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Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC  20549

 

FORM 10-Q

 

x Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the quarterly period ended June 30, 2012, or

 

o Transition report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934

 

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
Incorporation or Organization)

 

(IRS Employer Identification
Number)

 

 

600 La Terraza Boulevard, Escondido, California  92025-3873

(Address of Principal Executive Offices)

 

Registrant’s telephone number, including area code: (760) 741-2111

 

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 o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   YES x    NO o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer x   Accelerated filer o   Non-accelerated filer o   Smaller reporting company o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  YES  o  NO  x

 

There were 133,443,628 shares of common stock outstanding as of July 19, 2012.

 



Table of Contents

 

REALTY INCOME CORPORATION

 

Form 10-Q

 

June 30, 2012

 

TABLE OF CONTENTS

 

PART I.

FINANCIAL INFORMATION

Page

 

 

 

Item 1:

Financial Statements

 

 

 

 

 

Consolidated Balance Sheets

2

 

Consolidated Statements of Income

3

 

Consolidated Statements of Cash Flows

4

 

Notes to Consolidated Financial Statements

5

 

 

 

Item 2:

Management’s Discussion and Analysis of Financial Condition and
Results of Operations

 

 

 

 

 

Forward-Looking Statements

18

 

The Company

19

 

Recent Developments

22

 

Liquidity and Capital Resources

26

 

Results of Operations

31

 

Funds from Operations Available to Common Stockholders (FFO)

38

 

Adjusted Funds from Operations Available to
Common Stockholders (AFFO)

40

 

Property Portfolio Information

41

 

Impact of Inflation

47

 

Impact of Recent Accounting Pronouncements

47

 

Other Information

47

 

 

 

Item 3:

Quantitative and Qualitative Disclosures About Market Risk

47

 

 

 

Item 4:

Controls and Procedures

48

 

 

 

PART II.

OTHER INFORMATION

 

 

 

 

Item 1A:

Risk Factors

49

 

 

 

Item 2:

Unregistered Sales of Equity Securities and Use of Proceeds

49

 

 

 

Item 6:

Exhibits

49

 

 

SIGNATURE

52

 

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Table of Contents

 

PART I.  FINANCIAL INFORMATION

 

Item 1.              Financial Statements

 

REALTY INCOME CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

 

 

 

 

 

June 30, 2012 and December 31, 2011

(dollars in thousands, except per share data)

 

 

 

2012

 

2011

 

 

 

 

 

 

 

ASSETS

 

(unaudited)

 

 

 

Real estate, at cost:

 

 

 

 

 

Land

 

$ 1,807,891

 

$ 1,749,378

 

Buildings and improvements

 

3,347,490

 

3,222,603

 

Total real estate, at cost

 

5,155,381

 

4,971,981

 

Less accumulated depreciation and amortization

 

(870,165

)

(814,126

)

Net real estate held for investment

 

4,285,216

 

4,157,855

 

Real estate held for sale, net

 

18,965

 

2,153

 

Net real estate

 

4,304,181

 

4,160,008

 

Cash and cash equivalents

 

6,064

 

4,165

 

Accounts receivable, net

 

17,600

 

15,375

 

Goodwill

 

17,094

 

17,206

 

Other assets, net

 

231,620

 

222,635

 

Total assets

 

$ 4,576,559

 

$ 4,419,389

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Distributions payable

 

$      22,993

 

$      21,405

 

Accounts payable and accrued expenses

 

59,497

 

58,770

 

Other liabilities

 

30,925

 

29,179

 

Lines of credit payable

 

183,600

 

237,400

 

Mortgages payable, net

 

56,661

 

67,781

 

Notes payable

 

1,750,000

 

1,750,000

 

Total liabilities

 

2,103,676

 

2,164,535

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Preferred stock and paid in capital, par value $0.01 per share, 69,900,000 shares authorized and 25,150,000 shares issued and outstanding as of June 30, 2012, and 20,000,000 shares authorized and 13,900,000 shares issued and outstanding as of December 31, 2011

 

609,363

 

337,790

 

Common stock and paid in capital, par value $0.01 per share, 370,100,000 shares authorized and 133,439,028 shares issued and outstanding as of June 30, 2012, and 200,000,000 shares authorized and 133,223,338 shares issued and outstanding as of December 31, 2011

 

2,567,148

 

2,563,048

 

Distributions in excess of net income

 

(703,628

)

(645,984

)

Total stockholders’ equity

 

2,472,883

 

2,254,854

 

Total liabilities and stockholders’ equity

 

$ 4,576,559

 

$ 4,419,389

 

 

The accompanying notes to consolidated financial statements are an integral part of these statements.

 

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Table of Contents

 

REALTY INCOME CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

 

 

 

 

 

For the three and six months ended June 30, 2012 and 2011

(dollars in thousands, except per share data)

(unaudited)

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,  2012 

 

June 30,  2011 

 

June 30,  2012 

 

June 30,  2011 

 

 

 

 

 

 

 

 

 

 

 

REVENUE

 

 

 

 

 

 

 

 

 

Rental

 

$ 115,038

 

$ 101,361

 

$ 229,060

 

$ 197,934

 

Other

 

605

 

259

 

858

 

398

 

Total revenue

 

115,643

 

101,620

 

229,918

 

198,332

 

 

 

 

 

 

 

 

 

 

 

EXPENSES

 

 

 

 

 

 

 

 

 

Depreciation and amortization

 

35,475

 

28,673

 

70,560

 

55,104

 

Interest

 

28,806

 

25,647

 

57,758

 

50,769

 

General and administrative

 

9,273

 

7,987

 

18,441

 

15,857

 

Property

 

2,090

 

1,597

 

4,536

 

3,281

 

Income taxes

 

405

 

368

 

810

 

735

 

Total expenses

 

76,049

 

64,272

 

152,105

 

125,746

 

Income from continuing operations

 

39,594

 

37,348

 

77,813

 

72,586

 

Income from discontinued operations

 

3,813

 

1,900

 

4,858

 

2,661

 

Net income

 

43,407

 

39,248

 

82,671

 

75,247

 

Preferred stock dividends

 

(10,457

)

(6,063

)

(19,953

)

(12,127

)

Excess of redemption value over carrying value of preferred shares redeemed (see note 8)

 

--

 

--

 

(3,696

)

--

 

Net income available to common stockholders

 

$ 32,950

 

$ 33,185

 

$ 59,022

 

$ 63,120

 

 

 

 

 

 

 

 

 

 

 

Amounts available to common stockholders per common share:

 

 

 

 

 

 

 

 

 

Income from continuing operations:

 

 

 

 

 

 

 

 

 

Basic

 

$ 0.22

 

$ 0.25

 

$ 0.41

 

$ 0.49

 

Diluted

 

$ 0.22

 

$ 0.25

 

$ 0.41

 

$ 0.49

 

Net income:

 

 

 

 

 

 

 

 

 

Basic

 

$ 0.25

 

$ 0.26

 

$ 0.44

 

$ 0.52

 

Diluted

 

$ 0.25

 

$ 0.26

 

$ 0.44

 

$ 0.51

 

Weighted average common shares outstanding:

 

 

 

 

 

 

 

 

 

Basic

 

132,592,939

 

125,999,323

 

132,643,698

 

122,547,027

 

Diluted

 

132,828,540

 

126,202,047

 

132,785,213

 

122,691,418

 

 

The accompanying notes to consolidated financial statements are an integral part of these statements.

 

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Table of Contents

 

REALTY INCOME CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

 

 

 

For the six months ended June 30, 2012 and 2011

(dollars in thousands)(unaudited)

 

 

 

2012

 

2011

 

 

 

 

 

 

 

CASH FLOWS FROM OPERATING ACTIVITIES

 

 

 

 

 

Net income

 

$

82,671

 

$

75,247

 

Adjustments to net income:

 

 

 

 

 

Depreciation and amortization

 

70,560

 

55,104

 

Income from discontinued operations

 

(4,858

)

(2,661

)

Gain on sale of real estate

 

--

 

(155

)

Amortization of share-based compensation

 

5,550

 

4,347

 

Amortization of net premiums on mortgages payable

 

(168

)

--

 

Other non-cash adjustments

 

(301

)

--

 

Cash provided by discontinued operations:

 

 

 

 

 

Real estate

 

1,274

 

2,454

 

Collection of notes receivable by Crest

 

44

 

72

 

Change in assets and liabilities:

 

 

 

 

 

Accounts receivable and other assets

 

1,820

 

7,826

 

Accounts payable, accrued expenses and other liabilities

 

(659

)

(5,266

)

Net cash provided by operating activities

 

155,933

 

136,968

 

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES

 

 

 

 

 

Acquisition of and improvements to investment properties

 

(221,959

)

(303,764

)

Proceeds from the sales of real estate:

 

 

 

 

 

Continuing operations

 

--

 

675

 

Discontinued operations

 

18,549

 

4,372

 

Loans receivable

 

(3,795

)

--

 

Restricted escrow deposits

 

(6,449

)

(5,999

)

Net cash used in investing activities

 

(213,654

)

(304,716

)

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES

 

 

 

 

 

Cash distributions to common stockholders

 

(116,552

)

(106,131

)

Cash dividends to preferred stockholders

 

(18,480

)

(12,127

)

Borrowings from lines of credit

 

377,400

 

38,600

 

Payments on lines of credit

 

(431,200

)

(38,600

)

Principal payments on mortgages

 

(10,952

)

--

 

Proceeds from preferred stock offerings, net

 

395,377

 

--

 

Redemption of preferred stock

 

(127,500

)

--

 

Proceeds from common stock offering, net

 

--

 

285,605

 

Proceeds from bonds issued

 

--

 

150,000

 

Debt issuance costs

 

(7,058

)

(9,915

)

Proceeds from dividend reinvestment and stock purchase plan

 

1,548

 

716

 

Other items

 

(2,963

)

(2,336

)

Net cash provided by financing activities

 

59,620

 

305,812

 

Net increase in cash and cash equivalents

 

1,899

 

138,064

 

Cash and cash equivalents, beginning of period

 

4,165

 

17,607

 

Cash and cash equivalents, end of period

 

$

6,064

 

$

155,671

 

 

For supplemental disclosures, see note 15.

 

The accompanying notes to consolidated financial statements are an integral part of these statements.

 

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Table of Contents

 

REALTY INCOME CORPORATION AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2012

(unaudited)

 

1.                  Management Statement

 

The consolidated financial statements of Realty Income Corporation (“Realty Income”, the “Company”, “we”, “our” or “us”) were prepared from our books and records without audit and include all adjustments (consisting of only normal recurring accruals) necessary to present a fair statement of results for the interim periods presented. Readers of this quarterly report should refer to our audited consolidated financial statements for the year ended December 31, 2011, which are included in our 2011 Annual Report on Form 10-K, as certain disclosures that would substantially duplicate those contained in the audited financial statements have not been included in this report.

 

We report, in discontinued operations, the results of operations of properties that have either been disposed of or are classified as held for sale. As a result of these discontinued operations, certain of the 2011 balances have been reclassified to conform to the 2012 presentation.

 

At June 30, 2012, we owned 2,762 properties, located in 49 states, containing over 28.7 million leasable square feet, along with three properties owned by our wholly-owned taxable REIT subsidiary, Crest Net Lease, Inc., or Crest.

 

2.                  Summary of Significant Accounting Policies and Procedures

 

A.  The accompanying consolidated financial statements include the accounts of Realty Income, Crest, and other entities for which we make operating and financial decisions (i.e., control), after elimination of all material intercompany balances and transactions. We have no unconsolidated or off-balance sheet investments in variable interest entities.

 

B.  We have elected to be taxed as a real estate investment trust, or REIT, under the Internal Revenue Code of 1986, as amended, or the Code. We believe we have qualified and continue to qualify as a REIT. Under the REIT operating structure, we are permitted to deduct dividends paid to our stockholders in determining our taxable income. Assuming our distributions equal or exceed our net income, we generally will not be required to pay federal corporate income taxes on such income. Accordingly, no provision has been made for federal income taxes in the accompanying consolidated financial statements, except for the federal income taxes of Crest, which are included in discontinued operations. The income taxes recorded on our consolidated statements of income represent amounts paid by Realty Income for city and state income and franchise taxes.

 

C.  We recognize an allowance for doubtful accounts relating to accounts receivable for amounts deemed uncollectible. We consider tenant specific issues, such as financial stability and ability to pay rent, when determining collectability of accounts receivable and appropriate allowances to record.  The allowance for doubtful accounts was $582,000 at June 30, 2012 and $507,000 at December 31, 2011.

 

D.  We assign a portion of goodwill to our property sales, which results in a reduction of the carrying amount of our goodwill. In order to allocate goodwill to the carrying amount of properties that we sell, we utilize a relative fair value approach based on the original methodology for assigning goodwill.  As we sell properties, our goodwill will likely continue to gradually decrease over time.

