Business Context and Reporting Period
National Retail Properties, Inc. (NNN REIT, Inc. in the request) filed an unaudited Form 10-Q for the quarter and six months ended June 30, 2010. NNN is a REIT focused primarily on retail properties leased under long-term net leases, with separate Investment Assets and Inventory Assets segments.
- Investment Portfolio: 1,014 properties, approximately 11.4 million square feet, across 43 states.
- Occupancy: 97% of Investment Properties were leased or operated; 27 properties were vacant.
- Weighted average remaining lease term: approximately 12 years.
- Inventory Portfolio: 17 properties at June 30, 2010, compared with 19 at December 31, 2009.
Financial Metrics
| Metric | Quarter Ended June 30, 2010 | Quarter Ended June 30, 2009 | Six Months 2010 | Six Months 2009 |
|---|---|---|---|---|
| Continuing-operations revenue | $56.5 million | $58.2 million | $113.1 million | $116.3 million |
| Earnings from operations | $36.5 million | $37.1 million | $68.3 million | $74.0 million |
| Net earnings attributable to NNN | $21.2 million | $18.1 million | $37.6 million | $44.9 million |
| Net earnings available to common stockholders | $19.5 million | $16.4 million | $34.2 million | $41.5 million |
| Diluted earnings per share | $0.23 | $0.20 | $0.41 | $0.52 |
| Net cash provided by operating activities | Not provided for the quarter | Not provided for the quarter | $110.3 million | $77.7 million |
- Approximate continuing-operations operating margin was 64.6% for the quarter and 60.4% for the six months, based on reported earnings from operations divided by continuing-operations revenue.
- Approximate net margin attributable to NNN was 37.5% for the quarter and 33.2% for the six months on the same revenue basis.
- Total assets were $2.587 billion at June 30, 2010, compared with $2.591 billion at December 31, 2009.
- Cash and cash equivalents increased to $51.8 million from $15.2 million at year-end 2009.
- Total outstanding debt was $995.4 million, consisting of $30.2 million of mortgages, $346.4 million of convertible notes and $618.8 million of other notes payable.
- NNN’s $400 million revolving credit facility had no balance outstanding and $400 million available, excluding $647,000 of letters of credit. The facility matures in November 2012, with an option to extend to November 2013.
- Common dividends paid during the first six months were $62.2 million, or $0.75 per share. A $0.38 per-share dividend was declared in July 2010.
Cash Flow and Capital Allocation
- Operating cash flow was $110.3 million; investing activities used $18.6 million and financing activities used $55.1 million during the first six months.
- Operating cash flow benefited from $42.8 million of proceeds from Inventory Property dispositions and was sufficient, according to management, to fund dividends after considering cash flows related to Inventory Properties.
- NNN invested $38.6 million in 10 Investment Properties during the first six months and sold 11 Investment Properties for $11.4 million of net proceeds.
- The company issued 561,107 common shares under its dividend reinvestment and stock purchase plan for net proceeds of $11.8 million.
- Remaining construction and tenant-improvement commitments totaled $10.6 million for 14 Investment Properties.
Material Changes Versus the Prior Comparable Period
- Continuing-operations revenue declined 2.9% for the quarter and 2.8% for the six months, primarily because of lower rental income and tenant expense reimbursements.
- Rental income declined partly because 2009 included nonrecurring rent settlement fees of $2.1 million for the quarter and $4.9 million for the six months.
- Net earnings attributable to NNN increased 17.2% for the quarter but declined 16.3% for the six months. The quarterly improvement reflected the absence of the significant 2009 foreclosure-related loss.
- Six-month results included a $3.8 million other-than-temporary valuation impairment of commercial mortgage residual interests; the comparable 2009 period had no such charge.
- Depreciation and amortization increased 7.1% for the quarter and 4.1% for the six months. Interest expense increased 3.9% and 3.8%, respectively.
- Operating cash flow increased by $32.6 million year over year, primarily reflecting higher Inventory Property disposition proceeds and the absence of certain 2009 adjustments.
- Investment Property acquisitions increased to 10 properties in the first six months from none in the comparable 2009 period, while Inventory Properties declined from 30 at June 30, 2009 to 17.
Guidance, Outlook, Risks and Unusual Items
- The filing does not provide quantified earnings or revenue guidance. Management states that interim operating results may not be indicative of full-year 2010 results.
- Management expects capital requirements for the largely net-leased Investment Portfolio to remain modest and to be funded through operating cash flow and working capital, supplemented by the credit facility, debt or equity financing and asset dispositions as needed.
- Key risks include tenant credit deterioration, vacancies, geographic and tenant concentration, interest-rate changes, real estate values, refinancing needs and the performance of commercial mortgage residual interests.
- Convenience stores represented 26.2% of annual base rent, and restaurants represented 12.4% in aggregate. The portfolio is concentrated in the South and Southeast.
- TitleMax, a tenant leasing 30 properties, emerged from Chapter 11 in April 2010 after assuming all leases. Majestic Liquor Stores, a tenant leasing 13 properties, filed Chapter 11 in June 2010 and rejected four leases; management did not believe either matter would have a material adverse effect.
- Residual interests declined in carrying value from $20.2 million at year-end 2009 to $15.1 million at June 30, 2010. Their valuation uses significant unobservable assumptions, including a 25% discount rate and changing default and prepayment assumptions.
- NNN had no derivatives outstanding at June 30, 2010. No material legal proceedings or changes to previously disclosed risk factors were reported.
- The filing retrospectively adjusted second-quarter and six-month 2009 results for a final valuation of assets acquired in connection with a tenant default. The adjustment reduced reported 2009 net earnings attributable to NNN by $8.9 million.
- Management concluded that disclosure controls and procedures were effective as of June 30, 2010, and reported no material change in internal control over financial reporting.
Most Important Facts for Investors to Verify
- Whether the 97% leased-or-operated rate and 27 vacant properties change materially, particularly in concentrated tenant sectors.
- The refinancing and repayment plan for approximately $155.6 million of debt obligations scheduled to mature in 2010 and 2011, based on the debt maturity table.
- The sustainability of dividends relative to recurring operating cash flow, excluding property disposition proceeds and other unusual items.
- Future valuation changes in the commercial mortgage residual interests and the assumptions underlying those valuations.
- The financial effect of Majestic’s rejected leases and any additional tenant bankruptcies or lease restructurings.
- Future acquisition volume, capital commitments and the availability and terms of debt or equity financing.
- The adjusted 2009 comparative figures used in assessing year-over-year earnings and per-share trends.