STORE Capital Corp (STOR) 2015 Q1 法說會逐字稿

Good day and welcome to the STORE Capital first-quarter 2015 earnings conference call.

(Operator instructions)

I would now like to turn the conference over to Moira Conlon, Investor Relations for STORE Capital. Please go ahead.

Thank you, Laura, and welcome to all of who you have joined us for today's call to discuss STORE Capital's first-quarter 2015 financial results. Our earnings release, which we issued this morning along with a packet of supplemental information, is available on our Investor website, at ir.storecapital.com, under News and Market Data, Quarterly Results. I am here today with Chris Volk, President and Chief Executive Officer of STORE Capital; Cathy Long, Chief Financial Officer; and Mary Fedewa, Executive Vice President of Acquisitions. On today's call, Management will provide prepared remarks and then we will open the call up to your questions.

Before we begin, I'd like to remind you that comments on today's call will include forward-looking statements. Forward-looking statements can be identified by the use of words such as "estimate," "anticipate," "expect," "believe," "intend," "may," "will," "should," "seek," "approximate," or "plan," or the negative of these words and phrases or similar words and phrases. Forward-looking statements, by their nature, involve estimates, projections, goals, forecasts and assumptions, and are subject to risks and uncertainties that could cause actual results or outcomes to differ materially from those expressed in our forward-looking statements. These forward-looking statements speak only as of the date of this conference call and should not be relied upon as predictions of future events.

STORE Capital expressly disclaims any obligation or undertaking to update or revise any forward-looking statements made today to reflect any change in STORE Capital's expectations with regard thereto or any other changes in events, conditions or circumstances on which any such statement is based, except as required by law. Please refer to our SEC filings and our Investor Relations website for additional information.

With that, I would now like to turn the call over to Chris Volk. Chris, please go ahead.

Thanks, Moira. Welcome, everyone, to STORE Capital's first-quarter earnings call. With me today are Cathy Long, our CFO; and Mary Fedewa, our Executive Vice President of Acquisitions.

As you've all seen from our press release today, we're off to a strong start in 2015. In the first quarter, we posted AFFO of $0.34 per share and made investments of nearly $300 million. This sustains our growth momentum carried over from 2014. During the quarter, we declared a dividend of $0.25 per share, which represents an AFFO payout ratio of just under 74%, one of the lowest of all public net lease oriented companies. Our dividend is therefore highly protected, and all the more so in light of our sustained organic growth. Our low dividend payout ratio, combined with attractive lease escalations averaging 1.7% annually, is designed to position STORE to deliver a sustained and attractive internal AFFO growth per share. Factoring in the external growth we're achieving, we hope you can see the potential we have to deliver on the promise of exciting overall AFFO growth.

Recent REIT stock price performance driven by concerns over potential interest rate hikes tends to overlook the interest rate protections that our growth model provides. And of course, our management team has a 35-year history of successfully navigating across a variety of interest rate environments to deliver steady growth.

We ended the quarter with a run rate adjusted funded debt to EBITDA of just under 6 times, which also provides us with continued financial flexibility. As of March 31st, we had drawn only $162 million of our $300 million unsecured credit facility and had almost $1.2 billion in unencumbered assets. On April 16th, we contributed approximately $455 million of those assets to our A+ rated Master Funding conduit. We then issued $365 million in 7- and 10-year notes, which fully repaid our short-term credit facility and added to our investment capacity. Since then, we've invested this liquidity and begun again to access our unsecured credit facility, growing the level of unencumbered assets held by STORE. We expect that our total unencumbered assets will continue to increase, which will expand our financial flexibility and potentially broaden the menu of our financing options.

Our recently issued Master Funding term notes bear a weighted interest rate of 4.06%, which is well within our projections and is also the lowest rate realized by our conduit to date. With almost 75% of the notes having 10-year maturities, the weighted maturity is approximately 9.2 years. So as of today, we have very little exposure to floating interest rates and a well laddered liability stack. These long-term fixed rate borrowings, like our expected internal and external AFFO growth, should serve to protect our shareholders in rising interest rate environments.

Since our inception, a hallmark of STORE has been our direct origination platform that has resulted in an investment portfolio that ranks amongst the most diverse of any net lease market participant. The quality of our portfolio of profit center real estate investments is characterized in part by our histograms of tenant credit and contract ratings, which reflects the quality of the data we're able to collect, the systems we have developed, and the disclosure that we are able to provide. At the end of the first quarter, we estimated that approximately 76% of our investment contracts had quantitative investment grade ratings under our proprietary STORE Score model. Qualitatively, we would place the percentage even higher.

Our focus on master lease contracts has resulted in master leases for 84% of our properties, and 73% of our base rents, from multi-unit investments as of March 31st. Tenant default is the biggest risk faced by STORE and other net lease investment firms. To better manage this risk, we created and invested in sophisticated analytics that capture and evaluate ongoing corporate financial statements from virtually all of our customers, as well as unit level financial statements from approximately 97% of the properties that we own. In the ordinary course of our business, we realistically presume a level of tenant defaults, property management costs and losses. In 2014, we outperformed our own expectations, because we actually had no tenant losses. In fact, our overall 2014 loss rate approximated a negative 25 basis points of assets, which represents the percentage of average assets during the year contributed by gains that we had on the sales of assets.