 

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Table of Contents

 

E. Under the amendments issued in conjunction with ASU No. 2011-08, Intangibles – Goodwill and Other (Topic 350), an entity, through an assessment of qualitative factors, is not required to calculate the estimated fair value of a reporting unit, in connection with the two-step goodwill impairment test, unless the entity determines that it is more likely than not that its fair value is less than its carrying amount. Despite the issuance of ASU No. 2011-08, we elected to continue testing goodwill for impairment during the second quarter of each year as well as when events or circumstances occur, indicating that our goodwill might be impaired. During our tests for impairment of goodwill during the second quarters of 2012 and 2011, we determined that the estimated fair values of our reporting units exceeded their carrying values. We did not record any impairment on our existing goodwill in 2012 or 2011.

 

3.             Supplemental Detail for Certain Components of Consolidated Balance Sheets

 

 

 

June 30,

 

December 31,

 

A. Other assets, net, consist of the following (dollars in thousands) at:

 

2012

 

2011

 

Value of in-place leases, net of accumulated amortization

 

$    118,150

 

$    123,255

 

Value of above-market leases, net of accumulated amortization

 

29,749

 

30,081

 

Deferred bond financing costs, net

 

21,104

 

22,209

 

Notes receivable issued in connection with property sales

 

18,981

 

19,025

 

Note receivable acquired in connection with an acquisition

 

8,780

 

8,780

 

Loans receivable

 

7,341

 

2,554

 

Credit facility origination costs, net

 

9,444

 

3,141

 

Prepaid expenses

 

9,010

 

9,833

 

Restricted escrow deposits

 

6,449

 

50

 

Corporate assets, net of accumulated depreciation and amortization

 

864

 

849

 

Deferred financing costs on mortgages payable, net

 

593

 

751

 

Other items

 

1,155

 

2,107

 

 

 

$ 231,620

 

$ 222,635

 

 

B. Distributions payable consist of the following declared

 

June 30,

 

December 31,

 

distributions (dollars in thousands) at:

 

2012

 

2011

 

Common stock distributions

 

$ 19,499

 

$ 19,384

 

Preferred stock dividends

 

3,494

 

2,021

 

 

 

$ 22,993

 

$ 21,405

 

 

C. Accounts payable and accrued expenses consist of the

 

June 30,

 

December 31,

 

following (dollars in thousands) at:

 

2012

 

2011

 

Bond interest payable

 

$ 35,195

 

$ 35,195

 

Accrued costs on properties under development

 

6,711

 

4,766

 

Other items

 

17,591

 

18,809

 

 

 

$ 59,497

 

$ 58,770

 

 

 

 

June 30,

 

December 31,

 

D. Other liabilities consist of the following (dollars in thousands) at:

 

2012

 

2011

 

Rent received in advance

 

$ 16,579

 

$ 18,149

 

Value of in-place below-market leases, net of accumulated amortization

 

6,309

 

6,423

 

Security deposits

 

4,908

 

4,607

 

Other items

 

3,129

 

--

 

 

 

$ 30,925

 

$ 29,179

 

 

4.     Investments in Real Estate

 

We acquire the land, buildings and improvements that are necessary for the successful operations of retail and other commercial enterprises.

 

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Table of Contents

 

A.  During the first six months of 2012, we invested $221.5 million in 147 new properties and properties under development, with an initial weighted average contractual lease rate of 7.2%. These 147 new properties are located in 28 states, will contain over 1.4 million leasable square feet, and are 100% leased with an average lease term of 15.0 years. The tenants of the 147 properties acquired, operate in six industries: automotive collision services, crafts and novelties, drug store, general merchandise, restaurants – quick service, and transportation services. The investments to any one tenant were less than 10% of our total assets at December 31, 2011. The initial weighted average contractual lease rate is computed by dividing the estimated aggregate base rent for the first year of each lease by the estimated total cost of the properties. Acquisition transaction costs of $634,000 were recorded to general and administrative expense, on our consolidated statement of income, for the six months ended June 30, 2012.

 

In April 2012 we announced the signing of purchase agreements to acquire properties with an aggregate value of approximately $514 million, which were anticipated to close during the second quarter.  Included in the $221.5 million invested during the first six months of 2012, is $198 million invested in 139 properties of the previously announced acquisitions. Agreements to acquire properties for approximately $316 million have been terminated and will not be acquired. However, transaction flow remains strong, and we continue to believe we will meet or exceed our previously stated 2012 target of $650 million in new property acquisitions. While the total amount of acquisitions for 2012 will likely be higher than previously anticipated, the timing of the remaining acquisitions will be weighted more heavily towards the end of the year.

 

In comparison, during the first six months of 2011, we invested $364.2 million in 36 properties and properties under development, with an initial weighted average contractual lease rate of 7.6%. These 36 properties and properties under development, are located in 19 states, contain over 3.4 million leasable square feet, and are 100% leased with an average lease term of 15.5 years. Acquisition transaction costs of $913,000 were recorded to general and administrative expense, on our consolidated statement of income, for the six months ended June 30, 2011.

 

During the first six months of 2012, we capitalized costs of $2.4 million on existing properties in our portfolio, consisting of $698,000 for re-leasing costs and $1.7 million for building and tenant improvements. In comparison, during the first six months of 2011, we capitalized costs of $1.9 million on existing properties in our portfolio, consisting of $649,000 for re-leasing costs and $1.2 million for building and tenant improvements.

 

B.  Of the $221.5 million invested by us in the first six months of 2012, approximately $20.9 million was used to acquire three properties with existing leases. Associated with these three properties, we recorded $1.6 million as the intangible value of the in-place leases, $991,000 as the intangible value of above-market leases and $244,000 as the intangible value of below-market leases. Of the $364.2 million invested by us in the first six months of 2011, approximately $336.2 million was used to acquire 22 properties with existing leases. Associated with these 22 properties, we recorded $64.5 million as the intangible value of the in-place leases, $18.6 million as the intangible value of above-market leases and $1.9 million as the intangible value of below-market leases.

 

The value of the in-place and above-market leases is recorded to other assets on our consolidated balance sheet, and the value of the below-market leases is recorded to other liabilities on our consolidated balance sheet. The value of the in-place leases is amortized as depreciation and amortization expense, while the value of the above-market and below-market leases is amortized as rental revenue on our consolidated statements of income. All of these amounts are amortized over the life of the respective leases.

 

C.  The amounts amortized as a net decrease to rental income, for capitalized above-market and below-market leases, was $964,000 for the first six months of 2012 and was $316,000 for the first six months of 2011. The value of in-place leases amortized to expense was $6.7 million for the first six months of 2012 and was $2.2 million for the first six months of 2011.

 

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5.     Credit Facility

 

In May 2012, we entered into a new $1 billion unsecured acquisition credit facility, which replaced our $425 million acquisition credit facility that was scheduled to expire in March 2014. The initial term of the new credit facility expires in May 2016 and includes, at our option, a one-year extension. Under this new credit facility, our current investment grade credit ratings provide for financing at the London Interbank Offered Rate, commonly referred to as LIBOR, plus 1.075% with a facility commitment fee of 0.175%, for all-in drawn pricing of 1.25% over LIBOR. The borrowing rate is not subject to an interest rate floor or ceiling. We also have other interest rate options available to us. Our credit facility is unsecured and, accordingly, we have not pledged any assets as collateral for this obligation.

 

As a result of entering into our current credit facility, we incurred credit facility origination costs of $7.1 million.  At June 30, 2012, included in other assets on our consolidated balance sheet is $6.8 million of the $7.1 million, and $2.5 million incurred as a result of entering into our previous credit facilities.  These costs are being amortized over the remaining term of our current $1 billion credit facility.

 

At June 30, 2012, we had a borrowing capacity of $816.4 million available on our credit facility (subject to customary conditions of borrowing) and an outstanding balance of $183.6 million, as compared to an outstanding balance of $237.4 million at December 31, 2011.

 

The average interest rate on our outstanding borrowings under our credit facilities was 1.9% during the first six months of 2012, and was 2.1% during the first six months of 2011. At June 30, the effective interest rate was 1.3%. Our credit facility is subject to various leverage and interest coverage ratio limitations. At June 30, 2012, we remain in compliance with these covenants.

 

6.     Mortgages Payable

 

During 2011, we assumed mortgages totaling $67.4 million, payable to third-party lenders. These mortgages are secured by the properties on which the debt was placed and are non-recourse. We expect to pay off the mortgages as soon as prepayment penalties and costs make it economically feasible to do so. We intend to continue our policy of primarily identifying property acquisitions that are free from mortgage indebtedness. In the first six months of 2012, we repaid one mortgage in full for $10.7 million.

 

In aggregate, net premiums totaling $820,000 were recorded in 2011 upon assumption of the mortgages for above-market interest rates. Amortization of these net premiums is recorded as a reduction to interest expense over the remaining term of the respective notes, using a method that approximates the effective-interest method. These mortgages contain customary covenants, such as limiting our ability to further mortgage each applicable property or to discontinue insurance coverage, without the prior consent of the lender. At June 30, 2012, we remain in compliance with these covenants.

 

As a result of assuming these mortgages payable in 2011, we incurred deferred financing costs of $917,000 that were classified as part of other assets on our consolidated balance sheet.  The balance of these deferred financing costs was $593,000 at June 30, 2012, and $751,000 at December 31, 2011, which is being amortized over the remaining term of each mortgage.

 

The following is a summary of our mortgages payable at June 30, 2012 and December 31, 2011 (principal balance, unamortized premiums (discounts) and mortgage payable balances in thousands):

 

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Table of Contents

 

At June 30, 2012

 

Maturity
Date
(1)

 

Stated
Interest
Rate
(2)

 

Effective
Interest
Rate

 

Remaining
Principal
Balance
(1)

 

Amortized
Premium
(Discount)
Balance

 

Mortgage
Payable
Balance

12/1/13

(3)

 

6.25%

 

4.62%

 

$ 12,202

 

$   266

 

$ 12,468

9/1/14

(3)

 

6.25%

 

5.12%

 

11,591

 

255

 

11,846

6/10/15

 

 

4.74%

 

4.84%

 

23,625

 

(58)

 

23,567

12/28/13

(4)(5)

 

8.26%

 

8.26%

 

4,510

 

--

 

4,510

12/28/13

(4)(5)

 

8.26%

 

8.26%

 

4,270

 

--

 

4,270

 

 

 

 

 

 

$ 56,198

 

$   463

 

$ 56,661

 

At December 31, 2011

 

Maturity
Date
(1)

 

Stated
Interest
Rate
(2)

 

Effective
Interest
Rate

 

Remaining
Principal
Balance
(1)

 

Amortized
Premium
(Discount)
Balance

 

Mortgage
Payable
Balance

5/6/12

 

 

5.89%

 

5.19%

 

$ 10,664

 

$      26

 

$ 10,690

12/1/13

(3)

 

6.25%

 

4.63%

 

12,410

 

314

 

12,724

9/1/14

(3)

 

6.25%

 

5.09%

 

11,671

 

359

 

12,030

6/10/15

 

 

4.73%

 

4.84%

 

23,625

 

(68)

 

23,557

12/28/13

(4)(5)

 

8.26%

 

8.26%

 

4,510

 

--

 

4,510

12/28/13

(4)(5)

 

8.26%

 

8.26%

 

4,270

 

--

 

4,270

 

 

 

 

 

 

 

$ 67,150

 

$    631

 

$ 67,781

 

(1) The mortgages require monthly payments, with a principal payment due at maturity.

 

(2) The mortgages are at fixed interest rates, except for the mortgage maturing on June 10, 2015 with a floating variable interest rate calculated as the sum of the current 1 month LIBOR plus 4.50%, not to exceed an all-in interest rate of 5.5%.

 

(3) These are mortgages, with different maturity dates, associated with one property.

 

(4) These are mortgages, with the same maturity date, associated with one property.

 

(5) As part of the assumption of these mortgages payable related to our 2011 acquisitions, we also acquired an $8.8 million note receivable, upon which we will receive interest income at a stated rate of 8.14% through December 28, 2013.

 

7.     Notes Payable

 

A.    Our senior unsecured notes and bonds consist of the following at June 30, 2012 and December 31, 2011, sorted by maturity date (dollars in millions):

 

5.375% notes, issued in March 2003 and due in March 2013

 

$    100

 

5.5% notes, issued in November 2003 and due in November 2015

 

150

 

5.95% notes, issued in September 2006 and due in September 2016

 

275

 

5.375% notes, issued in September 2005 and due in September 2017

 

175

 

6.75% notes, issued in September 2007 and due in August 2019

 

550

 

5.75% notes, issued in June 2010 and due in January 2021

 

250

 

5.875% bonds, $100 issued in March 2005 and $150 issued in June 2011, both due in March 2035

 

250

 

 

 

$ 1,750

 

 

B.                 Re-opening of Unsecured Bonds due 2035

 

In June 2011, we re-opened our 5.875% senior unsecured bonds due 2035, or the 2035 Bonds, and issued $150 million in aggregate principal amount of these 2035 Bonds. The public offering price for the additional 2035 Bonds was 94.578% of the principal amount for an effective yield of 6.318% per annum. Those 2035 Bonds constituted an additional issuance of, and a single series with, the $100 million in aggregate principal amount of the 2035 Bonds that we issued in March 2005. The net proceeds of $140.1 million were used to fund property acquisitions.

