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, 1998, 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 ========== (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 26,837,164 shares of common stock outstanding as of August 12, 1998. Page 1 REALTY INCOME CORPORATION Form 10-Q June 30, 1998 Table of Contents ----------------- <TABLE> <CAPTION> PART I. FINANCIAL INFORMATION Pages ============================== ----- <S> <C> <C> 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......11-31 PART II. OTHER INFORMATION ========================== Item 4: Submission of matter to a vote of security holders................................... 31 Item 6: Exhibits and Reports on Form 8-K...................31-32 SIGNATURE................................................... 32 EXHIBIT INDEX............................................... 32 </TABLE> Page 2 PART I. FINANCIAL INFORMATION ============================== ITEM 1. FINANCIAL STATEMENTS <TABLE> <CAPTION> REALTY INCOME CORPORATION AND SUBSIDIARIES Consolidated Balance Sheets =========================== June 30, 1998 and December 31, 1997 (dollars in thousands, except per share data) 1998 1997 (Unaudited) =========== ========= <S> <C> <C> ASSETS Real estate, at cost: Land $ 249,911 $ 214,342 Buildings and improvements 548,271 485,455 --------- --------- 798,182 699,797 Less - accumulated depreciation and amortization (160,648) (152,206) --------- --------- Net real estate 637,534 547,591 Cash and cash equivalents 3,116 2,123 Accounts receivable 1,490 2,888 Due from affiliates 336 348 Other assets 3,106 3,170 Goodwill, net 20,439 20,901 --------- --------- TOTAL ASSETS $ 666,021 $ 577,021 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Distributions payable $ 4,428 $ 4,112 Accounts payable and accrued expenses 2,649 2,180 Other liabilities 4,582 4,814 Lines of credit payable 87,900 22,600 Notes payable 110,000 110,000 --------- --------- TOTAL LIABILITIES 209,559 143,706 --------- --------- </TABLE> Continued on next page Page 3 (continued) <TABLE> <CAPTION> REALTY INCOME CORPORATION AND SUBSIDIARIES Consolidated Balance Sheets =========================== June 30, 1998 and December 31, 1997 (dollars in thousands, except per share data) 1998 1997 (Unaudited) =========== ========= <S> <C> <C> Stockholders' equity Preferred stock, par value $1.00 per share, 20,000,000 shares authorized, no shares issued or outstanding -- -- Common stock, par value $1.00 per share, 100,000,000 shares authorized, 26,836,964 and 25,698,464 shares issued and outstanding in 1998 and 1997, respectively 26,837 25,698 Paid in capital in excess of par value 610,087 582,450 Accumulated distributions in excess of net income (180,462) (174,833) --------- --------- TOTAL STOCKHOLDERS' EQUITY 456,462 433,315 --------- --------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 666,021 $ 577,021 ========= ========= </TABLE> The accompanying notes to consolidated financial statements are an integral part of these statements. Page 4 <TABLE> <CAPTION> REALTY INCOME CORPORATION AND SUBSIDIARIES Consolidated Statements Of Income ================================= For the Three and Six Months Ended June 30, 1998 and 1997 (dollars in thousands, except per share data) (Unaudited) Three Three Six Six Months Months Months Months Ended Ended Ended Ended 6/30/98 6/30/97 6/30/98 6/30/97 ========== ========== ========== ========== <S> <C> <C> <C> <C> REVENUE Rental $ 20,343 $ 16,006 $ 39,511 $ 31,455 Interest and other 24 117 78 148 ---------- ---------- ---------- ---------- 20,367 16,123 39,589 31,603 ---------- ---------- ---------- ---------- EXPENSES Depreciation and amorti- zation 5,369 4,484 10,453 8,948 General and administrative 1,711 1,332 3,176 2,585 Property 426 362 899 853 Interest 2,864 2,009 5,355 3,321 Provision for impairment loss -- 70 -- 70 --------- ---------- ---------- ---------- 10,370 8,257 19,883 15,777 --------- ---------- ---------- ---------- Income from operations 9,997 7,866 19,706 15,826 Gain on sales of properties 311 202 526 427 ---------- ---------- ---------- ---------- NET INCOME $ 10,308 $ 8,068 $ 20,232 $ 16,253 ========== ========== ========== ========== Basic and diluted net income per share $ 0.38 $ 0.35 $ 0.77 $ 0.71 ========== ========== ========== ========== </TABLE> The accompanying notes to consolidated financial statements are an integral part of these statements. Page 5 <TABLE> <CAPTION> REALTY INCOME CORPORATION AND SUBSIDIARIES Consolidated Statements Of Cash Flows ===================================== For the six months ended June 30, 1998 and 1997 (dollars in thousands) (Unaudited) 1998 1997 ========= ========= <S> <C> <C> CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 20,232 $ 16,253 Adjustments to net income: Depreciation and amortization 10,453 8,948 Provision for impairment loss -- 70 Gain on sales of properties (526) (427) Change in assets and liabilities: Accounts receivable and other assets 1,655 593 Accounts payable, accrued expenses and other liabilities 207 1,853 --------- --------- Net cash provided by operating activities 32,021 27,290 --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from sales of properties 2,770 2,891 Acquisition of and additions to properties (102,014) (56,943) --------- --------- Net cash used in investing activities (99,244) (54,052) --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES Payments of distributions (25,545) (21,722) Bond offering proceeds -- 110,000 Proceeds from line of credit 111,300 36,200 Payment of lines of credit (46,000) (94,200) Proceeds from stock offerings, net of offering costs of $109 28,392 -- Payments to the defined benefit pension plan -- (2,223) </TABLE> Continued on next page Page 6 (continued) <TABLE> <CAPTION> REALTY INCOME CORPORATION AND SUBSIDIARIES Consolidated Statements Of Cash Flows ===================================== For the six months ended June 30, 1998 and 1997 (dollars in thousands) (Unaudited) 1998 1997 ========= ========= <S> <C> <C> Proceeds from stock options exercised 69 -- --------- --------- Net cash