10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2015
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                  to                 
Commission File Number: 1-12675 (Kilroy Realty Corporation)
Commission File Number: 000-54005 (Kilroy Realty, L.P.)
KILROY REALTY CORPORATION
KILROY REALTY, L.P.
(Exact name of registrant as specified in its charter)
 
 
 
Kilroy Realty Corporation
Maryland
95-4598246
 
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
 
 
 
Kilroy Realty, L.P.
Delaware
95-4612685
 
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
 
 
 
12200 W. Olympic Boulevard, Suite 200, Los Angeles, California 90064
(Address of principal executive offices) (Zip Code)
 
(310) 481-8400
(Registrant's telephone number, including area code)
 
 
 
N/A
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    
Kilroy Realty Corporation    Yes  þ    No   o
Kilroy Realty, L. P.         Yes  þ    No   o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    
Kilroy Realty Corporation     Yes  þ    No   o
Kilroy Realty, L.P.         Yes  þ    No   o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Kilroy Realty Corporation
 
 
 
Large accelerated filer     þ
Accelerated filer     o 
Non-accelerated filer     o
Smaller reporting company     o
(Do not check if a smaller reporting company)
 
 
 
 
Kilroy Realty, L.P.
 
 
 
Large accelerated filer     o
Accelerated filer     o 
Non-accelerated filer     þ
Smaller reporting company     o
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    
Kilroy Realty Corporation Yes  o     No   þ
Kilroy Realty, L.P. Yes  o     No   þ
As of October 23, 2015, 92,220,367 shares of Kilroy Realty Corporation common stock, par value $.01 per share, were outstanding.
 



EXPLANATORY NOTE
This report combines the quarterly reports on Form 10-Q for the period ended September 30, 2015 of Kilroy Realty Corporation and Kilroy Realty, L.P. Unless stated otherwise or the context otherwise requires, references to “Kilroy Realty Corporation” or the “Company,” “we,” “our,” and “us” mean Kilroy Realty Corporation, a Maryland corporation, and its controlled and consolidated subsidiaries, and references to “Kilroy Realty, L.P.” or the “Operating Partnership” mean Kilroy Realty, L.P., a Delaware limited partnership, and its controlled and consolidated subsidiaries.
The Company is a real estate investment trust, or REIT, and the general partner of the Operating Partnership. As of September 30, 2015, the Company owned an approximate 98.1% common general partnership interest in the Operating Partnership. The remaining approximate 1.9% common limited partnership interests are owned by non-affiliated investors and certain directors and officers of the Company. As the sole general partner of the Operating Partnership, the Company exercises exclusive and complete discretion over the Operating Partnership’s day-to-day management and control and can cause it to enter into certain major transactions, including acquisitions, dispositions and refinancings, and cause changes in its line of business, capital structure and distribution policies.
There are a few differences between the Company and the Operating Partnership that are reflected in the disclosures in this Form 10-Q. We believe it is important to understand the differences between the Company and the Operating Partnership in the context of how the Company and the Operating Partnership operate as an interrelated, consolidated company. The Company is a REIT, the only material asset of which is the partnership interests it holds in the Operating Partnership. As a result, the Company generally does not conduct business itself, other than acting as the sole general partner of the Operating Partnership, issuing equity from time to time and guaranteeing certain debt of the Operating Partnership. The Company itself is not directly obligated under any indebtedness, but guarantees some of the debt of the Operating Partnership. The Operating Partnership owns substantially all of the assets of the Company either directly or through its subsidiaries, conducts the operations of the Company’s business and is structured as a limited partnership with no publicly traded equity. Except for net proceeds from equity issuances by the Company, which the Company generally contributes to the Operating Partnership in exchange for units of partnership interest, the Operating Partnership generates the capital required by the Company’s business through the Operating Partnership’s operations, by the Operating Partnership’s incurrence of indebtedness or through the issuance of units of partnership interest.
Noncontrolling interests and stockholders’ equity and partners’ capital are the main areas of difference between the consolidated financial statements of the Company and those of the Operating Partnership. The common limited partnership interests in the Operating Partnership are accounted for as partners’ capital in the Operating Partnership’s financial statements and, to the extent not held by the Company, as noncontrolling interests in the Company’s financial statements. The Operating Partnership’s financial statements reflect the noncontrolling interest in Kilroy Realty Finance Partnership, L.P., a Delaware limited partnership (the “Finance Partnership”). This noncontrolling interest represents the Company’s 1% indirect general partnership interest in the Finance Partnership, which is directly held by Kilroy Realty Finance, Inc., a wholly owned subsidiary of the Company. The differences between stockholders’ equity, partners’ capital and noncontrolling interests result from the differences in the equity issued by the Company and the Operating Partnership, and in the Operating Partnership’s noncontrolling interest in the Finance Partnership.
We believe combining the quarterly reports on Form 10-Q of the Company and the Operating Partnership into this single report results in the following benefits:
Combined reports better reflect how management and the analyst community view the business as a single operating unit;
Combined reports enhance investors’ understanding of the Company and the Operating Partnership by enabling them to view the business as a whole and in the same manner as management;
Combined reports are more efficient for the Company and the Operating Partnership and result in savings in time, effort and expense; and
Combined reports are more efficient for investors by reducing duplicative disclosure and providing a single document for their review.
To help investors understand the significant differences between the Company and the Operating Partnership, this report presents the following separate sections for each of the Company and the Operating Partnership:
consolidated financial statements;
the following notes to the consolidated financial statements:
Note 8, Stockholders’ Equity of the Company;
Note 9, Partners’ Capital of the Operating Partnership;

i


Note 13, Net Income Available to Common Stockholders Per Share of the Company; and
Note 14, Net Income Available to Common Unitholders Per Unit of the Operating Partnership;
“Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
—Liquidity and Capital Resources of the Company;” and
—Liquidity and Capital Resources of the Operating Partnership.”
This report also includes separate sections under Part I, Item 4. Controls and Procedures and separate Exhibit 31 and Exhibit 32 certifications for each of the Company and the Operating Partnership to establish that the Chief Executive Officer and the Chief Financial Officer of each entity have made the requisite certifications and that the Company and Operating Partnership are compliant with Rule 13a-15 or Rule 15d-15 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and 18 U.S.C. §1350.


ii


KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
QUARTERLY REPORT FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2015
TABLE OF CONTENTS
 
 
 
 
Page
 
 
PART I – FINANCIAL INFORMATION
 
Item 1.
 
 
 
 
  
 
  
 
  
Item 1.
 
 
 
 
 
 
 
 
 
 
 
Item 2.
  
Item 3.
 
Item 4.
 
 
 
PART II – OTHER INFORMATION
 
Item 1.
 
Item 1A.
 
Item 2.
 
Item 3.
 
Item 4.
 
Item 5.
 
Item 6.
 
