10-Q 1 c78829e10vq.txt FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 FORM 10-Q (Mark one) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended JUNE 30, 2003 ------------- OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________ to __________ Commission file number 001-13777 --------- GETTY REALTY CORP. ------------------ (Exact name of registrant as specified in its charter) MARYLAND 11-3412575 -------- ---------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 125 JERICHO TURNPIKE, SUITE 103 JERICHO, NEW YORK 11753 (Address of principal executive offices) (Zip Code) (516) 478 - 5400 ---------------- (Registrant's telephone number, including area code) ------------------------------------------------------ (Former name, former address and former fiscal year, if changed since last report) 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 [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ] Registrant had outstanding 21,512,795 shares of Common Stock, par value $.01 per share, and 2,822,976 shares of Series A Participating Convertible Redeemable Preferred Stock, par value $.01 per share, as of August 1, 2003. GETTY REALTY CORP. INDEX
Page Number ----------- Part I. FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets as of June 30, 2003 and December 31, 2002 1 Consolidated Statements of Operations for the three and six months ended June 30, 2003 and 2002 2 Consolidated Statements of Cash Flows for the six months ended June 30, 2003 and 2002 3 Notes to Consolidated Financial Statements 4 - 9 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 10 - 16 Item 3. Quantitative and Qualitative Disclosures About Market Risk 17 Item 4. Controls and Procedures 17 Part II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K 18 Signatures 19
GETTY REALTY CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (in thousands, except share data) (unaudited)
-------------------------------------------------------------------------------------------------------------- June 30, December 31, -------------------------------------------------------------------------------------------------------------- Assets: 2003 2002 -------------------------------------------------------------------------------------------------------------- Real Estate: Land $ 143,869 $ 135,372 Buildings and improvements 176,824 172,682 --------- --------- 320,693 308,054 Less - accumulated depreciation 97,726 93,986 --------- --------- Real estate, net 222,967 214,068 Cash and equivalents 21,886 33,726 Deferred rent receivable 17,932 15,116 Recoveries from state underground storage tank funds, net 12,122 13,396 Mortgages and accounts receivable, net 3,870 5,193 Prepaid expenses and other assets 642 992 --------- --------- Total assets $ 279,419 $ 282,491 ========= ========= ----------------------------------------------------------------------------------------------------------- Liabilities and Shareholders' Equity: ----------------------------------------------------------------------------------------------------------- Mortgages payable $ 886 $ 923 Dividends payable 10,127 10,379 Accounts payable and accrued expenses 9,332 9,839 Environmental remediation costs 27,619 27,924 --------- --------- Total liabilities 47,964 49,065 --------- --------- Commitments and contingencies (notes 6, 7 and 9) Shareholders' equity: Preferred stock, par value $.01 per share; authorized 20,000,000 shares for issuance in series of which 3,000,000 shares are classified as Series A Participating Convertible Redeemable Preferred; issued 2,822,976 at June 30, 2003 and 2,865,768 at December 31, 2002 70,574 71,644 Common stock, par value $.01 per share; authorized 50,000,000 shares; issued 21,512,795 at June 30, 2003 and 21,442,299 at December 31, 2002 215 214 Paid-in capital 188,018 186,664 Dividends paid in excess of earnings (27,352) (25,096) --------- --------- Total shareholders' equity 231,455 233,426 --------- --------- Total liabilities and shareholders' equity $ 279,419 $ 282,491 ========= =========
The accompanying notes are an integral part of these financial statements. 1 GETTY REALTY CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share amounts) (unaudited)
--------------------------------------------------------------------------------------------------------------- Three months ended June 30, Six months ended June 30, --------------------------------------------------------------------------------------------------------------- 2003 2002 2003 2002 --------------------------------------------------------------------------------------------------------------- Revenues: Revenues from rental properties $ 16,672 $ 16,802 $ 33,349 $ 33,679 Other income, net 409 792 763 1,352 -------- -------- -------- -------- Total revenues 17,081 17,594 34,112 35,031 -------- -------- -------- -------- Expenses: Rental property expenses 2,672 3,061 5,584 6,166 Environmental expenses, net 2,166 1,657 3,713 3,306 General and administrative expenses 607 1,211 1,900 2,289 Depreciation expense 2,172 2,327 4,311 4,641 Interest expense 33 32 66 65 -------- -------- -------- -------- Total expenses 7,650 8,288 15,574 16,467 -------- -------- -------- -------- Net earnings before cumulative effect of accounting change 9,431 9,306 18,538 18,564 Cumulative effect of accounting change - - (550) - -------- -------- -------- -------- Net earnings 9,431 9,306 17,988 18,564 Preferred stock dividends 1,253 1,272 2,525 2,544 -------- -------- -------- -------- Net earnings applicable to common shareholders $ 8,178 $ 8,034 $ 15,463 $ 16,020 ======== ======== ======== ======== Net earnings per common share: Basic $ .38 $ .37 $ .72 $ .75 Diluted $ .38 $ .37 $ .72 $ .75 Weighted average common shares outstanding: Basic 21,498 21,434 21,470 21,429 Diluted 21,508 21,443 21,482 21,439 Dividends declared per share: Preferred $ .44375 $ .44375 $ .88750 $ .88750 Common $ .41250 $ .41250 $ .82500 $ .82500
The accompanying notes are an integral part of these financial statements. 2 GETTY REALTY CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) (unaudited)
----------------------------------------------------------------------------------------------------------- Six months ended June 30, ----------------------------------------------------------------------------------------------------------- 2003 2002 ----------------------------------------------------------------------------------------------------------- Cash flows from operating activities: Net earnings $ 17,988 $ 18,564 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation expense 4,311 4,641 Gain on dispositions of real estate (294) (816) Deferred rental revenue (2,816) (3,378) Accretion expense 496 -- Cumulative effect of accounting change 550 -- Changes in assets and liabilities: Recoveries from state underground storage tank funds, net 2,746 (1,266) Mortgages and accounts receivable, net 776 (356) Prepaid expenses and other assets 350 (68) Accounts payable and accrued expenses (507) (1,916) Environmental remediation costs (2,823) 2,368 -------- -------- Net cash provided by operating activities 20,777 17,773 -------- -------- Cash flows from investing activities: Collections of mortgages receivable, net 547 7 Property acquisitions (13,553) (1,073) Capital expenditures (78) (86) Proceeds from dispositions of real estate 715 1,641 -------- -------- Net cash provided by (used in) investing activities (12,369) 489 -------- -------- Cash flows from financing activities: Cash dividends paid (20,496) (20,219) Repayment of mortgages payable (37) (36) Stock options, common and treasury stock, net 285 199 -------- -------- Net cash used in financing activities (20,248) (20,056) -------- -------- Net decrease in cash and equivalents (11,840) (1,794) Cash and equivalents at beginning of period 33,726 37,523 -------- -------- Cash and equivalents at end of period $ 21,886 $ 35,729 ======== ======== Supplemental disclosures of cash flow information Cash paid (refunded) during the period for: Interest $ 66 $ 65 Income taxes, net 671 421 Recoveries from state underground storage tank funds (908) (1,878) Environmental remediation costs 3,020 3,574
