Kilroy Realty 8K Other events | KRC 15 Sep 03

EXHIBIT 99.1

ITEM 6. SELECTED FINANCIAL DATA

Kilroy Realty Corporation Consolidated

(in thousands, except per share, square footage and occupancy data)

	Year Ended December 31,
	2002			2001			2000			1999			1998
Statements of Operations Data:(1)
Rental income	$	180,576		$	175,693		$	155,061		$	135,111		$	111,638
Tenant reimbursements		21,429			20.684			18,080			15,403			14,054
Other property income		2,672			6,182			1,625			2,033			3,092

Total revenues		204,677			202,559			174,766			152,547			128,784

Property expenses		30,251			28,182			21,767			19,208			17,954
Real estate taxes		15,212			14,635			13,723			11,530			9,745
Provision for bad debts		6,672			3,723			1,796			2,189			924
Ground leases		1,354			1,507			1,643			1,397			1,223
General and administrative expenses		12,557			11,692			10,535			8,686			7,519
Provision for pre-development costs														1,700
Interest expense		35,380			41,024			38,205			26,149			20,568
Depreciation and amortization		58,933			50,563			39,834			32,572			25,176

Total expenses		160,359			151,326			127,503			101,731			84,809

Interest income		513			1,030			1,878			1,175			1,698
Interest income from related party								2,724
Equity in earnings from unconsolidated real estate								191

Total other income		513			1,030			4,793			1,175			1,698

Income from continuing operations before net gain on disposition of operating properties and minority interests		44,831			52,263			52,056			51,991			45,673
Net gain on disposition of operating properties		896			4,714			11,256			46

Income from continuing operations before minority interests		45,727			56,977			63,312			52,037			45,673
Minority interests:
Distributions on Cumulative Redeemable Preferred units		(13,500	)		(13,500	)		(13,500	)		(9,560	)		(5,556	)
Minority interest in earnings of Operating Partnership		(4,436	)		(4,025	)		(6,166	)		(5,907	)		(5,074	)
Recognition of previously reserved Development LLC preferred return		3,908
Minority interest in earnings of Development LLCs		(1,024	)		(3,701	)		(421	)		(199	)

Total minority interests		(15,052	)		(21,226	)		(20,087	)		(15,666	)		(10,630	)

Income from continuing operations		30,675			35,751			43,225			36,371			35,043

Discontinued operations:
Revenues from discontinued operations		9,058			9,898			9,437			8,205			7,543
Expenses from discontinued operations		(4,598	)		(5,349	)		(5,299	)		(4,108	)		(3,217	)
Net gain on disposition of discontinued operations		6,570
Minority interest attributable to discontinued operations		(1,393	)		(477	)		(517	)		(573	)		(547	)

Total discontinued operations		9,637			4,072			3,621			3,524			3,779

Net income before cumulative effect of change in accounting principle		40,312			39,823			46,846			39,895			38,822
Cumulative effect of change in accounting principle					(1,392	)

Net income	$	40,312		$	38,431		$	46,846		$	39,895		$	38,822

Share Data:
Weighted average shares outstanding—basic		27,450			27,167			26,599			27,701			26,989

Weighted average shares outstanding—diluted		27,722			27,373			26,755			27,727			27,060

Income from continuing operations per common share—basic	$	1.12		$	1.32		$	1.63		$	1.31		$	1.30

Income from continuing operations per common share—diluted	$	1.11		$	1.31		$	1.62		$	1.31		$	1.30

Net income per common share—basic	$	1.47		$	1.41		$	1.76		$	1.44		$	1.44

Net income per common share—diluted	$	1.45		$	1.40		$	1.75		$	1.44		$	1.43

Dividends declared per common share	$	1.98		$	1.92		$	1.80		$	1.68		$	1.62

	Kilroy Realty Corporation Consolidated
	December 31,
	2002			2001			2000			1999			1998
Balance Sheet Data:
Investment in real estate, before accumulated depreciation and amortization	$	1,686,218		$	1,600,994		$	1,496,477		$	1,410,238		$	1,194,284
Total assets		1,506,602			1,457,229			1,455,368			1,320,501			1,109,217
Total debt		762,037			714,587			723,688			553,516			405,383
Total liabilities		845,934			799,055			787,209			613,519			452,818
Total minority interests		220,697			217,546			226,734			234,053			180,500
Total stockholders’ equity		439,971			440,628			441,425			472,929			475,899

Other Data:
Funds From Operations(2)	$	97,940		$	91,558		$	83,471		$	80,631		$	71,174
Cash flows from:
Operating activities		95,554			106,082			74,009			84,635			73,429
Investing activities		(63,731	)		(73,406	)		(117,731	)		(192,795	)		(343,717	)
Financing activities		(32,533	)		(33,789	)		35,206			127,833			267,802
Office Properties:
Rentable square footage		7,447,605			7,225,448			6,624,423			6,147,985			5,600,459
Occupancy		91.1	%		93.9	%		96.2	%		96.4	%		95.7	%
Industrial Properties:
Rentable square footage		4,880,963			5,085,945			5,807,555			6,477,132			6,157,107
Occupancy		97.7	%		98.5	%		97.8	%		96.9	%		96.0	%

(1)

Certain line items within the Statements of Operations Data do not equal the amounts reported on the Company’s annual reports filed in previous years on Form 10-K. The variance is a result of the reclassification of the net income and net gains on the disposition of operating properties sold subsequent to December 31, 2001 to discontinued operations in accordance with SFAS 144 “Accounting for the Impairment of Disposal of Long-Lived Assets” (see Notes 2 and 21 in the Company’s consolidated financial statements).

(2)

As defined by the Board of Governors of the National Association of Real Estate Investment Trusts (“NAREIT”) in its March 1995 White Paper (and as clarified by the November 2000 NAREIT National Policy Bulletin which became effective on January 1, 2000), “Funds From Operations” represents net income (loss) before minority interests of common unitholders (computed in accordance with GAAP), excluding extraordinary items, as defined by GAAP, and gains and losses from sales of depreciable operating property, plus real estate related depreciation and amortization (excluding amortization of deferred financing costs and depreciation of non-real estate assets), and after adjustment for unconsolidated partnerships and joint ventures.

The Company considers Funds From Operations an appropriate alternative measure of performance for an equity REIT because it is predicated on cash flow analyses. While Funds From Operations is a relevant and widely used measure of operating performance of equity REITs, other equity REITS may use different methodologies for calculating Funds From Operations and, accordingly, Funds From Operations as disclosed by such other REITS may not be comparable to Funds From Operations published in this report. Therefore, 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. Funds From Operations should not be considered as a substitute 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. Further, Funds From Operations does not represent amounts available from management’s discretionary use because of needed capital reinvestment or expansion, debt service obligations, or other commitments and uncertainties.

Non-cash adjustments to arrive at Funds From Operations were as follows: in all periods, depreciation and amortization; in all periods except 2002, non-cash amortization of restricted stock grants; and in 2001, cumulative effect of change in accounting principle. For additional information, see “Non-GAAP Supplemental Financial Measure: Funds From Operations”, including a reconciliation of the Company’s GAAP net income to Funds from Operations for the years ended December 31, 2002, 2001 and 2000.

ITEM 7. 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 except to the extent the Company is required to do so in connection with its ongoing requirements under Federal securities laws to disclose material information. 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 Item 1—Business and under the caption “Factors Which May Influence Future Results of Operations” below. In light of these risks, uncertainties and assumptions, the forward-looking events discussed in this report might not occur.

Overview and Background

The Company, which owns, operates, develops, and acquires office and industrial real estate, primarily in Southern California, commenced operations upon the completion of its initial public offering in January 1997 and operates as a self-administered REIT. The Company owns its interests in all of its Properties through the Operating Partnership and the Finance Partnership and conducts substantially all of its operations through the Operating Partnership. The Company owned an 86.6% and 90.0% general partnership interest in the Operating Partnership as of December 31, 2002 and 2001, respectively. The Finance Partnership is a wholly-owned subsidiary of the Company.

Critical Accounting Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses for the reporting periods. Certain accounting policies are considered to be critical accounting estimates, as they require management to make assumptions about matters that are highly uncertain at the time the estimate is made and changes in the accounting estimate are reasonably likely to occur from period to period. Management believes the following critical accounting policies reflect the Company’s more significant judgments and estimates used in the preparation of the consolidated financial statements. For a summary of all the Company’s significant accounting policies see Note 2 to the Company’s consolidated financial statements.

Evaluation of asset impairment. The Company evaluates a property for potential impairment whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. In the event that these periodic assessments reflect that the carrying amount of a property exceeds the sum of the undiscounted cash flows (excluding interest) that are expected to result from the use and eventual disposition of the property, the Company would recognize an impairment loss to the extent the carrying amount exceeded the estimated fair value of the property. The estimation of expected future net cash flows is inherently uncertain and relies on subjective assumptions dependent upon future and current market conditions and events that affect the ultimate

value of the property. It requires management to make assumptions related to future rental rates, tenant allowances, operating expenditures, property taxes, capital improvements, occupancy levels, and the estimated proceeds generated from the future sale of the property.

The Company had not recorded any such impairment losses at December 31, 2002, 2001 and 2000. However the Company’s estimate of future cash flows are subject to revision as management’s assessment of market conditions changes. If the Company determines it is necessary to recognize a material impairment loss the Company’s financial position, and results of operations may be adversely affected.

Allowances for uncollectible current tenant receivables and unbilled deferred rents receivable. Tenant receivables and unbilled deferred rent receivables are carried net of the allowances for uncollectible tenant receivables and unbilled deferred rent. Management’s determination of the adequacy of these allowances requires significant judgments and estimates.

Current tenant receivables consist primarily of amounts due for contractual lease payments, reimbursements of common area maintenance expenses, property taxes and other expenses recoverable from tenants. Management’s determination of the adequacy of the allowance for uncollectible current tenant receivables is performed using a methodology that incorporates both a specific identification and aging analysis and includes an overall evaluation of the Company’s historical loss trends and the current economic and business environment. The specific identification methodology relies on factors such as the age and nature of the receivables, the payment history and financial condition of the tenant, the Company’s assessment of the tenant’s ability to meet its lease obligations, and the status of negotiations of any disputes with the tenant. The Company’s allowance also includes a reserve based on historical loss trends not associated with any specific tenant. This reserve as well as the Company’s specific identification reserve is reevaluated quarterly based on economic conditions and the current business environment.

Unbilled deferred rents receivable represents the amount that the cumulative straight-line rental income recorded to date exceeds cash rents billed to date under the lease agreement. Given the longer-term nature of these types of receivables, management’s determination of the adequacy of the allowance for unbilled deferred rents receivables is based primarily on historical loss experience. Management evaluates the allowance for unbilled deferred rents receivable using a specific identification methodology for the Company’s significant tenants assessing the tenants’ financial condition and its ability to meet its lease obligations. In addition, the allowance includes a reserve based upon the Company’s historical experience and current and anticipated future economic conditions that is not associated with any specific tenant.

Management’s estimate for the required allowances is reevaluated quarterly as economic and market conditions and the creditworthiness of the Company’s tenants change. For example, during 2001 and 2002, the Company experienced an increased incidence of bad debts. In light of this increased activity and the state of the overall economy and its effect on the collection of outstanding receivable balances, the Company increased its bad debt reserve levels. For the years ended December 31, 2002, 2001 and 2000 the Company recorded a provision for bad debts of approximately 3.4%, 1.9% and 1.0% of recurring revenue. Of the provision of 3.4% recorded for the year ended December 31, 2002, approximately 1.8% related specifically to reserves recorded for receivables from Peregrine. See further discussion on Peregrine in “Item 7: Managements Discussion and Analysis of Financial Condition and Results of Operations—Factors Which May Influence Future Results of Operations”. The Company’s reserve levels could continue to increase if the economy continues to weaken and/or if the Company continues to experience an increased incidence of bad debts. If the Company continues to experience increased levels of bad debt expense or if the Company experiences write-offs in excess of its allowances, the Company’s financial position, revenues and results of operations would be adversely affected.

Depreciable lives of leasing costs. The Company incurs certain capital costs in connection with leasing its properties. These leasing costs primarily include lease commissions and tenant improvements. Leasing costs are amortized on the straight-line method over the shorter of the estimated useful life of the asset or the estimated remaining term of the associated lease, ranging from one to 15 years. Management reevaluates the remaining

useful life of these costs as the creditworthiness of the Company’s tenants change. If management determines that the estimated remaining life of the respective lease has changed, the Company adjusts the amortization period and, therefore, the depreciation expense recorded each period may fluctuate. If the Company experiences increased levels of amortization or depreciation expense due to changes in the estimated useful lives of leasing costs, the Company’s financial position, and results of operations may be adversely affected.

Factors Which May Influence Future Results of Operations

Projected future occupancy rates, rental rate increases, increased levels of bad debt and operating result trends. For the years ended December 31, 2002 and 2001, average occupancy in the Company’s stabilized portfolio was 93.9% and 95.7%, respectively. The Company’s occupancy rate was 93.7% at December 31, 2002. Given the challenging economic environment, the increased incidence of lease defaults, and the uncertainty surrounding existing leases with Peregrine and Brobeck, the Company believes this occupancy rate is not likely to be sustainable. See additional discussion of Peregrine and Brobeck in “Recent Information Regarding Significant Tenants” below. In addition, as of December 31, 2002, leases representing approximately 11.6% and 9.9% of the square footage of the Company’s stabilized portfolio are scheduled to expire in 2003 and 2004, respectively. Although the Company has stringent lease underwriting standards and continually evaluates the financial capacity of both its prospective and existing tenants to proactively manage portfolio credit risk, downturns in tenants’ businesses may weaken tenants’ financial conditions and could result in additional defaults under lease obligations. If the Company is unable to lease a significant portion of any available space or space scheduled to expire, or if the Company experiences additional significant tenant defaults as a result of the current economic downturn, its results of operations, financial condition and cash flows would be adversely affected.

As of December 31, 2002, the Office and Industrial Properties represented 81.4% and 18.6%, respectively, of the Company’s annualized base rent. Leases representing approximately 1.6 million square feet of office space, or 16.5% of the Company’s annualized base rent, and 0.9 million square feet of industrial space, or 3.3% of the Company’s annualized base rent, are scheduled to expire during the next two years. Management believes that the average rental rates for its Properties are approximately at currently quoted market rates. The Company attained an average rental rate increase of 4.7% on a GAAP basis and an average rental rate decrease of 3.0% on a cash basis for the year ended December 31, 2002. Change in rents on a cash basis is calculated as the change between the stated rent for a new or renewed lease and the expiring stated rent for the same space. Given the challenging economic environment, the Company’s declining occupancy rate, and the uncertainty surrounding existing leases with Peregrine and Brobeck, the Company believes rental rate increases on a GAAP and cash basis are not likely to be obtainable in the near future. See additional discussion of Peregrine and Brobeck in “Recent Information Regarding Significant Tenants” below.

During 2001 and 2002, the Company experienced an increased incidence of bad debts. In light of this increased activity and the state of the overall economy and its effect on the collection of outstanding receivable balances, the Company increased its bad debt reserve levels. These reserve levels could continue to increase if the economy continues to weaken and/or if the Company continues to experience an increased incidence of bad debts. If the Company experiences continued or increased levels of bad debt expense, the Company’s financial position, revenues and results of operations would be adversely affected.

The Company’s operating results are and will continue to be affected by uncertainties and problems associated with the deregulation of the utility industry in California since 94.6% of the total rentable square footage of the Company’s stabilized portfolio is located in California. Energy deregulation has resulted in higher utility costs in some areas of the state and intermittent service interruptions. In addition, as a result of the events of September 11, 2002, the Company’s annual insurance costs increased across its portfolio approximately 14%. As of the date of this report, the Company has not experienced any material negative effects arising from either of these issues because approximately 71% (based on net rentable square footage) of the Company’s current

leases require tenants to pay utility costs and property insurance premiums directly, thereby limiting the Company’s exposure. The remaining 29% of the Company’s leases provide that the tenants reimburse the Company for these costs in excess of a base year amount.

Recent information regarding significant tenants. As of December 31, 2002, the Company’s largest tenant, The Boeing Company, leased an aggregate of approximately 1.0 million rentable square feet of office space under eight separate leases, representing approximately 9.5% of the Company’s total annual base rental revenues. One lease encompassing approximately 248,150 rentable square feet at 909 N. Sepulveda in El Segundo, California expired February 28, 2003. The Boeing Company vacated the space under this lease upon lease expiration. The remaining Boeing Company leases are scheduled to expire at various dates between July 2004 and March 2009.

As previously reported, the Company’s second largest tenant, Peregrine, filed for bankruptcy in September 2002. Peregrine leased four office buildings totaling approximately 423,900 rentable square feet under four separate leases; however, as part of the bankruptcy filing, Peregrine filed a motion to reject two of the leases encompassing 182,127 rentable square feet. In February 2003, the bankruptcy court approved the rejection of these leases.

Additional details of the leases are as follows:

	Rentable Square Feet	Annual Base Rental Revenues (in thousands)
Leases Rejected:
Building 1	52,375	$	1,682
Building 3 (1)	129,752		4,308

	182,127		5,990

Leases Not Rejected (2):
Building 2	129,680		3,779
Building 5 (3)	112,067		3,265

	241,747		7,044

Total	423,874	$	13,034

(1)

In February 2003, this building was 100% released to a new tenant. The lease is expected to commence in August 2003.

(2)

Peregrine has recently indicated that it intends to file a motion to reject these two leases.

(3)

Includes 64,496 rentable square feet of executed subleases with annual base rental revenue of approximately $2.1 million.

The Company’s sixth largest tenant, Brobeck, leases two buildings totaling 161,500 rentable square feet with annual base rental revenues of $4.2 million. The two leases with Brobeck represent approximately 2.4% of the Company’s annual base rental revenues. In February 2003, Brobeck dissolved and began winding up its operations. Brobeck did not timely pay rent for either building for February 2003 and remains in possession of both buildings. The Company is currently pursuing legal action against Brobeck.

The Company’s financial position, revenues and results of operations will be materially adversely affected if the Company is unable to re-lease the space it expects will be vacated by the aforementioned tenants.

The Company’s financial position, revenues and results of operations would be adversely affected if any of the Company’s other significant tenants fail to renew their leases or renew leases on terms less favorable to the Company, or if any of them became bankrupt or insolvent or otherwise unable to satisfy their lease obligations.

Current submarket information. The demand for space in the Los Angeles County region continues to be challenging and not be as strong as the Company experienced from 1998 through 2000. Consequently, management cannot predict when the Company will see significant positive leasing momentum given the level of

direct vacancy and concentration of sublease space currently available in this market. At December 31, 2002, the Company’s Los Angeles stabilized office portfolio was 88.3% occupied with approximately 373,200 rentable square feet available for lease. As of December 31, 2002, leases representing an aggregate of approximately 515,100 and 447,600 rentable square feet were scheduled to expire during the 2003 and in 2004, respectively, in this submarket. In addition, at December 31, 2002, the Company had two development projects in lease-up in the Los Angeles region encompassing an aggregate of approximately 284,700 rentable square feet.

At December 31, 2002, the Company’s San Diego office portfolio was 93.1% occupied with approximately 211,400 rentable square feet available for lease. Occupied square footage at December 31, 2002 included 241,747 rentable square feet leased to Peregrine, and 161,500 rentable square feet leased to Brobeck. Given the uncertainty surrounding the existing leases with with Peregrine and Brobeck, some or all of this square footage could be added to the rentable square feet available for lease during 2003. In addition, as of December 31, 2002, leases representing an aggregate of approximately 107,100 and 50,900 rentable square feet were scheduled to expire during 2003 and in 2004, respectively, in the Company’s San Diego stabilized office portfolio. At December 31, 2002, the Company had one development project in lease-up in the San Diego region encompassing approximately 114,800 rentable square feet which was 100% leased at December 31, 2002. This building is currently expected to reach stabilized occupancy in the third quarter of 2003.

At December 31, 2002, the Company’s Orange County properties were 98.8% occupied with approximately 54,000 rentable square feet available for lease. As of December 31, 2002, leases representing an aggregate of approximately 461,100 and 528,400 rentable square feet were scheduled to expire during 2003 and in 2004, respectively, in this submarket. In addition, at December 31, 2002 the Company had one renovation property in lease-up in the Orange County region encompassing approximately 78,000 rentable square feet.

Management believes that the average rental rates for all of its Properties generally are equal to the current average quoted market rate across all of the submarkets in which the Properties are located, although individual Properties within any particular submarket presently may be leased at above or below the rental rates within that submarket. The Company cannot give any assurance that leases will be renewed or that available space will be re-leased at rental rates equal to or above the current rental rates. If the Company is unable to lease a significant portion of the presently available space or space scheduled to expire in 2003 and 2004 at any of its Properties, if existing tenants do not renew their leases, or if rental rates decrease, the Company’s results of operations, financial condition and cash flows would be adversely affected.

Current sublease space. As of December 31, 2002, approximately 1,090,600 rentable square feet, or 8.8% of the square footage in the Company’s stabilized portfolio was available for sublease, of which approximately 4.7% was vacant space and the remaining 4.1% was occupied. Of the total 8.8% of rentable square feet available for sublease, approximately 6.5% is located in Orange County, of which 4.4% represents space available in two Orange County industrial buildings, and approximately 1.8% is in San Diego County. If the square footage available for sublease increased in specific regions, the rental rates for space available for direct lease by the Company would be impacted which could impact the Company’s results of operations, financial condition and cash flows.

Projected development trends. During the two years ended December 31, 2002 and 2001, the Company added ten office buildings encompassing an aggregate of approximately 748,600 rentable square feet to the Company’s stabilized portfolio of operating properties for a total estimated investment of approximately $173.5 million. As of December 31, 2002, the Company had three office properties in lease-up encompassing an aggregate of approximately 399,500 rentable square feet. The Company’s in-process development pipeline at December 31, 2002 included one office project, encompassing approximately 209,000 rentable square feet, which is expected to stabilize in 2004. In addition, as of December 31, 2002, the Company owned approximately 58.2 acres of undeveloped land upon which the Company currently expects to develop an aggregate of approximately 1.1 million rentable square feet of office space within the next three to five years.

The Company has a proactive development planning process, which continually evaluates the size, timing, and scope of the Company’s development program, and as necessary, scales development to reflect the economic conditions and the real estate fundamentals that exist in the Company’s development submarkets. Given the current economic environment, the Company will most likely not be able to attain historical levels of growth from development in the near future, and may not be able to complete and lease development projects to stabilized portfolio occupancy rates within the timeframes experienced by the Company during the last two to three years.

Results of Operations

During the year ended December 31, 2002, the Company added six office buildings from its development program, encompassing an aggregate of approximately 436,200 rentable square feet, to the Company’s stabilized portfolio of operating properties. During the year ended December 31, 2001, the Company completed the development of four office buildings encompassing an aggregate of approximately 312,400 rentable square feet which were included in the Company’s stabilized portfolio of operating properties at December 31, 2002. The Company’s stabilized portfolio consists of all of the Company’s Office and Industrial Properties, excluding properties recently developed by the Company that have not yet reached 95% occupancy and are within one year following substantial completion (“lease-up” properties) and projects currently under construction, renovation or in pre-development. At December 31, 2002, the Company had three office buildings encompassing an aggregate of approximately 399,500 rentable square feet which were completed during the year ended December 31, 2002 and were in the lease-up phase, and one office renovation property encompassing approximately 78,000 rentable square feet. The Company also had one office building under construction which when completed is expected to encompass approximately 209,000 rentable square feet. In addition, as of December 31, 2002, the Company owned approximately 58 acres of undeveloped land upon which the Company currently expects to develop an aggregate of approximately 1.1 million rentable square feet of office space within the next three to five years.

During the year ended December 31, 2002, the Company acquired one industrial building, encompassing approximately 107,000 square feet for a purchase price of approximately $8.1 million. During the year ended December 31, 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.

During the year ended December 31, 2002, the Company disposed of five office and twelve industrial building encompassing an aggregate of approximately 204,500 and 308,800 rentable square feet, respectively, for an aggregate sales price of $48.2 million and a net gain of approximately $6.6 million. During the year ended December 31, 2001, the Company disposed of two office and seventeen industrial buildings encompassing approximately 80,100 and 721,900 aggregate rentable square feet, respectively, for an aggregate sales price of $70.4 million and a net gain of approximately $4.7 million.

