Spirit Realty Capital Inc (SRC) 2005 Q3 法說會逐字稿

Good day, and welcome to the Spirit Finance Corporation Third Quarter Earnings Release Conference Call.

At this time all participants have been placed in a listen-only mode and the floor will be open for your questions following the presentation.

It is now my pleasure to turn the floor over to your host, Cathy Long, Chief Financial Officer of Spirit Finance.

Please go ahead.

Good afternoon. Thank you for joining us on our third quarter conference call.

I am Cathy Long, Chief Financial Officer of Spirit Finance. Along with me on today's conference call from Spirit is Mort Fleischer, Chairman; and Chris Volk, President and Chief Executive Officer.

Before we begin, I need to remind everyone that part of our discussion this afternoon will include forward-looking statements. They're not guarantees of future performance and therefore undue reliance should not 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 conditions.

And with that, I will pass the call to Mort.

Thank you, Cathy.

And thanks to all of you for joining us today on our conference call to discuss our third quarter results.

The format for today's call will be as follows. I'll provide some introductory comments, then Cathy will review our financial performance for the quarter, as well as our guidance for 2005. Chris will then discuss operations and make some additional remarks. Following our prepared remarks we'll be happy to address any questions that you may have.

I will let Cathy and Chris comment on the specifics of the third quarter, but I want to start off by saying that we are very excited about our third quarter results and the momentum that we've built for the future.

Going into the first quarter we were almost 80% of the way towards reaching our minimum target investment goal of 800 million for the year. At the same time, our third quarter FFO per diluted share was 50% above prior year levels for the same period.

Your patience while we built our foundation has been appreciated.

In view of management and the board of directors of Spirit, our momentum permitted us to evaluate a dividend increase for the end of the year, so we were pleased to announce today that we are planning to raise the fourth quarter dividend by 10.5% to $0.21 per share. This is consistent with our stated intent of annually assessing dividend levels.

With this brief opening remark, I'll turn the call back to Cathy.

Thank you, Mort.

I'll start by providing a review of our third quarter, then I'll provide an update on our real estate portfolio and review our guidance for the remainder of 2005.

For the third quarter we reported FFO of 11.9 million or $0.18 per diluted share, an AFFO of 11.6 million or $0.17 per diluted share.

Net income was 6.7 million or $0.10 per diluted share on revenues of $23.5 million, including revenues classified as discontinued operations, which I'll discuss in a moment.

The difference between AFFO and GAAP earnings for this quarter consisted of depreciation and amortization of $5.7 million, a $442,000 net gain on the sale of properties, and straight line rent adjustment of $299,000.

As you may recall, we raised our first outside capital in December 2003 and we're in the early ramp-up phase of the company during the first nine months of 2004. We reported 2004 third quarter FFO and AFFO of 4.7 million, which both equated to $0.12 per diluted share.

Net income was $3.2 million or $0.09 per diluted share on revenues of 8.2 million, including revenues classified as discontinued operations.

As a reminder, our 2005 diluted earnings per share are based on the weighted average number of shares outstanding of 67.5 million, which includes approximately 30 million shares that were issued in our IPO in December of 2004.

Turning to our balance sheet of September 30, 2005, we had 1.3 billion in total assets, including 1.2 billion in gross real estate investments, including the related lease intangibles, 59 million in mortgage and equipment notes, and 48 million in cash and cash equivalents.

From a liability perspective, we had 674 million in debt, including 637 million in long-term fixed rate debt, and 37 million outstanding on our variable rate secured credit facility.

We believe that our policy of strong asset and liability matching positions Spirit well for future moves in long-term interest rates, whatever they may be. Approximately three-fourths of our assets are match funded with long-term debt. Since the second quarter ended, we entered into a $200 million secured credit facility with Citigroup, and today finalized a $200 million credit facility with Credit Suisse, bringing our total credit line capacity to $400 million.

These new facilities replaced the 375 million in credit facilities that expired during the third quarter. Also, during the fourth quarter of this year we expect this 400 million of credit facility capacity to increase to 500 million with the addition of another $100 million credit facility from Citigroup.

As part of our strategy to match fund fixed rate assets with fixed rate liabilities, we also use interest rate swaps to manage our interest rate risk on long-term debt we expect to issue in 2006, which will replace our short-term borrowing.

In the third quarter we financed or acquired 131 properties totaling approximately $276 million. We further broadened our real estate investments and were pleased with how rapidly we're diversifying our asset base. We continue to acquire properties across many asset classes. Chris will elaborate on this and some of our third quarter transactions during his remarks.

