ITEM 1. BUSINESS General Highwoods Properties, Inc. (the "Company") is a self-administered and self-managed real estate investment trust ("REIT") that began operations through a predecessor in 1978. Originally founded to oversee the development, leasing and management of the 201-acre Highwoods Office Center in Raleigh, North Carolina, the Company has since evolved into one of the largest owners and operators of suburban office and industrial properties in the southeastern United States. Historically, the Company's real estate operations have been focused in the Raleigh-Durham, North Carolina market, an area also known as the Research Triangle, one of the nation's premier business centers. On June 14, 1994, the Company completed an initial public offering of 8,510,000 shares of Common Stock in connection with the reorganization of the Company's predecessor, whereby the Company succeeded to the ownership of 36 suburban office buildings, four service center properties, one warehouse facility and 94 acres of undeveloped land (the "Formation Transaction"). As of December 31, 1996, the Company owned a portfolio of 292 in-service office and industrial properties (the "Properties") and owned 238 acres (and had agreed to purchase an additional 311 acres) of undeveloped land suitable for future development (the "Development Land"). An additional 14 properties (the "Development Projects"), which will encompass approximately 1.0 million square feet, are currently under development. The Properties consist of 181 suburban office properties and 111 industrial properties (including 74 service centers) located in 16 markets in North Carolina, Florida, Tennessee, Georgia, Virginia, South Carolina and Alabama. The Company conducts substantially all of its activities through, and substantially all of its properties are held directly or indirectly by, Highwoods/Forsyth Limited Partnership (the "Operating Partnership"). The Operating Partnership is controlled by the Company as its sole general partner and, as of March 14, 1997, the Company owned approximately 84% of the limited partnership interests (the "Units") in the Operating Partnership. The remaining Units are owned by limited partners (including certain officers and directors of the Company). Each Unit may be redeemed by the holder thereof for the cash value of one share of Common Stock, or, at the Company's option, one share (subject to certain adjustments) of Common Stock. With each such exchange, the number of Units owned by the Company and, therefore, the Company's percentage interest in the Operating Partnership, will increase. In addition to owning the Properties, the Development Projects and the Development Land, the Company provides leasing, property management, real estate development, construction and miscellaneous tenant services for the Properties as well as for third parties. The Company conducts its third-party fee-based services through Highwoods Services, Inc. and Forsyth Properties Services, Inc., which are subsidiaries of the Operating Partnership. During the year, the Company sold its third-party brokerage business in the Research Triangle and the Piedmont Triad and currently provides such brokerage services only in Nashville, Tennessee. The Company was formed in North Carolina in 1994. The Company's executive offices are located at 3100 Smoketree Court, Suite 600, Raleigh, North Carolina 27604, and its telephone number is (919) 872-4924. The Company also maintains regional offices in Winston-Salem and Charlotte, North Carolina; Richmond, Virginia; Nashville and Memphis, Tennessee; Atlanta, Georgia; and Tampa and Boca Raton, Florida. Business Objectives and Strategy of the Company The Company seeks to maximize the total return to its stockholders (i) through contractual increases in rental rates from existing leases, (ii) by renewing or re-leasing space with expiring leases at higher effective rental rates, (iii) by increasing occupancy levels in properties, (iv) by acquiring new properties, (v) by developing new properties, including properties on the Development Land, and (vi) by providing a complete line of real estate services to the Company's tenants and to third parties. The Company believes that its in-house development, acquisition, construction management, leasing
and management services allow it to respond to the many demands of its existing and potential tenant base, and enable it to provide its tenants cost-effective services such as build-to-suit construction and space modification, including tenant improvements and expansions. In addition, the breadth of the Company's capabilities and resources provides it with market information not generally available and gives the Company increased access to development, acquisition and management opportunities. The Company believes that the operating efficiencies achieved through its fully integrated organization also provide a competitive advantage in setting its lease rates and pricing its other services. The Company's strategy has been to focus its real estate activities in markets where it believes its extensive local knowledge gives it a competitive advantage over other real estate developers and operators. As the Company has expanded into new markets, it has continued to maintain this localized approach by combining with local real estate operators with many years of development and management experience in their respective markets. Also, in making its acquisitions, the Company has sought to employ those property-level managers who are experienced with the real estate operations and the local market relating to the acquired properties, resulting in 87% of the portfolio currently being managed on a day-to-day basis by personnel that has had previous experience managing, leasing and/or developing those properties for which they are responsible. The Company seeks to acquire suburban office and industrial properties at prices below replacement cost that offer attractive returns, including acquisitions of underperforming, high-quality assets in situations offering opportunities for the Company to improve such assets' operating performance. In evaluating potential acquisition opportunities, the Company will continue to rely on the extensive experience of its management and its research capabilities in considering a number of factors, including: (i) the location of the property, (ii) the construction quality and condition of the property, (iii) the occupancy and demand of properties of a similar type in the market and (iv) the ability of the property to generate returns at or above levels of expected growth. (See " -- Recent Developments" for a discussion of the Company's acquisition and development activities during 1996.) The Company also believes that the 549 acres of Development Land should provide it with a competitive advantage in its future development activities. The Company may from time to time acquire properties from property owners through the exchange of Units in the Operating Partnership for the property owner's equity in the acquired property. As discussed above, each Unit received by these property owners is redeemable for cash from the Operating Partnership or, at the Company's option, shares of Common Stock. In connection with the transactions, the Company may also assume outstanding indebtedness associated with the acquired properties. The Company believes that this acquisition method may permit it to acquire properties at attractive prices from property owners wishing to enter into tax-deferred transactions. The Company has acquired 115 properties using the foregoing method since its inception, comprising 7.4 million rentable square feet. The Company is also committed to maintaining a capital structure that will allow it to grow through development and acquisition opportunities. As part of this commitment, the Company intends to operate with a ratio of debt to total market capitalization below 40%. At March 14, 1997, the ratio of debt to total market capitalization (based on a Common Stock price of $35.50 per share) was approximately 26%. The Company believes that this debt level improves its ability to borrow funds at attractive rates. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources."
Recent Developments Merger and Acquisition Activity The following table summarizes the mergers and acquisitions completed during the year ended December 31, 1996 (dollars in thousands):
(1) Excludes Highwoods Plaza One, which was then under development, development land and contingent purchase price, which total $14,900,000. (2) Net of approximately $21 million of cash held by Crocker. A significant portion of the Company's growth during 1996 resulted from its expansion into new markets. The Company entered 12 new markets and established five divisional offices as a result of the Crocker and the Eakin & Smith transactions (both transactions are described below). Eakin & Smith Transaction On April 1, 1996, the Company completed a merger with Eakin & Smith, Inc. and its affiliates ("Eakin & Smith") combining their property portfolios, management teams and business operations (the "Eakin & Smith Transaction"). Through the combination, the Company succeeded to the ownership of seven suburban office buildings totaling 848,000 square feet, a 103,000-square-foot suburban office development project, 18 acres of development land and Eakin & Smith's brokerage and property management operations. All the properties and development land are located in Nashville, Tennessee. The aggregate cost to the Company of the Eakin & Smith Transaction, including the completion of the in-process development project, was approximately $98.5 million payable through the issuance of 537,138 Units and 489,421 shares of Common Stock, the assumption of $37 million of indebtedness (with a weighted average fixed rate of 8.0%), and cash payments of approximately $33 million. The cost excludes options to purchase 105,000 shares of Common Stock at a price of $27.50 per share and warrants to purchase 150,000 shares of Common Stock at a price of $28.00 per share, as well as deferred payments of up to 54,056 shares of Common Stock, which are attributable to Eakin & Smith's brokerage and property management operation. Crocker Transaction On September 20, 1996, the Company completed its merger (the "Merger") with Crocker Realty Trust, Inc. ("Crocker"). As a result of the Merger, the Company acquired 58 suburban office properties and 12 service center properties (the "Crocker Properties") located in 15 southeastern markets in Florida, North Carolina, South Carolina, Tennessee, Georgia, Virginia and Alabama. The Crocker Properties encompass 5.7 million rentable square feet. The total cost of the acquisition of all the outstanding shares of Crocker Realty Trust, Inc. was approximately $565.8 million, which included cash payments for stock and outstanding options and warrants of $322.8 million and the assumption of
$243 million of debt with an average rate of 8.6%. This indebtedness included a $140 million mortgage note with a fixed rate of 7.9% (the "7.9% Mortgage Note"). With the exception of the 7.9% Mortgage Note, the Company has repaid substantially all of such assumed indebtedness. The Company believes that the merger offered a unique investment opportunity for future growth by allowing the Company to expand and diversify its operations to growth-oriented markets throughout the Southeast. In addition, the merger enhanced the Company's opportunities to engage in development projects and accretive acquisitions, such as the 1997 Century Center and Anderson transactions (see "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Recent Developments"), due to the inherent cost savings of previously established local real estate management and infrastructure. Development Activity The following table summarizes the 12 development projects placed in service during the year ended December 31, 1996 (dollars in thousands): Completed
The Company had 12 suburban office properties and two industrial properties under development totaling 1.0 million square feet of office and industrial space at December 31, 1996. The following table summarizes these development projects (dollars in thousands): Development in process
* Letters of intent improve the pre-leasing to 61%.
