10-K/A 1 amended10k2001.txt AMENDED 10K FOR 2001 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-K/A (Amendment No. 1) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended December 31, 2001 Commission File Number 1-13374 REALTY INCOME CORPORATION (Exact name of registrant as specified in its charter) Maryland 33-0580106 ----------------------------------------- ------------------------------------- (State or other jurisdiction of (IRS Employer Incorporation or organization) Identification Number) 220 West Crest Street, Escondido, California 92025 (Address of principal executive offices) Registrant's telephone number, including area code: (760)741-2111 Securities registered pursuant to Section 12 (b) of the Act: Name of Each Exchange Title of Each Class On Which Registered -------------------------------------------- ------------------------------ Common Stock, $1.00 Par Value New York Stock Exchange Preferred Stock Purchase Rights Class B Preferred Stock, $1.00 Par Value New York Stock Exchange Class C Preferred Stock, $1.00 Par Value New York Stock Exchange 8.25% Monthly Income Senior Notes, due 2008 New York Stock Exchange -------------------------------------------- ------------------------------ Securities registered pursuant to Section 12 (g) of the Act: None 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ X ] 1 At March 1, 2002, the aggregate market value of the Registrant's shares of common stock, $1.00 par value, held by non-affiliates of the Registrant was $1,016,101,000, at the New York Stock Exchange closing price of $31.40. At March 1, 2002, the number of common shares outstanding was 33,222,867, the number of Class B preferred shares outstanding was 2,745,700, the number of Class C preferred shares outstanding was 1,380,000 and the number of Monthly Income Senior Notes, due 2008 outstanding was 4,000,000. Documents incorporated by reference: Part III, Item 10, 11 and 12 incorporate by reference certain specific portions of the definitive proxy statement for Realty Income Corporation's Annual Meeting to be held on May 7, 2002, to be filed pursuant to Regulation 14A. Only those portions of the proxy statement which are specifically incorporated by reference herein shall constitute a part of this Annual Report. The following items are amended: o Item 6. Selected Financial Data o Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations o Item 8. Financial Statements and Supplementary Data REALTY INCOME CORPORATION Index to Form 10-K / A ------------------------------
Page PART II Item 6: Selected Financial Data ................................................................................ 3 Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations .................. 4 Item 8: Financial Statements and Supplementary Data ............................................................ 18 Signatures .......................................................................................................... 39 Officer Certifications .............................................................................................. 41 Exhibit Index ....................................................................................................... 43
2 PART II Item 6: Selected Financial Data (not covered by Independent Auditors' Report)
As of or for the years ended December 31, 2001 2000 1999 1998 1997 (dollars in thousands, except per share data) --------------------------------------------------------------------------------------------------------------------------- Total assets (book value) $1,003,708 $934,766 $905,404 $759,234 $577,021 Cash and cash equivalents 2,467 3,815 773 2,533 2,123 Lines of credit and notes payable 315,300 404,000 349,200 294,800 132,600 Total liabilities 331,915 419,197 370,573 309,025 143,706 Total stockholders' equity 671,793 515,569 534,831 450,209 433,315 Net cash provided by operating activities 90,035 56,590 72,154 64,645 52,692 Net change in cash and cash equivalents (1,348) 3,042 (1,760) 410 564 Total revenue (2) 124,084 116,053 102,071 82,957 65,719 Income from operations (2) 55,653 46,433 43,429 39,418 32,166 Gain on sales of properties 10,478 6,712 1,301 526 1,082 Income from discontinued operations (2) 1,427 1,643 1,866 1,586 1,522 Extraordinary item -- -- (355) -- -- Cumulative effect of change in accounting principle -- -- -- (226) -- Net income 67,558 54,788 46,241 41,304 34,770 Preferred stock dividends (9,712) (9,712) (5,229) -- -- Net income available to common stockholders 57,846 45,076 41,012 41,304 34,770 Distributions paid to common stockholders 64,871 58,262 55,925 52,301 44,367 Ratio of earnings to fixed charges (1) 3.5x 2.6x 2.7x 3.8x 5.1x Ratio of earnings to combined fixed charges and preferred stock dividends (1) 2.6x 2.0x 2.3x 3.8x 5.1x Basic and diluted net income per common share 1.98 1.69 1.53 1.55 1.48 Distributions paid per common share 2.2425 2.1825 2.085 1.965 1.893 Distributions declared per common share 2.2475 2.1875 2.095 1.975 1.895 Basic weighted average number of common shares outstanding 29,225,359 26,684,598 26,822,285 26,629,936 23,568,831 Diluted weighted average number of common shares outstanding 29,281,120 26,700,806 26,826,090 26,638,284 23,572,715 (1) Ratio of Earnings to Fixed Charges is calculated by dividing earnings by fixed charges. For this purpose, earnings consist of net income before interest expense. Fixed charges are comprised of interest costs (including capitalized interest) and the amortization of debt issuance costs. 3 (2) Our consolidated statements of income and consolidated statements of cash flows have been revised from those originally reported for the years ended December 31, 2001, 2000, 1999, 1998 and 1997 to separately reflect the results of discontinued operations for 22 properties that were sold during the nine months ended September 30, 2002 and nine properties held for sale at September 30, 2002. These results were previously included in income from operations. The revisions had no impact on our consolidated balance sheets or statements of stockholders' equity. The revision had no impact on net income or net income per share of common stock for the years ended December 31, 2001, 2000, 1999, 1998 and 1997. These revisions are being made in conjunction with the expected filing by the Company of a shelf registration statement, as a result of which the Company is required to revise its historical consolidated financial statements in accordance with Financial Accounting Statement No. 144 Accounting for the Impairment or Disposal of Long-Lived Assets ("Statement No. 144".) Statement No. 144 became effective January 1, 2002 and broadened the reporting requirements of discontinued operations to include a component of an entity rather than a segment of a business. Statement No. 144 states that a component of an entity comprises operations and cash flows that can be clearly distinguished, operationally and for financial reporting purposes, from the rest of the entity. In accordance with Statement No. 144, we report each individual property as a reporting component for determining discontinued operations.
Item 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS --------------------------------------------------------------- REVISION OF CONSOLIDATED STATEMENTS OF INCOME AND CONSOLIDATED STATEMENTS OF CASH FLOWS Our consolidated statements of income and consolidated statements of cash flows have been revised from those originally reported for the years ended December 31, 2001, 2000 and 1999 to separately reflect the results of discontinued operations for 22 properties that were sold during the nine months ended September 30, 2002 and nine properties held for sale at September 30, 2002. These results were previously included in income from operations. These revisions had no impact on our consolidated balance sheets or statements of stockholders' equity. These revisions had no impact on net income or net income per share of common stock for the years ended December 31, 2001, 2000 and 1999. These revisions are being made in conjunction with the expected filing by the Company of a shelf registration statement, as a result of which the Company is required to revise its historical consolidated financial statements in accordance with Financial Accounting Statement No. 144 Accounting for the Impairment or Disposal of Long-Lived Assets ("Statement No. 144".) Statement No. 144 became effective January 1, 2002 and broadened the reporting requirements of discontinued operations to include a component of an entity rather than a segment of a business. Statement No. 144 states that a component of an entity comprises operations and cash flows that can be clearly distinguished, operationally and for financial reporting purposes, from the rest of the entity. In accordance with Statement No. 144, we report each individual property as a reporting component for determining discontinued operations. See the discussions of discontinued operations in the "Results of Operations" section below. THE COMPANY Realty Income Corporation, The Monthly Dividend Company (R) a Maryland corporation ("Realty Income," the "Company," "our" or "we") was organized to operate as an equity real estate investment trust ("REIT"). Over the past 33 years Realty Income has been acquiring and owning freestanding retail properties that generate rental revenue under long-term (primarily 15 to 20 years) lease agreements. Our monthly distributions are supported by the cash flow from 1,124 retail properties leased to regional and national retail chains. We are a fully integrated, self-administered real estate company with in-house acquisition, leasing, legal, retail and real estate research, portfolio management and capital markets expertise. 4 Our primary business objective is to generate dependable monthly distributions from a consistent and predictable level of funds from operations ("FFO") per share. Additionally, we seek to increase distributions to stockholders and FFO per share through both active portfolio management and the acquisition of additional properties. At December 31, 2001, we owned a diversified portfolio: o Of 1,124 properties; o With an occupancy rate of 98.2%, or 1,104 of the 1,124 properties; o Leased to 78 retail chains doing business in 24 retail industries; o Located in 48 states; o With over 9.6 million square feet of leasable space; and o With an average leasable retail space of approximately 8,600 square feet on approximately 62,300 square feet of land. In addition to our real estate portfolio, at December 31, 2001, our subsidiary Crest Net Lease, Inc. ("Crest Net") owned a portfolio: o Of 24 retail properties; o Located in 14 states; o That will contain approximately 92,300 square feet of leasable space; o That are 100% leased and are held for sale; and o For a total investment of $22.3 million. LIQUIDITY AND CAPITAL RESOURCES CASH RESERVES. Realty Income is organized to operate as an equity REIT that 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. We intend to retain an appropriate amount of cash as working capital. At December 31, 2001, we had cash and cash equivalents totaling $2.5 million. We believe that our cash and cash equivalents on hand, cash provided from operating activities and borrowing capacity are sufficient to meet our liquidity needs for the foreseeable future. We intend, however, to use additional sources of capital to fund property acquisitions and to repay our credit facilities. CAPITAL FUNDING. We have a $200 million revolving, unsecured acquisition credit facility that expires in December 2003. We also have a $25 million revolving, unsecured credit facility that expires in February 2003. The credit facilities currently bear interest at 1.225% over the London Interbank Offered Rate, or LIBOR, and offer us other interest rate options. At March 1, 2002, we had borrowing capacity of $151.5 million available on our credit facilities and an outstanding balance of $73.5 million with an effective interest rate of 3.1%. These credit facilities have been and are 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 our exposure to interest rate risk. We have no mortgage debt on any of our properties. In June 1999, we filed a universal shelf registration statement with the Securities and Exchange Commission covering up to $409.2 million in value of common stock, preferred stock and debt securities. Through March 1, 2002, we have issued $209.3 million of common stock, preferred stock and debt securities under the universal shelf registration statement. At March 1, 2002, a balance of $199.9 million was available under our universal shelf registration statement. 