 




PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS (UNAUDITED) OF KILROY REALTY CORPORATION

KILROY REALTY CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
 
September 30, 2015
 
December 31, 2014
ASSETS
(unaudited)
 
 
REAL ESTATE ASSETS:
 
 
 
Land and improvements
$
850,280

 
$
877,633

Buildings and improvements
4,028,044

 
4,059,639

Undeveloped land and construction in progress (Note 2)
1,475,718

 
1,120,660

Total real estate assets held for investment
6,354,042

 
6,057,932

Accumulated depreciation and amortization
(999,557
)
 
(947,664
)
Total real estate assets held for investment, net ($176,947 and $211,755 of VIE, respectively, Note 1)
5,354,485

 
5,110,268

REAL ESTATE ASSETS AND OTHER ASSETS HELD FOR SALE, NET

 
8,211

CASH AND CASH EQUIVALENTS
567,940

 
23,781

RESTRICTED CASH (Note 1)
8,130

 
75,185

MARKETABLE SECURITIES (Note 12)
12,638

 
11,971

CURRENT RECEIVABLES, NET (Note 5)
11,533

 
7,229

DEFERRED RENT RECEIVABLES, NET (Note 5)
183,352

 
156,416

DEFERRED LEASING COSTS AND ACQUISITION-RELATED INTANGIBLE ASSETS, NET (Note 4)
173,457

 
201,926

DEFERRED FINANCING COSTS, NET
18,709

 
18,374

PREPAID EXPENSES AND OTHER ASSETS, NET
23,148

 
20,375

TOTAL ASSETS
$
6,353,392

 
$
5,633,736

LIABILITIES AND EQUITY
 
 
 
LIABILITIES:
 
 
 
Secured debt (Notes 6 and 12)
$
475,923

 
$
546,292

Unsecured debt, net (Notes 6 and 12)
2,181,382

 
1,783,121

Unsecured line of credit (Notes 6 and 12)

 
140,000

Accounts payable, accrued expenses and other liabilities
249,980

 
225,830

Accrued distributions (Note 15)
34,993

 
32,899

Deferred revenue and acquisition-related intangible liabilities, net (Note 4)
127,473

 
132,239

Rents received in advance and tenant security deposits
46,579

 
49,363

Liabilities of real estate assets held for sale

 
56

Total liabilities
3,116,330

 
2,909,800

COMMITMENTS AND CONTINGENCIES (Note 11)

 

EQUITY:
 
 
 
Stockholders’ Equity (Note 8):
 
 
 
Preferred stock, $.01 par value, 30,000,000 shares authorized:
 
 
 
6.875% Series G Cumulative Redeemable Preferred stock, $.01 par value, 4,600,000 shares authorized, 4,000,000 shares issued and outstanding ($100,000 liquidation preference)
96,155

 
96,155

6.375% Series H Cumulative Redeemable Preferred stock, $.01 par value, 4,000,000 shares authorized, issued and outstanding ($100,000 liquidation preference)
96,256

 
96,256

Common stock, $.01 par value, 150,000,000 shares authorized, 92,220,367 and 86,259,684 shares issued and outstanding, respectively
922

 
863

Additional paid-in capital
3,042,330

 
2,635,900

Distributions in excess of earnings
(62,850
)
 
(162,964
)
Total stockholders’ equity
3,172,813

 
2,666,210

Noncontrolling Interests:
 
 
 
Common units of the Operating Partnership (Note 7)
57,913

 
51,864

Noncontrolling interest in consolidated subsidiary (Note 1)
6,336

 
5,862

Total noncontrolling interests
64,249

 
57,726

Total equity
3,237,062

 
2,723,936

TOTAL LIABILITIES AND EQUITY
$
6,353,392

 
$
5,633,736


See accompanying notes to consolidated financial statements.

1


KILROY REALTY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited; in thousands, except share and per share data)
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2015
 
2014
 
2015
 
2014
REVENUES
 
 
 
 
 
 
 
Rental income
$
129,510

 
$
115,221

 
$
391,892

 
$
338,911

Tenant reimbursements
11,681

 
11,346

 
40,280

 
33,399

Other property income
362

 
2,457

 
1,690

 
7,650

Total revenues
141,553

 
129,024

 
433,862

 
379,960

EXPENSES
 
 
 
 
 
 
 
Property expenses
26,684

 
25,801

 
78,264

 
75,448

Real estate taxes
12,087

 
11,008

 
37,232

 
32,728

Provision for bad debts

 
58

 
289

 
58

Ground leases
862

 
771

 
2,451

 
2,306

General and administrative expenses
10,799

 
11,138

 
36,200

 
33,806

Acquisition-related expenses
4

 
431

 
397

 
1,268

Depreciation and amortization
49,422

 
50,032

 
152,567

 
148,647

Total expenses
99,858

 
99,239

 
307,400

 
294,261

OTHER (EXPENSES) INCOME
 
 
 
 
 
 
 
Interest income and other net investment (loss) gain (Note 12)
(694
)
 
(9
)
 
177

 
587

Interest expense (Note 6)
(12,819
)
 
(16,608
)
 
(44,561
)
 
(49,880
)
Total other (expenses) income
(13,513
)
 
(16,617
)
 
(44,384
)
 
(49,293
)
INCOME FROM CONTINUING OPERATIONS BEFORE GAINS ON SALES OF REAL ESTATE
28,182

 
13,168

 
82,078

 
36,406

Gain on sale of land (Note 3)

 

 
17,268

 
3,490

Gains on sales of depreciable operating properties (Note 3)
78,522

 

 
109,950

 

INCOME FROM CONTINUING OPERATIONS
106,704

 
13,168

 
209,296

 
39,896

DISCONTINUED OPERATIONS (Note 1)
 
 
 
 
 
 
 
Income from discontinued operations

 
548

 

 
2,091

Gains on dispositions of discontinued operations

 
5,587

 

 
110,391

Total income from discontinued operations

 
6,135

 

 
112,482

NET INCOME
106,704

 
19,303

 
209,296

 
152,378

Net income attributable to noncontrolling common units of the Operating
   Partnership
(1,945
)
 
(321
)
 
(3,850
)
 
(3,011
)
NET INCOME ATTRIBUTABLE TO KILROY REALTY CORPORATION
104,759

 
18,982

 
205,446

 
149,367

PREFERRED DIVIDENDS
(3,313
)
 
(3,313
)
 
(9,938
)
 
(9,938
)
NET INCOME AVAILABLE TO COMMON STOCKHOLDERS
$
101,446

 
$
15,669

 
$
195,508

 
$
139,429

Income from continuing operations available to common stockholders per common
   share – basic (Note 13)
$
1.10

 
$
0.11

 
$
2.18

 
$
0.34

Income from continuing operations available to common stockholders per common
   share – diluted (Note 13)
$
1.09

 
$
0.11

 
$
2.17

 
$
0.33

Net income available to common stockholders per share – basic (Note 13)
$
1.10

 
$
0.18

 
$
2.18

 
$
1.67

Net income available to common stockholders per share – diluted (Note 13)
$
1.09

 
$
0.18

 
$
2.17

 
$
1.63

Weighted average common shares outstanding – basic (Note 13)
92,150,341

 
83,161,323

 
89,077,012

 
82,525,033

Weighted average common shares outstanding – diluted (Note 13)
92,639,065

 
85,110,456

 
89,593,261

 
84,622,622

Dividends declared per common share
$
0.35

 
$
0.35

 
$
1.05

 
$
1.05











See accompanying notes to consolidated financial statements.

