Kilroy Realty Corporation (KRC)

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Kilroy Realty Corporation (KRC)

Q2 2008 Earnings Call

July 29, 2008 2:00 pm ET

Executives

Richard Moran - EVP and CFO

John Kilroy - President and CEO

Jeff Hawken - EVP and COO

Analysts

Lou Taylor - Deutsche Bank

Matthew Wokasch - Green Street Advisors

Dave Aubuchon - Baird

Irwin Guzman - Citi

George Auerbach - Merrill Lynch

Presentation

Operator

Good day, ladies and gentlemen and welcome to the second quarter 2008 Kilroy Realty Corp. earnings call. (Operator Instructions).

I would now like to turn the presentation over to your host for today's call, Mr. Richard Moran. You may proceed.

Richard Moran

Hi. Thank you very much and good morning everyone. Thank you for joining us. With me today are John Kilroy, our CEO; Jeff Hawken, our COO; Tyler Rose, our Treasurer and Heidi Roth, our Controller.

At the outset, I need to say that some of the information we will be discussing this morning is forward-looking in nature. Please refer to our supplemental package for a statement regarding the forward-looking information in this call and in the supplemental. This call is being telecast live on our website and will be available for replay for the next 10 days, both by phone and over the internet.

Our press release and supplemental package have been filed on a Form 8-K with the SEC and both are also available on our website. We released our second quarter results yesterday afternoon; FFO was $0.78 a share. That includes a $0.09 a share increasing our bad debt expense related to the Favrille situation that's outlined in our press release.

John will start the call with an overview of the quarter and our key markets, I'll add financial highlights and update our 2008 earnings guidance and then we will be happy to take your questions. John?

John Kilroy

Thanks, Dick, and hello everyone. Thanks for joining us. The second quarter was very similar to the first quarter for us at KRC. We continue to see economic uncertainty affecting our tenant's decision-making and we made solid leasing progress in spite of that uncertainty.

In terms of the economy, there is no question that continuing doubt about the future is affecting the pace at which transactions are getting executed. Job growth is slowed in our markets, but we haven't seen this translate into significant tenant contractions yet.

California's unemployment rates for June showed the moderate increases from the prior quarter with current rates of 7% in Los Angeles, 5.2% in Orange County and 5.9% in San Diego county. We were pleased with our leasing results during the quarter and continue to exceed our forecast.

So far this year, we've executed over 1.3 million square feet of new and renewing leases. During the quarter, we renewed two larger leases that were scheduled to expire in 2009.

In June, Epson signed a 10-year renewal on its 136,000 square foot lease in our Kilroy Airport Center Long Beach project. The lease was set to expire in October of 2009. Rent was up 19% on a cash basis and 39% on a GAAP basis.

And in May, Pacific Bell renewed its lease with us in Sorrento Mesa for a new five-year term. The lease covers a 133,000 square feet at our 6350 Sequence Drive project. Rent was up 10% on a cash basis and 24% on a GAAP basis. These transactions have given us a good head start on our 2009 expirations, which now totaled 1.5 million square feet.

On the development front, we just signed a lease with DIRECTV for the remaining 25,000 square feet at our redevelopment project in El Segundo, bringing that project to a 100% leased. Our combined in process development and redevelopment program encompassing about 611,000 square feet and six projects is now 69% leased.

Three of the projects are fully leased and we continue to see reasonably good interest on our small medical office building and our two office buildings in Sorrento Mesa as well as a 19% leased Sabre Springs Corporate Center project.

Now let me review the Favrille situation. They have been one of our long-standing, publicly-traded biotech tenants in the Sorrento Mesa submarket. After much promise and five years of effort, Favrille's cancer drug failed in its Phase III trials and the company has reduced it work force and faces liquidation.

The company leases both office and biotech space from us totaling a 130,000 square feet in our Pacific Center Court project. We have some protection against the loss in our letter of credit, which Dick will discuss in more detail, along with the impact on our near term financial results.

We are aggressively marketing the project and have several perspective tenants that have already toured the space. Favrille's failure was not economically or economy related, but rather the often binary nature of young life science companies.

Separately as you know, the company has three distinct leases with Intuit, including a regional headquarters lease on the 56 Corridor, a data center lease in the UTC Governor Park submarket and a lease with Intuit's credit card division in Calabasas.

In July, we negotiated a lease termination for the 90,000 square feet they occupy in the Calabasas market. That division is growing quickly, and our space no longer accommodates them. They held an option to terminate the lease in 2010, but agreed to pay us $6.3 million in cash now in order to vacate early.

Essentially, we received the present value of the remaining lease obligation. While the Calabasas market has been reasonably strong, Countrywide has a significant amount of space in the greater 101 Corridor area and the market may come under additional pressure as [BFA] figures out what to do with Countrywide's real estate. Our property is well located along the Freeway. And with the lease termination payment in hand, we will get a head start on our re-leasing efforts.

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