Kilroy Realty Corporation — 2011 Form 10-K
Reporting period: Fiscal year ended December 31, 2011; the filing was signed February 8, 2012. The company is a West Coast office and industrial REIT, operating primarily through Kilroy Realty, L.P. Most properties are in California, with six office properties in Washington.
Business context and portfolio
- At year-end, the stabilized portfolio comprised 143 buildings and 14.8 million rentable square feet, with 92.4% occupancy. Office occupancy was 90.1%; industrial occupancy was 100.0%.
- The company acquired 11 office buildings in 2011 for approximately $637.8 million, adding about 2.0 million square feet. It also had four office redevelopment projects under construction, totaling approximately 918,000 square feet.
- Management reported record annual leasing activity of 2.6 million square feet. A new DIRECTV lease for approximately 299,000 square feet at a property under redevelopment was expected to commence in the fourth quarter of 2012.
Financial results and key metrics
| Metric | 2011 | 2010 |
|---|---|---|
| Total revenue | $367.1 million | $287.4 million |
| Net operating income (NOI) | $259.3 million | $203.7 million |
| Income from continuing operations | $5.1 million | $10.3 million |
| Net income | $67.5 million | $19.9 million |
| Net income available to common stockholders; diluted EPS | $50.8 million; $0.87 | $4.5 million; $0.07 |
| NAREIT FFO | $136.2 million | $106.6 million |
| Cash from operating activities | $138.3 million | $119.8 million |
| Cash used in investing activities | $634.3 million | $701.8 million |
| Cash from financing activities | $486.0 million | $586.9 million |
NOI increased 27.3%, driven mainly by acquired properties and improved occupancy in the continuing core portfolio. Revenue grew 27.7%. Income from continuing operations declined as depreciation and amortization rose to $133.2 million and interest expense increased 49.2% to $89.4 million, primarily reflecting acquisitions and higher average debt. Net income included $62.4 million from discontinued operations, including a $51.6 million gain on 2011 property dispositions; therefore, net income and EPS substantially reflect asset-sale gains rather than continuing operations alone.
Fourth quarter: Revenue was $101.5 million and NOI was $73.3 million. Income from continuing operations was $3.3 million; net income was $44.9 million, including $41.6 million from discontinued operations. Net income available to common stockholders was $39.9 million, or $0.68 per share.
Debt, liquidity and distributions
- Year-end balance-sheet debt was $1.821 billion; gross principal debt used in the capitalization and maturity disclosures was approximately $1.837 billion. Debt was 42.4% of market capitalization, or 47.0% including preferred equity liquidation value.
- Approximately 90.1% of debt was fixed-rate. The weighted-average GAAP effective interest rate, including debt issuance costs, was 5.6%. A 100-basis-point increase in LIBOR was estimated to add approximately $1.8 million to annual interest expense before capitalization.
- The $500 million revolving credit facility had $182 million drawn and $318 million available at year-end; its amended maturity was August 2015. The company reported compliance with debt covenants.
- Approximately $253.3 million of principal was scheduled to mature in 2012, including $148 million of 3.25% exchangeable notes due in April and secured debt maturities. Management was evaluating refinancing options.
- Cash and cash equivalents were $4.8 million at year-end. Operating cash flow covered cash dividends during 2011, but the company depends on financing, asset sales and capital markets for growth and other funding needs.
- Common dividends were $1.40 per share for 2011, unchanged from 2010. Management stated it believed it could maintain the 2011 distribution level in 2012, subject to board discretion and REIT requirements.
Changes, outlook and material items
- Occupancy in the stabilized portfolio rose to 92.4% from 89.1% at year-end 2010. Average occupancy in the core portfolio increased to 92.0% from 86.2%.
- 2011 acquisitions and development activity increased the asset base; investment cash outflow remained substantial. The company issued $221 million net proceeds from a common stock offering and $325 million principal of 4.80% senior notes due 2018, and amended its credit facility to extend maturity and reduce pricing.
- Four redevelopment projects had estimated total investment of about $265 million, with approximately $114 million remaining at year-end; roughly $79 million was contractually committed. Management projected up to $35 million of 2012 capital improvements, tenant improvements and leasing costs for the stabilized portfolio, depending on leasing activity.
- Management cited stabilization in rental rates and concessions in many submarkets, while noting that fundamentals remained challenging. Portfolio cash rents were estimated to be 5%–10% above average quoted market rents; 2012 expirations were estimated to be 10%–15% above market, creating potential renewal and re-leasing pressure.
- Leases representing 8.2% and 13.4% of leased rentable space were scheduled to expire in 2012 and 2013, respectively. The 15 largest tenants accounted for 34.9% of annualized base rent; technology and media represented 33% of tenants.
- After year-end, the company sold two San Diego office buildings on January 30, 2012 for a net $146.1 million. Management expected a gain of approximately $73 million; the assets had been classified as held for sale at year-end.
- Management was discussing a proposed $150 million unsecured term loan and a credit-facility amendment, both expected in March 2012. These were prospective, not completed, at the filing date.
Risks, contingencies and unusual items
- Concentration in California exposes results to regional economic conditions, state fiscal and legislative developments, and local commercial real estate supply and demand.
- Tenant concentration, lease expirations, above-market in-place rents, tenant credit deterioration and the possibility of lower renewal rents may pressure occupancy and cash flows.
- Debt maturities, refinancing access, covenant restrictions and reliance on external capital could constrain investment or distributions. Credit-facility terms limit distributions in specified circumstances.
- Earthquake, environmental, casualty and regulatory risks could result in uninsured or inadequately insured costs. Management reported no known environmental liability or legal proceeding expected to have a material adverse effect.
- Development and redevelopment carry construction, entitlement, budget, leasing and timing risks. Management reported no impairment losses for the periods presented.
- The company reported effective disclosure controls and internal control over financial reporting; Deloitte issued unqualified opinions on the financial statements and internal controls.
Investor verification priorities
- Separate recurring operating performance from dispositions: verify the $51.6 million 2011 gain and the contribution of discontinued operations to reported net income and EPS.
- Review the 2012 debt maturity and refinancing plan, particularly the $148 million exchangeable notes and secured maturities, as well as subsequent financing and facility amendments.
- Track leasing outcomes for 2012–2013 expirations, market-versus-contract rent spreads, tenant concentration, and the commencement of the DIRECTV lease.
- Compare redevelopment budgets, remaining commitments, completion dates, pre-leasing and lease-up assumptions with actual results.
- Assess dividend coverage using recurring operating cash flow and FFO, accounting for capital spending, leasing costs, debt service and REIT distribution requirements.