 

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Table of Contents

 

8.     Issuance and Redemption of Preferred Stock

 

A.  In February 2012, we issued 14.95 million shares of our 6.625% Monthly Income Class F Cumulative Redeemable Preferred Stock at a price of $25 per share, including 1.95 million shares purchased by the underwriters upon the exercise of their overallotment option. In April 2012, we issued an additional 1.4 million shares of our Class F preferred stock at a price of $25.2863 per share.  After aggregate underwriting discounts and other offering costs totaling $13.8 million, we received total net proceeds of $395.4 million for the February and April offerings combined, of which $127.5 million were used to redeem all of our outstanding 7.375% Monthly Income Class D Cumulative Redeemable Preferred Stock and the balance was used to repay a portion of the borrowings under our credit facility. Beginning February 15, 2017, the Class F preferred shares are redeemable, at our option, for $25 per share.  The initial dividend of $0.1702257 per share was paid on March 15, 2012 and covered 37 days. Thereafter, dividends of $0.138021 per share will be paid monthly in arrears on the Class F preferred stock.

 

B.  We redeemed all of the 5.1 million shares of our 7.375% Monthly Income Class D Cumulative Redeemable Preferred Stock in March 2012 for $25 per share, plus accrued dividends.  We incurred a charge of $3.7 million, representing the Class D preferred stock original issuance costs that we paid in 2004.

 

9.     Issuance of Common Stock

 

In March 2011, we issued 8,625,000 shares of common stock at a price of $34.81 per share. After underwriting discounts and other offering costs of approximately $14.6 million, the net proceeds of approximately $285.6 million were used to fund property acquisitions.

 

10.     Fair Value of Financial Assets and Liabilities

 

Fair value is defined as the price that would be received from the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The disclosure for assets and liabilities measured at fair value, requires allocation to a three-level valuation hierarchy. This valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. Categorization within this hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

 

We believe that the carrying values reflected in our consolidated balance sheets reasonably approximate the fair values for cash and cash equivalents, accounts receivable, escrow deposits, loans receivable, and all liabilities, due to their short-term nature, except for our notes receivable issued in connection with property sales or acquired in connection with an acquisition, mortgages payable and our senior notes and bonds payable, which are disclosed below (dollars in millions).

 

 

 

Carrying value per

 

Estimated fair

 

At June 30, 2012

 

balance sheet

 

value

 

Notes receivable issued in connection with property sales

 

$

19.0

 

$

20.2

 

Notes receivable acquired in connection with an acquisition

 

$

8.8

 

$

8.8

 

Mortgages payable assumed in connection with acquisitions

 

$

56.7

 

$

57.4

 

Notes payable

 

$

1,750.0

 

$

1,972.2

 

 

 

 

Carrying value per

 

Estimated fair

 

At December 31, 2011

 

balance sheet

 

value

 

Notes receivable issued in connection with property sales

 

$

19.0

 

$

19.6

 

Note receivable acquired in connection with an acquisition

 

$

8.8

 

$

8.8

 

Mortgages payable assumed in connection with acquisitions

 

$

67.8

 

$

68.2

 

Notes payable

 

$

1,750.0

 

$

1,901.9

 

 

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Table of Contents

 

The estimated fair values of our notes receivable issued in connection with property sales or acquired in connection with an acquisition, and our mortgages payable have been calculated by discounting the future cash flows using an interest rate based upon the current 5-year or 7-year Treasury yield curve, plus an applicable credit-adjusted spread. The notes receivable were issued in connection with the sale of properties by Crest. Payments to us on these notes receivable are current and no allowance for doubtful accounts has been recorded for them. Because this methodology includes observable inputs that reflect our own internal assumptions and calculations, the measurement of estimated fair values related to our notes receivable and mortgages payable is categorized as level 3 on the three-level valuation hierarchy.

 

The estimated fair value of our senior notes and bonds payable is based upon indicative market prices and recent trading activity of our senior notes and bonds payable. Because this methodology includes inputs that are less observable by the public and are not necessarily reflected in active markets, the measurement of the estimated fair values related to our notes and bonds payable is categorized as level 2 on the three-level valuation hierarchy.

 

11.     Gain on Sales of Investment Properties

 

During the second quarter of 2012, we sold 14 investment properties for $15.0 million, which resulted in a gain of $3.4 million. During the first six months of 2012, we sold 19 investment properties for $18.6 million, which resulted in a gain of $4.0 million. The results of operations for these properties have been reclassified as discontinued operations.

 

In comparison, during the second quarter of 2011, we sold six investment properties for $3.3 million, which resulted in a gain of $1.1 million. During the first six months of 2011, we sold nine investment properties for $4.4 million, which resulted in a gain of $1.2 million. The results of operations for these properties have been reclassified as discontinued operations. Additionally, during the second quarter of 2011, we sold excess land from three properties for $675,000, which resulted in a gain of $155,000. This gain is included in other revenue on our consolidated statement of income for the three and six months ended June 30, 2011, because this excess land was associated with properties that continue to be owned as part of our core operations.

 

12.     Discontinued Operations

 

We review long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. An impairment is recorded if estimated future operating cash flows (undiscounted and without interest charges) plus estimated disposition proceeds (undiscounted) are less than the current book value of the property. Key factors that we use in this analysis include: projected rental rates, estimated holding periods, capital expenditures and property sales capitalization rates. Additionally, a property classified as held for sale is carried at the lower of carrying cost or estimated fair value, less estimated cost to sell.

 

For the first six months of 2012, we did not record any provisions for impairment. For the second quarter of 2011, we recorded a provision for impairment of $10,000 on one property, which was sold in 2011. For the first six months of 2011, we recorded total provisions for impairment of $210,000 on three properties; one in the automotive service industry, one in the motor vehicle dealerships industry and one in the pet supplies and services industry, all of which were sold in 2011.

 

Operations from 16 investment properties classified as held for sale at June 30, 2012, plus properties previously sold, are reported as discontinued operations. Their respective results of operations have been reclassified as income from discontinued operations on our consolidated statements of income. We do not depreciate properties that are classified as held for sale.

 

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Table of Contents

 

No debt was assumed by buyers of our investment properties, or repaid as a result of our investment property sales, and we do not allocate interest expense to discontinued operations related to real estate held for investment. We allocate interest expense related to borrowings specifically attributable to Crest. The interest expense amounts allocated to Crest are included in income from discontinued operations.

 

The following is a summary of income from discontinued operations on our consolidated statements of income (dollars in thousands):

 

 

 

Three months ended

 

Six months ended

 

Income from discontinued operations

 

June 30,
2012

 

June 30,
2011

 

June 30,
2012

 

June 30,
2011

 

Gain on sales of investment properties

 

$

3,354

 

$

1,096

 

$

3,965

 

$

1,224

 

Rental revenue

 

518

 

1,119

 

1,164

 

2,361

 

Other revenue

 

7

 

6

 

21

 

27

 

Depreciation and amortization

 

(163

)

(386

)

(381

)

(807

)

Property expenses

 

(99

)

(145

)

(236

)

(376

)

Provisions for impairment

 

--

 

(10

)

--

 

(210

)

Crest’s income from discontinued operations

 

196

 

220

 

325

 

442

 

Income from discontinued operations

 

$

3,813

 

$

1,900

 

$

4,858

 

$

2,661

 

Per common share, basic and diluted(1)

 

$

0.03

 

$

0.02

 

$

0.04

 

$

0.02

 

 

(1)   The per share amounts for income from discontinued operations above and the income from continuing operations and net income reported on the consolidated statements of income have each been calculated independently.

 

13.     Distributions Paid and Payable

 

A.  Common Stock

 

We pay monthly distributions to our common stockholders.  The following is a summary of the monthly distributions paid per common share for the first six months of 2012 and 2011:

 

Month

 

2012

 

2011

 

 

 

 

 

 

 

January

 

$ 0.1455000

 

$ 0.1442500

 

February

 

0.1455000

 

0.1442500

 

March

 

0.1455000

 

0.1442500

 

April

 

0.1458125

 

0.1445625

 

May

 

0.1458125

 

0.1445625

 

June

 

0.1458125

 

0.1445625

 

 

 

 

 

 

 

Total

 

$ 0.8739375

 

$ 0.8664375

 

 

At June 30, 2012, a distribution of $0.146125 per common share was payable and was paid in July 2012.

 

B.  Preferred Stock

 

In March 2012, we redeemed all of our 5.1 million shares of 7.375% Monthly Income Class D Cumulative Redeemable Preferred Stock, which were issued in 2004. During the first six months of 2012, we paid dividends to holders of our Class D preferred stock totaling $0.3841147 per share, or $2.0 million. During the first six months of 2011, we paid six monthly dividends to holders of our Class D preferred stock totaling $0.9218754 per share, or $4.7 million.

 

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Table of Contents

 

In 2006, we issued 8.8 million shares of 6.75% Monthly Income Class E Cumulative Redeemable Preferred Stock. Beginning December 7, 2011, the Class E preferred shares were redeemable, at our option, for $25 per share, plus any accrued and unpaid dividends. During each of the first six months of 2012 and 2011, we paid six monthly dividends to holders of our Class E preferred stock totaling $0.84375 per share, or $7.4 million, and at June 30, 2012, a monthly dividend of $0.140625 per share was payable and was paid in July 2012.

 

In February 2012, we issued 14.95 million shares of 6.625% Monthly Income Class F Cumulative Redeemable Preferred Stock at a price of $25 per share, including 1.95 million shares purchased by the underwriters upon the exercise of their overallotment option. In April 2012, we issued an additional 1.4 million shares of our Class F preferred stock at a price of $25.2863 per share. Beginning February 15, 2017, shares of our Class F preferred shares are redeemable, at our option, for $25 per share, plus any accrued and unpaid dividends. During the first six months of 2012, we paid four monthly dividends to holders of our Class F preferred stock totaling $0.5842887 per share, or $9.1 million, and at June 30, 2012, a monthly dividend of $0.138021 per share was payable and was paid in July 2012. The initial March 2012 dividend on our Class F preferred stock covered 37 days.

 

We are current on our obligations to pay dividends on our Class E and Class F preferred stock.

 

14.     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 net income available to common stockholders for the period by the weighted average 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.

 

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:

 

 

 

Three months ended

 

Six months ended

 

 

 

June 30,
2012

 

June 30,
2011

 

June 30,
2012

 

June 30,
2011

 

Weighted average shares used for the basic net income per share computation

 

132,592,939

 

125,999,323

 

132,643,698

 

122,547,027

 

Incremental shares from share-based compensation

 

235,601

 

202,724

 

141,515

 

144,391

 

Adjusted weighted average shares used for diluted net income per share computation

 

132,828,540

 

126,202,047

 

132,785,213

 

122,691,418

 

Unvested shares from share-based compensation that were anti-dilutive

 

16,200

 

12,600

 

16,400

 

12,600

 

 

15.     Supplemental Disclosures of Cash Flow Information

 

Interest paid was $55.7 million in the first six months of 2012 and was $49.0 million in the first six months of 2011.

 

Interest capitalized to properties under development was $277,000 in the first six months of 2012 and was $173,000 in the first six months of 2011.

 

Income taxes paid were $818,000 in the first six months of 2012 and were $946,000 in the first six months of 2011.

 

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Table of Contents

 

The following non-cash investing and financing activities are included in the accompanying consolidated financial statements:

 

A.  Share-based compensation expense was $5.6 million for the first six months of 2012 and was $4.3 million for the first six months of 2011.

 

B.  Accrued costs on properties under development resulted in an increase in buildings and improvements and accounts payable of $1.9 million at June 30, 2012, and $3.6 million at June 30, 2011.

 

C.  In 2011, we entered into loan agreements to fund development of real estate. Accrued loans receivable resulted in an increase in other assets of $889,000 at June 30, 2012.

 

D.  As part of the acquisition of three properties, during the first six months of 2011, we assumed $58.6 million of mortgages payable to third-party lenders and recorded $820,000 of net premiums. See note 6 for a discussion of these transactions.

 

E.  See note 12 for a discussion of impairments recorded by Realty Income in discontinued operations for the first six months of 2011.

