NNN REIT Inc (NNN) 2007 Q1 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to the National Retail Properties Incorporated first quarter 2007 earnings conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (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. Good afternoon and welcome to our first quarter 2007 earnings release call. On this call with me is Kevin Habicht, our Chief Financial Officer, who will review details of our first quarter financial results after brief opening comments from me.

We are extremely pleased with our record financial performance in the first quarter, which obviously positions us well for the balance of this year. Our portfolio continues to be in great shape with occupancy around 98%, and we have modest lease turnover in the remaining eight months of this year. The high level of occupancy is attributable to the quality of our fully diversified net lease retail portfolio. We currently own 730 properties, leased to nearly 200 different national or regional tenants in 44 states. These tenants operate in over 30 different segments of the retail industry, which provides us with very broad diversification.

In the first quarter, we acquired 25 properties for $67 million for our investment portfolio, at an average cap rate of approximately 8.55%. These properties were acquired from ten different tenants, and I should point out that we've previously completed sale leaseback transactions with eight of these ten tenants. It's worth highlighting a couple of additional details regarding our acquisition activity and the environment in which we operate.

As evidenced by the level of activity, our acquisition team continues to look at a large volume of transactions that allow us to selectively acquire high-quality retail real estate. The acquisition environment remains robust with opportunities created by mergers and acquisitions, transactions in the retail arena, generating just over half of the opportunities that we are currently evaluating.

Pricing continues to be stable and we are closing transactions at initial yields ranging from around 8% to the mid-9% range. This yield that we're obtaining is in most cases about 100 basis points higher than the yield that would be achieved through comparable net lease properties purchased one at a time. As mentioned on our call in January earlier this year, we've established a strong body of knowledge and reputation in the convenience store category, and we've continued to acquire properties in this line of trade. From a diversification standpoint, we have a number of different convenience store tenants conducting business in a variety of different geographic markets all over the country. Our two largest tenants in this category are both well-capitalized growing 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 businesses.

We like the fact that the type of convenience store sites that we are acquiring are small, discrete properties with high land value as a percentage of the total purchase price, and they're 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 we expect to continue increasing our exposure to the convenience store category.

Our earnings release points out that our acquisition activity in the first half of this year will be very strong. Obviously, it's important for us to quickly invest the proceeds from our equity offering that we completed in late March. Finally, on the acquisition side, one more point. I want to highlight that the majority of the acquisitions closing in the first half of 2007 are notable for their real estate quality. In one case, the attributes of the real estate that we're acquiring really could be showcased in our annual report. In another transaction, the rent coverage is unusually high.

Although the yield for these transactions is excellent given the high quality of the real estate that we're acquiring, our average yield in 2007 will be slightly less than it was last year. I estimate -- by the way, that's not a projection -- our average yield might be in the 8.25% range for the year as a whole. We continue to be active selling real estate, realizing $65 million from the sale of real estate in the first quarter. The majority of these sales came from our CRS directly off our 1031 Web site at very good prices. These sales are a continuation of our capital recycling strategy, which will continue in 2007, albeit not at the same pace, during the rest of the year.

In summary, NNN had a great quarter, realizing the benefits of the tenant relationships that we've established over the last couple of years. As we look at our company, our portfolio is in excellent shape. Our acquisition activity in 2007 is off to a great start, and our balance sheet is very strong, following the equity offering that we completed late in the quarter. We're extremely pleased with the growth in FFO per share that we've achieved this year and are optimistic about the way that NNN is positioned to continue to grow our FFO per share in 2007.

With those comments, I'll now hand over to Kevin.

Thanks, Craig. I'll start off with our precautionary statement that we have and will make certain statements that may be considered to be forward-looking statements under federal securities laws and the company's actual future results may differ significantly from the matters discussed in any forward-looking statements, and we may not release revisions to those forward-looking statements to reflect changes after the statements are made. Factors and risks that could cause actual results to differ materially from exceptions are disclosed from time to time in greater detail in the company's filings with the SEC and in today's press release.

