STORE Capital Corporation
Q4 2014 Earnings Call Transcript

Published: 4 Mar 2015

[Operator:]

Welcome and thank you for joining the STORE Capital fourth quarter and year end 2014 conference call. Today’s conference call is being recorded. At this time, all participants are in a listenonly mode but will be prompted for a question and answer session following the speaker’s remarks. And now I would like to introduce Moira Conlon, who will host today’s conference call. Moira, please go ahead.

[Moira Conlon:]

Thank you, Maureen, and welcome to all of you who have joined us for today’s call to discuss STORE Capital’s fourth quarter and full year 2014 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 would like to remind you that comments on today’s call will include forwardlooking statements. Forwardlooking statements can be identified by the use of words such as “estimate,” “anticipate,” “expect,” “believe,” “intend,” “may,” “will,” “should,” “seek,” “approximate,” or “planned,” or the negative of these words and phrases or similar words or phrases. Forwardlooking 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 the forwardlooking statements. These forwardlooking 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 forwardlooking 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.

[Christopher Volk:]

Good morning, everybody, and thank you all for joining us. I’d like to welcome our analysts and stockholders to our first earnings call. We appreciate the strong support from the investment community and our new stockholders who have participated in our successful IPO in November. In that offering, we raised net proceeds of $546 million, including the full exercise of the over-allotment option. We’re using the proceeds to further expand our real estate portfolio and to bolster our leadership in the middle market net-lease solutions for single tenant real estate. Now, to get here, over the past three and a half years, we grew to $2.8 billion in assets by deploying the private equity capital we had raised from Oaktree Capital and other institutional investors. And in that process, we became the first ever net-lease REIT to be conceived and incubated through the use of capital derived from prominent institutional investors. And after scaling the business, we determined that the time was right to go public. Since this is our first conference call as a public company, and since many of you may be new to the STORE story, I’d like to spend just a few minutes explaining to you what makes us different and how we’re well-positioned for continuing growth. First and foremost, we address a $2 trillion dollar market of profit center real estate that includes over 1.5 million properties, and, as a result, we can be highly selective in the investments we make. We provide net-lease solutions principally to middle market and larger companies that own single tenant operational real estate, which is the inspiration for our name. And we also call this “profit center” real estate. STORE assets are a distinct asset class in that they have three payment sources, whereas most real estate just has two. The differentiator lies in the primary payment source, which is embodied in the profits produced at the properties that we own. The remaining two payment sources reside in tenant credit quality and real estate residual values, which are payment sources that are common to all commercial real estate investments. We formed STORE to fill the unmet needs of thousands of middle market and larger companies that require access to efficient longterm capital, to capitalize, improve, and grow their businesses. At the heart of our success, is a strong reception by our customers to our flexible valueadded real estate net-lease finance solutions. Our ability to add value to our customers over other alternatives they have is embedded in both the thoughtful lease structuring and also our ability to service their needs long after we ink our contracts. Our recent IPO and listing on the New York Stock Exchange is an important affirmation that the need we fill for our many tenant customers is supported by the broad investing public in a win-win partnership. This is the third company that many on our leadership team have taken public, and so we appreciate maybe more than most the increasingly high bar that one has to hurdle to gain that affirmation. We have had a significant pipeline of targeted investment opportunities since the very day we opened our doors, and today that pipeline, which turns over multiple times a year, has grown to about $6 billion. This robust pipeline of opportunities allows us to be selective in choosing tenants and investments that meet our rigorous standards, and that offer attractive riskadjusted rates of return. Approximately 75% of our portfolio is actually sourced from direct originations with companies that we service. So we are largely about creating investment opportunities and not just gaining market share. Now, for a moment, I would like to turn to our well-diversified portfolio. For the year ended December 31, 2014, our real estate investment portfolio grew to $2.8 billion in gross investment dollars, representing 947 property locations bound by approximately 360 contracts, of which the vast majority are on our own lease forms. This compares to $1.7 billion in gross investment dollars, representing 622 property locations at December 31, 2013. Our properties are located in 46 states. They are operated by over 200 brand names or concepts, and no concept represents more than 4% of the portfolio revenues. Our customers operate across 67 industries within the service, retail, and industrial sectors of the U.S. economy. Restaurants, health clubs, early childhood education centers, movie theaters, and sporting goods stores represent the top industries in our portfolio. Substantially all of our properties are profit centers for our customers, and we receive ongoing unit level financial reporting on virtually all of these properties. 97% of our properties are under triple net leases, which will serve to lessen our property costs, and 73% of our multiunit investments are under master lease agreements, which is a highly prized feature from a credit vantage standpoint. Of the lease contracts in our portfolio, we consider approximately 80% of them to be of investment grade quality. Our weighted average investment contract rating is equivalent to a Baa3 rating, with a median STORE Score or contract rating of A2. The weighted average noncancellable remaining term of the leases as of December 31, 2014, was 15 years, and the weighted average annual lease escalation is 1.7%, of which about twothirds happens every single year. Now, turning to our operating platform, it is highly scalable. We built STORE with our own thirdgeneration, highly efficient systems to facilitate growth and operating leverage. These systems will enhance our ability to maintain portfolio quality and to function with a large complement of relationship managers, credit underwriters, and closers, where no transaction is too small. As we grow, we expect the cost to manage our portfolio will decline as a percentage of investment value. We have always had a flexible, conservative, and efficient capital structure that positions us to have a low cost of capital, even at our current size. We are one of the few REITs to have an A+ rated borrowing capacity through our Master Funding program. Our unsecured debt facility, which we put in place prior to the IPO, together with access to the public equity markets at the IPO, will dramatically increase our financing flexibility. And, finally, our liability flexibility allows us to start off 2015 with undrawn credit lines and substantial unencumbered assets, together with a dividend payout ratio for 2015 that was conceived to be conservative by design. Lastly, I would like to touch on the value we deliver to our customers. Today STORE is already one of the largest and fastest growing REITs in the United States. We are adding to our investment portfolio, and I’m pleased to report strong acquisition activity for the fourth quarter and the full year ended December 31, 2014. We originated $290 million of gross investment dollars, representing 105 property locations during the fourth quarter of 2014. These investments had a weighted average cash cap rate of 8%. For the year, we invested $1.1 billion in profit center real estate, representing 341 locations at an initial weighted average cash cap rate of 8.3%. The average annual lease escalations for these transactions was consistent with our overall portfolio of 1.7%, resulting in a gross unlevered investment return of approximately 10%. Our 2014 investment activity was achieved through almost 140 separate transactions and around 100 contracts. With this, I will turn the call over to our CFO, Cathy Long, for a review of the financial results.

