Kilroy Realty Corp (KRC) 2008 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the quarter three 2008 Kilroy Realty Corp earnings conference call. My name is Misal, and I will be your operator for today. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the call over to Mr. Richard Moran, please proceed, sir.

Thank you very much. Good morning, everyone. Thanks for joining us. With me today are John Kilroy, our CEO, Jeff Hawken, our COO, Tyler Rose, our Treasurer, and Heidi Roth, our Controller. At the outset, I need to say that some of the information we will be discussing this morning is forward-looking in nature. Please refer to our supplemental packet for the statement regarding the forward-looking information in this call and in the supplemental.

This call is being telecast live on our website and will be available for replay for the next ten days both by phone and over the internet. Our press release and supplemental packets have been filed on Form 8-K with the SEC and both are also available on our website. John will start the call with an overview of the quarter in our key markets. I will add financial highlights and update our 2008 earnings guidance, and then we will be happy to take your questions. John.

Thanks, Dick. Hello, everyone and thanks for joining us. KRC had a good third quarter. We reported solid financial results and added two office properties to the portfolio that were on schedule, on budget, and fully leased. The economic uncertainty caused by the extraordinary turmoil we are seeing in credit markets has caused many companies in the region to continue to delay making business decisions, including real estate decisions. They're trying to digest what all of the negative economic news means to their business.

Meanwhile, unemployment rates in our sub markets continue to tick up with Los Angeles at 7.8%, Orange County at 5.7%, and San Diego at 6.4%, yet we have not seen any widespread lay offs across regions or industries. So far, we are not seeing any new financial distress among our current roster of tenants other than the situations we discussed on previous calls. This is a market that will reward patience, quality assets, solid execution and financial strength. In leasing we have made very significant progress this year. Year-to-date we have executed new or renewing leases on 1.9 million square feet of space. By way of comparison, we signed 1.7 million square feet in all of 2007. In the third quarter, leases commenced on approximately 575,000 square feet of space at rents that were 34% higher on a GAAP basis.

We are making good progress on our 2009 expirations. We started 2008 with 2 million square feet expiring next year. We now have approximately 1.4 million square feet of that left. Of the 600,000 square feet of '09 renewals to date, the cash rents were up approximately 11% and the GAAP rents were up approximately 29%.

In development, we delivered two properties totaling 253,000 square feet during the quarter with a total investment of approximately $66 million. The first property is a newly developed 146,000 square foot medical facility, in our innovation corporate center located along the I-15 corridor in the Rancho Bernardo sub market of San Diego County. Our total investment in the property is approximately $49 million, the property is 100% leased and Scripps Health.

The second property is our redevelopment project at Kilroy Airport Center in El Segundo. Our total incremental investment on this 107,000 square feet building is approximately $17 million. It is leased to DirectTV. With two projects delivered for active development and redevelopment program now totals approximately 358,000 square feet in four projects. Included in our active development is the third and final building of our Kilroy Saber Springs office campus located at the intersection of Route 56 and I-15 in San Diego. This 148,000 square foot building is 100% leased to Bridgepoint Education and will be fully delivered later this quarter.

We are working on two smaller 50,000 square foot development buildings in our Sorrento Gateway project funding the 805 freeway. One is an office building and one is a medical office building. While leasing has been slower than anticipated, we are in serious negotiations with perspective tenants for both buildings. In terms of redevelopment, we are in lease up on our 104,000 square foot two-building Saber Springs Corporate Center located along the I-15 corridor in Rancho Bernardo. It is currently 19% leased and we are actively marketing the remaining space.

All of our in-process development and redevelopment was started in 2006 and 2007. Given the current economic climate, our activities on our development pipeline are to continue to improve our overall entitlement position where possible so as to accommodate a broader spectrum of users and be positioned for the future. With that overview let's move through a quick recap of our individual sub markets starting in San Diego.

