STORE Capital Corp (STOR) 2016 Q3 法說會逐字稿

Hello, and welcome to STORE Capital's Third Quarter 2016 Earnings Conference Call. (Operator Instructions.) Please note, this event is being recorded. I would now like to turn the conference over to Moira Conlon, Investor Relations for STORE Capital. Please go ahead.

Thank you, Carrie, and welcome to all of you joining us for today's call to discuss STORE Capital's Third Quarter 2016 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 up the call to your questions. In order to maximize participation while keeping our call to one hour, we will be observing a two-question limit during the Q&A portion of the call. Participants can then reenter the queue if they have follow-up questions.

Before we begin, I would like to remind you that comments on today's call will include forward-looking statements under the federal securities laws. Forward-looking statements are identified by words such as will be, intend, believe, expect, anticipate, or other comparable words and phrases. Statements that are not historical fact, such as statements about our expected acquisitions or our AFFO and AFFO per share guidance for 2016 and 2017, are also forward-looking statements. Our actual financial condition and results of operations may vary materially from those contemplated by such forward-looking statements. Discussion of the factors that could cause our results to differ materially from these forward-looking statements are contained in our SEC filings, including our reports on Forms 10-K and 10-Q.

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

Well, first, are you all awake after a thrilling Game 7? I hope so. So good morning, everyone, and welcome to STORE Capital's Third Quarter 2016 Earnings Call. With me today are Cathy Long, our CFO, and Mary Fedewa, our Executive Vice President of Acquisitions.

We continued to be active on the acquisition front, investing over $257 million during the quarter, bringing our total new investment to nearly $900 million for the first nine months of the year. Net of approximately $56 million in gross asset sales, our investment activity for the year totaled $842 million. Our portfolio remained healthy, with an occupancy rate of 99.2%, and approximately 75% of our net lease contracts rated investment-grade quality based upon our STORE Score methodology.

Our dividend payout ratio for the quarter was below 71% of our adjusted funds from operations, serving to provide our shareholders with a well-protected dividend and a company well-positioned for long-term internal growth based upon anticipated tenant rent increases and the reinvestment of our surplus cash flow

During the quarter, we were proud to raise our quarterly dividend to $0.29, which represents a sector-leading 7.4% increase over the past year.

Our funded debt-to-EBITDA on a run rate basis continued to be just under 6 times at the end of the quarter, with our unencumbered assets standing at $2.3 billion, or 47% of our total gross investments, providing us with flexibility in our financing options. In August, we received a corporate rating of BBB- with a positive outlook from Standard & Poor's, which adds to the BBB- rating we received from Fitch Ratings in 2015. We plan on continuing to access the unsecured term note market on our way to elevating our unencumbered assets to more than 50% of our total portfolio.

Meanwhile, we also have a valued A+ rating for our master funding conduit, which we employed in October, that issued $335 million in term notes. Here, we did something completely new for STORE. We sold $200 million of 10-year notes at a record low interest rate for us of 3.96%. Then, we retained $135 million worth of notes, which can be sold at any time as we need the additional term financing.

So, between our ability to issue BBB- rated unsecured notes and to readily sell issued but retain master funding notes, we've increased our capital flexibility considerably. The long-term aim of having these complementary investment-grade borrowing options is to lower our comparative costs of capital relative to companies that have fewer such options.

As we discussed in earlier calls, our interest rates on term borrowings highlights our historically high investment spreads that we've been able to realize and the stable, long-term, laddered borrowing maturities that we are creating. Our laddered maturities, supported by free cash flows after dividend payments, will largely protect STORE from liability sensitivity in the event of rising interest rates or interest rates reverted to more historic average levels.

Now here are some statistics relevant to our third quarter investment activity. Our weighted average lease rate stood at approximately 8.2%, up slightly from 7.8% last quarter. The average annual contractual lease escalation approximated 2%. The weighted average primary lease term was approximately 16.6 years. The median new tenant Moody's RiskCalc rating profile was BA1. The median post-overhead unit level fixed charge coverage ratio was approximately 2.4-to-1. The median new investment contract rating, or STORE Score, for investments made during the quarter was consistent at A1.

We added 15 new customers and expanded our profit center assets to include five net new industries, reflecting both our diversification strategy and value proposition across industry sectors. Our average new investment was made at approximately 70% of replacement cost. 86% of the revenues from the net lease investments made during the quarter were subject to master leases. All of the 85 new assets we acquired during the quarter are required to deliver us unit-level financial statements, giving us required unit-level financial reporting from 97% of the properties within our portfolio.

Our investment activity continued to be highly granular, with 38 separate transactions completed and an average transaction size of about $6.8 million. Finally, at the end of the quarter, the proportion of revenues realized from the top 10 customers continued to be highly diverse, at just 16.2% of annualized rents and interest. Further, our largest single customer represented just 2.3% of our annualized rents and interest.

