VEREIT, Inc.
Q1 2019 Earnings Call Transcript

Published: 8 May 2019

[Operator:]

Good afternoon and welcome to the VERIET First Quarter 2019 Earnings Conference Call. All participants would be on listen-only mode. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference to Bonni Rosen, Head of Investor Relations. Please go ahead.

[Bonni Rosen:]

Thank you, Gary. Thank you for joining us today for the VERIET 2019 first quarter earnings call. Joining me today are Glenn Rufrano, our Chief Executive Officer and Mike Bartolotta, Chirf Financial Officer. Today's call is being webcast on our website at veriet.com in the Investor Relations section. There will be a replay of the call beginning at approximately 02

[Glenn Rufrano:]

Thanks, Bonni, and thanks for joining our call. We're pleased with our operational results for the quarter. AFFO per diluted share was $0.18. Year-to-date acquisitions totaled $125 million and dispositions totaled $244 million. Net debt to normalized EBITDA was reduced from 5.9 to 5.7 times. Last year, we've repurchased $50 million of stock at an average price of $6.94. Year-to-date, we have sold $42.5 million through our ATM at an average price of $8.42, and we have formed a institutional partnership including six VEREIT industrial assets totaling 407 million, expected to close by the end of May. Leasing for the quarter was very active at 847,000 square feet and occupancy ending at a healthy 98.9%. In addition, same-store rent was up 0.9%. Of our 847,000 square feet of leasing activities, 815,000 square feet were renewals with 237,000 square feet early renewals. For renewals, we recaptured approximately 102% of prior rents. Notable renewal activity included 397,000 square feet of office, 224,000 square feet of retail including eight bank branches. The beginning of 2019 has seen elevated store closings compared to 2018 with roughly 6,000 announced along with 2800 openings. A large portion of the closures were due to bankruptcies of Payless and Gymboree of which we have no exposure. They're not in our merchandised categories. Another big component was ShopKo. We have only one small hometown location. Family Dollar owned by Dollar Tree announced they would seek to close as many as 390 of their 8,000 stores while opening 550 and renovating 1,000. Today, they have indicated 18 of our 388 stores will be closed for 0.1% of ARI, 14 of the stores related to close are in master leases and have a range of 8.1 to 13.5 years of remaining term. Four stores have four years or less with the earliest being two years. As you can see, there'll be no near term impact on our cash flows. Moving to our transaction activities, we find ourselves in a reasonable macro environment. Interest rates remain muted and appeared to be a healthy debt and equity market bolstering activity. That as a backdrop, year-to-date acquisitions total $125 million and included our preferred retail merchandise categories home and garden, home furnishings, and fitness. Dispositions have outpaced acquisitions at $244 million, which included a large officer sale for a $139 million at the end of April. This property was located in El Segundo, California with a tenant vacating and was a redevelopment opportunity. We're able to sell this property at a very attractive $400 a square foot. The lease is expiring in 2019 and we will reduce our lease rollover exposure for the year from 2.3% to 1.5%. A top 10 tenants now represents 27.1% and we continue to call restaurants, office, flat leases and non-core. As important, we are focused on our debt balances. We've reduced net debt to normalize EBITDA from 5.9 times to 5.7 times. Before Mike reviews our financial results, let me provide a brief update on litigation. On April 17th, a status conference with the court was held where the judge denied the motion for summary judgment and set a schedule for expert discovery. Year-to-date, the Company has entered into a series of agreements to settle claims with shareholders who decided not to participate as class members for approximately $28 million. In total, the Company has now settled claims of shareholders representing approximately 35.3% of VEREIT outstanding shares of common stock held at the end of the period for approximately $245 million. As you're aware, the judge has set a trial date for September 9th. Additional details regarding pending litigation can be found in our 10-Q filed today. Let me now turn the call over to Mike.

