NNN REIT, Inc.: Form 10-Q for the period ended Jun 30, 2023

The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes included in the Annual Report on Form 10-K of NNN REIT, Inc. for the year ended December 31, 2022 ("2022 Annual Report"). The term “NNN” or the “Company” refers to NNN REIT, Inc. and all of its consolidated subsidiaries. Effective May 1, 2023, National Retail Properties, Inc. changed its name to NNN REIT, Inc.

Forward-Looking Statements

The information herein contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities and Exchange Act of 1934 (the “Exchange Act”). 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. Further, forward-looking statements speak only as of the date they are made, and NNN undertakes no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results over time, unless required by law. The following are some of the risks and uncertainties, although not all risks and uncertainties, that could cause NNN's actual results to differ materially from those presented in NNN's forward-looking statement:

• Changes in financial and economic conditions, including inflation may have an adverse impact on NNN, its tenants, and commercial real estate in general;
• Loss of rent from tenants would reduce NNN's cash flow;
• A significant portion of NNN's annual base rent is concentrated in specific industry classifications, tenants and geographic locations;
• NNN may not be able to successfully execute its acquisition or development strategies;
• NNN may not be able to dispose of properties consistent with its operating strategy;
• Certain provisions of NNN's leases or loan agreements may be unenforceable;
• Competition from numerous other real estate investment trusts (“REIT”), commercial developers, real estate limited partnerships and other investors may impede NNN’s ability to grow;
• A natural disaster or impacts of weather or other event resulting in uninsured loss may adversely affect the operations of NNN's tenants and therefore the ability of NNN's tenants to pay rent, NNN's operating results and asset values of NNN's Property Portfolio (as defined below);
• NNN's ability to fully control the management of its net-leased properties may be limited;
• Vacant properties or bankrupt tenants could adversely affect NNN's business or financial condition;
• Cybersecurity risks and cyber incidents as well as other significant disruptions of NNN's information technology networks and related systems and resources, could adversely affect NNN's business, disrupt operations and expose NNN to liabilities to tenants, employees, capital providers, and other third parties;
• Future investment in international markets could subject NNN to additional risks;
• NNN may suffer a loss in the event of a default of or bankruptcy of a borrower;
• Property ownership through joint ventures and partnerships could limit NNN's control of those investments;
• NNN may be unable to obtain debt or equity capital on favorable terms, if at all;
• The amount of debt NNN has and the restrictions imposed by that debt could adversely affect NNN's business and financial condition;
• NNN is obligated to comply with financial and other covenants in its debt instruments that could restrict its operating activities, and the failure to comply with such covenants could result in defaults that accelerate the payment of such debt;
• NNN's ability to pay dividends in the future is subject to many factors;
• Owning real estate and indirect interests in real estate carries inherent risks;
• NNN's real estate investments are illiquid;
• NNN may be subject to known or unknown environmental liabilities and risks, including but not limited to liabilities and risks resulting from the existence of hazardous materials on or under properties owned by NNN;
• NNN's failure to qualify as a REIT for federal income tax purposes could result in significant tax liability;
• Compliance with REIT requirements, including distribution requirements, may limit NNN's flexibility and may negatively affect NNN's operating decisions;
• The share ownership restrictions of the Internal Revenue Code of 1986, as amended (the "Code"), for REITs and the 9.8% share ownership limit in NNN's charter may inhibit market activity in NNN's shares of stock and restrict NNN's business combination opportunities;
• The cost of complying with changes in governmental laws and regulations may adversely affect NNN's results of operations;
• Non-compliance with Title III of the Americans with Disabilities Act of 1990 and similar state and local laws could have an adverse effect on NNN's business and operating results;
• NNN's loss of key management personnel could adversely affect performance and the value of its securities;
• NNN's failure to maintain effective internal control over financial reporting could have a material adverse effect on its business, operating results and the market value of NNN's securities;
• An epidemic or pandemic (such as the outbreak and worldwide spread of a novel strain of coronavirus, and its variants ("COVID-19")), and the measures that international, federal, state and local governments, agencies, law enforcement and/or health authorities implement to address it, may precipitate or materially exacerbate one or more of the other risks, and may significantly disrupt NNN's tenants' ability to operate their businesses and/or pay rent to NNN or prevent NNN from operating its business in the ordinary course for an extended period;
• Acts of violence, terrorist attacks or war may affect NNN's properties, the markets in which NNN operates and NNN's results of operations;
• Changes in accounting pronouncements could adversely impact NNN's or NNN's tenants' reported financial performance;
• The market value of NNN's equity and debt securities is subject to various factors that may cause significant fluctuations or volatility;
• Even if NNN remains qualified as a REIT, NNN faces other tax liabilities that reduce operating results and cash flow; and
• Adverse legislative or regulatory tax changes could reduce NNN's earnings and cash flow and the market value of NNN's securities.

