ITEM 1.
BUSINESS
The Company
We are a self-administered REIT active in premier office and industrial submarkets along the West Coast. We own, develop, acquire and manage primarily Class A real estate assets in the coastal regions of Los Angeles, Orange County, San Diego, greater Seattle and the San Francisco Bay Area, which we believe have strategic advantages and strong barriers to entry. Class A real estate encompasses attractive and efficient buildings of high quality that are attractive to tenants, are well-designed and constructed with above-average material, workmanship and finishes and are well-maintained and managed. We qualify as a REIT under the Internal Revenue Code of 1986, as amended (the “Code”).
As of December 31, 2010, our stabilized portfolio was comprised of the following office buildings (the “Office Properties”) and industrial buildings (the “Industrial Properties”). As of December 31, 2010, all but one of our properties are located in California:
(1)
Includes ten office buildings acquired in 2010 (see Note 3 to our consolidated financial statements included in this report for additional information).
Our stabilized portfolio excludes undeveloped land, one office redevelopment property that is currently under construction and one industrial property that we are in the process of repositioning for residential use.
We own our interests in all of our Office Properties and Industrial Properties through the Operating Partnership and Kilroy Realty Finance Partnership, L.P. (the “Finance Partnership”), a Delaware limited partnership. We conduct substantially all of our operations through the Operating Partnership of which as of December 31, 2010, we owned a 96.8% general partnership interest. The remaining 3.2% common limited partnership interest in the Operating Partnership as of December 31, 2010 was owned by non-affiliated investors and certain of our directors and officers. Kilroy Realty Finance, Inc., a wholly-owned subsidiary of the Company, is the sole general partner of the Finance Partnership and owns a 1.0% general partnership interest. The Operating Partnership owns the remaining 99.0% limited partnership interest. We conduct substantially all of our development activities through Kilroy Services, LLC (“KSLLC”), which is a wholly-owned subsidiary of the Operating Partnership. With the exception of the Operating Partnership, all of the Company’s subsidiaries, which include, Kilroy Realty TRS, Inc., Kilroy Realty Management, L.P., Kilroy RB, LLC, Kilroy RB II, LLC, Kilroy Northside Drive, LLC, and Kilroy Realty 303, LLC are wholly-owned.
The following diagram illustrates our organizational structure as of December 31, 2010:
Available Information; Website Disclosure; Corporate Governance Documents
Kilroy Realty Corporation was incorporated in the state of Maryland on September 13, 1996 and Kilroy Realty, L.P. was organized in the state of Delaware on October 2, 1996. Our principal executive offices are located at 12200 W. Olympic Boulevard, Suite 200 Los Angeles, California 90064. Our telephone number at that location is (310) 481-8400. Our website is located at www.kilroyrealty.com. The information found on, or otherwise accessible through, our website is not incorporated into, and does not form a part of, this annual report on Form 10-K or any other report or document we file with or furnish to the United States Securities and Exchange Commission, or the SEC. All reports we will file with the SEC will be available free of charge via EDGAR through the SEC website at www.sec.gov. In addition, the public may read and copy materials we file with the SEC at the SEC’s public reference room located at 100 F Street, N.E., Washington, D.C. 20549. All reports that we will file with the SEC will also be available free of charge on our website at www.kilroyrealty.com as soon as reasonably practicable after we file those materials with, or furnish them to, the SEC.
The following documents relating to corporate governance are also available free of charge on our website under “Investor Relations-Corporate Governance” and available in print to any security holder upon request:
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Corporate Governance Guidelines
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Code of Business Conduct and Ethics
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Audit Committee Charter
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Executive Compensation Committee Charter
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Nominating / Corporate Governance Committee Charter
You may request copies of any of these documents by writing to:
Attention: Investor Relations
Kilroy Realty Corporation
12200 West Olympic Boulevard, Suite 200
Los Angeles, CA 90064
Business and Growth Strategies
Growth Strategies. We believe that a number of factors and strategies will enable us to continue to achieve our objectives of long-term sustainable growth in Net Operating Income (defined below) and FFO (defined below) as well as maximization of long-term stockholder value. These factors and strategies include:
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the quality and location of our properties;
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our ability to efficiently manage our assets as a low cost provider of commercial real estate through our seasoned management team possessing core capabilities in all aspects of real estate ownership, including property management, leasing, marketing, financing, accounting, legal, construction management, and new development;
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our strong financial position that has and will continue to allow us to pursue attractive acquisition opportunities;
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our access to development, redevelopment, acquisition, and leasing opportunities as a result of our extensive experience and significant working relationships with major west coast property owners, corporate tenants, municipalities, and landowners given our over 60-year presence in the California market; and
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our existing pipeline of undeveloped land holdings
“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, provision for bad debts, and ground leases) before depreciation. “FFO” is funds from operations as defined by the National Association of Real Estate Investment Trusts (“NAREIT”). See “Item 7: Management’s Discussion and Analysis of Financial
Condition and Results of Operations-Results of Operations” and “-Non-GAAP Supplemental Financial Measures: Funds From Operations” for a reconciliation of these measures to generally accepted accounting principles (“GAAP”) net income available for common stockholders.
Operating Strategies. We focus on enhancing long-term growth in Net Operating Income and FFO from our properties by:
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maximizing cash flow from our properties through active leasing, early renewals, and effective property management;
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structuring leases to maximize returns and internal growth;
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managing portfolio credit risk through effective underwriting, including the use of credit enhancements and interests in collateral to mitigate portfolio credit risk;
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managing operating expenses through the efficient use of internal management, leasing, marketing, financing, accounting, legal, and construction management functions;
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maintaining and developing long-term relationships with a diverse tenant base;
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managing our properties to offer the maximum degree of utility and operational efficiency to tenants;
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continuing to effectively manage capital improvements to enhance our properties’ competitive advantages in their respective markets and improve the efficiency of building systems; and
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attracting and retaining motivated employees by providing financial and other incentives to meet our operating and financial goals.
Acquisition Strategies. We believe we are well positioned to acquire properties as the result of our extensive experience, strong financial position, and ability to access capital. We continue to actively monitor our target markets and focus on acquiring additional high quality office and industrial properties that:
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provide attractive yields and significant potential for growth in cash flow from property operations;
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present growth opportunities in our existing or other strategic markets; and
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demonstrate the potential for improved performance through intensive management and leasing that should result in increased occupancy and rental revenues.
Development Strategies. We and our predecessors have developed office and industrial properties primarily located in California since 1947. As of December 31, 2010, our development pipeline included 116.7 gross acres of undeveloped land, with which we believe we will have the potential to develop over two million rentable square feet of office space in the future, depending upon economic conditions. Our strategy with respect to development is to:
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maintain a disciplined approach by emphasizing pre-leasing, commencing development in stages, or phasing, and cost control;
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continue to execute our build-to-suit philosophy in which we develop properties to be leased by specific committed tenants providing for lower-risk development;
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be the premier provider of two- to six-story campus style office buildings in California;
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reinvest capital from dispositions of nonstrategic assets into new state-of-the-market development assets with higher cash flow and rates of return; and
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evaluate redevelopment opportunities in supply-constrained markets since such efforts generally achieve similar returns to new development with reduced entitlement risk and shorter construction periods.
Redevelopment opportunities are those projects in which we spend significant development and construction costs on existing buildings pursuant to a formal plan, the intended result of which is a higher economic return on the property. We may engage in the additional development or redevelopment of office and/or industrial properties, when market conditions support a favorable risk-adjusted return on such development or redevelopment. We expect that our significant working relationships with tenants, municipalities, and landowners on the west coast will give us
further access to development opportunities. We cannot assure you that we will be able to successfully develop or redevelop any of our properties or that we will have access to additional development or redevelopment opportunities.
Financing Strategies. Our financing policies and objectives are determined by our board of directors. Our goal is to limit our dependence on leverage and maintain a conservative ratio of debt-to-total market capitalization. As of December 31, 2010, our total debt as a percentage of total market capitalization was 40.2%, and our total debt and liquidation value of our preferred equity as a percentage of total market capitalization was 45.8%, both of which were calculated based on the quoted closing price per share of the Company’s common stock of $36.47 on December 31, 2010. Our financing strategies are to:
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maintain financial flexibility, including a low secured to unsecured debt ratio, to maximize our ability to access a variety of both public and private capital sources;
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maintain a staggered debt maturity schedule in which the maturity dates of our debt are spread out over several years to limit risk exposure at any particular point in the capital and credit market cycles;
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complete financing in advance of the need for capital; and
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manage interest rate exposure by generally maintaining a greater amount of fixed-rate debt as compared to variable-rate debt.
We utilize multiple sources of capital, including borrowings under our unsecured line of credit, proceeds from the issuance of debt or equity securities and other bank and/or institutional borrowings, and dispositions of nonstrategic assets. There can be no assurance that we will be able to obtain capital as needed on terms favorable to us or at all. See the discussion under the caption “Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations-Factors That May Influence Future Results of Operations” and “Item 1A:
ITEM 1A
RISK FACTORS
The following section sets forth material factors that may adversely affect our business and operations. The following factors, as well as the factors discussed in “Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations-Factors That May Influence Future Results of Operations” and other information contained in this report, should be considered in evaluating us and our business.
Risks Related to our Business and Operations
Global market and economic conditions may adversely affect our liquidity and financial condition and those of our tenants. In the U.S., market and economic conditions continue to be challenging with tight credit conditions and modest growth. While recent economic data reflects a stabilization of the economy and credit markets, the cost and availability of credit may continue to be adversely affected. Concern about continued stability of the economy and credit markets generally, and the strength of counterparties specifically, has led many lenders and institutional investors to reduce, and in some cases, cease to provide funding to borrowers. Volatility in the U.S. and international capital markets and continued recessionary conditions in global economies, and in the California economy in particular, may adversely affect our liquidity and financial condition and the liquidity and financial condition of our tenants. If these market conditions continue, they may limit our ability and the ability of our tenants to timely refinance maturing liabilities and access the capital markets to meet liquidity needs.
Our operations and those of our tenants may be adversely affected by the impact of California economic conditions and California’s budget deficit. As of December 31, 2010, all but one of our properties and all of our undeveloped land are located in California. The continuing economic crisis has particularly affected the economy of California. The State of California began its fiscal year on July 1, 2010 with a significant reported deficit, which continues to impact and aggravate current recessionary conditions within the State. Given the budgetary situation in California, there is also the possibility that the California State Legislature could enact new tax legislation, increasing tax rates in California. New legislation also could cut funding for government programs that are relied upon by our tenants. The economic and legislative environment within the State could have an adverse impact on businesses operating in California, including us and our tenants.
As a result of these factors, continued economic weakness in California could impact our ability to generate revenues sufficient to meet our operating expenses or other obligations, which would adversely impact our financial condition, results of operations, cash flows, the quoted trading price of the Company’s common stock and of the Operating Partnership’s publicly-traded notes, and our ability to satisfy our debt service obligations and to pay dividends and distributions to our security holders.
Our performance and value are subject to risks associated with our investments in real estate assets and with trends in the real estate industry. Our economic performance and the value of our real estate assets, and consequently the value of the Company’s common stock, are subject to the risk that our properties may not generate revenues sufficient to meet our operating expenses or other obligations. A deficiency of this nature would adversely impact our financial condition, results of operations, cash flows, the quoted trading price of our securities, and our ability to satisfy our debt service obligations and to pay dividends and distributions to our security holders.
Events and conditions applicable to owners and operators of real estate that are beyond our control and could impact our economic performance and the value of our real estate assets may include:
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local oversupply or reduction in demand for office, industrial, or other commercial space, which may result in decreasing rental rates and greater concessions to tenants;
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inability to collect rent from tenants;
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vacancies or inability to rent space on favorable terms or at all;
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inability to finance property development and acquisitions on favorable terms or at all;
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increased operating costs, including insurance premiums, utilities, and real estate taxes;
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costs of complying with changes in governmental regulations;
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the relative illiquidity of real estate investments;
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changing submarket demographics; and
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property damage resulting from seismic activity or other natural disasters.
We depend upon significant tenants and the loss of a significant tenant could adversely affect our financial condition, revenues and results of operations. As of December 31, 2010, our fifteen largest tenants represented approximately 39.5% of total annualized base rental revenues. See further discussion on the composition of our tenants by industry and our largest tenants under “Item 1: Business-Significant Tenants” and “Item 2: Properties-Significant Tenants.”
Although we have been able to mitigate the impact of past significant tenant defaults on our financial condition, revenues, and results of operations, our financial condition, results of operations, ability to borrow funds, and cash flows would be adversely affected if any of our significant tenants fails to renew its lease(s), renew its lease(s) on terms less favorable to us, or becomes bankrupt or insolvent or otherwise unable to satisfy its lease obligations.
Downturn in tenants’ businesses may reduce our cash flows. For the year ended December 31, 2010, we derived approximately 99.0% of our revenues from continuing operations from rental income and tenant reimbursements. A tenant may experience a downturn in its business, which may weaken its financial condition and result in its failure to make timely rental payments or result in defaults under our leases. In the event of default by a tenant, we may experience delays in enforcing our rights as landlord and may incur substantial costs in protecting our investment.
The bankruptcy or insolvency of a major tenant also may adversely affect the income produced by our properties. If any tenant becomes a debtor in a case under the Bankruptcy Code, we cannot evict the tenant solely because of the bankruptcy. In addition, the bankruptcy court might permit the tenant to reject and terminate its lease with us. Our claim against the tenant for unpaid and future rent could be subject to a statutory cap that might be substantially less than the remaining rent actually owed under the lease. Therefore, our claim for unpaid rent would likely not be paid in full. Any losses resulting from the bankruptcy of any of our existing tenants could adversely impact our financial condition, results of operations, cash flows, the quoted trading price of our securities, and our ability to satisfy our debt service obligations and to pay dividends and distributions to our security holders.
We may be unable to renew leases or re-lease available space. As of December 31, 2010, we had office and industrial space available for lease representing approximately 10.9% of the total square footage of our properties. In addition, leases representing approximately 5.8% and 10.3% of the leased rentable square footage of our properties are scheduled to expire in 2011 and 2012, respectively. Above market rental rates on some of our properties may force us to renew or re-lease expiring leases at rates below current lease rates. As of December 31, 2010, we believe that the weighted average cash rental rates for our overall portfolio, including recently acquired properties, are approximately 10% above the current average quoted market rental rates, and weighted average cash rental rates for leases scheduled to expire during 2011 are approximately 15% above the current average quoted market rental rates, although individual properties within any particular submarket presently may be leased at, above, or below the current market rental rates within that submarket. We cannot give any assurance that leases will be renewed or that available space will be re-leased at rental rates equal to or above the current rental rates. If the average rental rates for our properties decrease or existing tenants do not renew their leases, our financial condition, results of operations, cash flows, the quoted trading price of the Company’s common stock and of the Operating Partnership’s publicly-traded notes, and our ability to satisfy our debt service obligations and to pay dividends and distributions to our security holders could be adversely affected.
We are subject to governmental regulations that may affect the development, redevelopment, and use of our properties. We are subject to governmental regulations that may have a material adverse effect on our financial condition, results of operations, cash flow, the quoted trading price of our securities, and our ability to satisfy our debt service obligations and to pay dividends and distributions to our security holders.
Our properties are subject to regulation under federal laws, such as the Americans with Disabilities Act of 1990 (the “ADA”) and updates thereof under which all public accommodations must meet federal requirements related to access and use by disabled persons, and state and local laws addressing earthquake, fire, and life safety requirements. Although we believe that our properties substantially comply with requirements under applicable governmental regulations, none of our properties have been audited or investigated for compliance by any regulatory agency. If we were not in compliance with material provisions of the ADA or other regulations affecting our properties, we might be required to take remedial action, which could include making modifications or renovations to properties. Federal, state, or local governments may also enact future laws and regulations that could require us to make significant modifications or renovations to our properties. If we were to incur substantial costs to comply with the ADA or any other regulations, our financial condition, results of operations, cash flows, the quoted trading price of our securities, and our ability to satisfy our debt service obligations and to pay dividends and distributions to our security holders could be adversely affected.
Our properties are subject to land use rules and regulations that govern our development, redevelopment, and use of our properties. Restrictions on our ability to develop, redevelop, or use our properties resulting from changes in the existing land use rules and regulations could have an adverse effect on our financial position, results of operations, cash flows, quoted trading price of our securities, our ability to satisfy our debt service obligations and to pay dividends and distributions to our security holders.
Increasing utility costs in California may have an adverse effect on our operating results and occupancy levels. The State of California continues to address issues related to the supply of electricity, water, and natural gas. In recent years, shortages of electricity have resulted in increased costs for consumers and certain interruptions in service. Increased consumer costs and consumer perception that the State is not able to effectively manage its utility needs may reduce demand for leased space in California office and industrial properties.
Our debt level reduces cash available for distribution and may expose us to the risk of default under our debt obligations. Payments of principal and interest on borrowings may leave us with insufficient cash resources to operate our properties or to pay in cash the distributions necessary to maintain the Company’s REIT qualification. See “-Risks Related to the Company’s Status as a REIT-Loss of the Company’s REIT status would have significant adverse consequences to us and the value of the Company’s common stock.” Our level of debt and the limitations imposed by our debt agreements may have substantial consequences to us, including the following:
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we may be unable to refinance our indebtedness at maturity, or the refinancing terms may be less favorable than the terms of our original indebtedness;
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cash flows may be insufficient to meet required principal and interest payments;
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we may be forced to dispose of one or more of our properties, possibly on disadvantageous terms;
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we may default on our obligations, and the lenders or mortgagees may foreclose on our properties that secure the loans and receive an assignment of rents and leases; and
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our default under one mortgage loan could result in a default on other indebtedness with cross default provisions.
If one or more of these events were to occur, our financial condition, results of operations, cash flow, the quoted trading price of our securities, and our ability to satisfy our debt service obligations and to pay dividends and distributions to our security holders could be adversely affected. In addition, foreclosures could create taxable income without accompanying cash proceeds, which could require our security holders to pay income tax. As of December 31, 2010, we had approximately $1.5 billion aggregate principal amount of indebtedness, $75.0 million of which is contractually due prior to December 31, 2011. Our total debt and preferred equity at December 31, 2010 represented 45.8% of our total market capitalization (which we define as the aggregate of our long-term debt, liquidation value of our preferred equity, and the market value of the Company’s common stock and common units).
For the calculation of our market capitalization and additional information on debt maturities see “Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources of the Company.”
Our credit facility includes financial covenants relating to our operations, which could limit our ability to make distributions to our stockholders. We rely exclusively on cash distributions we receive from the Operating Partnership for our working capital, including the cash necessary to pay dividends and distributions on shares of our common stock and preferred stock. The Operating Partnership has a $500 million unsecured revolving credit facility (the “Credit Facility”) which restricts the Operating Partnership from making, in any year, distributions to us or other holders of its partnership interests in an aggregate amount in excess of the greater of:
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95% of the Operating Partnership’s consolidated funds from operations (as defined in the Credit Facility) for such year; and
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an amount which results in distributions to us (excluding any preferred partnership distributions to the extent the same have been deducted from consolidated funds from operation for such year) in an amount sufficient to permit us to (a) pay dividends to our stockholders which we reasonably believe are necessary to maintain our qualification as a REIT for federal and state income tax purposes and (b) avoid the payment of federal or state income or exercise tax.
In addition, the Credit Facility provides that, if the Operating Partnership fails to pay when due any principal of or interest on any borrowings under the Credit Facility, then the Operating Partnership may make only those partnership distributions to us and other holders of its partnership interests necessary to enable us to make distributions to our stockholders which we reasonably believe are necessary to maintain our status as a REIT for federal and state income tax purposes. Any limitation on our ability to make distributions to our stockholders, whether as a result of these provisions in the Credit Facility or otherwise, could have a material adverse effect on the market value of our common stock and preferred stock.
We face significant competition, which may decrease the occupancy and rental rates of our properties. We compete with several developers, owners, and operators of office, industrial, and other commercial real estate, many of which own properties similar to ours in the same submarkets in which our properties are located but which have lower occupancy rates than our properties. Therefore, our competitors have an incentive to decrease rental rates until their available space is leased. As previously mentioned, at December 31, 2010 we believe that the weighted average cash rental rates for our overall portfolio are 10% above the current average quoted market rental rates. If our competitors offer space at rental rates below the rates currently charged by us for comparable space, we may be pressured to reduce our rental rates below those currently charged in order to retain tenants when our tenant leases expire. As a result, our financial condition, results of operations, cash flow, the quoted trading price of our securities, and our ability to satisfy our debt service obligations and to pay dividends and distributions to our security holders may be adversely affected.
Potential casualty losses, such as earthquake losses, may not be covered by insurance and payment of such losses may adversely affect our financial condition and results of operations. We carry comprehensive liability, fire, extended coverage, rental loss, and terrorism insurance covering all of our properties. Management believes the policy specifications and insured limits are appropriate given the relative risk of loss, the cost of the coverage, and industry practice. We do not carry insurance for generally uninsurable losses such as loss from riots or acts of God. Some of our policies, like those covering losses resulting from floods, are subject to limitations involving large deductibles or co-payments.
We are subject to environmental and health and safety laws and regulations, and any costs to comply with, or liabilities arising under, such laws and regulations could be material. As an owner, operator, manager, and developer of real properties, we are subject to environmental and health and safety laws and regulations. Certain of these laws and regulations impose joint and several liability, without regard to fault, for investigation and clean-up costs on current and former owners and operators of real property and persons who have disposed of or released hazardous substances into the environment. At some of the properties, there are asbestos-containing materials, or tenants routinely handle hazardous substances as part of their operations. In addition, historical operations, including the presence of underground storage tanks, have caused soil or groundwater contamination at or near
some of the properties. Although we believe that the prior owners of the affected properties conducted remediation of known soil contamination at these properties, we cannot assure you that all such contamination has been remediated. The discovery of previously unknown contamination or the compliance with existing or new environmental or health and safety laws and regulations could require us to incur costs or liabilities that could be material.
Earthquake damage to our properties could have an adverse effect on our financial condition and operating results. All but one of our properties are located in California. We carry earthquake insurance on our properties in an amount and with deductibles that management believes are commercially reasonable. However, the amount of our earthquake insurance coverage may not be sufficient to cover losses from earthquakes. In addition, our earthquake insurance policies include substantial self-insurance portions, and we may discontinue earthquake insurance on some or all of our properties in the future if the cost of premiums for earthquake insurance exceeds the value of the coverage discounted for the risk of loss. If we experience a loss that is uninsured or which exceeds policy limits, we could lose the capital invested in the damaged properties as well as the anticipated future cash flows from those properties. In addition, if the damaged properties are subject to recourse indebtedness, we would continue to be liable for the indebtedness, even if the properties were irreparable.
We may be unable to complete acquisitions and successfully operate acquired properties. We continually evaluate the market of available properties and may continue to acquire office and industrial properties and undeveloped land when strategic opportunities exist. Our ability to acquire properties on favorable terms and successfully operate them is subject to the following risks:
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we may potentially be unable to acquire a desired property because of competition from other real estate investors with significant capital, including both publicly traded REITs and institutional investment funds;
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the possibility that, even if we enter into agreements for the acquisition of office and industrial properties, we may be unable to complete such acquisitions since they remain subject to customary conditions to closing including the completion of due diligence investigations to management’s satisfaction;
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we may be unable to finance acquisitions on favorable terms or at all;
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we may spend more than budgeted amounts to make necessary improvements or renovations to acquired properties;
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we may lease acquired properties at below expected rental rates;
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we may acquire properties that are subject to liabilities for which we may have limited or no recourse; and
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we may be unable to complete an acquisition after making a nonrefundable deposit and incurring certain other acquisition related costs.
If we cannot finance property acquisitions on favorable terms or operate acquired properties to meet financial expectations, our financial condition, results of operations, cash flows, the quoted trading price of our securities, and our ability to satisfy our debt service obligations and to pay dividends and distributions to our security holders could be adversely affected.
We may be unable to successfully complete and operate acquired, developed, and redeveloped properties. There are significant risks associated with property acquisition, development, and redevelopment including the possibility that:
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we may be unable to lease acquired, developed, or redeveloped properties at expected rental rates or within budgeted timeframes;
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we may not complete development or redevelopment properties on schedule or within budgeted amounts;
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we may expend funds on and devote management’s time to acquisition, development, or redevelopment properties that we may not complete;
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we may encounter delays or refusals in obtaining all necessary zoning, land use, and other required entitlements, and building, occupancy, and other required governmental permits and authorizations;
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we may encounter delays, refusals, unforeseen cost increases, and other impairments resulting from third-party litigation; and
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we may fail to obtain the financial results expected from properties we acquire, develop, or redevelop.
If one or more of these events were to occur in connection with our acquired properties, undeveloped land, or development or redevelopment properties under construction, we could be required to recognize an impairment loss. These events could also have an adverse impact on our financial condition, results of operations, cash flow, the quoted trading price of our securities, and our ability to satisfy our debt service obligations and to pay dividends and distributions to our security holders.
While we historically have acquired, developed, and redeveloped office properties in California markets, we acquired one property in Washington during the year ended December 31, 2010 and may in the future acquire, develop, or redevelop properties for other uses and expand our business to other geographic regions where we expect the development or acquisition of property to result in favorable risk-adjusted returns on our investment. Presently, we do not possess the same level of familiarity with development of property types other than office and industrial, or with certain outside markets, which could adversely affect our ability to acquire or develop properties or to achieve expected performance.
We could default on leases for land on which some of our properties are located. As of December 31, 2010, we owned one office complex, Kilroy Airport Center in Long Beach, California, located on various land parcels, which we lease individually on a long-term basis. As of December 31, 2010, we had approximately 949,100 aggregate rentable square feet, or 6.8% of our total stabilized portfolio, of rental space located on these leased parcels. If we default under the terms of any particular lease, we may lose the ownership rights to the property subject to the lease. Upon expiration of a lease, we may not be able to renegotiate a new lease on favorable terms, if at all. The loss of the ownership rights to these properties or an increase of rental expense could have an adverse effect on our financial condition, results of operations, cash flow, the quoted trading price of our securities, and our ability to satisfy our debt service obligations and to pay dividends and distributions to our security holders.
Real estate assets are illiquid, and we may not be able to sell our properties when we desire. Our investments in our properties are relatively illiquid, limiting our ability to sell our properties quickly in response to changes in economic or other conditions. In addition, the Code generally imposes a 100% prohibited transaction tax on the Company on profits derived from sales of properties held primarily for sale to customers in the ordinary course of business, which effectively limits our ability to sell properties other than on a selected basis. These restrictions on our ability to sell our properties could have an adverse effect on our financial condition, results of operations, cash flow, the quoted trading price of our securities, and our ability to satisfy our debt service obligations and to pay dividends and distributions to our security holders.
We may invest in securities related to real estate, which could adversely affect our ability to pay dividends and distributions to our security holders. We may purchase securities issued by entities which own real estate and may, in the future, also invest in mortgages. In general, investments in mortgages are subject to several risks, including:
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borrowers may fail to make debt service payments or pay the principal when due;
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the value of the mortgaged property may be less than the principal amount of the mortgage note securing the property; and
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interest rates payable on the mortgages may be lower than our cost for the funds used to acquire these mortgages.
Owning these securities may not entitle us to control the ownership, operation, and management of the underlying real estate. In addition, we may have no control over the distributions with respect to these securities, which could adversely affect our ability to pay dividends and distributions to our security holders.
Future terrorist activity or engagement in war by the U.S. may have an adverse effect on our financial condition and operating results. Terrorist attacks in the U.S. and other acts of terrorism or war, may result in declining economic activity, which could harm the demand for and the value of our properties. In addition, the public perception that certain locations are at greater risk for attack, such as major airports, ports, and rail facilities, may decrease the demand for and the value of our properties near these sites. A decrease in demand could make it difficult for us to renew or re-lease our properties at these sites at lease rates equal to or above historical rates. Terrorist activities also could directly impact the value of our properties through damage, destruction, or loss, and the availability of insurance for these acts may be less, and cost more, which could adversely affect our financial condition. To the extent that our tenants are impacted by future attacks, their businesses similarly could be adversely affected, including their ability to continue to honor their existing leases.
Terrorist acts and engagement in war by the U.S. also may adversely affect the markets in which our securities trade and may cause further erosion of business and consumer confidence and spending and may result in increased volatility in national and international financial markets and economies. Any one of these events may cause a decline in the demand for our office and industrial leased space, delay the time in which our new or renovated properties reach stabilized occupancy, increase our operating expenses, such as those attributable to increased physical security for our properties, and limit our access to capital or increase our cost of raising capital.
Risks Related to our Organizational Structure
Our growth depends on external sources of capital that are outside of our control and the inability to obtain capital on terms that are acceptable to us, or at all, could adversely affect our financial condition and results of operations. The Company is required under the Code to distribute at least 90% of its taxable income (subject to certain adjustments and excluding net capital gain) and the Operating Partnership is required to make distributions to the Company to allow the Company to satisfy these REIT distribution requirements. For distributions with respect to our 2008 through 2011 taxable years, IRS guidance allows the Company to satisfy up to 90% of this requirement through the distribution of shares of its common stock, if certain conditions are met. Because of these distribution requirements, the Operating Partnership is required to make distributions to the Company, and we may not be able to fund future capital needs, including any necessary acquisition financing, from operating cash flow. Consequently, management relies on third-party sources of capital to fund our capital needs. We may not be able to obtain financing on favorable terms or at all. Any additional debt we incur will increase our leverage. Access to third-party sources of capital depends, in part, on general market conditions and the availability of credit, the market’s perception of our growth potential, our current and expected future earnings, our cash flows and cash distributions, and the quoted market price of our securities. If we cannot obtain capital from third-party sources, our financial condition, results of operations, cash flows, the quoted trading price of our securities, and our ability to satisfy our debt service obligations and to pay dividends and distributions to our security holders may be adversely affected.
Our common limited partners have limited approval rights, which may prevent us from completing a change of control transaction that may be in the best interests of all our security holders. The Company may not withdraw as the Operating Partnership’s general partner or transfer its general partnership interest in the Operating Partnership without the approval of the holders of at least 60% of the units representing common limited partnership interests, including the common units held by the Company in its capacity as the Operating Partnership’s general partner. In addition, the Company may not engage in a merger, consolidation, or other combination or the sale of substantially all of its assets or such similar transaction, without the approval of the holders of 60% of the common units, including the common units held by the Company in its capacity as the Operating Partnership’s general partner. The right of our common limited partners to vote on these transactions could limit our ability to complete a change of control transaction that might otherwise be in the best interest of all our security holders.
In certain circumstances, our limited partners must approve our dissolution and the disposition of properties contributed by the limited partners. For as long as limited partners own at least 5% of all of our partnership
interests, we must obtain the approval of limited partners holding a majority of the units representing common limited partnership interests before we may dissolve. As of December 31, 2010, limited partners owned approximately 3.2% of our partnership interests, of which 2.7% was owned by John B. Kilroy, Sr. and John B. Kilroy, Jr. In addition, we agreed to use commercially reasonable efforts to minimize the tax consequences to common limited partners resulting from the repayment, refinancing, replacement, or restructuring of debt, or any sale, exchange, or other disposition of any of our other assets. The exercise of one or more of these approval rights by the limited partners could delay or prevent us from completing a transaction that may be in the best interest of all our security holders.
