NNN REIT Inc (NNN) 2004 Q4 法說會逐字稿

Good day, everyone, and welcome to today's Commercial Net Lease Realty Inc. fourth quarter and year-end 2004 conference call.

Today's call is being recorded.

For opening remarks and introductions, I would like to turn the call over to the Chief Executive Officer and President, Mr. Craig Macnab.

Please go ahead, sir.

Tina, thank you.

Good morning and welcome to our fourth quarter 2004 earnings release call.

With me on this call is Kevin Habicht, our Chief Financial Officer, who will report on our fourth quarter and calendar 2004 financial results after certain brief comments from me.

As a reminder to those of you who do not already know, as we execute on our business plan for 2005, all of us at NNN are focused on the retail marketplace.

Our focus on net leased retail real estate properties is consistent with our core competencies and the expertise of our experienced associates.

Furthermore, this focus is proving successful, as evidenced by our excellent fourth quarter.

In the most recent quarter, we acquired 14 properties for $41.7 million for our investment portfolio at a weighted average cap rate slightly in excess of 9 percent.

This volume was helped considerably by the portfolio purchase of 11 properties from United Rentals totaling $25.4 million late in December.

This transaction was sourced by our team and was completed without the involvement of a real estate broker.

The yield on this portfolio is consistent with the accretive returns we are looking for.

For those of you that are not familiar with the company, United Rentals is the largest equipment rental company in North America, with an equity market capitalization in excess of $1 billion.

Turning to the acquisition environment, it continues to be difficult.

But as we increasingly focus on a broader universe of retailers, including more opportunistic retail real estate, we are finding a number of opportunities.

One of these opportunities which we are looking forward to close in the second quarter, is the previously announced National Properties acquisition.

This sole-source transaction will provide us approximately $60 million of assets with an initial yield in the mid-9's when it closes.

We think that this is an excellent current return for a portfolio of this caliber, which has an average lease life of 12 years.

Tenants in the National Properties portfolio include companies such as QuikTrip, Perkins, Academy Sports, and Walgreens.

The largest tenant in the portfolio is QuikTrip, and we are delighted to initiate our entry into the convenience store category with such a high-quality operator.

Our Development Group had a strong fourth quarter and an excellent 2004.

Taking advantage of the demand for high-quality assets, we successfully sold several of the properties that our team has developed.

The visibility for that business looks promising going into 2005.

However, on a quarterly basis, it will be lumpy.

In summary, we are very pleased with the results for 2004, and at this early stage in 2005, we are encouraged with the progress that our team is making.

If this progress continues, and absent any unanticipated surprises, we are optimistic that we will be able to show FFO per share growth in 2005.

Kevin, thank you.

Thanks, Craig, and let me make a standard disclaimer that I will tie to those comments as well as mine, that we're going to make certain statements on this call that might be considered to be forward-looking statements under federal securities laws.

The Company's actual future results may differ significantly from the matters discussed in any forward-looking statements.

And we might not release revisions to those forward-looking statements to reflect changes after the 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.

With that, let me just work through the press release results a little bit here.

As indicated, FFO was $20,760,000, or 39 cents per share for the fourth quarter of '04.

That compares with 38 cents for the same period last year, as well as for the immediately prior third quarter of '04.

For the year, FFO was $1.41.

However, excluding the management transition charges we had taken during the year, FFO per share would have been 40 cents in the fourth quarter and $1.48 for the year.

Total revenues for the third quarter were $33.1 million, which represented a 2.7 million or 8.8 percent increase from a year ago.

The increase in total revenues was primarily a result of the increased rental revenues which increased 11.4 percent or $2.9 million, and that was a result of the acquisitions made during 2004.

Total occupancy at year end was 97.4 percent.

That's up 90 basis points from the immediately prior quarter and 40 basis points from a year ago.

That is a result of a combination of leasing from vacancy as well as selling some, and obviously, acquiring some 100-percent occupied properties along the way as well.

Real estate expense reimbursements -- line item and revenues -- that decreased largely due to the lower expense reimbursements from our D.C. office property, which are now being paid for directly by the tenant rather than reimbursed by us.