With that, let me just go through some numbers. As indicated in the press release, we reported first quarter 2007 FFO results totaling $29.6 million, or $0.49 per share, representing a 19.5% increase over 2006's $0.41 per share. If you strip out the impairment charges for both quarters, which was $95,000 in '07 and $1.820 million in '06, per share results increased by 9% in the first quarter year over year, and it would have been $0.49 versus $0.45. We're pleased with these improved results which are being driven by a variety of factors, from accretive acquisitions, lower capital costs, bleeding G&A and recycling capital. On last quarter's call, we increased our FFO guidance from $1.77 to $1.83 per share. Today we are increasing the bottom end of our guidance to $1.79, based on projected core portfolio acquisitions of 400 to $450 million for the year, and adjusting for the impact of our recent 5.750 million share common stock offering.

Importantly, we see the first half of 2007 core portfolio acquisitions totaling over $300 million, though we feel very good about the visibility on our '07 acquisition pipeline and accordingly our new 2007 FFO per share guidance is now $1.79 to $1.83, which represents 8.4% growth from '06 to the midpoint of our '07 guidance.

Obviously, with $0.49 in the first quarter, this implies the remaining three quarters of '07 will be closer to the 44, 45% range. The other primary assumptions in this guidance are 100 to $120 million of core portfolio dispositions versus $80 million we have previously projected. G&A expense of $24 million and pretax gains on sale from our TRS properties of $11 million. We believe we have very good visibility on the guidance, but as always, the projections are based on a number of factors and uncertainties discussed in the public filings.

Let me quickly go through some of the details for the first quarter and then we'll take some questions. Looking at the income statement, total revenues for the first quarter increased to $42.7 million, driven by additional rent from investments made over the year. Page 5 of our press release does have some additional detail related to contingent percentage rents, straightline rents, and capital lease earned income for your information. Acquisitions in the core portfolio, as Craig mentioned, totaled $66.6 million for the first quarter. Occupancy at quarter end was 97.9%.

The interest and income -- interest income and other income from real estate transactions, which consists primarily of mortgage and mezzanine loan income, and some miscellaneous items, the $1.267 million that we reported in the first quarter was down slightly from last year due to lower mezzanine loan balance outstanding, partially offset with some fee income from two developments in the first quarter of '07. At the end of the first quarter, we had $16.5 million outstanding in our structured mezzanine loans. The interest income from mortgage residuals for the first quarter was $1.2 million, which was down from $1.3 million the prior quarter, and down from $2.3 million last year. The decrease is a result of the amortization of the underlying loans in the mortgage securitization pools.

First quarter's results were in-line with our projections and we're estimating a total of $4.25 million for 2007 for this line. G&A expense, we reported $6.3 million for the first quarter, and that was down from $6.8 million last year. That's largely due to lower deal pursuit costs. Our guidance for this line item is $24 million for full-year 2007. Property expenses net of tenant reimbursements were fairly flat with prior year amounts for the first quarter. During the first quarter, we did receive $700,000 of lease termination fees, $600,000 of that is reported in continuing ops rent and $100,000 in discontinued ops rent. That compares with no rent termination fees in the first quarter of '06 and $1.3 million in the fourth quarter of '06.

In other expenses and revenues, interest and other income increased to $1.303 million, that's up $488,000 from prior-year amounts and it's up $155,000 from prior-quarter amounts. These increases were largely due to higher cash balances and higher interest rates on those balances. Interest expense for the first quarter decreased to $11.6 million, that's down from $12.1 million first quarter '06 due to slightly lower average debt balances and slightly lower interest rates in part due to our convertible debt issuance last fall.

At quarter end, $20.8 million, or 2.6% of our $794 million of total liabilities was floating-rate debt. Floating-rate debt as a percent of gross book assets, which I think is more relevant was only 1%. We also reported the sale of five properties from our core investment portfolio during the first quarter, and those are reflected in the investment portfolio of discontinued operations. Those sales generated $7.5 million of net proceeds and produced a gain of $1.8 million. We continue to review our core portfolio and expect additional dispositions, as I mentioned, in the remainder of this year. Our original core portfolio disposition guidance was $80 million for '07. We now believe it will be 100 to $120 million.

