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Realty Income Corp. (NYSE:O)

Q2 2010 Earnings Conference Call

July 29, 2010 04:30 pm

Executives

Tom Lewis - CEO

Paul Meurer - EVP, CFO

Analysts

Jeffrey Donnelly - Wells Fargo

Tayo Okusanya - Jefferies & Company

Rich Moore - RBC Capital Markets

Andrew Fenton - Credit Suisse

Operator

Good day ladies and gentlemen thank you for standing by. Welcome to the Realty Income second quarter 2010 earnings conference call. Today's presentation all parties will be in a listen only mode. Following the presentation the conference will be opened for questions. (Operator Instructions). This conference is being recorded today Thursday, July 29, 2010. I would now like to turn the conference over to Mr. Tom Lewis, CEO of Realty Income, please go ahead sir.

Tom Lewis

Thank you Elisa good afternoon everyone and welcome to the conference call where we will review our operations and results for the second quarter and as I am always joined by some people in the room here, Paul Meurer, our Executive Vice President, Chief Financial Officer, Mike Pfeiffer, our EVP and General Counsel; John Case our EVP and Chief Investment Officer and Terry Miller, our Vice President, Corporate Communications.

And as I always do also during this conference call, we will make certain statements that maybe considered to be forward-looking statements under Federal Securities law, the company’s actual future results may differ significantly from the matters discussed in any forward-looking statements. And we’ll disclose in greater detail on the company’s quarterly and on the Form 10-K, the factors that could cause such differences.

And Paul will start by reviewing the numbers of the quarter.

Paul Meurer

Thanks Tom as usual let me walk through the financial statements briefly and provide a few highlights of our results for the quarter beginning with the income statement. Total revenue increased $83.5 this quarter versus $81.3 million during the second quarter of 2009. Rental revenue increased 2% overall reflecting new acquisitions over the past year, and some positive thanks to the rent increases for the quarterly period.

On the expense side depreciation and amortization expense increased by $742,000 in the comparative quarterly period as depreciation expense naturally increases as our property portfolio continues to grow.

Interest expense remains flat at around $21.5 million; we had only $26.9 million in borrowings on our credit facility at quarter end. And on a related note our coverage ratios remain strong with interest coverage at 3.5 times and fixed charge coverage at 2.7 times. General and administrative or G&A expenses in the second quarter were $6.65 million up from last year but flat from the first quarter of this year. As we mentioned last year due largely to recent hiring and our acquisitions and research department, our current projection for G&A for 2010 is about $26 million or about 7.5% of total revenues.

Naturally this will be impacted a bit by the level of acquisitions during the course of the year. Property expenses decreased to under $1.7 million in the comparative quarter and these are the expenses associated with our taxes maintenance and insurance expenses which we are responsible for on the properties we have available for lease.

Income taxes consistent income taxes paid to various states by the company and they remained at around $300,000 during the quarter. Income from discontinued operations for the quarter totaled approximately $1.3 million real estate acquired for resale refers to the operations of Crest Net Lease. Crest are a subsidiary that acquires and resells properties. However Crest did not sell any properties in the quarter but overall contributed income or FFO of $158,000.

Real estate investment refers to property sales by growth in income from our existing core portfolio. We sold seven properties during the second quarter resulting overall in income of approximately $1.1 million and a reminder of course that these property sales gains are not included in our FFO or in the calculation of our AFFO.

Preferred stock cash dividends remained at $6.1 million for the quarter and a net income available to common stock holders was approximately $25 million for the quarter. Funds from operations or FFO was $46.8 million for the quarter and FFO per share was $0.45 per share for the quarter.

Our adjusted funds from operations or AFFO or the actual cash that we have available for distribution as dividends was higher at $0.46 per share for the quarter. Our AFFO is usually higher than our FFO each quarter because our capital expenditures are very low and we had very minimal straight line rent in our portfolio. We increased our cash monthly dividend again this quarter and we have increased the dividend 51 consecutive quarters and 58 times overall since we went public over 15 years ago.

Now lets turn to the balance sheet briefly, we have continued to maintain our conservative and safe capital structure, our debt to total market cap is only 30% in our preferred stock outstanding represents just 6% of our capital structure.

We were very please to immediately match fund to the Diageo acquisition last month with $250 million or 5.75% unsecured bond due in 2021. Thus we were left with only $26.9 million of borrowings on our $355 million credit facility at the end of the quarter. This facility also has a $100 million accordion expansion feature. The initial term runs until May 2011, plus thereafter two one-year extension options. Our next bond maturity isn't until 2013.

