-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, QjBx4+vn8ANQgn3rbYtBFK+BacS1Go6SS3F51wWp0RL5HpFruImhEfYkyC7w+9Ay GxrJeyp5It3VBKmKXczsFQ== 0000950137-05-013412.txt : 20051108 0000950137-05-013412.hdr.sgml : 20051108 20051107174352 ACCESSION NUMBER: 0000950137-05-013412 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20050930 FILED AS OF DATE: 20051108 DATE AS OF CHANGE: 20051107 FILER: COMPANY DATA: COMPANY CONFORMED NAME: GETTY REALTY CORP /MD/ CENTRAL INDEX KEY: 0001052752 STANDARD INDUSTRIAL CLASSIFICATION: REAL ESTATE [6500] IRS NUMBER: 113412575 STATE OF INCORPORATION: MD FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-13777 FILM NUMBER: 051184347 BUSINESS ADDRESS: STREET 1: 125 JERICHO TURNPIKE CITY: JERICHO STATE: NY ZIP: 11753 BUSINESS PHONE: 5163382600 MAIL ADDRESS: STREET 1: 125 JERICHO TURNPIKE CITY: JERICHO STATE: NY ZIP: 11753 10-Q 1 c99540e10vq.txt FORM 10-Q UNITED STATES 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 SEPTEMBER 30, 2005 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 [ ] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X] Registrant had outstanding 24,716,052 shares of Common Stock, par value $.01 per share, as of November 7, 2005. GETTY REALTY CORP. INDEX
Page Number ----------- Part I. FINANCIAL INFORMATION Item 1. Financial Statements (unaudited) Consolidated Balance Sheets as of September 30, 2005 and December 31, 2004 1 Consolidated Statements of Operations for the Three and Nine Months ended September 30, 2005 and 2004 2 Consolidated Statements of Cash Flows for the Nine Months ended September 30, 2005 and 2004 3 Notes to Consolidated Financial Statements 4 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11 Item 3. Quantitative and Qualitative Disclosures about Market Risk 23 Item 4. Controls and Procedures 23 Part II. OTHER INFORMATION Item 1. Legal Proceedings 25 Item 5. Other Information 26 Item 6. Exhibits 27 Signatures 28
Part I. FINANCIAL INFORMATION Item 1. Financial Statements GETTY REALTY CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (in thousands, except share data) (unaudited)
September 30, December 31, 2005 2004 --------------- ------------ Assets: Real Estate: Land $ 172,091 $ 156,571 Buildings and improvements 199,437 190,019 --------- --------- 371,528 346,590 Less - accumulated depreciation and amortization (108,577) (106,463) --------- --------- Real estate, net 262,951 240,127 Deferred rent receivable 27,855 25,117 Cash and equivalents 954 15,700 Recoveries from state underground storage tank funds, net 4,888 5,437 Mortgages and accounts receivable, net 2,412 3,961 Prepaid expenses and other assets 1,316 386 --------- --------- Total assets $ 300,376 $ 290,728 ========= ========= Liabilities and Shareholders' Equity: Debt $ 34,931 $ 24,509 Environmental remediation costs 19,376 20,626 Dividends payable 11,009 10,495 Accounts payable and accrued expenses 7,246 9,595 --------- --------- Total liabilities 72,562 65,225 --------- --------- Commitments and contingencies Shareholders' equity: Common stock, par value $.01 per share; authorized 50,000,000 shares; issued 24,716,052 at September 30, 2005 and 24,694,071 at December 31, 2004 247 247 Paid-in capital 257,720 257,295 Dividends paid in excess of earnings (30,153) (32,039) --------- --------- Total shareholders' equity 227,814 225,503 --------- --------- Total liabilities and shareholders' equity $ 300,376 $ 290,728 ========= =========
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 September 30, Nine months ended September 30, -------------------------------- ------------------------------- 2005 2004 2005 2004 ------- ------- ------- ------- Revenues from rental properties $17,768 $16,425 $53,036 $49,379 Expenses: Rental property expenses 2,551 2,462 7,735 7,470 Environmental expenses, net 375 1,049 1,786 4,564 General and administrative expenses 1,167 1,492 3,767 4,124 Depreciation and amortization expense 2,086 1,764 6,100 5,428 ------- ------- ------- ------- Total operating expenses 6,179 6,767 19,388 21,586 ------- ------- ------- ------- Operating income 11,589 9,658 33,648 27,793 Other income, net 179 323 370 752 Interest expense (496) (12) (1,096) (52) ------- ------- ------- ------- Net earnings before income taxes 11,272 9,969 32,922 28,493 Income tax benefit 1,494 -- 1,494 -- ------- ------- ------- ------- Net earnings $12,766 $ 9,969 $34,416 $28,493 ======= ======= ======= ======= Net earnings per common share: Basic $ .52 $ .40 $ 1.39 $ 1.15 Diluted $ .52 $ .40 $ 1.39 $ 1.15 Weighted average shares outstanding: Basic 24,715 24,680 24,710 24,677 Stock options and restricted stock units 19 40 15 40 ------- ------- ------- ------- Diluted 24,734 24,720 24,725 24,717 ======= ======= ======= ======= Dividends declared per share: $ .445 $ .425 $ 1.315 $ 1.275
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)
Nine months ended September 30, ------------------- 2005 2004 -------- -------- Cash flows from operating activities: Net earnings $ 34,416 $ 28,493 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization expense 6,100 5,428 Deferred rental revenue (2,738) (3,344) Gain on dispositions of real estate (177) (334) Accretion expense 639 711 Stock-based compensation expense 102 14 Changes in assets and liabilities: Recoveries from state underground storage tank funds, net 856 1,818 Mortgages and accounts receivable, net 1,241 591 Prepaid expenses and other assets (1,001) 160 Environmental remediation costs (2,196) (2,713) Accounts payable and accrued expenses (855) 264 Accrued income taxes (1,494) -- -------- -------- Net cash provided by operating activities 34,893 31,088 -------- -------- Cash flows from investing activities: Property acquisitions and capital expenditures (29,571) (8,632) Collection of mortgages receivable, net 308 1,563 Proceeds from dispositions of real estate 895 641 -------- -------- Net cash used in investing activities (28,368) (6,428) -------- -------- Cash flows from financing activities: Cash dividends paid (32,016) (31,461) Borrowings under credit agreement, net 10,700 -- Repayment of mortgages payable, net (278) (316) Proceeds from stock issued 323 70 -------- -------- Net cash used in financing activities (21,271) (31,707) -------- -------- Net decrease in cash and equivalents (14,746) (7,047) Cash and equivalents at beginning of period 15,700 19,905 -------- -------- Cash and equivalents at end of period $ 954 $ 12,858 ======== ======== Supplemental disclosures of cash flow information Cash paid (refunded) during the period for: Interest $ 977 $ 49 Income taxes, net 446 373 Recoveries from state underground storage tank funds (1,495) (1,532) Environmental remediation costs 3,534 4,271
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 and 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, environmental remediation costs, depreciation and amortization, impairment of long-lived assets, litigation, accrued expenses, income taxes and exposure to paying an earnings and profits deficiency dividend. 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, 2004. 2. Earnings Per Share: Basic earnings per share is computed by dividing net earnings by the weighted average number of common shares outstanding during the period. Diluted earnings per share also give effect to the potential dilution from the issuance of common shares in settlement of stock option and restricted stock unit awards. 3. Stock-Based Employee Compensation: The Company recorded stock-based employee compensation expense of $38,000 and $102,000 for the three and nine months ended September 30, 2005, respectively, and $10,000 and $14,000 for the three and nine months ended September 30, 2004, respectively, utilizing the fair value basis of accounting. Under the fair value method of accounting, compensation expense equal to the fair value of the stock-based award at the date of grant is recognized as compensation expense ratably over the -4- vesting period of the award. Stock-based employee compensation expense is related to restricted stock units granted in June 2004 and March 2005 under the Company's Omnibus Incentive Compensation Plan which vest over five years from the date of grant. For the three and nine months ended September 30, 2005, the stock-based employee compensation expense is also related to stock options granted in September 2001 and December 2002 under the Company's Stock Option Plan which vest over four years from the date of grant. Effective December 31, 2002 the Company changed to the fair value basis of accounting for stock-based employee compensation for awards granted subsequent to that date. In 2004 the Company accounted for options granted under its stock option plan prior to January 1, 2003 using the intrinsic value method. Historically, the exercise price of options granted by the Company was the same as the market price at the grant date and stock-based compensation expense was not included in reported net earnings. Since there were no stock-based compensation awards granted from January 1, 2003 through March 31, 2004, stock-based employee compensation expense was not required to be recorded in the first quarter of 2004. Effective January 1, 2005, the Company changed to the fair value basis of accounting for all of the awards outstanding as of that date that it had been accounting for under the intrinsic value method. Had compensation cost for the Company's stock option plan been accounted for in 2004 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 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 Nine months ended ended September 30, September 30, 2004 2004 ------------- ------------- Net earnings, as reported $9,969 $28,493 Add: Stock-based employee compensation expense included in reported net earnings 10 14 Deduct: Total stock-based employee compensation expense using the fair value method 33 83 ------ ------- Pro-forma net earnings $9,946 $28,424 ====== ======= Net earnings per common share: As reported $ .40 $ 1.15 Pro-forma $ .40 $ 1.15
-5- 4. Shareholders' Equity: A summary of the changes in shareholders' equity for the nine months ended September 30, 2005 is as follows (in thousands, except share amounts):
Dividends Common Stock Paid In ------------------- Paid-in Excess Of Shares Amount Capital Earnings Total ---------- ------ -------- --------- -------- Balance, December 31, 2004 24,694,071 $247 $257,295 $(32,039) $225,503 Net earnings 34,416 34,416 Dividends (32,530) (32,530) Stock-based employee compensation expense 102 102 Stock issued 21,981 323 323 ---------- ---- -------- -------- -------- Balance, September 30, 2005 24,716,052 $247 $257,720 $(30,153) $227,814 ========== ==== ======== ======== ========