The accompanying notes are an integral part of these financial statements. 3 GETTY REALTY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. General: The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America ("GAAP"). The consolidated financial statements include the accounts of Getty Realty Corp. and its wholly-owned subsidiaries (the "Company"). The Company is a real estate investment trust ("REIT") specializing in the ownership and leasing of retail motor fuel and convenience store properties as well as petroleum distribution terminals. The Company manages and evaluates its operations as a single segment. All significant intercompany accounts and transactions have been eliminated. The financial statements have been prepared in conformity with GAAP, which requires management to make its best estimates, judgments and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the period reported. While all available information has been considered, actual results could differ from those estimates, judgments and assumptions. Estimates, judgments and assumptions underlying the accompanying consolidated financial statements include, but are not limited to, deferred rent receivable, recoveries from state underground storage tank funds, net, environmental remediation costs, depreciation, impairment of long-lived assets, litigation, accrued expenses and income taxes. The consolidated financial statements are unaudited but, in the opinion of management, reflect all adjustments (consisting of normal recurring accruals) necessary for a fair presentation. These statements should be read in conjunction with the consolidated financial statements and related notes, which appear in the Company's Annual Report on Form 10-K for the year ended December 31, 2002. 2. Earnings Per Common Share: Basic earnings per common share is computed by dividing net earnings less preferred dividends by the weighted average number of common shares outstanding during the period. Diluted earnings per common share also gives effect to the potential dilution from the exercise of stock options in the amount of 11,000 and 12,000 shares for the three and six months ended June 30, 2003, respectively, and 9,000 and 10,000 shares, respectively for the comparable prior year periods. For the three and six months ended June 30, 2003 and 2002, conversion of the Series A Participating Convertible Redeemable Preferred stock into common stock utilizing the if-converted method would have been antidilutive and therefore conversion was not assumed for purposes of computing either basic or diluted earnings per common share. 3. Stock-Based Compensation: In December 2002, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. ("SFAS") 148, "Accounting for Stock-Based Compensation--Transition and Disclosure--an amendment of SFAS 123." The Company voluntarily changed to the fair value basis of accounting for stock-based employee compensation for options granted subsequent to January 1, 2003 under its stock option plan. The Company will continue to account for options granted under its stock option plan prior to January 1, 2003 using the intrinsic value method. Had compensation cost for the Company's stock option plan been accounted for using the fair value method for all grants, the Company's total stock-based employee compensation expense using the fair value method, pro-forma net 4 earnings and pro-forma net earnings per share on a basic and diluted basis would have been as follows (in thousands, except per share amounts):
Three months ended Six months ended June 30, June 30, ---------------------------------------------- 2003 2002 2003 2002 ---------------------------------------------- Net earnings, as reported $ 9,431 $ 9,306 $17,988 $ 18,564 Add: Stock-based employee compensation expense included in reported net earnings -- (*) -- -- (*) -- Deduct: Total stock-based employee compensation expense using the fair value method 33 31 66 61 -------------------------------------------- Pro-forma net earnings $ 9,398 $ 9,275 $17,922 $ 18,503 ============================================ Net earnings per common share: As reported $ .38 $ .37 $ .72 $ .75 Pro-forma $ .38 $ .37 $ .72 $ .75
(*) There were no stock options granted during the three and six months ended June 30, 2003. 4. Cumulative Effect of Accounting Change: In June 2001, the FASB issued SFAS 143, "Accounting for Asset Retirement Obligations." SFAS 143 requires that obligations associated with the retirement of tangible long-lived assets be recognized at their fair value in the period when incurred if the asset retirement obligation results from the normal operation of those assets and a reasonable estimate of fair value can be made. Due to the adoption of SFAS 143 effective January 1, 2003, accrued environmental remediation costs and recoveries from state underground storage tank funds were adjusted to their estimated fair value resulting in a one-time cumulative effect of change in accounting charge of $550,000. Environmental liabilities and related assets are currently measured based on their expected future cash flows which have been adjusted for inflation and discounted to present value. Prior to the adoption of SFAS 143 generally accepted accounting principles required that if the best estimate of cost for a component of the liability could only be identified as a range, and no amount within the range was a better estimate than any other amount, the minimum of the range was accrued for that cost component. Historically, such accruals were not adjusted for inflation or discounted to present value. 5 5. Shareholders' Equity: A summary of the changes in shareholders' equity for the six months ended June 30, 2003 is as follows (in thousands, except per share amounts):
Dividends Preferred Stock Common Stock Paid In --------------------------------------------- Paid-in Excess Of Shares Amount Shares Amount Capital Earnings Total ----------------------------------------------------------------------------------------- Balance, December 31, 2002 2,866 $ 71,644 21,442 $ 214 $ 186,664 $ (25,096) $ 233,426 Net earnings 17,988 17,988 Cash dividends declared: Common -- $.8250 per share (17,719) (17,719) Preferred -- $.8875 per share (2,525) (2,525) Preferred stock conversion (43) (1,070) 49 1,070 -- Stock options 22 1 284 285 ---------------------------------------------------------------------------------------- Balance, June 30, 2003 2,823 $ 70,574 21,513 $ 215 $ 188,018 $ (27,352) $ 231,455 ========================================================================================
