UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
For the quarterly period ended March 31, 2007
OR
For the transition period from to
Commission File Number 001-11290
NATIONAL RETAIL PROPERTIES, INC.
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of incorporation
or organization)
(I.R.S. Employer
Identification No.)
450 South Orange Avenue, Suite 900, Orlando, Florida 32801
(Address of principal executive offices, including zip code)
(407) 265-7348
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) for the Securities Exchange Act of 1934 during the preceding 12 months (or for 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 is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large Accelerated Filer x Accelerated Filer ¨ Non-Accelerated Filer ¨.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange 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.
66,726,509 shares of Common Stock, $0.01 par value, outstanding as of April 27, 2007.
TABLE OF CONTENTS
Item 1.
Item 2.
Item 3.
Item 4.
Item 1A.
Item 5.
Item 6.
and SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except per share data)
Real estate, Investment Portfolio:
Accounted for using the operating method, net of accumulated depreciation and amortization:
Held for investment
Held for sale
Accounted for using the direct financing method:
Real estate, Inventory Portfolio, held for sale
Mortgages, notes and accrued interest receivable, net of allowance of $559 and $634, respectively
Mortgage residual interests
Cash and cash equivalents
Restricted cash
Receivables, net of allowance of $1,036 and $722, respectively
Accrued rental income, net of allowance
Debt costs, net of accumulated amortization of $11,819 and $11,339, respectively
Other assets
Total assets
Line of credit payable
Mortgages payable
Notes payable – secured
Notes payable – convertible
Notes payable, net of unamortized discount of $960 and $996, respectively
Financing lease obligation
Accrued interest payable
Other liabilities
Income tax liability
Total liabilities
Minority interest
Stockholders’ equity:
Preferred stock, $0.01 par value. Authorized 15,000,000 shares
Series A, 1,781,589 shares issued and outstanding at December 31, 2006, stated liquidation value of $25 per share
Series C Redeemable, 3,680,000 depositary shares issued and outstanding stated liquidation value of $25 per share
Common stock, $0.01 par value. Authorized 190,000,000 shares; 65,746,011 and 59,823,031 shares issued and outstanding at March 31, and December 31, respectively
Capital in excess of par value
Retained earnings
Accumulated other comprehensive income
Total stockholders’ equity
See accompanying notes to condensed consolidated financial statements.
3
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(unaudited)
Revenues:
Rental income from operating leases
Earned income from direct financing leases
Contingent rental income
Real estate expense reimbursement from tenants
Interest and other income from real estate transactions
Interest income on mortgage residual interests
Disposition of real estate, Inventory Portfolio:
Gross proceeds
Costs
Gain
Operating expenses:
General and administrative
Real estate
Depreciation and amortization
Impairment – mortgage residual interests valuation adjustment
Earnings from operations
Other expenses (revenues):
Interest and other income
Interest expense
Earnings from continuing operations before income tax benefit, minority interest and equity in earnings (losses) of unconsolidated affiliates
Income tax benefit
Equity in earnings (losses) of unconsolidated affiliates
Earnings from continuing operations
Earnings from discontinued operations:
Real estate, Investment Portfolio
Real estate, Inventory Portfolio, net of income tax expense and minority interest
Net earnings
4
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS – CONTINUED
Series A preferred stock dividends
Series B Convertible preferred stock dividends
Series C Redeemable preferred stock dividends
Net earnings available to common stockholders – basic
Series B convertible preferred stock dividends, if dilutive
Net earnings available to common stockholders – diluted
Net earnings per share of common stock:
Basic:
Continuing operations
Discontinued operations
Diluted:
Weighted average number of common shares outstanding:
Basic
Diluted
5
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
Cash flows from operating activities:
Adjustments to reconcile net earnings to net cash provided by operating activities:
Stock compensation expense
Accretion income on mortgage residual interests
Impairment – real estate
Amortization of notes payable discount
Amortization of deferred interest rate hedge gains
Equity in earnings of unconsolidated affiliates
Distributions received from unconsolidated affiliates
Minority interests
Gain on disposition of real estate, Investment Portfolio
Gain on disposition of real estate, Inventory Portfolio
Deferred income taxes
Change in operating assets and liabilities, net of assets acquired and liabilities assumed in business combinations:
Additions to real estate, Inventory Portfolio
Proceeds from disposition of real estate, Inventory Portfolio
Decrease in real estate leased to others using the direct financing method
Increase (decrease) in work in process
Decrease in mortgages, notes and accrued interest receivable
Decrease (increase) in receivables
Increase in accrued rental income
Increase (decrease) in other assets
Increase in accrued interest payable
Decrease (increase) in other liabilities
Increase (decrease) in current tax liability
Net cash provided by operating activities
Cash flows from investing activities:
Proceeds from the disposition of real estate, Investment Portfolio
Additions to real estate, Investment Portfolio:
Accounted for using the operating method
Increase in mortgages and notes receivable
Mortgage and note payments received
Cash received from mortgage residual interests
Payment of lease costs
Other
Net cash used in investing activities
6
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS – CONTINUED
Cash flows from financing activities:
Proceeds from line of credit payable
Repayment of line of credit payable
Repayment of mortgages payable
Payment of debt costs
Proceeds from issuance of common stock
Redemption of 1,781,589 shares of Series A Preferred Stock
Payment of Series A Preferred Stock dividends
Payment of Series B Convertible Preferred Stock dividends
Payment of Series C Redeemable Preferred Stock dividends
Payment of common stock dividends
Minority interest distributions
Stock issuance costs
Net cash provided by financing activities
Net increase in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
Supplemental disclosure of non-cash investing and financing activities:
Issued 206,718 shares of restricted and unrestricted common stock in 2007 pursuant to the Company’s 2000 Performance Incentive Plan
Issued 4,282 and 26,175 shares of common stock in 2007 and 2006, respectively, pursuant to the Company’s Deferred Director Fee Plan
Surrender of 7,100 shares of restricted common stock in 2007
Change in other comprehensive income
Note receivable accepted in connection with real estate transactions
7
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2007
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 “Company” refers to National Retail Properties, Inc. and its majority owned and controlled subsidiaries. These subsidiaries include the wholly owned qualified REIT subsidiaries of National Retail Properties, Inc., as well as the taxable REIT subsidiaries and their majority owned and controlled subsidiaries (collectively, the “TRS”).
