Kilroy Realty Corporation and Kilroy Realty, L.P. — Q1 2012 Form 10-Q
Reporting period: Three months ended March 31, 2012. The filing combines the REIT parent and its operating partnership; substantially all operations and debt are held through the Operating Partnership. Kilroy owns about 97.5% of it.
Business context and portfolio
Kilroy owns, develops, acquires and manages primarily Class A office properties, plus industrial properties, in coastal West Coast markets. At quarter-end, its stabilized portfolio comprised 150 buildings and 15.2 million rentable square feet: 91.6% occupied overall, including 90.0% for offices and 97.0% for industrial properties. Four office redevelopment projects totaling about 918,000 square feet were under construction.
Financial performance and liquidity
- Revenue: $99.4 million, up 18.7% from $83.8 million. Rental income rose to $90.2 million from $77.0 million.
- Property operating performance: Net operating income (NOI), a non-GAAP measure, was $72.7 million, up 25.3%; NOI was approximately 73.1% of revenue versus 69.2% a year earlier. Acquisition contributions drove most of the increase, with core-portfolio NOI up $4.4 million.
- Profit: Income from continuing operations was $5.0 million versus $1.8 million. Net income was $78.7 million, compared with $4.9 million, largely reflecting a $72.8 million gain on property dispositions. Common-stockholder net income was $67.5 million, or $1.06 per diluted share, versus $1.0 million, or $0.01. Continuing operations attributable to common stockholders remained a loss of $0.07 per share, versus a loss of $0.04.
- FFO: Funds from Operations attributable to common stockholders and unitholders was $33.0 million, compared with $30.1 million. FFO excludes the disposition gain; it is supplemental and is not a substitute for GAAP earnings or cash flow.
- Cash flow: Operating cash flow was $48.7 million, up from $43.8 million. Investing used $97.1 million, including $162.4 million for acquisitions, partially offset by $100.8 million of disposition proceeds. Financing provided $417.9 million, primarily from equity issuance and debt transactions.
- Balance sheet and debt: Total assets were $4.0 billion and total equity was $1.73 billion. Debt carrying value was about $1.79 billion, including $350.2 million secured, $308.7 million exchangeable notes and $1.13 billion unsecured debt; the credit facility had no balance. Gross debt principal was $1.80 billion. About 90.9% of debt was fixed-rate; weighted-average stated debt rate was 5.0%. Management reported compliance with debt covenants.
- Liquidity: Cash and cash equivalents were $374.4 million, with another $43.1 million restricted, including $42.4 million held for a potential Section 1031 exchange. The $500 million credit facility was undrawn. After the April repayment of $148.0 million of exchangeable notes and $129.4 million redemption payment for preferred shares, the company reported $44.2 million available cash at April 27, excluding restricted cash, and no credit-facility borrowings.
- Dividends: Common dividend was $0.35 per share for the quarter, unchanged year over year. Management said it believed it could maintain distributions at 2011 levels to meet 2012 REIT requirements, while noting dividends remain at the board’s discretion.
Material changes versus the prior comparable period
- NOI increased 25.3%, primarily from acquisitions, including seven office buildings in Menlo Park purchased for approximately $162.5 million; the acquired properties were 80.1% occupied at quarter-end.
- Core-portfolio average occupancy improved to 92.0% from 91.3%. Overall quarter-end stabilized occupancy was lower than year-end 2011 (92.4%), with acquisition-related vacancy and industrial lease expirations among the factors.
- General and administrative expense rose 33.6% to $8.8 million, primarily with company growth; depreciation and amortization increased 29.2% to $36.7 million, mainly from acquisitions. Interest expense was nearly flat at $21.2 million because higher gross interest costs were substantially offset by increased capitalized interest.
- In February, Kilroy issued 9.49 million common shares and received approximately $382.1 million net proceeds. In March, it issued $96.2 million net proceeds from 6.875% Series G preferred stock and entered into a $150 million unsecured term loan at LIBOR plus 1.75%.
- Two office buildings were sold in January for $146.1 million, producing the $72.8 million gain. A $42.4 million portion of proceeds remained with a qualified intermediary for a potential tax-deferred exchange.
Outlook, commentary and risks
- No specific earnings or FFO guidance is provided. Management said rental rates had generally stabilized in many submarkets, with modestly lower vacancy and leasing concessions and some rental-rate improvement. It estimated portfolio cash rents were about 5%–10% above current average market rents, but gave no assurance that vacancies could be re-leased at existing or market rates.
- Management anticipated possible increased development and redevelopment activity in the second half of 2012 and beyond if economic conditions improved and yields became attractive. Four active redevelopment projects had estimated total costs at completion ranging from $19.8 million to $148.3 million; completion was generally expected in 2012. The South of Market project was approximately 37% leased at quarter-end.
- As of the report date, Kilroy was negotiating possible acquisitions of three office properties and a development opportunity for about $443.6 million, including assumed debt of about $171.5 million; completion was not assured. Two further potential acquisitions were anticipated to close in Q2, subject to customary conditions.
- Key exposures include leasing demand and rental rates, tenant defaults, property values, access to debt and equity financing, interest-rate changes, refinancing and covenant compliance. About 70.3% of leased portfolio square footage was scheduled to expire through 2017; 2012–2013 expirations represent notable leasing and renewal exposure. Management cautioned that economic or credit-market weakness could impair financing and covenant performance.
- After quarter-end, the company repaid the 3.25% exchangeable notes and redeemed all Series E and Series F preferred shares. It reported no material litigation, no material changes to previously disclosed risk factors, and no off-balance-sheet arrangements. Management concluded disclosure controls were effective.
Important facts for investors to verify
- Separate recurring operating performance from the $72.8 million disposition gain; assess continuing-operations results and FFO alongside GAAP net income.
- Confirm the effects of the April debt repayment and preferred-stock redemption on cash, interest expense and preferred distributions; verify subsequent acquisition funding and closing status.
- Track occupancy, leasing spreads, tenant retention and the 2012–2013 lease-expiration schedule, including the newly acquired Menlo Park buildings.
- Monitor redevelopment spending, leasing progress and completion timing, especially the South of Market project, and compare actual costs with estimates.
- Review debt maturities, variable-rate exposure, covenant headroom and liquidity after the substantial equity issuance and subsequent cash uses.