<PAGE>
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
AMENDMENT NO. 1 TO FORM 10-Q
ON
FORM 10-Q/A
(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, 1999
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)
<TABLE>
<S> <C>
Maryland 95-4598246
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
</TABLE>
2250 East Imperial Highway, Suite 1200, El Segundo, California 90245
(Address of principal executive offices)
(310) 563-5500
(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, 1999, 27,629,210 shares of common stock, par value $.01 per
share, were outstanding.
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<PAGE>
KILROY REALTY CORPORATION
QUARTERLY REPORT FOR THE THREE MONTHS ENDED MARCH 31, 1999
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
PART I--FINANCIAL INFORMATION
<C> <S> <C>
Item 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets as of March 31, 1999 and December
31, 1998 (Unaudited)............................................ 3
Consolidated Statements of Operations for the three months ended
March 31, 1999 and 1998 (Unaudited)............................. 4
Consolidated Statements of Cash Flows for the three months ended
March 31, 1999 and 1998 (Unaudited)............................. 5
Notes to the Consolidated Financial Statements (Unaudited)...... 6
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS........................................... 12
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK...... 22
PART II--OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS............................................... 25
Item 2. CHANGES IN SECURITIES........................................... 25
Item 3. DEFAULTS UPON SENIOR SECURITIES................................. 25
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............. 25
Item 5. OTHER INFORMATION............................................... 25
Item 6. EXHIBITS AND REPORTS ON FORM 8-K................................ 25
SIGNATURES...................................................... 26
</TABLE>
2
<PAGE>
PART I--FINANCIAL INFORMATION
ITEM 1. Financial Statements
KILROY REALTY CORPORATION
CONSOLIDATED BALANCE SHEETS
(unaudited, in thousands, except share data)
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
---------- ------------
ASSETS
------
<S> <C> <C>
INVESTMENT IN REAL ESTATE (Note 2):
Land and improvements................................ $ 258,062 $ 253,500
Buildings and improvements........................... 849,155 828,425
Undeveloped land and construction in progress, net... 176,011 112,359
---------- ----------
Total investment in real estate..................... 1,283,228 1,194,284
Accumulated depreciation and amortization............ (151,939) (145,437)
---------- ----------
Investment in real estate, net...................... 1,131,289 1,048,847
CASH AND CASH EQUIVALENTS.............................. 2,463 6,443
RESTRICTED CASH........................................ 7,457 6,896
TENANT RECEIVABLES, NET................................ 15,814 15,630
NOTES RECEIVABLE FROM RELATED PARTIES.................. 8,798
DEFERRED FINANCING AND LEASING COSTS, NET.............. 17,375 16,168
PREPAID EXPENSES AND OTHER ASSETS...................... 4,423 3,146
---------- ----------
TOTAL ASSETS........................................ $1,178,821 $1,105,928
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
LIABILITIES:
Mortgage debt (Note 3)............................... $ 227,836 $ 133,383
Unsecured line of credit (Note 3).................... 232,000 272,000
Accounts payable and accrued expenses................ 18,718 18,091
Accrued distributions (Note 8)....................... 13,567 12,895
Rents received in advance and tenant security
deposits............................................ 13,065 13,160
---------- ----------
Total liabilities................................... 505,186 449,529
---------- ----------
COMMITMENTS AND CONTINGENCIES..........................
MINORITY INTERESTS (Note 4):
8.075% Series A Cumulative Redeemable Preferred
unitholders......................................... 73,716 73,718
9.375% Series C Cumulative Redeemable Preferred
unitholders......................................... 34,471 34,410
Common unitholders................................... 80,412 72,372
Minority interest in Development LLCs................ 9,733
---------- ----------
Total minority interests............................ 198,332 180,500
---------- ----------
STOCKHOLDERS' EQUITY (Note 5):
Preferred stock, $.01 par value, 27,200,000 shares
authorized, none issued and outstanding.............
8.075% Series A Cumulative Redeemable Preferred
stock, $.01 par value, 1,700,000 shares authorized,
none issued and outstanding.........................
Series B Junior Participating Preferred stock, $.01
par value, 400,000 shares authorized, none issued
and outstanding.....................................
9.375% Series C Cumulative Redeemable Preferred
stock, $.01 par value, 700,000 shares authorized,
none issued and outstanding.........................
Common stock, $.01 par value, 150,000,000 shares
authorized, 27,629,210 and 27,639,210 shares issued
and outstanding, respectively....................... 276 276
Additional paid-in capital........................... 488,565 487,467
Distributions in excess of earnings.................. (13,538) (11,844)
---------- ----------
Total stockholders' equity.......................... 475,303 475,899
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY.......... $1,178,821 $1,105,928
========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE>
KILROY REALTY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited, in thousands, except share and per share data)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
----------------------
1999 1998
---------- ----------
<S> <C> <C>
REVENUES (Note 6):
Rental income....................................... $ 32,818 $ 25,460
Tenant reimbursements............................... 4,123 3,225
Interest income..................................... 400 474
Other income........................................ 209 194
---------- ----------
Total revenues.................................... 37,550 29,353
---------- ----------
EXPENSES:
Property expenses................................... 5,134 3,971
Real estate taxes................................... 3,009 2,088
General and administrative expenses................. 2,314 1,559
Ground leases....................................... 337 305
Interest expense.................................... 5,759 4,786
Depreciation and amortization....................... 7,217 5,854
---------- ----------
Total expenses.................................... 23,770 18,563
---------- ----------
INCOME BEFORE EQUITY IN LOSS OF UNCONSOLIDATED
SUBSIDIARY AND MINORITY INTERESTS 13,780 10,790
EQUITY IN LOSS OF UNCONSOLIDATED SUBSIDIARY........... (1)
---------- ----------
INCOME BEFORE MINORITY INTERESTS...................... 13,780 10,789
---------- ----------
MINORITY INTERESTS:
Distributions on Cumulative Redeemable
Preferred units.................................... (2,334) (700)
Minority interest in earnings....................... (1,536) (1,210)
---------- ----------
Total minority interests.......................... (3,870) (1,910)
---------- ----------
NET INCOME............................................ $ 9,910 $ 8,879
========== ==========
Net income per common share--basic (Note 7)........... $ 0.36 $ 0.35
========== ==========
Net income per common share--diluted (Note 7)......... $ 0.36 $ 0.35
========== ==========
Weighted average shares outstanding--basic (Note 7)... 27,632,543 25,230,467
========== ==========
Weighted average shares outstanding--diluted (Note 7). 27,632,594 25,400,890
========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE>
KILROY REALTY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in thousands)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
-------------------
1999 1998
-------- ---------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income............................................... $ 9,910 $ 8,879
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization........................... 7,217 5,854
Provision for uncollectable tenant receivables and
deferred rent.......................................... 215 190
Restricted stock compensation........................... 126 115
Minority interest in earnings........................... 1,536 1,210
Other................................................... (217) 1
Changes in assets and liabilities:
Tenant receivables...................................... (696) 290
Deferred leasing costs.................................. (872) (1,318)
Prepaid expenses and other assets....................... (734) (258)
Accounts payable and accrued expenses................... 1,553 (330)
Rents received in advance and tenant security deposits.. (95) 1,097
Accrued distributions to Cumulative Redeemable Preferred
unitholders............................................ 73 700
-------- ---------
Net cash provided by operating activities.............. 18,016 16,427
-------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Expenditures for operating properties.................... (18,645) (124,716)
Expenditures for undeveloped land and construction in
progress................................................ (43,240) (6,157)
Proceeds from sale of undeveloped land................... 1,387
Increase in escrow deposits.............................. (11,325)
Net investment in and advances (to) from unconsolidated
subsidiary.............................................. (1,173) 19
-------- ---------
Net cash used in investing activities.................. (61,671) (142,179)
-------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuances of common stock.............. 58,992
Net proceeds from issuance of Cumulative Redeemable
Preferred units......................................... 58,377
Net (repayment) borrowings on line of credit............. (40,000) 20,000
Proceeds from issuance of mortgage debt.................. 95,000 5,000
Principal payments on mortgage debt...................... (547) (1,404)
Financing costs.......................................... (1,322) (578)
(Increase) decrease in restricted cash................... (561) 766
Distributions paid to common stockholders and common
unitholders............................................. (12,895) (10,804)