In central San Diego, active demand is currently registering approximately 5.9 million square feet of office space, according to CB Richard Ellis. This includes several hundred thousand square feet that is expected to be signed by the end of this year. In Del Mar, one of the regions strongest sub markets, KRC is the dominant office landlord with approximately two-thirds of the top tier class A product. Current direct vacancy here is approximately 14.2% and total vacancy is 16.8%. Our stabilized properties in Del Mar are 96% occupied.

In Sorrento Mesa, which is just south of Del Mar, KRC competes in the two and three-story product. Direct vacancy for this product type is currently 7.4% and total vacancy is 8.8%. Our stabilized properties here total approximately 1.9 million square feet and are currently 93% occupied. Further south in the UTC, Governor Park sub market, we also compete in the two-story product type. Our properties total 430,000 square feet of space. Current direct vacancy is about 4.9% and total vacancy is 10.8%. We have two vacancies in this market that brought our occupancy to 57%.

Along the I-15 corridor, east of Del Mar, KRC now own approximately 900,000 square feet of stabilized office space including our newly developed property and innovation corporate center that is 100% leased to Scripps Medical. The two story product type here has a direct vacancy rate of 12.4% and total vacancy of 13.1%. Our class A product direct vacancy is 24.7% and total vacancy is 26.2%. Our stabilized properties here are 84% occupied.

Further north in Orange County, industrial demand is solid with a current vacancy rate of just 4.4%. Our industrial portfolio totals about 3.7 million square feet here. It was 93% occupied at the end of the quarter, including the vacancy of the 157,000 square foot project we are rezoning to residential in Irvine.

Moving north to Los Angeles County, the sub markets of El Segundo and Long Beach both continue to demonstrate strength in demand. At Kilroy Airport Center Long Beach our seven-building office campus immediately adjacent to the Long Beach Airport remains 93% occupied. Class A direct vacancy here is 6.4% and total vacancy is 8%. In El Segundo, our stabilized properties now total 1.3 million square feet and are 95% occupied. That includes our recently stabilize redevelopment project which is leased to DirectTV.

Class A direct vacancy in El Segundo is now 10.1% and total vacancy is 10.8%. West L.A. remains a solid market with direct vacancy at 9.3% and total vacancy at 13.1%. Our properties here total 680,000 square feet and are 96% occupied. Sony BMG has recently notified us that they will be vacating the 95,000 square foot office building they lease from us in Santa Monica when its lease expires in January. This is a terrific building in a great location with an expiring rent that is well below market. We are already seeing interest from perspective tenants.

Finally, along the 101 corridor market which runs through northern Los Angeles and southern Ventura counties, direct vacancy in the class A product is currently 13.3% and total vacancy is 13.7%. Our properties in the market are currently 80% occupied. This includes the vacancy of [Intuit] in early September as a result of the lease termination we discussed in our last call. That's an update on the quarter and our markets.

To summarize, it is clear that as the economy has come under increasing pressure, decision makers are taking an even longer time to make real estate related decisions. Notwithstanding, KRC has made significant progress in leasing so far this year and while we can't and don't know how the global and national economies will perform, we are confident the quality of our assets, the strength of our financial position, and the talent and experience of our management team.

Finally, we remain focused on leasing, protecting our balance sheet and positioning our company for value-creating opportunities. Now Dick will cover the financial results. Dick.

Thanks, John. FFO was $1 a share in the third quarter and $2.64 for the first nine months of the year. The third quarter included a net impact of $0.12 related to the Intuit lease termination and $0.08 related to the Favrille liquidation, both of which we went through in detail on last quarter's call. Stabilized occupancy at the end of the third quarter was 90.7% down from 92.8% at the end of the second quarter and 94% at year end 2007. By product type, office occupancy was 89.5% and industrial occupancy was 93.4%.

Same-store NOI in the third quarter was up 16.1% on a GAAP basis 20.7% on a cash basis. Excluding the impact of the Intuit and Favrille situation, same-store NOI would have been flat on a GAAP basis and down 2% on a cash basis. For the first nine months of the year, GAAP NOI rose 1.6% and cash NOI was up 5.9%. Again, excluding the impact of both Intuit and Favrille and two lease termination payments that we received back in the second quarter of 2007, same-store NOI for the first nine months would have been up 1% on a GAAP basis and up 2% on a cash basis.

