Spirit Realty Capital Inc (SRC) 2017 Q2 法說會逐字稿

Good day, everyone, and welcome to the Spirit Realty second quarter earnings conference call. (Operator Instructions) Please do note that today's event is being recorded.

I would now like to turn conference over to [Brad Cohen]. Please go ahead, sir.

Thank you, operator, good afternoon, and thank you everyone, for joining us today. Presenting on today's call is President and Chief Executive Officer, Mr. Jackson Hsieh, and Chief Financial Officer, Mr. Phil Joseph.

Before we get started, I would like to remind everyone that this presentation contains forward-looking statements. Although we believe these forward-looking statements are based upon reasonable assumptions, they are subject to known and unknown risks and uncertainties that can cause actual results to differ materially from those currently anticipated due to a number of factors. I would refer you to the safe harbor statement in today's earnings release and supplemental information as well as our most recent filing with the SEC for a detailed discussion of the risk factors relating to these forward-looking statements. This presentation also contains certain non-GAAP measures. Reconciliations of non-GAAP financial measures to most directly comparable GAAP measures are included in today's earnings release and supplemental information, furnished to the SEC under Form 8-K. Both today's earnings release and supplemental information are available on the Investor Relations page of the company's website.

For our prepared remarks, I'm now pleased to introduce Mr. Jackson Hsieh. Jackson?

Good afternoon, and thanks for joining our second quarter 2017 earnings call. I want to begin the call with a brief update on our business and quarterly activity. Phil will then discuss our financial results, I'll finish back up with a more detailed discussion following up on our website, regarding our plan forward. As everyone knows, from the first quarter, we had a confluence of events that required us to revise our guidance and capital allocation plan for the year. We also did a poor job of articulating that message on the call. This was, however, by no means a reflection of the many outstanding attributes that make up Spirit, including its portfolio, people, processes and balance sheet.

I'm also especially satisfied that many of the initiatives that were put into motion over the past 10 months within Spirit began to take effect and are already enhancing our capabilities and results. As everyone knows, last quarter, we experienced a higher-than-normal amount of delinquent rent with certain workout situations and tenant bankruptcies, including Gander, hhgregg, Gordmans, Lone Star and Unique Ventures. That resulted in loss rent reserves of approximately $4.2 million. This was an aberration and by no means a reflection of our portfolio quality, operational capability and diversification of our business. We've tried to provide investors additional disclosure on our portfolio as a means to substantiate this statement, and most recently, if you look at our supplemental, we now show gross potential annualized rent which is referred and defined as contractual rent as well as annualized cash rent on our NAV page. Using these 2 numbers, you can calculate the net loss rent reserves. Also in April, we terminated a third-party servicer who managed over 60% of our assets. We took on those lease administration, property management and tenant surveillance responsibilities in the second quarter. We believe this is going to provide us much better visibility into our assets.

In the second quarter, our lost rent reserves were $1.1 million, which is approximately 1% of quarterly revenue. While Q1 was aberration, in this quarter, we saw the benefit of a number of operational and process improvements that were put into place in late 2016. Our same-store results, I'm happy to say, for the quarter are up 1.1% across our portfolio. Once again, a significant improvement compared to last quarter's Q1 negative 0.5%. This is a further indication of the positive health of our portfolio.

From a capital allocation standpoint, we were net seller of assets in the second quarter; however, we repurchased $200 million of common stock totaling 26.3 million shares at a weighted average price of $7.58. This resulted in a reduction of our float by 5.4%. We also acquired 9 properties that totaled over $92.8 million. 97% represented existing tenants such as Home Depot, Federal Express, Dave & Buster's, Sonny's BBQ, and White Oak gas stations. On a disposition front, we sold 48 properties that totaled over $109.6 million, which also included 5 Shopko stores. Preservation of balance sheet capacity and flexibility is important and our future capital allocation decisions will continue to reflect this objective.

We end the quarter at 6.6x recurring debt-to-EBITDA as compared to 6.5x in Q1 and this was net of Tom's severance charges. Our leverage target for year-end remains at 6.3x debt-to-EBITDA and our expectation is to continue to modestly acquire and sell assets throughout the balance of this year to achieve this target. As of June 30, our portfolio, which is comprised of single tenant critical operated real estate assets in 49 states was 97.9% occupied and had an average remaining lease term of 10.3 years. 44% of our contractual rental revenues were derived from national leases and 89% of our leases have built-in rental increases. Over 95% of our tenants provide us financial information and our weighted average unit 4-wall rent coverage remains at 3x with tenants that provide us [year] financials. Also, we renewed 6 of 8 expiring leases in the quarter and the revenue recapture rate was 94.7%. During the 6 months ending June 2017, we renewed 21 of 25 expiring leases, recapturing 98.7% of expiring rent.