The Company is authorized to issue 20,000,000 shares of preferred stock, par value $.01 per share, of which none were issued as of December 31, 2004 or September 30, 2005. 5. 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. As of September 30, 2005 and December 31, 2004 the Company had accrued $1,100,000 and $2,594,000, respectively, for this and certain other tax matters which it believes were appropriate based on information then currently available. The accrual for uncertain tax positions is adjusted as circumstances change and as the uncertainties become more clearly defined, such as when audits are settled or exposures expire. Accordingly, an income tax benefit of $1,494,000 was recorded in the third quarter of 2005 due to the net reduction in the amount accrued for uncertain tax positions to the extent that the uncertainties regarding these exposures have been resolved. The ultimate resolution of these matters may have a significant impact on the results of operations for any single fiscal year or interim period. 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, if any, are held in an institutional money market fund or federal agency discount notes. -6- As of September 30, 2005, the Company leased nine hundred forty-two of its one thousand sixty properties on a long-term net basis to Getty Petroleum Marketing Inc. ("Marketing") under a master lease ("Master Lease") and a coterminous supplemental lease for one property (collectively the "Marketing Leases") (see note 2 to the consolidated financial statements which appear in the Company's Annual Report on Form 10-K for the year ended December 31, 2004). 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 (the "Spin-Off"). In December 2000, Marketing was acquired by a subsidiary of OAO Lukoil, one of Russia's largest 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 Marketing Leases. Substantially all of the deferred rental revenue of $27,855,000 recorded as of September 30, 2005 is due to recognition of rental revenue on a straight-line basis under the Marketing Leases. 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 Marketing Leases when due. Under the Master Lease, the Company has agreed to provide limited environmental indemnification, capped at $4,250,000 and expiring in 2010, to Marketing for certain pre-existing conditions at six of the terminals which are owned by the Company. Under the agreement, Marketing will pay the first $1,500,000 of costs and expenses incurred in connection with remediating any such pre-existing conditions, Marketing and the Company will share equally the next $8,500,000 of those costs and expenses and Marketing will pay all additional costs and expenses over $10,000,000. The Company has not accrued a liability in connection with this indemnification agreement since it is uncertain that any amounts will be required to be paid under the agreement. 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. As of September 30, 2005 and December 31, 2004 the Company had accrued $2,667,000 and $3,623,000, respectively, for certain of these matters which it believes were appropriate based on information then currently available. The ultimate resolution of these matters is not expected to have a material adverse effect on the Company's financial condition or results of operations. In September 2003, the Company was notified by the State of New Jersey Department of Environmental Protection that the Company is one of approximately 60 potentially responsible parties for natural resource damages resulting from discharges of hazardous substances into the Lower Passaic River. The definitive list of potentially responsible parties and their actual responsibility for the alleged damages, the aggregate cost to remediate the Lower Passaic River, the amount of natural resource damages and the method of allocating such amounts among the potentially responsible parties have not been determined. In September 2004, the Company received a General Notice Letter from the US EPA (the "EPA Notice"), advising the Company that it may be a potentially responsible party for costs of remediating certain conditions resulting from discharges of hazardous substances into the Lower Passaic River. ChevronTexaco received the same EPA Notice regarding those same conditions. Additionally, the Company believes that ChevronTexaco is contractually obligated to -7- indemnify the Company, pursuant to an indemnification agreement, for most of the conditions at the property identified by the New Jersey Department of Environmental Protection and the EPA. Accordingly, the ultimate legal and financial liability of the Company, if any, cannot be estimated with any certainty at this time. From October 2003 through September 2005, the Company was notified that it had been made party to 38 cases in Connecticut, Florida, Massachusetts, New Hampshire, New Jersey, New York, Pennsylvania, Vermont, Virginia and West Virginia brought by local water providers or governmental agencies. These cases allege various theories of liability due to contamination of groundwater with MTBE as the basis for claims seeking compensatory and punitive damages. Each case names as defendants approximately 50 petroleum refiners, manufacturers, distributors and retailers of MTBE, or gasoline containing MTBE. The accuracy of the allegations as they relate to the Company, its defenses to such claims, the aggregate amount of damages, the definitive list of defendants and the method of allocating such amounts among the defendants have not been determined. Accordingly, the ultimate legal and financial liability of the Company, if any, cannot be estimated with any certainty at this time. 6. 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. Environmental expenses are principally attributable to remediation costs which include installing, operating, maintaining and decommissioning remediation systems, monitoring contamination, and governmental agency reporting incurred in connection with contaminated properties. Environmental remediation liabilities and related assets are measured at fair value based on their expected future cash flows which have been adjusted for inflation and discounted to present value. For the three and nine months ended September 30, 2005, the aggregate of the net changes in estimated remediation costs and accretion expense included in environmental expenses in the Company's consolidated statements of operations were $46,000 and $1,338,000, respectively, and $466,000 and $2,395,000, respectively, for the comparable prior year periods, which amounts were net of changes in estimated recoveries from state underground storage tank ("UST") remediation funds. Environmental expenses also include project management fees, legal fees and provisions for environmental litigation loss reserves. In accordance with leases with certain tenants, the Company has agreed to bring the leased properties with known environmental contamination to within applicable standards and to regulatory or contractual closure ("Closure") in an efficient and economical manner. Generally, upon achieving Closure at each individual property, the Company's environmental liability under the lease for that property will be satisfied and future remediation obligations will be the responsibility of the tenant. Of the nine hundred forty-two properties leased to Marketing as of September 30, 2005, the Company has agreed to pay all costs relating to, and to indemnify Marketing for, certain environmental liabilities and obligations for the remaining two hundred sixty-eight properties that are scheduled in the Master Lease and have not achieved Closure. The Company will continue to seek reimbursement from state UST remediation funds related to these environmental expenditures where available. The estimated future costs for known environmental remediation requirements are accrued when -8- 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 at 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 UST 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 developed from prior experience with the funds when such recoveries are considered probable. 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 and surrounding geology, 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 September 30, 2005, the Company has remediation action plans in place for 301 (93%) of the 324 properties for which it retained environmental responsibility and has not received a no further action letter and the remaining 23 properties (7%) remain in the assessment phase. As of September 30, 2005, December 31, 2004 and December 31, 2003 the Company had accrued $19,376,000, $20,626,000, and $23,551,000, respectively, as management's best estimate of the fair value of reasonably estimable environmental remediation costs. As of September 30, 2005, December 31, 2004 and December 31, 2003, the Company had also recorded $4,888,000, $5,437,000 and $7,454,000, respectively, as management's best estimate for recoveries from state UST remediation funds, net of allowance, related to environmental obligations and liabilities. Accrued environmental remediation costs and recoveries from state UST remediation funds have been accreted for the change in present value due to the passage of time and, accordingly, $639,000 and $711,000 of net accretion expense is included in environmental expenses for the nine months ended September 30, 2005 and 2004, respectively. Environmental expenditures were $3,534,000 and $4,271,000 and recoveries from UST remediation funds were $1,495,000 and $1,532,000 for the nine months ended September 30, 2005 and 2004, respectively. 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 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. -9- 7. Debt As of September 30, 2005, debt consisted of $34,700,000 in borrowings under the Credit Agreement, described below, bearing interest at 5.0% and $231,000 of mortgages due in varying amounts through May 1, 2015. On June 30, 2005, the Company entered into an unsecured three-year senior revolving $100,000,000 Credit Agreement ("Credit Agreement") with a group of six domestic commercial banks which replaced the Company's outstanding $50,000,000 uncommitted line of credit with one bank. The Credit Agreement matures on June 30, 2008 and does not provide for scheduled reductions in the principal balance prior to its maturity. Subject to the terms of the Credit Agreement, the Company has the right to increase the Credit Agreement by $25,000,000 and to extend the term of the Credit Agreement for one additional year. Borrowings under the Credit Agreement bear interest at a rate equal to the sum of a base rate or a LIBOR rate plus an applicable margin based on the Company's leverage ratio and ranging from 0.25% to 1.75%. The annual commitment fee on the unused Credit Agreement will range from 0.10% to 0.20% based on usage. The Credit Agreement includes customary terms and conditions, including financial covenants such as leverage and coverage ratios and other customary covenants, including limitations on the Company's ability to incur debt and pay dividends and maintenance of tangible net worth and events of default, including a change of control and failure to maintain REIT status. The Company does not believe that these covenants will limit its current business practices. 8. Acquisition On March 25, 2005, the Company acquired 23 convenience store and retail motor fuel properties in Virginia for approximately $29,000,000 which is included in land and buildings and improvements in the consolidated balance sheet as of September 30, 2005. Available cash and equivalents and revolving debt were utilized to finance the transaction. All of the properties are triple-net-leased to a single tenant who previously leased the properties from the seller and operates the locations under its proprietary convenience store brand in its network of over 200 locations. The lease provides for annual rentals at a competitive rate and provides for escalations thereafter. The lease has an initial term of fifteen years and provides the tenant options for three renewal terms of five years each. The lease also provides that the tenant is responsible for all existing and future environmental conditions at the properties. -10- Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations This discussion and analysis of financial condition and results of operations should be read in conjunction with the Section entitled "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" which appears in our Annual Report on Form 10-K for the year ended December 31, 2004, "Risks and Uncertainties" in Exhibit 99 to this Quarterly Report on Form 10-Q, and the consolidated financial statements and related notes which appear in this Quarterly Report on Form 10-Q. General We are a real estate investment trust ("REIT") specializing in the ownership and leasing of retail motor fuel and convenience store properties and petroleum distribution terminals. We elected to be taxed as a REIT under the federal income tax laws beginning January 1, 2001. As a REIT, we are not subject to federal corporate income tax on the taxable income we distribute to our shareholders. In order to continue to qualify for taxation as a REIT, we are required, among other things, to distribute at least 90% of our taxable income to shareholders each year. We lease or sublet our properties primarily to distributors and retailers engaged in the sale of gasoline and other motor fuel products, convenience store products and automotive repair services that are responsible for the payment of taxes, maintenance, repair, insurance and other operating expenses and for managing the actual operations conducted at these properties. Nine hundred forty-two of our one thousand sixty