[Mike Bartolotta:]

Thanks, Glenn, and thank you all for joining us today. We had a solid quarter achieving AFFO of $0.18 per diluted share and as usual we will focus on earnings from continuing operations for this call. For the quarter, rental revenue increased $3.6 million or 1% to $316.8 million. Net income increased $43 million to $71 million, primarily due to $48.4 million of insurance recoveries along with lower depreciation and amortization of $16.5 million, partially offset by a lower gain on distribution of real estate of $15 million and a $9.1 million restructuring charge taken in Q1 of 2019. This charge is associated with rightsizing our operations due to the ending of the Cole capital transition services agreement at the March. FFO per diluted share increased $0.03 from $0.16 to $0.19 mostly due to the Q1 insurance recovery, partially offset by the restructuring charge and $7.5 million of lower other income, which was due to Q4 of 2018 gain on the sale of certain mortgage related securities and the unexpected receipt of the prior full reserved receivable in Q4. AFFO per share increased approximately $0.005 to $0.18 mostly due to higher revenue and lower cash G&A of $2.1 million. The G&A decreased quarter-over-quarter was primarily due to the customary higher year-end compensation and other accrual adjustments that we noted in Q4. Also, as mentioned last quarter, we are anticipated taking an $11 million restructuring charge in 2019 of which approximately 80% relates to reducing space in our Phoenix and New York offices. So far, we've taken $9.1 million. The total restructuring amount includes roughly 40% of non-cash items such as a write-off of leasehold improvements and the fixed assets of Phoenix office. During the quarter, there were $14.7 million of litigation-related expenses. In addition, subsequent to the quarter, we settled additional shareholders out of the class for approximately $12.2 million, which was accrued in the first quarter expenses. As we mentioned last quarter, we've received $48.4 million of insurance proceeds, bringing litigation-related line item in the financials to a net positive of $21.5 million in Q1. Turning to our first quarter real estate activities, the Company purchased eight properties for $81 million at a weighted-average cash cap rate of 6.8%. In addition, the Company invested $4.5 million in one build-to-suit project. Subsequent to quarter, the Company acquired three properties for $44 million. During the quarter, we disposed 22 properties for 62 million, of this amount $59 million was used in the total weighted-average cash cap rate calculation of 6.9%, including $25.2 million of net sales of Red Lobster. The gain on the first quarter sales was approximately $11 million. In addition, the Company sold certain legacy and mortgage related investments during the quarter for an aggregate sale price of $8 million. And then subsequent to quarter, the Company disposed 14 properties for $173 million. We continued to strengthen our balance sheet and remained very liquid. In February, we utilized the remainder of our delayed-draw term loan to pay the 750 million bond, with the matured and we also entered into an interest rate swap, fixing the interest rate under $900 million term loan at 3.4%. In addition, secured debt was also reduced by $2.4 million during the first quarter. Our net debt to normalized EBITDA ended at 5.7 times. We're updating our net debt to normalized EBITDA target from approximately 6 times to a range of 5.7 to 6 times. Our fixed charge coverage ratio remained healthy or 3 times and our net debt to gross real estate investments ratio was 39%. Our unencumbered asset ratio was 75%. The weighted-average duration of our debt was 4.5 years and were 97% fixed. And with that, I'll turn the call back to Glenn.

[Glenn Rufrano:]

Thanks Mike. Since 2015, we've completed over 11 billion of capital transactions to reshape VEREIT. We continue to focus on capital allocation and capital costs by selling assets such as El Segundo office building and recycling it assets that enhanced the portfolio, managing our balance sheets to investment grade status thereby reducing the cost of our bank abundant and selling flat leases, which capital can be more productive in our balance sheet. This quarter, we have demonstrated two additional methods of working our capital to benefit VEREIT; one, by issuing equity through our ATM and an advantageous spread to the buyback just last year; and the second, by using internal assets to season institutional partnerships, providing lower costs capital and a business growth format. The institutional partnership was formed with the objective of creating an increasing portfolio of investment-grade industrial properties. The traditional 80/20 structured partnership will initially includes six VEREIT industrial assets totaling approximately 407 million at a cap rates just under 6%. The partnership is expected to close by the end of May. Our latest market activity is intended to create value within our balance sheet by adding to our assets base, a high return on capital business and reducing debt levels and attractive cost of capital. I'll now turn open the line for questions.

