U.S. Markets closed

Edited Transcript of STOR earnings conference call or presentation 2-May-19 4:00pm GMT

Q1 2019 STORE Capital Corp Earnings Call

SCOTTSDALE May 11, 2019 (Thomson StreetEvents) -- Edited Transcript of Store Capital Corp earnings conference call or presentation Thursday, May 2, 2019 at 4:00:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Catherine F. Long

STORE Capital Corporation - Executive VP, CFO, Treasurer & Assistant Secretary

* Christopher H. Volk

STORE Capital Corporation - President, CEO & Director

* Mary B. Fedewa

STORE Capital Corporation - Co-Founder, COO & Director

* Moira Conlon

STORE Capital Corporation - President, Financial Profiles, Inc.

================================================================================

Conference Call Participants

================================================================================

* Collin Philip Mings

Raymond James & Associates, Inc., Research Division - Analyst

* Craig Allen Mailman

KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst

* John James Massocca

Ladenburg Thalmann & Co. Inc., Research Division - Associate

* Ki Bin Kim

SunTrust Robinson Humphrey, Inc., Research Division - MD

* Nathan Daniel Crossett

Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst

* Robert Chapman Stevenson

Janney Montgomery Scott LLC, Research Division - MD, Head of Real Estate Research & Senior Research Analyst

* Robert Jeremy Metz

BMO Capital Markets Equity Research - Director & Analyst

* Todd Jakobsen Stender

Wells Fargo Securities, LLC, Research Division - Director & Senior Analyst

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Good morning, and welcome to the STORE Capital First Quarter 2019 Earnings Conference Call. (Operator Instructions) Please note this event is being recorded. I'll now turn the conference over to your host today, Moira Conlon. Please go ahead.

--------------------------------------------------------------------------------

Moira Conlon, STORE Capital Corporation - President, Financial Profiles, Inc. [2]

--------------------------------------------------------------------------------

Thank you, operator, and thank you all for joining us today to discuss STORE Capital's First Quarter 2019 Financial Results. This morning, we issued our earnings release and quarterly investor presentation, which includes supplemental information for today's call. These documents are available in the Investor Relations section of our website at ir.storecapital.com under News & Results, Quarterly Results.

I am here today with Chris Volk, President and Chief Executive Officer of STORE; Mary Fedewa, Chief Operating Officer; and Cathy Long, Chief Financial Officer. On today's call, management will provide prepared remarks, and then we will open the call up to your questions. (Operator Instructions)

Before we begin, I would like to remind you that today's comments will include forward-looking statements under the federal securities laws. Forward-looking statements are identified by words such as will be, intend, believe, expect, anticipate or other comparable words and phrases. Statements that are not historical facts, such as statements about our expected acquisitions, dispositions or our AFFO and AFFO per share guidance for 2019 are also forward-looking statements.

Our actual financial condition and results of operations may vary materially from those contemplated by such forward-looking statements. Discussion of those factors that could cause our results to differ materially from these forward-looking statements are contained in our SEC filings, including our reports on Form 10-K and 10-Q.

With that, I would now like to turn the call over to Chris Volk. Chris, please go ahead.

--------------------------------------------------------------------------------

Christopher H. Volk, STORE Capital Corporation - President, CEO & Director [3]

--------------------------------------------------------------------------------

Good morning, everyone, and welcome to STORE Capital's First Quarter 2019 Earnings Call. With me today are Mary Fedewa, our Chief Operating Officer; and Cathy Long, our Chief Financial Officer.

We began 2019 with a very active quarter on the investment front with investment activity of nearly $400 million, while adhering to the granularity and diversity we are known for. Mary will run through the numbers in more detail with you, but we're happy with our ongoing success of penetrating the large markets that we address while maintaining our focus on meeting the needs of our existing customers.

With the dividend payout ratio for the first quarter below 70% of adjusted funds from operations, a meaningful portion of our investment activity is being funded through retained cash flow. We pair that retained cash flow with our historic focus on maintaining annual tenant same-store rent contractual growth of nearly 2% to drive the majority of our expected AFFO growth per share. As Cathy will illustrate, we combined this internal growth with external growth that is intrinsically funded through new share issuances, which for the past 2 years have been successfully funded through our efficient at-the-market program.

During the quarter, we closed on our second issuance of public unsecured term debt, a $350 million offering of investment-grade rated 4.625% 10-year senior notes. As we have in past years, we expect to pair our unsecured debt offerings with other sources of efficient term borrowings, most notably our Master Funding conduit with its access to highly efficient AAA-rated notes.

At the conclusion of the first quarter, our pool of unencumbered assets stood at nearly $4.9 billion or about 61% of our gross investments, providing us with flexibility to our financing options and our unsecured noteholders with a very low unencumbered asset leverage profile.

Now as I do each quarter, here are some statistics that are relevant to our first quarter investment activity. Our weighted average lease rate during the quarter exceeded 7.8%. Add in the average annual contractual lease escalations for investments made during the quarter of 1.9%, and you get a gross rate of return of just under 10%. Now incorporate average corporate borrowings approximating 42% of investment cost at a spread over our borrowing cost of around 3.3%, and you'll arrive at a gross levered total return of better than 13%. This translates into returning after-tax cash operating cost of about 12%. Our outperforming investor returns from STORE and predecessor public companies been mostly driven by having favorable property-level rates of return, which is why we take the time to disclose investment yields, contractual annual lease escalations, investment spreads for our cost of long-term borrowings and our operating costs as a percentage of assets, which are the 4 essential variables that enable you to compute expected investment returns.

