NNN REIT Inc (NNN) 2008 Q3 法說會逐字稿

Greetings, ladies and gentlemen. Welcome to the National Retail Properties Incorporated third quarter 2008 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 you host, Mr Craig Macnab, Chief Executive Officer with National Retail Properties. Thank you, Mr Macnab, you may begin.

Thank you, Jen. Good afternoon and welcome to our third quarter 2008 earnings release call. On this call with me is Kevin Habicht, our Chief Financial Officer, who will review details of our third quarter financial results, plus provide guidance for 2009, after brief opening comments from me. We are very pleased with $0.50 of FFO in the third quarter, which is an 8.7% increase over the same period last year. Perhaps more importantly, we are delighted to have access to equity markets, where we sold 3.45 million shares a couple of short weeks ago. Given that we have yet to reinvest this capital, we have tightened our 2008 FFO guidance by a couple of pennies to a range of $1.97 to $1.99 per share. Including the proceeds from our recent equity offering, we have now raised a total of $123 million of equity in 2008 at an average price of a couple of pennies higher than $22 per share.

In addition, so far this year, our capital recycling has resulted in our selling approximately $209 million of properties with approximately three quarters of those coming from our TRS inventory portfolio. In other words, we have raised a lot of capital in 2008 and this time of deleveraging our conservative balance sheet continues to be strong. Kevin will provide the important details and metrics on our balance sheet in a moment. But we are extremely well positioned from both a liquidity and a leverage perspective. In the third quarter National Retail Properties acquired 36 properties for $68.1 million for our investment portfolio at an average cap rate of 9.35%. These properties were acquired from four different tenants and we previously completed sale lease backed transactions with three of these tenants. In this environment, what is perhaps more important is that in our third quarter we sold $71.3 million of properties at an average cap rate of 6.77%.

These properties were sold by our outstanding TRS team off our website without using brokers and you can observe from the excellent pricing that we executed well and the timing was just perfect. Given the environment, our portfolio continues to be in solid shape at the end of the quarter with occupancy at 96.9%, with a modest amount of leases expiring in 2009. Our average lease duration continues to be long and is still at about 13 years. To me it is inevitable that most commercial landlords will see deteriorating occupancy trends in 2009. NNN is no different and we are budgeting that our occupancy will decline by about 2.5%. Believe me, I hope that this guesstimate proves to be a conservative assumption, but given the recessionary environments in which we are operating, aggravated by weak consumer confidence, this appears to be the prudent thing for us to do at present. As most of you are aware, our largest line of trade is convenient stores.

Earlier this month we had a very successful investor day showcasing a number of our properties in Charlotte. For those of you that could not attend, we wanted to showcase the high quality of the real estate locations on which these C-stores are located, plus the breadth of merchandise that is sold inside the stores. Importantly, from a credit perspective, in a challenging retail environment our C-store tenants are currently experiencing exceptional gross margins as the price of oil has come crashing down, which, of course, improves their ability to pay our rent. Let me make a couple of comments about the acquisition and disposition landscape. We are operating in a environment where banks have essentially turned off the spigot in terms of lending money to real estate.

This has meant that A, the vast majority of our competition who are dependant on high amounts of bank debt, have completely disappeared. And secondly, cap rates are trending higher. With the difficulty of obtaining debt financing, cap rates are also clearly rising in the 1031 market. If I were to use one word to summarize our present acquisition posture, it is that we are being very selective. Our underwriting remains rigorous and we are passing on many opportunities. We have zero currently outstanding on our $400 million line of credit., so we are waiting for opportunities to become available that meet both our underwriting criteria as well as are priced appropriately. With that I will hand it over to Kevin.

Thanks, Craig. And let me start with our typical cautionary statement that we will make certain statements on this call that might 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 these forward-looking statements and we may not release revisions to these forward-looking statements to reflect changes after we made the statements. 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, as well as today's press release. With that, as indicated in the press release we reported third quarter 2008 FFO results totaling $36.7 million or $0.50 per share, which represents an 8.7% increase from $0.46 per share in the third quarter of '07. For the nine months we reported $1.51 of FFO per share,which represents a 6.3% increase over first nine months of '07.