[Catherine Long:]

Thanks, Chris. I’ll begin my remarks today with an overview of our fourth quarter ended December 31, 2014. Next I will review our full-year results. Then I will discuss our balance sheet and capital structure, followed by our guidance for 2015. Unless otherwise noted, all comparisons I make refer to the comparable period of the prior year. So starting with fourth-quarter results, total revenues increased 65%, to $55.2 million, primarily due to real estate portfolio growth. As Chris mentioned, our portfolio grew by $1.1 billion in gross investment dollars over the course of the year. Our portfolio’s base rent and interest on an annualized basis was approximately $238 million at December 31st. Total expenses increased to $41 million, compared to $26.2 million, about half of that change representing increased depreciation and amortization expense on our real estate acquisitions. Interest expense increased 43% to $17.8 million, as we used longterm borrowings to partially fund the acquisition of properties for our growing real estate portfolio. G&A expenses increased to $5.5 million from $3.7 million, primarily due to portfolio growth, staff additions to support the growth, and the increased costs associated with becoming a public company. Since substantially all of our leases are triple net, we incur very little property costs, less than $500,000 in all of 2014. Net income increased to $17.4 million, or $0.18 per basic and diluted share, compared to $7.5 million in net income, or $0.13 per basic and diluted share. Fourth quarter 2014 net income included an aggregate gain of $3.3 million on the sale of eight properties. A small portion of this gain was included in discontinued operations related to one property that was held for sale at the end of 2013. In comparison, for the fourth quarter of 2013, we reported a $200,000 gain, net of tax, on the sale of one property that quarter. I should point out that effective January 1, 2014, we early adopted accounting guidance ASU201408, which provides that we no longer have to report the results of these occasional sales of properties as discontinued operations, beginning with the properties that were sold in 2014 that weren’t already listed as held for sale at the beginning of that year. Moving on to AFFO, AFFO increased 85% to $33.7 million, or $0.35 per basic and diluted share, compared to AFFO of $18.3 million, or $0.33 per basic and diluted share. Again, the increase was primarily driven by the revenue generated by portfolio growth, partially offset by our increase in borrowings associated with that portfolio growth and the higher expenses to support the growth. For the period between the IPO closing date of November 21st and December 31st, we declared a dividend of $0.1139 per common share to our stockholders. This amount represents our intended quarterly cash dividend of $0.25 per share prorated over that partial period. Now, turning to our results for the full year ended December 31, 2014, total revenues for 2014 were $190.4 million, an increase of 75% from $108.9 million, driven primarily by portfolio growth. About half of the increase in revenues between periods was due to having a full year of revenue in 2014 on properties that were acquired throughout 2013. Likewise, the full impact of revenues from the properties we acquired throughout 2014 won’t be recognized until the current year 2015. Consistent with the prior year, rental revenues made up about 95% of our total revenues. Total expenses were $147.8 million compared to $86.4 million. Interest expense and G&A expense increased primarily due to portfolio growth. For the year, interest expense increased 73% to $68 million, and G&A expense increased 38%, or at about half the pace of new investments as a result of our scalability, to $19.5 million. Net income was $48.1 million, or $0.61 per basic and diluted share, compared to $26.3 million, or $0.52 per basic and diluted share. We had an aggregate gain of $5.5 million on the sale of 16 properties during 2014 versus $2.2 million in gains, net of tax, on the sale of 17 properties in 2013. As I mentioned earlier, a small portion of the gains we recognized on the sale of properties were classified in discontinued operations. We were able to generate gains above the original cost of our properties due to our direct sourcing model, which enables us to invest in properties at lease rates generally above the auction market. On a relative basis, our property sales during 2014 represented about 2% of our portfolio at the beginning of the year. The sales generated gains of about 16% on original cost. These gains represent 3/10 of 1% of the portfolio