Bill Lenehan - CEO Gerry Morgan - CFO.

Collin Mings - Raymond James RJ Milligan - Baird Dan Donlan - Ladenburg Thalmann.

Good morning and welcome to the FCPT announces earnings for the fourth quarter 2016 conference call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Gerry Morgan, CFO of FCPT. Please go ahead..

Thank you, Carey. A few quick, obligatory comments. During the course of this call we will make forward-looking statements, which are based on beliefs and assumptions made by us and information currently available to us. Our actual results will be affected by known and unknown risks and other factors that are beyond our control or ability to predict.

Our assumptions are not a guarantee of future performance and some will prove to be incorrect. For a more detailed description of some potential risk, please refer to our SEC filings, which can be found in the investor relations of our website at www.FCPT.com. All the information presented on this call is current as of today, February 23.

In addition, reconciliation to non-GAAP financial measures presented on this call such as FFO and AFFO can be found on the Company's website in the supplemental report. With that, I will turn the call over to Bill Lenehan.

Bill?.

Thank you, Gerry, and good morning, everyone. Thank you for joining. I want to start with some thoughts on the acquisition environment. Overall, cap rates appear to be trending a bit higher and volumes appear to be lighter, but neither is changing dramatically.

Higher cap rates are sensible given the higher interest rate environment, higher cost of long-term financing, et cetera.

Hard to precisely measure the impact, but I would say 25-basis point range on going-in cap rates on the kind of deals we tend to look at and lower-quality assets are pricing perhaps 25 to 50 basis points wider on a cap-rate basis, off their all-time lows.

What we've been hearing from the brokerage community is consistent with this, with some sellers anchored to historical asking cap rates, unwilling to adjust pricing, and therefore some assets are sitting on the market longer. On deal volumes, I would attribute the lower volumes to a few factors.

First, as rates were rapidly rising and public REIT valuations were falling in the fall, we, and I believe many of our public peers, became more cautious. Secondly, there was a lull around the election. I think people were simply focused on other things at that time.

Lastly, we've had numerous potential sellers inform us they intended to wait to see if the Obamacare capital gains tax, roughly 3.8%, would be repealed, though that now appears to potentially be further out into the future. Little has changed on the competition front, I would add.

Specific to FCPT, we've been very active closing acquisitions that we teed up earlier in 2016, including a handful of properties that closed in the beginning of 2017. [Indiscernible] to date, we've closed on 67 properties for approximately $109 million.

Excluding transaction costs, our weighted average going-in rate was 6.6%, with a weighted average initially lease term of 17 years and average rental growth rate of approximately 1.4%. We issued roughly 450,000 OP units for a handful of properties during the quarter.

Overall, we continue to be very pleased with how our acquisition process is working and how the team is underwriting properties. Darden, our largest tenant continues to post very strong results, meaningfully outperforming their peers.

Since we spun in Q4, 2015, their same-store revenues have averaged 2.5% annual growth and their store-level brand margins, weighted for our portfolio, have improved by an average of 130 basis points. As a result, our portfolio's already well-covered rents are now even safer. Our balance sheet remains in fantastic shape. Kudos to Gerry.

In January, we received an investment grade rating from Fitch. Operationally, we are on strong footing and I'm very pleased with how our business itself is running. Now Gerry will take you through the financial results.

Gerry?.

Thanks, Bill. First, a couple of comments on our results for the fourth quarter. We generated 24.6 million of cash rental income after excluding noncash straight-line rental adjustments. This result included the impact of the annual 1.5% cash rent increase on November 1 for all of the 416 properties leased to Darden.

As shown on Page 8 of our supplemental package and for purposes of modeling 2017 results, the annual cash-base rent for leases in place as of the end of the year is 101 million. Cash interest expense increased slightly in Q4 to $3.6 million verses prior quarters, as we began borrowing on the revolving credit facility to fund acquisitions.

The revolver had a balance of 45 million at quarter end and 305 million of remaining capacity. We ended the year with 9.4 million of cash general and administrative expenses after excluding non-cash stock-based compensation, which was slightly inside our 10 million target for 2016.