provided by financing activities 68,216 28,055 --------- --------- Net increase in cash and cash equivalents 993 1,293 Cash and cash equivalents, beginning of period 2,123 1,559 --------- --------- Cash and cash equivalents, end of period $ 3,116 $ 2,852 ========= ========= </TABLE> Interest paid during the first six months of 1998 and 1997 was $4.7 million and $3.1 million, 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 ========================================== June 30, 1998 (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 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, 1997, which are included in the Company's 1997 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 1998, the Company invested $102.0 million in 66 new properties and properties under development with an initial aggregate contractual lease rate of 10.3%. The 66 properties are located in 29 states and contain approximately 657,300 leasable square feet. The 66 properties are 100% leased under net leases, with an average initial lease length of 14.8 years. During the first six months of 1997, the Company invested $56.9 million in 37 new properties and properties under development with an initial aggregate contractual lease rate of 10.2%. The 37 properties are located in 18 states and contain approximately 589,200 leasable square feet. The 37 properties are 100% leased under net leases, with an average initial lease length of 14.4 years. 3. Credit Facility Available for Acquisitions The Company has a $150 million, three year, revolving, unsecured acquisition credit facility that expires in December 2000. The credit facility is from The Bank of New York, as agent, and several U.S. and non-U.S. banks. In November 1997, the Company obtained a $10 million unsecured line of credit with The Bank of New York, which was repaid and canceled in January 1998. As of June 30, 1998 and December 31, 1997, the outstanding balances on the credit facility and line of credit were $87.9 million and $22.6 million, respectively, with an effective interest rate of approximately 6.56% and 6.66%, respectively. Page 8 The credit facility currently bears interest at 0.85% over the London Interbank Offered Rate ("LIBOR") and offers the Company other interest rate options. A facility fee of 0.15%, per annum, accrues on the total commitment of the credit facility. The credit facility is subject to various leverage and interest coverage ratio limitations. The Company is and has been in compliance with these limitations. For the six months ended June 30, 1998 and 1997, interest of $234,000 and $82,000 respectively, was capitalized on properties under construction. For the three months ended June 30, 1998 and 1997, interest of $154,000 and $46,000, respectively, was so capitalized. 4. Common Stock Offerings A. In March 1998, the Company issued 372,093 shares of common stock to a unit investment trust at a net price to the Company of $25.53125 per share. The net proceeds of $9.5 million were used to repay borrowings under the credit facility of $7.9 million and to acquire properties. B. In February 1998, the Company issued 751,174 shares of common stock to a unit investment trust at a net price to the Company of $25.295 per share. The net proceeds of $18.9 million were used to repay borrowings under the credit facility. 5. Distributions Paid and Payable During the six months ended June 30, 1998, the Company paid three monthly distributions of $0.16 per share and three monthly distributions of $0.1625 per share, totaling $0.9675 per share. For the six months ended June 30, 1997, the Company paid six monthly distributions of $0.1575 per share, totaling $0.945 per share. As of June 30, 1998, a distribution of $0.165 per share was declared and paid on July 15, 1998. 6. Gain on Sales of Properties For the six months ended June 30, 1998, the Company sold five properties (two child care centers, one multi-tenant location and two restaurants) for $2.8 million and recognized a gain of $526,000. For the six months ended June 30, 1997, the Company sold seven properties (five restaurants, one child care center and one multi-tenant location) for $2.9 million and recognized a gain of $427,000. For the three months ended June 30, 1998, the Company sold two properties (one child care center and one restaurant) for $822,000 and recognized a gain of $311,000. For the three months Page 9 ended June 30, 1997 the Company sold three restaurant properties for $1.6 million and recognized a gain of $202,000. 7. Net Income per Share Basic net income per share is computed by dividing net income 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 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 share computation to the denominator of the diluted net income per share computation, for the three and six months ended June 30, 1998 and 1997 (net income was available to common shareholders for all periods presented): <TABLE> <CAPTION> Three Three Months Months Ended Ended 6/30/98 6/30/97 ---------- ---------- <S> <C> <C> Weighted average shares used for the basic net income computation 26,836,730 22,987,650 Incremental shares from the assumed conversion of stock options 8,361 2,942 ---------- ---------- Adjusted weighted average shares used for diluted net income computation 26,845,091 22,990,592 =========== ========== Six Six Months Months Ended Ended 6/30/98 6/30/97 ---------- ---------- Weighted average shares used for the basic net income computation 26,434,892 22,987,173 Incremental shares from the assumed conversion of stock options 7,627 2,990 ---------- ---------- Adjusted weighted average shares used for diluted net income computation 26,442,519 22,990,163 ========== ========== </TABLE> Page 10 8. Derivative Financial Instrument In May 1998, the Company entered into a treasury interest rate lock agreement to hedge against the possibility of rising interest rates applicable to an anticipated debt offering. Under the interest rate lock agreement, the Company receives or makes a payment based on the differential between a specified interest rate, 5.726%, and the actual 10-year treasury interest rate on a notional principal amount of $100 million, at the end of six months. Based on the 10-year treasury interest rate at June 30, 1998, the Company has an unrecognized loss of $1.5 million. 