Craig Macnab - CEO.
Kevin Habicht – CFO.
Jonathan Litt - Citigroup
David Fick - Stifel Nicolaus
Jeff Donnelly - Wachovia Securities
Dustin Pizzo - Banc of America Securities
Stephanie Krewson - Janney Montgomery Scott
National Retail Properties Inc. (NNN) Q407 Earnings Call February 4, 2008 2:00 PM ET
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.
Craig Macnab - CEO
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 tenant supplying range and performance is 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 rollover in 2008. A high level of property 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 tents are both profitable, publicly traded convenience store chains, namely the pantry and successor. At the corporate level the range coverage from both of these tenants is excellent. In the case of the pantry, rent coverage for the most recent 12 months was just over four times, and while I am not probe today in the details, but I can tell you that NNNs portfolio includes many of their higher performance tools including multiple properties that we earn in and around Charlotte, North Carolina.
Successor has recently completed a significant acquisition of a regional Texas-based chain, and if we use their pro forma numbers following this acquisition, the corporate level range coverage is 3.9 times. We’re 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 than convenient store operators Mikewell have their bags to the widened.
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 date ratings.
In terms of acquisitions, in the fourth quarter we acquired a $146 million of properties for our portfolio, an average GAAP rates of 8.62%. In 2007, our team did a superb job investing $867 million with most of this money going to our investment portfolio, with lesser amounts for properties purchase for resale, as well as investments in our development subsidiary.
In addition, we established a joint venture exclusively to acquired convenience stores and acquire 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 and 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 and 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 an average cap rate in the low 7s, 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 activities in the fourth quarter were a good example of improving our portfolio as our in-house 10/31 experts sold a couple of properties that have short term, 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 will now hand over to Kevin.
Kevin Habicht – Chief Financial Officer
Thank you, Craig. Let me start of with our cautionary statement that we are 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 in the company's filings with the SEC and in 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 totalling $32.15 million or $0.45 per share representing a 2.2% decrease from '06 at $0.46 per share. This was inline with our guidance and the street consensus.
Stripping out from 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 a $1.87 that’s up 12% from a $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're very pleased with these results. Accretive acquisitions, capital recycling and improved operating expense margins are all contributing to another very successful year. The results were at the high end of our guidance of 184 to 187 we gave on our last call. And notably 2007's 12% FFO growth followed 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 in our 2008 guidance by obtaining on those line items of the range by $1.94 to $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 and $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 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, and lastly pre-taxed, pre-overhead gains in 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.
I just want to go quickly through some of the details for the fourth quarter and we will 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 of capital recycling from dispositions.
Acquisitions in the core portfolio totaled a $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 full year-end was 98.3% that’s up 10 basis points from the immediately prior quarter and from a year ago.
On page 5 of our press release, includes some additional disclosure regarding contingent percentage rent, straight-line rent, and capital leased earned income for your information.
Also I note that during the fourth quarter we recorded $110,000 of lease termination fee income all that from continuing rent, and that compares with 3 million of lease termination fee income and a million 10 in the fourth quarter of 2006, again all in continuing out.
Interest and other incomes in real estate transactions that increased to $1.6 million in the fourth quarter of ‘07 from $600,000 to fourth quarter of ’06, largely due to increased mortgage and mezzanine loans, 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 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 assets line item that was 1.4 million for the fourth quarter, that is 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 a total of 4.5 million for this line item in 2008.
Just as 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 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 9 of the press release. I 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 10 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 is $24 million. It’s important to note here that we are seeing meaningful operational leverage efficiencies as G&A for 2007 was 12.9% of NOI as compared to 17.4% for 2006. And 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 look at 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 was $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 a $129.8 million outstanding on our bank line and that's out of our total liabilities of $1,130 billion.
We also reported the sale of 10 properties from our core investment portfolio during the fourth quarter, and that's reflected in the investment portfolio discontinued operations on page 7 in the press release. This capital recycling generated net proceeds of $31.4 million and produced a gain of $9.8million, and for the year as we mentioned, total core portfolio disposition totaled a $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 create meaningful value.