And with that, I will turn the call over to Mary.

Thank you, Chris, and good morning, everyone. During the third quarter, we continued to see steady investment activity along with stable cap rates. Acquisition volume was $257 million, which is consistent with the same period last year. As Chris mentioned, our average lease rate for third quarter was 8.2%. This represents an uptick from 7.8% last quarter and brings our year-to-date average cap rate to 8%. As we frequently note, variations in initial lease rates from quarter to quarter will happen, but our view is that over the long term, cap rates remain relatively steady in the market we address.

Including our third quarter investment activity, our portfolio remains consistent across industry types with approximately 70% in service industries, 16% in retail, and the remaining 14% in manufacturing assets, and approximately 75% of the contracts we create continue to be investment-grade quality.

When we started this company over five years ago, we were determined to build from a solid foundation. One of the key structural features of our foundation is our direct origination platform. This platform allows us to own deal flow. Owning deal flow allows us to create our own contracts, and in fact, we are using our own lease form approximately 90% of the time. Owning deal flow also enables us to provide tailored solutions to our customers, and in turn, to get paid for those solutions. The clear result is that since STORE's founding, our cap rates continue to be better than the auction marketplace. And finally, owning deal flow allows us to invest in real estate at rational prices.

As I have mentioned on prior calls, we expect to sell selected properties during the year to take advantage of opportunistic gains and to balance our portfolio. Our year-to-date property sales totaled approximately $56 million of gross investment value. We consider $32 million of these sales to be opportunistic, and we achieved cap rates on these sales of approximately 100 basis points less than our year-to-date acquisition cap rate. This demonstrates the market premium we are realizing as a result of the value we deliver to our customers.

As you saw in our press release, we have increased our 2016 acquisition guidance to $1.1 billion net of property sales, which we estimate will be $60 million to $80 million for the full year. Fourth quarter is off to a strong start. As of the end of this week, we will have funded over $1 billion in year-to-date gross acquisition volume.

With that, I'll turn the call to Cathy to talk about financial results and guidance.

Thank you, Mary. I'll start by discussing our balance sheet and capital structure, followed by our operating results for the third quarter and the guidance we announced today. Please note that all my remarks refer to the third quarter ended September 30, 2016, and all comparisons are year-over-year unless otherwise noted.

Our third quarter operating results and balance sheet strength reflect the continued healthy growth of our portfolio and our team's expertise in portfolio management. Our third quarter acquisition activity was funded through a combination of borrowings on our unsecured credit facility and equity raised through our ATM program. As planned, we launched our ATM program in the beginning of September this year. This equity program allows us to sell from time to time registered shares up to a maximum amount of $400 million. During September, we issued and sold approximately 2.5 million shares, raising $71.6 million in net proceeds.

Our total long-term debt outstanding at September 30 was $2.1 billion, with a weighted average maturity of 6.3 years and a weighted average interest rate of 4.6%. At the end of the third quarter, our leverage stood at a conservative 5.9 times net debt-to-EBITDA on a run rate basis, or roughly 45% on a debt-to-cost basis.

Subsequent to quarter end, we issued our seventh series of long-term fixed rate notes under our master funding debt program in the amount of $335 million. As Chris mentioned, we retained $135 million of that debt for future sale. This seventh series of notes included $20 million of BBB rated class B notes, which were also retained by the Company, bringing our total class B notes retained since the inception of our master funding program to $128 million.

As a reminder, since we hold the class B notes ourselves, the note asset and liability eliminate in consolidation, so they're not reflected as assets or debts on our consolidated balance sheet. Since these class B notes are issued and outstanding, they provide us with the flexibility to sell them to a third party in the future or use them as collateral for borrowings.

As of the end of the third quarter, gross investment in our real estate portfolio totaled $4.8 billion, of which approximately $2.5 billion has been pledged as collateral for our secured debt. The remaining $2.3 billion of real estate assets are unencumbered, providing us with multiple financing options to effectively manage our cost of capital.

Since our IPO, we've significantly expanded our financing flexibility to include a variety of debt and equity options to support our continued growth as we scale the business.

We entered the fourth quarter with $30 million in cash and nearly the full $500 million available on our credit facility, giving us plenty of liquidity to fund real estate acquisition opportunities.

Now, turning to our operating results, revenues increased 30% to $97 million, reflecting continuing growth in our real estate investment portfolio. Rental revenues again made up about 95% of our total revenues, with the remainder largely attributable to interest income on mortgages and leases accounted for as direct financing receivables.

Our portfolio has grown from $3.7 billion in gross investment a year ago, representing 1,246 property locations, to $4.8 billion, representing 1,576 property locations at quarter end.

