UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 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, 1997, 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) DELAWARE ======== (State or other jurisdiction of incorporation or organization) 33-0580106 ========== (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 checkmark 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 22,988,237 shares of common stock outstanding as of May 13, 1997. Page 1
REALTY INCOME CORPORATION Form 10-Q March 31, 1997 Table of Contents ----------------- PART I. FINANCIAL INFORMATION Pages ============================== ----- Item 1: Financial Statements Consolidated Balance Sheets........................ 3-4 Consolidated Statements of Income.................. 5 Consolidated Statements of Cash Flows.............. 6-7 Notes to Consolidated Financial Statements......... 8-11 Item 2: Management's Discussion and Analysis Of Financial Condition and Results Of Operations......12-28 PART II. OTHER INFORMATION ========================== Item 6: Exhibits and Reports on Form 8-K...................29-30 SIGNATURE................................................... 31 EXHIBIT INDEX............................................... 32 EXHIBITS....................................................33-39 Page 2
PART I. FINANCIAL INFORMATION ============================== ITEM 1. FINANCIAL STATEMENTS REALTY INCOME CORPORATION AND SUBSIDIARIES Consolidated Balance Sheets =========================== March 31, 1997 and December 31, 1996 (dollars in thousands, except per share data) 1997 1996 (Unaudited) =========== ========= ASSETS Real estate, at cost: Land $ 170,736 $ 165,598 Buildings and improvements 409,777 398,942 --------- --------- 580,513 564,540 Less - accumulated depreciation and amortization (141,649) (138,307) --------- --------- Net real estate 438,864 426,233 Cash and cash equivalents 3,332 1,559 Accounts receivable 1,219 1,905 Due from affiliates 326 383 Other assets 2,386 2,183 Goodwill, net 21,593 21,834 --------- --------- TOTAL ASSETS $ 467,720 $ 454,097 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Distributions payable $ 3,620 $ 3,619 Accounts payable and accrued expenses 335 1,172 Other liabilities 3,792 5,065 Line of credit payable 88,200 70,000 --------- --------- TOTAL LIABILITIES 95,947 79,856 --------- --------- Continued on next page Page 3
(continued) REALTY INCOME CORPORATION AND SUBSIDIARIES Consolidated Balance Sheets =========================== March 31, 1997 and December 31, 1996 (dollars in thousands, except per share data) 1997 1996 (Unaudited) =========== ========= Stockholders' equity Preferred stock, par value $1.00 per share, 5,000,000 shares authorized, no shares issued or outstanding -- -- Common stock, par value $1.00 per share, 40,000,000 shares authorized, 22,988,237 and 22,979,537 shares issued and outstanding in 1997 and 1996, respectively 22,988 22,980 Capital in excess of par value 516,204 516,004 Accumulated distributions in excess of net income (167,419) (164,743) --------- --------- TOTAL STOCKHOLDERS' EQUITY 371,773 374,241 --------- --------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 467,720 $ 454,097 ========= ========= 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 months ended March 31, 1997 and 1996 (dollars in thousands, except per share data) (Unaudited) 1997 1996 ========== ========== REVENUE Rental $ 15,449 $ 13,728 Interest 22 23 Other 9 27 ---------- ---------- 15,480 13,778 ---------- ---------- EXPENSES Depreciation and amortization 4,464 4,074 General and administrative 1,253 1,310 Property 491 446 Interest 1,312 520 Provision for impairment losses -- 323 ---------- ---------- 7,520 6,673 ---------- ---------- Income from operations 7,960 7,105 Gain on sales of properties 225 745 ---------- ---------- NET INCOME $ 8,185 $ 7,850 ========== ========== Net income per share $ 0.36 $ 0.34 ========== ========== Weighted average number of shares outstanding 22,989,728 22,976,891 ========== ========== 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 three months ended March 31, 1997 and 1996 (dollars in thousands) (Unaudited) 1997 1996 ========= ========= CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 8,185 $ 7,850 Adjustments to net income: Depreciation and amortization 4,464 4,074 Provision for impairment losses -- 323 Gain on sales of properties (225) (745) Change in assets and liabilities: Accounts receivable and other assets 657 614 Accounts payable, accrued expenses and other liabilities (2,053) (59) --------- --------- Net cash provided by operating activities 11,028 12,057 --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from sales of properties 1,339 1,523 Acquisition of and additions to properties (17,933) (3,241) --------- --------- Net cash used in investing activities (16,594) (1,718) --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Payments of distributions (10,861) (15,969) Proceeds from line of credit 18,200 21,300 Payment of line of credit -- (2,700) Payment of notes payable -- (12,597) Stock offering costs -- (31) --------- --------- Net cash provided by (used in) financing activities 7,339 (9,997) --------- --------- Continued on next page Page 6
(continued) REALTY INCOME CORPORATION AND SUBSIDIARIES Consolidated Statements Of Cash Flows ===================================== For the three months ended March 31, 1997 and 1996 (dollars in thousands) (Unaudited) 1997 1996 ========= ========= Net increase in cash and cash equivalents 1,773 342 Cash and cash equivalents, beginning of period 1,559 1,650 --------- --------- Cash and cash equivalents, end of period $ 3,332 $ 1,992 ========= ========= Interest paid during the first three months of 1997 and 1996 was $1.2 million and $421,000, respectively. 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 ========================================== March 31, 1997 (Unaudited) 1. Management Statement and General - ------------------------------------ The financial statements of Realty Income Corporation ("Realty Income" or the "Company") were prepared from the books and records of the Company without audit or verification and in the opinion of management 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 the audited financial statements of the Company for the year ended December 31, 1996, which are included in the Company's 1996 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. Credit Facility - ------------------- The Company has a $130 million, three year, revolving, unsecured acquisition credit facility that expires in November 1999. As of March 31, 1997 and December 31, 1996, the outstanding balance on the credit facility was $88.2 million and $70.0 million, respectively, with an effective interest rate of approximately 6.89% and 6.85%, respectively. A commitment fee of 0.15%, per annum, accrues on the average amount of the unused available credit commitment. The credit facility is subject to various leverage and interest coverage ratio limitations, all of which the Company is and has been in compliance with. For the three months ended March 31, 1997 and 1996, interest of $36,000 and $13,000, respectively, was capitalized on properties under construction. Page 8
