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Section 1: 10-Q (10-Q)

srg-10q_20160930.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2016

or

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _______to _______

Commission File Number 001-37420

SERITAGE GROWTH PROPERTIES

(Exact name of registrant as specified in its charter)

 

Maryland

38-3976287

(State of Incorporation)

(I.R.S. Employer Identification No.)

 

489 Fifth Avenue, 18th Floor, New York, New York

10017

(Address of principal executive offices)

(Zip Code)

 

Registrant’s telephone number, including area code: (212) 355-7800

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes      No  

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes      No  

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer

 

Accelerated filer

Non-accelerated filer

 (Do not check if a smaller reporting company)

Smaller reporting company

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes      No  

As of October 31, 2016, the registrant had the following common shares outstanding:

 

Class

Shares Outstanding

Class A common shares of beneficial interest, par value $0.01 per share

25,825,651

Class B common shares of beneficial interest, par value $0.01 per share

1,589,020

Class C common shares of beneficial interest, par value $0.01 per share

5,772,285

 

 


SERITAGE GROWTH PROPERTIES

QUARTERLY REPORT ON FORM 10-Q

QUARTER ENDED SEPTEMBER 30, 2016

TABLE OF CONTENTS

 

PART I.

FINANCIAL INFORMATION

 

 

 

Page

 

 

 

Item 1.

Condensed Consolidated Financial Statements (unaudited)

 

 

Condensed Consolidated Balance Sheets as of September 30, 2016 and December 31, 2015

3

 

Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2016 and the Period from July 7, 2015 (Date Operations Commenced) to September 30, 2015

4

 

Condensed Consolidated Statements of Equity for the Nine Months Ended September 30, 2016 and the Period from July 7, 2015 (Date Operations Commenced) to September 30, 2015

5

 

Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2016 and the Period from July 7, 2015 (Date Operations Commenced) to September 30, 2015

6

 

Notes to Condensed Consolidated Financial Statements

7

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

26

 

 

 

Item 3.

Quantitative and Qualitative Disclosure about Market Risk

38

 

 

 

Item 4.

Controls and Procedures

38

 

 

 

PART II.

OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

39

 

 

 

Item 1A.

Risk Factors

39

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

40

 

 

 

Item 3.

Defaults upon Senior Securities

40

 

 

 

Item 4.

Mine Safety Disclosures

40

 

 

 

Item 5.

Other Information

40

 

 

 

Item 6.

Exhibits

41

 

 

 

SIGNATURES

 

42

 

 

 


PART I.

FINANCIAL INFORMATION

Item 1.

Unaudited Condensed Consolidated Financial Statements

SERITAGE GROWTH PROPERTIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited, amounts in thousands, except share and per share amounts)

 

 

 

September 30, 2016

 

 

December 31, 2015

 

ASSETS

 

 

 

 

 

 

 

 

Investment in real estate

 

 

 

 

 

 

 

 

Land

 

$

840,021

 

 

$

840,563

 

Buildings and improvements

 

 

831,269

 

 

 

814,652

 

Accumulated depreciation

 

 

(78,025

)

 

 

(29,076

)

 

 

 

1,593,265

 

 

 

1,626,139

 

Construction in progress

 

 

44,172

 

 

 

13,136

 

Net investment in real estate

 

 

1,637,437

 

 

 

1,639,275

 

Investment in unconsolidated joint ventures

 

 

419,675

 

 

 

427,052

 

Cash and cash equivalents

 

 

90,029

 

 

 

62,867

 

Restricted cash

 

 

81,790

 

 

 

92,475

 

Tenant and other receivables, net

 

 

13,477

 

 

 

9,772

 

Lease intangible assets, net

 

 

505,564

 

 

 

578,795

 

Prepaid expenses, deferred expenses and other assets, net

 

 

12,466

 

 

 

23,123

 

Total assets

 

$

2,760,438

 

 

$

2,833,359

 

 

 

 

 

 

 

 

 

 

LIABILITIES AND EQUITY

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

Mortgage loans payable, net

 

$

1,165,675

 

 

$

1,142,422

 

Accounts payable, accrued expenses and other liabilities

 

 

130,283

 

 

 

120,860

 

Total liabilities

 

 

1,295,958

 

 

 

1,263,282

 

 

 

 

 

 

 

 

 

 

Commitments and contingencies (Note 10)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shareholders' Equity

 

 

 

 

 

 

 

 

Class A shares $0.01 par value; 100,000,000 shares authorized; 25,822,201

   and 24,817,842 shares issued and outstanding as of September 30, 2016 and

   December 31, 2015, respectively

 

 

258

 

 

 

248

 

Class B shares $0.01 par value; 5,000,000 shares authorized; 1,589,020 shares issued

   and outstanding as of September 30, 2016 and December 31, 2015

 

 

16

 

 

 

16

 

Class C shares $0.01 par value; 50,000,000 shares authorized; 5,775,735 and

   6,773,185 shares issued and outstanding as of September 30, 2016 and

   December 31, 2015, respectively

 

 

58

 

 

 

68

 

Additional paid-in capital

 

 

925,296

 

 

 

924,508

 

Accumulated deficit

 

 

(98,425

)

 

 

(38,145

)

Total shareholders' equity

 

 

827,203

 

 

 

886,695

 

Non-controlling interests

 

 

637,277

 

 

 

683,382

 

Total equity

 

 

1,464,480

 

 

 

1,570,077

 

Total liabilities and equity

 

$

2,760,438

 

 

$

2,833,359

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements. 

