2013.09.30 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 September 30, 2013
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.
121,857,587 shares of common stock, $0.01 par value, outstanding as of October 30, 2013.




TABLE OF CONTENTS
 
 
 
PAGE      
REFERENCE
Part I - Financial Information
 
Item 1.
 
 
 
 
 
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
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)
 
September 30, 2013
 
December 31, 2012
ASSETS
(unaudited)
 
 
Real estate portfolio:
 
 
 
Accounted for using the operating method, net of accumulated depreciation and amortization
$
4,221,892

 
$
3,793,416

Accounted for using the direct financing method
21,523

 
22,692

Real estate held for sale
16,792

 
18,699

Mortgages, notes and accrued interest receivable
16,693

 
27,770

Commercial mortgage residual interests
14,755

 
13,096

Cash and cash equivalents
6,530

 
2,076

Receivables, net of allowance of $2,936 and $855, respectively
2,736

 
3,112

Accrued rental income, net of allowance of $3,086 and $3,270, respectively
25,411

 
25,458

Debt costs, net of accumulated amortization of $19,556 and $17,965, respectively
13,535

 
12,781

Other assets
96,993

 
68,926

Total assets
$
4,436,860

 
$
3,988,026

LIABILITIES AND EQUITY
 
 
 
Liabilities:
 
 
 
Line of credit payable
$
—

 
$
174,200

Mortgages payable, including unamortized premium of $144 and $187, respectively
9,764

 
10,602

Notes payable – convertible, net of unamortized discount of $0 and $2,072, respectively
—

 
236,500

Notes payable, net of unamortized discount of $11,116 and $9,338, respectively
1,513,884

 
1,165,662

Accrued interest payable
27,913

 
17,527

Other liabilities
97,369

 
85,950

Total liabilities
1,648,930

 
1,690,441

 


 


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

 
287,500

Series E, 11,500,000 depositary shares issued and outstanding, at stated liquidation value of $25 per share
287,500

 
—

Common stock, $0.01 par value. Authorized 375,000,000 shares; 121,856,503 and 111,554,997 shares issued and outstanding, respectively
1,220

 
1,117

Excess stock, $0.01 par value. Authorized 390,000,000 shares; none issued or outstanding
—

 
—

Capital in excess of par value
2,347,014

 
2,101,002

Retained earnings (deficit)
(134,003
)
 
(90,952
)
Accumulated other comprehensive income (loss)
(2,548
)
 
(2,382
)
Total stockholders’ equity of NNN
2,786,683

 
2,296,285

Noncontrolling interests
1,247

 
1,300

Total equity
2,787,930

 
2,297,585

Total liabilities and equity
$
4,436,860

 
$
3,988,026

See accompanying notes to condensed 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 September 30,
 
Nine Months Ended September 30,
  
2013
 
2012
 
2013
 
2012
Revenues:
 
 
 
 
 
 
 
Rental income from operating leases
$
95,772

 
$
79,815

 
$
274,583

 
$
228,690

Earned income from direct financing leases
534

 
571

 
1,630

 
1,739

Percentage rent
267

 
242

 
800

 
574

Real estate expense reimbursement from tenants
3,113

 
2,658

 
9,203

 
8,024

Interest and other income from real estate transactions
341

 
512

 
1,095

 
1,982

Interest income on commercial mortgage residual interests
594

 
593

 
1,789

 
2,064

 
100,621

 
84,391

 
289,100

 
243,073

Retail operations:
 
 
 
 
 
 
 
Revenues
—

 
—

 
—

 
19,008

Operating expenses
—

 
—

 
—

 
(18,543
)
Net
—

 
—

 
—

 
465

Operating expenses:
 
 
 
 
 
 
 
General and administrative
7,534

 
8,653

 
25,209

 
23,282

Real estate
4,420

 
3,842

 
12,580

 
12,376

Depreciation and amortization
25,856

 
17,242

 
72,126

 
53,574

Impairment – commercial mortgage residual interests valuation
16

 
—

 
16

 
2,718

Impairment losses and other charges, net of recoveries
—

 
3,223

 
1,972

 
3,258

 
37,826

 
32,960

 
111,903

 
95,208

Earnings from operations
62,795

 
51,431

 
177,197

 
148,330

Other expenses (revenues):
 
 
 
 
 
 
 
Interest and other income
(722
)
 
(1,194
)
 
(1,433
)
 
(1,913
)
Interest expense
19,989

 
23,039

 
65,210

 
62,425

 
19,267

 
21,845

 
63,777

 
60,512

Earnings from continuing operations before income tax benefit (expense) and equity in earnings of unconsolidated affiliate
43,528

 
29,586

 
113,420

 
87,818

Income tax benefit (expense)
(365
)
 
7,438

 
(363
)
 
7,167

Equity in earnings of unconsolidated affiliate
—

 
3,769

 
—

 
4,074

Earnings from continuing operations
43,163

 
40,793

 
113,057

 
99,059

Earnings (loss) from discontinued operations, net of income tax expense
1,179

 
(2,803
)
 
2,794

 
2,231

Earnings including noncontrolling interests
44,342

 
37,990

 
115,851

 
101,290

Loss (earnings) attributable to noncontrolling interests:
 
 
 
 
 
 
 
Continuing operations
17

 
27

 
276

 
73

Discontinued operations
(7
)
 
(2
)
 
(223
)
 
(10
)
 
10

 
25

 
53

 
63

Net earnings attributable to NNN
$
44,352

 
$
38,015

 
$
115,904

 
$
101,353

 
See accompanying notes to condensed 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 September 30,
 
Nine Months Ended September 30,
  
2013
 
2012
 
2013
 
2012
 
 
 
 
 
 
 
 
Net earnings attributable to NNN
$
44,352

 
$
38,015

 
$
115,904

 
$
101,353

Series C preferred stock dividends
—

 
—

 
—

 
(1,979
)
Series D preferred stock dividends
(4,762
)
 
(4,762
)
 
(14,285
)
 
