Kilroy Realty - 10-Q quarterly report FY

 

 

UNITED STATES

 

 

 

(Mark One)

 

 

 

 

 

 

 

 

 

 

 

 

 

        As of August 10, 2001, 27,306,914 shares of common stock, par value $.01 per share, were outstanding.

 

 

KILROY REALTY CORPORATION

 

 

 

 

PART I—FINANCIAL INFORMATION

 

 

 

 

 

See accompanying notes to consolidated financial statements.

 

KILROY REALTY CORPORATION

 

 

 

See accompanying notes to consolidated financial statements.

 

KILROY REALTY CORPORATION

 

 

 

See accompanying notes to consolidated financial statements.

 

KILROY REALTY CORPORATION

 

 

 

See accompanying notes to consolidated financial statements.

 

KILROY REALTY CORPORATION

 

 

 

 

        Kilroy Realty Corporation (the “Company”) develops, owns, and operates office and industrial real estate, primarily in Southern California. The Company operates as a self-administered real estate investment trust (“REIT”). As of June 30, 2001, the Company’s stabilized portfolio of operating properties consisted of 87 office buildings (the “Office Properties”) and 75 industrial buildings (the “Industrial Properties”), which encompassed an aggregate of approximately 7.2 million and 5.6 million rentable square feet, respectively, and was approximately 94.9% occupied. The Company’s stabilized portfolio of operating properties consists of all of the Company’s Office and Industrial Properties excluding properties recently developed by the Company that have not yet reached 95.0% occupancy (“lease-up” properties) and projects currently under construction or in pre-development. As of June 30, 2001, the Company had five office properties encompassing an aggregate of approximately 357,600 rentable square feet which were in the lease-up phase. Lease-up properties are included in land and improvements and building and improvements on the consolidated balance sheets upon building shell completion. In addition, as of June 30, 2001, the Company had six office properties under construction or committed for construction which when completed are expected to encompass an aggregate of approximately 617,700 rentable square feet.

 

        The Company owns its interests in all of its properties through Kilroy Realty, L.P. (the “Operating Partnership”) and Kilroy Realty Finance Partnership, L.P. (the “Finance Partnership”) and conducts substantially all of its operations through the Operating Partnership. The Company owned an 89.9% general partnership interest in the Operating Partnership as of June 30, 2001. The Operating Partnership owns a 50% interest in two limited liability companies (the “Development LLCs”) which were formed to develop two multi-phased office projects in San Diego, California. The Allen Group, a group of affiliated real estate development and investment companies based in San Diego, California, is the other 50% member of the Development LLC’s. The Development LLCs are consolidated for financial reporting purposes since the Company controls all significant development and operating decisions.

 

        On January 1, 2001, Kilroy Services, Inc. (“KSI”) was merged into a newly formed entity, Kilroy Services, LLC (“KSLLC”). The Company historically accounted for the operating results of the development services business conducted by KSI under the equity method of accounting. Prior to the merger, John B. Kilroy, Sr., the Chairman of the Company’s Board of Directors, and John B. Kilroy, Jr., the Company’s President and Chief Executive Officer, owned 100% of the voting interest of KSI and the Operating Partnership owned 100% of the non-voting preferred stock and a 95% economic interest in KSI. In connection with the merger, Messers Kilroy received $8,000 in cash for their economic interest and KSLLC became a wholly-owned subsidiary of the Company. As a result, KSLLC was consolidated for financial reporting purposes beginning January 1, 2001. Unless otherwise indicated, all references to the Company include the Operating Partnership, the Finance Partnership, KSLLC, the Development LLC’s, and all wholly-owned subsidiaries and controlled entities.

 

 

        The accompanying interim financial statements have been prepared by the Company’s management in accordance with generally accepted accounting principles (“GAAP”) and in conjunction with the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures required for annual financial statements have been condensed or excluded pursuant to SEC rules and regulations. Accordingly, the interim financial statements do not include all of the information and footnotes required by GAAP in the United States of America for complete financial statements. In the opinion of management, the interim financial statements presented herein reflect all adjustments of a normal and recurring nature which are considered necessary for a fair presentation of the results for the interim periods presented. The results of operations for the interim period are not necessarily indicative of the results that may be expected for the year ended December 31, 2001. These financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2000. Certain prior year amounts have been reclassified to conform to the current period’s presentation.

 

 

        As part of the Company’s overall interest rate risk management strategy, the Company uses derivative instruments, including interest rate swaps and caps, to hedge exposures to interest rate risk on its debt. The Company does not enter into any derivative instruments for speculative purposes. On January 1, 2001, the Company adopted Statement of Financial Accounting Standards (“SFAS”) 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended by SFAS 138, “Accounting for Certain Derivative Instruments and Certain Hedging Activities” (collectively, “SFAS 133”). SFAS 133 establishes accounting and reporting standards for derivative instruments. Specifically, SFAS 133 requires an entity to recognize all derivatives as either assets or liabilities on the balance sheet at fair value. Additionally, any of the adjustments to fair value will affect either shareholders’ equity or net income depending on the nature of the hedge and whether the derivative instrument qualifies as a hedge for accounting purposes. The Company determines fair value based upon available market information at each balance sheet date using standard valuation techniques such as discounted cash flow analysis and option pricing models.

 

        Prior to the adoption of SFAS 133, the Company applied deferral accounting for all derivative financial instruments that were designated as hedges. Amounts paid or received under these agreements were recognized as adjustments to interest expense. The initial premiums on cap agreements were amortized over the life of the agreement using the straight-line method.