[Operator:]

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Sheila McGrath with Evercore ISI. Please go ahead.

[Sheila McGrath:]

Glenn, I wanted to ask you about the industrial JV. Are you still committed to the diversified approach with retail, industrial and office? And what do you envision the ideal sector mix for VEREIT?

[Glenn Rufrano:]

We are committed to diversification, Sheila. Within the boundaries that we talked about, we're still about 40% retail, roughly 20% restaurants, 15% to 20% office and 15% to 20% industrial. We have been taking our office down to the lower end of that range, as you can see the large office building we sold this quarter. And we'd like to keep industrial within that range as well that 15% to 20%. The partnership isn't intended to change diversification. It's actually intended to potentially provide more investment-grade industrial assets for us. The pricing is pretty tough. But with the partnership, we can participate in the growth of that business lines.

[Sheila McGrath:]

And for modeling purposes, when should we assume that starts and are there related fees to VEREIT?

[Glenn Rufrano:]

We're expecting to close by the end of the year with the 407 million -- I am sorry, at end of May -- at the end of May at 407 million, and that'll be about 340 million in proceeds to us. The fee stream, I would say, the commercial partnership fee stream of property management fees, asset management fees or promoted interest and on future deal and acquisition fee. The growth of this, we're not sure of. We have a partner that we believe and it's an offshore partner. At this time, we have confidentiality and so we're not exposing some of the detail, we will when we close. The growth of the partnership will depend upon good assets to purchase. Together, we hope to put together a reasonable sized portfolio.

[Operator:]

The next question comes from Anthony Paolone with JP Morgan. Please go ahead.

[Anthony Paolone:]

Just broadly, can you talk about -- you did a little bit of equity getting closer to may be something happening on the litigation front and you've now got the industrial joint venture just the ability to move towards a more consistent flow of acquisition or investment activity. Like, do you think the team is in place? Like, are we moving in that direction?

[Mike Bartolotta:]

Yes, we'll certainly hope so, Tony. I'll start off with the first part of your question on the equity and its positioning. As we look at asset allocation, we have three very important guidelines, increasing dilution, portfolio of quality. We're continuing to have portfolio of quality and continuing to have a very good balance sheet, certainly investment grade. When we issued equity this quarter at 842 a share, it's approximately 7% enterprise value. And if you look at the dispositions we've had, it's approximately 6.8% to 7%. And if you then take into consideration the partnership we are putting in place, it's just below six. And if you were to use cap rates as an indication of costs of capital, and I think it's pretty close for us, not exact best but it's very close. I think we have put together a good mix of cost to capital to minimize any dilution to bring our balance sheet north and that's a thought process behind the allocation of capital this quarter. Last part of the quarter is. Do we have the machine in place? Absolutely, we have bought of $4 billion -- we've disposed about $4 billion or $4.05 billion. We put the portfolio in really good shape. We have a balance sheet and an important as all of that, we have maintained a really good team for us to grow once we get over this year, yes.

[Anthony Paolone:]

Okay. And right now as you'll get deal for let's say, outside of the industrial area, where is the sweet spot as you see it in terms of cap rate and type of your tenant credit profile?

[Glenn Rufrano:]

In terms of tenant credit profile, we are about 41% investment grade. By the way in the industrial portfolio, we have 153 assets, 52% investment grade. So, we have a good investment portfolio there as part of industrial format. This quarter as you can see, we bought assets at about 6.8% and we bought them in retail merchandise categories that we really like. And that's been a big part of all our acquisitions. If its retail, it has to be on our retail merchandise categories that are in our investor presentation and you can take a look at all our tenants. This quarter it was home garden, home furnishings and fitness. Last year, if you go back and take a lot about 70% of our assets retail 30% industrials. And we would like to think that that mix will continue into this year.

[Anthony Paolone:]

And then just on the industrial joint venture and you did mention having a much larger portfolio than what's the initial seed assets are. Any chance of putting more into that or what was kind of the magic with the initial few assets?

