Four Corners Property Trust, Inc. annual report, FY2015

Business context and reporting period

Four Corners Property Trust, Inc. filed its first annual report for the year ended December 31, 2015. Darden Restaurants completed the spin-off on November 9, 2015, contributing 418 restaurant properties leased to Darden and the six-restaurant Kerrow LongHorn Steakhouse business. The company became an independent, publicly traded restaurant-property owner and operator; its shares began trading on the NYSE on November 10, 2015.

Comparisons with 2014 and 2013 are not like-for-like: historical results for those years primarily reflect Kerrow, while 2015 includes Kerrow for the full year and the new rental business only after the spin-off. The company had no historical stand-alone real estate operations results.

Financial performance and condition

Metric	2015	Prior comparable data
Total revenue	$33.5 million	$17.7 million in 2014; not comparable
Net income	$5.7 million	$32,000 in 2014; not comparable
Cash provided by operating activities	$21.7 million	$961,000 in 2014; not comparable
Cash used in investing activities	$0.6 million	$55,000 in 2014
Cash provided by financing activities	$76.9 million	Cash used of $0.9 million in 2014

• Revenue included $15.1 million of rental income, earned after the spin-off, and $18.3 million of restaurant revenue from Kerrow. Rental income is recognized straight-line; the balance sheet included $1.5 million of deferred rent receivable.
• Kerrow restaurant revenue rose 3.5% year over year, primarily as average check increased 4.3%, partly offset by a 0.8% decline in guest counts. Restaurant expenses were nearly flat; expenses fell to 92.8% of revenue from 95.7%, and restaurant operations net income increased to $1.3 million from $0.8 million.
• At year-end, cash and cash equivalents were $98.1 million. Total assets were $929.4 million, including $828.7 million of net real estate investments. Total liabilities were $487.8 million and equity was $441.6 million.
• Debt consisted of a fully drawn $400 million term loan, due November 2020; its balance-sheet carrying amount, net of financing costs, was $392.3 million. The $350 million revolving facility, due November 2019, was undrawn. Year-end term-loan interest averaged 1.99% before hedging-related costs and 3.4% including swaps and financing-cost amortization.
• Operating cash flow included a $7.9 million increase in deferred rental revenue and other working-capital movements. It should not be treated as a direct measure of recurring cash available for dividends.
• Management reported NAREIT FFO of $9.5 million and AFFO of $8.2 million, or $1.51 and $1.31 per diluted share, respectively. These figures reflect a partial-year real estate business and a weighted-average share count affected by the spin-off; the company cautions that its non-GAAP measures may not be comparable with other REITs.

Portfolio, material changes and capital returns

• At December 31, 2015, the company owned 424 properties: 418 leased to Darden and six operated by Kerrow. The leased portfolio comprised approximately 3.287 million square feet across 44 states, with a 14.5-year weighted-average remaining non-cancelable lease term.
• Annualized cash base rent from the 418 leased properties was approximately $94.4 million. Leases generally provide 1.5% annual rent escalations and are triple-net, placing most property operating costs on the tenant. Portfolio EBITDAR coverage was 4.2x.
• Darden is the sole tenant under the property leases and is the source of substantially all leasing revenue. Olive Garden represented 300 properties, approximately 74% of annual base rent; the filing also reports that it represented about 75% of lease revenue.
• The $400 million term loan funded the spin-off cash payment to Darden of $315 million, with remaining proceeds used for the purging distribution and corporate and working-capital needs. The company paid no dividends in 2015.
• After year-end, the board declared special distributions totaling $8.32 per share. The filing says the March 2, 2016 purging distribution was $347.0 million, or $8.12 per share based on approximately 42.7 million shares, paid in cash and stock; it reports $69.5 million of cash distributions for that payment. The distribution issued 17.1 million additional shares, bringing shares outstanding to 59.8 million. Management separately states that cash and cash equivalents had fallen by approximately $78 million by March 18 after funding the cash component.
• The company intends to qualify as a REIT beginning with its 2016 tax year and stated an expected initial regular dividend of $0.97 per share annually. It intends to pursue acquisitions and tenant diversification but set no fixed acquisition target. Future dividends remain subject to board approval and operating, financing and REIT-distribution requirements.

Outlook, risks and unusual items

• Management’s strategy is to maintain balance-sheet flexibility, acquire restaurant and food-service properties selectively, diversify tenants beyond Darden, and support tenant improvements where returns are attractive. The filing provides no earnings or acquisition guidance.
• Concentration is a central risk: Darden is the only lessee, and Olive Garden is the largest brand exposure. Darden’s ability and willingness to meet lease obligations, maintain restaurants and renew leases materially affect rental income, debt service and dividend capacity.
• The company faces risks associated with its $400 million term debt, interest rates, credit-facility covenants, refinancing and access to capital. Interest-rate swaps hedge the term loan; the filing reports $316,000 of other comprehensive loss on hedges and $3,000 of hedge ineffectiveness in earnings during 2015.
• Four Corners was a newly independent public company with limited stand-alone operating history. Transition services from Darden were expected to expire in 2016. Kerrow’s six operating restaurants also expose the company to restaurant-specific operating and legal risks.
• The company recorded a $2.944 million income-tax provision for 2015 and an $80.9 million deferred tax liability at year-end, largely related to real estate tax basis. Management expected an approximately $80.3 million tax benefit in first-quarter 2016 upon satisfying REIT requirements and proceeding with its REIT election.
• The spin-off’s tax-free treatment, potential indemnification obligations to Darden, REIT qualification and required distributions present material tax risks. Other disclosed risks include environmental and property-compliance liabilities, casualty and insurance exposure, lease renewal and re-leasing risk, and restrictions on certain strategic or equity transactions after the spin-off.
• Management said routine claims and legal proceedings were not expected to have a material adverse effect. There were no off-balance-sheet arrangements at year-end. Disclosure controls were assessed as effective; management’s internal-control-over-financial-reporting assessment and auditor attestation were not yet required for this newly public company.

Important facts for investors to verify

1. Reconcile the declared $8.32-per-share special distributions with the March 2 payment described as $8.12 per share, the $69.5 million cash amount, and the reported approximately $78 million cash reduction.
2. Assess Darden’s credit quality and lease coverage, the concentration of rent in Darden and Olive Garden, and the implications if stores close or leases are not renewed.
3. Review the post-distribution cash balance, term-loan terms and covenant headroom, and the availability and conditions of the undrawn revolver.
4. Track completion of the 2016 REIT election, the expected tax benefit, and any developments affecting the spin-off’s tax treatment or related indemnities.
5. Evaluate the sustainability of the stated regular dividend against recurring property cash flow, debt service and the company’s partial-year, non-comparable 2015 results.