Retail Value Inc. - Quarter Report: 2019 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

For the quarterly period ended March 31, 2019

OR

For the transition period from                  to                  

Commission file number 1-38517

RETAIL VALUE INC.

(Exact name of registrant as specified in its charter)

   3300 Enterprise Parkway

          Beachwood, OH 44122

(Address of principal executive offices)                (Zip Code)

Registrant’s telephone number, including area code:   (216) 755-5500

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 every Interactive Data File required to be submitted 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 such files).    Yes  ☒    No  ☐

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

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☒

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

Securities registered pursuant to Section 12(b) of the Act:

As of May 1, 2019, the registrant had 19,043,024 shares of common stock, $0.10 par value per share, outstanding.

Retail Value Inc.

QUARTERLY REPORT ON FORM 10-Q

QUARTER ENDED March 31, 2019

TABLE OF CONTENTS

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Retail Value Inc.

CONSOLIDATED BALANCE SHEETS

(unaudited, in thousands, except share amounts)  

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

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Retail Value Inc.

COMBINED AND CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(unaudited, in thousands, except per share amounts)

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

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Retail Value Inc.

COMBINED AND CONSOLIDATED STATEMENTS OF EQUITY

(unaudited, in thousands)

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

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Retail Value Inc.

COMBINED AND CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited, in thousands)

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

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Notes to Combined and Consolidated Financial Statements

On July 1, 2018, SITE Centers Corp., formerly known as DDR Corp. (“SITE Centers” or the “Manager”), completed the separation of Retail Value Inc., an Ohio corporation formed in December 2017 that owned and operated a portfolio of 48 real estate assets at the time of the separation that included 36 continental U.S. assets and 12 Puerto Rico assets (collectively, “RVI” the “RVI Predecessor” or the “Company”), into an independent public company.  At March 31, 2019, RVI owned 35 properties that included 23 continental U.S. assets and 12 Puerto Rico assets comprising 13 million square feet of gross leasable area (“GLA”) and located in 14 states and Puerto Rico.

In connection with the separation from SITE Centers, on July 1, 2018, the Company and SITE Centers entered into a separation and distribution agreement (the “Separation and Distribution Agreement”) pursuant to which, among other things, SITE Centers agreed to transfer properties and certain related assets, liabilities and obligations to RVI, and to distribute 100% of the outstanding common shares of RVI to holders of record of SITE Centers’ common shares as of the close of business on June 26, 2018, the record date.  On July 1, 2018, holders of SITE Centers’ common shares received one common share of RVI for every ten shares of SITE Centers’ common stock held on the record date.  In connection with the separation from SITE Centers, SITE Centers retained 1,000 shares of RVI’s series A preferred stock having an aggregate dividend preference equal to $190 million, which amount may increase by up to an additional $10 million depending on the amount of aggregate gross proceeds generated by RVI asset sales.

On July 1, 2018, the Company and SITE Centers also entered into an external management agreement (the “External Management Agreement”) which, together with various property management agreements, governs the fees, terms and conditions pursuant to which SITE Centers manages RVI and its properties.  SITE Centers provides RVI with day-to-day management, subject to supervision and certain discretionary limits and authorities granted by the RVI Board of Directors.  The Company does not have any employees.  In general, either SITE Centers or RVI may terminate the management agreements on December 31, 2019, or at the end of any six-month renewal period thereafter.  SITE Centers and RVI also entered into a tax matters agreement that governs the rights and responsibilities of the parties following RVI’s separation from SITE Centers with respect to various tax matters, and provides for the allocation of tax-related assets, liabilities and obligations.

Principles of Consolidation

The Company

For periods after July 1, 2018, the consolidated financial statements include the results of the Company and all entities in which the Company has a controlling interest.  All significant inter-company balances and transactions have been eliminated in consolidation.

RVI Predecessor

For periods prior to July 1, 2018, the accompanying historical condensed combined financial statements and related notes of the Company do not represent the statement of operations and cash flows of a legal entity, but rather a combination of entities under common control that have been “carved-out” of SITE Centers’ consolidated financial statements in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”).  All inter-company transactions and balances have been eliminated in combination.  The preparation of these combined financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the dates of the combined financial statements and the reported amounts of revenues and expenses during the reporting periods.  Actual results could differ from those estimates.

For periods prior to July 1, 2018, these combined financial statements reflect the revenues and direct expenses of the RVI Predecessor and include material assets and liabilities of SITE Centers that are specifically attributable to the Company.  RVI Predecessor equity in these combined financial statements represents the excess of total assets over total liabilities.  RVI Predecessor equity is impacted by contributions from and distributions to SITE Centers, which are the result of treasury activities and net funding provided by or distributed to SITE Centers prior to the separation from SITE Centers, as well as the allocated costs and expenses described below.  The combined financial statements also include the consolidated results of certain of the Company’s wholly-owned subsidiaries, as applicable.  All significant inter-company balances and transactions have been eliminated in consolidation.