The weighted average primary lease term of our new investment contracts continues to be long at approximately 17 years. The median new tenant Moody's RiskCalc rating profile for the quarter was Ba3. The median post-overhead unit-level fixed charge coverage ratio for assets purchased during the quarter was 2.7 to 1. The median new investment contract rating or STORE Score for investments was favorable at Baa2. Our average new investment was made at approximately 71% of replacement cost.

98% of the multiunit net-lease investments made during the quarter were subject to master leases. And all 83 new assets that we acquired during the quarter are required to deliver us unit-level financial statements, giving us unit-level financial reporting from 98% of the properties within our portfolio. This fact is critical to our ability to evaluate contract seniority and real estate quality as well as to our access to capital, including our inaugural issuance of AAA-rated Master Funding notes in October of last year.

And with that, I will turn the call over to Mary.

--------------------------------------------------------------------------------

Mary B. Fedewa, STORE Capital Corporation - Co-Founder, COO & Director [4]

--------------------------------------------------------------------------------

Thank you, Chris, and good morning, everyone. 2019 is off to a strong start. In the first quarter, we invested nearly $400 million in real estate acquisitions at a weighted average cap rate of 7.83%. This included investments in 44 separate transactions at an average transaction size of just under $9 million. The strong demand for our solutions has enabled us to close an investment every 1.5 days during the past few quarters. This is how we have built such a highly granular and diverse investment portfolio.

At the same time, our portfolio remained healthy with an occupancy rate of 99.7% and with approximately 3/4 of our net-lease contracts rated investment grade in quality based on our STORE Score methodology. Delinquencies and vacancies remained very low due to our strong tenant partnerships and continued active portfolio management. At the end of the first quarter, only 8 of our 2,334 property locations were vacant.

Dispositions were light during the first quarter with only 4 properties being sold. One was opportunistic and was sold for a 15% gain over cost, while the remaining 3 sales were part of our property management activities and resulted in an aggregate cash loss of slightly less than $10 million. For our projected sales during the remainder of the year, we expect to realize net gains over our costs similar to our past sales results.

Now turning to our portfolio performance. Our portfolio mix at the end of the first quarter remained steady with 65% of properties in the service sector, 18% in experiential and service-driven retail with a substantial online presence, and the remaining 17% in manufacturing. Overall, our portfolio remained highly granular and well diversified by design. Our top 10 customers were unchanged from last quarter. And at quarter end, revenue realized from our top 10 customers was 18% of annualized rents and interest, down slightly from the end of last year. Our single largest customer, Art Van, represented 2.7% of our annualized rents and interest, which places us below our target of having no tenant exceed 3% of our annual revenues.

Heading into the second quarter, we are excited about our prospects for the rest of 2019. Our pipeline remains strong and cap rates are holding steady. The investments we made last year to expand our staff are yielding strong results as reflected in our continued success in penetrating our large target market. Our direct origination team continues to identify plenty of middle-market companies across a diverse set of industries and geographies that are in need of the attractive, long-term real estate solutions that we are uniquely qualified to deliver.

And now I'll turn the call to Cathy to discuss our financial results.

--------------------------------------------------------------------------------

Catherine F. Long, STORE Capital Corporation - Executive VP, CFO, Treasurer & Assistant Secretary [5]

--------------------------------------------------------------------------------

Thank you, Mary. I'll begin by discussing our financial performance for the first quarter of 2019, followed by an update on our capital markets activity and balance sheet. Then I'll review our guidance.

As Chris and Mary discussed, we continue to grow our real estate portfolio, and that growth is reflected in our first quarter revenues, which increased 24% from the year ago quarter to $156.6 million. The annualized base rent and interest generated by our portfolio in place at March 31 also increased 24% to $646 million.

Total expenses for the first quarter increased to $109 million from $85.4 million last year, with roughly half of that increase due to higher depreciation and amortization expense related to our larger real estate portfolio.

Interest expense increased to $38.1 million from $29.3 million due primarily to additional long-term debt used to fund property acquisitions. The weighted average interest rate on our long-term debt has remained relatively steady, increasing about 5 basis points year-over-year.

G&A expenses for the first quarter were $12 million, up from $10.9 million a year ago. As a percentage of average portfolio assets, G&A expenses decreased to 62 basis points from 68 basis points a year ago, primarily reflecting the scale advantages in our growing company.

Property costs increased by $1.2 million year-over-year, primarily due to the adoption of the new lease accounting standards in 2019. These new standards require us to present items, such as impounded property taxes and the ground lease payments our tenants make on our behalf, on a gross basis as both rental revenue and property costs. This amounted to about $1.3 million for the quarter.

We delivered another strong quarter of AFFO and AFFO per share growth in the quarter. AFFO increased by nearly 26% to $107.8 million from $85.9 million a year ago. On a per share basis, AFFO was $0.48 per basic and diluted share, an increase of 9% from $0.44 per basic and diluted share a year ago.

Finally, we declared a quarterly cash dividend of $0.33 per share while continuing to maintain our low dividend payout ratio of just under 69%.

Now turning to our capital markets activity and balance sheet. We funded our strong acquisition volume with a combination of cash flow from operations, long-term borrowings and equity proceeds from our at-the-market program. At the end of February, we issued $350 million of 4.65% (sic) [4.625%] senior notes due in the year 2029 and used the net proceeds to pay down our credit facility. In March, we renewed our $100 million bank term loan and reduced the spread over LIBOR by 10 basis points. Also in March, we issued $41.7 million in 10-year CMBS debt at 4.8%. And finally, we defeased $6.7 million in debt on a property that's pending disposition and included in real estate held for sale on our balance sheet.