6. Commitments and Contingencies In order to qualify as a REIT, among other items, the Company paid a $64,162,000 special one-time "earnings and profits" (as defined in the Internal Revenue Code) cash distribution to shareholders in August 2001. Determination of accumulated earnings and profits for federal income tax purposes is extremely complex. Should the Internal Revenue Service successfully assert that the Company's accumulated earnings and profits were greater than the amount distributed, the Company may fail to qualify as a REIT; however, the Company may avoid losing its REIT status by paying a deficiency dividend to eliminate any remaining accumulated earnings and profits. The Company may have to borrow money or sell assets to pay such a deficiency dividend. In order to minimize the Company's exposure to credit risk associated with financial instruments, the Company places its temporary cash investments with high credit quality institutions. Temporary cash investments are held in an institutional money market fund and federal agency discount notes. The Company leases 970 of its 1,043 properties on a long-term net basis to Getty Petroleum Marketing Inc. ("Marketing") under the master lease entered into on February 1, 1997 and amended and restated effective December 9, 2000 (the "Master Lease"). Marketing operated substantially all of the Company's petroleum marketing businesses when it was spun-off to the Company's shareholders as a separate publicly held company in March 1997. In December 2000, Marketing was acquired by a subsidiary of OAO Lukoil, one of Russia's largest integrated oil companies. The Company's financial results depend largely on rental income from Marketing, and to a lesser extent on rental income from other tenants, and are therefore materially dependent upon the ability of Marketing to meet its obligations under the Master Lease. Marketing's financial results depend largely on retail petroleum marketing margins and rental income from its dealers. The petroleum marketing industry has been and continues to be volatile and highly competitive. Marketing has made all required monthly rental payments under the Master Lease when due. 6 The Master Lease is a "triple-net" lease, with Marketing responsible for the cost of all taxes, maintenance, repair, insurance and other operating expenses. In general, Marketing remains responsible for any violations of non-environmental laws that existed prior to the time of the amendment of the Master Lease. The Company also has agreed to indemnify Marketing for certain violations. The Company's indemnification responsibility for certain violations is capped at $1.375 million and expired in December 2002, unless curing of any violation commenced prior to such date. The Company has agreed to indemnify Marketing for certain pre-existing environmental conditions at six terminals which are owned by the Company. Under the agreement, Marketing will pay the first $1.5 million of costs and expenses incurred in connection with remediating any such pre-existing conditions, Marketing and the Company will share equally the next $8.5 million of those costs and expenses and Marketing will pay all additional costs and expenses over $10.0 million. The Company's indemnification responsibility for certain pre-existing environmental conditions at the six terminals is capped at $4.25 million and expires in December 2010. The Company has not accrued a liability for these indemnification agreements since it is uncertain that any significant amounts will be required to be paid under the agreements. Under the Master Lease, the Company also continues to have additional ongoing environmental remediation obligations for 306 scheduled properties as of June 30, 2003 (see note 7). The Company is subject to various legal proceedings and claims which arise in the ordinary course of its business. In addition, the Company has retained responsibility for all pre-spin-off legal proceedings and claims relating to the petroleum marketing business. These matters are not expected to have a material adverse effect on the Company's financial condition or results of operations. Prior to the spin-off, the Company was self-insured for workers' compensation, general liability and vehicle liability up to predetermined amounts above which third-party insurance applies. As of June 30, 2003 and December 31, 2002, the Company's consolidated balance sheets included, in accounts payable and accrued expenses, $1,090,000 and $1,602,000, respectively, relating to insurance obligations that may be deemed to have arisen prior to the spin-off of the Marketing business. During the three months ended June 30, 2003, the insurance loss reserves were reduced by $500,000. The Company's consolidated statements of operations for the three and six months ended June 30, 2003 included charges (credits) of $(373,000) and $(252,000), respectively, and $160,000 and $282,000, respectively, for the comparable prior year periods, for general and administrative insurance expense. Since the spin-off, the Company has maintained insurance coverage subject to certain deductibles. 7. Environmental Remediation Costs: The Company is subject to numerous existing federal, state and local laws and regulations, including matters relating to the protection of the environment. Currently, environmental expenses are principally attributable to remediation, monitoring, and governmental agency reporting incurred in connection with contaminated properties. In prior periods a larger portion of the expenses also included soil disposal and the replacement or upgrading of underground storage tanks ("USTs") to meet federal, state and local environmental standards, as well as routine monitoring and tank testing. For the three and six months ended June 30, 2003, net environmental expenses included in the Company's consolidated statements of operations were $2,166,000 and $3,713,000, respectively, and $1,657,000 and $3,306,000, respectively, for the comparable prior year period, which amounts were net of estimated net recoveries from state UST remediation funds. Under the Master Lease with Marketing, and in accordance with its leases with its other tenants, the Company agreed to bring the leased properties with known environmental contamination to regulatory or contractual closure ("Closure") in an economical manner, and thereafter, transfer all future environmental 7 risks to its tenants. Generally, upon achieving Closure at each individual property, the Company's environmental liability under its lease for that property will be satisfied and future remediation obligations will be the tenant's responsibility. The Company has agreed to pay all costs relating to, and to indemnify Marketing for, environmental liabilities and obligations scheduled in the Master Lease. The Company will continue to collect recoveries from state UST remediation funds related to these