The Chairman of our board of directors and our President and Chief Executive Officer each have substantial influence over our affairs. John B. Kilroy, Sr. is the Chairman of our board of directors and the father of John B. Kilroy, Jr., our President and Chief Executive Officer. Each is a member of our board of directors, and together, as of December 31, 2010, they beneficially owned approximately 3.3% of the total outstanding shares of the Company’s common stock. The percentage of outstanding shares of common stock beneficially owned includes 239,477 shares of common stock, 176,616 restricted stock units that were vested and held by John B. Kilroy, Jr. at December 31, 2010, and assumes the exchange into shares of the Company’s common stock of the 1,335,135 common units held by Messrs. Kilroy (which are redeemable in exchange for, at the option of the Company, an equal number of shares of the Company’s common stock). The beneficial ownership percentage excludes 33,201 nonvested restricted stock units held by John B. Kilroy, Jr. at December 31, 2010.
Pursuant to the Company’s charter, no other stockholder may own, actually or constructively, more than 7.0% of the outstanding Company common stock without obtaining a waiver from the board of directors. The board of directors has waived the ownership limits with respect to John B. Kilroy, Sr., John B. Kilroy, Jr., members of their families, and some of their affiliated entities. These named individuals and entities may own either actually or constructively, in the aggregate, up to 19.6% of the Company’s outstanding common stock, excluding Operating Partnership units that are exchangeable into shares of Company common stock. Consequently, Messrs. Kilroy have substantial influence on the Company, and because the Company is the manager of the Operating Partnership, on the Operating Partnership, and could exercise their influence in a manner that is not in the best interest of our stockholders, noteholders or unitholders. Also, they may, in the future, have a substantial influence on the outcome of any matters submitted to our stockholders or unitholders for approval.
There are restrictions on the ownership of the capital stock of the Company, which limit the opportunities for a change of control at a premium to existing security holders. Provisions of the Maryland General Corporation Law, the Company’s charter and bylaws, and the Operating Partnership’s partnership agreement may delay, deter, or prevent a change of control over us, or the removal of existing management. Any of these actions might prevent our security holders from receiving a premium for their common shares or common units over the then-prevailing market price of the shares of the Company’s common stock.
The Code contains ownership limits on the Company’s capital stock that apply as a result of the Company’s decision to be taxed as a REIT, including:
•
no more than 50% in value of the Company’s capital stock may be owned, actually or constructively, by five or fewer individuals, including some entities, during the last half of a taxable year;
•
the Company’s common stock must be held by a minimum of 100 persons for at least 335 days of a 12-month taxable year, or a proportionate part of a short taxable year; and
•
if the Operating Partnership, the Company or any entity which owns 10% or more of the Company’s capital stock, actually or constructively own 10% or more of one of the Operating Partnership’s tenants, a tenant of the Company or any partnership in which the Operating Partnership or the Company is a partner, then any rents received from that tenant will not be qualifying income for purposes of the Code’s REIT gross income tests, regardless of whether the rent is received directly or through a partnership.
The Company’s charter also establishes ownership limits to protect the Company’s REIT status. No single stockholder may own, either actually or constructively, absent a waiver from the board of directors, more than 7.0% (by value or by number of shares, whichever is more restrictive) of the Company’s common stock outstanding. Similarly, absent a waiver from the board of directors, no single holder of the Company’s 7.45% Series A
Cumulative Redeemable Preferred stock (the “Series A Preferred Stock”), if issued, may actually or constructively own any class or series of the Company’s preferred stock, so that their total capital stock ownership would exceed 7.0% by value of the Company’s total outstanding shares of capital stock; no single holder of the Company’s 7.8% Series E Cumulative Redeemable Preferred stock (the “Series E Preferred Stock”) may actually or constructively own more than 9.8% (by value or by number of shares, whichever is more restrictive) of the Company’s Series E Preferred Stock; and no single holder of the Company’s 7.5% Series F Cumulative Redeemable Preferred stock (the “Series F Preferred Stock”) may actually or constructively own more than 9.8% (by value or by number of shares, whichever is more restrictive) of the Company’s Series F Preferred Stock.
The board of directors may waive the ownership limits if it is satisfied that the excess ownership would not jeopardize the Company’s REIT status and if it believes that the waiver would be in our best interest. The board of directors has waived the ownership limits with respect to John B. Kilroy, Sr., John B. Kilroy, Jr., members of their families, and some of their affiliated entities. These named individuals and entities may own either actually or constructively, in the aggregate, up to 19.6% of the Company’s outstanding common stock, excluding units that are exchangeable into shares of common stock. The board of directors has also waived the ownership limits with respect to the initial purchasers of each of our 3.25% Exchangeable Senior Notes due 2012 (the “3.25% Exchangeable Notes”) and the 4.25% Exchangeable Senior Notes due 2014 (the “4.25% Exchangeable Notes” and, together with the 3.25% Exchangeable Notes, the “Exchangeable Notes”) and certain of their affiliated entities to beneficially own up to 9.8%, in the aggregate, of the Company’s common stock in connection with hedging the capped call transactions.
If anyone acquires shares in excess of any ownership limits, the transfer to the transferee will be void with respect to the excess shares, the excess shares will be automatically transferred from the transferee or owner to a trust for the benefit of a qualified charitable organization, the purported transferee or owner will have no right to vote those excess shares, and the purported transferee or owner will have no right to receive dividends or other distributions from those excess shares.
The Company’s charter contains provisions that may delay, deter, or prevent a change of control transaction. The following provisions of the Company’s charter may delay or prevent a change of control over us, even if a change of control might be beneficial to our security holders, deter tender offers that may be beneficial to our security holders, or limit security holders’ opportunity to receive a potential premium for their shares and/or units if an investor attempted to gain shares beyond the Company’s ownership limits or otherwise to effect a change of control:
•
The Company’s charter authorizes the board of directors to issue up to 30,000,000 shares of the Company’s preferred stock, including convertible preferred stock, without stockholder approval. The board of directors may establish the preferences, rights, and other terms, including the right to vote and the right to convert into common stock any shares issued. The issuance of preferred stock could delay or prevent a tender offer or a change of control even if a tender offer or a change of control was in our security holder’s interest. As of December 31, 2010, 5,060,000 shares of the Company’s preferred stock were issued and outstanding, consisting of 1,610,000 shares of the Company’s Series E Preferred Stock and 3,450,000 shares of the Company’s Series F Preferred Stock, and an additional 1,500,000 shares of preferred stock were designated as Series A Preferred Stock, which was reserved for possible issuance in exchange for the Operating Partnership’s outstanding Series A Preferred Units (the “Series A Preferred Units”); and
•
The Company’s charter states that any director, or the entire board of directors, may be removed from office at any time, but only for cause and then only by the affirmative vote of the holders of at least two thirds of the votes of the Company’s capital stock entitled to be cast in the election of directors.
The board of directors may change investment and financing policies without unitholder or stockholder approval, causing us to become more highly leveraged, which may increase our risk of default under our debt obligations.
We are not limited in our ability to incur debt. Our financing policies and objectives are determined by the board of directors. Our goal is to limit our dependence on leverage and maintain a conservative ratio of debt to total
market capitalization. However, our organizational documents do not limit the amount or percentage of indebtedness, funded or otherwise, that we may incur. As of December 31, 2010, we had approximately $1.5 billion aggregate principal amount of indebtedness outstanding, which represented 40.2% of our total market capitalization. Our total debt and the liquidation value of our preferred equity as a percentage of total market capitalization was approximately 45.8% as of December 31, 2010. See “Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources of the Company” for a calculation of our market capitalization. These ratios may be increased or decreased without the consent of our unitholders or stockholders. Increases in the amount of debt outstanding would result in an increase in our debt service, which could adversely affect cash flow and our ability to pay dividends and distributions to our security holders. Higher leverage also increases the risk of default on our obligations and limits our ability to obtain additional financing in the future.
We may issue additional common units and shares of capital stock without unitholder or stockholder approval, as applicable, which may dilute unitholder or stockholder investment. The Company may issue shares of our common stock, preferred stock, or other equity or debt securities without stockholder approval, including the issuance of shares to satisfy REIT dividend distribution requirements. Similarly, the Operating Partnership may offer our common or preferred units for contributions of cash or property without approval by our unitholders. Further, under certain circumstances, the Company may issue shares of our common stock in exchange for the Operating Partnership’s outstanding Exchangeable Notes. Existing security holders have no preemptive rights to acquire any of these securities, and any issuance of equity securities under these circumstances may dilute a unitholder’s or stockholder’s investment.
Sales of a substantial number of shares of the Company’s securities, or the perception that this could occur, could result in decreasing the quoted market price per share for the Company’s common stock and of the Operating Partnership’s publicly-traded notes. Management cannot predict whether future issuances of shares of the Company’s common stock or the availability of shares for resale in the open market will result in decreasing the market price per share of the Company’s common stock. As of December 31, 2010, 52,349,670 shares of the Company’s common stock and 5,060,000 shares of the Company’s preferred stock, consisting of 1,610,000 shares of Series E Preferred Stock and 3,450,000 shares of Series F Preferred Stock, were issued and outstanding, and an additional 1,500,000 shares of preferred stock were designated as Series A Preferred Stock, which was reserved for possible issuance in exchange for the Operating Partnership’s outstanding Series A Preferred Units.
As of December 31, 2010, the Company had reserved for future issuance the following shares of common stock: 1,723,131 shares issuable upon the exchange, at the Company’s option, of the Operating Partnership’s common units; 4,375,533 shares remained available for grant under our 2006 Incentive Award Plan (see Note 12 to our consolidated financial statements); 713,822 shares issuable upon settlement of restricted stock units (“RSUs”); 20,000 shares issuable upon exercise of outstanding options; and 975,101 shares issuable under our the Company’s Dividend Reinvestment and Direct Stock Purchase Plan, as well as 1,681,813 and 4,800,796 shares potentially issuable under certain circumstances, in exchange for the 3.25% Exchangeable Notes and 4.25% Exchangeable Notes, respectively. The Company has a currently effective registration statement registering 1,723,131 shares of our common stock for possible issuance to the holders of the Operating Partnership’s common units. That registration statement also registers 306,808 shares of common stock held by certain stockholders for possible resale. The Company also has a currently effective registration statements registering the 1,681,813 shares of our common stock that may potentially be issued in exchange for the Operating Partnership’s presently outstanding 3.25% Exchangeable Notes, and 4,800,796 shares of our common stock that may potentially be issued in exchange for the Operating Partnership’s presently outstanding 4.25% Exchangeable Notes. Consequently, if and when the shares are issued, they may be freely traded in the public markets.
Risks Related to the Company’s Status as a REIT
Loss of the Company’s REIT status would have significant adverse consequences to us and the value of the Company’s common stock. The Company currently operates in a manner that is intended to allow the Company to qualify as a REIT for federal income tax purposes under the Code. If the Company were to lose its REIT status, the
Company would face serious tax consequences that would substantially reduce the funds available for distribution to our unitholders and stockholders for each of the years involved because:
•
the Company would not be allowed a deduction for distributions to our stockholders in computing the Company’s taxable income and would be subject to federal income tax at regular corporate rates;
•
the Company could be subject to the federal alternative minimum tax and possibly increased state and local taxes; and
•
unless entitled to relief under statutory provisions, the Company could not elect to be taxed as a REIT for four taxable years following the year during which the Company was disqualified.
In addition, if the Company failed to qualify as a REIT, the Company will not be required to make distributions to our stockholders, and all distributions to our stockholders will be subject to tax as regular corporate dividends to the extent of its current and accumulated earnings and profits. As a result of all these factors, the Company’s failure to qualify as a REIT also could impair our ability to expand our business and raise capital and could adversely affect the value of the Company’s common stock.
Qualification as a REIT involves the application of highly technical and complex Code provisions for which there are only limited judicial and administrative interpretations. The complexity of these provisions and of the applicable Treasury regulations that have been promulgated under the Code is greater in the case of a REIT that, like us, holds its assets through a partnership. The determination of various factual matters and circumstances not entirely within our control may affect the Company’s ability to continue to qualify as a REIT. For example, to qualify as a REIT, at least 95% of the Company’s gross income in any year must be derived from qualifying sources. Also, the Company must make distributions to stockholders aggregating annually at least 90% of the Company’s taxable income (subject to certain adjustments and excluding net capital gain). For distributions with respect to our 2008 through 2011 taxable years, IRS guidance allows the Company to satisfy up to 90% of this requirement through the distribution of shares of its common stock, if certain conditions are met. In addition, legislation, new regulations, administrative interpretations, or court decisions may adversely affect the Company’s security holders, or the Company’s ability to qualify as a REIT for federal income tax purposes or the desirability of an investment in a REIT relative to other investments. Although management believes that we are organized and that we operate in a manner to permit the Company to continue to qualify as a REIT, we can provide no assurance to that effect.
To maintain the Company’s REIT status, we may be forced to borrow funds on a short-term basis during unfavorable market conditions. To qualify as a REIT, the Company generally must distribute to our stockholders at least 90% of the Company’s taxable income each year (subject to certain adjustments and excluding net capital gain) and we will be subject to regular corporate income taxes to the extent that we distribute less than 100% of our net taxable income each year. In addition, the Company will be subject to a 4% nondeductible excise tax on the amount, if any, by which distributions paid by us in any calendar year are less than the sum of 85% of our ordinary income, 95% of our net capital gains, and 100% of our undistributed income from prior years. For distributions with respect to our 2008 through 2011 taxable years, IRS guidance allows the Company to satisfy up to 90% of this requirement through the distribution of shares of its common stock, if certain conditions are met. To maintain the Company’s REIT status and avoid the payment of federal income and excise taxes, the Operating Partnership may need to borrow funds on a short-term basis and loan the proceeds to the Company so we can meet the REIT distribution requirements even if the then-prevailing market conditions are not favorable for these borrowings. These short-term borrowing needs could result from differences in timing between the actual receipt of income and inclusion of income for federal income tax purposes, or the effect of nondeductible capital expenditures, the creation of reserves, or required debt or amortization payments.
ITEM 1B.
ITEM 1B.
UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2.
PROPERTIES
General
As of December 31, 2010, our stabilized portfolio of operating properties was comprised of the following office and industrial properties, all but one of which are located in California.
Our stabilized portfolio excludes undeveloped land, one office redevelopment property that is currently under construction and one industrial property that we are in the process of repositioning for residential use. We own all of our properties through the Operating Partnership and the Finance Partnership. All our properties are held in fee except for the seven office buildings located at Kilroy Airport Center in Long Beach, California, which are held subject to leases for the land that expire in 2084.
In general, the Office Properties are leased to tenants on a full service gross or modified gross basis, and the Industrial Properties are leased to tenants on a triple net basis. Under a full service lease, the landlord is obligated to pay the tenant’s proportionate share of real estate taxes, insurance, and operating expenses up to the amount incurred during the tenant’s first year of occupancy (“Base Year”) or a negotiated amount approximating the tenant’s pro rata share of real estate taxes, insurance, and operating expenses (“Expense Stop”). The tenant pays its pro rata share of increases in expenses above the Base Year or Expense Stop. A modified gross lease is similar to a full service gross lease, except tenants are obligated to pay their proportionate share of certain operating expenses, usually electricity, directly to the service provider. Under a triple net lease and a modified net lease, tenants pay their proportionate share of real estate taxes, operating costs, and utility costs.
We believe that all of our properties are well maintained and do not require significant capital improvements. As of December 31, 2010, we managed all of our properties through internal property managers.
Office and Industrial Properties
The following table sets forth certain information relating to each of the stabilized Office Properties and Industrial Properties owned as of December 31, 2010.
(1)
Based on all leases at the respective properties in effect as of December 31, 2010. Includes month-to-month leases as of December 31, 2010.
(2)
Calculated as contractual base rental revenues as of December 31, 2010, determined in accordance with GAAP, annualized to reflect a twelve-month period. Annualized base rental revenues excludes the amortization of deferred revenue recorded for tenant-funded tenant improvements. Excludes month-to-month leases and vacant space as of December 31, 2010.
(3)
Reflects annualized contractual base rent calculated on a straight-line basis in accordance with GAAP excluding the amortization of deferred revenue related to tenant-funded tenant improvements and expense reimbursement revenue. Excludes month-to-month leases and vacant space as of December 31, 2010.
(4)
For these properties, the leases are written on a triple net basis.
(5)
For this property, leases of approximately 5,000 rentable square feet are written on a modified gross basis, a lease of approximately 2,000 rentable square feet is written on a full service gross basis, and a lease of approximately 3,000 rentable square feet is written on a gross basis whereby the tenant does not pay any operating expenses.
(6)
For these properties, the leases are written on a modified gross basis.
(7)
For these properties, the leases are written on a modified net basis.
(8)
For this property, a lease of approximately 20,000 rentable square feet is written on a modified net basis. A lease of approximately 5,000 rentable square feet was executed with one tenant during the fourth quarter of 2010 and is written on a modified gross basis. The remaining 18,000 rentable square feet is currently being marketed for lease.
(9)
For this property, leases of approximately 19,000 rentable square feet are written on a modified net basis, and leases of approximately 22,000 rentable square feet are written on a modified gross basis.
(10)
For this property, leases of approximately 20,000 rentable square feet are written on a full service gross basis, and leases of approximately 19,000 rentable square feet are written on a triple net basis.
(11)
For this property, a lease of approximately 144,000 rentable square feet is written on a modified net basis.
(12)
For this property, leases of approximately 15,000 rentable square feet are written on a full service gross basis, leases of approximately 31,000 rentable square feet are written on a triple net basis, and leases of approximately 18,000 rentable square feet are written on a modified triple net basis.
(13)
For this property, a lease of approximately 15,000 rentable square feet is written on a modified gross basis, and a lease of approximately 56,000 rentable square feet is written on a triple net basis.
(14)
For these properties, leases of approximately 142,000 rentable square feet are written on a modified net basis, and a lease of approximately 37,000 rentable square feet is written on a modified gross basis.
(15)
For this property, leases of approximately 168,000 rentable square feet are written on a triple net basis, and the remaining 20,000 rentable square feet are vacant.
(16)
For this property, a lease of approximately 41,000 rentable square feet is written on a modified gross basis. The remaining 11,000 rentable square feet is currently being marketed for lease.
(17)
For this property, a lease of approximately 47,000 rentable square feet is written on a modified net basis. The remaining 18,000 rentable square feet is currently being marketed for lease.
(18)
For this property, a lease of approximately 33,000 rentable square feet is written on a modified gross basis. The remaining 18,000 rentable square feet is currently being marketed for lease.
(19)
For this property, leases of approximately 24,000 rentable square feet are written on a modified gross basis.
(20)
For this property, a lease of approximately 70,000 rentable square feet is written on a modified net basis.
(21)
For this property, leases of approximately 82,000 rentable square feet are written on a modified gross basis, and a lease of approximately 17,000 rentable square feet is written on a gross basis. The remaining 5,000 rentable square feet is currently being marketed for lease.
(22)
For this property, a lease of approximately 15,000 rentable square feet is written on a modified gross basis. A lease of approximately 44,000 rentable square feet was executed with one tenant during the fourth quarter of 2010. The new lease is expected to commence in the first quarter of 2011.
(23)
For this property, a lease of approximately 13,000 rentable square feet is written on a modified net basis, and a lease of approximately 10,000 rentable square feet will commence in the first quarter of 2011 . The remaining 28,000 rentable square feet is currently being marketed for lease.
(24)
For this property, a lease of approximately 50,000 rentable square feet is written on a modified net basis. The remaining 30,000 rentable square feet is currently being marketed for lease.
(25)
For this property, a lease of approximately 65,000 rentable square feet was executed with one tenant during the fourth quarter of 2010. The new lease is expected to commence in the second quarter of 2011.
(26)
For this property, a lease of approximately 50,000 rentable square feet was executed with one tenant during the fourth quarter of 2010. The new lease is expected to commence in the second quarter of 2011.
(27)
For this property, a lease of approximately 103,000 rentable square feet was executed with one tenant during the fourth quarter of 2010. The new lease is expected to commence in the third quarter of 2011.
(28)
For these properties, the office leases are written on a full service gross basis and the retail leases are written on a triple net basis.
Re-entitlement Property
As of December 31, 2010, we were in the process of repositioning the following property for residential use.
During the year ended December 31, 2010, we received notification that the zoning to allow high density residential improvements on the land underlying this property was adopted by the city of Irvine. We are currently evaluating strategic alternatives for this property.
In Process Redevelopment Property
As of December 31, 2010, we were in the process of redeveloping the following property.
(1)
Based on management’s estimation of the earlier of stabilized occupancy (95%) or one year from the date of substantial completion.
Future Development Pipeline
The following table sets forth certain information relating to our undeveloped land located in San Diego, California as of December 31, 2010.
Significant Tenants
The following table sets forth information about our fifteen largest tenants based upon annualized rental revenues as of December 31, 2010.
(1)
Based upon annualized contractual base rental revenue, which is calculated on a straight-line basis in accordance with GAAP, for leases for which rental revenue is being recognized by us as of December 31, 2010.
(2)
The Intuit leases, which contribute $1.6 million and $13.5 million of annualized base rental revenues, expire in August 2012 and August 2017, respectively.
(3)
The Bridgepoint Education leases, which contribute $1.0 million, $6.3 million, and $7.8 million of annualized base rental revenues, expire in February 2017, July 2018, and September 2018, respectively.
(4)
The Scripps Health leases, which contribute $5.2 million and $7.4 million of annualized base rental revenues, expire in June 2021 and February 2027, respectively.
(5)
The Delta Dental leases, which contribute $0.5 million and $10.3 million of annualized base rental revenues, expire in December 2011 and May 2015, respectively.
(6)
The CareFusion Corporation leases, which contribute $0.8 million and $9.3 million of annualized base rental revenues, expire in February 2012 and August 2017, respectively.
(7)
The Hewlett-Packard Company leases, which contribute $4.3 million and $1.5 million of annualized base rental revenues, expire in April 2012 and July 2015, respectively.
(8)
The Wells Fargo leases, which contribute $0.1 million, $1.4 million, $1.0 million, $0.7 million, $2.0 million, and $0.1 million of annualized rental revenues, expire in January 2011, September 2013, November 2014, August 2015, September 2017, and February 2019, respectively.
(9)
During 2010, these leases were assigned from Verenium Corporation to BP Biofuels North America LLC. These leases, which contribute $2.9 million and $2.2 million of annualized base rental revenues, expire in November 2015 and March 2017, respectively.
(10)
We have entered into leases with various affiliates of the tenant name listed above.
The following table sets forth the composition of our tenant base by industry based on Standard Industrial Classifications as of December 31, 2010.
Lease Expirations
The following table sets forth a summary of our lease expirations for the Office Properties and Industrial Properties for each of the next ten years beginning with 2011, assuming that none of the tenants exercise renewal options or termination rights. See further discussion of our lease expirations under “Item 1A: Risk Factors”.
Lease Expirations by Segment(1)
(1)
The information presented reflects leasing activity through December 31, 2010. For leases that have been renewed early or space that has been re-leased to a new tenant, the expiration date and annualized base rent information presented takes into consideration the renewed or re-leased lease terms. Excludes space leased under month-to-month leases and vacant space as of December 31, 2010.
(2)
Reflects annualized contractual base rent calculated on a straight-line basis in accordance with GAAP excluding the amortization of deferred revenue related to tenant-funded tenant improvements and expense reimbursement revenue. Additionally, the underlying leases contain various expense structures including full service gross, modified gross and triple net.
Secured Debt
As of December 31, 2010, the Operating Partnership had six outstanding mortgage notes payable, which were secured by certain of our properties. Our secured debt represents an aggregate indebtedness of approximately $313.7 million, before the effect of unamortized discounts. See additional information regarding our secured debt in “Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations-Liquidity” and “Capital Resources-Liquidity Sources,” Notes 6 and 7 to our consolidated financial statements, and Schedule III-Real Estate and Accumulated Depreciation included with this report. Management believes that, as of December 31, 2010, the value of the properties securing the applicable secured obligations in each case exceeded the principal amount of the outstanding obligation.
ITEM 3.
ITEM 3.
LEGAL PROCEEDINGS
We and our properties are subject to routine litigation incidental to our business’, we are not a defendant in, and our properties are not subject to, any legal proceedings that, if determined adversely to us, would have a material adverse effect upon our financial condition, results of operations, or cash flows.
ITEM 4.
ITEM 4.
REMOVED AND RESERVED
PART II
ITEM 5.
ITEM 5.
MARKET FOR KILROY REALTY CORPORATION’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
The Company’s common stock is traded on the New York Stock Exchange (“NYSE”) under the symbol “KRC.” As of the date this report was filed, there were approximately 105 registered holders of the Company’s common stock. The following table illustrates the high, low, and closing prices by quarter as well as dividends declared during 2010 and 2009 as reported on the NYSE.
The Company pays distributions to common stockholders quarterly each January, April, July, and October at the discretion of the board of directors. Distribution amounts depend on our FFO, financial condition, capital requirements, the annual distribution requirements under the REIT provisions of the Code, and such other factors as the board of directors deems relevant.
MARKET FOR KILROY REALTY , L.P.’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
There is no established public trading market for the Operating Partnership’s partnership units. As of the date this report was filed, there were 17 holders of record of our common limited partnership units (including the Company’s general partnership interest).
The following table reports the distributions per common limited partnership unit declared during the years ended December 31, 2010 and 2009.
During 2009, the operating partnership redeemed 30,598 common limited partnership units for the same number of shares of the Company’s common stock. During 2010, the operating partnership did not redeem any common limited partnership units for shares of the Company’s common stock.
PERFORMANCE GRAPH
The following line graph compares the change in cumulative stockholder return on shares of the Company’s common stock to the cumulative total return of the NAREIT All Equity REIT Index, the Standard & Poor’s 500 Stock Index, and the SNL REIT Office Index for the five-year period ended December 31, 2010. We include an additional index, the SNL REIT Office Index, to the performance graph since management believes it provides additional information to investors about our performance relative to a more specific peer group. The SNL REIT Office Index is a published and widely recognized index that comprises 17 office equity REITs, including us. The graph assumes the investment of $100 in us and each of the indices on December 31, 2005 and, as required by the SEC, the reinvestment of all distributions. The return shown on the graph is not necessarily indicative of future performance.
ITEM 6.
ITEM 6.
SELECTED FINANCIAL DATA-KILROY REALTY CORPORATION
The following tables set forth selected consolidated financial and operating data on an historical basis for the Company. The following data should be read in conjunction with our financial statements and notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included below in this Form 10-K.
The consolidated balance sheet data as of December 31, 2010, 2009, 2008, 2007, and 2006 and the consolidated statement of operations data for each of the years then ended have been derived from the historical consolidated financial statements of Kilroy Realty Corporation audited by an independent registered public accounting firm.
KILROY REALTY CORPORATION CONSOLIDATED
(in thousands, except share, per share, square footage and occupancy data)
(1)
Represents the redemption value, less issuance costs of our issued and outstanding 1,500,000 Series A Preferred Units.
(2)
Includes the noncontrolling interest of the common units of the Operating Partnership.
(3)
We calculate FFO in accordance with the White Paper on FFO approved by the Board of Governors of NAREIT. The White Paper defines FFO as net income or loss calculated in accordance with GAAP, excluding extraordinary items, as defined by GAAP, and gains and losses from sales of depreciable operating 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.
We believe that FFO is a useful supplemental measure of our operating performance. The exclusion from FFO of gains and losses from the sale of operating real estate assets allows investors and analysts to readily identify the operating results of the assets that form the core of our activity and assists in comparing those operating results between periods. Also, because FFO is generally recognized as the industry standard for reporting the operations of REITs, it facilitates comparisons of operating performance to other REITs. However, other REITs may use different methodologies to calculate FFO, and accordingly, our FFO may not be comparable to all other REITs.
Implicit in historical cost accounting for real estate assets in accordance with GAAP is the assumption that the value of real estate assets diminishes predictably over time. Since real estate values have historically risen or fallen with market conditions, many industry investors and analysts have considered presentations of operating results for real estate companies using historical cost accounting alone to be insufficient. Because FFO excludes depreciation and amortization of real estate assets, we believe that FFO along with the required GAAP presentations provides a more complete measurement of our performance relative to our competitors and a more appropriate basis on which to make decisions involving operating, financing, and investing activities than the required GAAP presentations alone would provide.
However, FFO should not be viewed as an alternative measure of our operating performance since it does not reflect either depreciation and amortization costs or the level of capital expenditures and leasing costs necessary to maintain the operating performance of our properties, which are significant economic costs and could materially impact our results of operations.
Noncash adjustments to arrive at FFO were as follows: noncontrolling interest in earnings of the Operating Partnership, depreciation and amortization of real estate assets, and net gain (loss) from dispositions of operating properties. For additional information, see Item 7:
Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations “-Non-GAAP Supplemental Financial Measure: Funds From Operations” including a reconciliation of our GAAP net income available for common stockholders to FFO for the periods presented.
SELECTED FINANCIAL DATA-KILROY REALTY, L.P.
The following tables set forth selected consolidated financial and operating data on an historical basis for the Operating Partnership. The following data should be read in conjunction with our financial statements and notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included below in this Form 10-K.
The consolidated balance sheet data as of December 31, 2010, 2009, and 2008 and the consolidated statement of operations data for the years ended December 31, 2010, 2009, 2008, and 2007 have been derived from the historical consolidated financial statements of Kilroy Realty, L.P. audited by an independent registered public accounting firm. The consolidated balance sheet data as of December 31, 2007 and 2006 and the consolidated statement of operations data for the year ended December 31, 2006 have been derived from the unaudited historical consolidated financial statements of Kilroy Realty, L.P.
KILROY REALTY, L.P. CONSOLIDATED
(in thousands, except unit, per unit, square footage and occupancy data)
(1)
Represents the redemption value, less issuance costs of the Operating Partnership’s issued and outstanding 1,500,000 Series A Preferred Units.
(2)
Includes the noncontrolling interests in consolidated subsidiaries.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion relates to our consolidated financial statements and should be read in conjunction with the financial statements and notes thereto appearing elsewhere in this report. The results of operations discussion is combined for the Company and the Operating Partnership because there are no material differences in the results of operations between the two reporting entities.