During the quarter, we sold approximately 5 million shares of common stock under our ATM program at an average price of $32.31 per share, raising net equity proceeds of just over $158 million.

It's important to note that substantially all our long-term borrowings are fixed rate and our debt maturities are intentionally well laddered. Our median annual debt maturity is currently $287 million, and we have very little nonextendable debt coming due over the next couple of years. At quarter end, our leverage ratio was at the low end of our target range at 5.6x net debt to EBITDA on a run-rate basis, or around 41% on a net debt to cost basis.

Approximately 61% of our gross real estate portfolio was unencumbered at March 31, giving us substantial financing flexibility. We entered the second quarter with a strong balance sheet, a conservative leverage profile and plenty of liquidity to fund our acquisition pipeline. Our flexible funding sources include: $344 million of capacity on our $750 million equity ATM program that we launched last November; and the full amount available under our $600 million credit facility, which also has an $800 million accordion feature.

Now turning to our guidance for 2019. Considering our strong level of acquisition activity in the first quarter as well as our robust pipeline and positive outlook, we're affirming our 2019 guidance announced last November. Based on projected net acquisition volume of approximately $1.1 billion for 2019, we expect AFFO per share to be in the range of $1.90 to $1.96. Our AFFO guidance is based on a weighted average cap rate on new acquisitions of 7.85% and a target leverage ratio of 5.5 to 6x run rate net debt to EBITDA. AFFO per share in any period is sensitive to both the amount and timing of acquisitions, property dispositions and capital markets activities. Acquisition activity tends to be back-end weighted in each quarter. Our AFFO per share guidance for 2019 equates to anticipated net income of $0.88 to $0.91 per share, excluding gains or losses on property sales, plus $0.96 to $0.98 per share of expected real estate depreciation and amortization, plus $0.06 to $0.07 per share related to items such as straight-line rents, equity compensation and the amortization of deferred financing costs.

Before I turn the call over to Chris, I'd like to note a few changes to our balance sheet resulting from the new lease accounting standards this quarter. First, we recorded right of use assets of approximately $22 million for operating ground leases related to our portfolio. The right of use assets are shown as a separate line item in our portfolio on our balance sheet. Second, we recorded a right of use asset of approximately $5 million related to our corporate office in Scottsdale, which is included within other assets on our balance sheet. And third, we recorded a corresponding operating lease liability totaling $27.6 million, which is shown as a separate liability on our balance sheet. While these changes impact our financial statements, they don't impact our cash flows or the economics of our business. We'll provide additional details and disclosures related to the new lease accounting guidance in our upcoming 10-Q filing.

And now I'll turn the call back to Chris.

--------------------------------------------------------------------------------

Christopher H. Volk, STORE Capital Corporation - President, CEO & Director [6]

--------------------------------------------------------------------------------

Thanks so much, Cathy. As is customary for me to do, I will close with a few comments before turning the call over to the operator for questions.

We're in proxy season, and our proxy has 4 items to be voted on by stockholders. Three of these are the usual group of proposals, including the reappointment of our auditor, the approval of our board nominees for next year and the approval of executive officers' compensation based upon a review by our compensation consultants. The fourth is new and offers eligible stockholders the option to propose amendments to STORE's bylaws which proposals would be approved upon a majority vote of the outstanding shares entitled to be cast.

From day 1 as a public company, STORE has pursued best-in-class governance designed to limit management entrenchment, including being amongst the few REITs to actively opt out of MUTA or the Maryland Unsolicited Takeover Act. In this spirit, this proposal is intended to offer our long-term stockholders an added measure of control.

Our proxy this year also importantly contains expanded corporate disclosure regarding corporate responsibility, which is echoed by a new Corporate Responsibility tab in the front page of our corporate website and even in my recent annual letter to stockholders, which was made available at the time that we filed our annual 10-K with the SEC. Corporate responsibility discussions regarding the obligations of business leaders and Boards of Directors have been constructively promoted by many leading management teams and investment firms. We have taken a more proactive approach to such discussions in 2019 and look to count ourselves amongst these leaders.

From a broad corporate perspective, we take a view that the attention to ESG, or environmental, social and governance issues, is another way of thinking about our responsibility to all of our stakeholders. We actually started this company to meet the real estate capital needs of many real estate-intensive middle-market companies. So our customers are the stakeholders that inspired the formation of STORE Capital. Then came our stockholders and employees, followed by our business partners and the many communities around the country that we think can possibly impact the prudent investment of our capital alongside the growing businesses that are our customers.

Our measurement of success has always been to do well by all of our stakeholders. We win if we all win. This has been true for the 2 prior successful public companies that were founded and led by this leadership team and it's highly relevant today.

Finally, I recently offered my first Seeking Alpha post, which you might find interesting. The article addresses the business model dynamics of net-lease companies like STORE Capital and the 8 variables that we have as business leaders to mathematically drive our internal and external growth. Those 8 variables enable the computation of 6 additional key performance indicators as well as estimates of internal and external growth. Given such quantitative comparability, we started to benchmark ourselves against various peers at the beginning of the year based upon year-end 2018 data. In my opinion, quantitative business fundamentals like this are the foremost reason for STORE's outperforming and consistent stock performance from the beginning of 2015 to the end of 2018, while our share price to AFFO multiple differed little at these 2 points.

And with that, I'll return the call over to the operator for any questions you may have. Operator?

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) And the first question comes from Rob Stevenson with Janney.

--------------------------------------------------------------------------------

Robert Chapman Stevenson, Janney Montgomery Scott LLC, Research Division - MD, Head of Real Estate Research & Senior Research Analyst [2]

--------------------------------------------------------------------------------

Chris, given that you guys get financials on all your tenants, have any of them gotten hit with significant tariffs on Chinese-made goods? I'm thinking furniture, and maybe a few of the other businesses. And if so, what impact is that having on coverage?

