Four Corners Property Trust, Inc. (FCPT) Q3 2020 Earnings Report, Transcript and Summary

Good morning, and welcome to the FCPT Third Quarter 2020 Financial Results Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Mr. Gerry Morgan, CFO. Please go ahead, sir.

Thank you, Judith. During the course of this call, we will make forward-looking statements, which are based on beliefs and assumptions made by us. Our actual results will be affected by known and unknown factors, including the uncertainty related to the scope, severity and duration of the COVID-19 pandemic that are beyond our control or ability to predict. Our assumptions are not a guarantee of future performance and some will prove to be incorrect. For a more detailed description of some potential risks, please refer to our SEC filings, which could be found at fcpt.com. All the information presented on this call is current as of today, October 28, 2020. In addition, reconciliation to non-GAAP financial measures presented on this call, such as FFO and AFFO, can be found in the company's supplemental report also available on our website. And with that, I'll turn the call over to Bill.

Good morning. Thank you, everyone, for joining us to discuss our third quarter results. As we approach the fifth anniversary of FCPT's formation, we are proud of the progress made in building the team and growing and diversifying our high-quality portfolio. We are very pleased with the third quarter results and the strong level of 99% of contractual rent collections for the quarter and for October. While this has been one of the most challenging operating periods for restaurants in recent history, it's very important to differentiate between different restaurant types and specifically the kinds of properties that Four Corners owns. Our assets are typically suburban and not in urban course. They're all branded, and they're all part of large chains. These restaurant operators have proven resilient and adjusting their business models as many in the quick service and casual dining sectors have returned to sales near 2019 levels. In the case of quick-service operators, some have even exceeded 2019 levels. As we said last quarter, we continue to believe that strong operators, like those in our portfolio, should benefit in the long run from their scale and from their investment in technology and off-premise to-go capabilities. The coming months could be a fluid situation and, of course, hard to predict for restaurant operators. But we believe that the FCPT portfolio will continue to perform very well. On collections, a quick recap of the second and third quarters. For the second quarter, we collected over 92% of second quarter rent payments agreed to approximate -- to defer approximately 3% of repayments until -- defer the 3% and to abate an incremental 4% of rent as part of lease amendments with favorable modifications. Today, we're working with 3 remaining tenants, representing less than 0.4% of the portfolio to either modify their leases or terminate and then re-lease the properties. In the third quarter, we've collected 99.6% of contractual rent, and there were no additional deferrals or abatements. Our Kerrow subsidiary, which operates 6 LongHorn steakhouses in San Antonio, continues to also be impacted by COVID. Kerrow provides a wonderful window and real-time understanding into what our tenants are going -- are doing to adapt. The Kerrow team's hard work resulted in a return to profitability in the third quarter with positive EBITDA of $110,000. We broke ground in October to construct our seventh Kerrow LongHorn restaurant, which will be located next to a brand-new Olive Garden that we acquired in July. Now turning to our reported results in the second quarter. We achieved AFFO per share of $0.37, which represents a $0.02 and 5.7% year-over-year increase and a $0.03 increase from the second quarter, which had been impacted by COVID-related variances. Turning to acquisitions. I would remind everyone that we resumed our acquisition activities in the second half of June after we had clarity that our portfolio is going to be in very strong shape. We sharpened our focus on the most stable and creditworthy properties in our pipeline. This meant there were some targets that we decided to pass on. But in almost every case, we found substitutes from the sellers that we liked. In the quarter, we acquired 18 properties for a combined purchase price of $48 million at an initial weighted average cash yield of 6.3%. Speaking to the quality of these recent acquisitions, 17 of the 18 leases are with the brand's corporate operator or guaranteed by the corporate entity, and 10 of the leases are ground leases where FCPT owns the land and a tenant constructed the building. This typically equates to very low rents. Stepping back, I'd like to make 2 additional comments on acquisitions. For the year-to-date through today, we have acquired or made investments into properties totaling over $133 million, even with the pause for the most -- for the second quarter. We are quite busy now, which is typical for this time of the year. But specifically, I wanted to highlight the potential for tax-driven transactions that we're seeing in large volumes right now, with sellers trying to get ahead of possible tax law changes. Secondly, our outparcel acquisition strategy continues to pay dividends. Almost half of the acquisition volume in the quarter were outparcels. And since we initiated the outparcel effort in October 2017, we've now closed over $220 million, representing 120 properties. These can be difficult, lengthy transactions to close due to the parcelization and legal process, but they are compelling properties given the typically low rents and preponderance of ground leases and strong corporate operators. Now I'd like to turn to the announcement we made on October 5 regarding the strategic venture with Lubert-Adler, to invest up to $150 million to acquire and re-tenant vacant retail buildings. We began thinking about this idea in July of how we could position ourselves to buy vacated restaurant properties. These are brands that we avoided due to credit concerns, but some were well located from a fundamental real estate standpoint. Many of these operators have been in these locations for 30 or 40 years, and so we could see some good locations where there's an opportunity to convert them into new stores for strong and growing brands. This in turn will support the local retail areas and communities in the recovery from the economic impact of COVID-19. FCPT will invest up to $20 million in the venture, with Lubert-Adler contributing the remainder of the capital. In addition, FCPT will have the right, but not the obligation, to purchase properties from the venture for FCPT's long-term ownership portfolio once the properties are re-tenanted and stabilized. We think this is a great vehicle for us to strengthen the relationships with existing tenants, and Lubert-Adler brings experience and a strong track record of re-leasing vacant properties, including transactions such as Toys "R" Us, ShopKo and Albertsons. Thus far, we are really impressed with what they bring to the table, and we very much enjoy working with them. Finally, before I turn it over to Gerry to discuss some of the financial results and operational update, our team continues to work in combination of remote and in-office days and remains highly effective. We made some wonderful additions to the group in the third quarter with Samantha joining as Real Estate Counsel, Kelly coming on board as real estate controller, Kristi becoming our new Human Resources Manager, and Truman returning full-time from Claremont McKenna as an investment analyst. Everyone's bio is on the website if you're interested in learning more. In summary, we posted rent collections for Q3 that I believe were the highest in the net lease sector, which we hope and expect to continue on a go-forward basis. We are acquiring properties at good pace again, and we are excited to be building the portfolio and working on a new strategic venture with Lubert-Adler. Now Gerry will take you through the financial results. Gerry?

