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 June 30, 1999, or
=================
[ ] Transition report pursuant to section 13 or 15(d) of the
Securities Exchange Act of 1934
COMMISSION FILE NUMBER 1-13318
==============================
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
===================================================
(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 26,822,269 shares of common stock outstanding as of
August 6, 1999.
REALTY INCOME CORPORATION
Form 10-Q
June 30, 1999
Table of Contents
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PART I. FINANCIAL INFORMATION Page
============================== ----
Item 1: Financial Statements
Consolidated Balance Sheets........................ 3
Consolidated Statements of Income.................. 5
Consolidated Statements of Cash Flows.............. 6
Notes to Consolidated Financial Statements......... 8
Item 2: Management's Discussion and Analysis Of
Financial Condition and Results Of Operations...... 12
Item 3: Quantitative and Qualitative Disclosures About
Market Risk........................................ 31
PART II. OTHER INFORMATION
==========================
Item 4: Submission of Matters to a Vote of
Security Holders................................... 32
Item 6: Exhibits and Reports on Form 8-K................... 33
SIGNATURE................................................... 35
EXHIBIT INDEX............................................... 35
Page 2
PART I. FINANCIAL INFORMATION
==============================
ITEM 1. FINANCIAL STATEMENTS
REALTY INCOME CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
===========================
As of June 30, 1999 and December 31, 1998
(dollars in thousands, except per share data)
1999 1998
(Unaudited)
=========== =========
ASSETS
Real estate, at cost:
Land $ 323,542 $ 283,043
Buildings and improvements 655,430 606,792
--------- ---------
978,972 889,835
Less - accumulated depreciation
and amortization (183,325) (171,555)
--------- ---------
Net real estate 795,647 718,280
Cash and cash equivalents 16,818 2,533
Accounts receivable 2,320 2,973
Goodwill, net 19,515 19,977
Other assets 15,166 15,471
--------- ---------
Total assets $ 849,466 $ 759,234
========= =========
Continued on next page
Page 3
(continued)
REALTY INCOME CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
===========================
As of June 30, 1999 and December 31, 1998
(dollars in thousands, except per share data)
1999 1998
(Unaudited)
=========== =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Distributions payable $ 4,694 $ 4,559
Accounts payable and accrued expenses 9,242 4,036
Other liabilities 3,296 5,630
Line of credit payable 93,300 84,800
Notes payable 230,000 210,000
--------- ---------
Total liabilities 340,532 309,025
--------- ---------
Stockholders' equity
Preferred stock, par value
$1.00 per share, 20,000,000 shares
authorized, 2,760,000 shares issued
and outstanding 2,760 --
Common stock, par value $1.00 per
share, 100,000,000 shares
authorized, 26,822,447 and 26,817,103
shares issued and outstanding in
1999 and 1998, respectively 26,822 26,817
Paid in capital in excess of par value 673,596 609,669
Distributions in excess of net income (194,244) (186,277)
--------- ---------
Total stockholders' equity 508,934 450,209
--------- ---------
Total liabilities and
stockholders' equity $ 849,466 $ 759,234
========= =========
The accompanying notes to consolidated financial statements
are an integral part of these statements.
Page 4
REALTY INCOME CORPORATION AND SUBSIDIARIES
Consolidated Statements Of Income
=================================
For the three and six months ended June 30, 1999 and 1998
(dollars in thousands, except per share amounts)
(Unaudited)
Three Three Six Six
Months Months Months Months
Ended Ended Ended Ended
6/30/99 6/30/98 6/30/99 6/30/98
======== ======== ======== ========
REVENUE
Rental $ 24,864 $ 20,343 $ 48,812 $ 39,511
Interest and other 38 24 76 78
-------- -------- -------- --------
24,902 20,367 48,888 39,589
-------- -------- -------- --------
EXPENSES
Depreciation and
amortization 6,237 5,369 12,327 10,453
Interest 6,045 2,864 11,925 5,355
General and
administrative 1,755 1,711 3,401 3,176
Property 437 426 878 899
-------- -------- -------- --------
14,474 10,370 28,531 19,883
-------- -------- -------- --------
Income from operations 10,428 9,997 20,357 19,706
Gain on sales of
properties -- 311 -- 526
-------- -------- -------- --------
Net income 10,428 10,308 20,357 20,232
Preferred stock
dividends (629) -- (629) --
-------- -------- -------- --------
Net income available
to common
stockholders $ 9,799 $ 10,308 $ 19,728 $ 20,232
======== ======== ======== ========
Basic and diluted
net income per
common share $ 0.37 $ 0.38 $ 0.74 $ 0.77
======== ======== ======== ========
The accompanying notes to consolidated financial statements
are an integral part of these statements.
Page 5
REALTY INCOME CORPORATION AND SUBSIDIARIES
Consolidated Statements Of Cash Flows
=====================================
For the six months ended June 30, 1999 and 1998
(dollars in thousands)
(Unaudited)
1999 1998
========= =========
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 20,357 $ 20,232
Adjustments to net income:
Depreciation and amortization 12,327 10,453
Gain on sales of properties -- (526)
Change in assets and liabilities:
Accounts receivable and
other assets 1,497 1,655
Accounts payable, accrued
expenses and other liabilities 385 207
--------- ---------
Net cash provided by
operating activities 34,566 32,021
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sales of properties -- 2,770
Acquisition of and additions
to properties (84,936) (102,014)
Payment of other liabilities ( 1,713) --
--------- ---------
Net cash used in
investing activities (86,649) (99,244)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Borrowings from line of credit 114,300 111,300
Payments under line of credit (105,800) (46,000)
Distributions to common
stockholders (27,560) (25,545)
Distributions to preferred
stockholders (629) --
Proceeds from notes issued,
net of costs of $501 19,499 --
Proceeds from stock offerings,
net of offering costs of $2,441 and
$109 in 1999 and 1998, respectively 66,558 28,392
Proceeds from other stock issuances -- 69
--------- ---------
Net cash provided by
financing activities 66,368 68,216
--------- ---------
Continued on next page
Page 6
(continued)
REALTY INCOME CORPORATION AND SUBSIDIARIES
Consolidated Statements Of Cash Flows
=====================================
For the six months ended June 30, 1999 and 1998
(dollars in thousands)
(Unaudited)
1999 1998
========= =========
Net increase in cash and
cash equivalents 14,285 993
Cash and cash equivalents,
beginning of period 2,533 2,123
--------- ---------
Cash and cash equivalents,
end of period $ 16,818 $ 3,116
========= =========
For supplemental disclosures, see note 8.