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 a well- defined interest rate risk. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING STATEMENTS - -------------------------- This report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. When used in this quarterly report, the words estimated, anticipated and similar expressions are intended to identify forward-looking statements. Such forward-looking statements are inherently subject to risk and uncertainties, many of which cannot be predicted with accuracy and some of which might not even be anticipated. 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 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. For further description and detail of these and other factors please see "Business" and "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Company's Annual Report on Form 10- K and "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Company's Report on Form 10-Q for the quarterly period ended March 31, 1998. Readers are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date hereof. The Company undertakes no obligation to publicly release the results of any Page 11 revisions to these forward-looking statements which may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. GENERAL - ------- Realty Income Corporation, a Maryland corporation ("Realty Income" or the "Company") was organized to operate as an equity real estate investment trust ("REIT"). Realty Income is 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, 1998, the Company owned a diversified portfolio of 887 retail properties located in 43 states with over 6.9 million square feet of leasable space. Of the 887 properties in the portfolio, 881 are single-tenant properties with the remainder being multi-tenant properties. As of June 30, 1998, 878 of the 881 single-tenant properties, or over 99%, were net leased with an average remaining lease term (excluding extension options) of approximately 8.4 years. Net leases typically require the tenant to be responsible for property operating costs including property taxes, insurance and maintenance. 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 intends to pay distributions at a level greater than 95% of its taxable income (determined without regard to the deduction for dividends paid and by excluding any net capital gain) in order to meet REIT qualification requirements and to use undistributed cash flow 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 agreements 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. Realty Income adheres to a focused strategy of acquiring freestanding, single-tenant, retail properties leased to regional Page 12 and national retail chains under long-term, net lease agreements. The Company typically acquires retail store locations, which provides capital to the operators for continued expansion and other corporate purposes. Realty Income's acquisition and investment activities are concentrated in specific target markets and focus primarily on middle-market and upper-market retailers providing goods and services which satisfy basic consumer needs. 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 the tenant's gross sales above a specific level. From 1970 through December 31, 1997, Realty Income has acquired and leased back to regional and national retail chains 797 properties (including 32 properties that have been sold) and has collected over 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 share price appreciation. Management believes that the income generated under long-term leases, coupled with the tenant's responsibility for property expenses under the net lease structure, generally produces a more predictable income stream than many other types of real estate portfolios. Year 2000 Issue Some of Realty Income's existing computer programs identify a year by using only two digits instead of four which could cause these programs to fail or create erroneous results beginning in the year 2000. This situation has been referred generally as the Year 2000 issue. Management believes that the cost of remediation associated with the Company's corporate level computer systems will be minimal and the remediation is anticipated to be completed in the first quarter of 1999. The other essential component of the Year 2000 issue is to ensure that the Company's significant tenants are assessed for Year 2000 compliance. Management has initiated discussions with the Company's significant tenants in order to assess their readiness for the year 2000 issue. Due to the nature of the tenants' businesses, management does 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 the Company's results of operation or financial position. Page 13 Upon completion of the Company's assessment program, management will consider the necessity of implementing a contingency plan to mitigate any adverse effects associated with the Year 2000 issue. Though Realty Income does not expect the Year 2000 issue to have a material adverse effect on its result of operation or financial position there can be no assurances of that position. Other Information The Company's common stock is listed on the New York Stock Exchange under the symbol "O" and its central index key ("CIK") number is 726728. 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 leases on its retail properties. The Company intends to retain an appropriate amount of cash as working capital reserves. At June 30, 1998, the Company had cash and cash equivalents totaling $3.1 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, except that the Company intends to utilize additional sources of capital to fund property acquisitions and repayment of its acquisition credit facility. Capital Funding Realty Income has a $150 million, three-year revolving, unsecured acquisition credit facility that expires in December 2000. The credit facility currently bears interest at 0.85% over the London Interbank Offered Rate ("LIBOR") and offers the Company other interest rate options. As of August 12, 1998, $54.8 million of borrowing capacity was available to the Company under the acquisition credit facility. At that time, the outstanding balance was $95.2 million with an effective interest rate of 6.54%. 