Thanks, Bill. Our results returned to a more normalized level in the third quarter with less impact of COVID-19 related items than in the second quarter. We generated $36.8 million of cash rental income in the third quarter after excluding $1.8 million of straight-line and other noncash rental adjustments. 3 comments on accounting for rental income this quarter: First, we had no rental -- rent deferrals in the third quarter. As you may recall, we deferred $1.1 million of cash rent in the second quarter, which we recognized in the second quarter and still expect to be paid by the end of the year. Secondly, we did not abate any third quarter rent. We did complete several lease amendments in the third quarter in which we agreed to abate $1.6 million of second quarter rent as we disclosed on last quarter's call. In accordance with the appropriate GAAP revenue guidance in cases where the company abates rent as part of lease amendments, we are required to recognize the revenue for the abated rent in that current period and then treat the abated rent as a lease incentive to be amortized against future GAAP rental revenue over the remaining life of the leases as part of straight-line rent adjustments. We had deducted from Q2 AFFO $1.4 million as the rent we had expected to abate. We are deducting the remaining $200,000 of abated rent from third quarter AFFO. We did not deduct abated rent from FFO in accordance with the NAREIT definition of FFO. Finally, on collections, as Bill mentioned, we collected 99% of contractual rent in Q3, and we're also over 90 -- or at approximately 99% collected for Q2 after taking into account the deferred and abated rent referenced above. This means we had no material change to our collectibility or credit reserves in the quarter and also had no balance sheet impairments in the third quarter. On a run rate basis, the current annual cash base rent for leases in place as of September 30, 2020, is $147.8 million, and our weighted average 10-year annual cash rent escalator remains at approximately 1.5%. As a reminder, the rent on all of the original Darden leases increases by 1.5% on November 9 of each year, including this year. Following up on one point from Bill, we have purchased or invested $133.9 million of properties year-to-date through today. This includes a $4.2 million tenant allowance payment we made in the third quarter in exchange for increased rent, extended term and enhanced financial reporting, among other items. Similar to last quarter, you will also note that we again excluded our tenant's EBITDAR rental coverage this quarter. This is because much of the financial reporting includes time periods prior to the COVID-19 pandemic, and we want to be careful not to present a number that may no longer be representative of current tenant operations. It is our expectation that as tenant operations normalize, we will see rent coverage return to our historical levels. Our third quarter AFFO per share results of $0.37 represented a $0.02 per share increase in year-over-year results. Results were impacted negatively by approximately $0.005 for COVID-related variances to our Kerrow operating business and due to the $200,000 adjustment for abated rent in the second quarter, as I mentioned above. Turning to the balance sheet in the quarter. We issued 2.4 million shares of common stock via the ATM program at a weighted average operating price of $25.65 for gross proceeds of $62.5 million. We ended the quarter with no balance and full availability on our $250 million revolving line of credit and over $17 million of cash reserves. Our leverage metrics remain quite strong with a fixed charge coverage of 5x in the third quarter and net debt to adjusted EBITDAre of 5.3x at quarter end. We remain committed to maintaining a net debt leverage target below 5.5 to 6x. Finally, we paid our full third quarter dividend of $0.305 per share, which represented a payout ratio of 82% of AFFO. With that, back to Bill for closing comments.

