Seritage Growth Properties — Q3 2016 Form 10-Q
Reporting period: Quarter ended September 30, 2016; financial statements are unaudited. The 2015 quarterly comparison covers July 7, 2015, when operations began, through September 30, 2015, and is therefore a shorter period. Unless stated otherwise, amounts below are in U.S. dollars.
Business context
Seritage is a retail-property REIT formed in 2015. At September 30, 2016, its portfolio comprised 235 wholly owned properties and interests in 31 joint-venture properties, totaling approximately 42.4 million square feet. The strategy is to recapture Sears Holdings space and redevelop or retenant it for other retailers.
Financial performance and position
| Metric | Q3 2016 | 2015 comparison | Nine months 2016 |
|---|---|---|---|
| Total revenue | $57.6 million | $54.1 million | $182.5 million |
| Operating income (loss) | $(22.8) million | $(16.6) million | $(19.6) million |
| Net loss | $(37.2) million | $(31.9) million | $(64.5) million |
| Net loss attributable to common shareholders | $(21.1) million | $(18.3) million | $(36.6) million |
| Loss per Class A and C share | $(0.67) | $(0.58) | $(1.16) |
| Operating cash flow | Not separately stated | Not separately stated | $99.1 million |
Q3 rental income was $45.6 million and tenant reimbursements were $12.0 million. Depreciation and amortization was $44.5 million in the quarter and $121.4 million for nine months; Q3 included $9.0 million of amortization associated with recaptures. The $19.0 million Q3 litigation charge was a significant unusual expense.
Management-reported non-GAAP measures for Q3 were NOI of $45.0 million, Total NOI of $48.1 million, FFO of $12.3 million ($0.22 per diluted share and unit), and Company FFO of $32.6 million ($0.59 per diluted share and unit). For nine months, FFO was $72.0 million and Company FFO was $97.3 million. These measures are not substitutes for GAAP results or cash flow.
At September 30, assets were $2.76 billion, total liabilities $1.30 billion, and total equity $1.46 billion. Cash and cash equivalents were $90.0 million; restricted cash was $81.8 million. Mortgage debt had a $1.161 billion principal balance, plus $19.3 million drawn under the future-funding facility; $80.7 million remained available. The balance-sheet mortgage-loan carrying amount, net of financing costs, was $1.166 billion.
Nine-month investing cash use was $35.5 million, primarily for redevelopment; financing cash use was $36.4 million, including $55.6 million of dividends and distributions, partly offset by future-funding borrowings. Operating cash flow included a $39.9 million net benefit from timing changes in operating assets and liabilities. Cash flow should therefore be considered alongside those working-capital movements and restricted balances.
Material changes and operating developments
- Revenue rose from the shorter 2015 comparison period, reflecting additional operating days, completed redevelopment rents and the Master Lease’s annual rent increase, partly offset by recaptures. Direct Sears rent, excluding straight-line rent, was $33.4 million, or about 79% of Q3 rental income; third-party rent was $9.0 million, or about 21%.
- Seritage had exercised recapture rights at 15 properties by quarter-end and submitted seven additional notices afterward. Sears Holdings gave notice to terminate leases at 17 stores, totaling approximately 1.7 million square feet, with expected vacancy in January 2017. Sears was to pay a termination fee equal to one year of base rent plus estimated taxes and operating costs.
- The redevelopment pipeline comprised 25 projects totaling approximately 2.0 million square feet, with estimated total project costs of $286.5 million. Management expected to fund projects with cash, operating cash flow, facility draws and potential additional capital sources; these are estimates, not assured outcomes.
- Annualized base rent under the Master Lease was approximately $134.2 million. Signed leases, including leases not yet paying rent, would make third-party tenants approximately 31.4% of annual base rent.
Outlook, risks and contingencies
- No numerical earnings or cash-flow guidance was provided. The filing describes redevelopment plans and estimated project schedules and costs, which are subject to execution, leasing and funding risks.
- The mortgage loans are floating-rate, based on 30-day LIBOR plus a weighted-average spread of 465 basis points, and mature in July 2019, with two conditional one-year extensions. The weighted-average rate was 5.24% for Q3. Management estimated that an immediate 100-basis-point rate increase would raise annual pretax funding costs by approximately $11.8 million; an interest-rate cap has a 3.5% LIBOR strike.
- Seritage and its loan servicer had an agreement-in-principle concerning a cash-flow-sweep covenant, but no final amendment was assured. A sweep could restrict access to property cash and increase lender approval rights over budgets and redevelopment spending. Management stated it believed the company was in compliance with material loan terms.
- Tenant concentration is a central risk: substantially all properties were leased to Sears Holdings, and Sears accounted for most rental revenue. Sears’s financial condition and store closures could affect rent, leasing, redevelopment and debt-covenant tests.
- An agreement-in-principle to settle litigation challenging the 2015 Sears property transaction contemplated $40 million paid by defendants and insurers, including $19 million from Seritage. Court approval and definitive settlement documents remained outstanding; Seritage recorded its $19 million share as a Q3 charge while continuing to deny the allegations.
- The company declared a $0.25-per-share quarterly dividend for Q3 and another $0.25 dividend for Q4. Future dividends remain at the board’s discretion and depend on financial results, cash needs, covenants and other factors.
Most important facts for investors to verify
- Sears Holdings’ ability to pay rent, the status and timing of its store terminations, and the pace at which replacement tenants begin paying rent.
- Whether the loan amendment is finalized, whether any cash-flow sweep is imposed, and the company’s headroom under debt-yield, tenant-diversification and liquidity covenants.
- Redevelopment spending, lease-up progress, project cost and completion assumptions, and access to the remaining future-funding facility.
- Unrestricted versus restricted liquidity, debt-service requirements, floating-rate exposure and the sustainability of quarterly distributions relative to cash available.
- Final court approval and payment terms of the proposed litigation settlement, and any material changes in Sears-related or environmental contingencies.