Gains on properties held for sale reported in our revenue section decreased to $574,000.

This is a gain that came from the sale of one of the -- one property in our taxable subsidiary.

Additionally, we sold 6 properties from our core portfolio with a total leasable DLA of about 64,000 square feet at an average cap rate of around 8 percent.

These properties included 4 restaurants, 1 Good Guys and 1 vacant property, and is really a part of our ongoing portfolio pruning process.

This gain and the operating results of these properties are included in the supplemental information section that is labeled on the press release, Discontinued Operations Held for Investment.

And just a quick side note.

Unfortunately, GAAP requires us to report the gains on the sale of our properties in a total of 3 different line items.

And I'm sorry about that, but that's the way it is.

The gain on sales, investments, portfolio properties is reported in discontinued operations-held for investment, as I just mentioned.

The gains on the sale of our properties which are developed or acquired in our taxable sub are now reported in 2 places.

If rent had not commenced when we sold the property, it gets reported in our revenue section in the face of the P&L.

If rent had commenced before we sell the property, it gets reported in discontinued operations-held for sale.

So again, I'm sorry about that, but that's the way it is.

We did try to provide a little reconciliation in Note 1 in the press release to help everyone kind of work through that a little bit.

As we have indicated, there is going to be some choppiness in the gain on sale number from quarter to quarter, depending on the timing of the sales.

Lastly, in the revenue section, interest income and other income from real estate transactions increased $1,082,000.

That's largely a result of our structured finance investment that we made in the fourth quarter of 2003 on a California property portfolio.

The income associated with this investment, that one loan, increased $924,000 over the prior year's fourth quarter.

And frankly, a large portion of that increase, $418,000 of it, was due to a prepayment penalty associated with a payoff in mid-December 2004 of $20.9 million of the original $45.2 million loan.

We anticipated that this would get prepaid in January of 2005, and we expect the balance of the loan to get paid off probably in the first half of 2005.

Working down the P&L -- D&A expense of $5.8 million for the quarter.

That's down from 6.3 million in the year-ago period and flat with the third quarter of 2004.

As we previously mentioned, beginning January 1 of 2004, this line item now includes all the G&A of the REIT and the development and acquisition activities in our taxable sub.

Property expenses decreased to $3.1 million compared to last year's 3.4 million, primarily related to a reduction in the expenses from our D.C. office property which are now being directly paid by the tenant resident reimbursing us.

In other expenses and revenues, the interest and other income was fairly flat with last year at $722,000, and represents primarily the interest from one of our taxable subsidiary entities, the interest on a note and some modest third-party property management fees.

Interest expense increased $1.2 million from year-ago levels to 8.3 as a result of higher outstanding debt balances.

Debt was up about $58 million, or 12 percent, from a year ago, and we also have less short-term floating-rate debt than we had a year ago.

At year-end, 12/31/04, only $17.9 million, or 3 percent, of our 541 million of total liabilities was floating-rate debt; that compares with 10 percent floating-rate debt a year ago.

And floating-rate debt as a percent of total gross assets, which I frankly believe is a more meaningful metric, is down to 1.3 percent.

So as a result, any increase in short-term interest rates should not have a significant effect on our income statement.

The equity of earnings from unconsolidated entities was $1,030,000, up somewhat from the prior year fourth quarter.

With our taxable subsidiary now being consolidated into the REIT in '04, this line really represents two things now.

One, interest income from mortgage investments we made that are held in LLC's, which are capitalized with 100 percent equity; and two, our 25 percent equity interest in our headquarters office building.

And we expect this line item to be fairly consistent over time.

On our first quarter 2004 call, we provided 2004 FFO guidance that we didn't change for the balance of year of $1.45 to $1.48 excluding the management transition charges, which converts into $1.39 to $1.41 after those charges.

Actual results today came in at $1.48 and $1.41 before and after those transition charges, respectively.

The market for the disposition of properties we have developed or acquired for sale continues to be robust, and we continue to expect good gains in this year.

We do feel like 2005 is starting off well, but we are not revising our previously provided 2005 FFO per-share guidance of 1.48 to 1.52.

