Spirit Realty Capital Inc (SRC) 2015 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to Spirit Realty Capital's 2015 Second Quarter Earnings Conference Call. At this time, all lines have been placed in listen-only mode. Please note that today's conference call is being recorded. An audio replay will be available for one week beginning at 6 o'clock PM Eastern Time today and the webcast will be available for the next 90 days. The dial-in details for the replay can be found in today's press release, and can be obtained from the Investor Relations section of Spirit Realty's website at www.spiritrealty.com. After our speakers' remarks there will be a question and answer period. (Operator Instructions)

I will now turn the conference over to Mary Jensen, Vice President of Investor Relations for Spirit Realty Capital.

Thank you, operator. Joining us on the call today are Tom Nolan, our Chairman and Chief Executive Officer; Phil Joseph, our Chief Financial Officer, Gregg Seibert, our Chief Investment Officer; and Mark Manheimer, our Executive Vice President Asset Management.

During the course of this call, we will make forward-looking statements. These forward-looking statements are based on the beliefs of assumptions made by and information currently available to us. Our actual results will be affected by known and unknown risks, trends, uncertainties and factors that are beyond our control or our ability to predict. Although we believe that our assumptions are reasonable, they are not guarantee of future performance and some will prove to be incorrect.

Therefore our actual future results can be expected to differ from our expectations and those differences may be immaterial. For a more detailed description of some potential risks, please refer to our SEC filings which can be found in the Investor Relations section of our Website. All the information presented on this call is current as of today August 06, 2015. Spirit does not intend and undertakes no duty to update forward-looking statements unless required by law.

In addition, reconciliation to non-GAAP financial measures presented on this call, such as FFO and AFFO, can be found on the Company's quarterly report which can be obtained on the Investor Relations section of our Website.

During our prepared remarks today, Tom Nolan, our Chairman and CEO, will provide a review of our second quarter growth metrics, as well as an update on how we are progressing on our key focus areas. Phil Joseph, our CFO, will then discuss our quarterly financial results that were released earlier today. After our prepared remarks, Tom, Phil, along with Gregg Seibert and Mark Manheimer will be available to take your questions.

With that, I would like to turn the call over to Tom Nolan. Tom?

Thank you, Mary, and thank you everyone for joining us today as we discuss our second quarter results. Before I touch directly on that, I would note that later this quarter will mark the third year anniversary of Spirit's Initial Public Offering. I would like to spend a few minutes to reflect on the Company's activities since that date.

During our IPO road show in September of 2012, our commitment to prospective investors was to create a dynamic industry leader in a then relatively small world of public triple net REITs. We expressed our view at the time that there was tremendous risk-adjusted value potential in the sector and that we intended to capitalize on that. We also expressed the confidence that the institutional market, which finally embraced this sector, which after that point the leading market participants had capitalized themselves mostly through retail investor outreach. Clearly this institutionalization occurred and it's continuing. The market capitalization of public companies in this sector has increased many fold over these three years.

However, today our commitment to investors and prospective investors remains the same. We intend to be an industry leader and I would also note our view on the relative risk reward of the investment potential in this sector is also as favorable as it's ever been. I say that in the context that I appreciate the recent anxiety over the prospect that interest rates could go up and negatively affect our sector. It's certainly possible that rates could increase, but this isn't something we haven't managed before and I would remind everyone that the 10-year treasury yield is lower today than it was a year ago. And importantly, the spread between our acquisition cap rates and the benchmark yield remains wide by historical standards and therefore from my perspective, continues to present excellent risk adjusted investment opportunities.

This quarter, our reported initial cash yield on acquisitions was 7.67%. The 10-year treasury has been hovering recently around 2.2%, or a spread of over 500 basis points. That spread level indicates risk adjusted investment opportunity and we intend to continue to capitalize on it.

At the IPO, when we put our stake in the ground about being a leader in this sector, there was natural and legitimate skepticism. Number one, the executive management team was newly assembled. Number two, the portfolio had revenue concentration issues, with one tenant representing over 30% of the Company's revenue. And three, the right side of the balance sheet was viewed as too high and too rigid, therefore limiting growth potential.

Let me touch on what has transpired over these almost three years, starting in reverse order with the balance sheet. As you read in our press release, our debt to EBITDA at the end of this quarter stands at 6.7 times, the lowest ratio we have reported. We are very comfortable that around this range of indebtedness is a rational level to run this business. And also there is more to balance sheet and liability management than just a spot number. We have proven we are adept at proactively and accretively managing maturities. Today, we have a well-laddered debt profile and for those maturities that are on the horizon, we have proactively addressing those now with every expectation that they will be refinanced on a long-term basis with better terms as to both rate and collateral requirements. As Phil will reiterate later, our unencumbered asset pool stands at $2.8 billion, compared to practically zero at the time of the IPO. And this pool will only increase as we continue to refinance existing debt.

As to those IPO concerns over our inability to grow, I would note that today our market capitalization is around 3 times larger than at the IPO and importantly, from someone that is not a believer in growth for growth sake, I would call attention to the press release today that notes our AFFO per share, the ultimate litmus test of execution, [grew it] almost 6% this quarter over the comparable quarter last year and it's grown over 13% since the closing of the Cole merger.

As item two, revenue diversification. We have long acknowledged the issue and put up a thoughtful plan in place to address it. We devised a multi-pronged strategy and then executed it. At the time of the IPO, with the exception of EPR, Spirit had the least diversified top10 portfolio in the industry. Today, against that same peer group, we have the most diversified Top 10 portfolio. We even have the most diversified Top 5 portfolio. And I would add that not only is our Top 10 portfolio diversified, but at a weighted average unit level rent coverage ratio of 2.5 times, it has excellent credit metrics that should ensure the durability of our future cash flow.