5 In May 2001, we issued 2,850,000 shares of common stock at a price of $27.80 per share. We issued an additional 100,000 shares in May 2001 when the underwriters exercised their over-allotment option. The net proceeds of $77.5 million were used to repay borrowings under our $200 million acquisition credit facility and for other general corporate purposes. In October 2001, we issued 2,600,000 shares of common stock at a price of $28.50 per share. We issued an additional 350,000 shares in November 2001 when the underwriters exercised their over-allotment option. The net proceeds of $79.5 million were used to repay borrowings under our $200 million acquisition credit facility and for other general corporate purposes. In February 2002, we issued 273,150 shares of common stock to a unit investment trust at a net price to us of $30.26 per share, based on a 5% discount to the market price at the time of issuance of $31.85 per share. The net proceeds of $8.2 million were used to repay bank borrowings. We believe that our stockholders are best served by a conservative capital structure. At March 1, 2002, our total outstanding credit facility borrowings and outstanding notes were $303.5 million or approximately 20.9% of our total market capitalization of $1.45 billion. We define our total market capitalization as the sum of the: o Shares of our common stock outstanding multiplied by the last reported sales price of the common stock on the NYSE on March 1, 2002 of $31.40 per share; o Liquidation value of the Class B Preferred Stock; o Liquidation value of the Class C Preferred Stock; and o Outstanding borrowings on the credit facilities and outstanding notes at March 1, 2002. Historically, we have met our long-term capital needs through the issuance of common stock, preferred stock and investment grade, long-term, unsecured notes. We believe that the majority of our future issuances of securities should be in the form of common stock. However, we may issue additional preferred stock or debt securities from time to time. We may issue common stock when we believe that our share price is at a level that allows for the proceeds of any offering to be invested on an accretive basis into additional properties. In addition, we may issue common stock to permanently finance properties that were financed by our credit facilities or debt securities. However, we cannot assure you that we will have access to the capital markets at terms that are acceptable to us. We seek to maintain a conservative debt level on our balance sheet and solid interest and fixed charge coverage ratios. We currently are assigned investment grade corporate credit ratings on our senior unsecured notes from Fitch Ratings, Moody's Investor Service, Inc. and Standard & Poor's Rating Group. Currently, Fitch Ratings has assigned a rating of BBB, Moody's has assigned a rating of Baa3 and Standard & Poor's has assigned a rating of BBB- to our senior notes. These ratings could change based upon, among other things, our results of operations and financial condition. We also have received credit ratings from the same rating agencies on our preferred stock. Fitch Ratings has assigned a rating of BBB-, Moody's Investor Service, Inc. has assigned a rating of Ba1 and Standard & Poor's Rating Group has assigned a rating of BB+. These ratings could change based upon, among other things, our results of operations and financial condition. Realty Income and its subsidiaries have no unconsolidated investments in "special purpose entities" or off balance sheet financing, nor do we engage in trading activities involving energy or commodity contracts or other derivative instruments. 6 PROPERTY ACQUISITIONS. In 2001, we acquired 91 properties (the "New Properties") located in 25 states. In 2001, we invested $131.8 million in the New Properties and properties under development, which includes investments of $7.1 million for properties acquired before 2001. Estimated unfunded development costs on properties under construction at December 31, 2001 totaled $3.1 million. In 2001, we capitalized $401,000 for re-leasing costs and $547,000 for building improvements on existing properties in our portfolio. The initial weighted average annual unleveraged return on the $131.8 million invested in 2001 is estimated to be 11.0%, computed as estimated contractual net operating income (which in the case of a net-leased property is equal to the base rent or, in the case of properties under construction, the estimated base rent under the lease) for the first year of each lease, divided by the estimated total costs. Since it is possible that a tenant could default on the payment of contractual rent, we cannot assure you that the actual return on the funds invested will remain at the percentage listed above. The New Properties will contain approximately 877,200 leasable square feet and are 100% leased under net leases, with an average initial lease term of 20.1 years. At December 31, 2001, two of the New Properties were leased and under construction, pursuant to contracts under which the tenants agreed to develop the properties (with development costs funded by Realty Income) with rent scheduled to begin in the first half of 2002. In 2000, we acquired 13 properties (the "2000 Properties") and invested $70.0 million in the 2000 Properties and properties under development. In 2000, we also paid $308,000 for re-leasing costs and $90,000 for building improvements on existing properties in our portfolio. The initial weighted average annual unleveraged return on the $70.0 million invested in 2000 is estimated to be 10.8%, computed in the same manner as 2001's estimated initial weighted average annual unleveraged return and subject to the same uncertainty described above. These 13 properties contain approximately 676,100 leasable square feet and are 100% leased under net leases, with an average initial lease term of 18.3 years. DISTRIBUTIONS. We pay monthly distributions to our common stockholders. We paid cash distributions to our common stockholders of $64.9 million in 2001, $58.3 million in 2000 and $55.9 million in 1999. We pay quarterly distributions to our Class B preferred stockholders. We paid cash distributions to our Class B preferred stockholders of $6.4 million in both 2001 and 2000 and $3.9 million in 1999. Our Class B preferred stock was issued in May 1999. We pay monthly distributions to our Class C preferred stockholders. We paid cash distributions to our Class C preferred stockholders of $3.3 million in both 2001 and 2000 and $1.4 million in 1999. Our Class C preferred stock was issued in July 1999. CREST NET LEASE. We created Crest Net in January 2000 to buy, own and sell properties, primarily to buyers using tax-deferred exchanges under Section 1031 of the Internal Revenue Code of 1986, as amended. (the "Code"). In order to comply with the REIT qualification requirements in force when we created Crest Net, 5% of the common stock of Crest Net, which represented 100% of the voting stock, was not owned by the Company. Effective for 2001, the Code was modified to allow a REIT to own up to 100% of the voting stock and/or value of a corporation that elects with the REIT and qualifies to be treated as a taxable REIT subsidiary. Following the change in the Code, Realty Income and Crest Net jointly elected to treat Crest Net as a taxable REIT subsidiary, effective January 1, 2001, and in May 2001 we acquired the 5% of Crest Net's common stock owned by certain members of our management and the management of Crest Net for $507,000. The acquisition of the 5% of common stock was accounted for under the purchase method of accounting. The disinterested members of our Board of Directors unanimously approved this transaction. Crest Net originally issued this stock for $450,000. Realty Income also received rights to the undistributed earnings on the stock, which totaled $81,200. After this transaction, Realty Income owns 100% of Crest Net's stock. 7 In 2000, we invested $8.6 million in Crest Net common stock. In February 2000, we entered into a $25 million, revolving credit facility with Crest Net. The financial statements of Crest Net are consolidated into Realty Income's financial statements. All material intercompany transactions have been eliminated in consolidation. In 2001, Crest Net invested $24.7 million in 26 retail properties. Estimated unfunded development costs on properties under construction at December 31, 2001 totaled $2.8 million. These 26 properties will contain approximately 102,300 of leasable square feet, are 100% leased and have initial lease terms averaging 20.1 years. Three of these properties were sold in 2001. In 2000, Crest Net invested $28.6 million in nine retail properties. These nine properties contain approximately 398,100 leasable square feet, are 100% leased and have initial lease terms averaging 19.0 years. Eight of these properties were sold during 2000 and 2001. In 2001, Crest Net sold nine properties from its inventory for $28.9 million and we recorded a gain of $3.4 million, before income taxes. At the end of 2001, Crest Net carried an inventory of $22.3 million, which is included in real estate held for sale on our consolidated balance sheet. In 2001, Crest Net generated $2.4 million in funds from operations for Realty Income. The contribution, if any, to our FFO by Crest Net will depend on the timing and the number of property sales achieved by Crest Net, if any, in any given year. In 2000, Crest Net sold two properties for $6.2 million and we recorded a gain of $766,000, before income taxes. In 2000, Crest Net generated $422,000 in funds from operations for Realty Income. STOCK AND SENIOR DEBT PURCHASE PROGRAM. We regularly review our investment options to determine the best use of our capital. In January 2000, our Board of Directors authorized the purchase of up to $10 million of our outstanding common stock, preferred stock and senior debt securities. From time to time since January 2000, we concluded our share price justified purchasing shares since this provided an attractive return on our investment capital. We purchased an aggregate of $6.7 million of our securities from January 2000 through December 2001. In 2001, we invested $169,000 to purchase 6,800 shares of our common stock. 8 FUNDS FROM OPERATIONS ("FFO") Our FFO for 2001 increased by $10.6 million, or 15.8%, to $77.8 million versus $67.2 million in 2000. FFO in 1999 was $65.9 million. The following is a reconciliation of net income available to common stockholders to FFO and information regarding distributions paid and the diluted weighted average number of shares outstanding for 2001, 2000 and 1999 (dollars in thousands):
2001 2000 1999 ----------------------------------------------------------------------------------------------------------------------- Net income available to common stockholders $ 57,846 $ 45,076 $ 41,012 Depreciation and amortization: Continuing operations 28,535 28,413 25,385 Discontinued operations 590 590 567 Extraordinary item -- -- 355 Depreciation of furniture, fixtures and equipment (115) (128) (101) Provision for impairment losses: Continuing operations 1,380 -- -- Discontinued operations 70 -- -- Gain on sales of investment properties: Continuing operations (10,478) (6,712) (1,301) ----------------------------------------------------------------------------------------------------------------------- Total funds from operations $ 77,828 $ 67,239 $ 65,917 ======================================================================================================================= Distributions paid to common stockholders $ 64,871 $ 58,262 $ 55,925 FFO in excess of distributions paid to common stockholders $ 12,957 $ 8,977 $ 9,992 Diluted weighted average number of shares outstanding 29,281,120 26,700,806 26,826,090