Office rents increased 33% on a GAAP basis and 12% on a cash basis for leases that commenced during the quarter. Industrial rents were up 38% on a GAAP basis and 11% on a cash basis. As John mentioned, we have made substantial progress on 2009 renewals and we now have 1.4 million square feet of space expiring in 2009. About half of that is industrial and half is office.

From a regional perspective, we have 340,000 square feet expiring in Los Angeles, 800,000 square feet expiring in Orange County and 700,000 square feet of which is -- excuse me, 700,000 square feet of which is industrial and 240,000 square feet expiring in San Diego.

In terms of rent, while it is tough to make any estimates with any real confidence in these times, based on our most recent analysis of what we believe our current market conditions, we estimate that rent levels on our overall portfolio and for our 2009 expirations are about 10% under market. Capital expenditures in the third quarter totaled $7.7 million and our FAD pay out ratio was 71%. We delivered two fully leased office buildings during the quarter with a total investment of $66 million. Our active development program now includes four projects, including a redevelopment project. These represent a total investment of $121 million of which $97 million has been spent to date.

Our balance sheet strategy continues to emphasize liquidity, conservative leverage, flexibility and simplicity. We have no joint venture so we don't have any joint venture debt. We had a $72 million five-year mortgage mature in August and repaid it by drawing on our credit line. At the end of the third quarter we had $237 million outstanding on our [$550] million credit line giving us $313 million of committed available debt capacity. Our credit line is led by JPMorgan and Banc of America and runs through to April 2010. We have a one year extension to April 2011.

We don't have any remaining debt maturities in 2008. We have one additional loan that matures next year. That's a $75 million ten-year mortgage that comes due in April 2009. Now let me finish with updated earnings guidance. Obvious caveat that I should mention is that our guidance and internal forecasts are based on everything that we are currently aware of, but as we have all seen, there are uncertainties in the economy that could affect our results beyond what we currently anticipate. Last quarter our 2008 FFO guidance was $3.35 to $3.45 a share with a mid point of $3.40 a share and we are now reaffirming that same range again. That's the latest news from here and, operator, we will be happy to take any questions.

(OPERATOR INSTRUCTIONS). Your first question comes from the line of Michael Bilerman with Citi. Please proceed.

Good afternoon. It is (inaudible) here. I just had one question. It looks like you have about $300 million capacity left on the credit facility and an option to expand by that another $100 million. With development spend coming off, I am wondering if you considered repurchasing some stock at these levels?

Repurchasing stock, I think we are certainly mindful of the stock price and aware of that. I think our first priority right now as it has been over the last couple of years is making sure we protect our balance sheet and preserve our maximum liquidity. So that's something we have been actively considering, but at this point it is, our number one priority is to make sure we protect our balance sheet.

And you mentioned the Sony BMG expiration. As we look out into 2009, are there any other large expirations that you are focusing on now that we should be tracking?

No. Actually in L.A., the Sony building that's 95,000 square feet that comes back January 1 is the largest in the L.A. region. Everything else is pretty minimal.

Thank you.

Your next question comes from the line of Dave Rodgers with RBC Capital Markets.

This is Mike Carol here with Dave. How are you guys.

Good. Thank you.

My first question is that if the debt you repaid with your line of credit, what are your thoughts about permanent financing on that?

Well, I don't mean to sound, this is Dick speaking. I don't mean to sound relaxed at all. We are fortunate that we have a relatively low debt leverage compared with the, what debt capacity was available at the peak of the credit cycle. So we have tried to be very disciplined. So we have the flexibility and the luxury of not having to go into the debt markets right now. I think that is something we are actively aware of and testing day-to-day. I think over time you will see us back into debt markets but, right now, they're obviously rather lender favorable if they're open at all. So I think we will probably wait a bit and just see how things settle out. As I say, I don't mean at all to say we are relaxed because I don't think in this environment anybody can be.

