UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
[X] Quarterly report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the quarterly period ended March 31, 2002, or
[ ] Transition report pursuant to section 13 or 15(d) of the
Securities Exchange Act of 1934
COMMISSION FILE NUMBER 1-13374
REALTY INCOME CORPORATION
-------------------------
(Exact name of registrant as specified in its charter)
Maryland
--------
(State or other jurisdiction of incorporation or organization)
33-0580106
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(I.R.S. Employer Identification No.)
220 West Crest Street, Escondido, California 92025
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(Address of principal executive offices)
(760) 741-2111
--------------
(Registrant's telephone number)
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 for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES [X] NO [ ]
There were 33,317,452 shares of common stock outstanding as of May 13, 2002.
1
REALTY INCOME CORPORATION
Form 10-Q
March 31, 2002
TABLE OF CONTENTS
-----------------
PART I. FINANCIAL INFORMATION Page
----
Item 1: Financial Statements
Consolidated Balance Sheets....................................................... 3
Consolidated Statements of Income................................................. 4
Consolidated Statements of Cash Flows............................................. 5
Notes to Consolidated Financial Statements........................................ 6
Item 2: Management's Discussion and Analysis of
Financial Condition and Results of Operations....................................... 11
Item 3: Quantitative and Qualitative Disclosures about Market Risk.......................... 28
PART II. OTHER INFORMATION
Item 6: Exhibits and Reports on Form 8-K.................................................... 29
SIGNATURE .................................................................................... 30
EXHIBIT INDEX .................................................................................... 30
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
REALTY INCOME CORPORATION AND SUBSIDIARIES
------------------------------------------
CONSOLIDATED BALANCE SHEETS
---------------------------
March 31, 2002 and December 31, 2001
(dollars in thousands, except per share data)
2002 2001
(Unaudited)
- -------------------------------------------------------------------------------------------------------------------
ASSETS Real estate, at cost:
Land $ 412,864 $ 412,455
Buildings and improvements 767,836 765,707
- -------------------------------------------------------------------------------------------------------------------
1,180,700 1,178,162
Less accumulated depreciation and amortization (238,754) (233,848)
- -------------------------------------------------------------------------------------------------------------------
Net real estate held for investment 941,946 944,314
Real estate held for sale, net 24,336 23,356
- -------------------------------------------------------------------------------------------------------------------
Net real estate 966,282 967,670
Cash and cash equivalents 3,730 2,467
Accounts receivable 3,294 4,857
Goodwill, net 17,206 17,206
Other assets 11,069 11,508
- -------------------------------------------------------------------------------------------------------------------
Total assets $ 1,001,581 $ 1,003,708
===================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Distributions payable $ 7,977 $ 6,238
Accounts payable and accrued expenses 6,228 5,834
Other liabilities 4,345 4,543
Lines of credit payable 73,600 85,300
Notes payable 230,000 230,000
- -------------------------------------------------------------------------------------------------------------------
Total liabilities 322,150 331,915
- -------------------------------------------------------------------------------------------------------------------
Commitments and contingencies
Stockholders' equity:
Preferred stock and paid in capital, par value $1.00 per share, 20,000,000
shares authorized, 4,125,700 shares issued and outstanding 99,368 99,368
Common stock and paid in capital, par value $1.00 per share, 100,000,000
shares authorized, 33,298,234 and 32,829,111 shares issued and
outstanding in 2002 and 2001, respectively 806,227 795,505
Distributions in excess of net income (226,164) (223,080)
- -------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 679,431 671,793
- -------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 1,001,581 $ 1,003,708
===================================================================================================================
The accompanying notes to consolidated financial statements are an integral part
of these statements.
3
REALTY INCOME CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
---------------------------------
For the three months ended March 31, 2002 and 2001
(dollars in thousands, except per share data)
(unaudited)
2002 2001
- ------------------------------------------------------------------------------------------------------------
REVENUE
Rental $ 33,263 $ 29,346
Gain on sales of real estate acquired for resale 365 1,928
Interest and other 31 127
- ------------------------------------------------------------------------------------------------------------
33,659 31,401
- ------------------------------------------------------------------------------------------------------------
EXPENSES
Interest 5,605 8,059
Depreciation and amortization 7,474 7,173
General and administrative 2,389 2,041
Property 663 623
Other 288 779
Provision for impairment loss -- 330
- ------------------------------------------------------------------------------------------------------------
16,419 19,005
- ------------------------------------------------------------------------------------------------------------
Income from continuing operations 17,240 12,396
Income from discontinued operations 714 126
Gain on sales of investment properties 340 5,951
- ------------------------------------------------------------------------------------------------------------
Net income 18,294 18,473
Preferred stock dividends (2,428) (2,428)
- ------------------------------------------------------------------------------------------------------------
Net income available to common stockholders $ 15,866 $ 16,045
============================================================================================================
Basic and diluted net income per common share $ 0.48 $ 0.60
The accompanying notes to consolidated financial statements are
an integral part of these statements.
4
REALTY INCOME CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
For the three months ended March 31, 2002 and 2001
(dollars in thousands)
(unaudited)
2002 2001
- --------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 18,294 $ 18,473
Adjustments to net income:
Depreciation and amortization 7,474 7,173
Provision for impairment losses -- 330
Income from discontinued operations (714) (126)
Cash from discontinued operations 130 163
Investment in real estate acquired for resale (3,380) (3,802)
Proceeds from sales of real estate acquired for resale 2,744 14,033
Gain on sales of real estate acquired for resale (365) (1,928)
Gain on sales of investment properties (340) (5,951)
Amortization of deferred stock compensation 131 67
Change in assets and liabilities:
Accounts receivable and other assets 1,947 1,869
Accounts payable, accrued expenses and other liabilities 1,148 1,515
- --------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 27,069 31,816
- --------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from sales of investment
properties:
From continuing operations 1,198 17,054
From discontinued operations 2,174 --
Acquisition of and additions to investment properties (8,424) (7,542)
- --------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) investing activities (5,052) 9,512
- --------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Borrowings from lines of credit 34,700 28,600
Payments under lines of credit (46,400) (56,300)
Distributions to common stockholders (18,820) (14,770)
Distributions to preferred stockholders (819) (546)
Proceeds from stock offerings, net of offering costs of
$92 in 2002 8,173 --
Proceeds from other common stock issuances 2,412 34
Repurchase of stock -- (169)
- --------------------------------------------------------------------------------------------------------------------
Net cash used in financing activities (20,754) (43,151)
- --------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 1,263 (1,823)
Cash and cash equivalents, beginning of period 2,467 3,815
- --------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of period $ 3,730 $ 1,992
====================================================================================================================
For supplemental disclosures, see note 10.
The accompanying notes to consolidated financial statements are
an integral part of these statements.
5
REALTY INCOME CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
March 31, 2002
(Unaudited)
1. Management Statement
The consolidated financial statements of Realty Income Corporation ("Realty
Income", the "Company", "we" or "our") were prepared from our books and records
without audit and include all adjustments (consisting of only normal recurring
accruals) necessary to present a fair statement of results for the interim
periods presented. Certain of the 2001 balances have been reclassified to
conform to the 2002 presentation. Readers of this quarterly report should refer
to our audited financial statements for the year ended December 31, 2001, which
are included in our 2001 Annual Report on Form 10-K, as certain disclosures
which would substantially duplicate those contained in such audited financial
statements have been omitted from this report.
2. New Accounting Pronouncements
A. In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement No. 142, Goodwill and Other Intangible Assets. Statement No. 142
changes the accounting for goodwill from an amortization method to an
impairment-only approach. Under Statement No. 142, goodwill will be tested
annually and whenever events or circumstances occur indicating that goodwill
might be impaired.
We adopted the provisions of Statement No. 142 on January 1, 2002 and ceased
amortizing our goodwill, which totaled $17.2 million. This goodwill is subject
to the transition provisions of Statement No. 142. Statement No. 142 requires
the impairment test to be applied to relevant "reporting units". These
"reporting units" may differ from the specific entities acquired from which the
goodwill arose. We have not yet determined what the impact will be on our
financial position, results of operations or liquidity from testing our goodwill
for impairment. Amortization expense related to goodwill was $231,000 for the
three months ended March 31, 2001. We do not have any intangible assets or
unamortized negative goodwill.