at the beginning of the year. While these gains are excluded from AFFO and FFO, they do represent an important value creation tool that offsets portfolio risk. AFFO was $109.9 million, or $1.39 per basic and diluted share, compared to $61.7 million, or $1.23 per basic and diluted share. Now I will provide an update on our balance sheet and capital structure. For the first nine months of 2014 and prior to our IPO, we had two primary secured credit facilities that bore interest at a variable rate based on one month LIBOR, plus a credit spread ranging from 2.45% to 3%. In September 2014, we replaced these two credit facilities with a new $300 million unsecured credit facility that bears interest based on one month LIBOR, plus a credit spread ranging from 1.75% to 2.5% using a leveraged-based scale. I should mention that interest expense in 2014 included a nonrecurring charge for the writeoff of $1.2 million in remaining unamortized deferred financing costs related to the two credit facilities that were replaced. As of the end of 2014, we had nothing drawn on our credit facility, and the entire $300 million was available for use. In addition, we had unrestricted cash and cash equivalents of $136.3 million at year end, giving us liquidity for continuing real estate acquisition activity in 2015. In 2014, we issued STORE Master Funding net-lease mortgage notes payable, aggregating $260 million in principal amount. In addition, we added $53 million of traditional mortgage debt; bringing our total longterm debt outstanding to $1.28 billion at the end of 2014, up from $992 million in 2013. Of our total $2.8 billion gross investment in real estate at year end, approximately $1.85 billion is used as collateral for our secured debt, leaving $952 million of real estate assets unencumbered as of year-end. Mary will talk about the volume of assets we acquired and added to this unencumbered pool since year end, in her remarks. As Chris discussed, we completed our IPO in November. The offering generated net proceeds of $546 million, which were used to repay $223 million of borrowings outstanding under our credit facility, to redeem all outstanding shares of STORE Capital Series A Preferred Stock that amounted to $125,000, and to fund approximately $243 million of property acquisitions from the closing date of the IPO through year end. As of today, we have fully deployed all of the net proceeds from our IPO. 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 portfolio in place at year end, we estimate that our leverage ratio on a run rate EBITDA basis is approximately 5.3 times. Our overall weighted average debt maturity of approximately seven years is well-laddered. Only 7% of our debt portfolio comes due in the next three years. We maintain a flexible capital structure that enables us to be a highly competitive and efficient supplier of capital to our customers. Turning to guidance for 2015, we currently expect the following. First, AFFO. With material external growth as the primary driver of AFFO growth in 2015, we expect AFFO per share to be in the range of $1.33 to $1.39. Second, acquisitions. For 2015, we expect full year acquisitions of approximately $850 million at an average cap rate of about 8%. Our view on acquisition volume for 2015 results from strong acquisition activity we are seeing in the first two months of this year, which Mary will talk about in her remarks. The timing of these acquisitions is expected to be spread throughout the year, though history would show us that acquisition activity is generally weighted towards the end of each quarter and that there is often slightly higher acquisition activity in the fourth quarter. We intend to initially fund these acquisitions with a combination of excess cash from operations and our unsecured credit facility, and we intend to pay down our credit facility by accessing our STORE Master Funding facility over the course of the year. Third, leverage. As a private company for most of 2014, we were operating comfortably with a higher level of leverage, roughly at 60% loan-to-portfolio-cost for most of the year. PostIPO, we intend to operate at lower leverage, targeting a run rate debttoEBITDA level of between 6 and 7 times, which is more customary for publiclytraded REITs in our space. This translates into a loan-to-portfolio-cost of more like 50%. And, finally, G&A costs are expected to be between $28 million and $29 million for 2015, including commissions and equity comp. And we expect G&A costs as a percentage of our portfolio assets to trend lower over time due to our scalable platform. This concludes my remarks, and I’ll now turn the call over to Mary.