--------------------------------------------------------------------------------

Christopher H. Volk, STORE Capital Corporation - President, CEO & Director [3]

--------------------------------------------------------------------------------

Rob, we've been looking at the tariff stuff since actually last summer. So as it started kicking in, we started actually surveying all of our tenants directly. And we hired a lot of summer -- interns for the summer, we stuck with the interns doing just that. They're calling up a lot of companies and just finding out exactly what the impacts were. And the answer to all of that is that so far, our customers are not impacted at all. And I think it's because a lot of them import goods away from China. I mean there are a lot of other places you can get goods, whether it's Vietnam or Thailand. If you're in the furniture manufacturing businesses, which is what you've cited, there are all kinds of other places where you can buy parts. And that's really kind of what happens in furniture manufacturing, you're buying parts from places and then you're selling them in the U.S.

--------------------------------------------------------------------------------

Robert Chapman Stevenson, Janney Montgomery Scott LLC, Research Division - MD, Head of Real Estate Research & Senior Research Analyst [4]

--------------------------------------------------------------------------------

Okay. And then how should we be thinking about the pace of acquisitions, and what's the acquisition market out there for you guys these days? I mean you maintained $1.1 billion. You guys did $400 million roughly in the first quarter. Is there less product out there that you guys want to deal with on sale-leasebacks and everything? Or is it just sort of April, early May conservatism in terms of raising the acquisition guidance for the year?

--------------------------------------------------------------------------------

Mary B. Fedewa, STORE Capital Corporation - Co-Founder, COO & Director [5]

--------------------------------------------------------------------------------

Rob, this is Mary. Acquisitions are going really well, but you will notice we didn't sell that much in the first quarter. So sales are a little bit lumpy as you know. So right now, $1.1 billion is a net number. So I would say that we're pretty much on track from a gross basis, yes. And I think that our pipeline's good.

--------------------------------------------------------------------------------

Christopher H. Volk, STORE Capital Corporation - President, CEO & Director [6]

--------------------------------------------------------------------------------

And we're -- so much in the flow business, it's very hard to be predictive at this point in time. So we had a terrific start to the year and we're encouraged by it. But it's too early to start changing guidance and it's too early to try to sort of measure exactly what the timing and the impact it can have on future quarters in terms of the pace of acquisitions or the pace of sales, as Mary just said.

--------------------------------------------------------------------------------

Operator [7]

--------------------------------------------------------------------------------

And the next question comes from Jeremy Metz with BMO.

--------------------------------------------------------------------------------

Robert Jeremy Metz, BMO Capital Markets Equity Research - Director & Analyst [8]

--------------------------------------------------------------------------------

Given the success of the model, what are your interests in expanding outside of the U.S., if at all? Is that something you'd consider? Or is there just more than enough to do here, that you just see no need to stretch yourself into other international markets?

--------------------------------------------------------------------------------

Christopher H. Volk, STORE Capital Corporation - President, CEO & Director [9]

--------------------------------------------------------------------------------

Jeremy, I mean this is a very personal decision for companies to make. I mean I would say that we think the market's big enough for what we do here so that we don't need to do it overseas. I think also it reduces the complexity of how we operate and allow us, investors, to buy dollar-denominated assets that are based in America.

--------------------------------------------------------------------------------

Robert Jeremy Metz, BMO Capital Markets Equity Research - Director & Analyst [10]

--------------------------------------------------------------------------------

All right. And then just looking at your top 10 list, I know it didn't change much, but you added about 10 properties with Cadence Education. Can you just give us some more color on what's attractive about early education? And then given your growing relationship there, do you expect to add more? I think they have over 200 schools out there? So is that something we can see grow here?

--------------------------------------------------------------------------------

Christopher H. Volk, STORE Capital Corporation - President, CEO & Director [11]

--------------------------------------------------------------------------------

Well, early child education is a service you can't buy over the internet. So you can't educate your kids very easily over the internet. It's a very hot topic in politics today in terms of people wanting to make sure that kids got a way of getting educated and especially having access to early education is an insanely fragmented business. So there are lots of smaller operators. Cadence is an aggregator. It's a brand name you've never heard of, partly because they acquire regional chains or regional players around the country And keep those brand names around the country. So it's actually a composite of a lot of different names, and they run it very well. So we're just big believers in the space.

--------------------------------------------------------------------------------

Operator [12]

--------------------------------------------------------------------------------

And the next question comes from Ki Bin Kim with SunTrust.

--------------------------------------------------------------------------------

Ki Bin Kim, SunTrust Robinson Humphrey, Inc., Research Division - MD [13]

--------------------------------------------------------------------------------

Can you just talk about some of the types of tenants that are moving that fixed-charge coverage ratio up and there's a category of tenants that are maybe pulling that number down?

--------------------------------------------------------------------------------

Mary B. Fedewa, STORE Capital Corporation - Co-Founder, COO & Director [14]

--------------------------------------------------------------------------------

So Ki Bin, this is Mary. When you're talking about the fixed charge coverage ratio, as you know it's much better. So our customers are doing really, really well and they're growing. And we have some -- they're acquisitive, as Chris just mentioned, on several of them. A lot of them are integrating acquisitions that they've made, and so forth, so they've had increased expense and some leverage and they'll realize the volume coming forward. So we have really strong units and we're in really favorable places on capital stacks on our units that are driving a lot of that coverage.