As most of you know by now, we have recently experienced a tenant default from Heald College. STORE holds 5 of Heald's 12 campuses located in Northern California. As a tenant, Heald had always exhibited strong cash flows and unit level economic performance, giving it a very high margin for error. A combination of external regulatory and legal initiatives resulted in the permanent closure of this institution, which was founded in 1863. We learned about the school closures on Sunday, April 26th and had STORE staff at each of our five campuses the next day. With all of this said, it's important, first, to note that Heald only approximated about 1.4% of our base rent and interest as of March 31st and only about 1.2% of our future minimum rental payments as of that date. We anticipate that our recoveries from this default will be within typical ranges, which in our own experience is approximately 70% to 90%. Today, I can announce that we already have one school under contract to sell, and an agreement in principle to lease another school under a 15-year triple net lease. This translates into a weighted recovery rate in excess of 90% for these two schools that together comprise almost 60% of our Heald exposure. That leaves the three smaller schools that comprise just under 0.5% of our expected rents for 2015. The rents we received from Heald on these three remaining schools were generally within the marketplace, and these schools were well attended, so that should work in our favor for a strong recovery. Since portfolio management is a core competency of STORE, we expect to have these assets rented or sold. More importantly, we do not expect the impact on STORE from the Heald closures to be material, due primarily to our portfolio diversity and to the number of levers that we've built into our business model to manage risk. When we have vacant assets, we can always sell them; we can rent them out; we can rent them out and sell them; we can sell them and take back a seller note; we can sell them, take back a seller note and even sell the note. So you get the idea. And then we can also limit investment losses by realizing gains on the sale of other assets, as we do from time to time and as we did in 2014. In all of these endeavors, we are foremost committed to realizing maximum AFFO per share and enhancing our portfolio quality for the long term.

Before I turn the call to Cathy Long, I am pleased to announce today that we're raising our 2015 expected investment origination activity to $1 billion, which is based upon a combination of our sustained investment momentum to date, as well as to a continued robust pipeline of potential investment opportunities. With this level of investment activity, we're also raising our AFFO guidance range by $0.01, to $1.34 to $1.40 per share.

We will refine our 2015 guidance over the coming quarters, based upon the confluence of business variables, such as investment timing, initial lease rates, borrowing costs and operating expense levels. However, a more important result from the continued strong demand from our customers will be the impact on our 2016 AFFO per share, which will benefit from a full year of the investment spreads that we're able to lock in this year. It's our outlook for 2016 that will guide our Board as they evaluate dividend policy later on in the year. Cathy, the floor is yours.

Thanks, Chris. I'll begin my remarks today with an overview of the results for our first quarter ended March 31, 2015. Next I'll discuss our balance sheet and capital structure, followed by our guidance for 2015. Unless otherwise noted, all comparisons refer to year-over-year periods.

Starting with the income statement. Total revenues increased 56%, to $61.5 million, primarily due to the growth in our real estate portfolio, which generated additional rental revenues and interest income. This also marks an increase of 11% from $55.2 million in revenues reported in the fourth quarter of 2014. Our portfolio grew 56%, to $3.1 billion, representing 1,073 property locations at March 31, 2015, from $2 billion in gross investment amount representing 701 property locations at March 31st a year ago. This also reflects a 10% increase in the size of our real estate investment portfolio since year-end 2014.

Our portfolio's base rent and interest on an annualized basis was approximately $263 million at March 31st, as compared to $169 million a year ago.

As Mary will discuss, the weighted average cap rate for real estate investments closed during the first quarter was about 8.3%, slightly higher than the 8% weighted average rate we expect for all of 2015.

Total expenses for the first quarter increased to $44.3 million, compared to $30.6 million a year ago. Depreciation and amortization expense generally rises in proportion to the increase in the size of our real estate portfolio; and so for the first quarter, about half of our increase in total expenses was due to higher depreciation and amortization expense.

Interest expense increased about 20%, to $17.2 million, from $14.4 million, due primarily to an increase in long-term borrowings used to partially fund the acquisition of properties for our growing real estate investment portfolio. The long-term debt we added since March 31st a year ago included one series of STORE Master Funding net lease mortgage notes payable of $260 million in principal amount completed in May of 2014 and $26.5 million of traditional mortgage debt.

Property costs increased to $295,000 for the first quarter of 2015, due primarily to the accrual of property taxes on the five Heald College properties whose leases were terminated shortly after quarter end. We anticipate that our property costs will continue at an elevated level during the period while these properties are being remarketed.

G&A expenses increased to $6.6 million from $4.2 million, primarily due to the growth of our portfolio, staff additions to support the growth, and the increased costs associated with being a public company. As a percentage of revenue, G&A was consistent with the year ago period, at 11% of revenues.

Net income increased to $17.1 million, or $0.15 per basic and diluted share, compared to $9.5 million, or $0.15 per basic and diluted share. The increase in net income was primarily due to the additional rental revenues and interest income generated by the growth in our real estate investment portfolio, offset by a $1 million provision for impairment of one of our Heald College properties. In comparison, net income for the first quarter of 2014 included a $743,000 gain on the sale of one property.

