Form 10-K
Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-K

(Mark One)

 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the fiscal year ended December 31, 2009

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   56-1431377

(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)

Registrant’s telephone number, including area code: (407) 265-7348

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class:   Name of exchange on which registered:
Common Stock, $0.01 par value   New York Stock Exchange
7.375% Series C Preferred Stock, $0.01 par value   New York Stock Exchange

Securities registered pursuant to section 12(g) of the Act:

None

(Title of class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  x    No  ¨

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

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  ¨    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

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

The aggregate market value of voting common stock held by non-affiliates of the registrant as of June 30, 2009 was $1,371,916,984.

The number of shares of common stock outstanding as of February 16, 2010 was 82,916,942.


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DOCUMENTS INCORPORATED BY REFERENCE:

Registrant incorporates by reference into Part III (Items 10, 11, 12, 13 and 14) of this Annual Report on Form 10-K portions of National Retail Properties, Inc.’s definitive Proxy Statement for the 2010 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission (the “Commission”) pursuant to Regulation 14A. The definitive Proxy Statement will be filed with the Commission not later than 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K.


Table of Contents

 

TABLE OF CONTENTS

 

         PAGE      
REFERENCE
Part I     

Item 1.

 

Business

   2

Item 1A.

 

Risk Factors

   9

Item 1B.

 

Unresolved Staff Comments

   18

Item 2.

 

Properties

   18

Item 3.

 

Legal Proceedings

   18

Item 4.

 

Submission of Matters to a Vote of Security Holders

   18
Part II     

Item 5.

 

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

   19

Item 6.

 

Selected Financial Data

   21

Item 7.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   23

Item 7A.

 

Quantitative and Qualitative Disclosures About Market Risk

   44

Item 8.

 

Financial Statements and Supplementary Data

   45

Item 9.

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

   86

Item 9A.

 

Controls and Procedures

   86

Item 9B.

 

Other Information

   88
Part III     

Item 10.

 

Directors, Executive Officers and Corporate Governance

   88

Item 11.

 

Executive Compensation

   88

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

   88

Item 13.

 

Certain Relationships and Related Transactions, and Director Independence

   88

Item 14.

 

Principal Accountant Fees and Services

   88
Part IV     

Item 15.

 

Exhibits and Financial Statement Schedules

   89

Signatures

   94


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PART I

Unless the context otherwise requires, references in this Annual Report on Form 10-K to the terms “registrant” or “NNN” or 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.”

Statements contained in this annual report on Form 10-K, including the documents that are incorporated by reference, that are not historical facts are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”). Also, when NNN uses any of the words “anticipate,” “assume,” “believe,” “estimate,” “expect,” “intend,” or similar expressions, NNN is making forward-looking statements. Although management believes that the expectations reflected in such forward-looking statements are based upon present expectations and reasonable assumptions, NNN’s actual results could differ materially from those set forth in the forward-looking statements. Certain factors that could cause actual results or events to differ materially from those NNN anticipates or projects are described in Item 1A. “Risk Factors” of this Annual Report on Form 10-K.

Given these uncertainties, readers are cautioned not to place undue reliance on such statements, which speak only as of the date of this Annual Report on Form 10-K or any document incorporated herein by reference. NNN undertakes no obligation to publicly release any revisions to these forward-looking statements that may be made to reflect events or circumstances after the date of this Annual Report on Form 10-K.

Item 1.  Business

The Company

NNN, a Maryland corporation, is a fully integrated real estate investment trust (“REIT”) formed in 1984. NNN’s operations are divided into two primary business segments: (i) investment assets, including real estate assets, mortgages and notes receivable (including structured finance investments), and commercial mortgage residual interests (collectively, “Investment Assets”), and (ii) inventory real estate assets (“Inventory Assets”). The Inventory Assets are operated in the TRS.

Real Estate Assets

NNN acquires, owns, invests in, manages and develops properties that are leased primarily to retail tenants under long-term net leases and primarily held for investment (“Investment Properties” or “Investment Portfolio”). The Inventory Assets typically represent direct and indirect investment interests in real estate assets acquired or developed primarily for the purpose of selling the real estate (“Inventory Properties” or “Inventory Portfolio”). Inventory Assets typically consist of two types of properties, property for development (“Development Properties or Development Portfolio”) and improved properties (“Exchange Properties” or “Exchange Portfolio”). As of December 31, 2009, NNN owned 1,015 Investment Properties, with an aggregate leasable area of 11,373,000 square feet, located in 44 states. Approximately 96 percent of total properties in NNN’s Investment Portfolio were leased or operated at December 31, 2009. As of December 31, 2009, NNN owned 19 Inventory Properties.

Competition

NNN generally competes with numerous other REITs, commercial developers, real estate limited partnerships and other investors, including but not limited to, insurance companies, pension funds and financial institutions, that own, manage, finance or develop retail and net leased properties.

 

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Employees

As of January 31, 2010, NNN employed 57 full-time associates including executive and administrative personnel.

Other Information

NNN’s executive offices are located at 450 S. Orange Avenue, Suite 900, Orlando, Florida 32801, and its telephone number is (407) 265-7348. NNN has an Internet website at www.nnnreit.com where NNN’s filings with the Securities and Exchange Commission (the “Commission”) can be downloaded free of charge.

The common shares of National Retail Properties, Inc. are traded on the New York Stock Exchange (the “NYSE”), under the ticker symbol “NNN.” The depositary shares, each representing 1/100th of a share of 7.375% Series C Cumulative Redeemable Preferred Stock, par value $0.01 per share (“Series C Preferred Stock”), of NNN are traded on the NYSE under the ticker symbol “NNNPRC.”

Business Strategies and Policies

The following is a discussion of NNN’s operating strategy and certain of its investment, financing and other policies. These strategies and policies have been set by management and/or the Board of Directors and, in general, may be amended or revised from time to time by management and/or the Board of Directors without a vote of NNN’s stockholders.

Operating Strategies

NNN’s strategy is to invest primarily in retail real estate that is typically located along high-traffic commercial corridors near areas of commercial and residential density. Management believes that these types of properties, generally pursuant to triple-net leases, provide attractive opportunities for a stable current return and the potential for increased returns and capital appreciation. Triple-net leases typically require the tenant to pay property operating expenses such as real estate taxes, assessments and other government charges, insurance, utilities, repairs and maintenance and capital expenditures. Initial lease terms are generally 15 to 20 years.

In some cases, NNN’s investment in real estate is in the form of mortgages, structured finance investments or other loans which may be secured by real estate, a borrower’s pledge of ownership interests in the entity that owns the real estate or other assets. These investments may be subordinated to senior loans encumbering the underlying real estate or assets. Subordinated positions are generally subject to a higher risk of nonpayment of principal and interest than the more senior loans.

NNN holds investment real estate assets until it determines that the sale of such a property is advantageous in view of NNN’s investment objectives. In deciding whether to sell a real estate investment asset, NNN may consider factors such as potential capital appreciation, net cash flow, tenant credit quality, market lease rates, potential use of sale proceeds and federal income tax considerations.

NNN acquires and/or develops inventory real estate assets primarily for the purpose of resale.

NNN’s management team considers certain key indicators to evaluate the financial condition and operating performance of NNN. The key indicators for NNN may include items such as: the composition of NNN’s Investment Portfolio (including but not limited to tenant, geographic and line of trade diversification), the occupancy rate of NNN’s Investment Portfolio, certain financial performance ratios, profitability measures, industry trends and performance of competitors compared to that of NNN.

The operating strategies employed by NNN have allowed it to increase the annual dividend (paid quarterly) per common share for 20 consecutive years.

 

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Investment in Real Estate or Interests in Real Estate

NNN’s management believes that single tenant, freestanding net lease retail properties will continue to be attractive investment opportunities and that NNN is well suited to take advantage of these opportunities because of its experience in accessing capital markets, ability to underwrite and acquire properties, and because of management’s experience in seeking out, identifying and evaluating potential acquisitions.

In evaluating a particular acquisition, management may consider a variety of factors, including:

 

   

the location, visibility and accessibility of the property,

 

   

the geographic area and demographic characteristics of the community, as well as the local real estate market, including potential for growth, market rents, and existing or potential competing properties or retailers,

 

   

the size of the property,

 

   

the purchase price,

 

   

the non-financial terms of the proposed acquisition,

 

   

the availability of funds or other consideration for the proposed acquisition and the cost thereof,

 

   

the compatibility of the property with NNN’s existing portfolio,

 

   

the potential for, and current extent of, any environmental problems,

 

   

the quality of construction and design and the current physical condition of the property,

 

   

the financial and other characteristics of the existing tenant,

 

   

the tenant’s business plan, operating history and management team,

 

   

the tenant’s industry,

 

   

the terms of any existing leases, and

 

   

the rent to be paid by the tenant.

NNN intends to engage in future investment activities in a manner that is consistent with the maintenance of its status as a REIT for federal income tax purposes and that will not make NNN an investment company under the Investment Company Act of 1940, as amended. Equity investments in acquired properties may be subject to existing mortgage financings and other indebtedness or to new indebtedness which may be incurred in connection with acquiring or refinancing these investments.

Investments in Real Estate Mortgages, Commercial Mortgage Residual Interests, and Securities of or Interests in Persons Engaged in Real Estate Activities

While NNN’s primary business objectives and Investment Properties emphasize retail properties, NNN may invest in (i) a wide variety of property types and tenant types, (ii) leases, mortgages, commercial mortgage residual interests and other types of real estate interests, (iii) loans secured by personal property, (iv) loans secured by membership interests, or (v) securities of other REITs, other entities engaged in real estate activities or securities of other issuers, including for the purpose of exercising control over such entities. For example, NNN from time to time has made investments in mortgage loans or held mortgages on properties that NNN has sold and has made structured finance investments and other loans related to properties acquired or sold.

 

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Financing Strategy

NNN’s financing objective is to manage its capital structure effectively in order to provide sufficient capital to execute its operating strategies while servicing its debt requirements and providing value to its stockholders. NNN generally utilizes debt and equity security offerings, bank borrowings, the sale of properties, and to a lesser extent, internally generated funds to meet its capital needs.

NNN typically funds its short-term liquidity requirements including investments in additional retail properties with cash from its $400,000,000 unsecured revolving credit facility (“Credit Facility”). As of December 31, 2009, no balance was outstanding and $400,000,000 was available for future borrowings under the Credit Facility, excluding undrawn letters of credit totaling $653,000.

For the year ended December 31, 2009, NNN’s ratio of total liabilities to total gross assets (before accumulated depreciation) was approximately 37 percent and the secured indebtedness to total gross assets was approximately one percent. The total debt to total market capitalization was approximately 36 percent. Certain financial agreements to which NNN is a party contain covenants that limit NNN’s ability to incur debt under certain circumstances.

NNN anticipates it will be able to obtain additional financing for short-term and long-term liquidity requirements as further described in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity.” However, there can be no assurance that additional financing or capital will be available, or that the terms will be acceptable or advantageous to NNN.

The organizational documents of NNN do not limit the absolute amount or percentage of indebtedness that NNN may incur. Additionally, NNN may change its financing strategy at any time. NNN has not engaged in trading, underwriting or agency distribution or sale of securities of other issuers and does not intend to do so.

Strategies and Policy Changes

Any of NNN’s strategies or policies described above may be changed at any time by NNN without notice to or a vote of NNN’s stockholders.

Investment Properties

As of December 31, 2009, NNN owned 1,015 Investment Properties with an aggregate gross leasable area of 11,373,000 square feet, located in 44 states. Approximately 96 percent of the Investment Properties were leased at December 31, 2009.

The following table summarizes NNN’s Investment Properties as of December 31, 2009 (in thousands):

 

     Size(1)    Acquisition Cost(2)
   High    Low    Average    High    Low    Average

Land

   2,223    7    109    $ 8,882    $ 25    $ 1,086

Building

   135    1    11      17,049      44      1,520

(1)     Approximate square feet.

(2)     Costs vary depending upon size and local demographic factors.

In connection with the development of two Investment Properties, NNN has agreed to fund construction commitments (including construction, land costs and tenant improvements) of $14,651,000. As of December 31, 2009, NNN had funded $12,261,000 of this commitment, with $2,390,000 remaining to be funded.

As of December 31, 2009, NNN did not have any tenant that accounted for ten percent or more of its rental income.

 

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Leases

Although there are variations in the specific terms of the leases, the following is a summary of the general structure of NNN’s leases. Generally, the leases of the Investment Properties provide for initial terms of 15 to 20 years. As of December 31, 2009, the weighted average remaining lease term was approximately 12 years. The Investment Properties are generally leased under net leases pursuant to which the tenant typically will bear responsibility for substantially all property costs and expenses associated with ongoing maintenance and operation, including utilities, property taxes and insurance. In addition, the majority of NNN’s leases provide that the tenant is responsible for roof and structural repairs. The leases of the Investment Properties provide for annual base rental payments (payable in monthly installments) ranging from $8,000 to $1,876,000 (average of $213,000). Tenant leases generally provide for limited increases in rent as a result of fixed increases, increases in the Consumer Price Index (“CPI”), and/or increases in the tenant’s sales volume.

Generally, the Investment Property leases provide the tenant with one or more multi-year renewal options subject to generally the same terms and conditions as the initial lease. Some of the leases also provide that in the event NNN wishes to sell the Investment Property subject to that lease, NNN first must offer the lessee the right to purchase the Investment Property on the same terms and conditions as any offer which NNN intends to accept for the sale of the Investment Property.

Certain Investment Properties have leases that provide the tenant with a purchase option to acquire the Investment Property from NNN. The purchase price calculations are generally stated in the lease agreement or are based on the current market value at the time of exercise.

The following table summarizes the lease expirations, assuming none of the tenants exercise renewal options, of NNN’s Investment Portfolio for each of the next 10 years and then thereafter in the aggregate as of December 31, 2009:

 

       % of
Annual
Base
Rent
(1)
     # of
Properties
     Gross
Leasable
Area
(2)
            % of
Annual
Base
Rent
(1)
     # of
Properties
     Gross
Leasable
Area(2)

2010        

     2.3    36      408,000      2016      1.7    13      240,000

2011        

     2.1    21      389,000      2017      4.3    27      676,000

2012        

     3.3    34      484,000      2018      2.9    24      345,000

2013        

     4.7    39      849,000      2019      4.3    42      632,000

2014        

     5.0    44      622,000      Thereafter      66.3    676      5,324,000

2015        

     3.1    22      539,000                  

(1)     Based on annualized base rent for all leases in place as of December 31, 2009.

(2)     Approximate square feet.

 

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The following table summarizes the diversification of trade of NNN’s Investment Portfolio based on the top 10 lines of trade:

 

          % of Annual Base Rent(1)
     

Top 10 Lines of Trade

   2009    2008    2007

1.

   Convenience Stores    26.7%    25.7%    23.9%

2.

   Restaurants – Full Service    9.2%    8.7%    10.3%

3.

   Automotive Parts    6.8%    5.1%    4.9%

4.

   Theaters    6.3%    6.1%    4.2%

5.

   Automotive Service    5.7%    8.9%    5.2%

6.

   Books    4.1%    4.0%    4.4%

7.

   Drug Stores    4.1%    4.0%    5.0%

8.

   Restaurants – Limited Service    3.5%    3.3%    3.7%

9.

   Sporting Goods    3.2%    3.3%    3.9%

10.

   Grocery    2.9%    2.6%    2.9%
   Other    27.5%    28.3%    31.6%
                 
      100.0%    100.0%    100.0%
                 

(1)      Based on annualized base rent for all leases in place as of December 31 of the respective year.

The following table shows the top 10 states in which NNN’s Investment Properties are located as of December 31, 2009:

 

    

State

   # of
Properties
   % of
Annual
Base Rent
(1)

1.

   Texas    210    20.1%

2.

   Florida    85    10.0%

3.

   Illinois    39    7.0%

4.

   North Carolina    62    6.3%

5.

   Georgia    57    5.5%

6.

   Indiana    37    4.4%

7.

   Pennsylvania    87    4.3%

8.

   Ohio    31    3.8%

9.

   Tennessee    30    3.1%

10.

   Arizona    30    2.8%
   Other    347    32.7%
            
      1,015    100.0%
            

(1)     Based on annualized base rent for all leases in place as of December 31, 2009.

Mortgages and Notes Receivable

Mortgages are secured by real estate, real estate securities or other assets. Structured finance investments are secured by the borrowers’ pledge of their respective membership interests in the entities which own the respective real estate.

