-----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, UEwXFjBYpVKFBfs8CHacacfyCxSZLPFkos5VoMYLb5abmc+iw1A1fDRMfMyCKT9J PApehYfPKgK3t8LTnSf1vw== 0000726728-97-000024.txt : 19971114 0000726728-97-000024.hdr.sgml : 19971114 ACCESSION NUMBER: 0000726728-97-000024 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19970930 FILED AS OF DATE: 19971112 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: REALTY INCOME CORP CENTRAL INDEX KEY: 0000726728 STANDARD INDUSTRIAL CLASSIFICATION: REAL ESTATE INVESTMENT TRUSTS [6798] IRS NUMBER: 330580106 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-13374 FILM NUMBER: 97714866 BUSINESS ADDRESS: STREET 1: 220 W CREST ST CITY: ESCONDIDO STATE: CA ZIP: 92025-1707 BUSINESS PHONE: 6197412111 MAIL ADDRESS: STREET 1: 220 WEST CREST ST CITY: ESCONDIDO STATE: CA ZIP: 92025-1707 10-Q 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q ========= [X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended SEPTEMBER 30, 1997, or ================== [ ] Transition report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934 COMMISSION FILE NUMBER 1-13318 ============================== REALTY INCOME CORPORATION ========================= (Exact name of registrant as specified in its charter) MARYLAND ======== (State or other jurisdiction of incorporation or organization) 33-0580106 ========== (I.R.S. Employer Identification No.) 220 WEST CREST STREET, ESCONDIDO, CALIFORNIA 92025 =================================================== (Address of principal executive offices) (760) 741-2111 ============== (Registrant's telephone number) Indicate by checkmark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ] There were 25,698,664 shares of common stock outstanding as of November 10, 1997. Page 1 REALTY INCOME CORPORATION Form 10-Q September 30, 1997 Table of Contents ----------------- PART I. FINANCIAL INFORMATION Pages ============================== ----- Item 1: Financial Statements Consolidated Balance Sheets........................ 3-4 Consolidated Statements of Income.................. 5 Consolidated Statements of Cash Flows.............. 6-7 Notes to Consolidated Financial Statements......... 8-12 Item 2: Management's Discussion And Analysis Of Financial Condition And Results Of Operations......13-34 PART II. OTHER INFORMATION ========================== Item 6: Exhibits and Reports on Form 8-K...................34-35 SIGNATURE................................................... 35 EXHIBIT INDEX............................................... 36 EXHIBITS.................................................... 37 Page 2 PART I. FINANCIAL INFORMATION ============================== ITEM 1. FINANCIAL STATEMENTS REALTY INCOME CORPORATION AND SUBSIDIARIES Consolidated Balance Sheets =========================== September 30, 1997 And December 31, 1996 (dollars in thousands, except per share data) 1997 (Unaudited) 1996 =========== ========= ASSETS Real estate, at cost: Land $ 204,807 $ 165,598 Buildings and improvements 469,301 398,942 --------- --------- 674,108 564,540 Less - accumulated depreciation and amortization (147,677) (138,307) --------- --------- Net real estate 526,431 426,233 Cash and cash equivalents 6,198 1,559 Accounts receivable 1,599 1,905 Due from affiliates 348 383 Other assets 2,782 2,183 Goodwill, net 21,132 21,834 --------- --------- TOTAL ASSETS $ 558,490 $ 454,097 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Distributions payable $ 3,622 $ 3,619 Accounts payable and accrued expenses 4,250 1,172 Other liabilities 6,184 5,065 Line of credit payable 67,600 70,000 Notes payable 110,000 -- --------- --------- TOTAL LIABILITIES 191,656 79,856 --------- --------- Continued on next page Page 3 (continued) REALTY INCOME CORPORATION AND SUBSIDIARIES Consolidated Balance Sheets =========================== September 30, 1997 And December 31, 1996 (dollars in thousands, except per share data) 1997 (Unaudited) 1996 =========== ========= Stockholders' equity Preferred stock, par value $1.00 per share, 20,000,000 shares authorized, no shares issued or outstanding -- -- Common stock, par value $1.00 per share, 100,000,000 shares authorized, 22,998,664 and 22,979,537 shares issued and outstanding in 1997 and 1996, respectively 22,999 22,980 Capital in excess of par value 516,447 516,004 Accumulated distributions in excess of net income (172,612) (164,743) --------- --------- TOTAL STOCKHOLDERS' EQUITY 366,834 374,241 --------- --------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 558,490 $ 454,097 ========= ========= The accompanying notes to consolidated financial statements are an integral part of these statements. Page 4 REALTY INCOME CORPORATION AND SUBSIDIARIES Consolidated Statements Of Income ================================= For the three and nine months ended September 30, 1997 and 1996 (dollars in thousands, except per share data) (Unaudited) Three Three Nine Nine Months Months Months Months Ended Ended Ended Ended 9/30/97 9/30/96 9/30/97 9/30/96 ========= ========= ========= ========= REVENUE Rental $ 16,801 $ 13,777 $ 48,256 $ 41,106 Interest 34 27 161 77 Other 8 36 29 71 --------- --------- --------- --------- 16,843 13,840 48,446 41,254 --------- --------- --------- --------- EXPENSES Depreciation and amortization 4,706 4,052 13,654 12,175 General and administrative 1,338 1,272 3,923 3,870 Property 409 397 1,262 1,256 Interest 2,450 497 5,771 1,502 Provision for impairment losses 70 -- 140 323 --------- --------- --------- --------- 8,973 6,218 24,750 19,126 --------- --------- --------- --------- Income from operations 7,870 7,622 23,696 22,128 Gain on sales of properties 596 268 1,023 1,226 --------- --------- --------- --------- NET INCOME $ 8,466 $ 7,890 $ 24,719 $ 23,354 ========== ========== ========== ========== Net income per share $ 0.37 $ 0.34 $ 1.08 $ 1.02 ========== ========== ========== ========== Weighted average number of shares outstanding 22,999,536 22,977,501 22,993,205 22,976,974 ========== ========== ========== ========== The accompanying notes to consolidated financial statements are an integral part of these statements. Page 5 REALTY INCOME CORPORATION AND SUBSIDIARIES Consolidated Statements Of Cash Flows ===================================== For the nine months ended September 30, 1997 and 1996 (dollars in thousands) (Unaudited) 1997 1996 ========= ========= CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 24,719 $ 23,354 Adjustments to net income: Depreciation and amortization 13,654 12,175 Provision for impairment losses 140 323 Gain on sales of properties (1,023) (1,226) Change in assets and liabilities: Accounts receivable and other assets 901 1,060 Accounts payable, accrued expenses and other liabilities 4,677 (31) --------- --------- Net cash provided by operating activities 43,068 35,655 --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from sales of properties 3,858 3,645 Acquisition of and additions to properties (114,190) (19,984) --------- --------- Net cash used in investing activities (110,332) (16,339) --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Payments of distributions (32,586) (37,337) Proceeds from notes issued 109,152 -- Increase in other assets (286) -- Proceeds from line of credit 92,400 33,300 Payment of line of credit (94,800) (2,700) Payments to the defined benefit pension plan (2,223) -- Payment of notes payable -- (12,597) Proceeds from stock issued 246 -- Stock offering costs -- (188) --------- --------- Net cash provided by (used in) financing activities 71,903 (19,522) --------- --------- (Continued on next page) Page 6 (continued) REALTY INCOME CORPORATION AND SUBSIDIARIES Consolidated Statements Of Cash Flows ===================================== For the nine months ended September 30, 1997 And 1996 (dollars in thousands) (Unaudited) 1997 1996 ========= ========= Net increase (decrease) in cash and cash equivalents 4,639 (206) Cash and cash equivalents, beginning of period 1,559 1,650 --------- --------- Cash and cash equivalents, end of period $ 6,198 $ 1,444 ========= ========= For supplemental disclosures, see note 8. The accompanying notes to consolidated financial statements are an integral part of these statements. Page 7 REALTY INCOME CORPORATION AND SUBSIDIARIES Notes To Consolidated Financial Statements ========================================== September 30, 1997 (Unaudited) 1. Management Statement and General - ------------------------------------ The consolidated financial statements of Realty Income Corporation ("Realty Income" or the "Company") were prepared from the books and records of the Company without audit or verification and in the opinion of management include all adjustments (consisting of only normal recurring accruals) necessary to present a fair statement of results for the interim periods presented. Readers of this quarterly report should refer to the audited financial statements of the Company for the year ended December 31, 1996, which are included in the Company's 1996 Annual Report on Form 10-K, as certain disclosures which would substantially duplicate those contained in such audited financial statements have been omitted from this report. 