 

 

- 3 -


SERITAGE GROWTH PROPERTIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited, amounts in thousands, except per share amounts)

 

 

 

 

 

 

 

July 7, 2015

 

 

 

 

 

 

 

Three Months Ended

 

 

(date operations commenced) to

 

 

Nine Months Ended

 

 

 

September 30,

 

 

September 30,

 

 

September 30,

 

 

 

2016

 

 

2015

 

 

2016

 

REVENUE

 

 

 

 

 

 

 

 

 

 

 

 

Rental income

 

$

45,584

 

 

$

41,389

 

 

$

136,737

 

Tenant reimbursements

 

 

12,023

 

 

 

12,674

 

 

 

45,741

 

Total revenue

 

 

57,607

 

 

 

54,063

 

 

 

182,478

 

EXPENSES

 

 

 

 

 

 

 

 

 

 

 

 

Property operating

 

 

4,505

 

 

 

2,815

 

 

 

17,176

 

Real estate taxes

 

 

7,965

 

 

 

10,741

 

 

 

31,101

 

Depreciation and amortization

 

 

44,532

 

 

 

32,935

 

 

 

121,365

 

General and administrative

 

 

4,252

 

 

 

5,782

 

 

 

13,104

 

Litigation charge

 

 

19,000

 

 

 

-

 

 

 

19,000

 

Allowance for doubtful accounts

 

 

124

 

 

 

-

 

 

 

269

 

Acquisition-related expenses

 

 

-

 

 

 

18,340

 

 

 

73

 

Total expenses

 

 

80,378

 

 

 

70,613

 

 

 

202,088

 

Operating income

 

 

(22,771

)

 

 

(16,550

)

 

 

(19,610

)

Equity in income of unconsolidated joint ventures

 

 

1,497

 

 

 

2,720

 

 

 

4,495

 

Interest and other income

 

 

77

 

 

 

38

 

 

 

196

 

Interest expense

 

 

(15,931

)

 

 

(14,796

)

 

 

(47,297

)

Unrealized loss on interest rate cap

 

 

(47

)

 

 

(2,814

)

 

 

(1,898

)

Loss before income taxes

 

 

(37,175

)

 

 

(31,402

)

 

 

(64,114

)

Provision for income taxes

 

 

(72

)

 

 

(451

)

 

 

(412

)

Net loss

 

 

(37,247

)

 

 

(31,853

)

 

 

(64,526

)

Net loss attributable to non-controlling interests

 

 

16,145

 

 

 

13,552

 

 

 

27,972

 

Net loss attributable to common shareholders

 

$

(21,102

)

 

$

(18,301

)

 

$

(36,554

)

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss per share attributable to Class A and Class C

   common shareholders - Basic and diluted

 

$

(0.67

)

 

$

(0.58

)

 

$

(1.16

)

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average Class A and Class C

   common shares outstanding - Basic and diluted

 

 

31,419

 

 

 

31,384

 

 

 

31,414

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

 

- 4 -


SERITAGE GROWTH PROPERTIES

CONDENSED CONSOLIDATED STATEMENTS OF EQUITY

(Unaudited, amounts in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Additional

 

 

 

 

 

 

Non-

 

 

 

 

 

 

 

Class A

 

 

Class B

 

 

Class C

 

 

Paid-In

 

 

Accumulated

 

 

Controlling

 

 

Total

 

 

 

Shares

 

 

Amount

 

 

Shares

 

 

Amount

 

 

Shares

 

 

Amount

 

 

Capital

 

 

Deficit

 

 

Interests

 

 

Equity

 

Balance at July 7, 2015 (date

   operations commenced)

 

 

25,584

 

 

$

246

 

 

 

1,589

 

 

$

16

 

 

 

6,790

 

 

$

68

 

 

$

923,636

 

 

$

-

 

 

$

711,991

 

 

$

1,635,957

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

(18,301

)

 

 

(13,552

)

 

 

(31,853

)

Dividends and

   distributions declared

   ($0.00 per share and unit)

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

Issuance of restricted shares

 

 

217

 

 

 

2

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

(2

)

 

 

-

 

 

 

-

 

 

 

-

 

Vesting of restricted share units

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

Stock-based compensation

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

716

 

 

 

-

 

 

 

-

 

 

 

716

 

Share class exchanges, net

   (132,450 common shares)

 

 

132

 

 

 

1

 

 

 

-

 

 

 

-

 

 

 

(132

)

 

 

(1

)

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at September 30, 2015

 

 

25,933

 

 

$

249

 

 

 

1,589

 

 

$

16

 

 

 

6,658

 

 

$

67

 

 

$

924,350

 

 

$

(18,301

)

 

$

698,439

 

 

$

1,604,820

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2015

 

 

24,818

 

 

$

248

 

 

 

1,589

 

 

$

16

 

 

 

6,773

 

