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Edited Transcript of VER earnings conference call or presentation 8-May-19 5:30pm GMT

Q1 2019 VEREIT Inc Earnings Call

New York May 20, 2019 (Thomson StreetEvents) -- Edited Transcript of VEREIT Inc earnings conference call or presentation Wednesday, May 8, 2019 at 5:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Bonni Rosen

VEREIT, Inc. - SVP of IR

* Glenn J. Rufrano

VEREIT, Inc. - CEO & Director

* Michael J. Bartolotta

VEREIT, Inc. - Executive VP & CFO

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Conference Call Participants

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* Anthony Paolone

JP Morgan Chase & Co, Research Division - Senior Analyst

* Christopher Ronald Lucas

Capital One Securities, Inc., Research Division - Senior VP & Lead Equity Research Analyst

* Mitchell Bradley Germain

JMP Securities LLC, Research Division - MD and Senior Research Analyst

* Richard Jon Milligan

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Sheila Kathleen McGrath

Evercore ISI Institutional Equities, Research Division - Senior MD

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Presentation

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Operator [1]

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Good afternoon, and welcome to the VEREIT First Quarter 2019 Earnings Conference Call. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Bonni Rosen, Head of Investor Relations. Please go ahead.

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Bonni Rosen, VEREIT, Inc. - SVP of IR [2]

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Thank you, Gary. Thank you for joining us today for the VEREIT 2019 First 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 2:30 p.m. Eastern Time today. Dial-in for the replay is 1 (877) 344-7529 with the confirmation code of 10130427.

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 material 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, let me turn the call to you.

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Glenn J. Rufrano, VEREIT, Inc. - CEO & Director [3]

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Thanks, Bonnie, and thanks for joining our call. We're pleased with our operational results for the quarter, AFFO per diluted share was $0.18. Year-to-date acquisitions totaled $125 million, and dispositions totaled $244 million. Net debt-to-normalized EBITDA was reduced from 5.9 to 5.7x.

Last year, we repurchased $50 million of stock at an average price of $6.94. Year-to-date, we have sold $42.5 million through our ATM at an average price of $8.42, and we have formed an institutional partnership, including 6 VEREIT industrial assets totaling $407 million, expected to close by the end of May.

Leasing for the quarter was very active at 847,000 square feet and occupancy ending at a healthy 98.9%. In addition, same-store rent was up 0.9%. Of our 847,000 square feet of leasing activity, 815,000 square feet were renewals with 237,000 square feet early renewals. For renewals, we recaptured approximately 102% of prior rents. Notable renewal activity included 397,000 square feet of office, 224,000 square feet of retail, including 8 bank branches.

The beginning of 2019 has seen elevated store closings compared to 2018 with roughly 6,000 announced along with 2,800 openings. A large portion of the closures were due to bankruptcies of Payless and Gymboree of which we have no exposure. They're not in our merchandise categories.

Another big component was Shopko. We have only one small hometown location. Family Dollar, owned by Dollar Tree, announced they would seek to close as many as 390 of their 8,000 stores, while opening 550 and renovating 1,000.

To date, they have indicated 18 of our 388 stores would be closed or 0.1% of ARI. 14 of the stores related to close are in the -- are in master leases and have a range of 8.1 to 13.5 years of remaining term. 4 stores have 4 years or less, with the earliest being 2 years. As you can see, there'll be no near-term impact on our cash flows.

Moving to our transaction activity. We find ourselves in a reasonable macro environment. Interest rates remain muted and appears to be a healthy debt and equity market-bolstering activity. That as a [backstop], year-to-date acquisitions totaled $125 million and included our preferred retail merchandise categories: home and garden, home furnishings and fitness. Dispositions have outpaced acquisitions at $244 million, which included a large office sale for $139 million at the end of April. This property was located in El Segundo, California with a tenant vacating and was a redevelopment opportunity. We're able to sell this property at a very attractive $400 a square foot. The lease was expiring in 2019, and we will reduce our lease rollover exposure for the year from 2.3% to 1.5%.