(10,688
)
Series E preferred stock dividends
(4,780
)
 
—

 
(4,780
)
 
—

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

 
—

 
—

 
(3,098
)
Net earnings attributable to common stockholders
$
34,810

 
$
33,253

 
$
96,839

 
$
85,588

Net earnings per share of common stock:
 
 
 
 
 
 
 
Basic:
 
 
 
 
 
 
 
Continuing operations
$
0.28

 
$
0.33

 
$
0.80

 
$
0.78

Discontinued operations
0.01

 
(0.02
)
 
0.02

 
0.02

Net earnings
$
0.29

 
$
0.31

 
$
0.82

 
$
0.80

Diluted:
 
 
 
 
 
 
 
Continuing operations
$
0.28

 
$
0.32

 
$
0.79

 
$
0.77

Discontinued operations
0.01

 
(0.02
)
 
0.02

 
0.02

Net earnings
$
0.29

 
$
0.30

 
$
0.81

 
$
0.79

Weighted average number of common shares outstanding:
 
 
 
 
 
 
 
Basic
120,287,890

 
107,487,935

 
117,222,163

 
106,140,002

Diluted
121,230,232

 
110,339,705

 
119,356,194

 
108,091,909

Other comprehensive income:
 
 
 
 
 
 
 
Net earnings attributable to NNN
$
44,352

 
$
38,015

 
$
115,904

 
$
101,353

Amortization of interest rate hedges
128

 
57

 
306

 
171

Fair value forward starting swaps
—

 
—

 
(3,141
)
 
—

Unrealized gain – commercial mortgage residual interests
376

 
—

 
1,595

 
213

Stock value adjustments
36

 
(1
)
 
125

 
(2
)
Reclassification of noncontrolling interests
—

 
—

 
949

 
—

Comprehensive income attributable to NNN
$
44,892

 
$
38,071

 
$
115,738

 
$
101,735

    

See accompanying notes to condensed consolidated financial statements.


5

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


 
Nine Months Ended September 30,
 
2013
 
2012
Cash flows from operating activities:
 
 
 
Earnings including noncontrolling interests
$
115,851

 
$
101,290

Adjustments to reconcile net earnings to net cash provided by operating activities:
 
 
 
Depreciation and amortization
72,423

 
54,926

Impairment losses and other charges, net of recoveries
4,003

 
9,043

Impairment – commercial mortgage residual interests valuation
16

 
2,718

Amortization of notes payable discount
2,888

 
3,641

Amortization of debt costs
2,460

 
2,506

Amortization of mortgages payable premium
(43
)
 
(14
)
Amortization of deferred interest rate hedges
306

 
171

Equity in earnings of unconsolidated affiliate
—

 
(4,074
)
Distributions received from unconsolidated affiliate
—

 
7,019

Gain on disposition of real estate
(4,402
)
 
(4,446
)
Gain on note receivable and property foreclosure
—

 
(198
)
Performance incentive plan expense
6,531

 
7,010

Performance incentive plan payment
(2,139
)
 
—

Change in operating assets and liabilities, net of assets acquired and liabilities assumed in business combinations:
 
 
 
Additions to held for sale real estate
(1,029
)
 
(4,941
)
Decrease in real estate leased to others using the direct financing method
1,230

 
1,222

Decrease in mortgages, notes and accrued interest receivable
688

 
37

Decrease in receivables
1,433

 
1,014

Increase in commercial mortgage residual interests
(80
)
 
—

Increase in accrued rental income
(166
)
 
(695
)
Decrease in other assets
82

 
1,365

Increase in accrued interest payable
10,386

 
7,004

Increase (decrease) in other liabilities
4,061

 
(4,893
)
Increase (decrease) in current tax liability
580

 
(7,192
)
Net cash provided by operating activities
215,079

 
172,513

Cash flows from investing activities:
 
 
 
Proceeds from the disposition of real estate
52,092

 
32,371

Additions to real estate:
 
 
 
Accounted for using the operating method
(569,770
)
 
(416,068
)
Increase in mortgages and notes receivable
(3,086
)
 
(8,768
)
Principal payments on mortgages and notes receivable
14,225

 
10,668

Cash received from commercial mortgage residual interests
—

 
286

Payment of lease costs
(969
)
 
(1,583
)
Return of investment from unconsolidated affiliate
—

 
1,220

Other
(781
)
 
(313
)
Net cash used in investing activities
(508,289
)
 
(382,187
)
 
See accompanying notes to condensed consolidated financial statements.


6

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


 
Nine Months Ended September 30,
 
2013
 
2012
Cash flows from financing activities:
 
 
 
Proceeds from line of credit payable
$
445,000

 
$
685,900

Repayment of line of credit payable
(619,200
)
 
(751,500
)
Payment of interest rate hedge
(3,141
)
 
—

Repayment of mortgages payable
(795
)
 
(19,134
)
Proceeds from notes payable
347,406

 
320,011

Repayment of notes payable
—

 
(50,000
)
Repayment of notes payable – convertible
(246,797
)
 
—

Payment of debt costs
(3,265
)
 
(2,992
)
Proceeds from issuance of common stock
263,366

 
119,259

Proceeds from issuance of Series D preferred stock
—

 
287,500

Proceeds from issuance of Series E preferred stock
287,500

 
—

Stock issuance costs
(13,455
)
 
(11,200
)
Redemption of Series C preferred stock
—

 
(92,000
)
Payment of Series C preferred stock dividends
—

 
(1,979
)
Payment of Series D preferred stock dividends
(14,285
)
 
(10,688
)
Payment of Series E preferred stock dividends
(4,780
)
 
—

Payment of common stock dividends
(139,890
)
 
(124,139
)
Net cash provided by financing activities
297,664

 
349,038

Net increase in cash and cash equivalents
4,454

 
139,364

Cash and cash equivalents at beginning of year
2,076

 
2,082

Cash and cash equivalents at end of year
$
6,530

 
$
141,446

Supplemental disclosure of cash flow information:
 
 
 
