KILROY REALTY CORP quarterly report, Q2 FY2014

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Kilroy Realty Corporation — Q2 2014 Form 10-Q

Business context and reporting period. The filing covers the three and six months ended June 30, 2014. Kilroy is a West Coast office REIT; its stabilized portfolio comprised 105 buildings and 13.2 million rentable square feet, with 93.6% occupancy at quarter-end. The Company owns approximately 97.9% of the Operating Partnership; the combined filing reports substantially the same operating results for both entities.

Financial performance and position

  • Revenue: Q2 revenue was $129.2 million, up 9.6% year over year; first-half revenue was $255.0 million, up 11.4%. Rental income was $115.6 million for Q2 and $227.6 million for the first half.
  • Profit: Q2 net income was $31.1 million versus $10.1 million; first-half net income was $133.1 million versus $12.5 million. The increases were heavily affected by disposition gains: $14.7 million in Q2 and $104.8 million in the first half from discontinued operations. Continuing-operations income was $16.5 million for Q2 and $27.9 million for the first half. Common-stockholder diluted EPS was $0.32 and $1.46, respectively.
  • FFO: Funds from Operations attributable to common stockholders and unitholders was $63.3 million in Q2 versus $55.2 million, and $120.5 million in the first half versus $104.2 million.
  • Property operations: Management-defined NOI increased 10.1% to $91.8 million in Q2 and 12.2% to $180.6 million in the first half. Same-store NOI increased 2.4% and 3.8%, respectively. Average stabilized portfolio occupancy was 92.5% in Q2 versus 90.3% a year earlier.
  • Cash flow: First-half operating cash flow was $106.9 million, nearly unchanged from $107.0 million. Investing used $121.9 million, including property and development spending, partly offset by disposition proceeds. Financing provided $4.2 million. Cash and equivalents were $24.6 million at June 30, down from $35.4 million at year-end; restricted cash was $93.5 million.
  • Debt and liquidity: Gross principal debt was approximately $2.24 billion; total debt was 29.0% of market capitalization. Debt was 89.3% fixed-rate. The amended revolving facility totals $600 million, with $90 million drawn and $510 million available; it matures in July 2019. The company reported compliance with debt covenants.
  • Equity and distributions: The common dividend remained $0.35 per share for the quarter. The company sold 370,700 shares through its at-the-market program in the first half, generating $22.3 million net proceeds.

Material changes versus the prior comparable period

  • Revenue and NOI increased, supported by acquisitions, completed development/redevelopment assets, higher occupancy, and new leases at higher rates. Same-store rental income also rose, while same-store expenses increased.
  • Q2 and first-half reported net income rose sharply, primarily because 2014 included substantial property-sale gains; these gains should not be treated as recurring operating performance.
  • Interest expense declined 17.6% in Q2 and 15.1% in the first half, principally because more interest was capitalized as development activity increased. Gross interest expense was broadly flat.
  • The stabilized portfolio had 105 buildings versus 115 a year earlier, reflecting dispositions, acquisitions, and redevelopment completions. Occupancy improved year over year overall, though regional trends varied.

Outlook, commentary, risks, and unusual items

  • Management said market rental rates had generally stabilized and begun improving in many submarkets, and believed portfolio cash rents were approximately 5%–10% below current market rents. This is management’s estimate, not a guarantee of achieved rent growth.
  • Six development projects were under construction, with estimated total investment of approximately $1.5 billion; about $800 million had been incurred and $565 million remained committed. Management expects disciplined, phased development and favors pre-leased projects. The filing provides no formal earnings or FFO guidance.
  • Approximately $260.5 million of scheduled debt principal maturities and amortization remained for 2014, including $83 million of senior notes due in August and $172.5 million of exchangeable notes due in November. Holders had submitted $37 million of exchange notices; $27.7 million settled in July and $9.3 million was expected to settle in August. Management cited available revolver capacity and stated it believed it was positioned to refinance or repay maturities.
  • Development and redevelopment commitments, leasing and capital expenditure requirements, refinancing access, interest rates, tenant demand, rental rates, occupancy, and property values are key risks. A 100-basis-point LIBOR increase was estimated to raise annual interest expense by approximately $2.4 million before capitalization.
  • A tenant exercised an early termination right for approximately 79,000 square feet; the lease termination fee was $5.7 million, recognized over the period to termination. The company also announced a proposed approximately $27 million acquisition of a San Francisco land-owning entity, subject to shareholder approval and expected to close by year-end 2014.
  • Management reported no material adverse environmental matter, no material litigation, no material change in previously disclosed risk factors, and no off-balance-sheet arrangements. Disclosure controls were deemed effective.

Important facts for investors to verify

  1. Separate recurring operating performance from disposition gains when assessing earnings; review the reported FFO and NOI reconciliations.
  2. Track occupancy, lease commencements, renewal spreads, and expirations: 5.0% of occupied space was due to expire in the remainder of 2014 and 11.8% in 2015.
  3. Monitor funding and execution of the $1.5 billion development pipeline, including remaining commitments and project completion and leasing schedules.
  4. Confirm how the August and November 2014 debt maturities and exchangeable-note settlements were funded, and whether revolver availability and covenant headroom remain adequate.
  5. Assess liquidity using unrestricted cash separately from restricted cash, and consider ongoing dividends, development spending, leasing costs, and potential acquisitions.