-------- ---------
Net cash provided by financing activities.............. 39,675 130,349
-------- ---------
Net (decrease) increase in cash and cash equivalents...... (3,980) 4,597
Cash and cash equivalents, beginning of period............ 6,443 8,929
-------- ---------
Cash and cash equivalents, end of period ................. $ 2,463 $ 13,526
======== =========
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest, net of capitalized interest...... $ 5,111 $ 3,528
======== =========
Distributions paid to Cumulative Redeemable Preferred
unitholders............................................. $ 2,261
========
NON-CASH TRANSACTIONS:
Accrual of distributions payable (Note 8)................ $ 13,567 $ 12,413
======== =========
Issuance of common units of the Operating Partnership to
acquire operating properties and undeveloped land (Note
2)...................................................... $ 9,915 $ 13,511
======== =========
Minority interest recorded in connection with Development
LLC undeveloped land acquisitions (Notes 2 and 4)....... $ 9,733
========
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE>
KILROY REALTY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Three Months Ended March 31, 1999 and 1998
(Unaudited)
1. Organization
Kilroy Realty Corporation (the "Company") develops, owns, and operates
office and industrial real estate, primarily in Southern California. The
Company, which operates as a self-administered real estate investment trust
("REIT"), commenced operations upon the completion of its initial public
offering in January 1997. The Company is the successor to the real estate
business of the Kilroy Group, the Company's predecessor, which had been
engaged in the acquisition, management, financing, construction and leasing of
principally Class A suburban office and industrial properties in select
locations in key suburban submarkets, primarily in Southern California. As of
March 31, 1999, the Company's stabilized portfolio consisted of 82 office
properties and 86 industrial properties, which encompassed approximately 5.7
million and 6.2 million rentable square feet, respectively, and was 95.1%
occupied. In addition, as of March 31, 1999, the Company had under development
five office and one industrial building which when completed are expected to
encompass 408,000 and 212,000 rentable square feet, respectively. The Company
owns its interests in all of its properties through Kilroy Realty, L.P. (the
"Operating Partnership") and Kilroy Realty Finance Partnership, L.P. and
conducts substantially all of its operations through the Operating
Partnership. The Company owned an 85.5% general partnership interest in the
Operating Partnership as of March 31, 1999.
The majority of the Company's properties are located in Southern California.
The ability of the tenants to honor the terms of their respective leases is
dependent upon the economic, regulatory and social factors affecting the
communities and industries in which the tenants operate.
Basis of Presentation
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 ("SEC"). Certain information and footnote disclosures
required for annual financial statements have been condensed or excluded
pursuant to SEC rules and regulations. Accordingly, the interim financial
statements do not include all of the information and footnotes required by
generally accepted accounting principles for complete financial statements. In
the opinion of management, the interim financial statements presented herein
reflect all adjustments of a normal and recurring nature which are considered
necessary for a fair presentation of the results for the interim periods
presented. The results of operations for the interim period are not
necessarily indicative of the results that may be expected for the year ended
December 31, 1999. These financial statements should be read in conjunction
with the audited consolidated financial statements and the notes thereto
included in the Company's Annual Report on Form 10-K for the year ended
December 31, 1998.
2. Acquisitions and Dispositions
In February 1999, the Company acquired three acres of undeveloped land in
San Diego, California for $0.4 million in cash and 119,460 common units of the
Operating Partnership valued at $2.5 million based upon the closing share
price of the Company's common stock as reported on the New York Stock Exchange
("NYSE"). The undeveloped land was acquired from The Allen Group, a group of
affiliated real estate development companies based in Visalia, California. An
Executive Vice President of the Company received 76,896 of the total 119,460
common units issued in connection with the acquisition. The acquisition was
based upon terms that the Company believes were comparable to terms obtainable
from third-parties based on arm's-length negotiations.
In March 1999, the Company acquired one office property containing 126,000
aggregate rentable square feet in San Diego, California for $17.5 million in
cash and 168,402 common units of the Operating Partnership
6
<PAGE>
KILROY REALTY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Three Months Ended March 31, 1999 and 1998
(Unaudited)
valued at $3.6 million based upon the closing share price of the Company's
common stock as reported on the NYSE. The office property, which is 100%
leased through February 2014, was acquired pursuant to an existing agreement
executed between the Company and The Allen Group in October 1997. In May 1998,
the Company entered into an agreement to loan up to $2.3 million to a limited
liability company controlled by Richard S. Allen, a former member of the
Company's Board of Directors, to finance tenant improvements to this property.
The $2.3 million balance of the note and the related interest, which accrued
at a rate of Prime plus 1.00%, were repaid to the Company in connection with
the acquisition. An Executive Vice President of the Company received 98,476 of
the total 168,402 common units issued in connection with the acquisition. The
acquisition was based upon terms that the Company believes were comparable to
terms obtainable from third-parties based on arm's-length negotiations and was
funded primarily with existing working capital and borrowings on the Company's
revolving credit facility.
During the three months ended March 31, 1999, the Company acquired a 50%
interest in 55 acres of undeveloped land in San Diego, California for $16.1
million and 184,172 common units of the Operating Partnership valued at $3.8
million based upon the closing share price of the Company's common stock as
reported on the NYSE. The undeveloped land was acquired pursuant to an
existing agreement between the Company and The Allen Group that provided for
the joint development of two office projects, with approximately 1.0 million
aggregate rentable square feet, over the next five years. Both the Company and
The Allen Group contributed their respective 50% interests in the undeveloped
land to two limited liability companies (the "Development LLCs") upon the
completion of the acquisition. In connection with this anticipated
transaction, the Company entered into an agreement in May 1998 to loan up to
$8.5 million to a limited partnership controlled by Richard S. Allen to
finance infrastructure improvements on the undeveloped land. The $8.5 million
balance of the note was assumed by the Development LLCs in connection with the
undeveloped land acquisition. The related interest, which accrued at a rate of
LIBOR plus 1.85%, was paid to the Company by the limited partnership. An
Executive Vice President of the Company received 69,694 of the total 184,172
common units issued in connection with the acquisition. The acquisition was
based upon terms that the Company believes were comparable to terms obtainable
from third-parties based on arm's-length negotiations and was funded primarily
with existing working capital and borrowings on the Company's revolving credit
facility.
In February 1999, the Company sold eight acres of its 18-acre undeveloped
land parcel in Calabasas, California to the City of Calabasas for a total
sales price of $1.4 million. The land is part of a 66-acre development site
which is presently entitled for over 1.0 million rentable square feet of
office, retail and hotel development. The Company presently plans to develop
210,000 rentable square feet of office property on the remaining ten acres it
currently owns. The infrastructure improvements on the land were financed with
public facility bonds sponsored by the County of Los Angeles which were
refinanced in February 1999. In connection with the refinancing, the portion
of the original obligation that related to the eight acres the Company sold to
the City of Calabasas was defeased. The refinanced bonds, which were sponsored
by the City of Calabasas, currently have a principal balance of $12.5 million
and consist of: $5.9 million in serial bonds that mature annually beginning on
September 1, 2000 through September 1, 2012 with annual principal payments
ranging from $0.4 million to $0.6 million and interest rates ranging from
4.00% to 5.55%; $3.4 million of 5.65% Term Bonds due September 1, 2020; and
$3.2 million of 5.75% Term Bonds due September 1, 2028. Principal and interest
on the public facility bonds are to be charged to the Company and the other
property owners through special property tax bills through 2028. The bonds do
not contain cross-collateralization provisions and therefore if one property
owner defaulted on their special tax payments, the other property owners would
not be obligated to repay the defaulted taxes. Based on the planned
development of the total site, the Company's maximum obligation for its
portion of the development site is estimated at $5.5 million but may decrease
depending on the actual size and number of buildings built. Because the
assessment on each individual property owner is dependant upon the rate of
development of the entire development site and therefore is not fixed and
7
<PAGE>
KILROY REALTY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Three Months Ended March 31, 1999 and 1998
(Unaudited)
determinable, the obligation was not recorded by the Company at March 31,
1999. The periodic assessments are currently capitalized as development costs
and will be charged to operations upon the completion of construction.