2. Credit Facility - ------------------- The Company has a $130 million, revolving, unsecured acquisition credit facility that expires in November 1999. As of September 30, 1997 and December 31, 1996, the outstanding balance on the credit facility was $67.6 million and $70.0 million, respectively, with an effective interest rate of approximately 6.94% and 6.85%, respectively. A commitment fee of 0.15%, per annum, accrues on the average amount of the unused available credit commitment. For the nine months ended September 30, 1997 and 1996, interest of $135,000 and $91,000, respectively, was capitalized on properties under construction. For the three months ended September 30, 1997 and 1996, interest of $53,000 and $51,000 was so capitalized. 3. Properties - -------------- At September 30, 1997, the Company owned a diversified portfolio of 795 properties in 42 states. Of the Company's properties, 788 are single tenant properties with the remaining properties being multi- tenant properties. At September 30, 1997, seven properties were vacant and available for lease. During the first nine months of 1997, the Company acquired 64 retail properties located in 24 states at an aggregate cost of approximately $112.9 million (excluding the estimated unfunded development costs totaling $2.1 million on properties under construction). The company also invested $3.1 million in properties acquired in 1996, which were under development. Page 8 1997 ACQUISITION ACTIVITY THROUGH SEPTEMBER 30TH Total Invested through Tenant Industry City/State 9/30/97 ============ =========== ============ ============ 1ST QUARTER - ----------- Aaron Rents Home Furnishings Arlington, TX $ 1,849,000 Aaron Rents Home Furnishings Cedar Park, TX 1,080,000 Aaron Rents Home Furnishings Houston, TX 1,554,000 Barnes & Noble Book Store Tampa, FL 4,696,000 Econo Lube Auto Service Durham, NC 624,000 Econo Lube Auto Service Greensboro, NC 603,000 Econo Lube Auto Service Charleston, SC 511,000 Econo Lube Auto Service Columbia, SC 638,000 Econo Lube Auto Service Greenville, SC 500,000 Jiffy Lube Auto Service Springboro, OH 714,000 OfficeMax Office Supplies Lakewood, CA 4,497,000 2ND QUARTER - ----------- Aaron Rents Home Furnishings Ridgeland, MS 1,051,000 Aaron Rents Home Furnishings Memphis, TN 2,236,000 Aaron Rents Home Furnishings Webster, TX 821,000 Best Buy Consumer Electronics Smyrna, GA 4,184,000 Econo Lube Auto Service Denver, CO 723,000 Econo Lube (1) Auto Service Duluth, GA 360,000 Econo Lube (1) Auto Service Garner, NC 354,000 Econo Lube Auto Service Pineville, NC 559,000 Jiffy Lube(1) Auto Service Brentwood, TN 317,000 Linens 'N Things Home Accessories Omaha, NE 5,907,000 OfficeMax Office Supplies Hutchinson, KS 1,974,000 OfficeMax Office Supplies Salina, KS 2,070,000 Petco Pet Supplies Dickson City, PA 2,539,000 QuikTrip Convenience Store Dunwoody, GA 1,270,000 QuikTrip Convenience Store Lithonia, GA 1,163,000 QuikTrip Convenience Store Mableton, GA 847,000 QuikTrip Convenience Store Norcross, GA 1,035,000 QuikTrip Convenience Store Stone Mountain, GA 1,062,000 QuikTrip Convenience Store Godfrey, IL 1,108,000 QuikTrip Convenience Store Granite City, IL 1,100,000 QuikTrip Convenience Store Madison, IL 799,000 QuikTrip Convenience Store Tulsa, OK 635,000 Speedy Brake Auto Service Southington, CT 898,000 Speedy Brake Auto Service Billerica, MA 861,000 Continued on next page Page 9 (continued) Total Invested through Tenant Industry City/State 9/30/97 ============ =========== ============ ============ Staples Office Supplies Helena, MT 2,067,000 Staples Office Supplies New Philadelphia, OH 2,377,000 3RD QUARTER - ----------- Bob's Stores Apparel Store Danbury, CT 7,297,000 Bob's Stores Apparel Store Westbury, NY 10,287,000 East Coast Oil Convenience Store Midlothian, VA 627,000 Econo Lube (1) Auto Service Flagstaff, AZ 182,000 Econo Lube (1) Auto Service Midwest City, OK 129,000 Econo Lube (1) Auto Service The Village, OK 147,000 Econo Lube Auto Service Houston, TX 636,000 Hollywood Video Video Rental Birmingham, AL 1,256,000 Hollywood Video Video Rental Tulsa, OK 1,323,000 Hollywood Video Video Rental Columbia, TN 1,182,000 Hollywood Video Video Rental Jackson, TN 1,238,000 Hollywood Video Video Rental Murfreesboro, TN 1,292,000 Hollywood Video Video Rental Smyrna, TN 1,138,000 Hollywood Video Video Rental Beaumont, TX 1,126,000 Hollywood Video Video Rental Lubbock, TX 1,124,000 Jiffy Lube Auto Service Newport, KY 612,000 Jiffy Lube Auto Service Cincinnati, OH 493,000 Jiffy Lube Auto Service Fairfield, OH 558,000 Jiffy Lube Auto Service Milford, OH 623,000 Jiffy Lube Auto Service Nashville, TN 569,000 Just For Feet Shoe Store Houston, TX 3,396,000 Linens 'N Things Home Accessories Danbury, CT 4,240,000 Linens 'N Things Home Accessories Henderson, NV 4,371,000 Linens 'N Things Home Accessories Spring, TX 3,596,000 OfficeMax Office Supplies Riverside, CA 3,070,000 OfficeMax Office Supplies Westbury, NY 6,170,000 Speedy Brake Auto Service Akron, OH 599,000 ------------ Properties acquired in 1997 112,864,000 Funding in 1997 of buildings under development on land acquired in 1996 3,105,000 Capitalized expenditures relating to existing properties 22,000 ------------ TOTAL INVESTED $115,991,000 ============ Page 10 (1) The Company acquired these properties as undeveloped land and is funding construction and other costs relating to the development of the properties by the tenant. The tenants have entered into leases covering these properties and are contractually obligated to complete construction on a timely basis and to pay construction cost overruns to the extent they exceed the construction budget by more than a predetermined percentage. 4. Gain on Sales of Properties - ----------------------------------- For the nine months ended September 30, 1997, the Company sold nine properties (six restaurant, one multi-tenant and two child care centers) for a total of $3.9 million and recognized a gain of $1.0 million. For the nine months ended September 30, 1996, the Company sold five properties (four restaurant and one multi-tenant) for $3.6 million and recognized a gain of $1.2 million. For the three months ended September 30, 1997, the Company sold two properties (one child care and one restaurant) for $1.0 million and recognized a gain of $596,000. For the three months ended September 30, 1996, the company sold three properties (two restaurant and one multi-tenant) for $1.4 million and recognized a gain of $268,000. 5. Distributions Paid And Payable - ---------------------------------- During the nine months ended September 30, 1997, the Company paid nine monthly distributions of $0.1575 per share, totaling $1.4175 per share. For the nine months ended September 30, 1996, the Company paid nine monthly distributions of $0.155 per share, totaling $1.395 per share and paid a special distribution of $0.23 per share in January 1996. As of September 30, 1997, a distribution of $0.1575 per share was declared and payable. 6. Notes Payable - ----------------- On May 6, 1997 Realty Income issued $110 million of 7.75% unsecured notes due May 2007 (the "Notes"). The Notes were sold at 99.929% of par for a yield to the investors of 7.76%. After taking into effect the $1.1 million gain realized on the treasury interest rate lock agreement (see note 7), the effective interest rate to the Company on the Notes is 7.62%. The net proceeds from the sale of the Notes were used to repay $93.7 million of outstanding borrowings under the Company's credit facility and to acquire properties. Interest on the Notes is payable semiannually each May and November, commencing November 1997. Currently, there is no formal trading market for the Notes and the Company has not and does not intend to list the Notes on any security exchange. Page 11 7. Derivative Financial Instrument - ----------------------------------- The Company had a derivative financial instrument and did not use it for trading purposes. The derivative financial instrument was used to manage a well-defined interest rate risk. In December 1996, the Company entered into a treasury interest rate lock agreement to hedge against rising interest rates applicable to the debt offering described in note 6. Under the interest rate lock agreement, the Company was to receive or make a payment based on the differential between a specified interest rate (6.537%) and the actual 10-year treasury interest rate on notional principal amount of $90 million, at the end of six months. Based on the 10-year treasury interest rate at May 1, 1997, the Company realized a $1.1 million gain on the agreement, which was received in June 1997. The gain on the agreement is being amortized over 10 years (the life of the Notes) as an offset to interest expense. 