2


KILROY REALTY CORPORATION
CONSOLIDATED STATEMENTS OF EQUITY
(Unaudited; in thousands, except share and per share/unit data)
 
 
 
 
Common Stock
 
Total
Stock-
holders’
Equity
 
Noncontrolling Interests
 
Total
Equity
 
Preferred
Stock
 
Number of
Shares
 
Common
Stock
 
Additional
Paid-in
Capital
 
Distributions
in Excess of
Earnings
 
BALANCE AS OF DECEMBER 31, 2013
$
192,411

 
82,153,944

 
$
822

 
$
2,478,975

 
$
(210,896
)
 
$
2,461,312

 
$
54,848

 
$
2,516,160

Net income
 
 
 
 
 
 
 
 
149,367

 
149,367

 
3,011

 
152,378

Issuance of common stock
 
 
370,700

 
4

 
22,132

 
 
 
22,136

 
 
 
22,136

Issuance of share-based compensation awards
 
 
 
 
 
 
1,281

 
 
 
1,281

 
 
 
1,281

Noncash amortization of share-based compensation
 
 
 
 
 
 
10,345

 
 
 
10,345

 
 
 
10,345

Exercise of stock options
 
 
482,000

 
4

 
20,533

 
 
 
20,537

 
 
 
20,537

Repurchase of common stock, stock options and restricted stock units
 
 
(48,017
)
 
 
 
(2,861
)
 
 
 
(2,861
)
 
 
 
(2,861
)
Settlement of restricted stock units for shares of common stock
 
 
108,529

 
 
 

 
 
 

 
 
 

Common shares issued in connection with early exchange of 4.25% Exchangeable Notes
 
 
431,270

 
4

 
219

 
 
 
223

 
 
 
223

Common shares received in connection with capped call option transactions
 
 
(111,206
)
 
 
 
 
 
 
 

 
 
 

Exchange of common units of the Operating Partnership
 
 
1,000

 
 
 
28

 
 
 
28

 
(28
)
 

Adjustment for noncontrolling interest
 
 
 
 
 
 
(370
)
 
 
 
(370
)
 
370

 

Contribution by noncontrolling interest in consolidated subsidiary
 
 
 
 
 
 
 
 
 
 
 
 
336

 
336

Preferred dividends
 
 
 
 
 
 
 
 
(9,938
)
 
(9,938
)
 
 
 
(9,938
)
Dividends declared per common share and common unit ($1.05 per share/unit)
 
 
 
 
 
 
 
 
(88,332
)
 
(88,332
)
 
(1,896
)
 
(90,228
)
BALANCE AS OF SEPTEMBER 30, 2014
$
192,411

 
83,388,220

 
$
834

 
$
2,530,282

 
$
(159,799
)
 
$
2,563,728

 
$
56,641

 
$
2,620,369

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


 
 
 
Common Stock
 
Total
Stock-
holders’
Equity
 
Noncontrolling Interests
 
Total
Equity
 
Preferred
Stock
 
Number of
Shares
 
Common
Stock
 
Additional
Paid-in
Capital
 
Distributions
in Excess of
Earnings
 
BALANCE AS OF DECEMBER 31, 2014
$
192,411

 
86,259,684

 
$
863

 
$
2,635,900

 
$
(162,964
)
 
$
2,666,210

 
$
57,726

 
$
2,723,936

Net income
 
 
 
 
 
 
 
 
205,446

 
205,446

 
3,850

 
209,296

Issuance of common stock (Note 8)
 
 
5,640,033

 
56

 
387,453

 
 
 
387,509

 
 
 
387,509

Issuance of share-based compensation awards
 
 

 
 
 
1,268

 
 
 
1,268

 
 
 
1,268

Noncash amortization of share-based compensation
 
 
 
 
 
 
13,621

 
 
 
13,621

 
 
 
13,621

Exercise of stock options (Note 10)
 
 
265,000

 
3

 
11,289

 
 
 
11,292

 
 
 
11,292

Repurchase of common stock, stock options and restricted stock units
 
 
(39,317
)
 
 
 
(3,121
)
 
 
 
(3,121
)
 
 
 
(3,121
)
Settlement of restricted stock units for shares of common stock
 
 
78,937

 
 
 

 
 
 

 
 
 

Exchange of common units of the Operating Partnership
 
 
16,030

 
 
 
467

 
 
 
467

 
(467
)
 

Adjustment for noncontrolling interest
 
 
 
 
 
 
(4,547
)
 
 
 
(4,547
)
 
4,547

 

Contribution by noncontrolling interest in consolidated subsidiary
 
 
 
 
 
 
 
 
 
 
 
 
474

 
474

Preferred dividends
 
 
 
 
 
 
 
 
(9,938
)
 
(9,938
)
 
 
 
(9,938
)
Dividends declared per common share and common unit ($1.05 per share/unit)
 
 
 
 
 
 
 
 
(95,394
)
 
(95,394
)
 
(1,881
)
 
(97,275
)
BALANCE AS OF SEPTEMBER 30, 2015
$
192,411

 
92,220,367

 
$
922

 
$
3,042,330

 
$
(62,850
)
 
$
3,172,813

 
$
64,249

 
$
3,237,062



See accompanying notes to consolidated financial statements.

3


KILROY REALTY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited; in thousands)
 
 
Nine Months Ended September 30,
 
2015
 
2014
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income
$
209,296

 
$
152,378

Adjustments to reconcile net income to net cash provided by operating activities
(including discontinued operations):
 
 
 
Depreciation and amortization of building and improvements and leasing costs
150,531

 
148,878

Increase in provision for bad debts
289

 
58

Depreciation of furniture, fixtures and equipment
2,036

 
1,731

Noncash amortization of share-based compensation awards
11,272

 
8,817

Noncash amortization of deferred financing costs and debt discounts and premiums
1,412

 
3,563

Noncash amortization of net below market rents (Note 4)
(6,769
)
 
(6,216
)
Gain on sale of land (Note 3)
(17,268
)
 
(3,490
)
Gains on sales of depreciable operating properties (Note 3)
(109,950
)
 

Gains on dispositions of discontinued operations (Note 1)

 
(110,391
)
Noncash amortization of deferred revenue related to tenant-funded tenant improvements
(9,957
)
 
(7,695
)
Straight-line rents
(35,530
)
 
(15,245
)
Net change in other operating assets
(9,356
)
 
(795
)
Net change in other operating liabilities
16,606

 
25,671

Net cash provided by operating activities
202,612

 
197,264

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Expenditures for development and redevelopment properties and undeveloped land
(311,916
)
 