We define FFO, consistent with the National Association of Real Estate Investment Trust's definition, as net income available to common stockholders, plus depreciation and amortization of assets uniquely significant to the real estate industry, reduced by gains and increased by losses on (i) sales of investment property and provisions for impairment and (ii) extraordinary items. ADJUSTED FUNDS FROM OPERATIONS ("AFFO") We utilize AFFO as a measure of our cash available for distributions to our common stockholders. Most companies in our industry use a similar measurement, but they may use the term "CAD" (for Cash Available for Distribution) or "FAD" (for Funds Available for Distribution). We define AFFO as funds from operations: (i) plus certain non-cash items ( including amortization of note financing costs & stock compensation ), (ii) minus capitalized expenditures on existing properties in our portfolio ( such as capitalized leasing costs and commissions and capitalized building improvements), and (iii) plus or minus straight-line rent (which is non-cash rental revenue). AFFO for 2001 increased by $10.7 million, or 15.7%, to $78.9 million versus $68.2 million in 2000. AFFO for 1999 was $66.5 million. 9 The following is a reconciliation of FFO to adjusted FFO for the years ended December 31, 2001, 2000 and 1999. The adjustments are for non-cash items and capitalized expenditures on existing properties in our portfolio (dollars in thousands):
2001 2000 1999 ------------------------------------------------------------------------------------------------------------------ Funds from operations $ 77,828 $ 67,239 $ 65,917 Plus: Amortization of settlements on treasury lock agreements 756 756 756 Amortization of deferred financing costs 958 990 774 Amortization of stock compensation 301 194 216 Less: Capitalized leasing costs and commissions (401) (308) (242) Capitalized building improvements (547) (90) (148) Straight line rent (12) (534) (747) ------------------------------------------------------------------------------------------------------------------ Total adjusted funds from operations $ 78,883 $ 68,247 $ 66,526 ================================================================================================================== Distributions paid to common stockholders $ 64,871 $ 58,262 $ 55,925 AFFO in excess of distributions paid to common stockholders $ 14,012 $ 9,985 $ 10,601 Diluted weighted average number of shares outstanding 29,281,120 26,700,806 26,826,090
We consider FFO and AFFO to be appropriate measures of the performance of equity REITs. Financial analysts use FFO and AFFO in evaluating REITs. FFO and AFFO can be a way to measure a REIT's ability to make cash distribution payments. Presentation of this information is intended to assist the reader in comparing the performance of different REITs, although it should be noted that not all REITs calculate FFO and AFFO the same way; therefore, comparisons with other REITs may not be meaningful. FFO and AFFO are 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 Realty Income's performance. In addition, FFO and AFFO should not be considered as an alternative to reviewing our cash flows from operating, investing and financing activities as a measure of our liquidity, our ability to make cash distributions or our ability to pay interest payments. FFO GENERATED BY CREST NET LEASE Crest Net generated $2.4 million in FFO for Realty Income during the 2001 and $422,000 during 2000. Crest Net Lease was formed in January 2000. 10 The following is a calculation of the FFO generated by Crest Net in 2001 and 2000 (dollars in thousands):
2001 2000 --------------------------------------------------------------------------------------------------- Gains from the sales of real estate acquired for resale $ 3,374 $ 766 Rent and other revenue 1,816 1,234 Interest expense (869) (913) General and administrative expenses (496) (333) State and federal income taxes (1,400) (332) --------------------------------------------------------------------------------------------------- Funds from operations contributed by Crest Net $ 2,425 $ 422 ===================================================================================================
RESULTS OF OPERATIONS Management is required to make a number of assumptions and estimates that directly impact the consolidated financial statements and related disclosures. Those assumptions and estimates are the basis for certain of our accounting policies described in note 2 to the consolidated financial statements. The accounting policies that are most important to the portrayal of the Company's financial condition and results of operations, and require management's most difficult, subjective or complex judgments, are considered to be critical accounting policies. Because of the uncertainties inherent in making assumptions and estimates regarding unknown future outcomes, events may result in significant differences between our estimates and actual results. Management believes that each of our assumptions and estimates are appropriate under the circumstances, and represent the most likely outcome. We believe our critical accounting policies relate to depreciable lives of our real estate assets and recoverability (impairment) of our real estate assets. THE FOLLOWING IS A COMPARISON OF OUR RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2001 TO THE YEAR ENDED DECEMBER 31, 2000. Rental revenue was $119.9 million for 2001 versus $114.9 million for 2000, an increase of $5.0 million, or 4.4%. The increase in rental revenue is attributable to: o The 91 properties acquired in 2001, which generated revenue of $2.9 million; o The 13 properties acquired in 2000, which generated revenue of $6.0 million in 2001 compared to $1.7 million in 2000, an increase of $4.3 million; o Properties owned by Crest Net, which generated revenue of $1.8 million in 2001 compared to $1.2 million in 2000, an increase of $588,000; o Properties sold during 2000 and 2001, which generated revenue of $1.4 million in 2001 as compared to $7.0 million in 2000, a decrease of $5.6 million; o Net rental increase of $900,000 on development properties acquired before 2000 that started paying rent in 2000 and properties that were vacant during part of 2000 or 2001; and o Same store rents generated on 953 leased properties owned in all of both 2001 and 2000 increased by $1.7 million, or 1.7%, to $103.3 million from $101.6 million. Of the 1,124 properties in the portfolio at December 31, 2001, 1,119, or 99.6%, are single-tenant properties with the remaining properties being multi-tenant properties. Of the 1,119 single-tenant properties, 1,099, or 98.2%, were net leased with a weighted average remaining lease term (excluding extension options) of approximately 10.4 years. Of our 1,099 leased single-tenant properties, 1,087, or 98.9%, were under leases that provide for increases in rents through: 11 o Base rent increases tied to a consumer price index with adjustment ceilings; o Percentage rent based on a percentage of the tenants' gross sales; o Fixed increases; or o A combination of two or more of the above rent provisions. Percentage rent, which is included in rental revenue, was $1.7 million in 2001 and $2.0 million in 2000. Our portfolio of quality retail real estate owned under net leases continues to perform well and provide dependable lease revenue supporting the payment of monthly dividends. At December 31, 2001, our property portfolio of 1,124 retail properties was 98.2% leased with only 20 properties available for lease or sale. Of the 20 properties not leased at December 31, 2001, transactions to lease or sell eight properties were underway or completed as of March 1, 2002. We anticipate these transactions to be completed during the first half of 2002; although we cannot assure you that all of these properties will be sold or leased within this period. GAIN ON SALES OF REAL ESTATE ACQUIRED FOR RESALE. In 2001, Crest Net sold nine properties for $28.9 million and we recognized a gain of $3.4 million, before income taxes. In 2000, Crest Net sold two properties for $6.2 million and we recognized a gain of $766,000, before income taxes. At December 31, 2001, Crest Net had $22.3 million invested in 24 properties, which are held for sale. It is Crest Net's intent to carry an average inventory of between $20 to $25 million in real estate on an ongoing basis. Crest Net generates an earnings spread on the difference between the lease payments it receives and the cost of capital used to acquire the properties. It is our belief that at this level of inventory, these earnings will cover the ongoing operating expenses of Crest Net. INTEREST EXPENSE. The following is a summary of the five components of interest expense for 2001 and 2000 (dollars in thousands):
2001 2000 Net Change ---------------------------------------------------------------------------------------------------------------------- Interest on outstanding loans and notes $ 24,479 $ 30,259 $ (5,780) Amortization of settlements on treasury lock agreements 756 756 -- Credit facility commitment fees 513 508 5 Amortization of credit facility origination costs and deferred bond financing costs 1,103 1,072 31 Interest capitalized (385) (1,048) 663 ---------------------------------------------------------------------------------------------------------------------- Interest expense $ 26,466 $ 31,547 $ (5,081) ================================================================ ================= ================ ================== Credit facilities and notes outstanding (dollars in thousands): Years ended December 31, 2001 2000 Net Change ---------------------------------------------------------------------------------------------------------------------- Average outstanding balances $326,050 $384,921 $(58,871) Average interest rates 7.51% 7.86% (0.35%)
Interest on outstanding loans and notes was $5.8 million lower in 2001 than in 2000 primarily due to a decrease of $58.9 million in the average outstanding balances and a decrease of 35 basis points in our average interest rate. In 2001, the Federal Reserve decreased the federal funds rate 11 times by an aggregate total of 475 basis points. Correspondingly, the average borrowing rate on our credit facilities has declined during the same period. The average interest rate on our credit facilities decreased to 6.36% in 2001 from 7.67% in 2000. The majority of our credit facilities interest rate reductions in 2001 occurred during the second half of the year. 12 At December 31, 2001, the weighted average interest rate on our: o Credit facility borrowings of $85.3 million was 3.13%; o Notes payable of $230 million was 7.99%; and o Combined outstanding credit facilities and notes of $315.3 million was 6.68%. Our debt service coverage ratio for 2001 was 4.4 times and for 2000 was 3.5 times. Debt service coverage ratio is calculated as follows: earnings (income from operations) before interest, taxes, depreciation, amortization and impairment losses ("EBITDA") divided by interest expense. Our EBITDA for the year ended December 31, 2001 and 2000 was $115.9 million and $109.4 million, respectively. This information should not be considered as an alternative to any measure of performance as promulgated under GAAP. Our calculation of EBITDA may be different from the calculation used by other companies and, therefore, comparability may be limited. Our fixed coverage ratio for 2001 was 3.2 times and for 2000 was 2.7 times. Fixed coverage ratio is calculated as follows: EBITDA divided by the sum of interest expense and preferred stock dividends. This information should not be considered as an alternative to any measure of performance as promulgated under GAAP. DEPRECIATION AND AMORTIZATION was $28.5 million in 2001 versus $28.4 million in 2000. The increase in depreciation and amortization was due to the acquisition of properties in 2001, which was offset by property sales in 2001. The majority of our 2001 acquisitions occurred during the fourth quarter. Depreciation of buildings and improvements is computed using the straight-line method over an estimated useful life of 25 years. If we used a shorter or longer estimated useful life it could have a material impact on our results of operations and financial position. We believe that 25 years is an appropriate estimate of useful life. Amortization of goodwill for each of the years 2001, 2000 and 1999 was $924,000. In accordance with Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets," effective January 2002, our goodwill will no longer be amortized, but instead will be tested for impairment at least annually. If goodwill is determined to be impaired, a provision for impairment will be recorded to reduce the carrying value to its fair value. GENERAL AND ADMINISTRATIVE EXPENSES increased by $996,000 to $7.8 million in 2001 versus $6.8 million in 2000. General and administrative expenses as a percentage of revenue increased to 6.3% in 2001 as compared to 5.9% in 2000. Included in general and administrative expenses are $496,000 and $333,000 of expenses attributable to Crest Net in 2001 and 2000, respectively. General and administrative expenses, excluding expenses attributable to Crest Net, increased primarily due to increases in the cost of living, which includes increases in payroll costs. We had 53 employees at March 1, 2002 compared to 49 employees at March 1, 2001. 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 December 31, 2001, 20 properties were available for lease or sale, as compared to 25 at December 31, 2000. PROPERTY EXPENSES were $2.4 million in 2001 and $2.0 million in 2000. The $409,000 increase in property expenses is primarily attributable to an increase in portfolio property insurance and costs associated with properties available for lease. 13 OTHER EXPENSES were $1.8 million in 2001 and $807,000 in 2000. The increase in 2001 is primarily attributable to an increase in Crest Net income taxes. The following is a summary of our other expenses in 2001 and 2000 (dollars in thousands):
