Getty Realty Corp. (GTY) Q1 2012 Earnings Report, Transcript and Summary

Good day, and welcome to Getty Realty First Quarter 2012 Earnings Conference Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Mr. Josh Dicker, General Counsel. Please go ahead, sir.

Thank you very much. I would like to thank you all for joining us for Getty Realty’s quarterly end conference call. Yesterday evening, the company released its financial results for the quarter ended March 31, 2012 and filed its Form 10-Q with the Securities and Exchange Commission. These documents are available in the Investor Relations section of our website at www.gettyrealty.com. Certain statements made in the course of this call are not based on historical information and may constitute forward-looking statements. These statements are based on management’s current expectations and beliefs and are subject to trends and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. I refer you to the company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2011 as well as our quarterly and other filings with the SEC for a more detailed discussion of the risks and factors that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today. You should not place undue reliance on forward-looking statements, which reflect our view only as of the day hereof. The company undertakes no duty to update any forward-looking statements that may be made in the course of this call. With that, let me turn the call over to David Driscoll, our Chief Executive Officer.

Thanks, Josh. Prior to starting my formal statement, I want to introduce the other officers of the company who are on the call with me and Josh Dicker today. Mr. Leo Liebowitz, our Co-Founder and Chairman; Chief Financial Officer, Tom Stirnweis; and Kevin Shea, our Executive Vice President. Less than 2 months ago, we made the observation that it was an exciting time for us because we had the opportunity to eliminate the overhang caused by our largest tenant, Getty Petroleum Marketing, who I will refer to as Marketing in this call, without having to wait until their lease expired in 2015. I want to say at the outside of this quarter’s call that we have made demonstrable progress towards realizing that objective. Last week, as we had anticipated, we announced that Marketing rejected the master lease and its bankruptcy proceedings, and we also described some of the progress we have made repositioning the Marketing portfolio. With the rejection of the Master Lease, we now lease only a single property to Marketing outside the master lease. That single location is a leased property for us, so we earn only a modest spread. Thus that property’s contribution is immaterial to our overall performance. Since our properties constituted the vast majority of Marketing’s earning assets, we anticipate Marketing as a company will begin a process of winding down its affairs and move towards liquidation in the coming weeks. We now have a large claim against Marketing, and while we are not Marketing’s only creditor, we do have a priority position for some of our claim. As a result, it is possible we might receive some funds from their liquidation in the coming months. After that, additional recoveries may occur over a period of time and only as a result of successful litigation. Without meaning to underplay the value of our position or the vigor with which we intend to pursue it, we believe the timing and the amounts that might be recovered are at this point speculative. As we announced last week, we have started to redeploy the assets in the Marketing portfolio on both a permanent and interim basis. The results thus far are in accordance with our plans and expectations, and most importantly, we are generating revenues from the vast majority of the revenue generating assets in the Marketing portfolio. On April 30, Marketing leased approximately 780 individual properties and 9 distribution terminals from us. We had previously mentioned that approximately 160 of these locations, now 145 as a result of sales, leased dispositions and condemnations, are being marketed for sale. We also announced last week that we had entered into 6 separate long-term triple-net leases with regional fuel distributors comprising approximately 282 properties of the Marketing portfolio. The specific terms of these leases vary, but all are unitary triple-net long-term, which generally mean 15 years with renewals, containing provisions for CapEx and have CPI escalators. Some, dare I say most, also contain provisions for increased rent based on fuel volume increases. In addition, we have entered into an interim fuel supply agreement with Global Partners LP and a direct relationship with dealer operators in locations comprising an additional 254 properties located in the New York metro and New Jersey areas, pending entering into long-term leases. In these properties, we’re responsible for some maintenance, some taxes and insurance. In return, we receive rent fees and expense reimbursements from dealers and a portion of the fuel margin realized at the locations. In all but a handful of the remaining approximately 100 locations, we have established similar license and interim fuel supply arrangements, most with our new tenants in that particular geographic area. With that update on