The Company adopted Statement of Financial Accounting Standards No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”) on January 1, 2002. In accordance with the implementation provisions of SFAS 144, the operating results and gains or (losses) on property sales of real estate assets sold subsequent to December 31, 2001 are included in discontinued operations in the consolidated statement of operations. The Rental Operations discussion for the years ended December 31, 2002, 2001 and 2000 includes operating results for properties disposed of prior to December 31, 2001, but does not include operating results for properties disposed of during the year ended December 31, 2002 and during the six months ended June 30, 2003 (see Note 27 to the consolidated financial statements).

Rentable square footage in the Company’s portfolio of stabilized operating properties remained consistent at 12.3 million rentable square feet at December 31, 2002 and December 31, 2001. As of December 31, 2002, the Company’s portfolio of stabilized operating properties was comprised of 87 Office Properties encompassing 7.4 million rentable square feet and 50 Industrial Properties encompassing 4.9 million rentable square feet. The

stabilized portfolio occupancy rate at December 31, 2002 was 93.7%, with the Office and Industrial Properties 91.1% and 97.7% occupied, respectively, as of such date. The Company’s portfolio of stabilized operating properties at December 31, 2002 included the six office buildings the Company sold during the six months ended June 30, 2003 which encompassed approximately 260,900 rentable square feet.

Comparison of the Year Ended December 31, 2002 to the Year Ended December 31, 2001

Management internally evaluates the operating performance and financial results of its portfolio based on Net Operating Income for the following segments of commercial real estate property: Office Properties and Industrial Properties. The Company defines Net Operating Income as operating revenues from continuing operations (rental income, tenant reimbursements and other property income) less property and related expenses from continuing operations (property expenses, real estate taxes, provision for bad debts and ground leases). The Net Operating Income segment information presented within this Management’s Discussion and Analysis consists of the same Net Operating Income segment information disclosed in Note 20 of the Company’s consolidated financial statements in accordance with Statement of Financial Accounting Standards No. 131 “Disclosures about Segments of an Enterprise and Related Information.” The following table reconciles the Company’s Net Operating Income by segment to the Company’s net income for the years ended December 31, 2002 and 2001.

	Year Ended December 31,						Dollar Change			Percentage Change
	2002			2001			Dollar Change			Percentage Change
	(dollars in thousands)
Net Operating Income, as Defined
Office Properties	$	119,412		$	119,236		$	176		0.1	%
Industrial Properties		31,776			35,276			(3,500	)	(9.9	)

Total portfolio		151,188			154,512			(3,324	)	(2.2	)

Reconciliation to Consolidated Net Income:
Net Operating Income, as defined for reportable segments		151,188			154,512			(3,324	)	(2.2	)
Other expenses:
General and administrative expenses		12,557			11,692			865		7.4
Interest expense		35,380			41,024			(5,644	)	(13.8	)
Depreciation and amortization		58,933			50,563			8,370		16.6
Other income		513			1,030			(517	)	(50.2	)

Income from continuing operations before net gain on dispositions and minority interests		44,831			52,263			(7,432	)	(14.2	)
Net gain on disposition of operating properties		896			4,714			(3,818	)	(81.0	)

Income from continuing operations before minority interest		45,727			56,977			(11,250	)	(19.7	)
Minority interests attributable to continuing operations		(15,052	)		(21,226	)		6,174		29.1
Income from discontinued operations		9,637			4,072			5,565		136.7
Cumulative effect of change in accounting principle					(1,392	)		1,392		100.0

Net Income	$	40,312		$	38,431		$	1,881		4.9	%

Rental Operations

The following tables compare the Net Operating Income from continuing operations for the Office Properties and for the Industrial Properties for the years ended December 31, 2002 and 2001.

Office Properties

	Total Office Portfolio									Core Office Portfolio (1)
	2002		2001		Dollar Change			Percentage Change		2002		2001		Dollar Change			Percentage Change
	(dollars in thousands)
Operating revenues:
Rental income	$	145,593	$	137,880	$	7,713		5.6	%	$	120,453	$	121,044	$	(591	)	(0.5	)%
Tenant reimbursements		17,625		16,654		971		5.8			15,976		15,390		586		3.8
Other property income		2,583		5,843		(3,260	)	(55.8	)		2,312		417		1,895		454.4

Total	$	165,801	$	160,377	$	5,424		3.4	%	$	138,741	$	136,851	$	1,890		1.4

Property and related expenses:
Property expenses		27,265		25,603		1,662		6.5			23,716		23,153		563		2.4
Real estate taxes		12,191		11,136		1,055		9.5			10,023		9,192		831		9.0
Provision for bad debts		5,579		2,895		2,684		92.7			4,312		2,831		1,481		52.3
Ground leases		1,354		1,507		(153	)	(10.2	)		1,169		1,297		(128	)	(9.9	)

Total		46,389		41,141		5,248		12.8			39,220		36,473		2,747		7.5

Net Operating Income, as defined	$	119,412	$	119,236	$	176		0.1	%	$	99,521	$	100,378	$	(857	)	(0.9	)%

(1)

Stabilized office properties owned at January 1, 2001 and still owned at June 30, 2003.

Total revenues from Office Properties increased $5.4 million, or 3.4% to $165.8 million for the year ended December 31, 2002 compared to $160.4 million for the year ended December 31, 2001. Rental income from Office Properties increased $7.7 million, or 5.6% to $145.6 million for the year ended December 31, 2002 compared to $137.9 million for the year ended December 31, 2001. Rental income generated by the Core Office Portfolio decreased $0.6 million, or 0.5% to $120.4 million for the year ended December 31, 2002 compared to $121.0 million for the year ended December 31, 2001. This decrease was primarily attributable to a decline in occupancy in this portfolio. An increase of $9.2 million in rental income was generated by the office properties developed by the Company in 2002 and 2001 (the “Office Development Properties”), offset by a decrease of $0.9 million attributable to the office properties sold during 2001, net of the office property acquired in 2001 (the “Net Office Dispositions”).

Tenant reimbursements from Office Properties increased $1.0 million, or 5.8% to $17.6 million for the year ended December 31, 2002 compared to $16.7 million for the year ended December 31, 2001. An increase of $0.6 million, or 3.8% in tenant reimbursements was generated by the Core Office Portfolio. This was primarily due to the reimbursement of property expenses at one property at which the previous tenant paid the expenses directly. An increase of $0.5 million generated by the Office Development Properties was offset by a decrease of $0.1 million attributable to the Net Office Dispositions. Other property income from Office Properties decreased $3.3 million or 55.8% to $2.6 million for the year ended December 31, 2002 compared to $5.8 million for the year ended December 31, 2001. During the year ended December 31, 2001 the Company recognized a $5.4 million lease termination fee from eToys. During the year ended December 31, 2002 the Company recognized lease termination fees of $1.2 million and $0.7 million resulting from the early termination of leases at two buildings in San Diego. The remaining amounts in other property income from Office Properties for both periods consisted primarily of lease termination fees, management fees and tenant late charges.

Total expenses for Office Properties increased $5.2 million, or 12.8% to $46.4 million for the year ended December 31, 2002 compared to $41.2 million for the year ended December 31, 2001. Property expenses from Office Properties increased $1.7 million, or 6.5% to $27.3 million for the year ended December 31, 2002 compared to $25.6 million for the year ended December 31, 2001. An increase of $0.6 million in property expenses was attributable to the Core Office Portfolio. This increase was primarily attributable to the Company paying property expenses directly for one property at which the previous tenant paid the expenses directly. An increase of $1.3 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 $1.1 million, or 9.5% to $12.2 million for the year ended December 31, 2002 as compared to $11.1 million for the year ended December 31, 2001. Real estate taxes for the Core Office Portfolio increased $0.8 million, or 9.0% for the year ended December 31, 2002 compared to the comparable period in 2001. This increase was primarily due to refunds received for prior year real estate taxes successfully appealed by the Company during the year ended December 31, 2001. An increase of $0.3 million attributable to the Office Development Properties was partially offset by a decrease of $0.1 million attributable to the Net Office Dispositions. Ground lease expense decreased $0.2 million, or 10.2% for the year ended December 31, 2002 compared to the same period in 2001. Ground lease expense for the Core Office Portfolio decreased $0.1 million, or 9.9% for the year ended December 31, 2002 compared to the comparable period in 2001. During the second quarter of 2002 the Company renegotiated the ground leases at Kilroy Airport Center Long Beach resulting in a reduction of annual ground lease expense and simultaneously exercised the options to extend the ground leases for an additional fifty years. The ground leases now expire in July 2084. The provision for bad debts increased $2.7 million, or 92.7% to $5.6 million for the year ended December 31, 2002 compared to $2.9 million for the year ended December 31, 2001. During 2002, the Company increased its reserve for unbilled deferred rents specifically related to the Company’s watchlist tenants. The Company evaluates its reserve levels on a quarterly basis.

Net Operating Income, as defined, from Office Properties increased $0.2 million, or 0.1% to $119.4 million for the year ended December 31, 2002 compared to $119.2 million for the year ended December 31, 2001. A decrease of $0.8 million attributable to the Core Office Portfolio was offset by an increase of $1.7 million in the Office Development Properties and decrease of $0.7 million in Net Office Dispositions.

Industrial Properties

	Total Industrial Portfolio									Core Industrial Portfolio (1)
	2002		2001		Dollar Change			Percentage Change		2002		2001		Dollar Change			Percentage Change
	(dollars in thousands)
Operating revenues:
Rental income	$	34,983	$	37,813	$	(2,830	)	(7.5	)%	$	34,690	$	34,034	$	656		1.9	%
Tenant reimbursements		3,804		4,030		(226	)	(5.6	)		3,774		3,479		295		8.5
Other property income		89		339		(250	)	(73.7	)		89		7		82		1171.4

Total		38,876		42,182		(3,306	)	(7.8	)%		38,553		37,520		1,033		2.8

Property and related expenses:
Property expenses		2,986		2,579		407		15.8			2,985		2,116		869		41.1
Real estate taxes		3,021		3,499		(478	)	(13.7	)		2,985		3,118		(133	)	(4.3	)
Provision for bad debts		1,093		828		265		32.0			1,093		653		440		67.4

Total		7,100		6,906		194		2.8			7,063		5,887		1,176		20.0

Net Operating Income, as defined	$	31,776	$	35,276	$	(3,500	)	(9.9	)%	$	31,490	$	31,633	$	(143	)	(0.5	)%

(1)

Stabilized industrial properties owned at January 1, 2001 and still owned at June 30, 2003.

Total revenues from Industrial Properties decreased $3.3 million, or 7.8% to $38.9 million for the year ended December 31, 2002 compared to $42.2 million for the year ended December 31, 2001. Rental income from Industrial Properties decreased $2.8 million, or 7.5% to $35.0 million for the year ended December 31, 2002 compared to $37.8 million for the year ended December 31, 2001. Rental income generated by the Core Industrial Portfolio increased $0.7 million, or 1.9% for the year ended December 31, 2002 as compared to the year ended December 31, 2001. This increase was primarily attributable to holdover rent received at one property in the Orange County Portfolio. Average occupancy in the Core Industrial Portfolio decreased 0.6% to 97.2% for the year ended December 31, 2002 compared to 97.8% for the year ended December 31, 2001. The $0.7 million increase in rental income generated by the Core Industrial Portfolio was offset by a decrease of $4.3 million in rental income attributable to the seventeen industrial buildings sold during 2001 (the “Industrial Dispositions”). An increase of $0.3 million was attributable to the one industrial building acquired during the year ended December 31, 2002 (the “Industrial Acquisition”).

Tenant reimbursements from Industrial Properties decreased $0.2 million, or 5.6% to $3.8 million for the year ended December 31, 2002 compared to $4.0 million for year ended December 31, 2001. An increase of $0.3 million, or 8.5% generated by the Core Industrial Portfolio, was offset by a decrease of $0.5 million attributable to the Industrial Dispositions. Other property income from Industrial Properties decreased $0.2 million, or 73.7% to $89,000 for the year ended December 31, 2002 compared to $0.3 million for the year ended December 31, 2001. During the year ended December 31, 2001, the Company received $0.3 million in forfeited escrow deposits on four properties for which the pending sale did not occur. These properties were subsequently sold during the fourth quarter of 2001.

Total expenses from Industrial Properties increased $0.2 million, or 2.8% to $7.1 million for the year ended December 31, 2002 compared to $6.9 million for the year ended December 31, 2001. Property expenses from Industrial Properties increased $0.4 million, or 15.8% to $3.0 million for the year ended December 31, 2002 compared to $2.6 million for the year ended December 31, 2001. An increase of $0.9 million in property expenses for the Core Industrial Portfolio was offset by a decrease of $0.5 million attributable to the Industrial Dispositions. The increase in the Core Industrial Portfolio is primarily due to the Company paying property expenses directly at one property at which the previous tenant paid the expenses directly. The tenant defaulted and the lease was terminated in July 2002. Real estate taxes decreased $0.5 million, or 13.7% to $3.0 million for the year ended December 31, 2002 compared to $3.5 million for the year ended December 31, 2001. Real estate taxes for the Core Industrial Portfolio decreased $0.1 million for the year ended December 31, 2002 compared to the same period in 2001, and the remaining decrease of $0.4 million was attributable to the Industrial Dispositions. The provision for bad debts increased $0.3 million, or 32.0% to $1.1 million for the year ended December 31, 2002 compared to $0.8 million for the year ended December 31, 2001. During 2002, the Company increased its reserve for unbilled deferred rents specifically related to the Company’s watchlist tenants. The Company evaluates its reserve levels on a quarterly basis.

Net Operating Income, as defined, from Industrial Properties decreased $3.5 million, or 9.9% to $31.8 million for the year ended December 31, 2002 compared to $35.3 million for the year ended December 31, 2001. Net operating income for the Core Industrial Portfolio decreased $0.1 million, or 0.5% for the year ended December 31, 2002 compared to the same period in 2001. An increase of $0.3 million attributable to the Industrial Acquisition was offset by a decrease of $3.7 million attributable to the Industrial Dispositions.

Non-Property Related Income and Expenses

Other income decreased $0.5 million, or 50.2% to $0.5 million for the year ended December 31, 2002 compared to $1.0 million for the year ended December 31, 2001. A decrease of approximately $184,000 was attributable to interest earned on restricted cash balances held at Qualified Intermediaries, as defined by Section 1031 of the Internal Revenue Code, in January 2001, which were used in a tax deferred property exchange. The Company did not have any cash balances at Qualified Intermediaries in 2002. The remaining decrease was primarily attributable to a general decrease in interest rates.

General and administrative expenses increased $0.9 million, or 7.4% to $12.6 million for the year ended December 31, 2002 compared to $11.7 million for the year ended December 31, 2001. For the year ended December 31, 2002, the Company recorded a $0.5 million charge to general and administrative expenses for costs the Company paid for the fifth and final building that was to be leased to Peregrine. Peregrine surrendered the building back to the Company in June 2002, at which time it was still under construction and was not yet included in the Company’s portfolio of stabilized operating properties. The remaining increase was primarily due to the non-cash amortization of the restricted stock grants that were issued in February 2002.

Net interest expense decreased $5.6 million, or 13.8% to $35.4 million for the year ended December 31, 2002 compared to $41.0 million for the year ended December 31, 2001. Gross interest expense, before the effect of capitalized interest, decreased $5.2 million or 9.6% to $49.4 million for the year ended December 31, 2002 from $54.6 million for the year ended December 31, 2001 primarily due to a decrease in the Company’s weighted average interest rate. The Company’s weighted average interest rate decreased to 5.3% at December 31, 2002 compared to 6.8% at December 31, 2001. Total capitalized interest and loan fees increased $0.4 million or 3.0% to $14.0 million for the year ended December 31, 2002 from $13.6 million for the year ended December 31, 2001 primarily due to higher average balances eligible for capitalization during the year ended December 31, 2002 as compared to the same period in 2001.

Depreciation and amortization increased $8.4 million, or 16.6% to $58.9 million for the year ended December 31, 2002 compared to $50.5 million for the year ended December 31, 2001. The increase was due primarily to a charge of approximately $5.3 million for previously capitalized leasing costs related to the Company’s leases with Peregrine Systems, Inc., and an increase attributable to the development properties completed and stabilized since December 31, 2001.

Income from Continuing Operations

Income from continuing operations before net gains on dispositions and minority interests decreased $7.4 million or 14.2% to $44.8 for the year ended December 31, 2002 compared to $52.2 million for the year ended December 31, 2001. The decrease was primarily due to the decrease in Net Operating Income from the Industrial Properties of $3.5 million, an increase in depreciation and amortization expense of $8.4 million offset primarily by an decrease in interest expense of $5.6 million.

Comparison of the Year Ended December 31, 2001 to the Year Ended December 31, 2000

	Year Ended December 31,						Dollar Change			Percentage Change
	2001			2000			Dollar Change			Percentage Change
	(dollars in thousands)
Net Operating Income, as Defined
Office Properties	$	119,236		$	95,561		$	23,675		24.8	%
Industrial Properties		35,276			40,276			(5,000	)	(12.4	)

Total portfolio		154,512			135,837			18,675		13.7

Reconciliation to Consolidated Net Income:
Net Operating Income, as defined for reportable segments		154,512			135,837			18,675		13.7
Other expenses:
General and administrative expenses		11,692			10,535			1,157		11.0
Interest expense		41,024			38,205			2,819		7.4
Depreciation and amortization		50,563			39,834			10,729		26.9
Other income		1,030			4,793			(3,763	)	(78.5	)

Income from continuing operations before net gain on dispositions and minority interests		52,263			52,056			207		0.4
Net gain on disposition of operating properties		4,714			11,256			(6,542	)	(58.1	)

Income from continuing operations before minority interest		56,977			63,312			(6,335	)	(10.0	)
Minority interests attributable to continuing operations		(21,226	)		(20,087	)		(1,139	)	(5.7	)
Income from discontinued operations		4,072			3,621			451		12.4
Cumulative effect of change in accounting principle		(1,392	)					(1,392	)	100.0

Net Income	$	38,431		$	46,846		$	(8,415	)	(18.0	)%

Rental Operations

The following tables compare the Net Operating Income from continuing operations for the years ended December 31, 2001 and 2000.

Office Properties

	Total Office Portfolio									Core Office Portfolio (1)
	2001		2000		Dollar Change			Percentage Change		2001		2000		Dollar Change			Percentage Change
Operating revenues:
Rental income	$	137,880	$	113,088	$	24,792		21.9	%	$	99,603	$	97,946	$	1,657		1.7	%
Tenant reimbursements		16,654		13,287		3,367		25.3			12,711		12,150		561		4.6
Other property income		5,843		602		5,241		870.6			529		384		(145	)	(37.8	)

Total	$	160,377	$	126,977	$	33,400		26.3		$	112,843	$	110,480	$	2,363		2.1

Property and related expenses:
Property expenses		25,603		18,509		7,094		38.3			18,156		16,270		1,886		11.6
Real estate taxes		11,136		9,971		1,165		11.7			7,478		8,608		(1,130	)	(13.1	)
Provision for bad debts		2,895		1,293		1,602		123.9			2,327		1,249		1,078		86.3
Ground leases		1,507		1,643		(136	)	(8.3	)		1,297		1,506		(209	)	(13.9	)

Total		41,141		31,416		9,725		31.0			29,258		27,633		1,625		5.9

Net Operating Income, as defined	$	119,236	$	95,561	$	23,675		24.8	%	$	83,585	$	82,847	$	738		0.9	%

(1)

Stabilized office properties owned at January 1, 2000 and still owned at June 30, 2003.

Total revenues from Office Properties increased $33.4 million, or 26.3% to $160.4 million for the year ended December 31, 2001 compared to $127.0 million for the year ended December 31, 2000. Rental income from Office Properties increased $24.8 million, or 21.9% to $137.9 million for the year ended December 31, 2001 compared to $113.1 million for the year ended December 31, 2000. Of the $24.8 million net increase in rental income, $1.6 million was generated by the Core Office Portfolio and represented a 1.7% increase in rental income for the Core Office Portfolio. This increase was primarily attributable to an increase in rental rates on renewed and released space in this portfolio. Of the remaining increase, $22.4 million was generated by the office buildings developed by the Company in 2000 and 2001 (the “Office Development Properties”) and $0.8 million was attributable to the office property acquired in 2001, net of the effect of the office properties disposed of during 2001 and 2000 (the “Net Office Acquisition”).

Tenant reimbursements from Office Properties increased $3.4 million, or 25.3% to $16.7 million for the year ended December 31, 2001 compared to $13.3 million for the year ended December 31, 2000. An increase of $2.8 million in tenant reimbursements was generated by the Office Development Properties and Net Office Acquisition. The remaining increase of $0.6 million in tenant reimbursements was generated by the Core Office Portfolio which was primarily due to the reimbursement of higher expenses including utility costs. Other property income from Office Properties increased $5.2 million, or 870.6% to $5.8 million for the year ended December 31, 2001 compared to $0.6 million for the comparable period in 2000. This increase is attributable to the recognition of a $5.4 million lease termination fee resulting from the early termination of a lease with eToys (see Note 19 to the Company’s consolidated financial statements). The remaining amounts in other property 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 $9.7 million, or 31.0% to $41.1 million for the year ended December 31, 2001 compared to $31.4 million for the year ended December 31, 2000. Property expenses increased $7.1 million, or 38.3% to $25.6 million for the year ended December 31, 2001 compared to $18.5 million for the year ended December 31, 2000. An increase of $5.2 million in property expenses was attributable to the Office Development Properties and Net Office Acquisition. The remaining increase of $1.9 million in property expenses was attributable to the Core Office Portfolio and was due primarily to increased utility costs due to an increase in rates. During 2001, the State of California Public Utilities Commission (the “CPUC”) enacted rate increases aggregating approximately 40%, which affected the majority of the properties in the Company’s portfolio. These rate increases were effective in June 2002. In August 2001, to minimize the immediate impact to the Company and exposure to potential future increases, the Company signed a direct access contract with a provider to provide electricity for the six highest usage meters. This contract was effective October 1, 2001, and provided savings of approximately 15% of the increased utility cost for those six meters. This contract expires December 31, 2003. The CPUC is currently challenging the validity of direct access contracts, and the CPUC’s final decision could impact the Company’s exposure to increased utility costs. Real estate taxes increased $1.2 million, or 11.7% to $11.1 million for the year ended December 31, 2001 compared to $10.0 million for the year ended December 31, 2000. An increase of $2.3 million attributable to the Office Development Properties and Net Office Acquisition was offset by a decrease of $1.1 million attributable to the Core Office Portfolio. The decrease at the Core Office Portfolio was due to refunds received for prior year real estate taxes successfully appealed by the Company in 2001. Ground lease expense decreased $0.1 million or 8.3% for the year ended December 31, 2001 compared to the comparable period in 2000. The provision for bad debts increased $1.6 million, or 123.9% to $2.9 million for the year ended December 31, 2001 compared to the $1.3 million for the year ended December 31, 2000. During 2001, the Company increased its reserve levels due to the state of the overall economy and its effect on the collection of outstanding receivable balances. These reserve levels could continue to increase if the economy continues to weaken or if the Company experiences an increased incidence in defaults under existing leases. The Company evaluates its reserve levels on a quarterly basis.

Net Operating Income, as defined, from Office Properties increased $23.7 million, or 24.8% to $119.2 million for the year ended December 31, 2001 compared to $95.5 million for the year ended December 31, 2000. Of this increase, $23.0 million was generated by the Office Development Properties and Net Office Acquisition. The remaining increase of $0.7 million was generated by the Core Office Portfolio and represented a 0.9% increase in Net Operating Income for the Core Office Portfolio. The increase in Net Operating Income from the Core Office Portfolio was impacted by higher than expected property expenses, primarily utility costs. It is unclear whether these increases in property expenses will continue in future years.

Industrial Properties

	Total Industrial Portfolio									Core Industrial Portfolio (1)
	2001		2000		Dollar Change			Percentage Change		2001		2000		Dollar Change			Percentage Change
	(dollars in thousands)
Operating revenues:
Rental income	$	37,813	$	41,973	$	(4,160	)	(9.9	)%	$	36,996	$	34,252	$	2,744		8.0	%
Tenant reimbursements		4,030		4,793		(763	)	(15.9	)		4,290		3,690		600		16.3
Other property income		339		1,023		(684	)	(66.9	)		25		1,019		(994	)	(97.5	)

Total	$	42,182	$	47,789	$	(5,607	)	(11.7	)	$	41,311	$	38,961	$	2,350		6.0

Property and related expenses:
Property expenses		2,579		3,258		(679	)	(20.8	)		2,490		2,146		344		16.0
Real estate taxes		3,499		3,752		(253	)	(6.7	)		3,428		3,015		413		13.7
Provision for bad debts		828		503		325		64.6			694		338		356		105.3

Total	$	6,906	$	7,513		(607	)	(8.1	)%	$	6,612	$	5,499	$	1,113		20.2

Net Operating Income, as defined	$	35,276	$	40,276	$	(5,000	)	(12.4	)%	$	34,699	$	33,462	$	1,237		3.7	%

(1)

Stabilized industrial properties owned at January 1, 2000 and still owned at June 30, 2003.

