Kilroy Realty Corp (KRC) 2002 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Kilroy Realty Corporation 1st quarter 2002 earnings conference call. During the presentation all participants will be in a listen only mode. Afterwards, we will conduct a question and answer session. At that time if you have a question, please press the 1 followed by the 4 on your telephone. As a reminder, this conference is being recorded Tuesday, April 30, 2002. I would now like to turn the conference over to Mr. Richard Moran Executive Vice President and Chief Financial Officer of Kilroy Realty Corporation, please go ahead, Sir.

Thank you, good morning and thank you all for joining us. I'm Dick Moran and with me today are John Kilroy our CEO, Jeff Hawken, our COO, Tyler Rose, our Treasurer, Ann Marie Whitney our controller. Out the outset I need to say that some of the information we will be discussing this morning is forward looking in nature although the information is based on the company's [INAUDIBLE] actual results, including the timing and total investments of the company's development projects could vary from expectations stated here. Numerous factors will affect KRC's actual results. Some of which are beyond the company's control. These include the timing and strength of regional economic growth the strength of commercial and industrial real estate markets, economic liability of the company's tenant base, competitive market conditions, future interest rate levels and conditions of the capital markets. We assume no obligation to update publicly any forward- looking information whether as a result of new information, future events or otherwise. For discussions and important risks related to our business and an investment in our securities including risks that can cause actual results and events to differ materially from those stated. Please see the discussion of the captioned business risks and our annual report on form 10K for the year ended December 31, 2000. In light of these risks, under uncertainties and assumptions about the forward- looking events discussed today might not occur. This call is being Webcast live on our Website and at Streetevents.com and will be available for replay for the next seven days, both by phone and over the internet. Our press release and supplemental package have been filed under form AK with the SEC and are both available, also available on our website. We released our first quarter results, yesterday afternoon [INAUDIBLE], at 89 cents share, that includes a 13 cents per share addition to our income resulting from our completion of the Allen Group buy out and a 4 cent lease termination fee. I will review the details of both transactions later in the call excluding the impact of those items on our first quarter financial results. FFO was 72 cents a share. A penny ahead of consensus estimates. John will start the call with some remarks on the quarter and conditions that our team mark- markets. I'll touch on the financial highlights and then we'll be happy to take your questions. John?

