NNN REIT Inc (NNN) 2006 Q1 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the National Retail Properties first quarter 2006 earnings conference call. [OPERATOR INSTRUCTIONS] Also, as a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Craig Macnab, Chief Executive Officer of National Retail Properties. Thank you, Mr. Macnab. You may now begin, sir.

Dee, thank you very much. Good morning and welcome to the first quarter 2006 earnings release call for National Retail Properties. I have with me on this call Kevin Habicht, our Chief Financial Officer, who will report on our first quarter financial results after brief opening comments from me.

Last week we issued a press release announcing that we have changed our name to National Retail Properties. This change is completely consistent with our focus on primarily net leased retail real estate, plus our national presence, owning 564 properties located in 41 states. By the way, we are continuing to use the same ticker symbol of NNN.

Our earnings release of this morning references that we have amended the contract for the sale of our large office building located in Northern Virginia that is leased to the U.S. government. Before the payment of all fees and expenses, we now expect to receive $229 million when the sale of these office assets closes, which we expect to occur later this quarter. When the sale of these assets closes, we will have completed our transition to a national REIT that is focused on the retail sector, which, of course, is consistent with our new name of National Retail Properties.

From a value-creation standpoint, the sale of this property is very significant for our shareholders. When the sale is complete, we will generate a gain of approximately $50 million. Also, by investing the net proceeds of approximately $225 million in a tax-efficient fashion in a well-diversified pool of retail properties, we will increase our net rental revenues.

Early in the second quarter we eliminated eight positions in our development group and closed two offices in the Northeast. In this current quarter we expect to incur one-time costs of about $1.5 million, however on a recurring basis we are projecting a G&A reduction of about the same size. Following these changes, we will have a stronger, leaner and meaner development group, which will allow us to more cost effectively and efficiently develop retail real estate.

As a reminder, our development activities in our taxable REIT subsidiary are primarily focused on two activities. Firstly, we partner with a small number of experienced retail developers who generally have local sub-market expertise. On stabilization of these development properties, they tend to get sold. Following our personnel reduction I see no change in the outlook for this component of our business. In fact, we presently have visibility on a terrific pipeline of projects.

Secondly, in our taxable REIT subsidiary, we have a long history of developing free-standing net-leased retail properties, some of which we have sold and many of which we've continued to own in our investment portfolio. Prospectively, our development team will continue to focus on developing corner locations at busy intersections, however, we are shifting our emphasis away from drugstores to retail users who allow better returns on our development capital.

In the recent past, many of our development properties, primarily the drugstores, have been sold once developed. However, over time, we will also develop properties that we will own for our own investment portfolio.

We're also slightly increasing our emphasis on programmatic development. Over the last 12 months we've strengthened our relationship with two retailers by offering them certain development services. By adding value to their new store opening programs, we are receiving a better yield on these properties than if we were simply to purchase the assets from the retailer and, more importantly, we're securing our relationship with these retailers.

In summary, I am extremely satisfied with the progress that National Retail Properties continues to make. Our team is focused on retail real estate where we have a core competency. Our acquisition team continues to win business at attractive, risk-adjusted yields and our development group has a clear sense of direction and a strong pipeline. Our balance sheet is strong and after closing on the sale of the office buildings, the right side of our balance sheet will be in pristine condition. As a result, it is my subjective opinion that 2006 will be another outstanding year for NNN and, frankly, I'm feeling extremely positive about our prospects.

Kevin will now provide an update on our financial activities in the first quarter.

Thanks, Craig. Good morning.

Let me start with our standard cautionary statement that we will make certain statements that may 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 statement and we may not release revisions to these forward-looking statements to reflect changes after the statements are made. Factors and risks that could actual results to differ materially from expectations are disclosed from time to time in greater detail in the company's filings with the SEC, as well as in this morning's press release.

