XNYS:WPC W. P. Carey Inc Quarterly Report 10-Q Filing - 6/30/2012
Effective Date 6/30/2012
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q
For the quarterly period ended June 30, 2012 or
For the transition period from to Commission File Number: 001-13779
W. P. CAREY & CO. LLC (Exact name of registrant as specified in its charter)
Investor Relations (212) 492-8920 (212) 492-1100 (Registrant’s telephone numbers, including area code) 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 þ No ¨ 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 þ No ¨ 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.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ Registrant has 40,358,186 shares of common stock, no par value, outstanding at August 1, 2012.
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Forward-Looking Statements This Quarterly Report on Form 10-Q (the “Report”), including Management’s Discussion and Analysis of Financial Condition and Results of Operations in Item 2 of Part I of this Report, contains forward-looking statements within the meaning of the federal securities laws. These forward-looking statements generally are identified by the words “believe,” “project,” “expect,” “anticipate,” “estimate,” “intend,” “strategy,” “plan,” “may,” “should,” “will,” “would,” “will be,” “will continue,” “will likely result,” and similar expressions. It is important to note that our actual results could be materially different from those projected in such forward-looking statements. You should exercise caution in relying on forward-looking statements as they involve known and unknown risks, uncertainties and other factors that may materially affect our future results, performance, achievements or transactions. Information on factors which could impact actual results and cause them to differ from what is anticipated in the forward-looking statements contained herein is included in this Report as well as in our other filings with the Securities and Exchange Commission (the “SEC”), including but not limited to those described in Item 1A. Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2011 as filed with the SEC on February 29, 2012 (the “2011 Annual Report”). We do not undertake to revise or update any forward-looking statements. Additionally, a description of our critical accounting estimates is included in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section of our 2011 Annual Report. There has been no significant change in our critical accounting estimates.
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Table of ContentsCONSOLIDATED BALANCE SHEETS (UNAUDITED) (in thousands, except share amounts)
See Notes to Consolidated Financial Statements.
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Table of ContentsCONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) (in thousands, except share and per share amounts)
See Notes to Consolidated Financial Statements.
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Table of ContentsCONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED) (in thousands)
See Notes to Consolidated Financial Statements.
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Table of ContentsCONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (in thousands)
(Continued)
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Table of ContentsW. P. CAREY & CO. LLC CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (Continued)
Supplemental noncash investing activities: On May 2, 2011, in connection with entering into an amended and restated advisory agreement with Corporate Property Associates 16 – Global Incorporated (“CPA®:16 – Global”), we received a special membership interest in CPA®:16 – Global’s operating partnership and recorded as consideration a $28.3 million adjustment to Equity investments in real estate and the REITs to reflect the fair value of our special interest in that operating partnership (Note 3). Also on May 2, 2011, we exchanged 11,113,050 shares of Corporate Property Associates 14 Incorporated (“CPA®:14”) for 13,260,091 shares of CPA®:16 – Global, resulting in a gain of approximately $2.8 million. Additionally, we recognized a gain of $1.0 million on the conversion of our termination revenue to shares of CPA®:14 as a result of the fair value of the shares received exceeding the termination revenue (Note 3). In May 2011, we purchased the remaining interests in the Federal Express and Amylin investments from CPA®:14, which we had previously accounted for under the equity method. In connection with purchasing these properties, we recognized a net gain of $27.9 million to adjust the carrying value of our existing interests in these investments to their estimated fair values. We also assumed two non-recourse mortgages on the related properties with an aggregate fair value of $87.6 million at the date of acquisition (Note 3). See Notes to Consolidated Financial Statements.
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Note 1. Business W. P. Carey & Co. LLC (“W. P. Carey” and, together with its consolidated subsidiaries and predecessors, “we”, “us” or “our”) provides long-term financing via sale-leaseback and build-to-suit transactions for companies worldwide and manages a global investment portfolio. We invest primarily in commercial properties domestically and internationally that are generally triple-net leased to single corporate tenants, which requires each tenant to pay substantially all of the costs associated with operating and maintaining the property. We also earn revenue as the advisor to publicly-owned, non-listed real estate investment trusts, which are sponsored by us under the Corporate Property Associates brand name (the “CPA® REITs”) and invest in similar properties. At June 30, 2012, we were the advisor to the following CPA® REITs: Corporate Property Associates 15 Incorporated (“CPA®:15”), CPA®:16 – Global and Corporate Property Associates 17 – Global Incorporated (“CPA®:17 – Global”). We are also the advisor to Carey Watermark Investors Incorporated (“CWI” and, together with the CPA® REITs, the “REITs”), which we formed in March 2008 for the purpose of acquiring interests in lodging and lodging-related properties. At June 30, 2012, we owned and/or managed more than 970 properties domestically and internationally. Our owned portfolio was comprised of our full or partial ownership interest in 146 properties, substantially all of which were net leased to 69 tenants, and totaled approximately 11.4 million square feet (on a pro rata basis) with an occupancy rate of approximately 94%. In addition, through our consolidated subsidiaries, Carey Storage Management LLC (“Carey Storage”) and Livho, Inc. (“Livho”), we had interests in 21 self-storage properties and a hotel property, respectively, for an aggregate of approximately 0.8 million square feet (on a pro rata basis) at June 30, 2012. On February 17, 2012, we and CPA®:15 entered into a definitive agreement pursuant to which CPA®:15 will merge with and into one of our newly formed subsidiaries, W. P. Carey Inc. (the “Proposed Merger”) (Note 3). The closing of the Proposed Merger is subject to customary closing conditions, including the approval of our shareholders and the stockholders of CPA®:15. Upon approval of the Proposed Merger and immediately prior thereto, we intend to reorganize as a real estate investment trust (the “Proposed REIT Reorganization”). The Proposed REIT Reorganization is an internal reorganization of our corporate structure into a real estate investment trust to hold substantially all of our real estate assets attributable to our Real Estate Ownership segment, including the assets held by CPA®:15, while the activities conducted by our Investment Management segment subsidiaries will be organized under taxable real estate investment trust subsidiaries (“TRSs”). In July 2012, we entered into a number of agreements with the Estate of Wm. Polk Carey (the “Estate”), our Chairman and founder who passed away on January 2, 2012, including a voting agreement (the “Voting Agreement”) pursuant to which the Estate and W. P. Carey & Co., Inc., a wholly-owned corporation of the Estate (“HoldCo” and together with the Estate, the “Estate Shareholders”) have agreed, among other things, to vote their Listed shares, totaling approximately 27.92% of our outstanding common stock on July 16, 2012, the record date for the special meeting of our shareholders regarding the Proposed REIT Reorganization and Proposed Merger, in favor of those transactions (Note 16). Primary Business Segments Investment Management — We structure and negotiate investments and debt placement transactions for the REITs, for which we earn structuring revenue, and manage their portfolios of real estate investments, for which we earn asset-based management and performance revenue. We earn asset-based management and performance revenue from the REITs based on the value of their real estate-related, self-storage-related and lodging-related assets under management. As funds available to the REITs are invested, the asset base from which we earn revenue increases. We may also earn incentive and disposition revenue and receive other compensation in connection with providing liquidity alternatives to the REITs’ shareholders. Real Estate Ownership — We own and invest in commercial properties in the United States of America (“U.S.”) and the European Union that are then leased to companies, primarily on a triple-net lease basis. We may also invest in other properties if opportunities arise. We own interests in the REITs and account for these interests under the equity method of accounting. In addition, we receive a percentage of distributions of Available Cash, as defined in the respective advisory agreements, from the operating partnerships of CPA®:16 – Global, CPA®:17 – Global and CWI, and earn deferred revenue from our special member interest in CPA®:16 – Global’s operating partnership. Effective April 1, 2012, we include such distributions and deferred revenue in our Real Estate Ownership segment. Note 2. Basis of Presentation Our interim consolidated financial statements have been prepared, without audit, in accordance with the instructions to Form 10-Q and, therefore, do not necessarily include all information and footnotes necessary for a fair statement of our consolidated financial position, results of operations and cash flows in accordance with accounting principles generally accepted in the U.S. (“GAAP”).