In summary, we currently have excellent liquidity, and our overall balance sheet remains healthy and safe.

Now, let me turn the call back over to Tom, who will give some more background.

Tom Lewis

Thanks, Paul. Let me just start with the portfolio and run through the business. The portfolio continued to do pretty well on the second quarter, generally we are hearing from tenants their business have stabilized a bit and we are not hearing much about problems from the tenants relative to the portfolio. At the end of the quarter, the 15 largest tenants get about 54% of revenue. As you know we focus on trying to earn the more profitable properties with tenants and on the top 15 tenants the average cash flow EBITDA per store level was roughly 2.44 times.

The rent would then fade and we think that's why occupancy has remained fairly high. We ended the second quarter with 96.2% occupancy and 90 properties available for lease out of our 2350 properties. That occupancy level is down about 50 basis points from the first quarter and about 40 basis points versus the same period a year ago.

It's primarily due to getting back 14 Hollywood videos on the last day of the quarter and then some exploration leases also towards the end of the quarter. So then we have 24 new vacancies and then had 11 vacant properties that were leased or sold.

And that's the reason for the slight decline in occupancy, it's still very high but off a bit this quarter. Same store rents in the portfolio increased 0.1% during the second quarter, that compares to 0.8% in the first quarter and 0.5% in the same period a year ago, so little lower in same store rent also.

And if you kind of look across the different industries we are in relative to where the contribution, either declines or increases came from 8 and our other category and industries had declining same store rent. The tire industry was the primary corporate there, primarily with one tenant that was over half of it. And then after that the rest of the numbers were fairly small.

But together the nine categories were $476,000 and rent decline, there were four different industries that had flat rent and then 18 during the quarter that's saw same store rent increases. There really wasn't any dominant one but it was pretty broad based with the larger numbers being in the auto service, health and fitness, child care, convenience stores and in the theatre business.

And the 18 different industries together had a total increase about $578,000, so net-net just about over $100,000 gain for the quarter. Small increase in same store rent but obviously positive. And I think if you look at the portfolio with occupancy declining a little bit and fairly modest same store rent increases.

I think what we are seeing in the portfolio right now and I give the caveat of asset double dip is that we are probably looking this summer is being the trough really in this latest cycle of recession in the portfolio. And then I think looking into the third and fourth quarter what we are likely to see is same store rents picking up a bit. And also vacancy reducing little bit occupancy going up, in recent years probably the last two three same store rents have been little lower than typical and most years we have run 1% to 2% and we have been a bit behind that.

That 's been impacted by rent reductions from just a few tenants who have some issues and if you look at the numbers there are really only two tenants that are in the comp numbers on that. The main one is Big 10 Tires which is tenant; we had some issues with last year. They will go out of comp numbers in the fourth quarter. The other tenant is much smaller impact, they will go out in the second quarter, which mean we likely to see some additional increases in same store rents going into the third and fourth quarter.

But I think moving in the next year probably backup into 1% to 2% range in same store rent growth. I think also more interesting is we are seeing more broader based increases kind of across the portfolio. On the vacancy front, I mentioned we got back 14 Hollywood videos literally on the last date of second quarter. We have I think just five more and that will be it for Hollywood because we had 23 that we will be getting back and after that looking at the watch list again there is really not that much going on.

So my sense is looking at occupancy, we are probably seeing it being flat to up in the third quarter and then probably up a little bit in the fourth. And my sense is that we’ll probably see a bounce back on that in the next year that's pretty good. And if you couple that with the bounce back in the same-store rent increases, and I think we are likely seeing what is probably some good portfolio performance moving into 2011.

And maybe it's good to take a moment, kind of look back over the last three years or so and kind of sale through this in pretty good shape. Occupancy has remained above 96%, same-store rent has been up each of the quarter. Yes, during the last three years, we did have nine tenant events which were five sector 11s, two chapter 7s and then two different tenants where we have rent reductions where we’ve participated with some other creditors in making sure that they could move ahead.

And when we added all up, we lost about $0.11 per share in reoccurring FFO from these nine events. Fortunately that was pretty much completely offset by rent increases from other tenants and during the period we also did very little acquisition activity and when you put that together then basically through this period, flat earnings and I think sale through given the depth of what we saw the last year pretty well and now we are positioned where this summer would be the bottom hopefully and then 2011 looks pretty good. And if we can add some acquisitions to it, I think we should be able to grow both the top and bottom line at a decent clip next year.

