Spirit Realty Capital Inc (SRC) 2006 Q4 法說會逐字稿

Good day, and welcome to the Spirit Finance Corporation Fourth Quarter Earnings Release for 2006 Conference Call.

[OPERATOR INSTSRUCTIONS]

It is now my pleasure to turn the floor over to your host, Miss Cathy Long, Senior Vice-President and Chief Financial Officer. Please, go ahead.

Thank you. Good afternoon. Thank you for joining us on our fourth 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, Chris Volk, our President and Chief Executive Officer, and other members of our senior management team.

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 fourth quarter and full-year 2006 results. I'll provide some introductory comments, then Cathy will review our financial performance for the quarter and year ended December 31, 2006, and provide our initial guidance for 2007. 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.

Our second full year as a public company was much like our first from an operational standpoint. For 2006, our FFO per share increased 44%, which was in line with our guidance, and our acquisitions and originations of over $1.4 billion nearly doubled the size of our investment portfolio to over $2.8 billion. Our acquisitions have come without sacrificing credit or earnings quality, and most importantly, where it attracted spreads. We also ended the year with more than 80% of our investment portfolio match funded with fixed rate, long-term debt.

There are few companies that have built the kind of portfolio we have in such a short amount of time, competing in this challenging cap rate and yield curve environment. We continue to broaden our reach and we have become a more important player in the market as shown by the ShopKo transaction in May and the National Envelope transaction we completed at the end of the fourth quarter.

The opportunity of owning operationally essential real estate continues to be extremely large, in excess of a trillion-dollar market, and we are poised to continue to take advantage of this. It continues to be challenging to locate transactions and win deals, but our persistence and focus on providing a competitive and cost-effective solution for our customers is working, as you could see from our growth.

With that, let me turn the call to Cathy.

Thank you, Mort. I'll start by providing a review of the results of our fourth quarter activity and touch on some highlights for 2006, then I'll provide an update on our real estate investment portfolio, and provide our initial guidance for 2007.

Fourth quarter 2006 FFO and AFFO were both $0.27 per diluted share. These amounts represent year-over-year increases of 29% in FFO per share and 35% in AFFO per share. For the full year, our FFO reached $1.01 per diluted share, which represents a 44% increase on a per-share basis over 2005. Our full-year 2006 FFO per share amount of $1.01 does not include an additional $0.07 per share of cash gains from the sales of real estate during the year.

Our growth rates are a direct result of the strong acquisition volume that we've been able to achieve during 2006, having increased the size of our investment portfolio significantly during the past year. As we've anticipated, this strong FFO growth has driven our dividend payout ratio for the fourth quarter down to just over 80%. Our stable growing stream of FFO has projected our ability to pay dividends while also leaving us some cash to reinvest in our business.

For the fourth quarter, net income was $16 million, or $0.16 per diluted share, a 60% increase on a per-share basis from the comparable quarter in 2005, primarily fueled by the growth in our revenues. Revenues grew by 98% to $57.9 million, which includes revenues from properties classified as discontinued operations. For the full year, net income was $52.4 million, or $0.58 per diluted share, a 41% increase on a per-share basis over 2005. Revenues, including revenues from properties classified as discontinued operations, grew to $192 million, from $86 million in 2005.

The real estate acquisitions we made during 2006 have given us momentum going into 2007 when a full year's revenue will be generated from these acquisitions. The weighted average cash-on-cash yield on our portfolio is currently approximately 8.7%. I'll talk more about our real estate portfolio a little later. Just as important as creating a steady stream of rental revenue is financing our properties appropriately.

While many companies may not focus as hard as we do on the liability side of the balance sheet, to us, it's critical and can provide us with a competitive advantage. We've been able to match fund over 83% of our investment assets with long-term, fixed-rate debt. This means that we've financed a substantial portion of our properties with long-term debt, locking in a long-term fixed payment. The weighted average cost of our fixed rate debt is approximately 2.5 percentage points below our current cash yield on our investment portfolio. Because our debt rate is fixed over the entire 11-year average remaining term of the debt and our rent receipts are expected to increase over time to rent escalations, the excess of our cash revenues over our debt payments is expected to grow over time.