2001 2000 Net Change ---------------------------------------------------------------------------------------------------------------------- Realty Income state and local income taxes $ 392 $ 475 $ (83) Crest Net income taxes 1,400 332 1,068 ---------------------------------------------------------------------------------------------------------------------- Other expenses $ 1,792 $ 807 $ 985 ======================================================================================================================
PROVISION FOR IMPAIRMENT LOSSES of $1.45 million was recorded in 2001, of which $70,000 is included in income from discontinued operations. No provision for impairment loss was recorded in 2000 or 1999. We review long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. Generally, a provision is made for impairment loss if estimated future operating cash flows (undiscounted and without interest charges) plus estimated disposition proceeds (undiscounted) are less than the current book value. Impairment losses are measured as the amount by which the current book value of the asset exceeds the fair value of the asset. The carrying value of our real estate is the largest component of our consolidated balance sheet. If events should occur that required us to reduce the carrying value of our real estate by recording provisions for impairment losses, it could have a material impact on our results of operations or financial position. GAIN ON SALES OF INVESTMENT PROPERTIES. In 2001, we sold 35 properties for a total of $39.5 million and recognized a gain of $10.5 million. In 2000, we sold 21 properties for a total of $45.2 million and recognized a gain of $6.7 million. Included in the 21 properties sold in 2000, are two properties leased by one of our tenants that we exchanged, valued at $22.7 million, for two other properties owned by that tenant. The gain recognized from property sales in 2001 was $10.5 million, or $3.8 million greater than the gain recognized from property sales in 2000 of $6.7 million. We have an active portfolio management program that incorporates the sale of assets when we believe the reinvestment of the sales proceeds will generate higher returns, enhance the credit quality of our real estate portfolio or extend our average remaining lease terms. At December 31, 2001, we classified real estate with a carrying amount of $23.4 million as held for sale, of which $22.3 million is owned by Crest Net. Additionally, we anticipate selling investment properties from our portfolio that have not yet been specifically identified. We anticipate we will receive up to $50 million in proceeds from the sale of investment properties during the next 12 months. We intend to invest these proceeds into new retail property acquisitions. 14 INCOME FROM DISCONTINUED OPERATIONS. In accordance with Statement No. 144, the operations of nine properties listed as held for sale at September 30, 2002, plus 22 properties sold during the first nine months of 2002 were reported as income from discontinued operations for the years 2001, 2000 and 1999. The following is a summary of our income from discontinued operations for the years ended December 31, 2001 and 2000 (dollars in thousands): 2001 2000 ------------------------------------------------------------------ ------------- Rental revenue $ 2,173 $ 2,256 Other revenue 14 -- Depreciation and amortization (590) (590) Property expenses (100) (23) Provision for impairment loss (70) -- -------------------------------------------------------------------------------- Income from discontinued operations $ 1,427 $ 1,643 ================================================================================ PREFERRED STOCK DIVIDENDS. We paid preferred stock dividends of $9.7 million in both 2001 and 2000. NET INCOME AVAILABLE TO COMMON STOCKHOLDERS in 2001 increased by $12.7 million to $57.8 million versus $45.1 million in 2000. The calculation to determine net income available to common stockholders includes gains and losses from the sale of investment properties. The amount of gains and losses varies from year to year based on the timing of property sales and can significantly impact net income available to common stockholders. THE FOLLOWING IS A COMPARISON OF OUR RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2000 TO THE YEAR ENDED DECEMBER 31, 1999. RENTAL REVENUE was $114.9 million for 2000 versus $101.9 million for 1999, an increase of $13.0 million, or 12.8%. The increase in rental revenue was primarily due to the acquisition of 110 properties in 1999. These properties generated revenue of $15.4 million in 2000 compared to $6.9 million in 1999, an increase of $8.5 million. Included in rental revenue for 2000 is $1.2 million from properties owned by Crest Net. Percentage rent, which is included in rental revenue, was $2.0 million in 2000 and $1.7 million in 1999. Same store rents generated on 867 leased properties owned during all of both 2000 and 1999 increased by $1.5 million or 1.7%, to $88.9 million from $87.4 million. GAIN ON SALES OF REAL ESTATE ACQUIRED FOR RESALE. In 2000, Crest Net sold two properties for $6.2 million and we recognized a gain on the sales of $766,000, before income taxes. Crest Net was formed in 2000. 15 INTEREST EXPENSE. The following is a summary of the five components of interest expense for 2000 and 1999 (dollars in thousands):
2000 1999 Net Change ---------------------------------------------------------------------------------------------------------------------- Interest on outstanding loans and notes $ 30,259 $ 24,254 $6,005 Amortization of settlements on treasury lock agreements 756 756 -- Credit facility commitment fees 508 268 240 Amortization of credit facility origination costs and deferred bond financing costs 1,072 839 233 Interest capitalized (1,048) (1,644) 596 ---------------------------------------------------------------------------------------------------------------------- Interest expense $ 31,547 $ 24,473 $7,074 ====================================================================================================================== Credit facilities and notes outstanding (dollars in thousands): Years ended December 31, 2000 1999 Net Change ---------------------------------------------------------------------------------------------------------------------- Average outstanding balances $384,921 $325,564 $59,357 Average interest rates 7.86% 7.45% 0.41%
Interest on outstanding loans and notes was $6.0 million higher in 2000 than in 1999 primarily due to an increase of $59.4 million in the average outstanding balances and an increase of 41 basis points in our average interest rate. The average borrowing rate on our credit facilities during 2000 was 7.67%, or 150 basis points higher than our average borrowing rate during 1999. During 2000, LIBOR increased, which increased the average borrowing rate on our credit facilities. Our debt service coverage ratio for the years ended December 31, 2000 and 1999 was 3.5 times and 3.9 times, respectively. Our EBITDA (as defined above) for the years ended December 31, 2000 and 1999 was $109.4 million and $96.2 million, respectively. Our fixed coverage ratio for 2000 was 2.7 times and for 1999 was 3.2 times. DEPRECIATION AND AMORTIZATION was $28.4 million in 2000 versus $25.4 million in 1999. The increase in 2000 was primarily due to the full-year effect of depreciation on the properties acquired in 1999. GENERAL AND ADMINISTRATIVE EXPENSES increased by $300,000 to $6.8 million in 2000 versus $6.5 million in 1999. General and administrative expenses as a percentage of revenue decreased to 5.9% in 2000 as compared to 6.4% in 1999. Included in general and administrative expenses for 2000 are $305,000 of expenses attributable to Crest Net. PROPERTY EXPENSES were $2.0 million in 2000 and $1.8 million in 1999. The $193,000 increase in property expenses is primarily attributable to costs associated with properties available for lease. 16 Other expenses were $807,000 in 2000 and $424,000 in 1999. The increase in 2000 is primarily attributable to Crest Net state and federal income taxes of $332,000. The following is a summary of our other expenses for the years ended December 31, 2000 and 1999 (dollars in thousands):
2000 1999 Net Change ---------------------------------------------------------------------------------------------------------------------- Realty Income state and local income taxes $ 475 $ 424 $ 51 Crest Net income taxes 332 -- 332 ---------------------------------------------------------------------------------------------------------------------- Other expenses $ 807 $ 424 $ 383 ======================================================================================================================
NO PROVISION FOR IMPAIRMENT LOSS was recorded in 2000 or 1999. GAIN ON SALES OF INVESTMENT PROPERTIES. In 2000, we sold 21 properties for a total of $45.2 million and recognized a gain of $6.7 million. Included in the 21 properties sold in 2000, are two properties leased by one of our tenants that we exchanged, valued at $22.7 million, for two other properties owned by that tenant. In 1999, we sold three properties for $9.4 million and recognized a gain of $1.3 million. INCOME FROM DISCONTINUED OPERATIONS. The following is a summary of our income from discontinued operations for the years ended December 31, 2000 and 1999 (dollars in thousands): 2000 1999 -------------------------------------------------------------------------------- Rental revenue $ 2,256 $ 2,408 Other revenue -- 32 Depreciation and amortization (590) (567) Property expenses (23) (7) Provision for impairment loss -- -- -------------------------------------------------------------------------------- Income from discontinued operations $ 1,643 $ 1,866 ================================================================================ EXTRAORDINARY LOSS ON EARLY EXTINGUISHMENT OF CREDIT FACILITY. In December 1999, our $170 million credit facility was canceled simultaneously with the execution of our $200 million credit facility and unamortized fees of $355,000 relating to the $170 million credit facility were recorded as an extraordinary loss on the early extinguishment of the credit facility in 1999. PREFERRED STOCK DIVIDENDS. We paid preferred stock dividends of $9.7 million in 2000 and $5.2 million in 1999. Our outstanding preferred stock was issued during the second and third quarters of 1999. NET INCOME AVAILABLE TO COMMON STOCKHOLDERS in 2000 increased 10.0%, to $45.1 million versus $41.0 million in 1999. 17 IMPACT OF INFLATION Tenant leases generally provide for limited increases in rent as a result of increases in the tenants' sales volumes, increases in the consumer price index, and/or fixed increases. We expect that inflation will cause these lease provisions to result in increases in rent over time. During times when inflation is greater than increases in rent as provided for in the leases, rent increases may not keep up with the rate of inflation. Approximately 97.8% or 1,099 of the 1,124 properties in the portfolio are leased to tenants under net leases whereby the tenant is responsible for property costs and expenses. These lease features reduce our exposure to rising property expenses due to inflation. Inflation and increased costs may have an adverse impact on our tenants if increases in their operating expenses exceed increases in revenue. Item 8: Financial Statements and Supplementary Data -------------------------------------------