With that, as-- looking at the press release, as we indicated, we reported record quarterly results for the company with FFO totaling $23,627,000 or $0.41 per share for the first quarter of 2006. That represents a 10.8% increase over the prior year results and a 2.5% increase over the prior quarter's results. We are very pleased with the improved results as nearly all areas of operations are performing well and we are optimistic, as you heard from Craig, we'll show good results for the year.

Looking at some of the income statement details, we reported total revenues for the quarter of $43.5 million. The increase from first quarter '05 was primarily a result of increased revenues from investments that we had made over the past year, as well as increased gain on sale being included in the revenue section as GAAP accounting requires for properties sold prior to the production of any rent. These revenue increases were partially offset by the re-class of our D.C. office property revenues and expenses to discontinued operations.

The rental revenues increased 30.6% or $7.6 million. That did include $456,000 of contingent percentage rent, $456,000 in 2006, and that compares with $393,000 for the first quarter of '05.

As we noted, acquisitions in the core portfolio totaled $36.3 million in the first quarter. Occupancy at quarter end was 98.6%, which is up 30 basis points from the immediately prior quarter and up 110 basis points from a year ago.

As I alluded to earlier, we reported a $6.4 million gain on sale in our revenue section as a result of the sale of one property in our taxable REIT subsidiary, which was owned in a joint venture with one of our development partners. Half of that gain is reduced in the minority interest line item below, producing a net pretax gain to us of $3.2 million.

Interest income and other income from real estate transactions consists primarily of mortgage and mezzanine loan income, interest income and some miscellaneous items. The $151,000 increase for-- to $1.5 million came primarily from modestly higher average outstanding mezzanine loan balances compared to last year. At the end of the quarter we had $36 million outstanding in structured mez loans.

The interest income from mortgage residual assets of $2.3 million was produced as a result of our May 2005 equity investment in Orange Avenue Mortgage Investments, Inc., which is now consolidated on our books and more about which in just a moment.

G&A expense increased to $7.2 million for the quarter. That's up from $6.6 million in the prior fourth quarter '05 and that was primarily attributed to expensed deal-pursuit costs. The increase from the first quarter of '05 included the same pursuit cost increase, as well as the timing of several expense items.

Property expenses were flat with prior year amounts. We did book a $1.8 million impairment charge related to the mortgage residual assets that we acquired in May 2005 when we invested $9.4 million to acquire a 78.9% interest in Orange Avenue Mortgage Investments.

As a reminder, this entity owns a static pool of commercial mortgage residual assets that are experiencing above-average prepayment rates at the moment, which produces the impairment. Notably there, a substantial offset to this quarter's impairment charge is the amortization of a deferred tax liability on Orange Avenue's books, which created a $1,358,000 income tax benefit. So if you net-- the net impact of these two items, after minority interest, is approximately $365,000.

We have included some additional disclosure on this entity's impact on our consolidated P&L in our press release. While-- this investment has created some accounting noise, if you will, that can be distracting, however our $9.4 million investment in May 2005, this entity has produced over $13 million of net cash flow, our share of which is over $10 million. While time will tell precisely how much value is produced from this investment, based on interest rates, prepayment speeds, et cetera, we believe it will be a very successful investment as the early indications suggest.

In other expenses and revenues, interest and other income increased to $846,000. That's up from prior year amounts but flat with the prior quarter. The increase from 2005 was primarily due to higher cash balances and higher interest rates on those balances. Interest expense for the fourth quarter increased to $11.9 million. That's up from $10.8 million in the prior quarter and up $6-- up from $6.7 million in 2005. The increase from last-- last year, from 2005, is primarily a result of higher outstanding debt balances and higher short-term interest rates.

At the end of the quarter, $212 million of our $910 million of total liabilities were floating-- was floating rate. Floating rate debt as a percent of our gross book assets, which I believe is a more meaningful metric, was 11.3%. The increased use of short-term variable rate debt at this point in time for us was intentional as we expect over $130 million of net cash proceeds from our D.C. office sale, which will be used to pay down much of this variable rate debt.