The accompanying notes to consolidated financial statements
are an integral part of these statements.
Page 7
REALTY INCOME CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements
==========================================
June 30, 1999
(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. Readers
of this quarterly report should refer to our audited financial
statements for the year ended December 31, 1998, which are included in
our 1998 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. Property Acquisitions
During the first six months of 1999, we invested $88.9 million in 66
new retail properties and properties under development with an initial
aggregate contractual lease rate of 10.4%. These 66 properties are
located in 23 states and will contain approximately 623,100 leasable
square feet and are 100% leased, with an average initial lease term of
15.7 years.
During the first six months of 1998, we invested $102.0 million in 66
new retail properties and properties under development with an initial
aggregate contractual lease rate of 10.3%. These 66 properties are
located in 29 states and contain approximately 657,300 leasable square
feet and are 100% leased, with an average initial lease term of 14.8
years.
3. Distributions Paid and Payable
Realty Income pays distributions monthly. The following is a summary
of the monthly cash distributions per common share for the six months
ended June 30, 1999 and 1998. As of June 30, 1999, a distribution of
$0.1750 per common share was declared and was paid on July 15, 1999.
Month 1999 1998
-------- -------- --------
January $ 0.1700 $ 0.1600
February 0.1700 0.1600
March 0.1700 0.1600
April 0.1725 0.1625
May 0.1725 0.1625
June 0.1725 0.1625
-------- -------- --------
Total $ 1.0275 $ 0.9675
======== ======== ========
Page 8
3. Distributions Paid and Payable (continued)
In May 1999, we issued 2,760,000 shares of 9 3/8% class B cumulative
redeemable preferred stock. On June 30, 1999, dividends of $629,000
were paid on these preferred shares. Dividends are paid quarterly in
arrears.
4. Gain on Sales of Properties
For the six months ended June 30, 1999, no properties were sold. For
the six months ended June 30, 1998, we sold five properties (two
childcare centers, one multi-tenant location and two restaurants) for
$2.8 million and recognized a gain of $526,000.
For the three months ended June 30, 1998, we sold two properties (one
childcare center and one restaurant) for $822,000 and recognized a
gain of $311,000.
5. Net Income per Share
Basic net income per 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
share is computed by dividing the amount of net income available to
common stockholders for the period by each share 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 and six months
ended June 30, 1999 and 1998 (net income was available to common
stockholders for all periods presented):
Three Three
Months Months
Ended Ended
6/30/99 6/30/98
---------- ----------
Weighted average shares used for
the basic net income computation 26,822,370 26,836,730
Incremental shares from the assumed
exercise of stock options 4,968 8,361
---------- ----------
Adjusted weighted average shares
used for diluted net income
computation 26,827,338 26,845,091
=========== ==========
Page 9
5. Net Income per Share (continued)
Six Six
Months Months
Ended Ended
6/30/99 6/30/98
---------- ----------
Weighted average shares used for
the basic net income computation 26,822,376 26,434,892
Incremental shares from the assumed
exercise of stock options 3,915 7,627
---------- ----------
Adjusted weighted average shares
used for diluted net income
computation 26,826,291 26,442,519
========== ==========
For the three and six months ended June 30, 1999, stock options of
168,047 and 186,181, respectively, were anti-dilutive and have been
excluded from the incremental shares from the assumed conversion of
stock options. No stock options were anti-dilutive for the three and
six months ended June 30, 1998.
6. Notes Payable
In January 1999, we issued $20 million of 8.00% senior notes due 2009
(the "1999 Notes"). The 1999 Notes are unsecured and were sold at
98.757% of par to yield 8.10%. The proceeds from the offering were
used to pay down credit facility borrowings and for other corporate
purposes. Currently, there is no formal trading market for the 1999
Notes and we have not listed and do not intend to list the 1999 Notes
on any securities exchange.
7. Preferred Stock Offerings
A. In May 1999, we issued 2,760,000 shares of 9 3/8% class B
cumulative redeemable preferred stock at a price of $25.00 per share.
The net proceeds of $66.6 million were used to repay borrowings under
the credit facility.
B. In July 1999, we issued 1,380,000 shares of 9 1/2% class C
cumulative redeemable preferred stock at a price of $25.00 per share.
The net proceeds of $33.2 million were used to repay borrowings under
the credit facility.
8. Supplemental Disclosure of Cash Flow Information
Interest paid during the first six months of 1999 and 1998 was $10.4
million and $4.7 million, respectively.
In the first six months of 1999 and 1998, interest of $638,000 and
$234,000, respectively, was capitalized to properties under
development. For the three months ended June 30, 1999 and 1998,
interest of $344,000 and $154,000, respectively, was so capitalized.
Page 10
8. Supplemental Disclosure of Cash Flow Information (continued)
The following non-cash investing and financing activities are included
in the accompanying consolidated financial statements:
In 1999, the investment in properties resulted in an increase in
buildings and other liabilities of $4.2 million.
9. Segment Information
We evaluate performance and make resource allocation decisions on a
property by property basis. For financial reporting purposes, we have
grouped our operating segments into eight reportable segments. Our
segments combine properties into groups based upon the business of the
tenants. All of the properties have been acquired separately and are
incorporated into one of the applicable segments. Revenue is the only
components of segment profit and loss we measure. Since our revenue
is primarily from net leases, expenditures for additions to long-lived
assets were to acquire additional properties.