3. Properties - -------------- At March 31, 1997, the Company owned a diversified portfolio of 747 properties located in 42 states. Of the Company's properties, 740 are single tenant properties with the remaining properties being multi-tenant properties. At March 31, 1997, five properties were vacant and available for lease. One of the vacant properties was sold in May 1997 at a nominal gain. Eleven retail properties located in six states were acquired during the first three months of 1997 at an aggregate cost of approximately $16.0 million (excluding the estimated unfunded development costs totaling $1.6 million on five properties under construction). The Company also invested $2.0 million in nine development properties acquired in 1996. No additional capital expenditures were incurred during the first quarter of 1997. Total Invested through Tenant Industry City/State 3/31/97 ==================== =========== ============ =========== 1st Quarter Aaron Rents Home Furnishings Arlington, TX $ 1,845,000 Aaron Rents Home Furnishings Cedar Park, TX 1,079,000 Aaron Rents Home Furnishings Houston, TX 1,551,000 Barnes & Noble Book Store Tampa, FL 4,693,000 Econo Lube N' Tune(1) Auto Service Charleston, SC 218,000 Econo Lube N' Tune(1) Auto Service Columbia, SC 421,000 Econo Lube N' Tune(1) Auto Service Durham, NC 355,000 Econo Lube N' Tune(1) Auto Service Greensboro, NC 362,000 Econo Lube N' Tune(1) Auto Service Greenville, SC 222,000 Jiffy Lube Auto Service Springboro, OH 711,000 OfficeMax Office Supplies Lakewood, CA 4,495,000 ----------- Properties acquired in 1997 15,952,000 Funding in 1997 of buildings under development on land acquired in 1996 1,981,000 ----------- Total Invested $17,933,000 =========== (1) The Company acquired these properties as undeveloped land and is funding construction and other costs relating to the development of the properties by the tenant. The tenant has entered into leases covering these properties and is contractually obligated to complete construction on a timely basis and to pay construction cost overruns to the extent they exceed the construction budget by more than a predetermined percentage. Page 9
4. Gain on Sales of Properties - ------------------------------- For the three months ended March 31, 1997, the Company sold four properties (one multi-tenant, two restaurant and one child care center) for a total of $1.3 million and recognized a gain of $225,000. For the three months ended March 31, 1996, the Company sold one restaurant property for $1.5 million and recognized a gain of $745,000. 5. Distributions Paid and Payable - ---------------------------------- During the three months ended March 31, 1997, the Company paid three monthly distributions of $0.1575 per share, totaling $0.4725 per share. As of March 31, 1997, a distribution of $0.1575 per share had been declared (and was paid on April 15, 1997). 6. Employee Benefit Plan - ------------------------- As a result of the merger with R.I.C. Advisor, Inc. (the "Advisor") on August 17, 1995, (the "Merger") the Company assumed a defined benefit pension plan (the "Plan") covering substantially all of its employees. The Plan was terminated on January 2, 1996 and final disbursement of the Plan's assets occurred February 24, 1997. At March 31, 1997 and December 31, 1996, benefit obligations in excess of plan assets were $0 and $2.3 million, respectively, and are included in other liabilities in the accompanying balance sheet. In connection with the Merger, the Company assumed a benefit obligation of $1.9 million. The Merger agreement provides for indemnification by the former shareholders of the Advisor with respect to increases in the benefit obligation. A receivable from the Advisor's former shareholders has been recorded as of March 31, 1997 and December 31, 1996 for $326,000 and $383,000, respectively, and is included as due from affiliates in the accompanying consolidated balance sheets. Page 10
7. Derivative Financial Instrument - ----------------------------------- The Company has only limited involvement with a derivative financial instrument and does not use it for trading purposes. The derivative financial instrument is used to manage well- defined interest rate risks. In December 1996, the Company entered into a treasury interest rate lock agreement to hedge against rising interest rates applicable to its anticipated debt offering, see note 8. Under the interest rate lock agreement, the Company receives or makes a payment based on the differential between a specified interest rate, 6.537%, and the actual 10-year treasury interest rate on notional principal of $90 million, at the end of six months. Based on the 10-year treasury interest rate at May 1, 1997, the Company realized a $1.1 million gain on the agreement. 