properties are leased on a long-term basis under a master lease (the "Master Lease") and a coterminous supplemental lease for one property, (collectively the "Marketing Leases") to Getty Petroleum Marketing Inc. ("Marketing") which was spun-off to our shareholders 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. We rely upon the revenue from leasing retail motor fuel and convenience store properties and petroleum distribution terminals, primarily to Marketing, for substantially all of our revenues (88.9% for the nine months ended September 30, 2005). Accordingly, our revenues will be dependent to a large degree on the economic performance of Marketing and of the petroleum marketing industry and any factor that adversely affects Marketing or our other lessees may have a material adverse effect on our financial condition and results of operations. Marketing's financial results depend largely on retail petroleum marketing margins and rental income from subtenants who operate our properties. The petroleum marketing industry has been and continues to be volatile and highly competitive. In the event that Marketing cannot or will not perform its monetary obligations under the Marketing Leases with us, our financial condition and results of operations would be materially adversely affected. Although Marketing is wholly owned by a subsidiary of Lukoil, no assurance can be given that Lukoil will cause Marketing to fulfill any of its monetary obligations under the Marketing Leases. We periodically receive and review Marketing's financial statements and other financial data. We receive this information from Marketing pursuant to the terms of the Master Lease. Certain of this information is not publicly available and the terms of the Master Lease prohibit us from including this -11- financial information in our Annual Reports on Form 10-K, our Quarterly Reports on Form 10-Q or in our Annual Reports to Shareholders. The financial performance of Marketing may deteriorate, and Marketing may ultimately default on its monetary obligations to us before we receive financial information from Marketing that would indicate the deterioration or before we would have the opportunity to advise our shareholders of any increased risk of default. Certain financial and other information concerning Marketing is available from Dun & Bradstreet and may be accessed by their web site (www.dnbsearch.com) upon payment of their fee. The most recent selected financial data of Marketing which is publicly available is provided below. Neither we, nor our auditors, were involved in the preparation of this data. Getty Petroleum Marketing Inc. Selected Financial Data
For the years ended December 31, ------------------------------------ 2004 2003 2002 ---------- ---------- ---------- (unaudited, in thousands) OPERATING DATA: Total revenues $2,696,102 $1,297,042 $1,029,926 Total expenses 2,670,282 1,290,439 1,038,385 ---------- ---------- ---------- Earnings (loss) before provision (credit) for income taxes 25,820 6,603 (8,459) Provision (credit) for income taxes 10,784 3,157 (3,389) ---------- ---------- ---------- Net earnings (loss) $ 15,036 $ 3,446 ($5,070) ========== ========== ========== BALANCE SHEET DATA (AT END OF PERIOD): ASSETS: Cash and equivalents $ 76,485 $ 44,210 $ 18,678 Other current assets 161,901 68,971 62,448 ---------- ---------- ---------- Total current assets 238,386 113,181 81,126 Property and equipment, net 367,453 134,792 139,477 Other assets 54,292 3,956 5,338 ---------- ---------- ---------- Total assets $ 660,131 $ 251,929 $ 225,941 ========== ========== ========== LIABILITIES AND STOCKHOLDER'S EQUITY: Total current liabilities $ 214,171 $ 125,940 $ 107,362 Long-term liabilities 318,091 62,419 58,438 ---------- ---------- ---------- Total liabilities 532,262 188,359 165,800 Total stockholder's equity 127,869 63,570 60,141 ---------- ---------- ---------- Total liabilities and stockholder's equity $ 660,131 $ 251,929 $ 225,941 ========== ========== ==========
If Marketing does not fulfill its monetary obligations to us under the Marketing Leases, our financial condition and results of operations will be materially adversely affected. Based on our -12- review of the financial statements and other financial data Marketing has provided to us to date, we believe that Marketing has the liquidity and financial ability to continue to pay timely its monetary obligations under the Marketing Leases, as it has since the inception of the Master Lease in 1997. As part of a periodic review by the Division of Corporation Finance of the Securities and Exchange Commission ("SEC") of our Annual Report on Form 10-K for the year ended December 31, 2003, we received and responded to a number of comments. The only comment that remains unresolved pertains to the SEC's position that we must include the financial statements and summarized financial data of Marketing in our periodic filings. The SEC recently indicated that, unless we file Marketing's financial statements and summarized financial data with our periodic reports, (i) it will not consider our Annual Reports on Forms 10-K for the years 2000 - 2004 to be compliant; (ii) it will not consider us to be current in our reporting requirements; and (iii) it will not be in a position to declare effective any registration statements we may file for public offerings of our securities. We continue to dispute the SEC's position that these financial statements and the summarized financial data of Marketing are required. We do not believe that we have a material liability for offers and sales of our securities made pursuant to registration statements that did not contain the financial statements or summarized financial data of Marketing. We cannot accurately predict the consequences if we are ultimately unsuccessful in our position that the financial statements and summarized financial data of Marketing are not required. We manage our business to enhance the value of our real estate portfolio and, as a REIT, place particular emphasis on minimizing risk and generating cash sufficient to make required distributions to shareholders of at least 90% of our taxable income each year. In addition to measurements defined by generally accepted accounting principles ("GAAP"), our management also focuses on funds from operations ("FFO") and adjusted funds from operations ("AFFO") to measure our performance. FFO is generally considered to be an appropriate supplemental non-GAAP measure of the performance of REITs. FFO is defined by the National Association of Real Estate Investment Trusts as net earnings before depreciation and amortization of real estate assets, gains or losses on sales of real estate, non-FFO items reported in discontinued operations and extraordinary items. Other REITs may use definitions of FFO and/or AFFO that are different than ours and, accordingly, may not be comparable. We believe that FFO is helpful to investors in measuring our performance because FFO excludes various items included in GAAP net earnings that do not relate to, or are not indicative of, our fundamental operating performance such as gains or losses from property sales and depreciation and amortization of real estate assets. In our case, however, GAAP net earnings and FFO include the significant impact of deferred rental revenue (straight-line rent) on our recognition of revenues from rental properties, which results from fixed rental increases scheduled under certain leases with our tenants. In accordance with GAAP, the aggregate minimum rent due over the initial term of these leases is recognized on a straight-line basis rather than when due. GAAP net earnings and FFO for the three and nine months ended September 30, 2005 also include the income tax benefit recognized due to a net reduction in amounts accrued for uncertain tax positions related to being taxed as a C-Corp. prior to 2001. As a result, management pays particular attention to AFFO, a supplemental non-GAAP performance measure that we define as FFO less straight-line rent and income tax benefit. Income taxes have not had a significant impact on our earnings since the year ended December 31, 2001, when we first elected to be taxed as a REIT, and accordingly has not appeared as a separate item in our statement of operations or reconciliation of AFFO from net earnings. In management's view, -13- AFFO provides a more accurate depiction than FFO of the impact of scheduled rent increases under these leases and our election to be taxed as a REIT beginning in 2001. Neither FFO nor AFFO represent cash generated from operating activities calculated in accordance with GAAP and therefore should not be considered an alternative for GAAP net earnings or as a measure of liquidity. A reconciliation of net earnings to FFO and AFFO for the three and nine months ended September 30, 2005 and 2004 is as follows (in thousands, except per share amounts):
Three months ended Nine months ended September 30, September 30, ------------------ ----------------- 2005 2004 2005 2004 ------- ------- ------- ------- Net earnings $12,766 $ 9,969 $34,416 $28,493 Depreciation and amortization of real estate assets (*) 2,015 1,764 6,029 5,428 Gains on sales of real estate (105) (188) (177) (334) ------- ------- ------- ------- Funds from operations 14,676 11,545 40,268 33,587 Deferred rental revenue (straight-line rent) (853) (1,113) (2,738) (3,344) Income tax benefit (1,494) -- (1,494) -- ------- ------- ------- ------- Adjusted funds from operations $12,329 $10,432 $36,036 $30,243 ======= ======= ======= ======= Diluted per common share amounts: Earnings per share $ .52 $ .40 $ 1.39 $ 1.15 Funds from operations per share $ .59 $ .47 $ 1.63 $ 1.36 Adjusted funds from operations per share $ .50 $ .42 $ 1.46 $ 1.22 Diluted weighted average shares outstanding 24,734 24,720 24,725 24,717
(*) Depreciation and amortization expense as reflected in our Consolidated Statements of Operations also includes depreciation on non-real estate assets. Results of operations Quarter ended September 30, 2005 compared to the quarter ended September 30, 2004 Revenues from rental properties were $17.8 million for the three months ended September 30, 2005 and $16.4 million for the three months ended September 30, 2004. We received rent from properties leased to Marketing under the Marketing Leases of approximately $14.9 million in the three months ended September 30, 2005 and $14.7 million in the three months ended September 30, 2004. We also received rent from other tenants of $2.0 million in the three months ended September 30, 2005 and $0.6 million in the three months ended September 30, 2004. The increase in rent received was primarily due to rental income from the properties acquired in November 2004 and March 2005 and rent escalations, and was partially offset by the effect of lease terminations and property dispositions. In addition to rent received, revenues from rental properties include deferred rental revenues of $0.9 million for the three months ended September 30, 2005 and $1.1 million for the three months ended September 30, 2004, recognized as required by GAAP, related to the fixed -14- future rent increases scheduled under certain leases with our tenants. The aggregate minimum rent due over the initial term of these leases is recognized on a straight-line basis rather than when due. Rental property expenses, which are principally comprised of rent expense and real estate and other state and local taxes, were $2.6 million for the three months ended September 30, 2005, which was comparable to the $2.5 million recorded for the three months ended September 30, 2004. Environmental expenses, net for the three months ended September 30, 2005 were $0.4 million as compared to $1.0 million for the three months ended September 30, 2004. The decrease was principally due to a $0.4 million reduction in changes in estimated environmental expenses, net of estimated recoveries, and accretion expense as well as a $0.2 million reduction in legal fees and litigation related expenses as compared to the prior year period. The net changes in estimated environmental expenses and accretion expense aggregated $46,000 for the three months ended September 30, 2005 compared to $0.5 million