Mortgages and notes receivable consisted of the following at December 31 (dollars in thousands):

 

     2009    2008  

Mortgages and notes receivable

   $ 41,707    $ 55,495   

Structured finance investments

     -      4,514   

Accrued interest receivables

     269      387   

Unamortized premium

     -      84   
               
     41,976      60,480   

Less loan origination fees, net

     -      (8
               
   $ 41,976    $ 60,472   
               

 

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Commercial Mortgage Residual Interests

Orange Avenue Mortgage Investments, Inc. (“OAMI”), a majority owned and consolidated subsidiary of NNN, holds the residual interests (“Residuals”) from seven commercial real estate loan securitizations. Each of the Residuals is reported at fair value based upon an independent valuation; unrealized gains or losses are reported as other comprehensive income in stockholders’ equity, and other than temporary losses as a result of a change in timing or amount of estimated cash flows are recorded as an other than temporary valuation impairment. The Residuals had an estimated fair value of $20,153,000 and $22,000,000 at December 31, 2009 and 2008, respectively.

Inventory Assets

The Inventory Portfolio, which is owned by the TRS, is comprised of two components: the Development Portfolio and the Exchange Portfolio. NNN’s Inventory Portfolio is held with the intent to sell the properties to purchasers who are looking for replacement like-kind Exchange Property or to other purchasers with different investment objectives. As of December 31, 2009, the Inventory Portfolio consisted of 18 Development Properties (12 completed and six land parcels) and one Exchange Property.

The following table summarizes the 12 completed Development Properties and one Exchange Property as of December 31, 2009 (in thousands):

 

     Size(1)    Acquisition Cost(2)
     High    Low    Average    High    Low    Average

Land

   527    15    114    $ 8,959    $ 108    $ 1,526

Building

   224    2    27      28,717      352      3,668

(1)     Approximate square feet.

(2)     Costs vary depending upon size and local demographic factors.

Governmental Regulations Affecting Properties

Property Environmental Considerations.  Subject to a determination of the level of risk and potential cost of remediation, NNN may acquire a property where some level of contamination may exist. Investments in real property create a potential for substantial environmental liability on the part of the owner of such property from the presence or discharge of hazardous substances on the property or the improper disposal of hazardous substances emanating from the property, regardless of fault. As a part of its acquisition due diligence process, NNN generally obtains an environmental site assessment for each property. In such cases where NNN intends to acquire real estate where some level of contamination may exist, NNN generally requires the seller or tenant to (i) remediate the problem, (ii) indemnify NNN for environmental liabilities, and/or (iii) agree to other arrangements deemed appropriate by NNN, including, under certain circumstances, the purchase of environmental insurance to address environmental conditions at the property.

As of February 19, 2010, NNN has 68 Investment Properties currently under some level of environmental remediation. In general, the seller, the tenant or an adjacent land owner is responsible for the cost of the environmental remediation for each of these Investment Properties.

Americans with Disabilities Act of 1990.  The Investment and Inventory Properties, as commercial facilities, are required to comply with Title III of the Americans with Disabilities Act of 1990 (the “ADA”). Investigation of a property may reveal non-compliance with the ADA. The tenants will typically have primary responsibility for complying with the ADA, but NNN may incur costs if the tenant does not comply. As of February 19, 2010, NNN has not been notified by any governmental authority of, nor is NNN’s management aware of, any non-compliance with the ADA that NNN’s management believes would have a material adverse effect on its business, financial position or results of operations.

 

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Other Regulations.  State and local fire, life-safety and similar requirements regulate the use of NNN’s Investment and Inventory Properties. The leases generally require that each tenant will have primary responsibility for complying with regulations, but failure to comply could result in fines by governmental authorities, awards of damages to private litigants, or restrictions on the ability to conduct business on such properties.

Item 1A.  Risk Factors

Carefully consider the following risks and all of the other information set forth in this Annual Report on Form 10-K, including the consolidated financial statements and the notes thereto. If any of the events or developments described below were actually to occur, NNN’s business, financial condition or results of operations could be adversely affected.

Current financial and economic conditions may have an adverse impact on NNN, its tenants, and commercial real estate in general.

Current financial and economic conditions continue to be challenging and the continuation or worsening of such conditions, including any disruption in the capital markets, could adversely affect NNN’s business and results of operations and the financial condition of NNN’s tenants, developers, borrowers, lenders or the institutions that hold NNN’s cash balances and short-term investments, which may expose NNN to increased risks of default by these parties.

There can be no assurance that actions of the United States Government, Federal Reserve or other government and regulatory bodies intended to stabilize the economy or financial markets will achieve their intended effect. Additionally, some of these actions may adversely affect financial institutions, capital providers, retailers, consumers or NNN’s financial condition, results of operations or the trading price of NNN’s shares.

Potential consequences of the current financial and economic conditions include:

 

   

the financial condition of NNN’s tenants, which operate in the retail industry may be adversely affected, which may result in tenant defaults under the leases due to bankruptcy, lack of liquidity, operational failures or for other reasons;

 

   

the ability to borrow on terms and conditions that NNN finds acceptable, or at all, may be limited, which could reduce NNN’s ability to pursue acquisition and development opportunities and refinance existing debt, reduce NNN’s returns from acquisition and development activities and increase NNN’s future interest expense;

 

   

reduced values of NNN’s properties may limit NNN’s ability to dispose of assets at attractive prices and may reduce the availability of buyer financing;

 

   

the value and liquidity of NNN’s short-term investments and cash deposits could be reduced as a result of a deterioration of the financial condition of the institutions that hold NNN’s cash deposits or the institutions or assets in which NNN has made short-term investments, the dislocation of the markets for NNN’s short-term investments, increased volatility in market rates for such investments or other factors; and

 

   

one or more lenders under the Credit Facility could fail and NNN may not be able to replace the financing commitment of any such lenders on favorable terms, or at all.

NNN may be unable to obtain debt or equity capital on favorable terms, if at all.

NNN may be unable to obtain capital on favorable terms, if at all, to further its business objectives or meet its existing obligations. Debt and equity capital availability in the real estate market is severely strained. Nearly all of NNN’s debt, including the Credit Facility, is subject to balloon principal payments due at maturity. These maturities range between 2010 and 2017. The ability of NNN to make these scheduled

 

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principal payments may be adversely impacted by NNN’s inability to extend or refinance the Credit Facility, the inability to dispose of assets at an attractive price or the inability to obtain additional debt or equity capital. Capital that may be available may be materially more expensive or available under terms that are materially more restrictive than NNN’s existing capital which would have an adverse impact on NNN’s business, financial condition or results of operations.

Loss of revenues from tenants would reduce NNN’s cash flow.

NNN’s five largest tenants accounted for an aggregate of approximately 32 percent of NNN’s annual base rent as of December 31, 2009. The default, financial distress, bankruptcy or liquidation of one or more of NNN’s tenants could cause substantial vacancies among NNN’s Investment Portfolio. Vacancies reduce NNN’s revenues, increase property expenses and could decrease the ultimate sale value of each such vacant property. Upon the expiration of the leases that are currently in place, the tenant may choose not to renew the lease or, NNN may not be able to re-lease the vacant property at a comparable lease rate or without incurring additional expenditures in connection with such renewal or re-leasing.

A significant portion of the source of NNN’s Investment Portfolio annual base rent is heavily concentrated in specific industry classifications, tenants and in specific geographic locations.

As of December 31, 2009, approximately,

 

   

55 percent of NNN’s Investment Portfolio annual base rent is generated from five retail lines of trade, including convenience stores (27 percent) and full-service restaurants (9 percent),

 

   

32 percent of NNN’s Investment Portfolio annual base rent is generated from five tenants, including Pantry (9 percent) and Susser (9 percent),

 

   

49 percent of NNN’s Investment Portfolio annual base rent is generated from five states, including Texas (20 percent) and Florida (10 percent).

Any financial hardship and/or changes in these lines of trade, tenants or states could have an adverse effect on NNN’s results of operations.

Owning real estate and indirect interests in real estate carries inherent risks.

NNN’s economic performance and the value of its real estate assets are subject to the risk that if NNN’s properties do not generate revenues sufficient to meet its operating expenses, including debt service, NNN’s cash flow and ability to pay distributions to its shareholders will be adversely affected. As a real estate company, NNN is susceptible to the following real estate industry risks, which are beyond its control:

 

   

changes in national, regional and local economic conditions and outlook,

 

   

decreases in consumer spending and retail sales,

 

   

economic downturns in the areas where NNN’s properties are located,

 

   

adverse changes in local real estate market conditions, such as an oversupply, reduction in demand or intense competition for tenants,

 

   

changes in tenant preferences that reduce the attractiveness of NNN’s properties to tenants,

 

   

zoning, regulatory restrictions, or change in taxes, and

 

   

changes in interest rates or availability of financing.

All of these factors could result in decreases in market rental rates and increases in vacancy rates, which could adversely affect NNN’s results of operations.

 

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NNN’s real estate investments are illiquid.

Because real estate investments are relatively illiquid, NNN’s ability to adjust the portfolio promptly in response to economic or other conditions is limited. Certain significant expenditures generally do not change in response to economic or other conditions, including: (i) debt service (if any), (ii) real estate taxes, and (iii) operating and maintenance costs. This combination of variable revenue and relatively fixed expenditures may result, under certain market conditions, in reduced earnings and could have an adverse effect on NNN’s financial condition.

NNN may be subject to known or unknown environmental liabilities.

Subject to a determination of the level of risk and potential cost of remediation, NNN may acquire a property where some level of contamination may exist. Investments in real property create a potential for substantial environmental liability on the part of the owner of such property from the presence or discharge of hazardous substances on the property or the improper disposal of hazardous substances emanating from the property, regardless of fault. As a part of its acquisition due diligence process, NNN generally obtains an environmental site assessment for each property. In such cases where NNN intends to acquire real estate where some level of contamination may exist, NNN generally requires the seller or tenant to (i) remediate the problem, (ii) indemnify NNN for environmental liabilities, and/or (iii) agree to other arrangements deemed appropriate by NNN, including, under certain circumstances, the purchase of environmental insurance to address environmental conditions at the property.

As of February 19, 2010, NNN has 68 Investment Properties currently under some level of environmental remediation. In general, the seller, the tenant or an adjacent land owner is responsible for the cost of the environmental remediation for each of these Investment Properties. In the event of a bankruptcy or other inability on the part of these parties to cover these costs, NNN may have to cover the costs of remediation, fines or other environmental liabilities at these and other properties and may have liability to third parties. NNN may also own properties where required remediation has not begun or adverse environmental conditions have not yet been detected. This may require remediation or otherwise subject NNN to liability including liability to third parties. NNN cannot assure that (i) it will not be required to undertake or pay for removal or remediation of any contamination of the properties currently or previously owned by NNN, (ii) NNN will not be subject to fines by governmental authorities or litigation, (iii) NNN will not be subject to litigation by and liability to third parties, or (iv) the costs of such removal, remediation fines, third party liability, or litigation would not be material.

NNN may not be able to successfully execute its acquisition or development strategies.

NNN cannot assure that it will be able to implement its investment strategies successfully. Additionally, NNN cannot assure that its property portfolio will expand at all, or if it will expand at any specified rate or to any specified size. In addition, investment in additional real estate assets is subject to a number of risks. Because NNN expects to invest in markets other than the ones in which its current properties are located or properties which may be leased to tenants other than those to which NNN has historically leased properties, NNN will also be subject to the risks associated with investment in new markets or with new tenants that may be relatively unfamiliar to NNN’s management team.

NNN’s development activities are subject to, without limitation, risks relating to the availability and timely receipt of zoning and other regulatory approvals, the cost and timely completion of construction (including risks from factors beyond NNN’s control, such as weather or labor conditions or material shortages), the risk of finding tenants for the properties and the ability to obtain both construction and permanent financing on favorable terms. These risks could result in substantial unanticipated delays or expenses and, under certain circumstances, could prevent completion of development activities once undertaken or provide a tenant the opportunity to terminate a lease. Any of these situations may delay or eliminate proceeds or cash flows NNN expects from these projects, which could have an adverse effect on NNN’s financial condition.

 

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NNN may not be able to dispose of properties consistent with its operating strategy.

NNN may be unable to sell properties targeted for disposition (including its Inventory Properties) due to adverse market conditions. This may adversely affect, among other things, NNN’s ability to sell under favorable terms, execute its operating strategy, achieve target earnings or returns, retire or repay debt or pay dividends.

A change in the assumptions used to determine the value of commercial mortgage residual interests could adversely affect NNN’s financial position.

As of December 31, 2009, the Residuals had a carrying value of $20,153,000. The value of these Residuals is based on assumptions made by NNN to determine their value. These assumptions include discount rate, loan loss, prepayment speed and interest rate assumptions made by NNN to determine their value. If actual experience differs materially from these assumptions, the actual future cash flow could be less than expected and the value of the Residuals, as well as NNN’s earnings, could decline.

NNN may suffer a loss in the event of a default or bankruptcy of a borrower.

If a borrower defaults on a mortgage, structured finance loan or other loan made by NNN, and does not have sufficient assets to satisfy the loan, NNN may suffer a loss of principal and interest. In the event of the bankruptcy of a borrower, NNN may not be able to recover against all or any of the assets of the borrower, or the assets of the borrower may not be sufficient to satisfy the balance due on the loan. In addition, certain of NNN’s loans may be subordinate to other debt of a borrower. These investments are typically loans secured by a borrower’s pledge of its ownership interests in the entity that owns the real estate or other assets. These agreements are typically subordinated to senior loans secured by other loans encumbering the underlying real estate or assets. Subordinated positions are generally subject to a higher risk of nonpayment of principal and interest than the more senior loans. As of December 31, 2009, mortgages and notes receivables had an outstanding principal balance of $41,707,000. If a borrower defaults on the debt senior to NNN’s loan, or in the event of the bankruptcy of a borrower, NNN’s loan will be satisfied only after the borrower’s senior creditors’ claims are satisfied. Where debt senior to NNN’s loans exists, the presence of intercreditor arrangements may limit NNN’s ability to amend loan documents, assign the loans, accept prepayments, exercise remedies and control decisions made in bankruptcy proceedings relating to borrowers. Bankruptcy proceedings and litigation can significantly increase the time needed for NNN to acquire underlying collateral, if any, in the event of a default, during which time the collateral may decline in value. In addition, there are significant costs and delays associated with the foreclosure process.

Certain provisions of NNN’s leases or loan agreements may be unenforceable.

NNN’s rights and obligations with respect to its leases, structured finance loans, mortgage loans or other loans are governed by written agreements. A court could determine that one or more provisions of such an agreement are unenforceable, such as a particular remedy, a loan prepayment provision or a provision governing NNN’s security interest in the underlying collateral of a borrower or lessee. NNN could be adversely impacted if this were to happen with respect to an asset or group of assets.

Property ownership through joint ventures and partnerships could limit NNN’s control of those investments.

Joint ventures or partnerships involve risks not otherwise present for direct investments by NNN. It is possible that NNN’s co-venturers or partners may have different interests or goals than NNN at any time and they may take actions contrary to NNN’s requests, policies or objectives, including NNN’s policy with respect to maintaining its qualification as a REIT. Other risks of joint venture or partnership investments include impasses on decisions because in some instances no single co-venturer or partner has full control over the joint venture or partnership, respectively, or the co-venturer or partner may become

 

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insolvent, bankrupt or otherwise unable to contribute to the joint venture or partnership, respectively. Further, disputes may develop with a co-venturer or partner over decisions affecting the property, joint venture or partnership that may result in litigation, arbitration or some other form of dispute resolution.

Competition with numerous other REITs, commercial developers, real estate limited partnerships and other investors may impede NNN’s ability to grow.

NNN may not be in a position or have the opportunity in the future to complete suitable property acquisitions or developments on advantageous terms due to competition for such properties with others engaged in real estate investment activities. NNN’s inability to successfully acquire or develop new properties may affect NNN’s ability to achieve anticipated return on investment or realize its investment strategy, which could have an adverse effect on its results of operations.

Operating losses from retail operations on 12 Investment Properties may adversely impact NNN’s results of operations.

In June 2009, NNN acquired the operations of the auto service business which was operated on 12 Investment Properties. A third party manages and staffs these operations on behalf of NNN. The results of business operations from these properties are subject to the typical execution risks inherent with many retail operations including: merchandising, pricing, customer service, competition, consumer preferences and behavior, safety, compliance with various federal, state and local laws, ordinances and regulations, environmental contamination, unfavorable weather conditions, or other trends in the markets they serve. These factors could negatively impact NNN’s results of operations from these 12 Investment Properties.

Uninsured losses may adversely affect NNN’s ability to pay outstanding indebtedness.