The following table reconciles reported net income available to common
stockholders to adjusted net income available to common stockholders. It
excludes the effect of goodwill amortization expense that is no longer amortized
under Statement No. 142 (in thousands, except per share data):
For the quarter ended March 31, 2002 2001
- --------------------------------------------------------------------------------------------------
Reported net income available to common stockholders $15,866 $16,045
Goodwill amortization -- 231
- --------------------------------------------------------------------------------------------------
Adjusted net income available to common stockholders $15,866 $16,276
==================================================================================================
Basic and diluted earnings per share
For the quarter ended March 31, 2002 2001
- --------------------------------------------------------------------------------------------------
Reported Net income available to common stockholders $ 0.48 $ 0.60
Goodwill amortization -- 0.01
- --------------------------------------------------------------------------------------------------
Adjusted net income available to common stockholders $ 0.48 $ 0.61
==================================================================================================
6
B. In August 2001, the FASB issued Statement No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. Effective January 1, 2002,
Statement No. 144 superseded Statement No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of. Statement No. 144
requires long-lived assets to be disposed of to be measured at the lower of
carrying amount or fair value less cost to sell. It also broadened the reporting
requirements of discontinued operations to include a component of an entity
rather than a segment of a business. Statement No. 144 states that a component
of an entity comprises operations and cash flows that can be clearly
distinguished, operationally and for financial reporting purposes, from the rest
of the entity. The operations of six properties listed as held for sale at March
31, 2002 and three properties sold during the first quarter of 2002 were
reported as income from discontinued operations in 2002, and their respective
2001 results of operations were reclassified to income from discontinued
operations. As required by Statement No. 144, three other properties reported as
held for sale at December 31, 2001 that were sold during 2002 were not reported
as discontinued operations. The following is a summary of our income from
discontinued operations for the three months ended March 31, 2002 and 2001
(dollars in thousands):
Three months ended March 31, 2002 2001
--------------------------------------------------------------------------------------
Rental revenue $ 134 $ 150
Interest and other revenue -- 14
Depreciation and amortization (30) (37)
Property expenses (4) (1)
Provision for impairment loss (160) --
Gain on sales of investment properties 774 --
--------------------------------------------------------------------------------------
Income from discontinued operations $ 714 $ 126
======================================================================================
3. Retail Properties Acquired by Realty Income
During the first quarter of 2002, we invested $7.8 million in three new retail
properties and properties under development with an initial weighted average
contractual lease rate of 11.1%. These three properties are located in three
states, will contain approximately 44,300 leasable square feet and are 100%
leased, with an average initial lease term of 16.1 years.
During the first quarter of 2001, we invested $7.2 million in three new retail
properties and properties under development with an initial weighted average
contractual lease rate of 11.5%. These three properties are located in two
states, contain approximately 49,500 leasable square feet and are 100% leased,
with an average initial lease term of 20 years.
4. Gain on Sales of Investment Properties
During the first quarter of 2002, we sold six investment properties for $3.4
million and recognized a gain of $1.1 million. Of this gain, $774,000 is
included in income from discontinued operations.
During the first quarter of 2001, we sold 10 investment properties for $17.1
million and recognized a gain of $6.0 million.
7
5. Retail Properties Acquired by Crest Net
A. During the first quarter of 2002, Crest Net invested $2.9 million in two new
retail properties and properties under development. These two properties are
located in two states, will contain approximately 6,400 leasable square feet and
are 100% leased, with an average initial lease term of 17.6 years.
During the first quarter of 2001, Crest Net invested $3.8 million in four new
retail properties and properties under development. These four properties are
located in three states, will contain approximately 12,900 leasable square feet
and are 100% leased, with an average initial lease term of 19.3 years.
B. At March 31, 2002 and December 31, 2001, investments in properties owned by
Crest Net totaled $22.8 million and $22.3 million, respectively, and are
included in real estate held for sale, net on our consolidated balance sheets.
6. Gain on Sales of Real Estate Acquired for Resale
During the first quarter of 2002, Crest Net sold three properties for $2.7
million. We recognized a gain of $365,000 on the sale of these properties.
During the first quarter of 2001, Crest Net sold four properties for $14.0
million. We recognized a gain of $1.9 million on the sale of these properties.
7. Distributions Paid and Payable
A. We pay monthly distributions to our common stockholders. The following is a
summary of the monthly cash distributions per common share for the three months
ended March 31, 2002 and 2001. As of March 31, 2002, a distribution of $0.19125
per common share was declared (and was paid on April 15, 2002).
Month 2002 2001
---------------------------------------------------------------------------
January $ 0.190 $ 0.185
February 0.190 0.185
March 0.190 0.185
---------------------------------------------------------------------------
Total $ 0.570 $ 0.555
===========================================================================
B. In May 1999, we issued 2,760,000 shares of 9 3/8% Class B cumulative
redeemable preferred stock (the "Class B Preferred"), of which 2,745,700 shares
were outstanding during the first quarter of 2002 and 2001. Beginning May 25,
2004, the class B Preferred shares are redeemable at our option for $25.00 per
share. Dividends on the Class B preferred stock are paid quarterly in arrears.
During each of the first quarters of 2002 and 2001, we declared a quarterly
dividend to our Class B preferred stockholders of $0.5859 per share, totaling
$1.6 million. The 2002 first quarter dividend was paid on April 1, 2002.
C. In July 1999, we issued 1,380,000 shares of 9 1/2% Class C cumulative
redeemable preferred stock (the "Class C Preferred"), all of which were
outstanding during the first quarter of 2002 and 2001. Beginning July 30, 2004,
the Class C Preferred shares are redeemable at our option for $25.00 per share.
Dividends on the Class C preferred stock are paid monthly in arrears. During
each of the first quarters of 2002 and 2001, we paid three monthly dividends to
our Class C preferred stockholders of $0.1979 per share totaling, $819,000.
8
8. Net Income per Common Share
Basic net income per common share is computed by dividing net income available
to common stockholders by the weighted average number of common shares
outstanding during each period. Diluted net income per common share is computed
by dividing the amount of net income available to common stockholders for the
period by the number of common shares that would have been outstanding assuming
the issuance of common shares for all potentially dilutive common shares
outstanding during the reporting period.
The following is a reconciliation of the denominator of the basic net income per
common share computation to the denominator of the diluted net income per common
share computation for the three months ended March 31, 2002 and 2001:
For the three months ended March 31, 2002 2001
- -------------------------------------------------------------------------------------------------------------
Weighted average shares used for the basic net income per share
computation 33,044,470 26,612,009
Incremental shares from the assumed exercise of stock options 47,277 43,667
- -------------------------------------------------------------------------------------------------------------
Adjusted weighted average shares used for diluted net income per share
computation 33,091,747 26,655,676
=============================================================================================================
For the three months ended March 31, 2002, no stock options were anti-dilutive.
For the three months ended March 31, 2001, 50,000 stock options that were
anti-dilutive have been excluded from the incremental shares from the assumed
exercise of stock options.
9. Stock Offerings
In February 2002, we issued 273,150 shares of common stock to a unit investment
trust at a net price to us of $30.26 per share, based on a 5% discount to the
market price at the time of issuance of $31.85 per share. The net proceeds of
$8.2 million were used to repay bank borrowings.
10. Supplemental Disclosures of Cash Flow Information
Interest paid during the first three months of 2002 and 2001 was $3.4 million
and $6.1 million, respectively.
During the first three months of 2002 and 2001, interest of $176,000 and
$76,000, respectively, was capitalized related to properties under development.
The following non-cash financing activities are included in the accompanying
consolidated financial statements (dollars in thousands):
Restricted stock grants resulted in the following:
2002 2001
---- ----
Other assets $ -- $ 1,219
Common stock and paid in capital 2,726 1,219
Common stock and paid in capital,
deferred stock compensation (2,726) --
9
11. Segment Information
We evaluate performance and make resource allocation decisions on a property by
property basis. For financial reporting purposes, we have grouped our tenants
into 11 reportable segments based upon the business the tenants are in, except
for properties owned by Crest Net that are grouped in a separate segment. The
Crest Net segment is included in "other non-reportable segments." All of the
properties are incorporated into one of the applicable segments. Revenue is the
only component of segment profit and loss we measure.
The following tables set forth certain information regarding the properties
owned by us, classified according to the business of the respective tenants as
of March 31, 2002 (dollars in thousands):
Revenue
For the three months ended March 31, 2002 2001
- ------------------------------------------------------------------------------------------------------
Segment rental revenue:
Automotive parts $ 2,803 $ 2,481
Automotive service 1,713 1,734
Child care 6,975 6,781
Consumer electronics 1,140 1,237
Convenience stores 2,558 2,515
Health and fitness 1,241 981
Home furnishings 1,830 1,787
Restaurants 4,612 3,379
Sporting goods 1,396 -
Theaters 1,302 1,302
Video rental 1,120 1,133
Other non-reportable segments(1) 6,573 6,016
Reconciling items:
Gain on sales of real estate acquired for resale 365 1,928
Interest and other 31 127
- ------------------------------------------------------------------------------------------------------
Total revenue $ 33,659 $ 31,401
======================================================================================================
(1) Consolidates 13 retail industry segments and properties owned by Crest Net.
Assets
----------------------------------------------------
As of: March 31, 2002 December 31, 2001
- ----------------------------------------------------------------------------------------------------------------------------
Segment real estate, net of depreciation and amortization:
Automotive parts $ 73,214 $ 73,240
Automotive service 44,535 44,438
Child care 140,348 142,163
Consumer electronics 35,700 35,950
Convenience stores 81,190 81,701
Health and fitness 44,591 43,549
Home furnishings 67,879 68,384
Restaurants 127,255 130,393
Sporting goods 50,171 50,506
Theaters 47,081 47,273
Video rental 37,432 37,719
Other non-reportable segments(1) 216,886 212,354
- ----------------------------------------------------------------------------------------------------------------------------
Total net real estate 966,282 967,670
Non-real estate assets 35,299 36,038
- ----------------------------------------------------------------------------------------------------------------------------
Total assets $ 1,001,581 $ 1,003,708
============================================================================================================================
(1) Consolidates 13 retail industry segments and properties owned by Crest Net.