[Mary Fedewa:]

Thank you, Cathy, and good morning, everyone. Today I want to give you more color on what we are seeing in the marketplace and how we evaluate investment opportunities. I’ll begin with the market. I’m pleased to report that we are seeing many attractive transactions that support Chris’ comments on our strong pipeline of targeted investment opportunities. And overall, cap rates are holding fairly steady. We have seen some minor variations, but, overall, cap rates remain well within our target range for attractive opportunities. As Chris mentioned in the fourth quarter, our cap rate was 8%, which was slightly below our overall cap rate of 8.3% for 2014. So far in the first quarter, we are seeing cap rates slightly above 8%. February is just about over, and by month end, we expect to have closed approximately $160 million of transactions. Our net-lease financing solutions are continuing to create a lot of demand in the marketplace, and, at the same time, we are taking a highly disciplined approach to selecting the right investments for our portfolio. So we are really excited about the volume of quality transactions we’ve been able to close to date, and we are running slightly ahead of our initial plan for the year so far. That said, I want to remind you that this is a flow business, and it’s very hard to predict exactly when transactions will close, and it’s still too early to have a clear view through to the end of the year. As we move through the year, we will update our outlook as we have more information. And to address how we evaluate investment opportunities, our targeted investment opportunities are the result of our direct outreach to middle market and larger companies and the strong partnerships we form with these companies as we add value to their businesses and, in return, get paid for that value. Using this approach, we continue to build a quality portfolio brick by brick. We create granular investmentgrade contracts that fill a strong need in the market for efficient longterm capital. In fact, if you look at our top ten customers, substantially all of these relationships were created brick by brick. I look forward to keeping you updated on our progress, and I will now turn the call back over to Chris for some final remarks.

[Christopher Volk:]

Thank you, Mary. I wanted to first make a few comments about our press release today. This morning we simultaneously released both our earnings press release and our first supplemental information packet, both of which are available on our website and on EDGAR. The supplemental information packet was produced in order to present information graphically and in a userfriendly format. These complementary sources provide a great deal of disclosure about STORE as well as extensive information about the quality of our investment portfolio. We started with the simple notion that our investors should know what we believe to be important in evaluating our Company based upon our own 30plus years working in this industry. At the highest level, the disclosure includes portfolio stratifications that will be familiar to most of you. And at the more granular level, the disclosure includes tenant and contract credit quality histograms for our full portfolio, information regarding master lease components, future lease escalations, lease types -- whether they are double net or triple net, ground lease exposure, and property replacement cost estimates. The extent of some of this disclosure and much of what we put into our recent S11 may be less familiar to you. Our ability to regularly produce this information is due in no small way to the robust systems we’ve developed from scratch over the past three and a half years. Our disclosures, like our corporate governance policies, have been conceived to show you what we, as investors, would like to see. I would also like to put in a word for our website, which is the result of considerable thought and effort. There is a very good investor tab on the website. However, perhaps more importantly the website is keenly directed to our customers with video content, articles, blogs, and social media links. Taking a look at this will provide anyone with a much greater insight into our distinctive core competencies, deep customer relationships, solutionsoriented approach, and guiding investment principles. And following us on Facebook, LinkedIn, or Twitter will further keep you in touch with STORE. Finally, we cannot help but be excited by our many accomplishments in 2014 and prior years and also by the continued momentum we are seeing so far in 2015. We have worked hard to create a growth company, which is also a REIT, and that’s a really rare combination. And we have done this with a leadership team that has greater depth and experience investing in store properties than any other team in our asset class. We have positioned this Company to have a market-leading balance sheet with a well-protected dividend, and we have done this by filling an acute need in what we believe will be a win-win partnership for years to come. So now, as I turn the call over to the Operator, I want to say that we are also joined on this call by Michael Bennett, Michael Zieg, and Chris Burbach, which is the rest of our senior leadership team, and we’re here to help in answering any questions you might have. So, Operator, we’re open to questions.

[Operator:]

Thank you. We will now begin the questionandanswer session. [Operator Instructions] Our first question is from Vikram Malhotra, Morgan Stanley. Please go ahead.

[Vikram Malhotra:]

Thank you. Congrats, guys, on your first earnings call. Just wanted to check, Cathy, on the funding for acquisitions. You mentioned initially at least using the STORE Master Funding. Can you just maybe give your thoughts on the use of equity versus debt towards, maybe the second half of the year, kind of how you’re viewing the funding of acquisitions, both the cash you have and anything that you used on the revolver?