Financing Activity In June 1996, the Company completed a 11,500,000-share public offering of Common Stock (including 1,500,000 shares issued pursuant to the underwriters' over allotment option). The net proceeds of the offering totaled $292.9 million and were used primarily to fund the acquisition of Crocker. In July 1996, the Company sold an additional 250,000 shares of Common Stock to underwriters who participated in the Company's 11,500,000-share offering. The net proceeds from this offering were approximately $6.8 million. On September 27, 1996, the Company replaced a $140 million credit facility with a $280 million unsecured revolving line of credit (the "Revolving Loan") from a syndicate of lenders. The Revolving Loan requires monthly payments of interest only with the balance of all principal and accrued but unpaid interest due on October 31, 1999. The interest rate on the Revolving Loan at year end was LIBOR plus 135 basis points and will adjust based on the Company's senior unsecured credit rating within a range of LIBOR plus 100 basis points to LIBOR plus 175 basis points. On December 2, 1996, the Operating Partnership issued $100 million of 6 3/4% notes due December 1, 2003, and $110 million of 7% notes due December 1, 2006. The proceeds were used to reduce amounts outstanding on the Revolving Loan, to repay mortgage debt and to settle an interest rate swap agreement. In December 1996, the Company completed a public offering of 2,587,500 shares of Common Stock (including 337,500 shares issued pursuant to the underwriters' over allotment option) and a concurrent non-underwritten public offering of 1,093,577 shares of Common Stock with an institutional investor. The net proceeds from the two offerings totaled approximately $96.7 million. In connection with 1996 acquisitions, the Company issued 807,608 Units and 489,421 shares of restricted Common Stock valued at $35.6 million (based on the agreed-upon valuation of a share of Common Stock at the time of the acquisition). Competition The Properties compete for tenants with similar properties located in the Company's markets primarily on the basis of location, rent charged, services provided and the design and condition of the facilities. The Company also competes with other REITs, financial institutions, pension funds, partnerships, individual investors and others when attempting to acquire properties. Employees As of December 31, 1996, the Company employed 270 persons, as compared to 124 at December 31, 1995. The increase is primarily a result of the Company's geographic expansion.
ITEM 2.
ITEM 2. PROPERTIES General The following table sets forth certain information about the Properties at December 31, 1996 (dollars in thousands):
(1) Includes 74 service center properties. (2) Annualized Rental Revenue is December 1996 rental revenue (base rent plus operating expense pass throughs) multiplied by 12. (3) Includes 41 single-tenant properties comprising 2.6 million rentable square feet and 144,767 rentable square feet leased but not occupied. (4) Includes 26 single-tenant properties comprising 1.5 million rentable square feet and 48,136 rentable square feet leased but not occupied. (5) Excludes Ivy Distribution Center. Ivy is a 400,000-rentable square foot warehouse, which was constructed in stages. A portion of the building was built in 1930; major expansions took place in the mid-1940s, mid-1950s and 1981. In 1989, the entire property was renovated to convert it from a manufacturing facility to a warehouse.
The following table sets forth certain information about the portfolio of in-service and development properties as of December 31, 1996 and 1995:
Tenants The Properties are leased to approximately 1,800 tenants, which engage in a wide variety of businesses including computers, healthcare, telecommunications, finance, insurance and electronics. The following table sets forth information concerning the 20 largest tenants of the Properties as of December 31, 1996 (dollars in thousands):
(1) Calculated by multiplying December 1996 rental revenue (base rent plus operating pass throughs) by 12.
The following tables set forth certain information about the Company's leasing activities for the years ended December 31, 1996 and 1995.
The following tables set forth scheduled lease expirations for executed leases as of December 31, 1996, assuming no tenant exercises renewal options. Office Properties:
Industrial Properties:
(1) Includes operating expense pass throughs and excludes the effect of future contractual rent increases.
Table of Properties The following table and the notes thereto set forth information regarding the Properties at December 31, 1996:
(1) I = Industrial, S = Service Center and O = Office. (2) Raleigh Neurology Clinic has an option to purchase 33% of the Property in December 1998 for cash at the then current fair market value, as to be determined by an independent appraiser. (3) Glaxo Wellcome has the option to purchase the Property from March 1997 to the earlier of lease termination (currently March 2000) or March 2003 for cash at the then current fair market value to be determined by an appraiser chosen by the Company, provided the terms of such purchase are acceptable to the Company and Glaxo Wellcome. (4) Highland Industries, Inc., which entered into a 10-year lease beginning January 1991, has the option during the term of its lease to purchase the Property for a price of $1,034,000 during each of the first five years and, thereafter, at decreasing amounts through the tenth year of the lease term when the price will be $926,000. (5) Ivy Distribution Center enables the Company to establish relationships with potential tenants that need large blocks of affordable storage space, frequently on a short-term basis. With the exception of 1989 when the building was renovated to convert it from a manufacturing facility to a bulk warehouse facility, Ivy Distribution Center has produced a positive cash flow every year since its acquisition in 1978. (6) Kroger Co. has an option to purchase the Property through January 2001. The purchase price under the option is $10.0 million through January 1999 (and $10.8 million from January 1999 through January 2001) subject to all encumbrances, plus unamortized tenant improvements funded by the Company and unamortized leasing commissions. (7) Pump Parts & Services, Inc. has an option to purchase the Property for a purchase price of $39.24 per square foot ($589,793) (as of August 1996) subject to a minimum increase in the per square foot purchase price of 5% per year. (8) Properties subject to ground lease expiring December 31, 2082. The Company has the option to purchase the land during the lease term at the greater of $35,000 per acre or 85% of appraised value.
Development Land As of December 31, 1996, the Company owned 238 acres and had committed to purchase over the next six years an additional 311 acres of land for development. The following table sets forth the location, acreage, build-out capacity and estimated construction costs with respect to the Development Land (dollars in thousands):
(1) With respect to Development Land to be acquired, includes costs to acquire land.
All of the Development Land is zoned and available for office or industrial development, substantially all of which has utility infrastructure already in place. The Company believes that the cost of developing the Development Land could be financed with the funds available from the Company's existing credit facility, additional borrowings and offerings of equity and debt securities. The Company believes that its commercially zoned and unencumbered land in existing business parks gives the Company an advantage in its future development activities over other commercial real estate development companies in the Research Triangle, the Piedmont Triad, Richmond, Nashville and Charlotte. Any future development, however, is dependent on the demand for industrial or office 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, the Company will be subject to the risks associated with construction activities, including the risk that occupancy rates and rents at a newly completed property may not be sufficient to make the property profitable, construction costs may exceed original estimates and construction and lease-up may not be completed on schedule, resulting in increased debt service expense and construction expense. Option Land The Company has options to purchase or rights of first refusal to purchase, lease or develop a total of 166 acres of undeveloped land (the "Option Land") at locations adjacent to Properties in two existing business parks. The Company has long-term rights of first refusal to purchase, lease or develop: (i) 147 acres in the Expressway Commerce Center, which is targeted for development of warehouses and service center facilities and (ii) 19 acres adjacent to Creekstone Park, which is targeted for service center development. No assurance can be given that any of the Option Land will be purchased or developed by the Company.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS The Company is a party to a variety of legal proceedings arising in the ordinary course of its business. The Company believes that it is adequately covered by insurance and indemnification agreements. Accordingly, none of such proceedings are expected to have a material adverse effect on the financial position or results of operations of the Company. ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. ITEM X. EXECUTIVE OFFICERS OF THE REGISTRANT The following table sets forth certain information with respect to the executive officers of the Company:
In addition, on February 12, 1997, Gene H. Anderson was appointed to the Board of Directors and joined the Company as a senior vice president. Mr. Anderson is responsible for the operations of the Company's Atlanta properties. Mr. Anderson was the founder and president of Anderson Properties. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Recent Developments." Employment Agreements The Company's executive officers generally have employment agreements with the Company with a three-year duration. Messrs. Gibson and Fritsch have employment agreements through June 1997, Messrs. Turner, Wilson, Reece and Liuzzo have employment agreements through February 1998, Mr. Eakin's employment agreement runs through April 2000 and Mr. Anderson's employment agreement is through February 2000. Each contract includes provisions restricting the officers from competing with the Company during employment and, except in certain circumstances, for a limited period of time after termination of employment. Each of the employment contracts provides for severance payments in the event of termination by the Company without cause equal to the officer's base salary for the later of one year from the date of termination or the expiration of the three-year employment agreement.
PART II ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS Market Information and Dividends The Common Stock has been traded on the NYSE under the symbol "HIW" since the Company's initial public offering. The following table sets forth the quarterly high and low sales prices per share reported on the NYSE for the periods indicated and the distributions paid per share for each such period.