We think this capital recycling activity helps improve the quality of our portfolio demonstrating embedded value in the portfolio and supplies of capital for accretive acquisitions as we sell at retail prices and buy wholesale.
Looking at discontinued operations, this relates to our inventory properties, our TRS properties. We sold a total of five properties from our TRS with net proceeds of $12.1 million. Three of the five properties were from our development unit and two were from our 10/31 exchange unit. For the quarter, we had total pre-tax, pre-overhead gain on sale from our TRS was $1.8 million a gain on sale and that compares with $2.4 million for the fourth quarter of '06.
For the year pre-tax, pre-overhead TRS gains for '07 were $11 million, that compares with $9.7 in '06 and again as I mentioned we anticipate similar amount in '08, as what we had in '07 meaning $10 to $11 million dollars of pre-tax gains from the TRS.
Moving to the balance sheet, we finished the fourth quarter with total liabilities of $1,130 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 $4 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 '07. As of year-end '07, total debts and total assets on a gross book basis was 42.5% that's up slightly from 40.6% the prior year and down slightly from mainly preceding third quarters 43.2%.
On a market GAAP basis leverage was 38.6%. Again the value of maintaining balance sheet flexibility is more apparent in times like these, and we believe we are in 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.
Our final thoughts I guess, just with FFO per share growth of 12% in ‘07, 6% dividend increase which was the 18 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 portfolios and balance sheet is in very good shape and we are optimistic, we’re going to be able to continue delivering incremental per share results as we create value through targeted acquisitions, developments, and dispositions.
With that, I think we will ask for questions.
Our first question comes from the line of Jonathan Litt with Citigroup. Please go ahead with your question.
Hi, it’s Greg (Srivastava) here with John. Could you comment on how you plan to fund these 300-400 million of acquisition obviously this year?
Greg, we are looking at a variety of different portfolios. There are multiple opportunities out there in the market place and with carefully underwriting all of these, we are finding some good opportunities and we are yet to close most of these deal, and we will have to see what we close.
Do you have any sense on the timing for possible refinancing?
I think if we are planning to do 300 to 400 million first quarter price and we see today should be just pick a percent, divide that number by four. There are couples of other deals that we are looking at right now, and at this stage, it's premature to say whether any of them will fall into the first quarter.
I think, if you look at our disposition for the year, which we mentioned were about 80 million from the core portfolio, if you layer in this net disposition, if you well from our TRS which will continue to see good activity there and selling those properties, I think it will be a net seller of properties in that entity, we looked at the moment to the tune of $50 to 70 million, we have about $40 million of retained earnings. So all of those things are somewhat self funding of acquisition, 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….
Great, if I could just – if we think about the balance sheet capacity, you have about 300-400 million, but currently set 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, because near term given where LIBOR is, there is going to be benefit from keeping a balance down the line?
I think one of the things that we tried very hard to do is make sure, we got choices. There is no doubt about it, the spreads of 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 things, that we spend a great deal of time talking about internally and will continue to execute always to make sure we have access to a variety of different types of capital. So we are currently borrowing under our bank facility and we will see what happens based on our needs for capital as the year rolls out.
And then Craig, just one more on tenants credit. Do you have any specific tenant concerns given the fullback we seen in the economy?
Greg, I don’t think so. Right now we're paying a great deal of attention to which there is 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, #1. And #2, 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, on the defensive attributes of convenience stores. And, 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 cost of crude comes down and margins expand which of course is good for us from a credit standpoint. But right now our portfolio's is in pretty good shape.
Are you looking at any more restaurant deal?
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 'cause 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 our 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'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 price and yields? And how comfortable are you with the convenient stores growing as an element in a percentage of your assets under control?
Yeah. In the near term most of the convenient store fields 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 convenient store joint venture when it’s fully funded. First we'll also add small amounts of convenient 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 convenient 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 bucks segment or the – to say best buy Home Depot those type assets?
Yeah. 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've mentioned with new leases, we're not able to get those kinds of yields.
Well, it would seem 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?