Total revenues from Industrial Properties decreased $5.6 million, or 11.7% to $42.2 million for the year ended December 31, 2001 compared to $47.8 million for the year ended December 31, 2000. Rental income from Industrial Properties decreased $4.2 million, or 9.9% to $37.8 million for the year ended December 31, 2001 compared to $42.0 million for the year ended December 31, 2000. An increase of $2.7 million in net rental income was generated by the Core Industrial Portfolio which represented a 8.0% increase in rental income for the Core Industrial Portfolio. This increase was primarily attributable to an increase in rental rates on renewed and released space in this portfolio. Average Occupancy for the Core Industrial Portfolio remained consistent at 97.7% at December 31, 2001 and December 31, 2000. The increase in rental revenue generated by the Core Industrial Portfolio was offset by a decrease of $6.9 million generated by the industrial buildings disposed of during 2001 and 2000.

Tenant reimbursements from Industrial Properties decreased $0.8 million, or 15.9% to $4.0 million for the year ended December 31, 2001 compared to $4.8 million for the year ended December 31, 2000. A decrease of $1.4 million was attributable to the Industrial Dispositions, which was offset by an increase of $0.6 million attributable to the Core Industrial Portfolio. Other property income from Industrial Properties decreased $0.7 million, or 66.9% to $0.3 million for the year ended December 31, 2001 compared to $1.0 million for the comparable period in 2000. Other property income for the year ended December 31, 2000 included a $0.9 million lease termination fee from a building in El Segundo, California. Other property income for the years ended December 31, 2001 and 2000 consisted primarily of lease termination fees.

Total expenses from Industrial Properties decreased $0.6 million, or 8.1% to $6.9 million for the year ended December 31, 2001 compared to $7.5 million for the year ended December 31, 2000. Property expenses decreased $0.7 million, or 20.8% to $2.6 million for the year ended December 31, 2001 compared to $3.3 million for the year ended December 31, 2000. An increase of $0.3 million attributable to the Core Industrial Portfolio was offset by a decrease of $1.0 million in property expenses attributable to the Industrial Dispositions. The increase in the Core Industrial Portfolio was primarily due to higher utility costs and higher repairs and maintenance expense, which was partially offset by an increase in tenant reimbursements. Real estate taxes decreased $0.3 million, or 6.7% to $3.5 million for the year ended December 31, 2001 compared to $3.8 million for the year ended December 31, 2000. A decrease of $0.7 million attributable to the Industrial Dispositions was offset by a $0.4 million increase attributable to the Core Industrial Portfolio. This increase was primarily due to the effect of prior year real estate taxes which were successfully appealed and refunded to the Company in 2000.

The provision for bad debts increased $0.3 million, or 64.6% to $0.8 million for the year ended December 31, 2001 compared to $0.5 million for the year ended December 31, 2000. During 2001, the Company increased its reserve levels due to the state of the overall economy and its effect on the collection of outstanding receivable balances. These reserve levels could continue to increase if the economy continues to weaken or if the Company experiences an increased incidence in defaults under existing leases. The Company evaluates its reserve levels on a quarterly basis.

Net Operating Income, as defined, from Industrial Properties decreased $5.0 million, or 12.4% to $35.3 million for the year ended December 31, 2001 compared to $40.3 million for the year ended December 31, 2000. An increase of $1.2 million generated by the Core Industrial Portfolio, which represented a 3.7% increase in net operating income for the Core Industrial Portfolio, was offset by a $6.2 million decrease generated by the Industrial Dispositions. The increase in Net Operating Income from the Core Industrial Portfolio was impacted by higher than expected property and related expenses, primarily utility costs. It is unclear whether these increases in property expenses will continue in future years.

Non-Property Related Income and Expenses

Other income decreased $3.8 million, or 78.5% to $1.0 million for the year ended December 31, 2001 compared to $4.8 million for the year ended December 31, 2000. A decrease of $2.7 million was attributable to a decrease of interest income earned on a note receivable from a related party. This note was acquired in May 2000 and repaid in January 2001. In addition, a decrease of $0.4 million was attributable to a decrease in interest earning restricted cash balances held at Qualified Intermediaries for use in the tax deferred property exchanges. The remaining decrease was primarily due to a general decrease in interest rates.

General and administrative expenses increased $1.2 million, or 11.0% to $11.7 million for the year ended December 31, 2001 compared to $10.5 million for the year ended December 31, 2000. This increase was due primarily to increased compensation expense attributable to the non-cash amortization of restricted stock granted in June 2000.

Net interest expense increased $2.8 million, or 7.4% to $41.0 million for the year ended December 31, 2001 compared to $38.2 million for the year ended December 31, 2000. Gross interest expense, before the effect of capitalized interest, decreased $1.6 million or 2.8% to $54.6 million for the year ended December 31, 2001 from $56.2 million for the year ended December 31, 2000 primarily due to a decrease in the Company’s weighted average interest rate. The Company’s weighted average interest rate decreased to 6.8% at December 31, 2001 compared to 8.2% at December 31, 2000. Total capitalized interest and loan fees decreased $4.4 million or 24.5% to $13.6 million for the year ended December 31, 2001 from $18.0 million for the year ended December 31, 2000 primarily due to a decrease in the Company’s weighted average interest rate and lower construction in progress balances in 2001 compared to 2000.

Depreciation and amortization expense increased $10.7 million, or 26.9% to $50.5 million for the year ended December 31, 2001 compared to $39.8 million for the same period in 2000. The increase was primarily due to depreciation on the Office and Industrial Development Properties developed by the Company in 2000 and 2001 net of the effect of the properties disposed by the Company in 2000 and 2001.

Income From Continuing Operations

Income from continuing operations before net gain on dispositions and minority interests increased $0.2 million, or 0.4% to $52.3 million for the year ended December 31, 2001 from $52.1 million for the year ended December 31, 2000. The increase was due primarily to the increase in Net Operating Income from the Office and Industrial Properties of $18.7 million, offset primarily by a decrease in other income of $3.7 million, an increase in interest expense of $2.8 million and an increase in depreciation and amortization of $10.7 million.

Building and Lease Information

The following tables set forth certain information regarding the Company’s Office and Industrial Properties at December 31, 2002:

Occupancy by Segment Type

	Number of Buildings	Square Feet			Occupancy
Region	Number of Buildings	Total	Leased	Available	Occupancy
Office Properties:
Los Angeles	30	3,188,659	2,815,488	373,171	88.3	%
Orange County	10	468,385	414,329	54,056	88.5
San Diego	41	3,081,207	2,869,760	211,447	93.1
Other	6	709,354	683,260	26,094	96.3

	87	7,447,605	6,782,837	664,768	91.1	%

Industrial Properties:
Los Angeles	4	388,805	274,985	113,820	70.7	%
Orange County	44	4,196,741	4,196,741	—	100.0
Other	2	295,417	295,417	—	100.0

	50	4,880,963	4,767,143	113,820	97.7	%

Total Portfolio	137	12,328,568	11,549,980	778,588	93.7	%

Leasing Activity by Segment Type

For the year ended December 31, 2002

	Number of Leases(1)		Square Feet(1)		Changes in Rents(2)		Changes in Cash Rents(3)		Retention Rates(4)		Weighted Average Lease Term (in months)
	New	Renewal	New(5)	Renewal	Changes in Rents(2)		Changes in Cash Rents(3)		Retention Rates(4)		Weighted Average Lease Term (in months)
Office Properties	38	44	436,976	255,281	4.4	%	(2.4	)%	48.0	%	68
Industrial Properties	25	14	451,457	180,555	4.3	%	(5.8	)%	51.8	%	79

Total Portfolio	63	58	888,433	435,836	4.7	%	(3.0	)%	49.3	%	73

(1)

Includes first and second generation space, net of month-to-month leases. Excludes leasing on new construction. First generation space is defined as the space first leased by the Company.

(2)

Calculated as the change between GAAP rents for new/renewed leases and the expiring GAAP rents for the same space.

(3)

Calculated as the change between stated rents for new/renewed leases and the expiring stated rents for the same space.

(4)

Calculated as the percentage of space either renewed or expanded into by existing tenants at lease expiration.

(5)

The lease-up of 888,433 square feet to new tenants includes re-leasing of 685,367 square feet and first generation leasing of 203,066 square feet.

Development Program

At December 31, 2002, the Company had the following four office development projects in lease-up or under construction.

		Projected			Total Costs as of December 31, 2002		Percentage Leased as of December 31, 2002
Project Name / Submarket	Estimated Stabilization Date(1)	Square Feet Upon Completion	Total Estimated Investment(2)		Total Costs as of December 31, 2002		Percentage Leased as of December 31, 2002
			(in thousands)
Projects in Lease-Up:
12100 W. Olympic Blvd (WMC III) /West LA, CA	2nd Quarter 2003	151,000	$	60,069	$	46,211	23	%(3)
999 Sepulveda (Imperial & Sepulveda) / El Segundo, CA	3rd Quarter 2003	133,678		44,567		36,367	—	%
3721 Valley Centre Drive/ Del Mar, CA	3rd Quarter 2003	114,780		31,173		25,814	100	%

Total Projects in Lease-Up		399,458		135,809		108,392	37	%

Projects Under Construction:
12400 High Bluff (San Diego Corporate Center) / Del Mar, CA	3rd Quarter 2004	208,961		61,752		38,078	84	%

Total Projects Under Construction		208,961		61,752		38,078	84	%

Total In-Process Development Projects		608,419	$	197,561	$	146,470	53	%

(1)

Based on management’s estimation of the earlier of stabilized occupancy (95.0%) or one year following the date of substantial completion.

(2)

Represents total projected development costs at December 31, 2002.

(3)

Certain aspects of this lease are subject to governmental approval.

The Company’s lease-up and in-process development projects were 53% committed at December 31, 2002. As discussed under the caption “Factors Which May Influence Future Results of Operations” the demand for office space in the Los Angeles region, including the El Segundo and West Los Angeles submarkets, has not been as strong as the Company had experienced during the last two to three years due to the current economic environment. Consequently, management cannot reasonably predict when the Company will see significant positive leasing momentum given the level of direct vacancy and concentration of sublease space currently available in this market. The Company currently has two development projects in lease-up in the Los Angeles region encompassing an aggregate of 284,700 rentable square feet, 151,000 of which became available for lease in the second quarter of 2002 and 133,700 of which became available for lease in the third quarter of 2002. If the Company is unable to lease this space, the Company’s results of operations and cash flows will be adversely affected.

The Company also has 58.2 acres of undeveloped land in San Diego County comprising its future development pipeline that management currently expects to develop over the next three to five years. The Company has a proactive development planning process, which continually evaluates the size, scope, and timing of the Company’s future development program and, as necessary, scales development to reflect economic conditions and the real estate fundamentals that exist in the Company’s development submarkets. Given the current economic environment, the Company will most likely not be able to maintain historical levels of growth from development in the near future, and may not be able to complete and lease existing development projects to stabilized portfolio occupancy rates within the timeframes experienced by the Company during the last two to three years.

Liquidity and Capital Resources

Current Sources of Capital and Liquidity

The Company seeks to create and maintain a capital structure that allows for financial flexibility and diversification of capital resources. The Company’s primary source of liquidity to fund distributions, debt service, leasing costs, and capital expenditures is net cash from operations. The Company’s primary source of liquidity to fund development costs, potential undeveloped land and property acquisitions, temporary working capital, and unanticipated cash needs is the Company’s $425 million unsecured revolving credit facility, proceeds received from the Company’s disposition program and construction loans. As of December 31, 2002 and 2001 the Company’s ratio of total debt as a percentage of total market capitalization was 46.3% and 42.8%, respectively. As of December 31, 2002 and 2001, the Company’s ratio of total debt and cumulative redeemable preferred units as a percentage of total market capitalization was 55.7% and 52.1%, respectively.

In March 2002, the Company obtained a $425 million unsecured revolving credit facility (the “Current Credit Facility”) with a bank group led by J.P. Morgan Securities, Inc. to replace its previous $400 million unsecured revolving credit line (the “Previous Credit Facility”) which was scheduled to mature in November 2002. Also in March 2002, the Company repaid its $100 million unsecured debt facility, which was scheduled to mature September 2002, with borrowings under the Current Credit Facility. The Current Credit Facility bears interest at an annual rate between LIBOR plus 1.13% and LIBOR plus 1.75% (2.92% at December 31, 2002), depending upon the Company’s leverage ratio at the time of borrowing, and matures in March 2005. At December 31, 2002, the Company had borrowings of $255.0 million outstanding under the Current Credit Facility and availability of approximately $133.2 million.

In addition, as of March 4, 2003, the Company may issue up to $313 million of equity securities under a currently effective shelf registration statement.

Factors Which May Influence Future Sources of Capital and Liquidity

The Company has a $75.7 million variable-rate loan that is scheduled to mature in October 2003. If the Company is unable to obtain additional sources of re-financing, it could be required to borrow up to $75.7 million from its Current Credit Facility to pay-off this loan.

In 2002 and 2001, the Company used proceeds from dispositions of operating properties of approximately $46.5 million and $64.8 million, respectively, to fund a portion of its development activities and its share repurchase program. The Company currently expects to dispose of approximately $50 million of non-strategic assets in 2003. However, the Company cannot provide assurance that it will successfully complete this level of dispositions in 2003. In the event the Company is unable to successfully dispose of properties, the Company’s cash flow could be adversely effected and the Company’s leverage could increase.

In the event Brobeck continues not to make rental payments on its lease on the building secured by one of the Company’s mortgage loans, the Company would no longer meet the minimum debt service coverage ratio required under the provisions of this loan and approximately $10.7 million of the principal balance could become payable. See additional discussion on Brobeck in “Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations—Recent Information Regarding Significant Tenants.”

The Company’s secured debt was comprised of the following at December 31:

	2002		2001
	(in thousands)
Mortgage note payable, due April 2009, fixed interest at 7.20%, monthly principal and interest payments	$	88,630	$	91,005
Mortgage note payable, due January 2012, fixed interest at 6.70%, monthly principal and interest payments		79,287
Mortgage note payable, due February 2005, fixed interest at 8.35%, monthly principal and interest payments(a)		76,509		78,065
Mortgage note payable, due October 2003, interest at LIBOR plus 1.75%, (3.19% and 3.69% at December 31, 2002 and 2001, respectively), monthly interest-only payments(b)(c)		75,671		79,785
Construction loan payable, due April 2002, interest at LIBOR plus 2.00%, (4.13% at December 31, 2001(b)(d)				56,852
Mortgage loan payable, due January 2006, interest at LIBOR plus 1.75%, (3.17% and 3.63% at December 31, 2002 and 2001, respectively), monthly interest only payments(b)		31,000		31,000
Mortgage loan payable, due December 2005, interest at LIBOR plus 1.40%, (2.82% at December 31, 2002), monthly interest only payments(b)(i)		29,000
Mortgage note payable, due May 2017, fixed interest at 7.15%, monthly principal and interest payments		26,652		27,592
Mortgage note payable, due June 2004, interest at LIBOR plus 1.75%, (3.13% and 3.89% at December 31, 2002 and 2001, respectively), monthly principal and interest payments(b)		20,910		21,499
Mortgage loan payable, due August 2007, fixed interest at 6.51%, monthly principal and interest payments		17,951
Construction loan payable, due September 2004, interest at LIBOR plus 1.85% (3.23% at December 31, 2002)(b)(e)(f)		16,242
Mortgage loan payable, due November 2014, fixed interest at 8.13%, monthly principal and interest payments		12,516		12,679
Mortgage note payable, due December 2005, fixed interest at 8.45%, monthly principal and interest payments		11,549		12,034
Construction loan payable, due November 2002, interest at LIBOR plus 3.00% (5.04% at December 31, 2001)(b)(d)				11,659
Mortgage note payable, due November 2014, fixed interest at 8.43%, monthly principal and interest payments		9,737		10,156
Construction loan payable, due April 2002, interest at LIBOR plus 1.75% (3.65% at December 31, 2001)(b)(g)				9,088
Mortgage note payable, due December 2003, fixed interest at 10.00%, monthly interest accrued through December 31, 2000(h)				8,135
Mortgage note payable, due October 2013, fixed interest at 8.21%, monthly principal and interest payments		6,417		6,742
Mortgage loan payable, due August 2007, fixed interest at 7.21%, monthly principal and interest payments		4,966
Construction loan payable, due May 2003, interest at LIBOR plus 3.00% (5.09% at December 31, 2001)(b)(d)				3,296

	$	507,037	$	459,587

(a)

Beginning February 2005, the mortgage note is subject to increases in the effective annual interest rate to the greater of 10.35% or the sum of the interest rate for U.S. Treasury Securities maturing 15 years from the reset date plus 2.00%.

(b)

The variable interest rates stated as of December 31, 2002 and December 31, 2001 are based on the last repricing date during the respective periods. The repricing rates may not be equal to LIBOR at December 31, 2002 and December 31, 2001.

(footnotes continued on next page)

(c)

In September 2002, the Company repaid $4.1 million of the principal balance in connection with the disposition of the office property located in San Diego, California (see Note 3 in the Company’s consolidated financial statements).

(d)

In March 2002, the Company repaid these construction loans in connection with the acquisition of The Allen Group’s minority interest in the Development LLCs (see Notes 2 and 12 in the Company’s consolidated financial statements). The repayments were funded with borrowings under the Company’s Current Credit Facility.

(e)

This loan has an option to extend the maturity for one year.

(f)

This construction loan has a limited recourse provision that holds the Company liable for up to approximately $14.3 million plus any unpaid accrued interest.

(g)

In February 2002, the Company repaid this loan with borrowings under the Company’s Previous Credit Facility.

(h)

In September 2002, the Company repaid this loan with borrowings under the Company’s Current Credit Facility.

(i)

This loan has options to extend the maturity for up to two one-year periods.

The composition of the Company’s aggregate debt balances at December 31, 2002 and 2001 were as follows:

	Percentage of Total Debt				Weighted Average Interest Rate
	December 31, 2002		December 31, 2001		December 31, 2002		December 31, 2001
Secured vs. unsecured:
Secured	66.5	%	64.3	%	6.3	%	6.2	%
Unsecured	33.5	%	35.7	%	3.5	%	7.8	%

Fixed rate vs. variable rate:
Fixed rate(1)(2)(3)(5)(6)	63.5	%	76.5	%	6.7	%	7.6	%
Variable rate(4)(7)	36.5	%	23.5	%	3.0	%	4.0	%

Total Debt					5.3	%	6.8	%
Total Debt Including Loan Fees					5.8	%	7.4	%

(1)

At December 31, 2002, the Company had an interest-rate swap agreement, which expires in January 2005, to fix LIBOR on $50 million of its variable rate debt at 4.46%.

(2)

At December 31, 2002, the Company had an interest-rate swap agreement, which expires in November 2005, to fix LIBOR on $50 million of its variable rate debt at 2.57%.

(3)

At December 31, 2002, the Company had interest-rate swap agreements, which expire in December 2006, to fix LIBOR on $50 million of its variable rate debt at 2.98%.

(4)

At December 31, 2002, the Company had interest-rate cap agreements, which expire in January 2005, to cap LIBOR on $100 million of its variable rate debt at 4.25%.

(5)

At December 31, 2001, the Company had an interest rate swap agreement to fix LIBOR on $150 million of its variable rate debt at 6.95% that expired in February 2002.

(6)

At December 31, 2001, the Company had an interest rate swap agreement to fix LIBOR on $150 million of its variable rate debt at 5.48% that expired in November 2002.

(7)

At December 31, 2001, one of the Development LLCs had an interest-rate cap agreement to cap LIBOR on $57.0 million of variable rate construction debt at 8.50%.

The percentage of fixed rate debt to total debt at December 31, 2002 and 2001 does not take into consideration the portion of variable rate debt capped by the Company’s interest-rate cap agreements. Including the effects of the interest-rate cap agreements, the Company had fixed or capped approximately 76.7% and 84.4% of its total outstanding debt at December 31, 2002 and 2001, respectively.

At December 31, 2002, 56.1% of the Company’s total debt required interest payments based on LIBOR rates. During 2002, one-month LIBOR decreased from 1.83% at January 1 to 1.38% at December 31, a rate lower than it has been since the time of the Company’s IPO. Although the rates on 76.7% of the Company’s debt is either fixed, swapped or capped at December 31, 2002, the remaining 23.3% of the Company’s debt is exposed to fluctuations of the one-month LIBOR rate. The Company cannot provide assurance that it will be able to replace its interest-rate swap and cap agreements as they expire and, therefore, the Company’s results of operations could be exposed to rising interest rates in the future.

Contractual Obligations and Commitments

The following table provides information with respect to the maturities and scheduled principal repayments of the Company’s secured debt and Current Credit Facility at December 31, 2002, assuming the exercise of available debt extension options and provides information about the minimum commitments due in connection with the Company’s ground lease obligations at December 31, 2002:

	2003		2004-2005		2006-2007		After 2007		Total
Secured Debt	$	83,828	$	134,007	$	94,463	$	194,739	$	507,037
Credit Facility				255,000						255,000
Ground Lease Obligations		1,539		3,062		3,019		71,400		79,020

Total	$	85,367	$	392,069	$	97,482	$	266,139	$	841,057

The Credit Facility and certain other secured debt agreements contain covenants and restrictions requiring the Company to meet certain financial ratios and reporting requirements. Some of the more restrictive covenants include minimum debt service coverage ratios, a maximum total liabilities to total assets ratio, a maximum total secured debt to total assets ratio, a minimum cash flow to debt service and fixed charges ratio, a minimum consolidated tangible net worth and a limit of development activities as compared to total assets. Non-compliance with any one or more of the covenants and restrictions could result in the full or partial principal balance of the associated debt becoming immediately due and payable. The Company was in compliance with all its covenants at December 31, 2002. In addition, the Company’s construction loan, which is due September 2004, has a limited recourse provision that holds the Company liable up to approximately $14.3 million plus any unpaid accrued interest.

Capital Commitments and Other Liquidity Needs

As of December 31, 2002, the Company had an aggregate of approximately 608,400 rentable square feet of office space that was either in lease-up or under construction at a total budgeted cost of approximately $198 million. The Company has spent an aggregate of approximately $147 million on these projects as of December 31, 2002. The Company intends to finance the remaining $51 million of presently budgeted development costs from among one or more of the following sources: borrowings under the Current Credit Facility and the existing construction loan, proceeds from the Company’s disposition program, additional long-term secured and unsecured borrowings and working capital.

As of December 31, 2002, the Company had one office renovation property encompassing approximately 78,000 rentable square feet. The Company plans to spend approximately $3 million in improvements at this property in 2003. In addition, the Company is evaluating potential renovation opportunities at other buildings which could commit the Company to up to approximately an additional $30 million in capital expenditures in 2003. It is unknown at this point whether the Company will ultimately proceed with any of these additional renovation projects in 2003.

As of December 31, 2002, the Company had executed leases that committed the Company to $9 million in unpaid leasing costs and tenant improvements at December 31, 2002, and the Company had contracts outstanding for $1 million in capital improvements at December 31, 2002. In addition, for 2003, the Company plans to spend approximately $9 million to $12 million in capital improvements, tenant improvements, and leasing costs for properties within the Company’s stabilized portfolio, depending on leasing activity.

Capital expenditures may fluctuate in any given period subject to the nature, extent, and timing of improvements required to maintain the Company’s Properties. Tenant improvements and leasing costs may also fluctuate in any given period depending upon factors such as the type of property, the term of the lease, the type of lease, the involvement of external leasing agents and overall market conditions.

The Company is required to distribute 90% of its REIT taxable income (excluding capital gains) on an annual basis in order to qualify as a REIT for federal income tax purposes. Accordingly, the Company intends to continue to make, but has not contractually bound itself to make, regular quarterly distributions to common stockholders and common unitholders from cash flow from operating activities. All such distributions are at the discretion of the Board of Directors. The Company may be required to use borrowings under the Current Credit Facility, if necessary, to meet REIT distribution requirements and maintain its REIT status. The Company has historically distributed amounts in excess of its taxable income resulting in a return of capital to its stockholders, and currently has the ability to not increase its distributions to meet its REIT requirements for 2003. The Company considers market factors and Company performance in addition to REIT requirements in determining its distribution levels. Amounts accumulated for distribution to shareholders are invested primarily in interest-bearing accounts and short-term interest-bearing securities, which are consistent with the Company’s intention to maintain its qualification as a REIT. Such investments may include, for example, obligations of the Government National Mortgage Association, other governmental agency securities, certificates of deposit and interest-bearing bank deposits. On February 10, 2003, the Company declared a regular quarterly cash dividend of $0.495 per common share payable on April 17, 2003 to stockholders of record on March 31, 2003. This dividend is equivalent to an annual rate of $1.98 per share. In addition the Company is required to make quarterly distributions to its Series A, Series C and Series D Preferred unitholders, which in aggregate total approximately $14 million of annualized preferred dividends.