(292,803
)
Expenditures for acquisition of development properties (Note 2)
(130,609
)
 
(97,727
)
Expenditures for operating properties
(71,756
)
 
(93,977
)
Expenditures for acquisition of operating properties

 
(106,125
)
Net proceeds received from dispositions of land and operating properties (Note 3)
319,639

 
368,381

Decrease in acquisition-related deposits
3,200

 
1,000

Issuance of note receivable
(3,000
)
 

Decrease in restricted cash (Note 1)
57,776

 
32,293

Net cash used in investing activities
(136,666
)
 
(188,958
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Net proceeds from issuance of common stock (Note 8)
387,509

 
22,136

Borrowings on unsecured revolving credit facility
250,000

 
365,000

Repayments on unsecured revolving credit facility
(390,000
)
 
(410,000
)
Principal payments on secured debt (Note 6)
(67,335
)
 
(7,315
)
Net proceeds from the issuance of unsecured debt (Note 6)
397,776

 
395,528

Repayments of unsecured debt

 
(83,000
)
Repayments for early redemption of exchangeable senior notes

 
(37,092
)
Financing costs
(4,534
)
 
(8,043
)
Repurchase of common stock and restricted stock units
(3,121
)
 
(2,861
)
Proceeds from exercise of stock options (Note 10)
11,292

 
20,537

Contributions from noncontrolling interests in consolidated subsidiary
474

 
336

Dividends and distributions paid to common stockholders and common unitholders
(93,910
)
 
(88,540
)
Dividends and distributions paid to preferred stockholders and preferred unitholders
(9,938
)
 
(9,938
)
Net cash provided by financing activities
478,213

 
156,748

Net increase in cash and cash equivalents
544,159

 
165,054

Cash and cash equivalents, beginning of period
23,781

 
35,377

Cash and cash equivalents, end of period
$
567,940

 
$
200,431


4


KILROY REALTY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS – (Continued)
(Unaudited; in thousands)

 
Nine Months Ended September 30,
 
2015
 
2014
SUPPLEMENTAL CASH FLOWS INFORMATION:
 
 
 
Cash paid for interest, net of capitalized interest of $37,010 and $33,533 as of September 30, 2015 and 2014, respectively
$
45,678

 
$
42,633

NONCASH INVESTING TRANSACTIONS:
 
 
 
Accrual for expenditures for operating properties and development and redevelopment properties
$
89,009

 
$
92,693

Tenant improvements funded directly by tenants
$
12,944

 
$
23,069

Assumption of other liabilities in connection with development acquisitions
$
5,070

 
$
2,300

Release of holdback funds to third party
$
9,279

 
$

NONCASH FINANCING TRANSACTIONS:
 
 
 
Accrual of dividends and distributions payable to common stockholders and common unitholders
$
33,353

 
$
30,258

Accrual of dividends and distributions payable to preferred stockholders and preferred unitholders
$
1,656

 
$
1,656

Exchange of common units of the Operating Partnership into shares of the Company’s common stock
$
467

 
$
28






































See accompanying notes to consolidated financial statements.

5





ITEM 1: FINANCIAL STATEMENTS (UNAUDITED) OF KILROY REALTY, L.P.

KILROY REALTY, L.P.
CONSOLIDATED BALANCE SHEETS
(in thousands, except unit data)
 
 
September 30, 2015
 
December 31, 2014
ASSETS 
(unaudited)
 
 
REAL ESTATE ASSETS:
 
 
 
Land and improvements
$
850,280

 
$
877,633

Buildings and improvements
4,028,044

 
4,059,639

Undeveloped land and construction in progress (Note 2)
1,475,718

 
1,120,660

Total real estate assets held for investment
6,354,042

 
6,057,932

Accumulated depreciation and amortization
(999,557
)
 
(947,664
)
Total real estate assets held for investment, net ($176,947 and $211,755 of VIE, respectively, Note 1)
5,354,485

 
5,110,268

REAL ESTATE ASSETS AND OTHER ASSETS HELD FOR SALE, NET

 
8,211

CASH AND CASH EQUIVALENTS
567,940

 
23,781

RESTRICTED CASH (Note 1)
8,130

 
75,185

MARKETABLE SECURITIES (Note 12)
12,638

 
11,971

CURRENT RECEIVABLES, NET (Note 5)
11,533

 
7,229

DEFERRED RENT RECEIVABLES, NET (Note 5)
183,352

 
156,416

DEFERRED LEASING COSTS AND ACQUISITION-RELATED INTANGIBLE ASSETS, NET (Note 4)
173,457

 
201,926

DEFERRED FINANCING COSTS, NET
18,709

 
18,374

PREPAID EXPENSES AND OTHER ASSETS, NET
23,148

 
20,375

TOTAL ASSETS
$
6,353,392

 
$
5,633,736

LIABILITIES AND CAPITAL
 
 
 
LIABILITIES:
 
 
 
Secured debt (Notes 6 and 12)
$
475,923

 
$
546,292

Unsecured debt, net (Notes 6 and 12)
2,181,382

 
1,783,121

Unsecured line of credit (Notes 6 and 12)

 
140,000

Accounts payable, accrued expenses and other liabilities
249,980

 
225,830

Accrued distributions (Note 15)
34,993

 
32,899

Deferred revenue and acquisition-related intangible liabilities, net (Note 4)
127,473

 
132,239

Rents received in advance and tenant security deposits
46,579

 
49,363

Liabilities of real estate assets held for sale

 
56

Total liabilities
3,116,330

 
2,909,800

COMMITMENTS AND CONTINGENCIES (Note 11)
 
 
 
CAPITAL:
 
 
 
Partners’ Capital (Note 9):
 
 
 
6.875% Series G Cumulative Redeemable Preferred units, 4,000,000 units issued and
outstanding ($100,000 liquidation preference)
96,155

 
96,155

6.375% Series H Cumulative Redeemable Preferred units, 4,000,000 units issued and
outstanding ($100,000 liquidation preference)
96,256

 
96,256

Common units, 92,220,367 and 86,259,684 held by the general partner and 1,788,170 and 1,804,200
held by common limited partners issued and outstanding, respectively
3,034,341


2,521,900

Total partners’ capital
3,226,752

 
2,714,311

Noncontrolling interests in consolidated subsidiaries (Note 1)
10,310


9,625

Total capital
3,237,062


2,723,936

TOTAL LIABILITIES AND CAPITAL
$
6,353,392


$
5,633,736





See accompanying notes to consolidated financial statements.

