STORE Capital's (STOR) CEO Chris Volk on Q4 2015 Results - Earnings Call Transcript

| About: STORE Capital (STOR)

STORE Capital Corporation (NYSE:STOR)

Q4 2015 Results Earnings Conference Call

February 23, 2016 11:00 AM ET

Executives

Moira Conlon - IR

Chris Volk - President and CEO

Cathy Long - CFO

Mary Fedewa - EVP, Acquisitions

Chris Burbach - EVP, Underwriting

Craig Barnett - VP, Servicing Group

Analysts

Caitlin Burrows - Goldman Sachs

Vikram Malhotra - Morgan Stanley

Collin Mings - Raymond James

Michael Gorman - Cowen Group

Ki Bin Kim - SunTrust

Thomas Polise - BMO

Craig Mailman - KeyBanc Capital Markets

Tyler Grant - Green Street Advisors

Operator

Good day and welcome to the STORE Capital Fourth Quarter and Year-end 2015 Earnings Webcast and Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded.

I would now like to turn the conference over to Moira Conlon, Investor Relations for STORE Capital. Please go ahead.

Moira Conlon

Thank you, Carrie, and welcome to all of you joining us for today’s call to discuss STORE Capital’s fourth quarter and full year 2015 financial results. Our earnings release, which we issued this morning along with a packet of supplemental information, is available on our Investor website at ir.storecapital.com, under News & Market Data, Quarterly Results.

I am here today with Chris Volk, President and Chief Executive Officer of STORE Capital; Cathy Long, Chief Financial Officer ;and Mary Fedewa, Executive Vice President of Acquisitions.

On today’s call, management will provide prepared remarks and then we will open the call up to your questions. Before we begin, I would like to remind you that comments on today’s call 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 or our AFFO and AFFO per share guidance for 2016 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 the 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.

Chris Volk

Thank you, Moira. Good morning, everyone and welcome to STORE Capital’s year-end 2015 earnings call. With me today are Cathy Long, our CFO; and Mary Fedewa, our Executive Vice President of Acquisitions.

STORE delivered in 2015, and our pace of acquisitions exceeded our estimates, closing out the year at a record of over $1.2 billion. Our investment activity which grew our balance sheet by roughly a third, contributed to multiple rises in AFFO per share estimates throughout the year. Importantly, so did the timing of investment activity which is weighted towards the first half of the year, which is historically unusual for us. Added to weighted average annual lease rate of approximately 8.1% which exceeded our expectations, interest rates below our expectations and G&A cost in line with our expectations and our AFFO per share exceeded the year by $0.02 higher than the top of our November 2015 estimate range at $1.49 per share. The $0.02 beat in the fourth quarter owed itself partly to capital markets timing. On December 7th, store closed on the issuance of 14 million shares of stock generating net proceeds of $296.7 million. And truly before this, on November 19th, we closed our inaugural corporate unsecured term note issuance of $175 million. Had both those events occurred at the beginning of the quarter, the results would have been about $0.015 less.

So, the timing of investment in capital markets activities especially given our high space of relative growth can greatly impact our AFFO per share results. In our case, favorable timing during 2015 had the impact of accelerating AFFO per share growth from [2016 to 2015]. Cathy Long will elaborate on this further but growth is growth. And during 2015 we were able to use this growth through a shareholder dividend by 8% which was the highest rate of dividend growth of any public net-lease REIT. At the same time, our dividend payout ratio actually fell from 71.4% in the fourth quarter of 2014 to 67.5% in the fourth quarter of 2015. Both dividend payout ratios are amongst the lowest of any public net-lease REIT, making our dividend amongst the most highly protected. Altogether, our portfolio performance during the third quarter was strong and we closed out the year with an occupancy rate of 99.8%.

Turning to our financial position, we concluded the year with a run rate funded debt to EBITDA ratio of 5.7 times, while having accumulated nearly $1.6 billion in unencumbered assets or about 39% of our undepreciated balance sheet. During 2015, we issued a combined $540 million of long-term notes between our Master Funding conduit and our inaugural unsecured note issuance at a weighted cost of 4.4%.

With our 2015 investments yielding 8.1%, the realized spread we achieved was about 3.7%, which is historically very favorable. In addition, we added to the spread average future annual lease escalations of 1.7%, providing us with a 2015 growth spread of 5.4% on a growth unlevered yield of 9.8%. With virtually no floating rate borrowings, our attractive investment spreads are designed to be locked in for the long-term. So, we concluded 2015 with investment spreads and lease escalations amongst the highest and best in over 30 years of being in this business. For the fourth quarter, we generated approximately $273 million worth of investments at an average investment approximating $6 million over 43 separate transactions. Very importantly, we added 15 new customers, concluding the quarter with a total of 303 customers, providing our shareholders with an extremely granular portfolio of net leased assets.

During the year, our investments were made through 152 separate transactions, representing an average transaction size of approximately $8 million, with approximately a third of our investment activity derived from existing customers. This means that we closed on an investment faster than every other work day of the year, as we work to provided needed long-term capital solutions to our customers while growing our portfolio to $4 billion.

Here are a few statistics of the fourth quarter. Our weighted average lease rate for investments made during the fourth quarter stood at approximately 7.9%. Year to date, the weighted average lease rate for 2015 stood at about 8.1%.

The average annual contractual lease escalation for our fourth quarter investments made approximated 1.8%. The weighted average primary lease term for our fourth quarter investments was approximately 15 years. The median new tenant Moody’s RiskCalc credit rating profile for investments made during the quarter was Ba2. The median new investment contract rating, which is our STORE Score for investments made during the quarter, was A3. Our average new fourth quarter investment was made at approximately 80% of replacement cost. 72% of the multi-unit investments we made during the quarter were subject to master leases. With plan to convert some of the units to master leases in the future, we should elevate the statistic to over 80%. And all but two of the 86 assets we acquired during the quarter will deliver us with unit-level financial statements. And here we’ve planned to obtain unit-level financial reporting requirement on those two assets to arrive at a 100% financial reporting requirement.