 

$

68

 

 

$

924,508

 

 

$

(38,145

)

 

$

683,382

 

 

$

1,570,077

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

(36,554

)

 

 

(27,972

)

 

 

(64,526

)

Dividends and

   distributions declared

   ($0.75 per share and unit)

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

(23,726

)

 

 

(18,133

)

 

 

(41,859

)

Issuance of restricted shares

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

Vesting of restricted share units

 

 

7

 

 

 

0

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

(13

)

 

 

-

 

 

 

-

 

 

 

(13

)

Stock-based compensation

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

801

 

 

 

-

 

 

 

-

 

 

 

801

 

Share class exchanges, net

   (997,450 common shares)

 

 

997

 

 

 

10

 

 

 

-

 

 

 

-

 

 

 

(997

)

 

 

(10

)

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at September 30, 2016

 

 

25,822

 

 

$

258

 

 

 

1,589

 

 

$

16

 

 

 

5,776

 

 

$

58

 

 

$

925,296

 

 

$

(98,425

)

 

$

637,277

 

 

$

1,464,480

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

 

- 5 -


SERITAGE GROWTH PROPERTIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited, amounts in thousands)

 

 

 

 

 

 

 

July 7, 2015

 

 

 

Nine Months Ended

 

 

(date operations commenced) to

 

 

 

September 30,

 

 

September 30,

 

 

 

2016

 

 

2015

 

CASH FLOW FROM OPERATING ACTIVITIES

 

 

 

 

 

 

 

 

Net loss

 

$

(64,526

)

 

$

(31,853

)

Adjustments to reconcile net loss to net cash provided by operating activities:

 

 

 

 

 

 

 

 

Equity in income of unconsolidated joint ventures

 

 

(4,495

)

 

 

(2,720

)

Distributions from unconsolidated joint ventures

 

 

11,872

 

 

 

2,598

 

Unrealized loss on interest rate cap

 

 

1,898

 

 

 

2,814

 

Stock-based compensation

 

 

801

 

 

 

716

 

Depreciation and amortization

 

 

121,365

 

 

 

32,935

 

Amortization of deferred financing costs

 

 

4,021

 

 

 

1,324

 

Amortization of above and below market leases, net

 

 

(520

)

 

 

(194

)

Straight-line rent adjustment

 

 

(11,242

)

 

 

(3,923

)

Change in operating assets and liabilities

 

 

 

 

 

 

 

 

Tenants and other receivables

 

 

8,425

 

 

 

(662

)

Prepaid expenses, deferred expenses and other assets

 

 

8,496

 

 

 

(12,939

)

Restricted cash

 

 

(1,047

)

 

 

(2,856

)

Accounts payable, accrued expenses and other liabilities

 

 

24,043

 

 

 

22,292

 

Net cash provided by operating activities

 

 

99,091

 

 

 

7,532

 

CASH FLOW FROM INVESTING ACTIVITIES

 

 

 

 

 

 

 

 

Acquisition of real estate and unconsolidated joint ventures

 

 

-

 

 

 

(2,653,019

)

Development of real estate

 

 

(47,236

)

 

 

(3,896

)

Decrease (increase) in restricted cash

 

 

11,732

 

 

 

(74,830

)

Net cash used in investing activities

 

 

(35,504

)

 

 

(2,731,745

)

CASH FLOW FROM FINANCING ACTIVITIES

 

 

 

 

 

 

 

 

Proceeds from issuance of mortgage loans payable, net

 

 

-

 

 

 

1,161,196

 

Proceeds from Future Funding Facility

 

 

19,239

 

 

 

-

 

Payment of deferred financing costs

 

 

(6

)

 

 

(21,431

)

Proceeds from issuance of common stock and non-controlling interest

 

 

-

 

 

 

1,644,042

 

Offering related costs

 

 

-

 

 

 

(8,086

)

Common dividends paid

 

 

(31,482

)

 

 

-

 

Non-controlling interests distributions paid

 

 

(24,176

)

 

 

-

 

Net cash used by financing activities

 

 

(36,425

)

 

 

2,775,721

 

Net increase in cash and cash equivalents

 

 

27,162

 

 

 

51,508

 

Cash and cash equivalents, beginning of period

 

 

62,867

 

 

 

-

 

Cash and cash equivalents, end of period

 

$

90,029

 

 

$

51,508

 

 

 

 

 

 

 

 

 

 

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

 

 

 

 

 

 

 

 

Cash payments for interest

 

$

45,495

 

 

$

11,001

 

Capitalized interest

 

 

2,198

 

 

 

-

 

Income taxes paid

 

 

412

 

 

 

451

 

SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING

   ACTIVITIES

 

 

 

 

 

 

 

 

Development of real estate financed with accounts payable

 

 

3,442

 

 

 

6,214

 

Dividends and distribution declared and unpaid

 

 

13,954

 

 

 

-

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

- 6 -


SERITAGE GROWTH PROPERTIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 1 – Organization

Seritage Growth Properties (“Seritage”) was organized in Maryland on June 3, 2015 and was initially capitalized with 100 shares of Class A common shares.  The Company conducts its operations through Seritage Growth Properties, L.P. (the “Operating Partnership”), a Delaware limited partnership that was formed on April 22, 2015.  Unless the context otherwise requires, “Seritage” and the “Company” refer to Seritage, the Operating Partnership, and its subsidiaries.

