VEREIT, Inc.
Q2 2019 Earnings Call Transcript

Published: 7 Aug 2019

[Operator:]

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

[Bonni Rosen:]

Thank you for joining us today for the VERIET 2019 second quarter earnings call. Joining me today are Glenn Rufrano, our Chief Executive Officer; and Mike Bartolotta, Chief Financial Officer. Today's call is being webcast on our Web site 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 and capital allocation results for the quarter AFFO per diluted share was $0.18, and we are reaffirming our AFFO guidance range of $0.68 to $0.70. Year-to-date acquisitions totaled $221 million. As described last quarter, we formed an industrial partnership including six REIT outfits, totaling $407.5 million, which closed on May 30th, and contributed $326 million to dispositions. Portfolio sales were $430 million, bringing total dispositions to $756 million, including our 80% share of the industrial partnership. And we reduced net debt to normalized EBITDA from 5.9 to 5.7 in the first quarter, and further, to 5.3 times in Q2.Leasing for the quarter was very active, with 357,000 square feet leased, and occupancy ending at a healthy 99%. Same-store rent was up 1%. Year-to-date, we have leased 1.2 million square feet, of which 1.1 million square feet were renewals, and 248,000 square feet early renewals. Leasing activity included 442,000 square feet of retail, 407,000 square feet of office, 269,000 square feet of restaurants, and 85,000 square feet of industrial. For renewal leases, we recaptured approximately 100% of prior rents, and our remaining lease rollover exposure for the year is no 0.9%.Commercial real estate transactions in the first quarter were down 9% due to economic uncertainties at the end of 2018. But the interest rate dropped beginning early this year, the market has responded. And in Q2 and year-to-date, sales of $240 billion are on par with last year. We expect full-year sales to be comparable to the 2018 total of $578 billion. You can see we're taking advantage of a robust market in our asset allocation process. Excluding the industrial partnership, we are increasing our portfolio disposition guidance from $350 million to $500 million, to $500 million to $650 million, and our acquisition range from between $250 million and $500 million to $400 million and $600 million.Year-to-date acquisitions totaled $221 million, comprised of approximately 90% retail, and 10% industrial. Retail included our preferred merchandize categories, convenience, hobby, home furnishings, and discount retailers. Dispositions continue to outpace acquisitions, at $756 million, which includes the industrial partnership with KIS. This 80-20 partnership was seeded with six REIT assets with a weighted average lease term of 10.5 years, and a cap rate just under 6%. The portfolio includes the following tenants; Amazon, FedEx, TJX, Home Depot, and [indiscernible], and are located in Pennsylvania, Virginia, Tennessee, South Carolina, and Wisconsin.We have adjusted all our portfolio and financial metrics to account for our 20% share throughout the supplemental, including our net debt to EBITDA and property type ratings. As part of our transactions, we will receive asset management, property management, and the opportunity for acquisition fees, as well as a disproportionate share of equity based upon an IRR hurdle. As important we are focused on our debt balances. We've reduced net debt to normalized EBITDA for the year from 5.9 to 5.3, which includes the total of $245 million in litigation settlements, representing approximately 35.3% of REIT outstanding shares of common stock held at the end of the period.Before Mike reviews our financial results, let me provide a brief update on litigation. Expert discovery was completed at the end of July. As previously announced, the Judge moved the trial date from September 9, 2019 to January 21, 2020. This September 9 date will now be used as conference to address all pre-trial motions.On July 16, the SEC filed a complaint and entered into a settlement agreement with the company's former manager and certain of its principals. The court approved settlement on July 17. As part of the settlement, principals of the former manager have forfeited $2.9 million limited partner OP units along with $6.4 million in associated dividend that have not being paid on those units. Mike will discuss the accountings for this.To be clear, VEREIT was not a party to this SEC