Finally, that's the item one, yes, we were a new management team, but we didn't lack industry experience and we aren't newly assembled now. I am happy to have added Phil to the team. But the other three of us in the room today have been here since the IPO and this team has executed.

In addition to the items I have already touched on, I would note, since the IPO, in addition to the Cole merger, Spirit has invested in over $2 billion of real estate at an aggregate initial cash yield of 7.7%. Almost all of these investments contain contractual rent escalations and to date we have not had one payment default. In addition, through active and aggressive portfolio management, we have divested and recycled over $900 million of property. Finally, we have executed over $6.5 billion of capital markets transactions, all the while improving our AFFO per share and the aggregate quality of the portfolio. As I said a moment ago, in a less than two years since the closing of the Cole merger, Spirit has grown AFFO per share 13.4%.

Perhaps this is a good spot to touch on our Executive staffing plan. As I noted on prior calls, I assume many of the executive oversight responsibilities of our prior COO as I continue to assess the long-term needs of the organization. Over the intervening period, I have assigned acquisition oversight responsibility to Gregg and portfolio management oversight to Mark. With the addition of Phil to the team, we now have close to 100 years of actual real estate transaction experience sitting in this room, much of it in the case of Mark and Gregg directly from the net lease sector. I am very comfortable with the depth and breadth of our senior leadership team and the rest of the organization. That said, I am intending to add another executive to the team with more internal focus on important administrative and HR duties to complement our Group and to recognize the current and future needs of the Company. I expect to complete that search shortly.

Now, after you have indulged me for short look back at history, let me turn to the second quarter of 2015. As to our financial results, Spirit had an excellent first half and I believe our second half will be equally productive. This quarter, we reported AFFO per share of $0.22, a 5.8% increase over the comparable period from last year. Through our focused investment underwriting and capital recycling execution, revenues increased approximately 11% in the quarter. In addition, we paid a quarterly dividend of $0.17 per common share. Phil will get into greater detail on these numbers in a moment.

Turning to our existing portfolio, we continue to derive predictable cash flows from our stabilized portfolio, due to the credit quality of our tenants and our asset management expertise. We increased our occupancy by 40 basis points, remaining above 98% during the quarter with an average remaining lease term of 10.8 years, which is essentially unchanged from last quarter and up from 10.1 years at this time last year. At June 30, 2015, approximately 46% of our annual revenues were derived from Master Leases and approximately 89% of our single-tenant leases provides for periodic rent increases.

We believe that disciplined underwriting is the first step to a high quality diversified tenant roster, but it doesn't end there. As part of our asset management program, we continually review our tenants' corporate and [unit-rental] level financial performance, which helps us monitor our tenant's credit risk, as well as any underlying business and market trends. For the trailing 12 months, our unit level rent coverage was a healthy 2.8 times for our reporting tenants and consistent with what we reported a year ago.

Moving on to our investment activity, during the quarter we acquired 95 properties for approximately $289 million. The initial cash yield on these investments was approximately 7.67% and the average remaining lease term was 16.5 years, 77.5% of our acquisition activity was achieved through direct sale-leaseback transactions, and we obtained Master Leases on approximately 65.6% of them. Finally, over 95% of these leases provide for rent escalations over the term, an important element in establishing organic growth in the future.

We continue to execute on what we believe is a proven investment strategy, acquiring a diverse group of net leased properties that are operationally essential to our tenants, principally middle-market in terms of credit underwriting in well located geographic areas and across various industries.

As of the end of the quarter, you will note, we also have a new Top 10 tenant. Haggen Inc, a regional grocery chain, moved up to our number 4 tenant, representing 2.7% of our normalized revenues. As you may know, we were able to acquire these assets from a larger retail grocer who was mandated by the Federal Trade Commission to dispose of them. We acquired 20 assets for approximately $225 million, representing an initial yield of approximately 7.5%. These assets were underwritten on in-place and pro forma basis, with a unit level coverage north of 2 times. The assets are in well located infill neighborhoods, spanning the West Coast from Southern California to Washington State, and are secured under one Master Lease for 20 years. The lease provides for annual rent escalations of 2% per year. While we are confident of Haggen's expansion execution, we also took comfort in the quality of the real estate, particularly as it related to our acquisition basis. In a study we completed as part of our due diligence, our acquisition price was pegged at less than 60% of replacement cost for these assets. Now, I would note that while the replacement cost is not always reliable metric for all triple net assets, it most certainly is when you're analyzing densely populated, high barrier to entry West Coast locations, such as Laguna Beach and Carlsbad, California.

Going forward, we have a solid acquisition pipeline with numerous transactions already closed or under contract. The market for net leased properties while still competitive, is essentially unchanged from last quarter and we continue to underwrite attractive acquisition opportunities that are in line with our disciplined underwriting.

Turning back to our owned assets, as I noted, we now have the most diversified portfolio among the top net leased REITs. We got there because I'm pleased to report that we are well ahead of our stated Shopko diversification goal and have successively reduced our Shopko concentration to approximately 10% of our normalized revenues from 14% at the beginning of the year. You will note that in our supplemental package, we have included additional detail of the Shopko portfolio, both for assets that we have sold, as well of those we still own. This is more granular detail than we will likely provide on an ongoing basis, but given the volume of activity over the last six months, we thought it was appropriate and useful disclosure at this time.

