average

Annual
Rental Rate
Per Square
Foot for
Expirations


   Percent of
Annualized
Rental Revenue
Represented by
Expiring
Leases (2)


 
     ($ in thousands)  

2004 (4)

   4,658,273    16.3 %   $ 61,677    $ 13.24    14.7 %

2005

   4,980,146    17.4       72,645      14.59    17.3  

2006

   4,074,527    14.3       63,597      15.61    15.2  

2007

   3,550,166    12.5       39,310      11.07    9.4  

2008

   3,646,243    12.8       55,003      15.08    13.1  

2009

   2,352,466    8.3       35,885      15.25    8.6  

2010

   1,433,633    5.0       27,275      19.03    6.5  

2011

   1,216,172    4.3       23,041      18.95    5.5  

2012

   663,621    2.3       13,232      19.94    3.2  

2013

   783,640    2.8       13,233      16.89    3.2  

Thereafter

   1,134,357    4.0       13,864      12.22    3.3  
    
  

 

  

  

     28,493,244    100.0 %   $ 418,762    $ 14.70    100.0 %
    
  

 

  

  


(1) Includes effects of any early renewals exercised by tenants on or before December 31, 2003.

 

(2) Annualized Rental Revenue is December 2003 rental revenue (base rent plus operating expense pass-throughs) multiplied by 12.

 

(3) Includes 34,000 square feet of leases that are on a month-to-month basis or 0.1% of total annualized rental revenue.

 

(4) Includes 295,000 square feet of leases that are on a month-to-month basis or 0.7% of total annualized rental revenue.

 

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Table of Contents

ITEM 3. LEGAL PROCEEDINGS

 

We are a party to a variety of legal proceedings arising in the ordinary course of our business. We believe that we are adequately covered by insurance and indemnification agreements. Accordingly, none of these proceedings are expected to have a material adverse effect on our business, financial condition and results of operations.

 

We accrued $2.7 million in 2002 for litigation expenses related to various legal proceedings from previously completed mergers and acquisitions. These claims were fully settled by early 2003.

 

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

None.

 

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ITEM X. EXECUTIVE OFFICERS OF THE REGISTRANT

 

The following table sets forth information with respect to our executive officers:

 

Name


  

Age


  

Position and Background


Edward J. Fritsch

   45    Director, President and Chief Executive Officer.
          Mr. Fritsch joined us in 1982. He was a partner of our predecessor. Mr. Fritsch served as our chief operating officer from January 1998 until December 2003 when he became president and chief operating officer. He became chief executive officer in July 2004.

Michael E. Harris

   54    Executive Vice President and Chief Operating Officer.
          Mr. Harris became chief operating officer in July 2004. Prior to that, Mr. Harris was a senior vice president and responsible for our operations in Tennessee, Missouri, Kansas and Charlotte. Mr. Harris was executive vice president of Crocker Realty Trust prior to its merger with us in 1996. Before joining Crocker Realty Trust, Mr. Harris served as senior vice president, general counsel and chief financial officer of Towermarc Corporation, a privately owned real estate development firm. Mr. Harris is a member of the Advisory Board of Directors at SouthTrust Bank of Memphis, and Allen & Hoshall, Inc.

Gene H. Anderson

   59    Director and Senior Vice President.
          Mr. Anderson manages the operations of our Georgia properties and the Piedmont Triad division of North Carolina. Mr. Anderson was the founder and president of Anderson Properties, Inc. prior to its merger with the Company in 1997.

Michael F. Beale

   51    Senior Vice President.
          Mr. Beale is responsible for our operations in Florida. Prior to joining us in 2000, Mr. Beale was vice president of Koger Equity, Inc.

Robert Cutlip

   54    Senior Vice President and Regional Manager.
          Prior to joining us in September 2003, Mr. Cutlip was vice president of real estate for Progress Energy, a public company, where he was responsible for the development and facilities management in North Carolina, South Carolina, and Florida. Before joining Progress Energy, Mr. Cutlip was executive vice president for the Carolinas and Tennessee Region of Duke-Weeks Realty, a Real Estate Investment Trust. Mr. Cutlip is chairman-elect of the National Association of Industrial and Office Properties, an industry association for commercial real estate with over 11,000 members nationwide.

Carman J. Liuzzo

   43    Vice President of Investments and Strategic Analysis.
          Mr. Liuzzo served as our vice president, chief financial officer and treasurer from 1994 until November 2003. Prior to joining us, Mr. Liuzzo was vice president and chief accounting officer for Boddie-Noell Enterprises, Inc. and Boddie-Noell Restaurant Properties, Inc.

Mack D. Pridgen III

   55    Vice President, General Counsel and Secretary.
          Prior to joining us in 1997, Mr. Pridgen was a partner with Smith Helms Mullis & Moore, L.L.P. and prior to that a partner with Arthur Andersen & Co. Mr. Pridgen is an attorney and a certified public accountant.

W. Brian Reames

   41    Senior Vice President and Regional Manager.
          Mr. Reames became senior vice president and regional manager in August 2004 and has responsibility for our operations in Nashville, Memphis, Charlotte, Greenville and Columbia. Prior to that, Mr. Reames was vice president responsible for the Nashville division, a position held since 1996. Mr. Reames was a partner and owner at Eakin & Smith, Inc., a Nashville based office real estate development, leasing and management firm from 1989 until the merger with Highwoods Properties in April 1996.

 

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Table of Contents

Terry L. Stevens

   56    Vice President, Chief Financial Officer and Treasurer.
          Prior to joining us in December 2003, Mr. Stevens was executive vice president, chief financial officer and trustee for Crown American Realty Trust, a public company. Before joining Crown American Realty Trust, Mr. Stevens was director of financial systems development at AlliedSignal, Inc., a large multi-national manufacturer. Mr. Stevens was also an audit partner with Price Waterhouse. Mr. Stevens currently serves as trustee, chairman of the Audit Committee and member of the Compensation Committee of First Potomac Realty Trust, a public company.

 

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Table of Contents

 

PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON STOCK AND RELATED STOCKHOLDER MATTERS

 

The Common Stock has been traded on the New York Stock Exchange (“NYSE”) under the symbol “HIW” since the Company’s initial public offering. The following table sets forth the quarterly high and low stock prices per share reported on the NYSE for the quarters indicated and the dividends paid per share during such quarter.

 

     2003

   2002

Quarter Ended


   High

   Low

   Dividend

   High

   Low

   Dividend

March 31

   $ 22.38    $ 20.00    $ .585    $ 28.30    $ 25.39    $ .585

June 30

     22.77      20.17      .425      29.36      26.00      .585

September 30

     23.97      22.31      .425      26.65      23.00      .585

December 31

     26.02      24.32      .425      23.30      18.70      .585

 

On October 22, 2004, the last reported stock price of the Common Stock on the NYSE was $25.11 per share and the Company had 1,417 stockholders of record.

 

The Company intends to continue to pay quarterly dividends to holders of shares of Common Stock and holders of Common Units. Future dividend payments by the Company will be at the discretion of the Board of Directors and will depend on the actual funds from operations of the Company, its financial condition, capital requirements, the annual dividend requirements under the REIT provisions of the Internal Revenue Code and such other factors as the Board of Directors deems relevant. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources –Stockholder Dividends.”

 

During 2003, the Company’s Common Stock dividends totaled $1.86 per share, $1.18 of which represented return of capital for income tax purposes. The minimum dividend per share of Common Stock required for the Company to maintain its REIT status (excluding any net capital gains) was approximately $0.07 per share in 2003 and $0.90 per share in 2002.

 

The Company has a Dividend Reinvestment and Stock Purchase Plan under which holders of Common Stock may elect to automatically reinvest their dividends in additional shares of Common Stock and may make optional cash payments for additional shares of Common Stock. The Company may issue additional shares of Common Stock or repurchase Common Stock in the open market for purposes of satisfying its obligations under the Dividend Reinvestment and Stock Purchase Plan.

 

The Company has an Employee Stock Purchase Plan for all active employees. At the end of each three-month offering period, each participant’s account balance is applied to acquire shares of Common Stock at a cost that is calculated at 85.0% of the lower of the average closing price on the NYSE on the five consecutive days preceding the first day of the quarter or the five days preceding the last day of the quarter. Participants may contribute up to 25.0% of their pay. During 2003, employees purchased 50,812 shares of Common Stock under the Employee Stock Purchase Plan.

 

The section under the heading entitled “Equity Compensation Plan Information” in the Proxy Statement is incorporated herein by reference, except as noted in Item 11.

 

During the three months ended December 31, 2003, the Company issued 257,508 shares of Common Stock to holders of Common Units in the Operating Partnership upon the redemption of such Common Units in private offerings pursuant to Section 4(2) of the Securities Act. Each of the holders of the redeemed Common Units was an accredited investor under Rule 501 of the Securities Act. The Company has registered the resale of such shares under the Securities Act.

 

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ITEM 6. SELECTED FINANCIAL DATA

 

The following selected financial data as of December 31, 2003 and 2002 and for the three years ended December 31, 2003 is derived from the Company’s audited Consolidated Financial Statements included elsewhere herein. The selected financial data as of December 31, 2001, 2000 and 1999 and for the two years ended December 31, 2000 is derived from previously issued financial statements adjusted for revisions related to the restatements discussed below.

 

The Company has restated its results for the five-year period from 1999 through 2003. These restatements resulted from adjustments related to the accounting for a limited number of its prior real estate sales transactions occurring between 1999 and 2003, reclassifications for discontinued operations, accounting for minority interest, accounting for a debt retirement, and other items. Refer to Note 18 to the Consolidated Financial Statements for further discussion of the restatement adjustments. The information in the following table should be read in conjunction with the Company’s audited Consolidated Financial Statements and related notes included herein:

 

     Year Ended December 31,

 
     2003(1)

    2002(1)

    2001(1)

    2000(1)

    1999(1)

 

Rental and other revenues

   $ 504,699     $ 521,725     $ 535,375     $ 526,143     $ 557,379  

Operating expenses:

                                        

Rental property and other expenses

     178,412       169,563       169,056       157,881       171,388  

Depreciation and amortization

     142,103       140,790       127,627       114,374       107,501  

Impairment of assets held for use

     —         9,919       —         —         —    

General and administrative

     25,269       26,192       23,386       24,068       23,464  

Litigation expense

     —         2,700       —         —         —    

Cost of unsuccessful transactions

     —         —         —         —         1,500  
    


 


 


 


 


Total operating expenses

     345,784       349,164       320,069       296,323       303,853  

Interest expense:

                                        

Contractual

     119,526       118,952       118,896       108,353       115,399  

Amortization of deferred financing costs

     4,405       3,469       4,038       3,196       3,505  

Financing obligations

     17,691       12,488       11,841       1,773       1,065  
    


 


 


 


 


Total interest expense

     141,622       134,909       134,775       113,322       119,969  

Other income/expense:

                                        

Interest and other income

     6,220       7,713       13,991       9,680       9,566  

Loss on debt extinguishments

     (14,653 )     (378 )     (714 )     (4,711 )     (7,341 )

Gain on extinguishment of co-venture obligation

     16,301       —         —         —         —    
    


 


 


 


 


Total other income/expense

     7,868       7,335       13,277       4,969       2,225  
    


 


 


 


 


Income before disposition of property, co-venture expense, minority interest and equity in earnings of unconsolidated affiliates

     25,161       44,987       93,808       121,467       135,782  

Gains on disposition of property, net

     12,316       22,692       21,910       3,398       6,475  

Co-venture expense

     (4,588 )     (7,730 )     (6,859 )     (158 )     —    

Minority interest in the Operating Partnership

     (813 )     (4,347 )     (10,776 )     (12,050 )     (14,694 )

Equity in earnings of unconsolidated affiliates

     4,952       5,640       7,536       2,649       914  
    


 


 


 


 


Income from continuing operations

     37,028       61,242       105,619       115,306       128,477  

Discontinued operations net of minority interest

     10,916       20,635       11,761       11,728       8,268  
    


 


 


 


 


Net income

     47,944       81,877       117,380       127,034       136,745  

Dividends on preferred stock

     (30,852 )     (30,852 )     (31,500 )     (32,580 )     (32,580 )

Excess of preferred stock carrying value over repurchase value

     —         —         1,012       —         —    
    


 


 


 


 


Net income available for common stockholders

   $ 17,092     $ 51,025     $ 86,892     $ 94,454     $ 104,165  
    


 


 


 


 


Net income per common share – basic:

                                        

Income from continuing operations

   $ 0.12     $ 0.57     $ 1.39     $ 1.40     $ 1.56  
    


 


 


 


 


Net income

   $ 0.32     $ 0.96     $ 1.61     $ 1.60     $ 1.70  
    


 


 


 


 


Net income per common share – diluted:

                                        

Income from continuing operations

   $ 0.12     $ 0.57     $ 1.37     $ 1.39     $ 1.56  
    


 


 


 


 


Net income

   $ 0.32     $ 0.95     $ 1.59     $ 1.59     $ 1.69  
    


 


 


 


 


Dividends declared per common share

   $ 1.86     $ 2.34     $ 2.31     $ 2.25     $ 2.19  
    


 


 


 


 


 

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     Year Ended December 31,

     2003(1)

   2002(1)

   2001(1)

   2000(1)

   1999(1)

Balance Sheet Data:

                                  

Net real estate assets

   $ 3,224,214    $ 3,357,578    $ 3,564,017    $ 3,447,776    $ 3,637,018

Total assets

   $ 3,543,023    $ 3,769,086    $ 3,972,340    $ 4,032,906    $ 4,036,917

Total mortgages and notes payable

   $ 1,717,765    $ 1,793,760    $ 1,961,470    $ 1,825,586    $ 1,766,117

Financing obligations

   $ 124,063    $ 121,012    $ 76,089    $ 73,620    $ 22,651

Co-venture obligation

   $ —      $ 43,511    $ 40,482    $ 36,046    $ —  

Cumulative redeemable preferred shares

     377,445      377,445      377,445      397,500      397,500

Number of wholly owned in-service properties

     465      493      498      493      563

Total rentable square feet

     34,922,000      37,112,000      37,221,000      36,183,000      38,976,000

(1) In October 2001, the FASB issued SFAS No. 144 which requires assets classified as held for sale or sold as a result of disposal activities initiated subsequent to January 1, 2002 and whereby the operations and cash flows have been or will be eliminated from the ongoing operations of the Company and we will not have any significant continuing involvement in the operations after the disposal transaction to be reported as discontinued operations. Thus, in all periods presented above, we have reclassified to discontinued operations the operations and/or gain/(loss) from disposal of those properties that qualify for such treatment under SFAS No. 144.

 

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

You should read the following discussion and analysis in conjunction with the accompanying Consolidated Financial Statements and related notes contained elsewhere in this amended Annual Report on Form 10-K.

 

DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS

 

Some of the information in this amended Annual Report on Form 10-K may contain forward-looking statements. Such statements include, in particular, statements about our plans, strategies and prospects under this section and under the heading “Business.” You can identify forward-looking statements by our use of forward-looking terminology such as “may,” “will,” “expect,” “anticipate,” “estimate,” “continue” or other similar words. Although we believe that our plans, intentions and expectations reflected in or suggested by such forward-looking statements are reasonable, we cannot assure you that our plans, intentions or expectations will be achieved. When considering such forward-looking statements, you should keep in mind the following important factors that could cause our actual results to differ materially from those contained in any forward-looking statement:

 

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

 

  the financial condition of our tenants could deteriorate;

 

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

 

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

 

  an unexpected increase in interest rates would increase our debt service costs;

 

  we may not be able to continue to meet our long-term liquidity requirements on favorable terms;

 

  we could lose key executive officers; and

 

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

 

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

 

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

 

OVERVIEW

 

We are a fully integrated, self-administered REIT that provides leasing, management, development, construction and other customer-related services for our properties and for third parties. As of December 31, 2003, we own or have an interest in 530 in-service office, industrial and retail properties, encompassing approximately 41.7 million square feet. As of that date, we also owned 1,305 acres of development land, which is suitable to develop approximately 14.3 million rentable square feet of office, industrial and retail space. We are based in Raleigh, North Carolina, and our properties and development land are located in Florida, Georgia, Iowa, Kansas, Maryland, Missouri, North Carolina, South Carolina, Tennessee and Virginia.

 

We have restated our Consolidated Financial Statements contained herein and related financial information for the five-year period from 1999 through 2003. These restatements resulted primarily from adjustments related to the accounting for a limited number of our prior real estate sales transactions with continuing involvement occurring between 1999 and 2003, reclassifications for discontinued operations, accounting for minority interest, accounting for a debt retirement, and other items. Refer to Note 18 to the Consolidated Financial Statements for a more complete description of these adjustments. The following information should be read in conjunction with our audited Consolidated Financial Statements and related notes included herein.

 

Management of the Company is ultimately responsible for preparing and presenting the Company’s financial statements in accordance with GAAP. As part of these processes, we consulted with Ernst & Young LLP in their capacity as our independent auditors regarding the application of GAAP. In particular, we consulted with Ernst & Young LLP regarding certain of the real estate sales transactions with continuing involvement, accounting for the MOPPRS debt extinguishment in 2003, accounting for minority interest in the Operating Partnership, and accounting for the compensation costs to be recognized in 2004 in connection with the retirement of the Company’s former CEO.