AFFO increased about 80%, to $39.5 million, or $0.34 per basic and diluted share, compared to AFFO of $21.9 million, or $0.34 per basic and diluted share, in the first quarter of last year. This is also a 17% increase from last quarter's AFFO of $33.7 million, which highlights our strong sequential growth. Again, the increase in AFFO was primarily driven by the revenue generated by our portfolio growth, partially offset by the increase in interest expense related to borrowings associated with that portfolio growth, and the higher operating expenses to support the growth.

For the first quarter of 2015, we declared a regular quarterly cash dividend of $0.25 per common share to our stockholders, which was paid on April 15th. This represents a payout ratio of about 74% on AFFO per share of $0.34.

Now I'll provide an update on our balance sheet and capital structure. During the first quarter, we fully deployed all of the remaining net proceeds from our November 2014 IPO and borrowed $162 million under our unsecured credit facility to fund additional real estate acquisitions through March 31st. As of March 31, 2015, we had $30.3 million in unrestricted cash and cash equivalents, $138 million available on our credit facility, and a pool of unencumbered assets aggregating approximately $1.2 billion. Our total debt outstanding was $1.44 billion at March 31st, up from $1.28 billion at the end of 2014.

We measure leverage using a ratio of adjusted debt to EBITDA. Because of our high rate of growth, we look at this ratio on a run rate basis, using our estimated run rate EBITDA. Based on our real estate portfolio of $3.1 billion at March 31st, we estimate that our leverage ratio on a run rate debt to EBITDA basis was approximately 6 times.

Subsequent to the end of the first quarter, on April 8, 2015, we entered into a $50 million unsecured loan facility with a bank as a temporary supplement to our borrowing capacity under our unsecured revolving credit facility. Borrowings under this loan facility will generally bear interest at one-month LIBOR plus 2%. This facility has a three-month term with a one-month extension option, which would provide additional liquidity to us through the beginning of August.

As Chris discussed, also after quarter end, on April 16, 2015, we issued our sixth series of STORE Master Funding net lease mortgage notes, consisting of $365 million of A+ rated Class A notes and $30 million of Class B notes. The Class A notes are segregated into two tranches: $95 million of 7-year notes with an interest rate of 3.75%, and $270 million of 10-year notes with an interest rate of 4.17%. As with each of our previous Master Funding note series issuances, the Class B notes were retained by STORE.

Between our A+ rated long-term debt conduit, our short-term unsecured borrowings, and over $1 billion in unencumbered assets, we continue to maintain an efficient capital structure that provides us with access to long-term low cost capital.

Now turning to our guidance for 2015, we are raising our expectations for AFFO per share from a range of $1.33 to $1.39 to a range of $1.34 to $1.40.

Based on our robust acquisition activity for the first quarter and positive outlook for the remainder of the year, we've increased our guidance on acquisitions for the full year ending December 31, 2015 to $1 billion, up from the $850 million guidance that we provided in February. We continue to expect our average cap rate for the year to be about 8%. The timing of acquisitions is expected to be spread throughout the remainder of the year, though history would show us that acquisition activity is generally weighted towards the end of each quarter and that there's often slightly higher acquisition activity in the fourth quarter.

Regarding leverage, we continue to target a run rate debt to EBITDA level of between 6 and 7 times, which translates into a loan to portfolio cost of roughly 50%.

And finally, G&A costs are expected to be between $29 million and $30 million for 2015, including commissions and equity compensation. As we've mentioned before, we expect G&A costs as a percentage of our portfolio assets to trend lower over time, due to our scalable platform.

That concludes my remarks, and now I'll turn the call over to Mary.

Thanks, Cathy, and good morning to everyone. Today I'm going to provide some color on our portfolio and an update on what we're currently seeing in the market.

I'll begin with our portfolio. As Chris mentioned, in the first quarter, we added nearly $300 million in new investments at an initial cap rate of about 8.3%, which was slightly above our target of 8% for the year. As we've described before, we're in a flow business and cap rates will fluctuate slightly from quarter to quarter, based on the mix and timing of transactions. That said, given our investment activity to date and our expectations for the second quarter, we remain comfortable with our initial 8% rate estimate for the year.

Consistent with our investment approach, approximately 75% of the transactions we closed were originated directly. We were pleased that about one-third were with existing customers, who know firsthand the value we deliver.

From the start, we have focused on building our portfolio by creating contracts with a brick-by-brick approach and we're pleased to report that this continues. In the first quarter, we completed 32 new transactions at an average deal size of $9 million. We continue to apply our disciplined approach to selecting the right investments for our portfolio, and from a risk perspective, the contracts we created in the first quarter are consistent with our investment strategy. We know this because we monitor our entire portfolio using third-party risk algorithms. We then overlay unit level performance to determine a contract rating. As of March 31st, our median contract rating was A3 and approximately 76% of our portfolio had an investment grade contract rating using our STORE Score model.

At the end of first quarter, our portfolio of 1,073 properties were located across 46 states. Of the total, 74% were service properties, 15% were retail, and 11% were industrial.