--------------------------------------------------------------------------------

Ki Bin Kim, SunTrust Robinson Humphrey, Inc., Research Division - MD [15]

--------------------------------------------------------------------------------

And how does furniture figure into that mix? It does seem like more -- I mean furniture is traditionally physical, it's not about being very internet resistant. But if you look at Wayfair's numbers and their sales are up 40% year-over-year. So maybe that brings into question kind of long term, how resistant it can be?

--------------------------------------------------------------------------------

Christopher H. Volk, STORE Capital Corporation - President, CEO & Director [16]

--------------------------------------------------------------------------------

This is Chris. I would say that, well, furniture is itself a fragmented business. And Wayfair's sales -- well, I mean there's been a lot of [ways], let's put it this way. I mean but a lot of it is home -- is what I'll call smaller home furnishings. A lot of it is stuff that you can just put together easily, it's assemblable. You have the bed in the box type stuff, which obviously is for people like Mattress Firms and whatnot of the world to some degree. On the other hand, it's very hard to ship a sofa and when you deal with furniture stores, they do more than just provide you with furnishings. They provide with financing as well, and they provide you with consulting and design. So I mean there's no successful retailer in America, in my personal view, that doesn't have a high service component to it. I mean, so that's where the industry is all going to. So if you're buying stuff over the Internet, don't expect a lot of service from that. If you're buying stuff in a facility, then you do expect service from that. And so all the successful furniture retailers are providing high levels of service and they're providing immediacy of delivery. So it's hard to get like a 1-day delivery of a sofa or anything like that. So all of these places have distribution facilities. If Amazon ever wants to get into the furniture business which -- and by the way, I think that when you deal with online retailing, all the low-hanging fruit has been taken. I mean you start off with books, that's the lowest hanging fruit there is. I mean there's just -- it's a complete commodity and then you move from there. So the low-hanging fruit has been very heavily invaded. Now you're getting into high-hanging fruit, and I think furniture is high-hanging fruit. It's there. You can get some share, no question. But there's just a lot of furniture that is just very, very difficult to ship and deliver and get them with same-time delivery. People want to try out furniture. It's a personal preference in terms of what they do and they want to pick out their fabrics, so for all those reasons, furniture retailers and successful furniture retailers will continue to be successful. And guys like Wayfair will find their niche.

--------------------------------------------------------------------------------

Ki Bin Kim, SunTrust Robinson Humphrey, Inc., Research Division - MD [17]

--------------------------------------------------------------------------------

So just to clarify, your tenants, if you look at the coverage ratio, then sales trends look pretty healthy?

--------------------------------------------------------------------------------

Christopher H. Volk, STORE Capital Corporation - President, CEO & Director [18]

--------------------------------------------------------------------------------

Yes, I would say so. I mean if you look across our furniture retailing, I would say probably same-store sales is pretty flat, but it's not down. I mean -- and we have some by the way that are down and some that are up. But if you look at the overall number, it's been flat; if you look at the overall unit-level coverages. And we've dabbled some in furniture manufacturing too, by the way, and there you have, on the furniture manufacturing side, you have people that are delivering to retail storefronts but then you also have the ability to take advantage of some of the online sales as well. So on that side of the business, you get to cover more fronts of distribution.

--------------------------------------------------------------------------------

Operator [19]

--------------------------------------------------------------------------------

And the next question comes from Collin Mings with Raymond James.

--------------------------------------------------------------------------------

Collin Philip Mings, Raymond James & Associates, Inc., Research Division - Analyst [20]

--------------------------------------------------------------------------------

Just looking at the pipeline sector distribution graphic, restaurants ticked down again, continuing a trend that would seem to suggest this is maybe less of an opportunity set than it once was. You discussed your restaurant exposure a couple of quarters ago on the call, but can you just maybe update us on your thoughts as it relates to both where the portfolio currently sits as far as restaurant exposure, and the flow of deal opportunities coming through the door?

--------------------------------------------------------------------------------

Christopher H. Volk, STORE Capital Corporation - President, CEO & Director [21]

--------------------------------------------------------------------------------

Well, we like the space a lot. And so it -- but I would say that we've been seeing less deal flow through the restaurant space in general. And we've also been seeing a lot of heightened competition and not really necessarily from the public players, but from a lot of other folks as well. And so when you start seeing plenty of these barbecue restaurants going off in the mid-6 caps, you know that there's a...

--------------------------------------------------------------------------------

Mary B. Fedewa, STORE Capital Corporation - Co-Founder, COO & Director [22]

--------------------------------------------------------------------------------

Money out there.

--------------------------------------------------------------------------------

Christopher H. Volk, STORE Capital Corporation - President, CEO & Director [23]

--------------------------------------------------------------------------------

There's a lot of money out there chasing restaurant deals. So we're out trying to be value buyers and we're buying real estate and making investments that we think generate great risk-adjusted returns. And while we think that plenty of these barbecues or other types of restaurants that have been selling at low cap rates are potentially interesting investments, we just don't like the returns as much. So that's why we've made that decision.

--------------------------------------------------------------------------------

Collin Philip Mings, Raymond James & Associates, Inc., Research Division - Analyst [24]

--------------------------------------------------------------------------------

Okay. And then moving back to furniture real quick, just drilling down, any incremental color you can provide on the increased exposure to Ashley and DSG in the quarter? And just what the pipeline of future opportunities exist with them?

--------------------------------------------------------------------------------

Christopher H. Volk, STORE Capital Corporation - President, CEO & Director [25]

--------------------------------------------------------------------------------

So Dufresne Spencer Group is the largest Ashley distributor in the country. So they don't have franchisees, they have licensees. So they're a largest licensee, and they have been growing in part through acquisition and so that increase to Dufresne Spencer during the quarter was -- resulted from their acquisition. And Dufresne Spencer, by the way, is very heavily owned by Ashley Corporate, and so in a way, it's part and parcel of the entire vertically integrated system.