8. Supplemental Disclosure of Cash Flow Information - ---------------------------------------------------- Interest paid during the first nine months of 1997 and 1996 was $2.3 million and $1.1 million respectively. The following non-cash investing and financing activities are included in the accompanying financial statements: A. In 1997, the acquisition of three properties resulted in the following (dollars in thousands): Increases in: Land $1,724 Building 77 Other liabilities 1,801 B. In 1997, the Company granted shares of stock resulting in the following (dollars in thousands): Increases in: Other assets $216 Common Stock 9 Capital in excess of par 207 9. Subsequent Event - -------------------- On October 15, 1997, the Company issued 2,700,000 shares of common stock at a price of $27.00 per share. Page 12 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS When used in this Form 10-Q Report, the words estimated, anticipated and similar expressions are intended to identify forward-looking statements. Such statements are subject to certain risks and uncertainties which could cause actual results to differ materially. In particular, among the factors that could cause actual results to differ materially are continued qualification as a real estate investment trust, general business and economic conditions, competition, interest rates, accessibility of debt and equity capital markets and other risks inherent in the real estate business including tenant defaults, potential liability relating to environmental matters and illiquidity of real estate investments. For further description and detail of other factors please see "Business -- Other Items" in Form 10K for the year ended December 31, 1996. Readers are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date hereof. The Company undertakes no obligation to publicly release the results of any revisions to these forward-looking statements which may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. GENERAL ======= Realty Income Corporation, a Maryland corporation (the "Company" or "Realty Income"), is a fully integrated, self-administered and self- managed real estate investment trust ("REIT") that acquires and manages net leased retail properties. As of September 30, 1997, the Company owned a diversified portfolio of 795 properties located in 42 states with over 6.1 million square feet of leasable space. Of the 795 properties in the portfolio, 788 are single-tenant properties with the remainder being multi-tenant properties. As of September 30, 1997, 782 or over 99% of the 788 single-tenant properties were net leased with an average remaining lease term (excluding extension options) of approximately 8.5 years. Realty Income adheres to a focused strategy of acquiring freestanding, single-tenant, retail properties leased to regional and national retail chains under long-term, net lease agreements. The Company typically acquires and then leases back, retail store locations from retail chain store operators, providing capital to the operators for continued expansion and other purposes. Realty Income's acquisition and investment activities are concentrated in highly specific target markets and focus on middle-market retailers providing goods and services which satisfy basic consumer needs. The Company's net lease agreements generally are for initial terms of 10 to 20 years, require the tenant to pay a minimum monthly rent and property operating expenses (taxes, insurance and maintenance), and provide for future rent increases (typically subject to ceilings) based on increases in Page 13 the consumer price index or additional rent calculated as a percentage of tenant's gross sales above a specific level. Since 1970 and through August 31, 1997, Realty Income has acquired and leased back to regional and national retail chains 744 properties (including 31 properties that have been sold) and has collected approximately 98% of the original contractual rent obligation on these properties. Realty Income believes that the long-term ownership of an actively managed, diversified portfolio of retail properties leased under long-term, net lease agreements can produce consistent, predictable income and the potential for long-term capital appreciation. Management believes that long-term leases, coupled with tenants assuming responsibility for property expenses under the net lease structure, generally produce a more predictable income stream than many other types of real estate portfolios. The Company is a fully integrated real estate company with in-house acquisition, leasing, legal, financial underwriting, portfolio management and capital markets expertise. The five senior officers of the Company, who have each managed the Company's properties and operations for between seven and 12 years, owned approximately 0.9% of the Company's outstanding common stock, as of November 10, 1997. The directors and five senior officers of the Company, as a group, owned approximately 3.2% of the Company's outstanding common stock, as of November 10, 1997. Realty Income had 44 employees as of November 10, 1997. The Company's primary business objective is to generate a consistent and predictable level of funds from operations ("FFO") per share and distributions to stockholders. Additionally, the Company generally will seek to increase FFO per share and distributions to stockholders through both active portfolio management and the acquisition of additional properties. The Company also seeks to lower the ratio of distributions to stockholders as a percentage of FFO in order to allow internal cash flow to be used to fund additional acquisitions and for other corporate purposes. The Company's portfolio management focus includes: (i) contractual rent increases on existing leases; (ii) rental increases at the termination of existing leases when market conditions permit; and (iii) the active management of the Company's property portfolio, including selective sales of properties. The Company generally pursues the acquisition of additional properties under long-term, net lease agreements with initial contractual base rent which, at the time of acquisition and as a percentage of acquisition costs, is in excess of the Company's estimated cost of capital. Page 14 Other Information ----------------- Thomas A. Lewis succeeded William E. Clark as Chief Executive Officer of the Company in May 1997. Mr. Lewis has been an officer of the Company since 1987 and has served as the Vice Chairman of the Board of Directors since 1994. Mr. Clark has continued as Chairman of the Board of Directors. In May 1997, the Company was reincorporated as a Maryland corporation, which is also named Realty Income Corporation, pursuant to a merger of the Company into a wholly-owned Maryland subsidiary and the conversion of each outstanding share of Common Stock of the Company into one share of common stock of the surviving corporation. The Company's common stock is listed on the New York Stock Exchange under the symbol "O" and its central index key ("CIK") number is 726728. The Company anticipates that the year 2000 date issue will not adversely affect its current software or computers and will only minimally impact its consolidated financial position and results of operations. LIQUIDITY AND CAPITAL RESOURCES =============================== Cash Reserves ------------- Realty Income was organized for the purpose of operating as an equity REIT which acquires and leases properties and distributes to stockholders, in the form of monthly cash distributions, a substantial portion of its net cash flow generated from leases on its retail properties. The Company intends to retain an appropriate amount of cash as working capital reserves. At September 30, 1997, the Company had cash and cash equivalents totaling $6.2 million. Management believes that the Company's cash and cash equivalents on hand, cash provided from operating activities and borrowing capacity are sufficient to meet its liquidity needs for the foreseeable future. Capital Funding --------------- On October 15, 