LXP Industrial Trust: Form 10-Q for the period ended Jun 30, 2024

CONDITION AND RESULTS OF OPERATIONS

Introduction

Unless stated otherwise or the context otherwise requires, when we use the terms the “Company,” the “Trust,” “LXP,” “we,” “our,” and “us,” we refer collectively to LXP Industrial Trust and its consolidated subsidiaries. All of the Company's interests are held, and all of the property operating activities are conducted through special purposes entities, which we refer to as property owner subsidiaries or lender subsidiaries and are separate and distinct legal entities, but in some instances are consolidated for financial statement purposes and/or disregarded for income tax purposes. References herein to ‘‘this Quarterly Report” are to this Quarterly Report on Form 10-Q for the three and six months ended June 30, 2024. The results of operations contained herein for the three and six months ended June 30, 2024 and 2023 are not necessarily indicative of the results that may be expected for a full year.

When we use the term “REIT,” we mean real estate investment trust. All references to 2024 and 2023, refer to the periods ending June 30, 2024 and 2023, respectively, and our fiscal year ended December 31, 2023.

When we use the term “GAAP,” we mean United States generally accepted accounting principles in effect from time to time.

When we use the term “common shares,” we mean our shares of beneficial interest par value $0.0001, classified as common stock. When we use the term “Series C Preferred Shares,” we mean our beneficial interest classified as 6.50% Series C Cumulative Convertible Preferred Stock.

When we use the term “base rent,” we mean GAAP rental revenue and ancillary income, excluding billed tenant reimbursements and lease termination income.

When we use “Stabilized Portfolio,” we mean all real estate properties other than non-stabilized properties. We consider stabilization to occur upon the earlier of 90% occupancy of the property or one-year from the cessation of major construction activities. Non-stabilized, substantially completed development projects are classified within investments in real estate under construction.

The terms “FFO,” “Adjusted Company FFO,” and “NOI” are defined below.

The following is a discussion and analysis of the unaudited condensed consolidated financial condition and results of operations of LXP Industrial Trust for the three and six months ended June 30, 2024 and 2023, and significant factors that could affect its prospective financial condition and results of operations. This discussion should be read together with the accompanying unaudited condensed consolidated financial statements of the Company included herein and notes thereto and with the consolidated financial statements and notes thereto included in the Company's most recent Annual Report on Form 10-K, which was filed with the Securities and Exchange Commission, or SEC, on February 15, 2024, which we refer to as the Annual Report. Historical results may not be indicative of future performance.

Forward-Looking Statements. This Quarterly Report, together with other statements and information publicly disseminated by us, contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. We intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 and include this statement for purposes of complying with these safe harbor provisions. Forward-looking statements, which are based on certain assumptions and describe our future plans, strategies and expectations, are generally identifiable by use of the words “believes,” “expects,” “intends,” “anticipates,” “estimates,” “projects,” “may,” “plans,” “predicts,” “will,” “will likely result” or similar expressions. Readers should not rely on forward-looking statements since they involve known and unknown risks, uncertainties and other factors which are, in some cases, beyond our control and which could materially affect actual results, performances or achievements. In particular, among the factors that could cause actual results, performances or achievements to differ materially from current expectations, strategies or plans include, among others, those risks discussed below in “Management's Discussion and Analysis of Financial Condition and Results of Operations,” and under the headings “Risk Factors” in this Quarterly Report and under “Risk Factors” in Part I, Item A and “Management's Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of the Annual Report and other periodic reports filed by the Company with the SEC. Except as required by law, we undertake no obligation to publicly release any revisions to these forward-looking statements which may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. Accordingly, there is no assurance that our expectations will be realized.

Overview

As of June 30, 2024, we had equity ownership interests in approximately 117 consolidated warehouse/distribution facilities, located in 17 states and containing an aggregate of approximately 58.2 million square feet of space, approximately 93.5% of which was leased. During the three months ended June 30, 2024, we disposed of our remaining office properties and our portfolio is 100% industrial.