8. Subsequent Events - --------------------- A. Realty Income issued $110 million of 7.75% Notes due May 2007 (the "Notes"). The Notes were sold at 99.929 percent of par for a yield to the investors of 7.76%. After taking into effect the $1.1 million gain realized on the treasury interest rate lock agreement, see note 7, the effective interest rate to the Company on the Notes is 7.62%. The net proceeds from the sale of the Notes were used to repay $93.7 million of outstanding borrowings under the Company's credit facility and for other corporate purposes. Interest on the Notes is payable semiannually each May and November, commencing in November 1997. Currently, there is no formal trading market for the Notes and the Company has not and does not intend to list the Notes on any security exchange. B. Effective May 13, 1997, Thomas A. Lewis succeeded William E. Clark as Chief Executive Officer of the company. Mr. Lewis has been an officer of the Company since 1987 and has served as the Vice Chairman of the Board of Directors since 1994. Mr. Clark will continue as Chairman of the Board of Directors. Page 11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL ======= Realty Income Corporation ("Realty Income" or the "Company") is a fully integrated, self-administered and self-managed real estate investment trust ("REIT") which management believes is the nation's largest publicly-traded owner of freestanding, single- tenant, retail properties diversified geographically and by industry and operated under net lease agreements. As of April 1, 1997, the Company owned a diversified portfolio of 747 properties located in 42 states with over 5.4 million square feet of leasable space. Over 99% of the Company's properties were leased as of April 1, 1997. Realty Income adheres to a focused strategy of acquiring freestanding, single-tenant, retail properties leased to national and regional retail chains under long-term, net lease agreements. The Company typically acquires and then leases back, retail store locations from retail chain store operators, providing capital to the operators for continued expansion and other purposes. The Company's 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 or additional rent calculated as a percentage of tenant's gross sales above a specific level. Since 1970 and through December 31, 1996, Realty Income has acquired and leased back to national and regional retail chains over 700 properties (including 25 properties that have been sold) and has collected in excess of 98% of the original contractual rent obligation on these properties. Realty Income believes that the long-term ownership of an actively managed, diversified portfolio of retail properties leased under long-term, net lease agreements can produce consistent, predictable income and the potential for long-term capital appreciation. Management believes that long-term leases, coupled with tenants assuming responsibility for property expenses under the net lease structure, generally produce a more predictable income stream than many other types of real estate portfolios. As of April 1, 1997, the Company's single-tenant properties were leased pursuant to leases with an average remaining term (excluding extension options) of approximately 8.4 years. The Company is a fully integrated real estate company with in- house acquisition, leasing, legal, financial underwriting, portfolio management and capital markets expertise. The six Page 12
officers of the Company, who have each managed the Company's properties and operations for between six and 13 years, owned approximately 1.5% of the Company's outstanding common stock as of May 13, 1997. The directors and officers of the Company, as a group, owned approximately 4.0% of the Company's outstanding common stock as of May 13, 1997. Realty Income had 35 employees as of May 13, 1997. The Company's primary business objective is to generate a consistent and predictable level of funds from operations ("FFO") per share and distributions to stockholders. Additionally, the Company generally will seek to increase FFO per share and distributions to stockholders through both active portfolio management and the acquisition of additional properties. The Company also seeks to lower the ratio of distributions to stockholders as a percentage of FFO in order to allow internal cash flow to be used to fund additional acquisitions and for other corporate purposes. The Company's portfolio management focus includes (i) contractual rent increases on existing leases; (ii) rental increases at the termination of existing leases when market conditions permit; and (iii) the active management of the Company's property portfolio, including selective sales of properties. The Company generally pursues the acquisition of additional properties under long-term, net lease agreement with initial contractual base rent which, at the time of acquisition and as a percentage of acquisition costs, is in excess of the Company's estimated cost of capital. Other Information ----------------- Thomas A. Lewis succeeded William E. Clark as Chief Executive Officer of the Company effective May 13, 1997. Mr. Lewis has been an officer of the Company since 1987 and has served as the Vice Chairman of the Board of Directors since 1994. Mr. Clark will continue as Chairman of the Board of Directors. As a result of the merger with R.I.C. Advisor, Inc., (the "Advisor") in August 1995, the Company assumed a defined benefit pension plan (the "Plan") covering substantially all of its employees. The Plan was terminated in January 1996 and final disbursement of the Plan's assets occurred in February 1997. At the time the Plan's assets were disbursed, the Company met its obligation to the Plan of $2.2 million. The Company's common stock is listed on the New York Stock Exchange under the symbol "O." Page 13
LIQUIDITY AND CAPITAL RESOURCES =============================== Cash Reserves ------------- Realty Income was 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 lease revenue. The Company intends to retain an appropriate amount of cash as working capital reserves. At March 31, 1997, the Company had cash and cash equivalents totaling $3.3 million. Management believes that the Company's cash and cash equivalents on hand, cash provided from operating activities and borrowing capacity are sufficient to meet its liquidity needs for the foreseeable future. Capital Funding --------------- On May 6, 1997, Realty Income issued $110 million of 7.75% notes due May 2007 (the "Notes"). The Notes were sold at 99.929 percent of par for a yield to the investors of 7.76%. After taking into effect the gain of $1.1 million realized on the treasury interest rate lock agreement, which is described in the next paragraph, the effective interest rate on the Notes to the Company is 7.62%. The net proceeds from the sale of the Notes were used to repay $93.7 million of outstanding borrowings under the Company's credit