For periods prior to July 1, 2018, the combined financial statements include certain direct costs historically paid by the properties but contracted through SITE Centers, including but not limited to, management fees, insurance, compensation costs and

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out-of-pocket expenses directly related to the management of the properties (Note 11).  Further, the combined financial statements include an allocation of indirect costs and expenses incurred by SITE Centers related to the Company, primarily consisting of compensation and other general and administrative costs that have been allocated using the relative percentage of property revenue of the Company and SITE Centers’ management’s knowledge of the Company.  In addition, the combined financial statements include an allocation of interest expense on SITE Centers’ unsecured debt, excluding debt that is specifically attributable to the Company; interest expense was allocated by calculating the unencumbered net assets of each property held by the Company as a percentage of SITE Centers’ total consolidated unencumbered net assets and multiplying that percentage by the interest expense on SITE Centers unsecured debt.  The amounts allocated in the accompanying combined financial statements are not necessarily indicative of the actual amount of such indirect expenses that would have been recorded had the RVI Predecessor been a separate independent entity.  SITE Centers believes the assumptions underlying SITE Centers’ allocation of indirect expenses are reasonable.

Use of Estimates in Preparation of Financial Statements

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities and the reported amounts of revenues and expenses during the year.  Actual results could differ from those estimates.  

Reclassifications

Certain amounts in prior periods have been reclassified in order to conform with the current period’s presentation.  The Company reclassified $2.7 million of contractual lease payments from Other Income to Rental Income within total revenues on its combined statement of operations for the three months ended March 31, 2018, in connection with the adoption of Accounting Standards Update (“ASU”) No. 2016-02—Leases, as amended (“Topic 842”), as discussed below.

Rental Income

Rental Income on the combined and consolidated statements of operations includes contractual lease payments that generally include the following:

Upon adoption of Topic 842, Rental Income for the periods beginning on or after January 1, 2019, has been reduced for amounts the Company believes are not probable of being collected.  Rental income is recognized on a straight-line basis over the lease term. Rental income is not recognized when collection is not reasonably assured as the customer is placed on non-accrual status and rental income is recognized as cash payments are received.  

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Statements of Cash Flows and Supplemental Disclosure of Non-Cash Investing and Financing Information

Non-cash investing and financing activities are summarized as follows (in millions):

New Accounting Standard Adopted

Accounting for Leases

The Company adopted Topic 842 as of January 1, 2019, using the modified retrospective approach by applying the transition provisions at the beginning of the period of adoption.  The Company elected the following practical expedients permitted under the transition guidance within the new standard:

The Company did not adopt the practical expedient to use hindsight in determining the lease term.

The Company made the following accounting policy elections as a lessor in connection with the adoption:

The adoption of the standard impacted the Company’s consolidated financial statements as follows:

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The adoption of the new standard also resulted in various presentation changes in the Company’s consolidated statements of operations.  The Company aggregated the following components of contractual lease payments into one line item referred to as Rental Income:  Minimum Rents, Percentage and Overage Rents, Recoveries from Tenants, Ancillary Income and Lease Termination Fees.  The prior period presentation was conformed to the current period presentation for comparability related to these revenue components.  In addition, effective January 1, 2019, the Company presents bad debt as a component of Rental Income within Revenues.  For prior periods, bad debt expense is included in Operating and Maintenance Expenses.  In addition, effective January 1, 2019, the Company no longer records real estate taxes paid by major tenants directly to the applicable governmental authority.  For prior periods, these amounts are included in Recoveries from Tenants and Real Estate Taxes.  All of the aforementioned presentation changes had no impact on consolidated net income or consolidated cash flows.

New Accounting Standard to Be Adopted

Accounting for Credit Losses

In June 2016, the Financial Accounting Standards Board (the “FASB”) issued an amendment on measurement of credit losses on financial assets held by a reporting entity at each reporting date (ASU 2016-13, Financial Instruments – Credit Losses).  The guidance requires the use of a new current expected credit loss ("CECL") model in estimating allowances for doubtful accounts with respect to accounts receivable, straight-line rents receivable and notes receivable.  The CECL model requires that the Company estimate its lifetime expected credit loss with respect to these receivables and record allowances that, when deducted from the balance of the receivables, represent the estimated net amounts expected to be collected.  This guidance is effective for fiscal years, and for interim reporting periods within those fiscal years, beginning after December 15, 2019.  In November 2018, the FASB issued ASU 2018-19 to clarify that operating lease receivables recorded by lessors are explicitly excluded from the scope of Topic 326.  The Company is in the process of evaluating the impact of this guidance.

Other Assets, Net on the Company’s consolidated balance sheets consists of the following (in thousands):

Lessee

The Company is engaged in the operation of shopping centers that are either owned or, with respect to certain shopping centers, operated under long-term ground leases that expire at various dates through 2033.  The Company determines if an arrangement is a lease at inception.  