Our portfolio is primarily Class A real estate investments focused in our target markets within the Sunbelt and Midwest. We expect to grow in these markets by executing on our development pipeline and opportunistically acquiring facilities in these markets. However, increased financing costs continue to negatively impact transaction activity and development starts in our target markets and the markets where we own properties. Due to this, the current key drivers to growth in our revenue are leasing our vacant development properties and mark-to-market of our lease rollover.

Second Quarter 2024 Transaction Summary.

The following summarizes our significant transactions during the three months ended June 30, 2024.

Leasing Activity:

• Entered into a new lease and lease extensions encompassing 2.7 million square feet. The average fixed rent on the second generation new leases and extended leases was $5.22 per square foot compared to the average fixed rent on these leases before extension of $4.66 per square foot or $3.61 per square foot, excluding tenant improvement reimbursements as part of the expiring fixed rent in one lease. The weighted-average cost of tenant improvements and lease commissions was $2.15 per square foot for second generation new and extended leases.

Investments:

• Two vacant warehouse/distribution facilities containing an aggregate of 1.2 million square feet were placed in service one year after the completion of base building construction.
• Invested an aggregate of $34.7 million in development activities.

Debt:

• Repaid the $198.9 million aggregate principal balance of the outstanding 4.40% Senior Notes due 2024 at maturity.

Capital Recycling:

• Disposed of our interests in our two remaining consolidated office properties for an aggregate gross sale price of $15.8 million.

During the six months ended June 30, 2024, we completed and placed in service the following warehouse/distribution assets:

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Critical Accounting Estimates

Our critical accounting estimates are included in Part II, “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of the Company's Annual Report on Form 10-K for the year ended December 31, 2023. There have been no material changes to these estimates during the six months ended June 30, 2024.

Liquidity and Capital Resources

Cash Flows. We believe that cash flows from operations will continue to provide adequate capital to fund our operating and administrative expenses, regular debt service obligations and all dividend payments in accordance with applicable REIT requirements in both the short-term and long-term. However, our cash flow from operations may be negatively affected in the near term if we experience tenant defaults. In addition, we anticipate that cash on hand, borrowings under our unsecured revolving credit facility, capital recycling proceeds, issuances of equity, mortgage proceeds and other debt, as well as other available alternatives, will provide the necessary capital required by our business.

At June 30, 2024, our secured debt was $58.2 million compared to $60.9 million at December 31, 2023. Our property owner subsidiaries do not have mortgage maturities with balloon payments due until 2031. With respect to mortgages encumbering properties where the expected lease rental revenues are sufficient to provide an estimated property value in excess of the mortgage balance, we believe our property owner subsidiaries have sufficient sources of liquidity to meet these obligations through future cash flows from operations, the credit markets and, if determined appropriate by us, a capital contribution from us from either cash on hand ($48.7 million at June 30, 2024), property sale proceeds and borrowing capacity on our unsecured credit facility ($600.0 million at June 30, 2024, subject to covenant compliance).

Cash flows from operations were $77.4 million for the six months ended June 30, 2024 as compared to $92.6 million for the six months ended June 30, 2023. The decrease was primarily related to an increase in interest expense, a decrease in distributions from non-consolidated entities and the payment of a lease concession to a tenant. The underlying drivers that impact our working capital, and therefore cash flows from operations, are the timing of collection of rents, including reimbursements from tenants, payment of interest on debt and payment of operating and general and administrative costs. We believe the net-lease structure of the leases encumbering a majority of the properties in which we have an interest mitigates the risks of the timing of cash flows from operations since the payment and timing of operating costs related to the properties are generally borne directly by the tenant. The collection and timing of tenant rents are closely monitored by management as part of our cash management program.

Net cash provided by (used in) in investing activities totaled $82.1 million and $(38.9) million during the six months ended June 30, 2024 and 2023, respectively. Cash provided by investing activities in 2024 related primarily to redeeming investments in held-to-maturity securities, proceeds from property sales and distributions received from non-consolidated entities, offset by investments in real estate under construction, capital expenditures, lease costs, investments in non-consolidated entities and changes in real estate deposits, net. Cash used in investing activities in 2023 primarily related to investments in real estate under construction and capital expenditures, offset by net proceeds received from the disposition of real estate and distributions from non-consolidated entities.