So, in 2015, STORE delivered for our shareholders attracted AFFO and dividend growth together with improved portfolio diversity, consistent portfolio of quality, increased financial flexibility and the potential for continued growth in 2016 and beyond.

And with that I’ll turn the call over to Mary Fedewa.

Mary Fedewa

Thank you, Chris and good morning everyone. As Chris mentioned, we had a terrific year with over $1.2 billion in gross acquisitions. We grew our portfolio from $2.8 billion to nearly $4 billion, a 42% increase. In 2015, we added many new customers and about one-third of our business came from repeat customers. This strong level of repeat business is a clear indicator of the long-term relationships we create with our customers and the value we add long after the first cheque is written.

Our lease rate was 7.9% for the fourth quarter and 8.1% for the year. During the fourth quarter, cap rate compression continued in the auction marketplace but by deploying our direct origination approach to provide innovative solutions to our customers, we continued to achieve a cap rate spread over the auction marketplace. As you know, our cap rate estimate for 2016 is 7.75% and the good news is we’re seeing stable cap rates in excess of 7.75% so far this year.

Our pipeline remains strong with $7.4 billion of potential opportunities across industries consistent with those represented in our current portfolio. We continue to see plenty of companies that we deem investment grade quality based on STORE Score. Our momentum has continued and 2016 is off to a good start. By the end of this month, we expect to have funded over a $150 million so far this quarter. We are pleased with our 2015 results and are excited about another year of strong growth ahead in 2016.

With that, I’ll turn the call over to Cathy.

Cathy Long

Thanks, Mary. I’ll begin my remarks today with an overview of our operating results for the fourth quarter and year ended December 31, 2015. Next, I’ll discuss our balance sheet and capital structure, followed by a discussion of our guidance for 2016. Unless otherwise noted, all comparisons refer to year-over-year periods.

Starting with revenues, total revenues increased 44% to $79.6 million for the fourth quarter, bringing the year’s revenues to $284.8 an increase of 50% over the $190.4 million reported for 2014. The growth in total revenues was primarily due to the growth in our portfolio, which generated additional rental revenues and interest income. Consistent with the prior year, rental revenues made up about 95% of our total revenues with most of the remaining revenues representing interest income on mortgage loans, and leases accounted for as direct financing leases. About half of the increase in revenues for the year was due to the impact of a full year’s revenue in 2015 on properties that were acquired throughout 2014. The remainder mostly represented revenues on properties acquired during 2015.

2015 was a record year for investment activity; not only did we generate our highest annual acquisition volume to-date but over 56% of the acquisitions were closed in the first half of the year as compared to 52% for the first half of 2014. This accelerated pace of acquisitions resulted in more revenues from new properties being captured in a year, which drove revenues higher in 2015 than we originally anticipated.

Another key timing factor that contributed to the higher than expected revenues was that much of the property acquisition activity was weighted earlier in each month that had been our past experience, which also added to the revenue reported in 2015. Because we captured more revenue from 2015 acquisitions in 2015, the full impact of those acquisitions on 2016 revenue growth will be somewhat less of a market change than it was between 2014 and 2015.

As Chris mentioned, we invested $273 million in 86 properties during the fourth quarter, bringing our acquisitions for the year to over $1.2 billion, representing 394 property locations at a net increase of nearly 42% in our portfolio, year-over-year.

As of December 31, 2015, our portfolio totaled $4 billion, representing 1,325 property locations, up from $2.8 billion in gross investment, representing 947 property locations at year-end 2014. The annualized base rent and interest being generated by our portfolio in place at December 31, 2015 was $332.5 million as compared to an annualized $238 million on the portfolio that was in place at the beginning of 2015, an increase of nearly 40%.

The weighted average going in lease rate for real estate investments acquired during the fourth quarter was 7.9%, bringing the weighted average going in lease rate for the year to 8.1% as compared to 8.3% for 2014, reflecting the small amount of lease rate compression we were expecting and did see during 2015.

Total expenses for the fourth quarter increased 34% to $55 million compared to $41 million a year ago. Total expenses for the full year 2015 were $202 million compared to $148 million in the prior year. Again, most of the increase in expenses relates to the growth of the portfolio with more than half of the increases in total expenses due to higher depreciation and amortization, both for the quarter and for the year.

For the quarter, interest expense increased 26% to $22.5 million from $17.8 million a year ago. And for the year, interest expense increased 20% to $81.8 million. The rise in interest expense is due primarily to an increase in long-term borrowings used to partially fund the acquisition of properties for our growing portfolio. This increase was slightly offset by a decrease in the weighted average interest rate on our long-term debt.

Property cost increased to $393,000 for the fourth quarter of 2015 and totaled $1.5 million for the year with the increase over 2014 related primarily to property taxes, insurance and maintenance costs on properties that were vacant during a portion of 2015. As of December 31, 2015, our occupancy was 99.8% with only two restaurant properties not subject to a lease. And we have no scheduled lease maturities during 2016. While we do expect to incur some property level cost from time to time, we don’t expect property cost to be significant.

G&A expenses were $7 million for the fourth quarter compared to $5.5 million a year ago. And for the year, G&A expense increased to $28 million from $19.5 million. Higher G&A expense was primarily due to the growth of our portfolio and a related staff addition, along with the increased cost associated with being a public company since our IPO in November 2014. As we continue to grow, we remain focused on managing our cost. Even with the addition of the regulatory and governance cost associated with being a public company, G&A expense as a percentage of portfolio assets, decreased slightly from last year. We expect that G&A costs will rise in some measure as our real estate investment portfolio grows. However, we expect that G&A expense as a percentage of the portfolio will continue to decrease over time due to efficiencies and economies of scale.

Net income increased to $24.1 million for the quarter or $0.18 per basic and diluted share compared to $17.4 million or $0.18 per basic and diluted share for the year ago period. Our net income for the fourth quarter included a loss of about $600,000 on the sale of six properties. In comparison, net income for the fourth quarter of 2014 included an aggregate gain of $3.3 million on the sale of eight properties. For the year, net income was $83.8 million or $0.68 per basic and diluted share compared to $48.1 million or $0.61 per basic and diluted share for 2014.

