Business context and reporting period
Empire State Realty OP, L.P. filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2014. The partnership owns and operates office and retail properties in Manhattan and the greater New York metropolitan area, as well as the Empire State Building observatory. At quarter-end, its portfolio comprised 10.0 million rentable square feet and was 88.7% occupied, or 89.7% leased including signed leases not yet commenced.
Comparisons with 2013 require caution: the 2013 periods reflect the predecessor before the October 7, 2013 IPO and formation transactions, while 2014 includes the acquired properties and observatory operations consolidated into the partnership. The reported year-over-year changes therefore are not like-for-like measures of underlying growth.
Key financial metrics
| Metric | Three months ended September 30, 2014 | Nine months ended September 30, 2014 |
|---|---|---|
| Total revenue | $169.4 million | $464.9 million |
| Operating income | $43.4 million | $110.0 million |
| Net income | $22.7 million | $59.2 million |
| Net income attributable to common unitholders | $22.5 million | $59.0 million |
| Basic and diluted earnings per unit | $0.09 | $0.23 |
| FFO per unit / Core FFO per unit | $0.23 / $0.25 | $0.62 / $0.65 |
Calculated operating margin was approximately 25.6% for the quarter and 23.7% for the nine-month period; net margin was approximately 13.4% and 12.7%, respectively. These reported margins reflect the expanded consolidated portfolio and are not directly comparable with predecessor-period margins.
- Cash flow: Nine-month operating cash flow was $101.6 million; investing cash flow was negative $264.6 million; financing cash flow was positive $155.2 million. Cash and cash equivalents decreased $7.8 million to $52.9 million. Capital expenditures, excluding tenant improvements and leasing commissions, were $48.9 million.
- Liquidity: Restricted cash was $63.8 million. The company reported $422.8 million available under its secured revolving and term credit facility, with availability reduced by $21.6 million pending specified Empire State Building capital expenditures.
- Debt: Debt carrying value was $1.598 billion, comprising $1.006 billion of mortgage notes, $355.6 million under the credit facility, and $237.0 million of senior unsecured notes. Principal debt was $1.587 billion. Management reported a 4.29% weighted-average interest rate and 3.0-year weighted-average maturity; 75.0% of debt was fixed rate.
- Distributions: Common OP units received $0.085 per unit for the third quarter. Total distributions during the first nine months were $64.8 million, including preferred-unit distributions.
Material changes versus the prior comparable period
- Third-quarter revenue increased 172.1% to $169.4 million and net income increased to $22.7 million from $2.3 million. For the nine months, revenue increased 152.3% to $464.9 million and net income increased to $59.2 million from $7.3 million. Management attributed much of the increase to consolidation of four formerly non-controlled properties and the observatory after the 2013 formation transactions, plus the July 2014 acquisitions.
- The July 15, 2014 acquisitions of leasehold interests at 112 West 34th Street and 1400 Broadway had total consideration of $733.6 million, including assumed debt, cash and Series PR OP units. They contributed $17.0 million in revenue and a $0.2 million net loss attributable to common unitholders since acquisition through September 30.
- Observatory revenue was $35.7 million in the quarter, up 10.2% from the prior-year quarter on a pro forma basis cited by management, attributed to higher admissions, pricing and ticket mix. Nine-month observatory revenue was $83.4 million, up 9.2% from $76.4 million in 2013; visitor numbers for the nine-month period were approximately level with the prior-year record.
- Debt increased from $1.208 billion at December 31, 2013, reflecting acquisitions and financing activity. The company issued $250 million of 2.625% exchangeable senior notes due 2019, receiving $246.9 million net proceeds.
Outlook, risks and unusual items
- No specific earnings or revenue guidance was provided. Management expects positive operating cash flow and believes it can refinance 2014 and 2015 maturities using available liquidity and refinancing capacity. Subsequent to quarter-end, it repaid the $13.7 million 1350 Broadway second mortgage, refinanced Metro Center with a $100 million fixed-rate loan due 2024 at 3.59%, and refinanced One Grand Central Place with a $91 million floating-rate loan due 2017.
- Management estimated $85 million to $125 million of additional capital spending beyond September 30, 2014 to substantially complete Manhattan office redevelopment and repositioning, with work at the Empire State Building expected to continue through the end of 2016. Approximately $63.8 million of tenant improvements and leasing commissions were expected under signed lease obligations, principally over the following 12 months.
- Leases covering 2.5% of portfolio rentable area expire in the fourth quarter of 2014 and 8.6% in 2015; management estimated these represent 2.6% and 9.3% of annualized rent, respectively. Occupancy and rents depend on leasing conditions and successful completion of redevelopment; renovation and tenant relocation may weigh on occupancy in the near term.
- Key risks include office and retail demand, tenant defaults or non-renewals, interest-rate changes, refinancing and capital availability, redevelopment delays or cost overruns, observatory tourism, weather and competition, and litigation. A 1 percentage-point increase in short-term rates was estimated to increase interest expense by approximately $4.0 million for the period analyzed.
- Litigation related to the formation transactions remains a contingency. The court-approved $55 million settlement of the original class actions is payable by the estate of Leona M. Helmsley, Malkin affiliates and certain investors, not by the partnership. A second class action was dismissed, but plaintiffs appealed; 12 investors who opted out of the original settlement initiated arbitration in October 2014. The filing says an adverse outcome in related claims could materially affect the company, including through indemnification obligations and legal costs.
- Other notable items include $3.4 million of acquisition expenses for the nine months and $1.4 million of costs for the preferred-unit exchange offer. Management reported compliance with credit-facility covenants, no off-balance-sheet arrangements, and effective disclosure controls.
Most important facts for investors to verify
- How much of reported revenue and earnings improvement reflects acquired and newly consolidated operations versus comparable-property performance.
- Actual leasing, occupancy and rent trends, including lease expirations, signed-but-not-commenced leases, and tenant improvement and leasing commission requirements.
- Funding and execution of the remaining redevelopment program and the $63.8 million of signed-lease commitments.
- Refinancing outcomes and costs for near-term maturities, and the effect of floating-rate debt and any future rate changes on interest expense.
- Developments in the formation-transaction litigation, arbitration and any related indemnification exposure.
- Cash available for distributions after debt service, capital spending and required REIT distributions; FFO and Core FFO are non-GAAP measures and do not represent cash available for distributions.