As we grow, we intend to further diversify our purchases into additional property types, geographic areas and tenants in order to decrease our risk in any one area.

Our current gross real estate and mortgage loan portfolio is diversified geographically across 39 states, spread among retail, distribution, and service-oriented property types. The largest concentration of our real estate investments is in the restaurant segment, consisting of 406 properties owned or financed and totaling 32% of our gross portfolio value.

The second largest property type is movie theatres, consisting of 19 properties and reflecting 13% of our total portfolio.

And the third largest property type consists of 31 specialty retail properties, comprising 11% of the total portfolio's value.

Since the beginning of the year we've sold 39 properties with a gross investment value of $59 million for a net gain of $669,000. However, consistent with our definition of FFO, this gain is excluded from FFO. These properties were sold in order to replace assets that do not meet our long-term investment objectives with assets that provide better long-term stability.

These occasional sales are a normal part of our long-term business strategy of acquiring a diversified real estate investment portfolio. Because we intend to replace the properties sold, cash flows from future operations are only impacted to the extent there would be a significant delay in replacing the investment.

Under current accounting rules we're required to report the operating results of our sold properties and the gains and losses on these sales of discontinued operations. This classification has no impact on reported cash flow, net income, FFO, or with the reinvestment of the proceeds, or expectations of future revenues.

Generally, our properties are leased under long-term, triple-net lease arrangements, the weighted average maturity of the non-cancelable portion of our leases is 14.3 years, providing stable, long-term cash flows. Less than 5% of our lease portfolio will expire prior to the year 2013. Our leases have either scheduled rent escalations, which give rise to the straight line rent adjustment, or contingent rent escalations based on future changes in the Consumer Price Index or a percentage of the lessee's gross sales.

Contingent rent escalations are recognized in revenue only when the contingency is removed.

Turning to credit, I am pleased to report that our disciplined underwriting, along with our financing strategy, has positioned us well with a strong real estate portfolio. Through September 30th all of our properties are occupied and are current in their monthly lease and loan payments. Furthermore, our returns on the 1.2 billion in assets are basically locked in over the term of the lease, most for 15 years, as we have match-funded approximately 74% of these assets.

Our real estate portfolio is leased or financed to 94 companies with no single credit exposure greater than 6.5% of our total investment.

Our ten largest customers comprise 39% of our total dollar amount of our portfolio, down from 43% at June 30, 2005, and down from 55% at December 31st of last year. As we continue to grow, we anticipate that existing tenant concentrations will become even smaller.

Now I'll turn to our earnings guidance. As many of you know, it's not our policy to provide quarterly earnings guidance. We continue to be comfortable with our annual investment target, and our recent record investment activity supports this.

In addition, we have held to our targeted equity total rates of return in the vicinity of 12%. Management continues to expect FFO per diluted share for 2005 to range from $0.67 to $0.70 per share.

With that said, the timing of closing on real estate transactions varies significantly from quarter to quarter with many transactions expected to close at the end of the fourth quarter, which we'll expect will only modestly impact our results for this year.

In addition, the persistently flat yield curve impacts the spreads related to properties positioned on our short-term credit lines, which are tied to LIBOR. Here spreads have fallen costing as much as 150 to 200 basis points since the beginning of 2005 on our short-term borrowing.

We anticipate that such spreads can be recovered to traditional ranges when and if the yield curve reverts to more historic steep patterns.

Assuming the company closes at least 800 million of acquisitions by the end of 2005, it would represent an increase of 34% over the level of fiscal year 2004 investment activity.

Our pipeline remains strong, and we have a large variety of transactions to consider. In the fourth quarter we expect to close between 175 and 250 million. But again, it may have minimal contribution to fourth quarter results as we expect most transactions to close towards the end of the quarter.

We've discussed this before, but I feel it's important to mention again, from a timing perspective, based on our historical results, most transactions contribute to our revenue and FFO the quarter after they close. This we do not expect to change. Consequently the way to think about the company is by looking at our run rate to better understand the embedded value we're creating.

Taking into account the expected investment activity for the remainder of this year, the FFO quarterly run rate for the portfolio we expect to be in place at December 31st is expected to range from $0.23 to $0.24 per diluted share.

Now I'll turn the call over to Chris to discuss operations and some of our third quarter transactions.

Thank you, Cathy.

We're pleased to have announced closing over $1.3 billion in sale/leaseback transactions and mortgage loans since we've began purchasing real estate assets in December of 2003.