Is that your stand, too, with the April debt maturity, have you had any talks about how you are going to satisfy that one?

Pardon me.

The April debt maturity coming up in April of next year?

Well, there's a lot of time between now and then. As I say, fortunately, if you run through any analysis of our debt capacity, even in a return to fairly traditional prior generation mortgage lending policies, we have plenty of debt capacity to refinance our debt over time even if we have done the analysis for it. Even if you assume that we, that debt markets stay more than for the next five years and we have to refinance all of our debt, even that which matures in 2011, '12 and '13, even if you underride it at 9% or 10% we still have coverage of 1.6 or 1.7 on that based on our last 12 months NOI.

So, when you run any sort of analysis based on our current debt levels I think it, except in the absence, except in the case of a permanent cataclysm in the debt markets, we have adequate debt capacity to do it in an orderly manner and obviously what's underlying my comments here is that we are very mindful of diluting our shareholders over time if we incurred debt costs that are precipitously higher than where they might settle in. So I think we are just mindful. We are not relaxed but we are not panicking either.

How much unused capacity do you have on your line of credit?

Well, we have $237 million outstanding as of the end of the third quarter leaving just over $300 million available.

And then can you provide some color on how your tenant reserves or bad debt expense has changed I guess the past couple of quarters?

Well in the third quarter we didn't book any bad debt expense. As you know, you can't arbitrarily book a general reserve. So from second quarter to third quarter, there was no change in bad debt expense.

Okay. Thank you.

(OPERATOR INSTRUCTIONS). Your next question comes from the line of Dave Aubuchon with Robert W. Baird. Please proceed.

Yes. Can you give initial expectations for the space at Sony exiting, just eliminate your strategy right now?

Yes. That building is right in Santa Monica. It is a very well located facility. It is three buildings, underground park, 95,000 square feet. It is really a spectacular facility. So we are in the process of looking at different (inaudible) we are going to be making to it. We've had a fair amount of interest both from entertainment companies as well as architectural firms. So we are anticipating to have good demand for that facility as it hits the market in January.

You mentioned rents are well under market. Can you provide more detail and how much CapEx do you think you will spending on the space?

Yes, Dave. This is John. The rents in that building today are around $3 triple net. And the market is substantially greater than that. There, the brokers tell us they're anywhere from the high 5s to the high 6s depending upon different types of users. So we think there's some considerable upside. Whether we will recognize all of that in this market or not, we don't know.

You said it was a ten year lease that was expiring and what is your initial expectation for CapEx there in that space?

Jeff, do we have that?

Yes. I think we are anticipating probably in the $50 range as we kind of look at the broad users and not knowing if we will get a single tenant or multi-tenants.

Are they moving just within the market, are they exiting the market or do you know where they're going?

Well, yes, they're moving to I believe what was the Creative Artists building over in Beverly Hills which is, as I understand, is about 60,000 feet. They didn't need the entire 95,000 feet that we have.

Okay. Can you detail what the collateral is behind the $75 million maturity in April of 2009?

Yes. It is a portfolio of office properties in both the mainland, San Diego and Los Angeles.

Where would you guess that the $75 million is on a loan to value given today's market prices?

Well, you tell me what market prices are. But on a cap rate at just take 7% we think the loan to value is under 25%.

Okay. And then regarding, and I know you didn't give 2009 guidance, but just looking at the convert accounting guidance that goes into effect next year. Any initial guess, Dick, about what the impact is going to be there?

I'm not sure we are ready to say that, but basically as I understand it, you take what you would have borrowed at and, which we think would have been in the 5s then, and compare that with the actual coupon rate, which is 3.25, and you take the difference and record that as non-[cash interest expense. So I think that's what we will wind up doing.

And the assumption is when you actually executed the convert deal what you could borrow at and not current market? That's your interpretation?

Yes.

Okay. That's all I had. Thanks.

At this time there are no additional questions in the queue. I would now like to turn the call back over to Mr. Richard Moran for further remarks. Please proceed.

Thank you for joining us. We appreciate your interest in KRC.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.