VEREIT, Inc.
Q1 2015 Earnings Call Transcript

Published: 7 May 2015

[Operator:]

Good morning, and welcome to the American Realty Capital Properties First Quarter 2015 Earnings and Business Update Call. [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 at ARCP. Please go ahead.

[Bonni Rosen:]

Thank you. Good morning, everyone. Thank you for joining us today to review the American Realty Capital Properties' first quarter 2015 earnings and business update. Joining me today are Glenn Rufrano, our new Chief Executive Officer; and Mike Sodo, Chief Financial Officer. Today's call is being webcast on our website at arcpreit.com in the Investor Relations section. There will be a replay of the call beginning at approximately noon Eastern Time today. Dial-in for the replay is 1 [phone], with a confirmation code of 10065298. Before I turn the call over to Glenn, I would like to remind everyone that certain statements in this earnings and business update call, which are not historical facts, will be forward-looking. ARCP's actual results may differ materially from these forward-looking statements and the risk factors that could cause these differences are detailed in our SEC reports. In addition, as stated more fully in our SEC reports, ARCP disclaims any intent or obligation to update these forward-looking statements except as expressly required by law. Let me quickly review the format of today's call. First, Glenn will provide a short introduction and business update, followed by Mike presenting our first quarter financial results. Glenn will then conclude the call with a recap of our portfolio and Cole Capital activities before opening up the session for questions. Now I would like to turn the call over to Glenn Rufrano. Glenn?

[Glenn J. Rufrano:]

Thanks, Bonnie. Good morning, and thank you, everyone, for joining our investor call today. Having been with the company for a little over a month now, I'm excited to be able to share my initial observations and outline next steps and expectations. I've been spending my initial days meeting with our employees and talking to our shareholders and debt providers as well as learning more about our assets. I've met or spoken with over 50 shareholders and potential investors, working to develop an open dialogue. I've also had conversations with some of our tenants and plan to meet many more later this month at ICSC RECon, the largest industry gathering of retailers in the world. We have many properties and I've visited several in the New York Metro and Phoenix areas, inspecting a mix of retail, restaurant, office and industrial assets. So what have I learned so far? First and foremost, we are a full-service real estate operating company. We buy, sell, finance, asset manage, property manage and lease, all in-house. We also have an investment management arm, Cole Capital, an exceptional brand in the industry. Cole Capital is the combination of Cole Capital Distribution and Cole Capital Investment Management. The latter, a shared resource model with ARCP. Our scale permits us to maintain an integrated and sophisticated real estate team with decades of experience that allows us to efficiently access segments of the net lease market

[Michael Sodo:]

Thanks, Glenn. And thank you, all, for your time today. Let me start with the numbers for the first quarter of 2015. Our first quarter 2015 consolidated revenue was $394 million, an increase of $72.8 million versus the first quarter of 2014 mostly due to the increased size of our portfolio. FFO for the quarter was $0.21 per diluted share and AFFO for the quarter was $0.22 per diluted share, which excludes certain items including

[Glenn J. Rufrano:]

Thanks, Mike. Let me provide a short overview of our real estate in Cole Capital before a few closing remarks. We have a large, well-diversified portfolio that provides safety and financial flexibility. The following metrics demonstrate the diversity of the portfolio. We have over 4,600 properties totaling 102 million square feet with occupancy of 98.4%, and a weighted average annual remaining lease term of 11.7 years. 47% of the portfolio is occupied by investment-grade tenants. Retail, including restaurants, makes up 62% of the portfolio. We have broad diversification with 780 tenants across 42 industries in 49 states, and financial flexibility represented by having 63% of our assets unencumbered. Let me now turn to our Investment Management business, Cole Capital. At the end of the quarter, following the sale of the CCIT, Cole Capital had $6.1 billion of assets under management across its 3 open funds and closed offerings. During the quarter, Cole Capital raised $62 million, including DRIP, and acquired $225 million on behalf of its managed non-listed REITs, with approximately $225 million available for acquisitions. The filing of year-end financials at the end of March unleashed the capability to begin raising capital back to more historic levels. We received positive news that Pershing, Fidelity, TD Ameritrade and Schwab have resumed clearing trades of Cole-sponsored products, and many broker-dealers have lifted their suspension on selling agreements. Currently, there are 201 broker-dealers and RIAs, able to sell Cole Capital-sponsored REITs, which represents approximately 42% of 2014 gross capital raised. Our Cole Capital leadership team is confident we have the resources and talent to return Cole to its stature as one of the leaders in the non-listed REIT industry. I'll close on the importance of transparency. We have already begun to enhance transparency in our supplemental reporting for this quarter. For example, there's greater detail on asset purchases and sales, more meaningful same-store sales information. We've provided a more detailed breakdown of capital raised in DRIP within Cole Capital, and we have included additional disclosure on the Red Lobster portfolio. We will continue to seek ways to improve our transparency moving forward. I've truly enjoyed my first 5 weeks here at ARCP. While there are still challenges ahead, I'm encouraged by what we have in place and our ability to improve. For our next call and introduction of the business plan, we intend to have a new company name. I look forward to talking with you then. I'd now like to open the call up for questions.

