Spirit Realty Capital Inc (SRC) 2004 Q4 法說會逐字稿

Good day everyone and welcome to the Spirit Finance Corporation fourth quarter earnings release conference call.

[OPERATOR INSTRUCTIONS]

It is now my pleasure to turn the call over to your host, Ms. Cathy Long, Chief Financial Officer of Spirit Finance. Please go ahead.

Good afternoon. Thank you for joining us on our fourth quarter conference call. My name is Cathy Long. With me today is our co-founder, Chairman and CEO, Mort Fleischer and co-founder, President and COO, Chris Volk.

Before we begin I need to remind everyone that part of our discussion this afternoon will include forward-looking statements. They are not guarantees of future performance and therefore undo reliance should not be placed upon them. We refer all of you to our filings with the Securities and Exchange Commission for a more detailed discussion of the risks that may have a direct bearing on our operating results, performance and financial condition. And with that I'll pass the call to Mort.

Thank you Cathy and thanks to all of you for joining us today. We are pleased to be hosting our first conference call as a public company and would like to accomplish the following. I will begin with an overview of the fourth quarter and full year 2004. Cathy will provide a financial review of the year and guidance for 2005 and then Chris will offer an operational recap of our business and make some concluding comments before opening up the call to questions.

Let me begin with a brief history. Chris Volk and I started this company with a long-term vision to build shareholder value as we assist our customers with more efficient real estate capitalization strategies. We formed Spirit Finance to lower our customers' cost to capital by improving how they financed their operationally essential real estate assets.

We believe capitalization efficiency is the next significant frontier for the creation of incremental shareholder wealth for our customers and that through the selective acquisition of real estate, Spirit Finance can also generate attractive returns for our shareholders. While we were public less than 15 days before the 2004 fiscal year came to a close, our accomplishments and our progress for 2004 were significant.

In particular, the fourth quarter was quite productive and we are pleased to have concluded this initial phase of our transition from a private to a public company. In late December 2004, the company launched its initial public offering and listed Spirit Finance on the New York Stock Exchange.

We met our adjusted funds from operation per share expectations and also succeeded in accelerating our pace of acquisition closing just north of 200 million in the fourth quarter and close to 600 million for all of 2004. Since inception in late 2003 Spirit Finance has invested in 374 properties in 38 states, which were funded through initial equity proceeds, draws on a $250 million credit facility, the assumption of term debt and the use of interim seller financing. We anticipate that the equity capital raised in December together with our credit facility and long-term debt strategies will fuel Spirit's continued in growth in 2005.

Before turning the call to Cathy, let me briefly outline some of the major accomplishments in the past year. One, we raised 690 million in gross equity proceeds. Two, we invested 668 million in real estate properties. Three, we increased our team at Spirit from eight to 27 employees. Four, we declared dividends of $0.44 per share for our private investors. Five, we secured a $250 million credit facility. Six, and most importantly, we were profitable, generating over 13 million in funds for operation for 2004.

With that introduction I will turn the call back to Cathy Long, our Chief Financial Officer.

Thank you Mort. I'll start by providing a review of our fourth quarter and full year 2004 results and then I'll provide initial guidance for 2005. It's important to remember that Spirit Finance was organized in August 2003 with our first outside capital raised in December of that year.

Therefore the company doesn't have any significant comparative operating data. That said, today we reported fourth quarter FFO of 6.2 million and AFFO of six million for $0.15 per diluted share for each. Net income was 3.7 million or $0.09 per diluted share on revenues of 12.2 million.

The difference between AFFO and GAAP earnings this quarter consisted of depreciation and amortization of $2.5 million and straight line rent of $147,000. We've adopted a definition of FFO which is consistent with the NAREIT guidance, which states that FFO is net income computed in accordance with GAAP excluding any real estate related depreciation and amortization and gains or losses on the sale of portfolio assets. Our AFFO calculation also subtracts straight line rental revenue. We believe this is a better indicator of our results because it more closely reflects the cash rental payments received by the company.