environmental liabilities where available. The estimated future costs for known environmental remediation requirements are accrued when it is probable that a liability has been incurred and a reasonable estimate of fair value can be made. The environmental remediation liability is estimated based on the level and impact of contamination for each property. The accrued liability is the aggregate of the best estimate of the fair value of cost for each component of the liability. Recoveries of environmental costs from state underground storage tank remediation funds, with respect to both past and future environmental spending, are accrued at fair value as income, net of allowance for collection risk, based on estimated recovery rates when such recoveries are considered probable. Prior to the adoption of SFAS 143 effective January 1, 2003, if the best estimate of cost for a component of the liability could only be identified as a range, and no amount within the range was a better estimate than any other amount, the minimum of the range had been accrued for that cost component rather than the estimated fair value currently required under the recently adopted pronouncement. Environmental exposures are difficult to assess and estimate for numerous reasons, including the extent of contamination, alternative treatment methods that may be applied, location of the property which subjects it to differing local laws and regulations and their interpretations, as well as the time it takes to remediate contamination. In developing the Company's liability for probable and reasonably estimable environmental remediation costs, on a property by property basis, the Company considers among other things, enacted laws and regulations, assessments of contamination including the potential impact of the contamination and the surrounding geology, the quality of information available, currently available technologies for treatment, alternative methods of remediation and prior experience. These accrual estimates are subject to significant change, and are adjusted as the remediation treatment progresses, as circumstances change and as these contingencies become more clearly defined and reasonably estimable. As of June 30, 2003, the Company has remediation action plans in place for 351 (88%) of the 397 properties for which it retained environmental responsibility. Forty-seven properties (12%) remain in the assessment phase, which when completed will likely result in a change in estimate for those properties. As of June 30, 2003 and January 1, 2003, the Company had accrued $27,619,000 and $29,426,000, respectively, as management's best estimate of the fair value of reasonably estimable environmental remediation costs. As of June 30, 2003 and January 1, 2003, the Company had also recorded $12,122,000 and $14,348,000, respectively, as management's best estimate for recoveries from state UST remediation funds, net of allowance, related to environmental obligations and liabilities. The net environmental liability of $15,078,000 as of January 1, 2003 was subsequently accreted for the change in present value due to the passage of time and, accordingly, $248,000 and $496,000 of accretion expense is included in environmental expenses for the quarter and six months ended June 30, 2003, respectively. Environmental expenditures were $3,020,000 and recoveries from underground storage tank funds were $908,000 for the six months ended June 30, 2003. In view of the uncertainties associated with environmental expenditures, however, the Company believes it is possible that the fair value of future actual net expenditures could be substantially higher than these estimates. Adjustments to accrued liabilities for environmental remediation costs will be reflected in 8 the Company's financial statements as they become probable and a reasonable estimate of fair value can be made. Although future environmental expenses may have a significant impact on results of operations for any single fiscal year or interim period, the Company currently believes that such costs will not have a material adverse effect on the Company's long-term financial position. 8. Property Acquisitions: On May 1, 2003, the Company completed the acquisition of 41 retail service station and convenience store properties that it had been leasing for the past twelve years. The aggregate purchase price for these properties was approximately $13.0 million, excluding transaction costs. Forty of the locations are subleased to Marketing under the Master Lease through at least 2015. Current annual rent expense of approximately $1.3 million, and future rent escalations scheduled through 2056, will be eliminated as a result of the acquisition. Since the seller has agreed to indemnify the Company for historical environmental costs, and the seller's indemnity is supported by a $1,915,000 escrow fund established solely for that purpose, the Company's exposure to environmental remediation expenses should not change because of the acquisition. 9. Subsequent Event: On August 8, 2003, the Board of Directors approved the redemption of all 2,822,976 outstanding shares of Series A Participating Convertible Redeemable Preferred Stock ("Preferred Stock") on September 24, 2003. Holders of Preferred Stock will receive $25.00 plus accrued mandatory dividends of $.27118 for each share of Preferred Stock that is redeemed. Holders of Preferred Stock, in lieu of redemption, may exercise their right to convert each share into 1.1312 shares of Getty Realty Corp. Common Stock. Holders of Preferred Stock who elect to convert their shares to Common Stock, prior to the close of business on September 24, 2003, and who are holders of record of the Common Stock on September 25, 2003, will receive the $.4250 per share Common Stock dividend declared on August 8, 2003. Members of the Board of Directors holding Preferred Stock have advised the Company that they intend to convert all of their Preferred Stock into shares of Common Stock prior to September 24, 2003. Collectively, such Directors beneficially own approximately 40% of the outstanding shares of Preferred Stock, which would be converted into approximately 1,295,000 shares of Common Stock. The Company anticipates that a significant number of holders of Preferred Stock will exercise their right to convert their Preferred Stock into Common Stock prior to redemption. 