Our top 10 tenants now represent 27.1%, and we continue to call restaurants, office, flat leases and noncore. As important, we are focused on our debt balances. We reduced net debt to normalized EBITDA from 5.9x to 5.7x.

Before Mike reviews our financial results, let me provide a brief update on litigation. On April 17, a status conference with the court was held, where the judge denied the motion for summary judgment and set a schedule for expert discovery. Year-to-date, the company has entered into a series of agreements to settle claims with shareholders who decided not to participate as class members for approximately $28 million.

In total, the company has now settled claims of shareholders, representing approximately 35.3% of VEREIT's outstanding shares of common stock held at the end of the period for approximately $245 million. As you're aware, the judge has set a trial date for September 9. Additional details regarding pending litigation can be found in our 10-Q filed today.

Let me now turn the call over to Mike.

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Michael J. Bartolotta, VEREIT, Inc. - Executive VP & CFO [4]

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Thanks, Glenn, and thank you all for joining us today. We had a solid quarter, achieving AFFO of $0.18 per diluted share. And as usual, we'll focus on earnings from continuing operations for this call.

For the quarter, rental revenue increased $3.6 million or 1% to $316.8 million. Net income increased $43 million to $71 million, primarily due to $48.4 million of insurance recoveries along with lower depreciation and amortization of $16.5 million, partially offset by a lower gain on the disposition of real estate of $15 million and a $9.1 million restructuring charge taken in Q1 of 2019. This charge is associated with rightsizing our operations due to the ending of the Cole Capital transition services agreement at the end of March.

FFO per diluted share increased $0.03 from $0.16 to $0.19, mostly due to the Q1 insurance recovery, partially offset by the restructuring charge and $7.5 million of lower other income, which was due to Q4 2018 gain on the sale of certain mortgage-related securities and the unexpected receipt of a prior fully reserve receivable in Q4. AFFO per share increased approximately $0.5 to $0.18, mostly due to higher revenue and a lower cash G&A of $2.1 million.

The G&A decrease quarter-over-quarter was primarily due to the customary higher year-end compensation and other accrual adjustments that we noted in Q4. Also, as mentioned last quarter, we're anticipated taking an $11 million restructuring charge in 2019, of which approximately 80% relates to reducing space in our Phoenix and New York offices. So far, we have taken $9.1 million. The total restructuring amount includes roughly 40% of noncash items, such as the write-off of leasehold improvements and fixed assets of the Phoenix office.

During the quarter, there were $14.7 million of litigation-related expenses. In addition, subsequent to the quarter, we settled additional shareholders out of the class for approximately $12.2 million, which was accrued in the first quarter expenses. As we mentioned last quarter, we received $48.4 million of insurance proceeds, bringing the litigation-related line item in the financials to a net positive of $21.5 million in Q1.

Turning to our first quarter real estate activity. The company purchased 8 properties for $81 million at a weighted average cash cap rate of 6.8%. In addition, the company invested $4.5 million in one build-to-suit project. Subsequent to the quarter, the company acquired 3 properties for $44 million. During the quarter, we disposed of 22 properties for $62 million. Of this amount, $59 million was used in the total weighted average cash cap rate calculation of 6.9%, including $25.2 million of net sales of Red Lobster. The gain on the first quarter sales was approximately $11 million. In addition, the company sold certain legacy mortgage-related investments during the quarter for an aggregate sale price of $8 million. And then subsequent to the quarter, the company disposed of 14 properties for $173 million.

We continue to strengthen our balance sheet and remain very liquid. In February, we utilized the remainder of our delayed drawn term loan to pay the $750 million bond, which matured, and we also entered into an interest rate swap, fixing the interest rate on the $900 million term loan at 3.84%.

In addition, secured debt was also reduced by $2.4 million during the first quarter. Our net debt-to-normalized EBITDA ended at 5.7x. We're updating our net debt to normalized EBITDA target from approximately 6x to a range of 5.7 to 6x. Our fixed charge coverage ratio remained healthy at 3x, and our net debt-to-gross real estate investments ratio was 39%. Our unencumbered asset ratio was 75%, the weighted average duration of our debt was 4.5 years and were 97% fixed.

