Seritage Growth Properties — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016. Seritage began operations on July 7, 2015, following its acquisition of Sears Holdings properties; the filing does not provide prior-year operating results for a directly comparable period.
Business context
Seritage is a retail-property REIT focused on acquiring, leasing, redeveloping and retenanting properties. At June 30, 2016, its portfolio comprised 235 wholly owned properties and interests in 31 joint-venture properties, totaling approximately 42.4 million square feet. Sears Holdings leased a substantial majority of space at all but 14 wholly owned properties and at most JV properties.
Financial performance and position
- Revenue: Q2 total revenue was $61.9 million, comprising $45.9 million rental income and $15.9 million tenant reimbursements. First-half revenue was $124.9 million.
- Profitability: Q2 operating income was $2.8 million and net loss was $12.6 million; first-half operating income was $3.2 million and net loss was $27.3 million. Net loss attributable to common shareholders was $7.1 million for Q2 and $15.5 million for the first half; diluted loss per share was $0.23 and $0.49, respectively. Depreciation and amortization was $37.3 million in Q2, a substantial expense relative to revenue.
- Operating measures: Management reported Q2 NOI of $44.5 million and Total NOI, including the company’s share of joint ventures and specified adjustments, of $47.2 million. Q2 FFO was $30.2 million ($0.54 per diluted share and unit); Company FFO was $32.1 million ($0.58). These are non-GAAP measures and are not substitutes for GAAP results or cash flow.
- Cash flow: First-half operating cash flow was $65.0 million; investing cash outflow was $22.5 million, primarily reflecting property development; financing cash outflow was $41.7 million, primarily dividends and distributions. Cash and cash equivalents increased $0.8 million to $63.7 million. The filing reports $33.2 million of real-estate development spending.
- Debt and interest-rate exposure: Mortgage loans payable, net, were $1.145 billion. The loans are interest-only, mature in July 2019, bear LIBOR plus a weighted-average spread of 465 basis points, and had a weighted-average rate of 5.18% for the first half. A 100-basis-point rate increase was estimated to raise annual pretax funding costs by approximately $11.6 million. A $100 million future funding facility was undrawn.
- Liquidity and equity: Unrestricted cash was $63.7 million and restricted cash was $87.0 million; management also cited the undrawn facility and expected operating cash flow as liquidity sources. Total liabilities were $1.260 billion and total equity was $1.515 billion. Restricted cash is earmarked for specified purposes and is not equivalent to freely available cash.
- Dividends: The company declared quarterly dividends of $0.25 per Class A and Class C share for Q2 and Q3 2016, with equivalent distributions to Operating Partnership unitholders.
Material changes, outlook and risks
- The filing does not offer directly comparable prior-year operating results: Seritage had no operations before the July 2015 transaction. Accordingly, the reported period-over-period financial change cannot be assessed from this filing.
- Retenanting and redevelopment are central to the strategy. The listed pipeline covered approximately 1.009 million square feet, with estimated development costs of $159.5 million and total project costs of $172.5 million, including applicable termination fees. Completion estimates extended from Q4 2016 through Q2 2018. Management expected to fund projects with cash, operating cash flow, facility draws and other potential capital-raising activities; no formal earnings guidance was provided.
- Sears Holdings concentration is a key credit risk: it represented approximately 79% of Q2 rental income and 81% for the first half, excluding straight-line rent. The master lease provided $132.0 million of annual base rent as of June 30, 2016, with 2% annual increases in the initial and first two renewal terms. Sears had certain property termination rights, subject to notice, payment and limits.
- Seritage had exercised recapture rights at nine wholly owned properties by quarter-end; six additional notices were submitted after June 30. The GGP joint venture had submitted recapture notices for four properties. Redevelopment entails execution, leasing, cost and timing risks.
- Loan covenants include cash-flow sweeps tied to debt yield and tenant-diversification tests. The company stated it was in compliance with material loan terms at quarter-end. It also reported a $1.9 million first-half unrealized loss on its interest-rate cap.
- A shareholder derivative lawsuit challenges the Sears property transaction and seeks unspecified damages. Seritage disputes the claims; management could not estimate any possible loss or range. The company reported no material changes to previously disclosed risk factors and no real-estate or joint-venture impairment charges for the period.
Key facts for investors to verify
- Changes in Sears Holdings’ financial condition, rent-paying capacity and any exercise of master-lease termination rights.
- Progress, leasing commitments, spending and delivery dates for the redevelopment pipeline, including remaining funding needs.
- Liquidity available after accounting for restricted cash, dividends, development commitments and loan cash-sweep provisions.
- Compliance with debt-yield and tenant-diversification covenants, and the effect of LIBOR changes on interest expense.
- Developments in the transaction litigation and any resulting financial exposure.