Spirit Realty Capital Inc (SRC) 2013 Q1 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to Spirit Realty Capital's first-quarter 2013 results conference call. At this time, all lines have been placed on listen-only mode. After the speakers' remarks, there will be a question-and-answer period.

(Operator Instructions)

This conference call is being recorded, and a replay of the call will be available beginning at 6 PM Eastern time today for one week. The dial-in details for the replay can be found in today's press release. Additionally, there will be an audio webcast available on Spirit Realty Capital's website at www.spiritrealty.com, an archive of which will be available for 30 days. It is now my pleasure to turn the call over to Mr. Michael Bender, Senior Vice President and Chief Financial Officer of Spirit Realty Capital. Mr. Bender, please proceed.

Thank you, Patrick, and good afternoon, everyone. Thank you for joining us today. Here with me to discuss our first-quarter 2013 performance are Tom Nolan, Chairman and Chief Executive Officer; and Pete Mavoides, President and Chief Operating Officer. Tom will review our first-quarter performance and offer his perspective on the dynamics at play in the triple net lease market. I will provide you with more specifics about our financials, and Pete will walk you through our portfolio and recent acquisition activity. Tom will then wrap up our prepared remarks, after which we will be happy to take your questions.

Before we begin, please note that during this conference call, we will make certain statements that may be considered to be forward-looking statements under federal securities law. The Company's actual future results may differ significantly from the matters discussed in these forward-looking statements, and we may not release revisions to those forward-looking statements to reflect changes after the statements were made. I would now like to turn the call over to Tom Nolan, Spirit Realty Capital's Chairman and Chief Executive Officer.

Thank you, Mike, and thank you, everyone, who has joined us today. I'm very pleased with our results and with the performance of the team here at Spirit Realty Capital. Our existing business is performing well. Our portfolio is healthy. Our occupancy rates are up. And despite strong competition, we continue to acquire properties at attractive cash rates. We continue to perform as expected, and we're well positioned within an attractive and growing sector. In addition, we have made significant progress towards completing our merger with Cole II, while continuing to deliver steady, attractive returns to our shareholders.

As was talked about previously, this is an exciting time in the triple net lease industry. Institutional and retail investors attracted by the sector's stable, predictable yields continue to come into this space. Additionally, historically low interest rates and the economic recovery in the US have led to an active investment market, which is ripe with both one-off and portfolio sale-leaseback transactions, which feed our core growth model, as well as live entity-level transactions, similar to the Cole II opportunity.

As Pete will share with you in a bit, we have maintained our discipline and deployed our capital in a very thoughtful fashion, acquiring properties at attractive cap rates and divesting other properties where it makes sense. We've done this with an eye towards ensuring that we continue to optimize our portfolio so that it generates stable returns to our shareholders. We expect this favorable market environment to continue, and we remain confident about our ability to execute our strategy effectively.

As you may have noted, we have submitted to our shareholders a proxy statement for our merger with Cole II, which establishes a shareholder vote date of June 12. This puts the transaction on track to close in the third quarter of this year, as we have previously communicated. As we noted when we announced this merger, this exciting transaction materially accelerates our operational goals of diversifying the portfolio, deleveraging our balance sheet, and establishing our Company in a leadership position in this dynamic segment of the REIT industry.

As I hope you can appreciate, with a proxy statement outstanding, there really isn't much we can say on this call about the merger. That said, we continue to work collaboratively with the Cole organization toward the completion of the transaction, and I would like to take this opportunity to thank all the employees, both here at Spirit Realty Capital, and likewise, within the Cole organization, for working so hard toward making us ready to complete that merger seamlessly and efficiently for the benefit of both of our current shareholders. We are also pleased with the response we have received from our shareholders and Cole II shareholders, which has reinforced our strong belief in the merits of the proposed transaction. For those of you who would like more information about the merger, I encourage you to review the proxy materials.

We are looking forward to executing our strategy as a combined Company. In the interim, we will continue to focus on managing our portfolio and growing our business, with a sharp eye on maintaining a strong, diverse portfolio that yields stable and predictable cash flows that supports our dividend. With that, let me turn the call back to Mike for him to review with you our first-quarter results in more detail. Mike?

