Seritage Growth Properties — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. Unaudited figures below are in millions of dollars unless otherwise noted. Seritage is a retail-property REIT focused on leasing, redevelopment and retenanting. Its portfolio comprised 222 wholly owned properties and interests in 26 joint-venture properties, totaling approximately 38.7 million square feet.
Financial performance and liquidity
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Total revenue | $49.3 | $57.9 | $103.0 | $123.3 |
| Operating loss | $(24.8) | $(14.7) | $(32.2) | $(31.4) |
| Net income (loss) | $(10.6) | $(34.9) | $5.6 | $(67.7) |
| Net income (loss) attributable to common shareholders | $(8.0) | $(21.2) | $1.1 | $(41.1) |
| Diluted EPS | $(0.23) | $(0.63) | $0.03 | $(1.22) |
| Total NOI (non-GAAP) | $36.5 | $44.7 | $73.3 | $91.6 |
| Company FFO per diluted share and unit (non-GAAP) | $0.15 | $0.46 | $0.38 | $0.95 |
- Q2 rental income was $35.8 million, down from $42.2 million; tenant reimbursements were $12.5 million, down from $15.7 million. Q2 property operating and tax expense recovery was 79.6%, versus 92.9% a year earlier. The filing attributes the lower recovery rate partly to more unleased space.
- Six-month operating cash flow was $16.2 million, compared with $21.7 million. Investing cash outflow was $5.1 million, including $142.0 million of development spending and $134.6 million of real-estate sale proceeds. Financing cash outflow was $161.5 million, including $131.4 million of mortgage repayments and $27.9 million of common dividends and distributions.
- At June 30, cash and cash equivalents were $100.4 million and restricted cash was $166.5 million; restricted balances include funds reserved for redevelopment and other specified uses. Total assets were $2.615 billion and total equity was $1.299 billion.
- Consolidated debt was approximately $1.22 billion at June 30, including $1.079 billion of variable-rate mortgage debt and the future-funding facility. The mortgage debt bore LIBOR plus a weighted-average spread of 485 basis points; a 100-basis-point rate change was estimated to affect annual pretax funding costs by about $10.8 million.
Changes versus the prior comparable period
- Revenue fell 14.9% in Q2 and 16.4% for the six months. Lower Sears rent and termination-fee income outweighed growth in diversified-tenant rent. For the six months, Sears-related rental income was $45.1 million versus $60.9 million; diversified-tenant rental income increased to $24.5 million from $19.7 million.
- Management reported that diversified, non-Sears tenants would represent approximately 56.9% of annualized base rent when all signed leases, including leases not yet paying rent, are included. Sears accounted for 63.8% of Q2 rental income and 64.8% for the six months, excluding specified straight-line rent and termination-fee items.
- Six-month total NOI declined to $73.3 million from $91.6 million, and Company FFO per diluted share and unit fell to $0.38 from $0.95. Q2 operating loss widened despite lower depreciation and amortization, as revenue fell and general and administrative expense increased.
- Reported six-month net income included a $76.0 million gain on real-estate sales, primarily from contributing properties to joint ventures. Accordingly, reported net income does not by itself indicate recurring operating performance.
Outlook, material events and risks
- No specific earnings or revenue guidance is provided. At quarter-end, 73 redevelopment projects represented estimated total investment of $1.3 billion, with approximately $880 million remaining to be spent. Management described continued retenanting and redevelopment as central to diversifying rents away from Sears.
- After quarter-end, on July 31, Seritage entered a $2.0 billion senior secured term-loan facility with Berkshire Hathaway, initially funded at $1.6 billion. It used proceeds in part to repay the existing mortgage facilities and unsecured term loan. The new facility bears 7.0% interest, matures July 31, 2023, and includes a $400 million incremental facility. Financial-metric shortfalls can restrict asset sales and trigger additional collateral requirements.
- Sears gave notice during Q2 to terminate leases at 18 additional stores, representing about $10.7 million of annual base rent; expected vacancies were scheduled for August through November 2018. The company reported 74 properties terminated or subject to termination notices as of June 30. Sears’ financial condition and further lease terminations remain material risks.
- Seritage had exercised recapture rights at 63 properties. Recapture and termination activity can reduce rent, increase vacancy and redevelopment costs, and affect straight-line rent and lease-intangible amortization. Joint-venture sale gains for certain contributed properties remain subject to future valuation adjustments and cash settlements.
- The company disclosed Sears tenant concentration, redevelopment execution and funding needs, interest-rate exposure on pre-refinancing debt, environmental and insurance exposures, and cybersecurity risks. Management stated it believed it was in compliance with existing loan terms and that ordinary-course legal matters were not expected to have a material effect.
Important facts for investors to verify
- How quickly signed diversified-tenant leases commence rent, and whether the stated 56.9% annualized rent mix is realized.
- Progress, remaining costs, leasing, and expected returns for the 73 redevelopment projects, particularly the approximately $880 million still to be spent.
- Actual impact of Sears’ announced and future terminations on rent, occupancy, expense recoveries, and redevelopment requirements.
- Post-refinancing debt balances, use of incremental funding, covenant headroom, collateral triggers, and the cost and terms of the new 7.0% facility.
- Final settlement values for the Mark 302 and West Hartford joint ventures, which may differ from initially recognized gains.
- Whether operating cash generation and recurring FFO can support redevelopment spending and distributions; the filing presents no forward earnings guidance.