We had a gain net of impairment of $322,000 on the sale of 13 properties during 2015; this compares to an aggregate gain of $5.6 million on the sale of 16 properties in 2014, a small portion of which were classified in discontinued operations. The increases in net income were primarily driven by the additional rental revenues and interest income generated by the growth in our real estate investment portfolio.

For the quarter and the year, our strong operating results continued to provide AFFO per share growth. For the quarter, AFFO increased by 56% to $52.6 million or $0.40 per basic and diluted share compared to AFFO of $33.7 million or $0.35 per basic and diluted share in the fourth quarter of last year.

AFFO reported for the fourth quarter is somewhat higher than would be expected on our run rate basis because we did not have the full impact of our Q4 capital markets activities. These activities included our senior unsecured note issuance and our follow-on equity offerings, the proceeds of which were used among other things to pay-off our revolving credit facility. This positioned us well to begin this year with full availability on our revolver for acquisition activities scheduled for 2016.

For the year, AFFO was $183.5 million or $1.49 per basic and diluted share compared to a $109.9 million or $1.39 per basic and diluted share for 2014. Again, the increases in the AFFO were primarily driven by the revenue generated by our portfolio growth, partially offset by increased interest expense related to borrowings associated with the acquisition volume and the higher operating expenses to support our growth.

For the fourth quarter of 2015, we declared a regular quarterly cash dividend of $0.27 per common share to our stockholders, on AFFO per share of $0.40. Our low dividend payout ratio provides a level of free cash flow that serves to protect our dividend and provides cash that can be used for additional real estate acquisitions.

For the year, we declared dividends of $1.04 per common share to our stockholders. This included an increase in our quarterly dividend during the third quarter of 8% from our previous quarterly dividend amount.

Now, I’ll provide an update on our balance sheet and capital structure. As Chris mentioned, in December, we completed our second equity follow-on issuance since our IPO, which was also our first overnight equity offering under our shelf registration. Net proceeds after the underwriting discount and operating expenses were approximately $297 million. The net proceeds were used to acquire properties in December and pay off the outstanding balance on our revolving credit facility, which provides the full $400 million revolver as well as the cash on hand available for acquisition activity as we begin 2016. Our first follow-on equity offering of 11.6 million shares of common stock was completed last June, generating net proceeds of approximately $225 million that were used to pay down our revolver at that time and provide cash for continued acquisition activity.

Turning to our debt financing activity, in April 2015, we issued our sixth series of A+ rated STORE Master Funding net lease mortgage notes payable, aggregating $365 million in principal amount. The issuance included a mix of seven and ten-year notes at a blended rate of 4.06%. In September, we expanded our revolving credit facility from $300 million to $400 million and expanded the accordion feature from $200 million to $400 million for a total maximum borrowing capacity of $800 million. The amended facility also carries a lower interest rate, shaving 35 to 45 basis points from each of the tiered rates that are based on our leverage ratio. This multiyear credit facility now matures in September 2019.

In November, we closed our first private replacement of $175 million in investment grade rated senior unsecured notes. The notes were sold in two series, consisting of $75 million of seven-year notes at 4.95% and $100 million of nine-year notes at 5.24%. The notes pay interest semi-annually in May and November of each year and were rated BBB minus at trading. Today, virtually all of our borrowings consist of long-term fixed rate debt with well laddered maturities. This is consistent with our goal to minimize our exposure to floating rate debt by reducing the time between the acquisition of our real estate and the ultimate financing of that real estate with long-term fixed rate debt, thereby locking in the spread for as long as economically feasible.

Our total debt outstanding at December 31st was $1.8 billion with the weighted average maturity of 6.8 years and weighted average interest rate of 4.7%. Of growth investments in our real estate investment portfolio totaling approximately $4 billion at year-end, approximately $2.4 billion is used as collateral for our secured debt and the remaining $1.6 billion of real estate assets are unencumbered.

We measure leverage using a ratio of adjusted debt to EBITDA. And because of our high rate of growth, we look at this ratio on a run rate basis, using our estimated run rate EBITDA. Based on our $4 billion real estate portfolio at December 31st, we estimate that our leverage ratio on a run rate adjusted debt to EBITDA basis was approximately 5.7 times.

Now, turning to our guidance for 2016. We are affirming our 2016 AFFO per share guidance announced in November of $1.59 to $1.63, based on projected annual real estate net acquisition volume of approximately $750 million. That expected acquisition volume is net of anticipated sales in the range of $60 million to $80 million.

As our outperformance demonstrated in 2015, AFFO per share in any period is particularly sensitive to the timing of acquisitions during that period. While the timing of acquisitions during 2015 was weighted more to the first half of the year, the timing of acquisitions for 2016 is expected to be more spread out throughout the year, so weighted towards the end of each quarter.

Our AFFO guidance is based on the weighted average cap rate on new acquisitions of 7.75%. Our AFFO per share guidance for 2016 equates to anticipated net income of $0.72 to $0.74 per share plus $0.78 to $0.79 per share of expected real estate depreciation and amortization, plus approximately $0.09 to $0.10 per share related to non-cash items and real-estate transaction costs.

While we don’t give guidance on capital markets activities, we continue to target a leverage level based on the run rate funded debt to EBITDA ratio in the range of 6 to 7 times or roughly 45% to 50% leverage on the gross cost of our portfolio. Interest costs on new long-term debt for 2016 is estimated based on the weighted average interest rate of 5%. And finally, G&A costs are expected to be between $32 million and $34 million for 2016 including commissions and non-cash equity compensation.

That concludes my prepared remarks. And now, I’ll turn the call back to Chris.

Chris Volk

Thank you, Cathy. I have a few remarks to make before turning this call over to questions. To start, at the time of our November 2014 IPO, we were a controlled company with our founding institutional shareholder Oaktree Capital holding over 50% of our shares. Subsequently, through periodic sales of their shares and through the issuance of primary shares in 2015, the ownership position of Oaktree Capital fell below 50% upon our December 7, 2015 equity issuance. The results of this proportional ownership reduction was that we were no longer a controlled company as of year-end. In addition, Oaktree would give up one of its board seats which would alter the mix of our nine-member board of director to a puerility of non- Oaktree members. That board seat was filled with our board meeting last week with a press release issued at that time.