9 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS General We are a real estate company specializing in the ownership and leasing of retail motor fuel, convenience store properties and petroleum distribution terminals. We lease 970 of our 1,043 properties on a long-term net basis to Getty Petroleum Marketing Inc. ("Marketing"), which was spun-off to our stockholders as a separate publicly held company in March 1997. In December 2000, Marketing was acquired by a subsidiary of OAO Lukoil ("Lukoil"), one of Russia's largest integrated oil companies. Our financial results largely depend on rental income from Marketing, and to a lesser extent on rental income from other tenants, and are therefore materially dependent upon the ability of Marketing to meet its obligations under the master lease entered into in February 1, 1997 and amended and restated effective December 9, 2000 (the "Master Lease"). Marketing has made all required monthly rental payments under the Master lease when due. Results of Operations - Quarter ended June 30, 2003 compared with the quarter ended June 30, 2002 Net earnings for the three months ended June 30, 2003 were $9.4 million as compared with $9.3 million for the comparable prior year period. Diluted earnings per common share for the three months ended June 30, 2003 were $.38, as compared with $.37 for the comparable prior year period. Revenues from rental properties for the three months ended June 30, 2003 and 2002 were $16.7 million and $16.8 million, respectively. Approximately $14.7 million and $14.5 million of these rentals received in the three months ended June 30, 2003 and 2002 were from properties leased to Marketing under the Master Lease. In addition, revenues from rental properties include $1.4 million and $1.7 million of deferred rental revenue recognized in the three months ended June 30, 2003 and 2002, respectively, as required by generally accepted accounting principles ("GAAP"), related to the 2% future annual rent increases due from Marketing under the terms of the Master Lease. The aggregate minimum rent due over the initial 15-year term of the Master Lease is recognized on a straight-line basis rather than when due. Other income was $0.4 million for the three months ended June 30, 2003 as compared with $0.8 million for the three months ended June 30, 2002. The $0.4 million decrease was primarily due to reduced gains on the dispositions of properties recorded in the current period. Rental property expenses, which are principally comprised of rent expense and real estate and other state and local taxes, were $2.7 million for the three months ended June 2003, a decrease of $0.4 million from the three months ended June 30, 2002. The decrease was primarily due to a reduction in rent expense as a result of the exercise of lease purchase options, including the purchase of 41 properties in May 2003. Environmental expenses for the three months ended June 30, 2003 were $2.2 million, an increase of $0.5 million from the three months ended June 30, 2002. Environmental expenses for the quarter ended June 30, 2003 include $1.1 million for the net change in estimated environmental costs, a $0.3 million decrease from the prior period. The decrease in the change in estimated environmental costs was partially offset by accretion expense of $0.2 million recorded in the current quarter due to the increase in present 10 value resulting from the passage of time of the net environmental liability recorded as of January 1, 2003. In addition, the increase in environmental expenses resulted primarily from approximately $0.6 million of higher legal fees and environmental litigation expenses. (See "Environmental Matters" below). General and administrative expenses for the three months ended June 30, 2003 $0.6 million, a decrease of $0.6 million from the three months ended June 30, 2002. The decrease was primarily caused by a $0.5 million reduction in insurance loss reserves that were established under the Company's self-funded insurance program that was terminated in 1997. Depreciation and amortization for the three months ended June 30, 2003 was $2.2 million, a decrease of $0.1 million from the three months ended June 30 2002, as a result of certain assets becoming fully depreciated and dispositions of properties. Results of Operations - Six Months Ended June 30, 2003 compared with the six months ended June 30, 2002 Net earnings before cumulative effect of accounting change for the six months ended June 30, 2003 were $18.5 million as compared with $18.6 million for the comparable prior year period. Diluted earnings per common share for the six months ended June 30, 2003 were $0.72, as compared with $0.75 for the comparable prior year period. Revenues from rental properties for the six months ended June 30, 2003 and 2002 were $33.3 million and $33.7 million, respectively. Approximately $29.4 million and $29.1 million of these rentals received in the six months June 30, 2003 and 2002 were from properties leased to Marketing under the Master Lease. In addition, revenues from rental properties include $2.8 million and $3.4 million of deferred rental revenue recognized in the six months ended June 30, 2003 and 2002, respectively. Other income was $0.8 million for the six months ended June 30, 2003 as compared with $1.4 million for the six months ended June 30, 2002. The $0.6 million decrease was primarily due to reduced gains on the dispositions of properties recorded in the current period. Rental property expenses, which are principally comprised of rent expense and real estate and other state and local taxes, were $5.6 million for the six months ended June 2003, a decrease of $0.6 million from the six months ended June 30, 2002. The decrease was primarily due to a reduction in rent expense as a result of exercise of lease purchase options, including the purchase of 41 properties in May 2003. Environmental expenses for the six months ended June 30, 2003 were $3.7 million, an increase of $0.4 million from the six months ended June 30, 2002. Environmental expenses for the six months ended June 30, 2003 include $2.0 million for the net change in estimated environmental costs, a $0.8 million decrease from the prior period. The decrease in the change in estimated environmental costs was offset by accretion expense of $0.5 million recorded in the current period. In addition, the increase in environmental expenses resulted primarily from approximately $0.6 million of higher legal fees and environmental litigation expenses recorded during the second quarter of 2003. (See "Environmental Matters" below). General and administrative expenses for the six months ended June 30, 2003 were $1.9 million, a decrease of $0.4 million from the six months ended June 30, 2002. The decrease was primarily due to a $0.5 million reduction in insurance loss reserves that were established under the Company's self-funded insurance program that was terminated in 1997. 11 Depreciation and amortization for the six months ended June 30, 2003 was $4.3 million, a decrease of $0.3 million from the six months ended June 30, 2002, as a result of certain assets becoming fully depreciated and dispositions of properties. The cumulative effect of accounting change recorded for the six months ended. June 30, 2003 is due to the adoption of Statement of Financial Accounting Standards No. ("SFAS") 143 effective January 1, 2003. Accrued environmental remediation costs and the related recoveries from state underground storage tank funds were adjusted to their estimated fair value resulting in a one-time cumulative effect of change in accounting charge of $0.6 million. (See "Environmental Matters" below). Liquidity and Capital Resources Our principal sources of liquidity are available cash and equivalents, the cash flows from our business and our short-term uncommitted line of credit with a bank. Management believes that dividend payments and cash requirements for our business, including environmental remediation expenditures, capital expenditures and debt service, as