Business Context and Reporting Period
Company: National Retail Properties, Inc. (NNN REIT, Inc.)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2008
Business Overview: NNN is a fully integrated REIT operating in two primary segments: Investment Assets (real estate leased under long-term net leases, mortgages, and residual interests) and Inventory Assets (real estate held for sale). As of September 30, 2008, the company owned 990 Investment Properties with approximately 97% occupancy.
Key Financial Metrics
| Metric | Q3 2008 | Q3 2007 | 9 Months 2008 | 9 Months 2007 |
|---|---|---|---|---|
| Total Revenues (Continuing Ops) | $58,573 | $46,564 | $169,495 | $130,122 |
| Net Earnings | $30,274 | $47,386 | $94,215 | $122,745 |
| Net Earnings Available to Common | $28,578 | $45,690 | $89,126 | $117,656 |
| Diluted EPS | $0.39 | $0.68 | $1.22 | $1.82 |
| Cash from Operating Activities | N/A | N/A | $210,288 | $197,116 |
| Cash and Cash Equivalents | $2,514 | $26,443 | $2,514 | $26,443 |
| Total Debt Outstanding | $1,104,565 | $1,060,070 | $1,104,565 | $1,060,070 |
Note: All figures in thousands except per share data.
Material Changes vs. Prior Period
- Revenue Growth: Total revenues from continuing operations increased 25.8% in Q3 2008 and 30.3% for the nine months ended Sept 30, 2008, compared to 2007. This was driven primarily by the acquisition of 97 Investment Properties during the nine-month period and base rent increases.
- Earnings Decline: Despite revenue growth, Net Earnings decreased significantly (36% in Q3 and 23% for the nine months). This decline is largely attributed to a substantial reduction in earnings from discontinued operations (sales of Investment and Inventory properties) compared to the prior year.
- Expense Increases: Interest expense rose 25.0% in Q3 and 26.7% for the nine months due to the issuance of $234 million in convertible notes in early 2008, partially offset by the repayment of higher-cost debt. Depreciation and amortization increased 43.6% in Q3 due to new property acquisitions.
- Liquidity: Cash and cash equivalents dropped from $27.5 million at year-end 2007 to $2.5 million at Sept 30, 2008, reflecting heavy investment in property acquisitions ($318 million) and debt repayments.
Guidance, Outlook, Risks, and Unusual Items
- Discontinued Operations: A significant portion of prior-year earnings came from property dispositions. In Q3 2008, earnings from discontinued operations were $3.2 million compared to $26.3 million in Q3 2007. For the nine months, discontinued earnings were $19.2 million versus $63.5 million in 2007.
- Impairments: The company recorded a $758,000 other-than-temporary valuation impairment on commercial mortgage residual interests for the nine months ended Sept 30, 2008. Additionally, $4.1 million in real estate impairments were recorded in discontinued operations.
- Tenant Bankruptcy: Major tenant Uni-Mart, Inc. filed for Chapter 11 bankruptcy in May 2008. Uni-Mart leases 69 Investment Properties. In July 2008, Uni-Mart rejected leases for 13 properties. NNN recorded a $2.2 million income from a bankruptcy damage claim in Q3 2008 but noted uncertainty regarding future rent payments.
- Debt Management: In February/March 2008, NNN issued $234 million of 5.125% convertible senior notes due 2028. In October 2008 (subsequent event), the company extended its $400 million credit facility maturity to May 2010 and issued 3.45 million shares of common stock for $76.1 million in net proceeds.
- Dividends: NNN declared a common stock dividend of $0.375 per share in October 2008. The company maintains its REIT status by distributing at least 90% of taxable income.
Investor Verification Checklist
- Discontinued Operations Impact: Verify the sustainability of earnings by analyzing "Earnings from Continuing Operations" ($27.1M for Q3 2008) separately from the volatile "Earnings from Discontinued Operations."
- Uni-Mart Exposure: Assess the risk associated with the 13 properties rejected by Uni-Mart and the potential for vacancy or reduced rental income on the remaining 56 properties leased to the tenant.
- Liquidity Position: Review the low cash balance ($2.5M) relative to the $36.1M in remaining construction commitments and upcoming debt obligations.
- Convertible Debt: Evaluate the dilution risk associated with the $406.5 million in convertible notes outstanding, which have a conversion price of approximately $25.42 per share.
- Residual Interest Valuation: Monitor the fair value of commercial mortgage residual interests, which are Level 3 assets subject to significant valuation adjustments based on market conditions.