On June 11, 2015, Sears Holdings Corporation (“Sears Holdings”) effected a rights offering (the “Rights Offering”) to Sears Holdings stockholders to purchase common shares of Seritage in order to fund, in part, the $2.7 billion acquisition of 234 of Sears Holdings’ owned properties and one of its ground leased properties (the “Wholly Owned Properties”), and its 50% interests in three joint ventures (such joint ventures, the “JVs,” and such 50% joint venture interests, the “JV Interests”) that collectively own 28 properties, ground lease one property and lease two properties (collectively, the “JV Properties”) (collectively, the “Transaction”).  The Rights Offering ended on July 2, 2015, and the Company’s Class A common shares were listed on the New York Stock Exchange (“NYSE”) on July 6, 2015.

On July 7, 2015, the Company completed the Transaction with Sears Holdings and commenced operations.  The Company did not have any operations prior to the completion of the Rights Offering and the Transaction.

Seritage is a fully-integrated, self-administered, self-managed real estate investment trust (“REIT”) primarily engaged in the real property business through the Company’s investment in the Operating Partnership.  As of September 30, 2016, subsidiaries of the Operating Partnership lease a substantial majority of the space at all but 14 of the Wholly Owned Properties back to Sears Holdings under a master lease agreement (the “Master Lease”), with the remainder of such space leased to third-party tenants.  A substantial majority of the space at the JV Properties is also leased (or subleased) by the JVs to Sears Holdings under master lease agreements (collectively, the “JV Master Leases”).  The Master Lease and the JV Master Leases provide the Company and the JVs with the right to recapture certain space from Sears Holdings at each property for retenanting or redevelopment purposes.

 

 

Note 2 – Summary of Significant Accounting Policies

Basis of Presentation and Principles of Consolidation

These condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q of the Securities and Exchange Commission (“SEC”) and should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K, as amended, (the “Annual Report”), for the period from July 7, 2015 (Date Operations Commenced) to December 31, 2015.  Certain footnote disclosures which would substantially duplicate those contained in our Annual Report have been condensed or omitted from this quarterly report.  In the opinion of management, all adjustments necessary for a fair presentation (which include only normal recurring adjustments) have been included in this quarterly report.  Capitalized terms used, but not defined in this quarterly report, have the same meanings as set forth in our Annual Report.

The accompanying consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (“GAAP”).  The consolidated financial statements include the accounts of the Company, the Operating Partnership, each of their wholly-owned subsidiaries, and all other entities in which they have a controlling financial interest or entities that meet the definition of a variable interest entity (“VIE”) in which the Company has, as a result of ownership, contractual interests or other financial interests, both the power to direct activities that most significantly impact the economic performance of the VIE and the obligation to absorb losses or the right to receive benefits that could potentially be significant to the VIE.  All intercompany accounts and transactions have been eliminated.

If the Company has an interest in a VIE but it is not determined to be the primary beneficiary, the Company accounts for its interest under the equity method of accounting.  Similarly, for those entities which are not VIEs and over which the Company has the ability to exercise significant influence, but does not have a controlling financial interest, the Company accounts for its interests under the equity method of accounting.  The Company continually reconsiders its determination of whether an entity is a VIE and whether the Company qualifies as its primary beneficiary.

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To the extent such variable interests are in entities that cannot be evaluated under the VIE model, the Company evaluates its interests using the voting interest entity model.  The Company holds a 56.7% interest in the Operating Partnership and is the sole general partner which gives the Company exclusive and complete responsibility for the day-to-day management, authority to make decisions, and control of the Operating Partnership.  Through consideration of new consolidation guidance effective for the Company as of January 1, 2016, it has been concluded that the Operating Partnership is a VIE as the limited partners in the Operating Partnership, although entitled to vote on certain matters, do not possess kick-out rights or substantive participating rights.  Accordingly, the Company consolidates its interest in the Operating Partnership.  However, as the Company holds what is deemed a majority voting interest in the Operating Partnership, it qualifies for the exemption from providing certain of the disclosure requirements associated with investments in VIEs.

The portions of consolidated entities not owned by the Company and the Operating Partnership are presented as non-controlling interests as of and during the periods presented.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods.  The most significant assumptions and estimates relate to fair values of acquired assets and liabilities assumed for purposes of applying the acquisition method of accounting, the useful lives of tangible and intangible assets, real estate impairment assessments, and assessing the recoverability of accounts receivables.  These estimates are based on historical experience and other assumptions which management believes are reasonable under the circumstances.  Management evaluates its estimates on an ongoing basis and makes revisions to these estimates and related disclosures as experience develops or new information becomes known.  Actual results could differ from these estimates.

Segment Reporting

The Company currently operates in a single reportable segment which includes the acquisition, ownership, development, redevelopment, management, and leasing of retail properties.  The Company reviews operating and financial information for each property on an individual basis, and therefore, each property represents an individual operating segment.  The Company does not distinguish or group consolidated operations based on geography, size, or type.  The Company aggregates all properties into one reportable segment due to their similarities with regard to the nature and economics of the properties, tenants, and operations.