10
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
-----------------------------------------------------------------------
FORWARD-LOOKING STATEMENTS
This quarterly report on Form 10-Q contains forward-looking statements within
the meaning of Section 27A of the Securities Act and Section 21E of the Exchange
Act. When used in this quarterly report, the words estimated, anticipated and
similar expressions are intended to identify forward-looking statements.
Forward-looking statements are subject to risks, uncertainties, and assumptions
about Realty Income Corporation, including, among other things:
o Our anticipated growth strategies;
o Our intention to acquire additional properties;
o Our intention to sell properties;
o Our intention to re-lease vacant properties;
o Anticipated trends in our business, including trends in the market for
long-term net leases of freestanding, single-tenant retail properties;
o Future expenditures for development projects; and o Profitability of our
subsidiary, Crest Net Lease, Inc.
Future events and actual results, financial and otherwise, may differ materially
from the results discussed in the forward-looking statements. In particular,
some of the factors that could cause actual results to differ materially are:
o Our continued qualification as a real estate investment trust;
o General business and economic conditions;
o Competition;
o Interest rates;
o Accessibility of debt and equity capital markets;
o Other risks inherent in the real estate business including tenant defaults,
potential liability relating to environmental matters and illiquidity of real
estate investments; and
o Acts of terrorism and war.
Additional factors that may cause risks and uncertainties include those
discussed in the sections entitled "Business" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations" in the Company's
Annual Report on Form 10-K for the fiscal year ended December 31, 2001.
Readers are cautioned not to place undue reliance on forward-looking statements,
which speak only as of the date that this quarterly report was filed with the
Securities and Exchange Commission. We undertake no obligation to publicly
release the results of any revisions to these forward-looking statements that
may be made to reflect events or circumstances after the date of this quarterly
report or to reflect the occurrence of unanticipated events. In light of these
risks and uncertainties, the forward-looking events discussed in this quarterly
report might not occur.
11
THE COMPANY
Realty Income Corporation, "The Monthly Dividend Company," a Maryland
corporation ("Realty Income," the "Company," "our" or "we") was organized to
operate as an equity real estate investment trust ("REIT"). We are a fully
integrated, self-administered real estate company with in-house acquisition,
leasing, legal, retail and real estate research, portfolio management and
capital markets expertise.
Our primary business objective is to generate dependable monthly distributions
from a consistent and predictable level of funds from operations ("FFO") per
share. Additionally, we seek to increase distributions to stockholders and FFO
per share through both active portfolio management and the acquisition of
additional properties.
Our portfolio management focus includes:
o Contractual rent increases on existing leases;
o Rental increases at the termination of existing leases when market conditions
permit; and
o The active management of our property portfolio, including selective sales of
properties.
Our acquisition of additional properties adheres to a focused strategy of
acquiring primarily:
o Freestanding, single-tenant, retail properties;
o Properties leased to regional and national retail chains; and
o Properties under long-term, net-lease agreements.
As of March 31, 2002, we owned a diversified portfolio:
o Of 1,121 retail properties;
o With an occupancy rate of 98.0%, or 1099, of the 1,121 properties;
o Leased to 79 different retail chains;
o Doing business in 24 separate retail industries;
o Located in 48 states;
o With over 9.5 million square feet of leasable space; and
o With an average leasable retail space of 8,500 square feet on approximately
62,800 square feet of land.
Of the 1,121 properties in the portfolio, 1,116, or 99.6%, are single-tenant
retail properties with the remaining five being multi-tenant properties. As of
March 31, 2002, 1,094, or 98.0%, of the 1,116 single-tenant properties were
leased with an weighted average remaining lease term (excluding extension
options) of approximately 10.2 years.
In addition to our real estate portfolio, at March 31, 2002 our subsidiary,
Crest Net Lease, Inc. ("Crest Net") had invested $22.8 million in a portfolio:
o Of 23 retail properties;
o Located in 14 states;
o That will contain approximately 89,000 square feet of leasable space; and
o That are 100% leased and are held for sale.
We typically acquire, then lease back, retail store locations from chain store
operators, providing capital to the operators for continued expansion and other
corporate purposes. Our acquisition and investment activities are concentrated
in well-defined target markets and focus generally on middle-market retailers
providing goods and services that satisfy basic consumer needs.
12
Our net-lease agreements generally:
o Are for initial terms of 15 to 20 years;
o Require the tenant to pay minimum monthly rents and property operating
expenses (taxes, insurance and maintenance); and
o Provide for future rent increases (typically subject to ceilings) based on
increases in the consumer price index, fixed increases, or additional rent
calculated as a percentage of the tenants' gross sales above a specified
level.
We believe that the long-term ownership of an actively managed, diversified
portfolio of retail properties under long-term, net-lease agreements produces
consistent, predictable income. Also that long-term leases, coupled with the
tenant's responsibility for property expenses, generally produce a more
predictable income stream than many other types of real estate portfolios, while
continuing to offer the potential for growth in rental income.
We principally provide sale-leaseback financing primarily to less than
investment grade retail chains. From 1970 through December 31, 2001, we have
acquired and leased back to regional and national retail chains 1,158 properties
(including 83 properties that have been sold) and have collected approximately
98% of the original contractual rent obligations on those properties. We believe
that within this market we can achieve an attractive risk-adjusted return on the
financing we provide to retailers.
RECENT DEVELOPMENTS
Issuance of Common Stock. In February 2002, we issued 273,150 shares of common
stock to a unit investment trust at a net price to us of $30.26 per share, based
on a 5% discount to the market price at the time of issuance of $31.85 per
share. The net proceeds of $8.2 million were used to repay bank borrowings.
Funds from Operations (FFO). In the first quarter of 2002, our FFO increased by
$4.8 million, or 27.3%, to $22.4 million compared to $17.6 million for the same
quarter in 2001. See our discussion of FFO in this "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
In the first quarter of 2002, Crest Net generated $363,000 in FFO for Realty
Income compared to $1.2 million in the same quarter in 2001. The future
contribution, if any, to our FFO by Crest Net will depend on the timing and the
number of property sales it achieves, if any, in any given period.
Acquisition of Properties during the First Three Months of 2002. During the
first three months of 2002, we invested $7.8 million in three new retail
properties and properties under development with an initial weighted average
contractual capitalization rate of 11.1%. The new properties are 100% leased
with an initial average lease length of 16.1 years and will contain
approximately 44,300 leasable square feet.
We have signed an agreement with Midas (NYSE: MDS) to acquire approximately 80
automotive service properties for between $45 million to $50 million. The
properties simultaneously will be leased to Midas under a long term lease
agreement. The final acquisition price will be determined by real estate
appraisals currently underway on each of the properties. We expect the
acquisition to close during the second quarter of 2002.
Sales of Investment Properties. During the first three months of 2002, we sold
six properties for $3.4 million and recognized a gain of $1.1 million. Of this
gain, $774,000 is included in income from discontinued operations. The six
properties consisted of five restaurants and one child day care property. The
proceeds from the sale of these properties were used to repay outstanding
indebtedness on our $200 million credit facility and to invest in new
properties.
13
Crest Net. During the first quarter of 2002, Crest Net sold three properties
from its inventory for $2.7 million and we recorded a gain on the sales of
$365,000. Crest Net also invested $2.9 million in two new retail properties and
properties under development. At the end of the first quarter, Crest Net carried
an inventory of $22.8 million, which is included in real estate held for sale,
net on our balance sheet.
The financial statements of Crest Net are consolidated into Realty Income's
financial statements. All material intercompany transactions have been
eliminated in consolidation.
Increase in Monthly Distributions to Common Shareholders. We continue our
33-year policy of paying distributions monthly. Monthly distributions per share
were increased $0.00125 in January 2002 to $0.19 and in April 2002 to $0.19125.
The increase in April was our 18th consecutive quarterly increase and 20th
increase since 1995. During the first three months of 2002, we paid three
distributions of $0.19 per share, totaling $0.57 per share. In March and April
2002, we declared distributions of $0.19125 per share, which were paid on April
15, 2002 and payable on May 15, 2002, respectively. The monthly distribution of
$0.19125 per share represents a current annualized distribution of $2.295 per
share, and an annualized distribution yield of approximately 6.8% based on the
last reported sale price of the Company's Common Stock on the NYSE of $33.76 on
May 6, 2002. Although we expect to continue our policy of paying monthly
distributions, we cannot guarantee that we will maintain the current level of
distributions, that we will continue our pattern of increasing distributions per
share, or what the actual distribution yield will be for any future period.