Relative to the diversification as I mentioned there is 2350 properties in the portfolio, that’s up six from last quarter. We now have 32 retail industries in the portfolio and a 118 different chain and believe we are in 49 states. Looking at industry concentration, restaurants is the largest industry at 20.8%, that's down a bit from the end of last year, and also from last quarter and we will continue to work that down as we are not looking at acquisitions in that sector.

Convenience stores were 17.2%, that's up a bit, that's due primarily to rent increases, theaters are at 9.1% which is doing very well. Our major tenant there, Kerasotes theaters if you see, in the press release has disappeared from the top 15 tenants as they were acquired during the quarter by AMC Theaters which we think is a net credit positive for us.

Our largest tenant is about 5.9% of rent, that’s L.A. Fitness. Again the 15 largest tenants are about 54% of rent and when you get to tenant number 15, you are down around 2% of rental income and then it moves down pretty quickly after that. I would note that this quarter from a geographic standpoint with the Diageo transaction, California in the next quarter will become our largest state at about 11.7% of our revenue.

And it's interesting, normally you would say I think, okay the company has a larger exposure to the California economy, but I think given the Diageo transaction, a majority of their revenue is generated on a national basis rather than state basis. So I think it's a bit different than if we’d bought a bunch of stores in California. It's going to be a bigger percentage, but relative to the exposure to the California economy and it's not quite a symmetrical impact. But that number will go up next quarter.

Anyway we remain fairly well diversified and the average lease linked in the portfolio is at 11.4 years. So we are pleased given what's going on with the performance of the portfolio.

Moving on to acquisitions, obviously during the second quarter, we completed the majority of the Diageo acquisition. We also did a couple of other properties, so it was 13 properties for $261 million at average going in the yield of 7.5%. As Paul mentioned, we simultaneously financed majority of it with a $250 million 10-year note at around 58 which a lot of the lock in some pretty attractive spreads about a 170 basis points upfront. And that should accelerate as the leases all have increases in them.

With these transactions, we obviously worked up the credit curve with Diageo. So we had a lower initial rate given where the credit markets were, we were able to step in and I think put some pretty good spreads together. For the first six months, then that gave us $289 million of acquisitions. We have one more piece of about $11 million that will close in the third quarter in the Diageo transaction. That puts us at about $300 million for the year. So it looks like we are growing at a nice clip here.

Relative to the market overall, we continue to see a pretty good volume of transactions in the market place and that includes larger transactions to work on. Obviously we have the vast majority of the line available and the capital markets remain open, so we think we have the capital and this is a pretty good opportunity to go out and acquire. Relative to caps rate, I think they have continued to soften a little bit which to some extent explains why some of the sellers who are coming back into the market, and obviously likely a reflection of where the credit markets are and low rates out there.

Our guess is most transactions probably be in the 8% to 9% cap rate range which is just a little bit lower, but again we have faster capital being cheaper than it was, I think spreads have been maintained in a pretty good time to acquire out there even if cap rates have come off a little bit. But we are very positive relative to the opportunity to do some acquisitions here.

On guidance, for 2010, we’ll stay with the 184 to 186, that’s obviously flat to up about 1% in FFO and as the acquisitions have started to grow here, the top line again is moving up. As Paul mentioned to date, that has not hit the bottom line primarily to the additional G&A and primarily on the staff side and we think that will be the case going through the balance of the year. We have added a number of people. We will probably add a few more, not a lot and then CG&A likely stabilize as we get to the end of the year and hopefully with the acquisitions that we’re doing and we’ll continue to do, we’ll have that top line growth go to the bottom line over the next year or so.

For 2011 then, we’re estimating FFO at $1.96 to $2 per share, that’s 5% to 8% growth for next year and again, what I said earlier relative to, we think occupancy will come back a bit in same-store rent and if we’re able to add in some acquisitions, that should give us some good growth.

Paul mentioned the balance sheet is in good shape, we’re very liquid. So overall, I think good stability in the portfolio and a little bit more optimistic about growth going forward.

And with that, if can, we’ll still go ahead and open it up to questions at this point.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from the line of Jeffrey Donnelly with Wells Fargo.