In December 1999, the Company’s Board of Directors approved a share repurchase program, pursuant to which the Company is authorized to repurchase up to an aggregate of three million shares of its outstanding common stock. On November 21, 2002, the Company’s Board of Directors authorized the repurchase of an additional one million shares. During the fourth quarter of 2002, the Company repurchased 508,200 shares in open market transactions for an aggregate repurchase price of approximately $11 million or $22.39 per share. The Company’s policy is to make repurchases in open market transactions at the discretion of the Board of Directors and to finance repurchases through working capital, borrowings on the Company’s unsecured revolving credit facility and proceeds from real property dispositions. An aggregate of 1,227,500 shares currently remain eligible for repurchase under this program.

The Company believes that it will have sufficient capital resources to satisfy its liquidity needs over the next twelve months. The Company estimates it will have a range of approximately $276 million to $282 million of available sources to meet its short-term cash needs from the estimated availability of approximately $133 million under its Current Credit Facility, estimated operating cash flow ranging from $93 million to $99 million and $50 million of anticipated proceeds from dispositions of non-strategic assets. The Company estimates it will have a range of approximately $263 million to $266 million of commitments and capital expenditures over the next twelve months comprised of the following: $84 million in secured debt principal repayments; $51 million of planned expenditures for in-process development; $33 million of expenditures for potential redevelopment projects; $10 million of committed costs for executed leases and capital expenditures, and; budgeted capital improvements, tenant improvements and leasing costs for the Company’s stabilized portfolio ranging from approximately $9 million to $12 million, depending on leasing activity. In addition, based on the Company’s annualized dividends for the first quarter of 2003, the Company may distribute approximately $76 million to stockholders and common and preferred unitholders in 2003. There can be, however, no assurance that the Company will not exceed these estimated expenditure and distribution levels or be able to obtain additional sources of financing on commercially favorable terms, or at all.

The Company expects to meet its long-term liquidity requirements, which may include property and undeveloped land acquisitions and additional future development and redevelopment activity, through retained cash flow, borrowings under the Current Credit Facility, additional long-term secured and unsecured borrowings, dispositions of non-strategic assets, issuance of common units of the Operating Partnership, and the potential issuance of debt or equity securities. The Company does not intend to reserve funds to retire existing debt upon maturity. The Company will instead, seek to refinance such debt at maturity or retire such debt through the issuance of equity securities, as market conditions permit.

Historical Recurring Capital Expenditures, Tenant Improvements and Leasing Costs

The following tables set forth the capital expenditures, tenant improvements and leasing costs, excluding expenditures that are recoverable from tenants, for renewed and re-tenanted space within the Company’s stabilized portfolio for the three years ended December 31, 2002 on a per square foot basis.

	Year Ended December 31,
	2002		2001		2000
Office Properties:
Capital Expenditures:
Capital expenditures per square foot	$	0.06	$	0.35	$	0.14
Tenant Improvement and Leasing Costs(1):
Replacement tenant square feet		296,484		126,865		297,578
Tenant improvements per square foot leased	$	6.85	$	8.04	$	5.03
Leasing commissions per square foot leased	$	7.43	$	5.53	$	4.26
Total per square foot	$	14.28	$	13.57	$	9.29
Renewal tenant square feet		244,366		503,693		244,221
Tenant improvements per square foot leased	$	4.69	$	3.42	$	3.28
Leasing commissions per square foot leased	$	2.20	$	2.67	$	1.69
Total per square foot	$	6.89	$	6.09	$	4.97
Total per square foot per year	$	3.71	$	3.39	$	3.66
Average lease term (in years)		5.7		5.8		3.9

Industrial Properties:
Capital Expenditures:
Capital expenditures per square foot	$	0.12	$	0.10	$	0.05
Tenant Improvement and Leasing Costs(1):
Replacement tenant square feet		388,883		170,692		279,866
Tenant improvements per square foot leased	$	4.61	$	2.04	$	1.24
Leasing commissions per square foot leased	$	1.95	$	1.41	$	1.15
Total per square foot	$	6.56	$	3.45	$	2.39
Renewal tenant square feet		180,555		548,304		604,492
Tenant improvements per square foot leased	$	1.11	$	1.28	$	0.50
Leasing commissions per square foot leased	$	0.72	$	0.54	$	0.41
Total per square foot	$	1.83	$	1.82	$	0.91
Total per square foot per year	$	1.27	$	1.10	$	0.66
Average lease term (in years)		6.6		4.8		5.0

(1)

Includes only tenants with lease terms of 12 months or longer. Excludes leases for amenity, parking, retail and month-to-month tenants.

Capital expenditures may fluctuate in any given period subject to the nature, extent, and timing of improvements required to be made to the Properties. The Company believes that all of its Office and Industrial Properties are well maintained and do not require significant capital improvements.

Tenant improvements and leasing costs may also fluctuate in any given year depending upon factors such as the property, the term of the lease, the type of lease, the involvement of external leasing agents and overall market conditions. As several of the properties the Company disposed of during 2002 and 2001 were non-strategic multi-tenant office and industrial projects, which historically were re-leased at lower tenant improvement and leasing costs, the Company anticipates increased tenant improvement and leasing costs per square foot in 2003.

Historical Cash Flows

The principal sources of funding for development, acquisitions, and capital expenditures are cash flow from operating activities, the Current Credit Facility, secured and unsecured debt financing and proceeds from the Company’s dispositions. The Company’s net cash provided by operating activities decreased $10.5 million, or 9.9% to $95.6 million for the year ended December 31, 2002 compared to $106.1 million for the year ended December 31, 2001. This decrease 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. The decrease is also due to the timing differences in payments of accounts payable and other receivable balances at the end of each comparable period.

Net cash used in investing activities decreased $9.7 million, or 13.2% to $63.7 million for the year ended December 31, 2002 compared to $73.4 million for the year ended December 31, 2001. Cash used in investing activities for the year ended December 31, 2002 consisted primarily of expenditures for construction in progress of $84.9 million, $15.6 million in tenant improvements and capital expenditures, $7.5 million paid to acquire an industrial property, and $2.2 million of cash paid in connection with the acquisition of The Allen Group’s minority interest in Development LLCs (see Note 12 to the Company’s consolidated financial statements) offset by $46.5 million in net proceeds from the sale of 12 industrial and five office buildings. Cash used in investing activities for the year ended December 31, 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, expenditures for construction in progress of $105.4 million, and $15.7 million in tenant improvements and capital expenditures offset by $64.8 million in net proceeds received from the sale of 17 industrial and two office buildings.

Net cash used in financing activities decreased $1.3 million, or 3.7% to $32.5 million for the year ended December 31, 2002 compared to $33.8 million for the year ended December 31, 2001. Cash used in financing activities for the year ended December 31, 2002 consisted primarily of $208.2 million in principal payments on secured debt and the repayment of the unsecured term facility and four construction loans, $63.8 million in net distributions paid to common stockholders, common unitholders, and minority interests and $11.4 million paid for the Company’s stock repurchase program, partially offset $100.0 million net borrowings under the Current Credit Facility, $148.1 net proceeds from the issuance of secured debt after financing costs, and $4.2 million in proceeds received in connection with the exercise of stock options. Cash used in financing activities for the year ended December 31, 2001 consisted primarily of $62.6 million in net repayments to the Previous Credit Facility and principal payments on secured debt and $56.9 million in net distributions paid to common stockholders, common unitholders, and minority interests, partially offset by $51.1 million in net proceeds from the issuance of secured debt after financing costs, a $29.6 decrease in restricted cash used in a tax deferred property exchange and $5.0 million in proceeds received in connection with the exercise of stock options.

Non-GAAP Supplemental Financial Measure: Funds From Operations

Industry analysts generally consider Funds From Operations an alternative measure of performance for an equity REIT. 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) defines Funds From Operations to mean net income (loss) before minority interests of common unitholders (computed in accordance with GAAP), excluding extraordinary items, as defined by GAAP, and gains and losses from sales of depreciable operating property, plus real estate related depreciation and amortization (excluding amortization of deferred financing costs and depreciation of non-real estate assets), and after adjustment for unconsolidated partnerships and joint ventures.

methodologies for calculating Funds From Operations and, accordingly, Funds From Operations as disclosed by such other REITs may not be comparable to Funds From Operations published by the Company in this report. Therefore, 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. Funds From Operations should not be considered as a substitute 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, by quarter, for the years ended December 31, 2002, 2001 and 2000:

	2002 Quarter Ended
	December 31,			September 30,			June 30,			March 31,
	(in thousands)
Net income	$	13,965		$	7,885		$	4,957		$	13,507
Adjustments:
Minority interest in earnings of Operating Partnership		2,094			1,239			986			1,510
Depreciation and amortization		14,303			14,516			18,311			12,136
Net gains on dispositions of operating properties		(6,100	)		(470	)		(896	)

Funds From Operations (1)	$	24,262		$	23,170		$	23,358		$	27,153


	2001 Quarter Ended
	December 31,			September 30,			June 30,			March 31,
	(in thousands)
Net income	$	7,625		$	9,283		$	15,097		$	6,426
Adjustments:
Minority interest in earnings of Operating Partnership		834			1,027			1,796			845
Depreciation and amortization		12,634			12,123			12,030			12,970
Net gains on dispositions of operating properties		(707	)		(2,468	)		(1,234	)		(305	)
Cumulative effect on change in accounting principle											1,392
Non-cash amortization of restricted stock grants		547			547			548			548

Funds From Operations	$	20,933		$	20,512		$	28,237		$	21,876


	2000 Quarter Ended
	December 31,			September 30,			June 30,			March 31,
	(in thousands)
Net income	$	8,786		$	15,679		$	12,804		$	9,578
Adjustments:
Minority interest in earnings of Operating Partnership		1,241			2,227			1,843			1,372
Depreciation and amortization		11,037			9,941			9,645			9,323
Net (gains) losses on dispositions of operating properties					(7,288	)		(4,273	)		305
Non-cash amortization of restricted stock grants		508			508			134			102

Funds From Operations	$	21,572		$	21,067		$	20,153		$	20,680

(1)

Commencing January 1, 2002 non-cash amortization of restricted stock grants is not added back to calculate Funds from Operations.

Inflation

The majority of the Company’s leases require tenants to pay most operating expenses, including real estate taxes, utilities, insurance, and increases in common area maintenance expenses. The effect of such provisions is to reduce the Company’s exposure to increases in costs and operating expenses resulting from inflation.

New Accounting Pronouncements

In December 2002, the Financial Accounting Standards Board, (“FASB”) issued SFAS 148, “Accounting for Stock-Based Compensation—Transition and Disclosure” (“SFAS 148”). SFAS 148 amends SFAS 123 “Accounting for Stock Based Compensation” (“SFAS 123”) to provide alternative methods of transition for an entity that voluntarily changes to the fair value recognition provision of recording stock option expense. SFAS 148 also requires disclosure in the summary of significant accounting policies of the effects of an entity’s accounting policy with respect to stock options on reported net income and earnings per share in annual and interim financial statements. The Company voluntarily adopted the fair value recognition provision prospectively, for all employee awards granted or settled after January 1, 2002. Under this provision, total compensation expense related to stock options is determined using the fair value of the stock options on the date of grant and is recognized on a straight-line basis over the option vesting period. Prior to 2002, the Company accounted for stock options issued under this plan under the recognition and measurement provision of APB Opinion 25 “Accounting for Stock Issued to Employees and Related Interpretations”.

On January 1, 2002, the Company adopted the provisions of SFAS 142, “Goodwill and Other Intangible Assets” (“SFAS 142”). This statement makes significant changes to the accounting for business combinations, goodwill, and intangible assets. Among other provisions, SFAS 142 requires that a portion of the purchase price of real estate acquisitions be assigned to the fair value of an intangible asset for above market operating leases or intangible liability for below market operating leases. Such intangible assets or liabilities are then required to be amortized into revenue over the remaining life of the related lease. The adoption of this statement did not have a material effect on the Company’s results of operations or financial condition for the year ended December 31, 2002.

On January 1, 2002, the Company adopted the provisions of SFAS 144 “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”). SFAS 144 addresses financial accounting and reporting for the disposal of long-lived assets and supersedes FAS 121 “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.” In accordance with SFAS 144, the net income and the net gain on dispositions of operating properties sold subsequent to December 31, 2001 are reflected in the consolidated statement of operations as discontinued operations for all periods presented (see Note 21 to the Company’s consolidated financial statements). The net income and the net gain on dispositions of operating properties sold prior to December 31, 2001 are included in continuing operations for all periods presented. The adoption of this statement did not have a material effect on the Company’s results of operations or financial condition.

In April 2002, FASB issued SFAS 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections” (“SFAS 145”). The most significant provisions of this statement relate to the rescission of Statement No. 4 “Reporting Gains and Losses from Extinguishment of Debt.” SFAS 145 also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. Under SFAS 145, any gain or loss on extinguishment of debt that was classified as an extraordinary item in prior periods presented that does not meet certain defined criteria must be reclassified. The provisions of SFAS 145 are effective for fiscal years beginning after May 15, 2002. Management does not expect that the adoption of this statement will have a material effect on the Company’s results of operations or financial condition.

In June 2002, FASB issued SFAS 146, “Accounting for Costs Associated with Exit or Disposal Activities” (“SFAS 146”). SFAS 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force Issue No. 94-3 “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity”. SFAS 146 requires that a liability for a cost

associated with an exit or disposal activity be recognized when the liability is incurred. The provisions of SFAS 146 are effective for exit or disposal activities that are initiated after December 31, 2002. Management does not expect that the adoption of this statement will have a material effect on the Company’s results of operations or financial condition.

In November 2002, the FASB issued Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees Including Indirect Guarantees of Indebtedness of Others” (“FIN 45”). FIN 45 significantly changes the current practice in the accounting for, and disclosure of, guarantees. Guarantees and indemnification agreements meeting the characteristics described in FIN 45 are required to be initially recorded as a liability at fair value. FIN 45 also requires a guarantor to make significant new disclosures for virtually all guarantees even if the likelihood of the guarantor having to make payment under the guarantee is remote. The disclosure requirements within FIN 45 are effective for financial statements for annual or interim periods ending after December 15, 2002. The initial recognition and initial measurement provisions are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. The Company adopted the disclosure provisions of FIN 45 as of December 31, 2002. Management does not expect the adoption of the initial recognition and measurement provisions will have a material effect on the Company’s results of operations or financial condition.

In January 2003, the FASB issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”). FIN 46 clarifies the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements” and provides guidance on the identification of entities for which control is achieved through means other than through voting rights (“variable interest entities” or “VIEs”) and how to determine when and which business enterprise should consolidate the VIE. This new model for consolidation applies to an entity which either (1) the equity investors (if any) do not have a controlling financial interest or (2) the equity investment at risk is insufficient to finance that entity’s activities without receiving additional subordinated financial support from other parties. The provisions of this interpretation are immediately effective for VIEs formed after January 31, 2003. For VIEs formed prior to January 31, 2003, the provisions of this interpretation apply to the first fiscal year or interim period beginning after June 15, 2003. Management does not expect that the adoption of this standard will have a material effect on the Company’s results of operations or financial condition.

KILROY REALTY CORPORATION

CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 2002 AND 2001

AND FOR THE THREE YEARS ENDED DECEMBER 31, 2002

TABLE OF CONTENTS

		Page
Independent Auditors’ Report		F-2

Consolidated Balance Sheets as of December 31, 2002 and 2001		F-3

Consolidated Statements of Operations for the Years ended December 31, 2002, 2001 and 2000		F-4

Consolidated Statements of Stockholders’ Equity for the Years ended December 31, 2002, 2001 and 2000		F-5

Consolidated Statements of Cash Flows for the Years ended December 31, 2002, 2001 and 2000		F-6

Notes to Consolidated Financial Statements		F-7

Schedule of Valuation and Qualifying Accounts		F-44

F-1

INDEPENDENT AUDITORS’ REPORT

To the Board of Directors and Stockholders of Kilroy Realty Corporation:

We have audited the accompanying consolidated balance sheets of Kilroy Realty Corporation (the “Company”) as of December 31, 2002 and 2001 and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2002. Our audits also included the financial statement schedule listed in the index at Item 15. These financial statements and the financial statement schedule are the responsibility of the management of the Company. Our responsibility is to express an opinion on these financial statements and the financial statement schedule based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2002 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects, the information set forth therein.

As discussed in Notes 2 and 21 to the financial statements, the Company changed the presentation of the results of operations and realized gains and losses from properties disposed of in accordance with the adoption of Statement of Financial Accounting Standard 144 “Accounting for the Impairment or Disposal of Long-Lived Assets” during the year ended December 31, 2002.

DELOITTE & TOUCHE LLP

Los Angeles, California

February 25, 2003, except for Note 27

as to which date is August 28, 2003

F-2

KILROY REALTY CORPORATION

CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

	December 31,
	2002			2001
ASSETS

INVESTMENT IN REAL ESTATE (Notes 3, 17, 20, 26 and 27):
Land and improvements	$	288,228		$	269,366
Buildings and improvements, net		1,289,525			1,140,499
Undeveloped land and construction in progress, net		108,465			191,129

Total investment in real estate		1,686,218			1,600,994
Accumulated depreciation and amortization		(278,503	)		(241,665	)

Investment in real estate, net		1,407,715			1,359,329

CASH AND CASH EQUIVALENTS		15,777			16,487
RESTRICTED CASH		6,814			5,413
CURRENT RECEIVABLES, NET (Note 4)		3,074			4,770
DEFERRED RENT RECEIVABLES, NET (Note 5)		29,466			27,381
DEFERRED LEASING COSTS, NET (Notes 6 and 7)		31,427			33,120
DEFERRED FINANCING COSTS, NET (Notes 8 and 11)		6,221			3,948
PREPAID EXPENSES AND OTHER ASSETS		6,108			6,781

TOTAL ASSETS	$	1,506,602		$	1,457,229

LIABILITIES AND STOCKHOLDERS’ EQUITY

LIABILITIES:
Secured debt (Note 9)	$	507,037		$	459,587
Unsecured line of credit (Note 10)		255,000			155,000
Unsecured term facility (Note 10)					100,000
Accounts payable, accrued expenses and other liabilities (Note 11)		43,917			53,879
Accrued distributions (Note 13)		15,670			14,634
Rents received in advance, tenant security deposits and deferred revenue		24,310			15,955

Total liabilities		845,934			799,055

COMMITMENTS AND CONTINGENCIES (Note 16)

MINORITY INTERESTS (Note 12):
8.075% Series A Cumulative Redeemable Preferred unitholders		73,716			73,716
9.375% Series C Cumulative Redeemable Preferred unitholders		34,464			34,464
9.250% Series D Cumulative Redeemable Preferred unitholders		44,321			44,321
Common unitholders of the Operating Partnership		68,196			49,176
Minority interest in Development LLCs (Notes 1, 2 and 12)					15,869

Total minority interests		220,697			217,546

STOCKHOLDERS’ EQUITY (Note 13):
Preferred stock, $.01 par value, 26,200,000 shares authorized, none issued and outstanding
8.075% Series A Cumulative Redeemable Preferred stock, $.01 par value, 1,700,000 shares authorized, none issued and outstanding
Series B Junior Participating Preferred stock, $.01 par value, 400,000 shares authorized, none issued and outstanding
9.375% Series C Cumulative Redeemable Preferred stock, $.01 par value, 700,000 shares authorized, none issued and outstanding
9.250% Series D Cumulative Redeemable Preferred stock, $.01 par value, 1,000,000 shares authorized, none issued and outstanding
Common stock, $.01 par value, 150,000,000 shares authorized, 27,419,880 and 27,426,071 shares issued and outstanding, respectively		273			274
Additional paid-in capital		493,116			479,295
Distributions in excess of earnings		(47,629	)		(33,163	)
Accumulated net other comprehensive loss (Note 11)		(5,789	)		(5,778	)

Total stockholders’ equity		439,971			440,628

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	1,506,602		$	1,457,229

See accompanying notes to consolidated financial statements.

F-3

KILROY REALTY CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except share and per share data)

	Year Ended December 31,
	2002			2001			2000
REVENUES (Note 20):
Rental income	$	180,576		$	175,693		$	155,061
Tenant reimbursements		21,429			20,684			18,080
Other property income (Notes 2 and 19)		2,672			6,182			1,625

Total revenues		204,677			202,559			174,766

EXPENSES:
Property expenses		30,251			28,182			21,767
Real estate taxes		15,212			14,635			13,723
Provision for bad debts		6,672			3,723			1,796
Ground leases (Note 16)		1,354			1,507			1,643
General and administrative expenses (Note 7)		12,557			11,692			10,535
Interest expense		35,380			41,024			38,205
Depreciation and amortization (Note 2)		58,933			50,563			39,834

Total expenses		160,359			151,326			127,503

OTHER INCOME:
Interest income		513			1030			1,878
Interest income from related party (Note 17)								2,724
Equity in earnings from unconsolidated real estate (Note 17)								191

Total other income		513			1,030			4,793

INCOME FROM CONTINUING OPERATIONS BEFORE NET GAIN ON DISPOSITIONS AND MINORITY INTERESTS		44,831			52,263			52,056
Net gain on disposition of operating properties (Note 2)		896			4,714			11,256

INCOME FROM CONTINUING OPERATIONS BEFORE MINORITY INTERESTS		45,727			56,977			63,312

MINORITY INTERESTS:
Distributions on Cumulative Redeemable Preferred units		(13,500	)		(13,500	)		(13,500	)
Minority interest in earnings of Operating Partnership attributable to continuing operations		(4,436	)		(4,025	)		(6,166	)
Recognition of previously reserved Development LLC preferred return (Note 12)		3,908
Minority interest in earnings of Development LLCs		(1,024	)		(3,701	)		(421	)

Total minority interests		(15,052	)		(21,226	)		(20,087	)

INCOME FROM CONTINUING OPERATIONS		30,675			35,751			43,225

DISCONTINUED OPERATIONS
Revenues from discontinued operations		9,058			9,898			9,437
Expenses from discontinued operations		(4,598	)		(5,349	)		(5,299	)
Net gain on disposition of discontinued operations		6,570
Minority interest in earnings of Operating Partnership attributable to discontinued operations		(1,393	)		(477	)		(517	)

Total income from discontinued operations		9,637			4,072			3,621

NET INCOME BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE		40,312			39,823			46,846

CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE (Note 2)					(1,392	)

NET INCOME	$	40,312		$	38,431		$	46,846

Income from continuing operations per common share—basic (Note 22)	$	1.12		$	1.32		$	1.63

Income from continuing operations per common share—diluted (Note 22)	$	1.11		$	1.31		$	1.62

Net income per common share—basic (Note 22)	$	1.47		$	1.41		$	1.76

Net income per common share—diluted (Note 22)	$	1.45		$	1.40		$	1.75

Weighted average shares outstanding—basic (Note 22)		27,449,676			27,167,006			26,598,926

Weighted average shares outstanding—diluted (Note 22)		27,722,197			27,372,951			26,754,984

Dividends declared per common share (Note 23)	$	1.98		$	1.92		$	1.80

See accompanying notes to consolidated financial statements.