NNN’s properties are generally covered by comprehensive liability, fire, flood, and extended insurance coverage. NNN believes that the insurance carried on its properties is adequate in accordance with industry standards. There are, however, types of losses (such as from hurricanes, wars or earthquakes) which may be uninsurable, or the cost of insuring against these losses may not be economically justifiable. If an uninsured loss occurs or a loss exceeds policy limits, NNN could lose both its invested capital and anticipated revenues from the property, thereby reducing NNN’s cash flow.

Acts of violence, terrorist attacks or war may affect the markets in which NNN operates and NNN’s results of operations.

Terrorist attacks or other acts of violence may negatively affect NNN’s operations. There can be no assurance that there will not be terrorist attacks against businesses within the United States. These attacks may directly impact NNN’s physical facilities or the businesses or the financial condition of its tenants, developers, borrowers, lenders or financial institutions with which NNN has a relationship. The United States is engaged in armed conflict, which could have an impact on these parties. The consequences of armed conflict are unpredictable, and NNN may not be able to foresee events that could have an adverse effect on its business.

More generally, any of these events or threats of these events could cause consumer confidence and spending to decrease or result in increased volatility in the United States and worldwide financial markets and economies. They also could result in, or cause a deepening of, economic recession in the United States or abroad. Any of these occurrences could have an adverse impact on NNN’s financial condition or results of operations.

Vacant properties or bankrupt tenants could adversely affect NNN’s business or financial condition.

As of December 31, 2009, NNN owned 37 vacant, un-leased Investment Properties, including two vacant land parcels, which accounted for approximately four percent of total Investment Properties. NNN is actively marketing these properties for sale or lease but may not be able to sell or lease these properties on

 

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favorable terms or at all. The lost revenues and increased property expenses resulting from the rejection by any bankrupt tenant of any of their respective leases with NNN could have a material adverse effect on the liquidity and results of operations of NNN if NNN is unable to re-lease the Investment Properties at comparable rental rates and in a timely manner. As of December 31, 2009, approximately one percent of the total gross leasable area of NNN’s Investment Portfolio was leased to two tenants that have filed a voluntary petition for bankruptcy under Chapter 11 of the U.S. Bankruptcy Code and have the right to reject or affirm their lease with NNN. NNN anticipates the number of vacancies and bankrupt tenants will increase.

The amount of debt NNN has and the restrictions imposed by that debt could adversely affect NNN’s business and financial condition.

As of December 31, 2009, NNN had total mortgage debt outstanding of approximately $25,290,000, total unsecured notes payable of $962,056,000 and no balance outstanding on the Credit Facility. NNN’s organizational documents do not limit the level or amount of debt that it may incur. If NNN incurs additional indebtedness and permits a higher degree of leverage, debt service requirements would increase and could adversely affect NNN’s financial condition and results of operations, as well as NNN’s ability to pay principal and interest on the outstanding indebtedness or cash dividends to its stockholders. In addition, increased leverage could increase the risk that NNN may default on its debt obligations. The Credit Facility contains financial covenants that could limit the amount of distributions to NNN’s common and preferred stockholders.

The amount of debt outstanding at any time could have important consequences to NNN’s stockholders. For example, it could:

 

   

require NNN to dedicate a substantial portion of its cash flow from operations to payments on its debt, thereby reducing funds available for operations, real estate investments and other appropriate business opportunities that may arise in the future,

 

   

increase NNN’s vulnerability to general adverse economic and industry conditions,

 

   

limit NNN’s ability to obtain any additional financing it may need in the future for working capital, debt refinancing, capital expenditures, real estate investments, development or other general corporate purposes,

 

   

make it difficult to satisfy NNN’s debt service requirements,

 

   

limit NNN’s ability to pay dividends in cash on its outstanding common and preferred stock,

 

   

limit NNN’s flexibility in planning for, or reacting to, changes in its business and the factors that affect the profitability of its business, and

 

   

limit NNN’s flexibility in conducting its business, which may place NNN at a disadvantage compared to competitors with less debt or debt with less restrictive terms.

NNN’s ability to make scheduled payments of principal or interest on its debt, or to retire or refinance such debt will depend primarily on its future performance, which to a certain extent is subject to the creditworthiness of its tenants, competition, and economic, financial, and other factors beyond its control. There can be no assurance that NNN’s business will continue to generate sufficient cash flow from operations in the future to service its debt or meet its other cash needs. If NNN is unable to generate sufficient cash flow from its business, it may be required to refinance all or a portion of its existing debt, sell assets or obtain additional financing to meet its debt obligations and other cash needs.

NNN cannot assure stockholders that any such refinancing, sale of assets or additional financing would be possible or, if possible, on terms and conditions, including but not limited to the interest rate, which NNN would find acceptable or would not result in a material decline in earnings.

 

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NNN is obligated to comply with financial and other covenants in its debt that could restrict its operating activities, and the failure to comply with such covenants could result in defaults that accelerate the payment under such debt.

NNN’s unsecured debt contains various restrictive covenants which include, among others, provisions restricting NNN’s ability to:

 

   

incur or guarantee additional debt,

 

   

make certain distributions, investments and other restricted payments, including dividend payments on its outstanding common and preferred stock,

 

   

limit the ability of restricted subsidiaries to make payments to NNN,

 

   

enter into transactions with certain affiliates,

 

   

create certain liens,

 

   

consolidate, merge or sell NNN’s assets, and

 

   

pre-pay debt.

NNN’s secured debt generally contains customary covenants, including, among others, provisions:

 

   

relating to the maintenance of the property securing the debt,

 

   

restricting its ability to sell, assign or further encumber the properties securing the debt,

 

   

restricting its ability to incur additional debt,

 

   

restricting its ability to amend or modify existing leases, and

 

   

relating to certain prepayment restrictions.

NNN’s ability to meet some of its debt covenants, including covenants related to the condition of the property or payment of real estate taxes, may be dependent on the performance by NNN’s tenants under their leases.

In addition, certain covenants in NNN’s debt, including its Credit Facility, require NNN, among other things, to:

 

   

limit certain leverage ratios,

 

   

maintain certain minimum interest and debt service coverage ratios,

 

   

limit dividends declared and paid to NNN’s common and preferred stockholders, and

 

   

limit investments in certain types of assets.

NNN’s failure to comply with certain of its debt covenants could result in defaults that accelerate the payment under such debt and limit the dividends paid to NNN’s common and preferred stockholders which would likely have a material adverse impact on NNN’s financial condition and results of operations. In addition, these defaults could impair its access to the debt and equity markets.

Costs of complying with changes in governmental laws and regulations may adversely affect NNN’s results of operations.

NNN cannot predict what other environmental laws or regulations will be enacted in the future, how future laws or regulations will be administered or interpreted, or how future laws or regulations will affect NNN’s properties. Compliance with new laws or regulations, or stricter interpretation of existing laws,

 

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may require NNN, its retail tenants, or consumers to incur significant expenditures or impose significant environmental liability and could cause a material adverse effect on NNN’s results of operation.

The market value of NNN’s equity and debt securities is subject to various factors that may cause significant fluctuations or volatility.

As with other publicly traded securities, the market price of NNN’s equity and debt securities depends on various factors, which may change from time-to-time and/or may be unrelated to NNN’s financial condition, operating performance or prospects that may cause significant fluctuations or volatility in such prices. These factors, among others, include:

 

   

general economic and financial market conditions including the current global economic downturn,

 

   

level and trend of interest rates,

 

   

NNN’s ability to access the capital markets to raise additional capital,

 

   

the issuance of additional equity or debt securities,

 

   

changes in NNN’s funds from operations or earnings estimates,

 

   

changes in NNN’s debt ratings or analyst ratings,

 

   

NNN’s financial condition and performance,

 

   

market perception of NNN compared to other REITs, and

 

   

market perception of REITs compared to other investment sectors.

NNN’s failure to qualify as a real estate investment trust for federal income tax purposes could result in significant tax liability.

NNN intends to operate in a manner that will allow NNN to continue to qualify as a REIT. NNN believes it has been organized as, and its past and present operations qualify NNN as a REIT. However, the Internal Revenue Service (“IRS”) could successfully assert that NNN is not qualified as such. In addition, NNN may not remain qualified as a REIT in the future. Qualification as a REIT involves the application of highly technical and complex provisions of the Internal Revenue Code of 1986, as amended (the “Code”) for which there are only limited judicial or administrative interpretations and involves the determination of various factual matters and circumstances not entirely within NNN’s control. Furthermore, new tax legislation, administrative guidance or court decisions, in each instance potentially with retroactive effect, could make it more difficult or impossible for NNN to qualify as a REIT or avoid significant tax liability.

If NNN fails to qualify as a REIT, it would not be allowed a deduction for dividends paid to stockholders in computing taxable income and would become subject to federal income tax at regular corporate rates. In this event, NNN could be subject to potentially significant tax liabilities and penalties. Unless entitled to relief under certain statutory provisions, NNN would also be disqualified from treatment as a REIT for the four taxable years following the year during which the qualification was lost.

Even if NNN remains qualified as a REIT, NNN may face other tax liabilities that reduce operating results and cash flow.

Even if NNN remains qualified for taxation as a REIT, NNN may be subject to certain federal, state and local taxes on its income and assets, including taxes on any undistributed income, tax on income from some activities conducted as a result of a foreclosure, and state or local income, property and transfer taxes, such as mortgage recording taxes. Any of these taxes would decrease earnings and cash available

 

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for distribution to stockholders. In addition, in order to meet the REIT qualification requirements, NNN holds some of its assets through the TRS.

Adverse legislative or regulatory tax changes could reduce NNN’s earnings, cash flow and market price of NNN’s common stock.

At any time, the federal and state income tax laws governing REITs or the administrative interpretations of those laws may change. Any such changes may have retroactive effect, and could adversely affect NNN or its stockholders. For example, legislation enacted in 2003 and extended in 2006 generally reduced the federal income tax rate on most dividends paid by corporations to individual investors to a maximum of 15 percent (through 2010). REIT dividends, with limited exceptions, will not benefit from the rate reduction, because a REIT’s income generally is not subject to corporate level tax. As such, this legislation could cause shares in non-REIT corporations to be a more attractive investment to individual investors than shares in REITs, and could have an adverse effect on the value of NNN’s common stock.

Compliance with REIT requirements, including distribution requirements, may limit NNN’s flexibility and negatively affect NNN’s operating decisions.

To maintain its status as a REIT for U.S. federal income tax purposes, NNN must meet certain requirements on an on-going basis, including requirements regarding its sources of income, the nature and diversification of its assets, the amounts NNN distributes to its stockholders and the ownership of its shares. NNN may also be required to make distributions to its stockholders when it does not have funds readily available for distribution or at times when NNN’s funds are otherwise needed to fund capital expenditures or to fund debt service requirements. NNN generally will not be subject to federal income taxes on amounts distributed to stockholders, providing it distributes 100 percent of its REIT taxable income and meets certain other requirements for qualifying as a REIT. For each of the years in the three-year period ended December 31, 2009, NNN believes it has qualified as a REIT. Notwithstanding NNN’s qualification for taxation as a REIT, NNN is subject to certain state taxes on its income and real estate.

Changes in accounting pronouncements could adversely impact NNN’s reported financial performance.

Accounting policies and methods are fundamental to how NNN records and reports its financial condition and results of operations. From time to time the Financial Accounting Standards Board (“FASB”) and the Commission, who create and interpret appropriate accounting standards, may change the financial accounting and reporting standards or their interpretation and application of these standards that govern the preparation of NNN’s financial statements. These changes could have a material impact on NNN’s reported financial condition and results of operations. In some cases, NNN could be required to apply a new or revised standard retroactively, resulting in restating prior period financial statements.

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.

Section 404 of the Sarbanes-Oxley Act of 2002 requires annual management assessments of the effectiveness of the Company’s internal control over financial reporting. If NNN fails to maintain the adequacy of its internal control over financial reporting, as such standards may be modified, supplemented or amended from time to time, NNN may not be able to ensure that it can conclude on an ongoing basis that it has effective internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act of 2002. Moreover, effective internal control over financial reporting, particularly those related to revenue recognition, are necessary for NNN to produce reliable financial reports and to maintain its qualification as a REIT and are important in helping to prevent financial fraud. If NNN cannot provide reliable financial reports or prevent fraud, its business and operating results could be harmed, REIT qualification could be jeopardized, investors could lose confidence in the Company’s reported financial information, and the trading price of NNN’s shares could drop significantly.

 

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NNN’s ability to pay dividends in the future is subject to many factors.

NNN’s ability to pay dividends may be impaired if any of the risks described in this section were to occur. In addition, payment of NNN’s dividends depends upon NNN’s earnings, financial condition, maintenance of NNN’s REIT status and other factors as NNN’s Board of Directors may deem relevant from time to time.

Item 1B. Unresolved Staff Comments

None.

Item 2. Properties

Please refer to Item 1. “Business.”

Item 3. Legal Proceedings

In the ordinary course of its business, NNN is a party to various legal actions that management believes is routine in nature and incidental to the operation of the business of NNN. Management believes that the outcome of these proceedings will not have a material adverse effect upon its operations, financial condition or liquidity.

Item 4. Submission of Matters to a Vote of Security Holders

None.

 

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PART II

Item 5.  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

The common stock of NNN currently is traded on the NYSE under the symbol “NNN.” Set forth below is a line graph comparing the cumulative total stockholder return on NNN’s common stock, based on the market price of the common stock and assuming reinvestment of dividends, with the FTSE National Association of Real Estate Investment Trusts Equity Index (“NAREIT”) and the S&P 500 Index (“S&P 500”) for the five year period commencing December 31, 2004 and ending December 31, 2009. The graph assumes an investment of $100 on December 31, 2004.

LOGO

 

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For each calendar quarter indicated, the following table reflects respective high, low and closing sales prices for the common stock as quoted by the NYSE and the dividends paid per share in each such period.

 

2009

   First
Quarter
   Second
Quarter
   Third
Quarter
   Fourth
Quarter
   Year

High

   $ 17.52    $ 19.48    $ 22.80    $ 21.59    $ 22.80

Low

     12.26      14.95      15.85      18.87      12.26

Close

     15.84      17.35      21.47      21.22      21.22

Dividends paid per share

     0.375      0.375      0.375      0.375      1.500

2008

                        

High

   $ 23.66    $ 24.00    $ 24.57    $ 23.66    $ 24.57

Low

     19.63      20.75      19.60      10.53      10.53

Close

     22.05      20.90      23.95      17.19      17.19

Dividends paid per share

     0.355      0.375      0.375      0.375      1.480

The following presents the characterizations for tax purposes of such common stock dividends for the years ended December 31:

 

     2009     2008  

Ordinary dividends

   $ 1.495182    99.6788   $ 1.480000    100.0000

Capital gain

     0.003051    0.2034     -    -   

Unrecaptured Section 1250 Gain

     0.001767    0.1178     -    -   
                          
   $ 1.500000    100.000   $ 1.480000    100.0000
                          

NNN intends to pay regular quarterly dividends to its stockholders, although all future distributions will be declared and paid at the discretion of the Board of Directors and will depend upon cash generated by operating activities, NNN’s financial condition, capital requirements, annual distribution requirements under the REIT provisions of the Internal Revenue Code of 1986, as amended, and such other factors as the Board of Directors deems relevant.

In February 2010, NNN paid dividends to its stockholders of $31,026,000 or $0.375 per share of common stock.

On January 29, 2010, there were 1,857 stockholders of record of common stock.

 

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Item 6.  Selected Financial Data

Historical Financial Highlights

(dollars in thousands, except per share data)

 

        2009             2008             2007             2006             2005      

Gross revenues(1)

  $ 243,932      $ 247,352      $ 208,629      $ 180,877      $ 151,831   

Earnings from continuing operations

    57,690        98,582        77,232        59,232        46,395   

Earnings including noncontrolling interests

    56,399        119,971        155,742        184,422        95,559   

Net earnings attributable to NNN

    54,810        117,153        154,599        181,800        89,400   

Total assets

    2,590,962        2,649,471        2,539,673        1,917,516        1,736,588   

Total debt

    987,346        1,027,391        1,049,154        890,127        861,045   

Total stockholders’ equity

    1,564,240        1,566,860        1,417,647        1,109,479        828,087   

Cash dividends declared to:

         

Common stockholders

    120,256        110,107        92,989        76,035        69,018   

Series A preferred stockholders

    -        -        -        4,376        4,008   

Series B convertible preferred stockholders

    -        -        -        419        1,675   

Series C preferred stockholders

    6,785        6,785        6,785        923        -   

Weighted average common shares:

         

Basic

    79,846,258        74,249,137        66,152,437        57,428,063        52,984,821   

Diluted

    79,953,499        74,344,231        66,263,980        57,965,508        54,418,806   

Per share information:

         

Earnings from continuing operations:

         

Basic

  $ 0.62      $ 1.23      $ 1.06      $ 0.89      $ 0.76   

Diluted

    0.61        1.23        1.06        0.89        0.77   

Net earnings:

         

Basic

    0.60        1.48        2.23        3.05        1.57   

Diluted

    0.60        1.48        2.22        3.03        1.56   

Cash dividends declared to:

         

Common stockholders

    1.50        1.48        1.40        1.32        1.30   

Series A preferred stockholders

    -        -        -        2.45625        2.25   

Series B convertible preferred stockholders

    -        -        -        41.875        167.50   

Series C preferred depositary stockholders

    1.84375        1.84375        1.84375        0.250955        -   

Other data:

         

Cash flows provided by (used in):

         

Operating activities

  $ 149,502      $ 237,459      $ 130,147      $ 1,676      $ 19,226   

Investing activities

    (28,063     (256,304     (536,717     (90,099     (230,783

Financing activities

    (108,840     (6,028     432,394        81,864        217,844   

Funds from operations – diluted(2)

    90,087        142,355        121,602        96,416        81,803   

 

  (1) Gross revenues include revenues from NNN’s continuing and discontinued operations. In accordance with FASB guidance on Accounting for the Impairment or Disposal of Long-Lived Assets, NNN has classified the revenues related to (i) all Investment Properties that were sold and leasehold interest which expired, (ii) all Inventory Properties which generated revenues prior to disposition, and (iii) all Investment and Inventory Properties which generated revenue and were held for sale at December 31, 2009, as discontinued operations.