Now that we've covered revenues and debt costs, let's turn to general and administrative expenses. In terms of improving our operating efficiencies, our G&A expenses during the fourth quarter of 2006 were about 70 basis points of average gross investment assets as compared to 1.1% in the same period last year. We continue to work hard to maintain or improve this level of operating efficiency.

Turning to the balance sheet, at December 31, 2006, we had $2.9 billion in total assets, including approximately $2.8 billion in gross real estate owned, $75 million in mortgage and other loans receivable, and $52 million in cash and cash equivalents. At the end of the fourth quarter of 2006, we had $1.8 billion in debt, nearly all of it long-term, fixed-rate mortgages and notes payable.

On a short-term basis, we often use our variable rates secured credit facility to finance our acquisitions. We established a new Citibank credit facility in October at an expanded amount of $400 million, which we use to fund our real estate acquisitions, pending the issuance of long-term, fixed-rate debt. As a result of the expansion of our Citibank credit facility, we allowed our other credit facility to expire in November in accordance with its terms. From a capital standpoint, our leverage ratio of total debt to total assets was 63% at December 31.

Let me now provide an update on our real estate portfolio. We continue to have a diverse portfolio. The portfolio includes 1,034 properties, diversified geographically throughout 43 states and amongst the different industries in which our 145 customers operate. Only two states, Wisconsin, at 12%, and Texas, at 11%, accounted for 10% or more of the total dollar value of the real estate investment portfolio at December 31.

The three largest industries in which our customers operate as a percentage of our total investment portfolio were the general and discount retail industry at 29%, which is down from 33% at the end of last quarter, the restaurant industry at 22%, and the specialty retail industry at 10%. The company's real estate investments also include properties operated as movie theatres, industrial properties, automotive dealers, parts and service facilities, educational facilities, recreational facilities, distribution facilities, and supermarkets.

Our largest individual tenant at the end of 2006 was ShopKo Stores operating company at 26% of our portfolio assets, down from 29% at the end of the third quarter, with no other individual tenant representing greater than 4% of the total investment portfolio. 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. For assets reporting unit level financial information, the weighted average fixed charge coverage ratio at December 31, 2006 was approximately two to one. As with prior quarters, substantially all of our properties are occupied and are current in their monthly lease and loan payments.

In the fourth quarter, we completed nearly $317 million in real estate acquisitions and financing, bringing our 2006 acquisitions to over $1.4 billion. For the quarter, we added 28 new customers and 128 new properties to our portfolio. Our fourth quarter activity included our previously announced $75-million transaction with National Envelope Corporation, which closed at the end of the quarter. This high-quality tenant and long-term lease makes this an attractive real estate acquisition for us.

Now, I'll turn to our initial earnings guidance. As we discussed, previously, our policy is not to provide quarterly earnings guidance. Our earnings guidance is very sensitive to the timing of real estate acquisitions, which is difficult to predict. Based upon our best estimate of the timing and the amount of real estate acquisitions expected to be closed during 2007, we expect FFO per diluted share for 2007 to be in the range of $1.13 to $1.18, which is based upon completed between $800 million and $1 billion in acquisition volume.

We continue to see significant real estate investment opportunities in the marketplace. We're committed to remain true to our underwriting and investment returns discipline and complete only those transactions that will contribute to the increased cash flow over the company at this company over time. We have and will continue to turn away the deals that do not meet our strict underwriting and return standards. We believe this is the best way to run our business and create long-term shareholder value.

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

Thank you, Cathy. 2006 was a momentous year for Spirit. First, we achieved record investment activity of over $1.4 billion, which resulted from record deal close from which our investments were selected. Over two thirds of our dollar transaction close in 2006 came from internally generated opportunities with the remainder from transactions that involved financial or broker representation. With respect to the latter, it helps that Spirit gained recognition in the marketplace for the value we can deliver. As a result, we're able to see a higher percentage of the opportunities that exist within our marketplace.