our progress, I’m not going to spend a lot of time reviewing our first quarter results because the quarter continued to be materially affected by Marketing’s bankruptcy, and most importantly, Marketing’s contribution was not representative of the contribution we expect to receive and the cost we expect to incur from the portfolio in the coming quarters. This quarter’s results are backward looking at a time of great transition. They will not provide a good proxy for our business as we move ahead. Nevertheless, this is our earnings call, so I think a few items are noteworthy. Our revenues and expenses from the non-marketing properties were strong and performed within our expectations. Cash from Marketing allocated to the quarter amounted to approximately $8 million, which is reflected for GAAP purposes as $18 million of rental revenue offset by a $10 million charge to G&A for bad debt. I should note that we’ll retain this accounting convention, that is recording the full amount of revenues from Marketing even though we did not expect to receive them and then writing them off until April 30, which was the time that -- which was the day that the master lease was rejected by Marketing. Operating costs related to the Marketing bankruptcy comprising legal, accounting and other costs that we believe will diminish over time were approximately $1 million this quarter. As we communicated previously, our ongoing general and administrative expenses net of the bad debt expenses associated with grossing up the now-rejected master lease continued to rise to match the increased intensity of our business. However, they did not reach their full run rate this past quarter. In particular, we have added staff and expect to incur costs from outside contractors in the coming quarters. So I would ask you not to try to extrapolate from this quarter’s results. Over the long-term, these costs should decline as we make further progress on the repositioning process. AFFO decreased by $6.7 million to $9.7 million or $0.29 per share as compared to $16.4 million or $0.50 per share for the quarter ending March 31, 2011. FFO decreased by $4.3 million to $10.3 million or $0.31 per share for the quarter ended March 31, 2012. These results reflect the underlying strength of our non-marketing portfolio and the fact that we generated revenues from Marketing even while they were in bankruptcy, while Marketing absorbed much of their own cost during the quarter. Net environmental expenses and outlays were stable in the quarter. We saw the increased depreciation expense -- we saw increased depreciation expense as a result of cost capitalized related to the marketing environmental liability we assumed even though we did not begin making cash outlays until May 1. This is another item not fully reflected during this quarter. As we had previously stated, in 2012, we expect cash outlays and depreciation expense will significantly increase because we are now responsible to remediate contamination of our properties that Marketing previously had been responsible for. We are very comfortable that we can manage the remediation process, but we are also still not far along in our planning process to be able to provide you guidance regarding the magnitude of the impact. Finally, interest costs were approximately $1.5 million, which were in line with expectations resulting from our new credit agreement. We are slowly making progress with respect to property dispositions while we continue to advertise for sale or lease in approximately 145 locations, which have had their tanks removed. We continue to believe we will generate meaningful cash from dispositions in 2012, which we intend to invest in other properties. We only closed 2 property sales during this past quarter, realizing a net sale gain of approximately $550,000, but the pace of improvement is evidenced by the fact that we have closed 5 additional sales during April alone. With that background, I think we should open the call for questions. Before I do, I want to say again that while much work remains, we have done -- we have -- do not have all the details for you yet. We have also made considerable progress, and I am pleased with where we are, where we are going and grateful for the contribution and sacrifice our people have and are making. So with that in mind, operator, please open up the queue to see about any questions.

[Operator Instructions] And we’ll go first to Tony Paolone with JP Morgan.

Dave, I’d like to first start with the 282 locations that have been net leased back out. Can you tell us how you arrived at $17 million of net rent, how that compared to what you thought was allocated to those under the marketing lease, and then just give us a little bit more detail on the credit behind those?

I don’t, Tony, have the number about -- how that compares to the -- what was allocated under the Marketing lease. It’s obviously certainly less, but I can’t tell you by how much less. Let me see if we can find a way to get that number out in disclosure in the coming weeks. I’m sorry, what was the rest of the question?

How did you get to the $17 million? Can you give us an EBITDAR coverage on that or just put some parameters around gallonage or in-stores sales, just how you got to that number, how you think that’s fair?