Thanks, Gerry. As I mentioned when we opened the call, we are closing in next week on our fifth anniversary of our founding. We are grateful to our Board members who always provide meaningful counsel and to all of you, our equity and debt investors, who have been supporting us throughout. Over the last 5 years, we've been prudent in our investment approach and conservative in our capitalization and stand ready now to take advantage of opportunities in the marketplace, whether they derive from tax motivated selling or from COVID-related vacancy in the joint venture. We look forward to speaking with many of you during the upcoming virtual Nareit meetings and otherwise are available to answer any questions in the quarter or the portfolio. So please reach out. With that, we will turn back over to Judith for Q&A.

[Operator Instructions] The first question is from Nate Crossett with Berenberg.

Obviously, it was a strong 3Q. I was wondering if you can give us some color on how the pipeline looks going into the end of the year? You mentioned the tax-driven sales. Can you try and quantify this for us potentially? And also, can you remind us how much is left to close on the Seritage and Brookfield agreements?

Sure. So on the mall outparcel transactions, we'll be filing an updated presentation and all that detail will be in the appendix. But as far as the pipeline overall, very busy. Don't quite know exactly how much we're going to see on these tax-motivated deals, but it's been ramping the last couple of weeks. And depending on the outcome of the election, could imagine a very busy end of the year. So we don't provide guidance or talk about pipeline amounts. But I'd simply say, we're very busy.

Okay. On the recent venture with Lubert-Adler, I'm just curious how did that come about? Did they come to you? Did you go to them? And is this something where you could actually acquire the full $150 million back from them once everything is stabilized there? I'm just trying to [Technical Difficulty] you guys.

Sure. So it's very difficult as a REIT to buy non-income producing properties and so we wanted to bring in outside capital, and specifically outside capital that brought expertise with it. And we're very excited to work with Lubert-Adler. We were introduced by an investor in both of our platforms, who we've known for well over a decade. So it's been a terrific working relationship thus far. I do expect that we will be acquiring for full ownership, a significant number of the properties that we invest in. And we really think it will be -- has the potential for really aiding our 2022 and 2023 acquisition volumes as well as being strategic for our tenants who are looking for ways to grow.

Okay. I guess like who's doing most of the legwork in sourcing the potential properties for that venture? Is it them? Or is it you guys? Or is it...

We are working collaboratively. But obviously, we're in this market every day. And even the mall counterparties that we've worked with are already providing an ample list of properties that are actionable.

Okay. And maybe just on the weightings of the types of properties, is it going to be mostly restaurants? Or is it just property retail stuff?

I think it will be mostly restaurants. But certainly, we won't shy away from the other kinds of property types that we work with. But I think the source of the vacant property will be largely restaurant. And these will be the brands that were struggling pre-COVID, brands like Sizzler, Ponderosa, Fuddruckers, red roof Pizza Huts, Captain D's, things like that, that were struggling pre-COVID, and COVID has really made it difficult to see how those brands are going to come through.

Okay. I mean the successful restaurant brands right now, are you guys in dialogue with them and they're saying we're looking for new high-quality locations. And so when you kind of -- when the joint venture needs vacant asset, you can kind of go to them immediately and say, we have a location for you? Or how is that done?

I think that's precisely it. The winners in this marketplace, brands like Darden, but also brands like Taco Bell and KFC and BJs and Chili's, are going to want to grow coming out of this. And we provide a real estate solution for that growth. And we've been in constant dialogue with those brands over the last few months.

The next question is from Sheila McGrath with Evercore ISI.

Bill, on the joint venture, I was wondering if you could give us a little bit more detail on how the pricing mechanism might work? Once the property is leased, how will you agree on terms on pricing? And do you envision that the cap rate to the REIT on these acquisitions will compare favorably to pricing in the auction market? And if so, about how much an advantage?