6


KILROY REALTY, L.P.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited; in thousands, except unit and per unit data)

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2015
 
2014
 
2015
 
2014
REVENUES
 
 
 
 
 
 
 
Rental income
$
129,510

 
$
115,221

 
$
391,892

 
$
338,911

Tenant reimbursements
11,681

 
11,346

 
40,280

 
33,399

Other property income
362

 
2,457

 
1,690

 
7,650

Total revenues
141,553

 
129,024

 
433,862

 
379,960

EXPENSES
 
 
 
 
 
 
 
Property expenses
26,684

 
25,801

 
78,264

 
75,448

Real estate taxes
12,087

 
11,008

 
37,232

 
32,728

Provision for bad debts

 
58

 
289

 
58

Ground leases
862

 
771

 
2,451

 
2,306

General and administrative expenses
10,799

 
11,138

 
36,200

 
33,806

Acquisition-related expenses
4

 
431

 
397

 
1,268

Depreciation and amortization
49,422

 
50,032

 
152,567

 
148,647

Total expenses
99,858

 
99,239

 
307,400

 
294,261

OTHER (EXPENSES) INCOME
 
 
 
 
 
 
 
Interest income and other net investment (loss) gain (Note 12)
(694
)
 
(9
)
 
177

 
587

Interest expense (Note 6)
(12,819
)
 
(16,608
)
 
(44,561
)
 
(49,880
)
Total other (expenses) income
(13,513
)
 
(16,617
)
 
(44,384
)
 
(49,293
)
INCOME FROM CONTINUING OPERATIONS BEFORE GAINS ON SALES OF REAL ESTATE
28,182

 
13,168

 
82,078

 
36,406

Gain on sale of land (Note 3)

 

 
17,268

 
3,490

Gains on sales of depreciable operating properties (Note 3)
78,522

 

 
109,950

 

INCOME FROM CONTINUING OPERATIONS
106,704

 
13,168

 
209,296

 
39,896

DISCONTINUED OPERATIONS (Note 1)
 
 
 
 
 
 
 
Income from discontinued operations

 
548

 

 
2,091

Gains on dispositions of discontinued operations

 
5,587

 

 
110,391

Total income from discontinued operations

 
6,135

 

 
112,482

NET INCOME
106,704

 
19,303

 
209,296

 
152,378

Net income attributable to noncontrolling interests in consolidated subsidiaries
(64
)
 
(59
)
 
(211
)
 
(201
)
NET INCOME ATTRIBUTABLE TO KILROY REALTY, L.P.
106,640

 
19,244

 
209,085

 
152,177

PREFERRED DISTRIBUTIONS
(3,313
)
 
(3,313
)
 
(9,938
)
 
(9,938
)
NET INCOME AVAILABLE TO COMMON UNITHOLDERS
$
103,327

 
$
15,931

 
$
199,147

 
$
142,239

Income from continuing operations available to common unitholders per unit – basic (Note 14)
$
1.10

 
$
0.11

 
$
2.18

 
$
0.34

Income from continuing operations available to common unitholders per unit –
   diluted (Note 14)
$
1.09

 
$
0.11

 
$
2.17

 
$
0.33

Net income available to common unitholders per unit – basic (Note 14)
$
1.10

 
$
0.18

 
$
2.18

 
$
1.67

Net income available to common unitholders per unit – diluted (Note 14)
$
1.09

 
$
0.18

 
$
2.17

 
$
1.63

Weighted average common units outstanding – basic (Note 14)
93,938,783

 
84,965,523

 
90,869,696

 
84,329,317

Weighted average common units outstanding – diluted (Note 14)
94,427,507

 
86,914,656

 
91,385,945

 
86,426,906

Dividends declared per common unit
$
0.35

 
$
0.35

 
$
1.05

 
$
1.05











See accompanying notes to consolidated financial statements.

7


KILROY REALTY, L.P.
CONSOLIDATED STATEMENTS OF CAPITAL
(Unaudited; in thousands, except unit and per unit data)
 
 
Partners’ Capital
 
Total
Partners’ 
Capital
 
Noncontrolling Interests in Consolidated Subsidiaries
 
 
 
Preferred
Units
 
Number of
Common
Units
 
Common
Units
 
 
 
Total
Capital
BALANCE AS OF DECEMBER 31, 2013
$
192,411

 
83,959,144

 
$
2,315,361

 
$
2,507,772

 
$
8,388

 
$
2,516,160

Net income
 
 
 
 
152,177

 
152,177

 
201

 
152,378

Issuance of common units
 
 
370,700

 
22,136

 
22,136

 
 
 
22,136

Issuance of share-based compensation awards
 
 
 
 
1,281

 
1,281

 
 
 
1,281

Noncash amortization of share-based compensation
 
 
 
 
10,345

 
10,345

 
 
 
10,345

Exercise of stock options
 
 
482,000

 
20,537

 
20,537

 
 
 
20,537

Repurchase of common units, stock options and restricted stock units
 
 
(48,017
)
 
(2,861
)
 
(2,861
)
 
 
 
(2,861
)
Settlement of restricted stock units
 
 
108,529

 

 

 
 
 

Common units issued in connection with early exchange of 4.25% Exchangeable Senior Notes
 
 
431,270

 
223

 
223

 
 
 
223

Common units received in connection with capped call option transactions
 
 
(111,206
)
 
 
 
 
 
 
 

Contribution by noncontrolling interest in consolidated subsidiary
 
 
 
 
 
 
 
 
336

 
336

Preferred distributions
 
 
 
 
(9,938
)
 
(9,938
)
 
 
 
(9,938
)
Distributions declared per common unit ($1.05 per unit)
 
 
 
 
(90,228
)
 
(90,228
)
 
 
 
(90,228
)
BALANCE AS OF SEPTEMBER 30, 2014
$
192,411

 
85,192,420

 
$
2,419,033

 
$
2,611,444

 
$
8,925

 
$
2,620,369

 
 
 
 
 
 
 
 
 
 
 
 




 
Partners’ Capital
 
Total
Partners’ 
Capital
 
Noncontrolling Interests in Consolidated Subsidiaries
 
 
 
Preferred
Units
 
Number of
Common
Units
 
Common
Units
 
 
Total
Capital
BALANCE AS OF DECEMBER 31, 2014
$
192,411

 
88,063,884

 
$
2,521,900

 
$
2,714,311

 
$
9,625

 
$
2,723,936

Net income
 
 
 
 
209,085

 
209,085

 
211

 
209,296

Issuance of common units (Note 9)
 
 
5,640,033

 
387,509

 
387,509

 
 
 
387,509

Issuance of share-based compensation awards
 
 
 
 
1,268

 
1,268

 
 
 
1,268

Noncash amortization of share-based compensation
 
 
 
 
13,621

 
13,621

 
 
 
13,621

Exercise of stock options (Note 10)
 
 
265,000

 
11,292

 
11,292

 
 
 
11,292

Repurchase of common units, stock options and restricted stock units
 
 
(39,317
)
 
(3,121
)
 
(3,121
)
 
 
 
(3,121
)
Settlement of restricted stock units
 
 
78,937

 

 

 
 
 

Contribution by noncontrolling interest in consolidated subsidiary
 
 
 
 
 
 
 
 
474

 
474

Preferred distributions
 
 
 
 
(9,938
)
 
(9,938
)
 
 
 
(9,938
)
Distributions declared per common unit ($1.05 per unit)
 
 
 
 
(97,275
)
 
(97,275
)
 
 
 
(97,275
)
BALANCE AS OF SEPTEMBER 30, 2015
$
192,411

 
94,008,537

 
$
3,034,341

 
$
3,226,752

 
$
10,310

 
$
3,237,062













See accompanying notes to consolidated financial statements.