Then at the beginning of this month, we announced that Oaktree has sold another 14 million shares of stock which reduced their ownership of STORE by approximately 10% and which will result in them vacating another board seats that we are in the process of filling. So when this is complete, the Oaktree entities will hold three of our nine board seats and the board will be comprised of majority of independent directors fulfilling the requirement of non-controlled companies by the New York Stock Exchange.

In addition, as of last week, our nominating and governance and compensation committees are comprised of a majority independent directors, also as required by the New York Stock Exchange. Since our IPO, the audit committee has always been fully independent. These changes have been long expected are an important evolution in our transition from a privately held concern to a seasoned public company. That said, on behalf of all of us at STORE, Oaktree is as good a business partner as we could ever have hoped for and their help and participation in establishing this fine company has led to positive imprint on all of us here and making us better at what we do.

Now, for some final words. We had an Investor and Analyst Day recently on January 14th here in Scottsdale, Arizona which we gave an office tour and head a morning of panels that included investment case studies from our relationship managers and the opportunity to hear from a few STORE customers about the net lease marketplace. One of the questions we received pertained to the size of the middle market and larger customers we serve. To respond to this query, we have included a histogram of customer size in our supplemental financial information which is forthcoming.

Our median customer has annual revenues approximating $40 million with average revenues which are weighted by the revenues we receive of over $450 million. Nearly 85% of our customers have revenues in excess of $20 million. Virtually all of our customers survived the great recession and are engaged in resilient and relevant businesses. As of December 31, our 10 largest customers accounted for just under 17% of run rate revenues, which by design is historically low for any company we have led and also amongst the most diverse of any publicly traded net lease REIT. These top 10 customers had median corporate revenues of almost $700 million and weighted average revenues of almost $1.2 billion.

Now, shortly after our Investor and Analyst Day, the 10-year treasury rates pierced the 2% barrier with many analysts expressing concern regarding the potential for a recession. In this vein, one of the questions we have received is whether we would underwrite our investments differently, given this potential. The answer is no. In the course of underwriting net lease investments with those leases having terms of 15 years or better, we naturally presume that there will be one or more economic cycles during the course of our contract.

The issue then is margins of safety and we build margins of safety into everything we do. From our focus on profit centers, to the broad quality customer base we address, to our creation of investment grade contracts, to investments made below real estate replacement cost, through a wide spread use of master leases, to investments made at lease rates that are above NAV auction market yields, to receipt and analysis of tenant and unit level financial statements, to the independent appraisal of every assets, to our periodic portfolio of physical inspections, to our highly protected dividend, to our high embedded lease escalations, to our conservative leverage and balance sheet flexibility, to our management structure which has credit and closing silos, to our investment approval structure which has both management and board investment committees, to our direct originations ability and the most diverse portfolio in our history as leaders in this space. We have intentionally demonstrated our approach with industry leading disclosure backed by the best IT platform we’ve ever created. With our embedded margins of safety, we’ve taken delivered care to make STORE defensive even as we continue our growth trajectory.

So, as always, I’m joined today by STORE’s leadership team around the table in addition to Mary and Cathy. So we have Michael Bennett our General Counsel; and Chris Burbach, our Executive Vice President of Underwriting, Craig Barnett, Vice President in our Servicing Group is standing in for the elusive Mike Zieg away today.

And with that, I’d like to turn the call over to the operator for any questions that you may have.

Question-and-Answer Session

Operator

We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Caitlin Burrows of Goldman Sachs. Please go ahead.

Caitlin Burrows

Good morning. I was just wondering when you talk about the guidance, your guidance and the volume of acquisitions that you’re expecting and obviously that’s below last year’s actual and also your guidance as of the year ago for 2015. So, I was just wondering, as it appears lower, is this because you see some sort of slowdown; is it just because you only have so much visibility, so that’s what you’re comfortable with; is it a conservative number from combination of those things?

Chris Volk

Caitlin, this is Chris. Good morning. So, the answer is, like last year, we started off with $750 million guidance. We actually implicitly raised that guidance this call because we’re making it -- clearly it’s a net number and we expect to sell some assets. So that will take you to somewhere around, call it 830 worth of gross volume. If you look at us through the end of this month and Mary’s projection of 150 million; if you annualize that that gets us to 900 million. No, this is not a business you can prorate. It’s normally the second and fourth quarters historically been the most active. But last year that was definitely not the case. We had a lot of spillover that came from the fourth quarter of the prior year. And so what we did is rode from 2016 and shoved it into 2015.

If you look at the models of doing this, you don’t get a lot of bang for buck form just making investments during the course of the year because there’s certain amount of cost to making those investments and you have commission to cost and other cost to get expense, there is just not a lot of bang to buck but the timing has the biggest impact on what we do at this point. So, if we can have a very aggressive first half of the year, then we feel good about that. Otherwise, as I said earlier, growth is growth. And so, if you were to think about the guidance numbers to what will happen, if you model this out, is your run rate of AFFO per share in fourth quarter ends up having double-digit growth of your run rate last year, it’s just that you’re accelerating that into 2017. So, whether you can push that double-digit growth rate into 2016 is sort of academic. But it’s going to happen.

As to whether or not we grow the Company faster the 750 million or 830 million is the case maybe, on a gross number, if it’s up to our acquisition scheme, we’ll absolutely do that. Capital markets permitting and marketplace permitting, we see a lot of demand out there. We think that we can and should try to exceed that 750 million number and that’s what our goal will be during the course of the year.

Caitlin Burrows

Okay, thanks. And then just a similar question on the cap rates, I think it was Mary mentioned earlier that you guys are guiding to 7.75%, last year you were above 8% and actually so far in 2016, it has been looking a little bit better than the 7.75%. So, just wondering, over the course of 2015, there was some cap rate compression, I guess to what extent do you expect that to continue in 2016 or get back into that 8% range?