Interest paid, net of amount capitalized
$
50,667

 
$
50,872

Taxes paid
$
212

 
$
125

Supplemental disclosure of noncash investing and financing activities:
 
 
 
Issued 298,896 and 396,577 shares of restricted and unrestricted
    common stock in 2013 and 2012, respectively, pursuant to NNN’s
    performance incentive plan
$
8,218

 
$
8,576

Issued 12,186 and 12,373 shares of common stock in 2013 and 2012,
    respectively, to directors pursuant to NNN’s performance incentive plan
$
428

 
$
346

Issued 9,044 and 14,836 shares of common stock in 2013 and
    2012, respectively, pursuant to NNN’s Deferred Director Fee Plan
$
118

 
$
223

Surrender of 241 and of 4,712 shares of restricted common stock in 2013 and 2012, respectively
$
7

 
$
113

Change in other comprehensive income
$
166

 
$
(382
)
Change in lease classification (direct financing lease to operating lease)
$
—

 
$
757

Mortgages payable assumed in connection with real estate transactions
$
—

 
$
6,634

Mortgage receivable accepted in connection with real estate transactions
$
750

 
$
—

Real estate acquired in connection with mortgage receivable foreclosure
$
—

 
$
490

Real estate received in note receivable foreclosure
$
—

 
$
1,595

 
 
See accompanying notes to condensed consolidated financial statements.

7


NATIONAL RETAIL PROPERTIES, INC.
and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2013
(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 terms “NNN” and the “Company” refer 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, 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”). 
 
September 30, 2013
Property Portfolio:
 
Total properties
1,850

Gross leasable area (square feet)
20,292,000

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 U.S. generally accepted accounting principles ("GAAP"). 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 nine months ended September 30, 2013, may not be indicative of the results that may be expected for the year ending December 31, 2013. Amounts as of December 31, 2012, 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, 2012.
Principles of Consolidation – NNN’s condensed consolidated financial statements include the accounts of each of the Company's 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 nine months ended September 30, 2013, NNN recorded $470,000 and $1,010,000, respectively, in capitalized interest and recorded $336,000 and $1,204,000 in capitalized interest during the same periods in 2012, 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 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 and the applicable option terms if it is probable that the tenant will exercise the option. 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):
 
 
September 30, 2013
 
December 31, 2012
Intangible lease assets (included in Other assets):
 
 
 
 
Value of above market in-place leases, net
 
$
12,236

 
$
6,679

Value of in-place leases, net
 
59,365

 
37,889

Intangible lease liabilities (included in Other liabilities):
 
 
 
 
Value of below market in-place leases, net
 
29,678

 
23,708

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 (“NNN Crow JV”), with an affiliate of Crow Holdings Realty Partners IV, L.P., which is accounted for under the equity method of accounting. During the quarter ended September 30, 2012, NNN Crow JV sold all of its assets and paid off its bank term loan. In April 2013, NNN Crow JV was dissolved.
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 equivalents consist of demand deposits and money market accounts and 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 collectability 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 carry 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 September 30,
 
Nine Months Ended September 30,
 
2013
 
2012
 
2013
 
2012
Basic and Diluted Earnings:
 
 
 
 
 
 
 
Net earnings attributable to NNN
$
44,352

 
$
38,015

 
$
115,904

 
$
101,353

Less: Series C preferred stock dividends
—

 
—

 
—

 
(1,979
)
Less: Series D preferred stock dividends
(4,762
)
 
(4,762
)
 
(14,285
)
 
(10,688
)
Less: Series E preferred stock dividends
(4,780
)
 
—

 
(4,780
)
 
—

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

 
—

 
—

 
(3,098
)
Net earnings available to NNN’s common stockholders
34,810

 
33,253

 
96,839

 
85,588

Less: Earnings attributable to unvested restricted shares
(135
)
 
(215
)
 
(366
)
 
(525
)
Net earnings used in basic earnings per share
34,675

 
33,038

 
96,473

 
85,063

Reallocated undistributed loss
—

 
(1
)
 
(3
)
 
(4
)
Net earnings used in diluted earnings per share
$
34,675

 
$
33,037

 
$
96,470

 
$
85,059

 
 
 
 
 
 
 
 
Basic and Diluted Weighted Average Shares Outstanding:
 
 
 
 
 
 
 
Weighted average number of shares outstanding
121,096,076

 
108,461,120

 
117,973,443

 
107,039,590

Less: Unvested restricted stock
(469,370
)
 
(696,270
)
 
(441,588
)
 
(652,890
)
Less: Contingent shares
(338,816
)
 
(276,915
)
 
(309,692
)
 
(246,698
)
Weighted average number of shares outstanding used in basic
   earnings per share
120,287,890

 
107,487,935

 
117,222,163

 
106,140,002

Effects of dilutive securities:
 
 
 
 
 
 
 
Contingent shares
—

 
—

 
—

 
8,459

Convertible notes payable
768,843

 
2,692,153

 
1,963,457

 
1,787,275

Common stock options
—

 
—

 
—

 
1,287

Directors’ deferred fee plan
173,499

 
159,617

 
170,574

 
154,886

Weighted average number of shares outstanding used in
  diluted earnings per share
121,230,232

 
110,339,705

 
119,356,194

 
108,091,909

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.