recorded in the comparable period last year. The decrease in net changes in estimated environmental costs for the quarter was due, in part, to successfully obtaining additional reimbursements or regulatory approval for significantly less costly remediation treatment methods at a small number of locations. General and administrative expenses for the three months ended September 30, 2005 were $1.2 million compared to $1.5 million recorded for the three months ended September 30, 2004. The $0.3 million decrease was principally due to lower legal expenses. Depreciation and amortization expense for the three months ended September 30, 2005 was $2.1 million, as compared to the $1.8 million recorded for the three months ended September 30, 2004. The increase was primarily due to depreciation and amortization of properties acquired in November 2004 and March 2005 partially offset by property dispositions. As a result, total operating expenses declined by approximately $0.6 million for the three months ended September 30, 2005, as compared to the three months ended September 30, 2004. Other income, net for the three months ended September 30, 2005 was $0.2 million, which was comparable to $0.3 million recorded for the three months ended September 30, 2004. Interest expense, principally related to borrowings used to finance the acquisition of properties in November 2004 and March 2005, was $0.5 million for the three months ended September 30, 2005 and was insignificant for the three months ended September 30, 2004. The tax benefit of $1.5 million recorded in 2005 was recognized due to a net reduction in the amount accrued for uncertain tax positions to the extent that the uncertainties regarding these exposures have been resolved. Net earnings were $12.8 million for the three months ended September 30, 2005 as compared to $10.0 million for the comparable prior year period. Net earnings for the three months ended September 30, 2005 increased by 28.1%, or $2.8 million, over the comparable period in 2004. FFO -15- increased $3.1 million, or 27.1%, to $14.7 million and AFFO increased $1.9 million, or 18.2%, to $12.3 million in the three months ended September 30, 2005. FFO increased more than AFFO on both a dollar and percentage basis due to the income tax benefit recorded in 2005 which was partially offset by a $0.3 million decrease in deferred rental revenues (both of which are included in net earnings and FFO but are excluded from AFFO) recorded for the three months ended September 30, 2005 as compared to the three months ended September 30, 2004. Diluted earnings per share for the three months ended September 30, 2005 increased $0.12 per share to $0.52 per share, as compared to the three months ended September 30, 2004. Diluted FFO per share increased $0.12 per share to $0.59 per share compared to the three months ended September 30, 2004. Diluted AFFO per share for the three months ended September 30, 2005 increased $0.08 per share to $0.50 per share, as compared to the three months ended September 30, 2004. Nine months ended September 30, 2005 compared to nine months ended September 30, 2004 Revenues from rental properties were $53.0 million for the nine months ended September 30, 2005 and $49.4 million for the nine months ended September 30, 2004. We received rent from properties leased to Marketing under the Marketing Leases of approximately $44.7 million in the nine months ended September 30, 2005 and $44.2 million for the nine months ended September 30, 2004. We also received rent from other tenants of $5.6 million in the nine months ended September 30, 2005 and $1.8 million in nine months ended September 30, 2004. The increase in rent received was primarily due to rental income from the properties acquired in November 2004 and March 2005 and rent escalations, and was partially offset by the effect of lease terminations and property dispositions. In addition to rent received, revenues from rental properties include deferred rental revenues of $2.7 million for the nine months ended September 30, 2005 and $3.3 million for the nine months ended September 30, 2004. Rental property expenses were $7.7 million for the nine months ended September 30, 2005, which was comparable to the $7.5 million recorded for the nine months ended September 30, 2004. Environmental expenses, net were $1.8 million for the nine months ended September 30, 2005 as compared to $4.6 million for the nine months ended September 30, 2004. The decrease was primarily due to a $1.7 million reduction in litigation related expenses as well as a $1.1 million reduction in the change in estimated environmental costs, net of estimated recoveries, and accretion expense as compared to the prior year period. Environmental expenses for the nine months ended September 30, 2005 include a $0.6 million net credit for environmental litigation expense, which was principally recorded in the first quarter of 2005, due to net reductions in litigation loss reserve estimates. The net change in estimated environmental expenses and accretion expense aggregated $1.3 million for the nine months ended September 30, 2005 compared to $2.4 million recorded in the comparable period last year. General and administrative expenses were $3.8 million for the nine months ended September 30, 2005 as compared to $4.1 million recorded for the nine months ended September 30, 2004. The $0.3 million decrease was principally due to lower legal expenses. -16- Depreciation and amortization expense for the nine months ended September 30, 2005 was $6.1 million, as compared to the $5.4 million recorded for the nine months ended September 30, 2004. The increase was primarily due to depreciation and amortization of properties acquired in November 2004 and March 2005 partially offset by property dispositions. As a result, total operating expenses declined by approximately $2.2 million for the nine months ended September 30, 2005 as compared to the nine months ended September 30, 2004. Other income, net for the nine months ended September 30, 2005 was $0.4 million, as compared to $0.8 million recorded for the nine months ended September 30, 2004. The $0.4 million decrease as compared to the prior year period is primarily due to decreases in investment income and in gains on dispositions of properties. Interest expense, principally related to borrowings used to finance the acquisition of properties in November 2004 and March 2005, was $1.1 million for the nine months ended September 30, 2005 and was insignificant for the nine months ended September 30, 2004. The tax benefit of $1.5 million recorded in 2005 was recognized due a net reduction in the amount accrued for uncertain tax positions to the extent that the uncertainties regarding these exposures have been resolved. Net earnings were $34.4 million for the nine months ended September 30, 2005 as compared to $28.5 million for the comparable prior year period. Net earnings for the nine months ended September 30, 2005 increased by 20.8%, or $5.9 million, over the comparable period in 2004. FFO increased $6.7 million, or 19.9%, to $40.3 million and AFFO increased $5.8 million, or 19.1%, to $36.0 million in the nine months ended September 30, 2005. FFO increased more than AFFO on both a dollar and percentage basis due to the income tax benefit recorded in 2005 which was partially offset by a $0.6 million decrease in deferred rental revenues (both of which are included in net earnings and FFO but are excluded from AFFO) recorded for the nine months ended September 30, 2005 as compared to the nine months ended September 30, 2004. Diluted earnings per share for the nine months ended September 30, 2005 increased $0.24 per share to $1.39 per share, as compared to the nine months ended September 30, 2004. Diluted FFO per share increased $0.27 per share to $1.63 per share compared to respective amounts for the nine months ended September 30, 2004. Diluted AFFO per share for the nine months ended September 30, 2005 increased $0.24 per share to $1.46 per share, as compared to the nine months ended September 30, 2004. Liquidity and Capital Resources Our principal sources of liquidity are the cash flows from our business, funds available under a revolving credit agreement that matures in 2008 and available cash and equivalents. Management believes that dividend payments and cash requirements for our business for the next twelve months, -17- including environmental remediation expenditures, capital expenditures and debt service, can be met by cash flows from operations, borrowing under the revolving credit agreement and available cash and equivalents. We regularly review opportunities to acquire additional properties as part of our overall growth strategy and we expect to continue to pursue acquisitions that we believe will benefit our financial performance. To the extent that our current sources of liquidity are not sufficient to fund such acquisitions we will require other sources of capital, which may or may not be available on favorable terms or at all. On June 30, 2005, we entered into an unsecured three-year senior revolving $100.0 million credit agreement ("Credit Agreement") with a group of six domestic commercial banks. Subject to the terms of the Credit Agreement, we have the right to increase the Credit Agreement by $25.0 million and to extend the term of the Credit Agreement for one additional year. Borrowings under the Credit Agreement bear interest at a rate equal to the sum of a base rate or a LIBOR rate plus an applicable margin based on our leverage ratio and ranging from 0.25% to 1.75%. The annual commitment fee on the unused Credit Agreement will range from 0.10% to 0.20% based on the amount of borrowings. The Credit Agreement includes customary terms and conditions, including financial covenants such as leverage and coverage ratios and other customary covenants, including limitations on our ability to incur debt and pay dividends and maintenance of tangible net worth, and events of default, including a change of control and failure to maintain REIT status. We do not believe that these covenants will limit our current business practices. Total borrowings outstanding under the Credit Agreement at September 30, 2005 were $34.7 million, bearing interest at a rate of 5.0% per annum. Total borrowings increased to $37.2 million as of November 1, 2005 principally due to additional borrowings for dividends accrued as of September 30, 2005 of $11.0 million that were paid in October, net of repayments from positive cash flows provided by rental operations in October and November. Accordingly, we had $62.8 million of unused availability under the terms of the Credit Agreement as of November 1, 2005. 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. Payment of dividends is subject to market conditions, our financial condition and other factors, and therefore cannot be assured. Dividends paid to our shareholders were $32.0 million for the nine months ended September 30, 2005 and $31.5 million for the prior year period. We presently intend to pay stock dividends of $0.445 per quarter ($1.78 per share on an annual basis), and commenced doing so with the quarterly dividend declared in the quarter ended September 30, 2005. On March 25, 2005, we acquired 23 convenience store and retail motor fuel properties in Virginia for approximately $29.0 million which is included in land and buildings and improvements in the consolidated balance sheet as of September 30, 2005. We utilized available cash and equivalents and revolving debt to finance the transaction. All of the properties are triple-net-leased to a single tenant who previously leased the properties from the seller and operates the locations under its proprietary convenience store brand in its network of over 200 locations. The lease provides for annual rentals at -18- a competitive rate and provides for escalations thereafter. The lease has an initial term of fifteen years and provides the tenant options for three renewal terms of five years each. The lease also provides that the tenant is responsible for all existing and future environmental conditions at the properties. Critical Accounting Policies Our accompanying interim consolidated financial statements include the financial condition and results of operations 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. Although we have made our best estimates, judgments and assumptions regarding future uncertainties relating to the information included in our financial statements, giving due consideration to the accounting policies selected and materiality, actual results could differ from these estimates, judgments and assumptions. 