National Retail Properties, Inc. Q4 2009 Earnings Call Transcript

| About: National Retail (NNN)
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National Retail Properties, Inc. (NYSE:NNN) Q4 2009 Earnings Call February 5, 2010 10:30 AM ET


Craig Macnab - CEO

Kevin Habicht - CFO


RJ Milligan - Raymond James and Associates

Greg Schweitzer - Citigroup

Jeffrey Donnelly - Wells Fargo


Greetings, and welcome to the National Retail Properties Year End Earnings 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, Craig Macnab, CEO for National Retail Properties. Thank you, Mr. Macnab. You may now begin.

Craig Macnab

Jackie, thank you very much and good morning and welcome to our 2009 year end earnings release call. On this call with me this morning is Kevin Habicht, our Chief Financial Officer, who will review details of our fourth quarter and our year end financial results following my brief opening comments.

In 2009, we hit a milestone that we are very proud of where we're in for the 20th consecutive year we raised our cash dividend. This puts NNN in illustrious company, as there are only about 156 public companies that have consistently raised their dividend for 20 years.

As of the end of the year our portfolio was 96.4% leased and again this year we have very limited lease roll over. By the way for those of you that keep track of this data, we've remained at least 96% leased for the last seven years.

At this time, we currently own 1015 properties leased over 200 different national or regional tenants in 44 states. Our tenants operate in over 13 different segments of the retail industry, which we feel provides us with very broad diversification. Finally, on average, these tenants are contractually obligated to pay us rent for the next 12 years.

In terms of acquisitions, 2009 was a quiet year for NNN, as we acquired eight properties for $38.9 million at an average cap rate of 9.69%. Our disposition activity was also modest, as we sold 11 properties for 21.9 million at about an 8% cap rate.

For your information, the market for investment properties has recently improved, such that Walgreens, which is the bell cow in our net leased retail sector, are again closing in the mid 7% range in better locations. This is obviously a far cry from the mid 6% cap rates that were prevalent at the top of the market, but less than the 8% closing cap rates for Walgreens that we saw just a few months ago.

On the acquisition side, there have not been many opportunities that have passed through our rigorous underwriting process. At this time, we're of course focused on the ability of the tenant to pay the rent, but we're also being disciplined in the price per square foot that we are willing to pay for our acquisitions. An example of this was that in the fourth quarter our purchase of properties from a well-known national restaurant operator were at a very small premium of what the land alone is worth. As you can imagine, we like to start the risk award and it's a great example of the type of opportunities that our team will uncover when capital is less plentiful than it has been.

We continue to be very selective as we evaluate acquisitions. However, our pipeline is looking a little better than it has been for the last several months, and the quality of these acquisition opportunities remains attractive. As we look at the future, I like the way we are positioned. Our portfolio is in good shape. Our balance sheet is very strong, which will allow us to take advantage of the carefully underwritten acquisitions that we hope to make this year.


Kevin Habicht

Thanks, Craig. Let me start off by with our cautionary statements that we'll make certain statements that may be considered to be forward-looking statements under federal securities law. And 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 those forward-looking statements to reflect changes after the statements were made.

Factors and risks that could cause actual results to differ materially from our 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, a quick summary to start. First, FFO per share excluding just the non-cash impairments was $0.36 for the fourth quarter and $1.65 for the year 2009 which is at the bottom of our '09 FFO guidance range. Second, the 2010 FFO per share guidance range of $1.51 to $1.58 is unchanged. And third, as Craig alluded to you, there is little activity in the fourth quarter but our occupancy is holding up well and the balance sheet is in great shape which positions us well to capture acquisition opportunities.

With that, let me go me into a few details, as indicated in the press release, we reported fourth quarter 2009 FFO results which again excluding just the non-cash impairments totaled $0.36 for the quarter and $1.65 for the year, which was at the bottom of our $1.65 to $1.70 guidance range.

We also reported a recurring FFO metric this quarter, which not only eliminates the non-cash impairment charges but also three other items: One, a $3.4 million gain on debt buyback; secondly, a small $581,000 gain on sale of our TRS inventory property; and lastly, $731,000 of restructuring charge that we took in the first quarter related to downsizing in first quarter '09.

The recurring FFO per share for the year was $1.61 per share and $0.36 for the fourth quarter. A reconciliation of these amounts are on page six of the press release. Also on page six, we have as usual provided additional disclosure on other non-cash income statement amounts, which includes $1,476,000 of non-cash convertible debt, interest expense during the fourth quarter and 5.8 million of that for the year.