[Catherine Long:]

Sure. As I mentioned in my remarks, we use the revolver to initially acquire properties until we can amass a sufficiently large and diverse pool of properties to put longterm debt together on our — in our Master Funding program. And I might take a minute for those of you who don’t — are not familiar with the Master Funding program. This is our own conduit, and what is neat about the Master Funding program is that this is a conduit that we continue to add collateral to and then can continue to issue notes off of. Right now we have been issuing seven and tenyear notes, but we have quite a lot of flexibility with regard to what kind of notes we can issue off of that pool. What that provides us is flexibility, and that’s important, because Mary wants to provide flexibility to her customers, and so on the back end and I provide the same flexibility on the capital side. So with the Master Funding program, I can actually substitute assets in and out if I need to, or if I need to sell assets, I can substitute another one in. And so, it does provide us a lot of flexibility. What we’ll be doing is accessing that conduit during the year. As Chris mentioned, and as I mentioned in my remarks, we have quite a bit of unencumbered assets at this time, and so we will be pulling together a pool, and that will actually free up the line for further usage of the revolver. I probably didn’t mention and could mention that the revolver, as well, has an accordion feature that will allow it to be expanded up to $500 million should we need that capacity. So we do have quite a bit of flexibility in capacity with regards to borrowing. I did mention that we had a targeted fundeddebttoEBITDA range of between 6% and 7%, so if you are modeling out the Company, you can kind of see where we might be raising equity at that point.

[Vikram Malhotra:]

Okay. Thanks. And then just on the acquisitions, I may have missed this, but what was the remaining lease term on the acquisitions that you did in the quarter, and what are you making in in terms of cap rates for the full year, for 2015?

[Catherine Long:]

Yeah, our remaining lease term is generally 15 years, even on the new things that we acquire, because, as you recall, we are directly sourcing these. So we’re creating a lease and not necessarily buying an existing lease that would have a short lease term. So we’re still at 15 years. We were at 15 years last year, and we’re still at 15 years. And then for cap rates, 8% is about the average that we think during the year. There may be some slightly higher and some slightly lower, but we think 8% is reasonable.

[Vikram Malhotra:]

Okay. Thanks, guys.

[Catherine Long:]

Sure.

[Operator:]

Our next question is from Derek Van Dijkum, Credit Suisse. Please go ahead.

[Derek Van Dijkum:]

Hi. Good morning, guys.

[Christopher Volk:]

Good morning.

[Derek Van Dijkum:]

Just to talk about cap rates going forward, do you — it looks like over the past year or so, your average cap rate has trended down a little bit. How do you look at that going forward? If you could maybe provide a little more color on, are you seeing any more competition in the market that could potentially drive the cap rate — your average cap rate going forward a little lower?

[Mary Fedewa:]

This is Mary. Actually, we have — we’ve seen some compression, that’s correct, but not as much compression as there’s been in the marketplace, and that’s basically because, as Cathy mentioned, we’re directly sourcing from a very large and under-served part of the market. There’s over 70,000 middle market and larger companies that we can — that we’re sourcing from and being very selective with. I think in terms of competition in the market, interest rates have been persistently low, and there’s certainly plenty of capital out there chasing yield, but, for us, we’re very focused on this middle market and larger marketplace, and, from that perspective, we can be very selective, and we’ve seen a lot less compression in the market.

[Christopher Volk:]

And I would say also — this is Chris — that, the fourth quarter average was around 8%. The activity for the first quarter year to date, for whatever it’s worth, is slightly above 8%, and so I wouldn’t hold that as being sort of a linear trend that’s going down.

[Derek Van Dijkum:]

Sure.

[Christopher Volk:]

And if you talk to — even if you talk in the auction marketplace to realtors today, they’ll pretty much tell you that they think that cap rates are being pretty — are holding pretty stable.

[Derek Van Dijkum:]

Gotcha. Okay. And then just one other question on Heald. Any update on those assets at all or is it sort of status quo still?

[Christopher Volk:]

We’re status quo. They’re paying and the schools, to my knowledge, are doing fine. We’re in touch with them all the time, obviously. And, as anybody knows who’s followed Corinthian at all, they had three education brands, and Heald was far and away the engine for their corporate EBITDA and cash flow, and so that’s been kind of their crown jewel, and that is the — I expect that they will be probably sold to another operator sometime later on this year. But that’s been their stated intent, and I don’t think that they have an absolute gun to their head on timing as to when that’s going to happen, but I think it’s a process that’s ongoing. So we’ll work with them to facilitate a change in ownership, although I would be surprised if there’s a lot of change in management at the operating level in terms of the operating platform level of Heald College.

[Derek Van Dijkum:]

Got it. Okay. Thank you very much.

[Operator:]

Our next question is from Cedrik Lachance, Green Street Advisors. Please go ahead.

[Christopher Volk:]

Hey, Cedrik.

[Cedrik Lachance:]

Sorry. Can you guys hear me now?

[Christopher Volk:]

Yes.

[Cedrik Lachance:]

Okay. Great. Sorry. So just in terms of dispositions, given the way you’re putting together your portfolio, I would imagine there’s not a lot of properties that you acquire that you don’t want to own for the longest period of time. Therefore, why would you be selling assets so early in your ownership?

