KILROY REALTY CORP annual report, FY2018

Kilroy Realty Corporation — 2018 Form 10-K Summary

Reporting period: Fiscal year ended December 31, 2018. This combined filing covers Kilroy Realty Corporation, a REIT, and its controlled operating partnership. Unless noted, figures below are consolidated and in U.S. dollars.

Business context and portfolio

Owns, develops, acquires and manages primarily Class A office properties in coastal California and Greater Seattle; substantially all operations are conducted through Kilroy Realty, L.P.
At year-end, the stabilized portfolio included 94 office buildings with 13.2 million rentable square feet, 482 tenants and 94.4% occupancy (96.6% leased). It also included one 200-unit residential property, with 79.7% average occupancy.
Five development sites represented approximately 73 acres and more than 5.0 million square feet of estimated potential development, subject to entitlements, market conditions and other uncertainties.

Financial and operating results

Metric	2018	2017	Change
Total revenue	$747.3 million	$719.0 million	+3.9%
Net income	$277.9 million	$180.6 million	+53.9%
Net income available to common stockholders	$258.4 million	$151.2 million	+70.9%
Diluted earnings per share	$2.55	$1.51	Up from $1.51
Funds From Operations (FFO)	$360.5 million	$346.8 million	+4.0%
Net Operating Income (NOI)	$530.8 million	$513.0 million	+3.5%
Cash from operating activities	$410.0 million	$347.0 million	+18.2%

Net income included $142.9 million of gains on sales of depreciable properties, compared with $39.5 million in 2017, and $11.8 million of gains on land sales. Earnings growth therefore substantially exceeded growth in recurring NOI and FFO.
NOI from same-store properties increased 3.1%; total NOI growth also reflected development and acquisitions, partly offset by dispositions.
Investing cash outflow was $808.9 million, compared with $359.1 million in 2017, reflecting higher acquisition and development spending. Financing activities provided $503.1 million, and cash, cash equivalents and restricted cash ended the year at $171.0 million, including $119.4 million of restricted cash.
Year-end total debt was $2.956 billion gross principal ($2.933 billion net carrying value), up from $2.347 billion net in 2017. Debt was 31.4% of total market capitalization; 93.4% was fixed-rate. Stated weighted-average interest rate was 4.1%.
The $750 million revolving credit facility had $45 million outstanding and $705 million of remaining capacity; the $150 million term loan facility was fully drawn. Reported covenant tests were met at year-end.
Common dividends declared were $1.79 per share for 2018, versus $1.65 in 2017. Quarterly dividends rose to $0.455 per share in the second quarter and remained at that level through year-end.

Material changes and significant activity

Occupancy declined to 94.4% from 95.2% at year-end 2017; average stabilized portfolio occupancy for the two years was 94.1%. San Diego and Seattle occupancy fell year over year, while Greater Los Angeles improved.
Management reported a record 2.8 million square feet of new and renewal leasing in the stabilized portfolio. For leases executed in 2018, rents increased 36.0% on a GAAP basis and 14.8% on a cash basis, excluding specified space and lease categories. Management estimated portfolio cash rents were approximately 20% below current market rents.
Acquired four office buildings for approximately $257.0 million and a 39-acre South San Francisco development site for approximately $308.2 million. Sold 11 office buildings for $373.0 million gross proceeds, versus $186.6 million of gross dispositions in 2017.
Issued $400 million of 4.75% senior notes due 2028 and $250 million of private-placement notes due 2026; redeemed $250 million of 6.625% notes due 2020. The early redemption generated a $12.6 million loss on extinguishment of debt.
Sold 5 million shares through a forward equity offering structure at an initial gross offering price of $360.5 million; proceeds had not been received by year-end. The company also raised $132.1 million net through at-the-market share sales in 2018.
Fourth-quarter net income was $166.9 million, including $160.2 million attributable to the Company, compared with $32.5 million and $28.5 million, respectively, in fourth-quarter 2017. The filing attributes the full-year earnings increase in part to higher property-sale gains; quarterly results should likewise be evaluated alongside disposition activity.

Outlook, risks and contingencies

Management expected 2019 development spending of approximately $500–$600 million and potential property-disposition proceeds of approximately $150–$350 million. It anticipated $15–$20 million of capital improvements, tenant improvements and leasing costs for stabilized properties, excluding development projects. These are expectations, not guarantees.
Development exposure is substantial: three projects were under construction and two in the tenant-improvement phase. Current projects under construction had estimated total investment of approximately $1.6 billion; future development costs and timing depend on leasing, construction costs, approvals and market conditions.
Environmental remediation liabilities were $83.2 million at year-end, up from $28.3 million in 2017, primarily associated with development sites. Additional costs are possible but not reasonably estimable in the filing.
The Company faces a concentrated geographic and tenant risk profile: all properties are in California or Washington, 48% of annualized base rent came from technology tenants, and the 15 largest tenants accounted for 45.7% of annualized base rent. Leases representing 11.5% and 11.8% of leased square footage were due to expire in 2019 and 2020, respectively; 66% of 2019 expiring space had been re-leased by year-end.
Other material risks include economic and office-market weakness, tenant defaults or nonrenewals, interest-rate and refinancing risk, development delays or cost overruns, earthquakes and other natural disasters, environmental regulation, and REIT qualification and distribution requirements. A 100-basis-point rise in LIBOR was estimated to increase annual interest expense by approximately $2.0 million on year-end variable-rate debt.
Cross-claims were asserted against Company entities in litigation concerning settlement at the neighboring Millennium Tower in San Francisco; the Company disputes the allegations. Management stated that no pending litigation was believed likely to have a material adverse effect.
The Company committed to carbon-neutral operations by December 31, 2020. It also disclosed that adoption of new lease accounting in 2019 would add approximately $80–$95 million of ground-lease right-of-use assets and liabilities to the balance sheet, with no expected material effect on earnings or cash flows.
Management said operating cash flow and other available sources were expected to cover projected liquidity needs over the next 12 months, while cautioning that capital-market access and future financing availability are not assured.

Most important facts for investors to verify

Separate recurring operating performance from gains on asset sales: reconcile the $258.4 million of common-stockholder net income with $360.5 million of FFO and $530.8 million of NOI.
Track occupancy, lease renewals and achieved cash rents, especially the 2019–2020 expirations, major tenant exposure and leasing progress at development projects.
Review development budgets, committed spending and funding plans against the expected $500–$600 million of 2019 development spending and the $3.5–$5.0 billion estimated investment for the future pipeline.
Confirm forward equity settlement, any further at-the-market issuance, disposition proceeds, and how those sources affect leverage and per-share results.
Monitor environmental remediation estimates, the Millennium Tower-related claims, debt covenants, maturities and interest-rate exposure, including the LIBOR transition.