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ROU assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent the Company’s obligation to make lease payments arising from the lease.  Operating lease ROU assets and liabilities are recognized at the commencement date based on the present value of lease payments over the term of the lease.  As most of the Company’s leases do not include an implicit rate, the Company used its incremental borrowing rate based on the information available at the commencement date of the standard in determining the present value of lease payments.  For each lease, the Company utilized a market-based approach to estimate the incremental borrowing rate (“IBRs”), which required significant judgment.  The Company estimated base IBRs based on an analysis of (i) yields on comparable companies, (ii) observable mortgage rates and (iii) unlevered property yields and discount rates.  The Company applied adjustments to the base IBRs to account for full collateralization and lease term.  Operating lease ROU assets also include any lease payments made.  The Company has options to extend certain of the ground leases; however, these options were not considered as part of the lease term when calculating the lease liability as they were not reasonably certain to be exercised.  Lease expense for lease payments is recognized on a straight-line basis over the lease term.  

Operating lease ROU assets and operating lease liabilities are in the Company’s consolidated balance sheets as follows (in thousands):

Operating lease expenses are included in Operating and Maintenance Expense for the Company’s ground leases and aggregated $0.1 million for the three months ended March 31, 2019.  Supplemental information related to leases was as follows:

As determined under FASB Accounting Standards Codification (“ASC”) 840, Leases, the scheduled future minimum rental revenues from rental properties under the terms of all non-cancelable tenant leases, assuming no new or renegotiated leases or option extensions for such premises, and the scheduled minimum rental payments under the terms of all non-cancelable operating leases, principally ground leases, in which the Company is the lessee as of December 31, 2018, were as follows (in thousands):

As determined under Topic 842, maturities of lease liabilities were as follows for the years ended March 31, (in thousands):

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Lessor

Space in the shopping centers is leased to tenants pursuant to agreements that provide for terms generally ranging from one month to 30 years and for rents which, in some cases, are subject to upward adjustments based on operating expense levels, sales volume or contractual increases as defined in the lease agreements.  

The scheduled future minimum rental revenues from rental properties under the terms of all non-cancelable tenant leases, assuming no new or renegotiated leases or option extensions, as determined under Topic 842 for such premises for the years ending March 31, were as follows (in thousands):

The Company maintains a Credit Agreement (the “Revolving Credit Agreement”) with PNC Bank, National Association, as lender and administrative agent (“PNC”).  The Revolving Credit Agreement provides for borrowings of up to $30.0 million.  Borrowings under the Revolving Credit Agreement may be used by the Company for general corporate purposes and working capital.  The Company’s borrowings under the Revolving Credit Agreement bear interest at variable rates at the Company’s election, based on either (i) LIBOR plus a specified spread ranging from 1.05% to 1.50% depending on the Company’s Leverage Ratio (as defined in the Revolving Credit Agreement) or (ii) the Alternate Base Rate (as defined in the Revolving Credit Agreement) plus a specified spread ranging from 0.05% to 0.50% depending on the Company’s Leverage Ratio.  The Company is also required to pay a facility fee on the aggregate revolving commitments at a rate per annum that ranges from 0.15% to 0.30% depending on the Company’s Leverage Ratio.

The Revolving Credit Agreement matures on the earliest to occur of (i) March 9, 2021, (ii) the date on which the External Management Agreement is terminated, (iii) the date on which DDR Asset Management, LLC or another wholly-owned subsidiary of SITE Centers ceases to be the “Service Provider” under the External Management Agreement as a result of assignment or operation of law or otherwise and (iv) the date on which the principal amount outstanding under the Company’s mortgage loan is repaid or refinanced (Note 7).

The Company’s obligations under the Revolving Credit Agreement are guaranteed by SITE Centers in favor of PNC.  In consideration thereof, on July 2, 2018, the Company entered into a guaranty fee and reimbursement letter agreement with SITE Centers pursuant to which the Company has agreed to pay to SITE Centers the following amounts: (i) an annual guaranty commitment fee of 0.20% of the aggregate commitments under the Revolving Credit Agreement, (ii) for all times other than those referenced in clause (iii) below, when any amounts are outstanding under the Revolving Credit Agreement, an amount equal to 5.00% per annum times the average aggregate outstanding daily principal amount of such loans plus the aggregate stated average daily amount of outstanding letters of credit and (iii) in the event SITE Centers pays any amounts to PNC pursuant to SITE Centers’ guaranty (credit facility guaranty fee) and the Company fails to reimburse SITE Centers for such amount within three business days, an amount in cash equal to the amount of such paid obligations plus default interest which will accrue from the date of such payment by SITE Centers until repaid by the Company at a rate per annum equal to the sum of the LIBOR rate plus 8.50%.  

At March 31, 2019, there were no amounts outstanding under the Revolving Credit Agreement.