OTHER INFORMATION
Realty Income's common stock is listed on the New York Stock Exchange ("NYSE")
under the ticker symbol "O", our central index key ("CIK") number is 726728 and
cusip number is 756109-104.
Realty Income's 9 3/8% Class B cumulative redeemable preferred stock is listed
on the NYSE under the ticker symbol "OprB" and its cusip number is 756109-302.
Realty Income's 9 1/2% Class C cumulative redeemable preferred stock is listed
on the NYSE under the ticker symbol "OprC" and its cusip number is 756109-500.
Realty Income's 8.25% Monthly Income Senior Notes, due 2008, are listed on the
NYSE under the ticker symbol "OUI". The cusip number of these notes is
756109-203.
Realty Income had 53 employees as of May 6, 2002.
14
LIQUIDITY AND CAPITAL RESOURCES
Cash Reserves. Realty Income is organized for the purpose of operating as an
equity REIT that acquires and leases properties and distributes to stockholders,
in the form of monthly cash distributions, a substantial portion of its net cash
flow generated from leases on its retail properties. We intend to retain an
appropriate amount of cash as working capital. At March 31, 2002, we had cash
and cash equivalents totaling $3.7 million.
We believe that our cash and cash equivalents on hand, cash provided from
operating activities and borrowing capacity are sufficient to meet our liquidity
needs for the foreseeable future. We intend, however, to use additional sources
of capital to fund property acquisitions and to repay our credit facilities.
Capital Funding. We have a $200 million revolving, unsecured acquisition credit
facility that expires in December 2003. We also have a $25 million revolving,
unsecured credit facility that expires in February 2003. The credit facilities
currently bear interest at 1.225% over the London Interbank Offered Rate, or
LIBOR, and offer us other interest rate options. At May 6, 2002, we had
borrowing capacity of $154.3 million available on our credit facilities and an
outstanding balance of $70.7 million with an effective interest rate of 3.1%.
These credit facilities have been and are expected to be used to acquire
additional retail properties leased to national and regional retail chains under
long-term lease agreements. Any additional borrowings will increase our exposure
to interest rate risk. We have no mortgage debt on any of our properties.
In June 1999, we filed a universal shelf registration statement with the
Securities and Exchange Commission covering up to $409.2 million in value of
common stock, preferred stock and debt securities. Through May 6, 2002, we
issued $209.3 million of common stock, preferred stock and debt securities under
the universal shelf registration statement. At May 6, 2002, a balance of $199.9
million was available under our universal shelf registration statement.
In February 2002, we issued 273,150 shares of common stock to a unit investment
trust at a net price to us of $30.26 per share, based on a 5% discount to the
market price at the time of issuance of $31.85 per share. The net proceeds of
$8.2 million were used to repay bank borrowings.
We believe that our stockholders are best served by a conservative capital
structure. At May 6, 2002, our total outstanding credit facility borrowings and
outstanding notes were $300.7 million or approximately 19.7% of our total market
capitalization of $1.53 billion. We define our total market capitalization as
the sum of the:
o Shares of our common stock outstanding multiplied by the last reported sales
price of the common stock on the NYSE on May 6, 2002 of $33.76 per share;
o Liquidation value of the Class B Preferred Stock of $68.6 million;
o Liquidation value of the Class C Preferred Stock of $34.5 million; and
o Outstanding borrowings on the credit facilities and outstanding notes at
May 6, 2002.
Historically, we have met our long-term capital needs through the issuance of
common stock, preferred stock and investment grade, long-term, unsecured notes.
We believe that the majority of our future issuances of securities should be in
the form of common stock. However, we may issue additional preferred stock or
debt securities from time to time. We may issue common stock when we believe
that our share price is at a level that allows for the proceeds of any offering
to be invested on an accretive basis into additional properties. In addition, we
may issue common stock to permanently finance properties that were financed by
our credit facilities or debt securities. However, we cannot assure you that we
will have access to the capital markets at terms that are acceptable to us. We
seek to maintain a conservative debt level on our balance sheet and solid
interest and fixed charge coverage ratios.
15
We currently are assigned investment grade corporate credit ratings on our
senior unsecured notes from Fitch Ratings, Moody's Investors Service and
Standard & Poor's Ratings Group. Currently, Fitch Ratings has assigned a rating
of BBB, Moody's has assigned a rating of Baa3 and Standard & Poor's has assigned
a rating of BBB- to our senior notes. These ratings could change based upon,
among other things, our results of operations and financial condition.
We also have received credit ratings from the same rating agencies on our
preferred stock. Fitch Ratings has assigned a rating of BBB-, Moody's Investors
Service has assigned a rating of Ba1 and Standard & Poor's Ratings Group has
assigned a rating of BB+. These ratings could change based upon, among other
things, our results of operations and financial condition.
Realty Income and its subsidiaries have no unconsolidated investments in
"special purpose entities" or off balance sheet financing, nor do we engage in
trading activities involving energy or commodity contracts or other derivative
instruments.
Property Acquisitions. In the first quarter of 2002, we acquired three
properties (the "New Properties") located in three states and invested $7.8
million in the New Properties and properties under development, which includes
investments of $2.0 million for properties acquired before 2002 that were under
development. Estimated unfunded development costs on properties under
construction at March 31, 2002 totaled $1.8 million. In the first quarter of
2002, we capitalized $154,000 for re-leasing costs and $22,000 for building
improvements on existing properties in our portfolio.
The initial weighted average annual unleveraged return on the $7.8 million
invested in 2002 is estimated to be 11.1%, computed as estimated contractual net
operating income (which in the case of a net-leased property is equal to the
base rent or, in the case of properties under construction, the estimated base
rent under the lease) for the first year of each lease, divided by the estimated
total costs. Since it is possible that a tenant could default on the payment of
contractual rent, we cannot assure you that the actual return on the funds
invested will remain at the percentage listed above.
The New Properties will contain approximately 44,300 leasable square feet and
are 100% leased under net leases, with an average initial lease term of 16.1
years. At March 31, 2002, one of the New Properties was leased and under
construction, pursuant to a contract under which the tenant agreed to develop
the property (with development costs funded by Realty Income) with rent
scheduled to begin in the second half of 2002.
Distributions. We pay distributions to our common stockholders and Class C
Preferred stockholders on a monthly basis and to our Class B Preferred
stockholders on a quarterly basis if, as and when declared by our Board of
Directors. The Class B Preferred stockholders receive cumulative distributions
at a rate of 9.375% per annum on the $25 per share liquidation preference
(equivalent to $2.34375 per annum per share). The Class C Preferred stockholders
receive cumulative distributions at a rate of 9.5% per annum on the $25 per
share liquidation preference (equivalent to $2.375 per annum per share).
The May 2002 distribution of $0.19125 per common share represents a current
annualized distribution of $2.295 per share, and an annualized distribution
yield of approximately 6.8% based on the last reported sale price of $33.76 of
our common stock, on the NYSE on May 6, 2002.
In order to maintain our tax status as a REIT for federal income tax purposes,
we generally are required to distribute dividends to our stockholders
aggregating annually at least 90% of our REIT taxable income (determined without
regard to the dividends paid deduction and by excluding net capital gains) and
we are subject to income tax to the extent we distribute less than 100% of our
REIT taxable income (including net capital gains). In 2001, our distributions
totaled approximately 114.5% of our estimated REIT taxable income. Our estimated
REIT taxable income includes non-cash deductions for depreciation and
amortization. Our 2001 distributions to common stockholders were 83.4% of our
2001 funds from operations. We intend to continue to make distributions to our
stockholders that are sufficient to meet this distribution requirement and that
will reduce our exposure to income taxes.
16
Future distributions by us will be at the discretion of our Board of Directors
and will depend on, among other things, our results of operations, our funds
from operations, cash flow from operations, financial condition and capital
requirements, the annual distribution requirements under the REIT provisions of
the Internal Revenue Code of 1986, as amended, our debt service requirements and
other factors as the Board of Directors may deem relevant. In addition, our
credit facilities contain financial covenants which could limit the amount of
distributions payable by us in the event of a deterioration in our results of
operations or financial condition, and which prohibit the payment of
distributions on the common or preferred stock in the event that we fail to pay
when due (subject to any applicable grace period) any principal or interest on
borrowings under our credit facilities.
FUNDS FROM OPERATIONS ("FFO")
FFO for the first quarter of 2002 increased by $4.8 million, or 27.3%, to $22.4
million versus $17.6 million in the first quarter of 2001. The following is a
reconciliation of net income available to common stockholders to FFO, and
information regarding distributions paid and diluted weighted average number of
common shares outstanding for the first quarter of 2002 and 2001 (dollars in
thousands):
Three months ended March 31, 2002 2001
---------------------------------------------------------------------------------------------------------
Net income available to common stockholders $ 15,866 $ 16,045
Depreciation and amortization:
Continuing operations 7,474 7,173
Discontinued operations 30 37
Depreciation of furniture, fixtures and equipment (33) (28)
Provision for impairment loss:
Continuing operations -- 330
Discontinued operations 160 --
Gain on sales of investment properties:
Continuing operations (340) (5,951)
Discontinued operations (774) --
---------------------------------------------------------------------------------------------------------
Total funds from operations $ 22,383 $ 17,606
=========================================================================================================
Distributions paid to common stockholders $ 18,820 $ 14,770
FFO in excess of distributions to common stockholders $ 3,563 $ 2,836
Diluted weighted average number of
common shares outstanding 33,091,747 26,655,676
We define FFO, consistent with the National Association of Real Estate
Investment Trust's definition, as net income available to common stockholders,
plus depreciation and amortization of assets uniquely significant to the real
estate industry, reduced by gains and increased by losses on (i) sales of
investment property and provisions for impairment and (ii) extraordinary items.
