VNO

Business Context and Reporting Period

Company: Vornado Realty Trust (Vornado)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2005
Business Overview: Vornado is a fully-integrated Real Estate Investment Trust (REIT) owning and operating office, retail, and showroom properties, with significant concentrations in New York City and Washington, D.C. The company also holds a 47.6% interest in Americold (Temperature Controlled Logistics) and a 32.95% interest in Toys "R" Us, Inc. (Toys).

Key Financial Metrics

Material Changes vs. Prior Comparable Period

• Revenue Growth: Total revenues increased by $241.66 million (58.2%) for the quarter and $643.67 million (53.3%) for the nine months compared to the prior year. This growth was primarily driven by the consolidation of Americold Realty Trust (Temperature Controlled Logistics) beginning November 18, 2004, and various property acquisitions.
• Net Income Decline (Quarterly): Net income applicable to common shares decreased from $104.50 million in Q3 2004 to $27.22 million in Q3 2005. This decline was largely due to a $66.63 million mark-to-market charge on the Sears Holdings derivative position and the write-off of issuance costs for redeemed preferred units.
• Net Income Increase (Nine Months): Net income applicable to common shares increased from $337.39 million in the prior year to $387.35 million, driven by strong operating performance and gains on asset dispositions, offset by derivative mark-to-market expenses.
• EBITDA: EBITDA decreased by $36.17 million for the quarter but increased by $133.93 million for the nine months compared to the prior year periods.

Guidance, Outlook, Risks, and Unusual Items

Unusual Items and Derivatives

• Sears Holdings Derivative: The company recorded a $66.63 million expense in Q3 2005 due to the mark-to-market of a derivative position related to Sears Holdings. For the nine months, the net income from this position was $37.58 million.
• McDonald's Derivative: The company recorded $9.86 million of income in Q3 2005 from the mark-to-market of a derivative position on McDonald's common shares.
• Asset Dispositions: Net gains on dispositions included a $9.02 million gain on the sale of Prime Group Realty Trust shares and a $31.61 million gain on the sale of 400 North LaSalle (classified as discontinued operations).

Legal Proceedings and Contingencies

• H Street Acquisition: Following the acquisition of H Street Building Corporation, two corporations and a tenant filed lawsuits seeking rescission of the acquisition and damages. Vornado has filed counterclaims and believes the actions are without merit. Due to these legal actions, Vornado has not recorded its share of net income or debt for two 50%-owned corporations within H Street.
• Stop & Shop: Ongoing litigation regarding the reallocation of $5 million in annual rent. The court stayed discovery pending a decision on summary judgment motions.

Capital Resources and Liquidity

• Financing Activity: The company raised significant capital through the issuance of common shares ($780.75 million), preferred shares/units ($471.67 million), and exchangeable senior debentures ($490 million). These proceeds were used to fund acquisitions (including Toys "R" Us), redeem higher-cost preferred units, and for working capital.
• Debt Maturities: No notes and mortgages payable mature in 2005. Approximately $578.15 million matures in 2006.

Key Facts for Investor Verification

• Derivative Exposure: Verify the current valuation and potential future mark-to-market volatility of the Sears Holdings and McDonald's derivative positions, which significantly impact quarterly net income.
• H Street Litigation: Monitor the status of the lawsuits regarding the H Street acquisition, as a negative outcome could require the rescission of the deal or result in significant damages.
• Toys "R" Us Investment: Review the performance of the Toys "R" Us joint venture, noting that Vornado records its share of income/loss on a one-quarter lag basis.
• Preferred Unit Redemptions: Confirm the impact of ongoing redemptions of perpetual preferred units on future distribution obligations and the associated write-offs of issuance costs.
• FFO vs. GAAP: Note the significant divergence between GAAP Net Income and Funds From Operations (FFO) due to non-cash items like depreciation and derivative mark-to-market adjustments.