Our top five concepts were Ashley Furniture HomeStore, Gander Mountain, Applebee's, Popeye's Louisiana Kitchen and Starplex Cinemas. Taken together, these investments represent 13.8% of our total annualized base rent and interest.

In addition, we had 246 customers spread across 69 industries with about 380 contracts. Our portfolio remained highly diversified, with no single customer representing more than 3.5% of annualized base rent and interest, and combined, our top 10 customers totaled less than 19% of annualized base rent and interest. We are proud of our portfolio diversification, which is among the highest of any public net lease market participant.

Now turning to what we're seeing in the market. Our second quarter is off to a good start and, as of today, we have closed over $220 million of transactions, bringing our year-to-date acquisitions to about $515 million. So far in the second quarter, we're seeing cap rates slightly above 8%. As Chris mentioned, we're running ahead of our plan for the year, and this is why we've increased our 2015 acquisitions guidance to $1 billion.

We're pleased that our flexible net lease financing solutions continue to create significant demand in the marketplace. We believe this reflects the fact that we are creating real value for our customers that they are willing to pay for.

In conclusion, we're excited about the volume and the quality of the transactions we're seeing. With that, I'll turn the call back to Chris for his final remarks.

Thank you, Mary. Before I turn the call over to questions, I wanted to again highlight the detail contained within our earnings release today and also our supplemental information packet that's posted on our website. We've designed both to provide best-in-class information regarding STORE.

As always, my personal favorite chart is the one on page 10 of our supplemental information packet, which contains a complete tenant and contract quality histogram. That information is derived from tenant financial statements that are applied to third-party risk algorithms, as well as unit level financial statements that we receive from about 97% of our assets.

We will expand or modify our supplemental information packet from time to time, based on your comments, but we began this effort by disclosing statistics that we believe are important in assessing the results and the quality of STORE's diverse portfolio of profit center real estate investments.

This quarter, we added a statistic for the median four-wall unit level coverage, which stood about 2.4:1, versus the 1.95:1 for a coverage that is loaded with indirect overhead costs. We added the four-wall coverage statistic because not all participants in our industry apply indirect costs or an equivalent amount of indirect costs, so we wanted to be able to illustrate the difference. Obviously, we believe that the loaded coverages are a better way to look at asset essentiality, because tenants typically look to be able to cover these indirect costs.

Note also that we talk about median coverages rather than average coverages. Average coverages are not typically as good at illustrating portfolio risk, because the averages apply unit level cash flows across the portfolio, whereas our real investment risk is based on a contract-by-contract basis. Averages can also be more volatile, because they're influenced by numerical outliers. To illustrate this, the weighted average fully loaded coverage for STORE's portfolio was over 3 times as of March 31st, or more than a full turn higher than our median number. However, we have elected not to report this number, because we believe it to be less informative. Likewise, we tend to talk about median tenant credit ratings and lease contract ratings. Our unit level coverages are embedded in the contract ratings that you can see in the full distribution on page 10 of our supplemental information packet. Anyway, I hope you'll find this disclosure helpful, and we always welcome your feedback.

So with this, I conclude my comments and turn the call over to the operator for any questions you might have.

(Operator instructions)

Derek Van Dijkum, Credit Suisse.

Good morning.

Good morning.

Just wanted to get a little more info on Heald College and on the sale of the one asset and the potential lease on the other.

No problem. I should also say, I'm surrounded by our entire leadership team so we have a pretty deep bench- and Mike Zieg runs our Portfolio Servicing. I'll just turn it over to Mike to give some color on that.

Sure. As Chris noted in his earlier commentary, we have 60%, or almost 60%, of the Heald exposure with a resolution. As he mentioned, we're selling one property and leasing another, for a combined recovery of about 90%. So we're very pleased with that progress we've made so far.

The other assets -- these are all well located facilities. They're in small office buildings of less than 50,000 square feet. They're well located, very suitable for other users. Obviously, the first goal of ours is going to be find another education user in there, because that's how they're currently configured. So we expect these will get rented or sold and be within our typical recovery rates of what we expect overall, which over time range 70% to 90%.

Just so you know, the one that we're selling is being sold to a charter school that's actually located next door to the facility and they're looking to expand. The other one that we're leasing out is also going to be to a secondary school provider that's a for-profit secondary school provider that runs about 19 other locations, or 18 other locations. So a very nice company that we've been familiar with for a while.

Got it. Now given that you paid roughly, I guess, $40 million for the 5 assets, how does your calculus change potentially going forward when you -- because I think you get a lot of potential purchase price diversity when you buy, instead of 5 assets for $40 million, 40 assets for $1 million, how does that calculus come into play?

That's a good question. I think in our business, where you're dealing with granular asset portfolios, whenever you make big asset plays, which we'll do from time to time, there's less diversity in the assets. So you have to be, obviously, a strong believer in those assets and you have to believe that you're buying those assets at prices that are supportable in the marketplace.

There's always going to be a difference between the price that we buy an asset at and the price it would re-let out at, if it were dark. We can't run around the country and buy assets at dark values, because nobody would sell us assets for dark values when they're operating assets.

So an asset like these 5 facilities, these were well located facilities that had really great student attendance and pretty ballistic coverages, when they were running. And they were all in their second life. So they initially started their lives as office buildings and then they were reconfigured for education.

