NNN REIT Inc (NNN) 2009 Q2 法說會逐字稿

Greetings, ladies and gentlemen and welcome to the National Retail Properties' second-quarter 2009 earnings call. At this time, all participants are in a listen-only mode. A 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, CEO for National Retail Properties. Thank you, Mr. Macnab. You may begin.

Thank you, Claudia. Good morning and welcome to our 2009 second-quarter earnings release call. With me on the call this morning is Kevin Habicht, our Chief Financial Officer, who will review financial details on what was another uneventful, but solid quarter for National Retail Properties.

Our fully diversified portfolio is 96.7% occupied, which suggests that our net lease retail assets are performing better than those of most commercial landlords. We own 999 properties, which are leased to over 200 different retailers all across the country.

A couple of attributes of our portfolio are worth noting. Firstly, the bulk of our tenants are selling value and necessity items, which consumers continue to purchase. We have very few retailers selling luxury items.

Secondly, our average property was purchased for in the range of $2.5 million and to the extent we need to release a property, there are many more prospective users for this small-sized property than there are for much larger retail assets. In addition, there continues to be a surprisingly active market for purchasing these smaller retail properties.

When we initially provided 2009 guidance, we anticipated a weaker business environment this year, including difficulties with a couple of our tenants. Thus far this year, our portfolio is performing as we had anticipated and our challenges are relatively isolated.

Where a tenant is not fulfilling their contractual obligations and paying our rent in a timely manner, we will aggressively pursue our remedies and towards the end of the second quarter, we were forced to evict such a tenant. This eviction occurred outside of Chapter 11 and we have engaged a leading third-party operator to manage this auto service business that we now own.

During the quarter, we made no new investments, but did complete the development funding on four properties. In the last several months, we have underwritten a couple of potential acquisition opportunities. However, we have not closed on any of those as we continue to be extremely selective.

Not many sale-leaseback transactions have occurred for retail portfolios this year for a variety of reasons, including a gap in pricing expectations between sellers and potential buyers. The bid/ask spread is narrowing and more importantly, I am enthused about the multiyear opportunity that we have ahead of us to cherry-pick quality acquisition opportunities as much of the fragmented competition that we have encountered over the last several years is no longer in business. Many of these types of companies are no longer operating as they are unable to access the high amounts of leverage that fuel their operating models.

While we may not have been active on the acquisition front, our team has done an exceptional job in controlling expenses, which continue to trend lower and Kevin will discuss that. In a moment, he will also provide additional financial detail, but I do want to emphasize that National Retail Properties continues to operate with one of the strongest balance sheets amongst publicly traded REITs.

As a reminder, our leverage is low, our fixed charge and interest coverages are both in excess of three times. We also have plenty of access to bank debt under our line of credit and with AFFO well in excess of FFO our dividend is well-covered. Kevin?

Thanks, Craig. Let me start with our normal cautionary language that we will make certain statements that may be considered to be forward-looking, statements under federal securities laws. The Company's actual future results may differ significantly from the matters discussed in those forward-looking statements and we might 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 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 out of the way, as indicated in the press release, we reported second-quarter 2009 FFO results totaling $36 million, or $0.45 per share, which was down from prior year's $0.48 per share, but flat with the immediately prior first quarter. The decline from prior year amounts was primarily related to a decline in TRS gain on sale, as well as lower interest and other income.

As was required beginning January 1 of '09, these results do include the new convertible debt accounting, which added $1.434 million of non-cash interest expense, reducing our FFO by $0.02 a share. We have included this in our non-cash items disclosures on page 5 of the press release, which also includes stock-based compensation, non-real estate depreciation and amortization.

Notably, the net sum of these non-cash items is $2.6 million for the second quarter, which equates to about $0.03 per share of additional operating cash flow above our reported GAAP earnings and FFO results. For the first half of 2009, these items totaled $0.07 per share.

