Kilroy Realty Corporation / Kilroy Realty, L.P. — Q3 2014 Form 10-Q
Period: Three and nine months ended September 30, 2014. Amounts below are in U.S. dollars; financial statement amounts are converted from thousands to millions where appropriate. The filing combines the REIT parent and its operating partnership, whose operations are substantially the same.
Business context and operating performance
Kilroy owns, develops, acquires and manages primarily Class A office properties in coastal California and greater Seattle. At quarter-end, its stabilized portfolio comprised 105 buildings and 13.5 million rentable square feet, with 94.1% occupancy. The company owned 97.9% of the Operating Partnership.
- Quarter-end stabilized occupancy was up from 93.4% at December 31, 2013; average occupancy for the quarter was 94.0%, versus 91.4% a year earlier.
- Management reported portfolio net operating income (NOI), a non-GAAP measure, of $91.4 million for Q3, up 17.2%; nine-month NOI was $269.4 million, up 13.9%.
- Management attributed NOI gains to same-store rent and occupancy improvements, acquired properties, and newly stabilized development projects. Same-store NOI rose 8.7% in Q3 and 5.3% for the nine months.
Financial results and liquidity
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Total revenue | $129.0 million | $113.5 million | $380.0 million | $338.5 million |
| Income from continuing operations | $13.2 million | $3.2 million | $39.9 million | $9.9 million |
| Net income | $19.3 million | $9.0 million | $152.4 million | $21.5 million |
| Net income available to common stockholders | $15.7 million | $5.6 million | $139.4 million | $11.3 million |
| Diluted earnings per share | $0.18 | $0.07 | $1.63 | $0.13 |
| FFO attributable to common holders (non-GAAP) | $60.4 million | $55.9 million | $180.9 million | $160.1 million |
- Revenue growth reflected higher rental income and tenant reimbursements, property acquisitions and development completions. Q3 continuing-operations income improved substantially year over year.
- Nine-month net income includes $110.4 million of gains on dispositions of discontinued operations and a $3.5 million gain on land sale. Consequently, GAAP net income and EPS growth substantially reflect dispositions; FFO excludes the discontinued-operation disposition gains.
- Nine-month operating cash flow was $197.3 million, versus $186.3 million. Investing cash outflow was $189.0 million, versus $281.7 million, while financing cash inflow was $156.7 million, versus $275.8 million. Investing outflow included $490.6 million for acquisitions and operating/development expenditures, partly offset by $368.4 million of disposition proceeds.
- Cash and cash equivalents were $200.4 million at September 30, 2014, versus $35.4 million at year-end 2013; restricted cash was $17.5 million. The $600 million revolving facility was undrawn, and a separate $150 million term loan was outstanding.
- Debt principal totaled approximately $2.424 billion. Of total debt, 93.8% was fixed-rate and 6.2% variable-rate; weighted average stated interest rate was 4.7%. Debt was 31.5% of total market capitalization. The company reported covenant compliance.
- Common dividends declared were $0.35 per share for Q3, unchanged year over year. The company stated operating cash flow and available revolving capacity were expected to support distributions for the next 12 months, while noting there is no assurance capital sources remain available.
Material changes, outlook and risks
- In July, the Operating Partnership issued $400 million of 4.25% senior notes due 2029. The revolving credit facility was increased to $600 million and extended to July 2019; facility and term-loan pricing was reduced. The company repaid $83 million of notes at maturity in August and settled $37 million of 4.25% exchangeable notes early.
- The remaining $135.5 million of 4.25% exchangeable notes was due in November 2014. Management said cash on hand and the undrawn revolver positioned it to refinance or repay near-term maturities.
- During the nine months, the company acquired a Seattle office property for $106.1 million and San Francisco development land for $95.0 million. It sold properties and land for gross proceeds of approximately $372.4 million. Two additional properties were held for sale, with expected fourth-quarter gross proceeds of approximately $60.2 million.
- Five development projects were under construction at quarter-end, with total estimated investment of approximately $1.2 billion; $641.4 million had been incurred and $453.0 million remained committed. Management expects continued acquisition and development activity, subject to market conditions. A fully leased operating-property acquisition of approximately $100 million was under contract, expected to close in November. No specific earnings or revenue guidance was provided.
- Management said rents had generally stabilized or improved in many submarkets and estimated portfolio cash rents were 5–10% below current average market rents. Reported cash rent changes were affected by one renewal at below prior rates; excluding that lease, cash rents increased 6.5% for Q3 and 5.4% for the nine months.
- Key risks include lease expirations and tenant retention, property-market and regional economic weakness, development cost and timing, refinancing and capital-market access, and interest-rate exposure. A 100-basis-point LIBOR increase was estimated to raise annual interest expense by approximately $1.5 million before capitalization.
- Development and redevelopment commitments were approximately $453 million; other signed lease and contract commitments were approximately $61.7 million, excluding ground leases. The filing reported routine litigation, no known material environmental liability, and no material change to previously disclosed risk factors.
- A tenant’s early lease termination generated a $5.7 million fee, recognized over the termination period; $2.0 million was recorded in Q3 and cash was received in the quarter. Disclosure controls were reported effective, with no significant internal-control changes identified.
Important facts for investors to verify
- Whether the November 2014 exchangeable-note maturity was repaid, refinanced or exchanged, and the resulting dilution and funding costs.
- Actual completion and proceeds from the two held-for-sale properties, and closing of the announced acquisition under contract.
- Development spending, leasing and delivery progress, especially the $453 million committed balance and the project cost estimates.
- Occupancy, renewal spreads, tenant concentration and upcoming expirations; 11.0% of stabilized occupied space was scheduled to expire in 2015.
- Reconciliation of GAAP earnings to recurring operating performance, including the effect of property-sale gains and lease termination fees.
- Future liquidity, debt maturities, covenant headroom and distribution capacity as acquisitions and development continue.