Management is providing guidance for 2017 of an annual G&A run rate of approximately 11 million, again excluding non-cash stock-based competition and acquisition transaction costs. A reminder to everyone that we're not providing guidance on acquisition levels or FFO or AFFO for 2017, which are highly dependent on acquisition levels.

Turning to the balance sheet, Bill mentioned our ATM program, which we initiated in December at a 150 million level.

Our usage was limited in the fourth quarter, given that we just started in early December, but we continue to believe our smaller and more frequent typical acquisition size meshes well with an ATM program, which allows us to raise equity capital relatively quickly and in a cost-efficient way.

Finally, we ended 2017 with net debt to EBITDA of 4.4 times. In January we did receive our inaugural investment grade rating from Fitch of BBB-minus with a stable outlook. This is consistent with our plan to be in a position to access the unsecure debt markets as we look to extend maturities and broaden our access to capital.

We remain committed to a conservative capitalization strategy, with targeted net debt to EBITDA levels at or below 5.5 to 6 times. With that, I think, Operator, we would open it up to questions..

We will now begin the question-and-answer session [Operator Instructions] Our first question comes from Collin Mings of Raymond James. Please go ahead..

First question from me, just going back to some of the prepared remarks, Bill, just as far as the deal flow out there right now.

Has there been any change in the mix of, call it, corporate-owned assets verses franchisee-owned properties?.

The corporate deals are more lumpy, Colin. Bloomin' had portfolios that were selling earlier last year. You saw the Bob Evans deal. I imagine some portfolios of assets will come out of that. It's just more lumpy. There's frankly not a ton of public restaurant companies.

There's a lot of properties, but there's not a ton of companies that have owned real estate and when they decide to sell, you tend to get one or two companies a year trying to monetize their real estate. But I don't think any change overall because of the interest rate environment or the election or anything along those lines..

Okay.

Maybe talking a little bit more about the overall deal pipeline right now, how would you characterize it just given, again, as you talked about, some upward pressure on cap rates, maybe a little less deal flow than you have been seeing? How would you characterize your specific pipeline? Is it reasonable to think that there could there be some moderation in the pace of acquisitions for you guys relative to what we saw in the fourth quarter here to start the year?.

Yes, I think I would just think about the acquisition process as being a two- to three-month process overall from seeing a property for the first time to taking title. I think in the prepared remarks we talked about a lull around the election period as rates rose.

I think you'll see a little bit of a lull, but overall it seems to have picked up a little bit. We don't give guidance, but I think we feel like we'll be active and productive in 2017..

Okay.

Switching to the balance sheet real quick, as far as now with the investment grade rating from Fitch, how should we think about you guys approaching the debt market this year? Along those lines, if you were to go out and look at pricing, call it a tenured private placement right now, how would that pricing look on that?.

Gerry, I'll let you take that one..

As we stated earlier on the call, our objective is clearly to access the unsecured markets at some point to extend maturities. That's the one obvious part of our balance sheet where we'll make progresses is we extend the maturities of the debt to better match our asset maturities and to broaden the access to capital.

Consistent with our disclosure policies, however, we won't comment on potential capital markets activity. I would say that you've seen other issuers in the REIT remarket and in the triple net markets get good pricing recently and so we continue to believe that's going to be the right strategy for us..

Okay. One last one from me and I'll turn it over. Just curious, are there any other opportunities with U.S. restaurant properties? I know you guys had some success with a couple of different deals you announced.

Anything else from the pipeline there?.

Yes, let me just more broadly say that it's been a great relationship. Bob Stetson at USRP has purchased probably a thousand restaurant properties in his career and so it's, I think, a great complement to our portfolio that he sought us out to own OP units in a very significant amount, so we continue to work together on transactions.

We'll announce them the day they close..

The next question comes from RJ Milligan of Baird. Please go ahead..

Bill, you mentioned there was a little bit of a lull here given people were just focused elsewhere.

But given where your stock price is bouncing up against your all-time highs, turning in a premium to NAV, do you see this as an even brighter green light to go out and acquire at greater volumes? Are you going to be more aggressive in 2017 given your equity price?.