The equity and earnings from unconsolidated entities line item was a negative $33,000, which is consistent with the prior quarter. The decline from the first quarter '05 $1,081,000 of income is, again, primarily due to the May 2005 purchase of our equity interest in Orange Avenue. Previously we held a minority interest in some mortgage securities which got booked through this equity and earnings line item and, as I mentioned, beginning in May of 2005 we began to consolidate this entity on our financial statements. Currently and going forward this equity and earnings line item will primarily represent the GAAP results from our 25% equity interest in our headquarters office building.

In discontinued operations investment portfolio, we sold three properties from our core portfolio, generating $16.9 million of net proceeds and a $5 million gain. Primarily dispositions is a part of our portfolio pruning. Additionally, as I mentioned, our D.C. office property is included in this line item since that property's held for sale. Again, supplemental information on the line item is included in the press release.

Discontinued operations from inventory properties we sold a total of nine properties from our taxable subsidiary, one of which I mentioned previously in my comments on the revenue section. Two of those nine sold were from our development unit and they generated a gain of $3.6 million net of minority interest with net proceeds of $17.6 million. The other seven properties were sold out of our 1031 exchange unit and generated a gain of $807,000 with net proceeds of $7.2 million.

With our active acquisition pace late last year we still have a good amount of inventory held for sale in our taxable subsidiary, which we will be actively marketing this year. The market for disposition of properties continues to be good and we expect good gains this year. As indicated previously, there will be choppiness in our reported gains on sale number from quarter to quarter, just depending on the timing of those sales.

With regard to FFO guidance, we are increasing the bottom end of our guidance by $0.01 to $1.59 to $1.62 per share for 2006. The guidance is based on $140 million of portfolio acquisitions, selling our D.C. office building, plus another $40 million of additional portfolio investment properties, G&A expense of approximately $26 million, $7.8 million of revenue from our mortgage residual interests, TRS gains of approximately $22 million, pretax, pre-overhead, and a mezzanine loan payoff of $24.3 million in the second quarter. As always, these projections are based on a number of factors and uncertainties, as discussed in our public filings.

Moving to the balance sheet, we finished the quarter with total liabilities of $910.5 million. Of this amount, $160.4 was-- $160.4 million was secured debt. Approximately 16% of the company's total assets are encumbered, leaving 84% of the assets unencumbered. So in the first quarter we did pay off an $18.2 million mortgage. Additionally, we issued 1,067,700 shares of common stock from our stock purchase DRIP program, generating net proceeds of $23.2 million.

Total debt to total assets was 48.5% on a gross book basis. That's down slightly from 49.2% at year-end '05. On a market cap basis, our leverage was 39.6%. With our-- again, our active acquisition pace over the past few quarters, our overall leverage has drifted somewhere higher but will decline meaningfully with the sale of our TSA D.C. office building.

Interest coverage was 3.0 for the first quarter. Fixed charge coverage was 2.6 for the quarter. Again, we expect these coverages to rise somewhat with the sale of our D.C. office property.

That's all I really have. In closing, we-- we felt the first quarter results were a great start to 2006. We believe the portfolio and balance sheet are in very good shape and, as Craig indicated, are very optimistic we'll be able to deliver record results for 2006 as we seek to create value through targeted acquisitions, development, dispositions and drive the incremental per share result.

Dee, thanks very much. Let's open it up for questions.

Thank you. [OPERATOR INSTRUCTIONS] Our first question is coming from David Fick of Stifel Nicolaus. Your line is live for a question or comment, sir.

Good morning. Thank you. I was wondering if you guys could give us a little bit better guidance on the quarterly income from Orange?

Well, I mean, we did include in the press release-- that last page gives you a good-- I think a pretty decent summary of the income statement impact from Orange Avenue. Those line items represented there are the amounts that are included in our consolidated financials related to Orange Avenue. So you see the $2,297,000 of mortgage residual interest income. There is some debt associated with Orange Avenue that's on our balance sheet and you see the interest expense there.