Incorporating these non-cash amounts into the analysis produces recurring AFFO type of number of approximately $0.39 for the fourth quarter and $1.70 per share for the year, which solidly covers our $1.50 per share annual dividend.

Many of the income statement line items are very consistent with the prior quarter, as you'll note, and consistent with expectations, so I'm not going to through them in great detail. Occupancy, as Craig said, was 96.4% up 10 basis points from prior quarter levels. And the fundamentals of our portfolio and the company are performing well, in particular, in light of the economic environment.

Some comments on the impairment charges taken during the fourth quarter. As the markets began to stabilize a bit, and as we approached planning for 2010 and beyond, we undertook an aggressive review of our portfolio, and sized up our best estimate of what the future holds and our plan for individual assets. As we did this, we ended up with a couple of buckets, if you will, with a handful of assets that require impairment charges as we marked them to market. One of those buckets were assets that change classification from held for investment or held for sale and the change in that classification require an impairment analysis to be done.

As we evaluated our portfolio and plans, there were some properties that we changed classification from held for investment to held for sale, meaning we weren't or inclined to own those properties going forward. (inaudible) as there were some properties held for sale that we had no real reason to sell for those prices and we are more than comfortable owning them for the long-term.

We also took an impairment charge on a handful of land parcels that we owned in our TRS that we mark-to-market, and there are the few other miscellaneous properties that there were some change across the reevaluation. But at the end of the day the total for all of these buckets, if you will, amounted to $33.4 million impairment involving 24 of our over 1000 properties in our portfolio.

Additionally, in connection with us taking over the business of the 12 California auto service properties in second quarter of ’09, based on a preliminary valuation we booked goodwill in the second quarter of ‘09. While the performance of the stores continues to improve, we did write-down the previously reported goodwill by $8.2 million to better reflect the market value at the time we took ownership.

Our press release today, I will note, reports that that business produced $676,000 of income in the fourth quarter versus a $233,000 loss in the immediately prior third quarter. Lastly, we had $498,000 impairment on the commercial mortgage residual interest and that was based on our most recent third-party quarterly valuation. As we’ve mentioned in the past, despite some of the accounting noise associated with this investment, it’s been very successful generating 29 million of cash distributions to us from our $9.4 million investment four and half years ago. So in total non-cash impairment charges totaled $42.2 million in the fourth quarter related to 24 properties, the write-down of the previously recorded goodwill, as well as the mortgage residual interest valuation. We’ll note that 6.4 million of that impairment amount is reported in discontinued ops.

Moving onto our 2010 guidance, as I mentioned we did not make any change to our prior 2010 FFO per share guidance of $1.51 to $1.58. Adjusting for other non-cash items, we estimate would add approximately $0.13 per share of additional operating cash flow above our reported FFO results for the year. None of the primary assumptions in our guidance has changed the more notable ones being $170 million of acquisitions skewed somewhat to the second half of the year, $15 million of dispositions, G&A expense just under $23 million, no real change in occupancy, and $3.6 million of mortgage residual interest income and no TRS gain on sale.

Additionally, we are not projecting any lease termination fees or gains from debt repurchases that we’ve had in 2009. And as I mentioned last quarter that is the most notable change from 2009 results to 2010 projections is that we anticipate lower transactional income in 2010. Specifically, we are projecting zero lease termination fees and zero debt buyback gains in 2010 versus the $11.2 million we reported for these two line items in 2009. That translates to about $0.13 per share of swing. Plus there is an additional 4% of weighted average shares outstanding in 2010, which cost us about $0.06 per share. So while the core portfolio and operations are performing fine and our strong balance sheet and lower leverage positions us well for what may come, our guidance reflects lower transactional income and higher share count that will dampen per share results but produce higher quality earnings.

Craig alluded to, our balance sheet remains in very good shape with no material debt maturities until September 2011 and with all $400 million available on our bank credit facility. Again while this low leverage is a drag on per share results, these strong credit metrics position us well to maintain good access to capital and/or macroeconomic weakness and take advantage of attractive acquisition opportunities that arise, with no floating rate debt and 98% of our properties are unencumbered. We finished the year with total liabilities of $1.24 billion of total liabilities; that’s down $56 million from prior year-end amounts. Total debt to total assets on a gross book basis was 36.8% and that’s down from 38.5% at year-end 2008. Debt-to-EBITDA is 4.8 times at year-end 2009.