On March 11, 2019, certain wholly-owned subsidiaries of the Company entered into a mortgage loan with an initial aggregate principal amount of $900 million.  Substantially all proceeds from the mortgage loan were used to refinance and prepay all amounts outstanding under the Company’s February 2018 mortgage loan in the original aggregate principal amount of $1.35 billion. The borrowers’ obligations are evidenced by promissory notes which are secured by, among other things: (i) mortgages encumbering the borrowers’ properties located in the continental U.S. (which comprise substantially all of the Company’s properties located in the continental U.S.) and Plaza Del Sol located in Bayamon, Puerto Rico (collectively, the “Mortgaged Properties”); (ii) a pledge of the

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equity of the Company’s subsidiaries that own each of the Company’s properties located in Puerto Rico (collectively, the “Pledged Properties”) and a pledge of related rents and other cash flows, insurance proceeds and condemnation awards; and (iii) a pledge of any reserves and accounts of any borrower.

The loan facility will mature on March 9, 2021, subject to three one-year extensions at borrowers’ option based on certain conditions of the agreement.  The initial weighted-average interest rate applicable to the notes is equal to one-month LIBOR plus a spread of 2.30% per annum, provided that such spread is subject to an increase of 0.25% per annum in connection with any exercise of the third extension option.  Application of voluntary prepayments as described below will cause the weighted-average interest rate to increase over time.

The loan facility is structured as an interest only loan throughout the initial two-year term and any exercised extension options. As a result, so long as the borrowers maintain a minimum debt yield of 10% with respect to the Mortgaged Properties and no event of default exists, any property cash flows available following payment of debt service and funding of certain required reserve accounts (including reserves for payment of real estate taxes, insurance premiums, ground rents, tenant improvements and capital expenditures), will be available to the borrowers to pay operating expenses and for other general corporate purposes. The debt yield with respect to the Mortgages Properties was 12.8% as of March 31, 2019.

Subject to certain conditions described in the mortgage loan agreement, the borrowers may prepay principal amounts outstanding under the loan facility in whole or in part by providing (i) advance notice of prepayment to the lenders and (ii) remitting the prepayment premium described in the mortgage loan agreement. No prepayment premium is required with respect to any prepayments made after April 9, 2020. Additionally, no prepayment premium will apply to prepayments made in connection with permitted property sales. Each Mortgaged Property has a portion of the original principal amount of the mortgage loan allocated to it. The amount of proceeds from the sale of an individual Mortgaged Property required to be applied towards prepayment of the notes (i.e., the property’s “release price”), will depend upon the principal amount of the mortgage loan allocated to it and the debt yield at the time of the sale.  All proceeds for the sales of Pledged Properties other than Plaza Del Sol are required to be applied towards prepayment of the notes.

Voluntary prepayments made by the borrowers will be applied to tranches of notes (i) absent an event of default, in descending order of seniority (i.e., such prepayments will first be applied to the most senior tranches of notes) and (ii) following any event of default, in such order as the loan servicer determines in its sole discretion. As a result, the Company expects that the weighted average interest rate of the notes will increase during the term of the loan facility.

In the event of a default, the contract rate of interest on the notes will increase to the lesser of (i) the maximum rate allowed by law or (ii) the greater of (A) 4% above the interest rate otherwise applicable and (B) the Prime Rate (as defined in the mortgage loan) plus 1.0%. The notes contain other terms and provisions that are customary for instruments of this nature. The mortgage loan agreement also includes customary events of default, including among others, principal and interest payment defaults and breaches of affirmative or negative covenants, the mortgage loan agreement does not contain any financial maintenance covenants.

In connection with the refinancing, the Company incurred $20.2 million of aggregate financing costs which included a $1.8 million debt financing fee paid to SITE Centers.  This refinancing was treated as a loan modification versus a debt extinguishment pursuant to the applicable accounting guidance.  As a result, only the portion of the financing costs incurred related to the new lender group was capitalized.  The remaining financing costs not capitalized as a loan cost were recorded as debt extinguishment costs in the consolidated statement of operations along with the write-off of an allocation of the related unamortized deferred financing costs aggregating $12.7 million.

The following methods and assumptions were used by the Company in estimating fair value disclosures of financial instruments:

Cash and Cash Equivalents, Restricted Cash, Accounts Receivable and Accounts Payable and Other Liabilities

The carrying amounts reported in the Company’s combined and consolidated balance sheets for these financial instruments approximated fair value because of their short-term maturities.

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Debt

The fair market value of debt is estimated using a discounted cash flow technique that incorporates future contractual interest and principal payments and a market interest yield curve with adjustments for duration, optionality and risk profile, including the Company’s non-performance risk and loan to value and is classified as Level 3 in the fair value hierarchy.

Considerable judgment is necessary to develop estimated fair values of financial instruments.  Accordingly, the estimates presented are not necessarily indicative of the amounts the Company could realize on disposition of the financial instruments. The carrying amount of debt is $873.7 million and $967.6 million at March 31, 2019 and December 31, 2018, respectively.  The fair value of debt is $900.0 million and $1,016.1 million at March 31, 2019 and December 31, 2018, respectively.  

Interest Rate Cap

In March 2018, the Company entered into an interest rate cap in connection with entering into the mortgage loan, which was terminated with the new mortgage financing (Note 7).  At December 31, 2018, the notional amount of the interest rate cap was $1.0 billion.  The fair value of the interest rate cap was $1.2 million at December 31, 2018, and was included in Other Assets.  In March 2019, in connection with the mortgage refinancing, the Company received $0.3 million upon final settlement.  

