2012.06.30 Form 10-Q


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended June 30, 2012
OR
¨TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
For the transition period from                      to                     
Commission file number 001-11290
NATIONAL RETAIL PROPERTIES, INC.
(Exact name of registrant as specified in its charter)
 
Maryland
(State or other jurisdiction of
incorporation or organization)
56-1431377
(I.R.S. Employer Identification No.)
450 South Orange Avenue, Suite 900
Orlando, Florida 32801
(Address of principal executive offices, including zip code)
Registrant’s telephone number, including area code: (407) 265-7348

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes  x     No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer  x
  
Accelerated filer  ¨
  
Non-accelerated filer  ¨
  
Smaller reporting company  ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x
Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date.
108,190,322 shares of common stock, $0.01 par value, outstanding as of July 27, 2012.




TABLE OF CONTENTS
 
 
 
PAGE      
REFERENCE
Part I - Financial Information
 
Item 1.
 
 
 
 
 
Item 2.
Item 3.
Item 4.
Part II - Other Information
 
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.


PART I. FINANCIAL INFORMATION

Item 1.  Financial Statements
NATIONAL RETAIL PROPERTIES, INC.
and SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except per share data)
 
June 30, 2012
 
December 31, 2011
ASSETS
(unaudited)
 
 
Real estate portfolio:
 
 
 
Accounted for using the operating method, net of accumulated depreciation and amortization
$
3,485,819

 
$
3,225,119

Accounted for using the direct financing method
24,954

 
26,518

Real estate held for sale
40,351

 
36,105

Investment in unconsolidated affiliate
4,283

 
4,358

Mortgages, notes and accrued interest receivable, net of allowance
36,740

 
33,428

Commercial mortgage residual interests
12,395

 
15,299

Cash and cash equivalents
2,907

 
2,082

Receivables, net of allowance of $1,113 and $1,403, respectively
1,456

 
2,149

Accrued rental income, net of allowance of $3,086 and $4,870, respectively
25,330

 
25,187

Debt costs, net of accumulated amortization of $16,986 and $15,332, respectively
9,148

 
10,802

Other assets
60,607

 
53,382

Total assets
$
3,703,990

 
$
3,434,429

LIABILITIES AND EQUITY
 
 
 
Liabilities:
 
 
 
Line of credit payable
$
142,600

 
$
65,600

Mortgages payable, including unamortized premium of $216 and $0, respectively
29,341

 
23,171

Notes payable – convertible, net of unamortized discount of $4,256 and $6,363, respectively
357,479

 
355,371

Notes payable, net of unamortized discount of $4,763 and $5,033, respectively
845,237

 
894,967

Accrued interest payable
14,440

 
15,108

Other liabilities
87,483

 
76,336

Total liabilities
1,476,580

 
1,430,553

 


 


Equity:
 
 
 
Stockholders’ equity:
 
 
 
Preferred stock, $0.01 par value. Authorized 15,000,000 shares
 
 
 
Series D, 11,500,000 depositary shares issued and outstanding, at stated liquidation value
  of $25 per share
287,500

 
—

Series C, 3,680,000 depositary shares issued and outstanding, at stated liquidation value
  of $25 per share
—

 
92,000

Common stock, $0.01 par value. Authorized 190,000,000 shares; 107,449,071 and
  104,754,859 shares issued and outstanding, respectively
1,076

 
1,049

Excess stock, $0.01 par value. Authorized 205,000,000 shares; none issued or outstanding
—

 
—

Capital in excess of par value
2,015,121

 
1,958,225

Retained earnings (loss)
(74,123
)
 
(44,946
)
Accumulated other comprehensive income (loss)
(3,504
)
 
(3,830
)
Total stockholders’ equity of NNN
2,226,070

 
2,002,498

Noncontrolling interests
1,340

 
1,378

Total equity
2,227,410

 
2,003,876

Total liabilities and equity
$
3,703,990

 
$
3,434,429

See accompanying notes to consolidated financial statements.

3

NATIONAL RETAIL PROPERTIES, INC.
and SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(dollars in thousands, except per share data)
(Unaudited)

 
Quarter Ended June 30,
 
Six Months Ended June 30,
  
2012
 
2011
 
2012
 
2011
Revenues:
 
 
 
 
 
 
 
Rental income from operating leases
$
77,927

 
$
57,578

 
$
151,494

 
$
114,526

Earned income from direct financing leases
618

 
693

 
1,246

 
1,433

Percentage rent
221

 
132

 
332

 
247

Real estate expense reimbursement from tenants
2,505

 
2,142

 
5,337

 
4,422

Interest and other income from real estate transactions
764

 
543

 
1,470

 
1,164

Interest income on commercial mortgage residual interests
716

 
777

 
1,471

 
1,544

 
82,751

 
61,865

 
161,350

 
123,336

Retail operations:
 
 
 
 
 
 
 
Revenues
7,784

 
12,450

 
19,008

 
21,300

Operating expenses
(7,481
)
 
(11,760
)
 
(18,543
)
 
(20,612
)
Net
303

 
690

 
465

 
688

Operating expenses:
 
 
 
 
 
 
 
General and administrative
7,024

 
6,568

 
14,627

 
13,226

Real estate
4,025

 
3,919

 
8,597

 
7,573

Depreciation and amortization
19,032

 
13,765

 
37,140

 
27,184

Impairment – commercial mortgage residual interests valuation
2,718

 
267

 
2,718

 
396

 
32,799

 
24,519

 
63,082

 
48,379

Earnings from operations
50,255

 
38,036

 
98,733

 
75,645

Other expenses (revenues):
 
 
 
 
 
 
 
Interest and other income
(361
)
 
(283
)
 
(719
)
 
(625
)
Interest expense
19,394

 
17,512

 
39,039

 
35,174

 
19,033

 
17,229

 
38,320

 
34,549

Earnings from continuing operations before income tax expense and equity in earnings of unconsolidated affiliate
31,222

 
20,807

 
60,413

 
41,096

Income tax expense
(140
)
 
(210
)
 
(236
)
 
(191
)
Equity in earnings of unconsolidated affiliate
155

 
104

 
305

 
213

Earnings from continuing operations
31,237

 
20,701

 
60,482

 
41,118

Earnings from discontinued operations, net of income tax expense (Note 7)
2,239

 
568

 
2,817

 
1,005

Earnings including noncontrolling interests
33,476

 
21,269

 
63,299

 
42,123

Loss (earnings) attributable to noncontrolling interests:
 
 
 
 
 
 
 
Continuing operations
34

 
67

 
55

 
93

Discontinued operations
(5
)
 
(33
)
 
(17
)
 
(93
)
 
29

 
34

 
38

 
—

Net earnings attributable to NNN
$
33,505

 
$
21,303

 
$
63,337

 
$
42,123

 
See accompanying notes to consolidated financial statements. 
            

4

NATIONAL RETAIL PROPERTIES, INC.
and SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(dollars in thousands, except per share data)
(Unaudited)

 
Quarter Ended June 30,
 
Six Months Ended June 30,
  
2012
 
2011
 
2012
 
2011
 
 
 
 
 
 
 
 
Net earnings attributable to NNN
$
33,505

 
$
21,303

 
$
63,337

 
$
42,123

Series C preferred stock dividends
—

 
(1,696
)
 
(1,979
)
 
(3,392
)
Series D preferred stock dividends
(5,926
)
 
—

 
(5,926
)
 
—

Excess of redemption value over carrying value of preferred shares
   redeemed
—

 
—

 
(3,098
)
 
—

Net earnings attributable to common stockholders
$
27,579

 
$
19,607

 
$
52,334

 
$
38,731

Net earnings per share of common stock:
 
 
 
 
 
 
 
Basic:
 
 
 
 
 
 
 
Continuing operations
$
0.24

 
$
0.23

 
$
0.47

 
$
0.46

Discontinued operations
0.02

 
—

 
0.02

 
—

Net earnings
$
0.26

 
$
0.23

 
$
0.49

 
$
0.46

Diluted:
 
 
 
 
 
 
 
Continuing operations
$
0.24

 
$
0.23

 
$
0.46

 
$
0.46

Discontinued operations
0.02

 
—

 
0.03

 
—

Net earnings
$
0.26

 
$
0.23

 
$
0.49

 
$
0.46

Weighted average number of common shares outstanding:
 
 
 
 
 
 
 
Basic
105,992,014

 
84,409,788

 
105,417,595

 
83,771,728

Diluted
107,458,993

 
84,725,968

 
106,844,080

 
84,271,352

Other comprehensive income:
 
 
 
 
 
 
 
Net earnings attributable to NNN
$
33,505

 
$
21,303

 
$
63,337

 
$
42,123

Amortization of interest rate hedges
58

 
(42
)
 
114

 
(85
)
Fair value treasury locks
—

 
(6,881
)
 
—

 
(5,218
)
Unrealized gain - commercial mortgage residual interests
213

 
539

 
213

 
599

Stock value adjustments
—

 
(7
)
 
(1
)
 
(26
)
Comprehensive income attributable to NNN
$
33,776

 
$
14,912

 
$
63,663

 
$
37,393

    

See accompanying notes to consolidated financial statements.