We are very pleased with the results, they were in-line with our projections and street estimates. As Craig mentioned, our balance sheet's in excellent shape, with no material debt maturities until September, 2011 and no outstandings on our $400 million credit facility. As Craig mentioned also, to account for our recent 3.450 million common share equity offering, we did tighten our '08 guidance to $1.97 to $1.99, which represents about a 6% growth rate over 2007's $1.87 per share results. We also announced 2009 FFO per share guidance of $1.88 to $1.98, which allows for our cautious macroeconomic outlook. While our tenants have paid us rent fairly consistently over the years, our guidance factors in 2.5 -- 250 basis points of additional vacancy in 2009 and, that equates to about $0.06 to $0.07 per share.

If, how and when this additional vacancy occurs remains to be seen, but the macroeconomic environment is sufficiently poor that it seems prudent to assume some additional potential vacancy. We have no details to provide you in support of this additional vacancy number, just an educated guess. Also in 2009, we will adopt a new required accounting treatment for the interest on our $406 million of convertible debt outstanding, which will add approximately $6.5 million of noncash interest expense in 2009 and that equates to about $0.08 per share. Note a couple of things related to this. First, the guidance we quoted for '09 excludes this forthcoming accounting change, so that our 2008 and 2009 guidance is on an apples to apples basis. Secondly, once we start reporting under this rule in 2009, our 2008 historical numbers will also be adjusted to take into account this new rule.

So we are estimating about $0.07 of impact on our 2008 number, so there wont' be a big delta between '08 and '09 once we start reporting '09 results. And lastly, a somewhat counter intuitive impact of this accounting pronouncement in that on January 1, 2009 our debt will decrease by approximately $26 million and our equity will increase by the same amount. The timing of this accounting rule change is particularly ironic given that the likelihood of convertible debt actually converting into shares is diminished given the level of equity prices, but we don't make the rules. That's where that will come out. Other assumptions in our guidance for 2009 include $200 million of acquisitions in a core portfolio, as well as $50 million of dispositions. G&A expense of $23 million, mortgage residual interest income of $4 million before any minority interest, net property expenses of $4.2 million. And lastly, pretax pre-overhead gains on sale from TRS properties of $2 million.

As the economic and capital market uncertainty seemed to abound, the visibility on the guidance is obviously more clouded than we've historically had, but we are confident we can weather the economic storms and importantly believe our dividend is very secure. Consistent with this year and prior years, we hope to have the opportunity to raise guidance. Let me quickly go through a few details on the third quarter and then we will take some questions. Looking at the income statement, total revenues for the third quarter increased to $58.6 million, driven by additional rent from net new investments made over the past year as well as accretive capital recycling from dispositions. The acquisitions in the core portfolio totaled $68.1 million, as Craig just discussed, and $322 million for the first nine months. That is consistent with our 2008 full year guidance of $300 million to $400 million of acquisitions.

Occupancy at September 30 was 96.9%, that's down 150 basis points from the immediately prior quarter. Nearly all of that is due to the 13 Uni-Mart vacant C-store properties that we discussed last quarter and which we are in the process of releasing. Page five of the press release includes some additional disclosure regarding contingent percentage rents, straight line rents, and capital lease earned income for your info. And we also have added this quarter some additional disclosure that will assist in calculating an AFFO type number for us. During the third quarter we did record $2.284 million of lease termination fees, all of that is in the rent line item $1.640 million is in continuing ops and $644,000 in disc-ops inventory. That compares with $262,000 of lease term fee in the third quarter of '07. The fees that we got this past quarter were all related to the 13 vacant Uni-Mart properties that were rejected in bankruptcy.

