Spirit Realty Capital Inc (SRC) 2006 Q2 法說會逐字稿

Good day and welcome to the Spirit Finance Corporation's second quarter earnings release for 2000 conference call -- I'm sorry, 2006 conference call.

[OPERATOR INSTRUCTIONS]

It is now my pleasure to turn the floor over to your host, Miss Cathy Long, chief financial officer. Please go ahead, ma'am.

Good afternoon and thank you for joining us on our second quarter 2006 earnings conference call. I'm Cathy Long, chief financial officer of Spirit Finance Corporation. With me on today's conference call is Mort Fleischer, our chairman, and Chris Volk, our 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 are not guarantees of future performance and therefore undue 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 will pass the call to Mort.

Thank you, Cathy, and thank you, everyone, for joining us today on our conference call to discuss our second quarter 2006 results. I'll provide some introductory comments, then Cathy will review our financial performance for the quarter and guidance for 2006. Chris will then discuss operations and summarize our strategy going forward. Following our prepared remarks, we'll be happy to address any questions you may have.

We're very pleased to report an increase of 41% in funds for operation per diluted share for the second quarter. This type of increase is a direct result of our execution of the initiatives we put in place when we started this company only three years ago. Since we began purchasing real estate assets in December 2003, we have completed almost 2.6 billion of real estate acquisitions and mortgage and other loan investments.

Our vision when we started this company was to build shareholder value by aiding our customers with more efficient real estate monetization strategies. In these three short years we have demonstrated an ability to add numerous assets, both large and small, with the average deal completed in the $22 million range. We are committed to finding and closing on many of the large and small opportunities that exist to help corporate America in creating capital efficiency.

Our portfolio of real estate assets, our record of executing accretive acquisitions and our strong and safe dividend are evidence that we have built shareholder value in the time we have been public.

With that, let me turn the call to Cathy.

Thank you, Mort.

I'll start by providing a review of the results of our second quarter 2006 activity, then I'll provide an update on our real estate portfolio and our guidance for 2006.

For the second quarter of 2006 FFO and AFFO were $0.24 per diluted share, surpassing 2005 year-over-year per share results by 41% and 50% respectively. This solid increase is a direct result of our progress in building our real estate portfolio over the past year.

Net income was 11.2 million, or $0.14 per diluted share, while revenues grew by 140% to 43.4 million, which includes revenues from properties classified as discontinued operations. Our second quarter results include only a one-month benefit from the ShopKo real estate acquisition. The full quarterly effect of this transaction, which closed on May 31st, will be reflected in our third quarter operations.

It's important to point out that our FFO continues to track closely with our adjusted FFO, with a difference represented only by straight-line revenues. In addition, because our portfolio is comprised of net lease investments, unlike most real estate classes, net leases require very little in the way of capital expenditures that would otherwise detract from reported FFO.

As we have mentioned on prior calls, much of our portfolio rental increases are contingent on changes in the consumer price index and are reported as revenue only when the actual CPI increase is known. That means that our current revenue is much closer to actual cash rents received than if we had a significant component of our revenue represented by straight-line rents. We expect our CPI rent escalators on our existing portfolio to translate into same-store rent increases in the future, averaging around 1.5 to 2% annually. At a 60% leverage rate, that translates to about 3.75 to 5%.

Another internal growth opportunity comes from contingent rentals on leases that provide for additional rent based on a percentage of lessee sales. These percentage rents amounted to approximately $0.5 million for the first six months of 2006. The weighted average current cash-on-cash yield on our portfolio is approximately 8.6%, which does not include the benefit of any internal growth embedded in those leases.

By June 30th, 2006 we had built our balance sheet to nearly 2.6 billion in total assets, including 2.4 billion in gross real estate owned, 67 million in mortgage equipment and other loans receivable, and 88 million in cash and cash equivalents. At the end of the second quarter of 2006 we had 1.6 billion in debt, all of it long term fixed rate mortgages and notes payable. Approximately 92% of our investment portfolio was match funded with the fixed rate long term debt, which means that we have effectively locked in a minimum spread on our portfolio, insulating the portfolio from increases in interest rates while gaining the benefits of the rent escalations embedded in the leases.

From a capital standpoint, we approximate 63% total leverage when measured by cost. Our leverage consists of our proprietary and flexible Spirit Master Funding Conduit, just over 45% of our total debt outstanding at June 30th, with the remainder in commercial mortgage-backed debt. As of the end of June we had 500 million in unused capacity on our short-term credit facilities together with 88 million in cash with which to grow during the remainder of 2006.

