NNN REIT Inc (NNN) 2007 Q4 法說會逐字稿

Greetings, ladies and gentlemen and welcome to the National Retail Properties, Incorporated fourth 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 for National Retail Properties Incorporated. Thank you, Mr. Macnab. You may begin.

Doug, thank you and good afternoon to all of you and welcome to our 2007 year-end 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 my opening comments. NNN had a record year in 2007, and we are very pleased with our performance. More importantly, we are encouraged about the way that National Retail Properties is positioned for 2008. Our balance sheet is strong, our tenants are paying rent and performing satisfactorily, and we are seeing terrific deal flow. Our portfolio continues to be in great shape with over 98% of our properties occupied, with very limited lease rollovers in 2008. The high level of occupancy is attributable to the quality of our fully-diversified net lease retail portfolio. We currently own 908 properties, lease to just over 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. Finally, on average, these tenants are contractually obligated to pay us rent for the next 13 years. Our two largest tenants are both profitable, publicly traded convenient store chains, namely the Pantry and [SUSSA]. At the corporate level, the rent coverage from both of these tenants is excellent.

In the case of the Pantry, rent coverage for their most recent 12 months was just over four times and while I'm not privy to their inner details, I can tell you that NNN's portfolio includes many of their higher performing stores, including multiple properties that we earned in and around Charlotte, North Carolina. [SUSSA] has recently completed a significant acquisition of a regional Texas based chain and if we use their pro forma numbers following this acquisition, their corporate level rent coverage is 3.9 times. We are delighted that our two largest tenants are leading consolidators in the convenience store industry with visionary management teams and we do not worry about their ability to pay our rent. Let me add that we like the defensive characteristics of the convenience store industry and in the event that oil prices moderate, then convenience store operators might well have their backs to the wind. Finally, from a qualitative standpoint, it is worth repeating that about two-thirds of our annual base rent comes from tenants that are publicly traded and/or carry public debt ratings.

In terms of acquisitions, in the fourth quarter we acquired $146 million of properties for our portfolio at an average cap rate of 8.62%. In 2007, our team did a superb job investing $867 million, primarily -- with most of this money going to our investment portfolio, with lesser amounts for properties purchased for resale, as well as investments in our development subsidiary. In addition, we established a joint venture, exclusively to acquire convenience stores and acquired approximately $65 million of properties in the joint venture. We are currently being selective as we evaluate acquisition opportunities and carefully underwriting deals to reflect the current retail sales environment. However, it is worth noting that we are seeing plenty of opportunities to purchase net lease retail portfolios at attractive, risk adjusted yields.

In terms of the marketplace from the perspective of competition, much of the competition that we've experienced in the last 24 months has been from entities that need to line up financing before completing property acquisitions. Given the strength of NNN's balance sheet as we revert to a more normalized environment where cash is king, we believe that we will be able to selectively cherry pick from the transactions that we're currently evaluating. Our capital recycling program has been a great success and in 2007 we sold $148 million of properties at an average cap rate in the low sevens, generating non-FFO income of $56 million. Selling properties from our portfolio produces capital that we can reinvest in carefully underwritten properties, but it also allows us to strengthen the quality of our portfolio. Our activity in the fourth quarter were a good example of improving our portfolio. As our in-house 1031 experts sold a couple of properties that have shorter lease terms and inferior sales productivity.

In summary, NNN had a great year in 2007 and based on what I know today, I'm optimistic that 2008 will be another record year for National Retail Properties. I'll now hand over to Kevin.

Thanks, Craig. Let me start off with our cautionary statement that we're going to make certain statements that may be considered to be forward-looking under Federal Securities Laws and that the company's actual future results may differ significantly from the matters discussed in any of these forward-looking statements and we may not release revisions to those forward-looking statements to reflect changes after the statements were made. Factors and risks that could cause actual results to differ materially from expectations are disclosed from time to time in greater detail with the company's filing with the SEC and today's press release. With that thanks again for joining the call, as indicated in the press release, we reported fourth quarter 2007 FFO results totaling $32.15 million, or $0.45 per share, representing a 2.2% decrease, and '06 is $0.46 per share. This was in line with our guidance and street consensus. Stripping out some unusual items for both quarters, namely impairments and lease termination fee income, the per share results increased by 6.8% in the fourth quarter year-over-year, $0.47 versus $0.44.