The annualized base rent and interest being generated by the portfolio in place at the end of the quarter increased 27% to $395 million as compared to $312 million last year, with increased diversity by location, by industry, and by tenant. Total expenses increased 28% to $67 million compared to $52 million a year ago. The increase largely reflects the growth of the portfolio, with about half of the increase due to higher depreciation and amortization expense.

For the quarter, interest expense increased 27% to $27 million, from $21 million a year ago, as we continue to fund a portion of our acquisitions with long-term borrowings. This increase in interest expense from our borrowing activity was slightly offset by a decrease in the weighted average interest rate on our long-term debt, from 4.7% to 4.6%.

Property costs were $800,000 for the third quarter. The increase year over year was largely driven by real estate taxes and other property carrying costs incurred on properties that were vacant during the quarter. As of September 30, 12 of our properties were vacant and not subject to a lease. These properties represent a very small amount, less than 1% of the annualized base rent and interest generated by our portfolio. Property costs can vary quarter to quarter based on the timing of property vacancies and the level of underperforming properties, but are generally not significant to our operations.

G&A expenses were $8 million for the third quarter compared to $7 million a year ago. As a percentage of portfolio assets, G&A expenses decreased to approximately 70 basis points on an annualized basis compared to approximately 80 basis points a year ago, largely due to the benefits of efficiency and scale that come with portfolio growth.

About half of the increase in G&A expenses is due to higher compensation and benefits associated with staffing additions to support our growing investment portfolio. The remainder of the increase is primarily due to amortization expense, related to our equity-based compensation program, where our legacy comp plans are being replaced with our new public company comp programs that are more comprehensive and include more employees.

Net income increased to $36 million for the quarter, or $0.24 per basic and diluted share, compared to $23 million or $0.18 a year ago. Our net income for the third quarter included a gain of $6.7 million net of tax on the sale of 16 properties, versus the $700,000 gain on the sale of three properties last year.

Strong execution across the Company delivered a 31% increase in AFFO, resulting in $63.8 million of AFFO for the third quarter, compared to $48.6 million a year ago. AFFO per diluted share increased 8% in the quarter, to $0.41 from $0.38 last year.

For the third quarter, we declared a quarterly cash dividend of $0.29 per common share to our stockholders. On an annualized basis, this dividend of $1.16 per common share represents an increase of $0.08 per share or 7.4% over the previous annualized dividend.

Now, turning to our guidance for 2016, today we raised our projected 2016 annual real estate acquisition volume to $1.1 billion from $1 billion, which is net of anticipated property sales in the range of $60 million to $80 million. Our AFFO guidance is based on a weighted average cap rate of 7.75% on new acquisitions for the remainder of the year.

The timing and mix of debt and equity have an impact on our AFFO per share in any given period. While we don't give guidance on capital markets activities, we're currently targeting a more conservative leverage level that's based on a run rate net debt-to-EBITDA ratio of 6 times, plus or minus 25 basis points, or roughly 45% to 47% leverage on the gross cost of our portfolio.

Based on these assumptions, we're narrowing our 2016 AFFO per share guidance to a range of $1.62 to $1.63 from $1.61 to $1.63. This equates to anticipated net income of $0.73 to $0.74 per share, excluding net gains on the sale of properties, plus about $0.79 per share of expected real estate depreciation and amortization, plus approximately $0.10 per share related to non-cash items and real estate transaction costs.

Finally, I'll turn to our initial guidance for 2017. We currently expect 2017 AFFO per share in the range of $1.74 to $1.76 based on our current projections for real estate acquisitions for the remainder of 2016, plus projected annual real estate acquisition volume for 2017 of approximately $900 million.

As with 2016 and prior years, AFFO per share in any period is always sensitive to the timing of acquisitions during that period. The timing of acquisitions for 2017 is expected to be spread throughout the year, though weighted towards the end of each quarter. Our AFFO guidance is based on the weighted average cap rate on new acquisitions of 7.75%.

Our AFFO per share guidance for 2017 equates to anticipated net income of $0.78 to $0.79 per share, plus $0.87 to $0.88 per share of expected real estate depreciation and amortization, plus about $0.09 per share related to non-cash items and real estate transaction costs.

For 2017, we're targeting leverage based on run rate net debt-to-EBITDA of around 6 times, plus or minus 25 basis points, and interest costs on new long-term debt for 2017 is estimated based on a weighted average interest rate of about 5%.

And now, I'll turn the call back to Chris.

Thanks, Cathy. Before turning the call over to the operator for questions, I would like to make a few comments. Year to date, we've sold 21 properties with a gain over our initial cost of approximately $5 million. Although asset sales are a small part of our business activity, they are an important piece of our portfolio management activity.