Jeffrey Donnelly - Wells Fargo

I forget if you just, quarterly sales, financials from your tenants booked, what's been the progression in unit levels, [casual] coverages over the past year or so. Have you see a bottom or an inflection in that metric?

Tom Lewis

You know it's been pretty stable but it's throughout the last couple of years, but it's not the way you want to see stability. What happened is we were up around a 2, 7 forecast low coverage on the top 15 if you go back three years ago and it was dropping down into the 2-3s, 2-2s and if you look at the nine tenants that had credit events, one of the things that we did with them is adjust rents and the rents were adjusted down to get the cash flow coverage back up to a good level.

At the same time though, we were able to put in the majority of the leases, some type of recapture clause of the business increases we can get part of that. So I think what you would have seen Jeff is kind of 274 down into the 2-2s and 2-3s but with the adjustments that took it back up into the kind of the 2-4 level and that’s kind of where they sit today as 2-4-4. So we saw the real down draft going back over 18 to 24 months, but really over the last. I think starting in the third quarter last year, we started to see them flatten out and a few have seen the they're in the docking chain continuing to slide a bit but that was offset by the ones going up.

Jeffrey Donnelly - Wells Fargo

And if I could switch gears and ask a few questions on Diageo, by my math, it goes right from the first deal that you guys had done where the operating income of the actual assets, the property rent if you will. You know is it enough to, justify the rent that was paid to you guys, it certainly makes you more realigned on the credit of the entity. Fortunately, that’s wrong in this case. Is the catalyst sort of deal implied and your just not seeing attractive pricing elsewhere in the traditional net lease business, that’s why you guys went after it or?

Tom Lewis

There are transactions out there and I think, we have looked at the wine business a number of years ago and as we did our due diligence, we ended thinking that there were relevantly few opportunities because of kind of how we have to underwrite the business and I’ll go into detail if you want me to but the long and short of it is when this came up, given the work that we had done a few years ago and kind of the criteria we had come up and said, there’s only going to be a couple or three players that we would probably want to do something whether it is in this industry.

We identified and again, this is a few years ago kind of constellation brands, Diageo and Fortune brands and then Fortune brands sold their business to someone else and when this came with Diageo, we knew who they were. We absolutely knew the assets both the vineries and the vineyards ahead of time and given where spreads are and where we thought we could work, we thought it’d be a nice addition.

But it really does rely to a great extent on the credit and the due diligence as you know, we’re normally looking what you related to that the EBITDA on the real estate that we’re buying is generated for the tenants that they have to have the real estate to do it and typically if you look at this business, you can tie EBITDA to a vinery and the wine they produce and sell but its harder to do with the vineyards because a lot of the grape juice really is grown.

It is bought rather than grown and so hypothetically in chapter 11, if you have a vinery with some vineyards, what they could do is, if the vineyards weren’t extremely important to their wine brand, is they could reject the vineyards and the bankruptcy, keep the vinery and then go third party to buy the grapes and so that made it a little more difficult.

That led us to really take a look and say okay, the vineyards are going to have to be in some very special areas where it’s a strong premium brand and they have to label it a state bottle, which means that it needs to be grown right there or NAPA, which we should get a premium price for or some of the appellations in NAPA like Rutherford or Oakville or some of the others.

But if you just took the vineyards and their cash flow coverage, you could look at the income that would be provided. You probably couldn’t get comfortable there. You say okay, if I believe that the vineyards are then tied to the vinery and they need them, I can look at the cash flow coverages for the real estate buy as a function of what they’re making on their wines and then you can go okay, I can get more comfortable and then as you are in this case, if you’re looking at a wine company with 15 brands, you might say I’d get even more comfortable, but as we look at this business and its volatility and the structure of it and we did spend quite a bit of time, we really said we’re going to have to work with a very large players with multiple cash flows or its not going to make sense for us.

But fortunately, when we kind of predetermined all of that a while back and then walked away from the business, we talked parked the research and when this came up, we very quickly, I mean as soon as we saw what it was, we thought we could get there and it turned out we could.

Jeffrey Donnelly - Wells Fargo

I’m curious, are there provisions in the spring and say are required in order to maintain certain credit metrics or penalties compelling to do so and what was the reaction from the rating agencies, because there is a chunk your dealing with and you guys normally go after?

Tom Lewis

Right. We’ve done a number of deals this size, so we’re comfortable with that but the reaction from the rating agencies was very positive given who the tenant is and how their business and given these brands and these assets and so I think the reaction was very positive there.