So keeping them as education assets, as Mike said, is obviously the easiest thing to do, and it's going to give you the highest rates of recovery. I would tell you that on the three assets that we have, we're having interest in those assets. And a lot of the interest comes from other education providers, because it's hard to find these kinds of assets that are zoned like that and that have -- sort of like an office building with too much parking, if you think about it that way.

At the end of the day, assuming that we get the same kind of recoveries and we have the same diversity, then this investment will prove out to be no different from any restaurant default or anything else that we would have had. And that's the idea.

Got it. And then lastly, given the latest issuance of your STORE Master Funding notes, looks like you guys did a combo of 7 and 10-year maturities. How come you guys don't look at going longer-term and trying to match your lease term or your weighted average lease term with your debt maturities?

Technically speaking, you actually can't match fund leases. So let's say you have 15-year leases, which are average leases; doing 15-year notes won't match fund them. What REITs can do is match fund cash flows. So you have to focus on match funding cash flows, as opposed to lease contracts. After all, a 15-year lease has renewal options. So it's going to go on and on and on.

So in theory, if you think about it that way, our dividend payout ratio is 75% of AFFO. Assuming that we are able to reinvest that or use the proceeds to pay down debt, assume that that amount equals our debt maturities in any given year, then we're basically asset liability neutral. To the extent that we have more cash flow than we have debt maturities, we're asset sensitive. And to the extent we have more liabilities than mature, we're liability sensitive.

Every single REIT out there, I think, runs themselves with the same kind of philosophy, in that sense. And you're really trying to ladder maturities wisely, so you don't have any maturities due in any one year. So when we did the 7-year debt, it was actually a small piece of the deal. It was $91 million worth of debt. Most of the debt we did was 10-year, which we were happy to pay up for. But we had a hole in that 7-year period. So we wanted to fill in the holes as much as we could to make sure that we had a nice ladder.

Right. I guess if I look at your free cash flow this year after dividends, it's, call it, roughly $40 million. In 2017, 2018, 2019, you're going to start seeing some pretty big maturities. It looks like in order to get to that level where your free cash flow is able to pay off any maturities in any given year, you're going to have to increase your free cash flow quite substantially from where it is today.

I would say this is a growth REIT. If you think about the maturities of those Master Funding issuances, the 10-year one, if we wanted to have an equivalent amount of cash flow, that's correct. We would have to be a bigger company, which we fully expect to be a bigger company.

If we happen to be liability sensitive in one year, it's not the end of the world. A lot of REITs will have some years where they're liability sensitive. In the case of our earlier debt maturities, those debt maturities also happen to be at the highest interest rates. So they're close to 6% debt, which I would be glad to pay that off today. I don't know what the debt's going to be in three or four years. But I'm guessing that it will probably not be materially different from what the rate is, so that we won't have a lot to worry about.

Okay. Fair enough. Thank you.

Vikram Malhotra, Morgan Stanley.

Thank you. If it's possible, could you give us what the sale proceeds were from the Heald College transaction and then what the new rent levels are for the other asset?

Well, the asset that we're leasing out, we're basically getting the same rent that Heald was paying. And the asset that was being sold has not closed yet. In fact, the rent hasn't begun on the asset that is being leased out. So that rental will commence later on in the year. In terms of giving you the exact specifics on both of those, I'd rather not get that granular.

Okay. Maybe if you could just say where in the bar chart, the histogram of the credit, where did that fall, which category did Heald fall in?

Heald was actually, at the time, in the A1 area, I think. And part of that is because if you looked at the transaction, Heald as a credit had no debt at the credit level. And then the coverages, when we started off doing the deal, were around 13 to 1 and even as the most recent financial statements we had the coverages were close to 9 to 1.

So one of things about the histogram that I mentioned earlier, too, is the histogram is a quantitative histogram. It is not qualitative. So there are qualitative features that can affect credit risk. In this case, the overriding qualitative feature was that Corinthian ran into a dispute with the Department of Education and with the State Attorney General in California which ultimately caused its demise.

And it should be pointed out, by the way, that they had divested of many other locations around the country outside of California, which stay open today, which actually didn't have the unit-level economics that our assets did. So the fact that they were in California had a lot to do with the fact that they're not open today. Anyway, that's a qualitative discussion.

Now the qualitative features tend to work more often the other way. So for example, we could have an asset with an industrial borrower where we have a hugely favorable capital stack. They have debt, but the debt's very junior to us. We could be in assets that are very inexpensive, which happens a lot of times. So we're just in the assets very cheap. So there are certain transactional qualitative issues that just don't appear on this chart.

So what will happen with this transaction will be that we'll replace this transaction. We'll have one new customer, which we're excited to have, which is a well-capitalized, well-funded education company, not dependent on the Department of Education, and which will appear extremely strong, from a contract rating perspective. And then we'll have, the other one will be sold. And we'll take those assets and redeploy them.

And I should just comment to you that we always have a choice, do we sell the asset or not? We took a $1 million write down, because we're selling the asset. If we chose to own the asset and not sell it, we wouldn't take the write down at all. In fact, we could probably rent it out for less money and not take out a write down.