Hurricane Loss

In 2017, Hurricane Maria made landfall in Puerto Rico.  At March 31, 2019, the Company owned 12 assets in Puerto Rico, aggregating 4.4 million square feet of Company-owned GLA.  One of the 12 assets (Plaza Palma Real, consisting of approximately 0.4 million of Company-owned GLA) was severely damaged in Hurricane Maria.  At March 31, 2019, three anchor tenants and a few other tenants totaling 0.2 million square feet were open for business approximating 55% of Plaza Palma Real’s Company-owned GLA.  The other 11 assets sustained varying degrees of damage, consisting primarily of roof and HVAC system damage and water intrusion.  Although some of the tenant spaces remain untenantable, a majority of the Company’s leased space that was open prior to the storm was open for business by mid 2018.

The Company has engaged various consultants to assist with the damage scoping assessment.  The Company continues to work with its consultants to finalize the scope and schedule of work to be performed.  Restoration work is underway at all of the shopping centers, including Plaza Palma Real.  The Company anticipates that the repair and restoration work will be substantially complete by the end of 2019 with certain interior work being completed in 2020.  The timing and schedule of additional repair work to be completed are highly dependent upon any changes in the scope of work, the availability of building materials, supplies and skilled labor and the timing and amount of proceeds recovered under the Company’s insurance claims.

The Company maintains insurance on its assets in Puerto Rico with policy limits of approximately $330 million for both property damage and business interruption.  The Company’s insurance policies are subject to various terms and conditions, including a combined property damage and business interruption deductible of approximately $6.0 million.  The Company expects that its insurance for property damage and business interruption claims will include the costs to clean up, repair and rebuild the properties, as well as lost revenue.  Certain continental U.S.-based anchor tenants maintain their own property insurance on their Company-owned premises and are expected to make the required repairs to their stores.  The Company is unable to estimate the impact of potential increased costs associated with resource constraints in Puerto Rico relating to building materials, supplies and labor.  The Company believes it maintains adequate insurance coverage on each of its properties and is in active communication with the insurer with respect to the resolution of its claims.  The insurer has reserved its rights with respect to certain aspects of coverage, and it is possible that the Company’s cost to repair the damages sustained may substantially exceed the amount the Company is ultimately able to recover from the insurer.  

As of March 31, 2019, the estimated net book value of the property written off for damage to the Company’s Puerto Rico assets was $78.8 million.  However, the Company continues to assess the impact of the hurricane on its properties, and the final net book value write-offs could vary significantly from this estimate.  Any changes to this estimate will be recorded in the periods in which they are determined.

The Company’s Property Insurance Receivable was $16.0 million and $29.4 million at March 31, 2019 and December 31, 2018, respectively, which represents estimated insurance recoveries related to the net book value of the property damage written off, as well as other expenses, as the Company believes it is probable that the insurance recovery, net of the deductible, will exceed the net book value of the damaged property.  This receivable reflects payments aggregating $63.9 million made by the insurer through March 31, 2019.  The outstanding receivable is recorded as Property Insurance Receivable on the Company’s consolidated balance sheet as of

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March 31, 2019.  The Company received $13.8 million for the three months ended March 31, 2019 toward its property insurance claim.

The Company’s business interruption insurance covers lost revenue through the period of property restoration and for up to 365 days following completion of restoration. For the three months ended March 31, 2019 and March 31, 2018, rental revenues of $1.6 million and $3.8 million, respectively, were not recorded because of lost tenant revenue attributable to Hurricane Maria that has been partially defrayed by insurance proceeds.  The Company will record revenue for covered business interruption in the period it determines that it is probable it will be compensated and all the applicable contingencies with the insurance company have been resolved.  This income recognition criteria will likely result in business interruption insurance proceeds being recorded in a period subsequent to the period that the Company experiences lost revenue from the damaged properties.  For the three months ended March 31, 2018, the Company received insurance proceeds of approximately $2.0 million related to business interruption claims, which is recorded on the Company’s combined and consolidated statements of operations as Business Interruption Income.   

Pursuant to the terms of the Separation and Distribution Agreement in connection with the separation from SITE Centers, SITE Centers will be entitled to property damage insurance claim proceeds for unreimbursed restoration costs incurred through June 30, 2018, as well as business interruption losses for the same period.  Business interruption proceeds will continue to be recorded to revenue in the period that it is determined that SITE Centers will be compensated and all applicable contingencies with the insurer have been resolved.  

Legal Matters

The Company and its subsidiaries are subject to various legal proceedings, which, taken together, are not expected to have a material adverse effect on the Company.  The Company is also subject to a variety of legal actions for personal injury or property damage arising in the ordinary course of its business, most of which are covered by insurance.  While the resolution of all matters cannot be predicted with certainty, management believes that the final outcome of such legal proceedings and claims will not have a material adverse effect on the Company’s liquidity, financial position or results of operations.  

