VEREIT, Inc.
Q4 2019 Earnings Call Transcript

Published: 26 Feb 2020

[Operator:]

Good day and welcome to the VEREIT Fourth Quarter and Annual Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] Please note this event is being recorded.I'd now like to turn the conference over to Bonni Rosen, Head of Investor Relations. Please go ahead.

[Bonni Rosen:]

Thank you for joining us today for the VEREIT 2019 Fourth Quarter and Year End Earnings Call. Joining me today are Glenn Rufrano, our Chief Executive Officer; and Mike Bartolotta our Chief Financial Officer. Today's call is being webcast on our website at vereit.com in the Investor Relations section. There will be a replay of the call beginning at approximately 2

[Glenn Rufrano:]

Thanks, Bonni, and thanks for joining our call today. Over the last five years, we've resolved the legacy issues found in front of us, always focusing on growth and share price through reporting transparency, company stability and transformation to a net acquirer. Major components of the transformation include settling all outstanding litigation, which includes an agreement with the SEC, building a quality portfolio, enhancing the strength of our balance sheet, and maintaining continuity in an experienced management team.In 2019, we improved tenant diversification and office exposure continues to decrease. We've reduced net debt to normalize EBITDA below our original guidance due to net dispositions, along with our ATM usage. The result was achieving the BBB flat from Fitch, but then upgraded outwork for positive for Moody's.As you will see, we met our guidance while settling litigation. We'll be going through a financial and operational performance. FFO per diluted share for 2019 was $0.69, acquisitions totaled $426 million and dispositions $1.1 billion including $326 million from our industrial partnership. The global litigation settlement at a cost to the Company at $765.5 million was financed with an equity offering of $887 million.We issued a $129 million under the Company's ATM program and $600 million 10-year senior notes at 3.1%. Net to normalized EBITDA was reduced from 5.9 times to 5.7 times, and we've redeemed $300 million of preferred stock. We have access to capital markets not only for debt reduction but to extend on maturities. With the exception of our remaining 2020 converts, we have no unsecured bond maturities until 2024.Leasing for the year was very active with 3.7 million square feet leased and occupancy ending at a healthy 99.1%. For renewal leases, we recaptured approximately 97% of prior rents and same-store rank was up 1.2%. Our 3.7 million square feet of leasing activity represented 289 leases with 3 million square feet renewed of which 978,000 square feet were early renewables. Leasing included 1.7 million square feet of retail, 727,000 square feet of industrial, 687,000 square feet of office and 558,000 square feet of restaurants.Diversification is one of the most important ways for protect and provide income stability, not only do we reduce Red Lobster from 5.5% to 4.7%, but our top 10 concentration continue to improve. We were able to also take down exposures to Walgreens from over 4 to number 2 on our tenant list and Citizens Bank for 1.3% to 0.8% of income. 47 tenants individually represent 0.5% or greater of ARI, comprising 56% of the total portfolio while the remaining 572 tenants comprise 44%. We are introducing a new performance index for our retail and restaurant portfolio. For Q4, EBITDA coverage was 2.63 times which can be found on Page 36 of our supplemental.Turning to capital markets, commercial real estate sales volume excluding M&A increased in 2019. We once again took advantage of this activity including the portfolio. 2019 portfolio dispositions total 740 million and were centered around portfolio diversifiers. We sold 191 million of flat leases, 175 million of office, 136 million of Red Lobster and 228 million of non-core which included 56 million of bank branches.Acquisitions total 426 million comprised of approximately 90% retail and 10% industrial. Retail included our preferred merchandise categories, convenience, entertainment, fitness, specialty grocer and discount. We are all also very focused adding leases as evidenced by the Walt on acquisitions of 16 years and dispositions nine years before.Before Mike reviews our financial results, let me provide my last summary on litigation. On September 9th, we announced our global settlement for both the class action and derivative lawsuit, which the court gave final approval on January 21st of this year. In addition, on November 18th 2019, we announced an agreement with the SEC which is subject to documentation and approval to settle the SEC investigation for $8 million as a civil penalty.Let me now turn over the call to Mike.