Going forward, in terms of guidance, those-- the interest income from those mortgage residual assets will track the payment of-- the payoff of the loans that are included in that-- that entity and so over time you'll see the residual interest income decline over time. And so that'll just follow that pattern.

[inaudible] cost of the name?

You're kind of breaking up, there, David. I didn't hear that.

I'm sorry. What was the cost of the name change?

I didn't hear you. About the name?

What was the cost of the name change? It's very weird here.

Oh, it's just-- I think National Retail Properties is a better description of our company. We're clearly focused on the retail category, hence the retail, and we're a national REIT, so National Retail Properties. It's very consistent with who we are and what we do.

I understand the reason. What was the cost?

Oh, I'm sorry. The cost. The cost was pretty trivial, to be honest. The good news we needn't to hire a third-party expert and we've got a very modest branding initiative, very modest. The cost is inconsequential.

Okay. Can you give us a little bit more color on expected volume and cap rates for acquisitions?

Yes. Our-- our guidance for the year is $140 million of acquisitions. We're sticking to our 8.75% yield. We had a pretty good first quarter, ratably $36 million, but I think more significantly, we have a great deal of visibility in our pipeline, which gives us a fair degree of comfort that we are going to meet, but preferably exceed, that $140 million type number.

We have a number of transactions that we're in active dialogue on right now that are very consistent with what we've been trying to do. Our direct calling efforts on retailers, number one. Number two, trying to add some value to these relationships by using human capital, particularly in the areas of modest incremental amounts of development services to help these tenants open new stores. And if we continue doing that, we're going to get our share of transactions and right now the pipeline is full.

For what kind of yields?

At yields that are every bit 8.75%-type numbers.

Wow. Thanks.

Thank you and our next question is coming from Michael Bilerman of Citigroup. Your line is live for question or a comment, sir.

Hi, good morning.

Good morning, Michael.

I was wondering if you can just go over the $6 million reduction in purchase price on the D.C. office building. What caused the revision?

I-- it's the give and take that occurs in due diligence and no matter how you cut it, we would be naive if we didn't acknowledge that there is a small reduction. But more significantly, we are really pleased with the value creation from this transaction.

One way or another, by the time it's all said and done, we will have slightly over $170 million invested in this asset and when it closes we'll receive net proceeds of about $225 million. We're working very diligently to structure this transaction in a 1031 exchange and by reinvesting that $225 million in a well-diversified, high-quality retail portfolio, we will get slightly better rental revenues over time.

Okay. And then just following up on G&A, you said that there was a $1.5 million charge. Is that a-- that was included in the first quarter or that's coming in the second quarter?

The headcount reduction in our development group was in the second quarter and that-- those costs will be incurred in the current quarter and they are in our guidance, incorporated in our guidance. So just as Kevin pointed out earlier, in the first quarter we also-- our G&A was a little bit higher than we had previously articulated as we expensed some of our dead deal costs in our development subsidiary.

And what was that amount?

Michael, we haven't talked about that, but it was a number that was big enough for us to allude to.

I mean, what's going to take the G&A down for the second half of the year? Let's just assume if the first quarter goes into the second quarter and then you layer on another $1.5 million, your guidance only implies a significant dropoff in G&A for the second half of the year. How can we just get comfort that we're not going to see G&A continue to spike?

I think the-- it's close attention to the detail. The headcount is down and we are focused on clean G&A numbers. We did write off some of these pursuit costs and it's a detailed budget that we have internally. I don't know how to give you comfort on this call.

Yes. I mean, controlling G&A is an important part of what we do. And we've-- it's had our attention. If you go back to last year, we had $23-- the increase last year was about-- less than 2% increase in G&A. It's going to be up a little bit more this year, but it's a line item that we focus on and we think it will be under control. Like I said, this quarter's negative surprise on that side of the equation was related to these dead deal costs and other than that, we're right on budget.

Okay.