well as any preferred stock redemption payments required as described below, can be met by cash flows from operations, available cash and equivalents and the credit line. As of June 30, 2003, we had a line of credit amounting to $25.0 million, of which $0.3 million was utilized in connection with outstanding letters of credit. Borrowings under the lines of credit are unsecured and bear interest at the prime rate or, at our option, LIBOR plus 1.25%. The line of credit is subject to annual renewal in June 2004 at the discretion of the bank. On August 8, 2003, the Board of Directors approved the redemption of all 2,822,976 shares of outstanding Series A Participating Convertible Redeemable Preferred Stock ("Preferred Stock") on September 24, 2003. Holders of Preferred Stock will receive $25.00 plus accrued mandatory dividends of $.27118 for each share of Preferred Stock that is redeemed. Holders of Preferred Stock, in lieu of redemption, may exercise their right to convert each share into 1.1312 shares of Getty Realty Corp. Common Stock. Holders of Preferred Stock who elect to convert their shares to Common Stock, prior to the close of business on September 24, 2003, and who are holders of record of the Common Stock on September 25, 2003, will receive the $.4250 per share Common Stock dividend declared on August 8, 2003. Members of the Board of Directors holding Preferred Stock have advised us that they intend to convert all of their Preferred Stock into shares of Common Stock prior to September 24, 2003. Collectively, such Directors beneficially own approximately 40% of the outstanding shares of Preferred Stock, which would be converted into approximately 1,295,000 shares of Common Stock. We anticipate that a significant number of holders of Preferred Stock will exercise their right to convert their Preferred Stock into Common Stock prior to redemption. We elected to be taxed as a REIT under the federal income tax laws with the year beginning January 1, 2001. As a REIT, we are required, among other things, to distribute at least 90% of our taxable income to shareholders each year. We presently intend to pay common stock dividends of $0.4250 per quarter ($1.70 per share on an annual basis), and commenced doing so with the quarterly dividend declared in August 2003. Payment of dividends is subject to market conditions, our financial condition and other factors, and therefore cannot be assured. We declared cash common and preferred stock dividends of $.4125 and $.44375 per share, respectively, during each of the first two quarters in 2003 and 2002. These dividends aggregated $20.2 million for the six months ended June 30, 2003 and 2002. 12 In order to initially qualify for REIT status, we were required to make a distribution to shareholders in an amount at least equal to our accumulated earnings and profits from the years we operated as a taxable corporation. Determination of accumulated earnings and profits for federal income tax purposes is extremely complex. Should the Internal Revenue Service successfully assert that the Company's accumulated earnings and profits were greater than the amount distributed in 2001, the Company may fail to qualify as a REIT; however, the Company may avoid losing its REIT status by paying a deficiency dividend to eliminate any remaining accumulated earnings and profits. The Company may have to borrow money or sell assets to pay such a deficiency dividend. Capital expenditures, principally acquisitions, were $13.6 million for the six months ended June 30, 2003. On May 1, 2003, we completed the acquisition of 41 retail service station and convenience store properties that we had been leasing for the past twelve years. The aggregate purchase price for these properties was approximately $13.0 million, excluding transaction costs. Forty of the locations are subleased to Marketing under the Master Lease through at least 2015. Current annual rent expense of approximately $1.3 million, and future rent escalations scheduled through 2056, will be eliminated as a result of the acquisition. Since the seller has agreed to indemnify us for historical environmental costs, and the seller's indemnity is supported by a $1.9 million escrow fund established solely for that purpose, our exposure to environmental remediation expenses should not change because of the acquisition. Critical Accounting Policies Our accompanying consolidated financial statements include the accounts of Getty Realty Corp. and our wholly-owned subsidiaries. The preparation of financial statements in accordance with GAAP requires management to make estimates, judgments and assumptions that affect amounts reported in its financial statements. We have made our best estimates, judgments and assumptions relating to certain amounts that are included in our financial statements, giving due consideration to the accounting policies selected and materiality. We do not believe that there is a great likelihood that materially different amounts would be reported related to the application of the accounting policies described below. Application of these accounting policies, however, involves the exercise of judgment and use of assumptions as to future uncertainties and, as a result, actual results could differ from these estimates, judgments and assumptions. Our accounting policies are described in note 1 to the consolidated financial statements which appear in our Annual Report on Form 10-K for the year ended December 31, 2002. We believe the more critical of our accounting policies are as follows: Revenue recognition--we earn revenue primarily from operating leases with Marketing and other tenants. We recognize income under the Master Lease with Marketing on the straight-line method, which effectively recognizes contractual lease payments evenly over the initial fifteen-year term of the lease. A critical assumption in applying this accounting method is that the tenant will make all contractual lease payments during the initial lease term and that the deferred rent receivable of $17.9 million recorded as of June 30, 2003 will be collected when due, in accordance with the 2% annual rent escalations provided for in the Master Lease. Accordingly, we may be required to reverse a portion of the recorded deferred rent receivable if it becomes apparent that a property will be disposed of before the end of the initial lease term or if Marketing fails to make its contractual lease payments. Impairment of long-lived assets--real estate assets represent "long-lived" assets for accounting purposes. We review the recorded value of long-lived assets for impairment in value whenever any events 13 or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. We may become aware of indicators of potentially impaired assets upon tenant or landlord lease renewals, upon receipt of notices of potential governmental takings and zoning issues, or upon other events that occur in the normal course of business that would cause us to review the operating results of the property. We believe our real estate assets are not carried at amounts in excess of their estimated net realizable fair value amounts. Income taxes--our financial results generally will not reflect provisions