Balance sheet remains in very good shape with no material debt maturities and $378 million available on our $400 million credit facility. Let me just quickly go through a few details on the second quarter, then some comments on '09 guidance and then we will take questions.

Looking at the income statement, total revenues for the second quarter increased to $58.7 million, driven by additional rent from new investments made over the past year and increased tenant expense reimbursements offset somewhat by lower interest and other income.

As Craig mentioned, there is little new investment in the second quarter, just $12 million of development funding in the core portfolio, completing a few existing build-to-suit development projects. Occupancy at June 30 was 96.7%. That was flat with the immediately prior quarter, but it is down 170 basis points from June 2008.

Interest and other income from real estate decreased to $980,000 in the second quarter, largely due to lower outstanding mortgage and notes receivable balances. That is down from $90 million a year ago to roughly $50 million this past quarter.

G&A expense was $5.8 million for the second quarter. That is down slightly from prior year. More notably though, first-half 2009 G&A is down 18% from first-half 2008, primarily due to cost-cutting and we see G&A coming in around $22 million, maybe a little less for the full year 2009. That would represent a 12% reduction from 2008.

Property expenses net of tenant reimbursements was a $1.234 million net expense in the second quarter. That is up about $300,000 from prior quarter amounts, but it is due to increased vacancies, but down $100,000 from prior quarter amounts.

Interest expense for the second quarter decreased slightly from prior year to $15.4 million and was flat with first-quarter '09 results. At quarter-end, $22 million, or 2% of our total liabilities was floating rate.

In the second quarter, we bought back $2.5 million of our 2028 convertible notes and we reported a $1 million gain in connection with that repurchase. The good news is the credit markets have improved significantly. The bad news is we won't be buying back more of our bonds, which have run up materially in price.

Also during the quarter, in connection with the eviction that Craig mentioned, the tenant from 12 of our properties in late June, we booked a $1 million impairment on two of those properties and a $1 million gain in connection with a note receivable with this tenant that resulted in us taking possession and ownership of that tenant's business and business assets.

During the second quarter, we reported the sale of three properties from our core investment portfolio. And they are reflected in the investment portfolio discops on page 7 that these sales generated net proceeds of $5.6 million and produced a $600,000 gain, which is not included in our FFO results. We also sold one property in our inventory portfolio from our taxable subsidiary with net proceeds of $502,000.

Looking at the balance sheet, we finished the quarter with total liabilities of $1.052 billion. That is down slightly from the prior quarter and year-end amounts. We only have $26 million of secured debt; 98% of our total assets are unencumbered. Our next material debt maturity is September 2011 and through open market repurchases, we have reduced that original note balance from $172.5 million to $138.7 million at quarter-end.

As of June 30, '09, total debt to total assets on a gross book basis was 37.4%. That is down slightly from prior quarter's 37.9%. As I mentioned, we have $22 million outstanding on our $400 million bank line and we have begun discussions to extend that bank line May 2010 maturity. The value obviously of maintaining balance sheet flexibility is always important, but more apparent in times like these and we believe we are in very good position. Interest coverage was 3.5 times for the second quarter; fixed charge coverage was 3.1 times for the quarter.

Moving on to 2009, we did lower just the top end of our 2009 FFO per share guidance of $0.05 from a range of $1.65 to $1.75 to a new range of $1.65 to $1.70. While there is essentially no change of note in our projections and assumptions, just some fine-tuning, we do remain cautious on our economic outlook, much as the periodic transactional type income that typically occurs took place in the first half of 2009, so our results are a little skewed to the first half of '09 versus the second half.

Also, I alluded to earlier, based on the non-cash items on page 5 of the press release for the year 2009, we see approximately $0.15 to $0.16 per share of non-cash items included in our FFO per share guidance, suggesting an AFFO type number that is meaningfully above FFO.

While the visibility on our guidance is a little less clear today than in prior years, we remain confident we are well-positioned to take advantage of the good opportunities in the future and believe our dividend is very secure.