Additional information related to these risks and uncertainties are included in "Item 1A. Risk Factors" of NNN's 2022 Annual Report.

These risks and uncertainties may cause NNN's actual future results to differ materially from expected results. Readers are cautioned not to place undue reliance on such forward-looking statements, which speak only as of the date of this Quarterly Report on Form 10-Q. NNN undertakes no obligation to update or revise such forward-looking statements, whether as a result of new information, future events or otherwise.

Overview

NNN, a Maryland corporation, is a fully integrated REIT formed in 1984. NNN's assets are primarily real estate assets. NNN acquires, owns, invests in and develops properties that are leased primarily to retail tenants under long-term net leases and are primarily held for investment ("Properties" or "Property Portfolio", or individually a "Property").

As of June 30, 2023, NNN owned 3,479 Properties, with an aggregate gross leasable area of approximately 35,492,000 square feet, located in 49 states, with a weighted average remaining lease term of 10.2 years. Approximately 99 percent of the Properties were leased as of June 30, 2023.

NNN’s management team focuses on certain key indicators to evaluate the financial condition and operating performance of NNN. The key indicators for NNN include items such as: the composition of the Property Portfolio (such as tenant, geographic and line of trade diversification), the occupancy rate of the Property Portfolio, certain financial performance ratios and profitability measures, industry trends and industry performance compared to that of NNN.

NNN evaluates the creditworthiness of its significant current and prospective tenants. This evaluation may include reviewing available financial statements, store level financial performance, press releases, public credit ratings from major credit rating agencies, industry news publications and financial market data (debt and equity pricing). NNN may also evaluate the business and operations of its significant tenants, including past payment history and periodically meeting with senior management of certain tenants.

NNN continues to maintain its diversification by tenant, geography and tenant's line of trade. NNN’s largest line of trade concentrations are the restaurant (including full and limited service) (17.7%), convenience store (16.9%), and automotive service (14.5%) sectors. These sectors represent a large part of the freestanding retail property marketplace and NNN’s management believes these sectors present attractive investment opportunities. The Property Portfolio is geographically concentrated in the south and southeast United States, which are regions of historically above-average population growth. Given these concentrations, any financial hardship within these sectors or geographic regions could have a material adverse effect on the financial condition and operating performance of NNN.

As of June 30, 2023 and 2022, the Property Portfolio remained at least 99 percent leased and had a weighted average remaining lease term of approximately 10 years. High occupancy levels coupled with a net lease structure, provides enhanced probability of maintaining operating earnings.

Additional information related to NNN and the Property Portfolio is included in NNN's 2022 Annual Report.

Results of Operations

Property Analysis

General. The following table summarizes the Property Portfolio:

The following table summarizes the diversification of the Property Portfolio based on the top 20 lines of trade:

(1) Based on annualized base rent for all leases in place for each respective period.

Property Acquisitions. The following table summarizes the Property acquisitions (dollars in thousands):

(1) Includes additional square footage from completed construction on existing Properties.

(2) The cap rate is a weighted average, calculated as the initial cash annual base rent divided by the total purchase price of the Properties.

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

NNN typically funds Property acquisitions either through borrowings under NNN's unsecured revolving credit facility (the "Credit Facility") or by issuing its debt or equity securities in the capital markets.

Property Dispositions. The following table summarizes the properties sold by NNN (dollars in thousands):

(1) The cap rate is a weighted average of properties occupied at disposition, calculated as the cash annual base rent divided by the total sales price of the properties.

NNN typically uses the disposition proceeds to either pay down the Credit Facility or reinvest in real estate.

Analysis of Revenue

The following table summarizes NNN’s revenues (dollars in thousands):

(1) Includes rental income from operating leases, earned income from direct financing leases and percentage rent ("Rental Revenues").

Rental Income. Rental income increased for the quarter and six months ended June 30, 2023, as compared to the same periods in 2022. The increase is primarily due to the Rental Revenues from NNN's recent Property acquisitions (see "Results of Operations – Property Analysis – Property Acquisitions").