8


KILROY REALTY, L.P.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited; in thousands)

 
Nine Months Ended September 30,
 
2015
 
2014
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income
$
209,296

 
$
152,378

Adjustments to reconcile net income to net cash provided by operating activities
 (including discontinued operations):
 
 
 
Depreciation and amortization of building and improvements and leasing costs
150,531

 
148,878

Increase in provision for bad debts
289

 
58

Depreciation of furniture, fixtures and equipment
2,036

 
1,731

Noncash amortization of share-based compensation awards
11,272

 
8,817

Noncash amortization of deferred financing costs and debt discounts and premiums
1,412

 
3,563

Noncash amortization of net below market rents (Note 4)
(6,769
)
 
(6,216
)
Gain on sale of land (Note 3)
(17,268
)
 
(3,490
)
Gains on sales of depreciable operating properties (Note 3)
(109,950
)
 

Gains on dispositions of discontinued operations (Note 1)

 
(110,391
)
Noncash amortization of deferred revenue related to tenant-funded tenant improvements
(9,957
)
 
(7,695
)
Straight-line rents
(35,530
)
 
(15,245
)
Net change in other operating assets
(9,356
)
 
(795
)
Net change in other operating liabilities
16,606

 
25,671

Net cash provided by operating activities
202,612

 
197,264

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Expenditures for development and redevelopment properties and undeveloped land
(311,916
)
 
(292,803
)
Expenditures for acquisition of development properties (Note 2)
(130,609
)
 
(97,727
)
Expenditures for operating properties
(71,756
)
 
(93,977
)
Expenditures for acquisition of operating properties

 
(106,125
)
Net proceeds received from dispositions of land and operating properties (Note 3)
319,639

 
368,381

Decrease in acquisition-related deposits
3,200

 
1,000

Issuance of note receivable
(3,000
)
 

Decrease in restricted cash (Note 1)
57,776

 
32,293

Net cash used in investing activities
(136,666
)
 
(188,958
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Net proceeds from issuance of common stock (Note 8)
387,509

 
22,136

Borrowings on unsecured revolving credit facility
250,000

 
365,000

Repayments on unsecured revolving credit facility
(390,000
)
 
(410,000
)
Principal payments on secured debt (Note 6)
(67,335
)
 
(7,315
)
Net proceeds from the issuance of unsecured debt (Note 6)
397,776

 
395,528

Repayments of unsecured debt

 
(83,000
)
Repayments for early redemptions of exchangeable senior notes

 
(37,092
)
Financing costs
(4,534
)
 
(8,043
)
Repurchase of common stock and restricted stock units
(3,121
)
 
(2,861
)
Proceeds from exercise of stock options (Note 10)
11,292

 
20,537

Contributions from noncontrolling interests in consolidated subsidiary
474

 
336

Dividends and distributions paid to common unitholders
(93,910
)
 
(88,540
)
Dividends and distributions paid to preferred unitholders
(9,938
)
 
(9,938
)
Net cash provided by financing activities
478,213

 
156,748

Net increase in cash and cash equivalents
544,159

 
165,054

Cash and cash equivalents, beginning of period
23,781

 
35,377

Cash and cash equivalents, end of period
$
567,940

 
$
200,431

 

9


KILROY REALTY, L.P.
CONSOLIDATED STATEMENTS OF CASH FLOWS – (Continued)
(Unaudited; in thousands)

 
Nine Months Ended September 30,
 
2015
 
2014
SUPPLEMENTAL CASH FLOWS INFORMATION:
 
 
 
Cash paid for interest, net of capitalized interest of $37,010 and $33,533 as of September 30, 2015 and 2014, respectively
$
45,678

 
$
42,633

NONCASH INVESTING TRANSACTIONS:
 
 
 
Accrual for expenditures for operating properties and development and redevelopment properties
$
89,009

 
$
92,693

Tenant improvements funded directly by tenants
$
12,944

 
$
23,069

Assumption of other liabilities in connection with development acquisitions
$
5,070

 
$
2,300

Release of holdback funds to third party
$
9,279

 
$

NONCASH FINANCING TRANSACTIONS:
 
 
 
Accrual of dividends and distributions payable to common unitholders
$
33,353

 
$
30,258

Accrual of dividends and distributions payable to preferred unitholders
$
1,656

 
$
1,656









































See accompanying notes to consolidated financial statements.

10


KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Three Months Ended September 30, 2015 and 2014

1.    Organization and Basis of Presentation

Organization

Kilroy Realty Corporation (the “Company”) is a self-administered real estate investment trust (“REIT”) active in premier office submarkets along the West Coast. We own, develop, acquire and manage real estate assets, consisting primarily of Class A properties in the coastal regions of Los Angeles, Orange County, San Diego County, the San Francisco Bay Area and greater Seattle, 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”). 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 generally conduct substantially all of our operations through the Operating Partnership. Unless stated otherwise or the context indicates otherwise, the terms “Kilroy Realty Corporation” or the “Company,” “we,” “our,” and “us” refer to Kilroy Realty Corporation and its consolidated subsidiaries and the term “Operating Partnership” refers to Kilroy Realty, L.P. and its consolidated subsidiaries. The descriptions of our business, employees, and properties apply to both the Company and the Operating Partnership.

Our stabilized portfolio of operating properties was comprised of the following office properties at September 30, 2015:

 
Number of
Buildings
 
Rentable
Square Feet
 
Number of
Tenants
 
Percentage 
Occupied
Stabilized Office Properties
101

 
13,050,947

 
509

 
95.6
%

Our stabilized portfolio includes all of our properties with the exception of development and redevelopment properties currently under construction or committed for construction, “lease-up” properties, real estate assets held for sale and undeveloped land. We define redevelopment properties as those properties for which we expect to spend significant development and construction costs on the existing or acquired buildings pursuant to a formal plan, the intended result of which is a higher economic return on the property. As of September 30, 2015, we had no redevelopment properties. 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 September 30, 2015, we had one development project in the “lease-up” phase.

As of September 30, 2015, the following properties were excluded from our stabilized portfolio:

 
Number of
Properties/Projects
 
Estimated Rentable
Square Feet
Development projects in lease-up
1
 
108,539

Development projects under construction (1)

7
 
2,322,000

________________________
(1)
Estimated rentable square feet upon completion.

Our stabilized portfolio also excludes our near-term and future development pipeline, which as of September 30, 2015 was comprised of ten development sites, representing approximately 106 gross acres of undeveloped land.