[Operator:]

[Operator Instructions] First question comes from Mitch Germain, JMP Securities.

[Peter Lunenburg:]

It's Peter on for Mitch. Just kind of curious, you guys had referenced the 201 brokers and the RIAs able to sell the Cole Capital products. Where was that number at the peak or kind of early last fall?

[Glenn J. Rufrano:]

We're just taking a look that there may be a statistic here we could find, we'd like to be more exacting on that. I think the best way, we'll -- we would like to get you -- we'll get you some numbers on that, but the way we thought the best way to express it was to look at the brokers relative to what they sold in 2014. So the way to think about it is, 42% are represented now that sold the product in 2014 by dollar amount. Because the people themselves, there are thousands of people out there selling the product and so we thought that 201 based on 42% would be the best look. So we're looking for 58% of the sales productivity to come back this year.

[Operator:]

Next question comes from name Juan Sanabria, Bank of America.

[Juan C. Sanabria:]

Glen, I was hoping you could speak to how we should be thinking about the cost structure, particularly G&A, for the 2 different business segments. In particular, for Cole, the G&A looks like it whips around quite a bit. If you can give us a sense of what's fixed versus variable?

[Glenn J. Rufrano:]

Well, that's a -- I mean, we expected the question. So we're going to have a two-prong answer. Mike is going to give you a reasonable answer on dollars and then I'll be adding to that. Mike?

[Michael Sodo:]

Yes. And thanks for the question, Juan. As you all know, within our Form 10-Q, for -- on a consolidated basis, we have G&A for the quarter of just in excess of $33 million, about $15 million of that is attributable to the real estate segment. As we look at Cole Capital, that leaves a remainder of $18 million which is detailed a bit within the supplement itself. That $18 million is during a period of relatively depressed equity raise being $28 million, $29 million net of DRIP for the first quarter. I think as I -- as we think of directional guidance for G&A as well as cash flow for Cole Capital, we really correlate incremental G&A pertaining to incremental equity raises as being sufficiently covered by the dealer-manager fees, that we retain, being approximately 1% of equity raise. So from a fluctuating G&A perspective as we forecast numbers internally or if analysts do that externally, the general parameters I would say -- because there is a range of what that expense is for incremental dollars raised is, I would say that I'd focus on the 1% dealer-manager fee being on the equity-raised amount, sufficiently covers the G&A. The real driver for any economic uptick and cash flow at the Cole Capital level, primarily, is going to come from the acquisition fees we get as we -- as properties are bought within the managed REITs as well as the asset management fees that we get on in-place portfolio as well as any incremental growth to those portfolios.

[Glenn J. Rufrano:]

Juan, I'm just going to -- Juan, let me just add something here because we've spent some time on this over the last 5 weeks and we will continue to. I personally -- and as I discussed with the team here, I break it up into 2 different concepts. The $33 million, $15 million at the real estate, that number is a relatively stable number as we look at the portfolio. And whether it's the right number or not, we'll have to figure out, but it's stable relative to occupancy. Within 10 points of occupancy of this portfolio, we're not going to change our G&A. I mean, there's not much variably in a real estate operating company in my view. But when you look at Cole Capital, now we're in the realm of Cushman & Wakefield, which is a company I ran for 3.5 years. It's a service business. And G&A there will vary dramatically based upon production of your services. And the way we would look at it in the service business for a real estate investment management company would be certain ratios of EBITDA and G&A relative to revenue, and within G&A relative to revenue, what employment expense is relative to revenue. So we plan to take a look at the business going forward and analyze it as a service business as -- which is what it is and come up with ratios that we think are more appropriate.

