<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1997
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ________ to________
Commission file number 1-12675
KILROY REALTY CORPORATION
(Exact name of registrant as specified in its charter)
Maryland 95-4598246
(State or other jurisdiction (I.R.S. Employer Identification Number)
of incorporation or organization)
2250 East Imperial Highway 90245
El Segundo, California (Zip Code)
(Address of principal executive offices)
(213) 772-1193 (Registrant's telephone
number, including area code)
N/A
----------------------------
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No ____
As of May 12, 1997, 14,475,000 shares of common stock, par value $.01 per
share, were outstanding.
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
------
<S> <C>
PART I - FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
Consolidated balance sheet of Kilroy Realty Corporation as of March 1
31, 1997 and Combined Balance Sheet of the Kilroy Group
(predecessor to Kilroy Realty Corp.) as of December 31, 1996
Consolidated Statement of Operations of Kilroy Realty Corporation for 2
the period from February 1, 1997 to March 31, 1997 and the Combined
Statement of Operations of the Kilroy Group for the period from
January 1, 1997 to January 31, 1997 and for the three months ended
March 31, 1996.
Consolidated Statement of Cash Flows of Kilroy Realty Corporation for 3
the three months ended March 31, 1997 and the Combined Statement
of Cash Flows of the Kilroy Group for the three months ended
March 31, 1996.
Notes to the Kilroy Realty Corporation Consolidated and Kilroy 4
Group Combined financial statements
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND 8
RESULTS OF OPERATIONS
PART II - OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS 13
Item 2. CHANGES IN SECURITIES 13
Item 3. DEFAULTS UPON SENIOR SECURITIES 13
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 13
Item 5. OTHER INFORMATION 13
Item 6. EXHIBITS AND REPORTS ON FORM 8-K 13
</TABLE>
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. Financial Statements
KILROY REALTY CORPORATION (the "Company") and
KILROY GROUP (Predecessor to the Company)
Consolidated Balance Sheet of the Company and Combined Balance Sheet of the
Kilroy Group
(in thousands)
<TABLE>
<CAPTION>
Kilroy Realty Kilroy Group
Corp
March 31, December 31,
1997 1996
------------------------------------
<S> <C> <C>
ASSETS
------
RENTAL PROPERTIES (Notes 1, 2, and 4):
Land................................................................. $ 26,069 $ 12,490
Buildings and improvements........................................... 259,333 214,847
--------- ---------
Total rental properties........................................... 285,402 227,337
Accumulated depreciation and amortization............................ (111,791) (109,668)
-------- --------
Rental properties, net............................................ 173,612 117,669
CASH AND CASH EQUIVALENTS.............................................. 116,163
RESTRICTED CASH........................................................ 4,244
TENANT RECEIVABLES, NET................................................ 3,537 3,042
DUE FROM AFFILIATES.................................................... 1,261
DEFERRED CHARGES AND OTHER ASSETS, NET (Note 3)........................ 11,565 7,628
-------- --------
TOTAL................................................................ $ 310,382 $ 128,339
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
LIABILITIES:
Debt (Note 4)........................................................ $ 95,917 $ 223,297
Accounts payable and accrued expenses................................ 4,292 3,685
Accrued interest payable (Note 4).................................... 670 3,929
Accrued cost of option buy-out and tenant improvement (Note 2)....... 0 1,390
Rents received in advance and tenant security deposits............... 8,554 9,815
--------- ---------
Total liabilities................................................. 109,433 242,116
COMMITMENTS AND CONTINGENCIES (Note 6).................................
MINORITY INTEREST...................................................... 31,127
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value, 150,000,000 shares authorized:
14,475,000 shares issued and outstanding......................... 145
Additional paid-in capital.......................................... 167,025
Retained earnings (deficit) (Note 1)................................ 2,652 (113,177)
--------- ---------
TOTAL................................................................ $ 310,382 $ 128,339
========= =========
</TABLE>
See accompanying notes to financial statements.
1
<PAGE>
KILROY REALTY CORP. CONSOLIDATED AND KILROY GROUP COMBINED
STATEMENTS OF OPERATIONS
(in thousands, except per share data)
<TABLE>
<CAPTION>
Kilroy Kilroy Kilroy
Realty Corp Group Group
February 1, January 1, January 1,
1997 to 1997 to 1996 to
March 31, January 31, March 31,
1997 1997 1996
----------------------------------------------------------------
<S> <C> <C> <C>
REVENUES:
Rental income (Note 6)..................... $7,110 $2,760 $8,785
Tenant reimbursements...................... 706 275 862
Interest income............................ 971
Development services....................... 14 263
Other income............................... 185 4 11
---------- ------ ------
Total revenues........................ 8,972 3,053 9,921
---------- ------ ------
EXPENSES:
Property expenses........................... 1,239 579 1,533
Real estate taxes........................... 353 106 300
General and administrative.................. 725 78 528
Ground lease................................ 185 64 193
Development expense......................... 46 197
Interest expense............................ 1,531 1,895 5,227
Depreciation and amortization............... 1,744 787 2,281
---------- ------ ------
Total expenses......................... 5,777 3,555 10,259
---------- ------ ------
INCOME (LOSS) BEFORE EXTRAORDINARY GAINS,
EQUITY IN INCOME OF SUBSIDIARY AND MINORITY
INTEREST........................................ 3,195 (502) (338)
EQUITY IN LOSS OF UNCONSOLIDATED SUBSIDIARY..... (57)
MINORITY INTEREST............................... (486) 0 0
---------- ------ ------
INCOME (LOSS) BEFORE EXTRAORDINARY GAINS 2,652 (502) (338)
EXTRAORDINARY GAINS (Note 4)................... 0 3,204 0
---------- ------ ------
NET INCOME (LOSS)............................... $2,652 $2,702 $ (338)
========== ====== ======
Net income per common share
Income before extraordinary item........... $ .18
Extraordinary item......................... .00
----------
Net income per common share................ $ .18
==========
Weighted average shares outstanding............. 14,475,000
</TABLE>
See accompanying notes to financial statements.