 

Results of Operations

 

During 2003, approximately 84.0% of our rental revenue was derived from our office properties. As a result, while we own and operate a limited number of industrial and retail properties, our operating results depend heavily on successfully leasing our office properties. Furthermore, since most of our office properties are located in Florida, Georgia and North Carolina, employment growth in those states is and will continue to be an important determinative factor in predicting our future operating results.

 

The key components affecting our revenue stream are average occupancy and rental rates. During the past several years, as the average occupancy of our portfolio has decreased, our same property rental revenue has declined. Average occupancy generally increases during times of improving economic growth, as our ability to lease space outpaces vacancies that occur upon the expirations of existing leases, while average occupancy generally declines during times of slower economic growth, when new vacancies tend to outpace our ability to lease space. Asset acquisitions and dispositions also impact our rental revenues and could impact our average occupancy, depending upon the occupancy percentage of the properties that are acquired or sold.

 

Whether or not our rental revenue tracks average occupancy proportionally depends upon whether rents under new leases are higher or lower than the rents under the previous leases. During 2003, the average straight-lined rate per square foot on new leases signed in our Wholly Owned Properties was 0.7% lower than the average straight-lined rate per square foot on the expiring leases. A further indicator of the predictability of future revenues is the expected lease expirations of our portfolio. Our average office lease term, excluding renewal periods is 4.5 years. At December 31, 2003, the occupancy rate for our Wholly Owned Properties was 81.5%, and during 2004 leases on approximately 4.7 million square feet of space will expire that have not been renewed as of December 31, 2003. This square footage represents approximately 15% of our annualized rental revenue. As of September 30, 2004, based on our leasing efforts since December 31, 2003 and on other activity such as early lease terminations, the occupancy rate for our Wholly Owned Properties improved to 83.2%. As a result, in addition to seeking to increase our average occupancy by leasing current vacant space, we also must concentrate our leasing efforts on renewing leases on expiring space. For more information regarding our lease expirations, see “Properties – Lease Expirations.”

 

Our expenses primarily consist of depreciation and amortization, general and administrative expenses, rental property expenses and interest expense. Depreciation and amortization is a non-cash expense associated with the ownership of real property and generally remains relatively consistent each year, unless we buy or sell assets, since we depreciate our properties on a straight-line basis. General and administrative expenses, net of amounts capitalized, consist primarily of management and employee salaries and other personnel costs, corporate overhead and long-term incentive compensation. Rental property expenses are expenses associated with our ownership and

 

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operation of rental properties and include variable expenses, such as common area maintenance and utilities, and fixed expenses, such as property taxes and insurance. Some of these variable expenses may be lower as our average occupancy declines, while the fixed expenses remain constant regardless of average occupancy. Interest expense depends upon the amount of our borrowings, the weighted average interest rates on our debt and the amount capitalized on development projects.

 

We also record income from our investments in unconsolidated affiliates, which are our joint ventures except for two joint ventures which are included in our Consolidated Financial Statements as a result of our continuing involvement with the properties – see Note 3 to the Consolidated Financial Statements. We record in “equity in earnings of unconsolidated affiliates” our proportionate share of the unconsolidated joint ventures’ net income or loss. During 2003, income earned from these unconsolidated joint ventures aggregated $5.0 million, which represented approximately 10.3% of our total net income.

 

Additionally, SFAS No. 144 requires us to record net income received from properties sold or held for sale that qualify as discontinued operations under SFAS No. 144 separately as “income from discontinued operations.” As a result, we separately record revenues and expenses from these qualifying properties. During 2003, income, including gains and losses from the sale of properties, from discontinued operations accounted for approximately 22.8% of our total net income.

 

Liquidity and Capital Resources

 

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

 

Because we are a REIT, we are required under the federal tax laws to distribute at least 90.0% of our REIT taxable income to our stockholders. We generally use rents received from customers to fund our operating expenses, recurring capital expenditures and stockholder dividends. To fund property acquisitions, development activity or building renovations, we incur debt from time to time. As of December 31, 2003, we had approximately $982.8 million of secured debt outstanding and $735.0 million of unsecured debt outstanding. Our debt consists of mortgage debt, unsecured debt securities and borrowings under our Revolving Loan. As of October 22, 2004, we have approximately $47.3 million of additional borrowing availability under our Revolving Loan and our short-term cash needs (for the remainder of 2004) include, among other things, the funding of $9.4 million in development activity and $214.8 million in principal payments due on our long-term debt in the remainder of 2004 and 2005 which excludes $100.0 million related to Put Option Notes, which were extinguished in June, 2004.

 

Our Revolving Loan and the indenture governing our outstanding long-term unsecured debt securities each require us to satisfy various operating and financial covenants and performance ratios. As a result, to ensure that we do not violate the provisions of these debt instruments, we may from time to time be limited in undertaking certain activities that may otherwise be in the best interest of our stockholders, such as repurchasing capital stock, acquiring additional assets, increasing the total amount of our debt or increasing stockholder dividends. We review our current and expected operating results, financial condition and planned strategic actions on an ongoing basis for the purpose of monitoring our continued compliance with these covenants and ratios. While we are currently in compliance with these covenants and ratios and expect to remain so for the foreseeable future, we cannot provide any assurance of continued compliance and any failure to remain in compliance could result in an acceleration of some or all of our debt, severely restrict our ability to incur additional debt to fund short- and long-term cash needs or result in higher interest expense. See Note 5 to the Consolidated Financial Statements for disclosure regarding a waiver of and amendments to these covenants in 2004.

 

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To generate additional capital to fund our growth and other strategic initiatives and to lessen the ownership risks typically associated with owning 100.0% of a property, we may sell some of our properties or contribute them to joint ventures. When we create a joint venture with a strategic partner, we usually contribute one or more properties that we own and/or vacant land to a newly formed entity in which we retain an interest of 50.0% or less. In exchange for our equal or minority interest in the joint venture, we generally receive cash from the partner and retain all of the management income relating to the properties in the joint venture. The joint venture itself will frequently borrow money on its own behalf to finance the acquisition of, and/or leverage the return upon, the properties being acquired by the joint venture or to build or acquire additional buildings. Such borrowings are typically on a non-recourse or limited recourse basis. We generally are not liable for the debts of our joint ventures, except to the extent of our equity investment, unless we have directly guaranteed any of that debt. In most cases, we and/or our strategic partners are required to guarantee customary exceptions to non-recourse liability in non-recourse loans. See Note 15 to the Consolidated Financial Statements for additional information on certain debt guarantees.

 

We have historically also sold additional Common Stock or Preferred Stock, or issued Common Units to fund additional growth or to reduce our debt, but we have limited those efforts during the past five years because funds generated from our capital recycling program in recent years have provided sufficient funds. In addition, we used funds from our capital recycling to repurchase Common Stock in 2003, 2002 and 2001 and Preferred Stock in 2001.

 

Management’s Analysis

 

We believe that funds from operations (“FFO”) and FFO per share are beneficial to management and investors and are important indicators of the performance of any equity REIT. Because FFO and FFO per share calculations exclude such factors as depreciation and amortization of real estate assets and gains or losses from sales of real estate (which can vary among owners of identical assets in similar conditions based on historical cost accounting and useful life estimates), they facilitate comparisons of operating performance between periods and between other REITs. Our management believes that historical cost accounting for real estate assets in accordance with Accounting Principles Generally Accepted in the United States (“GAAP”) implicitly assumes that the value of real estate assets diminishes predictably over time. Since real estate values have historically risen or fallen with market conditions, many industry investors and analysts have considered the presentation of operating results for real estate companies that use historical cost accounting to be insufficient by themselves. As a result, management believes that the use of FFO and FFO per share, together with the required GAAP presentations, provide a more complete understanding of the Company’s performance relative to its competitors and a more informed and appropriate basis on which to make decisions involving operating, financing and investing activities. See “Funds from Operations.”

 

RESULTS OF OPERATIONS

 

On January 1, 2002, we adopted SFAS No. 144. As described in Note 12 to the Consolidated Financial Statements, we reclassified the operations and/or gain/(loss) from the disposal of certain properties to discontinued operations for all periods presented if the operations and cash flows have been or will be eliminated from our ongoing operations and we will not have any significant continuing involvement in the operations after the disposal transaction and the properties were either sold during 2003 and 2002 or were held for sale at December 31, 2003. Accordingly, the operations and gain/(loss) from the properties disposed of during 2001 and certain properties disposed of during 2002 were not reclassified to discontinued operations.

 

As more fully described in Note 18 to the Consolidated Financial Statements, three of our prior real estate sales transactions are accounted for as financing and/or profit-sharing arrangements. Although the rental revenues and operating expenses of these properties are recorded in our Consolidated Financial Statements, the net income excluding depreciation that is allocated to our partner or the third party buyer (to the extent of their ownership interest) is reclassified as interest expense for a financing arrangement or co-venture expense for a profit-sharing arrangement.

 

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Comparison of 2003 to 2002

 

The following table sets forth information regarding our restated results of operations for the years ended December 31, 2003 and 2002 ($ in millions):

 

     Year Ended December 31,

   

2003

to 2002

$ Change


   

% of

Change


 
     2003

    2002

     

Rental and other revenues

   $ 504.7     $ 521.7     $ (17.0 )   (3.3 )%

Operating expenses:

                              

Rental property and other expenses

     178.4       169.5       8.9     5.3  

Depreciation and amortization

     142.1       140.8       1.3     0.9  

Impairment of assets held for use

     —         9.9       (9.9 )   (100.0 )

General and administrative

     25.3       26.2       (0.9 )   (3.4 )

Litigation expense

     —         2.7       (2.7 )   (100.0 )
    


 


 


 

Total operating expenses

     345.8       349.1       (3.3 )   (0.9 )
    


 


 


 

Interest expense:

                              

Contractual

     119.5       119.0       0.5     0.4  

Amortization of deferred financing costs

     4.4       3.4       1.0     29.4  

Financing obligations

     17.7       12.5       5.2     41.6  
    


 


 


 

       141.6       134.9       6.7     5.0  

Other income/expense:

                              

Interest and other income

     6.2       7.7       (1.5 )   (19.5 )

Loss on debt extinguishments

     (14.6 )     (0.4 )     (14.2 )   3,550.0  

Gain on extinguishment of co-venture obligation

     16.3       —         16.3     100.0  
    


 


 


 

       7.9       7.3       0.6     8.2  
    


 


 


 

Income before disposition of property, co-venture expense, minority interest and equity in earnings of unconsolidated affiliates

     25.2       45.0       (19.8 )   (44.0 )

Gains on disposition of property, net

     12.3       22.7       (10.4 )   (45.8 )

Co-venture expense

     (4.6 )     (7.7 )     3.1     (40.3 )

Minority interest in the Operating Partnership

     (0.8 )     (4.4 )     3.6     (81.8 )

Equity in earnings of unconsolidated affiliates

     5.0       5.6       (0.6 )   (10.7 )
    


 


 


 

Income from continuing operations

     37.1       61.2       (24.1 )   (39.4 )

Discontinued operations:

                              

Income from discontinued operations, net of minority interest

     2.4       9.1       (6.7 )   (73.6 )

Gain on sale of discontinued operations, net of minority interest

     8.5       11.6       (3.1 )   (26.7 )
    


 


 


 

       10.9       20.7       (9.8 )   (47.3 )
    


 


 


 

Net income

     48.0       81.9       (33.9 )   (41.4 )

Dividends on preferred stock

     (30.9 )     (30.9 )     —       —    
    


 


 


 

Net income available for common stockholders

   $ 17.1     $ 51.0     $ (33.9 )   (66.5 )%
    


 


 


 

 

Rental and Other Revenues

 

The decrease in rental and other revenues from continuing operations was primarily the result of (1) a decrease in average occupancy rates in our Wholly Owned Properties from 86.4% for the year ended December 31, 2002 to 82.7% for the year ended December 31, 2003, and (2) from the effect of properties sold in 2003 and 2002 that were not accounted for as discontinued operations. The decrease in average occupancy rates was primarily a result of the disposition of certain properties and the bankruptcies of WorldCom and US Airways, which decreased average occupancy rates by 2.8% and rental and other revenues from continuing operations by $15.4 million. Amounts partly offsetting these decreases were: (1) during 2002, approximately $3.1 million of straightline rental income was written off in connection with the bankruptcy of WorldCom; (2) 2.0 million square feet of development properties were placed in-service and, as a result, increased rental and other revenues from continuing operations by approximately $8.6 million; and (3) rental revenues in 2002 only included a partial year of rental revenues from the Harborview Plaza transaction which occurred in June 2002, increasing 2003 rental revenues by approximately $3.8 million. In addition, construction income increased from 2002 to 2003, as a result of the development of certain office condominiums in 2003. Recovery income from certain operating expenses have decreased in the year ended December 31, 2003 due to lower occupancy.

 

During the year ended December 31, 2003, 954 second generation leases representing 7.6 million square feet of office, industrial and retail space were executed in our Wholly Owned Properties. The average rate per square foot

 

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on a GAAP basis over the lease term for leases executed in the year ended December 31, 2003 was 0.7% lower than the rent paid by previous customers.

 

As of the date of this filing, we are beginning to see a modest improvement in employment trends in several of our markets and an improving economic climate in the Southeast. There has been modest positive absorption of office space in most of our markets during the last five quarters. Occupancy in our Wholly Owned Properties increased to 83.2% at September 30, 2004 from 81.5% at December 31, 2003. We expect occupancy to increase modestly during the remainder of 2004.

 

Operating Expenses

 

The increase in rental and other operating expenses from continuing operations (real estate taxes, utilities, insurance, repairs and maintenance and other property-related expenses) primarily resulted from (1) general inflationary increases particularly compensation, utility costs, real estate taxes and insurance and (2) the fact that certain fixed operating expenses do not vary with net changes in our occupancy percentages, such as real estate taxes, insurance and utility rate changes. In addition, we had 2.0 million square feet of development properties placed in service during 2002 that resulted in an increase in rental and other operating expenses from continuing operations. Partly offsetting these increases was a decrease in rental and other operating expenses from continuing operations of properties sold in 2003 and 2002 that were not accounted for as discontinued operations.

 

Rental and other operating expenses as a percentage of rental and other revenue increased from 32.5% for the year ended December 31, 2002 to 35.4% for the year ended December 31, 2003. The increase was a result of the increases in rental and other operating expenses as described above and a decrease in rental and other revenues, primarily due to lower average occupancy, as described above.

 

Excluding the effects of property acquisitions or dispositions, we expect property and other operating expenses to increase slightly in 2004 due to inflationary increases along with increases in certain fixed operating expenses that do not vary with occupancy such as real estate taxes and utility rate changes.

 

The increase in depreciation and amortization from continuing operations in 2003 related to $14.0 million in depreciation from buildings, leasing commissions and tenant improvement expenditures for properties placed in-service during 2002 and $4.5 million from the write-off of deferred leasing costs and tenant improvements for customers who vacated their space prior to lease expiration. Partly offsetting these increases was a decrease in depreciation and amortization from continuing operations of properties sold in 2003 and 2002 that were not accounted for as discontinued operations.

 

Because there were no properties held for use with indicators of impairment and with carrying value exceeding the sum of their undiscounted future cash flows, no impairment loss related to properties held for use was recognized during the year ended December 31, 2003. For the year ended December 31, 2002, the impairment loss on properties held for use with a carrying value exceeding the sum of their undiscounted future cash flows was $0.8 million. We also recognized a $9.1 million impairment loss related to one office property, which had a carrying value in excess of the sum of the property’s undiscounted future cash flows, that has been demolished and may be redeveloped into a class A suburban office property in the future.

 

General and administrative expenses, net of amounts capitalized, decreased $0.9 million for the year ended December 31, 2003 compared to the year ended December 31, 2002. The decrease occurred because 2002 included $3.7 million of stock option expense related to option exercises; there was no corresponding expense in 2003. This decrease was offset by a decrease in 2003 of capitalization of certain general and administrative costs due to the decrease in development and leasing activity, an increase in long-term incentive compensation expense as a result of the issuance of restricted and phantom stock during 2003 and 2002, and higher expenses related to employee compensation from normal salary increases.

 

We accrued $2.7 million in the year ended December 31, 2002 for litigation expense related to various legal proceedings from previously completed mergers and acquisitions. These claims were fully paid and settled by early 2003.

 

In 2004, general and administrative expenses are expected to increase significantly due to inflationary increases in compensation, benefits and other expenses related to the implementation of the Sarbanes-Oxley Act, costs

 

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associated with the retirement package for our Chief Executive Officer, professional fees and other costs related to consideration of a strategic transaction that were incurred largely in the third quarter 2004, and professional fees and other costs related to the restatement of the Company’s financial statements.

 

Interest Expense

 

Contractual interest expense increased by $0.5 million in 2003. As a result of decreased development activity in 2003, capitalized interest decreased from $7.0 million for the year ended December 31, 2002 to $1.2 million for the year ended December 31, 2003, resulting in an increase in interest expense from continuing operations in 2003. Offsetting this increase was a decrease in interest caused by a decrease of approximately $95 million in the average outstanding debt balances in 2003 compared to 2002, and a decrease in average interest rates from 6.5% in 2002 to 6.4% in 2003.

 

Interest expense for the years ended December 31, 2003 and 2002 included $4.4 million and $3.4 million, respectively, of amortization of deferred financing costs.