For the full year, net income was $9 million or $0.24 per diluted share based on 37.7 million weighted average shares outstanding. Total revenues were 26.2 million for the year and FFO for 2004 was 13.6 million or $0.36 per diluted share. AFFO for 2004 was 13.3 million or $0.35 per diluted share.

Moving on to our balance sheet. On December 31, 2004, we had 782 million in total assets including $627 million in gross real estate investments and related lease intangibles, 41 million in mortgage loans receivable and $113 million in cash and cash equivalents.

On the liability side we had 179 million of mortgages and notes payable. Of that total $36 million is fixed rate secured term debt, $2.3 million is fixed rate unsecured debt and 140 million is variable rate seller financing. With our initial offering proceeds we paid down a line of credit. That 250 million credit facility continues to be available and will be used to fulfill a portion of our growth in 2005.

Subsequent to year-end we repaid the variable rate seller financing which totaled $140 million using cash and some new line advances on our credit facility. Concurrent with the repayment of the seller financing, we are transferring the notes and collateral to a new $125 million credit facility which we expect to use prior to placing our term debt in the second quarter. This facility offers Spirit continued capital flexibility which is important to our anticipated 2005 growth process.

During 2004, we invested nearly $600 million in 307 properties, including over $200 million of acquisitions in the fourth quarter. At year-end 2004, our real estate and mortgage loan portfolio totaled $668 million of investments in free standing retail, distribution and service oriented real estate representing 374 properties geographically diversified across 38 states.

The portfolio includes a broad array of retail distribution and service sector tenants. At year end, the three largest industries represented were restaurant properties 41%, movie theaters 17% and specialty and electronics retailer properties 13%. All of the properties we have are occupied and are current in their payments.

As of December 31, 2004, 91% of our real estate investment portfolio represented real estate we own and 6% represented mortgage loans secured by real estate. The weighted average maturity of the leases on our real estate was approximately 15 years at December 31, 2004. Only 3% of our lease portfolio will expire prior to 2012, resulting in a solid long-term cash flow from tenants.

The company's real estate portfolio was leased or financed to 49 companies with no individual credit exposure over 6.5% of the company's total investment. Approximately 45% of the portfolio was invested in properties leased to tenants who comprised less than 4% each of our current portfolio. As we continue to grow the existing tenant concentrations will become even smaller.

Now let me discuss our guidance for 2005. At this point in time we believe we will complete at least 800 million in real estate acquisitions during 2005. At the same time, we anticipate that the pace and timing of acquisitions will vary significantly quarter to quarter. We're building this company with a focus on producing growth over the long term, providing stable consistent cash flow. As we ramp up our acquisitions during 2005 FFO for the year per share is expected to grow 100% over 2004 by the end of the year.

Based on our acquisition projections, the expected ramp up throughout the year and our current outlook, we expect FFO per diluted share for 2005 to range from $0.70 to $0.75. Due to the significant ramp up in investment activity this year, we believe it's best to measure our performance based on our expected quarterly FFO run rate at the end of the year, which more closely reflects the stabilized earnings and leverage of the company.

At the end of 2005, taking into account our expected investment activity for the year, the FFO quarterly run rate is expected to be in the range of $0.23 to $0.26 per share. Our estimation of our 2005 investment activity potential results from the significant progress we made in 2004 and from our large pipeline of targeted investment opportunities. Chris will give you some further color on this investment potential.

Turning to our dividend policy, our most recent dividend declaration was $0.19 per share payable to stockholders of record on December 10 prior to the IPO which was paid on January 31, 2005. Management's goal is to continue to pay dividends at this level with future dividend increases addressed annually. The company expects to declare the next dividend on March 25. I'll now turn over the call to Chris Volk.

Thank you Cathy. 2004 was a successful year of transition for Spirit Finance that involved two steps. First was to insure that we had a strong scalable business model with the infrastructure in place to support our expected growth. And second to execute our strategic initiatives.

We expect by the end of 2005 we'll be able to report results that again demonstrate the capabilities of this company. With this in mind, Spirit today has a staff of 27 whose talents are further leveraged by outsourcing partners having considerable staff and resources. Currently, our G&A expense run rate is low relative to our peer group and we seek to maintain this operating cost efficiency as part of our strategy to offer competitive capital solutions for our customers.