The increased deal flow comes -- with increased yield flow comes selectivity. And with selectivity comes an ability to maintain credit quality and investment spreads. Spirit Finance has been able to generate attractive investment spreads by virtue of our direct origination capabilities, our strong yield flow, and our liability strategies.

Throughout 2006, our gross portfolio cash yield on investments averaged over 8.6% with our fixed rate debt priced approximately 250 basis points less. As Cathy said, we were 83% match funded at December 31, 2006. For those assets, they're selected to be warehouse and our short-term credit facility. Pending the issuance of long-term debt, we have placed hedges to lock in the spreads to our cost for the future of long-term debt.

As I stated earlier, portfolio selectivity is important to maintain credit quality. This past October, we held an investor and analyst day, and during the presentation, we noted that we received sight-level financial statements for almost 90% of the assets we hold and that the weighted fixed charge coverage ratio of the properties we hold approximated two to one. It is still at that level.

At the same time, we also spot evaluate the credit quality of our tenants through the use of such credit models, assigning scores of each of the 145 customers within our investment portfolio. Based on our updated information, we continue to have approximately 27% of our portfolio leased to tenants having effective internal credit ratings of BBB minus or better, 53% in the BB range, and 16% in the B range.

It is important to bear in mind that corporate credit ratings simply reflect the expected corporate annual default frequency for general corporate obligations. Spirit, by contrast, is in a far stronger position, holding mission critical real estate assets which have, on average, through all the coverages approximating two to one. We have been justly proud of our ability to maintain -- to obtain high quality tenants backed by strong cash flowing assets and long-term lease streams with the weighted average remaining term of approximately 16 years.

At the end of 2006, our long-term liability structure weighted slightly in favor of CMBS fundings at 56% with our own conduit, Spirit master funding, coming in at 44%. Both have been incredibly efficient for us with Master Funding offering Spirit, and therefore our tenants, greater asset flexibility. When you include the cost of hedging, issuance, and insurance associated with our Master Funding conduit, on average, both have realized similar costs.

During 2006, Spirit incurred $714 million in new CMBS borrowings, while increasing the master funding conduit by approximately $302 million. Currently, we have over $400 million in assets to qualify for a future inclusion into Spirit master funding. In addition to our term borrowing, Spirit accessed the equity markets three times during 2006 realizing net proceeds for approximately $428 million. The first two offerings, which occurred during the first half of 2006, were probably marketed transactions. The third offering for approximately $100 million gross was our first direct overnight publicly marketed transaction.

We have stated in the past that it is our intent to raise equity that can be immediately deployed either in new investments or to reduce short-term borrowings. At the end of 2006, our leverage ratio as a percentage of total assets at cost stood at 63%. During the year, our leverage ratio ranged from 56% to 63%. Spirit Finance has a highly scalable business model, which means that our cost to operate the company has steadily declined as a percentage of our investments.

For the first quarter of 2005, where our cost stood at 1.5% of average gross investments, to the last quarter of 2006 where the general and administrative costs stood at 0.7%, our scalable model was designed to add value for our stockholders. At a leverage of approximately two to one based on cost, the 80-basis point reduction in general and administrative expenses as a percentage of total cost, means the total implied investor returns are approximately 2.4% higher. For past real estate investments, such as the ones that Spirit Finance is engaged in, this is meaningful and contributes towards building stockholder value.

The results of the combination of investment activity, solid margins, and a scalable business model have been that our funds from operations per share rose 44% during 2006 to $1.01 per share. This represented an increase from our initial 2006 guidance, which was in the range of $0.93 to $0.98, due to a higher level of investment activity than we initially anticipated.

I should note that our FFO per share does not include $6 million, or $0.07 per share, of cash gains on the sale of real estate held for investment, which, if added, would raise our FFO per share to $1.08, or a 52% per share increase over 2005. At the same time, our FFO per share growth has steadily pushed down our dividend payout ratio from 127% during the first quarter of 2005 to 81% at the final quarter of 2006. Our current dividend, if annualized, comes in at approximately 77% of our current average FFO per share guidance for 2007.