Most of the gains resulted from opportunistic asset sales from our broker desk, which resulted in a cap rate spread relative to our initial investment cap rate of around 150 basis points. Importantly, the spread relative to our ability to reinvest the capital is about 100 basis points. As I stated to you on past calls, you can think of the spread as a negative vacancy rate, which helps to defray costs we might otherwise have from asset vacancies, which are a part of this business. So our ability to regularly harvest some asset gains at cap rates that are less than the rates at which we can redeploy the cash received provides an intended extra measure of investment protection.

Owning deal flow, as we do, and having a robust team of direct originators, as we do, enables us to originate lease contracts having positive spreads to net asset value, which provide a material margin of safety in what we do and helps make STORE a great business. We are focused on maintaining the strong foundation we established when we formed STORE. The significance of a strong foundation is that it really can't be changed or altered much over time.

So to give an example, our average lease escalators of 1.7% annually are amongst the best in the net lease space, and we disclose this quarterly to you on the escalators that we're able to generate during the contracts for the quarter. Knowing this enables you to more or less compute a gross rate of investment return. Changing the nature of lease escalations, once one has a large investment base of about $5 billion in investments, as we have, it is difficult, so we have to plan for this in advance and model it into our DNA.

Similarly, high dividend protection is hard to create, and that is why we introduced STORE as a public company with a well-protected dividend at the outset. That protection has actually increased since our IPO two years ago, while we have increased our dividend by a sector-leading 16%. In other words, we have raised our AFFO per share more than we have increased our dividends per share. The result is a better protected dividend, and a retained cash flow, like rent increases, contributes to better internal growth.

From experience, having grown net lease REIT businesses for the past 30 years, we learned that you really only have one chance to get this right as you set about to establish and grow a business, because external growth cannot always be as potent as it is now. Knowing that reality, we deliberately thought about the importance of such foundational elements.

Other elements built into our unique model include the receipt of store level financial statements, keeping our investments generally below replacement cost, having lease rates in excess of NAB lease rates, structuring smooth laddered debt maturities that start in 2019 and insulate us from interest rate risk, investing in leading edge information systems technology, and developing an industry-leading direct origination platform that is designed to own more deal flow and do more transactions with more customers in the large $2.5 trillion marketplace that we address.

Now, today we're giving guidance for 2017. The seeds for that guidance have been mostly planted through our investment activity this year, just as the investment spreads that we realize from new acquisitions in 2017 will bear the most fruit in 2018.

Taking a look at our dividend this quarter and comparing it to our initial 2017 guidance, we have a well-protected dividend with a current payout ratio ranging from 66% to 67% of expected AFFO. While we have an opportunity to be on a growth trajectory, and before our sheer size limits that comparative growth potential, our aim will be to have an increasing dividend protection, affording us elevated internal growth over the long run, at which point we anticipate a dividend growth commensurate with the AFFO per share that we generate. Our approach to this, like our approach to most of what we do, is foundational and lasting.

So let's change the topic. NAREIT's convention is now upon us, and many of you listening will likely be converging on Arizona in the next two weeks to meet with the companies that you follow. For us, this is an opportunity to, gratefully, not travel, and to welcome you here. If you've not received an invitation, we'll be having an open house at our brand new office for Wednesday the 16th of November, which will include both a tour and a systems demonstration.

Real estate investment trusts generally emphasize property tours, which is important given that desirable property features attract tenants and higher rents. But for a net lease REIT and for STORE, which has so much less need to market properties which are already leased on a very long-term basis, we succeed if our tenants succeed. That makes the systems tour more valuable and worthwhile, because you can see how we monitor our lease contracts and the success of our customers. The open house will be from 7:30 a.m. to 8:30 a.m., and you'll have a chance to meet the STORE team members that actively manage and track the performance of our customers, and enjoy a great breakfast while you're here. And to make it easy, we'll be providing a shuttle from the Marriott, where the NAREIT Conference is being held.

Finally, in closing, we continue to make tremendous progress in 2016. We're optimistic about our 2017 prospects and future growth, and as I turn the conference call over to the operator for questions, I'll tell you that with me today I have Michael Zieg, who runs servicing; Michael Bennett, our General Counsel; and Chris Burbach, our Executive Vice President of (inaudible).

So with that, operator, let's see if there are any questions.

(Operator Instructions.) Vikram Malhotra, Morgan Stanley.

Thank you. I just wanted to dig in a bit into the occupancy dip. Can you maybe just elaborate a bit on sort of what led to that, and then just plans as you think about occupancy over the next 12 months, how soon you can kind of deal with the vacancies?