5

NATIONAL RETAIL PROPERTIES, INC.
and SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
(Unaudited)


 
Six Months Ended June 30,
 
2012
 
2011
Cash flows from operating activities:
 
 
 
Earnings including noncontrolling interests
$
63,299

 
$
42,123

Adjustments to reconcile net earnings to net cash provided by operating activities:
 
 
 
Performance incentive plan expense
3,889

 
3,297

Depreciation and amortization
37,383

 
27,678

Impairment losses and other charges
380

 
—

Impairment – commercial mortgage residual interests valuation
2,718

 
396

Amortization of notes payable discount
2,378

 
3,335

Amortization of deferred interest rate hedges
114

 
(85
)
Equity in earnings of unconsolidated affiliate
(305
)
 
(213
)
Distributions received from unconsolidated affiliate
362

 
286

Gain on disposition of real estate portfolio
(2,752
)
 
(132
)
Gain on note receivable and property foreclosure
(198
)
 
—

Other
—

 
82

Change in operating assets and liabilities, net of assets acquired and liabilities assumed in business combinations:
 
 
 
Additions to held for sale real estate
(4,472
)
 
(212
)
Proceeds from disposition of held for sale real estate
—

 
1,058

Decrease in real estate leased to others using the direct financing method
807

 
802

Increase in work in process
(889
)
 
(575
)
Increase in mortgages, notes and accrued interest receivable
(345
)
 
(88
)
Decrease in receivables
633

 
998

Decrease (increase) in commercial mortgage residual interests
399

 
(127
)
Decrease (increase) in accrued rental income
(218
)
 
149

Decrease (increase) in other assets
487

 
(19
)
Decrease in accrued interest payable
(668
)
 
(57
)
Decrease in other liabilities
(3,490
)
 
(1,631
)
Increase in current tax liability
255

 
794

Net cash provided by operating activities
99,767

 
77,859

Cash flows from investing activities:
 
 
 
Proceeds from the disposition of real estate, Investment Portfolio
12,024

 
807

Additions to real estate:
 
 
 
Accounted for using the operating method
(287,923
)
 
(111,673
)
Accounted for using the direct financing method
—

 
(1,747
)
Increase in mortgages and notes receivable
(7,861
)
 
(4,090
)
Principal payments on mortgages and notes receivable
3,085

 
2,107

Payment of lease costs
(1,154
)
 
(672
)
Other
557

 
402

Net cash used in investing activities
(281,272
)
 
(114,866
)
 
See accompanying notes to consolidated financial statements.


6

NATIONAL RETAIL PROPERTIES, INC.
and SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
(Unaudited)


 
Six Months Ended June 30,
 
2012
 
2011
Cash flows from financing activities:
 
 
 
Proceeds from line of credit payable
$
614,400

 
$
328,800

Repayment of line of credit payable
(537,400
)
 
(270,600
)
Payment of interest rate hedge
—

 
(5,300
)
Repayment of notes payable
(50,000
)
 
—

Payment of debt costs
—

 
(2,920
)
Repayment of mortgages payable
(680
)
 
(541
)
Proceeds from issuance of common stock
60,319

 
56,391

Proceeds from issuance of preferred stock
287,500

 
—

Redemption of preferred stock
(92,000
)
 
—

Payment of Series C preferred stock dividends
(1,979
)
 
(3,392
)
Payment of Series D preferred stock dividends
(5,926
)
 
—

Payment of common stock dividends
(81,511
)
 
(63,887
)
Noncontrolling interest distributions
—

 
(45
)
Noncontrolling interest contributions
—

 
41

Stock issuance costs
(10,393
)
 
—

Net cash provided by financing activities
182,330

 
38,547

Net increase in cash and cash equivalents
825

 
1,540

Cash and cash equivalents at beginning of year
2,082

 
2,048

Cash and cash equivalents at end of year
$
2,907

 
$
3,588

Supplemental disclosure of cash flow information:
 
 
 
Interest paid, net of amount capitalized
$
38,800

 
$
33,230

Taxes paid (received)
$
78

 
$
(487
)
Supplemental disclosure of noncash investing and financing activities:
 
 
 
Issued 396,577 and 139,351 shares of restricted and unrestricted
    common stock in 2012 and 2011, respectively, pursuant to NNN’s
    performance incentive plan
$
8,576

 
$
3,407

Issued 8,389 and 4,623 shares of common stock in 2012 and 2011,
    respectively, to directors pursuant to NNN’s performance incentive plan
$
229

 
$
118

Issued 10,247 and 13,879 shares of common stock in 2012 and
    2011, respectively, pursuant to NNN’s Deferred Director Fee Plan
$
149

 
$
245

Surrender of 4,178 and of 4,494 shares of restricted common stock in 2012 and
    2011, respectively
$
98

 
$
94

Change in other comprehensive income
$
(326
)
 
$
(4,730
)
Change in lease classification (direct financing lease to operating lease)
$
757

 
$
2,243

Mortgage payable assumed in connection with real estate transaction
$
6,634

 
$
—

Real estate acquired in connection with mortgage receivable foreclosure
$
490

 
$
—

Real estate received in note receivable foreclosure
$
1,595

 
$
—

 
 
See accompanying notes to consolidated financial statements.

7


NATIONAL RETAIL PROPERTIES, INC.
and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2012
(unaudited)

Note 1 – Organization and Summary of Significant Accounting Policies:
Organization and Nature of Business – National Retail Properties, Inc., a Maryland corporation, is a fully integrated real estate investment trust (“REIT”) formed in 1984. The term “NNN” or the “Company” refers to National Retail Properties, Inc. and all of its consolidated subsidiaries. NNN has elected to treat certain subsidiaries as taxable REIT subsidiaries. These taxable subsidiaries and their majority owned and controlled subsidiaries are collectively referred to as the “TRS.”
NNN's assets include: real estate assets, mortgages and notes receivable, and commercial mortgage residual interests. NNN acquires, owns, invests in and develops properties that are leased primarily to retail tenants under long-term net leases and primarily held for investment (“Properties” or “Property Portfolio”). 
    
 
June 30, 2012
Property Portfolio:
 
Total properties
1,506

Gross leasable area (square feet)
17,798,000

States
47

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and do not include all of the information and note disclosures required by accounting principles generally accepted in the United States of America. The unaudited condensed consolidated financial statements reflect all adjustments which are, in the opinion of management, necessary for a fair presentation of the results for the interim periods presented. Operating results for the quarter and six months ended June 30, 2012, may not be indicative of the results that may be expected for the year ending December 31, 2012. Amounts as of December 31, 2011, included in the condensed consolidated financial statements have been derived from the audited consolidated financial statements as of that date. The unaudited condensed consolidated financial statements, included herein, should be read in conjunction with the consolidated financial statements and notes thereto as well as Management's Discussion and Analysis of Financial Condition and Results of Operations in NNN's Form 10-K for the year ended December 31, 2011.
Principles of Consolidation – NNN’s condensed consolidated financial statements include the accounts of each of the respective majority owned and controlled affiliates, including transactions whereby NNN has been determined to be the primary beneficiary in accordance with the Financial Accounting Standards Board (“FASB”) guidance included in Consolidation. All significant intercompany account balances and transactions have been eliminated. NNN applies the equity method of accounting to investments in partnerships and joint ventures that are not subject to control by NNN due to the significance of rights held by other parties.
Real Estate Portfolio – NNN records the acquisition of real estate which is not subject to a lease at cost, including acquisition and closing costs. The cost of properties developed by NNN includes direct and indirect costs of construction, property taxes, interest and other miscellaneous costs incurred during the development period until the project is substantially complete and available for occupancy. During the quarter and six months ended June 30, 2012, NNN recorded $436,000 and $868,000, respectively, in capitalized interest and recorded $247,000 and $569,000 in capitalized interest during the same periods in 2011, respectively.
Purchase Accounting for Acquisition of Real Estate Subject to a Lease – In accordance with the FASB guidance on business combinations, the fair value of the real estate acquired with in-place leases is allocated to the acquired tangible assets, consisting of land, building and tenant improvements, and identified intangible assets and liabilities, consisting of the value of above-market and below-market leases, value of in-place leases and value of tenant relationships, based in each case on their relative fair values. Acquisition costs incurred in connection with a business combination are expensed when incurred.
The fair value of the tangible assets of an acquired leased property is determined by valuing the property as if it were vacant, and the “as-if-vacant” value is then allocated to land, building and tenant improvements based on the determination of the fair values of these assets. The as-if-vacant fair value of a property is provided to management by a qualified appraiser.
In allocating the fair value of the identified intangible assets and liabilities of an acquired property, above-market and below-market in-place lease values are recorded as other assets or liabilities based on the present value (using an interest rate which

