Phillips Edison & Company, Inc. annual report, FY2017

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Phillips Edison & Company, Inc. — 2017 Form 10-K

Reporting period: Fiscal year ended December 31, 2017. The filing includes quarterly data, but is an annual report rather than a standalone Q4 filing. The company owns and operates grocery-anchored shopping centers and, after its October 4, 2017 acquisition of assets from Phillips Edison Limited Partnership (PELP), also runs a third-party investment management business. At year-end it owned 236 centers, totaling 26.3 million square feet in 32 states, and managed more than 340 centers overall.

Financial performance and position

  • Revenue: $311.5 million in 2017, up 20.9% from $257.7 million in 2016. The 2017 total includes $8.2 million of fees and management income and PELP results from October 4 onward. Q4 revenue was $102.8 million, versus $66.3 million in Q4 2016.
  • Profitability: GAAP net loss was $41.7 million, or $0.21 per share, compared with net income of $9.0 million in 2016. Q4 net loss attributable to stockholders was $30.1 million, or $0.17 per share, versus net income of $3.7 million, or $0.02 per share, in Q4 2016. Owned Real Estate segment profit was $206.4 million, up 17.4%; this is a non-GAAP segment measure, not consolidated operating income.
  • Non-GAAP measures: FFO attributable to stockholders and convertible noncontrolling interests was $84.2 million ($0.43 per diluted share), down from $110.4 million ($0.59) in 2016. MFFO was $125.2 million ($0.64 per diluted share), up from $107.9 million ($0.58). The measures exclude specified items and are not substitutes for GAAP results or cash flow.
  • Same-center operations: Pro forma same-center NOI increased 3.5% to $204.8 million; same-center revenue grew 2.1%. The comparison adjusts for the PELP transaction as if completed at the start of 2016.
  • Cash flow and distributions: Operating cash flow was $108.9 million, compared with $103.1 million in 2016. Gross distributions declared were $123.4 million, including $49.1 million reinvested through the DRIP; net cash distributions to common stockholders and OP unit holders were $81.2 million. Management reported operating cash flow below gross common distributions by $14.4 million and FFO below them by $39.1 million; the shortfall was funded with borrowings.
  • Debt and liquidity: Debt obligations, net, were $1.807 billion, versus $1.056 billion a year earlier. Debt to total enterprise value was 41.8%, using the company’s estimated share value. Cash and cash equivalents were $5.7 million, with $438.4 million available under the $500 million revolving facility. The company reported compliance with debt covenants. A 1 percentage-point rise in rates on unhedged variable-rate debt was estimated to add about $2.1 million in annual interest expense.
  • Balance sheet: Total assets were $3.526 billion and total equity was $1.479 billion at year-end. Capital expenditures were $42.1 million; investing activities used $620.7 million and financing activities provided $509.4 million.

Material changes versus prior periods

  • The PELP transaction expanded the company’s portfolio and added the investment management business and captive insurer. Consideration included 39.4 million OP units valued at $401.6 million, $30.4 million cash, assumed debt, and a $38.0 million estimated earn-out liability. The company became internally managed and had 304 employees at year-end.
  • Revenue and Owned Real Estate segment profit rose with acquisitions and portfolio growth. Pro forma same-center NOI increased 3.5%, while reported occupancy across the year-end portfolio was 93.9%.
  • GAAP results were weighed down by $15.7 million of PELP transaction expenses, $24.0 million of Class B unit vesting expense, $5.5 million related to termination of affiliate arrangements, higher depreciation and amortization, and higher interest expense. The Class B unit vesting charge was noncash.
  • Debt rose substantially, reflecting assumed debt, new borrowings and acquisition financing. The company added term and secured loan facilities; $65 million of a term loan commitment was drawn in January 2018.
  • Q4 revenue and loss both increased sharply year over year, primarily associated with the PELP transaction; the filing does not provide a clean, transaction-adjusted Q4 comparison.

Outlook, commentary, risks and unusual items

  • Outlook: Management expected the 2018 monthly distribution rate to remain at the 2017 annual rate, subject to Board discretion and operating conditions. It described retail real estate fundamentals as positive but decelerating, with rising vacancies and expected increases in short-term interest rates. No specific earnings or revenue guidance was provided.
  • Leasing: 2017 rent per square foot on renewed leases increased 8.5%, and portfolio retention was 93.8%. Management expected positive overall rent increases on expiring leases but cautioned that individual new-lease rents could rise or fall.
  • Liquidity and share value: Shares had no established public trading market. The Board’s $11.00 estimated value per share was based on October 5, 2017 valuation data, was unaudited, and is not a guaranteed resale, liquidation, or exchange-trading price. The SRP was funding-constrained: 10.8 million shares of requests remained unfulfilled at year-end, with no funds available for repurchases in Q4 2017 or Q1 2018 and limited repurchases expected for the rest of 2018.
  • Distribution sustainability: Distributions exceeded operating cash flow and FFO in 2017, with the shortfall funded by borrowing. The Board may change or suspend distributions, and the company does not guarantee continuation at the current rate.
  • Principal risks: Integration and execution following the PELP transaction; limited experience as a self-managed REIT; tenant and grocery-anchor credit, vacancies and retail disruption from e-commerce; geographic concentration (Florida represented 12.8% of ABR); interest rates, refinancing and debt maturities; illiquidity and constrained repurchases; REIT qualification and tax-protection obligations; and conflicts arising from managing affiliated REITs and funds.
  • Other contingencies: The PELP earn-out could result in up to 12.5 million additional OP units if specified milestones are met. A ten-year tax protection agreement may constrain certain property sales or debt decisions. Southeastern Grocers filed for bankruptcy in March 2018; the company had eight stores operated by its subsidiaries and did not expect a material financial statement impact. The filing reports no legal proceeding expected to have a material adverse effect.
  • Controls and audit: Management concluded disclosure controls and internal control over financial reporting were effective at December 31, 2017; the PELP acquisition materially changed internal controls during the year. Deloitte & Touche issued an unqualified opinion on the financial statements; it did not audit internal control effectiveness.

Important facts for investors to verify

  • How much of 2017’s revenue, NOI and cash flow is attributable to the acquired PELP assets, and whether integration produces expected efficiencies.
  • The assumptions and sensitivity behind the $11.00 estimated share value, including the appraisal’s use of management-provided information and its lack of property inspections.
  • Distribution coverage using recurring operating cash flow and FFO, and the extent to which future distributions may rely on borrowing or DRIP proceeds.
  • Debt maturities, refinancing capacity, covenant headroom, unhedged rate exposure and the terms of the new facilities.
  • The status and priority of the 10.8 million unfulfilled repurchase requests, and the practical limits on shareholder liquidity.
  • The earn-out milestones, potential OP unit dilution, tax-protection restrictions, and developments affecting the eight Southeastern Grocers-operated stores.