Sure. Vikram, this is Chris, and good morning. So first of all, if you look at the occupancy dip, it equates to a total of 12 properties, so it's not a material thing. It is part of what we do, so I mean, we're going to have this over time. And in fact, you should expect, and built into our projections for both this year and next year are a level of property vacancies that are naturally a part of this business. And if you look at seasoned companies, whether it's National Retail or realty income, you'll see that their occupancy levels will gravitate down towards some number that's kind of in the very high 90s. And over time, our occupancy level can't always stay at 100%, so it's going to drop a little bit.

We have a total amount of 12 vacant properties. We've had no -- all 12 of those vacant properties existed at the last conference call, and in fact, we talked about most of that because there's a Ruby Tuesday's franchisee that went out of business in Chicago that represented seven of those properties, and that was discussed, I know, during the last conference call.

So going into the last conference call, we had a stated low vacancy level, but the vacancy level was where it is today, pretty much. So out of the 12 properties, I would say that six of the seven Ruby Tuesdays have been identified with a resolution. Two of the other properties have been identified with a resolution. So we're basically dealing with a total of four properties that we're batting around in terms of what our choices are, and none of the cases are we really worried about where the recoveries are going to land. And of course, as you could see from our projections for the year, we've been solid in terms of where we expect our numbers to land for this year.

I mean, really, if you look at our numbers for this year from a projection perspective, the biggest driver of where we are today versus where we could have been for the numbers is that we decided to lower our leverage. So if we looked at our guidance from last November, we expected leverage being from 6 times EBITDA to 7 times EBITDA, and we were kind of budgeting in the midpoint around 6.4, 6.5, and that's a number of pennies a share, moving entire balance sheet leverage lower. So we've sacrificed that, and yet, still -- and we had vacancies, and yet we still hit -- we still are holding to the high end of our target range that we set for ourselves a year ago.

Okay, that's helpful. Then just if you can update us on your thoughts around maybe selling the vacant properties versus just pursuing new tenants. Any more color there would be helpful.

Sure. Well, think about it this way. Whether you sell a property or not, or re-lease a property, from your perspective as an investor, it has to be the same thing. So for example, if I have a property and I'm getting $1 million a year in rent and I re-rent it for $800,000, I get an 80% rate of recovery, okay? Now let's say I have a property cost of $1 million and I sell it for $800,000, is that an 80% recovery? No, not necessarily, because what I'm going to do is give the $800,000 to Mary and she's going to reinvest the money into a new property. And to the extent that she invested money into a new property at a cap rate that is less than the property that I was getting, the money I was getting, then basically my recovery ends up being slightly less.

So everything that you do has to be equated to what's happening from an AFFO perspective. Now, in the case of the Ruby Tuesday's, it's a good example. Our cap rate on those properties is close to 10%. Our current investment rate is 8%. So we have properties that we are going to sell in the Ruby Tuesday's and get all of our money back out of it, and yet our recovery, effectively, is going to be 80% because we're going to invest the money at 8%, and that's going to be it.

So, and sometimes it works the opposite way, where we're investing the money at higher cap rates than where the properties were at. But you get the picture.

Collin Mings, Raymond James.

Hey, good morning.

Good morning.

Hi, Collin.

Just first question as it relates to the guidance. Is there anything specific that you see or don't see that's really driving the expectation of acquisition volumes next year will moderate?

No, the guidance was $900 million net of sales starting out next year, and Collin, the pipeline looks terrific because as you know, the way we originate directly with our market being so large and having 70,000 middle market and larger companies for us to call on the pipeline, is very robust. And that's what we mean by owning deal flow, is we can create that ourselves. So the pipeline looks terrific, and I don't see anything on the horizon.

Yeah, so Collin, it's Chris. Just to put it in perspective, at this time last year when we were giving guidance, our initial guidance was $750 million net. Today, it's $900 million net. So we actually thought we were swinging out for you. And if we can do more than that, of course, Mary's team will want to do more than that, but we're in a flow business. And we're looking at so much and we're doing 30 to 40 transactions a quarter. I mean, there's just nobody that has that kind of a granular deal flow stream that we do, and it's because we own the deal flow. And because we do business this way, which is unique in the space, it's just hard for us to really kind of gauge where things will be.

Okay. And then I guess underlying that as far as recognizing the net number, relative to this year how are you thinking about potential disposition activity?

Well, we typically think that we'll sell somewhere between 1.5% to 2.5% of the pool, of the portfolio. And that's the beginning portfolio, so we're going to start off the year with give or take $5 billion worth of assets and we assume that we'll sell 1.5% to 2.5%.

Craig Mailman, KeyBanc Capital Markets.

Hey, everyone, this is Laura Dickson here with Craig.

Hey, Laura.

Hey. I was just curious, regarding the ATM activity in the quarter, just wondering how you envision using this lever going forward.