Net cash used in financing activities totaled $310.0 million and $85.0 million during the six months ended June 30, 2024 and 2023, respectively. Cash used in financing activities in 2024 was primarily related to the repayment of the 4.40% Senior Notes due 2024, dividends, debt service payments and the purchase of noncontrolling interests, offset by contributions from noncontrolling interests.

At-The-Market Offering Program. We maintain an At-The-Market offering program ("ATM program") under which we can issue common shares, including through forward sales contracts.

We may sell up to $350.0 million common shares over the term of the program. We did not sell shares under the ATM program during the six months ended June 30, 2024 and 2023, respectively.

Volatility in the capital markets, including as a result of general economic conditions, may negatively affect our ability to access the capital markets through our ATM program and other offerings.

Share Repurchase Program. In August 2022, our Board of Trustees authorized the repurchase of an additional 10.0 million common shares under our share repurchase program with no expiration date. We did not repurchase any common shares during the six months ended June 30, 2024 and 2023. At June 30, 2024, 6.9 million common shares remained available for repurchase under this authorization.

Dividends. Dividends paid to our common and preferred shareholders were $79.1 million and $76.1 million in the six months ended June 30, 2024 and 2023, respectively.

We declared a quarterly dividend of $0.13 per common share during the six months ended June 30, 2024, which is an increase of $0.005 per common share from the $0.125 per common share quarterly dividend declared during the six months ended June 30, 2023.

Financings. The following senior notes were outstanding as of June 30, 2024:

The senior notes are unsecured and requires interest payments semi-annually in arrears. We may redeem the senior notes at our option at any time prior to maturity in whole or in part by paying the principal amount of the senior notes being redeemed plus a make-whole premium.

A summary of the maturity dates and interest rates of our unsecured credit agreement, as of June 30, 2024, are as follows:

(1) Maturity date of the revolving credit facility can be extended to July 2027 at our option, subject to certain conditions. The interest rate includes a 0.10% adjustment. The interest rate spread ranges from SOFR plus 0.725% to 1.40%. At June 30, 2024, we had no borrowings outstanding and availability of $600.0 million, subject to covenant compliance.

(2) The Term SOFR portion of the interest rate was swapped to obtain a current fixed rate of 2.722% per annum until January 31, 2025.

As of June 30, 2024, we were compliant with all applicable financial covenants contained in our corporate-level debt agreements.

During 2007, we issued $200.0 million in Trust Preferred Securities, which bore interest at a fixed rate of 6.804% through April 2017 and, thereafter, bears interest at a variable rate of three-month SOFR plus a 26 basis point adjustment plus 170 basis points. These securities are (1) classified as liabilities, (2) due in 2037 and (3) currently redeemable by us. As of June 30, 2024, and 2023, there were $129.1 million of these securities outstanding.

Development Costs

As of June 30, 2024, the aggregate estimated total costs of our consolidated development projects included in investment in real estate under construction are $117.3 million. We expect to incur approximately $65.6 million of additional costs, excluding noncontrolling interests' share and potential developer incentive fees or partner buyouts, to fund all of the remaining costs for our consolidated development project commitments. However, the risks associated with development, including supply chain issues, could adversely impact our estimates. As of June 30, 2024, we had three consolidated and two non-consolidated subsidiaries that owned land parcels held for industrial development. We are unable to estimate the timing of any required fundings for potential development projects on these parcels.

Results of Operations

Three months ended June 30, 2024 compared with three months ended June 30, 2023. The increase in net income attributable to common shareholders of $13.5 million was primarily due to the items discussed below.

The decrease in other revenue of $1.0 million was primarily due to consent income recognized in 2023 and a decrease in parking income due to the sale of the Philadelphia, PA office property in 2023.

The increase in depreciation and amortization expense of $2.4 million was primarily due to properties completed and placed in service in 2023 and 2024.

The increase in non-operating income of $2.6 million was primarily due to an increase in interest income earned from investing in short-term investments.