I would draw your attention to a couple of key points highlighted on page 11 of the supplement. Clearly, Shopko is an attractive tenant and investors have responded accordingly. Our aggregate cap rate on sale of 7.3% is over 35 basis points inside of our acquisitions over the comparable period. In other words, not only have we met our stated divestiture goal, we have done so accretively, in spite of the reality that we were transacting as a motivated seller.

Second, as you all note, the key valuation and operating metrics of the assets we still own are substantially equal to or superior to the assets that we sold. I hope this puts the notion to bed that we only sold the best performing or most marketable locations. As you recall, we set a target of less than a 10% concentration by the end of the year. As we sit here on August 6, I'm happy to report that after giving effect to what has closed subsequent to quarter end and what's in the imminent pipeline, we have already met that goal.

In prior calls, we've been asked if we expect the concentration to continue to climb and the simple answer to that question is yes, but as opposed to the very public and motivated sales effort we've executed over the last six months, we will likely sell additional assets under our customary approach to active portfolio management, as we do with any disposition, where we're looking to opportunistically achieve superior pricing. In other words, the concentration will go down, but we will do it rationally when the opportunity presents itself.

Moving to our balance sheet, our leverage and capital structure continued to improve. Through our capital recycling efforts, as well as well timed capital markets transaction, we generated ample funds to finance our acquisition activity without the need to utilize our ATM during the quarter. As such, as I noted earlier, we have successfully reduced adjusted debt-to-annualized adjusted EBITDA to 6.7 times. Our fixed charge coverage ratio was 2.8 times and we continue to unencumber our portfolio to create greater flexibility. Year to date, we have also extinguished approximately $337 million of high coupon secured debt that had a weighted average rate of 5.64%.

With many of our stated portfolio objectives well underway or essentially behind us, we now intend to conduct more active shareholder engagement activities. We are currently planning a Non-Deal Roadshow in late September, among other initiatives. We will have more details to share in the coming weeks. We believe we have an exciting story to tell and look forward to that opportunity.

With that, I'll turn things over to Phil, who will walk you through our second quarter financial highlights. Phil?

Thanks Tom. We are very pleased with our strong second quarter financial results. More importantly, though, this quarter represent a new beginning for us in terms of enhanced financial disclosure. We are very excited about our inaugural supplemental financial disclosure and welcome your feedback. Our Spirit team put in a lot of hard work to produce this disclosure and I want to thank those throughout our organization that contributed.

Before I provide commentary on our earnings results for the quarter, I want to once again highlight the disciplined and measurable improvement in our portfolio and financial position. Our second quarter portfolio and financial overview, as noted on page 4 of the financial supplement, highlights our progress in this regard. We have accretively reduced our Shopko exposure to 10.4%, increased our real estate investment portfolio year-over-year by 8.7% to $8.2 billion, essentially [maintained] full occupancy at 98.7% and reduced leverage to 6.7 turns. We also hope that you find our financial ratios disclosure on this page informative as it relates to our stated goal of diversifying our access to institutional capital.

As Tom said, this afternoon, we reported AFFO of $0.22 per diluted share for the second quarter ended June 30, an increase of 6% compared to the second quarter of 2014 and a 2% increase from the 2015 first quarter. This year-over-year increase is primarily due to higher rental income as a result of our strong acquisition activity over the last 12 months, coupled with moderate same-store rental growth, consistent operating expenses and lower cash interest expense. On the same-store rental growth that we now disclose for our portfolio, please note that this figure will fluctuate from time to time, given the nature of annual versus periodic escalation terms contained in our leases, as well as the intra-quarter timing of schedule base rent increases. We believe that you will find this incremental financial disclosure on our portfolio helpful.

Total revenues for the quarter ended June 30 increased approximately 11% to $167.9 million compared to $151.8 million in the second quarter of 2014. Sequentially, revenues grew by over 3% in the second quarter when compared to the first quarter. During the current year second quarter, we recognized a $2.1 million legal settlement in other income following resolution of a dispute with a prior tenant. You may recall that we recognized a similar settlement with a different tenant in Q2 2014, which approximated $2.7 million.

Total operating expenses in the second quarter of 2015 decreased 1% to $173.4 million from $175.9 million in the same period of 2014. In the second quarter of 2014, we had ABS restructuring costs of approximately $13 million. Adjusting for this one-time charge, our operating expenses increased year-over-year by approximately $10.6 million. $10 million of this variance is attributable to certain non-cash items, namely asset impairment, depreciation and amortization and non-cash interest.

With respect to G&A, our G&A run rate remained consistent at 7.1% of total revenues. Cash interest, notably decreased over the second quarter of 2014 by approximately $1.2 million, even in light of moderately higher principal debt balance. Furthermore, it is important to note that our weighted average cash interest rate decreased by approximately 17 basis points to 4.92% from the prior-year second quarter, principally due to the repayment and re-financing of high coupon debt.

Moving on to our capital structure and liquidity, the Company is entering the second half of the year well positioned for prudent growth. In April, we raised net proceeds of approximately $268.8 million via a follow-on equity offering at $11.85 per share. In addition, during the quarter, we sold 42 properties raising gross sales proceeds of $285 million at a weighted average cap rate of 7.25%. These sales resulted in the recognition of a gain on sale of approximately $63 million, $57 million of which resulted from the sale of 16 Shopko assets. The proceeds from these transactions enabled us to improve our well balanced capital structure and accretively acquire over $288 million of assets during the quarter at a weighted average cap rate in excess of 7.6%.

During the quarter, we extinguished approximately $175 million of high coupon secured debt with a weighted average coupon rate of 5.54%, increasing our unencumbered asset base to $2.8 billion or 35% of our real estate investments. As a result of very efficient capital recycling and timely capital market transactions during the quarter, we reduced our net debt to adjusted EBITDA to 6.7 turns. As I've stated previously, we plan to end the year sub-7 from a leverage perspective.