In closing, as Craig mentioned, 2009 is proceeding as expected and besides working to make this our 20th consecutive year of increases in our annual dividend, the primary focus internally is to effectively manage any vacancies, control costs and get the bank credit facility term extended.

While it is not here yet, eventually, we are going to feel more comfortable being more offensive. I'm not sure we have quite reached that point in the cycle, but it appears to be not too far off. Looking out beyond this cycle though, we are very encouraged about what we believe will be a better environment for NNN than we have had in recent years, which have actually been pretty good years for us and we believe we will be well-positioned to capitalize on those opportunities. Craig?

Claudia, we would like to take any questions, please.

(Operator Instructions). RJ Milligan, Raymond James.

Good morning, guys. Craig, for the rest of the year, are you guys still looking for the 400-basis point decline in occupancy? Is that still part of the assumptions?

I think that, as I believe we have talked in the past, we were assuming an increase in vacancy, which essentially means lower rate. And so it is a combination of different things. It is a mix of properties. So for example, our Circuit City vacancies, those properties were much higher rent payers than for example a small 2500-foot convenience store. So there has been some of that. There has been a little bit of rent modification and so forth, all of which tends towards lower rental revenue. I think at the end of the day, it is in our numbers whether it is in the narrow count of that single number of occupancy or not, but the portfolio on the whole is doing fine.

So how much of that 400 basis points is already in the numbers and how much is an assumption going forward for the second half of the year if it is a combination of both rent and occupancy loss?

The second quarter is clearly going to be lower for a couple of different things -- rent modifications. There is some vacancy and then some of those one-time transactional items that Kevin referenced that we saw in the first half. But I think our year number is still going to be pretty solid.

Okay, great. Thanks, guys.

Dustin Pizzo, UBS.

Hi, thanks. Good morning, guys.

Dustin, congratulations on your new opportunity.

Thank you very much. The auto parts retailer you mentioned, Craig, should we expect to see any reduction in base rent there as you get the new operator in there? And as you're looking at that going forward, do you have a sense for what the new rent coverage will be on those properties?

That is clearly in our numbers. Maybe in response to RJ's question earlier, I should have referenced that as well. In the near term, we are actually operating this -- or the owner of this business. We have a third-party management group in there actually running it. I mean we don't have people here managing employees or a car auto service asset. This occurred right at the very, very end of the second quarter. And early indications are quite promising and we will be getting the difference between revenue and expenses as opposed to just getting rent. So it is going to show up in a different line item. We need that manager to execute and that business to expand.

In the scheme of things, one, it is in our numbers. We are having -- we have been having some difficulties with this tenant for several months and we were forced to evict him. That is unfortunately what happens.

Okay. So is that -- I guess just going back to RJ's question as well on the guidance -- is that the bulk of -- I mean if you look at the run rate between the second quarter to get to the midpoint of the full-year guidance, it looks like the numbers need to fall about, call it, 14% or so. So is that where the bulk of the decline is coming from?

It is a part of it. It is not the bulk, but just for round numbers, just assume it is picking up half of it.

Okay. And then were there any lease termination fees in the second quarter?

In the second quarter, we did have some, yes.

Yes, we did. We had $2.190 million and that was -- we're calling lease termination. It is really part of the rent settlement on the Uni-Mart properties that we were able to really accelerate, if you will, collection of rent via that letter of credit we had in place.

Okay. And then just finally on the guidance, are there any equity offerings that you are assuming in the guidance going forward?

No, sir.

Okay, thank you, guys.

By the same token, we also don't have any new rental revenue from much acquisitions that will show up in 2009. Very little transactional activity is in our guidance.

David Fick, Stifel Nicolaus.

Good morning. I have this beautiful picture of you with brake dust and grease on your hands.

You always knew I was the kind of person with dirty fingernails.

