Seritage Growth Properties — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018. Amounts below are in millions of dollars unless stated otherwise. Seritage is a retail-property REIT focused on leasing, recapturing and redeveloping properties; its portfolio included 225 wholly owned properties and interests in 24 joint-venture properties, totaling about 39 million square feet.
Financial performance
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Total revenue | $53.8 | $65.4 |
| Operating loss | $(7.4) | $(16.7) |
| Net income (loss) | $16.2 | $(32.8) |
| Net income (loss) attributable to Seritage common shareholders | $9.1 | $(19.8) |
| Diluted EPS | $0.26 | $(0.59) |
| Net cash from operating activities | $7.7 | $34.3 |
| NOI / Total NOI | $34.9 / $36.9 | $42.1 / $46.9 |
| Company FFO per diluted share and unit | $0.22 | $0.48 |
Revenue declined 17.8%. Rental income fell $12.1 million, primarily reflecting lower Sears rent and termination-fee income; third-party rental income increased $2.0 million. Net income turned positive mainly because of a $41.8 million gain on real estate sales, including the Santa Monica joint-venture transaction. The company still reported an operating loss. Property operating and real estate tax expense totaled $18.6 million against $16.7 million of tenant reimbursements, an expense recovery rate of 89.7%, down from 94.5%.
Development spending was $86.0 million, versus $22.8 million a year earlier. Investing cash outflow was $25.1 million, including $60.4 million of real-estate sale proceeds. Financing cash outflow was $87.3 million, including $73.0 million of mortgage repayment and common distributions. Cash, cash equivalents and restricted cash totaled $312.5 million at quarter-end; unrestricted cash was $135.1 million and restricted cash was $177.4 million. Restricted funds are not generally available for unrestricted corporate uses.
Debt, liquidity and capital
Consolidated debt was approximately $1.28 billion at March 31, 2018, including $1.14 billion of variable-rate mortgage debt and a $145 million unsecured term loan commitment funded at closing. Mortgage debt principal was reduced by $73.0 million during the quarter. The mortgage loans mature in July 2019, with two one-year extension options subject to conditions; the unsecured term loan matures no later than December 31, 2018. Mortgage borrowings bear interest at LIBOR plus a weighted-average spread of 4.78%; the reported Q1 weighted-average mortgage rate was 6.40%. A 100-basis-point rate increase was estimated to increase annual pretax funding costs by about $11.4 million.
Management stated it believed liquidity was sufficient, citing unrestricted and restricted cash, expected operating cash flow and $55 million of permitted but uncommitted unsecured borrowing capacity. The company reported compliance with material loan terms and minimum liquidity and net-worth requirements. It paid common distributions of $0.25 per share for the quarter and has 7.00% Series A preferred shares outstanding.
Material changes, outlook and risks
- Tenant concentration: Sears Holdings remained a major tenant. It accounted for 65.8% of Q1 rental income; the filing warns that adverse developments at Sears could materially affect Seritage. On an annualized base-rent basis, including signed leases not yet commenced, third-party tenants represented approximately 54.3%.
- Recaptures and lease terminations: Seritage had exercised recapture rights at 62 properties. Sears had terminated leases at 56 stores by quarter-end and subsequently gave notice of termination for nine more stores, with $5.8 million of annual base rent and an expected $11.5 million termination fee. Sears was expected to continue paying rent on those stores until vacating, anticipated in August 2018.
- Redevelopment execution and funding: The company reported 68 redevelopment projects with estimated total investment of $1.2 billion, of which approximately $895 million remained to be spent. Project costs, leasing, timing and future funding needs are significant execution considerations; one project was temporarily postponed while a lead tenant was sought.
- Joint venture transaction: Seritage contributed its Santa Monica property to a new joint venture and sold a 49.9% interest, receiving about $50.1 million and recording an initial $40.2 million gain. The contribution value is subject to later revaluation and a cash settlement, with the outcome dependent on project operating income and costs.
- Interest-rate and refinancing exposure: Most mortgage debt is variable-rate, and the mortgage maturity in 2019 and unsecured-loan maturity in 2018 create refinancing and liquidity risks. The filing describes cash-sweep triggers linked to debt yield, Sears performance, tenant diversification and specified Sears events.
- Other risks and outlook: Management provided no specific earnings or operating guidance. It cautioned that interim results may not indicate full-year performance. Disclosed risks include cybersecurity, insurance coverage and environmental liabilities; management did not expect current legal matters or environmental items to materially affect results or liquidity.
- Subsequent developments: After quarter-end, Seritage agreed to pursue multifamily developments on parcels at Overlake Plaza and NewPark Mall, and agreed to sell its Tanforan Mall Sears store and parcel for $42.0 million gross consideration.
Key facts for investors to verify
- Progress on retenanting and redevelopment, remaining project costs, lease commencements and resulting cash rents.
- Sears Holdings’ ability to meet rent obligations, the effect of additional store closures and the timing and collection of termination fees.
- Availability of unrestricted liquidity and refinancing plans for the 2018 unsecured and 2019 mortgage maturities, including the effect of floating rates and loan covenants.
- The final Santa Monica joint-venture valuation and settlement: the filing gives differing stated ranges for the potential final gain in its notes and MD&A ($10.2–$55.2 million versus $16.1–$61.1 million); the discrepancy should be clarified.
- Cash-flow quality: positive GAAP net income included substantial property-sale gains, while operating cash flow and Company FFO were lower than the prior-year period.