Accounting for Real Estate Acquisitions

Upon the acquisition of real estate, the Company assesses the fair value of acquired assets and liabilities assumed, including land, buildings, improvements and identified intangibles such as above-market and below-market leases, in-place leases and other items, as applicable, and allocates the purchase price based on these assessments.  In making estimates of fair values, the Company may use a number of sources, including data provided by third parties, as well as information obtained by the Company as a result of its due diligence, including expected future cash flows of the property and various characteristics of the markets where the property is located.

The fair values of tangible assets are determined on an "if vacant" basis. The "if vacant" fair value allocated to land is generally estimated via a market or sales comparison approach with the subject site being compared to similar properties that have sold or are currently listed for sale. The comparable properties are adjusted for dissimilar characteristics such as market conditions, location, access/frontage, size, shape/topography, or intended use, including the impact of any encumbrances on such use.  The "if vacant" value allocated to buildings and site improvements is generally estimated using an income approach and a cost approach that utilizes published guidelines for current replacement cost or actual construction costs for similar, recently developed properties.  Assumptions used in the income approach include capitalization and discount rates, lease-up time, market rents, make-ready costs, land value, and site improvement value.

The estimated fair value of in-place tenant leases includes lease origination costs (the costs the Company would have incurred to lease the property to the current occupancy level) and the lost revenues during the period necessary to lease-up from vacant to the current occupancy level. Such estimates include the fair value of leasing commissions, legal costs and tenant coordination costs that would be incurred to lease the property to this occupancy level. Additionally, the Company evaluates the time period over which such occupancy level would be achieved and includes an estimate of the net operating costs (primarily real estate taxes, insurance and utilities) incurred during the lease-up period, which generally ranges up to one year. The fair value of acquired in-place tenant leases is included in lease intangible assets on the condensed consolidated balance sheets and amortized over the remaining lease term for each tenant.

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Identifiable intangible assets and liabilities are calculated for above-market and below-market tenant and ground leases where the Company is either the lessor or the lessee. The difference between the contractual rental rates and the Company’s estimate of market rental rates is measured over a period equal to the remaining non-cancelable term of the leases, including significantly below-market renewal options for which exercise of the renewal option appears to be reasonably assured. Above-market tenant leases and below-market ground leases are included in lease intangible assets on the condensed consolidated balance sheets; below-market tenant leases and above-market ground leases are included in accounts payable, accrued expenses and other liabilities on the condensed consolidated balance sheets.  The values assigned to above-market and below-market tenant leases are amortized as reductions and increases, respectively, to base rental revenue over the remaining term of the respective leases.  The values assigned to below-market and above-market ground leases are amortized as increases and reductions, respectively, to property operating expenses over the remaining term of the respective leases.

The Company expenses transaction costs associated with business combinations in the period incurred.  These costs are included in acquisition-related expenses within the condensed consolidated statements of operations.

Real Estate Investments

Real estate assets are recorded at cost, less accumulated depreciation and amortization.

Expenditures for ordinary repairs and maintenance will be expensed as incurred.  Significant renovations which improve the property or extend the useful life of the assets are capitalized.  As real estate is undergoing redevelopment activities, all amounts directly associated with and attributable to the project, including planning, development and construction costs, interest costs, personnel costs of employees directly involved and other miscellaneous costs incurred during the period of redevelopment, are capitalized.  The capitalization period begins when redevelopment activities are underway and ends when the project is substantially complete.

Depreciation of real estate assets, excluding land, is recognized on a straight-line basis over their estimated useful lives as follows:

 

Building:

25 – 40 years

Site improvements:

5 – 15 years

Tenant improvements:

shorter of the estimated useful life or non-cancelable term of lease

The Company amortizes identified intangibles that have finite lives over the period they are expected to contribute directly or indirectly to the future cash flows of the property or business acquired, generally the remaining non-cancelable term of a related lease.

On a periodic basis, management assesses whether there are indicators that the value of the Company’s real estate assets (including any related intangible assets or liabilities) may be impaired.  If an indicator is identified, a real estate asset is considered impaired only if management’s estimate of current and projected operating cash flows (undiscounted and unleveraged), taking into account the anticipated and probability weighted holding period, are less than a real estate asset’s carrying value.  Various factors are considered in the estimation process, including expected future operating income, trends and prospects and the effects of demand, competition, and other economic factors.  If management determines that the carrying value of a real estate asset is impaired, a loss will be recorded for the excess of its carrying amount over its estimated fair value.  No such impairment losses were recognized for the three months ended September 30, 2016 or the period from July 7, 2015 (Date Operations Commenced) to September 30, 2015.  No such impairment losses were recognized for the nine months ended September 30, 2016.

Investments in Unconsolidated Joint Ventures

The Company accounts for its investments in unconsolidated joint ventures using the equity method of accounting as the Company exercises significant influence, but does not control these entities. These investments are initially recorded at cost and are subsequently adjusted for cash contributions, cash distributions, and earnings which are recognized in accordance with the terms of the applicable agreement.

