VEREIT, Inc.
Q3 2017 Earnings Call Transcript

Published: 8 Nov 2017

[Operator:]

Good morning and welcome to the VEREIT Q3 2017 Earnings Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Bonni Rosen, Director of Investor Relations. Please go ahead.

[Bonni Rosen:]

Thank you for joining us today for the VEREIT 2017 third quarter 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 1

[Glenn Rufrano:]

Thanks, Bonni, and thank you all for joining our call. We are pleased with the results for the quarter. AFFO per diluted share was $0.19. Year-to-date, acquisitions totaled $497 million and we've completed $532 million of dispositions. Net debt to EBITDA was 5.5 times, still below the guidance range of 5.7 to 6 times, providing acquisition capacities for the remainder of the year. We issued 600 million of senior notes to repay borrowings under our $500 million term loan, with remaining proceeds due to pay down secured debt. And we are increasing our AFFO guidance from $0.71-to-$0.73 to $0.73-to-$0.74 per share. Starting with operations, occupancy was 99%, up slightly from 98.6%. Same-store rent increased 0.01% for the quarter or 0.03% excluding the effects of certain office early lease renewal efforts. During the quarter, we had 355,000 square feet of lease renewals of which 248,000 square feet were executed early with 100% recovery. Notable lease transactions included a 66,000 square feet industrial property and 43,000 square feet of bank branches and 18,000 square feet of a national restaurant concept. We had three major hurricanes this season fortunately there is no major damage that impacted our financials. Third quarter acquisitions were $248.9 million with $45 million subsequent to the quarter. This includes 13 properties in multiple categories such as sporting goods, fitness, pet supplies, automotive service, home furnishings and discount retail. We purchased four industrial properties which represented approximately 45% of the acquisitions. For the year, acquisitions totaled 497 million. Third quarter dispositions were 65.4 million with 42.7 million subsequent to the quarter. These 32 active dispositions were spread across our strategic categories and included restaurants, office, joint venture, non-core and flat leases. Both Red Lobster and office exposure have steadily declined throughout the year moving towards the stated goal REIT's category. Dispositions for the year now totaled 532 million. As you can see, we became a net acquirer this quarter. We completed a bond offering in August with 600 million with 10 year notes at approximately 4%. Having achieved investment grade, we were able to price these bonds 100 basis points tighter than our offering in May of last year. There're not many times when you can measure success however the 100 basis points spread improvement demonstrates VEREIT's business plan accomplishment. Net debt to EBITDA is healthy at 5.5 times providing ample room for leverage neutral acquisitions and our debt is 99% fixed. During the quarter, Cole Capital raised 66.4 million of new equity an average of approximately 22 million per month. Capital raised for the third quarter is typically lowest in the year. We continue to add selling agreements and advisors and since the beginning of the year, Cole has been able to increase its market share of sales from 4.3% in Q1 to 8.3% in Q3. New equity for October was 24.2 million, an increase of 10% over the average monthly run rate last quarter. Before Mike reviews our financials, let me provide a brief update on litigation. The Court granted the plaintiff's motion for class certification and we've filed the petition with the appellate court seeking permission to appeal the court's order. The Court held a conference on November 1st to discuss a process and schedule for dispositions. The Court directed to parties to discuss a proposed schedule and return for another conference on December 4th. Additional details regarding pending litigations can be found in our 10-Q filed today. Let me turn the call over to Mike.

[Michael Bartolotta:]