And with that, I'll turn the call back to Glenn.

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Glenn J. Rufrano, VEREIT, Inc. - CEO & Director [5]

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Thanks, Mike. Since 2015, we've completed over $11 billion of capital transactions to reshape VEREIT. We continue to focus on capital allocation and capital cost by selling assets such as the El Segundo office building and recycling its assets that enhance the portfolio, managing our balance sheet to investment-grade status, thereby reducing the cost of our bank and bond debt, and selling flat leases, which capital can be more productive in our balance sheet.

This quarter, we have demonstrated 2 additional methods of working our capital to benefit VEREIT: one, by issuing equity through our ATM at an advantageous spread to the buyback just last year; and the second, by using internal assets to seed an institutional partnership, providing lower cost capital in a business growth format.

The institutional partnership was formed with the objective of creating an increasing portfolio of investment-grade industrial properties. The traditional 80-20 structured partnership will initially include 6 VEREIT industrial assets totaling approximately $407 million at a cap rate just under 6%. The partnership is expected to close by the end of May.

Our latest market activity is intended to create value within our balance sheet by adding to our asset base a high return on capital business and reducing debt levels and an attractive cost of capital.

I'll now turn open the line for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question comes from Sheila McGrath with Evercore ISI.

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Sheila Kathleen McGrath, Evercore ISI Institutional Equities, Research Division - Senior MD [2]

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Glenn, I wanted to ask you about the industrial JV. Are you still committed to the diversified approach with retail, industrial and office? And what do you envision the ideal sector mix for VEREIT?

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Glenn J. Rufrano, VEREIT, Inc. - CEO & Director [3]

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Well, we are committed to diversification, Sheila. Within the boundaries that we talked about, we're still about 40% retail, roughly 20% restaurant, 15% to 20% office and 15% to 20% industrial. We have been taking our office down to the lower end of that range, as you can see, with the large office building we sold this quarter, and we'd like to keep industrial within that range as well, that 15% to 20%. The -- And the partnership isn't intended to change diversification. It's actually intended to potentially provide more investment-grade industrial assets for us. [But the] pricing is pretty tough. But with the partnership, we can participate in the growth of that business line.

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Sheila Kathleen McGrath, Evercore ISI Institutional Equities, Research Division - Senior MD [4]

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And for modeling purposes, when should we assume that starts? And are there related fees to VEREIT?

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Glenn J. Rufrano, VEREIT, Inc. - CEO & Director [5]

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Well, we're expecting to close by the end of the year with the $407 million -- by, I'm sorry, the end of May at $407 million, and that will be about $340 million in proceeds to us. The fee stream, I would say, is a commercial partnership fee stream of property management fees, asset management fees, a promoted interest and on future deals, an acquisition fee. The growth of it, we're not sure of. We have a partner that we believe -- and it's an offshore partner. At this time, we have confidentiality, and so we're not exposing some of the detail. We will when we close. The growth of the partnership will depend upon good assets to purchase. Together, we hope this puts together a reasonable size portfolio.

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Operator [6]

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The next question comes from Anthony Paolone with JPMorgan.

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Anthony Paolone, JP Morgan Chase & Co, Research Division - Senior Analyst [7]

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Just broadly, can you talk about -- you did a little bit of equity getting closer to maybe something happening on the litigation front, and you've now got the industrial joint venture. Just the ability to move towards a more consistent flow of acquisition or investment activity. Like, do you think the team is in place? Like, are we moving in that direction?

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Glenn J. Rufrano, VEREIT, Inc. - CEO & Director [8]

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Yes. We certainly hope so, Tony. I'll start off with the first part of the question on the equity and its positioning. As we look at asset allocation, we have 3 very important guidelines: accretion, dilution, portfolio of quality. We're continuing to have a portfolio of quality and continuing to have a very good balance sheet, certainly investment grade. When we issued equity this quarter at $8.42 a share, it's approximately 7% enterprise value. And if you look at the dispositions we've had, it's approximately 6.8% to 7%. And if you then take into consideration the partnership we're putting in place, it's just below 6%. And if you were to use cap rates as an indication of cost of capital, and I think it's pretty close for us, not the exact (inaudible) but it's pretty close, I think we put together a good mix of cost of capital to minimize any dilution to bring our balance sheet north. And that's the thought process behind the allocation of capital this quarter.