So I'm less about the accounting implications of all this than I am about trying to be able to take the cash that we get and redeploy it and maximize adjusted funds from operations per share. I'm a finance guy, not an accounting guy. And I'm into real results. So that's what we're trying to generate.

Okay. And then maybe a bigger picture question. There seems to be a couple of maybe large sale lease back deals potentially that have taken place over the last quarter or so, and maybe a few teed up for the next few quarters. I know you obviously have been very granular in your approach, but what sort of size would you be comfortable with and would you engage in a larger transaction?

The biggest tenant exposure we have today is Gander Mountain, which is around 3.2% of revenues. I think we might be willing to go to something like 5%. I think that we want to make sure that we keep this -- I think there's a lot of value in keeping a pretty high level of diversity, from a risk perspective. And of course as we grow, we'll be able to do bigger and bigger transactions. But for now, I think that staying within that bandwidth is important.

Likewise, it's important to point out that even with Gander Mountain, as big as they are for us, that didn't happen all at once. It's 12 properties, I think, that were acquired one at a time in transactions, and eventually became a large relationship.

If you look at our last quarter, we added 21 new customers. And so we had 32 transactions, 21 of them were with new customers and the rest of them were with existing customers. So they're just adding on to customers that we believe in. And that's really been our mode of operating this. And we're on track today, at $1 billion, to do a material amount of business for 2015.

Thank you.

Craig Mailman, KeyBanc.

Hello, guys. Sort of a follow-up to that last question. Just curious, just from a deal perspective or technical perspective, what are the challenges on some of these potential large sale lease backs? We've heard some of the restaurant guys are getting agitated to do it. But just curious, from tax consequences and other things that may be impediments for you guys to get your arms around it.

Expand the question, get more specific for me.

What would be the biggest challenges for you guys to move ahead with that kind of transaction from a technical perspective, versus wanting to keep your tenant exposure at a certain level or from a credit perspective? Maybe there's nothing. I don't know. I'm just curious.

I would say that, first of all, if you're thinking about some of the transactions where activist shareholders are rooted in restaurant companies and are looking to have them divest of real estate and are looking for tax efficient ways of getting this done, I think that we think that's a very real possibility. Whether or not we could play a role in some of that would remain to be determined. But I think that from an investor perspective of any investor in STORE, one thing that we can't do is play in some big portfolio in some way that's going to hurt the diversity of the company that we've created. And so we don't intend to do that.

From a tax perspective, taxes are a large issue for people that own real estate. Because if you -- especially if you've run a C corporation and if you've been depreciating real estate for many years, when you sell the asset, the recapture is taxed at 34%, or somewhere in that neighborhood. And it's material and it can actually destroy the whole idea of doing a sale leaseback. If you have to pay that kind of tax leakage, why bother doing a sale leaseback? You can just debt finance it a lot easier, if you're looking for after tax dollars.

And these issues don't just affect big companies that are looking to sell real estate that you might have read about. These issues affect smaller companies, as well, that have held onto real estate. So if you think about the solutions that we provide our tenants, our customers, some of those solutions have been solutions designed to improve the tax efficiency of transactions. And those are the kinds of things that allow us to generate nice returns, because we're creating a lot of value for them.

Okay. That's helpful. And then just a quick clean-up one. You had mentioned that you guys give us the coverage on a median basis rather than an average, just because of the ability to skew. But what's the range of your coverages, kind of low to high?

The range is really wide, like the highest coverage -- what do you think it is, Michael, 13, 14?

13 or 14 at the unit level. We have one client that has absolutely no debt, a large company with 45 times coverage on their corporate. It's just all over the board.

So you really want to focus on medians. The median is where the contract risk really is. It's where we take the risk. And I wanted to make that point today. It's my opportunity to educate the world a little bit on how to look at stuff. And I think that median is the way you have to look at it. Averages get skewed.

What's the low end of that? What's the bottom you guys would underwrite to?

You can see that on the left, on the histogram. You can pretty much see that. Because you can see what the effective credit ratings are. So to focus on just the unit level coverage by itself is missing the point, because the risk is a combination of unit level and corporate risk. And so together, you're taking an aggregate risk.

So if you look at the histogram, you'll see that we have some assets -- we have a handful of triple C-plus investments. And those are the assets that we'll think about maybe selling some, or they could be assets where we're not worried about them at all, because the assets are performing fine at the asset level, or they're new builds and they're increasing, or we have corporate guarantees or we have other qualitative issues. So we'll think about that and assess it from time to time. But generally speaking, if we're comfortable, we keep it.

Okay. Great. Thank you.

Ki Bin Kim, SunTrust Robinson Humphrey.

Thank you. Just a quick question on the Heald College and maybe some other leases that will expire. But more specifically on Heald, what kind of capex would you have to spend on that new lease?

The new lease, actually, because we targeted an investor -- I'm sorry, an educator user and there's high demand for the property, we're actually putting no TIs into the property in the new lease. And it's a triple net lease, so effectively no different than Heald, we're getting 100% of rents and just did a quick switch of another tenant and put them in there. That's kind of our business model.

The real estate we're investing in is very fungible for other users and in high demand. So if it becomes available, like this one was, there was literally a feeding frenzy of people that wanted into that site, because of the high demand for good quality education facilities.