[Juan C. Sanabria:]

Okay, that's helpful. And could you talk a little bit about more about the dispositions? Kind of what you're thinking that you could be selling, I guess, ahead of giving more color in August, and what types of assets? Is Red Lobster kind of included in that today and any sort of pricing expectations you could provide within a range, I guess, would be helpful?

[Glenn J. Rufrano:]

I'm going to start off -- sound like a broken record that, that really has to be analyzed and referenced and relative to the portfolio we have, and that's what we're doing right now. When we -- when you put 6 portfolios and 2 businesses together and those businesses are portfolios as well, you would expect there are assets that should not be long-term assets for a business. This company has never culled its assets and our first look here is culling assets so that we can determine what the risk relationship long-term should be at our asset base. So that's where we're starting and we're starting that right now. What flows out of that will come out in the business plan as we talk about that in August. And -- but if you took a quick look, just to go to one of your points, you have to think diversification of tenants' important. And when you look at Red Lobster at 11% of the portfolio, it sticks out. So clearly, it's a portfolio will -- we will be thinking about earlier rather than later as we cull.

[Juan C. Sanabria:]

Okay. And just lastly for me, I'm not sure if you're going to have -- be able to give a response to this ahead of August. But in your head as you look at the peers and the balance sheet with regards to leverage, do you have a sense of a range of leverage metrics that you think would be sort of appropriate longer term?

[Glenn J. Rufrano:]

Well, let me -- I'll answer that and try to shed some light on it. Balance sheet management will be very important here, and certainly, part of the planning. I'd start out by, if you think about or analyze all the ratios that Mike gave, fixed rate coverage charge, so forth, they're reasonable ratios. We have no immediate need to have to do anything with the balance sheet and we have no liquidity issues at all. However, we are mindful of our peers both in the real estate REIT sector and our peers in the triple net sector and their ratios, and we have to compete longer term on cost of capital. As we think about all those elements, I would have no doubt that we should be moving toward investment grade, where we were before.

[Operator:]

Next question comes from Anthony Paolone, JPMorgan.

[Anthony Paolone:]

On the disposition side, just on -- follow-up on Juan's questions. Do you have anything in the market for sale now? Can you maybe articulate how much, if you do?

[Glenn J. Rufrano:]

There had been some culling concepts, as I got here, that we've reviewed. But right now, I don't think we're able to say what those are. We would hope to be able to do that next quarter.

[Anthony Paolone:]

Okay. But I mean, you had a decent amount of sales in the first quarter. Were those kind of in motion or could we see some more sales, maybe not to that magnitude, in 2Q or just trying to understand what the brackets are near term?

[Glenn J. Rufrano:]

Those were all basically done, you're right. And we have been -- and -- but the big one was the $270 -- $271 million one. But I think the best way I can answer that is to not give a number. I know that's not what you're looking for, and the reason is I don't want to provide some information that may not be right. We will know a lot more soon, but we don't know it today.

[Anthony Paolone:]

Okay, fair enough. In terms of -- I think you guys have Morgan Stanley and law firms and E&Y, what's the span like now on that side, on all these different advisors and folks that you've had around you? And what are they all doing now and focused on?

[Michael Sodo:]

Sure. And Tony, I'll just put it in kind of numeric perspective as we look at the first quarter Q, you all will see within our income statement, and then further disclosure, we have a merger and other nonroutine transaction number for $16.4 million within our document. The composition of that number is about $10 million related to legal and the remainder being, pertaining to other professional services, particularly, the work done by Ernst & Young and Grant Thornton as it pertains to the investigation and restatement. We're continuing to assess really, on the legal front, a go-forward expectation for the cost that will be incurred. As it pertains to the second bucket, being the other professional services, you should see a dramatic decline in that number as -- those efforts really have all but come to a stop.

