Business context and reporting period
Empire State Realty Trust, Inc. (ESRT) filed this unaudited Form 10-Q for the quarter ended September 30, 2013. ESRT had no meaningful operating activity before completing its IPO and formation transactions on October 7, 2013. Accordingly, the operating results below are those of its predecessor, not the post-transaction public company, and are not necessarily indicative of future results.
The predecessor combined interests in office and retail properties and management businesses in Manhattan and the greater New York metropolitan area. Following the formation transactions, ESRT’s portfolio included 18 properties and entitled development land. ESRT intends to qualify as a REIT beginning with its 2013 tax year.
Financial results and condition
Amounts below are in millions, except percentages. Predecessor statements are combined and unaudited.
| 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 presented quarterly | $62.0 | $85.6 | |
| Capital expenditures and improvements | Not presented quarterly | $56.1 | $53.1 |
Revenue increased 4.8% in Q3 and 4.3% for the nine-month period. Operating margin, calculated from reported figures, declined to approximately 16.5% from 28.3% in Q3 and to 19.7% from 30.2% for nine months. Net margin declined to approximately 3.7% from 15.2% in Q3 and 4.0% from 15.1% for nine months. No funds-from-operations figure is provided in the filing text.
At September 30, the predecessor reported total assets of $1,122.2 million, mortgage debt of $1,061.0 million, related-party unsecured loans and notes of $22.1 million, total liabilities of $1,153.8 million, and owners’ deficit of $31.6 million. Cash and cash equivalents were $105.6 million, with an additional $34.0 million of restricted cash. Post-IPO pro forma consolidated debt was approximately $1,197.3 million, with a 4.61% weighted-average interest rate and 3.3-year weighted-average maturity; 70.2% was fixed-rate.
For the nine months, operating cash flow was $62.0 million, investing cash outflow $56.5 million, and financing cash inflow $48.5 million; cash rose $54.1 million to $105.6 million. Operating cash flow was below the prior-year $85.6 million. The filing does not provide quarterly cash-flow figures.
Material changes versus prior period
- Net income fell 74.7% in Q3 and 72.6% for nine months, despite higher revenue. Operating expenses rose 22.2% in Q3 and 20.0% for nine months, driven in part by higher general and administrative, construction, depreciation and formation-related costs.
- General and administrative expense increased 68.1% in Q3 and 71.4% for nine months, mainly due to professional fees associated with the IPO and formation transactions and higher incentive compensation.
- Construction revenue rose 63.6% in Q3 and 55.7% for nine months, alongside higher construction expenses. Rental revenue grew, while tenant expense reimbursements and other income declined.
- Interest expense increased 8.5% in Q3 and 8.9% for nine months, primarily reflecting increased Empire State Building borrowing balances and financing-cost amortization.
- Office occupancy at September 30 was 85.2% overall, or 87.1% including signed leases not yet commenced. Retail space was 91.1% leased, or 91.6% including signed leases not yet commenced.
Outlook, commentary, risks and unusual items
- IPO and financing: On October 7, ESRT sold 82.225 million shares at $13.00 each, raising approximately $1.07 billion gross and $884.1 million net. It entered an $800 million secured revolving and term facility and used it to repay the $300 million outstanding Empire State Building term loan and a related-party loan. The facility has an accordion feature up to $1.25 billion, subject to conditions.
- Investment plans: Management expected to invest $15–$45 million more in Manhattan property renovations through year-end 2013, excluding tenant improvements and leasing commissions, and estimated another $100–$130 million would be needed to substantially complete the Empire State Building program by the end of 2016. These are estimates subject to change. Additional signed-lease tenant improvement and leasing commitments were estimated at $32.9 million for the remainder of 2013 and $72.8 million for the following 12 months.
- Leasing and operations: Management cited improved leasing activity and believed in-place rents were generally below market, while noting that repositioning may temporarily reduce occupancy. Four property-management contracts were scheduled for termination effective December 1, 2013, with ESRT to self-manage those properties.
- Debt and liquidity risks: Pro forma floating-rate debt was 29.8% of indebtedness. A 1 percentage-point increase in short-term rates would have increased nine-month interest expense by approximately $3.6 million, based on September 30 balances. Management anticipated hedging some exposure but gave no assurance of effectiveness. The credit facility includes leverage, fixed-charge, variable-rate-debt and other covenants; dividends may be restricted in certain circumstances.
- Litigation: A court-approved $55 million settlement of lawsuits concerning the consolidation and valuation was to be funded by the Helmsley estate, Malkin affiliates and certain participants—not ESRT or its Operating Partnership. Appeals remained pending; adverse appellate relief could have a material effect. Management could not predict the outcome or timing.
- Other matters: The company had not exercised options to acquire 112–122 West 34th Street or 1400 Broadway; option periods and independent valuation or negotiation processes remained relevant. The filing reports environmental matters, including asbestos-containing materials, but says management did not expect known remediation matters to have a material effect. Management identified tourism, weather and new observatory competition as risks to observatory revenue.
- No numerical earnings or dividend guidance is provided. ESRT said it expected quarterly distributions and must generally distribute at least 90% of REIT taxable income to maintain REIT qualification, subject to operating and debt obligations.
Investor facts to verify
- Review post-October 7 financial statements: this filing’s operating results are predecessor results and exclude the post-transaction consolidation of the non-controlled entities, including observatory operations.
- Confirm final purchase-price allocations for acquired assets and liabilities; management said these were not yet complete.
- Track the appeals and any remaining claims relating to the $55 million settlement and formation transactions.
- Monitor debt maturities, floating-rate exposure, credit-facility covenant headroom, refinancing needs and renovation funding.
- Check occupancy, lease expirations, tenant improvement commitments and leasing costs against management’s plans, and assess whether the REIT election and distribution policy are maintained.