Now let me address Shopko. In their first fiscal quarter, ending in April 2017, our Spirit-owned Shopko same-store sales were down 2.9%, with unit level coverage remaining at 2.48x. Our Shopko-owned stores are in good real estate locations and we own the majority of the most profitable stores within the Shopko operating company. We'll continue to sell Shopko stores throughout 2017. During the second quarter, we sold 5 Shopko stores for $25.5 million. The most recent Shopko sale was in late July, where we sold a store in Kennewick, Washington for $9.3 million at a 7.4% cap rate. We've reduced our Shopko rent concentration to 7.9% of Spirit's total contractual rent. Overall, our second quarter results were more demonstrative of the strength and reliability of our diversified portfolio of freestanding, triple-net real estate.

I'm going to pass the call along to Phil and after he finishes, I'll go into more detail on our plans.

Thanks, Jackson. As previously mentioned, we reported AFFO of $0.21 per diluted share for the second quarter of 2017, which includes nonrecurring cash severance expense of approximately $4.2 million. Excluding cash severance expense, adjusted AFFO was $0.22 per diluted share. Our reported AFFO per share represents a decrease of approximately $0.01 per share compared to the prior-year second quarter. The primary drivers related to this year-over-year performance are as follows: First, we have been very disciplined from a capital allocation perspective, as evidenced by our moderate net investment activity of approximately $82 million over the trailing 12 months, including our strategic 84 Lumber portfolio disposition. In addition, cash severance expense and moderately lower fee income also contributed to the variance from the prior second quarter.

Lastly, to the upside, our well-planned balance sheet management has notably reduced our cash interest expense during the year-over-year period. AFFO also notably improved sequentially, quarter-over-quarter, largely due to the rent loss reserve improvement that Jackson mentioned. We expect our rent loss reserve to moderate below our reported first quarter 2017 figure for the remainder of the year. Total revenues for the second quarter of 2017 were $168.6 million compared to $171.7 million in the second quarter of 2016. As already noted, moderate net acquisition activity and lower fee-related income contributed to the decline in revenues. Same-store rent growth for the quarter, when compared to the prior year second quarter, was up 1.1%, largely driven by organic rent growth in the portfolio as well as a theater development commencing rent.

On the expense front, we have separately disclosed transaction expenses related to the planned spinoff transaction. Total expenses, excluding costs associated with the spinoff transaction in the current year and headquarter relocation costs in the prior-year period, increased to $159.9 million in the current year second quarter from $147.1 million in the same period of 2016. Severance-related expenses totaling $11.1 million, in addition to higher property costs, largely drove the higher reported expenses while noncash impairments were also moderately higher. With respect to run rate G&A, excluding severance-related items, it represented approximately 7% of total revenues for the quarter. We continue to expect run rate G&A to approximate 7.5% of total revenues for the year. Our higher property costs are expected to moderate over the course of the year as we aggressively reduce our vacant property count via asset sales in addition to redeploying invested capital on underperforming properties.

Offsetting these higher expense categories was lower cash interest expense, which notably decreased by approximately 11% or $5 million during the year-over-year period. Our weighted average cash interest rate improved by approximately 27 basis points from the prior second quarter and now stands at 4.18%. Over the trailing 12 months, we have extinguished approximately $439 million of secured debt with a weighted average coupon of 5.7%. In addition, our unencumbered asset base currently stands at $4.9 billion, has increased by approximately $708 million year-over-year and continues to represent approximately 60% of our total real estate investments.

As of today, we have $264 million of debt coming due through the end of 2018, excluding nonrecourse debt transitioning to debt forbearance as well as our $420 million unsecured term loan which is extendable at our option. Our corporate liquidity currently stands at $442 million, including $10 million in unrestricted cash and $52 million of liquidity available in our Master Trust Notes for lease accounts. We expect to be a net disposer of assets for the year and our corporate liquidity will, as a result, improve over the course of the year.

In terms of our financial standing, our second quarter 2017 reported fixed charge coverage, excluding nonrecurring severance expense, stood at 3.6x. In addition, our second quarter 2017 reported leverage, excluding nonrecurring severance expense, was 6.6x. As previously mentioned, during the second quarter we completed our previously authorized $200 million share repurchase program, which equates to approximately 5.4% of our pre-buyback share count at a weighted average purchase price of $7.59. While our leverage has moderately increased sequentially compared to the first quarter due to these share repurchases, we continue to expect to end the year at 6.3 turns and will primarily achieve this via asset sales throughout the remainder of the year.

During the quarter, we declared dividends to common stockholders of $82.4 million, which represented an AFFO payout ratio of 83%, including severance charges compared to $83.9 million, representing a AFFO payout ratio of 80% in the comparable period a year ago. In conclusion, we are affirming our 2017 AFFO guidance range of $0.80 to $0.84 per common share. As previously communicated, the timing of our capital allocation activities, most notably deleveraging from asset sales during the second half of the year as well as the timing of capital redeployment activities on underperforming assets, will directionally drive our earnings during the second half of the year, relative to our guidance range.

I will now turn the call back to over to Jackson to comment on our planned spinoff transaction.