1997, Realty Income issued 2,700,000 shares of common stock at a price of $27.00 per share ("the Stock Offering"). The net proceeds were used to repay borrowings of $62.6 million under the acquisition credit facility and to acquire properties. These Page 15 borrowings under the acquisition credit facility were used to acquire properties during June 1997 through September 1997. On May 6, 1997, Realty Income issued $110 million of 7.75% notes due May 2007 (the "Notes"). The Notes were sold at 99.929% of par for a yield to the investors of 7.76%. After taking into effect the gain of $1.1 million realized on the treasury interest rate lock agreement, which is described in the next paragraph, the effective interest rate on the Notes to the Company is 7.62%. The net proceeds from the sale of the Notes were used to repay $93.7 million of outstanding borrowings under the Company's credit facility and to acquire properties. Interest on the Notes is payable semiannually each May and November, commencing November 1997. Currently, there is no formal trading market for the Notes and the Company has not listed and does not intend to list the Notes on any securities exchange. In December 1996, the Company entered into a treasury interest rate lock agreement to hedge against the possibility of rising interest rates. Under the interest rate lock agreement, the Company was to receive or make a payment based on the differential between a specified interest rate, 6.537%, and the actual 10-year treasury interest rate on notional principal of $90 million, at the end of six months. Based on the 10-year treasury interest rate at May 1, 1997, the Company realized a $1.1 million gain on the agreement, which was received in June 1997. The gain on the agreement is being amortized over 10 years (the life of the Notes) as an offset to interest expense. During the fourth quarter of 1996, the Company received investment grade senior unsecured debt ratings from Duff & Phelps Rating Company, Moody's Investor Services, Inc. and Standard and Poor's Credit Rating Group, of BBB, Baa3, and BBB-, respectively. These ratings are subject to change based upon, among other things, the Company's results of operations and financial condition. Realty Income has a $130 million, revolving, unsecured acquisition credit facility that expires in November 1999. The credit facility currently bears interest at 1.25% over the London Interbank Offered Rate ("LIBOR") and offers the Company other interest rate options. As of November 10, 1997, the full $130 million of borrowing capacity was available to the Company under the acquisition credit facility. On October 15, 1997, the net proceeds from the Stock Offering were used to repay outstanding borrowings under the credit facility. This credit facility has been and is expected to be used to acquire additional retail properties leased to national and regional retail chains under long term lease agreements. Any additional borrowings will increase the Company's exposure to interest rate risk. Realty Income expects to meet its long-term capital needs for the acquisition of properties through the issuance of public or private debt or equity. In August 1997, the Company filed a universal shelf Page 16 registration statement with the Securities and Exchange Commission covering up to $300 million in value of common stock, preferred stock or debt securities. Approximately $72.9 million in value of common stock and debt securities has been issued under the universal shelf registration statement through November 10, 1997. Property Acquisitions --------------------- During the first nine months of 1997, Realty Income acquired 64 retail properties located in 24 states for $112.9 million (excluding the estimated unfunded development costs of $2.1 million on properties under construction at September 30, 1997) and selectively sold nine properties, increasing the number of properties in its portfolio to 795. The 64 properties acquired will contain approximately 969,700 leasable square feet and are 100% leased under net leases, with an average initial lease term of 14.7 years. The weighted average annual unleveraged return on the cost of the 64 properties (including the estimated unfunded development cost of the nine properties under development) is estimated to be 10.30%, computed as estimated contractual net operating income (which in the case of a net leased property is equal to the base rent or, in the case of properties under construction, the estimated base rent under the lease) for the first year of each lease, divided by total acquisition and estimated development costs. Since it is possible that a tenant could default on the payment of contractual rent, no assurance can be given that the actual return on the cost of the 64 properties acquired in 1997 will not differ from the foregoing percentage. Of the properties acquired during the first nine months of 1997, 58 were occupied as of November 1, 1997 and the remaining six were pre- leased and under construction pursuant to contracts under which the tenant has agreed to develop the properties (with development costs funded by the Company) and to begin paying rent when the premises open for business. All of the properties acquired in 1997, including the properties under development, are leased with initial terms of 10 to 20 years. During the first nine months of 1997, the Company also invested $3.1 million in development properties acquired in 1996 and $22,000 in two existing property in its portfolio. Page 17 1997 ACQUISITION ACTIVITY THROUGH SEPTEMBER 30TH Initial Approx. Lease Leasable Term Square Tenant Industry City / State (Years) Feet - ------ -------- ------------ ------- ------- 1st Quarter - ----------- Aaron Rents Home Furnishings Arlington, TX 10.0 68,100 Aaron Rents Home Furnishings Cedar Park, TX 10.0 23,300 Aaron Rents Home Furnishings Houston, TX 10.0 70,300 Barnes & Noble Book Store Tampa, FL 14.2 30,000 Econo Lube Auto Service Durham, NC 15.0 2,800 Econo Lube Auto Service Greensboro, NC 15.0 2,400 Econo Lube Auto Service Charleston, SC 15.0 2,800 Econo Lube Auto Service Columbia, SC 15.0 2,800 Econo Lube Auto Service Greenville, SC 15.0 2,800 Jiffy Lube Auto Service Springboro, OH 20.0 2,400 OfficeMax Office Supplies Lakewood, CA 14.6 28,700 2nd Quarter - ----------- Aaron Rents Home Furnishings Ridgeland, MS 10.0 22,300 Aaron Rents Home Furnishings Memphis, TN 10.0 51,500 Aaron Rents Home Furnishings Webster, TX 10.0 22,600 Best Buy Consumer Electronics Smyrna, GA 20.0 46,100 Econo Lube Auto Service Denver, CO 15.0 2,800 Econo Lube (1) Auto Service Duluth, GA 15.0 2,800 Econo Lube (1) Auto Service Garner, NC 15.0 2,800 Econo Lube Auto Service Pineville, NC 15.0 2,800 Jiffy Lube (1) Auto Service Brentwood, TN 20.0 2,000 Linens 'N Things Home Accessories Omaha, NE 15.8 46,600 OfficeMax Office Supplies Hutchinson, KS 15.0 23,500 OfficeMax Office Supplies Salina, KS 15.0 23,500 Petco Pet Supplies Dickson City, PA 14.7 16,000 QuikTrip Convenience Store Dunwoody, GA 11.3 3,200 QuikTrip Convenience Store Lithonia, GA 18.3 3,200 QuikTrip Convenience Store Mableton, GA 17.4 3,200 QuikTrip Convenience Store Norcoss, GA 17.4 3,200 QuikTrip Convenience Store Stone Mountain, GA 11.3 3,200 QuikTrip Convenience Store Godfrey, IL 13.3 3,200 QuikTrip Convenience Store Granite City, IL 13.3 3,200 QuikTrip Convenience Store Madison, IL 13.3 3,200 QuikTrip Convenience Store Tulsa, OK 11.3 3,200 Speedy Brake Auto Service Southington, CT 15.1 5,300 Speedy Brake Auto Service Billerica, MA 15.0 5,000 (continued on next page) Page 18 (continued) Initial Approx. Lease Leasable Term Square Tenant Industry City / State (Years) Feet - ------ -------- ------------ ------- ------- Staples Office Supplies Helena, MT 14.7 24,600 Staples Office Supplies New Philadel- phia, OH 14.9 24,000 3rd Quarter - ----------- Bob's Stores Apparel Store Danbury, CT 15.3 50,000 Bob's Stores Apparel Store Westbury, NY 19.3 48,100 East Coast Oil Convenience Store Midlothian, VA 15.0 2,400 Econo Lube (1) Auto Service Flagstaff, AZ 15.0 2,800 Econo Lube (1) Auto Service Midwest City, OK 15.0 2,800 Econo Lube (1) Auto Service The Village, OK 15.0 2,800 Econo Lube Auto Service Houston, TX 15.0 2,600 Hollywood Video Video Rental Birmingham, AL 14.7 7,500 Hollywood Video Video Rental Tulsa, OK 13.2 8,500 Hollywood Video Video Rental Columbia, TN 14.2 7,500 Hollywood Video Video Rental Jackson, TN 15.0 7,500 Hollywood Video Video Rental Murfreesboro, TN 14.6 7,500 Hollywood Video Video Rental Smyrna, TN 14.6 7,500 Hollywood Video Video Rental Beaumont, TX 13.9 7,500 Hollywood Video Video Rental Lubbock, TX 15.0 7,500 Jiffy Lube Auto