The Company’s operations are divided into two primary business segments: (i) investment assets, including real estate assets, structured finance investments (included in mortgages, notes and accrued interest receivable on the condensed consolidated balance sheets) and mortgage residual interests (collectively, “Investment Assets”), and (ii) inventory real estate assets (“Inventory Assets”). The Company acquires, owns, invests in, manages and develops properties that are leased primarily to retail tenants under long-term net leases (“Investment Properties” or “Investment Portfolio”). As of March 31, 2007, the Company owned 730 Investment Properties, with an aggregate gross leasable area of 9,395,000 square feet, located in 44 states. In addition to the Investment Properties, as of March 31, 2007, the Company had $16,249,000 and $29,577,000 in structured finance investments and mortgage residual interests, respectively. The Inventory Assets are held in the TRS. The TRS, directly and indirectly, through investment interests, acquires and develops real estate primarily for the purpose of selling the real estate (“Inventory Properties” or “Inventory Portfolio”). As of March 31, 2007, the TRS held 77 Inventory Properties.
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, consisting of normal recurring 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 ended March 31, 2007 may not be indicative of the results that may be expected for the year ending December 31, 2007. Amounts as of December 31, 2006, included in the condensed consolidated financial statements, have been derived from the audited consolidated financial statements as of that date. These unaudited condensed consolidated financial statements 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 the Company’s Form 10-K for the year ended December 31, 2006.
Principles of Consolidation – In January 2003, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 46 (revised December 2003), “Consolidation of Variable Interest Entities” (“FIN 46R”). This Interpretation of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” addresses consolidation by business enterprises of variable interest entities.
The Company’s condensed consolidated financial statements include the accounts of each of the respective majority owned and controlled affiliates. All significant intercompany account balances and transactions have been eliminated. The Company applies the equity method of accounting to investments in partnerships and joint ventures that are not subject to control by the Company due to the significance of rights held by other parties.
8
Other Comprehensive Income – The components for other comprehensive income for the quarter ended March 31, 2007 (dollars in thousands):
Balance at beginning of period
Amortization of interest rate swap
Unrealized gain – mortgage residual interests
Stock value adjustment
Balance at end of period
The Company’s total comprehensive income for each of the quarters ended March 31 (dollars in thousands):
Other comprehensive income
Total comprehensive income
Earnings Per Share – Basic net earnings per share is computed by dividing net earnings available to common stockholders by the weighted average number of common shares outstanding during each period. Diluted net earnings per common share is computed by dividing net earnings available to common stockholders for the period by the number of common shares that would have been outstanding assuming the issuance of common shares for all potentially dilutive common shares outstanding during the periods.
The following is a reconciliation of the denominator of the basic net earnings per common share computation to the denominator of the diluted net earnings per common share computation for each of the quarters ended March 31:
Weighted average number of common shares outstanding
Unvested restricted stock
Weighted average number of common shares outstanding used in basic earnings per share
Effect of dilutive securities:
Restricted stock
Common stock options
Directors’ deferred fee plan
Assumed conversion of Series B Convertible Preferred Stock to common stock
Weighted average number of common shares outstanding used in diluted earnings per share
In April 2006, the Series B Convertible Preferred shares were converted into 1,293,996 shares of common stock and therefore are included in the computation of both basic and diluted weighted average shares outstanding. In addition, the potential dilutive shares related to convertible notes payable that were issued in September 2006 were not included in computing earnings per common share because their effects would be antidilutive.
9
New Accounting Standards – In September 2006, FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements” (“SFAS 157”). This statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands the disclosures about fair value measurements. SFAS 157 applies to other accounting pronouncements that require or permit fair value measurements. The changes to current practice resulting from the application of the SFAS 157 relate to the definition of fair value, the methods used to measure fair value and the expanded disclosures about fair value measurements. The definition focuses on the price that would be received to sell the asset or paid to transfer the liability at the measurement date (an exit price) and not the price that would be paid to acquire the asset or received to assume the liability at the measurement date (an entry price). This statement also emphasizes that fair value is a market-based measurement, not an entity specific measurement and subsequently a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability. The statement also clarifies that the market participant assumptions include assumptions about risk, and assumptions about the effect of a restriction on the sale or use of an asset. This statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. This statement should be applied prospectively as of the beginning of the year in which this statement is initially applied. A limited form of retrospective application of SFAS 157 is allowed for certain financial instruments. The Company is currently evaluating the provisions of SFAS 157 to determine the potential impact, if any, the adoption will have on the Company’s financial position or results of operations.