Additionally, our credit metrics continued to organically improve, as noted by our fixed charge coverage ratio of 2.8 turns and our ratio of unencumbered assets to unsecured debt in excess of 3.7 turns. These credit metrics as is, when paired with our sizable and growing unencumbered asset base and proven access to institutional capital markets, helps to solidify our goal of diversifying our access to institutional capital in an accretive fashion.

Now turning to corporate liquidity, as of June 30, we have approximately $20 million drawn on our $600 million unsecured credit facility. Currently, we have approximately $40 million in unrestricted cash and cash equivalents on our balance sheet and $55 million drawn under our $600 million line of credit. In addition, we have approximately $40 million of liquidity available in our [10.31] exchange and Master Trust notes release accounts that are available to fund real estate investments. In summary, our strong corporate liquidity position well positions us for prudent and accretive growth.

During the quarter, we declared a dividend to common stockholders of $75.1 million, which represented an AFFO payout ratio of 79% compared to $66.3 million, representing an AFFO payout ratio of 84% in the comparable period a year ago. In conclusion, as a result of our strong first half performance, we are increasing our 2015 AFFO guidance range to $0.85 to $0.87 per share from $0.84 to $0.86 per common share.

With that we will be happy to take your questions.

(Operator Instruction)Juan Sanabria , Bank of America/Merrill Lynch.

I was just hoping you could speak a little bit about, it seems like the revolver balance has gone up post quarter and how we should be thinking about that. Has that been going towards retiring debt or funding potential acquisitions, you've noted you closed on some stuff post quarter.

We said that the line has gone up a little bit. I mean we have ample corporate liquidity on our Corporate line of credit. I mean it is de minimis In terms of overall borrowings and in that regard, it's clearly viewed as an interim working capital facility and we look to keep our line balance at a minimal balance at all times.

I think you reference in your press release that it is up from the $20 million as of the quarter end. Is that --

Yes, but that's a de minimis amount. I mean it's --

I mean yes, we have bought -- we bought some properties subsequent to quarter-end, but to Phil's point, I don't think it went up that much. Matter of fact I think it went up a very small number.

On the new disclosure on the NAV at the back of the sup, is the annualized rents figure that you gave is that pro forma for acquisitions and dispositions that would have occurred during the quarter?

No, that is based on in-place rents at the end of the quarter.

So not pro forma for -- but the end of the quarter implies that it's adjusted for transactions that happened before the end of the period?

It's the in-place rent that's in place at the end of the quarter annualized, so in place at the end of the quarter is that annual rent annualized, for the rent received during that quarter.

And then the difference then versus the lease roll, where you have sort of the total rents expiring, could you just explain that?

(inaudible) between lot of different places.

Yes, page -- the last 17 and 18.

Yes, that -- I now need to get back to you on that one. I don't have a crisp answer on that one. But we definitely going to spend some time with you offline.

And then I just noticed some interesting disclosure. I think it was Page 15 on the variance with the different industries. Is it percent change in industry type, is that the change in sort of same-store rents across the industries, is that what you're highlighting there?

Yes. That's right, this is Mark. Yes, so we kind of did the same-store rents quarter over quarter for stores that were in place for the past call it 15 months, and then kind of bifurcated it all by industry.

And what drove then -- or what drives the above-average year-over-year increases, which are our merchandise, home improvement and entertainment, is that some sort of percent rent that you can capture as part of a lease?

Yes. it's always going to be kind of lumpy quarter to quarter, but what you're seeing there is, there were rent bumps, contractual rent bumps within both of those two industries and so both of those -- and home improvement and general merchandise were multi-year increases, so they're going to be a little bit more than kind of our 1% to 1.5% usual bumps.

I mean, if you recall, we get bumps two different ways. We either get them annually or we get them a certain percentage over a certain amount of years and the general merchandise category, I believe, the bigger tenant bumps only every three years. So you're going to get -- given this presentation, you're going to get lumpiness.

In the home improvement one, for instance, is actually one property, it's the Home Depot, pretty large property up in San Francisco where we had five years of CPI roll through that, that one property.

And just lastly -- I think I missed the detail, you mentioned the other income, the $2.3 million, some sort of settlement. What was that regarding, again?

That was just a longstanding settlement with a tenant that we just had a recovery with them, it was nothing out of the ordinary.

Is that something we should think of as an annual sort of number that occurs every second quarter, or it's just more a one-off in nature?

Not at all. As you manage your portfolio you are going to have tenant defaults and you have recoveries coming from tenant defaults, so it's not [an issue].

Obviously with 2,300 tenants, there's always the opportunity for a settlement. But the other reason we called it out is because it's not recurring, it's just the opposite. It is not a recurring item, and so we had revenue that people would not consider it to be recurring. So, we call it out and let people know that it was unusual, but it's not something I think we certainly don't underwrite and we wouldn't look at it to be recurring.

So it was sort of a lease term payment?

Yes, it was a settlement that was received.

Vikram Malhotra, Morgan Stanley.

Congrats guys on the strong quarter and getting the supplement out, lot of useful information in here. So, well put together. Just first question on Shopko. I guess as you went through this process over the second quarter, maybe what surprised you most, you are obviously ahead of your target and the cap rate seem pretty attractive, maybe even versus where you budgeted, but you know kind of what surprised you and then could you give us a little more color on kind of big picture, where you intend to take this eventually in terms of the exposure?