The expectations of FFO include some new anticipated staff additions during the course of 2005. As you might expect staffing additions during 2004 included a focus on the business generation side of the company. The investment volume that we completed during 2004 was accomplished principally through our senior management team and one sales person.

We enter 2005 with a full time sales staff of five, of which four were added during the course of 2004. We expect this to contribute to our investment pipeline expansion during the year resulting from improved sector coverage. Our sales staff actively calls on companies, financial sponsors and developers through a target database we have compiled of more than 4,000 separate accounts.

The results of this activity began to be realized in 2004 with more than 90% of our fourth quarter acquisitions resulting from direct calling efforts or referrals. Today, our pipeline of close to $2.3 billion in opportunity targets, about two-thirds is derived from direct origination activity, 21% comes from real estate brokers and 10% comes from investment bank and financial advisors.

The average potential transaction size in our pipeline is $28 million with the largest potential being $150 million. Approximately a quarter of the potential represents investment grade targets, 20% BB rated companies and 55% B or unrated companies. And I should point out here that some of the unrated companies have extremely high credit profiles.

Finally, given the large size of the existing market place most of the investment potential we see is already in the ground. We should say that approximately 20% of the potential comes from newly built sites with a vast majority coming from existing real estate assets.

The profile of the companies in our targeted pipeline continues to span the credit spectrum. At the end of 2004 approximately 35% of our existing portfolio had a rating, with approximately 6% investment grade. Our customers typically have numerous choices for capital and have selected Spirit.

The current environment for net lease real estate acquisitions is competitive. Sometimes we might delay or walk away from opportunities if we feel the reward does not warrant the capital risk. There might also be some variation in quarterly results as we seek the best possible terms rather than close a transaction to meet the expectations for a particular quarter. As shareholders ourselves, management firmly believes this is the best way to build a long term equity value in this business.

Over the past year, one of the initiatives that we stated we would undertake would be to direct more of our investment activities towards investment grade companies. We believe Spirit's potential is bright with our current pipeline and investment mix. As such, larger investment grade opportunities have the potential for contributing further to our expected growth.

This year, we have been spending time crafting and submitting presentations to select larger investment grade companies, none of which are included on our current pipeline. Without getting into specifics, we believe the proposals that have been made are compelling and will help to meaningfully lower the cost of capital of our prospective clients.

This is accomplished by combining our cost of capital and operational structure with efficient leverage strategies to look to deliver competitively priced leased products. We are encouraged by our initial effort and have many more prospects lined up for the future.

The discussion of investment and pipeline credit profiles leads to an important point which is that Spirit's shareholders will not benefit from lease cap rates as much as they will benefit from the spreads between the leases and the cost of funding. As a result, any successes we have in 2005 with high credit quality companies will come in concert with lower lease rates but within an effort to meet targeted total rates of return. We have stated that our leveraged total shareholder return targets are in the neighborhood of 12%.

While Cathy has addressed our guidance for 2005 it's important to remember that this management team was successful in its past endeavors by evaluating opportunities on ROE basis and allocating its financial resources to create solid return opportunities for shareholders.

The liability strategies that we employ will vary based upon the investments we make in order to realize our desired returns. We will likely employ several approaches this year. First, as we did in 2004, we plan to make some investments that involve debt assumption. Second, we may take advantage of select one-off financings that are available through existing debt conduits for properties that fit certain physical and credit profiles.

Third, larger investment grade investments will likely occur in concert with discrete, tailored debt structures. Lastly, for the primary portion of our portfolio we plan to enter into term structured finance transactions with the first of these scheduled to occur during the second quarter of this year. In concert with this transaction we have entered into an agreement with a AAA rated mono-line insurer which we believe will improve transaction efficiency and broaden the company's access to term debt capital.

The warehouse credit lines that we have in place represent the final portion of our liability structure and are used to accumulate assets pending term financing. Our principal credit facility is with Banc of America Securities for $250 million. As Cathy noted, we're currently in the process of completing an additional $125 million short term credit facility with another major financial institution which will add to our 2005 corporate flexibility. Prior to term execution we used interest rate hedge strategies to help insulate us from term debt rate increases.

