VEREIT, Inc.
Q3 2016 Earnings Call Transcript

Published: 2 Nov 2016

[Operator:]

Good day and welcome to the VEREIT Third Quarter 2016 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:]

Thank you for joining us today for the VEREIT 2016 third quarter earnings call. Joining me today are Glenn Rufrano, our Chief Executive 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 03

[Glenn Rufrano:]

Thanks, Bonni. And thank you for joining our call. Let me begin by highlighting a few items. We've completed approximately 803 million of disposition year-to-date. For the quarter, AFFO per diluted share was $0.20. Net debt to normalized EBITDA decreased from 6.6 times to 5.7 times. Also during the quarter we completed a $702.5 million offering of common stock with the proceeds reducing debt. Starting with operations, occupancy increased to 98% from 97.7% in Q2. Same-store rent was 0.1% for the quarter reduced from 0.8% due to the impact of the Ovation bankruptcy. Leasing activity was strong with over 663,000 square feet of lease extensions of which 23% were 2016 explorations. Notable segments included 361,000 square feet of office and industrial and 146,000 square feet of restaurants. As we outlined during our 2016 Investor Day we have a significant number of medical buildings averaging 8,000 square feet that have been classified as office. The characteristics of these facilities are more same like the medical, retail services and will be re-categorized in the future. We continue to make significant progress with our portfolio calling strategy. This quarter we dispose of 87 assets for $278 million. These transactions are spread across our targeted disposition categories. This included a three property GSA office portfolio for 77 million, flat lease properties totaling 44 million and 103 million of restaurants. We also sold one industrial property for 48 million that arose from an unsolicited offer. Subsequent to the quarter we closed on 55 million of properties including flat leases and restaurants. Year-to-date we have completed approximately 803 million of dispositions which surpasses the low-end our $800 million to $1 billion guidance range for the year. This is on top of the 1.4 billion of strategic dispositions in 2015. In regard to Red Lobster at quarter end our exposure decreased to 8.6% from 9%. So far this year we have sold 51 Red Lobster properties for net proceeds of approximately 174 million at 7% net cap rate and a gross cap rate of 6%. Additionally we have 24 properties undersigned PSA or LOI. On target for 2016 goal of $200 million to $250 million in sales. We are pleased with Red Lobster performance as the business continues to generate positive same restaurant sales growth. Additionally it was announced that Thai Union a public company and the world's largest seafood supplier made a $575 million strategic investment in Red Lobster. Thai Union’s investment is a testament to the great progress made under Golden Gate’s ownership and the potential ahead. Turning to the balance sheet, in August we initially planned a public offering of 50 million shares, which we’re able to upsize to 69 million shares including the greenshoe. With our $1 billion bond offering in May and the 700 million stock offering, we have demonstrated our ability to successfully access of the debt and equity markets. This has allowed us to reach investment grade metrics earlier than expected. During the quarter Cole Capital raised $136.4 million of new equity an average of $45 million a month. Cole also successfully closed one offering CCIT II and launched a new REIT CCIT III just part of our ongoing product sequencing. New equity for October was $23.4 million, which reflects a lower capital raise following the close of CCIT II and the ramp up of CCIT III. Before Mike reviews our quarterly financial results let me provide a brief update on litigation. As we mentioned on our last call the court had a case management conference in September during which the parties discussed a discovery schedule for various litigations. The court directed that document discovery should be substantially completed by December 15, 2016. And will hold another conference on January 10, 2017 to discuss the schedule for the remainder of discovery. Additional details regarding pending litigations can be found in our 10-Q filed today. Let me now turn the call over to Mike.

[Michael Bartolotta:]