The following tables set forth certain information as of June 30, 1999
(for the dates or periods presented below) regarding the properties
owned by us classified according to the business of the respective
tenants (dollars in thousands):
Three Three Six Six
Months Months Months Months
Ended Ended Ended Ended
Revenue for the: 6/30/99 6/30/98 6/30/99 6/30/98
------- ------- ------- -------
Segment rental revenue:
Automotive parts $ 2,108 $ 1,309 $ 4,182 $ 2,867
Automotive service 1,784 1,575 3,414 2,954
Child care 6,228 5,973 12,402 11,920
Consumer electronics 1,148 1,149 2,297 2,320
Convenience stores 1,519 1,291 2,886 2,401
Home furnishings 1,734 1,633 3,436 2,752
Restaurants 3,410 3,434 6,838 6,803
Video rental 1,115 726 2,187 1,367
Other non-reportable
segments 5,818 3,253 11,170 6,127
Reconciling items - Interest
and other revenue 38 24 76 78
------- ------- ------- -------
Total revenue $24,902 $20,367 $48,888 $39,589
======= ======= ======= =======
Page 11
9. Segment Information (continued)
Assets
---------------------
June 30, December 31,
As of: 1999 1998
-------- --------
Segment net real estate:
Automotive parts $ 74,128 $ 65,847
Automotive service 51,733 46,731
Child care 148,839 138,875
Consumer electronics 39,845 40,447
Convenience stores 52,765 43,986
Home furnishings 71,991 71,366
Restaurants 87,987 87,682
Video Rental 41,222 39,650
Other non-reportable segments 227,137 183,696
------- -------
Total segment net real estate 795,647 718,280
Reconciling items 53,819 40,954
-------- --------
Total assets $849,466 $759,234
======== ========
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
- --------------------------
This quarterly report on Form 10-Q (the "Quarterly Report"), 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. Such
forward-looking statements are subject to risks, uncertainties, and
assumptions about Realty Income Corporation, including, among other
things:
- Our anticipated growth strategies;
- Our intention to acquire additional properties;
- Anticipated trends in our business, including trends in the
market for long-term net leases of freestanding, single tenant
retail properties;
- Future expenditures for development projects; and
- Availability of capital to finance our business.
Future events and actual results, financial and otherwise, may differ
materially from the results discussed in the forward-looking
statements. In particular, among the factors that could cause actual
results to differ materially are:
Page 12
- The continued qualification as a real estate investment trust;
- General business and economic conditions;
- Competition;
- Interest rates;
- Accessibility of debt and equity capital markets; and
- Other risks inherent in the real estate business including
tenant defaults, potential liability relating to environmental
matters and illiquidity of real estate investments.
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, 1998.
Readers are cautioned not to place undue reliance on forward-looking
statements, which speak only as of the date of this filing. The
Company undertakes no obligation to publicly release the results of
any revisions to these forward-looking statements which may be made to
reflect events or circumstances after the date of this filing 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.
GENERAL
- -------
Realty Income Corporation, 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. As of June 30, 1999, we owned a
diversified portfolio of 1,036 retail properties located in 45 states
with over 8.4 million square feet of leasable space. Of the 1,036
properties in the portfolio, 1,029 are single-tenant retail properties
with the remainder being multi-tenant properties. As of June 30,
1999, 1,021, or 99.2%, of the 1,029 single-tenant properties were
leased with an average remaining lease term (excluding extension
options) of approximately 8.7 years.
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 generally will seek to
increase distributions to stockholders and FFO per share through both
active portfolio management and the acquisition of additional
properties.
Page 13
Our portfolio management focus includes:
- Contractual rent increases on existing leases;
- Rental increases at the termination of existing leases when
market conditions permit; and
- The active management of the Company's property portfolio,
including selective sales of properties.
Our acquisition of additional properties adheres to a focused strategy
of acquiring primarily:
- Freestanding, single-tenant, retail properties;
- Properties leased to regional and national retail chains; and
- Properties under long-term, net lease agreements.
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 acquisitions
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.
Our net lease agreements generally:
- Are for initial terms of 10 to 20 years;
- Require the tenant to pay a minimum monthly rent and property
operating expenses (taxes, insurance and maintenance); and
- 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
tenant's 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. We also believe
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.
Since 1970 and through December 31, 1998, Realty Income has acquired
and leased back to regional and national retail chains 944 properties
(including 34 properties that have been sold) and has collected in
excess of 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 that we provide to
retailers.
Page 14
RECENT DEVELOPMENTS
- -------------------
ACQUISITION OF 66 PROPERTIES DURING THE FIRST SIX MONTHS OF 1999.
During the first six months of 1999, we continued implementing our
growth plan, which is intended to increase our funds from operations
per share. As part of our plan, we acquired 66 additional properties
(the "1999 Properties") increasing the number of properties in the
portfolio by 6.8% to 1,036 properties at June 30, 1999 from 970
properties at December 31, 1998. During the first six months of 1999,
we continued to diversify our portfolio with the addition of one new
industry segment, Entertainment, and seven new retail chains. As of
June 30, 1999, our portfolio of 1,036 properties consists of 72
separate retail chains doing business in 22 separate retail segments.
During the first six months of 1999, we invested $88.9 million in the
1999 Properties and properties under development (including accrued
development costs of $5.5 million at June 30, 1999 and excluding
estimated unfunded development costs on properties under construction
at June 30, 1999 of $33.0 million). We also paid $185,000 for lease
commissions and $100,000 for building improvements on existing
properties in our portfolio. The weighted average annual unleveraged
return on the $88.9 million invested in the first six months of 1999
is estimated to be 10.4%, 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 of each property. Since it is
possible that a tenant could default on the payment of contractual
rent, no assurance can be given that the actual return on the funds
invested will not differ from the foregoing percentage.
The 1999 Properties are leased to 17 separate tenants operating in 14
different retail industries. The 1999 Properties are located in 23
states, will contain approximately 623,100 leasable square feet and
are 100% leased under net leases, with an average initial lease term
of 15.7 years. Of the 1999 Properties, 45 were occupied as of August
2, 1999 and the remaining properties were pre-leased and under
construction, pursuant to contracts under which the tenants have
agreed to develop the properties (with development costs funded by
Realty Income) and to begin paying rent when the premises open for
business.
INCREASE IN MONTHLY DISTRIBUTION. In January, April and July 1999,
the monthly distributions were increased $0.0025 to $0.17, $0.1725 and
$0.175 per share, respectively. Realty Income continues its policy of
paying distributions monthly. During the first six months of 1999, we
paid three distributions of $0.17 per share and three distributions of
$0.1725 per share, totaling $1.0275 per share. During the first six
months of 1998, the Company paid three distributions of $0.16 per
share and three distributions of $0.1625 per share, totaling $0.9675
per share. In June and July 1999, we declared distributions of $0.175
per share, which were paid on July 15, 1999 and payable on August 16,
Page 15
1999, respectively. The monthly distribution of $0.175 per share
represents a current annualized distribution of $2.10 per share, and
an annualized distribution yield of approximately 8.8% based on the
last reported sale price of the Company's Common Stock on the NYSE of
$24.00 on July 30, 1999. Although we expect to continue our policy of
paying monthly distributions, there can be no assurance that the
current level of distributions will be maintained by the Company or as
to the actual distribution yield for any future period.