Your last part of the question is, do we have the machine in place? Absolutely. We have bought over $4 billion -- we disposed of over $4 billion of assets, bought a $1.5 billion. We put the portfolio in really good shape. We have a good balance sheet and as important as all of that, we've maintained a really good team for us to grow once we get over this year. Yes.

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Anthony Paolone, JP Morgan Chase & Co, Research Division - Senior Analyst [9]

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Okay. And right now as you get deal for, say, outside of the industrial area, where's the sweet spot, as you see it, in terms of cap rate and type of tenant credit profile?

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Glenn J. Rufrano, VEREIT, Inc. - CEO & Director [10]

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We're -- in terms of tenant credit profile, we're about 41% investment grade. And by the way in the industrial portfolio, we have 153 assets, 52% investment grade. So we have a good investment-grade portfolio there as part of the industrial format. We -- this quarter, as you can see, we bought assets at about 6.8%, and we bought them in merchandise -- retail merchandise categories that we really like. And that's been a big part of all our acquisitions. If its retail, it has to be in our merchandise categories that are in our investor presentation, and you can take a look at all our tenants. This quarter, it was home garden, home furnishings and fitness. Last year, if you go back and take a look, about 70% of our assets were retail, 30% industrial, and we would like to think that, that mix will continue into this year.

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Anthony Paolone, JP Morgan Chase & Co, Research Division - Senior Analyst [11]

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Okay. And then just on the industrial joint venture, and you did mention having a much larger portfolio than what the initial seed assets are. Any chance of putting more into that? Or what was kind of the magic with the initial few assets?

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Glenn J. Rufrano, VEREIT, Inc. - CEO & Director [12]

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When you start a relationship as we are, you like to start it at comfortable capital relationship. $400 million was a reasonable amount of assets for us to put in. It was a reasonable amount of asset for our partner to take on. We'll continue the partnership to buy -- invest in industrial assets. There is no exclusivity, but we clearly want to, with this partner, continue the partnership in its format with industrial investment grade. Your point is that we buy assets from the outside, or can we put assets inside? We can do either. Our initial foray, we believe, will be buying assets outside of our portfolio.

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Anthony Paolone, JP Morgan Chase & Co, Research Division - Senior Analyst [13]

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Okay. And last question, I may have missed this. Was there any change to the September trial date?

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Glenn J. Rufrano, VEREIT, Inc. - CEO & Director [14]

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No.

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Operator [15]

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The next question comes from R.J. Milligan with Baird.

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Richard Jon Milligan, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [16]

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Just on the joint venture. Given the competitive market for industrial assets, how do you get comfortable increasing your exposure at this point in the cycle? And do you think we're in the early stages or later stages of the industrial cycle?

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Glenn J. Rufrano, VEREIT, Inc. - CEO & Director [17]

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Well, certainly at investment grade, triple-net long-term -- with triple-net long-term leases. Those cap rates are fairly low for us as we sit here right now, to your point. But with the partner who's comfortable with lower cap rates and high-grade long-term investment leases, we can be competitive. It's a little different business we're in than Prologis. Prologis is going to be in the turn state business, try to get 3%, 4%, 5% growth a year and our business, as you know, it's far less than that. But it's long-term, it's safer, and our partner is looking for long-term safe income streams.

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Richard Jon Milligan, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [18]

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Okay. And just a follow-up on Tony's question about contributing more assets. Is that potentially a source of capital to fund any judgments or set future settlements?

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Glenn J. Rufrano, VEREIT, Inc. - CEO & Director [19]

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I'm not going to address the second part of that, but the first part of that is could we -- the fact that we have 153 assets with 51% or 52% investment grade means we could certainly do that, and it's possible. It's not determined at this point, but it's possible.