The increase in interest and amortization expense of $7.5 million was primarily due to a $5.3 million increase related to the 2028 Senior Notes that were issued in November 2023. Capitalized interest decreased $2.6 million primarily due to less development activity in the three months ended June 30, 2024 compared to the three months ended June 30, 2023. These amounts were partially offset by a $0.4 million decrease in interest expense related to the 2024 Senior Notes that were paid off in June 2024 at maturity.

The decrease in impairment charges of $13.0 million was primarily related to impairment charges recognized on office properties during the three months ended June 30, 2023. There were no impairment charges recognized during the three months ended June 30, 2024.

The increase in gains on sales of properties of $8.4 million was related to the timing of property dispositions.

Six months ended June 30, 2024 compared with six months ended June 30, 2023. The decrease in net income (loss) attributable to common shareholders of $2.0 million was primarily due to the items discussed below.

The increase in rental revenues of $1.5 million was primarily due to an aggregate increase of $13.4 million in base rental revenue and tenant reimbursement income primarily due to properties placed in service and leasing, partially offset by a decrease of $12.0 million in rental revenue due to property sales.

The decrease in other revenue of $1.6 million was primarily due to a decrease in parking income due to the sale of the Philadelphia, PA office property in 2023.

The increase in depreciation and amortization expense of $4.1 million was primarily due to properties completed and placed in service in 2023 and 2024.

The increase in non-operating income of $6.2 million was primarily due to an increase in interest income earned from investing in short-term investments.

The increase in interest and amortization expense of $13.1 million was primarily due to a $10.6 million increase related to the 2028 Senior Notes that were issued in November 2023. Additionally, capitalized interest decreased $2.7 million primarily due to less development activity in the six months ended June 30, 2024 compared to the six months ended June 30, 2023. These amounts were offset by a $0.4 million decrease in interest expense related to the 2024 Senior Notes that were paid off in June 2024 at maturity.

The decrease in impairment charges of $16.5 million was primarily related to impairment charges recognized on office properties during the six months ended June 30, 2023. There were no impairment charges recognized during the six months ended June 30, 2024.

The decrease in equity in earnings (losses) of non-consolidated entities of $4.9 million was primarily due to recognizing our share of a gain on sale of property related to BSH Lessee L.P. in 2023 that resulted in an increase in equity in earnings of $4.8 million.

Same-Store Results

Same-store net operating income, or NOI, which is a non-GAAP measure, represents the NOI for consolidated properties that were owned, stabilized and included in our portfolio for the entirety of the two comparable reporting periods. We define NOI as operating revenues (rental income (less GAAP rent adjustments, non-cash income related to sales-type leases and lease termination income, net), and other property income) less property operating expenses. Other REITs may use different methodologies for calculating same-store NOI, and accordingly same-store NOI may not be comparable to other REITs. Management believes that same-store NOI is a useful supplemental measure of our operating performance because same-store NOI excludes the change in NOI from acquired and disposed of properties and it highlights operating trends such as occupancy levels, rental rates and operating costs on properties. However, same-store NOI should not be viewed as an alternative measure of our financial performance since it does not reflect the operations of our entire portfolio, nor does it reflect the impact of general and administrative expenses, acquisition-related expenses, interest expense, depreciation and amortization costs, other nonproperty income and losses, the level of capital expenditures and leasing costs necessary to maintain the operating performance of our properties, or trends in development and construction activities which are significant economic costs and activities that could materially impact our results from operations. We believe that net income is the most directly comparable GAAP measure to same-store NOI.

The following presents our consolidated same-store NOI, for the three and six months ended June 30, 2024 and 2023 ($000's):

Our same-store NOI increased for the three and six months ended June 30, 2024 compared to the three and six months ended June 30, 2023 by 5.0% and 5.1%, respectively, primarily due to an increase in cash base rents. As of June 30, 2024 and 2023, our historical same-store square footage leased was 99.4% and 99.5%, respectively.