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. Page 14 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 1997, the Company filed a universal shelf registration statement with the Securities and Exchange Commission covering up to $300 million in value of common stock, preferred stock and/or debt securities. Approximately $101.4 million in value of securities has been issued under the universal shelf registration statement through August 12, 1998. In May 1998, the Company entered into a treasury interest rate lock agreement to hedge against the possibility of rising interest rates applicable to an anticipated debt offering. Under the interest rate lock agreement, the Company receives or makes a payment based on the differential between a specified interest rate, 5.726%, and the actual 10-year treasury interest rate on a notional principal amount of $100 million, at the end of six months. Based on the 10-year treasury interest rate at June 30, 1998, the Company has an unrecognized loss of $1.5 million. On March 30, 1998, Realty Income issued 372,093 shares of common stock at a net price to the Company of $25.53125 per share to a unit investment trust. The net proceeds were used to repay borrowings of $7.9 million under the acquisition credit facility and to acquire additional properties. On February 23, 1998, Realty Income issued 751,174 shares of common stock at a net price to the Company of $25.295 per share to a unit investment trust. The net proceeds were used to repay borrowings of $18.9 million under the acquisition credit facility. The Company received investment grade corporate credit ratings 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 the Company's senior debt. These ratings are subject to change based upon, among other things, the Company's results of operations and financial condition. Property Acquisitions During the second quarter of 1998, Realty Income acquired 44 retail properties located in 20 states and invested $50.2 million (excluding estimated unfunded development costs on properties under construction at June 30, 1998) and selectively sold two properties. During the quarter, the Company also invested $60,000 in three existing properties in its portfolio. The 44 properties acquired will contain approximately 300,700 leasable square feet and are 100% leased under net leases, with an average Page 15 initial lease term of 14.4 years. The weighted average annual unleveraged return on the cost of the 44 properties (including the estimated unfunded development cost of the properties under development) is estimated to be 10.0%, 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 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 44 properties acquired in the second quarter of 1998 will not differ from the foregoing percentage. During the first six months of 1998, Realty Income acquired 66 retail properties located in 29 states and invested $102.0 million (excluding estimated unfunded development costs on properties under construction at June 30, 1998) and selectively sold five properties, increasing the number of properties in its portfolio by 7.4% to 887 from 826 at December 31, 1997. During the first half of 1998, the Company added two new industries and 11 new retailers to its real estate portfolio. The Company also invested $74,000 in five existing properties in its portfolio. The 66 properties acquired will contain approximately 657,300 leasable square feet and are 100% leased under net leases, with an average initial lease term of 14.8 years. The weighted average annual leveraged return on the cost of the 66 properties (including the estimated unfunded development cost of the properties under development) is estimated to be 10.3%, 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 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 66 properties acquired in 1998 will not differ from the foregoing percentage. Of the properties acquired during the first six months of 1998, 61 were occupied as of August 12, 1998 and the remaining properties 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 1998, including the properties under development, are leased with initial terms of 9 to 20 years. Page 16 The following table summarized Realty Income's 1998 acquisition activity by quarter. <TABLE> <CAPTION> Initial Approx. Properties Lease Term Leasable Total Acquired (Years) Square Feet Invested ========== ========== =========== ============ <S> <C> <C> <C> <C> 1st quarter 22 15.5 356,600 $ 51,812,000 2nd quarter 44 14.4 300,700 50,159,000 - -------------- ---------- ---------- ----------- ------------ Totals 66 14.8 657,300 $101,971,000 ============== ========== ========== =========== ============ </TABLE> Distributions Cash distributions paid during the first six months of 1998 and 1997 were $25.5 million and $21.7 million, respectively. During the first quarter of 1998, the Company paid three monthly distributions of $0.16 per share. During the second quarter of 1998, the Company paid three distributions of $0.1625 per share. Distributions for the first six months of 1998 totaled $0.9675 per share. In April and July 1998, the monthly distributions were increased to $0.1625 and $0.1650 per share, respectively. In June and July 1998, the Company declared distributions of $0.1650 per share which were paid on July 15, 1998 and payable on August 17, 1998, respectively. FUNDS FROM OPERATIONS ("FFO") - ----------------------------- FFO for the second quarter of 1998 increased by $2.92 million or 23.5% to $15.33 million versus $12.41 million during the second quarter of 1997. The following is a reconciliation of net income to FFO, and information regarding distributions paid and diluted weighted average number of shares outstanding for the second quarter of 1998 and 1997 (dollars in thousands): Page 17