None of our leases that I can remember require the tenant to maintain certain credit statistics, that is relevantly unheard of in the triple net lease business and I think its just kind of a non starter. But in this case, given these particular assets and I’ve spent a great deal of time up in that area and if you follow this business.

In Napa, California freezes over 90% of the wine in the US Napa is one of 16 areas in California and it produces only about 4% of the wine in the US. But if you look at the prices that they get for the grapes and the wine up there, the average price for a ton of Tavern A grapes last year in California was about a $1,078 and it ranged anywhere from $300 at the lowest turn, that’s the lowest for the 16 reasons up to Napa, where it $4,777 a ton. And so, when you start looking up into that area and you start looking at the growth in new vineyards and Napa is not even about 1% a year because they put restrictions on it and a lot of the premium brands operate up there and there’s a minimum amount of vineyards for those premium brands to buy.

We got a little more comfortable and I think they did too with a particular assets that we bought and also that they’d been in production. They said that these were the vineyards now for 25 to a 100 years and I think then coupling it into those two brands and one’s a 100 year old brand and the other one’s a 40 year old brand and that’s got them comfortable relative to what we’ve purchased and what we’ve paid but then it really, and this has been said by a lot of people and its true, then it really is a credit story getting a very long term lease with a very good company.

Jeffrey Donnelly - Wells Fargo

And then just a last question, normally a quick one, and I just look into the answer but did you guys consider buying a long term hedge on Diageo credit? You know aside from maybe Tom increasing his consumption of wine?

Tom Lewis

We did increase the consumption of wine and since you wanted a short answer, the answer is no.

Operator

Our next question comes from the line of Tayo Okusanya with Jefferies & Company. Please go ahead.

Tayo Okusanya - Jefferies & Company

Yes, good afternoon Tom. Lets take up the questions. In regards and different resale categories involved in, do you talk usually about categories where you thought overall underlined trends for the tenants who are principally strong and the categories where there was some weakness, even if that stuff is not on your watch list at this point?

Tom Lewis

Sure, let me take a minute and try and do that. I think if you divide up our portfolio, the majority of it is basic human needs, low price points and that’s done better than stuff that’s at the higher end. So I’ll start with really kind of a negative side. It is a small component in the portfolio, little over 2% of rent which is a tenant that is in the RV business and that was just a really, really business that got hit terribly hard over the last couple of years, given the consumer durable and high ticket. And if you look at industry volumes, in 2008 the volume of RV sales in the United States went up by about a third and then it did again in 2009.

And so that was an area that we were pretty deeply concerned with and we went in and worked with the tenant on some rent relief. That business has not gotten back up to peaks, but it’s stabilized, guess for this year is shipment. That were down as well, it’s 159,000 units, they are going to be up over 200,000.

So but that's one we continue to watch, but we were fortunate that our tenants there kind of has several lines of revenue. One is the sale of RVs, the other one is that they do sell pretty much, it's an RV superstore that they sell anything to people who use RV and then they also have a service component. But that's one that’s been tough.

Restaurant, is another obvious one, that's about 20% of rent and if you look at our portfolio, about 8% of the 20 or almost half is fast food and that has held up relatively well as the consumer traded down. But not as the consumers come back a little bit, their businesses have slowed a little bit. But the casual dining, that is really the other side of that was hit very, very hard. And that was evidenced by Buffets and a few other tenants that we worked with.

And it's still not great and we continue to watch that, but it’s stabilized a bit. The other area that typically, and we have been in this business for 30 years, has done very well under recession as the Child Day Care. And they had a little more same-store rent declines than they normally would have in their business and margin decline and I think it's over the years as government has got more and more into their business. Now 20% to 25% of the for pay child care business is paid for out of government transfer payments, and I think that some of those people have looked through the budget constraints in city, state and local government and that's been a little tougher business.

So those are three that when we look to are the ones that we worry a little more about. You didn't look as convenient store business and it can have some volatility, really is function of gas margins and there’s been a little bit sales come off a little bit in the store, but that business is very consistent and holds up as a lot of M&A activity and so there’s opportunities there and we like that business and then if you look at auto service, auto tire, that is one where we initially their business softened a bit going into the recession.

But now has come back because they are not buying new cars, eventually the after service are buying new tires, and those have come back. So those are kind of the key components, theaters have held up real well. Health and fitness has held up extremely well, those are about cheap entertainment, and then I think you are getting into some pretty small concentrations relative to the portfolio.