[Mike Bartolotta:]

Thanks, Glenn. Thank you all for joining us today. We had a very active year and as Glenn mentioned, we resolved our final legacy issues litigation. And nevertheless, we're still able to achieve the midpoint of our FFO guidance range of $0.69.In the fourth quarter, rental revenue increased 2.4 million or 1% to %305.4 million, primarily due to higher reimbursement income. Net income increased by $812.7 million from a net loss of $741 million to a net income of $71.2 million, primarily due to lower litigation or non-routine of $723.4 million due to the impact of recording of the litigation settlement in Q3 and lower legal expense in Q4.FFO per diluted share increased $0.80 from a negative of $0.66 to positive of $0.14, mostly due to the lower litigation and non-routine cost discussed about, partially offset by a greatest Q4 loss on the extinguishment of debt and the dilutive of delayed Q3 equity issuance, net of surrounded OP units on the Q4 weighted-average shares outstanding.AFFO per share decreased approximately $0.02 from $0.16, mostly due to the increase in the queue for weighted-average shares outstanding that I just mentioned, combined with slightly higher G&A and property operating expenses. G&A increased $2.5 million quarter-over-quarter for $17 million, primarily due to the normal Q4 year end compensation and payroll tax accrual adjustments.G&A for the year ended at $62.7 million, below our guidance range of $66 million to $69 million in a year in part due to slightly lower than anticipated costs for most operating expenses and the continuation of the Cole CIM transition services agreement that was still in effect in Q1. Our guidance for 2020 G&A is estimated to be $64 million to $66 million.Capital expenditures for the year came in at approximately $36 million, net of insurance proceeds, compared with our guidance of approximately $30 million primarily due to earlier than anticipated leasing commission. For 2020, we expect CapEx to be in the range of $30 million to $40 million. Litigation related expenses for the quarter were 659,000, bringing the year-to-date spend to 70.2 million in line with our guidance.Note, the litigation and other non-routine cost line items on the income statements also included $8 million of the accrual for the settlement of the pending SEC investigation. Thankfully, this will be the last time we speak of this line item, as we do not expect meaningful going forward. On September 9th, we announced that we had entered into agreements to settle the remaining civil litigation at a cost to the Company of approximately $765.5 million.Pursuant to the class action settlement, certain defendants agreed to pay a total of $1.025 billion, made up of $225 million from the Company's former external manager and its principles, 12.5 million from the Company's former CFO, $49 million from the Company's former auditor, and the balance of $738.5 million from the Company. In addition, we settled the remaining two opt outs for $27 million, which brings our total to $765 million.In October, we funded $966.3 million for the class, which included the cash value of the OP units and dividend surrendered by the formal manager and former CFO. The REIT now owns 99.9%, up from 97.6% of the operating partnership, which reflects all OP units surrendered back to us by the former manager and former CFO.Turning quarter fourth quarter real estate activity, the Company purchased 26 properties for $142 million at a weighted-average cash cap rate of 7.3%. Subsequent to the quarter, the Company purchased 23 properties for $128 million. During the quarter, we also disposed of 94 properties for $226 million, of this amount $210 million was used in the total-weighted average cash cap rate calculation of 6.5%.The gain on the fourth quarter sales was approximately $42 million, bringing the total for the year to 294 million. And subsequent to the quarter, the Company disposed of 11 properties for 30.3 million. In addition, we formed an office partnership with Arch Street Capital Advisors, which will include VREIT office assets totaling a 137.5 million at a capitalization rate of 7.8%.Partnership as a traditional 80

[Glenn Rufrano:]

Thanks Mike. I'll now turn to the guidance for 2020. AFFO per diluted share of $0.64 to $0.66, net debt to normalized EBITDA of 5.5 to 6 times, real estate operations with average occupancy above 98%, and same-store rental growth ranging from 0.3% to 0.8%, acquisitions totaling $1 billion to $1.3 billion and the average cap rate of 6.5% to 7.5%, dispositions totaling $250 million to $350 million and an average cap rate of 6.5% to 7.5%, targeting our diversification categories, office restaurants and non-core.Additionally, our program will continue to reduce flat leases, which have been providing an efficient form of internal equity. For instance, we sold $55.4 million of flat Walmart Sam's properties at 5.6% in the fourth quarter. Dispositions of a $110 million contributed to the office partnership, the Company's pro rata share, and we expect acquisitions for the industrial partnerships of $400 million to $600 million and acquisitions for the office partnership of $100 million to $200 million.We will continue to focus on reducing our office concentration to at least the bottom of our 15% to 20% range as well as reducing casual dining. We have given thought to increasing our sourcing opportunities by property types other than our existing portfolio or geographies outside the U.S. At this point in our life cycle, we believe using our current business model is the best way to secure appropriate investments. These avenues include discount retail, quick-service restaurants and non-investment grade industrial for the balance sheet.We've expanded off balance sheet with our partnerships to fit our core competencies or investment grade, single tenant industrial and long-term single-tenant office. We have positioned ourselves for off balance sheet investments always with three criteria in mind, full transparency in reporting, assets would not buy on the balance sheet, non-exclusivity thereby not encumbering the enterprise.With the options open to us, net acquisitions will not only provide growth but quality product. We except our deal pipeline of approximately $25 billion a year offered to us to expand at least by 20%. As you can see, we have a great start to the year with $128 million acquired on balance sheet and $280 million closed and under contract in the partnerships.I'll now open the line for questions.