3. Unsecured Line of Credit and Mortgage Debt
As of March 31, 1999, the Company had borrowings of $232 million and one
letter of credit in the amount of $0.1 million outstanding under its revolving
unsecured line of credit (the "Credit Facility"). Availability under the
Credit Facility was $77.9 million at March 31, 1999 based upon the value of
the Company's unencumbered stabilized operating assets.
On March 11, 1999, the Company executed a $95.0 million mortgage loan. The
mortgage loan is collateralized by nine office and industrial properties,
requires monthly principal and interest payments based on a fixed interest
rate of 7.20%, amortizes over 25 years, and matures in April 2009. Two letters
of credit totaling $2.0 million, which the Company issued under the Credit
Facility in December 1998 and January 1999 to cover the deposit and
application costs required by the mortgagor, expired upon the closing of the
mortgage loan. The Company used the proceeds from the mortgage loan to repay
borrowings under the Credit Facility and to fund development expenditures.
On April 23, 1999, the Company executed a $30.0 million mortgage loan. The
mortgage loan is collateralized by one office property and the related ground
leases, requires monthly principal and interest payments based on a fixed
interest rate of 7.15%, amortizes over 18 years, and matures in May 2017. The
Company used the proceeds from the mortgage loan to repay an existing mortgage
loan with an outstanding balance of $19.0 million at March 31, 1999, to repay
borrowings under the Credit Facility and to fund development expenditures.
Total interest capitalized for the three months ended March 31, 1999 and
1998 was $1.9 million and $1.4 million, respectively.
4. Minority Interests
Minority interests represent the preferred and common limited partnership
interests in the Operating Partnership and interests held by The Allen Group
in the Development LLCs.
During the three months ended March 31, 1999, the Operating Partnership
issued 472,034 common units of the Operating Partnership in connection with
operating property and undeveloped land acquisitions (see Note 2). As a
result, the Company owned an 85.5% general partnership interest in the
Operating Partnership as of March 31, 1999.
During the three months ended March 31, 1999, the Company became a 50%
managing member in the Development LLCs as a result of the acquisition of
certain undeveloped land and the simultaneous contribution of such land to the
Development LLCs (see Note 2). The Development LLCs are consolidated for
financial reporting purposes since the Company holds significant control over
the entities through a 50% ownership interest, combined with the ability to
control all significant development decisions.
5. Stockholders Equity
In February 1999, the Company filed a registration statement on Form S-3
with the SEC which registered the potential issuance and resale of up to
2,817,476 shares of the Company's common stock to the identified
8
<PAGE>
KILROY REALTY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Three Months Ended March 31, 1999 and 1998
(Unaudited)
holders of 2,817,476 common units of the Operating Partnership. The 2,817,476
common units, previously issued in connection with two 1997 transactions, may
be exchanged, at the Company's option, on a one-for-one basis, into shares of
the Company's common stock on or after January 31, 1999. The Company and the
Operating Partnership will not receive any of the proceeds from the issuance
of the common stock to the identified common unitholders. The registration
statement has not yet been declared effective by the SEC.
In March 1999, the Company filed a registration statement on Form S-3 with
the SEC which, in connection with the adoption of the Company's Dividend
Reinvestment and Direct Purchase Plan (the "Plan"), registered 1,000,000
shares of the Company's common stock. The Plan, which is designed to provide
the Company's stockholders and other investors with a convenient and
economical method to purchase shares of the Company's common stock, consists
of three programs: the Dividend Reinvestment Program (the "DRIP"), the Cash
Option Purchase Plan (the "COPP") and the Waiver Discount Plan (the "WDP").
The DRIP provides existing common stockholders with the opportunity to
purchase additional shares of the Company's common stock by automatically
reinvesting all or a portion of their cash dividends. The COPP provides
existing common stockholders and other investors with the opportunity to
purchase additional shares of the Company's common stock by making optional
cash purchases, at no discount to market, between $100 to $5,000 and $750 to
$5,000, respectively, in any calendar month. The WDP provides existing common
stockholders and other investors with the opportunity to purchase additional
shares of the Company's common stock by making optional cash purchases, at a
discount to market of up to 2.00% of the average per share price reported on
the NYSE, of greater than $5,000 in any calendar month. The Plan will acquire
shares of the Company's common stock from either new issuances directly from
the Company or from the open market or from privately negotiated transactions,
except for transactions executed under the WDP which will be purchased only
from previously unissued shares of common stock. Participation in the Plan is
entirely voluntary, and can be terminated at any time. The registration
statement has not yet been declared effective by the SEC.
In May 1999, the Company filed a registration statement on Form S-8 with the
SEC that registered the potential issuance and resale of up to 1,500,000
shares of the Company's common stock in connection with shares of the
Company's common stock issuable to the Company's employees and directors under
the 1997 Stock Option and Incentive Plan.
9
<PAGE>
KILROY REALTY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Three Months Ended March 31, 1999 and 1998
(Unaudited)
6. Segment Disclosure
The Company evaluates the performance of its segments based upon net
operating income. Net operating income is defined as operating revenues
(rental income, tenant reimbursements and other property income) less property
and related expenses (property expenses, real estate taxes, and ground leases)
and does not include interest income and expense, depreciation and
amortization, and corporate general and administrative expenses.
<TABLE>
<CAPTION>
Three Months
Ended
March 31,
----------------
1999 1998
------- -------
(in thousands)
<S> <C> <C>
Revenues and Expenses
Office Properties:
Operating revenues(1)...................................... $25,558 $19,858
Property and related expenses.............................. 6,486 5,101
------- -------
Net operating income, as defined........................... 19,072 14,757
------- -------
Industrial Properties:
Operating revenues(1)...................................... 11,592 9,021
Property and related expenses.............................. 1,994 1,263
------- -------
Net operating income, as defined........................... 9,598 7,758
------- -------
Total Reportable Segments:
Operating revenues(1)...................................... 37,150 28,879
Property and related expenses.............................. 8,480 6,364
------- -------
Net operating income, as defined........................... 28,670 22,515
------- -------
Reconciliation to Consolidated Net Income:
Total net operating income, as defined, for reportable
segments.................................................. 28,670 22,515
Other unallocated revenues:
Interest income.......................................... 400 474
Other unallocated expenses:
General and administrative expenses...................... 2,314 1,559
Interest expense......................................... 5,759 4,786
Depreciation and amortization............................ 7,217 5,854
------- -------
Net income before equity in loss of unconsolidated subsidiary
and minority interests...................................... 13,780 10,790
Equity in loss of unconsolidated subsidiary.................. (1)
Minority interests........................................... (3,870) (1,910)
------- -------
Net income................................................... $ 9,910 $ 8,879
======= =======
</TABLE>
- --------
(1) All operating revenues are comprised of amounts received from external
tenants.
10
<PAGE>
KILROY REALTY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Three Months Ended March 31, 1999 and 1998
(Unaudited)
7. Earnings Per Share
Basic earnings per share is computed by dividing net income by the weighted-
average number of common shares outstanding for the period. Diluted earnings
per share is computed by dividing net income by the sum of the weighted-
average number of common shares outstanding for the period plus the assumed
exercise of all dilutive securities. The Company does not consider common
units of the Operating Partnership to be dilutive since the exchange of common
units into common stock is on a one-for-one basis and would not have any
effect on diluted earnings per share. The following table reconciles the
numerator and denominator of the basic and diluted per-share computations for
net income.