--------------------------------------------------------------------------------

Operator [26]

--------------------------------------------------------------------------------

And the next question comes Nate Crossett with Berenberg.

--------------------------------------------------------------------------------

Nathan Daniel Crossett, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [27]

--------------------------------------------------------------------------------

I wanted to touch on cap rates and the growth spread over your cost of debt. And I know you have a slide in your presentation that showed you have the highest spread of the net lease players. So my question is, we've seen some of the larger players willing to acquire at a lower and lower cap rate versus what they've done historically. And so I just want to get a sense from you as to is there a level of spread that you just won't go below. And do you think you'll be able to kind of achieve that roughly 5% spread over the medium to long term?

--------------------------------------------------------------------------------

Christopher H. Volk, STORE Capital Corporation - President, CEO & Director [28]

--------------------------------------------------------------------------------

Okay. Well, the answer is that we've run public companies with far less spread. We've run successful public companies in previous lifetimes with less spreads than we're getting today. And so there is room to bring in our spread and still generate nice rates of return. That being said, we're not just in the spread business. I mean spread's nice, but the numerator matters. So whether you're investing in a 7 cap or a 6 cap, whatever, I mean the absolute dollar -- the absolute numerator does matter from a shareholder return perspective. And so we're mindful of both the spread and what the numerator is.

As I said earlier to the prior question, we are value investors. So we are looking to generate high rates of return. It's important that we be able to buy assets at yields that are in excess of where the auction marketplace would be at any given time. We'd like to be able to sell the assets the following day and actually make money on it if that's what we wanted to do. So we want to buy things. You can't buy at cap rates you can't get, is really what we'd like to do, with leases that you can't get.

And now in terms of margin for error, we have a flat ton of margin for error. So if you -- our investment AFFO yield is sub-11, which essentially says to you that with a -- if our yield -- somehow our AFFO yield gets hammered from 17 and we're going to stay down to 11, we can still actually buy stuff, up to that point and still make it work in terms of making incremental rates of return. That spread is probably the highest in the net lease space, and it means we're the most -- we have a very resilient platform, which we're very proud of. It also is a very big reason why we've been creating more compound [MDA] per share growth than anybody else in the space, which is also an exhibit on the pages that you were talking about. So it's -- so our defined definition of a win is not just hitting AFFO growth per share, but it's also hitting -- creating the most shareholder value growth on a compounded basis over the cost of our equity capital. And we're mindful for that. And if we have a -- if our cap rate or our multiple goes to 20 or goes higher, we're not going to take advantage of that multiple to, say, you wouldn't go do a lot of [keeper] stuff. We've been at high multiples. And they were at nice multiples, but we've been at higher multiples. And we haven't gone or run after investment-grade tenants or whatnot. We've made a very disciplined decision to go after the middle-market, stick to our knitting, and then that's what we're doing.

--------------------------------------------------------------------------------

Nathan Daniel Crossett, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [29]

--------------------------------------------------------------------------------

Okay, that's helpful. And then you mentioned on the call earlier that there were staff investments last year. Just curious as to how that continues to grow as you continue to get bigger. Are you expecting further investments this year? Maybe just a little color there.

--------------------------------------------------------------------------------

Christopher H. Volk, STORE Capital Corporation - President, CEO & Director [30]

--------------------------------------------------------------------------------

Yes. I mean -- and Mary can join on this, but I would say last year, we spent a lot of time sprucing up certain areas. I mean there are certain parts of this company that are just going to grow on the staffing front. And one of them is on the asset portfolio management side. We've been spending a lot of time also in terms of beefing up our middle management in this company a lot. And so we did that. That being said -- that being said, if you were to look at our numbers, and then I'm going to do something the way you don't know normally do it, but if you were to take our property costs, so basically the cost of running -- all the property costs, and back out all the reimbursable stuff. So Cathy Long talked to you about what's reimbursed to tenant in terms if ground leases and that kind of stuff. So if you were to look at our net cash property cost and you were to add our cash G&A cost, which back out the shareholder compensation which is -- an add it back to AFFO and is noncash anyway, and you were to take those cash costs, those collected cash costs and divide into average assets, and you were to do this -- I didn't do this for this quarter, but at the end of last quarter, at the end of FY '18, it would be around 60 basis points, maybe 59 basis points to run this. That would be the -- as efficient a net-lease company as there is. And we're not even the biggest. So we are incredibly efficient. We've been efficient because we have an exceptionally high occupancy rate. We have very little in the way of double net-lease properties requiring us to have any obligations for them. And we have invested a lot in IT technology, which allowed us to be more efficient. And we've outsourced certain aspects of our servicing platform, which have allowed us to be more efficient. So that basically, this company today has 90 employees running over the 2,500 properties with almost no administrative employees at all. And so we've -- and we've basically outsourced all of that. I mean so from an operating perspective, I just want to point out that if you were to sort of do the math -- and you have to do it a little bit forensically, so you have to peel back all these numbers, you would find that we're just insanely efficient relative to anybody out there.

--------------------------------------------------------------------------------

Operator [31]

--------------------------------------------------------------------------------

Next question comes from John Massocca with Ladenburg Thalmann.

--------------------------------------------------------------------------------

John James Massocca, Ladenburg Thalmann & Co. Inc., Research Division - Associate [32]

--------------------------------------------------------------------------------

So properties not operating but subject to the lease jumped a little bit kind of quarter-over-quarter, can you provide some color on what caused that, and maybe the lease term roughly remaining on those assets or any potential resolutions for those properties?