We do think this activity helps improve the quality of our portfolio, it demonstrates the embedded value in the core portfolio, and supplies capital for accretive acquisitions as we sell at retail prices and buy at wholesale prices. In disc ops inventory properties, we sold a total of 23 properties from our taxable subsidiaries, five of which were out of our development unit and 18 properties were from our 1031 exchange unit. For the quarter, total pretax pre-overhead gain on sale from our TRS was $4.7 million, compared to $4.4 million in the first quarter of '06. For the year, we expect total pretax gains of approximately $11 million. With our active acquisition pace, we've had a good amount of inventory for sale in our taxable subsidiary, which we are actively marketing. The markets for disposition of properties we developed or acquired for sale continues to be good. As we've indicated in the past, there'll be some choppiness to our reported gains on sale number from quarter to quarter depending on the timing of those sales.

Moving to the balance sheet, we finished first quarter with total liabilities of $793.6 million, of that amount, $60 million was secured debt, 94.6% of the company's total assets are unencumbered. Early in the first quarter, we completed the previously-announced redemption of $45 million of our Series A 9% preferred stock and late in the first quarter, we completed a 5 million share common equity issuance, which notably, this was our first common stock offering since 2003. In early April, as we indicated in the press release, underwriters over allotment [Green Shoe] was exercised bringing total proceeds from the 5.750 share issuance to approximately $136 million. We also issued 699,000 shares from our stock purchase DRIP program in the first quarter, which generated net proceeds of $16.7 million.

As of quarter end March 31, '07, total debt divided by -- over total assets was 37.9% on a gross book basis, that's excluding accumulated depreciation. That's down from 48.5% the prior year and down from 40.6% the prior quarter. On a market cap basis, leverage at the end of the first quarter was 32%. Interest coverage for the first quarter was 3.7 times, fixed charge coverage, 3.1 times. The coverages continue to improve over prior year due to lower borrowing costs and the accretive impact of our capital recycling efforts.

In closing, we are very pleased with the results coming out of the gate for '07 and have very good visibility on achieving our guidance for the year. We believe the portfolio and balance sheet are in very good shape and are optimistic we're going to be able to continue delivering incremental per-share results as we create value through targeted acquisitions, developments, and dispositions. With that, I'll turn it back to you, Craig.

Chris, we'd like to take any questions, please.

Thank you. (OPERATOR INSTRUCTIONS) One moment, please, while we poll for questions. Our first question comes from the line of Jonathan Litt with Citigroup.

Hi, this is [Andy Bigelow] with Jon. Given that your cap rate assumptions for 2007 acquisitions have come down, could you give some color on that? Is that related to acquiring maybe stronger properties or is that a reflection of where cap rates have moved?

I think that's good question and it is simply a function of acquiring high-quality properties. In the acquisitions that we're going to complete in the first half of this year, the majority of them will come from two transactions, where the real estate quality is very, very high. Its retail properties in primarily in a major, urban markets and the rent coverage is very high. As a result, the cap rate is slightly lower than what we averaged last year. However, the spread between what we are getting for these properties and what the underlying real estate might sell for on a retail basis, in other words, if we purchased these properties one at a time, it's probably wider than any of the other transactions we're looking at. So it's great real estate, high quality tenants resulting in a slightly lower yield.

And what would you estimate that gap is between buying one off versus buying in a portfolio transaction for these assets?

We try to get 100-basis point spread, generally, in what we're doing, and in this case it's closer to 150 basis points.

Okay. Then what cap rates should I assume for the dispositions in 2007?

I think those will end up probably in the low to mid-7s, depending specifically on which properties we decide to cull from the portfolio.

In that regard, I would really point you to what Kevin said. One of our objectives in capital recycling is to sell some of the weaker properties.

Okay, great. Then my last question is, how should I think about modeling the income tax amortization out of Orange Avenue?

