Empire State Realty OP, L.P. — Q1 2016 Form 10-Q
Business context and reporting period. The partnership, through Empire State Realty Trust, owns and operates office and retail properties in Manhattan and the greater New York metropolitan area, including the Empire State Building observatory. This summary covers the unaudited three months ended March 31, 2016, compared with Q1 2015. At quarter-end, the portfolio comprised 10.1 million rentable square feet. ESRT owned approximately 45.2% of the partnership units.
Key financial metrics
Unless otherwise noted, amounts are in millions of dollars. Per-unit results are dollars.
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Total revenue | $157.1 | $151.9 | +3.4% |
| Operating income | $34.1 | $23.8 | +43.6% |
| Operating margin | 21.7% | 15.6% | +6.1 percentage points |
| Net income | $16.7 | $7.9 | +111.8% |
| Net income attributable to common unitholders | $16.5 | $7.7 | +115.2% |
| Basic and diluted earnings per unit | $0.06 | $0.03 | Up $0.03 |
| Core FFO per diluted unit, non-GAAP | $0.22 | $0.20 | Up $0.02 |
| Net cash from operating activities | $59.5 | $47.4 | +$12.1 |
Q1 2016 comprehensive income attributable to common unitholders was a loss of $2.7 million, reflecting a $19.4 million unrealized loss on interest-rate swaps in other comprehensive income. This noncash hedge valuation loss did not reduce reported net income.
- Revenue and operating performance: Rental revenue rose 4.4% to $114.9 million; observatory revenue rose 16.2% to $21.2 million. Management attributed observatory growth to more visitors, favorable weather, the Easter calendar shift, and ticket mix. Property operating expenses fell 7.0%, while general and administrative expenses rose 20.0% and interest expense rose 11.9%.
- Occupancy and leasing: Total portfolio occupancy was 88.2%, or 89.8% leased including signed leases not yet commenced. Manhattan office occupancy was 86.4%; retail occupancy was 91.4%; and the Empire State Building was 89.2% occupied. The partnership signed 47 leases covering 255,723 square feet, reporting a 42.9% mark-to-market rent increase over previous fully escalated rents. Manhattan office new leases reportedly achieved a 50.9% increase.
- Cash flow and distributions: Operating cash flow was $59.5 million; investing activities used $24.1 million and financing activities used $37.7 million. Cash and cash equivalents were $44.4 million at quarter-end, down from $46.7 million at December 31, 2015. Distributions were $23.1 million in the cash-flow statement; declared dividends were $0.085 per unit.
- Debt and liquidity: Principal debt was $1.627 billion at March 31, with a weighted-average rate of 4.14% and maturity of 5.4 years. The balance-sheet carrying amount was $1.623 billion. The $800 million revolving credit facility had no borrowings, leaving stated availability of $800 million. Debt to total market capitalization was approximately 26%. Management reported compliance with applicable debt covenants.
- Debt maturities and refinancing: Approximately $336.0 million of debt principal matures in 2017 and $262.2 million in 2018; no debt maturity was scheduled for 2016, excluding amortization. A $20.2 million mortgage on 10 Union Square East was refinanced with a $50.0 million, 10-year fixed-rate mortgage at 3.7%, compared with the former 6.0% rate. Net proceeds of approximately $29.8 million were applied to the credit facility.
- Capital needs: The filing estimates approximately $59.5 million of capital expenditures, tenant improvements, and leasing commissions under existing lease commitments during the 12 months ending March 31, 2017. Q1 capital expenditures, excluding tenant improvements and leasing commissions, were $12.3 million.
Material changes versus Q1 2015
- Revenue increased $5.2 million, driven mainly by higher rents and observatory revenue. The prior-year construction activity ended: construction revenue and expense were both zero in Q1 2016, versus $1.6 million and $2.9 million, respectively, in Q1 2015.
- Operating expenses decreased 4.0%, including lower property costs and depreciation and amortization. Operating income rose 43.6%; however, interest expense increased by $1.9 million, partly reflecting the prior-year issuance of $350 million of senior notes and higher debt costs.
- Net cash provided by operations increased $12.1 million, which management attributed primarily to higher cash rents and lower deferred leasing costs. Cash used in financing increased to $37.7 million, primarily due to net debt repayments.
- Occupancy and rent-mark-to-market figures are reported for Q1 2016; the filing does not provide a directly comparable Q1 2015 portfolio occupancy figure in the supplied text.
Outlook, risks, and unusual items
- Outlook and funding: No specific earnings or revenue guidance was provided. Management expects positive operating cash flow and anticipates meeting short-term needs through operating cash flow, debt financing, and available revolver capacity; longer-term needs may also be funded through equity issuance or asset sales. The partnership is substantially completing its Manhattan office redevelopment and repositioning program and expects it to support future occupancy, rents, margins, and cash flows, while noting possible short-term occupancy pressure during renovation and leasing.
- Leasing and observatory risks: About 1.0 million square feet was available to lease, excluding signed leases not commenced. Leases covering 6.2% of portfolio area expire in 2016 and 7.0% in 2017. Observatory performance depends on tourism, ticket pricing, seasonality, competition, and weather. Q1 observatory results also benefited from favorable weather and the Easter calendar shift, factors that may not recur.
- Broadcasting: Management cited industry deterioration, an FCC spectrum auction, and a new competitor at One World Trade Center. CBS, NBC Universal, and WNET notified the partnership they would leave at lease expiry in 2017 or 2018; their leases generated approximately $6.3 million of 2015 revenue including reimbursements. Univision renewed through December 2025, but its annual revenue began at $1.9 million in January 2016, subject to escalations.
- Interest-rate exposure: Three swaps with $465 million aggregate notional had a $21.3 million liability at quarter-end. Management estimated that a 1% increase in short-term rates would increase interest expense by approximately $2.7 million based on variable-rate debt balances. The swaps reduce exposure but do not eliminate it.
- Litigation and contingencies: A separate appeal relating to former investors’ claims remained pending before the New York Court of Appeals as of March 31, 2016; management said the outcome and potential loss could not be reasonably estimated. Arbitration brought by 12 investors who opted out of an earlier settlement was scheduled to begin May 24, 2016. The partnership has indemnification obligations to certain directors and executives in related matters. Management warned an adverse outcome could materially affect the partnership. Other environmental matters were not expected by management to have a material effect, though it cautioned that not all liabilities may have been identified.
- Other: Management reported no material change to previously disclosed risk factors, no off-balance-sheet arrangements, and effective disclosure controls. Q1 results are not necessarily indicative of full-year results; observatory revenue is seasonal. The partnership reported no subsequent events.
Important facts for investors to verify
- Whether the reported leasing spreads, signed leases, and occupancy translate into commenced leases, higher cash rent, and sustained occupancy.
- How the 2017 and 2018 maturities will be refinanced, and whether refinancing terms, interest costs, and covenant headroom remain favorable.
- Whether the $59.5 million of committed capital and leasing expenditures are funded within management’s expected cash-flow and borrowing plans.
- Developments in the Court of Appeals matter and the investor arbitration, including any potential indemnification exposure or loss estimate.
- Broadcast tenant departures, replacement demand, and the financial impact of lower Univision revenue and broadcasting-market changes.
- How much Q1 observatory growth reflects recurring demand versus favorable weather, calendar timing, and seasonal patterns.