Thanks Jake and good morning, everyone. Thanks for joining us. Three months into the new year, the economic story here in California is mixed. Over all employment levels in the state appear to have stabilized after declining slightly last year. But we are not yet seeing any meaningful net new job creation. State economists are describing it as an in between period with employers taking a wait and see attitude about new hires. If you drill down a little further, there are some encouraging trends. The five-county Southern California region remains the strongest area in the State economically, while San Diego and Orange counties have job markets that remain strong and steady if not growing while the inland empire which includes both San Bernardino and Riverside counties posted net new job growth of more than 3% last month, the best performance in the State. In addition there are signs that the entertainment industry may be just beginning to emerge from its' nearly two-year slump with healthy increases last month in both motion picture jobs and filming days in the State. More broadly travel and tourism have improved from the sharp declines of late last year. Los Angeles county stands out as an exception to this improving economic picture. It is by far the biggest and most diverse job market in the region. It lost more economic momentum last year than any of the other counties in Southern California and appears likely to take more time to recover. Our commercial real estate markets tend to reflect local economic conditions. We continue to experience strong leasing interest and generally high occupancy rates for office properties in San Diego and industrial properties in Orange county. Los Angeles, on the other hand, remains a challenge. Although new supply is virtually nonexistent in our west side in El Segundo submarkets, there is substantial sublease space but is yet to be absorbed. This creates competition for a diminished number of potential tenants and provides little in the way of leasing traction. Overall, our stabilized portfolio has performed reasonably well so far this year. We ended the first quarter with an occupancy rate of 94.2% and have released about 41% of our 2002 expirations. In development we completed and stabilized $32 million in new office space last quarter which is 100% occupied. We also added a new development project to our committed pipeline. It is located in Del Mar and will serve as the new corporate headquarters for AMN Health Care services when it is completed in the second half of 2003. The 15 year lease with AMN is for 175,000 square feet and will cover approximately 84% of the 209,000 square foot office building. Our total committed pipeline now encompasses just over 900,000 square feet in eight properties. With those comments as a backdrop, let's take a closer look market by market. San Diego real estate markets are among the strongest in the State, particularly the coastal submarkets we are most active in. The region as a whole is benefiting from strict controls on new development and are relatively healthy regional economy that includes the defense industry and the biotech life science industry. KRC is well positioned in this market. We are- we were pleased last quarter to report we completed the buyout of the Allan Group's remaining interest in nine San Diego office properties and three San Diego development sites. When fully developed these properties will encompass more than one million square feet of office space. Dick will review the financial impact of the transaction in a few minutes. Demand for the space is evident in our continued leasing success. As I mentioned, KRC signed a lease with AMN Healthcare Services a supplier of temporary health care staff for 175,000 square feet of space in a new Del Mar property we plan to begin this quarter. It's reportedly the largest office lease signed in the county in the last three years and the third major lease we've inked in the region for product under development since the start of the year. Ahem, excuse me. The other two being GRW, a defense contractor and Vical, a life sciences company. In terms of specific submarkets let's start with Sorrento Mesa. This market continues to attract life science in a two- story product type. It's direct vacancy is 5.5% and total vacancy is about 13%. Our properties there are all fully leased. One of the properties that is stabilized in this quarter is in Sorrento Mesa and is fully leased for a term of fifteen years to Diversa, a life sciences company. In addition, we expect the 68,000 square foot property released to Vical for fifteen years to stabilize in the second quarter. In Del Mar, the direct vacancy remains under 6% while total vacancy has increased to 18%. We have two properties scheduled for delivery into this market later this year at a 100% leased as well as the AMN's corporate headquarters building that will be completed as I mentioned in the second half of 2003. In the Ranch Bernard [INAUDIBLE] area the two-story market has a 5% direct vacancy and 7% total vacancy. The second property we stabilized in this quarter is located in this market, it is a 70,000 square foot property fully leased to GRW for a term of 10 years. Over all, our occupancy rate in San Diego is over 97%. In Orange county our industrial properties remain in strong demand with an over all 98% occupancy rate. Further north of the [INAUDIBLE] Airport Center Long Beach we've experienced some softening in market conditions. Our project there encompasses seven buildings with approximately one million square feet and are currently 85% leased That's down from 95% at year end 2001. This property includes 50,000 square feet of space recently renewed by Boeing along with another 50,000 square feet they vacated. One the topic of Boeing as we said last quarter, we don't expect to hear further from them on their intentions concerning the Sea-Tac property in Seattle until later this year. Meanwhile, we are aggressively marketing the property in the event Boeing decides to move. Now let's move onto El Segundo. Demand has been impacted by 9-11. The direct vacancy rate has increased to 15% and total vacancy is now at 22%. Our construction and our 999 project is basically done, we have moved out our completion date for the project until the 3rd quarter as we work with the city of El Segundo to obtain a certificate of occupancy which has been held up due to a parking issue. In west Los Angeles we are actively marketing phase two of our west side media center project and completing construction of Phase 3 this quarter. Leasing in this project has obviously being impacted by the sluggishness of the LA market, however, we are seeing some initial signs that tenant interest in the project may begin to translate into some modest leasing progress on the project in the 2nd quarter. Finally, in Calabasas, our Phase two building of 100,000 square feet is now 96% committed. That brings you up to date on our key markets. We have some clear challenges ahead as the year unfolds, particularly in the Los Angeles submarkets where we unleashed space. But we're also well positioned the regions strongest markets and we remain the landlord of choice for many of Southern California's largest and most significant tenants. That will give us a better than average mark attraction as the economy improves. We'll continue to work through the cycle, adjusting the- as necessary but continuing to execute our business plan with long-term value creation as our fundamental objective. Now Dick will cover the financial results for the quarter and then we'll take questions. Dick?