In February 2007, FASB issued SFAS Statement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”) which expands the scope of what companies may carry at fair value. This statement also includes an amendment to SFAS Statement No. 115, “Accounting for Certain Investments in Debt and Equity Securities” (“SFAS 115”). SFAS 159 offers an irrevocable option to carry the vast majority of recognized financial assets and liabilities at fair value with changes in fair value recorded in earnings. This statement can be applied instrument by instrument but must be applied to the entire financial instrument and not portions thereof. This statement does not apply to: (a) financial assets and financial liabilities recognized under leases as defined in SFAS Statement No. 13 “Accounting for Leases” with the exception of a guarantee of a third party lease obligation or a contingent obligation arising from a cancelled lease; (b) financial instruments that are in whole or part, classified by the issuer as a component of stockholder’s equity (such as convertible debt security with a non-contingent beneficial conversion feature); (c) non-financial insurance contracts and warranties; and (d) financial instruments resulting from the separation of an embedded non-financial derivative instrument from a non-financial hybrid instrument and various employers’ and plan obligations for pension benefits, post retirement benefits and other forms of deferred compensation arrangements including stock purchase plans and stock option plans. The amendment to SFAS 115 affects entities with available-for-sale and trading securities. This statement is effective as of the beginning of the first fiscal year that begins after November 15, 2007. The Company is currently evaluating the provisions of SFAS 159 to determine the potential impact, if any, the adoption will have on the Company’s financial position or results of operations.
Use of Estimates – Management of the Company 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 condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America. Significant estimates include provision for impairment and allowances for certain assets, accruals, useful lives of assets and capitalization of costs. Actual results could differ from those estimates.
10
Note 2 – Real Estate – Investment Portfolio:
Leases – The Company generally leases its Investment Properties to established tenants. As of March 31, 2007, 695 of the Investment Property leases have been classified as operating leases and 48 leases have been classified as direct financing leases. For the Investment Property leases classified as direct financing leases, the building portions of the property leases are accounted for as direct financing leases while the land portions of 27 of these leases are accounted for as operating leases. Substantially all leases have initial terms of 10 to 20 years (expiring between 2007 and 2027) and provide for regular monthly payments. In addition, the tenant 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 building and carry property and liability insurance coverage. Certain of the Company’s Investment Properties are subject to leases under which the Company retains responsibility for certain costs and expenses of the property. As of March 31, 2007, the weighted average remaining lease term was approximately 12 years. Generally, the leases of the Investment Properties provide the tenant with one or more multi-year renewal options subject to generally the same terms and conditions as the initial lease.
Held for Investment – Accounted for Using the Operating Method – Real estate subject to operating leases consisted of the following (dollars in thousands):
March 31,
2007
Land and improvements
Buildings and improvements
Leasehold interests
Less accumulated depreciation and amortization
Work in progress
Less impairment
In connection with the development and tenant improvements of 19 Investment Properties, the Company has agreed to fund construction commitments (including land costs) of $48,008,000, of which $26,564,000 has been funded as of March 31, 2007.
Impairments – As a result of the Company’s review of long lived assets for impairment, including identifiable intangible assets, the Company recognized an impairment in discontinued operations of $95,000 for the quarter ended March 31, 2007. The Company did not recognize any impairment for the quarter ended March 31, 2006.
11
Note 3 – Real Estate – Inventory Portfolio:
As of March 31, 2007, the TRS owned 77 Inventory Properties: 60 completed inventory, eight under construction and nine properties pending development. As December 31, 2006, the TRS owned 97 Inventory Properties: 79 completed inventory, five under construction and 13 properties pending development. The real estate Inventory Portfolio consisted of the following (dollars in thousands):
Completed Inventory:
Land
Building
Construction projects:
Work in process
In connection with the development of eight Inventory Properties, the Company has agreed to fund construction commitments of $106,869,000, of which $42,189,000, including land costs, has been funded as of March 31, 2007.
The following table summarizes the number of Inventory Properties sold and the corresponding gain recognized on the disposition of Inventory Properties included in continuing and discontinued operations for each of the quarters ended March 31 (dollars in thousands):
Total continuing operations
Intersegment eliminations
Total discontinued operations
Note 4 – Mortgages, Notes and Accrued Interest Receivable:
As of March 31, 2007, the structured finance investments bear a weighted average interest rate of 12.6% per annum, of which 10.1% is payable monthly and the remaining 2.5% accrues and is due at maturity. The principal balance of each structured finance investment is due in full at maturity, which ranges from May 2007 to April 2009. The structured finance investments are secured by the borrowers’ pledge of their respective membership interests in the certain subsidiaries which own the respective real estate. As of March 31, 2007 and December 31, 2006, the outstanding principal balance of the structured finance investments was $16,249,000 and $13,917,000, respectively.
During the quarter ended March 31, 2007, the Company entered into structured finance investments of $4,221,000. In addition, the Company received principal payments of $1,889,000 on certain structured finance investments plus accrued interest during the quarter ended March 31, 2007.
