NNN REIT Inc (NNN) 2005 Q2 法說會逐字稿

Good day, and welcome to today's Commercial Net Lease Reality, Incorporated second quarter 2205 earnings 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.

Thank you.

And good morning to everybody on the call.

Welcome to our second quarter earnings release call.

On the call with me is Kevin Habicht, our Chief Financial Officer, who will report on our second quarter financial results after brief comments from me.

We're very pleased with the financial performance in the second quarter.

For us, the highlight of the quarter of the acquisition of National Properties in the second half of June, and we welcome the former National Property shareholders as new shareholders of N.N.N.

While this transaction is a relatively small acquisition, it is significant because the sole-sourced transaction gave us approximately $60 million of assets with an initial yield in the mid-9% range.

This is an excellent current return for a portfolio of this caliber with an average lease life of 12 years and, obviously, is well above what the yield rate or CAP rate would be, if those assets were purchased individually in the the marketplace.

Tenants in the portfolio include Quik Trip, Perkins, Academy sports, Walgreens.

The largest tenant is in the portfolio is Quik Trip and we're delighted to initiate our entry into the convenience store category with this very high quality company and operator.

As a reminder, in this transaction we did issue 1.64 million shares.

In the most recent quarter we acquired 49 properties for approximately $79.2 million, with the bulk of that being from National Properties, in our investment portfolio, at a weighted average CAP rate, as I mentioned earlier, in the mid-9% range.

Thus far this year, we have acquired $126 million of investment properties.

If transactions close for the properties we currently have under letter of intent or under contract, we will exceed our 2005 objective of acquiring $150 million of investment properties.

In terms of the quality of the portfolio, it continues to be in extremely good shape with occupancy improving in the quarter to 98.8% and, as I believe you all know, we have very few lease renewals in the remainder of 2005 and 2006.

In the second quarter our Development Group was also productive, and importantly, our team advanced several projects to position us very well for the balance of this year.

In fact, earlier in the third quarter, we closed on the sale of one of our development projects which will lead to a handsome gain for us in the third quarter.

In summary, we're very pleased with the financial performance of N.N.N, in the second quarter, and importantly, on the progress we are making on setting the stage to grow our F.F.O. per share in 2005 over that which we earned in 2004.

I will now hand over to Kevin.

Thanks, Craig.

And let me start with our standard cautionary statement, that we'll make certain statements that may be considered to be forward-looking statements under federal security laws.

The Company's actual future results might differ significantly from the matters discussed on any forward-looking statements and we might not release revisions to these 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, looking at the press release -- as indicated, F.F.O. was $20.435 million or $0.38 per share for the second quarter of 2005, that compares with $0.29 for the same period last year and $0.37 for the immediately prior quarter.

If you exclude the $3.2 million charge taken in the second quarter of last year, 2004, that quarter was $0.35, on a normalized basis.

So we are pleased with this year's second quarter's $0.03 per share or 8.6% increase over prior year's normalized results .

F.F.O. in the first half of 2005 was $0.75 per share which which represents a 5.6% increase over the first half 2004's $0.71, after adjusting for last year's charge.

Nearly all of our operations are performing better than planned at the moment, including acquisition volume, acquisition yield, gain on sale of inventory properties, occupancy and G&A.

Looking at the income line statement line items -- total revenues for the second quarter were $36.4 million, which represents a $3.8 million increase a year ago.

Primarily as a result of increased rental revenues from acquisitions that we have made over the past year.

As Craig mentioned,acquisitions in the core portfolio totaled $79 million in the second quarter of 2005, $61 million of which came through our National Properties merger on June 16th.

Occupancy at the end of June '05 was 98.8%, that's up 130 bases points from the immediately prior quarter and 210 basis points from year ago numbers.

The real estate expense reimbursement line item was fairly flat with the prior year amount.

In the revenue section, we did report a $378,000 gain on the sale from one of our properties in our tax [indiscernible].

The reason this sale shows up in the revenue section of Continuing Ops, rather than in Disc-Ops, like most of the dispositions, is due to the fact that the property had not started paying rent at the time of sale.

Interest and income -- interest income and other income from real estate transactions consist, primarily, of some mortgage receivables that we have and the mezzanine loan income and some miscellaneous items.

The $300,000 increase to $2.1 million in the second quarter, came, primarily, from some one-time items offset by lower mezzanine loan balances, compared to last year.

At the end of the quarter, we had $28.4 million outstanding in our structured mezzanine loan program.