Well, it was the result, Tony, of a process that we ran. We had divided the entire marketing portfolio into approximately a dozen individual geographic areas where we thought was -- they were natural for distributors to be interested for because they provided enough size and enough scale to provide the overhead and the management required for them to manage them efficiently. We then ran a process, we received multiple bids for all locations, and these were the best bids that we received for those particular portfolios although some of those even represent combinations of portfolios. Those 6, I think, or 7 or 8 geographic regions. With respect to coverages and things like that, the distributors themselves obviously ran the coverages because they are putting their credit on the line. It’s hard to come up with specific numbers, but they are all, I would say -- again, part of why I say it’s hard to come up with specific numbers is, because everybody going into these portfolios is expecting an improvement over them. But even based on historical, which were very much depressed results, I think that you were looking at 1.4 and above kind of coverages. Does that help?

Yes, it does. And what about just in terms of the way the leases were structured? And then one of the issues with the Marketing lease was that it gave you very little information about what was happening in your own portfolio.

No, no, no, we are -- yes, we learned that lesson a long time ago. And all of the leases that we’ve entered into, really since 2005, called for tenants to provide us with very regular information with respect to how the underlying properties are doing in terms of volumes, dealer rents or inside sales, whichever is relevant, as well as eliminating the really key problem that was inside the marketing lease, which was our requirement to keep that information confidential so that we could not disclose it. But I would tell you that from a larger perspective, the other thing you’re seeing us doing is reducing the concentration by moving into multiple tenants, which also obviates the particular issue. So we’ve got the disclosure, but we also don’t have the concentration.

Got it. And how would you characterize the 282 locations that you got done relative to quality across the whole portfolio? Those were above average, average, below average?

Average to above average. The properties that have moved into the interim supply with the global arrangement are probably higher quality properties. Those are the ones we’re more confident we’d able to enter into leases, and the reason that we’ve moved them into the interim arrangement is so that we can take our time and work through them, particularly the alternative real estate opportunities in the best way. But these were also very high quality properties. The approximately 100 that were not part of the global per se in the New York metro area and this particular arrangement are probably the bottom half quality properties. Any given one in there isn’t, but on average.

Okay. And in terms of the 145 that are for sale, it seemed like some of your recent sales were around $300,000 a box. What’s the expectation for the 145?

We haven’t gone there, and for now, I prefer not to. Maybe what we can do on an ongoing basis is start to report kind of like what the average sale price we’ve realized is. But even that I would caution you on because, as I’m sure you can realize pretty quickly, the higher value ones will go first. Right? So the average should tend to down over time or trend down.

Okay. What’s -- can you -- I know you said you don’t necessarily have specific numbers on environmental costs, but just how is the environmental process working in terms of you picking up what was previously the responsibility of Marketing? And are you able to, when you do these triple-net leases with the new tenant, off-load those environmental to them, or do you have to keep them going forward, or how does this work?

Well, we -- the environmental contamination on a piece of real estate is ultimately the owner of the property’s responsibility. We had by contract passed that on to Marketing back in the spin-off in 1997 and they had retained that liability. Now that Marketing is no longer able to meet its obligations under that contract, then it becomes our responsibility. We do not expect to be able to pass that on to anyone else. So even when we sell a property or we lease a property, we figure that we’re going to be responsible for the existing known and unknown environmental contamination in a property. Certainly when we enter into new leases on properties, a new -- any new contamination that occurs becomes the new lessee’s problem. But the pre-existing is ours.

And do you have a sense -- I know you don’t have any real specifics, but just any sense or ballpark as to what the environmental expenses will run going forward now that you have the Marketing assets back?

We’re getting our hands around that still. I think the best answer that I can give you is that I’ll be able to give you a sense of that number by or before next quarter’s call.

Okay. And then the last thing, on G&A and the run rate there, you said it’s going to pick up. Can you put any numbers around that, or do you have a sense of magnitude?

I haven’t calculated it, so it would be a very rough guess. But I think -- you’re looking at something that looks like -- more like a 20% or less of the existing rate than anything over that. But I’m not talking about it doubling or even a 50% increase, but it could be up 20%.

We’ll go next to Jeff Lau with Sidoti & Company.