 

16.     Segment Information

 

We evaluate performance and make resource allocation decisions on an industry by industry basis. For financial reporting purposes, we have grouped our tenants into 39 industry and activity segments. All of the properties are incorporated into one of the applicable segments. Because almost all of our leases require the tenant to pay operating expenses, revenue is the only component of segment profit and loss we measure.

 

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Table of Contents

 

The following tables set forth certain information regarding the properties owned by us, classified according to the business of the respective tenants, as of June 30, 2012 (dollars in thousands):

 

 

 

June 30,

 

December 31,

 

Assets, as of:

 

2012

 

2011

 

Segment net real estate:

 

 

 

 

 

Automotive service

 

$   99,803

 

$   101,175

 

Automotive tire services

 

188,267

 

191,387

 

Beverages

 

312,694

 

314,832

 

Child care

 

64,151

 

66,474

 

Convenience stores

 

679,895

 

690,246

 

Drug stores

 

159,015

 

154,015

 

General merchandise

 

199,647

 

17,690

 

Grocery stores

 

218,857

 

221,678

 

Health and fitness

 

292,475

 

293,624

 

Restaurants - casual dining

 

463,378

 

471,842

 

Restaurants - quick service

 

268,347

 

277,648

 

Theaters

 

377,101

 

383,452

 

Transportation services

 

116,684

 

107,632

 

Wholesale club

 

152,934

 

154,964

 

25 non-reportable segments

 

710,933

 

713,349

 

Total segment net real estate

 

4,304,181

 

4,160,008

 

 

 

 

 

 

 

Intangible assets:

 

 

 

 

 

Automotive tire services

 

500

 

529

 

Beverages

 

3,442

 

3,571

 

Drug stores

 

15,290

 

14,422

 

Grocery stores

 

5,467

 

5,655

 

Health and fitness

 

1,495

 

1,566

 

Restaurants - quick service

 

3,750

 

4,037

 

Theaters

 

28,812

 

31,162

 

Transportation services

 

28,624

 

28,944

 

Other non-reportable segments

 

60,519

 

63,450

 

Goodwill:

 

 

 

 

 

Automotive service

 

472

 

472

 

Automotive tire services

 

866

 

866

 

Child care

 

5,312

 

5,353

 

Convenience stores

 

2,069

 

2,073

 

Restaurants - casual dining

 

2,450

 

2,461

 

Restaurants - quick service

 

1,262

 

1,318

 

Other non-reportable segments

 

4,663

 

4,663

 

Other corporate assets

 

107,385

 

88,839

 

Total assets

 

$ 4,576,559

 

$ 4,419,389

 

 

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Table of Contents

 

 

 

Three months ended

 

Six months ended

 

Revenue

 

June 30,
2012

 

June 30,
2011

 

June 30,
2012

 

June 30,
2011

 

Segment rental revenue:

 

 

 

 

 

 

 

 

 

Automotive service

 

$   3,744

 

$   3,859

 

$   7,558

 

$   7,855

 

Automotive tire services

 

5,656

 

6,595

 

11,290

 

12,224

 

Beverages

 

6,105

 

5,843

 

12,210

 

11,512

 

Child care

 

5,365

 

5,434

 

10,781

 

11,003

 

Convenience stores

 

19,368

 

19,262

 

38,664

 

38,490

 

Drug stores

 

4,092

 

4,035

 

8,124

 

7,759

 

General merchandise

 

1,765

 

679

 

2,434

 

1,329

 

Grocery stores

 

4,387

 

1,634

 

8,779

 

3,268

 

Health and fitness

 

7,955

 

6,242

 

15,932

 

12,474

 

Restaurants - casual dining

 

8,648

 

11,329

 

17,522

 

22,714

 

Restaurants - quick service

 

7,045

 

5,976

 

14,386

 

12,391

 

Theaters

 

11,127

 

7,980

 

22,259

 

15,936

 

Transportation services

 

2,918

 

2,157

 

5,627

 

2,848

 

Wholesale club

 

3,025

 

-

 

6,051

 

-

 

25 non-reportable segments

 

23,838

 

20,336

 

47,443

 

38,131

 

Total rental revenue

 

115,038

 

101,361

 

229,060

 

197,934

 

Other revenue

 

605

 

259

 

858

 

398

 

Total revenue

 

$ 115,643

 

$ 101,620

 

$ 229,918

 

$ 198,332

 

 

17.     Common Stock Incentive Plans

 

In March 2012, our Board of Directors adopted, and in May 2012, stockholders approved, the Realty Income Corporation 2012 Incentive Award Plan, or the 2012 Plan, to enable us to attract and retain the services of directors, employees and consultants, considered essential to our long-term success. The 2012 Plan offers our directors, employees and consultants an opportunity to own stock in Realty Income and/or rights that will reflect our growth, development and financial success.  Under the terms of this plan, the aggregate number of shares of our common stock subject to options, stock purchase rights, or SPR, stock appreciation rights, or SAR, and other awards, will be no more than 3,985,734 shares. The maximum number of shares that may be subject to options, SPR, SAR and other awards granted under the plan to any individual in any calendar year may not exceed 3,200,000. The 2012 Plan replaced the 2003 Incentive Award Plan of Realty Income Corporation, or the 2003 Plan, which was set to expire in March 2013. No further awards will be granted under the 2003 Plan. The disclosures below incorporate activity for both the 2003 Plan and the 2012 Plan.

 

The amount of share-based compensation costs recognized in general and administrative expense on our consolidated statements of income was $2.6 million during the second quarter of 2012, was $2.2 million during the second quarter of 2011, was $5.6 million during the first six months of 2012, and was $4.3 million during the first six months of 2011.

 

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Table of Contents

 

The following table summarizes our common stock grant activity under our 2003 Plan and 2012 Plan, or the Incentive Award Plans.  Our common stock grants vest over periods ranging from immediately to 10 years.

 

 

 

For the six
months ended
June 30, 2012

 

For the year ended
December 31, 2011

 

 

 

Number of
shares

 

Weighted
average
price 
(1)

 

Number of
shares

 

Weighted
average
price 
(1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Outstanding nonvested shares, beginning of year

 

 

925,526

 

 

$ 20.21

 

 

924,294

 

 

$ 19.69

 

Shares granted

 

 

260,411

 

 

35.03

 

 

247,214

 

 

33.94

 

Shares vested

 

 

(286,276

)

 

27.39

 

 

(245,487

)

 

25.26

 

Shares forfeited

 

 

(275

)

 

26.02

 

 

(495

)

 

31.37

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Outstanding nonvested shares, end of each period

 

 

899,386

 

 

$ 24.76

 

 

925,526

 

 

$ 20.21

 

 

(1) Grant date fair value.

 

During the first six months of 2012, we issued 260,411 shares of common stock under our Incentive Award Plans. These shares vest over the following service periods: 26,484 vested immediately, 68,600 vest over a service period of two years, 16,000 vest over a service period of three years and 149,327 vest over a service period of five years.

 

As of June 30, 2012, the remaining unamortized share-based compensation expense totaled $22.3 million, which is being amortized on a straight-line basis over the service period of each applicable award.

 

Due to a historically low turnover rate, we do not estimate a forfeiture rate for our nonvested shares. Accordingly, unexpected forfeitures will lower share-based compensation expense during the applicable period. Under the terms of our Incentive Award Plans, we pay non-refundable dividends to the holders of our nonvested shares. Applicable accounting guidance requires that the dividends paid to holders of these nonvested shares be charged as compensation expense to the extent that they relate to nonvested shares that do not or are not expected to vest. However, since we do not estimate forfeitures given our historical trends, we did not record any amount to compensation expense related to dividends paid in 2012 or 2011.

 

18.     Dividend Reinvestment and Stock Purchase Plan

 

In March 2011, we established a Dividend Reinvestment and Stock Purchase Plan, or the DSPP, to provide our common stockholders, as well as new investors, with a convenient and economical method of purchasing our common stock and reinvesting their distributions. The DSPP also allows our current stockholders to buy additional shares of common stock by reinvesting all or a portion of their distributions. The DSPP authorizes up to 6,000,000 common shares to be issued.  During the first six months of 2012, we issued 41,513 shares and raised approximately $1.6 million under the DSPP. Since inception of the DSPP, we have issued 101,118 shares and raised approximately $3.6 million.

 

19.     Commitments and Contingencies

 

In the ordinary course of 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 financial position or results of operations.

 

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At June 30, 2012, we have contingent payments of $2.8 million for tenant improvements and leasing costs. In addition, we have committed $9.9 million under construction contracts, which is expected to be paid in the next six months.

 

20.     Subsequent Events

 

In July 2012, we declared the following dividends, which will be paid in August 2012:

 

-                    $0.146125 per share to our common stockholders;

-                    $0.140625 per share to our Class E preferred stockholders; and

-                    $0.138021 per share to our Class F preferred stockholders.

 

Item 2.              Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

FORWARD-LOOKING STATEMENTS

 

This quarterly report on Form 10-Q, including the documents incorporated by reference, contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. When used in this quarterly report, the words “estimated”, “anticipated”, “expect”, “believe”, “intend” and similar expressions are intended to identify forward-looking statements. Forward-looking statements include discussions of strategy, plans, or intentions of management. Forward-looking statements are subject to risks, uncertainties, and assumptions about Realty Income Corporation, including, among other things:

 

·                  Our anticipated growth strategies;

·                  Our intention to acquire additional properties and the timing of these acquisitions;

·                  Our intention to sell properties and the timing of these property sales;

·                  Our intention to re-lease vacant properties;

·                  Anticipated trends in our business, including trends in the market for long-term net-leases of freestanding, single-tenant properties; and

·                  Future expenditures for development projects.

 

Future events and actual results, financial and otherwise, may differ materially from the results discussed in the forward-looking statements.  In particular, some of the factors that could cause actual results to differ materially are:

 

·                  Our continued qualification as a real estate investment trust;

·                  General business and economic conditions;

·                  Competition;

·                  Fluctuating interest rates;

·                  Access to debt and equity capital markets;

·                  Continued volatility and uncertainty in the credit markets and broader financial markets;

·                  Other risks inherent in the real estate business including tenant defaults, potential liability relating to environmental matters, illiquidity of real estate investments, and potential damages from natural disasters;

·                  Impairments in the value of our real estate assets;

·                  Changes in the tax laws of the United States of America;

·                  The outcome of any legal proceedings to which we are a party or which may occur in the future; and

·                  Acts of terrorism and war.

 

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Additional factors that may cause risks and uncertainties include those discussed in the sections entitled “Business”, “Risk Factors”, and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011.

 

Readers are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date that this quarterly report was filed with the Securities and Exchange Commission, or SEC. While forward-looking statements reflect our good faith beliefs, they are not guarantees of future performance. We undertake no obligation to publicly release the results of any revisions to these forward-looking statements that may be made to reflect events or circumstances after the date of this quarterly report or to reflect the occurrence of unanticipated events. In light of these risks and uncertainties, the forward-looking events discussed in this quarterly report might not occur.

 

THE COMPANY

 

Realty Income Corporation, The Monthly Dividend Company®, is a Maryland corporation organized to operate as an equity real estate investment trust, or REIT. Our primary business objective is to generate dependable monthly cash distributions from a consistent and predictable level of funds from operations, or FFO, per share. Our monthly distributions are supported by the cash flow from our portfolio of properties leased to retail and other commercial enterprises. We have in-house acquisition, leasing, legal, credit research, real estate research, portfolio management, and capital markets expertise. Over the past 43 years, Realty Income and its predecessors have been acquiring and owning freestanding retail and other properties that generate rental revenue under long-term lease agreements (primarily 10 to 20 years).

 

In addition, we seek to increase distributions to stockholders and FFO per share through both active portfolio management and the acquisition of additional properties.

 

Generally, our portfolio management efforts seek to achieve:

 

·                  Contractual rent increases on existing leases;

·                  Rent increases at the termination of existing leases, when market conditions permit; and

·                  The active management of our property portfolio, including re-leasing vacant properties, and selectively selling properties, thereby mitigating our exposure to certain tenants and markets.

 

In acquiring additional properties, our strategy is primarily to acquire properties that are:

 

·                  Freestanding, single-tenant locations;

·                  Leased to regional and national commercial enterprises; and

·                  Leased under long-term, net-lease agreements.

 

At June 30, 2012, we owned a diversified portfolio:

 

·                  Of 2,762 properties;

·                  With an occupancy rate of 97.3%, or 2,687 properties leased and only 75 properties available for lease;

·                  Leased to 136 different retail and other commercial enterprises doing business in 38 separate industries;

·                  Located in 49 states;

·                  With over 28.7 million square feet of leasable space; and

·                  With an average leasable space per property of approximately 10,400 square feet.