Thanks, Glenn, and thank you all for joining us today. We had another quarter of on-plan performance, achieving AFFO of $0.20 per diluted share. Consolidated revenue was $362.9 million, just below last quarter's revenue of $371 million, mainly due to our disposition program. We reported net income of $30.2 million for the quarter versus net income of $3.2 million for the second quarter primarily due to a $27.7 million increase and the net gain on disposition of real estate this quarter. FFO per diluted share for the third quarter was $0.19 as compared to $0.20 for the second quarter, mostly due to lower rental income and increased loss from the extinguishment of debt and the diluted effect from issuing the 69 million shares from our recent equity offering on August. AFFO was $0.20 per diluted share as compared to $0.19 for the second quarter, primarily due to the current portion of a tax benefit of $10.9 million driven by the closing of CCIT II along with the lower G&A and lower interest expense. The tax benefit occurred a quarter earlier than expected and Q4 will not reflect such a benefit. We are reaffirming 2016 AFFO per diluted share guidance of $0.75 to $0.78. G&A for the quarter was $29.8 million versus $33.1 million in the second quarter, representing a decrease of $3.3 million. Real estate G&A was $12.1 million for the quarter, down $1.6 million from $13.7 million in the prior quarter, mostly due to higher equity based compensation and the cost of certain annual regulatory filings in Q2. Cole Capital G&A was $17.7 million, down $1.7 million from $19.4 million in Q2 primarily due to a larger program development cost write-off last quarter. Legal costs related to the matters arising from the audit committee investigation which are included in litigation and other non-routine costs was approximately $5.2 million for the quarter. This brings the total unit costs related to these matters to $13.4 million for the year excluding any insurance proceeds. We are reducing our previous estimate for gross legal cost for 2016 to $35 million to $40 million excluding any insurance proceeds. Turning to the third quarter real estate activity, the Company capitalized $0.8 million of development costs and placed $3.5 million asset into service at a cash cap rate of 10.6%. During the quarter, we sold 78 properties for $278 million at an average cash cap rate 6.6% and a pre-goodwill allocation gain of $35.8 million, which has reduced to $28.5 million after goodwill. Subsequent to the quarter, the Company disposed of nine properties for an aggregate sales price of $55 million at an average cash cap rate of 6.9%. Regarding the balance sheet and then as Glenn mentioned we completed a very successful equity offering during the quarter netting the company approximately $702.5 million. Using these proceeds at available liquidity we were able to pay-off the recent $300 million secured bank loan, $500 million from our unsecured term loan and took our line of credit to zero. We now have $2.3 billion of capacity available under our credit facility. Effectively, we were able to refinance our $1.3 billion of bonds that were coming due in February 2017 with 10-year bonds, five-year bonds and the remainder in equity staggering net debt repayment and improving our maturity schedule. Additionally, S&P raised its corporate rating of VEREIT to BB plus from BB and the rating on corporate debt to BBB minus from BB plus, which is investment grade. While staying within our 2016, AFFO guidance range, we have been able to achieve our balance sheet targets faster than anticipated through our disposition program and the equity offering and also created a well-laddered maturity schedule with the refinancing of our 2017 bonds. As of 9/30 our net debt-to-EBITDA was reduced to 5.7 times from 6.6 times last quarter. Our fixed charge coverage ratio remains healthy at 2.9 times and our net debt to gross asset ratio is under 41%. Our encumbered asset ratio was 66% and the weighted average duration of our debt increased to 4.5 years from 3.9 years. We also put in place the $750 million ATM as part of our objective to ensure that we have the right financial toolkit and giving us further flexibility as we move into stabilized business operations. And with that, I'll turn the call back to Glenn.

[Glenn Rufrano:]

Thank you, Mike. With our foundation solidly in place, we are able to move to the next phase in our business evolution. To do so, we should define ourselves. Many would say we are a net lease Company. But net lease simply describes how tenant pays its expenses. It's not what we do. We have always described ourselves as a full service real estate operator that has the infrastructure to buy, sell, finance, property manage, asset manage and lease properties with net lease characteristics. We now are positioned to move forward as a real estate equity finance Company. With this focus, we serve as a conduit to liquify capital from real estate investments that house businesses across America. In turn, product in this case, net lease, real estate is provided to us and the capital is invested efficiently back into the tenants operations. We transact in the primary market via sale leaseback and then a secondary market through acquisition. We can now execute with a proven transaction and operational infrastructure, large stabilized liquid portfolio that provides for a low cost of capital and a sizable market opportunity. As we move towards acquiring assets on the balance sheet, it's important to note that our transaction real estate teams have been very active participants in the market both in selling and buying. While we have been disposing of assets on the balance sheet, our team has acquired properties on behalf of the Cole REIT. We reviewed over 17 billion of deals through the third quarter, executed LOI’s on 3.2 billion and closed approximately 500 million for Cole. We know the markets well and can seamlessly transition to acquire for the balance sheet. At the same time, we have effectively managed more than 4,200 assets across various property types and sizes. Our portfolio is stable and diversified. Cash flow has been an integral part of our business. The very first pillar of the plan outlined our desired long-term portfolio and the coming strategy was established. With 2.2 billion of asset sales to date, we are approaching our targeted metrics. Our property mix that includes 60% to 70% retail and 15% to 20% office and industrial, no tenant greater than 5%, no industry greater than 10%, weighted average lease term approximating 10 years and investment grade tenants between 35% and 45%. The combination of our operating capabilities and improved portfolio enable us to move toward a competitive cost of capital. Our balance sheet is now safe, bolstered by well added debt maturities schedule as a result of our recent bond offering and other investment grade metrics enhanced by our recent equity offering. This significant progress is respected by S&P raising its corporate credit rating to BB plus. And the rating on our corporate debt to investment grade BBB minus. Our market opportunity is defined by its size and participants. Our internal analysis suggests the size of the retail office and industrial net lease universe. Approximately approximates 1.5 trillion. This is a very fragmented sector demonstrated by the public and private REIT’s comprising only 8%. There is ample opportunity for our team to access this market. And we are well-positioned to do so. With that, I'd now like to open the call to questions.