facility and for other corporate purposes. Interest on the Notes is payable semiannually each May and November, commencing November 1997. Currently, there is no formal trading market for the Notes and the Company has not listed and does not intend to list the Notes on any securities exchange. In December 1996, the Company entered into a treasury interest rate lock agreement to hedge against the possibility of rising interest rates. Under the interest rate lock agreement, the Company receives or makes a payment based on the differential between a specified interest rate, 6.537%, and the actual 10-year treasury interest rate on notional principal of $90 million, at the end of six months. Based on the 10-year treasury interest rate at May 1, 1997, the Company realized a $1.1 million gain on the agreement. During the fourth quarter of 1996, the Company received an investment grade senior unsecured debt rating from Duff & Phelps Rating Company, Moody's Investor Services, Inc. and Standard and Poor's Credit Rating Group, of BBB, Baa3, and BBB-, respectively. Page 14
These ratings are subject to change based upon, among other things, the Company's results of operations and financial condition. Realty Income has a $130 million three-year, revolving, unsecured acquisition credit facility that expires in November 1999. The credit facility currently bears interest at 1.25% over the London Interbank Offered Rate ("LIBOR") and offers the Company other interest rate options. As of May 13, 1997, the full $130 million of borrowing capacity was available to the Company under the acquisition credit facility. On May 6, 1997, the net proceeds from the Notes were used to repay outstanding borrowings under the credit facility. This credit facility has been and is 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 the Company's exposure to interest rate risk. Realty Income expects to meet its long-term capital needs for the acquisition of properties through the issuance of public or private debt or equity. In August 1995, the Company filed a universal shelf registration statement with the Securities and Exchange Commission covering up to $200 million in value of common stock, preferred stock or debt securities. Approximately $159.8 million in value of common stock and debt securities has been issued under the universal shelf registration statement through May 13, 1997. The Company is not currently involved in any negotiations and has not entered into any arrangements relating to any additional securities issuances. Property Acquisitions --------------------- During the first quarter of 1997, Realty Income acquired 11 retail properties located in six states for $16.0 million (excluding the estimated unfunded development costs of $1.6 million on five properties under construction at March 31, 1997) and selectively sold four properties, increasing the number of properties in its portfolio to 747 properties. The 11 properties acquired will contain approximately 236,200 leasable square feet and are 100% leased under net leases, with an average initial lease term of 14.0 years. The weighted average annual unleveraged return on the cost of the 11 properties (including the estimated unfunded development cost of the five properties under development) is estimated to be 10.2%, 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 total Page 15
acquisition and estimated development costs. 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 cost of the 11 properties acquired in 1997 will not differ from the foregoing percentage. Of the 11 properties acquired during the first quarter of 1997, six were occupied as of May 1, 1997 and the remaining five were pre-leased and under construction pursuant to contracts under which the tenant has agreed to develop the properties (with development costs funded by the Company) and to begin paying rent when the premises open for business. All of the properties acquired in 1997, including the properties under development, are leased with initial terms of 10 to 20 years. During the first quarter of 1997, the Company also invested $2.0 million in nine development properties acquired in 1996 No additional property capital expenditures were incurred during the first quarter of 1997. 1997 ACQUISITION ACTIVITY THROUGH MARCH 31 Initial Approx. Lease Leasable Term Square Tenant Industry City / State (Years) Feet ========== =============== ============= ===== ======= 1st Quarter Aaron Rents Home Furnishings Arlington, TX 10.0 68,000 Cedar Park, TX 10.0 23,300 Houston, TX 10.0 70,300 Barnes & Noble Book Store Tampa, FL 14.2 30,000 Econo Lube N' Tune Auto Service Charleston, SC (1) 15.0 2,800 Columbia, SC (1) 15.0 2,800 Durham, NC (1) 15.0 2,800 Greensboro, NC (1) 15.0 2,300 Greenville, SC (1) 15.0 2,800 Jiffy Lube Auto Service Springboro, OH 20.0 2,400 OfficeMax Office Supplies Lakewood, CA 14.6 28,700 ---- ------- Average / Total 14.0 236,200 ==== ======= (1) The Company acquired these properties as undeveloped land and is funding construction and other costs related to the development of the properties by the tenants. The tenant has entered into leases with the Company covering these properties and is contractually obligated to complete construction on a timely basis and to pay construction cost overruns to the extent they exceed the construction budget by more than a predetermined Page 16