Absolutely. Can you just tell us -- I think the question was asked, but I didn't hear the answer -- what the rent coverage is, EBITDA rent coverage is in that business based on your prior rents, in-place rents?

Well, the last couple of months, Dave, they weren't paying rent, so their rent coverage is close to zero on that one in the last couple of months. Unfortunately, this tenant diversified into some other business areas. Some of those investments were just unfortunately unsuccessful and created a lot of financial problems at this company. Operations deteriorated in the first part of the year and we have now evicted them and we are operating that business. At this point in time, I cannot specifically answer that because I just don't have the data in hand.

Can you tell us what the percentage of your rents this represented?

David, we are not going to go into that, but it is -- in the scheme of things, I mean it is -- let me put it to you this way. Over the next couple of quarters, we are going to be disclosing the operations of this tenant or revenue and expenses and so forth and it is too early to tell. But like everybody else, I am hopeful that it is going to improve in terms of performance. As I mentioned though, the first couple of weeks are going quite nicely.

Okay. And I understand that you are just getting your arms around it. Can you give us an idea of when this was originated, this transaction, this acquisition?

More than a year ago.

More than five years ago or more than a year ago?

More than a year ago, less than five.

All right. Your last increase was, in dividend, was April '08 and you referenced dividend and coverage and so forth. Can you -- part of your franchise has been a track record of dividend growth. Some idea on policy going forward?

Dave, in the near term, and clearly higher dividends are a part of us. As Kevin mentioned, we expect this year, calendar 2009, to be our 20th consecutive year of growing dividends. Our AFFO is well in excess of the dividend, as is FFO. I think that the increase this year is going to be modest at best. However, our Board will only take that discussion up in the next couple of months.

Okay. But we do expect something, if it is up to management, by the end of the year?

Well, just arithmetically given where we raised our dividend in calendar 2008, just arithmetically, there is a slight increment in our dividend in 2009, even if we do nothing.

Okay. I guess we will give you the math there, but you didn't actually increase it this year without a $0.01 or $0.02 between now and year-end, but okay, that is fine. Thank you.

Correct. And that is a subtle distinction, but the dividend, I believe, will be higher in 2009 that it was in 2008.

Well, you are already there, but --.

Correct.

That is different from a decision to grow it, but thank you.

That is correct and our Board hasn't addressed that yet.

All right. Thanks.

(Operator Instructions). Michael Bilerman, Citigroup.

Good morning, Craig. [Greg Joyce] is on the phone with me as well. If we go back to just the income that you have in place, you go back to your press release, you talked about $211 million of annualized base rent. At the end of the first quarter, you were at $221 million, so about a $10 million drop on an annualized basis. The automotive service industry dropped about 340 basis points, or about $7.5 million. Can we make the assumption then that, out of that $10 million drop sequentially, 75% of it was this one tenant?

Sorry. Repeat that very last question?

You had $211 million of annualized base rent at the end of June, which I assume already excludes the tenant that you took over with.

Right.

At the end of the first quarter, you had $221 million in annualized base rents. I assume that included the tenant. Even though I guess he wasn't paying rent, you had him there as his lease. So you had this big drop-off sequentially, about $10 million on an annualized basis in terms of just your base rent. Even though occupancy stayed flat, you had a $10 million reduction. Looking at your sector list, automotive services dropped from 8.9% of revenues down to 5.5%. I am making the assumption that that 340 basis point drop was all related to this one tenant that you took over from.

I mean I think that your analysis is directionally accurate. And the change in the number from the first to the second quarter is a function of a couple of different things -- this one particular tenant, some rent modifications, some lower releasing spreads on some of the vacancies and a combination of different things. But in general, your statement is directionally accurate.

And maybe if you can just, in terms of how widespread are some of these other activities in terms of the rent relief that you are giving, in terms of the lower rents and how are you restructuring these leases, are you able to get anything back and had that been going on prior to this quarter in terms of affecting your top line?