10


Other Comprehensive Income (Loss) – The following table outlines the changes in accumulated other comprehensive income (dollars in thousands):
 
Gain or Loss on Cash Flow Hedges (1)
 
Unrealized Gains and Losses on Commercial Mortgage Residual Interests (2)
 
Unrealized Gains and Losses on Available-for-Sale Securities
 
Total
 
Beginning balance, December 31, 2012
$
(5,693
)
 
$
3,244

 
$
67

 
$
(2,382
)
 
 
 
 
 
 
 
 
 
 
Other comprehensive income (loss)
(3,141
)
 
2,544

 
125

 
(472
)
 
Reclassifications from accumulated other comprehensive income to net earnings
306

 
—

 
—

 
306

(3) 
Net current period other comprehensive income (loss)
(2,835
)
 
2,544

 
125

 
(166
)
 
Ending balance, September 30, 2013
$
(8,528
)
 
$
5,788

 
$
192

 
$
(2,548
)
 
1) Additional disclosure is included in Note 10 - Derivatives.
2) Additional disclosure is included in Note 3 - Commercial Mortgage Residual Interests.
3) Reclassifications out of other comprehensive income are recorded in Interest Expense on the Condensed Consolidated Statements of Comprehensive Income. There is no income tax expense (benefit) resulting from this reclassification.
New Accounting Pronouncements – In December 2011, the FASB issued Accounting Standards Update ("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 GAAP and those entities that prepare their financial statements on the basis of International Financial Reporting Standards ("IFRS"). The amendments in this update are effective for annual reporting periods beginning on or after January 1, 2013. The adoption of the standard did not have a significant impact on NNN's financial position or results of operations.
In February 2013, the FASB issued ASU 2013-02. The objective of this update is to improve the reporting of reclassifications out of accumulated other comprehensive income. The update requires reporting significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required under GAAP to be reclassified in its entirety to net income or cross-reference other required disclosures that provide additional detail about amounts that are not. The amendments in this update are effective prospectively for reporting periods beginning after December 15, 2012. The adoption of the standard in the quarter ended March 31, 2013, did not have a significant impact on NNN's financial position or results of operations.
In February 2013, the FASB issued ASU 2013-04. The objective of this update is to provide guidance for the recognition, measurement, and disclosure of obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of this guidance is fixed at the reporting date. The amendments in this update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. NNN is currently evaluating ASU 2013-04 to determine the potential impact, if any, its adoption will have on NNN's financial position and results of operations.
In July 2013, the FASB issued ASU 2013-10. The amendments in this update permit the Fed Funds Effective Swap Rate (also referred to as Overnight Index Swap Rate) to be used as a United States benchmark interest rate for hedge accounting purposes under Topic 815, in addition to treasury obligations of the United States Government and the London Interbank Offered Rate. The amendments are effective prospectively for qualifying new or redesignated hedging relationships entered into on or after July 17, 2013. The adoption of the standard did not have a significant impact on NNN's financial position or results of operations.
In July 2013, the FASB issued ASU 2013-11. The objective of the amendments in this update is to eliminate the diversity in practice of financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. The provisions of the update are that an unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented, with certain exceptions, in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward. The amendments in this update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. NNN is currently evaluating ASU 2013-11 to determine the potential impact, if any, its adoption will have on NNN's financial position and results of operations.
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

11


financial statements in conformity with GAAP. Significant estimates include provisions 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 2013 presentation.

Note 2 – Real Estate:
Real Estate – Portfolio
Leases – The following outlines key information for NNN’s leases:
 
September 30, 2013
Lease classification:
 
Operating
1,861

Direct financing
13

Building portion – direct financing / land portion – operating
4

Weighted average remaining lease term
12 Years

The leases generally provide for periodic 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, and the terms and conditions of the lease for the renewal options remain the same as for the initial term, except for increases in rent in the renewal options.
Real Estate Portfolio – Accounted for Using the Operating Method – Real estate subject to operating leases consisted of the following as of (dollars in thousands):
 
September 30, 2013
 
December 31, 2012
Land and improvements
$
1,637,830

 
$
1,473,671

Buildings and improvements
2,904,914

 
2,563,729

Leasehold interests
1,290

 
1,290

 
4,544,034

 
4,038,690

Less accumulated depreciation and amortization
(393,339
)
 
(331,781
)
 
4,150,695

 
3,706,909

Work in progress
71,197

 
86,507

 
$
4,221,892

 
$
3,793,416

    
Real Estate – Held For Sale
As of September 30, 2013 and December 31, 2012, NNN categorized 10 of its Properties as held for sale. Real estate held for sale consisted of the following as of (dollars in thousands):
 
 
September 30, 2013
 
December 31, 2012
Property held for sale:
 
 
 
 
Land and improvements
 
$
10,591

 
$
10,445

Building and improvements
 
17,935

 
17,773

Accounted for using the direct financing method
 
464

 
525

Work in process
 
—

 
72

 
 
28,990

 
28,815

Less accumulated depreciation and amortization
 
(2,033
)
 
(1,997
)
Less impairment
 
(10,165
)
 
(8,119
)
 
 
$
16,792

 
$
18,699


In March 2013, NNN completed a strategic review of its Properties held for sale and reclassified 15 Properties that were previously held for sale to held for investment, included in Real Estate – Portfolio.

12


Real Estate – Dispositions
The following table summarizes the number of Properties sold and the corresponding gain recognized on the disposition of Properties included in discontinued operations (dollars in thousands):
 
Quarter Ended September 30,
 
Nine Months Ended September 30,
 
2013
 
2012
 
2013
 
2012
# of Sold
Properties
 
Gain
 
# of Sold
Properties
 
Gain
 
# of Sold
Properties
 
Gain
 
# of Sold
Properties
 
Gain
Discontinued operations (1)
22
 
$
1,228

 
8
 
$
1,694

 
31
 
$
4,249

 
18
 
$
4,446

Noncontrolling interests
 
 
—

 
 
 
—

 
 
 
153

 
 
 
—

 
 
 
$
1,228

 
 
 
$
1,694

 
 
 
$
4,402

 
 
 
$
4,446

(1) None of the gains from property sales for the period were reported in continuing operations.
Real Estate – Commitments
In connection with improvements to leased Properties, NNN has the following funding commitments (dollars in thousands):
 
September 30, 2013
 
# of
Properties
 
Total
Commitment(1)
 