(1) Prior to the Company's June 14, 1994, initial public stock offering. (2) No distribution was paid during this period. The accrued distribution of $0.075 per share was paid on November 16, 1994 at the time the Company paid its initial distribution for the period from inception to September 30, 1994. On March 14, 1997, the last reported sale price of the Common Stock on the NYSE was $35.50 per share. On March 14, 1997, the Company had 654 stockholders of record. The Company intends to continue to pay regular quarterly distributions to holders of shares of Common Stock and holders of Units. Although the Company intends to maintain its current distribution rate, future distributions 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 distribution requirements under the REIT provisions of the Internal Revenue Code of 1986 and such other factors as the Board of Directors deems relevant. During the year ended 1996, the Company's distributions totaled $48,259,000 of which $9,081,000 represented return of capital for financial statement purposes. The minimum per share distribution required to maintain REIT status was approximately $1.44 per share in 1996, $1.55 per share in 1995 and $.48 per share in 1994. The Company has instituted a Dividend Reinvestment and Stock Purchase Plan under which holders of Common Stock may elect to automatically reinvest their distributions 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 financing its obligations under the Dividend Reinvestment and Stock Purchase Plan. Sales of Unregistered Securities The Company issued 489,421 shares of Common Stock in connection with the merger of Eakin & Smith, Inc. into the Company on April 1, 1996. As a result of the merger, the Company succeeded to the third-party management and brokerage business of Eakin & Smith. The merger was part of the larger Eakin & Smith Transaction described above at "Business -- Recent Developments." The shares were issued to the three principals of Eakin & Smith, including John W. Eakin, who became an officer and director of the Company upon consummation of the transaction. The shares were issued pursuant to an exemption from the registration requirements of the Securities Act of 1933 (the "Securities Act") under Rule 506. Each of the three principals of Eakin & Smith are "accredited investors" under Rule 501 of the Securities Act. The Company exercised reasonable care to assure that the principals were not purchasing the shares with a view to their distribution.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA The following table sets forth selected financial and operating information for the Company as of December 31, 1996, 1995 and 1994, for the years ended December 31, 1996 and 1995, and for the period from June 14, 1994 (commencement of operations) to December 31, 1994. The following table also sets forth selected financial and operating information on a historical basis for the Highwoods Group (the predecessor to the Company) as of and for each of the years in the two-year period ended December 31, 1993, and for the period from January 1, 1994, to June 13, 1994. The pro forma operating data for the year ended December 31, 1994 assumes completion of the initial public offering and the Formation Transaction as of January 1, 1994. Due to the impact of the initial formation of the Company and the initial public offering in 1994, the second and third offerings in 1995 and the transactions more fully described in "Management's Discussion and Analysis -- Overview and Background," the historical results of operations for the year ended December 31, 1995 and the period from June 14, 1994 to December 31, 1994 may not be comparable to the current period results of operations. The Company and the Highwoods Group
(1) Rental property operating expenses include salaries, real estate taxes, insurance, repairs and maintenance, property management, security and utilities. (2) Rental property operating expenses include salaries, real estate taxes, insurance, repairs and maintenance, property management, security, utilities, leasing, development, and construction expenses.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview and Background The Highwoods Group (the predecessor to the Company) was comprised of 13 office properties and one warehouse facility (the "Highwoods-Owned Properties"), 94 acres of development land and the management, development and leasing business of Highwoods Properties Company ("HPC"). On June 14, 1994, following completion of the Company's initial public offering, the Company, through a business combination involving entities under varying common ownership, succeeded to the Highwoods-Owned Properties, HPC's real estate business and 27 additional office properties owned by unaffiliated parties (such combination being referred to as the "Formation Transaction"). Minority interest in the Company represents the limited partnership interest owned by various individuals and entities and not the Company in the Operating Partnership, the entity that owns the Company's properties and through which the Company, as the sole general partner, conducts substantially all of its operations. The Company acquired three additional Properties in 1994 after the Formation Transaction. In February 1995, the Company expanded into other North Carolina markets and diversified its portfolio to include industrial and service center properties with its $170 million, 57-Property business combination with Forsyth Partners (the "Forsyth Transaction"). During the year ended December 31, 1995, the Company acquired 144 Properties encompassing 6,357,000 square feet, at an initial cost of $369.9 million. During the year ended December 31, 1996, the Company acquired 91 Properties encompassing 7,325,500 square feet at a initial cost of $704.0 million. See "Business -- Recent Developments" for a description of the acquisition of Crocker and the Eakin & Smith Transaction and for a table summarizing all mergers and acquisitions completed during the year ended December 31, 1996. Given the effect of the acquisitions discussed above, the results of the Highwoods Group for the period from January 1, 1994, to June 13, 1994, are not comparable to the current operations of the Company. This information should be read in conjunction with the accompanying consolidated and combined financial statements and the related notes thereto. The pro forma operating data for the year ended December 31, 1994 assumes completion of the initial public offering and the Formation Transaction as of January 1, 1994. Results of Operations Comparison of 1996 to 1995 Revenue from rental operations increased $59.6 million, or 83.7% from $71.2 million in 1995 to $130.8 million in 1996. The increase is primarily a result of revenue from newly acquired and developed properties. Interest and other income increased 208.7% from $2.3 million in 1995 to $7.1 million in 1996. This increase is a result of the excess cash and cash equivalents resulting from the offering of Common Stock completed in the summer of 1996, and an increase in third-party management and leasing income. Rental operating expenses increased $18.3 million, or 107.6%, from $17.0 million in 1995 to $35.3 million in 1996. The increase is due to the addition of 8.2 million square feet to the in-service portfolio. Rental expenses as a percentage of related rental revenues increased from 23.9% for the year ended December 31, 1995 to 27.0% for the year ended December 31, 1996. The increase is a result of an increase in the percentage of office properties in the portfolio; which have fewer "triple net" leases, and approximately $400,000 in additional expenses related to the severe winter weather in 1996 and the hurricane in September of the same year. Depreciation and amortization for the years ended December 31, 1996 and 1995 was $22.1 million and $11.1 million, respectively. The increase of $11.0 million or 99.1% is due to a 130.9% increase
in depreciable assets. Interest expense increased $12.9 million or 94.0% from $13.7 million in 1995 to $26.6 million in 1996. The increase is attributable to the increase in outstanding debt related to the Company's acquisition and development activities. Interest expense for the years ended December 31, 1996 and 1995 included $1.9 million and $1.6 million, respectively, of non-cash deferred financing costs and amortization of the costs related to the Company's interest rate protection agreements. General and administrative expenses increased from 3.8% of rental revenue in 1995 to 4.3% in 1996. This increase is attributable to the addition of four regional offices in Nashville, Memphis, Tampa, and Boca Raton as a result of acquisitions. The duplication of certain personnel costs in the third quarter during the acquisition of Crocker also contributed to higher general and administrative expenses for the year ended December 31, 1996. Such duplicative costs were eliminated in the fourth quarter as the Company realized the planned synergies from the merger. Net income before minority interest and extraordinary item equaled $48.2 million and $28.9 million for the years ended December 31, 1996 and 1995, respectively. The extraordinary items consisted of prepayment penalties incurred in connection with the extinguishment of certain debt assumed in the Crocker merger in 1996 and the Forsyth Transaction in 1995. Comparison of 1995 to Pro Forma 1994 For the year ended December 31, 1995 total revenues were comprised of $71.2 million of rental revenues and $2.3 million of interest and other income. For the year ended December 31, 1994 pro forma total revenues included $33.6 million of rental revenues, $200,000 in distributions from Highwoods Services, Inc. and $456,000 of interest income. The $37.6 million increase in rental income from pro forma 1994 to 1995 was primarily attributable to the rental revenue derived from properties acquired during 1995. Revenues from the Company's initial portfolio of 41 properties increased by 2.1% over the comparable 1994 period. Vacancies in Smoketree Tower and Cape Fear partially offset rental rate increases and occupancy gains in other properties. The increase in interest income from $465,000 in pro forma 1994 to $2.3 million in 1995 was due primarily to the increase in short-term investments during the three-month period following the Company's 4,774,989-share offering in August 1995. Rental property expenses represented 23.9% of rental revenues in 1995 compared to 28.8% for pro forma 1994. The decline in this ratio was a result of increased operating efficiencies and the addition of revenues from industrial properties in 1995. Industrial properties are generally leased on a "triple net" basis, with the tenant paying all operating costs. General and administrative expenses increased from $1.1 million or 3.3% of total revenues for pro forma 1994 to $2.7 million or 3.8% of total revenues for 1995. The increase in general and administrative expenses was a result of the growth of the Company's operations into the Piedmont Triad and Richmond. Interest expense increased from $5.6 million for pro forma 1994 to $13.7 million for 1995. The increase in interest expense was a result of an increased debt level during 1995 compared to 1994 as the Company financed a portion of its 1995 acquisition activity through the use of debt financing. The Company's interest expense for 1995 included a benefit of $385,000 as a result of an interest rate protection agreement. Depreciation and amortization expense increased from $4.6 million for pro forma 1994 to $11.1 million for 1995. The increase in depreciation and amortization expense reflects the increase in real estate assets during 1995. Net income before minority interest and extraordinary item equaled $28.9 million or $1.87 per share for 1995 compared to $13.2 million or $1.47 per share for pro forma 1994.
