NNN REIT, Inc. (National Retail Properties, Inc.) — Q1 2011 Form 10-Q Summary
Business context and reporting period
Unaudited results for the quarter ended March 31, 2011, compared with the quarter ended March 31, 2010 and the December 31, 2010 balance sheet. NNN is a fully integrated REIT focused primarily on retail properties leased under long-term net leases. At March 31, 2011, the Investment Portfolio included 1,223 properties totaling approximately 13.32 million square feet across 46 states, with 97% of properties leased or operated and a weighted-average remaining lease term of 12 years. The company also owned 16 Inventory Properties.
Financial performance and key metrics
| Metric | Q1 2011 | Q1 2010 | Change |
|---|---|---|---|
| Continuing-operations revenue | $61.952 million | $56.494 million | 9.7% increase |
| Earnings from operations | $37.917 million | $31.818 million | 19.2% increase |
| Earnings from continuing operations | $20.725 million | $16.082 million | 28.9% increase |
| Net earnings attributable to NNN | $20.820 million | $16.365 million | 27.3% increase |
| Net earnings available to common stockholders | $19.124 million | $14.669 million | 30.4% increase |
| Basic and diluted EPS | $0.23 | $0.18 | Increase of $0.05 |
| Net cash provided by operating activities | $48.866 million | $46.446 million | 5.2% increase |
Continuing-operations operating margin was approximately 61.2%, compared with approximately 56.3% in the prior-year quarter. Net earnings attributable to NNN represented approximately 33.6% of continuing-operations revenue, compared with approximately 29.0% in Q1 2010.
- Rental income increased 10.4% to $58.213 million, primarily from 194 properties acquired during 2010.
- Operating expenses declined 2.0% to $24.033 million, mainly because the commercial mortgage residual-interest valuation adjustment fell to $129,000 from $3.683 million.
- General and administrative expense increased 19.2% to $6.657 million, primarily due to higher executive incentive compensation.
- Interest expense increased 10.4% to $17.662 million, reflecting greater Credit Facility borrowings and related debt balances.
- Discontinued operations contributed $128,000, compared with $216,000 in Q1 2010.
Cash flow, balance sheet, debt and liquidity
| Balance-sheet item | March 31, 2011 | December 31, 2010 |
|---|---|---|
| Total assets | $2.754 billion | $2.714 billion |
| Real estate, operating method, net | $2.560 billion | $2.520 billion |
| Total debt | $1.158 billion | $1.134 billion |
| Total equity | $1.537 billion | $1.529 billion |
| Cash and cash equivalents | $2.557 million | $2.048 million |
- Operating cash flow was $48.866 million. Investing activities used $57.944 million, including $57.512 million for operating-method Investment Properties and $1.747 million for direct-financing properties.
- Financing activities provided $9.587 million, including $23.2 million of net Credit Facility proceeds and $20.081 million of net DRIP proceeds, offset by $33.374 million of common and preferred dividends.
- NNN acquired 29 Investment Properties for total investments of $55.053 million, compared with four properties and $12.376 million in Q1 2010.
- The $400 million revolving Credit Facility had $184.2 million outstanding and approximately $215.8 million available at March 31, 2011, excluding $57,000 of undrawn letters of credit. It matures in November 2012, with an option to extend to November 2013.
- Weighted-average Credit Facility borrowings were $178.836 million at a weighted-average interest rate of 3.8% during the quarter.
- Remaining construction and land funding commitments totaled $19.087 million across 26 properties.
Material changes versus the prior comparable period
- Portfolio scale increased from 1,014 properties at March 31, 2010 to 1,223 properties at March 31, 2011; leased or operated occupancy improved from 96% to 97%.
- Q1 2011 acquisition activity was substantially higher than in Q1 2010, supporting the increase in rental revenue and depreciation expense.
- Operating cash flow increased modestly, while investing cash usage increased sharply because of property acquisitions.
- Total debt increased by $24.582 million from December 31, 2010, driven primarily by higher Credit Facility borrowings.
- Common dividends increased to $0.380 per share from $0.375 per share. Series C preferred dividends remained $0.4609 per depositary share.
- Commercial mortgage residual interests were carried at $16.402 million, with a $129,000 impairment in Q1 2011 versus $3.683 million in Q1 2010. The residuals remain Level 3 assets valued using significant unobservable assumptions.
Guidance, outlook, commentary, risks and unusual items
The filing does not provide specific earnings, acquisition, occupancy or dividend guidance. Management stated that operating cash flow, available cash, the Credit Facility, debt or equity financings and asset dispositions are expected to fund operating needs, commitments, acquisitions and dividends. Management also stated that the long-term net-lease structure should keep capital demands for most Investment Properties modest.
- Management cautioned that quarterly results may not be indicative of full-year 2011 results and identified forward-looking statements as subject to material risks.
- Key risks include tenant credit deterioration, vacancies, rent collection, concentration in convenience stores and restaurants, geographic concentration in the South and Southeast, refinancing and interest-rate risk, and valuation changes affecting residual interests.
- NNN had 38 vacant, unleased Investment Properties, approximately 3% of the Investment Portfolio. Approximately 1% of gross leasable area was leased to five tenants that had filed Chapter 11 bankruptcy petitions as of April 28, 2011.
- A 1% increase in interest rates on variable-rate debt would have increased quarterly interest expense by more than 2%, according to the filing.
- In March 2011, NNN entered into two treasury locks with a combined notional amount of $150 million to hedge potential long-term debt issuance. The hedges had a fair value of $1.663 million at quarter-end.
- NNN reported no material changes to previously disclosed risk factors, no applicable legal proceedings, no defaults upon senior securities and no reportable subsequent events through the filing review date.
- Management concluded that disclosure controls and procedures were effective as of March 31, 2011, with no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Reconcile reported earnings and dividends with non-GAAP measures commonly used for REIT analysis, including funds from operations; the provided filing text does not present a clear FFO amount.
- Review the maturity, refinancing and put-option schedule for the $1.158 billion of debt, particularly the 2026 convertible notes’ earliest put option in September 2011 and the Credit Facility maturity in November 2012.
- Assess whether the 97% leased-or-operated rate and tenant diversification adequately offset exposure to convenience stores, restaurants, bankrupt tenants and regional concentration.
- Monitor Credit Facility utilization, interest-rate sensitivity, treasury-lock outcomes and the effect of additional borrowing on dividend coverage.
- Evaluate the assumptions supporting the $16.402 million Level 3 commercial mortgage residual-interest valuation, including prepayment speeds, defaults, loss severity and discount rate.
- Confirm that the $19.087 million of remaining construction commitments and planned acquisitions can be funded while maintaining REIT distribution requirements and adequate liquidity.