Thanks, Glenn, and thank you all for joining us today. We had a good quarter, achieving AFFO of $0.19 per diluted share. Consolidated revenue was 333.7 million, just below last quarter's revenue of 336.9 million. Net income for the third quarter was 16.5 million versus net income of 34.2 million last quarter. The $17.7 million decrease was mostly the result of a loss on property sold versus the gain in last quarter representing a net difference of 43 million. This is partially offset by the following lower expense items totaling 26 million in the third quarter, litigation, depreciation and amortization, impairments and interest. FFO per diluted share for the third quarter was $0.18, above last quarter which was at $0.17, primarily due to 8.3 million in lower expenses including litigation, property operating and interest combined with a larger gain of 1.5 million on the extinguishment of debt and derivative instruments partially offset by the lower revenue of 3.2 million in Q3. AFFO was $0.19 per diluted share versus $0.18 last quarter, primarily due to a decrease in the current income tax provision of 11.1 million quarter-over-quarter partially offset by higher adjusted G&A of $1.2 million in Q3. G&A remains relatively flat for quarter-over-quarter at $29.8 million versus $29.4 million for the second quarter. The real-estate G&A was $13.1 million for the quarter down $1.2 million from $14.3 million in the prior quarter mostly due to the equity based compensation for directors that was granted and invested in Q2, along with the normal annual filings fees incurred in Q2. Coal capital G&A was 16.7 million up 1.6 million versus the 15.1 million in the prior quarter mostly due to higher non-reimbursable advisory expenses, higher program development cost and increased marketing expenses in Q3. Legal costs related to the matters arising from the audit committee investigation, which are included in litigation and other non-routine cost was approximately 9.5 million for the quarter, bringing our year-to-date amounts to 36.5 million. Turning to the third quarter real-estate activity, the Company purchased 11 properties for a 248 million at an average cash cap rates of 7% and then subsequent to the quarter the Company purchased six properties for 45 million at an average cash cap rate of 6.6%. During the quarter, we've disposed those 65.4 million of property lease at an average cash cap rate of 7.36% and a loss of 0.7 million. Subsequent to the quarter, the Company disposed four properties and a land parcel owned by an unconsolidated joint venture for an average sales price of 42.7 million at an average cash cap rate of 7.6%. We continue to strengthen our balance sheet and maturity schedule. As Glenn mentioned, in August we issued 600 million or 3.95% 10-year bonds at an issue price of 99.33% of par value. Proceeds from this offering were used to redeem our 500 million term loan with the remaining proceeds used to repay additional secured debt. This further laddered our maturity schedule and extended our duration. As of September 30, we had full capacity under our credit facility of 2.3 billion. In addition, we had 54.4 million of cash and essentially no floating rate debt. During the quarter, we reduced secured debt by 262 million with only 17.8 million coming due to the remainder of the year. Any secured debt coming due is expected to eventually be termed out as unsecured debt. With our net debt to normalized EBITDA was 5.5 times, up slightly from 5.4 times. Our fixed charge coverage ratio remains healthy at 3.1 times and our net debt to gross real estate investment ratio was 38%. Our encumbered asset ratio was 72% and our weighted average duration of our debt increased to 4.7 years. And with that, I'll turn it the call back to Glenn.

[Glenn Rufrano:]

Thanks Mike. Year-to-date, our key metrics are in line or better than our projected expectations. So the acquisitions and dispositions are on track to meet our guidance range targets of 450 million to 600 million. Our portfolio is performing well with occupancy increasing to 99% and our investment grade balance sheet remains liquid with the well laddered maturity schedule. Given this performance, we are increasing our AFFO guidance from $0.71 to $0.73 to $0.73 to $0.74 per share with Cole's contribution approximating $0.035. I'll now open the call for questions.

[Operator:]

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Michael Knott with Green Street Advisors. Please go ahead.

[Michael Knott:]

Glenn, question for you and we think about the balance of acquisitions and dispositions maybe looking into '18. I know you're not giving '18 guidance, but would it be fair for us to assume that '18 would probably look sort of like the second half of '17 where you're more leaning towards acquisitions rather than dispositions?

[Glenn Rufrano:]

I'll answer that by starting to talk about how we did '17. Michael, as you know, we had 450 to 600 for both acquisitions, dispositions front ended for dispositions and back ended for acquisitions, which is really the point. And then key is, our disposition program has always been a function of improving our portfolio. And so for us, we start out with what are we going to do to improve our portfolio next year for dispositions and then relate that to acquisitions. This year, we had guidance for Red Lobster which we're bringing down as you can see we've now gotten in the 6.8% of 200 million to 250 million. We're in that range and so we're well along meeting that schedule this year. We will continue to sell Red Lobster next year, and part of our guidance next year will be an indication of that because ultimately we want to get that down to 5%. Office was another major disposition item. We were over 22% in the beginning of the year and as you can see we're down to 20.3. We want to get that between 15% and 20%. We'll see where we end up, that will be part of our disposition guidance next year. And then the third component to dispositions will be non-core, we continually sell our non-core properties. And just to give you a sense, we sold 940 million of office, 890 million of Red Lobster and 400 million of non-core since we began this program. We'll continue to look at those three elements that will give us our projections for dispositions. We'll then be able to match acquisitions next year based upon how we see good acquisitions coming in. So I'd like to say, yes, to your question but I have to make sure that we go back to our disposition program is to improve the portfolio and our acquisition program has to continue to improve this.

