Realty Income Corporation (O) Q2 2017 Earnings Report, Transcript and Summary

Good afternoon and welcome to the VEREIT Second Quarter 2017 Earnings Conference Call and Webcast. 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.

Thank you. Thank you for joining us today for the VEREIT 2017 second quarter earnings call. Joining me today are Glenn Rufrano, our Chief Executive Officer; and Mike Bartolotta, our Chief Financial Officer. Today's call is being webcast on our website at vereit.com in the Investor Relations section. There will be a replay of the call beginning at approximately 3:00 PM Eastern Time today. Dial-in for the replay is 1-877-344-7529 with the confirmation code of 10109813. Before I turn the call over to Glenn, I would like to remind everyone that certain statements in this earnings call, which are not historical facts, will be forward-looking. VEREIT's actual results may differ materially from these forward-looking statements and factors that could cause these differences are detailed in our SEC filings, including the quarterly report filed today. In addition, as stated more fully in our SEC reports, VEREIT 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 begin by providing a business and operational update, followed by Mike presenting our quarterly financial results. Glenn will then wrap up with closing remarks. We will conclude today's call by opening the line for questions. Glenn?

Thanks, Bonni, and thanks for joining our call. Results are as expected. For the quarter, AFFO per diluted share is $0.18. To-date, acquisitions totaled $273.3 million and we've completed $433.6 million of dispositions. In line with guidance, disposition is frontend loaded and acquisition is backend. Net debt to EBITDA decreased to 5.4 times, before the guidance range of 5.7 to 6, providing capital flexibility. And we are narrowing our AFFO guidance from $0.70-to-$0.73 to $0.71-to-$0.73 per share. Starting with operations, occupancy was 98.6%, up slightly from 98.4%. Same-store rent was flat for the quarter. Excluding the effects of our early lease renewals efforts, same-store would have increased 0.3%. During the quarter, we had 720,000 square feet of lease renewals, of which 523,000 square feet were executed early. Notable early lease transactions included Wells Fargo and Rockwell Collins office properties, as well as the renewal for an industrial facility to lease to Iron Mountain. For the year, we have renewed 368,000 square feet of leases with a 100% recovery. We've also completed more than 660,000 square feet of early lease renewals with a 91% recovery. These leases have built in increases in an average wealth of 12 years. Turning to capital activity, during the quarter, we completed a restaurant exchange with Golden Gate Capital. In the transaction, VEREIT received 22 Bob Evans Restaurants by that 50 million, in exchange for 15 Red Lobster properties with the same value. This NOI exchange contributed to a reduction in our Red Lobster exposure to 7%, down from 7.4% and further diversified our restaurant portfolio on a non-dilutive basis. Second quarter acquisitions were $101.6 million and $70.2 million subsequent to the quarter. These 41 transactions included retail properties in multiple categories such as fitness, automotive service, hobby, and home and garden, as well two industrial properties representing 35% of the transactions. For the year, acquisitions totaled $273.3 million. Second quarter dispositions were $224.8 million with $9.6 million subsequent to the quarter. These 44 transactions were spread across our strategic categories, and included Red Lobster office, non-core properties, restaurants and flat leases. Of note, we sold a large energy-related office building in Texas for $387 a foot. Dispositions for the year now totaled $433.6 million, near the low end of our $450 million to $600 million guidance range. Capital allocation has strengthened the balance sheet with net debt to EBITDA of 5.4 times, providing ample room for leverage-neutral acquisitions. 99% of our debt is fixed, lessening any near-term impact of potential interest rate increases. During the quarter, Cole Capital raised $78 million of new equity, an average of $26 million a month, and an increase of 17% over the first quarter, while the industry was down 37%. Additionally, 23 new selling agreements were signed in Q2, representing more than 15,000 financial advisors. New equity for July was $22.3 million. Before Mike reviews our financial results, let me provide a brief update on litigation. The Court heard oral argument on the plaintiff's motion for class certification and scheduled a hearing on August 24 for each side's expert to testify regarding the class certification issues. Document discovery has also been substantially completed. Additional details regarding pending litigations can be found in our 10-Q filed today. Let me now turn the call over to Mike.

