NNN REIT Inc (NNN) 2006 Q4 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to the National Retail Properties Inc. fourth-quarter 2006 earnings conference call. (OPERATOR INSTRUCTIONS). As a reminder this conference is being recorded. It is now my pleasure to introduce your host, Mr. Craig Macnab, Chief Executive Officer. Thank you. Mr. Macnab, you may begin.

Thank you very much. Good morning and welcome to our year-end 2006 earnings release call. On this call with me is Kevin Habicht, our Chief Financial Officer, who will review details of our fourth-quarter and year-end financial results after brief opening comments from me.

We are extremely pleased with our financial performance in the fourth quarter and more importantly for the calendar year 2006. We had a successful and active fourth quarter to close out a terrific year for NNN, which resulted in us generating FFO of $1.67 per share from operations in 2006. These are record results for NNN, and we're very pleased to have grown FFO per share by just over 11% in 2006.

Our portfolio continues to be in great shape with occupancy of 98.2%, and we have very little lease turnover coming up in 2007 with only about 1.2% of our rent rolling over. The high level of occupancy is attributable to the quality of our fully diversified net leased retail portfolio. We currently own 710 properties, leased to 185 different national or regional tenants in 44 states. These tenants operate in 33 different segments of the retail industry, which provides us with very broad diversification.

In calendar 2006 we acquired 213 properties for $372 million for our investment portfolio at an average cap rate of approximately 86%. It is worth highlighting a couple of additional details regarding our 2006 acquisition activity and the environment in which we operate.

As evidenced by our record level of activity, the acquisition environment remains robust with opportunities created by M&A transactions in the retail arena generating about half of the opportunities that we evaluate and participate in. Pricing continues to be stable, and we are closing transactions at initial yields ranging from around 8% to the mid 9% range. This yield is in most cases about 100 basis points higher than the yield that would be achieved for comparable net leased properties purchased one at a time.

In 2006 we completed sale leaseback transactions with about 20 different tenants. With approximately half of these tenants or 10 different companies, we have now completed multiple transactions. When we acquire a property, our team is successfully making the process efficient and seamless for our tenants. As a result, we expect to again acquire net leased retail properties from many of these existing tenants in 2007.

In each of our two largest lines of trade within the retail sector, convenience stores and restaurants, we acquired about $150 million of properties in 2006.

At NNN we established a strong body of knowledge and reputation in the convenience store category, and we expect to continue acquiring properties in this line of trade. From a diversification standpoint, we have multiple different c-store tenants conducting business in a variety of different geographic markets all over the country. Our two largest tenants in this category are both large public companies that will continue to be at the forefront of consolidating this extremely fragmented industry, and we expect to continue providing leading convenience store operators sale leaseback capital as they grow their respective companies.

We like the fact that the type of convenience stores that we are acquiring are small discrete properties, ranging from 1 to 2 acres in size invariably located at busy traffic intersections. From a financial standpoint, these properties have solid unit level economics, providing excellent coverage on their ability to pay our rent. As you can infer from my comments, we really like the risk reward attributes of this sector, and as I mentioned a moment ago, we expect to continue increasing our exposure to the convenience store category.

In 2006 capital recycling was a huge activity for us. As reported, we sold just over $319 million of properties from our investment portfolio last year, including about $54 million of properties in the most recent quarter. While the large gains on sale are not included in our FFO, they are illustrative of the embedded value in our portfolio.

Key objectives of our capital recycling program are firstly to manage the portfolio quality and concentration amongst tenants; secondly, selling short-term lease-like properties, and most importantly, reinvesting the proceeds from selling assets in higher yielding, carefully underwritten retail properties ideally where the lease structure provides for rental growth over time.

In summary, we had a very successful and productive 2006. As we look at 2007, our portfolio is in excellent shape. We have a terrific acquisition pipeline and our balance sheet is strong. We are clearly pleased with the growth in FFO that we have achieved in 2006 and are optimistic about the way that National Retail Properties is positioned to continue to grow our FFO per share in 2007.

I will now hand over to Kevin.