Thanks John, FFO per share was 89 cents in the first quarter up from 72 cents in the 1st quarter of 2001. Those results include two items I'd like to review in greater detail. The first result's from the buy out of the Allen Group's minority interest. We owned a number of San Diego properties and development sites in a venture with the Allen Group that dated back to our acquisition of the Allen Company in 1997. We were the managing member of the venture and held options to acquire each of the properties as they were developed. We completed those acquisitions in March and as part of that transaction, we recognized 13 cents per share preferred return income on our equity investment that had been earned previously, but fully reserved for financial reporting purposes until the buy out was completed and the related litigation between the parties was settled. Page five of our supplemental report shows what our numbers for the quarter would have been without the one-time preferred recognition. The second item is a $1.2 million lease termination fee we received when one of our Sorrento Mesa tenants terminated a 38,000 square foot lease at the end of February. The bad news in this story was that the old rent was above market, resulting in a 25% rent reduction. The good news was first, that we received a lease termination fee that essentially made us whole for the remaining term of the old lease and that second, we re-leased the space to a new tenant with better credit and no down time or TI's. This transaction did have an impact on our 1st quarter rent increases and our stabilized portfolio which were down 0.8% on a GAP basis and up 2.2% on a cash basis. Excluding this deal and one other similar transaction in which we received a termination fee in a prior quarter and re-leased the space this quarter at a lower rate, Our GAP rents were up 13% on a GAP basis and 7% on a cash basis. Average occupancy in our stabilized portfolio split somewhat to 94.6% in the first quarter from 96.8% in the year earlier quarter. Overall occupancy at March 31 was 94.2%. On the same store basis, rental revenues were up 0.4% in the quarter while tenant reimbursements rose 4.2% mainly from higher utility and insurance cost pass throughs. Operating expenses for the quarter were up 4.7% also due to the, to higher utility and insurance costs. Same store NOI was up 3.2% in the quarter including the lease termination fee I mentioned earlier. Excluding the $1.2 million lease termination fee our same store NOI was essentially flat compared with last year. Our lease roll overs in 2002 total about 87,000 square feet as John mentioned. So far we've re-leased or renewed 41% of that space. In our development program we completed and stabilized two new projects with a total investment of $32 million in the first quarter both buildings are 100% leased. Our committed development pipeline includes 8 projects with a total investment of $263 million of which $161 million has been spent to date. The committed pipeline is currently 62% pre-leased or committed and 61% of that is executed leases and the remaining 1% is letters of intent. We completed a number of financing transactions last quarter that will contribute to the strength of our balance sheet. We were paid $100 million term loan and renewed our credit line for a new three year term on essentially the same terms as the old line. The amount of the line was increased from $400 to $425 million. We also completed a $80 million mortgage loan for a ten year term at 6.7%. That's consistent with our strategy of periodically extending and staggering our maturities. And finally, we also replaced a $150 million interest rate swap that expired with two new $50 million interest rate caps and one $50 million swap all run through January 2005. I should also point out that we've [INAUDIBLE] a way with calculated FFO beginning this quarter. We will no longer be adding back to FFO the amortization restricted stock graphs. That's consistent with [INAUDIBLE] FFO the definition that's clarified in the best practices report that was published last April. The change cut our first quarter FFO by a penny and-a-half and will reduce our FFO for the year by the year by roughly five cents. Let me finish with an update on earnings guidance. In our last conference call we offered FFO guidance of 3.05 to 3.15 a share. On an FFO basis for 2002. We'd like to revise the FFO guidance for the year to a new range of $3.15 to $3.23. That incorporates our first quarter results, the reduction in reported FFO from no longer adding back restricted stock amortization and our sense they were gonna continue to see relatively weak results in Los Angeles and a cyclical softness in the credit quality of some of our tenants over the rest of the year. That's the latest news from here. And with that, operator, we'd like to open up the call for questions.

Thank- you, ladies and gentlemen, if you would like to register a question please press the 1 followed by the 4 on your telephone. You will hear a three- tone prompt to acknowledge your request. If your question has been answered and you would like to withdraw your registration please press the 1 followed by the 3. If you are using a speaker phone, please lift your hand set before entering your request. One moment please, for the first question. Alexis Hughes with Bank of America Securities. Please go ahead.

Good afternoon. Could you provide more detail on the leasing progress at the West Side Media Center? What types of tenants are beginning to show interest and for what amount of space?

Well, we're, we're currently -- that's the encouraging thing that's going on now, Alexis. Is that we really are seeing quite a few tours going on in that project both for the Phase 2 building as well as for the to be completed this quarter Phase 3 building. They range from the entertainment type of companies anywhere from 3,000 feet to over 100,000 square feet. With a, with a significant number in sort of 15,000 foot plus or minus category. We're also seeing interest from companies out of the fire category. Various service companies, a couple of retail companies for ground floor space. So it's fairly broad based, but I use that as somewhat cautionary because, you know broad based a couple of years ago I think, conveyed something far different than it might today today. But we're pretty happy with the level of interest we're now seeing.