NOTES OFFERING. In January 1999, we issued $20 million of 8.00%
unsecured senior notes due 2009 (the "1999 Notes"). The 1999 Notes
were sold at 98.757% of par to yield 8.10%. The proceeds from the
offering were used to pay down bank borrowings and for other corporate
purposes. Currently, there is no formal trading market for the 1999
Notes and we have not listed and do not intend to list the 1999 Notes
on any securities exchange.
PREFERRED STOCK OFFERINGS. In May 1999, we issued 2,760,000 shares of
9 3/8% class B cumulative redeemable preferred stock ("Class B
Preferred Stock") at a price of $25.00 per share. The Class B
Preferred Stock trades on the New York Stock Exchange ("NYSE") under
the symbol OPrB. The cusip number of the Class B Preferred Stock is
756109-302. Dividends on the Class B Preferred Stock shall be payable
quarterly in arrears. The net proceeds of $66.6 million were used to
repay borrowings under the credit facility.
In July 1999, we issued 1,380,000 shares of 9 1/2% class C cumulative
redeemable preferred stock ("Class C Preferred Stock") at a price of
$25.00 per share. We have applied to list the Class C Preferred Stock
on the NYSE under the symbol OPrC. The cusip number of the Class C
Preferred Stock is 756109-500. Dividends on the Class C Preferred
Stock shall be payable monthly in arrears. The net proceeds of $33.2
million were used to repay borrowings under the credit facility.
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.
In October 1998, we issued 8.25% Monthly Income Senior Notes due 2008,
which are traded on the NYSE under the ticker symbol "OUI". The cusip
number of these Monthly Income Senior Notes is 756109-AA2.
Realty Income had 49 employees as of August 5, 1999.
Page 16
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
Cash and Cash Equivalents
Realty Income is organized for the purpose of operating as an equity
REIT which 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 June 30, 1999, Realty Income had cash and cash
equivalents totaling $16.8 million.
We believe that our cash and cash equivalents on hand, cash provided
by operating activities and borrowing capacity are sufficient to meet
our liquidity needs for the foreseeable future. However, we intend to
utilize additional sources of capital to fund property acquisitions
and to repay our acquisition credit facility.
Capital Funding
Realty Income has a $170 million, three-year revolving, unsecured
acquisition credit facility of which, $52 million expires in December
2000 and $118 million expires in December 2001. The credit facility
currently bears interest at 0.85% over the London Interbank Offered
Rate ("LIBOR") and offers us other interest rate options. As of
August 5, 1999, $73.3 million of borrowing capacity was available to
us under the acquisition credit facility. At that time, the
outstanding balance was $96.7 million with an effective interest rate
of 6.05%. This credit facility has been and is expected to be used to
acquire additional retail properties leased to regional and national
retail chains under long-term lease agreements. Any additional
borrowings will increase our exposure to interest rate risk.
We expect to meet our long-term capital needs for the acquisition of
properties through the issuance of public or private debt or equity.
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/or debt securities.
Through August 5, 1999, $34.5 million in value of common stock,
preferred stock and debt securities has been issued under the
universal shelf registration statement.
We received investment grade corporate credit ratings on our senior
unsecured debt from Duff & Phelps Rating Company, Moody's Investor
Service, Inc., and Standard & Poor's Rating Group in December 1996.
Currently, Duff & Phelps 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 debt. These ratings could change based upon,
among other things, our results of operations and financial condition.
Page 17
We have also received credit ratings from the same rating agentcies on
our preferred stock. Duff & Phelps Rating Company has assigned a
rating of BBB-, Moody's Investor Service, Inc. has assigned a rating
of Ba1, and Standard & Poor's Rating Group has assigned a rating of
BB+. These ratings could change based upon, among other things, our
results of operations and financial condition.
Distributions
Realty Income pays distributions monthly to its common stockholders.
Cash distributions paid to common stockholders during the first six
months of 1999 and 1998 were $27.6 million and $25.5 million,
respectively. During the first six months of 1999, cash distributions
paid to preferred stockholders was $629,000.
FUNDS FROM OPERATIONS ("FFO")
- -----------------------------
For the second quarter of 1999, FFO increased by $688,000 or 4.5% to
$16.0 million versus $15.3 million during the second quarter of 1998.
The following is a reconciliation of net income to FFO, and
information regarding distributions paid and diluted weighted average
number of common shares outstanding for the second quarter of 1999 and
1998 (dollars in thousands):
1999 1998
-------- --------
Net income $ 10,428 $ 10,308
Plus depreciation and amortization 6,237 5,369
Less:
Preferred stock dividends (629) --
Depreciation of furniture,
fixtures and equipment and
amortization of organization costs (22) (40)
Gain on sales of properties -- (311)
-------- --------
Total Funds From Operations $ 16,014 $ 15,326
======== ========
Distributions paid to:
common stockholders $ 13,881 $ 13,083
FFO in excess of distributions $ 2,133 $ 2,243
Diluted weighted average number
of common shares outstanding 26,827,338 26,845,091
Page 18
For the first six months of 1999, FFO increased by $1.9 million or
6.3% to $32.0 million versus $30.1 million during the same period of
1998.
The following is a reconciliation of net income to FFO, and
information regarding distributions paid and diluted weighted average
number of common shares outstanding for the first six months of 1999
and 1998 (dollars in thousands):
1999 1998
-------- --------
Net income $ 20,357 $ 20,232
Plus depreciation and amortization 12,327 10,453
Less:
Preferred stock dividends (629) --
Depreciation of furniture,
fixtures and equipment and
amortization of organization costs (43) (79)
Gain on sales of properties -- (526)
-------- --------
Total Funds From Operations $ 32,012 $ 30,080
======== ========
Distributions paid to:
common stockholders $ 27,560 $ 25,545
FFO in excess of distributions $ 4,452 $ 4,535
Diluted weighted average number
of common shares outstanding 26,826,291 26,442,519
We consider FFO to be an appropriate measure of the performance of an
equity REIT. FFO is used by financial analysts in evaluating REITs
and can be one measure of a REIT's ability to make cash distribution
payments. Presentation of this information provides the reader with
an additional measure to compare the performance of different REITs,
although it should be noted that not all REITs calculate FFO the same
way so comparisons with such REITs may not be meaningful.