17
ADJUSTED FUNDS FROM OPERATIONS
Adjusted FFO for the first quarter of 2002 increased by $4.6 million, or 25.8%,
to $22.4 million versus $17.8 million in the first quarter of 2001. The
following is a reconciliation of FFO to adjusted FFO for the three months ended
March 31, 2002 and 2001. The adjustments are for non-cash items and capitalized
expenditures on existing properties in our portfolio (dollars in thousands):
Three months ended March 31, 2002 2001
-------------------------------------------------------------------------------------------------------
Funds from operations $ 22,383 $ 17,606
Amortization of settlements on
treasury lock agreements 189 189
Amortization of deferred financing costs 238 249
Amortization of stock compensation 131 67
Capitalized leasing costs and commissions (154) (160)
Capitalized building improvements (22) (144)
Straight line rent (397) (26)
-------------------------------------------------------------------------------------------------------
Total adjusted funds from operations $ 22,368 $ 17,781
=======================================================================================================
We consider FFO and adjusted FFO to be appropriate measures of the performance
of equity REITs. Financial analysts use FFO and adjusted FFO in evaluating
REITs. FFO and adjusted FFO can be a way to measure a REIT's ability to make
cash distribution payments. Presentation of this information is intended to
assist the reader in comparing the performance of different REITs, although it
should be noted that not all REITs calculate FFO and adjusted FFO the same way;
therefore, comparisons with other REITs may not be meaningful.
FFO and adjusted FFO are not necessarily indicative of cash flow available to
fund cash needs and should not be considered as an alternative to net income as
an indication of Realty Income's performance. In addition, FFO and adjusted FFO
should not be considered as an alternative to reviewing our cash flows from
operating, investing and financing activities as a measure of liquidity, of our
ability to make cash distributions or our ability to pay interest payments.
FFO GENERATED BY CREST NET LEASE
Crest Net generated $363,000 in FFO for Realty Income during the first quarter
of 2002 and $1.2 million during the first quarter of 2001. The following is a
calculation of the FFO generated by Crest Net in the first quarter of 2002 and
2001 (dollars in thousands):
Three months ended March 31, 2002 2001
----------------------------------------------------------------------------------------------------
Gains from the sales of real estate acquired for resale $ 365 $ 1,928
Rent and other revenue 475 432
Interest expense (75) (283)
General and administrative expenses (196) (205)
Property expenses (42) --
Income taxes (164) (656)
Minority interest -- (53)
----------------------------------------------------------------------------------------------------
Funds from operations contributed by Crest Net $ 363 $ 1,163
====================================================================================================
18
RESULTS OF OPERATIONS
The following is a comparison of our results of operations for the three months
ended March 31, 2002 to the three months ended March 31, 2001.
Rental revenue was $33.3 million for the first quarter of 2002 versus $29.3
million for the first quarter of 2001, an increase of $4.0 million, or 13.7%.
The increase in rental revenue is attributable to:
o The three properties acquired in the first quarter of 2002, which generated
revenue of $58,000;
o The 91 properties acquired in 2001 generated revenue of $3.5 million in the
first quarter of 2002 compared to $42,000 in the first quarter of 2001, an
increase of $3.5 million;
o Properties owned by Crest Net, which generated revenue of $474,000 in the
first quarter of 2002 compared to $428,000 in the first quarter of 2001, an
increase of $46,000;
o Properties sold during 2001 and 2002 generated revenue of $33,000 in the first
quarter of 2002 as compared to $803,000 in the first quarter of 2001, a
decrease of $770,000;
o Net rental increase of $118,000 on development properties acquired before 2001
that started paying rent in 2001 and properties that were vacant during part
of 2001 or 2002;
o Same store rents generated on 990 leased properties owned in all of both 2002
and 2001 increased by $594,000, or 2.1%, to $28.37 million from $27.78
million; and
o Straight-line rent of $397,000 in the first quarter of 2002 as compared to
$26,000 in the first quarter of 2001, an increase of $371,000.
Of the 1,121 properties in the portfolio as of March 31, 2002, 1,116 are
single-tenant properties with the remaining properties being multi-tenant
properties. Of the 1,116 single-tenant properties, 1,094, or 98.0%, were net
leased with a weighted average remaining lease term (excluding extension
options) of approximately 10.2 years at March 31, 2002. Of our 1,094 leased
single-tenant properties, 1,080 or 98.7% were under leases that provide for
increases in rents through:
o Base rent increases tied to a consumer price index with adjustment ceilings;
o Overage rent based on a percentage of the tenants' gross sales;
o Fixed increases; or o A combination of two or more of the above rent
provisions.
Percentage rent, which is included in rental revenue during the first quarter of
2002 and 2001, was $143,000 and $119,000, respectively.
Our portfolio of retail real estate owned under net leases continues to perform
well and provide dependable lease revenue supporting the payment of monthly
dividends. As of March 31, 2002, our portfolio of 1,121 retail properties was
98.0% leased with 22 properties available for lease.
Of the 22 properties not leased at March 31, 2002, transactions to lease or sell
eight properties were underway or completed as of May 6, 2002. We anticipate
these transactions to be completed during the second and third quarter of 2002;
although we cannot guarantee that all of these properties can be sold or leased
within this period.
Gain on sales of real estate acquired for resale. During the first quarter of
2002, Crest Net sold three properties for $2.7 million and we recognized a gain
on the sale of $365,000, before income taxes. During the first quarter of 2001,
Crest Net sold four properties for $14.0 million and we recognized a gain on the
sale of $1.9 million, before income taxes.
19
At March 31, 2002, Crest Net had $22.8 million invested in 23 properties, which
are held for sale. It is Crest Net's intent to carry an average inventory of
between $20 to $25 million in real estate on an ongoing basis. Crest Net
generates an earnings spread on the differential between the lease payments it
receives and the cost of capital used to acquire the properties. It is our
belief that at this level of inventory, these earnings will more than cover the
ongoing operating expenses of Crest Net.
Interest Expense. The following is a summary of the five components of interest
expense for the three months ended March 31, 2002 and 2001 (dollars in
thousands):
Three months ended March 31, 2002 2001 Net Change
- ----------------------------------------------------------------------------------------------------------------------
Interest on outstanding loans and notes $ 5,188 $ 7,534 $ (2,346)
Amortization of settlements on treasury lock agreements 189 189 --
Credit facility commitment fees 128 128 --
Amortization of credit facility origination costs and deferred
bond financing costs 276 284 (8)
Interest capitalized (176) (76) (100)
- ----------------------------------------------------------------------------------------------------------------------
Interest expense $ 5,605 $ 8,059 $ (2,454)
======================================================================================================================
Credit facility and notes outstanding 2002 2001 Net Change
Three months ended March 31,
- ----------------------------------------------------------------------------------------------------------------------
$309,098 $389,838 $ (80,740)
Average outstanding balances (in thousands)
Average interest rates 6.81% 7.84% (1.03)%
Interest on outstanding loans and notes decreased by $2.3 million in the first
quarter of 2002 as compared to the first quarter of 2001 primarily due to a
decrease of $80.7 million in the average outstanding balances and a decrease of
103 basis points in our average interest rates. In 2001, the Federal Reserve
decreased the federal funds rate 11 times by an aggregate total of 475 basis
points. Correspondingly, the average borrowing rate on our credit facilities has
declined during the same period. The average interest rate on our credit
facilities decreased to 3.04% in the first quarter of 2002 from 7.46% in the
first quarter of 2001. The majority of our credit facilities interest rate
reductions in 2001 occurred during the second half of the year.
At May 6, 2002, the weighted average interest rate on our:
o Credit facility borrowings of $70.7 million was 3.07%; o Notes payable of $230
million was 7.99%; and
o Combined outstanding credit facilities and notes of $303.6 million were 6.83%.
Our debt service coverage ratio for the three months ended March 31, 2002 and
2001 was 5.5 times and 3.6 times, respectively. Debt service coverage ratio is
calculated as follows: earnings before interest, taxes, depreciation,
amortization and impairment losses ("EBITDA") divided by interest expense.
EBITDA is calculated as follows: net income plus interest expense, income taxes
and depreciation less gain on sales of investment properties. Our EBITDA for the
three months ended March 31, 2002 and 2001 was $30.7 million and $28.9 million,
respectively. This information should not be considered as an alternative to any
measure of performance as promulgated under GAAP. Our calculation of EBITDA may
be different from the calculation used by other companies and, therefore,
comparability may be limited.