Before entering into questions and answers I wanted to highlight a few points that Mort and I believe are important. Number one, our balance sheet and cash flow generation remains strong and will enable us to fund our growth internally during 2005. Number two, we are highly aligned with shareholders and will continue to evaluate our initiatives on an ROE basis to commit capital to areas where the risk adjusted returns are attractive.

Number three, by the end of the year we expect to invested a minimum of $800 million but due to the uncertainty of closing on certain transactions the time will vary from quarter to quarter. Number four, we have created an efficient, scalable company that addresses a large $1 trillion market place and has the ability to transcend the tenant credit spectrum.

Number five, Spirit Finance employs a risk evaluation strategy that includes diversification by geography, industry and tenant, attention to credit fundamentals including the credit paradigm employed by management for more than a decade and independent real estate valuations.

Number six, we are building Spirit Finance to be a leader in efficient corporate capital real estate capitalization strategies in order to lower our customers cost of capital. In an era of heightened competition and globalization, we believe that our focus on capital efficiency is timely and is a frontier for unleashing corporate wealth and shareholder wealth in corporate America.

And finally, this company has limited lease rollovers over the next 10 years and our growth expectations are driven first from our current pipeline of investment opportunities and second where we see a compelling economics for our customers.

Through leadership and a culture of accountability, this company has solid foundation from which we can continue to build sustainable growth. We're enthusiastic about our business prospects for fiscal 2005 and beyond. Our performance in 2004 affirms the strength of our core strategies and we believe that by adhering to these strategies we will continue to gain market share and generate long term shareholder value. With that said, Operator, we can open the line for questions.

And today's question and answer session will be conducted electronically.

[OPERATORS INSTRUCTIONS]

We'll go first today to Ross Nussbaum with Banc of America Securities.

Good afternoon everyone. Chris you talked about the pipeline being 2.3 billion. Could you perhaps break that out between what's under letter of intent and what's under contract and what do you just under review of due diligence at this point?

Ross, the answer is that the pipeline that we have basically involves generally sharing of data. We're subject to confidentiality agreements with virtually all of it. It's in various stages ranging from assets that are closing to assets that are under commitment letters.

Generally speaking, we do not enter into purchase and sale agreements until we're almost on the doorstep of closing a transaction, which is the most definitive form of investment. So we're not offering a break down of the pipeline at this point in time.

OK. Can you give us some color on what's happened in January and February?

I should start here and say that what we're going to do during the course of this year is give you annual guidance on where we're going to be. Clearly, the quarterly numbers are going to vary, which we said. The pipeline is strong and we're encouraged by that and we're open to giving you more color on the pipeline.

As we do transactions that are significant, and keep in mind that our largest investment, right today with a client is about $43 million. So if transactions are about $50 million, our goal is today to issue press releases on those. And as we get larger in size we will increase that threshold over time. But going forward, we're not going to give guidance on - we're not going to give statements as to how much we've closed in every single individual quarter every month because that could be misleading and the last month of each quarter is highly volatile.

OK. Perhaps you could walk us through the timing of the fourth quarter acquisitions because obviously it plays a role in modeling out the numbers here. And then maybe give us some color in terms of types of tenants and cap rates on the deals.

For this last quarter?

On the fourth quarter numbers, yes.

Cathy do you have a ...

Yes. The fourth quarter numbers, Ross, many of the acquisitions were heavily weighted towards the end of December and that's not unusual in real estate transactions. So if you're modeling something out I would tend to think that the end of the quarter weighting is probably most appropriate.

So of the just over 200 million you did in the quarter you're saying the lion's share was in December?

That's correct.

OK. And then final question. I just want to make sure I understood this correctly. The debt, the 140 million of variable rate debt that you mentioned opening the call, you said that's been paid off with the new line and some cash?

That's correct.

OK. And that was all done after year end?

Correct.

OK. Thank you.

For our next question today we'll go to Jessica Tully (ph) with Credit Suisse First Boston.