Service Newport, KY 14.5 2,700 Jiffy Lube Auto Service Cincinnati, OH 14.4 2,700 Jiffy Lube Auto Service Fairfield, OH 14.5 2,800 Jiffy Lube Auto Service Milford, OH 10.6 2,200 Jiffy Lube Auto Service Nashville, TN 17.9 2,100 Just For Feet Shoe Store Houston, TX 15.0 16,000 Linens 'N Things Home Accessories Danbury, CT 15.3 49,900 Linens 'N Things Home Accessories Henderson, NV 19.3 37,700 Linens 'N Things Home Accessories Spring, TX 19.3 36,000 OfficeMax Office Supplies Riverside, CA 14.2 30,000 OfficeMax Office Supplies Westbury, NY 13.6 20,200 Speedy Brake Auto Service Akron, OH 15.4 5,500 ----- ------- Average / Total 14.7 969,700 ===== ======= (1) The Company acquired these properties as undeveloped land and as of November 1, 1997 was funding construction and other costs related to the development of the properties by the tenants. The tenants have entered into leases with the Company covering these properties and are contractually obligated to complete construction on a timely basis and to pay construction cost overruns to the extent they exceed the construction budget by more than a predetermined percentage. Page 19 Distributions ------------- Cash distributions paid during the first nine months of 1997 and 1996 were $32.6 million and $37.3 million, respectively. The 1996 cash distributions include a special distribution of $5.3 million in January 1996. During the nine months ended September 30, 1997, the Company paid nine monthly distributions of $0.1575 per share, totaling $1.4175 per share. For the nine months ended September 30, 1996, the Company paid nine monthly distributions of $0.155 per share totaling $1.395 per share and a special distribution of $0.23 per share in January 1996. In September and October 1997, the Company declared two distributions of $0.1575 per share which were paid on October 15, 1997 and will be paid on November 17, 1997, respectively. FUNDS FROM OPERATIONS ("FFO") ============================= FFO for the third quarter of 1997 was $12.6 million versus $11.7 million during the third quarter of 1996, an increase of $951,000 or 8.2%. FFO for the nine months ended September 30, 1997 was $37.4 million versus $34.6 million during the comparable period of 1996, an increase of $2.8 million or 8.2%. Realty Income defines FFO as net income before gain on sales of properties, plus provision for impairment losses, plus depreciation and amortization. In accordance with the recommendations of the National Association of Real Estate Investment Trusts ("NAREIT"), amortization of deferred financing costs are not added back to net income to calculate FFO. Amortization of financing costs are included in interest expense in the consolidated statements of income. The following is a reconciliation of net income to FFO, distributions paid and weighted average number of shares outstanding for the third quarter of 1997 and 1996 (dollars in thousands): 1997 1996 ========= ========= Net income $ 8,466 $ 7,890 Plus depreciation and amortization 4,706 4,052 Plus provision for impairment losses 70 -- Less depreciation of furniture, fixtures and equipment and amortization of organization costs (36) (15) Less gain on sales of properties (596) (268) --------- --------- Total Funds From Operations $ 12,610 $ 11,659 ========= ========= (Continued on next page) Page 20 (continued) Cash Distributions Paid $ 10,864 $ 10,684 FFO in excess of Cash Distributions $ 1,746 $ 975 Weighted average number of shares outstanding 22,999,536 22,977,501 The following is a reconciliation of net income to FFO, distributions paid and weighted average number of shares outstanding for the nine months ended September 30, 1997 and 1996 (dollars in thousands): 1997 1996 ========= ========= Net income $ 24,719 $ 23,354 Plus depreciation and amortization 13,654 12,175 Plus provision for impairment losses 140 323 Less depreciation of furniture, fixtures and equipment and amortization of organization costs (60) (40) Less gain on sales of properties (1,023) (1,226) --------- --------- Total Funds From Operations $ 37,430 $ 34,586 ========= ========= Regular Cash Distributions Paid $ 32,586 $ 32,052 FFO in excess of Regular Distributions $ 4,844 $ 2,534 Special Cash Distributions Paid -- $ 5,285 Weighted average number of shares outstanding 22,993,205 22,976,974 Management considers FFO to be an appropriate measure of the performance of an equity REIT. FFO is used by financial analysts in evaluating REITs and can be one measure of a REIT's ability to make cash distribution payments. Presentation of this information provides the reader with an additional measure to compare the performance of different REITs, although it should be noted that not all REITs calculate FFO the same way so comparisons with such REITs may not be meaningful. FFO is not necessarily indicative of cash flow available to fund cash needs and should not be considered as an alternative to net income as an indication of the Company's performance or to cash flows from operating, investing, and financing activities as a measure of liquidity or ability to make cash distributions or to pay debt service. RESULTS OF OPERATIONS ===================== The following is a comparison of the three and nine months ended September 30, 1997 to the three and nine months ended September 30, 1996. Page 21 Rental revenue was $16.8 million for the quarter ended September 30, 1997 versus $13.8 million for the comparable quarter in 1996, an increase of $3.0 million. The increase in rental revenue was primarily due to the acquisition of 62 properties during 1996 and 64 properties during the first nine months of 1997 (the "New Properties".) The New Properties generated revenue of $3.0 million in the third quarter of 1997 compared to $99,000 in the third quarter of 1996, an increase of $2.9 million. At November 1, 1997 annualized contractual lease payments on the New Properties are approximately $17.9 million (excluding estimated rent from six properties under development and any percentage rents). Rental revenue was $48.3 million for the nine months ended September 30, 1997 versus $41.1 million for the comparable nine months in 1996, an increase of $7.2 million. The increase in rental revenue was primarily due to the New Properties which generated revenue of $6.8 million in the first nine months of 1997 compared to $165,000 during the first nine months of 1996, an increase of $6.7 million. Of the 795 properties in the portfolio as of September 30, 1997, 788 are single-tenant properties with the remaining properties being multi-tenant properties. As of September 30, 1997, 782 or over 99% of the 788 single-tenant properties were net leased with an average remaining lease term (excluding extension options) of approximately 8.5 years. At September 30, 1997, 781 or over 99% of the Company's 788 single tenant properties had leases which provide for increases in rents through: (i) base rent increases tied to a consumer price index with adjustment ceilings; (ii) overage rent based on a percentage of the tenants' gross sales or (iii) fixed increases. Some leases contain more than one of these clauses. Percentage rent, which is included in rental revenue, was $216,000 during the third quarter of 1997 and $247,000 for the comparable quarter in 1996. Percentage rent during the first nine months of 1997 and 1996 was $586,000 and $567,000, respectively. Same store rents generated on 668 properties owned during all of both the third quarter of 1997 and 1996 increased by $253,000 or 1.9%, to $13.74 million from $13.49 million. Same store rents generated on the same 668 properties owned during all of both the first nine months of 1997 and 1996 increased by $679,000 or 1.7%, to $41.05 million from $40.38 million. Page 22 The following table represents Realty Income's rental revenue by industry for the third quarter ended September 30, 1997 and 1996 (dollars in thousands): Three Months Ended ------------------------------------------- September 30, 1997 September 30, 1996 -------------------- -------------------- Rental Percentage Rental Percentage Industry Revenue of Total Revenue of Total =================== =========== ========== =========== ========== Apparel Stores $ 14 0.1% $ -- --% Automotive Parts 1,390 8.3 1,348 9.8 Automotive Service 1,110 6.6 669 4.9 Book Stores 121 0.7 -- -- Child Care 5,997 35.7 5,877 42.7 Consumer Electronics 1,148 6.8 10 0.1 Convenience Stores 1,048 6.2 666 4.8 Home Furnishings 986 5.9 624 4.5 Office Supplies 357 2.1 -- -- Pet Supplies 63 0.4 -- -- Restaurants 3,298 19.6 3,407 24.7 Shoe Stores 24 0.1 -- -- Video Rental 36 0.2 -- -- Other 1,209 7.3 1,176 8.5 -------- ------ -------- ------ Total $ 