 

  (2) The National Association of Real Estate Investment Trusts (“NAREIT”) developed Funds from Operations (“FFO”) as a relative non-GAAP financial measure of performance of a REIT in order to recognize that income-producing real estate historically has not depreciated on the basis determined under generally accepted accounting principles (“GAAP”). FFO is defined by NAREIT and is used by NNN as follows: net earnings (computed in accordance with GAAP) plus depreciation and amortization of assets unique to the real estate industry, excluding gains (or including losses) on the disposition of Investment Assets and NNN’s share of these items from NNN’s unconsolidated partnerships and joint ventures.

FFO is generally considered by industry analysts to be the most appropriate measure of operating performance of real estate companies. FFO does not necessarily represent cash provided by operating activities in accordance with generally accepted accounting principles GAAP and should not be considered an alternative to net income as an indication of NNN’s operating performance or to cash flow as a measure of liquidity or ability to make distributions. Management considers FFO an appropriate measure of operating performance of an equity REIT because it primarily excludes the assumption that the value of the

 

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real estate assets diminishes predictably over time, and because industry analysts have accepted it as an operating performance measure. NNN’s computation of FFO may differ from the methodology for calculating FFO used by other equity REITs, and therefore, may not be comparable to such other REITs.

NNN has earnings from discontinued operations in each of its segments, investment assets and inventory assets. All property dispositions from NNN’s investment segment are classified as discontinued operations. In addition, certain properties in NNN’s inventory segment that have generated revenues before disposition are classified as discontinued operations. These inventory properties have not historically been classified as discontinued operations, therefore, prior period comparable consolidated financial statements have been restated to include these properties in its earnings from discontinued operations. These adjustments resulted in an increase in NNN’s reported total revenues and total and per share earnings from continuing operations and a decrease in NNN’s earnings from discontinued operations. However, NNN’s total and per share net earnings available to common stockholders is not affected.

The following table reconciles FFO to their most directly comparable GAAP measure, net earnings for the years ended December 31:

 

    2009     2008     2007     2006     2005  

Reconciliation of funds from operations:

         

Net earnings attributable to NNN’s stockholders

  $ 54,810      $ 117,153      $ 154,599      $ 181,800      $ 89,400   

Real estate depreciation and amortization:

         

Continuing operations

    43,067        40,850        28,864        19,171        13,355   

Discontinued operations

    1,209        940        1,518        3,248        7,052   

Partnership/joint venture real estate depreciation

    178        177        31        463        606   

Partnership gain on sale of asset

    -        -        -        (262     -   

Gain on disposition of equity investment

    -        -        -        (11,373     -   

Gain on disposition of investment assets

    (2,392     (9,980     (56,625     (91,332     (9,816

Extraordinary gain

    -        -        -        -        (14,786
                                       

FFO

    96,872        149,140        128,387        101,715        85,811   

Series A preferred stock dividends(1)

    -        -        -        (4,376     (4,008

Series B convertible preferred stock dividends(1)

    -        -        -        (419     (1,675

Series C preferred stock dividends

    (6,785     (6,785     (6,785     (923     -   
                                       

FFO available to common stockholders – basic

    90,087        142,355        121,602        95,997        80,128   

Series B convertible preferred stock dividends, if dilutive

    -        -        -        419        1,675   
                                       

FFO available to common stockholders – diluted

  $ 90,087      $ 142,355      $ 121,602      $ 96,416      $ 81,803   
                                       

 

  (1)

The Series A and Series B preferred stock issuances are no longer outstanding.

For a discussion of material events affecting the comparability of the information reflected in the selected financial data, refer to Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

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Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis should be read in conjunction with Item 6. “Selected Financial Data,” and the consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K, and the forward-looking disclaimer language in italics before Item 1. “Business.”

The term “NNN” or the “Company” refers to National Retail Properties, Inc. and all of its consolidated subsidiaries. NNN has elected to treat certain subsidiaries as taxable real estate investment trust subsidiaries. These subsidiaries and their majority owned and controlled subsidiaries are collectively referred to as the “TRS.”

Overview

NNN, a Maryland corporation, is a fully integrated real estate investment trust (“REIT”) formed in 1984. NNN’s operations are divided into two primary business segments: (i) investment assets, including real estate assets, mortgages and notes receivable (including structured finance investments), and commercial mortgage residual interests (collectively, “Investment Assets”), and (ii) inventory real estate assets (“Inventory Assets”). NNN acquires, owns, invests in, manages and develops properties that are leased primarily to retail tenants under long-term net leases and primarily held for investment (“Investment Properties” or “Investment Portfolio”). The Inventory Assets typically represent direct and indirect investment interests in real estate assets acquired or developed primarily for the purpose of selling the real estate (“Inventory Properties” or “Inventory Portfolio”). Inventory Assets typically consist of two types of properties, property for development (“Development Properties or Development Portfolio”) and improved properties (“Exchange Properties” or “Exchange Portfolio”).

As of December 31, 2009, NNN owned 1,015 Investment Properties (including 12 properties with retail operations that NNN operates), with an aggregate gross leasable area of approximately 11,373,000 square feet, located in 44 states. Approximately 96 percent of total properties in NNN’s Investment Portfolio was leased or operated at December 31, 2009. In addition, as of December 31, 2009, NNN had $41,976,000 in mortgages and notes receivable (including accrued interest receivable and structured finance investments) and $20,153,000 of commercial mortgage residual interests. As of December 31, 2009, NNN owned 19 Inventory Properties, of which 18 were Development Properties (12 completed Inventory and six land parcels) and one was an Exchange Property.

NNN transferred 11 properties from the Inventory Portfolio to the Investment Portfolio in December 2009.

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 NNN’s Investment Portfolio and structured finance investments (such as tenant, geographic and line of trade diversification), the occupancy rate of NNN’s Investment 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 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 which NNN believes represents an area of attractive investment opportunity. NNN also has some geographic concentration in the south and southeast which NNN believes are historically areas of 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.

During the years ended December 31, 2009, 2008 and 2007, Investment Properties have remained at least 96 percent leased. The Investment Portfolio’s average remaining lease term of 12 years has remained

 

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fairly constant over the past three years which, coupled with its net lease structure, provides enhanced probability of maintaining occupancy and operating earnings.

The poor current economic environment has made it more difficult and more expensive to obtain debt and equity capital, which will likely reduce the pace of investments in new acquisitions or developments as well as the volume of dispositions. Additionally, the poor economic and retail environment will result in more retailers filing for bankruptcy and will make it more difficult to lease properties, which may have an adverse impact on NNN’s occupancy.

Critical Accounting Policies and Estimates

The preparation of NNN’s consolidated financial statements in conformance with accounting principles generally accepted in the United States of America requires management to make estimates and judgments on assumptions that affect the reported amounts of assets, liabilities, revenues and expenses as well as other disclosures in the financial statements. On an ongoing basis, management evaluates its estimates and judgments; however, actual results may differ from these estimates and assumptions, which in turn could have a material impact on NNN’s financial statements. A summary of NNN’s accounting policies and procedures are included in Note 1 of NNN’s consolidated financial statements. Management believes the following critical accounting policies, among others, affect its more significant judgments and estimates used in the preparation of NNN’s consolidated financial statements.

Real Estate – Investment Portfolio.  NNN records the acquisition of real estate 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.

Purchase Accounting for Acquisition of Real Estate Subject to a Lease.  In accordance with the FASB guidance on business combinations, the fair value of the real estate acquired with in-place leases is allocated to the acquired tangible assets, consisting of land, building and tenant improvements, and identified intangible assets and liabilities, consisting of the value of above-market and below-market leases, value of in-place leases, and value of tenant relationships, based in each case on their relative fair values.

Real estate is generally leased to tenants on a net lease basis, whereby the tenant is responsible for all operating expenses relating to the property, generally including property taxes, insurance, maintenance and repairs. The leases are accounted for using either the operating or the direct financing method. Such methods are described below:

Operating method  –  Leases accounted for using the operating method are recorded at the cost of the real estate. Revenue is recognized as rentals are earned and expenses (including depreciation) are charged to operations as incurred. Buildings are depreciated on the straight-line method over their estimated useful lives. Leasehold interests are amortized on the straight- line method over the terms of their respective leases. When scheduled rental revenue varies during the lease term, income is recognized on a straight-line basis so as to produce a constant periodic rent over the term of the lease. Accrued rental income is the aggregate difference between the scheduled rents which vary during the lease term and the income recognized on a straight-line basis.

Direct financing method  –  Leases accounted for using the direct financing method are recorded at their net investment (which at the inception of the lease generally represents the cost of the property). Unearned income is deferred and amortized into income over the lease terms so as to produce a constant periodic rate of return on NNN’s net investment in the leases.

Real Estate  –  Inventory Portfolio.  The TRS acquires and/or develops and owns properties primarily for the purpose of selling the real estate. The properties that are classified as held for sale at any given time may consist of properties that have been acquired in the marketplace with the intent to sell and properties

 

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that have been, or are currently being, constructed by the TRS. The TRS records the acquisition of the real estate at cost, including the acquisition and closing costs. The cost of the real estate developed by the TRS also includes direct and indirect costs of construction, interest and other miscellaneous costs incurred during the development period until the project is substantially complete and available for occupancy. Real estate held for sale is not depreciated and is recorded at the lower of cost or fair value.

Impairment  –  Real Estate.  Based upon the events or changes in certain circumstances, management periodically assesses its Investment Properties for possible impairment indicating that the carrying value of the asset, including accrued rental income, may not be recoverable through operations. Management determines whether an impairment in value has occurred by comparing the estimated future cash flows (undiscounted and without interest charges), including the residual value of the real estate, with the carrying cost of the individual asset. If an impairment is indicated, a loss will be recorded for the amount by which the carrying value of the asset exceeds its fair value.

Commercial Mortgage Residual Interest at Fair Value.  Commercial mortgage residual interests, classified as available for sale, are reported at their market values with unrealized gains and losses reported as other comprehensive income in stockholders’ equity. The commercial mortgage residual interests were acquired in connection with the acquisition of 78.9 percent equity interest of Orange Avenue Mortgage Investments, Inc. (“OAMI”). NNN recognizes the excess of all cash flows attributable to the commercial mortgage residual interests estimated at the acquisition/transaction date over the initial investment (the accretable yield) as interest income over the life of the beneficial interest using the effective yield method. Losses are considered other than temporary valuation impairments if and when there has been a change in the timing or amount of estimated cash flows, exclusive of changes in interest rates, that leads to a loss in value.

Revenue Recognition.  Rental revenues for non-development real estate assets are recognized when earned in accordance with the FASB guidance on accounting for leases, based on the terms of the lease at the time of acquisition of the leased asset. Rental revenues for properties under construction commence upon completion of construction of the leased asset and delivery of the leased asset to the tenant.

Adoption of New Accounting Standards with change in Accounting Principles.  Effective January 1, 2009, NNN adopted the new FASB guidance on accounting for convertible debt instruments that may be settled in cash upon conversion. The new guidance requires the liability and equity components of convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement) to be separately accounted for in a manner that reflects the issuer’s non-convertible debt borrowing rate. The debt component is to be recorded based upon the estimated fair value of non-convertible debt with similar terms. The resulting debt discount is amortized over the period during which the debt is outstanding as additional non-cash interest expense. The new guidance has been applied retrospectively.

Effective January 1, 2009, NNN adopted the new FASB guidance on determining whether instruments granted in share-based payment transactions are participating securities which also required retrospective application. The adoption of the new guidance on convertible debt and share-based payments resulted in non-cash adjustments to the amounts and per share amounts.

Use of Estimates.  Additional critical accounting policies of NNN include management’s estimates and assumptions relating to the reporting of assets and liabilities, revenues and expenses and the disclosure of contingent assets and liabilities to prepare the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America. Additional critical accounting policies include management’s estimates of the useful lives used in calculating depreciation expense relating to real estate assets, the recoverability of the carrying value of long-lived assets, including the commercial mortgage residual interests, the recoverability of the income tax benefit, the collectibility of receivables from tenants, including accrued rental income and capitalized overhead relating to development projects. Actual results could differ from those estimates.

 

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Results of Operations

Property Analysis – Investment Portfolio

General.  The following table summarizes NNN’s Investment Portfolio as of December 31:

 

     2009    2008    2007

Investment Properties Owned:

        

Number

   1,015    1,005    908

Total gross leasable area (square feet)

   11,373,000    11,251,000    10,610,000

Investment Properties:

        

Leased

   966    972    892

Operated

   12    -    -

Percent of Investment Properties – leased and operated

   96%    97%    98%

Weighted average remaining lease term (years)

   12    13    13

Total gross leasable area (square feet) – leased and operated

   10,508,000    10,728,000    10,355,000

NNN transferred 11 properties from the Inventory Portfolio to the Investment Portfolio in December 2009.

The following table summarizes the lease expirations, assuming none of the tenants exercise renewal options, of NNN’s Investment Portfolio for each of the next 10 years and then thereafter in the aggregate as of December 31, 2009:

 

    

% of

Annual
Base Rent
(1)

   # of
Properties
   Gross
Leasable
Area
(2)
        %
of Annual
Base
Rent
(1)
   # of
Properties
   Gross
Leasable
Area
(2)

2010

   2.3%    36    408,000    2016    1.7%    13    240,000

2011

   2.1%    21    389,000    2017    4.3%    27    676,000

2012

   3.3%    34    484,000    2018    2.9%    24    345,000

2013

   4.7%    39    849,000    2019    4.3%    42    632,000

2014

   5.0%    44    622,000    Thereafter    66.3%    676    5,324,000

2015

   3.1%    22    539,000            

(1)     Based on the annualized base rent for all leases in place as of December 31, 2009.

(2)     Approximate square feet.

 

The following table summarizes the diversification of NNN’s Investment Portfolio based on the top 10 lines of trade:

 

    

Lines of Trade

           2009                    2008                    2007        
1.    Convenience Stores    26.7%    25.7%    23.9%
2.    Restaurants – Full Service    9.2%    8.7%    10.3%
3.    Automotive Parts    6.8%    5.1%    4.9%
4.    Theaters    6.3%    6.1%    4.2%
5.    Automotive Service    5.7%    8.9%    5.2%
6.    Books    4.1%    4.0%    4.4%
7.    Drug Stores    4.1%    4.0%    5.0%
8.    Restaurants – Limited Service    3.5%    3.3%    3.7%
9.    Sporting Goods    3.2%    3.3%    3.9%
10.    Grocery    2.9%    2.6%    2.9%
   Other    27.5%    28.3%    31.6%
                 
       100.0%     100.0%     100.0%
                 

(1)     Based on annualized base rent for all leases in place as of December 31 of the respective year.

 

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The following table shows the top 10 states in which NNN’s Investment Properties are located in as of December 31, 2009:

 

    

State

   # of
    Properties    
   %
of Annual
Base Rent
(1)

  1.

   Texas    210    20.1%

  2.

   Florida    85    10.0%

  3.

   Illinois    39    7.0%

  4.

   North Carolina    62    6.3%

  5.

   Georgia    57    5.5%

  6.

   Indiana    37    4.4%

  7.

   Pennsylvania    87    4.3%

  8.

   Ohio    31    3.8%

  9.

   Tennessee    30    3.1%

10.

