Business context and reporting period
Empire State Realty OP, L.P. filed this Form 10-Q for the quarter ended September 30, 2013. The partnership had only $20 of cash and capital and no meaningful operating activity at quarter-end. The operating results and balance-sheet information below are for its predecessor, a combination of real estate and management businesses—not the post-IPO partnership on a comparable consolidated basis.
The IPO and formation transactions closed October 7, 2013, after the reporting period. They brought the predecessor’s portfolio and additional non-controlled property interests into the operating partnership. Management cautions that predecessor results are not indicative of the public company’s future results.
Financial and operating performance
Predecessor financial amounts below are in millions of dollars unless stated otherwise.
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Total revenue | $62.3 | $59.4 | $184.3 | $176.7 |
| Operating income | $10.3 | $16.8 | $36.3 | $53.3 |
| Net income | $2.3 | $9.0 | $7.3 | $26.6 |
| Net cash from operating activities | Not provided quarterly | $62.0 | $85.6 |
- Revenue rose 4.8% in Q3 and 4.3% for the first nine months. Rental revenue increased, while tenant expense reimbursements and other income declined. Construction revenue grew 63.6% in Q3 and 55.7% year to date.
- Profitability weakened: operating income fell 39.0% in Q3 and 32.0% year to date; net income fell 74.7% and 72.6%, respectively. Net margin was approximately 3.7% in Q3 2013 versus 15.2% a year earlier, and 4.0% for the first nine months versus 15.1%.
- Higher professional and formation-related costs, incentive compensation, depreciation and interest contributed to the decline. Year-to-date interest expense increased 8.9% to $43.8 million.
- Year-to-date operating cash flow was $62.0 million; investing activities used $56.5 million and financing activities provided $48.5 million. Cash increased $54.1 million from year-end 2012 to $105.6 million at September 30, 2013.
- At September 30, predecessor total assets were $1.122 billion and liabilities $1.154 billion, resulting in an owners’ deficit of $31.6 million. Mortgage debt was $1.061 billion; related-party unsecured loans and notes were $22.1 million.
- After the IPO and formation transactions, management reported approximately $1.197 billion of pro forma debt, a 4.61% weighted-average rate, 3.3-year weighted-average maturity and 70.2% fixed-rate debt. The $800 million secured revolving and term facility was used in part to refinance the Empire State Building loan, whose September 30 balance was $300 million.
Changes, outlook and material risks
- Occupancy at September 30 was 85.2% for office properties (87.1% including signed, not-yet-commenced leases); retail occupancy was 91.1%. Management reported about 1.1 million rentable square feet available to lease.
- Management expected to spend $15–$45 million on Manhattan office renovations through year-end 2013, excluding tenant improvements and leasing commissions, and estimated a further $100–$130 million to substantially complete the Empire State Building program by the end of 2016. Estimates were budget-based and subject to change; funding was expected from operating cash flow and borrowings.
- Management described leasing and repositioning as ongoing priorities, while noting potential short-term occupancy effects from renovation and tenant relocation. It expected quarterly stockholder distributions and intended to qualify as a REIT beginning with the 2013 tax year; REIT status and future distributions were not assured.
- Following the transactions, debt maturities were expected to be approximately $199.1 million in 2014, with no maturities for the remainder of 2013. Management cited refinancing alternatives, but noted floating-rate exposure and an intention to consider hedging. A 1 percentage-point increase in short-term rates was estimated to add about $3.6 million to nine-month interest expense on the stated pro forma debt balances.
- Litigation concerning the consolidation and related buyout remained subject to appeals. The court approved a $55 million settlement, payable by the Helmsley estate, Malkin affiliates and certain contributing participants—not the Company or Operating Partnership under the settlement terms. The filing warned that reversal or other claims could result in monetary damages or equitable relief and could materially adversely affect the business.
- Other risks include leasing demand and tenant credit, property and observatory competition, renovation costs and delays, interest rates, REIT qualification, environmental matters, and concentration in key properties. One Grand Central Place generated 27.3% of predecessor revenue for the first nine months of 2013.
Investor facts to verify
- Review post-October 7 financial statements: the quarter’s operating results are predecessor data and exclude full consolidation of the acquired non-controlled entities, including observatory operations.
- Confirm actual debt outstanding, facility borrowings, refinancing terms, covenants, maturities and hedging after the IPO; pro forma debt figures differ from the predecessor’s September 30 balance sheet.
- Track leasing, occupancy, tenant expirations, signed lease obligations and actual renovation spending against management estimates.
- Check the status and outcome of the class-action appeals and whether any new litigation or related liabilities arise.
- Assess actual REIT qualification and distributions, as well as finalized acquisition purchase-price allocations, which were still incomplete when the filing was prepared.