2
<PAGE>
KILROY REALTY CORP. CONSOLIDATED AND KILROY GROUP COMBINED
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Three Months Ended March 31
1997 1996
--------------------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)........................ $ 5,354 $ (338)
Adjustment to reconcile net income
(loss) to net cash provided by
operating activities:
Depreciation and amortization......... 2,531 2,281
Provision for bad debts............... 150 10
Extraordinary gain.................... (3,204)
Minority interest in earnings......... 486
Equity in loss of unconsolidated
subsidiary........................... 57
Changes in assets and liabilities:
Tenant receivables.................. (645) 215
Other assets........................ 801 (385)
Accounts payable and accrued
expenses........................... 607 2,032
Accrued interest payable............ (3,259) 239
Accrued cost of option buy-out and
tenant improvements................ (1,390)
Rents received in advance and
tenant security deposits........... (1,261) 300
--------- -------
Net cash provided by operating
activities...................... 227 4,354
--------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Expenditures for rental properties....... (59,555) (76)
Investment in joint venture.............. (51) 0
--------- -------
Net cash used in investing activities... (59,606) (76)
--------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of stock...... 302,780
Proceeds received from debt.............. 96,000 873
Principal payments on debt............... (218,893) (1,210)
Cash paid for loan costs................. (2,323)
Restricted cash.......................... (4,244)
Due from affiliates...................... (1,261)
Deemed and actual contributions from
(distributions to) partners, net........ 3,483 (3,941)
--------- -------
Net cash provided by (used in)
financing activities...................... 175,542 (4,278)
--------- -------
Net increase in cash and
cash equivalents.......................... 116,163 0
Cash and cash equivalents, beginning of
period.................................... 0 0
--------- -------
Cash and cash equivalents, end of
period.................................... $ 116,163 $ 0
========= =======
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest................... $ 3,872 $ 4,988
========= =======
</TABLE>
See accompanying notes to financial statements.
3
<PAGE>
KILROY REALTY CORP. CONSOLIDATED AND KILROY GROUP COMBINED
NOTES TO FINANCIAL STATEMENTS
Three Months Ended March 31, 1997 and 1996
1. Organization and Formation Transactions
Kilroy Realty Corporation (the "Company") was incorporated in Maryland
in September 1996 and is the successor to the operations of the Kilroy Group
("KG"). Kilroy Group consists of the combination of Kilroy Industries ("KI") and
various entities, the properties of which were under common control of KI and/or
its stockholders, including John B. Kilroy, Sr. and John B. Kilroy, Jr. John B.
Kilroy, Sr. and John B. Kilroy, Jr. are the Company's Chairman of the Board of
Directors, and President and Chief Executive Officer, respectively. KI has
historically provided acquisition, development, financing, construction and
leasing services with respect to the properties held by KG. KI has also provided
development services to third-party owners of properties for a fee. The
accompanying combined financial statements of KG have been presented on a
combined basis because of common ownership and management and because the
entities were the subject of a business combination in 1997 with the Company.
On January 31, 1997, the Company completed an initial public offering
of 12,500,000 shares of $.01 par value common stock (the "Offering"). The
Offering price was $23.00 per share resulting in gross proceeds of $287,500,000.
On February 7, 1997, the underwriters exercised their over-allotment option and,
accordingly, the Company issued an additional 1,875,000 shares of common stock
and received gross proceeds of $43,125,000. The aggregate proceeds to the
Company, net of underwriters' discount, advisory fee and offering costs were
approximately $302,800,000.
The following transactions occurred simultaneously with the completion of
the Offering (collectively, the "Formation Transactions"):
. The Company consummated various purchase agreements to acquire four properties
for approximately $58,000,000 in cash. The four properties had aggregate
operating revenues of approximately $9,100,000 and operating income
(before depreciation, amortization and interest) of approximately $6,300,000
during the year ended December 31, 1996.
. The Company became the sole general partner of Kilroy Realty, L.P. (the
"Operating Partnership"). Upon completion of the Offering, the Company
contributed substantially all of the net proceeds of the Offering in exchange
for an approximate 84.5% interest in the Operating Partnership. The Company
also contributed cash from the Offering to form Kilroy Realty Finance GP, Inc.
("Finance GP"), which was formed to serve as the general partner of Kilroy
Realty Finance Partnership, L.P. (the "Finance Partnership"). The Operating
Partnership executed various option and purchase agreements whereby it issued
2,652,374 units in the Operating Partnership ("Units"), representing an
approximately 15.5% partnership interest, to the continuing investors in
exchange for interest in properties. The Operating Partnership contributed
certain properties to the Finance Partnership in exchange for a limited
partnership interest therein. All properties acquired by the Company are held
by or through the Operating Partnership and the Finance Partnership. Unless
otherwise indicated, all references to the Company include the Operating
Partnership, the Finance Partnership, and Finance GP.
