Kilroy Realty Corporation (KRC) — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019. Unaudited results are consolidated with Kilroy Realty, L.P.; the company is a REIT focused on West Coast office and mixed-use real estate.
Financial and operating highlights
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Total revenue | $200.5 million | $187.1 million | $401.7 million | $369.9 million |
| Net income available to common stockholders | $42.2 million | $27.5 million | $79.1 million | $63.8 million |
| Diluted EPS | $0.41 | $0.27 | $0.77 | $0.63 |
| Net operating income (NOI) | $141.9 million | $129.5 million | $284.4 million | $262.2 million |
| Funds from operations (FFO) | $99.9 million | $88.6 million | $199.7 million | $184.9 million |
| Cash provided by operations | Not reported by quarter | Not reported by quarter | $165.7 million | $188.8 million |
- Q2 revenue rose 7.2%; common-stockholder net income rose 53.2%, and NOI rose 9.6%. Six-month revenue increased 8.6% and NOI increased 8.5%.
- NOI benefited from same-store rent growth and contributions from development and acquired properties. Q2 NOI also included a $7.2 million property-sale gain in net income, excluded from FFO.
- At June 30, total assets were $8.09 billion and total liabilities $3.91 billion. Debt at principal value was $3.21 billion; cash and restricted cash totaled $58.7 million. The revolver had $375 million drawn and $375 million available; a $150 million term loan was also outstanding.
- Debt was 29.7% of total market capitalization. Management reported compliance with debt covenants; the next stated debt maturities were in July 2022.
- The quarterly dividend increased 6.6% to $0.485 per share. The company reported 93.8% leased and 93.5% average occupied stabilized office space; average residential occupancy was 76.5% in Q2.
Material changes and unusual items
- Operating cash flow fell 12.3% year over year for the first half, which management attributed primarily to free-rent and beneficial-occupancy periods for tenants. Development and undeveloped-land spending increased to $372.8 million from $204.0 million.
- NOI growth included development properties ($7.6 million of Q2 increase) and acquisition properties ($4.2 million); disposition properties reduced Q2 NOI by $5.1 million. Prior-period bad-debt provisions also affected comparisons: the company recorded a $5.6 million provision in Q2 2018, while first-half 2019 included a net reversal of allowance, primarily reflecting improved tenant credit quality.
- Adoption of lease accounting standard Topic 842 in January 2019 brought $82.9 million of ground-lease right-of-use assets and $87.4 million of lease liabilities onto the balance sheet. Tenant reimbursements and related expenses are presented gross in certain cases, without a net-income effect. The company also began expensing indirect leasing costs, recording $4.4 million in the first half.
- In July, after quarter-end, the company settled forward equity agreements by issuing 5.0 million shares and receiving $354.3 million net, which was used to pay down the revolver. Revolver borrowings were $60 million as of the filing date.
Outlook, commitments and risks
- No quantified full-year earnings or FFO guidance is provided. Management said projected next-12-month liquidity needs are expected to be met through operating cash flow, credit facilities, asset dispositions, and possible debt or equity issuance, while noting there is no assurance financing will remain available.
- Five projects under construction had estimated total investment of approximately $2.2 billion; about $1.1 billion had been incurred and a further $903 million was committed. Two tenant-improvement projects had estimated investment of $685 million. Management expected up to $50 million of spending on future pipeline projects commencing in the remainder of 2019.
- The company anticipated it could raise approximately $150 million from dispositions during the rest of 2019, subject to market conditions and transaction completion. Its four-site future pipeline could support more than 4.0 million square feet, with estimated investment of $3.5 billion to $5.0 billion depending on entitlements and market conditions.
- Commitments of approximately $1.2 billion related to operating properties and development projects, excluding ground leases. Accrued environmental remediation liabilities were $71.6 million; additional costs may arise but could not be reasonably estimated. Routine litigation was not expected to have a material adverse effect.
- Key disclosed risks include tenant defaults or non-renewals, regional office-market weakness, interest rates and financing access, development delays or cost increases, environmental obligations, leasehold risks, and maintaining REIT status. Management reported no material change to previously disclosed risk factors.
Important facts for investors to verify
- Whether leasing, occupancy, tenant collections, and rental-rate gains support continued same-store NOI growth; note that the stabilized portfolio’s average cash rents were estimated to be about 20% below market.
- Progress, leasing, delivery timing, remaining commitments, and cost performance for major development projects, including Oyster Point, 333 Dexter, Netflix and Living // On Vine, and One Paseo.
- Actual disposition proceeds and use of capital, the remaining forward-equity settlements, and revolver balances after the July 2019 paydown.
- Cash-flow conversion and dividend coverage, given lower first-half operating cash flow and substantial development spending.
- Potential changes in environmental-remediation estimates and the effect of lease-accounting presentation changes when comparing periods.