 

Of the 2,762 properties in the portfolio, 2,746, or 99.4%, are single-tenant properties, and the remaining 16 are multi-tenant properties. At June 30, 2012, of the 2,746 single-tenant properties, 2,672 were leased with a weighted average remaining lease term (excluding rights to extend a lease at the option of the tenant) of approximately 11.1 years.

 

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We typically acquire properties under long-term leases with regional and national retailers and other commercial enterprises. Our acquisition and investment activities generally focus on businesses providing goods and services that satisfy basic consumer and business needs. In general, our net-lease agreements:

 

·                  Are for initial terms of 10 to 20 years;

·                  Require the tenant to pay minimum monthly rent and property operating expenses (taxes, insurance, and maintenance); and

·                  Provide for future rent increases based on increases in the consumer price index (typically subject to ceilings), additional rent calculated as a percentage of the tenants’ gross sales above a specified level, or fixed increases.

 

Investment Philosophy

We believe that owning an actively managed, diversified portfolio of commercial properties under long-term, net leases produces consistent and predictable income.  Net leases typically require the tenant to be responsible for monthly rent and property operating expenses including property taxes, insurance, and maintenance.  In addition, tenants are typically subject to future rent increases based on increases in the consumer price index (typically subject to ceilings), additional rent calculated as a percentage of the tenants’ gross sales above a specified level, or fixed increases. We believe that a portfolio of properties under long-term leases, coupled with the tenant’s responsibility for property expenses, generally produces a more predictable income stream than many other types of real estate portfolios, while continuing to offer the potential for growth in rental income.

 

Investment Strategy

When identifying new properties for acquisition, our focus is generally on providing capital to owners and operators of retail and other commercial enterprises by acquiring, then leasing back, the real estate they consider important to the successful operation of their business.

 

We primarily focus on acquiring properties leased to retail and other commercial enterprises based on the following guidelines:

 

·                  Tenants with reliable and sustainable cash flow;

·                  Tenants with revenue and cash flow from multiple sources;

·                  Large owners and users of real estate;

·                  Real estate that is critical to the tenant’s ability to generate revenue (i.e. they need the property in which they operate in order to conduct their business);

·                  Real estate and tenants that are willing to sign a long-term lease (10 or more years); and

·                  Property transactions where we can achieve an attractive spread over our cost of capital.

 

Historically, our investment focus has primarily been on retail and other commercial enterprises that have a service component because we believe the lease revenue from these types of businesses is more stable. Because of this investment focus, for the quarter ended June 30, 2012, approximately 77% of our retail rental revenue was derived from tenants with a service component in their business. We believe these service-oriented businesses would generally be difficult to duplicate over the Internet and that our properties continue to perform well relative to competition from Internet-based businesses.

 

Credit Strategy

We typically acquire and lease properties to regional and national commercial enterprises and believe that within this market we can achieve an attractive risk-adjusted return. Since 1970, our occupancy rate at the end of each year has never been below 96%.

 

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We believe the principal financial obligations of most commercial enterprises typically include their bank and other debt, payment obligations to suppliers and real estate lease obligations. Because we typically own the land and building in which a tenant conducts its business, we believe the risk of default on a tenant’s lease obligations is less than the tenant’s unsecured general obligations. It has been our experience that since tenants must retain their profitable locations in order to survive, in the event of reorganization they are less likely to reject a lease for a profitable location because this would terminate their right to use the property. Thus, as the property owner, we believe we will fare better than unsecured creditors of the same tenant in the event of reorganization. If a property is rejected by the tenant during reorganization, we own the property and can either lease it to a new tenant or sell the property. In addition, we believe that the risk of default on the real estate leases can be further mitigated by monitoring the performance of the tenants’ individual locations and considering whether to sell locations that are weaker performers.

 

In order to qualify for inclusion in our portfolio, new property acquisitions must meet stringent investment and credit requirements. The properties must generate attractive current yields and the tenant must meet our credit profile.  We have established a four-part analysis that examines each potential investment based on:

 

·                  Industry, company, market conditions and credit profile;

·                  For retail locations, store profitability, if profitability data is available;

·                  The importance of the location of the real estate to the operations of the company’s business; and

·                  Overall real estate characteristics, including property value and comparative rental rates.

 

Acquisition Strategy

We seek to invest in industries in which several, well-organized, regional and national retailers and other commercial enterprises are capturing market share through service, quality control, economies of scale, strong consumer brands, advertising, and the selection of prime locations. Our acquisition strategy is to act as a source of capital to regional and national commercial enterprises by acquiring and leasing back their real estate locations. We undertake thorough research and analysis to identify what we consider to be appropriate industries, tenants, and property locations for investment. Our research expertise is instrumental to uncovering net-lease opportunities in markets where our real estate financing program adds value. In selecting potential investments, we generally seek to acquire real estate that has the following characteristics:

 

·                  Properties that are freestanding, commercially-zoned with a single tenant;

·                 Properties that are important locations for regional and national commercial enterprises;

·                  Properties that we deem to be profitable for the tenants and/or can generally be characterized as important to the operations of the company’s business;

·                  Properties that are located within attractive demographic areas, relative to the business of our tenants, with high visibility and easy access to major thoroughfares; and

·                  Properties that can be purchased with the simultaneous execution or assumption of long-term, net-lease agreements, offering both current income and the potential for rent increases.

 

Portfolio Management Strategy

The active management of the property portfolio is an essential component of our long-term strategy. We continually monitor our portfolio for any changes that could affect the performance of the industries, tenants, and locations in which we have invested. We also regularly analyze our portfolio with a view toward optimizing its returns and enhancing our credit quality.

 

Our executives regularly review and analyze:

 

·                  The performance of the various industries of our tenants; and

·                  The operation, management, business planning and financial condition of our tenants.

 

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We have an active portfolio management program that incorporates the sale of assets when we believe the reinvestment of the sale proceeds will:

 

·                  Generate higher returns;

·                  Enhance the credit quality of our real estate portfolio;

·                  Extend our average remaining lease term; or

·                  Decrease tenant or industry concentration.

 

At June 30, 2012, we classified real estate with a carrying amount of $19.0 million as held for sale on our balance sheet. For the remainder of 2012, we intend to employ more active disposition efforts to further enhance the credit quality of our real estate portfolio. As a result, we anticipate selling investment properties from our portfolio that have not yet been specifically identified, from which we anticipate receiving between $25 million and $70 million in proceeds during the next 12 months. We intend to invest these proceeds into new property acquisitions, if there are attractive opportunities available. However, we cannot guarantee that we will sell properties during the next 12 months or be able to invest the proceeds from the sales of any properties in new properties.

 

Impact of Real Estate and Credit Markets

In the commercial real estate market, property prices have continued or generally continue to fluctuate. Likewise, during certain periods, the U.S. credit markets have experienced significant price volatility, dislocations, and liquidity disruptions, which may impact our access to and cost of capital. We continue to monitor the commercial real estate and U.S. credit markets carefully and, if required, will make decisions to adjust our business strategy accordingly. See our discussion of “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2011.

 

RECENT DEVELOPMENTS

 

Increases in Monthly Dividends to Common Stockholders

We have continued our 43-year policy of paying monthly dividends. Monthly dividends per common share increased by $0.0003125 in April 2012 to $0.1458125, and increased by $0.0003125 in July 2012 to $0.146125. The increase in July 2012 was our 59th consecutive quarterly increase and the 66th increase in the amount of our dividend since our listing on the New York Stock Exchange, or NYSE, in 1994. In the first six months of 2012, we paid three monthly cash dividends per share in the amount of $0.1455 and three in the amount of $0.1458125, totaling $0.8739375. In June 2012 and July 2012, we declared dividends of $0.146125 per share, which were paid in July 2012 and will be paid in August 2012, respectively.

 

The monthly dividends of $0.146125 per share represents current annualized dividends of $1.7535 per share, and an annualized dividend yield of approximately 4.2% based on the last reported sale price of our common stock on the NYSE of $41.77 on June 30, 2012. Although we expect to continue our policy of paying monthly dividends, we cannot guarantee that we will maintain our current level of dividends, that we will continue our pattern of increasing dividends per share, or what our actual dividend yield will be in any future period.

 

Acquisitions during the Second Quarter of 2012

During the second quarter of 2012, Realty Income invested $210.8 million in 145 new properties and properties under development, with an initial weighted average contractual lease rate of 7.1%. These 145 new properties are located in 28 states, will contain over 1.4 million leasable square feet, and are 100% leased with an average lease term of 15.0 years.

 

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Acquisitions during the First Six Months of 2012

During the first six months of 2012, Realty Income invested $221.5 million in 147 new properties and properties under development, with an initial weighted average contractual lease rate of 7.2%. These 147 new properties are located in 28 states, will contain over 1.4 million leasable square feet, and are 100% leased with an average lease term of 15.0 years. The tenants of the 147 properties acquired, operate in six industries: automotive collision services, crafts and novelties, drug store, general merchandise, restaurants – quick service, and transportation services.

 

The initial weighted average contractual lease rate is computed as estimated contractual net operating income (in a net-leased property that is equal to the aggregate base rent or, in the case of properties under development, the estimated aggregate base rent) for the first year of each lease, divided by the estimated total cost of the properties. 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 percentages listed above.

 

In April 2012 we announced the signing of purchase agreements to acquire properties with an aggregate value of approximately $514 million, which were anticipated to close during the second quarter.  Included in the $221.5 million invested during the first six months of 2012, is $198 million invested in 139 properties of the previously announced acquisitions. Agreements to acquire properties for approximately $316 million have been terminated and will not be acquired. However, transaction flow remains strong, and we continue to believe we will meet or exceed our previously stated 2012 target of $650 million in new property acquisitions. While the total amount of acquisitions for 2012 will likely be higher than previously anticipated, the timing of the remaining acquisitions will be weighted more heavily towards the end of the year.

 

Portfolio Discussion

 

Leasing Results

At June 30, 2012, we had 75 properties available for lease out of 2,762 properties in our portfolio, which represents a 97.3% occupancy rate. Since December 31, 2011, when we reported 87 properties available for lease and a 96.7% occupancy rate, we:

 

·                  Leased 24 properties;

·                  Sold ten properties available for lease; and

·                  Have 22 new properties available for lease.

 

During the first six months of 2012, 62 properties with expiring leases were leased to either existing or new tenants.  The rent on these leases was $4.7 million, as compared to the previous rent charged on these same properties of $4.8 million. At June 30, 2012, our average annualized rental revenue was approximately $16.99 per square foot on the 2,687 leased properties in our portfolio.

 

Investments in Existing Properties

In the second quarter of 2012, we capitalized costs of $1.3 million on existing properties in our portfolio, consisting of $431,000 for re-leasing costs and $914,000 for building and tenant improvements.

 

In the first six months of 2012, we capitalized costs of $2.4 million on existing properties in our portfolio, consisting of $698,000 for re-leasing costs and $1.7 million for building and tenant improvements.

 

As part of our re-leasing costs, we pay leasing commissions and sometimes provide tenant rent concessions.  Leasing commissions are paid based on the commercial real estate industry standard and any rent concessions provided are minimal.  We do not consider the collective impact of the leasing commissions or tenant rent concessions to be material to our financial position or results of operations.

 

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The majority of our building and tenant improvements are related to roof repairs, HVAC improvements, and parking lot resurfacing and replacements. It is not customary for us to offer significant tenant improvements on our properties as tenant incentives. The amounts of our capital expenditures can vary significantly, depending on the rental market, credit worthiness, and the willingness of tenants to pay higher rents over the terms of the leases.

 

$1 Billion Acquisition Credit Facility

In May 2012, we entered into a new $1 billion unsecured acquisition credit facility, which replaced our $425 million acquisition credit facility that was scheduled to expire in March 2014. The initial term of the new credit facility expires in May 2016 and includes, at our option, a one-year extension. Under this new credit facility, our current investment grade credit ratings provide for financing at the London Interbank Offered Rate, commonly referred to as LIBOR, plus 1.075% with a facility commitment fee of 0.175%, for all-in drawn pricing of 1.25% over LIBOR. The borrowing rate is not subject to an interest rate floor or ceiling. We also have other interest rate options available to us. Our credit facility is unsecured and, accordingly, we have not pledged any assets as collateral for this obligation.

 

Issuances and Redemption of Preferred Stock

In February 2012, we issued 14.95 million shares of our 6.625% Monthly Income Class F Cumulative Redeemable Preferred Stock at a price of $25 per share, including 1.95 million shares purchased by the underwriters upon the exercise of their overallotment option. In April 2012, we issued an additional 1.4 million shares of our Class F preferred stock at a price $25.2863 per share. Of the aggregate net proceeds of approximately $395.4 million from these issuances, $127.5 million were used to redeem all of our outstanding 7.375% Monthly Income Class D Cumulative Redeemable Preferred Stock and the balance was used to repay borrowings under our credit facility.  The dividend rate difference of 0.75% between the Class D and Class F preferred stock provides us dividend savings of $956,000 annually on the Class D redemption amount of $127.5 million. Beginning February 15, 2017, the Class F preferred shares are redeemable, at our option, for $25 per share. The initial dividend of $0.1702257 per share was paid on March 15, 2012, and covered 37 days. Thereafter, dividends of $0.138021 per share will be paid monthly, in arrears.