Just a quick question. I wanted to see if there’s any updates, obviously, with all that’s going on regarding the dividend?

At this point, we have -- are not in a position to make any comment on the dividend. I anticipated there might be some question about that. We’re obviously mindful of the fact that we’re a dividend-paying entity and it’s something that is very present on our minds, frankly, all the time and something that we are actively going to consider in the coming weeks and months. But at this point, I’m not in a position to comment on it and would prefer not to until we can.

Okay. And just going back, earlier in your comments, you said you guys have 282 locations on triple-net leases and then the other 254 in interim arrangements. What’s -- can you talk about again what the remaining locations are?

Well, you mean the approximately 100 that are not in the 254 or the 282 or the for-sale properties?

Yes, is that all that’s left? Is that…?

It’s only about 100. And those are, for all intents and purposes, in pretty much the same arrangement that the 254 are with Global. The difference being that the Global properties for the most part are concentrated in the New York metro, Northern New Jersey area, where the remaining 99 are really spread over the entire portfolio. Some of them are being currently supplied in the Global arrangements. Some of them are being supplied, they’re in New England, they’re being supplied by some of the new tenants in New England or the ones up in Buffalo. Ones up in Buffalo are being done by Global. Some of them are in South Jersey, some of them in Central Pennsylvania. They’re just sort of all over the map and we’re -- I think the important thing at this point is that we have -- we’re generating revenue from them and we have arranged to make sure that the dealers themselves can get fuel, get competitively priced fuel, get enough volume of that fuel so that the dealers can generate revenue so that they can continue to generate revenue for us.

Okay. So really, I guess, bottom line is all the properties that you received back or kind of got back from Marketing, you’re getting revenue on, aside from the ones that are being held for sale?

That’s correct. I think I said that in my remarks, but I think…

Yes, I’m sorry.

But I’m glad you said that, because it’s an important point to underscore. One of the great, dare I say, achievements that we’ve had here in a very short period of time is we’ve been able to transform all but a handful. And if somebody comes back and asks me a handful, I think the number is 6 of these properties immediately into revenue-generating assets. And those 6, by the way, are in the process of being dealt with over the next couple of days.

We’ll go next to Kevin Oro-Hahn with Ingalls & Snyder.

I had a quick question in terms of the gas prices at the pump, which I understand was one of the big issues under the Marketing lease. So we’re just kind of tracking here what the prices at the pump look like and noticed that it’s gone down in some cases. In other locations, those prices have stayed up like over $0.10 above competitors?

Yes.

I wonder if you could give any color on that. Like, are all the Global properties kind of -- have they all been reset at this point, or is there some variance on that?

No. I think what you’ve identified actually is the key to see when a property has been transitioned into a Global property versus has not yet. So, over the last 10 days, we’ve been rolling out somewhere between 25 and 30 properties per day that have been going over to Global, and on average, the prices at the street that those dealers are offering have been dropping anywhere between $0.06 and $0.25. So you’re actually -- just described precisely what you should be seeing on the street as that rollout continues.

We’ll go next to Matthew Feldman with Davidson Kempner.

Credit -- amended credit agreement references some appraisals that were outstanding as part of the amendment of the 70% LTV ratio.

Yes.

When do you expect those appraisals to come in and will you be sharing the results?

The appraisal process -- I don’t know how much you’ve dealt with commercial banks, particularly in the post FIRREA world. But FIRREA puts it close as we have in this world to a force field around the appraisal process so that we know very, very, very little about what’s going on inside that. The federal rules are constructed so that we couldn’t possibly influence it, but they also make the whole thing completely baffling to us, which I guess is my way of putting color around the fact that we don’t know when the appraisals will be completed. We do know that they will be shared with us. We have made no decision whatsoever whether we’ll share them publicly or not.

We’ll go to Brett Reiss with Janney Montgomery Scott.

You mentioned in the 10-Q that you have contracts to sell 12 additional properties. What is the aggregate amount or ballpark of those 12 properties?

I’m not sure what the reference is. Sorry, Brett, but let me just take a look.

