Empire State Realty Trust, Inc. quarterly report, Q2 FY2017

Empire State Realty Trust, Inc. — Q2 2017 Form 10-Q

Reporting period: Three and six months ended June 30, 2017; filed August 3, 2017. ESRT is a self-managed REIT focused on office and retail properties in Manhattan and the greater New York metropolitan area. Its portfolio included 10.1 million rentable square feet and the Empire State Building observatory.

Financial performance

Metric	Q2 2017	Q2 2016	Six months 2017	Six months 2016
Total revenue	$177.1 million	$165.8 million	$342.1 million	$322.9 million
Operating income	$51.4 million	$44.2 million	$88.1 million	$78.3 million
Net income	$31.4 million	$24.6 million	$50.5 million	$41.3 million
Net income attributable to common stockholders	$16.6 million	$11.1 million	$26.6 million	$18.5 million
Basic and diluted EPS	$0.10	$0.09	$0.17	$0.15

Q2 revenue rose 6.8%; operating income increased 16.4%. Operating margin was approximately 29.0%, versus 26.7% a year earlier. Six-month revenue grew 5.9% and operating income 12.5%.
Q2 rental revenue increased 7.3%, primarily due to higher rental rates and occupancy. Observatory revenue rose 6.7% to $34.0 million, mainly from higher ticket prices and the timing of Easter.
Q2 Core FFO was $73.2 million, versus $64.8 million. Six-month Core FFO was $134.5 million, versus $122.9 million. Core FFO is a non-GAAP measure and is not cash flow available for distributions.
Six-month net cash from operating activities was $87.4 million, compared with $92.1 million. Investing activities used $105.2 million, including $103.6 million of building and improvement additions; financing activities used $95.6 million. Cash and cash equivalents declined $113.4 million from year-end to $441.0 million.
At June 30, total debt principal was approximately $1.59 billion; weighted-average interest rate was 3.96% and weighted-average maturity 6.5 years. Cash was $441.0 million and the $1.1 billion revolving facility was undrawn. Net debt to total market capitalization was 15.5%. Debt covenants were met.
Dividends were $0.105 per share for Q2 and $0.21 per share for the first half. Total assets were $3.83 billion and total equity was $1.96 billion at June 30.

Material changes and operating developments

Q2 signed 51 leases covering 329,866 square feet, with a reported 31.0% portfolio-wide increase in mark-to-market rent over previous fully escalated rents. Manhattan office occupancy was 88.3%, or 90.7% leased including signed leases not commenced; total portfolio occupancy was 89.2%, or 91.3% leased including such leases.
Other revenue and fees increased substantially, primarily from lease cancellation income ($1.1 million in Q2; $8.8 million for the first half), a $0.7 million real estate tax refund, and higher interest income. This contributed to reported revenue growth.
Property operating expenses and real estate taxes increased; depreciation and amortization also rose. Interest expense was broadly unchanged. Six-month cash from operations was lower partly because of a cash payment to settle two forward-starting interest-rate hedges.
ESRT refinanced several mortgages during the quarter, including First Stamford Place, and reported no debt maturities in 2017 and approximately $262.2 million of maturities in 2018, excluding amortization.
The company began a multi-year Empire State Building project to relocate and expand the observatory entrance. It anticipates spending approximately $40–$50 million annually over the following three years; Q2 expenditures were $6.9 million.

Outlook, risks, and contingencies

Management expects positive operating cash flows and believes available liquidity and lender discussions support refinancing 2018 maturities. It expects to fund operating needs, distributions, leasing costs, and capital programs from operating cash flow, cash, borrowing capacity, mortgage financing, debt or equity issuance, and asset sales. No numerical earnings or FFO guidance is provided.
Approximately $52.5 million of capital expenditures, including tenant improvements and leasing commissions under existing lease agreements, was estimated at June 30. The company also reported approximately 0.9 million square feet available to lease; 3.5% and 8.8% of portfolio area was scheduled to expire in 2017 and 2018, respectively.
Management cited risks from leasing and tenant credit, vacancy and rents, refinancing and interest rates, capital availability, redevelopment costs and delays, observatory tourism and weather, broadcasting-market changes, ground leases, environmental matters, and REIT qualification. Observatory revenue is seasonal; first-half visitor count fell 4.4% year over year, while revenue rose 3.6%.
Broadcasting leases generally expire from 2017 to 2032. Four radio-broadcaster renewals were signed; Ion Television gave notice it would vacate at year-end 2017. Management said preliminary renewal proposals could yield lower revenue and higher capital expenditures.
An arbitration and stayed federal lawsuit by former Empire State Building investors allege fiduciary-duty and related claims concerning the IPO and formation transactions. Respondents intend to defend vigorously; additional arbitration hearings were scheduled for November 2017. Management said other routine litigation was not expected to materially affect results or liquidity.
Environmental investigations identified asbestos-containing materials at certain properties; management reported no removal plans that would trigger removal requirements and stated remediation at identified contaminated sites was completed. It cautioned that not all environmental liabilities may have been identified. The filing reports no material changes to risk factors and no subsequent events.

Important facts for investors to verify

Whether leasing, occupancy, and rent mark-to-market gains convert into durable cash rent, considering upcoming lease expirations and leasing costs.
How much of revenue and earnings growth depends on non-recurring lease cancellation income, refunds, or interest income.
Funding and execution of the Empire State Building project and the $52.5 million of estimated lease-related capital commitments.
Refinancing terms and timing for 2018 maturities, and exposure to floating rates and hedge fair-value changes.
Observatory attendance, pricing, weather and tourism trends; broadcasting tenant renewals, Ion Television’s departure, and potential revenue and capital-cost effects.
Developments in the investor arbitration and related litigation, and any resulting indemnification exposure.