Realty Income Corporation — Q3 2013 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2013; unaudited. Realty Income is a REIT focused on long-term net-leased commercial properties and monthly distributions. The January 2013 acquisition of American Realty Capital Trust (ARCT) substantially expanded the portfolio, making year-over-year results less directly comparable.
Financial performance and position
- Revenue: Q3 total revenue was $199.3 million, up 70.1% from $117.1 million; nine-month revenue was $550.4 million, up 61.5% from $340.8 million. Rental revenue rose 67.3% in Q3 and 60.1% year to date. Management attributed most of the increase to acquired properties; same-store rents increased 1.3% in both comparisons.
- Profit: Q3 net income attributable to the company was $51.6 million versus $37.5 million; income available to common stockholders was $41.1 million, or $0.21 diluted per share, versus $27.0 million, or $0.20. Nine-month common income was $149.8 million, or $0.80 diluted per share, versus $86.0 million, or $0.65. Continuing-operations income was $45.3 million in Q3 and $130.5 million year to date. Its margin on reported revenue was approximately 22.7% and 23.7%, respectively, versus 28.7% and 31.6% in 2012.
- REIT operating measures: Q3 diluted FFO was $0.59 per share versus $0.48; normalized FFO was $0.59 versus $0.52; AFFO was $0.60 versus $0.52. Nine-month diluted FFO was $1.72 versus $1.42, normalized FFO $1.79 versus $1.47, and AFFO $1.79 versus $1.52. These are non-GAAP measures and are not substitutes for cash flow or GAAP results.
- Cash flow: Nine-month operating cash flow was $345.7 million, up from $208.5 million. Investing used $1.211 billion, primarily for acquisitions; financing provided $870.5 million, including stock and debt proceeds. Ending cash was $10.0 million.
- Debt and liquidity: At September 30, total borrowings were approximately $4.55 billion: $3.20 billion notes and bonds, $811.1 million mortgages, $468.4 million credit-facility borrowings, and a $70.0 million term loan. Debt was about 35% of stated total market capitalization. The company reported $531.6 million of remaining facility capacity and compliance with debt covenants. After quarter-end, the facility was increased to $1.5 billion and October equity proceeds helped repay borrowings; reported available capacity then was approximately $1.4 billion.
- Portfolio and distributions: The company owned 3,866 properties in 49 states and Puerto Rico, with 98.1% occupancy and a weighted average remaining lease term of about 10.9 years for leased single-tenant properties. Common distributions paid in the first nine months totaled $298.5 million, about 88.5% of AFFO; management reported AFFO of $337.4 million. The October monthly common dividend of $0.1818542 per share represented an annualized $2.1822504.
Material changes and unusual items
- ARCT was acquired for approximately $3.2 billion, adding 515 properties; Realty Income issued about 45.6 million common shares. The acquisition and other 2013 property investments contributed to substantial asset and revenue growth. The preliminary ARCT purchase-price allocation remained subject to final valuation.
- Merger-related costs were $12.9 million in the first nine months of 2013; management estimated total ARCT transaction costs of approximately $21 million. Accelerated restricted-stock vesting added $3.7 million of compensation expense.
- Property-sale gains were $50.5 million for the first nine months of 2013 versus $6.0 million in 2012, materially contributing to reported net income. Impairment provisions in discontinued operations were $3.0 million year to date.
- The company issued $750 million of 4.65% notes due 2023 and raised $755.1 million net in a March common-stock offering. Common shares outstanding increased to 196.3 million at quarter-end from 133.5 million at year-end 2012, largely reflecting the ARCT transaction and equity issuance.
- John Case became CEO in September, succeeding Tom Lewis, who retired as CEO and remained Vice Chairman during the transition.
Outlook, risks and contingencies
- Management expected 2013 property sales to exceed $125 million and intended to reinvest proceeds in acquisitions where opportunities were attractive. It gave no specific earnings or FFO guidance and cautioned that future dividends and increases were not guaranteed.
- Management said cash, operating cash flow and borrowing capacity were sufficient for liquidity needs over the next twelve months. It also stated an intention to use long-term or permanent capital for acquisitions and to repay future facility borrowings.
- Key disclosed risks include tenant defaults, acquisition integration and valuation, access to capital markets, interest-rate changes, real estate values and impairments, competition, economic conditions, environmental matters, and maintaining REIT status. A 1% change in rates on the quarter-end credit-facility balance would change annual interest costs by approximately $4.7 million.
- At quarter-end, the company had $8.8 million of construction-contract commitments and $1.9 million of contingent tenant-improvement and leasing-cost payments. The ARCT-related shareholder litigation settlement received final court approval on October 24, 2013; Realty Income was responsible for approximately 25% of $512,751 in approved plaintiffs’ fees and expenses, with the balance payable by ARCT’s insurer.
- Management reported no material change in previously disclosed risk factors, effective disclosure controls, and no material weakness in internal controls.
Investor items to verify
- Separate acquisition-driven growth from underlying performance, including the 1.3% same-store rent increase and post-acquisition operating costs.
- Review the final ARCT purchase-price allocation, integration outcomes, and whether expected acquisition benefits are reflected in recurring results.
- Assess debt maturities, variable-rate exposure, facility availability, covenant headroom and funding needs alongside the company’s acquisition and dividend plans.
- Reconcile GAAP earnings with FFO, normalized FFO and AFFO, and distinguish recurring operations from property-sale gains, merger costs and other adjustments.
- Monitor occupancy, tenant and industry concentration, lease expirations, property dispositions, and the sustainability of distributions relative to cash generation.