F-4

KILROY REALTY CORPORATION

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(in thousands, except share and per share data)

	Number of Shares		Common Stock			Additional Paid-in Capital			Distributions in Excess of Earnings			Accumulated Net Other Comp. Loss			Total
BALANCE AT DECEMBER 31, 1999	27,808,410		$	278		$	491,204		$	(18,553	)	$			$	472,929
Net income										46,846						46,846
Repurchase of common stock (Note 13)	(2,009,300	)		(20	)		(41,440	)								(41,460	)
Conversion of common units of the Operating Partnership (Note 12)	481,290			5			(10,714	)								(10,709	)
Issuance of restricted stock (Notes 13 and 15)	175,000			2												2
Exercise of stock options (Note 15)	20,070						192									192
Non-cash amortization of restricted stock grants (Notes 13 and 15)							1,252									1,252
Adjustment for minority interest (Note 2)							19,896									19,896
Dividends declared ($1.80 per share)										(47,523	)					(47,523	)

BALANCE AT DECEMBER 31, 2000	26,475,470			265			460,390			(19,230	)					441,425
Net income										38,431						38,431
Net other comprehensive loss (Notes 2 and 11)													(5,778	)		(5,778	)

Comprehensive income																32,653
Conversion of common units of the Operating Partnership (Note 12)	687,591			6			13,652									13,658
Exercise of stock options (Note 15)	270,190			2			5,028									5,030
Repurchase of common stock	(7,180	)		1			(230	)								(229	)
Non-cash amortization of restricted stock grants (Notes 13 and 15)							2,190									2,190
Adjustment for minority interest (Note 2)							(1,735	)								(1,735	)
Dividends declared ($1.92 per share)										(52,364	)					(52,364	)

BALANCE AT DECEMBER 31, 2001	27,426,071			274			479,295			(33,163	)		(5,778	)		440,628
Net income										40,312						40,312
Net other comprehensive loss (Note 11)													(11	)		(11	)

Comprehensive income																40,301
Repurchase of common stock (Note 13)	(518,571	)		(5	)		(11,776	)								(11,781	)
Conversion of common units of the Operating Partnership (Note 12)	222,270			2			5,490									5,492
Exercise of stock options (Note 15)	208,381			2			4,247									4,249
Issuance of restricted stock (Notes 13 and 15)	81,729
Non-cash amortization of restricted stock grants (Notes 13 and 15)							3,709									3,709
Stock option expense (Notes 2 and 15)							23									23
Adjustment for minority interest (Note 2)							12,128									12,128
Dividends declared ($1.98 per share)										(54,778	)					(54,778	)

BALANCE AT DECEMBER 31, 2002	27,419,880		$	273		$	493,116		$	(47,629	)	$	(5,789	)	$	439,971

See accompanying notes to consolidated financial statements.

F-5

KILROY REALTY CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

	Year Ended December 31,
	2002			2001			2000
	(in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	40,312		$	38,431		$	46,846
Adjustments to reconcile net income to net cash provided by operating activities (including discontinued operations):
Depreciation and amortization		60,786			52,644			41,704
Cumulative effect of change in accounting principle					1,392
Provision for uncollectible tenant receivables		2,098			2,356			852
Provision for uncollectible unbilled deferred rents		4,669			1,485			1,021
Minority interests in earnings of Operating Partnership and Development LLCs		2,945			8,203			7,104
Non-cash amortization of restricted stock grants		3,709			2,190			1,252
Amortization of deferred financing costs		3,147			3,132			2,805
Net gains on dispositions of operating properties		(7,466	)		(4,714	)		(11,256	)
Other		60			(131	)		523
Changes in assets and liabilities:
Current receivables		(403	)		3,145			(3,152	)
Deferred rent receivables		(9,033	)		(9,359	)		(9,234	)
Deferred leasing costs		(6,464	)		(5,457	)		(6,619	)
Prepaid expenses and other assets		(1,792	)		(2,102	)		(2,950	)
Accounts payable, accrued expenses and other liabilities		(5,369	)		14,921			7,143
Rents received in advance and tenant security deposits		8,355			(54	)		(2,329	)
Accrued distributions to Cumulative Redeemable Preferred unitholders								299

Net cash provided by operating activities		95,554			106,082			74,009

CASH FLOWS FROM INVESTING ACTIVITIES:
Expenditures for operating properties		(15,610	)		(18,842	)		(15,899	)
Expenditures for undeveloped land and construction in progress		(84,862	)		(120,510	)		(166,391	)
Acquisition of operating property		(7,569	)
Acquisition of minority interest in Development LLC’s		(2,189	)
Net proceeds received from dispositions of operating properties		46,499			64,846			110,639
Cash paid to acquire note receivable from related party (Note 17)								(45,278	)
Decrease (increase) in escrow deposits					1,100			(1,106	)
Net advances to unconsolidated subsidiary								304

Net cash used in investing activities		(63,731	)		(73,406	)		(117,731	)

CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of secured and unsecured debt		155,664			53,502			210,405
Net borrowing (repayments) on unsecured line of credit		100,000			(36,000	)		(37,000	)
Principal payments on secured debt and unsecured term facility		(208,214	)		(26,603	)		(11,733	)
Share repurchase program		(11,398	)					(41,266	)
Financing costs		(7,634	)		(2,422	)		(4,068	)
Proceeds from exercise of stock options		4,248			5,030
(Increase) decrease in restricted cash		(1,401	)		29,601			(28,378	)
Distributions paid to common stockholders and common unitholders		(61,609	)		(57,317	)		(54,150	)
Net (distributions) contributions from minority interests in Development LLCs		(2,189	)		420			1,396

Net cash (used in) provided by financing activities		(32,533	)		(33,789	)		35,206

Net decrease in cash and cash equivalents		(710	)		(1,113	)		(8,516	)
Cash and cash equivalents, beginning of year		16,487			17,600			26,116

Cash and cash equivalents, end of year	$	15,777		$	16,487		$	17,600

SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest, net of capitalized interest	$	32,253		$	37,141		$	37,289

Distributions paid to Cumulative Redeemable Preferred unitholders	$	13,500		$	13,500		$	13,202

NON-CASH TRANSACTIONS:
Accrual of distributions payable (Note 13)	$	15,670		$	14,634		$	13,601

Issuance of common limited partnership units of the Operating Partnership to acquire minority interest in Development LLCs (Note 12)	$	38,689

Note receivable from related party repaid in connection with property acquisition (Note 17)				$	33,274

Issuance of secured note payable in connection with undeveloped land acquisition							$	8,500

Note receivable from related party satisfied in connection with acquisition of investment in unconsolidated real estate (Note 17)							$	11,319

See accompanying notes to consolidated financial statements.

F-6

KILROY REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Three Years Ended December 31, 2002

1. Organization and Ownership

Kilroy Realty Corporation (the “Company”) owns, operates and develops office and industrial real estate located in California, Washington and Arizona. The Company, which qualifies and operates as a self-administered real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as amended, commenced operations upon the completion of its initial public offering in January 1997. The Company is the successor to the real estate business of the Kilroy Group, which consisted of the combination of Kilroy Industries (“KI”) and various entities, the properties of which were under the common control of KI and/or its stockholders, including the Company’s Chairman of the Board of Directors, John B. Kilroy, Sr., and the Company’s President and Chief Executive Officer, John B. Kilroy, Jr.

As of December 31, 2002, the Company’s stabilized portfolio of operating properties was comprised of 87 office buildings (the “Office Properties”) and 50 industrial buildings (the “Industrial Properties,” and together with the Office Properties, the “Properties”) which encompassed approximately 7.4 million and 4.9 million rentable square feet, respectively, and was 93.7% occupied. The Properties include ten properties developed by the Company and stabilized during 2002 and 2001 which encompass an aggregate of approximately 436,200 and 312,400 rentable square feet, respectively. All but five of the Properties are located in Southern California.

The Company’s stabilized portfolio of operating properties excludes projects currently under construction, renovation or in pre-development and “lease-up” properties. The Company defines “lease-up” properties as properties recently developed by the Company that have not yet reached 95% occupancy and are within one year following substantial completion. The Company had three office lease-up properties at December 31, 2002, encompassing an aggregate of approximately 399,500 rentable square feet. As of December 31, 2002, the Company had one office property under construction and one office property under renovation which when completed are expected to encompass an aggregate of approximately 209,000 and 78,000 rentable square feet, respectively. All of the Company’s development, renovation, and lease-up projects are located in Southern California.

The Company owns its interests in all of the Properties through Kilroy Realty, L.P. (the “Operating Partnership”) and Kilroy Realty Finance Partnership, L.P. (the “Finance Partnership”). The Company conducts substantially all of its activities through the Operating Partnership in which, as of December 31, 2002 and 2001, it owned an 86.6% and 90.0% general partnership interest, respectively. The remaining 13.4% and 10.0% common limited partnership interest in the Operating Partnership as of December 31, 2002 and 2001, respectively, was owned by certain of the Company’s executive officers and directors, certain of their affiliates, and other outside investors (see Note 12). Kilroy Realty Finance, Inc, (“Finance Inc.”), a wholly-owned subsidiary of the Company, is the sole general partner of the Finance Partnership and owns a 1% general partnership interest. The Operating Partnership owns the remaining 99% limited partnership interest.

In 1999, the Company, through the Operating Partnership, became a 50% managing member 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, was the other 50% member of the Development LLCs. On March 25, 2002, the Company acquired The Allen Group’s interest in the assets and assumed The Allen Group’s proportionate share of the liabilities of the Development LLCs (see Notes 3 and 12). Subsequent to this transaction, the Development LLCs were liquidated and dissolved. The Development LLCs were consolidated for financial reporting purposes prior to their dissolution on March 25, 2002 since the Company controlled all significant development and operating decisions.

F-7

KILROY REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

On January 1, 2001, Kilroy Services, Inc. (“KSI”) was merged into a newly formed entity, Kilroy Services, LLC (“KSLLC”) (see Note 17). The Company historically accounted for the operating results of the development services business conducted by KSI under the equity method of accounting. As a result of the merger, KSLLC became a wholly-owned subsidiary of the Company and 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 and all wholly-owned subsidiaries and controlled entities.

2. Basis of Presentation and Significant Accounting Policies

Basis of Presentation:

The consolidated financial statements of the Company include all entities for which the Company has a controlling financial interest as measured by a majority of the voting interest. The consolidated statements also include entities that were formed for the purpose of facilitating IRS Section 1031 tax-deferred property exchanges. Entities in which the Company has a significant investment but are not controlled by the Company are accounted for under the equity method. All significant intercompany balances and transactions have been eliminated in the consolidated financial statements.

Significant Accounting Policies:

Operating properties—Operating properties are carried at the lower of historical cost less accumulated depreciation or estimated fair value. The cost of operating properties includes the purchase price or development costs of the properties. Costs incurred for the acquisition, renovation and betterment of the operating properties are capitalized to the Company’s investment in that property. Maintenance and repairs are charged to expense as incurred. The Company’s stabilized portfolio of operating properties consists of all of the Company’s Office and Industrial Properties, excluding projects currently under construction, renovation or in pre-development and lease-up properties. Lease-up properties are included in land and improvements and building and improvements on the consolidated balance sheets.

A property is evaluated for potential impairment whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. In the event that periodic assessments reflect that the carrying amount of a property exceeds the sum of the undiscounted cash flows (excluding interest) that are expected to result from the use and eventual disposition of the property, the Company would recognize an impairment loss to the extent the carrying amount exceeded the fair value of the property. The Company estimates the fair value using available market information or other industry valuation techniques such as present value calculations. The Company had not recorded any impairment losses for the years ended December 31, 2002, 2001 and 2000.

Depreciation and amortization of buildings and improvements—The cost of buildings and improvements are depreciated on the straight-line method over estimated useful lives of 25 to 40 years for buildings and the shorter of the lease term or useful life, ranging from one to 15 years, for tenant improvements. Depreciation expense for buildings and improvements for the three years ended December 31, 2002, 2001 and 2000, was $46.8 million, $41.9 million, and $35.6 million, respectively.

Construction in progress—Project costs clearly associated with the development and construction of a real estate project are capitalized as construction in progress. In addition, interest, loan fees, real estate taxes, general and administrative expenses that are directly associated with and incremental to the Company’s development activities, and other costs are capitalized during the period in which activities necessary to get the property ready for its intended use are in progress, including the pre-development and lease-up phases. Once the development and construction of the building shell of a real estate project is completed, the costs capitalized to construction in progress are transferred to land and improvements and buildings and improvements on the consolidated balance sheets as the historical cost of the property.

F-8

KILROY REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

At December 31, 2002 and 2001, construction in progress was carried net of a $1.1 million allowance for pre-development costs. The allowance, which provides for certain costs incurred for future development projects that the Company may at some point in the development process decide not to pursue, was established by estimating probable exposures to these types of costs for each of the projects in the Company’s future development pipeline. Management’s determination of the allowance was calculated on a project by project basis using a series of probability factors based on the Company’s historical experience. The allowance is increased by charges against other income. The allowance for pre-development costs at December 31, 2002 and 2001 was maintained at a level believed to be adequate by management.

In addition, at December 31, 2002, construction in progress was carried net of a $0.5 million allowance for costs the Company paid for an in process development project that was to be leased to Peregrine. Peregrine surrendered this building back to the Company in June 2002 (see Note 7). The $0.5 million charge was recorded in general and administrative expenses.

Cash and cash equivalents—The Company considers all money market funds with an original maturity of three months or less at the date of purchase to be cash equivalents.

Restricted cash—Restricted cash consists of cash held as collateral to provide credit enhancement for the Company’s mortgage debt, cash reserves for property taxes, capital expenditures and tenant improvements, and proceeds received from property dispositions that are held at Qualified Intermediaries for future use in tax-deferred exchanges.

Revenue recognition—In accordance with Statement of Financial Accounting Standards No. 13, “Accounting for Leases”, minimum annual rental revenue is recognized on a straight-line basis over the term of the related lease. Tenant reimbursement revenue, which is comprised of additional amounts recoverable from tenants for common area maintenance expenses and certain other recoverable expenses is recognized as revenue in the period in which the related expenses are incurred.

Allowances for uncollectible tenant receivables and unbilled deferred rent—Tenant receivables and unbilled deferred rent receivables are carried net of the allowances for uncollectible current tenant receivables and unbilled deferred rent. Management’s determination of the adequacy of these allowances is based primarily upon evaluations of historical loss experience, individual receivables, current economic conditions, and other relevant factors. The allowances are increased through the provision for bad debts.

Deferred leasing costs—Costs incurred in connection with property leasing are capitalized as deferred leasing costs. Deferred leasing costs consist primarily of leasing commissions which are amortized on the straight-line method over the lives of the leases which generally range from one to 15 years. Management re-evaluates the remaining useful lives of leasing costs as the creditworthiness of the Company’s tenants and economic and market conditions change. If management determines the estimated remaining life of the respective lease has changed, the Company adjusts the amortization period.

Deferred financing costs—Costs incurred in connection with debt financing are capitalized as deferred financing costs. Deferred financing costs consist primarily of loan fees which are amortized using the effective interest method over the terms of the respective loans.

Derivative financial instruments—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 employs derivative instruments that are designated as cash flow hedges, including 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.

F-9

KILROY REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

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 the Company to recognize all of its derivatives as either assets or liabilities on the Company’s consolidated balance sheet at fair value and to defer the related gains or losses on these contracts in stockholders’ equity as a component of accumulated other net comprehensive income or loss. To the extent that any of these contracts are not perfectly effective in offsetting the change in the value of the interest payments being hedged, changes in fair value relating to the ineffective portion of these contracts would be recognized in earnings (See Note 11). In the event that the Company were to terminate a derivative contract before its maturity date and the forecasted hedged transactions (e.g., the interest payments on the variable rate debt) were still probable to occur, the gains or losses deferred in accumulated other net comprehensive loss (“AOCL”) associated with the terminated contract would remain in AOCL upon the termination and would be reclassified into earnings in the same period in which the hedged transactions affect earnings, over the original term of the derivative contract. If the forecasted hedged transactions were no longer probable to occur, the gains or losses deferred in AOCL would be recognized in earnings immediately upon termination of the derivative contract.

In connection with the adoption of SFAS 133 on January 1, 2001, the Company recorded a $1.4 million cumulative effect of change in accounting principle to record an existing cap agreement at fair market value. Upon adoption, 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. The Company determines fair value based upon valuations obtained from an independent third-party for its outstanding interest rate swap and cap agreements at each balance sheet date. Valuations provided by the independent third-party are calculated using standard industry valuation procedures and rely on real-time market inputs consistent with valuation methods and data inputs employed by financial institutions and other market participants.

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.

Minority interests—Minority interests represent the preferred and common limited partnership interests in the Operating Partnership and interests held by The Allen Group in the Development LLCs prior to their dissolution on March 25, 2002 (see Notes 3 and 12). Net income is allocated to the common limited partners of the Operating Partnership (“Minority Interest of the Operating Partnership”) based on their ownership percentage of the Operating Partnership. The ownership percentage is determined by dividing the number of common limited partnership units held by the Minority Interest of the Operating Partnership by the total common limited partnership units outstanding. The issuance of additional shares of common stock or common limited partnership units results in changes to the Minority Interest of the Operating Partnership percentage as well as the total net assets of the Company. As a result, all capital transactions result in an allocation between the stockholders’ equity and Minority Interest of the Operating Partnership in the accompanying consolidated balance sheets to account for the change in the Minority Interest of the Operating Partnership ownership percentage as well as the change in total net assets of the Company.

Other property income—Other property income primarily includes revenue earned from lease termination fees (see Note 19) and management fees. For the year ended December 31, 2001, other property income also included approximately $0.8 million related to forfeited escrow deposits on four properties for which the pending sale did not occur.

F-10

KILROY REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Income taxes—The Company has elected to be taxed as a REIT under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the “Code”). To qualify as a REIT, the Company must distribute annually at least 90% of its adjusted taxable income, as defined in the Code, to its shareholders and satisfy certain other organizational and operating requirements. The Company generally will not be subject to federal income taxes if it distributes 100% of its taxable income for each year to its shareholders. If the Company fails to qualify as a REIT in any taxable year, it will be subject to federal income taxes (including any applicable alternative minimum tax) on its taxable income at regular corporate rates and may not be able to qualify as a REIT for four subsequent taxable years. Even if the Company qualifies for taxation as a REIT, it may be subject to certain state and local taxes on its income and property, and to federal income taxes and excise taxes on its undistributed taxable income. The Company believes that it has met all of the REIT distribution and technical requirements for the years ended December 31, 2002, 2001 and 2000 and was not subject to any federal income taxes (see Note 23 for tax treatment of the Company’s distributions). Management intends to continue to adhere to these requirements and maintain the Company’s REIT status.

In addition, any taxable income from the Company’s taxable REIT subsidiary, which was formed in August 2002, is subject to federal, state, and local income taxes. For the year ended December 31, 2002, the taxable REIT subsidiary did not have any GAAP or taxable net income and therefore did not incur any income tax expense.

Reclassifications—Certain prior year amounts have been reclassified to conform to the current year’s presentation.

Use of estimates—The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported periods. Actual results could differ from those estimates.

Fair value of financial instruments—The Company calculates the fair value of financial instruments using available market information and appropriate present value or other valuation techniques such as discounted cash flow analyses. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. The derived fair value estimates cannot always be substantiated by comparison to independent markets and in many cases, could not be realized in immediate settlement of the instrument. Fair values for certain financial instruments and all non-financial instruments are not required to be disclosed. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company at December 31, 2002 and 2001.

Concentration of credit risk—132 of the Company’s total 137 Properties are located in Southern California. The ability of the tenants to honor the terms of their respective leases is dependent upon the economic, regulatory and social factors affecting the communities in which the tenants operate.

As of December 31, 2002, 2001 and 2000, the Company’s ten largest office tenants represented approximately 32.2%, 34.6% and 28.9% of total annual base rental revenues and its ten largest industrial tenants represented approximately 8.9%, 9.1% and 9.3%, respectively, of total annual base rental revenues. Of this amount, the Company’s largest tenant, The Boeing Company, accounted for approximately 9.5%, 10.9% and 9.2% of the Company’s total annual base revenues, for the years ended December 31, 2002, 2001 and 2000, respectively. At December 31, 2002 and 2001, the Company had $0.2 million and $0.8 million, respectively, in outstanding receivables from this tenant which were primarily reimbursement billings.

F-11

KILROY REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

The Company has cash in financial institutions which is insured by the Federal Deposit Insurance Corporation (“FDIC”) up to $0.1 million per institution. At December 31, 2002 and 2001, the Company had cash accounts in excess of FDIC insured limits.

Adoption of Stock Option Accounting

At December 31, 2002, the Company had one stock option and incentive plan, which is described more fully in Note 15. Effective January 1, 2002, the Company voluntarily adopted the fair value recognition provisions of SFAS 123, prospectively for all employee stock option awards granted or settled after January 1, 2002. Under the fair value recognition provisions of SFAS 123, total compensation expense related to stock options is determined using the fair value of the stock options on the date of grant. Total compensation expense is then recognized on a straight-line basis over the option vesting period

Prior to 2002, the Company accounted for stock options issued under the recognition and measurement provisions of APB Opinion 25 “Accounting for Stock Issued to Employees and related Interpretations.” As a result, no stock option expense is reflected in 2001 or 2000 net income, as all stock options granted under the plan had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the fair value based method had been applied to all outstanding and unvested awards in each period.

	Year Ended December 31,
	2002			2001			2000
	(in thousands, except per share amounts)
Net income, as reported	$	40,312		$	38,431		$	46,846
Add: Stock option expense included in reported net income		23
Deduct: Total stock option expense determined under fair value recognition method for all awards		(160	)		(1,092	)		(1,475	)

Pro forma net income	$	40,175		$	37,339		$	45,371

Net Income per share:
Basic—as reported	$	1.47		$	1.41		$	1.76

Basic—pro forma	$	1.46		$	1.37		$	1.71

Diluted—as reported	$	1.45		$	1.40		$	1.75

Diluted—pro forma	$	1.45		$	1.36		$	1.70

F-12

KILROY REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

The fair value of each option grant issued in 2002, 2001, and 2000 is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions (amounts shown as 2002, 2001, and 2000, respectively): (a) dividend yield of 7.03%, 7.03%, and 6.90%, (b) expected volatility of the Company’s stock of 24.6%, 24.8%, and 26.2%, (c) risk free interest rate of 4.88%, 4.47%, and 5.18%, and (d) expected option life of seven years. The effects of applying the fair value provisions of SFAS 123 are not representative of the effects on net income and disclosed pro forma net income for future years because options vest over three years as discussed in Note 15 and additional awards can be made in future years.

Recent Accounting Pronouncements

On January 1, 2002, the Company adopted the provisions of SFAS 142, “Goodwill and Other Intangible Assets” (“SFAS 142”). This statement makes significant changes to the accounting for business combinations, goodwill, and intangible assets. Among other provisions, SFAS 142 requires that a portion of the purchase price of real estate acquisitions be assigned to the fair value of an intangible asset for above market operating leases or to an intangible liability for below market operating leases. Such intangible assets or liabilities are then required to be amortized into revenue over the remaining life of the respective leases. The adoption of this statement did not have a material effect on the Company’s results of operations or financial condition for the year ended December 31, 2002.

On January 1, 2002, the Company adopted the provisions of SFAS 144 “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”). SFAS 144 addresses financial accounting and reporting for the disposal of long-lived assets and supersedes FAS 121 “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.” In accordance with SFAS 144, the net income and the net gain on dispositions of operating properties sold subsequent to December 31, 2001 are reflected in the consolidated statement of operations as discontinued operations for all periods presented (see Note 21). In accordance with EITF 87-24 “Allocation of Interest to Discontinued Operations”, the Company has allocated interest on debt that is required to be repaid as a result of the disposal transaction to discontinued operations, but has elected not to allocate consolidated interest that is not directly attributable to the disposition property. The net income and the net gain on dispositions of operating properties sold prior to December 31, 2001 are included in continuing operations for all periods presented. The adoption of this statement did not have a material effect on the Company’s results of operations or financial condition.

F-13

KILROY REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

In November 2002, the FASB issued Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees”, Including Indirect Guarantees of Indebtedness of Others (“FIN 45”). FIN 45 significantly changes the current practice in the accounting for, and disclosure of, guarantees. Guarantees and indemnification agreements meeting the characteristics described in FIN 45 are required to be initially recorded as a liability at fair value. FIN 45 also requires a guarantor to make significant new disclosures for virtually all guarantees even if the likelihood of the guarantor having to make payment under the guarantee is remote. The disclosure requirements within FIN 45 are effective for financial statements for annual or interim periods ending after December 15, 2002. The initial recognition and initial measurement provisions are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. The Company adopted the disclosure provisions of FIN 45 as of December 31, 2002. Management does not expect the adoption of the initial recognition and measurement provisions will have a material effect on the Company’s results of operations or financial condition.

3. Acquisitions, Dispositions, and Completed Development Projects

Acquisition of Industrial Property

In August 2002, the Company acquired one industrial property, including undeveloped land adjacent to the Company’s one renovation property, from an unaffiliated third party for approximately $8.1 million. The property, which is located in Santa Ana, California, encompasses approximately 107,000 rentable square feet and the Company has leased 100% of the space to the seller. This lease expires June 30, 2003.

Acquisition of Minority Interest in Development LLC Properties

On March 25, 2002, the Company acquired The Allen Group’s interest in the assets of the Development LLCs which included nine San Diego office properties encompassing approximately 848,300 rentable square feet, and three San Diego development sites, encompassing approximately 11.9 acres (see Notes 2 and 12).