Statements contained in this report 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. Some of the information presented is forward-looking in nature, including information concerning projected future occupancy rates, rental rate increases, property development timing and costs, and investment amounts. Numerous factors could affect our actual results, some of which are beyond our control. These include the breadth and duration of the current slowness of economic growth and its impact on our tenants, the strength of commercial and industrial real estate markets, market conditions affecting tenants, our ability to complete and successfully integrate pending and recent acquisitions, competitive market conditions, interest rate levels, volatility in the trading prices of the Company’s securities, and capital market conditions. You are cautioned not to place undue reliance on this information, which speaks only as of the date of this report. We assume no obligation to update publicly any forward-looking information, whether as a result of new information, future events, or otherwise, except to the extent we are required to do so in connection with our ongoing requirements under federal securities laws to disclose material information. For a discussion of important risks related to our business, and related to investing in our securities, including risks that could cause actual results and events to differ materially from results and events referred to in the forward-looking information, see “Item 1A: Risk Factors and the discussion under the captions-Factors That May Influence Future Results of Operations” and “-Liquidity and Capital Resources” below. In light of these risks, uncertainties, and assumptions, our actual results could be materially different from the expectations stated in this report.
Overview and Background
We are a self-administered REIT active in premier office and industrial submarkets along the West Coast. We own, develop, acquire and manage primarily Class A real estate assets in the coastal regions of Los Angeles, Orange County, San Diego, greater Seattle and the San Francisco Bay Area, which we believe have strategic advantages and strong barriers to entry. We own our interests in all of our properties through the Operating Partnership and the Finance Partnership, and conduct substantially all of our operations through the Operating Partnership. We owned a 96.8% and 96.2% general partnership interest in the Operating Partnership as of December 31, 2010 and 2009, respectively.
Critical Accounting Policies
The preparation of financial statements in conformity with GAAP requires us to make estimates, assumptions, and judgments that affect the reported amounts of assets, liabilities, and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses for the reporting periods.
Certain accounting policies are considered to be critical accounting policies. Critical accounting policies are those policies that require our management team to make significant estimates and/or assumptions about matters that are uncertain at the time the estimates and/or assumptions are made or where we are required to make significant judgments and assumptions with respect to the practical application of accounting principles in our business operations. Critical accounting policies are by definition those policies that are material to our financial statements and for which the impact of changes in estimates, assumptions, and judgments could have a material impact to our financial statements.
The following critical accounting policies discussion reflects what we believe are the most significant estimates, assumptions, and judgments used in the preparation of our consolidated financial statements. This discussion of our critical accounting policies is intended to supplement the description of our accounting policies in the footnotes to our consolidated financial statements and to provide additional insight into the information used by management when evaluating significant estimates, assumptions, and judgments. For further discussion of our significant accounting policies, see Note 2 to the consolidated financial statements included in this report.
Rental Revenue Recognition
Rental revenue is our principal source of revenue. The timing of when we commence rental revenue recognition depends largely on our conclusion as to whether we are or the tenant is the owner for accounting purposes of the tenant improvements at the leased property. When we conclude that we are the owner of tenant improvements for accounting purposes, we record the cost to construct the tenant improvements as an asset, and we commence rental revenue recognition when the tenant takes possession of the finished space, which is typically when such tenant improvements are substantially complete.
The determination of whether we are or the tenant is the owner of the tenant improvements for accounting purposes is subject to significant judgment. In making that determination, we consider numerous factors and perform a detailed evaluation of each individual lease. No one factor is determinative in reaching a conclusion. The factors we evaluate include but are not limited to the following:
•
whether the lease agreement requires landlord approval of how the tenant improvement allowance is spent prior to installation of the tenant improvements;
•
whether the lease agreement requires the tenant to provide evidence to the landlord supporting the cost and what the tenant improvement allowance was spent on prior to payment by the landlord for such tenant improvements;
•
whether the tenant improvements are unique to the tenant or reusable by other tenants;
•
whether the tenant is permitted to alter or remove the tenant improvements without the consent of the landlord or without compensating the landlord for any lost utility or diminution in fair value; and
•
whether the ownership of the tenant improvements remains with the landlord or remains with the tenant at the end of the lease term.
In addition, we also record the cost of certain tenant improvements paid for or reimbursed by tenants when we conclude that we are the owner of such tenant improvements using the factors discussed above. For these tenant-funded tenant improvements, we record the amount funded or reimbursed by tenants as deferred revenue, which is amortized and recognized as rental revenue over the term of the related lease beginning upon substantial completion of the leased premises. During the years ended December 31, 2010, 2009, and 2008, we recorded $5.4 million, $2.0 million, and $28.1 million, respectively, of tenant-funded tenant improvements. The decreasing trend corresponds to the decrease we have been experiencing in our development and redevelopment activities since leases at our development and redevelopment properties generally have higher tenant-funded tenant improvements. For those periods, we also recognized $9.7 million, $9.8 million, and $11.3 million, respectively, of noncash rental revenue related to the amortization of deferred revenue recorded in connection with tenant-funded tenant improvements.
When we conclude that we are not the owner and the tenant is the owner of tenant improvements for accounting purposes, we record our contribution towards those improvements as a lease incentive, which is amortized as a reduction to rental revenue on a straight-line basis over the term of the related lease, and rental revenue recognition begins when the tenant takes possession of or controls the space.
Our determination as to whether we are or the tenant is the owner of tenant improvements for accounting purposes is made on a lease-by-lease basis and has a significant impact on the amount of noncash rental revenue that we record related to the amortization of deferred revenue for tenant-funded tenant improvements, and can also have a significant effect on the timing of our overall revenue recognition.
Tenant Reimbursement Revenue
Reimbursements from tenants consist of amounts due from tenants for common area maintenance, real estate taxes, and other recoverable costs, including capital expenditures. Calculating tenant reimbursement revenue requires an in-depth analysis of the complex terms of each underlying lease. Examples of judgments and estimates used when determining the amounts recoverable include:
•
estimating the final expenses, net of accruals, that are recoverable;
•
estimating the fixed and variable components of operating expenses for each building;
•
conforming recoverable expense pools to those used in establishing the base year or base allowance for the applicable underlying lease; and
•
concluding whether an expense or capital expenditure is recoverable pursuant to the terms of the underlying lease.
During the year, we accrue estimated tenant reimbursement revenue in the period in which the tenant reimbursable costs are incurred based on our best estimate of the amounts to be recovered. Throughout the year, we perform analyses to properly match tenant reimbursement revenue with reimbursable costs incurred to date. Additionally, during the fourth quarter of each year, we perform preliminary reconciliations and accrue additional tenant reimbursement revenue or refunds. Subsequent to year end, we perform final detailed reconciliations and analyses on a lease-by-lease basis and bill or refund each tenant for any cumulative annual adjustments in the first and second quarters of each year for the previous year’s activity. Our historical experience for the years ended December 31, 2009, 2008, and 2007 has been that our final reconciliation and billing process resulted in final amounts that approximated the total annual tenant reimbursement revenues recognized.
Allowances for Uncollectible Current Tenant Receivables and Deferred Rent Receivables
Tenant receivables and deferred rent receivables are carried net of the allowances for uncollectible current tenant receivables and deferred rent receivables. Current tenant receivables consist primarily of amounts due for contractual lease payments and reimbursements of common area maintenance expenses, property taxes, and other costs recoverable from tenants. Deferred rent receivables represent the amount by which the cumulative straight-
line rental revenue recorded to date exceeds cash rents billed to date under the lease agreement. As of December 31, 2010 and 2009, current receivables were carried net of an allowance for uncollectible amount of $2.8 million and $3.1 million, respectively, and deferred rent receivables were carried net of an allowance for uncollectible accounts of $3.8 million and $6.4 million, respectively.
Management’s determination of the adequacy of the allowance for uncollectible current tenant receivables and the allowance for deferred rent receivables is performed using a methodology that incorporates a specific identification analysis and an aging analysis and includes an overall evaluation of our historical loss trends and the current economic and business environment. This determination requires significant judgment and estimates about matters that are uncertain at the time the estimates are made, including the creditworthiness of specific tenants, specific industry trends and conditions, and general economic trends and conditions. Since these factors are beyond our control, actual results can differ from our estimates, and such differences could be material.
With respect to the allowance for uncollectible tenant receivables, the specific identification methodology analysis relies on factors such as the age and nature of the receivables, the payment history and financial condition of the tenant, our assessment of the tenant’s ability to meet its lease obligations, and the status of negotiations of any disputes with the tenant. With respect to the allowance for deferred rent receivables, given the longer-term nature of these receivables, the specific identification methodology analysis evaluates each of our significant tenants and any tenants on our internal watchlist and relies on factors such as each tenant’s financial condition and its ability to meet its lease obligations. We evaluate our reserve levels quarterly based on changes in the financial condition of tenants and our assessment of the tenant’s ability to meet its lease obligations, overall economic conditions, and the current business environment.
For the years ended December 31, 2010, 2009, and 2008, we recorded a total provision for bad debts for both current tenant receivables and deferred rent receivables of approximately (0.4)%, 0.2%, and 1.4%, respectively, of recurring rental revenue. The negative provision for the year ended December 31, 2010 reflects the reversal of approximately $1.0 million of a provision for bad debts recorded in prior years against outstanding receivables from a former tenant due to the settlement of outstanding litigation with the former tenant in 2010. Included in the provision amount for 2008 is approximately $3.1 million for the unrecoverable portion of the deferred rent receivable balance related to an early termination at one of our Office Properties in San Diego. Excluding the impact of the early termination on the provision for bad debts, for the year ended December 31, 2008, we recorded a provision for bad debts of approximately 0.3% of recurring revenue. During the year ended December 31, 2010, we wrote off approximately $1.7 million of receivables that were reserved in previous periods. Excluding the $1.0 million reversal of the provision in 2010, our historical experience has been that actual write-offs of current tenant receivables and deferred rent receivables has approximated the provision for bad debts recorded for the years ended December 31, 2010, 2009, and 2008. In the event our estimates were not accurate and we had to change our allowances by 1% of recurring revenue, the potential impact to our net income would be approximately $3.0 million, $2.8 million, and $2.8 million for the years ended December 31, 2010, 2009, and 2008, respectively.
Operating Property Acquisitions
We record the acquired tangible and intangible assets and assumed liabilities of operating property acquisitions at fair value at the acquisition date. We assess and consider fair value based on estimated cash flow projections that utilize available market information and discount and/or capitalization rates that we deem appropriate. Estimates of future cash flows are based on a number of factors including historical operating results, known and anticipated trends, and market and economic conditions. The acquired assets and assumed liabilities for an acquired operating property generally include but are not limited to: land, buildings and improvements, and identified tangible and intangible assets and liabilities associated with in-place leases, including tenant improvements, leasing costs, value of above-market and below-market leases, acquired in-place lease values, and tenant relationships, if any.
The fair value of land is derived from comparable sales of land within the same submarket and/or region. The fair value of buildings and improvements, tenant improvements, and leasing costs are based upon current market replacement costs and other relevant market rate information.
The fair value of the above-market or below-market component of an acquired in-place lease is based upon the present value (calculated using a market discount rate) of the difference between (i) the contractual rents to be paid pursuant to the lease over its remaining term and (ii) management’s estimate of the rents that would be paid using fair
market rental rates and rent escalations at the date of acquisition over the remaining term of the lease. We review in-place leases at acquired properties at the time of acquisition to determine if contractual rents are above or below current market rents for the acquired property, and we record an identifiable intangible asset or liability if there is an above or below-market lease. The amounts recorded for above-market leases are included in deferred leasing costs and acquisition-related intangibles, net on the balance sheet and are amortized on a straight-line basis as a reduction of rental income over the remaining term of the applicable leases. The amounts recorded for below-market leases are included in deferred revenue and acquisition-related liabilities, net on the balance sheet and are amortized on a straight-line basis as an increase to rental income over the remaining term of the applicable leases. If a lease were to be terminated prior to its contractual expiration (for example resulting from bankruptcy), amortization of the related unamortized above or below-market lease intangible would be accelerated.
The fair value of acquired in-place leases is derived based on management’s assessment of lost revenue and costs incurred for the period required to lease the “assumed vacant” property to the occupancy level when purchased. This fair value is based on a variety of considerations including, but not necessarily limited to: (1) the value associated with avoiding the cost of originating the acquired in-place leases; (2) the value associated with lost revenue related to tenant reimbursable operating costs estimated to be incurred during the assumed lease-up period; and (3) the value associated with lost rental revenue from existing leases during the assumed lease-up period. Factors considered by us in performing these analyses include an estimate of the carrying costs during the expected lease-up periods, current market conditions, and costs to execute similar leases. In estimating carrying costs, we include real estate taxes, insurance and other operating expenses, and estimates of lost rental revenue during the expected lease-up periods based on current market demand at market rates. In estimating costs to execute similar leases, we consider leasing commissions, legal and other related expenses. The amount recorded for acquired in-place leases is included in deferred leasing costs and acquisition-related intangibles, net on the balance sheet and amortized as an increase to depreciation and amortization expense over the remaining term of the applicable leases. If a lease were to be terminated or if termination were determined to be likely prior to its contractual expiration (for example resulting from bankruptcy), amortization of the related unamortized in-place lease intangible would be accelerated.
The determination of the fair value of the acquired tangible and intangible assets and assumed liabilities of operating property acquisitions requires us to make significant judgments and assumptions about the numerous inputs discussed above. The use of different assumptions in these fair value calculations could significantly affect the reported amounts of the allocation of our acquisition related assets and liabilities and the related amortization and depreciation expense recorded for such assets and liabilities. In addition, since the value of above and below market leases are amortized as either a reduction or increase to rental income, respectively, our judgments for these intangibles could have a significant impact on our reported rental revenues and results of operations.
Evaluation of Asset Impairment
We evaluate our real estate assets for potential impairment whenever events or changes in circumstances indicate that the carrying amount of a given asset may not be recoverable. We evaluate our real estate assets for impairment on a property-by-property basis. Indicators we use to determine whether an impairment evaluation is necessary include:
•
low occupancy levels or forecasted low occupancy levels at a specific property;
•
current period operating or cash flow losses combined with a historical pattern or future projection of potential continued operating or cash flow losses at a specific property;
•
deterioration in rental rates for a specific property as evidenced by sudden significant rental rate decreases or continuous rental rate decreases over numerous quarters, which could signal a continued decrease in future cash flow for that property;
•
deterioration of a given rental submarket as evidenced by significant increases in market vacancy and/or negative absorption rates or continuous increases in market vacancy and/or negative absorption rates over numerous quarters, which could signal a decrease in future cash flow for properties within that submarket;
•
significant increases in property sales yields, continuous increases in property sales yields over several quarters, or recent property sales at a loss within a given submarket, each of which could signal a decrease in the market value of properties;
•
significant change in strategy or use of a specific property or any other event that could result in a decreased holding period or significant development delay;
•
evidence of material physical damage to the property; and
•
default by a significant tenant when any of the other indicators above are present.
When we evaluate for potential impairment our real estate assets to be held and used, we first evaluate whether there are any indicators of impairment. If any impairment indicators are present for a specific real estate asset, we then perform an undiscounted cash flow analysis and compare the net carrying amount of the real estate asset to the real estate asset’s estimated undiscounted future cash flow over the anticipated holding period. If the estimated undiscounted future cash flow is less than the net carrying amount of the real estate asset, we perform an impairment loss calculation to determine if the fair value of the real estate asset is less than the net carrying value of the real estate asset. Our impairment loss calculation compares the net carrying amount of the real estate asset to the real estate asset’s estimated fair value, which may be based on estimated discounted future cash flow calculations or third-party valuations or appraisals. We recognize an impairment loss if the amount of the asset’s net carrying amount exceeds the asset’s estimated fair value. If we recognize an impairment loss, the estimated fair value of the asset becomes its new cost basis. For a depreciable long-lived asset, the new cost basis will be depreciated (amortized) over the remaining useful life of that asset.
Our undiscounted cash flow and fair value calculations contain uncertainties because they require management to make assumptions and to apply judgment to estimate future cash flow and property fair values, including selecting the discount or capitalization rate that reflects the risk inherent in future cash flow. Estimating projected cash flow is highly subjective as it requires assumptions related to future rental rates, tenant allowances, operating expenditures, property taxes, capital improvements, and occupancy levels. We are also required to make a number of assumptions relating to future economic and market events and prospective operating trends. Determining the appropriate capitalization rate also requires significant judgment and is typically based on many factors including the prevailing rate for the market or submarket, as well as the quality and location of the properties. Further, capitalization rates can fluctuate resulting from a variety of factors in the overall economy or within regional markets. If the actual net cash flow or actual market capitalization rates significantly differ from our estimates, the impairment evaluation for an individual asset could be materially affected.
Because of the economic and market environment, circumstances indicated that an analysis for potential impairment of certain of our properties was necessary in each of the years ended December 31, 2010, 2009, and 2008. As a result, for each property where such an indicator occurred and/or for properties within a given submarket where such an indicator occurred, we completed an impairment evaluation. After completing this process, we determined that for each of the properties evaluated, undiscounted cash flows over the holding period were in excess of carrying value and, therefore, we did not record any impairment losses for these periods.
Cost Capitalization and Depreciation
We capitalize costs associated with development and redevelopment activities, capital improvements, tenant improvements, and leasing activities. Amounts capitalized are depreciated or amortized over estimated useful lives determined by management. We depreciate buildings and improvements based on the estimated useful life of the asset, and we amortize tenant improvements and leasing costs over the shorter of the estimated useful life or estimated remaining life of the related lease. All capitalized costs are depreciated or amortized using the straight-line method.
Determining whether expenditures meet the criteria for capitalization and the assignment of depreciable lives requires management to exercise significant judgment. Expenditures that meet one or more of the following criteria generally qualify for capitalization:
•
provide benefit in future periods;
•
extend the useful life of the asset beyond our original estimates; and
•
increase the quality of the asset beyond our original estimates.
Our historical experience has demonstrated that we have not had material write-offs of assets and that our depreciation and amortization estimates have been reasonable and appropriate.
Factors That May Influence Future Results of Operations
Acquisitions. As a key component of our growth strategy, we continually evaluate selected property acquisition opportunities. During the year ended December 31, 2010, we acquired ten buildings in eight transactions for approximately $697.8 million (see Note 3 to our consolidated financial statements included in this report for additional information). We consider potential acquisitions on an ongoing basis and may have one or more potential acquisitions under consideration at any point in time, which may be at varying stages of the negotiation and due diligence review process. We generally finance our acquisitions through debt and equity offerings and borrowings on our unsecured line of credit. Costs associated with acquisitions are expensed as incurred and we may be unable to complete an acquisition after making a nonrefundable deposit or incurring acquisition-related costs.
In January 2011, we completed our third acquisition in San Francisco with the purchase of 250 Brannan Street in the South Financial District for approximately $33.0 million. The building encompasses approximately 91,000 rentable square feet and is currently 77% leased to two tenants.
Leasing Activity and Changes in Rental Rates. The amount of net rental income generated by our properties depends principally on our ability to maintain the occupancy rates of currently leased space and to lease currently available space, newly developed or redeveloped properties, and space available from unscheduled lease terminations. The amount of rental income we generate also depends on our ability to maintain or increase rental rates in our submarkets. Negative trends in one or more of these factors could adversely affect our rental income in future periods. The following tables set forth certain information regarding leases that commenced during the year ended December 31, 2010.
Lease Commencement Information by Segment
For Leases that Commenced During the Year Ended December 31, 2010
(1)
First generation leasing includes space where we have made capital expenditures that result in additional revenue generated when the space is re-leased. Second generation leasing includes space where we have made capital expenditures to maintain the current market revenue stream.
(2)
Represents leasing activity for leases that commenced during the period shown, including first and second generation space, net of month-to-month leases. Excludes leasing on new construction.
(3)
Calculated as the change between GAAP rents for new/renewed leases and the expiring GAAP rents for the same space. Excludes leases for which the space was vacant longer than one year, or vacant when the property was acquired .
(4)
Calculated as the change between stated rents for new/renewed leases and the expiring stated rents for the same space. Excludes leases for which the space was vacant longer than one year, or vacant when the property was acquired.
(5)
Calculated as the percentage of space either renewed or expanded into by existing tenants or subtenants at lease expiration.
The changes in rents and changes in cash rents reported above excludes leases of approximately 893,900 rentable square feet for the twelve months ended December 31, 2010, for which the space was vacant longer than one year or we are leasing the space for the first time. We exclude space vacant for more than one year in our change in rents calculations to provide a meaningful market comparison.
In general, we have experienced decreases in rental rates in many of our submarkets over the last several quarters as the result of continued slow economic growth and other related factors. During the fourth quarter of 2010, we executed 42 leases for an aggregate of 0.8 million rentable square feet. The weighted average change in
rents as compared to the expiring rents for the same space for these new leases was a 6.2% decrease in GAAP rents and a 14.7% decrease in cash rents, excluding leases for which the space was vacant longer than one year. As of December 31, 2010, we believe that the weighted average cash rental rates for our overall portfolio, including recently acquired properties, are approximately 10% above the current average market rental rates, although individual properties within any particular submarket presently may be leased either above, below, or at the current market rates within that submarket, and the average rental rates for individual submarkets may be above, below, or at the average cash rental rate of our portfolio. As previously discussed, our rental rates and occupancy are impacted by general economic conditions, including the pace of regional economic growth and access to capital. Therefore, given the impact of the current economic conditions and continued expectation of slow economic growth in our submarkets, we cannot give any assurance that leases will be renewed or that available space will be re-leased at rental rates equal to or above the current market rates. Additionally, decreased demand and other negative trends or unforeseeable events that impair our ability to timely renew or re-lease space could have further negative effects on our future financial condition, results of operations, and cash flows.
Scheduled Lease Expirations. In addition to the 1.5 million rentable square feet, or 10.9%, of currently available space in our stabilized portfolio, leases representing approximately 5.8% and 10.3% of the occupied square footage of our stabilized portfolio are scheduled to expire during 2011 and in 2012, respectively. The leases scheduled to expire during 2011 and in 2012 represent approximately 1.4 million rentable square feet of office space, or 12.0% of our total annualized base rental revenue, and 0.6 million rentable square feet of industrial space, or 1.3% of our total annualized base rental revenue, respectively. We believe that the weighted average cash rental rates are approximately 15% above the current average quoted market rates for leases scheduled to expire during 2011, although individual properties within any particular submarket presently may be leased either above, below, or at the current quoted market rates within that submarket, and the average rental rates for individual submarkets may be above, below, or at the average cash rental rate of our overall portfolio. Our ability to re-lease available space depends upon both general market conditions and the market conditions in the specific regions in which individual properties are located.
Development and Redevelopment Programs. We believe that a portion of our long-term future potential growth will continue to come from our development pipeline and redevelopment opportunities within our existing portfolio. Redevelopment opportunities are those projects in which we spend significant development and construction costs on existing buildings pursuant to a formal plan, the result of which is a higher economic return on the property. While in recent periods we have delayed the timing and reduced the scope of our development program activity as a result of economic conditions in our submarkets, we continue to proactively evaluate development and redevelopment opportunities throughout California.
In the third quarter of 2010 we commenced the redevelopment of one of our buildings in the El Segundo submarket of Los Angeles County which encompasses approximately 300,000 rentable square feet. We will be upgrading and modernizing the building and adjacent common areas since it was previously occupied by the Boeing Company and its predecessors for more than 25 years. The project has a total estimated investment of approximately $50 million and is currently expected to be completed in the third quarter of 2011 (see additional information under the caption “-Liquidity and Capital Resources of the Operating Partnership-Liquidity Uses-Redevelopment and Acquisition Opportunities”).
Over the next two years, we also plan to continue to evaluate redevelopment opportunities for certain other of our properties, which have been occupied by long-term tenants and require significant capital expenditures to upgrade and modernize the buildings. In addition, we plan to continue to focus on enhancing the entitlements for our existing development land pipeline, and performing additional activities to prepare for the time when development will again be economically attractive.
Incentive Compensation. Our Executive Compensation Committee determines compensation, including equity and cash incentive programs, for our executive officers. The programs approved by the Executive Compensation Committee have historically provided for equity and cash compensation to be earned by our executive officers based on certain performance measures, including financial, operating, and development targets. Incentive compensation for our executive officers for 2011 is structured to allow the Compensation Committee to evaluate a variety of key factors and metrics at the end of the year and make a determination of incentive
compensation for executive officers based on the Company’s and management’s overall performance. As a result, accrued incentive compensation and compensation expense for future incentive compensation awards will be affected by our operating and development performance, financial results, the performance of the trading price of the Company’s common stock, and market conditions. Consequently, we cannot predict the amounts that will be recorded in future periods related to executive compensation.
Share-Based Compensation. As of December 31, 2010, there was $4.8 million of total unrecognized compensation cost related to outstanding nonvested shares of restricted common stock and nonvested RSUs issued under share-based compensation arrangements. That cost is expected to be recognized over a weighted-average period of 1.5 years. Additional unrecognized compensation cost of $4.6 million related to 66,208 shares of restricted common stock and 97,597 nonvested restricted stock units issued under share-based compensation arrangements subsequent to December 31, 2010 is expected to be recognized over a weighted-average period of 2.1 years. See Note 12 to our consolidated financial statements for additional information regarding our share-based incentive compensation plan.
Stabilized Portfolio Information
The following table reconciles the changes in the rentable square feet in our stabilized portfolio of operating properties from December 31, 2009 to December 31, 2010:
Occupancy Information
The following table sets forth certain information regarding our stabilized portfolio:
Stabilized Portfolio Occupancy by Segment
(1)
Occupancy percentages reported are based on our stabilized portfolio for the period presented.
(2)
Occupancy percentages reported are based on Office Properties and Industrial Properties owned and stabilized at January 1, 2009 and still owned and stabilized as of December 31, 2010.
As of December 31, 2010, the Office Properties and Industrial Properties represented approximately 91.5% and 8.5%, respectively, of our total annualized base rental revenue and approximately 89.4% and 10.6%, respectively, of our total net operating income, as defined.
Current Regional Information
Although real estate fundamentals continue to be challenging in many of our regional submarkets, we have started to see an increase in occupancy across our portfolio, and we have generally seen a modest decrease in vacancy rates across many of our regional submarkets as well as a stabilization in rental rates and lease concession packages.
Los Angeles and Ventura Counties. Our Los Angeles and Ventura Counties stabilized office portfolio of 3.1 million rentable square feet was 89.3% occupied with approximately 328,800 vacant rentable square feet as of December 31, 2010 compared to 88.8% occupied with approximately 376,400 vacant rentable square feet as of December 31, 2009.
As of December 31, 2010, an aggregate of approximately 435,269 and 215,167 rentable square feet are scheduled to expire in this region during 2011 and 2012, respectively. The aggregate rentable square feet scheduled to expire in this region during 2011 and 2012 represents approximately 22.9% of the total occupied rentable square feet in this region and 5.1% of our annualized base rental revenues for our total stabilized portfolio.
San Diego County. Our San Diego stabilized office portfolio of 5.5 million rentable square feet was 86.4% occupied with approximately 744,300 vacant rentable square feet as of December 31, 2010 compared to 76.8% occupied with approximately 1.2 million vacant rentable square feet as of December 31, 2009. During the year ended December 31, 2010, we acquired five San Diego office buildings encompassing approximately 383,329 rentable square feet, which were 80.0% occupied as of December 31, 2010. In addition, we commenced 11 leases representing approximately 498,800 rentable square feet for space in this region that was vacant as of December 31, 2009.
As of December 31, 2010, leases representing an aggregate of approximately 76,594 and 463,179 rentable square feet are scheduled to expire during 2011 and 2012, respectively, in this region. The aggregate rentable square feet scheduled to expire in this region during 2011 and 2012 represents approximately 11.5% of the total occupied rentable square feet in this region and 5.0% of our annualized base rental revenues for our total stabilized portfolio. As of the date of this filing, we have leased approximately 155,000 rentable square feet of space in this region that was vacant at December 31, 2010. The new leases are scheduled to commence at various dates during the first three quarters of 2011.
Orange County. As of December 31, 2010, our Orange County stabilized industrial portfolio of approximately 3.4 million rentable square feet was 93.5% occupied with approximately 220,100 vacant rentable square feet compared to 87.6% occupied with approximately 429,900 vacant rentable square feet as of December 31, 2009. The increase in Orange County stabilized industrial portfolio occupancy is primarily attributable to three leases encompassing approximately 361,500 rentable square feet that commenced in 2010, partially offset by two leases encompassing approximately 139,800 rentable square feet that expired during the year. Furthermore, of the 220,100 rentable square feet that was vacant as of December 31, 2010, approximately
114,500 rentable square feet has been re-leased to two new tenants. These two new leases are expected to commence during the first half of 2011.
Our Orange County stabilized office portfolio of approximately 540,700 rentable square feet was 93.1% occupied with approximately 37,300 vacant rentable square feet as of December 31, 2010 compared to 49.8% occupied with approximately 139,100 vacant rentable square feet as of December 31, 2009. The increase in Orange County stabilized office portfolio occupancy is primarily attributable to two acquisitions and two dispositions made during the year. During the second quarter of 2010, we acquired two Orange County office buildings encompassing approximately 370,107 rentable square feet, which were 95.4% occupied as of December 31, 2010. During the fourth quarter of 2010, we disposed of two Orange County office buildings encompassing approximately 106,800 rentable square feet, which were 4.3% occupied as of the date of sale.
As of December 31, 2010, leases representing an aggregate of approximately 173,749 and 510,723 rentable square feet are scheduled to expire during 2011 and 2012, respectively, in this region. The aggregate rentable square feet scheduled to expire during 2011 and 2012 represents approximately 18.6% of the total occupied rentable square feet in this region and 2.0% of the annualized base rental revenues for our total stabilized portfolio. Of the 684,472 rentable square feet scheduled to expire during 2011 and 2012, approximately 602,409 rentable square feet is industrial space. Over the last year, the Orange County industrial market has experienced a significant decrease in rental rates.
San Francisco. During the year ended December 31, 2010, we acquired two office buildings in San Francisco encompassing approximately 1.2 million rentable square feet. These buildings were 84.3% occupied with approximately 188,900 vacant rentable square feet as of December 31, 2010. As of December 31, 2010, leases representing an aggregate of approximately 30,100 and 80,333 rentable square feet are scheduled to expire during 2011 and 2012, respectively, in this region. The aggregate rentable square feet scheduled to expire in this region during 2011 and 2012 represents approximately 11.0% of the total occupied rentable square feet in this region and less than 1.2% of our annualized base rental revenues for our total stabilized portfolio. As of the date of this filing, we have leased approximately 130,400 rentable square feet of space in this region that was vacant at December 31, 2010. The new leases are scheduled to commence at various dates during the first three quarters of 2011.
Greater Seattle. During the year ended December 31, 2010, we acquired one office building in Redmond, Washington, encompassing approximately 122,100 rentable square feet. The building was 100.0% occupied as of December 31, 2010 to a single tenant and the lease expires in 2015.
Results of Operations
Management internally evaluates the operating performance and financial results of our portfolio based on Net Operating Income for the following segments of commercial real estate property: Office Properties and Industrial Properties. We define “Net Operating Income” as operating revenues (rental income, tenant reimbursements, and other property income) less operating expenses (property expenses, real estate taxes, provision for bad debts, and ground leases). The Net Operating Income segment information presented within this Management’s Discussion and Analysis of Financial Condition and Results of Operations consists of the same Net Operating Income segment information disclosed in Note 18 to our consolidated financial statements.