As we look forward to 2007, our pipeline has potential investments remaining strong. Our guidance presumes approximately $800 million to $1 billion of new investments, and the range will, as always, be sensitive to timing. While the new investment target falls short of our 2006 activity, we have not baked in any transaction of the size of ShopKo, which now represents 26% of our total assets. To date, in 2007, we closed on about $100 million of new investments, and we anticipate a record first quarter in the range of $150 million to $200 million.

Spirit Finance has accomplished a great deal since we founded this company in 2003. We started Spirit with a vision that real estate leasing could be an invaluable treasury tool for corporate leaders to lower their cost to capital. We believe, then and now, that capital efficiency is the next frontier for value creation in corporate America and that events are proving this to be so. We believe that our success in 2006 and beyond owes itself to the talent of our staff, and to our ability to create [unparalleled] platform designed to fulfill our vision.

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

Thank you.

[OPERATOR INSTRUCTIONS]

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

Hey. Good morning, guys. Or good afternoon, guys. It's actual [Dustin] with Ross. Chris, is the EBITDA the coverage ratio on the ShopKo portfolio roughly the same as where it was at the end of the third quarter?

The answer is yes. If you look at it and you have -- you will see that the third quarter numbers are going to be included with our 10-K and the third quarter, they're on a January fiscal year end. So third quarter will be ending October 30. So let me give you some color on ShopKo.

The trailing 12-month end EBITDA ratio, which is something we focus on which adds back all the transaction costs and looks at the company on sort of a same-state basis, continues to be around 1.74 to 1, which is EBITDA divided by rent and interest expense. The ShopKo is for the year, and their year end, again, is going to be in January, but they have announced probably that they expect that their sales per store to be up for the year.

If you look at them through, and that's on a same-store sales basis, if you look at them through Q3, the sales overall will be up about 1.1%, but that's on two fewer ShopKo stores and about ten fewer Formida stores. So, basically, the comp sales were up around 3% through the third quarter. And I should point out that that is, for ShopKo, it's the first time sales have been same-store positive since 2001. And for Formida, the same-store positive, the first time since 1999.

So management is doing a great job. And I would say that from our perspective as making an investment in this, it was never predicated on making any improvements. So from our perspective, this has never been an issue of having a turnaround situation at all but the notion has been that if the company can continue to be -- maintaining approximately the same sales and profit margins that it's been maintaining over the last three years, that we would be in great shape and we believe that we are.

Today, the company, from a liquidity perspective, has -- you'll see on the 10-K, they had about $226 million available on their line of credit, which is about $102 million more than they had at January 28 of last year. And keep in mind that when we did the sale leaseback, that freed up about 90-some odd million dollars, like high 90s, in cash flow today, so net of the proceeds of our sale leaseback, they actually have more available in their cash facilities than they did if you adjust for the sale leaseback facility itself. So on a cash flow basis, they've been able to do well.

They are continuing to make progress in a lot of the initiatives that they've announced, and a lot of those initiatives were discussed in the analyst day that we had, last October. But to refresh you, some of that included some expense reductions. From a procurement perspective, ShopKo had about 1,876 vendors, which is an incredible number of vendors, and so they've been steadily working to reduce that.

Formida, I think, had about 1,160 vendors so they're trying to obviously make inroads in reducing that and that'll shape material costs. And then, of course, there have been corporate overhead savings at ShopKo that management has already announced their intentions of reaping some benefits from. So all in all, we think that we're excited by what we see them doing. We're excited about the management team that [Sun] has put in place. And, obviously, we'll keep you posted as we get the numbers.

Great. And then, I believe Ross has a follow up as well.

Hey. Hi, Chris. How are you? Cathy, actually, this one I think is for you. G&A forecast for '07?

We are down about 70 -- we're at about 70 basis points of average investment assets. We think that we can maintain or improve that for '07.