You slide in there a comment about trading at a premium to NAV. I wouldn't necessarily say that, that's -- I wouldn't affirm that. I would say that we feel like that our cost of capital's attractive and we look at this on a long-term basis. We have a fantastic initial portfolio. We're going to grow it sensibly, but we're not going to get anxious.

Our cost of capital is attractive and there are properties out there that are sensible to buy. I don't think our pricing of assets is going to get more aggressive. We don't give our cost to capital away to other people, but we certainly that think we can be very productive in 2017..

Okay. I was wondering if you could give us an update in terms of how you think about diversification. You've talked about in the past sort of a three-year plan or over the next several years where you would like to take the Darden exposure.

If you could give us an update on that?.

I think it's very consistent with our initial thoughts. We believe the Darden portfolio would be impossible to replicate. It's a very robust property portfolio from the standpoint of rent coverage and the productivity of the restaurants themselves are weaker assets.

We spent some time in the last few months trying to grade, on our acquisition model, every one of our existing assets. Our weaker assets still grade very well. They have -- the poorer properties have very low rents and obviously, most of those assets have very, very strong coverage. Our worse asset on our initial portfolio is 2.7 times, averaging 4.2.

We have a lot of properties with five and six times coverage. So I would say, overall, very little change to our thinking there. We intend to diversify slowly and deliberately and not get anxious to post some large transaction just to say we did it and potentially jeopardize the credit quality of the portfolio overall. We've been very deliberate.

We've screened 2,500 properties, inception to date, through our model, roughly, and we've purchased several dozen. But we've been very selective..

One last question.

How do you guys feel about staffing? Do you think you're appropriately staffed? What should we think about for G&A for 2017? Any comments on the acquisition platform as well?.

I think we'll add a couple people in 2017. Frankly, that's not where the -- there's not a significant change to G&A. It might go up a little bit, but still we'll be very moderate. I think we'll likely internalize our accounting function in 2017 and that we'll add for a couple of people, but overall very little change..

Great. Thanks, guys..

The next question comes from Dan Donlan of Ladenburg Thalmann. [Operator Instructions] Dan, please go ahead..

Bill, just wanted to dive in a little bit more into the acquisition environment. Is there anything out there? Some of the other REITs in the Matthews case have been buying short-term leases and then kind of restructuring them and pushing them out when it extends.

Is that something you're seeing at all or is that something you're interested in, in what you're seeing?.

We look at properties with all sorts of lease maturities. We had a lot of experience prior to Four Corners in doing that strategy, so it's something that we spend a lot of time on. To the extent that you can purchase a property at a reasonable price and then extend the maturity, it's a terrific business model. It is something we look at..

Okay, okay. Just curious, now you've been publicly traded for more than a year, are you starting to see more in-bound calls from interested sellers? Just kind of curious how your engagement with the brokerage community as well as industry participants has kind of progressed over the last couple of months..

That's a great question. I wouldn't say there's a significant change in the amount of inquiry and collaboration we have with the brokerage community. It was very strong right from the start, I think largely based upon the prior business activity the Management Team had in this space.

It was very strong from the start, but certainly it does help as we've purchased $100 million of properties. Typically, it's the sellers paying commission but as long as commission have been paid to the brokerage community, I think they understand that we're a real, live buyer, so it remains very strong.

On a daily basis, we're in touch with that community..

Okay.

As far as new potential tenants or existing tenants, do you have any reluctance of doing a deal that might bring another tenant into the fold that would be 10% or 5%? Do you have any type of threshold in mind, or a good deal with good coverages and good real estate you're happy to take a 15% tenant, given that Darden is still the majority of your rents? Just kind of curious your thoughts there..

Sure. I would first point out that it's a very different process than assembling an equity portfolio. We don't have the luxury in saying, I'd like to bring a 10% position and then placing an order with the trader. We have to sift through a lot of transactions.

We certainly, for the right credit at the right price with the right rents, we would certainly consider a larger transaction. Thus far, we found that the root to better diversification at reasonable rents with good credits has been in the smaller volume market, but we certainly would consider larger transactions.

We'd consider larger transactions that had multiple tenants as well..

Okay. Any uptick in that? I mean, there's been some consolidation within the QSR space in recent months. Just kind of curious if that kind of opens up opportunities that maybe weren't there a couple months ago..