And these fees were drawn against a letter of credit that we had put in place when we originated this deal. G&A expense was $5.2 million for the third quarter, that's flat with prior year amounts and down from $6 million in the second quarter. For the year we see G&A at $24.5 million to $25 million. Year-to-date 2008, we are continuing to see operating leverage improvements with G&A at 10.1% of total NOI revenues versus 11.6% in 2009 for the first nine months. Interest expense for the second quarter increased to $14.8 million. That's flat with the second quarter's $14.7 million report and it's up from $11.8 million last year due to higher average debt balances. At quarter end we had $53 million or 4.5% of our total liabilities were floating rate. Floating rate as a percent of gross book assets, which I think is more meaningful, was 1.9%

However, if you look at pro forma September 30, including the October 1 equity offering proceeds, we had -- we -- as of September 30th, pro forma basis and as of today, we had no floating rate debt with the receipt of those equity offering proceeds. During the third quarter we did report the sale of six properties from our core investment portfolio and they are reflected in the investment portfolio-disc-ops. This capital recycling generated net proceeds of $19.7 million and produced a gain of $2.6 million, which these gains are not included in our FFO results, but obviously create value as we reinvest those proceeds at higher cap rates. Disc-ops inventory properties, TRS properties, we sold a total of nine from our TRS with net proceeds of $51.6 million. Of those nine, we sold one development property and eight properties were sold from our 1031 exchange unit.

For the quarter total pretax, pre-overhead gain on sale from our TRS was $2.8 million and for the first nine months was $9.2 million, which is on track with our previous guidance of $10 million to $10.5 million of pretax for this line item in 2008. I will note that in the disc-ops inventory portfolio results, we also had a pretax impairment charge of $3.9 million related to several of our properties, mostly development properties, that we marked down to better reflect market conditions. The after tax impact of that charge is approximately $2.4 million. You also note on the balance sheet that total TRS inventory is down almost half since year-end 2007, so we've gone from $249 million to $126 million at the end of the third quarter. Also looking at the balance sheet, we finished the quarter with total liabilities of $1.169 billion, that's down $58 million from the prior quarter total liabilities. And we only have $27 million of secured debt, with 98% of the Company's total assets unencumbered.

There wasn't much balance sheet activity during the third quarter. However, late in the quarter, as we've mentioned already, we executed a $76 million common equity offering that actually closed on October 1st. So our pro forma -- September 30 balance sheet pro forma we received, our line of credit would reflect zero outstanding on our bank line with those equity proceeds pro forma. As we also noted in the press release, we recently extended the maturity of our bank line from May 2009 to May of 2010. If you look at September 30 total debt to total assets on a gross book basis was 42%. That is down slightly from 43.7% the prior quarter. And again, on a pro forma basis with the closed equity offering proceeds, total debt to total assets was 39.8%. And as I mentioned, we have no material debt maturity until September, 2011 and nothing outstanding on our $400 million bank line.

The value of maintaining the balance sheet flexibility is obviously more apparent in times like these and we believe we are in very good position, which will enhance our competitiveness. Interest coverage was 3.3 times for the third quarter. Fixed charge coverage was 3.0 times for the quarter. Lastly, we also recently declared our fourth quarter dividend, which marks 2008 as the 19th consecutive year of increases in our dividend. We are happy that we are one of the relatively few and shrinking group of companies with a dividend increase track record that long. We are also fortunate that our payout ratio is the lowest in our history and among the lowest in our sector, particularly on a AFFO basis. This, coupled with our -- the solid balance sheet that we have, our low debt maturities and low lease expirations should help us considerably weather this macroeconomic environment. With that, I think we will take some questions.

(OPERATOR INSTRUCTIONS) Our first question comes from the line of Mike Bilerman with Citi. Please proceed with your question.

It's [Greg Schatheim] here with Michael. Appreciate the additional disclosure. Just regarding the impairment, could you provide a bit more color on specific tenants that were part of that and what development makes up of the $125 odd million balance? On the inventory portfolio?

There is a total of four properties, two development and two exchange assets that we marked down and produced that $3.9 million impairment, like I said, after tax it's a $2.4 million bottom-line impact.

Two of those properties are Uni-Mart properties that were held in the TRS. We have released both of them and we have got to see where that goes, see what we do with it. But we have taken the prudent thing of writing some of them down, plus a couple, two content development properties. In this current environment, buyers of those types of properties cannot get the type of debt that they want to since cap rates are going up. So we've written them down.

What does development make up of the inventory portfolio balance.

It is about 75%.

Okay.

