NNN REIT Inc (NNN) 2003 Q4 法說會逐字稿

Good morning, and welcome, ladies and gentlemen, to the Commercial Net Lease Realty Year-End Earnings Conference Call.

At this time, I would like to inform you that this conference is being recorded and that all participants are in a listen-only mode.

At the request of the company, we will open up the conference up for questions and answers after the presentation.

I will now turn the conference over to Mr. James Seneff.

Please go ahead, sir.

James Seneff, Jr.: Good morning and welcome to our year-end earnings release call.

I have with me Gary Ralston, President and Chief Operating Officer, and Kevin Habicht, our Chief Financial Officer.

First, we're going to have Kevin go through the numbers.

Kevin?

Thanks, Jim, and I of course have to start with my obligatory comment that we will make certain statements that may be considered to be forward-looking under federal securities laws.

The company's actual future results may differ significantly from the matters discussed in any forward-looking statements, and we may not release revisions to these forward-looking statements to reflect changes after these statements are made.

Factors and risks that could cause actual results to differ materially from expectations are disclosed from time to time in greater detail in the company's filings with the SEC and in this morning's press release.

Thank you for joining the call.

As indicated in the press release, FFO was $18.432m, or 38 cents per share for the fourth quarter of '03.

That compares with 36 cents for the same period last year, and 37 cents for the immediately preceding third quarter.

This was a 5.6% increase over year-ago amounts.

For the full year 2003, it was $1.46 versus $1.43 in 2002.

Looking at some of the individual income statement line items, total revenues for the fourth quarter were $28.6m.

That's a $6.3m increase from a year ago.

The increase largely in total revenues is the result of the rental revenues increasing $5.7m, coming from acquisitions made in the REIT portfolio during 2003.

Total occupancy increased to 97.0% versus 94.6% a year ago.

In the interest and other income line item, that consisted primarily of $128,000 of property and asset management fees and $2.323m of interest and other income, much of which came from our unconsolidated subsidiary.

Additionally, these interest and other income amounts represent a $554,000 increase from the fourth quarter of last year.

That's primarily due to a $43m mezzanine loan investment on several California office properties in October, 2003, which Gary is going to discuss further in just a moment.

Our property expenses increased to $936,000 compared to last year but that was flat compared to the prior quarter.

All the increase in the fourth quarter of 2003 was related to the Washington, DC, office buildings, which is, again, consistent with the prior quarter as well.

Our G&A expense was $3.687m, a $1.339m increase from the same quarter last year.

This was a result from a number of factors, ranging from Sarbanes-Oxley related line items and D&O insurance, setting up our internal audit sector 404 plan, which is totally in place, to increased dead deal costs in the fourth quarter that were written off, as well as higher bonus expense in the fourth quarter of '03 versus the fourth quarter of '02.

We do not anticipate that the last quarter's G&A to be indicative of the 2004 levels, which we see running around $3m, maybe a little higher, per quarter in 2004.

Interest expense increased $726,000 from year-ago levels, to $7.6m.

This was a result of a modest increase in the debt outstanding, offset by lower average interest rates.

As of year-end '03, only 10%, or $48m, of our debt was floating rate debt.

That compares to 15% at the end of '02.

The net income from our unconsolidated entities was $3.174m for the fourth quarter of '03.

That compares to a $1.82m for the same period a year ago.

We sold 12 build-to-suit 1031 exchange properties in the fourth quarter, five were land only.

Total proceeds were roughly $36m, which is about half of our dispositions in '03, and the cap rates ranged from 9 1/4% for Black Angus/Winn-Dixie type properties to 7 1/4 for Walgreen's to mid to high sixes for brown lease deals, in our taxable sub in the fourth quarter.

As we mentioned, there is and will be some choppiness in this number and this obviously is some of the positive choppiness, but the market remains good for this activity and we're pleased with these results.

We do anticipate that we will begin to consolidate our taxable REIT subsidiary and Commercial Net Lease Realty Services on our parent financial statements in the first quarter of '02.