16,801 100.0% $ 13,777 100.0% ======== ====== ======== ====== The following table represents Realty Income's rental revenue by industry for the nine months ended September 30, 1997 and 1996 (dollars in thousands): Nine Months Ended ------------------------------------------- September 30, 1997 September 30, 1996 -------------------- -------------------- Rental Percentage Rental Percentage Industry Revenue of Total Revenue of Total =================== =========== ========== =========== ========== Apparel Stores $ 14 --% $ -- --% Automotive Parts 4,295 8.9 4,186 10.2 Automotive Service 3,008 6.2 1,910 4.6 Book Stores 273 0.6 -- -- Child Care 17,776 36.8 17,413 42.4 Consumer Electronics 3,262 6.8 10 -- Convenience Stores 2,650 5.5 1,959 4.8 Home Furnishings 2,529 5.2 1,872 4.5 Office Supplies 596 1.2 -- -- Pet Supplies 71 0.1 -- -- (Continued on next page) Page 23 (continued) Nine Months Ended ------------------------------------------- September 30, 1997 September 30, 1996 -------------------- -------------------- Rental Percentage Rental Percentage Industry Revenue of Total Revenue of Total =================== =========== ========== =========== ========== Restaurants 10,066 20.9 10,186 24.8 Shoe Stores 24 0.1 -- -- Video Rental 36 0.1 -- -- Other 3,656 7.6 3,570 8.7 -------- ------ -------- ------ Total $ 48,256 100.0% $ 41,106 100.0% ======== ====== ======== ====== Unleased properties are a factor in determining gross revenue generated and property costs incurred by the Company. At September 30, 1997, the Company had seven properties (one of which is a multi-tenant property) that were not under lease as compared to eight at September 30, 1996. At September 30, 1997, 788 or over 99% of the 795 properties in the portfolio were under lease agreements with third party tenants. Interest and other revenue during the third quarter of 1997 and 1996 totaled $42,000 and $63,000, respectively. The decrease of $21,000 was due to lower average cash and cash equivalent balances in the third quarter of 1997. Interest and other revenue for the first nine months of 1997 and 1996 totaled $190,000 and $148,000, respectively, an increase of $42,000. The increase in the first nine months of 1997 was primarily due to interest earned on bond offering proceeds in excess of the $93.7 million used to payoff the credit facility in May 1997. These proceeds were invested in new properties during May and June 1997. Depreciation and amortization was $4.7 million in the third quarter of 1997 versus $4.1 million for the comparable quarter in 1996 and $13.7 million for the nine months ended September 30, 1997 versus $12.2 million for the comparable nine months in 1996. The increase in 1997 was primarily due to depreciation of the New Properties. General and administrative expenses increased by $66,000 to $1.34 million in the third quarter of 1997 versus $1.27 million in 1996. The increase in general and administrative expenses was primarily due to an increase in property acquisition expenses. General and administrative expenses as a percentage of revenue decreased to 7.9% in the third quarter of 1997 as compared to 9.2% in 1996. General and administrative expenses increased by $53,000 to $3.92 million in the first nine months of 1997 versus $3.87 million in 1996. The increase in general and administrative expenses was primarily due to an increase in property acquisition expenses and employee costs. General and administrative expenses as a percentage of revenue Page 24 decreased to 8.1% in the first nine months of 1997 as compared to 9.4% in 1996. During the second and third quarter of 1997, the Company increased its number of employees to 44. The increase in employees is anticipated to increase general and administrative expenses on an annualized basis by $250,000 or less than one half of one percent of FFO on an annualized basis. Property expenses are broken down into costs associated with non-net leased multi-tenant properties, unleased single-tenant properties and general portfolio expenses. Expenses related to the multi-tenant and unleased single-tenant properties include, but are not limited to, property taxes, maintenance, insurance, utilities, property inspections, bad debt expense and legal fees. General portfolio costs include, but are not limited to, insurance, legal, property inspections and title search fees. At September 30, 1997, seven properties were available for lease as compared to eight at September 30, 1996. Property expenses were $409,000 in the third quarter of 1997 and $397,000 in the comparable quarter of 1996, an increase of $12,000. Property expenses were roughly flat at approximately $1.3 million during the first nine months of 1997 and 1996. Interest expense in the third quarter of 1997 increased by $2.0 million to $2.5 million, as compared to $497,000 during the third quarter of 1996. The following is a summary of the five components of interest expense for the third quarter of 1997 and 1996 (dollars in thousands): 1997 1996 Net Change ------ ----- ---------- Interest on outstanding loans and notes $2,405 $ 453 $1,952 Credit facility commitment fees 44 40 4 Amortization of credit facility origination costs and deferred bond financing costs 83 55 28 Amortization of the gain on the treasury lock agreement (29) -- (29) Interest capitalized (53) (51) (2) ------ ---- ------ Totals $2,450 $ 497 $1,953 ====== ===== ====== Interest incurred during the third quarter in 1997 was $2.0 million higher than in 1996, due to an increase in the average outstanding balances and a higher average interest rate. The higher average interest rate was due to interest on the Notes issued in May 1997. During the third quarter of 1997, the average outstanding balances and interest rate (after taking into effect amortization of the gain on the treasury lock agreement) were $125.7 million and 7.50% as compared to $26.1 million and 6.92% during the comparable period in 1996. Page 25 During the third quarter of 1997, the credit facility's average interest rate was 6.91% and average outstanding balance was $15.7 million. Interest expense in the first nine months of 1997 increased by $4.3 million to $5.8 million, as compared to $1.5 million during the first nine months of 1996. The following is a summary of the five components of interest expense for the first nine months of 1997 and 1996 (dollars in thousands): 1997 1996 Net Change ------ ------ ---------- Interest on outstanding loans and notes $5,654 $1,305 $4,349 Credit facility commitment fees 99 124 (25) Amortization of credit facility origination costs and deferred bond financing costs 199 164 35 Amortization of the gain on the treasury lock agreement (46) -- (46) Interest capitalized (135) (91) (44) ------ ------ ------ Totals $5,771 $1,502 $4,269 ====== ======= ====== Interest incurred during the first nine months of 1997 on all outstanding loans and notes was $4.3 million higher than in 1996 due to an increase in the average outstanding balances and higher average interest rate. The higher average interest rate was due to interest on the Notes issued in May 1997. During the first nine months of 1997, the average outstanding balances and interest rate (after taking into effect amortization of the gain on the treasury lock agreement) were $102.9 million and 7.29% as compared to $25.1 million and 6.96% during the comparable period of 1996. During the first nine months of 1997, the credit facility's average outstanding balance and interest rate were $43.3 million and 6.81%. The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. In the third quarter of 1997, a $70,000 charge was taken to reduce the net carrying value on one property because it became held for sale. During the first nine months of 1997, a $140,000 charge was taken on two properties. In the first nine months of 1996, a $323,000 charge was taken to reduce the net carrying value on two properties because they became held for sale. No charge was recorded for impairment losses in the third quarter of 1996. Three of these four properties have been sold. The Company anticipates a small number of property sales will occur in the normal course of business. During the third quarter of 1997, the Company sold two properties (one restaurant and one child care center) for $1.0 million and recognized a gain of $596,000. During the Page 26 comparable period of 1996, the Company sold three properties (two restaurant and one multi-tenant) for $1.4 million and recognized a gain of $268,000. During the first nine months of 1997, the Company sold nine properties (six restaurant, two child care centers and one multi-tenant location) for a total of $3.9 million