So that was 2 out of the 5 buildings. How about the prospects for the other 3?

We have varying levels of interest in the other 3. Again, they're all well located facilities in Northern California, and there's other education institutions that are either expanding or relocating that we've been in discussions with.

By the way, I would say that the experience that we're having here is not unusual. So in our history of doing this about 30 years, the average time it takes to fix a property is six months. When we do the budgeting and when Cathy does her budgeting, we're always assuming a certain level of defaults, we're assuming a certain level of property management costs, we're assuming a certain level of losses on relets. You always make those assumptions, whenever we create earnings or AFFO estimates at the beginning of the year.

So you have 2 of these properties of the 5 that are already fixed, and now you've got to deal with the other smaller assets, the other 3 assets. And if it takes a little bit longer, our average could be six months or it could be shorter. It could be longer but at the end of the day, you're talking, at this point, about 0.5% of revenue. So it's not a material issue.

I realize I need to keep it in perspective. It's not that big of a deal.

Just one other question on Heald and your STORE scores. You mentioned in the call that it was in the A1 area in regards to your histogram. I think that equates to, from your presentations in the past, maybe a 0.06% default rate. And I realize this is because of a regulatory issue and some other things involved, but does something like this change your thinking at all about how you guys come up with your STORE scores for credit risk?

Not in the least. The STORE score is what it is. It's a quantitative -- emphasize on quantitative -- measurement of risk. It is not qualitative.

If you think about people that have the government as a partner -- and here you have effectively the government as a partner and the government controlling the revenue streams -- if that partner decides to change what they do, then you can have -- you can experience adversity. So it has governmental risk associated with it, just as if you were in a hospital or you're in a nursing home or anything else where there's large extraneous factors that can happen. Here, something large and extraneous happened.

This school, by the way, I should point out, Heald was acquired five years ago by Corinthian for $400 million, and it's been running for 150 years. And if you had your credits from Heald, you could take them to virtually any state school in California. So in the span of one year, this school has been besieged so heavily by regulatory authorities that it was forced to shut down. And who could see that?

So we assumed when we were doing the Heald transaction, for example, the coverage was 13 to 1 at the time we did it. We assumed that there would be pressure on the price of the courses, that the 13 to 1 was kind of a short-term coverage. But it was 13 to 1. At the time it closed, it was 9 to 1.

Things like this happen. And it was unfortunate. I'm not happy about it. If I looked at it and said, why are all the Everest schools in Tennessee or wherever open, but our school, which is making most of the money for Corinthian, has actually closed? It's because our schools were in California. And so I had two things against us. One, we were in California; and two, we had the legal issues that we had. And that's what caused the problem.

So it has nothing to do with the STORE score. It has nothing to do with how we look at risk. It has everything to do with qualitative issues that can come and hurt you. And conversely, qualitative issues can benefit you. We have assets where the STORE score doesn't take any account into whether we're into an asset really dirt cheap. It takes no indication if we have guarantees. It takes no indication if we have other forms of credit enhancement, letters of credit, rent deposits. It is absolutely positively quantitative. And I would say that by and large, the qualitative issues tend to probably favor us more than they hurt us.

I apologize for thinking too much on a small part of your entire portfolio, but it was topical. Just one last quick question. Your weighted average yield for acquisitions this quarter was a little bit higher than I think your guidance range from the past, 8.3%. What should we expect for the second half of the year, roughly?

We're still looking at 8% as being a good weighted average rate for the whole year.

Okay. That's it. Thank you very much.

Andrew [Rosivach], Goldman Sachs.

Good morning, everybody. I wanted to ask, Chris, you made that point on 2016. I wanted to ask you a couple of questions on it. You've got an acquisition pace of $1 billion in your guidance. Obviously, you were running faster than that in the first quarter. You ran faster than that a little bit last year. Is there any reason why you've got to slow down, or are you just being careful?

I would say that we're trying to give you guidance on what we think we have visibility towards. Because we're in a flow business, it's hard for us to get expansive beyond that. No question we've seen a lot of activity in the first quarter. Some of that was slopping over from the end of last year. But still we've seen -- our pipeline today is north of $6 billion worth of deals that we're looking at. It churns all the times, but it's lots of transactions. We're seeing that we added 21 new customers in the first quarter. And if you look at those 21 customers, probably 70%, plus or minus of that, were investment grade contracts that we were able to create.

So we're very excited about the demand that we're seeing. And our relationship managers are likewise pretty jazzed up about where the year is heading. Is it possible to do over $1 billion? Yes. Keep in mind the $1 billion that we're estimating is a net number. There may be some property sales during the course of the year, and so that will be in that number.

I apologize. Mary, did you say what you've done in April or year to date?

Second quarter to date, we've done $220 million. And that puts us through yesterday and puts us year-to-date at $515 million, Andrew.

Terrific. Thank you. And one other on the 2016 run rate, Chris. I'm guessing that Heald, you've got just some natural drag over the course of the year that if you do get a 70% to 90% recovery rate, there's rent that you're not getting now that you would get in 2016, there's capital that you don't have now that you would get in 2016. Any sense of the order of magnitude of the drag, if you will, in 2015 that's probably going to go away next year?

