Empire State Realty OP, L.P. — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016. The partnership owns and operates office and retail real estate in Manhattan and the greater New York metropolitan area, plus the Empire State Building observatory. Its portfolio comprised 10.1 million rentable square feet.
Key financial results
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Revenue | $165.8m | $164.8m | $322.9m | $316.7m |
| Operating income | $44.2m | $45.0m | $78.3m | $68.8m |
| Net income | $24.6m | $26.6m | $41.3m | $34.5m |
| Net income attributable to common unitholders | $24.4m | $26.4m | $40.9m | $34.0m |
| Operating cash flow | — | — | $92.1m | $77.1m |
- Q2 revenue rose 0.6%, while operating income fell 1.9% and net income fell 7.3%. Operating margin was approximately 26.7%, versus 27.3% a year earlier.
- For the first half, revenue increased 2.0%, operating income 13.8%, and net income 19.9%. Operating margin improved to approximately 24.3% from 21.7%.
- Q2 earnings per unit were $0.09, compared with $0.10; first-half earnings per unit were $0.15, compared with $0.13. Distributions were $0.105 per unit in Q2 and $0.19 for the first half, versus $0.085 and $0.17, respectively.
- First-half NOI, a non-GAAP measure, was $179.0m versus $168.3m; Core FFO, also non-GAAP, was $64.8m for Q2 versus $68.3m and $122.9m for the first half versus $120.9m.
- Cash and cash equivalents were $35.5m at June 30; restricted cash was $59.1m. Operating cash flow of $92.1m was offset by $74.0m of investing outflows and $29.3m of financing outflows, producing an $11.2m decrease in cash.
- Total debt principal was $1.664bn; reported debt carrying values were approximately $1.660bn. Management reported a 4.08% weighted-average interest rate, 5.1-year weighted-average maturity, and debt-to-total-market-capitalization of approximately 24%. About $336m of debt, excluding amortization, matures in 2017.
Business trends and changes
- Observatory revenue increased 4.0% in Q2 and 8.6% in the first half, supported by ticket mix, weather, and higher first-half visitor counts. Q2 visitors were approximately 1.124m, down from 1.165m.
- First-half rental revenue grew 2.1%, which management attributed primarily to higher rental rates. Q2 rental revenue was essentially flat year over year.
- Q2 G&A rose 41.6%, including incremental litigation costs, higher incentive compensation and salaries, and equity compensation. First-half G&A rose 30.8%. Management said equity compensation expense was still ramping up and expected to stabilize after four years as a public company.
- First-half property operating expenses declined 3.5%, while real estate taxes increased 2.5%. Interest expense increased 5.2% in the first half, reflecting higher debt balances and rates. The construction business ceased soliciting new work in 2015 and completed its projects.
- At June 30, the portfolio was 86.6% occupied and 89.4% leased including signed leases not yet commenced. Manhattan office occupancy was 84.9%; Q2 new, renewal, and expansion leases achieved a reported 39.4% mark-to-market rent increase overall, and new Manhattan office leases achieved 58.1%.
Liquidity, outlook, risks, and contingencies
- The company reported $760m of revolver availability at June 30. On July 6, 2016, it increased committed revolver capacity from $800m to $1.1bn. It was in compliance with debt covenants at quarter-end.
- Management expects positive operating cash flow and anticipates funding near-term needs, including distributions, debt service, operations, and capital expenditures, through operating cash flow, borrowings, and available credit. It expects to fund long-term needs through these sources as well as debt or equity issuance and asset sales. No specific earnings or revenue guidance was provided.
- Approximately $52.8m of tenant improvements and leasing commissions were expected under existing lease agreements, principally over the 12 months ending June 30, 2017. First-half capital expenditures, excluding tenant improvements and leasing commissions, were $36.5m versus $23.5m.
- Interest-rate swaps with $465m aggregate notional value had a $32.2m liability at quarter-end; a $30.2m first-half unrealized loss was recorded in other comprehensive loss. Management estimated a 1% increase in short-term rates would increase interest expense by approximately $3m, based on variable-rate debt balances.
- Broadcasting leases face renewal and competitive risks: CBS, NBC, and WNET notified the company they will leave at lease expiration in 2017 or 2018; those leases generated approximately $6.3m of 2015 revenue including reimbursements. Management also cited industry changes, the FCC spectrum auction, and a new competitor. Univision and Emmis renewed on terms with lower initial annual revenue than prior arrangements.
- Formation-transaction litigation remains a potential contingency. The Second Class Actions were dismissed and the New York Court of Appeals denied leave to appeal in June 2016. A separate arbitration brought by 12 investors who opted out of the earlier settlement was underway; hearings were scheduled to resume in October 2016. The company said it could not reasonably estimate potential losses or indemnification obligations. The company stated it would not bear the $55m settlement payment in the earlier class action.
- Management identified risks including leasing demand, tenant defaults and renewals, tourism and weather, interest rates, refinancing and leverage, redevelopment costs and delays, property valuations, ground leases, and litigation. Environmental remediation obligations were not expected to be material, but the company noted it could not be certain that all environmental liabilities had been identified. Management reported effective disclosure controls and no material change in internal control over financial reporting.
Investor verification priorities
- Track occupancy, lease commencements, rental-rate spreads, and the cost of leasing and tenant improvements; verify whether mark-to-market gains convert into cash revenue.
- Review 2017 debt maturities and refinancing plans, revolver usage and capacity, covenant headroom, and sensitivity to floating rates.
- Monitor observatory demand and seasonality, and the effect of broadcasting tenant departures and renewals on revenue and required capital investment.
- Follow the investor arbitration, potential indemnification exposure, and the company’s ability to assess any resulting loss.
- Assess recurring cash generation against distributions and redevelopment commitments; NOI, FFO, and Core FFO are non-GAAP measures and are not substitutes for GAAP income or operating cash flow.