<TABLE>
<CAPTION>
Three Months Ended March 31, 1999
-----------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ---------
(in thousands, except share and
per share amounts)
<S> <C> <C> <C>
Basic.................................... $9,910 27,632,543 $0.36
Effect of dilutive securities:
Stock options granted.................. 51
------ ---------- -----
Diluted.................................. $9,910 27,632,594 $0.36
====== ========== =====
<CAPTION>
Three Months Ended March 31, 1998
-----------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ---------
(in thousands, except share and
per share amounts)
<S> <C> <C> <C>
Basic.................................... $8,879 25,230,467 $0.35
Effect of dilutive securities:
Stock options granted.................. 170,423
------ ---------- -----
Diluted.................................. $8,879 25,400,890 $0.35
====== ========== =====
</TABLE>
At March 31, 1999, Company employees and directors held options to purchase
2,343,000 shares of the Company's common stock that were antidilutive to the
diluted earnings per share computation. These options could become dilutive in
future periods if the average market price of the Company's common stock
exceeds the exercise price of the outstanding options.
8. Subsequent Events
On April 12, 1999 distributions aggregating $13.6 million were paid to
common stockholders and common unitholders of record on March 31, 1999.
On April 20, 1999, the Company acquired nine acres of undeveloped land
located in San Diego, California for an aggregate purchase price of
approximately $4.3 million.
On April 23, 1999, the Company executed a $30.0 million mortgage loan (see
Note 3).
11
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion relates to the consolidated financial statements of
the Company and should be read in conjunction with the financial statements
and notes thereto appearing elsewhere in this report. Statements contained in
this "Management's Discussion and Analysis of Financial Condition and Results
of Operations" that are not historical facts may be forward-looking
statements. Such statements are subject to certain risks and uncertainties,
which could cause actual results to differ materially from those projected.
You are cautioned not to place undue reliance on these forward-looking
statements.
Overview and Background
Kilroy Realty Corporation (the "Company") develops, owns, and operates
office and industrial real estate, primarily in Southern California. The
Company, which operates as a self-administered real estate investment trust
("REIT"), commenced operations upon the completion of its initial public
offering in January 1997. The Company is the successor to the real estate
business of the Kilroy Group, the Company's predecessor, which had been
engaged in the acquisition, management, financing, construction and leasing of
principally Class A suburban office and industrial properties in select
locations in key suburban submarkets, primarily in Southern California. The
Company owns its interests in all of its properties through Kilroy Realty,
L.P. (the "Operating Partnership") and Kilroy Realty Finance Partnership, L.P.
and conducts substantially all of its operations through the Operating
Partnership. The Company owned an 85.5% general partnership interest in the
Operating Partnership as of March 31, 1999.
Results of Operations
During the three months ended March 31, 1999, the Company acquired one
office property totaling 126,000 rentable square feet, for a total purchase
price of $21.1 million. During 1998, the Company acquired 25 office and 16
industrial buildings totaling 1.4 million and 674,000 aggregate rentable
square feet, respectively, for an aggregate acquisition cost of approximately
$254 million. Operating results for acquired properties are included in the
consolidated financial statements of the Company subsequent to their
respective acquisition dates.
As a result of the properties acquired subsequent to March 31, 1998,
rentable square footage in the Company's portfolio of stabilized properties
increased 2.3 million rentable square feet, or 24.2% to 11.9 million rentable
square feet at March 31, 1999 compared to 9.6 million rentable square feet at
March 31, 1998. As of March 31, 1999, the Company's portfolio of stabilized
properties was comprised of 82 office properties (the "Office Properties")
encompassing 5.7 million rentable square feet and 86 industrial properties
(the "Industrial Properties" and together with the Office Properties the
"Properties") encompassing 6.2 million rentable square feet. The Company's
stabilized portfolio consists of all of the Company's Office and Industrial
Properties with the exception of properties and projects included in
construction in progress. With respect to properties developed by the Company,
the Company's policy is to include properties in its stabilized portfolio upon
the earlier of one year from the date of substantial completion or the date
such property reaches stabilized occupancy of 95.0%. The portfolio occupancy
rate at March 31, 1999 was 95.1%, with the Office and Industrial Properties
94.8% and 95.4% occupied, respectively.
12
<PAGE>
Three Months Ended March 31, 1999 compared to Three Months Ended March 31,
1998
<TABLE>
<CAPTION>
Three Months
Ended March 31,
--------------- Dollar Percentage
1999 1998 Change Change
------- ------- ------ ----------
(dollars in thousands)
<S> <C> <C> <C> <C>
Revenues:
Rental income............................ $32,818 $25,460 $7,358 28.9%
Tenant reimbursements.................... 4,123 3,225 898 27.8
Interest income.......................... 400 474 (74) (15.6)
Other income............................. 209 194 15 7.7
------- ------- ------
Total revenues......................... 37,550 29,353 8,197 27.9
------- ------- ------
Expenses:
Property expenses........................ 5,134 3,971 1,163 29.3
Real estate taxes........................ 3,009 2,088 921 44.1
General and administrative expenses...... 2,314 1,559 755 48.4
Ground leases............................ 337 305 32 10.5
Interest expense......................... 5,759 4,786 973 20.3
Depreciation and amortization............ 7,217 5,854 1,363 23.3
------- ------- ------
Total expenses......................... 23,770 18,563 5,207 28.1
------- ------- ------
Income before equity in income (loss) of
unconsolidated subsidiary and minority
interests................................. $13,780 $10,790 $2,990 27.7%
======= ======= ======
</TABLE>
Rental Operations
Management evaluates the operations of its portfolio based on operating
property type. The following tables compare the net operating income, defined
as operating revenues less property and related expenses (property expenses,
real estate taxes and ground leases) before depreciation, for the Office and
Industrial Properties for three months ended March 31, 1999 and 1998.
Office Properties
<TABLE>
<CAPTION>
Three Months
Ended March 31,
--------------- Dollar Percentage
1999 1998 Change Change
------- ------- ------ ----------
(dollars in thousands)
<S> <C> <C> <C> <C>
Operating Revenues:
Rental income............................... $22,541 $17,427 $5,114 29.3%
Tenant reimbursements....................... 2,817 2,321 496 21.4
Other income................................ 200 110 90 81.8
------- ------- ------
Total..................................... 25,558 19,858 5,700 28.7
------- ------- ------
Property and related expenses:
Property expenses........................... 4,285 3,472 813 23.4
Real estate taxes........................... 1,864 1,323 541 40.9
Ground leases............................... 337 306 31 10.1
------- ------- ------
Total..................................... 6,486 5,101 1,385 27.2
------- ------- ------
Net operating income, as defined.............. $19,072 $14,757 $4,315 29.2%
======= ======= ======
</TABLE>
Total revenues from Office Properties increased $5.7 million, or 28.7% to
$25.6 million for the three months ended March 31, 1999 compared to $19.9
million for the three months ended March 31, 1998. Rental income from Office
Properties increased $5.1 million, or 29.3% to $22.5 million for the three
months ended March 31,
13
<PAGE>
1999 compared to $17.4 million for the three months ended March 31, 1998. Of
this increase, $0.1 million was generated by one office property acquired
during 1999 (the "1999 Office Acquisition"), $3.5 million was generated by the
Office Properties acquired during 1998 (the "1998 Office Acquisitions") and
$0.7 million was generated by the Office Properties developed in 1998 (the
"1998 Office Development Properties"). The remaining $0.8 million of the
increase was generated by the stabilized office properties owned at January 1,
1998 and still owned at January 1, 1999 (the "Core Office Portfolio"), and
represented a 5.3% increase in rental income for the Core Office Portfolio.
Average occupancy in the Core Office Portfolio remained consistent for the
three months ended March 31, 1999 compared to the three months ended March 31,
1998. The increase in rental income generated by the Core Office Portfolio was
primarily attributable to increases in rental rates.
Tenant reimbursements from Office Properties increased $0.5 million, or
21.4% to $2.8 million for the three months ended March 31, 1999 compared to
$2.3 million for three months ended March 31, 1998. Of this increase, $0.4
million was attributable to the 1999 Office Acquisition, the 1998 Office
Acquisitions and the 1998 Office Development Properties. The remaining $0.1
million of the increase was generated by the Core Office Portfolio. Other
income from office buildings increased $0.1 million, or 81.8% to $0.2 million
for the three months ended March 31, 1999 compared to $0.1 million for the
comparable period in 1998. This increase is primarily due to a $0.1 million
gain on the sale of eight acres of undeveloped land in Calabassas, California.