Thanks, Phil. Before I get into the discussion, I wanted to give you some background on our strategic discussion. I would also like to describe many of the conflictful forces at play within Spirit. Since the time that I joined Spirit, I've observed our business has 2 diverse core investment strategies on 1 platform: the first one, acquiring good real estate from investment-grade tenants and larger portfolios; and the second, acquiring good real estate with small and medium-sized tenants under master leases. We also have a conflicting liability structure of investment-grade senior unsecured funding and secured investment grade master funding vehicles. And all the while we've been trying to focus on reducing on our Shopko concentration. While many of our operational processes can effectively be applied to both investment strategies, we've concluded that it's more efficient to have separate financing approaches focused on each investment strategy. This is going to result in more effective capital structures. The reality is we're currently underutilizing these financing structures without capturing their benefits and opportunities and actually canceling each other out. Our Shopko investment is going to play a vital role to one of the strategies in that the sale proceeds of the Shopko properties will be the growth capital for the future. As we have explored how to best implement the removal of structural impediments and maximizing shareholder value, we've also overlaid our primary objectives to improve our balance sheet capacity and flexibility, generate cash proceeds to grow our business, optimize our tenant, industry and portfolio ratings which will likely result in a competitive cost of capital.

Our board, in consultation with our advisory team Morgan Stanley, Moelis & Company and Latham & Watkins, evaluated a wide range of strategic avenues for creating shareholder value. As are overlaid in these alternatives, various complex tax constraints, tax liability, prepayment costs, consent processes, counterparty uncertainty, length of time and probability of success were major considerations for each strategic alternative. After thorough review, we've evolved a practical and executable strategy to drive our business forward which addresses our primary objectives. If you all turn to Page 3 of the path forward addendum we posted our website, I'd like to take you through a few of the slides. Our plan is to leverage and spin off 2014 Master Funding Trust, we refer to that as Master Trust A, and our shop and real estate portfolio into a separate REIT which we are defining as -- referring to as SpinCo, which is on the right. We're going to continue to operate and asset-manage SpinCo and the Shopko assets will be unencumbered in this new company. This separation plan is the best risk adjusted strategic alternative which is practical and executable to maximize shareholder value.

I'm super excited about this plan because it's going to result in better alignment of capital structure with assets, unlock value inherent in our company and finally, remove and isolate certain structural impediments that have been present since Spirit's IPO. SpinCo is going to be able to pursue a wide range of tactics to optimize our large and valuable Shopko real estate portfolio. SpinCo will be able to continue to sell individual Shopko stores and pursue out parcel development on the over 70 acres of out parcel lots we've identified around our Shopko properties.

As this company continues to divest the unencumbered Shopko stores, the proceeds will be reallocated into quality real estate assets funded by the Master Trust A at a comparable loan-to-value. Leveraging and spinning off Master Trust A and Shopko into an independent company results in a business that can evaluate and focus on asset acquisitions utilizing the benefits of secured investment grade leverage through the master funding vehicle. The company will focus on high-quality real estate assets, operated by small and medium-sized tenants under national leases.

The separation impact on Spirit is simply awesome. Spirit will be liberated from many constraints currently present, resulting in significant enhanced growth prospects, portfolio segmentation of balance sheet. Our plan is to issue new notes in Master Trust A, resulting in 75% loan-to-value in the trust. Our preliminary third-party appraised valuation, performed in connection with the proposed notes offering, indicates an appraised value of $2.36 billion, or 6.75% cap rate, on annualized cash rent. We also raised additional debt proceeds on a few contributed assets under SpinCo. The total target loan proceeds, which will remain in Spirit, are expected to be approximately $400 million. We expect the AFFO per share of the combined companies and planned capital redeployment 1 year after the closing of the transaction to be accretive to expected 2017 results for Spirit. Approximately 20% to 25% of our expected 2017 AFFO will be reallocated to SpinCo post-transaction. The end result to Spirit post-separation is a company that will target initially net debt-to-EBITDA of 5x or below on a pro forma basis, assuming no redeployment of capital and 76% of our assets will be unencumbered. This is a game-changing improvement from where we sit today.

Upon completion of the transaction, our company's portfolio of investment grade equivalent tenancy will increase to approximately 45%. Portfolio segmentation will improve significantly, no tenant will result in more than 5% of contractual rents and the raised loan proceeds will greatly enhance our growth profile. With the additional proceeds generated as part of this transition, Spirit will carefully evaluate acquiring real estate assets and/or repurchasing stock. New Spirit will own over 1,540 properties, have gross investment of $5.4 billion, be largely service, retail and industrial-focused, with its largest 5 tenants being Walgreens, Church's Chicken, Circle K, Home Depot and CVS Drugs.