8


reflects the risks associated with the leases acquired) of the difference between (i) the contractual amounts to be paid pursuant to the in-place leases, and (ii) management’s estimate of fair market lease rates for the corresponding in-place leases, measured over a period equal to the remaining term of the lease, including the probability of renewal periods. The capitalized above-market lease values are amortized as a reduction of rental income over the remaining terms of the respective leases. The capitalized below-market lease values are amortized as an increase to rental income over the initial term unless the Company believes that it is likely that the tenant would renew the option whereby the Company would amortize the value attributable to the renewal over the renewal period.
The aggregate value of other acquired intangible assets, consisting of in-place leases, is measured by the excess of (i) the purchase price paid for a property after adjusting existing in-place leases to market rental rates over (ii) the estimated fair value of the property as-if-vacant, determined as set forth above. The value of in-place leases exclusive of the value of above-market and below-market in-place leases is amortized to expense over the remaining non-cancelable periods of the respective leases. If a lease were to be terminated prior to its stated expiration, all unamortized amounts relating to that lease would be written off. The value of tenant relationships is reviewed on individual transactions to determine if future value was derived from the acquisition.
Intangible assets and liabilities consisted of the following as of (in thousands):
 
 
June 30, 2012
 
December 31, 2011
Intangible lease assets (included in Other assets):
 
 
 
 
Value of above market in-place leases, net
 
$
6,999

 
$
5,907

Value of in-place leases, net
 
38,342

 
31,970

Intangible lease liabilities (included in Other liabilities):
 
 
 
 
Value of below market in-place leases, net
 
25,377

 
23,367

Investment in an Unconsolidated Affiliate – NNN accounts for its investment in an unconsolidated affiliate under the equity method of accounting. In September 2007, NNN entered into a joint venture, NNN Retail Properties Fund I LLC (the “NNN Crow JV”) with an affiliate of Crow Holdings Realty Partners IV, L.P., which is accounted for under the equity method of accounting.
Cash and Cash Equivalents - NNN considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Cash and cash equivalents consist of cash and money market accounts. Cash equivalents are stated at cost plus accrued interest, which approximates fair value.
Cash accounts maintained on behalf of NNN in demand deposits at commercial banks and money market funds may exceed federally insured levels; however, NNN has not experienced any losses in such accounts.
Valuation of Receivables – NNN estimates the collectibility of its accounts receivable related to rents, expense reimbursements and other revenues. NNN analyzes accounts receivable and historical bad debt levels, customer credit-worthiness and current economic trends when evaluating the adequacy of the allowance for doubtful accounts. In addition, tenants in bankruptcy are analyzed and estimates are made in connection with the expected recovery of pre-petition and post-petition claims.
Earnings Per Share – Earnings per share have been computed pursuant to the FASB guidance included in Earnings Per Share. Effective January 1, 2009, the guidance requires classification of the Company’s unvested restricted share units which contain rights to receive nonforfeitable dividends, as participating securities requiring the two-class method of computing earnings per share. Under the two-class method, earnings per common share are computed by dividing the sum of distributed earnings to common stockholders and undistributed earnings allocated to common stockholders by the weighted average number of common shares outstanding for the period. In applying the two-class method, undistributed earnings are allocated to both common shares and participating securities based on the weighted average shares outstanding during the period.

9


The following table is a reconciliation of the numerator and denominator used in the computation of basic and diluted earnings per common share using the two-class method (dollars in thousands):
 
 
Quarter Ended June 30,
 
Six Months Ended June 30,
 
2012
 
2011
 
2012
 
2011
Basic and Diluted Earnings:
 
 
 
 
 
 
 
Net earnings attributable to NNN
$
33,505

 
$
21,303

 
$
63,337

 
$
42,123

Less: Series C preferred stock dividends
—

 
(1,696
)
 
(1,979
)
 
(3,392
)
Less: Series D preferred stock dividends
(5,926
)
 
—

 
(5,926
)
 
—

Less: Excess of redemption value over carrying value of preferred shares redeemed
—

 
—

 
(3,098
)
 
—

Net earnings available to NNN’s common stockholders
27,579

 
19,607

 
52,334

 
38,731

Less: Earnings attributable to unvested restricted shares
(180
)
 
(152
)
 
(312
)
 
(286
)
Net earnings used in basic earnings per share
27,399

 
19,455

 
52,022

 
38,445

Reallocated undistributed income (loss)
—

 
—

 
—

 
—

Net earnings used in diluted earnings per share
$
27,399

 
$
19,455

 
$
52,022

 
$
38,445

 
 
 
 
 
 
 
 
Basic and Diluted Weighted Average Shares Outstanding:
 
 
 
 
 
 
 
Weighted average number of shares outstanding
107,006,399

 
85,309,082

 
106,321,014

 
84,635,929

Less: Unvested restricted stock
(696,804
)
 
(647,468
)
 
(631,329
)
 
(612,375
)
Less: Contingent shares
(317,581
)
 
(251,826
)
 
(272,090
)
 
(251,826
)
Weighted average number of shares outstanding used in basic earnings
   per share
105,992,014

 
84,409,788

 
105,417,595

 
83,771,728

Effects of dilutive securities:
 
 
 
 
 
 
 
Contingent shares
—

 
—

 
12,735

 
—

Convertible debt
1,310,445

 
160,006

 
1,259,319

 
346,699

Common stock options
1,419

 
3,162

 
1,855

 
3,305

Directors’ deferred fee plan
155,115

 
153,012

 
152,576

 
149,620

Weighted average number of shares outstanding used in diluted earnings
   per share
107,458,993

 
84,725,968

 
106,844,080

 
84,271,352


For the quarter and six months ended June 30, 2011, the potential dilutive shares related to certain convertible notes payable were not included in computing earnings per common share because their effects would be antidilutive.
Fair Value Measurement – NNN’s estimates of fair value of financial and non-financial assets and liabilities are based on the framework established in the fair value accounting guidance. The framework specifies a hierarchy of valuation inputs which was established to increase consistency, clarity and comparability in fair value measurements and related disclosures. The guidance describes a fair value hierarchy based upon three levels of inputs that may be used to measure fair value, two of which are considered observable and one that is considered unobservable. The following describes the three levels:
 
•
Level 1 – Valuation is based upon quoted prices in active markets for identical assets or liabilities.
•
Level 2 – Valuation is based upon inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
•
Level 3 – Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include option pricing models, discounted cash flow models and similar techniques.
New Accounting Pronouncements – In December 2011, the FASB issued Accounting Standards Update ("ASU") 2011-10 entitled Derecognition of in Substance Real Estate - a Scope Clarification. The amendments in this update clarify the scope of current U.S. generally accepted accounting principals ("GAAP"). The amendments will resolve the diversity in practice about

10


whether the guidance in subtopic 360-20 applies to the derecognition of in substance real estate when the parent ceases to have a controlling financial interest in a subsidiary that is in substance real estate because of a default by the subsidiary on its nonrecourse debt. The amendments in this update are effective for fiscal years, and interim periods within those years, beginning on or after June 15, 2012. The adoption of the standard did not have a significant impact on NNN's financial position or results of operations.
In December 2011, the FASB issued ASU 2011-11 amending its guidance on offsetting assets and liabilities in financial statements. The objective of this update will require disclosure to facilitate comparison between those entities that prepare their financial statements on the basis of U.S. GAAP and those entities that prepare their financial statements on the basis of IFRS. The amendments in this update are effective for annual reporting periods beginning on or after January 1, 2013. NNN is currently evaluating the provisions to determine the potential impact, if any, the adoption will have on its financial position and results of operations.
In June 2011, the FASB issued ASU 2011-05 which amended its guidance on the presentation of comprehensive income in financial statements. The new guidance requires that all nonowner changes in stockholders' equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The provisions of this new guidance were effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The adoption of this guidance changed the presentation of NNN's condensed consolidated financial statements but did not have an effect on NNN's results of operations.
In December 2011, the FASB issued ASU 2011-12, which indefinitely defers certain provisions of ASU 2011-05, including a requirement for entities to present reclassification adjustments out of accumulated other comprehensive income by component in both the statement in which net earnings is presented and the statement in which other comprehensive income is presented. The effective dates and expected changes to our presentation are the same as noted in ASU 2011-05 above.
Use of Estimates – Management of NNN has made a number of estimates and assumptions relating to the reporting of assets and liabilities, revenues and expenses and the disclosure of contingent assets and liabilities to prepare these consolidated financial statements in conformity with U.S. GAAP. Significant estimates include provision for impairment and allowances for certain assets, accruals, useful lives of assets and purchase price allocation. Actual results could differ from those estimates.
Reclassification – Certain items in the prior year’s consolidated financial statements and notes to consolidated financial statements have been reclassified to conform to the 2012 presentation.