Year Ended December 31, 2010 Compared to Year Ended December 31, 2009
The following table reconciles our Net Operating Income by segment to our net income for the years ended December 31, 2010 and 2009.
Rental Operations
Office Properties
The following table compares the Net Operating Income for the Office Properties for the years ended December 31, 2010 and 2009.
Office Properties
(1)
Office Properties owned and stabilized at January 1, 2009 and still owned and stabilized as of December 31, 2010.
Rental Income
Rental income from Office Properties increased $28.9 million, or 13.1%, for the year ended December 31, 2010 compared to the year ended December 31, 2009 primarily the result of:
•
An increase of $28.9 million generated by the ten office buildings we acquired during 2010 (the “Office Acquisition Properties”);
•
An increase of $2.7 million generated by a 1.5% increase in average occupancy for the Office Properties owned and stabilized as of January 1, 2009 and still owned and stabilized as of December 31, 2010 (the “Core Office Portfolio”) from 83.5% for the year ended December 31, 2009 to 85.0% for the year ended December 31, 2010; and
•
An offsetting decrease of $2.3 million generated by one office building that was moved from the stabilized portfolio to the redevelopment portfolio during the third quarter of 2010 upon the expiration of the lease for that building (the “Office Redevelopment Property”).
Tenant Reimbursements
Tenant reimbursements from Office Properties decreased $3.5 million, or 14.2%, for the year ended December 31, 2010 compared to the year ended December 31, 2009 as the result of:
•
A decrease of $2.8 million generated by the Core Office Portfolio primarily the result of the renewal of several leases, which resulted in the reset of the base year expense level;
•
A decrease of $1.2 million generated by the Office Redevelopment Property; and
•
An offsetting increase of $0.5 million generated by the Office Acquisition Properties.
Other Property Income
Other property income from Office Properties decreased $0.6 million, or 26.3%, for the year ended December 31, 2010 compared to the year ended December 31, 2009. Other property income for both periods consisted primarily of lease termination fees and other miscellaneous income within the Core Office Portfolio.
Property Expenses
Property expenses from Office Properties increased $7.9 million, or 17.3%, for the year ended December 31, 2010 compared to the year ended December 31, 2009 as the result of:
•
An increase of $7.0 million generated by the Office Acquisition Properties;
•
An increase of $1.2 million generated by the Core Office Portfolio primarily the result of:
•
An increase of $0.8 million attributable to a casualty loss and costs associated with the initial clean-up and repair at one of our properties in Los Angeles that sustained damage from water intrusion; and
•
An increase of $0.7 million attributable to an increase in certain recurring operating costs such as repairs and maintenance, property management expenses, janitorial and other service-related costs; and
•
An offsetting decrease of $0.3 million generated by the Office Redevelopment Property.
Real Estate Taxes
Real estate taxes from Office Properties increased $3.2 million, or 15.0%, for the year ended December 31, 2010 compared to the year ended December 31, 2009 primarily attributable to the Office Acquisition Properties.
Provision for Bad Debts
The provision for bad debts from Office Properties for the year ended December 31, 2010 included a $1.0 million reversal of a previously recorded provision for bad debts. During 2010, we settled outstanding litigation and received cash payments related to certain premises at one of our properties that had been abandoned by its former occupants (see Note 15 to our consolidated financial statements included in this report for additional information).
Ground Leases
Ground lease expense from Office Properties decreased $0.6 million, or 38.4%, for the year ended December 31, 2010 compared to the year ended December 31, 2009 primarily as the result of a ground rent expense adjustment for our Kilroy Airport Center, Long Beach project. During the first quarter of 2010, we were successful in negotiating a lower rental rate under the terms of the ground lease retroactive to January 1, 2006.
Net Operating Income
Net Operating Income from Office Properties increased $15.4 million, or 8.6%, for the year ended December 31, 2010 compared to the year ended December 31, 2009 primarily as the result of:
•
An increase of $19.4 million attributable to the Office Acquisition Properties;
•
An offsetting decrease of $3.0 million primarily attributable to the Office Redevelopment Property; and
•
An offsetting decrease of $0.4 million attributable to the Core Office Portfolio.
Industrial Properties
The following table compares the Net Operating Income for the Industrial Properties for the year ended December 31, 2010 and 2009.
Industrial Properties
(1)
Industrial Properties owned and stabilized at January 1, 2009 which are still owned and stabilized as of December 31, 2010.
Rental Income
Rental income from Industrial Properties decreased $1.8 million, or 6.7%, for the year ended December 31, 2010 compared to the year ended December 31, 2009 primarily as the result of:
•
A 3.2% decrease in average occupancy for the Industrial Properties owned and stabilized at January 1, 2009 and still owned and stabilized as of December 31, 2010 (the “Core Industrial Portfolio”) from 90.4% for the year ended December 31, 2009 to 87.2% for the year ended December 31, 2010; and
•
A decrease in GAAP rental income of approximately 26.5% for leases that commenced during the year ended December 31, 2010 (see additional information under the caption “-Factors That May Influence Results of Operations”).
Tenant Reimbursements
Tenant reimbursements from Industrial Properties decreased $0.3 million, or 7.6%, for the year ended December 31, 2010 compared to the year ended December 31, 2009 because of a decrease in the Core Industrial Portfolio’s average occupancy, as discussed above under the caption “-Rental Income.”
Property Expenses
Property expenses from Industrial Properties increased $0.4 million, or 11.3%, for the year ended December 31, 2010 compared to the year ended December 31, 2009 primarily as the result of an increase in nonreimbursable legal fees related to tenant defaults that occurred during 2009.
Provision for Bad Debts
Provision for bad debts from Industrial Properties decreased $0.5 million, or 109.9%, for the year ended December 31, 2010 compared to the year ended December 31, 2009 as the result of changes in our estimates of collectability of receivables from certain watchlist tenants.
Net Operating Income
Net Operating Income from Industrial Properties decreased $2.1 million, or 8.5%, for the year ended December 31, 2010 compared to the year ended December 31, 2009 primarily as the result of a decrease in average occupancy year over year at the Core Industrial Portfolio and a decrease in GAAP rental income of approximately 26.5% for leases that commenced during the year ended December 31, 2010.
Other Income and Expenses
General and Administrative Expense
General and administrative expenses decreased $12.0 million, or 30.0%, for the year ended December 31, 2010 compared to the year ended December 31, 2009 primarily resulting from $7.0 million of separation payments in our results for the year ended December 31, 2009 and an overall decrease in incentive compensation expenses.
Acquisition Related Expenses
During the year ended December 31, 2010, we incurred third-party acquisition costs of $2.2 million in connection with completed acquisitions and other potential acquisitions. In accordance with accounting provisions, all acquisition costs related to operating property acquisitions are expensed as incurred.
Depreciation and Amortization Expense
Depreciation and amortization increased by $16.2 million, or 18.5% for the year ended December 31, 2010 compared to the year ended December 31, 2009 primarily as the result of:
•
Approximately $12.3 million related to the Office Acquisition Properties; and
•
Approximately $4.2 million related to the change in estimated useful life of the industrial property that we are currently in the process of repositioning.
Interest Income and Other Investment Gains
Total interest income and other investment gains decreased by $0.3 million, or 25.8%, for the year ended December 31, 2010 compared to the year ended December 31, 2009 primarily as the result of a decrease of $0.3 million in interest income for the year ended December 31, 2010 as compared to the year ended December 31, 2009 attributable to the repayment of the note receivable in July 2010 (see Note 5 to our consolidated financial statements included in this report for additional information).
Interest Expense
The following table sets forth our gross interest expense, including debt discounts and loan cost amortization, net of capitalized interest for the years ended December 31, 2010 and 2009.
Gross interest expense, before the effect of capitalized interest, increased $14.2 million, or 25.4%, for the year ended December 31, 2010 compared to the year ended December 31, 2009 resulting from an increase in our average outstanding debt balances during 2010. In addition, our weighted average effective interest rate increased from approximately 5.2% for the year ended December 31, 2009 to approximately 6.2% for the year ended December 31, 2010.
Capitalized interest increased $0.3 million, or 3.4%, for the year ended December 31, 2010 compared to the year ended December 31, 2009 attributable to an increase in our weighted average interest rate, which caused a corresponding increase in the capitalization rate applied to development and redevelopment asset balances qualifying for interest capitalization. For the years ended December 31, 2010 and 2009, we did not capitalize interest on five of our seven development pipeline properties with an aggregate cost basis of approximately $77.8 million as of December 31, 2010. In addition, during the third quarter of 2010, we also ceased interest capitalization on another of our development pipeline properties with an aggregate cost basis of approximately $77.3 million as of December 31, 2010. We have suspended substantially all development activities related to these projects as a result of economic conditions in our submarkets and we determined these projects did not qualify for interest capitalization under GAAP.
(Loss) Gain on Early Extinguishment of Debt
During the year ended December 31, 2010, we recorded a loss on early extinguishment of debt of approximately $4.6 million realated to the repurchase of the 3.25% Exchangeable Notes with an aggregate stated principal amount of $150.0 million. During the year ended December 31, 2009, we recorded a gain on early extinguishment of debt of approximately $4.9 million resulting from the repurchase of the 3.25% Exchangeable Notes with an aggregate stated principal amount of $162.0 million. (See Note 7 to our consolidated financial statements included in this report for additional information pertaining to these exchangeable note repurchases).
Year Ended December 31, 2009 Compared to Year Ended December 31, 2008
The following table reconciles our Net Operating Income by segment to our net income for the years ended December 31, 2009 and 2008.
Rental Operations
Office Properties
The following table compares the Net Operating Income for the Office Properties for the year ended December 31, 2009 and 2008.
(1)
Office Properties owned and stabilized at January 1, 2008 and still owned and stabilized as of December 31, 2010.
Rental Income
Rental income from Office Properties decreased $2.9 million, or 1.3%, for the year ended December 31, 2009 compared to the year ended December 31, 2008 primarily resulting from:
•
A decrease of $14.4 million attributable to the Office Properties owned and stabilized at January 1, 2008 and still owned and stabilized as of December 31, 2010 (the “Core Office Portfolio”) primarily resulting from:
•
A decrease of $11.7 million primarily attributable to a 7.9% decrease in average occupancy from 91.9% for the year ended December 31, 2008 to 84.0% for the year ended December 31, 2009; and
•
A decrease of $2.7 million of noncash rental income primarily attributable to the acceleration of the amortization of the deferred revenue balance during the year ended December 31, 2008 related to tenant-funded tenant improvements associated with an early lease termination at one of our properties in San Diego (see Note 17 to our consolidated financial statements included with this report for additional information);
•
An offsetting increase of $11.6 million generated by one office development property that was added to the stabilized portfolio in the third quarter of 2008 and two office development properties that were added to the stabilized portfolio in the fourth quarter of 2008 (collectively, the “Office Development Properties”); and
•
An offsetting increase of $0.7 million generated by one office redevelopment property that was added to the stabilized portfolio in the third quarter of 2008 and one office redevelopment project consisting of two buildings that was added to the stabilized portfolio in the fourth quarter of 2008 (collectively, the “2008 Office Redevelopment Properties”).
Tenant Reimbursements
Tenant reimbursements from Office Properties decreased $2.5 million, or 9.5%, for the year ended December 31, 2009 compared to the year ended December 31, 2008 primarily as the result of:
•
A decrease of $3.2 million attributable to the Core Office Portfolio primarily resulting from a decrease in average occupancy, as discussed above under the caption “-Rental Income;” and
•
An offsetting increase of $1.0 million generated by the Office Development Properties and 2008 Office Redevelopment Properties.
Other Property Income
Other property income from Office Properties decreased $3.6 million, or 60.7%, for the year ended December 31, 2009 compared to the year ended December 31, 2008. Other property income for 2009 included a $1.4 million net lease termination fee related to a settlement with a former tenant. Other property income for 2008 included a $5.0 million net lease termination fee related to an early lease termination. Other property income for both periods consisted primarily of lease termination fees and other miscellaneous income within the Core Office Portfolio.
Property Expenses
Property expenses from Office Properties increased $0.5 million, or 1.2%, for the year ended December 31, 2009 compared to the year ended December 31, 2008 primarily resulting from:
•
An increase of $1.3 million attributable to the Office Development Properties;
•
An increase of $0.4 million attributable to the 2008 Office Redevelopment Properties; and
•
An offsetting decrease of $1.1 million attributable to the Core Office Portfolio primarily resulting from:
•
A decrease of $2.4 million primarily attributable to a decrease in certain recurring operating expenses such as utilities, property management expenses, repairs and maintenance costs, and janitorial and other service-related costs primarily attributable to a decrease in average occupancy as discussed above under the caption “-Rental Income;” and
•
An offsetting increase of $1.0 million primarily attributable to nonreimbursable legal fees largely related to tenant defaults and costs associated with nonrecurring repairs at one of our San Diego properties.
Real Estate Taxes
Real estate taxes from Office Properties increased $2.0 million, or 10.5%, for the year ended December 31, 2009 compared to the year ended December 31, 2008 primarily attributable to the Office Development Properties and the 2008 Office Redevelopment Properties.
Provision for Bad Debts
The provision for bad debts from Office Properties decreased $3.8 million, or 98.0%, for the year ended December 31, 2009 compared to the year ended December 31, 2008 as the result of changes in our estimates of collectability of receivables from certain watchlist tenants. The provision for bad debts for the year ended December 31, 2008 included a $3.1 million charge for the deferred rent receivable related to an early termination at one of our properties in San Diego (see Note 17 to our consolidated financial statements included with this report for additional information).
Net Operating Income
Net Operating Income from Office Properties decreased $7.7 million, or 4.2%, for the year ended December 31, 2009 compared to the year ended December 31, 2008 primarily attributable to:
•
A decrease of $16.5 million attributable to the Core Office Portfolio primarily attributable to a decrease in average occupancy year over year; and
•
An offsetting increase of $9.9 million generated by the Office Development Properties and the 2008 Office Redevelopment Properties.
Industrial Properties
The following table compares the Net Operating Income for the Industrial Properties for the year ended December 31, 2009 and 2008.
Industrial Properties
(1)
Industrial Properties owned and stabilized at January 1, 2008 and still owned and stabilized as of December 31, 2010.
Rental Income
Rental income from Industrial Properties decreased $1.0 million, or 3.6%, for the year ended December 31, 2009 compared to the year ended December 31, 2008 as the result of a decrease in average occupancy for the Industrial Properties owned and stabilized at January 1, 2008 and still owned and stabilized as of December 31, 2010 (the “Core Industrial Portfolio”). Average occupancy for the Core Industrial Portfolio decreased 6.7% from 96.5% for the year ended December 31, 2008 to 89.8% for the year ended December 31, 2009.
Tenant Reimbursements
Tenant reimbursements from Industrial Properties decreased $0.4 million, or 8.9%, for the year ended December 31, 2009 compared to the year ended December 31, 2008 primarily attributable to a decrease in average occupancy in the Core Industrial Portfolio as discussed above under the caption “-Rental Income.”
Other Property Income
Other property income from Industrial Properties increased $0.5 million, or 49.2%, for the year ended December 31, 2009 compared to the year ended December 31, 2008 primarily attributable to a $0.7 million net restoration fee received during the first quarter of 2009 from a tenant that vacated one of our Industrial Properties in Orange County. Other property income for both periods consisted primarily of lease termination fees and other miscellaneous income within the Core Industrial Portfolio.
Property Expenses
Property expenses from Industrial Properties increased $0.3 million, or 9.2%, for the year ended December 31, 2009 compared to the year ended December 31, 2008. The results for the year ended December 31, 2008 included a $0.6 million credit recorded in June 2008 for insurance proceeds received in connection with a casualty loss at one
property, which was recently reentitled for residential use (the “Industrial Reentitlement Property”). Excluding the insurance proceeds credit, property expenses from Industrial Properties decreased approximately $0.3 million for the year ended December 31, 2009 compared to December 31, 2008.
Real Estate Taxes
Real estate taxes from Industrial Properties increased $0.3 million, or 8.8%, for the year ended December 31, 2009 compared to the year ended December 31, 2008 primarily attributable to one building that was moved from our stabilized portfolio to our redevelopment portfolio.
Provision for Bad Debts
The provision for bad debts from Industrial Properties increased $0.3 million, or 181.7%, for the year ended December 31, 2009 compared to the year ended December 31, 2008 as the result of changes in our estimates of collectability of receivables from certain watchlist tenants.
Net Operating Income
Net Operating Income from Industrial Properties decreased $1.8 million, or 6.8%, for the year ended December 31, 2009 compared to the year ended December 31, 2008 as the result of:
•
A decrease of $1.3 million attributable to a decrease in average occupancy in the Core Industrial Portfolio primarily year over year; and
•
A decrease of $0.5 million primarily resulting from a credit recorded in 2008 for insurance proceeds related to our Industrial Reentitlement Property.
Other Income and Expenses
General and Administrative Expense
General and administrative expenses increased $1.7 million, or 4.4%, for the year ended December 31, 2009 compared to the year ended December 31, 2008 primarily as the result of a $7.0 million charge for separation payments, partially offset by a decrease in incentive compensation expense year over year and severance costs paid in 2008.
Depreciation and Amortization Expense
Depreciation and amortization expense increased $4.4 million, or 5.3%, for the year ended December 31, 2009 compared to the year ended December 31, 2008 primarily attributable to the Office Development Properties and the 2008 Office Redevelopment Properties.
Interest Income and Other Investment Gains (Losses)
Total interest income and other investment gains (losses) increased approximately $1.4 million, or 1,497.8%, for the year ended December 31, 2009 compared to the year ended December 31, 2008 primarily as the result of an increase in the fair value of the marketable securities held in connection with the Kilroy Realty Corporation 2007 Deferred Compensation Plan during the year ended December 31, 2009.
Interest Expense
The following table sets forth our gross interest expense, including debt discount and loan cost amortization, net of capitalized interest for the years ended December 31, 2009 and 2008.
Gross interest expense, before the effect of capitalized interest, decreased $7.7 million, or 12.1%, for the year ended December 31, 2009 compared to the year ended December 31, 2008 primarily as the result of a decrease in our average debt balance during the year ended December 31, 2009 compared to the year ended December 31, 2008 and, to a lesser extent, a decrease in our weighted-average effective interest rate from approximately 5.4% during the year ended December 31, 2008 to approximately 5.2% during the year ended December 31, 2009.
Capitalized interest decreased $8.4 million, or 46.6% for the year ended December 31, 2009 compared to the year ended December 31, 2008 primarily as the result of a decrease in our average development and redevelopment asset balances qualifying for interest capitalization during the year ended December 31, 2009 compared to the year ended December 31, 2008 and, to a lesser extent, a decrease in our weighted-average effective interest rate which caused a corresponding decrease in the capitalization rate applied to our development and redevelopment asset balances qualifying for interest capitalization. During the year ended December 31, 2009, we did not capitalize interest for certain development properties because we suspended substantially all development activities related to these projects as a result of economic conditions in our submarkets.
Gain on Early Extinguishment of Debt
Gain on early extinguishment of debt was approximately $4.9 million for the year ended December 31, 2009 and represents the net gain from the repurchase of the 3.25% Exchangeable Notes with an aggregate stated principal amount of $162.0 million (see Note 7 to our consolidated financial statements included with this report for additional information).
Liquidity and Capital Resources of the Company
In this “Liquidity and Capital Resources of the Company” section, the term the “Company” refers only to Kilroy Realty Corporation on an unconsolidated basis, and excludes the Operating Partnership and all other subsidiaries. For further discussion of the liquidity and capital resources of the Company on a consolidated basis see the section entitled “-Liquidity and Capital Resources of the Operating Partnership” below.
The Company’s business is operated primarily through the Operating Partnership. The Company issues equity from time to time, but does not otherwise generate any capital itself or conduct any business itself, other than incurring certain expenses in operating as a public company which are fully reimbursed by the Operating Partnership. The Company itself does not hold any indebtedness, and its only material asset is its ownership of partnership interests of the Operating Partnership. The Company’s principal funding requirement is the payment of dividends on its common and preferred stock. The Company’s source of funding for its dividend payments is distributions it receives from the Operating Partnership.
As of December 31, 2010, the Company owned a 96.8%, general partnership interest in the Operating Partnership excluding preferred units. The remaining 3.2% common limited partnership interest as of December 31, 2010 was owned by non-affiliate investors and certain of our executive officers and directors. Through its ownership as the sole general partner of the Operating Partnership, the Company has the full, exclusive and complete responsibility for the Operating Partnership’s day-to-day management and control. The Company causes the Operating Partnership to distribute all, or such portion as the Company may in its discretion determine, of its available cash in the manner provided in the Operating Partnership’s partnership agreement. Distributions from the Operating Partnership are the Company’s source of capital.
The Company is a well-known seasoned issuer with an effective shelf registration statement that allows the Company to register unspecified various classes of debt and equity securities and the Operating Partnership to register unspecified and various classes of debt securities. As circumstances warrant, the Company may issue securities from time to time on an opportunistic basis, dependent upon market conditions and available pricing. When the Company receives proceeds from preferred or common equity issuances, it is required by the Operating Partnership’s partnership agreement to contribute the proceeds from its equity issuances to the Operating Partnership in exchange for preferred or common partnership units of the Operating Partnership. The Operating Partnership may use the proceeds to repay debt, including borrowings under its line of credit, develop new or existing properties, to make acquisitions of properties, portfolios of properties, or for general corporate purposes.
The liquidity of the Company is dependent on the Operating Partnership’s ability to make sufficient distributions to the Company. The Company also guarantees some of the Operating Partnership’s debt, as discussed further in Note 6 to the consolidated financial statements. If the Operating Partnership fails to fulfill certain of its debt requirements, which trigger Company guarantee obligations, then the Company would be required to fulfill its cash payment commitments under such guarantees. However, the Company’s only significant asset and source of liquidity is its investment in the Operating Partnership.
The Company believes the Operating Partnership’s sources of working capital, specifically its cash flow from operations, and borrowings available under its credit facility, are adequate for it to make its distribution payments to the Company and, in turn, for the Company to make its dividend payments to its preferred and common shareholders. Cash flows from operating activities generated by the Operating Partnership for the year ended December 31, 2010 were sufficient to cover the Company’s payment of cash dividends to its shareholders. However, there can be no assurance that the Operating Partnership’s sources of capital will continue to be available at all or in amounts sufficient to meet its needs, including its ability to make distributions to the Company. The unavailability of capital could adversely affect the Operating Partnership’s ability to make distributions to the Company, which would in turn, adversely affect the Company’s ability to pay cash dividends to its shareholders.
As the sole general partner with control of the Operating Partnership, the Company consolidates the Operating Partnership for financial reporting purposes, and the Company does not have significant assets other than its investment in the Operating Partnership. Therefore, the assets and liabilities and the revenues and expenses of the Company and the Operating Partnership are substantially the same on their respective financial statements. Because the Company consolidates the Operating Partnership for financial reporting purposes, the section entitled “Liquidity and Capital Resources of the Operating Partnership” should be read in conjunction with this section to understand the liquidity and capital resources of the Company on a consolidated basis and how the Company is operated as a whole.
Distribution Requirements
The Company is required to distribute 90% of its taxable income (subject to certain adjustments and excluding net capital gain) on an annual basis to maintain qualification as a REIT for federal income tax purposes. As a result of this distribution requirement, the Operating Partnership cannot rely on retained earnings to fund its on-going operations to the same extent as other companies whose parent companies are not REITs. In addition, the Company may be required to use borrowings under the Operating Partnership’s Credit Facility, if necessary, to meet REIT distribution requirements and maintain its REIT status. The Company may also need to continue to raise capital in the equity markets to fund the Operating Partnership’s working capital needs, as well as potential developments of new or existing properties or acquisitions.
While historically the Company has satisfied its distribution requirement by making cash distributions to its shareholders, for distributions with respect to our 2008 through 2011 taxable years, IRS guidance allows the Company to satisfy up to 90% of this requirement through the distribution of shares of the Company’s common stock, if certain conditions are met. The Company intends to continue to make, but has not committed to make, regular quarterly cash distributions to common stockholders and common unitholders from cash flow from operating activities. All such distributions are at the discretion of the board of directors. The Company has historically distributed amounts in excess of our taxable income resulting in a return of capital to its stockholders
and the Company currently believes it has the ability to maintain distributions at the 2010 levels to meet its REIT requirements for 2011. The Company considers market factors and its performance in addition to REIT requirements in determining our distribution levels. Amounts accumulated for distribution to stockholders are invested primarily in interest-bearing accounts and short-term interest-bearing securities, which are consistent with the Company’s intention to maintain its qualification as a REIT. Such investments may include, for example, obligations of the Government National Mortgage Association, other governmental agency securities, certificates of deposit, and interest-bearing bank deposits.
On December 9, 2010, the Board of Directors declared a regular quarterly cash dividend of $0.350 per common share payable on January 18, 2011 to stockholders of record on December 31, 2010 and caused a $0.35 per Operating Partnership unit cash distribution to be paid in respect of the Operating Partnership’s common limited partnership interests, including those owned by the Company. These dividends and distributions are equivalent to an annual rate of $1.40 per share, which in aggregate totals approximately $76.7 million of annualized common dividends and distributions per year based on common shares, restricted stock units, and common units outstanding at December 31, 2010.
On December 9, 2010, the Board of Directors declared a dividend of $0.4875 per share on the Company’s Series E Preferred Stock and a dividend of $0.46875 per share on the Company’s Series F Preferred Stock for the period commencing on and including November 15, 2010 and ending on and including February 14, 2011. The Company is also required to make quarterly cash distributions to the 7.45% Series A Preferred unitholders of $0.7 million, payable on February 15, 2011. Dividends and distributions payable to the Series E and Series F Preferred stockholders and the Series A Preferred unitholders, total approximately $15.2 million of annualized preferred dividends and distributions per year.
Debt Covenants
One of the covenants contained within the Credit Facility prohibits the Company from paying dividends in excess of 95% of FFO.
Capitalization
As of December 31, 2010, our total debt as a percentage of total market capitalization was 40.2% and our total debt and liquidation value of our preferred equity as a percentage of total market capitalization was 45.8%, which was calculated based on the closing price per share of the Company’s common stock of $36.47 on December 31, 2010 as shown in the table below.
(1)
Represents gross aggregate principal amount due at maturity, before the effect of the unamortized discounts as of December 31, 2010.
(2)
Value based on $50.00 per share liquidation preference.
(3)
Value based on $25.00 per share liquidation preference.
(4)
Value based on closing price per share of the Company’s common stock of $36.47 as of December 31, 2010.
Liquidity and Capital Resources of the Operating Partnership
In this “Liquidity and Capital Resources of the Operating Partnership” section, the terms “we,” “our,” and “us” refer to the Operating Partnership or the Operating Partnership and the Company together, as the context requires.
General
Our primary liquidity sources and uses are as follows:
Liquidity Sources
•
Net cash flow from operations;
•
Borrowings under the Credit Facility;
•
Proceeds from additional secured or unsecured debt financings;
•
Proceeds from public or private issuance of debt or equity securities; and
•
Proceeds from the disposition of nonstrategic assets.
Liquidity Uses
•
Property or undeveloped land acquisitions;
•
Property operating and corporate expenses;
•
Capital expenditures, tenant improvement and leasing costs;
•
Debt service and principal payments, including debt maturities;
•
Distributions to common and preferred security holders; and
•
Development and redevelopment costs;
•
Repurchasing outstanding debt.
General Strategy
Our general strategy is to maintain a conservative balance sheet with a top credit profile and to maintain a capital structure that allows for financial flexibility and diversification of capital resources. We manage our capital structure to reflect a long -term investment approach and utilize multiple sources of capital to meet our long-term capital requirements. We believe that our current projected liquidity requirements for the next twelve month period, as set forth above under the caption ‘‘-Liquidity Uses,” will be satisfied using a combination of the liquidity sources listed above. We believe our conservative leverage and staggered debt maturities provide us with financial flexibility and enhances our ability to obtain additional sources of liquidity if necessary, and, therefore, we are well-positioned to refinance or repay maturing debt and to pursue our strategy of seeking attractive acquisition opportunities, which we may finance, as necessary, with future public and private issuances of debt and equity securities.
Financing Activities
During 2010, we completed a variety of capital raising activities which significantly extended our debt maturities and enabled us to fund ten building acquisitions in eight separate transactions. This financing and acquisition activity increased our consolidated total assets by approximately 35% as compared to December 31, 2009, without significantly increasing our total debt as a percentage of total market capitalization. The following activities occurred during the period (see Notes 7 and 10 to our consolidated financial statements included in this report for additional information):
•
In November 2010, the Operating Partnership issued $325.0 million in aggregate stated principal amount of 5.00% unsecured senior notes due 2015;
•
In September 2010, the Operating Partnership became a registered public entity with the SEC allowing more flexible access to the public debt and capital markets;
•
In August 2010, the Operating Partnership entered into a new $500.0 million Credit Facility with a term of three years plus a one year extension option. We used borrowings under the Credit Facility to repay, and then terminate, our previous $550.0 million unsecured line of credit (the “Prior Credit Facility”);
•
In August 2010, the Operating Partnership used borrowings under our Prior Credit Facility to repay a portion of our unsecured senior notes, with a principal balance of $61.0 million that was maturing;
•
In June 2010, the Operating Partnership completed a tender offer for the repurchase of $150 million in aggregate stated principal value of the 3.25% Exchangeable Notes;
•
In June 2010, the Operating Partnership assumed secured debt with a principal balance of $52.0 million in conjunction with the acquisition of Mission City Corporate Center in San Diego, CA;
•
In May 2010, the Operating Partnership issued $250.0 million in aggregate stated principal amount of 6.625% unsecured senior notes due 2020;
•
In April 2010, the Company completed an underwritten public offering of 9,200,000 shares of our common stock. The net offering proceeds, after deducting underwriting discounts and commissions and offering expenses, of approximately $299.8 million were contributed to the Operating Partnership in exchange for common units issued to the Company;
•
In April 2010, the Operating Partnership was assigned initial investment grade credit ratings by two major rating agencies, which we believe enhances our access to the capital markets by allowing the Operating Partnership to raise long-term unsecured debt financing in the bond market.
•
In March 2010, the Operating Partnership used borrowings under our Prior Credit Facility to repay a secured line of credit with an outstanding principal balance of $33.5 million that was scheduled to mature in April 2010.
•
In January 2010, the Operating Partnership used the proceeds from the issuance of a $71.0 million mortgage loan to repay an outstanding mortgage loan with a principal balance of $63.2 million that was scheduled to mature in April 2010. The mortgage loan is secured by five properties, bears interest at an annual rate of 6.51%, requires monthly interest and principal payments based on a 30-year amortization period, and is scheduled to mature on February 1, 2017.
Liquidity Sources
Exchangeable Notes, Unsecured Senior Notes, and Secured Debt
The aggregate principal amount of Exchangeable Notes, unsecured senior notes, and secured debt of the Operating Partnership outstanding as of December 31, 2010 was as follows:
(1)
Represents gross aggregate principal amount before the effect of the unamortized discounts as of December 31, 2010.
