VEREIT, Inc.
Q1 2016 Earnings Call Transcript

Published: 5 May 2016

[Operator:]

Good afternoon and welcome to the VEREIT First Quarter 2016 Financial Earnings Conference 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:]

At approximately noon Eastern Time we filed an 8-K/A to correct two minor discrepancies in our press release. The cap rate for the quarterly dispositions is 6.3% and the Cole Capital equity raise for April is $60.5 million. 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 03

[Glenn Rufrano:]

Thanks, Bonni. And thank you for joining our call. Let me begin with the key operational updates that we'll discuss today. For the quarter, AFFO per diluted share was in line with expectations at $0.21. Year-to-date we've completed approximately $345 million of dispositions. Net debt to normalized EBITDA decreased from 7.0 to 6.7 times and Cole Capital had a 24% increase in new equity raise. During the quarter, we did have a tenant file for bankruptcy, Ovation Brands. Because the proceedings are not complete, any impact resulting from the bankruptcy is not reflected in our quarterly occupancy. However, a receivable reserve is reflected in same-store sales calculations, which brought that metric from 1% to 0.5%. Regardless of the outcome, AFFO guidance will not change. Our ability to absorb a tenant situation such as this, which makes up just under 1% of our cash revenue, is a function of our diversified portfolio. To further refine portfolio diversification, our culling process continues to focus on two key segments, office properties and Red Lobster restaurants. Our goal is to reduce office exposure below 20%. We have identified a number of properties for sale, resulting in impairment charges for the quarter. We note that this does not reflect any potential gains from property sales. We intend to reduce Red Lobster exposure to approximately 5% of the portfolio. Last year we sold more than $420 million of properties and negotiated the ability to sell $600 million or approximately 190 locations through individual asset sales. Since the beginning of the year, we have closed seven individual transactions at an average gross cap rate of 5.7%, have LOIs and PSAs on 30 locations and are actively marketing another 90 properties with interest across all markets. Operationally, Red Lobster continues to perform well with six consecutive quarters of positive same-store sales. Looking at the broader industry, the capital markets for real estate continue to have equity available for investment. In 2015, U.S. transaction volume approximated 535 billion with 40% from private investors, 25% institutional, 16% foreign, and 11% REITs. We believe 2016, although having a slow start during the first quarter, will have investment sales activity slightly lower than 2015 for the similar mix of investors. [CMBS] [ph] has been more rocky as of late with 100 billion issued in 2015, forecasted to be 60 billion to 80 billion this year. We do see insurance companies and banks picking up most of that slack. Our disposition experience so far this year confirms the healthy demand for investment. Through May 3, we completed approximately $345 million of dispositions at an average cap rate of 6.4% with a variety of buying constituents. Transactions included a joint venture office property at a cap rate of 5.9 sold to a U.S. pension fund advisor and a flat lease industrial property also at a cap rate of 5.9, purchased by a real estate operator in joint venture with U.S. Pension Fund. The private and 1031 exchange buyers are actively pursuing our Red Lobsters and other small assets. The market is providing support for our disposition target of 800,000 to 1 billion for the year. Our balance sheet continues to move towards investment-grade metrics. We have now reduced debt by 2.6 billion and currently have 2.1 billion of liquidity, providing flexibility and optionality. We also shortly plan to file an S3 shelf registration statement. Mike will further discuss our thoughts on the 2017 bonds. During the quarter, Cole Capital raised $144.6 million of new equity, an average of $48 million a month. According to Stanger, Cole ranked third for non-listed REITs sponsored capital raised during March, and fourth for the first quarter. New capital raised for April was $60.5 million. We are pleased with Cole's performance as this continues to increase market share. In terms of the regulatory environment, the market continues to absorb the recent DoL fiduciary rule which was less impactful than originally anticipated, as well as the implementation of FINRA 15-02. Before turning the call over to Mike, let me touch really briefly on litigation. The judge set a date of May 12th for oral argument on pending motions to dismiss various complaints. Additional details regarding pending litigation can be found in our first quarter Q filed today. Mike will now take us through the financials.

