Kilroy Realty Corporation and Kilroy Realty, L.P. — 2019 Form 10-K
Reporting period: Fiscal year ended December 31, 2019. The filing covers the REIT and its controlled operating partnership; the company generally conducts its business through the partnership. The quarterly figures below are for Q4 2019.
Business context
Kilroy owns, develops, acquires and manages primarily Class A office and mixed-use properties in coastal California and Greater Seattle. At year-end, its stabilized portfolio included 112 office buildings totaling 13.48 million rentable square feet, plus one 200-unit residential property. Office occupancy was 94.6% and leased occupancy was 97.0%.
Financial and operating performance
| Metric | FY 2019 | FY 2018 | Change |
|---|---|---|---|
| Revenue | $837.5 million | $747.3 million | +12.1% |
| Net income available to common stockholders | $195.4 million | $258.4 million | -24.4% |
| Diluted earnings per share | $1.86 | $2.55 | Lower |
| Funds from Operations (FFO) | $418.5 million | $360.5 million | +16.1% |
| Net Operating Income (NOI) | $591.2 million | $530.8 million | +11.4% |
| Cash provided by operating activities | $386.5 million | $410.0 million | -5.7% |
| Cash used in investing activities | $1,228.3 million | $808.9 million | Greater outflow |
| Cash provided by financing activities | $747.1 million | $503.1 million | +48.5% |
Q4 2019 revenue was $220.2 million, net income was $77.9 million, and diluted EPS was $0.67. The annual decline in common-stockholder earnings was substantially affected by lower gains on sales of depreciable properties: $36.8 million in 2019 versus $142.9 million in 2018. FFO and NOI rose as the portfolio expanded and leasing and development contributed; these are non-GAAP supplemental measures, not substitutes for GAAP earnings or cash flow.
Same-store NOI increased 5.3%. Year-end office occupancy edged up to 94.6% from 94.4%, while average occupancy declined to 93.3% from 94.1%. The company reported 1.8 million square feet of new and renewal leases in its stabilized portfolio, with GAAP rent increases of 52.3% and cash rent increases of 29.6% on applicable leasing comparisons. Management estimated portfolio cash rents were about 20% below current market rents.
Debt, liquidity and distributions
- Year-end aggregate principal debt was approximately $3.58 billion, versus $2.93 billion a year earlier; debt was 28.3% of total market capitalization. Approximately 89% of debt was fixed-rate. Net debt on the balance sheet was $3.55 billion.
- The $750 million unsecured revolver had $245 million drawn and $505 million of remaining capacity; it and the $150 million term loan mature in July 2022. Management reported covenant compliance, with the next debt maturities beginning in 2022.
- Cash and cash equivalents were $60.0 million, with $16.3 million of restricted cash. Cash and restricted cash together declined to $76.3 million from $171.0 million.
- The company issued $500 million of 3.05% senior notes due 2030 and settled 5.0 million forward-sale shares for $354.3 million net proceeds. It also had forward equity agreements for 3.15 million shares, expected to settle from 2020 through early 2021; those agreements were unsettled as of the filing date.
- Common dividends declared rose to $1.91 per share for 2019 from $1.79 in 2018. The board retains discretion over future distributions. 2019 distributions exceeded taxable income, resulting in a return of capital to stockholders.
Material changes, outlook and risks
- Growth and capital deployment: 2019 included a 19-building Culver City acquisition and two development-site acquisitions, totaling $359 million in cash purchases; two office properties were sold for $133.8 million gross proceeds. Development and undeveloped-land spending increased, contributing to higher investing cash outflows.
- Development outlook: Six projects were under construction, with an estimated total investment of about $2.2 billion; two projects totaling 846,000 square feet were in tenant improvements. Management expected $500–$600 million of development spending in 2020 and estimated $150–$300 million of potential 2020 disposition proceeds. These estimates depend on market conditions, leasing, costs, approvals and execution. No formal earnings or FFO guidance is provided in the supplied filing text.
- Lease and tenant exposure: The 15 largest tenants accounted for 49.6% of annualized base rent; technology tenants represented 51% of stabilized-portfolio base rent. Leases covering 7.7% and 6.8% of leased space were scheduled to expire in 2020 and 2021, respectively. Management cautions that renewals and re-leasing at current or higher rents are not assured.
- Accounting change: Topic 842 adoption in 2019 changed presentation of rental income and tenant reimbursements, recognized ground-lease right-of-use assets and liabilities, and caused indirect leasing costs to be expensed rather than capitalized. The gross-up of tenant billbacks increased reported revenues and expenses without affecting NOI; adoption also included a $3.1 million cumulative-effect adjustment to equity.
- Environmental and legal matters: Environmental remediation liabilities were accrued at $80.7 million for certain development sites; additional costs are possible but not reasonably estimable. Litigation related to the nearby Millennium Tower reached a settlement-in-principle in August 2019, subject to documentation; the company disputes responsibility. Management reported no known legal proceeding expected to have a material adverse effect.
- Principal risks: Geographic concentration in California and Seattle; tenant and industry concentration; leasing, development and construction-cost risks; environmental remediation, earthquakes and other natural disasters; interest-rate, refinancing and capital-market exposure; and maintaining REIT status. A 100-basis-point rise in LIBOR was estimated to increase annual interest expense by about $4.0 million, before capitalization, assuming year-end variable debt remained unchanged.
- Management priorities: Continue development, selective acquisitions and capital recycling while maintaining a conservative balance sheet. The company also reiterated its goal of carbon-neutral operations by year-end 2020. These are forward-looking objectives, not guarantees.
Important facts for investors to verify
- Reconcile GAAP earnings with FFO and NOI, including the impact of property-sale gains and the 2019 accounting-presentation change.
- Review the debt maturity schedule, covenant headroom, revolver usage and settlement terms and dilution from outstanding forward equity agreements.
- Track actual 2020 development spending, project delivery and lease-up versus estimates, along with expected disposition proceeds.
- Assess major tenant and technology-sector concentration, upcoming lease expirations, renewal outcomes and realized leasing costs.
- Monitor environmental remediation estimates and the status and final terms of the Millennium Tower-related settlement.
- Confirm dividend coverage, taxable-income treatment and the company’s progress toward its carbon-neutral target.