In connection with the repayment of indebtedness related to the Forsyth Transaction, the Company incurred prepayment penalties of $1.0 million in 1995. This amount was recorded as an extraordinary item and is presented in the 1995 consolidated financial statements ($875,000) net of the minority interest share in such loss. Liquidity and Capital Resources Statement of Cash Flows The Company generated $71.3 million in cash flows from operating activities and $419.8 million in cash flows from financing activities for the year ended December 31, 1996. These combined cash flows of $498.9 million were used to fund $486.9 million of investing activities, which were primarily additions to real estate assets and the cash purchase price for the net assets of Crocker. Capitalization Mortgage and notes payable at December 31, 1996 totaled $555.9 million and were comprised of $296.9 million of secured indebtedness with an average rate of 8.0% and $259.0 million of unsecured indebtedness with an average rate of 7.1%. All of the mortgage and notes payable outstanding at December 31, 1996 were either fixed rate obligations or variable rate obligations covered by interest rate protection agreements (see below). The weighted average life of the indebtedness was approximately 6.5 years at December 31, 1996. Based on the Company's total market capitalization of $1.9 billion at December 31, 1996 (at the December 31, 1996, stock price of $33.75 per share and assuming the redemption of each of the 4,283,000 Units of minority interest in the Operating Partnership for a share of Common Stock), the Company's indebtedness represented approximately 29% of its total market capitalization. The Company completed the following financing activities during the year ended December 31, 1996: (Bullet) During June 1996, the Company completed a 11,500,000-share public offering of Common Stock (including 1,500,000 shares issued pursuant to the underwriters' over allotment option). The net proceeds of the offering totaled $292.9 million and were used primarily to fund the Crocker acquisition. (Bullet) In July 1996, the Company sold an additional 250,000 shares of Common Stock to underwriters who participated in the Company's 11,500,000-share offering. The net proceeds from this offering were approximately $6.8 million. (Bullet) In connection with the acquisition of Crocker, the Company assumed a $140 million mortgage note (the "7.9% Mortgage Note"). The note is secured by 46 Properties, which were acquired in the merger and held by a subsidiary of the Company. (Bullet) On September 27, 1996, the Company replaced a $140 million credit facility with a $280 million unsecured revolving line of credit (the "Revolving Loan") from a syndicate of lenders. The Revolving Loan requires monthly payments of interest only with the balance of all principal and accrued but unpaid interest due on October 31, 1999. The interest rate on the Revolving Loan at year end was LIBOR plus 135 basis points and will adjust based on the Company's senior unsecured credit rating within a range of LIBOR plus 100 basis points to LIBOR plus 175 basis points. (Bullet) On November 26, 1996, the Operating Partnership issued $100 million of 6 3/4% notes due December 1, 2003, and $110 million of 7% notes due December 1, 2006 (collectively, the "Public Notes"). The proceeds were used to reduce amounts outstanding on the revolving loan, to repay mortgage debt and to settle an interest rate swap agreement. (Bullet) In December 1996, the Company completed a public offering of 2,587,500 shares of Common Stock (including 337,500 shares issued pursuant to the underwriters' over allotment option) and a concurrent non-underwritten public offering of 1,093,577 shares of Common Stock with
an institutional investor. The net proceeds from the two offerings totaled approximately $96.7 million. (Bullet) In connection with the 1996 acquisitions, the Company issued 807,608 Units and 489,421 shares of restricted Common Stock valued at $35.6 million (based on the agreed-upon valuation of a share of Common Stock at the time of the acquisition). Additional information regarding the 7.9% Mortgage Note, the Public Note and the Revolving Loan is set forth in the notes related to the accompanying consolidated and combined financial statements. To protect the Company from increases in interest expense due to changes in the variable rate, the Company: (i) purchased an interest rate cap limiting its exposure to an increase in interest rates (one-month LIBOR plus 135 basis points) to 7.60% with respect to $80 million of the $280 million Revolving Loan, and (ii) entered into interest rate swaps that limit its exposure to an increase in the interest rates to 7.24% in connection with the $34 million of variable rate mortgages. The interest rate on all such variable rate debt is adjusted at monthly intervals, subject to the Company's interest rate protection program. Payments received from the counterparties under the interest rate protection agreements were $167,000, $385,000 and $25,000 for 1996, 1995 and 1994, respectively. The Company is exposed to certain losses in the event of non-performance by the counterparties under the cap and swap arrangements. The counterparties are major financial institutions and are expected to perform fully under the agreements. However, if they were to default on their obligations under the arrangements, the Company could be required to pay the full rate under the Revolving Loan and the variable rate mortgages, even if such rate were in excess of the rate in the cap and swap agreements. In addition, the Company may incur other variable rate indebtedness in the future. Increases in interest rates on its indebtedness could increase the Company's interest expense and could adversely affect the Company's cash flow and its ability to pay expected distributions to stockholders. Historically, rental revenue has been the principal source of funds to pay operating expenses, debt service and capital expenditures, excluding non-recurring capital expenditures. In addition, construction management, maintenance, leasing and management fees have provided sources of cash flow. Management believes that the Company will have access to the capital resources necessary to expand and develop its business. To the extent that the Company's cash flow from operating activities is insufficient to finance its acquisition costs and other capital expenditures, including development costs, the Company expects to finance such activities through the Revolving Loan and other debt and equity financing. The Company presently has no plans for major capital improvements to the existing properties, other than a $4 million renovation of a 17-year old office property and normal recurring non-revenue enhancing expenditures. The Company expects to meet its short-term liquidity requirements generally through its working capital and net cash provided by operating activities along with the previously discussed Revolving Loan. The Company expects to meet certain of its financing requirements through long-term secured and unsecured borrowings and the issuance of debt securities or additional equity securities of the Company. In addition, the Company anticipates utilizing the Revolving Loan primarily to fund construction and development activities. The Company does not intend to reserve funds to retire existing mortgage indebtedness or indebtedness under the Revolving Loan upon maturity. Instead, the Company will seek to refinance such debt at maturity or retire such debt through the issuance of additional equity or debt securities. The Company anticipates that its available cash and cash equivalents and cash flows from operating activities, together with cash available from borrowings and other sources, will be adequate to meet the capital and liquidity needs of the Company in both the short and long-term. However, if these sources of funds are insufficient or unavailable, the Company's ability to make the expected distributions discussed below may be adversely affected. In order to qualify as a REIT for Federal income tax purposes, the Company is required to make distributions to its stockholders of at least 95% of REIT taxable income. The Company expects to use its cash flow from operating activities for distributions to stockholders and for payment of recurring,
non-incremental revenue-generating expenditures. The Company intends to invest amounts accumulated for distribution in short-term investments. The following factors will affect cash flows from operating activities and, accordingly, influence the decisions of the Board of Directors regarding distributions: (i) debt service requirements after taking into account the repayment and restructuring of certain indebtedness; (ii) scheduled increases in base rents of existing leases; (iii) changes in rents attributable to the renewal of existing leases or replacement leases; (iv) changes in occupancy rates at existing Properties and procurement of leases for newly acquired or developed properties; and (v) operating expenses and capital replacement needs. Recent Developments Century Center Transaction On January 9, 1997, the Company acquired the 17-building Century Center Office Park, four affiliated industrial properties and 20 acres of land for development located in suburban Atlanta, Georgia (the "Century Center Transaction"). The properties total 1.6 million rentable square feet and, as of December 31, 1996, were 99% leased. The cost of the Century Center Transaction was $55.6 million in Units (valued at $29.25 per Unit, the market value of a share of Common Stock as of the signing of a letter of intent for the Century Center Transaction), the assumption of $19.4 million of secured debt and a cash payment of $53.1 million, drawn from the Company's $280 million Revolving Loan. All Units issued in the transaction are subject to restrictions on transfer and redemption. Such restrictions are scheduled to expire over a three-year period in equal annual installments commencing one year from the date of issuance. Century Center Office Park is located on approximately 77 acres, of which approximately 61 acres are controlled under long-term fixed rental ground leases that expire in 2058. The rent under the leases is approximately $180,000 per year with scheduled 10% increases in 1999 and 2009. The leases do not contain a right to purchase the subject land. The Company estimates a first-year net operating income from the properties acquired in the Century Center Transaction of $13.3 million. See " -- Disclosure Regarding Forward-looking Statements" below. Anderson Transaction On February 12, 1997, the Company acquired a portfolio of industrial, office and undeveloped properties in Atlanta from Anderson Properties, Inc. and affiliates (the "Anderson Transaction"). The Anderson Transaction involved 22 industrial properties and six office properties totaling 1.6 million rentable square feet, three industrial development projects totaling 402,000 square feet and 137 acres of land for development. The in-service properties were 94% leased as of December 31, 1996. The development projects have a cost-to-date of $4.6 million and are expected to be completed during 1997. The cost of the Anderson Transaction consisted of the issuance of $22.9 million of Units (valued at $29.25 per Unit, the market value of a share of Common Stock as of the signing of a letter of intent relating to the transaction), the assumption of $7.8 million of mortgage debt and a cash payment of $37.7 million. The cash amount does not include $11.1 million expected to be paid to complete the three development projects. Approximately $5.5 million of the Units are newly created Class B Units, which differ from other Units in that they are not eligible for cash distributions from the Operating Partnership. The Class B Units will convert to regular Units in 25% annual installments commencing one year from the date of issuance. Prior to such conversion, such Units will not be redeemable for cash or Common Stock. All other Units to be issued in the transaction are also subject to restrictions on transfer or redemption. Such lock-up restrictions will expire over a three-year period in equal annual installments commencing one year from the date of issuance. The Company estimates a first-year net operating income from the properties of $5.7 million. See "Disclosure Regarding Forward-looking Statements" below.