Well, we were happy to put the ATM in place. It is one more tool that we have to work with for raising capital, and it's efficient and it works for us. As we mentioned, our portfolio is very granular, so being able to be in the markets in small amounts throughout the quarter is very nice. But that being said, we have a lot of options and we've worked very hard since our IPO to make sure we have a lot of options to raise both debt and equity capital, and we'll be looking at those options as we go through the year and picking our spots for when the ATM's appropriate and then finding places where we may get better execution overall somewhere else.

So we love the ATM and we're happy to have it in place, but I don't know that we would rely on it totally. Does that answer your question?

Yes. Yeah, that makes sense. And then just separately, I noticed that industrial ticked up to about like 14.4% of annualized base rents in the quarter from 13.5% last quarter. Just wondering if this is something you're focusing more investments on now, if that's something you're focusing on?

This is Chris Volk. These things come in waves, and so a lot of it's just timing. We expect that the -- and we call it industrial. It's really manufacturing, so we're going to just -- in the future, we're going to label industrial sort of like a property type and manufacturing is more industrial, and we tend to sort of do things by industry. But we will be a high, kind of in the 15% or less range on that is what we expect long term. And we've always been very heavily bent towards service industries, so we expect to continue that and then of course, our retail we expect to be sort of in the neighborhood of 15% or less on retail.

Robert Stevenson, Janney Montgomery Scott, LLC.

Good morning, guys. Mary, given your cap rate stability comments in the prepared remarks, other than conservatism in guidance, what would have you guys really dropping down into a 7.75% acquisition yield next year? I mean, last year you guys did 8.1% on a billion-something, this year you guys have averaged 8%. Any strategic decision that you're making in terms of target-specific asset types that would push the cap rate lower, or is this just more or less conservatism, not knowing what the future holds?

Yeah. Hey, I think that that's right. It's this quarter, at 8.2%, certainly is not a trend. As you know, one quarter last quarter was 7.8%, so that's near 7.75%. So we had a couple of transactions that closed above an 8% cap this quarter. They kind of lump together. So I would think that over the long term, you're going to still look at a 7.75%. It's still a good number for us, but we are not strategically doing anything to try and get to that number, Rob. We're going out, we're providing solutions, and we're asking to be paid for those solutions, and we're going to continue that way.

And Rob, I'd say that it also depends a little bit on the mix. For example, if you're doing restaurants, restaurants are generally going to be below 7.75%. I mean, every now and then we get one for higher, but they're usually below. So if we did a quarter of lots of restaurant properties, you're going to get that. So sometimes it's just a sector-driven thing.

Okay. Yeah, I mean, I know the quarterly bumps around, but I was just thinking about (inaudible). Okay. And then Cathy, I know it's not a lot, but you guys have 13 leases rolling in 2017. In your earnings guidance, what are you anticipating in terms of the number of those leases that'll renew and what's the sort of new rent versus expiring sort of spread there?

We actually look at it on a lease-by-lease basis. So in certain instances where we're very confident that the leases will renew, we just continue that way. And in some case -- and basically, that was most of the cases that we looked at. But it is case by case, and so we do -- maybe if I had 1,200 leases that were maturing, I wouldn't do that, but because we have so very few, we actually go talk with Mike Zieg in portfolio management and he gives us those assumptions.

And since we originate virtually all of our own deal flow and write roughly 90% of the contracts, as you might expect, we don't write one- or two-year leases. These are transactions where we acquire them opportunistically from somebody else that had them, and we felt good about them at the time we did them.

Ki Bin Kim, SunTrust Robinson Humphrey.

Hi, guys. This is actually Ian on for Ki Bin. Just a quick question about CPI increases. Do you guys use core CPI or just standard CPI, and what increases that right now?

What am I modeling? Is that what you're asking?

What are the rent bumps right now for your customers that are receiving increases based on CPI?

Well, it depends on when the rent is bumping. So the rent bumps all throughout the year, so we don't have them all, say, bump on January 1 or something like that. They're dependent on when we actually did the deal. And so, if it's an annual bump, it would be annually from the day we did the deal. So it compares the CPI at that moment to what it would have been a year ago, and it's the change in CPI that would be looked at for the bump. And as you recall, we do the lesser of the change in -- 1.5 times the change in CPI or a fixed cap.

It's 1.25 times.

Oh, I'm sorry, I thought I said 1.25. Sorry, 1.25 times. So it's going to depend on who that is. And then the annual bumps would be just comparing the annual period, whereas some that bump every, say, five years are comparing what was the change in CPI over that five-year period. And we use regular CPI in our lease forms. Now, in the handful of leases that we may have acquired from someone else, perhaps there might be some unique CPI. But generally, we use regular CPI.

Okay. Thank you.

Vineet Khanna, Capital One Securities.

