Kilroy Realty Corporation — Q2 2010 Form 10-Q
Business context and reporting period
Quarter ended June 30, 2010; filed August 4, 2010. Kilroy Realty is a California-focused office and industrial REIT. At quarter-end its stabilized portfolio comprised 141 buildings and 13.74 million rentable square feet, with 85.1% occupancy. All figures below are in U.S. dollars; financial statement amounts are reported in thousands unless noted.
Financial results and liquidity
- Revenue: Q2 revenue was $72.4 million, up 1.9% from $71.1 million; six-month revenue was $139.2 million, down 3.0% from $143.6 million.
- Profit: Q2 net income attributable to Kilroy Realty was $2.0 million, but preferred distributions and dividends left a $1.8 million loss available to common stockholders, or $(0.04) per share. The comparable 2009 quarter produced $9.1 million available to common stockholders, or $0.25 per share. For the six months, common-stockholder income was $3.1 million, or $0.05 per share, versus $16.7 million, or $0.48 per share, in 2009.
- Property operating performance: Net operating income (NOI) was $51.0 million in Q2, down 4.0%; six-month NOI was $99.8 million, down 5.3%. Six-month office NOI declined 3.3%, while industrial NOI declined 18.5%.
- Funds from operations: FFO attributable to common stockholders and common unitholders was $21.7 million in Q2 versus $30.3 million in 2009; six-month FFO was $47.5 million versus $59.3 million. FFO is a non-GAAP measure and does not reflect capital expenditures or leasing costs.
- Cash flow: Six-month operating cash flow was $57.4 million, compared with $60.9 million in 2009. Investing activities used $414.1 million, mainly for acquisitions; financing activities provided $376.3 million. Cash and cash equivalents were $29.4 million at June 30, compared with $9.9 million at year-end 2009.
- Debt and liquidity: Total debt principal was approximately $1.182 billion; 87.3% was fixed-rate and 12.7% variable-rate. Debt was 39.6% of total market capitalization, or 46.3% including preferred equity liquidation value. The $550 million credit facility had $150 million drawn and $400 million of remaining capacity. The company reported compliance with debt covenants.
- Balance sheet: Total assets were $2.557 billion, up from $2.084 billion at year-end, primarily reflecting acquisitions. Total equity was $1.152 billion.
- Distributions: Common dividends declared were $0.35 per share for Q2 and $0.70 for the first half, compared with $0.93 for the first half of 2009.
Material changes versus prior periods
- Five acquisitions adding seven office buildings were completed in the first half for an aggregate purchase price of approximately $373.6 million. They included 303 Second Street in San Francisco, acquired for $233.3 million.
- The April public offering of 9.2 million common shares generated approximately $299.8 million in net proceeds. In May, the company issued $250 million of 6.625% unsecured notes due 2020.
- In June, the company repurchased $150 million principal amount of 3.25% exchangeable notes, recording a $4.6 million early-extinguishment loss. Remaining principal on those notes was $148 million.
- Despite acquisitions, core portfolio leasing conditions weakened. Six-month average occupancy was 83.5%, versus 86.8% in 2009. At June 30, 2.1 million square feet, or 14.9% of the stabilized portfolio, was vacant.
- For Q2 leases, management reported cash rents 24.8% lower and GAAP rents 22.0% lower than expiring rents for the comparable space, excluding space vacant for more than a year or leased for the first time. Management also reported continuing downward rental-rate pressure in many markets.
Outlook, management commentary, risks and unusual items
- No numerical full-year earnings or FFO guidance is provided. Management said it expected 2010 liquidity needs to be met using available sources, potentially including operating cash flow, debt and equity issuance, credit-facility borrowings, and asset dispositions.
- The company planned to enter a new $500 million unsecured revolving facility in August 2010, subject to customary conditions, and use it to repay and terminate the existing facility. The planned facility would have a three-year term plus a one-year extension option and an interest rate of LIBOR plus 2.675%. A $61 million unsecured note maturity in August 2010 was expected to be repaid with facility borrowings.
- Management had delayed and reduced development plans because of economic conditions; no development or redevelopment projects were under construction or committed as of June 30. The company reported no impairment losses for the periods presented.
- Management cited recession-related tenant weakness, vacancies, rental-rate declines, tenant defaults, and capital-market and refinancing conditions as risks. A 100-basis-point increase in LIBOR would increase annual interest expense by approximately $1.5 million, assuming variable debt balances remained unchanged.
- A dispute involving tenant Newgen Results and Teletech was in discovery, with trial scheduled for Q3 2010. An unfavorable outcome could produce a noncash operating impact ranging from $0 to approximately $3.5 million, primarily relating to deferred rent receivable.
- In July 2010, the company paid $19.2 million of aggregate dividends, distributions, and dividend equivalents and collected the full outstanding principal of its note receivable. Management reported effective disclosure controls; it reported no material changes to previously disclosed risk factors.
Investor verification priorities
- Track occupancy, leasing, tenant retention, and achieved renewal rents, particularly in industrial properties and the San Diego, Orange County, and El Segundo markets.
- Verify execution and terms of the planned replacement credit facility, repayment of the $61 million August 2010 maturity, and refinancing of subsequent debt maturities, including the credit facility in 2011 and exchangeable notes in 2012 and 2014.
- Assess whether operating cash flow and FFO can support distributions, property-level capital needs, and debt service as leasing conditions evolve.
- Review acquisition performance and integration, especially 303 Second Street and the other 2010 acquisitions, and monitor further acquisition spending.
- Follow the Newgen/Teletech litigation and the collectability of tenant and deferred-rent receivables; also distinguish recurring operating results from the $4.6 million debt-extinguishment loss and acquisition-related costs.