[Christopher Volk:]

Well, there are always a couple of reasons for it. I mean, you’re always tracking the portfolio all the time, and some of the — I would say probably half of the transactions that were sold last year were sold in concert with a larger transaction where we wanted to have greater portfolio diversity, and I’m being — sort of using a rule of thumb here, but I think it’s about half, and I’m getting some nods around the table. And the other half were assets that we sold where we thought that from a portfolio quality perspective, selling them would actually, in aggregate, enhance portfolio quality. And I think that that’s our job. That is what we’re supposed to do. One thing that I think is really important to point out to analysts who cover us — and when I say it’s our job, we’re in the business of actively managing a portfolio, and you should expect that, and part of actively managing it is trying to manage future risk, and so we’re doing this all the time. But one of the things that’s important that Cathy mentioned was that the gain on cost was 16%, and I can’t promise you that that will happen all the time, but if you look at the transactions last year, we sold 2% of the portfolio at the end of 2013. So our average gain was 16%. That works out to about 33 basis points of assets at the end of 2013. So look at it this way. If you had a default — so say you had a default, and it was 1%, Heald will be about 1% for example, by the end of this year. But if you had a default of 1% of the portfolio and you had a 70% recovery on that default, which is historically in line with what we do, your loss would be 30 basis points. Well, we made 30 basis points on sales from assets that were sold. If you look at our portfolio from the end of last year, it tells you just what a terrific business this is, where you can actually manage your risk, not only by properly managing any sort of credit exposure but by also selectively selling off assets to really help in aggregate. Make it so that the portfolio is delivering a profoundly great riskadjusted rate of return.

[Cedrik Lachance:]

Okay. And so as we get later in the stages, I guess, of the real estate cycle, the credit cycle, I would imagine banks are going to become a bigger competitor in providing financing to the tenants that you like to do business with. How can you position yourself to continue to create the kind of real estate transaction volume that you want to create while the banks become more comfortable lending to the same tenants that you do business with?

[Christopher Volk:]

Cedric, today, actually, we’re not seeing that, and I can’t even begin to see that in the near term. When we were running our first public company, FFCA, we did run into bank competition, so notwithstanding the fact that we were providing a lease, banks were giving 100% financing, they had low payment constants. FIRREA was passed in 1990, which was basically, in the wake of the S&L crisis in 1990, it was sort of the new standard by which assets would be valued and supposedly help control banks in their lending practices. But it didn't really force banks to control their lending practices, because they were still lending 100% loan to value in the 1990s, and they were doing so, because FIRREA itself didn’t prevent that, but along comes DoddFrank, and DoddFrank actually makes that more difficult, so it puts teeth into FIRREA. So I don’t see banks lending 100% any time soon, and they can’t lend fixed for the most part. Or if they lend fixed, they’ll do it floating, and they make people buy into a swap. So what happens is that somebody owns a piece of real estate, and they end up with trapped equity. They can have trapped equity for ten years, because they can’t actually prepay their loan without incurring a really huge burdensome cost, and, at the same time, we’re replacing the equity that they would otherwise have to put up, so we’re displacing the equity. So, anyway, for all those reasons, I don’t think that banks any time soon will be competing with us. The other thing I forgot about too was Basel III, which forces banks to risk adjust their capital, and when you’re dealing with middle market companies, it gets harder and harder for banks to gauge what the investment risk is and what the capital reserve should be for middle market companies, and so we have seen that middle market companies by and large, especially when it comes to longterm financing, tend to be underserved, and it’s certainly a profound reason for why we fill a big need in the marketplace.

[Cedrik Lachance:]

Okay, great. Thank you.

[Operator:]

Our next question is Craig Mailman, KeyBanc. Please go ahead.

[Craig Mailman:]

Hey, guys. Just maybe you want to follow up on some guidance assumptions, Cathy, and maybe another way of asking the equity question from earlier is what’s the ending fully diluted share count and OP unit count by year end 2015?

[Catherine Long:]

Well, actually, we’re not going to be disclosing that information in guidance. We’re giving guidance on our leverage levels, guidance on what we are going to add during the year, so we are hoping that in your model, you can kind of predict when — what that would be.

[Christopher Volk:]

We have no OP units —

[Craig Mailman:]

How about —

[Christopher Volk:]

We have no OP units, and, of course, we did the stock issuance, so you can take the stock issuance and add the shares to the other shares and —

[Craig Mailman:]

Right. What about interest expense? Can we get that number?

[Catherine Long:]

Well, our interest is, as we’re looking to guidance, we use our existing interest rate, which is 4.9%, basically 5%, so that’s basically what we’re using. If you want to look at the spread, we’re assuming a 8% cap rate on acquisitions and a 5% longterm debt rate.

[Craig Mailman:]

Okay. And then I know you guys aren’t giving FFO guidance, it looks like — just maybe the rationale there and what kind of spread you’d expect. I know it was $0.03 this quarter, but is that going to be a decent spread relative to FFO?

[Christopher Volk:]

I mean, our — unique amongst net-lease REITs is that our AFFO tends to be higher than our FFO number, because we have so little straight-lining of rents. So we just — I mean, straight-lining is, obviously, noncash, and it doesn’t mean anything, so AFFO, if you’re looking at net-lease REITs, is obviously the number to look at, and so we’re focusing on AFFO guidance and not FFO guidance. But, frankly, there’s not a lot of difference between the two of them.