Our fixed coverage ratio for the first quarter of 2002 and 2001 was 3.8 times
and 2.8 times, respectively. Fixed coverage ratio is calculated as follows:
EBITDA divided by the sum of interest expense and preferred stock dividends.
This information should not be considered as an alternative to any measure of
performance as promulgated under GAAP.
20
Depreciation and amortization was $7.5 million in the first quarter of 2002
versus $7.2 million in the first quarter of 2001. The increase in 2002 was
primarily due to the acquisition of properties during 2001. Depreciation of
buildings and improvements is computed using the straight-line method over an
estimated useful life of 25 years. If we used a shorter or longer estimated
useful life it could have a material impact on our results of operations and
financial position. We believe that 25 years is an appropriate estimate of
useful life. No depreciation has been recorded on Crest Net's properties because
they are held for sale.
Amortization of goodwill for the first quarter of 2001 was $231,000. In
accordance with Statement of Financial Accounting Standards No. 142, "Goodwill
and Other Intangible Assets," effective January 2002, our goodwill is no longer
amortized, but instead will be tested for impairment at least annually. If
goodwill is determined to be impaired, a provision for impairment will be
recorded to reduce the carrying value to its fair value.
General and administrative expenses increased by $348,000 to $2.4 million in the
first quarter of 2002 versus $2.0 million in the same quarter of 2001. General
and administrative expenses as a percentage of revenue increased to 7.1% in 2002
as compared to 6.5% in 2001. Included in general and administrative expenses are
$196,000 and $258,000 of expenses attributable to Crest Net in the first quarter
of 2002 and 2001, respectively. General and administrative expenses increased
primarily due to increases in the cost of living, which includes increases in
payroll costs.
We had 53 employees at May 6, 2002 as compared to 49 employees one year ago.
Property expenses are broken down into costs associated with non-net leased
multi-tenant properties, unleased single-tenant properties and general portfolio
expenses. Expenses related to the multi-tenant and unleased single-tenant
properties include, but are not limited to, property taxes, maintenance,
insurance, utilities, property inspections, bad debt expense and legal fees.
General portfolio costs include, but are not limited to, insurance, legal,
property inspections and title search fees. At March 31, 2002, 22 properties
were available for lease, as compared to 20 at December 31, 2001 and 24 at March
31, 2001.
Property expenses were $663,000 in the first quarter of 2002 and $623,000 in the
first quarter of 2001. The $40,000 increase in property expenses is primarily
attributable to an increase in portfolio property insurance and costs associated
with the properties available for lease.
Other expenses decreased $491,000 to $288,000 in the first quarter of 2002
versus $779,000 in the first quarter of 2001. The decrease in 2002 is due to a
decrease in Crest Net income taxes of $491,000. Crest Net taxes were lower
because its net income was lower.
The following is a summary of our other expenses for the three months ended
March 31, 2002 and 2001 (dollars in thousands):
Three months ended March 31, 2002 2001 Net Change
- ----------------------------------------------------------------------------------------------------------------------
Realty Income's state and local income taxes $ 124 $ 124 $ --
Crest Net's income taxes 164 655 (491)
- ----------------------------------------------------------------------------------------------------------------------
Other expenses $ 288 $ 779 $ (491)
======================================================================================================================
A provision for impairment loss of $330,000 was recorded in the first quarter of
2001. A provision for impairment loss of $160,000 was recorded in the first
quarter of 2002 and is included in discontinued operations. We review long-lived
assets for impairment whenever events or changes in circumstances indicate that
the carrying amount of the asset may not be recoverable. Generally, a provision
is made for impairment loss if estimated future operating cash flows
(undiscounted and without interest charges) plus estimated disposition proceeds
(undiscounted) are less than the current book value. Impairment losses are
measured as the amount by which the current book value of the asset exceeds the
fair value of the asset. The carrying value of our real estate is the largest
component of our consolidated balance sheet. If we were required to reduce the
carrying value of our real estate by recording provisions for impairment losses,
it could have a material impact on our results of operations and financial
position.
21
Income from discontinued operations. In August 2001, the Financial Accounting
Standards Board issued Statement No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets. Effective January 1, 2002, Statement No. 144
superseded Statement No. 121, Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to be Disposed Of. Statement No. 144 requires
long-lived assets to be disposed of, to be measured at the lower of carrying
amount or fair value less cost to sell. It also broadened the reporting
requirements of discontinued operations to include a component of an entity
rather than a segment of a business. Statement No. 144 states that a component
of an entity comprises operations and cash flows that clearly can be
distinguished, operationally and for financial reporting purposes, from the rest
of the entity. Six properties listed as held for sale at March 31, 2002 and
three properties sold during the first quarter of 2002 were reported as
discontinued operations. As required by Statement No. 144, three other
properties reported as held for sale at December 31, 2001, that were sold during
2002, were not reported as discontinued operations. The following is a summary
of our income from discontinued operations for the three months ended March 31,
2002 and 2001 (dollars in thousands):
Three months ended March 31, 2002 2001
------------------------------------------------------------------------------
Rent $ 134 $ 150
Interest and other -- 14
Depreciation and amortization (30) (37)
Property expenses (4) (1)
Impairment loss (160) --
Gain on sales of investment properties 774 --
------------------------------------------------------------------------------
Income from discontinued operations $ 714 $126
==============================================================================
Gain on sales of investment properties. During the first three months of 2002,
we sold six investment properties for $3.4 million and recognized a gain of $1.1
million. Of this gain, $774,000 is included in income from discontinued
operations. During the first three months of 2001, we sold 10 investment
properties for $17.1 million and recognized a gain of $6.0 million. The gain
recognized from property sales in the first quarter of 2002 was $340,000, or
$5.6 million less than the gain recognized from property sales in the first
quarter of 2001 of $6.0 million.
We have an active portfolio management program that incorporates the sale of
assets when we believe the reinvestment of the sale proceeds will generate
higher returns, enhance the credit quality of our real estate portfolio or
extend our average remaining lease term. At March 31, 2002, we classified real
estate with a carrying amount of $24.3 million as held for sale, which includes
$22.8 million in properties owned by Crest Net. Additionally, we anticipate
selling properties from our portfolio that have not yet been specifically
identified. We anticipate we will receive up to $50 million in proceeds from the
sale of properties during the next 12 months. We intend to invest these proceeds
into new property acquisitions.
Preferred stock dividends. We declared preferred stock dividends of $2.4 million
in both the first quarters 2002 and 2001.
Net income available to common stockholders was $15.9 million in the first
quarter of 2002 and $16.0 million in the first quarter of 2001, a decrease of
$179,000.
The calculation to determine net income available to common stockholders
includes gains and losses from the sale of investment properties. The amount of
gains and losses vary from period to period based on the timing of property
sales and can significantly impact net income available to common stockholders.
The gain recognized from property sales during the first quarter of 2002 was
$1.1 million. This was $4.8 million less than the gain recognized from property
sales during the first quarter of 2001. Excluding the gain on sales of
properties, net income available to common stockholders increased by $4.7
million.
22
PROPERTIES
As of March 31, 2002, we owned a diversified portfolio:
o Of 1,121 properties;
o With an occupancy rate of 98.0%, or 1,099 of the 1,121 properties;
o Leased to 79 different retail chains; o Doing business in 24 separate retail
industries;
o Located in 48 states; o With over 9.5 million square feet of leasable space;
and
o With an average leasable retail space of 8,500 square feet on approximately
62,800 square feet of land.
In addition to our real estate portfolio, at March 31, 2002 our subsidiary Crest
Net owned a portfolio of 23 properties and had invested $22.8 million.
At March 31, 2002, 1,094 or 97.6% of the 1,121 properties were leased under
net-lease agreements. Net leases typically require the tenant to be responsible
for minimum monthly rent and property operating expenses including property
taxes, insurance and maintenance. In addition, tenants are typically responsible
future rent increases (generally subject to ceilings) based on increases in the
consumer price index, fixed increases or additional rent calculated as a
percentage of the tenants' gross sales above a specified level.
Our net-leased retail properties are primarily leased to regional and national
retail chain store operators. Generally, buildings are single-story properties
with adequate parking on site to accommodate peak retail traffic periods. The
properties tend to be on major thoroughfares with relatively high traffic counts
and adequate access, egress and proximity to a sufficient population base to
constitute a suitable market or trade area for the retailer's business.
23
The following table sets forth certain information regarding our properties
classified according to the business of the respective tenants, expressed as a
percentage of our total rental revenue.