 

        On January 1, 2001, in connection with the adoption of SFAS 133, the Company recorded a $1.4 million cumulative effect of change in accounting principle to record an existing cap agreement at fair market value. The Company also recorded a $2.0 million non-cash charge to other comprehensive loss to record the Company’s swap on the balance sheet at fair market value.

 

        In June 2001, the Financial Accounting Standards Board issued two new pronouncements: SFAS 141, “Business Combinations” (“SFAS 141”), and SFAS 142, “Goodwill and Other Intangible Assets” (“SFAS 142”). These statements make significant changes to the accounting for business combinations, goodwill, and intangible assets. Among other provisions, SFAS 141 prohibits the use of the pooling-of-interests method, requiring all business combinations initiated after June 30, 2001 to be accounted for using the purchase method of accounting. SFAS 142 discontinues the practice of amortizing goodwill and other intangible assets and requires a periodic review process for impairment. SFAS 142 is effective for fiscal periods beginning after December 15, 2001. Management does not expect the adoption of these statements will have a material effect on the Company’s results of operations or financial position.

 

 

 

        In June 2001, the Company acquired 9.8 acres of undeveloped land in San Diego, California from an unaffiliated third party for $15.1 million, consisting of a cash payment of $6.0 million and the issuance of a $9.1 million non-interest bearing mortgage note payable to the seller. The note is secured by the undeveloped land and is due on or before December 6, 2001, the note’s stated maturity. The note may be prepaid at any time, in whole or in part, without penalty or premium.

 

        In January 2001, the Company acquired the fee interest in a parcel of land at 9455 Town Center Drive, San Diego for $3.1 million. The Company had previously leased this land from the city of San Diego. This land is the site of one of the Company’s Office Properties.

 

 

        In January 2001, the Operating Partnership purchased a 75% tenancy-in-common interest in a three-building office complex located in El Segundo, California for $33.4 million in cash. The complex, which encompasses an aggregate of approximately 366,000 rentable square feet, is comprised of two office buildings and a parking structure. One of the office buildings is 100% leased to The Boeing Company. The Company is currently redeveloping the second office building.

 

        The Company partially funded the acquisition with $28.4 million in proceeds from property dispositions that were held as restricted cash for the use in tax-deferred property exchanges and included in restricted cash at December 31, 2000. The remaining $5.0 million was funded with borrowings under the Company’s unsecured line of credit. The interest was purchased from entities owned by John B. Kilroy, Sr., the Company’s Chairman of the Board of Directors, John B. Kilroy, Jr. the Company’s President and Chief Executive Officer, and certain other Kilroy family members. Concurrent with the purchase of the 75% interest, the outstanding note receivable from related party and related accrued interest balances were paid to the Company.

 

        As a result of the acquisition, the Company now owns a 100% interest in the complex. The initial 25% tenancy-in-common interest was acquired by a wholly-owned subsidiary of the Company in October 2000 and was recorded as an investment in unconsolidated real estate on the consolidated balance sheet as of December 31, 2000.

 

 

        During the six months ended June 30, 2001, the Company sold the following properties:

 

 

        The Company recorded a gain of approximately $1.5 million in connection with the sales of these properties. The Company used the sales proceeds to fund development expenditures.

 

 

        During the six months ended June 30, 2001, the Company completed and stabilized the following development projects:

 

 

 

 

        At June 30, 2001, the Company had the following five office properties in the lease-up phase:

 

 

 

        As of June 30, 2001, the Company had borrowings of $185 million outstanding under its revolving unsecured line of credit (the “Credit Facility”) and availability of approximately $159 million. The Credit Facility bears interest at an annual rate of LIBOR plus a spread of between 1.13% and 1.75% (5.50% at June 30, 2001), depending upon the Company’s leverage ratio at the time of borrowing. The Company expects to use the Credit Facility to fund development expenditures, to fund potential undeveloped land acquisitions and for general corporate purposes.

 

        In June 2001, the Company repaid the $16.8 million principal balance of an existing construction loan which had an annual interest rate of LIBOR plus 1.75% and a stated maturity of October 2002. The payment was made in conjunction with a tax-deferred property exchange and was primarily funded with the $15.4 million in proceeds from the disposition of the industrial property in Roseville, California (see Note 2).

 

        Total interest capitalized for the three months ended June 30, 2001 and 2000 was $3.4 million and $4.0 million, respectively. Total interest capitalized for the six months ended June 30, 2001 and 2000 was $6.7 million and $8.0 million, respectively.

 

 

        The Company is exposed to the effect of interest rate changes in the normal course of business. The Company mitigates these risks by following established risk management policies and procedures which include the periodic use of derivatives. The Company’s primary strategy in entering into derivative contracts is to minimize the volatility that changes in interest rates could have on its future cash flows. The Company generally employs derivative instruments that are designated as cash flow hedges, typically interest rate swaps and caps, to effectively convert a portion of its variable-rate debt to fixed-rate debt. The Company does not enter into derivative instruments for speculative purposes.

 

 

        For interest rate swap agreements, the Company receives variable interest rate payments and pays fixed interest rate payments, thereby creating the equivalent of fixed rate debt. For interest rate cap agreements the Company effectively limits its interest expense to a certain specified rate on a portion of its variable rate debt. These agreements are reflected at fair value in the Company’s consolidated balance sheet and the related gains or losses on these contracts are deferred in stockholders’ equity as a component of accumulated other comprehensive income or loss. To the extent that any of these contracts are not considered to be perfectly effective in offsetting the change in the value of the interest payments being hedged, any changes in fair value relating to the ineffective portion of these contracts would be recognized in earnings. For the six months ended June 30, 2001, the Company did not record any gains or losses attributable to cash flow hedge ineffectiveness since the terms of the Company’s swap contracts and debt obligations are effectively matched.