[Anthony Paolone:]

Okay. So that $10 million legal one sounds like that's going to stick around for a bit here until that gets figured out?

[Michael Sodo:]

We're not sure which way it's moving, but there are legal efforts and multiple law firms continuing to be involved.

[Anthony Paolone:]

Okay, got it. And just on a follow-up on the G&A question. Now if you think about the REIT and the roughly $15 million there, if you didn't have Cole, would you have enough acquisition folks and asset management folks in that $15 million to do what you want to do with REIT?

[Glenn J. Rufrano:]

Yes, that's the way it's constructed.

[Anthony Paolone:]

Okay, got it. And then just, I guess, for my couple, items on the income statement. Straight-line rent was down from about $25 million to $20 million. What's the right run rate there?

[Michael Sodo:]

There's some -- there are some people that pay us in at certain intervals that are not monthly throughout the year. So sometimes, you'll have a little spike or decline in straight-line period-to-period. I would average, roughly the last 3, 4 quarters within the supplement.

[Anthony Paolone:]

Okay. And then, similar question on the expense leakage was, I think about $8 million in the quarter. Is that kind of a decent number or does that move around much?

[Michael Sodo:]

Yes, I think that's a fair estimate.

[Anthony Paolone:]

Okay. And last question for me, I'm not sure if you could answer this, but any sense as to where taxable net income is running?

[Michael Sodo:]

At this point in time, we're continuing to assess that, Tony, given our March 31 numbers. And I think we'll be in a better position to make statements related to that, the dividend and other components of the business plan in August.

[Glenn J. Rufrano:]

And I'd just chime in that -- clearly, that question is a very important question relative to our dividend policy. And the board will be assessing dividend policy very much based upon the answer to that, Tony.

[Operator:]

The next question comes from Vineet Khanna, Capital One Securities.

[Vineet Khanna:]

First one, Glenn, you've been there for over a month. And can you sort of prioritize your items of focus at this point?

[Glenn J. Rufrano:]

Well, they -- I, actually, where I started in the conversation is the way to think about this, it has been -- I'm going to start with what has been and then I'm going to go to what's next. Making sure I understand the thoughts of the employees here, making sure I understand the thoughts of the shareholders and stakeholders, including the debt holders. Looking at the assets, so that I can take -- get a picture of what we have and then where to go. Where to go is really what we're going to start -- we have started but we will be processing now, which is the business plan. And then I'll take all the information over the first 30 days and over the next couple of months, providing decision-making information on how we go forward relative to our assets, Cole Capital, management of the balance sheet. All 3 necessary to have guidance and we will project guidance for the remainder of the year. We'll obviously have the first 2 quarters, but the remainder of 2015. And with all those in place, we'll be in a position to provide a dividend policy. So those 5 elements that I just talked to you about will be taking a lot of my time over the next 2 months.

[Vineet Khanna:]

Okay. And then sort of shifting gears to sort of acquisitions dispositions, do you expect to be a net seller in the near term? I know you guys mentioned that the acquisitions that came through were already in the pipeline prior to the accounting announcement. So...

[Glenn J. Rufrano:]

At the ARCP level is your question, right?

[Vineet Khanna:]

Yes, yes. The ARCP level.

[Glenn J. Rufrano:]

Yes. Yes, I would think we'd be a net seller, yes.

[Vineet Khanna:]

Okay. And then shifting gears to Cole Capital, following the CCIT liquidity event, can you sort of quantify how much capital you think you recaptured from that? And then just taking a step back, how that sort of recapture, recycling rate has been historically at Cole? And how long the process is and what the rate of recapture is?

[Glenn J. Rufrano:]

I think that -- I know it's a very hard number, but I -- but just to give you a sense of how we think about it. Capital raised was roughly $5 million in January, $8 million in February, $17 million in March and $19 million in April. And as I mentioned, it was very hard to raise any capital until we restated our financials. So starting to ramp up the capital raising here. And I would have to say, there's not much turnover yet because we didn't have the availability to go out and get that capital. We're just getting there now.

[Vineet Khanna:]

Okay, fair enough. And then just turning to the income statement, specifically, G&A. Can you give sort of a headcount for G&A between the real estate and the Cole Capital groups?