We define FFO as net income before gain on sales of properties, plus
depreciation and amortization. In accordance with the recommendations
of the National Association of Real Estate Investment Trusts
("NAREIT"), amortization of deferred financing costs is not added back
to net income to calculate FFO. Amortization of financing costs is
included in interest expense in the consolidated statements of income.
FFO is 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 or to cash flows from
operating, investing, and financing activities as a measure of
liquidity or ability to make cash distributions or to pay debt
service.
Page 19
RESULTS OF OPERATIONS
- ---------------------
The following is a comparison of our results of operations for the
three and six months ended June 30, 1999 to the three and six months
ended June 30, 1998.
Rental revenue was $24.9 million for the second quarter of 1999 versus
$20.3 million for the comparable quarter of 1998, an increase of 22.7%
or $4.6 million. The increase in rental revenue was primarily due to
the acquisition of 66 properties during the first six months of 1999
and 149 properties during 1998 (the "New Properties"). Of the $4.6
million increase in rental revenue, $4.4 million was attributable to
revenue from New Properties. The New Properties generated revenue of
$5.8 million in the second quarter of 1999 compared to $1.4 million in
the second quarter of 1998.
Rental revenue was $48.8 million for the first six months of 1999
versus $39.5 million for the comparable period of 1998, an increase of
23.5% or $9.3 million. The increase in rental revenue was primarily
due to the acquisition of the New Properties. "). Of the $9.3 million
increase in rental revenue, $9.0 million was attributable to revenue
from New Properties. The New Properties generated revenue of $10.6
million in the first six months of 1999 compared to $1.6 million in
the comparable period of 1998, an increase of $9.0 million.
Of the 1,036 properties in the portfolio as of June 30, 1999, 1,029
are single-tenant properties with the remaining properties being
multi-tenant properties. Of the 1,029 single-tenant properties,
1,021, or 99.2%, were net leased with an average remaining lease term
(excluding extension options) of approximately 8.7 years. Of our
1,021 leased single-tenant properties, 1,013 or 99.2% were under
leases that provide for increases in rents through:
- Base rent increases tied to a consumer price index with
adjustment ceilings;
- Overage rent based on a percentage of the tenants' gross
sales; or
- Fixed increases.
Some leases contain more than one of these clauses. Percentage rent,
which is included in rental revenue, was $106,000 during the second
quarter of 1999 and 1998. Same store rents generated on 801 leased
properties owned during all of both the second quarter of 1999 and
1998 increased by $193,000 or 1.0%, to $18.60 million from $18.41
million. Same store rents generated on the same 801 leased properties
owned during all of both the first six months of 1999 and 1998
increased by $449,000 or 1.2%, to $37.36 million from $36.91 million.
Approximately 58% of our annualized rental revenue is attributable to
properties that were acquired over the last four and a half years. A
majority of the leases on these acquisitions provide for rent
increases after the fifth year of the lease. We anticipate rental
Page 20
increases on some of these acquisitions to start in the second half of
the year 2000.
At June 30, 1999, 1,028 or 99.2% of the 1,036 properties in the
portfolio were under lease agreements with third party tenants. At
June 30, 1999, we had eight properties that were not under lease, as
compared to five at December 31, 1998 and three at June 30, 1998.
Depreciation and amortization was $6.2 million in the second quarter
of 1999 versus $5.4 million in the second quarter of 1998.
Depreciation and amortization was $12.3 million in the first six
months of 1999 versus $10.5 million in the first six months of 1998.
The increase in 1999 was primarily due to depreciation of the New
Properties.
Interest expense in the second quarter of 1999 increased by $3.2
million to $6.05 million, as compared to $2.86 million in the second
quarter of 1998. Interest expense was higher in second quarter of
1999 than in the second quarter of 1998 due to an increase in the
average balances outstanding.
The following is a summary of the five components of interest expense
for the second quarter of 1999 and 1998 (dollars in thousands):
1999 1998 Net Change
------- ------- ----------
Interest on outstanding
loans and notes $ 5,928 $ 2,894 $ 3,034
Amortization of settlements
on treasury lock agreements 189 (29) 218
Credit facility commitment fees 65 57 8
Amortization of credit facility
origination costs and deferred
bond financing costs 207 96 111
Interest capitalized (344) (154) (190)
-------- -------- --------
Interest expense $ 6,045 $ 2,864 $ 3,181
======== ======== ========
Credit facility and notes outstanding (dollars in thousands)
- ------------------------------------------------------------
Three months ended June 30, 1999 1998 Net Change
------- ------- ----------
Average outstanding balances $321,660 $157,188 $164,472
Average interest rates 7.39% 7.38%
Page 21
Interest expense in the first six months of 1999 increased by $6.6
million to $11.93 million, as compared to $5.36 million in the first
six months of 1998. Interest expense was higher in 1999 than in 1998
due to an increase in the average balances outstanding, which was
partially offset by lower average interest rates.
The following is a summary of the five components of interest expense
for the first six months of 1999 and 1998 (dollars in thousands):
1999 1998 Net Change
------- ------- ----------
Interest on outstanding
loans and notes $ 11,643 $ 5,343 $ 6,300
Amortization of settlements
on treasury lock agreements 378 (57) 435
Credit facility commitment fees 129 113 16
Amortization of credit facility
origination costs and deferred
bond financing costs 413 190 223
Interest capitalized (638) (234) (404)
-------- -------- --------
Interest expense $ 11,925 $ 5,355 $ 6,570
======== ======== ========
Credit facility and notes outstanding (dollars in thousands)
- ------------------------------------------------------------
Six months ended June 30, 1999 1998 Net Change
------- ------- ----------
Average outstanding balances $314,118 $143,324 $170,794
Average interest rates 7.48% 7.52%
General and administrative expenses increased by $44,000 to $1.76
million in the second quarter of 1999 versus $1.71 million in the
second quarter of 1998. General and administrative expenses as a
percentage of revenue decreased to 7.0% in the second quarter of 1999
as compared to 8.4% in 1998.
