Kilroy Realty Corporation and Kilroy Realty, L.P. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; unaudited. Kilroy Realty Corporation is a REIT whose operating business is conducted primarily through Kilroy Realty, L.P. (the Operating Partnership). The Company held an approximately 97.9% interest in the Operating Partnership at quarter-end.
Business context and portfolio
Kilroy owns, develops, acquires and manages primarily Class A office properties in coastal California and Greater Seattle. Its stabilized portfolio comprised 111 office properties totaling 14.4 million rentable square feet, plus 200 residential units. Office occupancy was 94.1% at quarter-end, down from 96.0% at December 31, 2016; the portfolio was 95.7% leased. Three projects totaling approximately 1.15 million estimated office square feet were under construction.
Financial performance and liquidity
| Metric | Q1 2017 | Q1 2016 |
|---|---|---|
| Total revenue | $179.3 million | $145.4 million |
| Net income | $37.3 million | $178.1 million |
| Net income available to common stockholders | $26.3 million; $0.27 basic EPS, $0.26 diluted | $171.0 million; $1.85 basic EPS, $1.84 diluted |
| Net operating income (NOI; supplemental non-GAAP measure) | $127.2 million | $107.6 million |
| Funds from Operations (FFO; supplemental non-GAAP measure) | $81.9 million | $78.2 million |
| Cash provided by operating activities | $96.4 million | $78.2 million |
| Cash and cash equivalents at quarter-end | $478.4 million | — |
Revenue grew 23.3% and NOI grew 18.2%. NOI was approximately 70.9% of revenue, versus 74.0% in the prior-year quarter. Same-store NOI increased 2.8%; additional contributions came from stabilized developments and properties acquired in 2016. FFO increased approximately 4.8%.
The sharp decline in GAAP net income primarily reflects the prior-year quarter’s $146.0 million gain on property sales, compared with $2.3 million in Q1 2017. Q1 2017 common earnings also included a $3.8 million noncash charge for original issuance costs on redeemed Series G preferred stock.
Investing activities used $86.4 million, versus $134.2 million provided in Q1 2016, largely reflecting lower disposition proceeds. Financing activities provided $225.5 million, including the January common-stock offering and issuance of new notes; cash distributions and the Series G redemption partly offset these proceeds. Cash plus restricted cash was $485.6 million at quarter-end.
Gross debt principal was $2.581 billion ($2.566 billion net of unamortized discounts and financing costs): $467.1 million secured and the balance unsecured. Debt to total market capitalization was 26.0%, or 27.0% including preferred equity. The $600 million revolving facility was undrawn. The Operating Partnership issued $250 million of notes in February: $175 million at 3.35% due 2027 and $75 million at 3.45% due 2029. Management reported covenant compliance and substantial headroom against disclosed covenant limits.
Material changes versus the prior comparable period
- Revenue increased $33.9 million, driven by same-store growth, completed development projects and 2016 acquisitions. Total portfolio NOI increased $19.5 million; same-store NOI increased $2.9 million.
- Property expenses and real estate taxes increased, and the Company recorded a $1.3 million bad-debt provision, primarily related to two tenants. Depreciation and amortization rose 20.8% to $60.9 million.
- Reported interest expense rose 46.7% to $17.4 million. Gross interest expense increased 5.1%, while lower qualifying development balances reduced capitalized interest and financing costs.
- January’s public offering of 4.43 million common shares generated $308.8 million net proceeds. Kilroy used part of the proceeds toward the $184.3 million special dividend paid in January.
- The Company redeemed all $100 million of Series G preferred stock on March 30, 2017. Its regular common dividend declared for the quarter was $0.375 per share, up from $0.35 in Q1 2016.
Outlook, management commentary and risks
- No specific earnings or FFO guidance is provided in the filing. Management expects to fund projected needs over the next twelve months through operating cash flow, available borrowing capacity, capital recycling and potential debt or equity issuance; it cautions that funding availability is not assured.
- Management estimated 2017 capital recycling of approximately $100 million to $300 million, with a midpoint of $200 million, including the $12.1 million January property sale.
- Development spending is substantial: the three projects under construction had estimated total investment of approximately $1.1 billion, with about $481 million incurred and $433 million additionally committed at quarter-end. The Company anticipated potentially spending another $50 million to $200 million on pipeline projects it might start in 2017.
- Management described portfolio cash rents as approximately 16% below current average market rents, but cautioned that renewals and reletting at market rents are not assured. Approximately 5.9% of stabilized space was available; leases representing 5.7% of occupied space expire during the remainder of 2017 and 9.3% in 2018.
- The next stated debt maturity is a $122.9 million principal payment in February 2018, followed by $325 million of notes due in July 2018. Management cited staggered maturities and conservative leverage, but warned that weaker markets, tenant defaults, lower rents or asset values, and higher rates or constrained financing could pressure liquidity and covenant compliance.
- Potential additional environmental remediation costs are not reasonably estimable; $23.9 million of remediation liabilities were accrued. The Company also reported $560.5 million of commitments for operating-property and development contracts and executed leases, excluding ground leases.
- Management was evaluating the effects of new lease and revenue accounting standards. It expected the lease standard could materially affect results through certain leasing costs and could require balance-sheet recognition of ground lease obligations; undiscounted future minimum ground lease payments were $255.1 million.
- The Company anticipated that it might redeem all or part of its $100 million Series H preferred stock on or after August 15, 2017, depending on capital needs and market conditions. The filing reports no material changes to previously disclosed risk factors and no material litigation or off-balance-sheet arrangements.
Important facts for investors to verify
- Whether occupancy and leasing trends stabilize, particularly in Los Angeles and the San Francisco Bay Area, and how near-term lease expirations affect rents and tenant improvements.
- Progress, remaining costs, preleasing and delivery timing for the three active development projects and any new pipeline starts.
- Ability to refinance or repay the 2018 maturities, maintain covenant headroom and manage interest-rate exposure.
- Actual capital recycling proceeds versus the stated range, and the use of equity, debt and disposition proceeds to fund dividends and development.
- Tenant credit quality and collection trends, including the new bad-debt provision, as well as the scope and cost of environmental remediation.
- Whether the Company redeems Series H preferred stock and the resulting cash and noncash effects.