I think it is very, very isolated, which is a good thing. We continue to have some tenants, which I think applies to retail in general, they need consumption to expand. To the extent we modify a lease, we are definitely getting things back, including a kick-out option and so forth. We have not done it in widespread terms, but there are -- there was one additional tenant in the second quarter and right now, it is too early to tell, but I believe there will be one additional tenant in the third quarter.

And can you -- Kevin, I think you talked about $2.2 million of lease term fees. If memory serves, you had almost $2.8 million in the first quarter, so about $5 million year-to-date.

That's correct, $4.9 million, correct.

Can you just give a little bit more granularity as to what sort of rents were tied to those lease terms?

The bulk of that, virtually all of second quarter and a good piece of -- a very large piece of second quarter, which makes the vast majority of the first-half lease termination fees really were probably better labeled rent settlement, if you will, coming out of the you Uni-Mart letter of credit that we had. And as that worked through the bankruptcy process, we were able to draw upon that letter of credit for our damages, if you will. So we really weren't terminating leases so much as just drawing on that LC.

And all that is being booked into rental revenues?

Correct. It really advanced, accelerated I should say, rent payments.

And how much of that is in the back half of the year or is that effectively done at this point?

It is largely done. That is what I was alluding to in my comments and Craig's that first-half transactional -- I mean we get a fair amount of lease term kinds of fees throughout the year typically in a typical year. This year, it is more first-half loaded than second half and so it is going to be very little second half.

And that is out of -- when you show your annualized base rent, that $211 million, those lease term fees are excluded from that, correct?

Correct. Correct.

And then what is happening -- so I guess if you back out lease term fees out of first quarter and second quarter, the rental revenues actually went up sequentially. Is there anything else going on because it would appear that it should be going down?

Well, I think there is some just contractual increases, rent bumps, CPI-based rent bumps, etc.

Rent from acquisitions in prior periods.

Did most of this --?

Timing from acquisitions in 2008 being full rent payers in 2009.

I am just looking 1Q '09 to 2Q '09, but this $10 million drop in the annualized base rents, it sounds like most of that occurred towards the end of the quarter? That if your average rental income over each quarter was higher effectively.

I am not sure I can go there, but I mean, as Craig said, directionally you're right and there was a variety of things from this California auto service tenant to other tenants to other modifications to vacancies, the kitchen sink is in that number.

And the likelihood is you are going to make some income potentially, right? As you remove the tenant lease payment, you have the operations and if not 7 going to 0, it is seven probably going to, I don't know, 3.5.

It is really too soon to tell what that number will be, but --.

But we are expecting there to be a spread, yes, very definitely.

I mean is 50% reasonable? I mean because there is something --.

I mean initially there are expenses that have got to go against it with this new third-party manager, etc., etc., but over time, it should grow quite nicely.

Okay, I think Greg also has a question.

Hi, guys. Just one on development funding. How much less do you still have in terms of development?

A total of $11 million left.

And most of that is the big-box?

No, it is a variety. It is spread over 10, 11 projects. It is fairly small and it is -- most of it is in our core portfolio. I think it is just $1 million of that is in our TRS and the balance is in our core portfolio.

Okay, thanks.

Andrew DiZio, Janney Montgomery Scott.

Hi, good morning, guys. A couple of quick questions for you. First, with respect to the acquisitions that you guys have been taking a look at and underwriting, can you give us an example of kind of where they are coming up short from your criteria? Is it more pricing or quality or a combination?

It is really a combination. I think, earlier this year, we had some pricing differences. Those have narrowed. We've most recently took a look at a small portfolio of properties, maybe $20 million. We frankly felt that while the credit was more than fine, we felt that some of the real estate was in tertiary markets and that just didn't meet our underwriting criteria. But the short answer is it is a combination of all of the above.

Okay, thanks. And then, Kevin, the straight-line rent number for this quarter, is that a pretty clean number?

It is a little bit high and it will even out, if you will, over the course of the year, but it is a hair high from probably normal run rate.