We absolutely believe that we're helping our clients increase their equity returns by on-point sale/leaseback capital as a financial tool. We are encouraged that more companies and corporate shareholders are beginning to appreciate the benefits of leasing rather than owning passive real estate assets and that we can help them to lower their cost of capital and to create shareholder wealth.

As Cathy said, we closed on just under $276 million in acquisitions during the third quarter.

As importantly, we made tremendous progress in our efforts to diversify our efforts across industries, property types, and tenants. During the third quarter we invested in 131 assets that were leased to 33 tenants, and of those tenants, 24 were new to Spirit.

Our third quarter industry diversification included restaurants, 32%; movie theatres, 13%; specialty retailer properties, 11%; and educational facilities, 10%.

The weighted average base current cash yield approximated 8.2%, that excludes percentage rents with percentage rents as probably more like 8.4, and that was in line with our expectations during last quarter's conference call.

On average, the leases had annual expected escalations around 1.5%, which will provide Spirit with further growth as we head into 2006 and beyond. Our relationship management staff originated almost 90% of the transactions, and of that amount, about a third of the sellers were represented by financial advisers. Just over 10% of our third quarter business came in through brokerage relationships.

Today we have six relationship managers who are dedicated to serving specific industry tenant groups. Many of these relationship managers joined us in 2005, and we expect to realize the benefits of Spirit's growing investment in its sales team going forward, although this is in addition to business development efforts of Jeff Fleischer and the rest of the senior management team.

While there isn't enough time to go through each transaction that we completed during the first quarter, I want to touch upon a few of the largest.

We previously announced a $53.1 million sale/leaseback with Main Event for their six entertainment/restaurant facilities, of which four are located in and around Dallas, Texas; one is located off of I45 in Conroe, Texas; and one is located on U.S. Highway 183 in Austin, Texas.

This 20-year sale/leaseback transaction was simultaneously closed with efficient long-term commercial mortgage-backed securities financing. Main Event is a successful seven-year-old Dallas-based company that offers 60,000 square foot facility of combined dining, with bowling, laser tag, rock climbing and other indoor entertainment.

Secondly, we closed on seven Carmike Cinemas in Colorado, North Carolina, South Carolina, and Texas for $31.9 million. The theatres are all-seasoned and reside within some of Carmike's most penetrated markets. The theatres have 99 screens and average ten years in age. We acquired the theatres subject to existing leases which have just over 15 years remaining.

Carmike is the nation's second largest theatre chain by theatre count and the third largest by screen count. As of June, 2005 the company operated 311 theatres in 37 states with 2,471 screens.

Finally, we purchased 55 sale/leaseback assets from GE Franchise Finance. The assets included properties leased to 17 tenants included such concepts as Burger King and Pizza Hut, Fazoli's, Golden Corral, and Applebee's. The sites are seasoned and proven locations that were generally familiar to our leadership team. The dollar amount on that was 55 million --

Yep.

-- roughly, which was not on my script, I apologize.

Our confidence level remains high that we can accomplish our acquisition goals in 2005. Our pipeline of potential investment continues to range from 1.5 to $2 billion in opportunity targets. As Cathy stated, we are currently targeting between 175 and $250 million for the final quarter of the year.

I'll give you some overall pipeline statistics. We're evaluating 89 investment opportunities with an average investment size of about 18 million bucks. The weighted average year-one yield approximates 8.7%, which is close to the 8.5% guidance we've offered for the year. The median yield is closer to 8.6 since some of the larger transactions have lower year-one yields.

The yield ranges from a low of approximately 7% to a high of about 10%. The pipeline is across 14 principal sectors, with the largest continuing to be restaurants. About 2% of the pipeline has investment-grade ratings, 3% is double B or higher, that will be plus or higher; however, many of the unrated companies are just simply not rated and they're quite financially strong.

And I should also say that we have made and will make proposals to invest in great companies where we believe we can help management with more efficient capital structures.

None of these targeted companies are included within the pipeline. The pipeline is comprised of defined investment opportunities only.

During the third quarter we declined transactions totaling over 1.2 billion. Major reasons cited are credit quality, investor return issues or collateral. During that same time we lost out on almost $1.1 billion in business mostly due to low cap rates in the marketplace. So basically we walked away from $2.3 billion in potential business. Or one more way to think about it is that we're booking about 10% of the transactions we evaluate.

Our current pipeline is approximately 50% source from direct origination activity, 25% from real estate brokers, and about a quarter from investment bank and financial advisers. And we think this puts us far above our competitors in terms of generating internal leads (ph). Again, remember our market's very vast with more than 97% of the business being generated from already constructed operating real estate assets, while 3% is new development. The profile of the companies where our targeted pipeline continues to span the entire credit spectrum.