Okay, because I was wondering, I thought when I looked at your G&A for the fourth quarter of '06, it was a little higher than the third quarter. But I thought the third quarter number had some one-time ShopKo items in there. Was the fourth quarter including just some year-end comp?

Rephrase your question. Was it including -- oh, yes. There were some year-end accruals.

Okay. Timing fourth quarter acquisitions, how backend loaded was the $316 million in the fourth quarter?

Quite backend loaded. We had most of the transactions close in December.

A lot of them closed on December 29. It was a very busy day around here.

Okay. And I guess the last question, Chris, this one's probably for you. Is -- you look at the REIT industry today and the average AFFO yield of the average REIT is 4% and your AFFO yield is 9% or just a hair underneath that. And when you look at that dynamic, how do you still think about longer term? Is the REIT model the best way to fund the growth of your business if that dynamic isn't going to change?

We've been -- well, first of all, anybody who knows this management team knows that we know how to access multiple sorts of capital. So we have [carriers] and noses to the ground over the last year and have some ideas on improving the efficiency of raising capital. With that being said, you'll notice that even with, and we lag our peers and we lag the REITs industry, which is all true, we're seeing some uptick in our stock price recently. That's some slight narrowing at that gap, but it's still a very large gap.

And that being said, when we did the ShopKo transaction, for example, and we issued stock last June, we were still able to raise our guidance from the range of $0.93 to $0.96 to where it ended up being. I think the whole notion of raising equity is that any time we raise any equity, it should be accretive to shareholders. In other words, FFO per share needs to be higher after you raise the equity than it would have been before you raised the equity, and we followed that model since we started this company, and that's our goal.

Thank you.

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

Hey, guys. Just a couple of quick questions. I think I missed -- did you give the weighted average cost of debt on your balance sheet right now?

Yes, it's around 6.1, 6.2.

Sorry, I think I just missed that. And, Chris or Jeff, could you tell me outside of ShopKo, the $600 million that you closed, what was the hit rate there? I mean, how much product did you guys look at to get to the $600 million?

It still remains about ten to one, so we'll look at $6 million to close one.

Thanks. I appreciate it.

We'll go next to David Fick with Stifel Nicolaus.

Good afternoon. Could you -- just following up on Ross's question, give us an idea of the timing and scale of your next equity raise assumption in your guidance?

We plan to do smaller overnight offerings like we did in December. So I would estimate that when we're doing an equity offering, we would be in the $100-million range. And if you map that out with the acquisition volume, you can pretty much see that it is scheduled throughout the year and it'll just be based on exactly when the real estate acquisitions come in.

What we'd like to do is raise the equity when the real estate acquisitions are scheduled so that we're not sitting on the equity. So the timing of the equity is going to be based on the timing of the real estate acquisition, but there will be smaller, more overnight offerings.

You're presuming the market will remain fairly healthy and look for a small pocket to continue with?

That's correct.

Well, I guess that's important, David, because you want to -- there's a question as to how scarce is Spirit stock? I think that if you continually do public offerings, it's less scarce than if you do some freely placed offerings from time to time. We may do some public. We're always going to opportunistic.

As far as our view of the marketplace, I'm looking up at the Bloomberg in front of me and the ten-year treasury is still at 4.73. I mean, interest rates are roughly where they were when we started the company. And it's the kinds that we think there's a huge market for the kinds of returns we can generate.

Okay, which segues my next and final question. And that is there's an unbelievably strong [tick] market and 1031 market out there, especially for standalone retail and restaurant and I know you've been therefore focused on doing corporate and larger package-type deals. But how much tolerance do you have, given pricing today, for more retail, more restaurants? It's currently, together, 51% of your portfolio. And do you see in your pipeline more onesie, twosie deals or more big package deals?

You're correct. I mean, in the small box retail to continue to do deals that make sense. We need to buy wholesales. So the onesies, twosies don't make sense, but the larger deals are the deals that require either unique flexibility in leasing or tax structuring are the ones where we play.

And you feel comfortable continuing to grow that element of your portfolio, the retail and restaurant element?

