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Business Context and Reporting Period

Company: National Retail Properties, Inc. (formerly Commercial Net Lease Realty, Inc.)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2006
Business Overview: A fully integrated Real Estate Investment Trust (REIT) operating two primary segments: Investment Assets (long-term commercial net leases) and Inventory Assets (development and sale of real estate). As of September 30, 2006, the company owned 691 investment properties across 45 states and 102 inventory properties.

Key Financial Metrics

Note: Q3 2005 and 9-month 2005 comparative balance sheet data is not provided in the text.

Material Changes vs. Prior Period

• Revenue Growth: Total revenues from continuing operations increased 19.8% in Q3 2006 and 26.6% for the nine months ended September 30, 2006, compared to the prior year. This was driven primarily by the acquisition of 175 investment properties (858,000 sq. ft.) during the first nine months of 2006.
• Profitability: Net earnings increased significantly, aided by a $68.6 million gain on the disposition of investment properties (including the sale of DC Office Properties) and a $7.1 million gain on inventory dispositions in the nine-month period.
• Impairments: The company recorded an $8.8 million impairment charge on mortgage residual interests for the nine months ended September 30, 2006, due to increased prepayment speeds of underlying loans. This contrasts with no such charge in the prior year period.
• Debt Structure: In September 2006, the company issued $172.5 million in 3.95% convertible senior notes. Concurrently, the line of credit payable decreased from $162.3 million (Dec 31, 2005) to $78.8 million (Sep 30, 2006).
• Discontinued Operations: Earnings from discontinued operations were substantial ($81.9 million for the nine months), largely due to the sale of investment properties classified as discontinued under SFAS No. 144.

Guidance, Outlook, and Risks

• Capital Strategy: The company intends to use proceeds from a subsequent October 2006 preferred stock offering ($92 million gross) to redeem Series A Preferred Stock and repay credit facility borrowings.
• Dividends: The company maintains a policy of distributing a substantial portion of funds available to shareholders. Common dividends paid were $0.985 per share for the nine months ended September 30, 2006.
• Construction Commitments: As of September 30, 2006, the company had unfunded construction commitments of approximately $20.4 million ($72.2 million total commitment less $51.8 million funded).
• Risk Factors:
  • Tenant Concentration: The five largest tenants accounted for approximately 26% of base rent. Default or bankruptcy of major tenants could materially impact cash flow.
  • Market Risk: Exposure to interest rate changes on variable rate debt (credit facility). A 1% increase in rates would have increased interest expense by 3.7% for the nine-month period.
  • Valuation Risk: Mortgage residual interests are subject to valuation adjustments based on prepayment speeds and interest rates.

Investor Verification Checklist

• Discontinued Operations Impact: Verify the sustainability of earnings by analyzing the proportion of net income derived from discontinued operations (property sales) versus continuing operations (rental income).
• Mortgage Residual Impairment: Assess the long-term impact of the $8.8 million impairment on mortgage residual interests and the assumptions regarding prepayment speeds.
• Debt Maturity Profile: Review the contractual obligations table to confirm liquidity coverage for the $78.8 million revolving credit facility and other debt maturities due in 2007-2008.
• Construction Funding: Confirm the company's ability to fund the remaining $20.4 million in construction commitments without diluting equity or increasing leverage significantly.
• Tenant Credit Quality: Monitor the financial health of the top five tenants (Susser/Circle K, CVS, Best Buy, Uni-Mart, Barnes & Noble) which represent 26% of base rent.