Kilroy Realty Corporation (NYSE: KRC) — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016. Kilroy is a West Coast office REIT; its portfolio is concentrated in coastal California and Greater Seattle. The filing combines Kilroy Realty Corporation and its operating partnership, whose results are substantially similar.
Financial and operating highlights
| Metric | Q1 2016 | Q1 2015 / comparison |
|---|---|---|
| Total revenue | $145.4 million | $146.1 million; down 0.4% |
| Net income | $178.1 million | $44.0 million |
| Net income available to common stockholders | $171.0 million; $1.85 per diluted share | $39.9 million; $0.45 per diluted share |
| Funds from Operations (FFO), attributable to common stockholders and unitholders | $78.2 million | $91.5 million; down 14.6% |
| Net Operating Income (NOI) | $107.6 million | $107.6 million; essentially unchanged |
| Operating cash flow | $78.2 million | $55.0 million |
| Cash and cash equivalents | $38.6 million | $56.5 million at December 31, 2015 |
| Debt | $2.312 billion gross principal; $2.298 billion net carrying value | $75 million drawn on $600 million revolver |
| Common dividend | $0.35 per share | $0.35 per share |
| Stabilized portfolio occupancy | 94.9% at quarter-end | 94.8% at December 31, 2015; 95.6% at September 30, 2015 |
Reported net income included a $146.0 million gain from selling four office properties. Excluding real estate sale gains under the company’s stated FFO measure, FFO declined year over year. NOI margin was approximately 74% of revenue, calculated from reported figures; NOI is a non-GAAP supplemental measure.
Material changes and transactions
- Sold four San Diego-area office properties and a land parcel for $266.8 million gross proceeds; the four office assets generated a $146.0 million gain. Approximately $258.1 million of disposition proceeds was held in restricted cash for potential Section 1031 exchanges.
- Acquired a 1.75-acre San Francisco development site adjacent to the Flower Mart project for $31.0 million cash plus 867,701 operating partnership units valued at approximately $48.0 million, along with transaction costs.
- Stabilized two San Francisco office developments, 350 Mission Street and 333 Brannan Street; both were reported 100% leased.
- Same-store NOI rose only 0.1%: higher rental income was largely offset by lower tenant reimbursements and other property income. Stabilized development properties contributed $7.7 million of NOI, while dispositions and other items reduced NOI by $7.8 million.
- Interest expense fell 29.9% to $11.8 million, reflecting lower average debt and higher capitalization of interest on development activity. Operating cash flow increased 42.2%, which management attributed primarily to the expiration of free-rent periods on certain leases.
Liquidity, outlook, and risks
- Management said projected liquidity needs for the next 12 months were expected to be met through operating cash flow, the revolver, asset sales, and debt or equity issuance, while noting there is no assurance of continued access to capital. The revolver had $525 million of remaining capacity and matures in July 2019.
- Management anticipated 2016 asset dispositions of approximately $350 million to $650 million, including the $266.8 million already completed. Additional sales and successful Section 1031 exchanges were not assured; inability to complete exchanges could lead to a special dividend to limit taxes on gains.
- Two projects were under construction, with estimated total investment of approximately $645 million. Management estimated potential additional spending of $0–$175 million on current and potential 2016 development projects, depending on market conditions.
- The stabilized portfolio was 94.9% occupied; San Diego occupancy was 88.8%. Approximately 5.1% of stabilized space was available, and leases for 12.2% of annualized base rental revenue were scheduled to expire during the remainder of 2016 and 2017.
- Management estimated portfolio cash rents were about 15% below current average market rents, but cautioned that rents and occupancy depend on market conditions and lease renewals. The top 15 tenants accounted for 38.8% of annualized base rent, creating tenant-concentration exposure.
- Debt covenants were satisfied at quarter-end. Approximately 88.6% of debt was fixed-rate; management cited a 28% debt-to-total-asset-value ratio under credit-facility covenant calculations. Debt maturities, refinancing access, interest rates, tenant defaults, office demand, property values, construction costs, and environmental remediation remain risks. Accrued environmental remediation liabilities were $26.7 million, with possible additional costs not then estimable.
- No formal earnings or FFO guidance was provided. Management described West Coast office demand and rents as generally strong, while emphasizing market-dependent development, acquisition, and disposition plans.
Important facts for investors to verify
- How much of the 2016 net income increase reflects the one-time property-sale gain, and how underlying FFO and same-store NOI perform in subsequent quarters.
- Whether restricted disposition proceeds are deployed through qualifying Section 1031 exchanges, and the resulting tax or special-dividend implications.
- Leasing progress, occupancy and rent trends—particularly in San Diego—and renewal outcomes for the 2016–2017 expirations.
- Development spending, leasing and stabilization at projects in lease-up or under construction, including the Flower Mart pipeline.
- Debt maturities and refinancing plans, remaining revolver availability, covenant headroom, and the cost of future financing.
- Potential additional environmental remediation costs and the timing and amount of contractual development commitments.