If you now turn to Page 10 of our presentation, you'll see that the company's top 10 tenants will comprise 25% of the new company's total rent and 7 of the top 10 tenants will have investment grade equivalent ratings. Approximately 80% of the revenue of new Spirit will be from the current top 100 tenants of Spirit, which you can see in our additional supplemental. The top 10 industries will approach almost 61% of the company's total contractual rents and be predominantly service retail-oriented. This will truly be a unique and fortress-like company in terms of its portfolio, people and balance sheet, one of the best in the triple-net REIT sector. SpinCo will enter into an advisory contract with Spirit prior to the separation. There will be a new [invented] Board of Directors for the company and we will have dedicated people running the business. The new Spirit will provide all of the asset management, lease administration, accounting and acquisition support for SpinCo and its Board of Directors. The 2 companies will enter into a number of agreements including shared services, asset management and strategic alignment -- alliance arrangements, including a defined asset allocation policy and conflicts of interest protocol.

If you refer to Page 8, you'll see that SpinCo has gross real estate investment of $2.7 billion as comprised of 928 properties, 196 tenants, 73% reporting tenant unit financials and have over 60% of its assets under Master leases. All of the Shopko assets in SpinCo will be unencumbered. The company will have no near-term debt maturities. We expect to file our Form-10 document in the fourth quarter of this year, complete the note issuance in Master Trust A and have the separation transaction completed by the end of the second quarter of 2018.

In closing, our board and team of advisers and employees have worked expeditiously to evaluate the best path forward that is practical and executable to maximize value. This plan achieves many positive outcomes. It provides the right investment grade capital facilities for our 2 business strategies of acquiring good real estate with investment grade tenants and good real estate with small and medium-sized tenants. It provides a medium, which can preserve and realize meaningful value from our Shopko real estate portfolio. It maximizes the funding potential of our master funding vehicle, which will directly enhance the balance sheet, liquidity and credit metrics of new Spirit, and it provides both companies with competitive cost of capital. I'm super excited about the prospects for both Spirit and SpinCo and I'm encouraged by the many operational improvements we've made over the past few months, which are producing good results.

Before we open up to questions, I'd like to cover a couple of administrative matters. We plan to provide more detail and economic data on our plan after we file our Form-10 document. Until then, we're not going to be able to delve into the specifics around the legal and economic arrangements between SpinCo and Spirit. We're also still under NDA with Shopko and will be limited in our responses to any questions related to them.

With that, operator, will you please open up the lines?

(Operator Instructions) Our first question is from Alexander Goldfarb from Sandler O'Neill.

The main question, Jackson, is when you look back over the past 6 months, a lot of these actions that you guys have outlined here aren't really new, so in a sense the one quarter conference call sort of seems like an aberration, so how much of this stuff were you guys working on before? And then going forward, I understand where Spirit -- the RemainCo wins out but when you think about SpinCo it's still going to be over 20% exposed to Shopko, it's still going to have to slowly liquidate. Right now the environment for trying to develop new paths doesn't seem that great, so how do you -- how do we get excited about where SpinCo ends up versus RemainCo?

If you go to page 8, just focus on that for 1 minute in that path forward deck, Alex, the thing that the market I don't think really had a good understanding is the valuation of Master Trust A is quite significant. Obviously its $2.36 billion on an appraisal basis. SpinCo, I really talked about liberating new Spirit, it's actually SpinCo as well because the relation -- there's actually going to be a very symbiotic relationship between the Shopko stores and Master Trust A within SpinCo. As we continue to sell those stores off and we will continue to do that, within SpinCo, what you have to kind of have to keep in mind is the ability to reinvest those proceeds. If we reinvested in real estate, for every dollar of SpinCo -- of Shopko real estate that we sell, we can buy $4 of other real estate, financing it 75% LTV through Master Trust A. So if you take it to its full conclusion, if you put a 8% cap on our current rent for Shopko, that's $600 million in equity sales of Shopko stores, can buy $2.4 billion of real estate, which if you assume a cap rate of 7.5% will drive over 50% growth in AFFO of SpinCo. It can also repurchase stock, right? And so if we don't know where SpinCo is going to trade, we'll see where it trades, but I think it's going to have a very competitive cost of capital first of all, but if it decided -- the board decided to repurchase shares and you took that same math, you could retire probably 70% of the outstanding flow to SpinCo. So we think it's got a very attractive growth profile and it's going to be very efficient from a G&A standpoint.

But Jackson, because it's being managed by Spirit, in a sense it seems like the logical conclusion for SpinCo is liquidation, unless you guys are going to seat it with its own management. Otherwise, it seems like a distraction for you guys to run this sort of more investment grade oriented Spirit versus via resolving SpinCo.

Well, I think the priority for SpinCo is really going to be, once again, work through and monetize Shopko, for the benefit of SpinCo and I guess, Alex, the way to think about it is, we own Shopko today and we have been committed to reducing that exposure. It really doesn't move the needle in terms of improving the balance sheet of Spirit in totality, but when you think about the impact that is has on SpinCo, it's actually quite significant. I mean, very, very significant.

And the next questioner today will be Frank Lee with UBS.

Wanted to get your thoughts on your decision to do the spin versus -- your thought process on selling the company versus doing the spin?