[Mike Bartolotta:]

Thanks, Glenn, and thank you all for joining us today. We had a solid quarter of on-plan performance, achieving AFFO of $0.21 per diluted share. Consolidated revenue was $369 million, just below last quarter's revenue of $383.4 million, indicating a decrease of $14.4 million with approximately $10.1 million reflecting the expected impact from our current disposition program. We reported a net loss of $116.1 million for the quarter versus a net loss of $192 million for the quarter or an improvement of $76.2 million, primarily due to lower impairment charges in Q1. Impairments on our real estate assets in this quarter totaled $160.5 million which represented 125 properties with an estimated fair value of $462.5 million and a net book value of $623 million. As Glenn mentioned, we took impairment primarily on office properties we are culling as we further diversify the portfolio as well as assets related to Ovation bankruptcy filing. If you were to adjust for this item, you'd see relatively positive net income. FFO per diluted share for the first quarter was $0.21 as compared to $0.01 for the fourth quarter, mostly due to there being no Cole Capital goodwill and intangible asset impairments taken in Q1. AFFO was $0.21 per diluted share as compared to $0.20 for the fourth quarter, primarily due to the write-off of $11.3 million of program development cost in Q4 and none in Q1. AFFO excludes certain items including non-routine gains and expenses as well as the impact of a number of non-cash items. G&A for the quarter was $29.4 million versus $49.2 million in the fourth quarter, representing an improvement of $19.8 million. Adjusting for previously disclosed Q4 at $11.3 million program development cost write-down and $4.2 million of certain nonrecurring compensation adjustments in Cole and approximately $4 million of higher Q4 related real estate expenses, the fourth quarter G&A would have been approximately $29.7 million. Real estate G&A was $12.2 million for the quarter, down $4.4 million from $16.4 million in Q4, mostly due to a number of Q4 expenses that are not recurring in Q1 including the typical yearend bonus true up of approximately $0.6 million. Certain consulting agreement that ended in Q4, which was approximated as $1.3 million and $2.1 million of the amortization of certain market-based RSUs that ended in Q4. Cole Capital G&A was $17.2 million, down $15.3 million from the $32.5 million previously noted. Normalizing for the adjustments previously mentioned, Cole G&A for the fourth quarter would have been $17 million which shows essentially a flat quarter-over-quarter variance. Legal costs related to the matters arising from the audit committee investigation which are included in litigation and other non-routine transaction-related expenses were approximately $4.8 million for the quarter, excluding any insurance recoveries. In Q1 we received insurance proceeds of $10 million related to these matters, which is also reflected in the same line item. We are keeping our prior estimate for gross legal cost for 2016 at $45 million to $50 million, excluding any insurance proceeds. Turning to our first quarter real estate activity the company acquired one FedEx distribution facility for $20 million at an average cash cap rate of 7.1% that was a forward commitment from 2014. The company also capitalized $0.9 million of development costs and placed $6.9 million of assets into service at an average cash cap rate of 8.4%. During the quarter, we sold 59 properties for $295.2 million of gross proceeds, at an average cash cap rate of 6.3% and a pre-goodwill allocation gain of $40.4 million, which is $29 million after goodwill. Subsequent to the quarter, the company disposed the 28 properties for an aggregate gross sales price of $48.2 million at an average cash cap rate of 6.8%. Turning to the balance sheet. I'm very pleased to announce that our net debt to EBITDA was reduced to 6.7 time from 7 times last quarter. Our fixed charge coverage ratio remains healthy at 2.8 times. Our encumbered asset ratio increased to 65% and our net debt to gross asset ratio is just under 48%. Also, our floating rate debt was reduced from 6% in the fourth quarter to 3.5% at quarter's end. Our line of credit now stands at just $280 million and we remain very liquid. As Glenn mentioned, we are focused on our bonds which are due February 2017. At the current time, we are exploring a variety of options for refinancing, which include the public bond market, bank term debt and private placements. And in addition, we have $2 billion of capacity on our revolver which could be used for some portion. Lastly, we are pleased to have recently been upgraded by Moody's to stable outlook and by S&P depositor, reflecting the overall progress of our business plan. And with that, I'll turn the call back to Glenn.