 

        As of June 30, 2001, the Company had two interest rate swap agreements to receive variable rates of interest (LIBOR) and pay fixed rates of interest (weighted average rate of 6.21%) on an aggregate notional amount of $300 million, $150 million which expires in February 2002 and $150 million which expires in November 2002. The Company, through one of the Development LLC’s, also had one interest rate cap agreement with a LIBOR based cap rate of 8.50% and a notional amount of $54.4 million at June 30, 2001. The agreement had an initial notional amount of $21.1 million that increases to $57.0 million through August 2001, and then remains at $57.0 million until expiration in April 2002. Each of these instruments have been designated as cash flow hedges. As of June 30, 2001, the Company has a derivative liability of $5.7 million, which is included in accounts payable and accrued expenses in the consolidated balance sheet. During the next twelve months, the Company estimates that it will record approximately $5.0 million of interest expense related to these instruments.

 

        In January 2001, the Company terminated an interest rate cap agreement which had a LIBOR based cap rate of 6.50% and a notional amount of $150 million.

 

 

        Minority interests represent the preferred limited partnership interests in the Operating Partnership, the common limited partnership interests in the Operating Partnership not owned by the Company, and interests held by The Allen Group in the Development LLCs. The Company owned an 89.9% general partnership interest in the Operating Partnership as of June 30, 2001.

 

        During the six months ended June 30, 2001, 685,691 common units of the Operating Partnership were exchanged into shares of the Company’s common stock on a one-for-one basis. Of these 685,691 common limited partnership units, 410,849 common limited partnership units were owned by a partnership affiliated with The Allen Group. In addition, 47,500 of the 685,691 common limited partnership units were owned by Kilroy Industries, an entity owned by John B. Kilroy, Sr., the Chairman of the Company’s Board of Directors, and John B. Kilroy, Jr., the Company’s President and Chief Executive Officer. Neither the Company nor the Operating Partnership received any proceeds from the issuance of the common stock to the identified common unitholders.

 

 

        In January 2001, one of the Company’s tenants, eToys, Inc. (“eToys”) defaulted on its lease and, thereafter, declared bankruptcy on March 7, 2001. Prior to the eToys’ bankruptcy filing, the Company drew $15.0 million under two letters of credit which were held as credit support under the terms of the lease and as security for the related tenant improvements and leasing commissions. In May 2001, the United States Bankruptcy Court for the District of Delaware approved a stipulation rejecting the eToys’ lease. The Company recorded a net lease termination fee of $5.4 million representing the $15.0 million of letter of credit proceeds offset by $9.6 million of accounts receivable and other costs and obligations associated with the lease.

 

        Upon the execution of the stipulation, the Company obtained possession of approximately 128,000 of the total 151,000 rentable square feet leased to eToys. eToys continues to occupy the remaining 23,000 rentable square feet and has been paying rent on this space based on the terms in the stipulation. The Company currently expects eToys to vacate this space by August 31, 2001.

 

 

        The Company’s reportable segments consist of the two types of commercial real estate properties for which management internally evaluates operating performance and financial results: Office Properties and Industrial Properties. The Company also has certain corporate level activities including legal, accounting, finance, and management information systems which are not considered separate operating segments.

 

        The Company evaluates the performance of its segments based upon net operating income. Net operating income is defined as operating revenues (rental income, tenant reimbursements and other income) less property and related expenses (property expenses, real estate taxes and ground leases) and does not include interest income and expense, depreciation and amortization and corporate general and administrative expenses. All operating revenues are comprised of amounts received from third-party tenants.

 

 

 

 

8.    Earnings Per Share

 

        Basic earnings per share is computed by dividing net income by the weighted-average number of common shares outstanding for the period. Diluted earnings per share is computed by dividing net income by the sum of the weighted-average number of common shares outstanding for the period plus the number of common shares issuable assuming the exercise of all dilutive securities. The Company does not consider common units of the Operating Partnership to be dilutive since the exchange of common units into common stock is on a one-for-one basis and would not have any effect on diluted earnings per share. The following table reconciles the numerator and denominator of the basic and diluted per-share computations for net income.

 

 

        At June 30, 2001, Company employees and directors held options to purchase 88,000 shares of the Company’s common stock that were antidilutive to the diluted earnings per share computation. These options could become dilutive in future periods if the average market price of the Company’s common stock exceeds the exercise price of the outstanding options.

 

 

        On July 18, 2001, aggregate distributions of $14.6 million were paid to common stockholders and common unitholders of record on June 29, 2001.

 

        On August 1, 2001, the Company sold one office building encompassing approximately 41,100 aggregate rentable square feet to an unaffiliated third party. The building, which is located in Camarillo, California, was sold for an aggregate sales price of $6.6 million in cash.

 

ITEM 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

        The following discussion relates to the consolidated financial statements of the Company and should be read in conjunction with the financial statements and notes thereto appearing elsewhere in this report. Statements contained in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” that are not historical facts may be forward-looking statements. Such statements are subject to certain risks and uncertainties, which could cause actual results to differ materially from those projected. Some of the enclosed information presented is forward-looking in nature, including information concerning development timing and investment amounts. Although the information is based on the Company’s current expectations, actual results could vary from expectations stated here. Numerous factors will affect the Company’s actual results, some of which are beyond its control. These include the timing and strength of regional economic growth, the strength of commercial and industrial real estate markets, competitive market conditions, future interest rate levels 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. The Company assumes no obligation to update publicly any forward-looking information, whether as a result of new information, future events or otherwise. For a discussion of important risks related to the Company’s business, and an investment in its 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 the discussion under the caption “Business Risks” in the Company’s annual report on Form 10-K for the year ended December 31, 2000. In light of these risks, uncertainties and assumptions, the forward-looking events contained herein might not occur.