Amount
Funded
 
Remaining
Commitment
Real estate – portfolio
51
 
$
147,084

 
$
109,852

 
$
37,232

(1) Includes land, construction costs and tenant improvements.
Real Estate – Impairments
Management periodically assesses the Company's real estate for possible impairment whenever events or changes in circumstances indicate that the carrying amount of the asset, including accrued rental income, may not be recoverable through operations.  Events or circumstances that may occur include significant changes in real estate market conditions and the ability of NNN to re-lease or sell properties that are vacant or become vacant. If an impairment is indicated, it is recognized to the extent the current book value of the respective asset exceeds the fair value of the asset.
As a result of the Company's review of long lived assets, including identifiable intangible assets, NNN recognized the following real estate impairments (dollars in thousands):
 
 
Quarter Ended September 30,
 
Nine Months Ended September 30,
 
 
2013
 
2012
 
2013
 
2012
Continuing operations
 
$
—

 
$
3,223

 
$
1,957

 
$
3,258

Discontinued operations
 
727

 
5,440

 
2,046

 
5,785

Impairment recoveries – discontinued operations
 
(728
)
 
—

 
—

 
—

 
 
$
(1
)
 
$
8,663

 
$
4,003

 
$
9,043


The valuation of impaired assets is determined using widely accepted valuation techniques including discounted cash flow analysis, income capitalization, analysis of recent comparable sales transactions, actual sales negotiations and bona fide purchase offers received from third parties, which are level 3 inputs. NNN may consider a single valuation technique or multiple valuation techniques, as appropriate, when measuring the fair value of its real estate.

Note 3 – Commercial Mortgage Residual Interests:

NNN 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.


13


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:
 
September 30, 2013
 
December 31, 2012
Discount rate (1)
20% or 25%

 
25
%
Average life equivalent CPR(2) speeds range
0.80% to 19.39% CPR

 
0.80% to 24.31% CPR

Foreclosures:
 
 
 
Frequency curve default model
0.07% - 3.97% range

 
0.09% - 4.49% 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) For September 30, 2013, three of the securitizations have a 20% discount rate and four have a 25% discount rate.
(2) 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 the condensed consolidated statements of earnings (dollars in thousands):
 
Quarter Ended September 30,
 
Nine Months Ended September 30,
 
2013
 
2012
 
2013
 
2012
Unrealized gains
$
376

 
$
—

 
$
1,595

 
$
213

Other than temporary valuation impairment
$
16

 
$
—

 
$
16

 
$
2,718


Note 4 – Line of Credit Payable:
NNN's $500,000,000 revolving credit facility (the “Credit Facility”) had a weighted average outstanding balance of $49,975,000 and a weighted average interest rate of 1.4% during the nine months ended September 30, 2013. The Credit Facility matures October 2016, unless the Company exercises its option to extend maturity to October 2017. The Credit Facility bears interest at LIBOR plus 117.5 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 $1,000,000,000, subject to lender approval. As of September 30, 2013, there was no outstanding balance and $500,000,000 was available for future borrowings under the Credit Facility.

Note 5 – Notes Payable:
In April 2013, NNN filed a prospectus supplement to the prospectus contained in its February 2012 shelf registration statement and issued $350,000,000 aggregate principal amount of 3.300% Notes due April 2023 (the “2023 Notes”). The 2023 Notes were sold at a discount with an aggregate purchase price of $347,406,000 with interest payable semi-annually commencing on October 15, 2013. The discount of $2,594,000 is being amortized to interest expense over the term of the note using the effective interest method. The effective interest rate for the 2023 Notes after accounting for note discount is 3.388%. NNN previously entered into four forward starting swaps with an aggregate notional amount of $240,000,000. Upon issuance of the 2023 Notes, NNN terminated the forward starting swaps resulting in a liability of $3,156,000, of which $3,141,000 was deferred in other comprehensive income. The deferred liability is being amortized to interest expense over the term of the 2023 Notes using the effective interest method.
The 2023 Notes are senior unsecured obligations of NNN and are subordinated to all secured indebtedness and to the indebtedness and other liabilities of NNN's subsidiaries. Additionally, the 2023 Notes are redeemable at NNN's option, in whole or part anytime, for an amount equal to (i) the sum of the outstanding principal balance of the notes being redeemed plus accrued interest thereon to the redemption date, and (ii) the make whole amount, if any, as defined in the supplemental indenture dated April 9, 2013, relating to the 2023 Notes.
NNN received approximately $344,266,000 of proceeds in connection with the issuance of the 2023 Notes, net of debt issuance costs totaling $3,140,000 consisting primarily of underwriting discounts and commissions, legal and accounting fees, rating agency fees and printing expenses.

14



Note 6 – Notes Payable – Convertible:
NNN recorded the following in interest expense relating to the 3.950% convertible senior notes due 2026 (the "2026 Notes") and the 5.125% convertible senior notes due 2028 (the "2028 Notes") (dollars in thousands):
 
Quarter Ended September 30,
 
Nine Months Ended September 30,
 
2013
 
2012
 
2013
 
2012
Contractual interest expense
$
26

 
$
4,227

 
$
5,400

 
$
12,682

Noncash interest charges
—

 
1,082

 
2,072

 
3,189

Amortization of debt costs
—

 
291

 
566

 
851

Total interest expense
$
26

 
$
5,600

 
$
8,038

 
$
16,722

As of December 31, 2012, $15,537,000 of the principal amount of 2026 Notes were outstanding. In January 2013, the Company paid approximately $20,702,000 in aggregate settlement value for the $15,537,000 of settled notes. The difference between the amount paid and the principal amount of the settled notes of $5,028,000 was recognized as a decrease to additional paid-in capital and $137,000 was recorded as interest expense.
As of December 31, 2012, $223,035,000 of the principal amount of 2028 Notes were outstanding. In June 2013, NNN called all of the outstanding 2028 Notes for redemption on July 11, 2013. On July 11, 2013, $130,000 principal amount of the 2028 Notes was settled at par plus accrued interest. As of September 30, 2013, holders of the remaining balance of $222,905,000 principal amount of 2028 Notes had elected to convert into cash and shares of the Company's common stock in accordance with the conversion formula which is based on the average daily closing price of NNN's common stock price over a period of 20 days commencing after receipt of a note holder's conversion notice. In 2013, the Company issued 2,407,911 shares of common stock and paid approximately $226,427,000 in aggregate settlement value for the $223,035,000 of settled notes. The difference between the amount paid and the principal amount of the settled notes of $3,197,000 was recognized as a decrease to additional paid-in capital and $195,000 was recorded as interest expense.