12
Note 5 – Mortgage Residual Interests:
Orange Avenue Mortgage Investments, Inc. (“OAMI”) holds the mortgage residual interests (“Residuals”) from seven securitizations. Each of the Residuals is recorded at fair value based upon a third-party 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. As a result of the increase in prepayments of the underlying loans of the Residuals, the Company recognized an other than temporary valuation impairment of $1,820,000 for the quarter ended March 31, 2006. The Company did not recognize an other than temporary valuation impairment for the quarter ended March 31, 2007. The Company recorded $154,000 and $28,000 of unrealized gains as other comprehensive income for the quarters ended March 31, 2007 and 2006, respectively.
Note 6 – Line of Credit Payable:
The Company has an existing loan agreement for a $300,000,000 revolving credit facility (the “Credit Facility”). The Credit Facility had a weighted average outstanding balance of $64,287,000 and a weighted average interest rate of 6.2% for the quarter ended March 31, 2007.
Following the use of proceeds of the common stock issuance described in Note 8 below, as of March 31, 2007, the Company had no outstanding balance on its Credit Facility. As of December 31, 2006, the Credit Facility had an outstanding balance of $28,000,000.
Note 7 – Preferred Stock:
The following table outlines each issuance of the Company’s preferred stock (dollars in thousands, except per share data):
Non-Voting
Preferred
Stock
Issuance
Dividends Declared and Paid
For the Quarter Ended March 31,
Per
Share
9% Series A (1)
6.7% Series B Convertible (2)
7.375% Series C Redeemable Depositary Shares (3)
(1)
Effective January 2, 2007, the Company redeemed all 1,781,589 shares of Series A Preferred Stock, at their redemption price of $25.00 per share plus all accumulated and unpaid dividends through the redemption date of $0.20625 per share, for an aggregate redemption price of $25.20625.
(2)
In April 2006, the holder of the Company’s Series B Convertible Preferred Stock elected to convert those 10,000 shares into 1,293,996 shares of common stock.
(3)
In October 2006, the Company issued 3,680,000 depositary shares, each representing 1/100th of a share of 7.375% Series C Redeemable Preferred Stock.
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Note 8 – Common Stock:
In March 2007, the Company filed a prospectus supplement to the prospectus contained in its February 2006 shelf registration statement and issued 5,000,000 shares of common stock at a price of $24.70 per share and received gross proceeds of $123,500,000. Subsequently, in April 2007, the Company issued an additional 750,000 shares of common stock in connection with the underwriters’ over-allotment option and received gross proceeds of $18,525,000. In connection with this offering, the Company incurred stock issuance costs totaling approximately $5,430,000, consisting primarily of underwriters’ fees and commissions, legal and accounting fees and printing expenses.
During the quarters ended March 31, 2007 and 2006, the Company declared and paid dividends to its common shareholders of $20,115,000 and $18,014,000, respectively, or $0.335 and $0.325 per share, respectively, of common stock.
Dividend Reinvestment and Stock Purchase Plan. In February 2006, the Company filed a shelf registration statement with the Securities and Exchange Commission for its Dividend Reinvestment and Stock Purchase Plan (“DRIP”) which permits the issuance by the Company of 12,191,394 shares of common stock. The following outlines the common stock issuances pursuant to the DRIP for each of the quarters ended March 31 (dollars in thousands):
Shares of common stock
Net proceeds
Note 9 – Income Taxes:
In June 2006, the FASB issued Financial Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”), which clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements in accordance with SFAS No. 109, “Accounting for 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.
The Company is subject to the provisions of FIN 48 as of January 1, 2007, and has analyzed its various federal and state filing positions. The Company believes that its income tax filing positions and deductions are well documented and supported. Additionally, the Company believes that its accruals for tax liabilities are adequate. Therefore, no reserves for uncertain income tax positions have been recorded pursuant to FIN 48. In addition, the Company did not record a cumulative effect adjustment related to the adoption of FIN 48.
For income tax purposes, the Company has taxable REIT subsidiaries in which certain real estate activities are conducted. Additionally, the Company has its 78.9 percent equity interest in OAMI. The Company has consolidated OAMI in its financial statements as a result of the Company’s acquisition of OAMI in May 2005. OAMI, upon making its REIT conversion, has remaining tax liabilities relating to the built-in-gain of its assets.
The Company treats some depreciation expense and certain other items differently for tax than for financial reporting purposes. The principal differences between the Company’s effective tax rates for the quarters ended March 31, 2007 and 2006, and the statutory rates relate to state taxes and nondeductible expenses such as meals and entertainment expenses.
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The components of the net income tax asset (liability) consist of the following (dollars in thousands):
Temporary differences:
Built-in-gain
Depreciation
Excess interest expense carryforward
Net operating loss carryforward
Net deferred income tax asset (liability)
Current income tax asset (payable)
Income tax asset (liability)
In assessing the ability to realize a deferred tax asset, management considers whether it is more likely than not that some portion or the entire deferred tax asset will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. The net operating loss carryforwards were generated by the Company’s taxable REIT subsidiaries. The net operating loss carryforwards expire in 2026. Based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not that the Company will realize all of the benefits of these deductible differences that existed as of March 31, 2007.