Thanks, Glenn, and thank you all for joining us today. We had a good quarter, achieving AFFO of $0.18 per diluted share. Consolidated revenue was $336.9 million, below last quarter's revenue of $348 million, primarily due to net dispositions during the year, along with lower operating expense reimbursements in certain adjustments to CAM. Net income for the second quarter was $34.2 million versus net income of $14.8 million last quarter. The increase was mostly the result of a higher gain on properties sold in this quarter, along with a gain on extinguishment of debt this quarter, partially offset by lower real estate revenue and a higher impairment charge. FFO per diluted share for the second quarter was $0.17, consistent with the first quarter also at $0.17. Q2 had lower real estate revenue, along with higher litigation costs, partially offset by a gain on the extinguishment of debt and a decrease in the income tax provision, resulting in a flat quarter-over-quarter change. AFFO was $0.18 per diluted share versus $0.19 last quarter, mainly due to lower real estate revenue and the increase in current income and franchise taxes, offset by lower property operating, G&A and interest expenses, along with an increase in Cole Capital revenue. G&A for the quarter was $29.4 million versus $29.1 million for the first quarter, representing an increase of $0.3 million. Real estate G&A was $14.3 million for the quarter, up $1.7 million from $12.7 million in the prior quarter. This was mostly due to the equity-based compensations for directors that is granted and vest in Q2, and certain annual filing fees incurred in Q2. Cole Capital G&A was $15.1 million in the second quarter, down $1.5 million from $16.6 million in Q1. This decrease was mainly due to slightly lower compensation and benefits, professional fees and office expenses during the quarter. Legal expenses related to the matters arising from the Audit Committee investigation, which are included in litigation and other non-routine costs were approximately $14.4 million for the quarter, bringing the year-to-date amount to $27 million. Turning to our second quarter real estate activity, the company purchased 38 properties for $101.6 million at an average cash cap rate of 7%. Subsequent to the quarter of the company purchased three properties for $70.2 million and an average cash cap rate of 6.5%. During the quarter, we disposed of 37 properties for $224.8 million at an average cash cap rate of 6.9% and a gain of $43.1 million, subsequent to the quarter the company disposed of seven properties for an aggregate sales price of $9.6 million at an average cash cap rate of 7.2%. Our balance sheet remains very safe and liquid, we continue to have full capacity under our credit facility of $2.3 billion. At June 30, we also had $292.5 million in cash and essentially no floating rate debt. During the quarter, we've reduced secured debt by $203.8 million with only $162.5 million coming due during the remainder of the year. Any secured debt coming due is expected to eventually be termed out with unsecured debt. As of June 30, our net debt to normalized EBITDA was reduced to 5.4 times from 5.5 times. Our fixed charge coverage ratio remains healthy at 3 times, and our net debt to gross real estate investments ratio was 38%. Our unencumbered asset ratio was 70% and the weighted average duration of our debt stands at 4 years. And with that, I'll turn it back to Glenn.

Thanks, Mike. REITs business model incorporate the large diversified portfolio providing the ability to whether cyclical and secular change. We maintain a proven infrastructure and the expertise to effectively manage our portfolio. Our focus in on four property types, single-tenant retail, restaurant, office and industrial, which spreads volatility and provide optionality to take advance of market dislocations over time. Presenting the characteristics of our property types, we can illustrate our risk is mitigated. Single-tenant retail is differentiated from other general retail format, we have a large percentage of credit tenants 47% of investment grade and 66% of our tenants are public companies. Generally, we do not have co-tenancy or occupancy requirements. We are able to target individual tenants and merchandise categories, and our portfolio was dominated by off price and necessity shopping with only 0.2% of income from apparel and jewelry, far less than other retail formats. Our diversified restaurant portfolio is primarily comprised a strong national dinning concepts, according to Nation's Restaurant News, which publishes the top industry brand based upon system like sales. 86% of our casual dining tenants and 78% of our cook service restaurants are ranked in the top 25 of their respective category, beyond Red Lobster, we have low concentration by tenant concepts. Combined 92% of our retail tenant based is service, retail merchandise categories with lower online disruption and restaurants. The average size of our office assets are 148,000 square feet with 59% of our tenants investment grade. These properties are strategic to their companies business with 33% corporate headquarters and 67% corporate operations. Facilities are spread across top MSAs such as Chicago, Dallas, Boston and Washington, D.C. Our industrial assets are in close proximity to ports, railways and major freeways with three quarters located in the top 50 markets, as logistics and delivery become increasingly important. Our properties are essential to the tenants operations with 87% dedicated to distribution and warehousing. 57% of our industrial tenants are investment grade. Our ability to implement our plan during the past two years has enabled us to strengthen our business model and reshape the portfolio. We have sold over $3 billion of assets including approximately $890 million of office, $870 million of Red Lobster restaurants, $710 million in flat leases, $360 million of non-core and $125 million of retail joint ventures, in all realizing a gain of $200 million. We've decreased top 10 tenant portfolio concentration from 33.3% to 29.4% and reduced net debt-to-EBITDA from 7.6 times to 5.4 times today. We are now poised to provide capital to corporate clients through a targeted acquisition process. With that, I'll now open the line to questions.

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Joshua Dennerlein with Bank of America Merrill Lynch. Please go ahead.

Hey, good afternoon, guys.

Yes, good afternoon.