[Glenn Rufrano:]

Thanks, Mike. Let me wrap up with the discussion on retail. More than 60% of our portfolio was comprised of retail and restaurant properties, plus a number of our office and industrial assets are leased to retailers, such as Petsmart, Home Depot and TJX. If we include the Cole REIT portfolio, we own or manage approximately 68 million square feet of retail. Later this month, our retail team will be heading to ICSC RECON, the largest real estate conference in the world. We view this event as a great opportunity to meet with our tenants as well as real estate brokers, owners, developers, banks, and other stake holders to learn more about their businesses and update them on VEREIT. During the two and a half day event, our team will host more than 80 face-to-face retailer meetings with tenants like Wal-Mart, Home Depot, Petco, Cole and DICK'S Sporting Goods. Additionally, we will hold our sixth annual leasing symposium where we meet with over 100 real estate brokers who represent us in the local markets as well as hear from new and expanding retailers. Following RECON, our leasing team will coordinate strategic alliance reviews, visiting our tenants at their corporate locations to learn more about their operations and discuss how we can leverage our partnership to benefit landlord and tenant. From a portfolio perspective, the majority of our retails tenants provide necessity shopping or services, the main categories include discount retail like Ross, Family Dollar, and Marshall's; pharmacies including CVS and Walgreens; grocers represented by Albertsons and Kroger; and basic needs and service retailers such as Kirkland's, Bed Bath & Beyond, LA Fitness, [indiscernible]. Our team will also be meeting with restaurant tenants. More than ever restaurants are inherent resistant retailers which ultimately help drive traffic to more traditional retailers and the restaurant industry as a whole has experienced 23 consecutive quarters of same store sales growth. At RECON, we'll be meeting with current restaurants such as [indiscernible] Jimmy John's and Pizza Hut as well as prospects in expanding concepts. We continually monitor the credit and store performance in our retail portfolio. As we look forward in 2016, exposure to sporting goods is limited and we don't foresee any issues from the consolidation in the pharmacy category. Overall, our watch list exposure is only 0.5% of our retail and restaurant portfolio, and our operations team is in regular communication with those tenants. When we meet with many of you at REIT week in June, we'll be able to provide updates on these meetings and the industry as a whole. I'd now open the line for questions.

[Operator:]

We will now begin the question-and-answer session. [Operator Instructions] At this time, we will pause momentarily to assemble our roster. Our first question comes from Anthony Paolone of JPMorgan. Please go ahead.

[Anthony Paolone:]

Thanks and good afternoon. First question is with your stock bouncing off the lows here, how do you think about that in the context of using it for perhaps de-levering a little bit faster or for being able to continue with your dispositions but also return to some acquisitions as well?

[Glenn Rufrano:]

We are focused, Tony, as you know on our disposition. And when we discussed our disposition strategy, it is the culling strategy. So we're always trying to provide enhanced portfolio, not necessarily just to provide internal capital, but it's one and the same because we have internal capital. We don't think we need external capital yet as we continue to cull this portfolio. But we will continually look for a point in time which you're implying. What's the point in time when VEREIT can move to offense instead of defense? We don't know when that is, but we know how to gauge it. We need to get our investment-grade metric where they should be. We don't want to chase our tail here. When of our investment grade metrics with internal capital are where we believe they should be and we've given ranges and we continually talk to the rating agencies about that there will be a point in time when our cost to capital gets adequate, so that we can be on the offense.

[Anthony Paolone:]

Okay. Thank you. And with regards to what you have in the market now, can you give us a sense as to just the amount of properties you have, just out with brokers at the moment, size of that pool?