Land Acquisitions

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 mortgage note payable to the seller. The Company repaid the $9.1 million principal balance in November 2001.

F-14

KILROY REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

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.

Related Party Acquisition

In January 2001, the Company acquired a 75% tenancy-in-common interest in an office complex located in El Segundo, California 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. The complex encompasses approximately 366,000 aggregate rentable square feet and is comprised of two office buildings and one parking structure. One of the office buildings is included in the Company’s stabilized portfolio of operating properties. The Company is redeveloping the second office building which was in the lease-up phase at December 31, 2002. As a result of the acquisition, the Company 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 (see Note 17 for further details of this transaction).

Dispositions

During the year ended December 31, 2002, the Company sold the following properties:

Location	Property Type	Month of Disposition	Number of Buildings	Rentable Square Feet	Sales Price ($ in millions)
3990 Ruffin Road San Diego, CA	Office	September	1	45,600	$	6.5

23600/23610 Telo Avenue Torrance, CA	Office	November	2	80,000		7.1

Walnut Park Business Center Diamond Bar, CA	Industrial	November	3	165,700		12.0

1240/1250 Lakeview Boulevard Anaheim, CA	Office	November	2	78,900		9.0

Alton Business Center Irvine, CA	Industrial	December	9	143,100		13.6

Total			17	513,300	$	48.2

During the year ended December 31, 2002, the Company recorded a net gain of approximately $6.6 million in connection with the sale of these properties. The Company used the net proceeds to fund its development program, finance the Company’s stock repurchase program (see Note 13) and repay borrowings under the Current Credit Facility (defined in Note 10). The net income and the net gains on disposition for these properties have been included in discontinued operations for the years ended December 31, 2002, 2001 and 2000 (see Note 21).

F-15

KILROY REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

During the year ended December 31, 2001, the Company sold the following properties:

Location	Property Type	Month of Disposition	Number of Buildings	Rentable Square Feet	Sales Price ($ in millions)
6828 Nancy Ridge Drive San Diego, CA	Industrial	February	1	39,700	$	3.3

199 & 201 N. Sunrise Avenue Roseville, CA	Industrial	April	2	162,200		15.4

4880 Santa Rosa Road Camarillo, CA	Office	August	1	41,100		6.6

1900 Aerojet Way Las Vegas, NV	Industrial	August	1	106,700		5.0

795 Trademark Drive Reno, NV	Industrial	September	1	75,300		7.3

41093 County Center Drive Temecula, CA	Industrial	September	1	77,600		5.4

1840 Aerojet Way Las Vegas, NV	Industrial	September	1	102,900		5.1

184-220 Technology Drive Irvine, CA	Industrial	October	10	157,500		19.0

2231 Rutherford Road Carlsbad, CA	Office	December	1	39,000		3.3

Total			19	802,000	$	70.4

During the year ended December 31, 2001, the Company recorded a net gain of approximately $4.7 million in connection with the sale of these properties. The Company used the net proceeds to fund its development program and repay borrowings under the Previous Credit Facility (defined in Note 10). During the year ended December 31, 2002, the Company recognized a gain of approximately $896,000 related to the disposition of an industrial property in Irvine, California that the Company sold in October 2001. This additional gain had previously been reserved for financial reporting purposes until certain contingencies associated with the disposition were resolved. The net income and the net gains on disposition for these properties have been included in continuing operations for the years ended December 31, 2002, 2001 and 2000 as it relates to properties sold prior to the prospective adoption of SFAS 144 (see Note 21).

F-16

KILROY REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Completed Development Projects

During the year ended December 31, 2002, the Company added the following six development projects to the Company’s stabilized portfolio:

Location	Property Type	Completion Date	Stabilization Date	Number of Buildings	Rentable Square Feet	Percentage Leased
15051 Ave. of Science Rancho Bernardo, CA	Office	Q2 2001	Q1 2002	1	70,600	100	%

4939 Directors Place Sorrento Mesa, CA	Office	Q1 2002	Q1 2002	1	60,700	100	%

23975 Park Sorrento Calabasas, CA	Office	Q2 2001	Q2 2002	1	100,600	100	%

15073 Ave. of Science Rancho Bernardo, CA	Office	Q2 2001	Q2 2002	1	46,800	100	%

10390 Pacific Center Ct. Sorrento Mesa, CA	Office	Q4 2001	Q2 2002	1	68,400	100	%

12340 El Camino Real Del Mar, CA	Office	Q3 2002	Q3 2002	1	89,100	100	%

Total				6	436,200

In addition, the Company had also completed the following three office development projects, which were in the lease-up phase at December 31, 2002:

Location	Property Type	Completion Date	Number of Buildings	Rentable Square Feet	Estimated Stabilization Date(1)	Percentage Leased
12100 W. Olympic Blvd. West Los Angeles, CA	Office	Q2 2002	1	151,000	Q2 2003	23	%(2)

999 Sepulveda Blvd. El Segundo, CA	Office	Q3 2002	1	133,700	Q3 2003	0	%

3721 Valley Centre Dr. Del Mar, CA	Office	Q3 2002	1	114,800	Q3 2003	100	%

Total			3	399,500

(1)

Based on Management’s estimation of the earlier of the stabilized occupancy (95%) or one year from the date of substantial completion.

(2)

Certain aspects of this lease are subject to governmental approval.

F-17

KILROY REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

During the year ended December 31, 2001, the Company completed and stabilized the following four development projects, which were added to the Company’s stabilized portfolio:

Location	Property Type	Completion Date	Stabilization Date	Number of Buildings	Rentable Square Feet
5717 Pacific Center Sorrento Mesa, CA	Office	Q2 2001	Q2 2001	1	68,000

10243 Genetic Center Drive Sorrento Mesa, CA	Office	Q2 2001	Q2 2001	1	102,900

23925 Park Sorrento Calabasas, CA	Office	Q1 2001	Q3 2001	1	11,800

3661 Valley Center Drive Del Mar, CA	Office	Q2 2001	Q4 2001	1	129,700

Total				4	312,400

4. Current Receivables

Current receivables consisted of the following at December 31:

	2002			2001
	(in thousands)
Tenant rent, reimbursements, and other receivables	$	7,573		$	7,605
Allowance for uncollectible tenant receivables		(4,499	)		(2,835	)

Current receivables, net	$	3,074		$	4,770

5. Deferred Rent Receivables

Deferred rent receivables consisted of the following at December 31:

	2002			2001
	(in thousands)
Unbilled deferred rent	$	35,453		$	30,833
Allowance for unbilled deferred rent		(5,987	)		(3,452	)

Deferred rent receivables, net	$	29,466		$	27,381

6. Deferred Leasing Costs

Deferred leasing costs are summarized as follows at December 31:

	2002			2001
	(in thousands)
Deferred leasing costs	$	57,233		$	54,603
Accumulated amortization		(25,806	)		(21,483	)

Deferred leasing costs, net	$	31,427		$	33,120

F-18

KILROY REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

7. Charge for Previously Capitalized Leasing Costs

The Company’s second largest tenant, Peregrine Systems, Inc. (“Peregrine”) leased four office buildings totaling approximately 423,900 rentable square feet under four separate leases. During the year ended December 31, 2002, Peregrine advised the Company that it likely would not need all of the buildings upon resolution of its financial issues, therefore, the Company recorded a $5.3 million charge to depreciation and amortization for leasing commissions and certain tenant improvements that were previously capitalized in connection with the leases with Peregrine. In addition, the Company recorded a $0.5 million charge to general and administrative expenses for costs the Company paid for a fifth and final building that was to be leased to Peregrine. Peregrine surrendered this building back to the Company in June 2002, at which time it was still under construction and was not yet included in the Company’s portfolio of operating properties. In September 2002, Peregrine filed for bankruptcy, and as part of its bankruptcy filing, Peregrine filed a motion to reject two of the leases encompassing 182,127 rentable square feet. Peregrine did not file to reject the remaining two leases at that time. Peregrine has recently indicated that it intends to file a motion to reject the remaining two leases. The Company did not record additional reserves upon Peregrine’s bankruptcy as the leasing commissions and certain tenant improvements related to the leases with Peregrine were fully reserved.

8. Deferred Financing Costs

Deferred financing costs are summarized as follows at December 31:

	2002			2001
	(in thousands)
Deferred financing costs	$	15,257		$	10,058
Fair value of interest rate cap agreements (See Note 11)		212
Accumulated amortization		(9,248	)		(6,110	)

Deferred financing costs, net	$	6,221		$	3,948

F-19

KILROY REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

9. Secured Debt

The following table sets forth the composition of the Company’s secured debt at December 31:

	2002		2001
	(in thousands)
Mortgage note payable, due April 2009, fixed interest at 7.20%, monthly principal and interest payments	$	88,630	$	91,005
Mortgage note payable, due January 2012, fixed interest at 6.70%, monthly principal and interest payments		79,287
Mortgage note payable, due February 2005, fixed interest at 8.35%, monthly principal and interest payments(a)		76,509		78,065
Mortgage note payable, due October 2003, interest at LIBOR plus 1.75%, (3.19% and 3.69% at December 31, 2002 and 2001, respectively), monthly interest-only payments(b)(c)		75,671		79,785
Construction loan payable, due April 2002, interest at LIBOR plus 2.00%, (4.13% at December 31, 2001)(b)(d)				56,852
Mortgage loan payable, due January 2006, interest at LIBOR plus 1.75%, (3.17% and 3.63% at December 31, 2002 and 2001, respectively), monthly interest only payments(b)		31,000		31,000
Mortgage loan payable, due December 2005, interest at LIBOR plus 1.40%, (2.82% at December 31, 2002), monthly interest only payments(b)(i)		29,000
Mortgage note payable, due May 2017, fixed interest at 7.15%, monthly principal and interest payments		26,652		27,592
Mortgage note payable, due June 2004, interest at LIBOR plus 1.75%, (3.13% and 3.89% at December 31, 2002 and 2001, respectively), monthly principal and interest payments(b)		20,910		21,499
Mortgage loan payable, due August 2007, fixed interest at 6.51%, monthly principal and interest payments		17,951
Construction loan payable, due September 2004, interest at LIBOR plus 1.85% (3.23% at December 31, 2002)(b)(e)(f)		16,242
Mortgage loan payable, due November 2014, fixed interest at 8.13%, monthly principal and interest payments		12,516		12,679
Mortgage note payable, due December 2005, fixed interest at 8.45%, monthly principal and interest payments		11,549		12,034
Construction loan payable, due November 2002, interest at LIBOR plus 3.00% (5.04% at December 31, 2001)(b)(d)				11,659
Mortgage note payable, due November 2014, fixed interest at 8.43%, monthly principal and interest payments		9,737		10,156
Construction loan payable, due April 2002, interest at LIBOR plus 1.75% (3.65% at December 31, 2001)(b)(g)				9,088
Mortgage note payable, due December 2003, fixed interest at 10.00%, monthly interest accrued through December 31, 2000(h)				8,135
Mortgage note payable, due October 2013, fixed interest at 8.21%, monthly principal and interest payments		6,417		6,742
Mortgage loan payable, due August 2007, fixed interest at 7.21%, monthly principal and interest payments		4,966
Construction loan payable, due May 2003, interest at LIBOR plus 3.00% (5.09% at December 31, 2001)(b)(d)				3,296

	$	507,037	$	459,587

(footnotes on next page)

F-20

KILROY REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(a)

(b)

(c)

In September 2002, the Company repaid $4.1 million of the principal balance in connection with the disposition of the office property located in San Diego, California (see Note 3).

(d)

In March 2002, the Company repaid these construction loans in connection with the acquisition of The Allen Group’s minority interest in the Development LLCs (see Notes 2 and 12). The repayments were funded with borrowings under the Company’s Current Credit Facility.

(e)

This loan has an option to extend the maturity for one year.

(f)

This construction loan has a limited recourse provision that holds the Company liable for up to approximately $14.3 million plus any unpaid accrued interest.

(g)

In February 2002, the Company repaid this loan with borrowings under the Company’s Previous Credit Facility.

(h)

In September 2002, the Company repaid this loan with borrowings under the Company’s Current Credit Facility.

(i)

This loan has options to extend the maturity for up to two one-year periods.

The Company’s secured debt was collateralized by 79 operating properties and one in process development project at December 31, 2002 with a combined net book value of $614 million and 61 operating properties and four in process development projects at December 31, 2001 with a combined net book value of $626 million. As of December 31, 2002 and 2001, the Company’s secured debt had a weighted average interest rate, excluding loan fees, of 5.97% and 6.19%, respectively.

At December 31, 2002, nine of the Company’s secured loans contained restrictions that would require the payment of prepayment penalties for the acceleration of outstanding debt. The mortgage notes payable are secured by deeds of trust on certain of the Company’s properties and the assignment of certain rents and leases associated with those properties.

Certain secured debt agreements contain restrictive covenants including minimum debt yields and debt service coverage ratios. The Company was in compliance with all of the covenants at December 31, 2002 and 2001.

Scheduled contractual principal payments for the above secured debt at December 31, 2002, assuming the Company does not exercise any of the extension options, were as follows:

Year Ending	(in thousands)
2003	$	83,828
2004		44,608
2005		118,399
2006		37,526
2007		27,937
Thereafter		194,739

Total	$	507,037

F-21

KILROY REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

10. Unsecured Line of Credit and Unsecured Term Facility

In March 2002, the Company obtained a $425 million unsecured revolving credit facility (the “Current Credit Facility”) with a bank group led by J.P. Morgan Securities, Inc. to replace its previous $400 million unsecured revolving credit line (the “Previous Credit Facility”) which was scheduled to mature in November 2002. The Company repaid its $100 million unsecured debt facility, which was scheduled to mature September 2002, with borrowings under the Current Credit Facility. The Current Credit Facility bears interest at an annual rate between LIBOR plus 1.13% and LIBOR plus 1.75% (2.92% at December 31, 2002), depending upon the Company’s leverage ratio at the time of borrowing, and matures in March 2005. At December 31, 2002, the Company had borrowings of $255.0 million outstanding under the Current Credit Facility and availability of approximately $133.2 million. The fee for unused funds ranges from an annual rate of 0.20% to 0.35% depending on the Company’s leverage ratio. The Company expects to use the Current Credit Facility to finance development expenditures, to fund potential acquisitions and for other general corporate uses.

The Current Credit Facility contain covenants requiring the Company to meet certain financial ratios and reporting requirements. Some of the more restrictive covenants include a minimum debt service coverage ratio, a maximum total liabilities to total assets ratio, a maximum total secured debt to total assets ratio, a minimum cash flow to debt service and fixed charges ratio, a minimum consolidated tangible net worth and a limit of development activities as compared to total assets. The Company was in compliance with all of the covenants of the Current Credit Facility, the Previous Credit Facility and the Unsecured Debt Facility at December 31, 2002 and 2001.

Total interest and loan fees capitalized for the years ended December 31, 2002, 2001 and 2000 were $14.0 million, $13.6 million and $18.0 million, respectively.

11. Derivative Financial Instruments

As of December 31, 2002 and 2001, the Company reported liabilities of $3.7 million and $5.8 million, respectively, reflecting the fair value of its interest rate swap agreements which are included in other liabilities in the consolidated balance sheets. As of December 31, 2002 the Company reported an asset of $0.2 million reflecting the fair value of its interest rate cap agreements which is included in deferred financing costs in the consolidated balance sheet (see Note 8).

The following table sets forth the terms and fair market value of the Company’s derivative financial instruments at December 31:

Type of Instrument	Notional Amount		Index	Strike		Maturity Date		2002			2001
	(in thousands)							(in thousands)
Interest rate swap	$	50,000	LIBOR	4.46	%	January 2005		$	(2,735	)	$
Interest rate swap		50,000	LIBOR	2.57	%	November 2005	��		(457	)
Interest rate swap		25,000	LIBOR	2.98	%	December 2006			(248	)
Interest rate swap		25,000	LIBOR	2.98	%	December 2006			(248	)
Interest rate swap		150,000	LIBOR	6.95	%	February 2002						(1,281	)
Interest rate swap		150,000	LIBOR	5.48	%	November 2002						(4,497	)

Total included in other liabilities									(3,688	)		(5,778	)

Interest rate cap		50,000	LIBOR	4.25	%	January 2005			105
Interest rate cap		50,000	LIBOR	4.25	%	January 2005			105
Interest rate cap		50,000	LIBOR	8.50	%	April 2002

Total included in deferred financing costs									210

Total								$	(3,478	)	$	(5,778	)

F-22

KILROY REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

The instruments described above have been designated as cash flow hedges. The Company uses these instruments to hedge the interest rate risk associated with a portion of its pool of outstanding variable-rate debt that is equal in principal amount to the notional amount of the Company’s outstanding derivative instruments. (See Notes 9 and 10 for a discussion of the Company’s outstanding variable rate and fixed rate debt.) The significant terms of the Company’s pool of outstanding variable-rate debt, which include the LIBOR index and the repricing dates, have been set to effectively match the terms of the Company’s hedging instruments. The Company’s strategy is to effectively convert a portion of its variable-rate debt to fixed-rate debt.

During 2002, the Company paid a $2.4 million premium to enter into two interest rate cap agreements, which represented the fair market value at the inception of the agreements. This premium will be amortized into earnings over the term of the cap agreements using the caplet value approach.

As of December 31, 2002 and 2001, the balance in accumulated net other comprehensive loss was $5.8 million for both periods relating to the net decrease in the fair market value of the derivative instruments outstanding at the end of each period. For the years ended December 31, 2002 and 2001, the Company did not record any gains or losses attributable to cash flow hedge ineffectiveness since the terms of the Company’s derivative contracts and debt obligations were and are expected to continue to be effectively matched. Amounts reported in accumulated other comprehensive loss will be reclassified to interest expense as interest payments are made on the Company’s variable-rate debt. During the year ending December 31, 2003, the Company estimates that it will reclassify approximately $3.7 million to interest expense.

See Note 2 for the transition adjustments made in connection with the adoption of SFAS 133 on January 1, 2001 and disclosure of the accounting for derivative financial instruments prior to the adoption.

12. Minority Interests

Common Limited Partnership Unitholders

The Company owned an 86.6% and 90.0% general partnership interest in Operating Partnership as of December 31, 2002 and 2001, respectively. The remaining 13.4% and 10.0% common limited partnership interest as of December 31, 2002 and 2001, respectively, was owned by certain of the Company’s executive officers and directors, certain of their affiliates, and other outside investors in the form of common limited partnership units. The common limited partnership units are redeemable at the option of the unitholders. Upon receipt of the notice of redemption, the Company may elect, subject to certain limitations, to exchange the common limited partnership units for shares of the Company’s common stock on a one-for-one basis or cash equal to the fair market value at the time of redemption.

During the year ended December 31, 2002, 222,270 common limited partnership units of the Operating Partnership were exchanged into shares of the Company’s common stock on a one-for-one basis. Of these 222,270 common limited partnership units, 177,563 common limited partnership units were owned by a partnership affiliated with The Allen Group. During the year ended December 31, 2001, 687,591 common limited partnership units of the Operating Partnership were exchanged into shares of the Company’s common stock on a one-for-one basis. Of these 687,591 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 687,591 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 common limited partnership holders.

F-23

KILROY REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Development LLC’s

At December 31, 2001, the Minority Interest in Development LLC’s represents interests held by The Allen Group in the Development LLC’s (see Note 1). On March 25, 2002, the Company acquired The Allen Group’s minority interest in the assets and assumed The Allen Group’s proportionate share of the liabilities of the Development LLCs. The net consideration was approximately $40.9 million. The acquisition was funded with $2.2 million in cash and 1,398,068 common limited partnership units of the Operating Partnership valued at $38.7 million based upon the closing share price of the Company’s common stock as reported on the New York Stock Exchange. In connection with the acquisition, the Company recognized $3.9 million of preferred return income that had been previously earned but fully reserved for financial reporting purposes until the acquisition was complete and the related litigation between the parties was settled. The preferred return investment earned a 12.5% annual rate of return. In connection with the acquisition, the Company repaid three construction loans, which were secured by certain of the Development LLC properties (see Note 9).

Preferred Unitholders

As of December 31, 2002 and 2001, the Company had issued and outstanding 700,000 9.375% Series C Cumulative Redeemable Preferred units (the “Series C Preferred units”), 1,500,000 8.075% Series A Cumulative Redeemable Preferred units (the “Series A Preferred units”), and 900,000 9.250% Series D Cumulative Redeemable Preferred units (the “Series D Preferred units”), representing preferred limited partnership interests in the Operating Partnership with a liquidation value of $50.00 per unit. The Series C, Series A and Series D Preferred units, which may be called by the Operating Partnership at a price equal to the liquidation value on or after November 24, 2003, February 6, 2003, and December 9, 2004, respectively, have no stated maturity or mandatory redemption and are not convertible into any other securities of the Operating Partnership. The Series C, Series A and Series D Preferred Units are exchangeable at the option of the majority of the holders for shares of the Company’s 9.375% Series C Cumulative Redeemable Preferred stock beginning November 24, 2008, the Company’s 8.075% Series A Cumulative Redeemable Preferred stock beginning February 6, 2008, and the Company’s 9.250% Series D Cumulative Redeemable Preferred beginning December 9, 2009, respectively or earlier under certain circumstances.

Each series of preferred units may be exchanged for shares of a corresponding series of preferred stock of the Company’s preferred stock at the election of 51% of the holders of the applicable series of preferred units:

(i) if distributions on the applicable series have not been timely made for any six prior quarters, or the Operating Partnership is likely to become a publicly traded partnership for federal income tax purposes;

(ii) if, prior to the tenth anniversary of their date of issuance, the respective class of preferred units would not be considered “stock and securities” for federal income tax purposes; and

(iii) at any time following the tenth anniversary of their date of issuance.

In addition, each series of preferred units may also be exchanged for shares of a corresponding series of the Company’s preferred stock if either the Operating Partnership or the initial holder of the preferred units believes, based upon the opinion of counsel, that the character of Operating Partnership’s assets and income would not allow it to qualify as a REIT if it were a corporation. In lieu of exchanging preferred units for preferred stock, the Company may elect to redeem all or a portion of the respective series of preferred units for cash in an amount equal to $50.00 per unit plus accrued and unpaid distributions. Each series may only be exchanged in whole, but not in part, and each exchange is subject to the REIT ownership limits contained in the Company’s charter.

F-24

KILROY REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

The Company makes quarterly distributions to the Series C, Series A and Series D Preferred unitholders on the 15th day of each February, May, August and November. Included in the Series C, Series A and Series D Preferred unit balances on the balance sheet at December 31, 2002 and 2001 were $0.4 million, $0.8 million and $0.5 million of accrued distributions payable to the Series C, Series A and Series D Preferred unitholders, respectively.

13. Stockholders’ Equity

During 2002 and 2001, 222,270 and 687,591 common limited partnership units of the Operating Partnership were exchanged into shares of the Company’s common stock, respectively (see Note 12). Neither the Company nor the Operating Partnership received any proceeds from the issuance of the common stock to the common limited partnership unitholders.

In February 2002, the Company filed a registration statement on Form S-3 which registered the potential issuance and resale of up to a total of 1,133 shares of the Company’s common stock in exchange for 1,133 common limited partnership units of the Operating partnership previously issued in connection with the related party acquisition (see Note 17). The common limited partnership units may be exchanged at the Company’s option into shares of the Company’s common stock on a one-for-one basis. Neither the Company nor the Operating Partnership will receive any proceeds from the issuance of the common stock resulting from any such exchange.

In February 2003, the Company’s Compensation Committee granted an aggregate of 118,733 restricted shares of the Company’s common stock to certain executive officers and key employees. In February 2002, the Company’s Compensation Committee granted an aggregate of 81,729 restricted shares of the Company’s common stock to certain executive officers. In June 2000, the Company’s Compensation Committee granted 175,000 shares of restricted stock to certain key employees. The restricted shares have the same dividend and voting rights as common stock. The restricted shares are included in the Company’s calculation of weighted average diluted outstanding shares at December 31, 2002, 2001 and 2000 (see Note 15 for the terms of the restricted stock grants and the related amortization of compensation expense).

In November 2002, the Company’s Board of Directors authorized the repurchase of an additional one million shares under its existing common stock share repurchase program. This action increased the total authorized shares under this program to an aggregate of four million shares. During the years ended December 31, 2002 and 2000, the Company repurchased 508,200 and 1,999,300 shares of its common stock in open market transactions for an aggregate price of $11.4 million and $41.2 million, or $22.39 and $20.58 per share, respectively. The Company did not repurchase any shares during the year ended December 31, 2001. Repurchases were funded primarily through proceeds received from the Company’s disposition program, working capital and borrowings on the Company’s Credit Facility. As of December 31, 2002, an aggregate of 1,227,500 shares remained eligible for repurchase under this program.