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Table of ContentsNotes to Consolidated Financial Statements
In the opinion of management, the unaudited financial information for the interim periods presented in this Report reflects all normal and recurring adjustments necessary for a fair statement of results of operations, financial position and cash flows. Our interim consolidated financial statements should be read in conjunction with our audited consolidated financial statements and accompanying notes for the year ended December 31, 2011, which are included in our 2011 Annual Report, as certain disclosures that would substantially duplicate those contained in the audited consolidated financial statements have not been included in this Report. Operating results for interim periods are not necessarily indicative of operating results for an entire fiscal year. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts and the disclosure of contingent amounts in our consolidated financial statements and the accompanying notes. Actual results could differ from those estimates. The unaudited consolidated financial statements included in this Report have been retrospectively adjusted to reflect the disposition (or planned disposition) of certain properties as discontinued operations for all periods presented. Certain prior year amounts have been reclassified to conform to the current year presentation. Basis of Consolidation The consolidated financial statements reflect all of our accounts, including those of our majority-owned and/or controlled subsidiaries. The portion of equity in a subsidiary that is not attributable, directly or indirectly, to us is presented as noncontrolling interests. All significant intercompany accounts and transactions have been eliminated. We have investments in tenancy-in-common interests in various domestic and international properties. Consolidation of these investments is not required as they do not qualify as VIEs and do not meet the control requirement required for consolidation. Accordingly, we account for these investments using the equity method of accounting under current authoritative accounting guidance. We use the equity method of accounting because the shared decision-making involved in a tenancy-in-common interest investment creates an opportunity for us to have significant influence on the operating and financial decisions of these investments and thereby creates some responsibility by us to achieve a return on our investment. Additionally, we own interests in single-tenant net leased properties leased to corporations through noncontrolling interests in partnerships and limited liability companies that we do not control but over which we exercise significant influence. We account for these investments under the equity method of accounting. At times the carrying value of our equity investments may fall below zero for certain investments. We intend to fund our share of the investments’ future operating deficits should the need arise. However, we have no legal obligation to pay for any of the liabilities of such investments nor do we have any legal obligation to fund operating deficits. Counterparty Credit Risk Portfolio Exception Election Effective January 1, 2011, or the “effective date,” we have made an accounting policy election to use the exception in Accounting Standards Codification (“ASC”) 820-10-35-18D, the “portfolio exception,” with respect to measuring counterparty credit risk for derivative instruments, consistent with the guidance in 820-10-35-18G. We manage credit risk for our derivative positions on a counterparty-by-counterparty basis (that is, on the basis of its net portfolio exposure with each counterparty), consistent with our risk management strategy for such transactions. We manage credit risk by considering indicators of risk such as credit ratings, and by negotiating terms in our International Swaps and Derivatives Association, Inc. (“ISDA”) master netting arrangements with each individual counterparty. Credit risk plays a central role in the decision of which counterparties to consider for such relationships and when deciding with whom it will enter into derivative transactions. Since the effective date, we have monitored and measured credit risk and calculated credit valuation adjustments for our derivative transactions on the basis of its relationships at ISDA master netting arrangement level. We receive reports from an independent third-party valuation specialist on quarterly basis providing the credit valuation adjustments at the counterparty portfolio level for purposes of reviewing and managing our credit risk exposures. Since the portfolio exception applies only to the fair value measurement and not to financial statement presentation, the portfolio-level adjustments are then allocated in a reasonable and consistent manner each period to the individual assets or liabilities that make up the group, in accordance with other applicable accounting guidance and our accounting policy elections. Derivative transactions are measured at fair value in the statement of financial position each reporting period. We note that key market participants take into account the existence of such arrangements that mitigate credit risk exposure in the event of default. As such, we elect to apply the portfolio exception in 820-10-35-18D with respect to measuring counterparty credit risk for all of our derivative transactions subject to master netting arrangements. Out-of-Period Adjustment During the second quarter of 2012, we identified an error in the consolidated financial statements related to the misapplication of accounting guidance on the involuntary disposals of two parcels of land in the fourth quarter of 2010. We concluded that this adjustment, with a net impact on income from continuing operations and income attributable to W. P. Carey members of $1.8 million
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Table of ContentsNotes to Consolidated Financial Statements
on our statement of operations for the second quarter of 2012, was not material to our results for the prior year period or for the period of adjustment. Accordingly, this change was recorded in the consolidated financial statements in the second quarter of 2012 as an out-of-period adjustment as follows: a reduction to Accounts payable, accrued expenses and other liabilities of $2.1 million and a reduction to Net investments in properties of $0.3 million on the consolidated balance sheet; and an increase in Gain on sale of real estate of $2.0 million, an increase in Property expenses of $0.4 million, an increase in Other real estate income of $0.2 million and an increase in Other interest income of $0.1 million on the consolidated statement of operations. Note 3. Agreements and Transactions with Related Parties Advisory Agreements with the REITs We have advisory agreements with each of the REITs pursuant to which we earn certain fees or are entitled to receive distributions of cash flow. The CPA® REIT advisory agreements that are currently in place are scheduled to expire on the earlier of the date that the Proposed Merger is consummated or September 30, 2012 unless otherwise renewed. The terms of the advisory agreements are outlined in our 2011 Annual Report, except as otherwise stated below. The CWI advisory agreement that is currently in place is scheduled to expire on September 30, 2012 unless otherwise renewed. The following table presents a summary of revenue earned and/or cash received from the REITs in connection with providing services as the advisor to the REITs (in thousands):
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Table of ContentsNotes to Consolidated Financial Statements
Unpaid transaction fees, including accrued interest, are included in Due from affiliates in the consolidated financial statements. Unpaid transaction fees bear interest at annual rates ranging from 5% to 7%. The following tables present the amount of unpaid transaction fees and interest earned on these fees (in thousands):
Other Transactions with Affiliates Proposed Merger On February 17, 2012, we and CPA®:15 entered into a definitive agreement pursuant to which CPA®:15, our subsidiary W. P. Carey Inc. and other parties thereto pursuant to which, through a series of transactions, W. P. Carey Inc. will acquire CPA®:15 as an indirect subsidiary (the “Merger Agreement”). In connection with the Proposed Merger, W. P. Carey Inc. filed a registration statement with the SEC, which was declared effective on July 30, 2012 (the “Form S-4”), regarding the shares of its common stock to be issued to stockholders of CPA®:15 in the Proposed Merger. Special meetings have been scheduled on September 13, 2012 to obtain the approval of CPA®:15’s stockholders of the Proposed Merger and the approval of our shareholders of the Proposed Merger and the Proposed REIT Reorganization. The closing of the Proposed Merger is subject to customary closing conditions. If the Proposed Merger is approved and the other closing conditions are met, we currently expect that the closing will occur in the third quarter of 2012, although there can be no assurance of such timing. At June 30, 2012, CPA®:15’s portfolio was comprised of full or partial ownership interests in 305 properties, substantially all of which were triple-net leased to 75 tenants, and totaled approximately 27 million square feet (on a pro rata basis), with an occupancy rate of approximately 99%. At June 30, 2012, the leases had an average remaining life of 9.9 years and an estimated annual contractual minimum base rent of $219.4 million (on a pro rata basis). We expect to assume the related property debt comprised of 68 fixed-rate and nine variable-rate non-recourse mortgage loans with an estimated aggregate fair value of $1.1 billion and a weighted-average annual interest rate of 5.8% at June 30, 2012 (on a pro rata basis). During the six months ended June 30, 2012, we earned $12.4 million in fees from CPA®:15 and recognized $3.8 million in equity earnings based on our ownership of shares in CPA®:15.
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Table of ContentsNotes to Consolidated Financial Statements
In the Proposed Merger, CPA®:15 stockholders will be entitled to receive $1.25 in cash and 0.2326 shares of our common stock for each share of CPA®:15 common stock owned, which equated to $11.97 per share of CPA®:15 common stock based on our $46.08 per share closing price as of July 23, 2012. The estimated total Proposed Merger consideration includes cash of approximately $151.5 million and the issuance of approximately 28,190,000 of our shares, based on the total shares of CPA®:15 outstanding of 131,598,908, of which 10,418,731 shares were owned by us, on July 16, 2012, the record date. As a condition of the Proposed Merger, we have agreed to waive the subordinated disposition and termination fees we would be entitled to receive from CPA®:15 upon its liquidation pursuant to the terms of our advisory agreement. We have also obtained a commitment from various lenders for a $175.0 million term loan as part of our existing credit facility in order to pay for the cash portion of the consideration in the Proposed Merger, which expires on the earlier of the termination or closing of the Proposed Merger or September 30, 2012. The commitment letters are subject to a number of closing conditions, including the lenders’ satisfactory completion of due diligence and determination that no material adverse change has occurred, and there can be no assurance that we will be able to obtain the term loan on acceptable terms or at all. Upon approval of the Proposed Merger and immediately prior thereto, we intend to reorganize as a real estate investment trust. The Proposed REIT Reorganization is an internal reorganization of our corporate structure into a real estate investment trust to hold substantially all of our real estate assets attributable to our Real Estate Ownership segment, including the assets held by CPA®:15, while the activities conducted by our Investment Management segment subsidiaries will be organized under TRSs. Transactions With Estate of Wm. Polk Carey On July 23, 2012, we entered into certain agreements with the Estate Shareholders, including the Voting Agreement, pursuant to which the Estate Shareholders agreed to vote in favor of the Proposed Merger and the Proposed REIT Reorganization (Note 16). CPA® :14/16 Merger On May 2, 2011, CPA®:14 merged with and into a subsidiary of CPA®:16 – Global. In connection with the CPA®:14/16 Merger, on May 2, 2011, we purchased the remaining interests in three jointly-owned investments from CPA®:14, in which we already had a partial ownership interest, for an aggregate purchase price of $31.8 million, plus the assumption of $87.6 million of indebtedness. Upon consummation of the CPA®:14/16 Merger, we earned revenues of $31.2 million in connection with the termination of the advisory agreement with CPA®:14 and $21.3 million of subordinated disposition revenues. We elected to receive our termination revenue in 2,717,138 shares of CPA®:14, which were exchanged into 3,242,089 shares of CPA®:16 – Global in the CPA®:14/16 Merger. Upon closing of the CPA®:14/16 Merger, we received 13,260,091 shares of common stock of CPA®:16 – Global in respect of our shares of CPA®:14. In connection with the CPA®:14/16 Merger, we acquired a special member interest in CPA®:16 – Global’s operating partnership. We initially recorded the special member interest as an equity investment at its fair value of $28.3 million and an equal amount to deferred revenues, which we recognize into earnings on a straight-line basis over the expected period of performance. Other We are the general partner in a limited partnership (which we consolidate for financial statement purposes) that leases our home office space and participates in an agreement with certain affiliates, including the REITs, for the purpose of leasing office space used for the administration of our operations and the operations of our affiliates and for sharing the associated costs. This limited partnership does not have any significant assets, liabilities or operations other than its interest in the office lease. The average estimated minimum lease payment for the office lease, inclusive of noncontrolling interests, at June 30, 2012 approximates $3.0 million annually through 2016.
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Table of ContentsNotes to Consolidated Financial Statements
The table below presents income from noncontrolling interest partners related to reimbursements from these affiliates (in thousands):
The following table presents deferred rent due to affiliates related to this limited partnership, which are included in Accounts payable, accrued expenses and other liabilities in the consolidated balance sheets (in thousands):
We own interests in entities ranging from 5% to 95%, as well as jointly-controlled tenancy-in-common interests in properties, with the remaining interests generally held by affiliates, and own common stock in each of the REITs. We consolidate certain of these investments and account for the remainder under the equity method of accounting. One of our directors and officers is the sole shareholder of Livho, a subsidiary that operates a hotel investment. We consolidate the accounts of Livho in our consolidated financial statements because it is a VIE and we are its primary beneficiary. Family members of one of our directors have an ownership interest in certain companies that own noncontrolling interests in one of our French majority-owned subsidiaries. These ownership interests are subject to substantially the same terms as all other ownership interests in the subsidiary companies. An employee owns a redeemable noncontrolling interest (Note 12) in W. P. Carey International LLC (“WPCI”), a subsidiary company that structures net lease transactions on behalf of the CPA® REITs outside of the U.S., as well as certain related entities. During May 2011, we loaned $4.0 million at the 30-day London inter-bank offered rate (“LIBOR”) plus 2.5% to CWI which was repaid on June 6, 2011. In addition, during February 2011, we loaned $90.0 million at an annual interest rate of 1.15% to CPA®:17 – Global, which was repaid on April 8, 2011, its maturity date. In connection with these loans, we received interest income from CWI and CPA®:17 – Global totaling less than $0.1 million and $0.2 million during the three and six months ended June 30, 2011, respectively. Note 4. Net Investments in Properties Real Estate Real estate, which consists of land and buildings leased to others, at cost, and which are subject to operating leases, is summarized as follows (in thousands):
We did not acquire real estate assets or record any related intangible assets during the six months ended June 30, 2012. Assets disposed of during this period are disclosed in Note 15. Impairment charges recognized on certain properties are discussed below. During this period, the U.S. dollar strengthened against the Euro, as the end-of-period rate for the U.S. dollar in relation to the Euro at June 30, 2012 decreased by 2.9% to $1.2578 from $1.2950 at December 31, 2011. The impact of this strengthening was a $1.8 million decrease in Real estate from December 31, 2011 to June 30, 2012.