The income tax (expense) benefit consists of the following components for each of the quarters ended March 31 (dollars in thousands):
Net earnings before income taxes
Provision for income tax benefit (expense):
Current:
Federal
State and local
Deferred:
Total provision for income taxes
Total net earnings
15
Note 10 – Earnings from Discontinued Operations:
Real Estate – Investment Portfolio – In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” the Company has classified the revenues and expenses related to (i) all Investment Properties that were sold and expired leasehold interests, and (ii) any Investment Property that was held for sale as of March 31, 2007, as discontinued operations. The following is a summary of the earnings from discontinued operations from the Investment Portfolio for each of the quarters ended March 31 (dollars in thousands):
Impairments – real estate
Other expenses:
Earnings before gain on disposition of real estate
Gain on disposition of real estate
Earnings from discontinued operations
16
Real Estate – Inventory Portfolio – The Company has classified as discontinued operations the revenues and expenses related to (i) Inventory Properties which generated rental revenues prior to disposition, and (ii) Inventory Properties which generated rental revenues and were held for sale as of March 31, 2007. The following is a summary of the earnings from discontinued operations from the Inventory Portfolio for each of the quarters ended March 31 (dollars in thousands):
Interest and other from real estate transactions
Disposition of real estate:
Earnings before income tax expense and minority interest
Income tax expense
Note 11 – Segment Information:
The Company has identified two primary financial segments: (i) Investment Assets and (ii) Inventory Assets. The following tables represent the segment data and a reconciliation to the Company’s consolidated totals for the quarters ended March 31 (dollars in thousands):
External revenues
Intersegment revenues
2006
17
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, 2006. This information 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. These statements generally are characterized by the use of terms such as “believe,” expect” and “may.”
The term “Company” refers to National Retail Properties, Inc. and its majority owned and controlled subsidiaries. These subsidiaries include the wholly owned qualified REIT subsidiaries of the Company as well as the taxable REIT subsidiaries and their majority owned and controlled subsidiaries (collectively, “TRS”).
Overview
The Company’s operations are divided into two primary business segments: (i) investment assets, including real estate assets, structured finance investments (included in mortgages, notes and accrued interest receivable on the condensed consolidated balance sheets) and mortgage residual interests (collectively, “Investment Assets”), and (ii) inventory real estate assets (“Inventory Assets”). The Company acquires, owns, invests in, manages and develops properties that are leased primarily to retail tenants under long-term net leases (“Investment Properties” or “Investment Portfolio”). The Inventory Assets are held in the TRS. The TRS, directly and indirectly, through investment interests, owns real estate primarily for the purpose of selling the real estate (“Inventory Properties” or “Inventory Portfolio”).
As of March 31, 2007, the Company owned 730 Investment Properties, with an aggregate leasable area of 9,395,000 square feet, located in 44 states. Approximately 98 percent of the Company’s Investment Portfolio was leased at March 31, 2007. In addition to the Investment Properties, as of March 31, 2007, the Company had $16,249,000 and $29,577,000 in structured finance investments and mortgage residual interests (“Residuals”), respectively.
The TRS, directly and indirectly, through investment interests, owns real estate primarily for the purpose of selling the real estate (“Inventory Properties” or “Inventory Portfolio”). The TRS acquires and develops Inventory Properties (“Development Properties” or “Development Portfolio”) and also acquires existing Inventory Properties (“Exchange Properties” or “Exchange Portfolio”). As of March 31, 2007, the TRS held 77 Inventory Properties, of which 26 were Development Properties (nine completed inventory, eight under construction and nine properties pending development) and 51 were Exchange Properties.
The Company’s management team focuses on certain key indicators to evaluate the financial condition and operating performance of the Company. The key indicators for the Company include items such as: the composition of the Company’s Investment Portfolio and structured finance investments (such as tenant, geographic and industry classification diversification), the occupancy rate of the Company’s Investment Portfolio, certain financial performance ratios and profitability measures, industry trends and performance compared to that of the Company, and returns the Company receives on its invested capital.
The Company has recently increased its investments in the convenience store and restaurant sectors. Both of these sectors represent a large part of the freestanding retail property marketplace which the Company believes represents areas of attractive investment opportunity. Similarly, the Company has some geographic concentration in the south and southwest which the Company believes are areas of above-average population growth.
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Results of Operations
Property Analysis – Investment Portfolio
General. The following table summarizes the Company’s Investment Portfolio:
Investment Properties Owned:
Number
Total gross leasable area (square feet)
Investment Properties Leased:
Percent of total gross leasable area
Weighted average remaining lease term (years)
The following table summarizes the diversification of the Company’s Investment Portfolio based on the top 10 lines of trade as of March 31, 2007 (dollars in thousands):
Top 10 Lines of Trade
Convenience Stores
Restaurants – Full Service
Drug Stores
Sporting Goods
Consumer Electronics
Books
Grocery
Restaurants – Limited Service
Furniture
Travel Plazas
Based on the annualized base rent for all leases in place as of the respective period.
Property Acquisitions. The following table summarizes the Investment Property acquisitions for each of the quarters ended March 31 (dollars in thousands):
Acquisitions:
Number of Investment Properties
Gross leasable area (square feet)
Total dollars invested (1)
Includes dollars invested on projects currently under construction.
The Company typically uses the proceeds from property sales either to pay down the outstanding indebtedness of the Company’s credit facility or reinvest in real estate.