<TABLE> <CAPTION> 1998 1997 -------- -------- <S> <C> <C> Net income $ 10,308 $ 8,068 Plus depreciation and amortization 5,369 4,484 Plus provision for impairment loss -- 70 Less depreciation of furniture, fixtures and equipment and amortization of organization costs (40) (13) Less gain on sales of properties (311) (202) -------- -------- Total Funds From Operations $ 15,326 $ 12,407 ======== ======== Cash Distributions Paid $ 13,083 $ 10,861 FFO in excess of Distributions $ 2,243 $ 1,546 Diluted weighted average number of shares outstanding 26,845,091 22,990,592 </TABLE> FFO for the first six months of 1998 increased by $5.26 million or 21.2% to $30.08 million versus $24.82 million during the same period of 1997. The following is a reconciliation of net income to FFO, and information regarding distributions paid and diluted weighted average number of shares outstanding for the first six months of 1998 and 1997 (dollars in thousands): <TABLE> <CAPTION> 1998 1997 ---------- ---------- <S> <C> <C> Net income $ 20,232 $ 16,253 Plus depreciation and amortization 10,453 8,948 Plus provision for impairment loss -- 70 Less depreciation of furniture, fixtures and equipment and amortization of organization costs (79) (24) Less gain on sales of properties (526) (427) -------- -------- Total Funds From Operations $ 30,080 $ 24,820 ======== ======== Cash Distributions Paid $ 25,545 $ 21,722 FFO in excess of Distributions $ 4,535 $ 3,098 Diluted weighted average number of shares outstanding 26,442,519 22,990,163 </TABLE> Page 18 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. Realty Income defines 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 are 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 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 and six months ended June 30, 1998 to the three and six months ended June 30, 1997. Rental revenue was $20.34 million for second quarter of 1998 versus $16.01 million for the comparable quarter of 1997, an increase of 27.0% or $4.33 million. The increase in rental revenue was primarily due to the acquisition of 162 properties during 1997 and the first six months of 1998 (the "New Properties"). The New Properties generated revenue of $4.99 million in the second quarter of 1998 compared to $659,000 in the second quarter of 1997, an increase of $4.33 million. Rental revenue was $39.51 million for the first six months of 1998 versus $31.46 million for the comparable period of 1997, an increase of 25.6% or $8.05 million. The increase in rental revenue was primarily due to the acquisition of the New Properties. The New Properties generated revenue of $8.75 million in the first six months of 1998 compared to $794,000 in the comparable period of 1997, an increase of $7.95 million. Of the 887 properties in the portfolio as of June 30, 1998, 881 are single-tenant properties with the remaining properties being multi-tenant properties. Of the 881 single-tenant properties 878, or over 99%, were net leased with an average remaining lease Page 19 term (excluding extension options) of approximately 8.4 years. At June 30, 1998, 878 of the Company's 881 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. Percentage rent, which is included in rental revenue, was $67,000 during the second quarter of 1998 and $76,000 in the comparable quarter of 1997. Percentage rent during the first six months of 1998 and 1997 was $275,000 and $369,000, respectively. Same store rents generated on 717 properties owned during the entire first six months of 1998 and 1997 increased by $319,000 or 1.1%, to $30.40 million from $30.08 million. Same store rents generated on the same 717 properties owned during the entire second quarter of 1998 and 1997 increased by $195,000 or 1.3%, to $15.17 million from $14.97 million. The following tables represent Realty Income's rental revenue by industry (dollars in thousands): <TABLE> <CAPTION> Annualized as Six Months Ended of July 1, 1998 June 30, 1998 --------------------- --------------------- Rental(1) Percentage Rental Percentage Industry Revenue of Total Revenue of Total - -------------------- ------- ---------- ------- ---------- <S> <C> <C> <C> <C> Apparel Stores $ 3,927 4.5% $ 1,497 3.8% Automotive Parts 7,398 8.4 2,745 6.9 Automotive Service 6,742 7.7 3,076 7.8 Book Stores 450 0.5 225 0.6 Child Care 24,502 27.9 11,920 30.2 Consumer Electronics 4,432 5.1 2,320 5.9 Convenience Stores 5,301 6.0 2,401 6.1 Health & Fitness 360 0.4 -- -- Home Furnishings 8,065 9.2 2,752 7.0 Office Supplies 2,476 2.8 1,256 3.2 Pet Supplies & Services 435 0.5 136 0.3 Private Education 1,000 1.1 271 0.6 Restaurants 13,902 15.9 6,804 17.2 Shoe Stores 529 0.6 247 0.6 Video Rental 3,315 3.8 1,367 3.5 Other 4,895 5.6 2,494 6.3 - -------------------- ------- ------ ------- ------ Totals $87,729 100.0% $39,511 100.0% ==================== ======= ====== ======= ====== </TABLE> Page 20 [FN] (1) Annualized rental revenue is calculated by multiplying the monthly contractual base rent as of July 1, 1998 by 12 and adding the previous 12 month's historic percentage rent, which totaled $1.7 million. For properties under construction, an estimated contractual base rent is used based upon the estimated total costs of each property. </FN> <TABLE> <CAPTION> Six Months Ended June 30, 1997 --------------------- Rental Percentage Industry Revenue of Total - -------------------- ------- ---------- <S> <C> <C> Apparel Stores $ -- --% Automotive Parts 2,906 9.3 Automotive Service 1,897 6.0 Book Stores 152 0.5 Child Care 11,779 37.4 Consumer Electronics 2,114 6.7 Convenience Stores 1,602 5.1 Health and Fitness -- -- Home Furnishings 1,543 4.9 Office Supplies 239 0.8 Pet Supplies & Services 8 -- Private Education -- -- Restaurants 6,768 21.5 Shoe Stores -- -- Video Rental -- -- Other 2,447 7.8 - -------------------- ------- ------ Totals $31,455 100.0% ==================== ======= ====== </TABLE> At