Tayo Okusanya - Jefferies & Company

Well, that's helpful. And then with Diageo, just kind of given the cap rate you guys provided for you second quarter acquisition. I guess it's safe to assume that you have done close to a 7.5 cap as well?

Tom Lewis

Yes, they were the majority of the acquisitions there. And it is lower, but again being to step in and finance it with the bond offering was very attractive and I think the arbitrage between where the long-term debt of the same tenant is trading and where the transaction was done made it pretty attractive.

Tayo Okusanya - Jefferies & Company

And then rent coverage of 2.04, could you talk a little bit about the discretion of that number at this point, is this still pretty much, everything all kind of tied close to that number or is it the range kind of broaden out a bit.

Tom Lewis

That's pretty a good bell curve. I would say going back two three years ago, the lowest out there was about a two which was extraordinarily comfortable. Today we are looking at about a 1.59 on the low side and 3.53 on the high side. And there are really only a couple of tenants in the top 15 that are down into the 1s, but you can be somewhat comfortable when you get 1.5 above because as we have now done over 1067 rollovers at the end of leases, our experience has been if you got a 1.5 coverage, you have the tenant that is making enough money on that unit where they are going want it. And that's the bottom tenant is just really right around 1.5.

Tayo Okusanya - Jefferies & Company

That’s the RV guy or no?

Tom Lewis

No.

Tayo Okusanya - Jefferies & Company

Okay.

Tom Lewis

I can't discuss their financials and EBITDA, or they weren’t given to me.

Operator

Our next question comes from the line of Rich Moore with RBC Capital Markets. Please go ahead.

Rich Moore - RBC Capital Markets

On the Diageo acquisition, Paul what was the charge actually, the acquisition expense on that within G&A?

Paul Meurer

Not very high, so it will be disclosed in our Q that comes out later today, but for the second quarter, our total acquisition related expense is that for FAS 141R that we needed to expense was $40,000. Those numbers are going to be quite variable, it's going to depend on particular transactions in terms of who pays for what expenses. Whether there is transfer taxes involved in different states. So we have a portfolio that involves multiple states and for whatever reasons there is lots of expenses that we need to pay for it as opposed to the tenant taking care of. It could be a much higher number. In this case, that was not the case. Diageo had already done a lot of work to prepare for the offering.

Tom Lewis

That's another way of saying that the G&A was actually in people and the things we are trying to do here to grow the business, not really on the property expense side.

Rich Moore - RBC Capital Markets

Tom as I understand you really don't have any bankruptcy concerns at the moment other than obviously Hollywood?

Tom Lewis

Right, while being in the credit business, you are always concerned, but no there is nobody right now that's on the watch list that we think is eminent or we see some substantial problem with and that’s a very different case in the last three years whether it be a couple of three names sitting on the watch list at any given time.

Rich Moore - RBC Capital Markets

Thinking about Hollywood for a second. How would you characterize those locations considering I usually think about Hollywood is having pretty strong, that sort of industry even having strong locations to release. I mean would you characterize these in that manner, maybe stronger than the typical tenants that you have or is that not true?

Tom Lewis

Well that’s interesting. Normally, you wouldn’t think that and when we bought these, there was a huge amount of development, these lease were brought 10 or 11 years ago by both Blockbuster and Hollywood and so we looked at a lot of units and selected just one package, bought at one time and off the top, these are about 8,000 sq ft buildings, are on one to two acres of land.

We paid a $1 million to a $1.4 million and they are mostly outpad types to (inaudible) good traffic. Rents when we brought them were about 16 a foot and they’ve grew to 19 a foot and when they had their Chapter 11 a couple of years ago, the recovery rate was pretty good and they weren’t that difficult to lease. The problem in the business right now is while they are good assets, there is an awful lot of video stores to release out there. If you just take Hollywood and then just some of the other change that would have problems. So there’s really blood on the market, we’re seeing good activity but I think the rent spreads are going to drop pretty dramatically there and we have received 23 of these, we’ve got 18 back to date and I think we’ve got five to go and we have a lot of activity, but that will be a hit there, but we’ve gotten out the numbers.

Rich Moore - RBC Capital Markets

On the restaurants, it sounds like you are pretty actively bringing that down. Is that accuracy, you are going to probably sell off more of the restaurants in the next few quarters?