and recorded a gain of $1.0 million. During the comparable period of 1996, the Company sold five properties (four restaurant and one multi-tenant) for $3.6 million and recognized a gain of $1.2 million. For the third quarter of 1997, the Company had net income of $8.5 million versus $7.9 million in 1996. The $576,000 increase in net income is primarily due to the increase in rental revenue from New Properties of $2.9 million and an increase in same store rents on 668 properties owned during both periods of $253,000, which were partially offset by an increase in depreciation and amortization and interest expense, totaling $2.6 million. For the first nine months 1997, the Company had net income of $24.7 million versus $23.4 million in 1996. The $1.4 million increase in net income is primarily due to the increase in rental revenue from New Properties of $6.7 million and an increase in same store rents on 668 properties owned during both periods of $679,000, which were partially offset by an increase in depreciation and amortization and interest expense, totaling $5.7 million. PROPERTIES ========== As of October 1, 1997, Realty Income owned a diversified portfolio of 795 properties in 42 states consisting of over 6.1 million square feet of leasable space. The portfolio consists of two apparel stores, 98 automotive parts and accessories stores, 78 automotive service locations, one book store, 317 child care centers, 37 consumer electronics stores, 52 convenience stores, 14 home furnishings and accessories stores, seven office supplies stores, one pet supplies store, 167 restaurant facilities, one shoe store, eight video rental locations and 12 other properties. Of the 795 properties, 731 or 92% were leased to national or regional retail chain operators; 41 or 5% were leased to franchisees of retail chain operators; 16 or 2% were leased to other tenant types; and seven or less than 1% were available for lease. At October 1, 1997, over 98% of the properties were under net lease agreements. Net leases typically require the tenant to be responsible for property operating costs including property taxes, insurance and expenses of maintaining the property. The Company's net leased retail properties are primarily leased to national and regional chain store operators. At October 1, 1997, the properties averaged approximately 7,700 square feet of leaseable retail space on approximately 45,600 square feet of land. Generally, Page 27 buildings are single-tenant retail properties with adequate parking on site to accommodate peak retail periods. The properties tend to be on major thoroughfares with relatively high traffic counts and adequate access, egress and proximity to a sufficient population base to constitute a sufficient market or trade area for the retailer's business. The following table sets forth certain geographic diversification information regarding Realty Income's portfolio at October 1, 1997: Number Approx. Percent of of Leasable Annualized Annualized Proper- Percent Square Base Base State ties Leased Feet Rent (1) Rent ========== ======= ======= ======== =========== ======== Alabama 7 100% 49,800 $ 452,000 0.6% Arizona 27 99 181,200 2,436,000 3.4 California 54 92 1,031,900 10,846,000 15.0 Colorado 43 98 236,400 3,107,000 4.3 Connecticut 7 100 122,300 1,572,000 2.2 Florida 48 100 457,300 4,231,000 5.9 Georgia 44 100 252,500 3,502,000 4.8 Idaho 11 100 52,000 659,000 0.9 Illinois 28 100 192,200 2,416,000 3.3 Indiana 22 100 117,600 1,385,000 1.9 Iowa 8 100 51,700 457,000 0.6 Kansas 17 100 176,000 1,873,000 2.6 Kentucky 12 100 36,000 914,000 1.3 Louisiana 2 100 10,700 126,000 0.2 Maryland 6 100 34,900 508,000 0.7 Massachusetts 5 100 25,900 542,000 0.8 Michigan 5 100 26,900 356,000 0.5 Minnesota 17 100 118,400 1,739,000 2.4 Mississippi 12 100 128,900 902,000 1.2 Missouri 27 100 163,600 1,924,000 2.7 Montana 2 100 30,000 276,000 0.4 Nebraska 9 100 93,700 1,091,000 1.5 Nevada 6 100 66,900 760,000 1.1 New Hampshire 1 100 6,400 125,000 0.2 New Jersey 2 100 22,700 346,000 0.5 New Mexico 3 100 12,000 103,000 0.1 New York 7 100 106,500 2,272,000 3.1 North Carolina 22 100 88,300 1,466,000 2.0 Ohio 53 100 247,100 3,937,000 5.4 Oklahoma 13 100 77,500 849,000 1.2 Oregon 17 100 92,400 1,066,000 1.5 Pennsylvania 5 100 44,300 676,000 0.9 South Carolina 19 100 75,000 1,143,000 1.6 South Dakota 1 100 6,100 79,000 0.1 Tennessee 17 100 164,400 1,852,000 2.6 Texas 133 99 1,074,700 10,173,000 14.1 (Continued on next page) Page 28 (continued) Number Approx. Percent of of Leasable Annualized Annualized Proper- Percent Square Base Base State ties Leased Feet Rent (1) Rent ========== ======= ======= ======== =========== ======== Utah 7 100 45,400 591,000 0.8 Virginia 17 100 81,500 1,339,000 1.9 Washington 42 98 249,700 2,977,000 4.1 West Virginia 2 100 16,800 147,000 0.2 Wisconsin 11 100 60,500 738,000 1.0 Wyoming 4 100 20,100 264,000 0.4 ----- ----- --------- ----------- ------ Totals 795 99% 6,148,200 $72,217,000 100.0% ===== ===== ========= =========== ====== (1) Annualized base rent is calculated by multiplying the monthly contractual base rent as of October 1, 1997 for each of the properties by 12, except that, for the properties under construction, estimated contractual base rent for the first month of the respective leases is used instead of base rent as of October 1, 1997. The estimated contractual base rent for the properties under construction is based upon the estimated acquisition costs of the properties. Annualized base rent does not include percentage rents (i.e., additional rent calculated as a percentage of the tenant's gross sales above a specified level), if any, that may be payable under leases covering certain of the properties. Percentage rent totaled $1.7 million in 1996. The following table sets forth certain information regarding the Company's properties as of October 1, 1997, classified according to the business of the respective tenants: Approx. Realty Total Income Approx. Annual- Loca- Owned Leasable ized Industry tions Loca- Square Base Tenant Segment (1) tions Feet Rent (2) ========== ========= ======= ====== ======== ========= APPAREL STORES - -------------- Bob's Stores Apparel Store 30 2 98,000 $ 1,928,000 --- --------- ---------- AUTOMOTIVE PARTS & ACCESSORIES - ------------------------------ CSK Auto Parts 580 79 409,200 4,223,000 Discount Tire Parts 310 18 104,900 1,178,000 Other Parts -- 1 3,400 49,000 --- --------- ---------- Total Automotive Parts & Accessories 98 517,500 5,450,000 --- --------- ---------- (Continued on next page) Page 29 (continued) Approx. Realty Total Income Approx. Annual- Loca- Owned Leasable ized Industry tions Loca- Square Base Tenant Segment (1) tions Feet Rent (2) ========== ========= ======= ====== ======== ========= AUTOMOTIVE SERVICE - ------------------ Econo Lube N' Tune Service 210 26 72,400 1,763,000 Jiffy Lube Service 1,400 35 82,700 2,257,000 Q-Lube Service 490 4 7,600 183,000 R & S Strauss Service 110 2 31,200 431,000 Speedy Brake Service 1,080 10 56,700 787,000 Other Service -- 1 3,100 42,000 --- --------- ---------- Total Automotive Service 78 253,700 5,463,000 --- --------- ---------- BOOK STORES - ----------- Barnes & Noble Book Stores 1,010 1 30,000 450,000 --- --------- ---------- CHILD CARE - ---------- Children's World Learning Centers Child Care 530 134 964,000 13,916,000 Kinder-Care Learning Centers Child Care 1,150 13 79,800 1,087,000 La Petite Academy Child Care 790 167 959,000 8,751,000 Other Child Care -- 3 13,300 70,000 --- --------- ---------- Total Child Care 317 2,016,100 23,824,000 --- --------- ---------- CONSUMER ELECTRONICS - -------------------- Best Buy Electronics 270 3 150,900 1,738,000 Rex Stores Electronics 230 34 408,300 2,694,000 --- --------- ---------- Total Consumer Electronics 37 559,200 4,432,000 --- --------- ---------- (Continued on next page) Page 30 (continued) Approx. Realty Total Income Approx. Annual- Loca- Owned Leasable ized Industry tions Loca- Square Base Tenant Segment (1) tions Feet Rent (2) ========== ========= ======= ====== ======== ========= CONVENIENCE STORES - ------------------ 7-ELEVEN Convenience 20,240 3 9,700 235,000 Dairy Mart Convenience 1,020 22 66,500 1,523,000 East Coast Oil Convenience 40 3 8,800 286,000 QuikTrip Convenience 330 9 28,800 924,000 The Pantry Convenience 400 14 34,400 1,333,000 Other Convenience -- 1 2,100 0 --- --------- ---------- Total Convenience Stores 52 150,300 4,301,000 --- --------- ---------- HOME FURNISHINGS & ACCESSORIES - ------------------------------ Aaron Rents Furnishings 290 6 258,000 888,000 Levitz Furnishings 130 4 376,400 2,502,000 Linens 'N Things Accessories 170 4 170,100 1,753,000 --- --------- ---------- Total Home Furnishings & Accessories 14 804,500 5,143,000 --- --------- ---------- OFFICE SUPPLIES - --------------- OfficeMax Office Supplies 560 5 125,900 1,759,000 Staples Office Supplies 560 2 48,600 456,000 --- --------- ---------- Total Office Supplies 7 174,500 2,215,000 --- --------- ---------- PET SUPPLIES - ------------ Petco Pet Supplies 340 1 16,000 253,000 --- --------- ---------- RESTAURANTS - ----------- Carvers Dinner House 90 3 26,600 495,000 Don Pablo's Dinner House 70 7 60,700 611,000 Other Dinner House -- 12 93,100 887,000 Golden Corral Family 460 85 501,200 6,616,000 Sizzler Family 630 7 37,600 848,000 Other Family -- 2 11,600 108,000 (Continued on next page) Page 31 (continued) Approx. Realty Total Income Approx. Annual- Loca- Owned Leasable ized Industry tions Loca- Square Base Tenant Segment (1) tions Feet Rent (2) ========== ========= ======= ====== ======== ========= Hardees Fast Food 3,100 3 10,300 144,000 Taco Bell Fast Food 4,890 24 54,100 1,502,000 Whataburger Fast Food 520 9 23,000 616,000 Other Fast Food -- 15 50,000 878,000 --- --------- ---------- Total Restaurants 167 868,200 12,705,000 --- --------- ---------- SHOE STORES - ----------- Just For Feet Shoe Stores 660 1 16,000 332,000 --- --------- ---------- VIDEO RENTAL - ------------ Hollywood Video Video Rental 70 8 60,700 1,008,000 --- --------- ---------- TOTAL OTHER Miscellaneous 12 583,500 4,713,000 --- --------- ---------- Totals 795 6,148,200 $72,217,000 === ========= =========== (1) Approximate total number of retail locations in operation (including both corporate owned and franchised locations), based on information provided to the Company by the respective tenants. (2) Annualized base rent is calculated by multiplying the monthly contractual base rent as of October 1, 1997 for each of the properties by 12, except that, for the properties under construction, estimated contractual base rent for the first month of the respective lease is used instead of base rent as of October 1, 1997. The estimated contractual base rent for the properties under construction is based upon the estimated acquisition costs of the properties. Annualized base rent does not include percentage rents (i.e., additional rent calculated as a percentage of the tenant's gross sales above a specified level), if any, that may be payable under leases covering certain of the properties. Percentage rent totaled $1.7 million in 1996. Of the 795 properties in the portfolio, 788 are single-tenant properties with the remaining being multi-tenant properties. As of October 1, 1997, 782 or over 99% of the 788 single-tenant properties were net leased with an average remaining lease term (excluding Page 32 extension options) of approximately 8.5 years. The following table sets forth certain information regarding the timing of initial lease term expirations (excluding extension options) on the Company's 782 net leased, single tenant retail properties: Percent of Total Number of Annualized Annualized Year Leases Expiring Base Rent (1) Base Rent ======== =============== ============= ================= 1997 7 $ 282,000 0.4% 1998 7 268,000 0.4 1999 27 1,228,000 1.8 2000 30 1,528,000 2.2 2001 53 4,015,000 5.9 2002 74 5,954,000 8.7 2003 66 5,137,000 7.5 2004 109 8,906,000 13.0 2005 87 6,123,000 9.0 2006 28 2,390,000 3.5 2007 85 5,413,000 7.9 2008 43 3,611,000 5.3 2009 12 898,000 1.3 2010 38 3,176,000 4.6 2011 34 4,394,000 6.4 2012 33 3,946,000 5.7 2013 4 1,853,000 2.7 2014 4 458,000 0.7 2015 26 4,914,000 7.2 2016 7 1,357,000 2.0 2017 7 2,504,000 3.7 2018 1 39,000 0.1 --------- ------------ ------- Totals 782 (2) $68,394,000 100.0% ========= ============ ======= (1) Annualized base rent is calculated by multiplying the monthly contractual base rent as of October 1, 1997 for each of the properties by 12, except that, for the properties under construction, estimated contractual base rent for the first month of the respective leases is used instead of base rent as of October 1, 1997. The estimated contractual base rent for the properties under construction is based upon the estimated acquisition costs of the properties. Annualized base rent does not include percentage rents (i.e., additional rent calculated as a percentage of the tenant's gross sales above a specified level), if any, that may be payable under leases covering certain of the properties. Percentage rent totaled $1.7 million in 1996. (2) The table does not include seven multi-tenant properties (one of which is vacant) and six vacant, unleased single-tenant properties owned by the Company. The lease expirations for properties under construction are based on the estimated date of completion of such properties. Page 33 IMPACT OF INFLATION - ------------------- Tenant leases generally provide for limited increases in rent as a result of increases in the tenant's sales volumes and/or increases in the consumer price index. Management expects that inflation will cause these lease provisions to result in increases in rent over time. However, during times when inflation is greater than increases in rent as provided for in the leases, rent increases may not keep up with the rate of inflation. Over 98% of the properties in the portfolio are leased to tenants under net leases in which the tenant is responsible for property costs and expenses. These features in the leases reduce the Company's exposure to rising property expenses due to inflation. Inflation and increased costs may have an adverse impact on the tenants if increases in the tenant's operating expenses exceed increases in revenue. PART II. OTHER INFORMATION =========================== ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K A. Exhibits: Exhibit No. Description =========== =========== 3.1 Amended and Restated Bylaws of Realty Income Corporation (filed as Exhibit 3.2 to the Company's 10-Q for the quarter ended September 30, 1995 and incorporated herein by reference) 3.2 Articles of Incorporation of Realty Income Corporation (filed as Appendix B to the Company's Proxy Statement and incorporated herein by reference) 4.1 Form of Indenture dated as of May 6, 1997 between the Company and The Bank of New York (filed as Exhibit 4.1 to the Company's Form 8-K dated May 5, 1997 and incorporated herein by reference) 4.2 Pricing Committee Resolutions and Form of 7 3/4% Notes due 2007 (filed as Exhibit 4.2 to the Company's 8-K dated May 5, 1997 and incorporated herein by reference) Page 34 4.3 First Supplemental Indenture dated as of May 28, 1997 between the Company and The Bank of New York (incorporated by reference to the Company's Form 8-B12B dated July 29, 1997 and incorporated herein by reference) 4.4 Specimen Stock Certificate for Registrant's Common Stock (incorporated by reference to the Company's Form 8-B12B dated July 29, 1997 and incorporated herein by reference) 10.1 First Amendment to the Stock Incentive Plan, dated as of June 12, 1997 (incorporated by reference to the Company's Form 8-B12B dated July 29, 1997 and incorporated herein by reference) 10.2 Form of Employment Agreement between the Company and its Executive Officers (incorporated by reference to the Company's Form 8-B12B dated July 29, 1997 and incorporated herein by reference) 27 Financial Data Schedule B. No report on Form 8-K was filed by registrant during the quarter for which this report is filed. A report on Form 8-K was dated and filed on October 15, 1997 reporting the issuance of 2,700,000 shares of common stock as a price of $27.00 per share on October 15, 1997. SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. REALTY INCOME CORPORATION (Signature and Title) /s/ GARY M. MALINO Date: November 12, 1997 ---------------------------------- Gary M. Malino, Senior Vice President Chief Financial Officer (Principal Financial and Accounting Officer) Page 35 EXHIBIT INDEX Exhibit No. Description Page =========== =========== ---- 27 Financial Data Schedule..................... 37 Page 36 EX-27 2
5 This Schedule contains summary financial information extracted from the registrant's Balance Sheet as of September 30, 1997 and Income Statement for the nine months ended September 30, 1997 and is qualified in its entirety by reference to such financial statements. 1 9-MOS DEC-31-1997 SEP-30-1997 6,198,000 0 1,947,000 0 0 0 674,108,000 (147,677,000) 558,490,000 0 177,600,000 22,999,000 0 0 343,835,000 558,490,000 0 48,446,000 0 0 18,839,000 140,000 5,771,000 24,719,000 0 24,719,000 0 0 0 24,719,000 1.08 1.08 Current assets and current liabilities are not applicable to the Company under current industry standards. /FN Page 37
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