Impairment charges were recorded on assets based on the difference between the carrying value of the assets and the estimated fair market value.  These impairments primarily were triggered by indicative bids received and changes in market assumptions due to the disposition process.

Items Measured at Fair Value on a Non-Recurring Basis

The valuation of impaired real estate assets and investments is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each asset, as well as the income capitalization approach considering prevailing market capitalization rates, analysis of recent comparable sales transactions, actual sales negotiations and bona fide purchase offers received from third parties.  In general, the Company considers multiple valuation techniques when measuring fair value of real estate.  However, in certain circumstances, a single valuation technique may be appropriate.

For operational real estate assets, the significant assumptions included the capitalization rate used in the income capitalization valuation, as well as the projected property net operating income.  These valuation adjustments were calculated based on market conditions and assumptions made by SITE Centers or the Company at the time the valuation adjustments and impairments were recorded, which may differ materially from actual results if market conditions or the underlying assumptions change.

The following table presents information about the Company’s impairment charges on nonfinancial assets that were measured on a fair-value basis for the three months ended March 31, 2019.  The table also indicates the fair value hierarchy of the valuation techniques used by the Company to determine such fair value (in millions).

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The following table presents quantitative information about the significant unobservable inputs used by the Company to determine the fair value of non-recurring items (in millions):

The following table presents fees and other amounts charged by SITE Centers (in thousands):

As of March 31, 2019 and December 31, 2018, the Company had amounts payable to SITE Centers of $34.1 million and $34.0 million, respectively.  The amounts are included as Payables to SITE Centers on the consolidated balance sheets and primarily represent amounts owed to SITE Centers for restricted cash escrows held by the mortgage lender at the time of the Company’s separation from SITE Centers.

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12.Earnings Per Share

The following table provides the net loss and the number of common shares used in the computations of “basic” earnings per share (“EPS”), which utilizes the weighted-average number of common shares outstanding, and “diluted” EPS (in thousands, except per share amounts):  

Dividends

In December 2018, the Company declared a 2018 dividend on its common shares of $1.30 per share that was paid in a combination of cash and the Company’s common shares, subject to a Puerto Rico withholding tax of 10%.  The aggregate amount of cash paid to shareholders was limited to 20% of the total dividend paid.  In connection with the 2018 dividend, in January 2019, the Company issued 578,238 common shares, based on the volume-weighted average trading price of $29.8547 per share, and paid $6.7 million in cash, which includes the Puerto Rico withholding tax.

13.Segment Information

The Company has two reportable operating segments: continental U.S. and Puerto Rico.  The table below presents information about the Company’s reportable operating segments (in thousands):

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14.Subsequent Events

From April 1, 2019 to May 7, 2019, the Company sold one shopping center, Mariner Square in Spring Hill, Florida, for $17.0 million.  Net proceeds were primarily used to repay mortgage debt outstanding.

Restricted cash of $46.8 million generated from two asset sales was used to repay mortgage debt in April 2019.

In April 2019, the Company received $10.0 million from the insurer with respect to its Hurricane Maria property insurance claim.

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Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) provides readers with a perspective from management on the financial condition, results of operations and liquidity of Retail Value Inc. and its related consolidated real estate subsidiaries (collectively, the “Company” or “RVI”) (NYSE: RVI) and other factors that may affect the Company’s future results.  The Company believes it is important to read the MD&A in conjunction with its Annual Report on Form 10-K for the year ended December 31, 2018, as well as other publicly available information.

RVI is an Ohio company formed in December 2017 that, as of March 31, 2019, owned and operated a portfolio of 35 assets, composed of 23 continental U.S. assets and 12 assets in Puerto Rico.  These properties consisted of retail shopping centers composed of 13 million square feet of Company-owned gross leasable area (“GLA”) and were located in 14 states and Puerto Rico.  The Company’s continental U.S. assets comprised 60% and the properties in Puerto Rico comprised 40% of its total consolidated revenue for the three months ended March 31, 2019.  The Company’s centers have a diverse tenant base that includes national retailers such as Walmart/Sam’s Club, Bed, Bath & Beyond, the TJX Companies (T.J. Maxx, Marshalls and HomeGoods), Best Buy, Gap, PetSmart, Ross Stores, Kohl’s, Dick’s Sporting Goods and Michaels.  At March 31, 2019, the aggregate occupancy of the Company’s shopping center portfolio was 88.4%, and the average annualized base rent per occupied square foot was $15.63.  Prior to the Company’s separation on July 1, 2018, the Company was a wholly-owned subsidiary of SITE Centers Corp., formerly known as DDR Corp. (“SITE Centers” or the “Parent Company”).

Unless otherwise expressly stated or the context otherwise requires, in the case of information as of dates or for periods prior to the Company’s separation from SITE Centers, references to the “Company” and the “RVI Predecessor” refer to the combined and consolidated entities of SITE Centers that owned the assets comprising the Company’s portfolio as of July 1, 2018, assuming that such entities owned only the assets comprising the Company’s portfolio as of July 1, 2018.

