Seritage Growth Properties — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019; comparisons are to the corresponding 2018 periods. Amounts are in millions unless stated otherwise. Seritage is a retail-property REIT focused on leasing, redeveloping and diversifying its portfolio. At quarter-end, it held interests in 221 properties totaling approximately 35.1 million square feet.
Financial results and liquidity
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Total revenue | $40.5 | $49.3 | $84.4 | $103.0 |
| Rental revenue | $38.7 | $48.4 | $82.3 | $102.1 |
| Net income (loss) | $(25.9) | $(10.6) | $(36.8) | $5.6 |
| Net income (loss) attributable to Seritage common shareholders | $(18.1) | $(8.0) | $(26.3) | $1.1 |
| GAAP diluted loss (income) per share | $(0.50) | $(0.23) | $(0.73) | $0.03 |
| Company-defined Total NOI | $14.6 | $36.5 | $38.9 | $73.3 |
- Q2 rental revenue from Sears/Kmart stores was $11.5 million, 35% of rental revenue, versus $33.6 million and about 70% a year earlier. Diversified, non-Sears rental revenue was $21.4 million, 65%, versus $14.2 million and about 30%.
- Six-month net cash used in operating activities was $26.5 million, versus $16.2 million provided in 2018. Investing activities used $146.9 million, primarily for $182.6 million of development and property improvements; financing activities used $33.9 million. Cash and cash equivalents declined to $325.5 million from $532.9 million at year-end 2018.
- At June 30, total assets were $2.80 billion, total liabilities $1.70 billion and total equity $1.10 billion. Term Loan Facility carrying value was $1.598 billion. It bears fixed interest at 7.0% and matures July 31, 2023; reported interest expense was $22.1 million for Q2 and $45.6 million for the first half.
- Seritage reported $325.5 million of unrestricted cash and a $400 million incremental funding facility, subject to financial and rental-income conditions. The filing says management believed liquidity was sufficient for current needs.
Material changes and drivers
- Rental revenue fell $9.7 million in Q2 and $19.8 million for the first half, mainly as Sears/Kmart rent declined, partly offset by higher diversified-tenant rent and straight-line rent.
- Higher property operating and tax costs reflected Seritage directly paying utilities and other costs at some vacated properties that Sears/Kmart had paid previously. Interest expense increased with higher average borrowings and rates under the Term Loan Facility.
- Depreciation and amortization decreased substantially year over year, primarily because the prior-year periods included accelerated amortization of lease intangibles associated with lease recaptures and terminations.
- Reported gains on real estate sales were $11.6 million in Q2 and $32.9 million for the first half. First-half items included property-sale gains, a $3.8 million gain on contributing a property to a joint venture, and a $7.2 million gain on a land exchange.
- Seritage adopted the new lease accounting standard on January 1, 2019; it reported no material impact on its financial statements.
Outlook, risks and contingencies
- Management’s stated strategy is to redevelop former single-tenant properties into multi-tenant and mixed-use assets, grow property income and diversify tenants. The 87 redevelopment projects originated on its platform were estimated to require total investment of $1.55–$1.63 billion ($1.43–$1.51 billion at Seritage’s share), with $835–$910 million ($775–$850 million at share) remaining to be spent. These are project estimates, not earnings guidance.
- The board did not expect to declare additional common-share dividends for the remainder of 2019, subject to reevaluation at year-end for REIT distribution requirements. It expected quarterly preferred dividends to continue.
- Seritage was not in compliance with certain Term Loan Facility financial metrics at June 30. As a result, asset sales or joint-venture dispositions require Berkshire Hathaway’s consent, and the lender may require mortgages and other collateral. The company said it believed it complied with the facility’s other terms.
- Access to the incremental facility depends, among other conditions, on achieving at least $200 million of annualized rental income from non-Sears tenants and projecting at least that amount for the succeeding four quarters.
- Holdco was the tenant at 50 wholly owned properties and four joint-venture properties; the filing notes material rental-revenue concentration and warns that adverse developments at Holdco could materially affect Seritage.
- A Sears Holdings bankruptcy-related lawsuit names Seritage and affiliates and challenges, among other matters, the 2015 property transactions. Plaintiffs allege the properties were worth $649–$749 million more than the purchase price and seek rescission or damages. The case was at an early stage; Seritage disputed the claims and had recorded no litigation liability.
Important facts for investors to verify
- Progress in replacing Sears/Kmart rent with diversified tenants, including actual occupancy, rent commencement and collections.
- Redevelopment spending, completion timing, leasing results and whether project costs remain within estimates.
- Compliance with debt covenants, lender consent requirements, collateral rights and the conditions for drawing the incremental facility.
- Cash burn and available liquidity relative to development commitments, debt service and the common-dividend pause.
- Developments in the Sears Holdings litigation and any resulting financial, operational or governance exposure.