   Arizona    30    2.8%
   Other    347    32.7%
            
      1,015    100.0%
            

(1)     Based on annualized base rent for all leases in place as of December 31, 2009.

Property Acquisitions.  The following table summarizes the Investment Property acquisitions for each of the years ended December 31 (dollars in thousands):

 

     2009    2008    2007

Acquisitions:

        

Number of Investment Properties

     8      109      235

Gross leasable area (square feet)

     290,000      868,000      2,205,000

Total dollars invested(1)

   $       36,335    $       355,107    $       696,682

(1)     Includes dollars invested on projects under construction for each respective year.

Property Dispositions.  The following table summarizes the Investment Properties sold by NNN for each of the years ended December 31 (dollars in thousands):

 

    2009    2008    2007

Number of properties

    9      19      37

Gross leasable area (square feet)

        234,000          290,000          997,000

Net sales proceeds

  $ 15,621    $ 59,796    $ 146,041

Net gain

  $ 2,392    $ 9,980    $ 56,625

NNN typically uses the proceeds from property sales either to pay down the outstanding indebtedness of NNN’s revolving credit facility (the “Credit Facility”) or reinvest in real estate.

 

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Property Analysis – Inventory Portfolio

General.  The following table summarizes the number of properties held for sale in NNN’s Inventory Portfolio as of December 31:

 

     2009    2008    2007

Development Portfolio:

        

Completed Inventory Properties

   12    11    8

Properties under construction

   -    1    9

Land parcels

   6    7    6
              
           18            19            23
              

Exchange Portfolio:

        

Inventory Properties

   1    13    33
              

Total Inventory Properties

   19    32    56
              

Property Acquisitions.  The following table summarizes the property acquisitions and dollars invested in the Inventory Portfolio for each of the years ended December 31 (dollars in thousands):

 

     2009    2008    2007

Development Portfolio:

        

Number of properties acquired

     2      3      3

Dollars invested(1)

   $     2,633    $ 9,545    $ 64,694

Exchange Portfolio:

        

Number of properties acquired

     -      4      23

Dollars invested

   $ -    $ 19,994    $ 105,152

Total dollars invested

   $ 2,633    $     29,539    $     169,846

(1)     Includes dollars invested in projects under construction or tenant improvements for each respective year.

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 years ended December 31 (dollars in thousands):

 

     2009    2008    2007
     # of
Properties
   Gain    # of
Properties
   Gain    # of
Properties
   Gain

Development(1)

   3    $ 569    6    $ 4,751    13    $ 5,125

Exchange

   1      12    19      4,607    58      5,888
                                   
                   4    $     581                25    $     9,358                71    $     11,013
                                   

(1)     Net of noncontrolling interests.

 

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Revenue from Continuing Operations Analysis

General.  During the year ended December 31, 2009, NNN’s rental income increased primarily due to the acquisition of Investment Properties (See “Results of Operations – Property Analysis – Investment Portfolio – Property Acquisitions”). NNN anticipates any significant increase in rental income will continue to come primarily from additional property acquisitions.

The following summarizes NNN’s revenues from continuing operations (dollars in thousands):

 

                Percent of Total   2009
Versus
2008
Percent

Increase
(Decrease)
  2008
Versus
2007
Percent
Increase
(Decrease)
    2009   2008   2007   2009   2008   2007    

Rental Income(1)

  $   214,625   $   210,684   $   163,669   92.6%   92.4%   91.2%   1.9%   28.7%

Real estate expense reimbursement from tenants

    8,387     7,012     5,591   3.6%   3.1%   3.1%   19.6%   25.4%

Interest and other income from real estate transactions

    4,535     5,804     5,268   2.0%   2.5%   3.0%   (21.9)%   10.2%

Interest income on commercial mortgage residual interests

    4,252     4,636     4,882   1.8%   2.0%   2.7%   (8.3)%   (5.0)%
                                 

Total revenues from continuing operations

  $ 231,799   $ 228,136   $ 179,410   100.0%   100.0%   100.0%   1.6%   27.2%
                                 

(1)     Includes rental income from operating leases, earned income from direct financing leases and percentage rent from continuing operations (“Rental Income”).

Revenue from Operations by Source of Income.  NNN has identified two primary operating segments, and thus, sources of revenue: (i) earnings from NNN’s Investment Assets, and (ii) earnings from NNN’s Inventory Assets. NNN revenues from continuing operations come primarily from Investment Assets. The following table summarizes the revenues from continuing operations for each of the years ended December 31 (dollars in thousands):

 

                    Percent of Total    2009
Versus
2008
Percent
Increase
(Decrease)
   2008
Versus
2007
Percent
Increase
(Decrease)
     2009    2008    2007    2009    2008    2007      

Investment Assets

   $ 231,623    $ 228,009    $ 179,079    99.9%    99.9%    99.8%    1.6%    27.3%

Inventory Assets

     176      127      331    0.1%    0.1%    0.2%    38.6%    (61.6)%
                                         

Total revenues

   $ 231,799    $ 228,136    $ 179,410    100.0%    100.0%    100.0%    1.6%    27.2%
                                         

Comparison of Year Ended December 31, 2009 to Year Ended December 31, 2008.

Rental Income.  Rental Income increased for the year ended December 31, 2009, as compared to 2008, due to a full year of Rental Income from the 109 Investment Properties with an aggregate gross leasable area of 868,000 square feet which were acquired during 2008. Additionally, eight Investment Properties were acquired in 2009 with an aggregate gross leasable area of 290,000 square feet. In addition, NNN recorded $5,072,000 as compared to $2,671,000 in lease termination fees and rent settlement fees during the years ended December 31, 2009 and 2008, respectively.

 

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Real Estate Expense Reimbursement from Tenants.  Real estate expense reimbursements from tenants increased for the year ended December 31, 2009, as compared to 2008. The increase is attributable to the reimbursements from certain properties acquired in 2008 as well as reimbursements resulting from the re-leasing of existing vacancies.

Interest and Other Income from Real Estate Transactions.  Interest and other income from real estate transactions decreased for the year ended December 31, 2009, as compared to 2008, primarily due to a lower weighted average principal balance on NNN’s mortgages receivable and structured finance investments during the year ended December 31, 2009. For the years ended December 31, 2009 and 2008, the weighted average outstanding principal balance on NNN’s mortgages receivable and structured finance investments was $38,968,000 and $57,475,000, respectively.

Interest Income on Commercial Mortgage Residual Interests.  Interest income on commercial mortgage residual interests (“Residuals”) decreased for the year ended December 31, 2009, as compared to December 31, 2008 but remained stable as a percent of total revenue from continuing operations. The decrease in interest income on Residuals is primarily the result of the increase in the loan delinquencies and asset amortization, which is partially offset by a decrease in loan prepayments.

Comparison of Year Ended December 31, 2008 to Year Ended December 31, 2007.

Rental Income.  Rental Income increased for the year ended December 31, 2008, as compared to the same period in 2007, primarily from the addition of 109 Investment Properties with an aggregate gross leasable area of 868,000 square feet. In addition, the increase in Rental Income is also attributable to a full year of Rental Income from the 235 Investment Properties with an aggregate gross leasable area of 2,205,000 square feet which were acquired during the year ended December 31, 2007.

Real Estate Expense Reimbursement from Tenants.  Real estate expense reimbursements from tenants remained consistent as a percentage of total revenues from continuing operations. The increase for the year ended December 31, 2008, as compared to 2007, was attributable to a full year of reimbursements from certain tenants acquired in 2007 and the reimbursements from newly acquired properties in 2008.

Interest and Other Income from Real Estate Transactions.  Interest and other income from real estate transactions increased slightly for the year ended December 31, 2008, as compared to 2007. The increase was primarily due to an increase in the weighted average outstanding principal balance on NNN’s mortgages receivable balance. For the year ended December 31, 2008 and 2007, the weighted average outstanding principal balance on NNN’s mortgages receivable was $57,475,000 and $47,705,000, respectively. The increase was partially offset by a decrease in interest income earned on the structured finance investments. For the years ended December 31, 2008 and 2007, the weighted average outstanding principal balance on NNN’s structured finance investments was $8,614,000 and $16,795,000, respectively.

Interest Income on Commercial Mortgage Residual Interests.  Interest income on the Residuals for the year ended December 31, 2008, as compared to December 31, 2007, decreased slightly as a result of lower outstanding loan balances. The decrease was partially offset by an increase in interest income due to the increase in the discount rate from 17% to 25% during the third quarter of 2007.

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 which are sold prior to rent commencement are reported in continuing operations. The slight decrease in the gain from the disposition of real estate is solely dependent on respective sales price and cost basis of the Inventory Properties sold.

 

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Analysis of Expenses from Continuing Operations

General.  During 2009, operating expenses from continuing operations increased primarily due to the impairments recorded on real estate. The following summarizes NNN’s expenses from continuing operations (dollars in thousands):

 

     2009     2008     2007  

General and administrative

   $ 21,776      $ 24,878      $ 23,565   

Real estate

     13,684        10,007        7,805   

Depreciation and amortization

     46,769        44,181        31,340   

Impairment – real estate

     28,114        1,234        416   

Impairment – commercial mortgage residual interests valuation

     498        758        638   

Restructuring costs

     731        -        -   
                        

Total operating expenses

   $ 111,572      $ 81,058      $ 63,764   
                        

Interest and other income

   $ (1,375   $ (3,748   $ (4,751

Interest expense

     62,151        63,964        51,846   

Loss on interest rate hedge

     -        804        -   
                        

Total other expenses (revenues)

   $     60,776      $     61,020      $     47,095   
                        

 

    Percentage of Total
Operating Expenses
  Percentage of
Revenues from
Continuing Operations
  2009
Versus
2008
Percent
Increase
(Decrease)
  2008
Versus
2007
Percent
Increase
(Decrease)
    2009   2008   2007   2009   2008   2007    

General and administrative

  19.5%   30.7%   37.0%   9.4%   10.9%   13.1%   (12.5)%   5.6%

Real estate

  12.3%   12.4%   12.2%   5.9%   4.4%   4.4%   36.7%   28.2%

Depreciation and amortization

  41.9%   54.5%   49.1%   20.2%   19.4%   17.5%   5.9%   41.0%

Impairment – real estate

  25.2%   1.5%   0.7%   12.1%   0.5%   0.2%   2,178.3%   196.6%

Impairment – commercial mortgage residual interests valuation adjustment

  0.4%   0.9%   1.0%   0.2%   0.3%   0.4%   (34.3)%   18.8%

Restructuring costs

  0.7%   -   -   0.3%   -   -   N/C(1)   -
                           

Total operating expenses

  100.0%   100.0%   100.0%   48.1%   35.5%   35.6%   37.6%   27.1%
                           

Interest and other income

  (2.3)%   (6.1)%   (10.1)%   (0.6)%   (1.7)%   (2.7)%   (63.3)%   (21.1)%

Interest expense

  102.3%   104.8%   110.1%   26.8%   28.0%   28.9%   (2.8)%   23.4%

Loss on interest rate hedge

  -   1.3%   -   -   0.4%   -   (100.0)%   N/C(1)
                           

Total other expenses (revenues)

  100.0%   100.0%   100.0%   26.2%   26.7%   26.2%   (0.4)%   29.6%
                           

(1)     Not calculable (“N/C”)

Comparison of Year End December 31, 2009 to Year Ended December 31, 2008.

General and Administrative Expenses.  General and administrative expenses decreased for the year ended December 31, 2009, as compared to the same period in 2008 and decreased both as a percentage of total operating expenses and as a percentage of revenues from continuing operations. The decrease in general and administrative expenses for the year ended December 31, 2009, is primarily attributable to a decrease in compensation of personnel and a decrease in lost pursuit costs.

Real Estate.  Real estate expenses remained fairly stable as a percentage of total operating expenses, but increased as a percentage of revenues from continuing operations for the year ended December 31, 2009, as compared to the same period in 2008. The increase in real estate expenses for the year ended December 31, 2009, is primarily attributable to an increase in tenant reimbursable real estate expenses from 2008 acquisitions as well as an increase in expenses related to un-leased properties.

 

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Depreciation and Amortization.  Depreciation and amortization expenses decreased as a percentage of total operating expenses and increased as a percentage of revenues from continuing operations for the year ended December 31, 2009, as compared to the year ended December 31, 2008. The dollar increase is primarily a result of depreciation recognized on the 109 Investment Properties with an aggregate gross leasable area of 868,000 square feet acquired in 2008. This increase is partially offset by the additional amortization in connection with the termination of certain leases during 2008.

Impairment  –  Real Estate.  Based upon the events or changes in certain circumstances, management periodically assesses its Investment Properties for possible impairment indicating that the carrying value of the asset, including accrued rental income, may not be recoverable through operations. Events or circumstances that may occur include changes in real estate market conditions, the ability of NNN to re-lease properties that are currently vacant or become vacant, and the ability to sell properties at an attractive return. Generally, NNN calculates a possible impairment by comparing the estimated future cash flows to the current net book value. Impairments are measured as the amount by which the current book value of the asset exceeds the fair value of the asset. As a result of the Company’s review of long-lived assets for impairments, for the years ended December 31, 2009, and 2008, NNN recorded real estate impairments totaling $28,114,000 and $1,234,000, respectively.

Impairment  –  Commercial Mortgage Residual Interests Valuation.  In connection with the independent valuations of the Residuals’ fair value, during the years ended December 31, 2009 and 2008, NNN recorded an other than temporary valuation adjustment of $498,000 and $758,000 respectively, as a reduction of earnings from operations.

Restructuring Costs.  During the year ended December 31, 2009, NNN recorded restructuring costs of $731,000 in connection with a workforce reduction. No such costs were incurred during 2008.

Interest Expense.  Interest expense decreased for the year ended December 31, 2009, as compared to the same period in 2008, and decreased as a percentage of total operating expenses and as a percentage of revenues from continuing operations. The decrease in interest expense is primarily attributable to a decrease of $99,907,000 in weighted average long-term debt outstanding.

The following represents the primary changes in debt that have impacted interest expense:

 

  (i) repurchase of $2,500,000 and $8,500,000 of convertible notes payable due June 2028 with an effective interest rate of 7.192% in May 2009 and February 2009, respectively,

 

  (ii) repurchase of $3,800,000, $5,000,000 and $25,000,000 of convertible notes payable due September 2026 with an effective interest rate of 5.840% in March 2009, January 2009 and November 2008, respectively,

 

  (iii) issuance of $234,035,000 of convertible notes payable due June 2028, with an effective interest rate of 7.192% in March 2008,

 

  (iv) payoff of the $100,000,000 7.125% notes payable in March 2008,

 

  (v) payoff of the $12,000,000 10.00% secured note payable in February 2008,

 

  (vi) the decrease of $78,860,000 in the weighted average debt outstanding on the Credit Facility for year ended December 31, 2009 as compared to 2008, and

 

  (vii) the decrease in weighted average interest rate on the Credit Facility from 3.83% during the year ended December 31, 2008, to 1.19% during the year ended December 31, 2009.

Comparison of Year End December 31, 2008 to Year Ended December 31, 2007.

General and Administrative Expenses.  General and administrative expenses increased for the year ended December 31, 2008, as compared to the same period in 2007, but decreased both as a percentage of total operating expenses and as a percentage of revenues from continuing operations. The increase in the

 

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amount of general and administrative expenses for the year ended December 31, 2008, is primarily related to an increase in lost pursuit costs.

Real Estate.  Real estate expenses remained stable as a percentage of revenues from continuing operations, but increased slightly as a percentage of total operating expenses for the year ended December 31, 2008, as compared to the same period in 2007. The increase in real estate expenses for the year ended December 31, 2008, is primarily attributable to an increase in tenant reimbursable real estate expenses related to newly acquired Investment Properties as well as an increase in expenses related to vacant properties.

Depreciation and Amortization.  Depreciation and amortization expenses increased both as a percentage of total operating expenses and as a percentage of revenues from continuing operations for the year ended December 31, 2008, as compared to the year ended December 31, 2007. The increase is primarily a result of the depreciation recognized on (i) the 109 Investment Properties with an aggregate gross leasable area of 868,000 square feet, acquired in 2008, and (ii) a full year of depreciation and amortization on the 235 Investment Properties with an aggregate gross leasable area of 2,205,000 square feet which were acquired during the year ended December 31, 2007.

Impairment – Real Estate.  NNN reviews long-lived assets for impairment whenever certain events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. Events or circumstances that may occur include changes in real estate market conditions, the ability of NNN to re-lease properties that are currently vacant or become vacant, and the ability to sell properties at an attractive return. Generally, NNN calculates a possible impairment by comparing the estimated future cash flows to the current net book value. Impairments are measured as the amount by which the current book value of the asset exceeds the fair value of the asset. During the years ended December 31, 2008 and 2007, $1,234,000 and $416,000 of real estate impairments were recorded, respectively.