Debt Composition
The composition of our aggregate debt balances between fixed- and variable-rate debt as of December 31, 2010 and 2009 were as follows:
(1)
Excludes the impact of the amortization of the noncash debt discount related to the accounting required for our Exchangeable Notes.
(2)
Includes the impact of the amortization of the noncash debt discounts related to the accounting required for our Exchangeable Notes.
Credit Facility
As discussed above under the caption “-2010 Financing Activities,” the Operating Partnership entered into the Credit Facility in August 2010 and used borrowings under the Credit Facility to repay, and then terminate, the Prior Credit Facility. The following table summarizes the balance and significant terms of the Credit Facility and Prior Credit Facility as of December 31, 2010 and December 31, 2009, respectively:
(1)
We may elect to borrow, subject to bank approval, up to an additional $200 million under an accordion feature under the terms of the Credit Facility.
(2)
Under the terms of the Credit Facility, we may exercise an option to extend the maturity date by one year.
(3)
In April 2010, we exercised an option to extend the maturity date of the Prior Credit Facility by one year.
(4)
As of December 31, 2010, the Credit Facility bore interest at an annual rate of LIBOR plus 2.675%. As of December 31, 2009, the Prior Credit Facility bore interest at an annual rate of LIBOR plus 0.85% to 1.35% depending upon our leverage ratio at the time of borrowing.
(5)
As of December 31, 2010, the facility fee for the Credit Facility was at an annual rate of 0.575%. In addition, we also incurred debt origination and legal costs of approximately $5 million, which will be amortized as additional interest expense through the contractual maturity date. As of December 31, 2009, the fee for unused funds for the Prior Credit Facility was at an annual rate of 0.15% to 0.20%, depending on the balance of our daily average undrawn balance.
Liquidity Uses
Contractual Obligations
The following table provides information with respect to the Operating Partnership’s contractual obligations as of December 31, 2010. The table (i) indicates the maturities and scheduled principal repayments of our secured debt, Exchangeable Notes, unsecured senior notes, and Credit Facility; (ii) indicates the scheduled interest payments of our fixed-rate and variable-rate debt as of December 31, 2010; (iii) provides information about the minimum commitments due in connection with our ground lease obligations and other lease and contractual commitments; and (iv) provides estimated redevelopment commitments as of December 31, 2010. Note that the
table does not reflect our available debt maturity extension options and reflects gross aggregate principal amounts before the effect of unamortized discounts.
(1)
Includes the $52.0 million gross aggregate principal amount of the loan due in April 2012 before the effect of the unamortized discount of approximately $0.6 million as of December 31, 2010.
(2)
Represents gross aggregate principal amount before the effect of the unamortized discount of approximately $20.5 million as of December 31, 2010.
(3)
Represents gross aggregate principal amount before the effect of the unamortized discount of approximately $2.2 million as of December 31, 2010.
(4)
As of December 31, 2010, 89.0% of our debt was contractually fixed. The information in the table above reflects our projected interest rate obligations for these fixed-rate payments based on the contractual interest rates, interest payment dates, and scheduled maturity dates.
(5)
As of December 31, 2010, 11.0% of our debt bore interest at variable rates. The variable interest rate payments are based on LIBOR plus a spread of 2.675% as of December 31, 2010. The information in the table above reflects our projected interest rate obligations for these variable-rate payments based on outstanding principal balances as of December 31, 2010, the scheduled interest payment dates, and the contractual maturity dates.
(6)
One of our ground lease obligations is subject to a fair market value adjustment every five years; however, the lease includes ground rent subprotection and infrastructure rent credits which currently limit our annual rental obligations to $1.0 million. The contractual obligations for this ground lease included above assumes the $1.0 million annual ground lease rental obligation in effect as of December 31, 2010.
(7)
Amounts represent commitments under signed leases and contracts for operating properties, excluding tenant-funded tenant improvements. The timing of these expenditures may fluctuate.
(8)
Amounts represent contractual commitments for redevelopment contracts and projects under construction at December 31, 2010. Costs include the remaining total estimated investment, excluding capitalized interest, development overhead, potential future leasing costs, and tenant improvements for these projects. The timing of these expenditures may fluctuate based on the ultimate progress of construction.
Potential Future Capital Requirements
Potential Future Acquisitions
During the year ended December 31, 2010, we spent approximately $637.6 million in cash to acquire ten properties in eight transactions. We expect that in 2011 we will continue to pursue and evaluate strategic opportunities to acquire additional properties that provide attractive yields, significant potential for growth in cash flow from operations, present growth opportunities in strategic markets, or demonstrate the potential for improved performance through strategic management. We expect that any material acquisitions will be funded with borrowings under our Credit Facility or the public issuance of new debt or equity securities.
Redevelopment and Development Opportunities
As of December 31, 2010, we had one redevelopment project under construction. This project has a total estimated investment of approximately $50 million of which we have incurred approximately $15 million as of December 31, 2010. Of the remaining $35 million yet to be incurred, we are currently contractually obligated to approximately $15 million over the next year as shown in our contractual obligations table above. We expect we also may incur up to approximately $20 million of the $50 million in leasing related costs for this project, depending
on leasing activity. Ultimate timing of these expenditures may fluctuate given the ultimate progress and leasing status of the redevelopment project.
Over the next year, we may also redevelop certain other properties that have been occupied by long-term tenants and thus require significant capital expenditures to update and modernize the buildings. We are also focusing on enhancing the entitlements for our existing development land pipeline and are evaluating strategic alternatives for the one property that was recently re-entitled for residential use. We estimate that we could spend up to to an additional $20 million on these efforts during 2011.
In addition, we continually evaluate the size, timing, costs, and scope of our development program and, as necessary, scale activity to reflect the market conditions and the real estate fundamentals that exist in our strategic submarkets. Therefore, depending on future market conditions, we anticipate that we may have additional spending for our future development pipeline projects during 2011 and beyond.
Potential Future Leasing Costs and Capital Improvements
Given the current economic conditions, the amounts we are required to spend on tenant improvements and leasing costs are expected to remain above historical levels for us to be able to execute leases at current market terms, as evidenced in the table below. The amounts we ultimately incur for tenant improvements and leasing costs will depend on actual leasing activity. Tenant improvements and leasing costs generally fluctuate in any given period depending on factors such as the type of property, the term of the lease, the type of the lease, the involvement of external leasing agents, and overall market conditions. Capital expenditures may fluctuate in any given period subject to the nature, extent, and timing of improvements required to maintain our properties.
We currently project we could spend up to $25 million in capital improvements, tenant improvements, and leasing costs in 2011 for properties within our stabilized portfolio, depending on leasing activity, in addition to the $42 million of lease and contractual commitments discussed in our capital commitments table above.
The following tables set forth our historical capital expenditures, tenant improvements, and leasing costs, excluding tenant-funded tenant improvements, for renewed and re-tenanted space within our stabilized portfolio for each of the three years during the period ended December 31, 2010 on a per square foot basis.
(1)
Includes only tenants with lease terms of 12 months or longer. Excludes leases for month-to-month and first generation expenditures. First generation expenditures are those expenditures that ultimately result in additional revenue generated when the space is re-leased.
As a result of the volume of leases that commenced in 2010, office capital expenditures trended higher than in past years. We believe that all of our properties are well maintained and do not require significant capital improvements, and do not anticipate this trend to continue.
Distribution Requirements
For a discussion of our dividend and distribution requirements, please see the Distribution Requirements discussion under Liquidity and Capital Resources of the Company.
Other Potential Future Liquidity Uses
We may seek to repurchase additional debt securities depending on prevailing market conditions, our liquidity requirements, and other factors.
We have the ability to repurchase preferred stock in open market transactions. We may repurchase our outstanding preferred stock in the future depending upon market conditions and our liquidity and financial position.
An aggregate of 988,025 common shares currently remain eligible for repurchase under a share-repurchase program approved by our board of directors. We did not repurchase shares of common stock under this program during the year ended December 31, 2010. We may repurchase additional shares of our common stock in the future depending upon market conditions.
Factors That May Influence Future Sources of Capital and Liquidity
We continue to evaluate sources of financing for our business activities, including borrowings under the Credit Facility, issuance of public and private unsecured debt, fixed-rate secured mortgage financing, and offerings of the Company’s common stock. However, the Operating Partnership’s ability to obtain new financing or refinance existing borrowings on favorable terms could be impacted by various factors including the state of economic conditions, significant tenant defaults, a further decline in the demand for office or industrial properties, a further decrease in market rental rates or market values of real estate assets in our submarkets, and the amount of future borrowings. These events could result in the following:
•
decreases in our cash flows from operations, which could create further dependence on our Credit Facility;
•
an increase in the proportion of variable-rate debt, which could increase our sensitivity to interest rate fluctuations in the future; and
•
a decrease in the value of our properties, which could have an adverse effect on the Operating Partnership’s ability to incur additional debt, refinance existing debt at competitive rates, or comply with its existing debt obligations.
In addition to the factors noted above, the Operating Partnership’s credit ratings are subject to ongoing evaluation by credit rating agencies and may be changed or withdrawn by a rating agency in the future if, in its judgment, circumstances warrant. In the event that the Operating Partnership’s credit ratings are downgraded, we may incur higher borrowing costs and may experience difficulty in obtaining additional financing or refinancing existing indebtedness.
Debt Covenants
The Credit Facility, unsecured senior notes, and certain other secured debt arrangements contain covenants and restrictions requiring us to meet certain financial ratios and reporting requirements. Key existing financial covenants and their covenant levels include:
We believe that the Operating Partnership was in compliance with all its debt covenants as of December 31, 2010. Our current expectation is that the Operating Partnership will continue to meet the requirements of its debt covenants in both the short and long term. However, in the event of a continued economic slow down and continued volatility in the credit markets, there is no certainty that the Operating Partnership will be able to continue to satisfy all the covenant requirements.
Historical Cash Flow Summary
Our historical cash flow activity for the year ended December 31, 2010 as compared to the year ended December 31, 2009 was as follows:
Operating Activities
Our cash flows from operations depends on numerous factors including the occupancy level of our portfolio, the rental rates achieved on our leases, the collectability of rent and recoveries from our tenants, the level of operating expenses, the impact of property acquisitions and related financing activities, and other general and administrative costs. Our net cash provided by operating activities decreased by $5.1 million, or 4.1%, for the year ended December 31, 2010 compared to the year ended December 31, 2009 primarily as the result of an increase in expenditures for severance costs and acquisition related costs.
Investing Activities
Our net cash used in investing activities is generally used to fund property acquisitions, recurring and nonrecurring capital expenditures for our operating properties, and development and redevelopment projects . Our net cash used in investing activities increased $651.3 million, or 1,290.4%, for the year ended December 31, 2010 compared to the year ended December 31, 2009. This net increase was primarily attributable to the following:
•
Approximately $637.6 million in cash paid to acquire ten operating properties in eight transactions during 2010;
•
An increase of $35.6 million in expenditures for our operating properties in 2010 primarily for tenant improvement projects and leasing commissions related to increased leasing activity;
•
An offsetting decrease primarily as the result of $10.7 million in cash received for the repayment of the note receivable balance and $10.0 million in proceeds received from the sale of properties.
Financing Activities
Our net cash provided by or used in financing activities is generally impacted by our capital raising activities net of dividends and distributions paid to common and preferred security holders. Net cash provided by financing activities increased by $661.1 million, or 891.4%, for the year ended December 31, 2010 compared to the year ended December 31, 2009, and was primarily attributable to an increase in our capital raising activities during 2010 to fund our 2010 property acquisitions (see 2010 Financing Activities discussion under the heading Liquidity and Capital Resources of the Operating Partnerships for additional information).
Off-Balance Sheet Arrangements
As of December 31, 2010 and as of the date this report was filed, we did not have any off-balance sheet transactions, arrangements, or obligations, including contingent obligations.
Non-GAAP Supplemental Financial Measure: Funds From Operations
We calculate FFO in accordance with the White Paper on FFO approved by the Board of Governors of NAREIT. The White Paper defines FFO as net income or loss calculated in accordance with GAAP, excluding extraordinary items, as defined by GAAP, and gains and losses from sales of depreciable operating 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.
We believe that FFO is a useful supplemental measure of our operating performance. The exclusion from FFO of gains and losses from the sale of operating real estate assets allows investors and analysts to readily identify the operating results of the assets that form the core of our activity and assists in comparing those operating results between periods. Also, because FFO is generally recognized as the industry standard for reporting the operations of REITs, it facilitates comparisons of operating performance to other REITs. However, other REITs may use different methodologies to calculate FFO, and accordingly, our FFO may not be comparable to all other REITs.
Implicit in historical cost accounting for real estate assets in accordance with GAAP is the assumption that the value of real estate assets diminishes predictably over time. Since real estate values have historically risen or fallen with market conditions, many industry investors and analysts have considered presentations of operating results for real estate companies using historical cost accounting alone to be insufficient. Because FFO excludes depreciation and amortization of real estate assets, we believe that FFO along with the required GAAP presentations provides a more complete measurement of our performance relative to our competitors and a more appropriate basis on which to make decisions involving operating, financing, and investing activities than the required GAAP presentations alone would provide.
However, FFO should not be viewed as an alternative measure of our operating performance since it does not reflect either depreciation and amortization costs or the level of capital expenditures and leasing costs necessary to maintain the operating performance of our properties, which are significant economic costs and could materially impact our results from operations.
The following table presents our FFO for the years ended December 31, 2010, 2009, 2008, 2007, and 2006:
(1)
Reported amounts are attributable to common stockholders and common unitholders.
The following table presents our weighted average common shares and common units outstanding for the years ended December 31, 2010, 2009, 2008, 2007, and 2006:
Inflation
Since the majority of our leases require tenants to pay most operating expenses, including real estate taxes, utilities, insurance, and increases in common area maintenance expenses, we do not believe our exposure to increases in costs and operating expenses resulting from inflation is material.
New Accounting Pronouncements
There are currently no recently issued accounting pronouncements that are expected to have a material effect on our financial condition and results of operations in future periods.
ITEM 7A.
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The primary market risk we face is interest rate risk. We mitigate this risk by following established risk management policies and procedures. These policies include maintaining prudent amounts of debt, including a greater amount of fixed-rate debt as compared to variable-rate debt in our portfolio, and may include the periodic use of derivative instruments. As of December 31, 2010 and 2009, we did not have any interest-rate sensitive derivative assets or liabilities.
Information about our changes in interest rate risk exposures from December 31, 2009 to December 31, 2010 is incorporated herein by reference from Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations “-Liquidity and Capital Resources of the Operating Partnership.”
Market Risk
As of December 31, 2010, approximately 11% of our total outstanding debt of $1.5 billion was subject to variable interest rates. The remaining 89.0% bore interest at fixed rates. All of our interest rate sensitive financial instruments are held for purposes other than trading purposes.
In general, interest rate fluctuations applied to our variable-rate debt will impact our future earnings and cash flows. Conversely, interest rate fluctuations applied to our fixed-rate debt will generally not impact our future earnings and cash flows, unless such instruments mature or are otherwise terminated and need to be refinanced. However, interest rate fluctuations will impact the fair value of the fixed-rate debt instruments.
With the exception of the Exchangeable Notes and our publicly traded unsecured senior notes, we generally determine the fair value of our fixed-rate debt by performing discounted cash flow analyses using an appropriate market rate. We calculate the market rate by obtaining period-end treasury rates for maturities that correspond to the
maturities of our fixed-rate debt and then adding an appropriate credit spread based on information obtained from third-party financial institutions. These credit spreads take into account factors, including but not limited to, our credit profile, the tenure of the debt, amortization period, whether the debt is secured or unsecured, and the loan-to-value ratio of the debt. We determine the fair value of the liability component of our Exchangeable Notes by performing discounted cash flow analysis using an appropriate market interest rate for similar non-convertible conventional debt instruments. We determine the fair value of each of our publicly traded unsecured senior notes based on their quoted trading price at the end of the reporting period. See Note 16 to our consolidated financial statements included in this report for additional information on the fair value of our financial assets and liabilities as of December 31, 2010 and 2009.
As of December 31, 2010, the total outstanding balance of our variable-rate debt included borrowings on our Credit Facility of $159.0 million and was indexed to LIBOR plus a spread of 2.675% (weighted average interest rate was 2.99% ). As of December 31, 2009, the total outstanding balance of our variable-rate debt included borrowings of $97.0 million on our Prior Credit Facility, which was indexed to LIBOR plus a spread of 0.85%, and borrowings of $33.5 million on our secured line of credit, which was indexed to LIBOR plus a spread of 0.75% (weighted average interest rate was 1.1%). Assuming no changes in the outstanding balance of our existing variable-rate debt as of December 31, 2010, a 100 basis point increase in the LIBOR rate would increase our projected annual interest expense, before the effect of capitalization, by approximately $1.6 million. Comparatively, if interest rates were 100 basis points higher as of December 31, 2009, our projected annual interest expense, before the effect of capitalization, would have been $1.3 million higher.
The total carrying value of our fixed-rate debt, including our Exchangeable Notes, was approximately $1.3 billion and $841.5 million as of December 31, 2010 and 2009, respectively. The total estimated fair value of our fixed-rate debt was approximately $1.3 billion and $842.1 million as of December 31, 2010 and 2009, respectively. For sensitivity purposes, a 100 basis point increase in the discount rate equates to a decrease in the total fair value of our fixed-rate debt of approximately $47.2 million, or 3.6%, as of December 31, 2010. Comparatively, a 100 basis point increase in the discount rate equates to a decrease in the total fair value of our fixed-rate debt of approximately $20.2 million, or 2.4%, as of December 31, 2009.
The above sensitivity analyses do not consider interrelationships between different market movements, which could result in additional changes in the fair value of our debt and Exchangeable Notes, beyond the amounts calculated.
ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See the index included at Item 15: Exhibits, Financial Statement Schedules.
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A.
ITEM 9A.
CONTROLS AND PROCEDURES
Kilroy Realty Corporation
The Company maintains disclosure controls and procedures (as defined in Rule 13a-15(e) or Rule 15d-15(e) under the Exchange Act) that are designed to ensure that information required to be disclosed in our reports under the Exchange Act, is processed, recorded, summarized, and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
As required by SEC Rule 13a-15(b), we carried out an evaluation, under the supervision and with the participation of management including the Chief Executive Officer and Chief Financial Officer, of the effectiveness
of the design and operation of the disclosure controls and procedures as of the end of the period covered by this report. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded, as of that time, that our disclosure controls and procedures were effective at the reasonable assurance level.
Changes in Internal Control Over Financial Reporting
There have been no changes that occurred during the fourth quarter of the year covered by this report in the Company’s internal control over financial reporting identified in connection with the evaluation referenced above that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
Management’s Report on Internal Control Over Financial Reporting
Internal control over financial reporting is a process designed by, or under the supervision of, our Chief Executive Officer and Chief Financial Officer and effected by our board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP. Internal control over financial reporting includes those policies and procedures that: (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that our receipts and expenditures are being made only in accordance with authorizations of management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of assets that could have a material effect on the consolidated financial statements.
Management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control over financial reporting is supported by written policies and procedures and by an appropriate segregation of responsibilities and duties. The Company has used the criteria set forth in the Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission to assess our internal control over financial reporting. Based upon this assessment, management concluded that internal control over financial reporting operated effectively as of December 31, 2010.
Deloitte & Touche LLP, the Company’s independent registered public accounting firm, has audited the Company’s financial statements and has issued a report on the effectiveness of the Company’s internal control over financial reporting.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Kilroy Realty Corporation
Los Angeles, California
We have audited the internal control over financial reporting of Kilroy Realty Corporation (the “Company”) as of December 31, 2010, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedules as of and for the year ended December 31, 2010, of the Company and our report dated February 10, 2011, expressed an unqualified opinion on those financial statements and financial statement schedules.
/s/ DELOITTE & TOUCHE LLP
Los Angeles, California
February 10, 2011
Kilroy Realty, L.P.
The Operating Partnership maintains disclosure controls and procedures (as defined in Rule 13a-15(e) or Rule 15d-15(e) under the Exchange Act) that are designed to ensure that information required to be disclosed in our reports under the Exchange Act, is processed, recorded, summarized, and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer of our general partner, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
As required by SEC Rule 13a-15(b), the Operating Partnership carried out an evaluation, under the supervision and with the participation of management including the Chief Executive Officer and Chief Financial Officer of our general partner, of the effectiveness of the design and operation of the disclosure controls and procedures as of the end of the period covered by this report. Based on the foregoing, the Chief Executive Officer and Chief Financial Officer of our general partner concluded, as of that time, that our disclosure controls and procedures were effective at the reasonable assurance level.
Changes in Internal Control Over Financial Reporting
There have been no changes that occurred during the fourth quarter of the year covered by this report in the Operating Partnership’s internal control over financial reporting identified in connection with the evaluation referenced above that has materially affected, or is reasonably likely to materially affect, the Operating Partnership’s internal control over financial reporting.
Management’s Report on Internal Control Over Financial Reporting
Internal control over financial reporting is a process designed by, or under the supervision of, the Chief Executive Officer and Chief Financial Officer of our general partner and effected by the board of directors, management, and other personnel of our general partner to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP. Internal control over financial reporting includes those policies and procedures that: (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that our receipts and expenditures are being made only in accordance with authorizations of management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of assets that could have a material effect on the consolidated financial statements.
Management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control over financial reporting is supported by written policies and procedures and by an appropriate segregation of responsibilities and duties. The Operating Partnership has used the criteria set forth in the Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission to assess our internal control over financial reporting. Based upon this assessment, management concluded that internal control over financial reporting operated effectively as of December 31, 2010.
Deloitte & Touche LLP, the Operating Partnership’s independent registered public accounting firm, has audited the Operating Partnership’s financial statements and has issued a report on the effectiveness of the Operating Partnership’s internal control over financial reporting.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Partners of
Kilroy Realty, L.P.
Los Angeles, California
We have audited the internal control over financial reporting of Kilroy Realty, L.P. (the “Operating Partnership”) as of December 31, 2010, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Operating Partnership’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Operating Partnership’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Operating Partnership maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedules as of and for the year ended December 31, 2010, of the Operating Partnership and our report dated February 10, 2011, expressed an unqualified opinion on those financial statements and financial statement schedules.
/s/ DELOITTE & TOUCHE LLP
Los Angeles, California
February 10, 2011
ITEM 9B.
ITEM 9B.
OTHER INFORMATION
Not applicable.
PART III
ITEM 10.
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by Item 10 is incorporated by reference from our definitive proxy statement for our annual stockholders’ meeting presently scheduled to be held in May 2011.
ITEM 11.
ITEM 11.
EXECUTIVE COMPENSATION
The information required by Item 11 is incorporated by reference from our definitive proxy statement for our annual stockholders’ meeting presently scheduled to be held in May 2011.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by Item 12 is incorporated by reference from our definitive proxy statement for our annual stockholders’ meeting presently scheduled to be held in May 2011.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by Item 13 is incorporated by reference from our definitive proxy statement for our annual stockholders’ meeting presently scheduled to be held in May 2011.
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by Item 14 is incorporated by reference from our definitive proxy statement for our annual stockholders’ meeting presently scheduled to be held in May 2011.
PART IV
ITEM 15.
ITEM 15.
EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a)(1) and (2) Financial Statements and Schedules
The following consolidated financial information is included as a separate section of this annual report on Form 10-K:
All other schedules are omitted since the required information is not present in amounts sufficient to require submission of the schedule or because the information required is included in the financial statements and notes thereto.
(3)
Exhibits
*
Filed herewith

Management contract or compensatory plan or arrangement.
(1)
Previously filed by Kilroy Realty Corporation as an exhibit to the Registration Statement on Amendment No. 3 to Form S-11 (No. 333-15553).
(2)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 10-K for the year ended December 31, 2003.
(3)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 8-K as filed with the Securities and Exchange Commission on February 11, 1998.
(4)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 8-K/A as filed with the Securities and Exchange Commission on December 19, 1997.
(5)
Pursuant to Rule 406T of Regulation S-T , these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934 and otherwise are not subject to liability under these sections.
(6)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 10-K for the year ended December 31, 2000.
(7)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 8-K as filed with the Securities and Exchange Commission on August 11, 2004.
(8)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 8-K as filed with the Securities and Exchange Commission on December 9, 2004.
(9)
Previously filed by Kilroy Realty Corporation as an exhibit to the Registration Statement on Amendment No. 2 to Form S-11 (No. 333-15553).
(10)
Previously filed by Kilroy Realty Corporation as an exhibit to the Registration Statement on Form S-11 (No. 333-15553).
(11)
Previously filed by Kilroy Realty Corporation as an exhibit to the Registration Statement on Amendment No. 5 to Form S-11 (No. 333-15553).
(12)
Previously filed by Kilroy Realty Corporation as an exhibit to the Registration Statement on Amendment No. 4 to Form S-11 (No. 333-15553).
(13)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 8-K as filed with the Securities and Exchange Commission on June 6, 1997.
(14)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 8-K as filed with the Securities and Exchange Commission on July 15, 1997.
(15)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 8-K as filed with the Securities and Exchange Commission on July 3, 1997.
(16)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 10-Q for the quarter ended September 30, 1997.
(17)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 8-K as filed with the Securities and Exchange Commission on November 21, 1997.
(18)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 8-K as filed with the Securities and Exchange Commission on December 29, 1997.
(19)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 10-Q for the quarter ended September 30, 1998.
(20)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 10-K for the year ended December 31, 2001.
(21)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 10-Q for the quarter ended March 31, 2004.
(22)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 8-K as filed with the Securities and Exchange Commission on October 28, 2004.
(23)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 10-Q for the quarter ended March 31, 2006.
(24)
Previously filed by Kilroy Realty Corporation as an exhibit to the Registration Statement on Form S-8 filed with the Securities and Exchange Commission on June 28, 2006.
(25)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 8-K as filed with the Securities and Exchange Commission on February 8, 2007.
(26)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 10-K for the year ended December 31, 2006.
(27)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 8-K as filed with the Securities and Exchange Commission on March 22, 2007.
(28)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 8-K as filed with the Securities and Exchange Commission on April 5, 2007.
(29)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 8-K as filed with the Securities and Exchange Commission on April 11, 2007.
(30)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 10-Q for the quarter ended March 31, 2007.
(31)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 8-K as filed with the Securities and Exchange Commission on December 12, 2008.
(32)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 10-Q for the quarter ended June 30, 2007.
(33)
Previously filed by Kilroy Realty Corporation as an exhibit to Form 8-K as filed with the Securities and Exchange Commission on January 2, 2008.
(34)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 10-Q for the quarter ended September 30, 2008.
(35)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 8-K as filed with the Securities and Exchange Commission on May 27, 2009.
(36)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 10-Q for the quarter ended June 30, 2009.
(37)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 8-K as filed with the Securities and Exchange Commission on July 23, 2009.
(38)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 8-K as filed with the Securities and Exchange Commission on July 5, 2005.
(39)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 8-K as filed with the Securities and Exchange Commission on November 25, 2009.
(40)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 10-K for the year ended December 31, 2008.
(41)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 10-K for the year ended December 31, 2009.
(42)
Previously filed by Kilroy Realty, L.P. as an exhibit to the General Form for Registration of Securities on Form 10 as filed with the Securities and Exchange Commission on August 18, 2010.
(43)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 8-K as filed with the Securities and Exchange Commission on May 25, 2010.
(44)
Previously filed by Kilroy Realty Corporation as an exhibit to the Registration Statement on Form S-8 as filed with the Securities and Exchange Commission on June 11, 2010.
(45)
Previously filed by Kilroy Realty Corporation and Kilroy Realty, L.P. as an exhibit on Form 8-K as filed with the Securities and Exchange Commission on November 4, 2010.
(46)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 8-K as filed with the Securities and Exchange Commission on May 27, 2010.
(47)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 8-K as filed with the Securities and Exchange Commission on August 11, 2010.
(48)
Previously filed by Kilroy Realty Corporation and Kilroy Realty, L.P. as an exhibit on Form 8-K as filed with the Securities and Exchange Commission on January 13, 2011.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Kilroy Realty Corporation has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on February 10, 2011.
KILROY REALTY CORPORATION
By
/s/ Heidi R. Roth
Heidi R. Roth
Senior Vice President and Controller
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that we, the undersigned officers and directors of Kilroy Realty Corporation, hereby severally constitute John B. Kilroy, Sr., John B. Kilroy, Jr., Jeffrey C. Hawken, Tyler H. Rose and Heidi R. Roth, and each of them singly, our true and lawful attorneys with full power to them, and each of them singly, to sign for us and in our names in the capacities indicated below, the Form 10-K filed herewith and any and all amendments to said Form 10-K, and generally to do all such things in our names and in our capacities as officers and directors to enable Kilroy Realty Corporation to comply with the provisions of the Securities Exchange Act of 1934, as amended, and all requirements of the Securities and Exchange Commission, hereby ratifying and confirming our signatures as they may be signed by our said attorneys, or any of them, to said Form 10-K and any and all amendments thereto.
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Kilroy Realty, L.P. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on February 10, 2011.
KILROY REALTY, L.P.
By
/s/ Heidi R. Roth
Heidi R. Roth
Senior Vice President and Controller
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that we, the undersigned officers and directors of Kilroy Realty Corporation, as sole general partner and on behalf of Kilroy Realty, L.P., hereby severally constitute John B. Kilroy, Sr., John B. Kilroy, Jr., Jeffrey C. Hawken, Tyler H. Rose and Heidi R. Roth, and each of them singly, our true and lawful attorneys with full power to them, and each of them singly, to sign for us and in our names in the capacities indicated below, the Form 10-K filed herewith and any and all amendments to said Form 10-K, and generally to do all such things in our names and in our capacities as officers and directors to enable Kilroy Realty Corporation, as sole general partner and on behalf of Kilroy Realty, L.P., to comply with the provisions of the Securities Exchange Act of 1934, as amended, and all requirements of the Securities and Exchange Commission, hereby ratifying and confirming our signatures as they may be signed by our said attorneys, or any of them, to said Form 10-K and any and all amendments thereto.
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 2010 AND 2009 AND FOR
THE THREE YEARS ENDED DECEMBER 31, 2010
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and
Stockholders of Kilroy Realty
Corporation Los Angeles, California
We have audited the accompanying consolidated balance sheets of Kilroy Realty Corporation (the “Company”) as of December 31, 2010 and 2009, and the related consolidated statements of operations, equity, and cash flows for each of the three years in the period ended December 31, 2010. Our audits also included the financial statement schedules listed in the Index at Item 15. These financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2010 and 2009, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2010, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2010, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 10, 2011, expressed an unqualified opinion on the Company’s internal controls over financial reporting.
/s/ DELOITTE & TOUCHE LLP
Los Angeles, California
February 10, 2011
KILROY REALTY CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
See accompanying notes to consolidated financial statements
KILROY REALTY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share data)
See accompanying notes to consolidated financial statements.
KILROY REALTY CORPORATION
CONSOLIDATED STATEMENTS OF EQUITY
(in thousands, except share and per share/unit data)
See accompanying notes to consolidated financial statements.