Note 2 – Real Estate – Portfolio:
Leases – The following outlines key information for NNN’s leases:
    
 
June 30, 2012
Lease classification:
 
Operating
1,493

Direct financing
14

Building portion – direct financing / land portion – operating
5

Weighted average remaining lease term
12 Years

The leases generally provide for limited increases in rent as a result of fixed increases, increases in the consumer price index, and/or increases in the tenant’s sales volume. Generally, the tenant is also required to pay all property taxes and assessments, substantially maintain the interior and exterior of the property and carry property and liability insurance coverage. Certain of NNN’s Properties are subject to leases under which NNN retains responsibility for specific costs and expenses of the property. Generally, the leases of the Properties provide the tenant with one or more multi-year renewal options subject to generally the same terms and conditions, including rent increases, consistent with the initial lease term.

11


Real Estate Portfolio – Accounted for Using the Operating Method – Real estate subject to operating leases consisted of the following as of (dollars in thousands):
 
June 30, 2012
 
December 31, 2011
Land and improvements
$
1,390,175

 
$
1,315,339

Buildings and improvements
2,309,079

 
2,118,303

Leasehold interests
1,290

 
1,290

 
3,700,544

 
3,434,932

Less accumulated depreciation and amortization
(302,435
)
 
(270,023
)
 
3,398,109

 
3,164,909

Work in progress
87,710

 
60,210

 
$
3,485,819

 
$
3,225,119

    

In connection with the improvements of leased Properties, NNN has the following funding commitments (dollars in thousands):
 
June 30, 2012
 
# of
Properties
 
Total
Commitment(1)
 
Amount
Funded
 
Remaining
Commitment
Real Estate Portfolio
54

 
$
167,243

 
$
127,693

 
$
39,550

(1) Includes land and construction costs.

Note 3 – Commercial Mortgage Residual Interests:

In 2010, NNN acquired the 21.1% non-controlling interest in its majority owned and controlled subsidiary, Orange Avenue Mortgage Investments, Inc. (“OAMI”), for $1,603,000, and OAMI became a wholly owned subsidiary of NNN. NNN accounted for the transaction as an equity transaction in accordance with the FASB guidance on consolidation. OAMI holds the residual interests (“Residuals”) from seven commercial mortgage securitizations. Each of the Residuals is recorded at fair value based upon an independent valuation. Unrealized gains and losses are reported as other comprehensive income in stockholders' equity and other than temporary losses as a result of a change in the timing, or amount of estimated cash flows are recorded as an other than temporary valuation impairment.

Due to the expected timing of future cash flows relating to the Residuals, the independent valuation adjusted certain of the valuation assumptions. The following table summarizes the key assumptions used in determining the value of the Residuals as of:
 
June 30, 2012
 
December 31, 2011
Discount rate
25
%
 
25
%
Average life equivalent CPR (1) speeds range
0.80% to 20.42% CPR

 
2.18% to 18.57% CPR

Foreclosures:
 
 
 
Frequency curve default model
0.1% - 3.9% range

 
0.2% - 4.7% range

Loss severity of loans in foreclosure
20
%
 
20
%
Yield:
 
 
 
LIBOR
Forward 3-month curve

 
Forward 3-month curve

Prime
Forward curve

 
Forward curve

(1) Conditional prepayment rate.

The following table summarizes the recognition of unrealized gains and/or losses recorded as other comprehensive income as well as other than temporary valuation impairments recorded in condensed consolidated statements of earnings (dollars in thousands):
 
Quarter Ended June 30,
 
Six Months Ended June 30,
 
2012
 
2011
 
2012
 
2011
Unrealized gains
$
213

 
$
539

 
$
213

 
$
599

Other than temporary valuation impairment
2,718

 
267

 
2,718

 
396


12



Note 4 – Line of Credit Payable:

In May 2011, NNN amended and restated its credit agreement increasing the borrowing capacity under its unsecured revolving credit facility from $400,000,000 to $450,000,000 and amending certain other terms under the former revolving credit facility (as the context requires, the previous and new revolving credit facility, the “Credit Facility”). The Credit Facility had a weighted average outstanding balance of $52,946,000 and a weighted average interest rate of 1.8 percent during the six months ended June 30, 2012. The Credit Facility matures May 2015, with an option to extend maturity to May 2016. The Credit Facility bears interest at LIBOR plus 150 basis points; however, such interest rate may change pursuant to a tiered interest rate structure based on NNN's debt rating. The Credit Facility also includes an accordion feature to increase the facility size up to $650,000,000, subject to lender approval. As of June 30, 2012, $142,600,000 was outstanding and $307,400,000 was available for future borrowings under the Credit Facility, excluding undrawn letters of credit totaling $3,800,000.

Note 5 – Stockholders' Equity:
The following table outlines the dividends declared and paid for each issuance of NNN's stock (in thousands, except per share data):
 
 
Six Months Ended June 30,
 
 
2012
 
2011
Series C preferred stock (1):
 
 
 
 
Dividends
$
1,979

 
$
3,392

 
Per share
0.5378

 
0.9218

 
 
 
 
 
Series D preferred stock (2):
 
 
 
 
Dividends
5,926

 
—

 
Per share
0.5153

 
—

 
 
 
 
 
Common stock:
 
 
 
 
Dividends
81,511

 
63,887

 
Per share
0.770

 
0.760

1) The Series C preferred stock was redeemed in March 2012. The dividends paid during the quarter ended March 31, 2012 include accumulated and unpaid dividends through the redemption date.
2) The Series D preferred stock dividends paid during the quarter ended June 30, 2012 include accumulated and unpaid dividends from the issuance date through the declaration date. The Series D preferred stock has no maturity date and will remain outstanding unless redeemed.

In February 2012, NNN filed a shelf registration statement with the Securities and Exchange Commission (the "Commission") which permits the issuance by NNN of an indeterminate amount of debt and equity securities.
In February 2012, NNN issued 11,500,000 depositary shares representing interests in our 6.625% Series D Cumulative Redeemable Preferred Stock ("Series D Preferred Stock") at a price of $25.00 per depositary share generating net proceeds of $277,645,000. In connection with this offering, NNN incurred stock issuance costs totaling approximately $9,855,000, consisting primarily of underwriters' fees and commissions, legal and accounting fees and printing expenses.
In March 2012, NNN redeemed all outstanding depositary shares (3,680,000) representing interests in its 7.375% Series C Cumulative Redeemable Preferred Stock (“Series C Preferred Stock”). The Series C Preferred Stock was redeemed at $25.00 per depositary share, plus accumulated and unpaid distributions through the redemption date, for an aggregate redemption price of $25.0768229 per depositary share. The excess carrying amount of preferred stock redeemed over the cash paid to redeem the preferred stock was $3,098,000 representing Series C Preferred Stock issuance costs.
In May 2012, NNN established an at-the-market (“ATM”) equity program which allows NNN to sell up to an aggregate of 9,000,000 shares of common stock from time to time over the next three years. NNN intends to use the net proceeds from this offering to repay outstanding indebtedness under the Credit Facility, to fund potential property acquisitions and for other general corporate purposes. During the quarter and six months ended June 30, 2012, NNN issued approximately 395,000 shares of common stock through the ATM at an average price of $27.30 per share generating approximately $10,527,000 in net proceeds. In connection with the ATM, NNN incurred stock issuance costs totaling approximately $253,000, consisting primarily of underwriters' fees and commissions and legal and accounting fees.
In July 2012, NNN declared a dividend of $0.395 per share, which is payable in August 2012 to its common stockholders of

13


record as of July 31, 2012.
In February 2012, NNN filed a shelf registration statement with the Commission for its Dividend Reinvestment and Stock Purchase Plan (“DRIP”) which permits the issuance by NNN of up to 16,000,000 shares of common stock. The following outlines the common stock issuances pursuant to the DRIP (dollars in thousands):
        
 
Six Months Ended June 30,
 
2012
 
2011
Shares of common stock
1,881,807

 
2,284,335

Net proceeds
$
49,476

 
$
56,447


Note 6 – Income Taxes:
NNN has elected to be taxed as a REIT under the Internal Revenue Code (“Code”), commencing with its taxable year ended December 31, 1984.  To qualify as a REIT, NNN must meet a number of organizational and operational requirements, including a requirement that it currently distribute at least 90% of its REIT taxable income to its stockholders.  NNN intends to adhere to these requirements and maintain its REIT status. As a REIT, NNN generally will not be subject to corporate level federal income tax on taxable income that it distributes currently to its stockholders.  NNN may be subject to certain state and local taxes on its income and property, and to federal income and excise taxes on its undistributed taxable income, if any.  The provision for federal income taxes in NNN's consolidated financial statements relates to its TRS operations and any potential taxable built-in gain.  NNN did not have significant tax provisions or deferred income tax items during the periods reported hereunder.

In June 2006, the FASB issued guidance, which clarifies the accounting for uncertainty in income taxes recognized in a company's financial statements in accordance with FASB guidance included in Income Taxes. The interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.