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Table of ContentsNotes to Consolidated Financial Statements
Operating Real Estate Operating real estate, which consists of our investments in 21 self-storage properties through Carey Storage and our Livho hotel subsidiary, at cost, is summarized as follows (in thousands):
Impairment Charges We periodically assess whether there are any indicators that the value of our real estate investments may be impaired or that their carrying value may not be recoverable. For investments in real estate in which an impairment indicator is identified, we follow a two-step process to determine whether the investment is impaired and to determine the amount of the charge. First, we compare the carrying value of the real estate to the future net undiscounted cash flow that we expect the real estate will generate, including any estimated proceeds from the eventual sale of the real estate. If this amount is less than the carrying value, the real estate is considered to be impaired, and we then measure the loss as the excess of the carrying value of the real estate over the estimated fair value of the real estate, which is primarily determined using market information such as recent comparable sales or broker quotes. If relevant market information is not available or is not deemed appropriate, we perform a future net cash flow analysis discounted for inherent risk associated with each investment. During the six months ended June 30, 2012, we recognized impairment charges totaling $3.7 million on two vacant properties, which are currently classified as Real estate on the consolidated balance sheet, in order to reduce the carrying value of the properties to their estimated fair values, which approximated their estimated selling prices (Note 7). As of the date of this Report, these properties are being marketed for sale, although there can be no assurance that we will be able to sell these properties at acceptable prices or at all. Impairment charges recognized within discontinued operations are discussed in Note 15. Other In connection with our prior acquisitions of properties through June 30, 2012, we have recorded net lease intangibles of $66.3 million, which are being amortized over periods ranging from one year to 40 years. In-place lease, tenant relationship and above-market rent intangibles are included in Intangible assets and goodwill, net in the consolidated financial statements. Below-market rent intangibles are included in Accounts payable, accrued expenses and other liabilities in the consolidated financial statements. Amortization of below-market and above-market rent intangibles is recorded as an adjustment to Lease revenues, while amortization of in-place lease and tenant relationship intangibles is included in Depreciation and amortization. Net amortization of intangibles, including the effect of foreign currency translation, was $1.3 million and $1.0 million for the three months ended June 30, 2012 and 2011, respectively, and $2.6 million and $1.4 million for the six months ended June 30, 2012 and 2011, respectively. Note 5. Finance Receivables Assets representing rights to receive money on demand or at fixed or determinable dates are referred to as finance receivables. Our finance receivable portfolios consist of our Net investments in direct financing leases and deferred acquisition fees. Operating leases are not included in finance receivables as such amounts are not recognized as an asset in the consolidated balance sheets. Deferred Acquisition Fees Receivable As described in Note 3, we earn revenue in connection with structuring and negotiating investments and related mortgage financing for the REITs. A portion of this revenue is due in equal annual installments ranging from three to four years, provided the REITs meet their respective performance criteria. Unpaid deferred installments, including accrued interest, from all of the REITs were included in Due from affiliates in the consolidated financial statements.
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Table of ContentsNotes to Consolidated Financial Statements
Credit Quality of Finance Receivables We generally seek investments in facilities that we believe are critical to a tenant’s business and that we believe have a low risk of tenant defaults. At June 30, 2012 and December 31, 2011, none of the balances of our finance receivables were past due and we had not established any allowances for credit losses. Additionally, there have been no modifications of finance receivables. We evaluate the credit quality of our tenant receivables utilizing an internal 5-point credit rating scale, with 1 representing the highest credit quality and 5 representing the lowest. The credit quality evaluation of our tenant receivables was last updated in the second quarter of 2012. We believe the credit quality of our deferred acquisition fees receivable falls under category 1, as the REITs are expected to have the available cash to make such payments. A summary of our finance receivables by internal credit quality rating is as follows (dollars in thousands):
At both June 30, 2012 and December 31, 2011, Other assets, net included less than $0.1 million of accounts receivable related to amounts billed under these direct financing leases. Note 6. Equity Investments in Real Estate and the REITs We own interests in the REITs and unconsolidated real estate investments. We account for our interests in these investments under the equity method of accounting (i.e., at cost, increased or decreased by our share of earnings or losses, less distributions, plus contributions and other adjustments required by equity method accounting, such as basis differences from other-than-temporary impairments). These investments are summarized below. Income from equity investments in real estate represents our proportionate share of the income or losses of these investments as well as certain depreciation and amortization adjustments related to other-than-temporary impairment charges. The following table presents information about our equity income from the REITs and jointly-owned investments (in thousands):
REITs We own interests in the REITs and account for these interests under the equity method because, as their advisor and through our ownership in their common stock, we do not exert control over, but have the ability to exercise significant influence on, the REITs. Shares of the REITs are publicly registered and the REITs file periodic reports with the SEC, but the shares are not listed on any exchange and are not actively traded. We earn asset management and performance revenue from the REITs and have elected, in certain cases, to receive a portion of this revenue in the form of common stock of the REITs rather than cash.
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Table of ContentsNotes to Consolidated Financial Statements
The following table sets forth certain information about our investments in the REITs (dollars in thousands):
The following tables present combined summarized financial information for the REITs. Amounts provided are total amounts attributable to the REITs and do not represent our proportionate share (in thousands):
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Table of ContentsNotes to Consolidated Financial Statements
As disclosed in its financial statements for the second quarter of 2011, CPA®:16 – Global accounted for the CPA®:14/16 Merger using preliminary fair values of the assets acquired and liabilities assumed. During the third quarter of 2011, CPA®:16 – Global finalized its assessment of the fair values of the assets acquired and liabilities assumed and made certain adjustments (the “CPA®:16 – Global Measurement Period Adjustments”) during that quarter. Our proportionate share of the CPA®:16 – Global Measurement Period Adjustments before income taxes was approximately $2.6 million. In accordance with ASC 805-10-25, Accounting for Business Combinations, we have retrospectively adjusted our financial statements for the three and six months ended June 30, 2011 to include such adjustments. Interests in Unconsolidated Real Estate Investments We own interests in single-tenant net leased properties that are leased to corporations through noncontrolling interests (i) in partnerships and limited liability companies that we do not control but over which we exercise significant influence or (ii) as tenants-in-common subject to common control. Generally, the underlying investments are jointly-owned with affiliates. We account for these investments under the equity method of accounting. The following table sets forth our ownership interests in our equity investments in real estate and their respective carrying values. The carrying value of each investment is affected by the timing and nature of distributions (dollars in thousands):
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Table of ContentsNotes to Consolidated Financial Statements
The following tables present combined summarized financial information of our equity investments. Amounts provided are the total amounts attributable to the investments and do not represent our proportionate share (in thousands):
Note 7. Fair Value Measurements Under current authoritative accounting guidance for fair value measurements, the fair value of an asset is defined as the exit price, which is the amount that would either be received when an asset is sold or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The guidance establishes a three-tier fair value hierarchy based on the inputs used in measuring fair value. These tiers are: Level 1, for which quoted market prices for identical instruments are available in active markets, such as money market funds, equity securities and U.S. Treasury securities; Level 2, for which there are inputs other than quoted prices included within Level 1 that are observable for the instrument, such as certain derivative instruments including interest rate caps and swaps; and Level 3, for securities that do not fall into Level 1 or Level 2 and for which little or no market data exists, therefore requiring us to develop our own assumptions. Items Measured at Fair Value on a Recurring Basis The methods and assumptions described below were used to estimate the fair value of each class of financial instrument. For significant Level 3 items we have also provided the unobservable inputs along with their weighted average ranges. Money Market Funds — Our money market funds, which are included in Cash and cash equivalents in the consolidated financial statements, are consisted of government securities and U.S. Treasury bills. These funds were classified as Level 1 as we used quoted prices from active markets to determine their fair values. Derivative Assets and Liabilities — Our derivative assets and liabilities, which are included in Other assets, net and Accounts payable, accrued expenses and other liabilities, respectively, in the consolidated financial statements, are primarily comprised of interest rate swaps and foreign currency future contracts. These derivative instruments were measured at fair value using readily observable market inputs, such as quotations on interest rates. These derivative instruments were classified as Level 2 because they are custom, over-the-counter contracts with various bank counterparties that are not traded in an active market. Other Securities — Our other securities, which are included in Other assets, net in the consolidated financial statements, are primarily comprised of our interest in a commercial mortgage loan securitization. This fund is not traded in an active market. We estimated the fair value of these securities using internal valuation models that incorporate market inputs and our own assumptions about future cash flows. We classified these assets as Level 3.