. The Finance Partnership and the Operating Partnership borrowed $84,000,000
and $12,000,000, respectively, under two mortgage loans.
. The Operating Partnership used a portion of the Offering proceeds and the
proceeds of the new mortgage borrowings of $96,000,000 to repay
approximately $219,000,000 of indebtedness.
The Company is engaged in the acquisition, development, ownership and operation
of office and industrial properties located in California, Washington and
Arizona. As of March 31, 1997, the Company owned and operated 14 office
properties encompassing approximately 2.0 million rentable square feet and 12
industrial properties encompassing approximately 1.3 million rentable square
feet.
4
<PAGE>
KILROY REALTY CORP. CONSOLIDATED AND KILROY GROUP COMBINED
NOTES TO FINANCIAL STATEMENTS--(Continued)
2. Basis of Presentation and Significant Accounting Policies
The consolidated financial statements include the consolidated financial
position of the Company, the Operating Partnership, Finance GP and the Finance
Partnership at March 31, 1997 and the results of their operations for the period
from February 1, 1997 to March 31, 1997. Subsequent to the Offering, the
operating results of the service business currently conducted by Kilroy
Services, Inc. are reflected in the accompanying financial statements on the
equity method of accounting. All significant intercompany balances and
transactions have been eliminated in the consolidated financial statements.
The combined financial statements of the Kilroy Group reflect a combination of
real estate properties, which were under common control of KI and/or its
stockholders, including John B. Kilroy, Sr. and John B. Kilroy, Jr. The Kilroy
Group is considered the predecessor entity to the Company due to common
ownership and management; therefore, its combined financial statements are
presented for comparative purposes.
The accompanying interim financial statements have been prepared by the
Company's management in accordance with generally accepted accounting principles
and in conjunction with the rules and regulations of the Securities and
Exchange Commission. In the opinion of management, the interim financial
statements presented herein, reflect all adjustments of a normal and recurring
nature which are necessary to fairly state the interim financial statements.
The results of operations for the interim period are not necessarily indicative
of the results that may be expected for the eleven months ended December 31,
1997. These financial statements should be read in conjunction with the
Company's prospectus dated January 28, 1997 and the Kilroy Group's audited
financial statements and the notes thereto included in the Company's Annual
Report on Form 10-K for the year ended December 31, 1996.
The Company intends to qualify as a real estate investment trust ("REIT")
under Section 856 through 860 of the Internal Revenue Code of 1986, as amended
(the "Code"). As a REIT, the Company will not generally be subject to corporate
Federal income taxes as long as it satisfies certain technical requirements of
the Code relating to composition of its income and assets, and requirements
relating to distributions of taxable income to shareholders.
Significant Accounting Policies:
Restricted cash--Restricted cash consists of cash held as collateral to
provide credit enhancement for the mortgage loans payable and cash reserves for
capital expenditures and tenant improvements.
Due from affiliates--Due from affiliates represents amounts paid by the
Company for certain loan costs, tenant improvements and leasing commissions, the
obligations for which were assumed by KI.
Accrued cost of option buy-out and tenant improvements--In September 1996, KG
amended the terms of certain of their lease agreements. Such amendments included
a $500,000 allowance for tenant improvements. In addition, KG agreed to pay
$3,150,000 in consideration for the cancellation of an option to purchase a 50%
equity interest in Kilroy Airport Center at El Segundo, which was reflected in
the statement of operations as of December 31, 1996. In November 1996,
$2,260,000 of the total liability of $3,650,000, was paid by KI and its
stockholders. In January 1997, $100,000 of the amount was paid by KG and the
remaining balance was paid by the Company with the proceeds of the Offering.
5
<PAGE>
KILROY REALTY CORP. CONSOLIDATED AND KILROY GROUP COMBINED
NOTES TO FINANCIAL STATEMENTS--(Continued)
3. Deferred Charges and Other Assets
Deferred charges and other assets are summarized as follows for the Company at
March 31, 1997 and the Kilroy Group at December 31, 1996, respectively:
<TABLE>
<CAPTION>
March 31, December 31,
------------------------------
1997 1996
------- --------
(In thousands)
<S> <C> <C>
Deferred assets:
Deferred financing costs........... $ 2,323 $ 2,968
Deferred leasing costs............. 12,567 11,563
------- -------
Total deferred assets.............. 14,890 14,531
Accumulated amortization.............. (5,110) (7,728)
------- -------
Deferred assets, net.................. 9,780 6,803
Prepaid expenses and other............ 1,785 825
------- -------
Total deferred charges and other
assets, net.......................... $11,565 $ 7,628
======= =======
</TABLE>
4. Debt
At March 31, 1997, debt consists of an $83,917,000 mortgage loan (the
"Permanent Loan") secured by certain of the properties and a $12,000,000
mortgage loan (the "SeaTac Loan") secured by an office complex in Seattle,
Washington. The Permanent Loan requires monthly principal and interest
payments based on an interest rate of 8.35%, amortizes over a 25-year period and
matures in 2022, but is subject to increases in the effective interest rate
beginning in 2005. The SeaTac Loan requires monthly payments of interest based
on a variable rate of LIBOR plus 3% (8.77% at March 31, 1997) and matures in
July 1997 with two options to extend for six months each. As of March 31, 1997
the loans have a weighted average interest rate of 8.40%.