This should not have any impact on our bottom line or balance sheet to speak of, except more detail, rather than line items consolidated into one line item.

Lastly, with regard to the income statement, again we'll note that we've included in our press release some additional disclosure to allow you to adjust the income statement line item, so you can see what the P&L would look like if FAS 144 had not been applied and classified some of the activities as discontinued operations.

With regard to guidance for 2004, we're not changing our guidance for the year, from the $1.48 to $1.52 range, which we announced on last quarter's call.

At this point, we see 36 to 37 cents per quarter in the first half, and 37 to 39 cents per quarter in the second half.

Moving to the balance sheet, we noted two fourth quarter capital events in the press release.

In November, we closed on a $95 million mortgage that was secured by our two Washington, DC, office buildings leased to the federal government.

The debt was structured as ten-year, interest-only debt, so it will have no negative impact on our fixed charge coverages.

At a 5.42% fixed interest rate, we felt like this was very attractive long-term debt.

Additionally, in December, we raised $64 million of additional common equity as a part of our regular capital plan.

We finished 2003 with total liabilities of $478m; that fell slightly from the end of the third quarter.

Of this amount, $148m was mortgage debt.

With the addition of the mortgage debt I just mentioned we did in the fourth quarter, approximately 20% of the company's total assets are encumbered by mortgages, leaving 80% of the company's assets unencumbered, and we do not anticipate encumbering any additional assets in the portfolio.

If you look total debt to assets, which we look at a gross book basis, excluding accumulated depreciation, debt to total assets was 37.6%; that's down from the third quarter, 40.1%, and down from a year ago, 40.4%, and frankly, this is the lowest leverage we've been operating with for several years, actually.

On the interest coverage front, we continue to make improvements there.

Interest coverage for the fourth quarter of 2003 was 3.6 times.

Full year 2003 coverage was 3.5 times, and that compares to 3.4 in '02 and 2.9 in 2001.

On the fixed charge coverage front, we were 2.8 times in the fourth quarter of 2003.

Full year 2003, fixed charge coverage was 2.8 times, and that compares with 2.7 in 2002 and 2.6 in 2001.

So again, very pleased with the trends in these coverages.

We do expect them to moderate a bit with rising interest rates, though.

I think that's all I had.

We were very pleased with the results for the year and think we're on good footing to have a good 2004.

Let me turn it back to you Jim, for now.

James Seneff, Jr.: Thank you, Kevin.

Now Gary will give us a portfolio update.

Thank you, Jim.

It is a requirement for us to repeat regularly that we're proud of our 2003 increased dividends to shareholders.

It represents the 14th consecutive year of increased dividends.

Our investment strategy is designed to create an attractive, risk-adjusted return for our shareholders, and central to that strategy is our commitment to real estate value.

Disciplined diversification, geographically, by industrial classification, and by individual tenant enhances the stability of our operating income.

Our portfolio is made up of single-tenant properties in good locations that are net leased over a long term to credit-worthy tenants.

We currently own 349 properties in 39 states, leased to 128 tenants, and 47 different industrial classifications.

Long-term net leases are a key component to the safety of our dividend and the common thread of our investments.

The net lease structure reduces real estate operating risk, because tenants are responsible for paying property taxes, insurance, and operating expenses.

Further, we believe that leases in excess of a decade in duration bridge real estate and economic cycles.

The weighted average remaining lease term of our portfolio at year-end was 11 years.

To help you better understand our work to build an annuitous income-generating portfolio, we have provided some additional information about our portfolio construction.

In addition to the disclosure with our press release, I would share with you the geographic diversification, based on the [NAREIT] regions.

In the Northeast Region, we have 50 properties, representing 32.5% of our base rental income.

In the Southeast, 96 properties, representing 23%.

In the South, 87 properties representing 17%.

In the Midwest, 55 properties representing 11%.

In the West, 33 properties representing 10.8%.

In the Rocky Mountain, 27 properties representing 5.5%.

128 individual corporate tenants to us means that we are well-diversified by individual tenant.