And just for what it's worth, the biggest piece of that is a power center in the west side of Dallas that has -- that's almost complete. There are a couple of very good tenants in there. There is a ground lease with Penney's. There is a ground lease with Belk's and several other properties. To the extent you're concerned about it's value it's a very good asset.

And could you walk through the thought process on the inventory portfolio. You invest a small amount this quarter and how comfortable are you with keeping that balance high in the current environment. Is the goal not to drawn down as soon as possible?

Well, I think we have made great progress in calendar 2008 shrinking it by about a half from 250 odd to 120 something as the end of the third quarter. We -- when we purchase portfolios, we will periodically put some of those properties into the exchange portfolio, inventory portfolio. These are properties that we are quite happy to hold for the duration. One or two of these properties that we're currently marketing for sale, we might take a look at and see if we want to continue to hold them. Let me give you an example of that. We have a property in Puerto Rico where the tenant performs extremely well. There are certain tax issues with doing business in Puerto Rico and if we could sell this property, I think we would be happy to do it.

By the same token, if we hold this property and maybe put it back into our investment portfolio, it's a great asset, it's well located and the tenant is doing very, very well. So at the margin, Greg, we made terrific progress in shrinking the sort of at risk portion of our TRS portfolio earlier in 2008. We did have a couple of Uni-Mart properties in there. Obviously, I wish we had sold them earlier, but we knew that the tenant was having difficulties. We elected to take them off the market and not sell them. Post Chapter 11 of Uni-Mart, I think we have already sold one of these properties just fine and two of them we've just recently impaired. So what you're probably going to see is our inventory portfolio steadily declining. We have a Walgreens in there right now, that's under letter of intent. We have a KeyBanc property, that's under letter of intent too. We will have to see if they close, they're still haven't past their inspection period. We are going to move that down slowly from here on out.

Thanks. Just finally in regards to the extension of the line, any change to the major terms and conditions, specifically your spread is it still around 65 over LIBOR?

There was no change to amy of the provisions in connection with the extension. Yes, we are still priced at LIBOR plus 65.

Great, thanks a lot.

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

Good afternoon, guys. Craig, can you talk maybe a little broadly about asset pricing and maybe differentiate between where you are at today, or where you are seeing today, I guess, on smaller one off deals versus larger portfolios and I guess if you are so bold, could you look into your crystal ball and maybe give us a sense where you think pricing inevitably settles on assets when this credit turmoil passes and when ever that happens.

Jeff, good afternoon. Cap rates are clearly trending higher and in the retail space it's probably being caused by any of a number of things. Deterioration in the retail environment number one. Number two, in the one off market, the 1031 market, there are clearly less buyers than there were before, so the demand for properties is down. But at the end of the day the biggest single factor is that buyers are struggling to get bank debt to close on their real estate's purchases. It's no different to this morning we all read that car sales in October were pitiful. Well, when people are used to buying automobiles on credit and they cannot get a bank loan to finance a car purchase, car sales go down. In our business it's exactly the same. If buyers of real estate cannot access debt, cap rates are going up. So if you take in the net lease space, the bell cow being the Walgreens, cap rates there are trending higher. We do have one of them under contract. So I don't want to jinx that too much.

There are more Walgreens on the market by a factor of three than there were on a normalized basis in 2006 or 2007, so there is a lot of inventory on the market. People that were developing Walgreens are suddenly going to find that they are truly not able to get a spread when they sell them. In terms of the crystal ball, that's where the banks control that. My sense is that bank lending is really not going to improve in the first couple of months into 2009, which means cap rates will probably trend even higher than where they are today. At a point in time it's going to settle out, banks will come back into the market and pricing will normalize. I don't believe that Walgreens are going to trade in the mid 6s or low 6s for a long period of time. But -- by the way, the credit spreads on their paper have also expanded.

So right now there is price discovery going on. There is a significant difference between the bid and the ask and really not a lot of deals are closing. And I just add one more thing that to -- for us all to be concerned about, a lot of these types of properties were purchased by highly leveraged, in highly leveraged transactions with five year interest only money. The second half of 2009, 2010, a lot of this paper is going to roll off and we need to have the banks come back to the table by that time.