 

Interest expense on financing obligations increased by $5.2 million in 2003 – see Note 3 to the Consolidated Financial Statements for additional information on our financing transactions. Of the total $5.2 million increase, $4.6 million occurred because 2002 only included a partial year of interest expense on financing obligations from the Harborview and Eastshore transactions which closed in September 2002 and in November 2002, respectively. The remainder of the increase relates to interest on the MG-HIW Orlando financing transaction.

 

Total interest expense is expected to decline in 2004 primarily due to (1) the December 1, 2003 refinancing of certain long-term debt with new borrowings that have lower interest rates, (2) the June 2004 refinancing of the Put Option Notes with borrowings on the Company’s Revolving Loan which currently has lower floating rate interest, (3) purchase of our partner’s interest in the Orlando City Group properties in MG-HIW, LLC in March 2004 which eliminated interest on the $62.5 million financing obligation, and (4) selling a 60.0% interest in these Orlando properties in June 2004 into a joint venture and the resultant elimination of interest from the related $136.2 million of secured debt. These transactions are discussed in the footnotes to the Consolidated Financial Statements.

 

Other Income/Expense

 

The decrease in interest and other income in 2003 is primarily related to the collection of a legal settlement amounting to $1.6 million recorded as other income in the year ended December 31, 2002 related to previously completed mergers and acquisitions offset by a decrease in interest income due to the collection of notes receivable during the years ended December 31, 2002 and 2003 and lower interest rates earned on cash reserves.

 

Loss on debt extinguishments increased $14.2 million from 2002 to 2003 due primarily to the $14.7 million loss recorded in early 2003 related to the MOPPRS debt retirement transaction described in Note 5 to the Consolidated Financial Statements.

 

In July 2003, we acquired our partner’s interest in the MG-HIW, LLC non-Orlando City Group properties and recognized a $16.3 million gain upon settlement of the $44.5 million co-venture obligation that was recorded on our books. As described in Note 3 to the Consolidated Financial Statements, the non-Orlando City Group properties in MG-HIW, LLC were accounted for as a profit sharing arrangement.

 

Gains on Disposition of Property; Co-venture Expense; Minority Interest; Equity in Earnings of Unconsolidated Affiliates

 

In 2003, gain on disposition of properties was comprised of a (1) $8.7 million net gain related primarily to the disposition of approximately 1.0 million square feet of office properties that did not meet certain conditions to be classified as discontinued operations, (2) $3.8 million net gain related to the disposition of 108.5 acres of land, which includes a gain of approximately $1.0 million related to the condemnation of 4.0 acres of land and an impairment loss of $0.5 million related to three land parcels held for sale at December 31, 2003, and (3) a $0.2 million impairment loss on depreciable properties. In 2002, gain on disposition of properties was comprised of a $15.5 million net gain related to the disposition of 533,263 square feet of office properties, that did not meet certain conditions to be classified as discontinued operations, and a $7.2 million net gain related to the disposition of 112.7 acres of land.

 

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Co-venture expense relates to the operations of the MG-HIW, LLC non-Orlando City Group properties accounted for as a profit-sharing arrangement, as more fully described in Note 3 to the Consolidated Financial Statements. The decrease of $3.1 million in co-venture expense in 2003 is largely due to our acquisition of our partner’s interest in the non-Orlando City Group properties in July 2003 and the resultant elimination of recording co-venture expense as of that date.

 

Minority interest in the continuing operations income of the Operating Partnership, after preferred partnership unit distributions, decreased from $4.4 million in 2002 to $0.8 million in 2003 because of a corresponding reduction in the Operating Partnership’s income from continuing operations.

 

The decrease in equity in earnings from continuing operations of unconsolidated affiliates was primarily a result of lower occupancy in 2003 for certain joint ventures. Partly offsetting this decrease was an increase of $0.5 million in equity in earnings in 2003 related to a charge taken by a certain joint venture in 2002 related to an early extinguishment of debt loss resulting in a decrease in equity in earnings of $0.3 million in 2002 and an increase in equity in earnings in 2003 of $0.2 million as a result of a gain recognized by a certain joint venture related to the disposition of land in 2003.

 

Discontinued Operations

 

In accordance with SFAS No. 144, we classified net income of $10.9 million and $20.7 million, net of minority interest, as discontinued operations for the year ended December 31, 2003 and 2002, respectively. These amounts pertained to 2.3 million square feet of property, four apartment units and 122.8 acres of revenue-producing land sold during 2002 and 2003 and 274,744 square feet of property and 88 apartment units held for sale at December 31, 2003. These amounts include gain on the sale of these properties, net of impairment charges related to discontinued operations, of $8.5 million and $11.6 million, net of minority interest, in 2003 and 2002, respectively.

 

Preferred Stock Dividends

 

We recorded $30.9 million in Preferred Stock dividends in each of the years ended December 31, 2003 and 2002.

 

Net Income

 

We recorded net income in 2003 of $48.0 million, which was a 41.4% decrease from net income of $81.9 million in 2002, primarily due to a decrease in rental revenues as a result of lower occupancy and the bankruptcies of WorldCom and US Airways, the effects on continuing and discontinued operations from being a net seller in 2003 and 2002 of operating properties under our capital recycling plan, an increase in interest expense and increased loss on debt extinguishments in 2003. These decreases were offset by the contribution of development properties placed in service during 2003 and by the gain on settlement of the co-venture obligation related to the MG-HIW, LLC non-Orlando properties. In 2004, we expect net income to be lower as compared with 2003 due to flat average occupancy and pressure on rental rates, higher depreciation and amortization, higher property operating costs, loss on extinguishment of the Exercisable Put Option Notes on June 15, 2004, and higher general and administrative costs (including costs associated with our CEO’s retirement package, professional fees and other costs related to consideration of a strategic transaction and professional fees and other costs related to the restatement of our financial statements), which amounts should be offset by lower interest expense and settlement of our bankruptcy claim against WorldCom as more fully described in Note 20 to the Consolidated Financial Statements.

 

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Comparison of 2002 to 2001

 

The following table sets forth information regarding our restated results of operations for the years ended December 31, 2002 and 2001 ($ in millions):

 

     Year Ended December 31,

   

2002

to 2001

$ Change


   

% of

Change


 
   2002

    2001

     
          

Rental and other revenues

   $ 521.7     $ 535.4     $ (13.7 )   (2.6 )%

Operating expenses:

                              

Rental property and other expenses

     169.5       169.1       0.4     0.2  

Depreciation and amortization

     140.8       127.6       13.2     10.3  

Impairment of assets held for use

     9.9       —         9.9     100.0  

General and administrative

     26.2       23.4       2.8     12.0  

Litigation expense

     2.7       —         2.7     100.0  
    


 


 


 

Total operating expenses

     349.1       320.1       29.0     9.1  
    


 


 


 

Interest expense:

                              

Contractual

     119.0       118.9       0.1     (0.1 )

Amortization of deferred financing costs

     3.4       4.0       (0.6 )   (15.0 )

Financing obligations

     12.5       11.9       0.6     5.0  
    


 


 


 

       134.9       134.8       0.1     (0.1 )

Other income/expense:

                              

Interest and other income

     7.7       14.0       (6.3 )   (45.0 )

Loss on debt extinguishments

     (0.4 )     (0.7 )     0.3     (42.9 )
    


 


 


 

       7.3       13.3       (6.0 )   (45.1 )
    


 


 


 

Income before disposition of property, co-venture expense, minority interest and equity in earnings of unconsolidated affiliates

     45.0       93.8       (48.8 )   (52.0 )

Gains on disposition of property, net

     22.7       21.9       0.8     3.7  

Co-venture expense

     (7.7 )     (6.8 )     (0.9 )   13.2  

Minority interest in the Operating Partnership

     (4.4 )     (10.8 )     6.4     (59.3 )

Equity in earnings of unconsolidated affiliates

     5.6       7.5       (1.9 )   (25.3 )
    


 


 


 

Income from continuing operations

     61.2       105.6       (44.4 )   (42.1 )

Discontinued operations:

                              

Income from discontinued operations, net of minority interest

     9.1       11.8       (2.7 )   (22.9 )

Gain on sale of discontinued operations, net of minority interest

     11.6       —         11.6     100.0  
    


 


 


 

       20.7       11.8       8.9     75.4  
    


 


 


 

Net income

     81.9       117.4       (35.5 )   (30.2 )

Dividends on preferred stock

     (30.9 )     (31.5 )     0.6     (1.9 )

Excess of preferred stock carrying value over repurchase value

     —         1.0       (1.0 )   (100.0 )
    


 


 


 

Net income available for common stockholders

   $ 51.0     $ 86.9     $ (35.9 )   (41.3 )%
    


 


 


 

 

Rental and Other Revenues

 

The decrease in rental and other revenues from continuing operations was primarily due to a decrease in average occupancy rates in our Wholly Owned Properties from 91.8% for the year ended December 31, 2001 to 86.4% for the year ended December 31, 2002. The average occupancy decreased primarily due to tenant rollover and early lease terminations at various properties where vacant space was not re-leased due to the lack of demand for office space coupled with an increasing supply of competitive space. During 2002, approximately 2.0 million square feet of development properties were placed in-service that leased-up slower than expected and, as a result, have also adversely affected the occupancy of our overall portfolio. Rental and other revenues also decreased due to (1) the impact of dispositions during 2002 and 2001 that were not classified as discontinued operations; (2) a $3.1 million write off of straight line rental income in 2002 related to the bankruptcy of WorldCom; and (3) a decrease in leasing and development fee income in 2002. Partly offsetting these decreases was an increase in recovery income from certain operating expenses in 2002 and an increase in lease termination fees in 2002.

 

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During the year ended December 31, 2002, 840 second generation leases representing 5.6 million square feet of office, industrial and retail space were executed at an average rate per square foot on a GAAP basis that was 5.5% lower than the average rate per square foot on the expired leases.

 

Operating Expenses

 

The increase in rental and other operating expenses from continuing operations (real estate taxes, utilities, insurance, repairs and maintenance and other property-related expenses) primarily resulted from (1) general inflationary increases particularly salaries, benefits, utility costs, real estate taxes and insurance and (2) the fact that certain fixed operating expenses do not vary with net changes in our occupancy percentages, such as real estate taxes, insurance and utility rate changes. In addition, we had 3.3 million square feet of development properties placed in service during 2002 and 2001 that resulted in a $3.4 million increase in rental and other operating expenses from continuing operations. Partly offsetting these increases was a decrease due to the impact of the dispositions during 2002 and 2001 that were not classified as discontinued operations.

 

The increase in depreciation and amortization from continuing operations was due to an increase in amortization related to leasing commissions and tenant improvement expenditures for properties placed in-service during 2001 and 2002 and the write-off of $5.8 million of deferred leasing costs primarily related to the leases rejected by WorldCom at December 31, 2002. These increases were partially offset by a decrease in depreciation for properties disposed of during 2002 and 2001 that are not classified as discontinued operations.

 

For the year ended December 31, 2002, the impairment loss on properties held for use with a carrying value exceeding the sum of their undiscounted future cash flows was $0.8 million. We also recognized a $9.1 million impairment loss related to one office property, which had a carrying value in excess of the sum of the property’s undiscounted future cash flows, that has been demolished and may be redeveloped into a class A suburban office property in the future. There were no impairments on assets held for use recorded in 2001.

 

General and administrative expenses, net of amounts capitalized, increased $2.8 million in 2002. Included in general and administrative expenses in 2002 was a compensation charge of $3.7 million related to the exercise of options compared to $1.2 million for such option expense in 2001. Such exercises were recorded as compensation expense under FASB Interpretation No. 44 (“Accounting For Certain Transactions Involving Stock Options, An Interpretation of APB Opinion No. 25”) as described in Note 14 to the Consolidated Financial Statements.

 

We accrued $2.7 million in the year ended December 31, 2002 for litigation expense related to various legal proceedings from previously completed mergers and acquisitions. These claims were fully paid and settled in early 2003.

 

Interest Expense

 

Contractual interest expense increased by $0.1 million from 2001 to 2002. This net increase resulted from a decrease in average interest rates from 7.2% in 2001 to 6.5% in 2002, offset by (1) a decrease in capitalized interest from $16.9 million in 2001 to $7.0 million in 2002, which increased interest expense from continuing operations by $9.9 million and (2) an increase in the average outstanding debt balances of approximately $21.3 million in 2002 compared to 2001.

 

Interest expense on financing obligations increased by $0.6 million in 2002 – see Note 3 to the Consolidated Financial Statements for additional information on real estate sales that are accounted for as financing transactions.

 

Other Income/Expense

 

The decrease in interest and other income from continuing operations primarily resulted from a decrease in interest income in the year ended December 31, 2002 due to the collection of notes receivable during 2001 and 2002. Partly offsetting this decrease is a legal settlement amounting to $1.6 million recorded as other income in 2002.

 

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Gain on Disposition of Property; Co-venture Expense; Minority Interest; Equity in Earnings of Unconsolidated Affiliates

 

In 2002, gain on disposition of properties was comprised of a $15.5 million net gain related to the disposition of 533,263 square feet of office properties, that did not meet certain conditions to be classified as discontinued operations and a $7.2 million net gain related to the disposition of 112.7 acres of land. In 2001, gain on disposition of properties was comprised of a $17.2 million net gain related to the disposition of 1,672 apartment units and from other property sales, and a $4.7 million net gain related to the disposition of 180.3 acres of land.

 

Co-venture expense relates to the operations of the MG-HIW, LLC non-Orlando City Group properties accounted for as a profit-sharing arrangement, as more fully described in Note 3 to the Consolidated Financial Statements. The increase in co-venture expense is due to a decline in interest rates from 2001 to 2002, which increased the net operating income of the non-Orlando City Group properties, 80.0% of which is reflected as co-venture expense. Slightly offsetting this increase is the decrease in base rent as a result of two tenants in the non-Orlando City Group properties vacating space mid-year in 2002.

 

Minority interest in the continuing operations income of the Operating Partnership, after preferred partnership unit distributions, decreased from $10.8 million in 2001 to $4.4 million in 2002 because of a corresponding reduction in the Operating Partnership’s income from continuing operations.

 

The decrease in equity in earnings of unconsolidated affiliates was primarily a result of lower lease termination fees and lower property operating expense reimbursements in 2002. The decrease in earnings was partly offset by lower interest expense incurred during 2002 as a result of lower weighted average borrowing rates and earnings from certain joint ventures formed with unrelated investors during 2002.

 

Discontinued Operations

 

In accordance with SFAS No. 144, we classified net income of $20.7 million and $11.8 million, net of minority interest, as discontinued operations for the years ended December 31, 2002 and 2001, respectively, which pertained to 2.3 million square feet of property, four apartment units and 122.8 acres of revenue-producing land sold during 2002 and 2003 and 274,744 square feet of property and 88 apartment units held for sale at December 31, 2003. Included in the 2002 amounts was a gain on the sale of these properties of $15.2 million, net of minority interest, offset by impairment charges of $3.6 million, net of minority interest.

 

Preferred Stock Dividends and Repurchases

 

We recorded $30.9 million and $31.5 million in Preferred Stock dividends in the years ended December 31, 2002 and 2001, respectively. The decrease resulted from the Company’s repurchase of $20.1 million of its Preferred Stock at carrying value during 2001 for total cash consideration of $18.5 million. This repurchase was recorded in accordance with Emerging Issues Task Force Topic D-42, “The Effect on Calculation of Earnings per Share for the Redemption or Induced Conversion of Preferred Stock.” As a result, in 2001, we classified the excess of the carrying value of the Preferred Stock, net of issuance costs, over the repurchase value as an increase in the income available to common stockholders. There were no Preferred Stock repurchases in 2002.

 

Net Income

 

We recorded net income in 2002 of $81.9 million, which was a 30.2% decrease from net income of $117.4 million in 2001, primarily due to a decrease in rental revenues as a result of lower occupancy and the bankruptcies of WorldCom and US Airways, the net effects on continuing and discontinued operations from being a net seller in 2002 of operating properties under our capital recycling plan, an increase in rental property operating expenses, an increase in depreciation and amortization and a decrease in gain on the disposition of land and depreciable assets.

 

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Table of Contents

 

LIQUIDITY AND CAPITAL RESOURCES

 

Statement of Cash Flows

 

As required by GAAP, we report and analyze our cash flows based on operating activities, investing activities and financing activities. The following table sets forth the changes in the Company’s restated cash flows from 2002 to 2003 ($ in thousands):

 

     Year Ended December 31,

       
     2003

    2002

    Change

 

Cash Provided by Operating Activities

   $ 160,923     $ 214,568     $ (53,645 )

Cash Provided by Investing Activities

     124,164       121,167       2,997  

Cash Used in Financing Activities

     (279,332 )     (323,113 )     43,781  
    


 


 


Total Cash Flows

   $ 5,755     $ 12,622     $ (6,867 )
    


 


 


 

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

 

Cash provided by or used in investing activities generally relates to capitalized costs incurred for leasing and major building improvements and our acquisition, development, disposition and joint venture activity. During periods of significant net acquisition and/or development activity, our cash used in such investing activities will generally exceed cash provided by investing activities, which typically would consist of cash received upon the sale of properties or distributions from our joint ventures. During 2003 and 2002, since our disposition and joint venture activity slightly outpaced our acquisition activity, we recorded positive cash flow from investing activities in both years.