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Table of ContentsNotes to Consolidated Financial Statements
Redeemable Noncontrolling Interest — We account for the noncontrolling interest in WPCI as a redeemable noncontrolling interest. We determined the valuation of the redeemable noncontrolling interest using widely accepted valuation techniques, including expected discounted cash flows of the investment as well as the income capitalization approach, which considers prevailing market capitalization rates. We classified this liability as Level 3. Unobservable inputs for WPCI include a discount for lack of marketability, a discount rate and EBITDA multiples with weighted average ranges of 20% – 30%, 23% – 27% and 3x – 5x, respectively. Significant increases or decreases in any one of these inputs in isolation would result in significant changes in the fair value measurement. The following tables set forth our assets and liabilities that were accounted for at fair value on a recurring basis. Assets and liabilities presented below exclude assets and liabilities owned by equity investments (in thousands):
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Table of ContentsNotes to Consolidated Financial Statements
We did not have any transfers into or out of Level 1, Level 2 and Level 3 measurements during the three and six months ended June 30, 2012 and 2011. Gains and losses (realized and unrealized) included in earnings for other securities are reported in Other income and (expenses) in the consolidated financial statements. Our other financial instruments had the following carrying values and fair values as of the dates shown (in thousands):
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Table of ContentsNotes to Consolidated Financial Statements
We estimated that our other financial assets and liabilities (excluding net investments in direct financing leases) had fair values that approximated their carrying values at both June 30, 2012 and December 31, 2011. Items Measured at Fair Value on a Non-Recurring Basis We perform an assessment, when required, of the value of certain of our real estate investments in accordance with current authoritative accounting guidance. As part of that assessment, we determine the valuation of these assets using widely accepted valuation techniques, including expected discounted cash flows or an income capitalization approach, which considers prevailing market capitalization rates. We review each investment based on the highest and best use of the investment and market participation assumptions. We determined that the significant inputs used to value these investments fall within Level 3. As a result of our assessments, we calculated impairment charges based on market conditions and assumptions that existed at the time. The valuation of real estate is subject to significant judgment and actual results may differ materially if market conditions or the underlying assumptions change. The following tables present information about our other assets that were measured on a fair value basis (in thousands):
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Table of ContentsNotes to Consolidated Financial Statements
Note 8. Risk Management and Use of Derivative Financial Instruments In the normal course of our ongoing business operations, we encounter economic risk. There are three main components of economic risk: interest rate risk, credit risk and market risk. We are primarily subject to interest rate risk on our interest-bearing liabilities. Credit risk is the risk of default on our operations and our tenants’ inability or unwillingness to make contractually required payments. Market risk includes changes in the value of our properties and related loans, as well as changes in the value of our other securities and the shares we hold in the REITs due to changes in interest rates or other market factors. In addition, we own investments in the European Union and are subject to the risks associated with changing foreign currency exchange rates. Use of Derivative Financial Instruments When we use derivative instruments, it is generally to reduce our exposure to fluctuations in interest rates and foreign currency exchange rate movements. We have not entered, and do not plan to enter into, financial instruments for trading or speculative purposes. The primary risks related to our use of derivative instruments are that a counterparty to a hedging arrangement could default on its obligation or that the credit quality of the counterparty may be downgraded to such an extent that it impairs our ability to sell or assign our side of the hedging transaction. While we seek to mitigate these risks by entering into hedging arrangements with counterparties that are large financial institutions that we deem to be creditworthy, it is possible that our hedging transactions, which are intended to limit losses, could adversely affect our earnings. Furthermore, if we terminate a hedging arrangement, we may be obligated to pay certain costs, such as transaction or breakage fees. We have established policies and procedures for risk assessment and the approval, reporting and monitoring of derivative financial instrument activities. We measure derivative instruments at fair value and record them as assets or liabilities, depending on our rights or obligations under the applicable derivative contract. Derivatives that are not designated as hedges must be adjusted to fair value through earnings. For a derivative designated and that qualified as a fair value hedge, the change in the fair value of the derivative is offset against the change in fair value of the hedged asset, liability, or firm commitment through earnings. For a derivative designated and qualified as a cash flow hedge, the effective portion of the change in fair value of the derivative is recognized in Other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative’s change in fair value is immediately recognized in earnings. The following table sets forth certain information regarding our derivative instruments (in thousands):
The following table presents the impact of derivative instruments on the consolidated financial statements (in thousands):
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Table of ContentsNotes to Consolidated Financial Statements
See below for information on our purposes for entering into derivative instruments and for information on derivative instruments owned by unconsolidated entities, which are excluded from the tables above. Interest Rate Swaps and Caps We are exposed to the impact of interest rate changes primarily through our borrowing activities. To limit this exposure, we attempt to obtain mortgage financing on a long-term, fixed-rate basis. However, from time to time, we or our investment partners may obtain variable-rate non-recourse mortgage loans and, as a result, may enter into interest rate swap agreements or interest rate cap agreements with counterparties. Interest rate swaps, which effectively convert the variable-rate debt service obligations of the loan to a fixed rate, are agreements in which one party exchanges a stream of interest payments for a counterparty’s stream of cash flow over a specific period. The notional, or face, amount on which the swaps are based is not exchanged. Interest rate caps limit the effective borrowing rate of variable-rate debt obligations while allowing participants to share in downward shifts in interest rates. Our objective in using these derivatives is to limit our exposure to interest rate movements. The interest rate swaps that we had outstanding on our consolidated subsidiaries at June 30, 2012 were designated as cash flow hedges and are summarized as follows (dollars in thousands):
The interest rate caps that our unconsolidated jointly-owned investments had outstanding at June 30, 2012 were designated as cash flow hedges and are summarized as follows (dollars in thousands):
Foreign Currency Contracts We are exposed to foreign currency exchange rate movements. We manage foreign currency exchange rate movements by generally placing both our debt obligation to the lender and the tenant’s rental obligation to us in the same currency. This reduces our overall exposure to the actual equity that we have invested and the equity portion of our cash flow. However, we are subject to foreign currency exchange rate movements to the extent of the difference in the timing and amount of the rental obligation and the debt service. We may also face challenges with repatriating cash from our foreign investments. We may encounter instances where it is difficult to repatriate cash because of jurisdictional restrictions or because repatriating cash may result in current or future tax liabilities. Realized and unrealized gains and losses recognized in earnings related to foreign currency transactions are included in Other income and (expenses) in the consolidated financial statements.
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Table of ContentsNotes to Consolidated Financial Statements
In order to hedge certain of our foreign currency cash flow exposures, we enter into foreign currency forward contracts. A foreign currency forward contract is a commitment to deliver a certain amount of currency at a certain price on a specific date in the future. By entering into forward contracts, we are locked into a future currency exchange rate for the term of the contract. These instruments guarantee that the exchange rate will not fluctuate beyond the range of the options’ strike prices. The following table presents the foreign currency derivative contracts we had outstanding at June 30, 2012 which were designated as cash flow hedges (dollars in thousands, except strike price):
Other Amounts reported in Other comprehensive income related to interest rate swaps will be reclassified to interest expense as interest payments are made on our variable-rate debt. At June 30, 2012, we estimate that an additional $1.3 million will be reclassified as interest expense during the next 12 months related to our interest rate swaps. Some of the agreements we have with our derivative counterparties contain certain credit contingent provisions that could result in a declaration of default against us regarding our derivative obligations if we either default or are capable of being declared in default on certain of our indebtedness. At June 30, 2012, we had not been declared in default on any of our derivative obligations. The estimated fair value of our derivatives that were in a net liability position was $5.1 million, which included accrued interest but excluded any adjustment for nonperformance risk. If we had breached any of these provisions at June 30, 2012, we could have been required to settle our obligations under these agreements at their aggregate termination value of $5.7 million. Portfolio Concentration Risk Concentrations of credit risk arise when a group of tenants is engaged in similar business activities or is subject to similar economic risks or conditions that could cause them to default on their lease obligations to us. We regularly monitor our portfolio to assess potential concentrations of credit risk. While we believe our portfolio is reasonably well diversified, it does contain concentrations in excess of 10%, based on the percentage of our annualized contractual minimum base rent for the second quarter of 2012, in certain areas, as shown in the table below. The percentages in the table below represent our directly-owned real estate properties and do not include our pro rata share of equity investments.
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Table of ContentsNotes to Consolidated Financial Statements
Except for our investment in CPA®:16 – Global, there were no significant concentrations, individually or in the aggregate, related to our unconsolidated jointly-owned investments. At June 30, 2012, we owned approximately 18.2% of CPA®:16 – Global, which had total assets at that date of approximately $3.5 billion consisting of a portfolio comprised of full or partial ownership interests in 503 properties substantially all of which were triple-net leased to 144 tenants, and has certain concentrations within its portfolio, which are outlined in its periodic filings. Note 9. Debt Line of Credit We have a $450.0 million unsecured revolving line of credit with various lenders that matures in December 2014, but may be extended by one year at our option, subject to the conditions provided in the credit agreement. At our election, the principal amount available under the line of credit may be increased by up to an additional $125.0 million, subject to the conditions provided in the credit facility agreement. The line of credit also permits (i) up to $150.0 million to be borrowed in certain currencies other than the U.S. dollar, (ii) swing line loans of up to $35.0 million, and (iii) the issuance of letters of credit in an aggregate amount not to exceed $50.0 million. At June 30, 2012, the outstanding balance on this line of credit was $233.2 million with an annual interest rate consisting of LIBOR plus 1.75%. In addition, as of June 30, 2012, our lenders had issued letters of credit totaling $6.8 million on our behalf in connection with certain contractual obligations. At June 30, 2012, the line of credit had unused capacity of $194.9 million, reflecting outstanding letters of credit, which reduce amounts that may be drawn. The line of credit is expected to be utilized primarily for potential new investments, repayment of existing debt and general corporate purposes as well as for repurchases of our Listed Shares from the Estate Shareholders (Note 16). Additionally, we have obtained a commitment for a $175.0 million term loan as part of our credit facility to fund the cash portion of the consideration in the Proposed Merger (Note 3). The credit agreement stipulates six financial covenants that require us to achieve certain ratios and benchmarks at the end of each quarter. We were in compliance with these covenants at June 30, 2012.
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Table of ContentsNotes to Consolidated Financial Statements
Non-Recourse and Limited-Recourse Debt Non-recourse and limited-recourse debt consists of mortgage notes payable, which are collateralized by the assignment of real property, and direct financing leases, with an aggregate carrying value of $443.7 million at June 30, 2012. Our mortgage notes payable had fixed annual interest rates ranging from 3.1% to 7.8% and variable effective annual interest rates ranging from 2.0% to 7.3% with maturity dates ranging from 2012 to 2025 at June 30, 2012. Scheduled Debt Principal Payments Scheduled debt principal payments during each of the next five calendar years following June 30, 2012 and thereafter are as follows (in thousands):
Note 10. Commitments and Contingencies At June 30, 2012, we were not involved in any material litigation. For a description of a recent agreement that we entered into regarding repurchases of Listed shares from the Estate Shareholders, see Note 16. Various claims and lawsuits arising in the normal course of business are pending against us. The results of these proceedings are not expected to have a material adverse effect on our consolidated financial position or results of operations. Note 11. Equity and Stock-Based and Other Compensation Stock-Based Compensation The total compensation expense (net of forfeitures) for our stock-based compensation plans was $4.5 million and $6.2 million for the three months ended June 30, 2012 and 2011, respectively, and $9.8 million and $8.7 million for the six months ended June 30, 2012 and 2011, respectively, all of which are included in General and administrative expenses in the consolidated financial statements. Total stock-based compensation expense for each of the three and six months ended June 30, 2012 included a reduction of $1.7 million in compensation expense as a result of revising the expected payout ratio of the performance stock units (“PSUs”) issued in 2010 and 2011. The income tax benefit recognized by us related to these plans totaled $2.0 million and $2.8 million for the three months ended June 30, 2012 and 2011, respectively, and $4.2 million and $3.9 million for the six months ended June 30, 2012 and 2011, respectively. There has been no significant activity or changes to the terms and conditions of any of our stock-based compensation plans or arrangements during 2012, other than as described below.