That, frankly, will amortize over the life of the residual. So as the residual balance declines, it will -- the related income tax amortization will decline pro rata, if you will. So short answer is, over the next two to three years, that income tax liability will go away. But it will be on a declining basis over time.

Thank you.

Our next question comes from the line of Jeff Donnelly with Wachovia Securities.

Thank you. Craig, I'm trying to get a sense of the change in spreads between the initial cash yields on acquisitions that you've seen in the marketplace and borrowing rates over the past year. Can you give us some those metrics where you've seen the change in cap rates and where you've seen borrowing rates go?

Yes. Jeff, I think that for the one-off buyer, particularly the buyer who is using as much leverage as possible, maximizing the loan to value ratio, as the ten-year treasury oscillates so their cost of debt moves around, as it so happens, given the demand for 1031 real estate or alternatively just single properties providing leveraged yields, we really aren't seeing much change in the type of cap rates that we are getting when we're selling properties one-by-one.

As you well know, you can go to NNN1031.com to see the properties we're offering or alternatively to the Web site that we host, NNNEX.com and you'll get to see a wide number of retail properties and their pricing. In our case, I think that the -- for the tenants that we've previously done business with, and are continuing to do business with, the cap rate really isn't changing much as borrowing costs move around maybe 10 bips or just small amounts. So Jeff, even though the correlation probably should be closer, supply and demand forces in the market don't cause it to be that tight.

Okay. But if you had to speculate, I'm curious, do you think that spread, if you will, stays constant, if you will, as you look forward 12 to 18 months?

We still see enormous demand for net lease retail properties, and I don't think there's going to be much change in the cap rate. By the same token, none of us are smart enough to guess what interest rates are going to do, but I don't really see a whole lot of change in the ten-year -- next 12 months.

A comment you made a moment ago prompted me to ask this. Lenders have been incredibly aggressive in terms of proceeds and rate and virtually all property types, and even some that they historically have not been, but net lease, however, has traditionally been a fairly high-leverage business. to people who are portfolio buyers, as well as one-off buyers. How is that aggressive lending behavior manifesting itself in your business? Are you seeing lenders become less sensitive on certain terms or what are you seeing there?

Good question, again. And I think it speaks to the virtues of the net lease format, where these types of properties have long lease duration and highly predictable rental streams. Financial institutions have and continue to be prepared to provide debt in the range of 80% to leverage buyers against these properties. Frankly, there hasn't been that much change. In some of the other categories with there's lease up risk or development risk, et cetera where financial institutions have been prepared to take on more risk than they did three to five years ago, you've had changes there. In our category, it's pretty steady.

Just one last question, was that -- I guess why not more aggressively take advantage of the current situation? If you're buying in portfolios at pretty attractive cap rates and you can sell assets one off at a favorable spread, I guess why not aggressively become more a seller of the one-off properties, even to the extent it means you become a net seller or have to do special dividends to shareholders. Is that something you guys have considered?

I think that in order to get the types of yields that we are getting, which are above market, we have to work very hard. We have to sift through a variety of transactions and at present, we're just remaining disciplined on our pricing. In many transactions, there are other people that will offer either higher proceeds or lower yields. We don't get those transactions, but one of the strengths of our business model is that it's not dependent on huge volumes of acquisitions. So our current guidance, we've slightly increased the amount of acquisitions that we're projecting this year. Importantly, the timing of those is coming in in the first half of this year, but in the second half, although currently, our pipeline does not have any large transactions in it, we're actively looking at a couple right now. But if we see good acquisitions, we'll take advantage of it. But I do want to emphasize that our model doesn't require us to acquire large amounts of properties. We have to look at large amounts of properties to sift through and to find the quality we want at the right level of reward, risk adjusted.

I will add just to that, we have been active recyclers of capital. I mean, we've been maybe the most active in the net lease arena. Last year we sold over $300 million of property. A good chunk of that was one property. This year we're looking at 100 to $120 million of core portfolio dispositions on top of our TRS dispositions. So that's not lost on us. Particularly, when we're able to sell what we think are the among the weaker of or properties at very aggressive cap rates, we are doing so. And that is an opportunity for us to grow the bottom line.