At the end of the third quarter our customer credit profile was mostly unchanged from the second quarter of 2005. About 50% of our existing portfolio is rated, about 12% of our existing portfolio has an investment grade or equivalent from at least one nationally recognized credit rating agency. Our customers typically have numerous choices for capital and they have selected Spirit.

As Cathy mentioned, we expect Q4 investments will be in the range of 175 to $250 million, which we are really encouraged by. And on the fourth quarter worth up to $250 million in investments positions to be very comfortable with our initial investment guidance.

Some words on the expected Q4 activity. During the fourth quarter we may have as many as 25 transactions that we close with the weighted average year-one cash-on-cash yield of 8.85%, in the range of 7.6 to 10%.

Over 90% of the transactions will likely be slated for Spirit term funding, or in other funding sources as opposed to CMBS funding, which provides us with an efficient cost of execution and more flexibility.

The largest transaction will be nearly $45 million for the largest sector being restaurants.

Investments slated for the Spirit term funding would entail the interim use of our credit lines. Our internal pricing discipline will continue to focus on transaction FFO impact and the ability to match-fund lease cash flows and the achievement at the targeted internal rates of return.

While flat yield curve has cost us as much as 150 to 200 basis points in spread on the assets we hold, pending term debt execution, we continue to be focused on our long-term returns, which we believe remain very attractive.

Before we open the call up for questions, I'd like to discuss some of the meaningful capital markets initiatives that we have undertaken both in the third quarter and at the beginning of this quarter.

During the third quarter we completed Spirit Master Funding, our own net-lease conduit that is a ground-breaking transaction in terms of our corporate flexibility and the flexibility we can permit for our net-lease customers.

Secondly, we lined up $400 million in new credit lines, which are priced within the lines that we had expiring during the third quarter.

Third, we are in the process of closing an additional $100 million credit facility that will effectively give Spirit up to $250 million in added investment capacity. This will prevent (ph) Spirit to access capital markets with a less diluted impact to shareholders going forward.

Fourth, we expect to file a shelf registration later in the year as we become shelf-eligible. This is going to further add to Spirit's financial flexibility.

And lastly, we'll continue to hedge our warehouse investments in order to lock into attractive long-term equity spreads. At the end of the third quarter Spirit was highly match-funded with long-term liabilities and assets funded on lines with hedges in place.

We have a strong and flexible balance sheet and believe that our investment and liability management strategies are positioning us to be an industry leader. We are able to combine our cost of capital and operational structure with efficient leverage strategies to deliver competitively priced lease products.

The management team of Spirit has worked together through a variety of interest rate and economic cycles. We continue to believe that the corporate capital markets strongly favor our treasury solutions as a means to reduce corporate America's cost of capital. We look towards the future with excitement regarding our investment and asset management strategies and are constantly evaluating new and creative strategies to add value to our customers and shareholders. We, as shareholders, believe that our future is bright and as the needs of corporate America for efficient capital will create meaningful opportunities for us.

With that said, Operator, I would like to open the line for questions.

Thank you.

(Operator instructions.)

One moment while we assemble our roster.

(Operator instructions.)

We'll go first to Ken Avalos with Raymond James.

Go ahead, please.

Good afternoon, guys.

I was hoping -- and I know it's hard for you to comment on the pipeline a ton, but I was hoping you could give us an idea of what type of credit industry trade line might be represented at the low end of that cap rate range that you quoted and at the high end. Thanks.

Ken, this is Chris, and I'll work on this and Mort will, I hope as well.

I think that there is no one industry that just represents the lowest end of the cap rate line. To the extent that people are focused on cap rates that are not investment-grade companies, by the way, because the investment-grade companies will tend to have lower cap rates, those will tend to be transactions where we're competing effectively with the 1031 or tick markets. Those cap rates tend to be ideally suited to just simply smaller assets. So they could be restaurant assets, they could be drugstore assets, they could be grocery store assets. It just really spans the spectrum.

Our view of this is that while we will lose business to these marketplaces, that Spirit effectively creates a lot more value-added solutions than most of these types of owners because we're long-term holders of the assets, and as such, we can create leases that are much more flexible for our tenants. Our view of the flexibility that we can create is that it's worth about 200 basis points, and that's just in sort of lost opportunity costs. And for companies that are looking for maximizing how they operate going forward, we think that Spirit represents a better solution.