June 30, 1998, the Company had three properties that were not under lease, as compared to four at March 31, 1998 and eight at December 31, 1997. At June 30, 1998, 884, or over 99%, of the 887 properties in the portfolio were under lease agreements with third party tenants. Interest and other revenue during the second quarter of 1998 and 1997 totaled $24,000 and $117,000, respectively, a decrease of $93,000. Interest and other revenue during the first six months of 1998 and 1997 totaled $78,000 and $148,000, respectively, a decrease of $70,000. The decrease in 1998 was primarily due to interest earned in 1997 on bond offering proceeds in excess of the $93.7 million used to payoff the credit facility in May 1997. Page 21 These proceeds were invested in new properties during May and June 1997. Depreciation and amortization was $5.4 million in the second quarter of 1998 versus $4.5 million in the comparable quarter of 1997 and $10.5 million for the first six months of 1998 versus $8.9 million for the comparable six months of 1997. The increase in 1998 was primarily due to depreciation of New Properties. General and administrative expenses increased by $379,000 to $1.7 million in the second quarter of 1998 versus $1.3 million in the comparable quarter of 1997. The increase in general and administrative expenses was primarily due to an increase in property acquisition expenses and employee costs. General and administrative expenses as a percentage of revenue increased to 8.4% in the second quarter of 1998 as compared to 8.3% in the comparable quarter of 1997. During 1997, the Company increased its number of employees to 47 from 35. The majority of the new employees work primarily on new property acquisitions and were hired during the second and third quarter of 1997. General and administrative expenses increased by $591,000 to $3.2 million in the first six months of 1998 versus $2.6 million in the first six months of 1997. The increase in general and administrative expenses was primarily due to an increase in property acquisition expenses and employee costs. General and administrative expenses as a percentage of revenue decreased to 8.0% in the first six months of 1998 as compared to 8.2% in the first six months of 1997. 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, 1998, three properties were available for lease, as compared to four at March 31, 1998 and eight at December 31, 1997. Property expenses were $426,000 in the second quarter of 1998 and $362,000 in the second quarter of 1997, an increase of $64,000. The increase in property expenses was primarily attributable to the New Properties. It is anticipated that property expenses will increase as additional properties are acquired. Property expenses as a percentage of revenue decreased to 2.3% in the first six months of 1998 as compared to 2.7% in the first six months of 1997. Page 22 Property expenses were $899,000 in the first six months of 1998 and $853,000 in the comparable period of 1997, an increase of $46,000. The increase in property expenses was primarily attributable to the New Properties. Property expenses as a percentage of revenue decreased to 2.1% in the second quarter of 1998 as compared to 2.2% in the same quarter of 1997. Interest expense in the second quarter of 1998 increased by $855,000 to $2.9 million, as compared to $2.0 million in the second quarter of 1997. The following is a summary of the five components of interest expense for the second quarter of 1998 and 1997 (dollars in thousands): <TABLE> <CAPTION> 1998 1997 Net Change -------- -------- ---------- <S> <C> <C> <C> Interest on outstanding loans and notes $ 2,894 $ 1,970 $ 924 Amortization of the gain on the 1996 treasury lock agreement (29) (18) (11) Credit facility commitment fees 57 35 22 Amortization of credit facility origination costs and deferred bond financing costs 96 68 28 Interest capitalized (154) (46) (108) -------- -------- -------- Totals $ 2,864 $ 2,009 $ 855 ======== ======== ======== </TABLE> Interest on outstanding loans and notes was $924,000 higher in the second quarter of 1998 than in 1997, due to an increase in the average outstanding balances, which was partially offset by lower average interest rate. During the second quarter of 1998, the average outstanding balances and interest rate (after taking into affect amortization of the gain on the treasury lock agreement) on the Notes and credit facility were $157.2 million and 7.31% as compared to $103.9 million and 7.54% during the second quarter of 1997. During the second quarter of 1998, the credit facility's average interest rate was 6.48% and average outstanding balance was $47.2 million. The credit facility's balance at June 30, 1998 was $87.9 million. Page 23 Interest expense for the first six months of 1998 increased by $2.0 million to $5.36 million, as compared to $3.32 million in the comparable period of 1997. The following is a summary of the five components of interest expense for the first six months of 1998 and 1997 (dollars in thousands): <TABLE> <CAPTION> 1998 1997 Net Change -------- -------- ---------- <S> <C> <C> <C> Interest on outstanding loans and notes $ 5,343 $ 3,248 $ 2,095 Amortization of the gain on the 1996 treasury lock agreement (57) (18) (39) Credit facility commitment fees 113 56 57 Amortization of credit facility origination costs and deferred bond financing costs 190 117 73 Interest capitalized (234) (82) (152) -------- -------- ---------- Totals $ 5,355 $ 3,321 $ 2,034 ======== ======== ========== </TABLE> Interest on outstanding loans and notes was $2.1 million higher in the first six months of 1998 than in 1997, due to an increase in the average outstanding balances and higher average interest rate. During the first six months of 1998, the average outstanding balances and interest rate (after taking into affect amortization of the gain on the treasury lock agreement) on the Notes and credit facility were $143.3 million and 7.44% as compared to $90.1 million and 7.23% during the comparable period of 1997. During the first six months of 1998, the credit facility's average interest rate was 6.53% and average outstanding balance was $33.3 million. 