settlement. In addition, nothing in the SEC settlement just discussed, precludes us from asserting any claims against any of these in the future. Additional details regarding pending litigations can be found in our 10-Q filed today.Let me 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 decreased $4.8 million or 1.5% to $312 million. Mostly due to net disposition year-t-date. Net income increased $221.3 million to $292.3 million primarily due to a higher gain on the disposition of real estate of $210.9 million along with lower depreciation and amortization of 18.5, lower restructuring cost of $8.8 million, lower settlement expense of $12.2 million, and the $26.5 million of OP Unit recovery recorded in litigation expense in Q2.This was partially by $8 million of higher ongoing litigation expenses in Q2 and prior recognition of $48.4 million of insurance recoveries received last quarter. FFO per diluted share decreased $0.01, from $0.19 to $0.18, mostly due to lower rental revenue of $4.8 million and the higher litigation and non-routine cost net of $17.7 million discussed above. Partially offset by a lower restructuring charge of $8.8 million and $3.6 million of higher other income mostly due to the unexpected receipt of a prior fully receivable.AFFO per share was essentially flat quarter-over-quarter at $018. G&A increased $1.6 million quarter-over-quarter to $16.4 million primarily due to certain equity compensation that is always recorded in the second quarter and determination of the Cole transaction transition services agreement at the end of Q1. During the quarter, there were $22.8 million of litigation related expenses.In addition, we recorded a credit of approximately $26.5 million which represents the cancellation of the approximately 9.2 million OP Units. This brings the litigation related line item in the financials to a credit of $3.8 million in Q2. You will also see a correspondent reduction in non-controlling interest for the 2.9 OP Units and an adjustment for the associated $6.4 million of unpaid dividend and distributions payable on the liability side of the balance sheet.Year-to-date litigation related expenses have totaled $37.5 million. We still expect growth litigation expenses in 2019 remarkable les than the 2018 which was approximately 70.07. Turning to our second quarter real estate activity. The company purchased 25 properties for $190 million at a weighted average cash cap rate 7.3%. In addition, the company invested $8.3 million in one Build-to-Suit project with an investment today at $15.8 million and an estimated remaining investment of $11.9 million.And in subsequent to quarter, the company acquired three properties for $21.8 million. During the quarter we disposed the 53 properties for $658 million. Of this amount $493 million was used in the total weighted average cap rate calculation of 6.5% including $53.5 million of net sales of Red Lobster. The gain on the second quarter sale was approximately $233 million, primarily due to the [indiscernible] window office sale and the investment partnership.And then subsequent to the quarter, the company disposed the 12 properties for $27.5 million. We continue to strengthen and liquefy our balance sheet including the industrial partnership proceeds, we took our line of credit balance to zero, paid down $172 million of secured debt, and announced the partial redemption of 100 million of preferred stock, which was redeemed on July 5.Given the current interest rate environment, we thought it was prudent to lock in a rate to partially reduce risk on future debt, of which the earliest expected significant maturity date isn't until December, 2020. Subsequent to the quarter, the company entered into forward-starting interest rate swaps with a total notional amount of $400 million, and an average effective treasury rate of approximately 2.1%. The swaps are structured to hedge the interest rate risk associated with the potential issuance of 10-year public debt between May 1, 2020 and December 31, 2021.Our net debt to normalized EBITDA ended at 5.3 times. We are updating our net debt to normalized EBITDA target from a range of 5.7 to 6 times, to 5.5 to 5.7 times. Our fixed charge coverage ratio remains healthy at three times, and our net debt to gross real estate investment ratio was 37%. Our unencumbered asset ratio was 76%, the weighted average duration of our debt was 4.4 years, and we are 99.8% fixed.And with that, I'll turn the call back to Glenn.