A new revenue line this quarter is the interest income from mortgage residual interest, as a result of our previously announced acquisition of 78.9% of Orange Avenue Mortgage Investments, Inc., which is now consolidated on our books.

We have provided, in the press release, some additional balance sheet and income statement data for this entity so that you could better see the various components and this investment's impact on our consolidated balance sheet and income statement.

Prior to May 2005, when we exercised our equity option, we owned a minority interest in some of these residual interest assets whose net income would flow through our P&L on the Equity and Earnings line.

Beginning in May, post-exercise, we are now reporting all of the interest income, interest expense and modest amounts of G&A on our P&L, and subtracting out the 21% minority interest.

Assuming continued performance in the underlying loan collateral underneath of these residual interests, over the near term, we expect the results of these mortgage residual interests and this entity to approximate the results of the second quarter.

In connection with this investment, in May, we did book a $19 million extraordinary gain or $11.8 million after-tax as a result of acquiring assets valued at $28 million for $9 million.

The gain, obviously, was excluded from F.F.O.

G&A expense -- G&A expense was $5.8 million for the quarter, that's up from $5.4 million in a year ago period, but in line with the guidance given last quarter of $6 million per quarter for the balance of 2005.

Property expenses were $2.7 million.

That's down $195,000 from prior quarter amounts, primarily due to fewer vacant properties.

That's down $488,000 from prior year amounts, due to lower expenses at our D.C. office property and fewer vacant properties, as well.

A couple of one-time items in the P&L this quarter included two impairment charges of $741,000 in Continuing Ops, and $575,000 in Discontinued Ops.

And additionally, we received lease termination fees of $1.557 million in the second quarter and that's included in rental revenue in Discontinued Operations, that was related to two properties we intend to sell.

Notably, I have to point out too, that there was a $1.3 million lease term fees in rental revenue in the second quarter of 2004 and $1.6 million of lease termination fees in the first quarter of 2005.

So, this past quarter's fees didn't drive much of the improved results.

In other expenses and revenues, interest and other income declined $443,000 from last year, to $309,000, as a result of lower outstanding loan balance to one of our taxable subsidiary units.

And down $158,000 from the prior first quarter of '05, due to some small one-time items in that first quarter.

Interest expense increased to $8.8 million, that was primarily due to higher outstanding debt balances and, to a much lessor extent, due to higher short-term interest rates.

At the end of second quarter '05, we had $97 million of our $683 million of total liability which was floating rate debt, that's 14.2%.

Floating rate debt as a percent of gross assets, which I believe is a more meaningful metric, is 6.1%.

The equity in earnings line item on our P&L are from unconsolidated entities, was $100,00 and that compares to $1.286 million last year and a $1.081 million last quarter.

The significant decline is, as I indicated earlier, primarily due to the May 2005 purchase of the equity interest in Orange Avenue Mortgage Investments.

The minority interests we previously held in these mortgage securities was recorded as equity in earnings; but beginning in May of this year, we began to consolidate this investment on our balance sheet and the income statement ,as I indicated earlier.

Going forward, the equity and earnings line item really will, primarily, represent the results from our 25% equity interest in our headquarters office building which produces a GAAP loss of around $50,00 to $75,000 per quarter, typically.

But, it is obviously F.F.O. positive.

In Discontinued Operations, in the investment portfolio, we sold two vacant properties from our core portfolio; the GLA of 70,000 square feet.

The gain and the results from these properties are included in the supplemental information on Discontinued Ops that we provided.

Likewise, the Discontinued Operations inventory properties -- we sold a total of eight properties from our taxable sub.

Three of the properties sold from our Development Unit gained -- generated a gain of $2.3 million, with a disposition CAP rate of 7.1%.

And five of the properties were sold out of our 1031 exchange unit and generated a gain of $600 million (ph) -- $600,000, with net proceeds of $2.1 million and a 7.5% CAP rate.

As we've indicated, there will be some choppiness in this number from quarter to quarter, depending on the timing of the sale.

With regard to F.F.O. guidance, we are again slightly increasing our guidance to $1.50 to $1.52 per share for 2005, increasing the bottom range by a penny.

We currently believe acquisitions could approach $200 million in 2005, versus the previous guidance of $150 million.

We do feel like the first half of 2005 has started very well and the visibility for the balance of the year is good.

The environment -- the acquisition environment is still a challenge.

But we have done well, this year, uncovering transactions The market for disposition of properties we've developed or acquired for sale continues to be robust and we continue to expect good gains there this year.