We previously announced during the fourth quarter that we closed on a new $400 million unsecured credit facility that matures November 2012 and provide us the option to extend maturity to November 2013 at our sole option, and we are very pleased with this new facility and believe it demonstrates the strength of our business and strong credit metrics. We have no amounts outstanding on that credit facility today. Interest coverage for the fourth quarter was 3.2 times and 3.3 times for the year 2009, fixed charge coverage was 2.9 times for the quarter and 3.0 or the year.

So in conclusion, I mean we’re very pleased with how the company is positioned and believe there will be good opportunities in 2010. We’re staying focused on managing the assets we own, maintaining occupancy, controlling cost, and looking to capitalize on solid opportunities to be more offensive.

With that, Jackie, I think we’ll open it up for questions.

Question-and-Answer Session


Thank you. We will now be conducting a question and answer session. (Operator Instructions). Thank you. Our first question is coming from RJ Milligan of Raymond James and Associates.

RJ Milligan - Raymond James and Associates

Craig, about a year ago a lot of people thought the acquisition market and the opportunities would be pretty robust in the net lease space. It was just a matter of time for the buyers and sellers to find that right price. Have you kind of changed that optimism in terms do you still think those opportunities will be there once that pricing is done or do you think it will be more of a trickle over the next year or two?

Craig Macnab

That’s a important question and a good question. I think that couple of things. Number one, our guidance for this year is a $170 million of acquisitions weighted towards the second half of this year and obviously when you put together projections, you’ve got to make your best estimates. I personally hope that we can do better than that but for all this to happen a couple of things need to occur for: Number one, the buyers and sellers need to agree on prices. There’s been a lot of volatility around that. Just a couple of weeks ago, Walgreens were closing at better than 8%. As people have felt more comfortable about real estate prices stabilizing, today you’re seeing good locations for Walgreens closing at 7.5%. So, sellers continue to hope that pricing reverts to where it was two years ago. That’s not going to happen, because the debt markets aren’t going to allow that.

In terms of opportunity for national retail properties acquisition opportunities, they’ve traditionally come from two different areas; one, retailers opening new stores having them on their balance sheet and looking to sell those. Obviously, in today’s world, retailers are not opening a lot of new stores through new development. They maybe re-leasing space created by vacancy somewhere else, but that does not hold a transaction in and of itself.

And then secondly we have been a meaningful participant of transactions occurring. So, for example, just to randomly pick a name, a Burger King franchisee acquiring another Burger King franchisee in a different market perhaps owned by a private equity firm where there was debt financing to help make it happen and as part of the capital stake they would sell us real estate. That transactional activity has been very, very low for the last 12 months, because the debt markets or middle market transactions have essentially disappeared. So within that background there is not a great deal of transactional activity. On the other side, RJ, we have very little competition, and of course there are good companies like Realty Income in our space, but the average participant who is using high leverage to buy properties is absolutely gone.

So quality wise the type of deals we are seeing are terrific and that 170 million, if we do that this year, we’ll qualitatively be better than what everything we can dream about to do. We have a couple of deals right now where the rent per square foot is considerably lower than what it would have been a couple of years ago. Cap rates are high for quality assets. Now, there are all kinds of things that have to happen before those deals closed including a once instance dealing with the [special] services, for those of you that haven’t done it and by the way, this is a performing asset, but unfortunately, it just has too much debt.

Dealing with special services is enough to cause my ear to fall out. So, RJ I think that the opportunity set is going to be good. The quality is going to be particularly good. And depending on where the markets end up in the next second half of this year is going to be more than enough volumes for us.

RJ Milligan - Raymond James and Associates

So Craig, the transactions or the opportunities that you are seeing are they from distressed sellers now?

Craig Macnab

No. We are not a good buyer of somebody else’s rubbish. We are very focused on high quality net lease retail assets. And if anything, we’ve focused on buying properties that just weren’t available at these cap rates a couple of years ago. We, obviously, are looking at distressed, and have spent a lot of time underwriting these types of properties. At the end of the day, there is a reason why they are distressed, and generally that’s not going to meet our underwriting standards.

RJ Milligan - Raymond James and Associates

Even if they were refinanced, say, ‘05, ‘06 period and levered, it’s just a leverage issue not necessarily a --

Craig Macnab

On the leverage side, there are some opportunities. We continue to see that lenders are extending and pretending. And we were quite interested in one particular transaction where much to my surprise the lender wants the interest. So I think the day of reckoning is coming there. But it still isn’t as prevalent as we had anticipated a year ago.