For the full year '07, FFO per share was $1.87, that's up 12% from $1.67 in 2006. Again, if you strip out unusual items for both year-to-date amounts, per share results increased by 6.9% for the year, 1.87 versus 1.75 per share. As Craig said, we are very pleased with these results. Accretive acquisitions, capital recycling, improved operating expense margins they are all contributing to another very successful year. The results were at the high end of our guidance of 1.84 to 1.87 we gave on our last call and notably, 2007's 12% FFO growth followed's 2006's 11.3% growth, all that to say that the comps were not easy by any means in 2007, nor will they be in 2008. We are increasing our 2008 guidance by a $0.01 on both ends of the range from $1.94 to a $1.99 up to $1.95 to $2 per share. We still feel like we have good visibility on achieving this guidance which represents 4% to 7% per share growth over 2007, $1.87 result.

Additionally, we are not changing any of our primary assumptions in the 2008 guidance, which as a reminder was $300 to $400 million of core portfolio acquisitions, $80 million of core portfolio dispositions, G&A expense of $24 million, mortgage residual interest income of 4.5 million, that's before minority interest, and net property expenses of $3.1 million lastly, pretax, pre-overhead gains on sale from our TRS properties of $10 to $11 million. Again, we believe we have pretty good visibility on this guidance but as always, the projections are based on a number of factors and uncertainties discussed in our public filings and we can have some choppiness quarter-to-quarter. Wanted to quickly go through some of the details for the fourth quarter and we'll take some questions.

Looking at the income statement, total revenues for the fourth quarter were $52.6 million driven by additional rent from new investments made over the past year, as well as our accretive capital recycling from dispositions. Acquisitions in the core portfolio totaled 152.1 million, as Craig just discussed, for the year, total revenues increased $45.3 million to 186.4 million for full year '07. The acquisitions for the year totaled $697 million in the core portfolio. Occupancy at year-end was 98.3%, that's up ten basis points from the immediately prior quarter and from a year ago.

On page five of our press release, that includes some additional disclosure regarding contingent percentage rents, straight line rents and capital leased earned income for your information. Also, I'd note that during the fourth quarter we recorded $110,000 of lease termination fee income, all that's in continuing ops. Rent and that compares with a million three of lease termination fee income in the fourth quarter of 2006, again, all in continuing ops.

Interest and other income from real estate transactions, that increased to 1.6 million in the fourth quarter of '07 from 600,000 in the fourth quarter of '06 largely due to increased mortgage and mezzanine loan notes receivable balances outstanding compared to the prior year. Additionally, we did recognize a $270,000 fee in the fourth quarter of '07 on a development project of ours. At the end of the year, '07, we had 14.5 million outstanding in structured mezzanine loans and we had 51.4 million of mortgage and notes receivable outstanding as well.

The interest income from mortgage residual asset line item, that was 1.4 million for the fourth quarter, that's fairly flat with the 2006 amounts and up slightly from the 1.1 million in the immediately prior third quarter. And that's due to the increased discount rate assumption we mentioned last quarter. If you look at year-over-year, this interest income dropped from 7.3 million to 4.9 million as anticipated as a result of the amortization of the underlying loans and the mortgage securitization pools. We are estimating that total 4.5 million for this line item in 2008. This is a reminder, these are commercial mortgage residual assets which reside in our 79% owned Orange Avenue Mortgage Investments. That's an entity we had purchased that interest in May of 2005 for $9.4 million. Since that time, our share of the cash, net cash flow generated by that entity has been 22.6 million, so despite some accounting noise from the investment, the returns on this investment have been oversized which is what we expected and why we pulled the trigger on that option. Detailed information on this entity is on page nine of the press release. Also wanted to note that prior to December of 2007, this entity was sitting on over $20 million of restricted cash. In December those restrictions expired and we used ten million of that cash to pay off some of Orange Avenue's notes payable and we plan to pay off the remaining 12.5 million of notes in that entity during the first quarter of '08.

G&A expense for the fourth quarter '07 was $6 million, that's flat with prior year amounts. G&A for 2007 full year was 23.5 million, notably down on an absolute basis, down $467,000 or 1.9% from 2006's $24 million. Important to note here that we are seeing meaningful operational leverage efficiencies as G&A for 2007 was 12.9% of NOI and that as compared to 17.4% for 2006. Again, notably, our guidance anticipates continued growth and efficiencies with total G&A of 24 million for 2008. Property expenses net of tenant reimbursements increased to $950,000 for the fourth quarter. That's up 320,000 for the quarter and 470,000 for the year, compared to 2006. We did book an impairment charge of 1.5 million in the fourth quarter of '07. Generally related to properties we intend to sell.