Okay, thanks. That's all from me.

Jeff Donnelly, Wells Fargo.

Good morning, guys. The fixation of late have been on, I guess, the challenge among restaurants or auto-oriented retailers or leisure-oriented uses. As you think about acquisitions, what are some of the broader categories you might prefer to actually stay away from in the near future that you think will be continuing to face pressure?

I think the area that is the most under duress is consumer durables. So auto retailers have clearly really, really struggled. Fortunately, we have very little exposure there and to the extent we do, they tend to be in one national publicly traded auto retailers and fortunately the brands are generally the imports, which are doing well. But we do have little exposure.

The other area in consumer durables that is a challenge is furniture. Weakened housing markets, weakened furniture sales are directly related and I think I have seen some numbers that said, in the second half of 2008, furniture sales are down as much as 40%. At that level, some of these stores are struggling to cover their fixed costs, let alone make any money. So that is -- those are areas where we just don't see any opportunities at all.

Restaurants, number one, there are too many restaurants in this country. What is going to happen is a lot of the family-owned restaurants are just struggling and they are going to go out of business. The chains continue to do well. Quick service restaurants are -- as people are migrating to lower price points -- are doing very, very nicely. I would anticipate there will be some opportunities in that area. The high-end steak restaurants continue to report very weak numbers. That is a category that we will probably stay away from.

And just one last question is, thus far this year, there has been somewhat of a minor recovery, I guess I'd say, in real estate lending activity, certainly compared to the start of the year. Has there been much improvement in secured net lease financing as the year has moved on? And can you give us some sense of where -- I know every deal is different, but the spreads or debt service coverage or LTVs are today? I'm trying to understand where the pressure points are for the private investor out there.

The pressure points are getting the bank financing, so it is getting debt to finance real estate purchases. And while the big banks look like they are coming back into the market, we are certainly seeing that as we are in the early stages of our discussions about redoing our credit facility, which I think Kevin mentioned is going quite well. But I think secured debt for small real estate transactions is difficult. There is not nearly as much capital available for that as there was a year ago.

Having said that, smaller transaction size sales, which is defined in our terminology less than $4 million, and then when you get down below $2.5 million the market widens again, you are still seeing some activity there. If people take the time to go to our NNN 1031, which is where we have data on the properties we are selling, you will see that cap rates continue to be very, very low for one-off transactions, particularly where the dollar size is in the lower amounts, $1.5 million or less.

Great. Thank you, guys.

(Operator Instructions). David Fick, Stifel Nicolaus.

Yes, Craig, a couple. On your last comment regarding your NNN website, that is the ask. Wouldn't you today have to substantially adjust, given that the 1031 market isn't finding flows of capital out of tax-oriented transactions?

Dave, that is a fair comment, but it is really surprising to me, some of the cap rates, the closing cap rates on some of these restaurant properties that we have been selling, some for our own account and some for one or two other third parties, that we have been selling some ground lease properties at really unbelievably low cap rates, closing sub 6.5%.

How much did you close in the last quarter?

I don't know what the dollar amount was, but there were probably eight or nine in that range transactions.

Great. Okay. Did you settle with this auto service operator or is there still a potential claim that will work its way through the courts and would you take back financing on a sale of this business?

The first answer -- the first question, I hope it is completely behind us, David. But who knows what happens. But I do believe it is completely behind us. And in terms of the second one, we do very definitely expect to sell this business for an amount in excess of what we have in it. I need to be careful there with regard to all disclosure liability. When the time comes to sell it, which I don't expect to be in the next six or nine months, we will be negotiating as hard as we can at that point in time.

All of the units are in California?

Yes, sir.

Thank you.

Gentlemen, we have no further questions at this time. I would like to turn the floor back over to management for any closing comments.

Claudia, thanks very much. We appreciate your interest and we look forward to talking to you in the next couple of months. Thanks very much.

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