Kilroy Realty Corporation — Q3 2017 Form 10-Q
Reporting period: Three and nine months ended September 30, 2017. Kilroy is a West Coast office and mixed-use REIT; substantially all operations are conducted through Kilroy Realty, L.P. Figures below are in U.S. dollars and, unless stated otherwise, millions.
Financial and operating performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Total revenue | $181.5 | $168.3 | $541.4 | $473.9 |
| Net income | $75.5 | $56.4 | $148.1 | $268.4 |
| Net income available to common stockholders | $66.6 | $50.6 | $122.7 | $251.1 |
| Diluted earnings per share | $0.67 | $0.54 | $1.23 | $2.69 |
| Net cash from operating activities | Not provided quarterly | Not provided quarterly | $276.5 | $252.6 |
| Funds from operations (FFO) | $89.5 | $88.5 | $260.2 | $249.5 |
- Q3 revenue increased 7.8%; total portfolio net operating income (NOI) rose 5.4% to $129.5 million. Same-store NOI increased 2.4% in Q3 and 1.7% for the nine-month period.
- Nine-month revenue increased 14.2%, while GAAP net income declined 44.8%. The prior-year period included $164.3 million of gains on property sales versus $39.5 million in 2017; this largely explains the reported earnings decline.
- Nine-month interest expense rose 25.0% to $51.5 million, principally reflecting higher average debt balances and less interest capitalization. Depreciation and amortization increased 15.8% to $185.7 million.
- Cash and cash equivalents were $65.0 million at September 30; restricted cash was $179.3 million, including about $170.6 million of disposition proceeds held for potential Section 1031 exchanges. Cash, cash equivalents and restricted cash totaled $244.2 million.
- Net cash used in investing activities was $180.7 million, including $270.8 million for development and undeveloped land and $61.9 million for operating properties and other capital assets. Financing activities used $101.7 million.
Balance sheet, debt and liquidity
- Total assets were $6.84 billion and total equity was $3.90 billion. Debt principal was $2.45 billion, including $464.0 million secured debt, $1.925 billion unsecured notes and $60.0 million drawn on the revolving facility. Debt was 25.5% of total market capitalization, as calculated by the company.
- The amended revolving facility has $750 million capacity, with $690 million available at quarter-end; the separate $150 million term-loan facility was undrawn and subject to delayed-draw conditions. The facilities mature in July 2022.
- In February, the Operating Partnership issued $175 million of 3.35% notes due 2027 and $75 million of 3.45% notes due 2029. The company also raised $308.8 million net through a January common-stock offering and redeemed both preferred series for $200 million in aggregate.
- Scheduled debt maturities include $451.7 million in 2018, including $325 million of unsecured notes. The company also reported a $123.8 million mortgage maturity in February 2018 at a property partnership and intended to prepay it in Q4 2017. Management reported compliance with debt covenants.
- Quarterly common dividend declared was $0.425 per share; the nine-month declared amount was $1.225 per share. Cash dividends and distributions paid during the nine months included the payment of a $184.3 million special dividend declared in 2016.
Portfolio, changes and management commentary
- At September 30, the stabilized portfolio included 101 office buildings totaling 13.7 million rentable square feet and one 200-unit residential property. Office occupancy was 94.0%, versus 96.0% at December 31, 2016; office space was 96.2% leased. The residential property was 72.0% occupied.
- Management said portfolio cash rents averaged approximately 15% below current market rents, while noting material differences by market and property. Q3 leasing activity showed 51.5% GAAP rent increases for new leases and 31.5% for renewals among leases commenced, with different cash-rent results.
- The company sold 11 operating properties and one undeveloped parcel for gross proceeds of $186.6 million during the nine months. Property dispositions generated $39.5 million of gains. The company added one development project to the stabilized portfolio.
- Four projects were under construction, with estimated total investment of approximately $1.4 billion; $708.1 million had been incurred and $622 million was additionally committed. The office space at The Exchange on 16th was fully leased to Dropbox, with lease commencement phased from Q4 2018 through Q4 2019; the office portion of 100 Hooper was fully pre-leased to Adobe.
- Management described development and acquisitions as dependent on market conditions, and said it favors phased development and projects with pre-leasing. The filing gives no company-wide earnings or FFO guidance.
Risks, contingencies and unusual items
- Development execution, leasing and occupancy, tenant defaults, construction costs, entitlement delays, property values, financing availability and interest rates are identified risks. The filing states there were no material changes to the risk factors in the 2016 Form 10-K.
- Commitments for operating properties and development projects totaled approximately $755 million, excluding ground leases. Environmental remediation liabilities of $27.1 million were accrued for future development projects; additional costs were possible but not reasonably estimable.
- Future undiscounted minimum payments under ground leases totaled $252.8 million. The company expected adoption of the new lease standard to require recognition of ground-lease right-of-use assets and liabilities and said changes to leasing-cost accounting could materially affect results.
- Management reported no material adverse environmental liability for stabilized properties, no material litigation, and no off-balance-sheet arrangements. It noted that forward-looking plans and estimates are subject to uncertainty.
- Subsequent to quarter-end, the company acquired a 1.2-acre San Diego development site for $19.4 million on October 10, 2017.
Important facts for investors to verify
- Whether occupancy, same-store NOI and leasing trends improve, particularly as 11.6% of annualized base rent was scheduled to expire during the remainder of 2017 and 2018.
- Development spending, remaining commitments, construction timing and lease commencement for major projects, including the phased Dropbox lease.
- Plans and funding for 2018 debt maturities, use of revolving and delayed-draw capacity, and continued compliance with debt covenants.
- How much of the restricted disposition proceeds is ultimately reinvested through Section 1031 exchanges, and any resulting tax or dividend consequences.
- Potential additional environmental remediation costs and the eventual accounting and earnings effects of new lease standards.