At June 30th, 2006 our investment portfolio was comprised of 897 owned or financed properties, geographically dispersed across 42 states. Only two states, Wisconsin at 13% and Texas at 11%, accounted for more than 10% of our total dollar investment in our portfolio. The top three industries in which our customers operate were general and discount retailers 33%, restaurants 20%, and specialty retailers 9%. Our real estate portfolio also includes movie theaters, educational facilities, automotive dealers, parts and service facilities, industrial properties and supermarkets.

As of the end of the second quarter, the weighted average maturity of the non-cancelable portion of our leases is 16 years, providing us with stable long-term cash flows, and less than 2% of our lease portfolio will expire in the next five years. As we have anticipated, our FFO dividend payout ratio for the second quarter was reduced to 88%, falling steadily since our IPO in December 2004. A key benefit of the ShopKo transaction is that our payout ratio is expected to continue to drop as the full benefit of the cash flow from this transaction is realized.

Turning to credit, we continue to adhere to our diligent underwriting standards and portfolio monitoring process. This strategy has continued to result in a strong real estate portfolio of operationally essential real estate properties occupied by stable long term tenants. As with prior quarters, all of our properties are occupied and are current in their monthly lease and loan payments.

During the quarter we sold 17 properties with a gross investment value of 17.8 million for a net gain of 1.4 million. We used the proceeds from the property sales in our recent equity offering to pay off our short-term credit lines and acquire new properties. In the second quarter we completed over 881 million in real estate acquisitions. This added nine new customers and 195 new properties to our portfolio.

As a reminder, current accounting principles require that we report the operating results of our sold properties, including the gains or losses on the dispositions, as discontinued operations. This classification has no impact on reported cash flow, net income, FFO or with the reinvestment of proceeds or expectations of future revenues.

Now I'll turn to our earnings guidance. We continue to see significant real estate investment opportunity in the single tenant market. That said, we will remain true to our underwriting and investment returns discipline and complete only those transactions that will contribute to the increased cash flow of this company over time. It is likely that the timing of the remaining acquisitions will fall late in the third and fourth quarters.

As we've discussed previously, our policy is not to provide quarterly earnings guidance. Based on our estimate of the timing and the amount of real estate acquisitions closed during the remaining portion of the year, we confirm our previous FFO per diluted share guidance for 2006 in the range of $0.99 to $1.04.

I'll now turn the cal. over to Chris who will share some of his insights on our real estate portfolio operations and strategy.

Thank you, Cathy.

As you have seen from the financial overview, the state of our business is excellent and we anticipate FFO growth per diluted share this year to range from 41% to almost 49%. As a result, our dividend payout ratio will range from approximately 81% to 85% against quality recurring cash flows. Because our results for 2006 will reflect only a partial year of ownership of the assets we hold, the actual run rate dividend payout ratio will approximate 80% or less. That's absent any growth from the expected 2007 acquisitions or 2007 rent increases. Our FFO growth provides room for future dividend increases, which we and our Board annually evaluate in the fourth quarter.

We owe our record results to the capabilities of our experienced staff and to our ability to book over $1 billion in new business so far this year at spreads averaging approximately 250 basis points over the cost of our borrowings. Spreads like this come from a combination of strong marketing efforts for our services and efficient debt originated through our well-developed banking relationships and our own unique Master Funding Conduit.

While Spirit participates in traditional real estate markets where the principle advantages are limited to speed, showing up with the money and price, our core focus is dealing directly with the tenant. This is where Spirit best delivers its competitive advantages, including customized flexible leases, tax efficient structuring, capital markets knowledge, and a capacity to execute on both small and large transactions.

By combining these competitive advantages with our direct marketing efforts, we're able to execute investments having lease rates and investment spreads that are typically higher than would otherwise be achieved in an auction marketplace. The thought process is to create demand for our services rather than to compete only in traditional real estate markets by being the highest bidder.

Turning to servicing efforts, our portfolio is fully occupied and all of our tenants are current in their lease and loan payments. We monitor all of our tenants' corporate financial statements, evaluate them regularly with a credit rating model, and receive store level financial data for over 90% of our properties. On average, the store level lease coverage approximates two to one.