 

 

        Kilroy Realty Corporation (the “Company”) develops, owns, and operates office and industrial real estate, primarily in Southern California. The Company operates as a self-administered real estate investment trust (“REIT”). The Company owns its interests in all of its properties through Kilroy Realty, L.P. (the “Operating Partnership”) and Kilroy Realty Finance Partnership, L.P. and conducts substantially all of its operations through the Operating Partnership. The Company owned an 89.9% general partnership interest in the Operating Partnership as of June 30, 2001.

 

 

        A significant part of the Company’s revenue growth for each of the three- and six-month periods ended June 30, 2001 is attributable to its recently completed development projects. During the six months ended June 30, 2001, the Company completed the development of and stabilized two office buildings encompassing an aggregate of approximately 170,900 rentable square feet. During the year ended December 31, 2000 the Company completed the development of nine office buildings encompassing an aggregate of approximately 1.0 million rentable square feet. All of these completed development properties were included in the Company’s portfolio of stabilized operating properties at June 30, 2001. The Company’s stabilized portfolio of operating properties consists of all of the Company’s office and industrial properties excluding properties recently developed by the Company that have not yet reached 95.0% occupancy (“lease-up” properties) and projects currently under construction or in pre-development. At June 30, 2001, the Company had five office buildings encompassing an aggregate of approximately 357,600 rentable square feet in the lease-up phase which were completed during the six months ended June 30, 2001. The Company’s development pipeline at June 30, 2001 included six office projects under construction or committed for construction which are expected to be completed over the next two years and encompass an aggregate of approximately 617,700 rentable square feet. In addition, the Company has an aggregate of approximately 1.3 million rentable square feet of presently planned future office development projects.

 

        During the six months ended June 30, 2001, the Company acquired a 75% tenancy-in-common interest in a three-building office complex encompassing an aggregate of approximately 366,000 rentable square feet. The initial 25% tenancy-in-common interest was acquired by a wholly-owned subsidiary of the Company in October 2000 and was recorded as an investment in unconsolidated real estate on the consolidated balance sheet as of December 31, 2000. As a result, the Company now owns a 100% interest in the complex (see Note 2 to the consolidated financial statements.) The Company did not acquire any additional operating properties during the year ended December 31, 2000. During the six months ended June 30, 2001, the Company disposed of three industrial buildings encompassing an aggregate of approximately 201,900 rentable square feet, for an aggregate sales price of $18.7 million. During the year ended December 31, 2000, the Company disposed of nine office and nine industrial buildings encompassing an aggregate of approximately 286,700 and 669,800 rentable square feet, respectively, for an aggregate sales price of $113.6 million.

 

        As a result of the property acquired and the projects developed and stabilized by the Company subsequent to June 30, 2000, net of the effect of properties disposed of subsequent to June 30, 2000, rentable square footage in the Company’s portfolio of stabilized properties increased by an aggregate of approximately 270,000 rentable square feet, or 2.1%, to 12.8 million rentable square feet at June 30, 2001 compared to 12.5 million rentable square feet at June 30, 2000. As of June 30, 2001, the Company’s stabilized portfolio was comprised of 87 office properties (the “Office Properties”) encompassing an aggregate of approximately 7.2 million rentable square feet and 75 industrial properties (the “Industrial Properties”) encompassing an aggregate of approximately 5.6 million rentable square feet. The stabilized portfolio occupancy rate at June 30, 2001 was 94.9%, with the Office and Industrial Properties 93.7% and 96.5% occupied, respectively.

 

 

 

Rental Operations

 

        Management evaluates the operations of its portfolio based on operating property type. The following tables compare the net operating income, defined as operating revenues (rental income, tenant reimbursements and other income) less property and related expenses (property expenses, real estate taxes and ground leases) before depreciation, for the Office Properties and for the Industrial Properties for the three months ended June 30, 2001 and 2000.

 

 

 

        Total revenues from Office Properties increased $15.6 million, or 50.3% to $46.7 million for the three months ended June 30, 2001 compared to $31.1 million for the three months ended June 30, 2000. Rental income from Office Properties increased $8.5 million, or 31.1% to $36.0 million for the three months ended June 30, 2001 compared to $27.5 million for the three months ended June 30, 2000. Rental income generated by the Core Office Portfolio increased $0.3 million, or 1.2% for the three months ended June 30, 2001 as compared to the three months ended June 30, 2000. This increase was primarily attributable to growth provided by increases in rental rates on renewed and released space in this portfolio. Average occupancy in the Core Office Portfolio decreased 2.2% to 94.6% for the three months ended June 30, 2001 compared to 96.8% for the three months ended June 30, 2000. Of the remaining increase of $8.2 million in rental income from Office Properties, an increase of $9.0 million was generated by the office properties developed by the Company in 2001 and 2000 (the “Office Development Properties”), offset by a decrease of $0.8 million attributable to the office properties sold during 2000, net of the effect of the office property acquired in 2001 (the “Net Office Dispositions”).

 

        Tenant reimbursements from Office Properties increased $1.7 million, or 53.0% to $5.0 million for the three months ended June 30, 2001 compared to $3.3 million for the three months ended June 30, 2000. An increase of $1.0 million, or 32.1% in tenant reimbursements was generated by the Core Office Portfolio and was primarily due to an increase in property expenses and real estate taxes which were reimbursable by tenants. Of the remaining increase of $0.7 million, an increase of $0.8 million in tenant reimbursements was generated by the Office Development Properties offset by a decrease of $0.1 million attributable to the Net Office Dispositions. Other income from Office Properties increased $5.3 million to $5.6 million for the three months ended June 30, 2001 compared to $0.3 million for the three months ended June 30, 2000. This increase was primarily attributable to the recognition of a $5.4 million lease termination fee resulting from the bankruptcy court’s rejection of the eToys’ lease (see Note 6 to the consolidated financial statements.) The remaining other income from Office Properties for both periods consisted primarily of lease termination fees, management fees and tenant late charges.