19
Property Dispositions. The following table summarizes the Investment Properties sold by the Company for each of the quarters ended March 31 (dollars in thousands):
Number of properties
Net sales proceeds
Net gain
Property Analysis – Inventory Portfolio
General. The following summarizes the number of properties held for sale in the Company’s Inventory Portfolio:
December 31,
Development Properties:
Completed inventory
Under construction
Pending development
Exchange Portfolio:
Inventory Properties
Total Inventory Properties
Property Acquisitions. The following table summarizes the property acquisitions and dollars invested in the Inventory Portfolio for each of the quarters ended March 31 (dollars in thousands):
Development Portfolio:
Number of properties acquired
Dollars invested (1)
Dollars invested
Total dollars invested
Property Dispositions. The following table summarizes the number of Inventory Properties sold and the corresponding gain recognized from the disposition of real estate held for sale included in earnings from continuing and discontinued operations for each of the quarters ended March 31 (dollars in thousands):
Development
Exchange
Intercompany eliminations
Minority interest, Development
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Revenue from Continuing Operations Analysis
General. During the quarter ended March 31, 2007, the Company’s rental income increased primarily due to the addition of Investment Properties. The Company continues to maintain a stable Investment Portfolio occupancy rate and anticipates that any significant increase in rental income will continue to come largely from additional property acquisitions. The following summarizes the Company’s revenues from continuing operations for each of the quarters ended March 31 (dollars in thousands):
PercentIncrease
(Decrease)
Rental Income (1)
Total revenues
Includes rental income from operating leases, earned income from direct financing leases and contingent rental income from continuing operations (“Rental Income”).
Revenue from Operations by Source of Income. The Company has identified two primary business segments, and thus, sources of revenue: (i) earnings from the Company’s Investment Assets and (ii) earnings from the Company’s Inventory Assets. The revenues generated by each of the Company’s two primary operating segments have remained relatively consistent as a percentage of the Company’s total revenues from continuing operations. The following table summarizes the revenues from continuing operations for each of the quarters ended March 31 (dollars in thousands):
Versus
Percent
Increase
Investment Assets
Inventory Assets
Rental Income. Rental Income increased largely due to the continued acquisition of Investment Properties. During the quarter ended March 31, 2007, the Company added 25 Investment Properties with an aggregate gross leasable area of 114,000 square feet. Additionally, the increase in Rental Income is partially attributable to the acquisition of 213 Investment Properties with an aggregate gross leasable area of 1,130,000 square feet during the year ended December 31, 2006.
Real Estate Expense Reimbursements from Tenants. Real estate expense reimbursements from tenants remained constant as a percentage of total revenues from continuing operations. The increase in the quarter ended March 31, 2007 when compared with the same period last year is a result of the newly acquired Investment Properties in 2006.
Interest Income on Mortgage Residual Interests. The decrease in interest income on mortgage residual interests for the quarter ended March 31, 2007 as compared to the quarter ended March 31, 2006 is a result of the amortization and prepayments of the underlying loans.
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Gain from Disposition of Real Estate, Inventory Portfolio. Inventory Properties typically are operating properties and are classified as discontinued operations. However, the gains on the sale of Inventory Properties that are sold prior to rent commencement are reported in continuing operations. The following table summarizes the Inventory Property dispositions included in continuing operations for each of the quarters ended March 31 (dollars in thousands):
# of
Properties
Gain, net of minority interest
Analysis of Expenses from Continuing Operations
General. Operating expenses from continuing operations decreased slightly for the quarter ended March 31, 2007 as compared to the quarter ended March 31, 2006. The following summarizes the Company’s expenses from continuing operations for each of the quarters ended March 31 (dollars in thousands):
Total operating expenses
Total other expenses (revenues)
General and Administrative. General and administrative expenses remained fairly stable as a percentage of total operating expenses. For the quarter ended March 31, 2007 as compared to the quarter ended March 31 2006, general and administrative expenses decreased primarily as a result of a decrease in lost pursuit costs.
Real Estate. The increase in real estate expenses for the quarter ended March 31, 2007 as compared to the quarter ended March 31, 2006, was primarily attributable to an increase in tenant reimbursable real estate expenses. The increase was also attributable to an increase in expenses related to vacant properties and an increase in certain expenses not reimbursable by tenants.
Depreciation and Amortization. The increase in depreciation and amortization expense for the quarter ended March 31, 2007 is primarily attributed to the depreciation on (i) the 25 Investment Properties with aggregate gross leasable area of 114,000 square feet acquired during the quarter ended March 31, 2007 and (ii) the 213 Investment Properties with an aggregate gross leasable area of 1,130,000 square feet during the year ended December 31, 2006.
Impairment – Mortgage Residual Interests Valuation Adjustment. In connection with the independent valuations of the mortgage residual interests’ (“Residuals”) fair value, the Company reduced the carrying value of the Residuals to reflect such fair value at March 31, 2006. The valuation impairment during the quarter ended March 31, 2007 was classified as temporary and was recorded as other comprehensive income.
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Interest Expense. Interest expense decreased slightly for the quarter ended March 31, 2007 as compared to the quarter ended March 31, 2006. The following represents the primary changes in debt that have impacted interest expense:
Earnings from Discontinued Operations
In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” the Company classified as discontinued operations the revenues and expenses related to its Investment Properties that were sold and its leasehold interests that expired as well as the revenues and expenses related to any Investment Property that was held for sale at March 31, 2007. The Company also classified as discontinued operations the revenues and expenses of its Inventory Properties that were sold which generated rental revenues as well as the revenues and expenses related to its Inventory Properties held for sale which generated rental revenues as of March 31, 2007. The Company records discontinued operations by the Company’s identified segments: (i) Investment Assets and (ii) Inventory Assets. The following table summarizes the earnings from discontinued operations for each of the quarters ended March 31 (dollars in thousands):
# of Sold
Inventory Assets, net of minority interest
The Company occasionally sells Investment Properties and may reinvest the proceeds of the sales to purchase new properties. The Company evaluates its ability to pay dividends to stockholders by considering the combined effect of income from continuing and discontinued operations.