On a periodic basis, management assesses whether there are indicators, including the operating performance of the underlying real estate and general market conditions, that the value of the Company’s investments in unconsolidated joint ventures may be impaired.  An investment’s value is impaired only if management’s estimate of the fair value of the Company’s investment is less than its carrying value and such difference is deemed to be other-than-temporary.  To the extent impairment has occurred, the loss is measured as the excess of the carrying amount of the investment over its estimated fair value.  No such impairment losses were recognized for the three months ended September 30, 2016 or the period from July 7, 2015 (Date Operations Commenced) to September 30, 2015.  No such impairment losses were recognized for nine months ended September 30, 2016.

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Cash and Cash Equivalents

The Company considers instruments with an original maturity of three months or less to be cash and cash equivalents. Cash and cash equivalents balances may, at a limited number of banks and financial institutions, exceed insurable amounts. The Company believes it mitigates this risk by investing in or through major financial institutions and primarily in funds that are insured by the United States federal government.

Restricted Cash

Restricted cash represents cash deposited in escrow accounts which generally can only be used for the payment of real estate taxes, debt service, insurance, and future capital expenditures as required by certain loan and lease agreements, as well as legally restricted tenant security deposits.  As of September 30, 2016, the Company had approximately $81.8 million of restricted cash, including $35.8 million related to future capital investments such as unfunded construction commitments, deferred maintenance and environmental reserves, $31.4 million related to basic property carrying costs such as real estate taxes, insurance and ground rent, and $14.6 million of prepaid rental income.

Tenant and Other Receivables

Accounts receivable includes unpaid amounts billed to tenants, accrued revenues for future billings to tenants for property expenses, and amounts arising from the straight-lining of rent.  The Company periodically reviews its receivables for collectability, taking into consideration changes in factors such as the tenant’s payment history, the financial condition of the tenant, business conditions in the industry in which the tenant operates, and economic conditions in the area where the property is located.  In the event that the collectability of a receivable with respect to any tenant is in doubt, a provision for uncollectible amounts will be established or a direct write-off of the specific rent receivable will be made.  For accrued rental revenues related to the straight-line method of reporting rental revenue, the Company performs a periodic review of receivable balances to assess the risk of uncollectible amounts and establish appropriate provisions.

Revenue Recognition

Rental income is recognized on a straight-line basis over the non-cancelable terms of the related leases.  For leases that have fixed and measurable rent escalations, the difference between such rental income earned and the cash rent due under the provisions of the lease is recorded as deferred rent receivable and included as a component of tenant and other receivables on the condensed consolidated balance sheets.

In leasing tenant space, the Company may provide funding to the lessee through a tenant allowance.  In accounting for a tenant allowance, the Company will determine whether the allowance represents funding for the construction of leasehold improvements and evaluate the ownership of such improvements.  If the Company is considered the owner of the improvements for accounting purposes, the Company will capitalize the amount of the tenant allowance and depreciate it over the shorter of the useful life of the improvements or the related lease term.  If the tenant allowance represents a payment for a purpose other than funding leasehold improvements, or in the event that the Company is not considered the owner of the improvements for accounting purposes, the allowance is considered to be a lease incentive and is recognized over the lease term as reduction of rental revenue on a straight-line basis.

The Company commences recognizing revenue based on an evaluation of a number of factors. In most cases, revenue recognition under a lease begins when the lessee takes possession of or controls the physical use of the leased asset.  Generally, this occurs on the lease commencement date.

Tenant reimbursement income arises from tenant leases which provide for the recovery of all or a portion of the operating expenses and real estate taxes of the respective property.  This revenue is accrued in the same periods as the expenses are incurred.

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Accounting for Recapture and Termination Activity Pursuant to the Master Lease

Seritage 100% Recapture Rights.  The Company generally treats the delivery of a 100% recapture notice as a modification of the Master Lease as of the date of notice.  Such a notice and lease modification result in the following accounting adjustments for the recaptured property:

Accrued rental revenues related to the straight-line method of reporting rental revenue that is deemed uncollectable as result of the lease modification is amortized over the remaining shortened life of the lease from the date of notice to the date of termination.

Intangible lease assets and liabilities that are deemed to be impacted by the lease modification are amortized over the shorter of the shortened lease term or the remaining useful life of the asset or liability.

A 100% recapture will generally occur in conjunction with obtaining a new tenant or a real estate development project.  As such, termination fees, if any, associated with the 100% recapture notice are generally capitalized as either an initial direct cost of obtaining a new lease or a necessary cost of the real estate project and depreciated over the life of the new lease obtained or the real estate asset being constructed or improved.

Seritage 50% Recapture Rights.  The Company generally treats the delivery of a 50% recapture notice as a modification of the Master Lease as of the date of notice.  Such a notice and lease modification result in the following accounting adjustments for the recaptured property:

The portion of accrued rental revenues related to the straight-line method of reporting rental revenue that is subject to the lease modification is amortized over the remaining shortened life of the lease from the date of notice to the date of termination.  The portion of accrued rental revenues related to the straight-line method of reporting rental revenue that is attributable to the retained space is amortized over the remaining life of the Master Lease.