[Operator:]

Thank you. We will now begin the question-and-answer session. [Operator Instructions]. Our first question will come from Jeremy Metz with BMO Capital Markets. Please go ahead.

[Jeremy Metz:]

I just want to talk about the partnership angle a little bit for the industrial partnerships. Are these existing from what you did last year? Are they new? How much equity will you be contributing out of the $400 million to 600 million? And then can you talk about the potential fee opportunities within these?

[Glenn Rufrano:]

Yes, I'll start and then as Bonnie mentioned, both Tom and Paul are here, so I'll kick this with the Tom. But Jeremy to start with the fees, we have confidentiality in the partnerships, but I can give you a good sense of about how the fees will work for both partnerships, both the industrial and the office. The asset management fee is approximately a half a point on equity. The acquisition fee on new asset would be a half a point on gross asset.The property management fee approximates 1% of revenues. And then we have a disproportionate sharing of equity of promote, but that's down the road and that's a little different for each one. But those three key would approximate what we'd be getting from the partnerships. In terms of the industrial partnership and what we've been looking at, it's both existing and to be built, and I'll let Tom fill you in on that.

[Tom Roberts:]

Yes, a lot of the assets are going to be newer. State-of-the-art distribution facilities and as you know, it's an investment grade appetite for industrial. And generally, these are built to suit assets that are in some cases a forward commitment that allow us to get a little higher yield by trending in those and funding those 6 to 9 months out. So as you know, we did contribute 6 assets off the balance sheet of $407 million, about 4.8 million square feet and that was slightly under a fixed cap.So, the one thing we have noticed is our pipeline of sourced assets has increased. That's obviously an area we couldn't compete in the past on the balance sheet because of pricing. So, with this new form of equity, we're seeing tremendous activity in that industrial investment grade. Like I said, state-of-the-art distribution warehouse type facility. So, we're very excited about the activity. Glenn mentioned, we have 280 million -- 248 million on the industrial front that's under contract schedule to close here late first, early second quarter.

[Jeremy Metz:]

And sorry, the 700 to 600 million is that your share? Or is that the gross value and you'll have a percentage of that?

[Mike Bartolotta:]

That's the gross value, Jeremy, and it's an 80

[Jeremy Metz:]

And then, in terms of the office partnership acquisitions, just Glenn, how do you way your desire you guys talked about a longer term goal of getting office down to the lower end 15%? So, is this just part of what it took to get that office transaction to happen and therefore buying a few additional deals or something you had to agree to even add 20% or whatever the equity is, I forget. Is that just part of it or is it contributions from you into that partnership is, how this acquisition this 100 to 200, how we should be thinking about it any color?

[Mike Bartolotta:]

Sure, no, no, it's a good question. First, in terms of the office, I start-up by saying, we are selling the three offices, three office properties, and there 137 million 80% gets sold in. So, we reduced office concentration that you'll see in the first and second quarter of this year, as the assets go in there, which is an important part of this.The second is it's a much smaller acquisition vehicle. As you can see, it's we're projecting a 100 to 200 million versus 400 to 600 million in the industrial. And again, it's an 80

[Jeremy Metz:]

And then just the last question for us here, just given where you've raised the equity, where the stock is. How should we think about further taking down the preferred or even maybe more broadly, just talk about your desire to de-lever further from here just in terms of the guidance? It just doesn't look like there's much in there necessarily at the outset for further deleveraging here, but I assume that's part of the plan going forward.

[Glenn Rufrano:]

Also, the big question and then I'll hand it over to Mike on the prep. We've given a range of five to six and obviously we're at 5.7, and deleveraging will mean taking at below 5.7, so we put up a bottom number on there that we could try to achieve if we can create some over-equitization for some of our transactions but want to make sure we have enough room and the leverage to commit and complete our program for acquisitions. In terms of the prep, Mike?

[Mike Bartolotta:]

I think in terms of the prep, I could just tell you Jeremy, we'll continue to look at them as we have all along and we'll look at everything. We'll look at whether or not if there was any logic to 10 year, 30 year, whether it makes any sense to put a new prep out. We are working with our banks all the time to make sure we understand what the market is on all of these items, and we'll be opportunistic about doing it. We have been opportunistic on the two that we've done so far, the $100 million out of the institutional partnership and then when we had some capital available with a good refinancing that we did in the fourth quarter and over the 200 as the agency say, we're nibbling away at them. So I think we'll continue to do that as opportunities come up.