Executive Summary

In order to consummate the Company’s separation from SITE Centers, on July 1, 2018, the Company and SITE Centers entered into a separation and distribution agreement (the “Separation and Distribution Agreement”), pursuant to which, among other things, SITE Centers agreed to transfer properties and certain related assets, liabilities and obligations to RVI and to distribute 100% of the outstanding common shares of RVI to holders of record of SITE Centers’ common shares as of the close of business on June 26, 2018, the record date.  On July 1, 2018, the separation date, holders of SITE Centers’ common shares received one common share of RVI for every ten shares of SITE Centers’ common stock held on the record date.  In connection with the separation, SITE Centers retained 1,000 shares of RVI’s series A preferred stock (the “RVI Preferred Shares”) having an aggregate dividend preference equal to $190 million, which amount may increase by up to an additional $10 million depending on the amount of aggregate gross proceeds generated by RVI asset sales.

In March 2019, the Company entered into a mortgage loan in the aggregate principal amount of $900 million in order to refinance and prepay all amounts outstanding under its February 2018 mortgage loan, which had an original principal balance of $1.35 billion.  The Company incurred costs of $20.2 million in connection with the financing, which includes a $1.8 million debt financing fee paid to SITE Centers.  

The Company expects to focus on realizing value in its portfolio through operations and sales of its assets.  The Company primarily intends to use net asset sale proceeds first to repay mortgage debt, second to make distributions on account of the RVI Preferred Shares, up to the preference amount, and third to make distribution to holders of the Company’s preferred and common shareholders.  In addition, pursuant to the Separation and Distribution Agreement, and subject to maintaining its status as a Real Estate Investment Trust (“REIT”), the Company has agreed to repay to SITE Centers certain cash balances held in restricted accounts on the separation date in connection with the original mortgage loan.  The Company has agreed to pay these amounts to SITE Centers as soon as reasonably possible out of its operating cash flow but in no event later than March 31, 2020.

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From January 1, 2019 through March 31, 2019, the Company sold the following assets (in thousands):

Manager

The Company is party to an external management agreement (the “External Management Agreement”), which, together with various property management agreements, governs the fees, terms and conditions pursuant to which SITE Centers serves as the Company’s manager.  The Company does not have any employees.  In general, either the Company or SITE Centers may terminate these management agreements on December 31, 2019, or at the end of any six-month renewal period thereafter.  

Pursuant to the External Management Agreement, the Company pays SITE Centers and certain of its subsidiaries a monthly asset management fee in an aggregate amount of 0.5% per annum of the gross asset value of the Company’s properties (calculated in accordance with the terms of the External Management Agreement).  The External Management Agreement also provides for the reimbursement of certain expenses incurred by SITE Centers in connection with the services it provides to the Company along with the payment of transaction-based fees to SITE Centers in the event of any debt financings or change of control transactions.

Pursuant to the property management agreements, the Company pays SITE Centers and certain of its subsidiaries a monthly property management fee in an aggregate amount of 3.5% and 5.5% of the gross revenue (as calculated in accordance with the terms of the property management agreements) of the Company’s continental U.S. properties and the Puerto Rico properties, respectively, on a monthly basis.  The property management agreements also provide for the payment to SITE Centers of certain leasing commissions and financing fees and a disposition fee of 1% of the gross sale price of each asset sold by the Company.

RESULTS OF OPERATIONS

Where used, references to “Comparable Portfolio Properties” reflect shopping center properties owned as of March 31, 2019.

Revenues from Operations (in thousands)

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The following table summarizes the key components of the 2019 rental income as compared to 2018:

The decrease in base and percentage rental income primarily is due to the disposition of assets as noted in (D) below.  The decrease in the occupancy rate primarily was due to a combination of anchor store tenant expirations and tenant bankruptcies.  The 2018 occupancy rate reflects the impact of unabsorbed vacancy related to Toys “R” Us/Babies “R” Us locations rejected in the retailer’s bankruptcy proceeding in 2018, other bankruptcies and lower occupancy rates within the Puerto Rico portfolio, partially offset by new leasing activity and the sale of assets with a lower occupancy rate versus the portfolio average.

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Expenses from Operations (in thousands)

The decrease in real estate taxes for the Comparable Portfolio Properties is a result of the adoption of Topic 842.

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Other Income and Expenses (in thousands)

Interest costs capitalized in conjunction with capital projects were $0.3 million for the three months ended March 31, 2019, compared to $0.1 million for the comparable period in 2018.  The change in the amount of interest costs capitalized is a result of the restoration work in Puerto Rico.

Tax expense and Net Loss (in thousands)

NON-GAAP FINANCIAL MEASURES

Funds from Operations and Operating Funds from Operations

Definition and Basis of Presentation

The Company believes that Funds from Operations, or FFO, and Operating FFO, both non-GAAP financial measures, provide additional and useful means to assess the financial performance of REITs.  FFO and Operating FFO are frequently used by the real estate industry, as well as securities analysts, investors and other interested parties, to evaluate the performance of REITs.  The Company also believes that FFO and Operating FFO more appropriately measure the core operations of the Company and provide benchmarks to its peer group.