[Glenn Rufrano:]

When you start a relationship as we are, you'd like to start it comfortable capital relationship. 400 million was a reasonable amount of assets for us to put in and it was a reasonable amount of assets for our partner take on. We'll continue the partnership to buy -- invest in industrial assets. There's no exclusivity, but we clearly want to with this partner continue the partnership and its format with industrial investment grade. Your point is that we buy assets from the outside or can we put assets inside, we can do either. Our initial foray we believe will be buying assets outside of our portfolio.

[Anthony Paolone:]

And last question, I may have missed this. Was there any change to the September trial date?

[Glenn Rufrano:]

No.

[Operator:]

The next question comes from R. J. Milligan with Baird. Please go ahead.

[R. J. Milligan:]

Just on the joint venture, given the competitive market for industrial assets. How do you get comfortable increasing your exposure at this point in the cycle? And do you think we're in the early stages or later stages of the industrial cycle?

[Glenn Rufrano:]

Well, certainly at investment grade, triple net long-term -- with triple net long-term leases, those cap rates are fairly low for us as we sit here right now, to your point. But with the partner, who's comfortable with lower cap rates and high grade long-term investment leases, we can't be competitive. It's a little different business we're in than Prologis. Prologis is going to be in the turn space business trying to get 3%, 4%, 5% growth a year. In our business as you know, it's far less than that. But its long-term, it's safer and our partners looking for long-term safe income streams.

[R. J. Milligan:]

Just to follow-up on Tony's question about contributing more assets. Is that potentially a source of capital to fund any judgments or future settlements?

[Glenn Rufrano:]

Well, I'm not going to get to the second part of that. But the first part of that is could we, actually we have 153 assets with 51% or 52%, investment grades need, we could certainly do that. And it's possible, it's not determined at this point, but it's possible.

[Operator:]

The next question comes from Mitch Germain of JMP Securities. Please go ahead.

[Mitch Germain:]

Glenn, is there anything else that you own as a category that might fit a JV type of construct in the future?

[Glenn Rufrano:]

Mitch, this concept started because we had a series of groups approached us about doing or participating in partnership with them. And I would tell you that the two property types that we have had the most contact with people from the outside were industrial and office.

[Mitch Germain:]

So does that leave the door open for potentially another JV down the road?

[Glenn Rufrano:]

It does, if we were --if we thought it was beneficial to us, but remembered its capital allocation, it has to have a good accretive or dilution or least dilutive effect. We have to maintain portfolio quality and it has to a positive effect on our balance sheet. If we can meet those criteria, that's possibility.

[Mitch Germain:]

I'm curious if your definition of non-core when you think about assets to sell. Does that definition to have a flexibility depending on some of the conditions of your customers or the outlook of may be some of your customers even though they're setting potentially in one year core segments. I'm just curious about what that definition is?

[Glenn Rufrano:]

Sure. Likely, we did sell some non-core this quarter, so let me go through a couple of those. We had a Denny's restaurant that we thought was in a off location and we're not comfortable with it and it became non-core. We also have very few but we have a few shopping centers, smaller shopping centers, this is core in a sense we sold the small shopping center for Melrose Park in the low sevens cap rate. And then, another concept Equity non-core decent bank branches where we're not comparable with the long-term nature of them. So, those are three different property types that we may classified as non-core this quarter alone.

[Mike Bartolotta:]

Great. Also, I know that you -- appreciate your commentary about store closings and some your exposures too, some of the travel retailers and I'm curious if there is any change in terms of how you want to -- potentially looking to call some exposure to certain customers or retail segments over the course of rest of the year?

[Glenn Rufrano:]

We are always thinking about that Mich. As a matter of fact, Paul, Tom and I and our home team will be heading to Las Vegas Saturday to recon, and we have a full schedule of meetings with through the retailers to grow as much as we can to understand their businesses. And so, we're constantly thinking about what we should call and I think we'll get some good information in a week.

[Operator:]

Next question comes from Chris Lucas with Capital One Securities. Please go ahead.