[Glenn Rufrano:]

Sure. I'll first go through some of the stats with you. If you remember, we first had guidance in dispositions in August of '15 of $1.8 billion to 2.2 billion. Of that we sold the $1.4 billion in last year and this year we are up to 345. So we have sold a $1.7 billion of our original guidance of a $1.8 billion, well ahead of what we though. We increased that guidance also as you know from 2.2 to 2.4. So as we sit here today to get to 2.2, we need another $400 million and to get to 2.4, it's another 200 million. If we want to get anywhere close to that, we have to have double of that on the market. So if you took those statistics, that's about what we're going to have on the market. What we're never going to do is sell assets to hurt NAV. And in order to make sure we don't hurt our NAV, we think about double the assets on the market we need.

[Anthony Paolone:]

Okay, thanks. And then just last question. With regards to the office product you have out there, it seems like there's some of that in the hopper given the write-down. What kind of cap rates you think we should anticipate for that segment of sales?

[Glenn Rufrano:]

The best way I think I can answer that, Tony, is that we've indicated we can get to our targets by having a range of 6.5 to 7.5. We believe that that will be the range. As we have sold 1.7 so far, since the initial program, we'd average 6.8. We see no reason why we can't get to our target of this year within that range.

[Anthony Paolone:]

Okay, great. Thank you.

[Operator:]

Our next question comes from Tyler Grant of Green Street Advisors. Please go ahead.

[Tyler Grant:]

Hello, guys.

[Glenn Rufrano:]

Hey Tyler.

[Tyler Grant:]

Just to start off, next quarter will mark a year since you had laid out your business plan, that's focused on the four pillars. Overall, you and your team have done a very good job, executing on the plan and it looks like you will complete your goals in August. Do you expect that you're going to update your strategic goals and if so, are there areas that you're currently keying in on?

[Glenn Rufrano:]

We'd love to believe that Tyler. We love to in August be exactly where we expect to be. And if that's the case, we would owe the market on understanding of where we think we'd go next. Right now, we’ll stick with our guidance for the year and our original goals and think we can get it through the year, but if we can get it earlier, we will certainly give you an update.

[Tyler Grant:]

Sure. And then on impairments for the quarter, they were $160 million. What was the cause of that?

[Mike Bartolotta:]

That $160 million, as we said, we really had -- and as we've indicated in our discussion, we really had both -- Ovation had a piece of that and it was also the fact that we now had a broader group of properties in the office market. So it was those two items that changed from the fourth quarter to the first quarter, that caused us to go back and look at those properties and to do the normal type of review that you have to do to determine impairment.

[Glenn Rufrano:]

Just on that, because I think everybody's aware, but impairment really just looks slightly downs relative to properties that we can sell, and doesn't provide any indication that whether there are gains, and I mentioned this in the statements I made and I can give you statistics to show how we look at both even though GAAP accounting looks at one, we'd sold the 1.7 billion of real estate all together here. And we have a GAAP gain of $78 million. So it's going to be the combination that we look at here Tyler but for the GAAP purposes, we only can take it down as you know.

[Tyler Grant:]

Okay, good. What portion of your portfolio have you actually assessed for goodwill impairments?

[Mike Bartolotta:]

We have a process that we go through and look at anything that has any kind of indicator. Hopefully there's - an indicator that you look for. So every quarter we review basically the entire portfolio. So this -- and only those - obviously that have an indicator do we do more specific testing on.

[Tyler Grant:]

Okay, that's really helpful. Thank you.

[Glenn Rufrano:]

Thank you.

[Operator:]

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

[Mitch Germain:]

Good afternoon. So I know that you guys have laid out a leverage target, 6 to 7 times, obviously we're nearing the mid-point of that. What about get to gross assets? Is there a target that you guys have in mind for that metric?

[Glenn Rufrano:]

We're about 48% now. That is I believe a less dramatic relationship, but it will naturally come down. If our number is right, we’ll be somewhere between 40% and 45% if we get to the 6 -- in that low 6 number.

[Mitch Germain:]

And that's kind of where you want to be over time?

[Glenn Rufrano:]

I think it's a result of where we want to be over time, yes.

[Mitch Germain:]

And then, Glenn, just to kind of understand the asset sales program. I appreciate all the commentary on that. I mean it seems like you'll be on the high end if not even above that. I mean is that -- directionally, it seems like sales will continue to be a big pillar of the strategy at least over the course of the next six or seven quarters, is that correct?