Great. Thanks, guys.

Our next question comes from David Fick with Stifel Nicolaus.

Hi. Most of our questions were answered. A general question, I guess, for Craig. The industry keeps consolidating here and seems like every month or two another one of your peers decides to take the big check from GE Capital or someone else. Clearly there's a market that's aggressive for -- and more aggressive on an aggregate portfolio basis than the one off transaction. Are you guys receiving overtures, and generally, how do you react to the consolidation and elimination of many of your peers?

Dave, your comments are well taken that two of our companies in our peer group have -- one is already closed and the other one, I guess, is under contract at very, very aggressive cap rates. Which speaks to the value or the underlying value of a company such as ours, because it's difficult to acquire on an individual basis 730 net lease properties with slightly less than $3 million per purchase. I think as managers, our job is to continue to execute, keep our business running as well as we can, and if we do that, it undoubtedly attracts attention of other people.

Okay. I know you're hesitant to answer the question, but -- let me try it another way. Where do you think your portfolio would trade if there was a trade today, in terms of cap rate?

Some of the other companies, one of them which was a portfolio overwhelmingly of restaurant properties, traded at a sub-7 cap rate, and the buyer also had to, in addition to that, or chose to purchase preferred, which was selling at a discount, which had the affect of lowering the cap rate to pick a number, 6.9% cap rate. We own a higher quality portfolio than that that traded, but the market suggests something around a 7% rate.

Okay, great. I'll see you in Las Vegas.

Look forward to it.

Our next question comes from Ken Avalos with Raymond James.

Thanks. My questions were answered.

Our next question comes from Charlie Place with Ferris Baker Watts.

Good afternoon. I have just a couple quick questions. You talked about that you're looking for $11 million of gains out of your inventory portfolio. It seems that part of it gets recognized as continuing operations and the other part gets -- is included in the discontinued operations. Do you have a feel for what the breakout between those two numbers would be?

The $11 million refers only to the TRS, our taxable REIT subsidiary, which all flowed through the discontinued operations. So we have a reconciliation in the press release at the bottom of page 5 which highlights kind of the $4.7 million of pretax pre-overhead gains this quarter. That's one reason why we're at $0.49 in the first quarter and we think we'll be a little bit below that in the subsequent quarters of '07 because of the choppiness of the gain on sale activity just manifested itself more largely in the first quarter. But all that $11 million relates to the TRS and disc ops.

Let me make a couple of points. Firstly, thank you very much for picking up coverage on our company. It was a well-written, comprehensive report. As Kevin mentioned, those $11 million of gains are both pretax and pre-overhead in our taxable REIT subsidiary. But I think in the first quarter what we clearly do is, we sold at retail pricing some properties that we previously purchased in a portfolio transaction and realized at least 100-basis point spread in that transaction having held those properties for less than six months.

Great. Secondly, Kevin, you mentioned very quickly your fixed coverage ratio. I think you said it was 5.1% for the quarter or 3.1 times for the quarter. What was it for last year? And year end?

Compared to last year, it was -- interest coverage was 3.0, and last quarter it was 3.6.

And the fixed coverage ratio?

Last year, 2.6, and prior quarter, fourth quarter, 3.0.

Great. Lastly, you have a -- at the bottom of your balance sheet, you have a shares outstanding number of $65.7 million. Does that not include the Green Shoe?

That's correct. The Green Shoe didn't take place until early April. That's a March 31 number.

Thank you very much.

I think our 10-Q, when that comes out, will show about 66.6 million shares.

And our Q should be out hopefully by end of day.

Excellent.

There are no further questions at this time.

Chris, thank you very much. We appreciate all of your interest in NNN and as Kevin indicated in his closing comments, we feel very good about the way the company is positioned and our outlook for the rest of the year. We look forward to seeing some of you at the conferences in the next month or so and we'll be talking to you in three months. Thanks very much.