General and administrative expenses increased by $225,000 to $3.4
million in the first six months of 1999 versus $3.2 million in the
first six months of 1998. General and administrative expenses as a
percentage of revenue decreased to 7.0% in the first six months of
1999 as compared to 8.0% in 1998.
Page 22
In March 1998, the Emerging Issues Task Force reached a consensus on
Issue No. 97-11, "Accounting for Internal Costs Relating to Real
Estate Property Acquisitions" ("EITF 97-11"). EITF 97-11 provides
that internal costs of preacquisition activities incurred in
connection with the acquisition of a property that will be classified
as operating at the date of acquisition should be expensed as
incurred. Prior to EITF 97-11, these costs were capitalized. Of the
increases in general and administrative expenses during the first six
months of 1999, approximately $81,000 is due to the change in
accounting for internal acquisition costs. EITF 97-11 was effective
at the end of the first quarter of 1998.
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 June 30, 1999, eight properties
were available for lease as compared to five at December 31, 1998 and
three at June 30, 1998.
Property expenses were $437,000 in the second quarter of 1999 and
$426,000 in 1998. The $11,000 increase in property expenses is
primarily attributable to costs associated with vacant properties,
which was partially offset by lower insurance costs. We anticipate
property expenses to increase as we acquire additional properties.
Property expenses were $878,000 in the first six months of 1999 and
$899,000 in the first six months of 1998. The $21,000 decrease in
property expenses is primarily attributable to lower insurance costs,
which was partially offset by costs associated with vacant properties.
During the second quarter of 1998, we sold two properties (one child
care center and one restaurant) for a total of $822,000 and recognized
a gain of $311,000. No properties were sold in the first six months
of 1999.
During the first six months of 1998, we sold five properties (two
child care centers, two restaurants and a multi-tenant location) for a
total of $2.8 million and recognized a gain of $526,000.
In the second quarter of 1999 and 1998, we had net income of $10.4
million and $10.3 million, respectively. Rental revenue increased by
$4.5 million due to an increase in rental revenue from New Properties
of $4.4 million, which was substantially offset by an increase of $4.0
million in the following expenses:
- Depreciation and amortization of $868,000; and
- Interest expense of $3.18 million.
Page 23
In the first six months of 1999 and 1998, we had net income of $20.4
million and $20.2 million, respectively. Rental revenue increased by
$9.3 million due to an increase in rental revenue from New Properties
of $9.0 million, which was substantially offset by an increase of $8.4
million in the following expenses:
- Depreciation and amortization of $1.87 million; and
- Interest expense of $6.57 million.
For the three and six months ended June 30, 1999, we paid preferred
stock dividends of $629,000.
PROPERTIES
- ----------
As of June 30, 1999, we owned a diversified portfolio of 1,036
properties located in 45 states with over 8.4 million square feet of
leasable space. At June 30, 1999, 1,021 or 98.6% of the 1,036
properties were 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.
Our net leased retail properties are primarily leased to regional and
national retail chain store operators. The average leasable retail
space of the 1,036 properties is approximately 8,200 square feet on
approximately 51,400 square feet of land. 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.
Page 24
The following table sets forth certain information regarding our
properties classified according to the business of the respective
tenants (dollars in thousands):
Annualized Percentage of Total
Rent as of Rental Revenue for
Number June 30, 1999(1) the Years Ended
of ------------------- -------------------
Prop- Rental Percentage
Industry erties Revenue of Total 1998 1997 1996
- -------------------- ------ -------- ---------- ------ ------ ------
Apparel Stores 5 $ 3,927 3.6% 4.1% 0.7% --%
Automotive Parts 138 9,541 8.7 7.8 9.1 10.5
Automotive Service 105 7,202 6.5 7.5 6.4 4.8
Book Stores 1 450 0.4 0.6 0.5 --
Business Services 1 124 0.1 * -- --
Child Care 336 27,927 25.4 29.2 35.9 42.0
Consumer Electronics 37 4,431 4.0 5.4 6.5 0.9
Convenience Stores 70 6,435 5.9 6.1 5.5 4.6
Craft and Novelty 2 425 0.4 * -- --
Drug Stores 1 235 0.2 0.1 -- --
Entertainment 4 1,545 1.4 -- -- --
General Merchandise 11 687 0.6 * -- --
Grocery Stores 2 771 0.7 * -- --
Health and Fitness 6 3,329 3.0 0.1 -- --
Home Furnishings 35 6,872 6.2 7.8 5.6 4.4
Home Improvement 35 4,381 4.0 * -- --
Office Supplies 8 2,476 2.3 3.0 1.7 --
Pet Supplies and
Services 8 1,549 1.4 0.6 0.2 --
Private Education 5 1,497 1.4 0.9 -- --
Restaurants 177 14,464 13.1 16.2 19.8 24.4
Shoe Stores 4 1,234 1.1 0.8 0.2 --
Video Rental 35 4,501 4.1 3.8 0.6 --
Other 10 6,054 5.5 6.0 7.3 8.4
- -------------------- ------ -------- ------ ------ ------ ------
Totals 1,036 $110,057 100.0% 100.0% 100.0% 100.0%
==================== ====== ======== ====== ====== ====== ======
* Less than 0.1%
[FN]
(1) Annualized rental revenue is calculated by multiplying the
monthly contractual base rent as of June 30, 1999 for each of the
properties by 12 and adding the previous 12 month's historic
percentage rent, which totaled $1.8 million (i.e., additional rent
calculated as a percentage of the tenant's gross sales above a
specified level.) For properties under construction, an estimated
contractual base rent is used based upon the estimated total costs of
each property.
</FN>
Page 25
Of the 1,036 properties in the portfolio at June 30, 1999, 1,029 were
single-tenant properties with the remaining properties being multi-
tenant properties. As of June 30, 1999, 1,021 of the 1,029 single-
tenant properties, or 99.2%, were net leased with an average remaining
lease term (excluding extension options) of approximately 8.7 years.
The following table sets forth certain information regarding the
timing of the lease term expirations (excluding extension options) on
our 1,021 net leased, single-tenant retail properties as of June 30,
1999.