But the acquisition opportunities for us are going to be very good over the next period of time. I don’t believe that volumes are going to be anything like they were two or three years ago, but right now, our pipeline is pretty good.


Thank you. Our next question is coming from Greg Schweitzer of Citigroup.

Greg Schweitzer - Citigroup

I’m here with Michael Bilerman as well. Craig, could you talk a little bit more about the impairments you took this quarter? Taking the land aside, what were some of the tenants underlining some of those properties?

Craig Macnab

A couple of different things. Firstly, I do want to reiterate that these are non-cash items. Secondly, it’s something of a self-inflicted wound and we have elected to go ahead and take these where we had a sense that the values were less. But let me give you a couple of specific examples without mentioning the tenants or the dollars. We have some land contiguous to a very strong development with excellent tenants in it. And at this current point in time that phase two land, if you will, is not going to be developed to the types of returns that we would commit to allocate capital to.

As it so happen, somebody has come along and said they are very interested in buying the development, we don’t want to earn the development without the land next to it. In the event we sell it, and believe me we’re so far from that, but in the event we’ll, we would walk away from this phase two land, which in today’s world is less than what we paid for it.

So we’ve marked it down. Now, whether that deal happens or not is a complete crack sheet. Secondly, just I am giving you a different example. We had a property that’s been vacant for a period of time, but it was once upon a time the furniture store, and somebody has come along and is interested in buying it. And as opposed to our interest, which is always to re-lease our vacant properties, but in this particular instance if they want to buy it, we might let him own that, again, we’ve taken an impairment on it. And then there is a whole another bucket around where we -- consistently we have told you that some of our properties in our TRS were happy to hold for that duration.

As we looked to move those from the held-for-sale category to the held-for-investment, we are required to make an impairment analysis. So, for example, we had a property in Puerto Rico and the reason we hadn’t discussed held-for-sale category is we didn’t have enough presence in Puerto Rico to make sense holding these given the tax issues there. That property is doing very well. That tenant is performing nicely. And we decided to transfer it to our held-for-investment lo and behold accounting normally requires there to be an impairment on that.

So to me this is a (inaudible). But I think it’s the right thing to do, and we are going to move on. And to me it doesn’t fundamentally change the strength of National Retail Properties.

And then finally, just to make sure my answer is complete, we do have that auto service operation in California. At the time we purchased it, we had to do a preliminary valuation there was this so called goodwill that we accounted for. And despite the fact that the operation has gone quite well and I think it’s going to steadily improve over the next period of time, we’ve chosen to write-off that GAAP goodwill.

Greg Schweitzer - Citigroup

I believe the goodwill that you took in the second quarter was around 12 million (inaudible) the full amount?

Craig Macnab

It’s what was driven by the valuation. So as you do the math there, you can see we are at little under $4 million now in what’s left, and that’s what the valuation required.

Kevin Habicht

Yes. So, Greg, you are correct 12 to four in round numbers.

Greg Schweitzer - Citigroup

Okay. And then just touching on the development in the TRS the first phase, how is leasing going there?

Craig Macnab

Well, I think we have very little. To be honest, we haven’t been in the development business for years. We do have some residual land. The biggest piece of it was this one property that I previously described just a moment ago. But we have a couple of pieces of land that, frankly, are just held up right now, and we chose to write those down. Five or six different properties, a little bits of money each one of them, but on the one property contiguous to that multi-tenant property, it’s been a great success, by the way we chose to mock that vacant or that phase two land down.

Any land purchased in the last couple of years waiting for development owned by any commercial landlord is worth less today than you paid for it. Why? Because there are no tenants to go in it.

Greg Schweitzer - Citigroup

Got it. And just one final one, the re-leasing of the vacant Value City and Circuit City boxes, how is that progressing?

Craig Macnab

Frankly, our leasing efforts in 2009, I think our team did a very, very nice job close to 50 different leases. Leasing activity as you are hearing elsewhere has recently grouped up if you are looking for general comment. In the last two months or so, we’ve got some nice activity going. That particular project that you asked about, we want to continue to make progress with the City, et cetera, et cetera, because it will involve a new multi-tenant building with two high quality retail tenants.