We have one tenant representing over a 15% concentration.

That's the United States of America.

We believe this is a strong credit which serves to enhance the overall credit profile of the company.

We have one tenant greater than 10%; that's Eckerd.

Eckerd Corporation is a subsidiary of JC Penney Corporation.

They're headquartered in Clearwater, Florida.

They're one of America's largest retail drug chains, with approximately 2,700 drug stores in 20 states.

Their third quarter sales were $3.6b and operating profit was $34m.

Sales for three quarters was approximately $11b and they generated, operating profit for the first three quarters of their fiscal year, $206m.

The company added or relocated 103 stores through the third quarter and they plan another 111 new or relocated stores in the fourth quarter.

We understand that plans for new stores in 2004 is consistent with 2003; that means more than 200 new or relocated stores.

That sounds to us like a company that is very committed to free-standing drug stores.

As previously announced, JC Penney is in the process of evaluating strategic alternatives for Eckerd.

We have only one tenant with more than 5% concentration; that's Best Buy.

Best Buy is North America's leading specialty retailer of consumer electronics, personal computers, entertainment software, and appliances, with approximately 750 retail stores in the United States and Canada.

For the 39 weeks ending November 29th, '03, their revenues rose 15%, to $16.1b.

Net income from continuing operations before accounting changes rose 36%, to $331m.

Revenues reflect higher same-store sales and the addition of 72 stores in the past 12 months.

Net income also reflects higher margins and improved efficiencies.

Consistent with our historical commitment to credit tenants, over 50% of our rental income is attributable to tenants with an investment grade or implied investment grade senior unsecured debt rating.

Our line of trade industrial classification is broad -- 47 industrial classifications, using the North American Industrial Classification System.

The largest concentration is the federal government, representing 17% -- 16.7% of our current rental income.

Pharmacies representing 11.8%, supermarket and other grocery stores representing 9.3%, book stores representing 7.8%, sporting good stores representing 7.4%, full-service restaurants representing 7.1%, radio, television, and other electronics stores representing 6.7%, office supply and stationery stores representing 5.6%, limited service restaurants representing 5.2%, furniture stores representing 4.3%, all other home furnishing stores representing 3.1%.

There are four industrial classifications between 1% and 2% -- that's jewelry stores, home improvement, department stores, hobby, toy, and game stores.

The remaining 32 industrial classification categories represent concentrations of less than 1% each.

We had no property dispositions in the fourth quarter from our core portfolio.

During the fourth quarter in our core portfolio, we acquired from an institutional partner the remaining interest in four cash-and-carry grocery stores in Florida, three Target discount department stores in California, two Albertson grocery stores in California, and a Ross Dress For Less store in California.

We also completed construction on an Eckerd drugstore in Dallas, Texas.

The total investment was approximately $26m, just for the record.

Our return on the invested dollars, or the cap rate, was approximately 10%.

In the fourth quarter, we originated a $19m mezz loan, secured by two 11-story office towers, totaling approximately 500,000 square feet in the Woodland Hills submarket of Los Angeles, California.

The buildings are the headquarters of 21st Century Insurance.

The combined loan to value is 89.5%, and the total debt service coverage ratio is 1.18.

We also originated a $24.4m mezz loan, secured by a portfolio of seven office buildings in Sacramento, California.

There are three buildings in the Roseville submarket, one building in the Folsom submarket, and three buildings in the Rancho Cordova submarket.

The tenants in the buildings are Agilent Technologies -- they are in two buildings, Allstate Insurance, Kaiser Foundation, the State of California, and Verizon Wireless occupies two buildings.

The combined loan-to-value is 89.4%, the total debt service coverage ratio is 1.19.

As Kevin mentioned, the loans bear interest at 13.5%, of which 2.5% accrues and they mature in November, 2007.

Re-leasing is a critical element of our business.

We've consistently demonstrated our ability to lease space in the past and we remain even vigilant.

We had one notable new tenant in the fourth quarter.