First of all, Heald itself is only 1.2% of our run rate. And if you look at it on 2016, it's probably going to be less than 1% of the run rate, if you were to take Heald overall. But keep in mind that when we give estimates, as always, we're factoring in a certain level of default anyway. You have to do that in our business. We can't assume that we have 100% occupancy all the time. And we can't assume that we don't have any property costs. It would be unwise for us to make that assumption.

That's right, Chris. In your guidance, what is the credit loss reserve that you guys run through?

It ranges from year to year. It scales up over time. But it's kind of--

So if it's like 20 or 30 bps is what you had this year? I can't remember.

It starts off at like 1% to 1.5% from a default, 1% to 1.5%. We can stress it to 2% or something like that for the year.

Got it. And then the last thing on Heald, there were a couple mortgages under the properties, right, that were non-recourse?

Yes, that's true. So we had $40 million worth of investments, $40 million or $39 million.

$39 million.

$39 million. Of that, two of the properties were in a CMBS facility and three were in our own conduit. In terms of the properties that have been fixed, one of those was a CMBS conduit property. And that's the one that's being re-rented. And then one of the properties that's in our conduit is being sold.

Got it. So one of the properties where you have non-recourse single asset CMBS is one of the ones that hasn't been addressed yet?

Right. That's correct.

To make this even tinier than it already is. All right. Thanks a lot, everybody.

Thank you.

Cedrik Lachance of Green Street Advisors.

Thank you. I just want to go back to the coverage ratios. What percentage, if any, of your portfolio has a coverage ratio of less than 1 or less than 1.25?

Again, it depends. If you're talking about fully loaded or not fully loaded. Do we have that number in front of us? It's a relatively small number.

I would just about rather you just focus on the histogram on page 10. Basically, if you look at the blue lines, which is the credit contract rating, you'll see these slivers of blue lines around triple C, B3. Those are going to be the areas where you're going to have negative coverages. It's a small number.

I'm sorry to go back to the college question, but I'll avoid talking about the one that closed. I won't even use the name. Just in big picture terms, though, you do have about 5.5% of your income that either comes from junior colleges or colleges and professional schools. How do you think about that category going forward, given what we've learned over the last year in terms of government intervention and how the environment has changed in terms of these professional schools, in particular? What percentage of your portfolio do you want in the category? How do you think about underwriting it? Will you make more investments in it? So if you could cover all of those, it would be great.

If you look at our portfolio today, outside of Heald, we have 3 for-profit tenants remaining that are for profit. They're all trade school type tenants. Most of the degrees that they offer are Masters and PhD degrees and four-year degrees. Heald was classified as a junior college. The rest of the for-profits, the other 4 assets we own are not. People get very nice jobs out of all these schools. I think that we feel okay with them.

We have some exposure to post-secondary remaining from that, but that's all non-profit. One of those is a trade school. The rest of them are community colleges. And community colleges are funded by state taxpayer dollars, and so the revenue streams tend to be pretty strong from the community college side.

We feel pretty strong about community colleges. We think that there's a strong need for them. We actually believe that the for-profit sector fulfills a need, because these students have a choice of where to go. And most of them who go to for-profit schools go there because they can't find community colleges to go to.

That being said, the regulatory environment that we're in is caustic. It's uncertain, and it would cause one to stay away from for-profit schools at this point, until the air is clear. I would say, if I could get on a political soap box for a second, that the rules that for-profit schools have to abide by, in my view, should be abided by all schools. To the extent that schools are evaluated and students are burdened by student loans, for-profit schools shouldn't be singled out as being bad actors simply because they're for-profit schools. Although I'm sure there are bad actors across the universe, and Corinthian may or may not have been a bad actor.

But nonetheless, I don't have to worry about that. What I have to worry about is, are we going to do any for-profit stuff in the near future? And the answer is no.

Thank you. Just the last one. You have a stated goal on that EBITDA front of 6 to 7 times. So now you just got into the low end of that range. On a fully adjusted basis, I would imagine as you fulfill your expected $1 billion this year, you'll creep up to, at the very least, the middle of the range. At what point is equity contemplated in your funding plans?

We can be a little bit flexible about that. And of course, we can move north of 7 for a short period of time, if that's what we want to do. So for the interim period, so we're not going to have 7 as a cap and then say that we have to just do it right then and there. But clearly, given the volume that we're doing, there will be equity out there.

And we're excited to do that. Because the reason we're deploying the equity and the reason -- if we have to access equity, it will be because we're growing. And hopefully, if you look at the spreads that we've been able to generate, we did average lease rates of north of 8, but let's say 8. Our average borrowing cost is 4. That's 400 basis points of spread which, in my 30 years of doing this, is as nice a spread as I've ever seen. I think for the existing shareholders that we have, while we can do this kind of business and while we can meet this demand, we should do it.

Great. Thank you.

This concludes our question-and-answer session. I would like to turn the conference back over to Chris Volk for any closing remarks.

Operator, thank you very much. And thank you all for attending. On behalf of everybody here at STORE, we're delighted to make the call. And you know how to find us if you have any questions. So thanks so much. Good-bye.

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