Kilroy Realty Corporation (KRC) — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; comparisons are with Q1 2017 unless stated otherwise. Kilroy is a West Coast office and mixed-use REIT. Its stabilized portfolio included 104 office properties with 13.9 million rentable square feet, 94.3% occupied and 96.7% leased, plus a 200-unit residential property. Five development projects were under construction.
Financial performance and position
| Metric | Q1 2018 | Prior period / context |
|---|---|---|
| Total revenue | $182.8 million | $179.3 million; up 2.0% |
| Net income | $41.0 million | $37.3 million; up 9.9% |
| Net income attributable to KRC | $36.2 million | $33.5 million |
| Common earnings per share | $0.36 basic and diluted | $0.27 basic and $0.26 diluted |
| Funds from Operations (FFO) | $96.3 million | $81.9 million; up 17.5% |
| Net operating income (NOI) | $132.7 million | $127.2 million; up 4.4% |
| Cash from operating activities | $94.1 million | $96.4 million; down 2.4% |
| Cash and cash equivalents | $53.1 million | $57.6 million at December 31, 2017; restricted cash was nil at quarter-end |
| Total debt, gross principal | $2.564 billion | $2.545 billion net carrying amount; 26.4% of total market capitalization |
NOI was approximately 72.6% of revenue, compared with approximately 70.9% in Q1 2017 (calculated from reported figures). The company declared a quarterly common dividend of $0.425 per share, up from $0.375; the related $43.5 million of dividends, distributions and equivalents was paid on April 18, 2018.
Investing activities used $247.7 million, primarily for development and operating-property expenditures and a $111.0 million acquisition. Financing activities provided $139.8 million, including $90.0 million of net revolving-credit borrowings and $120.0 million of term-loan cash proceeds. These proceeds funded investment and other corporate needs; cash and cash equivalents plus restricted cash declined $13.7 million during the quarter.
Material changes versus Q1 2017 and year-end 2017
- Revenue increased 2.0%; rental income rose $6.2 million, while other property income declined $2.6 million, partly reflecting a prior-year tenant termination payment.
- NOI rose 4.4%. Same-store NOI increased 5.4%, reflecting higher rents and occupancy and lower bad-debt provisions, partly offset by lower other property income and higher operating costs.
- Net income available to common stockholders increased 37.7%, helped by the absence of preferred dividends and redemption costs recorded in Q1 2017. FFO increased 17.5%.
- Reported interest expense fell 22.2% to $13.5 million, primarily because more interest was capitalized to development projects. Gross interest expense declined only 1.6%; the weighted-average interest rate including loan-fee amortization was 4.3%, versus 4.4%.
- The company acquired three South San Francisco buildings for $111.0 million. It drew the full $150.0 million term-loan capacity and had $50.0 million outstanding on its revolver, leaving $700.0 million of revolver capacity.
- Office occupancy was 94.3% at March 31, 2018, compared with 95.2% at December 31, 2017; average occupancy for the quarter was 94.8%, versus 94.3% a year earlier.
Outlook, risks and unusual items
- Capital and development plans: Management anticipated $250 million to $750 million of potential 2018 capital recycling proceeds, subject to market conditions and successful transactions. The five projects under construction had an estimated total investment of about $1.7 billion; approximately $940 million had been incurred and a further $628 million committed. The company expected it might spend another $100 million to $300 million on pipeline projects commenced during the rest of 2018.
- Projects and leasing: The Exchange on 16th was fully leased to Dropbox, with construction expected to complete in the first half of 2018. 100 Hooper’s office space was fully pre-leased to Adobe; its PDR space was 39% leased. Management estimated portfolio cash rents were 10%–15% below current market on average, but noted submarket differences. Leases covering 6.5% of occupied space were due to expire in the remainder of 2018 and 11.8% in 2019.
- Liquidity and leverage: Management said projected needs for the next 12 months were expected to be met through operating cash flow, available credit, capital recycling and possible capital-market issuance, but gave no assurance of availability. Debt covenants were met at quarter-end. About 7.8% of debt was variable-rate; a 100-basis-point LIBOR increase was estimated to add approximately $2.0 million to annual interest expense, before capitalization.
- Commitments and contingencies: Contract and executed-lease commitments were approximately $748.4 million, excluding ground leases. Environmental remediation liabilities of $28.2 million were accrued for development projects; possible additional costs could not yet be reasonably estimated. Undiscounted future minimum ground-lease payments were $250.2 million.
- Accounting change: Management expected the lease standard effective in 2019 to materially affect the financial statements, including expense recognition for certain leasing costs and balance-sheet recognition of ground-lease assets and liabilities. It had not quantified the full impact.
- Other disclosures: No material change to previously reported risk factors and no material adverse legal proceedings were reported. The filing provides no formal earnings or FFO guidance.
Important facts for investors to verify
- Track occupancy, leasing spreads, tenant retention and expirations—especially the 2018–2019 lease roll and regional occupancy changes.
- Verify development budgets, completion schedules, pre-leasing, remaining commitments and the timing of rent commencement for major projects.
- Assess whether projected dispositions and other funding sources materialize to support development spending, acquisitions, debt service and distributions.
- Monitor debt balances, variable-rate exposure, refinancing terms, covenant headroom and the effect of higher rates.
- Confirm the eventual financial-statement impact of the new lease standard and any additional environmental remediation costs.
- Interpret GAAP earnings alongside FFO and cash flow: FFO excludes real-estate depreciation and does not reflect capital expenditures or leasing costs.