Good afternoon. I was wondering if you could talk a little bit about of any variations in cap rates by property class? You know, restaurants versus movie theaters versus distribution centers?

And then also any just kind of broad cap rate variances by tenant quality?

Hi Jessica. This is Chris Volk and I will give you some color on this. And I'm going to start off just giving you some discussion on cap rates but then I'm going to really focus on the discussion on spreads.

If you look at the portfolio that we have today the pipeline of activity we have today our expected average cap rate on it is 8.75, but the median is 8.50. But that being said the low is about 7 and the high is close to 11, which are both of those being outliers of course.

The types of escalations on leases, which of course are important too, the average is about 1.7% and I think our current portfolio is kind of in the neighborhood of 150. All that being said you should know that the important thing is to focus on what the spread is going to be between the lease and our long term cost of debt. And as we look at some of the investment grade transactions or some specific transactions that may be suitable for commercial mortgage backed securities conduits.

We'll see those transactions being slightly higher levered than the other transactions with tighter spreads but bigger returns on equity, which is exactly how we intend to run this business.

OK. So there's not really in terms of different types of products, movie theaters, restaurants, there's not really that any significant variants that's typical?

There is some variance. I mean, what you tend to find as a rule of thumb and I'm going to be very generic here. But as a rule of thumb, the smaller the asset is oddly enough the tighter the spreads tend to be because the assets tend to be highly suitable for the 1031 market.

OK.

So that's just a rule of thumb. You don't always see that. But outside of that the lease rates will also vary to some degree by credit quality. You tend to find that the lease spreads are more efficient for investment grade companies than they are as you move down the credit spectrum. Because when you go down the credit spectrum the bid tends to be somewhat variant. And, again, you have the 1031 and there are market factors that can contribute to that.

Thank you.

Our next question today we'll go to Michael Bilerman with Smith Barney.

Good afternoon. I was wondering if you could go through the 800 million that you want to acquire in '05? Can you just walk me through the timing that's embedded in your 70 to 75 guidance?

Mike, the 800 million that we're looking at for 2005 is more heavily weighted to the back end of the year. We believe that second and fourth quarter will likely be the largest quarters. And December traditionally for real estate is the largest month of the year.

Now when I factor in, you know, for my expectations for FFO I assume that December acquisitions occur late in the month. And so I really don't have any impact on FFO for my December acquisitions, which is why I think it's important to focus on a run rate at the end of the year with the portfolio having a full quarter of revenue. Otherwise the fourth quarter of 2005 if a lot of the acquisitions are in December, you won't have any FFO impact at all from those acquisitions until the first quarter of '06.

And Mike, this is Chris. I mean, the models that we use here presume that every closing we have occurs on the last day of the each month. And of course the last month of each quarter tends to have the most in closings. And to Cathy's point, December being certainly the busiest month of the year, which I'd like to change that and in all the year's I've been doing this we can't change it.

December being the busiest month of the year, you don't get the impact of that at all. Which is why if you look at a fully deployed balance sheet and you're looking at a run rate and you're saying, we're in the neighborhood of $0.24, $0.26 a share on a run rate.

What that says, is that in 2006 on just a run rate FFO your FFO per share is up roughly 25% over 2005 without having made any acquisitions in 2006.And you're FFO per share this year and 2005 is up 100% over 2004.

Right. I can understand how you get to the 23 to 26 on a run rate. What I'm just trying to understand is just walking through the percentages each quarter of that 800 so that at least I can in my mindset understand how you build up the $0.70 to $0.75.

Mike, I don't have that information in front of me and maybe, you know, we could either talk off line or whatever. I just don't have that information in front of me, the exact percentages.

And how does this acquisition timing differ from what you were thinking about a couple of months ago during the IPO process?

I'd say it's not too terribly different. I mean it may be - I don't think it's that terribly different, Mike.

OK. It sounds like its much more back ended to me, but maybe that's just the way I'm thinking about it. In terms of your run rate FFO today, it's about $0.18 if you don't acquire anything?

Mike, we haven't computed the run rate FFO today. It's as if we hadn't acquired anything.

OK.