For the year we had total impairment charges including any related to our mortgage residuals totaling 2.6 million. Unlike the meaningful amount of gains Craig alluded to earlier from the sale of our core portfolio properties, these impairment charges are included in our reported FFO results. In other expenses and revenues, interest and other income, $1.6 million for the fourth quarter, that was up from 1.1 million the prior year, primarily due to higher rates on our higher cash balances. Interest expense for the fourth quarter increased to 13.9 million. That's up from 10.8 in the fourth quarter of '06, again, due to higher average debt balances outstanding. At year end we had $129.8 million outstanding on our bank line and that's out of a total liabilities of one million -- $1.13 billion.

We also reported a sale of ten properties from our core investment portfolio during the fourth quarter and that's reflected in the investment portfolio discontinued operations on page seven in the press release. That capital recycling generated net proceeds of $31.4 million produced a gain of 9.8 million and for the year, as we mentioned, total core portfolio dispositions totaled 146 million in net proceeds and produced a gain of 56.6 million which as I noted these gains are not included in our FFO results but obviously in our minds creates meaningful value. The capital recycling activity helps improve the quality of or portfolio, demonstrates the embedded value in the portfolio and supplies the capital for accretive acquisitions as we sell at resale prices and buy wholesale. Looking at discontinued operations as it relates to our inventory properties, our TRS properties, we sold a total of five properties from our TRS, net proceeds of 12.1 million, three of the five properties were from our development unit and two were from our 1031 exchange unit. For the quarter, we had total pretax, pre-overhead gain on sale from our TRS was $1.8 million of gain on sale and that compares to 2.4 million for the fourth quarter of '06. For the year, pretax, pre-overhead TRS gains for '07 were $11 million, that compares with 9.7 in '06 and again, as I mentioned, we anticipate a similar amount in '08 as what we had in '07, meaning $10 to $11 million of pretax gain from the TRS.

Moving to the balance sheet, we finished the fourth quarter with total liabilities $1.13 billion of that amount, only 39.5 million was secured debt. Leaving 97.1% of our company's total assets unencumbered. During the fourth quarter we did complete a four million share common offering that generated 99.1 million of proceeds. As well as we generated 22.3 million of proceeds from issuing around 915,000 shares from our stock purchase dividend reinvestment program. Additionally during the fourth quarter, we expanded our bank credit facility from $300 million to $400 million in October of '07.

As of year-end, '07, total debt to total assets on a gross book basis was 42.5%, that's up slightly from 40.6% the prior year and down slightly from immediately preceding third quarter's 43.2%. On a market cap basis, leverage was 38.6%. Again, the value of maintaining balance sheet flexibility is more apparent in times like these and we believe we're in a very good position which will enhance our competitiveness at the margin. Interest coverage was 3.3 times for the fourth quarter and 3.5 times for the year. Fixed charge coverage, 2.9 times for the fourth quarter and 3.0 for 2007.

Final thoughts, I guess, just with FFO per share growth of 12% in '07, a 6% dividend increase which was 18th consecutive year of annual dividend increases, we are very pleased with 2007 results and we believe we are in good position to deliver solid growth in 2008. The portfolio is and end balance sheet is in very good shape and we are optimistic we are going to be continue delivering incremental per share results as we create value through targeted acquisitions, developments and dispositions. With that I'll think we will ask for questions.

Thank you. Ladies and gentlemen, at this time we will be conducting a question-and-answer session. (OPERATOR INSTRUCTIONS). Our first question comes from the line of Jonathan Litt with CitiGroup. Please go ahead with your question.

Hi, it's Greg (inaudible) with John. Could you comment on how you plan to spend the 3 to 400 million of acquisitions you've guided to this year?

Greg, we're looking at a variety of different portfolios. There are multiple opportunities out there in the marketplace and we're carefully underwriting all of these. We're finding some good opportunities and we've yet to close most of these deals so we'll have to see what we close.

Do you have any sense on the timing for possible refinancings?

I think our -- if we're planning to do 3 to 400 million first quarter, based on what we see today, should be just pick a percent, divide that number by four. There are a couple of other deals that we are looking at right now and it's -- at this stage it's premature to say whether any of them will fall into the fourth quarter.

I think if you look at our dispositions for the year which we mentioned were about 80 million from the core portfolio, if you layer in net dispositions if you will from our TRS which we continue to see good activity there, selling our properties, we'll be a net seller of properties in that entity to the tune of 50 to $70 million. We have about $40 million of retained earnings. All of those things are somewhat self funding of acquisitions plus we do have the capacity and the balance sheet that allows us to add leverage if we so choose.