Total expenses from Office Properties increased $1.4 million, or 27.2% to
$6.5 million for the three months ended March 31, 1999 compared to $5.1
million for the three months ended March 31, 1998. Property expenses increased
$0.8 million, or 23.4% to $4.3 million and real estate taxes increased $0.5
million, or 40.9% to $1.8 million for the three months ended March 31, 1999
compared to $3.5 million and $1.3 million, respectively, for the three months
ended March 31, 1998. Of the collective increase of $1.3 million in property
expenses and real estate taxes, $1.2 million was attributable to the 1998
Office Acquisitions and the 1998 Office Development Properties. The remaining
$0.1 million of the increase at the Core Office Portfolio was primarily due to
an increase in real estate taxes at the SeaTac Office Center which resulted
from the completion of substantial renovations. Ground lease expense remained
consistent for the three months ended March 31, 1999 compared to the
comparable period in 1998.
Net operating income, as defined, from Office Properties increased $4.3
million, or 29.2% to $19.1 million for the three months ended March 31, 1999
compared to $14.8 million for the three ended March 31, 1998. Of this
increase, $3.5 million was generated by the 1999 Office Acquisition, the 1998
Office Acquisitions, and the 1998 Office Development Properties. The remaining
increase of $0.8 million was generated by the Core Office Portfolio and
represents a 6.4% increase in net operating income for the Core Office
Portfolio.
Industrial Properties
<TABLE>
<CAPTION>
Three Months
Ended
March 31,
-------------- Dollar Percentage
1999 1998 Change Change
------- ------ ------ ----------
(dollars in thousands)
<S> <C> <C> <C> <C>
Operating Revenues:
Rental income............................... $10,277 $8,032 $2,245 28.0%
Tenant reimbursements....................... 1,305 904 401 44.4
Other income................................ 10 85 (75) (88.2)
------- ------ ------
Total..................................... 11,592 9,021 2,571 28.5
------- ------ ------
Property and related expenses:
Property expenses........................... 850 498 352 70.7
Real estate taxes........................... 1,144 765 379 49.5
------- ------ ------
Total..................................... 1,994 1,263 731 57.9
------- ------ ------
Net operating income, as defined.............. $ 9,598 $7,758 $1,840 23.7%
======= ====== ======
</TABLE>
14
<PAGE>
Total revenues from Industrial Properties increased $2.6 million, or 28.5%
to $11.6 million for the three months ended March 31, 1999 compared to $9.0
million for the three months ended March 31, 1998. Rental income increased
$2.3 million, or 28.0% to $10.3 million for the three months ended March 31,
1999 compared to $8.0 million for the three months ended March 31, 1998. Of
this increase, $1.0 million was generated by the Industrial Properties
acquired during 1998 (the "1998 Industrial Acquisitions") and $1.3 million was
generated by the Industrial Properties developed in 1998 (the "1998 Industrial
Development Properties"). Rental income from the stabilized industrial
properties owned at January 1, 1998 and still owned at January 1, 1999 (the
"Core Industrial Portfolio") remained consistent for the three months ended
March 31, 1999 compared to the comparable period in 1998.
Tenant reimbursements from Industrial Properties increased $0.4 million, or
44.4% to $1.3 million for the three months ended March 31, 1999 compared to
$0.9 million for three months ended March 31, 1998. Of this increase, $0.2
million was attributable to the 1998 Industrial Acquisitions and the 1998
Industrial Development Properties. The remaining $0.2 million was attributable
to the Core Industrial Portfolio, of which $0.1 million correlated with the
increase in real estate taxes reimbursable by tenants. Other income decreased
$75,000 or 88.2% to $10,000 for the three months ended March 31, 1999 compared
to $85,000 for the same period in 1998. Other income for the three months
ended March 31, 1998 included $75,000 in lease termination fees.
Total expenses from Industrial Properties increased $0.7 million, or 57.9%
to $2.0 million for the three months ended March 31, 1999 compared to $1.3
million for the three months ended March 31, 1998. Property expenses increased
$0.3 million, or 70.7% to $0.8 million and real estate taxes increased $0.4
million, or 49.5% to $1.1 million for the three months ended March 31, 1999
compared to $0.5 million and $0.8 million, respectively, for the three months
ended March 31, 1998. Of the collective $0.7 million increase in property
expenses and real estate taxes, $0.5 million was attributable to the 1998
Industrial Acquisitions and the 1998 Industrial Development Properties. The
remaining $0.2 million increase was attributable to the Core Industrial
Portfolio and was primarily due to an increase in real estate taxes
attributable to acquisition-related increases on properties acquired by the
Company in 1997.
Net operating income, as defined, from Industrial Properties increased $1.8
million, or 23.7% to $9.6 million for the three months ended March 31, 1999
compared to $7.8 million for the three months ended March 31, 1998. An
increase of $1.9 million in net operating income generated from the 1998
Industrial Acquisitions and the 1998 Industrial Development Properties was
offset by a decrease of $0.1 million in net operating income from the Core
Industrial Portfolio. This decrease was due primarily to the recognition of
$0.1 million in lease termination fees during the three months ended March 31,
1998.
Non-Property Related Income and Expenses
Interest income decreased $0.1 million, or 15.6% to $0.4 million for the
three months ended March 31, 1999 compared to $0.5 million for the three
months ended March 31, 1998 due to a decrease in cash on hand.
General and administrative expenses increased $0.8 million, or 48.4% to $2.3
million for the three months ended March 31, 1999 compared to $1.5 million for
the three months ended March 31, 1998, due to increased management,
administrative and personnel costs associated with the Company's increased
portfolio size.
Interest expense increased $1.0 million, or 20.3% to $5.8 million for the
three months ended March 31, 1999 compared to $4.8 million for the comparable
period in 1998, primarily due to a general increase in mortgage borrowings and
higher monthly average outstanding balances under the Company's Credit
Facility during the first quarter of 1999. The Company's weighted average
interest rate decreased 0.5% to 7.0% at March 31, 1999 compared to 7.5% at
March 31, 1998.
Depreciation and amortization expense increased $1.4 million, or 23.3% to
$7.2 million for the three months ended March 31, 1999 compared to $5.8
million for the comparable period in 1998. The increase was due to a full
quarter of depreciation on properties acquired during 1998.
15
<PAGE>
Liquidity and Capital Resources
The Company has a $350 million unsecured revolving line of credit (the
"Credit Facility") which bears interest at a rate of either LIBOR plus 1.00%,
LIBOR plus 1.13%, LIBOR plus 1.25% or LIBOR plus 1.38% (6.23% at March 31,
1999) depending on the Company's leverage ratio at the time of borrowing, and
matures in February 2000, with the lender's option to extend for one year.
Availability under the Credit Facility depends upon the value of the Company's
unencumbered stabilized operating assets and was $77.9 million at March 31,
1999. As of March 31, 1999, the Company had borrowings of $232 million and one
letter of credit in the amount of $0.1 million outstanding under the Credit
Facility.
On March 11, 1999, the Company executed a $95.0 million mortgage loan. The
mortgage loan is collateralized by nine office and industrial properties,
requires monthly principal and interest payments based on a fixed interest
rate of 7.20%, amortizes over 25 years, and matures in April 2009. Two letters
of credit totaling $2.0 million, which the Company issued under the Credit
Facility in December 1998 and January 1999 to cover the deposit and
application costs required by the mortgagor, expired upon the closing of the
mortgage loan. The Company used the proceeds from the mortgage loan to repay
borrowings under the Credit Facility and to fund development expenditures.