Okay and then Dick, I was wondering if you can provide more color on your guidance for the year. The $3.15 to $3.23, is that, that's including the 13 cents as well as the 4-cent lease termination fee?

Yes, and the 13 cents Is clearly a one-tide, one- time item. We highlighted the 4 cents because it, it does obviously it did, did affect the 1st quarter. It's obviously inherently difficult to forecast lease termination fees. But in effect we don't have, we think we in effect got most of our lease termination fee income that we would have forecasted just having to bunch up and occur in the 1st quarter. If you go back last year was distorted because we had the E-toys lease termination. But it- but two years ago, our lease termination fees were $1.6 million as I recall. So I, my, I, I- our sense is that we don't see any other big lease termination fees on the horizon and we would have expected several cents a share this year anyway. It just happened to occur all in the 1st quarter.

Just trying to compare this to your guidance from last quarter. Should I assume then that, that the 3.15 to 3.23 is if I exclude the 13 cents is really 3.02 to 3.10?

Well on an apples to apples basis, yes. And last quarter, if you recall, we offered 3.05 to 3.15.

Okay, okay. So it's not because, because the lease termination fees were just recognized sooner than you may have expected? It's- I, I shouldn't assume that it goes to 2.98 to 3.06?

Right.

Okay, great. And actually one follow-up on West Side Media Center. When does West Side Media Center Phase 3 become an issue from an FFO standpoint? When do you, when, when are you not able to capitalize the interest expense, etc.?

It'll be a year after completion which is scheduled for the end of this quarter.

The end of this quarter?

Yeah.

Okay, thank you.

Michael Merrin with Prudential Securities. Please go ahead with your question.

Good afternoon. Just a follow-up on the development question. There's one other project that's 100%- that's uh, vacant or has no preleasing Imperial Sepulveda. Same question on that one when I,

Sorry?

When, when you have to stop capitalizing interest on that project?

As John mentioned in his remarks, we're going to completion date for that project will be in the 3rd quarter. Most likely that as we show in our supplemental that the 2nd quarter next year is when we'll stop capitalizing.

Second quarter next year... okay. How much capitalized interest did you have during the quarter?

$3.5 million.

.5 million, okay. The occupancy rate you show on page 8, that doesn't include leased available for sublease space, right? That's just occupied space.

That's right. The space where we have leases.

Now, okay, it, it, so it includes space that's leased which may not necessarily be occupied?

That's right.

Okay, do you know what the percentage of sublease available in your portfolio is?

9%.

How much?

9% of portfolio.

9%? Okay. And um, did Paragrin Systems take occupancy in the last development project that you completed for them or are they gonna sublease that building?

They're gonna, look like, like the last building, building five they're gonna sublease.

K. All right and um, Dick, you mentioned the leasing spreads after an adjustment. I guess the spreads were flat during the quarter.

Yes.

What was the adjustment that got those spreads up to 7?

There were, there were two leases, Mike, that, that where we had roll downs and, and obviously we're not saying they don't count. They did. But it's useful to just, just distinguish. If you, that, that there, there were really two buckets. Two leases where we had roll down and all others were up 13% on a GAP basis and 7% on a cash basis on average.

Okay.

That, that latter group is, is not fundamentally inconsistent with our recent experience.

Okay. What, what yield do you expect on your recent acquisition of remaining interest, Allan's remaining interest in the development?

If we go back to when we originally entered into that transaction and bought the Allen Company in 1997, the basic guidance we gave, is that the development returns would be on the order of 11% on a cash basis the acquisitions returns would probably be on the order of 9% on a cash basis and that since it was a 50-50 deal, that would average out to roughly 10. And interestingly enough even after five years later, that's essentially the way it came out.

Ok.

The acquisition returns were essentially 9%.

Alright, on the remaining development pipeline, what's your updated estimate of the development yields on that on average?

We've always said that we shoot for 10 or so on a cash basis. In the period of 99-2000 and even into 2001 we were doing better than that. But I think now we'd- say that over all our pipeline looks like it's a 10% cash return sort of number.