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Table of ContentsNotes to Consolidated Financial Statements
2012 Award Activity In January 2012, the compensation committee of our board of directors approved long-term incentive (“LTIP”) awards to key employees consisting of 168,900 restricted stock units (“RSUs”), which represent the right to receive shares of our common stock over time, and 162,400 PSUs, which represent the right to receive shares of our common stock based on the level of achievement during a specified performance period of one or more performance goals for us set by the independent Compensation Committee of our Board of Directors. The RSUs are scheduled to vest in equal annual installments over three years. Vesting of the PSUs is conditioned upon the extent that we achieve the performance goals during the performance period, which was set as January 1, 2012 through December 31, 2014. The ultimate number of shares to be issued upon vesting of PSUs will depend on the extent to which we meet the performance goals and can range from zero to three times the original “target” awards noted above. In February and March 2012, in connection with entering into employment agreements with two key officers, the Compensation Committee granted 42,000 PSUs and 78,000 RSUs to the officers that have the same terms and performance goals as noted above. Additionally, in January 2012, two investment officers received awards pursuant to their existing employment agreements, consisting of 120,000 PSUs, of which the vesting of 100,000 PSUs are subject to the same three-year performance goals set by the Compensation Committee and the vesting of 20,000 PSUs are subject to our Chief Executive Officer’s discretion, based on the officers’ performance in the next two years. As a result of the 2012 awards, we currently expect to recognize compensation expense totaling approximately $25.3 million over the vesting period, of which $2.0 million and $3.6 million was recognized during the three and six months ended June 30, 2012, respectively. We will review our performance against these goals on an ongoing basis and update expectations as warranted. Employee Stock Purchase Plan In June 2012, our shareholders approved an amendment to the Employee Stock Purchase Plan (“ESPP”), which increased the number of shares of our common stock available for issuance under ESPP to 500,000 shares. Earnings Per Share Under current authoritative guidance for determining earnings per share, all unvested share-based payment awards that contain non-forfeitable rights to distributions are considered to be participating securities and therefore are included in the computation of earnings per share under the two-class method. The two-class method is an earnings allocation formula that determines earnings per share for each class of common shares and participating security according to dividends declared (or accumulated) and participation rights in undistributed earnings. Our unvested RSUs contain rights to receive non-forfeitable distribution equivalents, and therefore we apply the two-class method of computing earnings per share. The calculation of earnings per share below excludes the income attributable to the unvested RSUs from the numerator. The following table summarizes basic and diluted earnings (in thousands, except share amounts):
Securities included in our diluted earnings per share determination consist of stock options and restricted stock awards. Securities totaling 57,565 shares and 122,623 shares for the three and six months ended June 30, 2011, respectively, were excluded from the earnings per share computations above as their effect would have been anti-dilutive. There were no such anti-dilutive securities during the three and six months ended June 30, 2012. In July 2012, 15,020 RSUs, with a total value of $0.7 million, were issued to our directors for services they rendered pursuant to automatic annual grants under the 2009 Non-Employee Directors’ Incentive Plan. These RSUs could have a dilutive impact on our earnings per share calculation.
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Table of ContentsNotes to Consolidated Financial Statements
Note 12. Noncontrolling Interests Noncontrolling interest is the portion of equity in a subsidiary not attributable, directly or indirectly, to a parent. There were no changes in our ownership interest in any of our consolidated subsidiaries for the six months ended June 30, 2012. The following tables present a reconciliation of total equity, the equity attributable to our shareholders and the equity attributable to noncontrolling interests (in thousands):
Redeemable Noncontrolling Interest We account for the noncontrolling interest in WPCI held by one of our officers (Note 3) as a redeemable noncontrolling interest, as we have an obligation to repurchase the interest from that officer, subject to certain conditions. The officer’s interest is reflected at
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Table of ContentsNotes to Consolidated Financial Statements
estimated redemption value for all periods presented. Redeemable noncontrolling interest, as presented on the consolidated balance sheets, reflects an adjustment of $0.1 million and $(0.5) million at June 30, 2012 and December 31, 2011, respectively, to present the noncontrolling interest at redemption value. The following table presents a reconciliation of redeemable noncontrolling interest (in thousands):
Note 13. Income Taxes We recognized an income tax benefit of $1.9 million and $0.2 million for the three and six months ended June 30, 2012, respectively, as a result of pre-tax losses generated by our taxable subsidiaries, while the income tax provision for the three and six months ended June 30, 2011 was $25.0 million and $32.6 million, respectively. The difference in the provision for income taxes reflected in the consolidated statements of income as compared to the provision calculated at the statutory federal income tax rate is primarily attributable to state and foreign income taxes, the tax classification of entities in the consolidated group and various permanent differences between pre-tax GAAP income and taxable income. We have elected to be treated as a partnership for U.S. federal income tax purposes. As partnerships, we and our partnership subsidiaries are generally not directly subject to tax. We conduct our investment management services primarily through taxable subsidiaries. These operations are subject to federal, state, local and foreign taxes, as applicable. We conduct business in the U.S. and the European Union, and as a result, we or one or more of our subsidiaries file income tax returns in the U.S. federal jurisdiction and various state and certain foreign jurisdictions. Certain of our inter-company transactions that have been eliminated in consolidation for financial accounting purposes are also subject to taxation. Periodically, shares in the REITs that are payable to our taxable subsidiaries in consideration for services rendered are distributed from these subsidiaries to us. Our tax returns are subject to audit by taxing authorities. Such audits can often take years to complete and settle. The tax years 2008 through 2012 remain open to examination by the major taxing jurisdictions to which we are subject. Our subsidiary, Carey REIT II, Inc. (“Carey REIT II”), owns our real estate assets and has elected to be taxed as a real estate investment trust under Sections 856 through 860 of the Internal Revenue Code. In connection with the CPA®:14/16 Merger in May 2011, we formed a wholly-owned subsidiary, Carey REIT III, Inc. (“Carey REIT III”), to hold a special membership interest in the newly formed operating partnership of CPA®:16 – Global (Note 3). Carey REIT III has also elected to be taxed as a real estate investment trust under the Internal Revenue Code. We believe we have operated, and we intend to continue to operate, in a manner that allows Carey REIT II and Carey REIT III to continue to qualify as real estate investment trusts. Under the real estate investment trust operating structure, Carey REIT II and Carey REIT III are permitted to deduct distributions paid to their shareholders and generally will not be required to pay U.S. federal income taxes. Accordingly, no provision has been made for U.S. federal income taxes in the consolidated financial statements related to either Carey REIT II or Carey REIT III.
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Table of ContentsNotes to Consolidated Financial Statements
Note 14. Segment Reporting We evaluate our results from operations by our two major business segments — Investment Management and Real Estate Ownership (Note 1). Effective April 1, 2012, we include cash distributions and deferred revenue received and earned from the operating partnerships of CPA®:16 – Global, CPA®:17 – Global and CWI in our Real Estate Ownership segment. Results of operations for the prior year periods have been reclassified to conform to the current period presentation. The following table presents a summary of comparative results of these business segments (in thousands):
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Table of ContentsNotes to Consolidated Financial Statements
At June 30, 2012, our international investments within our Real Estate Ownership segment were comprised of investments in France, Poland, Germany and Spain. The following tables present information about these investments (in thousands):
Note 15. Discontinued Operations From time to time, tenants may vacate space due to lease buy-outs, elections not to renew their leases, insolvency or lease rejection in the bankruptcy process. In these cases, we assess whether we can obtain the highest value from the property by re-leasing or selling it. In addition, in certain cases, we may try to sell a property that is occupied. When it is appropriate to do so under current authoritative accounting guidance for the disposal of long-lived assets, we classify the property as an asset held for sale on our consolidated balance sheet and the current and prior period results of operations of the property are reclassified as discontinued operations. The results of operations for properties that are held for sale or have been sold are reflected in the consolidated financial statements as discontinued operations for all periods presented and are summarized as follows (in thousands):
2012 — During the six months ended June 30, 2012, we sold five domestic properties for $25.2 million, net of selling costs, and recognized a net loss on these sales of $0.5 million, excluding impairment charges of $3.1 million recognized in the current year and $6.9 million previously recognized during 2011. The net loss on sale of real estate recognized during the six months ended June 30, 2012 included $0.3 million related to properties sold during the second quarter of 2012. 2011 — During the six months ended June 30, 2011, we sold four domestic properties for $10.6 million, net of selling costs, and recognized a net gain on these sales of $0.7 million, excluding impairment charges of $2.3 million previously recognized during the six months ended June 30, 2010. Net gain recognized during the six months ended June 30, 2011 included a net loss of $0.1 million related to properties sold during the second quarter of 2011. Note 16. Subsequent Events On July 23, 2012, we entered into certain agreements with the Estate Shareholders, including a Voting Agreement (Note 3) and a Share Purchase Agreement. Pursuant to the Share Purchase Agreement, we (and following the consummation of the proposed Merger, W. P. Carey Inc.) have agreed to purchase up to an aggregate amount of $85.0 million of our Listed shares (and following the consummation of the proposed Merger, shares of W. P. Carey Inc. common stock) beneficially owned by the Estate Shareholders in the following manner: (i) prior to
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Table of ContentsNotes to Consolidated Financial Statements
the date of the dissemination of the Joint Proxy Statement / Prospectus of W. P. Carey and CPA®:15 underlying the Form S-4 (the “Joint Proxy Statement / Prospectus”), the Estate Shareholders collectively had a one-time option to sell up to an aggregate amount of $25.0 million of Listed shares (the “First Sale Option”), which, as discussed below, has been exercised; (ii) at any time following the consummation of the Proposed Merger, but on or before the later of (a) December 31, 2012, and (b) 30 days following the consummation of the Proposed Merger, the Estate Shareholders collectively have a one-time option to sell up to an aggregate amount of $20.0 million of W. P. Carey Inc. common stock (the “Second Sale Option”); and (iii) at any time following January 1, 2013, but on or before the later of (a) March 31, 2013, and (b) the date that is six (6) months following the date of the consummation of the Proposed Merger, the Estate Shareholders collectively have a one-time option to sell up to an aggregate amount of $40.0 million of W. P. Carey Inc. common stock (the “Third Sale Option,” and with the First Sale Option and Second Sale Option, each a “Sale Option”). In connection with the exercise of a Sale Option, we and W. P. Carey Inc. have agreed to pay a per share purchase price equal to 96% of the volume weighted average price of one Listed share, and/or one share of W. P. Carey Inc. common stock, as applicable, for the ten (10) business days immediately prior to the date of notification of exercise. On July 27, 2012, we received a notice from the Estate Shareholders indicating their intention to fully exercise the First Sale Option, and as a result, on August 2, 2012 we repurchased 561,418 Listed shares for $25.0 million from the Estate Shareholders pursuant to the First Sale Option at a price of $44.5301 per share. We used our existing line of credit to finance the purchase pursuant to the First Sale Option. We currently intend to draw on our existing unsecured line of credit or the new $175.0 million term loan (Note 9) in order to finance the purchase of the Listed shares pursuant to the remaining Sale Options if and when the Estate Shareholders should decide to exercise them.
