Kilroy Realty Corporation (NYSE: KRC) — Q3 2019 Form 10-Q
Reporting period: Three and nine months ended September 30, 2019. Amounts below are in U.S. dollars; financial statement amounts are generally in millions unless noted. Kilroy is a West Coast office and mixed-use REIT operating primarily through Kilroy Realty, L.P.
Financial and operating performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Total revenue | $215.5 | $186.6 | $617.2 | $556.5 |
| Net income | $48.3 | $38.3 | $137.3 | $111.0 |
| Net income available to common stockholders | $43.8 | $34.4 | $122.9 | $98.2 |
| Basic EPS | $0.41 | $0.34 | $1.19 | $0.97 |
| Net operating income (NOI), as defined by the company | $152.2 | $131.0 | $436.5 | $393.2 |
| Funds from operations (FFO) | $109.2 | $94.2 | $309.0 | $279.2 |
Q3 NOI rose 16.1%; nine-month NOI rose 11.0%. Same-store NOI increased 8.3% in Q3 and 5.5% for the nine months. FFO is a non-GAAP supplemental measure and is not a substitute for GAAP results or a measure of cash available for distribution.
Cash flow: Nine-month cash from operations was $301.4, down 5.0% from $317.2, which management attributed primarily to free-rent and beneficial-occupancy periods for tenants. Investing used $727.2, including $555.0 of development and undeveloped-land expenditures. Financing provided $558.7. Cash and restricted cash ended the period at $303.9, including $297.6 of cash and cash equivalents.
Balance sheet, debt and liquidity
- Total assets were $8.624 billion and total liabilities were $4.084 billion at September 30, 2019.
- Debt at gross principal value was $3.335 billion: $259.0 million secured and approximately $3.075 billion unsecured. The revolver had no outstanding borrowings and $750 million of capacity; the $150 million term loan was fully drawn.
- Debt was 28.4% of total market capitalization. 95.5% of debt was fixed-rate; the weighted average stated rate was 3.9%. Management reported compliance with debt covenants.
- In September, the Operating Partnership issued $500 million of 3.05% senior notes due February 2030. The filing identifies July 2022 as the next debt maturity; the debt schedule also lists intervening scheduled amortization and payments.
- Nine-month cash dividends and distributions paid were $143.8 million. The declared quarterly rate was $0.485 per share/unit. Management said liquidity sources were expected to cover projected needs for the next 12 months, while noting this was not assured.
Material changes and business developments
- Revenue and earnings increased year over year, supported by development properties entering service, acquisitions, and higher rents on new and renewed leases. The 2019 revenue presentation changed under lease-accounting rules: tenant reimbursements and related items are included with rental income, and reimbursed property costs are presented gross. The gross-up does not affect NOI; prior periods were not restated.
- Stabilized office occupancy was 92.1% at quarter-end, versus 94.4% at December 31, 2018. The San Francisco Bay Area was 89.1% occupied, down from 96.4% at year-end. Stabilized office space totaled 13.3 million rentable square feet; 97.3% was leased.
- As of September 30, the company had six development projects under construction with estimated total investment of about $2.2 billion, plus two projects in the tenant-improvement phase. Development spending and leasing activity create substantial funding and execution demands.
- The company issued five million shares in July, receiving net proceeds of approximately $354 million. It also had forward equity agreements covering 1.20 million shares, not yet settled at the filing date, with settlement expected by March or April 2020.
- After quarter-end, Kilroy completed a $186 million acquisition of a fully leased 158,000-square-foot Culver City office campus on October 15. It paid $53.2 million of dividends, distributions and dividend equivalents on October 16.
Outlook, risks and unusual items
The filing gives no specific earnings or FFO guidance. Management described a disciplined development and acquisition strategy, with future development activity dependent on market conditions, leasing, construction costs, and entitlements. Its four-site future pipeline could support more than 5.0 million square feet, with estimated investment of $3.5–$5.0 billion, subject to those factors. Management expected a $115.5 million sale of a property held for sale to close in Q4 2019.
- Development commitments: approximately $1.2 billion for contracts and executed leases related to development projects and operating properties, excluding ground leases. Six projects under construction had about $885 million of additional committed investment at quarter-end.
- Environmental remediation: $75.1 million accrued for certain development sites; additional costs are possible but not reasonably estimable in the filing.
- Tenant concentration: the top 15 tenants represented 45.3% of annualized base rent. Leasing, renewal, tenant credit, and occupancy changes may affect future rental income.
- Other stated risks include adverse West Coast market or economic conditions, tenant defaults, financing availability and interest-rate exposure, development delays or cost overruns, environmental matters, and REIT qualification. The company reported no material change to previously disclosed risk factors and no legal proceeding it believed would have a material adverse effect.
- Topic 842 adoption brought $83 million of ground-lease right-of-use assets and $87 million of ground-lease liabilities onto the balance sheet. The company also began expensing indirect leasing costs; $8.4 million was expensed in the first nine months of 2019.
Important facts for investors to verify
- Whether occupancy and leasing trends—particularly in the San Francisco Bay Area—stabilize, and how the 2020 lease expirations are renewed or replaced.
- Progress, leasing, timing and final costs for major development projects, including the $2.2 billion under-construction program and the larger future pipeline.
- Debt terms, maturity schedule, covenant headroom, and availability and cost of financing as development and acquisition needs continue.
- Settlement proceeds and share dilution from the outstanding forward equity agreements, and the funding of the completed Culver City acquisition.
- Whether the expected property disposition closes on schedule and at the anticipated price, and whether environmental remediation costs exceed recorded accruals.
- Comparability of reported revenue and expense trends across periods given the prospective lease-accounting presentation changes.