Thanks. Let me start with the customary cautionary statement. We will make certain statements that may be considered to be forward-looking statements under federal security laws. The Company's actual future results may differ significantly from the matters discussed in these forward-looking statements, and we may 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, as indicated in the press release, as Craig mentioned, we reported fourth-quarter 2006 FFO results totaling $27.1 million or $0.46 per share. For the year FFO totaled $1.67 per share, representing an 11.3% increase over 2005's $1.50. We are very pleased with these improved results, which are being driven by a variety of factors from accretive acquisitions, lower costs, capital costs, squeezing G&A, recycling capital, etc. all driving higher results. Results were slightly ahead of guidance due to higher rental revenues with fourth-quarter core portfolio acquisitions of $104 million at the high end of guidance, as well as $54 million of acquisitions in our TRS 1031 exchange unit.

Last quarter we introduced 2007 guidance of $1.74 to $1.80 per share. Today we are increasing that guidance based on somewhat higher core portfolio acquisitions of $250 million to $300 million for '07. But more importantly, we see more of these acquisitions occurring sooner in the year rather than ratably over the four quarters for our prior guidance.

Accordingly, we are increasing 2007 FFO per share guidance to $1.77 to $1.83 per share. The new guidance represents an 8% growth from 2006 to the midpoint of '07. We obviously will revisit this next quarter when we have better sense on how the acquisition volume and timing for the year is going to shake out. But we do believe the visibility is certainly good on the guidance, but as always, the projections are based on a number of factors and uncertainties as discussed in our public filings.

Let me go quickly through some of the details in the fourth quarter, and then we will take some questions. Looking at the income statement, total revenues for the fourth quarter increased to $41.6 million, driven primarily from additional rents on investments made over the past year. Likewise, for the year, total revenue increased to $150.8 million, again driven by increased rental revenues.

I will note that we again have included some additional disclosure on page five of the press release regarding contingent percentage rents, straight line rents and capital leased earned income for your information.

Acquisitions for the core portfolio totaled $104.4 million in the fourth quarter and $371.6 million for the year. Occupancy at year-end '06 was 98.2%, and that was flat with the immediately prior quarter and down 10 basis points from year ago numbers.

The interest and other income from real estate transactions in our revenue section, that consists primarily of mortgage and mezzanine loan income and a few miscellaneous items. The $679,000 amount that we reported for the fourth quarter was flat with the prior quarter and was down from 2005's fourth quarter, primarily the result of a payoff of a $24 million mezzanine loan in the second quarter in April of '06. At the end of 2006, we had $14.2 million outstanding in structured mezzanine loans.

The interest income from mortgage residual assets was $1.3 million for the fourth quarter. That was down from $1.7 million the prior quarter and down from $2.6 million last year. That decrease, as we have discussed on prior calls, is a result of the amortization of underlying loans in the mortgage securitization pools. These fourth-quarter results were in line with our projections, and we're estimating a total of $4.2 million on this line item in 2007.

G&A expense was $6 million for the fourth quarter. That is down from $6.2 million last year. For the year, G&A was $24 million. In the fourth quarter of '06 this year, we did reach class some G&A expenses totaling approximately $1.2 million for the full-year '06 and $1.1 million for the full-year '05 that got reclassified some to property expenses and some to interest expense to better categorize those expenses. For the year G&A did meet our guidance, and our guidance for G&A in '07 is now $23 million.

Property expenses net of tenant reimbursements were fairly flat with the prior year amounts for the quarter, and they were up slightly for the year. During the fourth quarter, we did receive $1.3 million of lease termination fees, and that is reported in continuing operations in the rent line item, and that compares with $575,000 in the fourth quarter of '05, which was reported in discontinued operations. For the year total lease termination fees were $3.3 million in '06 and 3.8 in 2005.

In other expenses and revenues down below, interest and other income, that increased $1.48 million. That is up $288,000 from prior year amounts and up $312,000 from prior quarter, and these increases are just largely due to higher cash balances and higher interest rates on those balances.

Interest expense for the fourth quarter increased to $10.8 million. That is up from $10.0 million in fourth-quarter '05, and that was due slightly to higher debt balances and higher short-term rates. Interest expense decreased from the prior quarter due to lower coupon on convertible debt transaction we completed in September and the preferred stock issuance we executed in October.