I hope you are not disappointed with the answer, but we weren't surprised by much. We've -- I know we've been saying for a while, we think they are very good tenants, not sure everybody agreed with us and clearly, again with the concentration, it just drew a lot of attention, but we knew given the improving performance and Shopko has had improving performance over the last 12 months, between the quality of the real estate, the improving performance of the tenant, we felt pretty confident that we were going to be able to move within a relative scale, the amount of product that we needed to move and so, no clearly, we set a target by the end of the year, we gave ourselves some room, but if we could get there sooner, we were certainly going to do that and we were happy to do that.

Now, as to the final target, we expect it to go lower. I really want to avoid kind of -- again, having better motivated [sellers] over the last six months. I'm pretty happy that we were able to get 7.31% as a motivated seller. I am trying to take the motivated seller [mental] off and so from hereon out, we're going to be -- we will be selling them and we'll be doing that opportunistically, but I want to resist putting a target out there, because quite frankly that makes you a motivated seller again.

So I think you can -- you can look for the concentration to continue to go down, but we'll be doing it hopefully on terms that we find attractive.

Okay. And then --

And Vikram (multiple speakers) add maybe a little bit of color as you can kind of take a look, we tried to add a little bit in the supplement on page 11, where we get into not only we're able to hit [7.3%] on the cap rate, but we also tried to improve the portfolio at the same time, so we're able to increase the sales per unit, sales per square foot, cash flow per location, and the rent coverage as well as the lease term.

And to clarify, did that number, the overall sales number include the distribution center that you had as part of Shopko?

Yes it does.

Just a question on one of your tenants I saw in the top 20, the Red Lobster Hospitality, is that something new or is that's been all long.

That's something that we bought at the end of last year.

And was that part of -- how did that process work in terms of your buying those assets?

It was a sale leaseback with a private equity firm that purchased Red Lobster.

Which we did maybe six months after the larger sale-leaseback that got done.

And then just last one on your new tenant, the Haggen, obviously the metrics you cited seem pretty strong. I'm just kind of wondering, you mentioned coverage at [2], and we've heard at least in certain press releases that there being some, call it, operational challenges, some layoffs. Was that kind of pre-planned as part of Haggen's original acquisition or is it something more recent?

So, yes, and some of the sales changes were mostly part of their business plan, things that they had in their plan, that they were anticipating for the part.

Alexander Goldfarb, Sandler O' Neill.

And again nice job on the supplemental. Few questions, the first is, Tom, just stepping back sort of from everything and you look at the market and obviously what it unfortunately has done to your stock price, hopefully you know the Shopko dispositions get some recognition. But assuming that market stays as it is, how do you guys think about your acquisition potential for the remainder of this year and into next with where the stock currently is, or is your view that with what you have lined up to sell, you'll be able to sell enough to fund acquisitions and still be able to delver and unencumber as, as you guys have discussed?

Sure, I am happy to address that. I guess there are a couple of points embedded in there and there's no question, the general stock performance of the triple net sector has been tough the last 60 days and it's been a little tougher on us and you can't -- the numbers speak for themselves. I do believe obviously, we are [confident] we've had a good quarter; we've had a good year and our expectation is for brighter days ahead. But in terms of the reality of dealing with where we are right now, I think we're moving ahead business as usual and the cap rates that we're buying and we're very happy with the type of real estate that we're getting, where it supports a nice portfolio of real estate at a 7.7% cap. We can buy accretively at a 7.7% cap today, even with the share price where it is. So, kind of that certainly one level. And I think that we were -- I would like to point out, I think we've been reasonably disciplined on that capital, even when we had a better month. I look at acquisitions in terms of what the right risk adjusted returns for the asset, not necessarily what can I pay for it and then run up and pay that amount. You saw across the industry, there were -- in the last couple of quarters there have been some decent portfolios that have moved at some pretty aggressive cap rates, I guess, in our view, portfolios in the 6s, more than -- at least one of them sub-6 and we weren't participating in those. We look at them, we certainly price them, but we really like the portfolio that we are able to put together and the assets that we're able to acquire and we did that at a 7.7% cap. So with the general trade-off in the sector you might not see some of those portfolios being done at the pricing that was being done, but we weren't doing those anyway. And so yes, we can buy accretively.

To your other point, yes, we expect to continue to recycle. I mean we have been doing it since the venue. I mean $900 million of assets have been recycled through this Company, since the IPO. We'll continue to do that; we'll continue to do it from a portfolio management standpoint. And in other words, we will make portfolio management decisions and get ahead of what may be prospective issues or alternatively, we'll do it where we see opportunities to recycle and reinvest the capital at a better rate. So I think you'll see a combination of all of those things, but where the bottom line is, is that the stock is where it is, but we can continue to buy properties accretively, grow AFFO per share. And obviously we're very confident that we're going to close that multiple gap and hopefully have better performance going forward. That's certainly our ambition.

And then the second question is in the release you talked about renewals being only about two-thirds of the leases that expired. So what's going on with the leases that didn't expire as far as were those tenants who close shop or moved out? And then as far as downtime for backfilling, and just more broadly, how should we think about renewals for the portfolio?

Yeah, I'll let Mark touch on it. I guess I would offer one quick view, which is historically our renewals have been around 80%. Well, we're a little lower this particular quarter, but the sample size is so low that it is really takes kind of one property and your ratios go out of whack. So I'll let Mark get to the specifics, but we don't draw any trends from that one quarter given the relative small amount of properties that were involved.

Yes to echo out what Tom said, it is an extremely small sample size, which we like to have a low number of expirations. And I would probably kind of think we'd gravitate back towards the mean over time. And then I guess the second part of your question, the specific locations that did not renew this year, those are up for [re-lease] or for sale.

