Kilroy Realty Corporation — Q2 2016 Form 10-Q
Business context and reporting period
Unaudited results cover the three and six months ended June 30, 2016. Kilroy is a West Coast office-focused REIT, operating primarily through Kilroy Realty, L.P. At quarter-end, its stabilized office portfolio comprised 102 buildings and 13.66 million rentable square feet, 95.5% occupied. The filing combines the Company and Operating Partnership; their operating results are substantially the same.
Financial and operating results
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Total revenue | $160.1 million | $146.2 million | $305.6 million | $292.3 million |
| Net income | $33.9 million | $58.6 million | $212.0 million | $102.6 million |
| Net income available to common stockholders | $29.5 million; $0.32 diluted EPS | $54.2 million; $0.61 diluted EPS | $200.5 million; $2.15 diluted EPS | $94.1 million; $1.06 diluted EPS |
| Funds from Operations (FFO) | $82.7 million | $74.8 million | $160.9 million | $166.4 million |
| Net Operating Income (NOI) | $116.3 million | $106.1 million | $223.9 million | $213.7 million |
| Cash provided by operating activities | Not provided for quarter alone | Not provided for quarter alone | $137.6 million | $116.8 million |
Revenue rose 9.5% in Q2 and 4.5% for the first half. Total NOI increased 9.6% and 4.8%, respectively; same-store NOI grew 3.2% in Q2 and 2.1% in the first half. Stabilized development properties contributed $16.1 million of Q2 NOI and $23.8 million for the first half. The approximate NOI-to-revenue ratios, calculated from reported figures, were 72.6% for Q2 and 73.3% for the first half.
GAAP earnings comparisons were heavily affected by property-sale gains: Q2 2015 included $31.4 million of gains on depreciable property sales, versus none in Q2 2016. First-half 2016 included $146.0 million of such gains, compared with $31.4 million in first-half 2015. FFO, which excludes those gains, increased in Q2 but declined 3.3% year to date.
At June 30, total assets were $6.30 billion and total liabilities $2.87 billion. Cash and cash equivalents were $26.3 million; restricted cash was $266.2 million, primarily disposition proceeds held for potential tax-deferred exchanges. Gross debt principal was $2.45 billion, with $2.44 billion net carrying value. Debt was 83.3% fixed-rate and 16.7% variable-rate; weighted-average GAAP effective interest rate including financing costs was 4.4%. Total debt equaled 27.4% of market capitalization. Operating cash flow exceeded cash dividends and distributions paid during the first half.
Material changes versus comparable periods
- Q2 net income and diluted EPS fell year over year mainly because the prior-year quarter had a $31.4 million property-sale gain. First-half net income and EPS rose substantially, chiefly due to $146.0 million of 2016 property-sale gains.
- Same-store occupancy averaged 95.1% in Q2 versus 96.3% a year earlier; portfolio occupancy at June 30 was 95.5%, up from 94.8% at December 31, 2015.
- Cash from operations increased 17.8% year over year for the first half, attributed to expiration of free-rent periods and stabilization of completed developments, partly offset by property dispositions.
- Investing cash use increased to $304.5 million from $85.0 million, including increased restricted cash from dispositions, acquisitions, and development spending. Financing provided $136.7 million, versus $27.4 million used in the prior-year period, largely reflecting revolving-credit borrowings.
- Debt at quarter-end included $220 million drawn on the revolving facility, compared with none at December 31, 2015. On July 20, $258.1 million of released restricted cash was used to repay the revolver; no revolver borrowings remained as of the report date.
Outlook, risks, contingencies, and unusual items
- No formal earnings or FFO guidance is provided. Management describes plans to pursue development prudently, favor pre-leased projects, and selectively assess acquisitions while maintaining a strong balance sheet.
- Management anticipated approximately $800 million of 2016 capital recycling, including $330.7 million completed by the filing date. The company reported $281.7 million of gross sales proceeds from first-half dispositions and $49.0 million from a sale completed July 21.
- Management estimated $160–$200 million of taxable gains in 2016 that might not be deferred through Section 1031 exchanges. If necessary to meet REIT distribution requirements and limit taxes, the company may make a special distribution; its amount and timing are not assured.
- Development exposure includes one project under construction with estimated total investment of about $485 million and two office projects in lease-up, plus a recently completed residential project. The company estimated potential additional spending of $0–$100 million on current or pipeline projects that might commence in 2016, subject to market conditions.
- Contractual commitments included $329 million for development, $65.3 million of lease and other commitments, and $394.3 million of operating-property and development contracts/executed leases (the measures have different stated scopes). The company also recorded $26.0 million of environmental remediation liabilities; further costs on certain development sites were possible but not reasonably estimable.
- Debt maturities include $451.7 million in 2018 and $485.3 million in 2019, before debt accounting adjustments. A 100-basis-point increase in LIBOR was estimated to raise annual interest expense by about $4.1 million at the June 30 variable-debt balance. The company reported compliance with debt covenants.
- Leasing risks include 0.6 million square feet of available stabilized space, 2.1% of occupied area expiring in the remainder of 2016 and 9.3% in 2017. Top 15 tenants accounted for 38.9% of annualized base rent; LinkedIn alone accounted for 5.4%.
- Management cited potential impacts from weaker demand, lower rents or property values, tenant defaults, credit-market volatility, development costs, and inability to refinance or meet covenants. No material change to previously disclosed risk factors was reported. No material litigation was identified; disclosure controls were deemed effective.
Investor verification priorities
- Separate recurring property performance from sale gains; reconcile GAAP earnings with FFO and review same-store NOI and occupancy trends.
- Confirm execution and use of disposition proceeds, including the July revolver repayment and the completed $49.0 million sale; assess progress toward the anticipated capital-recycling target and any resulting tax or distribution needs.
- Review development budgets, leasing and stabilization progress, remaining commitments, and potential environmental remediation costs.
- Monitor upcoming debt maturities, variable-rate exposure, covenant headroom, and refinancing options.
- Track renewals and tenant concentration, particularly expirations in 2016–2017 and exposure to major tenants.