Our ability to service investments is highly scalable, which has accounted for some of our record FFO performance. In the fourth quarter of 2004, when Spirit had its initial public offering, our general and administrative cost approximated 1.4% of our average total assets. This past quarter they stood at almost half that level, or just less than 75 basis points.

At the end of June the ShopKo investment accounted for about 29% of our real estate investments, which is expected to go down to around 25% by year-end as we continue to execute on our real estate acquisition plan. In light of the size of the ShopKo investment, you will see the first quarter ShopKo financial statements filed within our forthcoming 10-Q, together with some commentary on the results from operations.

Keep in mind, the financials reported will be for the quarter ended April 29th, 2006, which precedes the date of the real estate sale to Spirit. In addition, as you would expect, ShopKo's results will continue to be impacted by acquisition related charges such as the deferred financing costs that have to be expensed upon the extinguishment of debt, but the results will be consistent with historical performance in terms of gross margin and cash flow.

With regard to liquidity, the company's credit availability is presently over $100 million higher than what was reported at their January 2006 fiscal year-end due primarily to the use of excess proceeds from our transaction to reduce their asset-backed credit facility. As we mentioned on our conference call last quarter, both ShopKo and Pamida have quality senior leadership teams and we continue o be excited about the prospects for both brands.

Looking forward, our pipeline of investment opportunities where we have executed confidentiality agreements and received proposed transaction information continues to stand at between 2 and $3 billion. With so much attention being paid to public and private transactions and M&A activity, we are aware of billions more of potential transactions. Today, the appeal of our leases, which are largely match funded through long-term borrowings, has never been better.

For example, despite 17 consecutive quarter point increases in the federal funds rate, the 10 year treasury today stands within 75 basis points of where it was when we raised our first private equity capital in December of 2003 or took Spirit public in December of 2004. Not only are long-term rates historically attractive, but bond spreads continue to be tight. At the same time, inverted borrowing cost curves, with short term borrowings costing more than long term debt, make our long term leases and our efficient capital proposition even more attractive to our customers.

We continue to be confident that we will find accretive investment opportunities throughout the remainder of 2006 and today affirm 1.6 billion in expected acquisitions volume for the year, while remaining disciplined about pricing, credit and lease documentation. For example, over the past two years the investments we have selected to make represent just 10% of the investments we have considered.

Let me leave you with a few reasons on why Spirit. First, we have demonstrated our lease origination capabilities to deliver superior returns and we have taken groundbreaking steps to finance ourselves more efficiently. Together, our efforts have resulted in enviable cash flow spreads that have translated into record operating performance.

Second, the market for what we do is extremely large and, in our view, is growing. At the same time REITs, which are ideal real estate holders, have little market share of the markets we address. Our capital and operational structures have given Spirit the opportunity to be a first mover in this large marketplace.

Third, our investments are characterized by good and stable cash flow coverages, rational investment amounts and market-based rents.

Fourth, the quality of our funds from operations is strong and recurring. Our dividend payout ratio will track from 81 to 85% this year with an even lower run rate on a full year basis. At the same time, our current dividend yield is high relative to the broader REIT market or to any direct peer group.

Fifth, we are virtually match funded and have locked into attractive long-term spreads that are anticipated to actually increase over time as rents rise. Moreover, because we originate such a large portion of our investments outside of traditional real estate channels, we believe we have a better ability to raise lease rates in the event of rising long-term interest rates.

Sixth, at our current share price and with a monthly cash rent approximating $18 million, we're trading at an [inaudible] rate of about 8.3%, which indicates an overall discount in that asset value.

Seventh, our growth and recurring FFO per share is significant and our share price is low relative to the FFO per share growth we generate as measured by the broad REIT market or to any direct peer group.

And lastly, management has over 20 years of experience of disciplined lease pricing, disciplined attention to credit, and disciplined attention to lease enforcement and documentation. We are strongly aligned with our stockholders and aim to create long-term value for all stakeholders.

So with that said, Operator, I'd like to turn the line open now for questions.

Thank you, sir.

[OPERATOR INSTRUCTIONS]

We'll take our first question from [Paula Poskin] with Robert W. Baird.

Hello. Can you hear me?

Yes, we can.

I'm sorry, lost you there for a moment. I just wanted to ask if you could give a little bit more color on the acquisition volume and timing, particularly saying that you're looking for it to be weighted more heavily to the backend of third and fourth quarters, is there any change in the types of transactions that you're seeing?

Paula, no. This is Chris.