Number of Annualized Percent of
Leases Rent (1) (2) Annualized
Year Expiring (2) (in thousands) Rent
- ------ ------------ -------------- ----------
1999 19 $ 1,055 1.0%
2000 36 1,896 1.8
2001 47 3,904 3.7
2002 85 6,828 6.5
2003 68 5,607 5.3
2004 113 9,347 8.9
2005 81 6,029 5.7
2006 28 2,528 2.4
2007 94 6,539 6.2
2008 68 5,838 5.5
2009 23 2,829 2.7
2010 42 3,382 3.2
2011 38 5,497 5.2
2012 52 5,874 5.6
2013 103 16,431 15.6
2014 36 6,139 5.8
2015 31 4,047 3.8
2016 13 1,989 1.9
2017 11 4,127 3.9
2018 17 2,158 2.0
2019 14 2,475 2.4
2033 2 940 0.9
- ------ ------- ---------- -------
Totals 1,021 $105,459 100.0%
====== ======= ========== =======
[FN]
(1) Annualized rent is calculated by multiplying the monthly
contractual base rent as of June 30, 1999 for each of the properties
by 12 and adding the previous 12 month's historic percentage rent,
which totaled $1.8 million (i.e., additional rent calculated as a
percentage of the tenant's 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.
(2) This table does not include seven multi-tenant properties and
eight vacant, unleased single-tenant properties owned by the Company.
The lease expirations for properties under construction are based on
the estimated date of completion of such properties.
</FN> Page 26
The following table sets forth certain state-by-state information
regarding Realty Income's property portfolio as of June 30, 1999.
Annualized
Approximate Rent (1) Percent of
Number of Percent Leasable (in thou- Annualized
State Properties Leased Square Feet sands) Rent
- ------------ ---------- ------- ----------- ---------- ----------
Alabama 9 100% 63,300 $ 609 0.6%
Arizona 31 100 211,800 2,878 2.6
Arkansas 5 100 36,700 614 0.6
California 63 92 1,145,200 14,262 13.0
Colorado 43 100 275,700 3,801 3.5
Connecticut 10 100 223,800 2,976 2.7
Delaware 1 100 5,400 72 0.1
Florida 84 99 817,600 10,151 9.2
Georgia 51 100 320,600 4,872 4.4
Idaho 12 100 58,500 852 0.8
Illinois 35 100 258,300 3,546 3.2
Indiana 29 100 170,400 2,232 2.0
Iowa 10 100 67,900 675 0.6
Kansas 23 100 240,400 2,600 2.4
Kentucky 13 100 43,500 1,101 1.0
Louisiana 5 100 39,600 501 0.5
Maryland 8 100 48,300 714 0.6
Massachusetts 8 100 57,500 1,061 1.0
Michigan 11 100 73,500 1,011 0.9
Minnesota 25 100 261,200 2,809 2.6
Mississippi 15 100 148,500 1,139 1.0
Missouri 33 100 203,800 2,589 2.4
Montana 2 100 30,000 291 0.3
Nebraska 10 100 98,700 1,231 1.1
Nevada 7 100 86,400 1,319 1.2
New Hampshire 1 100 6,400 127 0.1
New Jersey 4 100 45,400 602 0.5
New Mexico 5 100 46,000 335 0.3
New York 18 94 223,100 4,162 3.8
North Carolina 32 100 171,400 2,968 2.7
North Dakota 1 100 22,000 65 0.1
Ohio 66 100 331,200 5,336 4.8
Oklahoma 17 100 102,200 1,299 1.2
Oregon 17 100 92,400 1,245 1.1
Pennsylvania 23 100 168,600 2,285 2.1
South Carolina 23 100 93,000 1,549 1.4
South Dakota 1 100 6,100 86 0.1
Tennessee 25 96 221,300 2,618 2.4
Texas 155 100 1,288,900 13,921 12.6
Utah 9 100 58,200 808 0.7
Virginia 29 100 133,100 2,802 2.5
(continued on the next page)
Page 27
(continued)
Annualized
Approximate Rent (1) Percent of
Number of Percent Leasable (in thou- Annualized
State Properties Leased Square Feet sands) Rent
- ------------ ---------- ------- ----------- ---------- ----------
Washington 43 100 252,600 3,384 3.1
West Virginia 2 100 16,800 147 0.1
Wisconsin 18 100 167,300 2,143 1.9
Wyoming 4 100 20,100 269 0.2
- -------------- -------- ------- ----------- ---------- ---------
Totals/Average 1,036 99% 8,452,700 $110,057 100.0%
============== ======== ======= =========== ========== =========
[FN]
(1) Annualized rent is calculated by multiplying the monthly
contractual base rent as of June 30, 1999 for each of the properties
by 12 and adding the previous 12 month's historic percentage rent,
which totaled $1.8 million (i.e., additional rent calculated as a
percentage of the tenant's 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>
The table on the next page sets forth certain information regarding
the properties owned by Realty Income as of June 30, 1999, classified
according to the retail business types and the level of services they
provide (dollars in thousands).
Page 28
Percent of
Number of Annualized Annualized
Industry Properties Rent (1) Rent
- -------- ---------- ---------- ----------
Tenants selling goods
- ---------------------
Apparel Stores 5 $ 3,927 3.6%
Automotive Parts 81 4,738 4.3
Book Stores 1 450 0.4
Consumer Electronics 37 4,431 4.0
Craft and Novelty 2 425 0.4
Drug Stores 1 235 0.2
General Merchandise 11 687 0.6
Grocery Stores 2 771 0.7
Home Furnishings 35 6,872 6.2
Home Improvement 13 1,377 1.3
Office Supplies 8 2,476 2.3
Pet Supplies 2 467 0.4
Shoe Stores 4 1,234 1.1
---------- ---------- ----------
202 28,090 25.5
---------- ---------- ----------
Tenants selling goods and services
- ----------------------------------
Automotive Parts 57 4,803 4.4
Business Services 1 124 0.1
Convenience Stores 70 6,435 5.9
Home Improvement 22 3,004 2.7
Pet Supplies and Services 6 1,082 1.0
Restaurants 177 14,464 13.1
Video Rental 35 4,501 4.1
---------- ---------- ----------
368 34,413 31.3
---------- ---------- ----------
Tenants providing services
- --------------------------
Automotive Service 105 7,202 6.5
Child Care 336 27,927 25.4
Entertainment 4 1,545 1.4
Health and Fitness 6 3,329 3.0
Private Education 5 1,497 1.4
Other 10 6,054 5.5
---------- ---------- ----------
466 47,554 43.2
---------- ---------- ----------
TOTALS 1,036 $ 110,057 100.0%
========== ========== ==========
Page 29
[FN]
(1) Annualized rent is calculated by multiplying the monthly
contractual base rent as of June 30, 1999 for each of the properties
by 12 and adding the previous 12 month's historic percentage rent,
which totaled $1.8 million (i.e., additional rent calculated as a
percentage of the tenant's 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>
THE YEAR 2000 ISSUE
===================
Some computer programs identify a year by using only two digits
instead of four. This method of identification could cause these
programs to fail or create erroneous results in the year 2000. This
situation has been referred to generally as the Year 2000 issue.
