Kilroy Realty Corporation — Q3 2013 Form 10-Q
Reporting period: Three and nine months ended September 30, 2013. Kilroy is a West Coast office REIT operating primarily through Kilroy Realty, L.P.; it owned 97.8% of the partnership at quarter-end.
Business and portfolio
The stabilized portfolio comprised 103 office properties totaling 12.5 million rentable square feet, with 92.2% occupancy at September 30. The company also had 14 properties held for sale, five development projects under construction, and two properties in lease-up.
Financial performance
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Total revenue | $115.7 million | $99.0 million | $344.5 million | $276.4 million |
| Net income | $9.0 million | $2.5 million | $21.5 million | $83.5 million |
| Income (loss) from continuing operations | $2.7 million | $(2.2) million | $10.3 million | $(4.9) million |
| Net income (loss) available to common stockholders | $5.6 million | $(2.8) million | $11.3 million | $64.0 million |
| Net income (loss) per common share | $0.07 | $(0.04) | $0.13 | $0.92 |
| Net operating income (NOI), as defined by the company | $79.2 million | $68.4 million | $240.2 million | $195.0 million |
| Funds from operations (FFO), as defined by the company | $55.9 million | $43.1 million | $160.1 million | $115.6 million |
Q3 revenue increased 16.9% and NOI increased 15.9% year over year. Nine-month revenue increased 24.6% and NOI increased 23.2%. Growth reflected acquisitions, redevelopment and leasing activity; nine-month NOI also benefited from a $5.2 million property-damage settlement. Nine-month net income fell substantially from 2012, which included a $72.8 million gain on property dispositions; 2013 included a $0.4 million disposition gain.
Cash flow, debt and liquidity
- Nine-month operating cash flow was $186.3 million, compared with $147.3 million in 2012. Investing activities used $281.7 million; financing activities provided $275.8 million.
- Cash and cash equivalents were $197.2 million at September 30, versus $16.7 million at year-end 2012. Restricted cash was $17.9 million.
- Gross debt principal was approximately $2.154 billion. The revolving facility had no borrowings and $500 million of remaining capacity. Management reported compliance with debt covenants.
- Debt was 93% fixed-rate and 7% variable-rate; weighted-average GAAP effective interest rate was 4.8%. A 100-basis-point LIBOR increase was estimated to raise annual interest expense by about $1.5 million before capitalization.
- Stated debt maturities and scheduled amortization included $265.3 million in 2014 and $395.1 million in 2015. The $172.5 million principal balance of 4.25% exchangeable notes is due November 2014; the notes became exchangeable for the quarter ending December 31, 2013 after the stock-price trigger was met.
- Common dividends declared were $0.35 per share for Q3 and $1.05 per share for the first nine months. The company completed a September common-stock offering with net proceeds of about $295.9 million and raised another $54.4 million net through its ATM program during the first nine months.
Changes, outlook and risks
- Four operating office buildings were acquired in two transactions for approximately $296.4 million during the first nine months. In September, the company also completed a common-stock offering to support general corporate purposes, including potential acquisitions and development.
- Management said rental rates had generally stabilized or improved in many submarkets, while portfolio average occupancy was 92.2% at quarter-end versus 92.8% at December 31, 2012. Same-store average occupancy for Q3 was 91.7%, down from 93.2% a year earlier.
- Leasing of commenced leases showed a 24.8% increase in GAAP rents and 5.2% increase in cash rents for new and renewal space in Q3, based on the company’s stated methodology. Leases representing 10.1% of stabilized occupied area were scheduled to expire in 2014.
- No quantitative earnings or FFO guidance was provided. Management anticipated fourth-quarter closings for the remaining San Diego properties held for sale, subject to customary conditions. It expected to focus on land acquisitions and development opportunities through late 2013 and early 2014.
- Five projects under construction had estimated total investment of $861.7 million, of which $484.9 million had been incurred. The company estimated possible additional investment of $200 million to $225 million during the remainder of 2013 and 2014 if further projects proceed; actual timing and costs may vary.
- Key risks include leasing and occupancy weakness, tenant defaults, property-market and credit-market conditions, refinancing and interest-rate exposure, substantial development commitments, REIT distribution requirements, and joint-venture dependence. Management identified no legal proceeding expected to have a material adverse effect and reported no off-balance-sheet arrangements.
- Subsequent events included the October sale of an Anaheim property for $9.6 million and purchase of a 2-acre Redwood City parcel for $17.0 million, completing land assembly for the planned Crossing 900 project.
Important facts for investors to verify
- Whether the San Diego property sales closed on the expected timetable and at anticipated proceeds.
- Leasing, occupancy and rent trends, especially 2014 expirations and the lower same-store occupancy comparison.
- Development budgets, pre-leasing, construction schedules and funding needs across the project pipeline.
- Refinancing plans for the 2014 exchangeable notes and other near-term debt maturities, and ongoing covenant headroom.
- How much reported earnings and NOI reflect recurring property operations versus settlements, dispositions and acquisition-related growth.