We're continuing to evaluate a range of potential alternatives to improve these results.

The acquisition environment continues to be difficult, but we are making some progress here.

As always, the projections are based on a number of factors and uncertainties discussed in our public filings.

Lastly, moving to the balance sheet, there was little change in the capital structure during the quarter.

We finished the fourth quarter with total liabilities of $541 million.

That is down 32 million from the prior quarter, but up 58 million from year-end '03.

Of this debt outstanding, $157 million was mortgage debt; approximately 22 percent of the total assets of the Company are encumbered by mortgages, leaving 78 percent of the assets unencumbered.

We do not anticipate encumbering additional assets at this time.

Debt to total assets on a gross book basis, which has been historically our primary leverage measure, was 39.3 percent on a gross book basis, which is down slightly from 40.9 percent at the end of the third quarter, and up slightly from 37.9 at the end of '03.

On a market cap basis, leverage at year-end was 33.5 percent.

Excluding the transition charges, the interest coverage for the fourth quarter was 3.86 and our fixed charge coverage was 3.0 for the fourth quarter.

For the year, interest in fixed charge coverage ratios were 3.64 and 2.82, respectively, excluding the transition charges.

We are pleased with these coverages, but we do expect they may moderate a bit with interest rates rising.

In closing, just I think -- as I have mentioned, the acquisition environment is not exactly what we would like but we believe we are focused on improving the long-term operating performance and bottom-line results.

The Company is in very good financial position, and the core portfolio is performing well.

We have a very solid portfolio of properties and equally solid capital structure.

Our challenge really is to grow the bottom-line.

And we are optimistic that we are going to be able to deliver on that in 2005.

That ends my comments, Craig.

Sheila, we would like to open it to questions, please.

(OPERATOR INSTRUCTIONS) Ross Nussbaum, Banc of America Securities.

Good morning -- it's actually (indiscernible) here with Ross.

Kevin, I may have missed it, but what was the yield on the 20.9 million you received in the fourth quarter from the structured finance investments?

The $20.9 million payoff in December of 2004 was related to the larger -- a piece of the larger $45.2 million loan we did back in mid-fourth quarter of '03.

The yield on that particular loan was in the low teens kind of number.

Okay, and then -- I guess as a follow-up to that, what is the yield on the new structured finance investments you made?

And also, what types of investments are they?

Ross, we are making small mezzanine loans, secured generally by retail real estate, and they are in the mid-teens type returns.

In the event we were to end up owning these, which we hope we don't do but in the event we do, they would have cash-on-cash yields to us of in excess of 9 percent.

And right now, we see that as a good place to put small amounts of money.

And then I guess switching gears a little bit, it looks like about 8 cents per share, or about 20 percent of the fourth quarter FFO, came from those gains on distribution of real estate held for sale.

And is that becoming an increasing part of the business?

Can you kind of comment on where you see the run rates for that going forward?

Can you help us out a little bit?

Ross, I think that our development subsidiary, and as you know, we have got a long track record of building primarily freestanding single-tenant retail properties including a number of drugstores, and right now we continue to have a pretty good pipeline into that.

And we are expecting that the type of volume in calendar 2005 will be approximately the same as in 2004.

In the fourth quarter, our gains were a little bit higher than frankly we had projected occurring.

But we have got pretty good visibility into 2005.

We have got a quality portfolio of properties under development.

And if the current cap rate environment stays where it is we are going to take advantage of that and sell them and generate the same types of gains in '05 as we did in '04.

And just a side note, obviously all the gains in our taxable sub are taxed.

So it doesn't all translate to the bottom-line, the gains on sale.

Okay, and then finally, we noticed that I guess CarMax is now one of your top tenants.

Can you guys give us some color on how many deals you have done with them, and sort of what the average cap rate would be?

Which tenant was that, Ross?

It was CarMax.

CarMax.

We did a -- earlier in the year, in the first half of the year, we purchased really in a reverse build-to-suit a large CarMax site in the western part of the United States.

And in the fourth quarter, we have just pretty much finished out the development of that and frankly, the lease-up of -- which had just occurred -- of a paired (ph) contiguous to that.