Moving down to the balance sheet, the primary change was related to our Orange Avenue Mortgage Investment transaction and the Nat. merger.

We paid $9.4 million cash for the Orange Avenue equity interest.

Couple of items to mention, regarding the supplemental Orange Avenue balance sheet that we provided you.

One, that entity has $30 million dollars in notes payable outstanding that are due to in 2007 and 2008, with a 10% interest rate which we can prepay next year.

And secondly, that balance sheet includes $31 million of cash, a large amount, the majority of which is restricted by an asset sale agreement which will expire in December 2007.

With regard to the Nat. merger, during the second quarter we did issue 1.6 million shares of common stock and assumed a 20.8 million bank term debt, due June 2009, that is priced at LIBOR plus 120.

We finished the second quarter with $683 million of liabilities.

As I mentioned, of that amount, $154 million was mortgage debt.

Approximately 20% of the Company's assets are encumbered by mortgages, leaving 80% of the assets unencumbered.

Total debt to total assets on a gross-booked basis is 43.1%.

That's up, slightly, from 40.7% a year ago.

On a market CAP basis, leverage was 36.6%.

Interest coverage for the second quarter of '05 was 3.8 times.

Fixed charge coverage was -- and the 3.8 was flat with last quarter and up from 3.5, a year ago.

The fixed charge coverage was 2.9 times for the second quarter of 2005, that's down about a half a tenth (0.05) from last quarter, and up from 2.7, last year.

We're pleased with the level of these coverages, but as we projected, they have moderated slightly with rising interest rates.

In summary, second quarter's 8.6% increase and per share results were good and we feel like 2005 is shaping up very well as we continue to focus on improving the long-term performance and bottom line results.

The Company's in good financial position.

The core portfolio is performing well.

We've had a solid portfolio of properties and equally solid capital structure.

And our challenge is to grow the bottom line and we are very optimistic that we'll be able to deliver on that in 2005.

With that, I'll turn it back to you, Craig.

Well, we would love to take any questions.

Thank you, sir. [OPERATOR INSTRUCTIONS] We'll first go to David Carlisle, Smith Barney.

Hi guys, I'm here with Michael Bilerman, as well.

First question I had for you was , in terms of the launch of your web-based Net Lease Exchange site a few weeks back, I was just curious, how that is going?

What kind of information you're learning from the site?

And whether you've been able to source any acquisitions or dispositions through that.

David, we did launch this.

It's really a chief R&D endeavor.

It's astonishing how many hits it is getting.

It's a very good tool for us to, just constantly get a reminder of what market activity is.

We're working with it.

And, we'll see where it goes developmentally.

But, I don't want to -- anybody to assume, that this is a major initiative for us.

Okay.

Very well.

I guess, maybe, turning to a specific transaction.

I saw that [Trust Street] had made a very large acquisition of Perkins Restaurant properties in the last couple of weeks.

I was wondering if you guys had looked at that, and if so, why you passed on it.

I read about it, and, we -- our acquisition goals for 2005 were to acquire about $150 million worth of properties at rates of return where we were -- looking for 9%-type returns.

And, I -- I don't have any inside information.

But, I suspect that the CAP rate on that was in another ozone.

Right.

It's actually a good point in terms of the compression of CAP rates.

I had heard, anecdotally, that that one had a lower CAP rate, obviously, than 9%.

And also, I heard, anecdotally, about two auto dealerships that were sold at 7.25% and 7.6%, recently.

In that regards, there seems to be a lot of aggressive capital in the marketplace, especially on the [103015], but also, just new entrants into the space.

In light of all that, do you expect to be increasing your dispositions much, this year?

David, there's no doubt about it.

It's very competitive environment there.

Notwithstanding the small uptick in interest rates this year -- CAP rates have continued to compress.

And, all of us are having to work much, much harder to try to identify opportunities to add value.

Total dispositions -- we made some good progress in the first quarter, in terms of our capital recycling objectives.

We're always looking at it.

We have a couple things we're talking about right now, and I emphasis talking about.

That's internally.

Okay.

Great.

That's all I've got.

Thanks a lot.

Thanks, Dave.

We'll take our next question from Eric Rothman, Wachovia Securities.

Good morning.

I was curious about the $200 million, potentially, of acquisitions that Kevin had mentioned.

What portion of that is under letter of intent that, Craig, you had spoken of?

Eric, I think we've done a pretty good job of setting expectations and finding a way to meet or achieve them.