Liquidity
General. The Company’s demand for funds has been and will continue to be primarily for (i) payment of operating expenses and dividends; (ii) property acquisitions and development, structured finance investments and capital expenditures; (iii) payment of principal and interest on its outstanding indebtedness, and (iv) other investments.
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Cash and Cash Equivalents. Below is a summary of the Company’s cash flows for each of the quarters ended March 31 (in thousands):
Cash and cash equivalents:
Provided by operating activities
Used in investing activities
Provided by (used in) financing activities
Increase (decrease)
Net cash at beginning of period
Net cash at end of period
Cash provided by operating activities represents cash received primarily from rental income from tenants, gain on the disposition of Inventory Properties and interest income less general and administrative expenses and interest expense. The change in cash provided by operations for the quarters ended March 31, 2007, and 2006, is primarily the result of changes in revenues and expenses as discussed in “Results of Operations.”
Changes in cash for investing activities are primarily attributable to the acquisitions and dispositions of Investment Properties.
The Company’s financing activities for the period ended March 31, 2007 include the following significant transactions:
$123,500,000 in gross proceeds from the issuance of 5,000,000 shares of common stock
$20,115,000 in dividends paid to common stockholders
•
$1,696,000 in dividends paid to holders of depositary shares, each representing 1/100th of a share of the Company’s Series C Redeemable Preferred Stock
$44,540,000 paid to redeem all 1,781,589 shares of Series A Preferred Stock at the liquidation value of $25.00 per share
$28,000,000 in net payments on the Company’s credit facility
$16,718,000 in net proceeds from the issuance of 699,346 shares of common stock in connection with the Dividend Reinvestment and Stock Purchase Plan (“DRIP”)
Subsequently, in April 2007, the Company issued an additional 750,000 shares of common stock in connection with the underwriters’ over-allotment option and received gross proceeds of $18,525,000.
Contractual Obligations and Commercial Commitments. The Company has agreed to fund construction commitments in connection with the development and tenant improvements of additional properties as outlined below at March 31, 2007 (dollars in thousands):
Investment Portfolio
Inventory Portfolio
Including land costs.
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As of March 31, 2007, the Company does not have any other contractual cash obligations, such as purchase obligations, financing lease obligations or other long-term liabilities other than those reflected in the table. In addition to items reflected in the table, the Company has preferred stock with cumulative preferential cash distributions, as described below under “Dividends.”
Dividends. The Company has made an election to be taxed as a REIT under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended, and related regulations. The Company 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 the Company 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 affect the Company’s income and its ability to pay dividends. The Company believes it has been organized as, and its past and present operations qualify the Company as, a REIT. Additionally, the Company intends to continue to operate so as to remain qualified as a REIT for federal income tax purposes.
One of the Company’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. During the quarters ended March 31, 2007 and 2006, the Company declared and paid dividends to its common stockholders of $20,115,000 and $18,014,000, respectively, or $0.335 and $0.325 per share, respectively, of common stock.
Holders of each of the Company’s preferred stock issuances are entitled to receive, when and as authorized by the board of directors, cumulative preferential cash distributions based on the stated rate and liquidation preference per annum. The following table outlines each issuance of the Company’s preferred stock (dollars in thousands, except per share data):
Non-Voting Preferred Stock Issuance
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Capital Resources
Generally, cash needs for property acquisitions, structured finance investments, debt payments, dividends, capital expenditures, development and other investments have been funded by equity and debt offerings, bank borrowings, the sale of properties and, to a lesser extent, from internally generated funds. Cash needs for other items have been met from operations. Potential future sources of capital include proceeds from the public or private offering of the Company’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 the Company’s total outstanding debt (dollars in thousands):
Notes payable
Total outstanding debt
Indebtedness. The Company expects to use indebtedness primarily for property acquisitions and development of single-tenant retail properties, either directly or through investment interests and structured finance investments. As of March 31, 2007, there were no material changes in the Company’s indebtedness except as noted below.
Line of Credit Payable. The Company has an existing loan agreement for a $300,000,000 revolving credit facility (the “Credit Facility”). The Credit Facility had a weighted average outstanding balance of $64,287,000 and a weighted average interest rate of 6.2% for the quarter ended March 31, 2007.
Following the use of proceeds of the common stock issuance described below, as of March 31, 2007, the Company had no outstanding balance on its Credit Facility. As of December 31, 2006, the Credit Facility had an outstanding balance of $28,000,000.
Equity
Common Stock Issuance. In March 2007, the Company filed a prospectus supplement to the prospectus contained in its February 2006 shelf registration statement and issued 5,000,000 shares of common stock at a price of $24.70 per share and received gross proceeds of $123,500,000. Subsequently, in April 2007, the Company issued an additional 750,000 shares of common stock in connection with the underwriters’ over-allotment option and received gross proceeds of $18,525,000. In connection with this offering, the Company incurred stock issuance costs totaling approximately $5,430,000, consisting primarily of underwriters’ fees and commissions, legal and accounting fees and printing expenses.