Yeah, hi. Thanks for taking my questions. Can you maybe talk about reported financials and rent coverage and how they've been trending for the full service and limited service restaurants?

Yeah, I mean, I -- this is Chris. If you're looking at the restaurant portfolios, the coverages have been holding pretty stable. We've not seen any sort of massive amounts of variability. If you look at our strat reports of the restaurants today, the restaurant space versus other spaces, it's holding up fine. So and I've always felt like the restaurant industry is a zero sum game, anyway. So we've had -- you can read for yourself some of the brands out there are doing better than other brands at any given point in time, and so right today, if you're looking at our difference between full service and limited service, both the coverages are over 2 at this point (inaudible) if you look at the whole portfolio strat.

Okay, great. And then just regarding the office move, are there any one-time costs related with that, and then maybe you could talk about where you've been growing headcount.

Yeah. This is Cathy. For the office move, we're just actually moving down the street, so the costs will be minimal. The new office is larger, so it will be slightly more expensive than where we are today, but we are busting at the seams, so we are very grateful that we are able to be in this location for as long as we have been, frankly.

For headcount, we continue to add some headcount in certain areas to flesh out the property management area, for example, and things like that, but no real big, big changes. It's just that right now, we have every seat taken, and if you want to come and visit us, we don't have very many conference rooms left and things like that. So the new office will have more conference space. We do have customers come to visit us and potential customers and things like that, and so we make quite a bit of use of our conference space and we were really running short in that area.

My office counts as a conference room right now.

This is true. So it's really going to -- you know, and we have some collaborative furniture that we have in the new space that allows us to work in teams a little easier. And so it's just going to work better for us as we continue to invest in the platform, and potentially prepare for being able to do additional growth.

So from a G&A perspective, our G&A as a percentage of assets this year is roughly 80 basis points. We're around 70 now. We're assuming it's going to be 70 maybe next year. And after that, we'll get down to 60 or so. So the G&A is going to come down. One of the things we always tell people is that nearly half of our G&A cost, our cash G&A, so some of the G&A is non-cash, employee stock compensation, which is not a small number. But nearly half of our cash compensation is basically on the front end of the business, so it's all the direct relationship managers, it's all the credit people that are involved with doing the transactions, it's all the closers doing the transactions. And that makes it, from a mix, relative to other net lease companies, that is sort of a high mix on the front end of the business, which comes with owning the deal flow that you have.

So if we want to invest in more deal flow ownership next year, we may increase that number if we thing that we have a chance of making better inroads into the $2.5 trillion marketplace and becoming sort of -- growing organically through that. So we're going to just weigh that over the course of the next year in terms of what we do on the front end. Otherwise, the G&A staff cost is pretty modest. You obviously have Mike Zieg's department, which is the servicing group that's going to add people. It's going to be much more variable expense, but it's small. And Cathy has, obviously, to add financial reporting professionals and whatnot, and add Sarbanes-Oxley-type professionals, but those are sort of the main kind of needs, and they tend to be at the fringes.

Daniel Donlan, Ladenburg Thalmann & Co.

Hi, this is actually John Massocca on for Dan. Just want to start off, I was looking to see if maybe you could give me some color on the strength of your Gander and Mills Fleet locations as we enter the winter apparel season, and just kind of thoughts on if we have another weak winter sales season like last year, would you have any concerns about coverage at those locations?

Well, you know, we may be the only Gander landlord that actually knows how our stores are performing since we have unit level financial statements, and we obviously have trailing 12 unit level financial statements, which includes their fourth quarter last year, which was a more difficult fourth quarter because of sales. So if you look at the trailing numbers, we're not concerned about our coverages. They're performing. The company to date is performing just fine and (inaudible) pleased with their performance.

Mills Fleet has been around for 50 years, 60 years. I mean, the average Mills Fleet store does about $45 million in revenues. I mean, they're an enormous thing if you've ever seen them. It's a Costco on steroids. It's like Costco combined with a Tractor Supply or something. And these are marketplaces where Amazon Prime's not going to hit tomorrow, so these are filling an absolute need in the markets that they have.

From a store level performance number, they knock the cover off the ball, so there's nothing I could say that would even remotely cause one to be concerned. On top of which, unlike dealing with soft goods, the guys at Mills Fleet are selling all kinds of stuff besides soft goods products, so the level of sheer diversity they have in their sales mix is unlike any other retailer that you would (inaudible).

So it would be fair to say that it would have to be a pretty drastically bad sales season for those locations to kind of come into question?

I mean, if you looked at Mills Fleet during the great recession from 2008 to 2009 and if you excluded the price of gas, which they -- a lot of them sell gas. So if you exclude the price of gas, which tends to be volatile, their sales were all flat, so going through the greatest recession in my lifetime.