--------------------------------------------------------------------------------

Mary B. Fedewa, STORE Capital Corporation - Co-Founder, COO & Director [33]

--------------------------------------------------------------------------------

Sure, John. This is Mary. So yes, I would say that the majority of those are in -- majority of those individual properties are in master leases. So a little over 70% are in master leases, and they are just simply individual properties that we're working through with tenants in a master lease, that they're looking to make some change. And in one case in particular, they actually closed the site to remodel and reimage, and then they're going to reopen that site. So it's a combination of those kind of activities, operational flexibility. But as you know, we have a substantial portion of our leases in master leases. I think it's like 91% in master leases. And so that's helpful. These are individual properties covered by the master lease, and we're working with tenants on that. There's no concentration in any one tenant. It's an entire diverse list of tenants. So...

--------------------------------------------------------------------------------

Christopher H. Volk, STORE Capital Corporation - President, CEO & Director [34]

--------------------------------------------------------------------------------

John, I think we may be -- this is Chris. I don't know how many people even disclose the number of properties that are empty but paying rent. I mean others are afraid to comment or disclose properties are empty and not paying rent. But I mean we've been disclosing this intentionally just because we think it's just important to keep abreast of it, and it forces us to keep that number down. So our servicing group works for the tenants to basically minimize that number and find ways to either close stores, sublease stores, swap stores out. And we're doing a transaction right now with one of our tenants to swap out 10 properties, so 10 properties they don't like for 10 properties they do like. So -- and this is all part and parcel of the business that we're in.

--------------------------------------------------------------------------------

Mary B. Fedewa, STORE Capital Corporation - Co-Founder, COO & Director [35]

--------------------------------------------------------------------------------

Keeps our master leases really healthy.

--------------------------------------------------------------------------------

John James Massocca, Ladenburg Thalmann & Co. Inc., Research Division - Associate [36]

--------------------------------------------------------------------------------

That make sense. And then your exposure to manufacturing has kind of grown steadily over roughly the last 18 months. What is making those types of assets attractive, especially given kind of continued cap rate compression in that space in the amount of capital chasing industrial? And how are you able to kind of endorse acquisitions that have returns kind of in line with your kind of historical averages?

--------------------------------------------------------------------------------

Christopher H. Volk, STORE Capital Corporation - President, CEO & Director [37]

--------------------------------------------------------------------------------

Well, I mean we do a fair amount of business direct, and that always helps. I would say that the businesses that we're doing tend to be very basic blocking and tackling businesses that are -- they're not sexy. And they've been around for long time, and we think they have no functional obsolescence. They're going to be around for a while. We'll probably -- my guess is that -- we'll probably get manufacturing, we'll stabilize between 15% and 17% of where we are. And so I don't think that you're going to see it creep up a lot more from where it is.

--------------------------------------------------------------------------------

Operator [38]

--------------------------------------------------------------------------------

And the next question comes from Todd Stender with Wells Fargo.

--------------------------------------------------------------------------------

Todd Jakobsen Stender, Wells Fargo Securities, LLC, Research Division - Director & Senior Analyst [39]

--------------------------------------------------------------------------------

For the acquisitions in the quarter, the lease escalators came in above your overall portfolio average. You've already got the highest rent bumps in the net-lease space. Can you talk about how you ask for these or require these, I guess, in your negotiations? And then should we expect this to keep edging up closer to 2% over time?

--------------------------------------------------------------------------------

Mary B. Fedewa, STORE Capital Corporation - Co-Founder, COO & Director [40]

--------------------------------------------------------------------------------

Todd, this is Mary. So we -- the direct origination engine here actually asked for these escalations. So it's really simple. You go meet with a CEO or a CFO or someone on the leadership team and you talk about what value we can add and how they can be better off if we owned their real estate versus them. And we -- generally, there's some sort of -- there's always a use for the funds. So they're either recapitalizing their balance sheet, they're making an acquisition. Maybe there's some estate planning going on, so we're creating a solution for them and adding value. And once we figure that out, we say that will be -- thank you very much, the rates will be -- the escalations will be this, and the net on this frequency. So our salespeople are actually paid to ask for higher escalations and more frequent escalations, so they make the ask. And it's really that simple. And I think that 2% annual is sort of the market escalation rate. So generally, you'll see -- I don't see you'll see much higher than that as we move forward but...

--------------------------------------------------------------------------------

Christopher H. Volk, STORE Capital Corporation - President, CEO & Director [41]

--------------------------------------------------------------------------------

If you were to like look at LoopNet or something like that, it's very common to see escalators of like 10% every 5, which becomes -- which actually works out to like 1.9 years something, on a compounded basis -- 1.8 on a compounded basis. We tend to push for the annual escalations because we don't want to wait around for 5 years. And because we asked for 10% every 5 years, then in the last periods, you sometimes just don't get those escalations. They'd mystically go away. And so we do that and so the majority of our escalators are annual.

--------------------------------------------------------------------------------

Todd Jakobsen Stender, Wells Fargo Securities, LLC, Research Division - Director & Senior Analyst [42]

--------------------------------------------------------------------------------

Okay. Appreciate that. And then just looking at medical and then medical, dental and then behavioral health keep ticking up. Can you guys talk about how you're underwriting those, maybe length of leases, and then just speak to the fungibility of the real estate?