We leased 53,000 square feet, a former Home Place store in Ft. Myers, to Lee County.

We are pleased with our current occupancy level of 97% and expect to maintain our historic occupancy in the mid 90s.

Our unconsolidated subsidiary, essentially the activities of our build-and-sell and buy-and-resell teams, as Kevin noted, do result in some potential variability in earnings.

We were pleased with the activities in the fourth quarter, which as you noted, generated over half of the annual earnings from those activities.

Our build-to-suit development team was very active.

In the fourth quarter, we completed construction on three Eckerd drugstores in Oklahoma and a Home Depot that actually was a site development ground lease in Michigan.

We started construction on two drugstores in Texas, an Eckerd and a Walgreen's.

In addition, we have under construction Best Buy stores in Michigan and Tennessee, a Cash and Carry in Florida, and a parcel we're developing for Wal-Mart in Michigan.

In the fourth quarter, we closed on the sale of a Macaroni Grill in Idaho, a Laz-Z-Boy furniture store in New Jersey, a Walgreen's drugstore in Texas, and two Eckerd drugstores in Oklahoma.

Our 1031 exchange buy-and-resale team was also active in the fourth quarter.

We closed on the sale of various land leases, including an Amoco gas station in Miami, three restaurants in Miami, a Rooms To Go furniture store in Miami, as well as a restaurant in Minnesota and a Winn-Dixie grocery store in Georgia.

We believe that 2003 was another year of solid performance and that we're well-positioned for 2004.

James Seneff, Jr.: Thank you, Gary.

Now I'd like to review some of the highlights for 2003.

The dividends increased to $1.28 per share, marking the 14th consecutive year of increases.

We are one of 228 companies out of 10,000 listed companies that have achieved this.

We invested $325m, including mezz loans, in properties owned by the company and its affiliates.

That's a record for the company.

We increased occupancy from 95% to 97%.

We launched a broadened property sector diversification strategy, which included industrial and office, we sold 14 properties, generating $25m of net proceeds, we increased interest and fixed charge coverage ratios to 3.5 from 2.8, respectively, and the total return to shareholders was 25.3%, and we've outperformed the Morgan Stanley and NAREIT indexes as well as the S&P, NASDAQ, and Russell 2000 for the three, five, and 10-year period, with a 10-year return, total return, of 12.2%.

And now we'd like to open it up for questions.

Thank you. [Operator Instructions] Our first question comes from Ross Nussbaum from Smith Barney.

Please state your question.

Hi.

Good morning, everyone.

James Seneff, Jr.: Good morning.

My question is on the mezzanine loans.

First, what do the lease expirations look like for these office buildings and what's the current occupancy rates?

The buildings are essentially 100% occupied.

They're single-tenant buildings, there are a couple of other tenants who are located in the 21st Century Insurance building.

They have the right to take over the space, if any of those tenants would vacate.

The 21st Century Insurance leases go through November of 2014.

The various leases in the Sacramento office buildings range from a remaining term of six to 11 years, and the average maturity takes us through mid-2011.

OK.

And where do you think the rents are, relative to the market today?

We felt that the rents on those properties are consistent with the market rents.

If we were to, you know, look at our position as a owner, so to speak -- if we, you know, took a ``loan to own'' perspective, which is really the way we underwrite things, we would end up with a return on our invested capital of approximately 9.22%, which we felt for California office buildings, leased to credit tenants, is very comfortable.

James Seneff, Jr.: And I think that's an important comment, and we really did underwrite these in the worst-case scenario which we frankly don't think is going to happen, that we would own these properties and we'd be happy to own these properties.

They were underwritten in that way, and you know, everything we do, whether it's in the build-to-suit arena or in this particular phase, we're always looking to work with properties we're willing to own.

OK.

Can you-- are you booking the full 13.5% in FFO or just the 11.5% in cash?

We are- I mean, we're booking the entire amount.

It's something that, you know, it's accruing, and so until we get a sense that we have a reason not to, you know, we're kind of compelled to, so yes, we're booking the entire 13.5%.