Below is a reconciliation of net income (loss) to same-store NOI for periods presented ($000's):

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Funds From Operations

We believe that Funds from Operations, or FFO, which is a non-GAAP measure, is a widely recognized and appropriate measure of the performance of an equity REIT. We believe FFO is frequently used by securities analysts, investors and other interested parties in the evaluation of REITs, many of which present FFO when reporting their results. FFO is intended to exclude GAAP historical cost depreciation and amortization of real estate and related assets, which assumes that the value of real estate diminishes ratably over time. Historically, however, real estate values have risen or fallen with market conditions. As a result, FFO provides a performance measure that, when compared year over year, reflects the impact to operations from trends in occupancy rates, rental rates, operating costs, development activities, interest costs and other matters without the inclusion of depreciation and amortization, providing a perspective that may not necessarily be apparent from net income.

The National Association of Real Estate Investment Trusts, or NAREIT, defines FFO as “net income (calculated in accordance with GAAP), excluding depreciation and amortization related to real estate, gains and losses from the sales of certain real estate assets, gains and losses from change in control and impairment write-downs of certain real estate assets and investments in entities when the impairment is directly attributable to decreases in the value of depreciable real estate held by the entity. The reconciling items include amounts to adjust earnings from consolidated partially-owned entities and equity in earnings of unconsolidated affiliates to FFO.” FFO does not represent cash generated from operating activities in accordance with GAAP and is not indicative of cash available to fund cash needs.

We present FFO available to common shareholders and unitholders - basic and also present FFO available to all equityholders and unitholders - diluted on a company-wide basis as if all securities that are convertible, at the holder's option, into our common shares, are converted at the beginning of the period. We also present Adjusted Company FFO available to all equityholders and unitholders - diluted, which adjusts FFO available to all equityholders and unitholders - diluted for certain items which we believe are not indicative of the operating results of our real estate portfolio. We believe this is an appropriate presentation as it is frequently requested by securities analysts, investors and other interested parties. Since others do not calculate these measures in a similar fashion, these measures may not be comparable to similarly titled measures as reported by others. These measures should not be considered as an alternative to net income as an indicator of our operating performance or as an alternative to cash flow as a measure of liquidity.

Adjusted Company FFO, NOI and the other non-GAAP financial measures should not be considered as alternatives to, or more meaningful than, net income or loss as determined in accordance with GAAP. FFO, Adjusted Company FFO and NOI, and GAAP net income (loss) differ because FFO, Adjusted Company FFO and NOI exclude many items that are factored into GAAP net income or loss.

Because of the differences between FFO, Adjusted Company FFO, NOI and GAAP net income or loss, FFO, Adjusted Company FFO and NOI may not be accurate indicators of our operating performance, especially during periods in which we are acquiring and selling properties. In addition, FFO, Adjusted Company FFO and NOI are not necessarily indicative of cash flow available to fund cash needs and investors should not consider FFO, Adjusted Company FFO or NOI as alternatives to cash flows from operations, as an indication of our liquidity or as indicative of funds available to fund our cash needs, including our ability to make distributions to our shareholders.

Neither the SEC nor any other regulatory body has passed judgment on the acceptability of the adjustments that we use to calculate FFO, Adjusted Company FFO and NOI. Also, because not all companies calculate FFO, Adjusted Company FFO and NOI the same way, comparisons with other companies’ measures with similar titles may not be meaningful.

The following presents a reconciliation of net income (loss) attributable to common shareholders to FFO available to common shareholders and unitholders and Adjusted Company FFO available to all equityholders and unitholders for the three and six months ended June 30, 2024 and 2023 (unaudited and dollars in thousands, except share and per share amounts):

(1) Transaction costs including costs associated with terminated investments, such as non-refundable deposits and legal fees.

(2) Includes OP units other than OP units that were held by us.