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. 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, environmental remediation costs (see "Environmental Matters" below), real estate, depreciation and amortization, impairment of long-lived assets, litigation, accrued expenses, income taxes and exposure to paying an earnings and profits deficiency dividend. The information included in our financial statements that is based on estimates, judgments and assumptions is subject to significant change and is adjusted as circumstances change and as the uncertainties become more clearly defined. 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, 2004. We believe that the more critical of our accounting policies relate to revenue recognition, impairment of long-lived assets, income taxes, environmental costs and recoveries from state underground storage tank funds and litigation, each of which is discussed in "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the year ended December 31, 2004. Environmental Matters We are subject to numerous existing federal, state and local laws and regulations, including matters relating to the protection of the environment. In accordance with the leases with certain of our tenants, we have agreed to bring the leased properties with known environmental contamination to within applicable standards and to regulatory or contractual closure ("Closure") in an efficient and economical manner. 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. We will continue to seek reimbursement from state UST remediation funds related to these environmental liabilities where available. As of September 30, 2005, we have remediation action plans in place for 301 (97%) of the 324 properties for which we retained environmental responsibility and the remaining 23 properties (7%) remain in the assessment phase. -19- As of September 30, 2005, December 31, 2004 and December 31, 2003, we had accrued $19.4 million, $20.6 million, and $23.6 million, respectively, as management's best estimate of the fair value of reasonably estimable environmental remediation costs. As of September 30, 2005, December 31, 2004 and December 31, 2003, we had also recorded $4.9 million, $5.4 million and $7.5 million, respectively, as management's best estimate for net recoveries from state UST remediation funds, net of allowance, related to environmental obligations and liabilities. Accrued environmental remediation costs and recoveries from state UST remediation funds have been accreted for the change in present value due to the passage of time and, accordingly, $0.6 million and $0.7 million of accretion expense is included in environmental expenses for the nine month periods ended September 30, 2005 and 2004, respectively. Environmental expenditures were $3.5 million, and recoveries from underground storage tank funds were $1.5 million for the nine month period ended September 30, 2005. We currently estimate that our net environmental remediation spending will be approximately $5.0 million during 2005. Our business plan for 2005 currently projects a net change in estimated remediation costs and accretion expense of approximately $3.6 million. Environmental liabilities and related assets are currently measured at fair value based on their expected future cash flows which have been adjusted for inflation and discounted to present value. We also use probability weighted alternative cash flow forecasts to determine fair value. For locations where remediation efforts are not assumed to be completed during the current year, we assumed a 50% probability factor that the actual environmental expenses will exceed engineering estimates for an amount assumed to equal one year of expenses aggregating $6.2 million for those sites. Accordingly, the environmental accrual as of September 30, 2005 was increased by $2.4 million, net of assumed recoveries and before inflation and present value discount adjustments. The resulting net environmental accrual as of September 30, 2005 was then further increased by $1.2 million for the assumed impact of inflation using an inflation rate of 2.75%. Assuming a credit-adjusted risk-free rate of 7.0%, we then reduced the net environmental accrual, as previously adjusted, by a $2.5 million discount to present value. Had we assumed an inflation rate that was 0.5% higher and a discount rate that was 0.5% lower, net environmental liabilities as of September 30, 2005 would have increased by $0.2 million and $0.1 million, respectively, for those factors for an aggregate increase in the net environmental accrual of $0.3 million. However, the aggregate net change in environmental estimates and accretion expense recorded during the nine months ended September 30, 2005 would not have changed significantly if these changes in the assumptions were made effective December 31, 2004. 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. For the nine months ended September 30, 2005 and 2004, the aggregate of the net change in estimated remediation costs and accretion expense included in our consolidated statement of operations amounted to $1.4 million and $2.4 million, respectively, which amounts were net of probable recoveries from state UST remediation funds. 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. -20- Our discussion of environmental matters should be read in conjunction with "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" which appears in the Company's Annual Report on Form 10-K for the year ended December 31, 2004 and the consolidated financial statements and related notes (including notes 5 and 6) which appear in this Quarterly Report on Form 10-Q. 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. Examples of forward-looking statements include statements regarding our expectations regarding future payments from Marketing; the expected effect of regulations on our long-term performance; our expected ability to maintain compliance with applicable regulations; the adequacy of our current and anticipated cash flows; our belief that we do not have a material liability for offers and sales of our securities made pursuant to registration statements that did not contain the financial statements of Marketing; our expectations regarding future acquisitions; the impact of the covenants included in the Credit Agreement on our current business practices; the probable outcome of litigation or regulatory actions; our expected recoveries from underground storage tank funds; our exposure to environmental remediation expenses; our estimates regarding remediation costs and accretion expense; our expectations as to the long-term effect of environmental liabilities on our financial condition; our exposure to interest rate fluctuations; our expectations regarding corporate level federal income taxes; the indemnification obligations of the Company and others; assumptions regarding the future applicability of accounting estimates, assumptions and policies; our intention to pay future dividends and our beliefs about the reasonableness of our accounting estimates, judgments and assumptions. These forward-looking statements are based on our current beliefs and assumptions and information currently available to us and involve known and unknown risks (including the risks described herein and other risks that we describe from time to time in our filings with the Securities and Exchange Commission), uncertainties and other factors, which may cause our actual results, performance and achievements 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, 2004, as updated by Exhibit 99 filed with this Quarterly Report on Form 10-Q, 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 taxation and other regulations; potential litigation exposure; our expectations as to the cost of completing environmental remediation; the risk of loss of our management team; the impact of our electing to be taxed as a REIT, including subsequent failure to qualify as a REIT; risks associated with owning real estate located in the same region of the United States; risks associated with potential future acquisitions; losses not covered by insurance; future dependence on external sources of capital; our potential inability to pay dividends and terrorist attacks and other acts of violence and war. -21- 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 that 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. -22- Item 3. Quantitative and Qualitative Disclosures About Market Risk We do not use derivative financial or commodity instruments for trading, speculative or any other purpose. We had no outstanding derivative instruments as of September 30, 2005 or at any time during the nine months then ended. We do not have any foreign operations, and are therefore not exposed to foreign currency exchange rate risks. We are exposed to interest rate risks, primarily as a result of our $100.0 million Credit Agreement. We manage our exposure to this risk by minimizing, to the extent feasible, our overall borrowing and monitoring available financing alternatives. Our interest rate risk has changed as compared to December 31, 2004 due to increased borrowings under the Credit Agreement but we do not foresee any significant changes in our exposure or in how we manage this exposure in the near future. We use borrowings under the Credit Agreement to finance acquisitions and for general corporate purposes. Borrowings under our Credit Agreement bear interest at a rate equal to the sum of a base rate or a LIBOR rate plus an applicable margin based on our leverage ratio and ranging from 0.25% to 1.75%. At September 30, 2005, we had borrowings outstanding of $34.7 million under our Credit Agreement bearing interest at a rate of 5.0% per annum, and had not entered into any instruments to hedge our resulting exposure to interest-rate risk. Management believes that the fair value of the debt equals its carrying value at September 30, 2005 and December 31, 2004. Our exposure to fluctuations in interest rates will increase or decrease in the future with increases or decreases in the amount of borrowings outstanding under our Credit Agreement. In order to minimize our exposure to credit risk associated with financial instruments, we place our temporary cash investments with high-credit-quality institutions. Temporary cash investments, if any, are held in an institutional money market fund and short-term federal agency discount notes. 