NNN REIT, INC. annual report, FY2011

NNN REIT, Inc. (National Retail Properties, Inc.) — FY2011 Form 10-K Summary

Business context and reporting period

Annual report for the fiscal year ended December 31, 2011, filed February 24, 2012. NNN is a Maryland REIT focused primarily on acquiring, owning and developing single-tenant retail properties leased under long-term net leases. At year-end, the portfolio comprised 1,422 properties totaling approximately 16.4 million square feet across 47 states, with approximately 97% of properties leased or operated and a weighted-average remaining lease term of approximately 12 years.

Beginning in 2011, NNN reported one operating segment because its inventory-assets activities were no longer significant for separate segment reporting. The company had 59 full-time associates as of January 31, 2012.

Key financial metrics

Metric	FY2011	FY2010	Change
Gross revenues	$271.7 million	$237.1 million	+14.6%
Continuing-operations revenues	$265.8 million	$227.9 million	+16.6%
Net earnings attributable to NNN	$92.3 million	$73.0 million	+26.5%
Continuing-operations earnings	$91.1 million	$70.6 million	+29.0%
Diluted earnings per share	$0.96	$0.80	+20.0%
Diluted FFO available to common stockholders	$139.7 million	$108.3 million	+28.9%
Operating cash flow	$182.9 million	$187.9 million	-2.6%
Total assets	$3.434 billion	$2.714 billion	+26.6%
Total debt	$1.339 billion	$1.134 billion	+18.1%
NNN stockholders’ equity	$2.002 billion	$1.527 billion	+31.1%
Common dividends per share	$1.53	$1.51	+1.3%

Continuing-operations revenue was composed primarily of rental income of $250.4 million, or 94.2% of total continuing-operations revenue. Earnings from operations were $164.4 million, compared with $133.7 million in 2010. Based on reported figures, continuing-operations earnings represented approximately 34% of continuing-operations revenue, while net earnings attributable to NNN represented approximately 34% of gross revenues.

Retail operations generated $45.1 million of revenue and $2.0 million of net income, compared with $33.0 million and $1.3 million, respectively, in 2010.
Depreciation and amortization increased to $58.1 million from $48.0 million, primarily due to portfolio growth.
Interest expense increased to $74.8 million from $65.2 million.
Net impairment losses and other charges were a $1.4 million recovery in 2011 versus $7.5 million of expense in 2010; the 2011 amount included recovery of $3.1 million of a prior mortgage-receivable reserve.
NNN recorded a $1.0 million impairment of commercial mortgage residual interests, down from $4.0 million in 2010.

Material changes versus prior comparable period

NNN acquired 218 properties in 2011 for total investment of $772.5 million, compared with 194 properties and $256.6 million in 2010. Acquisitions added approximately 3.45 million square feet.
Eight properties were sold for net proceeds of $12.6 million and a $0.5 million gain, compared with 18 properties sold for $58.8 million and a $1.7 million gain in 2010.
Property count increased from 1,195 to 1,422, and gross leasable area increased from 13.0 million to 16.4 million square feet. Occupancy remained approximately 97%.
In July 2011, NNN issued $300 million of 5.50% notes due 2021. Total debt increased by $205.4 million, although Credit Facility borrowings declined from $161.0 million to $65.6 million.
NNN issued 17.3 million common shares in public offerings during 2011 and raised net proceeds of approximately $427.7 million; DRIP issuances added $93.5 million of net proceeds.
The $450 million unsecured revolving Credit Facility was amended and restated in May 2011, up from $400 million. At year-end, $65.6 million was outstanding and $384.4 million was available, excluding $57,000 of letters of credit.
Prior-period financial information was reclassified for properties sold or held for sale as discontinued operations. This reduced reported continuing-operations revenue and earnings but did not affect total net earnings available to common stockholders.