percentage. As of March 31, 1997, the total acquisition and estimated construction costs for the properties under development was $3.1 million, of which $1.6 million had not been funded. Distributions ------------- Cash distributions paid during the first three months of 1997 and 1996 were $10.9 million and $16.0 million, respectively. The 1996 cash distributions include a special distribution of $5.3 million. During the three months ended March 31, 1997, the Company paid three monthly distributions of $0.1575 per share, totaling $0.4725 per share. For the three months ended March 31, 1996, the Company paid three monthly distributions of $0.155 per share totaling $0.465 per share and a special distribution in January 1996 of $0.23 per share. In March and April 1997, the Company declared two distributions of $0.1575 per share which was paid on April 15, 1997 and will be paid on May 15, 1997, respectively. FUNDS FROM OPERATIONS ("FFO") ============================= FFO for the first quarter of 1997 was $12.4 million versus $11.5 million during the first quarter of 1996, an increase of $924,000 or 8.0%. Realty Income defines FFO as net income before gain on sales of properties, plus provision for impairment losses, plus depreciation and amortization. In accordance with the recommendations of the National Association of Real Estate Investment Trusts ("NAREIT"), amortization of deferred financing costs are not added back to net income to calculate FFO. Amortization of financing costs are included in interest expense in the consolidated statements of income. Below is a reconciliation of net income to FFO for the quarters ended March 31, 1997 and 1996 (dollars in thousands): 1997 1996 ========= ========= Net income $ 8,185 $ 7,850 Plus depreciation and amortization 4,464 4,074 Plus provision for impairment losses -- 323 Less depreciation of furniture, fixtures and equipment (11) (13) Less gain on sales of properties (225) (745) --------- --------- Total Funds From Operations $ 12,413 $ 11,489 ========= ========= Page 17
For the quarters ended March 31, 1997 and 1996, FFO exceeded cash distributions, excluding the non-recurring special distribution of $5.3 million in 1996 (pertaining to the merger with R.I.C. Advisor, Inc.) by $1,552,000 and $805,000, respectively. Management considers 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. 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 the Company'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. RESULTS OF OPERATIONS ===================== The following is a comparison of the three months ended March 31, 1997 to the three months ended March 31, 1996. Rental revenue was $15.4 million for the quarter ended March 31, 1997 versus $13.7 million for the comparable quarter in 1996, an increase of $1.7 million. The increase in rental revenue was primarily due to the acquisition of 73 properties during 1996 and the first quarter of 1997 (the "New Properties"). The New Properties generated revenue in 1997 and 1996 of $1.6 million and $12,000, respectively, an increase of $1.6 million. Annualized contractual lease payments on the New Properties are approximately $7.6 million (excluding estimated rent from five properties under development and any percentage rents). Of the 747 properties in the portfolio as of March 31, 1997, 740 are single-tenant properties with the remaining properties being multi-tenant properties. As of March 31, 1997, 735 or 99% of the single-tenant properties were net leased with an with an average remaining lease term (excluding extension options) of approximately 8.4 years. At March 31, 1997, 734 of the Company's 740 single tenant properties had leases which provide for increases in rents through (i) base rent increases tied to a consumer price index with adjustment ceilings; (ii) overage rent based on a percentage of the tenants' gross sales or (iii) fixed increases. Some leases contain more than one of these clauses. Rental revenue generated on 673 properties owned during both the first quarter of 1997 and 1996 increased by $214,000 or 1.6%, Page 18
from $13.58 million to $13.80 million. Percentage rent, which is included in rental revenue, was $293,000 for 1997 and $220,000 for 1996. The following table represents Realty Income's rental revenue by industry for the three months ended March 31, 1997 and 1996 (dollars in thousands): March 31, 1997 March 31, 1996 ---------------------- ---------------------- Rental Percentage Rental Percentage Industry Revenue of Total Revenue of Total =================== =========== ========== =========== ========== Automotive Parts $ 1,268 8.2% $ 1,181 8.6% Automotive Service 1,180 7.6% 953 6.9% Book Stores 32 0.2% -- -- Child Care 5,889 38.1% 5,768 42.0% Consumer Electronics 1,044 6.8% -- -- Convenience Stores 786 5.1% 646 4.7% Home Furnishings 642 4.2% 624 4.6% Office Supplies 80 0.5% -- -- Restaurant 3,303 21.4% 3,371 24.6% Other 1,225 7.9% 1,185 8.6% -------- ------ -------- ------ Total $ 15,449 100.0% $ 13,728 100.0% ======== ====== ======== ====== Unleased properties are a factor in determining gross revenue generated and property costs incurred by the Company. At March 31, 1997, the Company had five properties that were not under lease as compared to four properties at March 31, 1996. In May 1997, one of the unleased properties was sold at a nominal gain. The remaining 742 properties were under lease agreements with third party tenants at March 31, 1997. Interest and other revenue totaled $31,000 in the first quarter of 1997 as compared to $50,000 in 1996, a decrease of $19,000. Depreciation and amortization was $4.5 million in the first quarter of 1997 verses $4.1 million for the comparable quarter in. The $390,000 increase in 1997 was primarily due to the depreciation of the New Properties. General and administrative expenses decreased by $57,000 to $1.25 million in the first quarter of 1997 versus $1.31 million in 1996. The decrease in general and administrative expenses was due to lower legal fees, professional fees and printing costs, which were partially offset by higher personnel costs. The higher personnel costs were primarily due to costs of a 401(k) plan initiated by the Company during the third quarter of 1996. Page 19
Property expenses were $491,000 in 1997 and $446,000 in 1996, an increase of $45,000. Property expenses are broken down into costs associated with multi-tenant non-net lease 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, site checks, bad debt expense and legal fees. General portfolio costs include, but are not limited to, insurance, legal, site checks and title search fees. Property expenses of $279,000 were incurred during 1997 on eight multi-tenant properties, seven of which were owned at March 31, 1997. During the first quarter of 1997, one multi-tenant property was sold. Property expenses of $283,000 were incurred on ten multi-tenant properties in 1996, all of which were owned at March 31, 1996. Expenses incurred in 1997 on eight unleased single-tenant properties totaled $97,000 as compared to $59,000 in 1996 on six unleased single-tenant properties. At March 31, 1997, five properties were available for lease, one of which was sold in May 1997. At March 31, 1996, four single-tenant properties were available for lease. The $38,000 increase in unleased single-tenant property expenses in 1997 as compared to 1996 is primarily due to an increase in property taxes on the additional vacant properties. General portfolio expenses in 1997 and 1996 totaled $115,000 and $104,000, respectively. The increase in general portfolio expenses is primarily due to the cost of environmental insurance initially purchased in December 1996. Interest expense is made up of four components which include: (i) interest on outstanding loans and notes; (ii) commitment fees on the undrawn portion of the credit facility; (iii) amortization of the credit facility origination costs and bond costs; which are offset, in part, by: (iv) interest capitalized on properties under development. Interest capitalized on properties under development is included in the cost of the completed property and amortized over the estimated useful life of the property. Page 20
