Seritage Growth Properties — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017. Amounts are in U.S. dollars; financial statement amounts are in millions unless stated otherwise.
Business context
Seritage is a retail-property REIT focused on owning, leasing, redeveloping and retenanting properties. At quarter-end, its portfolio comprised 230 wholly owned properties and interests in 28 joint-venture properties, totaling more than 40 million square feet. Sears Holdings remained its largest tenant and a substantial source of rental revenue.
Financial performance and liquidity
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Total revenue | $64.0 | $57.6 | $187.3 | $182.5 |
| Operating loss | $(18.0) | $(22.8) | $(49.4) | $(19.6) |
| Net income (loss) | $17.3 | $(37.2) | $(50.4) | $(64.5) |
| Net income (loss) attributable to common shareholders | $10.5 | $(21.1) | $(30.5) | $(36.6) |
| GAAP diluted EPS | $0.31 | $(0.67) | $(0.91) | $(1.16) |
| NOI, company-reported non-GAAP | $37.7 | $45.0 | $120.2 | $133.9 |
| Operating cash flow | — | $56.9 | $100.1 |
- Q3 net income included $43.7 million gain on sale of joint-venture interests and $13.0 million gain on sale of real estate. The nine-month net loss reflects operating results despite those gains.
- Nine-month rental income was $139.5 million, up from $136.7 million. Tenant reimbursements were $47.8 million, versus $45.7 million. Depreciation and amortization rose to $170.3 million from $121.4 million; accelerated amortization related to Sears recaptures and terminations was a principal driver.
- Q3 interest expense was $18.0 million; nine-month interest expense was $53.1 million. The company reported no operating margin measure; its reported NOI declined year over year for both periods.
- At September 30, cash and cash equivalents were $104.2 million and restricted cash was $202.5 million, including $174.4 million reserved for redevelopment and other capital costs. Total assets were $2.73 billion and total liabilities were $1.40 billion.
- Consolidated debt was approximately $1.30 billion: about $1.21 billion under variable-rate mortgage loans and the future-funding facility, plus $85 million principal under the unsecured term loan. Mortgage debt matures in July 2019, with two one-year extension options subject to conditions. The unsecured loan matures December 31, 2017, or earlier if the mortgage debt is repaid or refinanced.
- Management said liquidity was sufficient for current needs, citing unrestricted and restricted cash, operating cash flow and expected proceeds from a subsequent joint-venture sale. Nine-month development spending was $164.1 million; financing cash flow included $80.0 million of future-funding draws and $85.0 million of unsecured-loan proceeds.
Material changes and transactions
- In July, Seritage sold its 50% interests in eight GGP joint-venture properties for $190.1 million and contributed five wholly owned properties to a new GGP joint venture, selling a 50% interest for $57.5 million. The transactions generated reported gains totaling $56.7 million and approximately $171.6 million of additional cash proceeds before closing costs; $50.6 million of mortgage debt was repaid.
- After quarter-end, Seritage agreed to sell its 50% interest in five Simon joint-venture assets for $68.0 million, subject to closing conditions. Management expected approximately $7.0 million of value creation above basis and cash proceeds for redevelopment and general corporate purposes.
- Third-party tenants accounted for 25.3% of rental income in the first nine months, compared with 20.0% a year earlier. Based on annualized base rent and signed leases, including leases not yet paying rent, management estimated third-party tenants would represent 45.4% as of September 30.
- Seritage had 55 redevelopment projects underway or originated, with estimated total investment of $676.0 million and $520.5 million remaining to spend.
Outlook, risks and unusual items
- No formal earnings or operating guidance was provided. Management said results for the interim periods may not indicate full-year or future results.
- Sears-related concentration is a central risk: 171 wholly owned properties were leased to Sears, and most joint-venture property space was also leased to Sears. Sears accounted for 74.7% of nine-month rental income excluding termination fees and stated straight-line rent adjustments. Seritage disclosed Sears had reported substantial doubt about its ability to continue as a going concern, and warned that a deterioration in Sears’ ability to pay could harm Seritage’s results, liquidity, debt service and dividends.
- Sears had terminated, or given notice to terminate, leases at 56 stores totaling 7.4 million square feet. Aggregate base rent at those stores when terminated was approximately $23.6 million; Sears had paid approximately $45.1 million in termination fees. Releasing, redeveloping and re-leasing vacated space entails execution, timing and cost risks.
- The $85 million unsecured loan due December 31, 2017 required repayment, extension or refinancing; management identified cash, capital raising, asset sales and new joint ventures as potential options. Mortgage financing is secured by wholly owned properties and pledged joint-venture interests and includes cash-sweep conditions and financial covenants. The company stated it was in compliance at filing.
- Mortgage and future-funding borrowings are variable-rate. Seritage estimated a 100-basis-point rate increase would raise annual pretax funding costs by about $12.1 million; an interest-rate cap had a 3.5% LIBOR strike.
- Management did not expect the 2017 wildfires or hurricanes to have a material impact; it reported Sears stores were open and rent payments had not been interrupted. The company reported no material expected impact from ordinary-course legal matters or environmental liabilities.
- Q3 GAAP earnings benefited from asset-sale gains, while termination-fee income was $10.6 million for the quarter and $17.4 million for the nine months. The prior-year comparative periods included a $19.0 million litigation charge, absent in 2017.
Most important facts for investors to verify
- Whether the Simon transaction closed on the expected terms and how proceeds were used.
- How the December 2017 unsecured-loan maturity was addressed, and the company’s refinancing and liquidity position ahead of the July 2019 mortgage maturity.
- Sears Holdings’ ongoing ability to meet rent and other lease obligations, including the effect of further store closures and lease terminations.
- Redevelopment spending against the $520.5 million remaining commitment, and whether signed leases commence and generate expected rents.
- How much of reported earnings and cash generation is recurring, given asset-sale gains, termination fees, accelerated amortization and restricted cash.
- Progress in reducing tenant concentration and the implications of mortgage cash-sweep tests, covenants and variable-rate exposure.