Seritage Growth Properties — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; unaudited. Seritage is a retail-property REIT focused on leasing, redevelopment and retenanting. Its portfolio included 235 wholly owned properties and interests in 31 joint-venture properties, totaling more than 42 million square feet. Sears Holdings remained the principal tenant.
Key financial metrics
| Metric | Q1 2017 | Q1 2016 / prior date |
|---|---|---|
| Total revenue | $65.4 million | $63.0 million |
| Operating income (loss) | $(16.7) million | $0.4 million |
| Net loss | $(32.8) million | $(14.7) million |
| Net loss attributable to common shareholders | $(19.8) million; $(0.59) per share | $(8.3) million; $(0.27) per share |
| Operating cash flow | $37.9 million | $25.1 million |
| Cash used in investing activities | $(28.8) million | $(7.0) million |
| Cash used in financing activities | $(8.4) million | $(27.8) million |
| Cash and restricted cash | $140.4 million total, including $26.5 million unrestricted and $113.9 million restricted | $145.6 million total |
| Mortgage debt carrying value | $1.174 billion; $1.188 billion principal outstanding | $1.167 billion carrying value at December 31, 2016 |
Revenue rose about 3.8%, but operating results worsened. Depreciation and amortization increased to $58.7 million from $39.5 million, primarily because of accelerated amortization of lease intangibles following Sears recaptures and terminations. Interest expense was $16.6 million, versus $15.7 million. No impairment losses were recorded in either period.
Selected supplemental non-GAAP measures: NOI was $42.1 million versus $44.4 million; Total NOI was $46.9 million versus $46.5 million; Adjusted EBITDA was $42.4 million versus $47.3 million; FFO per diluted share and unit was $0.56 versus $0.53; and Company FFO per diluted share and unit was $0.48 versus $0.59. The filing cautions that these measures are not substitutes for GAAP results or cash flow.
Material changes and operating developments
- Rental income increased to $49.2 million from $45.2 million. Q1 2017 included $6.1 million of Sears termination-fee income; increased third-party rent was partly offset by lower Master Lease rent and lower straight-line rent.
- Excluding termination fees and straight-line rental income, Sears contributed $31.7 million, or about 76.6% of rental income in the quarter. Third-party tenants contributed $9.7 million, or about 23.4%; including all signed leases, some not yet paying rent, third-party tenants represented approximately 39.7% of annual base rent at quarter-end.
- Seritage had exercised recapture rights at 30 properties by March 31. It reported 38 new redevelopment projects with estimated total investment of $457.6 million, of which $394.5 million remained to be spent.
- Redevelopment and property development cash spending was $22.8 million; investments in joint ventures were $5.9 million. Operating cash flow benefited from termination fees and additional third-party rent.
- The board declared a quarterly dividend of $0.25 per Class A and Class C share; operating-partnership unit holders receive an equal distribution.
Debt, liquidity, outlook and risks
- The principal mortgage loans mature in July 2019, with two one-year extension options subject to conditions. They carry variable rates based on 30-day LIBOR plus a weighted-average spread of 465 basis points; the reported weighted-average loan rate was 5.54%. A four-year interest-rate cap has a 3.5% LIBOR strike. Management estimated that a 100-basis-point rate move would change annual pretax funding costs by about $11.8 million.
- The $100 million Future Funding Facility had $27.0 million drawn and $73.0 million available at March 31. A $200 million unsecured delayed-draw facility from lenders controlled by ESL was undrawn at quarter-end; maximum available draw was $100 million through April 30 and increased to $150 million on May 1, subject to facility terms. The loan matures no later than December 31, 2017 and bears 6.50% base interest. The related-party arrangement was approved by the board and audit committee, with Edward Lampert recusing himself.
- Management stated it believed liquidity was sufficient, citing unrestricted and restricted cash, remaining facility capacity and expected operating cash flow. Much of the restricted cash is earmarked for redevelopment, leasing costs, maintenance, environmental matters and property carrying costs and is not generally available for other purposes.
- No formal earnings or financial guidance was provided. Management expects to fund redevelopment through cash, operating cash flow, facility draws and potential capital raising. Project completion dates and costs are estimates and may change.
- Tenant concentration is a major risk. Seritage disclosed Sears Holdings’ going-concern uncertainty, potential pension funding needs and the possibility that Sears may be unable to meet rent and other obligations. Sears had vacated 17 stores in January 2017; 19 additional stores were vacated in April after termination notices, with approximately $10.9 million in termination fees. Subsequent to quarter-end, Seritage also issued recapture notices for seven properties.
- Mortgage covenants include cash-flow sweep triggers tied to debt yield, Sears performance, tenant diversification and specified Sears events. Seritage reported compliance and noted an amendment requiring $30.0 million, plus $3.3 million monthly, to be deposited in a redevelopment reserve; no cash-flow sweep was imposed under the resolved disagreement.
- A settlement of Sears shareholder litigation provides for $40.0 million in total payments, including $19.0 million by Seritage, subject to court approval scheduled for May 9, 2017. Seritage had recorded its $19.0 million charge in Q3 2016; the company continued to deny the claims.
Most important facts for investors to verify
- Whether Sears can sustain rent payments and how quickly tenant and revenue concentration will decline.
- Actual leasing, occupancy, redevelopment costs and returns compared with the 38-project pipeline and estimated remaining spend.
- Availability and conditions of the Future Funding Facility and related-party unsecured loan, and the company’s ability to refinance mortgage debt due in 2019.
- Cash-flow sweep covenant status, required reserve deposits and the amount of liquidity that is truly unrestricted.
- Court approval and final payment of the litigation settlement, and the timing and rent impact of store vacancies and recaptures.