Mary Fedewa

As you can imagine, it’s little bit early to tell for the year but what I’ll say is to-date, we’re still right around the high 7s on our cap rates, so no real change from the fourth quarter to 2016 so far.

Chris Volk

And a quick change over time. I mean as theory with a ten-year being a 175, you would think the cap rates would come in but we’re also seeing some choppy market from the debt side, which I think is also serving to push cap rates in the other direction. And right today, I would say that we’re not seeing any cap rate compression. So, we’re cautiously optimistic that we can maintain cap rates in excess of our targets.

Operator

Our next question comes from Vikram Malhotra of Morgan Stanley. Please go ahead.

Vikram Malhotra

Just to clarify on your STORE Score page that you show, it seemed like there was a slight change in the methodology, or maybe the access changed a bit. Could you just maybe clarify that and correct me if I am wrong? And then could you also just talk about the increase in coverage, were there any particular tenants or sectors that resulted in the increase?

Chris Volk

Vikram, I’m going to let Craig answer this question.

Craig Barnett

So, the access just changed from -- previous quarter was by investment and this quarter it’s by annualized rent and interest, just to be consistent with other…

Chris Volk

So, we just took our STORE Score and we just weighted it by rent and interest revenues posted by investments. So, it was just a weighting issue. From a chart perspective, we’re not seeing any change in STORE Score or in fact tenant EDF. So, there is kind of sort of similar bandwidth. From a unit level coverage perspective, if you look at the median coverage for the quarter, it’s actually little higher than it was last quarter. Again, I wouldn’t read anything into that in terms of a trend. It’s not like -- I mean we thought that this is -- I mean from the time we started this company after the great recession, we’ve always thought the economy was fragile. So, this s a company that’s built for economy that’s in state that it’s in and sort of a steady state or even can take some hit. So, I mean it’s not designed -- I think that what we’re seeing at the unit level, we’re seeing basically revenues tick up a tiny bit but expenses are also higher, and so net-net the coverage is about the same. And that’s fine with us. As I said once earlier on a call, flat is the new up in market like this. And so, we’re looking for consistency and that’s what we’re getting.

Vikram Malhotra

And then you guys did a couple of deals -- couple of at home deals. If you could maybe give us a bit more color on just how large the boxes were, what the rent bumps are, and maybe a sense of cap rates?

Chris Volk

Sure. So, in terms of -- we added two properties in the fourth quarter. I would say just in terms of the size of the boxes consistent with what we have in the portfolio already, there is nothing new or interesting in terms of the change in the exposure there. And in terms of cap rate, it’d be consistent with what we have in there before.

Vikram Malhotra

And then just last one, Chris, you -- I believe on -- you gave an interview I am getting to who at some point but you touched some interesting comments about states leasebacks. Can you maybe just update us on what you’re hearing from the market, any color on what owners are saying?

Chris Volk

Well, the color is that if you have a choice, if you are running a company and unless you’re sitting on so much cash, you don’t know what to do with it, and your choice is whether you want to rent or own pieces of real estate. Obviously we found that it’s quite simple to convey to people that renting real estate is better. Not only does it lower their cost of capital but it basically gives them a more flexible balance sheet which can be little bit counterintuitive but that’s kind of what’s happened. And that’s driven by the complexities of the long-term financial markets that are otherwise available to people outside of sale leasebacks.

And those levels of operational flexibility create the opportunity for us to create value for companies long after the check is written. And by doing that we’re able to garner lease rates that are above the auction marketplace because we’re adding more value than what we’re charging our customers. And so that’s always key but it’s also relying on having a direct origination sales force to be able to get that added value which translates into value for our shareholders.

Operator

Our next question comes from Collin Mings of Raymond James. Please go ahead.

Collin Mings

First question from me, just on the 60-80 million of dispositions you’re looking at for 2016. Any themes as it relates to assets you’re looking to jettison?

Chris Volk

No, we always sell 1% to 1.5% of the portfolio a year, somewhere in that neighborhood. And some of it is defensive but we’re concerned about residual value, some of it’s where we’re taking opportunistic profits. I was listening on some conference calls by other participants and that case that my answer almost identical to the one I just gave you. I think that for us to do this is also important because it helps to offset risk. So for example to the extent we incur any vacancies during the year and have losses on those vacancies which can happen in this business, we can offset those vacancy losses with -- by triggering some gains also on the sales of real estate. So, if you look at 2014 for example, we had almost $6 million in gains, we had no vacancies during that year. So, it’s like a negative default rate. 2015, net gain was very small, $300,000 but that included the sale of three vacant properties that we sold off where there was a modest loss. So we offset all that and basically ended up having minimal losses if anything from asset vacancies. So when you’re looking at the business holistically, one of the really terrific things about the lease base is that you can manage investment risk not just at the property level which -- you often focus a lot on what happens in every single properties and actually manage risk at the portfolio level which is something that you pay us to do.

Collin Mings

Okay, thanks for that Chris. And then Cathy, it looks like on G&A, I think came in at $28 million for 2015 and that was a little bit below your expectations. Can you maybe just give us a little bit more detail on the investments that you’re making as to have that step up from $28 million to call it $33 million at the midpoint here for ‘16?

Cathy Long

Sure. Some of it is related to the growth in the portfolio. So, you’ll find some of the increases being on the servicing side. We’re still scaling up. And the employee additions that we’ll be making will be centered around the IT and servicing side to backend of the business, if you will. There will also be cost related to the Oaktree board members rolling off and having us new paid board members coming on. There will be additional employees, 10 additional employees that we’ll be adding this year, and then some rating agency costs for example. Every time we issue a new tranche of debt, there will be additional ongoing monitoring fees. And then we’ll put a little bit more money into our public relations, our investor relations, things like that. And also as part of the portfolio growth, you do have a franchise taxes and things like that that would be a normal part of growth in the portfolio. So, we’ll see that as well.

Collin Mings

And then last one for me, I’ll turn it over. It just looks like the number of locations subject to a ground lease went from 9 to 14 during 4Q. Can you maybe just touch on those investments?

Chris Volk

So, the answer -- I know three of them which were facilities that are based there on ground leases but they are not really on ground leases, they’re sort of on municipal land, which is three of the additions.