Thanks, Frank. We've been working with our team of advisers and we've had an extremely extensive review of various alternatives to create value. I guess before -- when you think about different alternatives, you really have to really overlay, REITs have very complex rules as it relates to buying and selling real estate, as you know. The tax basis in our assets is generally lower than the market value. We've got very significant yield maintenance to the extent we -- versus prepaid these Master Trust Notes. We consider time, the element of time in terms of the best execution and counterparty risk and also weighing probability of success, but I would say, probably the most important thing, as it relates to the [overall] alternatives, was basically the residual impact on whatever we did with the other aspects of Spirit. So when you try to think about what we've completed, we believe that we've completed. We've got the best plan that's practical, executable and will provide the best risk-adjusted return for shareholders.

And the next questioner today is Vikram Malhotra with Morgan Stanley.

Just staying away from the spin. Can you just maybe update us on actions you've taken during the quarter or maybe just during the past few months on resolving tenant issues that you had over the last 3 months? Where are you with that? And where do you expect to be in the next few months?

We -- last quarter, obviously, as I said, we didn't do a great job of articulating the messages on that call. I guess, the take away would be, just look at our operations this quarter. We've got 1.1% same-store growth, our loss rent reserves are $1.1 million, occupancy rates way up, we retired 5.4% of our float and our cash rents increased from $604 million to $611 million. The disclosure that we decided to put out this quarter, changing from normalized rental revenue to a contractual rent, it is sort of the best cash proxy of what our assets can earn. So every quarter, you're going to be able to look at our supplemental. Go to page 19, go to page 21 and you can take the -- do the addition or subtraction there to figure out what the net loss rent was. Last quarter was an aberration. I have to say, we've got really high-quality group of tenants in our portfolio; we try to outline every one of them. And if you think about $1 million of lost rent on a business that's generating over $150 million of revenue, it's really pretty small.

Of the $4 million in rent that you outlined last quarter, per quarter then you -- if you extrapolate that, you mentioned it was $16 million in the year, as part of your guidance to the low end. How much of the $4 million is actually recovered?

Well, I think what I'd really kind of get you to focus on is kind of moving forward. I don't think we did a great job of articulating a lot of those issues, so the change in disclosure will make it completely transparent for you.

I'm just trying to figure out -- because you've kept the guidance as same, so I'm assuming the moving parts that you had described earlier still exist, to some extent, because the other moving parts. So have -- whether it's 10 tenants or 15 tenants or whatever accounted for the $4 million, can you just highlight what has been resolved, like is the -- has the cinema been resolved? Has the restaurant been -- just I'm trying to look for some more color on what has been resolved and what is still pending?

The cinema is basically, we've executed -- we're finalizing a new lease with a new operator. One of the restaurant portfolios is under contract. The other restaurant portfolio paid rent through the second quarter.

So some of the (inaudible).

Actually, (inaudible) -- Vikram, I'll come back to you if you get back in the queue, but we've actually got a lot of folks we've got to get back to.

And our next questioner today is going to be Anthony Paolone with JPMorgan.

I'm probably going to beat a dead horse here, but on the Master Trust, at a very elementary level, can you just describe what the value that is, because it seems like you're ascribing a lot of value to having that structure, it just seems like you're just using more leverage, which I would imagine you could do in lots of things and you don't need the Master Trust. I'm just trying to understand whether these Master Trusts were really like handcuffing you or whether there's really value to that? And is it just an auto -- automatic thing that you can lever them up 75% on the value that you guys came up with or isn't there a market that has to clear that or -- how does this thing work?

The Master Trust, other companies use them, there's a card master trust lease, and there's other triple-net operators that use these facilities. The investors, the reasons why they buy these type of notes is, these are extremely diverse rosters of tenants and properties and the Master Trust has very specific rules to not overweight industries or locations and so they focus a lot on LTV and that's really because of the rating agencies, so there's a whole structured rating process that goes along with this. So the best way for me to try to describe how we think about it is, the Master Trust wants to constantly issue notes and constantly redeploy capital and wants to do it more efficiently at a much higher leverage than currently is levered, even the way we have it. And it's sort of diametrically opposite from what our unsecured bondholders want, where they want less secure collateral, less LTV. So if you think about what we're doing, is we're basically divvying up Master Trust and Shopko to our shareholders but we're taking on a massive amount of debt and return on capital to Spirit to rebalance our company and be a fortress REIT.

So effectively, you're not subject to how the stock market thinks about valuing the SpinCo assets, you'll be able to pull 75% of the value of that out no matter what through the debt?

Through the financing, yes. And the one thing that is interesting is, if you think about the cost of capital for that company, that company is going to have all of this unencumbered Shopko collateral that it's going to sell. If I were to kind of draw up what is cost of capital, it's 75% of the cap stack is at a 4.5% kind of interest rate and the other 25% which would be the public equity, let's assume it traded at 10x the EFA yield, yes, that would be a cost of capital below 6%. So it's really quite interesting opportunity for shareholders.

And right now, the appraisal on SpinCo is at a cap rate that's inside of where all of Spirit is trading today, is that fair?