[Glenn Rufrano:]

Thanks, Mike. We continue to focus on three objectives, lowering our debt level, refreshing and diversifying our portfolio through reinvestment, and maintaining an experienced execution team. The first two objectives results from our careful review of current and future asset allocation, our process considers accretion and dilution, balance sheet goals, and portfolio quality. Reduced debt levels with minimum dilution has been achieved by seeding the industrial partnership with internal assets, prudent use of our ATM, and execution of an interest rate hedge with accretion provided by the partial redemption of our preferred stock.Our acquisition ambitions center around the desired portfolio construct to protect against future disruptors. And experienced execution is found within senior real estate team, seasoned with company tenure of over eight years, more than double the length of time we've had our new name. KIS, our new institutional partner has also recognized the value of our underlying management in their commitment to a long-term relationship.With that, I'd now like to open up the line for questions.

[Operator:]

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

[Sheila McGrath:]

Yes. Good afternoon. Your leverage metrics improved to levels not seen in years, largely from that industrial sale. I know you updated the near-term leverage targets but I just wanted to understand how we should think about this going into 2020. Should you consider that there continues to be a net seller to raise proceeds to pay down the preferred stock?

[Mike Bartolotta:]

Well, Sheila, if you -- the answer for 1990 is in a large part of our presentation, even though we have updated both our disposition and acquisition activity, we're still in that filler this year. And the net selling position is exactly as you stated, to keep our leverage low, that is one of our -- the tree objectives. As you noticed, that's one of the big ones. So we will be a net seller this year, yes.

[Sheila McGrath:]

Okay. And then Glenn, following up on that, you did execute well on that industrial portfolio sale, are there any other opportunities to kind of cobble together a portfolio that you might do better than individual asset sales?

[Glenn Rufrano:]

Well, we are working with KIS, our partner, to find some other assets that will fit in that portfolio. We have nothing to announce right now. We have had conversation with others on partnerships in the office sector, so there may be ways that we can provide for, what we would call, high return on capital partnerships, where we seed with our current assets, reduce the assets we want -- like to have out of our portfolio either because it's a very low cap rate or because in the case of office, we're reducing office, and at the same time being able to provide a growth vehicle.

[Sheila McGrath:]

Okay. And last question. Glenn, was hoping you could give some high level views on the retail environment right now, and your tenant watch list?

[Glenn Rufrano:]

Well, we've had 7,000 or 8,000 closures this year so far, which isn't good. For us though, I'm going to knock on every piece of wood here, we remain at 99% because we have not really been hit very hard with those closures. As you know, most of those closures have been in the mall sector, and very apparel related, which we have very little. I have some confidence that there is some stabilizing occurring with tenants who are absolutely finding ways to use omnichannel as the way to provide profitability. So we're -- and my view, specially coming out of ITSE, our tenants, no one understand online is here to stay, they're dealing with it.And the ones who have the resources to compete online and provide that service will be here for a long time. So we are watching very closely. And as we've talked about before, we care about tenants who not only understand that online is important, but have the resources to implement it, because it is very expensive and without much margin.And that was the first part of your question. And the second?

[Sheila McGrath:]

And I guess the watch list -- kind of watch list.

[Glenn Rufrano:]

That's right. We've had a tenant watch list of around 2% or sometimes a little higher over the last two or three years. And I would tell you now; we're at the low end of that watch list. We're feeling pretty good about the credits that we have right now, and are happy to have a lower watch list percentage.

[Sheila McGrath:]

Okay. Thank you.

[Glenn Rufrano:]

Thank you, Sheila.

[Operator:]

Our next question comes from Mitch Germain with JMP Securities. Please go ahead.

[Mitch Germain:]

Thank you. Just, and Glenn, looking at your top tenants I'm curious, a, are we done with reducing your exposures to Red Lobster. And maybe, b, what your thoughts are for Family Dollar. Obviously there's been some headlines out of Dollar General. I guess both of them.

[Glenn Rufrano:]

No, yes. Mitch, talking Red Lobster, we're down to 5.1%, and our goal was always to get below 5%. We've sold $53 million in the quarter, but we actually have 98 million year-to-date. I feel very confident by year-end we're going to be below our 5%. And once we get below 5, that 5% we'll evaluate how far we'll go down. I would tell you that we're pleased with Red Lobster. And in 2015, Golden Gate took over. The sales went up very nicely actually on the portfolio. And then there were some down years in the 2016-'17. But in the last three to four quarters our portfolio has really done well with positive sales. So we are pleased with the portfolio, and pleased with their balance sheet as they've strengthened it with [indiscernible] Union coming in as a partner. So we'll get down below 5%, and then we'll evaluate how much more we think we should take that down.On the dollar stores, Family Dollar and Dollar Tree at about 3.5%, and Dollar General is 3.1%. It's really Family Dollar that we've had some of the question marks about. And we're watching them closely. The vault on Dollar Tree and Family Dollar is eight years, and it's close to eight years on Dollar General as well. So we have plenty of term there. There were some closures we announced last time. And we've had a few more since then. But in total, the total closures for the Family Dollar stores is about 0.2%. So it's very small in our portfolio, but it's clearly a good business. A business that's growing, in fact all those companies are still growing. But they're evaluating certain locations, and we keep an eye on that.