Under what scenario do you not get the 2.5% accrual?

James Seneff, Jr.: There is no scenario, absent, you know, inability for the borrower to repay the loan, and we take the property back.

OK.

And how did this transaction come about?

It's not something that you guys have historically done?

We've been active, Ross, in the acquisition front, underwriting properties and examining them, and so this was originally something we looked as a partnership or JV.

We actually had underwritten the properties in Sacramento as a potential purchaser, and someone was willing to pay a little more than we were comfortable with.

We determined that a better investment vehicle for the company, it just was cleaner, instead of doing some sort of partnership, was to do a mezz loan position.

It, you know, makes us, we think, a bit more secure.

It clarifies things.

It does cap our upside, but we're very comfortable with the returns that we're getting.

We think they're very equity-like.

OK.

And the timing of these deals, you said, was October, you completed them?

Yes.

OK.

My last question relates to the mortgage financing you put on the Washington, DC, assets.

Why-- why only an interest-only mortgage?

Why are you afraid of the amortization?

James Seneff, Jr.: We're not particularly afraid of it.

I mean, I think in some respects, clearly, our metrics can handle that.

It really didn't cost us much, so we felt like, you know, that was a small plus that we wanted to put in place.

Loan to value was in the kind of high 50s kind of range.

You know, our goal obviously is to increase our credit ratings there, and hopefully, you know, this will support that, to some small degree.

OK, thank you.

[Operator Instructions] Our next question comes from Paul Puryear from Raymond James.

Please state your question.

Thanks.

Good morning, everyone.

James Seneff, Jr.: Hey, Paul.

Hey, Paul.

Could you-- how do we think about the '04 strategy for the mezz portion of your business, in terms of the yields and the amount that you might do there?

Yeah, our expectation is that we would originate and return something in the vicinity of $35m and we believe we can generate returns of 12%, plus or minus, on those dollars.

And that's out of a total investment expectation of what level?

Between $250m and $350m.

OK.

And should we expect you to continue to make investments, either through the mezz strategy or direct ownership in other commercial properties, office or industrial?

James Seneff, Jr.: Yes.

As part of the diversification strategy.

And then also, could you just-- I mean, the G&A is up 20% this year, it looks like.

How do you-- could you just comment on that and how should we look at G&A for '04?

Yeah, I think a couple of things.

One, it is up and G&A in '02 was a little bit lower than probably average, in some respects, in terms of what we were running.

I mentioned kind of a laundry list of things, as it related to fourth quarter, from Sarbanes-Oxley, legal, accounting, internal audit kinds of things, to increased debt deals and then also higher bonus expense, which was lower in '02 and back to more average levels in '03.

But I think what we see for '04 is again, kind of G&A running around $3m per quarter, maybe a little higher.

I think as, you know, we look at this as a percent of revenues, we see that'll be dropping under 10% next year.

And I think-- I don't know to what extent you're kind of comparing us and others and I just want to be clear -- our G&A item includes, you know, everything and the kitchen sink, basically, meaning we don't have property management, asset management people, that are getting charge to, call it ``real estate operating expense'' line items.

Everything is being run through our G&A line item, so-- as well as the entire leasing team is in the G&A line item, so I think that's one item.

Like I said, I'm not certain how other REITs do it.

And the other, in the case of net lease REIT, you know, revenues obviously are lower, given that we don't gross-- you're really looking at net operating income, compared to other REITs that are not net lease.

And so if you're trying to do a G&A to revenue kind of number, you know, we-- we-- I think that's just an adjustment you have to make.

OK, thanks.

[Operator Instructions] If there are no further questions, I will now turn the conference back to Mr. Seneff.

James Seneff, Jr.: I want to wish everyone a Happy New Year and thank you for joining us.

Have a good day.

Ladies and gentlemen, if you wish to access the replay for this call, you may do so by dialing 800-428-6051, or 973-709-2089, with an ID number of 331448.

This concludes our conference for today.

Thank you all for participating and have a nice day.

All parties may now disconnect.