 

We redeemed all of the 5.1 million shares of our 7.375% Monthly Income Class D Cumulative Redeemable Preferred Stock in March 2012 for $25 per share, plus accrued dividends. We incurred a charge of $3.7 million, representing the Class D preferred stock original issuance costs that we paid in 2004.

 

Universal Shelf Registration

In March 2012, we filed a shelf registration statement with the SEC, which is effective for a term of three years and will expire in March 2015. This replaces our prior shelf registration statement, which expired in March 2012. In accordance with SEC rules, the amount of securities to be issued pursuant to this shelf registration statement was not specified when it was filed and there is no specific dollar limit. The securities covered by this registration statement include (1) common stock, (2) preferred stock, (3) debt securities, (4) depositary shares representing fractional interests in shares of preferred stock, (5) warrants to purchase debt securities, common stock, preferred stock or depositary shares, and (6) any combination of these securities. We may periodically offer one or more of these securities in amounts, prices and on terms to be announced when and if the securities are offered. The specifics of any future offerings, along with the use of proceeds of any securities offered, will be described in detail in a prospectus supplement, or other offering materials, at the time of any offering.

 

2012 Incentive Award Plan

In March 2012, our Board of Directors adopted, and in May 2012, stockholders approved, the Realty Income Corporation 2012 Incentive Award Plan, or the 2012 Plan, to enable us to attract and retain the services of directors, employees and consultants, considered essential to our long-term success. The 2012 Plan offers our directors, employees and consultants an opportunity to own stock in Realty Income and/or rights that will reflect our growth, development and financial success.  The 2012 Plan replaced the 2003 Incentive Award Plan of Realty Income Corporation, which was set to expire in March 2013.

 

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Net Income Available to Common Stockholders

Net income available to common stockholders was $33.0 million in the second quarter of 2012, versus $33.2 million in the second quarter of 2011, a decrease of $235,000. On a diluted per common share basis, net income was $0.25 in the second quarter of 2012, compared to $0.26 in the second quarter of 2011.

 

Net income available to common stockholders was $59.0 million in the first six months of 2012, versus $63.1 million in the same period of 2011, a decrease of $4.1 million. On a diluted per common share basis, net income was $0.44 in the first six months of 2012, compared to $0.51 in the first six months of 2011. Net income available to common stockholders in the first six months of 2012 includes a $3.7 million charge for the excess of redemption value over carrying value of the Class D preferred shares, which represents $0.03 on a diluted per common share basis.

 

The calculation to determine net income available to common stockholders includes gains from the sale of properties. The amount of gains varies from period to period based on the timing of property sales and can significantly impact net income available to common stockholders.

 

The gain from the sale of properties during the second quarter of 2012 was $3.4 million, as compared to the gain from the sale of properties and excess land of $1.3 million during the second quarter of 2011. The gain from the sale of properties during the first six months of 2012 was $4.0 million, as compared to the gain from the sale of properties and excess land of $1.4 million during the first six months of 2011.

 

Funds from Operations Available to Common Stockholders (FFO)

In the second quarter of 2012, our FFO increased by $4.3 million, or 7.1%, to $65.2 million, versus $60.9 million in the second quarter of 2011. On a diluted per common share basis, FFO was $0.49 in the second quarter of 2012, compared to $0.48 in the second quarter of 2011, an increase of $0.01, or 2.1%.

 

In the first six months of 2012, our FFO increased by $8.2 million, or 7.0%, to $125.9 million, versus $117.7 million in the first six months of 2011. On a diluted per common share basis, FFO was $0.95 in the first six months of 2012, compared to $0.96 in the first six months of 2011, a decrease of $0.01, or 1.0%. FFO in the first six months of 2012 includes a $3.7 million charge for the excess of redemption value over carrying value of the Class D preferred shares, which represents $0.03 on a diluted per common share basis.

 

See our discussion of FFO (which is not a financial measure under U.S. generally accepted accounting principles, or GAAP) later in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” which includes a reconciliation of net income available to common stockholders to FFO.

 

Adjusted Funds from Operations Available to Common Stockholders (AFFO)

In the second quarter of 2012, our AFFO increased by $4.1 million, or 6.6%, to $66.5 million, versus $62.4 million in the second quarter of 2011. On a diluted per common share basis, AFFO was $0.50 in the second quarter of 2012, as compared to $0.49 in the second quarter of 2011, an increase of $0.01, or 2.0%. In the first six months of 2012, our AFFO increased by $12.2 million, or 10.1%, to $132.8 million, versus $120.6 million in the first six months of 2011. On a diluted per common share basis, AFFO was $1.00 in the first six months of 2012, as compared to $0.98 in the first six months of 2011, an increase of $0.02, or 2.0%.

 

See our discussion of AFFO (which is not a financial measure under GAAP) later in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” which includes a reconciliation of net income available to common stockholders to FFO and AFFO.

 

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LIQUIDITY AND CAPITAL RESOURCES

 

Capital Philosophy

Historically, we have met our long-term capital needs by issuing common stock, preferred stock and long-term unsecured notes and bonds. Over the long term, we believe that common stock should be the majority of our capital structure. 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 accretively invested into additional properties. In addition, we may issue common stock to permanently finance properties that were financed by our credit facility or debt securities. However, we cannot assure you that we will have access to the capital markets at times and at terms that are acceptable to us.

 

Our primary cash obligations, for the current year and subsequent years, are included in the “Table of Obligations,” which is presented later in this section. We expect to fund our operating expenses and other short-term liquidity requirements, including property acquisitions and development costs, payment of principal and interest on our outstanding indebtedness, property improvements, re-leasing costs and cash distributions to common and preferred stockholders, primarily through cash provided by operating activities, borrowing on our $1 billion credit facility, and occasionally through public securities offerings.

 

Conservative Capital Structure

We believe that our stockholders are best served by a conservative capital structure. Therefore, we seek to maintain a conservative debt level on our balance sheet and solid interest and fixed charge coverage ratios. At June 30, 2012, our total outstanding borrowings of senior unsecured notes, mortgages payable and credit facility borrowings were $1.99 billion, or approximately 24.3% of our total market capitalization of $8.19 billion.

 

We define our total market capitalization at June 30, 2012 as the sum of:

·                  Shares of our common stock outstanding of 133,439,028 multiplied by the last reported sales price of our common stock on the NYSE of $41.77 per share on June 30, 2012, or $5.57 billion;

·                  Aggregate liquidation value (par value of $25 per share) of the Class E preferred stock of $220 million;

·                  Aggregate liquidation value (par value of $25 per share) of the Class F preferred stock of $408.8 million;

·                  Outstanding borrowings of $183.6 million on our credit facility;

·                  Outstanding mortgages payable of $56.7 million; and

·                  Outstanding senior unsecured notes and bonds of $1.75 billion.

 

Mortgage Debt

As of June 30, 2012, we had $56.2 million of mortgages payable, which were assumed in connection with our property acquisitions in 2011. Additionally, at June 30, 2012, we have net premiums totaling $463,000 on these mortgages. During the first six months of 2012, we paid $11 million in principal payments, which includes $10.7 million to pay off one mortgage in March.

 

Our mortgages payable are secured by the properties on which the debt was placed and are non-recourse. We expect to pay off the mortgages payable as soon as prepayment penalties and costs make it economically feasible to do so. We intend to continue our policy of primarily identifying property acquisitions that are free from mortgage indebtedness.

 

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$1 Billion Acquisition Credit Facility

In May 2012, we entered into a new $1 billion unsecured acquisition credit facility, which replaced our $425 million acquisition credit facility that was scheduled to expire in March 2014. The initial term of the credit facility expires in May 2016 and includes, at our option, a one-year extension. Under this new credit facility, our current investment grade credit ratings provide for financing at LIBOR, plus 1.075% with a facility commitment fee of 0.175%, for all-in drawn pricing of 1.25% over LIBOR, as compared to our previous credit facility where the interest rate was LIBOR, plus 1.85% with a facility commitment fee of 0.35%, for all-in drawn pricing of 2.20% over LIBOR. The borrowing rate is not subject to an interest rate floor or ceiling.  We also have other interest rate options available to us. At June 30, 2012, we had a borrowing capacity of $816.4 million available on our credit facility (subject to customary conditions to borrowing) and an outstanding balance of $183.6 million. The interest rate on borrowings outstanding under our credit facility, at June 30, 2012, was 1.3% per annum. We must comply with various financial and other covenants in our credit facility. At June 30, 2012, we remain in compliance with these covenants.

 

We expect to use our credit facility to acquire additional properties and for other corporate purposes.  Any additional borrowings will increase our exposure to interest rate risk. We have the right to request an increase in the borrowing capacity of the credit facility, up to $500 million, to a total borrowing capacity of $1.5 billion. Any increase in the borrowing capacity is subject to approval by the lending banks participating in our credit facility.

 

We generally use our credit facility for the short-term financing of new property acquisitions. Thereafter, when capital is available on acceptable terms, we generally seek to refinance those borrowings with the net proceeds of long-term or permanent financing, which may include the issuance of common stock, preferred stock or debt securities. We cannot assure you, however, that we will be able to obtain any such refinancing, or that market conditions prevailing at the time of the refinancing will enable us to issue equity or debt securities upon acceptable terms.

 

Authorized Shares

In June 2012, our stockholders approved an increase in the number of authorized shares of our common stock to 370,100,000 and the number of authorized shares of our preferred stock to 69,900,000.

 

Cash Reserves

We acquire and lease properties and distribute to stockholders, in the form of monthly cash dividends, a substantial portion of our net cash flow generated from leases on our properties. We intend to retain an appropriate amount of cash as working capital. At June 30, 2012, we had cash and cash equivalents totaling $6.1 million.

 

We believe that our cash and cash equivalents on hand, cash provided from operating activities, and borrowing capacity is 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 future borrowings under our credit facility.

 

Credit Agency Ratings

The borrowing rates under our credit facility are based upon our credit ratings. We are currently assigned the following investment grade corporate credit ratings on our senior unsecured notes and bonds:  Fitch Ratings has assigned a rating of BBB+, Moody’s Investors Service has assigned a rating of Baa1 and Standard & Poor’s Ratings Group has assigned a rating of BBB to our senior notes. All of these ratings have “stable” outlooks.

 

Based on our current ratings, the current facility interest rate is LIBOR plus 1.075% with a facility commitment fee of 0.175%, for all-in drawn pricing of 1.25% over LIBOR. The credit facility provides that the interest rate can range between: (i) LIBOR plus 1.85% if our credit facility is lower than BBB-/Baa3 and (ii) LIBOR plus 1.00% if our credit rating is A-/A3 or higher.

 

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In addition, our credit facility provides for a facility commitment fee based on our credit ratings, which ranges from (i) 0.45% for a rating lower than BBB-/Baa3, and (ii) 0.15% for a credit rating of A-/A3 or higher.

 

We also issue senior debt securities from time to time and our credit ratings can impact the interest rates charged in those transactions. If our credit ratings or ratings outlook change, our cost to obtain debt financing could increase or decrease.

 

The credit ratings assigned to us could change based upon, among other things, our results of operations and financial condition. These ratings are subject to ongoing evaluation by credit rating agencies and we cannot assure you that our ratings will not be changed or withdrawn by a rating agency in the future if, in its judgment, circumstances warrant. Moreover, a rating is not a recommendation to buy, sell or hold our debt securities, preferred stock or common stock.

 

Notes Outstanding

Our senior unsecured note and bond obligations consist of the following as of June 30, 2012, sorted by maturity date (dollars in millions):

 

5.375% notes, issued in March 2003 and due in March 2013

 

$

100

 

5.5% notes, issued in November 2003 and due in November 2015

 

150

 

5.95% notes, issued in September 2006 and due in September 2016

 

275

 

5.375% notes, issued in September 2005 and due in September 2017

 

175

 

6.75% notes, issued in September 2007 and due in August 2019

 

550

 

5.75% notes, issued in June 2010 and due in January 2021

 

250

 

5.875% bonds, $100 issued in March 2005 and $150 issued in June 2011, both due in March 2035

 

250

 

 

 

$

1,750

 

 

All of our outstanding unsecured notes and bonds have fixed interest rates. Interest on all of our senior note and bond obligations is paid semiannually. All of these notes and bonds contain various covenants, including: (i) a limitation on incurrence of any debt which would cause our debt to total adjusted assets ratio to exceed 60%; (ii) a limitation on incurrence of any secured debt which would cause our secured debt to total adjusted assets ratio to exceed 40%; (iii) a limitation on incurrence of any debt which would cause our debt service coverage ratio to be less than 1.5 times; and (iv) the maintenance at all times of total unencumbered assets not less than 150% of our outstanding unsecured debt. At June 30, 2012, we remain in compliance with these covenants.