Well, David, we're looking at, if you take a look in our press release. Just can we do that right now.
And we’ll -- I think everybody's 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, it has been reasonable for you to do over the last few years. But you're now getting to the point where a pretty big portion is coming from credit that is not strong as historically it had been?
There is no doubt about it. The credit on some the deals we are doing today are not as good as Walgreen's credit, there is no doubt about that. But 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 a, 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 I am barking up the same tree, but I am curious. Are you guys seeing opportunities or increasing number of opportunities to help, I guess, of helping distressed retailers, or retailers out there who are having difficulty obtaining credit or refinancing loans, and I guess are extended beyond retailers into restaurants and other services too?
See, 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 bid in single-digit type yields, today that paper is no longer available. So as they value sale/lease backs, it is so much more attractive for them, and that there are just a lot of deals in the marketplace right now. Some of these deals are from companies that have not considered sale/lease backs in the last 12 or even 24 months. It is just a lot of product in the market right now.
Does that tell you though, that maybe you should be sitting back on the sidelines and waiting. You know, I think I asked you this in the last quarter as well, because if the financing markets are tough right now, and I am guessing there are not a lot of well-capitalized buyers out there, are you better off to sit back on the sidelines and maybe have a little stress on the asset pricing, rather than just diving right in?
Let me tell you what we are doing. The first thing we are doing, is we are underwriting to current levels of retail performance, number. #2, we are cherry-picking from most of 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 are getting. Just getting higher yields does not make a deal more attractive.
Just one last set of questions, can you talk a little bit about what has been happening with the spreads between initial cash yields and borrowing spreads in the last few months, and what sort of returns do you think investors are underwriting today?
What type of investors, Jeff?
What type of total returns investors are underwriting today, on MetLife?
What we are 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% of that numbers.
Do you think that is where the market is?
I think that is probably better than where the market is. We are selling some properties right now, at prices that the total return will be unleveraged 7.5 to 8 in the quarter.
And just one last question and I am curious, if the transaction market, while there is a lot of product out there, it appears to have slowed. What impact can that have on your ability to either acquire into assets in ‘08, do you think -- there some reasonable risk of either lower earnings contribution, whether it is you guys or some of your competitors, from that activity or just a risk of a longer hold period, any result on that?
You know, I think you are overstating the fact that there is lots of product in the market. I think one of the most important things is what I said earlier, that companies such as Natural Retail Properties, and you cover another one that is very similar, we are both in terrific shape right now. We have had good balance sheets, and we are cash buyers. The difference as we look at the competitive market place is that one year ago, 15 months ago, somebody who just could articulate a couple of sentences consecutively, could borrow money to do whatever deals and get a great return. Today being a cash buyer are just far more opportunities and to be honest the quality of some of these deals is very, very good. You know, one of reasons in my opening comments I talked about the rent coverage of our two bigger tenants both of which are around four times rent coverage of the last 12 months pro forma numbers. That’s a pretty safe deal, it’s based I can tell, and if we didn’t get un-leveraged 10% type returns from those, I think it beats most of the other deals that companies in your coverage ratio, coverage portfolio we are getting.
Great. Thanks guys.
Our next question comes from the line of Dustin Pizzo with Banc of America Securities. Please go ahead with your question.
Hi this is (Inaudible) with Dustin Pizzo. I want to 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 on the tip of my tongue. I don’t have that.
Okay. Also do you have any concerns about your portfolio on a regional basis?
No, I don’t think so. You know, different parts of the economy are performing slightly different Sydney, 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 a lot better than some of the other states. Florida is a big state for us. Texas is another big state for us. Retailers in Texas are continuing to do quite well.
Alright, thank you.
(Operator Instructions). Our next question comes from the line of Stephanie Krewson with Janney Montgomery Scott. Please go ahead with your question.
Hi guys. 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 progress?
We had about 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 are not breaking that out?
That was 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?
Doug, 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 are positioned in 2008. Our balance sheet is 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 and we will be talking to you all soon.
Ladies and gentlemen, this does conclude today's teleconference. Thank you for you participation. You may disconnect your lines at this time.
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