Yes. And, again, restaurants are 22%. And if you look going forward at restaurants as a percentage of our targeted business, it continues to be in roughly the 25% to 30% range. So we expect it remains roughly the same.

Okay, thanks.

[OPERATOR INSTRUCTIONS]

We'll go next to Jonathan Litt with Citigroup.

Hi. This is Ambika with John. In your guidance that you gave for 2007, can you give a breakdown of acquisition activity for each quarter?

It's too hard to predict, Ambika.

So what's assumed in guidance right now?

You can assume that it's going to be a weighted average of less than half, slightly less than half. So if I say $800 million, the weighted average will be slightly less than $400 million.

Okay.

Does that help you?

Yes. And then, just given the ski season this year, what's the status and [cash flow] coverage of Camelback Mountain?

I don't have the current numbers from Camelback, but they can pump -- I think they can pump 7,000 gallons of water a minute. And if you look at their website, I think you're going to see that their base is like 36 inches or something. It's probably the only mountain with any snow on it all year. By the way, it was the only mountain with any snow on it last year and they did really well.

Okay. And then, can you give some color on where you're seeing the most opportunities, in which sectors in your acquisition pipeline?

It's really a diverse group. We continue to call on 17 different industries and we tend to focus directly on the active PE firms. We call directly on publics and privates and we maintain relationships with the investment banks and advisors who are active in the single tenant space. So it's a very, very diversified group of industries.

We tend to go where there are pockets and it tends to shift so we have anchored transactions in each space and we continue to develop those relationships and look for referrals from our existing customer base, which is something that's relatively new to us versus where we were a year or two ago. So, we've been enjoying that as well.

So what would you say the ratio is of private equity sourced deals in the acquisition pipeline versus other deals sourced through just finding them or one-off transactions?

It's probably a third private equity, and then a third retail, and a third coming from the advisory brokerage community.

Thank you.

And we'll go next to Chris Lucas with Robert W. Baird.

Good afternoon, everyone.

Hi, Chris.

Could you guys just remind us of what the dividend policy is in terms of just how you look at your dividends going forward?

Well, what we've historically done is evaluate our dividends in the fourth quarter of each year. It's conceivable that we evaluate the dividends over a regular basis in that going forward. And as you can see from the number we're getting to, a dividend payout ratio, that is pretty low.

And if you look last year, if you were to include the cash gains from the sales of real estate and a lot of that sales of real estate, by the way, to David Fick's earlier question, was the 1031-type market. So it helps us take advantage of that if we want to adjust our portfolio. If you were to look at our payout ratio, including those sales, it was obviously in the 70s last year as well.

What's a good sort of taxable minimum level for you guys in terms of a percentage of SSL?

If you're looking for a specific number that's going to trigger a dividend increase, we don't have one to give you.

Okay. And then, just on the sales, what sort of a cap rate spread was there between what you were buying versus what the tick market was?

The average cap rate on the assets we sold was 7.70.

Okay. Thank you.

And we'll go next to Jim Sullivan with Green Street Advisors.

Thanks. Hey, Chris. Can you talk a little bit more about the fourth quarter investments, specifically aside of the $75 million with National Envelope? What was the other [inaudible]?

Just one second, Jim.

It was really a mix. We had restaurants, we had some distribution facilities. That was primarily the rest. We had some auto in there as well. Auto dealerships, but smaller sizes.

It wasn't three big deals?

Correct.

No, no. It was -- Jim, our policy is generally to do press releases on transactions that are in excess of $50 million. Otherwise, we'd do press releases all the time. So they were all smaller transactions and they were spread across restaurants and car dealership business, and some distribution business.

And can you give us the average yield on those investments?

870. About 870 cash yield.

Thank you.

[OPERATOR INSTRUCTIONS]

And there are no further questions at this time. I'd like to turn the conference back over to management for any additional or closing remarks.

Thank you very much, and you'll get the 10-K shortly. And I look forward to seeing you in the future. Bye.

Thank you, everyone. That does conclude today's conference. You may now disconnect.