I'm curious than to me when you look out and I guess as it relates to your 2009 guidance, do you think that your -- the acquisitions that you're baking into that guidance then you are going to back end maybe for that reason towards a time where maybe you can see more stress in the market? And I guess related to that, most of the acquisitions you've been doing in recent years have been at call it low 8 cap rates, do you think a year from now you will be in the 9s or 10s or still in the 8's?

In the most recent quarter, our average cap rate was at 9.35. I think the previous quarter was in the very high 8s, so clearly we are participating in this rising cap rate trend. We have a couple of properties in the very, very high 8's, but those are for tenants that have very good credit and there is very good real estate underlying it. Our cap rates in certainly for the next six months, all have a 9 in front of them.

I guess, Kevin, just a question also on your 2009 guidance, maybe this is sold into our occupancy assumption, but what sort of allowance are you making for bad debts in 2009?

We really blend those two things together and we have very little receivable outstanding so we are not staring at any kind of big receivable issues at the moment and so, but that's really blended into our occupancy rent number. We are not anticipating anything beyond what we've commented on.

Do you budget anything for incremental capital, was it, for the stores that just went vacant in Q3?

Absolutely, we assume property expenses, obviously, will rise in conjunction with losing rent on stores.

I'm thinking capital in and above maybe to release or induce releasing those stores.

In our business it's a very, very small amount. Here we are releasing some of the vacant Uni-Marts, by the way that process is going very well. And in almost every case we are releasing them as is with zero capital expenditures going in. Just to help somebody on another question, we do have two Circuit Cities that are on the store closure list, both of these are California based properties, one of them, both of them are well located. One is just off the five and the other one is at the right in the pin corner on a entrance to a [Akia] Home Depot anchored center. Those boxes are in the low 20,000 feet contiguous to one of these was a Home Depot expo. A big retail REIT purchased that property and split it up and re-leased the properties at rent nicely higher than we are currently getting from Circuit City. So there is a possibility we would have to put some TI into that if we were going to split it up. We would only split it up if we could get rents that made sense, otherwise we will be re-leasing a 20,000 foot box. But, Jeff, in terms of our total cash and Company, capital expenditure's very small dollars for us.

Thanks, guys.

Thank you. Our next question comes from the line of David Fick with Stifel Nicolaus. Please proceed with your question.

Good afternoon. Given the 150 bps quarter over quarter occupancy decline, I'm wondering if you could give us a bit more detail on tenants in terms of your top ten tenant exposure, as well as a bit more specificity on exactly what was in that 150 bps and what you expect over the next year in your '09 guidance.

David, a couple of different things. The most recent quarter all of that vacancy difference was Uni-Mart. So there was one tenant, which we talked about on the last call, and I hope you were all expecting. The re-leasing of those properties is going just fine, in fact here in this quarter a couple of them already re-leased. But going forward who knows where the vacancy is. Two, we learned just yesterday, two Circuit Cities. I think after Christmas there are going to be many store closings and, to be honest, one of the things that we are very focused on internally here is what is going to happen to some of these retailers on their bank covenants and whether that's going to cause a problem. It's hard to see where that is going to play out and where the problems are.

But in terms of our tenants, our two biggest tenants are convenient store operators, the single biggest one is the Pantry. I think they've pre-released -- their year-end is a September year-end. They've pre-released and essentially said if anything their margins are going to be higher than what the Street was expecting. As I mentioned convenient store margins in October were arguably the highest they ever had. Gasoline margins were running $0.40 plus a gallon verses a more normalized $0.10 to $0.12 a gallon. The Pantry, number one we have got excellent real estate and I hope your colleague who attended our investor day can attest to that. Secondly, their financial performance right now is just fine. And by the way, that goes for the convenient sector is one of the few categories in retail that is doing well. Our second biggest tenant is a very well managed public convenient store Company called [SUSSA].