Analysis of Expenses

The following table summarizes NNN’s expenses (dollars in thousands):

General and Administrative. General and administrative expense increased for the quarter and six months ended June 30, 2023, as compared to the same periods in 2022. The increase is primarily attributable to an increase in long-term incentive compensation costs.

Depreciation and Amortization. Depreciation and amortization expense increased for the quarter and six months ended June 30, 2023, as compared to the same periods in 2022. The increase is primarily due to the increase in NNN's Property Portfolio from recent acquisitions (see "Results of Operations – Property Analysis – Property Acquisitions").

Impairment Losses – Real Estate, Net of Recoveries. As a result of NNN's review of long-lived assets, including identifiable intangible assets, NNN recognized real estate impairments, net of recoveries for the quarter and six months ended June 30, 2023 and 2022, which were less than one percent of NNN's total assets for the respective periods as reported on the Condensed Consolidated Balance Sheets. Due to NNN's core business of investing in real estate leased primarily to retail tenants under long-term net leases, the inherent risks of owning commercial real estate, and unknown potential changes in financial and economic conditions that may impact NNN's tenants, NNN believes it is reasonably possible to incur real estate impairment charges in the future.

Executive Retirement Costs. In April 2022, the former President and Chief Executive Officer retired from employment, as contemplated under the Company’s long-term executive succession planning process and as previously announced in January 2022. During the quarter and six months ended June 30, 2023 and 2022, NNN recorded executive retirement costs in connection with the long-term incentive compensation related to the retirement and transition agreement.

Interest Expense. Interest expense increased for the quarter and six months ended June 30, 2023, as compared to the same periods in 2022. The increase is primarily due to the Credit Facility having a weighted average outstanding balance of $228,576,000 with a weighted average interest rate of 5.67% for the six months ended June 30, 2023 compared to a weighted average outstanding balance of $9,028,000 with a weighted average interest rate of 2.04% for the six months ended June 30, 2022.

Liquidity and Capital Resources

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) capital expenditures; (iv) payment of principal and interest on its outstanding indebtedness; and (v) other investments.

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, maintaining its investment grade credit rating, staggering debt maturities and providing value to NNN’s stockholders. NNN’s capital resources have and will continue to include, if available (i) proceeds from the issuance of public or private equity or debt capital market transactions; (ii) secured or unsecured borrowings from banks or other lenders; (iii) proceeds from the sale of Properties; and (iv) to a lesser extent, by internally generated funds as well as undistributed funds from operations. 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.

NNN typically expects to fund both its short-term and long-term liquidity requirements, including investments in additional Properties, with cash and cash equivalents, cash provided from operations and advances from NNN's Credit Facility. As of June 30, 2023, NNN had $2,281,000 of cash and cash equivalents and $767,500,000 available for future borrowings under the Credit Facility. NNN may also fund liquidity requirements with new debt or equity issuances, although newly issued debt may be at higher interest rates than the rates on NNN's existing debt outstanding. NNN has the ability to limit future property acquisitions and strategically increase property dispositions. NNN expects these sources of liquidity and the discretionary nature of its property acquisition funding needs will allow NNN to meet its financial obligations over the long term.

Cash Flows. NNN had $2,281,000 in cash and cash equivalents and $2,971,000 in restricted cash or cash held in escrow at June 30, 2023. The table below summarizes NNN’s cash flows (dollars in thousands):

Cash flow activities include:

Operating Activities. Cash provided by operating activities represents cash received primarily from rental income and interest income less cash used for general and administrative expenses. NNN’s cash flow from operating activities has been sufficient to pay the distributions for each period presented. The change in cash provided by operations for the six months ended June 30, 2023 and 2022, 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.

Investing Activities. Changes in cash for investing activities are primarily attributable to the acquisitions and dispositions of Properties as discussed in "Results of Operations – Property Analysis." NNN typically uses cash on hand or proceeds from its Credit Facility to fund the acquisition of its Properties.

Financing Activities. NNN’s financing activities for the six months ended June 30, 2023, included the following significant transactions:

• $166,300,000 in net borrowings from NNN's Credit Facility,
• $28,592,000 from the issuance of 650,135 shares of common stock in connection with the at-the-market ("ATM") equity program,
• $1,615,000 from the issuance of 35,922 shares of common stock in connection with the Dividend Reinvestment and Stock Purchase Plan ("DRIP"),
• $199,146,000 in dividends paid to common stockholders, and
• $9,774,000 payment in April for the repayment of the remaining mortgages payable principal.