Thank you, Tom. In the first quarter ended March 31, 2013, we generated total revenue of $72.8 million, an increase of 4.8%, compared to $69.5 million in the first quarter of 2012. A 5.9% growth in rental income was partially offset by lease termination fees recognized in the first quarter of 2012. Lease termination fees periodically result from negotiations with tenants where we may agree to lower lease payments by removing properties from a master lease. G&A expenses in the first quarter were approximately $13.6 million, compared to $6.2 million in the first quarter of 2012. This increase was primarily attributable to $6.5 million in charges associated with the proposed Cole II merger. Under current Generally Accepted Accounting Principles, a significant portion of the non-contingent costs associated with the acquisition and related financing, including professional fees, are expensed as they are incurred.

Property costs were approximately $960,000 in the first quarter of 2013, a slight decrease from the previous year. This reduction was primarily due to our higher occupancy rates compared to a year ago. We also reduced our interest expense in the first quarter compared to the first quarter of 2012. This was primarily due to the extinguishment of the term note as a result of the IPO in September of 2012, which was partially offset by $3.6 million in costs arising from the financing commitments associated with the merger. Modest increases in depreciation and amortization reflect the expansion of our portfolio. We did not record an impairment charge in the first quarter this year.

So net loss attributable to common shareholders for the first quarter of 2013 was $8.3 million, or $0.10 per share, compared to a net loss attributable to common shareholders of $12.4 million, or $0.48 per share, for the first quarter of 2012. Funds from operations, or FFO, for first quarter of 2013 were $21.9 million, or $0.26 a share. Items related to the Cole II merger and related financing discussed earlier reduced FFO for this quarter by approximately $0.12 per share. FFO for the first quarter a year ago was $24 million, or $0.52 a share. Adjusted funds from operations, or AFFO, for the first quarter of 2013 totaled $36.5 million, or $0.43 per share, compared to $27.6 million, or $0.61 per share, for the first quarter of 2012. Ongoing adjustments to convert FFO to AFFO primarily consist of non-cash interest expense, non-cash revenues and non-cash compensation. In the first quarter 2013, also adjusted for Cole II merger-related transaction and financing costs, all of that is detailed in our press release.

On the balance sheet, we continue to reduce our leverage. Since our IPO at the end of the third quarter of 2012, we have acquired $134 million in property using only $39 million of new borrowing. During that time, we have also repaid $26 million. To provide a little more historical perspective, our gross investment in real estate has grown $116 million in the last year, whereas our debt has decreased $706 million.

Finally, as we noted last quarter, we have withdrawn our guidance in light of our pending merger with Cole II. We will evaluate our estimate upon consummation of the transaction. It is worth noting, however, that excluding the impact of the merger-related items, our first-quarter 2013 performance was in line with the guidance we provided prior to the Cole II merger announcement in January. With that, I will now turn the call over to Pete Mavoides, our President and Chief Operating Officer. Pete?

Thank you, Mike. As Tom mentioned earlier, our portfolio is very healthy, and we are pleased with the progress that we are making in optimizing the portfolio by maximizing occupancy, recycling capital, and making accretive acquisitions. All with the goal of delivering stable and predictable cash flows that support our dividend. Our gross investment as of March 31, 2013 totaled $3.7 billion, substantially all of which was invested in 1,232 properties that were 98.9% occupied. This represents a slight increase from 98.8% occupancy at December 31, 2012 and 98% at March 31, 2012. We currently have only 13 properties available for lease or sale. We view 98% occupancy as essentially full, but we continue to focus on re-leasing or selling those properties not currently occupied.

During the quarter, we invested $56.5 million in 31 new real estate properties, with tenants in place at an average initial cap rate of 8.36%. This represents seven individual transactions, with two new and five existing tenants, with an average initial lease term of nearly 18 years. This compared to $33 million and 25 real estate properties in the first quarter of 2012. We are encouraged by the quality of opportunities presented to us on an off-market basis from our existing tenant base, as well as the opportunities to establish new tenant relationships in the current market.

Our properties are generally leased under long-term triple net leases, with a weighted average remaining maturity of approximately 10.9 years. Approximately 65% of our annual rent is contributed from properties under master leases, and 96% of all our leases provide for rental increases. Of the new investments made during the quarter, 57% were subject to master leases, and all of the leases provided for annual increases that average 1.6%. We currently have 11 properties, expiring rents of approximately $2.2 million for the remainder of 2013. We are having discussions with those tenants and anticipate the majority of these tenants will exercise their renewal options in new leases and that our occupancy rate will remain stable throughout the year.