 

        Total expenses from Office Properties increased $3.1 million, or 41.0% to $10.8 million for the three months ended June 30, 2001 compared to $7.7 million for the three months ended June 30, 2000. Property expenses from Office Properties increased $1.4 million, or 26.9% to $6.6 million for the three months ended June 30, 2001 compared to $5.2 million for the three months ended June 30, 2000. An increase of $0.1 million in property expenses was attributable to the Core Office Portfolio. This increase was primarily attributable to higher utility costs due to an increase in rates. Of the remaining increase of $1.3 million, an increase of $1.5 million generated by the Office Development Properties was offset by a decrease of $0.2 million attributable to the Net Office Dispositions. Real estate taxes increased $1.7 million, or 85.6% to $3.8 million for the three months ended June 30, 2001 as compared to $2.1 million for the three months ended June 30, 2000. Real estate taxes for the Core Office Portfolio increased $0.7 million, or 40.6% for the three months ended June 30, 2001 compared to the comparable period in 2000. This increase was primarily due to supplemental real estate taxes paid during the three months ended June 30, 2001 and real estate tax refunds received during the three months ended June 30, 2000. An increase of $1.1 million attributable to the Office Development Properties was offset by a decrease of $0.1 million attributable to the Net Office Dispositions. Ground lease expense from Office Properties remained consistent for both periods. A decrease of $0.1 million in the Core Office Portfolio was offset by an increase of $0.1 million in the Office Development Properties. The decrease in the Core Office Portfolio is due to the acquisition of the fee interest in the land at one of the Core Office Portfolio properties in January 2001.

 

        Net operating income, as defined, from Office Properties increased $12.5 million, or 53.3% to $35.9 million for the three months ended June 30, 2001 compared to $23.4 million for the three months ended June 30, 2000. Of this increase, $0.6 million was generated by the Core Office Portfolio and represented a 2.6% increase in net operating income for the Core Office Portfolio. The remaining increase of $11.9 million was generated by an increase of $12.5 million from the Office Development Properties, offset by a $0.6 million decrease attributable to the Net Office Dispositions.

 

 

 

        Total revenues from Industrial Properties decreased $2.0 million, or 14.9% to $11.3 million for the three months ended June 30, 2001 compared to $13.3 million for the three months ended June 30, 2000. Rental income from Industrial Properties decreased $1.9 million, or 15.9% to $10.0 million for the three months ended June 30, 2001 compared to $11.9 million for the three months ended June 30, 2000. Rental income generated by the Core Industrial Portfolio increased $0.5 million, or 5.9% for the three months ended June 30, 2001 as compared to the three months ended June 30, 2000. This increase was primarily attributable to an increase in rental rates on renewed and released space in this portfolio. Average occupancy in the Core Industrial Portfolio decreased 1.4% to 96.9% for the three months ended June 30, 2001 compared to 98.3% for the three months ended June 30, 2000. The $0.5 million increase in rental income generated by the Core Industrial Portfolio was offset by a decrease of $2.4 million in rental income attributable to the twelve industrial buildings sold during 2001 and 2000 (the “Industrial Dispositions”).

 

        Tenant reimbursements from Industrial Properties decreased $0.2 million, or 12.7% to $1.1 million for the three months ended June 30, 2001 compared to $1.3 million for three months ended June 30, 2000. This decrease was attributable to a $0.4 million decrease in tenant reimbursements attributable to the Industrial Dispositions offset by a $0.2 million increase in tenant reimbursements for the Core Industrial Portfolio. Other income from Industrial Properties increased $0.1 million, or 178.6% to $0.1 million for the three months ended June 30, 2001 compared to $42,000 for the three months ended June 30, 2000.

 

        Total expenses from Industrial Properties decreased $0.1 million, or 5.5% to $1.7 million for the three months ended June 30, 2001 compared to $1.8 million for the three months ended June 30, 2000. Property expenses from Industrial Properties remained consistent for the three months ended June 30, 2001 compared to the three months ended June 30, 2000. An increase of $0.2 million in property expenses for the Core Industrial Portfolio was offset by a decrease of $0.2 million attributable to the Industrial Dispositions. The increase in the Core Industrial Portfolio was primarily due to higher utility costs due to an increase in rates. Real estate taxes decreased by $0.1 million for the three months ended June 30, 2001 compared to the three months ended June 30, 2000. Real estate taxes for the Core Industrial Portfolio increased $0.1 million, or 20.4% for the three months ended June 30, 2001 compared to the same period in 2000. This $0.1 million increase was offset by a decrease of $0.2 million attributable to the Industrial Dispositions.

 

        Net operating income, as defined, from Industrial Properties decreased $1.9 million, or 16.5% to $9.5 million for the three months ended June 30, 2001 compared to $11.4 million for the three months ended June 30, 2000. Net operating income for the Core Industrial Portfolio increased $0.4, or 4.0% for the three months ended June 30, 2001 compared to the same period in 2000 which was offset by a decrease of $2.3 million attributable to the Industrial Dispositions.

 

 

        Interest income decreased $0.7 million, or 72.7% to $0.3 million for the three months ended June 30, 2001 compared to $1.0 million for the three months ended June 30, 2000. The decrease was primarily due to a $0.7 million decrease of interest earned on the note receivable from related party. This note was acquired in May 2000 and repaid in January 2001.