Interest expense increased by $792,000 to $1.3 million in the first quarter of 1997 as compared to $520,000 during the first quarter of 1996. The following is a summary of the four components of interest expense for the first quarter of 1997 and 1996 (dollars in thousands): 1997 1996 Net Change ------ ----- ---------- Interest on outstanding loans $1,279 $ 435 $ 844 Credit facility commitment fees 20 45 (25) Amortization of credit facility origination costs and bond financing costs 49 54 (5) Interest capitalized (36) (14) (22) ------ ---- ----- Totals $1,312 $ 520 $ 792 ====== ===== ===== Interest incurred on outstanding loans was $844,000 higher in 1997 than in 1996 due to an increase in the average outstanding balance which was partially offset by lower interest rates on the acquisition credit facility and certain variable rate notes (which were issued in August 1994 and redeemed in March 1996). During the first quarter of 1997, the average outstanding balance and interest rate were $76.2 million and 6.81% as compared to $24.5 million and 7.15% during the comparable period in 1996. During both periods, a commitment fee of 0.15% per annum was incurred on the undrawn portion of the credit facility. Commitment fees decreased in 1997 as compared to 1996 because the average available borrowing capacity was lower in 1997. The amortization of credit facility origination costs and bond financing costs decreased in 1997 as compared to 1996, because in the first quarter of 1997 the term of the credit facility was extended one year to November 1999, which extended the period of time over which credit facility fees are amortized. The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. In 1996, a $323,000 charge was taken to reduce the net carrying value on two properties because they became held for sale. No charge was recorded for impairment losses in 1997. The Company anticipates a small number of property sales will occur in the normal course of business. During the first quarter of 1997, the Company recorded a gain of $225,000 on the sale of four properties (one multi-tenant, two restaurant and one child care center). These sales generated cash proceeds of $1.3 million. During the comparable period of 1996, the Company sold one restaurant property for $1.5 million and recognized a gain of $745,000. Page 21
For the first quarter of 1997, the Company had net income of $8.2 million versus $7.9 million in 1996. The $335,000 increase in net income is primarily due to the increase in rental revenue from New Properties of $1.6 million, offset by an increase in depreciation and amortization and interest expense, totaling $1.2 million. PROPERTIES ========== As of April 1, 1997, Realty Income owned a diversified portfolio of 747 properties in 42 states consisting of over 5.4 million square feet of leasable space. The portfolio consist of 159 after-market automotive retail locations (80 automotive parts stores and 79 automotive service locations), one book store, 318 child care centers, 36 consumer electronics stores, 42 convenience stores, seven home furnishings stores, one office supply store, 171 restaurant facilities and 12 other properties. Of the 747 properties, 684 or 91% were leased to national or regional retail chain operators; 42 or 6% were leased to franchisees of retail chain operators; 16 or 2% were leased to other tenant types; and five or less than 1% were available for lease. At April 1, 1997, over 98% of the properties were under net lease agreements. Net leases typically require the tenant to be responsible for property operating costs including property taxes, insurance and expenses of maintaining the property. The Company's net leased retail properties are primarily leased to national and regional chain store operators. At April 1, 1997, the properties averaged approximately 7,300 square feet of leaseable retail space on approximately 43,500 square feet of land. Generally, buildings are single-store properties with adequate parking on site to accommodate peak retail 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 sufficient market or trade area for the retailer's business. Page 22
The following table sets forth certain geographic diversification information regarding Realty Income's portfolio at April 1, 1997: Number Approx. Percent of of Leasable Annualized Annualized Proper- Percent Square Base Base State ties Leased Feet Rent (1) Rent ========== ======= ======= ======== =========== ======== Alabama 6 100% 42,300 $ 319,000 0.5% Arizona 26 100 178,400 2,362,000 3.8 California 53 98 1,001,900 10,593,000 17.1 Colorado 42 98 233,500 2,984,000 4.8 Connecticut 4 100 17,200 240,000 0.4 Florida 49 100 461,900 4,264,000 6.9 Georgia 37 100 187,600 2,448,000 3.9 Idaho 11 100 52,000 656,000 1.1 Illinois 25 100 182,600 2,081,000 3.4 Indiana 23 100 122,800 1,438,000 2.3 Iowa 8 100 51,700 456,000 0.7 Kansas 15 100 129,000 1,441,000 2.3 Kentucky 11 100 33,300 835,000 1.3 Louisiana 2 100 10,700 126,000 0.2 Maryland 6 100 34,900 505,000 0.8 Massachusetts 4 100 20,900 440,000 0.7 Michigan 5 100 26,900 353,000 0.6 Minnesota 17 100 118,400 1,713,000 2.7 Mississippi 11 100 106,600 792,000 1.3 Missouri 27 100 163,600 1,842,000 2.9 Montana 1 100 5,400 71,000 0.1 Nebraska 8 100 47,100 509,000 0.8 Nevada 5 100 29,100 353,000 0.6 New Hampshire 1 100 6,400 122,000 0.2 New Jersey 2 100 22,700 346,000 0.6 New Mexico 3 100 12,000 103,000 0.2 New York 5 100 38,300 539,000 0.9 North Carolina 20 100 82,200 1,337,000 2.1 Ohio 48 100 210,500 3,426,000 5.5 Oklahoma 9 100 60,200 543,000 0.9 Oregon 18 100 98,500 1,133,000 1.8 Pennsylvania 4 100 28,300 420,000 0.7 South Carolina 20 95 85,000 1,152,000 1.9 South Dakota 1 100 6,100 79,000 0.1 Tennessee 10 100 78,900 963,000 1.6 Texas 127 99 980,900 9,073,000 14.6 Utah 7 100 45,400 591,000 1.0 Virginia 16 100 79,000 1,256,000 2.0 Washington 42 98 249,700 2,959,000 4.8 West Virginia 2 100 16,800 147,000 0.2 Wisconsin 11 100 60,500 738,000 1.2 Wyoming 5 100 26,900 324,000 0.5 ----- ----- --------- ----------- ------ Totals 747 99% 5,446,100 $62,072,000 100.0% ===== ===== ========= =========== ====== Page 23