Once again, the cap rate is in the 1,000 or so properties within Master Trust A. It's been appraised -- every asset has been appraised by a third party. So there's individual asset valuations at each page and what would be kind of interesting is, if you remember that addendum to the -- that we gave out on the supplemental on Page 3, which gave our real estate net asset value components, if you sort of said how is this portfolio -- how would it be illustrative with the rest of Spirit? If you took that 6.75% cap rate and thought about the rest of the business, that would be one conclusion. If you went to Page 5 of our path forward deck, you've seen that histogram before, right? We spend a lot of time talking about how we rank our portfolio. The blue shaded area, those are the assets of Master Trust A and Shopko and you can see the green, which is the rest of the company, is very comparable. So I'm not going to tell you what the cap rates are for our LLV, but just we went through a pretty lengthy exercise with the appraisal firm.

And our next questioner will be Joshua Dennerlein with Bank of America Merrill Lynch.

Just wanted to ask, (inaudible) selling the company would've been the right course of action? Why now? Why the SpinCo?

We're fiduciaries. Of course, if we found a compelling -- our stack is sold every day. If there's a compelling price or a concept, I'm sure we would consider it. But we believe that this path forward is really the one that's going to maximize most value in kind of the best, most practical, efficient way.

Did you guys look for buyers or just was this kind of internal debate you had?

Once again, I've got to mention, we have very high-quality team of advisers -- financial advisers, that spend a lot of time with our board, and obviously we rely on them to give us judgments about the market and the viability of various different alternatives and look, I think that they are also very supportive of our plan.

On the Master Trust B, though, that will remain in the new Spirit, RemainCo, what's your plan with that? Can you eventually dissolve that? Simplify the business a little bit in RemainCo?

First of all, the assets in Master Trust B, we really like the assets just like we like the assets in A. Yes, there's a little bit of yield maintenance cost to dissolve Master Trust B if we were to do that. I think we'll reevaluate -- it's a much smaller trust in that the amount of secured debt after this transaction is going to be quite insignificant, so we'll look at that at a later date. It's sort of down on the priority list.

And our next questioner today is Vincent Chao with Deutsche Bank.

Just maybe a follow-up on the last question, I guess why was the Master Trust B not included in SpinCo?

Master Trust -- SpinCo doesn't need 2 Master Trusts, they've got one that's pretty powerful. With Master Trust B, look, I think, we've probably highlighted the value of these things beyond just the asset value. So look, I think we'll reevaluate different options with B. It's extremely valuable real estate and I think the structure's very valuable. So we'll revaluate options for that a later date, but we didn't think it made sense to -- 1 Master Trust with Shopko is the right symbiotic relationship because that trust is going to issue a lot of new notes going forward.

And just maybe 1 question on the accretion that you mentioned, 1 year out for the combined company on AFFO, what does that assume in terms of the $400 million of proceeds that will be generated at the new Spirit as well on the Shopko sales front and reuse of those proceeds? What is assumed in that accretion comment?

We kind of assume that if we got that $400 million of capital into new Spirit, that we would buy 2x that amount of capital in real estate at a certain -- at different cap rate ranges and we actually didn't use too much assumption on SpinCo because that's a harder one to calculate, based on the pace of the sales. But if you actually work through that one, you can actually generate quite a bit of additional earnings on a combined basis.

Okay, but that was not assumed in your comments?

No.

And our next questioner today will be David Corak with FBR.

I know your remarks will be a little bit limited on Shopko given the NDA, but just wondering what Sun's role will be going down this route? Maybe you can comment on any involvement they had in the process and more importantly, would a Shopko Chapter 11 bankruptcy change the plan here?

Well, first of all, to do this transaction it doesn't require any consent from Shopko and as you note -- duly noted, we don't want to comment on hypotheticals. But if there were a change in any way to our Shopko portfolio, it would not preclude us from completing this transaction.

I guess another way of asking is if tomorrow morning you came out and you saw a Chapter 11, do you still go down this route?

We're committed to this plan and, like I said, if there are other more interesting opportunities to create value, we would consider it. But a change in any type of -- a change in anything at Shopko would not preclude us from completing this or stop us.

Fair enough. And then last one from me. Can you talk about the strategic alliance agreements between the companies? You mentioned some potential conflicts of interest that you're working on, but just any color you can give us around that?

Look, on that one, we've given probably you a lot to think about and digest with all this disclosure we put out but we'll go into much more detail after we file our Form 10 later this year and enter lay out the exact relationships and...

And the next questioner today will be Dan Donlan with Ladenburg Thalmann.

Just curious on the converts, what is -- what happens there on this spin? Is it considered a change in control? Do you have to redeem them? Just kind of curious there.

Because this is a dividend, and it's not a substantially large dividend, it's just a slight reset so it's just a slight reset of the conversion price, the strike price, straight strike price.

You don’t have to -- you're not required to redeem them?

No. No. The strike price will reset based on the distribution.