A question, how should we think about acquisitions and dispositions for the second half of the year? Do you expect to kind of stay near the lower end of your range for dispositions or do you think you'll keep chugging through? And do you expect to be a net acquirer?

Well, we are at $433 million of dispositions. We're pretty close to the low end. I would expect we'll be somewhere between the $450 million and $600 million. And if we find the right pricing on the assets for sale, we could be closer to $600 million. On the acquisitions, as we mentioned in our guidance, it would be tail end loaded. We're $273 million to-date. We do expect to get and we will get into the guidance of $450 million to $600 million. And if we can find the right acquisitions, we would expect to be in the higher end of that range.

Okay. And moving on, have you started your evaluation of whether or not Cole is better inside VEREIT or potentially sold off to a third party?

Well, our goal has continued to be to reestablish and increase the value of Cole. We believe we've done a really good job of that. And we continue to do that. The critical issues this year have been bringing Cetera and Advisor Group on, two very large companies, who are now just beginning to sell. For instance, Cetera has now started marketing INAV, and over the last few months have increased their sales nicely. They are just going to start as we speak V and III. They've been approved. And so, we're hoping to see some benefit of that in the tail end of the year. Advisor Group has approved V and has been increasing sales of V over the last few months. They will now being their due diligence on INAV and then III. So we are expecting to have some real nice push there. As we look at reestablishing net value, we'll then think about what we do about Cole, whether it's internal or external. Our goal is to increase value. We'll then decide whether the market is valuing it properly.

Got it, and one last one for me, the Red Lobster and Bob Evans exchange, can you discuss how that came about and if there is opportunity to do more?

Well, the Golden Gate Capital as you know owns Red Lobsters, is a terrific partner that's done a great job on Red Lobster. They purchased Bob Evans. And we saw an opportunity for us to sell Red Lobster, which is a goal. Even though the properties are doing well, we just want to take that concentration down. And at the same time, diversify our casual dining portfolio with Bob Evans, which is a brand we like certainly in the hands of Golden Gate. Not only we like them, they are 5,600 square feet. We've got good corners. And so, we thought it would be a good way to have an acquisition and disposition at the same time. It was an NOI exchange. And that allowed us to diversify on a purely non-dilutive basis. The valuation cap rate for Red Lobster, for each of the portfolio was 7.25. And remember, as we sell Red Lobster, as we have been selling Red Lobsters. The net to us is about 7 on an individual property. $50 million, 7.25 seems fair. And we thought it's a very fair price for Bob Evans. As a matter of fact, in terms of comps, we think that was very fair. So Golden Gate helped us. And we'd love to find opportunities like that. They're rare though.

Got it. Thank you [indiscernible].

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

Yes, good afternoon. Glenn, I was wondering if you could touch on the tenant watch-list, any notable change from last quarter and your insights just on retail, grocery store and movie theatre exposure.

Sure, I'll start out with the credit watch-list. Last quarter, we were just slightly over 2%. We're the same, Sheila. We really haven't changed very much. If you think about the quarter, there hasn't been as much noise in the second quarter as in the first. There's been some with a few mall tenants like True Religion and Michael Kors. And there's also been some discussion on movie theatres. We have none. So I could answer that right away for you.

Thank you.

And so we have found the quarter that didn't change much at all in our credit watch. I think your second part of that was retail and general.

Well, retail and also just your thoughts on grocery stores.

Got you. On grocers, our grocers are 4.5% our income right now. Of that, Albertsons is just about 2% - got 2.1% and then the rest are spread out amongst many others. No other grocer more than 0.7%. And so, they're pretty diversified group of grocers. We feel pretty good about it. They're traditional and compete well. The sales are good for the grocers we get sales for. Our total occupancy cost is 2.7%. And so we're well within the range of them being able to pay us. And so we're happy with the grocer concentration we have right now.

Okay, great. And one follow-up, on the legal settlement process, if you can just give us your insight, if the guilty verdict on the prior CFO, does that have any impact on this legal process. And then if you can just give us some insight, I know you can early comment on magnitude and stuff, but just key assign on kind of the steps in terms of timing, you mentioned in August Day, and that was in the Q, so just some clarity that you can frame for us on that?

On the court case, Sheila, what I can say is that the civil lawsuits will continue to proceed on the contract, there are no change in that. In terms of the timing, class certification was the concept that I just talked about in that. What will be reviewed on the August Meeting.

Okay. And so will there be news in August that you would - that we would hear or that just like a formality?

There could be news, because the court could rule on the class certification in it, so we would announce whatever that ruling is, it's not just a formality, it's a formal process.

Okay. Thank you.

Okay. Thank you.

The next question comes from Michael Knott with Green Street Advisors. Please go ahead.

Hey, guys. Glenn, just curious how are you thinking about the Red Lobster concentration, if you still expect to get that down to 6% by the end of the year. And then what the timing would be to hit the ultimate goal on that?