Our real estate portfolio is diversified geographically throughout 57 states and among various properties. One state, Wisconsin, accounted for 11% of the annual rent contribution of the real estate portfolio, and no other state contributed more than 10%. As of March 31, 2013, Spirit Realty Capital's three largest property types based upon annual rent, were general and discount retail at 29%; restaurants at 19%, split between casual dining at 9% and quick-serve at 10%; and specialty retail at 9%. Our new investments during the quarter were in C stores, automotive service, medical office, and quick-serve restaurant, growing some segments that we viewed as under weighted in the portfolio.

An important indicator of risk in the portfolio is the unit-level rent coverage, which is a measure of how essential our properties are to our tenants' ability to conduct their operations and generate profits. As of March 31, 2013, for the tenants that report, the average unit-level rent coverage on a trailing 12-month basis for our top-10 tenants and for the portfolio as a whole was 2.68 and 2.6 times, respectively. This compares favorably to 2.43 and 2.48 times for the same period last year. We also made select dispositions of properties during the first quarter of 2013, where and when we saw opportunities to sell assets at attractive prices, and in line with our broader strategy to diversify and optimize returns in the portfolio. We continue to pursue a mix of acquisitions and selective sales, in line with our focus on geographic and tenant diversity and long-term, sustainable returns.

As Tom mentioned, it is an active triple net lease market, and we expect that to continue. We are maintaining our disciplined [approach], as evidenced by our average acquisition cap rate of 8.36% during the first-quarter 2013. And we continue to see ample opportunity to deploy our capital. We have the capacity to invest more over the balance of 2013, particularly once we complete our merger with Cole II. As a combined Company, we anticipate that we will have greater access to debt markets and capital markets, which should position us well to compete effectively for attractive properties. As we continue to build our business and manage our portfolio, we will remain true to our guiding principles. Namely, acquiring operationally essential real estate properties leased to strong tenants, and an unrelenting focus on thorough credit and real estate analysis. With that, I will turn it back to Tom for some concluding remarks before the Q&A.

Thank you, Pete. I know you are probably eager to turn to your question, so I'll just take this opportunity to express my appreciation for the work the team here at Spirit Realty is doing. I'm proud of the way everyone here has kept focused and executed on the business plan that was the foundation of our IPO, while also working to complete a significant merger that will put us in a leadership position in this exciting and dynamic industry.

I also want to take a moment to thank all of our shareholders. We appreciate the responsibility you have given us to be stewards of your investment dollars. We are focused on generating predictable and attractive returns for you. We are pleased to doing that with our existing business, and we are excited about the future promise that our combined Cole II / Spirit Realty Capital business holds. We intend to continue executing our accretive organic acquisition program, on which our earnings guidance was constructed, while at the same time staying attentive to other possible transactions that would meet our objectives of enhancing shareholder value. With that, operator, we are now ready for questions.

(Operator Instructions)

Your first question comes from the line of Rob Stevenson with Macquarie. Please proceed.

A couple of questions. Pete, did you say that the annual escalators on the new first-quarter leases was 1.6%, or was that on the acquisitions?

That was on the acquisitions in the first quarter, which were the new leases entered into.

Okay, what is the portfolio overall, in terms of annual escalator, the average annual escalators these days?

We estimate that to be about 1.25% to 1.5%. We had a varying escalation periods and varying escalation terms across our tenants, but that's where it usually comes out.

Okay. And then can you guys talk a little bit about you gave the rent coverage for the top-10 tenants in the portfolio as a whole. Can you talk a bit about ShopKo and the operational improvement? Or whether or not you're seeing that in the conversion of the Pamida stores and how that's going et cetera?

Rob, we make it a policy not to talk about specific tenants on our call. You'll see the ShopKo financials will be reported in our quarter, our Q when it goes out tomorrow. And I think you'll find nothing surprising there. A pretty stable performance with maybe a little noise associated with the Pamida merger.

Okay, and then in terms of the merger, are you guys -- when you guys bid in there doing the due diligence et cetera, has there been any red flags in terms of any of the major tenants on the Cole side that has you a little nervous at this point or anything?