NNN, in accordance with FASB guidance included in Income Taxes, has analyzed its various federal and state tax filing positions. NNN believes that its income tax filing positions and deductions are well documented and supported. Additionally, NNN believes that its accruals for tax liabilities are adequate. Therefore, no reserves for uncertain income tax positions have been recorded pursuant to the FASB guidance. In addition, NNN did not record a cumulative effect adjustment related to the adoption of the FASB guidance.

NNN has had no increases or decreases in unrecognized tax benefits for current or prior years since adopting the guidance. Further, no interest or penalties have been included since no reserves were recorded and no significant increases or decreases are expected to occur within the next 12 months. When applicable, such interest and penalties will be recorded as non-operating expenses. The periods that remain open under federal statute are 2008 through 2012. NNN also files in many states with varying open years under statute.


14


Note 7 – Earnings from Discontinued Operations:
NNN classified the revenues and expenses related to properties which were sold or were held for sale as of June 30, 2012, as discontinued operations. The following is a summary of the earnings from discontinued operations (dollars in thousands):
 
Quarter Ended June 30,
 
Six Months Ended June 30,
 
2012
 
2011
 
2012
 
2011
Revenues:
 
 
 
 
 
 
 
Rental income from operating leases
$
687

 
$
1,273

 
$
1,571

 
$
2,163

Earned income from direct financing leases
—

 
20

 
6

 
40

Interest and other income from real estate transactions
110

 
165

 
262

 
359

 
797

 
1,458

 
1,839

 
2,562

Operating expenses:
 
 
 
 
 
 
 
General and administrative
4

 
3

 
7

 
7

Real estate
192

 
346

 
478

 
621

Depreciation and amortization
35

 
132

 
95

 
263

Impairment losses and other charges
345

 
—

 
380

 
—

 
576

 
481

 
960

 
891

Other expenses (revenues):
 
 
 
 
 
 
 
Interest expense
360

 
340

 
717

 
681

 
360

 
340

 
717

 
681

Earnings before gain on disposition of real estate and income tax
   expense
(139
)
 
637

 
162

 
990

Gain on disposition of real estate
2,438

 
1

 
2,752

 
132

Income tax expense
(60
)
 
(70
)
 
(97
)
 
(117
)
Earnings from discontinued operations attributable to NNN
2,239

 
568

 
2,817

 
1,005

Earnings attributable to noncontrolling interests
(5
)
 
(33
)
 
(17
)
 
(93
)
Earnings from discontinued operations attributable to NNN
$
2,234

 
$
535

 
$
2,800

 
$
912


Note 8 – Derivatives:
In accordance with the guidance on derivatives and hedging, NNN records all derivatives on the balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative and the resulting designation. Derivatives used to hedge the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives used to hedge the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges.
NNN’s objective in using derivatives is to add stability to interest expense and to manage its exposure to interest rate movements or other identified risks. To accomplish this objective, NNN primarily uses treasury locks, forward swaps and interest rate swaps as part of its cash flow hedging strategy. Treasury locks and forward starting swaps are used to hedge forecasted debt issuances. Treasury locks designated as cash flow hedges lock in the yield/price of a treasury security. Forward swaps also lock the associated swap spread. Interest rate swaps designated as cash flow hedges hedging the variable cash flows associated with floating rate debt involve the receipt of variable rate amounts in exchange for fixed-rate payments over the life of the agreements without exchange of the underlying principal amount.
For derivatives designated as cash flow hedges, the effective portion of changes in the fair value of the derivative is initially reported in other comprehensive income (outside of earnings) and subsequently reclassified to earnings when the hedged transaction affects earnings, and the ineffective portion of changes in the fair value of the derivative is recognized directly in earnings.
NNN discontinues hedge accounting prospectively when it is determined that the derivative is no longer effective in offsetting changes in the cash flows of the hedged item, the derivative expires or is sold, terminated, or exercised, the derivative is re-designated as a hedging instrument or management determines that designation of the derivative as a hedging instrument is no longer appropriate.

15


When hedge accounting is discontinued, NNN continues to carry the derivative at its fair value on the balance sheet, and recognizes any changes in its fair value in earnings or may choose to cash settle the derivative at that time.
In June 2011, NNN terminated its two treasury locks with a total notional amount of $150,000,000 that were hedging the risk of changes in the interest-related cash outflows associated with the potential issuance of long-term debt. The fair value of the treasury locks, designated as cash flow hedges, when terminated was a liability of $5,300,000, of which $5,218,000 was deferred in other comprehensive income.
As of June 30, 2012, $5,811,000 remains in other comprehensive income related to the effective portion of NNN’s previous interest rate hedges. During the six months ended June 30, 2012 and 2011, NNN reclassed out of comprehensive income $114,000 as an increase to interest expense and $85,000 as a reduction to interest expense, respectively. Over the next 12 months, NNN estimates that an additional $240,000 will be reclassified as an increase in interest expense. Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest expense as interest payments are made on NNN’s long-term debt.
NNN does not use derivatives for trading or speculative purposes or currently have any derivatives that are not designated as hedges. NNN had no derivative financial instruments outstanding at June 30, 2012.

Note 9 – Segment Information:

As a result of a continued reduction of investments in real estate acquired for the purpose of resale, the previously reported segment of inventory assets no longer meets the criteria for significance for separate segment reporting. Therefore, for the quarters and six months ended June 30, 2012 and 2011, NNN's operations are reported within one business segment in the condensed consolidated financial statements.

Note 10 – Fair Value Measurements:
NNN currently values its Residuals based upon an independent valuation which provides a discounted cash flow analysis based upon prepayment speeds, expected loan losses and yield curves. These valuation inputs are generally considered unobservable; therefore, the Residuals are considered Level 3 financial assets. The table below presents a reconciliation of the Residuals (dollars in thousands):
 
Six Months Ended June 30, 2012
Balance at beginning of period
$
15,299

Total gains (losses) – realized/unrealized:
 
Included in earnings
(2,718
)
Included in other comprehensive income
213

Interest income on Residuals
1,471

Cash received from Residuals
(1,870
)
Purchases, sales, issuances and settlements, net
—

Transfers in and/or out of Level 3
—

Balance at end of period
$
12,395

Changes in gains (losses) included in earnings attributable to a change in unrealized gains (losses) relating to
    assets still held at the end of period
$
(130
)

Note 11 – Fair Value of Financial Instruments:
NNN believes the carrying value of its Credit Facility approximates fair value based upon its nature, terms and variable interest rate. NNN believes that the carrying value of its cash and cash equivalents, mortgages, notes and other receivables, mortgages payable and other liabilities at June 30, 2012 and December 31, 2011, approximate fair value based upon current market prices of similar issues. At June 30, 2012 and December 31, 2011, the fair value of NNN’s notes payable and convertible notes payable, collectively, was 1,347,658,000 and $1,362,922,000, respectively, based upon the quoted market price, which is level one valuation.


16


Note 12 – Subsequent Events:
NNN reviewed all subsequent events and transactions that have occurred after June 30, 2012, the date of the condensed consolidated balance sheet. There were no reportable subsequent events or transactions.

17


Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes included in the Annual Report on Form 10-K of National Retail Properties, Inc. for the year ended December 31, 2011. The term “NNN” or the “Company” refers to National Retail Properties, Inc. and all of its consolidated subsidiaries. NNN has elected to treat certain subsidiaries as taxable real estate investment trust subsidiaries. These subsidiaries and their majority owned and controlled subsidiaries are collectively referred to as the “TRS.”

Forward-Looking Statements

The information herein contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities and Exchange Act of 1934 (the “Exchange Act”). These statements generally are characterized by the use of terms such as “believe,” “expect,” “intend,” “may,” or similar words or expressions. Forward-looking statements are not historical facts or guarantees of future performance and are subject to known and unknown risks. Certain factors that could cause actual results or events to differ materially from those NNN anticipates or projects include, but are not limited to, the following:

•
Current financial and economic conditions may have an adverse impact on NNN, its tenants, and commercial real estate in general;
•
NNN may be unable to obtain debt or equity capital on favorable terms, if at all;
•
Loss of revenues from tenants would reduce NNN's cash flow;
•
A significant portion of the source of NNN's Property Portfolio annual base rent is heavily concentrated in specific industry classifications, tenants and in specific geographic locations;
•
Owning real estate and indirect interests in real estate carries inherent risk;
•
NNN's real estate investments are illiquid;
•
Costs of complying with changes in governmental laws and regulations may adversely affect NNN's results of operations;
•
NNN may be subject to known or unknown environmental liabilities and hazardous materials on properties owned by NNN;
•
NNN may not be able to successfully execute its acquisition or development strategies;
•
NNN may not be able to dispose of properties consistent with its operating strategy;
•
A change in the assumptions used to determine the value of commercial mortgage residual interests could adversely affect NNN's financial position;
•
NNN may suffer a loss in the event of a default or bankruptcy of a borrower or a tenant;
•
Certain provisions of NNN's leases or loan agreements may be unenforceable;
•
Property ownership through joint ventures and partnerships could limit NNN's control of those investments;
•
Competition with numerous other REITs, commercial developers, real estate limited partnerships and other investors may impede NNN's ability to grow;
•
NNN's loss of key management could adversely affect performance and the value of its common stock;
•
Uninsured losses may adversely affect NNN's ability to pay outstanding indebtedness;
•
Acts of violence, terrorist attacks or war may adversely affect the markets in which NNN operates and NNN's results of operations;
•
Vacant properties or bankrupt tenants could adversely affect NNN's business or financial condition;
•
The amount of debt NNN has and the restrictions imposed by that debt could adversely affect NNN's business and financial condition;
•
NNN is obligated to comply with financial and other covenants in its debt instruments that could restrict its operating activities, and the failure to comply with such covenants could result in defaults that accelerate the payment of such debt;
•
The market value of NNN's equity and debt securities is subject to various factors that may cause significant fluctuations or volatility;
•
NNN's failure to qualify as a real estate investment trust for federal income tax purposes could result in significant tax liability;
•
Even if NNN remains qualified as a REIT, NNN may face other tax liabilities that reduce operating results and cash flow;
•
Adverse legislative or regulatory tax changes could reduce NNN's earnings, cash flow and market price of NNN's common stock;
•
Compliance with REIT requirements, including distribution requirements, may limit NNN's flexibility and negatively affect NNN's operating decisions;
•
Changes in accounting pronouncements could adversely impact NNN's or NNN's tenants' reported financial

18


performance;
•
NNN's failure to maintain effective internal control over financial reporting could have a material adverse effect on its business, operating results and share price;
•
NNN's ability to pay dividends in the future is subject to many factors; and
•
Cybersecurity risks and cyber incidents could adversely affect NNN's business and disrupt operations.

Additional information related to these risks and uncertainties are included in Item 1A. Risk Factors of NNN's Annual Report on Form 10-K for the year ended December 31, 2011, and may cause NNN's actual future results to differ materially from expected results. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements, which speak only as of the date of this Quarterly Report on Form 10-Q. NNN undertakes no obligation to update or revise such forward-looking statements, whether as a result of new information, future events or otherwise.
Overview
NNN, a Maryland corporation, is a fully integrated real estate investment trust (“REIT”) formed in 1984. NNN assets include: real estate assets, mortgages and notes receivable, and commercial mortgage residual interests. NNN acquires, owns, invests in and develops properties that are leased primarily to retail tenants under long-term net leases and primarily held for investment (“Properties” or “Property Portfolio”).
As of June 30, 2012, NNN owned 1,506 Properties, with an aggregate gross leasable area of approximately 17,798,000 square feet, located in 47 states. Approximately 98 percent of total properties in the Property Portfolio were leased as of June 30, 2012. Effective May 1, 2012, none of NNN's Properties were operated.
NNN’s management team focuses on certain key indicators to evaluate the financial condition and operating performance of NNN. The key indicators for NNN include items such as: the composition of the Property Portfolio (such as tenant, geographic and line of trade diversification), the occupancy rate of the Property Portfolio, certain financial performance ratios and profitability measures, and industry trends and performance compared to that of NNN.
NNN continues to maintain its diversification by tenant, geography and tenant’s line of trade. NNN’s highest lines of trade concentrations are the convenience store and restaurant (including full and limited service) sectors. These sectors represent a large part of the freestanding retail property marketplace and NNN’s management believes these sectors present attractive investment opportunities. NNN’s Property Portfolio is geographically concentrated in the south and southeast United States, which are regions of historically above-average population growth. Given these concentrations, any financial hardship within these sectors or geographic locations, respectively, could have a material adverse effect on the financial condition and operating performance of NNN.
Prior to December 31, 2011, NNN reported its operations in two primary business segments, investment assets and inventory assets. As a result of a continued reduction of investments in real estate acquired for the purpose of resale, the previously reported segment of inventory assets no longer meets the criteria for significance for separate segment reporting. Currently, NNN's operations are reported within one business segment in the financial statements and all properties are considered part of the Properties or Property Portfolio. As such, property counts and calculations involving property counts reflect all NNN properties.



19


Results of Operations
Property Analysis
General.  The following table summarizes NNN’s Property Portfolio as of:
 
June 30, 2012
 
December 31, 2011
 
June 30, 2011
Properties Owned:
 
 
 
 
 
Number
1,506

 
1,422

 
1,248

Total gross leasable area (square feet)
17,798,000

 
16,428,000

 
13,623,000

Properties:
 
 
 
 
 
Leased and operated
1,471

 
1,375

 
1,209

Percent of Properties – leased and operated
98
%
 
97
%
 
97
%
Weighted average remaining lease term (years)
12

 
12

 
12

Total gross leasable area (square feet) – leased and operated
17,331,000

 
15,681,000

 
12,912,000


The following table summarizes the diversification of NNN’s Property Portfolio based on the top 10 lines of trade:
 
 
 
 
% of Annual Base Rent (1)
 
 
Lines of Trade
 
June 30, 2012
 
December 31, 2011
 
June 30, 2011
1.
 
Convenience stores
 
22.6
%
 
24.6
%
 
22.9
%
2.
 
Restaurants - full service
 
11.4
%
 
9.4
%
 
10.6
%
3.
 
Automotive parts
 
6.0
%
 
6.5
%
 
7.6
%
4.
 
Automotive service
 
5.9
%
 
4.9
%
 
5.3
%
5.
 
Theaters
 
4.6
%
 
5.0
%
 
5.7
%
6.
 
Sporting goods
 
4.5
%
 
4.8
%
 
4.5
%
7.
 
Wholesale clubs
 
3.7
%
 
4.0
%
 
0.4
%
8.
 
Restaurants - limited service
 
3.6
%
 
3.6
%
 
4.2
%
9.
 
Drug Stores
 
3.2
%
 
3.2
%
 
3.8
%
10.
 
Consumer electronics
 
3.2
%
 
3.5
%
 
2.5
%
 
 
Other
 
31.3
%
 
30.5
%
 
32.5
%
 
 
 
 
100.0
%
 
100.0
%
 
100.0
%
(1) Based on annualized base rent for all leases in place for each respective period.

Property Acquisitions.  The following table summarizes the Property acquisitions (dollars in thousands):
 
Quarter Ended June 30,
 
Six Months Ended June 30,
 
2012
 
2011
 
2012
 
2011
Acquisitions:
 
 
 
 
 
 
 
Number of Properties
27

 
25

 
94

 
54

Gross leasable area (square feet)
880,000

 
303,000

 
1,473,000

 
657,000

Total dollars invested(1)
$
114,980

 
$
54,208

 
$
312,958

 
$
109,261

(1) Includes dollars invested in projects under construction or tenant improvements for each respective year.
NNN typically funds property acquisitions either through borrowings under NNN's unsecured revolving credit facility or by issuing its debt or equity securities in the capital markets.

20


Property Dispositions.  The following table summarizes the properties sold by NNN (dollars in thousands):
 
Quarter Ended June 30,
 
Six Months Ended June 30,
 
2012
 
2011
 
2012
 
2011
Number of properties
7

 
—

 
10

 
2

Gross leasable area (square feet)
81,000

 
—

 
101,000

 
11,000

Net sales proceeds
$
6,589

 
$
—

 
$
11,741

 
$
1,831

Net gain
$
2,438

 
$
—

 
$
2,752

 
$
86


NNN typically uses the proceeds from property sales either to pay down the credit facility or reinvest in real estate.
Revenue from Continuing Operations Analysis
General.  During the quarter and six months ended June 30, 2012, NNN’s rental income increased primarily due to the increase in rental income from property acquisitions (See “Results of Operations – Property Analysis – Property Acquisitions”). NNN anticipates increases in rental income will continue to come from additional property acquisitions and increases in rents pursuant to lease terms.
The following summarizes NNN’s revenues from continuing operations (dollars in thousands):
 
Quarter Ended June 30,
 
 
 
Six Months Ended June 30,
 
 
 
2012
 
2011
 
2012
 
2011
 
Percent
Increase
(Decrease)
 
2012
 
2011
 
2012
 
2011
 
Percent
Increase
(Decrease)
 
 
 
 
 
Percent of Total
 
 
 
 
 
 
 
