Seritage Growth Properties — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016. Seritage is a retail-property REIT formed in 2015; it began operations on July 7, 2015, following its $2.7 billion acquisition of properties and joint-venture interests from Sears Holdings. Accordingly, it had no operations in the year-earlier quarter, so a comparable Q1 year-over-year operating comparison is unavailable.
Financial results and liquidity
| Metric | Q1 2016 |
|---|---|
| Total revenue | $63.0 million |
| Operating income | $0.4 million; approximately 0.6% of revenue |
| Equity income from unconsolidated JVs | $2.1 million |
| Interest expense | $15.7 million |
| Net loss | $14.7 million; $8.3 million attributable to common shareholders |
| Basic and diluted loss per Class A and C share | $0.27 |
| Operating cash flow | $24.9 million |
| Investing cash flow | $(3.5) million |
| Financing cash flow | $(27.8) million |
| Cash and cash equivalents at March 31 | $56.4 million; restricted cash was $89.2 million |
| Debt | $1.144 billion net carrying value; approximately $1.161 billion principal |
Depreciation and amortization was $39.5 million. The company reported non-GAAP FFO of $29.5 million ($0.53 per diluted share and unit) and normalized FFO of $32.6 million ($0.59 per diluted share and unit); these measures are not substitutes for GAAP earnings or cash flow.
Compared with December 31, 2015, total assets declined from $2.833 billion to $2.792 billion, total liabilities from $1.263 billion to $1.251 billion, and total equity from $1.570 billion to $1.542 billion. Cash fell by $6.4 million. The filing provides no prior-year-quarter operating figures.
Business, portfolio and material developments
- The portfolio comprised 235 wholly owned properties with over 37.0 million square feet and 31 JV properties with over 5.4 million square feet, across 49 states and Puerto Rico for wholly owned assets.
- Most portfolio space was leased to Sears Holdings. Excluding straight-line rent, Sears accounted for $33.4 million, or about 82%, of Q1 rental income; third-party tenants accounted for $7.2 million, or about 18%. Signed leases not yet paying rent increased the estimated third-party share of annual base rent to about 27% at quarter-end.
- Q1 rent included $4.4 million of straight-line rent. Tenant reimbursements were $17.8 million, compared with $18.6 million of property operating costs and real estate taxes.
- Seritage exercised recapture rights for one auto center during the quarter. As of quarter-end it had recapture notices covering four wholly owned properties in total; the GGP JV had submitted notices for four properties. Five additional wholly owned property notices were submitted after quarter-end.
- The redevelopment pipeline covered 10 projects and approximately 659,400 square feet, with estimated development costs of $101.5 million and total project costs of $114.2 million. Seven of 15 projects acquired at formation had been completed; eight remained in progress.
Outlook, risks and unusual items
- Management said liquidity was sufficient for commitments, citing $56.4 million unrestricted cash, $89.2 million restricted cash, a $100 million future-funding facility with no amount drawn at March 31, and expected operating cash flow. The facility is subject to conditions.
- No numerical earnings or operating guidance was provided. Management intended to fund redevelopment through cash, operating cash flow, the future-funding facility and potential capital raising. Quarterly dividends were declared at $0.25 per Class A and Class C share, with equivalent distributions to operating-partnership unitholders; future distributions remain at the board’s discretion.
- Mortgage loans mature in July 2019, bear interest at 30-day LIBOR plus a weighted-average spread of 465 basis points, and were interest-only at a weighted-average 5.16% rate in Q1. A four-year interest-rate cap has a 3.5% LIBOR strike; its fair-value loss was $1.4 million in Q1. Management estimated that a 100-basis-point rate change would affect annual pretax funding costs by about $11.6 million.
- Loan covenants can trigger cash-flow sweeps, including if debt yield falls below 11% or tenant-diversification tests are not met. Management said it was in compliance with material loan terms at quarter-end.
- Concentration in Sears is a key exposure: the filing says substantially all property space was leased to Sears or its affiliates. Sears also has specified termination rights, subject to limits and notice requirements.
- Shareholder litigation challenges the Sears property transaction and seeks unspecified damages. Seritage disputed the claims; management could not estimate a possible loss or range.
- The company recognized no real estate or JV investment impairment in Q1. It reported a $1.4 million unrealized interest-rate-cap loss and $4.9 million of additional amortization associated with recaptured space.
Important facts for investors to verify
- Sears Holdings’ financial condition, rent-paying ability, and the degree of tenant diversification actually achieved.
- Redevelopment execution, leasing, project costs and timing, and availability and terms of funding for the pipeline.
- Debt-covenant headroom, debt-yield calculations, interest-rate exposure, and conditions governing the future-funding facility.
- Cash available for operations and redevelopment after restricted reserves, debt service, and dividends and distributions.
- Developments in the transaction-related litigation and any changes to environmental, insurance or other contingencies.