[Michael Knott:]

And then also sort of on the disposition front also touching strategy. Is there any update you can provide on where you're at with thinking about selling the Cole NTR platform?

[Glenn Rufrano:]

We continue to make sure we strengthen that platform and we've done a good job on that. We have strengthened it this year by bringing Cetera on, an advisory group as you know, that's our focus. Our secondary focus is thinking about any transaction. So, we're going to continue on our focus and as always for any asset in the portfolio we maintain optionality.

[Operator:]

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

[Sheila McGrath:]

Glenn, retail exposure continues to be a hot button with industrials. Could you give us your updated view on the retail environment? And more specifically, how your tenant watch list this quarter might compare to a quarter or two ago?

[Glenn Rufrano:]

On the tenant watch list, last quarter we were a little above 2% and we've slightly increased that not by much. I mean we have two [indiscernible] went into bankruptcy where the much just happened this quarter. So we didn’t have a whole lot of change, just a slide increase. It's a good time in the year for merchants. You would hope that this time in the year, they're going to lead through the end of the year and we're seeing that. We have about 40% retail. The important part of our retail is the type of exposure, Sheila as we talked about. As you know, we have in our investor presentation given every retailer that we have, so that the market to make adjustments on our retail. We feel very comfortable with the form of retail we have here. 92% of our retail, if you include restaurants and retail includes restaurants, service and retailers that we think have minimal exposure or lesser exposure to the internet. So we feel good about our tenancies. We feel good about our categories and as we talked about before the tenants within our categories are very well scrutinized. We are going to continue to have a retail environment where we'll watch our tenants, will have some fallout in the retail in general. We've had very little fallout in our portfolio and we hope that continues.

[Sheila McGrath:]

Just one follow-up. I understand you can't discuss like the settlement on the legal actions, but as you did mentioned in your remarks that you are appealing one ruling. What exactly are you repealing? And if you could give us any insight on when you might know the result of that appeal?

[Glenn Rufrano:]

That's on class certification and we just felt that we should repeal the judge's order because we believe it's deficient in the number of respects.

[Sheila McGrath:]

And then, how long does it take to -- or you can't predict when you might hear about?

[Glenn Rufrano:]

Unpredictable at this time, as I mentioned we have another -- we'll be visiting the Court again in early December. I don’t know if we'll know something by then or not.

[Operator:]

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

[Mitchell Germain:]

Glenn, I appreciate the perspective on the assets sell strategy and the way you're looking at it for next year. I'm curious, how much of the portfolio would you kind of on a percentage basis put into that non-core bucket?

[Glenn Rufrano:]

We rate our assets each year, Mitch, A, B & C and we do it. It's rolling number. And it's actually as you would expect come down over the last couple of years, as we sold a lot of this non-core, it's somewhere in the 2% to 5% ranges as the last time we looked at it.

[Mitchell Germain:]

And so and this is -- would that include office or we really just thinking and/or unconsolidated JVs or those are separate and that's really looking at the rest of the portfolio?

[Glenn Rufrano:]

It would carve out the non-controlled JVs. It would include the rest of the portfolio. The percentage -- as the percentage, it's kind of a normal percentage for portfolio of anybody such. But the way we think about non-core, these are going to be assets where we have some physical location on or risk impediment could be related to the tenant itself. And we don’t fully we can cure it at a cost, but the return on capital that's adequate for ourselves. So, we have a very specific definition which is return on capital, which could include as you could see other forms of real estate office, retail or industrial.

[Mitchell Germain:]

And then last one from me. I'm just curious I mean you guys have done a pretty good job in terms of reducing leverage and extending the maturity profile, but I know this convertible notes expiring next year, the credit facility expires next year. So, maybe just kind of talk, if you can provide some perspective on the balance sheet strategy for the course of 2018?

[Michael Bartolotta:]

It's Mike. Mitch, I'll take it. Obviously, we're not giving guidance but the credit facility is extendable and through '19 to 19, so we've optionality as to what we're going to do with it. At the moment, the converts are still selling at a price that would cost us a significant amount of money to prepay. And so, we believe at the moment -- and we watch this all the time, but at the moment we believe it's better to be a little bit more patient and get closer to the due date before they get pad. And obviously, we have the credit facility there if we can do it some other way but we've gone to the market now twice, more recently very-very successfully with a very good price. So we don't believe we have any significant issue and that one year extension on the line gives us plenty of comfort.