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Table of ContentsItem 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Management’s discussion and analysis of financial condition and results of operations (“MD&A”) is intended to provide the reader with information that will assist in understanding our financial statements and the reasons for changes in certain key components of our financial statements from period to period. MD&A also provides the reader with our perspective on our financial position and liquidity, as well as certain other factors that may affect our future results. Our MD&A should be read in conjunction with our 2011 Annual Report. Business Overview We provide long-term financing via sale-leaseback and build-to-suit transactions for companies worldwide and manage a global investment portfolio of more than 970 properties, including our owned portfolio. We operate in two business segments — Investment Management and Real Estate Ownership, as described below. Investment Management — As of June 30, 2012, we provided services to four affiliated publicly-owned, non-listed real estate investment trusts: CPA®:15, CPA®:16 – Global, CPA®:17 – Global and CWI. In May 2011, another affiliated publicly-owned, non-listed real estate investment trust, CPA®:14, merged with and into a subsidiary of CPA®:16 – Global. We structure and negotiate investments and debt placement transactions for the REITs, for which we earn structuring revenue, and manage their portfolios of real estate investments, for which we earn asset-based management and performance revenue. We earn asset-based management and performance revenue from the CPA® REITs based on the value of their real estate-related and, for CWI, its lodging-related assets under management. As funds available to the REITs are invested, the asset base from which we earn revenue increases. We may also earn incentive and disposition revenue and receive other compensation in connection with providing liquidity alternatives to the REIT shareholders, as we did for CPA®:14 shareholders with the CPA®:14/16 Merger. Real Estate Ownership — We own and invest in commercial properties in the U.S. and the European Union that are then leased to companies, primarily on a triple-net lease basis, which requires the tenant to pay substantially all of the costs associated with operating and maintaining the property. We may also invest in other properties if opportunities arise. We own interests in the REITs and account for these interests under the equity method of accounting. In addition, we receive a percentage of distributions of Available Cash as defined in the respective advisory agreements from the operating partnerships of CPA®:16 – Global, CPA®:17 – Global and CWI, and earn deferred revenue from our special member interest in CPA®:16 – Global’s operating partnership. Effective April 1, 2012, we include such distributions and deferred revenue in our Real Estate Ownership segment. At June 30, 2012, our portfolio was comprised of our full or partial ownership interest in 146 properties, including certain properties in which the CPA® REITs also have an ownership interest. Substantially all of these properties, totaling approximately 11.4 million square feet (on a pro rata basis), were net leased to 69 tenants, with an occupancy rate of approximately 94%. In addition, through our consolidated subsidiaries, Carey Storage and Livho, we have interests in 21 self storage properties and a hotel property, respectively. Collectively, at June 30, 2012, the CPA® REITs owned all or a portion of over 800 properties, including certain properties in which we have an ownership interest. Substantially all of these properties, totaling approximately 106 million square feet (on a pro rata basis), were net leased to 222 tenants, with an average occupancy rate of approximately 99%. Financial Highlights (In thousands)
We consider the performance metrics listed above, including certain supplemental metrics that are not defined by GAAP (“non-GAAP”), such as Funds from operations — as adjusted (“AFFO”) and Adjusted cash flow from operating activities (“ACFO”), to be
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Table of Contentsimportant measures in the evaluation of our results of operations, liquidity and capital resources. We evaluate our results of operations with a primary focus on increasing and enhancing the value, quality and amount of assets under management by our Investment Management segment and the ability to generate the cash flow necessary to meet our objectives in our Real Estate Ownership segment. Results of operations by reportable segment are described below in Results of Operations. See Supplemental Financial Measures below for our definition of these non-GAAP measures and reconciliations to their most directly comparable GAAP measure. Total revenues decreased during the three and six months ended June 30, 2012 as compared to the same periods in 2011. Revenues from our Investment Management segment decreased during the current year periods primarily due to the incentive, termination and subordinated disposition revenue recognized in connection with providing a liquidity event for CPA®:14 stockholders through the CPA®:14/16 Merger in May 2011 as well as a lower volume of investments structured on behalf of the REITs in the current year periods. This decrease was partially offset by revenues from the properties we purchased in May 2011 from CPA®:14 in connection with the CPA®:14/16 Merger, which contributed to an increase in revenues from our Real Estate Ownership. Net income attributable to W. P. Carey members decreased during the three and six months ended June 30, 2012 as compared to the same periods in 2011. Results from operations in our Investment Management segment were significantly lower during the current year periods as a result of the incentive, termination and subordinated disposition revenue recognized in connection with the CPA®:14/16 Merger in May 2011 as well as a lower volume of investments structured on behalf of the REITs in the current year periods. Results from operations in our Real Estate Ownership segment were also lower during the current year periods as compared to the same periods in 2011, primarily as a result of a net gain recognized on purchasing properties from CPA®:14 in connection with the CPA®:14/16 Merger in May 2011. Cash flow from operating activities decreased during the six months ended June 30, 2012 as compared to the same period in 2011, primarily due to subordinated disposition revenues received in connection with providing a liquidity event to CPA®:14 stockholders through the CPA®:14/16 Merger in May 2011 and higher payments for bonuses to employees and commissions to investment officers as a result of higher net income as well as higher investment volume in 2011 as compared to 2010. Additionally, cash flow from operating activities decreased in the current year period as a result of lower structuring revenue received due to the lower investment volume during the six months ended June 30, 2012 as compared to the prior year period. These decreases were partially offset by higher distributions of Available Cash received from the operating partnerships of CPA®:16 – Global and CPA®:17 – Global in the current year period. Our quarterly cash distribution increased to $0.567 per share for the second quarter of 2012, which equates to $2.27 per share on an annualized basis. Our AFFO supplemental measure decreased during the three and six months ended June 30, 2012 as compared to the same period in 2011, primarily due to the $52.5 million incentive, termination and subordinated disposition income recognized in connection with the CPA®:14/16 Merger in May 2011 as well as a decrease in structuring revenue due to lower investment volume in the current year periods in the Investment Management segment. These decreases were partially offset by an increase in AFFO in our Real Estate Ownership segment in the current year period primarily as a result of income earned from the properties we purchased from CPA®:14 in 2011 in connection with the CPA®:14/16 Merger as well as income generated from our equity interests in the CPA® REITs, including our $121.0 million incremental investment in CPA®:16 – Global in connection with the CPA®:14/16 Merger. Adjusted cash flow from operating activities increased during the six months ended June 30, 2012 as compared to the same period in 2011, as a result of higher working capital balances. Significant Developments Proposed Merger On February 21, 2012, we announced that our Board of Directors had approved the Proposed REIT
Reorganization in order to qualify as a REIT for U.S. federal income tax purposes and the Proposed Merger with
CPA®:15 (collectively, the “Transactions”). The consummation of these Transactions is subject to
certain conditions, including the effectiveness of a registration statement on Form
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Table of ContentsTransactions With Estate of Wm. Polk Carey Voting Agreement On July 23, 2012, we entered into the Voting Agreement with the Estate Shareholders, pursuant to which the Estate Shareholders have agreed to, among other things, vote (or cause to be voted) any and all Listed shares beneficially owned by the Estate Shareholders as of the date of the Voting Agreement or subsequently acquired or beneficially owned by the Estate Shareholders (collectively, the “Estate Shares”) in favor of: the Proposed Merger and the Proposed REIT Reorganization. The Voting Agreement terminates upon the earliest to occur of (i) the Effective Time (as defined in the Merger Agreement), (ii) the date on which the Merger Agreement is terminated in accordance with its terms, (iii) the date of any material modification, waiver or amendment of the agreement pursuant to which the Proposed REIT Reorganization will occur and/or the Merger Agreement that is adverse to the Estate Shareholders such that W. P. Carey must distribute to its shareholders a supplement or amendment to the Joint Proxy Statement/Prospectus relating to the proposed Transactions filed with the SEC from time to time, and (iv) our failure to consummate, in accordance with and subject to the terms of the Share Purchase Agreement, the repurchase of Listed shares pursuant to the exercise of the First Sale Option , which as described above occurred on August 2, 2012. The obligations of the Estate Shareholders contained in the Voting Agreement are conditioned upon and subject to receipt by the Estate from the board of directors of W. P. Carey Inc., prior to the consummation of the Merger, of an executed non-waivable exemption from the applicable REIT provisions for the Estate to beneficially own up to eighteen percent (18%) of the aggregate outstanding shares of W. P. Carey Inc. common stock or any other outstanding class or series of W. P. Carey Inc.’s stock. Furthermore, subject to certain limited exceptions, during the term of the Voting Agreement, the Estate Shareholders have agreed not to, directly or indirectly, transfer, sell, offer, exchange, assign, pledge or otherwise dispose of or encumber any of the Estate Shares. Mr. Francis J. Carey, a director of W. P. Carey and W. P. Carey Inc., currently serves as a co-executor of the Estate and as a director of HoldCo. Share Purchase Agreement Concurrently with the execution of the Voting Agreement, we, W. P. Carey Inc. and the Estate Shareholders entered into the Share Purchase Agreement, pursuant to which we have agreed to purchase up to an aggregate amount of $85.0 million worth of Listed shares and, following the completion of the Proposed Merger, shares of W. P. Carey Inc. common stock, owned by the Estate Shareholders, as described in Note 16. On July 27, 2012, we received a notice from the Estate Shareholders indicating their intention to fully exercise the First Sale Option, and as a result, on August 2, 2012 we repurchased 561,418 Listed shares for $25.0 million