Preferred Stock Offering On February 7, 1997 the Company issued 125,000 shares of 8 5/8% perpetual preferred stock for $1,000 per share. The net proceeds of $121.7 million were used to reduce existing indebtedness and fund the Anderson Transaction. The preferred stock is not redeemable prior to February 2027. The preferred stock is not subject to any sinking fund or mandatory redemption and is not convertible into any other securities of the Company. Possible Environmental Liabilities Under various Federal, state and local laws, ordinances and regulations, such as the Comprehensive Environmental Response Compensation and Liability Act or "CERCLA," and common laws, an owner or operator of real estate is liable for the costs of removal or remediation of certain hazardous or toxic substances on or in such property as well as certain other costs, including governmental fines and injuries to persons and property. Such laws often impose such liability without regard to whether the owner or operator knew of, or was responsible for, the presence of such hazardous or toxic substances. The presence of such substances, or the failure to remediate such substances properly, may adversely affect the owner's or operator's ability to sell or rent such property or to borrow using such property as collateral. Persons who arrange for the disposal or treatment of hazardous or toxic substances may also be liable for the costs of removal or remediation of such substances at a disposal or treatment facility, whether or not such facility is owned or operated by such person. Certain environmental laws impose liability with respect to the release and maintenance of asbestos-containing materials ("ACM"), and third parties may seek recovery from owners or operators of real property for personal injuries associated with asbestos-containing materials. A number of Company properties contain ACM or material that is presumed to be ACM. In connection with the ownership and operation of its properties, the Company may be liable for such costs. In addition, it is not unusual for property owners to encounter on-site contamination caused by off-site sources, and the presence of hazardous or toxic substances at a site in the vicinity of a property could require the property owner to participate in remediation activities in certain cases or could have an adverse effect on the value of such property. As of the date hereof, substantially all of the Properties have been subjected to a Phase I environmental assessment. These assessments have not revealed, nor is management of the Company aware of, any environmental liability that it believes would have a material adverse effect on the Company's financial position, operations or liquidity taken as a whole. This projection, however, could prove to be incorrect depending on certain factors. For example, the assessments may not reveal all environmental liabilities, or may underestimate the scope and severity of environmental conditions observed, with the result that there may be material environmental liabilities of which the Company is unaware or, material environmental liabilities may have arisen after the assessments were performed of which the Company is unaware. In addition, assumptions regarding groundwater flow and the existence and source of contamination are based on available sampling data, and there are no assurances that the data is reliable in all cases. Moreover, there can be no assurance that (i) future laws, ordinances or regulations will not impose any material environmental liability or (ii) the current environmental condition of the Properties will not be affected by tenants, by the condition of land or operations in the vicinity of the Properties, or by third parties unrelated to the Company. Some tenants use or generate hazardous substances in the ordinary course of their respective businesses. These tenants are required under their leases to comply with all applicable laws and are responsible to the Company for any damages resulting from the tenants' use of the property. The Company is not aware of any material environmental problems resulting from tenants' use or generation of hazardous substances. There are no assurances that all tenants will comply with the terms of their leases or remain solvent and that the Company may not at some point be responsible for contamination caused by such tenants. Compliance with the Americans with Disabilities Act Under the Americans with Disabilities Act (the "ADA"), all public accommodations and commercial facilities are required to meet certain Federal requirements related to access and use by disabled persons. These requirements became effective in 1992. Compliance with the ADA requirements could
require removal of access barriers, and non-compliance could result in imposition of fines by the U.S. government or an award of damages to private litigants. Although the Company believes that the Properties are substantially in compliance with these requirements, the Company may incur additional costs to comply with the ADA. Although the Company believes that such costs will not have a material adverse effect on the Company, if required changes involve a greater expenditure than the Company currently anticipates, the Company's results of operations, liquidity and capital resources could be materially adversely affected. Funds From Operations and Cash Available for Distributions The Company considers Funds from Operations ("FFO") to be a useful financial performance measure of the operating performance of an equity REIT because, together with net income and cash flows, FFO provides investors with an additional basis to evaluate the ability of a REIT to incur and service debt and to fund acquisitions and other capital expenditures. Funds from Operations does not represent net income or cash flows from operations as defined by GAAP, and FFO should not be considered as an alternative to net income as an indicator of the Company's operating performance or as an alternative to cash flows as a measure of liquidity. Funds from Operations does not measure whether cash flow is sufficient to fund all of the Operating Partnership's cash needs including principal amortization, capital improvements and distributions to stockholders. Funds from Operations does not represent cash flows from operating, investing or financing activities as defined by GAAP. Further, FFO as disclosed by other REITs may not be comparable to the Company's calculation of FFO, as described below. Funds from operations and cash available for distributions should not be considered as alternatives to net income as an indication of the Company's performance or to cash flows as a measure of liquidity. Funds from Operations means net income (computed in accordance with generally accepted accounting principles) excluding gains (or losses) from debt restructuring and sales of property, plus depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures. In March 1995, the National Association of Real Estate Investment Trusts ("NAREIT") issued a clarification of the definition of FFO. The clarification provides that amortization of deferred financing costs and depreciation of non-real estate assets are no longer to be added back to net income in arriving at FFO. Cash available for distribution is defined as funds from operations reduced by non-revenue enhancing capital expenditures for building improvements and tenant improvements and lease commissions related to second generation space.
Funds from operations and cash available for distribution for the years ended December 31, 1996 and 1995 are summarized in the following table (in thousands):
(1) Assumes redemption of Units for shares of Common Stock. Minority interest Unit holders and the stockholders of the Company share equally on a per Unit and per share basis; therefore, the per share information is unaffected by conversion. Inflation In the last five years, inflation has not had a significant impact on the Company because of the relatively low inflation rate in the Company's geographic areas of operation. Most of the leases require the tenants to pay their pro rata share of operating expenses, including common area maintenance, real estate taxes and insurance, thereby reducing the Company's exposure to increases in operating expenses resulting from inflation. In addition, many of the leases are for terms of less than seven years, which may enable the Company to replace existing leases with new leases at a higher base if rents on the existing leases are below the then-existing market rate. Disclosure Regarding Forward-looking Statements The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements to encourage companies to provide prospective information about their companies without fear of litigation so long as those statements are identified as forward-looking and are accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those projected in the statement. Accordingly, the Company hereby identifies the following important factors that could cause the Company's actual financial results to differ materially from those projected by the Company in forward-looking statements: (i) unexpected increases in development of office or industrial properties in the Company's markets; (ii) deterioration in the financial condition of tenants; (iii) construction costs of properties exceeding original estimates;
(iv) delays in the completion of development projects or acquisitions; (v) delays in leasing or releasing space; (vi) incorrect assessments of (or changes in) the environmental condition of the Company's properties; (vii) unexpected increases in interest rates; and (viii) loss of key executives. ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA See page of the financial report included herein. ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None.
PART III ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The section under the heading "Election of Directors" of the Proxy Statement for the Annual Meeting of Stockholders to be held April 29, 1997 (the "Proxy Statement") 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. ITEM 11.
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. ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The section under the heading "Security Ownership of Certain Beneficial Owners and Management" of the Proxy Statement is incorporated herein by reference. ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The section under the heading "Certain Relationships and Related Transactions" of the Proxy Statement is incorporated herein by reference.
PART IV ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 10-K (a) List of Documents Filed as a Part of this Report 1. Consolidated Financial Statements and Report of Independent Auditors See Index on Page 2. Financial Statement Schedules See Index on Page 3. Exhibits
(1) Filed as a part of the Company's Current Report on Form 8-K dated April 1, 1996 and incorporated herein by reference. (2) Filed as a part of the Company's Current Report on Form 8-K dated April 29, 1996 and incorporated herein by reference. (3) Filed as a part of the Company's Current Report on Form 8-K dated January 9, 1997 and incorporated herein by reference. (4) Filed as part of Registration Statement 33-88364 with the Securities and Exchange Commission and incorporated herein by reference. (5) Filed as part of Registration Statement 33-76952 with the Securities and Exchange Commission and incorporated herein by reference. (6) Filed by Crocker Realty Trust, Inc. as part of Registration Statement No. 33-88482 filed with the Securities and Exchange Commission and incorporated herein by reference. (7) Filed as a part of the Operating Partnership's Current Report on Form 8-K dated December 2, 1996 and incorporated herein by reference. (8) Filed as a part of the Company's Current Report on Form 8-K dated February 12, 1997 and incorporated herein by reference. (9) Filed as a part of the Company's Annual Report on Form 10-K for the year ended December 31, 1995 and incorporated herein by reference. (10) Management contract or compensatory plan. (11) Filed as part of the Company's Current Report on Form 8-K dated September 27, 1996 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 During the fourth quarter, the Company filed the following Form 8-K:
SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Raleigh, State of North Carolina, on March 27, 1997. HIGHWOODS PROPERTIES, INC. By: /s/ RONALD P. GIBSON Ronald P. Gibson, President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons in the capacities and on the dates indicated.
All other schedules are omitted because they are not applicable, or because the required information is included in the financial statements or notes thereto.
REPORT OF INDEPENDENT AUDITORS THE BOARD OF DIRECTORS AND STOCKHOLDERS HIGHWOODS PROPERTIES, INC. We have audited the accompanying consolidated balance sheets of Highwoods Properties, Inc. as of December 31, 1996 and 1995, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the two years ended December 31, 1996 and for the period from June 14, 1994 (commencement of operations) to December 31, 1994. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. 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 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Highwoods Properties, Inc. at December 31, 1996 and 1995, and the consolidated results of its operations and cash flows for each of the two years in the period ended December 31, 1996 and for the period from June 14, 1994 (commencement of operations) to December 31, 1994 in conformity with generally accepted accounting principles. Also, in our opinion, the financial statement schedule when considered in relation to the basic financial statements taken as a whole presents fairly in all material respects the information set forth therein. ERNST & YOUNG LLP Raleigh, North Carolina February 14, 1997
HIGHWOODS PROPERTIES, INC. Consolidated Balance Sheets (Dollars in thousands, except per share amounts)
See accompanying notes to consolidated financial statements.
HIGHWOODS PROPERTIES, INC. Consolidated Statements of Income (Dollars in thousands, except per share amounts) For the Years Ended December 31, 1996 and 1995 and for the Period from June 14, 1994 (commencement of operations) to December 31, 1994
See accompanying notes to consolidated financial statements.
HIGHWOODS PROPERTIES, INC. Consolidated Statements of Stockholders' Equity (Dollars in thousands) For the Years Ended December 31, 1996 and 1995 and for the Period from June 14, 1994 (commencement of operations) to December 31, 1994
See accompanying notes to consolidated financial statements.
HIGHWOODS PROPERTIES, INC. Consolidated Statements of Cash Flows (Dollars in thousands) For the Years Ended December 31, 1996 and 1995 and for the Period from June 14, 1994 (commencement of operations) to December 31, 1994
See accompanying notes to consolidated financial statements.
HIGHWOODS PROPERTIES, INC. Consolidated Statements of Cash Flows -- Continued (Dollars in thousands) For the Years Ended December 31, 1996 and 1995 and for the Period from June 14, 1994 (commencement of operations) to December 31, 1994
Supplemental disclosure of non-cash investing and financing activities The following summarizes the net assets contributed or assets acquired subject to mortgages and notes payable:
See accompanying notes to consolidated financial statements.