The fixed rate Permanent Loan of $83,917,000 at March 31, 1997 approximates
its fair value based on terms currently offered to the Company. The carrying
values of the variable rate SeaTac Loan at March 31, 1997, also approximates its
fair value.
In January, the Kilroy Group recorded an extraordinary gain of $3,204,000
consisting of approximately $1,283,000 of unamortized deferred financing fees
written off and a net gain on partial forgiveness of a mortgage obligation of
$4,487,000.
5. Stock Options
The Company has established a stock option and incentive plan for the purpose
of attracting and retaining qualified executives and to reward them for superior
performance in achieving the Company's business goals and enhancing stockholder
value. In conjunction with the offering and as of March 31, 1997, 945,000 of
the Company's authorized shares have been granted to directors, officers and
employees and an additional 455,000 have been reserved for issuance under such
plan. The term of each option is ten years from the date of grant. Each option
vests 33 1/3% per year over three years beginning on the first anniversary date
of the grant and is exercisable at a price per share equal to the fair market
value on the date of grant.
6
<PAGE>
KILROY REALTY CORP. CONSOLIDATED AND KILROY GROUP COMBINED
NOTES TO FINANCIAL STATEMENTS--(Continued)
6. Significant Tenant
Rental income from one tenant, Hughes Electronics Corporation's Space &
Communications Company ("Hughes"), was $1,743,000 for the two months ended
March 31, 1997.
7. Commercial Real Estate Investments
Subsequent to March 31, 1997, the Company acquired the following properties
from unaffiliated third parties:
<TABLE>
<CAPTION>
Description Acreage/Square footage Location of property Purchase price (millions)
- ---------------------- ----------------------- -------------------- -------------------------
<S> <C> <C> <C>
Undeveloped land 15 (acres) Foothill Ranch, CA $ 3.4
Office building 91,000 sq. ft. Calabasas, CA $11.7
Office buildings 115,000 sq. ft. Anaheim, CA $ 8.1
Industrial building 109,000 sq. ft. Anaheim, CA $ 5.4
</TABLE>
The acquisitions were funded out of working capital. The Company has also
entered into letters of intent to purchase approximately $130 million of
additional properties. Each of the proposed acquisitions remains subject to the
completion of due diligence procedures and no assurance can be given that the
Company will consummate any of the proposed acquisitions.
8. Earnings Per Share
Net income per share was calculated using the weighted average number of
shares outstanding of 14,475,000.
9. Unaudited Pro Forma Condensed Consolidated Financial Information
The accompanying unaudited pro forma information for the three months ended
March 31, 1997 and 1996 are presented as if the Formation Transactions described
in Note 1 to the financial statements had occurred on January 1, 1996. Such pro
forma information is based upon the historical consolidated financial statements
of the Company and the Kilroy Group and should be read in conjunction with the
consolidated and combined financial statements and the notes thereto.
This unaudited pro forma condensed consolidated information does not purport
to represent what the actual results of operations of the Company would have
been assuming such Formation Transactions had been completed as set forth above,
nor do they purport to predict the results of operations for future periods.
Pro Forma Income Statement
(in thousands, except per share data)
<TABLE>
<CAPTION>
Three Months Ended March 31,
1997 1996
---------------------------------
<S> <C> <C>
Total revenues.......................... $ 13,308 $ 12,979
----------- -----------
Net income before extraordinary items... $ 3,930 $ 3,750
=========== ===========
Net income.............................. $ 3,930 $ 3,750
=========== ===========
Income per share of common stock........ 0.27 0.26
=========== ===========
Weighted average number of shares of
common stock Outstanding............... 14,475,000 14,475,000
=========== ===========
</TABLE>
7
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the financial
statements and notes thereto appearing elsewhere in this report.
Overview and Background
Kilroy Realty Corporation (the "Company") owns, operates and develops commercial
and industrial real estate, primarily in Southern California. The Company was
formed in January 1997 as a self-administered REIT. The Company's predecessor,
the Kilroy Group, had been engaged in the acquisition, management, financing,
construction and leasing of commercial and industrial properties. Following
completion of the initial public offering and the related formation transactions
(see Note 1 to the Consolidated Financial Statements for a discussion of the
organization and formation of the Company), the Company owned 14 office
buildings and 12 industrial buildings and succeeded to the Kilroy Group's real
estate business. The office and industrial properties encompass approximately
2.0 million and 1.3 million rentable square feet, respectively, and were 88.8%
leased as of March 31, 1997. The Company owns all of the properties through
the Operating Partnership and the Finance Partnership.
As a result of the formation transactions, the Company's total assets increased
to $310,382,000, including real estate assets of $173,612,000, net of
accumulated depreciation. The market capitalization of the Company based on the
market value of the 14,475,000 issued and outstanding shares of the Company's
common stock, 2,652,374 Operating Partnership units, and the $95,917,000 of debt
outstanding at March 31, 1997 was $551,933,000. The Company's total debt-to-
market capitalization ratio at March 31, 1997 was 17.4%.