Okay, perfect. And just real quick, Phil, on the $610 million cash rent number, how does -- how do you see that trending through the end of the year? You mentioned that you thought you'd see property operating expenses moderating but in guidance, does that number proceed to kind of stay flat to move down to move up, irrespective of any additional asset sales?

Yes. Directionally, obviously we're not giving guidance on cash runs but one of the things I mentioned in terms of the timing of capital allocation decisions which will drive our earnings guidance throughout the year, obviously, the timing of asset sales is directionally going to drive our cash rent number. One thing to keep in mind is that we're going to continue to have organic rent growth in the portfolio. Also, one thing to keep in mind as it relates to cash rents is the characterization of the assets that we sell. Yes, we will be selling some income producing assets but we also are going to be monetizing non-income producing assets, think vacant assets, as we -- as you mentioned as we look to reduce our property cost leakage over time. So look, from a contraction -- from a cash rent perspective, I would expect it to moderate lower over the course of the year, but again, there is going to be, as you can imagine, this timing factor is relating to capital allocation decisions and also the character of the asset that we sell.

Okay. But in terms of not factoring in any type of timing though, do you think that 610 number moves up or down? And you're saying you think it moves down slightly. That's because of timing though, not because of further credit issues? That's what I'm trying to get at.

Couple of things. It's going to moderate lower because we're going to be selling more income-producing assets and it's also, from a credit issue perspective, we expect our credit loss rent reserves to moderate lower over the course of the year as well. So directionally, it will be lower.

Okay. And then just lastly on the dividend, is there any change contemplated with the spinoff? Is there -- does the dividend stay where it is and how you -- have you looked at the policies there in terms of what will be for the RemainCo and the -- or new Spirit and then the SpinCo?

We'll give more update on the dividend around the time after we do a Form 10.

(Operator Instructions) And our next questioner today will be Ki Bin Kim with SunTrust.

I'm trying to digest this all but one way this works, it seems like it hinges on your ability to raise $400 million. But that hinges on a lot of different variables. I'll just ask one question: Is there any -- where are the kind of high-level covenants in Master Trust A?

There is no -- there are really no covenants. The only things specific to court rules is when you put collateral in or you want to substitute collateral or you sell a property, and you want to redeploy cash, there are specific rules around that but there's really -- there's no technically covenants the way you think about bank facility. So the Master Trust A, it's pretty straight-forward. These facilities literally raise billions and billions of dollars of capital for student loans, credit card receivables, timeshare. I mean, the real estate application, it kind of only works -- it works really well for this asset class because small granular property is very diversified, so it's pretty straightforward. It's a very tried and true financing vehicle in the asset-backed market.

So there is no debt-to-asset value limitations?

No, there's no financial covenants. It's sort of like structured finance like a CMBS. There's collateral and there's structured ratings levels.

And so if I think about this deal, it feels like -- sorry for my crude analysis, but in this short period of time, it's all I can come up with. But it feels like kind of corporate level liposuction. You have this fat that you want to get rid of Shopko and all its problems and you're kind of separating it too so that the remaining company looks a lot prettier. But it makes sense, I think, to a point where if you're dressing it up for a sale, the RemainCo, is that the case that it just makes it a lot more easier for someone else to digest it without Shopko?

Go ahead and finish, I'll try to answer. What was your last question?

Is that kind of what the end goal is or it is more -- this is the kind of cleaner going concern and that's what we're going to run with and the RemainCo asset sale is not really in the cards right now?

Well, just stepping back, try to remember what we're -- it's really important to remember what we're solving for. It's really critical. Right now, we don't have a great cost of capital, our leverage of 6.6x is too high in my opinion for this type of current company. We need to diversify our tenant roster with our largest tenant, which is going to take, based on run rate where were saw $100 million of Shopkos a year, kind of on average it only takes six years to wind that position down. So we're solving for to try and create great -- good cost of capital, remove our own impediments, obviously. We want to deleverage, we want to do something that's accretive to NAV and growth, we want to do something that is simple and flexible and we want to make sure it's actionable. And if you kind of step back and you have to digest this thing, but this separating the business in the way we've done it actually accomplishes all those things for new Spirit, we call it RemainCo, but for SpinCo, SpinCo is going to be a great little company. When you step back and start to analyze it and think about it, look to page 13 in path forward, that's going to -- there's a lot of growth in that company and I guess, the thing is, if we try to do it all together, which we've been doing for the last 3 years, you're kind of like fighting -- your arms are kind of tied. It's pretty difficult.

(Operator Instructions) And our next questioner will be Michael Knott with Green Street Advisors.

Jackson, on the spin, I hear you on what you're trying to solve for but I guess as I think about it from a combined basis, combine both companies, what it sounds like we're talking about levering up to either buy assets or buy back stock and incurring a little bit of G&A to do so. So I guess my question is, is any of the assumption here predicated on the idea that there might be a free lunch with regards to the evaluation of the new REIT that you're putting out there? Is this going to have super high leverage, super high tenant concentration, so I'm just curious how you're thinking about that. Is there sort of an assumption of a free lunch?