So it is like many CarMax sites, a large number of acres and frankly the rent is pretty high.

Jonathan Litt, Smith Barney.

This is actually Mike Billerman (ph);

I am here with John.

I was wondering if you could go over -- you know, you talk about refocusing on retail.

At which point have you seen cap rates continue to decline?

And I would probably argue if you look at your D.C. office building for that sort of credit tenant, it probably has declined even further.

At what point do you consider monetizing and harvesting that value?

Mike, that's a good question.

And just as a reminder to those on the call, we have right now 2 office properties.

By far, the biggest is the D.C. office property, which we purchased in 2003.

We are finishing up some capital improvements to it.

By the time it is all said and done, we will have in the range of $173 to $175 million invested in it.

The tenant is the U.S. Government.

Cap rates clearly are very attractive for this type of asset.

I think there are some tax issues that we’ve got to get around.

As I mentioned, we did purchase this in late 2003.

But depending on what opportunities we have to deploy this type of capital, I think it's something that we will clearly be evaluating in 2005.

In terms of -- does it have to be reinvesting into assets, or you consider a distribution to shareholders?

I think we should look at both, Michael.

But it clearly needs to be accretive to shareholders either way for us to pursue it.

Okay.

Just looking at the $72 million of properties that you bought, can you just give me a little bit of color of how much of that was held for investment purposes versus how much you've put into held for sale?

And then, can you just break out a little bit more color?

I think you had said 25 million was netted rentals.

If you can just break that out a little bit further for us, that would be great.

In the investment portfolio, we purchased 14 different assets; 11 of them were retail locations for United Rentals.

Of the 41.7 million that I mentioned that goes into the investment portfolio, 25 million of that was for United Rentals.

And there were 3 other assets, the individual retail properties, that we purchased.

We then purchased a small number of assets in a 10-31 exchange business and then we spent a fair amount of money, as I mentioned, finishing up the reverse build-to-suit on the CarMax in the western part of the United States, a small amount of investment in the TSA office building in Washington D.C. that we talked about a moment ago, Michael.

Then in our development subsidiary, we invested in about $15 million.

So the sum of all those pieces adds up to the 70-odd million you mentioned.

And how much was CarMax?

CarMax was 7.5 million.

Okay.

And then just on -- conversely, on the assets you sold, you sold 40 million.

How much of that was core investment versus -- in a taxable sub?

About 13 million of that was from the core portfolio, and the balance, 27 million, from the taxable sub.

And can you just go over what is held for sale now?

You said about $16 million.

Can you just break that out between the development properties and existing stabilized assets that you are looking to sell?

Yes, the held for sale is all related to the development, taxable sub properties.

Are you thinking about holding development on your own books instead of selling it?

I'm hopeful that in the back end of calendar 2005, we will put into our investment portfolio the first of the properties that we develop ourselves, right now.

We did not do it in 2004, and I'm hoping that we initiate this in the second half of 2005.

Eric Rothman, Wachovia Securities.

I was curious about the remaining portion of the structured finance loan on the California office portfolio.

What is the prepayment penalty associated with that remaining $25 million?

Eric, just to remind ourselves -- and I will get to that.

Obviously, with the benefit of hindsight and looking at what we are seeing right now, the structured finance investment has played out exactly the way that we thought it would, in that the buyer of the asset is selling it perhaps a little faster than we might have anticipated.

There are prepayment penalties and it is a declining scale that starts at 2 percent.

And depending on when its -- the balance of the structured finance loan is prepaid, it will probably be a number slightly less than 2 percent.

So slightly less than 2 percent on the remaining 25-odd million dollars?

Correct.

Correct.

And then with respect to the United Rentals, I guess I was hoping to get a little bit more color on just exactly what an equipment rental location is.

Is it truly a retail location, or is this more of an industrial use?

You know, I think it depends on how you look at it, and you're asking a good, fair question.

United Rentals is by far the dominant player in the equipment rental business in the country.

They have got 770-odd rental locations.

It's a big company, as I mentioned, an equity market of over $1 billion.

And I think that they, on their third quarter conference call, suggested that they were going to have $250 million of free cash flow.