Tom Lewis

We are selling a little bit and if we get anything new, it would be with an existing tenant and one little unit here or there but essentially not buying and we are selling a few but the other thing is if you look at the two tenants that are still in the same store comp numbers, one of them is a restaurant and that’s where some of the rent came down.

Rich Moore - RBC Capital Markets

Ok I got you and then as far as acquisitions go, any particular category, obviously beyond wines, is exciting for you?

Tom Lewis

You know its pretty broad based, I would be surprised if we’re not back into some of our existing areas that we’ve invested in on the next few acquisitions. We’re out looking a couple of three new things that will comment on when we finally get something or work on but my chances probably the balance of the year will probably be back in kind of the core stuff.

Operator

Our next question comes from the line of (inaudible). Please go ahead.

Unidentified Analyst

What do you think happens with area finance?

Tom Lewis

I don't know and I wouldn’t speculate. We obviously knew Chris and Mart very well and some a lot in the last couple of years. We’ve talked to them a little bit, but haven’t been deeply involved and obviously, we wouldn’t comment on anything we were looking at, be an individual or a larger type transaction. I’d only go back and this is, its not on spared, its generic.

We’ve been offered a lot of companies over the years and generically, its kind of difficult to do M&A in our opinion in this business and that’s the function that we spend so much time on underwriting and then when something comes along to have to underwrite a large package all at once is problematic and that’s been the case, I actually I don't know.

Unidentified Analyst

But you won't comment, I guess, what you’re working on. Will you comment on what you’re not working on?

Tom Lewis

No because then if we weren’t working on something and you asked me, I said yes. Next time when you ask me if we were working on something, then you’d be able to identify it. So I think if we are working, it is yes, it’s no comment and if we weren’t, it’s no comment and if we were looking at it, but not interested, it would be no comment and if we weren’t looking at it but interested, it’d be no comment.

Unidentified Analyst

You’ve made a couple of hires in 2010, obviously bringing John on board. Should we read in any way, shape or form into that as you are starting to have succession planning costs? Does that have any bearing on the hires you’ve made?

Tom Lewis

Interesting there is no relative to me, no succession thoughts at the moment, so no. But relative to the hires we make ,yes. Well one of the things that we’re doing is we have a strategic planning program and a major emphasis of that is leadership development and that’s really looking at the company and doing an organization chart for five years from now and 10 years from now and trying to look at where are people that are in the organization today, that are likely to move away over that period of time and then looking inhouse and developing people and then also going outside to get some talent, either for that reason or variety.

The advance in general you might looking to go anywhere in the new future, the answer is no and I don’t think any of our senior officers are in that mode at the moment.

Operator

Our next question comes from the line of Andrew Fenton with Credit Suisse.

Andrew Fenton - Credit Suisse

I was just thinking as the economy picks up, do you see activity at Crest picking up or do you think that stay dormant?

Tom Lewis

If it does kind of only on a marginal basis, we got Crest obviously because we saw a lot of risks there and the timing worked out perfectly and Crest was really valuable since we started in 2000, when it was competitive atmosphere and we bought large portfolios and wanted to sell off part of them.

There are a lot of people who have exited our business, probably more than the deal flow has dropped and so to date, we haven’t had to buy a lot in a transaction that we didn’t want to own and we haven’t had to do it and so as long as we don’t have to do that, that was the only reason we were using Crest.

It wasn’t a side business to make a buck. While we made money, it was really so we could work on large transactions and sell off a bit.

If down the road it became the case where we needed to do that, I think we’d take a long hard look about our confidence in the economy and in the number of buyers out there for that type of property, before you’d add much inventory because I think it’s a lot riskier business than it looked like for about seven eight years, we were aware of that.

We were in a period of declining cap rates and it made anybody who flipped or did this type of business. Later, it looked like a very easy business, but in normal times with relatively stable cap rates, it’s a tough business and an easy business to get caught in. So we’d like to minimize what we do there unless we’re absolutely forced to, based on competition and acquisition.

Operator

This concludes today’s conference call. I will turn the call over to management for concluding remarks.

Tom Lewis

Well thank you very much everybody and in the end, a pretty solid in the portfolio. Now let’s see if we can start moving the top and bottom line and thank you for taking the time to be on the call and we’ll talk to you next quarter, thank you.

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Source: Realty Income Corp. Q2 2010 Earnings Conference Call
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