[Operator:]

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Mitch Germain of JMP Securities. Please go ahead.

[Mitch Germain:]

Good afternoon.

[Glenn Rufrano:]

Hi, Mitch.

[Bonni Rosen:]

Hi, Mitch.

[Mitch Germain:]

Congrats Glenn on all the progress so far. Just a couple questions for me. How do you expect to use the ATM on a forward basis, is it really going to be just matched up against smaller transactions. I'm just curious about your thoughts about using that?

[Michael Bartolotta:]

Mitch, it’s Mike. I mean right now what we've been trying to do all along is get ourselves established to have the right financial toolkit and the flexibility to move forward and be ready to go and take the next steps. But at this point, we don't have specific plans for accessing that.

[Mitch Germain:]

Just looking at acquisitions in general. It seems like you guys might be more focused in on given your size right, portfolios or M&A rather than one-off deals, is that a good reflection of how you're looking at growth at this point or is it really leveraging one-off deals that you are identifying for the Cole platform?

[Glenn Rufrano:]

It’d be a combination Mitch. It's always nice to be able work both sides of that market, as you know about 98% of our assets and 25 million or less which is a great diversifier and we will certainly play in that market, but if with our size we can find portfolios especially portfolio as a discount. We want to be in the long-term deal market as well. So it's going to be both sides and opportunistic.

[Mitch Germain:]

Great. Last one for me, actually two more. Number one, Glenn just remind me, I know that you had some selling agreements with Golden Gate with regards to Red Lobster. I know a bunch of that was going to be postponed into 2017. What's kind of targeted for Red Lobster sales for next year?

[Glenn Rufrano:]

I'll start with this year then I'll come to next, Mitch [indiscernible]. We thought we would sell to 2 to 2.50 this year and you could see we’re well on our way to that with 174 million to date. If we reach that target which we expect we could be similar target next year.

[Mitch Germain:]

Gotcha. Okay. And then last one, I know it's been a loss – actually about the selling agreements in Cole in terms of reestablishing old relationships creating new relationships, how's that going along?

[Glenn Rufrano:]

Year-to-date we have 38 new broker dealer relationships, we've actually got eight this quarter and four just after the quarter. They've been across the country. The larger broker dealers we have not signed on yet.

[Mitch Germain:]

Okay. Thank you.

[Glenn Rufrano:]

Thank you.

[Operator:]

The next question comes from Joshua Dennerlein of BAML. Please go ahead.

[Joshua Dennerlein:]

Hey, guys. Just kind of a follow-up on that last question. For Cole, what is the market share currently of Cole and once you get the larger broker dealers online, what do you expect that to stabilize that?

[Michael Bartolotta:]

If we look at this quarter where we sold $136.4 million or 13.7% of the market. If we look at the first three quarters we’re about 12.1% of the market. And that's been generally increasing over time as you know in 2015 if I quoted the fourth quarter of 2015 we were 5%. So we went from 5% in the fourth quarter of 2015 to 13.7% in the third quarter this year. But those are pretty good numbers and we're proud of being able to get to that level. We will drop a bit in the fourth quarter. If you notice that in the last month, our $23 million was lower than the prior month, but it's because one of our REIT CCIT II is closed and we're opening three. So it's a little hard for us to tell you exactly where we expect to be subject to when CCIT II start selling again.

[Joshua Dennerlein:]

Okay. Thanks for that. And then on your office portfolio versus diversification target, I think you want to be 15% to 20%, you’re at 23.1% now. Do you expect to hit that by year-end? Do you have anything outstanding for settlement fees?