Percentage of Rental Revenue (1)
--------------------------------------------------------------------------------------------
Annualized Rent
as of For the Years Ended December 31,
----------------------------------------------------------------------
March 31,
Industry 2002(2) 2001 2000 1999 1998 1997 1996
- -----------------------------------------------------------------------------------------------------------------------------
Apparel Stores 2.4% 2.4% 2.4% 3.8% 4.1% 0.7% --%
Automotive Parts 7.7 8.3 8.3 8.6 7.8 9.1 10.5
Automotive Service 5.4 5.7 5.8 6.6 7.5 6.4 4.8
Book Stores 0.5 0.4 0.5 0.5 0.6 0.5 --
Business Services 0.1 0.1 0.1 0.1 * -- --
Child Care 21.9 23.9 24.7 25.3 29.2 35.9 42.0
Consumer Electronics 3.5 4.0 4.9 4.4 5.4 6.5 0.9
Convenience Stores 7.8 8.4 8.4 7.2 6.1 5.5 4.6
Craft and Novelty 0.4 0.4 0.4 0.4 * -- --
Drug Stores 0.2 0.2 0.2 0.2 0.1 -- --
Entertainment 1.9 1.8 2.0 1.2 -- -- --
General Merchandise 0.5 0.6 0.6 0.6 * -- --
Grocery Stores 0.6 0.6 0.6 0.5 * -- --
Health and Fitness 4.1 3.6 2.4 0.6 0.1 -- --
Home Furnishings 5.5 6.0 5.8 6.5 7.8 5.6 4.4
Home Improvement 1.2 1.3 2.0 3.6 * -- --
Office Supplies 2.1 2.2 2.3 2.6 3.0 1.7 --
Pet Supplies and Services 1.7 1.6 1.5 1.1 0.6 0.2 --
Private Education 1.3 1.5 1.4 1.2 0.9 -- --
Restaurants 14.2 12.2 12.3 13.3 16.2 19.8 24.4
Shoe Stores 0.9 0.7 0.8 1.1 0.8 0.2 --
Sporting Goods 4.2 0.9 -- -- -- -- --
Theaters 3.9 4.3 2.7 0.6 -- -- --
Video Rental 3.4 3.7 3.9 4.3 3.8 0.6 --
Other 4.6 5.2 6.0 5.7 6.0 7.3 8.4
- -----------------------------------------------------------------------------------------------------------------------------
Totals 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
=============================================================================================================================
* Less than 0.1%
<FN>
(1) Does not include properties owned by our subsidiary, Crest Net.
(2) Annualized rent is calculated by multiplying the monthly contractual base
rent as of March 31, 2002 for each of the properties by 12 and adding the
previous 12 month's historic percentage rent on properties owned at March 31,
2002, which totaled $1.7 million (i.e., additional rent calculated as a
percentage of the tenants' gross sales above a specified level). For the
properties under construction, an estimated contractual base rent is used based
upon the estimated total costs of each property.
</FN>
Of the 1,121 properties in the portfolio at March 31, 2002, 1,116 were
single-tenant properties with the remaining properties being multi-tenant
properties. At March 31, 2002, 1,094 of the 1,116 single-tenant properties, or
98.0%, were net leased with a weighted average remaining lease term (excluding
extension options) of approximately 10.2 years.
24
The following table sets forth certain information regarding the timing of the
initial lease term expirations (excluding extension options) on our 1,094
net-leased, single-tenant retail properties at March 31, 2002 (dollars in
thousands):
Number of Annualized Percentage of
Year Leases Expiring(1) Rent(1)(2) Annualized Rent
- ----------------------------------------------------------------------------------------------------------------
2002 79 $ 6,518 5.1%
2003 79 6,684 5.3
2004 118 10,176 8.0
2005 84 6,605 5.2
2006 75 6,739 5.3
2007 92 6,331 5.0
2008 63 5,669 4.5
2009 28 2,502 2.0
2010 44 3,858 3.0
2011 35 5,302 4.2
2012 49 5,803 4.6
2013 70 12,348 9.8
2014 35 6,287 5.0
2015 35 4,186 3.3
2016 14 1,496 1.2
2017 13 4,609 3.6
2018 16 1,988 1.6
2019 49 8,246 6.5
2020 10 3,664 2.9
2021 96 14,746 11.6
2022 1 123 0.1
2023 2 341 0.3
2026 2 372 0.3
2033 2 1,118 0.9
2034 3 879 0.7
- ----------------------------------------------------------------------------------------------------------------
Totals 1,094 $ 126,590 100.0%
================================================================================================================
<FN>
(1) Does not include five multi-tenant properties and 22 vacant, unleased
single-tenant properties owned by the Company and properties owned by our
subsidiary, Crest Net. The lease expirations for properties under construction
are based on the estimated date of completion of such properties.
(2) Annualized rent is calculated by multiplying the monthly contractual base
rent as of March 31, 2002 for each of the properties by 12 and adding the
previous 12 month's historic percentage rent on properties owned at March 31,
2002, which totaled $1.7 million (i.e., additional rent calculated as a
percentage of the tenants' gross sales above a specified level). For the
properties under construction, an estimated contractual base rent is used based
upon the estimated total costs of each property.
</FN>
25
The following table sets forth certain state-by-state information regarding
Realty Income's property portfolio as of March 31, 2002 (dollars in thousands):
Approximate Percentage of
Number of Percent Leasable Annualized Annualized Rent
State Properties(1) Leased Square Feet Rent(1)(2)
- ------------------------------------------------------------------------------------------------------------------
Alabama 15 100% 142,600 $ 1,413 1.1%
Alaska 2 100 128,500 1,003 0.8
Arizona 30 100 225,500 3,678 2.8
Arkansas 8 100 48,800 916 0.7
California 53 100 992,800 13,890 10.5
Colorado 43 98 265,600 3,946 3.0
Connecticut 15 100 241,500 3,665 2.8
Delaware 1 100 5,400 72 *
Florida 91 92 1,164,700 14,761 11.2
Georgia 63 98 450,700 6,366 4.8
Idaho 11 100 52,000 761 0.6
Illinois 37 100 306,200 4,278 3.2
Indiana 27 97 157,700 2,056 1.6
Iowa 10 100 67,600 702 0.5
Kansas 21 100 190,000 2,208 1.7
Kentucky 13 100 43,600 1,151 0.9
Louisiana 7 100 47,100 716 0.5
Maryland 9 100 91,100 1,328 1.0
Massachusetts 22 100 100,100 2,450 1.9
Michigan 10 100 68,100 990 0.7
Minnesota 22 87 239,800 2,191 1.7
Mississippi 21 100 171,000 1,739 1.3
Missouri 35 100 230,400 2,997 2.3
Montana 2 100 30,000 305 0.2
Nebraska 9 100 87,100 1,142 0.9
Nevada 6 100 81,300 1,297 1.0
New Hampshire 6 100 23,900 593 0.4
New Jersey 10 100 47,400 1,189 0.9
New Mexico 5 100 46,000 361 0.3
New York 24 96 265,600 5,514 4.2
North Carolina 33 100 170,200 3,250 2.5
North Dakota 1 100 22,000 65 *
Ohio 65 99 371,800 5,489 4.1
Oklahoma 19 100 107,600 1,535 1.2
Oregon 16 100 198,100 1,825 1.4
Pennsylvania 30 100 243,400 3,504 2.6
Rhode Island 1 100 3,500 116 0.1
South Carolina 47 100 142,000 4,034 3.0
South Dakota 2 100 12,600 175 0.1
Tennessee 29 97 237,900 3,201 2.4
Texas 149 97 1,191,300 13,791 10.4
Utah 7 100 45,400 644 0.5
Vermont 1 100 2,500 87 0.1
Virginia 29 100 301,900 5,065 3.8
Washington 40 100 261,800 3,214 2.4
West Virginia 2 100 16,800 160 0.1
Wisconsin 18 100 171,000 2,080 1.6
Wyoming 4 100 20,100 271 0.2
- ------------------------------------------------------------------------------------------------------------------
Totals/Average 1,121 98% 9,532,000 $ 132,184 100.0%
==================================================================================================================
* Less than 0.1%
<FN>
(1) Does not include properties owned by our subsidiary, Crest Net.
(2) Annualized rent is calculated by multiplying the monthly contractual base
rent as of March 31, 2002 for each of the properties by 12 and adding the
previous 12 month's historic percentage rent on properties owned at March 31,
2002, which totaled $1.7 million (i.e., additional rent calculated as a
percentage of the tenants' gross sales above a specified level). For the
properties under construction, an estimated contractual base rent is used based
upon the estimated total costs of each property.