These types of locations, if you've traveled to different cities, you will see them on highway interchanges right there at exit ramps.

For example, some of the properties we've acquired in this initial portfolio are in Texas.

And if you are in the Dallas-Fort Worth market driving around, you are very likely to see them.

They are very well located facilities.

They do a number of things.

They sell certain consumable merchandise.

In addition to that, they rent and sell some of the fixed equipment that industrial users would rental or buy from them.

The other thing we like about it is that, which is somewhat typical of our whole entire portfolio, that a large component of the investment is in the land.

As kind of a purist, we like that.

So are these located a little bit further out from the city center?

Not necessarily.

I mean, if you are driving between Dallas and Ft. Worth, right there on that highway, you will see it right there by Texas Stadium.

And what type of yield were those acquired at?

The yield that I mentioned in my comments, Eric, is that it's consistent with the accretive returns we are looking for.

And I think we've previously said we're looking for 9 percent type returns.

That's 9 percent plus would be the assumption there.

In terms of other industries that maybe you are interested in or not interested in, how do drugstores rank in terms of what you may be looking at for opportunities?

In terms of putting them -- the current cap rate environment for drugstores, particularly Walgreens, CVS, is very aggressive.

And it's unlikely other than as part of a portfolio that we would acquire additional drugstores into the portfolio.

As I mentioned earlier, we are very, very pleased to acquire in the national properties pending acquisition, one well-located Walgreens, which as a blended cap rate, comes in above 9 percent.

But I think we are going to continue to develop freestanding drugstores, and in the current environment we're a seller of those.

And in terms of convenience stores, you mentioned in the quote in the release, that you are excited about convenience stores.

What exactly is it that you find attractive about them in this current environment?

The types of convenience stores that we will be acquiring in the national properties acquisition are extremely well located, corner retail locations.

This portfolio is primarily in two different places, both in the northern suburbs of Atlanta, the city such as Alpharetta or Roswell and places like that.

These are corner locations doing very high-volume sales, and then there are some in Iowa as well.

And QuikTrip is a large, very large private company with an extremely good balance sheet that produces prodigious amounts of cash.

And they are a high-quality retail operator.

And if we can, we would like to do more business with them.

So the attraction there is more on the credit quality side, necessarily than the pricing of today.

Is that correct?

No, Eric, it's both of those actually.

Convenience store pricing is such that we can build value for our shareholders if we acquire them.

It is a consolidating industry.

There are many players besides the big gorillas of 7-11, Circle K, and so forth.

Most of these, or I guess all of these convenience store locations also have gas on them?

Is that accurate?

In the portfolio we purchased, yes.

These are not just small, little mom-and-pop retail operators.

And how do you get around the environment environmental issues?

Or I guess, how do you mitigate environmental issues related to the gas station portion of it?

In the due diligence, it's a significant factor.

And you're asking the right question, and obviously, we've engaged third-party consultants to do Phase I and Phase II reviews where necessary.

With respect to the NAPA (ph) portfolio, do you anticipate flipping out any particular assets, like maybe even that Walgreens or what not, to lower your basis and enhance your yield?

Or do you think you will keep it lock, stock, and barrel?

We're looking at that.

There's a couple of properties in there that probably don't fit -- not the Walgreens, specifically.

But for example, there are small headquarters office building that over time, we will probably seek to sell.

But on balance, we will be keeping the vast majority of those assets.

How much value do you think is in that office building?

It's modest.

It's one of the 43 properties.

And so it's -- .

It's small dollars, Eric.

But I think that in round numbers, depending on where our stock price ends up at the time we complete or consummate this acquisition, of the $60 million approximately total assets that we will acquire, a small amount of that is what we are currently thinking about selling.

Lastly, with respect your guidance of $1.48 to $1.52, can you talk just a little bit to us about what other assumptions underlie that?

Obviously, the completion of the NAPE acquisition (multiple speakers) second quarter.

What other acquisitions do you have modeled in there?

We have modeled in just generally about $150 million of acquisitions in '05.

The NAPE acquisition obviously is a piece of that, $60 million, roughly.

And so that was our general guidance as it relates to acquisitions.