 

        General and administrative expenses increased $0.5 million, or 18.7% to $3.0 million for the three months ended June 30, 2001 compared to $2.5 million for the three months ended June 30, 2000. This increase was primarily due to increased compensation expense attributable to the non-cash amortization of restricted stock granted in June 2000.

 

        Interest expense increased $0.7 million, or 6.7% to $10.6 million for the three months ended June 30, 2001 compared to $9.9 million for the three months ended June 30, 2000, primarily due to a net increase in aggregate indebtedness. The Company’s weighted average annual interest rate decreased approximately 1.0% to 7.2% at June 30, 2001 as compared to 8.2% at June 30, 2000.

 

        Depreciation and amortization increased $2.9 million, or 29.8% to $12.5 million for the three months ended June 30, 2001 compared to $9.6 million for the three months ended June 30, 2000. The increase was due primarily to depreciation on properties developed and stabilized by the Company subsequent to June 30, 2000, net of the effect of properties disposed of by the Company subsequent to June 30, 2000.

 

Six Months Ended June 30, 2001 Compared to Six Months Ended June 30, 2000

 

 

 

        Management evaluates the operations of its portfolio based on operating property type. The following tables compare the net operating income, defined as operating revenues (rental income, tenant reimbursements, other income) less property and related expenses (property expenses, real estate taxes and ground leases) before depreciation, for the Office Properties and for the and Industrial Properties for the six months ended June 30, 2001 and 2000.

 

 

 

        Total revenues from Office Properties increased $24.1 million, or 39.5% to $85.0 million for the six months ended June 30, 2001 compared to $60.9 million for the six months ended June 30, 2000. Rental income from Office Properties increased $16.1 million, or 29.7% to $70.1 million for the six months ended June 30, 2001 compared to $54.0 million for the six months ended June 30, 2000. Rental income generated by the Core Office Portfolio increased $0.7 million, or 1.3% for the six months ended June 30, 2001 as compared to the six months ended June 30, 2000. This increase was primarily attributable to growth provided by increases in rental rates on renewed and released space in this portfolio. Average occupancy in the Core Office Portfolio decreased 1.8% to 94.9% for the six months ended June 30, 2001 compared to 96.7% for the six months ended June 30, 2000. Of the remaining increase of $15.4 million in rental income from office properties, an increase of $17.1 million was generated by the Office Development Properties, offset by a decrease of $1.7 million generated by the Net Office Dispositions.

 

        Tenant reimbursements from Office Properties increased $2.8 million, or 43.6% to $9.3 million for the six months ended June 30, 2001 compared to $6.5 million for the six months ended June 30, 2000. An increase of $1.3 million in tenant reimbursements was generated by the Core Office Portfolio which was primarily due to the increase in property expenses and real estate taxes which were reimbursable by tenants. An increase of $1.6 million was generated by the Office Development Properties offset by a decrease of $0.1 million attributable to the Net Office Dispositions. Other income from Office Properties increased $5.2 million to $5.7 million for the six months ended June 30, 2001 compared to $0.5 million for the six months ended June 30, 2000. This increase is attributable to the recognition of a $5.4 million lease termination fee resulting from the bankruptcy court’s rejection of the eToys’ lease (see Note 6 to the consolidated financial statements.) The remaining amounts in other income from Office Properties for both periods consisted primarily of lease termination fees, management fees and tenant late charges.

 

        Total expenses from Office Properties increased $4.9 million, or 32.7% to $19.9 million for the six months ended June 30, 2001 compared to $15.0 million for the six months ended June 30, 2000. Property expenses increased $2.8 million, or 28.0% to $12.7 million for the six months ended June 30, 2001 compared to $9.9 million for the six months ended June 30, 2000. An increase of $0.1 million in property expenses was attributable to the Core Office Portfolio which was due to higher utility costs due to an increase in rates. Of the remaining increase of $2.7 million in property expenses, an increase of $3.0 million attributable to the Office Development Properties was offset by a $0.3 million decrease attributable to the Net Office Dispositions. Real estate taxes increased $2.1 million, or 50.2% to $6.4 million for the six months ended June 30, 2001 as compared to $4.3 million for the six months ended June 30, 2000. Of this increase, $0.7 million was attributable to real estate taxes on the Core Office Portfolio. This increase was due to supplemental real estate taxes paid during the six months ended June 30, 2001 and the effect of refunds received during the six months ended June 30, 2000. Of the remaining increase of $1.4 million, an increase of $1.6 million attributable to the Office Development Properties was offset by a decrease of $0.2 million attributable to the Net Office Dispositions. Ground lease expense from Office Properties was consistent for the six months ended June 30, 2001 compared to the six months ended June 30, 2000. A decrease of $0.1 million in the Core Office Portfolio was offset by an increase of $0.1 million in the Office Development Properties. The decrease in the Core Office Portfolio is due to the acquisition of the fee interest in the land at one of the Core Office Portfolio properties in January 2001.

 

        Net operating income, as defined, from Office Properties increased $19.2 million, or 41.7% to $65.2 million for the six months ended June 30, 2001 compared to $46.0 million for the six months ended June 30, 2000. Of this increase, $1.2 million was generated by the Core Office Portfolio and represented a 2.7% increase in net operating income for the Core Office Portfolio. Of the remaining increase of $18.0 million, an increase of $19.2 million generated by the Office Development Properties was offset by a decrease of $1.2 million attributable to the Net Office Dispositions.