The portion of intangible lease assets and liabilities that are deemed to be impacted by the lease modification is amortized over the shorter of the shortened lease term or the remaining useful life of the asset or liability.  The portion of intangible lease assets and liabilities that is attributable to the retained space is amortized over the remaining useful life of the asset or liability.

Sears Holdings Termination Rights.  The Master Lease provides Sears Holdings with certain rights to terminate the Master Lease with respect to properties that cease to be profitable for operation by Sears Holdings.  Such a termination would generally result in the following accounting adjustments for the terminated property:

Accrued rental revenues related to the straight-line method of reporting rental revenue that is subject to the termination is amortized over the remaining shortened life of the lease from the date of notice to the date of termination.

Intangible lease assets and liabilities that are deemed to be impacted by the termination are amortized over the shorter of the shortened lease term or the remaining useful life of the asset or liability.

Termination fees required to be paid by Sears Holdings are recognized as follows:

 

For the portion of the termination fee attributable to the annual base rent of the subject property, termination income is recognized on a straight-line basis over the shortened life of the lease from the date the termination fee becomes legally binding to the date of termination.

 

For the portion of the termination fee attributable to estimated real estate taxes and property operating expenses for the subject property, prepaid rental income is recorded in the period such fee is received and recognized as tenant reimbursement revenue in the same periods as the expenses are incurred.

Derivatives

The Company’s use of derivative instruments is limited to the management of interest rate exposure and not for speculative purposes.  In connection with the issuance of the Company’s mortgage loans, the Company purchased for $5.0 million an interest rate cap with a term of four years, a notional amount of $1.26 billion and a strike rate of 3.5%.  The interest rate cap is measured at fair value and included as a component of prepaid expenses, deferred expenses and other assets on the condensed consolidated balance sheets.  The Company has elected not to utilize hedge accounting, and therefore, the change in fair value is included within change in fair value of interest rate cap on the consolidated statements of operations.  For the three months ended September 30, 2016, the Company recorded a loss of $47 thousand related to the change in fair value of the interest rate cap compared to a loss of $2.8 million during the period from July 7, 2015 (Date Operations Commenced) to September 30, 2015.  For the nine months ended September 30, 2016, the Company recorded a loss of $1.9 million related to the change in fair value of the interest rate cap.

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Stock-Based Compensation

The Company generally recognizes equity awards to employees as compensation expense and includes such expense within general and administrative expenses on the condensed consolidated statements of operations.  Compensation expense for equity awards is generally based on the fair value of the common shares at the date of the grant and is recognized (i) ratably over the vesting period for awards with time-based vesting and (ii) for awards with performance-based vesting, at the date the achievement of performance criteria is deemed probable, an amount equal to that which would have been recognized ratably from the date of the grant through the date the achievement of performance criteria is deemed probable, and then ratably from the date the achievement of performance criteria is deemed probable through the remainder of the vesting period.

Concentration of Credit Risk

Concentrations of credit risk arise when a number of operators, tenants, or obligors related to the Company's investments are engaged in similar business activities, or activities in the same geographic region, or have similar economic features that would cause their ability to meet contractual obligations, including those to the Company, to be similarly affected by changes in economic conditions. As of September 30, 2016, substantially all of the Company's real estate properties were leased to Sears Holdings, and the majority of Company’s rental revenues were derived from the Master Lease (see Note 6).  Sears Holdings is a publicly traded company that is subject to the informational filing requirements of the Securities Exchange Act of 1934, as amended, and is required to file periodic reports on Form 10-K and Form 10-Q with the SEC.  Refer to www.sec.gov for Sears Holdings publicly-available financial information.

Other than the Company's tenant concentration, management believes the Company's portfolio was reasonably diversified by geographical location and did not contain any other significant concentrations of credit risk.  As of September 30, 2016, the Company's portfolio of 235 Wholly Owned Properties was diversified by location across 49 states and Puerto Rico.

Earnings per Share

The Company has three classes of common stock.  The rights, including the liquidation and dividend rights, of the holders of the Company’s Class A common shares and Class C non-voting common shares are identical, except with respect to voting. As the liquidation and dividend rights are identical, the undistributed earnings are allocated on a proportionate basis. The net earnings per share amounts are the same for Class A and Class C common shares because the holders of each class are legally entitled to equal per share distributions whether through dividends or in liquidation.  Class B non-economic common shares are excluded from earnings per share computations as they do not have economic rights.

All outstanding non-vested shares that contain non-forfeitable rights to dividends are considered participating securities and are included in computing earnings per share pursuant to the two-class method which specifies that all outstanding non-vested share-based payment awards that contain non-forfeitable rights to distributions are considered participating securities and should be included in the computation of earnings per share.

Recently Issued Accounting Pronouncements

In August 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments,” which is intended to address diversity in practice related to how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The amendments in ASU 2016-15 address eight specific cash flow issues as well as application of the predominance principle (dependence on predominant source or use of receipt or payment) and are effective for public business entities for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years with early adoption permitted.  The Company is currently evaluating the impact this amendment will have on its consolidated financial statements.

In March 2016, the FASB issued ASU 2016-09, “Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting,” which amends accounting for income taxes related to share-based compensation, the related classification in the statement of cash flows, and share award forfeiture accounting. The new guidance is effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. Early adoption is permitted. The Company is evaluating the impact of adopting this new accounting standard on its consolidated financial statements.