Off-Balance Sheet Arrangements

As of June 30, 2024, we had investments in various real estate entities with varying structures. The real estate investments owned by our institutional joint ventures are generally financed with non-recourse debt. Non-recourse debt is generally defined as debt whereby the lenders' sole recourse with respect to borrower defaults is limited to the value of the assets collateralized by the debt. The lender generally does not have recourse against any other assets owned by the borrower or any of the members or partners of the borrower, except for certain specified exceptions listed in the particular loan documents. These exceptions generally relate to “bad boy” acts, including fraud, prohibited transfers and breaches of material representations, and environmental matters. We have guaranteed such obligations for certain of our non-consolidated entities with respect to $453.6 million of such non-recourse debt. We believe the likelihood of making any payments under such guaranties is remote and we generally have an agreement from each partner to reimburse us for its proportionate share of any liability related to a guarantee trigger unless such trigger is caused solely by us.

DISCLOSURES ABOUT MARKET RISK

Our exposure to market risk relates primarily to our variable-rate indebtedness not subject to interest rate swaps and our fixed-rate debt. Our consolidated aggregate principal variable-rate indebtedness not subject to interest rate swaps was $129.1 million at June 30, 2024 and 2023, which represented 8.1% and 8.6%, respectively, of our aggregate principal consolidated indebtedness. During the three months ended June 30, 2024 and 2023, our variable-rate indebtedness had a weighted-average interest rate of 7.3% and 6.7%, respectively, and had the weighted-average interest rate been 100 basis points higher, our interest expense for the three months ended June 30, 2024 and 2023 would have increased by $0.3 million and $0.5 million, respectively. During the six months ended June 30, 2024 and 2023, our variable-rate indebtedness had a weighted-average interest rate of 7.3% and 6.5%, respectively. Had the weighted-average interest rate been 100 basis points higher, our interest expense for the six months ended June 30, 2024 and 2023 would have increased $0.7 million and $1.0 million, respectively. At each of June 30, 2024 and 2023, our aggregate principal consolidated fixed-rate debt was $1.5 billion and $1.4 billion, respectively, which represented 91.9% and 91.4%, respectively, of our aggregate principal indebtedness.

For certain of our financial instruments, fair values are not readily available since there are no active trading markets as characterized by current exchanges between willing parties. Accordingly, we derive or estimate fair values using various valuation techniques, such as computing the present value of estimated future cash flows using discount rates commensurate with the risks involved. However, the determination of estimated cash flows may be subjective and imprecise. Changes in assumptions or estimation methodologies can have a material effect on these estimated fair values, especially given the volatility of the current economic environment. The following fair value was determined using the interest rates that we believe our outstanding fixed-rate indebtedness would warrant as of June 30, 2024. We believe the fair value is indicative of the interest rate environment as of June 30, 2024, but this amount does not take into consideration the effects of subsequent interest rate fluctuations. Accordingly, we estimate that the fair value of our fixed-rate indebtedness was $1.3 billion as of June 30, 2024.

Our interest rate risk objectives are to limit the impact of interest rate fluctuations on earnings and cash flows and to lower our overall borrowing costs. To achieve these objectives, we manage our exposure to fluctuations in market interest rates through the use of fixed-rate debt instruments to the extent that reasonably favorable rates are obtainable with such arrangements. We may enter into derivative financial instruments such as interest rate swaps or caps to mitigate our interest rate risk on a related financial instrument or to effectively lock the interest rate on a portion of our variable-rate debt. As of June 30, 2024, we had four interest rate swap agreements (see Note 8 to our unaudited condensed consolidated financial statements contained in this Quarterly Report).

Evaluation of Disclosure Controls and Procedures. Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as such terms are defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this Quarterly Report to determine if such controls and procedures were effective to ensure that information required to be disclosed by us in reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms and that information required to be disclosed by us in reports filed or submitted under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Management, including each of our Chief Executive Officer and Chief Financial Officer, has concluded that our disclosure controls and procedures were effective as of June 30, 2024.

Changes in Internal Control Over Financial Reporting. There were no changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter to which this Quarterly Report relates that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Limitations on the Effectiveness of Controls. Internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its inherent limitations. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial reporting also can be circumvented by collusion or improper management override. Because of such limitations, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over financial reporting. However, these inherent limitations are known features of the financial reporting process. Therefore, it is possible to design into the process safeguards to reduce, though not eliminate, this risk.