Vincent Chao, Deutsche Bank.

Maybe just to follow up on the renewals here, just of the remaining [20] that are set to expire this year, I guess what's the -- how are those conversations going and I guess do you expect to retain roughly 80% of those or how should we think about just the near-term expirations?

I mean I hate to speculate how those are going, but I would generally assume it will be generally in line with our past experience.

The sample sizes are smaller, shouldn't have a material impact on our performance.

And then maybe just on the investment side, obviously you just talked about the cost of capital side of things, but just from an opportunity set perspective, given some of the -- some of the volatility in the rate environment and things like that just curious, has that changed the dynamic? I think I heard you earlier in the call say that the conditions have been basically the same, but just curious if there's any geographic areas or industry pockets where you're seeing more or less opportunity as a result of the current rate environment?

No, I think it's been reasonably consistent. I mean as we have said in prior call, obviously if you have a big rate move, ultimately it will work its way through the cap rated, it always does. They don't go in lock-step, but at the moment the changes and there's obviously been volatility, but, I mean again, we're lower than we were a year ago and it's seemingly going to stay there for a while and I know it seems like the CNBC and the Wall Street Journal are all focused on the Fed. We look at the 10-year treasury more than what the Fed is going to do and it really hasn't added that much element; that volatility really hasn't changed the pricing dynamic very much. Gregg, I don't if you want to weigh in on --

No, the industry is again very consistent the past quarter, there hasn't been any much fluctuation at all, and the cap rates, I don't find one industry where there has been a significant impact one way or the other on where they've been for the past 12 months.

And then probably I know the answer for this too, but just in terms of (inaudible) obviously we've now had another fall back in oil prices, so we got that, plus the interest rate environment. But I guess you know is that -- anything changing there in terms of investors or companies willingness to sell?

No. I mean I haven't seen that dynamic impact the market.

And then just last question on the settlement fee income in the quarter, I think it's about $0.02 or so added. I guess was that something that you guys were thinking about or new -- was this a potential in the context of the prior guidance or was that -- is that incremental to the outlook?

First, I just -- there's a correction, it's $2 million not $0.02.

Oh, sorry, yes.

Certainly not $0.02.

And again, as we said, I think we have a large portfolio, from time to time, we'll have tenant settlement issues come up and like Tom said, we just want to point it out, but as I did point out in my script as well is that we had same amount in the second quarter of last year. So just directionally want to point you guys in the right direction.

And I see in terms of your specific guidance question, I think you we made a guidance change here, because we're sitting in August, we've come off of a strong first half of the year. The Shopko recycling has gone well and so therefore we've made an adjustment.

Ross Nussbaum, UBS.

Phil, could you elaborate a little more on what the game plan is for the $1.2 billion of CMBS you've got expiring before the end of 2017? Is it unsecured, is it bank term loans, is it a little of both, what's the game plan for that at this point?

No, it's non-recourse debt and I guess when we look -- when I look at our debt maturity profile, I view it as being a tremendous opportunity for us from a couple different standpoints. Obviously, it's a great opportunity for us to reduce our cost of capital and refinance that debt at a much lower rate. Also, you already have a very sizable unencumbered asset base, and that's just going to only increase the size of it. So if you're question is from a refinance risk perspective, it's not there, it's very moderately leveraged debt, it's granular and as I've mentioned, it's non-recourse in nature. And you also need to bear in mind that given our existing unencumbered asset pool of $2.8 billion, I mean, that's an additional source of liquidity, the question is refinance related.

No, I think the question is your intent to replace the CMBS with CMBS, investment grade unsecured, or bank term loans?

I mean, we are converting to a more unsecured borrow. So, again, I think to Phil's question, this is a real opportunity. We are going to have a host of different alternatives to put in place for that and I would say it was actually coming at us sooner.

So, Ross, I'm sorry, we kind of cut you off there. Did we miss you question or what?

No, no, I think you addressed that one, I got a follow up, that's on a different topic, which is Haggen. From an acquisition underwriting perspective, maybe I can just say this bluntly, how did you gain confidence that they weren't going to screw up going from 18 stores to something nearly tenfold that? I mean this went from a small operator to somebody who grew tenfold. So how do you have comfort that they're going to make that transition and how do you underwrite that risk?

Again I'll let Gregg do it, because he ran the due diligence, but to me it's just what we do -- it's real estate due diligence. It's like from my standpoint, I guess what I've always done, which is getting to know the real estate, getting to know the tenant, getting to know the business plan and we met with management, we reviewed the stores, we reviewed all the comps, we reviewed market trends, so we ran a very extensive due diligence and we took tremendous confidence. These are some of the best infill grocery store locations that were being disposed of. And so, from -- and as I mentioned in my original text, the replacement cost of these assets was less than 60%. So we had a strong tailwind of fantastic real estate, and yes, we had a regional operator who is becoming a super regional operator, and there was a risk associated with that. But I think that's one of the reasons you're seeing the economics that you saw; that's why you have a master lease, that's why you have rent bumps the level that you have. But again, Gregg, I will let you go from there.

Just add a couple of notes to what Tom said, but they still have the back office being done by SUPERVALU, so that was not something they had to convert overnight to a totally new system. Another thing to point out is they did not one buy these all at once, it was phased in over a few quarters. So they would buy, for example, a store or two every other day. The team is in place, the executive team, specifically heavy in Southern California, a market they were not in, they were already in the Pacific Northwest obviously. The executive team has been in place for some time prior to the merger to work on this conversion and they have a plan going forward that makes a lot of sense on dispositions, they held back, they have a lot of dry powder, lot of unencumbered assets. Their plan was to not always operate all of these locations as Haggen, and that does not to apply to the Spirit stores, we're able to effectively cherry pick the best assets that they wanted to keep a long-term. So -- plus as Tom alluded to, we have a lot of financial diligence on their locations, unit level information, we looked at every site, and kind of [shuttered] the ones we thought were kind of in agreement with the Company that they wanted to keep over the long term and which we got comfortable in a variety of ways.