(1) Annualized base rent is calculated by multiplying the monthly contractual base rent as of April 1, 1997 for each of the properties by 12, except that, for the properties under construction, estimated contractual base rent for the first month of the respective leases is used instead of base rent as of April 1, 1997. The estimated contractual base rent for the properties under construction is based upon the estimated acquisition costs of the properties. Annualized base rent does not include percentage rents (i.e., additional rent calculated as a percentage of the tenant's gross sales above a specified level), if any, that may be payable under leases covering certain of the properties. The following table sets forth certain information regarding the Company's properties, classified according to the business of the respective tenants: Approx. Realty Total Income Approx. Annual- Loca- Owned Leasable ized Industry tions Loca- Square Base Tenant Segment (1) tions Feet Rent (2) ========== ========= ======= ====== ======== ========= AFTER-MARKET AUTOMOTIVE - ----------------------- CSK Auto Parts 580 79 409,200 $ 4,192,000 Discount Tire Service 310 18 103,200 1,177,000 Econo Lube N' Tune Service 210 18 49,400 1,257,000 Jiffy Lube Service 1,400 29 68,700 1,851,000 Q Lube Service 490 4 7,600 183,000 R & S Strauss Service 110 2 31,200 431,000 Speedy Muffler King Service 1,080 7 40,900 531,000 Other Parts/Service -- 2 6,500 90,000 --- -------- ---------- Total After-market Automotive 159 716,700 9,712,000 BOOK STORES - ----------- Barnes & Noble Book Stores 1,010 1 30,000 450,000 --- -------- --------- Total Book Stores 1 30,000 450,000 Page 24
Approx. Realty Total Income Approx. Annual- Loca- Owned Leasable ized Industry tions Loca- Square Base Tenant Segment (1) tions Feet Rent (2) ========== ========= ======= ====== ======== ========= CHILD CARE - ---------- Children's World Learn- ing Centers Child Care 530 134 964,000 13,612,000 Kinder-Care Learning Centers Child Care 1,150 13 79,800 1,087,000 La Petite Academy Child Care 790 170 972,700 8,853,000 Other Child Care -- 1 4,200 -- --- --------- ---------- Total Child Care 318 2,020,700 23,552,000 CONSUMER ELECTRONICS - -------------------- Best Buy Consumer Electronics 270 2 104,800 1,321,000 Rex Stores Consumer Electronics 230 34 408,300 2,694,000 --- -------- --------- Total Consumer Electronics 36 513,100 4,015,000 CONVENIENCE STORES - ------------------ 7-ELEVEN Convenience 20,240 3 9,700 235,000 Dairy Mart Convenience 1,020 22 66,500 1,513,000 East Coast Oil Convenience 40 2 6,400 219,000 The Pantry Convenience 400 14 34,400 1,333,000 Other Convenience -- 1 2,100 31,000 --- -------- --------- Total Convenience Stores 42 119,100 3,331,000 HOME FURNISHINGS - ---------------- Levitz Home Fur- nishings 130 4 376,400 2,496,000 Aaron Rents Home Fur- nishings 290 3 161,600 464,000 --- -------- --------- Total Home Furnishings 7 538,000 2,960,000 Page 25
Approx. Realty Total Income Approx. Annual- Loca- Owned Leasable ized Industry tions Loca- Square Base Tenant Segment (1) tions Feet Rent (2) ========== ========= ======= ====== ======== ========= OFFICE SUPPLIES - --------------- OfficeMax Office Supplies 560 1 28,700 431,000 --- -------- --------- Total Office Supplies 1 28,700 431,000 RESTAURANTS - ----------- Don Pablo's Dinner House 70 7 60,700 604,000 Carvers Dinner House 90 3 26,600 495,000 Other Dinner House -- 13 108,300 1,015,000 Golden Corral Family 460 87 512,500 6,747,000 Sizzler Family 630 7 37,600 841,000 Other Family -- 4 23,400 151,000 Hardees Fast Food 3,100 3 10,300 144,000 Taco Bell Fast Food 4,890 24 54,100 1,502,000 Whataburger Fast Food 520 9 23,000 616,000 Other Fast Food -- 14 39,800 747,000 --- -------- --------- Total Restaurants 171 896,300 12,862,000 TOTAL OTHER Miscellaneous 12 583,500 4,759,000 --- -------- --------- Total 747 5,446,100 $62,072,000 === ========= ========== (1) Approximate total number of retail locations in operation (including both corporate owned and franchised locations), based on information provided to the Company by the respective tenants during the first quarter of 1997. (2) Annualized base rent is calculated by multiplying the monthly contractual base rent as of April 1, 1997 for each of the properties by 12, except that, for the properties under construction, estimated contractual base rent for the first month of the respective leases is used instead of base rent as of April 1, 1997. The estimated contractual base rent for the properties under construction is based upon the estimated acquisition costs of the properties. Annualized base rent does not include percentage rents (i.e., additional rent calculated as a percentage of the tenant's gross sales above a specified level), if any, that may be payable under leases covering certain of the properties. Page 26
Of the 747 properties in the portfolio at April 1, 1997, 740 are single-tenant properties with the remaining being multi-tenant properties. As of April 1, 1997, 735 or 99% of the single-tenant properties were net leased with an average remaining lease term (excluding extension options) of approximately 8.4 years. The following table sets forth certain information regarding the timing of initial lease term expirations (excluding extension options) on the Company's 735 net leased, single tenant retail properties: Percent of Total Number of Annualized Annualized Year Leases Expiring Base Rent (2) Base Rent ======== =============== ============= ================= 1997 25 (3) $ 1,068,000 1.8% 1998 4 168,000 0.3 1999 20 900,000 1.5 2000 27 1,335,000 2.3 2001 49 3,796,000 6.5 2002 74 5,878,000 10.1 2003 68 5,163,000 8.9 2004 110 8,896,000 15.3 2005 86 6,044,000 10.4 2006 29 2,446,000 4.2 2007 82 4,949,000 8.5 2008 39 3,174,000 5.5 2009 12 896,000 1.5 2010 34 2,729,000 4.7 2011 31 3,541,000 6.1 2012 8 714,000 1.2 2013 -- -- -- 2014 2 265,000 0.5 2015 25 4,789,000 8.2 2016 7 1,351,000 2.3 2017 2 83,000 0.1 2018 1 39,000 0.1 --------- ------------ ------- Total 735 (1) $58,224,000 100.0% ========= ============ ======= (1) The table does not include seven multi-tenant properties and five vacant, unleased properties owned by the Company. The lease expirations for properties under construction are based on the estimated date of completion of such properties. Page 27