Okay. Can you offer any guidance on G&A?

I don't think we have anything to say in detail other than we don't, don't anticipate any marked differences over the balance of the year from what happened in the 1st quarter.

Okay. And the same store numbers that, are in the supplemental on a GAP basis, that's it?

Yeah, yeah.

Okay, thank you very much.

Thank you.

Anatole Pevnev with McDonald Investments. Please proceed with your question.

Good afternoon, gentlemen. On the other income, and I don't know if you already answered this question, can you break out the components of other income?

It was all one lease termination fee.

Okay. And then there's the announcement of Northrup Grumin winning a contract on, to build some naval warships, do you expect to see any, any impact on the L.A. Market?

[INAUDIBLE] it's too early to tell. I don't know that Northrup's made any announcements with regard to it's workforce implications. What I read is they were sort of surprised to win it, it's obviously very good news. And but, but we don't have anything to say on that as yet.

Alright, thank you.

Lou Taylor with Deutsche Bank Securities. Please go ahead with your question.

Hi, actually it's John Perry. On the development pipeline, noticed on Imperial and Sepulveda and West Side Media three the expected investment went up by a couple million bucks on both projects. Can you just characterize what's going into the higher cost?

Higher carrying cost from lower lease period.

Okay, and just so I understand, I just wanna clarify on the new guidance. It includes the 13% from Allen. The 5% reduction from the reduction of the amortized, the amortization and the 4 cent- and includes 4-cent lease termination fee?

Yeah, although I, I would hasten to add as I tried to explain perhaps inarticulately earlier that the 4 cents did absolutely affect the 1st quarter, but we don't have any other significant lease termination fees on the horizon, at least none that are, that have visibility today. And we would have expected to, on the order of magnitude to have a million or 2 of lease termination fees for the year. So we really haven't and- there isn't any variance in our guidance as a result of

Okay.

lease termination fees on an annual basis.

Okay, okay Thanks.

Ladies and Gentlemen, if there any additional questions, please press the 1 followed by the 4 at this time. David Gough with Robertson Stevens, please go ahead with your question.

Hi guys, looking at the sheet where you consolidate your renewals for the quarter, it looks like the average lease term was down pretty substantially at least on the, the office side. Is that something that the tenants are driving or something you guys are consciously doing to retain occupancy or something, something all together different skewing different, skewing those numbers?

I think it's really just a function of what we are seeing. Obviously we're aggressively renewing leases and we're trying to stagger them , you know, over short or long-term based on the product type and the tenant. So it's sort of a mixed bag depending on the actual product and the, the tenants we are deal- dealing with.

Okay. Thank you.

Dave AuBuchon with AG Edwards. Please go ahead with your question.

First question is on the same, same store basis, do you have those numbers on cash revenues, expenses and NOI?

I can, I can get back to you on that.

Okay, second question is in the Los Angeles portfolio, the 31 office properties, the 83.9% occupancy, I guess, is low- somewhat drastically lower than I thought it would be. I guess I'm curious in your comments, are you out performing your market in those buildings? I mean, where is the market? I can see kinda waited to where you are on the sub-market level in L.A..

Well, obviously L.A. is a, is a, Dave, is a, is a huge turn in the markets we're in. We are out performing and let me look at a table here. The question is, are occupancy versus the market [INAUDIBLE]. Yeah, we're, we're, we're doing quite a bit better than -- the, the, the average, excuse me, we're doing better than the average market for sure. And I point out that some of this vacancy that we just received is an example in our Long Beach properties occurred since the beginning of the year. So we haven't had time to re-lease the space yet-

Mm-hm

but we are performing quite a bit better. And we, we anticipate to, to perform better.

So I guess the market I can see is somewhere between 80 and 84%? Where is West L.A.?

Hang on just one sec.

Dave, and based on our numbers, west L.A. in the total market is 13% base accounting sublease and you, you have the class A Santa Monica, West L.A. Market it's as much as 25% vacant. That's obviously a much tiny-, a very tiny slice arrowing it way down. And El Segundo, when you count total vacancy, we have it at 22% and the Long Beach Airport we have depending on how you define it, between 10 and 13%. And I think what's happened and what we were getting at earlier is that each of those markets, the, there have been some real falloffs in the last quarter. In, in occupancy. And in many instances it's tenants downsizing but in many other instances it's tenants that have just been affected by the recession. But le- some of the later land gone out of business.