for current or deferred federal income taxes since we elected to be taxed as a REIT effective January 1, 2001. Our intention is to operate in a manner that will allow us to continue to be taxed as a REIT and, as a result, we do not expect to pay substantial corporate-level federal income taxes. Many of the REIT requirements, however, are highly technical and complex. If we were to fail to meet the requirements, we may be subject to federal income tax. Certain states do not follow the federal REIT rules and we have included provisions for these taxes in rental property expenses. Environmental costs and recoveries from state underground storage tank funds--we provide for the estimated fair value of future environmental remediation costs when it is probable that a liability has been incurred and a reasonable estimate of fair value can be made (see "Environmental Matters" below). Since environmental exposures are difficult to assess and estimate and knowledge about these liabilities is not known upon the occurrence of a single event, but rather is gained over a continuum of events, we believe that it is appropriate that our accrual estimates are adjusted as the remediation treatment progresses, as circumstances change and as environmental contingencies become more clearly defined and reasonably estimable. Recoveries of environmental costs from state underground storage tank remediation funds, with respect to past and future spending, are accrued as income, net of allowance for collection risk, based on estimated recovery rates when such recoveries are considered probable. A critical assumption in accruing for these recoveries is that the state underground storage tank fund programs will be administered and funded in the future in a manner that is consistent with past practices and that future environmental spending will be eligible for reimbursement under these programs. Effective January 1, 2003, environmental liabilities and related assets are measured based on their expected future cash flows which have been adjusted for inflation and discounted to present value. Environmental Matters We are subject to numerous existing federal, state and local laws and regulations, including matters relating to the protection of the environment. Currently, environmental expenses are principally attributable to remediation, monitoring and governmental agency reporting incurred in connection with contaminated properties. In prior periods, a larger portion of the expenses also included soil disposal and the replacement or upgrading of underground storage tanks ("USTs") to meet federal, state and local environmental standards, as well as routine monitoring and tank testing. For the six months ended June 30, 2003 and June 30, 2002, net environmental expenses included in our consolidated statements of operations amounted to $3.7 million and $3.3 million, respectively, which amounts were net of estimated net recoveries from state UST remediation funds. Under the Master Lease with Marketing, and in accordance with leases with other tenants, we agreed to bring the leased properties with known environmental contamination to regulatory or contractual closure ("Closure") in an economical manner and, thereafter, transfer all future environmental risks to our tenants. Generally, upon achieving Closure at an individual property, our environmental liability under the lease for that property will be satisfied and future remediation obligations will be the responsibility of our tenant. 14 We have agreed to pay all costs relating to, and to indemnify Marketing for, environmental liabilities and obligations scheduled in the Master Lease. We will continue to collect recoveries from certain state UST remediation funds related to these environmental liabilities where available. We have also agreed to provide limited environmental indemnification to Marketing for pre-existing environmental conditions at six terminals owned by us. Under the indemnification agreement, Marketing will pay the first $1.5 million of costs and expenses incurred in connection with remediating any such pre-existing conditions, Marketing will share equally with us the next $8.5 million of those costs and expenses and Marketing will pay all additional costs and expenses over $10.0 million. Our indemnification responsibility under this agreement is capped at $4.25 million and expires in December 2010. We have not accrued a liability for this indemnification agreement since it is uncertain that any significant amounts will be required to be paid under the agreement. The estimated future costs for known environmental remediation requirements are accrued when it is probable that a liability has been incurred and a reasonable estimate of fair value can be made. The environmental remediation liability is estimated based on the level and impact of contamination for each property. Recoveries of environmental costs from state underground storage tank remediation funds, with respect to both past and future environmental spending, are accrued at fair value as income, net of allowance for collection risk, based on estimated recovery rates when such recoveries are considered probable. The accrued liability is the aggregate of the best estimate of the fair value of cost for each component of the liability. Prior to the adoption of SFAS 143 effective January 1, 2003, if the best estimate of cost for a component of the liability could only be identified as a range, and no amount within the range was a better estimate than any other amount, the minimum of the range was accrued for that cost component rather than the estimated fair value currently required under the recently adopted pronouncement. Environmental exposures are difficult to assess and estimate for numerous reasons, including the extent of contamination, alternative treatment methods that may be applied, location of the property which subjects it to differing local laws and regulations and their interpretations, as well as the time it takes to remediate contamination. In developing our liability for probable and reasonably estimable environmental remediation costs, on a property by property basis, we consider among other things, enacted laws and regulations, assessments of contamination including the potential impact of the contamination and the surrounding geology, the quality of information available, currently available technologies for treatment, alternative methods of remediation and prior experience. These accrual estimates are subject to significant change, and are adjusted as the remediation treatment progresses, as circumstances change and as these contingencies become more clearly defined and reasonably estimable. As of June 30, 2003, we have remediation action plans in place for 351 (88%) of the 397 properties for which we retained environmental responsibility. Forty-seven properties (12%) remain in the assessment phase, which when completed will likely result in a change in estimate for those properties. As of June 30, 2003 and January 1, 2003, we had accrued $27.6 million and $29.4 million, respectively, as management's best estimate of the fair value of reasonably estimable environmental remediation costs. As of June 