Sure. So the -- we don't have an obligation to purchase the properties. And reciprocally, there isn't a fixed cap rate that we can demand to purchase them at. We'll have to work out and negotiate a fair price. But I would note that if, in fact, it was a transaction we brought to the table and, therefore, earn a promote, crediting that promote against the purchase price, the basic math is 50 to 60 basis points in cap rate credit. And so, obviously, we want to be fair with our partners. But I think they clearly understand our motivation, which is not to be generating fees and promote, frankly, but the long-term ownership of well-located, high-quality properties. So it's a negotiation thus far. Lubert-Adler has been very fair and straightforward in their dealing. So we're looking forward to executing on that.

And then on the mall relationships, you bought mostly leased properties. Just wondering if this venture would enable you to go back to those partners and possibly purchase vacant properties?

Precisely. And we're already doing so.

Okay. Great. And one last one. Gerry, on the 1.5% Darden increase that you mentioned, I think you said November 9. Is that already straight-lined into rent revenues? Or how will we see that in the income statement?

Yes. It's already part of our straight-line. I'm just saying in the capped income, you'll see that increase in our fourth quarter cash revenues.

The next question is from RJ Milligan with Raymond James.

Just one question. The mix towards non-restaurant properties and acquisitions in the third quarter was a little bit higher than it's been in the past. Just curious how you envision that mix going forward for acquisitions?

Yes. It's -- RJ, it's not something that we've planned specifically. Obviously, we widened our aperture a year ago or so. And so deals have just been coming through the pipeline. A lot of these are in the Seritage deals, which were a little bit more evenly distributed between restaurants and non-restaurants. But there's not a master plan behind that. We're going to look to buy properties that we think are sensible. The mix will change over time. And certainly, as we've looked into other property types, we feel like the amount of properties that we can address is greater.

The next question is from John Massocca with Ladenburg Thalmann.

So looking at the portfolio where it stand today and kind of just in the context of the fact that your first kind of 5 tenants are publicly traded and what they've done to kind of build a capital reserve in light of the current volatile environment is kind of publicly known. But maybe outside of that, as you look at the portfolio today, what portion roughly do you think is maybe slightly at risk if you do go into either a second lockdown or some of these commercial restrictions end up being a little longer term? Just any color there would be helpful.

Very small.

Okay. And then as I think about Kerrow, maybe longer term, obviously, it's been an insightful view into the restaurant industry in kind of recent months. But is that longer-term a portion of kind of the business you want to keep? Or could that potentially be something that's either fully disposed of or kind of structured into more of a net lease kind of investment for you guys?

Sure. So I think it's important to keep in mind that Kerrow is an extraordinarily well-run business. Carol, who runs that business in San Antonio, obviously overseen from here in Mill Valley. But Carol, who runs that business and the 6 managing partners that report to her are true professionals. And it's been very valuable to understand day-by-day how they're operating. So I'll leave it at that. It obviously put a little bit of noise into our numbers, but I think it's understandable and it's proven to be very valuable as we negotiate with tenants and want to understand exactly what's going on, on a day-to-day basis. And it allows us to explore some growth that we wouldn't normally be able to explore as we were able to purchase an Olive Garden this summer that had adjacent land in which we can, in very sort of mindful of risk way, grow a seventh property, which further provides some learnings on that process. So again, very well run, very insightful. Certainly during the spring, we were in daily contact with Carol on exactly what was going on in the business, the changes she was making, ways in which they were creating additional revenue. But no plans as of today.

[Operator Instructions] The next question is a follow-up from Sheila McGrath with Evercore.

So I was wondering if -- since you're ramping up acquisitions, if we expect any increase in G&A with adding personnel for the -- going into fourth quarter and 2021?

I wouldn't look at fourth quarter as much as going forward. I think G&A will increase as our properties number increases. But we've been very careful on G&A. And now in addition to that, we have the offset of some of the economics from the Lubert-Adler venture. But I don't think the G&A change will be anything surprising to folks. We're just maturing as a team, bringing in more capability, but nothing substantial.

And then on the JV, should we be modeling some sort of other income fee stream or it's just immaterial? Or how should we think about that?

I mean our reason for doing this deal is not to create an asset management business. It's not really capturing onetime promotes. It's providing a pipeline of great tenants, long-term leases, our lease form that we intend to have a 100% ownership of once the properties are paying. So that's the way I'm thinking of it and how I think it will unfold. But it certainly -- it does -- it will offset some amount of the additional overhead that we're going to incur in order to execute the plan on the joint venture.

[Operator Instructions] There are no more questions registered. This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Morgan for any closing remarks.

Bill?

None from me. Thanks, everyone. We're certainly available for questions. If anyone would like to chat, reach out. Hope all is well. Thanks.

Thank you.

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