Note 7 – Stockholders' Equity:
Dividends – The following table outlines the dividends declared and paid for each issuance of NNN's stock (in thousands, except per share data):
 
 
Nine Months Ended September 30,
 
 
2013
 
2012
Series C preferred stock (1):
 
 
 
 
Dividends
$
—

 
$
1,979

 
Per share
—

 
0.5378

 
 
 
 
 
Series D preferred stock (3):
 
 
 
 
Dividends
14,285

 
10,688

 
Per share
1.2422

 
0.9293

 
 
 
 
 
Series E preferred stock (2)(3):
 
 
 
 
Dividends
4,780

 
—

 
Per share
0.4156

 
—

 
 
 
 
 
Common stock:
 
 
 
 
Dividends
139,890

 
124,139

 
Per share
1.195

 
1.165

1) The Series C preferred stock was redeemed in March 2012. The dividends paid during the nine months
ended September 30, 2012 include accumulated and unpaid dividends through the redemption date.
2) The Series E preferred stock dividends paid during the quarter ended September 30, 2013 include
accumulated and unpaid dividends from the issuance date through the declaration date.
3) The Series D and E preferred stock have no maturity date and will remain outstanding unless redeemed.
In October 2013, NNN declared a dividend of $0.405 per share, which is payable in November 2013 to its common stockholders of record as of October 31, 2013.

15


Preferred Stock Issuances – 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 gross proceeds of $287,500,000. In connection with this offering, NNN incurred stock issuance costs totaling approximately $9,855,000, consisting primarily of underwriters' fees and commissions, rating agency fees, legal and accounting fees and printing expenses.
In March 2012, NNN redeemed all 3,680,000 outstanding depositary shares representing interests in its 7.375% Series C Cumulative Redeemable Preferred Stock (“Series C Preferred Stock”). The Series C Preferred Stock was redeemed at a price of $25.00 per depositary share, plus accumulated and unpaid distributions through the redemption date, for an aggregate redemption price of approximately $25.0768 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 2013, NNN issued 11,500,000 depositary shares representing interests in its 5.700% Series E Cumulative Redeemable Preferred Stock ("Series E Preferred Stock") at a price of $25.00 per depositary share generating gross proceeds of $287,500,000. In connection with this offering, NNN incurred stock issuance costs totaling approximately $9,856,000, consisting primarily of underwriters' fees and commissions, rating agency fees, legal and accounting fees and printing expenses.
At The Market Offerings – In May 2012, NNN established an at-the-market equity program ("2012 ATM") which allowed NNN to sell up to an aggregate of 9,000,000 shares of common stock from time to time through May 2015. The following table outlines the common stock issuances pursuant to the 2012 ATM (dollars in thousands, except per share data):
 
Nine Months Ended September 30,
 
2013
 
2012
Shares of common stock
4,676,542

 
2,251,798

Average price per share (net)
$
32.60

 
$
28.97

Net proceeds
152,435

 
65,245

Stock issuance costs (1)
2,161

 
1,171

(1) Stock issuance costs consist primarily of underwriters' fees and commissions, and legal and accounting fees.
In March 2013, NNN established a second ATM equity program ("2013 ATM") which allows NNN to sell up to an aggregate of 9,000,000 shares of common stock from time to time through March 2015. The following table outlines the common stock issuances pursuant to the 2013 ATM (dollars in thousands, except per share data):
 
Nine Months Ended September 30, 2013
Shares of common stock
2,280,450

Average price per share (net)
$
37.82

Net proceeds
86,237

Stock issuance costs (1)
1,585

(1) Stock issuance costs consist primarily of underwriters' fees and commissions, and legal and accounting fees.
Dividend Reinvestment and Stock Repurchase Plan – 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 table outlines the common stock issuances pursuant to NNN's DRIP (dollars in thousands):
 
Nine Months Ended September 30,
 
2013
 
2012
Shares of common stock
634,146

 
1,994,113

Net proceeds
$
21,159

 
$
52,781


Note 8 – 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

16


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.
NNN has had no increases or decreases in unrecognized tax benefits for current or prior years. 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 2010 through 2013. NNN also files tax returns in many states with varying open years under statute.


17


Note 9 – Earnings from Discontinued Operations:
NNN classified the revenues and expenses related to Properties which were sold or were held for sale as of September 30, 2013, as discontinued operations. The following is a summary of the earnings (loss) from discontinued operations (dollars in thousands):
 
Quarter Ended September 30,
 
Nine Months Ended September 30,
 
2013
 
2012
 
2013
 
2012
Revenues:
 
 
 
 
 
 
 
Rental income from operating leases
$
791

 
$
1,606

 
$
1,999

 
$
5,796

Earned income from direct financing leases
12

 
37

 
38

 
121

Real estate expense reimbursement from tenants
63

 
124

 
231

 
323

Interest and other income from real estate transactions
1

 
4

 
37

 
38

 
867

 
1,771

 
2,305

 
6,278

Operating expenses:
 
 
 
 
 
 
 
General and administrative
3

 
2

 
218

 
7

Real estate
219

 
305

 
479

 
846

Depreciation and amortization
148

 
301

 
297

 
1,204

Impairment losses and other charges, net of recoveries
(1
)
 
5,440

 
2,046

 
5,785

 
369

 
6,048

 
3,040

 
7,842

Other expenses:
 
 
 
 
 
 
 
Interest expense
136

 
183

 
444

 
552

 
136

 
183

 
444

 
552

Earnings (loss) before gain on disposition of real estate and income tax expense
362

 
(4,460
)
 
(1,179
)
 
(2,116
)
Gain on disposition of real estate
1,228

 
1,694

 
4,402

 
4,446

Income tax expense
(411
)
 
(37
)
 
(429
)
 
(99
)
Earnings (loss) from discontinued operations attributable to NNN including noncontrolling interests
1,179

 
(2,803
)
 
2,794

 
2,231

Earnings attributable to noncontrolling interests
(7
)
 
(2
)
 
(223
)
 
(10
)
Earnings (loss) from discontinued operations attributable to NNN
$
1,172

 
$
(2,805
)
 
$
2,571

 
$
2,221


Note 10 – 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.