[Glenn J. Rufrano:]

We have about 400 people in total at ARCP that work within both. And if we were going to do an allocation, we would have roughly 150 people in ARCP and 250 people working for Cole as a provider of equity and investment management, both. And if you remember, when we defined Cole, we defined Cole's investment management as a shared resource with ARCP. So understanding those concepts, that's about the ratio.

[Vineet Khanna:]

Okay, understood. And then finally, operating margin was down sequentially in the quarter. What was the cause there? And then operating margin has just sort of been volatile relative to the peers, can you just talk about that?

[Glenn J. Rufrano:]

Is that operating margin on a consolidated basis?

[Vineet Khanna:]

Yes.

[Glenn J. Rufrano:]

Okay. That -- Mike?

[Michael Sodo:]

I think, clearly it's -- there's a decline in the contribution from Cole Capital, as it pertains to lower levels of equity raise and lower levels of acquisitions within those managed REITs as was in the press release and demonstrated in our supplement.

[Vineet Khanna:]

Sure. And then what about sort of on the real estate portfolio basis?

[Michael Sodo:]

On a real estate portfolio basis, if you compare Q4 to Q1, there was a nominal downtick in occupancy but the 0.9% downtick in the occupancy really, -- the rents attributable to that property were about 0.2% of our rents. So that really wouldn't do it. It's probably more so related to Blackstone sale, which happened in Q4. It was a $1.9 billion portfolio that had a rent contribution in the fourth quarter, but no longer had it is as we downsized the portfolio with that as well as our Q1 net dispositions.

[Glenn J. Rufrano:]

But you make a good point. I think operating margins should start to be understandable now, very difficult with all the activity that went on last year.

[Operator:]

Your last question comes from Paul Adornato from BMO Asset Capital Markets.

[Paul E. Adornato:]

My questions are regarding understanding net asset value, and the value of the portfolio as it stands today. So first, where has the market moved since many of these assets were acquired? Do you think that the market has moved against you, so to speak, in terms of pricing, given the expectation of rising interest rates?

[Glenn J. Rufrano:]

I'm going to start off with the first one. In terms of timing, some of these assets, because they came in through Cole or CapLease, could have been bought a while ago. Although many of them -- I'd say, the bulk of them were, certainly, bought over the last 2 years, '13 and '14, perhaps going back to '12. And so if we just narrow that time frame, I don't think in that time frame, the cap rates have gone against us at all yet. I mean, we have seen no indication of that. In fact, there's still been some pressure on cap rates. Your point though about the last 2 days or 3 days with the tenure going to 2.25, plus or minus, could have an impact. I don't -- we don't know it yet. But could it have an impact? It could. Time will tell, and the market will establish that.

[Paul E. Adornato:]

Okay. And what's your -- what kind of ongoing review in terms of impairments do you do? I'm just trying to get a sense of if you're sitting on losses or impairments once the assets do trade?

[Michael Sodo:]

Paul, we review every asset for impairment on a quarterly basis and that's just a routine component of our accounting policies, and that was done in the first quarter and did not result in any impairments as of March 31.

[Glenn J. Rufrano:]

But I'd like to just go back to what Mike talked about in his presentation. We review impairments relative to the real estate basis, every quarter. And when Mike is saying, is relative to the real estate basis, there were no impairments on the assets and we review the value of Cole and there were no impairments to Cole that was taken last quarter. But we have on our balance sheet -- and you'll see it's consolidated, $1.8 billion broken up into $1. 5 billion real estate and roughly $400 million in goodwill for Cole, an additional number. And every time we sell an asset, that goodwill in the real estate, that $1.5 billion gets tapped on top of any gain or loss at the asset level. And we want to make that clear, because it's an unusual goodwill element that most realty companies have what we have. We look at this merely as the relationship between the book value of the real estate and the real estate as it's sold. But there will be an additional number that will be placed on there, each time we sell an asset.

[Paul E. Adornato:]

Okay. And so again, what actually gave rise to the goodwill? That's the excess of purchase price over market price for Cole or for each component of the portfolio as it was acquired?