 

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

 

The decrease of $53.6 million in cash provided by operating activities was primarily a result of lower net income due to the disposition of certain properties under our capital recycling program, a decrease in average occupancy rates for our wholly owned portfolio and the bankruptcies of WorldCom and US Airways. In addition, the level of net cash provided by operating activities is affected by the timing of receipt of revenues and payment of expenses.

 

The increase of $3.0 million in cash provided by investing activities was primarily a result of an increase in proceeds from dispositions of real estate assets of approximately $10.1 million, partly offset by a decrease in distributions/repayments from unconsolidated affiliates of approximately $3.6 million and a decrease in investments in notes receivable of approximately $2.9 million for the year ended December 31, 2003.

 

The decrease of $43.8 million in cash used in financing activities was primarily a result of a decrease of $115.1 million in net repayments on the unsecured Revolving Loan, mortgages and notes payable and a decrease of $29.4 million in distributions paid on Common Stock and Common Units for the year ended December 31, 2003. This decrease was partly offset by an increase of $14.7 million for the repurchase of Common Stock and Common Units, a decrease of $41.2 million in borrowings on the financing obligation, the payment of $26.2 million on the co-venture obligation and payments on extinguishment of debt of $16.3 million related to the MOPPRS refinancing for the year ended December 31, 2003.

 

In 2004, we expect to continue our capital recycling program of selectively disposing of non-core properties or other properties in order to use the net proceeds for investments or other purposes. At December 31, 2003, we had

 

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0.44 million square feet of properties, 88 apartment units and 168.1 acres of land under letter of intent or contract for sale in various transactions with a carrying value of $65.7 million. These transactions are subject to customary closing conditions, including due diligence and documentation, and are expected to close during 2004. However, we can provide no assurance that all these transactions will be consummated. As of September 2004, we have closed on some of these transactions consisting of 169,962 square feet of properties and 67.4 acres of land.

 

During 2004, we expect to have positive cash flows from operating activities. The net cash flows from investing activities in 2004 could be positive or negative, depending on the level and timing of property dispositions, property acquisitions, development, and capitalized leasing and improvement costs. Any positive cash flows from operating and investing activities in 2004 are expected to be used to pay stockholder and unitholder distributions, required debt amortization and recurring capital expenditures.

 

Capitalization

 

The following table sets forth our capitalization as of December 31, 2003 and December 31, 2002 (in thousands, except per share amounts):

 

     December 31,
2003


   December 31,
2002


Mortgages and notes payable, at recorded book value

   $ 1,717,765    $ 1,793,760

Financing obligations

   $ 124,063    $ 121,012

Co-venture obligations

     —        43,511

Preferred stock, at redemption value

   $ 377,445    $ 377,445

Common Stock and Common Units outstanding

     59,677      60,375

Per share stock price at period end

   $ 25.40    $ 22.10

Market value of common equity

     1,515,795      1,334,288
    

  

Total market capitalization with debt

   $ 3,735,068    $ 3,670,016
    

  

 

Based on our total market capitalization of approximately $3.7 billion at December 31, 2003 (at the December 31, 2003 per share stock price of $25.40 and assuming the redemption for shares of Common Stock of the 6.2 million Common Units in the Operating Partnership not owned by the Company), our mortgages and notes payable represented approximately 46.0% of our total market capitalization. Mortgages and notes payable at December 31, 2003 was comprised of $982.8 million of secured indebtedness with a weighted average interest rate of 6.3% and $735.0 million of unsecured indebtedness with a weighted average interest rate of 6.2%. As of December 31, 2003, our outstanding mortgages and notes payable were secured by real estate assets with an aggregate carrying value of approximately $1.6 billion.

 

We do not intend to reserve funds to retire existing secured or unsecured debt upon maturity. For a more complete discussion of our long-term liquidity needs, see “Liquidity and Capital Resources - Current and Future Cash Needs.”

 

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The following table sets forth a summary regarding our known contractual obligations at December 31, 2003 ($ in thousands):

 

          Amounts due during year ending December 31,

    
     Total

   2004

   2005

   2006

   2007

   2008

   Thereafter

Fixed Rate Debt: (1)

                                                

Unsecured

                                                

Put Option Notes (2)

   $ 100,000    $ 100,000    $ —      $ —      $ —      $ —      $ —  

Notes

     460,000      —        —        110,000      —        100,000      250,000

Secured:

                                                

Mortgage Loans Payable (3)

     777,849      12,871      81,447      19,362      79,476      14,343      570,350
    

  

  

  

  

  

  

Total Fixed Rate Debt

     1,337,849      112,871      81,447      129,362      79,476      114,343      820,350
    

  

  

  

  

  

  

Variable Rate Debt:

                                                

Unsecured:

                                                

Term Loan

     120,000      —        120,000      —        —        —        —  

Revolving Loan

     55,000      —        —        55,000      —        —        —  

Secured:

                                                

Mortgage Loans Payable (3)

     204,916      235      279      201,175      3,227      —        —  
    

  

  

  

  

  

  

Total Variable Rate Debt

     379,916      235      120,279      256,175      3,227      —        —  
    

  

  

  

  

  

  

Total Long Term Debt

     1,717,765      113,106      201,726      385,537      82,703      114,343      820,350

Operating Lease Obligations:

                                                

Land Leases (4)

     48,909      1,269      1,273      1,213      1,194      1,194      42,766

Purchase Obligations:

                                                

MG-HIW, LLC Letter of Credit (4),(5)

     7,500      7,500      —        —        —        —        —  

MG-HIW Metrowest I and II, LLC (4)

     3,200      3,200      —        —        —        —        —  

Completion Contracts (4)

     18,204      18,204      —        —        —        —        —  

Other Long Term Liabilities Reflected on the Balance Sheet:

                                                

Plaza Colonade Debt Repayment Guarantee (4)

     2,468      —        —        2,468      —        —        —  

Plaza Colonnade Completion Guarantee (4)

     376      —        376      —        —        —        —  

Highwoods DLF 97/26 DLF 99/32, LP Lease Guarantee (4)

     855      —        —        —        —        855      —  

Capital One Lease Guarantee (6)

     3,136      1,734      —        334      369      378      321

Industrial Portfolio Lease Guarantee (6)

     2,347      850      991      506      —        —        —  

MG-HIW, LLC Financing Obligation (7)

     60,991      60,991      —        —        —        —        —  

SF-HIW Harborview Financing Obligation (7)

     13,566      —        —        —        —        —        13,566

Eastshore Financing Obligation (7)

     28,873      —        —        —        28,873      —        —  

Tax Increment Financing Obligation (8)

     20,633      687      775      863      913      976      16,419

DLF Note Payable (9)

     3,280      187      216      250      286      325      2,016
    

  

  

  

  

  

  

Total

   $ 1,932,103    $ 207,728    $ 205,357    $ 391,171    $ 114,338    $ 118,071    $ 895,438
    

  

  

  

  

  

  


(1) The Operating Partnership’s unsecured notes of $560.0 million bear interest at rates ranging from 7.0% to 8.125% with interest payable semi-annually in arrears. Any premium and discount related to the issuance of the unsecured notes, together with other issuance costs, is being amortized over the life of the respective notes as an adjustment to interest expense. All of the unsecured notes, except for the Put Option Notes, are redeemable at any time prior to maturity at our option, subject to certain conditions including the payment of make-whole amounts. Our fixed rate mortgage loans generally are either locked out to prepayment for all or a portion of their term or are pre-payable subject to certain conditions including prepayment penalties.

 

(2) See Note 5 to the Consolidated Financial Statements. Although not contractually due, the Put Option Notes were retired in June 2004.

 

(3) The mortgage loans payable were secured by real estate assets with an aggregate carrying value of approximately $1.6 billion at December 31, 2003.

 

(4) See Note 15 to the Consolidated Financial Statements.

 

(5) This letter of credit was terminated in March 2004.

 

(6) These liabilities represent gains that were deferred in accordance with SFAS No. 66 when we sold these properties to third parties. We defer gains on sales of real estate up to our maximum exposure to contingent loss. See Note 15 to the Consolidated Financial Statements.

 

(7) These liabilities represent our financing obligation to either our partner in the respective joint venture or the third party buyer as a result of accounting for these transactions as a financing arrangement. See Note 3 to the Consolidated Financial Statements.

 

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(8) In connection with Tax Increment Financing for construction of a public garage related to an office building constructed by us, we are obligated to pay fixed special assessments over a 20-year period. The net present value of these assessments, discounted at 6.93%, is shown as a Financing Obligation in the Balance Sheet. We also receive special tax revenues and property tax rebates which are intended, but not guaranteed, to provide funds to pay the special assessments.

 

(9) Represents a fixed obligation which we owe our partner in Highwoods DLF 98/29, LP. This amount arose from an excess contribution from our partner at the formation of the joint venture. See Note 2 to the Consolidated Financial Statements.

 

Refinancings in 2003

 

On February 2, 1998, the Company (through the Operating Partnership) sold $125.0 million of MandatOry Par Put Remarketed Securities (“MOPPRS”) which were originally expected to mature on February 1, 2013. The fixed interest rate was 6.835% through January 31, 2003, and would be reset at that date at 5.715% plus a spread as determined under the terms of the MOPPRS. In connection with the original issuance, the Company granted a remarketing option to one of the underwriters for the MOPPRS, the consideration for which was reflected in the premium price of the bonds and aggregated $3.5 million. This consideration was deferred and included in deferred financing cost and was amortized to income over the term of the MOPPRS. The option, if exercised, allowed the option holder to purchase the MOPPRS on January 31, 2003 from the holders for $125.0 million and then resell the MOPPRS in a new offering to new investors at the reset interest rate (5.715% plus the spread). If the option holder did not exercise the option, the Company would be required to repurchase the MOPPRS for $125.0 million plus any accrued interest. The Company also had a one-time right to redeem the MOPPRS from the option holder on January 31, 2003 for $125.0 million plus the then present value of the remarketing option.

 

On January 28, 2003, the Company, the option holder, and an intermediary entered into an agreement under which the option holder agreed to exercise its option to acquire the MOPPRS on January 31, 2003 and the intermediary agreed to acquire the MOPPRS from the option holder for $142.7 million. The intermediary and the Company also agreed to exchange the MOPPRS for new Company debt instruments in the future, subject to certain terms and conditions. The MOPPRS transaction between the option holder and the intermediary occurred on January 31, 2003 and the interest rate on the MOPPRS was reset at 8.975%. On February 4, 2003, a new $142.8 million mortgage loan with a third party, secured by 24 of the Company’s properties, was executed; this loan bears a fixed interest rate of 6.03% and matures in February 2013. The intermediary received the proceeds from the new mortgage loan, and the mortgage loan and the MOPPRS were then exchanged between the Company and the intermediary. The Company then retired the MOPPRS. The retirement of the MOPPRS has been accounted for as an extinguishment (See Note 18 to the Consolidated Financial Statements). Accordingly, $14.7 million was charged to loss on extinguishment of debt in the quarter ended March 31, 2003.

 

On July 17, 2003, we amended and restated our existing revolving loan. The amended and restated $250.0 million revolving loan (the “Revolving Loan”) is from a group of nine lender banks, matures in July 2006 and replaces our previous $300.0 million revolving loan. The Revolving Loan carries an interest rate based upon our senior unsecured credit ratings. As a result, interest currently accrues on borrowings under the Revolving Loan at a rate of LIBOR plus 105 basis points. The terms of the Revolving Loan require us to pay an annual facility fee equal to .25% of the aggregate amount of the Revolving Loan. We currently have a credit rating of BBB- assigned by Standard & Poor’s and Fitch Inc. In August 2003, Moody’s Investor Service downgraded our credit rating from Baa3 to Ba1. We cannot provide any assurances that Moody’s or the other rating agencies will not further change our credit ratings. If Standard and Poor’s or Fitch Inc. were to lower our credit ratings without a corresponding increase by Moody’s, the interest rate on borrowings under our Revolving Loan would be automatically increased by 60 basis points.

 

On December 1, 2003, $146.5 million of our 8.0% Notes and $100.0 million of our 6.75% Notes matured. We refinanced $127.5 million with 10-year secured debt at an effective rate of 5.25%. $100.0 million was refinanced with a two-year unsecured term loan with a floating rate initially set at 1.3% over LIBOR. The balance, equaling $19.0 million, was repaid using funds from our Revolving Loan.

 

Refinancings in 2004

 

In 1997, a trust formed by the Operating Partnership sold $100.0 million of Exercisable Put Option Securities due June 15, 2004 (“X-POS”). The assets of the trust consisted of, among other things, $100.0 million of

 

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Exercisable Put Option Notes due June 15, 2011 (the “Put Option Notes”), issued by the Operating Partnership. The Put Option Notes bore an interest rate of 7.19% from the date of issuance through June 15, 2004. In connection with the initial issuance of the Put Option Notes, a counter party was granted an option to purchase the Put Option Notes from the trust on June 15, 2004 at 100.0% of the principal amount. The counter party exercised this option and acquired the Put Option Notes on June 15, 2004. On that same date, the Company exercised its option to acquire the Put Option Notes from the counter party for a purchase price equal to the sum of the present value of the remaining scheduled payments of principal and interest (assuming an interest rate of 6.39%) on the Put Option Notes, or $112.3 million. The difference between the $112.3 million and the $100.0 million was charged to loss on extinguishment of debt in the quarter ended June 30, 2004. The Company borrowed funds from its Revolving Loan to make the $112.3 million payment.

 

In late June 2004, we repaid $51.0 million of the increased borrowing under our Revolving Loan with proceeds from the sale of a 60.0% interest in five office buildings in Orlando, Florida and from the sale of a building at Highwoods Preserve in Tampa, Florida. See Notes 3 and 4 to the Consolidated Financial Statements for further details of these asset sales.

 

Operating and Financial Covenants and Performance Ratios

 

The terms of the $250 million Revolving Loan, the $120 million bank term loans and the indenture that governs our outstanding notes require us to comply with certain operating and financial covenants and performance ratios. We are currently in compliance with all such requirements. Although we expect to remain in compliance with the covenants and ratios under our Revolving Loan, bank term loans and indenture for the foreseeable future, depending upon our future operating performance and property and financing transactions, we cannot assure you that we will continue to be in compliance.

 

If we fail to comply with these financial ratios and other covenants (see below) and such conditions were not waived by the lending banks, we would be unable to borrow any further amounts under the Revolving Loan, which could adversely affect our ability to fund our operations, and our lenders could accelerate any debt outstanding under our Revolving Loan, bank term loans or our indenture. If our debt cannot be paid, refinanced or extended at maturity, in addition to our failure to repay our debt, we may not be able to make distributions to stockholders at expected levels or at all. Furthermore, if any refinancing is done at higher interest rates, the increased interest expense could adversely affect our cash flows and ability to make distributions to stockholders. Any such refinancing could also impose tighter financial ratios and other covenants that could restrict our ability to take actions that could otherwise be in our stockholders’ best interest, such as funding new development activity, making opportunistic acquisitions, repurchasing our securities or paying distributions.

 

The following table sets forth more detailed information about the Company’s ratio and covenant compliance under the Revolving Loan and the bank term loans, which have identical covenants, as of December 31, 2003 and 2002. Certain of these definitions (including the covenants regarding non-GAAP financial measures such as EBITDA, Cash Available for Distribution (“CAD”) and adjusted NOI) may differ from similar terms used in the accompanying Consolidated Financial Statements and may, for example, consider our proportionate share of investments in unconsolidated affiliates. For a more detailed description of the covenants in our Revolving Loan, including definitions of certain relevant terms, see the credit agreement governing our Revolving Loan, which is incorporated by reference in this amended Annual Report as Exhibit 10.13.

 

     2003

 

Total Liabilities Less Than or Equal to 57.5% of Total Assets

     53.8 %

Unencumbered Assets Greater Than or Equal to 2 times Unsecured Debt

     2.23  

Secured Debt Less Than or Equal to 35% of Total Assets

     28.7 %

Adjusted EBITDA Greater Than 2.10 times Interest Expense (1)

     2.10  

Adjusted EBITDA Greater Than 1.55 times Fixed Charges (1)

     1.55  

Adjusted NOI Unencumbered Assets Greater Than 2.25 times Interest on Unsecured Debt

     2.45  

Tangible Net Worth Greater Than $1.574 Billion

   $ 1.6 billion  

Restricted Payments, including distributions to shareholders, Less Than or Equal to 95% of CAD

     72.3 %

 

(1) A waiver was obtained with respect to this covenant in October 2004 as described below:

 

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In March 2004, the Company amended its Revolving Loan and the two bank term loans. The changes modified certain definitions used in all three loans to determine amounts that are used to compute financial covenants and also adjusted one of the financial ratio covenants.

 

In June 2004, the Company further amended its Revolving Loan and the two bank term loans. The changes excluded the $12.3 million charge taken related to the retirement of the X-POS from the calculations used to compute financial covenants.

 

In August 2004, the Company further amended its Revolving Loan and two bank term loans. The changes excluded the effects of accounting for three sales transactions as financing and/or profit sharing arrangements under SFAS No. 66, as described in Note 18 to the Consolidated Financial Statements, from the calculations used to compute financial covenants, adjusted one financial covenant and temporarily adjusted a second financial covenant until the earlier of December 31, 2004 or the period when the Company can record income from the settlement of a claim against WorldCom (see Note 20 to the Consolidated Financial Statements).