Impairment – Commercial Mortgage Residual Interests Valuation.  In connection with the independent valuations of the Residuals’ fair value, during the years ended December 31, 2008 and 2007, NNN recorded an other than temporary valuation adjustment of $758,000 and $638,000, respectively, as a reduction of earnings from operations.

Interest Expense.  Interest expense increased for the year ended December 31, 2008, as compared to the same period in 2007, but decreased as a percentage of total operating expense and as a percentage of revenues from continuing operations. The increase in interest expenses is primarily attributable to an increase of $233,201,000 in weighted average long-term debt outstanding. The increase in interest expense was partially offset by an overall decrease in weighted average interest rate for 2008 as compared to 2007.

The following represents the primary changes in debt that have impacted interest expense:

 

  (i) repurchase of $25,000,000 of convertible notes payable due September 2026 with an effective interest rate of 5.840% in November 2008,

 

  (ii) issuance of $234,035,000 of convertible notes payable due June 2028, with an effective interest rate of 7.192% in March 2008,

 

  (iii) payoff of the $100,000,000 7.125% notes payable in March 2008,

 

  (iv) payoff of the $12,000,000 10.00% secured note payable in February 2008,

 

  (v) payoff of $26,041,000 10-year financing lease obligation with interest rate of 5.00% in November 2007,

 

  (vi) payoff of the $10,500,000 10.00% secured note in December 2007,

 

  (vii) payoff of the $20,800,000 variable rate term note in October 2007,

 

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  (viii) repayment of mortgage in September 2007, with balance of $7,305,000 at December 31, 2006, and an interest rate of 7.37%,
  (ix) issuance of $250,000,000 of notes payable due October 2017, with an effective interest rate of 6.92% in September 2007,

 

  (x) decrease of $5,403,000 in the weighted average debt outstanding on the revolving Credit Facility for the year ended December 31, 2008, as compared to the same period in 2007, and

 

  (xi) decrease in weighted average interest rate on the revolving Credit Facility from 6.24% for the period ended December 31, 2007, to 3.83% for the period ended December 31, 2008.

Discontinued Operations

Earnings (Loss)

NNN classified as discontinued operations the revenues and expenses related to its Investment Properties that were sold, its leasehold interests that expired or were terminated and any Investment Properties that were held for sale at December 31, 2009. NNN also classified as discontinued operations the revenues and expenses of its Inventory Properties that generated rental revenues. NNN records discontinued operations by NNN’s identified segments: (i) Investment Assets, and (ii) Inventory Assets. The following table summarizes the earnings from discontinued operations for the years ended December 31 (dollars in thousands):

 

    2009     2008     2007  
  # of Sold
Properties
  Gain   Earnings/
(Loss)
    # of Sold
Properties
  Gain   Earnings/
(Loss)
    # of Sold
Properties
  Gain   Earnings/
(Loss)
 

Investment Assets

  9   2,392   260      19   $ 9,980   $ 12,112      37   $ 56,625   $ 68,976   

Inventory Assets

  2   558   (1,551   24     9,347     9,277      69     10,681     9,534   

Noncontrolling interests

  -   -   (47   -     -     (2,927   -     -     (1,299
                                                 
              11       2,950   (1,338               43   $   19,327   $   18,462              106   $   67,306   $   77,211   
                                                 

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

Impairment—Real Estate.  NNN periodically assesses its real estate for possible impairment whenever certain 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 changes in real estate market conditions, the ability of NNN to re-lease properties that are vacant, and the ability to sell properties at an attractive price. Generally, NNN calculates a possible impairment by comparing the estimated future cash flows to the current net book value. Impairments are measured as the amount by which the current book value of the asset exceeds the fair value of the asset. During the years ended December 31, 2009, 2008, and 2007, NNN recognized real estate impairments on discontinued operations of $6,400,000, $4,426,000, and $1,554,000, respectively.

Impact of Inflation

NNN’s leases typically contain provisions to mitigate the adverse impact of inflation on NNN’s results of operations. 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. During times when inflation is greater than increases in rent, rent increases may not keep up with the rate of inflation.

 

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The Investment Properties are leased to tenants under long-term, net leases which typically require the tenant to pay certain operating expenses of a property, thus, NNN’s exposure to inflation is reduced. Inflation may have an adverse impact on NNN’s tenants.

Liquidity

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

NNN expects to meet these requirements (other than amounts required for additional property investments, mortgages and notes receivables, including structured finance investments) through cash provided from operations and NNN’s Credit Facility. NNN utilizes the Credit Facility to meet its short-term working capital requirements. As of December 31, 2009, no balance was outstanding and $400,000,000 was available for future borrowings under the Credit Facility, excluding undrawn letters of credit totaling $653,000. NNN anticipates that any additional investments in properties, mortgages and notes receivables and structured finance investments during the next 12 months will be funded by the Credit Facility, cash provided from operations, the issuance of long-term debt or the issuance of common or preferred equity or other instruments convertible into or exchangeable for common or preferred equity. However, there can be no assurance that additional financing or capital will be available, or that the terms will be acceptable or advantageous to NNN.

Cash and Cash Equivalents.  The table below summarizes NNN’s cash flows for each of the years ended December 31 (in thousands):

 

     2009     2008     2007  

Cash and cash equivalents:

      

Provided by operating activities

   $ 149,502      $ 237,459      $ 130,147   

Used in investing activities

     (28,063         (256,304         (536,717

Provided by (used in) financing activities

         (108,840     (6,028     432,394   
                        

Increase (decrease)

     12,599        (24,873     25,824   

Net cash at beginning of period

     2,626        27,499        1,675   
                        

Net cash at end of period

   $     15,225      $     2,626      $     27,499   
                        

Cash provided by operating activities represents cash received primarily from rental income from tenants, proceeds from the disposition of Inventory Properties and interest income less cash used for general and administrative expenses, interest expense and acquisition and disposition of its Inventory Properties. NNN’s cash flow from operating activities, net of cash used in and provided by the acquisition and disposition of its Inventory Properties, has been sufficient to pay the distributions for each period presented. NNN uses proceeds from its Credit Facility to fund the acquisition of its Inventory Properties. The change in cash provided by operations for the years ended December 31, 2009, 2008 and 2007, is primarily the result of changes in revenues and expenses as discussed in “Results of Operations.” Cash generated from operations is expected to fluctuate in the future.

Changes in cash for investing activities are primarily attributable to the acquisitions and dispositions of Investment Properties.

NNN’s financing activities for the year ended December 31, 2009, included the following significant transactions:

 

   

$8,588,000 in net payments on the repurchase of $11,000,000 of convertible notes payable due June 2028 with an effective interest rate of 7.192%,

 

   

$6,994,000 in net payments on the repurchase of $8,800,000 of convertible notes payable due September 2026 with an effective interest rate of 5.84%,

 

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$120,256,000 in dividends paid to common stockholders,

 

   

$6,785,000 in dividends paid to holders of the depositary shares of NNN’s Series C Preferred Stock,

 

   

$67,354,000 in net proceeds from the issuance of 3,766,452 shares of common stock in connection with the Dividend Reinvestment and Stock Purchase Plan (“DRIP”), and

 

   

$26,500,000 in net payments on NNN’s Credit Facility.

Financing Strategy.  NNN’s financing objective is to manage its capital structure effectively in order to provide sufficient capital to execute its operating strategy while servicing its debt requirements and providing value to NNN’s stockholders. NNN generally utilizes debt and equity security offerings, bank borrowings, the sale of properties, and to a lesser extent, internally generated funds to meet its capital needs.

NNN typically funds its short-term liquidity requirements including investments in additional Investment Properties with cash from its Credit Facility. As of December 31, 2009, no balance was outstanding and $400,000,000 was available for future borrowings under the Credit Facility, excluding undrawn letters of credit totaling $653,000.

For the year ended December 31, 2009, NNN’s ratio of total liabilities to total gross assets (before accumulated depreciation) was approximately 37 percent and the secured indebtedness to total gross assets was approximately one percent. The total debt to total market capitalization was approximately 36 percent. Certain financial agreements to which NNN is a party contain covenants that limit NNN’s ability to incur debt under certain circumstances. The organizational documents of NNN do not limit the absolute amount or percentage of indebtedness that NNN may incur. Additionally, NNN may change its financing strategy.

Contractual Obligations and Commercial Commitments.  The information in the following table summarizes NNN’s contractual obligations and commercial commitments outstanding as of December 31, 2009. There was no outstanding balance on the Credit Facility at December 31, 2009. The table presents principal cash flows by year-end of the expected maturity for debt obligations and commercial commitments outstanding as of December 31, 2009.

 

     Expected Maturity Date (dollars in thousands)
     Total    2010    2011    2012    2013    2014    Thereafter

Long-term debt(1)

   $ 1,007,025    $ 21,022    $ 139,798    $ 69,290    $ 223,898    $ 150,881    $ 402,136

Operating lease

     4,557      891      917      945      973      831      -
                                                

Total contractual cash obligations(2)

   $ 1,011,582    $ 21,913    $ 140,715    $ 70,235    $ 224,871    $ 151,712    $ 402,136
                                                

(1)     Includes amounts outstanding under the mortgages payable, convertible notes payable and notes payable and excludes unamortized note discounts.

(2)     Excludes $7,471 of accrued interest payable.

In addition to the contractual obligations outlined above, in connection with the development of two Investment Properties, NNN has agreed to fund construction commitments (including construction, land costs and tenant improvements) of $14,651,000. As of December 31, 2009, NNN had funded $12,261,000 of this commitment, with $2,390,000 remaining to be funded. As of December 31, 2009, NNN did not have any funding commitments relating to the development of Inventory Properties.

As of December 31, 2009, NNN had outstanding letters of credit totaling $653,000 under its Credit Facility.

 

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As of December 31, 2009, NNN did not have any other material contractual cash obligations, such as purchase obligations, financing lease obligations or other long-term liabilities other than those reflected in the table. In addition to items reflected in the table, NNN has issued preferred stock with cumulative preferential cash distributions, as described below under “Dividends.”

Management anticipates satisfying these obligations with a combination of NNN’s cash provided from operations, current capital resources on hand, its Credit Facility, debt or equity financings and asset dispositions.

Many of the Investment Properties are recently constructed and are generally net leased. Therefore, management anticipates that capital demands to meet obligations with respect to these Investment Properties will be modest for the foreseeable future and can be met with funds from operations and working capital. Certain of NNN’s Investment Properties are subject to leases under which NNN retains responsibility for certain costs and expenses associated with the Investment Property. Management anticipates the costs associated with NNN’s vacant Investment Properties or those Investment Properties that become vacant will also be met with funds from operations and working capital. NNN may be required to borrow under its Credit Facility or use other sources of capital in the event of unforeseen significant capital expenditures.

The lost revenues and increased property expenses resulting from vacant properties or uncollectibility of lease revenues could have a material adverse effect on the liquidity and results of operations if NNN is unable to release the Investment Properties at comparable rental rates and in a timely manner. As of December 31, 2009, NNN owned 37 vacant, un-leased Investment Properties (including two vacant land parcels) which accounted for approximately four percent of total Investment Properties held in NNN’s Investment Portfolio. Additionally, as of January 31, 2010, one Investment Property is leased to a tenant that filed a voluntary petition for bankruptcy under Chapter 11 of the U.S. Bankruptcy Code. As a result, this tenant has the right to reject or affirm its leases with NNN.

In May 2008, one of NNN’s tenants, Uni-Mart, Inc. (“Uni-Mart”), which leased 77 properties, filed a petition for reorganization under Chapter 11 of the U.S. Bankruptcy Code. During the year ended December 31, 2008, Uni-Mart elected to reject the leases of 16 properties owned by NNN. NNN had re-leased 15 of the 16 properties as of December 31, 2009. On April 1, 2009, Uni-Mart rejected the leases of 36 additional properties. All of the 36 properties were subject to subleases with convenience store operators and all of the subleases with the operators were assigned from Uni-Mart to NNN effective April 1, 2009. On April 30, 2009, Uni-Mart assumed all of the remaining leases for 24 properties between Uni-Mart and NNN. In January 2010, these leases were assigned from Uni-Mart to other operators, and NNN no longer has any leases with Uni-Mart as of January 8, 2010. For the years ended December 31, 2009 and 2008, NNN recorded $3,371,000 and $2,421,000, respectively, of income in connection with the Uni-Mart bankruptcy rent settlement.

On April 20, 2009, one of NNN’s tenants, Titlemax Holdings, LLC and its affiliated companies (collectively, “Titlemax”), which leased 30 Investment Properties from NNN, filed a petition of reorganization under Chapter 11 of the U.S. Bankruptcy Code. On February 3, 2010, Titlemax assumed all of its leases with NNN.

Dividends.  NNN 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 and intends to continue to operate so as to remain qualified as a REIT for federal income tax purposes. NNN generally will not be subject to federal income tax on income that it distributes to its stockholders, provided that it distributes 100 percent of its REIT taxable income and meets certain other requirements for qualifying as a REIT. If NNN fails to qualify as a REIT in any taxable year, it will be subject to federal income tax on its taxable income at regular corporate rates and will not be permitted to qualify for treatment as a REIT for federal income tax purposes for four years following the year during which qualification is lost. Such an event could materially adversely affect NNN’s income and ability to pay dividends.

 

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One of NNN’s primary objectives, consistent with its policy of retaining sufficient cash for reserves and working capital purposes and maintaining its status as a REIT, is to distribute a substantial portion of its funds available from operations to its stockholders in the form of dividends. During the years ended December 31, 2009, 2008 and 2007, NNN declared and paid dividends to its common stockholders of $120,256,000, $110,107,000, and $92,989,000, respectively, or $1.50, $1.48 and $1.40 per share, respectively, of common stock.

The following presents the characterizations for tax purposes of such common stock dividends for the years ended December 31:

 

    2009   2008   2007

Ordinary dividends

  $ 1.495182   99.6788%   $ 1.480000   100.000%   $ 1.397402   99.8144%

Qualified dividends

    -   -     -   -     0.000414   0.0296%

Capital gain

    0.003051   0.2034%     -   -     0.002184   0.1560%

Unrecaptured Section 1250 Gain

    0.001767   0.1178%     -   -     -   -
                             
  $     1.500000   100.000%   $     1.480000   100.000%   $     1.400000   100.0000%
                             

In February 2010, NNN paid dividends to its common stockholders of $31,026,000, or $0.375 per share of common stock.

Holders of NNN’s preferred stock issuance 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 the issuance of NNN’s preferred stock:

 

Non Voting
Preferred Stock
Issuance

  Shares
Outstanding
At December 31,
2009
  Liquidation
Preference Per
Share
  Fixed Annual
Cash
Distribution
(per share)

7.375% Series C(1)

      3,680,000       25.00       1.84375

 

  (1)

In October 2006, NNN issued 3,680,000 depositary shares, each representing 1/100th of a share of 7.375% Series C Cumulative Redeemable Preferred Stock. See Capital Resources – Debt and Equity Securities.”

 

NNN declared and paid dividends to its Series C Preferred stockholders of $6,785,000 or $1.84375 per depository share during each of the years ended December 31, 2009, 2008 and 2007. The Series C Preferred Stock has no maturity date and will remain outstanding unless redeemed.

Capital Resources

Generally, cash needs for property acquisitions, mortgages and notes receivable investments, debt payments, dividends, structured finance investments, 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, by internally generated funds. Cash needs for other items have been met from operations. If available, future sources of capital include proceeds from the public or private offering of NNN’s debt or equity securities, secured or unsecured borrowings from banks or other lenders, proceeds from the sale of properties, as well as undistributed funds from operations.

 

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Debt

The following is a summary of NNN’s total outstanding debt as of December 31 (dollars in thousands):

 

     2009    Percentage of
Total
   2008    Percentage of
Total

Line of credit payable

   $ -    -    $ 26,500    2.6%

Mortgages payable

     25,290    2.6%      26,290    2.6%

Notes payable – convertible

     343,380    34.8%      356,122    34.6%

Notes payable

     618,676    62.6%      618,479    60.2%
                       

Total outstanding debt

   $         987,346            100.0%    $         1,027,391            100.0%
                       

Indebtedness.  NNN expects to use indebtedness primarily for property acquisitions and development of single-tenant retail properties, either directly or through investment interests, and mortgages and notes receivable.