Collin Mings, Raymond James.

Hey, thanks. I just wanted to go back real quickly to the ATM. Just, Cathy, for the modeling purposes, is there a way we should think about what would be the maximum that you guys would look to raise in a quarter under the ATM?

You know, I think that if we needed significant volume in any quarter that would be, say, more than 10% to 15% of our trading volume, that the ATM may or may not be the best answer there, and we might consider one of our many other options.

Hey, Collin, this is Chris. I mean, the ATM is a great tool, and it's really perfect for a company like us where we're growing steadily and granularly with lots of little transactions, so you can basically almost match one yourself and bleed in some equity at the same time as you're bleeding in deals. But we're incredibly mindful of the fact that if you want to diversify your shareholder base, you can't do it through an ATM. So you're going to do it through other ways, whether it's block trades or whether it's overnight transactions. So a lot of the discussions about how we're going to raise equity capital get down to tactical considerations like that, and not just how much money we need.

Okay, that's helpful. And then Chris, just recognizing it bounces around a bit quarter to quarter, just can you highlight if there's anything specific that knocked that median EDF down a notch?

Well, the EDF -- so if you looked at the histogram, you'll see that the EDF went from the median corporate EDF, slipped from Ba1, so BB+, down to BB2. That gargantuan move equates to 11 basis points of higher default probability. So basically, it's almost nonexistent.

If you look at the STORE Score, which is sort of the [law] contract score, it's basically flat from a risk perspective. If you peel back why did the EDF drop or why did the default probability rise 11 basis points, in some cases it was because there were companies that were underperforming. In some cases, it's because companies just change their capital structures. We had companies where they took on debt, there was a change in control on the company level, and so again, tenant credit is always a transient thing in this business.

So if you noticed this last week, Yum! Brands, for example, spun off Yum! China, and in doing that they left all the debt with the parent company so the parent company went from being a BBB company down to a BB company. So it's just [either] choices the companies make based upon how their shareholders are going to do, because they run companies for shareholders, not for debt guys. So we're going to focus on the STORE Score.

I would tell you that, just sort of as a large focus, when you're thinking about portfolio performance, if you look at a portfolio that this leadership team put together from 2003 to 2007 and then held static roughly through 2012 through the greatest recession in my lifetime, the entire loss for that period of time was something like 3.2%, which works out to about 40 basis points a year, which that excludes the offsetting benefits of rent bumps or portfolio property gains.

So we are designing an asset portfolio designed to be as bulletproof as you can get, and part of that's being done here by actually having much, much higher portfolio diversity, and we're in a hundred different industries today. And you want to have things that are non-correlated, right? So, for example, movie theaters, in a way, are correlated, and the reason they're correlated is because if you have a bad movie at one theater, you'll have bad movies at all the theaters. Drug stores are highly correlated. So, for example, if you have -- your customers at drug stores are all the same customers. They're Medicare CMS, they're Aetna Healthcare, they're Blue Cross Blue Shield and so on, and you're part of the healthcare delivery system in the United States. So the same things can happen.

So when you're putting portfolios together, it's important to seek diversity where you have non-correlated tenants as much as possible to be able to insulate you from issues, which we have done. So we feel good about the EDF scores where they are. We don't see anything that's secular in the economy at this point in time, and because we are the only guys that actually disclose what our whole EDF score is, you'll be the first to know if you see something big that happens, and that's why we disclose it.

Daniel Donlan, Ladenburg Thalmann.

Hey, it's John on again. Just a quick one. Do you guys have your same-store NOI growth for the portfolio? I'm sorry if I missed that.

We don't disclose same-store NOI growth for the portfolio. Frankly, it's sort of a trailing number anyway, so if you're looking at where the growth is and where -- you know, what contributed to the growth, whether it was external growth or internal growth, the answer is right this second, for this year, it'll be mostly external growth because on a relative basis, we've been growing pretty highly, and if you're looking at NOI growth where you had the same property for both 2016 and 2015 and you had it for 12 months, then that percentage of the portfolio is pretty small and it won't really tell you that much.

But that's why we take great pains to tell you what our lease escalators are for the assets we acquired during the quarter, so you understand what the gross returns are, and that's why we disclose the entire lease escalators for our entire portfolio so that as you're looking at this and you're modeling this out, you can do this yourself. And most of those escalators are going to happen because unless CPI is ridiculously low, most of them are going to happen. And the reason we do the CPIs so much is because we just hate straight-lining rents.

That makes absolute sense. Thanks. That's it for me.

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

Well, thank you again, everybody, for patiently listening to us, and we're here if you have any questions, and look forward to seeing you at NAREIT if you're able to come. Thank you. Bye-bye.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect your lines. Have a great day.