Kilroy Realty Corporation / Kilroy Realty, L.P. — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014. Kilroy is a West Coast office REIT; the Operating Partnership conducts substantially all operations. The Corporation owned 97.9% of the Partnership at quarter-end. Dollar amounts below are in U.S. dollars.
Business context and portfolio
- The stabilized portfolio comprised 107 office buildings and 13.3 million rentable square feet, with 92.4% occupancy at quarter-end, down from 93.4% at December 31, 2013. Average occupancy for the quarter was 93.1%, versus 91.0% in Q1 2013.
- Six development projects were under construction, with approximately 2.54 million estimated square feet. The 360 Third Street redevelopment in San Francisco was stabilized during the quarter and was 96% leased at March 31.
Financial performance and liquidity
| Metric | Q1 2014 | Q1 2013 / comparison |
|---|---|---|
| Total revenue | $125.8 million | $111.0 million; up 13.4% |
| Net operating income (NOI), continuing operations | $88.8 million | $77.6 million; up 14.4% |
| NOI as a share of revenue | 70.6% | 70.0% |
| Income from continuing operations | $11.4 million | $0.2 million |
| Net income | $101.9 million | $2.4 million |
| Net income available to common stockholders | $96.5 million; $1.17 basic and $1.14 diluted per share | Loss of $0.9 million; loss of $0.02 per share |
| Funds from operations (FFO) | $57.2 million | $49.1 million; up 16.6% |
| Operating cash flow | $45.1 million | $56.5 million; down 20.2% |
| Cash and cash equivalents at quarter-end | $95.5 million | $35.4 million at December 31, 2013 |
Quarterly net income included a $90.1 million gain on property dispositions; continuing-operations income and FFO provide context for performance excluding that gain. Cash from investing activities was $97.3 million, including $309.8 million of net disposition proceeds and acquisition, operating-property, and development expenditures. Financing activities used $82.2 million. The common dividend declared was $0.35 per share, unchanged from Q1 2013.
- Debt: Gross principal debt was approximately $2.149 billion. Debt was 93% fixed-rate; weighted average stated and GAAP effective rates were 4.8%. The $500 million revolving credit facility was undrawn at March 31; the separate term loan balance was $150 million.
- Maturities and covenants: $172.5 million of exchangeable notes mature in November 2014 and $83.0 million of senior notes mature in August 2014. Management reported full availability under the revolver and compliance with debt covenants. Total debt to market capitalization was 29.5%.
Material changes versus the prior comparable period
- Revenue rose with acquisitions, stronger same-store rental income and reimbursements, and lease-termination income. Same-store NOI increased 5.2%; acquired and stabilized development/redevelopment properties also contributed to NOI growth.
- Net income rose sharply mainly because Q1 2014 included the $90.1 million disposition gain; Q1 2013 had no such gain. Continuing-operations income also improved, while interest expense fell 12.6% to $17.3 million.
- Operating cash flow declined, which management attributed primarily to timing of payments of accounts payable and accrued liabilities. Investing cash flow increased with the San Diego property sales.
- The company sold 12 San Diego office properties for gross proceeds of approximately $294.7 million and acquired one fully occupied Seattle office building for $106.1 million.
Outlook, management commentary, risks and unusual items
- Management said it expects to pursue value-add acquisitions and development opportunities, while using disposition proceeds for acquisitions, development, debt repayment and general corporate purposes. No specific full-year revenue, earnings or FFO guidance was provided.
- Management believed liquidity sources would cover projected needs for the next 12 months and stated it could maintain 2014 distributions at current levels, while noting distributions remain subject to board discretion and REIT requirements.
- Six projects under construction had estimated total investment of approximately $1.5 billion; approximately $689.2 million had been incurred and $648.0 million remained committed. Construction timing and costs may vary. Management also disclosed approximately $733.6 million of operating and redevelopment contract and executed-lease commitments, excluding ground leases.
- A tenant exercised an early termination option for approximately 79,000 square feet in San Diego. The $5.7 million termination fee is being recognized through the termination date in Q3 2014; $1.7 million was recorded in Q1.
- Leasing and occupancy remain material risks: 7.6% of stabilized space was available, and leases covering 7.8% and 12.9% of occupied space were scheduled to expire during the remainder of 2014 and in 2015, respectively. San Diego occupancy declined to 88.1% from 90.8% at year-end.
- Other risks include refinancing upcoming maturities, interest-rate and credit-market changes, tenant defaults, development costs and execution, and the possibility of failing debt covenants. Management reported no material litigation, environmental liability, off-balance-sheet arrangements or material change in reported risk factors.
Important facts for investors to verify
- How much of reported earnings and cash generation is sustainable after excluding disposition gains and lease-termination income; review NOI and FFO reconciliations.
- Progress in refinancing or repaying the $255.5 million of exchangeable and senior notes maturing in 2014, plus scheduled principal amortization.
- Leasing trends, renewal rates and occupancy—particularly in San Diego—and the impact of 2014–2015 lease expirations.
- Actual remaining costs, leasing, completion timing and funding for the six development projects and other contractual commitments.
- Whether the April 2014 sale of the Via Frontera land for $33.1 million and the San Diego dispositions produce the expected capital-recycling and tax outcomes.