[Glenn Rufrano:]

We as you would expect, we do have office on the market, we don't know if it will hit by year-end it will be subject to whether we can close deals. I think it's more reasonable to think its next year. And we’ve been very clear on all our selling program, we're not giving away NAV. So timing is we're less concerned with timing than we are with NAV but it would be an expectation for next year.

[Joshua Dennerlein:]

Okay. Thanks. I appreciate that color. Thank you, Glenn.

[Glenn Rufrano:]

Thank you.

[Operator:]

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

[Christopher Lucas:]

Hey, good afternoon everybody. I guess just Mike or Glenn just a question about the guidance for the year based on what you've racked up so far this year that implies fourth quarter guidance of $0.15 to $0.18. And I'm just curious is that what sort of issues would get you to the low end of guidance for the year?

[Michael Bartolotta:]

I will leave some of this. But one point is that we had that $0.01 in this quarter. That was an anomaly. So this quarter as was indicated in some of the reports Chris was a head of guidance, but that $0.01 tax really could have been anywhere in the year. So it’s from your standpoint I understand it's a timing issue from our standpoint was an annual issue.

[Christopher Lucas:]

Go ahead Mike, sorry.

[Michael Bartolotta:]

No, no go ahead.

[Christopher Lucas:]

No. I was just going to ask could you provide maybe a little more color on the tax issue and why the timing was third quarter that your tax adjustments tend to be pretty lumpy. So, just kind of curious as to how it is…

[Glenn Rufrano:]

It’s very lumpy. It’s related to the closure of CCIT II and so basically what you had were write-off that occurred over the life of CCIT II and differed tax benefit was set up for it and basically once the closure actually occurred which occurred on September 17, which was within the confines of the third quarter. That's when you were able to take it out of the deferred benefit and put it through the current and obviously that's wanted to effects AFFO. So that that's really what drove the timing of that item. We knew we would have it during the year but we didn't know when we would have it and so we had anticipated the fourth quarter but in reality it went into the third quarter.

[Christopher Lucas:]

Okay. But again I guess the low end just seems to be very low. I mean your run rate on the real estate portfolio is roughly $0.18 a share. So I'm just trying to understand how you get to $0.15. Is there one time items that we're not thinking about? Is there I’m just not following.

[Glenn Rufrano:]

First, Chris that's at the low end right.

[Christopher Lucas:]

Yes. Right that's what I'm worried about because otherwise why not tighten the range.

[Glenn Rufrano:]

Yes. Blame it on me, I'm a pretty conservative guy Chris. And so we thought it would be important just to leave the same range out there. So there's no there's nothing hidden in that range that would lead you to one conclusion being in the low-end or the high end. And in terms of where there can be some changes that could be some changes in G&A. Just let me fluctuate.

[Christopher Lucas:]

Okay. Thank you. And then Glenn you mentioned a little bit about re-characterization of some of the smaller…

[Glenn Rufrano:]

Yes.

[Christopher Lucas:]

How much of an impact is that to sort of the buckets that you look at between the different product types?

[Glenn Rufrano:]

It's point nine, Chris and just to explain that, we could have taken that earlier. We have a group of assets that the average size is 8,000 square feet, has nothing to do with an office building. They're primarily leased to dialysis companies or docking of boxes as you know and so we don't think they have anything to do with the office portfolio, it’s in the supplemental, we have broken it down for you. So that if you would to look at its Page 7, we’ll get to the page, we have broken on down a special chart to break down our office into corporate headquarters, corporate operations and medical services and you'll see the square footage, the size and the amount, it’s on Page 40, of the supplemental.

[Christopher Lucas:]

Okay. Thank you appreciate that. And then last question for me. I guess just given the significant progress you guys have made on the balance sheet and to some degree that the ratings with asset lease S&P. What are the conversations like with the other rating agencies at this point? And when do you expect to sort of get everybody lined up on the same page?

[Michael Bartolotta:]

Well as we have done consistently we'll be having those conversations in the next couple of weeks, our meetings already scheduled with both S&P and Moody's and we'll do what we've always done. We're going to go back, Chris and we're going to you know we'll go over the quarter with them, we’ll answer their questions and we're really totally transparent with them. I think at this point we're just going to continue to do that and we will hopefully get to where we need to be with Moody’s just as we have with S&P.

[Glenn Rufrano:]

Lot of easier Chris at this level than it was a year ago.

[Christopher Lucas:]

Okay. Very good. Understood. Thank you so much. Appreciate the time.