Material Cash Requirements

NNN's material cash requirements include (i) long-term debt maturities; (ii) interest on long-term debt; (iii) common stock dividends (although all future distributions will be declared and paid at the discretion of the Board of Directors); and (iv) to a lesser extent, Property construction and other Property related costs that may arise.

The table below presents material cash requirements related to NNN's long-term obligations outstanding as of June 30, 2023 (see "Capital Structure") (dollars in thousands):

(1) Includes only principal amounts outstanding under notes payable and excludes unamortized note discounts and debt costs.

(2) Interest calculation on notes payable based on stated rate of the principal amount.

Property Construction. NNN has committed to fund construction on 39 Properties. The improvements of such Properties are estimated to be completed within 12 months. These construction commitments, at June 30, 2023, are outlined in the table below (dollars in thousands):

(1) Includes land, construction costs, tenant improvements, lease costs and capitalized interest.

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.

Properties. Generally, the Properties are leased under long-term triple net leases, which require the tenant to pay all property taxes and assessments, utilities, to maintain the interior and exterior of the Property, and to carry property and liability insurance coverage. Therefore, management anticipates that capital demands to meet obligations with respect to these Properties will be modest for the foreseeable future and can be met with funds from operations and working capital. Certain Properties are subject to leases under which NNN retains responsibility for specific costs and expenses associated with the Property. Management anticipates the costs associated with these Properties, NNN's vacant Properties or those Properties that become vacant will also be met with funds from operations and working capital. NNN may be required to borrow under its Credit Facility or use other sources of capital in the event of significant capital expenditures or major repairs.

The lost revenues and increased property expenses resulting from vacant Properties or the inability to collect lease revenues could have a material adverse effect on the liquidity and results of operations if NNN is unable to re-lease the Properties at comparable rental rates and in a timely manner.

As of June 30, 2023, NNN owned 22 vacant, un-leased Properties which accounted for less than one percent of total Properties, and less than one percent of aggregate gross leasable area held in the Property Portfolio.

Additionally, as of July 31, 2023, less than one percent of total Properties, and less than one percent of aggregate gross leasable area held in the Property Portfolio, was leased to one tenant currently in bankruptcy under Chapter 11 of the U.S. Bankruptcy Code. As a result, this tenant has the right to reject or affirm its lease with NNN.

NNN generally monitors the financial performance of its significant tenants on an ongoing basis.

Dividends. One of NNN’s primary objectives is to distribute a substantial portion of its funds available from operations to its stockholders in the form of dividends, while retaining sufficient cash for reserves and working capital purposes and maintaining its status as a REIT.

The following table outlines the dividends declared and paid for NNN's common stock (dollars in thousands, except per share data):

In July 2023, NNN declared a dividend of $0.5650 per share which is payable in August 2023 to its common stockholders of record as of July 31, 2023.

Capital Structure

NNN has used, and expects to use in the future, various forms of debt and equity securities primarily to pay down or refinance its outstanding debt, to finance property acquisitions and to fund construction on its Properties.

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

(1) In April 2023, NNN repaid the remaining mortgages payable principal balance of $9,774.

Line of Credit Payable. NNN's $1,100,000,000 Credit Facility had a weighted average outstanding balance of $228,576,000 and a weighted average interest rate of 5.67% during the six months ended June 30, 2023. In December 2022, NNN entered into an amendment to the Credit Facility, to change the base interest rate from LIBOR to the Secured Overnight Financing Rate ("SOFR") plus a SOFR adjustment of 10 basis points ("Adjusted SOFR"). The Credit Facility bears interest at Adjusted SOFR plus 77.5 basis points; however, such interest rate may change pursuant to a tiered interest rate structure based on NNN's debt rating. Additionally, as part of NNN's environmental, social and governance ("ESG") initiative, pricing may be reduced if specified ESG metrics are achieved. The Credit Facility matures in June 2025, unless the Company exercises its options to extend maturity to June 2026. The Credit Facility also includes an accordion feature which permits NNN to increase the facility size up to $2,000,000,000, subject to lender approval. In connection with the Credit Facility, loan costs are classified as debt costs on the Condensed Consolidated Balance Sheets. As of June 30, 2023, $332,500,000 was outstanding and $767,500,000 was available for future borrowings under the Credit Facility, and NNN was in compliance with each of the financial covenants.

Universal Shelf Registration Statement. In August 2020, 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. Information related to NNN's publicly held debt and equity securities is included in NNN's 2022 Annual Report.

Debt Securities – Notes Payable. Each of NNN’s outstanding series of unsecured notes is summarized in the table below (dollars in thousands):

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

(2) Includes the effects of the discount at issuance.

