Phillips Edison–ARC Shopping Center REIT Inc. — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2014. The filing is unaudited. The registrant invests primarily in grocery-anchored U.S. shopping centers; it reported 120 properties across 27 states, with 94.9% of rentable area leased. The primary share offering closed in February 2014; shares remain available through the dividend reinvestment plan (DRP).
Financial performance and position
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Revenue | $43.9 million, vs. $15.2 million in 2013 | $79.6 million, vs. $26.4 million in 2013 |
| Operating income (loss) | $2.8 million, vs. $0.6 million | $5.6 million, vs. $(0.2) million |
| Net loss attributable to stockholders | $(1.9) million, vs. $(2.0) million | $(2.3) million, vs. $(4.8) million |
| Net loss per share | $(0.01), vs. $(0.05) | $(0.01), vs. $(0.18) |
| Operating cash flow | Not separately stated for the quarter | $35.1 million, vs. $8.6 million |
| Cash and cash equivalents | $20.3 million at June 30, down from $460.3 million at December 31, 2013 | |
| Debt | $348.4 million principal outstanding; weighted-average rate 5.1%. Fair value of borrowings was $361.3 million. |
Year-over-year revenue growth largely reflects portfolio expansion: the company owned 120 properties at June 30, 2014, compared with 46 a year earlier. In the first half, it acquired 37 grocery-anchored centers and one adjacent strip center for approximately $602.8 million, including $139.0 million of assumed debt. Acquisition expenses were $11.3 million for the half-year and weighed on GAAP results.
Same-center NOI for 26 comparable properties fell 2.3% to $12.3 million for the first half; management attributed most of the decline to a prior-year adjustment to recovery income. First-half FFO was $32.3 million, or $0.18 per share; FFO adjusted for acquisition expenses was $43.6 million, or $0.25 per share. These are non-GAAP measures and do not represent cash available for distributions.
Liquidity, debt and distributions
- First-half cash decreased $440.0 million: operating activities provided $35.1 million, investing used $458.0 million, and financing used $17.1 million. Investing outflows primarily reflected acquisitions.
- The $350 million unsecured revolving facility had $32.0 million drawn and $227.1 million of current borrowing capacity under the borrowing-base calculation. The drawn balance bears LIBOR plus 1.30% and matures in December 2017, with two six-month extension options.
- Management reported a 17.9% leverage ratio and stated a longer-term target of approximately 30%–40% loan-to-value as investment proceeds are deployed. Debt covenants were met at June 30. A one-percentage-point increase in rates on unhedged variable-rate debt was estimated to add about $0.3 million of annual interest expense.
- Gross first-half distributions were $59.0 million, including $31.0 million reinvested through the DRP; net cash distributions were $27.9 million. Operating cash flow did not cover gross distributions. The company stated that distributions in excess of operating cash flow were funded with primary-offering proceeds and warned that distributions may continue to use offering proceeds or borrowings.
Outlook, commentary and risks
- No formal earnings or revenue guidance is provided. Management expects revenue and expenses to rise as recently acquired properties contribute for a full year and further acquisitions are made; it expects general and administrative costs to decline as a percentage of revenue.
- Management expects monthly distributions to continue unless business or economic conditions make them imprudent. It disclosed that the distribution may include a return of capital and may not be sustainable if operating cash flow remains insufficient.
- The board authorized an August 2014 distribution at the same daily rate as recent months, equivalent to a 6.70% annualized yield on a $10.00 purchase price. July and August distributions were paid after quarter-end.
- After quarter-end, five properties were acquired for a combined $62.1 million. Initial purchase-accounting disclosures were incomplete at filing date.
- In February 2014, the company sold a $50 million credit-facility interest-rate swap. It recognized a $0.690 million gain from accelerated hedge-related reclassification and a $0.326 million loss from subsequent fair-value changes. At June 30, it had an $11.8 million swap effectively fixing that mortgage debt at 5.22%; the $32.0 million revolving-facility balance remained unhedged.
- Key risks include reliance on affiliated advisor, sub-advisor and property manager services; interest-rate exposure; refinancing needs; and dependence on acquisitions to grow operating cash flow. Management reported no material litigation, environmental claims, off-balance-sheet arrangements or debt defaults, and stated that disclosure controls were effective.
- The DRP price was $9.50 per share, compared with reported net tangible book value of $8.20 per share; the filing warns that DRP purchasers experience immediate dilution on that measure.
Important facts for investors to verify
- Whether operating cash flow can sustain distributions without further reliance on offering proceeds or borrowing.
- Acquisition performance, occupancy, tenant retention and same-center NOI trends; current portfolio occupancy was 94.9%.
- Available credit capacity, borrowing-base eligibility, debt maturities and compliance with loan covenants as the portfolio grows.
- Actual leverage relative to management’s 30%–40% target and the sensitivity of interest expense to rates.
- Related-party fees and the economics of the DRP, including the difference between its share price and net tangible book value.