Craig Barnett

In general, I would just say, when you think about -- when we acquired properties subject to a ground lease, typically as part of the larger portfolio where that might be one of the assets that they might have -- they own the building but not the land underneath. And part of our focus on being a total solution for our customers we’ll buy the overlaying building but it’s nothing material.

Chris Volk

I think one of the properties is on an airport runway and adjacent to an airport where you had another location where you basically can’t get the land adjacent to airport. So, it’s a valuable piece of land but you just can’t get the title. As a general rule, we dislike ground lease [ph] with a passion and that’s one of the reasons we disclose them too you and probably make us refrain from doing too many of them. And tend -- to they can overstate rent income. So, I think it’s important for us to be mindful of the risks of ground leases but we’ll occasional do some. And some of the properties we have under ground lease by the way are prepaid ground leases. We have one property here, I mean most of our ground leases are sort of like non-ground lease, ground leases so we have a property here in Arizona where the ground lease payment is sort of equivalent to what property taxes otherwise be and so on but it’s technically the ground. So, we included as such.

Operator

Our next question comes from Michael Gorman of Cowen Group. Please go ahead.

Michael Gorman

Question for you Cathy; there are some comments about choppiness in the debt markets keeping cap rates up on the acquisition side. I’m curious from your perspective what you guys are seeing in the markets right now and how that might influence how you look to fund the debt portion of your acquisition activity over the course of the year?

Cathy Long

As you recall, we last year did our first inaugural issuance of unsecured notes. You heard of that strategy was to broaden our access to debt market. So, we have our Master Funding secured conduit that is our own conduit and that market is basically the ABS debt market. So, we -- it’s a very large pool of assets that we can work with there. And we continue to have that as one of our debt work courses. We added the senior unsecured notes and having access to that market because we have a growing pool of encumbered assets. So, what we’re looking to do and what we put in place last year was really a strategy to broaden our asset to the debt market, so that we can at any one point in time when we wish to issue debt, compare the two markets and pick our spots the best we can. The markets have been little bit choppy. We have going into the year a lot of dry powder to do acquisitions. So, we’re not necessarily in a rush to tap the debt markets at this very moment but we will be looking throughout the year to pick our spot.

Chris Volk

I would say that our ability to have both choices doing unsecured term notes and our choice of doing an A+ rated Master Funding conduit is very useful for us. So, we’ll be able to select from menu of options, as we look for. Our target debt rate, budget debt rate for this year is around 5 and I think that we feel comfortable with that number. And hopefully with any luck we come inside [ph] but we certainly feel comfortable with the number today.

Michael Gorman

So, I guess it would be fair to say then that now that you have that flexibility and you’ve done inaugural offering that you’re agnostic between the two debt buckets, just depending on what’s best for your capital structure at that particular point in time?

Chris Volk

The answer is yes, I am sort of agnostic to it. Although I like the poetry of adding a little bit of each to the mix over time because what ends up happening is that the unsecured note holders, if you do this over the next five years or so, the unencumbered debt assets with the unencumbered assets will go off substantially, while the encumbered assets will gradually increase. And the unencumbered folks are likely to benefit from the Master Funding conduit because we’ll end up having higher coverage of their debt relative to the unencumbered asset pools available than would happen if we were just solely an unsecured rated company.

So, I think that having both vehicles is valuable. We got the BBB minus rating last year. As a person who has done the debt route before was unsecured debt and we were the first guys to get an unsecured credit rating for a net lease company back in 1995. When you do this, you have to be pretty sure about it and not be really content with the BBB minus. So, you’re expecting to build yourself up, so that you will be able to get an improved credit rating, just kind of BBB is sort of the area that you’d like to be at long-term. And so, when we did this, we did it knowing it cost a little bit of money, in the short term we could have had cheaper options if it was all about just the rate. But for the long-term what we expect is that not only is our G&A going to scale but our debt costs are going to scale as well. So that our debt cost will just get better.

Operator

Our next question comes from Ian Gall [ph] of SunTrust. Please go ahead.

Ki Bin Kim

Thanks. This is actually Ki Bin. Just a couple of quick questions on your guidance. I know you don’t want to comment specifically on what the capital raise, what part of that is in guidance. But are you assuming half of your acquisitions are funded by equity in the guidance number?

Chris Volk

Yes. Well, Ki Bin, you’re assuming that you’re maintaining your leverage ratio as sort of 6 to 7 times, so that takes you to between 40% and 50% leverage on cost. I am not -- we’re not an enterprise value type, I think it’s silly calculation calculating value. So, the answer that is there will be some of that along those lines. We’ve been asked often times and I’ll mentioned this too that we’ve been asked whether we expect it do an ATM offering and we’ve been clear that we do expect to do an ATM filing at some point in time. And the ATM could be a meaningful part of the equity capital raise during the course of the year. And I think it’s intelligent for a company that’s growing the way we’re growing.

Ki Bin Kim

And just a quick timing question. I think I heard you guys say it, three is $332.5 million of annualized base rent currently today. If I look at where the fourth quarter ended times for, it’s about $318 million. So, is it correct to assume about 13.5 million is going to come just from the deals -- from a timing -- shift of timing of deals occurred in the fourth quarter, that’s going to bleed into 2016?

Cathy Long

Yes, if you look at the number annualized base rent at year-end, it’s just taking a snapshot of the portfolio at year-end at the lease rates that they were at year-end including anything that might have bumped during the period and just staying on an annualized basis what was that. So, if we bought things during fourth quarter and they had only been bought in December for example, there would only be one month of revenue in that quarter. So, this is actually taking just that snapshot right at year-end. Does that make the sense?

Ki Bin Kim

Yes. And generally when leases are coming up for due, I know it’s not a lot every year. What percent of those expirations are you re-leasing versus selling ahead of time?

Cathy Long

Actually we have no lease maturities coming up for 2016, because we’re a new company and all of our leases pretty much are created by us as long-term leases. Their lease terms are 15 to 20 years. So we have nothing coming due and very little -- I think we had two or three come up last year and they were basically re-lease.

