Kilroy Realty Corporation — Q3 2012 Form 10-Q
Reporting period: Three and nine months ended September 30, 2012. Amounts are in U.S. dollars; financial statement figures are generally in millions unless noted. Kilroy is a West Coast office and industrial REIT operating primarily through Kilroy Realty, L.P.; the company owned 97.6% of the partnership at quarter-end.
Business context and portfolio
- The stabilized portfolio comprised 111 office buildings and 12.66 million rentable square feet, with 91.1% occupancy at September 30, compared with 90.0% at June 30 and 92.4% at December 31, 2011.
- During the first nine months, Kilroy acquired 12 office buildings for approximately $572 million and three development opportunities for approximately $158 million. The company reported four redevelopment projects under construction and one office development under construction.
- All 39 industrial properties and five office properties, totaling 3.72 million square feet, were classified as held for sale. Their results were reported in discontinued operations; the company consequently reported one segment, Office Properties.
Financial performance and position
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Total revenue | $104.3 | $86.4 | $293.8 | $243.4 |
| Net operating income (NOI) | $72.3 | $60.3 | $208.5 | $170.8 |
| Income (loss) from continuing operations | $(0.7) | $(3.4) | $1.5 | $(3.7) |
| Net income | $2.5 | $14.3 | $83.5 | $22.6 |
| Net income (loss) available to common stockholders | $(2.8) | $10.2 | $64.0 | $10.9 |
| Basic earnings (loss) per common share | $(0.04) | $0.17 | $0.92 | $0.18 |
- Revenue increased 20.7% in both the quarter and nine-month period. NOI increased 19.9% for Q3 and 22.1% year to date, primarily reflecting acquired properties. Derived NOI margin was approximately 69.3% for Q3 2012 and 71.0% for the first nine months.
- Same-store NOI was down 0.9% in Q3 but up 2.5% for the nine-month period. Average same-store occupancy was 90.8% for Q3 and 91.5% year to date.
- Year-to-date net income included a $72.8 million gain on property dispositions. Common earnings were also reduced by $7.0 million of noncash original issuance costs associated with preferred securities redeemed in 2012. Q3 common loss reflected $2.1 million of these costs.
- Cash provided by operations was $147.3 million for the first nine months, versus $114.1 million a year earlier. Investing activities used $541.3 million, including acquisitions and development spending; financing activities provided $405.3 million. Cash and cash equivalents were $16.1 million at quarter-end.
- At September 30, total assets were $4.22 billion and total liabilities were $2.15 billion. Gross debt principal was approximately $1.85 billion; 90.4% was fixed-rate and 9.6% variable-rate. The reported debt-to-market-capitalization ratio was 33.7%, or 37.3% including preferred equity liquidation value.
- The $500 million credit facility had $27 million drawn and $473 million of remaining capacity. Management reported compliance with debt covenants. The common dividend declared was $0.35 per share for the quarter, unchanged from 2011.
Changes, outlook, risks, and unusual items
- Growth in revenue and NOI was largely acquisition-driven; depreciation and amortization rose 31.3% year to date. General and administrative expense rose 31.4%, partly due to new executive stock-option compensation, higher payroll costs, and company growth.
- The company issued common equity in February and August 2012, raising approximately $382.1 million and $253.8 million net, respectively, and issued Series G and H preferred stock for approximately $96.2 million net each. It redeemed Series E and F preferred stock and Series A preferred units, and repaid $148 million of 3.25% exchangeable notes at maturity using a new $150 million term loan.
- Management expected development activity to increase in 2013, subject to market conditions, project economics, and pre-leasing. It described rental rates as stabilized or improving in many submarkets, but gave no formal earnings or FFO guidance.
- Contracts were in place to sell the industrial portfolio and five office properties. Management expected gross proceeds of approximately $355 million before selling costs and anticipated closing by year-end 2012; completion was not assured. The January 2012 sale of two office buildings generated $146.1 million of proceeds and a $72.8 million gain.
- Key risks include leasing demand, occupancy and rent changes, tenant defaults, property values, access to financing, refinancing and interest-rate exposure, and compliance with debt covenants. Approximately $263 million of stated debt maturities fell in 2014 and $420 million in 2015. A 100-basis-point LIBOR increase was estimated to add approximately $1.8 million to annual interest expense at the reported variable-debt balances.
- The 4.25% exchangeable notes, with $172.5 million principal due November 2014, became exchangeable during Q4 2012 after the share-price trigger was met. Routine litigation was reported, with no proceeding believed likely to have a material adverse effect. The filing reported no off-balance-sheet arrangements and no material change in previously disclosed risk factors.
Important facts for investors to verify
- Whether the contracted sales of the industrial portfolio and five office properties closed on expected terms and by year-end, and how proceeds were applied.
- Actual stabilized and same-store occupancy, lease commencements, renewal retention, and rent changes—especially against the sizable 2013 lease expirations.
- Development budgets, construction timing, pre-leasing, and funding needs for the active pipeline and projects planned for 2013.
- Debt maturities, covenant headroom, variable-rate exposure, and potential dilution or settlement choices related to the exchangeable notes.
- The effect of 2012 equity issuance on per-share results and the sustainability of distributions relative to operating cash flow and REIT requirements.