[Glenn Rufrano:]

And Jeremy, part of your question is, I’d just conclude that the arms and legs we're using here to provide growth. And a big part of our business model now is to not have to focus on anyone property type, but to use our infrastructure across the property types that we know and understand well, and take on the balance sheet where we feel there's an adequate cost of capital relative to -- adequate return relative to our cost of capital, and take assets like the industrial partnership that we cannot buy, because right now kind of be talking about in the low fives for a bunch of the assets we're looking at.We like those assets. We don't mind having a small piece of those assets and be able to get fees because of the infrastructure. And the office is there because we can provide some fee income on long-term leases. So the big issue that we think we have in trying to meet all our requirements here is looking for opportunities, so we don't get caught in any one property type at any given time.

[Operator:]

Our next question will come from Sheila McGrath with Evercore. Please go ahead.

[Sheila McGrath:]

Glenn, your shares are still trading at a big discount to some of the larger cap net lease peers, and it could be in part because of that office exposure. So just wondering how you're approaching the asset management and disposition strategy for those assets, and would you consider sale of those assets more quickly?

[Glenn Rufrano:]

We agree with you. Our multiple is lower than we think our competition is. I just would break it up and office could be a component, just as Jeremy asked about leverage, we have people who asked about our leverage. I don't think our leverage is high. But in terms of loading the gun, so you can buy more assets, people would say our leverage could be a little high and your payout ratio is a little high, because of the litigation settlement. So we think there are a few reasons that we are very focused on and why our multiple maybe a bit lower than others and needs to be corrected over time.In terms of the office, we started out about 23%, 24%, if you remember at office and we set a guideline of 15% to 20% to bring it down too. We've never bought an office building on balance sheet nor will we. We have sold $130 million of office, billion dollars of office and have tried to make sure we do that at reasonable pricing. We have 12 million square feet in 79 properties and office left on the balance sheet, and we will -- what we expect to show you is proper asset management with our office portfolio.If we can have a larger transaction that has an NAV number that we can agree with, we're not immune to that, but this is not a giveaway. We're not going to give our assets away, we know how to asset management. And so we will, I'll use your words. We will use proper asset management to move towards that lower number. But if we could do something below that number that makes sense, we're certainly open to it.

[Sheila McGrath:]

And then on the tenant watch list, just wondered if you could update us on the typical tenants we're hearing about these days, Art Van, et cetera and just how your tenant watch list looks in historic context?

[Glenn Rufrano:]

I think with Paul here, I'm going to throw that over to him. Paul?

[Paul McDowell:]

Our watch lists has remained reasonably stable over the past few years, so we haven't seen a large impact to our watch list over the past few years. And in fact, it's remained pretty stable over the past few quarters on a weighted lease adjusted basis of around 2% to 2.5%. So the stuff that you're seeing in the marketplace today, it's not that unusual the first quarter to see tenants throwing in the towel and you've seen that a little bit and there's some high profile tenants in the market now that people are talking about like Art Van and Crystal. We're lucky that we're very diversified and we have very limited exposure to either one. Our Art Van exposure is eight properties at 0.6% of rents and Crystal is 37 properties at 0.4% of rents, so we don't have a lot of exposure to the meanings you're hearing from today.

[Operator:]

Our next question will come from Anthony Paolone with JP Morgan. Please go ahead.

[Anthony Paolone:]

On that point, I guess the watch list and credit, your same store NOI growth is expected to decelerate in 2020. Can you talk about what's behind that?

[Mike Bartolotta:]

If you go through our same stores, you'll notice that we break it down by each of the four components. The major component this year was office, actually of the 1.2 is it was almost half of it. And the reason for that was that we had an office tenant in 2018, we did a blend and extend and we actually gave them free rent for a period of time in '18. And so our ‘18 same-store suffered because of that and this year they came back they were always in the pool. They had zero last year or pretty close this year. They started paying rent after the free rent period was over. So we had a higher number at 1.2%.We believe it'll be more stabilized next year but we're always aware that these blend and extends at any given time can reduce same-store, it doesn't mean we're not going to do them, because we do them to get more term and we get more NAV. So we're not going to hurt NAV for the sake of same-store, we’ll just explain it as it comes through.

[Anthony Paolone:]

So then is there anything in the 2020 guidance or same-store stats that you're counting for at this point around Art Van or Crystal, or anything else on the watch list?