At quarter-end we had $48.8 million or 6% of our $819 million of total liabilities were a floating-rate debt. Floating-rate debt as a percent of total gross book assets, which I, frankly, believe was a more meaningful metric, was 2.4%.

We did have a line item on our income statement this quarter for the gain on disposition of equity investment, and that represents the gain on sale of our 25% interest in our headquarter office building. In 1999 we invested $750,000 for that 25% equity interest and over the last past seven years received cash distributions totaling $13 million, including $10.2 million in October of '06 in connection with the sale of that interest.

We also reported the sale of 19 properties from our core investment portfolio during the fourth quarter, and those are reflected in the investment portfolio of discontinued operations. The sales of those properties have generated net proceeds of $54.3 million and a gain of $22.8 million and notably a cash gain of $21.1 million. As Craig pointed out for the year, we have created -- harvested significant value through the sale of $319.4 million worth of properties from our core portfolio, producing a GAAP gain of $91 million and, more importantly, a cash gain of a little over $80 million. As noted, these gain sales clearly demonstrate the embedded value in our core portfolio.

Similarly, like in discontinued operations inventory properties, those are properties in our TRS, we sold a total of 18 properties, four of which were out of our development unit, and 14 properties were from our 1031 Exchange unit.

We have active acquisition pace and a good amount of inventory held for sale in our taxable subsidiary that we're actively marketing, and that marketplace continues to be good for our dispositions.

Moving to the balance sheet, we finished the fourth quarter with total liabilities of $819.2 million. Of that amount, only $60 million was secured debt. 94% of the Company's total assets are unencumbered. During the fourth quarter, we issued 92 million of 7 3/8 Series C perpetual preferred, and we called for the redemption of 45 million of 9% Series A preferred, and that redemption we did complete on January 2 of '07 and creates over $700,000 of annual savings on that dividend.

Additionally, during the fourth quarter, we issued 1,044,000 shares of common stock from our stock purchase [grip] program, generating net proceeds of $23.1 million. At year-end '06 total debt to total assets was 40.6% on a gross booked basis, which excludes accumulated depreciation, and that is down from 45.4% in the prior quarter and down from 49.2% at year-end. On a market cap basis, leverage was 35.2%.

Interest coverage was 3.6 times for the fourth quarter and 3.2 times for the year. Fixed charge coverage was 2.9 times for the quarter and 2.8 times for the year.

In closing, again we're very pleased with the results for '06. I am especially encouraged about how 2007 looks likely to produce very solid per share growth. Again, I'm happy about this is coming from a variety of factors from acquisitions to lower capital costs, squeezing G&A, recycling capital, etc. We believe the portfolio and balance sheet are in very good shape and are optimistic we're going to be able to deliver incremental per-share results as we create value through targeted acquisitions, development and dispositions.

With that, I will stop. Craig, I think we will take questions.

Please, can you open it up to questions?

(OPERATOR INSTRUCTIONS). Jonathan Litt, Citigroup.

This is Amit Bhalla on the phone with Jon Litt. My first question is on your acquisition pipeline for 2007 of $250 million to $300 million. Would you say that the pipeline consists of larger transactions or more one-off deals?

That is a good question, and it is pretty much the same as 2006. As a company we spend a great deal of time focusing on creating multiple transactions with tenants, and these range from very small $1 million to $2.5 million type transactions, and then also, of course, we're interested in portfolio transactions. I think it is fair to say that in 2006 it was about 50-50, and right now we're probably about the same.

Given the higher cap rates that you are seeing, the M&A deals, obviously those deals come with a little higher risk. How is NNN underwriting that risk given that those companies often operate at higher leverage?

That is a good question. Our approach is identical for every property. Our underwriting team goes and visits each and every property that we acquire, and we pay attention to the fundamental real estate metrics -- rent per square foot how that compares to market rents; what the rent coverage at the unit level is; what the alternative use for that property would be and so forth, and then, of course, our credit team will pay attention to what the balance sheet of the tenant is going to look like.

I think that we are very focused on trying to get rent coverage, ability of the tenant to pay rent at the unit level of at least two times, and we are obtaining those. There are a couple of transactions out there in the marketplace where rent coverage will be less than that, and we just passed on one here in the last couple of days. It is a good company, perhaps a good opportunity. Rent coverage is a little tighter than we would like to see it.