 

Industrial Properties

 

 

        Total revenues from Industrial Properties decreased $4.0 million, or 14.9% to $22.9 million for the six months ended June 30, 2001 compared to $26.9 million for the six months ended June 30, 2000. Rental income from Industrial Properties decreased $2.7 million, or 11.9% to $20.3 million for the six months ended June 30, 2001 compared to $23.0 million for the six months ended June 30, 2000. An increase of $1.6 million was generated by the Core Industrial Portfolio and represented a 8.8% increase in rental income for the Core Industrial Portfolio. This increase in rental income for the Core Industrial Portfolio is primarily attributable to increases in rental rates on renewed and re-leased space in this portfolio. Average occupancy in the Core Industrial Portfolio decreased 0.6% to 97.4% for the six months ended June 30, 2001 as compared to 98.0% for the six months ended June 30, 2000. The increase in rental income contributed by the Core Industrial Portfolio was offset by a decrease of $4.3 million in rental income attributable to the Industrial Dispositions.

 

        Tenant reimbursements from Industrial Properties decreased $0.4 million, or 14.5% to $2.4 million for the six months ended June 30, 2001 compared to $2.8 million for six months ended June 30, 2000. An increase of $0.2 million was attributable to the Core Industrial Portfolio which was offset by a $0.6 million decrease attributable to the Industrial Dispositions. Other income from Industrial Properties decreased by $0.9 million for the six months ended June 30, 2001 compared to the six months ended June 30, 2000. Other income for the six months ended June 30, 2000 included a $0.9 million lease termination fee from a building in El Segundo, California. The remaining amounts in other income from Industrial Properties for both periods consisted primarily of lease termination fees, management fees and tenant late charges.

 

        Total expenses from Industrial Properties decreased $0.2 million, or 4.5% to $3.6 million for the six months ended June 30, 2001 compared to $3.8 million for the six months ended June 30, 2000. Property expenses from Industrial Properties increased by $0.1 million, or 2.5% to $1.7 million for the six months ended June 30, 2001 compared to $1.6 million for the six months ended June 30, 2000. An increase of $0.4 million in the Core Industrial Portfolio was offset by a decrease of $0.3 million in property expense attributable to the Industrial Dispositions. The increase in property expenses for the Core Industrial Portfolio was primarily due to higher utility costs due to an increase in rates. Real estate taxes decreased by $0.2 million or 9.9% to $1.9 million for the six months ended June 30, 2001 compared to $2.1 million for the six months ended June 30, 2000. An increase of $0.2 million was attributable to the Core Industrial Portfolio which was offset by a decrease of $0.4 million attributable to the Industrial Dispositions.

 

        Net operating income, as defined, from Industrial Properties decreased $3.8 million, or 16.6% to $19.2 million for the six months ended June 30, 2001 compared to $23.0 million for the six months ended June 30, 2000. An increase of $0.2 million was generated by the Core Industrial Portfolio and represented a 1.1% increase in net operating income for the Core Industrial Portfolio. This was offset by a decrease of $4.0 million attributable to the Industrial Dispositions.

 

 

        Interest income decreased $0.6 million, or 45.2% to $0.7 million for the six months ended June 30, 2001 compared to $1.3 million for the six months ended June 30, 2000. The decrease was primarily due to a $0.6 million decrease of interest earned on the note receivable from related party. This note was acquired in May 2000 and repaid in January 2001.

 

        General and administrative expenses increased $1.2 million, or 23.2% to $6.4 million for the six months ended June 30, 2001 compared to $5.2 million for the six months ended June 30, 2001. This increase was due primarily to increased compensation expense attributable to the non-cash amortization of restricted stock granted in June 2000.

 

        Interest expense increased $3.6 million, or 20.4% to $21.4 million for the six months ended June 30, 2001 compared to $17.8 million for the six months ended June 30, 2000, primarily due to a net increase in aggregate indebtedness. The Company’s weighted average annual interest rate decreased approximately 1.0% to 7.2% at June 30, 2001 as compared to 8.2% at June 30, 2000.

 

        Depreciation and amortization increased $7.0 million, or 36.8% to $25.9 million for the six months ended June 30, 2001 compared to $18.9 million for the six months ended June 30, 2000. The increase was due primarily to a full six months of depreciation on properties developed by the Company subsequent to June 30, 2000 net of the effect of properties disposed of by the Company subsequent to June 30, 2000.

 

 

        The Company has a $400 million unsecured revolving credit facility (the “Credit Facility”) which bears interest at an annual rate between LIBOR plus 1.13% and LIBOR plus 1.75% (5.50% at June 30, 2001), depending upon the Company’s leverage ratio at the time of borrowing, and matures in November 2002. As of June 30, 2001, the Company had borrowings of $185 million outstanding under the Credit Facility and availability of approximately $159 million. The Company uses the Credit Facility to finance development expenditures, to fund potential undeveloped land acquisitions and for general corporate purposes.

 

        The Company has a $100 million unsecured debt facility, which matures in September 2002 with two one-year extension options, requires monthly interest-only payments based upon an annual interest rate between LIBOR plus 1.13% and LIBOR plus 1.75% (5.50% at June 30, 2001), depending upon the Company’s leverage ratio at the time of borrowing. The same pool of unencumbered assets is used to determine availability for the Credit Facility and the $100 million unsecured debt facility.

 

        The following table sets forth the composition of the Company’s secured debt at June 30, 2001 and December 31, 2000:

 

 

        The following table sets forth certain information with respect to the maturities and scheduled principal repayments of the Company’s secured debt and unsecured term facility at June 30, 2001, assuming the exercise of available debt extension options:

 

 

        The following table sets forth certain information with respect to the Company’s aggregate debt composition at June 30, 2001 and December 31, 2000:

 

 

        As of August 10, 2001, the Company had an aggregate of $313 million of equity securities available for issuance under a shelf registration statement.