It’s in a good location. Value City in the scheme of things had a low rate per square foot, and over time, I am quite optimistic that we are going to end up replacing that re-leasing that vacant property with high quality tenants at a higher rate that we were receiving. Having said that, Greg, it’s not just clicking my fingers and happening as fast as an impatient me would like.


Thank you. (Operator Instructions). Our next question is coming from Jeffrey Donnelly of Wells Fargo.

Jeffrey Donnelly - Wells Fargo

Craig, a question and actually I got your guidance and maybe this maybe better directed towards Kevin, that are you going to quantifying for us what you see is the FFO benefit from leasing in your portfolio over the course of 2010 versus say where you finished out in ‘09?

Kevin Habicht

I don’t have a real number for you. But given that we are not really showing any meaningful change in occupancy, I think we’ll be trading a lot or little bit, there'll be a little bit upside, but I can't quantify that for you right now on this call.

Craig Macnab

Let me add slightly different thing, Jeff one of the things that's encouraging for us is that we have turned the corner on having a portfolio which has previously been characterized as having no growth. And in 2009 our same-store rent, if you will, moved up by just a little bit less than 1% on a 20.6%, but given that we have a lot of high investment grade tenants where we have contractual bonds we now have really for the first time starting to see a little bit of growth from our portfolio. And obviously, that's going to improve over time.

Jeffrey Donnelly - Wells Fargo

And anyway, I just wanted to be sure and I'm thinking about it correctly. But if we annualize your fourth quarter FFO per share, I think it's somewhere in the mid $40 range and if there is not a lot of movement from leasing over the course of the year, I guess the question is, does that put a lot of onus on the acquisition getting done on the back half of the year, to meet the guidance that you're looking at or I guess is there something else I'm just not thinking about in the numbers?

Kevin Habicht

Yeah, I don't know precisely in your model, I mean we are very comfortable with the FFO guidance we've given and it's 53.5 million which is fourth quarter rental revenue I think those will get there coupled with the acquisitions and all of the other assumptions that we lay down related to that. So, I mean, I can maybe talk to you further about that, in particular, but we are very comfortable where we are.

Jeffrey Donnelly - Wells Fargo

Okay, we can follow up on that. And then just the last question is, if any sort of two part is, do you have any or much exposure to movie galleries, has there been any new side of that. And I guess can you give us details around what you're seeing with the leases that you have with Barnes & Noble and OfficeMax given that there has been [with] those guys as well?

Craig Macnab

Yeah. So in terms of broad tenants held, one of the good things is that we have been active program for many years to sell tenants that we had to dealt with. Today, we've got two Hollywood video, it wasn't that long ago, we had five of them. Not only do we have two of them, but one of them fortunately the lease expires here in middle of the year. We already have that property released to one of the big national auto parts company. So that the Hollywood video impact to us is absolutely diminimal. The other property, which is in Southwest Colorado is a very well located assets and while we look out Hollywood video is doing well there. So we expect them to continue to assume.

I think, retail has obviously had a good year from a profitability standpoint. I don't think there is going to be a whole lot top (inaudible). There is a lot of euphoria about retail sales in January being up 3% to whatever that number was, that was against a pre-dismal January 2009.

So in the book category, that category is (inaudible), the big lenders to Borders are the ones that hold the cards there. And I suspect that one shareholder that has a fair amount of ownership plus some data outstanding to Borders is keenly focused on doing everything he can to make sure they survive, given that his date is comes due. I'm sure he'll accommodate something. We have fortunately well located properties leased to these tenants and regardless of where they go our analysis appears that suggest we're in pretty good shape.

In terms of OfficeMax, you know the office category hasn't done that well. One thing that's curious if you take the time to look at OfficeMax you'll see that their balance sheet is quite strong and they have a large slug of cash, which means that they're going to be around for a long period of time and then just to make sure my answer is complete here. There is this other one called Rite Aid, we do have some Rite Aid stores. And the good news is Rite Aid continues to extend their debt maturities, which will give them more time, but sooner than later they're going to need some revenue growth.


Thank you. There are no further questions at this time; I would like to hand the floor back over to management for any closing comments.

Craig Macnab

Jackie, thanks very much. We appreciate you all taking the time. We understand there are lots of other calls here. And we feel that our positioning for 2010 is pretty good in this economic environment. Quality of acquisition opportunities we're looking at is encouraging. And I'm excited about the opportunities for us over the next couple of years. Thanks very much. I guess, we'll be meeting with some of you in March, and then we'll be talking to you in a couple of months. Thanks very much.


This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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