Results of Operations
The Company's management believes that in order to provide meaningful historical
analysis of the financial statements, certain adjustments must be made to the
historical Kilroy Group financial statements to make accounting periods
comparable. Accordingly the results of operations for the period January 1,
1997 to January 31, 1997 have been adjusted to reflect interest income, general
and administrative expenses, interest expense and extraordinary items as if the
Offering had been consummated on January 1, 1997. The following sections
discuss the results of operations as adjusted.
Three Months Ended March 31, 1997 compared to Three Months Ended March 31, 1996
<TABLE>
<CAPTION>
Three months ended March 31,
(in thousands, as adjusted)
1997 1996
<S> <C> <C>
REVENUES:
Rental income................... $ 9,870 $ 8,785
Tenant reimbursements........... 981 862
Interest income................. 1,457
Development services............ 14 263
Other income.................... 189 11
------- -------
Total revenues............... 12,511 9,921
------- -------
EXPENSES:
Property expenses............... 1,818 1,533
Real estate taxes............... 459 300
General and administrative...... 1,088 528
Ground leases................... 249 193
</TABLE>
8
<PAGE>
<TABLE>
<S> <C> <C>
Development expense............. 46 197
Interest expense................ 2,297 5,227
Depreciation and amortization... 2,531 2,281
------- -------
Total expenses............... 8,488 10,259
------- -------
INCOME (LOSS)..................... $ 4,023 $ (338)
======= =======
</TABLE>
Total revenues increased $2.6 million, or 26.1%, for the three months ended
March 31, 1997 compared to the same period of 1996. Revenues from base rents
increased $1.1 million, or 12.4%, to $9.9 million in 1997 compared to $8.8
million in 1996. Rents from office properties increased $0.8 million during the
three months ended March 31, 1997 from the comparable period in 1996. This
improvement was due to an increase in office space under lease of 398,000 square
feet, from 1,285,000 square feet at March 31, 1996 to 1,683,000 square feet at
March 31, 1997. The bulk of the square footage increase reflects four office
properties acquired in connection with the Offering. Rents from industrial
properties increased $0.3 million during the three months ended March 31, 1997
compared to the same period in 1996. The increase was due to the purchase of
three industrial buildings with approximately 421,000 square feet under lease in
connection with the Offering. Average occupancy in industrial buildings owned
during both periods was comparable from period to period. Tenant reimbursements
increased to $1.0 million in 1997 from $0.9 million for 1996. The $0.1 million
increase was primarily due to tenant reimbursements in connection with the
office and industrial buildings purchased in connection with the Offering.
Interest income increased $1.5 million due to interest earned on the $116.2
million of net Offering proceeds remaining after the purchase of the properties
discussed above and the repayment of debt. Other income for the three months
ended March 31, 1997 includes a $0.1 million gain on the sale of furniture and
equipment.
Expenses for the three months ended March 31, 1997 decreased by $1.8 million,
or 17.3%, to $8.5 million compared to $10.3 million in 1996. Property expenses,
real estate taxes and ground lease expense increased $0.3 million, $0.2 million
and $0.1 million, respectively, primarily due to the properties purchased at the
Offering. Interest expense decreased $2.9 million, or 56.1%, to $2.3 million
in 1997 from $5.2 million in 1996, primarily as a result of the repayment of
$127.4 million in debt in connection with the Offering (see Liquidity and
Capital Resources below).
Net income was $4.0 million for the three months ended March 31, 1997 compared
to a $.3 million loss for the same period in 1996. The net change of $4.3
million is due primarily to an increase in rental income of $1.1 million, an
increase in interest income of $1.5 million and a decrease in interest expense
of $2.9 million.
Liquidity and Capital Resources
Upon completion of the Offering, the Company used a portion of the net
proceeds of approximately $302.8 million to acquire certain properties for
approximately $58.0 million, and reduce its total indebtedness by approximately
$127.4 million leaving working capital of approximately $116.2 million. The
Company is currently negotiating a $150.0 million credit facility (the "Credit
Facility"). The Credit Facility will be used primarily to finance acquisitions
of additional properties. The availability of funds under the Credit Facility is
expected to be subject to, among other things, the value of the underlying
collateral securing it. The Company expects that, initially, it will have
approximately $50.0 million in availability under the Credit Facility.
Subsequent to March 31, 1997, the Company purchased approximately $24.9
million of office and industrial properties and $3.4 million of land. All of the
acquisitions were funded out of working capital. The Company has also entered
into letters of intent to purchase an additional $130.0 million of properties.
The Company anticipates that the acquisitions, if consummated, will be funded
out of working capital and funds available through the Credit Facility.
The Company anticipates that distributions will be paid from cash available
for distribution, which is expected to exceed cash historically available for
distribution as a result of the reduction in debt service resulting from the
9
<PAGE>
repayment of indebtedness with the net proceeds of the Offering. The Company
intends to make distributions quarterly, subject to the discretion of the Board
of Directors. Amounts accumulated for distribution will be invested primarily in
interest-bearing accounts and short-term interest-bearing securities, consistent
with the Company's intention to qualify for taxation as a REIT. Such investments
may include, U.S. government obligations, obligations of the Government
National Mortgage Association, other governmental agency securities,
certificates of deposit and interest-bearing bank deposits.