[Chris Lucas:]

Hey. Good afternoon, Glenn and everyone else. On the guidance for the rest of the year, you are running right now, I guess on net negatives on investments at least from what was reported in the release today plus the JV 400-ish million call it roughly. Are you still expecting to be sort of net flat for the year on acquisitions dispositions?

[Glenn Rufrano:]

I would put the JV the partner to be aside. You know, our guidance is 250 to 500 on acquisitions and 350 to 500 on dispositions, that part of it, we are holding right now. Outside of that though, we do have this partnership and even with that partnership, we believe will be in the 68% to 70% range.

[Chris Lucas:]

Okay. And then on the partnership, Glenn, the assets that were contributed, how to compare to sort of rest of industrial portfolio? And was there any sort of specific criteria used to pull those specific assets out?

[Glenn Rufrano:]

The partner was seeking to build the portfolio investment grade. So these are investing grade tenants. s I mentioned, they're six out of many, many more than we have, but they're investment-grade tenants, their geographies provide a little diversification. Their sizes provide a bit of diversification. So we tried to create a portfolio that had some diversification in into itself, recognizing that fixed assets will never be fully diversified. But we wanted to start there. And we were able to get satisfaction to our partner ourselves. So the important part is that when we both like to do is build his portfolio, so it is truly diversified in geography and tenants over a longer period.

[Christopher Lucas:]

Is there going to be mortgage or anything placed on the JV or how do you reserve debt allowed in the JV sort of how you think about the capital structure?

[Glenn Rufrano:]

We will. The access and the partnership will have between 60% and 65% leveraged.

[Christopher Lucas:]

Okay, and then the last question on the on the JV for me just as it relates to sort of the fee side of it. How do you think about that? Is it that increment yield relative to sort of use of equity or how or is it? Or is there really any profit on that sort of added responsibility? Just trying to understand how you guys think about it?

[Glenn Rufrano:]

No, no, absolutely. Remember, these are assets that we've been managing ourselves anyway. And so the fee stream, which would be the property management fee, and the asset management, fee in this instance, would absolutely have a large component of profit. And, I believe proves the value of our infrastructure. There's this partner wants to invest with us because we know how to properly manage an asset and manage these portfolios. And we have great access to products. So the pastry name is the ability for the infrastructure of this company to create value for the shareholders.

[Operator:]

The next question is a follow-up from Sheila McGrath with Evercore ISI. Please go ahead.

[Sheila McGrath:]

I guess I just wanted to check in on the how you look at this Series F preferred on a longer term basis? And the same question on, how we should think of the convertible notes in 2020.

[Mike Bartolotta:]

So, Sheila, it's Mike. I'll take that one. I mean, the preferred the answer we're going to give is one that we've said in the past is that's something we'll be looking at and seeing what we can do with them. But at the moment, they only became pre-payable at no cost in January. And so we'll look at our option over time on that. When we take a look at it converts, the converts that are doing 2020 are actually do December 15, 2020. And so again, that's something that we'll monitor as we go forward. But at the moment, they're at a fairly reasonable rate. They're 3.75. And so there's not too much at the moment were doing anything early with them makes sense and our access to the markets and what have you been pretty well proven, surpass transactions. And we feel comfortable with that timing at the moment.

[Sheila McGrath:]

And then one other question. Glenn, there was a due date in the 10-Q August 19th related to the litigation. If you could just explain to us is that like a date that we should focus on that you might update the market on progress or are there any other kind of trial updates along the way before September?

[Glenn Rufrano:]

August 19th date, Sheila's is a pretrial conference. My understanding is, at the time, the court will likely address various pre-trial motions and discuss a schedule for trial. It's pretty normal procedure that, a pretty normal on meeting that occurs before a trial. So, nothing abnormal there, if did come out that we thought was relevant, we certainly would make it available.

[Operator:]

This concludes our question-and-answer session. I'd like to turn the conference back over to Glenn Rufrano for any closing remarks.

[Glenn Rufrano:]

Thanks everybody for joining us. I know there are some of you that we may be meeting at ICSE in a week and we look forward to that and new week coming up. Thanks again. Have a good day.

[Operator:]

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