The Company has a Dividend Reinvestment and Direct Purchase Plan (the “Plan”) designed to provide the Company’s stockholders and other investors with a convenient and economical method to purchase shares of the Company’s common stock. The Plan consists of three programs that provide existing common stockholders and other investors the opportunity to purchase additional shares of the Company’s common stock by reinvesting cash dividends or making optional cash purchases within specified parameters. Depending on the program, the Plan acquires shares of the Company’s common stock from either new issuances directly from the Company, from the open market or from privately negotiated transactions. As of December 31, 2002, there were no previously unissued shares acquired under the Plan.

F-25

KILROY REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

The Company has an effective “shelf” registration statement for the issuance of $313 million of the Company’s equity securities.

Accrued distributions at December 31, 2002 and 2001, consisted of the following amounts payable to registered common stockholders of record holding 27,419,880 and 27,426,071 shares of common stock, respectively, and common unitholders holding 4,236,752 and 3,060,954 common limited partnership units of the Operating Partnership, respectively:

	December 31,
	2002		2001
	(in thousands)
Distributions payable to:
Common stockholders	$	13,573	$	13,165
Common unitholders of the Operating Partnership		2,097		1,469

Total accrued distributions	$	15,670	$	14,634

14. Future Minimum Rent

The Company has operating leases with tenants that expire at various dates through 2018 and are either subject to scheduled fixed increases or adjustments based on the Consumer Price Index. Generally, the leases grant tenants renewal options. Leases also provide for additional rents based on certain operating expenses. Future minimum rent under operating leases, excluding tenant reimbursements of certain costs, as of December 31, 2002, are summarized as follows:

Year Ending	(in thousands)
2003	$	161,911
2004		148,930
2005		133,411
2006		116,051
2007		97,277
Thereafter		299,498

Total	$	957,078

15. Employee Retirement and Stock Option and Incentive Plans

Retirement Savings Plan

The Company has a retirement savings plan designed to qualify under Section 401(k) of the Internal Revenue Code (the “401(k) Plan”). The 401(k) Plan allows participants to defer up to sixty percent of their eligible compensation on a pre-tax basis, subject to certain maximum amounts allowed by the Internal Revenue Code. The 401(k) Plan provides for a matching contribution by the Company in an amount equal to fifty-cents for each one dollar of participant contributions up to a maximum of five percent of the participant’s annual salary. Participants vest immediately in the amounts contributed by the Company. Employees of the Company are eligible to participate in the 401(k) Plan on the first day of the month after three months of service. For the years ended December 31, 2002, 2001, and 2000, the Company contributed $0.3 million, $0.3 million, and $0.2 million respectively to the 401(k) Plan.

F-26

KILROY REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Stock Option and Incentive Plan

The Company has established a stock option and incentive plan (the “Stock Plan”) for the purpose of attracting and retaining officers and key employees, under which restricted shares or stock options may be granted. The Stock Plan authorizes the issuance of 3,000,000 shares of common stock of the Company. The Compensation Committee, comprised of three Directors who are not officers of the Company, determines compensation, including awards under the Stock Plan, for the Company’s executive officers.

Restricted Shares

Restricted shares of common stock are subject to restrictions determined by the Company’s Compensation Committee. Restricted stock has the same dividend and voting rights as common stock and is legally issued and outstanding. Restricted shares are included in the Company’s weighted average diluted outstanding shares at December 31, 2002, 2001 and 2000.

In connection with the Company’s initial public offering in January 1997, 100,000 restricted shares of common stock were issued to an executive officer of the Company for a price of $1,000 and vest 20% per year over a five-year period. Compensation expense was determined by reference to the market value of the Company’s common shares and was amortized on a monthly basis over the five-year vesting period. Compensation expense relating to these shares was approximately $0.6 million and $0.4 million for the years ended December 31, 2001 and 2000, respectively.

In June 2000, the Company granted an aggregate of 175,000 restricted shares of common stock to certain key employees. The restricted shares vest 100% on March 1, 2003. Compensation expense for the restricted shares is calculated based on the closing per share price of $24.94 on the June 23, 2000 grant date and is amortized on a straight-line basis over the vesting period. The compensation expense related to this restricted stock grant was approximately $1.6 million, $1.6 million and $0.8 million for the years ended December 31, 2002, 2001 and 2000, respectively.

In February 2002, the Company’s Compensation Committee granted an aggregate of 81,729 restricted shares of common stock to certain executive officers. Compensation expense for the restricted shares is calculated based on the closing per share price of $25.74 on the February 26, 2002 grant date and is amortized on a straight-line basis over the vesting period. Of the shares granted, 20,541 vest over a one-year period and 61,188 vest over a two-year period. The compensation expense related to this restricted stock grant was approximately $1.1 million for the year ended December 31, 2002.

In February 2002, the Company’s Compensation Committee approved two new programs under the Stock Plan for the future potential issuance of restricted shares of common stock and one program under the Stock Plan for the potential payment of cash to certain key employees as part of their annual and long-term incentive compensation. The number of shares that will ultimately be issued and the amount of cash that will ultimately be paid under these programs will be contingent upon both the Company and the individuals meeting certain financial, operating and development performance targets during each fiscal year. The awards are payable at the discretion of the Compensation Committee. The restricted stock awards will vest over one to two years, depending upon the specific program and will be expensed over the performance and vesting periods.

In February 2003, the Company’s Compensation Committee granted an aggregate of 118,733 restricted shares of common stock to certain executive officers and key employees. Compensation expense for the restricted shares is calculated based on the closing per share price of $21.63 on the February 10, 2003 grant date and is amortized on a straight-line basis over the vesting period. Of the shares granted, 25,903 vest over a one-

F-27

KILROY REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

year period and 92,830 vest over a two-year period. The Company recorded approximately $1.0 million in compensation expense related to this restricted stock grant during the year ended December 31, 2002 as it related to the 2002 performance period. The restricted stock award will be expensed over the performance and vesting periods.

Stock Options

At December 31, 2002 and 2001, an aggregate of 1,167,272 and 1,436,341 options were exercisable for shares of the Company’s common stock at a weighted average exercise price of $23.30 and $23.15, respectively. The weighted average exercise price of the options outstanding at December 31, 2002 and 2001 was $23.40 and $23.22, respectively, with a weighted average remaining contractual life of 5.0 years and 6.0 years, respectively. Stock options vest at 33¹/3% per year over three years beginning on the first anniversary date of the grant and are exercisable at the market value on the date of the grant. The term of each option is ten years from the date of the grant.

The Company’s stock option activity is summarized as follows:

	Number of Options		Weighted Average Exercise Price
Outstanding at December 31, 1999	1,994,000		$	23.07
Granted	95,000			23.93
Exercised	(59,535	)		22.42
Cancelled	(16,666	)		27.69

Outstanding at December 31, 2000	2,012,799			23.13
Granted	25,000			26.51
Exercised	(424,797	)		22.43
Cancelled	(80,000	)		25.06

Outstanding at December 31, 2001	1,533,002			23.22
Granted	25,000			25.77
Exercised	(292,403	)		22.67
Cancelled	(25,000	)		23.00

Outstanding at December 31, 2002	1,240,599			23.40

Effective January 1, 2002, the Company voluntarily adopted the fair value recognition provisions of SFAS 123, prospectively for all employee awards granted, modified, or settled after January 1, 2002 (see Note 2). Accordingly, the Company recorded approximately $23,000 of compensation expense for the year ended December 31, 2002. This compensation expense relates to the Company’s annual grant of 25,000 stock options to the Company’s non-employee Directors, which occurred in February 2002.

16. Commitments and Contingencies

Operating leases—The Company has noncancelable ground lease obligations on the SeaTac Office Center in Seattle, Washington expiring December 2032, with an option to extend the lease for an additional 30 years; 12312 W. Olympic Boulevard in Santa Monica, California with the primary lease expiring in January 2065 and a smaller secondary lease expiring in September 2011; and Kilroy Airport Center, Long Beach, California with a lease period for Phases I, II and III expiring July 2084 and a lease period for Phase IV expiring in 2035. On the Kilroy Airport Center and the SeaTac Office Center ground leases, rentals are subject to adjustments every five years based on the Consumer Price Index. On the 12312 W. Olympic Boulevard ground lease, rentals are subject to adjustments every year based on the Consumer Price Index.

F-28

KILROY REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

During the year ended December 31, 2002 the Company renegotiated the ground leases at Kilroy Airport Center, Phases I, II, and III in Long Beach, California resulting in a reduction of annual ground lease expense of approximately $0.3 million. The ground lease obligation will be subject to fair market value adjustments every five years. The Company also exercised the option to extend the ground leases for an additional fifty years. The ground leases now expire in July 2084 as discussed above.

The minimum commitment under these leases at December 31, 2002 was as follows:

Year Ending	(in thousands)
2003	$	1,539
2004		1,540
2005		1,522
2006		1,508
2007		1,511
Thereafter		71,400

Total	$	79,020

Litigation—Neither the Company nor any of the Company’s Properties are presently subject to any material litigation nor, to the Company’s knowledge, is any material litigation threatened against any of them which if determined unfavorably to the Company would have a material adverse effect on the Company’s cash flows, financial condition or results of operations. The Company is party to litigation arising in the ordinary course of business, none of which if determined unfavorably to the Company, individually or in the aggregate, is expected to have a material adverse effect on the Company’s cash flows, financial condition or results of operations.

Environmental Matters—The Company follows the policy of monitoring its Properties for the presence of hazardous or toxic substances. While there can be no assurance that a material environmental liability does not exist, the Company is not currently aware of any environmental liability with respect to the Properties that would have a material effect on the Company’s financial condition, results of operations and cash flows. Further, the Company is not aware of any environmental liability or any unasserted claim or assessment with respect to an environmental liability that the Company believes would require additional disclosure or the recording of a loss contingency.

17. Related-Party Transactions

Acquisition and Note Receivable from Related Party

In a series of transactions from May 2000 through January 2001, the Company acquired the fee interest in a three building office complex located in El Segundo, California from KAICO, a partnership 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.

On May 1, 2000, the Company purchased a non-recourse note receivable secured by the office complex with an outstanding principal balance of $60.8 million, accrued interest of $10.2 million, an annual interest rate of 9.63%, and a maturity date of February 1, 2005 from an institutional lender for $45.3 million. At the time of the acquisition, KAICO was in payment default under the terms of the note. The Company recorded its investment in the impaired note at the $45.3 million purchase price and recorded no additional impairment

F-29

KILROY REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

allowance since the Company believed that the purchase price of the note was less than the fair market value of the complex securing it as supported by independent, third-party appraisals. The Company and KAICO also entered into agreements whereby the Company agreed to pay KAICO approximately $3.3 million for the reimbursement of expenditures incurred by KAICO on the complex since 1997 and for the modification of an existing option that the Company held to purchase the complex. The acquisition of the note was funded with borrowings under the Company’s Credit Facility.

As a result of the acquisition of the note, the Company received approximately $2.7 million which was recorded as interest income during the year ended December 31, 2000. In October 2000, the Company and KAICO agreed to modify the terms of the note to write down the principal value and accrued interest to $45.3 million. In connection with the modification of the note in October 2000, a wholly-owned subsidiary of the Company acquired a 25% tenancy-in-common interest in the complex from KAICO subject to 25% or $11.3 million of the $45.3 million note in exchange for 1,133 common units of the Operating Partnership valued at approximately $30,000 based upon the closing share price of the Company’s common stock as reported on the New York Stock Exchange. During the fourth quarter of 2000, the Company recorded approximately $0.2 million as other income related to its equity in earnings from its 25% tenancy-in-common interest.

In January 2001, the Company purchased the remaining 75% tenancy-in-common interest in the complex from KAICO for $33.4 million in cash. The Company partially funded the acquisition with $28.4 million in proceeds from property dispositions that were held for use in tax-deferred property exchanges. The remaining $5.0 million was funded with borrowings under the Company’s Credit Facility. 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. The Company owned a 100% interest in the complex as a result of the acquisition of the 75% interest.

In July 2002, KAICO received a $1.4 million net insurance payment for earthquake related damage to this three building office complex. In connection with the initial acquisition, KAICO and the Company agreed that KAICO would be entitled to retain all claims under policies of insurance in effect with respect to these properties, with the exception that KAICO transferred to the Company the rights to any claims under any insurance policy that related to the portion of the complex known as 909 North Sepulveda Boulevard. Of the total $1.4 million payment, $1.2 million related to claims for 955 and 999 North Sepulveda Boulevard and $0.2 million related to claims for 909 North Sepulveda Boulevard. Based on the agreement between KAICO and the Company, the $0.2 million that related to 909 North Sepulveda Boulevard was paid to a wholly-owned subsidiary of the Company in July 2002.

Other Transactions

On January 1, 2001, KSI was merged into a newly formed entity, KSLLC. Prior to the merger, John B. Kilroy, Sr. and John B. Kilroy, Jr. owned 100% of the voting interest of KSI, and the Operating Partnership owned 100% of the non-voting preferred stock representing a 95% economic interest in KSI. In connection with the merger, Messrs. Kilroy received $8,000 in cash for their economic interest and KSLLC became a wholly-owned subsidiary of the Company (see Note 1).

As part of the Company’s marketing strategy, in April 2000, KSI entered into an agreement with TradeWind Navigation, Inc., a company owned solely by John B. Kilroy, Sr., to charter a sailing vessel for 26 weeks during the year. KSLLC assumed this agreement on January 1, 2001. The Company uses the sailing vessel in its marketing efforts by sponsoring broker events. During both years ended December 31, 2002 and 2001, KSLLC paid TradeWind Navigation, Inc. approximately $0.3 million, under this agreement. During year ended December 31, 2000, KSI paid TradeWind Navigation, Inc. approximately $0.2 million under this agreement. This agreement will terminate in April 2003.

F-30

KILROY REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

In October 1997, KSI entered into a management agreement to manage the development of certain properties owned by entities under the common control of a senior executive officer of The Allen Group. KSLLC assumed this agreement and the related receivables as of January 1, 2001. At December 31, 2001, KSLLC had a receivable balance of $80,000 for management fees earned. This agreement was terminated in March 2002 and the Company received payment for the related receivable balances in connection with the acquisition of The Allen Group’s minority interest in the Development LLC’s (see Notes 2 and 12).

At December 31, 2002 and 2001, other assets include a note receivable and accrued interest totaling approximately $0.2 million and $0.3 million, respectively due from a Senior Vice President of the Company. The note, which was issued in November 2000, bears interest at 8%, matures in July 2005, and is secured by real property owned by the officer.

18. Fair Value of Financial Instruments

The carrying amounts of the Company’s cash and cash equivalents, restricted cash and accounts payable approximate fair value due to their short-term maturities. The carrying amounts of the Company’s variable-rate secured debt and unsecured term facility and outstanding borrowings on the Credit Facility approximate fair value since the interest rates on these instruments are equivalent to rates currently offered to the Company.

For fixed-rate secured debt, the Company estimates fair value by using discounted cash flow analyses based on borrowing rates for similar types of borrowing arrangements. The fair value of the Company’s fixed-rate secured debt was $359 million and $301 million at December 31, 2002 and 2001, respectively.

19. Lease Termination Fee

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 occupied the remaining 23,000 rentable square feet through August 15, 2001 and paid rent on this space based upon the terms in the stipulation.

In August 2002, one of the Company’s former tenants, EBC I, formerly known as eToys, Inc. (“eToys”) filed a lawsuit in the United States Bankruptcy Court District of Delaware against the Company seeking return of the proceeds from two letters of credit previously drawn down by the Company (the “EBC I Lawsuit”). The tenant originally caused its lenders to deliver an aggregate of $15 million in letters of credit to secure its obligations under its lease with the Company and also to secure its obligations to repay the Company for certain leasing and tenant improvement costs. eToys defaulted on its lease and other obligations to the Company in January 2001 and subsequently filed for bankruptcy in March 2001. In January 2003, the bankruptcy court abstained from hearing the EBC I Lawsuit with respect to all state law issues other than whether the Company’s retention or application of the letters of credit proceeds violated section 502(b)(6) of the Bankruptcy Code. Therefore to the extent EBC I intends on proceeding with its claims, it will be required to refile a separate lawsuit in the California Superior Court. As of the date of this report, the Company has received no notice of such refilling. However, if EBC I files and prevails in a separate lawsuit, it could have a material adverse effect upon the financial condition, results of operations and cash flows of the Company.

F-31

KILROY REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

20. Segment Disclosure

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 administration, 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 property income) less property and related expenses (property expenses, real estate taxes, provision for bad debts and ground leases) and excludes interest income and expense, depreciation and amortization, and corporate general and administrative expenses. The accounting policies of the reportable segments are the same as those described in the Company’s summary of significant accounting policies (see Note 2). There is no intersegment activity.

The following tables reconcile the Company’s segment activity to its consolidated results of operations and financial position as of and for the years ended December 31, 2002, 2001 and 2000.

	Year Ended December 31,
	2002			2001			2000
	(in thousands)
Revenues and Expenses:
Office Properties:
Operating revenues(1)	$	165,801		$	160,377		$	126,977
Property and related expenses		46,389			41,141			31,416

Net operating income, as defined		119,412			119,236			95,561

Industrial Properties:
Operating revenues(1)		38,876			42,182			47,789
Property and related expenses		7,100			6,906			7,513

Net operating income, as defined		31,776			35,276			40,276

Total Reportable Segments:
Operating revenues(1)		204,677			202,559			174,766
Property and related expenses		53,489			48,047			38,929

Net operating income, as defined		151,188			154,512			135,837

Reconciliation to Consolidated Net Income:
Total net operating income, as defined, for reportable segments		151,188			154,512			135,837
Other unallocated revenues:
Interest income		513			1,030			1,878
Interest income from related party								2,724
Equity in earnings from unconsolidated real estate								191
Other unallocated expenses:
General and administrative expenses		12,557			11,692			10,535
Interest expense		35,380			41,024			38,205
Depreciation and amortization		58,933			50,563			39,834

Income from continuing operations		44,831			52,263			52,056
Net gains on dispositions of operating properties		896			4,714			11,256
Minority interests		(15,052	)		(21,226	)		(20,087	)
Income from discontinued operations		9,637			4,072			3,621
Cumulative effect of change in accounting principle					(1,392	)

Net income	$	40,312		$	38,431		$	46,846

(1)

All operating revenues are comprised of amounts received from third-party tenants.

F-32

KILROY REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

	December 31,
	2002		2001
	(in thousands)
Assets:
Office Properties:
Land, buildings and improvements, net	$	1,081,971	$	933,300
Undeveloped land and construction in progress, net		108,465		191,129
Total assets(1)		1,242,437		1,176,141

Industrial Properties:
Land, buildings and improvements, net		217,279		234,900
Total assets(1)		229,245		248,459

Total Reportable Segments:
Land, buildings and improvements, net		1,299,250		1,168,200
Undeveloped land and construction in progress, net		108,465		191,129
Total assets(1)		1,471,682		1,424,600

Reconciliation to Consolidated Assets:
Total assets for reportable segments		1,471,682		1,424,600
Other unallocated assets:
Cash and cash equivalents		15,777		16,487
Restricted cash		6,814		5,413
Deferred financing costs, net		6,221		3,948
Prepaid expenses and other assets		6,108		6,781

Total consolidated assets	$	1,506,602	$	1,457,229

(1)

Includes land, buildings and improvements, undeveloped land and construction in progress, current receivables, deferred rents receivable, and deferred leasing costs, all shown on a net basis.

	December 31,
	2002		2001
	(in thousands)
Capital Expenditures:(1)
Office Properties:
Expenditures for undeveloped land and construction in progress	$	117,600	$	134,004
Acquisition of operating properties		7,569		38,875
Recurring capital expenditures and tenant improvements		14,490		11,933

Industrial Properties:
Recurring capital expenditures and tenant improvements		1,120		4,989

Total Reportable Segments:
Expenditures for undeveloped land and construction in progress		117,600		134,004
Acquisition of operating properties		7,569		38,875
Recurring capital expenditures and tenant improvements		15,610		16,922

(1)

Total consolidated capital expenditures are equal to the same amounts disclosed for total reportable segments.

F-33

KILROY REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

21. Discontinued Operations

In accordance with SFAS 144, the net income and the net gain on dispositions of operating properties sold subsequent to December 31, 2001 are reflected in the consolidated statement of operations as discontinued operations for all periods presented (see Note 2). For the years ended December 31, 2002, 2001 and 2000, discontinued operations relates to the 12 industrial and five office buildings that the Company sold in 2002 (see Note 3) and the six office buildings that the Company sold during the six months ended June 30, 2003 (see Note 27). In connection with the disposition of one of the properties sold in 2002 and one of the properties sold in 2003, the Company repaid approximately $4.1 million and $8.0 million, respectively, in principal of a mortgage loan partially secured by these properties. The related interest expense was allocated to discontinued operations. The following table summarizes the income and expense components that comprise discontinued operations:

	Year Ended December 31,
	2002			2001			2000
	(in thousands)
REVENUES:
Rental income	$	7,951		$	8,701		$	8,048
Tenant reimbursements		1,081			1,168			1,361
Other property income		26			29			28

Total revenues		9,058			9,898			9,437

EXPENSES:
Property expenses		1,482			1,634			1,580
Real estate taxes		814			860			868
Provision for bad debts		95			119			77
Interest expense		354			655			904
Depreciation and amortization		1853			2,081			1,870

Total expenses		4,598			5,349			5,299

Income from discontinued operations before net gain on disposition of discontinued operations and minority interests		4,460			4,549			4,138
Net gain on disposition of discontinued operations		6,570
Minority interest in earnings of Operating Partnership attributable to discontinued operations		(1,393	)		(477	)		(517	)

Total income from discontinued operations	$	9,637		$	4,072		$	3,621

The following table summarizes the total income from discontinued operations by the Company’s reportable segments:

	Year Ended December 31,
	2002		2000		2001
	(in thousands)
Reportable Segments:
Office Properties	$	5,207	$	2,724	$	2,443
Industrial Properties		4,430		1,348		1,178

Total income from discontinued operations	$	9,637	$	4,072	$	3,621

F-34

KILROY REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

22. 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 assumed exercise of all dilutive securities. The Company does not consider common limited partnership units of the Operating Partnership to be dilutive securities since the exchange of common limited partnership 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 for the years ended December 31, 2002, 2001 and 2000:

	Year Ended December 31,
	2002		2001			2000
	(in thousands, except share and per share amounts)
Numerator:
Net income from continuing operations before cumulative effect of change in accounting principle	$	30,675	$	35,751		$	43,225
Discontinued operations		9,637		4,072			3,621
Cumulative effect of change in accounting principle				(1,392	)

Net income—numerator for basic and diluted earnings per share	$	40,312	$	38,431		$	46,846

Denominator:
Basic weighted average shares outstanding		27,449,676		27,167,006			26,598,926
Effect of dilutive securities—stock options and restricted shares		272,521		205,945			156,058

Diluted weighted average shares and common share equivalents outstanding		27,722,197		27,372,951			26,754,984

Basic earnings per share:
Net income from continuing operations before cumulative effect of change in accounting principle	$	1.12	$	1.32		$	1.63
Discontinued operations		.35		0.14			0.13
Cumulative effect of change in accounting principle				(0.05	)

Net income	$	1.47	$	1.41		$	1.76

Diluted earnings per share:
Net income from continuing operations before cumulative effect of change in accounting principle	$	1.11	$	1.31		$	1.62
Discontinued operations		0.34		0.14			0.13
Cumulative effect of change in accounting principle				(0.05	)

Net income	$	1.45	$	1.40		$	1.75

At December 31, 2002, Company employees and directors held options to purchase 941,092 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.