The Company believes the Offering and the application of its proceeds have
improved its financial performance, principally as a result of the substantial
reduction in its overall debt and its debt-to-equity ratio. With the net
proceeds of the Offering, the Company reduced its overall mortgage indebtedness
by $127.4 million, and has debt outstanding as of the date of this report of
$95.9 million, comprised of an $83.9 million mortgage loan and a $12.0 million
mortgage loan. The $83.9 million mortgage loan requires monthly principal and
interest payments based on an interest rate of 8.35%, amortizes over 25 years
and matures in 2022. It is subject to increases in the effective interest rate
beginning in 2005, giving the Company incentive to refinance or repay the
indebtedness at that time. However, no assurance can be given that the Company
will be able to repay such indebtedness as of such date, or to refinance such
indebtedness as of such date on terms favorable to the Company. The $12.0
million mortgage loan requires monthly payments of interest computed at a
variable rate of interest equal to the 30-day London interbank overnight rate
plus 3.0% and matures in July 1997. The $127.4 million reduction in mortgage
indebtedness will result in a significant reduction in annual mortgage interest
expense as a percentage of total revenue. The market capitalization of the
Company, based on the market closing price at March 31, 1997 of $26.63 per
share, and the debt outstanding at March 31, 1997, is approximately $551.9
million including total debt of approximately $95.9 million (assuming the
exchange into shares of Common Stock, on a one-for-one basis, of all 2,652,374
Units outstanding). As a result, the Company's debt-to-total market
capitalization ratio was approximately 17.4%.
The Company expects to meet its short-term liquidity requirements generally
through its initial working capital, net cash provided by operations and
additional debt or equity financing. The Company presently has no financial
commitments in its capacity as a developer of real estate projects and believes
that it will have sufficient capital resources to satisfy its obligations and to
meet both operating requirements and expected distributions in accordance with
REIT requirements.
The Company expects to meet certain of its long-term liquidity requirements,
including the repayment of long-term debt of $83.9 million (less scheduled
principal repayments) in 2005, the repayment of debt of $12.0 million in July
1997 and possible property acquisitions and development, through long-term
secured and unsecured borrowings, including the Credit Facility, and the
issuance of debt securities or additional equity securities of the Company or,
possibly in connection with acquisitions of land or improved properties, the
issuance of Units of the Operating Partnership.
Historical Cash Flows
Historically, the Kilroy Group's principal sources of funding for operations
and capital expenditures were cash flow from operating activities and secured
debt financing. The Kilroy Group incurred a net loss before extraordinary items
for the three months ended March 31, 1997. However, after adding back
depreciation and amortization, the properties generated positive net operating
cash flows in the period.
The Company's net cash from operating activities decreased $4.1 million for
the three months ended March 31, 1997 compared to the same period in 1996, from
$4.3 million in 1996 to $0.2 million in 1997. The decrease was primarily due to
the payment of accrued interest of $3.3 million and the accrued cost of option
buy-out and tenant improvements of $1.4 million, and lower rents received in
advance, of $1.3 million. These increases in cash used were offset by an
increase in net income before extraordinary gains of $2.5 million, due primarily
to an increase in base rents of $1.1 million and a decrease in interest expense
of $1.8 million.
Net cash used in investing activities increased $59.5 million to $59.6 million
for the three months ended March 31, 1997 from $0.1 million for 1996. The
increase was due to the purchase of four office properties and three
10
<PAGE>
industrial properties for an aggregate purchase price of $58.0 million and
additional tenant improvements of $1.6 million.
Cash flows provided by financing activities totaled $175.5 million for the
three months ended March 31, 1997 compared to net cash used in financing
activities of $4.3 million in the 1996 period. The increase is primarily due to
net proceeds from the Offering of $302.8 million, a net repayment of debt of
$122.9 million and loan costs and restricted cash of $2.3 million and $4.2
million, respectively, in the 1997 period compared to net principal payments of
$.3 million in the 1996 period. In 1997 there was a contribution from partners
of $2.2 million net of amounts owed to affiliates, compared to a net
distribution of $3.9 million in 1996.
Funds from Operations
Industry analysts generally consider Funds from Operations, as defined by
NAREIT, an alternative measure of performance for an equity REIT. Funds from
Operations is defined by NAREIT to mean net income (loss) determined in
accordance with GAAP, excluding gains (or losses) from debt restructuring and
sales of property, plus depreciation and amortization (other than amortization
of deferred financing costs and depreciation of non-real estate assets), and
after adjustment for unconsolidated partnerships and joint ventures. The Company
believes that in order to facilitate a clear understanding of the combined
historical operating results of the Company, Funds from Operations should be
examined in conjunction with net income (loss) as presented in the financial
statements included elsewhere in this report. The Company computes Funds from
Operations in accordance with standards established by the Board of Governors of
NAREIT in its March 1995 White Paper, which may differ from the methodologies
used by other equity REITs and, accordingly, may not be comparable to that
published by such other REITs. Funds from Operations should not be considered as
an alternative to net income (loss), as an indication of the Company's
performance or to cash flows as a measure of liquidity or the ability to pay
dividends or make distributions.