HIGHWOODS PROPERTIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1996 1. DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES Organization and Formation of the Company Highwoods Properties, Inc. (the "Company") is a self-administered and self-managed real estate investment trust (REIT) which operates in the southeastern United States. The Company's assets include 181 suburban office properties, 111 industrial properties and 238 acres of undeveloped land suitable for future development. The Company was incorporated in Maryland in February 1994 and is the successor to the operations of the Highwoods Group. On June 14, 1994, the Company commenced operations upon completion of a public offering of 7,400,000 shares of $.01 par value Common Stock (plus 1,110,000 shares subsequently issued pursuant to the underwriters' over-allotment option, the "Initial Public Offering"). The Initial Public Offering price was $21 per share resulting in gross offering proceeds of $178,710,000. Proceeds to the Company, net of underwriters' discount, an advisory fee and total offering expenses, were $164,481,300. The following transactions (the "Formation Transactions") occurred in connection with the Initial Public Offering: (Bullet) Through the merger of Highwoods Properties Company ("HPC") into the Company certain investors received 476,190 shares of restricted Common Stock in exchange for their holdings in HPC. (Bullet) The Company consummated various purchase agreements to acquire certain interests in 41 properties, including 27 properties that were not owned by the Highwoods Group prior to the Initial Public Offering. For the 14 properties previously owned by the Highwoods Group, negative net assets of approximately $9,272,000 were contributed to the Operating Partnership at their historical cost. Approximately, $8,400,000 was distributed to the non-continuing partners of the Highwoods Group for their partnership interests in the 14 properties. For the 27 properties not owned by the Highwoods Group, the Company issued approximately $4,200,000 of units in the Operating Partnership ("Units"), assumed $54,164,000 of debt and paid $82,129,000 in cash. These 27 properties were recorded at their purchase price using the purchase method of accounting. (Bullet) The Company became the sole general partner of Highwoods/Forsyth Limited Partnership, formerly Highwoods Realty Limited Partnership (the "Operating Partnership"), by contributing its ownership interests in the 41 properties and its third-party fee business and all but $10,400,000 of the net proceeds of the Initial Public Offering in exchange for an approximate 88.3% interest in the Operating Partnership. (Bullet) The Operating Partnership executed various option and purchase agreements whereby it paid approximately $81,352,000 in cash, issued 1,054,664 Units and assumed approximately $118,111,000 of indebtedness in exchange for fee simple interests in the 41 properties and the development land. (Bullet) The Operating Partnership contributed the third-party management and development business and the third-party leasing business to Highwoods Services, Inc. (formerly Highwoods Realty Services, Inc. and Highwoods Leasing Company) in exchange for 100% of each company's non-voting common stock and 1% of each company's voting common stock.
HIGHWOODS PROPERTIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued) 1. DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES -- Continued Generally one year after issuance (the "lock-up period"), the Operating Partnership is obligated to redeem each Unit at the request of the holder thereof for cash equal to the fair market value of one share of the Company's Common Stock at the time of such redemption, provided that the Company at its option may elect to acquire any such Unit presented for redemption for cash or one share of Common Stock. When a Unit holder redeems a Unit for a share of Common Stock or cash, the minority interest will be reduced and the Company's share in the Operating Partnership will be increased. The Units owned by the Company are not redeemable for cash. At December 31, 1996, the lock-up period had expired with respect to 3,475,629 of the 4,283,237 Units issued and outstanding. Basis of Presentation The consolidated financial statements include the accounts of the Company and the Operating Partnership. The Company's investments in Highwoods Services, Inc. and Forsyth Properties Services, Inc. (the "Service Companies") are accounted for using the equity method of accounting. All significant intercompany balances and transactions have been eliminated in the consolidated financial statements. The Company is a real estate investment trust ("REIT") under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended. Minority interest represents the limited partnership interest in the Operating Partnership owned by Unit holders other than the Company. Per share information is calculated using the weighted average number of shares outstanding. The extraordinary loss represents the write-off of loan origination fees and prepayment penalties paid on the early extinguishment of debt and is shown net of the minority interest's share in the loss. Real Estate Assets Real estate assets are stated at the lower of cost or fair value. All capitalizable costs related to the improvement or replacement of commercial real estate properties are capitalized. Depreciation is computed by the straight-line method over the estimated useful life of 40 years for buildings and improvements and 5 to 7 years for furniture and equipment. Tenant improvements are amortized over the life of the respective leases, using the straight-line method. In March 1995, the FASB issued Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed of," which requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. Statement No. 121 also addresses the accounting for long-lived assets that are expected to be disposed of. The Company adopted the Statement in the first quarter of 1996 and the adoption did not have any material effect. Cash Equivalents The Company considers highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Revenue Recognition Minimum rental income is recognized on a straight-line basis over the term of the lease. Unpaid rents are included in accounts receivable. Certain lease agreements contain provisions which provide reimbursement of real estate taxes, insurance, advertising and certain common area maintenance
HIGHWOODS PROPERTIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued) 1. DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES -- Continued (CAM) costs. These additional rents are recorded on the accrual basis. All rent and other receivables from tenants are due from commercial building tenants located in the properties. Deferred Lease Fees and Loan Costs Lease fees, concessions and loan costs are capitalized at cost and amortized over the life of the related lease or loan term, respectively. Income Taxes The Company is a real estate investment trust ("REIT") for federal income tax purposes. A corporate REIT is a legal entity that holds real estate assets, and through distributions to stockholders, is permitted to reduce or avoid the payment of Federal income taxes at the corporate level. To maintain qualification as a REIT, the Company must distribute to stockholders at least 95% of REIT taxable income. No provision has been made for income taxes because the Company qualified as a REIT, distributed the necessary amount of taxable income and, therefore, incurred no income tax expense during the period. Concentration of Credit Risk Management of the Company performs ongoing credit evaluations of its tenants. The properties are leased to approximately 1,800 tenants, in 16 geographic locations, which engage in a wide variety of businesses. There is no dependence upon any single tenant. Interest Rate Risk Management The Company enters into various interest rate swaps and collars in managing its interest rate risk. Payments to or from the counterparties are recorded as adjustments to interest expense. The Company has designated these instruments as hedges against existing liabilities and accordingly utilizes hedge accounting. The Company is exposed to certain losses in the event of non-performance by the counterparties under the collar and swap arrangements. The counterparties are major financial institutions with credit ratings of Aa3 or better, and are expected to perform fully under the agreements. However, if they were to default on their obligations under the arrangements, the Company could be required to pay the full rate under its Revolving Loan and the variable rate mortgages, even if such rate were in excess of the rate in the collar and swap agreements. The Company would not realize a material loss as of December 31, 1996 in the event of non-performance by any one counterparty. Additionally, the Company limits the amount of credit exposure with any one institution. Stock Compensation The Company grants stock options for a fixed number of shares to employees with an exercise price equal to the fair value of the shares at the date of grant. As described in Note 8, the Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and related interpretations in accounting for its employee stock options. Use of Estimates The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
HIGHWOODS PROPERTIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued) 2. MORTGAGES AND NOTES PAYABLE Mortgages and notes payable consisted of the following at December 31, 1996 and 1995 (in thousands):
Mortgage notes payable were secured by real estate with an aggregate carrying value of $595,000,000 at December 31, 1996. The Company has entered into interest swap agreements with financial institutions to effectively fix the interest rate on the variable rate mortgages and variable rate notes at a rate of 7.2%. At December 31, 1996, the notional amounts of the interest rate swaps equaled the outstanding balance of the indebtedness. The swaps expire in June 1999 and July 2000 upon the maturity of the respective indebtedness and had a cost basis of $475,000 at December 31, 1996. The 7.9% Mortgage Note is secured by 46 of the Properties (the "Mortgage Note Properties"), which are held by AP Southeast Portfolio Partners, L.P. (the "Financing Partnership"). The Company has a 99.99% economic interest in the Financing Partnership, which is managed, indirectly, by the Company. The 7.9% Mortgage Note is a conventional, monthly pay, first mortgage note in the principal amount of $140 million issued by the Financing Partnership. The 7.9% Mortgage Note is a limited recourse obligation of the Financing Partnership as to which, in the event of a default under the indenture or the mortgage, recourse may be had only against the Mortgage Note Properties and other assets that have been pledged as security. The 7.9% Mortgage Note was issued to Kidder Peabody Acceptance Corporation I pursuant to an indenture, dated March 1, 1994 (the "Mortgage Note Indenture"), among the Financing Partnership, Bankers Trust Company of California, N.A., and Bankers Trust Company. The Mortgage Note Indenture provides for a lockout period that prohibits optional redemption payments in respect of principal of the 7.9% Mortgage Note (other than a $7 million premium-free redemption payment) prior to November 1998. Thereafter, the Financing Partnership may make optional redemption payments in respect of principal of the 7.9% Mortgage Note on any distribution date, subject to the payment of a yield maintenance charge in connection with such payments made prior to August 1, 2000. Under the terms of the purchase agreement relating to the Mortgage Note Properties, the Financing Partnership may be obligated to pay NationsBank, N.A. a deferred contingent purchase price. This