Okay. Thanks. And then just on --

If I could just, if we think about the balance sheet capacity, you have about 300 to 400 million. Currently that's from the credit facility. Now, should we expect an unsecured debt offering in the near future and how should we think about the pricing of that. Near-term, given where LIBOR is, there is going to be benefit from keeping in balance on the line.

I think one of the things that we try very hard to do is make sure we've got choices. There's no doubt about it, the spreads over treasuries, if we are to do a debt offering, and I emphasize if, are much higher than they were the last time we did a debt offering. But by the same token, the treasury yields are much lower. So the actual cost, if we were to do a debt offering, is about the same. Right now, LIBOR is clearly very inexpensive, but one of the things that we spend a great deal of time talking about internally and will continue to execute on is to make sure we have access to a variety of different types of capital. So we're currently borrowing under our bank facility. We'll see what happens based on needs for capital as the year rolls out.

Craig, just one more on tenant credits. Do you have any specific tenant concerns given the recent pullback we've seen in the economy?

I don't think so. Right now we're paying great deal of attention to it. There's no doubt about it, some of the tenants are not performing as well as they have in the past. The restaurant companies are going to face not only slower sales environment but higher cost environment, so that's going to impact them. Our exposure to that sector is not extensive, number one. And number two, our restaurant portfolio is very, very diversified. I think we've got about 50 different tenants in that area. One of the things that I would like you to focus in on are the defensive attributes of convenience stores. Some of those companies are reporting numbers, they're not seeing the kind of growth that they have in the past. But don't underestimate that if the price of oil comes down, the price of crude comes down and margins expand, which of course is good for us from a credit standpoint, but right now our portfolio is in good shape.

Are you looking at any more restaurant deals?

We are absolutely looking at all kinds of deals, including restaurant deals. We've in the last couple of weeks passed on several restaurant deals just because we didn't think the risk adjusted returns were what they needed to be.

Okay. Thank you.

Our next question comes from the line of David Fick with Stifel Nicolaus. Please go ahead with your question.

Good afternoon. Just focusing back, since most of your growth is now coming from acquisitions and I realize you're looking at everything under the sun, Craig, but could you just, if you had to guess where you got -- you've given guidance on acquisitions, so you must have some sense of the specifics, where are you going to be concentrating in terms of product type and yield and how comfortable are you with the convenience stores growing as an element, percentage of your assets under control?

In the near-term, most of the convenience store deals that we close on will be going into our joint venture with our institutional partner. So far we've acquired about $65 million of properties there. We expect to acquire about $220 million of properties in that convenience store joint venture when it's fully funded. But we will also add small amounts of convenience stores into our investment portfolio. We're looking at a wide variety of transactions currently, as I mentioned to Greg a moment ago, certainly we are looking at some restaurant deals, we're looking at convenience store deals and if you go down our categories, we're looking at deals in most of the categories that you see at the top of our list.

Is it fair to say that you're not anticipating growing the Big Box segment or the Best Buy, Home Depot, Lowe's type assets?

Yes You asked in your opening question and I didn't fully answer that, this year we are internally using 8.5% as the cap rate on average that ultimately works its way through our budget and the types of tenants you mentioned with new leases were not able to get those kind of yields.

It seems fair then to say that the majority of your acquisitions are going to have to be focused outside of the joint venture on the restaurant area, is that fair?

I don't think that's accurate, no.

Where else do you expect to be investing?

Wow, David, we're looking at -- if you take a look in our press release, just do that right now.

I think everybody is aware of what you own today. The issue is how can you get 8% or better yields without running the risk curve out a little bit further in your portfolio as I think has been reasonable for to you do over the last few years. But you're now getting to the point where a pretty big portion is coming from credit that arguably isn't as strong as historically it had been.

There's no doubt about it. The credit on some of the deals we're doing today are not as good as Walgreens' credit. There's no doubt about that. Let me tell you that we are very carefully underwriting each and every one of these deals. The rent coverage both at the corporate level and at the store level is more than sufficient in today's retail sales environment and then the real estate fundamentals that we also look at are more than acceptable.

Okay. Thank you.

Our next question comes from the line of Jeff Donnelly with Wachovia Securities. Please go ahead with your question.

Good afternoon, Craig. Maybe barking up the same tree, but I'm curious, are you guys seeing opportunities or increasing number of opportunities to help retailers out there who are having difficulty obtaining credit or refinancing loans and I guess I'd extend that beyond retailers to restaurants and other services too?