On April 23, 1999, the Company executed a $30.0 million mortgage loan. The
mortgage loan is collateralized by one office property and the related ground
leases, requires monthly principal and interest payments based on a fixed
interest rate of 7.15%, amortizes over 18 years, and matures in May 2017. The
Company used the proceeds from the mortgage loan to repay an existing mortgage
loan with an outstanding balance of $19.0 million at March 31, 1999, to repay
borrowings under the Credit Facility and to fund development expenditures.
On March 10, 1999, the Company filed a registration statement on Form S-3
with the SEC which, in connection with the adoption of the Company's Dividend
Reinvestment and Direct Purchase Plan (the "Plan"), registered 1,000,000
shares of the Company's common stock. The Plan, which is designed to provide
the Company's stockholders and other investors with a convenient and
economical method to purchase shares of the Company's common stock, consists
of three programs: the DRIP, the COPP and the WDP. The DRIP provides existing
common stockholders with the opportunity to purchase additional shares of the
Company's common stock by automatically reinvesting all or a portion of their
cash dividends. The COPP provides existing common stockholders and other
investors with the opportunity to purchase additional shares of the Company's
common stock by making optional cash purchases, at no discount to market,
between $100 to $5,000 and $750 to $5,000, respectively, in any calendar
month. The WDP provides existing common stockholders and other investors with
the opportunity to purchase additional shares of the Company's common stock by
making optional cash purchases, at a discount to market of up to 2.00% of the
average per share price reported on the NYSE, of greater than $5,000 in any
calendar month. The Plan will acquire shares of the Company's common stock
from either new issuances directly from the Company, from the open market or
from privately negotiated transactions, except for transactions executed under
the WDP which will be purchased only from previously unissued shares of common
stock. Participation in the Plan is entirely voluntary, and can be terminated
at any time. The Company intends to use the proceeds received from the Plan,
less transaction costs, for development and investment activities, repayment
of outstanding indebtedness and general corporate uses. This registration
statement has not yet been declared effective by the SEC.
In January 1998, the Company filed a "shelf" registration statement on Form
S-3 with the SEC that registered $400 million of equity securities of the
Company. As of May 12, 1999, an aggregate of $313 million of equity securities
were available for issuance under the registration statement.
16
<PAGE>
Capital Expenditures
As of March 31, 1999, the Company had approximately 408,000 and 212,000
rentable square feet of office and industrial space, respectively, under
construction at a total budgeted cost of approximately $85.5 million. The
Company has spent an aggregate of $42.1 million on these projects as of March
31, 1999. The Company intends to finance the remaining $43.4 million of
development costs with borrowings under the Credit Facility and working
capital. In addition, at March 31, 1999, the Company has also spent $134
million on land and pre-development costs for phased development projects
which are planned for the next five years.
At March 31, 1999, the Company had escrow deposits of $0.4 million for the
contemplated acquisition of one office building with 50,000 aggregate rentable
square feet. The aggregate acquisition cost of the land and building is
estimated to be approximately $9.0 million. The Company intends to finance the
acquisition with borrowings under the Credit Facility and working capital.
In connection with an agreement signed with The Allen Group in October 1997,
the Company is committed to purchase two office properties totaling 254,000
rentable square feet for an aggregate purchase price of $40.1 million. On
March 19, 1999, the Company acquired the first of the two office properties
encompassing 126,000 rentable square feet for $17.5 million in cash and
168,402 common units of the Operating Partnership valued at approximately $3.6
million based upon the closing share price of the Company's common stock as
reported on the NYSE. The acquisition was based upon what the Company believes
were terms comparable to terms obtainable from third-parties based on arm's-
length negotiations. An Executive Vice President of the Company received
98,476 of the total 168,402 common units. The Company intends to finance the
remaining acquisition with borrowings under the Credit Facility and the
issuance of approximately $7.4 million of common units of the Operating
Partnership.
The transaction with The Allen Group also provides for the development of
two office projects in San Diego, California with approximately 1.0 million
aggregate rentable square feet for an estimated aggregate development cost of
approximately $150 million. The Company agreed to purchase a 50% interest in
the two projects and to manage the development of both projects upon
completion of all necessary entitlements and infrastructure. During the three
months ended March 31, 1999, the Company purchased a 50% managing interest in
both of the development projects for an aggregate purchase price of
$16.1 million and 184,172 common units of the operating Partnership valued at
approximately $3.8 million based upon the closing share price of the Company's
common stock on the NYSE. Both the Company and The Allen Group contributed
their respective 50% interests to the Development LLCs. The acquisitions were
based upon what the Company believes were terms comparable to terms obtainable
from third-parties based on arm's-length negotiations. An Executive Vice
President of the Company received 69,694 of the total 184,172 common units.
The Company has the option to purchase The Allen Group's remaining interest in
both projects for a purchase price to be determined upon completion of the
projects. Construction of phase 1 of both office projects commenced in the
fourth quarter of 1998 and the total budgeted investment of phase 1 of both
projects of $39.4 million is included in the total budgeted cost of
$85.5 million discussed above.
The Company believes that it will have sufficient capital resources to
satisfy its obligations and planned capital expenditures for the next twelve
months. The Company expects to meet its long-term liquidity requirements
including possible future development and property acquisitions, through
retained cash flow, long-term secured and unsecured borrowings, and the
issuance of debt or equity securities or the issuance of common units of the
Operating Partnership.
17
<PAGE>
Building and Lease Information
The following tables set forth certain information regarding the Company's
Office and Industrial Properties at March 31, 1999:
Occupancy by Segment Type
<TABLE>
<CAPTION>
Number of Square Feet
Region Buildings Total Leased Available Occupancy
- ------ --------- ---------- ----------- --------- ---------
<S> <C> <C> <C> <C> <C>
Office Properties:
Los Angeles................ 27 2,418,339 2,304,466 113,873 95.3%
Orange County.............. 27 1,010,983 914,657 96,326 90.5
San Diego.................. 22 1,587,580 1,535,040 52,540 96.7
Other...................... 6 709,614 671,872 37,742 94.7
--- ---------- ---------- -------
82 5,726,516 5,426,035 300,481 94.8
--- ---------- ---------- -------
Industrial Properties:
Los Angeles................ 8 679,736 679,561 175 100.0
Orange County.............. 62 3,946,456 3,808,447 138,009 96.5
San Diego.................. 3 199,351 199,351 -- 100.0
Other...................... 13 1,326,557 1,181,799 144,758 89.1
--- ---------- ---------- -------
86 6,152,100 5,869,158 282,942 95.4
--- ---------- ---------- -------
Total...................... 168 11,878,616 11,295,193 583,423 95.1%
=== ========== ========== =======
</TABLE>
Lease Expirations by Segment Type
<TABLE>
<CAPTION>
Percentage
Square of Leased Annual Base
Footage Square Feet Rent Under
Number of of Represented Expiring
Expiring Expiring by Expiring Leases
Year of Lease Expiration Leases(1) Leases Leases(2) (in 000's)(3)
- ------------------------ --------- --------- ----------- -------------
<S> <C> <C> <C> <C>
Office Properties:
Remaining 1999................... 80 524,016 9.4% $ 9,435
2000............................. 91 394,472 7.1 7,317
2001............................. 93 1,062,137 19.0 14,891
2002............................. 46 534,873 9.6 7,745
2003............................. 35 218,753 3.9 3,736
2004............................. 27 801,467 14.3 15,825
--- --------- -------
372 3,535,718 63.3% 58,949
--- --------- -------
Industrial Properties:
Remaining 1999................... 67 391,289 6.8% $ 2,475
2000............................. 82 952,556 16.5 7,128
2001............................. 51 870,845 15.1 5,172
2002............................. 21 184,885 3.2 1,813
2003............................. 27 735,333 12.7 4,759
2004............................. 8 458,262 7.9 3,394
--- --------- -------
256 3,593,170 62.2% 24,741
--- --------- -------
Total............................ 628 7,128,888 62.6% $83,690
=== ========= =======
</TABLE>
- --------
(1) Represents the total number of tenants. Some tenants have multiple leases.
Excludes leases for amenity, retail, parking and month to month tenants.