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In March 2016, the FASB issued ASU 2016-07, “Investments - Equity Method and Joint Ventures (Topic 323): Simplifying the Transition to the Equity Method of Accounting,” which eliminates the requirement to retroactively adjust an investment that subsequently qualifies for equity method accounting (as a result of an increase in level of ownership interest or degree of influence) as if the equity method of accounting had been applied during all prior periods that the investment was held. The new standard requires that the investor add the cost of acquiring additional ownership interest in the investee to its current basis and prospectively adopt the equity method of accounting. Any unrealized gains or losses in an available-for-sale investment that subsequently qualifies as an equity method investment should be recognized in earnings at the date the investment qualifies as an equity method investment. The new guidance is effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods and requires prospective adoption. Early adoption is permitted. The Company has evaluated the impact of this standard, and has concluded that it has no material impact on its consolidated financial statements.

In February 2016, the FASB issued Accounting Standards Codification (“ASC”) 842 (“ASC 842”), “Leases” which replaces the existing guidance in ASC 840, Leases.  ASC 842 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018.  ASC 842 requires a dual approach for lessee accounting under which a lessee would account for leases as finance leases or operating leases.  Both finance leases and operating leases will result in the lessee recognizing a right-of-use (ROU) asset and a corresponding lease liability.  For finance leases, the lessee would recognize interest expense and amortization of the ROU asset and for operating leases, the lessee would recognize a straight-line total lease expense.  The Company is currently assessing the impact that adoption of this guidance will have on its consolidated financial statements.

In February 2015, the FASB issued ASU 2015-02, “Amendments to the Consolidation Analysis,” which makes certain changes to both the variable interest model and the voting model, including changes to (1) the identification of variable interests (fees paid to a decision maker or service provider), (2) the variable interest entity characteristics for a limited partnership or similar entity and (3) the primary beneficiary determination.  The Company adopted ASU 2015-02 on January 1, 2016.  The adoption of this standard did not have a material impact on its consolidated financial statements.

In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers,” which outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance.  ASU 2014-09 states that “an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.”  While ASU 2014-09 specifically references contracts with customers, it may apply to certain other transactions such as the sale of real estate or equipment.  In July 2015, the FASB voted to defer the effective date of ASU 2014-09 by one year.  Accordingly, ASU 2014-09 is effective for annual periods beginning after December 15, 2017, with early adoption permitted for annual periods beginning after December 15, 2016.  The standard can be applied either retrospectively to each prior reporting period presented or as a cumulative-effect adjustment recognized as of the date of initial application.  The FASB has also issued the following standards which clarify ASU 2014-09 and have the same effective date as the original standard: ASU 2016-12, “Revenue from Contracts with Customers: Narrow-Scope Improvements and Practical Expedients,” and ASU 2016-10, “Revenue from Contracts with Customers: Identifying Performance Obligations and Licensing,” and ASU 2016-08, “Revenue from Contracts with Customers: Principal versus Agent Considerations (Reporting Revenue Gross versus Net).”  The Company is evaluating the impact of adopting these new accounting standards on its consolidated financial statements.

 

 

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Note 3 – Acquisitions

On July 7, 2015, the Company purchased the Wholly Owned Properties and JV Interests at their fair value for $2.7 billion, with the substantial majority of such properties being leased back to Sears Holdings.

The following table summarizes the final purchase price and fair values of the net assets acquired in the Transaction (in thousands):

 

Proceeds from issuance of common stock and non-controlling interest

 

 

 

 

 

$

1,644,042

 

Less: Offering related costs

 

 

 

 

 

 

(8,212

)

Proceeds from issuance of mortgage loans payable

 

 

 

 

 

 

1,161,196

 

Less: Deferred financing costs

 

 

 

 

 

 

(21,446

)

Total sources of funds net of offering and financing costs

 

 

 

 

 

 

2,775,580

 

 

 

 

 

 

 

 

 

 

Real estate assets acquired

 

 

 

 

 

 

 

 

Land

 

 

840,563

 

 

 

 

 

Buildings and improvements

 

 

810,499

 

 

 

 

 

Lease intangibles

 

 

 

 

 

 

 

 

In-place leases

 

 

595,443

 

 

 

 

 

Below-market ground lease

 

 

11,766

 

 

 

 

 

Above-market leases

 

 

9,058

 

 

 

 

 

Below-market leases

 

 

(20,045

)

 

 

 

 

Investments in unconsolidated joint ventures

 

 

429,012

 

 

 

 

 

Total fair value of real estate assets acquired

 

 

 

 

 

 

2,676,296

 

Plus: Restricted cash

 

 

 

 

 

 

 

 

Environmental expenses reserve

 

 

12,034

 

 

 

 

 

Deferred maintenance reserve

 

 

10,575

 

 

 

 

 

Total restricted cash

 

 

 

 

 

 

22,609

 

Less: Assumed liabilities

 

 

 

 

 

 

 

 

Real estate taxes payable

 

 

(23,277

)

 

 

 

 

Environmental expenses

 

 

(12,034

)