Kilroy Realty Corporation — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019. Kilroy is a West Coast office and mixed-use REIT; substantially all operations are conducted through Kilroy Realty, L.P. The financial statements are unaudited.
Business context and portfolio
The stabilized portfolio included 94 office buildings with 13.2 million rentable square feet, 92.5% occupied and 96.2% leased at quarter-end, plus a 200-unit residential property. Average stabilized office occupancy during the quarter was 93.1%, versus 94.8% a year earlier. The company had three projects in tenant-improvement phases and five under construction.
Financial performance and position
| Metric | Q1 2019 | Comparable period / prior date |
|---|---|---|
| Total revenue | $201.2 million | $182.8 million in Q1 2018, up 10.1% |
| Net income | $41.8 million | $41.0 million in Q1 2018, up 2.0% |
| Net income available to common stockholders | $36.9 million; $0.36 per diluted share | $36.2 million; $0.36 per diluted share |
| Net operating income (company-defined) | $142.4 million | $132.7 million in Q1 2018, up 7.3% |
| Funds from Operations (FFO) | $99.8 million | $96.3 million in Q1 2018 |
| Cash provided by operating activities | $99.8 million | $94.1 million in Q1 2018 |
| Cash used in investing activities | $213.5 million | $247.7 million in Q1 2018 |
| Cash and cash equivalents; restricted cash | $49.7 million; $6.3 million | Combined balance was $171.0 million at December 31, 2018 |
| Total debt, gross principal | $3.02 billion | Debt to total market capitalization: 27.9% |
| Revolver | $185 million drawn; $565 million remaining capacity | $45 million drawn at December 31, 2018 |
Net income margin was approximately 20.8% of revenue and company-defined NOI was approximately 70.8% of revenue. These calculated ratios are not company-reported GAAP margins. Total assets were $7.88 billion and total equity was $4.18 billion at quarter-end. The company reported compliance with debt covenants. The next stated debt maturities are in 2022; aggregate principal maturities are $340.6 million in 2022 and $305.8 million in 2023, with most debt due thereafter.
Material changes and notable items
- Revenue increased, supported by same-store leasing and development and acquisition contributions. Total NOI rose 7.3%; same-store NOI increased 3.2%.
- Quarter-end stabilized occupancy declined from 94.4% at December 31, 2018; average quarterly occupancy was also lower year over year. Management estimated portfolio cash rents were about 20% below current market rates.
- General and administrative expense increased 50.0% to $23.3 million, mainly due to higher compensation and share-based compensation. Depreciation and amortization increased 5.5% to $66.1 million.
- Reported interest expense fell 16.7% to $11.2 million, although gross interest expense rose 13.3%; higher development-related interest capitalization more than offset the increase in gross expense.
- Investing outflows included $181.7 million for development properties and undeveloped land. No operating-property acquisitions were made in Q1 2019, versus $111.0 million of acquisition spending in Q1 2018.
- The company repaid a $74.3 million secured mortgage in February. Revolver borrowings increased by $140 million net during the quarter.
- The board declared a quarterly dividend/distribution of $0.455 per share/unit, up from $0.425 in Q1 2018. The April 17 payment totaled approximately $47.6 million including dividend equivalents.
Outlook, risks and contingencies
- No specific earnings or FFO guidance is provided. Management expects to fund development and other liquidity needs through operating cash flow, credit facilities, debt or equity issuance, asset dispositions and potential strategic ventures; it cautions that these sources may not remain available on acceptable terms.
- Management estimated $150 million to $350 million of potential disposition proceeds for the remainder of 2019, subject to market conditions and transaction execution.
- Five projects under construction had estimated total investment of approximately $2.2 billion; about $958.9 million had been incurred and a further $940 million committed. Three tenant-improvement projects had estimated total investment of approximately $955 million. The future pipeline could require $3.5 billion to $5.0 billion if pursued, subject to entitlements and market conditions.
- Contract and executed-lease commitments related to operating properties and development projects were approximately $1.2 billion, excluding ground leases. Accrued environmental remediation liabilities were $74.4 million; additional costs may arise but could not be reasonably estimated.
- Key risks include tenant defaults or nonrenewals, occupancy and rental-rate changes, development delays or cost overruns, environmental remediation, interest rates and access to financing, real estate market weakness, and REIT qualification. Certain obligations include long-term ground leases; recognized ground-lease liabilities were $87.2 million.
- Adoption of lease accounting standard Topic 842 resulted in $82.9 million of right-of-use ground lease assets and $87.4 million of ground-lease liabilities at adoption. It also changed presentation of tenant reimbursements and led to expensing indirect leasing costs; management reported no material impact on operating results from adoption.
Investor verification points
- Reconcile operating cash flow: the cash-flow statement reports $99.8 million in Q1 2019 versus $94.1 million in Q1 2018, while MD&A prose says operating cash flow decreased by $5.7 million. The filing text is internally inconsistent on this point.
- Assess occupancy and lease rollover: 7.2% of occupied square footage was scheduled to expire during the remainder of 2019 and 11.2% in 2020; leasing outcomes and tenant retention will affect future cash flows.
- Track development funding, leasing, completion timing and total remaining commitments, particularly for large projects and the proposed Oyster Point and San Diego developments.
- Monitor revolver usage, the 2022–2023 maturities, covenant headroom and settlement of forward equity sale agreements. Shares sold under forward agreements had not yet generated proceeds for the company at quarter-end.
- Consider comparability effects from Topic 842 presentation changes and the $3.5 million reversal of a tenant receivable allowance, which benefited Q1 2019 results.