Cash flow, liquidity and debt

Operating cash flow of $182.9 million covered common and preferred dividends declared of approximately $140.5 million, although investing activities used $752.1 million, primarily for property acquisitions.
Financing activities provided $569.2 million, principally through common-stock offerings and the issuance of 5.50% notes. Year-end cash and cash equivalents were only $2.1 million.
Total debt consisted of $65.6 million under the revolving facility, $23.2 million of mortgages, $355.4 million of convertible notes and $895.0 million of other notes.
Reported leverage ratios were approximately 39% total liabilities to total gross assets, 1% secured debt to total gross assets and 33% total debt to market capitalization.
Contractual cash obligations totaled $1.353 billion, including $70.2 million due in 2012, $224.9 million in 2013 and $216.5 million in 2015. The schedule excludes $15.1 million of accrued interest payable.
NNN had $55.1 million remaining to fund construction commitments for 54 properties, from total commitments of $158.7 million.
Management stated that the company was in compliance with Credit Facility and note covenants at December 31, 2011.

Guidance, outlook, commentary and risks

Management expects future rental-income growth primarily from additional property acquisitions and contractual rent increases. It expects operating needs, dividends and debt service to be funded through operating cash flow and available credit, with acquisitions and development funded through the Credit Facility, debt or equity offerings, asset sales and other capital sources. The filing provides no quantified earnings or FFO guidance.

Portfolio concentration remains material: approximately 51% of annual base rent came from five retail lines of trade, 27% from five tenants and 47% from five states. Convenience stores represented 24.6% of annual base rent; Texas represented 23.0%.
NNN owned 38 vacant, unleased properties, approximately 3% of the portfolio, at year-end. Less than 1% of gross leasable area was leased to four Chapter 11 tenants as of January 31, 2012.
Lease expirations were limited in the near term: 1.5% of annual base rent was scheduled to expire in 2012, 3.5% in 2013 and 3.3% in 2014, assuming no renewal options were exercised.
Key risks include tenant defaults or bankruptcies, re-leasing risk, geographic and industry concentration, access to capital markets, refinancing and balloon maturities, interest-rate changes, covenant compliance, property-value impairment, environmental liabilities and the ability to complete development projects.
Sixty-six properties were under some level of environmental remediation as of February 15, 2012. Management generally expected sellers, prior owners, tenants or adjacent landowners to bear remediation costs, but noted that indemnities may not be collectible.
The commercial mortgage residual interests had a fair value of $15.3 million and were sensitive to discount rates, prepayment speeds, defaults, loss severity and interest-rate assumptions.
NNN had no derivatives outstanding at December 31, 2011. A 1% increase in interest rates on variable-rate debt would have increased interest expense by less than 2% for 2011.

Subsequent events and unusual items

On February 23, 2012, NNN issued 11.5 million Series D preferred depositary shares at a 6.625% rate and received gross proceeds of approximately $287.5 million.
NNN intended to use approximately $277.9 million of net Series D proceeds to redeem the Series C preferred stock on March 15, 2012, with remaining proceeds available for general corporate purposes, including potential repayment of Credit Facility debt.
NNN recognized a $1.5 million noncash goodwill impairment charge in 2011 related to acquired auto-service operations.
Ernst & Young issued unqualified audit opinions on the financial statements and internal control over financial reporting. Management concluded that disclosure controls and internal controls were effective.

Most important facts for investors to verify

Whether acquisition volume and equity issuance can continue to support portfolio and FFO growth without excessive dilution or leverage.
The maturity and refinancing plan for the $69.3 million of debt due in 2012 and the $223.9 million due in 2013, including convertible-note put dates.
Tenant credit quality and exposure to convenience stores, restaurants, Texas and the largest tenants.
Progress in leasing or selling the 38 vacant properties and resolving bankrupt-tenant exposures.
Funding requirements and expected returns for the $55.1 million of remaining development commitments.
Environmental remediation obligations, insurance coverage and potential uninsured liabilities.
The completed redemption of Series C preferred stock and the effect of Series D issuance on capital structure and preferred dividend obligations.
Reconciliations between GAAP earnings, FFO and operating cash flow, including the effect of discontinued-operations reclassifications and noncash impairments.