Table of Contents Page A. Independent Auditors' Report......................................................... 19 B. Consolidated Balance Sheets, December 31, 2001 and 2000........................................................... 20 C. Consolidated Statements of Income, Years ended December 31, 2001, 2000 and 1999......................................... 21 D. Consolidated Statements of Stockholders' Equity, Years ended December 31, 2001, 2000 and 1999......................................... 22 E. Consolidated Statements of Cash Flows, Years ended December 31, 2001, 2000 and 1999......................................... 23 F. Notes to Consolidated Financial Statements........................................... 24 G. Consolidated Quarterly Financial Data (unaudited) for 2001 and 2000........................................................ 38 H. Schedule III Real Estate and Accumulated Depreciation (incorporated by reference to the Schedule III Real Estate and Accumulated Depreciation filed with Realty Income's Form 10-K for the fiscal year ended December 31, 2001)
Schedules not filed: All schedules, other than that indicated in the Table of Contents, have been omitted as the required information is inapplicable or the information is presented in the financial statements or related notes. 18 Independent Auditors' Report The Board of Directors and Stockholders Realty Income Corporation: We have audited the consolidated financial statements of Realty Income Corporation and subsidiaries as listed in the accompanying table of contents. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule III listed in the accompanying table of contents. These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Realty Income Corporation and subsidiaries as of December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related financial statement schedule III, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. /s/KPMG LLP San Diego, California January 18, 2002, except as to Note 22, which is as of February 28, 2002; and as to the tenth paragraph of Note 2, Notes 3, 12B and 20, which are as of December 9, 2002 19 REALTY INCOME CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS ----------------------------------------- December 31, 2001 and 2000 (dollars in thousands, except per share data)
2001 2000 ------------------------------------------------------------------------------------------------------------------ ASSETS Real estate, at cost: Land $ 412,455 $ 368,057 Buildings and improvements 765,707 705,470 ------------------------------------------------------------------------------------------------------------------ 1,178,162 1,073,527 Less accumulated depreciation and amortization (233,848) (212,379) ------------------------------------------------------------------------------------------------------------------ Net real estate held for investment 944,314 861,148 Real estate held for sale, net 23,356 33,130 ------------------------------------------------------------------------------------------------------------------ Net real estate 967,670 894,278 Cash and cash equivalents 2,467 3,815 Accounts receivable 4,857 5,053 Goodwill, net 17,206 18,130 Other assets 11,508 13,490 ------------------------------------------------------------------------------------------------------------------ Total assets $ 1,003,708 $934,766 ================================================================================================================== LIABILITIES AND STOCKHOLDERS' EQUITY Distributions payable $ 6,238 $ 4,914 Accounts payable and accrued expenses 5,834 5,969 Other liabilities 4,543 4,314 Lines of credit payable 85,300 174,000 Notes payable 230,000 230,000 ------------------------------------------------------------------------------------------------------------------ Total liabilities 331,915 419,197 ------------------------------------------------------------------------------------------------------------------ Commitments and contingencies Stockholders' equity Preferred stock and paid in capital, par value $1.00 per share, 20,000,000 shares authorized, 4,125,700 shares issued and outstanding 99,368 99,368 Common stock and paid in capital, par value $1.00 per share, 100,000,000 shares authorized, 32,829,111 and 26,563,519 shares issued and outstanding in 2001 and 2000, respectively 795,505 630,932 Distributions in excess of net income (223,080) (214,731) ------------------------------------------------------------------------------------------------------------------ Total stockholders' equity 671,793 515,569 ------------------------------------------------------------------------------------------------------------------ Total liabilities and stockholders' equity $ 1,003,708 $ 934,766 ==================================================================================================================
The accompanying notes to consolidated financial statements are an integral part of these statements. 20 REALTY INCOME CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME -------------------------------------------------- Years Ended December 31, 2001, 2000 and 1999 (dollars in thousands, except per share data)
2001 2000 1999 --------------------------------------------------------------------------------------------------------------------- REVENUE Rental $ 119,888 $ 114,934 $ 101,862 Gain on sales of real estate acquired for resale 3,374 766 -- Interest and other 822 353 209 --------------------------------------------------------------------------------------------------------------------- 124,084 116,053 102,071 --------------------------------------------------------------------------------------------------------------------- EXPENSES Interest 26,466 31,547 24,473 Depreciation and amortization 28,535 28,413 25,385 General and administrative 7,840 6,844 6,544 Property 2,418 2,009 1,816 Other 1,792 807 424 Provision for impairment losses 1,380 -- -- --------------------------------------------------------------------------------------------------------------------- 68,431 69,620 58,642 --------------------------------------------------------------------------------------------------------------------- Income from operations 55,653 46,433 43,429 Gain on sales of investment properties 10,478 6,712 1,301 --------------------------------------------------------------------------------------------------------------------- Income from continuing operations 66,131 53,145 44,730 Income from discontinued operations 1,427 1,643 1,866 Extraordinary loss on early extinguishment of credit facility -- -- (355) --------------------------------------------------------------------------------------------------------------------- Net income 67,558 54,788 46,241 Preferred stock dividends (9,712) (9,712) (5,229) --------------------------------------------------------------------------------------------------------------------- Net income available to common stockholders $ 57,846 $ 45,076 $ 41,012 ===================================================================================================================== Income from continuing operations per common share: Basic and diluted $ 1.93 $ 1.63 $ 1.47 Net income available to common stockholders per common share: Basic and diluted $ 1.98 $ 1.69 $ 1.53
The accompanying notes to consolidated financial statements are an integral part of these statements. 21 REALTY INCOME CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY -------------------------------------------------------------------------- Years Ended December 31, 2001, 2000 and 1999 (dollars in thousands)
Preferred Common Shares of stock and stock and Distributions ------------------------------ Preferred Common paid in paid in in excess of Stock Stock capital capital net income Total ------------------------------------------------------------------------------------------------------------------------------------ Balance, December 31, 1998 -- 26,817,103 $ -- $ 636,486 $ (186,277) $ 450,209 Net income -- -- -- -- 46,241 46,241 Distributions paid and payable -- -- -- -- (61,423) (61,423) Shares issued in stock offering, net of offering costs of $3,821 4,140,000 -- 99,679 -- -- 99,679 Shares issued -- 5,600 -- 139 -- 139 Shares forfeited -- (539) -- (14) -- (14) ------------------------------------------------------------------------------------------------------------------------------------ Balance, December 31, 1999 4,140,000 26,822,164 99,679 636,611 (201,459) 534,831 Net income -- -- -- -- 54,788 54,788 Distributions paid and payable -- -- -- -- (68,060) (68,060) Shares purchased (14,300) (284,500) (276) (6,223) -- (6,499) Shares issued -- 27,800 -- 593 -- 593 Shares forfeited -- (1,945) -- (49) -- (49) Stock offering costs -- -- (35) -- -- (35) ------------------------------------------------------------------------------------------------------------------------------------ Balance, December 31, 2000 4,125,700 26,563,519 99,368 630,932 (214,731) 515,569 Net income -- -- -- -- 67,558 67,558 Distributions paid and payable -- -- -- -- (75,907) (75,907) Shares issued in stock offerings, net of offering costs of $9,044 -- 5,900,000 -- 157,041 -- 157,041 Shares purchased -- (6,800) -- (169) -- (169) Shares issued -- 380,527 -- 9,340 -- 9,340 Shares forfeited -- (8,135) -- (202) -- (202) Deferred stock compensation, net of forfeitures and amortization -- -- -- (1,437) -- (1,437) ------------------------------------------------------------------------------------------------------------------------------------ Balance, December 31, 2001 4,125,700 32,829,111 $ 99,368 $ 795,505 $ (223,080) $ 671,793 ====================================================================================================================================
The accompanying notes to consolidated financial statements are an integral part of these statements. 22 REALTY INCOME CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS -------------------------------------------------------- Years Ended December 31, 2001, 2000 and 1999 (dollars in thousands)
2001 2000 1999 ---------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 67,558 $ 54,788 $ 46,241 Adjustments to net income: Depreciation and amortization 28,535 28,413 25,385 Provision for impairment losses 1,380 -- -- Income from discontinued operations (1,427) (1,643) (1,866) Cash from discontinued operations 2,087 2,233 2,433 Investments in real estate acquired for resale (24,535) (28,577) -- Proceeds from sales of real estate acquired for resale 28,912 6,215 -- Gain on sales of real estate acquired for resale (3,374) (766) -- Gain on sales of investment properties (10,478) (6,712) (1,301) Extraordinary item -- -- 355 Amortization of deferred stock compensation 301 -- -- Changes in assets and liabilities: Accounts receivable and other assets 1,125 485 25 Accounts payable, accrued expenses and other liabilities (49) 2,154 882 ---------------------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 90,035 56,590 72,154 ---------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from sales of investment properties 39,543 22,536 9,431 Acquisition of and additions to investment properties (132,291) (56,142) (174,056) Increase in other assets -- (450) -- Payment of other liabilities -- -- (1,713) ---------------------------------------------------------------------------------------------------------------------------- Net cash used in investing activities (92,748) (34,056) (166,338) ---------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES Borrowings from lines of credit 196,300 157,700 221,200 Payments under lines of credit (285,000) (102,900) (186,800) Distributions to common stockholders (64,871) (58,262) (55,925) Distributions to preferred stockholders (9,712) (9,712) (5,229) Proceeds from common stock offerings, net of offering costs 157,041 -- -- Proceeds from preferred stock offerings, net of offering costs -- (35) 99,679 Proceeds from other stock issuances 7,776 216 -- Proceeds from notes issued, net of costs of $501 -- -- 19,499 Shares purchased (169) (6,499) -- ---------------------------------------------------------------------------------------------------------------------------- Net cash provided by (used in) financing activities 1,365 (19,492) 92,424 ---------------------------------------------------------------------------------------------------------------------------- Net increase (decrease) in cash and cash equivalents (1,348) 3,042 (1,760) Cash and cash equivalents, beginning of year 3,815 773 2,533 ---------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents, end of year $ 2,467 $ 3,815 $ 773 ============================================================================================================================ For supplemental disclosures, see note 16.