Are these freestanding or these sitting in shopping centers?

They are both, but a lot of them are the anchor of a shopping center.

And you've got a ground lease --

We do not own the shop space, we only anchor.

And I guess just as a side note, I would add to Gregg's statement, where not only did we cherry pick the strongest cash flow properties that were available and put them on a master lease, the assets that we did not select were subsequently been sold on the [10.31] market at about a 5% cap.

Right, there has been six trades in the past 45 days at a 5.23% cap rate.

Okay, just to clarify, you don't own the dirt under most of the 20%?

No, we own all the dirt.

You do?

We own all the land and all buildings.

And then the rent per square foot, ballpark, can you give us a sense of where that is?

Yes, I mean it's market rents we feel or below market rents, in the mid-teens.

Thank you.

And we got pretty comfortable in the real estate underwriting, as they're well located California and up the West Coast locations, at or below market, where even if this is something that we get back, we feel that there are a number of grocers that would step in at these rents or higher.

Right. And as Mark further nailed down to the specifics, but most of our exposure on this transaction is in the metropolitan areas of Seattle, Portland, Los Angeles, and San Diego.

But just to be clear, so there is no misunderstanding, we own the store, we own the dirt. (multiple speakers). These are 100% owned by Spirit, and when you were referencing markets, properties that we didn't buy they were outside of the portfolio that we bought, they have subsequently traded, and they traded since some of this noise has come out that made reference to earlier and then traded at cap rates between 5% and 6%. Our portfolio is under master lease at 7.5%.

Chris Lucas, Capital One Securities.

Maybe, Tom, to follow up on that -- the last point that you were making, looks like you had a little bit of a net spread between what you bought this past quarter and what you sold, given the capital markets conditions, should we expect more of an opportunity in the matching of dispositions and taking advantage of the arbitrage opportunity that might exist in the disposition market to help fund better acquisition opportunities?

There's been a lot of what you saw in the dispositions for Shopko. So I mean we've to recognize that we won't have that significant volume in every quarter, but we are an active recycler. I mean we will sell and we will look for opportunities where we think we can get and make basically a trade of an asset that we own for one that would like to own and obviously do it in an accretive fashion. So, we will do that, and have done that. And as I said, since the IPO this team has sold at this point and recycled close to $900 million of assets. So, we're not afraid to do it. We'll do it when we see the opportunity and it will be a component of the funds that we have available to us going forward.

And every quarter we take a look at the portfolio and I'd probably put our sales into three buckets that we try to take a look at. One being strategic or non-core assets. For instance strategic being Shopko and non-core being the multi-tenant assets that we got from the Cole II merger and then another bucket would be opportunistic sales where we think the market is recognizing or over valuing assets. For instance, that might not have a great lease, but might have an investment grade credit where with some expense leakage where we think we can get out of them at a pretty aggressive cap rates. And then the third bucket that we're constantly looking at are derisking sales where we're taking a look at where we think that we might be susceptible to losing some rent. And so we try to protect the cash flow streams by selling those properties.

And then Phil, I guess, just wanted to get an update on how you're thinking about approaching the rating agencies and what kind of conversations you're having with them as you continue to build that unencumbered base and work towards having a more flexible structure on the debt side?

So with the rating agencies, what you need to appreciate is that we are engaging with them and that's something that we haven't done before. So as it relates to the process, as I mentioned before, the rating agencies don't move on a dime. However, 2017 is a very transformative year for us. And as you know, with the rating agency, they take a prospective view in terms of a rating. They look -- they are able to look ahead 12 to 18 months and are making a decision today. So we are going to be having more active dialogs with them, but the key thing to point out is that this is going to happen organically. There is not a seismic shift that needs to happen on our balance sheet to get there. And clearly, I would be remiss if I didn't say, today I think we clearly are an investment grade credit. And I think all of that's going to really take for us to get there is more active engagement with them and just stay tuned.

And then the last question for me again with Phil, on the operating expenses, I mean just on a gross basis expenses were down sort of year-over-year, revenues were up 10%. I guess is there some seasonality or some one-time items that sort of drive some of the volatility in the operating expense line quarter-to-quarter?

No, there really isn't a big movers. From a seasonality perspective, our G&A remains constant at 7% of gross revenues. As I mentioned in my prepared comments, we normalize our operating expenses, taking out the one-time charges related to the ABS restructuring that occurred in the second quarter of last year, but not much seasonality in our operating expenses.

Dan Donlan, Ladenburg Thalman.

Just sort of going back to the Haggen's acquisitions, I think the Albertsons have to sell assets per the FTC, and if so, kind of was that more representative of the general set of properties that they had. I mean they didn't really sell their poorest performing properties, did they?

Could you repeat the last couple of words you said, the what properties?

The Haggen's assets, could you --

Right. So it was obviously part of the Albertsons-Safeway merger. So the FTC mandated that they sell off a negotiated number and location of stores. So in order to complete their merger, they had to simultaneously sell those assets.

And they had to sell it to a strategic buyers as well.

If you go back in the press at the time, you can see there were a lot of firms, I think [Samsung] wanted to buy it and there was a lot of interest in the transaction, but the FTC required that the assets be sold to an existing chain that was already in the market. And Haggen was already on the West Coast. So they were a prime candidate for the West Coast assets.