Is it possible so I don’t hold other people up on the call that I can talk to somebody offline on that?

Sure, you’re welcome to call me.

Okay. I just want to make sure I – there is only 6 properties not paying any rent?

There’s only 6 properties that we’ve not identified an alternative fuel supply for. And actually by the close of business today, I think that will be down to 1 or 2.

Okay. So you’re not having to go through the laborious dispossessed route of any of the tenants?

Not yet. There are some tenants in some places. Again, I would describe this as a handful of properties that have decided to try to use the Marketing bankruptcy to improve their position relative to their landlord. And we’ll use whatever is appropriate legal means to get the maximum value out of our properties. We own the properties, not the dealers.

Right. But if somebody, a tenant, decides to play hardball, are they able to occupy the property without paying you anything until you go through the landlord and tenant dispossess proceedings?

All of that, Brett, ultimately is up to the determination of the court. So far, we haven’t found that to be the case.

Okay. Now, in the fourth quarter, you made an estimate and accrued an additional $47 million in environmental liabilities that you think will be responsible for, now that marketing is no longer there. When you sell -- you mentioned that when you sell properties, we’re having to more often than not retain the environmental liability. Is that retention of that environmental liability included in that $47 million estimate that you made in the fourth quarter?

Yes, the $47 million is the estimated -- best estimated fair market value of our -- the incremental environmental liability and tank removal liability that we’ve inherited from Marketing.

Okay.

If a property gets sold, it just stays in that $47 million.

Okay. Now, the $0.19 that you report in this quarter is net earnings. Is any portion of that taxable earnings that you in theory have to pay 90% of to retain your REIT status?

The $0.19 is a GAAP measurement, Brett, of earnings. And we don’t report on a quarterly basis what our taxable income is. GAAP is a reasonable proxy for taxable earnings, particularly in this quarter where there weren’t a lot of straight-line issues going on inside rents. So I’d tell you it’s a reasonable proxy, but it’s not a -- it’s not definitive because it’s GAAP, not tax.

And we’ll go next to Tony Paolone with JP Morgan.

There has been articles written about just some of the push-back that some of the operators are giving to these new distributors and the debate between during commission fuel sales versus them being able to set their own prices. I mean, can you maybe talk about how the money is made or not made and how you fall in that debate, and just to give us a better understanding of how the business really works here?

Sure. I think the -- first of all, the question of commission dealer versus dealer tank wagon pricing, Tony, is what you’re touching on. And in one case, the dealer actually buys the gas from the distributor. It’s his own credit. He puts it in the tanks himself. He sets the price himself. He decides what kind of margin he wants to make and what kind of volume he’s going to pump, because obviously if he sets his price more competitively, he’s going to have more volume; if he sets his price higher, he’s going to have lower volume. In the commission dealer arrangement, the distributor owns the gas and puts the gas into the tank and the distributor sets the price, and he pays a commission anywhere between $0.07 and $0.12, I think is what was cited in the press articles, to the dealer. And in that case, both are really concerned. It’s much more of a volume-oriented kind of scheme than a dealer tank wagon. We are, generally speaking, agnostic about the -- whatever mode of fuel supply goes on in the properties. We’re interested in generating the most amount of cash on a long-term basis from the properties. And therefore, we just simply come out on an agnostic basis. Now, we’ve offered the properties to the distributors on a free and clear basis, which is what they legally are according to courts and all of the definition, for them to decide how they want to operate them. Some dealers in some places have decided that, no, they would like to operate the way the dealer wants to, even though nobody has yet explained to me anyway why they have any legal rights to do that. The important thing I think for us is that we have leases in place with dealers who are paying -- by the way, have paid us May rent on those properties. And while we are cooperating with those dealers or with those distributors in dealing with these dealers to try to help explain to them that they don’t have any right to do what they are seeking to do, as far as we’re concerned, we have an effective binding lease in place with our tenants.

So in the instance of like Global Partners, so they are paying you the rent?

We don’t have a lease with Global. So let’s be clear about that.

