Seritage Growth Properties — Q1 2019 Form 10-Q
Period: Three months ended March 31, 2019. Seritage is a retail real estate owner and developer focused on redeveloping former Sears properties. Its portfolio comprised 225 properties and approximately 35.6 million square feet, including joint venture interests.
Financial performance and position
| Metric | Q1 2019 | Q1 2018 / prior period |
|---|---|---|
| Total revenue | $43.9 million | $53.8 million |
| Net income (loss) | $(10.9) million | $16.2 million |
| Net income (loss) attributable to common shareholders | $(8.2) million; $(0.23) per share | $9.1 million; $0.26 per share |
| NOI / Total NOI (non-GAAP) | $23.1 million / $24.3 million | $34.9 million / $36.9 million |
| Operating cash flow | $(16.8) million | $7.7 million |
| Investing cash flow | $(56.6) million | $(25.1) million |
| Financing cash flow | $(16.9) million | $(87.3) million |
| Cash and cash equivalents | $442.6 million | $532.9 million at Dec. 31, 2018 |
| Debt | $1.6 billion | Approximately $1.6 billion at Dec. 31, 2018 |
Rental revenue fell 19% to $43.6 million. GAAP interest expense increased to $23.5 million from $16.4 million, while property operating expenses and real estate taxes together rose to $20.4 million from $18.6 million. The reported $21.3 million gain on real estate sales partly offset operating costs; depreciation and amortization was $26.2 million. The filing does not present a conventional operating margin.
Material changes and business developments
- Holdco acquired Sears’ operating business in February. A new master lease covering 51 properties took effect March 12, replacing the Original Master Lease for accounting purposes. Q1 master-lease revenue was $20.7 million, versus $36.0 million in the comparable 2018 period.
- Rental income from Sears/Holdco represented 47.5% of Q1 rental income, down from approximately 66.5%. Diversified non-Sears tenants contributed $20.5 million, up from $15.1 million. Including signed leases not yet paying rent, non-Sears tenants represented approximately 88.1% of annualized base rent at quarter-end.
- Seritage sold seven properties for $29.5 million in aggregate consideration and contributed a property to a new joint venture. Real estate sale gains totaled $21.3 million in the income statement.
- Its 84 redevelopment projects had estimated total costs of $1.5 billion ($1.4 billion at Seritage’s share), with approximately $890 million ($835 million at share) still to be spent.
Liquidity, debt, outlook and risks
- The $1.6 billion Term Loan Facility matures July 31, 2023, bears fixed interest at 7.0%, and is secured by equity pledges. The separate $400 million incremental facility is conditional on specified non-Sears rental-income tests.
- Seritage reported noncompliance with certain Term Loan financial metrics at March 31. The filing says this is not itself an event of default, but restricts asset sales and joint ventures without Berkshire Hathaway’s consent and gives the lender the right to request mortgages and other collateral.
- Management said $442.6 million of unrestricted cash, together with potential access to the conditional incremental facility, was sufficient for current needs. Q1 development spending was $85.4 million; operating cash flow was negative.
- The board did not expect to declare additional common dividends for the rest of 2019, subject to reevaluation at year-end for REIT distribution requirements. It expected preferred dividends to continue quarterly.
- Holdco and Sears-related lease exposure remains a material tenant concentration. Holdco can terminate locations under lease terms, including specified rights to terminate without fees beginning in year two; the company had not exercised new Holdco lease recapture rights by quarter-end.
- On April 18, 2019, Sears entities sued Seritage and other defendants, alleging, among other claims, that the 2015 property transactions were fraudulent transfers. The complaint alleges the properties were worth $649–$749 million more than the purchase price and seeks rescission or damages. Seritage disputes the claims; no litigation liability was recorded, and the outcome and potential loss were not estimable in the filing.
Important facts for investors to verify
- Whether Seritage meets the Term Loan covenants, obtains lender consent for transactions, or faces additional collateral requirements.
- Holdco’s rent payments and lease termination activity, as well as the status of Sears leases in joint ventures.
- Actual leasing, construction progress, costs and returns versus the $835 million remaining redevelopment investment at Seritage’s share.
- Cash burn and funding needs relative to unrestricted cash, conditional incremental borrowing capacity and the 2023 loan maturity.
- Developments and potential financial consequences of the Sears litigation, and the board’s dividend decisions.