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. No charge was recorded for impairment loss during the first six months of 1998. In the second quarter and first six months of 1997, a $70,000 charge was taken to reduce the net carrying value on one property because it became held for sale. This property was sold in the second quarter of 1997. During the second quarter of 1998, the Company sold two properties (one child care center and one restaurant) for a total of $822,000 and recorded a gain of $311,000. During the second quarter of 1997, the Company sold three restaurant properties for $1.6 million and recognized a gain of $202,000. Page 24 During the first six months of 1998, the Company sold five properties (two child care centers, one multi-tenant location and two restaurants) for a total of $2.8 million and recorded a gain of $526,000. During the first six months of 1997, the Company sold seven properties (five restaurants and one child care center and one multi-tenant location) for $2.9 million and recognized a gain of $427,000. In the second quarter of 1998, the Company had net income of $10.3 million versus $8.1 million in 1997. The $2.2 million increase in net income is primarily due to the increase in rental revenue from the New Properties of $4.3 million, which was partially offset by an increase in depreciation and amortization, general and administrative, and interest expense totaling $2.1 million. In the first six months of 1998, the Company had net income of $20.2 million versus $16.3 million in the comparable period of 1997. The $3.9 million increase in net income is primarily due to the increase in rental revenue from the New Properties of $8.0 million, which was partially offset by an increase in depreciation and amortization, general and administrative, and interest expense totaling $4.1 million. PROPERTIES - ---------- As of July 1, 1998, Realty Income owned a diversified portfolio of 887 properties in 43 states consisting of over 6.9 million square feet of leasable space. At July 1, 1998, approximately 99% 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 maintenance. The Company's net leased properties are retail locations primarily leased to regional and national retail chain store operators. The average leasable retail space of the 887 properties is approximately 7,800 square feet on approximately 47,000 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 sufficient population base to constitute a sufficient market or trade area for the retailer's business. The following table sets forth certain information regarding the Company's properties as of July 1, 1998, classified according to the business of the respective tenants. Page 25 <TABLE> <CAPTION> Approximate Percent of Number of Leasable Annualized Annualized Industry Properties Square Feet Rent (1) Rent - -------------------- ---------- ----------- ----------- --------- <S> <C> <C> <C> <C> Apparel Stores 5 228,800 $ 3,927,000 4.5% Automotive Parts 112 613,700 7,398,000 8.4 Automotive Service 97 322,700 6,742,000 7.7 Book Stores 1 30,000 450,000 0.5 Child Care 315 2,007,300 24,502,000 27.9 Consumer Electronics 37 559,200 4,432,000 5.1 Convenience Stores 61 168,200 5,301,000 6.0 Health & Fitness 1 32,700 360,000 0.4 Home Furnishings 35 1,016,100 8,065,000 9.2 Office Supplies 8 198,400 2,476,000 2.8 Pet Supplies & Services 2 28,100 435,000 0.5 Private Education 3 59,300 1,000,000 1.1 Restaurants 170 861,200 13,902,000 15.9 Shoe Stores 2 27,700 529,000 0.6 Video Rental 26 194,000 3,315,000 3.8 Other 12 555,600 4,895,000 5.6 - -------------------- ---------- ----------- ----------- --------- TOTALS 887 6,903,000 $87,729,000 100.0% ==================== ========== =========== =========== ========= </TABLE> [FN] (1) Annualized Rent is calculated by multiplying the monthly contractual base rent as of July 1, 1998 by 12 and adding the previous twelve month's historic percentage rent, which totaled $1.7 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> Of the 887 properties in the portfolio at July 1, 1998, 881 were single-tenant properties with the remaining properties being multi-tenant properties. As of July 1, 1998, 878 of the 881 single-tenant properties, or over 99%, 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 the lease term expirations (excluding extension options) on the Company's 878 net leased, single-tenant retail properties as of July 1, 1998. Page 26 <TABLE> <CAPTION> Percent of Number of Total Leases Annualized Annualized Year Expiring Base Rent(1)(2) Base Rent - ------ --------- --------------- ---------- <S> <C> <C> <C> 1998 2 $ 96,000 0.1% 1999 30 1,248,000 1.5 2000 38 1,969,000 2.4 2001 48 4,076,000 5.0 2002 79 6,346,000 7.7 2003 66 5,147,000 6.3 2004 111 9,056,000 11.0 2005 84 6,036,000 7.4 2006 29 2,473,000 3.0 2007 91 5,793,000 7.1 2008 53 4,356,000 5.3 2009 16 1,144,000 1.4 2010 39 3,706,000 4.5 2011 36 4,669,000 5.7 2012 52 5,854,000 7.1 2013 48 8,401,000 10.2 2014 6 749,000 0.9 2015 27 4,976,000 6.1 2016 10 1,640,000 2.0 2017 11 4,092,000 5.0 2018 2 221,000 0.3 - ------ --------- --------------- ---------- Totals 878 $ 82,048,000 100.0% ====== ========= =============== ========== </TABLE <FN> (1) Annualized base rent is calculated by multiplying the monthly contractual base rent as of July 1, 1998 by 12. For properties under construction, an estimated contractual base rent is used based upon the estimated total costs of each property. 