(3) NNN entered into forward starting swaps which were hedging the risk of changes in forecasted interest payments on forecasted issuance of long-term debt. Upon the issuance of a series of unsecured notes, NNN terminated such derivatives, and the resulting fair value was deferred in other comprehensive income. The deferred liability (asset) is being amortized over the term of the respective notes using the effective interest method. Additional disclosure is included in Note 6 – Notes Payable and Derivatives.

(4) The aggregate principal balance of the unsecured note maturities for the next five years is $1,500,000.

Each series of the notes represents senior, unsecured obligations of NNN and is subordinated to all secured debt of NNN. Each of the notes 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 all 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 outstanding debt offerings, NNN incurred debt issuance costs totaling $38,145,000 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 presented as a reduction to notes payable 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 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 June 30, 2023, NNN was in compliance with those covenants.

Equity Securities

At-The-Market Offerings. Under NNN's shelf registration statement, NNN established an ATM equity program which allows NNN to sell shares of common stock from time to time. The following outlines NNN's ATM program:

The following table outlines the common stock issuances pursuant to NNN's ATM equity program (dollars in thousands, except per share data):

(1) Stock issuance costs consist primarily of underwriters' fees and commissions, and legal and accounting fees.

Dividend Reinvestment and Stock Purchase Plan. In February 2021, NNN filed a shelf registration statement that was automatically effective with the Commission for its DRIP, which permits NNN to issue up to 6,000,000 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 (dollars in thousands):

Critical Accounting Estimates

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and do not include all of the information and note disclosures required by U.S. generally accepted accounting principles. The unaudited condensed consolidated financial statements reflect all adjustments (including normal recurring accruals) which are, in the opinion of management, necessary for a fair presentation of the results for the interim periods presented. The preparation of NNN’s condensed consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses as well as other disclosures in the condensed consolidated financial statements. On an ongoing basis, management evaluates its estimates and assumptions; however, actual results may differ from these estimates and assumptions, which in turn could have a material impact on NNN’s consolidated financial statements. A summary of NNN’s critical accounting estimates is included in NNN’s 2022 Annual Report. NNN has not made any material changes to these policies during the periods covered by this Quarterly Report on Form 10-Q.

NNN is exposed to interest rate risk primarily as a result of its variable rate Credit Facility and its fixed rate long-term debt which is used to finance NNN’s Property acquisitions and development 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 reduce overall borrowing costs. To achieve its objectives, NNN borrows at both fixed and variable rates on its long-term debt and periodically uses derivatives to hedge the interest rate risk of future borrowings. As of June 30, 2023, NNN had no outstanding derivatives.

As of June 30, 2023, NNN's variable rate Credit Facility had $332,500,000 outstanding, a weighted average outstanding balance of $228,576,000 with a weighted average interest rate of 5.67% compared to a weighted average outstanding balance of $9,028,000 with a weighted average interest rate of 2.04% for the same period in 2022.

The information in the table below summarizes NNN’s market risks associated with its debt obligations outstanding. The table presents, by year of expected maturity, principal payments and related interest rates for debt obligations outstanding as of June 30, 2023. The table incorporates only those debt obligations that existed as of June 30, 2023, and it does not consider those debt obligations or positions which could arise after this date and therefore 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 approximately one percent for the six months ended June 30, 2023.

(1) Includes NNN’s notes payable, each exclude unamortized discounts and debt costs. The fair value is based upon quoted market prices as of the close of the period, which is a Level 1 valuation since NNN's notes payable are publicly traded on the over-the-counter market.

(2) Weighted average effective interest rate for periods after 2027.

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Evaluation of Disclosure Controls and Procedures. An evaluation was performed under the supervision and with the participation of NNN's management, including NNN's Chief Executive Officer, Chief Financial Officer, and Chief Accounting Officer ("NNN's Chief Officers"), of the effectiveness as of June 30, 2023, of the design and operation of NNN's disclosure controls and procedures as defined in Rule 13a-15(e) under the Exchange Act. Based on that evaluation, NNN's Chief Officers concluded that the design and operation of these disclosure controls and procedures were effective as of the end of the period covered by this report.

Changes in Internal Control over Financial Reporting. There has been no change in NNN's internal control over financial reporting that occurred during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, NNN's internal control over financial reporting.

There were no material changes in NNN's risk factors disclosed in Item 1A. Risk Factors in NNN's Annual Report on Form 10-K for the year ended December 31, 2022.