The following table presents the Company's Funds from Operations for the
period from February 1, 1997 to March 31, 1997 and for the pro forma three
months ended March 31, 1997:
<TABLE>
<CAPTION>
Pro Forma
February 1, Three Months
1997 to ended March
March 31, 1997 31, 1997
-------------- -------------
<S> <C> <C>
Net income $2,652 $3,930
Add
Minority interest 486 720
Depreciation and amortization 1,744 2,531
Other 77 115
------ ------
Funds from Operations $4,959 $7,296
====== ======
</TABLE>
The following table presents the Company's Funds Available for Distribution for
the period from February 1, 1997 to March 31, 1997 and for the pro forma three
months ended March 31, 1997:
<TABLE>
<CAPTION>
Pro Forma
February 1, Three Months
1997 to ended March
March 31, 1997 31, 1997
-------------- ------------
<S> <C> <C>
Funds from Operations
Adjustments $4,959 $7,296
Amortization of deferred financing costs 161 242
Second generation tenant improvements
and leasing commissions (212) (318)
</TABLE>
11
<PAGE>
Net effect of straight-line rents 5 8
------ ------
Funds Available for Distribution $4,913 $7,228
====== ======
Inflation
The majority of the Company's tenant leases require tenants to pay most
operating expenses, including real estate taxes and insurance, and increases in
common area maintenance expenses, which reduce the Company's exposure to
increases in costs and operating expenses resulting from inflation.
12
<PAGE>
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
During the three months ended March 31, 1997, no legal proceedings were
initiated against or on behalf of the Company, the adverse determination of
which would have a material adverse effect upon the financial condition and
results of operations of the Company.
ITEM 2. CHANGES IN SECURITIES
During the three months ended March 31, 1997, the Company issued 100,000
restricted shares of common stock to an officer of the Company for aggregate
cash consideration of $1,000. In addition, the Operating Partnership issued
2,652,374 partnership units (the "Units") to accredited investors in exchange
for the contribution of property. The shares of common stock and the Units,
respectively, were issued in reliance on an exemption registration requirement
pursuant to regulation D under the Securities Act of 1933 as amended.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES - None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - None
ITEM 5. OTHER INFORMATION - None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
<TABLE>
<CAPTION>
Exhibit
Number Description
------- -----------
<S> <C>
3.1* Articles of Amendment and Restatement of the Registrant.
3.2* Amended and Restated Bylaws of the Registrant.
3.3* Form of Certificate for Common Stock of the Registrant.
10.1* Amended and Restated Agreement of Limited Partnership of Kilroy Realty, L.P.
10.2* Form of Registration Rights Agreement among the Registrant and the persons named therein.
10.3* Omnibus Agreement, dated as of October 30, 1996, by and among Kilroy Realty, L.P. and the parties named therein.
10.4* Supplemental Representations, Warranties and Indemnity Agreement by and among Kilroy Realty, L.P. and the parties named
therein.
10.5* Pledge Agreement by and among Kilroy Realty, L.P., John B. Kilroy, Sr., John B. Kilroy, Jr. and Kilroy Industries.
10.6* 1997 Stock Option and Incentive Plan of the Registrant and Kilroy Realty, L.P.
10.7* Form of Indemnity Agreement of the Registrant and Kilroy Realty, L.P. with certain officers and directors.
10.8* Lease Agreement, dated January 24, 1989, by and between Kilroy Long Beach Associates and the City of Long
Beach for Kilroy Long Beach Phase I.
10.9* First Amendment to Lease Agreement, dated December 28, 1990, by and between Kilroy Long Beach Associates
and the City of Long Beach for Kilroy Long Beach Phase I.
10.10* Lease Agreement, dated July 17, 1985, by and between Kilroy Long Beach Associates and the City of Long Beach
for Kilroy Long Beach Phase III.
10.11* Lease Agreement, dated April 21, 1988, by and between Kilroy Long Beach Associates and the Board of
Water Commissioners of the City of Long Beach, acting for and on behalf of the City of Long Beach, for Long
Beach Phase IV.
10.12* Lease Agreement, dated December 30, 1988, by and between Kilroy Long Beach Associates and City of
</TABLE>
13
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Description
------- -----------
<S> <C>
Long Beach for Kilroy Long Beach Phase II.
10.13* First Amendment to Lease, dated January 24, 1989, by and between
Kilroy Long Beach Associates and the City of Long Beach for
Kilroy Long Beach Phase III.
10.14* Second Amendment to Lease Agreement, dated December 28, 1990, by
and between Kilroy Long Beach Associates and the City of Long
Beach for Kilroy Long Beach Phase III.
10.15* First Amendment to Lease Agreement, dated December 28, 1990, by
and between Kilroy Long Beach Associates and the City of Long
Beach for Kilroy Long Beach Phase II.
10.16* Third Amendment to Lease Agreement, dated October 10, 1994 , by
and between Kilroy Long Beach Associates and the City of Long
Beach for Kilroy Long Beach Phase III.
10.17* Development Agreement by and between Kilroy Long Beach Associates
and the City of Long Beach.
10.18* Amendment No. 1 to Development Agreement by and between Kilroy
Long Beach Associates and the City of Long Beach.
10.19* Ground Lease by and between Frederick Boysen and Ted Boysen and
Kilroy Industries, dated May 15, 1969, for SeaTac Office Center.
10.20* Amendment No. 1 to Ground Lease and Grant of Easement, dated
April 27, 1973, among Frederick Boysen and Dorothy Boysen, Ted
Boysen and Rose Boysen and Sea/Tac Properties.