Line of Credit Payable.  NNN’s $400,000,000 revolving Credit Facility had a weighted average outstanding balance of $10,824,000 and a weighted average interest rate of 1.19% during the year ended December 31, 2009. In November 2009, NNN entered into a credit agreement for a new $400,000,000 credit facility, replacing the former revolving credit facility (as the context requires, the previous and new revolving credit facility, the “Credit Facility”). The Credit Facility matures November 2012, with an option to extend maturity to November 2013. The Credit Facility bears interest at LIBOR plus 280 basis points with a 1.0% LIBOR floor; however, such interest rate may change pursuant to a tiered interest rate structure based on NNN’s debt rating. The Credit Facility also includes an accordion feature for NNN to increase, at its option, the facility size up to $500,000,000. As of December 31, 2009, no balance was outstanding, and $400,000,000 was available for future borrowings under the Credit Facility, excluding undrawn letters of credit totaling $653,000.

In accordance with the terms of the Credit Facility, NNN is required to meet certain restrictive financial covenants, which, among other things, require NNN to maintain certain (i) leverage ratios, (ii) debt service coverage, (iii) cash flow coverage, and (iv) investment limitations. At December 31, 2009, NNN was in compliance with those covenants. In the event that NNN violates any of these restrictive financial covenants, it could cause the indebtedness under the Credit Facility to be accelerated and may impair NNN’s access to the debt and equity markets and limit NNN’s ability to pay dividends to its common and preferred stockholders, each of which would likely have a material adverse impact on NNN’s financial condition and results of operation.

Mortgages Payable.  The following table outlines the mortgages payable included in NNN’s consolidated financial statements (dollars in thousands):

 

Entered

   Balance    Interest
Rate
    Maturity(3)    Carrying
Value of
Encumbered
Asset(s)
(1)
   Outstanding Principal
Balance at December 31,
              2009    2008

December 1999(4)

   $ 350    8.50   December 2009    $ -    $ -    $ 49

December 2001(2)

     623    9.00   April 2014      820      267      315

December 2001(2)

     698    9.00   April 2019      1,247      392      418

December 2001(2)

     485    9.00   April 2019      1,215      201      214

June 2002

         21,000    6.90   July 2012      24,505      19,170      19,477

February 2004(2)

     6,952    6.90   January 2017      11,764      4,554      5,036

March 2005(2)

     1,015    8.14   September 2016      1,341      706      781
                            
           $         40,892    $         25,290    $         26,290
                            

 

  (1)

Each loan is secured by a first mortgage lien on certain of NNN’s properties. The carrying values of the assets are as of December 31, 2009.

  (2)

Date entered represents the date that NNN acquired real estate subject to a mortgage securing a loan. The corresponding original principal balance represents the outstanding principal balance at the time of acquisition.

  (3)

Monthly payments include interest and principal, if any; the balance is due at maturity.

  (4)

In December 2009, upon maturity NNN repaid the outstanding principal balance and the property was released from the mortgage lien. This was a self-amortizing mortgage.

 

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Notes Payable – Convertible.  Each of NNN’s outstanding series of convertible notes are summarized in the table below (dollars in thousands):

 

Terms

   2026
Notes(1)(2)(4)
    2028
Notes(2)(5)(6)
 

Issue Date

     September 2006        March 2008   

Net Proceeds

   $ 168,650      $ 228,576   

Stated Interest Rate(8)

     3.950%        5.125%   

Debt Issuance Costs

   $ 3,850 (3)    $ 5,459 (7) 

Earliest Conversion Date

             September 2025                June 2027   

Earliest Put Option Date

     September 2011        June 2013   

Maturity Date

     September 2026        June 2028   

Original Principal

   $ 172,500      $ 234,035   

Repurchases

     (33,800     (11,000
                

Outstanding principal balance at December 31, 2009

   $ 138,700      $ 223,035   
                

 

  (1)

NNN repurchased $3,800, $5,000 and $25,000 in March 2009, January 2009 and November 2008, respectively, for a purchase price of $3,100, $3,894 and $19,188, respectively, resulting in a gain of $607, $958 and $4,961, respectively.

  (2)

Debt issuance costs include underwriting discounts and commissions, legal and accounting fees, rating agency fees and printing expenses. These costs have been deferred and are being amortized over the period to the earliest put option date of the holders using the effective interest method.

  (3)

Includes $48, $66 and $349 of note costs which were written off in connection with the repurchase of $3,800, $5,000 and $25,000 of the 2026 Notes, respectively.

  (4)

The conversion rate per $1 principal amount was 41.6750 shares of NNN’s common stock, which is equivalent to a conversion price of $23.9952 per share of common stock.

  (5)

The conversion rate per $1 principal amount was 39.3459 shares of NNN’s common stock, which is equivalent to a conversion price of $25.4156 per share of common stock.

  (6)

NNN repurchased $2,500 and $8,500 in May 2009 and February 2009, respectively, for a purchase price of $2,049 and $6,539, respectively, resulting in a gain of $342 and $1,525, respectively.

  (7)

Includes $48 and $171 of note costs which were written off in connection with the repurchase of $2,500 and $8,500 of the 2028 Notes, respectively.

  (8)

With the adoption of the new accounting guidance on convertible debt securities, the effective interest rate for the 2026 Notes and the 2028 Notes are 5.840% and 7.192%, respectively.

Each series of convertible notes represents senior, unsecured obligations of NNN and are subordinated to all secured indebtedness of the Company. Each note is redeemable at the option of NNN, in whole or in part, at a redemption price equal to the sum of (i) the principal amount of the notes being redeemed plus accrued and unpaid interest thereon through but not including the redemption date, and (ii) the make-whole amount, if any, as defined in the applicable supplemental indenture relating to the notes.

Notes Payable. Each of NNN’s outstanding series of non-convertible notes are summarized in the table below (dollars in thousands):

 

    Notes    

   Issue Date    Principal    Discount(3)    Net Price    Stated
Rate
   Effective
Rate
(4)
   Maturity
Date

2010(1)

   September 2000    $     20,000    $         126    $     19,874    8.500%    8.595%    September 2010

2012(1)

   June 2002      50,000      287      49,713    7.750%    7.833%    June 2012

2014(1)(2)(5)

   June 2004      150,000      440      149,560    6.250%    5.910%    June 2014

2015(1)

   November 2005      150,000      390      149,610    6.150%    6.185%    December 2015

2017(1)(6)

   September 2007      250,000      877      249,123    6.875%    6.924%    October 2017

 

  (1)

The proceeds from the note issuance were used to pay down outstanding indebtedness of NNN’s Credit Facility.

  (2)

The proceeds from the note issuance were used to repay the obligation of the 2004 Notes.

  (3)

The note discounts are amortized to interest expense over the respective term of each debt obligation using the effective interest method.

  (4)

Includes the effects of the discount, treasury lock gain and swap gain (as applicable).

  (5)

NNN entered into a forward starting interest rate swap agreement which fixed a swap rate of 4.61% on a notional amount of $94,000. Upon issuance of the 2014 Notes, NNN terminated the forward starting interest rate swap agreement resulting in a gain of $4,148. The gain has been deferred and is being amortized as an adjustment to interest expense over the term of the 2014 Notes using the effective interest method.

  (6)

NNN entered into an interest rate hedge with a notional amount of $100,000. Upon issuance of the 2017 Notes, NNN terminated the interest rate hedge agreement resulting in a liability of $3,260, of which $3,228 was recorded to other comprehensive income. The liability has been deferred and is being amortized as an adjustment to interest expense over the term of the 2017 Notes using the effective interest method.

 

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Each series of notes represent senior, unsecured obligations of NNN and are subordinated to all secured indebtedness of NNN. The notes are redeemable at the option of NNN, in whole or in part, at a redemption price equal to the sum of (i) the principal amount of the notes being redeemed plus accrued and unpaid interest thereon through the redemption date, and (ii) the make-whole amount, if any, as defined in the applicable supplemental indenture relating to the notes.

In connection with the note and convertible note offerings, NNN incurred debt issuance costs totaling $5,459,000 consisting primarily of underwriting discounts and commissions, legal and accounting fees, rating agency fees and printing expenses. Debt issuance costs for all note issuances have been deferred and are being amortized over the term of the respective notes using the effective interest method.

In accordance with the terms of the indentures, pursuant to which NNN’s notes and convertible notes have been issued, NNN is required to meet certain restrictive financial covenants, which, among other things, require NNN to maintain (i) certain leverage ratios, and (ii) certain interest coverage. At December 31, 2009, NNN was in compliance with those covenants.

NNN’s failure to comply with certain of its debt covenants could result in defaults that accelerate the payment under such debt and limit the dividends paid to NNN’s common and preferred stockholders which would likely have a material adverse impact on NNN’s financial condition and results of operations. In addition, these defaults could impair its access to the debt and equity markets.

In March 2008, NNN repaid the 7.125% $100,000,000 notes that were due in March 2008.

Debt and Equity Securities

NNN has used, and expects to use in the future, issuances of debt and equity securities primarily to pay down its outstanding indebtedness and to finance investment acquisitions. NNN has maintained investment grade debt ratings from Standard and Poor’s, Moody’s Investor Service and Fitch Ratings on its senior, unsecured debt since 1998. In June 2008, NNN’s debt rating was upgraded by Moody’s Investor Service. In February 2009, NNN filed a shelf registration statement with the Securities and Exchange Commission (the “Commission”) which was automatically effective and permits the issuance by NNN of an indeterminate amount of debt and equity securities.

A description of NNN’s outstanding series of publicly held notes is found under “Debt – Notes Payable – Convertible” and “Debt – Notes Payable” above.

7.375% Series C Cumulative Redeemable Preferred Stock.  In October 2006, NNN issued 3,200,000 depositary shares, each representing 1/100th of a share of 7.375% Series C Cumulative Redeemable Preferred Stock (“Series C Preferred Stock”), and received gross proceeds of $80,000,000. In addition, NNN issued an additional 480,000 depositary shares in connection with the underwriters’ over-allotment option and received gross proceeds of $12,000,000. In connection with this offering, NNN incurred stock issuance costs of approximately $3,098,000, consisting primarily of underwriting commissions and fees, legal and accounting fees and printing expenses.

Holders of the depositary shares are entitled to receive, when and as authorized by the Board of Directors, cumulative preferential cash dividends at the rate of 7.375% of the $25.00 liquidation preference per depositary share per annum (equivalent to a fixed annual amount of $1.84375 per depositary share). The Series C Preferred Stock underlying the depositary shares ranks senior to NNN’s common stock with respect to dividend rights and rights upon liquidation, dissolution or winding up of NNN. The Series C Preferred Stock has no maturity date and will remain outstanding unless redeemed. NNN may redeem the Series C Preferred Stock underlying the depositary shares on or after October 12, 2011, for cash, at a redemption price of $2,500.00 per share (or $25.00 per depositary share), plus all accumulated, accrued and unpaid dividends.

 

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In January 2007, NNN used $44,540,000 of the net proceeds from the offering to redeem the Series A Preferred Stock; and the remainder of the net proceeds were used to repay borrowings under the Credit Facility.

Common Stock Issuances.  In March 2007, NNN issued 5,000,000 shares of common stock at a price of $24.70 per share and received net proceeds of $118,020,000. Subsequently, in April 2007, NNN issued an additional 750,000 shares of common stock in connection with the underwriters’ over-allotment option and received net proceeds of $17,730,000. In connection with this offering, NNN incurred stock issuance costs totaling approximately $6,217,000 consisting primarily of underwriters’ fees and commissions, legal and accounting fees and printing expenses.

In October 2007, NNN issued 4,000,000 shares of common stock at a price of $25.94 per share and received net proceeds of $99,150,000. In connection with this offering, NNN incurred stock issuance costs totaling approximately $4,874,000 consisting primarily of underwriters’ fees and commissions, legal and accounting fees. In October 2007, NNN used a portion of the net proceeds to repay the outstanding principal balance on its term note.

In October 2008, NNN issued 3,450,000 shares of common stock in a registered, underwritten public offering at a price of $23.05 per share and received net proceeds of $75,958,000. In connection with this offering, NNN incurred stock issuance costs totaling approximately $3,565,000 consisting primarily of underwriters’ fees and commissions, legal and accounting fees. NNN used the net proceeds to repay borrowings under the Credit Facility and to acquire Investment Properties.

Dividend Reinvestment and Stock Purchase Plan.  In June 2009, NNN filed a shelf registration statement which was automatically effective, with the Commission for its DRIP, which permits the issuance by NNN of 16,000,000 shares of common stock. NNN’s DRIP provides an economical and convenient way for current stockholders and other interested new investors to invest in NNN’s common stock. The following outlines the common stock issuances pursuant to NNN’s DRIP for each of the years ended December 31 (dollars in thousands):

 

      2009    2008    2007

Shares of common stock

     3,766,452      2,146,640      2,645,257

Net proceeds

   $ 67,354    $ 47,372    $ 62,980

The proceeds from the issuances were used to pay down outstanding indebtedness under NNN’s Credit Facility.

Mortgages and Notes Receivable.

Mortgages and notes receivable consisted of the following at December 31 (dollars in thousands):

 

      2009    2008  

Mortgages and notes receivable

   $ 41,707    $ 55,495   

Structured finance investments

     -      4,514   

Accrued interest receivable

     269      387   

Unamortized premium

     -      84   
               
     41,976      60,480   

Less loan origination fees, net

     -      (8
               
   $ 41,976    $ 60,472   
               

Mortgages are secured by real estate, real estate securities or other assets. Structured finance investments are secured by the borrowers’ pledge of their respective membership interests in the entities which own the respective real estate.

 

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Commercial Mortgage Residual Interests.

In connection with the independent valuations of the Residuals’ fair value, NNN adjusted carrying value of the Residuals to reflect such fair value at December 31, 2009. Due to changes in market conditions relating to residual assets, the independent valuation changed several valuation assumptions. The following table summarizes the changes to the key assumptions used in determining the value of the Residuals as of December 31:

 

      2009    2008

Discount rate

   25%    25%

Average life equivalent CPR speeds range

   14.5% to 20.7% CPR    31.7% to 39.4% CPR

Foreclosures:

     

Frequency curve default model

   6% average rate    1.1% maximum rate

Loss severity of loans in foreclosure

   20%    10%

Yield:

     

LIBOR

   Forward 3-month curve    Forward 3-month curve

Prime

   Forward curve    Forward curve

The following table summarizes the recognition of unrealized gains and/or losses recorded as other comprehensive income as well as other than temporary valuation impairment as of December 31 (dollars in thousands):

 

      2009    2008    2007

Unrealized gains

   $ -    $ 2,009    $ -

Unrealized losses

     1,640      -      326

Other than temporary valuation impairment

     498      758      638

Business Combination.

In connection with the default of a note receivable and certain lease agreements between NNN and one of its tenants, in June 2009, NNN acquired the operations of the auto service business which was operated on 12 Investment Properties. The note foreclosure resulted in a loss of $7,816,000. NNN recorded the value of the assets received at fair value. No liabilities were assumed. The fair value of the assets resulted in goodwill of $3,400,000.

 

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Item 7A.  Quantitative and Qualitative Disclosures About Market Risk

NNN is exposed to interest rate risk primarily as a result of its variable rate Credit Facility and its fixed rate debt which is used to finance NNN’s development and acquisition activities, as well as for general corporate purposes. NNN’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, NNN borrows at both fixed and variable rates on its long-term debt. As of December 31, 2009, NNN had no outstanding derivatives.

The information in the table below summarizes NNN’s market risks associated with its debt obligations outstanding as of December 31, 2009 and 2008. The table presents principal payments and related interest rates by year for debt obligations outstanding as of December 31, 2009. NNN has a variable interest rate risk on its Credit Facility which had no outstanding balance as of December 31, 2009. The weighted average rate for the Credit Facility for the year ended December 31, 2009 was 1.19%. The fair value of the Credit Facility as of December 31, 2009 and 2008 was $0 and $26,500,000, respectively. The table incorporates only those debt obligations that existed as of December 31, 2009; it does not consider those debt obligations 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, NNN’s ultimate realized gain or loss with respect to interest rate fluctuations will depend on the exposures that arise during the period, NNN’s hedging strategies at that time and interest rates. If interest rates on NNN’s variable rate debt increased by one percent, NNN’s interest expense would have increased by one percent for the year ended December 31, 2009.

 

Fixed Rate Debt Obligations (dollars in thousands)

      Mortgages    Unsecured Debt(1)
      Debt
  Obligation  
   Weighted
Average

Interest Rate
   Debt
  Obligation  
   Effective
Interest Rate

2010

   $ 1,022    7.19%    $ 19,987    8.60%

2011

     1,098    7.20%      134,421    5.84%

2012

     19,290    6.92%      49,909    7.83%

2013

     863    7.35%      208,960    7.19%

2014

     880    7.27%      149,771    5.91%

Thereafter

     2,137    7.36%      399,008    6.65%
                   

Total

   $ 25,290    7.01%    $ 962,056    6.64%
                   

Fair Value:

           

December 31, 2009

   $ 25,290       $ 987,275   
                   

December 31, 2008

   $ 26,290       $ 709,944   
                   

 

  (1)

Includes NNN’s notes payable and convertible notes payable, each net of unamortized discounts. NNN uses Bloomberg software to determine the fair value.