Yes, I think that one of the reasons that the deal flow right now is so good is that where two years ago companies could issue their most -- perhaps their junk type dirt in single digit type yields. Today, that paper is no longer available. So as they evaluate sale leasebacks, it's so much more attractive for them and there are just a lot of deals in the marketplace right now. Some of these deals are from companies that have not considered sale leasebacks in the last 12 or even 24 months. Just a lot of product on the market right now.

Does that tell you, though, that maybe you should be sitting back on the sidelines and waiting. I think I asked you this on the last quarter as well. If the financing markets are tough right now and I'm guessing there aren't a lot of well capitalized buyers out there, are you better sitting back on the sidelines and have a little stress come to asset pricing rather than delve right in.

Let me tell you what we are doing. First thing we're doing is we're underwriting to current levels of retail performance, number one. Number two, we are cherry picking from amongst the deal flow that we see, which we think is the most attractive on a risk adjusted basis and the most attractive does not mean necessarily the highest yield. What it means is the safest yield for the return we're getting. Just getting higher yields doesn't make a deal more attractive.

Just one last set of questions. Can you talk a little bit about what's been happening between the spreads initial cash yields and borrowing spreads over the last few months and what sort of returns you think investors are underwriting today?

What type of investors, Jeff?

What type of total returns are investors underwriting today on net lease?

Well, what we're looking at is through a combination of initial yield, pick a number, 8.5%, and then bumps over the duration on an unleveraged basis you're getting to 10% type numbers.

You think that's where the market is?

I think it's probably better than where the market is. We're selling some properties right now at prices that total return will be unleveraged, 7.5 to 8.25.

Just one last question, and I'm curious, I mean if the transaction market, there's a lot of product out there, it appears to have slowed. What impact can that have on your ability to either acquire and flip assets in '08? Is there some reasonable risk of either lower earnings contribution, whether it's you guys or some of your competitors, from that activity or just a risk of a longer hold period maybe as a result of that?

I think you're overstating the effect that there's lots of product in the market. I think one of the most important things what I said earlier, that companies such as National Retail Properties and you covered another one that's very similar, we're both in terrific shape right now. We've got good balance sheets and we're cash buyers. The difference as we look at the competitive marketplace is that one year ago, 15 months ago, somebody who just could articulate a couple of sentences consecutively could borrow money to do one of these deals and get a great return. Today, being a cash buyer, there's just far more opportunities and to be honest, the quality of some of these deals is very, very good. One of the reasons in my opening comments I talked about the rate coverage of our two bigger tenants, both of which are around four times rent coverage of the last 12 month pro forma numbers, that's pretty safe deal, as best I can tell. And if we can get unleveraged 10% type returns from those, I think it beats most of the other deals that companies in your coverage ratio, coverage portfolio are getting.

Thanks, Craig.

Our next question comes from the line of Dustin Pizzo with Bank of America Securities. Please go ahead with your question.

This is (inaudible) with Dustin. On a follow-up on the restaurant question, what is the average rent coverage for the restaurant sector within the portfolio?

To be honest, I don't have that number at the tip of my tongue. I don't have it.

Okay. Also, do you have any concerns about your portfolio on a regional basis?

No, I don't think so. Different parts of the economy are performing slightly different. Certainly Florida right now, the housing boom is dramatically fallen off and retail sales performance in Florida is not nearly as robust as it was. Having said that, it's better than some of the other states. Florida is a big state for us. Texas, which is another big state for us, retailers in Texas are continuing to do quite well.

Thank you.

Ladies and gentlemen, (OPERATOR INSTRUCTIONS). Our next question comes from the line of Stephanie Cruisken inwith Janney Montgomery Scott. Please go ahead with your question.

Just two data points that are not in your supplemental information and forgive my voice, I have a cold. What was your CIP at the end of the year, construction in progress?

We had about -- hang on one second. We had 17 million under construction.

Okay. And then your disclosure changed a little bit on your balance sheet. Is it safe to assume that you have zero held for sale in your investment portfolio since you're not breaking that out?

That's a good assumption.

Okay. Thanks, guys.

Gentlemen, there are no further questions in the queue at this time. Would you like to make some closing comments?

Thanks very much. We appreciate all of you joining our conference call. I do want to reiterate that we feel very good about the way we're positioned in 2008. Our balance sheet's in good shape. Our tenants are performing well and there are plenty of opportunities out there from which we will carefully identify new acquisition opportunities. Thanks very much. We'll be talking to you all soon.

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