(2) Based on total leased square footage for the respective portfolios as of
March 31, 1999.
(3) Determined based upon aggregate base rent to be received over the term,
divided by the term in months, multiplied by 12, including all leases
executed on or before April 1, 1999.
18
<PAGE>
Leasing Activity by Segment Type
For the Quarter Ended March 31, 1999
<TABLE>
<CAPTION>
Weighted
Number of Average
Leases Square Feet Lease
----------- --------------- Retention Term (in
New Renewal New(1) Renewal Rate months)
--- ------- ------- ------- --------- --------
<S> <C> <C> <C> <C> <C> <C>
Office Properties................ 18 21 212,506 260,585 66.8% 68
Industrial Properties............ 24 15 109,802 150,269 51.9 49
--- --- ------- -------
Total............................ 42 36 322,308 410,854 60.4% 61
=== === ======= =======
</TABLE>
- --------
(1) The lease-up of 302,308 square feet to new tenants includes re-leasing of
94,344 square feet and first generation leasing of 227,964 square feet.
Historical Cash Flows
The Company's net cash provided by operating activities increased $1.6
million, or 9.7% to $18.0 million for the three months ended March 31, 1999
compared to $16.4 million for the three months ended March 31, 1998. The
increase was primarily due to the increase in net income resulting from a full
quarter of operating results from the 1998 Office and Industrial Acquisitions
and an increase in net operating income, as defined, generated by the Core
Office and Industrial Portfolios. The increase was partially offset by
increased interest expense and general and administrative expenses.
Cash used in investing activities decreased $80.5 million, or 56.6% to $61.7
million for the three months ended March 31, 1999 compared to $142 million for
the three months ended March 31, 1998. The decrease was due primarily to the
purchase of one office property for $15.2 million (net of $3.6 million of
contributed value in exchange for which the Company issued common units of the
Operating Partnership and the repayment of an existing $2.3 million note
receivable), the purchase of 58 acres of undeveloped land for $16.5 million
(net of $6.3 million of contributed value in exchange for which the Company
issued common units of the Operating Partnership), the sale of eight acres of
undeveloped land for $1.4 million, expenditures for construction in progress
of $26.7 million, and $3.1 million in additional tenant improvements and
capital expenditures for the three months ended March 31, 1999 versus the
purchase of 25 office and industrial properties for $120 million (net of $13.5
million of contributed value in exchange for which the Company issued common
units of the Operating Partnership), the purchase of 2 acres of undeveloped
land for $1.6 million, expenditures for construction in progress of $6.2
million, $3.0 million in additional tenant improvements and capital
expenditures and $11.3 million for escrow deposits for the three months ended
March 31, 1998.
Cash provided by financing activities decreased $90.7 million, or 69.6% to
$39.7 million for the three months ended March 31, 1999 compared to $130
million for the three months ended March 31, 1998. Cash provided by financing
activities for the three months ended March 31, 1999 consisted primarily of
proceeds of $95.0 million from the issuance of mortgage debt, partially offset
by $40.0 million in repayments on the Credit Facility and $12.9 million in
distributions paid to common stockholders and common unitholders. Cash
provided by financing activities for the three months ended March 31, 1998
consisted of net proceeds of $59.0 million from common stock offerings, net
proceeds of $58.4 million from the issuance of 8.075% Series A Cumulative
Redeemable Preferred units, $25.0 million in net proceeds from the issuance of
mortgage debt and borrowings under the Credit Facility, partially offset by
$10.8 million in distributions paid to common stockholders and common
unitholders.
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) before minority
interests of common unitholders (computed in accordance with GAAP), excluding
gains (or
19
<PAGE>
losses) from debt restructuring and sales of property, plus real estate
related depreciation and amortization (excluding amortization of deferred
financing costs and depreciation of non-real estate assets), and after
adjustment for unconsolidated partnerships and joint ventures. The Company
considers Funds from Operations an appropriate measure of performance of an
equity REIT because it is predicated on cash flow analyses. 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 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 Funds from Operations published by such other REITs. Funds from
Operations should not be considered as an alternative to net income (loss)
(computed in accordance with GAAP) as an indicator of the properties'
financial performance or to cash flow from operating activities (computed in
accordance with GAAP) as an indicator of the properties' liquidity, nor is it
indicative of funds available to fund the properties' cash needs, including
the Company's ability to pay dividends or make distributions.
The following table presents the Company's Funds from Operations for the
three months ended March 31, 1999 and 1998.
<TABLE>
<CAPTION>
Three Months
Ended March 31,
---------------
1999 1998
------- -------
(in thousands)
<S> <C> <C>
Net income..................................................... $ 9,910 $ 8,879
Add:
Minority interest in earnings.............................. 1,536 1,210
Depreciation and amortization.............................. 7,217 5,854
Other...................................................... 127 118
------- -------
Funds from Operations.......................................... $18,790 $16,061
======= =======
</TABLE>
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.
Year 2000
The Year 2000 issue ("Y2K") refers to the inability of certain computer
systems, as well as certain hardware and equipment containing date sensitive
data, to recognize accurate dates commencing on or after January 1, 2000. This
has the potential to affect those systems adversely. In 1997, the Company's
Information Technology Committee, which is comprised of representatives from
senior management and various departments including accounting, property
management and information systems, identified three phases in the Company's
Y2K efforts: discovery and assessment, remediation and implementation, and
testing and verification. Although many of the phases are being completed
simultaneously, the following sections describe the activities that the
Company has or expects to perform to meet its Y2K objectives, as well as
management's assessment of the Company's risk of non-compliance.
The Company's State of Readiness
The initial phase of discovery and assessment consists of evaluating and
identifying all of the Company's information technology and non-information
technology systems that contain date sensitive data. The following summary
describes the classifications of systems that were identified and the
Company's current state of readiness for each classification.
20
<PAGE>
Information Technology Systems
The Company's information technology systems fall into three general
categories: accounting and property management systems, network operating
systems, and desktop software. The Company replaced its accounting and
property management system, acquired all new network hardware and software,
and updated all of its desktop systems and software after its IPO in early
1997. The new accounting and property management system, which was tested upon
its implementation in 1997, and all the Company's network hardware and
software, desktop systems and software packages are Y2K compliant as asserted
by the software vendors. In addition, management performed additional testing
during 1999 by setting the dates in the operating system and the accounting
and property management system ahead to the year 2000. Management believes
there is no material Y2K exposure with respect to its information technology
systems.
Building Management Systems
The Company has identified five categories of building management systems
that could have potential Y2K exposure: building automation (e.g., HVAC),
security card access, fire and life safety, elevator, and office equipment.
During 1998, property management executives and personnel began gathering data
to identify all of the Company's Y2K sensitive building management systems and
to assess whether such systems are currently Y2K compliant or will need to be
modified or replaced. Management has completed the discovery and assessment
phase and determined the Company's state of readiness as to building
management systems in early 1999. Management expects to complete the
remediation and implementation phase by September 1999 and the testing and
verification phase by the end of fiscal year 1999.
Costs to Address the Company's Y2K Efforts
Since the replacement of the accounting and property management system, the
acquisition of new network hardware and software and the installation of
updated desktop systems and software was performed as a result of the Company
becoming a public traded REIT and not in response to Y2K compliance issues,
and further, since phase 1 of the building management systems efforts are
being performed by 13 salaried Company employees who are not paid for overtime
and who management expects will spend 10% of their annual working hours over a
2 to 3 year period focusing on Y2K compliance issues, Y2K costs incurred to
date have been minimal and have not been material to the Company's financial
position or results of operations.
While expected future costs, which will include costs to complete phases 2
and 3 for the building management systems, are not readily quantifiable at
this time, it is management's belief that a significant portion of such costs
will be treated as operating expenses and will be reimbursed to the Company
under most tenant leases. Consequently, management does not believe that such
expenses will have a material effect on the Company's financial position or
results of operations.