 

In early October 2004, the Company obtained a waiver from the lenders of the Company’s Revolving Loan and two bank term loans for certain covenant violations caused by the effects, on a restated basis, of the loss on debt extinguishment from the MOPPRS transaction in early 2003, as described in Notes 5 and 18 to the Consolidated Financial Statements.

 

The aforementioned modifications did not change the economic terms of the loans. In connection with these modifications, the Company incurred certain loan costs that are capitalized and amortized over the remaining term of the loans.

 

The following table sets forth more detailed information about the Operating Partnership’s ratio and covenant compliance under the Operating Partnership’s indenture as of December 31, 2003 and 2002. Certain of these definitions may differ from similar terms used in the Consolidated Financial Statements and may, for example, consider our proportionate share of investments in unconsolidated affiliates. For a more detailed discussion of the covenants in our indenture, including definitions of certain relevant terms, see the indenture governing our unsecured notes, which is incorporated by reference in this amended Annual Report as Exhibit 4.2.

 

     2003

    2002

 

Overall Debt Less Than or Equal to 60% of Adjusted Total Assets

   42.2 %   42.4 %

Secured Debt Less Than or Equal to 40% of Adjusted Total Assets

   24.2 %   18.5 %

Income Available for Debt Service Greater Than 1.50 times Annual Service Charge

   2.6     2.9  

Total Unencumbered Assets Greater Than 200% of Unsecured Debt

   333.0 %   284.2 %

 

Current and Future Cash Needs

 

Historically, rental revenue has been the principal source of funds to meet our short-term liquidity requirements, which primarily consist of operating expenses, debt service, stockholder dividends, any guarantee obligations and recurring capital expenditures. In addition, construction management, maintenance, leasing and management fees have provided sources of cash flow. Major capital improvement obligations related to the existing properties total $2.1 million. In addition, we could incur tenant improvements and lease commissions related to any releasing of space previously leased by WorldCom and US Airways or other vacant space.

 

In addition to the requirements discussed above, our short-term (through the end of 2004) liquidity requirements also include the funding of approximately $9.4 million of our existing development activity (as of the date of this filing) and first generation tenant improvements and lease commissions on properties placed in-service that are not fully leased. We expect to fund our short-term liquidity requirements through a combination of working capital, cash flows from operations and some or all of the following:

 

  borrowings under our unsecured Revolving Loan (which has up to $47.3 million of availability as of October 22, 2004);

 

  the selective disposition of non-core assets or other assets;

 

 

the sale or contribution of some of our Wholly Owned Properties, development projects and

 

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development land to strategic joint ventures to be formed with unrelated investors, which will have the net effect of generating additional capital through such sale or contributions;

 

  the issuance of secured debt (at October 22, 2004, we had approximately $2.2 billion of unencumbered real estate assets at cost); and

 

  the issuance of new unsecured debt.

 

Our long-term liquidity needs generally include the funding of existing and future development activity, selective asset acquisitions and the retirement of mortgage debt, amounts outstanding under the Revolving Loan and long-term unsecured debt. Our goal is to maintain a flexible capital structure. Accordingly, we expect to meet our long-term liquidity needs through a combination of (1) the issuance by the Operating Partnership of additional unsecured debt securities, (2) the issuance of additional equity securities by the Company and the Operating Partnership as well as (3) the sources described above with respect to our short-term liquidity. We expect to use such sources to meet our long-term liquidity requirements either through direct payments or repayments of borrowings under the unsecured Revolving Loan. As mentioned above, we do not intend to reserve funds to retire existing secured or unsecured indebtedness upon maturity. Instead, we will seek to refinance such debt at maturity or retire such debt through the issuance of equity or debt securities.

 

We anticipate that our available cash and cash equivalents and cash flows from operating activities, with cash available from borrowings and other sources, will be adequate to meet our capital and liquidity needs in both the short and long term. However, if these sources of funds are insufficient or unavailable, our ability to pay dividends to stockholders and satisfy other cash payments may be adversely affected.

 

Stockholder Dividends

 

To maintain our qualification as a REIT, we must distribute to stockholders at least 90.0% of our REIT taxable income. REIT taxable income, the calculation of which is determined by the federal tax laws, does not necessarily equal net income under GAAP. We generally expect to use our cash flow from operating activities for dividends to stockholders and for payment of recurring capital expenditures. Future dividends will be made at the discretion of our Board of Directors. The following factors will affect our cash flows and, accordingly, influence the decisions of the Board of Directors regarding dividends:

 

  debt service requirements after taking into account debt covenants and the repayment and restructuring of certain indebtedness;

 

  scheduled increases in base rents of existing leases;

 

  changes in rents attributable to the renewal of existing leases or replacement leases;

 

  changes in occupancy rates at existing properties and execution of leases for newly acquired or developed properties; and

 

  operating expenses and capital replacement needs, including tenant improvements and leasing costs.

 

Off Balance Sheet Arrangements

 

The Company has several off balance sheet joint venture and guarantee arrangements. The joint ventures were formed with unrelated investors to generate additional capital to fund property acquisitions, repay outstanding debt or fund other strategic initiatives and to lessen the ownership risks typically associated with owning 100.0% of a property. When we create a joint venture with a strategic partner, we usually contribute one or more properties that we own to a newly formed entity in which we retain an interest of 50.0% or less. In exchange for an equal or minority interest in the joint venture, we generally receive cash from the partner and retain the management income relating to the properties in the joint venture. For financial reporting purposes, the sales of assets we sold to two of our joint ventures are accounted for as financing and/or profit-sharing arrangements.

 

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As of December 31, 2003, our unconsolidated joint ventures had $574.5 million of total assets and $392.3 million of total liabilities. Our weighted average equity interest based on the total assets of these unconsolidated joint ventures was 40.1%. During 2003, these unconsolidated joint ventures earned $11.8 million of total net income, of which our share was $5.0 million. For a more detailed discussion of our unconsolidated joint venture activity, see Note 2 in the Consolidated Financial Statements.

 

As required by GAAP, we use the equity method of accounting for our unconsolidated joint ventures in which we exercise significant influence but do not control the major operating and financial policies of the entity regarding encumbering the entities with debt and the acquisition or disposal of properties. As a result, the assets and liabilities of these joint ventures are not included on our balance sheet and the results of operations of these joint ventures are not included on our income statement, other than as equity in earnings of unconsolidated affiliates. Generally, we are not liable for the debts of our joint ventures, except to the extent of our equity investment, unless we have directly guaranteed any of that debt. In most cases, we and/or our strategic partners are required to guarantee customary limited exceptions to non-recourse liability in non-recourse loans.

 

As of December 31, 2003, our unconsolidated joint ventures had $375.0 million of outstanding debt. The following table sets forth the principal payments due on that outstanding long-term debt as recorded on the respective joint venture’s books at December 31, 2003 ($ in thousands):

 

     Percent
Owned


    Total

    Amounts due during year ending December 31,

   Thereafter

         2004

   2005

   2006

   2007

   2008

  

Board of Trade Investment Company

   49.00 %   $ 749     $ 184    $ 198    $ 215    $ 152    $ —      $ —  

Dallas County Partners (1)

   50.00 %     38,000       969      1,041      4,419      13,332      5,764      12,475

Dallas County Partners II (1)

   50.00 %     22,465       1,242      1,375      1,522      1,684      1,863      14,779

Fountain Three (1)

   50.00 %     29,924       1,106      1,172      1,243      1,316      6,400      18,687

RRHWoods, LLC (1)

   50.00 %     67,307       1,273      403      431      4,241      381      60,578

4600 Madison Associates, LP

   12.50 %     16,721       711      762      815      873      935      12,625

Highwoods DLF 98/29, LP

   22.81 %     67,241       1,035      1,107      1,185      1,268      1,356      61,290

Highwoods DLF 97/26 DLF 99/32, LP

   42.93 %     59,027       714      770      831      897      969      54,846

Highwoods-Markel Associates, LLC

   50.00 %     40,000       558      643      682      722      766      36,629

MG-HIW Metrowest II, LLC

   50.00 %     7,326       —        7,326      —        —        —        —  

Concourse Center Associates, LLC

   50.00 %     9,695       176      189      202      217      232      8,679

Plaza Colonnade, LLC

   50.00 %     16,496       —        —        —        16,496      —        —  
          


 

  

  

  

  

  

Total

         $ 374,951 (2)   $ 7,968    $ 14,986    $ 11,545    $ 41,198    $ 18,666    $ 280,588
          


 

  

  

  

  

  


(1) Des Moines joint ventures.

 

(2) All of this joint venture debt is non-recourse to us except (1) in the case of customary exceptions pertaining to such matters as misuse of funds, environmental conditions and material misrepresentations and (2) those guarantees and loans described in the following paragraphs.

 

In connection with the Des Moines joint ventures, we guaranteed certain debt and the maximum potential amount of future payments that we could be required to make under the guarantees is $25.5 million. Of this amount, $8.6 million arose from housing revenue bonds that require credit enhancements in addition to the real estate mortgages. The bonds bear a floating interest rate, which at December 31, 2003 averaged 1.3%, and mature in 2015. Guarantees of $9.5 million will expire upon two industrial buildings becoming 93.8% and 95.0% leased or when the related loans mature. As of December 31, 2003, these buildings were 90.0% and 64.0% leased, respectively. The remaining $7.4 million in guarantees relate to loans on four office buildings that were in the lease-up phase at the time the loans were initiated. Each of the loans will expire by May 2008. The average occupancy of the four buildings at December 31, 2003 was 91.0%. If the joint ventures are unable to repay the outstanding balances under the loans, we will be required, under the terms of the agreements, to repay the outstanding balances. Recourse provisions exist that enable us to recover some or all of such payments from the joint ventures’ assets and/or the other partners. The joint ventures currently generate sufficient cash flow to cover the debt service required by the loans.

 

In connection with the RRHWoods, LLC joint venture, we renewed our guarantee of $6.2 million to a bank in July 2003; this guarantee expires in August 2006 and may be renewed by us. The bank provides a letter of credit securing industrial revenue bonds, which mature in 2015. We would be required to perform under the guarantee should the joint venture be unable to repay the bonds. We have recourse provisions in order to recover from the joint venture’s assets and the other partner for amounts paid under the guarantee in excess of our proportionate share. The

 

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property collateralizing the bonds is 100.0% leased and currently generates sufficient cash flow to cover the debt service required by the bond financing.

 

With respect to the Plaza Colonnade, LLC joint venture, we have included $2.8 million in other liabilities and increased our investment in unconsolidated affiliates by $2.8 million on our consolidated balance sheet at December 31, 2003 related to two separate guarantees of a construction loan agreement and a construction completion agreement. The construction loan matures in February 2006, with two one-year options to extend the maturity date that are conditional on completion and lease-up of the project. The term of the construction completion agreement requires the core and shell of the building to be completed by December 15, 2005. Currently, the building is scheduled to be completed in December 2004. Both guarantees arose from the formation of the joint venture to construct an office building. If the joint venture is unable to repay the outstanding balance under the construction loan agreement or complete the construction of the office building, we would be required, under the terms of the agreements, to repay our 50.0% share of the outstanding balance under the construction loan and complete the construction of the office building. The maximum potential amount of future payments by us under these agreements is $34.9 million. No recourse provisions exist that would enable us to recover from the other partner amounts paid under the guarantee. However, given that the loan is collateralized by the building, we and our partner could obtain and liquidate the building to recover the amounts paid should we be required to perform under the guarantee.

 

In addition to the Plaza Colonnade, LLC construction loan and completion agreement described above, the partners have collectively provided $12.0 million in letters of credit in December 2002, $6.0 million by us and $6.0 million by our partner. We and our partner would be held liable under the letter of credit agreements should the joint venture not complete construction of the building. The letters of credit expire in December 31, 2004. No recourse provisions exist that would enable us to recover from the other partner amounts drawn under the letter of credit. The building is nearing completion and the first tenant is expected to take occupancy in the fourth quarter of 2004.

 

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 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 terminate the lease 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 beginning January 1, 2006. In turn, we agreed to compensate the joint venture for any economic losses incurred as a result of these lease modifications. Based on the lease guarantee agreement, we recorded approximately $0.9 million in other liabilities and recorded a deferred charge of $0.9 million in September 2003. However, should new tenants occupy the vacated space during the two and a half year guarantee period, our liability under the guarantee would diminish. Our maximum potential amount of future payments with regard to this guarantee is $1.1 million. No recourse provisions exist to enable us to recover the amounts paid to the joint venture under this lease guarantee arrangement.

 

On December 29, 2003, we contributed an additional three in-service office properties encompassing approximately 290,853 rentable square feet valued at approximately $35.6 million to the existing Highwoods-Markel, LLC joint venture. The joint venture’s other partner, Markel Corporation, contributed an additional $3.6 million in cash to maintain its 50.0% ownership interest and the joint venture borrowed and refinanced approximately $40.0 million from a third party lender. We retained our 50.0% ownership interest in the joint venture and received net cash proceeds of approximately $31.9 million. We are the manager and leasing agent for the properties and receive customary management fees and leasing commissions.

 

In July 2003, we entered into an option agreement with our partner, Miller Global, to acquire its 50.0% interest in the assets of MG-HIW Metrowest I, LLC and MG-HIW Metrowest II, LLC for $3.2 million. We had previously guaranteed $3.7 million (50.0%) of the $7.4 million construction loan to fund the development of this property, of which $7.3 million was outstanding at December 31, 2003. On March 2, 2004, we exercised our option and acquired our partner’s 50.0% equity interest in the assets of MG-HIW Metrowest I, LLC and MG-HIW Metrowest II, LLC for $3.2 million. The assets in MG-HIW Metrowest I, LLC and MG-HIW Metrowest II, LLC include 87,832 square feet of property and 7.0 acres of development land zoned for the development of 90,000 square feet of office space. The $7.4 million construction loan to fund the development of this property was paid in full by us at closing.

 

On February 25, 2004, we and Kapital-Consult, a European investment firm, formed Highwoods KC Glenridge, LLC, which on February 26, 2004 acquired from a third party Glenridge Point Office Park, consisting of two office

 

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buildings aggregating 185,000 square feet located in the Central Perimeter sub-market of Atlanta. The buildings are currently 91.1% occupied. We contributed $10.0 million to the joint venture in return for a 40.0% equity interest and Kapital-Consult contributed $14.9 million for a 60.0% equity interest in the partnership. The joint venture entered into a $16.5 million 10-year secured loan on the assets. We are the manager and leasing agent for this property and receive customary management fees and leasing commissions. The acquisition also includes 2.9 acres of development land that can accommodate 150,000 square feet of office space.

 

RRHWoods, LLC and Dallas County Partners each developed a new office building in Des Moines, Iowa. On June 25, 2004, the joint ventures financed both buildings with a $7.4 million loan from a bank. As an inducement to make the loan at a 6.3% long-term interest rate, we and our partner agreed to master lease the vacant space and guaranteed $1.6 million, or $0.8 million each, with limited recourse. As of June 30, 2004, the buildings are together 82.0% leased. As leasing improves, the obligations under the loan agreement diminish. As of June 30, 2004, we recorded $1.3 million in other liabilities and $1.3 million as a deferred charge on our Consolidated Balance Sheet with respect to this guarantee. The maximum potential amount of future payments that we could be required to make under the master leases in place is approximately $4.8 million. We believe that the likelihood of paying on our $0.8 million guarantee is remote since the master lease payments provide the required 1.3 debt coverage ratio and, should we have to pay, we would recover the $0.8 million from other joint venture assets.

 

On June 28, 2004, Kapital-Consult, a European investment firm, bought an interest in HIW-KC Orlando, LLC, an entity formed by us. HIW-KC Orlando, LLC owns five in-service office properties, encompassing 1.3 million rentable square feet, located in the central business district of Orlando, Florida which were valued under the joint venture agreement at $212.0 million, including amounts related to our guarantees described below, and which were subject to a $136.2 million secured mortgage loan. Our partner contributed $41.4 million in cash and received a 60.0% equity interest in return. The joint venture borrowed $143.0 million under a ten-year fixed rate mortgage loan from a third party lender and repaid the $136.2 million loan. We retained a 40.0% equity interest in the joint venture and received net cash proceeds of approximately $46.6 million of which $33.0 million was used to pay down our Revolving Loan and $13.6 million was used to pay down another loan of ours. In connection with this transaction, we agreed to guarantee rent to the joint venture for 3,248 rentable square feet commencing in August 2004 and expiring in April 2011. In connection with this guarantee, as of June 30, 2004 we included $0.6 million in other liabilities and reduced the total amount of gain to be recognized by the same amount. Additionally, we agreed to guarantee re-tenanting costs for approximately 11% of the joint venture’s total square footage. We recorded a $4.1 million contingent liability with respect to such guarantee as of June 30, 2004 and reduced the total amount of gain to be recognized by the same amount. We believe our estimate related to the re-tenanting costs guarantee is accurate. However, if our assumptions prove to be incorrect, future losses may occur. The contribution was accounted for as a partial sale as defined by SFAS No. 66 and we recognized a $15.9 million gain in June 2004. Since we have an ongoing 40.0% financial interest in the joint venture and since we are engaged by the joint venture to provide management and leasing services for the joint venture, for which we receive customary management fees and leasing commissions, the operations of these properties will not be reflected as discontinued operations consistent with SFAS No. 144 and the related gain on sale will be included in continuing operations in the second quarter 2004.