As of September 30, 2015, all of our stabilized portfolio properties and development projects were owned and all of our business was conducted in the state of California with the exception of twelve office properties and a recently acquired development opportunity located in the state of Washington. All of our properties and development projects are 100% owned, excluding a development project owned by Redwood City Partners, LLC (“Redwood LLC”), a consolidated subsidiary.

As of September 30, 2015, the Company owned an approximate 98.1% common general partnership interest in the Operating Partnership. The remaining approximate 1.9% common limited partnership interest in the Operating Partnership as of September 30, 2015 was owned by non-affiliated investors and certain of our executive officers and directors (see Note 7). Both the general

11


KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)


and limited common partnership interests in the Operating Partnership are denominated in common units. Generally, the number of common units held by the Company is equivalent to the number of outstanding shares of the Company’s common stock, and the rights of all the common units to quarterly distributions and payments in liquidation mirror those of the Company’s common stockholders. The common limited partners have certain redemption rights as provided in the Operating Partnership’s Seventh Amended and Restated Agreement of Limited Partnership, as amended, the “Partnership Agreement” (see Note 7).

Kilroy Realty Finance, Inc., which is a wholly owned subsidiary of the Company, is the sole general partner of the Finance Partnership and owns a 1.0% common general partnership interest in the Finance Partnership. The Operating Partnership owns the remaining 99.0% common limited partnership interest. Kilroy Services, LLC (“KSLLC”), which is a wholly owned subsidiary of the Operating Partnership, is the entity through which we generally conduct substantially all of our development activities. With the exception of the Operating Partnership and Redwood LLC, all of our subsidiaries are wholly owned.

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, Redwood LLC and all of our wholly owned and controlled 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, Redwood LLC and all wholly-owned and controlled subsidiaries of the Operating Partnership. All intercompany balances and transactions have been eliminated in the consolidated financial statements.

The accompanying interim financial statements have been prepared by management in accordance with accounting principles generally accepted in the United States of America (“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 for complete financial statements. In the opinion of management, the accompanying interim financial statements reflect all adjustments of a normal and recurring nature that are considered necessary for a fair presentation of the results for the interim periods presented. However, the results of operations for the interim periods are not necessarily indicative of the results that may be expected for the year ending December 31, 2015. The interim financial statements for the Company and the Operating Partnership should be read in conjunction with the audited consolidated financial statements and notes thereto included in our annual report on Form 10-K for the year ended December 31, 2014.

Certain amounts in the consolidated statements of operations for prior periods have been reclassified to reflect the activity of discontinued operations disposed of prior to the Company's adoption of Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”) No. 2014-08 (“ASU 2014-08”). Properties classified as held for sale and/or disposed of prior to January 1, 2015 are presented as discontinued operations for all periods presented.

Variable Interest Entities

At September 30, 2015, the consolidated financial statements of the Company and the Operating Partnership included one variable interest entity (“VIE”), in which we were deemed to be the primary beneficiary. The VIE, Redwood LLC, was established in the second quarter of 2013 in connection with an undeveloped land acquisition. The impact of consolidating the VIE increased the Company’s total assets, liabilities and noncontrolling interests by approximately $180.7 million (of which $176.9 million related to real estate held for investment on our consolidated balance sheet), approximately $43.5 million and approximately $6.3 million, respectively, as of September 30, 2015.
As of December 31, 2014, the consolidated financial statements of the Company and the Operating Partnership included two VIEs, in which we were deemed to be the primary beneficiary. One of the VIEs was Redwood LLC and the remaining VIE was established during the fourth quarter of 2014 to facilitate potential Section 1031 Exchanges. During the three months ended March 31, 2015, the Section 1031 Exchange was successfully completed and the VIE was terminated. As a result, $59.2 million of our restricted cash balance at December 31, 2014, which related to prior period disposition proceeds that were set aside to facilitate the Section 1031 Exchange, was released from escrow. The impact of consolidating the VIEs increased the Company’s total assets, liabilities and noncontrolling interests by approximately $219.6 million (of which $211.8 million related to real estate held for investment on our consolidated balance sheet), approximately $23.4 million and approximately $5.9 million, respectively, as of December 31, 2014.




12


KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)



Adoption of New Accounting Pronouncements    
Effective January 1, 2015, the Company adopted FASB ASU 2014-08, which changed the criteria for reporting discontinued operations while enhancing disclosures in this area. Under the new guidance, only disposals representing a strategic shift that has (or will have) a major effect on an entity's operations and final results, such as a major line of business, a major geographical area or a major equity investment, should be presented as discontinued operations. The Company adopted and applied the new guidance on a prospective basis as required by ASU 2014-08. Therefore, real estate assets classified as held for sale and/or disposed of subsequent to January 1, 2015 that do not represent a strategic shift will be presented in continuing operations for all periods presented. Properties classified as held for sale and/or disposed of prior to January 1, 2015 will continue to be presented in discontinued operations for prior periods presented. In accordance with this guidance, the operations of the ten properties sold during the nine months ended September 30, 2015 are presented in continuing operations for the nine months ended September 30, 2015. For the nine months ended September 30, 2014, discontinued operations includes the income and gains on all of the properties sold in 2014.

Recently Issued Accounting Pronouncements    

On August 12, 2015, the FASB issued ASU No. 2015-14 (“ASU 2015-14”) to defer the effective date of ASU No. 2014-09, which outlines a single comprehensive model for entities to use in accounting for revenues arising from contracts with customers and notes that lease contracts with customers are a scope exception. Public business entities may elect to adopt the amendments as of the original effective date; however, adoption is required for annual reporting periods beginning after December 15, 2017. The Company is currently assessing the impact of the guidance on our consolidated financial statements and notes to our consolidated financial statements.
On April 7, 2015, the FASB issued ASU No. 2015-03 (“ASU 2015-03”) to amend the accounting guidance for the presentation of debt issuance costs. The standard requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. On August 18, 2015, the FASB also issued ASU No. 2015-15 (“ASU 2015-15”) to address the presentation of debt issuance costs specifically related to line-of-credit arrangements. The standard clarifies that an entity may defer and present debt issuance costs as an asset and amortize the costs ratably over the term of the line-of-credit arrangement, regardless of whether there are an outstanding borrowings on the line-of credit arrangement. ASU 2015-03 and ASU 2015-15 are effective for public business entities for fiscal years beginning after December 15, 2015 and retrospective application is required. Early adoption of the guidance is permitted. The Company expects to adopt the guidance effective January 1, 2016 and the guidance will not have any impact on our consolidated statements of operations, equity/capital, or cash flows.
In February 2015, the FASB issued an update (“ASU 2015-02”) Amendments to the Consolidation Analysis to ASC Topic 810, Consolidation.  ASU 2015-02 affects reporting entities that are required to evaluate whether they should consolidate certain legal entities.  Specifically, the amendments: (i) modify the evaluation of whether limited partnerships and similar legal entities are VIEs or voting interest entities, (ii) eliminate the presumption that a general partner should consolidate a limited partnership, (iii) affect the consolidated analysis of reporting entities that are involved with VIEs, and (iv) provide a scope exception for certain entities.  ASU 2015-02 is effective for interim and annual reporting periods beginning after December 15, 2015.  The Company is  currently assessing  the impact of the guidance on our consolidated financial statements and notes to our consolidated financial statements. 