[Mike Bartolotta:]

We would hope everything's in there. We've taken that into consideration.

[Anthony Paolone:]

And then on the office exposure, if I look over the next three years, it looks like 6% of revenue expires in office. Are those assets with where you're coming up on the expiration? Are those things that could be sold to help with your weighted-average lease term, or as you reduce office exposure you have to go for the longer duration stuff? And are there any large known move outs in that mix?

[Glenn Rufrano:]

I'll start with a big picture answer then I'm going to hand it over to Paul. The office has a weighted average lease term of 4.6 years, and so selling shorter-term office is difficult in terms of maintaining value. We have been working through the assets on an asset management basis to see if we could blend and extend it, it could cost us some rent, it could cost us some TIs. But we think as of now that has been the better way to minimize our exposure when we can't sell an asset. For instance, we sold an asset last year in North Grumman, which actually was an asset to be vacant pretty quickly but it was in a very good location and at $138 million, we've got a very good price. So we're going to take advantage of any situation we can in office, but we do recognize with that lower wall it is more difficult. Paul, is there anything?

[Paul McDowell:]

No, I think that covers it pretty well. I’d say over the next few years, we see our expirations are about one-third office, one-third retail and one-third restaurant and industrial put together. And obviously, we focused very carefully on that. And as Glenn has said, we look to extend tenants in place and when we extend the tenant in place that hopefully gives us an ability to sell that asset into the open market. And we also as Glenn mentioned, we have some good office buildings that are very valuable without a tenant in place. We mentioned one in California. We have another one outside Seattle, which we're getting ready to -- which we hope to dispose of during the course of this year. So it's just a sort of a classic blocking and tackling asset management.

[Glenn Rufrano:]

And similar to Sheila’s question, if we could find a method for a larger transaction that we felt maintain value, we’re certainly open to it.

[Operator:]

[Operator Instructions] Our next question will come from Spenser Allaway with Green Street Advisors. Please go ahead.

[Spenser Allaway:]

So 2019 was obviously a very robust year, just in terms of dispositions. But as you look at the portfolio today, what portion of the remaining portfolio would you say is kind of subject to strategic divestment, or maybe said differently, how much more prudent would you ideally like to do?

[Mike Bartolotta:]

In the 250 to 350, now that that's the portfolio disposition. Outside of that would be the disposition, Spencer, for the office partnership. So that's outside of that 110, so that would automatically take down some of our office. So then we have 250 to 350. And in that 250 to 350, it would be primarily office and casual dining and non-core. Those are the three categories that are strategic that on how we'd like to strategically position the portfolio.

[Spenser Allaway:]

So 2020 guidance kind of captures everything that you guys would just kind of bucket into that strategic divestment and nothing beyond that?

[Mike Bartolotta:]

No, not at this point. To be fair, we've had strategic investments so far and it's been 5 billion for the last five years. So it's been a very big program and you can see last year was $1.1 billion. So we hope we're minimizing the strategic requirements here. And part of it as you can see this year we sold over 60 million of bank branches. So when we say non-core, within non-core there may be small strategies that we're looking at.

[Spenser Allaway:]

And then just in regards to the expected CapEx spend, I think you mentioned somewhere between $30 million and $40 million for the year. Just curious how the fares relative to spend in recent years, and then also realizing you can't provide commentary probably on each line item but can you just provide a little color on how you would expect that to be broken out between TIs or maintenance CapEx?

[Mike Bartolotta:]

I'll hand it over to Paul, but on the big picture, we were $36 million this year, a bit above the $30 million we expected. And the range of $30 million to $40 million is our projection for next year. Paul?

[Paul McDowell:]

Yes, I think it's important to recognize that we've been under guidance over the past several years. In 2019, we had a variety of positive events that drove CapEx up primarily in the form of leasing commissions from back filling some vacant space like a Toys R Us box, a shift in tenancy from one of our office buildings from a below investment grade tenant to an investment grade tenant and higher rents. All these things we did, as Glen mentioned before, increased net asset value. So we're willing to spend CapEx if we think that we can increase NAV.The '20 guidance is driven off of trends we saw in '19 with an eye towards our expiration schedule over the next several years, a significant portion of which is office. And I would say to your question as maintenance as compared to maintenance CapEx or new leasing activity, tenant improvements or LC, the majority of what we would see expect for CapEx in 2020 would be for TIs and LCs associated with new leasing activities at our properties.

[Operator:]

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

[Glenn Rufrano:]

Thanks everybody for joining us. We like this format. We're going to keep come around to help us as we talk through the year. And we look forward to seeing many of you at Citibank next week. Thank you.

[Operator:]

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