Chris Volk

And then if you look at the short term leases that would be on the portfolio, they would be almost all third party paper that we bought. So, if you look at our portfolio, roughly 90% of the paper or contracts we have are done on our lease form or done on a preferred lease form. So, we created -- so even though 75% is direct business and 25% comes from brokers, that doesn’t really fully speak they really are because of that 90% plus or minus of the contracts that we’re doing are contracts that we’re originating and you can only do that if you’re doing directly with the tenant.

Now, there will be a piece of contracts that we’ll buy that are down on the people’s paper and that will be there in the shorter term lease maturities if you are looking at the histogram of short term lease maturities. And almost all those are properties that we expect fully to relet on the same or better term which is obviously why we made the purchase of the properties in the first place, so they’re opportunistic.

Cathy Long

Right. So for the four that actually expired last year, three of them were renewed with the same tenant and one of them actually got picked up by another one of our customers.

Ki Bin Kim

Okay

Cathy Long

So they all relet in short order.

Operator

Our next question comes from Thomas Polise of BMO. Please go ahead.

Thomas Polise

Good morning, guys. What are your thoughts on increasing the size of your sales team given that the portfolio is growing and it takes more acquisitions to move the needle?

Chris Volk

Say it again please.

Thomas Polise

What are your thoughts on increasing the size of your sales team given that the portfolio is growing and it takes more acquisitions to move the needle.

Mary Fedewa

Well, I’ll tell you -- this is Mary. I’ll tell you that the market is definitely there, when you think about how we approach the market. There are over 70,000 middle market companies that own their real estate that really need us knock on their door. So, I’ll tell you the market is there and this is going to be a matter of whether the capital markets are there and whether we have the opportunity to do that. So, it’s always a thought.

Chris Volk

I mean the question is appropriate in the sense that for us to do -- we did $1.2 billion worth of transactions last year with six direct people and two indirect people. So, we had eight calling officers, including Mary. Mary was also calling officer, and by the way -- so am I. So, there are other people here that are calling in companies to try to originate business. So, in a way, for us to do more business would be -- requires to hire more sales people. So we wanted to grow 1.3 billion, 1.4 billion, 1.5 billion worth of business every year, it would be to hire more sales people. And over time that may be something that we do. But we’re going to obviously not be hyper aggressive about that rate of growth. But you should know that that’s a possibilities that’s out there and we’re all excited about being able to one day do that.

Operator

Our next question comes from Craig Mailman of KeyBanc Capital Markets. Please go ahead.

Craig Mailman

I just want to clarify, Chris, I think you said that you guys are almost on pace to do 900 million for the year, and I think Mary said 150 core days, should we just imply that the pipeline over the next month or so is about 75 million?

Chris Volk

I wouldn’t make an implication on that. I mean, I just took the two months at 150 million and just annualized it and said 900. So, we have -- basically if you factor in sold properties, we’re saying that we’ll do 830 gross worth of volume. So, but I really think that annualizing the first quarter is not quite that simple. So, historically the second quarter is bigger than the first quarter, it wasn’t last year but historically it’s bigger than the -- second quarter is bigger; historically the fourth quarter is the biggest and that wasn’t the case last year. So, for all those reasons, we have a difficult time frame to tell you we’re going to do a $1 billion, because we don’t really seen. We don’t have a vision to the flow business that we’re doing one-off business, when you’re doing transactions and your average transactions size of $8 million last year. It’s just hard to have that -- look out to know exactly what the volume is going to be.

Craig Mailman

Okay. I apologize if you guys said this. Do you have update of what’s under contract?

Chris Volk

We don’t give that out.

Craig Mailman

Okay. And then just separately, you made a point that when you guys gave initial guidance on the investments an you had 7.75 of the cap rate, the tenure [ph] is obviously higher. Just curious with the volatility you have seen in credit spreads, I guess just back of envelope about 50 basis-point different on the base rate. Do you guys feel like for your commensurate STORE Scores, what you are seeing on the cap rate side is consistent with what you’re seeing on spreads in terms of the yield relative to the base rate.

Chris Volk

I’ll do my best to answer; I’m not sure that I fully get the question. But I…

Craig Mailman

I guess what I’m trying to [multiple speakers]

Chris Burbach

Chris, this is Chris Burbach. I think that part of your question is assuming this is a really liquid market and the reality is that we’re doing sale leasebacks and the rates don’t move as quickly as the debt markets. So, as Mary was saying, there is a certain level of stickiness on our cap rates from the fourth quarter over to today. And I think that’s probably generally true in the debt markets too; there’s a certain level of stickiness at the absolute levels and you see a little bit of tightening on the base rate, interest rates but there’s not a ton of movement in terms of overall rates.

Chris Volk

Yes. So for us, what we’ve been seeing is that with some of the widening of spreads on the debt markets, the 10-year treasury is really not the deal, because the debt cost is a deal. So, we’re widening some of the debt costs; we have seen the cap rates have been holding pretty flat. And I think if you were to survey the auction market which we don’t do a whole lot of stuff in the auction market but if you were to survey brokers, they’d probably tell also the cap rates have been flat. And I think that’s good for us. So, I like having flat cap rates. I like to be able to keep it. In this business by the way, a quarter point in cap rates worth double a quarter point in debt. So, you don’t think we’re just in the spread business, I mean I quoted spread but that’s not like a whole thing. I mean the gross rates of return really-really matter over a long period of time. And so if you can hold those cap rates solid, if we could be closer to an 8 this year round to a 7.75, this 25 basis points mean 50 to you as a shareholder and that’s a big deal. And it’s much better than having 25 basis points of savings on the debt side.

On the debt side where some of the disruption to debt market are also been favorable in the sense that we’re seeing that high yield money and LBL financial sponsor money is harder to come by when they’re acquiring companies, we’re as a result seeing companies being bought for a lower multiples at this point in time. I always like to see companies being bought for lower multiples, it’s less of our key. And so all that stuff I think is exciting right at the moment.

Craig Mailman

And I think Chris answered, I was getting at more -- Chris Burbach, more at is the credit risk or the sale leaseback being appropriately priced in your different pockets of STORE Scores versus what happening in the credit markets just for straight up debt?