Hi, Chris.

I guess I will just give some comments on timing, which is that the timing of the transactions tends to be weighted towards the end of the quarter, as you know, and the fourth quarter tends to be larger than the third quarter historically. We're not going to give any particular guidance for this quarter, just to say that we're going to be there for the year in terms of investment. I could -- I'm going to turn -- if you don't mind, turn it over to Jeff Fleischer, who runs acquisitions and is sitting next to me, and he can talk about the color of the market and if we're seeing anything that's different from where we've been.

Thank you.

Paula, we can characterize the market as really being primarily focused at private equity transactions, public to private transactions and a large increase in M&A activity and that's primarily been our marketing focus. And then on what we refer to as the commodities side of the business, which is really small box retail, we've noticed that long-term interest rates have risen typically faster than retail cap rates. And so selectively we've played in that market but there's been less activity in that commodity business than what you may have seen from us last year. So our focus this year has been primarily on more strategic and direct acquisitions, calling directly on retailers, private equity and focused on M&A activity.

That's helpful. Thank you very much.

And we'll take our next question from Jonathan Litt with Citigroup.

Hi, this is [Ambica Gual] calling with John. 30% of the ShopKo portfolio was set aside for substitution. Is there any update on that part of the portfolio?

Ambica, this is Chris. The answer is the reason the 30% was set aside for substitution is because in traditional commercial-backed transactions, there's no ability to substitute. So what we did was we did something rather unique, which was to give them the ability to really run their business. If you look at our Master Funding transaction, for example, which is 45% of our long-term liabilities, we generally give our tenants actually 100% substitution rights over time. So if the property has the same or better appraised value, there's the same or better [store level] cash flows, we give them that ability because it's extremely important for our clients to have operational flexibility.

There is less of that kind of flexibility that's available in the [inaudible] market, so you shouldn't read into the 30% any stated intentions of management or of Spirit other than to allow the company to really run their business effectively and not have the debt interfere, in addition to which the leases are 20 years and a 30% limitation is -- a 30% limitation over the full term of the lease, which is a little more onerous obviously than we would normally have if we'd done a Master Funding transaction.

The transactions that we did with ShopKo at the time were with stores that the company intended to remain open. They actually pulled stores out that they were unsure about so that the properties that were in the transaction, on the ShopKo side, designed to be properties that they had kept. I think we're aware of one Pamida store that has been closed, which we knew about going into the transaction. But the ShopKo properties, which constitute the vast majority of it, which is about $700-plu million of the transaction, are intended to -- were intended to stay open when we did the transactions.

Okay. And then for funding sources, have you thought about pursuing the joint venture route or are you going to stick with equities?

We have always had people talking to us about joint ventures and we are going to definitely evaluate it and are evaluating it. It's got pluses and minuses and we're thinking about it.

Is anything eminent or is it more further down the line?

I can't respond to that.

Okay, thank you.

We'll go next to Greg Andrews with Green Street Advisors.

Good afternoon. The range of guidance remains pretty wide for this time of year, it seems to me, given the activity to date. What would -- what would cause you to come in either at the kind of low end or the high end? What are the variables that kind of govern that range?

This is Cathy. One of the big variables is the timing of closing of real estate transactions. If we close a transaction in September it's going to have more FFO impact on 2006 than if we close it in December. So the biggest variable probably is timing.

Great. Thank you.

There appear to be no further questions. At this time I'll turn the call back over to Mr. Mort Fleischer for any closing comments.

By year-end we should have in excess of 3 billion of investments and an FFO run rate north of 100 million a year, which if we close a place would go on for long years. Just want to make that point that we lock these spreads in and these cash flows are for long periods of time. We've been able to achieve what we think are impressive growth results by following the old tried and true method of adding value to our customers.

Spirit, as we've been saying all throughout this presentation, is all about efficient capitalization. In its simplest form, we're helping our customers drive higher return on equity, which is why we are able to achieve attractive lease rates with well-run companies that have quality real estate. We believe, as Chris pointed out, that we have a first mover competitive advantage, as we've developed the technology to minimize taxes when we purchase the real estate, while at the same time we provide customized flexible leases that allow our customers to run their business. We continue to believe that balance sheet efficiency is the next frontier for our clients and our results indicate that.

So I want to thank all of you for joining the conference and we'll talk to you next quarter. Thanks very much.

This does conclude today's conference call. We appreciate your participation. You may disconnect at this time.