Yeah, we're at 7 now which is pretty good. I think, there is a shot to get close to 6%. We clearly, we are marketing them, Michael, we are continuing to do that. But we are making sure, we are marketing them prudently, we have gained continually there, as you can see that's a good part of the $200 million in gains we've had. We bought them at 7.8 and we're selling them at less. And we expect to continue that. So I'd say there is a good chance, we'll get very close to 6%. And then, we will look into next year to move it down to the 5% range.

And then just in general, if it does turnout that you are sort of pivoting in the back half more towards being a net buyer, just curious I think about sort of extrapolating the trend into 2018, if you were in our shoes, how would you think about, how much of pivoting that might be, how are you thinking about your cost of capital today?

I think, part of your question is net buyer. We would expect in 2018 to have less disposition activity, because our portfolio as we've illustrated getting pretty close to where we would like to be from a diversification standpoint. So if we do - we have left disposition next year. If we find acquisition activity that will help us be a net acquirer next year. So that's an expectation. In terms of cost of capital today, everything is self-financed. We talked about our net debt to EBITDA of 5.4 times, well below the target of 5.7 to 6. So we have debt capacity, and we have other disposition activity to finance those certainly to this year.

Thank you.

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

Good afternoon. So Glenn, I want to ask Mike's question in a different way. I know you have some contracts or obviously, some agreement in place to sell some Red Lobster next year, I think it's around 250 is all of that still a play here or is it now just really your ability or you guys are wanting to sell Red Lobster at your schedule?

It's really in our schedule. We have pretty good flexibility here. There are no constraints over the next year and all in terms of selling Red Lobster. So it's up to us, we like it, we love the 20 year leases, the exchange we've made of 20 year leases for Red Lobster's, for roughly 20 year leases of Bob Evans, so that's wonderful. But we'll continue to look at selling them at the right price.

Got you. And I just - one last question for me in terms of guidance. I think, you obviously narrowed the range, but if we kind of think of the cadence for the next two quarters, if dispositions slow, acquisitions pick up, it seems like, if nothing changes from your current levels, you already at the high end of the range, you have the net acquisition you might actually have some offside to that. So just curious about your thoughts in terms of how the playbook looks rest of the year?

The pickup on the bottom, I'd start there, is a result of being $0.01 over consensus as you can see $0.19 and $0.18, which we believe will stabilize that bottom. In terms of the top end of the range, you point is the exact point. How we have net acquisitions in the last half of the year. We have the capacity, and we certainly have the throughput we have in the first two quarters about $12 billion of deals given to us to take a look at. So the markets there, it's only a question of whether we find the transactions, we like it. We do there is a shot that we can get that at higher end.

Many thanks.

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

Good afternoon, everyone. Mike, just the question on the insurance recoveries related to litigation hasn't been any at least that I've seen in - reported in the Qs. What's the expectation in terms of the timing on something like that?

We continue to work with our agents and our lawyers were working on that, but we've never given guidance on that. We collect them - and report them as we collect them.

Okay. And then, Glenn, on the office sales that you've mentioned earlier in the call, I think, it was Dallas, was that a - was it vacant but paying tenant in that building? Or what exactly - could you give us a little more color on that?

Sure. That was a building in Plano, Texas. A good location, good building, 100% leased to Encana, the energy firm. Encana never occupied the building, but they sublet the building and actually had that building just beyond 90%. And so it's a good building, a little - the structure and the lease, for us with subtenants wasn't optimum. The buyer was some who had some land around that building, and by joining the land in the building, put together a nice property. And we think, we've got a very fair price.

And then, just shifting over to Cole quickly. I guess, I'm just wondering how you think about the pace of both the process for signing up new distribution agreements and then probably more importantly once they're signed, the pace to actually get these different platforms in the position where they have done their diligence and are actually able to sell the product. Is that - has that been occurring at a pace that you were comfortable with? Or it feels slow to me, but I'm just curious at how guys think about it.

Well, it is slower than you or would like, I'd say, Chris, just listening to you. Because if we just take Cetera and Advisor Group, who terrific companies. They have a very diligent due diligence process. I am surprised actually at the extent, but I admire it. They make sure that not only is the advisor acceptable, but each of the products goes through due diligence. And for instance, as I mentioned, Cetera initially not only diligence stuff, but INAV. Then it took a while for them to go through CCPT V and CCIT III. They just got through that. Advisor Group started out with V and now it's moved on to INAV and it will take some time for them to diligence INAV and then diligence III, it's a process. And whether I think gets too long or too short, doesn't matter. It's a reasonable process and we will work with them and we'll get through it.

Okay. Great. Thank you. Appreciate it.

Yeah.

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

We thank everybody for being with us this summer day and we look forward to speaking with you between now and the third quarter. Thank you.