[Mitch Germain:]

Got you. That's very helpful. With regards to the industrial joint venture, I guess if there is an asset that fits the criteria, how does that work? Do they get right of first refusal, or is it a one-to-them one-to-you, how should we consider that over time?

[Glenn Rufrano:]

Well, the industrial joint venture of KIS has no exclusivity at all, Mitch. So in fact if -- and as you know, these are all investment grade assets. If an investment grade industrial property came to us today we do not even have to show it to them. Now, we would because the partnership will be built on that basis and those assets are very expensive. But we don't have any exclusivity with regard to new assets coming in, and we have no exclusivity with regard to selling assets from our existing portfolio. We didn't want to encumber this business with a joint venture that would have any level of exclusivity. But if we had, and we do; as you know, we had 153 industrial properties before the six went into the venture over 50%, just over 50%investment grade; if we wanted to sell another investment grade asset into the venture, we could approach KS and they would certainly like to see us do that.

[Mitch Germain:]

Got you, okay. Last one from me, Mike, I must apologize I might have missed some of your comments, but what is the plan for the convert?

[Mike Bartolotta:]

So basically, I mean, we just put the swap in place, which hopefully mitigates any of the potential interest rate risk of just letting it float. But we can wait till that becomes due, which is in December of 2020.

[Mitch Germain:]

Great. So you have some time. And if I could sneak one more in, Glenn, obviously, there was an SEC ruling on some of the old AR Capital executives; has there been any progress on the SEC investigation of VEREIT, or is that now kind of - I believe that they were separate, correct? Is that - is my understanding correct?

[Glenn Rufrano:]

Yes, Mitch, they are absolutely separate. It just occurred with the former manager and the principles with them, not with us. We continue to work closely with the SEC and have conversation with them. But there has been - there is no resolution that we'd be able to speak about.

[Mitch Germain:]

Thanks so much.

[Glenn Rufrano:]

Thank you.

[Operator:]

Our next question comes from Caitlin Burrows with Goldman Sachs. Please go ahead.

[Caitlin Burrows:]

Hi, everyone. Maybe just sticking on the topic of the trial, I guess looking into 2020, the trial is now expected to start in late January. I think you'd previously mentioned it could take like four to six weeks. And I think reasonable thought is that at the end of that time, you would be expected to pay something out and that would be by the end of about 1Q. So I guess I'm just wondering, when we think about timing, what do you think could delay the process beyond this timeframe any further?

[Glenn Rufrano:]

Well, I'm going to first admit I'm not a lawyer, Caitlin. And so whenever I say can't be held against me. But I'll tell you and repeat what I've been told. A trial can always be changed. It's been changed once. And as you know, it wasn't changed for reasons related to the case necessarily. The judge had a personal reason to change that date. Could it be changed again? It could. I would hope not. So let's assume that the date holds in January, because I hope so. After that, in terms of payment, I'm not sure I can give you the exact date on that in 2020. The timeframe is one that we've talked about before. Four to eight weeks, I think is the range that I've been given, and then it's a question of how the parties - what comes out of that, what the damage award is, if any, and whether or not there is any appeal? So I don't think I can give you a timeframe in 2020. But our objective would - we hope that it would be as soon as possible.

[Caitlin Burrows:]

And I guess just on to the extent you have something that you could share on the topic of potential appeal; is that just you potentially find out an amount and then decide if you want to pay it or if you want to push back on that, or how does that process work?

[Glenn Rufrano:]

I can't give you the specifics. But it's my understanding, either party can appeal.