10.21* Amendment No. 2 to Ground Lease and Grant of Easement, dated May
17, 1997, among Frederick Boysen and Dorothy Boysen, Ted Boysen
and Rose Boysen and Sea/Tac Properties.
10.22* Airspace Lease, dated July 10, 1980, by and among the Washington
State Department of Transportation, as Lessor, and Sea Tac
Properties, Ltd. and Kilroy Industries, as lessee.
10.23* Lease, dated April 1, 1980, by and among Bow Lake, Inc., as
lessor, and Kilroy Industries and SeaTac Properties, Ltd., as
lessees for Sea/Tac Office Center.
10.24* Amendment No. 1 to Ground Lease, dated September 17, 1990,
between Bow Lake, Inc., as lessor, and Kilroy Industries and
Sea/Tac Properties, Ltd., as lessee.
10.25* Amendment No. 2 to Ground lease, dated March 21, 1991, between
Bow Lake, Inc., as lessor, and Kilroy Industries and Sea/Tac
Properties, Ltd., as lessee.
10.26* Property Management Agreement between Kilroy Realty Finance
Partnership, L.P. and Kilroy Realty, L.P.
10.27* Form of Environmental Indemnity Agreement.
10.28* Option Agreement by and between Kilroy Realty, L.P. and Kilroy
Airport Imperial Co.
10.29* Option Agreement by and between Kilroy Realty, L.P. and Kilroy
Calabasas Associates.
10.30* Employment Agreement between the Registrant and John B.
Kilroy, Jr.
10.31* Employment Agreement between the Registrant and Richard E.
Moran Jr.
10.32* Employment Agreement between the Registrant and Jeffrey C.
Hawken.
10.33* Employment Agreement between the Registrant and C. Hugh Greenup.
10.34* Noncompetition Agreement by and between the Registrant and John
B. Kilroy, Sr.
10.35* Noncompetition Agreement by and between the Registrant and John
B. Kilroy, Jr.
10.36* License Agreement by and among the Registrant and the other
persons named therein.
10.37* Form of Indenture of Mortgage, Deed of Trust, Security Agreement,
Financing Statement, Fixture Filing and Assignment of Leases,
Rents and Security Deposits.
10.38* Form of Mortgage Note.
10.39* Form of Indemnity Agreement.
10.40* Form of Assignment of Leases, Rents and Security Deposits.
10.41* Form of Credit Agreement.
10.42* Form of Variable Interest Rate Indenture of Mortgage, Deed of
Trust, Security Agreement, Financing Statement, Fixture Filing
and Assignment of Leases and Rents.
10.43* Form of Environmental Indemnity Agreement.
10.44* Form of Assignment, Rents and Security Deposits.
10.45* Form of Revolving Credit Agreement.
10.46* Form of Mortgage, Deed of Trust, Security Agreement, Financing
Statement, Fixture Filing and Assignment of Leases and Rents.
10.47* Assignment of Leases, Rents and Security Deposits.
</TABLE>
14
<PAGE>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
27.1** Financial Data Schedule.
* Previously filed as an exhibit to Registration Statement on Form S-11 (No.
333-15553) and incorporated herein by reference.
** Filed herewith.
Reports on Form 8-K. - None
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized on May 14, 1997.
Kilroy Realty Corporation
By: /s/ John B. Kilroy, Jr.
John B. Kilroy, Jr.
President and Chief Executive Officer
By: /s/ Richard E. Moran Jr.
Richard E. Moran Jr.
Executive Vice President and
Chief Financial Officer
By: /s/ Ann Marie Whitney
Ann Marie Whitney
Vice President and Controller
15
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10-Q
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 3-MOS
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1996
<PERIOD-START> JAN-01-1997 JAN-01-1996
<PERIOD-END> MAR-31-1997 MAR-31-1996
<CASH> 116,163 0
<SECURITIES> 0 0
<RECEIVABLES> 5,300 4,670
<ALLOWANCES> (1,763) (1,628)
<INVENTORY> 0 0
<CURRENT-ASSETS> 0 0
<PP&E> 285,402 227,337
<DEPRECIATION> (111,791) (109,668)
<TOTAL-ASSETS> 310,382 128,339
<CURRENT-LIABILITIES> 0 0
<BONDS> 0 0
0 0
0 0
<COMMON> 145 0
<OTHER-SE> 169,677 128,339
<TOTAL-LIABILITY-AND-EQUITY> 310,382 128,339
<SALES> 0 0
<TOTAL-REVENUES> 12,025 9,921
<CGS> 0 0
<TOTAL-COSTS> 5,906 5,032
<OTHER-EXPENSES> 0 0
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 3,426 5,227
<INCOME-PRETAX> 2,693 (338)
<INCOME-TAX> 0 0
<INCOME-CONTINUING> 2,693 (338)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 3,204 0
<CHANGES> 0 0
<NET-INCOME> 5,354<F1> (338)
<EPS-PRIMARY> 0 0
<EPS-DILUTED> 0 0
<FN>
<F1>NET INCOME IS AFTER EQUITY IN LOSS OF UNCONSOLIDATED SUBSIDIARY ($57) AND
MINORITY INTEREST ($486).
</FN>
</TABLE>