18


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.
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 April 2013, NNN terminated four forward starting swaps with an aggregate notional amount of $240,000,000 that were hedging the risk of changes in forecasted interest payments on a forecasted issuance of long-term debt. When terminated, the fair value of the forward starting swaps, designated as cash flow hedges, was a liability of $3,156,000, of which $3,141,000 was deferred in other comprehensive income. The amount reported in accumulated other comprehensive income will be reclassified to interest expense as interest payments are made on the 2023 Notes.
As of September 30, 2013, $8,528,000 remained in other comprehensive income related to the effective portion of NNN’s 2013 and previous interest rate hedges. During the nine months ended September 30, 2013 and 2012, NNN reclassified out of comprehensive income $306,000 and $171,000, respectively, as an increase to interest expense. Over the next 12 months, NNN estimates that an additional $703,000 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 September 30, 2013.

Note 11 – 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 roll forward of the Residuals (dollars in thousands):
 
Nine Months Ended
 
September 30, 2013
Balance at beginning of period
$
13,096

Total gains (losses) – realized/unrealized:
 
Included in earnings
(16
)
Included in other comprehensive income
1,595

Interest income on Residuals
1,789

Cash received from Residuals
(1,709
)
Purchases, sales, issuances and settlements, net
—

Transfers in and/or out of Level 3
—

Balance at end of period
$
14,755

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
$
(328
)

Note 12 – 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 September 30, 2013 and December 31, 2012, approximate fair value based upon current market prices of similar issues. At September 30, 2013 and December 31, 2012, the fair value of NNN’s notes payable was $1,559,656,000 and $1,585,756,000, respectively, based upon quoted market prices, which is a level one valuation since NNN's debt is publicly traded.

Note 13 – Subsequent Events:
NNN reviewed its subsequent events and transactions that have occurred after September 30, 2013, the date of the condensed consolidated balance sheet. There were no reportable subsequent events or transactions.

19


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, 2012. The terms “NNN” and the “Company” refer 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:

•
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 from 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 personnel could adversely affect performance and the value of its common stock;
•
Uninsured losses may adversely affect NNN's operating results and asset values;
•
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;

20


•
Changes in accounting pronouncements could adversely impact NNN's or NNN's tenants' reported financial 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;
•
Cybersecurity risks and cyber incidents could adversely affect NNN's business and disrupt operations; and
•
Future investments in international markets could subject NNN to additional risks.

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, 2012, 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's assets include: real estate, mortgages and notes receivable, and commercial mortgage residual interests (the "Residuals"). 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 September 30, 2013, NNN owned 1,850 Properties, with an aggregate gross leasable area of approximately 20,292,000 square feet, located in 47 states. Approximately 98 percent of the Properties in the Property Portfolio were leased as of September 30, 2013.
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.



21


Results of Operations
Property Analysis
General.  The following table summarizes NNN’s Property Portfolio:
 
September 30, 2013
 
December 31, 2012
 
September 30, 2012
Properties Owned:
 
 
 
 
 
Number
1,850

 
1,622

 
1,530

Total gross leasable area (square feet)
20,292,000

 
19,168,000

 
18,331,000

Properties:
 
 
 
 
 
Leased and unimproved land
1,814

 
1,588

 
1,497

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

 
12

 
12

Total gross leasable area (square feet) – leased
19,728,000

 
18,524,000

 
17,755,000


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
 
September 30, 2013
 
December 31, 2012
 
September 30, 2012
1.
 
Convenience stores
 
19.9
%
 
19.8
%
 
21.6
%
2.
 
Restaurants - full service
 
9.8
%
 
10.7
%
 
11.3
%
3.
 
Automotive service
 
7.6
%
 
7.6
%
 
6.4
%
4.
 
Restaurants - limited service
 
5.4
%
 
5.2
%
 
3.5
%
5.
 
Automotive parts
 
5.1
%
 
5.6
%
 
5.8
%
6.
 
Theaters
 
4.4
%
 
4.7
%
 
4.5
%
7.
 
Banks
 
4.1
%
 
0.2
%
 
0.2
%
8.
 
Health and fitness
 
4.0
%
 
3.7
%
 
2.8
%
9.
 
Sporting goods
 
3.7
%
 
4.0
%
 
4.5
%
10.
 
Wholesale clubs
 
3.1
%
 
3.4
%
 
3.6
%
 
 
Other
 
32.9
%
 
35.1
%
 
35.8
%
 
 
 
 
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 September 30,
 
Nine Months Ended September 30,
 
2013
 
2012
 
2013
 
2012
Acquisitions:
 
 
 
 
 
 
 
Number of Properties
35

 
30

 
261

 
124

Gross leasable area (square feet)
243,000

 
575,000

 
1,468,000

 
2,048,000

Total dollars invested(1)
$
90,070

 
$
139,600

 
$
570,334

 
$
452,558

(1) Includes dollars invested in projects under construction or tenant improvements for each respective year.
NNN typically funds property acquisitions either through available cash, borrowings under its unsecured revolving Credit Facility (see "Debt – Line of Credit Payable") or by issuing its debt or equity securities in the capital markets.