We think we will have dispositions from the core portfolio of maybe 30-plus million dollars this year as well.

So that is kind of what our operating assumptions on the acquisition disposition front.

Do you expect those dispositions will occur earlier in the year, or later in the year?

I would say earlier in the year, just based on where we see things, or at least the majority of it earlier.

I'm sure it will get spread out, but -- .

And that is the sale of core portfolio (multiple speakers) or that is build-to-suit?

No, that is just core.

I'm focused on the core, kind of rent-generating properties.

The others that are we are developing for sale or acquiring for sale in the portfolio a short period to time.

So I don't get too focused on the rent that they produce.

So yes, that's just core portfolio.

Sure.

And then in terms of I guess just total volume of build-to-suit sales that you might expect?

You know, I don't think that it will be materially different than where we were last year, frankly.

The dispositions for the year and the gains that we're projecting from the sales would be consistent where we were in '04, maybe a million or so higher.

And that's where we need to focus on, is really the opportunity to capture gains there and it's less driven by the investment.

Now the metric there is really the after-tax, after-expenses gains, as it so happens, provided we're developing a similar mix of properties and cap rates remain the same, the dollar volume will be in the same range.

Dan Sullivan, Wachovia.

Sorry to back-to-back you with Wachovia guys.

Quick question.

In the press release, you guys mentioned that you're refocusing your strategy on retail properties.

Could you talk a little bit about that?

Does that mean that going forward, you are not going to pursue office, industrial, or anything along those lines, or was that just kind of the current market conditions that you had in 2004?

What are you looking at going forward in terms of an asset mix?

Dan, thank you for clarifying that comment, because right now, internally, our sole focus is on retail properties.

It's consistent with the team and their experience that they have, our presence in the market and where we see we can build value for shareholders.

So on a going-forward basis, you're going to be looking just primarily at retail assets?

Yes, sir.

Okay, so office is kind of won and done, effectively?

I don't think -- well, you will not see us make an office or industrial acquisition unless it's small part of a portfolio in calendar 2005.

At this time, we have one question remaining in the queue. (OPERATOR INSTRUCTIONS) Jeff Donnelly, Wachovia.

Kind of comical -- it's the trifecta.

All right -- it's the bonus call.

Don't think I've seen this happen before.

Actually, just a follow-up question, as well Craig, that my counterparts also here have not asked.

You know, I guess generally on strategy, you are sharing -- you're obviously new to the fold here in some ways.

You've been on board for about 9 to 12 months.

I was curious in general sort of what signposts should we expect to see maybe in 2005 that would help measure the impact of Craig Macnab and the success or progress that NNN is making?

And as more to the point, do you have any specific objectives for 2005 for the Company that maybe we have not addressed here in the call already?

I don't think there's any additional metrics that you should focus on, Jeff.

I think as I indicated in my opening comments, we internally as a management team, as a group, are focused on building value for shareholders.

In the near term, we are going to do that by a couple of different ways.

If we continue to -- if we execute on plan and grow the FFO per share, that will do two things.

One, whatever multiple you put on it, if it remains the same our stock price will grow in value.

In addition, it will allow us over time to grow our dividend and this combination of both of those will build value for shareholders.

So the primary focus internally is to work at growing FFO per share.

That is the metric we are focused on.

Obviously, there are many subsidiary metrics and goals that we have internally in terms of portfolio quality, occupancy, management development, and so forth.

But I think if you just focus on the one, which is FFO per share growth.

Well, I guess, building up on that, is there a risk that NNN will incur maybe additional transition expenses in 2005, whether it's related to staffing down in the office area as you mentioned, or perhaps just general changes in the team you have been constructing?

I don't think so.

I think that we have a couple of people that left the Company earlier in 2004 and there are always additional hires where we may take advantage of good people that come our way.

We actually hope that we have one of those people starting to work for us in the next 10 days.

But I don't see -- right now, we do not see additional transition expense occurring in 2005.

(OPERATOR INSTRUCTIONS) We have no further questions at this time.

Mr. Macnab, I would like to turn the conference back over to you for any additional or closing remarks.

In about 3 months.

Thank you very much.