[Glenn Rufrano:]

That is correct. But again it's correct because it's the proper way to enhance our portfolio, and we're seeing pretty good prices. We're happy with the prices we're getting and at the same time enhancing the portfolio. If those two relationships continue, we see no reason why it is not very good internal capital for us to reallocate into the portfolio.

[Mitch Germain:]

Got you. And then last one for me, Michael. I missed you on the G&A commentary, the $12 million for the real estate arm, is that the way to think about the run-rate going forward?

[Mike Bartolotta:]

Well, like in any company, it doesn't actually have completely pro rata going forward and we don't give guidance on specifics for the year. But I think if you look at last year, last year real estate was at about 60 for the full year. And obviously, we’re going to have some increases just due to the fact that we're improving. So I wouldn't say it's 12 on a run rate. It's going to be something a little higher.

[Mitch Germain:]

Thank you.

[Glenn Rufrano:]

Thank you.

[Operator:]

Okay, our next question comes from Paul Adornato of BMO Capital Markets. Please go ahead.

[Paul Adornato:]

Hi, good afternoon. I was wondering if you could tell us where the gains on the property sales this quarter came from. Was it just a couple of properties or one segment in particular?

[Glenn Rufrano:]

Well, we had two large sales, one was in office building joint venture where [indiscernible] was a tenant. That we sold at 5.9, which had a substantial gain. And the other was the Wal-Mart freezer, which was another 5.9 flat lease with Wal-Mart that had a substantial game. They're in the supplemental and you'll be able to see those two gains. They are roughly 29 million for the both of them.

[Paul Adornato:]

Great. And, Glenn, a year ago, you kind of differed comment on the potential fail of the Cole platform saying that that you wanted to get the value back to where you think it should be. You certainly made a lot of progress there, so just wondering if you were able to indicate whether you liked the business or perhaps are exploring on selling the platform?

[Glenn Rufrano:]

Well, it's not like or dislike. We're business people who look at assets and we look at value. A common theme around here is that whatever assets we have if we want to play us a lot for it, we'll consider it. If I go back to Cole directly, we're really pleased with Cole's performance, they've done a really great job. Do we believe that it has got to its ultimate value? We are not sure of that and we would like to get it performing better. So the best answer I can have Paul is we're still in that period where we want to maximize the value of that asset under all circumstances for our shareholders. We are not sure we are there yet. We think there's some room to go.

[Paul Adornato:]

Great. And keeping that the regulators have kind of been a little bit more benign towards the industry, that is the non-trade REIT industry. Do you think that has now improved valuations or increased the appetite from with the entrance into the non-traded REIT business?

[Glenn Rufrano:]

We here first applaud the regulators. We think FINRA 15-02 on the transparency was the absolute right thing to do. And as you know, we have NAVs on all our Cole's REIT now. And from the DoL standpoint, we also applaud the fiduciary rule. We think it's just appropriate to deal your investors as fiduciaries. It is certainly less dramatic with DoL than expected. And that's probably a help for the industry in selling. So we applaud what the regulators are doing. We think and believe that the industry will change to conform to the requirements that are necessary for all investors and look forward to the business growing.

[Paul Adornato:]

Great. Thank you.

[Operator:]

Our next question comes from Juan Sanabria of Bank of America. Please go ahead.

[Juan Sanabria:]

Thanks for the time. Glenn, on the litigation front, what's the earliest you could look to potentially settle? You mentioned the next hearing day, but at what point are you able to ensure settlement discussions?

[Glenn Rufrano:]

Well, you're going to be one step ahead of me there, Juan, but what I can tell you is this, as I mentioned, the judge has set a date for May 12th for oral argument and pending motions. Once the judge rules on those matters, and we don't know whether it's May 12th or not or later -- something later, sooner the better, but once the judge rules in those matters, discovery can begin. And that's about as far as we can see right now.