 

The following is a summary of the key financial covenants for our senior unsecured notes, as defined and calculated per the terms of our notes. These calculations, which are not based on GAAP measurements, are presented to investors to show our ability to incur additional debt under the terms of our notes only and are not measures of our liquidity or performance. The actual amounts as of June 30, 2012 are:

 

Note Covenants

 

Required

 

Actual

Limitation on incurrence of total debt

 

< 60% of adjusted assets

 

37.8%

Limitation on incurrence of secured debt

 

< 40% of adjusted assets

 

1.1%

Debt service coverage (trailing 12 months)

 

> 1.5 x

 

3.7x

Maintenance of total unencumbered assets

 

> 150% of unsecured debt

 

265.8%

 

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The following table summarizes the maturity of each of our obligations as of June 30, 2012 (dollars in millions):

 

Table of Obligations

 

 

 

 

 

 

 

 

 

 

 

 

Ground

 

Ground

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Leases

 

Leases

 

 

 

 

 

Year of 

 

Credit

 

Notes
and

 

Mortgages

 

 

 

Paid by
Realty

 

Paid by
Our

 

 

 

 

 

Maturity

 

Facility(1)

 

Bonds

 

Payable(2)

 

Interest (3)

 

Income(4)

 

Tenants(5)

 

Other (6)

 

Totals

 

2012

 

$

--

 

 

$

--

 

0.3

 

55.7

 

$

0.1

 

$

2.1

 

$

12.7

 

$

70.9

 

2013

 

--

 

 

100.0

 

20.9

 

107.1

 

0.1

 

4.1

 

--

 

232.2

 

2014

 

--

 

 

--

 

11.4

 

102.5

 

0.1

 

3.9

 

--

 

117.9

 

2015

 

--

 

 

150.0

 

23.6

 

99.7

 

0.1

 

3.9

 

--

 

277.3

 

2016

 

183.6

 

 

275.0

 

--

 

87.2

 

0.1

 

3.8

 

--

 

549.7

 

Thereafter

 

--

 

 

1,225.0

 

--

 

429.3

 

0.2

 

49.3

 

--

 

1,703.8

 

Totals

 

$

183.6

 

 

$

1,750.0

 

56.2

 

881.5

 

$

0.7

 

$

67.1

 

$

12.7

 

$

2,951.8

 

 

(1) The initial term of the credit facility expires in May 2016 and includes, at our option, a one-year extension.

(2) Excludes net premiums recorded on the mortgages payable.  The balance of these net premiums at June 30, 2012, is $463,000.

(3) Interest on the credit facility, notes, bonds and mortgages payable has been calculated based on outstanding balances as of June 30, 2012 through their respective maturity dates.

(4) Realty Income currently pays the ground lessors directly for the rent under the ground leases.

(5) Our tenants, who are generally sub-tenants under ground leases, are responsible for paying the rent under these ground leases. In the event a tenant fails to pay the ground lease rent, we are primarily responsible.

(6) “Other” consists of $9.9 million of commitments under construction contracts and $2.8 million of contingent payments for tenant improvements and leasing costs.

 

Our credit facility and notes payable obligations are unsecured. Accordingly, we have not pledged any assets as collateral for these obligations. Our mortgages payable are secured by the properties on which the debt was placed and are non-recourse.

 

Preferred Stock Outstanding

In 2006, we issued 8.8 million shares of our 6.75% Monthly Income Class E Cumulative Redeemable Preferred Stock. Beginning December 7, 2011, shares of Class E preferred stock were redeemable at our option for $25 per share, plus any accrued and unpaid dividends. Dividends on shares of Class E preferred stock are paid monthly in arrears.

 

In February 2012, we issued 14.95 million shares of our 6.625% Monthly Income Class F Cumulative Redeemable Preferred Stock at $25 per share, including 1.95 million shares purchased by the underwriters upon the exercise of their overallotment option. In April 2012, we issued an additional 1.4 million shares of Class F Cumulative Redeemable Preferred Stock at $25.2863 per share. Beginning February 15, 2017, shares of our Class F preferred stock are redeemable at our option for $25 per share, plus any accrued and unpaid dividends. Dividends on the shares of Class F preferred shares will be paid monthly in arrears.

 

We are current on our obligations to pay dividends on our Class E and Class F preferred stock.

 

No Off-Balance Sheet Arrangements or Unconsolidated Investments

We have no unconsolidated or off-balance sheet investments in “variable interest entities” or off-balance sheet financing, nor do we engage in trading activities involving energy or commodity contracts or other derivative instruments. Additionally, we have no joint ventures or mandatorily redeemable preferred stock. As such, our financial position and results of operations are not affected by accounting regulations regarding the consolidation of off-balance sheet entities and classification of financial instruments with characteristics of both liabilities and equity.

 

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Dividend Policy

Distributions are paid monthly to our common, Class E preferred and Class F preferred stockholders if, and when, declared by our Board of Directors.

 

In order to maintain our status as a REIT for federal income tax purposes, we generally are required to distribute dividends to our stockholders aggregating annually at least 90% of our taxable income (excluding net capital gains), and we are subject to income tax to the extent we distribute less than 100% of our taxable income (including net capital gains). In 2011, our cash distributions totaled $243.6 million, or approximately 127.7% of our estimated taxable income of $190.8 million. Our estimated taxable income reflects non-cash deductions for depreciation and amortization. Our estimated taxable income is presented to show our compliance with REIT dividend requirements and is not a measure of our liquidity or performance.

 

We intend to continue to make distributions to our stockholders that are sufficient to meet this dividend requirement and that will reduce or eliminate our exposure to income taxes. Furthermore, we believe our funds from operations are more than sufficient to support our current level of cash distributions to our stockholders. Our cash distributions to common stockholders, for the first six months of 2012, totaled $116.6 million, representing 87.8% of our adjusted funds from operations available to common stockholders of $132.8 million. In comparison, our 2011 cash distributions to common stockholders totaled $219.3 million, representing 86.5% of our adjusted funds from operations available to common stockholders of $253.4 million.

 

The Class E preferred stockholders receive cumulative distributions at a rate of 6.75% per annum on the $25 per share liquidation preference (equivalent to $1.6875 per annum per share). The Class F preferred stockholders receive cumulative distributions at a rate of 6.625% per annum on the $25 per share liquidation preference (equivalent to $1.65625 per annum per share). Dividends on our Class E and Class F preferred stock are current.

 

Future distributions will be at the discretion of our Board of Directors and will depend on, among other things, our results of operations, FFO, AFFO, cash flow from operations, financial condition and capital requirements, the annual dividend requirements under the REIT provisions of the Internal Revenue Code of 1986, as amended, our debt service requirements and any other factors the Board of Directors may deem relevant. In addition, our credit facility contains financial covenants that could limit the amount of distributions paid by us in the event of a default, and which prohibit the payment of distributions on the common or preferred stock in the event that we fail to pay when due (subject to any applicable grace period) any principal or interest on borrowings under our credit facility.

 

Dividends of our current and accumulated earnings and profits for federal income tax purposes generally will be taxable to stockholders as ordinary income, except to the extent that we recognize capital gains and declare a capital gains dividend, or that such amounts constitute “qualified dividend income” subject to a reduced rate of tax. The maximum tax rate on non-corporate taxpayers for “qualified dividend income” is generally 15%. In general, dividends payable by REITs are not eligible for the reduced tax rate on qualified dividend income, except to the extent that certain holding requirements have been met with respect to the REIT’s stock and the REIT’s dividends are attributable to dividends received from certain taxable corporations (such as our taxable REIT subsidiary, Crest Net Lease, Inc., or Crest) or to income that was subject to tax at the corporate or REIT level (for example, if we distribute taxable income that we retained and paid tax on in the prior taxable year). For taxable years beginning after December 31, 2012, the 15% capital gains tax rate is currently scheduled to increase to 20%, and the rate applicable to dividends is currently scheduled to increase to the tax rate then applicable to ordinary income.

 

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Distributions in excess of earnings and profits generally will first be treated as a non-taxable reduction in the stockholders’ basis in their stock, but not below zero. Distributions in excess of that basis, generally, will be taxable as a capital gain to stockholders who hold their shares as a capital asset. Approximately 20.6% of the distributions to our common stockholders, made or deemed to have been made in 2011, were classified as a return of capital for federal income tax purposes. We estimate that in 2012, between 15% and 22% of the distributions may be classified as a return of capital.

 

Matters Pertaining To Certain Tenants

Friendly Ice Cream Corporation, or Friendly’s, one of our tenants, emerged from bankruptcy on June 28, 2012.  We continue to estimate that we will recover approximately 80% of the $16.1 million of annualized rent that Friendly’s was paying us before their bankruptcy filing.  Buffets Holding, Inc., or Buffets, another one of our tenants, emerged from bankruptcy on July 18, 2012.  We continue to estimate that we will recover approximately 65% of the $18.2 million of annual rent that Buffets was paying us before their bankruptcy filing.

 

RESULTS OF OPERATIONS

 

Critical Accounting Policies

Our consolidated financial statements have been prepared in accordance with GAAP, and are the basis for our discussion and analysis of financial condition and results of operations. Preparing our consolidated financial statements requires us to make a number of estimates and assumptions that affect the reported amounts and disclosures in the consolidated financial statements. We believe that we have made these estimates and assumptions in an appropriate manner and in a way that accurately reflects our financial condition. We continually test and evaluate these estimates and assumptions using our historical knowledge of the business, as well as other factors, to ensure that they are reasonable for reporting purposes. However, actual results may differ from these estimates and assumptions. This summary should be read in conjunction with the more complete discussion of our accounting policies and procedures included in note 2 to our consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2011.

 

In order to prepare our consolidated financial statements according to the rules and guidelines set forth by GAAP, many subjective judgments must be made with regard to critical accounting policies. One of these judgments is our estimate for useful lives in determining depreciation expense for our properties. Depreciation on a majority of our buildings and improvements is computed using the straight-line method over an estimated useful life of 25 years. If we use a shorter or longer estimated useful life, it could have a material impact on our results of operations. We believe that 25 years is an appropriate estimate of useful life.

 

When acquiring a property, we allocate the fair value of real estate acquired to: (1) land, (2) building and improvements, and (3) identified intangible assets and liabilities, based in each case on their estimated fair values. Intangible assets and liabilities consist of above-market or below-market lease value of in-place leases, the value of in-place leases, and tenant relationships, as applicable. In addition, any assumed mortgages payable are recorded at their estimated fair values.

 

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Another significant judgment must be made as to if, and when, impairment losses should be taken on our properties when events or a change in circumstances indicate that the carrying amount of the asset may not be recoverable. A provision is made for impairment if estimated future operating cash flows (undiscounted and without interest charges) plus estimated disposition proceeds (undiscounted) are less than the current book value of the property. Key inputs that we estimate in this analysis include projected rental rates, estimated holding periods, capital expenditures, and property sales capitalization rates. If a property is held for sale, it is carried at the lower of carrying cost or estimated fair value, less estimated cost to sell. The carrying value of our real estate is the largest component of our consolidated balance sheet. Our strategy of primarily holding properties, long-term, directly decreases the likelihood of their carrying values not being recoverable, thus requiring the recognition of an impairment. However, if our strategy, or one or more of the above assumptions were to change in the future, an impairment may need to be recognized. If events should occur that require us to reduce the carrying value of our real estate by recording provisions for impairment, it could have a material impact on our results of operations.

 

The following is a comparison of our results of operations for the three and six months ended June 30, 2012 to the three and six months ended June 30, 2011.

 

Rental Revenue

Rental revenue was $115.0 million for the second quarter of 2012, versus $101.4 million for the second quarter of 2011, an increase of $13.6 million, or 13.4%. The increase in rental revenue in the second quarter of 2012, compared to the second quarter of 2011, is primarily attributable to:

 

·

The 147 properties (1.5 million square feet) acquired by Realty Income in 2012, which generated $1.5 million of rent in the second quarter of 2012;

·

The 164 properties (6.2 million square feet) acquired by Realty Income in 2011, which generated $19.68 million of rent in the second quarter of 2012 compared to $4.95 million of rent in the second quarter of 2011, for an increase of $14.7 million;

·

Same store rents generated on 2,287 properties (19.6 million square feet), during the second quarters of 2012 and 2011, decreased by $1.0 million, or 1.1%, to $92.14 million from $93.18 million;

·

A net decrease of $1.7 million relating to the aggregate of (i) rental revenue from 130 properties (1.1 million square feet) that were available for lease during part of 2012 or 2011, (ii) rental revenue related to 45 properties sold during 2012 and 2011, and (iii) lease termination settlements, which, in aggregate, totaled $1.2 million in the second quarter of 2012 compared to $2.9 million in the second quarter of 2011; and

·

A net increase in straight-line rent and other non-cash adjustments to rent of $197,000, in the second quarter of 2012, as compared to the second quarter of 2011.