And just one more thing. That $1.5 million one-time cost in the second quarter will be incurred in our taxable REIT subsidiary so that, firstly, will come through, ultimately, in FFO as a debit against the gains that we generate from our sale of development properties, the sale of our exchange properties and then also it's reduced by taxes.

So that's excluded from your $26 million of G&A forecast?

Correct.

Okay. That makes a little bit more sense, then. Can you just walk through, again, you had the impairment charges last quarter and I know that was the revision from your purchase price accounting. You have them again now. Why shouldn't we continue to see impairment charges going forward?

Yes. I mean, to be honest, it's driven by the prepayment speeds, largely, on the underlying portfolio of loans that underlies these mortgage residual interest securities. So there could be.

Like I say, the important thing is that we do have this somewhat offsetting tax liability amortization that, frankly, is partly driven by-- actually, it's largely driven by the prepayment of those mortgage residuals. So it's a significant offset to that charge. In the first quarter, as I mentioned, we had $1,820,000 impairment charge offset by approximately $1,358,000 income tax benefit, producing a net charge, after minority interests, excluding the 21% we don't own, of about $365,000.

So, yes, it could be there. It could become a number we need to worry about, but it's-- has its own mitigating factor attached to it and time will tell.

I guess, maybe, stepping back from it, Craig, I think one of the reasons you bought this in, put aside that it appears that it's going to be good value creation, was to minimize the conflict of interest. Is there any sense of just getting-- because it does mess up your financials and there's something every quarter, just sell it off and just reap the benefits today?

I think one of the challenges for us is to provide enough disclosure that helps you understand it. Just as a reminder, these prepayments accelerate in an environment where there's a very flat yield curve and I-- as the yield curve gets back to having a little bit more of an inverted slope. The first quarter was particularly tough there where the borrowers had floating rate debt that they could refinance into fixed-rate debt at essentially the same price. So for the borrowers it was a prudent step.

But I think in terms of, as Kevin mentioned, we have slightly over $9 million invested. We, ourselves, have received over $10 million of cash so far and we're going to get, really, multiples of that over the next several years.

If we-- we would have an opportunity to sell this, the question is that presumably the buyer would be a financial institution and they would use their own assumptions and discount rate, et cetera. There is some debt on this that is on our balance sheet that you can't prepay immediately.

Anyway, the short answer is having analyzed it, we are much better off maintaining-- keeping this asset and reaping the full value rather than have somebody hair count-- haircut or discount the asset.

It is noise, Michael, and we recognize that, but I think that that noise, by the way, is at its peak right now. But that's my speculation. It's not a guarantee.

My last question is just how much do you have sitting in inventory, both for sale and in your development subsidiary?

Yes. Just-- on that, our-- in our exchange properties we do have a healthy inventory. The sum of these pieces is about $150 million, which is even-- slightly more in the development subsidiary, where we've got about $80-odd million, $85 million, frankly, and we've got about $65 million in exchange properties. A healthy amount of those exchange properties were purchased in the middle of December last year and in the first quarter. We have sold down some of those at the end of the quarter.

The second quarter, based on properties that we can now exchange, have under contract, is going to be a very active quarter for us and we will get some healthy reduction there. But by the same token, our acquisition activity is going to lead to adding more inventory there. So there'll be pretty much a wash and that's going to remain at about a $65 million number certainly through the end of the second quarter.

We do-- on the development side, we sold some properties in the beginning of January. We also purchased or bought some land right at the end of the first quarter. I think, based on our healthy pipeline, I do see this amount, which is right now about $85 million, trending up over the balance of this year.

So based on those comments, 2Q gains will likely-- your first half gains will likely be more than your second half gains. Is this embedded in your guidance?

I think that our exchange gains in the first half of this year will be good. Our development gains are somewhat back-end loaded, which, if you think about it, is the sequence where retailers open their stores to get ready for the Christmas season. So our development subsidiary will have more gains at the back end of this year.

Okay, great. Thank you very much for your time.

Thank you. [OPERATOR INSTRUCTIONS] Our next question is coming from Eric Rothman of Wachovia Securities. Your line is live for a question or a comment, sir.