F-35

KILROY REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

23. Tax Treatment of Distributions

The following table reconciles the dividends declared per common share to the dividends paid per common share during the years ended December 31, 2002, 2001 and 2000 as follows:

	2002			2001			2000
Dividends declared per common share	$	1.980		$	1.920		$	1.800
Less: Dividends declared in the current year, and paid in the following year		(0.495	)		(0.480	)		(0.450	)
Add: Dividends declared in the prior year, and paid in the current year		0.480			0.450			0.420

Dividends paid per common share	$	1.965		$	1.890		$	1.770

The income tax treatment for distributions reportable for the years ended December 31, 2002, 2001, and 2000 as identified in the table above, was as follows:

	2002				2001				2000
Ordinary income	$	1.522	77.47	%	$	1.093	57.82	%	$	1.110	62.71	%
Return of capital		0.292	14.88			0.742	39.27			0.448	25.31
Capital gains		0.070	3.56			0.029	1.52			0.149	8.42
Unrecaptured section 1250 capital gains		0.081	4.09			0.026	1.39			0.063	3.56

	$	1.965	100.00	%	$	1.890	100.00	%	$	1.770	100.00	%

F-36

KILROY REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

24. Quarterly Financial Information (Unaudited)

Summarized quarterly financial data for the years ended December 31, 2002 and 2001 was as follows:

	2002 Quarter Ended(1)
	March 31,			June 30,		September 30,		December 31,
	(in thousands, except per share amounts)
Revenues from continuing operations	$	50,761		$	50,908	$	50,169	$	52,840
Net Operating Income from continuing operations(2)		38,596			37,283		37,124		38,185
Income from continuing operations		12,409			3,755		6,630		7,882
Discontinued operations		1,098			1,202		1,255		6,083
Net income		13,507			4,957		7,885		13,965
Net income per share—basic	$	0.50		$	0.18	$	0.29	$	0.51
Net income per share—diluted	$	0.49		$	0.18	$	0.28	$	0.50

	2001 Quarter Ended(1)
	March 31,			June 30,		September 30,		December 31,
	(in thousands, except per share amounts)
Revenues from continuing operations	$	48,902		$	55,747	$	49,488	$	48,422
Net Operating Income from continuing operations(2)		37,218			43,665		37,051		36,578
Income from continuing operations before cumulative effect of change in accounting principle		6,946			14,060		8,225		6,519
Discontinued operations		872			1,037		1,058		1,106
Cumulative effect of change in accounting principle		(1,392	)
Net income		6,426			15,097		9,283		7,625
Net income per share before cumulative effect of change in accounting principle—basic	$	0.29		$	0.56	$	0.34	$	0.28
Net income per share before cumulative effect of change in accounting principle—diluted	$	0.29		$	0.55	$	0.34	$	0.28
Net income per share—basic	$	0.24		$	0.56	$	0.34	$	0.28
Net income per share—diluted	$	0.24		$	0.55	$	0.34	$	0.28

(1)

The summation of the quarterly financial data may not equal the annual number reported on the consolidated statement of operations due to rounding differences.

(2)

See Note 20 for definition of Net Operating Income.

The quarterly financial information does not equal the amounts reported on the Company’s quarterly reports on Form 10Q due to the reclassification of the net income and net gains on the dispositions of operating properties sold subsequent to December 31, 2001 to discontinued operations, in accordance with SFAS 144 (see Note 21).

F-37

KILROY REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

25. Subsequent Events

On January 17, 2003, aggregate distributions of $15.7 million were paid to common stockholders and common unitholders of record on December 31, 2002.

In January 2003, Peregrine Systems, Inc. indicated to the Company that it intends to file a motion to reject the remaining two leases encompassing approximately 241,750 rentable square feet that it has with the Company.

In January 2003, the Company recognized a $4.1 million lease termination fee from the early termination of a lease at 68,000 square foot property in San Diego, California.

On February 10, 2003, the Company’s Board of Directors declared a regular quarterly cash dividend of $0.495 per common share payable on April 17, 2003 to shareholders of record on March 28, 2003.

On February 14, 2003, aggregate distributions of $3.4 million were paid to the Series C, Series A and Series D Preferred unitholders.

In February 2003, Brobeck, Phleger & Harrison LLP, the Company’s sixth largest tenant, dissolved and began winding up its operations. Brobeck leases two buildings totaling 161,500 rentable square feet with annual base rental revenues of $4.2 million. The two leases with Brobeck represent approximately 2.4% of the Company’s annual base rental revenues. Brobeck did not timely pay rent for either building for February 2003 and remains in possession of the premises. The Company is currently pursuing legal action against Brobeck.

F-38

KILROY REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

26. Schedule of Rental Property

	December 31, 2002
		Initial Cost				Costs Capitalized Subsequent to Acquisition/ Improvement		Gross Amounts at Which Carried at Close of Period							Accumulated Depreciation		Date of Acquisition(A)/ Construction(C)(1)		Net Rentable Square Feet
Property Location	Encumbrances	Land		Buildings and Improvements		Costs Capitalized Subsequent to Acquisition/ Improvement		Land		Building			Total		Accumulated Depreciation		Date of Acquisition(A)/ Construction(C)(1)		Net Rentable Square Feet
		(dollars in thousands)
Office Properties:
Kilroy Airport Center, El Segundo El Segundo, California	$76,509(3)	$	6,141	$	69,195	$	26,389	$	6,141	$	95,584		$	101,725	$	61,363	1983	(C)	706,302
Kilroy Airport Center, Phase I— Long Beach, California							25,514				25,514			25,514		4,403	1997	(A)	225,083
Kilroy Airport Center, Phase II— Long Beach, California					47,387		10,919				58,306			58,306		29,378	1989	(C)	395,613
La Palma Business Center 4175 E. La Palma Avenue Anaheim, California	(3)		1,518		2,612		623		1,518		3,235			4,753		632	1997	(A)	43,228
2829 Townsgate Road Thousand Oaks, California	(3)		5,248		8,001		1,233		5,248		9,234			14,482		1,873	1997	(A)	81,158
181/185 S. Douglas Street El Segundo, California	(3)		525		4,687		3,332		628		7,916			8,544		4,555	1978	(C)	62,150
SeaTac Office Center Seattle, Washington	26,652				25,993		20,533				46,526			46,526		32,295	1977	(C)	532,430
2100 Colorado Avenue Santa Monica, California	88,630(4)		5,474		26,087		458		5,476		26,543			32,019		4,166	1997	(A)	94,844
5151-5155 Camino Ruiz Camarillo, California			4,501		19,710		1,915		4,501		21,625			26,126		3,505	1997	(A)	265,372
111 Pacifica Irvine, California	(4)		5,165		4,653		1,114		5,166		5,766			10,932		1,093	1997	(A)	67,381
2501 Pullman/1700 Carnegie Santa Ana, California			6,588		9,211		3,639		7,127		12,311			19,438		1,260	1997	(A)	129,766
26541 Agoura Road Calabasas, California			1,979		9,630		2,466		1,979		12,096			14,075		3,302	1997	(A)	90,878
9451 Toledo Way Irvine, California					869		1,207				2,076			2,076		712	1997	(A)	27,200
1633 26th Street Santa Monica, California			2,080		6,672		1,454		2,040		8,166			10,206		1,777	1997	(A)	44,915
4351 Latham Avenue Riverside, California			307		1,555		169		307		1,724			2,031		323	1997	(A)	21,357
4361 Latham Avenue Riverside, California			764		3,577		145		765		3,721			4,486		606	1997	(A)	30,581
601 Valencia Avenue Brea, California			3,518		2,900		99		3,519		2,998			6,517		515	1997	(A)	60,891
3750 University Avenue Riverside, California	11,549		2,909		19,372		849		2,912		20,218			23,130		3,182	1997	(A)	124,986
6215/6220 Greenwich Drive San Diego, California	22,253		4,796		15,863		8,225		5,148		23,736			28,884		4,173	1997	(A)	212,214
6055 Lusk Avenue San Diego, California	75,671(5)		3,935		8,008		21		3,942		8,022			11,964		1,184	1997	(A)	93,000
6260 Sequence Drive San Diego, California	(5)		3,206		9,803		23		3,212		9,820			13,032		1,450	1997	(A)	130,000
6290 Sequence Drive San Diego, California	(5)		2,403		7,349		17		2,407		7,362			9,769		1,087	1997	(A)	90,000
8101 Kaiser Blvd Anaheim, California			2,369		6,180		418		2,377		6,590			8,967		1,056	1997	(A)	60,177
3130 Wilshire Blvd. Santa Monica, California			8,921		6,579		3,737		9,188		10,049			19,237		2,443	1997	(A)	88,338
12312 W. Olympic Blvd. Los Angeles, California			3,325		12,202		574		3,399		12,702			16,101		1,854	1997	(A)	78,000
Anaheim Corporate Center Anaheim, California			5,305		10,149		1,766		5,311		11,909	��		17,220		2,234	1997	(A)	157,758
525 N. Brand Blvd. Glendale, California			1,360		8,771		114		1,373		8,872			10,245		1,270	1997	(A)	43,647

F-39

KILROY REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

	December 31, 2002
		Initial Cost				Costs Capitalized Subsequent to Acquisition/ Improvement			Gross Amounts at Which Carried at Close of Period						Accumulated Depreciation		Date of Acquisition(A)/ Construction(C)(1)		Net Rentable Square Feet
Property Location	Encumbrances	Land		Buildings and Improvements		Costs Capitalized Subsequent to Acquisition/ Improvement			Land		Building		Total		Accumulated Depreciation		Date of Acquisition(A)/ Construction(C)(1)		Net Rentable Square Feet
		(dollars in thousands)
Kilroy Airport Long Beach —Phase IV(2) Long Beach, California						$	2,088				$	2,088	$	2,088	$	1,470
501 Santa Monica Blvd. Santa Monica, California	(4)	$	4,547	$	12,044		1,143		$	4,551		13,183		17,734		2,231	1998	(A)	70,045
5770 Armada Drive Carlsbad, California	(5)		2,626		7,880		7			2,626		7,887		10,513		1,071	1998	(A)	81,712
6340/6350 Sequence Drive San Diego, California	(4)		7,375		22,126		2,402			7,386		24,517		31,903		3,988	1998	(A)	199,000
15378 Avenue of Science San Diego, California	(5)		3,565		3,796		1,586			3,565		5,382		8,947		591	1998	(A)	68,910
Pacific Corporate Center San Diego, California	(4)		14,979		39,634		3,857			14,978		43,492		58,470		6,604	1998	(A)	411,339
9455 Towne Center Drive San Diego, California	(5)				3,936		3,143			3,118		3,961		7,079		663	1998	(A)	45,195
12225/12235 El Camino Real San Diego, California	(5)		3,207		18,176		42			3,213		18,212		21,425		2,214	1998	(A)	115,513
12348 High Bluff Drive San Diego, California	(5)		1,629		3,096		1,353			1,629		4,449		6,078		1,654	1999	(C)	40,274
4690 Executive Drive San Diego, California	(5)		1,623		7,926		455			1,623		8,381		10,004		1,068	1999	(A)	50,929
9785/9791 Towne Center Drive San Diego, California	(5)		4,536		16,554		46			4,546		16,590		21,136		1,777	1999	(A)	126,000
5005/5010 Wateridge Vista Drive San Diego, California	20,910		7,106		15,816		5,577			9,223		19,276		28,499		1,758	1999	(C)	172,778
3579 Valley Center Drive San Diego, California			2,167		6,897		1,834			2,841		8,057		10,898		629	1999	(C)	52,375
Kilroy Airport Center—Phase III Long Beach, California					49,654		4,219					53,873		53,873		8,543	1999/2000	(C)	328,502
12390 El Camino Real San Diego, California	31,000(6)		3,453		11,981		87			3,453		12,068		15,521		1,507	2000	(C)	72,332
6310 Sequence Drive San Diego, California	(4)		2,941		4,946		(7	)		2,941		4,939		7,880		574	2000	(C)	62,415
15435/15445 Innovation Drive San Diego, California			4,286		12,622		10			4,286		12,632		16,918		2,587	2000	(C)	103,000
24025 Park Sorrento Calabasas, California			845		15,896		417			845		16,313		17,158		2,014	2000	(C)	100,592
12200 W. Olympic Blvd. Los Angeles, California			4,329		35,488		2,596			3,977		38,436		42,413		3,424	2000	(C)	151,019
3611 Valley Centre Drive San Diego, California			4,184		19,352		5,604			5,261		23,879		29,140		1,494	2000	(C)	129,680
3811 Valley Centre Drive San Diego, California			3,452		16,152		5,542			4,471		20,675		25,146		1,198	2000	(C)	112,067
4955 Directors Place San Diego, California	17,951(7)		2,521		14,122		2,156			3,160		15,639		18,799		1,172	2000	(C)	76,246
10390 Pacific Center San Diego, California			3,267		5,779		4,554			3,267		10,333		13,600		140	2001	(C)	68,400
5717 Pacific Center San Diego California			2,693		6,280		6			2,693		6,286		8,979		352	2001	(C)	67,995
23975 Park Sorrento Calabasas, California			765		17,720		2,332			765		20,052		20,817		1,164	2001	(C)	100,592
23925 Park Sorrento San Diego, California			50		2,346		221			50		2,567		2,617		138	2001	(C)	11,789
909 N. Sepulveda Blvd. El Segundo, California			3,576		34,042		262			3,576		34,304		37,880		1,836	2001	(A)	248,148
15051 Avenue of Science San Diego, California			2,888		5,780		5,579			2,888		11,359		14,247		400	2001	(C)	70,617
15073 Avenue of Science San Diego, California			2,070		5,728		1,303			2,070		7,031		9,101		446	2001	(C)	46,759

F-40

KILROY REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

	December 31, 2002
		Initial Cost				Costs Capitalized Subsequent to Acquisition/ Improvement			Gross Amounts at Which Carried at Close of Period						Accumulated Depreciation		Date of Acquisition(A)/ Construction(C)(1)		Net Rentable Square Feet
Property Location	Encumbrances	Land		Buildings and Improvements		Costs Capitalized Subsequent to Acquisition/ Improvement			Land		Building		Total		Accumulated Depreciation		Date of Acquisition(A)/ Construction(C)(1)		Net Rentable Square Feet
		(dollars in thousands)
3661 Valley Centre Drive San Diego, California		$	4,038	$	21,144	$	2,847		$	4,762	$	23,267	$	28,029	$	1,065	2001	(C)	129,752
10243 Genetic Center Drive San Diego, California	(6)		4,632		19,549		2			4,632		19,551		24,183		1,245	2001	(C)	102,875
12100 W. Olympic Blvd. Los Angeles, California			352		45,611		402			8,091		38,274		46,365		43	2002	(C)	151,000
4939 Directors Place San Diego, California	(7)		2,225		12,698		719			2,225		13,417		15,642		322	2002	(C)	60,662
12340 El Camino Real San Diego, California			4,201	$	13,896		724			4,201		14,620		18,821		156	2002	(C)	89,168
3721 Valley Centre Blvd. San Diego, California			4,297		18,967		1,404			4,297		20,371		24,668			2002	(C)	114,780
999 N. Sepulveda Blvd. El Segundo, California			1,407		34,326		591			1,407		34,917		36,324			2002	(C)	133,678

TOTAL OFFICE PROPERTIES	$371,125	$	198,169	$	928,975	$	182,056		$	216,301	$	1,092,899	$	1,309,200	$	227,229			7,923,407

Industrial Properties:
2031 E. Mariposa Avenue El Segundo, California	(3)	$	132	$	867	$	2,698		$	132	$	3,565	$	3,697	$	3,540	1954	(C)	192,053
3340 E. La Palma Avenue Anaheim, California	(3)		67		1,521		4,960			67		6,481		6,548		4,385	1966	(C)	153,320
2260 E. El Segundo Blvd. El Segundo, California	(3)		1,423		4,194		2,099			1,703		6,013		7,716		3,876	1979	(C)	113,820
2265 E. El Segundo Blvd. El Segundo, California	(3)		1,352		2,028		651			1,571		2,460		4,031		1,881	1978	(C)	76,570
1000 E. Ball Road Anaheim, California	(3)		838		1,984		921			838		2,905		3,743		2,473	1956 1974	(C) (A)	100,000
1230 S. Lewis Road Anaheim, California	(3)		395		1,489		2,058			395		3,547		3,942		2,889	1982	(C)	57,730
12681/12691 Pala Drive Garden Grove, California	(3)		471		2,115		2,706			471		4,821		5,292		4,083	1980	(A)	84,700
2270 E. El Segundo Blvd. El Segundo, California			361		100		156			419		198		617		116	1977	(C)	6,362
5115 N. 27th Avenue Phoenix, Arizona			125		1,206		843			125		2,049		2,174		1,270	1962	(C)	130,877
12752/12822 Monarch Street Garden Grove, California	(3)		3,975		5,238		587			3,975		5,825		9,800		1,108	1997	(A)	277,037
4155 E. La Palma Avenue Anaheim, California	(3)		1,148		2,681		387			1,148		3,068		4,216		595	1997	(A)	74,618
4125 E. La Palma Avenue Anaheim, California	(3)		1,690		2,604		14			1,690		2,618		4,308		478	1997	(A)	69,472
Brea Industrial Complex Brea, California	$29,000(8)		1,263		13,927		195			1,263		14,122		15,385		2,363	1997	(A)	276,278
Garden Grove Industrial Complex Garden Grove, California			1,868		11,894		483			1,868		12,377		14,245		2,122	1997	(A)	275,971
17150 Von Karman Irvine, California	(8)		4,848		7,342		72			4,848		7,414		12,262		1,206	1997	(A)	157,458
7421 Orangewood Avenue Garden Grove, California	(3)		612		3,967		1,500			612		5,467		6,079		614	1997	(A)	82,602
5325 East Hunter Avenue Anaheim, California	84,253(9)		1,728		3,555					1,728		3,555		5,283		576	1997	(A)	109,449
9401 Toledo Way Irvine, California			8,572		7,818		(2,331	)		5,665		8,394		14,059		1,253	1997	(A)	244,800
12400 Industry Street Garden Grove, California			943		2,110		35			943		2,145		3,088		357	1997	(A)	64,200
2055 S.E. Main Street Irvine, California			772		2,343		137			772		2,480		3,252		393	1997	(A)	47,583

F-41

KILROY REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

	December 31, 2002
		Initial Cost				Costs Capitalized Subsequent to Acquisition/ Improvement			Gross Amounts at Which Carried at Close of Period						Accumulated Depreciation		Date of Acquisition(A)/ Construction(C)(1)		Net Rentable Square Feet
Property Location	Encumbrances	Land		Buildings and Improvements		Costs Capitalized Subsequent to Acquisition/ Improvement			Land		Building		Total		Accumulated Depreciation		Date of Acquisition(A)/ Construction(C)(1)		Net Rentable Square Feet
		(dollars in thousands)
14831 Franklin Avenue Tustin, California		$	1,112	$	1,065	$	272		$	1,113	$	1,336	$	2,449		293	1997	(A)	36,256
1675 MacArthur Costa Mesa, California	(9)		2,076		2,114		166			2,076		2,280		4,356		332	1997	(A)	50,842
3130/3150 Miraloma Anaheim, California	(9)		3,335		3,727		(11	)		3,335		3,716		7,051		564	1997	(A)	144,000
3125 E. Coronado Street Anaheim, California	(9)		3,669		4,341		245			3,669		4,586		8,255		669	1997	(A)	144,000
1951 E. Carnegie Santa Ana, California			1,830		3,630		1,381			1,844		4,997		6,841		831	1997	(A)	100,000
5115 E. La Palma Avenue Anaheim, California	(9)		2,462		6,675		4,502			2,464		11,175		13,639		1,743	1997	(A)	286,139
3735 Imperial Highway Stockton, California	6,417		764		10,747		18			764		10,765		11,529		1,589	1997	(A)	164,540
1250 N. Tustin Avenue Anaheim, California	(8)		2,098		4,158		200			2,098		4,358		6,456		574	1998	(A)	84,185
2911 Dow Avenue Tustin, California			1,124		2,408		591			1,124		2,999		4,123		328	1998	(A)	51,410
25202 Towne Center Drive Foothill Ranch, California	(9)		3,334		8,243		4,701			4,949		11,329		16,278		2,553	1998	(C)	303,533
3250 E. Carpenter Avenue Anaheim, California	(3)						2,289					2,289		2,289		406	1998	(C)	41,225
925 / 1075 Lambert Road Brea, California	(9)		3,326		7,020		1,752			3,326		8,772		12,098		1,661	2000	(C)	178,811
Anaheim Technology Center Anaheim, California	(9)		10,648		20,221		4,706			10,649		24,926		35,575		4,114	2000	(C)	593,992
2525 Pullman Anaheim, California			4,283		3,276		318			4,283		3,594		7,877		39	2002	(A)	107,130

TOTAL INDUSTRIAL PROPERTIES	$119,670	$	72,644	$	156,608	$	39,301		$	71,927	$	196,626	$	268,553	$	51,274			4,880,963

TOTAL ALL PROPERTIES	$490,795	$	270,813	$	1,085,583	$	221,357		$	288,228	$	1,289,525	$	1,577,753	$	278,503			12,804,370

(1)

Represents date of construction or acquisition by the Company, or the Company’s Predecessor, the Kilroy Group.

(2)

These costs represent infrastructure costs incurred in 1989.

(3)

These properties secure a $76.5 million mortgage note.

(4)

These properties secure a $88.6 million mortgage note.

(5)

These properties secure a $75.7 million mortgage note.

(6)

These properties secure a $31.0 million mortgage note.

(7)

These properties secure a $17.9 million mortgage note.

(8)

These properties secure a $29.0 million mortgage note.

(9)

These properties secure a $5.0 million and a $79.3 million mortgage note.

The aggregate gross cost of property included above for federal income tax purposes, approximated $1.5 billion as of December 31, 2002.

F-42

The following table reconciles the historical cost of the total investment in real estate, net from January 1, 2000 to December 31, 2002:

	Year Ended December 31,
	2002			2001		2000
	(in thousands)
Land, building and improvements, beginning of year	$	1,409,865		$	1,321,439	$	1,220,593
Net additions during period—Acquisition, improvements, etc. (net of dispositions)		167,888			88,426		100,846

Land, building and improvements, end of year		1,577,753			1,409,865		1,321,439

Undeveloped land and construction in progress, net, beginning of year		191,129			162,633		189,645
Change in undeveloped land and construction in progress, net		(82,664	)		28,496		(27,012	)

Undeveloped land and construction in progress, net, end of year		108,465			191,129		162,633
Investment in unconsolidated real estate							12,405

Total investment in real estate, net, end of year	$	1,686,218		$	1,600,994	$	1,496,477

The following table reconciles the accumulated depreciation from January 1, 2000 to December 31, 2002:

	Year Ended December 31,
	2002		2001		2000
	(in thousands)
Beginning of year	$	241,665	$	205,332	$	174,427
Net additions during the period		36,838		36,333		30,905

End of year	$	278,503	$	241,665	$	205,332

27. Subsequent Dispositions

During the six months ended June 30, 2003, the Company sold the following properties:

Location	Type	Month of Disposition	Number of Buildings	Rentable Square Feet	Sales Price ($ in millions)
4351 Latham Avenue Riverside, CA	Office	April	1	21,400	$	2.8

5770 Armada Drive Carlsbad, CA	Office	May	1	81,700		14.4

Anaheim Corporate Center Anaheim, CA	Office	June	4	157,800		13.8

Total			6	260,900	$	31.0

Since the Company’s financial statements for the year ended December 31, 2002 included in its Annual Report on Form 10-K will be incorporated by reference in a registration statement on Form S-3 subsequently filed with the SEC, the SEC requires the financial statements to be restated to reflect discontinued operations treatment for the properties sold during the six months ended June 30, 2003. The net income for these properties has been reclassified to discontinued operations for the years ended December 31, 2002, 2001 and 2000 to conform with the presentation in the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2003 (see Note 21).

F-43

KILROY REALTY CORPORATION

SCHEDULE II—VALUATION AND QUALIFYING ACCOUNTS

Year Ended December 31, 2002, 2001 and 2000

(in thousands)

	Balance at Beginning of Period		Charged to Costs and Expenses or Rental Revenue		Deductions			Balance at End of Period
Year Ended December 31, 2002—Allowance for uncollectible tenant receivables	$	2,835	$	2,098	$	(434	)	$	4,499
Year Ended December 31, 2001—Allowance for uncollectible tenant receivables	$	1,617	$	2,356	$	(1,138	)	$	2,835
Year Ended December 31, 2000—Allowance for uncollectible tenant receivables	$	1,354	$	852	$	(589	)	$	1,617
Year Ended December 31, 2002—Allowance for unbilled deferred rent	$	3,452	$	4,669	$	(2,134	)	$	5,987
Year Ended December 31, 2001—Allowance for unbilled deferred rent	$	2,000	$	1,485	$	(33	)	$	3,452
Year Ended December 31, 2000—Allowance for unbilled deferred rent	$	1,339	$	1,021	$	(360	)	$	2,000
Year Ended December 31, 2002—Allowance for pre-development costs	$	1,050	$	519	$	(3	)	$	1,566
Year Ended December 31, 2001—Allowance for pre-development costs	$	506	$	588	$	(44	)	$	1,050
Year Ended December 31, 2000—Allowance for pre-development costs	$	703			$	(197	)	$	506

F-44

Kilroy Realty (KRC) 8-KOther events