I think the way we look at it, if you go to Page 8 in our path forward, the Master Trust A has got great assets in it. Some of our best assets are in that company. We've got, for instance, all of our Popeyes restaurants, chicken -- in that trust, all of our HD Supplys are in that trust, all of our [Martins] and [Manns] -- some of our best concepts are in that trust. But that trust is almost like a standalone entity but it doesn't have growth capital and so that's the secret of -- our belief why it makes so much sense. We've been very clear that we want to monetize Shopko, just given the concentration we have. And so monetizing Shopko within Spirit today, it just doesn't really move the needle, where in SpinCo, it does make a big difference in terms of what it invests in. In terms of free lunch on the G&A, look, if you think about both companies, Spirit -- new Spirit was going to buy $800 billion worth of capital that's left -- that's part of the dividend of SpinCo and SpinCo is going to buy quite a bit of real estate as well, so both companies are going to grow asset base but it's also the same G&A of Spirit. So it's going to be just much cheaper for -- it's much more efficient, much cheaper. There's a tremendous knowledge and operating base that's in this company that's going to be shared between the 2 companies, the rating system is the same, the way we look at the world, the way we think about risk. And if you think about the additional G&A load and we'll go into more specifics after we file the Form 10, but setting up a board, it's not really a lot of additional G&A expense.

I guess part of my comment was your comment about the SpinCo might have a really attractive cost of capital because effectively what you said was 75% of the capital structure would be debt and so I was just wonder -- I don't know if any of us know how that 25% of the equity will actually trade?

Yes. I don't know either, but what I can say is that earnings will grow, the dividends will -- as a result, dividend coverage will get better and the board of SpinCo, the independent board, there may be strategic options for that company later, down the line, but first and foremost it's going to get growth capital from the sale of the Shopko stores to kind of build itself out.

And our next questioner today will be Michael Carroll with RBC Capital Markets.

Jackson, can you kind of just give us a quick highlight of what the goal is with SpinCo? It sounds like the goal is to wind down these investments over time. Or do you consider SpinCo a going concern from this point going forward?

SpinCo -- the beauty of the Master funding vehicle is that you can continue to roll over notes, so when we have a maturity, or a tranche of notes in Master Trust A, we can basically redo the appraisal, go back to the rating agencies and sell 10-year notes out of the same collateral pool. So it's kind of like the beauty of this trust is versus a CMBS, it's almost like its own company, and so -- and the way to think about is, it's almost like a perpetual life fund, and it is better than that, because it can constantly issue new notes as the collateral value and the trust increases. They are very, very efficient and effective vehicles for small assets that are very diversified. I would say that we designed SpinCo to really succeed. It's got a real -- it's not dependent on raising public equity to succeed, that's the key.

And the next questioner today will be Chris Lucas from Capital One Securities.

On the -- I just want to make sure I understand what the transaction will look like from where we are today on the liability side to where we will be post-spin as it relates to the remaining or the new Spirit? So today you've got bank debt, CMBS debt, Master Trust debt and unsecured notes, and it sounds like after the spin, you're going to have the same basically pieces of the debt structure so the debt structure for the new Spirit will not be any less complicated. Is that fair?

Right. Yes, sir.

And then just a quick one on the master trust notes whether they are the 2013 series or the 2014 series, do they have the ability to redeem at par or essentially prepay early without the penalty?

No. It's a yield maintenance, is the only way to redeem them.

There is no optionality to redeem early, though, is what I'm asking?

The one thing on that though is that there is one series related to the '13 trust that we can redeem early in December, at par.

Series A or the 2013 one?

2013 series, right but most of these series are subjected to yield maintenance.

And one of the reasons why -- and you just went through the liability structure; I appreciate it. If you think about Master Trust A, I'll just give you some -- currently as it sits today, Master Trust A represents about 25% of Spirit's total contractual rent, yet it represents 34% of our outstanding debt, long-term debt, just outstanding debt, so -- and that's in its current form before we lever it. So just removing Master Trust A, just literally removing it, actually delevers the company. In this case we're just raising a lot more money around it and that's one of the benefits of this dividend distribution and the way we're contemplating it.

Ladies and gentlemen, this will conclude our question-and-answer session. Now I'd like to turn the conference back over to Jackson Hsieh for his closing remarks.

Well, thank you, everyone for joining my first call as Spirit's new CEO. I know we've come a long way since last quarter's call, but I did want to remind everyone that we met at mainly right after the call that -- when our kind of path forward was, I want to just go back to that. First and foremost, we committed that we would try to provide best-in-class disclosure as it relates to what's in the triple-net REIT sector. Second was we were going to remove structural impediments. The third was we were going to repurchase stock in a leveraged, neutral way, fourth was we're going to optimize our portfolio and fifth was we're going to preserve our balance sheet and capacity. So there's obviously been a lot of material we've released for you to review and consider and we hope it's helpful and look forward to speaking with you soon. Thank you.

And the conference is now concluded. Thank you all for attending today's presentation. You may now disconnect your lines.