13


KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)


2.    Acquisitions

Development Project Acquisitions

During the nine months ended September 30, 2015, we acquired the development opportunities listed below from unrelated third parties. The acquisitions were funded with proceeds from various sources, including the Company’s unsecured revolving credit facility, at-the-market stock offering program (see Note 8) and prior year disposition proceeds. As of September 30, 2015, the underlying assets were included as undeveloped land and construction in progress in our consolidated balance sheets.

Project
 
Date of Acquisition
 
City/Submarket
 
Type
 
Purchase Price
(in millions)
333 Dexter (1)
 
February 13, 2015
 
South Lake Union, WA
 
Land
 
$
49.5

100 Hooper (2)
 
July 7, 2015
 
San Francisco, CA
 
Land
 
78.0

Total Acquisitions
 
 
 
 
 
 
 
$
127.5

________________________
(1)
Acquisition comprised of four adjacent parcels in the South Lake Union submarket of Seattle, Washington located at 330 Dexter Avenue North, 333 Dexter Avenue North, 401 Dexter Avenue North, and 400 Aurora Avenue North. In connection with this acquisition, we also assumed $2.4 million in accrued liabilities and acquisition costs that are not included in the purchase price above.
(2)
In connection with this acquisition, we assumed $4.1 million in accrued liabilities and acquisition costs that are not included in the purchase price above. The Company expects to develop and own two buildings on the site encompassing office and production design and repair space totaling approximately 400,000 square feet.

3.    Dispositions

Operating Property Dispositions

The following table summarizes the operating properties sold during the nine months ended September 30, 2015:
Location
 
Property Type
 
Month of Disposition
 
Number of Buildings
 
Rentable Square Feet
15050 NE 36th Street, Redmond, WA
 
Office
 
April
 
1
 
122,103

San Diego Properties - Tranche 1 (1)
 
Office
 
April
 
3
 
384,468

San Diego Properties - Tranche 2 (2)
 
Office
 
July
 
6
 
539,823

Total Dispositions
 
 
 
 
 
10
 
1,046,394

________________________ 
(1)
The San Diego Properties - Tranche 1 include the following: 10770 Wateridge Circle, 6200 Greenwich Drive, and 6220 Greenwich Drive.
(2)
The San Diego Properties - Tranche 2 include the following: 6260 Sequence Drive, 6290 Sequence, Drive, 6310 Sequence Drive, 6340 Sequence Drive, 6350 Sequence Drive, and 4921 Directors Place.

The ten buildings encompassing 1,046,394 rentable square feet were sold for a gross sales price of $309.2 million, resulting in a gain on sale of $110.0 million.

Land Disposition

During the nine months ended September 30, 2015, the Company sold a land parcel located at 17150 Von Karman in Irvine, California for a gross sales price of $26.0 million, resulting in a gain on sale of $17.3 million.

14


KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)



4.    Deferred Leasing Costs and Acquisition-Related Intangible Assets and Liabilities, net

The following table summarizes our deferred leasing costs and acquisition-related intangible assets (acquired value of leasing costs, above-market operating leases, in-place leases and below-market ground lease obligation) and intangible liabilities (acquired value of below-market operating leases and above-market ground lease obligation) as of September 30, 2015 and December 31, 2014:

 
September 30, 2015
 
December 31, 2014
 
(in thousands)
Deferred Leasing Costs and Acquisition-Related Intangible Assets, net:
 
 
 
Deferred leasing costs
$
201,605

 
$
216,102

Accumulated amortization
(74,997
)
 
(74,904
)
Deferred leasing costs, net
126,608

 
141,198

Above-market operating leases
11,026

 
20,734

Accumulated amortization
(6,380
)
 
(13,952
)
Above-market operating leases, net
4,646

 
6,782

In-place leases
74,071

 
97,250

Accumulated amortization
(32,331
)
 
(43,773
)
In-place leases, net
41,740

 
53,477

Below-market ground lease obligation
490

 
490

Accumulated amortization
(27
)
 
(21
)
Below-market ground lease obligation, net
463

 
469

Total deferred leasing costs and acquisition-related intangible assets, net
$
173,457

 
$
201,926

Acquisition-Related Intangible Liabilities, net: (1)
 
 
 
Below-market operating leases
$
55,136

 
$
68,051

Accumulated amortization
(26,632
)
 
(30,620
)
Below-market operating leases, net
28,504

 
37,431

Above-market ground lease obligation
6,320

 
6,320

Accumulated amortization
(399
)
 
(324
)
Above-market ground lease obligation, net
5,921

 
5,996

Total acquisition-related intangible liabilities, net
$
34,425

 
$
43,427

________________________
(1)
Included in deferred revenue and acquisition-related intangible liabilities, net in the consolidated balance sheets.

The following table sets forth amortization related to deferred leasing costs and acquisition-related intangibles for the three and nine months ended September 30, 2015 and 2014, including amounts attributable to discontinued operations for 2014:

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2015
 
2014
 
2015
 
2014
 
(in thousands)
Deferred leasing costs (1)
$
6,932

 
$
7,132

 
$
20,847

 
$
20,683

Above-market operating leases (2)
487

 
1,305

 
2,135

 
4,230

In-place leases (1)
3,073

 
5,169

 
11,710

 
17,090

Below-market ground lease obligation (3)
2

 
2

 
6

 
6

Below-market operating leases (4)
(2,228
)
 
(2,940
)
 
(8,905
)
 
(10,054
)
Above-market ground lease obligation (5)
(26
)
 
(26
)
 
(76
)
 
(76
)
Total
$
8,240

 
$
10,642

 
$
25,717

 
$
31,879

________________________
(1)
The amortization of deferred leasing costs related to lease incentives is recorded to rental income and other deferred leasing costs and in-place leases is recorded to depreciation and amortization expense in the consolidated statements of operations for the periods presented.
(2)
The amortization of above-market operating leases is recorded as a decrease to rental income in the consolidated statements of operations for the periods presented.
(3)
The amortization of the below-market ground lease obligation is recorded as an increase to ground lease expense in the consolidated statements of operations for the periods presented.
(4)
The amortization of below-market operating leases is recorded as an increase to rental income in the consolidated statements of operations for the periods presented.
(5)
The amortization of the above-market ground lease obligation is recorded as a decrease to ground lease expense in the consolidated statements of operations for the periods presented.

15


KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)



The following table sets forth the estimated annual amortization expense related to deferred leasing costs and acquisition-related intangibles as of September 30, 2015 for future periods:

Year
Deferred Leasing Costs
 
Above-Market Operating Leases (1)
 
In-Place Leases
 
Below-Market Ground Lease Obligation (2)
 
Below-Market Operating Leases (3)
 
Above-Market Ground Lease Obligation (4)