No, I think -- I'm happy to say I think we did significant, obviously due diligence before we announced the merger. And I think what we've found is what we expected. It's an excellent portfolio. It is constructed similarly to ours, in the sense that, obviously, there are thousands of properties.

There's any given issue with any given property, just as we have in our own portfolio. But in terms of our expectations of underwriting versus where we stand today, I think we're very comfortable.

Okay, then one last question for Mike. You said that the first quarter was essentially in line with the guidance that you guys had originally provided before it got pulled. If I look at the quarter and I think about it from a $0.26 and then adding back the $0.12, I get to a $0.38 quarterly run rate, which is well above the top end of the range of the standalone SRC guidance. Was there anything that was coming down the pipeline from SRC standalone portfolio towards the back end of the year that would've slowed the quarterly earnings number?

No, no. I understand. That's correct, there wouldn't be anything. In fact, as you might guess, you actually build a little bit because of the build in the portfolio.

Okay, because if I annualize to $1.52, I think the guidance range was like $1.35 to $1.40. So you guys are running well above where you otherwise expected to be.

I know we said in our comments that it was consistent with guidance. Again, we were being cautious because we withdrew guidance. And once you withdraw it, you don't want to then be comparing what you've withdrawn.

And so that was probably our conservatism here. But Rob, I think you've done the math correctly. And at the current run rate, assuming that run rate continues, we would have, in fact, exceeded the initial guidance that we had given in the range that you have suggested.

Next question line of Alexander Goldfarb with Sandler O'Neill. Please proceed.

Just a question for you on the G&A. If we back out the $6.1 million in the first-quarter G&A that relates specifically to the Cole transaction expense, that brings you up to $7.5 million, which is up from the $5.9 million, call it $6 million that you had in your fourth quarter.

And if we go back to the transcript on the fourth-quarter call, you guys said that the fourth quarter was basically a good run rate, except for sprinkling in a little bit relating to Cole. But $1.5 million ramp up sounds more than just a sprinkling. So can you just give us some color on is $7.5 million the right run rate, or even that level may increase or still include some extra stuff that may be more than one-timish, versus a baseline G&A?

Well first, the $0.4 million that's mentioned in the earnings release brings the adjustment to $6.5 million. There is that part in there. Then we do have in the first quarter, we are bringing in a little bit more of the non-cash restricted stock amortization, which is not cash. But you're also beginning to see our addition to staff that we are making in anticipation of the merger to some extent.

Okay so, and I understand you don't want to comment on what G&A will be post-merger. But as far as the ramp up for second and third quarter, is $7.5 million a good run rate? Or is this going to go up by another $0.5 million or $1 million in each successive quarter?

I wouldn't expect the latter. I think that $7 million is probably pretty close.

So $7 million is a good G&A run rate?

Yes.

And then --

I wouldn't expect it to grow as it has. Again, we probably should have made this comment last quarter, but any time you're -- obviously, when you're adding in employees, you're not adding them in the first day of the month or the first day of the quarter. And so the subsequent quarter, you're picking up -- it's whole quarters' worth of employees, when the previous quarter you were only picking up however long they were there. And so, there is a natural ramp up.

And we are being conservative in the sense that we are hiring and want to have people in place and sitting at their desks being prepared to manage this portfolio the day that it closes. So I think we're very comfortable with where we will be administratively, relative to the peer group and to the industry. But we don't want to be short-sighted in terms of being prepared to close the transaction and manage it effectively.

Okay, and then as far scalability, the additional people that you need, that you're bringing on board, is that more for the accounting department? Because there's not much property management here. So trying to get a sense of where these people are filling in to help bring the platform up to where it needs to be to integrate everything.

Well, I'd let Pete Chime in, but there is some back office for the accounting, although there is some scalability there as well. I think a little bit of incremental on the property, but obviously the acquisition staff.

I would say we had some natural growth in headcount and G&A just steady state as we transitioned from being a private to being a public Company, which was probably a 20% to 25% growth in headcount. And the Cole II addition also puts in another 20% to 25%, as we increase our asset management staff about 25%, increase our acquisition staff about 50%. And so you're seeing the effects of both of that.

So even absent Cole, you guys would have been growing the G&A line as you're bulking up. Really it sounds like the acquisition folks.