[Juan Sanabria:]

Okay, and then on the Cole Capital's business, what percentage of the dollar volume that you had previously under the old regime is back online, what percent of that dollar volume is back on the platform?

[Glenn Rufrano:]

The best way to answer that is to go back to the way the product was sold in '14 or '13. It was the 80-20 rule. 20% of the broker deals and large ones were selling 80 percent of the product. And we have still not gotten some of the larger ones back on the platform. We're still working with them. We're being patient, due diligence they're not back. So that if I gave you the percentage, it's still closer to a third, but what really counts here, Juan, because if you look at what's going on with Cole, in the first quarter of '15, we averaged 19.4 million a month; second quarter 22; third quarter 38; fourth quarter 48 a month. The reason for those increases was more not just because of that percentage, it was because what we've been able to do is increase the amount of agents working for us and at the same time brings on new broker dealers. And so we have continually increased those numbers from that existing pool that we started with in the beginning of '15. And that's the reason for those increases. We are broadening the distribution for Cole which we think is beneficial for us. And there's a hope and expectation that if we get one or two of those major platforms on, it could really propel us.

[Juan Sanabria:]

Okay. And then you kind of touched on the Red Lobster sales that you're working with Golden Gate, I think 7 close to sub-6 cap rate, any sense of where the valuations are for those locations that are under LOI or the others that are being marketed either on a cap rate basis or EBITDA or per square foot basis to help us think of that pricing is relative to the initial transaction?

[Glenn Rufrano:]

Yes, the one that we sold for the quarter, Juan, if you look in the supplemental we actually give, it was a 6% cap rate. If you look at all seven that we sold, which includes 6 subsequent of quarter, the gross capital is about 5.7. And those are the numbers that we're seeing, I would say that 5.5% to 6% is where we are seeing the growth cap rate for the Red Lobster we're selling individually including the 30 we have under LOI or purchase and sale agreement. That's the range of the gross cap rate.

[Juan Sanabria:]

Great. And one last just big picture conceptual question for me, on the Cole business with the shift towards lower fees, how should -- how do you think the individual financial advisors that work for these broker dealers are incentivized to sell the product with lower fees relative to how they used to think about the business and maybe kind of lick their chopstick thinking about the fess they can get from getting people into these individual NTRs. How does that incentive mechanism change as the industry changes towards lower commission and how does that not really impact the potential inflows into the coal business.

[Glenn Rufrano:]

The best way I can express it is you're a young man.

[Juan Sanabria:]

Not anymore.

[Glenn Rufrano:]

Well, but over time the world changes and we have to change with it. This business is changing and the individual broker who was getting 7 and really liked it, has to wake up one day and say, if I can't get 7 what are my alternatives and there are not many. And so the way the world's turning, this business will change from having a bigger upfront fee to perhaps a smaller upfront fee in a trail. So that it will be more about business over time instead of upfront. For instance, we have filed for CCIT II in 5, the ability to sell tea-shirts. You may have noticed that. So we're not providing for that community lower upfront fees and a trail instead of the typical A shares and we believe there will be success in selling those shares yet to be determined.

[Juan Sanabria:]

Thanks for your time, Glenn.

[Glenn Rufrano:]

Thank you.

[Operator:]

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

[Chris Lucas:]

Good afternoon, everyone. Glenn, thanks for taking the time. I just have one really simple question. In the footnote disclosure on the Red Lobster sale, you provide both the gross and then the net cap rate and that spreads about 100 basis points, is that a way that we should be thinking about how that relationship with the tenant will ultimately work out or is there something more going on in terms of how that economics move on those deals.

[Glenn Rufrano:]

That is a good way to do it, Chris. There is waterfall. But if you look at the waterfall in general, the net cap rate to us will be about 100 basis points higher cap rate than the gross. So there it is a 6 to 7 and about 100 basis points worth.

[Chris Lucas:]

Perfect, that's all I have.

[Glenn Rufrano:]

Thank you.

[Operator:]

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

[Glenn Rufrano:]

Thank you, everybody, for joining us today and we do look forward to seeing many of you at REIT week. Bye now.

[Operator:]

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