Kilroy Realty Corporation — Q2 2017 Form 10-Q
Reporting period: Three and six months ended June 30, 2017. The filing combines Kilroy Realty Corporation, a REIT, and its operating partnership; operating results are substantially the same. The company owns and develops primarily Class A office and mixed-use properties in coastal California and Greater Seattle.
Business and portfolio
At June 30, the stabilized portfolio included 111 office properties with 14.4 million rentable square feet and one residential property with 200 units. Office occupancy was 93.9% (96.0% leased); average occupancy for the quarter was 94.2%, versus 95.0% a year earlier. Four development projects totaling an estimated 1.8 million square feet were under construction. Columbia Square Phase 2, about 365,000 square feet, entered the stabilized portfolio and was 82% occupied and 100% leased.
Financial highlights
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Total revenue | $180.6 million | $160.1 million | $359.9 million | $305.6 million |
| Net income | $35.3 million | $33.9 million | $72.6 million | $212.0 million |
| Net income available to common stockholders | $29.8 million | $29.5 million | $56.2 million | $200.5 million |
| Diluted EPS | $0.30 | $0.31 | $0.56 | $2.15 |
| Net operating income (NOI) | $128.8 million | $116.3 million | $256.0 million | $223.9 million |
| Funds from operations (FFO) | $88.8 million | $82.7 million | $170.7 million | $160.9 million |
| Operating cash flow | — | — | $178.4 million | $137.6 million |
Q2 revenue increased 12.8% and NOI increased 10.7%; six-month revenue and NOI rose 17.8% and 14.3%, respectively. NOI was approximately 71.3% of revenue in Q2, compared with 72.6% a year earlier. FFO rose 7.3% in Q2 and 6.1% for the first half. Common dividends declared were $0.425 per share for Q2, versus $0.375 a year earlier.
The sharp decline in first-half GAAP net income and EPS chiefly reflects the prior-year period’s $146.0 million gain on property sales; 2017 recorded only $2.3 million of such gains. Other factors include higher depreciation, interest expense and a $3.8 million noncash charge for original issuance costs on redeemed Series G preferred stock.
Cash, debt and liquidity
- At June 30, cash and cash equivalents were $387.6 million; restricted cash was $8.2 million and marketable securities were $16.0 million.
- Debt principal totaled approximately $2.580 billion: $465.6 million secured and the remainder unsecured. Net carrying value was $2.565 billion. No borrowings were outstanding on the $600 million revolving facility at quarter-end. Debt was 25.2% of total market capitalization; management reported compliance with debt covenants.
- First-half operating cash flow was $178.4 million, investing cash outflow was $216.0 million, and financing cash inflow was $183.3 million. Investing outflow increased substantially from 2016, mainly because property disposition proceeds were much lower.
- In January, the company raised approximately $308.8 million net from a common-stock offering. In February, the operating partnership issued $250 million of senior notes at 3.35% and 3.45%, due in 2027 and 2029. The Series G preferred stock was redeemed for $100 million in March.
- After quarter-end, the July 24 credit agreement increased revolving capacity to $750 million, retained a $150 million term-loan facility, extended maturity to July 2022, and reduced borrowing costs. The term loan and a separate $39 million term loan were repaid with available cash; the facility was undrawn at closing. The agreement permits up to $600 million of additional capacity subject to conditions.
Changes, outlook and risks
- Same-store NOI increased 1.4% for the first half, while development and acquisition properties added $17.9 million and $10.8 million of NOI, respectively. Higher property costs, taxes and bad-debt provision offset part of same-store revenue growth.
- Leasing data showed positive rent changes: for leases commenced in the first half, GAAP rents rose 26.5% and cash rents 12.9%; retention was 55.3%. Management estimated portfolio cash rents were about 16% below market, but noted meaningful differences by region and property.
- Management anticipated $100 million to $300 million of 2017 capital recycling, with a $200 million midpoint, including the January sale. It expected to spend an additional $25 million to $150 million on potential development starts in the remainder of 2017, depending on conditions. No earnings or FFO guidance was provided in the supplied filing text.
- Four projects under construction had estimated total investment of about $1.4 billion; approximately $617 million had been incurred and $588 million committed. The company also reported approximately $736.8 million of commitments for contracts and executed leases, excluding ground leases.
- The company announced plans to redeem all $100 million of Series H preferred stock on August 15, 2017; the redemption was expected to result in a $3.7 million noncash charge to common-stockholder income in Q3. The July 12 common dividend payment totaled $43.3 million including distributions and equivalents.
- Key risks include office occupancy and tenant retention, lease expirations, regional economic and real-estate conditions, interest rates and refinancing access, development costs and schedules, and environmental remediation. Environmental liabilities of $21.3 million were accrued; possible additional costs on certain projects were not estimable. Management reported no material litigation or material change to previously disclosed risk factors.
Most important facts for investors to verify
- Whether occupancy and leasing trends stabilize, particularly against 2017–2018 expirations representing 13.2% of annualized base rent.
- Whether development projects stay on schedule and within budget, and whether expected leasing supports planned pipeline starts.
- Execution and funding of the stated capital-recycling plan and development commitments, including the $25–$150 million potential 2017 starts.
- Post-quarter credit-facility terms, repayments, borrowing capacity and compliance with covenants; distinguish June 30 balances from the July refinancing.
- Cash available after preferred-stock redemption and dividends, and the effect of the redemption charge on Q3 common earnings.
- Tenant concentration and credit quality: the 15 largest tenants represented 37.7% of annualized base rent; LinkedIn was the largest at 5.0%.