Acquisition and accounting, it was a big transition from 2012 to 2013 becoming public again

My second question is as relates to management's time, you spoke about you guys are still looking for acquisitions. If we think about the Cole is obviously a big deal. From management time -- management, for lack of a better word. Is all the focus on Cole? And therefore, it is conceivable that not as much focus is on backfilling tenants or acquisitions? Or do you guys feel comfortable that all cylinders are firing in each of the respective departments?

I think we certainly feel comfortable. Looking at the quarter, I think we have 13 properties that are vacant. And certainly that number has come down. Our occupancy has gone up, and that shows some good management focus there.

We deployed capital consistent with the guidance that we provided and a little bit ahead of that, both in terms of volume and rate. And so I think that flowed through the numbers as well. And so we are equally split, keeping our eye on the ball of executing the business plan that we put in place before the Cole II merger, and then obviously, getting that Cole II deal done.

(Operator Instructions)

Your next question comes from the line of Rich Moore with RBS Capital Markets.

The credit profile of the assets that you bought this quarter, what did that look like?

Rich, it is generally consistent with the portfolio. Slightly better from a unit-level coverage, and consistent from an overall corporate credit perspective.

Okay, good. Thanks Pete. And then, you don't really provide a same-store rental increase number. Is that the 1.25% you're talking about? If we just assume that most of the stuff in your portfolio is same-store, and 1.25% is about your average. Is that what you're thinking in terms of a same-store rental number, quarter over quarter, year-over-year?

That's generally how we look at it, Rich, yes.

Okay great. Thank you. And then looking at acquisitions, are you guys seeing -- you're exactly right, I think, Tom.

This space is clearly much hotter than it's ever been, but when things get hot, you get competition. And are you seeing a lot of competition for the stuff you're looking at, maybe new players coming in? Or is it just a playground out there, and you guys have about anything you want to look at?

I think it's an excellent question. We are not seeing excessive amounts of competition relative to where we've seen it before. And the playing field is reasonably consistent. You've got the well-known public companies that have been out there a long time and have done a good job and have relationships that they are utilizing.

We've been around 10 years. We're utilizing the relationships that we have. And then the private players, the private REITs, that sector of the industry has been around for a long time as well. Now the players have changed a little bit over time, but it's been around for a long time.

I think those groups have been probably a little bit more successful in the last year raising capital than maybe they've up to then. So there might be some more competition in that regard. But my sense from working and spending time with our acquisition staff, given the relatively modest amounts of acquisition targets we had this year, that we were very comfortable that we've got sufficient opportunities to sift through to find the ones that meet our investment criteria.

It's always going to be a competitive market. If there's good risk-adjusted returns in it, it will draw competition. But I don't think -- at the moment, we haven't -- I don't think we've seen a free-for-all or any of the companies doing things inconsistent with their business plans. I think the discipline industry-wide has been very good.

And I would add, Rich, it certainly seems to me that it is the same names. And the guys who have been in the space a long time doing more and competing harder than really a change in the competitive environment where new guys have entered in.

We get asked this question a lot, and have Cap rates come down? And there's no question, from the time, even from the time that we went public to today, Cap rates have come down. But they have not come down dramatically.

And, of course, the relative arbitrage versus the financing market is they've moved almost in lock step to the point where the accretion possibilities have remained reasonably consistent, even with those more aggressive Cap rates. So more competition will drive lower cap rates. We have seen lower Cap rates, but not in the fashion I think at this point that is causing us alarm, relative to the things we are looking at.

Okay good, thank you. And then the last thing is on the opportunities you're seeing. You said that there's plenty out there to look at. Is that all retail that you are thinking, or is there some temptation to spread out beyond that?

We are looking the majority at retail, Rich. As we have said the past, we will look to grow our portfolio the way it exists today. We are comfortable the way it exists today, and we are 70% retail, and the balance across industrial and office. And we are sticking to that.

And so we may see some gravitational wave from retail, if the opportunity makes sense, the real estate is operationally essential, and we can get comfortable with it. But you'll continue to see us do the vast majority of our investing in retail.

That concludes the Q&A portion of today's call. I'll turn the call back over to Mr. Tom Nolan.

Thank you, Patrick, and thank everyone for your interest in Spirit and for listening in to our call today. And we look forward to talking to everyone again soon. Thank you very much.

That concludes today's call. You may now disconnect.