Percent of Total
 
 
Rental Income(1)
$
78,766

 
$
58,403

 
95.2
%
 
94.4
%
 
34.9%
 
$
153,072

 
$
116,206

 
94.9
%
 
94.2
%
 
31.7%
Real estate expense reimbursement from tenants
2,505

 
2,142

 
3.0
%
 
3.5
%
 
16.9%
 
5,337

 
4,422

 
3.3
%
 
3.6
%
 
20.7%
Interest and other income from real estate transactions
764

 
543

 
0.9
%
 
0.9
%
 
40.7%
 
1,470

 
1,164

 
0.9
%
 
0.9
%
 
26.3%
Interest income on commercial mortgage residual interests
716

 
777

 
0.9
%
 
1.2
%
 
(7.9)%
 
1,471

 
1,544

 
0.9
%
 
1.3
%
 
(4.7)%
Total revenues from continuing operations
$
82,751

 
$
61,865

 
100.0
%
 
100.0
%
 
33.8%
 
$
161,350

 
$
123,336

 
100.0
%
 
100.0
%
 
30.8%

(1) Includes rental income from operating leases, earned income from direct financing leases and percentage rent from continuing operations (“Rental Income”).
Rental Income.  Rental Income increased in amount and as a percent of the total revenues from continuing operations for the quarter and six months ended June 30, 2012, as compared to the same period in 2011. The increase for the quarter and six months ended June 30, 2012, is primarily due to the acquisition of 93 properties with aggregate gross leasable area of approximately 1,466,000 square feet during the six months ended 2012 and 218 properties with aggregate gross leasable area of approximately 3,445,000 square feet during 2011.
Real Estate Expense Reimbursement from Tenants.  Real estate expense reimbursements from tenants increased for the quarter and six months ended June 30, 2012, as compared to the same period in 2011, but remained relatively stable as a percentage of total revenues from continuing operations. The increase is primarily attributable to a full year of reimbursements from certain properties acquired in 2011.

21


Analysis of Expenses from Continuing Operations
General.  Operating expenses from continuing operations increased during the quarter and six months ended June 30, 2012, primarily due to the increase in depreciation expense from certain properties acquired in 2011 and impairment on the commercial mortgage residual interest ("Residuals") valuations. The following table summarizes NNN’s expenses from continuing operations for the quarters ended June 30 (dollars in thousands):
 
 
 
 
 

Percent
Increase
(Decrease)
 
Percentage of Total
 
Percentage of
Revenues from
Continuing Operations
 
2012
 
2011
 
 
2012
 
2011
 
2012
 
2011
General and administrative
$
7,024

 
$
6,568

 
6.9%
 
21.4
 %
 
26.8
 %
 
8.5
 %
 
10.6
 %
Real estate
4,025

 
3,919

 
2.7%
 
12.3
 %
 
16.0
 %
 
4.9
 %
 
6.3
 %
Depreciation and amortization
19,032

 
13,765

 
38.3%
 
58.0
 %
 
56.1
 %
 
23.0
 %
 
22.3
 %
Impairment – commercial mortgage residual interests valuation
2,718

 
267

 
918.0%
 
8.3
 %
 
1.1
 %
 
3.3
 %
 
0.4
 %
Total operating expenses
$
32,799

 
$
24,519

 
33.8%
 
100.0
 %
 
100.0
 %
 
39.7
 %
 
39.6
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest and other income
$
(361
)
 
$
(283
)
 
27.6%
 
(1.9
)%
 
(1.6
)%
 
(0.4
)%
 
(0.5
)%
Interest expense
19,394

 
17,512

 
10.7%
 
101.9
 %
 
101.6
 %
 
23.4
 %
 
28.3
 %
Total other expenses
$
19,033

 
$
17,229

 
10.5%
 
100.0
 %
 
100.0
 %
 
23.0
 %
 
27.8
 %

The following table summarizes NNN’s expenses from continuing operations for the six months ended June 30 (dollars in thousands):
 
 
 
 
 

Percent
Increase
(Decrease)
 
Percentage of Total
 
Percentage of
Revenues from
Continuing Operations
 
2012
 
2011
 
 
2012
 
2011
 
2012
 
2011
General and administrative
$
14,627

 
$
13,226

 
10.6%
 
23.2
 %
 
27.3
 %
 
9.1
 %
 
10.7
 %
Real estate
8,597

 
7,573

 
13.5%
 
13.6
 %
 
15.7
 %
 
5.3
 %
 
6.1
 %
Depreciation and amortization
37,140

 
27,184

 
36.6%
 
58.9
 %
 
56.2
 %
 
23.0
 %
 
22.0
 %
Impairment – commercial mortgage residual interests valuation
2,718

 
396

 
586.4%
 
4.3
 %
 
0.8
 %
 
1.7
 %
 
0.3
 %
Total operating expenses
$
63,082

 
$
48,379

 
30.4%
 
100.0
 %
 
100.0
 %
 
39.1
 %
 
39.1
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest and other income
$
(719
)
 
$
(625
)
 
15.0%
 
(1.9
)%
 
(1.8
)%
 
(0.4
)%
 
(0.5
)%
Interest expense
39,039

 
35,174

 
11.0%
 
101.9
 %
 
101.8
 %
 
24.2
 %
 
28.5
 %
Total other expenses
$
38,320

 
$
34,549

 
10.9%
 
100.0
 %
 
100.0
 %
 
23.8
 %
 
28.0
 %
    

General and Administrative Expenses.  General and administrative expenses increased for the quarter and six months ended June 30, 2012, as compared to the same period in 2011, but decreased as a percentage of total operating expenses and as a percentage of revenues from continuing operations. The increase in general and administrative expenses is primarily attributable to an increase in stock based incentive compensation.
Real Estate.  Real estate expenses increased for the quarter and six months ended June 30, 2012, as compared to the same period in 2011, but decreased as a percentage of total operating expenses and as a percentage of revenues from continuing operations. The increase is primarily due to an increase in tenant reimbursable expenses for certain properties acquired in 2011.
Depreciation and Amortization.  Depreciation and amortization expenses increased as a percentage of total operating expenses and as a percentage of revenues from continuing operations for the quarter and six months ended June 30, 2012, as compared to the quarter and six months ended June 30, 2011. The increase is primarily due to depreciation expense from the 218 properties

22


with aggregate gross leasable area of approximately 3,445,000 square feet acquired during 2011.
Impairment  –  Commercial Mortgage Residual Interests Valuation.  In connection with the independent valuations of the Residuals fair value, during the six months ended June 30, 2012 and 2011, NNN recorded an other than temporary valuation adjustment of $2,718,000 and $396,000, respectively, as a reduction of earnings from operations.
Interest Expense.  Interest expense increased for the quarter and six months ended June 30, 2012, as compared to the same periods in 2011.
The following represents the primary changes in debt that have impacted interest expense:
(i)
the issuance of $300,000,000 in July 2011 of notes payable with a maturity of July 2021, and stated interest rate of 5.500%, and
(ii)
the decrease of $138,154,000 in the weighted average debt outstanding on the Credit Facility for the six months ended June 30, 2012, as compared to the same period in 2011.
Discontinued Operations
Earnings (Loss). NNN classified as discontinued operations the revenues and expenses related to its revenue generating Properties that were sold and any revenue generating Properties that were held for sale at June 30, 2012.
The following table summarizes the earnings from discontinued operations for the quarters ended June 30 (dollars in thousands):
 
2012
 
2011
# of Sold
Properties
 
Gain
 
Earnings
 
# of Sold
Properties
 
Gain
 
Earnings
Properties
7

 
$
2,438

 
$
2,239

 
—

 
$
1

 
$
568

Noncontrolling interests
—

 
—

 
(5
)
 
—

 
—

 
(33
)
 
7

 
$
2,438

 
$
2,234

 
—

 
$
1

 
$
535


The following table summarizes the earnings from discontinued operations for the six months ended June 30 (dollars in thousands):
 
2012
 
2011
# of Sold
Properties
 
Gain
 
Earnings
 
# of Sold
Properties
 
Gain
 
Earnings
Properties
10

 
$
2,752

 
$
2,817

 
2

 
$
87

 
$
1,005

Noncontrolling interests
—

 
—

 
(17
)
 
—

 
—

 
(93
)
 
10

 
$
2,752

 
$
2,800

 
2

 
$
87

 
$
912

    

NNN periodically sells Properties and may reinvest the sales proceeds to purchase additional properties. NNN evaluates its ability to pay dividends to stockholders by considering the combined effect of income from continuing and discontinued operations.

Liquidity
General.  NNN’s demand for funds has been and will continue to be primarily for (i) payment of operating expenses and cash dividends; (ii) property acquisitions and development; (iii) origination of mortgages and notes receivable; (iv) capital expenditures; (v) payment of principal and interest on its outstanding indebtedness; and (vi) other investments.

