Seritage Growth Properties — Q2 2017 Form 10-Q
Business context and reporting period
Quarter ended June 30, 2017; unaudited results compare the three and six months ended June 30, 2017 with the corresponding 2016 periods. Seritage is a retail-property REIT focused on acquiring, leasing, redeveloping and retenanting properties. Its portfolio included 235 wholly owned properties (about 36.6 million square feet) and 31 joint-venture properties (about 5.5 million square feet). Sears Holdings remained a major tenant across 180 wholly owned properties.
Financial performance and liquidity
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Total revenue | $57.9 million | $61.9 million | $123.3 million | $124.9 million |
| Operating income (loss) | $(14.7) million | $2.8 million | $(31.4) million | $3.2 million |
| Net loss | $(34.9) million | $(12.6) million | $(67.7) million | $(27.3) million |
| Net loss attributable to common shareholders | $(21.2) million | $(7.1) million | $(41.1) million | $(15.5) million |
| Loss per Class A and C share | $(0.63) | $(0.23) | $(1.22) | $(0.49) |
| FFO per diluted share and unit | $0.43 | $0.54 | $0.99 | $1.07 |
| Company FFO per diluted share and unit | $0.46 | $0.58 | $0.95 | $1.16 |
- Q2 NOI was $40.4 million versus $44.5 million; Total NOI, including the company’s share of joint ventures and excluding specified non-cash and variable items, was $44.7 million versus $47.2 million. Six-month NOI was $82.4 million versus $88.9 million; Total NOI was $91.6 million versus $93.7 million.
- Six-month operating cash flow was $29.2 million, down from $70.3 million. Investing activities used $121.1 million, chiefly $106.1 million for real estate development and $15.0 million for joint-venture investments. Financing activities provided $134.7 million, including $80.0 million drawn from the Future Funding Facility and $85.0 million from the unsecured term loan.
- At June 30, cash and cash equivalents were $9.9 million and restricted cash was $172.6 million; restricted cash included $146.9 million reserved for redevelopment and other capital needs. Management also cited $65 million of remaining unsecured term-loan capacity, anticipated operating cash flow, and subsequent GGP proceeds as liquidity sources.
- Consolidated debt was approximately $1.35 billion, including $1.261 billion of variable-rate mortgage loans and Future Funding Facility borrowings and $85 million outstanding under the unsecured term loan. Mortgage debt matures in July 2019, with two one-year extension options subject to conditions. The unsecured term loan matures by December 31, 2017 or earlier if the mortgage debt is repaid or refinanced.
- Quarterly dividends declared were $0.25 per Class A and Class C share. No formal full-year earnings or operating guidance is provided in the filing.
Material changes versus the prior comparable period
- Q2 revenue fell 6.4%; six-month revenue declined 1.3%. Six-month rental income was nearly flat, but included $6.8 million of termination-fee income. Third-party tenant rental income increased, while Sears-related rent and straight-line rent declined.
- Net losses widened substantially. Depreciation and amortization increased to $109.2 million for the six months, including approximately $37.3 million of accelerated amortization associated with Sears space recaptures and terminations. Interest expense rose to $35.0 million from $31.4 million, reflecting higher average borrowing and LIBOR rates.
- Third-party tenants represented 24.4% of six-month rental income, excluding specified straight-line rent and termination fees, versus approximately 19% in 2016. Including signed leases not yet paying rent, management estimated third-party tenants would represent 43.9% of annualized base rent at June 30.
- At June 30, Seritage had exercised recapture rights at 40 properties. Sears gave notice in June to terminate leases at 20 stores, covering approximately 3.8 million square feet and $11.2 million in annual base rent, with planned vacating in October 2017. Sears had also vacated 19 stores in April and 17 in January; related termination fees were approximately $10.9 million and $10.0 million, respectively.
Outlook, commentary, risks and unusual items
- Management said it believed liquidity was sufficient for operating costs, debt service, redevelopment and distributions, and reported compliance with material loan terms. On July 12, 2017, after quarter-end, Seritage completed GGP transactions for $247.6 million gross consideration, reduced mortgage debt by $50.6 million and received approximately $171.6 million in cash before closing costs, intended for redevelopment and general corporate purposes.
- The redevelopment pipeline comprised 50 projects with estimated total investment of $624.8 million, of which $518.7 million remained to be spent. Timing, lease-up, construction costs and tenant commitments are important execution risks.
- Tenant concentration is a central risk: Sears accounted for a substantial majority of rental revenue. Sears disclosed in its most recent 10-K that substantial doubt existed about its ability to continue as a going concern and that pension and postretirement obligations were underfunded. A Sears deterioration or failure to meet lease obligations could materially affect Seritage’s revenue, debt service and distributions.
- Mortgage borrowings are primarily variable-rate; management estimated that an immediate 100-basis-point rate increase would raise annual pretax funding costs by about $12.6 million. Debt covenants include cash-flow sweep triggers tied to debt yield, Sears performance, tenant diversification and specified Sears events. The mortgage facility also requires at least $1.0 billion net worth and $50 million minimum liquidity.
- Seritage paid $19.0 million as part of a $40.0 million settlement of litigation challenging the original Sears property transaction. The Delaware Court of Chancery approved the settlement in May 2017; defendants denied the allegations and received customary releases.
- Management reported no real-estate or joint-venture impairment charges for the periods presented. It reported effective disclosure controls and no material change in internal control over financial reporting.
Important facts for investors to verify
- Review Sears Holdings’ current financial condition, store closure plans and ability to meet rent, reimbursement and termination-fee obligations.
- Confirm post-quarter GGP transaction proceeds, the use of cash and debt reduction, and remaining liquidity after restricted funds and redevelopment needs.
- Track redevelopment spending against the $518.7 million remaining project investment, leasing progress and the timing of rent commencement.
- Assess refinancing and extension options for the July 2019 mortgage maturity, unsecured term-loan repayment, variable-rate exposure and any cash-flow sweep triggers.
FFO, Company FFO, NOI and Total NOI are non-GAAP measures and are not substitutes for GAAP earnings or operating cash flow.