NNN is also exposed to market risks related to NNN’s 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 based upon an independent valuation, had a carrying value of $20,153,000 and $22,000,000 as of December 31, 2009 and 2008, 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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Item 8. Financial Statements and Supplementary Data

Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders of National Retail Properties, Inc. and Subsidiaries

We have audited National Retail Properties, Inc. and Subsidiaries’ internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). National Retail Properties, Inc. and Subsidiaries’ management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, National Retail Properties, Inc. and Subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on the COSO criteria.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of National Retail Properties, Inc. and Subsidiaries as of December 31, 2009 and 2008, and the related consolidated statements of earnings, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2009 and our report dated February 25, 2010 expressed an unqualified opinion thereon.

LOGO

Miami, Florida

February 25, 2010

 

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Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders of National Retail Properties, Inc. and Subsidiaries

We have audited the accompanying consolidated balance sheets of National Retail Properties, Inc. and Subsidiaries as of December 31, 2009 and 2008, and the related consolidated statements of earnings, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2009. Our audits also included the financial statement schedules listed in the index at Item 15(a). These financial statements and schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of National Retail Properties, Inc. and Subsidiaries at December 31, 2009 and 2008, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2009, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), National Retail Property Inc.’s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 25, 2010 expressed an unqualified opinion thereon.

LOGO

Miami, Florida

February 25, 2010

 

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NATIONAL RETAIL PROPERTIES, INC.

and SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(dollars in thousands, except per share data)

 

ASSETS

   December 31,
2009
   December 31,
2008

Real estate, Investment Portfolio:

     

Accounted for using the operating method, net of accumulated depreciation and amortization

   $         2,329,827    $         2,373,878

Accounted for using the direct financing method

     31,317      31,240

Real estate, Inventory Portfolio, held for sale

     72,423      85,122

Investment in unconsolidated affiliate

     4,703      4,927

Mortgages, notes and accrued interest receivable, net of allowance

     41,976      60,472

Commercial mortgage residual interests

     20,153      22,000

Cash and cash equivalents

     15,225      2,626

Receivables, net of allowance of $583 and $4,003, respectively

     1,946      3,612

Accrued rental income, net of allowance of $2,875 and $4,144, respectively

     25,745      23,972

Debt costs, net of accumulated amortization of $10,008 and $12,852, respectively

     13,884      11,342

Other assets

     33,763      30,280
             

Total assets

   $ 2,590,962    $ 2,649,471
             

LIABILITIES AND STOCKHOLDERS’ EQUITY

     

Line of credit payable

   $ -    $ 26,500

Mortgages payable

     25,290      26,290

Notes payable – convertible, net of unamortized discount of $18,355 and $25,413, respectively

     343,380      356,122

Notes payable, net of unamortized discount of $1,324 and $1,521, respectively

     618,676      618,479

Accrued interest payable

     7,471      7,608

Other liabilities

     29,283      45,526
             

Total liabilities

     1,024,100      1,080,525
             

Commitments and contingencies (Note 26)

     

Stockholders’ equity:

     

Preferred stock, $0.01 par value. Authorized 15,000,000 shares

     

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

     92,000      92,000

Common stock, $0.01 par value. Authorized 190,000,000 shares; 82,427,560 and 78,340,428 shares issued and outstanding, respectively

     825      784

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

     -      -

Capital in excess of par value

     1,408,491      1,337,018

Retained earnings

     62,413      134,644

Accumulated other comprehensive income

     511      2,414
             

Total stockholders’ equity of National Retail Properties, Inc.

     1,564,240      1,566,860

Noncontrolling interests

     2,622      2,086
             

Total equity

     1,566,862      1,568,946
             

Total liabilities and equity

   $ 2,590,962    $ 2,649,471
             

See accompanying notes to consolidated financial statements.

 

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NATIONAL RETAIL PROPERTIES, INC.

and SUBSIDIARIES

CONSOLIDATED STATEMENTS OF EARNINGS

(dollars in thousands, except per share data)

 

     Year Ended December 31,  
      2009     2008     2007  

Revenues:

      

Rental income from operating leases

   $ 210,215      $ 206,477      $ 159,065   

Earned income from direct financing leases

     3,070        3,103        3,221   

Percentage rent

     1,340        1,104        1,383   

Real estate expense reimbursement from tenants

     8,387        7,012        5,591   

Interest and other income from real estate transactions

     4,535        5,804        5,268   

Interest income on commercial mortgage residual interests

     4,252        4,636        4,882   
                        
     231,799        228,136        179,410   
                        

Disposition of real estate, Inventory Portfolio:

      

Gross proceeds

     953        4,900        1,750   

Costs

     (916     (4,879     (1,418
                        

Gain

     37        21        332   
                        

Retail operations:

      

Revenues

     15,595        -        -   

Operating expenses

     (15,176     -        -   
                        

Net

     419        -        -   
                        

Operating expenses:

      

General and administrative

     21,776        24,878        23,565   

Real estate

     13,684        10,007        7,805   

Depreciation and amortization

     46,769        44,181        31,340   

Impairment – real estate

     28,114        1,234        416   

Impairment – commercial mortgage residual interests valuation adjustment

     498        758        638   

Restructuring costs

     731        -        -   
                        
     111,572        81,058        63,764   
                        

Earnings from operations

     120,683        147,099        115,978   
                        

Other expenses (revenues):

      

Interest and other income

     (1,375     (3,748     (4,751

Interest expense

     62,151        63,964        51,846   

Loss on interest rate hedge

     -        804        -   
                        
     60,776        61,020        47,095   
                        

Earnings from continuing operations before income tax benefit, equity in earnings of unconsolidated affiliate, loss on note receivable foreclosure and gain on extinguishment of debt

     59,907        86,079        68,883   

Income tax benefit

     1,126        7,178        8,300   

Equity in earnings of unconsolidated affiliate

     421        364        49   

Loss on note receivable foreclosure

     (7,196     -        -   

Gain on extinguishment of debt

     3,432        4,961        -   
                        

Earnings from continuing operations

     57,690        98,582        77,232   

Earnings (loss) from discontinued operations (Note 18):

      

Real estate, Investment Portfolio

     260        12,112        68,976   

Real estate, Inventory Portfolio, net of income tax expense

     (1,551     9,277        9,534   
                        
     (1,291     21,389        78,510   
                        

See accompanying notes to consolidated financial statements.

 

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NATIONAL RETAIL PROPERTIES, INC.

and SUBSIDIARIES

CONSOLIDATED STATEMENTS OF EARNINGS – CONTINUED

(dollars in thousands, except per share data)

 

     Year Ended December 31,  
      2009     2008     2007  

Earnings including noncontrolling interests

   $ 56,399      $ 119,971      $ 155,742   

Loss (earnings) attributable to noncontrolling interests:

      

Continuing operations

     (1,542     109        156   

Discontinued operations

     (47     (2,927     (1,299
                        
     (1,589     (2,818     (1,143
                        

Net earnings attributable to National Retail Properties, Inc.

     54,810        117,153        154,599   

Other comprehensive income

     (1,903     1,688        (3,622
                        

Total comprehensive income

   $ 52,907      $ 118,841      $ 150,977   
                        

Net earnings attributable to National Retail Properties, Inc.

   $ 54,810      $ 117,153      $ 154,599   

Series C preferred stock dividends

     (6,785     (6,785     (6,785
                        

Net earnings attributable to common stockholders

   $ 48,025      $ 110,368      $ 147,814   
                        

Net earnings per share of common stock:

      

Basic:

      

Continuing operations

   $ 0.62      $ 1.23      $ 1.06   

Discontinued operations

     (0.02     0.25        1.17   
                        

Net earnings

   $ 0.60      $ 1.48      $ 2.23   
                        

Diluted:

      

Continuing operations

   $ 0.61      $ 1.23      $ 1.06   

Discontinued operations

     (0.01     0.25        1.16   
                        

Net earnings

   $ 0.60      $ 1.48      $ 2.22   
                        

Weighted average number of common shares outstanding:

      

Basic

     79,846,258        74,249,137        66,152,437   
                        

Diluted

     79,953,499        74,344,231        66,263,980   
                        

See accompanying notes to consolidated financial statements.

 

49


Table of Contents

NATIONAL RETAIL PROPERTIES, INC.

and SUBSIDIARIES

CONSOLIDATED STATEMENTS OF EQUITY

Years Ended December 31, 2009, 2008 and 2007

(dollars in thousands, except per share data)

 

     Series A
  Preferred  
Stock
    Series C
Preferred
Stock
  Common
Stock
  Capital in
  Excess of  
Par Value
    Retained
Earnings
    Accumulated
Other
  Comprehensive  
Income
    Total
  Stockholders’  
Equity
      Noncontrolling  
Interests
    Total
Equity
 

Balances at December 31, 2006

  $         44,540      $         92,000   $         598   $         888,085      $         79,558      $                   4,698      $         1,109,479      $                   1,619      $         1,111,098   

Net earnings

    -        -     -     -        154,599        -        154,599        1,143        155,742   

Dividends declared and paid:

                 

$1.84375 per depositary share of Series C preferred stock

    -        -     -     -        (6,785     -        (6,785     -        (6,785

$1.40 per share of common stock

    -        -     6     13,947        (92,989     -        (79,036     -        (79,036

Redemption of 1,781,589 shares of Series A preferred stock

    (44,540     -     -     -        -        -        (44,540     -        (44,540

Issuance of common stock:

                 

9,861,323 shares

    -        -     98     247,643        -        -        247,741        -        247,741   

2,054,805 shares – discounted stock purchase program

    -        -     21     49,006        -        -        49,027        -        49,027   

Issuance of 198,119 shares of restricted common stock

    -        -     2     (2     -        -        -        -        -   

Stock issuance costs

    -        -     -     (11,206     -        -        (11,206     -        (11,206

Amortization of deferred compensation

    -        -     -     2,091        -        -        2,091        -        2,091   

Interest rate hedge termination

    -        -     -     -        -        (3,119     (3,119     -        (3,119

Amortization of interest rate hedges

    -        -     -     -        -        (309     (309     -        (309

Unrealized loss – commercial mortgage residual interests

    -        -     -     -        -        (427     (427     101        (326

Stock value adjustment

    -        -     -     -        -        132        132        -        132   

Contributions from noncontrolling interests

    -        -     -     -        -        -        -        155        155   

Distributions to noncontrolling interests

    -        -     -     -        -        -        -        (62     (62
                                                                   

Balances at December 31, 2007

  $ -      $ 92,000   $ 725   $ 1,189,564      $ 134,383      $ 975      $ 1,417,647      $ 2,956      $ 1,420,603   

See accompanying notes to consolidated financial statements.

 

50


Table of Contents

NATIONAL RETAIL PROPERTIES, INC.

and SUBSIDIARIES

CONSOLIDATED STATEMENTS OF EQUITY – CONTINUED

Years Ended December 31, 2009, 2008 and 2007

(dollars in thousands, except per share data)

 

     Series A
  Preferred  
Stock
  Series C
Preferred
Stock
  Common
Stock
  Capital in
  Excess of  
Par Value
    Retained
Earnings
    Accumulated
Other
  Comprehensive  
Income
    Total
  Stockholders’  
Equity
      Noncontrolling  
Interests
    Total
Equity
 

Balances at December 31, 2007

  $ -   $ 92,000   $ 725   $ 1,189,564      $ 134,383      $ 975      $ 1,417,647      $ 2,956      $ 1,420,603   

Net earnings

    -     -     -     -        117,153        -        117,153        2,818        119,971   

Dividends declared and paid:

                 

$1.84375 per depositary share of Series C preferred stock

    -     -     -     -        (6,785     -        (6,785     -        (6,785

$1.48 per share of common stock

    -     -     4     8,472        (110,107     -        (101,631     -        (101,631

Issuance of common stock:

                 

3,523,285 shares

    -     -     35     80,633        -        -        80,668        -        80,668   

1,753,201 shares – discounted stock purchase program

    -     -     18     38,878        -        -        38,896        -        38,896   

Issuance of 217,397 shares of restricted common stock

    -     -     2     (2     -        -        -        -        -   

Stock issuance costs

    -     -     -     (3,582     -        -        (3,582     -        (3,582

Equity component of convertible debt

    -     -     -     20,467        -        -        20,467        -        20,467   

Amortization of deferred compensation

    -     -     -     2,588        -        -        2,588        -        2,588   

Interest rate hedge termination

    -     -     -     -        -        (162     (162     -        (162

Amortization of interest rate hedges

    -     -     -     -        -        (109     (109     -        (109

Unrealized gain – commercial mortgage residual interests

    -     -     -     -        -        1,760        1,760        249        2,009   

Stock value adjustment

    -     -     -     -        -        (50     (50     -        (50

Contributions from noncontrolling interests

    -     -     -     -        -        -        -        41        41   

Distributions to noncontrolling interests

    -     -     -     -        -          -        (5,483     (5,483

Other

    -     -     -     -        -        -        -        1,505        1,505   
                                                                 

Balances at December 31, 2008

  $         -   $         92,000   $         784   $         1,337,018      $         134,644      $                   2,414      $         1,566,860      $                   2,086      $         1,568,946   

See accompanying notes to consolidated financial statements.

 

51


Table of Contents

NATIONAL RETAIL PROPERTIES, INC.

and SUBSIDIARIES

CONSOLIDATED STATEMENTS OF EQUITY – CONTINUED

Years Ended December 31, 2009, 2008 and 2007

(dollars in thousands, except per share data)

 

     Series A
  Preferred  
Stock
  Series C
Preferred
Stock
  Common
Stock
  Capital in
  Excess of  
Par Value
    Retained
Earnings
    Accumulated
Other
  Comprehensive  
Income
    Total
  Stockholders’  
Equity
      Noncontrolling  
Interests
    Total
Equity
 

Balances at December 31, 2008

  $ -   $ 92,000   $ 784   $ 1,337,018      $ 134,644      $ 2,414      $ 1,566,860      $ 2,086      $ 1,568,946   

Net earnings

    -     -     -     -        54,810        -        54,810        1,589        56,399   

Dividends declared and paid:

                 

$1.84375 per depositary share of Series C preferred stock

    -     -     -     -        (6,785     -        (6,785     -        (6,785

$1.50 per share of common stock

    -     -     1     1,797        (120,256     -        (118,458     -        (118,458

Issuance of common stock:

                 

99,738 shares

    -     -     1     1,435        -        -        1,436        -        1,436   

3,664,182 shares – discounted stock purchase program

    -     -     36     65,519        -        -        65,555        -        65,555   

Issuance of 262,546 shares of restricted common stock

    -     -     3     (3     -        -        -        -        -   

Stock issuance costs

    -     -     -     (113     -        -        (113     -        (113

Equity component of extinguishment of convertible debt

    -     -     -     (795     -        -        (795     -        (795

Amortization of deferred compensation

    -     -     -     3,443        -        -        3,443        -        3,443   

Amortization of interest rate hedges

    -     -     -     -        -        (159     (159     -        (159

Unrealized gain – commercial mortgage residual interests

    -     -     -     -        -                (1,744     (1,744     104        (1,640

Contributions from noncontrolling interests

    -     -     -     -        -        -        -        152        152   

Distributions to noncontrolling interests

    -     -     -     -        -        -        -        (552     (552

Other

    -     -     -     190        -        -        190        (757     (567
                                                                 

Balances at December 31, 2009

  $                 -   $         92,000   $         825   $         1,408,491      $         62,413      $                         511      $         1,564,240      $                   2,622      $   1,566,862   
                                                                 

See accompanying notes to consolidated financial statements.

 

52


Table of Contents

 

NATIONAL RETAIL PROPERTIES, INC.

and SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(dollars in thousands)

 

     Year Ended December 31,  
     2009     2008     2007  

Cash flows from operating activities:

      

Earnings including noncontrolling interests

   $ 56,399      $ 119,971      $ 155,742   

Adjustments to reconcile net earnings to net cash provided by operating activities:

      

Stock compensation expense

     4,172        3,299        2,604   

Stock options expense – tax effect

     190        -        -   

Depreciation and amortization

     48,485        45,347        32,927   

Impairment – real estate

     34,514        5,660        1,970   

Impairment – commercial mortgage residual interests valuation

     498        758        638   

Amortization of notes payable discount

     6,006        5,670        2,724   

Amortization of deferred interest rate hedges

     (159     (162     (309

Equity in earnings of unconsolidated affiliates

     (421     (364     (49

Distributions received from unconsolidated affiliates

<