HIGHWOODS PROPERTIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued) 2. MORTGAGES AND NOTES PAYABLE -- Continued contingent payment, which will in no event exceed $4.4 million, is due on April 1, 1998 if the actual four-year cumulative cash flow of such properties exceeds the projected four-year cumulative cash flow. Based on the estimates of future operations, the Company does not believe that any deferred contingent purchase principal price will be payable. On November 26, 1996, the Operating Partnership issued $100,000,000 of unsecured 6 3/4% notes due December 1, 2003 and $110,000,000 of unsecured 7% notes due December 1, 2006. Interest on the notes is payable semi-annually on June 1 and December 1 commencing on June 1, 1997. In accordance with the terms of the Indenture under which the unsecured notes are issued, the Company is required to (a) limit its total indebtedness, (b) limit its level of secured debt, (c) maintain a minimum debt service coverage ratio and (d) maintain a minimum level of unencumbered assets. At December 31, 1996, the Company was in compliance with these covenants. In September 1996, the Company obtained a $280,000,000 unsecured revolving loan which matures on October 31, 1999. Borrowings under the revolving loan will adjust based upon the Company's senior unsecured debt rating with a range of 30-day LIBOR plus 100 basis points to LIBOR plus 175 basis points. At December 31, 1996, the rate was set at 30-day LIBOR plus 135 basis points and the effective interest rate was 6.91%. The terms of the revolving loan require the Company to pay a commitment fee equal to .15% to .25% of the unused portion of the revolving loan and include certain restrictive covenants which limit, among other things, dividend payments, and which require compliance with certain financial ratios and measurements. At December 31, 1996, the Company was in compliance with these covenants. To limit increases in interest expense on $80,000,000 of the revolving loan, the Company has purchased an interest rate collar which limits its exposure to an increase in 30-day LIBOR to 6.25% through November 2001. The initial premium used to acquire the $80,000,000 interest rate cap is being amortized over the term of the collar. Payments received from counterparties under the above interest rate protection agreements were $167,000 in 1996, $385,000 in 1995 and $25,000 in 1994 and were recorded as a reduction of interest expense. The aggregate maturities of the mortgage and notes payable at December 31, 1996 are as follows (in thousands):
Total interest capitalized was $2,935,000 in 1996, $507,000 in 1995 and $17,000 in 1994. 3. MANAGEMENT COMPENSATION PROGRAM The Company has established an incentive compensation plan for employees of the Company. The plan provides for payment of a cash bonus to participating officers and employees if certain Company performance objectives are achieved. The amount of the bonus to participating officers and employees is based on a formula determined for each employee by the Compensation Committee, but may not exceed 100% of base salary. All bonuses may be subject to adjustment to reflect individual
HIGHWOODS PROPERTIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued) 3. MANAGEMENT COMPENSATION PROGRAM -- Continued performance as measured by specific qualitative criteria to be approved by the Compensation Committee. Bonuses are accrued in the year earned and included in accrued expenses in the Consolidated Balance Sheets. In addition, as an incentive to retain top management, the Company has established a deferred compensation plan which provides for phantom stock awards. Under the deferred compensation plan, phantom stock or stock appreciation rights equal in value to 25% of the yearly cash bonus may be set aside in an incentive pool, with payment after five years. If an employee leaves the Company for any reason (other than death, disability or normal retirement) prior to the end of the five-year period, all awards under the deferred compensation plan will be forfeited. 4. 401(k) SAVINGS PLAN The Company has a 401(k) savings plan covering substantially all employees who meet certain age and employment criteria. The Company matches the first 6% of compensation deferred at the rate of 50% of employee contributions. During 1996, 1995 and 1994, the Company contributed $160,000, $51,000 and $0, respectively to the Plan. Administrative expenses of the plan are paid by the Company. 5. RENTAL INCOME The Company's real estate assets are leased to tenants under operating leases, substantially all of which expire over the next ten years. The minimum rental amounts under the leases are generally either subject to scheduled fixed increases or adjustments based on the Consumer Price Index. Generally, the leases also require that the tenants reimburse the Company for increases in certain costs above the base year costs. Expected future minimum rents to be received over the next five years and thereafter from tenants for leases in effect at December 31, 1996, are as follows (in thousands):
6. RELATED PARTY TRANSACTIONS The Company makes advances to Highwoods Services, Inc. and Forsyth Properties Services, Inc. for working capital purposes. These advances bear interest at a rate of 7% per annum and totaled $2,406,000 at December 31, 1996, and $1,274,000 at December 31, 1995. The Company recorded interest income from these advances of $91,000, $43,000 and $15,000 for the years ended December 31, 1996 and 1995, and for the period from June 14, 1994, to December 31, 1994, respectively. During the year ended December 31, 1995, the Company acquired two properties encompassing 99,334 square feet at an aggregate purchase price of $6,850,000 from partnerships in which certain officers and directors of the Company owned a majority interest. These transactions were accounted for using the purchase method of accounting and their operating results are included in the Statements of Income from their respective acquisition dates.
HIGHWOODS PROPERTIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued) 7. DISTRIBUTIONS Distributions paid were $1.86 and $1.75 per share for the years ended December 31, 1996 and 1995 respectively, and $.50 per share for the period from June 14, 1994, to December 31, 1994. For federal income tax purposes, the following table summarizes the estimated taxability of distributions paid:
The Company's tax return for the year ended December 31, 1996, has not been filed, and the taxability information for 1996 is based upon the best available data. The Company's tax returns have not been examined by the Internal Revenue Service, and therefore the taxability of distributions is subject to change. The tax basis of the Company's assets and liabilities are $1,186,654,000 and $592,106,000 respectively. On February 4, 1997, the Board of Directors declared a distribution of $.48 per share payable on February 21, 1997, to stockholders of record on February 14, 1997. 8. STOCK OPTIONS AND WARRANTS As of December 31, 1996, 1,381,455 shares of the Company's authorized Common Stock were reserved for issuance upon the exercise of options under the Amended and Restated 1994 Stock Option Plan. For the Company's executive and senior officers and non-independent directors, the options vest in four equal installments on the second, third, fourth, and fifth anniversaries of the date of grant. For other employees and independent directors, the options vest in four equal installments on the first, second, third and fourth anniversaries of the date of grant.
HIGHWOODS PROPERTIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued) 8. STOCK OPTIONS AND WARRANTS -- Continued In 1995, the Financial Accounting Standards Board issued a Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation," ("SFAS 123"). SFAS 123 recommends the use of a fair value based method of accounting for an employee stock option whereby compensation cost is measured at the grant date on the fair value of the award and is recognized over the service period (generally the vesting period of the award). However, SFAS 123 specifically allows an entity to continue to measure compensation cost under Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") so long as pro forma disclosures of net income and earnings per share are made as if SFAS 123 had been adopted. The Company has elected to follow APB 25 and related interpretations in accounting for its employee stock options because the Company believes that the models available to estimate the fair value of employee stock options do not provide a reliable single measure of the fair value of employee stock options. Moreover, such models required the input of highly subjective assumptions, which can materially affect the fair value estimates. APB 25 requires the recognition of compensation expense at the date of grant equal to the difference between the option price and the value of the underlying stock. Because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, the Company records no compensation expense for the award of employee stock options. Under SFAS 123, a public entity must estimate the fair value of a stock option by using an option-pricing model that takes into account as of the grant date the exercise price and expected life of the options, the current price of the underlying stock and its expected volatility, expected dividends on the stock, and the risk-free interest rate for the expected term of the option. SFAS provides examples of possible pricing models and includes the Black-Scholes pricing model, which the Company used to develop its pro forma disclosures. However, as previously noted, the Company does not believe that such models provide a reliable single measure of the fair value of employee stock options. Furthermore, the Black-Scholes model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable, rather than for use in estimating the fair value of employee stock options subject to vesting and transferability restrictions. Because SFAS 123 is applicable only to options granted subsequent to December 31, 1994, only options granted subsequent to that date were valued using this Black-Scholes model. The fair value of these options was estimated at the date of grant using the following weighted-average assumptions for 1996 and 1995: risk-free interest rate of 6.47%; expected volatility of .182; dividend yield of 7.07% and a weighted-average expected life of the options of five years. Had the compensation cost for the Company's stock option plans been determined based on the fair value at the date of grant for awards in 1996 and 1995 consistent with the provisions of SFAS 123, the Company's net income and net income per share would have decreased to the pro forma amounts indicated below:
HIGHWOODS PROPERTIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued) 8. STOCK OPTIONS AND WARRANTS -- Continued The following table summarizes information about stock options outstanding at December 31, 1996:
Exercise prices for options outstanding as of December 31, 1996 ranged from $20.75 to $29.63. The weighted average remaining contractual life of those options is 8.7 years. Using the Black-Scholes options valuation model, the weighted average fair value of options granted during 1996 and 1995 was $3.10 and $1.90, respectively. Warrants: In connection with various acquisitions in 1995 and 1996, the Company issued warrants to certain officers and directors of the Company to purchase 100,000 shares of the Company's Common Stock at $21 per share and 150,000 shares at $28 per share. The warrants expire 10 years from the date of issuance and are exercisable as of December 31, 1996.
HIGHWOODS PROPERTIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued) 9. COMMITMENTS AND CONTINGENCIES Lease: Two of the properties located in the Parkway Plaza development are subject to a land lease expiring December 31, 2082. Rental payments are to be adjusted yearly based on the consumer price index. The Company has the option to purchase the leased land during the lease term at the greater of 85% of appraised value or $35,000 per acre. The obligation for future minimum lease payments is as follows (in thousands):
Litigation: The Company is a party to a variety of legal proceedings arising in the ordinary course of its business. These matters are generally covered by insurance or indemnities. All of these matters, taken together, are not expected to have a material adverse effect on the accompanying consolidated financial statements notwithstanding possible insurance recovery. Contracts: The Company has entered into construction contracts totaling $62.2 million at December 31, 1996. The amounts remaining on these contracts as of December 31, 1996, totaled $17.1 million. The Company has entered into a contract under which it is committed to acquire 50 acres of land over a four-year period for an aggregate purchase price of approximately $8,000,000. The seller has the option to elect to receive the purchase price in either cash or Units valued at $26.67 per Unit. The Company has also entered into a contract under which it is committed to acquire 18 acres of land on or before August 1, 1998, for an aggregate purchase price of approximately $2,032,000. Environmental Matters: Substantially all of the Company's properties have been subjected to Phase I environmental reviews. Such reviews have not revealed, nor is management aware of, any environmental liability that management believes would have a material adverse effect on the accompanying consolidated financial statements.