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Operator [20]

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The next question comes from Mitch Germain with JMP Securities.

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Mitchell Bradley Germain, JMP Securities LLC, Research Division - MD and Senior Research Analyst [21]

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Glenn, is there anything else that you own, asset category, that might fit a JV type of construct in the future?

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Glenn J. Rufrano, VEREIT, Inc. - CEO & Director [22]

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Mitch, no, we -- this concept started because we had a series of groups approach us about doing -- or participating in a partnership with them. And I would tell you that the 2 property types that we have had the most contact with people from the outside were industrial and office.

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Mitchell Bradley Germain, JMP Securities LLC, Research Division - MD and Senior Research Analyst [23]

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So does that leave the door open for potentially another JV down the road?

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Glenn J. Rufrano, VEREIT, Inc. - CEO & Director [24]

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It does. If we were -- if we thought it was beneficial to us. But remember, it's capital allocation. It has to have a good accretive or dilution -- or at least dilutive effect. We have to maintain portfolio quality, and it has to have a positive effect on our balance sheet. If we can meet those criteria, there's a possibility.

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Mitchell Bradley Germain, JMP Securities LLC, Research Division - MD and Senior Research Analyst [25]

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Got you. I'm curious if your definition of noncore, when you think about assets to sell. Does that definition have flexibility depending upon some of the conditions of some of your customers or the outlook on maybe some of your customers, even though if they're sitting potentially in one of your core segments? I'm just curious about kind of what that definition is.

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Glenn J. Rufrano, VEREIT, Inc. - CEO & Director [26]

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Sure. Well, actually, we did sell some noncore this quarter. So let me go through a couple of those. We had a Denny's restaurant that we thought was in a off location. And we're not -- was not comfortable with it, and it became noncore. We also have very few -- but we have a few shopping centers, smaller shopping centers. This quarter, for instance, we sold a small shopping center called Melrose Park at a -- in a low 7s cap rate. And then another concept that could be noncore could be some bank branches, where we're not comfortable with the long-term nature of them. So those are 3 different property types that we had classified as noncore for this quarter alone.

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Mitchell Bradley Germain, JMP Securities LLC, Research Division - MD and Senior Research Analyst [27]

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Great. Last one for me. I know that you -- appreciate your commentary about store closings and some of your exposures to some of the troubled retailers. And I'm curious if there's any change in terms of how you want to potentially looking to call some exposure to certain customers or retail segments over the course of the rest of the year?

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Glenn J. Rufrano, VEREIT, Inc. - CEO & Director [28]

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We're always thinking about that, Mitch. As a matter of fact, Paul, Tom and I, and our whole team will be heading to Las Vegas Saturday to RECon. And we have a full schedule of meetings with a series of retailers to probe as much as we can to understand their businesses. And so we're constantly thinking about what we should call. And actually, we -- I think we'll get some good information in a week.

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Operator [29]

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

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Christopher Ronald Lucas, Capital One Securities, Inc., Research Division - Senior VP & Lead Equity Research Analyst [30]

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On the -- on guidance for the rest of the year, you're running right now, I guess, net negative on investments, at least from what was reported in the release today plus the JV $400-ish million, call it, roughly. Are you still expecting to be sort of net flat for the year on acquisitions/dispositions?

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Glenn J. Rufrano, VEREIT, Inc. - CEO & Director [31]

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I would put the JV -- the partnership to the aside. Our guidance is $250 million to $500 million on acquisitions and $350 million to $500 million on dispositions, that part of it we are holding to right now. Outside of that though, we do have the partnership, and even with that partnership, we believe we'll be in the $0.68 to $0.70 range.

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Christopher Ronald Lucas, Capital One Securities, Inc., Research Division - Senior VP & Lead Equity Research Analyst [32]

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Okay. And then on the partnership, Glenn, the assets that were contributed. How do they compare to sort of the rest of the industrial portfolio? And was there any sort of specific criteria used to pull those specific assets out?

