Kilroy Realty Corporation and Kilroy Realty, L.P. — Q3 2010 Form 10-Q
Reporting period: Three and nine months ended September 30, 2010. Kilroy is a California-focused office and industrial REIT; substantially all operations and debt are held by its Operating Partnership. Unless noted, figures below are consolidated and in millions of dollars.
Financial performance and key metrics
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Total revenue | $79.8 | $68.5 | $219.0 | $212.1 |
| Net income | $3.7 | $12.2 | $14.5 | $37.3 |
| Net income available to common shareholders | $(0.1) | $8.1 | $3.0 | $24.8 |
| Common EPS | $(0.01) | $0.17 | $0.04 | $0.64 |
| Net operating income (NOI) | $56.9 | $49.2 | $156.7 | $154.6 |
| Funds from Operations (FFO), as reported | $29.7 | $30.2 | $77.2 | $89.5 |
- Cash flow: Nine-month operating cash flow was $94.9, down from $98.0. Investing used $434.7, principally reflecting property acquisitions; financing provided $338.2. Cash and cash equivalents were $8.3 at quarter-end.
- Debt and liquidity: Total debt principal was $1.174 billion, versus $1.174 billion of total market capitalization debt listed by the company. The $500 million revolving facility had $205 million drawn and $295 million available. Total assets were $2.536 billion; total liabilities were $1.329 billion. The filing reports compliance with debt covenants.
- Debt profile: 82.5% of debt was fixed-rate and 17.5% variable-rate; GAAP effective debt interest rate was 6.3%. A 100-basis-point LIBOR increase was estimated to raise annual interest expense by approximately $2.1 million, before capitalization.
- Distributions: Common dividends were $0.35 per share for Q3, unchanged from Q3 2009; nine-month declared dividends were $1.05 per share versus $1.28.
Material changes versus comparable periods
- Q3 revenue rose 16.5%, while net income fell 70.0%; common shareholders had a small loss versus $8.1 million of income a year earlier. Nine-month net income fell 61.2% and common EPS declined from $0.64 to $0.04.
- Revenue and total NOI benefited substantially from 2010 acquisitions. Nine-month total NOI grew 1.4%, but core office NOI declined 2.7% and core industrial NOI declined 12.0%.
- Higher depreciation and amortization and higher interest expense weighed on earnings. Nine-month interest expense rose 16.7% to $40.9 million; the period also included a $4.6 million loss on repurchase of exchangeable notes, compared with a $3.1 million gain in 2009.
- The company acquired seven office buildings for approximately $429.4 million, including San Francisco’s 303 Second Street. It issued 9.2 million common shares for net proceeds of approximately $299.8 million and issued $250 million of 6.625% senior notes due 2020.
- Stabilized portfolio occupancy was 86.4% at September 30, compared with 82.8% at December 31, 2009. Average stabilized occupancy for the first nine months was 84.1%, down from 86.0% a year earlier.
Outlook, risks and unusual items
- Management reported declining rents across many submarkets. For leases commencing in the first nine months, comparable cash rents declined 13.7% and GAAP rents declined 15.1%; Q3 leasing data showed decreases of 9.4% in cash rents and 19.9% in GAAP rents. Management estimated portfolio cash rents were about 10% above current average market rents, creating renewal and re-leasing risk.
- Management described regional fundamentals as challenging, while noting occupancy improvement since year-end and some stabilization in rents and concessions. No formal earnings guidance was provided.
- One El Segundo office redevelopment, approximately 300,000 rentable square feet, has estimated total investment of $50 million and is expected to finish in Q3 2012. Management said development activity remained delayed or scaled back in response to market conditions.
- After quarter-end, the company agreed to acquire two office properties totaling 588,000 square feet for approximately $238 million, with closings anticipated in Q4 subject to customary conditions. It also sold one industrial building for approximately $5 million.
- Risks include weak economic and leasing conditions, tenant defaults, acquisition execution, refinancing and interest-rate exposure, property impairment, and compliance with financial covenants. The company reported no impairment losses and no material changes to previously disclosed risk factors. A litigation settlement generated a $3.6 million cash payment and a $0.6 million reversal of prior bad-debt allowance.
- The top 15 tenants represented 39.8% of annualized base rent; Intuit accounted for 5.6%. The filing reported no legal proceedings expected to have a material adverse effect and no off-balance-sheet arrangements.
Most important facts for investors to verify
- Whether acquired and pending properties deliver expected occupancy, rent, and cash-flow contributions, and whether the announced Q4 acquisitions closed on the stated terms.
- Lease renewals, rent spreads, occupancy trends, and upcoming expirations—especially in industrial properties and office markets where existing rents exceed market levels.
- Cash available after operating needs, distributions, redevelopment spending, and debt maturities; confirm availability and terms of revolving credit and refinancing options.
- The effect of higher debt costs, the $4.6 million debt-repurchase loss, and increased depreciation on recurring earnings and FFO.
- Tenant concentration, covenant headroom, and the assumptions supporting the planned $50 million redevelopment and its leasing-related costs.