HIGHWOODS PROPERTIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued) 10. DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS The following disclosures of estimated fair values were determined by management using available market information and appropriate valuation methodologies. Considerable judgment is necessary to interpret market data and develop estimated fair values. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that the Company could realize upon disposition of the financial instruments. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair values. The carrying amounts and estimated fair values of the Company's financial instruments at December 31, 1996, were as follows (in thousands):
The fair values for the Company's fixed rate mortgages and notes payable were estimated using discounted cash flow analysis, based on the Company's estimated incremental borrowing rate at December 31, 1996, for similar types of borrowing arrangements. The carrying amounts of the Company's variable rate borrowings approximate fair value. The fair values of the Company's interest rate swap and interest rate collar agreements represent the estimated amount the Company would receive or pay to terminate or replace the financial instruments at current market rates. Disclosures about the fair value of financial instruments are based on relevant information available to the Company at December 31, 1996. Although management is not aware of any factors that would have a material effect on the fair value amounts reported herein, such amounts have not been revalued since that date and current estimates of fair value may significantly differ from the amounts presented herein. 11. PRO FORMA INFORMATION (UNAUDITED) The following unaudited pro forma information has been prepared assuming the following transactions all occurred as of January 1, 1995: (1) the 1995 acquisition of 144 properties at an initial cost of $369,900,000, (2) the 1996 acquisition of 91 properties at an initial cost of $704,000,000, (3) the February 1995, August 1995, Summer 1996, and December 1996 Common Stock offerings and (4) the November 1996 issuance of $210,000,000 of unsecured notes. Pro forma interest expense was calculated based on the indebtedness outstanding after debt repayment and using the effective interest rate on such indebtedness. In connection with various transactions, the Company issued Operating Partnership Units and shares of Common Stock totaling 2,677,748 in 1995 and 1,267,737 in 1996 which were recorded at their fair market value upon the closing date of the transactions.
The pro forma information is not necessarily indicative of what the Company's results of operations would have been if the transactions had occurred at the beginning of each period presented.
HIGHWOODS PROPERTIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued) 11. PRO FORMA INFORMATION (UNAUDITED) -- Continued Additionally, the pro forma information does not purport to be indicative of the Company's results of operations for future periods. 12. SUBSEQUENT EVENTS Acquisition of Suburban Atlanta Properties Century Center Transaction. On January 9, 1997, the Company acquired the 17-building Century Center Office Park, four affiliated industrial properties and 20 acres of Development Land located in suburban Atlanta, Georgia (the "Century Center Transaction"). The properties total 1.6 million rent-able square feet and, as of December 31, 1996, were 99% leased. The cost of the Century Center Transaction was $55.6 million in Units (valued at $29.25 per Unit, the market value of a share of Common Stock as of the signing of a letter of intent for the Century Center Transaction), the assumption of $19.4 million of secured debt and a cash payment of $53.1 million drawn from the Company's $280 million Revolving Loan. All Units issued in the transaction are subject to restrictions on transfer and redemption. Such restrictions are scheduled to expire over a three-year period in equal annual installments commencing one year from the date of issuance. Century Center Office Park is located on approximately 77 acres, of which approximately 61 acres are controlled under long-term fixed rental ground leases that expire in 2058. The rent under the leases is approximately $180,000 per year with scheduled 10% increases in 1999 and 2009. The leases do not contain a right to purchase the subject land. Anderson Transaction. On February 12, 1997, the Company acquired a portfolio of industrial, office and undeveloped properties in Atlanta from affiliates of Anderson Properties (the "Anderson Transaction"). The Anderson Transaction involves 22 industrial properties and six office properties totaling 1.6 million rentable square feet, three industrial development projects totaling 402,000 square feet and 137 acres of land for development. The cost of the Anderson Transaction consisted of the issuance of $22.9 million of Units (valued at $29.25 per Unit, the market value of a share of Common Stock as of the signing of a letter of intent relating to the transaction), the assumption of $7.8 million of mortgage debt and a cash payment of $37.7 million. The cash amount does not includes $11.1 million expected to be paid to complete the three development projects. Approximately $5.5 million of the Units are newly created Class B Units, which differ from other Units in that they are not eligible for cash distributions from the Operating Partnership. The Class B Units will convert to regular Units in 25% annual installments commencing one year from the date of issuance. Prior to such conversion, such Units will not be redeemable for cash or Common Stock. All other Units to be issued in the transaction are also subject to restrictions on transfer or redemption. Such lock-up restrictions will expire over a three-year period in equal annual installments commencing one year from the date of issuance. Preferred Stock Offering On February 7, 1997 the Company issued 125,000 shares of 8 5/8% perpetual preferred stock for $1,000 per share. The net proceeds of $121.7 million were used to pay down existing indebtedness and fund the Anderson Transaction. The preferred stock is not redeemable prior to February 2027. The preferred stock is not subject to any sinking fund or mandatory redemption and is not convertible into any other securities of the Company.
HIGHWOODS PROPERTIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued) 13. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED): Selected quarterly financial data for the years ended December 31, 1996 and 1995, and for the period from June 14, 1994, to December 31, 1994, is as follows (in thousands except per share amounts):
* The total of the four quarterly amounts for net income per share do not equal the total for the year due to the use of a weighted average to compute the average number of shares outstanding.
HIGHWOODS PROPERTIES, INC. SCHEDULE III -- REAL ESTATE AND ACCUMULATED DEPRECIATION December 31, 1996 (In thousands)
(1) These assets are pledged as collateral for a $11,612,000 first mortgage loan. (2) These assets are pledged as collateral for a $31,410,000 first mortgage loan. (3) These assets are pledged as collateral for a $40,167,000 first mortgage loan. (4) These assets are pledged as collateral for a $8,629,000 first mortgage loan. (5) These assets are pledged as collateral for a $4,924,000 first mortgage loan. (6) Reflects land transferred to the Willow Oak Property. (7) Reflects land transferred to the Global property. (8) Reflects land transferred to the Hewlett Packard property, Inacom property, Two AirPark East property, AirPark East-Simplex property. (9) The aggregate cost for Federal Income Tax purposes was approximately $964,000,000. (10) Patewood III and IV are considered one property for encumbrance purposes.
HIGHWOODS PROPERTIES, INC. NOTE TO SCHEDULE III (in thousands) As of December 31, 1996, 1995 and 1994 A summary of activity for real estate and accumulated depreciation is as follows:
(a) Reconciliation of total cost to balance sheet caption at December 31, 1996, 1995 and 1994 (in thousands):
(b) Reconciliation of total accumulated depreciation to balance sheet caption at December 31, 1996, 1995 and 1994 (in thousands):
REPORT OF INDEPENDENT AUDITORS BOARD OF DIRECTORS AND STOCKHOLDERS HIGHWOODS PROPERTIES, INC. We have audited the accompanying combined statements of income, owners' deficit and cash flows for the period from January 1, 1994 to June 13, 1994 of the Highwoods Group. These financial statements and schedule are the responsibility of the Highwoods Group's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audit in accordance with generally accepted auditing standards. 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 audit provides a reasonable basis for our opinion. In our opinion, the combined financial statements referred to above present fairly, in all material respects, the combined results of operations and cash flows for the period from January 1, 1994 to June 13, 1994 of the Highwoods Group in conformity with generally accepted accounting principles. ERNST & YOUNG LLP Raleigh, North Carolina January 10, 1995
HIGHWOODS GROUP COMBINED STATEMENT OF INCOME (In thousands)
See accompanying notes.
HIGHWOODS GROUP COMBINED STATEMENT OF OWNERS' DEFICIT (In thousands)
See accompanying notes.
HIGHWOODS GROUP COMBINED STATEMENT OF CASH FLOWS (In thousands)
See accompanying notes.
HIGHWOODS GROUP NOTES TO COMBINED FINANCIAL STATEMENTS PERIOD FROM JANUARY 1, 1994 THROUGH JUNE 13, 1994 1. DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES Description of Business The Highwoods Group is engaged in the ownership, management, operation, leasing and development of commercial real estate properties. The Highwoods Group owns and operates 14 buildings located in the Research Triangle Park region of North Carolina. Principles of Combination The Highwoods Group is not a legal entity but rather a combination of commercial real estate properties that are organized as general partnerships and are under common control, and an affiliated real estate management company, the Highwoods Properties Company ("HPC"). HPC provides property management services to the properties. All significant intercompany transactions and balances have been eliminated in the combination. On June 14, 1994, the Highwoods Group transferred all of its assets and liabilities to Highwoods Realty Limited Partnership in connection with Highwoods Properties, Inc.'s initial public offering of common stock. Cash Equivalents The Highwoods Group considers highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Revenue Recognition Minimum rental income is recognized on a straight-line basis over the term of the lease, and due and unpaid rents are included in rents and other receivables from tenants in the accompanying balance sheet. Certain lease agreements contain provisions which provide reimbursement of real estate taxes, insurance and certain common area maintenance (CAM) costs. These additional rents are recorded on the accrual basis. All rent and other receivables from tenants are due from commercial building tenants located in the properties. Lease fee income is recognized 50% when the lease is signed and 50% when the tenant takes occupancy. Other Income Other income consists primarily of management fees generated by HPC from providing property management services to third parties and interest income. Income Taxes No provision has been made for income taxes because the commercial real estate properties are owned by partnerships whose partners are required to include their respective share of profits or losses in their individual tax returns. HPC elected to be taxed for federal and state income tax purposes as an S-Corporation under provisions of the Internal Revenue Code. Consequently income, losses and credits are passed through directly to the stockholders, rather than being taxed at the corporate level. 2. LEASES The Highwoods Group leases automobiles, and office space under various operating leases. Total rent expense for these leases was $70,000 for the period from January 1, 1994 to June 13, 1994. As of June 13, 1994, the Company did not have contractual leases in place with remaining terms of one year or more.