23


Cash and Cash Equivalents.  The table below summarizes NNN’s cash flows (in thousands):
 
Six Months Ended June 30,
 
2012
 
2011
Cash and cash equivalents:
 
 
 
Provided by operating activities
$
99,767

 
$
77,859

Used in investing activities
(281,272
)
 
(114,866
)
Provided by financing activities
182,330

 
38,547

Increase
825

 
1,540

Net cash at beginning of period
2,082

 
2,048

Net cash at end of period
$
2,907

 
$
3,588


Cash provided by operating activities represents cash received primarily from rental income from tenants, proceeds from the disposition of certain properties and interest income less cash used for general and administrative expenses, interest expense and acquisition of certain properties. NNN’s cash flow from operating activities, net of cash used in and provided by the acquisition and disposition of certain properties, has been sufficient to pay the distributions for each period presented. NNN generally uses proceeds from its Credit Facility or from offerings of equity or debt securities in the capital markets to fund the acquisition of its properties. The change in cash provided by operations for the six months ended June 30, 2012 and 2011, is primarily the result of changes in revenues and expenses as discussed in “Results of Operations.” Cash generated from operations is expected to fluctuate in the future.
Changes in cash for investing activities are primarily attributable to the acquisitions and dispositions of Properties.
NNN’s financing activities for the six months ended June 30, 2012, included the following significant transactions:
•
$77,000 in net proceeds from NNN's credit facility,
•
$277,645,000 in net proceeds from the issuance of 11,500,000 depositary shares representing interests in NNN's 6.625% Series D Cumulative Redeemable Preferred Stock (the "Series D Preferred Stock") in February,
•
$92,000,000 paid to fully redeem NNN's 7.375% Series C Cumulative Redeemable Preferred Stock (the "Series C Preferred Stock"),
•
$49,476,000 in net proceeds from the issuance of 1,881,807 shares of common stock in connection with the Dividend Reinvestment and Stock Purchase Plan ("DRIP"),
•
$10,527,000 in net proceeds from the issuance of approximately 395,000 shares of common stock in connection with the at-the-market ("ATM") equity program,
•
$81,511,000 in dividends paid to common stockholders,
•
$1,979,000 in dividends paid to holders of the depositary shares of NNN’s Series C Preferred Stock,
•
$5,926,000 in dividends paid to holders of the depositary shares of NNN’s Series D Preferred Stock, and
•
$50,000,000 in repayment of notes payable.
Contractual Obligations and Commercial Commitments. As of June 30, 2012, NNN has agreed to fund construction commitments in connection with the improvements of leased Properties as outlined in the table below (dollars in thousands):
 
# of
Properties
 
Total
Commitment(1)
 
Amount
Funded
 
Remaining
Commitment
Real Estate Portfolio
54

 
$
167,243

 
$
127,693

 
$
39,550

(1) Includes land and construction costs.
 As of June 30, 2012, NNN did not have any other material contractual cash obligations, such as purchase obligations, financing lease obligations or other long-term liabilities other than those reflected in the table above and previously disclosed under Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations included in NNN's Annual Report on Form 10-K for the year ended December 31, 2011. In addition to items reflected in the table, NNN has issued preferred stock with cumulative preferential cash distributions, as described below under “Dividends.”
Management anticipates satisfying these obligations with a combination of NNN’s cash provided from operations, current

24


capital resources on hand, its credit facility, debt or equity financings and asset dispositions.
Generally the Properties are leased under long-term net leases, which generally require the tenant to pay all property taxes and assessments, substantially maintain the interior and exterior of the property and carry property, and liability insurance coverage. Therefore, management anticipates that capital demands to meet obligations with respect to these Properties will be modest for the foreseeable future and can be met with funds from operations and working capital. Certain of NNN’s Properties are subject to leases under which NNN retains responsibility for specific costs and expenses associated with the Property. Management anticipates the costs associated with NNN’s vacant Properties or those Properties that become vacant will also be met with funds from operations and working capital. NNN may be required to borrow under its credit facility or use other sources of capital in the event of unforeseen significant capital expenditures.
The lost revenues and increased property expenses resulting from vacant properties or uncollectibility of lease revenues could have a material adverse effect on the liquidity and results of operations if NNN is unable to re-lease the Properties at comparable rental rates and in a timely manner. As of June 30, 2012, NNN owned 35 vacant, un-leased Properties which accounted for less than two percent of total Properties held in NNN’s Property Portfolio.
NNN generally monitors the financial performance of NNN's significant tenants on an ongoing basis.
Dividends.  NNN has made an election to be taxed as a REIT under Sections 856 through 860 of the Code, as amended, and related regulations and intends to continue to operate so as to remain qualified as a REIT for federal income tax purposes. NNN generally will not be subject to federal income tax on income that it distributes to its stockholders, provided that it distributes 100 percent of its REIT taxable income and meets certain other requirements for qualifying as a REIT. If NNN fails to qualify as a REIT in any taxable year, it will be subject to federal income tax on its taxable income at regular corporate rates and will not be permitted to qualify for treatment as a REIT for federal income tax purposes for four years following the year during which qualification is lost. Such an event could materially adversely affect NNN’s income and ability to pay dividends. NNN believes it has been structured as, and its past and present operations qualify NNN as, a REIT.
One of NNN’s primary objectives, consistent with its policy of retaining sufficient cash for reserves and working capital purposes and maintaining its status as a REIT, is to distribute a substantial portion of its funds available from operations to its stockholders in the form of dividends.
The following table outlines the dividends declared and paid for each issuance of NNN's stock (in thousands, except per share data):
 
 
Six Months Ended June 30,
 
 
2012
 
2011
Series C preferred stock (1):
 
 
 
 
Dividends
$
1,979

 
$
3,392

 
Per share
0.5378

 
0.9218

 
 
 
 
 
Series D preferred stock (2):
 
 
 
 
Dividends
5,926

 
—

 
Per share
0.5153

 
—

 
 
 
 
 
Common stock:
 
 
 
 
Dividends
81,511

 
63,887

 
Per share
0.770

 
0.760

1) The Series C preferred stock was redeemed in March 2012. The dividends paid during the quarter ended March 31, 2012 include accumulated and unpaid dividends through the redemption date.
2) The Series D preferred stock dividends paid during the quarter ended June 30, 2012 include accumulated and unpaid dividends from the issuance date through the declaration date. The Series D preferred stock has no maturity date and will remain outstanding unless redeemed.

In July 2012, NNN declared a dividend of $0.395 per share which is payable in August 2012 to its common stockholders of record as of July 31, 2012.

Capital Resources
Generally, cash needs for property acquisitions, mortgages and notes receivable investments, debt payments, capital

25


expenditures, development and other investments have been funded by equity and debt offerings, bank borrowings, the sale of properties and, to a lesser extent, by internally generated funds. Cash needs for operating expenses and dividends have generally been funded by internally generated funds. If available, future sources of capital include proceeds from the public or private offering of NNN’s debt or equity securities, secured or unsecured borrowings from banks or other lenders, proceeds from the sale of properties, as well as undistributed funds from operations.

Debt
The following is a summary of NNN’s total outstanding debt as of (dollars in thousands):
 
June 30, 2012
 
Percentage of
Total
 
December 31, 2011
 
Percentage of
Total
Line of credit payable
$
142,600

 
10.4%
 
$
65,600

 
4.9%
Mortgages payable
29,341

 
2.1%
 
23,171

 
1.8%
Notes payable – convertible
357,479

 
26.0%
 
355,371

 
26.5%
Notes payable
845,237

 
61.5%
 
894,967

 
66.8%
Total outstanding debt
$
1,374,657

 
100.0%
 
$
1,339,109

 
100.0%

Indebtedness.  NNN expects to use indebtedness primarily for property acquisitions and development of single-tenant retail properties, either directly or through investment interests, and mortgage and note receivables.
Line of Credit Payable. In May 2011, NNN amended and restated its credit agreement increasing the borrowing capacity under its unsecured revolving credit facility from $400,000,000 to $450,000,000 and amending certain other terms under the former revolving credit facility (as the context requires, the previous and new revolving credit facility, the “Credit Facility”). The Credit Facility had a weighted average outstanding balance of $52,946,000 and a weighted average interest rate of 1.8 percent during the quarter ended June 30, 2012. The Credit Facility matures May 2015, with an option by NNN to extend maturity to May 2016. The Credit Facility bears interest at LIBOR plus 150 basis points; however, such interest rate may change pursuant to a tiered interest rate structure based on NNN's debt rating. The Credit Facility also includes an accordion feature for NNN to increase the facility size up to $650,000,000, subject to lender approval. As of June 30, 2012, $142,600,000 was outstanding, and $307,400,000 was available for future borrowings under the Credit Facility, excluding undrawn letters of credit totaling $3,800,000.
Notes Payable – Convertible.  Each of NNN’s outstanding series of convertible notes is summarized in the table below (dollars in thousands, except per share conversion price):
Terms
 
2026 Notes(1)(3)
 
2028 Notes(1)(4)
 
Issue date
 
September 2006

  
March 2008

  
Net proceeds
 
$
168,650

  
$
228,576

  
Stated interest rate
 
3.950
%
  
5.125
%
(5) 
Debt issuance costs
 
$
3,850

(2) 
$
5,459

 
Earliest conversion date (6)
 
September 2025

  
June 2027

  
Earliest put option date
 
September 2016

 
June 2013

  
Maturity date
 
September 2026

  
June 2028

  
Original principal
 
$
172,500

  
$
234,035

  
Repurchases
 
(33,800