[Caitlin Burrows:]

Got it. And then I guess just thinking about leverage, you guys did bring it down nicely in the quarter. So going forward over the next, call it, 6 to 12 months to the extent that it does get higher; I guess, how would you plan to address that going forward? And to the extent it does get higher early in 2020, how quickly do you think it could come down later in 2020 or going forward?

[Glenn Rufrano:]

No, I have to give you a preface to the answer here. The preface is how we have thought about leverage relative to our litigation. And if I go back, I know we've had a conversation, people have asked

[Caitlin Burrows:]

Got it, okay. Thank you.

[Glenn Rufrano:]

Thank you.

[Operator:]

Our next question comes from Spenser Allaway with Green Street Advisors. Please go ahead.

[Spenser Allaway:]

Thank you. Maybe just going back to the retail environment for a minute; have negotiations, specifically as it relates to just like re-leasing properties, have they become more difficult and/or have you seen changes in the terms that tenants are asking for? So whether that's lease term or rent bumps?

[Glenn Rufrano:]

I'd say, yes, Spenser, to give you a one word answer. That answer change has changed over time. Sometimes when the landlord has a bit more power and sometimes when the tenant has a bit more power, and that's a general statement. And then within that general statement there may be a location or a tenant where the power is in - negotiating power is in either direction. Right now there's certainly some pressure on retail rents across the board. And we're finding it difficult to get our tenants to renew long-term in some cases. In other cases, we've made some good long-term deals especially on blend and extend.But that fight between us and our partner, which is always a good fight and a reasonable fight, will continue over years and we feel confident that with the positions we have, we are doing fine. Our 99% lease gives you an indication of that. But ultimately, what I would tell you, that will protect us, in my view anyway, would be diversification. What we don't want is to be in a position where any tenant could put a gun on our head to any great extent or geography could put a gun to our head in any great extent. So we are looking at tenants, it's not an easy environment, we'll get through it and ultimately our diversification will be our protection.

[Spenser Allaway:]

Okay. And then maybe just in regards to retail pricing, are there any industries specifically of where you've seen cap rates move one way or the other in any material fashion?

[Glenn Rufrano:]

I think it's been pretty stable this year so far. As I mentioned in the beginning remarks, as we came out of the fourth quarter of last year, the tenure was up 20 bps, 30 bps, and so we had a little bit up first quarter. But that roughness didn't necessarily convert into different cap rates. I think it converted into less transaction activity, people just waiting. The tenure went down before this latest drop, 110, 120 basis points in the first quarter. And all of a sudden in the second quarter, there was a dramatic change, in at least our view, in terms of product in the market and closure, meeting of the minds between by some sellers. But again, not a lot of change in cap rates in my view. So the timing is important, but people have been waiting out the interest rate movement. And it's now back in favor, frankly, for cap rates being stable or in some cases maybe even dropping.

[Spenser Allaway:]

Okay. And then last one, if I may. Obviously, you guys have been active in the capital markets. But just as we kind of move in the back half of the year and given your improved cost of equity, is there any reason why we wouldn't see you guys get a little bit more aggressive in utilizing our ATM?

[Glenn Rufrano:]

The ATM, we did not use it this quarter, as you've noted. And the best I could say about that, there are going be times when matters relating to various legal proceedings may influence our ability or willingness to be part of open market transactions. We'll continue to consider when we can have transactions in the marketplace. And if it's appropriate, we would certainly act as we did in the first quarter.

[Spenser Allaway:]

Thank you.

[Glenn Rufrano:]

Thank you.

[Operator:]

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

[Chris Lucas:]

Good afternoon. Glenn. Just maybe following up in that vein, I guess you guys redeemed some preferred this quarter. I guess, bigger picture; how do you guys think about preferred in the capital stack? And given where the capital markets are today, rather than buying down that preferred, is there an opportunity to refinance a big slug of that with the new issuance? And how would you guys think about that?

[Glenn Rufrano:]

I'm going to let Mike start that and then I'll chime in.