Right. I understand that you don’t have a lease, but are they paying you right now to operate or is it the other way around and you have to get something from the operator in the store?

In the Global -- in the interim fuel supply arrangements, what’s happening is that the individual dealer is occupying the property and paying us for occupancy. He’s paying us a license fee. It’s akin to rent. So we’re collecting rent directly from the dealers. In addition, Global is putting fuel into those locations and selling that fuel on a commission basis so that Global owns the fuel, Global is setting the prices, and I made the point in an earlier question. But generally speaking, if Global comes in and takes these over, the prices are coming down anywhere between $0.06 and $0.25 per gallon on a street basis. And then Global is paying the credit card commissions and all the other expenses and paying a commission to the dealers and paying us a fee on a per-gallon basis for the fuel that gets pumped in those stations.

And in turn, your cost then remain things like environmental, taxes…

It’s more of a gross lease versus a net lease. So think about it now in terms of a gross lease. So we’re responsible for some of the maintenance, not all of it. I mean, the tenant is responsible for sort of day-to-day sweeping and cleaning, but we’re responsible for some of the larger level maintenance. We’re responsible for insurance. We’re responsible for taxes although we do get reimbursements for taxes. But again, it’s kind like a CAM charge. Some of it we get full reimbursement, some of it we get reimbursement over a base. It varies kind of thing.

And where do you think this arrangement is relative to where you could ultimately lock up a net lease with a distributor like in terms of just the level of, you know, call it rent for now?

It varies with margin. So when margins are really good, I think we’ll actually make more money under this arrangement. When margins are more towards the tight end, I think we’d make less money under this arrangement than we would under a net lease. At this point, I will tell you, today, margins are pretty good.

Okay. And then just last thing, the $47 million just mentioned, the environmental accrual, is that -- did I understand it right, that’s the net present value of what you expect the future environmental cost to be, just like the -- I think the $600,000 in the first quarter that you took in environmental expenses? Is that $47 million the incremental NPV of that going forward, or is that something else?

It’s almost like we should do a tutorial on environmental, but the $47 million is the net present value of the known environmental contamination. So what the -- of it would cost to remediate the known environmental contamination plus the cost to remove all of the tanks on a net present value basis. That’s what the $47 million is. The $600,000 represents a change to the estimate of the $47 million. Does that make any sense?

I thought the $600,000 in the first quarter was basically your ongoing environmental expenses for the -- that you’ve incurred that…

I’m sorry. You know what, the $600,000 in the first quarter is the -- it has to do with the legacy portfolio, not the $47 million.

Right. So, as you bring in the Marketing assets now and you would add something on top of the normal legacy expenses each quarter, is that $47 million the NPV of those incremental expenses that we’ll see each quarter?

Yes, but we won’t be adding expenses. It reflects itself in depreciation. We’ll be depreciating the $47 million because the next layer of this is the $47 million causes you to write up your assets by $47 million. So what you’re going do is you’re going to see it reflected through as depreciation expense.

So this would actually be different than the legacy assets in the way it’s accounted for?

It’s -- so the legacy assets and these assets are going to be accounted for in a different way going forward than they were in the past.

So how would -- so how would one kind of step back and look at your reported results and then say how much are these guys spending in cash each quarter to just cover environmental items?

Well, the cash number will be a disclosed item because it will be in the fund flow statement, and we will highlight that number for you.

But it won’t necessarily be on the income statement because depreciation is going to capture that?

Correct.

We’ll take our final question from Jeff Lau with Sidoti & Company.

Just a follow-up on the properties for sale. The 145 is after the 5 sold in April, right?

Yes. It’s -- the 145 is -- it started with about 162 approximately 9 months ago. There have been lease expirations, condemnations, properties that were eliminated from the list, plus sales, to bring it down to 145.

And at this time, we have no further questions and we’ll turn the call back over to the speakers.

Well, I want to thank everyone for your continued interest in the company. We always are available to answer questions. We’re making a lot of progress, and we look forward to talking to you in the coming months. Thank you all for the call, and we’ll talk to you soon.

That does conclude today’s conference. Thank you for your participation.