And then as far as -- you mentioned some sales in the low-fives, some in the low-sixes, how do you think those properties stack up relative to what you bought? And did you get a look at the assets you bought before the other assets were sold to that entity?

Yes, we looked at those assets. And the assets we had, we picked the assets we've obviously and that transaction closed after ours and we think ours are equal to or better than the assets that were sold.

And then looking at Shopko on page 11, all of the metrics that you provided are better that you own or better than what was sold. So just kind of curious on how we should think about the cap rate on the remaining assets. You sold everything thus far for a [7.3%]. Would you think that the remaining assets that you have with Shopko are kind of worth at or below that, or maybe the real estate associated with what you have maybe -- the ground maybe is worth less than maybe what you sold or do you think it's (inaudible)?

Yes, we selected the assets that we brought to market because we thought that A, they would be marketable and then we would be able to move them, but B, we really wanted to increase the performance metrics, the portfolio that we delevered. So if we were to go out and sell some of the cherries that are still in there, we could certainly get a lower cap rate, but that's not something that I would anticipate us doing.

I mean obviously Dan, as I said in my prepared remarks, I know I kind of hoped the statistic speak for themselves in the sense that I was constantly getting informal queries as to, I hear there they are transacting, but you must only be transacting the very best. I think they are pretty monolithic as we've made the point before (technical difficulty) they're very similar. The bell curve of their performance is actually pretty narrow; that store isn't that much different than probably their weakest store. So we are obviously reluctant to give you a cap rate, so I'm not going to give you a number, but I think we feel pretty good that we've lightened up the exposure by a third and yet all of the operating metrics have gotten better. So we clearly hope that people will look at that and say, they own a pretty solid group of assets that they have left.

Yes. It'll be pretty ironic if people start saying you sold too much a year from now. But just kind of -- I just have a couple more questions -- that the two-way coverage that you've provided, is that four-wall?

Yes. That's four-wall.

And then going back to page 18, one of the -- I forgot to ask one of the other questions about the annualized rents that you provided, the [614.7], is that a GAAP or cash number?

Cash.

So is the number on page 17 cash as well or is that a GAAP?

That should be cash and let me get back to you on that one. I want to circle back in terms of -- I think I have an answer, but I want to give you the right answer, Dan.

Yes, you've got some assets held for sale in that NAV page. (multiple speakers). I'll follow up with that. And then lastly, footnote 2 on page 9, it looks like you have some debt that's in default that's coming due this year. And then you have this -- something on the income statement, the accrued interest on defaulted loans. So are you just basically not paying any interest on those loans, you are going to get back the assets, in which case there shouldn't be any type of economic change when this debt actually comes due?

Yes, the capitalized interest, we're obviously not -- we were not paying it. Again, when we look at our loans that are like in default, we view them as a pure opportunity for us, given the option value there and low yield, debt yield, they're pretty much non-income producing assets and you can imagine the pickup that you get with respect to debt to EBITDA in that regard.

And to your point, yes, it won't have an impact. Most of these assets were actually legacy assets, restructured actually prior believe it or not, they're originally from the IPO, prior to the IPO and most of the economics had already been taken off of the table. There where no economic facilitated for them, but we basically had what in the private world I used to refer to as a hope certificate. Again, this was done prior to my even joining the Company. And so those assets have just kind of sat there and then the debt is ultimately -- the hope certificate didn't turn out, which is fine. But, so, now those loans will ultimately -- and the assets will go off the balance sheet, but there is no economic impact because we didn't have any economic impact associated with them in our underwriting.

And as Tom mentioned, the bulk of that is from pre-IPO and then the remaining loans that are potentially gone back to the lender are from the Cole II merger.

And I lied I've got one more. Phil is it unheard of or is it possible that you guys could get investment grade rated between now and year-end?

I like you putting the pressure on Dan, I like that.

(inaudible) But nothing is off the table. But again it's going to take up -- they don't move on a dime and again, not all agencies think alike. Certain agencies -- there's a potential, but again, the clear thing to message is that we're going to get there organically. There is -- I do think we're there now.

Yes. I think that's an important point, Dan, is a nice way to finish, which is I guess that we think we're there now, we don't really -- it's not going to require a cathodic change. We're going to present a nice business plan. But we also understand the kind of the courtesies of dealing with the rating agencies and they don't particularly like it when you put dates out there and suggest that you're going to have something occur at a certain time. So we're going to get in very active engagement with them. I think they are going to like what they see. As Phil has already said, we think that the metrics, as we put them through their models, suggest that we're already there. But it'll take time and if we can get there sooner, we're certainly we're going to work hard to do that. And it's -- when something is outside of your control, we certainly want to be conservative and I know, and certainly Phil's perspective as well. So all I can tell you is we're going to work hard on it, it's just going to be hard to fix a day.

Having no further questions, this concludes our question-and-answer session. I would like to turn the conference back over to Mr. Nolan for any closing remarks.

Thank you, operator and thank you all again for joining us today. We do believe we had an excellent and productive first half of the year and are looking forward to delivering an equally attractive second half. We believe the quality and diversification of our portfolio as well as our expertise within the net lease space will continue to provide sustainable, risk-adjusted growth that supports an attractive dividend and creates value for our stakeholders.

On behalf of Phil, Greg, Mark and I, we look forward to meeting with you and discussing all the positive things Spirit is doing and to create value for our constituency. However, in the mean time, if you would like to meet with us, please feel free to contact Mary Jensen, our Vice President, Investor Relations. In the meantime, good night to all and thank you very much.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.