 

 

Rental revenue was $229.1 million for the first six months of 2012, versus $197.9 million for the first six months of 2011, an increase of $31.2 million, or 15.8%.  The increase in rental revenue in the first six months of 2012, compared to the first six months of 2011, is primarily attributable to:

 

·

The 147 properties (1.5 million square feet) acquired by Realty Income in 2012, which generated $1.5 million of rent in the first six months of 2012;

·

The 164 properties (6.2 million square feet) acquired by Realty Income in 2011, which generated $39.2 million of rent in the first six months of 2012 compared to $5.6 million in the first six months of 2011, for an increase of $33.6 million;

·

Same store rents generated on 2,287 properties (19.6 million square feet) during the first six months of 2012 and 2011 decreased by $2.0 million, or 1.1%, to $184.46 million from $186.43 million;

·

A net decrease of $2.7 million relating to the aggregate of (i) rental revenue from 130 properties (1.1 million square feet) that were available for lease during part of 2012 or 2011, (ii) rental revenue related to 45 properties sold during 2012 and 2011, and (iii) lease termination settlements, which in aggregate, totaled $2.7 million in the first six months of 2012 compared to $5.4 million in the first six months of 2011; and

 

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·                  A net increase in straight-line rent and other non-cash adjustments to rent of $547,000 in the first six months of 2012 as compared to the first six months of 2011.

 

Excluding 180 leases with Friendly’s and Buffets, same store rents generated on 2,107 properties, during the second quarter of 2012, increased by $908,000, or 1.1%, to $86.45 million from $85.54 million. Excluding 180 leases with Friendly’s and Buffets, same store rents generated on 2,107 properties, during the first six months of 2012, increased by $1.9 million, or 1.1%, to $173.1 million from $171.2 million.

 

For purposes of determining the same store rent property pool, we include all properties that were owned for the entire year-to-date period, as of both the current and prior year except for properties during the current or prior year that; (i) were available for lease at any time, (ii) were under development, (iii) we have made an additional investment in, (iv) were involved in eminent domain and rent was reduced and (v) were re-leased with rent-free periods.  Each of the exclusions from the same store pool is separately addressed within the applicable sentences above explaining the changes in rental revenue for the period.

 

Of the 2,762 properties in the portfolio at June 30, 2012, 2,746, or 99.4%, are single-tenant properties, and the remaining 16 are multi-tenant properties. Of the 2,746 single-tenant properties, 2,672, or 97.3%, were net leased with a weighted average remaining lease term (excluding rights to extend a lease at the option of the tenant) of approximately 11.1 years at June 30, 2012. Of our 2,672 leased single-tenant properties, 2,458, or 92.0%, were under leases that provide for increases in rents through:

 

·                  Primarily base rent increases tied to a consumer price index (typically subject to ceilings);

·                  Percentage rent based on a percentage of the tenants’ gross sales;

·                  Fixed increases; or

·                  A combination of two or more of the above rent provisions.

 

Percentage rent, which is included in rental revenue, was $274,000 in the second quarter of 2012, and $235,000 in the second quarter of 2011. Percentage rent was $852,000 in the first six months of 2012 and $685,000 in the first six months of 2011. Percentage rent, in the second quarter and first six months of 2012, was less than 1% of rental revenue and we anticipate percentage rent to continue to be less than 1% of rental revenue for the remainder of 2012.

 

Our portfolio of real estate, leased primarily to regional and national commercial enterprises under net leases, continues to perform well and provides dependable lease revenue supporting the payment of monthly dividends to our stockholders. At June 30, 2012, our portfolio of 2,762 properties was 97.3% leased with 75 properties available for lease, as compared to 87 at December 31, 2011 and 68 at June 30, 2011. It has been our experience that approximately 2% to 4% of our property portfolio will be unleased at any given time; however, it is possible that the number of properties available for lease could exceed these levels in the future.

 

Depreciation and Amortization

Depreciation and amortization was $35.5 million for the second quarter of 2012, as compared to $28.7 million in the second quarter of 2011. Depreciation and amortization was $70.6 million for the first six months of 2012, as compared to $55.1 million for the first six months of 2011. The increase in depreciation and amortization was primarily due to the acquisition of properties in 2012 and 2011, which was partially offset by property sales in those same years. As discussed in the section entitled “Funds from Operations Available to Common Stockholders,” depreciation and amortization is a non-cash item that is added back to net income available to common stockholders for our calculation of FFO and AFFO.

 

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Interest Expense

Interest expense was $28.8 million for the second quarter of 2012, as compared to $25.6 million for the second quarter of 2011. Interest expense was $57.8 million for the first six months of 2012, as compared to $50.8 million for the first six months of 2011.  The increase in interest expense was primarily due to an increase in borrowings attributable to the $150 million re-opening of our 5.875% senior unsecured bonds due 2035 in June 2011, interest on our mortgages payable, and higher credit facility borrowings, which were partially offset by lower average interest rates.

 

As a result of entering into our current credit facility, we incurred credit facility origination costs of $7.1 million.  At June 30, 2012, included in other assets on our consolidated balance sheet is $6.8 million of the $7.1 million, and $2.5 million incurred as a result of entering into our previous credit facilities.  These costs are being amortized over the remaining term of our current $1 billion credit facility.

 

The following is a summary of the components of our interest expense (dollars in thousands):

 

 

 

Three months ended

 

Six months ended

 

 

 

June 30,
2012

 

June 30,
2011

 

June 30,
2012

 

June 30,
2011

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest on our credit facility, notes, bonds and mortgages

 

$

27,562

 

$

24,683

 

$

55,526

 

$

48,904

 

Interest included in discontinued operations

 

(149)

 

(198)

 

(339)

 

(399)

 

Credit facility commitment fees

 

415

 

377

 

792

 

754

 

Amortization of credit facility origination costs, deferred financing costs and net mortgage premiums

 

1,110

 

887

 

2,056

 

1,683

 

Interest capitalized

 

(132)

 

(102)

 

(277)

 

(173)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

$

28,806

 

$

25,647

 

$

57,758

 

$

50,769

 

 

 

 

Three months ended

 

Six months ended

 

Credit facility, mortgages and notes
outstanding

 

June 30,
2012

 

June 30,
2011

 

June 30,
2012

 

June 30,
2011

 

Average outstanding balances (dollars in thousands)

 

$

1,883,041

 

$

1,634,727

 

$

1,902,648

 

$

1,620,085

 

Average interest rates

 

5.85

%

6.04

%

5.83

%

6.04

%

 

At June 30, 2012, the weighted average interest rate on our:

 

·                  Notes and bonds payable of $1.75 billion was 6.03%;

·                  Mortgages payable of $56.7 million was 5.38%;

·                  Credit facility outstanding borrowings of $183.6 million was 1.32%; and

·                  Combined outstanding notes, bonds, mortgages and credit facility borrowings of $1.99 billion was 5.58%.

 

EBITDA and Adjusted EBITDA (earnings before interest, taxes, depreciation and amortization)

EBITDA and Adjusted EBITDA are non-GAAP financial measures. Our EBITDA and Adjusted EBITDA computation may not be comparable to EBITDA and Adjusted EBITDA reported by other companies that interpret the definitions of EBITDA and Adjusted EBITDA differently than we do. Management believes EBITDA and Adjusted EBITDA to be meaningful measures of a REIT’s performance because it is widely followed by industry analysts, lenders and investors and is used by management as one measure of performance. In addition, management utilizes Adjusted EBITDA because our $1 billion credit facility uses a similar metric to measure our compliance with certain covenants. EBITDA and Adjusted EBITDA should be considered along with, but not as an alternative to, net income as a measure of our operating performance.

 

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The following is a reconciliation of net income, our most directly comparable GAAP measure, to EBITDA and Adjusted EBITDA (dollars in thousands):

 

 

 

Three months ended

 

Six months ended

 

 

 

June 30,
2012

 

June 30,
2011

 

June 30,
2012

 

June 30,
2011

 

Net income

 

$

43,407

 

$

39,248

 

$

82,671

 

$

75,247

 

Interest expense

 

28,806

 

25,647

 

57,758

 

50,769

 

Interest expense included in discontinued operations

 

149

 

198

 

339

 

399

 

Income taxes

 

405

 

368

 

810

 

735

 

Income tax benefit included in discontinued operations

 

(127)

 

(88)

 

(159)

 

(179)

 

Depreciation and amortization

 

35,475

 

28,673

 

70,560

 

55,104

 

Depreciation and amortization in discontinued operations

 

163

 

386

 

381

 

807

 

 

 

 

 

 

 

 

 

 

 

EBITDA

 

$

108,278

 

$

94,432

 

$

212,360

 

$

182,882

 

Provisions for impairment

 

 --

 

10

 

 --

 

210

 

Amortization of net premiums on mortgages payable

 

(71)

 

 --

 

(168)

 

 --

 

Gain on sale of land

 

 --

 

(155)

 

 --

 

(155)

 

Gain on property sales in discontinued operations

 

(3,354)

 

(1,096)

 

(3,965)

 

(1,224)

 

 

 

 

 

 

 

 

 

 

 

Adjusted EBITDA

 

$

104,853

 

$

93,191

 

$

208,227

 

$

181,713

 

 

Interest Coverage Ratio

Interest coverage ratio is calculated as: Adjusted EBITDA divided by interest expense, including interest recorded as discontinued operations. We consider interest coverage ratio to be an appropriate supplemental measure of a company’s ability to meet its interest expense obligations. Our calculation of interest coverage ratio may be different from the calculation used by other companies and, therefore, comparability may be limited. This information should not be considered as an alternative to any GAAP liquidity measures.

 

 

 

Three months ended

 

Six months ended

 

Dollars in thousands

 

June 30,
2012

 

June 30,
2011

 

June 30,
2012

 

June 30,
2011

 

 

 

 

 

 

 

 

 

 

 

Adjusted EBITDA

 

$

104,853

 

$

93,191

 

$

208,227

 

$

181,713

 

Divided by interest expense(1)

 

$

28,955

 

$

25,845

 

$

58,097

 

$

51,168

 

 

 

 

 

 

 

 

 

 

 

Interest coverage ratio

 

3.6

 

3.6

 

3.6

 

3.6

 

 

(1) Includes interest expense recorded to discontinued operations.

 

Fixed Charge Coverage Ratio

Fixed charge coverage ratio is calculated in exactly the same manner as interest coverage ratio, except that preferred stock dividends are also added to the denominator. We consider fixed charge coverage ratio to be an appropriate supplemental measure of a company’s ability to make its interest and preferred stock dividend payments. Our calculation of the fixed charge coverage ratio may be different from the calculation used by other companies and, therefore, comparability may be limited. This information should not be considered as an alternative to any GAAP liquidity measures.

 

 

 

Three months ended

 

Six months ended

 

Dollars in thousands

 

June 30,
2012

 

June 30,
2011

 

June 30,
2012

 

June 30,
2011

 

Adjusted EBITDA

 

$

104,853

 

$

93,191

 

$

208,227

 

$

181,713

 

Divided by interest expense plus preferred stock dividends(1)

 

$

39,412

 

$

31,908

 

$

78,050

 

$

63,295

 

 

 

 

 

 

 

 

 

 

 

Fixed charge coverage ratio

 

2.7

 

2.9

 

2.7

 

2.9

 

 

(1) Includes interest expense recorded to discontinued operations. Excludes the charge of $3.7 million for the excess of redemption value over carrying value of the Class D preferred shares redeemed during the six months ended June 30, 2012.

 

35



Table of Contents

 

General and Administrative Expenses

General and administrative expenses increased by $1.3 million to $9.3 million in the second quarter of 2012, as compared to $8.0 million in the second quarter of 2011. Included in general and administrative expenses are one-time acquisition transaction costs of $392,000, for the second quarter of 2012, as compared to $542,000, for the second quarter of 2011.

 

General and administrative expenses increased by $2.5 million to $18.4 million in the first six months of 2012, as compared to $15.9 million in the first six months of 2011. Included in general and administrative expenses are one-time acquisition transaction costs of $634,000, for the first six months of 2012, as compared to $913,000, for the first six months of 2011. General and administrative expenses increased primarily due to increases in employee and proxy costs. In July 2012, we had 89 employees, as compared to 78 employees in July 2011.

 

 

 

Three months ended

 

Six months ended

 

Dollars in thousands

 

June 30,

2012

 

June 30,
2011

 

June 30,
2012

 

June 30,
2011

 

General and administrative expenses