And, so far this year, we've purchased slightly less than $130 million of properties for our portfolio.

And, I think we have a pretty good line of site on a number that will -- I think what Kevin said, was in the range of -- or up to $200 million and we have a pretty good line of site on that.

However, we have not completed due diligence, and, all kinds of things might happen.

Sure.

Remind us, the target that you had set of $150 million, that was gross.

What, if we were to factor in dispositions, would that number be net?

Yes, we had -- in our plan, had slated to sell about $35 million worth of properties during the year, which we largely completed in the first quarter.

As Craig indicated, we continue to call through the portfolio to identify other potential sale candidates.

We're not looking for wholesale sales, if you will, but more rifle-shot selected properties where we think we can get very attractive yields and we see limited upsides.

As reminder, what we sold in the first quarter was sold at a 6.6% CAP rate, which we felt, was overwhelmingly attractive.

So we're calling through the portfolio regularly, trying to identify those assets we might sell.

At the moment, we don't have anything of any material amounts slated to be sold.

I guess, you had mentioned or I thought you mentioned, that there were two vacant properties that recently became vacant, with respect to the lease term.

Are those that were sold or going to be listed?

The two properties we sold out of the core portfolio were vacant properties.

One of which was recently acquired in the National Properties portfolio acquisition, a small office building that we sold soon after we completed that merger and then another one just from our core portfolio.

Okay.

Great.

I was hoping to get a bit more detail on the impairment charges and, as well as that lease termination income -- what was the story there?

The impairment, on the face of our balance sheet, was $741,000 in Continuing Operations is related to a Winn-Dixie store, and if you recall, we took a charge in the first quarter on another one.

We have a total of three Winn-Dixies, two of which are slated to be closed and we've taken impairment charges on both of those.

You know, we just decided we think we're getting ahead of curve and just being prudent.

And then I think that lease termination relates it to one of the properties that we, subsequently, turned around and sold as a vacant asset.

Right.

And Discontinued Ops in the investment portfolio, you'll see impairment charge as well as a $1.248 million of lease term fee relating to a property we're planning to sell.

So at the moment, you don't expect any more termination -- excuse me, you don't expect any more impairment charges related to any of those assets?

Correct.

Do you see any -- I guess it's always hard to say -- impairment charges related to other assets?

That is much harder to predict, it is a more opportunistic-type item -- we don't have anything in our near-term sight.

Thank you very much.

Eric, just to stay with that, one of the things that Kevin said, which I think is important, is that our lease termination revenue in the second quarter was not that -- really, for the first half of this year -- is not that different to what it was last year.

So the improved operations are what are driving our earnings per share.

It's not one-time charges.

In addition to that, we've been fairly cautious in recognizing impairments where we see pending issues.

That's great.

That's great.

Well, could you just remind us again, I know that you'd said it earlier, what was the lease term income for the year-to-date period versus the year-to-date period last year?

For the year-to-date?

Yes.

Hang on one second.

In the first quarter -- in the second quarter of this year we had $1.250 in Discontinued Ops, as well as -- hang on one second.

Let me get my notes.

Let's see.

We had lease term fees of $1.557 in the second quarter.

And we had $1.6 last -- first quarter of 2005.

Okay.

So, this year it's been --

$3.1 million.

Exactly.

In 2004, same period?

In 2004, we had $1.3 million in the second quarter of lease term fees.

And I'd have to get you the amount on the first quarter of 2004.

Okay.

I guess we'll just circle back with that.

Thank you very much.

I appreciate it.

Yes.

[OPERATOR INSTRUCTIONS] Mr. Macnab, it appears that there are no further questions.

I would like to turn the conference --

Thanks very much.

Just in summary, we're very pleased with where we are through the first six months of the year.

We're encouraged about the outlook for the balance of the year.

All of our operations are performing better than planned at the present.

Acquisition volumes have been good.

The yields have been right in line with what we're striving for.

Our Development Business is performing well and its occupancy and the quality of the portfolio is in very, very good shape.

Thanks very much.

We look forward to talking to you in three months time.

Thank you.

That does conclude today's teleconference.

Thank you all for your participation.

A replay of today's conference will be available, starting at 1:00 pm eastern time, and run until midnight on August 1st.

To access this replay, please dial 1-888-203-1112, and enter the confirmation code of 7505324.

Again, that's 1-888-203- 1112.

Confirmation code 7505324.

The replay is also available on the Company's website at www.nnnreit.com.

Again that's, www.nnnreit.com.