Got it mapped out, I mean, but we could certainly work on that but we have not done that.

Right. OK. In terms of the distribution facilities you bought in the fourth quarter from Hugh's (ph), can you walk me through what those assets are and how you think on a distribution facilities?

Sure. The Hugh's transaction was about $38 million. As you know, Hugh's is a BBB rated company and is a leader in distribution of plumbing and electrical supplies. And we acquired some of their distribution centers around the country. They've been growing pretty substantially through acquisitions.

The properties that we acquired were all appraised independently and what we did was acquired the properties for values really based upon their ability to be re rented at similar rent rates. So we're basically in at or south of replacement costs with run rates that are comparable to market at the time. So that makes us feel comfortable that if for some reason Hugh's is not - does not renew at some point we can re rent the property.

We find that the assets are fundable, which is something that Spirit looks for in its investments. And we think that it will be a good complement to the portfolio structured term transaction that we're going to put together later second quarter.

OK. In terms of the build-up during 2004 you obviously initially relied on some of the old FFCA investments and some of the WAMU (ph) loans that FFCA originated to sort of build your portfolio. Within your 2.3 billion, is there anything from GE or WAMUin there?

None.

OK. In terms of, a last question, just on G&A. What are you forecasting in your $0.70 to $0.75 in terms of G&A?

G&A for the year we're expecting to be around $12 million.

Twelve million. And actually just one other, just on the term financing you want to do in the second quarter. What are you anticipating in terms of size and rates?

I would say that the size will range between $300 to 400 million and the rate will be in the neighborhood of 6%.

Then do you expect at that point to take whatever's out on your line and fund any acquisition phase?

That's correct.

I guess because if you don't know how much you would have acquired by then? Because I guess you don't have it in front of you?

The answer is that we've not - we have not - we're not giving quarterly guidance. So if I tell you that we're going to do it in May, and say this is exactly how many transactions we're going to have under contract - I will say in principal that what we want to do is not necessarily time it perfectly. Ideally in theory you would just you would have all the properties lined up and you wouldn't have any cash sitting on your balance sheet.

If there's some cash sitting on our balance sheet for a short term period of time that's what we're going to do. We're not in the business of taking interest rate risks. We're in the business of trying to lock in long term spreads.

And you had locked in 235 million back in October, right?

That's correct.

What rate was that locked in at?

That's 4.17 on a 10 year. And, you know, it - today the 10 year treasury is at 4.38, roughly, and if you look between the time we got started with this company at the end of, the beginning of 2003 and really we start at the end of 2003 in terms of investing, the 10 year is really in the middle of where it has been.

But the interesting thing is the yield curve has flattened over the long term. So the short end of the term has come up and the long term has been able to stay in kind of the range where it has been, which in a way we think is going to also help us long term from a competitive strategy as we talk to companies who are looking for efficient sources of financing when you have a flat yield curve like that.

Right. I appreciate all your time. Thanks.

Thanks, Mike.

We'd like to remind everyone if you do have a question press star one on your touchtone phone. We'll go now to Chris George (ph) with Omega Advisors.

Hi. My question's been asked and answered. Or I should say, asked but not answered.

And at this time we have no further questions in the queue. Gentlemen, I'll turn the call back to you for closing remarks.

Let me say that we very much appreciate all of your confidence. This is Mort. I want to say that we've been very encouraged by the prospects that Spirit has. We've been more particularly encouraged by our ability to start talking to some larger companies. I'm not going to give a lot of color to that, but we've been working very hard on talking to larger companies.

We've been working very hard to determine where there are real holes in the market that work and practice. And I think we're beginning to discover more of that. And I think you'll start to see more results from us as the year goes along, and our ability to add efficient capitalization.

This is a concept of using real estate as a financial tool that nobody's been able to figure out how to unlock the safe. We at Spirit are absolutely determined to figure out how we can show our customer how a sale lease back is not just a real estate transaction, but a sale lease back is another financing mechanism which will help them add value and we're making progress.

We thank you very much for your confidence.

And this does conclude our conference call for today. We do appreciate your participation. You may disconnect at this time.