VORNADO REALTY TRUST quarterly report, Q3 FY2010

Vornado Realty Trust — 2010 Third-Quarter Form 10-Q

Business context and reporting period

Vornado Realty Trust is an integrated REIT operating primarily through Vornado Realty L.P., with major office, retail and Merchandise Mart properties concentrated in the New York City and Washington, D.C. markets. This unaudited filing covers the three and nine months ended September 30, 2010, with comparisons to the corresponding 2009 periods. Vornado owned approximately 92.8% of the Operating Partnership and had 182.7 million common shares outstanding at September 30, 2010.

Financial results and key metrics

Metric	Three months ended September 30	Nine months ended September 30
Total revenues	$707.0 million, up 5.3%	$2.099 billion, up 3.8%
Operating income	$228.3 million; 32.3% margin	$692.3 million; 33.0% margin
Net income attributable to Vornado	$104.3 million	$390.9 million
Net income attributable to common shareholders	$95.2 million; diluted EPS $0.52	$353.3 million; diluted EPS $1.92
FFO attributable to common shareholders plus assumed conversions	$249.0 million; $1.31 per diluted share	$814.0 million; $4.29 per diluted share
Net cash provided by operating activities	Not separately provided for the quarter	$594.7 million

Same-store EBITDA increased year over year on a GAAP basis by 3.3% in New York office, 4.7% in Washington office and 12.3% in retail, but declined 5.4% at Merchandise Mart. Cash-basis same-store EBITDA changes were 4.8%, 9.5%, 9.8% and negative 4.7%, respectively.
Occupancy at September 30, 2010 was 96.0% for New York office, 94.7% for Washington office, 92.5% for retail, 91.1% for Merchandise Mart office and 91.5% for Merchandise Mart showroom space.
Cash and cash equivalents were $846.3 million, compared with $535.5 million at December 31, 2009. Restricted cash was $148.2 million and marketable securities were $355.8 million.
Consolidated debt was $11.110 billion, consisting primarily of $8.993 billion of notes and mortgages, $1.231 billion of senior unsecured notes, $489.3 million of exchangeable debentures and $396.7 million of convertible debentures. No revolving credit facility debt was outstanding at quarter-end.
Approximately $1.992 billion of consolidated debt was variable rate, exposing annual net income to an estimated $19.9 million increase for a 1% rise in base rates, before considering other effects.
Common dividends were $0.65 per share for the quarter and $1.95 per share for the nine months. Operating cash flow exceeded common dividends paid of $354.9 million for the nine-month period.

Material changes versus the prior comparable period

Quarterly common-share earnings declined from $126.3 million, or $0.70 diluted EPS, to $95.2 million, or $0.52, primarily because the 2009 period included $43.3 million of discontinued-operation income, including real estate sale gains. FFO nevertheless increased from $1.25 to $1.31 per diluted share.
Nine-month common-share earnings increased from $200.3 million, or $1.17 diluted EPS, to $353.3 million, or $1.92. The comparison benefited from substantially lower mezzanine-loan loss accruals and the absence of the large 2009 charge for surrendered equity awards, partially offset by the absence of 2009 real estate sale gains.
Operating income increased 9.9% in the quarter and 9.9% for the nine months, while total expenses increased 6.8% and 1.0%, respectively.
Interest and other investment income increased to $47.4 million in the quarter from $20.5 million and to $65.9 million for the nine months from a $63.6 million loss. The improvement included a $32.2 million mark-to-market gain on J.C. Penney-related derivatives and much lower mezzanine-loan loss accruals.
Debt increased from $10.940 billion at December 31, 2009, while revolving credit debt declined from $852.2 million to zero. Vornado issued $500 million of 4.25% senior notes and completed a $660 million securitization of mortgages on 40 strip shopping centers.
Vornado launched Vornado Capital Partners with $550 million of initial equity commitments, including a $200 million commitment from Vornado, and expected total commitments of $1 billion.

Guidance, outlook, risks and unusual items

Management stated that cash flow from continuing operations was expected to fund operations, distributions, debt amortization and recurring capital expenditures over the following twelve months. The filing did not provide formal earnings or FFO guidance.
Debt maturities were approximately $184 million during the remainder of 2010 and $2.087 billion during 2011. Management expected to refinance or repay maturities using cash and available credit facilities, but stated that acquisitions and development could require additional borrowings or equity.
Three non-recourse loans were in default and in special servicing because property cash flows were insufficient to fund debt service. The company accrued $12.4 million of default interest and fees for the nine months. One California property was foreclosed in October 2010, and a High Point, North Carolina property was subject to a receivership motion. The filing states that these matters were not expected to materially affect operations, capital raising or credit ratings, but ultimate resolution remained uncertain.
Vornado owned an economic interest in 9.9% of J.C. Penney and held options to acquire 15.5 million additional shares. The derivative gain was material but non-cash and may cause significant future earnings volatility. Vornado also entered into a forward contract after quarter-end for 4.8 million J.C. Penney shares.
Vornado acquired a 26.2% interest in LNR Property Corporation for $116 million in cash plus conversion of a $15 million mezzanine loan. LNR consolidated substantial CMBS and CDO trust liabilities that were described as non-recourse to Vornado and other equity holders.
Commitments included approximately $195.7 million of additional capital to partially owned entities, up to $52 million for a proposed LNR-managed fund and approximately $400 million to $425 million for the planned 220 Central Park South development.
The company recorded a $10.1 million litigation loss accrual related to Pentagon Row. It also faced ongoing Stop & Shop litigation involving approximately $5 million of annual rent; management did not expect either matter to have a material adverse effect.
Subsequent events included the acquisition of 510 Fifth Avenue for $57 million, the sale of a 45% interest in two Washington properties and an expected fourth-quarter gain of approximately $54 million on the Warner Building transaction.
Management reported no material changes to the risk factors in the 2009 Form 10-K. Disclosure controls and procedures were deemed effective as of September 30, 2010.

Important facts for investors to verify

Reconcile reported FFO growth with GAAP earnings, discontinued operations, the J.C. Penney derivative gain and other comparability adjustments.
Review the schedule and refinancing plans for the $2.087 billion of 2011 maturities, including covenant headroom and interest-rate exposure.
Monitor the three special-servicing loans, the foreclosure and receivership proceedings, accrued default interest and any balance-sheet impact.
Assess occupancy, lease-rollover exposure, leasing spreads and same-store performance by New York, Washington, retail and Merchandise Mart segments.
Evaluate the liquidity impact of the Real Estate Fund, LNR investment, 220 Central Park South commitment and other partially owned-entity funding obligations.
Track the valuation and settlement requirements of the J.C. Penney options and forward contract, as future mark-to-market changes may materially affect reported earnings.
Confirm subsequent-quarter accounting for the property dispositions, foreclosure, debt repurchases and other October 2010 transactions.