Okay. And then my last question is the operating margin kind of dropped in the fourth quarter. I wanted to know if that was a result of the reclass you were talking about between G&A and operating expenses?

When you say operating margin, what number are you looking at particularly?

Just operating expenses, you know -- (multiple speakers)

At kind of the NOI level?

Yes.

Yes, no. That is partly related to that reclassification, and nothing material is going on there to change moving forward.

Right. So going forward, would we see that same trend of higher operating expenses and maybe a shift out of G&A to operating expenses?

I think we would continue at the same level as that now. We are not anticipating any change in that. And the total reclass as it related to property expenses for the year was about $600,000. So not a big swing one way or the other.

(OPERATOR INSTRUCTIONS). Ken Avalos, Raymond James.

I wanted to ask about pricing both on the acquisition and dispositions side. And particularly, Craig, what have cap rates done on c-store pricing as the credits have really improved pretty dramatically there over the past year?

I think it is that one of the reasons why we're increasing our exposure to the convenience store industry is twofold. Number one, we have got a terrific presence and body of knowledge. The second thing is that we really like the relative value opportunity of c-stores. You are correct that a number of the operators' credit profiles has significantly improved, such as our single largest tenant, [Sosa], went public in 2006, and obviously their credit is a whole lot better.

As they are paying down their expense of subordinated debt, the rate coverage ratio will be a whole lot higher if you add back in interest as opposed to doing it at EBITDA level.

Pricing is stable I think across the board, and I think that the point that has significance to NNN is the mix of properties that we might buy within a quarter. You will recall that last year we were generally talking about an average cap rate of around 8.75, and at the end of the year, I think our average cap rate was 8.64. That does not reflect any deterioration in yields or pricing change. It is simply a fact that we consciously purchased certain properties where the quality of the property is higher, which is consistent with our entire portfolio. We're not burning yield.

So the market is very stable right now. It is just how you allocate capital. And I think just so you know in 2007 in terms of the visibility that we have on the acquisition pipeline that Kevin mentioned, some of this is with higher quality tenants, and we're still getting pricing around an 8% kind of number. But those are with very, very good operators.

So just clarify something for me. When you say mix reflects a shift in quality, when you're referencing quality, do you mean from a credit side or from a physical/site perspective?

Correct. If we are -- and we're not acquiring Walgreens properties -- but say Walgreens traits trades at a lower cap rate than a Rite Aid reflecting the relative difference in their credit.

Right. Okay. So it is just a credit then. It is not really you're buying bigger parcels or anything like that. It's really on the credit side?

Correct.

Okay. And then just my other question was on disposition pricing. Can you give us any sense of that? I think you give us a little bit of flavor last quarter, but any change there on the disposition side and sort of the mix of buyers, are you seeing any dropping out of 1031 buyers, or how is that marketplace for you?

The demand for individual properties in the net lease retail category continues to be terrific. There are a lot of buyers out there for these properties. Provided interest rates remain at the levels, cap rates are still very low.

I think the market is stable. People can go and take a look at our website and see what the prices are that we are offering properties at. And those prices range from the high 6s to the low 8s depending on who the tenant is.

Can you give us a sense for the relative spread between c-store cap rates and restaurant cap rates and then maybe any other lines of business that you're going to focus on?

Yes, the category which -- the two biggest categories that we deal in in most of the net lease retail players are restaurants is by far the single biggest category. There are a lot of participants in that, and cap rates are lower in that category than some of the other areas. And, of course, I'm excluding drugstores where pricing for Walgreens, CVS stores is very aggressive. We are a developer of those properties and a merchant building seller of them at these low prices. But, Ken, I think it is clear to say that if quality of the tenant is the same, real estate attributes are the same, that c-stores command 75 to perhaps 100 basis points higher initial yield than a comparable restaurant property.

(OPERATOR INSTRUCTIONS). Gentlemen, there are no further questions at this time.

Thank you very much. Let me just add that we are very excited as we head into 2007. We've got a great acquisition pipeline, and it is that incremental rent that drives FFO per share. And both Kevin and I are in the office today if there are any questions.

Thank you very much, and we wish all of you a fantastic 2007. Good morning.

Thank you. Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.