And so then do you have a sense just, you know working at the ground level there that, you know, are, are we close to a bottom in L.A. or are we gonna see more the, kind of purging of the space?

Well I guess, Dave, I think it's too early to tell. We are seeing some signs of certainly in the west side of re-leasing activity which is very encouraging. I'd say the markets are definitely in a state of flex. People are finding reasons not to commit to space typically rather than going out and committing the space. I think a lot just depends on what we're going to see in the next quarter or two. It, it's just too, I just feel that the crystal ball is sufficiently cloudy that I really can't give you a specific answer. I'd like to.

Has, has, has the crystal ball become cloudier since the beginning of the year? Is that fair to say or...?

Well, I don't know that I'd say it's cloudier. I think in West L.A. we're beginning to see some very encouraging signs of leasing activity that we only began to see a little bit of in the last quarter. So I think that's very strong. In El Segundo the market is down, 9-11 affects a lot of companies that are here. Some of the defense contractors are, are needing new space, we think that's a positive sign. But we haven't really seen any big, big leases. We're, we're seeing a little bit in, in markets. You know, the typical thing you see in recession, sort of a musical chairs game as an example. We did the deal with DirecTV for 180,000 square feet and they consolidated into a, into one of our buildings in El Segundo. They moved out of substantial space in anther building. A tenant then move- is moving into the space they vacated rather than taking space in another building they were gonna lease. So a little bit of that's going on I think we're gonna see that for a while longer. The good news is there is so- there are some deals being done that are consuming the sublease space. And that's a very positive sign.

And in general, the commentary on market rents, I don't know if you can go by sub- markets, but have they fallen to where you think where they are today? I mean, have they fallen to where you thought they would fall and how much more downside do we have?

I can't tell you how much more downside we have. I can tell you that depending upon the market and the type of product we see rents reduced anywhere from 5 to 20% And off, off of a year and-a-half ago high or so. A lot of that's driven by the availability of sublease space and as it diminishes, I think we'll see rentals go back up. Obviously demand is a big factor in that as well. And while we're beginning to see demand increase in some sub- markets, it's, it's, it's still sluggish in others. But to say when the bottom is, I can't tell you. I wish I knew. But we'll, we're gonna find that out as we continue here.

Okay, [INAUDIBLE] I just circle back on this, the cast and forecast numbers.

The NOI, at 3.8% I don't have the break down of revenues and expenses. I can get back to you on that.

Okay, thank you.

Stuart Seeley with UBS Warberg. Please go ahead with your questions.

Thank- you. Good afternoon, did I hear you say that 9% of your portfolio is under subleases currently?

Yes.

And what's the, what's the historical norm and, and if this is above average which I'm presuming it is, does that put any of your, your revenues or rents at above average risk?

Well, I think 9% is, you know, a little bit higher than historical. I think our historical is typically run around 5% versus 9. And of that 9%, I think about 75% of that is actually vacant and 25% is actually occupied but still available for sublease. And a lot of the tenants are actually pretty strong credits. I don't know that we're really concerned about the dynamics of the sublease at this time.

0Do you have a sense for the, the portion of that which is, which is currently vacant, but under lease which is going to be aggressively marketed by your tenants? I mean, can you get a sense for how much term there is left and whether or not that makes sense for them to do that?

I think, again, it's a mixed bag given the, the amount of square feet. But in some cases the leases are fairly long-term with strong credit so the tenants, you know, are looking for subtenants and they're gonna be fairly aggressive, but again a lot of those markets,you know, were essentially stabilized and so we don't really see that as competitive to our other buildings. And I think in some cases, you know, they're fairly patient in terms of right- getting the right subtenant.

Okay, thank you very much.

Once again Ladies and Gentlemen, if there are any additional questions, please press the 1-4 at this time. Gentlemen, I am showing no further questions at this time. I'd like to turn the conference back over to you for any closing remarks you may have.

We thank you all very much, we all- as always we appreciate your interest in KRC, and this busy conference call [INAUDIBLE] and thank you and have a good day.

Ladies and Gentlemen, that does conclude your conference call for today. We thank you for your participation and ask that you please disconnect your lines.