(2) Annualized base rent is calculated by multiplying the monthly contractual base rent as of April 1, 1997 for each of the properties by 12, except that, for the properties under construction, estimated contractual base rent for the first month of the respective leases is used instead of base rent as of April 1, 1997. The estimated contractual base rent for the properties under construction is based upon the estimated acquisition costs of the properties. Annualized base rent does not include percentage rents (i.e., additional rent calculated as a percentage of the tenant's gross sales above a specified level), if any, that may be payable under leases covering certain of the properties. (3) In May 1997, Realty Income entered into lease extensions on all 12 of its La Petite Academy properties that had leases which expired on December 31, 1996 and have been leased on a month to month basis in 1997. The new leases are for terms of one to five years and provide for fixed rental payments equal to the base rents and percentage rents earned in 1996, plus percentage rents based upon unit sales. Of the Company's 170 La Petite Academy properties, these 12 properties are the first ones to complete their initial lease terms. The balance of the Company's leases with La Petite Academy expire between June 1997 and April 2008. The 12 properties were acquired by the Company from La Petite Academy in 1981 and leased back under net lease agreements with an initial lease term of 15 years. IMPACT OF INFLATION - ------------------- Tenant leases generally provide for limited increases in rent as a result of increases in the tenant's sales volumes and/or increases in the consumer price index. Management expects 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. Over 98% of the properties are leased to tenants under net leases in which the tenant is responsible for property costs and expenses. These features in the leases reduce the Company's exposure to rising 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. Page 28
PART II. OTHER INFORMATION =========================== ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K A. Exhibits: Exhibit No. Description =========== =========== 2.1 Agreement and Plan of Merger between Realty Income Corporation and R.I.C. Advisor, Inc. dated as of April 28, 1995 (incorporated by reference to Appendix A to the Company's definitive Proxy Statement filed September 30, 1995) 3.1 Amended and Restated Certificate of Incorporation of Realty Income Corporation (filed as Exhibit 3.1 to the Company's Form 10-Q for the quarter ended September 30, 1994 and incorporated herein by reference) 3.2 Amended and Restated Bylaws of Realty Income Corporation (filed as Exhibit 3.2 to the Company's 10-Q for the quarter ended September 30, 1995 and incorporated herein by reference) 4.1 Form of 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) 4.2 Pricing Committee Resolutions and Form of 7 3/4% Notes due 2007 (filed as Exhibit 4.2 to the Company's 8-K dated May 5, 1997 and incorporated herein by reference) 10.1 Revolving Credit Agreement (filed as Exhibit 99.2 to the Company's Form 8-K dated December 16, 1994 and incorporated herein by reference) 10.2 First Amendment to the Revolving Credit Agreement (filed as Exhibit 10.2 to the Company's Form 10-Q for the quarter ended September 30, 1996 and incorporated herein by reference) Page 29
Exhibit No. Description =========== =========== 10.3 Second Amendment to the Revolving Credit Agreement (filed as Exhibit 99.2 to the Company's Form 8-K dated December 19, 1995 and incorporated herein by reference) 10.4 Third Amendment to the Revolving Credit Agreement (filed as Exhibit 10.4 to the Company's Form 10-K for the year ended December 31, 1996 and incorporated herein by reference) 10.5 Fourth Amendment to the Revolving Credit Agreement, filed herein 10.6 Stock Incentive Plan (filed as Exhibit 4.1 to the Company's Registration Statement on Form S-8 (Registration number 33-95708) and incorporated herein by reference) 10.7 Form of Indemnification Agreement to be entered into between the Company and the executive officers of the Company (filed as Exhibit 10.4 to the Company's Form 10-Q for the quarter ended September 30, 1996 and incorporated herein by reference) 10.8 Form of Management Incentive Plan (filed as Exhibit 10.5 to the Company's Form 10-Q for the quarter ended September 30, 1996 and incorporated herein by reference) 27 Financial Data Schedule (electronically filed with the Securities and Exchange Commission only) 99.1 Press release announcing that Thomas A. Lewis has been selected to succeed William E. Clark as Chief Executive Officer of the Company, filed herewith. B. No report on Form 8-K was filed by registrant during the quarter for which this report is filed. A report on Form 8-K was dated and filed on May 5, 1997 in connection with the issuance of $110,000,000 principal amount of 7.75% Notes due 2007. Page 30
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: May 14, 1997 ---------------------------------- Gary M. Malino, Vice President Chief Financial Officer (Principal Financial and Accounting Officer) Page 31
EXHIBIT INDEX Exhibit No. Description Page =========== =========== ---- 10.5 Fourth Amendment to the Revolving Credit Agreement, filed herein..................... 33 27 Financial Data Schedule (electronically filed with the Securities and Exchange Commission only)............................ 38 99.1 Press release announcing that Thomas A. Lewis has been selected to succeed William E. Clark as Chief Executive Officer of the Company... 39 Page 32