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 reports filed under the Securities Exchange Act of 1934, as amended, 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 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 -23- 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 have concluded that the Company's disclosure controls and procedures were effective at a reasonable assurance level as of September 30, 2005. There have been no changes in the Company's internal control over financial reporting during the latest fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. -24- PART II. OTHER INFORMATION Item 1. Legal Proceedings In July 2005, we were notified that an action was commenced against Getty Petroleum Marketing Inc. ("Marketing"), in United States District Court, Northern District of New York, by a property owner regarding certain discharges of petroleum that are alleged to have originated, in whole or in part, from a property we own and lease to Marketing. Pursuant to the terms of the lease for this property, Marketing has requested and we have agreed to provide the defense for this matter. The case is in its early stages. In July 2005, we received a demand from a property owner for reimbursement of cleanup and soil removal costs, at a former retail motor fuel property located in Brooklyn, New York, supplied by us with gasoline that the owner expects to incur in connection with the proposed development of its property. The owner claims that the costs will be reimbursable pursuant to an Indemnity Agreement that we entered into with the property owner. Although we have acknowledged responsibility for the contaminated soil, and have been engaged in the remediation of the same, we have denied responsibility for the full extent of the costs estimated to be incurred. Litigation has not been commenced and discussions regarding the demand are in their early stages. In September 2005, we received a demand from a property owner for reimbursement of cleanup and soil removal costs claimed to have been incurred by it in connection with the development of its property located in Philadelphia, Pennsylvania that, in part, is a former retail motor fuel property supplied by us with gasoline. The current owner claims that the costs are reimbursable pursuant to an Indemnity Agreement that we entered into with the prior property owner. Although we have acknowledged responsibility for a portion of the contaminated soil, and were engaged in the remediation of the same, we have denied responsibility for the full extent of the costs estimated to be incurred. Litigation has not been commenced and discussions regarding the demand are in their early stages. In June 1999, a case was commenced in New York Supreme Court in Nassau County against Marketing. The plaintiff is seeking monetary damages and alleges that he contracted acute myelogenous leukemia as a result of exposure to benzene-containing gasoline, between 1992 and 1998, when he worked periodically at an independently owned and operated retail motor fuel property which we supplied with gasoline. Although we are not named in the case, we are indemnifying Marketing pursuant to written agreements. In September 2005 we were advised that the case was dismissed, with prejudice. However, in October 2005 the plaintiff filed an appeal of this dismissal. From October 2003 through September 2005, the Company was notified that it had been made party to 38 cases in Connecticut, Florida, Massachusetts, New Hampshire, New Jersey, New York, Pennsylvania, Vermont, Virginia and West Virginia brought by local water providers or governmental agencies. These cases allege various theories of liability due to contamination of groundwater with MTBE as the basis for claims seeking compensatory and punitive damages. Each case names as defendants approximately 50 petroleum refiners, manufacturers, distributors and retailers of MTBE, -25- or gasoline containing MTBE. The accuracy of the allegations as they relate to the Company, its defenses to such claims, the aggregate amount of damages, the definitive list of defendants and the method of allocating such amounts among the defendants have not been determined. Accordingly, the ultimate legal and financial liability of the Company, if any, cannot be estimated with any certainty at this time. Please refer to "Item 3. Legal Proceedings" of our Annual Report on Form 10-K for the year ended December 31, 2004 and notes 3 and 5 to our consolidated financial statements in such Form 10-K, as well as to Part II, "Item 1. Legal Proceedings" of our Quarterly Reports on Form 10-Q for the quarters ended March 31, 2005 and June 30, 2005 and notes 5 and 6 to our accompanying consolidated financial statements which appear in this Form 10-Q for additional information. Item 5. Other Information (a) On June 30, 2005, we entered into an unsecured three-year senior revolving $100.0 million Credit Agreement with JPMorgan Chase Bank, N.A. ("JPMorgan"), as administrative agent for itself and for Bank of America as Syndication Agent, Citizens Bank of Rhode Island, as Documentation Agent, Israel Discount Bank of New York, North Fork Bank and HSBC Bank USA, National Association. The credit facility replaced our $50.0 million uncommitted line of credit with JPMorgan that expired on June 30, 2005. The Credit Agreement matures on June 30, 2008 and does not provide for scheduled reductions in the principal balance prior to its maturity. Subject to the terms of the Credit Agreement, we have the right to increase the Credit Agreement by $25.0 million and to extend the term of the Credit Agreement for one additional year. Borrowings under the Credit Agreement bear interest at a rate equal to the sum of a base rate or a LIBOR rate plus an applicable margin based on our leverage ratio and ranging from 0.25% to 1.75%. The annual commitment fee on the unused Credit Agreement will range from 0.10% to 0.20% based on usage. The Credit Agreement includes customary terms and conditions, including financial covenants such as leverage and coverage ratios and other customary covenants, including limitations on our ability to incur debt and pay dividends and maintenance of tangible net worth, and events of default, including a change of control and failure to maintain REIT status. We do not believe that these covenants will limit our current business practices. If any event of default were to occur and if the default were not subsequently waived by the lenders, the lenders would be entitled to declare all amounts outstanding under the Credit Agreement immediately due and payable. We are not aware of any event of default under the Credit Agreement that occurred prior to, or existed as of, the date of the filing of this Quarterly Report on Form 10-Q. The Credit Agreement is attached as Exhibit 10.21 to the Quarterly Report on Form 10-Q for the quarterly period ending June 30, 2005, which we filed with the Securities and Exchange Commission on August 9, 2005. -26- Item 6. Exhibits
Exhibit No. Description of Exhibit - ----------- ---------------------- 31(i).1 Rule 13a-14(a) Certification of Chief Financial Officer 31(i).2 Rule 13a-14(a) Certification of Chief Executive Officer 32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 (a) 32.2 Certifications of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 (a) 99 Risks and Uncertainties
(a) These certifications are being furnished solely to accompany the Report pursuant to 18 U.S.C. Section 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. -27- 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: November 7, 2005 BY: /s/ Thomas J. Stirnweis ------------------------------------ (Signature) THOMAS J. STIRNWEIS Vice President, Treasurer and Chief Financial Officer Dated: November 7, 2005 BY: /s/ Leo Liebowitz ------------------------------------ (Signature) LEO LIEBOWITZ Chairman and Chief Executive Officer -28- EX-31.(I).1 2 c99540exv31wxiyw1.txt RULE 13A-14(A) CERTIFICATION OF CFO EXHIBIT 31(i).1 Rule 13a-14(a) Certification of Chief Financial Officer I, Thomas J. Stirnweis, certify that: 1. I have reviewed this Quarterly Report on Form 10-Q of Getty Realty Corp.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting, which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Dated: November 7, 2005 BY: /s/ Thomas J. Stirnweis ------------------------------------ (Signature) THOMAS J. STIRNWEIS Vice President, Treasurer and Chief Financial Officer EX-31.(I).2 3 c99540exv31wxiyw2.txt RULE 13A-14(A) CERTIFICATION OF CEO EXHIBIT 31(i).2 Rule 13a-14(a) Certification of Chief Executive Officer I, Leo Liebowitz, certify that: 1. I have reviewed this Quarterly Report on Form 10-Q of Getty Realty Corp.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting, which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Dated: November 7, 2005 BY: /s/ Leo Liebowitz ------------------------------------ (Signature) LEO LIEBOWITZ Chairman and Chief Executive Officer EX-32.1 4 c99540exv32w1.txt CERTIFICATION OF CEO PURSUANT TO 18 U.S.C. SECTION 1350 EXHIBIT 32.1 Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted by Section 906 of the Sarbanes-Oxley Act of 2002, the undersigned officer of Getty Realty Corp. (the "Company") hereby certifies, to such officer's knowledge, that: (i) the Quarterly Report on Form 10-Q of the Company for the quarterly period ended September 30, 2005 (the "Report") fully complies with the requirements of Section 13(a) or Section 15(d), as applicable, of the Securities Exchange Act of 1934, as amended (subject to the Company's position prevailing in regard to the remaining unresolved SEC comment, as more fully described in the Report); and (ii) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Dated: November 7, 2005 BY: /s/ Leo Liebowitz ------------------------------------ (Signature) LEO LIEBOWITZ Chairman and Chief Executive Officer A signed original of this written statement required by Section 906 has been provided to Getty Realty Corp. and will be retained by Getty Realty Corp. and furnished to the Securities and Exchange Commission or its staff upon request. The foregoing certification is being furnished solely to accompany the Report pursuant to 18 U.S.C. Section 1350, and is not being filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and is 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. EX-32.2 5 c99540exv32w2.txt CERTIFICATION OF CFO PURSUANT TO 18 U.S.C. SECTION 1350 EXHIBIT 32.2 Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted by Section 906 of the Sarbanes-Oxley Act of 2002, the undersigned officer of Getty Realty Corp.(the "Company") hereby certifies, to such officer's knowledge, that: (i) the Quarterly Report on Form 10-Q of the Company for the quarterly period ended September 30, 2005 (the "Report") fully complies with the requirements of Section 13(a) or Section 15(d), as applicable, of the Securities Exchange Act of 1934, as amended (subject to the Company's position prevailing in regard to the remaining unresolved SEC comment, as more fully described in the Report); and (ii) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Dated: November 7, 2005 BY: /s/ Thomas J. Stirnweis ------------------------------------ (Signature) THOMAS J. STIRNWEIS Vice President, Treasurer and Chief Financial Officer A signed original of this written statement required by Section 906 has been provided to Getty Realty Corp. and will be retained by Getty Realty Corp. and furnished to the Securities and Exchange Commission or its staff upon request. The foregoing certification is being furnished solely to accompany the Report pursuant to 18 U.S.C. Section 1350, and is not being filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and is 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. EX-99 6 c99540exv99.txt RISKS AND UNCERTAINTIES EXHIBIT 99 Risks and Uncertainties We are subject to various risks that could have a negative effect on the Company and its financial condition, many of which are beyond our control. 