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Glenn J. Rufrano, VEREIT, Inc. - CEO & Director [33]

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Well, we -- our partner, we're seeking to build a portfolio of investment grade. So these are investment-grade tenants. As I mentioned, they're 6 out of many, many more that we have, but their -- the investment-grade tenants, their geographies provide a little diversification. Their sizes provide a bit of diversification. So we try to create a portfolio that had some diversification in [into] itself, recognizing that 6 assets will never be fully diversified. But we wanted to start there, and we were able to get satisfaction between our partner and ourselves. The important part is that what we both like to do is build this portfolio so it is truly diversified in geography and tenant over a longer period.

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Christopher Ronald Lucas, Capital One Securities, Inc., Research Division - Senior VP & Lead Equity Research Analyst [34]

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Is there going to be a mortgage or anything placed on the -- in this JV? Or how do you -- is there -- is debt allowed in the JV? Sort of how do you think about the capital structure?

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Glenn J. Rufrano, VEREIT, Inc. - CEO & Director [35]

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It will. The assets in the partnership will have between 60% and 65% leverage.

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Christopher Ronald Lucas, Capital One Securities, Inc., Research Division - Senior VP & Lead Equity Research Analyst [36]

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Okay. And then the last question on the JV for me. Just as it relates to sort of the fee side of it. How do you think about that? Is that incremental yield relative to sort of your use of equity? Or is it -- or is there really any profit on that sort of added responsibility? I'm just trying to understand how you guys think about it.

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Glenn J. Rufrano, VEREIT, Inc. - CEO & Director [37]

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No, no. Absolutely. Remember, these are assets that we've been managing ourselves anyway. And so the fee stream, which would be the property management [theme] and the asset management fee, in this instance, would absolutely have a large component of profit. And I believe it proves the value of our infrastructure. This partner wants to invest with us because we know how to property manage and asset manage these portfolios, and we have great access to product. So the fee stream is the ability for the infrastructure of this company to create value for the shareholder.

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Operator [38]

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The next question is a follow-up from Sheila McGrath with Evercore ISI.

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Sheila Kathleen McGrath, Evercore ISI Institutional Equities, Research Division - Senior MD [39]

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Yes. I just wanted to check in on the -- how you look at the series of preferred on a longer-term basis and the same question on how we should think of the convertible notes in 2020.

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Michael J. Bartolotta, VEREIT, Inc. - Executive VP & CFO [40]

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So Sheila, it's Mike. I'll take that one. I mean, the preferred, the answer we're going to give is one that we've said in the past, is that's something we'll be looking at and seeing what we can do with them. But at the moment, they only became prepayable at no cost in January. And so we'll look at our options over time on that. When we take a look at the convert, the converts that are due in 2020 are actually due December 15, 2020. And so, again, that's something that we'll monitor as we go forward. But at the moment, they're at a fairly reasonable rate there at 3.75%. And so there's not too much at the moment where doing anything early with them makes sense, and our access to the markets and what have yous been pretty well proven in our past transactions. So we feel comfortable with that timing at the moment.

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Sheila Kathleen McGrath, Evercore ISI Institutional Equities, Research Division - Senior MD [41]

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Okay. And then one other question. Glenn, there was a new date in the 10-Q August 19 related to the litigation. If you could just explain to us, is that like a date that we should focus on that you might update the market on progress? Or are there any other kind of trial updates along the way before September?

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Glenn J. Rufrano, VEREIT, Inc. - CEO & Director [42]

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The August 19 date, Sheila, is a pretrial conference. My understanding is, at that time, the court will likely address various pretrial motions and discuss a schedule for trial. It's pretty normal procedure that -- and pretty normal meeting that occurs before a trial. So nothing abnormal there. If something did come out that we thought was relevant, we certainly would make it available.

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Operator [43]

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

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Glenn J. Rufrano, VEREIT, Inc. - CEO & Director [44]

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Thanks, everybody, for joining us. I know there are some of you that we may be meeting at ICSC in a week, and we look forward to that and NAREIT's coming up. Thanks again. Have a good day.

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Operator [45]

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