Good morning. How many folks do you have in development today after the eight reduction earlier this quarter?

We reduced our development subsidiary in half. So we went basically from 16 people to eight.

And with half as many people, how is it that you expect to be able to deal with the same or more volume in the development?

It's-- that's a fair question and it's a function of the remaining-- firstly, we do have a very healthy pipeline right now, some of which is joint venture development projects where we are partnering with third parties. The second piece is, obviously, as you would expect, we-- our remaining people are quite productive individuals and our pipeline is very good and our activity level is encouraging.

So it sounds as though you do expect to use more third parties? Just in general more third party--?

I think in the very short term, Eric, there's a little bit of an increase in that activity, which will result in us-- our investment in the development subsidiary increasing, but over time -- and I'm talking in the pretty near term -- we will be doing more self development. But those dollars will be less than the third party activity.

I just want to reiterate that despite these changes, our development activity is quite encouraging, obviously. The area's looking very good.

Is there any difference in the economics of a self-funded development versus a partner development?

There are a number of pieces to it. Firstly, with a development partner we don't have the long timeline and the pre-development costs that one incurs. And so on a risk-adjusted basis, the economics are pretty similar.

Okay.

But just as a reminder, in our development subsidiary, we are allocating human capital to help some of these-- on our programmatic development side, we are helping retailers accelerate their store opening program and we have some people working on that and those are sort of either in our acquisition group or in our development group and in that number of eight developers I did not include the people that are helping these programmatic development activity, which-- and those properties are coming directly into our pipeline at yields that are nice and attractive.

And what is the yield premium on those programmatic developments versus--?

It depends on how much work and effort we're putting in, but it goes from 50 to 200 basis points.

Over acquisition yields or over just a comparable development elsewhere?

Oh, over acquisition yields, I'm sorry.

Acquisition. Sure.

Sorry.

And, I guess, just in general, what type of yields are you seeing out of your development pipeline?

We're looking to get double-digit returns out of our development pipeline. You're not getting that on free-standing drugstore development deals, which is one of the reasons we are deemphasizing that activity, even though we continue to have some of those in our pipeline.

Having taken the term “net lease” out of your name, shall we-- should we think of it that you're, perhaps, moving away in some small way from--?

Well, I think you should look at us as primarily net lease retail properties. We will do some that are not net lease, particularly in the development side, but we'll tend to sell those, as well. We're going to remain focused on net lease retail.

And then just lastly, the dividend reinvestment program, did something change there with having added over 1 million shares in the quarter? It strikes me that is significantly higher than it was in the past.

I mean, it's a dividend reinvestment and a stock purchase plan and so there's two components where folks can sign up to reinvest their dividends. There's also folks who can sign up to make new investments in the company. Anyone who wants to do that on a large-scale basis really has to ask permission, more than $10,000 a month, but we issued, as we indicated 1,068,000 shares last quarter. We issued 705,000 shares in the fourth quarter of '05. We have the ability to regulate that, to a large degree, frankly, by granting waivers to those who are buying stock or not granting waivers and so to the extent we're not happy with our share price, that-- that number could be dramatically lower in terms of share issuance if we so choose.

And to be specific, at this current stock price, that window is closed, absolutely. Dead closed.

Do participants have the ability to buy the stock at a discount here? If I take the number of shares divided by the proceeds--

Yes. You get, I think, about a net of $21.73 net and frequently there's a 1% to 1.5% kind of discount. It's modest.

Okay. Thank you very much.

Thank you.

[OPERATOR INSTRUCTIONS] Gentlemen, at this time, I'm showing no further questions.

Dee, thanks very much. In conclusion, I would like to reiterate that all of the segments of our business are going well, that we have a lot of optimism for the balance of 2006. We look forward to talking to you in about 90 days. Thanks very much.

Thank you, ladies and gentlemen, for your participation in this morning's teleconference. You may disconnect your lines at this time.