[Craig Mailman:]

Okay. And then, Mary, your comment on cap rates was helpful. Just curious since you guys are able to keep them in the 8% range, maybe a little bit above, is there any big discrepancy between the STORE scores that you guys are able to sign contracts at today versus maybe a year ago to get that same yield?

[Christopher Volk:]

The answer is no. I mean the contract credit ratings are within the same bandwidth, so there’s not any deviation. Mary can give you chapter and verse of why we have a higher lease rate. I mean — it sort of starts with solving — providing solutions for customers and dealing directly and then imparting to customers that the value that we create for them is very often much more added after we ink the contract, so when customers are just solely concerned about rate and proceeds in the marketplace that we serve, a lot of times the people that are delivering that capital can’t provide them with the kind of flexibility that we can, which really adds value or can take away value from a business. So that’s part of it. The second is that if you’re doing 75% of your business directly and there’s no broker involved, you get 50 basis points right there.

[Craig Mailman:]

Okay. And then just, lastly, so you guys did $160 million of investments through February. What do you guys have under contract in LOI?

[Christopher Volk:]

Well, you know, we thought about disclosing this, and when we did the offering, there was some disclosure about what was in closing. Keep in mind that what’s in closing is — what’s in closing has a lot of fall out, so there could be as much as 20% fall out from transactions that are in closing. So what we’re really much more comfortable with is giving you guidance in terms of saying we think we can do about $850 million for the year, and you can put some brackets around that if you want to. And, we don’t want to give specific forward guidance. We gave you closing volumes, but we’re not going to close it all in the next 60 days. It tends to bleed out over time. We will close some deals in March, so March, we’re not going to shut the place down. So we’ve done $160 million through today in February, and we may close a deal today or tomorrow, so we’ve got a couple more days in February, and then — which we’re very encouraged by, by the way. I mean, if you’re looking at it historically, the busiest two quarters tend to be the second and the fourth, and we’re starting off to a rock-solid first quarter, but some of that, again, was due to some spillover from the fourth quarter of last year, so you shouldn’t necessarily read into that we’re going to do this every single first quarter. It doesn’t always happen like that, so we’ll be very careful about giving guidance that way. In our business, as Cathy said, if you close a deal in the first month of the quarter versus the last month in the quarter, just that little difference makes a huge difference to the AFFO per share number, so — and in a growth story like STORE, we have to be very careful about trying to make sure that we give you prudent direction.

[Craig Mailman:]

Great. Thank you.

[Operator:]

Our next question is Stan Fediuk, SunTrust Robinson Humphrey. Please go ahead.

[Stan Fediuk:]

Good morning, everyone.

[Catherine Long:]

Good morning.

[Stan Fediuk:]

Can you just provide some color on the portfolio quality that was acquired in 4Q 2014 — for example, fixed charge coverage ratio for the portfolio, and what were the property types and locations?

[Christopher Volk:]

Introduce yourself.

[Michael Zieg:]

This is Mike Zieg. The acquisitions we made have been consistent with the prior year, and our median FCC at the unit level remains about two times, about 2.06. As far as the locations, they really vary across the country, and remain consistent. As you can see in the supplemental information packet, we’re in 46 states and pretty well-diversified.

[Christopher Volk:]

I would point out when we disclosed coverage; one of the things that is distinct about us is that the coverage is not a four-wall number. It is a — and a lot of times there’s no — I would like to — maybe we should go with the CFA Institute and try to come up with some standardization about how everybody discloses stuff, but our disclosure for coverages is not four-walls. So if we were doing four-wall, it would be sort of north of 3 somewhere. But if you were doing — but we tend to do it on four-wall minus indirect costs as well, because if we have a restaurant that goes vacant, for example, nobody will run it for four-wall. They have to absorb at the very least the cost of running the store, so we’re very big believers in giving you a disclosure of coverage that’s net of indirect costs. And so the median coverage is 2 to 1. The weighted average coverage is actually quite a bit above 2 to 1, because we have a handful of credits that just do so well that it drags it up. But I think that the median’s sort of the number you should look at, and it’s been stable.

[Stan Fediuk:]

Okay. And regarding your current acquisitions and what you’re focusing on, is it the same type of property locations and types?

[Mary Fedewa:]

Yes, this is Mary, absolutely it is, very consistent.

[Stan Fediuk:]

Okay. Consistent, great. Thank you.

[Operator:]

Our next question is Dan Donlan, Ladenburg Thalmann. Please go ahead.

[Dan Donlan:]

Thank you and good morning.

[Catherine Long:]

Hi, Dan.

[Dan Donlan:]

I had a quick question on your fullservice restaurants, which is your highest customer industry. Have lower gas prices improved your coverages there from a cash flow perspective?