22


Property Dispositions.  The following table summarizes the Properties sold by NNN (dollars in thousands):
 
Quarter Ended September 30,
 
Nine Months Ended September 30,
 
2013
 
2012
 
2013
 
2012
Number of properties
22

 
8

 
31

 
18

Gross leasable area (square feet)
169,000

 
40,000

 
301,000

 
141,000

Net sales proceeds
$
35,971

 
$
20,347

 
$
52,585

 
$
32,088

Net gain, net of non-controlling interest
$
1,228

 
$
1,694

 
$
4,402

 
$
4,446


NNN typically uses the proceeds from property sales either to pay down the Credit Facility or reinvest in real estate.
Analysis of Revenue From Continuing Operations
General.  During the quarter and nine months ended September 30, 2013, rental income increased primarily due to an 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 September 30,
 
Nine Months Ended September 30,
 
2013
 
2012
 
2013
 
2012
 
Percent
Increase
(Decrease)
 
2013
 
2012
 
2013
 
2012
 
Percent
Increase
(Decrease)
 
 
 
 
 
Percent of Total
 
 
 
 
 
 
 
Percent of Total
 
 
Rental Income(1)
$
96,573

 
$
80,628

 
96.0
%
 
95.5
%
 
19.8%
 
$
277,013

 
$
231,003

 
95.8
%
 
95.0
%
 
19.9%
Real estate expense
  reimbursement from
  tenants
3,113

 
2,658

 
3.1
%
 
3.1
%
 
17.1%
 
9,203

 
8,024

 
3.2
%
 
3.3
%
 
14.7%
Interest and other
  income from real
  estate transactions
341

 
512

 
0.3
%
 
0.7
%
 
(33.4)%
 
1,095

 
1,982

 
0.4
%
 
0.8
%
 
(44.8)%
Interest income on
  commercial mortgage
  residual interests
594

 
593

 
0.6
%
 
0.7
%
 
0.2%
 
1,789

 
2,064

 
0.6
%
 
0.9
%
 
(13.3)%
Total revenues from
  continuing operations
$
100,621

 
$
84,391

 
100.0
%
 
100.0
%
 
19.2%
 
$
289,100

 
$
243,073

 
100.0
%
 
100.0
%
 
18.9%

(1) Includes rental income from operating leases, earned income from direct financing leases and percentage rent from continuing operations (“Rental Income”).
Quarter and Nine Months Ended September 30, 2013 versus Quarter and Nine Months Ended September 30, 2012
Rental Income. Rental Income increased as a percent of the total revenues from continuing operations but remained relatively stable as a percentage of total revenues for the quarter and nine months ended September 30, 2013, as compared to the same periods in 2012. The increase is primarily due to the acquisition of 261 properties with aggregate gross leasable area of approximately 1,468,000 square feet during the nine months ended September 30, 2013 and 232 properties with aggregate gross leasable area of approximately 2,955,000 square feet during 2012.
Real Estate Expense Reimbursement from Tenants. Real estate expense reimbursements from tenants increased for the quarter and nine months ended September 30, 2013, as compared to the same periods in 2012, but was consistent 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 2012.


23


Analysis of Expenses from Continuing Operations
General.  Operating expenses from continuing operations increased for the quarter and nine months ended September 30, 2013, primarily due to an increase in depreciation expense from certain Properties acquired in 2013. The following table summarizes NNN’s expenses from continuing operations for the quarters ended September 30 (dollars in thousands):
 
 
 
 
 

Percent
Increase
(Decrease)
 
Percentage of Total
 
Percentage of
Revenues from
Continuing Operations
 
2013
 
2012
 
 
2013
 
2012
 
2013
 
2012
General and administrative
$
7,534

 
$
8,653

 
(12.9)%
 
19.9
 %
 
26.2
 %
 
7.5
 %
 
10.3
 %
Real estate
4,420

 
3,842

 
15.0%
 
11.7
 %
 
11.7
 %
 
4.4
 %
 
4.6
 %
Depreciation and amortization
25,856

 
17,242

 
50.0%
 
68.4
 %
 
52.3
 %
 
25.7
 %
 
20.4
 %
Impairment – commercial mortgage residual interests valuation
16

 
—

 
N/C (1)
 
—
 %
 
—
 %
 
—
 %
 
—
 %
Impairment losses and other charges, net of recoveries
—

 
3,223

 
(100.0)%
 
—
 %
 
9.8
 %
 
—
 %
 
3.8
 %
Total operating expenses
$
37,826

 
$
32,960

 
14.8%
 
100.0
 %
 
100.0
 %
 
37.6
 %
 
39.1
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest and other income
$
(722
)
 
$
(1,194
)
 
(39.5)%
 
(3.7
)%
 
(5.5
)%
 
(0.7
)%
 
(1.4
)%
Interest expense
19,989

 
23,039

 
(13.2)%
 
103.7
 %
 
105.5
 %
 
19.9
 %
 
27.3
 %
Total other expenses
$
19,267

 
$
21,845

 
(11.8)%
 
100.0
 %
 
100.0
 %
 
19.2
 %
 
25.9
 %
(1) Not Calculable ("N/C")
The following table summarizes NNN’s expenses from continuing operations for the nine months ended September 30 (dollars in thousands):
 
 
 
 
 

Percent
Increase
(Decrease)
 
Percentage of Total
 
Percentage of
Revenues from
Continuing Operations
 
2013
 
2012
 
 
2013
 
2012
 
2013
 
2012
General and administrative
$
25,209

 
$
23,282

 
8.3%
 
22.5
 %
 
24.4
 %
 
8.7
 %
 
9.6
 %
Real estate
12,580

 
12,376

 
1.6%
 
11.2
 %
 
13.0
 %
 
4.4
 %
 
5.1
 %
Depreciation and amortization
72,126

 
53,574

 
34.6%
 
64.5
 %
 
56.3
 %
 
24.9
 %
 
22.1
 %
Impairment – commercial mortgage residual interests valuation
16

 
2,718

 
(99.4)%
 
—
 %
 
2.9
 %
 
—
 %
 
1.1
 %
Impairment losses and other charges, net of recoveries
1,972

 
3,258

 
(39.5)%
 
1.8
 %
 
3.4
 %
 
0.7
 %
 
1.3
 %
Total operating expenses
$
111,903

 
$
95,208

 
17.5%
 
100.0
 %
 
100.0
 %
 
38.7
 %
 
39.2