from the Estate Shareholders pursuant to the First Sale Option at a price of $44.5301 per share. Following this repurchase, the Listed shares beneficially owned by the Estate Shareholders represented in the aggregate approximately 27.93% of the outstanding Listed shares, on August 2, 2012. Registration Rights Concurrently with the execution of the Voting Agreement and the Share Purchase Agreement, we, W. P. Carey Inc. and the Estate Shareholders entered into a Registration Rights Agreement (the “Registration Rights Agreement”). The Registration Rights Agreement provides the Estate Shareholders with, at any time following the consummation of the Proposed REIT Reorganization, but on or before the third anniversary thereof, subject to certain exceptions and limitations, three demand rights (the “Demand Registration Rights”) for the registration via an underwritten public offering of, in each instance, between a minimum of (i)(a) $50.0 million with respect to one Demand Registration Right, and (b) $75.0 million with respect to two Demand Registration Rights, and a maximum of (ii) $250.0 million, worth of shares of W. P. Carey Inc. common stock owned by the Estate Shareholders as of the date of the Registration Rights Agreement. Additionally, the Registration Rights Agreement provides the Estate Shareholders with, subject to certain exceptions and limitations, unlimited “piggyback” registration rights (the “Piggyback Registration Rights,” and together with the Demand Registration Rights, the “Estate Shareholders’ Registration Rights”) pertaining to the shares of W. P. Carey Inc. common stock owned by the Estate Shareholders as of the date of the Registration Rights Agreement. The Estate Shareholders’ Registration Rights are subject to customary lock-up and cutback provisions, and the Registration Rights Agreement contains customary indemnification provisions. We and W. P. Carey Inc. have agreed to bear the expenses incurred in
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Table of Contentsconnection with the filing of any registration statements attributable to the exercise of the Estate Shareholders’ Registration Rights, other than any (i) underwriting fees, discounts and sales commissions, (ii) fees, expense and disbursements of legal counsel of the Estate Shareholders, and (iii) transfer taxes, in each case relating to the sale or disposition by the Estate Shareholders of shares of W. P. Carey Inc. common stock pursuant to the Registration Rights Agreement. Changes in Management On July 17, 2012, we announced that Mark J. DeCesaris had informed us of his intention to resign as our Chief Financial Officer and as Chief Financial Officer of the REITs. Mr. DeCesaris plans to remain in those positions, maintaining his responsibilities and assisting in the recruitment of a new Chief Financial Officer, until the transition of his duties is complete. Our board of directors also appointed Mr. DeCesaris to serve as a director, effective as of July 17, 2012. Current Trends General Economic Environment We and our managed funds are impacted by macro-economic environmental factors, the capital markets, and general conditions in the commercial real estate market, both in the U.S. and globally. Economic conditions in the U.S. continue to show some signs of stabilization, while the economic outlook in Europe remains uncertain. It is not possible to predict with certainty the outcome of these trends. Nevertheless, our views of the effects of the current financial and economic trends on our business, as well as our response to those trends, are presented below. Foreign Exchange Rates Fluctuations in foreign currency exchange rates impact both our Real Estate Ownership and Investment Management segments. In our Real Estate Ownership segment, we are impacted through our ownership of properties in the European Union, primarily France, and through our equity ownership in the CPA® REITs, which each have significant foreign investments, primarily in countries that use the Euro. In our Investment Management segment, exchange rate fluctuations may impact the asset management revenue we receive for managing the portfolios of the CPA® REITs as well as the quarterly distributions of available cash we receive from the operating partnerships of CPA®:16 – Global and CPA®:17 – Global. Our results of foreign operations benefit from a weaker U.S. dollar and are adversely affected by a stronger U.S. dollar relative to foreign currencies. For the six months ended June 30, 2012, our Euro-denominated revenue was $5.1 million. International investments carried on our balance sheet are marked to the spot exchange rate as of the balance sheet date. The U.S. dollar strengthened at June 30, 2012 versus the spot rate at December 31, 2011. The Euro/U.S. dollar exchange rate at June 30, 2012 was $1.2578, a 2.9% decrease from the December 31, 2011 rate of $1.2950. This strengthening had an unfavorable impact on our balance sheet, and especially those of the CPA® REITs, at June 30, 2012 as compared to the balance sheet at December 31, 2011. The operational impact of currency fluctuations on our international investments is measured throughout the year. Due to the decline of the Euro to the U.S. dollar, the average rate we utilized to measure these operations decreased by 7.5% during the six months ended June 30, 2012 versus the same period in 2011. This decrease had an unfavorable impact on our results of operations for us and the CPA® REITs in the current year period as compared to the prior year period. As a result, our share of earnings in the CPA® REITs was modestly impacted; however, as a result of hedging, distributions from the CPA®:16 – Global and CPA®:17 – Global operating partnerships were not significantly impacted. Capital Markets Domestically, new issuances of commercial mortgage-backed securities debt and increasing capital inflows to both commercial real estate debt and equity markets helped increase the availability of mortgage financing and sustained transaction volume during the past few quarters. We continue to observe that the cost for domestic debt remains in check while events in the Euro-zone have impacted the price and availability of financing and have affected global commercial real estate capitalization rates, which vary depending on a variety of factors, including asset quality, tenant credit quality, geography and lease term. Investment Opportunities Through our Investment Management segment, we earn structuring revenue on the investments we structure on behalf of the REITs. Our ability to complete these investments on behalf of the REITs, and thereby earn structuring revenue, fluctuates based on the pricing and availability of both transactions and financing, among other factors.
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Table of ContentsWe continue to see investment opportunities that we believe will allow us to structure transactions on behalf of the REITs on favorable terms. Although capitalization rates continue to vary widely, we believe that the investment environment remains attractive and that we will be able to achieve attractive risk-adjusted returns for our managed funds. We have benefited from commercial de-leveraging and recent new construction activity that has provided attractive investment opportunities for net lease investors such as W. P. Carey and the CPA® REITs. While the investment community continues to remain risk averse, we have experienced increased competition for investments, both domestically and internationally. We believe this is because the net lease financing market is perceived as a relatively conservative investment vehicle, and further capital inflows into the marketplace could put additional pressure on the returns that we can generate from our investments and our willingness and ability to execute transactions. In addition, we expect to continue to expand our ability to source deals in new markets. We structured investments on behalf of the REITs totaling approximately $269.7 million during the six months ended June 30, 2012, and based on current conditions, we expect that we will be able to continue to take advantage of the investment opportunities we are seeing in the U.S. and internationally through the near term. International investments comprised 10% (on a pro rata basis) of total investments structured during the six months ended June 30, 2012. While international activity fluctuates from quarter to quarter, we currently expect that such transactions will continue to form a significant portion of the investments we structure, although the relative portion of international investments in any given period will vary. We calculate net operating income for each property as the rent that we receive from a tenant, less debt service for any financing obtained for our investment in such property. The capitalization rate for an investment is a function of the purchase price that we are willing to pay for an investment, the rent that the tenant is willing to pay and the risk we are willing to assume. In our target markets for the CPA® REITs, we have recently seen capitalization rates in the U.S. ranging from 6.25% to 11.0% and ranging from 6.5% to 12.0% internationally. The variability is due largely to the quality of the underlying assets, tenant credit quality and the terms of the leases and their geographic markets. Additionally, we have observed that capitalization rates for commoditized transactions are within the lower end of these ranges while the higher end is comprised of off-market deals requiring specialized knowledge. Financing Conditions Through our Investment Management segment, we earn structuring revenue related in part to the debt we obtain for the REITs. In addition, through our Real Estate Ownership segment, we are impacted by the cost and availability of financing for our owned properties and, through our equity interests, for properties owned by the REITs. Despite the recent stabilization in the U.S. credit and real estate financing markets, the ongoing sovereign debt issues in Europe have had the impact of increasing the cost of debt in certain international markets and made it more challenging for us to obtain debt for certain international deals. During the six months ended June 30, 2012, we obtained non-recourse mortgage financing totaling $241.4 million on behalf of the REITs and $1.3 million for our owned real estate portfolio (each on a pro rata basis). Real Estate Sector As noted above, the commercial real estate market is impacted by a variety of macro-economic factors, including but not limited to growth in gross domestic product, unemployment, interest rates, inflation and demographics. These fundamentals remain at risk of deteriorating further in Europe, which may result in higher vacancies, lower rental rates and lower demand for vacant space in future periods related to international properties. We and the CPA® REITs are chiefly affected by changes in the appraised values of our properties, tenant defaults, inflation, lease expirations and occupancy rates. Net Asset Values of the REITs We own shares in each of the REITs, which we report in our Real Estate Ownership segment, and we earn asset management revenue through our Investment Management segment based on a percentage of average invested assets for each REIT. As such, we benefit from rising investment values and are negatively impacted when these values decrease. The net asset values (“NAVs”) of CPA®:15 and CPA®:16 – Global did not change significantly between 2010 and 2011 primarily due to high occupancy rates, acceptable tenant credit quality and the long-term leases within their portfolios. The NAVs of the CPA® REITs are based on a number of variables, including discount rate, individual tenant credits, lease terms, lending credit spreads, foreign currency exchange rates and tenant defaults, among others. We do not control these variables and, as such, cannot predict how they will change in the future.