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 below and in our Annual Report on Form 10-K for the year ended December 31, 2004 and those that are detailed from time to time in our other filings with the Securities and Exchange Commission. We are subject to risk inherent in owning and leasing real estate. We are subject to varying degrees of risk generally related to leasing and owning real estate many of which are beyond our control. In addition to general risks related to owning properties used in the petroleum marketing industry, risks include, among others, liability for long-term lease obligations, changes in regional and local economic and real estate market conditions; changes in supply of, or demand for rental properties similar to ours; competition for tenants and changes in rental rates; our ability to relet properties on favorable terms or at all; our ability to collect rent payments when due; changes in interest rates and in the availability, cost and terms of financing; the potential for uninsured casualty and other losses, the impact of present or future environmental legislation and compliance with environmental laws; adverse changes in zoning laws and other regulations; and acts of terrorism and war. In addition, real estate investments are relatively illiquid, which means that our ability to vary our portfolio of properties in response to changes in economic and other conditions may be limited. Our revenues are primarily dependent on the performance of Getty Petroleum Marketing Inc., our primary tenant. Although we periodically receive and review financial statements and other financial information from Marketing, some of the information is not publicly available. We may not have sufficient information to identify a deterioration of the financial performance or condition of Marketing, or have sufficient time to advise our shareholders of such deterioration prior to any default by Marketing on its monetary obligations to us that may result from such deterioration. If Marketing does not fulfill its monetary obligations to us, our financial condition and results of operations will be materially adversely affected. We rely upon the revenues from leasing retail motor fuel and convenience store properties and petroleum distribution terminals, primarily to Marketing, for substantially all of our revenues (88.9% for the nine months ended September 30, 2005). Accordingly, our revenues will be dependent to a large degree on the economic performance of Marketing and of the petroleum marketing industry and any factor that adversely affects Marketing or our other lessees may have a material adverse effect on our financial condition and results of operations. Marketing is wholly owned by a subsidiary of Lukoil, one of the largest integrated Russian oil companies. In the event that Marketing cannot or will not perform its monetary obligations under the Marketing Leases with us, our financial condition and results of operations would be materially adversely affected. Although Marketing is wholly owned by a subsidiary of Lukoil, no assurance can be given that Lukoil will cause Marketing to fulfill any of its obligations under the Marketing Leases. We periodically receive and review Marketing's financial statements and other financial data. We receive this information from Marketing pursuant to the terms of the Master Lease. Certain of this information is not publicly available and the terms of the Master Lease prohibit us from including this financial information in our Annual Report on Form 10-K, our Quarterly Reports on Form 10-Q or in our Annual Report to Shareholders. The financial performance of Marketing may deteriorate, and Marketing may ultimately default on its monetary obligations to us before we receive financial information from Marketing that would indicate the deterioration or before we would have the opportunity to advise our shareholders of any increased risk of default. Additionally, any financial data of Marketing that we are able to provide in our periodic reports is derived from financial data provided by Marketing and neither we, nor our auditors, have been involved with the preparation or review of such data. As part of a periodic review by the Division of Corporation Finance of the Securities and Exchange Commission ("SEC") of our Annual Report on Form 10-K for the year ended December 31, 2003, we received and responded to a number of comments. The only comment that remains unresolved pertains to the SEC's position that we must include the financial statements and summarized financial data of Marketing in our periodic filings. The SEC recently indicated that, unless we file Marketing's financial statements and summarized financial data with our periodic reports,: (i) it will not consider our Annual Reports on Forms 10-K for the years 2000 - 2004 to be compliant; (ii) it will not consider us to be current in our reporting requirements; and (iii) it will not be in a position to declare effective any registration statements we may file for public offerings of our securities. We continue to dispute the SEC's position that these financial statements and summarized financial data of Marketing are required. We do not believe that we have a material liability for offers and sales of our securities made pursuant to registration statements that did not contain the financial statements or summarized financial data of Marketing. We cannot accurately predict the consequences if we are -1- ultimately unsuccessful in our position that the financial statements and summarized financial data of Marketing are not required. Certain financial and other information concerning Marketing is available from Dun & Bradstreet and may be accessed by their web site (www.dnbsearch.com) upon payment of their fee. If Marketing does not fulfill its monetary obligations to us under the Marketing Leases, our financial condition and results of operations will be materially adversely affected. Based on our review of the financial statements and other financial data Marketing has provided to us to date, we believe that Marketing has the liquidity and financial ability to continue to pay timely its monetary obligations to us under the Marketing Leases, as it has since the inception of the Master Lease in 1997. Marketing's earnings and cash flow from operations depend upon rental income from its tenants and the sale of refined petroleum products at margins in excess of its fixed and variable expenses. A large, rapid increase in wholesale petroleum prices would adversely affect Marketing's profitability and cash flow if the increased cost of petroleum products could not be passed on to Marketing's customers or if automobile consumption of gasoline were to significantly decline. Petroleum products are commodities whose prices depend on numerous factors that affect the supply of and demand for petroleum products. The prices paid by Marketing and other petroleum marketers for products are affected by global, national and regional factors. We cannot be certain how these factors will affect petroleum product prices or supply in the future, or how in particular they will affect Marketing or our other tenants. We believe that Marketing currently relies on various suppliers for the purchase of refined petroleum products. Substantially all of our tenants depend on the same industries for their revenues. We derive substantially all of our revenue from leasing, primarily on a triple-net basis, retail motor fuel and convenience store properties and petroleum distribution terminals to tenants in the petroleum marketing industry. Accordingly, our revenues will be dependent on the economic success of the petroleum marketing industry, and any factors that adversely affect that industry could also have a material adverse effect on our financial condition and results of operations. The success of participants in that industry depends upon the sale of refined petroleum products at margins in excess of fixed and variable expenses. A large, rapid increase in wholesale petroleum prices would adversely affect the profitability and cash flows of Marketing and our other tenants if the increased cost of petroleum products could not be passed on to their customers or if automobile consumption of gasoline were to significantly decline. Petroleum products are commodities whose prices depend on numerous factors that affect the supply of and demand for petroleum products. The prices paid by Marketing and other petroleum marketers for products are affected by global, national and regional factors. We cannot be certain how these factors will affect petroleum product prices or supply in the future, or how in particular they will affect Marketing or our other tenants. We believe that Marketing currently relies on various suppliers for the purchase of refined petroleum products. Property taxes on our properties may increase without notice. Each of our owned properties is subject to real property taxes. The real property taxes on our properties and any other properties that we develop or acquire in the future may increase as property tax rates change and as those properties are assessed or reassessed by tax authorities. To the extent that our tenants are unable or unwilling to pay such increase in accordance with their leases, our net operating expenses may increase. Compliance with environmental regulations may be costly. The real estate business and the petroleum products industry are subject to numerous federal, state and local laws and regulations, including matters relating to the protection of the environment. Under certain environmental laws, a current or previous owner or operator of real estate may be liable for contamination resulting from the presence or discharge of hazardous or toxic substances or petroleum products at, on or under such property, and may be required to investigate and clean-up such contamination. Such laws typically impose liability and clean-up responsibility without regard to whether the owner or operator knew of or caused the presence of the contaminants, or the timing or cause of the contamination, and the liability under such laws has been interpreted to be joint and several unless the harm is divisible and there is a reasonable basis for allocation of responsibility. For example, liability may arise as a result of the historical use of a property or from the migration of contamination from adjacent or nearby properties. Any such contamination or liability may also reduce the value of the property. In addition, the owner or operator of a property may be subject to claims by third parties based on injury, damage and/or costs, including investigation and clean-up costs, resulting from environmental contamination present at or emanating from a property. The properties owned or controlled by us are leased primarily as retail motor fuel and convenience store properties, and therefore may contain, or may have contained, underground storage tanks for the storage of petroleum products and other hazardous or toxic substances, which creates a potential for the release of such products or substances. Some of the properties may be adjacent to or near properties that have contained or currently contain underground storage tanks used to store petroleum products or other hazardous or toxic substances. In addition, certain of the properties are on, adjacent to or near properties upon which others -2- have engaged or may in the future engage in activities that may release petroleum products or other hazardous or toxic substances. There may be other environmental problems associated with our properties of which we are unaware. These problems may make it more difficult for us to relet or sell our properties on favorable terms or at all. We have agreed to provide limited environmental indemnification, capped at $4.25 million and expiring in 2010, to Marketing for certain pre-existing conditions at six of the terminals we own and lease to Marketing. 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 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. We have not accrued a liability in connection with this indemnification agreement since it is uncertain that any amounts will be required to be paid under the agreement. As of September 30, 2005 we had accrued $19.4 million as management's best estimate of the fair value of reasonably estimable environmental remediation costs and we had also recorded $4.9 million as management's best estimate for recoveries from state UST remediation funds, net of allowance, related to environmental obligations and liabilities. Environmental expenditures were $3.5 million and recoveries from underground storage tank funds were $1.5 million for the nine months ended September 30, 2005. For the nine months ended September 30, 2005, net changes in estimated remediation costs and accretion expense included in our consolidated statements of operations amounted to $1.4 million, which was net of probable recoveries from state UST remediation funds. We currently estimate that our net environmental spending will be approximately $5.0 million during 2005. Our business plan for 2005 currently projects a net change in estimated remediation costs and accretion expense of approximately $3.6 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 whether state underground storage tank fund programs will be administered and funded in the future in a manner that is consistent with past practices or whether 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. For additional information with respect to environmental remediation costs and estimates see "Environmental Matters" in "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" which appears in the Company's Annual Report on Form 10-K for the year ended December 31, 2004 and note 5 to our