--------------------------------------------------------------------------------

Christopher H. Volk, STORE Capital Corporation - President, CEO & Director [43]

--------------------------------------------------------------------------------

Behavioral health's been staying sort of flat for the last 3 years, but -- and that includes everything from eating disorders to drug rehab, alcohol rehab. We've done a handful of those, but I wouldn't say we have a big push on it. On the medical, dental, we've been seeing some of that. They've been just roll-up concepts of dental practices and certain medical practices, and whether it's dermatology or whatever, in terms of how fungible they are, they's really fungible. I mean they are assets that oftentimes were used as a -- or had other prior -- previous uses prior to being medical or dental facilities. Sometimes they are in areas where there's just nothing but medical and dental offices around, so that they're in a hub like that. But I would say they're highly fungible.

--------------------------------------------------------------------------------

Operator [44]

--------------------------------------------------------------------------------

And the next question comes from Craig Mailman with KeyBanc.

--------------------------------------------------------------------------------

Craig Allen Mailman, KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst [45]

--------------------------------------------------------------------------------

Maybe just to ask an earlier question a little bit differently. I know you guys don't like to address investment guidance at this point in the year. But can you maybe just give us a little bit of color on where you stand on the remaining dispositions? Because if you just annualize this quarter's AFFO, you're kind of $0.01 below the midpoint of the range. So just trying to get at what are kind of the puts and takes here as you go through the balance of the year that kept the midpoint unchanged.

--------------------------------------------------------------------------------

Christopher H. Volk, STORE Capital Corporation - President, CEO & Director [46]

--------------------------------------------------------------------------------

You think we're at midpoint -- well, I would say that I -- we don't -- you're suggesting we should lower our guidance?

--------------------------------------------------------------------------------

Craig Allen Mailman, KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst [47]

--------------------------------------------------------------------------------

No, no, no. You guys are -- just this quarter, you're already at above 92% annualized and you typically do more acquisitions sort of at the end of the quarter. So...

--------------------------------------------------------------------------------

Christopher H. Volk, STORE Capital Corporation - President, CEO & Director [48]

--------------------------------------------------------------------------------

Okay. I mean I would say -- I mean some of the questions we have gotten from people are why we're not out raising our guidance. And the answer is just because we're in a flow business and there's a lot of things that can happen. And so we -- for the last 3 years, we -- I'm proud to tell you that we have given guidance in November of the preceding year and we've actually come in the range of that guidance for basically 3 years straight without really adjusting outside of that range. I mean so we've been very predictable in terms of what we've been doing. With any luck, this year we'll be not too far off from that from a guidance perspective. And in terms of property sales activity, property sales activity really, really waffles from quarter to quarter. So -- and you can look last year and see from quarter to quarter that we did some -- some were incredibly busy disposition quarters; some were not. We've been selling $250 million of these, plus or minus, worth of real estate for the last 2 years. I think that you can see us selling $250 million to $300 million worth of assets and potentially more. I mean -- but during the course of this year, this last quarter, we actually lost money on the assets we sold. I mean Mary pointed out we made a lot of money on one asset, but it was offset by money on assets that we sold that we lost some money on. But during the course of the year, my expectation is that you'll see us make a fair bit of money on selling assets in the aggregate, which is what you're trying to do. And then we have a disclosure in our book on the property sales where you can see that they've been -- our property sales and our -- from a cap rate perspective, has tended to be a lower cap rate on property sales than our investment cap rates, which allowed us to roll the cash accretively last year and at probably 0.5 point to internal growth. In most years, that's less than that. So last year was just a good year. On the average, this adds about 10 basis points to internal growth and -- but it's sort of there as part of the engine of balancing the portfolio and adding another way to grow our AFFO per share.

--------------------------------------------------------------------------------

Craig Allen Mailman, KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst [49]

--------------------------------------------------------------------------------

That's helpful. I guess what I was trying to get at is you guys only did $17 million of dispos in the first quarter. Do you have anything else under contract or any visibility on kind of, is it going to be more back-end weighted in the year is what I'm trying to get at.

--------------------------------------------------------------------------------

Christopher H. Volk, STORE Capital Corporation - President, CEO & Director [50]

--------------------------------------------------------------------------------

Well, the answer is sure. I mean the answer is we do have items under contract today. We always have items under contract. We don't give disclosure on that. I don't know, I expect -- I can't say how the second quarter is going to pencil out. I mean I can probably give you an indication, but I won't. But it will vary. And I think that we'll hit our numbers for this year. Do you assume it's back-end weighted for the purposes of your investment? Well, if you assume it's back-end weighted, then basically it doesn't really take away as much from AFFO per share, so it causes you to raise your estimates. So if you assume it's more front-end weighted, then it will be sort of more neutral to your estimates of AFFO per share. I would probably assume that it's more neutral.

--------------------------------------------------------------------------------

Moira Conlon, STORE Capital Corporation - President, Financial Profiles, Inc. [51]

--------------------------------------------------------------------------------

Yes, and we've prior had a second -- a large second quarter of sales. Q2 sometimes has a lot of sales. And as you know on our balance sheet, we do have real estate investments held for sale of $15 million but on the intent it would go out pretty quickly, if that helps.

--------------------------------------------------------------------------------

Operator [52]

--------------------------------------------------------------------------------

Thank you. And we have reached the end of the question-and-answer session. So at this time, I'd like to return the conference over to Chris Volk for any closing comments.

--------------------------------------------------------------------------------

Christopher H. Volk, STORE Capital Corporation - President, CEO & Director [53]

--------------------------------------------------------------------------------

Well, thank you all for attending the first quarter 2019 earnings call. Mary and Cathy and I will be attending REIT Week in New York City in June, so let us know if you'd like to arrange a meeting then. And until then, we're around for any follow-up questions as usual during the day. Have a great day, everyone. Thank you.

--------------------------------------------------------------------------------

Operator [54]

--------------------------------------------------------------------------------

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