 

Financing and Profit-Sharing Arrangements

 

The following summarizes sale transactions that are accounted for as financing and/or profit-sharing arrangements under paragraphs 25 through 29 of SFAS No. 66, as described in Note 1 to the Consolidated Financial Statements.

 

- MG-HIW, LLC

 

On December 19, 2000, we formed a joint venture with Miller Global, MG-HIW, LLC, pursuant to which we sold or contributed to MG-HIW, LLC 19 in-service office properties in Raleigh, Atlanta, Tampa (the “Non-Orlando City Group”) and Orlando (collectively the “City Groups”), valued at approximately $335 million. As part of the formation of MG-HIW, LLC, Miller Global contributed approximately $85 million in cash for an 80.0% ownership interest and the joint venture borrowed approximately $238.8 million from a third-party lender. We retained a 20.0% ownership interest and received net cash proceeds of approximately $307 million. During 2001, we contributed a 39,000 square foot development project to MG-HIW, LLC for $5.1 million. The joint venture borrowed an additional $3.7 million under its existing debt agreement with a third party and we retained our 20.0% ownership

 

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interest and received net cash proceeds of approximately $4.8 million. The assets of each of the City Groups were legally acquired by four separate LLC’s for which MG-HIW, LLC was the sole member.

 

The Non-Orlando City Group consisted of 15 properties encompassing 1.3 million square feet and were located in Atlanta, Raleigh and Tampa. Based on the nature and extent of certain rental guarantees made by us with respect to these properties, the transaction did not qualify for sale treatment under SFAS No. 66. The transaction has been accounted for as a profit-sharing arrangement, and accordingly, the assets, liabilities and operations of the properties remain on our books and a co-venture obligation has been established for the amount of equity contributed by Miller Global related to the non-Orlando City Group properties. The income from operations of the properties, excluding depreciation, is being allocated 80.0% to Miller Global and is reported as “co-venture expense” in our Consolidated Financial Statements. We continue to depreciate the properties and record all of the depreciation on our books. In addition to the co-venture expense, we recorded expense of $1.3 million, $0.7 million and $0.7 million related to payments made under the rental guarantees for the years ended December 31, 2003, 2002 and 2001, respectively.

 

On July 29, 2003, we acquired our partner’s 80.0% equity interest in the non-Orlando City Groups. We paid Miller Global $28.1 million, repaid $41.4 million of debt related to the properties and assumed $64.7 million of debt. We recognized a $16.3 million gain on the settlement of the $43.5 million co-venture obligation recorded on our books.

 

With respect to the Orlando City Group, which consists of five properties encompassing 1.3 million square feet located in the central business district of Orlando, we assumed obligations to make improvements to the assets as well as master lease obligations and guarantees on certain vacant space. Additionally, we guaranteed a leveraged internal rate of return (“IRR”) of 20.0% on Miller Global’s equity. See Note 15 to the Consolidated Financial Statements for further discussion of the guarantee. The contribution of these Orlando properties is accounted for as a financing arrangement under SFAS No. 66 – see Note 18 to the Consolidated Financial Statements. Consequently, the assets, liabilities and operations related to the properties remain on our books and a financing obligation has been established for the amount of equity contributed by Miller Global related to the Orlando City Group. The income from operations of the properties, excluding depreciation, is being allocated 80.0% to Miller Global and reported as “interest on financing obligation” in our Consolidated Financial Statements. This financing obligation is also adjusted each period by accreting the obligation up to the 20.0% guaranteed internal rate of return by a charge to interest expense, such that the financing obligation would equal at the end of each period the amount due to Miller Global including the 20.0% guaranteed return. We recorded interest expense on the financing obligation of $11.6 million, $10.1 million and $9.9 million, which includes amounts related to this IRR guarantee and payments made under the rental guarantees, for the years ended 2003, 2002 and 2001, respectively. We have continued to depreciate the Orlando properties and record all of the depreciation on our books.

 

On July 29, 2003, we also entered into an option agreement to acquire Miller Global’s 80.0% interest in the Orlando City Group. On March 2, 2004, we exercised our option and acquired our partner’s 80.0% equity interest in the Orlando City Group. The properties were 83.8% leased as of December 31, 2003 and were encumbered by $136.2 million of floating rate debt with interest based on LIBOR plus 200 basis points. At the closing of the transaction, we paid our partner, Miller Global, $62.5 million and a $7.5 million letter of credit delivered to the seller in connection with the option was cancelled. Since the initial contribution of these assets was accounted for as a financing arrangement and since the financing obligation was adjusted each period for the IRR guarantee, no gain or loss was recognized upon the extinguishment of the financing obligation.

 

- SF-HIW Harborview, LP

 

On September 11, 2002, we contributed Harborview Plaza, an office building located in Tampa, Florida, to SF-HIW Harborview Plaza, LP (“Harborview LP”), a newly formed entity, in exchange for a 20.0% limited partnership interest and $35.4 million in cash. The other partner contributed $12.6 million of cash and a new loan was obtained by the partnership for $22.8 million. In connection with this disposition, we entered into a master lease agreement with Harborview LP for five years on the vacant space in the building (approximately 20%). We also guaranteed to Harborview LP the payment of tenant improvements and lease commissions of $1.2 million. Our maximum exposure to loss under the master lease agreement was $2.1 million at September 11, 2002 and was $1.4 million at December 31, 2003. Additionally, our partner in Harborview LP was granted the right to put its 80.0% equity interest in Harborview LP to us in exchange for cash at any time during the one-year period commencing on September 11, 2014. The value of the 80.0% equity interest will be determined at the time, if ever, that such partner

 

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elects to exercise its put right, based upon the then fair market value of Harborview LP’s assets and liabilities, less 3.0%, which was intended to cover the normal costs of a sale transaction.

 

Because of the put option and the master lease agreement, this transaction is accounted for as a financing transaction, as described in Notes 1 and 18 to the Consolidated Financial Statements. Accordingly, the assets, liabilities and operations related to Harborview Plaza, the property owned by Harborview LP, and any new financing by the partnership remain on our books. As a result, we have established a financing obligation liability equal to the net equity contributed by the other partner. At the end of each reporting period, the balance of the financing obligation is adjusted to equal the current fair value, which is $13.6 million at December 31, 2003, but not less than the original financing obligation. This adjustment is amortized prospectively through September 2014. Additionally, the net income from the operations before depreciation of Harborview Plaza allocable to the 80.0% partner is recorded as interest expense on financing obligation. We continue to depreciate the property and record all of the depreciation on our books. Additionally, any payments made under the master lease agreement are expensed as incurred ($0.4 million and $0.3 million were expensed during the years ended December 31, 2003 and 2002, respectively) and any amounts paid under the tenant improvement and lease commission guarantee are capitalized and amortized to expense over the remaining lease term. At such time as the put option expires or otherwise is terminated, we will record the transaction as a sale and recognize gain on sale.

 

- Eastshore

 

On November 26, 2002, we sold three buildings located in Richmond, Virginia (the “Eastshore” transaction) for a total purchase price of $28.5 million in cash, which was paid in full by the buyer at closing. Each of the sold properties is a single tenant building leased on a triple-net basis to Capital One Services, Inc., a subsidiary of Capital One Financial Services, Inc.

 

In connection with the sale, we entered into a rental guarantee agreement for each building for the benefit of the buyer to guarantee any shortfalls that may be incurred in the payment of rent and re-tenanting costs for a five-year period from the date of sale (through November 2007). Our maximum exposure to loss under the rental guarantee agreements was $18.7 million at the date of sale and was $15.9 million as of December 31, 2003. No payments were made during 2003 or 2002 in respect of these rent guarantees. However, in June 2004, we began to make monthly payments to the buyer, at an annual rate of $0.1 million, as a result of the existing tenant renewing a lease in one building at a lower rental rate.

 

These rent guarantees are a form of continuing involvement as discussed in paragraph 28 of SFAS No. 66. Because the guarantees cover the entire space occupied by a single tenant under a triple-net lease arrangement, our guarantees are considered a guaranteed return on the buyer’s investment for an extended period of time. Therefore, the transaction has been accounted for as a financing transaction following the accounting method described in Note 1 to the Consolidated Financial Statements. Accordingly, the assets and operations are included in the Consolidated Financial Statements, and a financing obligation of $28.5 million was recorded which represents the amount received from the buyer at the time of sale. The income from the operations of the properties, other than depreciation, is allocated 100.0% to the owner as interest expense on a financing obligation. Payments made under the rent guarantees are charged to expense as incurred. This transaction will be recorded as a completed sale transaction in the future when the maximum exposure to loss under the guarantees is equal to or less than the related gain.

 

Interest Rate Hedging Activities

 

To meet in part our long-term liquidity requirements, we borrow funds at a combination of fixed and variable rates. Borrowings under our Revolving Loan bear interest at variable rates. Our long-term debt, which consists of long-term financings and the unsecured issuance of debt securities, typically bears interest at fixed rates. In addition, we have assumed fixed rate and variable rate debt in connection with acquiring properties. Our interest rate risk management objectives are to limit the impact of interest rate changes on earnings and cash flows and to lower our overall borrowing costs. To achieve these objectives, from time to time we enter into interest rate hedge contracts such as collars, swaps, caps and treasury lock agreements in order to mitigate our interest rate risk with respect to various debt instruments.

 

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The following table sets forth information regarding our interest rate hedge contracts as of December 31, 2003 ($ in thousands):

 

Type of Hedge


   Notional
Amount


   Maturity
Date


  

Reference Rate


   Fixed
Rate


    Fair Market
Value


Interest Rate Swap

   $ 20,000    1/2/2004    1 month USD-LIBOR-BBA    0.990 %   $ 3

Interest Rate Swap

   $ 20,000    6/1/2005    1 month USD-LIBOR-BBA    1.590 %     20
                           

                            $ 23
                           

 

The interest rate on all of our variable rate debt is adjusted at one and three month intervals, subject to settlements under these interest rate hedge contracts. We also enter into treasury lock agreements from time to time in order to limit our exposure to an increase in interest rates with respect to future debt offerings. During 2003, only a nominal amount was received from counter parties under interest rate hedge contracts. The swap that matured on January 2, 2004 was not renewed or extended.

 

Related Party Transactions

 

We have previously reported that we have had a contract to acquire development land in the Bluegrass Valley office development project from GAPI, Inc., a corporation controlled by an executive officer/director of the Company. On January 17, 2003, we acquired an additional 23.5 acres of this land from GAPI, Inc. for cash and shares of Common Stock valued at $2.3 million. In May 2003, 4.0 acres of the remaining acres not yet acquired by the Company was taken by the Georgia Department of Transportation to develop a roadway interchange for consideration of $1.8 million. The Department of Transportation took possession and title of the property in June 2003. As part of the terms of the contract between us and GAPI, Inc., we were entitled to the proceeds from the condemnation of $1.8 million, less the contracted purchase price between us and GAPI, Inc. for the condemned property of $0.7 million. On September 30, 2003, as a result of the condemnation, we received the proceeds of $1.8 million. A related party payable of $0.7 million to GAPI, Inc. related to the condemnation of the development land is included in accounts payable, accrued expenses and other liabilities in our Consolidated Balance Sheet at December 31, 2003 and a gain of $1.0 million related to the condemnation of the development land is included in gain on disposition of land in our Consolidated Statement of Income for the year ended December 31, 2003. We believe that the purchase price with respect to each transaction did not exceed market value. These transactions were unanimously approved by the executive committee and the full Board of Directors (with the related executive officer/director abstaining from the vote).

 

During 2000, in connection with the formation of the MG-HIW Peachtree Corners III, LLC, one of our affiliates made a construction loan to this joint venture. Interest accrued at a rate of LIBOR plus 200 basis points. This construction loan was repaid in full in July 2003 when we were assigned our partner’s 50.0% equity interest in the single property encompassing 53,896 square feet owned by MG-HIW Peachtree Corners III, LLC.

 

From 1998 to 2000, we advanced a total of $0.8 million to an officer/director of the Company related to certain expenses paid by us on behalf of the officer/director. During 2002, this advance, along with accrued interest, was repaid by the officer/director.

 

CRITICAL ACCOUNTING ESTIMATES

 

The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses for the reporting period. Actual results could differ from our estimates.

 

The policies and estimates used in the preparation of our Consolidated Financial Statements are described in Note 1 to our Consolidated Financial Statements for the year ended December 31, 2003. However, certain of our significant accounting policies contain an increased level of assumptions used or estimates made in determining their impact on our Consolidated Financial Statements. Management has reviewed our critical accounting policies and estimates with the audit committee of the Company’s Board of Directors and the Company’s independent auditors.

 

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We consider our critical accounting estimates to be those used in the determination of the reported amounts and disclosure related to the following:

 

  Real estate assets;

 

  Allowance for doubtful accounts; and

 

  Property operating expense recoveries.

 

Real Estate Assets

 

All capitalizable costs related to the improvement or replacement of commercial real estate properties are capitalized. Depreciation is computed using the straight-line method over the estimated useful life of 40 years for buildings, 15 years for building improvements and five to seven years for furniture, fixtures and equipment. Tenant improvements are amortized over the life of the respective leases which currently average 4.5 years, using the straight-line method. Real estate assets are stated at the lower of cost or fair value, if impaired.

 

Expenditures directly related to the development and construction of real estate assets are included in net real estate assets and are stated at cost in the Consolidated Balance Sheets. Expenditures directly related to the leasing of properties are included in other assets and are stated at cost in the Consolidated Balance Sheets. Development expenditures include pre-construction costs essential to the development of properties, development and construction costs, interest costs, real estate taxes, salaries and other costs incurred during the period of development. Interest costs are capitalized until the building is ready for its intended use. Construction expenditures include compensation incurred in connection with specific construction projects. Leasing expenditures include compensation incurred in connection with successfully securing leases on the properties. Estimated costs related to unsuccessful activities are expensed as incurred. If our assumptions regarding the successful efforts of development, construction and leasing are incorrect, the resulting adjustments could impact earnings.

 

Upon the acquisition of real estate, we assess the fair value of acquired tangible assets such as land, buildings and tenant improvements, intangible assets such as above and below market leases, acquired-in place leases and other identified intangible assets and assumed liabilities in accordance with SFAS No. 141, “Business Combinations.” We allocate the purchase price to the acquired assets and assumed liabilities based on our relative fair values. We assess and consider fair value based on estimated cash flow projections that utilize appropriate discount and/or capitalization rates as well as available market information. The fair value of the tangible assets of an acquired property considers the value of the property as if it were vacant.

 

Above and below market leases acquired are recorded at their fair value. Fair value is calculated as the present value of the difference between (1) the contractual amounts to be paid pursuant to each in-place lease and (2) management’s estimate of fair market lease rates for each corresponding in-place lease, using a discount rate that reflects the risks associated with the leases acquired and measured over a period equal to the remaining term of the lease for above-market leases and the initial term plus the term of any below-market fixed rate renewal options for below-market leases. The capitalized above-market lease values are amortized as a reduction of base rental revenue over the remaining term of the respective leases and the capitalized below-market lease values are amortized as an increase to base rental revenue over the remaining term of the respective leases.

 

The value of in-place leases is based on our evaluation of the specific characteristics of each tenant’s lease. Factors considered include estimates of carrying costs during hypothetical expected lease-up periods, current market conditions and costs to execute similar leases. In estimating carrying costs, we include real estate taxes, insurance and other operating expenses and estimates of lost rentals at market rates during the expected lease-up periods, depending on local market conditions. In estimating costs to execute similar leases, we consider tenant improvements, leasing commissions and legal and other related expenses. The value of an in-place lease is amortized to depreciation and amortization expense over the remaining term of the respective lease. If a tenant vacates its space prior to its contractual expiration date, any unamortized balance of its related intangible asset is expensed.

 

The value of a tenant relationship is based on our overall relationship with the respective tenant. Factors considered include the tenant’s credit quality and expectations of lease renewals. The value of a tenant relationship is amortized to expense over the initial term and any renewal periods defined in the respective leases. Based on our

 

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acquisitions to date, we have deemed tenant relationships to be immaterial and have not allocated any amounts to this intangible asset.

 

Real estate and leasehold improvements are classified as long-lived assets held for sale or as long-lived assets to be held for use. Real estate is classified as held for sale when the criteria set forth in SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” are satisfied; this determination requires management to make estimates and assumptions, including assessing the probability that potential sales transactions may or may not occur. Actual results could differ from those assumptions. In accordance with SFAS No. 144, we record assets held for sale at the lower of the carrying amount or estimated fair value. Fair value of assets held for sale is equal to the estimated or contracted sales price with a potential buyer less costs to sell. The impairment loss is the amount by which the carrying amount exceeds the estimated fair value. With respect to assets classified as held for use, if events or changes in circumstances, such as a significant decline in occupancy or change in use, indicate that the carrying value may be impaired, an impairment analysis is performed. Such analysis consists of determining whether the asset’s carrying amount will be recovered from its undiscounted estimated future operating cash flows. These cash flows are estimated based on a number of assumptions that are subject to economic and market uncertainties including, among others, demand for space, competition for tenants, changes in market rental rates and costs to operate each property. If the carrying amount of a held for use asset exceeds the sum of its undiscounted future operating cash flows, an impairment loss is recorded for the difference between estimated fair value of the asset and the net carrying amount. We generally estimate the fair value of assets held for use by using discounted cash flow analysis; in some instances, appraisal information may be available and is used in addition to the discounted cash flow analysis. As the factors used in generating these cash flows are difficult to predict and are subject to future events that may alter our assumptions, the discounted and/or undiscounted future operating cash flows estimated by us in our impairment analyses or those established by appraisal may not be achieved and we may be required to recognize future impairment losses on our properties held for sale and held for use.