KILROY REALTY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
KILROY REALTY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS-(Continued)
(in thousands)
See accompanying notes to consolidated financial statements.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Partners of Kilroy Realty, L.P.
Kilroy Realty, L.P.
Los Angeles, California
We have audited the accompanying consolidated balance sheets of Kilroy Realty, L.P. (the “Operating Partnership”) as of December 31, 2010 and 2009, and the related consolidated statements of operations, capital, and cash flows for each of the three years in the period ended December 31, 2010. Our audits also included the financial statement schedules listed in the Index at Item 15. These financial statements and financial statement schedules are the responsibility of the Operating Partnership’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Operating Partnership as of December 31, 2010 and 2009, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2010, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Operating Partnership’s internal control over financial reporting as of December 31, 2010, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 10, 2011, expressed an unqualified opinion on the Operating Partnership’s internal controls over financial reporting.
/s/ DELOITTE & TOUCHE LLP
Los Angeles, California
February 10, 2011
KILROY REALTY, L.P.
CONSOLIDATED BALANCE SHEETS
(in thousands, except unit data)
See accompanying notes to consolidated financial statements.
KILROY REALTY, L.P.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except unit and per unit data)
See accompanying notes to consolidated financial statements.
KILROY REALTY, L.P.
CONSOLIDATED STATEMENTS OF CAPITAL
(in thousands, except unit and per unit data)
See accompanying notes to consolidated financial statements.
KILROY REALTY, L.P.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
KILROY REALTY, L.P.
CONSOLIDATED STATEMENTS OF CASH FLOWS-(Continued)
(in thousands)
See accompanying notes to consolidated financial statements.
KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Three Years Ended December 31, 2010
1.
Organization and Ownership
Organization
Kilroy Realty Corporation (the “Company”) is a self-administered real estate investment trust (“REIT”) active in the premier office and industrial submarkets along the West Coast. We own, develop, acquire and manage real estate assets primarily in the coastal regions of Los Angeles, Orange County, San Diego, greater Seattle and the San Francisco Bay Area, which we believe have strategic advantages and strong barriers to entry. We qualify as a REIT under the Internal Revenue Code of 1986, as amended (the “Code”). The Company’s common stock is publicly traded on the New York Stock Exchange (“NYSE”) under the ticker symbol “KRC.”
We own our interests in all of our real estate assets through Kilroy Realty, L.P. (the “Operating Partnership”) and Kilroy Realty Finance Partnership, L.P. (the “Finance Partnership”). We conduct substantially all of our operations through the Operating Partnership. Unless the context indicates otherwise, the term “Company” refers to Kilroy Realty Corporation and its consolidated subsidiaries and the term “Operating Partnership” refers to Kilroy Realty, L.P. and its consolidated subsidiaries. The terms “we,” “our,” and “us” refer to the Company or the Company and the Operating Partnership together, as the context requires. The descriptions of our business, employees, and properties apply to both the Company and the Operating Partnership.
The following table of office buildings (the “Office Properties”) and industrial buildings (the “Industrial Properties”) summarizes our stabilized portfolio of operating properties as of December 31, 2010. As of December 31, 2010, all but one of our properties was located in California.
(1)
Includes ten office buildings acquired in 2010 (see Note 3 to our consolidated financial statements included in this report for additional information).
Our stabilized portfolio excludes undeveloped land, development and redevelopment properties currently under construction, “lease-up” properties, and one industrial property that we are in the process of repositioning for residential use. We define “lease-up” properties as properties we recently developed or redeveloped that have not yet reached 95% occupancy and are within one year following cessation of major construction activities. As of December 31, 2010, we had no properties that were in the lease-up phase. During the year ended December 31, 2010, we commenced redevelopment on one of our properties that was previously occupied by a single tenant for over 25 years. The redevelopment property encompasses approximately 300,000 rentable square feet of office space and is located in the El Segundo submarket of Los Angeles county. As of December 31, 2010, we had one industrial property that we are currently in the process of repositioning for residential use. During the year ended December 31, 2010, we received notification that the zoning to allow high density residential improvements on the land underlying this industrial property was adopted by the City of Irvine and we are currently evaluating strategic opportunities for this property.
As of December 31, 2010, the Company owned a 96.8% general partnership interest in the Operating Partnership. The remaining 3.2% common limited partnership interest in the Operating Partnership as of December 31, 2010 was owned by non-affiliated investors and certain of our directors and officers (see Note 9). Both the general and limited common partnership interests in the Operating Partnership are denominated in common units. The number of common units held by the Company is at all times equivalent to the number of outstanding shares of the Company’s common stock, and the entitlements of all the common units to quarterly distributions and payments in liquidation mirror those of the the Company’s common stockholders. The
KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
common limited partners have certain redemption rights as provided in the Operating Partnership’s Fifth Amended and Restated Agreement of Limited Partnership (as amended, the “Partnership Agreement”) (see Note 9).
Kilroy Realty Finance, Inc., our wholly-owned subsidiary, is the sole general partner of the Finance Partnership and owns a 1.0% general partnership interest. The Operating Partnership owns the remaining 99.0% limited partnership interest. Kilroy Services, LLC (“KSLLC”), which is a wholly-owned subsidiary of the Operating Partnership, is the entity through which we conduct substantially all of our development activities. With the exception of the Operating Partnership, all of our subsidiaries, which include which include, Kilroy Realty TRS, Inc., Kilroy Realty Management, L.P., Kilroy RB, LLC, and Kilroy RB II, LLC, Kilroy Northside Drive, LLC, and Kilroy Realty 303, LLC are wholly-owned.
2.
Basis of Presentation and Significant Accounting Policies
Basis of Presentation
The consolidated financial statements of the Company include the consolidated financial position and results of operations of the Company, the Operating Partnership, the Finance Partnership, KSLLC, and all of our wholly-owned subsidiaries. The consolidated financial statements of the Operating Partnership include the consolidated financial position and results of operations of the Operating Partnership, the Finance Partnership, KSLLC, and all wholly-owned subsidiaries of the Operating Partnership. All intercompany balances and transactions have been eliminated in the consolidated financial statements.
The consolidated financial statements of the Company and the Operating Partnership also include a variable interest entity (“VIE”) of which we are deemed to be the primary beneficiary. During the year ended December 31, 2010, we established a bankruptcy-remote VIE, Kilroy Realty Northside Drive, LLC, to hold the $52.6 million of assets and liabilities purchased and $51.1 million of secured debt, net, assumed in connection with the acquisition of three office buildings in San Diego, California (see Notes 3 and 7). The assets held by this entity are not available to satisfy the debts and other obligations of the Company or the Operating Partnership.
Change in Statements of Operations Presentation for the Company
Certain prior period amounts in the Company’s consolidated statement of operations have been reclassified to conform to the current period presentation. We reclassified interest expense to be presented under Other (Expenses) Income in the Company’s consolidated statements of operations for all periods presented. Interest expense had previously been presented under Expenses.
Significant Accounting Policies
Acquisitions
We record the acquired tangible and intangible assets and assumed liabilities of operating property acquisitions at fair value at the acquisition date. The acquired assets and assumed liabilities for an operating property acquisition generally include but are not limited to: land, buildings and improvements, and identified tangible and intangible assets and liabilities associated with in-place leases, including tenant improvements, leasing costs, value of above-market and below-market leases, acquired in-place lease values, and tenant relationships, if any.
The fair value of land is derived from comparable sales of land within the same submarket and/or region. The fair value of buildings and improvements, tenant improvements, and leasing costs are based upon current market replacement costs and other relevant market rate information.
The fair value of the above-market or below-market component of an acquired in-place lease is based upon the present value (calculated using a market discount rate) of the difference between (i) the contractual rents to be paid pursuant to the lease over its remaining term and (ii) management’s estimate of the rents that would be paid using fair market rental rates and rent escalations at the date of acquisition over the remaining term of the lease. The
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amounts recorded for above-market leases are included in deferred leasing costs and acquisition-related intangibles, net on the balance sheet and are amortized on a straight-line basis as a reduction of rental income over the remaining term of the applicable leases. The amounts recorded for below-market leases are included in deferred revenue and acquisition-related intangible liabilities, net and are amortized on a straight-line basis as an increase to rental income over the remaining term of the applicable leases.
The fair value of acquired in-place leases is derived based on management’s assessment of lost revenue and costs incurred for the period required to lease the “assumed vacant” property to the occupancy level when purchased. The amount recorded for acquired in-place leases is included in deferred leasing costs and acquisition-related intangible assets, net and amortized as an increase to depreciation and amortization expense over the remaining term of the applicable leases.
We record undeveloped land acquisitions at the purchase price paid and capitalize the associated acquisition costs.
Operating Properties
Operating properties are generally carried at historical cost less accumulated depreciation. Properties held for sale are reported at the lower of the carrying value or the fair value less estimated cost to sell. The cost of operating properties includes the purchase price or development costs of the properties. Costs incurred for the renovation and betterment of the operating properties are capitalized to our investment in that property. Maintenance and repairs are charged to expense as incurred.
When evaluating properties to be held and used for potential impairment, we first evaluate whether there are any indicators of impairment for any of our properties. If any impairment indicators are present for a specific property, we then perform an undiscounted cash flow analysis and compare the net carrying amount of the property to the property’s estimated undiscounted future cash flow over the anticipated holding period. If the estimated undiscounted future cash flow is less than the net carrying amount of the property, we then perform an impairment loss calculation to determine if the fair value of the property is less than the net carrying value of the property. Our impairment loss calculation compares the net carrying amount of the property to the property’s estimated fair value, which may be based on estimated discounted future cash flow calculations or third-party valuations or appraisals. We would recognize an impairment loss if the asset’s net carrying amount exceeds the asset’s estimated fair value. If we were to recognize an impairment loss, the estimated fair value of the asset would become its new cost basis. For a depreciable long-lived asset, the new cost basis would be depreciated (amortized) over the remaining useful life of that asset. We did not record any impairment losses for the periods presented.
Development and Redevelopment Properties
All costs clearly associated with the acquisition, development, and construction of a development or redevelopment property are capitalized as project costs. In addition, the following costs are capitalized as project costs during periods in which activities necessary to prepare the property for its intended use are in progress: pre-construction costs essential to the development of the property, interest, real estate taxes, insurance, and internal compensation and administrative costs that are clearly related to our development or redevelopment activities.
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For development and redevelopment properties that are pre-leased, we cease capitalization when revenue recognition commences, which is upon substantial completion of tenant improvements.
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For development and redevelopment properties that are not pre-leased, we may not immediately build out the tenant improvements. Therefore we cease capitalization when revenue recognition commences upon substantial completion of the tenant improvements, but in any event not later than one year after the cessation of major construction activities. We also cease capitalization on a development or
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redevelopment property when activities necessary to prepare the property for its intended use have been suspended.
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For development or redevelopment properties with multiple tenants and staged leasing, we cease capitalization and begin depreciation on the portion of the development or redevelopment property for which revenue recognition has commenced.
Once major construction activity has ceased and the development or redevelopment property is in the lease-up phase, the costs capitalized to construction in progress are transferred to land and improvements, buildings and improvements, and deferred leasing costs on our consolidated balance sheets as the historical cost of the property.
Depreciation and Amortization of Buildings and Improvements
The cost of buildings and improvements and tenant improvements are depreciated using the straight-line method of accounting over the estimated useful lives set forth in the table below. Depreciation expense for buildings and improvements, including discontinued operations, for the three years ended December 31, 2010, 2009, and 2008 was $86.3 million, $74.0 million, and $68.8 million, respectively.
(1)
Tenant improvements are amortized over the shorter of the lease term or the estimated useful life.
Discontinued Operations and Properties Held for Sale
The revenues and expenses of operating properties that have been sold, if material, and the revenues and expenses of properties that have been classified as held for sale, if material, are reported in the consolidated statements of operations as discontinued operations for all periods presented through the date of the applicable disposition. The net gains (losses) on disposition of operating properties are reported in the consolidated statements of operations as discontinued operations in the period the properties are sold. In determining whether the revenues, expenses, and net gains (losses) on dispositions of operating properties are reported as discontinued operations, we evaluate whether we have any significant continuing involvement in the operations, leasing, or management of the sold property. If we were to determine that we had any significant continuing involvement, the revenues, expenses and and net gain (loss) on dispositions of the operating property would not be recorded in discontinued operations.
A property is classified as held for sale when certain criteria are met, including but not limited to the availability of the asset for immediate sale, the existence of an active program to locate a buyer, and the probable sale or transfer of the asset within one year. If such criteria are met, we present the applicable assets and liabilities related to the property held for sale, if material, separately on the balance sheet and we would cease to record depreciation and amortization expense. Properties held for sale are reported at the lower of their carrying value or their estimated fair value less the estimated costs to sell. We did not have any properties classified as held for sale as of December31, 2010 or 2009.
Revenue Recognition
We recognize revenue from rent, tenant reimbursements, parking, and other revenue sources once all of the following criteria are met:
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the agreement has been fully executed and delivered;
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services have been rendered;
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the amount is fixed or determinable; and
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the collectability of the amount is reasonably assured.
Minimum annual rental revenues are recognized in rental revenues on a straight-line basis over the term of the related lease. Rental revenue recognition commences when the tenant takes possession or controls the physical use of the leased space. In order for the tenant to take possession, the leased space must be substantially ready for its intended use. To determine whether the leased space is substantially ready for its intended use, management evaluates whether we are or the tenant is the owner of tenant improvements for accounting purposes. When management concludes that we are the owner of tenant improvements, rental revenue recognition begins when the tenant takes possession of the finished space, which is when such tenant improvements are substantially complete. In certain instances, when management concludes that we are not the owner (the tenant is the owner) of tenant improvements, rental revenue recognition begins when the tenant takes possession of or controls the space.
When management concludes that we are the owner of tenant improvements for accounting purposes, management records the cost to construct the tenant improvements as a capital asset. In addition, management records the cost of certain tenant improvements paid for or reimbursed by tenants as capital assets when management concludes that we are the owner of such tenant improvements. For these tenant improvements, management records the amount funded or reimbursed by tenants as deferred revenue, which is amortized on a straight-line basis as additional rental revenue over the term of the related lease.
When management concludes that the tenant is the owner of tenant improvements for accounting purposes, management records our contribution towards those improvements as a lease incentive, which is included in deferred leasing costs on our consolidated balance sheets and amortized as a reduction to rental revenue on a straight-line basis over the term of the lease.
Tenant Reimbursements
Reimbursements from tenants, consisting of amounts due from tenants for common area maintenance, real estate taxes, and other recoverable costs, are recognized as revenue in the period the expenses are incurred. Tenant reimbursements are recognized and recorded on a gross basis, as we are generally the primary obligor with respect to purchasing goods and services from third-party suppliers, have discretion in selecting the supplier, and have credit risk.
Other Property Income
Other property income primarily includes amounts recorded in connection with lease terminations. Lease termination fees are amortized over the remaining lease term, if applicable. If there is no remaining lease term, they are recognized when received and realized. Other property income also includes miscellaneous income from tenants, such as fees related to the restoration of leased premises to their original condition and fees for late rental payments.
Allowances for Uncollectible Tenant and Deferred Rent Receivables
We carry our current and deferred rent receivables net of allowances for uncollectible amounts. Our determination of the adequacy of these allowances is based primarily upon evaluations of individual receivables, current economic conditions, historical loss experience, and other relevant factors. The allowances are increased or decreased through the provision for bad debts on our consolidated statements of income.
Cash and Cash Equivalents
We consider all highly-liquid investments with original maturities of three months or less to be cash equivalents.
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Restricted Cash
Restricted cash consists of cash held as collateral to provide credit enhancement for the Operating Partnership’s mortgage debt, including cash reserves for capital expenditures, tenant improvements, and property taxes.
Marketable Securities / Deferred Compensation Plan
Marketable securities reported in our consolidated balance sheets represent the assets held in connection with the Kilroy Realty Corporation 2007 Deferred Compensation Plan (the “Deferred Compensation Plan”) (see Note 13). We hold the Deferred Compensation Plan assets in a limited rabbi trust. As a result, the marketable securities are treated as trading securities for financial reporting purposes and are adjusted to fair value at the end of each accounting period, with the corresponding gains and losses recorded in interest income and other investment gains (losses).
At the time eligible management employees (“Participants”) defer compensation or earn mandatory Company contributions, or if we were to make a discretionary contribution, we record compensation cost and a corresponding deferred compensation plan liability, which is included in accounts payable, accrued expenses, and other liabilities on our consolidated balance sheets. This liability is adjusted to fair value at the end of each accounting period based on the performance of the benchmark funds selected by each Participant, and the impact of adjusting the liability to fair value is recorded as an increase or decrease to compensation cost.
Deferred Leasing Costs
Costs incurred in connection with successful property leasing are capitalized as deferred leasing costs. Deferred leasing costs consist primarily of leasing commissions and also include certain internal payroll costs and lease incentives, which are amortized using the straight-line method of accounting over the lives of the leases which generally range from one to 20 years. We reevaluate the remaining useful lives of leasing costs as the creditworthiness of our tenants and economic and market conditions change. If we determine that the estimated remaining life of a lease has changed, we adjust the amortization period accordingly.
Deferred Financing Costs
Costs incurred in connection with debt financings are recorded as deferred financing costs. Deferred financing costs are generally amortized using the straight-line method of accounting, which approximates the effective interest method, over the contractual terms of the applicable financings. As of December 31, 2010 and 2009, deferred financing costs were reported net of accumulated amortization of $12.1 million and $9.7 million, respectively.
Exchangeable Debt Instruments
Effective January 1, 2009, we adopted new accounting provisions with respect to exchangeable debt instruments. This guidance requires the initial proceeds from exchangeable debt that may be settled in cash, including partial cash settlements, to be bifurcated between a liability component and an equity component associated with the embedded conversion option. The objective of the guidance is to require the liability and equity components of exchangeable debt to be separately accounted for in a manner such that the interest expense on the exchangeable debt is not recorded at the stated rate of interest but rather at an effective rate that reflects the issuer’s conventional debt borrowing rate at the date of issuance. These new provisions were applied retrospectively to our financial statements to the April 2007 issuance date of the 3.25% Exchangeable Senior Notes due 2012 (the “3.25% Exchangeable Notes”).
We calculate the liability component of exchangeable debt based on the present value of the contractual cash flows discounted at a comparable market conventional debt borrowing rate at the date of issuance. The difference
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between the principal amount and the fair value of the liability component is reported as a discount on the exchangeable debt that is accreted as additional interest expense from the issuance date through the contractual maturity date using the effective interest method. A portion of this additional interest expense is capitalized to the development and redevelopment balances qualifying for interest capitalization each period. The liability component of the exchangeable debt is reported net of discounts on our consolidated balance sheets.
We calculate the equity component of exchangeable debt based on the difference between the initial proceeds received from the issuance of the exchangeable debt and the fair value of the liability component at the issuance date. The equity component is included in additional paid-in-capital, net of issuance costs, on our consolidated balance sheets. We allocate issuance costs for exchangeable debt between the liability and the equity components based on their relative values.
Debt Discounts
Original issuance debt discounts and other discounts related to debt instruments are generally accreted on a straight-line basis, which approximates the effective interest method. The discounts are recorded as additional interest expense from the date of issuance through the contractual maturity date of the related debt.
Noncontrolling Interests in the Company’s Consolidated Financial Statements
Noncontrolling interests in the Company’s consolidated financial statements represent the issued and outstanding 1,500,000 Series A Preferred Units of the Operating Partnership (“Series A Preferred Units”) and common limited partnership interests in the Operating Partnership not held by the Company (“noncontrolling common units”).
Effective January 1, 2009, we adopted new accounting provisions with respect to noncontrolling interests. This guidance required that amounts formerly reported as minority interests be reported as noncontrolling interests on the our consolidated financial statements. In connection with the issuance of this guidance, certain revisions were also made to related SEC guidance that clarified that noncontrolling interests with redemption provisions outside of the control of the issuer and noncontrolling interests with redemption provisions that permit the issuer to settle in either cash or common shares at the option of the issuer were subject to further evaluation to determine whether permanent or temporary equity classification was appropriate and to determine whether fair value or cost basis accounting was appropriate.
The Series A Preferred Units are presented in the temporary equity section of the Company’s consolidated balance sheets after total liabilities and before equity and reported at redemption value, less issuance costs, given that the Series A Preferred Units contain a right of redemption at the option of the holders in the event of certain corporate events (see Note 9).
Noncontrolling common units are presented in the equity section of the Company’s consolidated balance sheets and reported at their proportionate share of the net assets of the Operating Partnership. The accounting provisions we adopted in 2009 require that noncontrolling interests with redemption provisions that permit the issuer to settle in either cash or common shares at the option of the issuer be further evaluated to determine whether equity or temporary equity classification on the balance sheet is appropriate. Since the common units contain such a provision, we evaluated this guidance and determined that the common units qualify for equity presentation in the Company’s consolidated financial statements (see Note 9).
Net income attributable to noncontrolling common units is allocated based on their relative ownership percentage of the Operating Partnership during the reported period. The noncontrolling interest ownership percentage is determined by dividing the number of noncontrolling common units by the total number of common units outstanding. The issuance or redemption of additional shares of common stock or common units results in changes to the noncontrolling interest percentage as well as the total net assets of the Company. As a result, all equity transactions result in an allocation between equity and the noncontrolling
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interest in the Company’s consolidated balance sheets and statements of equity to account for the changes in the noncontrolling interest ownership percentage as well as the change in total net assets of the Company.
Preferred Partnership Interests on the Operating Partnership’s Consolidated Balance Sheets
Preferred partnership interests of the Operating Partnership represent the issued and outstanding 1,500,000 7.45% Series A Preferred Units, 1,610,000 7.80% Series E Cumulative Redeemable Preferred Units (“Series E Preferred Units”) and 3,450,000 7.50% Series F Cumulative Redeemable Preferred Units (“Series F Preferred Units”).
The Series A Preferred Units are presented in the temporary equity section of the Operating Partnership’s consolidated balance sheets after total liabilities and before equity and reported at redemption value, less issuance costs, given that the Series A Preferred Units contain a right of redemption at the option of the holders in the event of certain corporate events (see Note 9).
The Series E and Series F Preferred Units are presented in the permanent equity section of the Operating Partnership’s consolidated balance sheets given that the Series E and Series F Preferred Units may redeemed only at our option (see Notes 9 and 11). The Company is the holder of both the Series E and Series F Preferred Units and for each Series E and Series F Preferred Unit, the Company has an equivalent number of shares of 7.80% Series E Cumulative Redeemable Preferred Stock and shares of 7.50% Series F Cumulative Redeemable Preferred Stock publicly issued and outstanding.
Common Partnership Interests on the Operating Partnership’s Consolidated Balance Sheets
The common units held by the Company and the noncontrolling common units held by the common limited partners are both presented in the permanent equity section of the Operating Partnership’s consolidated balance sheets in partners’ capital. The redemption rights of the noncontrolling common units permit us to settle the redemption obligation in either cash or shares of the Company’s common stock at our option (see Note 9).
Noncontrolling Interests on the Operating Partnership’s Consolidated Balance Sheets
Noncontrolling interests of the Operating Partnership represent the Company’s 1% general partnership interest in the Finance Partnership. This noncontrolling interest is presented in the permanent equity section of the Operating Partnership’s consolidated balance sheets given that these interests are not convertible or redeemable into any other ownership interest of the Company or the Operating Partnership.
Equity Offerings
Underwriting commissions and offering costs incurred in connection with equity offerings are reflected as a reduction of additional paid-in capital.
The net proceeds from any equity offering of the Company are contributed to the Operating Partnership in exchange for a number of common units equivalent to the number of shares of common stock issued and are reflected in the Operating Partnership’s consolidated financial statements as an increase in partners’ capital.
Gains and Losses on Early Extinguishment of Debt
Gains and losses on early extinguishment of debt represents the gains and losses recorded in connection with the repurchases of portions of our outstanding 3.25% Exchangeable Notes (see Note 7). We calculate the gain or loss on early extinguishment of debt as the difference on the repurchase date between the estimated fair value of the liability component and the net carrying amount of the repurchased exchangeable debt. Deferred financing costs are written off against the gain on early extinguishment of debt or added to the loss on early extinguishment of debt in proportion to the exchangeable debt repurchased.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Share-based Incentive Compensation Accounting
For share-based awards in which the performance period precedes the grant date, we recognize compensation cost over the requisite service period, which includes both the performance and service vesting periods, using the accelerated attribution expense method. The requisite service period begins on the date the Executive Compensation Committee authorizes the award and adopts any relevant performance measures.
During the performance period for a share-based award program, we estimate the total compensation cost of the potential future awards. We then record compensation cost equal to the portion of the requisite service period that has elapsed through the end of the reporting period. For programs with performance-based measures, the total estimated compensation cost is based on our most recent estimate of the probable achievement of the pre-established specific corporate performance measures. These estimates are based on our latest internal forecasts for each performance measure. For programs with market measures, the total estimated compensation cost is based on the fair value of the award at the applicable reporting date.
For share-based awards for which there is no pre-established performance period, we recognize compensation cost over the service vesting period, which represents the requisite service period, on a straight-line basis.
In accordance with the provisions of our share-based incentive compensation plans, we accept the return of shares of Company common stock, at the current quoted market price, from certain key employee to satisfy minimum statutory tax-withholding requirements related to shares that vested during the period.
For share based awards granted by the Company, the Operating Partnership issues a number of common units equal to the number of shares of common stock ultimately granted by the Company in respect of such awards.
Basic and Diluted Net Income (Loss) Available to Common Stockholders per Share
Basic net income (loss) available to common stockholders per share is computed by dividing net income (loss) available for common stockholders, after the allocation of income to participating securities, by the weighted-average number of vested common shares outstanding, for the period. Diluted net income (loss) available to common stockholders per share is computed by dividing net income (loss) available for common stockholders, after the allocation of income to participating securities, by the sum of the weighted-average number of common shares outstanding, for the period plus the assumed exercise of all dilutive securities. The impact of the outstanding common units is considered in the calculation of diluted net income (loss) available to common stockholders per share. The common units are not reflected in the diluted net income (loss) available to common stockholders per share calculation because the exchange of common units into common stock is on a one for one basis, and the common units are allocated net income on a per share basis equal to the common stock (see Note 20). Accordingly, any exchange would not have any effect on diluted net income (loss) available to common stockholders per share.
The dilutive effect of the outstanding nonvested shares of common stock (“nonvested shares”) and restricted stock units (“RSUs”) that have not yet been granted but are contingently issuable under the share-based compensation programs is reflected in the weighted average diluted shares calculation by application of the treasury stock method at the beginning of the quarterly period in which all necessary conditions have been satisfied. The dilutive effect of stock options are reflected in the weighted average diluted outstanding shares calculation by application of the treasury stock method. The dilutive effect of Exchangeable Notes are reflected in the weighted average diluted outstanding shares calculation when the average quoted trading price of the Company’s common stock on the NYSE is above the Exchangeable Notes exchange prices for the periods presented.
Effective January 1, 2009, we adopted new accounting provisions which require that nonvested share-based payment awards containing nonforfeitable rights to dividends or dividend equivalents, such as nonvested shares and RSUs, be included in the computation of basic and diluted net income available to common stockholders per share pursuant to the two-class method. The new accounting provisions were applied retrospectively to the net income available to common stockholders per share calculation for all periods presented.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Basic and Diluted Net Income (Loss) Available to Common Unitholders per Unit
Basic net income (loss) available to common unitholders per unit is computed by dividing net income (loss) available for common unitholders, after the allocation of income to participating securities, by the weighted-average number of vested common units outstanding for the period. Diluted net income (loss) available to common unitholders per unit is computed by dividing net income (loss) available for common unitholders, after the allocation of income to participating securities, by the sum of the weighted-average number of common units outstanding, for the period plus the assumed exercise of all dilutive securities.
The dilutive effect stock options, Exchangeable Notes, outstanding nonvested shares, RSUs, and awards containing nonforfeitable rights of dividend equivalents, is reflected in diluted net income (loss) available to common unitholders per unit in the same manner as noted above for net income (loss) available for common stockholders per share.
Fair Value Measurements
The fair value of our financial assets and liabilities are disclosed in Note 16 to our consolidated financial statements. The only assets and liabilities recorded at fair value on a recurring basis in our consolidated financial statements are the marketable securities and the related deferred compensation plan liability. We elected not to apply the fair value option for any of our eligible financial instruments or other items.
We determine the estimated fair value of financial assets and liabilities utilizing a hierarchy of valuation techniques based on whether the inputs to a fair value measurement are considered to be observable or unobservable in a marketplace. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect our market assumptions. This hierarchy requires the use of observable market data when available. The following is the fair value hierarchy:
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Level 1-quoted prices for identical instruments in active markets;
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Level 2-quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which significant inputs and significant value drivers are observable in active markets; and
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Level 3-fair value measurements derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.
We determine the fair value for the marketable securities and deferred compensation plan liability using quoted prices in active markets for identical assets. Our other financial instruments, which are only disclosed at fair value, are comprised of secured debt, unsecured senior notes, unsecured line of credit, Exchangeable Notes, and the note receivable.
We determine the fair value of our secured debt, private unsecured senior note, and unsecured line of credit by performing discounted cash flow analyses using an appropriate market discount rate for similar types of instruments. We determine the fair value of the liability component of our Exchangeable Notes by performing discounted cash flow analyses using an appropriate market interest rate for similar non-convertible conventional debt instruments. We determine the fair value of each of our two publicly traded unsecured senior notes based on their quoted trading price at the end of the reporting period. We determine the all-in rates by obtaining period-end treasury rates for fixed-rate debt, or period-end LIBOR rates for variable-rate debt, for maturities that correspond to the maturities of our debt and then adding an appropriate credit spread obtained from third-party financial institutions. These market credit spreads take into account factors including, but not limited to, our credit profile, the tenure of the debt, amortization period, whether the debt is secured or unsecured, and the loan-to-value ratio of the debt. These calculations are significantly affected by the assumptions used, including the discount rate, credit spreads, and estimates of future cash flow.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
We estimate the fair value of the note receivable by using discounted cash flow analyses based on an appropriate market rate for a similar type of instrument. Carrying amounts of our cash and cash equivalents, restricted cash, and accounts payable approximate fair value resulting from their short-term maturities.
Income Taxes
We have elected to be taxed as a REIT under Sections 856 through 860 of the Code. To qualify as a REIT, we must distribute annually at least 90% of our adjusted taxable income, as defined in the Code, to our security holders and satisfy certain other organizational and operating requirements. For distributions with respect to our 2008 through 2011 taxable years, IRS guidance allows the Company to satisfy up to 90% of this requirement through the distribution of shares of its common stock, if certain conditions are met. We generally will not be subject to federal income taxes if we distribute 100% of our taxable income for each year to our security holders. If we fail to qualify as a REIT in any taxable year, we will be subject to federal income taxes (including any applicable alternative minimum tax) on our taxable income at regular corporate rates and we may not be able to qualify as a REIT for four subsequent taxable years. Even if we qualifiy for taxation as a REIT, we may be subject to certain state and local taxes on our income and property and to federal income taxes and excise taxes on our undistributed taxable income. We believe that we have met all of the REIT distribution and technical requirements for the years ended December 31, 2010, 2009 and 2008, and we were not subject to any federal income taxes (see Note 22). We intend to continue to adhere to these requirements and maintain the Company’s REIT status.