 

 

        As of June 30, 2001, the Company had an aggregate of approximately 975,300 rentable square feet of office space that was either in lease-up, under construction or committed for construction at a total budgeted cost of approximately $240 million. The Company has spent an aggregate of approximately $125 million on these projects as of June 30, 2001. The Company intends to finance $11 million of the remaining $115 million of presently budgeted development costs, with proceeds from construction loans obtained in 2000. The Company intends to finance the remaining $104 million of budgeted development costs with additional construction loan financing, proceeds from the Company’s disposition program, borrowings under the Credit Facility and from working capital.

 

        In connection with an agreement signed with The Allen Group in October 1997, the Company agreed to purchase one office property encompassing approximately 128,000 rentable square feet, subject to the property meeting certain occupancy thresholds and other tenancy requirements. The purchase price for this property will be determined at the time of acquisition based on the net operating income at the time of acquisition. The Company expects that in the event that this acquisition does occur, it would be financed with borrowings under the Credit Facility and the issuance of common limited partnership units of the Operating Partnership.

 

        The Company believes that it will have sufficient capital resources to satisfy its obligations and planned capital expenditures for the next twelve months. The Company expects to meet its long-term liquidity requirements including possible future development and undeveloped land acquisitions, through retained cash flow, long-term secured and unsecured borrowings, proceeds from the Company’s dispositions program, or the issuance of common or preferred units of the Operating Partnership.

 

 

        The following tables set forth certain information regarding the Company’s Office and Industrial Properties at June 30, 2001:

 

 

 

Lease Expirations by Segment Type

 

 

 

 

Historical Cash Flows

 

        The principal sources of funding for development, acquisitions, and capital expenditures are the Credit Facility, cash flow from operating activities, secured and unsecured debt financing and proceeds from the Company’s dispositions. The Company’s net cash provided by operating activities increased $12.6 million, or 33.2% to $50.5 million for the six months ended June 30, 2001 compared to $37.9 million for the six months ended June 30, 2000. This increase was primarily attributable to the effect of the $15.0 million the Company drew under two letters of credit after one of its tenants defaulted on its lease in January 2001 (see Note 6 to the Company’s consolidated financial statements).

 

        Net cash used in investing activities decreased $60.3 million, or 56.6% to $46.2 million for the six months ended June 30, 2001 compared to $106.5 million for the six months ended June 30, 2000. Cash used in investing activities for the six months ended June 30, 2001 consisted primarily of the acquisition of the fee interest in the land at the site of one of the Office Properties for $3.1 million, the purchase of 9.8 acres of undeveloped land for $15.1 million (net of a $9.1 secured note issued in connection with the disposition) expenditures for construction in progress of $51.9 million, and $3.4 million in additional tenant improvements and capital expenditures offset by $18.3 million in net proceeds received from the sale of three industrial buildings. Cash used in investing activities for the six months ended June 30, 2000 consisted primarily of $45.3 million paid to acquire a note receivable, the purchase of 17 acres of undeveloped land for $11.3 million (net of an $8.5 million mortgage note payable issued in connection with the acquisition), expenditures for construction in progress of $76.9 million, and $7.6 million in additional tenant improvements and capital expenditures offset by $26.3 million in net proceeds received from the sale of five office and four industrial buildings.

 

        Net cash used in financing activities decreased $67.0 million, or 113.6% to $8.0 million net cash used by financing activities for the six months ended June 30, 2001 compared to $59.0 million net cash provided by financing activities for the six months ended June 30, 2000. Cash used by financing activities for the six months ended June 30, 2001 consisted primarily of $25.7 million in repayments to the Credit Facility and principal payments on secured debt and $28.1 million in distributions paid to common stockholders and common unitholders, partially offset by a $27.8 decrease in restricted cash used in a tax deferred property exchange and $16.8 million of additional funding drawn under the Company’s existing construction loans. Cash provided by financing activities for the six months ended June 30, 2000 consisted primarily of $77.0 million in borrowings under the Credit Facility, and $52.0 million in net proceeds from issuance of mortgage and construction debt partially offset by $27.0 million in distributions paid to common stockholders and common unitholders and $41.3 million paid for the Company’s stock repurchase program.

 

 

        Industry analysts generally consider Funds From Operations, as defined by NAREIT, an alternative measure of performance for an equity REIT. Funds From Operations is defined by NAREIT to mean net income (loss) before minority interests of common unitholders (computed in accordance with GAAP), excluding gains (or losses) from debt restructuring and sales of property, plus real estate related depreciation and amortization (excluding amortization of deferred financing costs and depreciation of non-real estate assets), and after adjustment for unconsolidated partnerships and joint ventures. The Company considers Funds From Operations an appropriate measure of performance of an equity REIT because it is predicated on cash flow analyses. The Company believes that in order to facilitate a clear understanding of the historical operating results of the Company, Funds From Operations should be examined in conjunction with net income as presented in the financial statements included elsewhere in this report. The Company computes Funds From Operations in accordance with standards established by the Board of Governors of NAREIT in its March 1995 White Paper as clarified by the November 2000 NAREIT National Policy Bulletin which became effective on January 1, 2000 which may differ from the methodologies used by other equity REITs and, accordingly, may not be comparable to Funds From Operations published by such other REITs. Funds From Operations should not be considered as an alternative to net income (loss) (computed in accordance with GAAP) as an indicator of the properties’ financial performance or to cash flow from operating activities (computed in accordance with GAAP) as an indicator of the properties’ liquidity, nor is it indicative of funds available to fund the properties’ cash needs, including the Company’s ability to pay dividends or make distributions.

 

        The following table presents the Company’s Funds From Operations for the three and six months ended June 30, 2001 and 2000.