 

As of December 31, 2003, we had 0.44 million square feet of property, 88 apartment units and 168.1 acres of land under contract for sale or letter of intent in various transactions totaling $90.3 million. These real estate assets have a carrying amount of $65.7 million and have been classified as assets held for sale in the accompanying financial statements.

 

Sales Of Real Estate

 

We account for sales of real estate in accordance with SFAS No. 66. For sales transactions meeting the requirements of SFAS No. 66 for full profit recognition, the related assets and liabilities are removed from the balance sheet and the resultant gain or loss is recorded in the period the transaction closes. For sales transactions that do not meet the criteria for full profit recognition, we account for the transactions in accordance with the methods specified in SFAS No. 66. For sales transactions with continuing involvement after the sale, if the continuing involvement with the property is limited by the terms of the sales contract, profit is recognized at the time of sale and is reduced by the maximum exposure to loss related to the nature of the continuing involvement. Sales to entities in which we have an interest are accounted for in accordance with partial sale accounting provisions as set forth in SFAS No. 66.

 

For sales transactions that do not meet sale criteria as set forth in SFAS No. 66, we evaluate the nature of the continuing involvement, including put and call provisions, if present, and account for the transaction as a financing arrangement, profit-sharing arrangement or other alternate method of accounting rather than as a sale, based on the nature and extent of the continuing involvement. Some transactions may have numerous forms of continuing involvement. In those cases, we determine which method is most appropriate based on the substance of the transaction.

 

If we have an obligation to repurchase the property at a higher price or at a future indeterminable value (such as fair market value), or we guarantee the return of the buyer’s investment or a return on that investment for an extended period, we account for such transaction as a financing transaction. If we have an option to repurchase the property at a higher price and it is likely we will exercise this option, the transaction is accounted for as a financing transaction. For transactions treated as financings, we record the amounts received from the buyer as a financing obligation and continue to keep the property and related accounts recorded on our books. The results of operations of the property, net of expenses other than depreciation (net operating income), will be reflected as “interest expense” on the financing obligation. If the transaction includes an obligation or option to repurchase the asset at a higher price, additional interest is recorded to accrete the liability to the repurchase price. For options or obligations

 

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to repurchase the asset at fair market value at the end of each reporting period, the balance of the liability is adjusted to equal the current fair value to the extent fair value exceeds the original financing obligation. The corresponding debit or credit will be recorded to a related discount account and the revised debt discount is amortized over the expected term until termination of the option or obligation. If it is unlikely such option will be exercised, the transaction is accounted for under the deposit method or profit-sharing method. If we have an obligation or option to repurchase at a lower price, the transaction is accounted for as a leasing arrangement. At such time as these repurchase obligations expire, a sale will be recorded and gain recognized.

 

If we retain an interest in the buyer and provide certain rent guarantees or other forms of support where the maximum exposure to loss exceeds the gain, we account for such transaction as a profit-sharing arrangement. For transactions treated as profit-sharing arrangements, we record a profit-sharing obligation for the amount of equity contributed by the other partner and continue to keep the property and related accounts recorded on our books. The results of operations of the property, net of expenses other than depreciation (net operating income), will be allocated to the other partner for their percentage interest and reflected as “co-venture expense” in our Consolidated Financial Statements. In future periods, a sale is recorded and profit is recognized when the remaining maximum exposure to loss is reduced below the amount of gain deferred.

 

Allowance for Doubtful Accounts

 

Accounts receivable are reduced by an allowance for amounts that may become uncollectible in the future. We evaluate the adequacy of our allowance for doubtful accounts on a quarterly basis. The evaluation primarily consists of reviewing past due account balances and considering such factors as the credit quality of our tenants, historical trends of the tenant and/or other debtor, current economic conditions and changes in customer payment terms. Additionally, with respect to tenants in bankruptcy, we estimate the expected recovery through bankruptcy claims and increase the allowance for amounts deemed uncollectible. If our assumptions regarding the collectibility of accounts receivable prove incorrect, we could experience write-offs of accounts receivable or accrued straight-line rents receivable in excess of our allowance for doubtful accounts.

 

Property Operating Expense Recoveries

 

Property operating cost recoveries from tenants (or cost reimbursements) are determined on a lease-by-lease basis. The most common types of cost reimbursements in our leases are common area maintenance (“CAM”) and real estate taxes, where the tenant pays a share of operating and administrative expenses and real estate taxes, as determined in each lease.

 

The computation of cost reimbursements from tenants for CAM and real estate taxes is complex and involves numerous judgments including the interpretation of terms and other lease provisions. Leases are not uniform in dealing with such cost reimbursements and there are many variations in the computations. Most tenants make monthly fixed payments of CAM, real estate taxes and other cost reimbursement items. We record these payments as income each month. We also make adjustments, positive or negative, to cost recovery income to adjust the recorded amounts to our best estimate of the final amounts to be billed and collected with respect to the cost reimbursements. After the end of the calendar year, we compute each tenant’s final cost reimbursements and, after considering amounts paid by the tenant during the year, issue a bill or credit for the appropriate amount to the tenant. The differences between the amounts billed, less previously received payments and the accrual adjustment are recorded as increases or decreases to cost recovery income when the final bills are prepared, usually beginning in March and completed by June or July. The net amounts of any such adjustments have not been material in the years presented.

 

FUNDS FROM OPERATIONS

 

We believe that funds from operations (“FFO”) and FFO per share are beneficial to management and investors and are important indicators of the performance of any equity REIT. Because FFO and FFO per share calculations exclude such factors as depreciation and amortization of real estate assets and gains or losses from sales of operating real estate assets (which can vary among owners of identical assets in similar conditions based on historical cost accounting and useful life estimates), they facilitate comparisons of operating performance between periods and between other REITs. Our management believes that historical cost accounting for real estate assets in accordance with GAAP implicitly assumes that the value of real estate assets diminishes predictably over time. Since real estate values have historically risen or fallen with market conditions, many industry investors and analysts have considered

 

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the presentation of operating results for real estate companies that use historical cost accounting to be insufficient by themselves. As a result, management believes that the use of FFO and FFO per share, together with the required GAAP presentations, provide a more complete understanding of the Company’s performance relative to its competitors and a more informed and appropriate basis on which to make decisions involving operating, financing and investing activities.

 

FFO and FFO per share as disclosed by other REITs may not be comparable to our calculation of FFO and FFO per share as described below. However, you should be aware that FFO and FFO per share are non-GAAP financial measure and do therefore not represent net income or net income per share as defined by GAAP. Net income and net income per share as defined by GAAP are the most relevant measures in determining our operating performance because FFO and FFO per share include adjustments that investors may deem subjective, such as adding back expenses such as depreciation and amortization. Furthermore, FFO per share does not depict the amount that accrues directly to the stockholders’ benefit. Accordingly, FFO and FFO per share should never be considered as alternatives to net income or net income per share as indicators of our operating performance.

 

Our calculation of FFO, which we believe is consistent with the calculation of FFO as defined by the National Association of Real Estate Investment Trusts (“NAREIT”) and which appropriately excludes the cost of capital improvements and related capitalized interest, is as follows:

 

  Net income (loss) computed in accordance with GAAP;

 

  Plus depreciation and amortization of assets uniquely significant to the real estate industry;

 

  Less gains, or plus losses, from sales of depreciable operating properties (but excluding impairment losses, see Note 2 following the table) and items that are classified as extraordinary items under GAAP;

 

  Plus minority interest;

 

  Less dividends to holders of Preferred Stock;

 

  Plus or minus adjustments for unconsolidated partnerships and joint ventures (to reflect funds from operations on the same basis); and

 

  Plus or minus adjustments for depreciation and amortization and gains/(losses) on sales and minority interest related to discontinued operations.

 

Other REITs may not define FFO in accordance with the current NAREIT definition or may interpret the current NAREIT definition differently than we do.

 

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Restated FFO and FFO per share for the years ended December 31, 2003, 2002 and 2001 are summarized in the following table ($ in thousands):

 

     2003

    2002

    2001

 
     Amount

    Per Share
Diluted


    Amount

    Per Share
Diluted


    Amount

    Per Share
Diluted


 

Funds from operations:

                                                

Net income

   $ 47,944             $ 81,877             $ 117,380          

Dividends to preferred shareholders

     (30,852 )             (30,852 )             (31,500 )        

Excess of preferred stock carrying value over repurchase value

     —                 —                 1,012          
    


         


         


       

Net income applicable to common shareholders

     17,092     $ 0.32       51,025     $ 0.95       86,892     $ 1.59  

Add/(Deduct):

                                                

Depreciation and amortization of real estate assets (1)

     139,276       2.60       138,071       2.58       124,592       2.28  

Gain on disposition of depreciable real estate assets (2)

     (8,677 )     (0.16 )     (15,527 )     (0.29 )     (17,208 )     (0.31 )

Minority interest from the Operating Partnership in income from operations

     813       0.02       4,347       0.08       10,776       0.20  

Transition adjustment upon adoption of SFAS No. 133

     —         —         —         —         556       0.01  

Unconsolidated affiliates:

                                                

Depreciation and amortization of real estate assets (1), (5)

     7,278       0.13       7,648       0.14       6,769       0.12  

Discontinued operations (4):

                                                

Depreciation and amortization of real estate assets (1)

     1,354       0.02       5,426       0.10       5,563       0.10  

Gain on sale, net of minority interest from the Operating Partnership (2)

     (8,600 )     (0.16 )     (15,153 )     (0.28 )     —         —    

Minority interest from the Operating Partnership in income from discontinued operations

     307       0.01       1,229       0.03       1,664       0.03  
    


 


 


 


 


 


Funds from operations before amounts allocable to minority interest in the Operating Partnership (3)

     148,843       2.78       177,066       3.31       219,604       4.02  

Minority interest in the Operating Partnership in funds from operations

     (16,640 )     (0.31 )     (21,182 )     (0.40 )     (27,288 )     (0.50 )
    


 


 


 


 


 


Funds from operations applicable to common shareholders (3)

   $ 132,203     $ 2.47     $ 155,884     $ 2.91     $ 192,316     $ 3.52  
    


 


 


 


 


 


Dividend payout data:

                                                

Dividends paid per common share/common unit

   $ 1.86             $ 2.34             $ 2.31          
    


         


         


       

As a % of funds from operations

     75.3 %             80.4 %             65.6 %        
    


         


         


       

Weighted average shares outstanding - diluted

     53,522               53,587               54,654          
    


         


         


       

(1) In connection with the SEC’s adoption of Regulation G, which governs the presentation of non-GAAP financial measures in documents filed with the SEC, we revised our definition of FFO for 2003 and all periods presented relating to the add-back of non-real estate depreciation and amortization. Our revised definition is in accordance with the definition provided by NAREIT.

 

(2) In October 2003, NAREIT issued a Financial Reporting Alert that changed its current implementation guidance for FFO regarding impairment losses. Accordingly, impairment losses related to depreciable assets have now been included in FFO for the periods presented. See Note 4 to our Consolidated Financial Statements for a breakdown of gain on disposition and impairment of depreciable assets.

 

(3) As a result of FASB’s SFAS No. 145, “Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections,” gains or losses on the extinguishment of debt are no longer classified as an extraordinary item in our Consolidated Statements of Income. Therefore, the calculation of FFO no longer includes an add-back of this amount. Amounts previously reported in 2002 and 2001 have been adjusted to reduce FFO by extraordinary items in those years. The 2003 Funds from Operations include a gain on extinguishment of co-venture obligation of $16.3 million and a loss on debt extinguishment of $14.7 million.

 

(4) For further discussion related to discontinued operations, see Note 12 to the Consolidated Financial Statements.

 

(5) Depreciation and amortization of real estate assets includes adjustments for gains on disposition of depreciable assets of $0.1 million and $0.3 million for 2003 and 2002, respectively.

 

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As a result of the changes to FFO due to the matters discussed in Note 18 to the Consolidated Financial Statements and in footnotes (1), (2) and (3) above, FFO has been reduced by the following in dollars and per share amounts:

 

     Year Ended December 31,

 
     2003

    2002

    2001

 

Change as discussed in Note 18 to the Consolidated Financial Statements

   $ (833 )   $ (7,150 )   $ (13,993 )

Change as discussed in Note 1 above

     (3,446 )     (3,382 )     (3,698 )

Change as discussed in Note 2 above

     (288 )     (13,503 )     —    

Change as discussed in Note 3 above

     —         (687 )     (714 )
    


 


 


FFO in dollars before amounts allocable to minority interest from the Operating Partnership

   $ (4,567 )   $ (24,722 )   $ (18,405 )
    


 


 


Change as discussed in Note 18 to the Consolidated Financial Statements

   $ (0.02 )   $ (0.13 )   $ (0.24 )

Change as discussed in Note 1 above

     (0.06 )     (0.05 )     (0.06 )

Change as discussed in Note 2 above

     (0.01 )     (0.23 )     —    

Change as discussed in Note 3 above

     —         (0.01 )     (0.01 )
    


 


 


FFO per share

   $ (0.09 )   $ (0.42 )   $ (0.31 )
    


 


 


 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

The effects of potential changes in interest rates are discussed below. Our market risk discussion includes “forward-looking statements” and represents an estimate of possible changes in fair value or future earnings that would occur assuming hypothetical future movements in interest rates. These disclosures are not precise indicators of expected future effects, but only indicators of reasonably possible effects. As a result, actual future results may differ materially from those presented. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources” and the Notes to Consolidated Financial Statements for a description of our accounting policies and other information related to these financial instruments.

 

To meet in part our long-term liquidity requirements, we borrow funds at a combination of fixed and variable rates. Borrowings under our Revolving Loan and bank term loans bear interest at variable rates. Our long-term debt, which consists of secured and unsecured long-term financings and the issuance of unsecured debt securities, typically bears interest at fixed rates although some loans bear interest at variable rates. In addition, we have assumed fixed rate and variable rate debt in connection with acquiring properties. Our interest rate risk management objectives are to limit the impact of interest rate changes on earnings and cash flows and to lower our overall borrowing costs. To achieve these objectives, from time to time we enter into interest rate hedge contracts such as collars, swaps, caps and treasury lock agreements in order to mitigate our interest rate risk with respect to various debt instruments. We do not hold or issue these derivative contracts for trading or speculative purposes.

 

As of December 31, 2003, we had approximately $1,338 million of fixed rate debt outstanding. The estimated aggregate fair value of this debt at December 31, 2003 was $1,419 million. If interest rates increase by 100 basis points, the aggregate fair market value of our fixed rate debt as of December 31, 2003 would increase by approximately $71 million. If interest rates decrease by 100 basis points, the aggregate fair market value of our fixed rate debt as of December 31, 2003 would decrease by approximately $78 million.

 

As of December 31, 2003, we had approximately $360 million of variable rate debt outstanding that was not protected by interest rate hedge contracts. If the weighted average interest rate on this variable rate debt is 100 basis points higher or lower during the 12 months ended December 31, 2004, our interest expense would be increased or decreased approximately $3.6 million.

 

For a discussion of our interest rate hedge contracts in effect at December 31, 2003, see “Management’s Discussion and Analysis of Financial Conditions and Results of Operations – Liquidity and Capital Resources – Interest Rate Hedging Activities.” If interest rates increase by 100 basis points, the aggregate fair market value of these interest rate hedge contracts as of December 31, 2003 would increase by approximately $0.3 million. If interest rates decrease by 100 basis points, the aggregate fair market value of these interest rate hedge contracts as of December 31, 2003 would decrease by approximately $0.2 million.

 

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In addition, we are exposed to certain losses in the event of nonperformance by the counter parties under the hedge contracts. We expect the counter parties, which are major financial institutions, to perform fully under the contracts. However, if either of the counter parties was to default on its obligation under an interest rate hedge contract, we could be required to pay the full rates on our debt, even if such rates were in excess of the rate in the contract.

 

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

See page F-1 of the financial report included herein.

 

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

 

None.

 

ITEM 9A. CONTROLS AND PROCEDURES

 

GENERAL

 

The purpose of this section is to discuss the effectiveness of our disclosure controls and procedures and our internal control over financial reporting. The statements in this section represent the conclusions of Edward J. Fritsch, our CEO, and Terry L. Stevens, our CFO. Mr. Fritsch became our CEO on July 1, 2004 and Mr. Stevens became our CFO on December 1, 2003.