In addition, any taxable income from our taxable REIT subsidiary, which was formed in August 2002, is subject to federal, state, and local income taxes. For each of the years ended December 31, 2010, 2009, and 2008, the taxable REIT subsidiary had less than $30,000 of taxable income.
Uncertain Tax Positions
We include favorable tax positions in the calculation of tax liabilities if it is more likely than not that our adopted tax position will prevail if challenged by tax authorities.
As a result of our REIT status, in computing our annual taxable income we are able to claim a dividends-paid deduction on our tax return for the full amount of common and preferred dividends paid to our stockholders. Since this dividends-paid deduction has historically exceeded our taxable income, the Company has historically had significant return of capital to its stockholders. In order for us to be required to record any unrecognized tax benefits or additional tax liabilities, any adjustment for potential uncertain tax positions would need to exceed the return of capital.
We evaluated the potential impact of identified uncertain tax positions for all tax years still subject to potential audit under state and federal income tax law and concluded that our return of capital would not be materially affected for any of the years still subject to potential audit. As of December 31, 2010, the years still subject to audit are 2006 through 2010 under the California state income tax law and 2007 through 2010 under the federal income tax law. We concluded that we did not have any unrecognized tax benefits or any additional tax liabilities as of December 31, 2010 and 2009.
Concentration of Credit Risk
All of our operating and development properties are located in California with the exception of the operation of one property in the state of Washington. The ability of the tenants to honor the terms of their leases is dependent upon the economic, regulatory, and social factors affecting the communities in which the tenants operate.
As of December 31, 2010, our 15 largest tenants represented approximately 39.5% of total annualized base rental revenues.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
We have deposited cash with financial institutions that is insured by the Federal Deposit Insurance Corporation (“FDIC”) up to $250,000 per institution. As of December 31, 2010 and 2009, we had cash accounts in excess of FDIC insured limits.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported periods. Actual results could differ from those estimates.
Recent Accounting Pronouncements
In December 2010, the Financial Accounting Standards Board issued new guidance clarifying that the disclosure of supplementary proforma information for business combinations should be presented such that revenues and earnings of the combined entity are calculated as though the relevant business combinations that occurred during the current reporting period had occurred as of the beginning of the comparable prior annual reporting period. The guidance also improves the usefulness of the supplementary proforma information by requiring a description of the nature and amount of material, non-recurring proforma adjustments that are directly attributable to the business combinations. As permitted by the new guidance, we early adopted these provisions and applied them to the supplementary proforma disclosures for our acquisitions in Notes 26 and 27.
3.
Acquisitions
During the year ended December 31, 2010, we acquired the ten operating properties listed below from unrelated third parties. Unless otherwise noted, we funded these acquisitions principally with the net proceeds from the issuance of the 6.625% unsecured senior notes due in 2020 (see Note 7), 5.000% unsecured senior notes due in 2015 (see Note 7), the net proceeds from the Company’s public offering of common stock (see Note 10), and borrowings under the unsecured line of credit (see Note 7):
(1)
This property is a part of Mission City Corporate Center.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(2)
These properties are part of Mission City Corporate Center. We assumed secured debt with an outstanding principal balance of $52.0 million, net of an initial discount of $0.9 million, in connection with this acquisition (see Notes 2 and 7).
(3)
Excludes acquisition-related costs.
The related assets, liabilities, and results of operations of all acquired properties are included in the consolidated financial statements as of the date of acquisition. The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the respective acquisition dates:
(1)
The purchase of 303 Second Street, San Francisco, CA, and 100 First Street, San Francisco, CA, represent the two largest acquisitions and 61% of the total purchase price of the total acquisitions for the year ended December 31, 2010.
(2)
The purchase price of all other acquisitions completed during the year ended December 31, 2010 were individually less than 5%, and in aggregate less than 10%, of the Company’s total assets as of December 31, 2009.
(3)
Represents buildings and improvements and tenant improvements.
(4)
Represents in-place leases (approximately $31.7 million with a weighted average amortization period of 6.0 years), above-market leases (approximately $21.3 million with a weighted average period of 5.8 years), and unamortized leasing commissions (approximately $17.1 million with a weighted average amortization period of 4.5 years).
(5)
Represents unfunded tenant improvements and leasing commission obligations for in-place leases of which approximately $2.5 million was held in an escrow account as restricted cash at the date of acquisition. As of December 31, 2010, $6.4 million of obligations and $0.3 million of restricted cash remains included on our consolidated balance sheet.
(6)
Represents below-market leases (weighted average amortization period of 10.9 years).
(7)
Represents the mortgage debt assumed in connection with the acquisition of Mission City Corporate Center (see Note 7).
(8)
Reflects the purchase price net of assumed secured debt and other lease related obligations.
KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
4.
Deferred Leasing Costs and Acquisition-related Intangible Assets and Liabilities, net
The following table summarizes our deferred leasing costs, identified acquisition-related intangible assets (acquired value of leasing costs, above-market and in-place leases) and intangible liabilities (acquired value of below-market leases), net as of December 31, 2010 and 2009:
(1)
Included in deferred leasing costs and acquisition-related intangible assets net on the consolidated balance sheets.
(2)
Included in deferred revenue and acquisition-related intangible liabilities, net in the consolidated balance sheets (see Note 8).
The following table sets forth amortization for the period related to acquisition-related intangibles for the years ended December 31, 2010, 2009 and 2008:
(1)
Recorded to depreciation and amortization expense in the consolidated statements of operations for the periods presented.
(2)
Net above-market leases are recorded as a decrease to rental income for the year ended December 31, 2010 and net below-market leases are recorded as an increase to rental income for the years ended December 31, 2009 and 2008 in the consolidated statements of operations.
KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The following table sets forth the estimated annual amortization expense related to acquisition-related intangibles as of December 31, 2010 for future periods:
(1)
Represents estimated annual net amortization related to above / (below)-market leases. Amounts shown for 2011-2015 represent net above market leases which will be recorded as a decrease to rental income in the consolidated statement of operations, and amounts shown for the periods thereafter represent net below-market leases which will be recorded as increases to rental income in the consolidated statement of operations.
5.
Receivables
Current Receivables, net
Current receivables, net is primarily comprised of contractual rents and other lease-related obligations due from tenants. The balance consisted of the following as of December 31, 2010 and 2009:
Deferred Rent Receivables, net
Deferred rent receivables, net consisted of the following as of December 31, 2010 and 2009:
Note Receivable
In July 2010, we received $10.6 million in cash for the full repayment of the outstanding note receivable.
6.
Secured and Unsecured Debt of the Company
In this Note 6, the Company refers solely to Kilroy Realty Corporation and not to any of our subsidiaries. The Company itself does not hold any indebtedness. All of our secured and unsecured debt is held directly by the Operating Partnership.
KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The Company generally guarantees all the Operating Partnership’s unsecured debt obligations including the unsecured line of credit (the “Credit Facility”), the 6.625% unsecured senior notes due 2020, the 5.00% unsecured senior notes due 2015, the 6.45% unsecured senior notes due 2014, and the Exchangeable Notes. As of December 31, 2010 and 2009, the Operating Partnership had $1.1 billion and $0.7 billion, respectively, outstanding in total under these unsecured debt obligations.
In addition, although the remaining $0.3 billion of the Operating Partnership’s debt for both years is secured and non-recourse to the Company, the Company provides limited customary secured debt guarantees for items such as voluntary bankruptcy, fraud, misapplication of payments, and environmental liabilities.
The Company and the Operating Partnership are both named parties to the capped call option transactions discussed further in Note 7.
Debt Covenants and Restrictions
One of the covenants contained within the $500 million Credit Facility as discussed further below in Note 7) prohibits the Company from paying dividends in excess of 95% of funds from operations (“FFO”).
7. Secured and Unsecured Debt of the Operating Partnership
Secured Debt
The following table sets forth the composition our secured debt as of December 31, 2010 and 2009:
(1)
In June 2010, we assumed a mortgage note with an outstanding principal balance of $52.0 million in conjunction with the acquisition of Mission City Corporate Center in San Diego, CA. This secured debt was recorded at fair value on date of the acquisition resulting in a discount of approximately $0.9 million of which $0.3 million was amortized in 2010 (see Note 3). The mortgage note and the three properties that secure the mortgage note are held in a bankruptcy remote special purpose entity and are not available to satisfy the debts and other obligations of the Company or the Operating Partnership.
(2)
The variable interest rate stated as of December 31, 2009 is based on LIBOR at the last repricing date in 2009.
(3)
The public facility bonds (the “Bonds”), the proceeds from which were used to finance infrastructure improvements on one of the Company’s undeveloped land parcels, were issued in February 2008 by the City of Carlsbad. The Bonds have annual maturities from September 1, 2011 through September 1, 2038, with interest rates ranging from 4.40% to 6.20%. Principal and interest payments for the Bonds will be charged through the assessment of special property taxes.
The Operating Partnership’s secured debt was collateralized by 29 operating properties as of December 31, 2010 with a combined net book value of $389 million and 47 operating properties at December 31, 2009 with a combined net book value of $397 million. Of the 29 operating properties collateralized at December 31, 2010, three
KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
properties are held separately in a bankruptcy remote special purpose entity for the $51.4 million mortgage debt and are not available to satisfy the debts and other obligations of the Company or the Operating Partnership.
As of December 31, 2010, six of the Operating Partnership’s seven secured loans contained restrictions that would require the payment of prepayment penalties for the acceleration of outstanding debt. The mortgage notes payable are secured by deeds of trust on certain of our properties and the assignment of certain rents and leases associated with those properties. The Bonds are secured by property tax payments.
Exchangeable Senior Notes
The following table summarizes the balance and significant terms of the Exchangeable Notes outstanding as of December 31, 2010 and 2009:
(1)
Interest on the 3.25% Exchangeable Notes is payable semi-annually in arrears on April 15th and October 15th of each year.
(2)
Interest on the 4.25% Exchangeable Notes is payable semi-annually in arrears on May 15th and November 15th of each year.
(3)
The rate at which we record interest expense for financial reporting purposes, which reflects the amortization of the discount on the Exchangeable Notes (see Note 2). This rate represents our conventional debt borrowing rate at the date of issuance.
(4)
The exchange rate, exchange price, and the number of shares to be delivered upon conversion are subject to adjustment under certain circumstances including increases in our common dividends.
The Exchangeable Notes are exchangeable for shares of the Company’s common stock prior to maturity only upon the occurrence of certain events as follows: (i) during any calendar quarter, if the closing sale price per share of the common stock of the Company is more than 130% of the exchange price per share of the Company’s common stock for at least 20 trading days in a specified period, (ii) during the five consecutive trading-day period following any five consecutive trading days in which the trading price per $1,000 principal amount of the Exchangeable Notes was less than 98% of the product of the closing sale price per share of the Company’s common stock multiplied by the applicable exchange rate, (iii) if the Exchangeable Notes have been called for redemption, (iv) upon the occurrence of specified corporate transactions, (v) if the Company’s common stock ceases to be listed or approved for quotation for 30 consecutive trading days, or (vi) on or after November 15, 2011 or on or after August 15, 2014 for the 3.25% Exchangeable Notes and 4.25% Exchangeable Notes, respectively.
Upon exchange, the holders of the Exchangeable Notes will receive (i) cash up to the principal amount of the Exchangeable Notes and (ii) to the extent the exchange value exceeds the principal amount of the Exchangeable Notes, shares of the Company’s common stock. At any time prior to November 15, 2011 or August 15, 2014 for the 3.25% Exchangeable Notes and 4.25% Exchangeable Notes, respectively, the Operating Partnership may irrevocably elect, in its sole discretion without the consent of the holders of the Exchangeable Notes, to settle all of the future exchange obligations of the Exchangeable Notes in shares of common stock. Any shares of common stock delivered for settlement will be based on a daily exchange value calculated on a proportionate basis for each
KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
day of a 50 trading-day observation period or a 30 trading-day observation period for the 3.25% Exchangeable Notes and 4.25% Exchangeable Notes, respectively. The average trading price of the Company’s common stock on the NYSE for the years ended December 31, 2010 and 2009 was below the exchange price of the Exchangeable Notes for these respective periods, thus, the Exchangeable Notes were not considered in the money for the purposes of our diluted and earnings per share calculations for the years ended December 31, 2010 and 2009 (see Notes 20 and 21).
Exchangeable Note Tender Offer and Note Repurchases
During the year ended December 31, 2010, we repurchased 3.25% Exchangeable Notes with an aggregate stated principal amount of $150.0 million for approximately $151.1 million in cash, including transaction costs, pursuant to a tender offer. As a result of the transaction, we recorded a net loss on early extinguishment of debt of approximately $4.6 million and charged approximately $2.7 million, representing the amount of the cash repurchase proceeds allocated to the equity component, to additional paid-in capital.
During the year ended December 31, 2009, we repurchased 3.25% Exchangeable Notes with an aggregate stated principal amount of $162.0 million for approximately $150.4 million in cash, including transaction costs. As a result of the transaction, we recorded a net gain on early extinguishment of debt of approximately $4.9 million and charged approximately $2.3 million, which represented the amount of the cash repurchase proceeds allocated to the equity component, to additional paid-in capital.
Interest Expense for the Exchangeable Notes
The unamortized discount on the Exchangeable Notes is accreted as additional interest expense from the date of issuance through the maturity date of the applicable Exchangeable Notes. The following table summarizes the total interest expense attributable to the Exchangeable Notes based on the effective interest rates set forth above, before the effect of capitalized interest, for the years ended December 31, 2010, 2009, and 2008:
Capped Call Transactions
In connection with the offerings of the Exchangeable Notes, we entered into capped call option transactions (“capped calls”) to mitigate the dilutive impact of the potential conversion of the Exchangeable Notes. The capped calls, as amended, are separate transactions entered into by us with the relevant financial institutions, are not part of the terms of the Exchangeable Notes, and do not affect the holders’ rights under the Exchangeable Notes. The strike prices of the capped calls, which are subject to customary anti-dilution adjustments, correspond to the exchange prices of the applicable Exchangeable Notes. The following table summarizes our capped call option positions as of December 31, 2010 and December 31, 2009:
KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(1)
The capped calls mitigate the dilutive impact to us of the potential exchange of two-thirds of the 3.25% Exchangeable Notes into shares of common stock.
(2)
The capped calls mitigate the dilutive impact to us of the potential exchange of all of the 4.25% Exchangeable Notes into shares of common stock.
(3)
Subsequent to the repurchase of $150.0 million of aggregate stated principal of the 3.25% Exchangeable Notes, we had the above referenced outstanding capped calls.
(4)
Subsequent to the repurchase of $162.0 million of aggregate stated principal of the 3.25% Exchangeable Notes, we had the above referenced outstanding capped calls.
The capped calls are expected to terminate upon the earlier of the maturity date of the related Exchangeable Notes or upon the date upon which the Exchangeable Notes are no longer outstanding resulting from an exchange or repurchase by us. The initial cost of capped calls were recorded as a reduction to additional paid-in capital.
Unsecured Senior Notes
The following table summarizes the balance and significant terms of the unsecured senior notes issued by the Operating Partnership in 2010 as of December 31, 2010:
(1)
The 6.625% unsecured senior notes were initially issued in a private placement transaction. In November 2010 we completed an exchange offer of the private unsecured notes for fully registered unsecured notes. The terms of the registered unsecured senior notes were substantially identical to the outstanding private unsecured senior notes, except for transfer restrictions and registration rights relating to the outstanding private unsecured senior notes. We did not receive any additional proceeds as a result of the exchange offer.
(2)
The 6.625% unsecured senior notes had an original issuance discount of $2.1 million that is being amortized through the maturity date of the notes.
(3)
Interest on the 6.625% unsecured senior notes is payable semi-annually in arrears on June 1st and December 1st of each year.
(4)
The 5.000% unsecured senior notes were issued in a registered public offering.
(5)
The 5.000% unsecured senior notes had an original issuance discount of $0.2 million that is being amortized through the maturity date of the notes.
(6)
Interest on the 5.000% unsecured senior notes is payable semi-annually in arrears on May 3rd and
November 3rd of
each year.
(7)
Effective interest rate includes impact of the amortization of the original issuance discounts.
We used the net proceeds from the two 2010 unsecured senior note offerings to fund operating property acquisitions and to repurchase $150.0 million in aggregate principal balance of the 3.25% Exchangeable Notes.
In addition to the two new unsecured note issuances above, as of December 31, 2010 and 2009 we also had outstanding Series B unsecured senior notes with an aggregate principal balance of $83.0 million that mature in August 2014. The series B notes require semi-annual interest payment each February and August based on a fixed annual interest rate of 6.45%. As of December 31, 2009 we also had outstanding Series A unsecured senior notes with an aggregate principal balance of $61.0 million and an interest rate of 5.72%. In August 2010, we used borrowings under our prior $550.0 million unsecured line of credit (the “Prior Credit Facility”) to repay the Series A unsecured senior notes upon maturity.
Unsecured Line of Credit
In August 2010, we entered into a $500.0 million Credit Facility and used borrowings under the Credit Facility to repay, and then terminate, the Prior Credit Facility. The Credit Facility has a term of three years plus a one year extension at our option and bears interest at an annual rate of LIBOR plus 2.675%. We may elect to borrow up to an
KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
additional $200.0 million under an accordion option, subject to bank approval. We expect to use borrowings under the Credit Facility for general corporate purposes, to fund acquisitions, to finance development and redevelopment expenditures, and potentially to repay long-term debt. The following table summarizes the balance and significant terms of the Credit Facility and Prior Credit Facility as of December 31, 2010 and December 31, 2009, respectively:
(1)
We may elect to borrow, subject to bank approval, up to an additional $200 million under an accordion feature under the terms of the Credit Facility.
(2)
Under the terms of the Credit Facility, we may exercise an option to extend the maturity date by one year.
(3)
In April 2010, we exercised an option to extend the maturity date of the Prior Credit Facility by one year.
(4)
As of December 31, 2010, the Credit Facility bore interest at an annual rate of LIBOR plus 2.675%. As of December 31, 2009, the Prior Credit Facility bore interest at an annual rate of LIBOR plus 0.85% to 1.35% depending upon our leverage ratio at the time of borrowing.
(5)
As of December 31, 2010, the facility fee for the Credit Facility was at an annual rate of 0.575%. In addition, we also incurred debt origination and legal costs of approximately $5 million in connection with the Credit Facility, which will be amortized as additional interest expense through the contractual maturity date. As of December 31, 2009, the fee for unused funds for the Prior Credit Facility was at an annual rate of 0.15% to 0.20%, depending on the balance of our daily average undrawn balance.
Debt Covenants and Restrictions
The Credit Facility, the unsecured senior notes, and certain other secured debt arrangements contain covenants and restrictions requiring us to meet certain financial ratios and reporting requirements. Some of the more restrictive financial covenants include a maximum ratio of total debt to total asset value, a minimum fixed charge coverage ratio, a minimum unsecured debt ratio, a minimum unencumbered asset pool debt service coverage ratio, and a minimum unencumbered debt yield. Noncompliance with one or more of the covenants and restrictions could result in the full or partial principal balance of the associated debt becoming immediately due and payable. We believe we were in compliance with all of our debt covenants as of December 31, 2010 and December 31, 2009.
Debt Maturities
The following table summarizes the stated debt maturities and scheduled amortization payments, excluding debt discounts, as of December 31, 2010:
(1)
Includes full principal balance of outstanding debt before impact of all debt discounts.
KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Capitalized Interest and Loan Fees
The following table sets forth our gross interest expense, including debt discount and loan cost amortization, net of capitalized interest for the years ended December 31, 2010, 2009 and 2008. The capitalized amounts are a cost of development and increase the carrying value of undeveloped land and construction in progress.
8.
Deferred Revenue and Acquisition Related Liabilities, net
Deferred revenue and acquisition-related liabilities, net consisted of the following at December 31, 2010 and 2009:
(1)
See Note 4 for additional information.
Deferred Revenue Related to Tenant-funded Tenant Improvements
During the years ended December 31, 2010, 2009, and 2008, $9.7 million, $9.8 million, and $11.3 million, respectively, of deferred revenue related to tenant-funded tenant improvements was amortized and recognized as rental income. The following is the estimated amortization of deferred revenue related to tenant-funded tenant improvements as of December 31, 2010 for the next five years and thereafter:
9.
Noncontrolling Interests on the Company’s Consolidated Financial Statements
Series A Preferred Units of the Operating Partnership
As of both December 31, 2010 and 2009, the Operating Partnership had issued and outstanding 1,500,000 Series A Preferred Units representing preferred limited partnership interests in the Operating Partnership with a redemption value of $50.00 per unit. There were no changes in this noncontrolling interest for all years presented. The Series A Preferred Units have a right of redemption at the option of the holders in the event of certain change of
KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
control events, certain repurchases of the Company’s publicly registered equity securities, an involuntary delisting of the Company’s common stock from the NYSE, or a loss of the our REIT status.
Distributions on the Series A Preferred Units accrue at an annual rate of 7.45%. The Series A Preferred Units, which may be called by the Operating Partnership at a price equal to the liquidation value, have no stated maturity or mandatory redemption and are not convertible into any other securities of the Operating Partnership. The Series A Preferred Units are exchangeable at the option of the majority of the holders for shares of the Company’s 7.45% Series A Cumulative Redeemable Preferred stock (“Series A Preferred Stock”) under certain circumstances:
(i) if distributions on the series have not been timely made for any six prior quarters, or the Operating Partnership is likely to become a publicly traded partnership for federal income tax purposes;
(ii) if the Series A Preferred Units would not be considered “stock and securities” for federal income tax purposes; and
(iii) at any time following September 30, 2015.
In addition, the Series A Preferred Units may also be exchanged for shares of Series A Preferred Stock of the Company if either the Operating Partnership or the initial holder of the Series A Preferred Units believe, based upon the opinion of counsel, that the character of Operating Partnership’s assets and income would not allow it to qualify as a REIT if it were a corporation. In lieu of exchanging Series A Preferred Units for Series A Preferred Stock, we may elect to redeem all or a portion of the Series A Preferred Units for cash in an amount equal to $50.00 per unit plus accrued and unpaid distributions. The Series A Preferred Units may only be exchanged in whole, but not in part, and each exchange is subject to the REIT ownership limits contained in the Operating Partnership’s charter.
The Operating Partnership makes quarterly distributions to the preferred unitholders each February, May, August, and November. As of December 31, 2010 and 2009, the accrued distribution payable to holders of Series A Preferred Units, which is included in Series A Preferred Units noncontrolling interest on the balance sheet, was $0.7 million.
Common Units of the Operating Partnership
The Company owned a 96.8% and 96.2% common general partnership interest in the Operating Partnership as of December 31, 2010 and 2009, respectively. The remaining 3.2% and 3.8% common limited partnership interest as of December 31, 2010 and 2009, respectively, was owned by non-affiliate investors and certain of our executive officers and directors in the form of noncontrolling common units. There were 1,723,131 noncontrolling common units outstanding as of December 31, 2010 and 2009.
The noncontrolling common units may be redeemed by unitholders for cash. We, at our option, may satisfy the cash redemption obligation with shares of the Company’s common stock on a one-for-one basis. Whether satisfied in cash or shares of the Company’s common stock, the value for each noncontrolling common unit upon redemption is the amount equal to the average of the closing quoted price per share of the Company’s common stock, par value $.01 per share, as reported on the NYSE for the ten trading days immediately preceding the applicable balance sheet date. The aggregate value upon redemption of the then-outstanding noncontrolling common units was $61.4 million and $53.6 million as of December 31, 2010 and 2009, respectively. This redemption value does not necessarily represent the amount that would be distributed with respect to each noncontrolling common unit in the event of a termination or liquidation of the Company and the Operating Partnership. In the event of a termination or liquidation of the Company and the Operating Partnership, it is expected in most cases that each noncontrolling common unit would be entitled to a liquidating distribution equal to the amount payable with respect to each share of the Company’s common stock.
KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
10.
Stockholders’ Equity of the Company
Preferred Stock
As of December 31, 2010 and 2009, the Company had 1,610,000 shares of its 7.80% Series E Cumulative Redeemable Preferred Stock (“Series E Preferred Stock”) and 3,450,000 shares of its 7.50% Series F Cumulative Redeemable Preferred Stock (“Series F Preferred Stock”) issued and outstanding. The Series E Preferred Stock and the Series F Preferred Stock each have a liquidation preference of $25.00 per share and may be redeemed at our option. Dividends on both the Series E Preferred Stock and Series F Preferred Stock are cumulative and are payable quarterly in arrears on the 15th day of each February, May, August, and November. Neither the Series E Preferred Stock nor the Series F Preferred Stock has a stated maturity and neither is subject to mandatory redemption or any sinking fund.
Issuance of Common Stock
In April 2010, the Company completed an underwritten public offering of 9,200,000 shares of its common stock. The net offering proceeds, after deducting underwriting discounts and commissions and offering expenses, were approximately $299.8 million. We used a portion of the net proceeds from the offering to fund acquisitions, repay borrowings on the Prior Credit Facility, and for general corporate purposes.
In June 2009, the Company completed an underwritten public offering of 10,062,500 shares of its common stock. The net offering proceeds, after deducting underwriting discounts, commissions, and offering expenses, were approximately $191.7 million. The Company used the net proceeds from the offering to repay a portion of the borrowings under the Prior Credit Facility and for other general corporate purposes.
Exchange of Noncontrolling Common Units of the Operating Partnership
During the years ended December 31, 2009 and 2008, 30,598, and 435,596 noncontrolling common units were redeemed for shares of the Company’s common stock on a one-for-one basis, respectively. No noncontrolling common units were exchanged during the year ended December 31, 2010. Neither the Company nor the Operating Partnership received any proceeds from the issuance of the common stock to the noncontrolling common unitholders.
Dividend Reinvestment and Direct Purchase Plan
The Company has a Dividend Reinvestment and Direct Purchase Plan (the “DRIP Plan”) 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. The DRIP Plan provides existing common stockholders and other investors the opportunity to purchase additional shares of the Company’s common stock by reinvesting cash dividends or making optional cash purchases within specified parameters. The DRIP Plan acquires shares of the Company’s common stock from either new issuances directly from the Company, from the open market, or from privately negotiated transactions. As of December 31, 2010, no shares had been acquired under the DRIP Plan from new issuances.
Share Repurchases
An aggregate of 988,025 shares currently remain eligible for repurchase under a share-repurchase program approved by the Company’s board of directors in prior periods. The Company did not repurchase shares of common stock under this program during the years ended December 31, 2010 or 2009. During the year ended December 31, 2008, the Company repurchased 239,475 shares of its common stock in open market transactions for an aggregate price of approximately $11.5 million or $48.23 per share.
KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Accrued Dividends and Distributions
The following tables summarize accrued dividends and distributions for the noted outstanding shares of common stock, preferred stock, and noncontrolling units as of December 31, 2010 and 2009:
(1)
The amount includes the value of the dividend equivalents that will be paid with additional fully-vested RSUs (see Note 12).
(1)
The amount includes nonvested shares.
11.
Preferred and Common Units in the Operating Partnership’s Consolidated Financial Statements
Series A Preferred Units of the Operating Partnership
For a discussion of the Series A Preferred Units of the Operating Partnership including terms, redemption rights, distribution right and exchange rights, please see Note 9.
Series E Preferred Units and Series F Preferred Units
As of December 31, 2010 and 2009, the Operating Partnership had issued and outstanding 1,610,000 Series E Preferred Units and 3,450,000 Series F Preferred Units representing preferred limited partnership interests in the Operating Partnership. The Company is the sole holder of both the Series E Preferred Units and Series F Preferred Units and for each Series E and Series F Preferred Unit outstanding, the Company has an equivalent number of shares of Series E Preferred Stock and Series F Preferred Stock issued and outstanding. The terms of the Series E and Series F Preferred Units are identical to the terms of the Series E and Series F Preferred Stock discussed in Note 10. Dividends for the Series E and Series F Preferred Units are paid to the Company. The Company then uses these funds to pay dividends to the holders of its Series E Preferred Stock and Series F Preferred Stock.
Issuance of Common Units
In April 2010, the Company completed an underwritten public offering of 9,200,000 shares of the its common stock as discussed in Note 10. The net offering proceeds of approximately $299.8 million were contributed by the Company to the Operating Partnership in exchange for 9,200,000 common units.
KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
In June 2009, the Company completed an underwritten public offering of 10,062,500 shares of its common stock as discussed in Note 10. The net offering proceeds of approximately $191.7 million were contributed by the Company to the Operating Partnership in exchange for 10,062,500 common units.
Common Units Outstanding
The Company owned 52,349,670 and 43,148,762 common units representing a 96.8% and 96.2% common general partnership interest in the Operating Partnership as of December 31, 2010 and 2009, respectively. The remaining 1,723,131 common units outstanding, representing a 3.2% and 3.8% common limited partnership interest as of December 31, 2010 and 2009, respectively, was owned by non-affiliate investors and certain of our executive officers and directors in the form of noncontrolling common units. For a further discussion of the noncontrolling common units, including exchanges during the years ended December 31, 2010 and 2009, please refer to Notes 9 and 10.
Accrued Distributions
The following tables summarize accrued distributions for the noted common and preferred units as of December 31, 2010 and 2009:
(1)
The amount includes the value of the dividend equivalents that will be paid with additional fully-vested RSUs (see Note 12).
12.
Share-Based Compensation
Stockholder Approved Equity Compensation Plans
We establish share-based incentive compensation plans for the purpose of attracting and retaining officers, key employees, and non-employee board members. As of December 31, 2010, we had one share-based incentive compensation plan, the Kilroy Realty 2006 Incentive Award Plan as amended (the “2006 Plan”), which was adopted by our board of directors and approved by our stockholders.
In May 2009, our stockholders approved the third amendment to the 2006 Plan. The amendment increased the number of shares of common stock authorized under the 2006 Plan by 1,595,000 shares.
KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
In May 2010, our stockholders approved the fourth amendment to the 2006 Plan. The amendment increased the number of shares of common stock authorized under the 2006 Plan by 2,990,000 shares such that the total aggregate number of shares available for issuance pursuant to the 2006 Plan was 6,120,000 shares as of December 31, 2010. Both amendments also made certain changes regarding how awards are counted prospectively against the number of shares available for issuance under the 2006 Plan.
As of December 31, 2010, 4,375,533 shares were available for grant under the 2006 Plan. The number of shares that remains available for grant is calculated using the weighted share counting provisions set forth in the 2006 Plan, which are based on the type of awards that are granted. The maximum number of shares available for grant subject to full value awards (which generally include equity awards other than options and stock appreciation rights) was 1,498,470 shares as of December 31, 2010.