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Table of ContentsCredit Quality of Tenants The credit quality of tenants primarily impacts our Real Estate Ownership segment. As a net lease investor, we are exposed to credit risk within our tenant portfolio, which can reduce our results of operations and cash flow from operations if our tenants are unable to pay their rent. Within our managed portfolios, tenant defaults can reduce the asset management revenue in our Investment Management segment if they lead to a decline in the appraised value of the assets of the CPA® REITs and they can also reduce our income and distributions from equity investments in the CPA® REITs in our Real Estate Ownership segment. Tenants experiencing financial difficulties may become delinquent on their rent and/or default on their leases and, if they file for bankruptcy protection, may reject our lease in bankruptcy court, resulting in reduced cash flow, which may negatively impact NAVs and require us or the CPA® REITs to incur impairment charges. Even where a default has not occurred and a tenant is continuing to make the required lease payments, we may restructure or renew leases on less favorable terms, or the tenant’s credit profile may deteriorate, which could affect the value of the leased asset and could in turn require us or the CPA® REITs to incur impairment charges. Conversely, improving credit quality has a positive impact on NAVs. Despite the stabilization in domestic general business conditions over the past few quarters, which had a favorable impact on the overall credit quality of our tenants, we believe that there still remain significant risks to an economic recovery in the Euro-zone and its impact on the global economy. As of the date of this Report, we have no significant exposure to tenants operating under bankruptcy protection in our owned portfolio or in the CPA® REIT portfolios. It is possible, however, that tenants may file for bankruptcy or default on their leases in the future and that economic conditions may again deteriorate. To mitigate credit risk, we have historically looked to invest in assets that we believe are critically important to our tenants’ operations and have attempted to diversify our owned portfolio and the CPA® REITs’ portfolios by tenant, tenant industry and geography. We also monitor tenant performance through review of rent delinquencies as a precursor to a potential default, meetings with tenant management and review of tenants’ financial statements and compliance with any financial covenants. When necessary, our asset management process includes restructuring transactions to meet the evolving needs of tenants, re-leasing properties, refinancing debt and selling properties, as well as protecting our rights when tenants default or enter into bankruptcy. Inflation Inflation impacts our lease revenues and, through our equity ownership in the CPA® REITs and joint investments, our equity in earnings within our Real Estate Ownership segment because our leases and those of the CPA® REITs generally have rent adjustments that are either fixed or based on formulas indexed to changes in the Consumer Price Index (“CPI”) or other similar indices for the jurisdiction in which the property is located. Because these rent adjustments may be calculated based on changes in the CPI over a multi-year period, changes in inflation rates can have a delayed impact on our results of operations. We have seen modest inflation in the U.S. during the past quarter that may favorably affect rents in our owned portfolio and in the portfolios of the CPA® REITs in coming years. Lease Expirations and Occupancy Lease expirations and occupancy rates impact our revenues and, through our equity ownership in the CPA® REITs and joint investments, our equity in earnings within our Real Estate Ownership segment. Within our managed portfolios, vacancies can reduce the asset management revenue in our Investment Management segment if they lead to a decline in the appraised value of the assets of the CPA® REITs and can also reduce our income and distributions from equity investments in the CPA® REITs. We actively manage our owned real estate portfolio and the portfolios of the CPA® REITs and generally begin discussing options with tenants in advance of scheduled lease expirations. In certain cases, we may obtain lease renewals from our tenants; however, tenants may elect to move out at the end of their term or may elect to exercise purchase options, if any, in their leases. In cases where tenants elect not to renew, we may seek replacement tenants or try to sell the property. As of June 30, 2012, 7% of the annualized contractual minimum base rent in our owned portfolio is scheduled to expire in the next twelve months. We currently anticipate that we will be able to renew a majority of the remaining leases scheduled to expire in 2012. For those leases that we believe will be renewed, it is possible that renewed rents may be below the tenants’ existing contractual rents and that lease terms may be shorter than historical norms. The occupancy rate for our owned real estate portfolio was 94% at June 30, 2012, an increase of 1% from December 31, 2011, reflecting the sale of a vacant property in 2012.
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Table of ContentsInvestor Capital Inflows Trends for investor capital inflows primarily impact our Real Estate Ownership segment because the REITs we manage that are in an offering period are dependent upon the funds raised to acquire assets and maintain portfolio diversification. Additionally, the presence of sufficient capital enables us to structure investments and earn structuring revenue in our Investment Management segment. During the second quarter, investor capital inflows for non-listed real estate investment trusts overall declined 8.5% compared to the prior quarter. However, we raised $176.7 million and $186.0 million on behalf of CPA®:17 – Global during the first and second quarters of 2012, respectively, reflecting an increase of 5.3%. Since the beginning of CPA®:17 – Global’s follow-on offering on April 7, 2011 through June 30, 2012, we raised $781.3 million for CPA®:17 – Global. Since beginning fundraising for CPA®:17 – Global in December 2007 through June 30, 2012, we have raised more than $2.3 billion on its behalf. For CWI, we raised $83.1 million from the beginning of its offering in September 2010 through June 30, 2012, of which $11.7 million and $24.3 million were raised during the first and second quarters of 2012, respectively, representing an increase of 107.7%. In June 2012, CWI’s board of directors extended its primary offering for one year to September 15, 2013. If CWI files another registration statement prior to September 15, 2013 in order to sell additional shares in a follow-on offering, CWI could continue to sell shares in the ongoing primary offering until the earlier of March 16, 2014 or the effective date of the subsequent registration statement.
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Table of ContentsResults of Operations We evaluate our results of operations by our two major business segments — Investment Management and Real Estate Ownership. Effective April 1, 2012, we include cash distributions and deferred revenue received and earned from the operating partnerships of CPA®:16 – Global, CPA®:17 – Global and CWI in our Real Estate Ownership segment. Results of operations for the prior year periods have been reclassified to conform to the current period presentation. A summary of comparative results of these business segments is as follows: Investment Management (in thousands)
Asset Management Revenue We earn asset-based management and performance revenue from the REITs based on the value of their real estate-related assets under management. This asset management revenue may increase or decrease depending upon (i) increases in the REIT asset bases as a result of new investments; (ii) decreases in the REIT asset bases as a result of sales of investments; (iii) increases or decreases in the appraised value of the real estate-related assets in the REIT investment portfolios; and (iv) whether the CPA® REITs are meeting their performance criteria. Each CPA® REIT met its performance criteria for all periods presented. The availability of funds for new investments is substantially dependent on our ability to raise funds for investment by the REITs. For the three and six months ended June 30, 2012 as compared to the same periods in 2011, asset management revenue decreased by $1.0 million and $5.2 million, respectively. Asset management revenue from CPA®:16 – Global decreased by $2.2 million and $8.1 million, respectively, primarily due to a change in our fee arrangement with CPA®:16 – Global under its umbrella partnership real estate investment trust (“UPREIT”) structure after the CPA®:14/16 Merger. Immediately after the CPA®:14/16 Merger in May 2011, our asset management revenue from CPA®:16 – Global was reduced from 1% to 0.5% of the property value of the assets under management and we now receive a distribution of 10% of the Available Cash of CPA®:16 – Global’s operating partnership, which we record as Income from equity investments in the REITs within the Real Estate Ownership segment. Asset management revenue from CPA®:15 also decreased by $0.5 million and $0.6 million during the three and six months ended June 30, 2012, respectively, as a result of recent property sales. These decreases were partially offset by increases in revenue of $1.7 million and $3.4 million, respectively, during the three and six months ended June 30, 2012 from CPA®:17 – Global as a result of new investments that it entered into during 2011 and 2012.
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Table of ContentsStructuring Revenue We earn structuring revenue when we structure investments and debt placement transactions for the REITs. Structuring revenue is dependent on investment activity, which is subject to significant period-to-period variation. We structured real estate investments on behalf of the REITs totaling $98.0 million and $269.7 million, respectively, during the three and six months ended June 30, 2012, compared to $249.2 million and $594.0 million, respectively, for the three and six months ended June 30, 2011. For the three and six months ended June 30, 2012 as compared to the same periods in 2011, structuring revenue decreased by $2.1 million and $10.4 million, respectively, primarily due to the lower investment volume in the current year periods. Incentive, Termination and Subordinated Disposition Revenue Incentive, termination and disposition revenue is generally earned in connection with events in which we provide liquidity or alternatives to the REITs’ shareholders. These events do not occur every year and no such event occurred during the three or six months ended June 30, 2012. In connection with providing a liquidity event for CPA®:14 shareholders, in May 2011, we earned termination revenue of $31.2 million and subordinated disposition revenue of $21.3 million, which we received in shares of CPA®:14 and cash, respectively. These CPA®:14 shares were subsequently converted to shares of CPA®:16 – Global in connection with the CPA®:14/16 Merger. Wholesaling Revenue We earned a wholesaling fee of $0.15 per share sold in connection with CPA® 17 – Global’s initial public offering through April 7, 2011. In addition, as discussed in Note 3, we earn a dealer manager fee of up to $0.35 per share sold in connection with CPA®:17 – Global’s follow-on offering and $0.30 per share sold in connection with CWI’s initial public offering. We re-allow all or a portion of the dealer manager fees to selected dealers in the offerings. Dealer manager fees that are not re-allowed are classified as wholesaling revenue. Wholesaling revenue earned is generally offset by underwriting costs incurred in connection with the offerings, which are included in General and administrative expenses. For the three and six months ended June 30, 2012 as compared to the same periods in 2011, wholesaling revenue increased by $1.2 million and $1.7 million, respectively, primarily due to increases in shares sold in connection with CPA® 17 – Global and CWI’s offerings in the current year periods. Reimbursed and Reimbursable Costs Reimbursed costs (revenue) from affiliates and reimbursable costs (expenses) represent costs incurred by us on behalf of the REITs, consisting primarily of broker-dealer commissions and marketing and personnel costs, which are reimbursed by the REITs. Revenue from reimbursed costs from affiliates is offset by corresponding charges to reimbursable costs. For the three and six months ended June 30, 2012 as compared to the same periods in 2011, reimbursed and reimbursable costs increased by $3.4 million and $4.4 million, respectively, primarily due to increases in commissions paid to broker-dealers of $2.6 million and $2.9 million in the respective periods related to CPA® 17 – Global and CWI’s offerings as a result of corresponding increases in funds raised. In addition, personnel costs reimbursed by the REITS increased by $0.8 million and $1.5 million, respectively, as a result of an increase in the number of personnel in 2012. General and Administrative For the three months ended June 30, 2012 as compared to the same period in 2011, general and administrative expenses increased by $0.4 million, primarily due to the following: $1.3 million of costs incurred in connection with the Proposed Merger; a $0.9 million increase in underwriting costs in connection with CPA® 17 – Global and CWI’s offerings; a $0.4 million increase in office rent; and a $0.3 million increase in professional fees. These increases were substantially offset by decreases in compensation-related costs, including a decrease in stock-based compensation expense of $1.7 million as a result of changes in the expected vesting of the PSUs granted in 2011 and 2010 and a decrease of $0.8 million in commissions to investment officers, in each case, as a result of lower investment volume during the current year period.
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