30, 2003 and January 1, 2003, we had also recorded $12.1 million and $14.3 million, respectively, as management's best estimate for net recoveries from state UST remediation funds, net of allowance, related to environmental obligations and liabilities. The net environmental liability of $15.1 million as of January 1, 2003 was subsequently accreted for the change in present value due to the passage of time and, accordingly, $0.5 million of accretion expense is included in environmental expenses for the six months ended June 30, 2003. Environmental expenditures and recoveries from underground 15 storage tank funds were $3.0 million and $0.9 million, respectively, for the six months ended June 30, 2003. During 2003, we estimate that our net environmental remediation spending will be approximately $6.5 million and our business plan for 2003 reflects a net change in estimated remediation costs of approximately $5.0 million. In view of the uncertainties associated with environmental expenditures, however, we believe it is possible that the fair value of future actual net expenditures could be substantially higher than these estimates. Adjustments to accrued liabilities for environmental remediation costs will be reflected in our financial statements as they become probable and a reasonable estimate of fair value can be made. Although future environmental costs may have a significant impact on results of operations for any single fiscal year or interim period, we believe that such costs will not have a material adverse effect on our long-term financial position. We cannot predict what environmental legislation or regulations may be enacted in the future or how existing laws or regulations will be administered or interpreted with respect to products or activities to which they have not previously been applied. We cannot predict if state underground storage tank fund programs will be administered and funded in the future in a manner that is consistent with past practices and if future environmental spending will continue to be eligible for reimbursement under these programs. Compliance with more stringent laws or regulations, as well as more vigorous enforcement policies of the regulatory agencies or stricter interpretation of existing laws which may develop in the future, could have an adverse effect on our financial position, or that of our tenants, and could require substantial additional expenditures for future remediation. Forward Looking Statements Certain statements in this Quarterly Report may constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. When we use the words "believes", "expects", "plans", "projects", "estimates" and similar expressions, we intend to identify forward-looking statements. These forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance and achievements of to be materially different from any future results, performance or achievements expressed or implied by these forward-looking statements. These factors are more fully detailed in our Annual Report on Form 10-K for the year ended December 31, 2002 and include, but are not limited to: risks associated with owning and leasing real estate generally; dependence on Marketing as a tenant and on rentals from companies engaged in the petroleum marketing and convenience store businesses; competition for properties and tenants; risk of tenant non-renewal; the effects of regulation; our expectations as to the cost of completing environmental remediation; and the impact of our electing to be taxed as a REIT, including subsequent failure to qualify as a REIT and future dependence on external sources of capital. As a result of these and other factors, we may experience material fluctuations in future operating results on a quarterly or annual basis, which could materially and adversely affect our business, financial condition, operating results and stock price. An investment in our stock involves various risks, including those mentioned above and elsewhere in this report and those which are detailed from time to time in our other filings with the Securities and Exchange Commission. You should not place undue reliance on forward-looking statements, which reflect our view only as of the date hereof. We undertake no obligation to publicly release revisions to these forward-looking statements that reflect future events or circumstances or reflect the occurrence of unanticipated events. 16 Item 3. Quantitative and qualitative disclosures about market risk Information in response to this item is incorporated by reference from Note 6 of the Notes to Consolidated Financial Statements in this Form 10-Q. Item 4. Controls and procedures The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company's Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Commission's rules and forms, and that such information is accumulated and communicated to the Company's management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. As required by SEC Rule 13a-15(b), the Company carried out an evaluation, under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer and the Company's Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures as of the end of the quarter covered by this report. Based on the foregoing, the Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective at the reasonable assurance level. There has been no change in the Company's internal controls over financial reporting during the Company's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company's internal controls over financial reporting. 17 PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K (a) Exhibits: Designation of Exhibit in this Quarterly Report on Form 10-Q Description of Exhibit ------------------------ ---------------------- 31 Certifications of Chief Executive Officer and Chief Financial Officer pursuant to Section 302 of Sarbanes-Oxley Act of 2002 32 Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C.ss.1350 (*) (*) These certifications are being furnished solely to accompany the Report pursuant to 18 U.S.C. ss. 1350, and are not being filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and are not to be incorporated by reference into any filing of the Company, whether made before or after the date hereof, regardless of any general incorporation language in such filing. (b) Reports filed on Form 8-K: On August 11, 2003, the Company announced its earnings for the quarter and six months ended June 30, 2003, which was furnished under Item 12 "Results of Operations and Financial Condition" on Form 8-K. Also on August 11, 2003, the Company announced that its Board of Directors approved the redemption of all outstanding shares of Preferred Stock and declared certain dividends. The press release related thereto was filed under Item 5 "Other Events" on Form 8-K. 18 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. GETTY REALTY CORP. ------------------ (Registrant) Dated: August 12, 2003 BY: /s/ Thomas J. Stirnweis ----------------------------- (Signature) THOMAS J. STIRNWEIS Vice President, Treasurer and Chief Financial Officer Dated: August 12, 2003 BY: /s/ Leo Liebowitz ------------------------------ (Signature) LEO LIEBOWITZ President and Chief Executive Officer 19