In December 2018, the National Association of Real Estate Investment Trusts (“NAREIT”) issued NAREIT Funds From Operations White Paper - 2018 Restatement (the “2018 FFO White Paper”).  The purpose of the 2018 FFO White Paper was not to change the fundamental definition of FFO but to clarify existing guidance and to consolidate into a single document, alerts and policy bulletins issued by NAREIT since the last FFO white paper was issued in 2002.  The 2018 FFO White Paper was effective starting

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with first quarter 2019 reporting.  The Company did not report any changes in the calculation of FFO in 2019 related to the clarification in the 2018 FFO White Paper.

FFO excludes GAAP historical cost depreciation and amortization of real estate and real estate investments, which assume that the value of real estate assets diminishes ratably over time.  Historically, however, real estate values have risen or fallen with market conditions, and many companies use different depreciable lives and methods.  Because FFO excludes depreciation and amortization unique to real estate and gains and losses from property dispositions, it can provide a performance measure that, when compared year over year, reflects the impact on operations from trends in occupancy rates, rental rates, operating costs, interest costs and acquisition, disposition and development activities.  This provides a perspective of the Company’s financial performance not immediately apparent from net income determined in accordance with GAAP.

FFO is generally defined and calculated by the Company as net income (loss) (computed in accordance with GAAP), adjusted to exclude (i) gains and losses from disposition of real estate property and related investments, which are presented net of taxes, if any, (ii) impairment charges on real estate property and related investments and (iii) certain non-cash items.  These non-cash items principally include real property depreciation and amortization of intangibles.  The Company’s calculation of FFO is consistent with the definition of FFO provided by NAREIT.

The Company believes that certain charges and income recorded in its operating results are not comparable or reflective of its core operating performance.  Operating FFO is useful to investors as the Company removes non-comparable charges and income to analyze the results of its operations and assess performance of the core operating real estate portfolio.  As a result, the Company also computes Operating FFO and discusses it with the users of its financial statements, in addition to other measures such as net income (loss) determined in accordance with GAAP and FFO.  Operating FFO is generally defined and calculated by the Company as FFO excluding certain charges and gains that management believes are not comparable and indicative of the results of the Company’s operating real estate portfolio.  Such adjustments include gains/losses on the early extinguishment of debt, net hurricane-related activity, transaction costs and other restructuring type costs.  The disclosure of these charges and income is generally requested by users of the Company’s financial statements.  

The adjustment for these charges and income may not be comparable to how other REITs or real estate companies calculate their results of operations, and the Company’s calculation of Operating FFO differs from NAREIT’s definition of FFO.  Additionally, the Company provides no assurances that these charges and income are non-recurring.  These charges and income could be reasonably expected to recur in future results of operations.

These measures of performance are used by the Company for several business purposes and by other REITs.  The Company uses FFO and/or Operating FFO in part (i) as a disclosure to improve the understanding of the Company’s operating results among the investing public, (ii) as a measure of a real estate asset’s performance and (iii) to compare the Company’s performance to that of other publicly traded shopping center REITs.

For the reasons described above, management believes that FFO and Operating FFO provide the Company and investors with an important indicator of the Company’s operating performance.  They provide recognized measures of performance other than GAAP net income, which may include non-cash items (often significant).  Other real estate companies may calculate FFO and Operating FFO in a different manner.

The Company’s management recognizes the limitations of FFO and Operating FFO when compared to GAAP’s net income.  FFO and Operating FFO do not represent amounts available for dividends, capital replacement or expansion, debt service obligations or other commitments and uncertainties.  The Company’s management does not use FFO or Operating FFO as an indicator of the Company’s cash obligations and funding requirements for future commitments or redevelopment activities.  Neither FFO nor Operating FFO represents cash generated from operating activities in accordance with GAAP, and neither is necessarily indicative of cash available to fund cash needs.  Neither FFO nor Operating FFO should be considered an alternative to net income computed in accordance with GAAP or as an alternative to cash flow as a measure of liquidity.  FFO and Operating FFO are simply used as additional indicators of the Company’s operating performance.  The Company believes that to further understand its performance, FFO and Operating FFO should be compared with the Company’s reported net loss and considered in addition to cash flows determined in accordance with GAAP, as presented in its combined and consolidated financial statements.  Reconciliations of these measures to their most directly comparable GAAP measure of net loss have been provided below.

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Reconciliation Presentation

FFO and Operating FFO were as follows (in thousands):

The increase in FFO primarily was a result of debt extinguishment charges and transaction costs incurred in connection with the Company’s mortgage loan in 2018, partially offset by the dilutive impact from the disposition of assets.  The decrease in Operating FFO primarily was due to the dilution of asset sales.

The Company’s reconciliation of net loss to FFO and Operating FFO is as follows (in thousands).  The Company provides no assurances that these charges and income adjusted in the calculation of Operating FFO are non-recurring.  These charges and income could reasonably be expected to recur in future results of operations.