</FN>
26
The following table sets forth certain information regarding the properties
owned by Realty Income at March 31, 2002, classified according to the retail
business types and the level of services they provide (dollars in thousands):
Number of Annualized Percentage of
Industry Properties(1) Rent(1)(2) Annualized Rent
- ----------------------------------------------------------------------------------------------------------------------
TENANTS PROVIDING SERVICES
Automotive Service 99 $ 7,101 5.4%
Child Care 327 28,909 21.9
Entertainment 8 2,564 1.9
Health and Fitness 9 5,479 4.2
Private Education 5 1,738 1.3
Theaters 10 5,209 3.9
Other 8 6,097 4.6
--------------------------------------------------------------------------------
466 57,097 43.2
--------------------------------------------------------------------------------
TENANTS SELLING GOODS AND SERVICES
Automotive Parts (with installation) 64 5,850 4.4
Business Services 1 124 0.1
Convenience Stores 105 10,305 7.8
Home Improvement 2 187 0.1
Pet Supplies and Services 6 1,561 1.2
Restaurants 225 18,743 14.2
Video Rental 34 4,501 3.4
--------------------------------------------------------------------------------
437 41,271 31.2
--------------------------------------------------------------------------------
TENANTS SELLING GOODS
Apparel Stores 5 3,103 2.4
Automotive Parts 75 4,346 3.3
Book Stores 2 606 0.5
Consumer Electronics 36 4,639 3.5
Craft and Novelty 2 517 0.4
Drug Stores 1 235 0.2
General Merchandise 11 687 0.5
Grocery Stores 2 726 0.6
Home Furnishings 38 7,284 5.5
Home Improvement 18 1,377 1.0
Office Supplies 9 2,820 2.1
Pet Supplies 3 671 0.5
Shoe Stores 5 1,221 0.9
Sporting Goods 11 5,584 4.2
- ----------------------------------------------------------------------------------------------------------------------
218 33,816 25.6
- ----------------------------------------------------------------------------------------------------------------------
TOTALS 1,121 $ 132,184 100.0%
======================================================================================================================
<FN>
(1) This table does not include properties owned by our subsidiary, Crest Net.
(2) Annualized rent is calculated by multiplying the monthly contractual base
rent as of March 31, 2002 for each of the properties by 12 and adding the
previous 12 month's historic percentage rent on properties owned at March
31,2002, which totaled $1.7 million (i.e., additional rent calculated as a
percentage of the tenants' gross sales above a specified level). For the
properties under construction, an estimated contractual base rent is used based
upon the estimated total costs of each property.
</FN>
27
IMPACT OF INFLATION
Tenant leases generally provide for limited increases in rent as a result of
increases in the tenants' sales volumes, increases in the consumer price index,
and/or fixed increases. We expect that inflation will cause these lease
provisions to result in increases in rent over time. During times when inflation
is greater than increases in rent as provided for in the leases, rent increases
may not keep up with the rate of inflation.
Approximately 97.6% or 1,094 of the 1,121 properties in the portfolio are leased
to tenants under net leases whereby the tenant is responsible for property costs
and expenses. These lease features reduce our exposure to rising property
expenses due to inflation. Inflation and increased costs may have an adverse
impact on our tenants if increases in their operating expenses exceed increases
in revenue.
IMPACT OF ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement
No. 142, Goodwill and Other Intangible Assets. Statement No. 142 requires that
goodwill and intangible assets with indefinite useful lives no longer be
amortized, but instead tested for impairment at least annually in accordance
with the provisions of Statement No. 142. Statement No. 142 also requires that
intangible assets with definite useful lives be amortized over their respective
estimated useful lives to their estimated residual values, and reviewed for
impairment in accordance with FASB Statement No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of.
The Company adopted Statement No. 142 effective January 1, 2002. At the date of
adoption, the Company had unamortized goodwill in the amount of $17.2 million.
The Company does not have any intangible assets or unamortized negative
goodwill. Amortization expense related to goodwill was $231,000 during the first
quarter of 2001. We have not yet determined what the impact will be on our
financial position, results of operations or liquidity from testing our goodwill
for impairment.
In August 2001, the FASB issued Statement No. 144, Accounting for the Impairment
or Disposal of Long-Lived Assets. Statement No. 144 will supersede Statement No.
121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of. Statement No. 144 requires long-lived assets to be
disposed of, to be measured at the lower of carrying amount or fair value less
cost to sell. The Company adopted the provisions of Statement No. 144 on
January 1, 2002. The adoption of Statement No. 144 has not had a material effect
on our financial position, results of operations or liquidity.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
We are exposed to interest rate changes primarily as a result of our credit
facilities and long-term notes used to maintain liquidity and expand our real
estate investment portfolio and operations. Our interest rate risk management
objective is to limit the impact of interest rate changes on earnings and cash
flow and to lower our overall borrowing costs. To achieve our objectives we
issue our long-term notes, primarily at fixed rates and may selectively enter
into derivative financial instruments such as interest rate lock agreements,
interest rate swaps and caps in order to mitigate our interest rate risk on a
related financial instrument. We are not a party to any derivative financial
instruments at March 31, 2002. We do not enter into any transactions for
speculative or trading purposes.
28
Our interest rate risk is monitored using a variety of techniques. The table
below presents the principal amounts, weighted average interest rates, fair
values and other terms required by year of expected maturity to evaluate the
expected cash flows and sensitivity to interest rate changes (dollars in table
in millions).
Expected Maturity Data
---------------------------------------
2003 Thereafter Total Fair Value(2)
---- ---------- ----- -------------
Fixed rate debt -- $ 230.0(1) $ 230.0 $ 226.1
Average interest rate -- 7.99% 7.99%
Variable rate debt $73.6 -- $ 73.6 $ 73.6
Average interest rate 3.12% -- 3.12%
<FN>
(1) $110 million matures in 2007, $100 million matures in 2008 and $20 million
matures in 2009.
(2) We base the fair value of the fixed rate debt at March 31, 2002 on the
closing market price or indicative price per each note. The fair value of the
variable rate debt approximates its carrying value because its terms are similar
to those available in the market place.
</FN>
The table incorporates only those exposures that exist as of March 31, 2002, it
does not consider those exposures or positions that could arise after that date.
As a result, our ultimate realized gain or loss with respect to interest rate
fluctuations would depend on the exposures that arise during the period, our
hedging strategies at the time, and interest rates.
PART II. OTHER INFORMATION
Item 6. Exhibits And Reports On Form 8-K
A. Exhibits:
Exhibit No. Description
3.1 Articles of Incorporation of the Company (filed as Appendix B
to the Company's Proxy Statement dated March 28, 1997
("1997 Proxy Statement") and incorporated herein by
reference).
3.2 Bylaws of the Company (filed as Appendix C to the Company's
1997 Proxy Statement and incorporated herein by reference).
3.3 Articles Supplementary of the Class A Junior Participating
Preferred Stock of Realty Income Corporation (filed as exhibit
A of exhibit 1 to Realty Income's registration statement on
Form 8-A, dated June 26, 1998, and incorporated herein by
reference).
3.4 Articles Supplementary to the Articles of Incorporation of
Realty Income Corporation classifying and designating the
Class B Preferred Stock (filed as exhibit 4.1 to the Company's
Form 8-K dated May 24, 1999 and incorporated herein by
reference).
3.5 Articles Supplementary to the Articles of Incorporation of
Realty Income Corporation classifying and designating the
Class C Preferred Stock (filed as exhibit 4.1 to the Company's
Form 8-K dated July 29, 1999 and incorporated herein by
reference).
4.1 Pricing Committee Resolutions and Form of 7.75% Notes due 2007
(filed as Exhibit 4.2 to the Company's Form 8-K dated May 5,
1997 and incorporated herein by reference).
29
Exhibit No. Description
4.2 Indenture dated as of May 6, 1997 between the Company and The
Bank of New York (filed as Exhibit 4.1 to the Company's Form
8-K dated May 5, 1997 and incorporated herein by reference).
4.3 First Supplemental Indenture dated as of May 28, 1997, between
the Company and The Bank of New York (filed as Exhibit 4.3 to
the Company's Form 8-B and incorporated herein by reference).
4.4 Rights Agreement, dated as of June 25, 1998, between Realty
Income Corporation and The Bank of New York (filed as an
exhibit 1 to the Company's registration statement on Form 8-A,
dated June 26, 1998, and incorporated herein by reference).
4.5 Pricing Committee Resolutions (filed as an exhibit 4.2 to
Realty Income's Form 8-K, dated October 27, 1998 and
incorporated herein by reference).
4.6 Form of 8.25% Notes due 2008 (filed as exhibit 4.3 to Realty
Income's Form 8-K, dated October 27, 1998 and incorporated
herein by reference).
4.7 Indenture dated as of October 28, 1998 between Realty Income
and The Bank of New York (filed as exhibit 4.1 to Realty
Income's Form 8-K, dated October 27, 1998 and incorporated
herein by reference).
4.8 Pricing Committee Resolutions and Form of 8% Notes due 2009 (filed as
exhibit 4.2 to Realty Income's Form 8-K, dated January 21, 1999 and
incorporated herein by reference).
B. One report on Form 8-K was filed by the registrant during the quarter for
which this report is filed.
On March 1, 2002, we filed a Form 8-K in connection with the issuance of
up to 273,150 shares of the Company's common stock pursuant to the
Company's shelf registration statement on Form S-3 filed on June 16,
1999, as amended on July 13, 1999.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
REALTY INCOME CORPORATION
(Signature and Title) /s/ GREGORY J. FAHEY
--------------------------------------------
Date: May 13, 2002 Gregory J. Fahey, Vice President, Controller
(Principal Accounting Officer)
EXHIBIT INDEX
Exhibit
No. Description
- --------- -----------
-- None
30