Thanks.

Can you talk a little bit -- and I apologize, I'm just not real familiar with the Main Event Entertainment, et cetera. Can you just talk a little bit about their competitive position versus a Dave & Busters in the local market out there in Texas?

Dave -- well, Main Event is an entertainment or an entertainment facility. So it combines restaurants with bowling, laser tag, video games, and rock climbing. The company does compete with some companies like Dave & Buster's or Jillian's. They've competed very effectively as a privately-held company that has done a terrific job and has a strong management team.

The properties that we financed were financed through the commercial mortgage-backed securities market, which is a little unusual for restaurant properties because restaurant properties typically don't get financed readily into the CMBS market. The reason we were able to do that is because the properties themselves are just highly fungible properties. They're 6,000 square foot boxes that almost look like supermarkets or a Linens 'n Things type stores. So because of the credit quality as the transaction and the fungibility of the assets, we were able to get very attractive financing, which helped us from a spread perspective.

That helps. Thank you.

We go next to Ross Nussbaum with BOA Securities.

Hi, good afternoon.

Cathy, I missed a number, I just wanted to make sure I'm understanding this. At the end of the quarter, the variable rate debt was limited to just 36.5 million on the credit facility?

Correct.

So at what point -- what's the amount at which you'd seek out permanent financing?

Well, I think that with our Master Funding vehicle that we've set up, it's set up so that we can issue new tranches of debt fairly readily. However, I would think that there would be a fairly minimum-sized transaction of say, 150 to 200 million of debt before we would pull a long-term debt issuance off of that line.

So is it fair to say that you may, in fact, be going back sort of every quarter to be fixing the debt on the acquisitions that you're doing? Or will it be a little longer than that?

It could be, depending on volume, Ross.

Okay. Chris, on the acquisitions you did during the quarter, about half of them were focused in on those three deals that you discussed. Can you talk a little bit about the nature of the other 140 million or so deals that you did? Were they sort of concentrated in the same kinds of industries?

Just one second here.

I don't have the whole list in front of me, Ross, so -- I mean -- wait. If you look across the industry, basically it's more specialty retailers. We had a small medical facility, which is basically a long-term leased outpatient facility to a group of physicians in Texas. We had more restaurants. We had a motor sports transaction, which is basically sort of a motorcycle type of facility. And we had a daycare facility and some auto parts facilities, and that's about it. I mean, some more restaurants, again, it was heavily restaurants and some of the other facilities cost a little bit more.

Okay. The other question I have is, with respect to the timing of acquisitions, it seems as though some of the lumpiness has come out for the past couple quarters. You've been sort of consistent on the acquisition basically since the second or third quarter and now heading into the fourth. Is that a cognizant effort to sort of smooth things out, or is it just a function of the activity and the volumes that you're seeing in the market?

Hey, Ross, this is Mort. We're not in the business of smoothing things out, we're in the business of creating as much value as we can professionally do. So it just is the way it was.

Thanks, Mort.

You're welcome.

(Operator instructions.)

It appears we have no further questions. I'd like to turn the conference back over to Mort Fleischer for any closing comments.

Just in closing, I'd like to point out that this company's probably about 22 months old, and if you think about what we've accomplished, if you just listen to what we were saying, if you look on the debt side, we've got huge flexibility. We can use the CMBS market, we can use structured debt, more importantly, the flexibility that the master trust gives us, it allows us to almost act like an investment-grade company when, in fact, we're not and don't intend to be because it allows us huge flexibility.

We have a lot of traction on our sales side that we're starting to gain. We've got 5,000 companies in our database. We're defining our markets. We have salespeople that are making a lot of in-rows. We're seeing a lot of activity that we didn't see just a few months back.

Most importantly, what we're starting to see is that our thoughts on using a sale/leaseback as an efficient tool to help a -- to help our customers add value or to help them drive returns on equity is starting to really take hold and that this approach that we're using -- and I want to point out that I'm an entrepreneur, and most of you who know me already know that, and I always like to say that when it becomes clear to everybody else, it's too late.

And that's why we started Spirit Finance because what we really see is in a world of globalization and in a world that's full of oversupply of everything, as you'll hear me talk about all the time, we believe that we're on the cutting edge of using these sale/leasebacks as a financial tool and that over time we're going to get -- we will not be out chasing business that everybody's out getting, we're going to be creating new values with new customers.

So we thank you for your confidence, and we'll talk to you next quarter.

That does conclude today's conference call. You may disconnect your lines. We appreciate your participation. And have a nice day.