Thus the holdings has the vast majority of their properties in Texas. The Texas economy, Texas retail is doing perhaps the best in the nation. SUSSA has also preannounced that they've met all the metrics that Wall Street is expecting. Both Kevin and myself and several others in our Company have met with the senior management at both of these companies recently and they are doing just fine. In fact, if we had opportunities to acquire more of their properties, we probably would. Cap rates today would be higher than what we obtained in the past. And then some of our other very biggest tenants are companies you know well, Best Buy, Sports Authority, CVS, and so forth.

What are you presuming in your '09 guidance again?

We are assuming 250 basis points of additional vacancy.

From here?

Yes.

It will be really great if you could start putting your top ten tenant exposure in your quarterlies as opposed to just your year-end. Thanks.

Just while we are waiting for the next question, one other thing for people to be aware of is that, as Kevin mentioned, our guidance for 2009 assumes very little gains in the TRS. If there is more debt available and we can move some of that product to prices that make sense we will be very pleased to outperform.

Thank you. Our next question comes from the line of Craig Kucera with BB&T Capital Markets. Please proceed with your question.

Yes, hi, I had a question about your -- how you look at underwriting now that the world appears to have changed over the last month or two. I know you mentioned that you're being a little bit more selective, but can you quantify that at all? Are you looking for sort of minimum cash flow coverage at this point in time?

Craig, we are focusing on the same things we always have. The first thing is what's the quality of that real estate location. If we ever have to release it, who is in that market, who would a tenant be, what are market rents in that market and then all the traditional demographic ingress, egress, traffic trap, et cetera, So the first thing we hang our hats on is real estate. And it just be very clear why that's so important. We sign very long-term leases, 15, 20 years. Over that time frame, it is inevitable that the tenants financial performance is going to change. Circuit City a couple of years was a great tenant. We are about to get two of those stores back and the good news is the real estate locations are both very good. One in Foothill Ranch, California and the other in east Palo Alto.

So real estate is the first thing we pay attention to. Secondly, we need to be very comfortable that our tenant can pay us rent. Not only do we need rent coverage, but we need to be very vigilant on what the balance sheet situation is for that particular tenant. I was just at lunch earlier today telling one of our bankers about a particular property that we are currently underwriting. It's a extremely well located property for a tenant that's doing just fine, but they have got too much debt coming due in the first half of 2009. And while the property is extremely well located, we don't need to take on that type of risk. That's a property we are passing on. That's illustrative of being selective. Now just to stay with it for one more second, the third point which is very, very important, is that we get to own these properties for a long period of time.

How we structure that transaction is really important. What information we require the tenant to send to us. In the case of Uni-Mart, we are very pleased that we did manage to have a letter of credit there. And as Kevin pointed out in his comments, we did draw $2.4 million of this letter of credit in the third quarter, which mitigates a healthy amount of our exposure bill. So, it is real estate, financial underwriting and then the terms and conditions in the lease.

Great, thank you. Thank you for the color. I also had a question, you guys have pushed down your payout ratio over the last several years in regard to the dividend and your revised guidance here looks like it is, excluding the convertible debt interest expense, more or less flat. Can you comment on the board's philosophy in regard to the dividend. Are they looking to kind of keep it towards what looks to be maybe approaching a floor or do you have any color there?

We haven't talked about next year's dividend, Craig, so I can't give you that color. But let me just add a couple of points. Firstly, regardless of what the noncash charges for that convert, our cash FFO, if you will, which in our case FFO and AFFO are approximately the same number, our guidance is a range of $1.88 to $1.98. So no matter where you peg in there, but just perhaps for simplicity peg the middle of that range, our -- at $1.50, it is a payout ratio of about 78%. So one thing I feel very comfortable with is that our dividend is extremely well covered at this point in time. And if we -- if the market has any level of normality in it in 2009, I am hopeful that our board will consider allowing National Retail Properties to have its 20th consecutive year of a dividend increase. Now just to make sure, I put in parentheses, I'm not committing to what the amount of that increase will be. But our dividend is well covered on a any metric you take a look at.

Fair enough. Thanks a lot.

(OPERATOR INSTRUCTIONS) Gentlemen, it appears there are no further questions. Do you have any closing comments?

Jen, thank you very much. We appreciate all of you paying attention, we know it's a busy season. We also look forward to seeing several of you in November in San Diego. Until then, have a great afternoon.

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