Kilroy Realty Corporation — Q3 2011 Form 10-Q
Reporting period: Three and nine months ended September 30, 2011. Kilroy is a West Coast office and industrial REIT; substantially all operations are conducted through Kilroy Realty, L.P. Unless noted, financial amounts below are in millions.
Financial performance and position
- Revenue: Q3 revenue was $97.3, up 22.8% from $79.3 a year earlier. Nine-month revenue was $276.4, up 27.1% from $217.5.
- Profit: Q3 net income was $14.3 versus $3.7; net income available to common stockholders was $10.2, or $0.17 per share, versus a loss of $0.1, or $0.01 per share. Nine-month common earnings were $10.9, or $0.18 per share, versus $3.0, or $0.04. Continuing operations available to common stockholders remained loss-making: $(0.05) per share in Q3 and $(0.06) for nine months.
- Key operating measure: Net operating income (NOI) was $69.1 in Q3, up 22.5%, and $195.6 for nine months, up 25.9%. Growth was primarily acquisition-driven; same-property/core portfolio NOI rose 2.9% in Q3 and 4.9% year to date.
- Cash flow: Nine-month operating cash flow was $114.1, compared with $94.9. Investing used $553.2, including $481.8 for acquired properties; financing provided $439.8. Cash and cash equivalents ended at $15.5; restricted cash was $25.4.
- Debt and liquidity: Gross debt was $1.777 billion at September 30; all debt was fixed-rate at that date. The $500 million revolver had no balance outstanding and was extended to August 2015. Subsequent to quarter-end, the company reported $165 million drawn, primarily for debt repayments and an acquisition deposit. Management reported compliance with debt covenants.
- Capital and distributions: Debt was 46.0% of total market capitalization; debt plus preferred equity was 51.1%. Common dividends were $0.35 per share per quarter ($1.05 for nine months), unchanged from 2010.
Material changes versus prior comparable periods
- Nine-month revenue and NOI rose substantially, mainly reflecting acquisitions. The company acquired nine office properties for approximately $516.3 million during the period; stabilized portfolio size increased to 15.18 million square feet.
- Q3 stabilized occupancy was 92.8% overall: office 90.6% and industrial 100.0%. Total portfolio occupancy was higher than a year earlier, while regional results varied.
- Q3 and nine-month net income benefited from a $12.6 million gain on disposition of discontinued operations. Excluding discontinued operations, continuing-operations income fell to $1.4 million in Q3 from $3.3 million and to $9.0 million for nine months from $13.5 million.
- Interest expense increased 51.7% in Q3 and 61.8% for nine months, largely due to higher average debt associated with acquisitions. Depreciation and amortization also increased with portfolio growth.
- April’s equity offering issued 6.04 million shares and raised net proceeds of approximately $221.0 million. In July, the company established an at-the-market program allowing up to $200 million of stock sales; none had been sold as of the report date.
Outlook, commentary and risks
- No specific earnings or FFO guidance was provided. Management said it believed it could maintain distributions at 2010 levels to meet 2011 REIT requirements, but regular distributions remain subject to board discretion and available capital.
- Management described fundamentals as challenging but noted improving occupancy, modestly lower vacancy, positive net absorption in many submarkets, and stabilization in rents and concessions. New and renewal leases signed in the first nine months showed weighted-average declines of 10.7% in GAAP rents and 15.7% in cash rents under the filing’s stated methodology.
- The company had four property dispositions in negotiation, including a potential residentially entitled land sale, with aggregate indicated sales price of approximately $205 million. Completion and proceeds are uncertain. It also held $23.3 million of net proceeds from a property sale with a qualified intermediary for a potential tax-deferred exchange.
- Three office redevelopment projects were under construction. Two projects commenced redevelopment in Q3; estimated total investments at completion were approximately $19.3 million and $38.8 million, with expected completion in Q2 and Q3 2012. A previously commenced, pre-leased project had an estimated total investment of $58.3 million and expected completion in Q3 2012.
- Risks include weak economic growth and tenant demand, occupancy and rent pressure, acquisition and disposition execution, development costs and timing, refinancing and capital-market access, interest rates, and debt-covenant compliance. Management cautioned that forward-looking expectations may not be achieved. No material change to previously disclosed risk factors or material adverse legal proceedings was reported.
Important facts for investors to verify
- How much of revenue and NOI growth is sustainable same-property performance versus acquired assets, and how occupancy and rents evolve by region.
- The effect of the $12.6 million disposition gain on reported earnings; continuing-operations results were weaker than total net income suggests.
- Post-quarter revolver borrowings, the refinancing of $120.7 million of secured mortgages, and remaining borrowing capacity and covenant headroom.
- Whether the potential $205 million of dispositions and pending acquisitions close, and whether proceeds and tax-deferred exchanges proceed as planned.
- Lease expirations, renewal spreads, redevelopment budgets and completion dates, and the company’s ability to maintain distributions amid acquisition and financing needs.