We have no shortage of opportunities. We see, and as I mentioned, grade many, many properties every week. The question is our discipline on pricing and our discipline on credit. There's no lack of properties that we would buy, it's the constraint of where rents are sent and what the pricing is..

Okay. Lastly, just kind of curious your sales appetite in 2017.

Is it something that you'll consider or is it kind of a case-by-case basis if you get a good offer on some of your assets that you wouldn't pass it up?.

We typically get in-bound calls for properties on a weekly basis, if not more, and we tend to wait until we find pricing that's quite attractive. That is almost exclusively from the 1031 exchange market. I would just mention that market because you identify twice what you have to exchange, is one in which closing certainty is weak.

You should expect for every transaction that you see we have closed that we've gotten close to closing at least twice as many. It just is a process where quite often buyers who are typically individuals oftentimes don't close..

[Operator Instructions] Our next question is a follow up from Collin Mings of Raymond James. Please go ahead..

Just two quick follow-ups from me.

First, just recognizing you aren't providing specific capital markets specific guidance, can you talk about the constraints or how much you could potentially raise through the ATM in any given quarter?.

The real -- that's a great question, Collin. The real constraint on ATM issuance is the number of days that you're allowed to be in the market. There are a lot of blackout dates around earnings and in other factors.

But we've only really been active for a very short period of time before the end of the year when and we decided to put ourselves in a blackout period, so we don't know yet. All the advice we've gotten from our advisors is it would be very meaningful and a way to finance our business in a steady state.

Obviously, if we had a larger transaction that acquired significant equity, we think we could access the equity markets in a more normal way, but for our steady state of acquisitions, we think as long as we're not in blackout, it's a great methodology.

Very fluid as far as matching the sources and uses of cash and very reasonably priced when it comes to underwriters' discount and fees..

Okay, all right. That's helpful to understand a little bit more how you're thinking about it. I just wanted to touch on the EBITDAR coverages. On the fourth quarter, it looks like what you acquired the coverages were 2.9 times.

Just curious about the range that you're seeing out there and how is that factoring into your underwriting process, because obviously, that coverage is a little less than some of the legacy Olive Garden and other Darden properties. Just curious how you think about that as that average inherently is going to drift a little lower.

Just anything you could talk about coverages and kind of your expectations there..

I think it's -- I can make two comments. We tend to be in the mid-twos on the transactions we're looking at and then we try to factor in judgment.

A pro forma adjusted coverage ratio that assumes rent growth and margin increases on a new operator has less credibility in our mind than an existing operator who has a long track record and very consistent sales. We try to build in a cushion, but we try to be in the mid-twos. We think that is the right ratio.

It's the market ratio that the people tend to focus on, but I also think it's the right ratio. Many other property types have market coverage ratios that have been set over time that are not sensible, in my view, but mid-twos in the restaurant space seems to be a good number..

Appreciate the color. Thanks, guys..

Great..

Thanks..

Operator, we're approaching our longest conference call to date, so if there's any other questions we'd love to take them.

Operator?.

Our next question is another follow-up from Dan Donlan of Ladenburg Thalmann. Please go ahead..

It's still probably a record there for everybody else, Bill, given that we're at 20 minutes or so. Just had one quick question on the dividend policy. How are you guys -- could you remind us what you look for there in terms of AFFO coverage and kind of what the Board's philosophy is on rent increases -- sorry, on increases there.

Is it something that you guys kind of look at on a quarterly basis in terms of an increase or you kind of the adopt philosophy that many others have, which is kind of a once-a-year type of increase thing?.

I think we'll look at it. We look at it at every Board meeting and intra-Board meeting on a percentage of AFFO basis. We've said 80% is sort of the range. Obviously, as we acquire assets and our AFFO grows, it'll hover around that number. It's certainly something that we'll think about in 2017..

This concludes our question and answer session. I would now like to turn the conference back over to Bill Lenehan for any closing remarks..

Just wanted to say thank you for all your support in 2016. It's been a great year. We're very happy with how the business is operating and look forward to 2017. Thank you, everyone..

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect your lines. Have a great day..