The accompanying notes to consolidated financial statements are an integral part of these statements. 23 REALTY INCOME CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------- December 31, 2001, 2000 and 1999 1. ORGANIZATION AND BASIS OF PRESENTATION Realty Income Corporation ("Realty Income," the "Company," "we" or "our") is organized as a Maryland corporation. We invest in commercial retail real estate and have elected to be taxed as a real estate investment trust ("REIT"). At December 31, 2001, we owned 1,124 properties in 48 states containing over 9.6 million leasable square feet, excluding 24 properties owned by our subsidiary, Crest Net Lease, Inc. ("Crest Net"). Our consolidated statements of income and consolidated statements of cash flows have been revised from those originally reported for the years ended December 31, 2001, 2000 and 1999 to separately reflect the results of discontinued operations for 22 properties that were sold during the nine months ended September 30, 2002 and nine properties listed as held for sale at September 30, 2002. These revisions had no impact on our consolidated balance sheets or statements of stockholders' equity. These revisions had no impact on net income or net income per share of common stock for the years ended December 31, 2001, 2000 and 1999. These revisions are being made in conjunction with the expected filing by the Company of a shelf registration statement, as a result of which the Company is required to revise its historical consolidated financial statements in accordance with Financial Accounting Statement No. 144 Accounting for the Impairment or Disposal of Long-Lived Assets ("Statement No. 144".) Statement No. 144 became effective January 1, 2002 and broadened the reporting requirements of discontinued operations to include a component of an entity rather than a segment of a business. Statement No. 144 states that a component of an entity comprises operations and cash flows that can be clearly distinguished, operationally and for financial reporting purposes, from the rest of the entity. In accordance with Statement No. 144, we report each individual property as a reporting component for determining discontinued operations. The tenth paragraph of Note 2, Note 3, 12B and 20 to the consolidated financial statements show the effects of the revisions. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PROCEDURES Principles of Consolidation - The accompanying consolidated financial statements include the accounts of Realty Income, Crest Net and other entities for which we make operational and financial decisions (control), after elimination of all material intercompany balances and transactions. Cash Equivalents - We consider all short-term, highly liquid investments that are readily convertible to cash and have an original maturity of three months or less at the time of purchase to be cash equivalents. Depreciation and Amortization - Depreciation of buildings and improvements and amortization of goodwill are computed using the straight-line method over an estimated useful life of 25 years. Amortization of goodwill for each of the years 2001, 2000 and 1999 was $924,000. In accordance with the Financial Accounting Standards Board Statement No. 142, "Goodwill and Other Intangible Assets," effective January 2002, our goodwill will no longer be amortized, but instead will be tested for impairment at least annually. Leases - All leases are accounted for as operating leases. Under this method, lease payments are recognized as revenue on a straight-line basis over the lease term regardless of when the payments are due. We recognize contingent rent revenue from tenants only after the tenants exceed their sales breakpoint. Rental increases based upon changes in the consumer price indexes are recognized only after the changes in the indexes have occurred, and then applied according to the lease agreements. 24 In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 "Revenue Recognition in Financial Statements" ("SAB 101"). SAB 101 reflects the basic principles of revenue recognition in existing accounting principles generally accepted in the United States of America ("U.S."). The Company adopted SAB 101 in the first quarter of 2000, which had no effect on the Company's consolidated financial statements. Federal Income Taxes - We have elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended ("IRS Code"). We believe Realty Income has qualified and continues to qualify as a REIT and therefore will be permitted to deduct distributions paid to its stockholders, eliminating the federal taxation of income represented by those distributions at the Company's level. Accordingly, no provision has been made for federal income taxes in the accompanying consolidated financial statements, except for federal income taxes of Crest Net, which totaled $1.2 million and $264,000 in 2001 and 2000, respectively, and are included in other expenses. Earnings and profits, which determine the taxability of distributions to stockholders, differ from net income reported for financial reporting purposes due to differences for IRS Code purposes in the estimated useful lives and methods used to compute depreciation and the carrying value (basis) on the investments in properties, among other things. The following reconciles our net income available to common stockholders to taxable income for the year ended December 31, 2001 (dollars in thousands) (unaudited): Net income available to common stockholders $ 57,846 Tax gain on sale of real estate less than book gain (12,734) Dividends received from Crest Net 2,500 Elimination of net revenue and expenses from Crest Net (3,314) Preferred dividends not deductible for tax 9,712 Depreciation and amortization timing differences 9,951 Impairment losses 1,450 Other adjustments (617) -------------------------------------------------------------------------------- Estimated taxable net income $ 64,794 ================================================================================ Maintenance and Repairs - Expenditures for maintenance and repairs are expensed as incurred. Replacements and betterments are capitalized. Provision for Impairment Losses - We review long-lived assets, including goodwill, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Generally, a provision is made for impairment loss if estimated future operating cash flows (undiscounted and without interest charges) plus estimated disposition proceeds (undiscounted) are less than the current book value. Impairment loss is measured as the amount by which the current book value of the asset exceeds the fair value of the asset. If a property is held for sale, it is carried at the lower of cost or estimated fair value, less costs to sell. A provision for impairment losses of $1.45 million was recorded in 2001, of which $70,000 is included in income from discontinued operations. No provision for impairment loss was recorded in 2000 or 1999. Net Income Per Common Share - Basic net income per common share is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding during each period. Diluted net income per common share is computed by dividing the amount of net income available to common stockholders for the period by the number of common shares that would have been outstanding assuming the issuance of common shares for all potentially dilutive common shares outstanding during the reporting period. 25 The following is a reconciliation of the denominator of the basic net income per common share computation to the denominator of the diluted net income per common share computation, for the years ended December 31:
2001 2000 1999 ----------------------------------------------------------------------------------------------------------------------- Weighted average shares used for basic net income per share computation 29,225,359 26,684,598 26,822,285 Incremental shares from the assumed exercise of stock options 55,761 16,208 3,805 ----------------------------------------------------------------------------------------------------------------------- Adjusted weighted average shares used for diluted net income per share computation 29,281,120 26,700,806 26,826,090 =======================================================================================================================
In 2001, no stock options were anti-dilutive. In 2000 and 1999, 296,653 and 186,181 stock options, respectively, were anti-dilutive and therefore excluded from the incremental shares from the assumed exercise of stock options. Stock Option Plan - We account for our stock option plan in accordance with the provisions of Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. As such, compensation expense would be recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123"), permits entities to recognize as expense over the vesting period, the fair value of all stock-based awards on the date of grant. Alternatively, SFAS No. 123 allows entities to continue to apply the provisions of APB Opinion No. 25 and provide pro forma net income and pro forma income per share disclosures for employee stock option grants made after 1994, as if the fair-value based method defined in SFAS No. 123 had been applied. We have elected to continue to apply the provisions of APB Opinion No. 25 and provide the pro forma disclosure provisions of SFAS No. 123. Derivative Financial Instruments - In two instances, in 1996 and 1998, we used interest rate treasury lock agreements to protect against the possibility of rising interest rates. These instruments each met the requirement for hedge accounting, including a high correlation to a specific transaction. Accordingly, the amount received and paid under the terms of the agreements is recognized in income as a yield adjustment to interest expense. Use of Estimates - The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. Management believes that the estimates and assumptions that are most important to the portrayal of the Company's financial condition and results of operations, in that they require management's most difficult, subjective or complex judgments, form the basis for the accounting policies deemed to be most critical to the Company. These critical accounting policies relate to depreciable lives of our real estate assets and recoverability (impairment) of our real estate assets. We believe our estimates and assumptions related to these critical accounting policies are appropriate under the circumstances; however, should future events or occurrences result in unanticipated consequences, there could be a material impact on our future financial condition or results of operations. Reclassifications - Certain of the 2000 and 1999 balances have been reclassified to conform to the 2001 presentation. 26 3. DISCONTINUED OPERATIONS The operations of nine properties listed as held for sale at September 30, 2002, plus 22 properties sold during the first nine months of 2002 were reported as income from discontinued operations for the years ended 2001, 2000 and 1999. The following is a summary of our income from discontinued operations for the years ended December 31, 2001, 2000 and 1999 (dollars in thousands):
2001 2000 1999 ---------------------------------------------------------------------------------------------------- Rental revenue $ 2,173 $ 2,256 $ 2,408 Other revenue 14 -- 32 Depreciation and amortization (590) (590) (567) Property expenses (100) (23) (7) Provision for impairment loss (70) -- -- ---------------------------------------------------------------------------------------------------- Income from discontinued operations $ 1,427 $ 1,643 $ 1,866 ==================================================================================================== Basic and diluted income from discontinued operations per common share $ 0.05 $ 0.06 $ 0.07
The following is a summary of the assets and liabilities associated with the nine properties listed as held for sale at September 30, 2002, plus 22 properties sold during the first nine months of 2002 (dollars in thousands): As of December 31, 2001 2000 ------------------------------- Segment net real estate: Automotive parts $ 347 $ 364 Child care 2,298 2,480 Health and fitness 87 87 Home furnishings 2,696 2,788 Restaurants 6,640 6,934 Other non-reportable segments 1,590 1,638 -------------------------------------------------------------------------------- Total net real estate 13,658 14,291 Non-real estate assets 76 114 -------------------------------------------------------------------------------- Total assets $13,734 $ 14,405 ================================================================================ Accounts payable and accrued expenses $ 161 $ 162 Other liabilities 60 25 -------------------------------------------------------------------------------- Total liabilities $ 221 $ 187 ================================================================================ 4. INVESTMENT IN SUBSIDIARY In January 2000, we acquired 95% of the common stock of Crest Net, all of which is non-voting, and certain members of our management and Crest Net management acquired 5% of the common stock, all of which is voting stock. In May 2001, we acquired the 5% of common stock of Crest Net owned by certain members of our management and management of Crest Net for $507,000. The acquisition of the 5% of common stock was accounted for under the purchase method of accounting. After this transaction, Realty Income owns 100% of the stock of Crest Net. Crest Net was created to buy, own and sell properties, primarily to buyers using tax-deferred exchanges, under Section 1031 of the IRS Code. 27 At December 31, 2001 and 2000, investments in properties owned by Crest Net totaled $22.3 million and $23.1 million, respectively, and are included in real estate held for sale, net in our consolidated balance sheets. 