[Mike Bartolotta:]

Yes, Chris, we, as you know, we took $100 million down and it has a pretty positive effect going forward. At the same time though it has a negative effect on our net debt-to-EBITDA. So that $100 million effects, net debt-to-EBITDA, negative by 0.01. So it's always a concern because the rating agencies have a different temperament depending on which agency. But they don't consider the preferred as debt completely. We have looked at potentially swapping it out with another set of preferred, and we'll continue to look at that. Up till now when you look at the cost of doing that compared to the savings, it hasn't been [indiscernible] really something we would want to do yet. But we'll certainly monitor it.

[Chris Lucas:]

And then, I guess, Mike, while I have you, just looking at your sort of mortgage schedule; most of the rates in the next period or sort of mid-fives and I guess the question I would have is, how aggressive would you look to prepay or diffuse those mortgages, given the current environment and how far out would you like to go?

[Mike Bartolotta:]

Chris, I'm smiling because we look at them every - all the time. We took roughly $74 million, $75 million of them out earlier this quarter. But we always compare the prepayment cost or the make whole cost that almost all of them have. And so we always make sure that there's a positive arbitrage in doing that.

[Chris Lucas:]

And so I guess just going back to the preferred for a second, if you guys did a refinancing or reissue to swap out the existing with a newer issue; is that something that might be impacted by the issues that Glenn described as it related to the use of the ATM?

[Glenn Rufrano:]

it would be, it's a security. And the issue we would have, Chris, would affect any new security.

[Chris Lucas:]

Okay, thank you. That's all I have. Appreciate it.

[Glenn Rufrano:]

Thank you.

[Operator:]

Our next question comes from Sheila McGrath with Evercore ISI. Please go ahead.

[Sheila McGrath:]

Yes, you mentioned $6.4 million removed from the dividend payable liability. I just wanted to clarify that there are other OP units that you're currently not paying dividends that could be a source of capital in any settlement, I think it was over $13 million. I just want to confirm that.

[Glenn Rufrano:]

Sheila, you're right. If you were to look at our cue last quarter, it would have had $13.1 million. And when you look at it this quarter, it has $13.1 million. And so we have not changed that even though that $2.9 million came out.

[Sheila McGrath:]

Okay, good. And then, just curious, I'm not sure if you can comment on this, Glenn. But in the settlement with the former managers, there was a statement that they were obliged to pay a fee to the SEC. And I'm just wondering, wouldn't it be more appropriate that very shareholders benefit from that payment rather than the government agency because for VEREIT shareholders are the ones that are bearing the burden of the litigation fees, just your thoughts there.

[Glenn Rufrano:]

Yes, how about that? But let me go into a bit of an explanation. I want to break that down. Besides the 2.9 million operating units and the $6.4 million in the dividends, which Mike just described how it ran through the balance sheet. Your question, which I understand is, there were two other components to the SEC settlement with the former Manager in the principles. One was called [indiscernible] $12.3 million, and the other was a civil penalty of $22 million approximately. Of the two, the $12.3 million, the general objective of that as I understand it will be to provide funds for uncompensated injured parties. So that's a minute to set aside for those circumstances. The $22 million as my understanding is the civil penalty. And it would be wonderful if we can have some of all that for current shareholders, but it's not there right now.

[Sheila McGrath:]

Okay, got it. And one last one. In your queue, you mentioned the date for the trial being January 21, 2020. And then there were two other dates mentioned one in September and one in November. Are those just like procedural routine meetings or could some, new information come out for investors to focus in on at those meetings?

[Glenn Rufrano:]

The one in September is for pretrial motions in concluding motions regarding each side's expert, so that as I understand that's a normal procedure and process before a court case. And then, in November, you're now very close to January. If there's anything else to address in pre-trial matters, it will be addressed then. But again, my understanding is that the primary one will be here in September.

[Sheila McGrath:]

Okay. Thank you.

[Glenn Rufrano:]

Thank you.

[Operator:]

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

[Glenn Rufrano:]

I thank everybody for joining us today. We're actually holding this call in New York, sometimes even in Phoenix, but for anybody it is the last time we'll be in this office. We are moving to Nine West 44th Street between fifth and sixth. So if anybody wants to visit us after this week, you can visit us there. Thank you for participating in the call. Have a good summer.

[Operator:]

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