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 properties. Percentage rent for the previous twelve months totaled $1.7 million. (2) This table does not include six multi-tenant properties and three 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> The following table sets forth certain state-by-state information regarding the properties owned by the Company as of July 1, 1998. Page 27 </TABLE> <TABLE> <CAPTION> Approximate Percent of Number of Percent Leasable Annualized Annualized State Properties Leased Square Feet Rent (1) Rent - -------------- ---------- ------- ----------- ----------- ---------- <S> <C> <C> <C> <C> <C> Alabama 8 100% 56,600 $ 537,000 0.6% Arizona 28 99 183,800 2,557,000 2.9 Arkansas 3 100 14,600 191,000 0.2 California 52 94 987,800 11,028,000 12.6 Colorado 41 100 228,500 3,208,000 3.7 Connecticut 9 100 216,300 2,825,000 3.2 Florida 56 100 564,000 5,845,000 6.7 Georgia 46 100 266,600 3,838,000 4.4 Idaho 12 100 58,500 856,000 1.0 Illinois 29 100 202,200 2,579,000 2.9 Indiana 24 100 130,000 1,691,000 1.9 Iowa 9 100 60,300 574,000 0.7 Kansas 19 100 192,500 2,128,000 2.4 Kentucky 13 100 43,500 1,078,000 1.2 Louisiana 5 100 39,600 508,000 0.6 Maryland 6 100 34,900 535,000 0.6 Massachusetts 6 100 37,900 731,000 0.8 Michigan 7 100 44,800 652,000 0.8 Minnesota 18 100 126,500 1,950,000 2.2 Mississippi 14 100 143,100 1,066,000 1.2 Missouri 30 100 176,800 2,182,000 2.5 Montana 2 100 30,000 296,000 0.3 Nebraska 9 100 93,700 1,134,000 1.3 Nevada 7 100 86,400 1,333,000 1.5 New Hampshire 1 100 6,400 125,000 0.1 New Jersey 2 100 22,700 351,000 0.4 New Mexico 3 100 12,000 107,000 0.1 New York 9 100 170,600 3,596,000 4.1 North Carolina 28 100 125,800 2,228,000 2.5 Ohio 63 100 309,900 4,990,000 5.7 Oklahoma 15 100 85,800 1,020,000 1.2 Oregon 17 100 92,400 1,257,000 1.4 Pennsylvania 16 100 118,400 1,685,000 1.9 South Carolina 22 100 90,500 1,419,000 1.6 South Dakota 1 100 6,100 84,000 0.1 Tennessee 20 100 188,400 2,235,000 2.6 Texas 138 100 1,109,800 11,157,000 12.7 Utah 7 100 45,400 594,000 0.7 Virginia 28 100 115,400 2,447,000 2.8 Washington 43 100 252,600 3,406,000 3.9 West Virginia 2 100 16,800 147,000 0.2 Wisconsin 15 100 95,000 1,291,000 1.5 Wyoming 4 100 20,100 268,000 0.3 - -------------- ---------- ------- ----------- ---------- ---------- Totals 887 99% 6,903,000 $87,729,000 100.0% ============== ========== ======= =========== ========== ========== </TABLE> Page 28 [FN] (1) Annualized Rent is calculated by multiplying the monthly contractual base rent as of July 1, 1998 by 12 and adding the previous twelve month's historic percentage rent, which totaled $1.7 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 following table sets forth certain information regarding the properties owned by the Company as of July 1, 1998, classified according to the business of the respective tenants. <TABLE> <CAPTION> Number of Annualized Percent of Properties Rent (1) Revenue ---------- ---------- ---------- <S> <C> <C> <C> GOODS Apparel Stores 5 $ 3,927,000 4.5% Automotive Parts 79 4,799,000 5.5 Book Stores 1 450,000 0.5 Consumer Electronics 37 4,432,000 5.0 Home Furnishings 35 8,065,000 9.2 Office Supplies 8 2,476,000 2.8 Pet Supplies 1 253,000 0.3 Shoe Stores 2 529,000 0.6 ---------- ---------- ---------- 168 24,931,000 28.4 ---------- ---------- ---------- GOODS WITH SERVICES Automotive Parts 33 2,599,000 3.0 Convenience Stores 61 5,301,000 6.0 Pet Supplies & Services 1 182,000 0.2 Restaurants 170 13,902,000 15.8 Video Rental 26 3,315,000 3.8 ---------- ---------- ---------- 291 25,299,000 28.8 ---------- ---------- ---------- SERVICES Automotive Service 97 6,742,000 7.7 Child Care 315 24,502,000 27.9 Health & Fitness 1 360,000 0.4 Other 12 4,895,000 5.6 Private Education 3 1,000,000 1.2 ---------- ---------- ---------- 428 37,499,000 42.8 ---------- ---------- ---------- TOTALS 887 $87,729,000 100.0% ========== ========== ========== </TABLE> Page 29 [FN] (1) Annualized Rent is calculated by multiplying the monthly contractual base rent as of July 1, 1998 by 12 and adding the previous twelve month's historic percentage rent, which totaled $1.7 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> 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. Approximately 99% 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 the Company's 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. IMPACT OF ACCOUNTING PRONOUNCEMENTS - ----------------------------------- In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("Statement No. 133"). Statement No. 133 establishes accounting and reporting standards for derivative instruments. The Company anticipates that the adoption of Statement No. 133 will not have a material effect on the financial position, results of operations or liquidity of the Company. Page 30 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, 1998, 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. 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 --------- ---------- ------- --------- Roger P. Kuppinger 2001 18,566,031 70.2 151,855 Michael D. McKee 2001 18,562,151 70.1 155,735 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K A. Exhibits: <TABLE> <CAPTION> Exhibit No. Description =========== =========== <S> <C> 3.1 Articles of Incorporation of the Company (filed) as Appendix B to the Company's Proxy Statement dated March 28, 1997 ("1997 Proxy Statement") and incorporated herein by reference) 3.2 Bylaws of the Company (filed as Appendix C to the Company's 1997 Proxy Statement and incorporated herein by reference) 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) 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) Page 31 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) 10.1 Amended and restated credit agreement dated as of November 29, 1994 and restated as of December 30, 1997, filed herein 27 Financial Data Schedule, filed herein </TABLE> 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 was dated and filed June 29, 1998 reporting the implementation of a stockholders rights plan. 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 <TABLE> <S> <C> (Signature and Title) /s/ GARY M. MALINO Date: August 12, 1998 ------------------------------------- Gary M. Malino, Senior Vice President Chief Financial Officer (Principal Financial and Accounting Officer) EXHIBIT INDEX </TABLE> <TABLE> <CAPTION> Exhibit No. Description =========== =========== <S> <C> 10.1 Amended and restated credit agreement dated as of November 29, 1994 and restated as of December 30, 1997 27 Financial Data Schedule </TABLE> Page 32