[Operator:]

Our next question comes from Haendel St. Juste with Mizuho. Please go ahead.

[Haendel St. Juste:]

Glenn, I guess I'm curious on your thoughts about casual dining restaurant here, looks like you're still about 16% of revenue. I think you've bought Cabela's during the quarter. So I guess I am curious, what you're thinking about exposure to that subsector and what we might see new there, beyond Red Lobster next year?

[Glenn Rufrano:]

So, I think the question there was on restaurants. We have about 14% in casual dining. The Red Lobster is 6.8%, that's some percentage moving down. If we go through the rest of it, the Applebee is 1.7, On the Border 0.8, Olive Garden 0.6, everything else becomes small. So we're very diversified within that sector. We'll continue to take the percentage of that sector down as we take Red Lobster down, and some of our calling has been with non-national restaurants. If you noticed each of our quarters will have some restaurants that we've been selling, and then we've been -- it's been an exerted focus on non-national restaurants. So that will come down over time as part of our diversification. You've also mentioned Cabela's, now that's a different category. Is that something you'd like to talk about Haendel?

[Haendel St. Juste:]

Maybe I missed because I am really more curious about the exposure to restaurants, so that certainly helped. And then I guess more broadly and we've discussed this before on a few calls, but just curious about. What's next? Obviously, you've been facing the question a few times, the last few quarters, you guys -- you've successfully implemented your strategic plan from late '15. Just curious of the next two, three, four years strategic priorities; and in the past you've said that you've seen some merit to perhaps having a smaller but equally diverse portfolio. So on the one hand you liked you size inversely, but can also see the merit of the small portfolio. So curious on got some updated thinking there and maybe any strategic guidepost for the next few years?

[Glenn Rufrano:]

I'll start out with our business model Haendel, which is really the basis for the plan that we've put in place. As we've discussed, the business model for this is -- for our business, we believe start with the fact that we provide capital to corporate America and the trades for that capital is their housing long-term that they can secure because they're running their business out of it. It makes a lot of sense for corporate America to sell their housing, they have -- should have a better cost of capital internally, freeze of capital to run their business. That's what we do. That's what we will do for the long-term. And that business model we believe can be executed most efficiently, if it's large and diversified. It gets the large diversification of the portfolio there's couple of things should continue to help us with our cost of capital. You can see how our debt rates have come down to 100 basis points in one year in large price because of our portfolio. The other important product of the large diversified portfolio is to provide optionality on sourcing. We don’t want to be in the position where we are only providing capital to corporate partners in anyone property type. We like to providing capital in the variety of property types so that we can search for opportunities. So our whole business land was to create a business model and we are just about there. So, we're excited about that and that's that business model that will drive us for the next three to four years.

[Haendel St. Juste:]

And then going back to the Cabela's, could you provide some thoughts on exposure to outdoor supports camping type of operators in light of some of the recent troubles in that subsector?

[Glenn Rufrano:]

Well, we have about 0.8 in Academy and 0.2 in Dick's. So we like and think there are two very good purveyors of sports, one higher end and one lower end. We've just added Cabela's which is 0.8 as well, so we have a total of about 2%. The Cabela's transaction was a $120 million. We've spent a good amount of time with Jim Hagale, who is the CEO of Bass Pro, running across with his plan. And Bass Pro right now in terms of destinations, one of the top 10 destinations in the country. They drop from 50 miles and people spend 2.5 hours in their stores. There we went and spend a good amount of time on their merchandize. They are about 25% of apparels, 25% marine, 25% fishing and 25% hunting and really have a good handle on the market when we provide a great experience for the client that they serve. The combinations with Cabela create really great synergies. They not only spend synergies, Cabela is a very strong in hunting and Bass Pro is very strong in marine and fishing. Cabela is a very strong in the West and Northeast, Bass Pro very strong in the South and Southeast. If you look at their combination, they also provide some online resistance. Their product hunting marine are not online products. They have a very strong minimum advertise price program and they have a huge lot of private label program, which you cannot get online. So when we looked at the business, the combination of the business and the future relative to their online resistance, we like what we saw and we make this investment.

[Haendel St. Juste:]

So it sounds like we should expect incremental EBIT more exposure, you mention I think 2% exposure that a number sounds like you would like to grow a bit more?

[Glenn Rufrano:]

I'm not sure. No, I am not sure. We are talking about a little lot more exposure. We are at this point in this category we are only buying businesses that we really like.