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Dividend Reinvestment and Stock Purchase Plan. In February 2006, the Company filed a shelf registration statement with the Securities and Exchange Commission for the DRIP which permits the issuance by the Company of 12,191,394 shares of common stock. The Company’s DRIP provides an economical and convenient way for current stockholders and other interested new investors to invest in the Company’s common stock. The following outlines the common stock issuances pursuant to the DRIP for each of the quarters ended March 31 (dollars in thousands):
Structured Finance Investments
Structured finance agreements are typically loans secured by a borrower’s pledge of ownership interests in the entity that owns the real estate. These agreements are typically subordinated to senior loans secured by first mortgages encumbering the underlying real estate. Subordinated positions are generally subject to a higher risk of nonpayment of principal and interest than the more senior loans. As of March 31, 2007, the structured finance investments bear a weighted average interest rate of 12.6% per annum, of which 10.1% is payable monthly and the remaining 2.5% accrues and is due at maturity. The principal balance of each structured finance investment is due in full at maturity, which ranges from May 2007 to April 2009. As of March 31, 2007 and December 31, 2006, the outstanding principal balance of the structured finance investments was $16,249,000 and $13,917,000, respectively.
Mortgage Residual Interests
OAMI holds the mortgage residual interests (“Residuals”) from seven securitizations. Each of the Residuals is recorded at fair value based upon a third-party 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. As a result of the increase in historical prepayments of the underlying loans of the Residuals, the Company recognized an other than temporary valuation impairment of $1,820,000 for the quarter ended March 31, 2006. The Company recorded temporary valuation changes of $154,000 and $28,000 of unrealized gains as other comprehensive income for the quarters ended March 31, 2007 and 2006, respectively.
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The Company is exposed to interest changes primarily as a result of its variable rate Credit Facility and its long-term, fixed rate debt used to finance the Company’s development and acquisition activities, and for general corporate purposes. The Company’s interest rate risk management objective is to limit the impact of interest rate changes on earnings and cash flows and to lower its overall borrowing costs. To achieve its objectives, the Company borrows at both fixed and variable rates on its long-term debt. The Company had no outstanding derivatives as of March 31, 2007 and December 31, 2006.
The information in the table below summarizes the Company’s market risks associated with its debt obligations outstanding as of March 31, 2007 and 2006. The table presents principal cash flows and related interest rates by year for debt obligations outstanding as of March 31, 2007. The variable interest rates shown represent the weighted average rates for the Credit Facility and Term Note at the end of the periods. As the table incorporates only those exposures that exist as of March 31, 2007, it does not consider those exposures or positions which could arise after this date. Moreover, because firm commitments are not presented in the table below, the information presented therein has limited predictive value. As a result, the Company’s ultimate realized gain or loss with respect to interest rate fluctuations will depend on the exposures that arise during the period, the Company’s hedging strategies at that time and interest rates. If interest rates on the Company’s variable rate debt increased by 1%, the Company’s interest expense would have increased by less than two percent for the quarter ended March 31, 2007.
WeightedAverage
Interest
Rate(1)
Rate
Effective
2008
2009
2010
2011
Thereafter
Total
Fair Value:
December 31, 2006
The Credit Facility interest rate varies based upon a tiered rate structure ranging from 55 to 112.5 basis points above LIBOR based upon the debt rating of the Company. The Term Note interest rate varies based upon a tiered rate structure ranging from 85 to 165 basis points above LIBOR based upon the debt rating of the Company.
Includes Company’s notes payable, net of unamortized note discounts and convertible notes payable.
In July 2004, the Company sold five investment properties for $26,041 and subsequently leased back the properties under a 10-year financing lease obligation. The Company may repurchase one or more of the properties subject to put and call options included in the financing lease.
The Company is also exposed to market risks related to the Residuals. Factors that may impact the market value of the Residuals include delinquencies, loan losses, prepayment speeds and interest rates. The Residuals, which are reported at market value, had a carrying value of $29,577,000 and $31,512,000 as of March 31, 2007 and December 31, 2006, respectively. Unrealized gains and losses are reported as other comprehensive income in stockholders’ equity. Losses are considered other than temporary and reported as a valuation impairment in earnings from operations if and when there has been a change in the timing or amount of estimated cash flows that leads to a loss in value.
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Evaluation of Disclosure Controls and Procedures. As of the end of the period covered by this report, an evaluation was performed under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness as of March 31, 2007 of the design and operation of the Company’s disclosure controls and procedures as defined in Rule 13a-15(e) under the Securities and Exchange Act of 1934, as amended. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the design and operation of these disclosure controls and procedures were effective as of the end of the period covered by this report.
Changes in Internal Control over Financial Reporting. There has been no change in the Company’s internal control over financial reporting that occurred during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
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PART II. OTHER INFORMATION
The following exhibits are filed as a part of this report.
30
31
32
33
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
DATED this 2nd day of May 2007.
/s/ Craig Macnab
/s/ Kevin B. Habicht
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Exhibit Index
35
36
37
ND: 4831-8038-4513, Ver 1ND: 4843-0916-8129, Ver 5ND: 4843-0916-8129, Ver 5ND: 4843-0916-8129, Ver 5ND: 4843-0916-8129, Ver 4ND: 4843-0916-8129, Ver 4ND: 4843-0916-8129, Ver 4
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