[Glenn J. Rufrano:]

It -- no, it's only for the businesses. And the 2 businesses that were bought were Cole and that's primarily where it came from, and also CapLease.

[Operator:]

Next question comes from Ross Nussbaum, UBS.

[Ross T. Nussbaum:]

Glenn, welcome to ARCP.

[Glenn J. Rufrano:]

Thank you.

[Ross T. Nussbaum:]

Can we talk for a minute about conceptually the long-term future of the non-traded REIT business? And perhaps get your thoughts on, if we turn the clock ahead maybe 5 or 10 years, do you think there is a realistic scenario where you get margin compression in the fees for this business? And I guess the question comes from, I personally always struggled with why investors would want to pay high fees for an investment in a liquid asset when they can go buy a public REIT for a tiny fraction of the cost. And I guess, it would seem to me that if we roll the clock ahead 5 or 10 years and we've got a better history and understanding of the returns between public REITs and non-traded REITs, if those numbers end up being similar or, frankly, in the advantage court for public REITs, wouldn't it suggest that the margins for the non-traded business would ultimately need to come down?

[Glenn J. Rufrano:]

Because I'm an old timer, instead of going just forward, I'm going to start going backwards. And if I go backwards 30 years, we always had a private market to sell to individuals real estate product, they were just called limited partnerships. And so this is not a new product. It's a product that's been around for a very long time. And in my mind, when I question it, I -- it's similar to institutions because institutions can invest in a liquid security, in a REIT or they can invest in a private fund and they always choose to do some of both. So the market just decides it wants public and private for different reasons. In some cases, the private market says, "I like a higher dividend, I don't want to look at volatility, whether it's right or wrong it doesn't make any difference." So there has been historically, a market for public and private real estate both at the retail level and at the institutional level. If I go forward, do I think that can change? It may be, especially as it pertains to your fee concept. And the reason is, we already know FINRA is creating more transparency and there's been discussion at the DOL as well, and there may be some fee changes in the private market but that could be tantamount to what happened in the mutual fund market not too long ago. I would think that there will be a public and private market for real estate, 10 years from now. After I say all that, how it will play out? I'm not sure exactly. Will the fees be different? Probably, and maybe should be. But I would think there would be a market for both.

[Ross T. Nussbaum:]

Okay, that's helpful. The other question -- I may have missed this early because I had to drop for a second. Did you comment on the litigation if there's a timeline in terms of dealing with the litigation?

[Glenn J. Rufrano:]

We didn't. And we don't have a timeline. Litigation is ongoing and if we can shed some light on it at any given time, we will.

[Ross T. Nussbaum:]

Do you think it's resolved by the end of this year?

[Glenn J. Rufrano:]

I actually don't -- we don't know, as an organization. And as Mike just said, we spent $10 million in the first quarter on litigation. So we've got -- we hope and expect some very smart people to guide us.

[Operator:]

We have a follow-up question from Paul Adornato, BMO Asset Capital Markets.

[Paul E. Adornato:]

So you said 42% are now online again. Can you tell us what products you have available and how productive they are? I guess what I'm getting at is turning on the switch is one thing, but then getting them to actually sell is another. And so what's your sense about credibility in the market and the ability of the brokers to actually sell the product?

[Glenn J. Rufrano:]

Well, if you -- in our supplemental is a -- is complete detail on this. So I could actually direct you to Page 45. But I can go through it quickly. The open programs are Cole Credit Property Trust V. It's raised $179 million. Cole Real Estate Income Strategy, which is the INAV, that's the current property -- project we have in here that is already FINRA-compliant right now, and it trades and has a daily value to it. It has $137 million. And Cole Office & Industrial REIT, CCIT II, has $259 million in it currently. All 3 are open and all 3 are really the concepts that are in the numbers that we've given you for the quarter, for new raise. As I went through those new raise numbers, $5 million, $8 million, $17 million and $19 million, they're going into those 3 funds. And then we have 1 closed fund Cole Credit Property Trust IV.

[Operator:]

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

[Bonni Rosen:]

Thanks, Glenn. And thanks, Mike. And thank you again, everyone, for joining us today. If you have any follow-up questions, please contact our Investor Relations team at [phone].

[Operator:]

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