The Executive Compensation Committee, which is comprised of four independent directors, may grant the following share-based awards as provided under the 2006 Plan: incentive stock options, nonqualified stock options, restricted stock (nonvested shares), stock appreciation rights, performance shares, performance stock units, dividend equivalents, stock payments, deferred stock, RSUs, profit interest units, performance bonus awards, performance-based awards, and other incentive awards to eligible individuals. For each award granted under our share-based incentive compensation programs, the Operating Partnership simultaneously issues to the Company a number of common units equal to the number of shares of common stock ultimately paid by the Company in respect of such awards.
All of our outstanding share-based awards issued prior to 2007 were issued under the 1997 Stock Option and Incentive Plan (the “1997 Plan”), which was terminated by our board of directors in September 2006. Any awards that were outstanding upon the termination of the 1997 Plan continued in effect in accordance with the terms of such plan and the applicable award agreement following termination of the 1997 Plan.
Stock Award Deferral Program
We have a Stock Award Deferral Program (the “RSU Program”) under the 2006 Plan, which has been effective since the fourth quarter of 2007. Under the RSU Program, participants may defer receipt of awards of nonvested shares that may be granted by electing to receive an equivalent number of RSUs in lieu of nonvested shares. Each RSU represents the right to receive one share of our common stock in the future and is subject to the same vesting conditions that would have applied if the award had been issued in nonvested shares. RSUs carry with them the right to receive dividend equivalents such that participants receive additional, fully-vested RSUs at the time dividends are paid equal to the value of the dividend paid on the shares underlying participant’s RSUs. Shares issued in settlement of vested RSUs will be distributed in a single lump sum distribution upon the earlier of (1) the date specified by the participant when the election is made, which must be later than the final vesting date of the RSUs, or (2) upon other certain events specified under the RSU program.
Share-Based Compensation Programs
The Executive Compensation Committee has historically awarded nonvested shares and RSUs under the following share-based compensation programs. These share-based awards were valued based on the quoted closing share price of the Company’s common stock on the NYSE on the grant date. Dividends are paid on all outstanding shares and RSUs whether vested or nonvested and are not forfeitable if the underlying shares or RSUs ultimately do not vest.
Executive Officer Share-Based Compensation Programs
The Executive Compensation Committee has annually approved compensation programs that include the potential issuance of share-based awards to our Chief Executive Officer, Chief Operating Officer, and Chief Financial Officer (“the Executive Officers”) as part of their annual and long-term incentive compensation.
KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Historically, the number of nonvested shares or nonvested RSUs issued has been contingent upon certain corporate performance and market conditions. The share-based awards are generally issued in the first quarter after the end of the performance period, which is the same as our fiscal year end. The share-based awards generally have a service vesting period, which has historically ranged from one to three years, depending on the type of award.
Key Employee Share-Based Compensation Program
The Executive Compensation Committee has historically awarded nonvested shares or nonvested RSUs to other key employees on an annual basis as part of their long-term incentive compensation. The share-based awards are generally issued in the first quarter, and the individual share awards vest in equal annual installments over the applicable service vesting period, which has historically ranged from two to five years.
Non-employee Board Members Share-Based Compensation Program
The Executive Compensation Committee awards nonvested shares or nonvested RSUs to non-employee board members on an annual basis as part of the board members’ annual compensation and to newly elected board members in accordance with our board of directors compensation program. The share-based awards are generally issued in the second quarter, and the individual share awards vest in equal annual installments over the applicable service vesting period, which will be one year.
Summary of Nonvested Shares
A summary of our nonvested shares activity from January 1, 2010 through December 31, 2010 is presented below:
(1)
The total shares vested include 13,036 of shares that were then tendered to satisfy minimum statutory tax withholding requirements related to the restricted shares that have vested in accordance with the terms of the 2006 Plan. We accept the return of shares at the current quoted market price of the Company’s common stock to satisfy tax obligations.
A summary of our nonvested and vested shares activity for the years ended December 31, 2010, 2009, and 2008 is presented below:
(1)
Total fair value of shares vested was calculated based on the quoted closing share price of the Company’s common stock on the NYSE on the day of vesting.
(2)
In addition, during the year ended December 31, 2009, we issued 51,040 shares of common stock under a share-based compensation program that were fully vested upon issuance. The grant date fair value per share of this award was $26.94.
KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Summary of Restricted Stock Units
A summary of our RSU activity from January 1, 2010 through December 31, 2010 is presented below:
(1)
On July 1, 2010, certain vested RSUs were settled in shares of the Company’s common stock given that this date was six months plus one day subsequent to one individual’s separation from service from the Company. For certain individuals without an elected distribution date greater than six months beyond separation from service, RSUs are automatically settled in common shares six months plus one day subsequent to separation from service to comply with tax code requirements. Of the total 97,593 RSUs held by this individual, 53,451 were settled for shares of the Company’s common stock and 44,142 RSUs were canceled to cover the statutory minimum tax withholding.
(2)
RSUs issued as dividend equivalents are vested upon issuance.
(3)
We accept the return of RSUs, at the current quoted market price of the Company’s common stock, to satisfy minimum statutory tax-withholding requirements related to either RSUs that have vested or RSU dividend equivalents in accordance with the terms of the 2006 Plan.
A summary of our RSU activity for the years ended December 31, 2010, 2009, and 2008 is presented below:
(1)
Total fair value of RSUs vested was calculated based on the quoted closing share price of the Company’s common stock on the NYSE on the day of vesting.
Compensation Cost Recorded During the Period
The total compensation cost for all share-based compensation programs was $7.4 million, $13.3 million, and $16.3 million for the years ended December 31, 2010, 2009, and 2008, respectively. Included in the total $7.4 million of compensation cost for the year ended December 31, 2010 was the reversal of approximately $1.0 million of cumulative compensation expense previously recorded during the years 2007 through 2010 for the 2007 Development Performance Plan, since the performance targets for this program were not ultimately achieved. Of the total share-based compensation cost, $1.4 million, $1.1 million, and $1.1 million was capitalized as part of real estate assets for the years ended December 31, 2010, 2009, and 2008, respectively. As of December 31, 2010, there was approximately $4.8 million of total unrecognized compensation cost related to nonvested incentive awards granted under share-based compensation arrangements that is expected to be recognized over a weighted-average period of 1.5 years. The remaining compensation cost related to these nonvested incentive awards had been recognized in periods prior to December 31, 2010.
The $4.8 million of unrecognized compensation cost does not reflect the potential future compensation cost for the approved executive officer share-based compensation programs under which share-based awards have not yet
KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
been granted as of December 31, 2010. These programs have a performance period that precedes the grant date. We recorded approximately $1.6 million related to these programs for the year ended December 31, 2010, which is included in the total $7.4 million compensation cost discussed above.
13.
Employee Benefit Plans
401(k) Plan
We have a retirement savings plan designed to qualify under Section 401(k) of the Code (the “401(k) Plan”). Our employees are eligible to participate in the 401(k) Plan on the first day of the month after three months of service. The 401(k) Plan allows eligible employees (“401(k) Participants”) to defer up to 60% of their eligible compensation on a pre-tax basis, subject to certain maximum amounts allowed by the Code. The 401(k) Plan provides for a matching contribution by the Company in an amount equal to fifty cents for each one dollar of participant contributions up to a maximum of 10% of the 401 (k) Participant’s annual salary. 401(k) Participants vest immediately in the amounts contributed by us. For each of the years ended December 31, 2010, 2009, and 2008, we contributed $0.5 million to the 401(k) Plan.
Deferred Compensation Plan
In 2007, we adopted the Deferred Compensation Plan, under which directors and certain management employees may defer receipt of their compensation, including up to 70% of their salaries and up to 100% of their director fees and bonuses, as applicable. In addition, employee participants will receive mandatory Company contributions to their Deferred Compensation Plan accounts equal to 10% of their gross monthly salaries, without regard to whether such employees elect to defer salary or bonus compensation under the Deferred Compensation Plan. Our board of directors may, but has no obligation to, approve additional discretionary contributions by the Company to Participant accounts. We hold the Deferred Compensation Plan assets in a limited rabbi trust, which is subject to the claims of our creditors in the event of bankruptcy or insolvency.
See Note 16 for further discussion of our Deferred Compensation Plan assets and related Deferred Compensation Plan liability as of December 31, 2010 and 2009. Our liability under the Deferred Compensation Plan was fully funded as of December 31, 2010 and 2009.
14.
Future Minimum Rent
We have operating leases with tenants that expire at various dates through 2027 and are either subject to scheduled fixed increases or adjustments in rent based on the Consumer Price Index. Generally, the leases grant tenants renewal options. Leases also provide for additional rents based on certain operating expenses. Future contractual minimum rent under operating leases as of December 31, 2010 for future periods is summarized as follows:
KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
15.
Commitments and Contingencies
General
As of December 31, 2010, we had commitments of approximately $65.2 million for contracts and executed leases directly related to our operating and redevelopment properties.
In the normal course of business, we are required to post construction bonds to guarantee our performance of government-mandated infrastructure improvements. As of December 31, 2010, we had outstanding construction bonds of $2.1 million.
Ground Leases
We have noncancellable ground lease obligations on Kilroy Airport Center Phases I, II, and III in Long Beach, California with a lease period expiring in July 2084. Rental rates are subject to adjustments every five years based on fair market value. During the third quarter of 2009, we exercised our option to terminate a ground lease at Kilroy Airport Center Phase IV in Long Beach. We had previously leased this land, which is adjacent to our Office Properties at Kilroy Airport Center, Long Beach, for potential future development opportunities.
The minimum commitment under our ground leases as of December 31, 2010 for five years and thereafter was as follows:
(1)
One of our ground lease obligations is subject to a fair market value adjustment every 5 years; however, the lease includes ground rent subprotection and infrastructure rent credits which currently limit our annual rental obligations to $1.0 million. The contractual obligations for that ground lease included above assumes the $1.0 million or annual lease rental obligation in effect as of December 31, 2010.
Litigation
We and our properties are subject to litigation arising in the ordinary course of business. To our knowledge, neither we nor any of our properties are presently subject to any litigation or threat of litigation which, if determined unfavorably to us, would have a material adverse effect on our cash flow, financial condition, or results of operations.
In the third quarter of 2010, we settled outstanding litigation related to certain premises at one of our properties that had been abandoned by its former occupants. In connection with this legal settlement, we received a $3.6 million cash payment in 2010. In addition, in January 2011 we also received a $1.0 million cash payment relating to this matter. As a result, during the year ended December 31, 2010, we reversed approximately $1.0 million of our allowance for bad debts which was previously recorded in prior periods for receivables related to the lease at this property.
Insurance
We maintain commercial general liability, auto liability, employers liability, umbrella/excess liability, special form property, difference in conditions including earthquake and flood, environmental, rental loss, and terrorism insurance covering all of our properties. Management believes the policy specifications and insured limits are
KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
appropriate given the relative risk of loss, the cost of the coverage, and industry practice. We do not carry insurance for generally uninsurable losses such as loss from governmental action, nuclear hazard, and war and military action. Some of our policies are subject to limitations of coverage, qualifications, terms, conditions, and involve large deductibles or co-payments. In addition, our earthquake insurance policies include substantial self-insurance portions.
Environmental Matters
We follow the policy of monitoring our properties for the presence of hazardous or toxic substances. While there can be no assurance that a material environmental liability does not exist, we are not currently aware of any environmental liability with respect to the properties that would have a material adverse effect on our financial condition, results of operations, and cash flow. Further, we are not aware of any environmental liability or any unasserted claim or assessment with respect to an environmental liability that we believe would require additional disclosure or the recording of a loss contingency.
16.
Fair Value Measurements and Disclosures
Assets and Liabilities Reported at Fair Value
The only assets and liabilities we record at fair value in our consolidated financial statements are the marketable securities and related deferred compensation plan liability related our the Deferred Compensation Plan (see Note 13). We recorded net gains of approximately $0.4 million for the years ended December 31, 2010 and 2009 and a net loss of approximately $1.0 million for the year ended December 31, 2008 related to the change in fair value of the marketable securities, which was reported in interest income and other investment gains (losses) in the consolidated statements of operations. We adjust the deferred compensation plan liability to fair value at the end of each accounting period based on the performance of the benchmark funds selected by each Participant and the impact of adjusting the liability is recorded as an increase or decrease to compensation cost. For each of the years ended December 31, 2010 and 2009, we recorded approximately $0.4 million of total compensation cost resulting from the increase in the fair value of benchmark funds. For the year ended December 31, 2008, we recorded a net reduction of approximately $1.0 million to compensation cost resulting from a decline in the fair value of the benchmark funds.
The following table sets forth the fair value of our marketable securities and related deferred compensation liability as of December 31, 2010 and 2009:
(1)
Based on quoted prices in active markets for identical securities.
(2)
The marketable securities are held in a limited rabbi trust.
(3)
The deferred compensation liability is reported on our consolidated balance sheets in accounts payable, accrued expenses, and other liabilities.
KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Financial Instruments Disclosed at Fair Value
The following table sets forth the carrying value and the fair value of our other financial assets and liabilities as of December 31, 2010 and 2009:
(1)
This note receivable was re-paid in full during 2010 (see Note 5).
(2)
In August 2010, we entered into a new $500.0 million Credit Facility and used the borrowing under the Credit Facility to repay, and then terminate the $550.0 million Prior Credit Facility (see Note 7).
17.
Other Significant Transactions or Events
General and administrative expenses for the year ended December 31, 2009 include a $7.0 million charge related to separation payments resulting from the resignation, for personal reasons, of our former Chief Financial Officer in December 2009.
Lease Terminations
In the second quarter of 2008, a tenant at one of our San Diego office properties notified us of its intent to cease its business operations and to not pay any future rental payments under its lease beyond June 2008. We held a $3.6 million letter of credit and a $0.3 million security deposit as credit support under the terms of the lease. At June 30, 2008, we increased our provision for bad debts by approximately $3.1 million to reserve for the portion of the deferred rent receivable balance related to the lease that we estimated would not be recoverable after the application of the letter of credit proceeds and security deposit. In July 2008, we entered into an agreement with the tenant to terminate the lease as of August 31, 2008. During the third quarter of 2008, we drew down the letter of credit and applied the $3.9 million letter of credit proceeds and security deposit to July and August rent and the outstanding deferred rent receivable and accounts receivable balances. During the year ended December 31, 2008, we also recognized approximately $2.7 million of noncash rental revenue, which was primarily a result of the acceleration of the amortization of the deferred revenue balance related to tenant-funded tenant improvements associated with this lease.
In July 2008, we entered into an agreement with a tenant at one of our San Diego office properties to early terminate one of its leases in 2008. The lease that was terminated encompassed approximately 90,000 rentable square feet of office space and was scheduled to expire in July 2014. The tenant had the option to early terminate this lease in 2010. The tenant vacated approximately 95% of the premises in the third quarter of 2008 and the remaining premises during the first quarter of 2009. We recognized a net lease termination fee, which is included in other property income, of approximately $0.1 million and $5.0 million during the years ended December 31, 2009 and 2008, respectively.
KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
18.
Segment Disclosure
Our reportable segments consist of the two types of commercial real estate properties for which our chief operating decision-makers internally evaluate operating performance and financial results: Office Properties and Industrial Properties. We also have certain corporate level activities including legal administration, accounting, finance, and management information systems, which are not considered separate operating segments.
We evaluate the performance of our 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, ground leases, and provisions for bad debts) and excludes other income and expenses such as interest expense, depreciation and amortization, acquisition related expenses and corporate general and administrative expenses. There is no intersegment activity.
The following tables reconcile the segment activity to consolidated net income for the years ended December 31, 2010, 2009, and 2008, and the consolidated assets, consolidated expenditures, and tenant improvements as of December 31, 2010 and 2009:
(1)
All operating revenues are comprised of amounts received from third-party tenants.
KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(1)
Includes land, buildings, and improvements, undeveloped land and construction in progress, current receivables, deferred rent receivable and deferred leasing costs, and acquisition-related intangible assets, all shown on a net basis.
KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(1)
Total consolidated acquisitions and capital expenditures are equal to the same amounts disclosed for total reportable segments.
(2)
Includes expenditures for building improvements, tenant improvements, and deferred leasing costs for our operating properties.
19.
Property Dispositions
The following table summarizes properties sold during the years ended December 31, 2010 and 2009. We did not sell any properties during the year ended December 31, 2008. We recorded a net gain on the disposition of discontinued operations of $0.9 million and $2.5 million, for the years ended December 31, 2010 and 2009 respectively, related to these dispositions.
The following table summarizes the total income from discontinued operations within the statement of operations by the reportable segments for the years ended December 31, 2010, 2009, and 2008:
KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
20.
Net Income Available to Common Stockholders Per Share of the Company
The following table reconciles the numerator and denominator of the basic and diluted per-share computations for the Company’s net income available to common stockholders for the years ended December 31, 2010, 2009, and 2008:
As of December 31, 2010, 2009, and 2008, the effect of the assumed exchange of the Exchangeable Notes was not included in the net income available to common stockholder per share calculation as it was antidilutive to income from continuing operations available to common stockholders since the average quoted trading price of the
KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Company’s common stock on the NYSE for the periods presented was below the Exchangeable Notes exchange prices.
21.
Net Income Available to Common Unitholders per Unit of the Operating Partnership
The following table reconciles the numerator and denominator in computing the Operating Partnership’s basic and diluted per-unit computations for net income available to common unitholders for the years ended December 31, 2010, 2009, and 2008:
As of December 31, 2010,2009, and 2008, the effect of the assumed exchange of the Exchangeable Notes was not included in the net income available to common unitholder per unit calculation as it was antidilutive to income from continuing operations available to common unitholders since the average quoted trading price of the Company’s common stock on the NYSE for the periods presented was below the Exchangeable Notes exchange prices.
KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
22.
Tax Treatment of Distributions
The following table reconciles the dividends declared per common share to the dividends paid per common share during the years ended December 31, 2010, 2009, and 2008 as follows:
The income tax treatment for the dividends to common stockholders reportable for the years ended December 31, 2010, 2009, and 2008 as identified in the table above was as follows:
(1)
Capital gains are comprised entirely of 15% rate gains.
The income tax treatment for the dividends to Series E preferred stockholders reportable for the years ended December 31, 2010, 2009, and 2008 was as follows:
(1)
Capital gains are comprised entirely of 15% rate gains.
The income tax treatment for the dividends to Series F preferred stockholders reportable for the years ended December 31, 2010, 2009, and 2008 was as follows:
(1)
Capital gains are comprised entirely of 15% rate gains.
KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
23.
Quarterly Financial Information of the Company (Unaudited)
Summarized quarterly financial data for the years ended December 31, 2010 and 2009 was as follows:
(1)
See Note 18 for definition of Net Operating Income.
(2)
The summation of the quarterly net income available to common stockholders per share (basic and diluted) does not equal the annual number reported on the consolidated statement of operations primarily resulting from the impact of the April 2010 and June 2009 equity offerings.
(3)
The summation of the quarterly financial data may not equal the annual number reported on the consolidated statement of operations resulting from rounding differences.
KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
24.
Quarterly Financial Information of the Operating Partnership (Unaudited)
Summarized quarterly financial data for the years ended December 31, 2010 and 2009 was as follows:
(1)
See Note 18 for definition of Net Operating Income.
(2)
The summation of the quarterly net income available to common unitholders per unit (basic and diluted) does not equal the annual number reported on the consolidated statement of operations primarily resulting from the impact of the April 2010 and June 2009 equity offerings.
(3)
The summation of the quarterly financial data may not equal the annual number reported on the consolidated statement of operations resulting from rounding differences.
25.
Subsequent Events
On January 18, 2011, aggregate dividends, distributions, and dividend equivalents of $19.2 million were paid to common stockholders, common unitholders, and RSU holders of record on December 31, 2010.
On January 26, 2011, the Executive Compensation Committee granted 66,208 shares of restricted stock and 97,597 RSUs to the Executive Officers and other key employees under the 2006 Plan.
In January 2011, we entered into a new secured mortgage loan with a principal balance of $135 million. The mortgage debt is scheduled to mature in February 2018. The mortgage debt, which bears contractual interest at a rate
KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
of 4.27%, requires interest only payments for the first two years with a 30-year amortization schedule thereafter, and is secured by our 303 Second Street property in San Francisco, California.
In January 2011, we completed the acquisition of a 91,000 rentable square foot office building in San Francisco, California for a purchase price of approximately $33.0 million.
26.
Pro Forma Results of the Company (Unaudited)
The following unaudited pro forma consolidated results of operations of the Company for the year ended December 31, 2010 and 2009 assumes that the acquisitions of 303 Second Street and 100 First Street, in San Francisco, California, were completed as of January 1, 2009. Pro forma data may not be indicative of the results that would have been reported had the acquisitions actually occurred as of January 1, 2009, nor does it intend to be a projection of future results.
(1)
The purchase of 303 Second Street and 100 First Street represent the two largest acquisitions and 61% of the total purchase price of the Company’s total acquisitions for the year ended December 31, 2010. The purchase price of all other acquisitions completed during the year ended December 31, 2010 were individually less than 5%, and in aggregate less than 10%, of the Company’s total assets as of December 31, 2009.
(2)
The pro forma earnings for the year ended December 31, 2010 were adjusted to exclude non-recurring, acquisition-related expenses of $0.8 million incurred in 2010 for 303 Second Street and 100 First Street. The pro forma data for the year ended December 31, 2009 were adjusted to include these charges.
The following table summarizes actual results for certain operating data, which is included and reported in our consolidated results, for the properties at 303 Second Street and 100 First Street, in San Francisco, California, from May 26, 2010 and November 10, 2010, the dates of acquisition, respectively, through December 31, 2010:
(1)
Reflects the net operating income less depreciation for these properties and amortization of lease related intangibles.
KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
27.
Pro Forma Results of the Operating Partnership (Unaudited)
The following unaudited pro forma consolidated results of operations of the Operating Partnership for the year ended December 31, 2010 and 2009 assumes that the acquisitions of 303 Second Street and 100 First Street, in San Francisco, California, were completed as of January 1, 2009. Pro forma data may not be indicative of the results that would have been reported had the acquisitions actually occurred as of January 1, 2009, nor does it intend to be a projection of future results.
(1)
The purchase of 303 Second Street and 100 First Street represent the two largest acquisitions and 61% of the total purchase price of the Company’s total acquisitions for the year ended December 31, 2010. The purchase price of all other acquisitions completed during the year ended December 31, 2010 were individually less than 5%, and in aggregate less than 10%, of the Company’s total assets as of December 31, 2009.
(2)
The pro forma earnings for the year ended December 31, 2010 were adjusted to exclude non-recurring, acquisition-related expenses of $0.8 million incurred in 2010 for 303 Second Street and 100 First Street. The pro forma data for the year ended December 31, 2009 were adjusted to include these charges.
The following table summarizes actual results for certain operating data, which is included and reported in our consolidated results, for the properties at 303 Second Street and 100 First Street, in San Francisco, California, from May 26, 2010 and November 10, 2010, the dates of acquisition, respectively, through December 31, 2010:
(1)
Reflects the net operating income less depreciation for these properties and amortization of lease related intangibles.
SCHEDULE II-Valuation And Qualifying Accounts
KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
SCHEDULE II-VALUATION AND QUALIFYING ACCOUNTS
Years ended December 31, 2010, 2009, and 2008
(in thousands)
SCHEDULE III-REAL ESTATE AND ACCUMULATED DEPRECIATION
KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
SCHEDULE III-REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31,
KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
SCHEDULE III-REAL ESTATE AND ACCUMULATED DEPRECIATION-(Continued)
December 31,
KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
SCHEDULE III-REAL ESTATE AND ACCUMULATED DEPRECIATION-(Continued)
December 31,
KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
SCHEDULE III-REAL ESTATE AND ACCUMULATED DEPRECIATION-(Continued)
December 31,
KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
SCHEDULE III-REAL ESTATE AND ACCUMULATED DEPRECIATION-(Continued)
December 31,
(1)
The initial costs of buildings are depreciated over 35 years using a straight-line method of accounting; improvements capitalized subsequent to acquisition are depreciated over the shorter of the lease term or useful life, generally ranging from one to 20 years.
(2)
Represents our date of construction or acquisition, or our predecessor, the Kilroy Group.
(3)
Includes square footage from our stabilized portfolio.
(4)
These costs represent infrastructure costs incurred in 1989. During the third quarter of 2009, we exercised our option to terminate the ground lease at Kilroy Airport Center, Phase IV in Long Beach, California. We had previously leased this land, which is adjacent to our Office Properties at Kilroy Airport Center, Long Beach, for potential future development opportunities.
(5)
Excludes 286,151 square feet in lease-up at December 31, 2010.
(6)
These properties secure a $15.2 million mortgage note.
(7)
These properties secure a $70.3 million mortgage note.
(8)
These properties secure a $73.0 million mortgage note.
(9)
This property secures a $30.4 million mortgage note.
(10)
These properties secure a $70.0 million mortgage note.
(11)
These properties secure a $52.0 million mortgage note.
(12)
We recently re-entitled this property to allow residential use; therefore the property is excluded from the stabilized portfolio. The property encompasses approximately 157,000 square feet.
(13)
Represents the principal balance of the public facility bonds (the “Bonds”), the proceeds from which were used to finance infrastructure improvements on one of our undeveloped land parcels. The Bonds are secured by property tax payments.
(14)
Includes initial cost of redevelopment building transferred to construction in progress during the year ended December 31, 2010.
(15)
Represents gross aggregate principal amount before the effect of the unamortized discount of approximately $0.6 million as of December 31, 2010.
The aggregate gross cost of property included above for federal income tax purposes approximated $2.9 billion as of December 31, 2010.
KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
SCHEDULE III-REAL ESTATE AND ACCUMULATED DEPRECIATION-(Continued)
December 31,
The following table reconciles the historical cost of total real estate held for investment from January 1, 2008 to December 31, 2010:
(1)
Related to the redevelopment property transferred to construction in progress during the year ended December 31, 2010.
The following table reconciles the accumulated depreciation from January 1, 2008 to December 31, 2010:
(1)
Related to the redevelopment property transferred to construction in progress during the year ended December 31, 2010.
EXHIBIT INDEX
Exhibit
Number
Description
.4*
Section 1350 Certification of Chief Financial Officer of Kilroy Realty, L.P.
.1
The following Kilroy Realty Corporation and Kilroy Realty, L.P. financial information for the year ended December 31, 2010, formatted in XBRL (extensible Business Reporting Language): (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Changes in Equity and (iv) Consolidated Statements of Cash Flows and (v) Notes to the Consolidated Financial Statements, tagged as blocks of text.(5)
*
Filed herewith

Management contract or compensatory plan or arrangement.
(1)
Previously filed by Kilroy Realty Corporation as an exhibit to the Registration Statement on Amendment No. 3 to Form S-11 (No. 333-15553).
(2)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 10-K for the year ended December 31, 2003.
(3)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 8-K as filed with the Securities and Exchange Commission on February 11, 1998.
(4)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 8-K/A as filed with the Securities and Exchange Commission on December 19, 1997.
(5)
Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934 and otherwise are not subject to liability under these sections.
(6)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 10-K for the year ended December 31, 2000.
(7)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 8-K as filed with the Securities and Exchange Commission on August 11, 2004.
(8)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 8-K as filed with the Securities and Exchange Commission on December 9, 2004.
(9)
Previously filed by Kilroy Realty Corporation as an exhibit to the Registration Statement on Amendment No. 2 to Form S-11 (No. 333-15553).
(10)
Previously filed by Kilroy Realty Corporation as an exhibit to the Registration Statement on Form S-ll (No. 333-15553).
(11)
Previously filed by Kilroy Realty Corporation as an exhibit to the Registration Statement on Amendment No. 5 to Form S-11 (No. 333-15553).
(12)
Previously filed by Kilroy Realty Corporation as an exhibit to the Registration Statement on Amendment No. 4 to Form S-11 (No. 333-15553).
(13)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 8-K as filed with the Securities and Exchange Commission on June 6, 1997.
(14)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 8-K as filed with the Securities and Exchange Commission on July 15, 1997.
(15)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 8-K as filed with the Securities and Exchange Commission on July 3, 1997.
(16)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 10-Q for the quarter ended September 30, 1997.
(17)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 8-K as filed with the Securities and Exchange Commission on November 21, 1997.
(18)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 8-K as filed with the Securities and Exchange Commission on December 29, 1997.
(19)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 10-Q for the quarter ended September 30, 1998.
(20)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 10-K for the year ended December 31, 2001.
(21)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 10-Q for the quarter ended March 31, 2004.
(22)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 8-K as filed with the Securities and Exchange Commission on October 28, 2004.
(23)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 10-Q for the quarter ended March 31, 2006.
(24)
Previously filed by Kilroy Realty Corporation as an exhibit to the Registration Statement on Form S-8 filed with the Securities and Exchange Commission on June 28, 2006.
(25)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 8-K as filed with the Securities and Exchange Commission on February 8, 2007.
(26)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 10-K for the year ended December 31, 2006.
(27)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 8-K as filed with the Securities and Exchange Commission on March 22, 2007.
(28)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 8-K as filed with the Securities and Exchange Commission on April 5, 2007.
(29)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 8-K as filed with the Securities and Exchange Commission on April 11, 2007.
(30)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 10-Q for the quarter ended March 31, 2007.
(31)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 8-K as filed with the Securities and Exchange Commission on December 12, 2008.
(32)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 10-Q for the quarter ended June 30, 2007.
(33)
Previously filed by Kilroy Realty Corporation as an exhibit to Form 8-K as filed with the Securities and Exchange Commission on January 2, 2008.
(34)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 10-Q for the quarter ended September 30, 2008.
(35)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 8-K as filed with the Securities and Exchange Commission on May 27, 2009.
(36)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 10-Q for the quarter ended June 30, 2009.
(37)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 8-K as filed with the Securities and Exchange Commission on July 23, 2009.
(38)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 8-K as filed with the Securities and Exchange Commission on July 5, 2005.
(39)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 8-K as filed with the Securities and Exchange Commission on November 25, 2009.
(40)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 10-K for the year ended December 31, 2008.
(41)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 10-K for the year ended December 31, 2009.
(42)
Previously filed by Kilroy Realty, L.P. as an exhibit to the General Form for Registration of Securities on Form 10 as filed with the Securities and Exchange Commission on August 18, 2010.
(43)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 8-K as filed with the Securities and Exchange Commission on May 25, 2010.
(44)
Previously filed by Kilroy Realty Corporation as an exhibit to the Registration Statement on Form S-8 as filed with the Securities and Exchange Commission on June 11, 2010.
(45)
Previously filed by Kilroy Realty Corporation and Kilroy Realty, L.P. as an exhibit on Form 8-K as filed with the Securities and Exchange Commission on November 4, 2010.
(46)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 8-K as filed with the Securities and Exchange Commission on May 27, 2010.
(47)
Previously filed by Kilroy Realty Corporation as an exhibit on Form 8-K as filed with the Securities and Exchange Commission on August 11, 2010.
(48)
Previously filed by Kilroy Realty Corporation and Kilroy Realty, L.P. as an exhibit on Form 8-K as filed with the Securities and Exchange Commission on January 13, 2011.