5. CREDIT FACILITIES A. In December 1999, we entered into a $200 million, revolving, unsecured acquisition credit facility that expires in December 2003. The $200 million credit facility is with The Bank of New York, as administrative agent, and several U.S. and non-U.S. banks. At December 31, 2001 and 2000, the outstanding balances on the acquisition credit facility were $63.7 million and $149.9 million, respectively, with an effective interest rate of approximately 3.1% and 7.8%, respectively. The $200 million credit facility currently bears interest at 1.225% over the London Interbank Offered Rate ("LIBOR") and offers us other interest rate options. A facility fee of 0.225% per annum accrues on the total commitment of the credit facility. In December 1999, our previous $170 million credit facility was canceled simultaneously with the execution of the $200 million credit facility, and unamortized fees of $355,000 relating to our $170 million credit facility were recorded as an extraordinary loss on early extinguishment of the credit facility. This resulted in an extraordinary item of $0.01 per basic and diluted common share in 1999. B. In February 2000, we entered into a $25 million, three-year, revolving, unsecured credit agreement with the Bank of Montreal, which expires in February 2003. At December 31, 2001 and 2000, the outstanding balances on the credit facility were $21.6 million and $24.1 million, respectively, with an effective interest rate of approximately 3.2% and 7.9%, respectively. The $25 million credit facility bears interest at 1.225% over LIBOR. A facility fee of 0.225% per annum accrues on the total commitment of the credit facility. C. The average borrowing rate on our credit facilities during 2001 was 6.4% or 130 basis points lower than our average borrowing rate during 2000 of 7.7%. Our credit facilities are subject to various leverage and interest coverage ratio limitations. The Company is and has been in compliance with these covenants. D. In 2001, 2000 and 1999, interest of $385,000, $1.0 million and $1.6 million, respectively, was capitalized with respect to properties under development. 6. NOTES PAYABLE In January 1999, we issued $20 million of 8.0% senior notes due 2009 (the "1999 Notes"). The 1999 Notes are unsecured and were sold at 98.757% of par to yield 8.1%. Interest on the 1999 Notes is payable semiannually. In October 1998, we issued $100 million of 8.25% Monthly Income Senior Notes due 2008 (the "1998 Notes"). The 1998 Notes are unsecured and were sold at par ($25.00). In May 1998, we entered into a treasury interest rate lock agreement associated with the 1998 Notes. In settlement of the agreement, we made a payment of $8.7 million in October 1998. The payment on the agreement is being amortized over 10 years (the life of the 1998 Notes) as a yield adjustment to interest expense. After taking into effect the results of a treasury interest rate lock agreement, the effective rate to us on the 1998 Notes is 9.12%. Interest on the 1998 Notes is payable monthly. In May 1997, we issued $110 million of 7.75% senior notes due 2007 (the "1997 Notes"). The 1997 Notes are unsecured and were sold at 99.929% of par to yield 7.76%. In December 1996, we entered into a treasury interest rate lock agreement associated with the 1997 Notes. In settlement of the agreement, we received $1.1 million in June 1997. The payment received on the agreement is being amortized over 10 years (the life of the 1997 Notes) as a yield adjustment to interest expense. After taking into effect the results of a treasury interest rate lock agreement, the effective interest rate to us on the 1997 Notes is 7.62%. Interest on the 1997 Notes is payable semiannually. 28 Interest incurred on the 1999 Notes, 1998 Notes and 1997 Notes collectively for the years ended December 31, 2001, 2000 and 1999 was $18.4 million, $18.4 million and $18.3 million, respectively. 7. PROPERTY ACQUISITIONS A. In 2001, we invested $131.8 million in 91 new retail properties and properties under development with an average initial contractual lease rate of 11.0%. In 2000, we invested $70.0 million in 13 new retail properties and properties under development with an average initial contractual lease rate of 10.8%. B. In 2001, Crest Net invested $24.7 million in 26 new retail properties. In 2000, Crest Net invested $28.6 million in nine new retail properties. At December 31, 2001, Crest Net owned 24 properties that are held for sale. 8. DISTRIBUTIONS PAID AND PAYABLE A. We pay monthly distributions to our common stockholders. The following is a summary of monthly cash distributions paid per common share for the years ended December 31: Month 2001 2000 1999 -------------------------------------------------------------------------------- January $0.18500 $0.18000 $0.17000 February 0.18500 0.18000 0.17000 March 0.18500 0.18000 0.17000 April 0.18625 0.18125 0.17250 May 0.18625 0.18125 0.17250 June 0.18625 0.18125 0.17250 July 0.18750 0.18250 0.17500 August 0.18750 0.18250 0.17500 September 0.18750 0.18250 0.17500 October 0.18875 0.18375 0.17750 November 0.18875 0.18375 0.17750 December 0.18875 0.18375 0.17750 -------------------------------------------------------------------------------- Total $2.24250 $2.18250 $2.08500 ================================================================================ The following presents the federal income tax characterization of distributions paid or deemed to be paid to common stockholders for the years ended December 31: 2001 2000 1999 -------------------------------------------------------------------------------- Ordinary income $1.94838 $1.76796 $1.84680 Return of capital 0.29412 0.41454 0.19860 Capital gain -- -- 0.03960 -------------------------------------------------------------------------------- Totals $2.24250 $2.18250 $2.08500 ================================================================================ At December 31, 2001, a distribution of $0.19 per common share was declared (and was paid in January 2002). At December 31, 2000, a distribution of $0.185 per common share was declared (and was paid in January 2001). 29 B. In May 1999, we issued 2,760,000 shares of 9 3/8% Class B cumulative redeemable preferred stock (the "Class B Preferred"). Beginning May 25, 2004, the Class B Preferred shares are redeemable at our option at $25.00 per share. Dividends on the Class B Preferred are paid quarterly in arrears. For the years ended December 31, 2001, 2000 and 1999, dividends of $6.4 million, $6.4 million and $3.9 million, respectively, were paid on our Class B Preferred. The following presents the federal income tax characterization of dividends paid or deemed to be paid to Class B Preferred stockholders for the years ended December 31: 2001 2000 1999 -------------------------------------------------------------------------------- Ordinary income $2.34360 $2.34360 $1.37310 Capital gain -- -- 0.02660 -------------------------------------------------------------------------------- Totals $2.34360 $2.34360 $1.39970 ================================================================================ C. In July 1999, we issued 1,380,000 shares of 9 1/2% Class C cumulative redeemable preferred stock (the "Class C Preferred"). Beginning July 30, 2004, the Class C Preferred shares are redeemable at our option at $25.00 per share. Dividends on the Class C Preferred are paid monthly in arrears. For the years ended December 31, 2001, 2000 and 1999, dividends of $3.3 million, $3.3 million and $1.4 million, respectively, were paid on our Class C Preferred. The following presents the federal income tax characterization of dividends paid or deemed to be paid to Class C Preferred stockholders for the years ended December 31: 2001 2000 1999 -------------------------------------------------------------------------------- Ordinary income $2.37480 $2.37480 $0.97070 Capital gain -- -- 0.01880 -------------------------------------------------------------------------------- Totals $2.37480 $2.37480 $0.98950 ================================================================================ 9. COMMON STOCK OFFERINGS A. In May 2001, we issued 2,850,000 shares of common stock at a price of $27.80 per share. We issued an additional 100,000 shares in May 2001 when the underwriters exercised their over-allotment option. The net proceeds of $77.5 million were used to repay borrowings under our $200 million acquisition credit facility and for other general corporate purposes. B. In October 2001, we issued 2,600,000 shares of common stock at a price of $28.50 per share. In November 2001, 350,000 additional shares were issued when the underwriters exercised their over-allotment option. The net proceeds of $79.5 million were used to repay borrowings under our $200 million acquisition credit facility and for other general corporate purposes. 10. PREFERRED STOCK OFFERINGS A. In May 1999, we issued 2,760,000 shares of Class B Preferred stock at a price of $25.00 per share. The net proceeds of $66.5 million were used to repay bank borrowings. At December 31, 2001 and 2000, 2,745,700 of these shares were outstanding. 30 B. In July 1999, we issued 1,380,000 shares of Class C Preferred stock at a price of $25.00 per share. The net proceeds of $33.2 million were used to repay bank borrowings. At December 31, 2001 and 2000, all of these shares were outstanding. 11. PURCHASES OF REALTY INCOME SECURITIES In January 2000, our Board of Directors authorized the purchase of up to $10 million of our outstanding common stock, preferred stock and senior debt securities. We purchased an aggregate of $6.7 million of our securities from January 2000 through December 2001. In 2001, we invested $169,000 to purchase 6,800 shares of our common stock at an average price of $24.82 per share. In 2000, we invested $6.5 million to purchase 284,500 shares of common stock at an average price of $21.87 per share and 14,300 shares of our Class B preferred stock at an average price of $19.27 per share. 12. OPERATING LEASES A. General - At December 31, 2001, we owned 1,124 properties in 48 states, excluding properties owned by Crest Net. Of these 1,124 properties, 1,119 are single-tenant and the remainder are multi-tenant. At December 31, 2001, 20 properties were vacant and available for lease or sale. Substantially all leases are net leases whereby the tenant pays property taxes and assessments, maintains the interior and exterior of the building and leased premises, and carries insurance coverage for public liability, property damage, fire and extended coverage. Percentage rent for 2001, 2000 and 1999 was $1.7 million, $2.0 million and $1.7 million, respectively. At December 31, 2001, minimum annual rents to be received on the operating leases are as follows (dollars in thousands): For the years ending December 31, ----------------------------------------------------------------------- 2002 $ 127,981 2003 119,882 2004 112,221 2005 102,963 2006 96,383 Thereafter 816,032 ------------------------------------------------------------------------ TOTAL $ 1,375,462 ======================================================================== B. Major Tenants - The following schedule presents rental revenue, including percentage rents, from tenants representing more than 10% of our total revenue for the years ended December 31, 2001, 2000 or 1999 (dollars in thousands):
Tenants 2001 2000 1999 ------------------------------------------------------ ------------------- -------------------- ------------------- Children's World Learning Centers, Inc. (1) $14,830 $14,698 $14,371 La Petite Academy, Inc. (2) -- (3) 12,233 10,730
(1) Includes $291, $320 and $312 relating to rental revenue included in income from discontinued operations for 2001, 2000 and 1999, respectively. (2) Includes $354 and $523 relating to rental revenue included in income from discontinued operations for 2000 and 1999, respectively. (3) Rental revenue from La Petite Academy, Inc. represented less than 10% of our total revenue for 2001. 31 13. GAIN ON SALES OF REAL ESTATE ACQUIRED FOR RESALE In 2001, Crest Net sold nine properties for $28.9 million. We recognized a gain of $3.4 million on the sales of these properties. In 2000, Crest Net sold two properties for $6.2 million. We recognized a gain of $766,000 on the sales of these properties. 14. GAIN ON SALES OF INVESTMENT PROPERTIES In 2001, we sold 35 properties for $39.5 million and recognized a gain of $10.5 million. In 2000, we sold or exchanged 21 properties for $45.2 million and recognized a gain of $6.7 million. Included in the 21 properties were two properties leased by one of our tenants that we exchanged for two other properties owned by that tenant for no gain (see note 16B). In 1999, we sold three properties for $9.4 million and recognized a gain of $1.3 million. 15. FAIR VALUE OF FINANCIAL INSTRUMENTS We believe that the carrying values reflected in the consolidated balance sheets at December 31, 2001 and 2000 reasonably approximate the fair values for cash and cash equivalents, accounts receivable, and all liabilities, due to their short-term nature, except for lines of credit payable and notes payable. In making these assessments, we used estimates. The fair value of the lines of credit payable approximates its carrying value because its terms are similar to those available in the market place. The fair value of the notes payable at December 31, 2001 and 2000 is estimated to be $230.1 million and $212.2 million, respectively, based upon the closing market price per note or indicative price per each note at December 31, 2001 and 2000, respectively. 16. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Interest paid in 2001, 2000 and 1999 was $25.3 million, $29.8 million and $22.4 million, respectively. The following non-cash investing and financing activities are included in the accompanying consolidated financial statements (dollars in thousands): A. Additions to properties resulted in the following: 2001 1999 ---- ---- Buildings $421 $9,057 Real estate held for sale, net 183 -- Other liabilities 604 9,057 32 B. In 2000, we exchanged two properties leased by one of our tenants for two other properties owned by that tenant, which resulted in the following: Land $(2,031) Buildings 1,386 Accumulated depreciation 645 C. In 2001, the acquisition of the 5% of Crest Net common stock not previously owned by Realty Income resulted in the following: Accounts receivable $ (450) Accounts payable and accrued expenses (450) D. In 2001, we reclassified unamortized amounts of restricted stock grants included in other assets to deferred stock compensation (reported as a component of common stock and paid in capital), which resulted in the following: Other assets $ (376) Deferred stock compensation 376 E. Restricted stock grants resulted in the following: 2001 2000 1999 ---- ---- ---- Other assets $ -- $ 377 $ 139 Common stock and paid in capital 1,564 377 139 Deferred stock compensation 1,564 -- -- F. Restricted stock forfeitures resulted in the following: 2001 2000 1999 ---- ---- ---- Other assets $ -- $ (49) $(14) Common stock and paid in capital (202) (49) (14) Deferred stock compensation (202) -- -- 17. EMPLOYEE BENEFIT PLAN We have a 401(k) plan covering substantially all of our employees. Under our 401(k) plan, employees may elect to make contributions to the plan up to a maximum of 15% of their compensation, subject to limits under the IRS Code. We match 50% of our employee's contributions, up to 3% of the employee's compensation. Our aggregate matching contributions each year has been immaterial to our results of operations. 18. STOCK INCENTIVE PLAN In 1993, our Board of Directors approved a stock incentive plan (the "Stock Plan") designed to attract and retain directors, officers and employees of the Company by enabling those individuals to participate in the ownership of the Company. The Stock Plan authorizes the issuance in each calendar year of up to 3% of the total shares outstanding at the end of such year. The Stock Plan provides for grants of up to 1,950,308 shares. The Stock Plan provides for the award (subject to ownership limitations) of a broad variety of stock-based compensation alternatives such as nonqualified stock options, incentive stock options, restricted stock and performance awards. Stock options are granted with an exercise price equal to the underlying stock's fair market value at the date of grant. Stock options expire 10 years from the date they are granted and vest over service periods of one, three, four and five years. 33 In 2001, 2000 and 1999, the Company issued 61,500, 17,800 and 5,600 shares of restricted stock, respectively, which vest over periods ranging from three years to ten years. The weighted average fair market values of the restricted stock issued in 2001, 2000 and 1999 were $25.43, $21.15 and $24.85, respectively. The following table summarizes our stock option activity for the years 2001, 2000 and 1999:
2001 2000 1999 -------------------------- -------------------------- ------------------------- Weighted Weighted Weighted Average Average Average Number of Exercise Number of Exercise Number of Exercise Shares Price Shares Price Shares Price ---------------------------------------------------------------------------------------------------------------------- Outstanding, beginning of year 618,186 $23.77 647,848 $24.73 438,604 $24.77 Options granted -- -- 142,000 20.65 220,371 24.67 Options exercised (319,027) 24.38 (10,000) 21.63 -- -- Options canceled (24,096) 22.50 (161,662) 25.02 (11,127) 25.16 ---------------------------------------------- ---------------- ---------------- Outstanding, end of year 275,063 23.16 618,186 23.77 647,848 24.73 ============================================== ================ ================ Options exercisable, end of year 229,875 438,437 380,064 Weighted average fair value of each option granted during the year -- $1.65 $2.23
At December 31, 2001, the options exercisable under the Stock Plan had exercise prices ranging from $20.00 to $26.06 with a weighted average price of $23.29, and expiration dates ranging from August 2004 to February 2010 with a weighted average remaining term of 6.4 years. The fair value of each stock option grant was estimated at the date of grant using the binomial option-pricing model with the following assumptions: 2000 1999 -------------------------------------------------------------------------------- Expected dividend yield 9.70% 7.66% Risk-free interest rate 6.30% 5.04% Volatility 15.00% 15.20% Expected life of options 10 years 10 years We apply APB Opinion No. 25 in accounting for the Stock Plan and, accordingly, no compensation cost has been recognized for our stock options in the consolidated financial statements. Had we determined compensation cost based on the fair value at the grant date for its stock options under SFAS No. 123, our net income available to common stockholders and diluted net income per common share would have been as follows: 34
2001 2000 1999 -------------------------------------------------------------------------- -------------------------------------------- Net income available to common stockholders (dollars in thousands): As reported $ 57,846 $ 45,076 $ 41,012 Pro forma 57,630 44,983 40,536 Diluted net income per common share: As reported $ 1.98 $ 1.69 $ 1.53 Pro forma 1.97 1.68 1.51
19. STOCKHOLDER RIGHTS PLAN In 1998, our Board of Directors adopted a Stockholder Rights Plan (the "Rights Plan") that will expire in July 2008. The Rights Plan assigns one right (a "Right") to purchase one one-hundredth (1/100th) of a share of our Class A Junior Participating Preferred Stock, par value $1.00 per share, for each share of common stock owned on or issued after July 1, 1998. Currently, the Rights are not exercisable and do not trade separately from our common stock. Under specified circumstances, stockholders will be able to exercise their Rights if a person or group acquires 15% of our common stock or makes a tender offer to acquire 15% or more of our common stock. In these circumstances, stockholders other than the acquirer would be able to exercise the Rights to purchase our common stock or, in some situations, the acquirer's stock at a 50% discount. 35 20. SEGMENT INFORMATION We evaluate performance and make resource allocation decisions on a property by property basis. For financial reporting purposes, we have grouped our tenants into 11 reportable segments based upon the business the tenants are in, except for properties owned by Crest Net that are grouped in a separate segment. The Crest Net segment is included in "other non-reportable segments." All of the properties are incorporated into one of the applicable segments. Revenue is the only component of segment profit and loss we measure. The accounting policies of the segments are the same as those described in note 2. The following tables set forth certain information regarding the properties owned by us, classified according to the business of the respective tenants as of December 31, 2001 (dollars in thousands):
Revenue -------------------------------------------------------- For the years ended December 31, 2001 2000 1999 -------------------------------------------------------- Segment rental revenue: Automotive parts $ 9,883 $ 9,482 $ 8,826 Automotive service 6,893 6,864 6,869 Child care 28,160 27,917 25,593 Consumer electronics 4,734 5,728 5,794 Convenience stores 10,137 9,679 7,557 Health and fitness 4,280 2,781 614 Home furnishings 6,817 6,352 6,658 Restaurants 13,646 13,258 12,751 Sporting goods 1,116 -- -- Theaters 5,209 3,175 582 Video rental 4,465 4,514 4,444 Other non-reportable segments(1) 24,548 25,184 22,174 Reconciling items: Gain on sales of real estate acquired for resale 3,374 766 -- Interest and other 822 353 209 ---------------------------------------------------------------------------------------------------------------------- Total revenue $124,084 $116,053 $102,071 ====================================================================================================================== (1) Consolidates 13 retail industry segments and Crest Net.
36
Assets ---------------------------------------- As of December 31, 2001 2000 ------------------- -------------------- Segment net real estate: Automotive parts $ 73,240 $ 74,487 Automotive service 44,438 47,603 Child care 142,163 149,838 Consumer electronics 35,950 40,820 Convenience stores 81,701 81,639 Health and fitness 43,549 34,918 Home furnishings 68,384 70,140 Restaurants 130,393 82,402 Sporting goods 50,506 -- Theaters 47,273 48,003 Video rental 37,719 39,598 Other non-reportable segments(1) 212,354 224,830 ---------------------------------------------------------------------------------------------------------------------- Total net real estate 967,670 894,278 Non-real estate assets 36,038 40,488 ---------------------------------------------------------------------------------------------------------------------- Total assets $1,003,708 $934,766 ====================================================================================================================== (1) Consolidates 13 retail industry segments and Crest Net.
21. COMMITMENTS AND CONTINGENCIES In the ordinary course of our business, we are party to various legal actions which we believe are routine in nature and incidental to the operation of our business. We believe that the outcome of the proceedings will not have a material adverse effect upon our consolidated statements taken as a whole. 22. SUBSEQUENT EVENT In February 2002, we issued 273,150 shares of common stock to a unit investment trust at a net price to us of $30.26 per share, based on a 5% discount to the market price at the time of issuance of $31.85 per share. The net proceeds of $8.2 million were used to repay bank borrowings. 37
REALTY INCOME CORPORATION AND SUBSIDIARIES CONSOLIDATED QUARTERLY FINANCIAL DATA -------------------------------------------------------------------- (dollars in thousands, except per share data) (not covered by Independent Auditors' Report) First Second Third Fourth Quarter Quarter Quarter Quarter Year --------------------------------------------------------------------------------------------------------------------- 2001 Total revenue $ 31,009 $ 29,372 $ 30,441 $ 33,262 $ 124,084 Interest expense 8,059 6,587 6,080 5,740 26,466 Depreciation and amortization expense 7,062 7,010 7,087 7,376 28,535 Other expenses 3,755 2,863 3,287 3,525 13,430 Income from operations 12,133 12,912 13,987 16,621 55,653 Income from discontinued operations 389 400 393 245 1,427 Net income 18,473 13,476 17,186 18,423 67,558 Net income available to common stockholders 16,045 11,048 14,758 15,995 57,846 Basic and diluted net income per common share(1) 0.60 0.39 0.50 0.50 1.98 Dividends paid per common share 0.55500 0.55875 0.56250 0.56625 2.24250 2000 Total revenue $ 27,774 $ 27,865 $ 29,343 $ 31,071 $ 116,053 Interest expense 7,158 7,471 8,184 8,734 31,547 Depreciation and amortization expense 6,601 6,697 6,765 8,350 28,413 Other expenses 2,197 2,198 2,666 2,599 9,660 Income from operations 11,818 11,499 11,728 11,388 46,433 Income from discontinued operations 432 426 392 393 1,643 Net income 12,912 12,863 12,351 16,662 54,788 Net income available to common stockholders 10,484 10,435 9,923 14,234 45,076 Basic and diluted net income per common share 0.39 0.39 0.37 0.54 1.69 Dividends paid per common share 0.54000 0.54375 0.54750 0.55125 2.18250 (1) Net income per share is computed independently for each quarter and the full year based on the respective weighted average shares outstanding. Therefore, the sum of the quarterly net income per common share amounts may not equal the annual amount reported.
38 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. REALTY INCOME CORPORATION By: /s/THOMAS A. LEWIS ----------------------------------- Thomas A. Lewis Vice Chairman of the Board of Directors, Chief Executive Officer Date: December 18, 2002 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated. By: /s/WILLIAM E. CLARK ----------------------------------- William E. Clark Chairman of the Board of Directors Date: December 18, 2002 By: /s/THOMAS A. LEWIS ----------------------------------- Thomas A. Lewis Vice Chairman of the Board of Directors, Chief Executive Officer (Principal Executive Officer) Date: December 18, 2002 By: /s/DONALD R. CAMERON ---------------------------- Donald R. Cameron Director Date: December 18, 2002 By: /s/ROGER P. KUPPINGER Roger P. Kuppinger Director Date: December 18, 2002 39 SIGNATURES (continued) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated. By: /s/MICHAEL D. MCKEE --------------------- Michael D. McKee Director Date: December 18, 2002 By: /s/WILLARD H. SMITH JR ---------------------------- Willard H. Smith Jr Director Date: December 18, 2002 By: /s/KATHLEEN R. ALLEN, Ph.D. ---------------------------- Kathleen R. Allen, Ph.D. Director Date: December 18, 2002 By: /s/PAUL M. MEURER ---------------------------- Paul M. Meurer Executive Vice President, Chief Financial Officer and Treasurer (Principal Financial Officer) Date: December 18, 2002 By: /s/GREGORY J. FAHEY ---------------------------- Gregory J. Fahey Vice President, Controller (Principal Accounting Officer) Date: December 18, 2002 40 OFFICER CERTIFICATIONS I, Thomas A. Lewis, certify that: 1. I have reviewed this amendment to the annual report on Form 10-K/A of Realty Income Corporation; 2. Based on my knowledge, this annual 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 annual report; and 3. Based on my knowledge, the financial statements, and other financial information included in this annual 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 annual report. Date: December 18, 2002 /s/ THOMAS A. LEWIS ----------------------------------- Thomas A. Lewis Chief Executive Officer and Vice Chairman of the Board 41 I, Paul M. Meurer, certify that: 1. I have reviewed this amendment to the annual report on Form 10-K/A of Realty Income Corporation; 2. Based on my knowledge, this annual 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 annual report; and 3. Based on my knowledge, the financial statements, and other financial information included in this annual 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 annual report. Date: December 18, 2002 /s/ PAUL M. MEURER ----------------------------------- Paul M. Meurer Executive Vice President, Chief Financial Officer and Treasurer 42 EXHIBIT INDEX Exhibit No. Description 23.1 Independent Auditors' Consent. 43