Chris Burbach

I understand, I think we’ll always tell you that I think from a risk adjusted basis we blow away the alternatives, and so it’s not really priced that way.

Chris Volk

Yes. I mean I would tell you that if you look at -- in theory, you should -- if you wanted to be perfect, you would price every deal separately on location and also separately on the tenant, and we would run our business this way. The market’s not that efficient and we’re the only people out there that you have a STORE Score, it’s just why it’s STORE score.

So, if somebody else is pricing differently then they’re going to price it differently and we’re not out of a deal. So we’re doing our best to make sure that we’re adhering to discipline and that’s one of the reasons we are disclosing. Last quarter our typical STORE Score or the median STORE Score was 8.2. I mean that’s pretty strong. So, we’re keeping our discipline the best we can and are beating coverage with higher for the portfolio. So again, we’re doing the best to maintain consistency.

Craig Mailman

And then just the last one on the conduit versus the unsecured, and I apologize for not knowing this. But I know we have the risk retention issues coming up with CMBS later this year. Would those asset backs be subject to that same risk retention issue that we’re going to see later this year and just curious, and then how does that factor…

Chris Volk

The answer is absolutely not because we’re the people retaining the risk, so we own -- so unlike the CMBS market where you’re basically parsing a loan and historically putting no equity in the transaction, the risk retention requirements are requiring people to have a tail of risk and those are the issuers of debt. In our case, we are the equity and the transaction and we have substantial equity. And then on top of the equity, we have the BBB bonds which are sitting on our sheet. And as of the fourth quarter, we were sitting on $106 million worth of BBB rated bonds that we don’t plan to sell, we’re just going to keep them.

Operator

Our next question comes from Tyler Grant of Green Street Advisors. Please go ahead.

Tyler Grant

Just a quick question, can you guys comment on how the STORE Score on properties owned as of the date of the IPO has changed; so for example as it improved or as it deteriorated?

Chris Volk

Well, that’s an interesting question. So, we do run this and we’re looking at credit deterioration and credit improvement. And it pretty much looks like a bell curve. We have about just as many people improving as deteriorating. But the improvements aren’t huge and the deteriorations aren’t huge either. So basically, it’s a tight spread which tells you that the things are as -- like I said earlier, flat to new up, so it’s basically flat. But we track it.

Tyler Grant

And then, just moving on to the idea of master leases, so within your portfolio, about 80% of your ABR is generated from leases that are structured as master leases. Recent events at some of your net lease peers would suggest that in the case of bankruptcy, so some of the economics can actually fall within the lessee’s hands when you do have a master lease in place. So, how do you weigh the pros and cons of deciding whether or not you want to use the master lease when underwriting a sale leaseback? And why would you continue to do so, if it doesn’t protect you in the case of bankruptcy?

Chris Volk

So, I am not sure who you’re referring to, but we’ve done -- I’ve been doing master leases and have been involved in master leases since the 90s. And we started getting involved there because we had a large fast food chain operator who filed for bankruptcy. And if you look to the pool of our assets, they’re all covered but there were a bunch that didn’t cover very well. And the leases were all cross defaulted. And so when the tenant filed for bankruptcy we did our very level best to make a very strong case of cross default would hold off in bankruptcy court. And we tried to force the tenant to take all the stores, since they all made money, even though -- together, even though some of them individually did not. We found that the cross default got blow away in bankruptcy and fact never stands out. I mean, so they cross default. And when it comes to leases are not really worth a lot. They had some small value at certain points in time but in the court of bankruptcy they have almost no value.

So had we had a master lease in that case, we would have been instantly better off because they would not have been able to cherry pick assets that they could shutdown and keep all the good assets. And ever since that point in time, we’ve done master leases on a very large pace. And it’s the only way that you can really truly have a diversified lease stream in a way because if you think about -- if you don’t do a master lease then every single contract, every single property stands on its own as an island risk. But if you can combine the islands of risk, then you have a continent. So, you can get a lot of protection through true diversity of sources.

If you’re giving somebody a construction loan for example, or construction lease for doing a new build store and no one ever knows how the new build stores are going to work, if you can roll that into a master lease, it’s just a terrific tool because you can -- we can therefore undertake the risk but then also combining the other assets where the coverage is really strong and be much more comfortable with having taking that risk if we’ve done a standalone transaction. In the course of tenant insolvencies. And we’ve gone through -- I’m sure 100s of insolvencies since the ‘90s, we have never failed to win on a master lease defense in terms of -- in bankruptcy court.

And so basically it puts the eggs in our basket in terms of what happens with the assets. I mean what you want is an alignment of interest. If you think about what creates a risk here -- and you’re dealing with profits in a real estate, unit level coverages are very important. Those unit level coverages become aggregate unit level coverages if you have a master lease. You don’t have to worry about every single individual store, as much. You can now aggregate. And higher the higher the coverage is, the less likely there’s is going to be the fall off, but more likely, it’s going to be for recovery. If you are in a cheap replacement cost that’s also good, alignments of interest are good. The master leases, the best way far and away that you can get a good alignment of interest for the tenant. So if something happened, they will pick up a phone and call you, and maybe you will reduce the rent, maybe you don’t. But it becomes up to our choice to do that. And we’re going to do what is best for our shareholders and not force our tenant to do what’s best for them and to the exclusion of us.

And so, I think that’s what’s so important about a master lease. Now master leases on the other hand, like if you’re trying to sort of flip off individual assets ,they can become little bit more problematic, and you may have seen that with some other tenants. So, if you make a master leases, it’s like $500 million master lease, I mean, there’s no buyers for $500 million master lease. So you got to do it in smaller chunk and so, we’ve seen those issues as well. But basically master leases are absolutely important and they’re institutional tool and any institution that’s involved with that business should do them.

Operator

[Operator Instructions] Seeing no further questions, this concludes our question-and-answer session. I would now like to turn the conference back over to Chris Volk for any closing remarks.

Chris Volk

Nothing special, just thank you very much for joining today and listening to us. And we look forward to talking to you in the future. Thank you so much.

Operator

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

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