[Operator:]

We have a follow-up question from Michael Knott with Green Street Advisors. Please go ahead.

[Michael Knott:]

Glenn, just wanted to get your thoughts on pharmacy business. I know you have some exposure there obviously Walgreens, CVS among your top tenants. Just wanted to get your thoughts on the long-term appeal of that business given prospects, essentially of Amazon jumping in there and what that could mean for the bricks-and-mortar side of that business, any thoughts you have would be appreciated?

[Glenn Rufrano:]

Walgreens is about 3.3% of our income and CVS is a little more than 2%, so we do certainly care about them. As we think about those, we've been looking at their sales and just a couple of sales statistics that we note, Walgreens have really had pretty good comparable sales this year. In the fourth quarter, comps were up 5.6. For the fiscal year, they were 4.7. However, we're parsing out is that retail has been down, it was down 2% in the quarter and 1% for the year, so pharmacy sales have been very good. The same thing holds true for CVS. Pharmacy sales have been fine. They have a pharmacy service segment business which is very strong. So there competition against Amazon in pharmacy and my sense is, they're pretty prepared for that. What we're considering is whether their total environment which includes retail will change over time and we think it will. On the previous call someone asked this question and what I mentioned was, as our CVS was a more of a healthcare provider and sure enough what they're doing, we're going to work that note. That's clearly going to be part of their progress going forward. We may see emergency care units in CVS with their pharmacy. When we think about Walgreens, Walgreens is really owned by Boots. In my Cushman & Wakefield days, they were client of ours over in Europe, very strong for their retail, ultra-type product. So we do believe both of these companies will change over time and probably change in different directions, but they're strong, they're healthy and we have confidence they'll be around.

[Michael Knott:]

And then last one from me would just be on the topic of lease expirations. They begin ticking up for you in earnest over the next few years, and just was curious about your thoughts on sort of the ability of your asset management platform to be able to handle that and curious just thoughts on anything related to that topic?

[Glenn Rufrano:]

First of all we think the asset management program is in place to handle it, Michael, but more importantly in each of the calls this year, you've heard me talk about lease renewals, but I've always talked about early renewals. We've made an exerted effort to get in front of early renewals each quarter this year, and we're doing a pretty good job. If you just look at this quarter, we leased 355,000 square feet, but 248,000 square feet of that were early renewals. So we are very focused on those expirations at time and we fully expect to minimize the extent of that percentage.

[Operator:]

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

[Anthony Paolone:]

On Cole putting aside when or if you make a strategic decision there. Is there a level either of AUM or EBITDA or capital raising that you see as being more optimal, if you have to extract that business out of the vary platform?

[Glenn Rufrano:]

Anthony, we fully expect that business will grow overtime. We've had some hiccups here because of the DOL in the marketplace not Cole. Cole's market share has been increasing. The DOL is clearly heard some of the money raise, but as we followed this, the SEC and DOL are finally getting together to discuss what that provision could or should be. And we are confident they will come to a conclusion and settle the issue of the fiduciary rule, not that it's a bad rule that just that it's filled the fine. That will happen in our view. The deregulation push in Washington is also going to help us. So we like to see -- we expect this market to pick up and that pick up will absolutely costs a pick up for code.

[Anthony Paolone:]

[Indiscernible] been a matter of just making the outlook a little bit more clear because of the regulatory backdrop as opposed to needs to be at the certain size. Is that the way to think about it?

[Glenn Rufrano:]

I think it's a chicken in egg, Anthony. The regulatory background will currently effective and then we will give this new consideration along the way.

[Anthony Paolone:]

And then some another question is just -- in terms of the December 4th conference, can you just describe kind of what that means or what you think is the topic to be address at that point?

[Glenn Rufrano:]

Look, there maybe a few topics, but our main topic will be depositions.

[Anthony Paolone:]

Okay. And what -- I guess my understanding, the discovery was largely done so then you go into depositions and then how does that play out from there?

[Glenn Rufrano:]

The discovery is two components, one is document preparation and distribution which is predominantly done, the second part of discovery is depositions and there will be some scheduling up that will be proposed in December and that will get it started, and that's the second part of discovery.

[Anthony Paolone:]

How long does that typically take?

[Glenn Rufrano:]

We're unsure of that now. We'll know more as those scheduling meetings occur.

[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:]

Thanks everybody for joining us today. We are certainly happy with the quarter and we look forward to talking you at the end of the year. Bye now.

[Operator:]

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