Efforts to Identify the Y2K Issues of Significant Third Parties
Due to the Company's diverse tenant base, the success of the Company's
business is not closely tied to the success of any one particular tenant. In
addition, the success of the Company's business is also not closely tied to
the operations of any one vendor, supplier or manufacturer. However, the
Company is in the process of surveying significant tenants, vendors, suppliers
and other relevant third parties, to determine that their systems will be Y2K
compliant and that the Company's normal operations will continue without
interruption. Management anticipates this project will be completed by
September 1999.
The Risks of Y2K Non-Compliance
Management does not believe that the impact of the Y2K issue will have a
material adverse effect on the Company's financial condition or results of
operations. This belief is based upon both the analysis of the Company's Y2K
issues and the Company's assessment of the Y2K exposure related to tenants,
vendors, and
21
<PAGE>
other significant third parties as discussed above. No assurance can be given
about facts and resultant effects of Y2K issues unknown to the Company at this
time.
The Company's worst case Y2K scenario would be that the Company's
information and building management systems fail. In the event that the
Company's information systems fail, the Company would be forced to manually
perform its accounting and property management record-keeping functions until
the information systems could be restored. In the event that the Company's
building management systems fail, the Company's tenants would not have access
to or be able to conduct their normal business activities at the Company's
properties until the building management systems could be restored. These
events could have a material adverse effect on the Company's financial
position and results of operations.
Developing Contingency Plans
The Company does not currently have a contingency plan in place in the event
of a Y2K failure. Such a contingency plan is expected to be developed by the
end of the third quarter 1999.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Changes in Primary Risk Exposures
In March 1999, the Company executed a fixed rate mortgage loan with a
principal balance of $95.0 million, monthly principal and interest payments
based upon a fixed interest rate of 7.20% and a 25-year amortization schedule,
and a maturity date of April 2009. The Company used a portion of the proceeds
from the new $95.0 million fixed rate mortgage loan to repay borrowings under
its existing variable rate Credit Facility. As a result of the execution of
the new $95.0 million mortgage loan and the simultaneous repayment of a
portion of borrowings outstanding under the Credit Facility, the Company's
ratio of fixed rate debt to total debt (excluding Cumulative Redeemable
Preferred units) increased 17.2% from 28.2% at December 31, 1998 to 45.4% at
March 31, 1999.
In April 1999, the Company executed a second fixed rate mortgage loan with a
principal balance of $30.0 million, monthly principal and interest payments
based upon a fixed rate of 7.15% and an 18-year amortization schedule, and a
maturity date of May 2017. The Company used the proceeds from the new
$30.0 million fixed rate mortgage loan to pay off an existing $19.0 million
variable rate mortgage loan and to repay borrowings under its existing
variable rate Credit Facility. As a result of the execution of the new
$30.0 million mortgage loan and the simultaneous repayment of a the Company's
existing $19.0 million variable rate mortgage loan and a portion of borrowings
outstanding under the Credit Facility, the Company's ratio of fixed rate debt
to total debt (excluding Cumulative Redeemable Preferred units) increased 3.2%
from 45.4% at March 31, 1999 to 48.6% at April 30, 1999.
The tabular presentation below provides information about the Company's
interest rate sensitive financial and derivative instruments as of March 31,
1999. All of the Company's interest rate sensitive financial and derivative
instruments are designated as held for purposes other than trading.
For the Credit Facility, the table presents the assumption that the
outstanding principal balance at March 31, 1999 will be paid upon the Credit
Facility's maturity in February 2000, and that the option to extend the term
of the Credit Facility until February 2001 will not be exercised. The table
also presents the related maximum interest rate index for outstanding Credit
Facility borrowings in 1999 and 2000.
For variable rate mortgage debt, the table presents the assumption that the
outstanding principal balance at March 31, 1999 will be paid in April 1999,
since as discussed above, the Company subsequently repaid this loan in April
1999. The table also presents the related interest rate index.
22
<PAGE>
For fixed rate mortgage debt, the table presents the assumption that the
outstanding principal balance at March 31, 1999 will be paid according to
scheduled principal payments and that the Company will not prepay any of the
outstanding principal balance. The table also presents the related weighted-
average interest rate for outstanding fixed rate mortgage debt borrowings from
1999 through 2003 and thereafter.
For the Series A and Series C Preferred units, the table presents the
assumption that the outstanding Preferred Units at March 31, 1999 will be
exchanged into shares of the Company's 8.075% Series A and 9.375% Series C
Cumulative Redeemable Preferred stock, respectively, in 2008 when the
Preferred units become exchangeable at the option of the majority of the
holders. The table also presents the related weighted-average interest rate
for outstanding Preferred units from 1999 through the exchange date, however
the same interest rates will apply when the Preferred units are exchanged into
the Cumulative Redeemable Preferred stock.
For interest rate caps, the table presents notional amounts, average cap
rates and the related interest rate index upon which cap rates are based, by
contractual maturity date. Notional amounts are used solely to calculate the
contractual cash flow to be received under the contract and do not reflect
outstanding principal balances at March 31, 1999.
Interest Rate Risk Analysis--Tabular Presentation
Financial Assets and Liabilities
Outstanding Principal by Expected Maturity Date
(dollars in millions)
<TABLE>
<CAPTION>
Maturity Date
------------------------------------------------ Fair Value at
There- March 31,
1999 2000 2001 2002 2003 after Total 1999
------ ------ ------ ------ ------ ------ ------ -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Liabilities:
Line of credit:
Variable rate......... $232.0 $232.0 $232.0
Average interest rate LIBOR LIBOR
index................ +1.38% +1.38%
Mortgage debt:
Variable rate......... $ 19.0 $ 19.0 $ 19.0
Average interest rate LIBOR
index................ +1.50%
Fixed rate............ $ 2.6 $ 3.9 $ 4.2 $ 4.6 $ 5.0 $188.5 $208.8 $211.9
Average interest
rate................. 7.83% 7.83% 7.83% 7.83% 7.83% 7.83%
Series A and C Preferred
units:
Fixed rate............ $107.0 $107.0 $ 99.2
Average interest
rate................. 8.49% 8.49% 8.49% 8.49% 8.49% 8.49%
</TABLE>
23
<PAGE>
Interest Rate Risk Analysis--Tabular Presentation
Financial Derivative Instruments
Notional Amounts by Contractual Maturity
(dollars in millions)
<TABLE>
<CAPTION>
Maturity Date Fair
----------------------------------------- Value at
There- March 31,
1999 2000 2001 2002 2003 after Total 1999
----- ------ ---- ---- ---- ------ ------ ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest Rate Derivatives
Used to Hedge the Line of
Credit:
Interest rate cap
agreements:
Notional amount......... $150.0 $150.0 $0.1
Cap rate................ 6.50% 6.50%
Forward rate index...... LIBOR LIBOR
</TABLE>
24
<PAGE>
PART II--OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
During the three months ended March 31, 1999, no legal proceedings were
initiated against or on behalf of the Company, which if determined unfavorably
to the Company would have a material adverse effect upon the cash flows,
financial condition and results of operations of the Company.
ITEM 2. CHANGES IN SECURITIES--None
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
------- -----------
<C> <S>
*10.1 Promissory Notes Aggregating $95.0 Million Payable to Teachers
Insurance and Annuity Association of America.
*10.2 Form of Deed of Trust, Assignment of Leases and Rents, Security
Agreement and Fixture Filing Statement Securing Promissory Notes
Payable to Teachers Insurance and Annuity Association of America.
*27.1 Financial Data Schedule.
</TABLE>
- --------
* Previously filed.
(b) Reports on Form 8-K--None
25
<PAGE>
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 August 6, 1999.
Kilroy Realty Corporation
By: /s/ John B. Kilroy, Jr.
-------------------------------------
John B. Kilroy, Jr.
President and Chief Executive
Officer
(Principal Executive Officer)
By: /s/ Richard E. Moran Jr.
-------------------------------------
Richard E. Moran Jr.
Executive Vice President and
Chief Financial Officer
(Principal Financial Officer)
By: /s/ Ann Marie Whitney
-------------------------------------
Ann Marie Whitney
Vice President and Controller
(Principal Accounting Officer)
26
