Kilroy Realty Corporation — Q2 2012 Form 10-Q
Reporting period: Three and six months ended June 30, 2012. Unless noted otherwise, financial amounts below are in U.S. dollars; figures are consolidated with Kilroy Realty, L.P., the operating partnership.
Business context
Kilroy is a REIT focused on owning, developing, acquiring, and managing office and industrial properties, primarily in West Coast markets. At June 30, 2012, its stabilized portfolio comprised 153 buildings and 15.6 million rentable square feet, with 90.0% occupancy. The Company owned 97.6% of the Operating Partnership.
Financial and operating performance
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Total revenue | $103.9 million | $88.4 million | $203.3 million | $172.2 million |
| Net operating income (NOI) | $73.2 million | $62.4 million | $145.9 million | $120.4 million |
| Income from continuing operations | $2.3 million | $1.2 million | $7.2 million | $3.0 million |
| Net income | $2.3 million | $3.5 million | $80.9 million | $8.3 million |
| Net income (loss) available to common stockholders | $(0.8) million | $(0.3) million | $66.7 million | $0.7 million |
| Funds from operations (FFO), attributable to common holders | $39.5 million | $31.6 million | $72.5 million | $61.8 million |
- Q2 revenue increased 17.6% and NOI increased 17.4% year over year. Six-month revenue rose 18.1% and NOI rose 21.2%. Management attributed much of NOI growth to acquired office properties; same-store office NOI grew 0.5% in Q2 and 3.0% for the six-month period.
- Q2 common-stockholder loss was $0.02 per share. Six-month net income available to common stockholders was $1.00 per share, substantially reflecting a $72.8 million gain on property dispositions. Continuing-operations loss was $0.09 per share for the six-month period.
- Six-month operating cash flow was $78.6 million, versus $56.5 million in 2011. Investing activities used $301.6 million; financing activities provided $236.3 million. Cash at June 30 was $18.1 million.
- At June 30, total assets were $3.85 billion and total liabilities were $2.04 billion. Debt principal was approximately $1.79 billion. Total debt was 33.0% of market capitalization; debt plus preferred equity liquidation value was 36.3%.
- The $500 million credit facility had $102 million drawn and $398 million of remaining capacity. Debt was 85.9% fixed-rate and 14.1% variable-rate; weighted average GAAP effective interest rate was 5.0%, excluding debt issuance costs.
- NOI was approximately 70.5% of revenue in Q2 and 71.8% for the six-month period. These are calculated ratios, not company-presented GAAP margins.
- Common distributions were $0.35 per share per quarter, or $0.70 for the six months. The Company reported compliance with debt covenants; its credit facility and term-loan covenants included a maximum debt-to-asset-value ratio of 60%, versus reported performance of 34%.
Material changes and notable transactions
- During the first half, Kilroy acquired ten office buildings for approximately $307.1 million and a fully pre-leased Mountain View development site for $84.0 million. It sold two San Diego office buildings for approximately $146.1 million and recorded a $72.8 million disposition gain.
- In February, the Company issued 9.49 million common shares for approximately $382.1 million net proceeds. It also issued 4 million Series G preferred shares for approximately $96.2 million net proceeds, and redeemed Series E and F preferred stock for $126.5 million plus accrued dividends. The redemption resulted in a $4.9 million noncash charge for original issuance costs.
- The Operating Partnership repaid $148 million of 3.25% exchangeable notes at maturity using a new $150 million variable-rate term loan. It also repaid two mortgages totaling $101 million that were due in August 2012, assumed a $34 million mortgage with an acquisition, and obtained a $97 million mortgage at 4.48%.
- After quarter-end, the Company acquired a San Francisco development site for $18.5 million, a Bellevue office building for $186.1 million (assuming $83.5 million of mortgage debt), and a Los Angeles office building for $79.0 million plus accrued liabilities (assuming $53.8 million of mortgage debt).
- Office occupancy was 89.3% at quarter-end, compared with 88.1% a year earlier; industrial occupancy was 92.5%, versus 97.0%. Same-store office average occupancy improved year over year, while industrial occupancy weakened.
Outlook, risks, and contingencies
- The filing provides no formal numerical earnings or FFO guidance. Management said it expected liquidity needs for the next twelve months to be met through operating cash flow, credit-facility capacity, debt or equity financing, and asset dispositions. It believed distributions could be maintained at 2011 levels to meet 2012 REIT requirements, but distributions remain subject to board discretion and liquidity availability.
- Management planned to continue evaluating acquisitions, development and redevelopment, and asset sales. It described rental rates as generally stabilizing in many submarkets, but noted that leasing, occupancy, rental rates, and asset values remain exposed to regional economic and market conditions. Portfolio cash rents were estimated to be up to 5% above current average market rates.
- Development plans included a 341,000-square-foot Mountain View project, 100% pre-leased and expected to cost approximately $200 million at completion, with completion expected in Q1 2015. Four redevelopment projects were also under construction; timing and costs may change.
- Key risks include tenant defaults, weaker leasing demand or rents, property-value declines, refinancing and capital-market access, interest-rate increases, and potential covenant breaches. A 100-basis-point increase in LIBOR was estimated to raise annual interest expense by approximately $2.5 million, assuming variable-rate balances remained unchanged.
- The filing reported no material litigation, no off-balance-sheet arrangements, and no material changes to the risk factors in the 2011 Form 10-K. Management stated disclosure controls were effective at a reasonable-assurance level.
Most important facts for investors to verify
- How much of reported first-half earnings growth is attributable to the $72.8 million disposition gain, and how recurring operating results compare using FFO and same-store NOI.
- Whether occupancy and leasing trends improve, particularly the decline in industrial occupancy and weaker same-store industrial NOI in Q2.
- Progress, final costs, leasing commencement, and completion timing for development and redevelopment projects, including the pre-leased Mountain View project.
- Funding and refinancing plans for scheduled debt maturities, post-quarter acquisitions, and the substantial contractual commitments disclosed in the filing.
- Whether management’s expected distribution capacity remains supported by operating cash flow, available credit, and compliance with debt covenants.