[Glenn Rufrano:]

Thank you.

[Michael Bartolotta:]

Bye-bye.

[Operator:]

The next question comes from Anthony Paolone of JPMorgan. Please go ahead.

[Anthony Paolone:]

If I look at your legal costs that you guided to for the full-year it seems like that loads a lot into the fourth quarter. Is that a timing matter or is the run rate as we start to look into next year going to just the higher I guess as you are in discovery and there are a couple charges made?

[Michael Bartolotta:]

We haven't given guidance for next year yet, but obviously we're anticipating an uptick in this next fourth quarter as we proceed through different stage.

[Glenn Rufrano:]

When we give guidance which will be on the fourth quarter call, Tony we will give this as part of it.

[Anthony Paolone:]

Okay. But it sounds like [indiscernible] and that was maybe 2013 year-to-date and…

[Glenn Rufrano:]

That’s right. Yes.

[Anthony Paolone:]

So there is a legitimate ramp at some level here happening.

[Glenn Rufrano:]

Yes. And it's in part as I did discuss and the litigation section discoveries beginning now and the judge has put a date on it in December at which the parties will provide discovery and that has caused a bit of a ramp up in this quarter.

[Anthony Paolone:]

Okay. Anybody or any sectors on the watch list right now from a credit point of view?

[Glenn Rufrano:]

Nothing that specific. We have a probability weighted of about close to 2% and I would tell you it's not a sector necessarily, but as you know we do look at some sectors. One sector we look at very closely is energy and we have about 3% of our income in energy, but only half of that we think could be at some level of probability on our watch list. The other area that we have cared a lot about is office in Texas and really office in Houston. We have about 3% of our office portfolio in Texas of which 0.8% is Houston and the rest is primarily Dallas, a 100% lease we feel very good about. Those have been two areas outside of the general population of tenants that we’ve cared about and we're on top of those and think about them every day.

[Anthony Paolone:]

Okay. Thanks. And then last question, you talked about on the acquisition side the amount of underwriting you did, letter of intent and then kind of what actually are closed. When you pivot to making acquisitions on balance sheet, again, it is simple as just keeping that deal flow as it is and just directing the flow to the balance sheet or how would that work?

[Michael Bartolotta:]

Well, the deal flow at 17 billion we that is pretty robust and it's a very big market and large market out there as you know and we will absolutely be looking into that deal flow for activity on the balance sheet. We have a pure allocation process that we go through right now today in terms of how that deal flow is allocated and not only is it a very precise process. It gets reported to each board each quarter, so we're very comfortable that we have been doing everything necessary to pivot here to the balance sheet and as I use the word seamless in the script and I really think it will be.

[Anthony Paolone:]

So you see that happening at some point in 2017 where that flow just gets moved to the balance sheet?

[Michael Bartolotta:]

The appropriate part of that flow, yes.

[Anthony Paolone:]

Okay. Thank you.

[Glenn Rufrano:]

Thank you.

[Operator:]

The next question comes from Paul Adornato of BMO Capital Markets. Please go ahead.

[Paul Adornato:]

Thanks, good afternoon. Glenn in the past you've consistently stated that you would evaluate the ongoing inclusion of Cole platform into very – once you felt that the value had been restored there, appreciate your comments that you still have perhaps a little bit of wood to chop in terms of restoring that value. But maybe you could comment if you would on that concept?

[Glenn Rufrano:]

Paul, we haven't changed a lot on the thought process. Cole has come a long way and we're really happy and proud of the way they've reestablished their brand in market share. But as you know, it's a bit of a shaky market. They've done a good job in the shaky market. We expect that market – the DOL, especially the DOL and understanding of the DOL process will shake out this year into the next year. So we're going to continue to work with Cole to make sure it maximizes its value and watch the market at the same time.

[Paul Adornato:]

Okay. Great. And perhaps just one more for me. Glenn you've accomplished so much during your tenure. And I was wondering if it's too early to talk about succession and whether you plan to be there for the next phase of the Company?

[Glenn Rufrano:]

Probably way too early, Paul, but what I’d say it’s not a reasonable question. I'm going to work until I die. It's only a question whether I die here. So I really have no plans at all and the management team is in really good shape and I'm really happy to be here.

[Paul Adornato:]

Great. Thanks so much. End of Q&A

[Operator:]

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

[Glenn Rufrano:]

Thanks everybody for joining us today. We're really happy about our performance and we look forward to speaking to you on the fourth quarter call. Thank you.

[Operator:]

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