The first essential component of our Year 2000 assessment program was
to determine if our internal mission-critical computer systems were
compliant. We have completed a review of our software and hardware
and determined (through a combination of internal testing and vendor
representations that their products have been tested and are
compliant) that all internal mission-critical systems (those systems
that are necessary to conduct our business activities) are Year 2000
compliant. We have also reviewed our non-mission critical software
and hardware and have identified a few third-party products that are
not Year 2000 compliant. We have scheduled upgrades or replacement of
these non-compliant products before the end of October 1999. We
believe that the total cost of remediation associated with our
corporate level computer systems will be less than $30,000, of which
less than $20,000 is anticipated to be spent during 1999. We
anticipate that we will complete remediation of our internal computer
systems before the end October 1999.
The second essential component of our Year 2000 assessment program was
to ensure that our tenants are assessed for Year 2000 compliance. We
had discussions with each of our tenants that represent more than 0.5%
of our revenue in order to assess their readiness for the Year 2000
issue. Of this group, tenants representing approximately 98% of our
revenue from these have confirmed that they are Year 2000 compliant or
anticipate being compliant by the end of the third quarter of 1999.
Due to the nature of the tenants' businesses, we do not believe the
Year 2000 issue will materially impact the tenants' ability to pay
rent. However, the failure of one or more tenants as a result of the
Year 2000 issue could have a material adverse effect on our results of
operations or financial position.
The third component of our Year 2000 assessment program was to ensure
that our mission-critical vendors are assessed for Year 2000
compliance. We have had discussions with these significant vendors in
Page 30
order to assess their ability to successfully resolve the Year 2000
issue. Of our mission-critical vendors, 100% have confirmed that they
are Year 2000 compliant or anticipate being compliant by the end of
the third quarter of 1999. Our transfer agent has advised us it is
Year 2000 compliant.
While we are continually reviewing the Year 2000 preparedness of our
key tenants and vendors, we rely on their representations and can not
be assured that all of their computer systems will be Year 2000
compliant. It is possible that relevant information has not been made
available for our assessment, or that potential solutions will not be
within our control.
We continue to evaluate the Year 2000 issue, which includes the
determination of whether or not to implement a contingency plan. We
have completed our assessment program and we are currently in the
implementation and replacement stage of our remediation program.
Though we do not expect the Year 2000 issue to have a material adverse
effect on our results of operations or financial position, there can
be no assurances of that position.
IMPACT OF INFLATION
===================
Tenant leases generally provide for limited increases in rent as a
result of increases in the tenant's 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. However, 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 98.6% or 1,021 of the properties in the portfolio are
leased to tenants under net leases in which the tenant is responsible
for property costs and expenses. These features in the leases reduce
our exposure to rising property expenses due to inflation.
Inflation and increased costs may have an adverse impact on the
tenants if increases in the tenant's operating expenses exceed
increases in revenue.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
====================================================================
We are exposed to interest rate changes primarily as a result of our
credit facility and long-term debt 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 flows and to lower our
Page 31
overall borrowing costs. To achieve our objectives we borrow
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 do not enter into any transactions
for speculative or trading purposes.
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
----------------------
There- Fair
2001 after Total Value (2)
---- ------ ------ ---------
Fixed rate debt -- $230.0(1) $230.0 $221.1
Average interest rate 7.99% 7.99%
Variable rate debt $ 93.3 -- $ 93.3 $ 93.3
Average interest rate 6.06% -- 6.06%
[FN]
(1) $110 million matures in 2007, $100 million matures in 2008 and
$20 million matures in 2009.
(2) The fair value of the fixed rate debt is based upon the closing
market price per each note at June 30, 1999. 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>
As the table incorporates only those exposures that exist as of
June 30, 1999, 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 will depend on the
exposures that arise during the period, our hedging strategies at the
time, and interest rates.
PART II. OTHER INFORMATION
- ---------------------------
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The annual meeting of stockholders of Realty Income Corporation was
held on May 5, 1999, at which two directors were elected to the board
of directors. Proxies for the meeting were solicited pursuant to
Section 14(a) of the Securities Exchange Act of 1934 and there was no
solicitation in opposition to management's solicitations.
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All of management's nominees for directors as listed in the proxy
statement were elected with the following vote:
Authority
Year Term Shares to vote
Expires Voted For Percent withheld
--------- ---------- ------- ---------
Donald R. Cameron 2002 20,351,735 75.9 570,415
Willard H. Smith Jr. 2002 20,353,855 75.9 568,295
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 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).
3.3 Bylaws of the Company (filed as Appendix C to the
Company's 1997 Proxy Statement 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).
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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 an exhibit 4.3 to
Realty Income's Form 8-K, dated October 27, 1998
and incorporated herein by reference).
4.7 Form of 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).
27 Financial Data Schedule, filed herein
B. One report on Form 8-K was filed by registrant during the
quarter for which this report is filed.
A report on Form 8-K dated May 24, 1999 was filed on
May 25, 1999 reporting the issuance of 2,760,000 shares of
our 9 3/8% Class B Cumulative Redeemable Preferred Stock.
Page 34
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/ GARY M. MALINO
Date: August 6, 1999 -------------------------------------
Gary M. Malino, Senior Vice President
Chief Financial Officer (Principal
Financial and Accounting Officer)
EXHIBIT INDEX
Exhibit No. Description
=========== ===========
27 Financial Data Schedule
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