[Christopher Volk:]

I’m going to say that I don't know yet, because, we get these financial statements quarterly, typically, but they lag. So the low gas prices have not been going on for much more than the last 90 days or whatnot. But certainly it will be helpful, and if you look at, basically, all the retailer and earnings numbers that I’ve seen from other companies today, there have been a lot of samestore sales increases that have impressed the market, and I have to think that the lower gas prices help across the board.

[Dan Donlan:]

Okay. And if I’m looking at this page 13 of the supplemental, how do the coverages look kind of by customer industry? I mean, how does the full-service look relative to the limited-service on the restaurant side, kind of versus the childhood education centers and movie theaters?

[Christopher Volk:]

Well, keep in mind, when you’re looking at coverages, no two coverages are equal, so, for example, a 1.50 coverage in a chain restaurant is not as good as a 1.50 coverage in early childhood education. So you’re talking about what’s the sort of tolerable falloff level, and you can’t do direct applesandapples comparisons between them, which is why we don’t disclose this stuff. But I would tell you that our coverages on the casual — on the fullservice portfolio are slightly higher than they are for the — and maybe a quarter of a turn better than they are for the limitedservice. And that’s to be expected. You have something that’s (a) a more expensive investment, so you want to make sure that you’re getting some margin for that, and (b) there’s probably a little bit less volatility in some of the limitedservice numbers, so we could be willing to move to slightly lower coverages in limitedservice.

[Dan Donlan:]

Okay. And then as far as competition goes, there’s not too many of the other REITs that are going after these properties. Have you seen anyone else kind of creep into this industry? And there’s been talk of foreign capital coming in. Obviously, it takes a long time to build out the platform that you have, but just kind of curious as to who you’re competing against. Is 1031 becoming more aggressive here? Or because you’re sourcing directly from retailers, you’re just not seeing anything?

[Christopher Volk:]

Well, first of all, I would say that there are other public REITs that have been big players in restaurants or big players in Cstores and sort of middle market and larger companies, so I would sort of push back a little bit on the notion that there’s nobody else that’s going after some of the stuff that we’re doing. I think that there are some public companies who are doing it. We are not seeing any foreign capital in our space. We’re not seeing any sort of new sources of capital. I would say that we’ve been doing this for 30 years, and players have come and gone, so there are a lot of players that were there in the 1990s, and, of course, we sold our first company to GE Capital, which today is doing virtually no net-lease business in real estate, so there are people that go and there are people that come back in, and yet the market is the same size or bigger. So that’s — hence, the need for participants in the marketplace. We’re here to grow it, we’re not here to steal market share from any of these people.

[Dan Donlan:]

Okay. Yeah, I guess I was talking more along those lines of if you’re guiding to 8% caps, and some of the other REITs that have reported are guiding to 7% cap rates, obviously, they’re going after different properties than you guys are, so just kind of curious if — what the competition is on that side. And with that in mind, do you see yourself — your cap rates going down if your cost of capital improves, maybe you’ve chased — I know your strategy is — to do your own credit underwriting, but do you chase some of the lower cap rate deals?

[Christopher Volk:]

We will go after a low cap rate deal from time to time. We — I think that’s the thing that you should know is that the average transaction size that we did last year is under $10 million. I mean, the number of transactions we did — I mean, we did 140 transactions last year. There’s no one in our space that I know of who did 140 transactions, with 100 contracts. And so the entire way that you originate, the paradigm by which you’re originating is just substantially different. And that causes us as a Company to have perhaps more origination staff than most people, because you’ve got to do that. We have to have more credit staff than most people, we have to have a lot of closers, and yet, despite having all that, we’re a very efficient operating company and very heavily dependent upon the efficiency of the systems that we’ve built, which, being the third time around, we can do that. And when you’re doing transactions that are that size, it gives you a lot of freedom. If you’re doing transactions that are, let’s say, north of $50 million or in that neighborhood, every one of those transactions will have some financial advisors, kind of an auction process, and we’ll win some of that stuff, but last year the biggest transaction we did was —

[Mary Fedewa:]

$40 million.

[Christopher Volk:]

$40 million.

[Mary Fedewa:]

With three properties.

[Christopher Volk:]

With three properties. Yeah, three properties for $40 million is the biggest transaction we did all last year.

[Dan Donlan:]

Okay. Thank you, Chris, really appreciate it.

[Christopher Volk:]

Bye.

[Operator:]

Having no further questions, this concludes our question and answer session. I would like to turn the conference back over to Moira Conlon for any closing remarks. End of Q&A

[Moira Conlon:]

Actually, we’re turning it over to Chris Volk for any closing remarks.

[Christopher Volk:]

And Chris Volk wishes you all a great day, and thank you very much, and we look forward to seeing you in the future. Goodbye.

[Operator:]

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect. 3 STORE Capital February 26, 2015, at 11