 

The CEO and CFO evaluations of our disclosure controls and procedures over financial reporting include a review of the controls’ objectives and design, the controls’ implementation by us and the effect of the controls on the information generated for use in this amended Annual Report. We seek to identify data errors, control problems or acts of fraud and confirm that appropriate corrective action, including process improvements, is undertaken. Our disclosure controls and procedures over financial reporting are also evaluated on an ongoing basis through the following:

 

  activities undertaken and reports issued by employees in our internal audit department;

 

  by management’s evaluation of the results of audits provided by our independent auditors in connection with their audit activities;

 

  other personnel in our finance and accounting organization;

 

  members of our internal disclosure committee; and

 

  members of the audit committee of our Board of Directors.

 

Our management, including the CEO and CFO, do not expect that our disclosure controls and procedures and internal control over financial reporting will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of disclosure controls and procedures and internal control over financial reporting must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

 

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DISCLOSURE CONTROLS AND PROCEDURES

 

SEC rules require us to maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our annual and periodic reports filed with the SEC is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us is accumulated and communicated to our management, including our CEO and CFO, to allow timely decisions regarding required disclosure.

 

As described above under “Explanatory Note,” the purpose of this amended Annual Report is to restate our previously reported financial results for fiscal years 2001 through 2003 included in our 2003 Annual Report on Form 10-K. These restatements are primarily due to: adjustments relating to the accounting for a limited number of our prior real estate sales transactions with continuing involvement occurring between 1999 and 2003, reclassifications related to discontinued operations with continuing involvement, accounting for a debt extinguishment transaction, accounting for minority interest, and various other matters. We believe that the material adjustments relate to transactions that were previously disclosed by the Company in prior SEC filings. For instance, the nature of the Company’s material continuing involvement related to our real estate sales transactions, the material facts relating to our retirement of the $125 million principal amount of MOPPRS, and the method of accounting for minority interest were disclosed in our prior quarterly and annual regulatory and financial filings with the Securities and Exchange Commission and our annual reports.

 

Based on our evaluation of disclosure controls and procedures, as of the date of the filing of this amended Annual Report, our CEO and CFO believe that our disclosure controls and procedures are effective to ensure that information required to be disclosed in its financial reports has been made known to management, including the CEO and CFO, and other persons responsible for preparing such reports and is recorded, processed, summarized and reported.

 

INTERNAL CONTROL OVER FINANCIAL REPORTING

 

SEC rules also require us to maintain internal control over financial reporting designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP. Internal control over financial reporting includes those policies and procedures that:

 

  pertain to the maintenance of records that in reasonable detail accurately and fairly reflect our transactions and dispositions of assets;

 

  provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures are being made only in accordance with authorizations of management and directors; and

 

  provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.

 

As noted above and described above under “Explanatory Note,” the purpose of this amended Annual Report is to restate our previously reported financial results for fiscal years 2001 through 2003 included in our 2003 Annual Report on Form 10-K. These restatements are primarily due to: adjustments relating to the accounting for a limited number of our prior real estate sales transactions with continuing involvement occurring between 1999 and 2003, reclassifications related to discontinued operations with continuing involvement, accounting for a debt extinguishment transaction, accounting for minority interest, and various other matters. We believe that the adjustments required to be made to the historical financial statements resulted from prior unintentional misapplication of GAAP.

 

A majority of the adjustments made as part of the restatement relate to transactions that occurred or methods that were adopted during the 1997 to 2002 timeframe. While a number of those early adjustments had continuing effects into 2003 and 2004, only a few adjustments related to transactions that occurred or methods that were adopted in 2003 or 2004, such as the MOPPRS debt extinguishment in early 2003 and the CEO retirement package in the first quarter of 2004, both of which required some amount of subjective judgment to determine the proper accounting methodology.

 

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Ernst & Young LLP has issued an unqualified opinion dated October 22, 2004 on our restated 2003, 2002 and 2001 Consolidated Financial Statements that are included in this amended Annual Report. On October 26, 2004, Ernst & Young LLP advised our Audit Committee that they identified the following material weaknesses during their audits of the restated financial statements for 2003, 2002 and 2001: inadequate procedures for appropriately assessing and applying accounting principles to complex transactions; lack of adequate finance and accounting staff to appropriately identify and evaluate accounting for transactions; inadequate procedures to ensure critical information regarding a transaction is known by the persons accounting for such transaction; and lack of application of GAAP to transactions due to perceived immateriality of transactions.

 

Since late 2002, we have added several experienced staff to our Finance and Accounting Departments. These included an Assistant Controller (new position), a Director of Financial Standards and Compliance (new position), a Senior Director of Investor Relations (replacement) and a new Chief Financial Officer (replacement, as the former CFO assumed a new position within the Company). During 2003 and 2004 up to the filing date of this amended Annual Report, we have further improved our internal control over financial reporting by, among other things, expanding supervisory activities and monitoring techniques and strengthening our procedures designed to ensure that information relating to transactions directly or indirectly involving the Company and its subsidiaries is made known to persons responsible for preparing our financial statements. We have also implemented revised checklists and additional management oversight of our accounting staff to ensure appropriate assessment and application of GAAP to all transactions, particularly complex transactions such as sales of real estate with continuing involvement that are governed by SFAS No. 66.

 

Other than the foregoing and the adjustments that are being made as described under “Explanatory Note” and Note 18 to our restated Consolidated Financial Statements, there have been no changes in our internal controls over financial reporting since December 31, 2003 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

Section 404 of the Sarbanes-Oxley Act of 2002 requires public companies, including us, with a fiscal year that ends on December 31 to report on the effectiveness of their internal control over financial reporting in their 2004 Annual Report on Form 10-K, which we are required to file with the SEC no later than March 16, 2005. Our independent auditor will be required to attest to that report. Our management, including our CEO and CFO, and our audit committee are working diligently to ensure that our internal control over financial reporting provides reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP.

 

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PART III

 

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

 

On March 31, 2004, the Company filed a Proxy Statement for the Annual Meeting of Stockholders, which was held on May 18, 2004. The section under the heading “Election of Directors” of such Proxy Statement for the Annual Meeting of Stockholders held May 18, 2004 is incorporated herein by reference for information on directors of the Company. See ITEM X in Part I hereof for information regarding executive officers of the Company.

 

The Section under the heading “Committees of the Board of Directors – Audit Committee” of the Proxy Statement is incorporated herein by reference.

 

We have adopted a Code of Business Conduct and Ethics that applies to all employees and members of our Board of Directors. We have also adopted a separate Code of Ethics for our CEO and Senior Financial Officers. A copy of both Codes is available free of charge on our corporate website, which is http://www.highwoods.com. We intend to satisfy the disclosure requirement under Item 10 of Form 8-K regarding an amendment to, or a waiver from, a provision of these Codes of Ethics by posting such information on our website as identified above. Our website also includes our board committee charters and our corporate governance guidelines. Alternatively, you may request any of this information free of charge by writing to us at Highwoods Properties, Inc., Investor Relations, 3100 Smoketree Court, Suite 600, Raleigh, NC 27604.

 

ITEM 11. EXECUTIVE COMPENSATION

 

The section under the heading “Election of Directors” entitled “Compensation of Directors” of the Proxy Statement and the section titled “Executive Compensation” of the Proxy Statement are incorporated herein by reference except for the 2003 Year-End Option Values table, which is superseded by the table below.

 

The following table sets forth information with respect to options held by the following Named Executive Officers as of December 31, 2003:

 

    

Number of

Securities Underlying

Options at 2003 Year-End (1)


  

Value of

Unexercised In-the-Money

Options at 2003 Year-End (2), (3)


Name


   Exercisable

   Unexercisable

   Exercisable

   Unexercisable

Ronald P. Gibson

   365,699    507,725    $ 1,266,306    $ 1,324,840

Edward J. Fritsch

   264,792    249,427    $ 1,025,140    $ 646,716

Carman J. Liuzzo

   213,595    193,127    $ 936,729    $ 500,787

Mack D. Pridgen III

   176,297    172,620    $ 792,652    $ 447,570

Gene H. Anderson

   42,516    94,113    $ 45,520    $ 153,484

Michael E. Harris

   122,718    94,113    $ 295,132    $ 241,684

(1) Options include incentive stock options and nonqualified stock options. Options have varying vesting schedules of no less than four year ratable vesting.

 

(2) Represents the difference between a closing price of $25.40 per share of common stock on December 31, 2003 and the options’ exercise prices as adjusted by any Dividend Equivalent Right (“DER”) as described in (3) below.

 

(3) 196,660 nonqualified stock options granted to the Named Executive Officers in 1997 were accompanied by a DER pursuant to the 1997 Performance Award Plan. The Plan provided that if the total return on a share of common stock exceeds certain thresholds during the five-year vesting period ending in 2002, the exercise price of such stock options with a DER will be reduced under a formula that is based on dividends and other distributions that are made with respect to such a share during the period beginning on the date of grant and ending upon exercise of such stock option. Based on the performance of the common stock during the five-year vesting period and the level of dividends paid on common stock through December 31, 2003, the exercise price per share has been reduced by $8.12. As of December 31, 2003, 166,968 of these options held by the Named Executive Officers remain outstanding.

 

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ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

 

The sections under the headings “Voting Securities and Principal Stockholders” and “Equity Compensation Plan Information” of the Proxy Statement are incorporated herein by reference.

 

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

 

The section under the heading “Related Party Transactions” of the Proxy Statement is incorporated herein by reference.

 

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

 

The section under the heading “Ratification of Appointment of Independent Auditors” of the Proxy Statement is incorporated herein by reference.

 

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PART IV

 

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

 

(a) List of Documents Filed as a Part of this Report

 

  1. Consolidated Financial Statements, Consolidated Financial Statement Schedules and Report of Independent Registered Public Accounting Firm. See Index on Page F-1

 

  2. Exhibits

 

Ex.

  FN

  

Description


  3.1     (1)    Amended and Restated Articles of Incorporation of the Company
  3.2     (2)    Amended and Restated Bylaws of the Company
  4.1     (2)    Specimen of certificate representing shares of Common Stock
  4.2     (3)    Indenture among the Operating Partnership, the Company and First Union National Bank of North Carolina dated as of December 1, 1996
  4.3     (4)    Specimen of certificate representing 8 5/8% Series A Cumulative Redeemable Preferred Shares
  4.4     (5)    Specimen of certificate representing 8% Series B Cumulative Redeemable Preferred Shares
  4.5     (6)    Specimen of certificate representing 8% Series D Cumulative Redeemable Preferred Shares
  4.6     (6)    Specimen of Depositary Receipt evidencing the Depositary Shares each representing 1/10 of an 8% Series D Cumulative Redeemable Preferred Share
  4.7     (6)    Deposit Agreement, dated April 23, 1998, between the Company and First Union National Bank, as preferred share depositary
  4.8     (7)    Rights Agreement, dated as of October 6, 1997, between the Company and First Union National Bank, as rights agent
  4.9     (8)    Agreement to furnish certain instruments defining the rights of long-term debt holders
  4.10   (17)    Amendment No. 1, dated as of October 7, 2003, to the Rights Agreement, dated as of October 7, 1997, between the Company and Wachovia Bank, N.A., as rights agent
10.1     (2)    Amended and Restated Agreement of Limited Partnership of the Operating Partnership
10.2     (4)    Amendment to Amended and Restated Agreement of Limited Partnership of the Operating Partnership with respect to Series A Preferred Units
10.3     (5)    Amendment to Amended and Restated Agreement of Limited Partnership of the Operating Partnership with respect to Series B Preferred Units
10.4     (6)    Amendment to Amended and Restated Agreement of Limited Partnership of the Operating Partnership with respect to Series D Preferred Units
10.5     (9)    Amendment to Amended and Restated Agreement of Limited Partnership of the Operating Partnership with respect to certain rights of limited partners upon a change of control
10.6     (10)    Form of Registration Rights and Lockup Agreement among the Company and the Holders named therein, which agreement is signed by all Common Unit holders
10.7     (11)    Amended and Restated 1994 Stock Option Plan
10.8     (8)    1997 Performance Award Plan
10.9     (12)    Form of Executive Supplemental Employment Agreement between the Company and Named Executive Officers
10.10   (13)    Form of warrants to purchase Common Stock of the Company issued to John L. Turner, William T. Wilson III and John E. Reece II
10.11   (14)    Form of warrants to purchase Common Stock of the Company issued to W. Brian Reames, John W. Eakin and Thomas S. Smith

 

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Ex.

   FN

  

Description


10.12    (15)    1999 Shareholder Value Plan
10.13    (16)    Amended and Restated Credit Agreement among Highwoods Realty Limited Partnership, Highwoods Properties, Inc., the Subsidiaries named therein and the Lenders named therein, dated as of July 17, 2003
21         (12)    Schedule of subsidiaries of the Company
23              Consent of Ernst & Young LLP
31.1           Certification Pursuant to Section 302 of the Sarbanes-Oxley Act
31.2           Certification Pursuant to Section 302 of the Sarbanes-Oxley Act
32.1           Certification Pursuant to Section 906 of the Sarbanes-Oxley Act
32.2           Certification Pursuant to Section 906 of the Sarbanes-Oxley Act

(1) Filed as part of the Company’s Current Report on Form 8-K dated September 25, 1997 and amended by articles supplementary filed as part of the Company’s Current Report on Form 8-K dated October 4, 1997 and articles supplementary filed as part of the Company’s Current Report on Form 8-K dated April 20, 1998, each of which is incorporated herein by reference.

 

(2) Filed as part of Registration Statement 33-76952 dated February 28, 1994 with the SEC and incorporated herein by reference.

 

(3) Filed as part of the Operating Partnership’s Current Report on Form 8-K dated December 2, 1996 and incorporated herein by reference.

 

(4) Filed as part of the Company’s Current Report on Form 8-K dated February 12, 1997 and incorporated herein by reference.

 

(5) Filed as part of the Company’s Current Report on Form 8-K dated September 25, 1997 and incorporated herein by reference.

 

(6) Filed as part of the Company’s Current Report on Form 8-K dated April 20, 1998 and incorporated herein by reference.

 

(7) Filed as part of the Company’s Current Report on Form 8-K dated October 4, 1997 and incorporated herein by reference.

 

(8) Filed as part of the Company’s Annual Report on Form 10-K for the year ended December 31, 1997 and incorporated herein by reference.

 

(9) Filed as part of the Operating Partnership’s Quarterly Report on Form 10-Q for the quarter ended June 30, 1997 and incorporated herein by reference.

 

(10) Filed as part of the Company’s Annual Report on Form 10-K for the year ended December 31, 1995 and incorporated herein by reference.

 

(11) Filed as part of the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2002.

 

(12) Filed as part of the Company’s Annual Report on Form 10-K for the year ended December 31, 1998 and incorporated herein by reference.

 

(13) Filed as part of Registration Statement 33-88364 with the SEC and incorporated herein by reference.

 

(14) Filed as part of the Company’s Current Report on Form 8-K dated April 1, 1996 and incorporated herein by reference.

 

(15) Filed as part of the Company’s Annual Report on Form 10-K for the year ended December 31, 1999 and incorporated herein by reference.

 

(16) Filed as part of the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2003 and incorporated herein by reference.

 

(17) Filed as part of the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2003 and incorporated herein by reference.

 

The Company will provide copies of any exhibit, upon written request, at a cost of $.05 per page.

 

(b) Reports on Form 8-K

 

None.

 

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SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Raleigh, State of North Carolina, on November 15, 2004.

 

HIGHWOODS PROPERTIES, INC.

By:   /s/    EDWARD J. FRITSCH        
   

Edward J. Fritsch

President and Chief Executive Officer

 

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INDEX TO FINANCIAL STATEMENTS

 

     Page

Highwoods Properties, Inc.

    

Report of Independent Registered Public Accounting Firm

   F-2

Restated Financial Statements:

    

Consolidated Balance Sheets as of December 31, 2003 and 2002

   F-3

Consolidated Statements of Income for the Years Ended December 31, 2003, 2002 and 2001

   F-4

Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2003, 2002 and 2001

   F-5

Consolidated Statements of Cash Flows for the Years Ended December 31, 2003, 2002 and 2001

   F-6

Notes to Consolidated Financial Statements

   F-8

Schedule II – Valuation and Qualifying Accounts and Reserves

   F-58

Schedule III – Real Estate and Accumulated Depreciation

   F-59

All other schedules are omitted because they are not applicable or because the required information is included in the Consolidated Financial Statements or notes thereto.

 

F-1


Table of Contents

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

The Board of Directors and Stockholders

    of Highwoods Properties, Inc.

 

We have audited the accompanying consolidated balance sheets of Highwoods Properties, Inc. as of December 31, 2003 and 2002, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2003. Our audits also included the financial statement schedules listed in the Index at Item 15(a). These financial statements and schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Highwoods Properties, Inc. at December 31, 2003 and 2002, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2003, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.

 

As discussed in Notes 1, 18 and 19 to the consolidated financial statements, the accompanying consolidated balance sheets as of December 31, 2003 and 2002 and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2003 and the financial statement schedules listed in the Index at Item 15(a) have been restated.

 

In 2003, as discussed in Note 1 to the consolidated financial statements, the Company adopted the provisions of Statement of Financial Accounting Standards No. 145, “Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections.” In 2002, as discussed in Note 12 to the consolidated financial statements, the Company adopted the provisions of Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.”

 

/S/ ERNST & YOUNG LLP

 

Raleigh, North Carolina

October 22, 2004

 

F-2


Table of Contents

HIGHWOODS PROPERTIES, INC.

 

Consolidated Balance Sheets

 

($ in thousands)

 

(Restated)