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Business Context and Reporting Period

Company: National Retail Properties, Inc. (NNN REIT, Inc.)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2007
Business Overview: A fully integrated Real Estate Investment Trust (REIT) owning and managing single-tenant retail properties leased under long-term net leases. Operations are divided into two segments: Investment Assets (operating and direct financing leases) and Inventory Assets (properties held for sale).

Key Financial Metrics

Note: Q2 2006 Net Earnings were significantly higher due to large gains from discontinued operations ($67.6M vs $26.7M in Q2 2007). Continuing operations earnings grew 74% year-over-year in Q2 2007.

Material Changes vs. Prior Period

• Portfolio Expansion: The Investment Portfolio grew from 710 properties (Dec 31, 2006) to 859 properties (June 30, 2007). During the six months ended June 30, 2007, the company acquired 163 properties totaling 1,047,000 square feet for approximately $404.4 million.
• Revenue Growth: Revenues from continuing operations increased 34.4% in Q2 2007 and 27.8% for the six-month period, primarily driven by new property acquisitions.
• Discontinued Operations: Earnings from discontinued operations decreased significantly compared to the prior year due to fewer property dispositions. In Q2 2007, 9 investment properties were sold (gain of $22.6M) compared to 3 properties sold in Q2 2006 (gain of $59.5M).
• Debt Structure: The line of credit payable increased from $28.0 million at year-end 2006 to $172.6 million at June 30, 2007, reflecting increased borrowing to fund acquisitions.
• Preferred Stock: The company redeemed all 1,781,589 shares of Series A Preferred Stock in January 2007 for approximately $44.5 million.

Guidance, Outlook, and Risks

• Outlook: Management anticipates significant increases in rental income will continue to come primarily from additional Investment Property acquisitions. The company is increasing investments in convenience store and restaurant sectors.
• Liquidity: The company maintains a $300 million revolving credit facility. As of June 30, 2007, $172.6 million was outstanding. Cash provided by operating activities for the six months ended June 30, 2007, was $124.1 million.
• Dividends: The company declared a common stock dividend of $0.355 per share in July 2007. It intends to maintain its REIT status by distributing a substantial portion of taxable income.
• Risks:
  • Interest Rate Risk: Exposure to variable rates on the credit facility. A 1% increase in rates would increase interest expense by less than 3%.
  • Market Risk: Mortgage residual interests are subject to valuation changes based on prepayment speeds and interest rates. No other-than-temporary impairment was recorded in 2007, unlike the $2.7M impairment in 2006.
  • Construction Commitments: The company has unfunded construction commitments of approximately $88.6 million ($61.6M for Investment Portfolio and $118.2M for Inventory Portfolio, with $91.2M already funded).

Investor Verification Checklist

• Discontinued Operations Impact: Verify the sustainability of earnings by analyzing "Continuing Operations" ($21.9M Q2 2007) separately from "Discontinued Operations" ($26.7M Q2 2007), as the latter is volatile and dependent on asset sales.
• Acquisition Funding: Confirm the source of capital for the $404M in acquisitions (debt vs. equity) and the impact on leverage ratios given the increase in the line of credit to $172.6M.
• Occupancy Rates: Verify the 98% occupancy rate of the Investment Portfolio and the weighted average remaining lease term of 13 years.
• Preferred Stock Obligations: Review the dividend obligations for the remaining Series C Redeemable Preferred Stock ($3.4M paid in first half of 2007).
• Subsequent Events: Note the disposition of 25 properties in July 2007 for $78.4M with an estimated gain of $17.4M, which occurred after the reporting period.