consolidated financial statements in our Annual Report to Shareholders filed as exhibit 13 in such Form 10-K, and "Environmental Matters" in "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations" which appears in this Quarterly Report on Form 10-Q, and the accompanying consolidated financial statements and related notes which appear in this Form 10-Q (including note 5). We are defending pending lawsuits and claims and are subject to material losses. We are subject to various lawsuits and claims, including litigation related to environmental matters, damages resulting from leaking UST and toxic tort claims. The ultimate resolution of certain matters cannot be predicted because considerable uncertainty exists both in terms of the probability of loss and the estimate of such loss. Our ultimate liabilities resulting from such lawsuits and claims, if any, may be material to our results of operations in the period in which they are recognized. Our properties are concentrated in the Northeast United States, and adverse conditions in that region, in particular, could negatively impact our operations. A significant portion of the properties we own and lease are located in the Northeast United States. Because of the concentration of our properties in that region, in the event of adverse economic conditions in that region, we would likely experience higher risk of default on payment of rent payable to us (including under the Marketing Leases) than if our properties were more geographically diversified. Additionally, the rents on our properties may be subject to a greater risk of default than other properties in the event of adverse economic, political, or business developments or natural hazards that may affect the -3- Northeast United States and the ability of our lessees to make rent payments. In the event of any natural disaster, our ability to pay dividends could be adversely affected. We are in a competitive business. The real estate industry is highly competitive. Where we own properties, we compete for tenants with a large number of real estate property owners and other companies that sublet properties. Our principal means of competition are rents charged in relation to the income producing potential of the location. In addition, we expect other major real estate investors, some with much greater resources, will compete with us for attractive acquisition opportunities. These competitors include petroleum manufacturing, distributing and marketing companies, other REITs, investment banking firms and private institutional investors. This competition has increased prices for commercial properties and may impair our ability to make suitable property acquisitions on favorable terms in the future. Our future cash flow is dependent on renewal of leases and reletting of our space. We are subject to risks that financial distress of our tenants may lead to vacancies at our properties, that leases may not be renewed, that locations may not be relet or that the terms of renewal or reletting (including the cost of required renovations) may be less favorable than current lease terms. In addition, numerous properties compete with our properties in attracting tenants to lease space. The number of competitive properties in a particular area could have a material adverse effect on our ability to lease our properties or newly acquired properties and on the rents charged. If we were unable to promptly relet or renew the leases for all or a substantial portion of these locations, or if the rental rates upon such renewal or reletting were significantly lower than expected, our cash flow could be adversely affected and the resale values or our properties could decline. The Marketing Leases have an initial term expiring in December 2015, and generally provide Marketing with three renewal options of ten years each and a final renewal option of three years and ten months extending to 2049. Each of the renewal options may be exercised only on an "all or nothing" basis. We may acquire or develop new properties, and this may create risks. We may acquire or develop properties or acquire other real estate companies when we believe that an acquisition or development matches our business strategies. We may not succeed in consummating desired acquisitions or in completing developments on time or within our budget. We also may not succeed in leasing newly developed or acquired properties at rents sufficient to cover their costs of acquisition or development and operations. We are subject to losses that may not be covered by insurance. Marketing, and other tenants, as the lessee of our properties, are required to provide insurance for such properties, including casualty, liability, fire and extended coverage in amounts and on other terms as set forth in our master leases. We carry insurance against certain risks and in such amounts as we believe are customary for businesses of our kind. However, as the costs and availability of insurance change, we may decide not to be covered against certain losses (such as certain environmental liabilities, earthquakes, hurricanes, floods and civil disorders) where, in the judgment of management, the insurance is not warranted due to cost or availability of coverage or the remoteness of perceived risk. There is no assurance that our insurance against loss will be sufficient. The destruction of, or significant damage to, or significant liabilities arising out of conditions at our properties due to an uninsured cause would result in an economic loss and could result in us losing both our investment in, and anticipated profits from, such properties. When a loss is insured, the coverage may be insufficient in amount or duration, or a lessee's customers may be lost, such that the lessee cannot resume its business after the loss at prior levels or at all, resulting in reduced rent or a default under its lease. Any such loss relating to a large number of properties could have a material adverse effect on our financial condition. Failure to qualify as a REIT would have adverse consequences to our shareholders. We elected to be taxed as a REIT beginning January 1, 2001. We cannot, however, guarantee that we will continue to qualify in the future as a REIT. In order to initially qualify for REIT status, we were required, among other items, to make a distribution to shareholders in an amount at least equal to our accumulated "earnings and profits" (as defined by the Internal Revenue Code) from the years we operated as a taxable corporation. On August 1, 2001, we paid the earnings and profits distribution to our shareholders in an amount that we estimated was required in order for us to qualify as a REIT. Determination of accumulated earnings and profits for federal income tax purposes is extremely complex. Should the Internal Revenue Service successfully assert that our accumulated earnings and profits were greater than the amount distributed, we may fail to qualify as a REIT; however, we may avoid losing our REIT status by paying a deficiency dividend to eliminate any remaining accumulated earnings and profits. We may have to borrow money or sell assets to pay such a deficiency dividend. We cannot give any assurance that new legislation, regulations, administrative interpretations or court decisions will not significantly change the requirements relating to our qualification. If we fail to qualify as a REIT, we will again be subject to federal income tax at regular corporate rates, and could be subject to the federal alternative minimum tax, we would be required to pay significant income -4- taxes and would have less money available for our operations and distributions to shareholders. This would likely have a significant adverse effect on the value of our securities. We could also be precluded from treatment as a REIT for four taxable years following the year in which we lost the qualification, and all distributions to stockholders would be taxable as regular corporate dividends to the extent or our current and accumulated earnings and profits. As a REIT, we are dependent on external sources of capital which may not be available on favorable terms. To maintain our status as a REIT, we must distribute to our shareholders each year at least ninety percent of our net taxable income, excluding any net capital gain. Because of these distribution requirements, it is not likely that we will be able to fund all future capital needs, including acquisitions, from income from operations. Therefore, we will have to rely on third-party sources of capital, which may or may not be available on favorable terms or at all. Moreover, additional equity offerings may result in substantial dilution of shareholders' interests, and additional debt financing may substantially increase our leverage. Our access to third-party sources of capital depends upon a number of factors, including general market conditions, the market's perception of our growth potential, our current and potential future earnings and cash distributions and the market price of our common stock. The loss of certain members of our management team could adversely affect our business. We depend upon the skills and experience of our executive officers. Loss of the services of any of them could have a material adverse effect on our business and financial condition. We do not have employment agreements with any of our executives. Our business operations may not generate sufficient cash for distributions or debt service. We cannot assure you that our business will generate sufficient cash flow from operations or that future borrowings will be available to us in an amount sufficient to enable us to make distributions on our common stock, to pay our indebtedness, or to fund our other liquidity needs. We may not be able to repay or refinance existing indebtedness on favorable terms, which could force us to dispose of properties on disadvantageous terms (which may also result in losses) or accept financing on unfavorable terms. Our ability to meet the financial and other covenants relating to our Credit Agreement may be dependent on the performance of our tenants. Failure to comply with these covenants could result in an event of default that, if not cured or waived, could result in the acceleration of all or a substantial portion of our indebtedness under our Credit Agreement. We may be unable to pay dividends and our equity may not appreciate. Under the Maryland General Corporation Law, our ability to pay dividends would be restricted if, after payment of the dividend, (1) we would not be able to pay indebtedness as it becomes due in the usual course of business or (2) our total assets would be less than the sum of our liabilities plus the amount that would be needed, if we were to be dissolved, to satisfy the rights of any shareholders with liquidation preferences. There currently are no shareholders with liquidation preferences. No assurance can be given that our financial performance in the future will permit our payment of any dividends. As a result of the factors described above, we may experience material fluctuations in future operating results on a quarterly or annual basis, which could materially and adversely affect our business, stock price and ability to pay dividends. Terrorist attacks and other acts of violence or war may affect the market, on which our common stock trades, the markets in which we operate, our operations and our results of operations. Terrorist attacks or armed conflicts could affect our business or the businesses of our tenants or of Marketing or its parent. The consequences of armed conflicts are unpredictable, and we may not be able to foresee events that could have an adverse effect on our business. More generally, any of these events could cause consumer confidence and spending to decrease or result in increased volatility in the U.S. and worldwide financial markets and economy. They also could be a factor resulting in, or a continuation of, an economic recession in the U.S. or abroad. Any of these occurrences could have a significant adverse impact on our operating results and revenues and may result in volatility of the market price for our common stock. -5- -----END PRIVACY-ENHANCED MESSAGE-----